-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HnnzeUOyqzzN0hb8/dMeTU16L/33Dn4ZmmzNPKMIJUCTaZNJe6IDSz/C7wurhZ8q pFOeWAfAUeCX8bBPSN4xyg== 0000950136-96-001176.txt : 19961210 0000950136-96-001176.hdr.sgml : 19961210 ACCESSION NUMBER: 0000950136-96-001176 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19960831 FILED AS OF DATE: 19961209 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: JENNIFER CONVERTIBLES INC CENTRAL INDEX KEY: 0000806817 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-FURNITURE STORES [5712] IRS NUMBER: 112824646 STATE OF INCORPORATION: DE FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-09681 FILM NUMBER: 96677257 BUSINESS ADDRESS: STREET 1: 419 CROSSWAYS PK DR CITY: WOODBURY STATE: NY ZIP: 11797 BUSINESS PHONE: 5164961900 MAIL ADDRESS: STREET 2: 419 CROSSWAYS PARK DR CITY: WOODBURY STATE: NY ZIP: 11797 10-K 1 FORM 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended Commission File number 1-9681 August 31, 1996 JENNIFER CONVERTIBLES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 11-2824646 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 419 Crossways Park Drive Woodbury, New York 11797 5712 - --------------------------------------- ------------------------- (Address of principal executive office) (Primary Standard Industrial Classification Code Number) Registrant's telephone number, including area code (516) 496-1900 --------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 ---------------------------- (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Aggregate market value of voting stock held by non-affiliates of registrant as of November 22, 1996: $11,475,000 Shares of Common Stock outstanding as of November 25, 1996: 5,700,725 DOCUMENTS INCORPORATED BY REFERENCE NONE PART I Item 1. Business Unless otherwise set forth herein, the term the "Company" includes Jennifer Convertibles, Inc., a Delaware corporation, and its direct or indirect subsidiaries. Business Overview The Company is the owner and licensor of the largest group of sofabed specialty retail stores in the United States, with 125 Jennifer Convertibles(R) stores located on the Eastern seaboard, in the Midwest, on the West Coast and in the Southwest as of August 31, 1996 . As of August 31, 1996, the Company also operated 36 "Jennifer Leather" ("Jennifer Leather") stores. Of the Jennifer Convertibles(R) stores, as of August 31, 1996, 50 were owned by the Company and 75 were licensed by the Company. 2
NUMBER OF STORES IN OPERATION AS OF AUGUST 31, 1996 ================================================================================================ LPS AND TOTAL OTHER PRIVATE TOTAL CONVERTIBLES LEATHER COMPANY LICENSEES(1) COMPANY(2) STORES ------------------------------------------------------------------------------------------------ REGION TRI-STATE AREA NEW YORK 6 11 17 3 21 41 NEW JERSEY 9 8 17 4 21 CONNECTICUT 4 1 5 2 7 ------------------------------------------------------------------------------------------------ SUBTOTAL 19 20 39 9 21 69 ARIZONA 3 3 CALIFORNIA 4 4 22 26 FLORIDA 4 4 9 13 GEORGIA 4 4 ILLINOIS 15 15 INDIANA 3 3 3 KANSAS 1 1 1 MARYLAND 3 1 4 3 7 MASSACHUSETTS 7 5 12 12 MICHIGAN 6 6 6 MISSOURI 4 4 4 NEVADA 2 2 NEW HAMPSHIRE 2 2 2 OHIO 4 4 PENNSYLVANIA 4 4 VIRGINIA 2 1 3 3 WISCONSIN 2 2 2 WASHINGTON, D.C. 1 1 2 2 ----------------------------------------------------------------------------------------------- TOTAL 50 36 86 75 21 182 ===============================================================================================
(1) These include certain limited partnership licensees ("LPs"), which are licensees whose accounts are included in the consolidated financial statements of the Company, and licensees (the "Unconsolidated Licensees") whose accounts are not so included. (2) These 21 stores are not owned and do not pay royalties to the Company. They operate in New York (the "Private Stores") and 19 of such stores are owned by a company (the "Private Company") that, is owned by an individual who was a principal stockholder of the Company and the brother-in-law of Harley J. Greenfield, the Company's Chairman of the Board, Chief Executive Officer and a director and principal stockholder. In addition, Mr. Greenfield and Edward Seidner (also an officer, director and principal stockholder of the Company) retain a substantial economic interest in the Private Company through ownership of $10,273,204 in the aggregate principal amount of secured Private Company promissory notes issued in connection with the redemption of their stock ownership in the Private Company. Accordingly, the Private Company may be deemed an affiliate of the Company. The remaining two stores are sublicensees of the Private Company and one of such stores is owned by the father of an executive officer of the Company. The 19 New York stores are operated in substantially the same way as the Companyowned stores. See "Notes to Consolidated Financial Statements - Footnote - Related Party Transactions." 3 Jennifer Convertibles(R) stores specialize in the retail sale of a complete line of sofabeds and companion pieces, such as loveseats, chairs and recliners, designed and priced to appeal to a broad range of consumers. The sofabeds and companion pieces are made by several manufacturers and range from high-end merchandise to relatively inexpensive models. Each store has a kiosk devoted to mattress sales. The Jennifer Leather stores specialize in the retail sale of leather livingroom furniture. In fiscal 1997, the Company also opened two test Jennifer Living Room stores which sell a broad range of livingroom furniture, including furniture of the type sold in Jennifer Convertibles and Jennifer Leather stores. The Company is the largest dealer of Sealy(R) sofabeds in the United States. Merchandise is displayed in attractively decorated model room settings in the store designed to show the merchandise as it would appear in the customer's home. In order to generate sales, the Company and its licensees rely on the attractive image of the stores, competitive pricing, prompt delivery and extensive advertising. The table below sets forth information with respect to the number of stores (Company-owned and licensed) opened since fiscal 1986:
Fiscal Years 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Company-owned stores open at end of period (1)(2)(3)(4) 86 90 55 34 33 33 39 42 31 13 Licensed stores open at end of period 75 79 113 87 42 15 0 0 0 0 -- -- --- --- -- -- -- -- -- -- Total stores open at end of period 161 169 168 121 75 48 39 42 31 13 === === === === === === ==== ==== ==== ====
- ---------- (1) Stores acquired from affiliated companies are reflected as opened in the year they were opened by the affiliate, not in the year they were acquired by the Company. (2) For fiscal 1994, includes the 19 Jennifer Leather and two Elegant Living stores open at the end of such fiscal year. (3) For fiscal 1995, includes the 38 Jennifer Leather stores and one Elegant Living store open at the end of such fiscal year. (4) For fiscal 1996, includes 36 Jennifer Leather stores. Store Image and Merchandise The Company believes that the image presented by its stores is an important factor in its overall marketing strategy. Accordingly, stores are designed to display the Company's merchandise in attractive model room settings. All the Company's stores are of a similar clearly defined style, are designed as showrooms for the merchandise and are carpeted, well-lighted and well-maintained. Inventories for delivery are maintained in separate warehouses. The Company displays a variety of sofabeds and companion pieces (including cocktail tables) at each Jennifer Convertibles retail location with carpeting and accessories. In contrast to certain of its competitors that primarily target particular segments of the 4 market, the Company attempts to attract customers covering a broad socio-economic range of the market and, accordingly, offers a complete line of sofabeds made by a number of manufacturers in a variety of styles at prices currently ranging from approximately $400 to $2,200. The Jennifer Leather stores similarly offer a complete line of leather living room furniture in a variety of styles and colors at prices currently ranging from approximately $499 to $5,000. The Company generally features attractive price incentives to promote the purchase of merchandise. In addition to offering merchandise by brand name manufacturers, the Company offers merchandise at its Jennifer Convertibles and Jennifer Leather stores under the "Jennifer" brand name. Although each style of sofabed, loveseat, chair and recliner is generally displayed at Jennifer Convertibles stores in one color and fabric, samples of the other available colors and fabrics are available. On selected merchandise, up to 2,000 different colors and fabrics are available on selected items for an additional charge. Leather furniture is offered in a number of different grades of leather and colors. The Company currently emphasizes contemporary and traditional sofabeds and companion pieces in the Jennifer Convertibles stores and contemporary leather pieces in the Jennifer Leather stores. The Company generates additional revenue by selling tables and offering related services, such as fabric protection and a lifetime warranty. Fabric protection services are obtained from, and the warranty is given by, the Private Company, which retains approximately 1/3 of the revenues generated from such services. See "Certain Relationships and Related Transactions." Merchandise ordered from inventory (approximately 55% of sales in the Jennifer Convertibles stores and 35% of sales in the Jennifer Leather stores) is generally available to be delivered within a week. Customers who place orders for items, colors or fabrics not in inventory ("special orders") must generally wait four to six weeks for delivery, except for Italian leather merchandise which may take up to 20 weeks. The Company believes that its delivery times on stocked items and special orders are significantly faster than the usual delivery times for furniture and that its ability to offer quick delivery of merchandise represents a significant competitive advantage. Operations Generally, the Company's stores are open seven days per week. Stores are typically staffed by a manager, one full-time salesperson and in some cases, one or more part-time salespersons, as dictated by the sales volume and customer traffic of each particular store. In some cases, where sales volume and customer traffic so warrant, stores may be staffed with one to three additional full-time salespersons. The Company's licensed stores are substantially the same in appearance and operation as the Company-owned stores. The Company and its licensees have district managers throughout the United States. The district managers supervise store management and monitor stores within their assigned district to ensure compliance with operating procedures. District managers report to and coordinate operations in their district with the Company's executive management. An inventory of approximately 70% of the items displayed in the stores, in the colors and fabrics displayed, is usually stocked at the Private Company's warehouse facilities (described below.) The Company and its licensees typically require a minimum cash, check or credit card deposit of 50% of the purchase price when a sales order is given, with the balance, if any, payable in cash or certified or official bank check upon delivery of the merchandise. The balance of the purchase price is collected by the independent trucker making the delivery. 5 Marketing The Company and its licensees advertise in newspapers, transit, radio and on television in an attempt to saturate its marketplaces. The Company's approach to advertising requires the Company to establish a number of stores in each area it enters. This concentration of stores enables area advertising expenses to be spread over a larger revenue base and to increase the prominence of the local advertising program. The Company's and the LPs' expenditures for advertising were approximately $12,265,000 (11.6 %) of sales in the fiscal year ended August 31, 1996 as compared to approximately $15,729,000 (12.5%) of sales in the prior year. The Company creates advertising campaigns which may be used by the Company's stores and may be used by the Private Stores. The Private Company is charged a share of advertisements which target customers in New York, New Jersey and Connecticut. (See "Certain Relationships and Related Transactions.") However, the Company also advertises independently of the Private Company outside of the New York metropolitan area. The Company is entitled to reimbursement from most of its licensees, which are responsible for their respective costs of advertising; however, the approach and format of such advertising is usually substantially the same for the Company and its licensees. The Company has the right to approve the content of all licensee advertising. In order to further understand its markets, the Company carefully monitors its sales, interviews customers and obtains other information reflecting trends in the furniture industry and changes in customer preferences. The Company also reviews industry publications, attends trade shows and maintains close contact with its suppliers to aid in identifying trends and changes in the industry. Leasing Strategy and Current Locations The Company considers the ability to obtain attractive, high-traffic store locations to be critical to the success of its stores. The Company, together with outside real estate consultants, selects sites and negotiates leases on behalf of its licensees. The site selection process involves numerous steps, beginning with the identification of territories capable of sustaining a number of stores sufficient to enable such stores to enjoy significant economies of scale, particularly in advertising, management and distribution. Significant factors in choosing a territory include market demographics and the availability of newspapers and other advertising media to efficiently provide an advertising umbrella in the new territory. Once a territory is selected, the Company picks the specific locations within such territory. Although a real estate consultant typically screens sites within a territory and engages in preliminary lease negotiations, each site is inspected by an officer of the Company and the Company is responsible for approval of each location. The leased locations are generally in close proximity to heavily populated areas, shopping malls, and other competing retail operations which are on or near major highways or major thoroughfares, are easily accessible by auto or other forms of transportation and provide convenient parking. The locations currently leased by the Company and its licensees range in size from 1,900 square feet to a little over 8,000 square feet. The Company anticipates that stores opened in the future will range from approximately 2,000 square feet to 4,000 square feet. Management believes that optimal store size for a Jennifer Convertibles store is approximately 3,000 square feet while optimal store size for a Jennifer Leather store is 4,000 square feet. Stores may be freestanding or part of a strip shopping center. 6 In fiscal 1996, the Company and the LPs closed an aggregate of eight stores. Several were closed for non-performance, but a number of such closings were due to the Company's plan to combine separate Jennifer Convertibles and Jennifer Leather stores located in the same demographic areas into one store. The primary benefit of combining both operations into one store was an elimination of the real estate expenses and other expenses associated with the closed showroom. Additional benefits realized included reductions of personnel and, in a number of cases, elimination of duplicate office equipment and telephone lines. Although combining two stores into one store generally reduces sales, management believes that sales at the combined store will generate more profit due to the elimination or reduction of expenses described above. Although the Company and the LPs closed stores during fiscal 1996, the Company does not anticipate closing a significant number of stores during fiscal 1997 and it will selectively open additional stores if attractive opportunities present themselves. Sources of Supply The Company currently purchases merchandise, for its stores and the stores of its licensees and the Private Company, from a variety of domestic manufacturers generally on 40 to 90 day terms. The combined purchasing power of the Company, its licensees and the Private Company enables them to receive the right, in some instances, to market exclusively certain products, fabrics and styles. See "Certain Relationships and Related Transactions." The Company's principal suppliers of sofabeds are Klaussner Furniture Industries, Inc. ("Klaussner") and Sealy Furniture of Maryland, Inc. ("Sealy Maryland"). Sealy(R) brand name sofabeds are the Company's largest selling brand name item and the Company believes that Sealy(R) brand name mattresses are the largest selling mattresses in the world and have the highest consumer brand awareness. The Company also believes that Sealy Maryland is the largest manufacturer of Sealy(R) brand name convertible sofabeds. The Company is the largest sofabed specialty retailer and the largest Sealy(R) sofabed dealer in the United States. During the fiscal year ended August 31, 1996, the Company purchased approximately 79% of its merchandise from Klaussner and approximately 14% of its merchandise from Sealy Maryland. Leather furniture is purchased primarily from Klaussner and Industries Natuzzi S.p.A. The loss of Klaussner as a supplier could have a material adverse effect on the Company. In March 1996, as part of a series of transactions (the "Klaussner Transaction") the Company, among other things, granted Klaussner a security interest in substantially all of its assets in exchange for improved credit terms. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a fuller description of the Klaussner Transaction. Licensing Arrangements The Company's arrangements with its licensees typically involve providing the licensee with a license, bearing a royalty of 5% of sales, to use the name Jennifer Convertibles(R). The Company's existing licensing arrangements are not uniform and vary from licensee to licensee. Generally, however, the Company either manages the licensed stores or, if the licensee is a partnership, has a subsidiary act as general partner of such partnership, in each case, for 1% of the licensees' profits. The arrangements generally have a term ranging between 10 and 20 years (and may include options on the licensee's part to extend the license for additional periods) and involve the grant of exclusivity as to defined territories. In some cases, the Company also has an option to purchase the licensee or the licensed stores for a price based on an established formula or valuation method. Investors in certain licensees have, in certain 7 circumstances (including a change of control of the Company), the right to put their investments to the Company for a price based upon an established formula or valuation method. The Private Company currently provides warehousing, fabric protection and other services to licensees on substantially the same basis as such services are provided to the Company and the Company purchases merchandise for the licensees. The Company also provides certain accounting services to certain licensees for which it generally charges $6,000 per store, per annum. As of August 31, 1996, the Company was owed an aggregate of $15,043,000 for royalties, advances and merchandise by its licensees, a substantial portion of which was overdue. Of such amount, $9,400,000 due from the LPs is not shown separately on the Company's financial statements as a result of the consolidation of the LPs and $5,643,000 due from Unconsolidated Licensees was reserved against in such financial statements due to doubts as to collectibility. Most of the investors in the licensees have other relationships with the Company or its current or former management. See "Certain Relationships and Related Transactions." As set forth under "Legal Proceedings," the Memoranda of Understanding ("MOUS") as to the settlement of certain class and derivative litigation contemplate that the Company will receive the limited partnership interests in licensees which now own 55 licensed stores, representing all but 20 of the royalty bearing licensed stores in connection with the settlement of certain litigation. Although the Company does not believe that certain transactions in which licenses were granted to operate stores were subject to state and Federal laws regulating the offer and sale of franchises, the applicability of such laws is uncertain as applied to the Company's licensing program, and there can be no assurance that a court would not take the position that the Company should have complied with such laws in connection with those transactions. In order to reduce or eliminate this uncertainty, in 1993 the Company offered certain licensees the opportunity to rescind their license agreements. All such licensees declined such offers of rescission. Warehousing and Related Services Effective January 1, 1994, the Company and the Private Company entered into a new warehousing agreement (the "New Warehousing Agreement") which terminated the original Warehousing and Purchasing Agreement (the "Original Warehousing Agreement") entered into in 1986. Pursuant to the New Warehousing Agreement (which expires in 2001), the Company currently utilizes the warehousing and distribution facilities leased and operated by the Private Company and, as of July 1996, consisting of a 236,000 square foot warehouse facility in North Carolina, and satellite warehouse facilities in New Jersey and California (collectively, the "Warehouse Facilities"). Until June 1996, the Company had utilized a warehouse facility in Inwood, New York. The Warehouse Facilities service Company-owned and licensed stores and the Private Stores. The Company presently uses the Warehouse Facilities to service all of the Company-owned and licensed stores. Although the Company is not obligated to use the Warehouse Facilities of the Private Company, it has done so to avoid the administrative and other costs associated with developing and maintaining the infrastructure required to manage warehousing and handling independently. The New Warehousing Agreement provides that the Private Company is not obligated to provide services for more than 300 Company-owned stores. The Company pays the Private Company a monthly warehouse fee (the "Warehouse Fee") equal to 5% of the retail selling price of all merchandise (including the retail selling price of any related services, such as fabric protection and merchandise warranties) delivered from the Warehouse Facilities to customers of the Company-owned stores plus 5% of the retail selling price of all merchandise delivered from the Warehouse Facilities to Company-owned stores for display purposes. 8 In addition, the Private Company has separately contracted with the Company's licensees to provide warehousing and handling services for licensed stores for a fee equal to 5% of the retail price of merchandise delivered to the licensees' customers and on other terms substantially similar to those under the New Warehousing Agreement. The Private Company also provides a number of other services, including arranging for freight deliveries, providing customer service, data entry processing and related services, fabric protection and warranty services and other customer services. In addition to the Warehouse Fee, the Company pays the Private Company a portion (approximately one-third) of the fabric protection and merchandise warranty revenues collected from customers and the Company also pays the Private Company for freight charges based on quoted freight rates. See "Certain Relationships and Related Transactions." The Private Company is only obligated to provide warehousing for 300 Company-owned stores. If the Company expands to more than 300 Company-owned stores or if the Warehouse Facilities, for some reason, can not service all such stores, the Company may be required to purchase or lease warehousing facilities to serve such additional stores. In such event, the Company believes that adequate public warehousing facilities would be available for such services. The Company would also incur certain warehousing costs not incurred by the Company for stores serviced by the Warehouse Facilities. As described in "Legal Proceedings," the MOUS contemplate that the Company and the Private Company will enter into a new warehousing agreement pursuant to which the arrangements described above will be substantially revised and the Company will take over the warehousing and related functions over a period ending January 1, 1999. In contemplation of the settlement, in August 1996, the Company began to take over certain functions, including customer service, cash processing, order processing and store support. Trademarks The trademarks Jennifer Convertibles(R), Jennifer Leather(R), and With a Jennifer Sofabed, There's Always a Place to Stay(R) are registered with the U.S. Patent and Trademark Office and now owned by the Company. An application has been filed for a trademark for "Jennifer Living Rooms." The Private Company, as licensee, was granted a perpetual royalty-free license to use and sublicense the proprietary marks in the State of New York, subject to certain exceptions. See "Certain Relationships and Related Transactions." Employees As of August 31, 1996, the Company had 418 employees, including seven executive officers. The Company trains personnel to meet its expansion needs by having its most effective managers and salespersons train others and evaluate their progress and potential for the Company. The Company believes that its employee relations are satisfactory. None of the Company's employees are represented by a collective bargaining unit. The Company has never experienced a strike or other material labor dispute. 9 Competition The Company competes with other furniture specialty stores, major department stores, individual furniture stores, discount stores and chain stores, some of which have been established for a long time in the same geographic areas as the Company's stores (or areas where the Company or its licensees may open stores). The Company believes that the principal areas of competition with respect to its business are store image, price, delivery time, selection and service. The Company believes that it competes effectively with such retailers because its stores offer a broader assortment of convertible sofabeds than most of its competitors and, as a result of volume purchasing, it is able to offer its merchandise at attractive prices. The Company also advertises more extensively than many of its competitors and offers substantially faster delivery on most of its items. 10 Item 2. Properties The Company maintains its executive offices in Woodbury, New York pursuant to a lease which expires in the year 2005. As of August 31, 1996, the Company and the LPs lease all of their store locations pursuant to leases which expire between 1997 and 2009. None of its leases expire until fiscal 1997, at which time eight leases will expire although the lessee has an option to renew each such lease. The leases are usually for a base term of at least five years. For additional information concerning the leases, see Note 9 of "Notes to Consolidated Financial Statements." Item 3. Legal Proceedings. The Company is involved in a number of proceedings described below. A. The Class Action Litigation Beginning in December 1994, a series of 11 class actions were brought against the Company, various of its present and former officers and directors, and certain third parties, in the United States District Court for the Eastern District of New York. The complaints in all of these actions alleged that the Company and the other defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder in connection with the press release (the "Press Release") issued by the Company on or about December 2, 1994. All of these class actions have been consolidated under the caption In Re Jennifer Convertibles, Case No. 94 Civ. 5570, pending in the Eastern District of New York (the "Class Action Litigation"). In March 1996, the parties in the Class Action Litigation signed a Memorandum of Understanding for the purpose of settling the Class Action Litigation (the "Class Action MOU"). The terms of the Class Action MOU (which are described below) are subject to a stipulation of settlement and other documentation to be submitted to the United States District Court for the Eastern District of New York, as well as the approval of the terms of the settlement by that Court. The Class Action MOU also provides that the settlement of the Class Action Litigation is contingent upon final Court approval of the proposed settlement set forth in another Memorandum of Understanding dated March 18, 1996 with respect to certain derivative actions pending in: (a) the United States District Court for the Eastern District of New York; (b) the Supreme Court of the State of New York; and (c) the Court of Chancery in the State of Delaware (the "Derivative Action MOU"). These derivative actions and the terms of the Derivative Action MOU, are also described below. The Class Action MOU provides for the payment to certain members of the class and their attorneys of an aggregate maximum amount of $7 million in cash and preferred stock having a present value of $370,000. The cash portion of the settlement will be funded entirely by insurance company proceeds. The stock portion of the settlement will be provided by the Company based on a new issue of preferred stock of the Company having an aggregate present value of $370,000, which will bear an annual dividend of 7% and which will be convertible into the Company's Common Stock (at such time as the Company's Common Stock trades at $7.00 per share or higher) at $7.00 per share. 11 The settlement of the Class Action Litigation is a claims made settlement, meaning that the actual amount of cash and stock to be paid out will depend on the number of persons entitled to participate in the settlement who actually file valid proofs of claim. All those who purchased Common Stock during the period from December 9, 1992 through December 2, 1994 and who held their stock through December 2, 1994, will be entitled to participate in the settlement. The Class Action MOU also provides that the defendants will not object to an application by plaintiffs' attorneys for fees and expenses of up to 1/3 of the total of the maximum amount of the cash and stock proceeds of the settlement, without regard to the number of class members who filed valid proofs of claim. B. The Derivative Litigation Beginning in December 1994, a series of six actions were commenced as derivative actions on behalf of the Company, against Harley J. Greenfield, Fred J. Love, Edward B. Seidner, Bernard Wincig, Michael J. Colnes, Michael Rosen, Al Ferarra, William M. Apfelbaum, Glenn S. Meyers, Lawrence R. Haut, Jara Enterprises, Inc., Jerome I. Silverman, Jerome I. Silverman Company, Selig Zises and BDO Seidman & Co.(1) in: (a) the United States District Court for the Eastern District of New York, entitled Philip E. Orbanes v. Harley J. Greenfield, et al., Case No. CV 94-5694 (DRH) and Meyer Okun and David Semel v. Al Ferrara, et al., Case No. CV 95-0080 (DRH); Meyer Okun Defined Benefit Pension Plan, et al. v. BDO Seidman & Co., Case No. CV 95-1407 (DRH); and Meyer Okun Defined Benefit Pension Plan v. Jerome I. Silverman Company, et. al., Case No. CV 95-3162 (DRH); (b) the Court of Chancery for the County of New Castle in the State of Delaware, entitled Massini v. Harley Greenfield, et. al., Civil Action No. 13936 (WBC); and (c) the Supreme Court of the State of New York, County of New York, entitled Meyer Okun Defined Benefit Pension Plan v. Harley J. Greenfield, et. al., Index No. 95-110290 (collectively, the "Derivative Litigation"). The complaints in each of these actions assert various acts of wrongdoing by the defendants, as well as claims of breach of fiduciary duty by the present and former officers and directors of the Company, including but not limited to claims relating to the matters described in the Press Release. In March 1996, all of the parties to the derivative action (including the Company), except for Selig Zises ("Zises") and BDO Seidman & Co. ("Seidman") signed a Memorandum of Understanding for the purpose of settling all of the claims involving those parties in the Derivative Litigation (the "Derivative Litigation MOU"). The terms of the Derivative Litigation MOU (which are discussed below) are subject to a stipulation of settlement and other documentation to be submitted to the appropriate Court(s), as well as Court approval of the terms of the settlement. The Derivative Litigation MOU also provides that the settlement of the Derivative Litigation is contingent upon final Court approval of the proposed settlement set forth in the Class Action MOU, by the United States District Court for the Eastern District of New York. The terms of the Class Action MOU have already been described above. - ---------- (1) Each of these individuals and entities is named as a defendant in at least one action. 12 The Derivative Litigation MOU annexes as Exhibit A thereto a signed agreement (the "Settlement Agreement") dated March 5, 1996 between the Private Company and the Company. The Settlement Agreement, although signed, provides that it too is subject to and dependent upon Court approval of the settlement of the Derivative Litigation. The Settlement Agreement is designed to restructure the relationship between the Private Company and the Company, in order to reduce and eliminate any alleged actual or potential conflicts of interest, and to provide tangible benefits to the Company. The Settlement Agreement contemplates, inter alia, as follows: 1. From the date of the execution of the Settlement Agreement until December 31, 1997, the Private Company will bill the Company for services under a new warehousing agreement, a warehousing fee of 8.3% of the retail selling price of merchandise leaving the Warehouse Facilities for Company stores and their customers and a redelivery fee equal to 3% of the retail selling price of merchandise which is required to be redelivered to customers, under certain circumstances. The Company will be entitled to a reduction in the warehousing fee to the extent, and as of the date, that the Company assumes the costs of providing certain non-warehousing services presently provided by the Private Company to the Company. The Settlement Agreement contemplates that once the Company has assumed all of these services, the warehousing fee shall be reduced to 7.2%, which will then be the warehousing fee until December 31, 1997, and that under all circumstances, from January 1, 1998 through December 31, 1998, the warehousing fee shall be 7.2%. Upon the effective date of the Settlement Agreement, the Company will no longer pay the Private Company separately for "fabric protection" services. 2. In the event that the volume of merchandise shipped from all of the Private Company's warehouses to Company stores during calendar year 1996 fails to equal a retail selling price of $135,000,000, the Company shall pay the Private Company an additional fee of $65,000 for each million dollars of the shortfall (the "Shortfall Payments"), but in no event more than $650,000. The Private Company will repay the Company for the Shortfall Payments in the following manner: (i) 50% in 1997 if $140,000,000 or more in shipments is achieved; (ii) 50% in 1998 if $140,000,000 or more in shipments is achieved; and (iii) the balance of any Shortfall Payments not repaid by the Private Company to the Company under (i) and (ii) above will be repaid over seven years in equal monthly installments, without interest, beginning on January 1, 1999. The Company anticipates that it will not achieve sales of $135,000,000 in calendar 1996 and, accordingly, it will be liable for the Shortfall Payments if the settlement is approved as contemplated. 3. On January 1, 1999, the Private Company will assign to the Company all of its real property interests in or to the various warehouse facilities then being operated by the Private Company (including all related computer hardware), including any fee simple and/or leasehold interest,subject only to any mortgages, purchase money security agreements, leasehold obligations, racking and forklifting expenses, and other operation expenses relating to such property interest and the mortgage on the Inwood warehouse. The Settlement Agreement also provided that, as of December 31, 1998, the aggregate of all mortgages on the Inwood Warehouse facility would not exceed $2,850,000 and that, to the extent that the aggregate of all such mortgages was less than $2,850,000 as of that date, the Company would pay the Private Company the difference between $2,850,000 and the actual amount of such mortgages by way of set-off against the Private Company's obligation to the Company for warehousing services. 13 4. The Settlement Agreement provided that if the Private Company sold the Inwood Warehouse before December 31, 1998 (as it has already done), then the Private Company would pay the Company $25,000 per month starting January 1, 1999 for a period of 84 months. The Settlement Agreement also provided that if the Inwood Warehouse was sold for more than $4,500,000 (net of all reasonable and customary expenses and brokerage commissions), the Company would be entitled to any such excess. However, the Inwood Warehouse was sold in June 1996 for less than $4,500,000. 5. Commencing January 1, 1999, and continuing for seven years, the Company will provide the Private Company all warehousing services formerly provided by the Private Company to the Company for a fee equal to 2% of the Private Company's deemed retail selling price, plus an additional fee for any fabric protection services sold by the Private Company to customers, payable at the then current invoice rate. 6. The Private Company will acquire the interest of the limited partners in the LPs known as Jennifer, LP III, Jennifer, LP IV, Jennifer, LP V (the "Partnerships"). The Private Company will also purchase stock of the shareholders of Southeastern Florida Holding Co., Inc. ("S.F.H.C."). The Private Company will assign its Partnership interests and stock to the Company at no cost (except as described below). As of March 15, 1996, S.F.H.C. and the Partnerships own an aggregate of 55 licensed Jennifer Convertibles stores which, after such assignment, will be wholly-owned by the Company. In this connection, the Private Company and the Company will release the aforementioned limited partners and the shareholders, officers and directors of S.F.H.C. from all claims, including all obligations under the notes referred to below. Although it is not reflected in the Settlement Agreement, it is currently contemplated that the shareholders of S.F.H.C. will receive 10-year warrants to purchase an aggregate of 180,000 shares of Common Stock at $7.00 per share. In addition, the maturity date of three-year notes (with an aggregate remaining balance of $300,000) originally entered into by them in connection with their purchase of warrants (the "Original Warrants"), expiring June 1998, to purchase an aggregate of 180,000 shares of Common Stock at $15.625 per share, will be extended to 10 years after the settlement is approved. The extended notes will bear interest at a rate of 7.12% per annum, and 10% of the principal amount of such notes will be due each year. Such notes will be secured by the Original Warrants to purchase an aggregate of 105,636 shares of Common Stock (representing the unpaid for Original Warrants) and the Company's sole remedy, until the notes mature, upon any default in the payment of principal of such notes, will be to cancel a proportionate number of Original Warrants. There is no signed agreement with the limited partners or the shareholders of S.F.H.C. as to the transfer of the interests in the Partnerships and S.F.H.C. described above and there can be no assurance that the Private Company will be able to obtain such agreements and to transfer the interests in the Partnerships and S.F.H.C. on the terms contemplated above or at all. If the Private Company is unable to obtain such agreements and to make the transfer, the settlement will not be consummated on the terms outlined above or possibly, at all. 7. The Private Company agrees to pay the Company, under the offset agreement described in Paragraph 11 below, $1,400,000 in resolution of certain intercompany accounts as of August 26, 1995 to be paid, $17,000 per month to be applied toward principal and interest, with interest computed at 6% annually. 8. Commencing January 1, 1999, the Private Company will provide a license to the Company permitting the Company to use and change the Private Company's computer program without fee. As of January 1, 1999, the Company will also assume the obligations and personnel of the computer department presently maintained by the Private Company. 14 9. On or after the effective date of the Settlement Agreement, and through December 31, 1998, although the Private Company will continue to be responsible to apply fabric protection (at no additional charge to the Company), the Company will be responsible for any claims on breach of warranty relating to fabric protection (irrespective of whether the sale was made by the Private Company or the Company), provided, that, as to such claims made as to merchandise sold by the Private Company, the Company may bill the Private Company for outside parts and labor directly expended in connection therewith. 10. The Private Company will assume and pay the $1,200,000 debt of certain stockholders of S.F.H.C. to S.F.H.C. in 84 equal monthly installments without interest, beginning January 1, 1999. 11. As of the effective date of the Settlement Agreement, the Private Company and the Company will enter into an offset agreement similar to the one described under "Certain Relationships and Related Transactions" dealing with the offset of obligations for the period not covered by the initial offset agreement and providing for cash payments to the extent that any amounts due under such agreement exceeds $1,000,000. 12. Royalties aggregating $100,147 from certain licensees managed by the Private Company will be paid in 84 equal monthly installments, commencing January 1, 1999, without interest. The Derivative Litigation MOU also provides, inter alia, as follows: 1. All of the plaintiffs in the derivative actions and the Company will release all of current and former officers and directors, including Isabelle Silverman, and the defendants in the derivative actions (except for Zises, KPMG Peat Marwick ("Peat") and Seidman), from all claims which were or could have been asserted against them in the Derivative Litigation or in any other Court including, but not limited to: (a) the matters discussed or referred to in the Final Report of Counsel to the Independent Committee of the Board of Directors of Jennifer Convertibles, Inc., dated January 26, 1995 (as described under "Certain Relationships and Related Transactions"); (b) the draft complaint in a proposed action entitled Zises, et. ano. v. Greenfield, et al., (S.D.N.Y.) dated March 30, 1994; (c) all transactions publicly disclosed by Jennifer through the date of filing with the SEC of its Annual Report on Form 10-K for the year ended August 26, 1995; and (d) the negotiation and approval of the settlement of the Class Action Litigation. 2. Although one or more of the derivative actions may continue against Peat, Zises and/or Seidman, the Derivative Litigation MOU contains provisions designed to relieve those receiving releases from any claims by Peat, Seidman and/or Zises for contribution or indemnification. 3. The defendants in the derivative actions will not object to an application by counsel for the plaintiffs in the derivative actions for an award of attorneys' fees and expenses up to an aggregate of $795,000. Of this amount, the first $500,000 will be funded by an insurance carrier for one of the defendants other than the Company; $165,000 will be paid in cash by the Private Company, and the remaining portion of fees and expenses will be paid by the Company in preferred stock having a present value of up to $130,000. The preferred stock to be issued by the Company will be of the same type and will be subject to the same terms and conditions as the preferred stock to be issued in connection with the Class Action Litigation described above. 15 C. SEC Investigation On May 3, 1995, the Securities and Exchange Commission commenced a formal investigation as to the Company. Subpoenas have been issued to the Company and certain of its current and former management and the Company and such persons have furnished various contracts, records and information. D. Other Litigation The Company is also subject, in the ordinary course of business, to a number of litigations in relation to leases for those of its stores which it has closed or relocated. Item 4. Submission of Matters to a Vote of Security Holders. Not Applicable 16 PART II Item 5: Market For Registrant's Common Equity and Related Stockholder Matters The principal market for the Common Stock during the fiscal year ended August 31, 1996 was the Nasdaq National Market(R) (the "NASDAQ NMS") until the Common Stock was delisted effective April 17, 1995. Thereafter, the Common Stock traded in the "pink sheets", until May 16, 1995, when it commenced trading on the Bulletin Board. The following table sets forth, for the fiscal periods indicated, the high and low sales prices for the Common Stock as reported by the NASDAQ NMS until April 17, 1995 and, thereafter the high and low bid prices of the Common Stock in the "pink sheets" or Bulletin Board, as the case may be. Such quotations since April 17, 1995 reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. High Low ----- ----- Fiscal Year 1995: 1st Quarter..................... $8 5/8 $6 1/2 2nd Quarter..................... 7 1/2 2 1/4 3rd Quarter..................... 4 1/4 2 3/4 (NASDAQ) 2 1/2 2 1/4 (Pinksheets) 2 5/8 2 1/8 (Bulletin Board) 4th Quarter..................... 3 1/2 2 (Bulletin Board) High Low ----- ----- Fiscal Year 1996: 1st Quarter..................... $3 3/4 $1 13/16 2nd Quarter..................... 3 3/8 2 3rd Quarter..................... 3 1/4 2 1/16 4th Quarter..................... 3 1/4 2 As of November 18, 1996, there were approximately 262 holders of record and approximately 4,600 beneficial owners for the Common Stock. On November 22, 1996, the closing bid and asked prices of the Common Stock as reported on the NASDAQ Bulletin Board were $2 3/8 and $2 1/2, respectively. Dividend Policy The Company has never paid a dividend on its Common Stock and does not anticipate paying dividends on the Common Stock at the present time. The Company currently intends to retain earnings, if any, for use in its business. There can be no assurance that the Company will ever pay dividends on its Common Stock. The Company's dividend policy with respect to the Common Stock is within the discretion of the Board of Directors and its policy with respect to dividends in the future will depend on numerous factors, including the Company's earnings, financial requirements and general business conditions. 17 Item 6. Selected Financial Data The Following table presents certain selected financial data for Jennifer Convertibles, Inc. and subsidiaries:
(in thousands, except share data) ----------------------------------------------------------------------- Year Ended Year Ended Year Ended Year Ended Year Ended 8/31/96 8/26/95 8/27/94 8/31/93 8/31/92 ------- ------- ------- ------- ------- Operations Data: Net sales $ 106,041 $ 126,074 $ 97,420 $ 64,348 $ 33,383 ----------- ----------- ----------- ----------- ----------- Cost of sales, including store occupancy, warehousing, delivery and fabric protection 72,708 86,964 67,974 43,898 20,741 Selling, general and administrative expenses 37,618 45,955 34,139 22,652 10,618 Depreciation and amortization 1,852 2,261 2,091 1,583 555 Termination of consulting agreement, legal and other costs -- 500 6,604 -- -- Write off of purchased limited partners' interests -- -- 3,482 -- -- Provision for losses on amounts due from Private Company and Unconsolidated Licensees 952 3,088 3,284 -- -- Loss from store closings 191 1,670 -- -- -- ----------- ----------- ----------- ----------- ----------- 113,321 140,438 117,574 68,133 31,914 ----------- ----------- ----------- ----------- ----------- Operating (loss) income (7,280) (14,364) (20,154) (3,785) 1,469 ----------- ----------- ----------- ----------- ----------- Other income (expense) Royalty income 375 523 644 711 779 Interest income 195 311 473 674 237 Interest expense (47) (48) (61) (640) (164) Gain on sale of securities -- -- 336 61 -- Other income, net 880 1,670 1,374 696 74 ----------- ----------- ----------- ----------- ----------- 1,403 2,456 2,766 1,502 926 ----------- ----------- ----------- ----------- ----------- (Loss) income before income taxes (benefit), minority interest and extraordinary item (5,877) (11,908) (17,388) (2,283) 2,395 Income taxes (benefit) 146 160 (322) 113 968 ----------- ----------- ----------- ----------- ----------- (Loss) income before minority interest and extraordinary item (6,023) (12,068) (17,066) (2,396) 1,427 Extraordinary item-utilization of net operating loss carryforwards -- -- -- -- 748 Minority interest share of losses -- -- 2,449 2,902 -- ----------- ----------- ----------- ----------- ----------- Net (loss) earnings ($ 6,023) ($ 12,068) ($ 14,617) $ 506 $ 2,175 =========== =========== =========== =========== =========== (Loss) earnings per common and common equivalent share: Before extraordinary item ($ 1.06) ($ 2.12) ($ 2.56) $ 0.09 $ 0.34 Extraordinary item -- -- -- -- 0.16 ----------- ----------- ----------- ----------- ----------- Net (loss) earnings per share ($ 1.06) ($ 2.12) ($ 2.56) $ 0.09 $ 0.50 =========== =========== =========== =========== =========== Weighted average number of common and common equivalent shares 5,700,725 5,700,725 5,700,725 6,013,000 4,605,000 =========== =========== =========== =========== =========== Cash Dividends -- -- -- -- -- =========== =========== =========== =========== =========== 8/31/96 8/26/95 8/27/94 8/31/93 8/31/92 ------- ------- ------- ------- ------- Store data: Company-owned stores open at end of period 86 90 55 34 33 Consolidated licensed stores open at end of period 64 68 99 73 28 Licensed stores not consolidated open at end of period 11 11 14 14 14 ----------- ----------- ----------- ----------- ----------- Total stores open at end of period 161 169 168 121 75 =========== =========== =========== =========== =========== 8/31/96 8/26/95 8/27/94 8/31/93 8/31/92 ------- ------- ------- ------- ------- Balance Sheet Data: Working capital (deficiency) ($ 15,757) ($ 10,988) $ 1,240 $ 11,573 $ 11,053 Total assets 25,435 33,871 44,922 37,488 28,819 Long-term obligations 230 337 477 118 11,733 Total liabilities 35,741 38,154 37,137 15,305 16,539 (Capital deficiency) stockholders' equity (10,306) (4,283) 7,785 22,183 12,280 (Capital deficiency) stockholders' equity per share ($ 1.81) ($ 0.75) $ 1.37 $ 3.69 $ 2.67
18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW The Company is the owner and licensor of sofabed specialty retail stores that specialize in the sale of a complete line of sofabeds and companion pieces such as loveseats, chairs and recliners and specialty retail stores that specialize in the sale of leather furniture. For the fiscal years ended August 31, 1992 and August 31, 1993, the Company did not consolidate the operations of the LP's of which subsidiaries of the Company served as general partners. In November 1994, during the course of its audit, KPMG Peat Marwick, the Company's independent auditor at the time, advised the Company that its method of accounting for the LP's should be changed and would likely require a restatement of previously announced financial results. In addition, on December 2, 1994, as more fully discussed under "Certain Relationships and Related Transactions," a special committee of the Company's Board of Directors delivered a summary report which concluded that the Company had meritorious claims against three members of its management, the Private Company and others. The Company announced these matters publicly in a press release on December 2, 1994. As more fully discussed under "Legal Proceedings," the Company and certain of its management became involved in class action and derivative litigations relating to such matters and, on May 3, 1995, the Securities and Exchange Commission commenced an investigation relating to such matters. In November 1994, the Company determined that it should consolidate the operating losses of such LP's, to the extent they exceeded the capital contributions of the limited partners, in its financial statements for the fiscal year ended August 27, 1994 and the Company subsequently determined that such accounting treatment would have been the appropriate treatment for the 1993 and 1992 fiscal years as well. Accordingly, the 1994, 1995 and 1996 consolidated financial statements include the operations of such LP's in excess of capital contributed by the limited partners as well as those of the Company and its subsidiaries. - 19 - The operating losses in excess of capital contributions of the LP's that are included in the consolidated financial statements are as follows: Years Ended --------------------------- (In Thousands) 8/27/94 8/26/95 8/31/96 ------- ------- ------- Total operating losses before capital contributions of LP's $(9,781) $(7,288) $(4,206) -------- -------- -------- Total capital contributions 2,449 - - -------- -------- -------- Net operating losses $(7,332) $(7,288) $(4,206) ======== ======== ======== Two of the LP's, the losses of which are included in the table above for the fiscal year ended August 27, 1994, were subsequently acquired by the Company. The losses of such LP's for that year totalled $2,596,000. Prior to fiscal 1996, the Company relied upon the Private Company to provide and maintain all data entry processing and other related services that support its business. Employees of the Private Company provided these services as well as other related services such as all accounts payable (nonmerchandise), all payroll preparation services, inventory control reporting, certain store cash recording and initial review of cash activity and store customer service. Starting in fiscal 1996, the Company has been assuming these responsibilities. The Company has for all fiscal years prior to September 1, 1994 engaged the accounting firm of Jerome I. Silverman Company ("JISCO") to provide general accounting and tax services. Effective September 1, 1994, the Company terminated the accounting and tax services of JISCO and hired 19 employees who had previously worked directly for JISCO. This group, under the direction of a new Executive Vice President and Chief Financial Officer hired on August 1, 1994, established the Company's general accounting offices. RESULTS OF OPERATIONS: FISCAL YEAR ENDED AUGUST 31, 1996 COMPARED TO FISCAL YEAR ENDED AUGUST 26, 1995: Net sales decreased by 15.9% to $106,041,000 for the fiscal year ended August 31, 1996 as compared to $126,074,000 for the year ended August 26, 1995. This decrease is mainly attributable to the closing of eight stores since the prior year period, a physical split of 14 Jennifer Convertibles stores into both a Jennifer Convertibles store and a Jennifer Leather store (thereby cannibalizing sales), a reduction in the number of credit promotions that the Company has been able to offer customers to stimulate business and an industry-wide softness. Comparable store sales (those open for a full year in each period) decreased by 16.3% partially as a result of the physical split described above. All royalty income earned in the fiscal year ended August 31, 1996 of $375,000 has been fully reserved due to uncertainty as to the collectibility of such amounts from the Unconsolidated Licensees. - 20 - Cost of sales decreased 16.4% to $72,708,000 for the year ended August 31, 1996 from $86,964,000 for the fiscal year ended August 26, 1995. The dollar decrease of $14,256,000 is attributable to the lower sales and lower occupancy costs due to the closed stores, while the decrease in the cost of sales as a percentage of sales to 68.6% from 69.0% is essentially due to lower costs of merchandise. Warehouse expenses of $5,302,000 and fabric protection services of $2,972,000 provided by the Private Company decreased from $6,304,000 and $3,804,000, respectively, from the previous year due to the lower sales volume in the current fiscal year. Selling, general and administrative expenses were $37,618,000 for the fiscal year ended August 31, 1996 as compared to $45,955,000 for the fiscal year ended August 26, 1995, a decrease of $8,337,000 or 18.1% over the prior year. This decrease was due principally to reductions in salaries and related benefits of $3,586,000 (principally because of the lower sales volume which generated lower commissions as well as fewer stores in operation during the current fiscal year) and lower advertising expenses of $3,464,000. Legal fees were higher in the current fiscal year by $403,000 to $1,275,000 primarily because of the new Credit and Security Agreement signed with the Company's principal supplier, Klaussner Furniture Industries, Inc. (see Liquidity and Capital Resources below). Accounting fees declined by $421,000 to $313,000 for the year in part as the result of improved controls installed during the current fiscal year. Various other store expense categories were reduced due to the implementation of the Company's cost reduction programs. Selling, general and administrative expenses as a percentage of sales were 35.5% for the fiscal year ended August 31, 1996 as compared to 36.5% in the prior year. The Company's receivables from the Private Company, the Unconsolidated Licensees and S.F.H.C. increased by $952,000 in the fiscal year ended August 31, 1996 to $7,324,000. These entities have losses and capital deficiencies. The Company has fully reserved for all amounts due from the Private Company and the Unconsolidated Licensees. This resulted in a provision for loss of $952,000. In prior years, the Company had reserved the full amounts due which totalled $6,372,000. In connection with the uncertainty of collectibility and the relationship between the Company, the Private Company and the Unconsolidated Licensees, the Company will account for subsequent transactions with these entities on an offset basis. However, if the result of the offset is a receivable due from them, then such net amount will be generally recognized only at the time when cash is received from these entities. Interest income decreased by $116,000 to $195,000 for the fiscal year ended August 31, 1996 as compared to the prior year. The decrease reflects the generally lower level of investments throughout the fiscal year. Other income decreased to $880,000 in the fiscal year ended August 31, 1996 from $1,670,000 in the prior year. This decrease is primarily attributable to adjustments related to cancelled customer orders. Net (loss) in the fiscal year ended August 31, 1996 was $(6,023,000) compared to a net (loss) of $(12,068,000) in the prior year, a decrease of loss of $6,045,000. The primary reason for the decreased loss was due to expense reductions and operating efficiencies the Company was able to achieve as discussed above together with lower store closing costs and a substantially lower provision for losses from the Private Company and Unconsolidated Licensees reflecting the reduced increase in such amount over the prior year. - 21 - FISCAL YEAR ENDED AUGUST 26, 1995 COMPARED TO FISCAL YEAR ENDED AUGUST 27, 1994: Net sales increased by 29.4% to $126,074,000 for the fiscal year ended August 26, 1995 as compared to $97,420,000 for the year ended August 27, 1994. This increase is attributable in part to the opening of 20 new Jennifer Leather stores and 20 new Jennifer Convertibles stores. The Company and the LP's closed an aggregate of 35 Jennifer Convertibles stores, one Elegant Living store and one Jennifer Leather store in the fiscal year. Comparable store sales (those open for a full year in each period) increased by 4.7%. All royalty income earned in the fiscal year ended August 26, 1995 of $523 has been fully reserved due to uncertainty as to the collectibility of such amounts from the Unconsolidated Licensees. Cost of sales increased 27.9% to $86,964,000 for the year ended August 26, 1995 from $67,974,000 for the fiscal year ended August 27, 1994. The dollar increase of $18,990,000 is attributable to the higher sales while the decrease in the cost of sales as a percentage of sales to 68.9% from 69.8% is essentially due to lower costs of merchandise due to higher vendor rebates and lower occupancy costs due to the closed stores. Warehouse expenses of $6,304,000 and fabric protection services of $3,804,000 provided by the Private Company increased from $4,871,000 and $3,298,000, respectively, from the previous year due to the higher sales volume in the current fiscal year. Selling, general and administrative expenses were $45,955,000 for the fiscal year ended August 26, 1995, as compared to $34,139,000 for the fiscal year ended August 27, 1994, an increase of $11,816,000, or 34.6% over the prior year. This increase was due principally to direct costs associated with the higher number of stores in operation in the current fiscal year. Selling, general and administrative expenses as a percentage of sales were 36.5% for the fiscal year ended August 26, 1995 as compared to 35.0% in the prior year. Advertising expenses increased by $4,372,000, or 38.5%, over the prior year essentially due to the initial advertising programs for the opening of the new Jennifer Leather stores as well as the new Jennifer Convertibles stores opened by the LP's. Salaries increased $4,701,000, or 36.7%, due to the expansion of Jennifer Leather and Jennifer Convertibles stores, the assumption of purchasing and advertising responsibilities from the Private Company and the hiring of additional executive officers and other staff. The Company's receivables from the Private Company, the Unconsolidated Licensees and S.F.H.C increased by $1,256,000 in the fiscal year ended August 26, 1995 to $6,372,000. These entities have losses and capital deficiencies. The Company has fully reserved for all amounts due from the Private Company and the Unconsolidated Licensees. This resulted in a provision for loss of $3,088,000. In the prior year, the Company had reserved the full amount of amounts due from Unconsolidated Licensees which totalled $3,284,000. On November 1, 1995, the Company signed an Offset Agreement with the Private Company whereby it assumed $1,866,000 of indebtedness to the Company previously owed by certain Unconsolidated Licensees. In connection with the uncertainty of collectibility and the relationship between the Company, the Private Company and the Unconsolidated Licensees, the Company will account for subsequent transactions with these entities on an offset basis. However, if the result of the offset is a receivable due from them, then such net amount will be generally recognized only at the time when cash is received from these entities. - 22 - The Company and LP's closed an aggregate of 37 stores during the fiscal year ended August 26, 1995. As a result, the Company wrote off various store fixed assets, reversed the deferred rent liability previously established for these stores and incurred settlement costs to eliminate the leasehold liabilities for these stores. These costs aggregated $1,670,000. Interest income decreased by $162,000 to $311,000 for the fiscal year ended August 26, 1995 as compared to the prior year. The decrease reflects the generally lower level of investments throughout the fiscal year, and lower levels of interest rates. Other income increased to $1,670,000 in the fiscal year ended August 26, 1995 from $1,374,000 in the prior year. This increase is primarily attributable to adjustments related to cancelled customer orders. Net (loss) in the fiscal year ended August 26, 1995 was $(12,068,000) compared to a net (loss) of $(14,617,000) in the prior year, a decrease of loss of $2,549,000. The primary reason for the decreased loss was due to the charges in the prior year for termination of consulting agreement, legal and other costs of $6,604,000 and the write-off of purchased limited parties' interests of $3,482,000; however, operating losses in the fiscal year ended August 26, 1995 increased as discussed above. LIQUIDITY AND CAPITAL RESOURCES: As of August 31, 1996, the Company and LP's had an aggregate working capital deficiency of $15,757,000 compared to a deficiency of $10,988,000 at August 26, 1995 and had available cash and cash equivalents of $3,600,000 compared to $7,729,000 at August 26, 1995. The Company is continuing to fund the operations of the LP's which, as described above, continue to generate operating losses. All such losses have been consolidated in the Company's consolidated financial statements. Additionally, the Company's receivables from the Private Company, the Unconsolidated Licensees, including S.F.H.C. increased by $952,000 in the current fiscal year. These entities have operating losses and capital deficiencies. Accordingly, a reserve for possible non-collection of such receivables in the amount of $952,000 for the current fiscal year has been provided. There can be no assurance that the total receivables of $7,324,000 will be collected. It is the Company's intention to continue to fund these operations in the future. The Company and the Private Company have entered into offset agreements that permit the two companies to offset their current obligations to each other. As part of such agreements, the Private Company agreed to assume certain liabilities owed to the Company by the Unconsolidated Licensees. In March 1996, the Company executed a Credit and Security Agreement ("Agreement") with its principal supplier, Klaussner Furniture Industries, Inc. ("Klaussner") which effectively extended the payment terms for merchandise shipped from 60 days to 81 days. As part of the Agreement, the Company granted a security interest in all of its assets as well as assigning leasehold interests, trademarks and a licensee agreement to operate the Company's business in the event of default. Klaussner also lent $1,440,000 to the Private Company to be used to pay down the mortgage balance on the warehouse property. This paydown also reduced the Company's guarantee to the mortgagor. - 23 - In June 1996, the Private Company sold its principal New York warehouse and repaid the mortgage thereon. As a result, the Company's guaranty of a portion of such mortgage obligation was extinguished without any liability to the Company. The proposed settlement of the derivative and class action litigations (as described elsewhere) will come from insurance company payments and the issuance of new Preferred Stock by the Company. There will be no cash outlays by the Company other than legal costs. Additionally, a new proposed agreement with the Private Company (as described in the Notes to the Consolidated Financial Statements) contemplates significant changes to the operating relationship between the companies. In fiscal 1996 and 1995, the Company and the LP's closed an aggregate of 40 stores. Several were closed for non-performance, but a number of such closings were due to the Company's decision to combine separate Jennifer Convertibles and Jennifer Leather stores located in the same demographic areas into one store. The primary benefit of combining both operations into one store was an elimination of the real estate expenses and other expenses associated with the closed showroom. Additional benefits realized included reductions of personnel and, in a number of cases, elimination of duplicate office equipment and telephone lines. Although combining two stores into one store generally reduces sales, management believes that sales at the combined store will generate more profit due to the elimination or reduction of expenses described above. Management feels that with the above noted Klaussner Agreement and the significant cost cutting measures undertaken, including, but not limited to, the closing of stores, the reduction in salaries of certain management personnel, additional vendor allowances of $1,075,000 and cash payments from the Private Company in connection with the offset agreements, ($566,000 received November, 1996) the Company anticipates losses for fiscal 1997 but will have adequate cash flow to fund its operations. For the year ended August 31, 1996 and year ended August 26, 1995, the Company and the LP's spent $989,000 and $4,292,000, respectively, for capital expenditures. The Company anticipates capital expenditures totalling approximately $625,000 during fiscal 1997 for general maintenance of its stores. INFLATION: There was no significant impact on the Company's operations as a result of inflation during the fiscal year ended August 31, 1996. - 24 - Item 8. Financial Statements and Supplementary Data. See Index immediately following the signature page Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None Item 10. Directors and Executive Officers of the Company The names and ages of the Company's directors and the Company's executive officers as of November 30, 1996 are as follows: Position(s) with the Name Age Company - -------------------- --- ------------------------------------ Harley J. Greenfield 52 Chairman of the Board, Chief Executive Officer and President Edward G. Bohn 51 Director Kevin J. Coyle 52 Director Edward B. Seidner 42 Director and Executive Vice President Bernard Wincig 65 Director George J. Nadel 54 Executive Vice President, Chief Financial Officer and Treasurer Rami Abada 37 Executive Vice President and Chief Operating Officer Ronald E. Rudzin 34 Senior Vice President - Retail Stores Leslie Falchook 36 Vice President - Administration Kevin Mattler 39 Vice President - Store Operations The Company's directors are elected at the Annual Meeting of stockholders and hold office until their successors are elected and qualified. The Company's officers are appointed by the Board of Directors and serve at the pleasure of the Board of Directors. The Company currently has no compensation or nominating committees. The Board of Directors held seven (7) meetings during the 1996 fiscal year. None of the directors attended fewer than 75% of the number of meetings of the Board of Directors or any committee of which he is a member, held during the period in which he was a director or a committee member, as applicable. The Board of Directors has a Stock Option Committee, which as of August 31, 1996, consisted of Messrs. Greenfield and Seidner. The Stock Option Committee did not meet during the last fiscal year. The Stock Option Committee is authorized to administer the Company's stock option plans. The Board of Directors has an Audit Committee, which during the fiscal year ended August 31, 1996, consisted of Harley Greenfield, Bernard Wincig, Edward Bohn and Kevin Coyle. During such fiscal year, the Audit Committee held nine (9) meetings. The Audit Committee is responsible for reviewing the adequacy of the structure of the Company's financial organization and the implementation 25 of its financial and accounting policies. In addition, the Audit Committee reviews the results of the audit performed by the Company's outside auditors before the Annual Report to Stockholders is published. The Company also has a Monitoring Committee consisting of Edward Bohn, Kevin Coyle and Bernard Wincig to monitor transactions between the Company and the Private Company. Set forth below is a biographical description of each director and executive officer of the Company as of August 31, 1996. Harley J. Greenfield Mr. Greenfield has been the Chairman of the Board, Chief Executive Officer and President of the Company since August 1986. Mr. Greenfield has been engaged for more than 25 years in the furniture wholesale and retail business and was one of the co-founders of the Private Company which established the Jennifer Convertibles concept in 1975. Mr. Greenfield is a member of the Home Furnishings Association. Edward G. Bohn Mr. Bohn has been a director of the Company since February 1995. Since March 1995, he has been engaged as a Consultant for Borlas Sales in Avenel, New Jersey, an importer/exporter of consumer electronics. Borlas also handles the sale and installation of software. Since June 1995, he has been a Director of Nuwave Technologies, Inc. He has also operated as an Independent Consultant in financial and operational matters since September 1994 through the present. Mr. Bohn was employed by Emerson Radio Corporation, which designs and sells consumer electronics, in various capacities from January 1983 through March 1994. From March 1993 to March 1994, he was the Senior Vice President-Special Projects; he was Chief Financial Officer from March 1991 through March 1993 and Treasurer/Vice President of Finance prior to that. Emerson Radio filed in the United States Bankruptcy Court, District of New Jersey, for protection under Chapter 11 of the Federal Bankruptcy Act on September 29, 1993 and was discharged on March 31, 1994. Kevin J. Coyle Mr. Coyle was appointed as a director of the Company in February 1995. Mr. Coyle is a certified public accountant specializing in litigation support. Until 1993, Mr. Coyle was President of Olde Kraft Company Ltd. ("Olde Kraft"), a retail furniture business operating seven stores in the New York Metropolitan Area. Olde Kraft filed a Chapter XI petition in bankruptcy in October 1993 and converted to a Chapter VII in October 1994. Mr. Coyle graduated from Queens College with a BS in accounting and is a member of the American Institute of Certified Public Accountants and the New York State Society of Certified Public Accountants. Edward B. Seidner Mr. Seidner became a director of the Company in August 1986 and an Executive Vice President of the Company in September 1994. From 1977 until November 1994, Mr. Seidner was an officer and a director of the Private Company. Mr. Seidner has been engaged for more than 15 years in the furniture wholesale and retail business. Mr. Seidner is a member of the Home Furnishings Association. 26 Bernard Wincig Mr. Wincig became a director of the Company in September 1986. Mr. Wincig has been an attorney in private practice since 1962. Mr. Wincig received his Juris Doctor degree from Brooklyn Law School. George J. Nadel Mr. Nadel joined the Company and became Executive Vice President, Chief Financial Officer and Treasurer on August 1, 1994. Prior to joining the Company, from October 1989 to July 1994, Mr. Nadel was the Senior Vice President and Chief Financial Officer of Loehmann's Inc., a retail chain specializing in ladies clothing and accessories. Prior to joining Loehmann's, from June 1986 to October 1989, Mr. Nadel was the Chairman and Chief Executive Officer of The Dry Goods, Inc., a chain of discount department stores, which in November 1988 filed a Chapter XI petition in bankruptcy. Mr. Nadel has over thirty years experience in various senior financial officer positions with companies in the retail industry and is a Certified Public Accountant. Rami Abada Mr. Abada became the Executive Vice President and Chief Operating Officer of the Company on April 12, 1994. Prior to joining the Company, Mr. Abada had been employed by the Private Company since 1982. Ronald E. Rudzin Mr. Rudzin became Senior Vice President - Retail Stores on April 12, 1994. Prior to joining the Company, Mr. Rudzin had been employed by the Private Company since 1979. Mr. Rudzin was, and is, in charge of directing the sales force of the Company, including the Private Stores and licensed stores. Leslie Falchook Mr. Falchook has been a Vice President of the Company since September 1986. Mr. Falchook is primarily involved with the internal operations of the Company. Prior to joining the Company, Mr. Falchook had been employed by the Private Company since 1982. Kevin Mattler Mr. Mattler became Vice President - Store Operations on April 12, 1994 and has been with the Company since 1988. Mr. Mattler is involved with, and supervises, the operation of the Company's licensed stores and during his tenure with the Company Mr. Mattler has been involved in all facets of its operations. Prior to joining the Company, Mr. Mattler had been employed by the Private Company since 1982. Certain of the directors and former officers of the Company are defendants in the litigation described under "Legal Proceedings" above. See also "Certain Relationship and Related Transactions." 27 Item 11. Executive Compensation SUMMARY COMPENSATION TABLE The following table sets forth compensation paid for the fiscal years ended August 31, 1996, August 26, 1995 and August 27, 1994 (or such shorter period as such employees were employed by the Company) of those persons who were (i) the chief executive officer at August 31, 1996 and (ii) the four other most highly compensated executive officers of the Company at August 31, 1996 whose total annual salary and other compensation exceeded $100,000 (collectively, the "Named Executive Officers"). ANNUAL LONG-TERM COMPENSATION COMPENSATION ------------ ------------ SECURITIES NAME AND FISCAL UNDERLYING ALL OTHER PRINCIPAL POSITION YEAR SALARY ($) OPTIONS (#) COMPENSATION - ------------------ ---- ---------- ----------- ------------ Harley J. Greenfield, 1996 $352,307 0 0 Chairman of the 1995 400,000 0 0 Board, Chief 1994 0 0 0 Executive Officer and President Edward B. Seidner, 1996 $264,231 0 Executive Vice 1995 300,000 President George J. Nadel 1996 $250,000 0 0 Executive Vice 1995 202,083 50,000(1) President and Chief 1994 16,667(1) 0 Financial Officer Leslie Falchook, 1996 $127,712 0 0 Vice President - 1995 144,670 0 0 Administration 1994 144,670 0 Rami Abada 1996 $132,115 0 0 Executive Vice 1995 150,000 0 0 President and Chief 1994 100,000 0 0 Operating Officer Ronald E. Rudzin 1996 $132,115 0 0 Senior Vice 1995 150,000 0 0 President Retail 1994 100,000 0 0 Stores 28 - ---------- (1) Mr. Nadel joined the Company on August 1, 1994. On August 1, 1995, Mr. Nadel was granted options to purchase 25,000 shares of Common Stock at $2.50 per share and, on February 1, 1995, Mr. Nadel was granted options to purchase 25,000 shares of Common Stock at $3.53 per share, in each case the market value on the date of grant. Such options vest over a three-year period. Non-employee directors currently receive a fee of $10,000 per year, plus $500 per meeting attended (an aggregate of $82,800 in fiscal 1996). Directors are reimbursed for out-of-pocket expenses incurred in connection with their services as such. Effective February 1, 1996, the salaries of each of the Company's officers was reduced (other than George J. Nadel, a portion of whose salary was deferred), in connection with the Company's costcutting program. The annual salaries of the Company's executive officers, effective February 1, 1996 are as follows: Harley Greenfield-$320,000; Edward Seidner - $240,000, George J. Nadel - $225,000, Rami Abada - $120,000, Ronald E. Rudzin - $120,000, Leslie Falchook - $116,000 and Kevin Mattler - $96,000. Stock Option Plans The Company has Incentive and Non-Qualified Stock Option Plans (the "Plans"), pursuant to which, as of August 31, 1996, options to purchase an aggregate of 631,547 shares of Common Stock were outstanding and under which options to purchase an aggregate of 215,453 shares of Common Stock were available for grant. In addition, options granted outside of the Plans to purchase an additional 180,000 shares of Common Stock were outstanding as of August 31, 1996. The Plans are administered by a Stock Option Committee (the "Committee") consisting of two persons appointed by the Board of Directors. As of August 31, 1996, the Committee consisted of Harley Greenfield and Edward B. Seidner. The Committee has full and final authority (a) to determine the persons to be granted options, (b) to determine the number of shares subject to each option and whether or not options shall be incentive stock options or non-qualified stock options, (c) to determine the exercise price per share of the options (which, in the case of incentive stock options, may not be less per share than 100% of the fair market value per share of the Common Stock on the date the option is granted or, in the case of a stockholder owning more than 10% of the stock of the Company, not less per share than 110% of the fair market value per share of the Common Stock on the date the option is granted), (d) to determine the time or times when each option shall be granted and become exercisable and (e) to make all other determinations deemed necessary or advisable in the administration of the Plans. In determining persons who are to receive options and the number of shares to be covered by each option, the Committee considers the person's position, responsibilities, service, accomplishments, present and future value to the Company, the anticipated length of his future service and other relevant factors. Members of the Committee are not eligible to receive options under the Plans or otherwise during the period of time they serve on the Committee and for one year prior thereto, but may receive options after their term on the Committee is over. Officers and directors, other than members of the Committee, may receive options under the Plans. The exercise price of all options granted under or outside of the Plans equalled or exceeded the market value of the underlying shares on the date of grant. 29 OPTION GRANTS IN LAST FISCAL YEAR No options were granted during the fiscal year ended August 31, 1996. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES
Name of Securities Underlying Value of Unexercised Unexercised Options at In-the-Money Options at August 31, 1996 August 31, 1996(1) Shares Acquired on Value Name Exercise (#) Realized Unexercisable Exercisable Unexercisable Exercisable - ---------------------- ------------ -------- ------------- ----------- ------------- ----------- Harley J. Greenfield (2)(4) N/A N/A 30,000 267,047 $0 $0 Edward B. Seidner N/A N/A 0 0 0 0 George J. Nadel(3)(4) N/A N/A 33,332 16,668 0 0 Leslie Falchook(4)(5) N/A N/A 0 20,000 0 0 Rami Abada N/A N/A 0 0 0 0 Ronald E. Rudzin(4)(6) N/A N/A 0 50,000 0 0
- ---------- (1) Amount reflects the market value of the underlying shares of Common Stock as reported on the Bulletin Board on August 31, 1996 (a bid price of $2.50) less the exercise price of each option. (2) Includes (i) 122,047 options granted on September 17, 1991 at an exercise price of $4.88 per share, (ii) 150,000 options granted on April 6, 1992, at an exercise price of $8.375 per share, in connection with Mr. Greenfield's employment agreement, with such options vesting and becoming exercisable at the rate of 30,000 per year, with the first installment having become exercisable on April 6, 1993, and (iii) 25,000 options granted on January 25, 1993 at an exercise price of $13.125 per share. (3) Includes 25,000 options granted on August 1, 1995 to Mr. Nadel at an exercise price of $2.50 per share and 25,000 options granted on February 1, 1995 at an exercise price of $3.53 per share, of such options, 16,668 were exercisable at August 31, 1996. (4) All options were granted at an exercise price equal to the market value of the underlying Common Stock on the date of grant. (5) Includes 20,000 options granted on January 25, 1993 to Mr. Falchook at an exercise price of $13.125 per share. All of such options were exercisable at August 31, 1996. (6) Includes 50,000 options granted on March 7, 1988 at an exercise price of $2.75 per share, which options have all vested. 30 Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth, as of August 31, 1996, information regarding the beneficial ownership of the Company's Common Stock by (i) each person who is known to the Company to be the owner of more than five percent of the Company's Common Stock, (ii) each of the Company's directors, (iii) each of the Named Executive Officers (as defined in Item 11) and (iv) by all directors and executive officers of the Company as a group:
Amount and Nature Percent (%) of Class of Beneficial Outstanding as of Beneficial Owner Ownership(1) August 31, 1996 - ---------------- ------------ --------------- Harley J. Greenfield 1,181,241 (2)(3) 19.8% Fred J. Love 585,662 (2)(5)(6) 10.3 Edward B. Seidner 553,914 (2)(4) 9.7 Jara Enterprises, Inc. ("Jara") 343,579 (6) 6.0 JCI Consultants, L.P 1,200,000 (3)(7) 17.4 Bernard Wincig 144,573 (8) 2.5 Edward G. Bohn 8,334 (9) 0.1 Kevin J. Coyle 9,584 (9) 0.2 Leslie Falchook 45,000 (10) 0.8 George J. Nadel 16,668 (11) 0.3 Rami Abada 53,000 (12) 1.0 Ronald E. Rudzin 62,500 (13) 1.1 Hans J. Klaussner and Klaussner 1,085,623 (15) 19.0 All directors and executive 1,707,441 (2)(3)(4)(5)(6)(8)(9) 27.9 officers as a group (ten (10) persons) (10)(11)(12)(13)(14)(15)
- ---------- * Less than 0.1% (1) All of such shares are owned directly with sole voting and investment power, unless otherwise noted below. (2) The address of Messrs. Greenfield and Seidner is c/o Jennifer Convertibles, 419 Crossways Park Drive, Woodbury, New York 11797. The address of Fred J. Love is One Ames Court, Plainview, New York 11803. Mr. Greenfield and Mr. Love are brothers-in-law. See "Certain Relationships and Related Transactions." The shares of Common Stock owned by Messrs. Greenfield, Seidner and Love and the Private Company were pledged to Klaussner as part of the Klaussner Transaction. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (3) Includes (a) 492,916 shares of Common Stock owned by Messrs. Love and Seidner which have been placed in a voting trust (the "Voting Trust") (which expired in October 1996) administered by Mr. Greenfield as a voting trustee, pursuant to the Jennifer Voting Trust Agreement, under which Mr. Greenfield has shared voting and shared dispositive power with respect to such shares, (b) 171,790 Shares owned by Jara and representing a portion of 292,831 31 shares underlying options granted to Mr Greenfield by Mr. Love (which are already included as beneficially owned under (a) above) and the Private Company (the Greenfield Option"), over which Mr. Greenfield has no voting power but has shared dispositive power, as such shares may not be disposed of without the consent of Mr. Greenfield, and (c) 267,047 shares underlying vested options (but does not include 30,000 shares of Common Stock underlying stock options not vested as of August 31, 1996) granted to Mr. Greenfield by the Company, with respect to which shares Mr. Greenfield would have sole voting and dispositive power upon exercise of such options. See "Executive Compensation." Does not include 1,200,000 shares of Common Stock underlying options, which became exercisable on April 1, 1996, owned by JCI Consultant, L.P. ("JCI") and as to which Mr. Greenfield would be voting trustee. See "Certain Relationships and Related Transactions." (4) Includes (a) 250,583 shares of Common Stock owned by Mr. Seidner which are subject to the Voting Trust, over which Mr. Seidner has shared voting and shared dispositive power, and (b) 292,831 shares underlying the options granted to Mr. Seidner by Mr. Love and the Private Company (the "Seidner Option"), over which Mr. Seidner has no voting power but has shared dispositive power, as such shares may not be disposed of without the consent of Mr. Seidner. (5) Includes (a) 343,579 shares of Common Stock owned by the Private Company, over which Mr. Love has sole voting and dispositive power, as such shares are not subject to the Voting Trust, but which are subject to the Greenfield Option and the Seidner Option (the "Options") granted to Messrs. Greenfield and Seidner, respectively, (the "Optionees") and may not be disposed of without the consent of the relevant Optionee, and (b) 243,083 shares owned by Mr. Love which are subject to the Voting Trust and the Options and as to which Mr. Love has no voting power but has shared dispositive power. (6) All of such shares are beneficially owned by Mr. Love , the sole stockholder of Jara. Includes shares of Common Stock owned by three of Jara's wholly-owned subsidiaries. Jara's address was 245 Roger Avenue, Inwood, New York 11696 as of August 31, 1996 and is One Ames Court, Plainview, New York 11803 as of the date of this Annual Report. Mr. Love has sole voting and shared dispositive power over such shares, as such shares are subject to the Options and may not be disposed of without the consent of the relevant Optionee. Does not include 50,000 shares of Common Stock pledged to Jara by Rami Abada, an executive officer of the Company. (7) Represents 1,200,000 shares of Common Stock underlying exercisable options. (8) Includes 8,800 shares of Common Stock owned by Mr. Wincig's wife and 25,000 shares of Common Stock underlying vested options. (9) Includes, as to each individual, 8,334 shares of Common Stock underlying vested options, but does not include, as to each individual, 16,666 shares of Common Stock underlying options granted, which options have not yet vested. 32 (10) Includes 20,000 shares of Common Stock underlying options which have vested. (11) Includes 16,666 shares of Common Stock underlying options which are exercisable, but does not include 33,334 shares of Common Stock underlying options which are not currently exercisable. (12) Includes 50,000 shares pledged to Jara as described in Note 6. (13) Includes 50,000 shares of Common Stock underlying vested options. (14) Includes 25,000 shares of Common Stock underlying options granted to an officer of the Company other than a Named Executive Officer, which options are currently exercisable. (15) Represents shares pledged to Klaussner by Messrs. Greenfield, Seidner and Love and Jara pursuant to the Klaussner transaction. Based on information contained in the Schedule 13D filed by Hans J. Klaussner and Klaussner, Hans J. Klaussner is the sole stockholder of the parent of Klaussner and, accordingly, may be deemed the beneficial owner of shares owned by Klaussner. The principal address of Klaussner is 405 Lewallen Street, Asheboro, North Carolina 27203. Hans J. Klaussner's address is 7614 Gegenbach, Germany. Based on the Company's review of reports filed by directors, executive officers and 10% shareholders of the Company on Forms 3, 4 and 5 pursuant to Section 16 of the Securities and Exchange Act of 1934, all such reports were filed on a timely basis during fiscal year 1995. 33 Item 13. Certain Relationships and Related Transactions The Private Company In 1975, Harley J. Greenfield and his brother-in-law, Fred J. Love, formed the Private Company and created the Jennifer Convertibles concept with a single store on Park Avenue South in New York City. In 1977, they were joined by Edward B. Seidner and together the three expanded the Private Company until, by 1986, there were 21 Jennifer Convertibles stores operating in New York. The Company was incorporated in Delaware in August 1986 with the goal of expanding Jennifer Convertibles throughout the United States. To this end, an affiliated company, owned by Messrs. Greenfield, Love and Seidner (the "Licensor"), granted the Company the perpetual royalty-free, exclusive license (the "License") to use, sublicense and franchise the use of the trademark "Jennifer Convertibles(R)" which permitted the Company to open Jennifer Convertibles stores outside of New York State and the Private Company agreed, under the Original Warehousing Agreement, to support the Company by providing access to its warehousing and distribution facilities and by permitting the Company to take advantage of the Private Company's merchandise purchasing power (see "Business - Warehousing"). On March 18, 1987, the Company completed its initial public offering with five Jennifer Convertibles stores in New Jersey and Connecticut. Until November 1994 when Messrs. Greenfield and Seidner sold their interests in the Private Company for a long-term note (the "Jara Notes") and options to purchase the Common Stock owned by Mr. Love and the Private Company, Harley J. Greenfield (the Chairman of the Board, Chief Executive Officer, President and a principal stockholder of the Company), Fred J. Love (a director of the Company until August 10, 1995 and principal stockholder of the Company as of August 31, 1996) and Edward B. Seidner (a director, officer and principal stockholder of the Company) each owned 33-1/3% of Jara, which, together with its subsidiaries, comprises the Private Company, which owns or licenses the Private Stores. Following such sale, Mr. Love beneficially owns 100% of the Private Company. The Private Company is responsible for the warehousing for the Company-owned stores, the Company's licensed stores and the Private Stores, and leases and operates the Warehouse Facilities. Until December 31, 1993, the Private Company was also responsible for the purchasing and for certain advertising and promotional activities for the Company-owned stores, the Company's licensed stores and the Private Stores. Effective January 1, 1994, the Company assumed the responsibility for purchasing and advertising for itself, its licensees, and the Private Stores. The Private Company is responsible for an amount which approximates its pro-rata share of all advertising production costs and costs of publication of promotional material within the New York area. Until October 28, 1993, a corporation of which Messrs. Greenfield, Seidner and Love each owned 33-1/3% (the "Licensor") owned the trademarks "Jennifer Convertibles(R)" and "With a Jennifer Sofabed, There's Always a Place to Stay(R)" (collectively the "Marks"). On October 28, 1993, the Marks were assigned to the Company from the Licensor for nominal consideration, and the Company agreed to license such Marks to Jara in New York, as described below. Mr. Love is, and until November 1994, Mr. Seidner was, an executive officer and director of Jara and the Licensor. During the fiscal year ended August 31, 1996, Mr. Seidner received approximately $360,000 of interest on the Jara Notes from the Private Company. During the fiscal year ended August 31, 1996, Mr. Greenfield received approximately $360,000 of interest on the Jara Notes from the Private Company. With the exception of 6,250 shares owned directly by 34 Mr. Seidner, as of August 31, 1996, the shares of Common Stock directly owned by Messrs. Love and Seidner were in a voting trust, which expired October 15, 1996, administered by Mr. Greenfield as voting trustee. The shares of Common Stock owned by Messrs. Greenfield, Love, and Seidner and Jara were pledged to Klaussner as part of the Klaussner transaction. In November 1994, Mr. Greenfield and Mr. Seidner sold their interests in the Private Company in exchange for the Jara Notes and options (the "Buy-Out Options") to purchase the Common Stock owned by Mr. Love and the Private Company. The Jara Notes are $10,273,204 in aggregate principal amount ($5,136,602 owned by Mr. Greenfield and $5,136,602 owned by Mr. Seidner), bear interest at a rate of 7.5% per annum and are due in December 2023. Only interest is payable on the Jara Notes until December 1, 2001 and, thereafter principal is payable monthly through the maturity date. The Jara Notes are secured by (i) a security interest in the Private Company's personal property, (ii) Mr. Love's personal guarantee of the Private Company's performance under the Jara Notes, and (iii) a stock pledge by Mr. Love of his stock in the Private Company to secure his obligations under the guarantees. Subject to court approval of the Settlement Agreement, Messrs. Greenfield and Seidner have agreed to subordinate, until January 1, 1999, their right to receive payments in respect of the Jara Notes, if the Private Company is in default in the payment of any cash obligation to the Company arising after August 7, 1996. Such subordination does not apply to any distribution in respect of a disposition of substantially all of the assets of the Private Company. The Buy-Out Options are exercisable for an aggregate of 585,662 shares of Common Stock (292,831 by Mr. Greenfield and 292,831 by Mr. Seidner) at a price of $15.00 per share until they expire on November 7, 2004. The License Pursuant to a license agreement between the Company and Jara, Jara has the perpetual, royalty-free right to use, and to sublicense and franchise the use of, the Marks in the State of New York. The license is exclusive in such territory, subject to certain exceptions. The Purchasing and Warehousing Agreement Prior to January 1, 1994, the Private Company and the Company were parties to a Warehousing and Purchasing Agreement (the "Original Warehousing Agreement") pursuant to which the Private Company was obligated to make merchandise available to the Company on the same basis as such merchandise was made available to the Private Stores and was obligated to promptly order merchandise requested by the Company to fill special orders. The Original Warehousing Agreement provided that the Private Company would sell such merchandise to the Company at the Private Company's cost. Additionally, the Private Company was obligated to provide certain warehousing and handling services to the Company for up to 100 Company-owned stores and 200 Company licensed stores. In return, the Company paid the Private Company a fee equal to 5% of the retail selling price of all merchandise (including the retail selling price of any related services, such as fabric protection and merchandise warranties) delivered to customers of the Company's stores from the warehouse facilities operated by the Private Company, plus 5% of the retail selling price of all merchandise delivered from such warehouse facilities to Company-owned stores for display purposes. Effective January 1, 1994, the Company assumed the responsibility for purchasing for itself, its licensees and the Private Company. However, the Private Company 35 continued to provide warehousing and handling services as described above. During the fiscal year ended August 31, 1996 the Company and the LPs paid warehouse fees to the Private Company aggregating approximately $5,302,000. During the fiscal year ended August 31, 1996, the Private Company purchased from the Company approximately $10,200,000 of merchandise (net of discounts and allowances). Under the terms of the Warehousing Agreement, however, the Company was not obligated to use the Private Company's warehouse facilities or purchase through the Private Company. As part of the transfer of the purchasing function, the Private Company, on May 29, 1994, agreed to pay the Company $1,000,000 representing discounts and allowances received from suppliers with respect to merchandise previously delivered. Such payment was in the form of a note, dated May 29, 1994, calling for payments in 36 equal monthly installments and bearing interest at 8% per annum. The Private Company made $333,334 of payments on such note during the fiscal year ended August 31, 1996, leaving $305,555 principal amount outstanding as of August 31, 1996. As set forth in "Business-Warehousing," the Private Company also provides certain other services at the Warehouse Facilities, including arranging for goods to be delivered to the Warehouse Facilities and customers and providing fabric protection, customer service and warranty services. The Private Company is reimbursed by the Company and its licensees for freight charges on deliveries to the Warehouse Facilities at predetermined freight rates. The Private Company also provides fabric protection services, including a life-time warranty, to customers of the Company and its licensees. The Company retains approximately 2/3 of the revenues from fabric protection and the warranty. During the fiscal year ended August 31, 1996, the Company and the LPs paid $3,042,000 for freight charges and $2,972,000 for fabric protection to the Private Company. See "The Committee Report" below. The Inwood, New York warehouse facility (the "Inwood Warehouse"), which was the main facility servicing the Company's stores until such facility was sold in June 1996, was owned (subject to a ground lease) equally by two corporations, one of which was owned 33-1/3% by each of Messrs. Greenfield, Love and Seidner and the other of which was partially owned by the brother-in-law of Isabelle Silverman, the Company's Vice President-Finance and Treasurer from May 1, 1992 to January 1, 1994. On December 1, 1994, the Inwood Warehouse was transferred to a corporation owned by Fred Love. On June 29, 1988, the Company acquired a 10-year option to purchase the Inwood Warehouse (subject to a ground lease with a non-affiliate expiring in February 2035) for its appraised value, as of June 1988, of $9,000,000, increasing each year of the option period by an additional $900,000. The option was granted in consideration of the guarantee by the Company, and others, of $6,500,000 of mortgage financing on the Inwood Warehouse. The guarantors, other than the Company (i.e., Jara and Messrs. Greenfield, Love and Seidner), agreed to indemnify the Company against any loss under the guarantee and agreed to pay the Company an annual guarantee fee of $32,500, representing 1/2 of 1% of the amount guaranteed. As of August 31, 1993, the mortgage was refinanced and the amount guaranteed by the Company was reduced from $6,500,000 to $5,000,000 (which mortgage was scheduled to become due on October 7, 1994). The mortgage was refinanced again, in October 1994, and was due over a five-year period with a final maturity date of October 7, 1999. The Company guaranteed a portion of the debt equal, at any time, to 60% of the aggregate amount of the debt then outstanding. The other guaranty and indemnity arrangements as to such refinancing were the same as for the original financing, and the Company was entitled to receive an annual guarantee fee of 1/2 of 1% of the amount guaranteed. In March 36 1996, as part of the Klaussner Transaction, among other things, Klaussner loaned the Private Company $1,440,000, which was used to reduce the debt guaranteed by the Company from $4,800,000 to $3,360,000 and the lender agreed that the Company's liability under the guarantee would be limited to the lesser of 60% of the debt or $2,016,000. In June 1996, in connection with the sale of the Inwood Warehouse, the mortgage was extinguished without liability to the Company. The Company also guarantees the lease for the Private Company's satellite warehouse in California. Such lease expires September 30, 1998 and the annual base rent is $133,000. Pursuant to an agreement dated September 1, 1993, the Company is indemnified against any liability arising under such guaranty by the Private Company. By agreement, dated May 19, 1995, between the Company and the Private Company, the parties agreed to settle a dispute as to certain discounts and allowances on merchandise owed to the Company by the Private Company and certain licensees managed by the Private Company for the period from January 1, 1994 to April 30, 1995. The agreement provides that the Private Company will pay the Company $473,000, $200,000 of which was paid in May 1995, and the balance in five equal installments (inclusive of interest at a rate of 10.5% per annum) through November 1, 1995. As of December 1995, all of such amounts had been paid. In addition, the Company agreed, beginning in May 1995, to pay the Private Company its share of discounts and allowances within 30 days of the end of each month. By agreement (the "Offset Agreement") dated November 1, 1995, the Private Company and the Company acknowledged that as of August 26, 1995 the Private Company owed the Company $9,267,962, certain licensees owed the Company $2,117,616 for merchandise purchased (of which $1,865,813 was past due) and the Company owed the Private Company $11,459,677. In addition, the Private Company agreed to assume the obligations of the licensees referred to above and to offset the amounts owed to the Company by the Private Company against the amounts owed to the Private Company by the Company. By agreement dated March 1, 1996, the Private Company and the Company agreed to continue to offset, on a monthly basis, amounts owed by the Private Company and certain licensees to the Company for purchasing, advertising, and other services and matters against amounts owed by the Company to the Private Company for warehousing services, fabric protection, freight and other services and matters. Amounts owed by the Private Company to the Company as of August 31, 1996 are reserved against in the accompanying consolidated financial statements due to uncertain collectibility. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Advertising Agreement Under the advertising agreement with the Private Company, the Private Company bears a share of all advertising production costs and costs of publication of promotional advertising material within the New York area. During the fiscal year ended August 31, 1996, the Company charged the Private Company and the Unconsolidated Licensees $2,374,000 for advertising. 37 Jennifer Living Rooms In September 1996, the Company, opened two test "Jennifer Living Rooms" stores in St. Louis, Missouri. As part of its license with the Private Company, the Private Company also has the royalty free right to open "Jennifer Living Rooms" stores in New York. In October 1996, the Private Company began operating a test store in New York under the name "Jennifer Living Rooms." Other Matters As described under the heading "The Committee" below, a committee of the Board of Directors consisting of Michael Colnes concluded that the Company had claims against Messrs. Greenfield, Love, Seidner and the Private Company. During fiscal 1996, the Company paid legal fees for Harley J. Greenfield of $44,700 in connection with these matters. JCI Related parties of JCI, which is the holder of options to purchase 1,200,000 shares of Common Stock, also own a majority limited partnership interest in Jennifer Chicago, L.P. (the "Chicago Partnership"), an LP which operates, pursuant to a license agreement with the Company, 15 Jennifer Convertibles stores in the Chicago, Illinois area, and, until the Company purchased it as of September 1, 1994, Jennifer L.P. II ("L.P. II"), an LP which operated, pursuant to a license agreement with the Company, 21 Jennifer Convertible stores in the Detroit, St. Louis, Indianapolis, Milwaukee and Kansas City metropolitan areas. During the fiscal year ended August 31, 1996, the Company earned $507,000 of royalties from the Chicago Partnership, which are not separately shown in the financial statements due to the consolidation of the LPs for financial statement purposes. Other Matters In January 1994, Rami Abada, the Company's Executive Vice President and Chief Operating Officer, and Ronald Rudzin the Company's Senior Vice President - - Retail Stores, joined the Company. Mr. Abada and Mr. Rudzin each own interests in certain licensed Jennifer Convertibles stores, which they acquired while employees of the Private Company. Mr. Abada owned until October 1996, a 20% interest in one corporation which owns six licensed Jennifer Convertibles stores. During the year ended August 31, 1996, such corporation incurred approximately $160,000 in royalties and $1,443,000 for merchandise purchases owed to the Company. Such entity did not make any payments to the Company in respect of a 9% secured note, due December 31, 2001, in the original principal amount of $810,000 (which principal amount was $638,000 as of August 31, 1996). In addition, such corporation owes the Company $500,000 principal amount under a Revolving Credit Agreement pursuant to which all available revolving credit loans have been drawn down. Such loans bear interest at prime plus 3% and were due on June 1, 1995. Mr. Abada also 38 owned a 20% interest in each of two corporations, (until October 1996, when he acquired the remaining 80% interest in such corporations) which each own a licensed Jennifer Convertibles store. During the year ended August 31, 1996, such corporations incurred an aggregate of approximately $80,300 in royalties and $714,900 for merchandise purchases owed to the Company. Mr. Rudzin owns one licensed Jennifer Convertibles store and his father owns two licensed Jennifer Convertibles stores which during the fiscal year ended August 31, 1996 incurred approximately $34,000 (for Mr. Rudzin's stores) and $100,600 (for Mr. Rudzin's father's stores) of royalties and $308,400 (for Mr. Rudzin's store) and $892,200 (for Mr. Rudzin's father's stores) for merchandise purchases. During the fiscal year ended August 31, 1996, Mr. Abada received $328,000 of salary, severance pay, distributions and other payments from such licensees and the Private Company and Mr. Rudzin received approximately $198,000 of salary, distributions and other payments from such licensees and the Private Company. Amounts owed to the Company by the corporate licensees referred to above, (each of which is an Unconsolidated Licensee) have been fully reserved against in the accompanying financial statements for the 1994, 1995 and 1996 fiscal years due to uncertain collectibility. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Subject to court approval of the Settlement Agreement, Mr. Abada and Mr. Rudzin have agreed, from the date of such approval forward, to personally guarantee the merchandise purchases and royalty obligations of the Unconsolidated Licensees in which they respectively have an ownership interest. The Company uses and the Private Company from time to time, also uses Wincig & Wincig, a law firm of which Bernard Wincig, a director of the Company and a stockholder, is a partner. Mr. Wincig received approximately $188,500 of legal fees from the Company and the LPs and an aggregate of approximately $36,000 from the Private Company during the fiscal year ended August 31, 1996. In November 1996, Klaussner agreed to give the Company $1,075,000 of vendor allowances. See also "Business- Sources of Supply" for other transactions with Klaussner. The Committee Report On April 12, 1994, the Company's Board of Directors established a committee consisting of one director, Michael Colnes ("Colnes"), to investigate (i) allegations set forth in a draft complaint (the "Draft Complaint") delivered to the Company by counsel to Selig Zises and Glenn S. Meyers and (ii) related party transactions. Colnes was assisted in such investigation by the law firm of Schulte Roth & Zabel and the accounting firm of Ernst & Young, LLP. On December 2, 1994, Colnes delivered a summary report (the "Summary Report") concluding that the Company had meritorious claims against Harley J. Greenfield, Edward B. Seidner, Fred J. Love, the Private Company, Isabelle Silverman, and Jerome I. Silverman, a senior advisor to the Company. On January 26, 1995, Colnes delivered the final report (the " Committee Report"), which reaffirmed substantially all the conclusions contained in the Summary Report. In March 1995, the Company's Board of Directors received the response (the "Response") to the Committee Report. The Response, which was prepared on behalf of Mr. Greenfield, by the law firm of Skadden, Arps, Slate, Meagher & Flom and Ten Eyck Associates, Inc., an independent 39 consulting firm headed by Ernest Ten Eyck, formerly an assistant chief accountant at the Securities and Exchange Commission, concluded that there were no valid claims. The Response stated, among other things, that "Based upon its unrestricted review of the books and records of both the Private Company and the Company...Ten Eyck found nothing in the Company-Private Company relationship that appears to be improper or reflects adversely on the integrity of the senior management of the Company, including Mr. Greenfield." Set forth below is a brief summary of those matters as to which the Committee Report recommended that the Company take legal action and the Response's reply. As set forth under "Legal Proceedings," in March 1996, the Company signed a Memorandum of Understanding with designed to settle the issues raised by the Committee Report. See "Legal Proceedings." Rebates A. The Committee Report The Committee Report concluded that there were meritorious claims relating to rebates received by the Private Company from merchandise vendors, which were passed on to the Company, but not to the Company's licensees. The claims fall into three categories: (i) that the rebates paid to the Company were paid annually, rather than upon receipt by the Private Company, (ii) that rebates with respect to licensees were retained by the Private Company rather than paid to the Company, including, for a short period, rebates with respect to licensees which had entered into purchasing and warehousing contracts directly with the Company instead of with the Private Company, and (iii) that, when the Private Company agreed to transfer the rebates from licensees to the Company effective as of January 1, 1994 and agreed to give the Company a note (the "Rebate Note") for $1,000,000 representing the amount of such rebates for previously delivered merchandise, representatives of the Private Company misrepresented to the Company's Board of Directors that the Private Company did not have sufficient funds to pay the Rebate Note, on the basis of which misrepresentation the Board agreed to accept the Rebate Note rather than pressing for payment in cash. B. The Response The Response asserts that the Private Company was not contractually obligated to pass such rebates along to the Company and that the Committee Report acknowledged that such rebates were passed along as a matter of practice and not contract. The Response also asserts that the agreements with the licensees were quite clear that the licensees were not entitled to such rebates and that, during all relevant times, the purchasing and warehousing functions were performed for licensees entirely by the Private Company and were not and could not have been performed by the Company. The Response concludes that since the Company was not entitled to the rebates (but only received them as an accommodation), the Company can not complain about delay in the payment of such rebates. The Response also takes the position that due to a miscalculation the Company received approximately $450,000 in excess rebates for the fiscal years 1988 through 1993 which really 40 belonged to the Private Company. In addition, the Response states that, since the Private Company was providing all the services to licensees, it would have been an unfair windfall for the Company to receive the related rebates. As to the Rebate Note, the Response argues that (1) since the Company is not entitled to rebates there was no misrepresentation and asserts that the Private Company had no obligation to pay the $1,000,000 at all, and (2) the Note bears interest, provides for an increased interest rate in the event of default and is being paid in a timely manner. Fabric Protection A. The Committee Report The Private Company provides fabric protection services, including a life-time warranty, to those customers of the Company and its licensees who purchase such services. Approximately 2/3 of the revenues from fabric protection are retained by the Company and its licensees. The remaining 1/3 (approximately $3,300,000 and $3,800,000 paid by the Company and the LPs for the years ended August 27, 1994 and August 31, 1996, respectively) was paid to the Private Company and has been used, according to the Response, to cover the cost of fabric protection and warranty services and to fund the provision of additional services to the Company and the LPs which the Private Company was not obligated to provide. The Committee Report concluded that since the Company's Board of Directors had never approved the arrangement, the Company had a claim against the Private Company for an amount equal to the profit made by it for providing such services. B. The Response The Response cites provisions of Delaware law to the effect that a related party transaction does not need to be approved by the disinterested members of the Board if the transaction is fair. The Response states, based on a survey of the prices charged for fabric protection by a number of non-affiliated third parties (which do not provide a life-time warranty) and certain consultants, that the price charged by the Private Company is "not only fair, but generous." Accordingly, the Response concludes that the Company has no claim for damages regarding fabric protection. Freight Charges A. The Committee Report The Private Company charges the Company and its licensees for delivery of merchandise from the manufacturer to its warehouse at a price equal to the manufacturer's freight rate for such delivery. The Original Warehousing Agreement was silent as to freight charges, other than for the statement that purchasing should be done "at cost." The warehousing agreement and purchasing agreement, each entered into in December 1993 (the "New Agreements"), specifically provided that 41 the freight delivery component of cost should be based on the manufacturer's freight rate. From time to time, the Private Company hires independent truckers to deliver merchandise to its warehouse at a price less than the manufacturer's freight rate. The Committee Report concluded that the Company has a claim for the difference between the freight rate and the amount charged by the independent truckers. B. The Response The Response states that the Private Company actually charged the Company significantly less than "cost" for freight, primarily because the Private Company did not separately bill the Company for certain costs which it incurs for delivering merchandise from the central warehouse in New York to satellite warehouses or local distribution or staging areas in territories outside of New York. Accordingly, the Response concludes that the Private Company has not made any money on freight charges to the Company. Assumption of Purchasing Responsibilities A. The Committee Report In connection with the Company's assumption from the Private Company of the merchandise purchasing function, effective January 1, 1994, the Committee Report claimed that Messrs. Greenfield, Love, Seidner and Silverman and Mrs. Silverman (i) misled the Company's Board of Directors that assuming the purchasing function would not entail additional cost (in connection with the transfer of the purchasing function, two new officers were appointed to the Company and six former employees of the Private Company, with salaries aggregating $166,000 per annum, became employees of the Company) and (ii) caused licensees to pay receivables of approximately $4,300,000 to the Private Company instead of to the Company, thereby allowing the receivable from the licensees (which the Committee Report believed to be insolvent) to grow. B. The Response The Response argues that there was no misrepresentation and that, among other things, disclosure in the Company's prior public filings had clearly indicated that the assumption of the purchasing function would involve additional costs. In addition, the Response notes that the addition of certain of the six employees was unrelated to the assumption of the purchasing function. The Response also states, among other things, that payments of receivables by licensees were made, as is customary, on the basis of oldest receivables first. Amounts due to the Private Company that were paid were for periods prior to December 31, 1993 and amounts due to the Company were for the period subsequent to January 1, 1994. 42 Pass Through of Credit From Supplier A. The Committee Report According to the Committee Report, a principal supplier to the Company, the Private Company and the licensees gave a credit to the Private Company of $50,000 for each new Jennifer Convertibles store opened between September 1991 and February 1994, for a total of $3,500,000. The Committee concluded that this transaction was not disclosed to the Company's Board of Directors and that the Private Company should have passed such loans on to the Company's licensees, and that the Company was damaged by its failure to do so. B. The Response The Response indicates that the arrangement between the Private Company and its supplier was never intended to be passed along to the Company's licensees. Pursuant to the Purchasing Agreements with the licensees, the Private Company bore most of the risk of carrying inventory and the terms upon which such licensees purchased from the Private Company, including payment terms, were set forth in the contracts with such licensees. In addition, because the credit was actually a loan which bore interest at 3% above prime, the Private Company did not benefit from, and the Company was not damaged by, the failure to pass the credit along to the licensees. Use of Rebates and Supplier Credit to Develop Warehouses A. The Committee Report The Committee Report states that the use by the Private Company of licensee rebates and supplier credits for which the Committee Report concluded (as set forth above) the Company had a claim in order to extend the Private Company's warehouse system was a usurpation of corporate opportunity which belonged to the Company. B. The Response The Response states that for the reasons discussed earlier the Company does not have a valid claim for the credits or the rebates and that, in any event, the warehousing function has always been performed by the Private Company since the Company's inception, and the Company has not had, until recently, the financing to open its own warehouse or the inclination to use such financing to open warehouses instead of stores. The Response, therefore, concludes that there was no usurpation of corporate opportunity. 43 Other Claims A. The Committee Report Among other things, the Committee Report also concluded that the Company had claims for breach of fiduciary duty against the principal officers of the Company relating to the obstruction of its work by denying it full access to the books and records of the Private Company and for improper delegation of authority by Messrs. Greenfield, Seidner and Love to Mr. Silverman. B. The Response The Response contends there is no support for the claim as to obstruction against Mr. Greenfield (who on several occasions voiced his support of Colnes' request for access) and indicates that Delaware law permits delegation of certain duties. The Colnes Letter On or about November 22, 1994, Colnes sent a letter to Harley Greenfield as President of the Company, calling Mr. Greenfield's attention to certain information which had come to Colnes' attention during the previous few days through his work on the Committee (the "Letter"). The Letter reviewed certain transactions recorded on the books and records of S.F.H.C., the owner of six licensee stores, the Private Company and its affiliates, the Company, and certain LPs (LPs III through V). Based on his review of the transactions, the Letter sets forth the following conclusions: (a) "It appears... that Private Company funds [totalling $300,000] were used by S.F.H.C. to acquire the stock of Summit"(2) Investment Group, Inc. ("Summit") from the Company, and that "no funds were contributed by the purported stockholders of S.F.H.C. to the acquisition of the stock of Summit;" (b) S.F.H.C. made a loan of $1,000,000 on behalf of one of its purported shareholders to invest in LP III, which funds were required by S.F.H.C. for its operations and not otherwise available for personal use by S.F.H.C. shareholders; and further, that S.F.H.C. was able to pay a total of more than $1,000,000 due from it to the Private Company by allowing its accounts payable to the Company to accumulate from zero to more than $1,000,000, most of which was older than 30 days; - ---------- (2) SFHC was created for the specific purpose of acquiring Summit. 44 (c) "It appears... that [$500,000 in] Company funds were used by S.F.H.C. and ... shareholders for capital contributions to LPs IV and V and that no funds were contributed by either the limited partners of LPs III through V or the purported stockholders of S.F.H.C.; and further, that Private Company funds [totalling $1,100,000] were used for additional capital contributions to LPs IV and V." On April 3, 1995, Jerome I. Silverman, as accountant to the Private Company, responded to Mr. Greenfield regarding the various matters raised in the Letter (the "Silverman Response"). The Silverman Response states that the funding for S.F.H.C. and LPs III through V was consistent with the requirement that 80% or more of the equity interest in each of these entities be owned by parties who were not affiliated with either the Company or the Private Company, in order to enable the Company to take advantage of the accounting technique of off-balance sheet financing. With respect to the specific transactions discussed in the Letter, and its conclusions as summarized in (a), (b), and (c) above, the Silverman Response states: (a) The cash portion of the purchase price which S.F.H.C. paid for Summit [$270,000] represented only 20% of the equity of Summit (and therefore S.F.H.C.) and was put up by Mr. Abada, who personally borrowed those funds from the Private Company pursuant to a loan collateralized by 50,000 shares of Common Stock. The remaining 80% in S.F.H.C. is owned by three other individuals who are not affiliated with either the Company or the Private Company, and that 80% equity interest was acquired for an interest-bearing note from S.F.H.C. to the Company which is being paid on a current basis; (b) At the time the $1,000,000 loan from S.F.H.C. was made to a shareholder to fund his capital contribution to LP III, the Private Company still had responsibility for purchasing and there were no trade accounts payable from S.F.H.C. to the Company; (c) The $500,000 in loans from the Company to S.F.H.C. was consistent with the loans made to other licensees of the Company and was contemplated by the "Use of Proceeds" section in the Prospectus for the Debenture offering and the revolving credit agreement, and the decision as to the manner in which those funds were used was within the authority of the shareholders of S.F.H.C. or Mr. Silverman as their duly authorized representative; and further, the Private Company funds used for the additional capital contributions to LPs IV and V were secured by promissory notes from the limited partners of those LPs to the Private Company. 45 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Financial Statements. See the Index immediately following the signature page. (b) Reports on Form 8-K. During the quarter ended August 31, 1996, the Company did not file Current Reports on Form 8-K. (c) Exhibits. 3.1 - Certificate of Incorporation of the Company (Incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement -File Nos. 33-22214 and 33-10800 (the "Registration Statement"). 3.2 - By-Laws of the Company. (Incorporated herein by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended August 26, 1995). 4.1 - Form of Underwriter's Warrant for the purchase of shares of Common Stock (Incorporated herein by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-2 - File No. 33-47871 (the "Registration Statement on Form S-2")). 10.1 - Incentive and Non-Qualified Stock Option Plan, as amended (Incorporated herein by reference to Exhibit 10.4 to the Registration Statement). 10.2 - Stock Option Agreement, dated March 21, 1991, between Jennifer Convertibles, Inc. and JCI Consultant L.P. (Incorporated herein by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated March 21, 1991). 10.3 - Voting Trust Agreement, dated March 21, 1991, between Harley J. Greenfield, Jennifer Convertibles, Inc. and JCI Consultant L.P. (Incorporated herein by reference to Exhibit 3 to the Company's Current Report on Form 8-K dated March 31, 1991). 46 10.4 - Registration and Sales Agreement, dated March 21, 1991, between Jennifer Convertibles, Inc. JCI Consultant, L.P., Harley J. Greenfield, Fred J. Love, Edward B. Seidner and Jara Enterprises, Inc. (Incorporated herein by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated March 21, 1991). 10.5 - Agreement of Limited Partnership of Jennifer Chicago, L.P. (the "Partnership"), dated July 24, 1991 (Incorporated herein by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated July 24, 1991 - related to series of agreements related to Limited Partnership of Jennifer Chicago L.P.). 10.6 - Purchase Option Agreement, dated July 24, 1991, between Jennifer Convertibles, Inc. and the limited partner of the Partnership (Incorporated herein by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated July 24, 1991). 10.7 - Omnibus Agreement, dated July 24, 1991, between Jennifer Convertibles, Inc. and the Partnership (Incorporated herein by reference to Exhibit 3 to the Company's Current Report on Form 8-K dated July 24, 1991). 10.8 - Warehousing and Purchasing Agreement, dated July 24, 1991, between Jennifer Convertibles Inc., and the Partnership (Incorporated herein by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated July 24, 1991). 10.9 - Amended and restated 1991 Incentive and Non-Qualified Stock Option Plan (Incorporated herein by reference to Exhibit 10.29 to the Registration Statement on Form S-2). 10.10 - Amendment to Stock Option Agreement dated February 25, 1992 between the Company and JCI (Incorporated herein by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated February 25, 1992). 10.11 - Letter Agreement dated February 25, 1992 among the Company, JCI and Harley J. Greenfield, amending a Voting Trust Agreement (Incorporated herein by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated February 25, 1992). 10.12 - Amended and Restated Registration and Sale Agreement dated as of February 25, 1992 among the Company, JCI, Harley J. Greenfield, Fred J. Love, 47 Edward B. Seidner and Jara (Incorporated herein by reference to Exhibit 3 to the Company's Current Report on Form 8-K dated February 25, 1992). 10.13 - Warehousing Agreement, dated as of December 31, 1993, between Jennifer Convertibles, Inc. and Jennifer Warehousing, Inc. (Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ending February 26, 1994). 10.14 - Purchasing Agreement, dated as of December 31, 1993, between Jennifer Convertibles, Inc. and Jara Enterprises, Inc. (Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ending February 26, 1994). 10.15 - Advertising Agreement, dated as of December 31, 1993, between Jennifer Convertibles, Inc. and Jara Enterprises, Inc. (Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ending February 26, 1994). 10.16 - Amendment No. 1 to Warehousing Agreement, dated as of May 28, 1994, amending the Warehousing Agreement referred to in 10.29 and the related Rebate Note. (Incorporated herein by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the fiscal year ended August 27, 1994). 10.17 - Amendment No. 1 to Purchasing Agreement, dated as of May 28, 1994, amending the Purchasing Agreement referred to in 10.30. (Incorporated herein by reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K for the fiscal year ended August 27, 1994). 10.18 - License Agreement, dated as of October 28, 1993, among Jennifer Convertibles Licensing Corp. and Jara Enterprises, Inc. (Incorporated herein by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated November 30, 1993). 10.19 - Letter Agreement with JCI Consultant, L.P. (Incorporated herein by reference to the Company' Current Report on Form 8-K dated August 1, 1994). 10.20 - Agreement, dated as of May 19, 1995, among Jennifer Convertibles, Inc., Jennifer Purchasing Corp., Jara Enterprises, Inc. and the licensees signatory thereto. (Incorporated herein by reference to Exhibit 10.38 to the Company's Annual Report on Form 10-K for the fiscal year ended August 26, 1995.) 48 10.21 - Agreement, dated as of November 1, 1995, among Jennifer Convertibles, Inc., Jennifer Purchasing Corp., Jara Enterprises, Inc. and the licensees signatory thereto. (Incorporated herein by reference to Exhibit 10.39 to the Company's Annual Report on Form 10-K the for fiscal year ended August 26, 1995.) 10.22 - Settlement Agreement, dated as of March 8, 1996, between Jennifer Convertibles, Inc. and Jara Enterprises, Inc. (Incorporated by reference to Exhibit 3 to the Company's Current Report on Form 8-K dated March 18, 1996). 10.23 - Memorandum of Understanding for Settlement of Jennifer Convertibles Securities Litigation (Incorporated by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated March 18, 1996). 10.24 - Memorandum of Understanding for Settlement of Certain Derivative Claims (Incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated March 18, 1996). 10.25 - Form of Note, dated November 1994, made by Jara Enterprises, Inc. to Harley J. Greenfield and Edward B. Seidner. (Incorporated herein by reference to Exhibit 10.43 to the Company's Annual Report on Form 10-K for the fiscal year ended August 26, 1995.) 10.26 - Form of Option, dated November 7, 1994 to purchase Common Stock from Fred Love, Jara Enterprises, Inc. and certain subsidiaries to Harley J. Greenfield and Fred Love. (Incorporated herein by reference to Exhibit 10.44 to the Company's Annual Report on Form 10-K for the fiscal year ended August 26, 1995.) 10.27 - Form of Subordination Agreement, dated as of August 9, 1996, by Harley J. Greenfield and Edward B. Seidner. (Incorporated herein by reference to Exhibit 10.45 to the Company's Annual Report on Form 10-K for the fiscal year ended August 26, 1995.) 10.28 - Credit and Security Agreement, dated as of March 1, 1996, among Klaussner Furniture Industries, Inc. and Jennifer Convertibles, Inc. and the other signatories thereto (Incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated March 18, 1996). 11.1 - Statement re computation of Net (Loss) Per Share (for fiscal years ended August 31, 1996, August 26, 1995 and August 27, 1994). 49 22.1 - Subsidiaries of the Company. (Incorporated herein by reference to Exhibit 22.1 on the Company's Annual Report on Form 10-K for fiscal year ended August 27, 1994.) (d) Financial Statement Schedules. All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is shown in the consolidated financial statements or notes thereto. 50 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. JENNIFER CONVERTIBLES, INC. By: /s/ Harley J. Greenfield -------------------------- Harley J. Greenfield, Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated below. 51 NAME POSITION DATE - ---- -------- ---- /s/ Harley J. Greenfield ------------------------ Harley J. Greenfield Chairman of the Board, December 6, 1996 President and Chief Executive Officer (Principal Executive Officer) /s/ George J. Nadel ------------------------ George J. Nadel Executive Vice President, December 6, 1996 Chief Financial Officer and Treasurer (Principal Financial Officer and Principal Accounting Officer) /s/ Edward B. Seidner ------------------------ Edward B. Seidner Director December 6, 1996 /s/ Bernard Wincig ------------------------ Bernard Wincig Director December 6, 1996 /s/ Edward Bohn ------------------------ Edward Bohn Director December 6, 1996 /s/ Kevin J. Coyle ------------------------ Kevin J. Coyle Director December 6, 1996 52 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Index to Financial Statements Independent Auditors' Report.........................................F1 Consolidated Balance Sheets at August 31, 1996 and August 26, 1995 ...................................................F3 Consolidated Statements of Operations for the years ended August 31, 1996, August 26, 1995 and August 27, 1994.................F4 Consolidated Statements of Stockholders' Equity (Capital Deficiency) for the years ended August 31, 1996, August 26, 1995 and August 27, 1994..................................F5 Consolidated Statements of Cash Flows for the years ended August 31, 1996, August 26, 1995 and August 27, 1994.................F6 Notes to the Consolidated Financial Statements.......................F7 REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders Jennifer Convertibles, Inc. Woodbury, New York We have audited the accompanying consolidated balance sheets of Jennifer Convertibles, Inc. (the "Company") and subsidiaries as at August 31, 1996 and August 26, 1995, and the related consolidated statements of operations, stockholders' equity (capital deficiency) and cash flows for the year ended August 31, 1996. These financial statements are the responsibility of the Company's management. We conducted our audits of the consolidated balance sheets as at August 31, 1996 and August 26, 1995, and the related consolidated statements of operations, stockholders' equity (capital deficiency) and cash flows for the year ended August 31, 1996, in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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 consolidated balance sheets as at August 31, 1996 and August 26, 1995, and the related consolidated statements of operations, stockholders' equity (capital deficiency) and cash flows for the year ended August 31, 1996 present fairly, in all material respects, the consolidated financial position of Jennifer Convertibles, Inc. and subsidiaries at August 31, 1996 and August 26, 1995, and the consolidated results of their operations and their cash flows for the year ended August 31, 1996, in conformity with generally accepted accounting principles. We were engaged to audit the consolidated statements of operations, stockholders' equity (capital deficiency) and cash flows of the Company for the years ended August 26, 1995 and August 27, 1994. These financial statements are the responsibility of the Company's management. We were not engaged to audit the financial statements of the Company as at and for the year ended August 27, 1994 until subsequent to that date. The Company was unable to furnish us with documentation to enable us to satisfy ourselves as to the opening balances for such year. In addition, certain significant records and documents pertaining to the year ended August 31, 1994 could not be located. Further, the Company recorded significant charges and credits in the fiscal year ended August 26, 1995 as to which it was unable to furnish us with sufficient documentation to enable us to determine whether any portion of such charges and credits was applicable to the year ended August 27, 1994. As discussed in Notes 1 and 3, a company owned by three officers of the Company (the "Private Company") performed purchasing, warehousing and inventory control, distribution, fabric protection, advertising, data processing and other services on behalf of the Company for all or part of the periods covered by the accompanying financial statements. Effective January 1, 1994, the Company began providing the purchasing and advertising services for itself, the Private Company and other affiliates. The Private Company was unable to provide us with documentation for certain of the transactions performed by the Private Company on behalf of the Company. F1 The Company did not have an adequate system of internal accounting controls over the financial information processed for the Company by the Private Company prior to August 26, 1995. Further, the chief financial officer of the Company has stated that he was unable to maintain internal controls over the financial data processed by the Private Company on behalf of the Company and that the Company was seriously deficient regarding the adequacy of internal controls that support its operations prior to August 26, 1995. As a result of this lack of control, the chief financial officer has stated that he was unable to provide certain representations we requested regarding the Company's statements of operations and cash flows for the year ended August 26, 1995 and the financial statements as at and for the year ended August 27, 1994. Because of the matters discussed in the preceding three paragraphs, we are unable to express, and we do not express, an opinion on the accompanying consolidated statements of operations, stockholders' equity (capital deficiency) and cash flows for the years ended August 26, 1995 and August 27, 1994. No representation to the contrary should be expressly or implicitly assumed from the issuance of the accompanying financial statements. As discussed in Note 9, in December 1994 and January 1995, the Company and certain of its officers became defendants in class and derivative actions. The Company is attempting to settle the above litigations and has agreed to terms which, subject to the execution of definite agreements and court approval, would settle the class action and derivative litigations. Further, in May 1995, the Securities and Exchange Commission commenced an investigation relating to the aforementioned matters. The outcome of these matters is not presently determinable and an unfavorable outcome could have a material adverse affect on the Company's ability to continue as a going concern. Attention is directed to Note 1 with respect to various operational problems which the Company has experienced in the past three years and management's plans for contending with these problems. Attention is also directed to Notes 1, 3 and 9 with respect to various related party transactions. Richard A. Eisner & Company, LLP New York, New York November 22, 1996 F2 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except for share data) ASSETS
(SEE NOTE 5) August 31, 1996 August 26, 1995 ---------------- ---------------- Current assets: Cash and cash equivalents $ 3,600 $ 7,729 Merchandise inventories 8,221 9,432 Refundable income taxes 23 131 Prepaid expenses 446 761 Accounts receivable 1,588 2,504 Other current assets 8 101 ---------------- ---------------- Total current assets 13,886 20,658 Store fixtures, equipment and leasehold improvements, at cost, net 8,739 9,771 Due from Private Company and Unconsolidated Licensees, net of reserves of $7,324 and $6,372 at August 31, 1996 and August 26, 1995. -- -- Deferred lease costs and other intangibles, net 1,317 1,839 Goodwill, at cost, net 568 586 Other assets (primarily security deposits) 925 1,017 ------------------ ----------------- $ 25,435 $ 33,871 ================== ================= LIABILITIES AND (CAPITAL DEFICIENCY) Current liabilities: Accounts payable, trade $ 15,746 $ 16,108 Customer deposits 8,875 9,017 Accrued expenses and other current liabilities 5,022 6,521 ----------------- ---------------- Total current liabilities 29,643 31,646 Deferred rent and allowances 5,868 6,171 Long-term obligations under capital leases 230 337 ----------------- ---------------- Total liabilities 35,741 38,154 ----------------- ---------------- Commitments and contingencies (Capital deficiency) Preferred stock, par value $.01 per share. Authorized 1,000,000 shares; no shares issued -- -- Common stock, par value $.01 per share. Authorized 10,000,000 shares; issued and outstanding 5,700,725 shares at August 31, 1996 and August 26, 1995 57 57 Additional paid-in capital 22,911 22,911 Notes receivable from warrant holders (300) (300) Accumulated (deficit) (32,974) (26,951) ----------------- ---------------- (10,306) (4,283) ----------------- ---------------- $ 25,435 $ 33,871 ================= ================
Attention is directed to the foregoing Accountants' Report and to the accompanying Notes to the Consolidated Financial Statements. F3 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Consolidated Statements of Operations (In thousands, except for share data)
Year ended Year ended Year ended August 31, 1996 August 26, 1995 August 27, 1994 --------------- --------------- --------------- Net sales $106,041 $126,074 $97,420 ------------ ----------- ------------- Cost of sales, including store occupancy, warehousing, delivery and fabric protection (including charges from Private Company of $11,836, $13,883, and $28,521) 72,708 86,964 67,974 Selling, general and administrative expenses (including advertising charges from Private Company of $0,$0 and $3,786) 37,618 45,955 34,139 Depreciation and amortization 1,852 2,261 2,091 Termination of consulting agreement, legal and other costs -- 500 6,604 Write off of purchased limited partners' interests -- -- 3,482 Provision for losses on amounts due from Private Company and Unconsolidated Licensees 952 3,088 3,284 Loss from store closings 191 1,670 -- ------------ ----------- ------------- 113,321 140,438 117,574 ------------ ----------- ------------- Operating (loss) (7,280) (14,364) (20,154) ------------ ----------- ------------- Other income (expense): Royalty income 375 523 644 Interest income 195 311 473 Interest expense (47) (48) (61) Gain on sale of securities -- -- 336 Other income, net 880 1,670 1,374 ------------ ----------- ------------- 1,403 2,456 2,766 ------------ ----------- ------------- (Loss) before income taxes (benefit) and minority interest (5,877) (11,908) (17,388) Income taxes (benefit) 146 160 (322) ------------ ----------- ------------- (Loss) before minority interest (6,023) (12,068) (17,066) Minority interest share of losses -- -- 2,449 ------------ ----------- ------------- Net (loss) ($6,023) ($12,068) ($14,617) ============ ============ ============= (Loss) per common and common equivalent share: Net (loss) per share ($1.06) ($2.12) ($2.56) ============ ============ ================ Weighted average number of common and common equivalent shares 5,700,725 5,700,725 5,700,725 ============ ============ ================
Attention is directed to the foregoing Accountants' Report and to the accompanying Notes to the Consolidated Financial Statements. F4 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (Capital Deficiency) Fiscal Years ended August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands, except for share data)
Common stock Additional Notes receivable --------------------------- paid-in from warrant Accumulated Shares Par value capital holders (deficit) Totals ------------ ------------- ---------- ---------- ----------- --------- Balances at August 31, 1993 5,697,725 $ 57 $ 22,392 $ -- $ (266) $ 22,183 Exercise of outstanding stock options for cash 3,000 -- 8 -- -- 8 Issuance of warrants in connection with limited partnership agreements -- -- 511 (300) -- 211 Net (loss) -- -- -- -- (14,617) (14,617) ------------ ------ ---------- ---------- ---------- ---------- Balances at August 27, 1994 5,700,725 57 22,911 (300) (14,883) 7,785 Net (loss) -- -- -- -- (12,068) (12,068) -------------- ------ ---------- ---------- ---------- ------------ Balances at August 26, 1995 5,700,725 57 22,911 (300) (26,951) (4,283) Net (loss) -- -- -- -- (6,023) (6,023) -------------- ------ ---------- ---------- ---------- ---------- Balances at August 31, 1996 5,700,725 $ 57 $ 22,911 $ (300) $ (32,974) $ (10,306) ============== ====== ========== ========== ========== ==========
Attention is directed to the foregoing Accountants' Report and to the accompanying Notes to the Consolidated Financial Statements. F5 JENNIFER CONVERTIBLES INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands)
Year ended Year ended Year ended August 31, 1996 August 26, 1995 August 27, 1994 --------------- --------------- --------------- Cash flows from operating activities: Net (loss) ($6,023) ($12,068) ($14,617) Adjustments to reconcile net (loss) to net cash (used in) operating activities: Depreciation and amortization 1,852 2,261 2,091 Acquisition of limited partnership interests -- -- (3,000) Writeoff of purchased limited partnership interests -- -- 3,482 Provision for losses on amounts due from Private Company and Unconsolidated Licensees 952 3,088 3,284 Loss from store closings 191 1,670 -- Deferred rent 246 656 2,776 (Gain) on sale of investment securities -- -- (336) (Gain) on sale of subsidiaries -- -- (102) Minority interest -- -- (449) Changes in operating assets and liabilities: Decrease (increase) in merchandise inventories 1,211 716 (6,276) Decrease (increase) in refundable income taxes 108 2,127 (1,190) Decrease (increase) in prepaid expenses 315 956 (1,468) Decrease (increase) in accounts receivable 916 (785) (1,390) Decrease (increase) in other current assets 93 1,374 (582) (Increase)in due from Private Company and Unconsolidated Licensees (952) (1,256) (5,249) Decrease (increase) in other assets 46 (567) 685 (Decrease) increase in accounts payable trade (362) 717 13,985 Increase (decrease) in customer deposits (142) (443) 3,812 (Decrease) increase in accrued expenses and and other current liabilities (1,499) 1,206 3,565 ----------- ---------------- ------------- Net cash (used in) operating activities (3,048) (348) (979) ----------- ---------------- ------------- Cash flows from investing activities: Capital expenditures (989) (4,292) (5,021) Deferred lease costs and other intangibles 15 (1,580) (1,673) Sale of investments in government securities, net -- -- 5,431 Decrease (increase) in due from limited partners -- 1,000 (1,000) ----------- ---------------- ------------- Net cash (used in) investing activities (974) (4,872) (2,263) ----------- ---------------- ------------- Cash flows from financing activities: Issuance of warrants -- -- 211 Exercise of stock options -- -- 8 Payments of obligations under capital leases (107) (140) (70) ----------- ---------------- ------------- Net cash (used in) provided by financing activities (107) (140) 149 ----------- ---------------- ------------- Net (decrease)in cash and cash equivalents (4,129) (5,360) (3,093) Cash and cash equivalents at beginning of year 7,729 13,089 16,182 ----------- ---------------- ------------- Cash and cash equivalents at end of year $3,600 $7,729 $13,089 =========== ================ ============= Supplemental disclosure of cash flow information: Income taxes (refunded) paid during the year $ 108 ($2,127) $1,190 =========== ================ ============= Interest paid $ 47 $48 $61 =========== ================ =============
Supplemental disclosure of noncash transactions: See Note 7 -Warrants See Note 9 -Commitments, Contingencies and other Matters Attention is directed to the foregoing Accountants' Report and to the accompanying Notes to the Consolidated Financial Statements. F6 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) (1) Business and Basis of Preparation The consolidated financial statements include the accounts of Jennifer Convertibles, Inc. and subsidiaries (the "Company") and as described below, certain licensees. The Company is the owner and licensor of domestic sofabed specialty retail stores that specialize in the sale of a complete line of sofabeds and companion pieces such as loveseats, chairs and recliners and specialty retail stores that specialize in the sale of leather furniture. As at August 31, 1996, 86 Company-owned stores operated under the Jennifer Convertibles and Jennifer Leather names. Commencing in the latter part of the fiscal year ended August 31, 1992, the Company began licensing stores to limited partnerships ("LP's") of which a subsidiary of the Company is the general partner. The Company's subsidiary made nominal capital contributions to the LP's and the limited partners contributed approximately $6,660. All of the LP's have had losses since inception and the Company has made advances to them to fund such losses. The Company has control of the LP's and, as a result, consolidates the accounts of the LP's in its financial statements. Included in the Company's consolidated Statement of Operations are the losses of the LP's in excess of the limited partners' capital contributions. As at August 31, 1996 and August 26, 1995, the LP's operated 64 and 68 stores under the Jennifer Convertibles name. During the year ended August 27, 1994 and subsequent thereto, the Company purchased the interest of certain limited partners (who had made capital contributions aggregating $2,670) for $3,000, which was $3,482 in excess of such limited partners' capital accounts at August 27, 1994. Such amount has been charged to operations in the year ended August 27, 1994. The Company has also licensed stores to parties which may be deemed affiliates ("Unconsolidated Licensees"). Under the applicable license agreements, the Company is entitled to a royalty of 5% of sales. As at August 31, 1996, 11 stores were operated by such Unconsolidated Licensees and the results of their operations are not included in the consolidated financial statements (See Notes 3 and 9). Also not included in the consolidated financial statements are the results of operations of 21 stores in the New York Metropolitan Area which are owned by a company (the "Private Company") which, until November 1994, was owned by three of the officers/directors/principal stockholders of the Company. In November 1994, the Private Company redeemed the stock in the Private Company of two of the principal stockholders (Harley Greenfield and Edward Seidner) for a note in the amount of $10,273 collateralized by the assets of the Private Company and due in 2023 (See Note 9). In connection with such transaction, Fred Love, the remaining principal stockholder, granted Messrs. Greenfield and Seidner options expiring in November 2004 to purchase the 585,662 shares of the Company's Common Stock owned by him and the Private Company for $15.00 per share. F7 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) The Company, the LP's, the Private Company and the Unconsolidated Licensees have had numerous transactions with each other as more fully discussed in Note 3. Further, the Company has made advances to the Private Company and the Unconsolidated Licensees which have been reserved for in full due to uncertainty of collection. Because of the numerous related party transactions, the results of operations are not necessarily indicative of what they would be if all transactions were with independent parties. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. The Company incurred net losses in the last three fiscal years ended Augusut 31, 1996 and operating losses have continued subsequent to that date with the Company's equity and working capital being further depleted. Additionally, the Company is involved in the following unresolved matters which may have a significant impact on the Company's operations: a) As discussed in Note 9, a report by an independent committee of the Board of Directors appointed to investigate a complaint relating to transactions between the Company and the Private Company which may result in claims by the Company. b) The Company has been served with 11 class action complaints and six derivative action lawsuits as discussed in Note 9. c) As discussed in Note 9, on May 3, 1995, the Securities and Exchange Commission advised the Company that it had commenced a formal investigation into the affairs of the Company. Management has addressed the aforementioned issues, as follows: o As discussed in Note 9, the Company has agreed to terms which, subject to definitive agreements and court approval, would not only settle the class action and derivative litigations but change its operating relationship with the Private Company and resolve outstanding disputes relating to transactions between the Company and the Private Company. o Approximately 40 unprofitable stores have been closed in 1995 and 1996 and expense reduction plans have been implemented in 1996 throughout all operational areas of the Company. o As discussed in Note 5, the Company has entered into a credit and security agreement with its largest supplier, Klaussner Furniture Industries, Inc. ("Klaussner") (which accounts for approximately 79% of the Company's purchases of merchandise) which, based on current terms, effectively extended the payment terms for merchandise shipped from 60 days to 81 days. Additional allowances of $1,075 have been obtained for fiscal 1997. F8 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) (2) Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Jennifer Convertibles, Inc., its subsidiaries and the LP's. A subsidiary of the Company is the general partner of each of the LP's. Fiscal Year Commencing with the year ended August 27, 1994, the Company has adopted a fiscal year ending on the last Saturday in August which would be either 52 or 53 weeks long. Previously, the fiscal year ended on August 31. Cash and Cash Equivalents The Company considers all short-term, highly liquid instruments with a maturity of three months or less to be cash equivalents. Cash equivalents, consisting principally of money market instruments and United States Treasury bills as of August 31, 1996 and August 26, 1995, total $-0- and $4,000, respectively. Merchandise Inventories Merchandise inventories are stated at the lower of cost (determined on the first-in, first-out method) or market and are physically located, as follows: 8/31/96 8/26/95 ------- ------- Showrooms $3,963 $ 4,421 Warehouses 4,258 5,011 ------ ------- $8,221 $ 9,432 ====== ======= Vendor discounts and allowances in respect to merchandise purchased by the Company are included as a reduction of inventory and cost of sales. Store Fixtures, Equipment and Leasehold Improvements Store fixtures and equipment, including property under capital leases, are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over estimated useful lives or, when applicable, the life of the lease, whatever is shorter. Betterments and major remodeling costs are capitalized. Leasehold improvements are capitalized and amortized over the shorter of their estimated useful lives or the terms of the respective leases. Goodwill Goodwill consists of the excess of cost of the Company's investments in certain subsidiaries over the fair value of net assets acquired. Impairment is assessed based on cash flows of the related stores. Goodwill is being amortized over forty years from the acquisition date using the straight-line method. Accumulated amortization at August 31, 1996 and August 26, 1995 amounted to $556 and $538, respectively. F9 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Deferred Lease and Other Intangible Costs Deferred lease costs, consisting primarily of lease commissions and payments made to assume existing leases are deferred and amortized over the term of the lease. Pre-opening costs are expenses associated with the opening of new stores which are deferred and amortized over a one-year period. Deferred Rent and Allowances Pursuant to certain of the Company's leases, rent expense charged to operations differs from rent paid because of the effect of free rent periods and work allowances granted by the landlord. Accordingly, the Company has recorded deferred rent and allowances of $5,868 and $6,171 at August 31, 1996 and August 26, 1995, respectively. Rent expense is calculated by allocating total rental payments, including those attributable to scheduled rent increases reduced by work allowances granted, on a straight-line basis, over the respective lease term. Revenue Recognition Sales are recognized upon delivery of the merchandise to the customer. A minimum deposit of 50% is typically required upon placing a sales order. (Loss) Per Share (Loss) per share for the years ended August 31, 1996, August 26, 1995 and August 27, 1994 were computed by dividing the net (loss) by the weighted average number of shares of Common Stock outstanding. Options and warrants outstanding are not included because their effect is anti-dilutive. Advertising Advertising costs are expensed as incurred. Concentration of Risks The Company purchases 93% of its inventory from two suppliers (79% and 14%, respectively) under normal trade terms. The larger supplier, Klaussner, has executed a Credit and Security Agreement with the Company (See Note 5). The Company utilizes many local banks as depositories for cash receipts received at its showrooms. Such funds are transferred weekly to concentration accounts maintained at one commercial bank. At August 31, 1996 and August 26, 1995, amounts on deposit with this one bank totalled 86% and 81%, respectively, of total cash. Use of Estimates The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F10 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Recent Pronouncements In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation" which is effective for the Company's 1996 financial statements. SFAS No. 123 allows companies to either account for stock-based compensation under the new provisions of SFAS No. 123 or under the provisions of APB No. 25, but requires pro forma disclosure in the footnotes to the financial statements as if the measurement provisions of SFAS No. 123 had been adopted. At this time, the Company intends to continue accounting for its stock-based compensation in accordance with the provisions of APB No. 25. As such, the adoption of SFAS No. 123 will not impact the financial position or results of operations of the Company. (3) Related Party Transactions Prior to January 1, 1994, merchandise was purchased and warehoused for the Company and the LP's by the Private Company under a 15-year Warehousing Agreement dated November 3, 1986. In connection with this agreement, the Private Company also provided services relating to purchasing, distribution, customer service, data entry processing and other related services. In the fiscal year ended August 31, 1996, all such services have been transferred to the direct control of the Company's management except for distribution, inventory control reporting and data processing. Such agreement did not preclude the Company from purchasing merchandise directly from other parties or using other warehousing facilities. Pursuant to this agreement, the Company was obligated to pay for inventory at the Private Company's cost, net of vendor discounts and allowances but the LP's did not receive the vendor discounts and allowances. On January 1, 1994, the Company assumed the purchasing responsibility (see below). The Company and LP's pay a monthly warehousing fee based on 5% of the retail sales prices and fabric protection revenue collected from customers. Additionally, the Private Company provides fabric protection, lifetime warranty services and freight services at pre-determined rates. The Company's cost of sales includes these charges. Revenue from customers for fabric protection services is included in net sales. Indicated below are the amounts charged by the Private Company: Year Ended -------------------------------- 8/31/96 8/26/95 8/27/94 ------- ------- ------- Included in Cost of Sales: Purchases of inventory $ - $ - $18,230 Freight* 3,042 3,775 2,122 Fabric protection services 2,972 3,804 3,298 Warehousing fees at 5% 5,302 6,304 4,871 Additional warehouse fees (Note 9) 520 - - ------- ------- ------- Total $11,836 $13,883 $28,521 ----- ======= ======= ======= *For periods prior to January 1, 1994, freight was included in the purchases of inventory. The Company has negotiated new operating arrangements with the Private Company, subject to execution of definitive agreements and court approval of the settlement of various class and derivative actions (See Note 9). F11 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Effective January 1, 1994, the Company assumed the responsibility from the Private Company for purchasing merchandise for itself, the LP's, the Unconsolidated Licensees and the Private Company. The Company acquired from the Private Company the inventory that was in the warehouse on January 1, 1994 for $2,575, which was the Private Company's cost basis for such inventory. During the years ended August 31, 1996, August 26, 1995 and August 27, 1994 (which only includes the period January 1, 1994 through August 27, 1994) approximately $10,471, $12,500 and $7,478, respectively, of inventory at cost was purchased by the Private Company through the Company and $1,900, $3,105 and $2,350, respectively, of inventory at cost was purchased by the Unconsolidated Licensees through the Company. In addition, effective January 1, 1994, the Private Company transferred to the Company the right to receive the benefit of any vendor discounts and allowances in respect to merchandise purchased by the Company on behalf of the LP's and certain other licensees. The Company had always been entitled to the benefit of such discounts in respect to merchandise purchased by the Company for its stores. To evidence its obligation for certain accrued discounts, the Private Company executed a promissory note in the amount of $1,000. This note, which bears interest at 8% per annum, is payable in equal monthly installments over three years commencing August 1, 1994. In addition, since the Private Company retained the right to receive the benefit of any discounts refunded or credited by suppliers in respect of merchandise purchased by the Private Company through the Company, for the period January 1, 1994 through August 27, 1994, an amount equal to $471 was credited to the Private Company on account of discounts for such period, $692 was credited for the year ended August 26, 1995 and $583 was credited for the year ended August 31, 1996. Prior to January 1, 1994, the Company was party to Advertising Agreements with the Private Company. Pursuant to these agreements, the Company could elect, on a case-by-case basis, to participate in particular joint advertising programs with the Private Company for a fee not to exceed 8% of the aggregate sales of the Company's New Jersey and Connecticut stores. Such fee was based on an equitable portion (as defined in the Advertising Agreements) of the Private Company's costs. The Company had a similar agreement for its stores located in New York, except that such stores paid a flat 8% of sales for advertising. During the year ended August 27, 1994, $3,786 was allocated under the Advertising Agreements. The amount expended under the Advertising Agreements for the fiscal year ended August 27, 1994 only includes the period September 1, 1993 through December 31, 1993, which was the period such agreements were in effect. Effective January 1, 1994, the Company assumed the responsibility of advertising for itself, the LP's, the Unconsolidated Licensees and the Private Company. Under the new arrangement, the Private Company and Unconsolidated Licensees are charged a share of advertising costs which aggregated $2,374, $2,498 and $1,718 for the years ended August 31, 1996, August 26, 1995 and August 27, 1994, respectively. Two executive officers of the Company own interests in certain Unconsolidated Licensee stores. Rami Abada, Executive Vice President and Chief Operating Officer of the Company, owns a 20% interest in Southeastern Florida Holding Corp. ("S.F.H.C.") which owns six licensed stores. During the three years ended August 31, 1996, S.F.H.C. incurred approximately $160, $185 and $252 in royalties to the Company. Principal and interest payments of approximately $-0-, $23 and $151 for the three years ended August 31, 1996 were received in connection with a 9% secured note, due December 31, 2001. The original principal amount of $810 had been reduced to $638 as of August 31, 1996. In addition, S.F.H.C. owes the Company $500 under a Revolving Credit Agreement pursuant to which the entire available revolving credit loan has been drawn down. Such loan F12 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) bears interest and is payable at prime plus 3% but has not been paid. The same executive also owns a 20% interest in two other corporations that are also part of the Unconsolidated Licensees. During the three years ended August 31, 1996, such corporations incurred approximately $81, $97 and $106 in royalties to the Company. Ronald Rudzin, Senior Vice President - Retail Stores of the Company, owns one licensed store and his father owns two licensed stores which, during the three years ended August 31, 1996, incurred royalties aggregating approximately $134, $239 and $283, respectively, to the Company (See Note 10). In October 1996, Rami Abada transferred his 20% interest in S.F.H.C. to individuals who are also limited partners in LP's III, IV and V. In turn, he received the entire equity interest in the two corporate Unconsolidated Licensees that were owned in part by such individuals. By agreement (the "Offset Agreement") dated November 1, 1995, the Private Company and the Company acknowledged that as of August 26, 1995 the Private Company owed the Company $9,268, certain Unconsolidated Licensees owed the Company $2,118 for merchandise purchased (of which $1,866 was past due) and the Company owed the Private Company $11,455 for warehousing fees, freight and fabric protection services. In addition, the Private Company agreed to assume the obligations of certain Unconsolidated Licensees in the amount of $1,866 and to offset the amounts owed to the Company by the Private Company and such licensees against the amounts owed to the Private Company by the Company. By agreement dated March 1, 1996, the Private Company and the Company agreed to continue to offset, on a monthly basis, amounts owed by the Private Company and certain Unconsolidated Licensees to the Company for purchasing, advertising and other services and matters against amounts owed by the Company to the Private Company for warehousing services, fabric protection, freight and other services and matters. The proposed settlement agreement contemplates that the Offset Agreement will be modified to provide that to the extent either party owes the other an amount in excess of $1,000 for current obligations, such excess will be paid in cash. All amounts due from the Private Company and Unconsolidated Licensees are fully reserved since these entities have losses and capital deficiencies. In connection with the uncertainty of collectibility and in consideration of the potential additional financial support that the Company may provide to the Private Company and the Unconsolidated Licensees, the Company will account for subsequent transactions with these entities on an offset basis. However, if the result of the offset is a receivable due from them, then such net amount will be generally recognized only at the time when cash is received from these entities. A reserve has been provided in the consolidated financial statements for amounts due from these entities, as follows: F13 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Unconsolidated Licensees Private (Other Than Company S.F.H.C.) S.F.H.C. Totals ------- --------- -------- ------ At August 31, 1996: Gross amount due $ 1,682 $ 3,341 $ 2,301 $ 7,324 Reserves (1,682) (3,341) (2,301) (7,324) -------- -------- -------- -------- Net Amount $ -0- $ -0- $ -0- $ -0- ======== ======== ======== ======== At August 26, 1995: Gross amount due $ 2,410 $ 1,167 $ 2,795 $ 6,372 Reserves (2,410) (1,167) (2,795) (6,372) -------- -------- -------- -------- Net Amount $ -0- $ -0- $ -0- $ -0- ======== ======== ======== ======== At August 27, 1994: Gross amount due $ 1,832 $ 972 $ 2,312 $ 5,116 Reserves -0- (972) (2,312) (3,284) -------- -------- -------- -------- Net Amount $ 1,832 $ -0- $ -0- $ 1,832 ======== ======== ======== ======== The Private Company has stated that, if the settlement described in Note 9 is not consummated, it may assert claims of approximately $1,200 against the Company for various additional amounts owed from prior years. The Company believes the claims are either without merit or would be exceeded by the amount of counter-claims the Company would make under such circumstances. Accordingly, the Company has not provided for any losses that may occur as a result of this assertion. Until October 28, 1993, the Private Company owned certain trademarks and had granted the Company a royalty-free license to use and to sublicense and franchise the use of such trademarks throughout the world, except New York State. On October 28, 1993, the licensor, for nominal consideration, assigned these trademarks to the Company. The Company then granted the Private Company a perpetual, royalty-free license to use and to sublicense and franchise the use of such trademarks in the State of New York. The license is exclusive in such territory, subject to certain exceptions. The Company was one of the guarantors of a $5,000 bank mortgage on the Private Company's warehouse facility utilized by the Company. On June 30, 1996, the Private Company completed the sale of such warehouse and the Company's guarantee was terminated. Effective September 1, 1991, the Company entered into a five-year employment agreement with its President and Chief Executive Officer, Harley Greenfield, pursuant to which he agreed to devote his full time to the business of the Company and not to compete during the term of his employment agreement or for a period of one year thereafter. In lieu of cash compensation, the President was granted options to purchase 150,000 shares of Common Stock at $8.375 per share, the market value on the date of grant and therefore no compensation charge was recorded in the fiscal year ended August 27, 1994. Such options vest at the rate of 30,000 shares per year, subject to acceleration for changes of control, mergers and similar events. F14 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Effective September 1, 1994, Harley Greenfield, the President and Chief Executive Officer, and Edward Seidner, who became an Executive Vice President on such date, began receiving a salary of $400 and $300 per annum, respectively, from the Company. Such amounts were reduced, effective February 1, 1996 to $320 and $240 per annum, respectively. In addition, they receive substantial economic benefits from the Private Company. Effective January 1, 1994, Rami Abada, Executive Vice President and Chief Operating Officer, and Ronald Rudzin, Senior Vice President - Retail Stores, each began receiving a salary of $150 per annum from the Company. Such amounts were reduced, effective February 1, 1996 to $120 each per annum. In addition, they receive substantial economic benefits from the Private Company and certain Unconsolidated Licensees. Another director (and stockholder) of the Company received approximately $188, $336 and $371 in legal fees in 1996, 1995 and 1994, respectively. Further, he owned, until May 1995, a 20% interest in each of two Private Company stores and receives substantial economic benefits from the Private Company. (4) Store Fixtures, Equipment and Leasehold Improvements August 31, August 26, 1996 1995 --------- --------- Automobiles $ 68 $ 68 Store fixtures and furniture 6,129 6,175 Leasehold improvements 6,434 6,398 Computer equipment 1,026 612 ------- ------- 13,657 13,253 Less: Accumulated depreciation and amortization (4,918) (3,482) ------- ------- $ 8,739 $ 9,771 ======= ======= At August 31, 1996 and August 26, 1995, equipment cost includes $907 and $907, and accumulated depreciation and amortization includes $465 and $406 on equipment under capital leases. (5) Credit and Security Agreement with Klaussner: On March 5, 1996, the Company and Klaussner executed a Credit and Security Agreement that provides that Klaussner effectively extended the payment terms for merchandise shipped from 60 days to 81 days and was provided with the following: a) A security interest in all the Company's assets including accounts receivable, inventory, store fixtures and equipment, as well as the assignment of leaseholds, trademarks and a license agreement to operate the Company's business in the event of default and non-payment of the Company's guaranty. b) The common stock holdings of Harley Greenfield, Edward Seidner and Fred Love, President of the Private Company have been pledged along with the pledge of the Private Company's stock interest in the Company. F15 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) In addition, Klaussner agreed to lend $1,440 to the Private Company. The $1,440 was used to pay down the mortgage obligation of the warehouse corporation. The $1,440 is in addition to $3,500 due from the Private Company to Klaussner outstanding at August 31, 1996, which liability was incurred by the Private Company prior to January 1, 1994. (6) Income Taxes Effective September 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". The cumulative effect of this accounting change did not have a material effect on the financial condition or results of operations for the Company. Components of income tax expense (benefit) are as follows: Year Ended ------------------------------- 8/31/96 8/26/95 8/27/94 ------- ------- ------- Current: Federal $ - $ - $(593) State 145 160 271 Deferred: Federal - - - State - - - ---- ---- ----- $145 $160 $(322) ==== ==== ===== Expected tax expense (benefit) based on the statutory rate is reconciled with actual tax expense (benefit) as follows: Percent of Pre-Tax Earnings (Loss) Year Ended ---------------------------------- 8/31/96 8/26/95 8/27/94 ------- ------- ------- "Expected" tax expense (benefit) (34.0)% (34.0)% (34.0)% Increase (reduction) in taxes resulting from: State income tax, net of federal income tax benefit 1.6 % 1.4 % 1.8 % Non-deductible items 1.0 % .5 % 7.0 % Other (2.7)% (1.8)% ( 2.5)% Change in valuation allowance 36.6 % 35.2 % 25.5 % ------- ------- ------- 2.5 % 1.3 % ( 2.2)% ======= ======= ======= F16 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) The principal components of deferred tax assets, liabilities and the valuation allowance are as follows: August 31, 1996 August 26, 1995 --------------- --------------- Deferred tax assets: Federal and state net operating loss carryforwards $ 5,378 $ 2,336 Reserve for losses on loans and advances 2,928 2,926 Accrued partnership losses 1,385 2,584 Deferred rent expense 1,326 1,329 Inventory capitalization 216 232 Other expenses for financial reporting, not yet deductible for taxes 578 305 -------- ------- Total deferred tax assets, before valuation allowance 11,811 9,712 Less: Valuation allowance (10,113) (7,969) -------- ------- Total deferred tax assets $ 1,698 $ 1,743 ======== ======= Deferred tax liabilities: Difference in book and tax basis of fixed assets $ 1,571 $ 1,473 Other 127 270 -------- ------- Total deferred tax liabilities 1,698 1,743 -------- ------- Net deferred tax assets $ -0- $ -0- ======== ======= The Company's deferred tax asset has been fully reserved since it is considered more likely than not that the amount will not be realized. During the years ended August 31, 1996 and August 26, 1995, the valuation allowance increased by $2,144 and $4,202, respectively. The Company has a net operating loss carryforward of approximately $13,000, expiring $6,000 in the year 2010 and $7,000 in the year 2011. (7) Warrants In the fiscal year ended August 27, 1994, under the terms of the limited partnership agreements for LP III, LP IV and LP V (see Note 11), the three limited partners each purchased for $170 five-year warrants to purchase 60,000 shares of the Company's Common Stock at an exercise price of $15.625 per share. Each of the limited partners paid approximately $70 in 1994 and issued a $100 term note to the Company as payment for the warrants. These notes bear interest at a rate of 7.12% per annum and, effective September 1996, are payable over ten years (with 10% of principal due annually). For each annual principal payment which is not made, $10,564 of the warrants shall be cancelled. The notes receivable from warrant holders are recorded in (Capital Deficiency). F17 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) (8) Stock Options Plans In November 1986, the Company adopted an Incentive and Non-Qualified Stock Option Plan (the "1986 Plan") under which 150,000 shares of Common Stock were reserved for issuance to selected management and other key employees of the Company. The Amended and Restated 1991 Incentive and Non-Qualified Stock Option Plan (the "1991 Plan" and together with the 1986 Plan hereinafter referred to as the "Plans") was adopted by the Company in September 1991 and amended in April 1992. Under the 1991 Plan, 700,000 shares of Common Stock were reserved for issuance to selected management and other key employees of the Company. The terms of both Plans are substantially similar. The exercise price with respect to qualified incentive options may not be less than 100% of the fair market value of the Common Stock at the date of grant. From time to time, the Company grants additional stock options outside of the Plans to individuals or entities in recognition of contributions made to the Company. Information regarding the Company's stock options under and outside the Plans is summarized below: Number of Shares ---------------------------------- 1996 1995 1994 -------- -------- -------- Outstanding, beginning of year... 836,547 736,547 803,697 Granted (at $2.50 to $15.75 per share).............. - 137,500 50,000 Exercised (at $2.75 per share)... - - (3,000) Canceled (at $2.75 to $15.75 per share) (25,000) ( 37,500) (114,150) --------- --------- --------- Outstanding, end of period (at $2.50 to $15.75 per share)..... 811,547 836,547 736,547 ========= ========= ========= Exercisable, end of period....... 706,883 628,051 545,053 ========= ========= ========= See Note 11 with respect to options outstanding held by JCI to purchase 1,200,000 shares of Common Stock of the Company. The number of shares of Common Stock reserved for options available for grant under the Plans was 215,453 at August 31, 1996. (9) Commitments, Contingencies and Other Matters Leases The Company and LP's lease retail store locations under operating leases for varying periods through 2009 which generally are renewable at the option of the lessee. Certain leases contain provisions for additional rental payments based on increases in certain indexes. Future minimum lease payments and future minimum sublease rentals for all noncancelable leases with initial terms of one year or more consisted of the following at August 31, 1996: F18 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Year Ending August ---------------------------------------- 1997......................... $11,498 1998......................... 11,080 1999......................... 10,684 2000......................... 10,138 2001......................... 9,466 Thereafter................... 27,104 ------- $79,970 The Company has guaranteed the lease obligation of the California warehouse which is operated by the Private Company. The annual lease obligation for this location is $133 and the lease expires on September 30, 1998. Rental expense for all operating leases amounted to approximately $14,166, $15,770 and $12,456, net of sublease income of $170, $301 and $211 for the years ended August 31, 1996, August 26, 1995 and August 27, 1994, respectively. The Company and LP's have long-term capital leases for certain equipment. The leases are for periods of three to five years with an option to purchase at the end of the lease periods for a nominal price. The following is a schedule of future lease payments for the capital leases: Year Ending August ---------------------------------------- 1997.............................. $ 160 1998.............................. 160 1999.............................. 137 457 Amount representing interest...... (55) ------ Present value of minimum lease payments................... 402 Less: Current portion............ 172 ------ $ 230 ====== Accrued Expenses and Other Current Liabilities The components of accrued expenses and other current liabilities are: 8/31/96 8/26/95 ------- ------- Advertising $ 958 $1,577 Payroll 744 697 Legal 216 374 Accounting 356 936 Store closings 455 852 Settlement costs 500 500 Sales tax 778 805 Other 1,015 780 ------ ------ $5,022 $6,521 ====== ====== F19 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Advertising Expense Advertising expense for the years ended August 31, 1996, August 26, 1995 and August 27, 1994 aggregated $12,265, $15,729 and $11,357, respectively. Other Conclusions of the Independent Committee A draft complaint ("Complaint") on behalf of an unnamed plaintiff was delivered to the Company in March 1994. The Complaint raised certain issues and potential causes of action that may exist in favor of the Company against the Private Company and others. The Company's President advised the Board of Directors that, in his view, the Complaint was without merit. The Board appointed an independent committee (the "Committee") consisting of one director to investigate the allegations in the Complaint and certain other matters. On November 22, 1994, the same director who was on the Committee submitted a letter to the President of the Company which contained information relevant to the (1) Funding of S.F.H.C. (See Note 11) and (2) the funding of Limited Partnerships (LP's) III through V (See Note 11). The letter essentially detailed the flow of funds from the Private Company, certain Unconsolidated Licensees and the Company to S.F.H.C. and its subsidiary ("Summit"). Additionally, it disclosed that as of August 27, 1994, S.F.H.C. had a receivable from officers of $1,861. It asserted that neither (a) the payment to fund S.F.H.C.'s purchase of the stock of Summit nor (b) the capital contributions to LP's III through V were obtained from sources outside the Company or the Private Company. On December 2, 1994, the Board of Directors of the Company received the Summary Report of Counsel to the Independent Committee which, amongst other matters, concluded that it "has reviewed many significant related party transactions and recommends to the Board that the Company assert claims to recover damages for harm caused the Company". On January 26, 1995, the Board of Directors received the "Final Report of Counsel to the Independent Committee of the Board of Directors" which reached the same conclusions and recommendations. On March 10, 1995, the Board of Directors received the "Response of Harley Greenfield to the January 26, 1995 Final Report of Counsel to the Independent Committee" that asserted that there were no valid claims. On April 3, 1995, it received a similar response from a financial consultant to the Company to the letter dated November 22, 1994 from Michael Colnes to Harley Greenfield that asserted that there was nothing improper. Class Action and Derivative Action Lawsuits Between December 6, 1994 and January 5, 1995, the Company was served with 11 class action complaints and six derivative action lawsuits which deal with losses suffered as a result of the decline in market value of the Company's stock as well as the Company having "issued false and misleading statements regarding future growth prospects, sales, revenues and net income". The ultimate outcome of these matters is not presently determinable (see below). F20 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Proposed Settlement of Derivative Litigation In March 1996, the Company signed a Memorandum of Understanding ("Derivative Memorandum") for the purpose of settling all of the claims involving those parties in the derivative litigation. The Derivative Memorandum is subject to a settlement of all claims against the Company, its present and/or former officers, directors, certain accountants, consultants and representatives, the Private Company, its present and/or former officers, directors, employees, accountants, consultants and/or representatives and the discontinuance of the class action litigation presently pending. It also is conditioned upon mutual releases between the Company and the Private Company. Attorney's fees will be funded by an insurance carrier for one of the defendants other than the Company for $500. The Private Company will pay $165 in cash and the Company will pay the remaining portion of fees and expenses in ("Preferred Stock"). The Preferred Stock will have an aggregate value of $130, paying an annual dividend of 7% and convertible into Common Stock (at such time as the Company's Common Stock trades at $7.00 per share or higher) at $7.00 per share. This settlement is subject to execution of definitive documents and final court approval. In accordance with FASB Statement No. 5, the $130 value of the Preferred Stock has been accrued in the fiscal year ended August 26, 1995 as part of estimated settlement costs. Proposed Settlement of Class Action Litigation In March 1996, the Company and the parties in the class action litigation signed a Memorandum of Understanding ("Class Memorandum") which is subject to a Stipulation of Settlement to be submitted to the court for final approval. The Class Memorandum provides for the payment to certain members of the class and their attorneys of an aggregate maximum amount of $7,000 in cash and Preferred Stock having a value of $370. (Terms and conditions of such Preferred Stock are described above.) The cash portion of the settlement will be funded entirely by insurance company proceeds. In accordance with FASB Statement No. 5, the $370 value of the Preferred Stock has been accrued in the fiscal year ended August 26, 1995. The proposed settlement of the class action litigation is a claims made settlement. All claimants who purchased the Company's Common Stock during the period from December 9, 1992 through December 2, 1994 and who held their stock through December 2, 1994, will be entitled to participate in the settlement. Proposed Settlement with the Private Company The Company signed an agreement ("Settlement Agreement") with the Private Company subject to execution of definitive agreements and court approval and settlement of the derivative and class action litigation. The Settlement Agreement restructures the relationship between the Private Company and the Company in order to reduce and eliminate any alleged actual or potential conflicts of interest. F21 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) A) (Warehouse Services): The Settlement Agreement contemplates that until December 31, 1997, the Company will pay the Private Company for all services under the warehousing agreement 8.3% of the retail sales prices, less the costs of certain services that will be assumed by the Company previously provided by the Private Company, but no lower than 7.2% of sales. For 1998, the fee will be 7.2% (see L below). Upon the effective date, the Company will no longer pay the Private Company separately for "fabric protection" services. The Company has also agreed to pay an additional warehouse fee during the calendar year 1996 if the total retail sales of the Company are less than $135 million. The Company will pay the Private Company $65 for each million dollar shortfall in annual sales, adjusted quarterly based upon current sales projections, up to $650 ($520 accrued at August 31, 1996). The Company has also agreed to pay a re-delivery fee to the Private Company of 3% of selling price for customer deliveries that have to be re-delivered to customers under certain circumstances. In 1997 and 1998, if an annual sales level of $140 million is achieved, the Private Company will pay back 50% of previous shortfall payments in each of such years. To the extent the shortfall is not so repaid in full, starting on January 1, 1999, the Private Company will repay the balance of the shortfall over seven years without interest. B) (Assignment of Real Property Interests of Warehouses): The Settlement Agreement contemplates that, effective January 1, 1999, the Company will receive all real property interests in the various warehouses serving the business along with the leasehold interests subject to mortgages and other security agreements. The mortgage obligation on the Inwood, New York warehouse will not exceed $2,850 at December 31, 1998. To the extent that such mortgage is less than this amount as of that date, the Company will pay the Private Company the difference between $2,850 and the actual amount of such mortgage by way of set-off against the Private Company's obligation to the Company for warehousing services (see L below). C) (Warehouse Services to the Private Company): Commencing January 1, 1999, the Company will provide the Private Company all warehousing services for 2% of the Private Company's delivered retail selling prices, plus a fee for "fabric protection" services. D) (Freight Charges): The Company will continue to pay all freight charges (for inventory delivered to warehouses) through December 31, 1998, based upon an agreed schedule with the Private Company. E) (Assignment of Interest in Certain Limited Partnerships and Other Corporate Licensee): The Private Company will purchase the interests of the limited partnerships known as LP III, LP IV and LP V and the equity interest of the shareholders of S.F.H.C. and assign these interests to the Company. The Company, in turn, will release the limited partners and the shareholders, officers and directors of S.F.H.C. from all claims and/or obligations owed to the Company. F22 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Although it is not reflected in the Settlement Agreement, it is currently contemplated that the shareholders of S.F.H.C. will receive new ten year warrants to purchase an aggregate of 180,000 shares of Common Stock at $7.00 per share. It is also contemplated that the limited partners of the Partnerships will retain the Original Warrants (as described below). There are no signed agreements with the limited partners of the Partnerships and the shareholders of S.F.H.C. as to the transfers described above and there can be no assurance that the Private Company will be able to obtain such agreements. If the Private Company is unable to obtain such agreements and to make the transfer, the settlement will not be consummated on the various terms outlined herein or possibly, at all. F) (Inter-Company Accounts): The Private Company will pay the Company under the offset agreement (described in J, below) $1,400 in resolution of certain inter-company account balances as of August 26, 1995 at $17 per month to be applied toward principal and interest at 6%, until repaid. G) (License of Computer Programs): Commencing January 1, 1999, the Private Company will license the Company to use and change the Private Company's computer programs without fee. The Company will also assume the obligations and personnel of the Computer Department, presently maintained by the Private Company. H) (Warranty and Fabric Protection): Upon execution of the Settlement Agreement, the Company will be responsible for any claims for breach of warranty relating to "fabric protection" in connection with sales by both the Company and the Private Company. I) (Amounts Due From Officers of S.F.H.C. of $1,200): The Private Company will assume and pay $1,200 of the debt of the officers of S.F.H.C. owed to S.F.H.C. This amount will be paid to the Company in 84 equal monthly installments, without interest, beginning January 1, 1999. J) (Offset Agreements): On November 1, 1995 and March 1, 1996, the Company and the Private Company entered into offset agreements. Such offset agreements permit the two companies to offset their current obligations to each other for merchandise purchases, warehouses fees, fabric protection fees and freight. The Settlement Agreement contemplates that amounts owing in excess of $1,000 at any time will be paid in cash. As part of the offset agreement, the Private Company agreed to assume certain liabilities owed to the Company by the Unconsolidated Licensees. K) (Royalties): The Unconsolidated Licensees will pay to the Company any royalties owed under the offset agreement. The Private Company will pay royalties owed of $100 for stores that the Unconsolidated Licensees have closed commencing January 1, 1999 in 84 equal monthly installments without interest. F23 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) L) (Agreement of Sale of Inwood, New York Warehouse): On June 30, 1996, the Private Company sold the Inwood, New York warehouse which has been the principal warehouse in the distribution system. In connection with this sale, the Settlement Agreement contemplates that the Company will receive from the Private Company payments of $25 per month for 84 months commencing January 1, 1999. The Agreement also contemplates that, effective December 1, 1996, the warehouse fee will be reduced to 7.2% of the retail sales prices and fabric protection revenue collected from customers. M) (Subordination): Subject to court approval of the Settlement Agreement, Messrs. Greenfield and Seidner have agreed to subordinate, until January 1, 1999, their right to receive payments in respect of the $10,273 owed to them by the Private Company, if the Private Company is in default in the payment of any cash obligation to the Company arising after August 7, 1996 after giving effect to any offsets as between Messrs. Greenfield and Seidner and the Private Company. Such subordination does not apply to any distribution in respect of a disposition of substantially all of the assets of the Private Company. Securities and Exchange Commission Investigation On December 9, 1994, the Company was advised that the Securities and Exchange Commission (SEC) was conducting an inquiry of the Company's affairs "to determine whether there have been violations of the federal securities laws". The SEC requested that the Company voluntarily provide certain documents in connection with its December 2, 1994 press release "concerning the adjustment in the valuation of certain subsidiaries on the Company's balance sheet". Since that date, the SEC has also requested the Final Report of Counsel to the Independent Committee of the Board of Directors and the November 22, 1994 letter from a director of the Company to the President (as more fully described above). Additionally, the SEC requested the "responses" to these documents and the Company furnished them with the "Response of Harley Greenfield to the January 26, 1995 Final Report of Counsel to the Independent Committee" dated March 10, 1995 and the "Response of Jerome I. Silverman to the letter dated November 22, 1994 from Michael Colnes to Harley Greenfield" dated April 3, 1995. On May 3, 1995 the SEC commenced a formal investigation into the affairs of the Company. Subpoenas have been issued to the Company and certain of its current and former management to furnish various contracts and accounting records which have been complied with. The outcome of the SEC investigation is not presently determinable. NASDAQ Suspension Effective April 17, 1995, the NASDAQ Listing Qualifications Committee (the "Qualifications Committee") reviewed the request of the Company for an extension of its current exception to the filing requirements for continued listing on the NASDAQ National Market. The Qualifications Committee determined to deny the Company's request and accordingly, the Company's Common Stock was delisted from the NASDAQ stock market. F24 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) (10) Sale of Subsidiaries In September 1990, the Company sold two of its stores to a licensee of a New York store, and effective December 27, 1990, the Company sold four of its stores for the assumption of certain liabilities and $10 in cash per store to the same licensee. During the fiscal year ended August 27, 1994, one of the purchasers of such stores, formerly an employee of the Private Company, became an executive officer of the Company. The Company also entered into a ten-year license agreement with the purchasers pursuant to which such stores pay the Company a royalty of 5% of their sales for the right to use the "Jennifer Convertibles" name (See Note 3). The purchasers assumed the liabilities owed by such stores, including liabilities owed to the Company, in the form of six ten-year, non-interest bearing promissory notes with aggregate annual payments of approximately $150, with additional payments required based upon sales in excess of certain minimum amounts. The balance of the notes, net of imputed interest at the rate of 8%, which have been reserved for in full in the consolidated financial statements, are as follows: August 31, August 26, 1996 1995 ---------- ---------- Notes receivable $ 554 $ 674 Less: imputed interest (120) (186) ------ ----- Notes receivable, net $ 434 $ 488 ====== ===== The purchasers of the stores have assumed the Company's obligations under the store leases. However, the Company remains a guarantor of certain of the leases and, therefore, is contingently liable for claims arising under the terms of the respective leases in the aggregate amount of $30. (11) Other Agreements JCI Consulting Agreement On July 29, 1994, the Company reached an agreement with JCI Consultant, L.P. ("JCI") to terminate a February 25, 1992 consulting agreement with JCI pursuant to which, among other things, JCI rendered advice on the establishment and financing of Company-owned and licensed stores. The consulting fees were to have been paid at the rate of $10 per month through February 1996, plus an amount each fiscal quarter through August 2010 equal to the greater of (i) $100 or (ii) 10% of the Company's consolidated pre-tax income for such quarter, until such time as an aggregate of $7,980 in consulting fees had been paid. Under the terms of the termination agreement, the Company paid $2,500 and JCI waived the right to receive any further consulting fees of approximately $6,500, (the remaining portion of the $7,980) which might otherwise have become payable over the term of the Consulting Agreement. F25 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) JCI has retained all rights in and to the options to purchase 1,200,000 shares of Common Stock at $8.00 per share which were previously granted to JCI. Such options terminate on March 21, 2001 and become exercisable on April 1, 1996. Under a ten-year Voting Trust Agreement expiring March 21, 2001, the Chief Executive Officer and President of the Company will be the voting trustee for the shares of Common Stock which may be received by JCI upon the exercise of the option. Furthermore, in connection with the termination of the Consulting Agreement, JCI agreed that, except for the aforementioned option shares, it would not at any time acquire, directly or indirectly, more than 5% of the issued and outstanding shares of Common Stock of the Company for a period ending July 29, 2000. Contemporaneous with the granting of the options to JCI, the Company, JCI, the Principal Stockholders and the Private Company entered into a registration and sale agreement (the "Registration Agreement") pursuant to which JCI has certain demand and "piggy-back" registration rights. Subject to certain exceptions, the Registration Agreement grants a right of first refusal to the Company to purchase all option shares which are proposed to be sold. If the Company declines to exercise such right of first refusal, the Principal Stockholders and the Private Company will have the right of first refusal. Chicago Partnership Agreement In July, 1991, the Company entered into agreements pursuant to which a limited partnership, Jennifer Chicago, L.P. (the "Chicago Partnership"), was established for the purpose of operating Jennifer Convertibles stores in the Chicago, Illinois metropolitan area. Pursuant to a 20-year License Agreement, the Company receives a royalty of 5% of sales from the Chicago Partnership's stores and has given the Chicago Partnership the exclusive right to open Jennifer Convertibles stores in the defined territory. Pursuant to the Partnership Agreement, the limited partner (a party related to JCI) contributed $990 to the Partnership and agreed to make additional capital contributions of up to $100. The Company made a capital contribution of $10. Under the Partnership Agreement, allocations and distributions shall, subject to certain exceptions, be made 99% to the limited partners and 1% to the General Partner. The Company has consolidated and recorded the operating losses of the Partnership in excess of limited partner's capital contributions in the Consolidated Statements of Operations (see Note 1). Under a Purchase Option Agreement, the Company has the right to purchase all the limited partners' interests in the Partnership for a price equal to the fair market value thereof, as determined by one or more investment bankers selected by the Company and the limited partners. Also, the limited partners can put their interests to the Private Company if certain executives of the Company and the Private Company own less than 700,000 shares of the Company's common stock. Summit Agreement On October 9, 1990, the Company and a wholly-owned subsidiary entered into a series of agreements with Crown Investment Group, Ltd. ("Crown"), an affiliate of Klaussner, and its wholly-owned subsidiary, Summit, pursuant to which six licensed stores were established in Florida. Under a licensing agreement, the Company receives a 5% royalty on sales by the Florida stores. Pursuant to a management agreement, the Company provides management services, subject to limitations, to the Florida stores and will receive, each fiscal year, a fee equal to 1% of the consolidated net pre-tax income of Summit and its subsidiaries. During fiscal 1996, 1995 and 1994, Summit and its subsidiaries had a consolidated net loss. Pursuant to a Put Agreement, Crown had the right, subject to certain conditions, to put all the capital stock of Summit to the Company for 180,000 shares of the Company's Common Stock. F26 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) Pursuant to an agreement dated December 30, 1991 between Crown and S.F.H.C., Crown sold to the Company all of the capital stock in Summit in exchange for 180,000 shares of Common Stock of the Company. Simultaneously, the Company sold the Summit capital stock to S.F.H.C. in exchange for $270 in cash and a note in the principal amount of $810 (See Notes 3 and 9). The note is secured by the stock of Summit, bears interest at a rate of 9% per annum and is payable over ten years in equal monthly installments of $10. An individual who is an officer and stockholder of S.F.H.C. became an executive officer of the Company in 1994. Such officer is indebted to the Private Company in the amount of $300 in connection with the purchase by S.F.H.C. of Summit. On June 1, 1993, S.F.H.C. and the Company entered into a Revolving Credit Agreement which allows S.F.H.C. to borrow up to $500 from the Company. The revolving credit loans bear interest at the prime rate plus 3.0%, and are payable in full on June 1, 1995. As of August 31, 1996, $500 had been advanced, and has been fully reserved for (See Note 3 for a discussion of reserves established for these amounts). The operations of this entity are not consolidated in the Company's Consolidated Statements of Operations. Second Limited Partnership Agreement In November 1992, Jennifer L.P. II (the "Second Partnership") was established by the Company for the purpose of operating Jennifer Convertibles stores in the Detroit, St. Louis, Indianapolis, Milwaukee and Kansas City metropolitan areas on the same terms as the Chicago Partnership (see above). The Company has recorded the operating losses of the partnership in excess of the limited partners' capital contributions in the Consolidated Statements of Operations until the date of acquisition (see Note 1). On September 1, 1994, the Company purchased the entire limited partnership interest in the Second Partnership for $750 which was written off in the fiscal year ended August 27, 1994. Elegant Partnership In early 1993, the Company's subsidiary became a general partner in a limited partnership ("Elegant Partnership") formed for the purpose of test marketing specialty retail home furnishing stores, operating under the names "Elegant Living" ("Elegant Living") and "Jennifer Leather" ("Jennifer Leather"). The Elegant Living stores specialized in the sale of upholstered living room furniture. The Jennifer Leather stores specialized in the sale of leather furniture. The Elegant Partnership's limited partner made a capital contribution to the Partnership of $2,000. The Company has recorded the operating losses of the partnership in excess of the limited partners' capital contributions in the Consolidated Statements of Operations until the date of acquisition (see Note 1). Effective November 30, 1993, the Company acquired for $2,250, the limited partner's interest in the Elegant Partnership through the Private Company, which had owned the option to acquire such interest from the limited partner for $2,250. Such amount was written off in the fiscal year ended August 27, 1994. The Company acquired five Jennifer Leather and four Elegant Living stores. The limited partner is an affiliate of Klaussner. Pursuant to the terms of the purchase agreement, the proceeds were used to fully liquidate that limited partner's debt to a bank which debt was guaranteed by Messrs. Greenfield, Love and Seidner. F27 JENNIFER CONVERTIBLES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements - (Continued) August 31, 1996, August 26, 1995 and August 27, 1994 (In thousands except for share amounts) LP III, LP IV and LP V The Company has entered into three additional Limited Partnership Agreements (the "Agreements") establishing LP's III, IV and V which require the limited partners to invest $1,000 in each partnership. The Agreements call for the opening of 25 Jennifer Convertible stores in each partnership. Under the terms of the Agreements, the Company is to receive a fee of $10 per store, plus a royalty of 5% of the partnership's sales. The Company has recorded the operating losses of the LP's in excess of the limited partners capital contributions in the Consolidated Statements of Operations (see Note 1). The Company has also provided a $500 revolving credit loan to each of the operating LP's. These loans bear interest at the prime rate plus 3%. As part of the Agreements, the Company received options to purchase the limited partners' interest commencing January 1999 at a price of five times the partnership's earnings before income taxes for the prior year, as defined. Also, pursuant to the agreement, the limited partners can put their interest to the Company for either 100,000 shares of stock of the Company or $1,000 compounded at 25% if there is a change in management, as defined, through the year 2002. The investors have also purchased, for approximately $510, warrants ("Original Warrants") exercisable between June 1994 and June 1998 to purchase 180,000 shares of the Company's Common Stock at an exercise price of $15.625 per share. As of August 31, 1996, the limited partners have paid approximately $210 and signed ten year notes to pay $300 as payment for these warrants (See Note 7). As of August 27, 1994, capital contributions from the limited partners of $1,000 had been received for L.P. III, $500 had been received for L.P. IV and $500 had been received for L.P. V. $1,000 was received on December 1, 1994 for LP's IV and V (see Note 9). F28 EX-11.1 2 COMPUTATION OF NET (LOSS) PER SHARE EXHIBIT 11.1 JENNIFER CONVERTIBLES INC. AND SUBSIDIARIES STATEMENT RE: COMPUTATION OF NET (LOSS) PER SHARE YEARS ENDED AUGUST 31, 1996, AUGUST 26, 1995 AND AUGUST 27, 1994 (in thousands, except per share data)
1996 1995 1994 Fully Fully Fully Primary Diluted Primary Diluted Primary Diluted ------- ------- ------- ------- ------- ------- Net (loss) ($6,023) ($6,023) ($12,068) ($12,068) ($14,617) ($14,617) ====== ====== ======= ======= ======= ======= Common shares outstanding 5,701 5,701 5,701 5,701 5,701 5,701 ====== ====== ======= ======= ======= ======= Net (loss) per common share ($1.06) ($1.06) ($2.12) ($2.12) ($2.56) ($2.56) ====== ====== ======= ======= ======= =======
EX-27 3 FINANCIAL DATA SCHEDULE
5 YEAR AUG-31-1996 AUG-31-1996 $3,600,000 0 1,588,000 0 8,221,000 13,886,000 13,657,000 4,918,000 25,435,000 29,643,000 0 57,000 0 0 (10,363,000) 25,435,000 106,041,000 106,041,000 72,708,000 113,321,000 0 0 47,000 (5,877,000) 146,000 (6,023,000) 0 0 0 (6,023,000) ($1.06) ($1.06)
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