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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
- - EXCHANGE ACT OF 1934
For the quarterly period ended October 30, 2002
----------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- - EXCHANGE ACT OF 1934
For the transition period from ______________ to _____________
Commission File No. 1-327
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KMART CORPORATION
-----------------
(Exact name of registrant as specified in its charter)
Michigan 38-0729500
- ---------------------------------------- -------------------------------------
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
3100 West Big Beaver Road - Troy, Michigan 48084
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (248) 463-1000
--------------
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
--- ---
As of December 17, 2002, 519,050,664 shares of Common Stock of Kmart Corporation
were outstanding.
INDEX
PART I FINANCIAL INFORMATION PAGE
- ------ --------------------- ----
Item 1. Financial Statement
Condensed Consolidated Statements of Operations-- 3
(Unaudited) 13 and 39 weeks ended October 30, 2002 and
October 31, 2001 (Restated)
Condensed Consolidated Balance Sheets-- 4
(Unaudited) October 30, 2002, October 31, 2001 (Restated)
and January 30, 2002 (Restated)
Condensed Consolidated Statements of Cash Flows-- 5
(Unaudited) 39 weeks ended October 30, 2002 and
October 31, 2001 (Restated)
Notes to Condensed Consolidated Financial 6-25
Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Results of 26-45
Operations and Financial Condition
Item 3. Quantitative and Qualitative Disclosures about Market Risk 46
Item 4. Controls and Procedures 47
PART II OTHER INFORMATION
- ------- -----------------
Item 3. Defaults Upon Senior Securities 48
Item 5. Other Information 48
Item 6. Exhibits and Reports on Form 8-K 48
Signatures 49
Certifications 50-51
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
13 WEEKS ENDED 39 WEEKS ENDED
----------------------------- ------------------------------
(AS RESTATED - (AS RESTATED -
SEE NOTE 1) SEE NOTE 1)
OCTOBER 30, OCTOBER 31, OCTOBER 30, OCTOBER 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Sales $ 6,729 $ 8,019 $ 21,887 $ 25,273
Cost of sales, buying and occupancy 5,586 6,463 18,811 20,451
------------ ------------ ------------ ------------
Gross margin 1,143 1,556 3,076 4,822
Selling, general and administrative expenses 1,511 1,831 4,888 5,546
Equity income (loss) in unconsolidated subsidiaries 8 11 27 (13)
Restructuring, impairments and other charges (6) 5 9 120
------------ ------------ ------------ ------------
Loss before interest, income taxes, reorganization
items and dividends on convertible preferred
securities of subsidiary trust (354) (269) (1,794) (857)
Interest expense, net (contractual interest for 13
and 39 weeks ended October 30, 2002 was $105 and
$306, respectively) 37 96 102 267
Reorganization items, net -- -- 278 --
Income tax benefit (7) (127) (19) (362)
Dividends on convertible preferred securities of
subsidiary trust, net of income taxes of $0, $6,
$0 and $18 respectively (contractual dividend for
13 and 39 weeks ended October 30, 2002 was $17 and
$52 net of tax, respectively) -- 11 -- 34
------------ ------------ ------------ ------------
Net loss from continuing operations (384) (249) (2,155) (796)
Net gain from discontinued operations 1 -- 37 --
------------ ------------ ------------ ------------
Net loss $ (383) $ (249) $ (2,118) $ (796)
============ ============ ============ ============
Basic/Diluted loss per common share from
continuing operations $ (0.76) $ (0.50) $ (4.28) $ (1.62)
Basic/Diluted gain per common share from
discontinued operations -- -- 0.07 --
------------ ------------ ------------ ------------
Basic/Diluted loss per common share $ (0.76) $ (0.50) $ (4.21) $ (1.62)
============ ============ ============ ============
Basic/Diluted weighted average shares (millions) 502.5 497.8 502.7 492.4
See accompanying Notes to Condensed Consolidated Financial Statements.
3
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
(AS RESTATED - (AS RESTATED -
SEE NOTE 1) SEE NOTE 1)
OCTOBER 30, OCTOBER 31 JANUARY 30,
2002 2001 2002
------------- ------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 381 $ 366 $ 1,245
Merchandise inventories 6,330 8,256 5,796
Other current assets 687 763 800
------------- ------------- -------------
TOTAL CURRENT ASSETS 7,398 9,385 7,841
Property and equipment, net 5,764 6,921 6,093
Other assets and deferred charges 230 562 249
------------- ------------- -------------
TOTAL ASSETS $ 13,392 $ 16,868 $ 14,183
============= ============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Long-term debt due within one year $ -- $ 478 $ --
Accounts payable 1,825 3,758 89
Accrued payroll and other liabilities 691 1,163 420
Taxes other than income taxes 306 271 143
------------- ------------- -------------
TOTAL CURRENT LIABILITIES 2,822 5,670 652
Long-term debt and notes payable 575 3,310 330
Capital lease obligations 660 881 857
Other long-term liabilities 209 916 132
------------- ------------- -------------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 4,266 10,777 1,971
LIABILITIES SUBJECT TO COMPROMISE 7,128 -- 8,093
Company obligated mandatorily redeemable convertible preferred securities of a
subsidiary trust holding solely 7 3/4% convertible junior subordinated
debentures of Kmart (redemption value
$883, $898 and $898, respectively) 874 890 889
Common stock, $1 par value, 1,500,000,000 shares authorized;
503,458,279, 498,416,655 and 503,294,515 shares outstanding,
respectively 503 498 503
Capital in excess of par value 1,709 1,682 1,695
(Accumulated deficit) retained earnings (1,088) 3,021 1,032
------------- ------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 13,392 $ 16,868 $ 14,183
============= ============= =============
See accompanying Notes to Condensed Consolidated Financial Statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
OCTOBER 30, OCTOBER 31,
2002 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (2,118) $ (796)
Adjustments to reconcile net loss to net cash
used for operating activities:
Net Gain from discontinued operations (37) --
Restructuring, impairments and other charges 821 268
Reorganization items, net 278 --
Depreciation and amortization 558 618
Equity (income) loss in unconsolidated subsidiaries (27) 13
Dividends received from Meldisco 45 51
Changes in Operating Assets and Liabilities:
Increase in inventories (1,202) (1,900)
Increase in accounts payable 859 1,562
Deferred income taxes and taxes payable (23) (348)
Other assets 66 64
Other liabilities 252 183
Cash used for store closings and other charges (147) (157)
------------- -------------
NET CASH USED FOR OPERATING ACTIVITIES (675) (442)
------------- -------------
NET CASH USED FOR REORGANIZATION ITEMS (113) --
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (206) (1,084)
Investment in BlueLight.com -- (45)
------------- -------------
NET CASH USED FOR INVESTING ACTIVITIES (206) (1,129)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of debt -- 1,887
Proceeds from DIP Credit Facility 245 --
Debt issuance costs (36) --
Issuance of common shares -- 40
Payments on debt (22) (275)
Payments on capital lease obligations (57) (62)
Payments of dividends on preferred securities of subsidiary trust -- (54)
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 130 1,536
------------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (864) (35)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,245 401
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 381 $ 366
============= =============
See accompanying Notes to Condensed Consolidated Financial Statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
1. RESTATEMENT OF PRIOR PERIODS
As part of the review and preparation of this report on Form 10-Q for
the 13 and 39 week periods ended October 30, 2002, Kmart Corporation and
its Subsidiaries ("Kmart," "we" or "our") identified certain adjustments
that were recorded out-of-period, while others were previously identified
and described in our second quarter report on Form 10-Q, filed with the
SEC on September 16, 2002. Upon review of the aggregate impact of the new,
as well as the previously disclosed and recorded adjustments, we concluded
that restating our financial statements for the prior periods was
appropriate because the aggregate impact was material to the current
estimate of our 2002 fiscal year results.
The net effect of these adjustments on the 26 week period ended
July 31, 2002 was to decrease our previously reported net loss by $92.
The tables below show the effects of the restatements on reported
losses for the prior periods presented in this Form 10-Q and which relate
primarily to:
a) Lease accrual adjustments - An understatement of historical accruals
for certain leases with varying rent payments and a related
understatement of historical rent expense.
b) Accounts payable adjustments - A software programming error in Kmart's
accounts payable system that resulted in some paid invoices awaiting a
store report of delivery not being appropriately treated in our
financial statements. This error, restricted to a single vendor with
unique billing arrangements, resulted in an understatement of Cost of
sales, buying and occupancy since 1999.
c) Inventory loads - Adjustments, as previously disclosed in the 2002
second quarter report on Form 10-Q, for certain costs formerly
capitalized into inventory. Inventory included amounts added for
internal purposes to analyze gross margin on a comparable basis across
all business units and to optimize purchasing decisions. These amounts
are commonly referred to in the retail industry as "inventory loads,"
and should have been eliminated for external reporting purposes to the
extent the related inventory remained unsold at the end of the period.
d) Vendor allowances - The premature recording, as previously disclosed
in the 2002 second quarter report on Form 10-Q, of vendor allowance
transactions in fiscal year 2000 and prior fiscal years.
In addition, given the restatement for the items noted above, Kmart
is adjusting previously reported financial results for miscellaneous
immaterial items that were identified and previously recorded in the
ordinary course of business. These items are now being recorded in the
appropriate fiscal periods.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The summary of the effects of the restatement on the 13 and 39 weeks
ended October 31, 2001 are presented in the tables below.
13 Weeks Ended October 31, 2001
-----------------------------------------------------------------------------------------------
Adjustments
-------------------------------------------------------------------
As Lease Accounts
previously accrual payable Inventory Vendor As
reported* adjustments adjustments loads allowances Other restated
-----------------------------------------------------------------------------------------------
Sales $8,019 $- $- $- $- $- $8,019
Cost of sales, buying
and occupancy $6,434 $1 $14 $15 ($20) $19 $6,463
-----------------------------------------------------------------------------------------------
Gross margin $1,585 ($1) ($14) ($15) $20 ($19) $1,556
Selling, general and
administrative expenses $1,837 $- $- $4 $- ($10) $1,831
Operating (loss) income ($246) ($1) ($14) ($19) $20 ($9) ($269)
(Benefit from) pro-
vision for
income taxes ($118) $- ($5) ($7) $7 ($4) ($127)
-----------------------------------------------------------------------------------------------
Net (loss) income ($235) ($1) ($9) ($12) $13 ($5) ($249)
===============================================================================================
Basic/Diluted (loss) earnings per
common share ($0.47) ($-) ($0.02) ($0.02) $0.02 ($0.01) ($0.50)
===============================================================================================
39 Weeks Ended October 31, 2001
-----------------------------------------------------------------------------------------------
Adjustments
-------------------------------------------------------------------
As Lease Accounts
previously accrual payable Inventory Vendor As
reported* adjustments adjustments loads allowances Other restated
-----------------------------------------------------------------------------------------------
Sales $25,273 $- $- $- $- $- $25,273
Cost of sales, buying
and occupancy $20,521 $4 $30 $6 ($84) ($26) $20,451
-----------------------------------------------------------------------------------------------
Gross margin $4,752 ($4) ($30) ($6) $84 $26 $4,822
Selling, general and
administrative expenses $5,553 $- $- ($6) $- ($1) $5,546
Operating (loss) income ($934) ($4) ($30) $- $84 $27 ($857)
(Benefit from) pro-
vision for
income taxes ($390) ($1) ($11) $- $31 $9 ($362)
-----------------------------------------------------------------------------------------------
Net (loss) income ($845) ($3) ($19) $- $53 $18 ($796)
===============================================================================================
Basic/Diluted (loss) earnings per
common share ($1.72) ($-) ($0.04) $- $0.11 $0.03 ($1.62)
===============================================================================================
*As previously reported in the Form 10-Q/A for the third quarter 2001 filed on
June 12, 2002.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The following is a summary of the effects of the restatement on our
unaudited Condensed Consolidated Balance Sheets for all amounts that
changed by 5% or more for the periods ended October 31, 2001 and January
30, 2002.
As
previously As
reported restated
-------------- -------------
January 30, 2002*
Accounts payable $103 $89
Accrued payroll and other liabilities $378 $430
Other long-term liabilities $79 $132
Retained earnings $1,261 $1,032
October 31, 2001**
Other assets and deferred charges $483 $562
Other long-term liabilities $865 $916
* - As previously reported in the Form 10-K filed on May 15, 2002.
** - As previously reported in the Form 10-Q/A for the third quarter 2001
filed on June 12, 2002.
We will file Amendment No. 1 Annual Report on Form 10-K/A for the 2001
fiscal year and amended Quarterly Reports on Form 10-Q/A for the first two
quarters of the 2002 fiscal year as soon as practicable.
2. BASIS OF PRESENTATION
General
These interim unaudited Condensed Consolidated Financial Statements
have been prepared on a going concern basis, which assumes continuity of
operations and realization of assets and satisfaction of liabilities in the
ordinary course of business, and in accordance with Statement of Position
90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization under
the Bankruptcy Code." Accordingly, all pre-petition liabilities subject to
compromise have been segregated in the unaudited Condensed Consolidated
Balance Sheets and classified as Liabilities subject to compromise, at the
estimated amount of allowable claims. Liabilities not subject to compromise
are separately classified as current and non-current. Revenues, expenses,
realized gains and losses, and provisions for losses resulting from the
reorganization are reported separately as Reorganization items, net, except
for those required to be reported as discontinued operations in conformity
with Statement of Financial Accounting Standards ("SFAS") No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets," ("SFAS
No. 144") in the unaudited Condensed Consolidated Statements of Operations.
Cash used for reorganization items is disclosed separately in the unaudited
Condensed Consolidated Statements of Cash Flows.
These interim unaudited Condensed Consolidated Financial Statements
have been prepared in accordance with the rules and regulations of the SEC.
Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States
of America for complete financial statements. In the opinion of management,
all adjustments (which include normal recurring adjustments) considered
necessary for a fair presentation have been included. Operating results for
the 39 week period ended October 30, 2002 are not necessarily indicative of
the results that may be expected for the 2002 fiscal year ending January
29, 2003. These unaudited Condensed Consolidated Financial Statements
should be read in conjunction with the audited Condensed Consolidated
Financial Statements and the notes thereto included in Amendment No. 1 to
our Annual Report on Form 10-K/A for the fiscal year ended January 30,
2002, to be filed with the SEC as soon as practicable.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Reclassifications
Certain reclassifications of prior period financial statements have
been made to conform to the current interim period presentation.
3. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On January 22, 2002 ("Petition Date"), Kmart and 37 of its U.S.
subsidiaries (collectively, the "Debtors") filed voluntary petitions for
reorganization under Chapter 11 of the federal bankruptcy laws ("Bankruptcy
Code" or "Chapter 11") in the United States Bankruptcy Court for the
Northern District of Illinois ("Court") under case numbers 02 B 02462
through 02 B 02499. The reorganization is being jointly administered under
the caption "In re Kmart Corporation, et al. Case No. 02 B 02474." The
Debtors are currently operating their business as debtors-in-possession
pursuant to the Bankruptcy Code.
We decided to seek judicial reorganization based upon a rapid decline
in our liquidity resulting from our below-plan sales and earnings
performance in the fourth quarter of the 2001 fiscal year, the evaporation
of the surety bond market and erosion of supplier confidence. Other factors
included intense competition in the discount retailing industry,
unsuccessful sales and marketing initiatives, the continuing recession, and
capital market volatility. As a debtor-in-possession, Kmart is authorized
to continue to operate as an ongoing business, but may not engage in
transactions outside the ordinary course of business without the approval
of the Court, after notice and an opportunity for a hearing.
At first day hearings held on January 22 and 25, 2002, the Court
entered orders granting authority to Kmart to, among other things, pay
pre-petition and post-petition employee wages, salaries, benefits and other
employee obligations, to pay selected vendors and other providers for
pre-petition amounts owed, and to honor customer service programs,
including warranty returns, layaways and gift certificates. On January 25,
2002, the Court also gave interim approval for $1.15 billion of a $2
billion senior secured debtor-in-possession financing facility ("DIP Credit
Facility") for the payment of permitted pre-petition claims, working
capital needs, letters of credit and other general corporate purposes. On
March 6, 2002, the Court approved the entire $2 billion DIP Credit Facility
underwritten by JP Morgan Chase Bank, Fleet Retail Finance, Inc., General
Electric Capital Corporation and Credit Suisse First Boston to supplement
our cash flow from operations during the reorganization process. The DIP
Credit Facility was amended and approved by the Court on August 29, 2002,
to provide additional flexibility under the financial covenant contained
therein that requires certain minimum levels of cumulative earnings before
interest, taxes, depreciation, amortization and other charges ("EBITDA").
The DIP Credit Facility requires that we maintain certain other financial
covenants and restricts liens, indebtedness, capital expenditures, dividend
payments and sales of assets.
Under the Bankruptcy Code, actions to collect pre-petition
indebtedness, as well as most other pending litigation, are stayed and
other pre-petition contractual obligations generally may not be enforced
against Kmart. Absent an order of the Court, substantially all pre-petition
liabilities are subject to settlement under a plan of reorganization to be
voted upon by creditors and equity holders and approved by the Court. As
provided by the Bankruptcy Code, the Debtors initially have the exclusive
right to solicit a plan of reorganization for 120 days. On July 24, 2002,
the Court approved our request to extend the period during which we have
the exclusive right to file a plan of reorganization and the period in
which we have the exclusive right to solicit acceptances with respect to
any plan we may timely file until February 28, 2003 and April 22, 2003,
respectively. Under a timeline reviewed with the Board of Directors and the
three independent statutory committees in our Chapter 11 reorganization
case, Kmart plans to complete a five-year business plan by the end of our
2002 fiscal year. Thereafter, we also intend to file a proposed plan of
reorganization with the Court on or before February 24, 2003 and, subject
to approval by the Court and the attainment of all requisite approvals,
emerge from bankruptcy as soon thereafter as practicable.
The United States Trustee has appointed an unsecured creditors'
committee, a financial institutions' committee and an equity holders'
committee. These official committees and their legal representatives often
take positions on matters that come before the Court, and are the most
likely entities with which Kmart will negotiate the terms of a plan of
reorganization. There can be no assurance that these committees will
support Kmart's positions in the bankruptcy proceedings or the plan of
reorganization once proposed, and disagreements between Kmart and these
committees could
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
protract the bankruptcy proceedings, could negatively impact our ability to
operate during bankruptcy and could delay our emergence from bankruptcy.
Kmart understands that, as a result of the trading in claims against
us, certain entities or groups may have accumulated significant positions
in various classes of claims. The existence of such positions, which may
change from time to time, could affect our ability to obtain confirmation
of a plan or, possibly, the terms thereof.
On September 11, 2002, the United States Trustee filed an amended
notice of appointment for the official committee of financial institutions
pursuant to which two holders of Kmart's bond debt were added to the
financial institutions committee. These holders, ESL Investments and Third
Avenue Value Fund, have indicated to us that they have acquired a
significant amount of our pre-petition balance sheet debt and are actively
participating in the statutory committee process and the Chapter 11 cases,
including with respect to supporting our emergence from Chapter 11 on the
expedited timeframe we previously reported.
There can be no assurance that a reorganization plan or plans will be
proposed by the Debtors or confirmed by the Court, or that any such plan(s)
will be consummated; in addition, the timing of such actions may be other
than currently planned by Kmart. If the Debtors fail to file a plan of
reorganization during the exclusivity period described above (as such
period may be extended) or if such plan is not accepted by the required
number of creditors and equity holders, any party in interest may
subsequently file its own plan of reorganization. A plan of reorganization
cannot become effective until confirmed by the Court, upon certain findings
being made by the Court which are required by the Bankruptcy Code. The
Court may confirm a plan notwithstanding the non-acceptance of the plan by
an impaired class of creditors or equity security holders if certain
requirements of the Bankruptcy Code are met. If it is determined that
liabilities subject to compromise in the Chapter 11 cases exceed the fair
value of the assets available to satisfy them, unsecured claims may be
satisfied at less than 100% of their face value and the equity interests of
Kmart's shareholders may have no value.
In connection with the preparation of a plan of reorganization, we
have engaged and continue to engage in discussions and/or negotiations with
the various statutory committees, and, to the extent appropriate, with
significant holders of claims or other third parties concerning the
possible terms of a plan of reorganization. Kmart may also engage in
discussions with such parties to determine their level of interest in
facilitating a plan of reorganization. Under the possible terms of a plan
of reorganization being discussed with the statutory committees
representing Kmart's creditors, those creditors would not receive a full
recovery of their claim amounts, the Kmart common stock would be cancelled,
and the holders of such common stock would receive little or no
consideration. We expect that the equity holders' committee would oppose
any plan that provides no consideration to equity holders and that both
creditors' committees would oppose any plan that would provide other than
nominal consideration to such holders. We expect discussions to continue
among ourselves, the various statutory committees, including the equity
holders' committee, and other third parties as to the terms of any such
consideration and cannot predict the value of the consideration, if any,
that may be received by the holders of Kmart common stock pursuant to a
plan of reorganization. In light of the foregoing, we consider the value of
the Kmart common stock to be highly speculative and caution equity holders
that the stock may ultimately be determined to have no value. Accordingly,
Kmart urges that appropriate caution be exercised with respect to existing
and future investments in the Kmart common stock.
Under the Bankruptcy Code, we may assume or reject executory contracts
and unexpired leases, including our store leases, subject to the approval
of the Court and our satisfaction of certain other requirements. In the
event we choose to reject an executory contract or unexpired lease, parties
affected by these rejections may file claims with the court-appointed
claims agent as proscribed by the Bankruptcy Code and/or orders of the
Court. Unless otherwise agreed, the assumption of an executory contract or
unexpired lease will require Kmart to cure all prior defaults under such
executory contract or lease, including all pre-petition liabilities, some
of which may be significant. In addition, in this regard, we expect that
liabilities that will be subject to compromise through the Chapter 11
process will arise in the future as a result of the rejection of additional
executory contracts and/or unexpired leases, and from the determination of
the Court (or agreement by parties in interest) of allowed claims for items
that we now claim as contingent or disputed. Conversely, we would expect
that the assumption of additional executory contracts may convert some
liabilities shown on our financial statements as subject to compromise to
post-petition liabilities. Due to the uncertain nature of many of the
potential claims, we are unable to project the magnitude of such claims
with any degree of certainty. Kmart has incurred, and will continue to
incur, significant costs associated with the reorganization.
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
On April 15, 2002, we filed with the Court schedules of assets and
liabilities and statements of financial affairs setting forth, among other
things, the assets and liabilities of the Debtors as shown by our books and
records, subject to the assumptions contained in certain notes filed in
connection therewith. All of the schedules and the statements of financial
affairs are subject to further amendment or modification. The deadline for
creditors to file proofs of claim with the court-appointed claims agent was
July 31, 2002, with certain limited exceptions for extensions granted by
the Court. Kmart plans to amend the schedules and statements of financial
affairs to include the names and addresses of certain personal injury and
related creditors who were inadvertently omitted from such filings and has
filed a motion for an order establishing a supplemental bar date for the
filing of proofs of claim by such creditors. Differences between amounts
scheduled by Kmart and claims by creditors are being investigated and
resolved in connection with our claims resolution process. That process has
commenced and, in light of the number of creditors of the Debtors and
claims filed, will take time to complete. Accordingly, the ultimate number
and amount of allowed claims is not presently known. Similarly, the
ultimate distribution with respect to allowed claims is not presently
ascertainable.
On September 24, 2002, the Court approved our request to pay eligible
reclamation claimants 75% of allowed reclamation claims in full
satisfaction of these claims. Payments were required by November 30, 2002
or 30 days after a claimant elects to receive such payment. As of November
30, we have paid reclamation claims of $9. Alternatively, holders of
allowed reclamation claims may elect to receive 100% of such claims when we
emerge from Chapter 11. Vendors who elect to receive 75% of their
reclamation claims are required to comply with certain terms. We estimate
that there are approximately $120 of allowed reclamation claims.
We have filed numerous motions in the Chapter 11 case whereby we were
granted authority or approval with respect to various items which are
required by the Bankruptcy Code and/or necessary for our reorganization
efforts. In addition to motions pertaining to store closure and real estate
disposition matters, we have obtained orders providing for, among other
things, (i) implementation of a key employee retention and incentive
program, (ii) authorization of a second lien for vendors in connection with
our secured inventory trade credit program, (iii) authorization of a
settlement agreement with our sureties who support our self-insurance
program and state licensing requirements, (iv) the extension of time to
assume or reject leases, (v) implementation of uniform procedures for
resolving or otherwise liquidating our numerous pre-petition personal
injury actions, (vi) implementation of uniform procedures for resolving or
otherwise liquidating numerous mechanics and materialmen's liens, (vii)
approval of standing bidding procedures to be utilized in connection with
asset sales, (viii) authority to compromise or settle certain classes of
deminimis controversy and allowed claims without further court approval,
(ix) approval of procedures to sell certain deminimis assets free and clear
of liens, claims and encumbrances and to pay market rate broker commissions
in connection with such sales without further court approval and (x)
assumption of agreements with our key brand partners and other key vendor
partners.
Under the priority scheme established by the Bankruptcy Code,
substantially all post-petition liabilities and pre-petition liabilities
need to be satisfied before shareholders are entitled to receive any
distribution. The ultimate recovery to creditors, trust convertible
preferred securities holders and/or common shareholders, if any, will not
be determined until confirmation of a plan or plans of reorganization and
substantial completion of claims reconciliation by Kmart and claims
allowance by the Court. The amounts to be received by the various classes
of creditors pursuant to a plan of reorganization will depend, among other
things, upon (i) the impact of guarantees of certain pre-petition debt
which were previously given by a number of Kmart's subsidiaries and (ii)
the treatment of the trust convertible preferred securities holders. No
assurance can be given as to what values, if any, will be ascribed in the
bankruptcy cases to each of these constituencies.
As described above, a plan of reorganization could also result in
holders of Kmart common stock receiving no distribution on account of their
interests and cancellation of their interests. Holders of Kmart common
stock should assume that they could receive little or no value as part of a
plan of reorganization. In addition, under certain conditions specified in
the Bankruptcy Code, a plan of reorganization may be confirmed
notwithstanding its rejection by an impaired class of creditors or equity
holders and notwithstanding the fact that equity holders do not receive or
retain property on account of their equity interests under the plan. In
light of the foregoing, Kmart considers, as described above, the value of
the common stock to be highly speculative and cautions equity holders that
the stock may ultimately be determined to have no value. Accordingly, Kmart
urges that appropriate caution be exercised with respect to existing and
future investments in the Kmart common stock or in any claims related to
pre-petition liabilities and/or other Kmart securities.
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The ability of Kmart to continue as a going concern is predicated upon
numerous issues, including our ability to achieve the following:
- developing a long-term strategy and/or market niche to revitalize our
business and return Kmart to profitability;
- taking appropriate action to offset the negative effects that the
Chapter 11 filing has had on our business, including the loss in
customer traffic and the impairment of vendor relations;
- operating within the framework of our DIP Credit Facility, including
its limitations on capital expenditures and its financial covenants,
our ability to generate cash flows from operations or seek other
sources of financing and the availability of projected vendor credit
terms;
- attracting, motivating and/or retaining key executives and associates;
and
- developing and, thereafter, having confirmed by the Court, a plan of
reorganization.
These challenges are in addition to those operational and competitive
challenges faced by Kmart in connection with our business as a discount
retailer. See "Cautionary Statement Regarding Forward-Looking Information."
A plan of reorganization could materially change the amounts reported
in the financial statements, which do not give effect to all adjustments of
the carrying value of assets or liabilities that might be necessary as a
consequence of a plan of reorganization.
4. 2002 COST REDUCTION INITIATIVE
On August 19, 2002, we announced a cost reduction initiative aimed at
realigning our organization to reflect our current business needs following
the completion of the closure of 283 stores. We eliminated approximately
400 positions at our corporate headquarters and approximately 50 positions
nationally that provided corporate support. As a result of the job
eliminations we recorded a charge of $15 during the second quarter of
fiscal 2002. The charge includes severance, outplacement services and
continuation of healthcare benefits in accordance with the severance plan
provisions of our Key Employee Retention Plan ("KERP"), which was approved
by the Court in March 2002. This charge is included in the line
Restructuring, impairment and other charges in our unaudited Condensed
Consolidated Statements of Operations.
5. DISCONTINUED OPERATIONS
For the 13 and 39 week periods ended October 30, 2002, we credited
income for $1 and $37, respectively, primarily to reduce estimated reserves
for our remaining lease obligations for the Builder's Square, Inc.,
Hechinger Company, Pace Membership Warehouse, Inc. and Furr's Restaurants
locations. These amounts primarily related to lease settlement agreements
with our landlords, adjustments to our estimated allowable claims for the
lease obligations and income related to the recovery of claims through the
bankruptcy of Hechinger Company.
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
6. REORGANIZATION ITEMS, NET
Reorganization items, net represent amounts we incurred as a direct
result of our Chapter 11 filing and are presented separately in the
unaudited Condensed Consolidated Statements of Operations. For the 13 and
39 weeks ended October 30, 2002, the following amounts have been recorded:
13 Weeks 39 Weeks
Ended Ended
--------- ---------
2002 store closings $ 4 $ 222
Employee costs 20 83
Professional fees 14 81
Settlement of pre-petition liabilities (24) (58)
Lease auction (19) (21)
Sale of pharmacy lists -- (18)
Interest income (1) (10)
Other 6 (1)
--------- ---------
Reorganization items, net $ -- $ 278
========= =========
The following paragraphs provide additional information relating to
costs that were reported in the line Reorganization items, net in our
unaudited Condensed Consolidated Statement of Operations for the 13 and 39
week periods ended October 30, 2002:
2002 Store Closings
On March 20, 2002, the Court approved the closure of 283 stores.
Stores were selected by evaluating the market and financial performance of
every store and the terms of every lease. Candidates for closure were
stores that did not meet our financial requirements for ongoing operations.
All of the stores were closed as of June 2, 2002.
SFAS No. 144 requires closed stores to be classified as discontinued
operations when a) the operations and cash flows of the stores have been
(or will be) eliminated from our ongoing operations and b) we will not have
any significant continuing involvement in the operations of the stores
after the closure. Based on these criteria, we evaluated the 283 stores
closed during the second quarter and determined that in substantially all
the cases, the operations and cash flows of the stores should not be
eliminated from our ongoing operations. The results of operations for 28
stores were considered to be discontinued operations under the criteria set
forth in SFAS No. 144, however; total Sales, Gross margin, and Selling,
general and administrative expenses ("SG&A") for these stores represented
less than 1% of total Sales, Gross margin and SG&A, and were not considered
material for separate presentation in the unaudited Condensed Consolidated
Statement of Operations.
In conjunction with these 283 store closings, we recorded charges of
$4 and $222 for expenses related to store closings during the 13 and 39
week periods ended October 30, 2002, respectively. These charges are
included in Reorganization items, net in the unaudited Condensed
Consolidated Statement of Operations. We charged $228 to our closed store
reserve for allowable claims related to lease terminations and other costs
and reclassified $144 of capital lease obligations to the closed store
reserve during the first quarter of fiscal 2002. During the second and
third quarters of fiscal 2002, we recorded a credit of $10 and a charge of
$4, respectively, to adjust our estimated allowable claims. The reserve for
estimated costs was recorded in accordance with Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity" ("EITF 94-3"). See Note 11
for a summary of reserve activity.
13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Employee Costs
In March 2002, we received Court approval to implement the KERP which
provides cash incentives and certain benefits to key members of our
salaried management team. The retention program provisions of the KERP are
expected to encourage employees to continue their employment with Kmart
through the reorganization process. For the 13 and 39 week periods ended
October 30, 2002, we recorded charges of $20 and $83, respectively, for the
KERP benefits and other employee benefits for associates at our closed
stores that were not covered under the KERP.
Professional Fees
For the 13 and 39 week periods ended October 30, 2002, we recorded $14
and $81, respectively, for professional fees. Professional fees include
financial, legal, real estate and valuation services directly associated
with our reorganization process.
Settlement of Pre-petition Liabilities
For the 13 and 39 week periods ended October 30, 2002, we recorded
gains of $24 and $58, respectively, representing the difference between the
settlement value of certain pre-petition obligations and the estimated
amounts recorded for allowable claims, primarily related to lease
termination agreements between Kmart and its landlords.
Lease Auction
Kmart and certain subsidiaries entered into several Asset Purchase and
Designation Rights Agreements ("Agreements") with Kimco Realty Corporation,
Schottenstein Stores Corporation and Klaff Realty, LP and other purchasers
("Purchasers"), in accordance with the bidding procedures order entered by
the Court on May 10, 2002. Under terms of the Agreements we agreed to sell
to the Purchasers the designation rights with respect to 56 leaseholds for
closed stores and our interest in the leasehold for one closed store, the
Purchaser of which defaulted under its Agreement and the lease was
rejected. During the designation period, as defined under the Agreements,
the Purchasers of designation rights shall have the sole, exclusive and
continuing right to select, identify and designate (i) which leases shall
be assumed and assigned (and if assigned to whom), or terminated, and (ii)
which properties shall be excluded from the transaction. During fiscal year
2002, the leaseholds on the 283 stores not covered by the Agreements have
been rejected or terminated.
In consideration for designation rights acquisitions, the Purchasers
are obligated to pay $46, of which $14 and $26 were paid in cash during the
13 and 39 week periods ended October 30, 2002, respectively. The remaining
$20 is to be paid as the Purchaser of the designation rights with respect
to 54 leaseholds receives net proceeds from the sale or assignment of the
properties, but not later than December 31, 2002. The Purchasers are
responsible for paying all carrying costs related to such properties during
the designation period in accordance with the Agreements. In addition, we
may be entitled to additional proceeds in the event that designation rights
transactions exceed a specified level of proceeds.
A pro-rata portion of the guaranteed proceeds of $46 will be
recognized as income at either the effective date of the property
assignment or termination, when we are informed by the Purchasers of their
intention to exclude certain leaseholds from future assignments or
terminations, or upon expiration of the designation rights period. At the
time we are legally released as the primary obligor under the lease
agreement, the allowed claim amount established in connection with the
Court's approval of our plan to close the store and reject the lease will
be reversed. Both the income from the sale of the designation rights and
the reversal of the allowed claim amount are reported as Reorganization
items, net in the unaudited Condensed Consolidated Statement of Operations.
During fiscal 2002, 22 leases under the Agreements have been assigned,
four have been terminated or rejected under landlord agreements and seven
have been excluded. Five of the excluded leases were rejected before the
end of the third quarter of 2002. The two remaining excluded leases have
been or will be assigned, terminated or rejected in the fourth quarter. For
the 13 and 39 week periods ended October 30, 2002 we recognized $19 and $21
of proceeds, respectively, from the sale of designation rights. The
remaining funds received have been deferred and will be recognized in our
unaudited Condensed Consolidated Statement of Operations as described
above.
14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Other Reorganization Items
For the 13 and 39 week periods ended October 30, 2002, we recorded $0
and $18 of income, respectively, for the sale of pharmacy lists and $1 and
$10, respectively, for interest income earned on excess cash balances. For
the 13 and 39 week periods ended October 30, 2002, we recorded $6 of
expenses, and a credit of $1, respectively, for other reorganization items.
7. MARKDOWNS FOR INVENTORY LIQUIDATION
For the 39 week period ended October 30, 2002, we recorded charges of
$785 to write-down inventory liquidated at our 283 closing stores to net
realizable value, given the accelerated liquidation strategy. This charge
is included in Cost of sales, buying and occupancy in the unaudited
Condensed Consolidated Statements of Operations.
For the year, $348 of the charge was recorded relating to the
write-down of inventory initially existing at the closing stores to its
estimated selling value in connection with liquidation sales in the 283
stores. During the liquidation sale the actual markdowns required to
liquidate the inventory were lower than expected. As a result, in the
second quarter, we recorded a credit of $36 to adjust our original estimate
of $384. In addition, $117 of the charge related to liquidation fees and
expenses associated with the disposition of inventory through the
liquidation sales at the 283 closing stores.
The remaining $320 was recorded relating to the acceleration of
markdowns on approximately 107,000 stock keeping units ("SKUs"), the
majority of which were transferred from our remaining open stores to the
283 closing stores and included in the liquidation sales. The liquidation
of these SKUs required higher markdowns than anticipated, accordingly, an
adjustment of $54 was recorded in the second quarter of 2002 to adjust our
original estimate of $266.
The following table summarizes the components of the charge for
markdowns for inventory liquidation during fiscal year 2002:
Writedown of
Inventory in Accelerated
the 283 Liquidator Markdown of
Closing Fees and Discontinued
Stores Expenses SKUs Total
------------- ------------- ------------- -------------
First Quarter $ 384 $ 108 $ 266 $ 758
Second Quarter
Adjustments for actual selling values (36) -- 54 18
Additional fees and expenses -- 9 -- 9
------------- ------------- ------------- -------------
Total $ 348 $ 117 $ 320 $ 785
============= ============= ============= =============
8. INTEREST EXPENSE, NET
Interest income of $1 and $3 is included in the line Interest expense,
net in the unaudited Condensed Consolidated Statements of Operations for
each of the 13 and 39 week periods ended October 30, 2002 and October 31,
2001, respectively. Interest income earned as a result of excess cash
balances due to the Chapter 11 filing are recorded in the line
Reorganization items, net in the unaudited Condensed Consolidated
Statements of Operations, see Note 6.
15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
As of the Petition Date, we ceased accruing interest on unsecured
pre-petition debt classified as Liabilities subject to compromise in our
unaudited Condensed Consolidated Balance Sheets in accordance with SOP
90-7. Interest at the stated contractual amount on unsecured debt that was
not charged to results of operations for the 13 and 39 week periods ended
October 30, 2002 was approximately $67 and $204, respectively.
9. INCOME TAXES
In the fourth quarter of fiscal 2001, we recorded a valuation
allowance against our net deferred tax assets, in accordance with SFAS No.
109, "Accounting for Income Taxes," as realization of such assets in future
years is uncertain.
We have continued to maintain a valuation allowance against our net
deferred tax assets, and accordingly, we have not recognized any tax
benefit from our losses in fiscal 2002. The $19 tax benefit recorded in the
39 weeks ended October 30, 2002 relates primarily to $12 now refundable to
Kmart as a result of the Job Creation and Worker Assistance Act of 2002
which was enacted in the first quarter of fiscal 2002 and $14 related to a
special provision of the Internal Revenue Code that allows a 10-year
carryback of certain losses, partially offset by $7 of expense related to
income taxes paid to foreign jurisdictions in the third quarter of 2002.
10. RESTRUCTURINGS
Supply Chain Operations
On September 6, 2001 we restructured certain aspects of our supply
chain infrastructure, including the reconfiguration of our distribution
center network and implementation of new operating software across our
supply chain. In conjunction with these actions, we recorded a charge of
$148 ($94, net of tax) in the third quarter of fiscal 2001.
We recorded a $92 charge related to the planned disposal of supply
chain software and hardware and other assets that are no longer utilized,
in accordance with SFAS No. 144.
Operating software was replaced at four of our distribution centers in
2002; however, we have suspended the replacement initiative at our other
fourteen distribution centers. Accordingly, we have discontinued the
acceleration of depreciation at these centers and any remaining net book
value of assets will be depreciated over the original useful lives. There
was $9 recorded for accelerated depreciation in the 39 weeks ended October
30, 2002 of which $7 and $2 was included in Cost of sales, buying and
occupancy and SG&A, respectively.
A $47 charge was recorded for lease terminations and contractual
employment obligations for staff reductions of 956 employees at our
distribution centers in accordance with EITF 94-3.
The following table summarizes the significant components and
presentation, in the unaudited Condensed Consolidated Statements of
Operations, of the charge for the restructuring of our supply chain
operations during the third quarter of fiscal 2001.
Cost of
sales, buying
and occupancy SG&A Total
------------ ------------ ------------
Asset impairments $ 5 $ 87 $ 92
Lease obligations 37 -- 37
Contractual employment obligations 10 -- 10
Accelerated depreciation on software 9 -- 9
------------ ------------ ------------
Total $ 61 $ 87 $ 148
============ ============ ============
16
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
In the second quarter of fiscal 2002, we recorded a credit of $5 in
Reorganization items, net related to lease settlement agreements with our
landlords. See Note 11 contained herein for a summary of reserve activity.
Restructuring of BlueLight.com
We recorded a $92 charge ($73, net of tax) related to our e-commerce
site, BlueLight.com, in the second quarter of fiscal 2001, comprised of $41
for the impairment of our investment in BlueLight.com and $51 for the
restructuring of our e-commerce business.
Based upon the changing environment for the internet businesses, in
which the ability for such businesses to raise capital was restricted,
management's revised future cash flow projections and the potential need
for significant additional cash advances, we adopted a multi-step plan to
substantially restructure the operations of BlueLight.com.
The initial step was executed in the second quarter of 2001, by
acquiring the remaining 40% interest in BlueLight.com, LLC, principally
through the purchase of all outstanding common and preferred stock of
BlueLight.com, Inc., a holding company. BlueLight.com, Inc. and
BlueLight.com LLC (hereinafter together or individually, "BlueLight.com")
then became wholly-owned subsidiaries of Kmart, which allowed us to execute
our restructuring plan. The purchase price of the additional interest was
$85, with $69 being satisfied through the issuance of 6.1 million
unregistered shares of Kmart common stock and $16 paid in cash. Based upon
the revised cash flow projections for the business, we recorded in the
second quarter of fiscal 2001 a $41 charge to write-down our investment in
BlueLight.com to fair value in accordance with SFAS No. 144. Fair value was
determined using the present value of estimated future cash flows. In
connection with the transaction, the return of capital put rights for $62.5
and the 4.4 million warrants for Kmart stock originally granted to SOFTBANK
Venture Capital (currently Mobius Venture Capital) and other investors were
terminated. The $62.5 liability for the return of capital puts, recorded
due to uncertainties surrounding a start-up operation in the highly
competitive e-commerce industry, was relieved.
Of the $51 restructuring charge, $29 related to assets impaired as a
result of the restructuring. These assets represent furniture and fixtures,
leasehold improvements, and computer software and hardware, the majority of
which were located in the headquarters of BlueLight.com, and were not
utilized in the restructured operations. These assets were reduced to the
lower of carrying amount or fair value less cost to sell in accordance with
SFAS No. 144. Fair value was determined using the present value of
estimated future cash flows. Liabilities for lease terminations, contract
terminations and other costs totaling $22 were established in accordance
with EITF 94-3 as a result of the decision to exit the BlueLight.com
headquarters building and outsource certain aspects of our overall
e-commerce business, including fulfillment, technology and customer
service.
During the third quarter of 2001, we continued executing our
restructuring plan, including formally communicating severance benefits to
114 employees at the BlueLight.com headquarters. We recorded an additional
$5 ($3, net of tax) charge to provide for these costs.
In the third quarter of fiscal 2002 we reduced the reserves
established for BlueLight.com contract terminations by $6 based on our
revised estimates for the remaining obligations. All charges related to the
impairment of our investment and restructuring of BlueLight.com are
included in the line Restructuring, impairment and other charges in the
unaudited Condensed Consolidated Statements of Operations.
Additionally, during the third quarter of 2002, we reversed, through
Reorganization items, net, $4 of the charge for lease terminations to
reduce the reserve to the amount of the estimated allowed claim under the
Bankruptcy Code.
See Note 11 contained herein for a summary of reserve activity. The
results of BlueLight.com's operations are fully consolidated in our
financial statements commencing July 31, 2001. See Note 20 contained herein
for a summary of the sale of certain assets of BlueLight.com.
17
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Employee Severance and VERP
During the first quarter of 2001, our workforce was reduced by 350
employees through a voluntary early retirement program ("VERP") and other
employee separations. The total cost of the realignment aggregated $23
($15, net of tax), which is included in our unaudited Condensed
Consolidated Statement of Operations for the 39 week period ended October
31, 2001 in the line item Restructuring, impairments and other charges. The
charge related to 130 employees that accepted the VERP offer, with costs
aggregating $6. The remaining 220 employees were severed and given
post-employment benefits including severance, outplacement services,
continuation of healthcare benefits and other benefits totaling $17. Of the
charge, $19 was reserved for and paid out of our general corporate assets,
including benefits for highly-compensated employees accepting the VERP
offer, and the remaining $4 was paid out of the Kmart Employee Pension
Plan. See Note 11 contained herein for a summary of reserve activity.
11. RESTRUCTURING RESERVE ACTIVITY
The following table provides information regarding reserve activity
during the 39 week periods ended October 30, 2002 and October 31, 2001,
respectively, for the fiscal year 2000 strategic actions charge, the fiscal
year 2001 employee severance and VERP charge, the fiscal year 2001
BlueLight.com restructuring charge, the fiscal year 2001 supply chain
restructuring charge and the fiscal year 2002 store closings charge.
Reserves established in connection with the fiscal 2002 store closings
charge are comprised of $228 relating to estimated allowable claims
associated with lease rejections. Please refer to Amendment No. 1 to our
2001 Annual Report on Form 10-K/A for the fiscal year ended January 30,
2002, which will be filed with the SEC as soon as practicable, for a
discussion of the 2000 strategic actions charge. The liabilities
aggregated $406 and $215 at October 30, 2002 and October 31, 2001,
respectively.
39 Weeks Ended
-------------------------------------------------------------------------------------
October 30, 2002 October 31, 2001
----------------------------------------- -----------------------------------------
2002 2001 2001 2000 2001 2001 2001 2000
Store Supply BlueLight Strategic VERP/ Supply BlueLight Strategic
Closings Chain .com Actions Severance Chain .com Actions
-------- -------- --------- --------- --------- -------- --------- ---------
Balance, beginning of year $ -- $ 11 $ 18 $ 98 $ -- $ -- $ -- $ 177
Additions charged to operations 228 2 -- -- 19 47 27 --
Reclassifications 144 -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total additions 372 2 -- -- 19 47 27 --
Reductions:
Cash payments:
Lease obligations 23 -- -- 7 -- -- 1 31
Employee costs -- 5 -- -- 17 -- 3 --
Contractual obligations -- -- 1 -- -- -- 2 --
Other costs -- -- -- -- -- -- 1 --
Non-cash reductions:
Adjustments 10 -- 10 -- -- -- -- --
Pre-petition liability settlements 34 5 -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Balance, end of period $ 305 $ 3 $ 7 $ 91 $ 2 $ 47 $ 20 $ 146
======== ======== ======== ======== ======== ======== ======== ========
18
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
12. LOSS PER SHARE
Net loss per common share is computed as follows:
13 Weeks Ended 39 Weeks Ended
-------------------------------- -------------------------------
(as restated - (as restated -
see Note 1) see Note 1)
October 30, October 31, October 30, October 31,
2002 2001 2002 2001
------------- --------------- ------------- --------------
Net loss from continuing operations $ (384) $ (249) $ (2,155) $ (796)
Discontinued operations 1 - 37 -
------------- --------------- ------------- --------------
Net loss $ (383) $ (249) $ (2,118) $ (796)
Basic/Diluted weighted average shares
outstanding 502.5 497.8 502.7 492.4
Basic/Diluted loss per common share:
Net loss from continuing operations $ (0.76) $ (0.50) $ (4.28) $ (1.62)
Discontinued operations $ - - 0.07 -
------------- --------------- ------------- --------------
Basic/Diluted loss per common share $ (0.76) $ (0.50) $ (4.21) $ (1.62)
============= =============== ============= ==============
We calculate loss per share in accordance with SFAS No. 128, "Earnings
Per Share." In all periods presented net losses were incurred, therefore
dilutive common stock equivalents were not used in the calculation of
earnings per share as they would have an anti-dilutive effect. Options to
purchase 50.5 million and 58.8 million shares of common stock at prices
ranging from $4.86 to $26.03 and $5.34 to $26.03 were excluded from the
calculations for the 13 and 39 week periods ended October 30, 2002 and
October 31, 2001, respectively. The calculations also exclude the effect of
trust convertible preferred securities. For the 13 and 39 week periods
ended October 30, 2002 and October 31, 2001 diluted shares outstanding
exclude approximately 58.9 million and 59.9 million common shares,
respectively, from potential conversion of certain trust convertible
preferred securities due to their anti-dilutive effect.
Since October 30, 2002 and prior to December 17, 2002, Kmart has
received conversion notices from holders of 4,679,439 trust convertible
preferred securities. Such securities were convertible into 15,597,974
shares of Kmart common stock.
13. COMPREHENSIVE LOSS
Comprehensive loss represents net loss, adjusted for the effect of
other items that are recorded directly to shareholders' equity. In the
second quarter of 2002 we recorded an adjustment to shareholders' equity in
accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," of $2 to reduce the value of our investment in
certain equity securities to current market value. Comprehensive loss and
net loss are equivalent for all other periods presented.
14. RELATED PARTY DISCLOSURE
Commencing March 2002, Kmart engaged various services of AP Services
(formerly known as JA&A Services), a consulting firm, whose Chairman and
another Principal hold executive officer positions within Kmart.
Specifically, their Chairman, Albert A. Koch, currently serves as our Chief
Financial Officer, and another Principal, Edward J. Stenger, currently
serves as our Treasurer. For the 13 and 39 week periods ended October 30,
2002, we recorded expenses for such services totaling $2 and $9,
respectively. Fees paid to the firm have aggregated approximately $4 and $7
for the 13 and 39 week periods ended October 30, 2002, respectively, for
services rendered under the consulting agreement, including the services of
Messrs. Koch and Stenger. In addition to hourly fees and expenses, AP
Services will also receive an annual performance fee of 0.75% of EBITDA
exceeding a certain minimum threshold for each year services are rendered
under terms of the agreement.
19
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
15. LIABILITIES SUBJECT TO COMPROMISE
Under bankruptcy law, actions by creditors to collect indebtedness we
owe prior to the Petition Date are stayed and certain other pre-petition
contractual obligations may not be enforced against Kmart and 37 of its
U.S. subsidiaries. We have received approval from the Court to pay certain
pre-petition liabilities including employee salaries and wages, benefits
and other employee obligations. Except for secured debt and capital lease
obligations, all pre-petition liabilities have been classified as
Liabilities subject to compromise in the unaudited Condensed Consolidated
Balance Sheets. Adjustments to the claims may result from negotiations,
payments authorized by Court order, additional rejection of executory
contracts including leases, or other events.
Pursuant to an order of the Court, we mailed notices to all known
creditors that the deadline for filing proofs of claim with the Court was
July 31, 2002. A limited number of personal injury claimants omitted from
such notice process will be given additional time to file their claims. An
estimated 45,000 claims were filed as of July 31, 2002 out of an estimated
1.1 million notices sent to constituents. Amounts that we have recorded are
in many instances different from amounts filed by our creditors.
Differences between amounts scheduled by Kmart and claims by creditors are
being investigated and resolved in connection with our claims resolution
process. Until the process is complete, the ultimate number and amount of
allowable claims cannot be ascertained. In this regard, it should be noted
that the claims reconciliation process may result in material adjustments
to current estimates of allowable claims.
The following table summarizes the components of Liabilities subject
to compromise in our unaudited Condensed Consolidated Balance Sheets as of
October 30, 2002 and as of January 30, 2002:
(as restated-
see Note 1)
October 30, January 30,
2002 2002
-------------- --------------
Debt and notes payable $ 3,324 $ 3,346
Accounts payable 2,262 3,153
Closed store reserves 705 484
General liability and workers compensation 261 312
Pension obligation 180 195
Taxes payable 162 149
Other liabilities 234 454
-------------- --------------
Total liabilities subject to compromise $ 7,128 $ 8,093
============== ==============
Following is a reconciliation of the changes in Liabilities subject to
compromise for the period from the Petition Date through October 30, 2002:
(as restated-
see Note 1)
Cumulative since
Petition Date
-----------------
Balance, Petition Date $ 8,585
First day court orders authorizing payment of employee wages, benefits and
other employee obligations, sales and use taxes and payments to critical vendors (846)
Adjustment to general liability and workers compensation accruals (174)
Revisions to estimated allowable claim amounts (131)
Adjustments to closed store reserves 106
Gain on settlement of pre-petition liabilities (86)
Court order authorizing payment of additional trade accounts payable (66)
Other (260)
-----------------
Balance, end of period $ 7,128
=================
20
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
16. INVENTORIES AND COST OF MERCHANDISE SOLD
A substantial portion of our inventory is accounted for using the
last-in, first-out ("LIFO") method. Since LIFO costs can only be determined
at the end of each fiscal year when inflation rates and inventory levels
are finalized, estimates are used for LIFO purposes in the interim
unaudited Condensed Consolidated Financial Statements. Inventories valued
on LIFO at October 30, 2002, October 31, 2001 and January 30, 2002 were
$269, $194 and $269 lower, respectively, than the amounts that would have
been reported under the first-in, first-out method.
17. INVESTMENTS IN AFFILIATED RETAIL COMPANIES
Meldisco
All Kmart footwear departments are operated under a license agreement
with the Meldisco subsidiaries of Footstar, Inc. ("FTS"), substantially all
of which are 49% owned by Kmart and 51% owned by FTS.
The following table summarizes net sales, gross margin and net income
for the 13 and 39 week periods ended October 30, 2002 and October 31, 2001,
respectively.
13 Weeks Ended 39 Weeks Ended
--------------------------- ---------------------------
October 30, October 31, October 30, October 31,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Net sales $ 261 $ 293 $ 857 $ 904
Gross margin 125 138 406 434
Net income 16 22 55 69
BlueLight.com
On July 31, 2001, we acquired the remaining 40% interest in
BlueLight.com, and BlueLight.com's operations were fully consolidated into
our financial statements. For the 39 week period ended October 31, 2001,
BlueLight.com had net sales of $8, gross margin of $1 and net loss of $55.
See Note 10 for a further discussion on Bluelight.com.
Penske
On April 9, 2002, we reached an agreement with Penske Corporation,
Penske Auto Centers, Inc., and Penske Auto Centers, LLC (collectively
"Penske") whereby Penske and Kmart worked together to wind-down operations
at auto service centers at more than 563 Kmart stores in 44 states
following Penske's unilateral decision to close the business as of April 6,
2002. This matter did not have a material adverse effect on our liquidity,
financial position or results of operations for the 39 weeks ended October
30, 2002.
18. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which
requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The associated asset
retirement costs would be capitalized as part of the carrying amount of the
long-lived asset and depreciated over the life of the asset. The liability
is accreted at the end of each period through charges to interest expense.
If the obligation is settled for other than the carrying amount of the
liability, a gain or loss will be recognized on settlement. The provisions
of SFAS No. 143 will be effective for our fiscal year beginning January 30,
2003. We have not yet determined the impact, if any, of the adoption of
SFAS No. 143.
We are currently reviewing SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections," which was issued in May 2002. The statement
rescinds FASB No. 4, "Reporting Gains and Losses from Extinguishment of
Debt," and an amendment of that statement, FASB No. 64,
21
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." As a
result, gains and losses from extinguishment of debt will no longer be
aggregated and classified as an extraordinary item, net of related income
tax effect, in the statement of operations. Instead, such gains and losses
will be classified as extraordinary items only if they are determined to be
unusual or infrequently occurring items. SFAS No. 145 also requires that
gains and losses from debt extinguishments, which were classified as
extraordinary items in prior periods, be reclassified to continuing
operations if they do not meet the criteria for extraordinary items. The
provisions related to this portion of the statement are required to be
applied in fiscal years beginning after May 15, 2002, with earlier
application encouraged.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities." SFAS No. 146 addresses significant issues regarding
the recognition, measurement, and reporting of costs associated with exit
and disposal activities, including restructuring activities that are
currently accounted for pursuant to the guidance that the EITF set forth in
EITF 94-3. The scope of SFAS No. 146 also includes (1) costs related to
terminating a contract that is not a capital lease and (2) termination
benefits that employees who are involuntarily terminated receive under the
terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement, or an individual deferred compensation contract. SFAS No. 146
will be effective for exit or disposal activities that are initiated after
December 31, 2002. We will apply the provisions of this statement to
restructuring activities following the effective date.
In November 2002, the Emerging Issues Task Force (EITF) reached a
final consensus on Issue No. 02-16, "Accounting by a Reseller for Cash
Consideration Received from a Vendor," which addresses how a reseller of a
vendor's product should account for cash consideration received from a
vendor. The EITF issued guidance on the following two issues, as follows:
(1) cash consideration received from a vendor should be recognized as a
reduction of cost of sales in the reseller's income statement, unless the
consideration is reimbursement for selling costs or payment for assets or
services delivered to the vendor, and (2) performance-driven vendor rebates
or refunds (e.g., minimum purchase or sales volumes) should be recognized
as a reduction of cost of sales only if the payment is considered probable,
and the method of allocating such payments in the financial statements
should be systematic and rational based on the reseller's progress in
achieving the underlying performance targets. The provisions of EITF 02-16
will be effective for our fiscal year beginning January 30, 2003. We have
not yet determined the impact, if any, of adopting this newly issued
guidance.
19. OTHER COMMITMENTS AND CONTINGENCIES
Contingent Liabilities
As of October 30, 2002, we had (i) guaranteed obligations for real
property leases of certain current and former subsidiaries of Kmart
including, but not limited to, The Sports Authority, Inc., OfficeMax, Inc.
and Borders Group, Inc., some of which leases have been assigned
pre-petition; (ii) contingent liability under real property leases assigned
by Kmart pre-petition; and (iii) guaranteed $70 of indebtedness of other
parties related to certain of our leased properties financed by industrial
revenue bonds. Our rights and obligations with respect to our guarantee of
leases of the former subsidiaries The Sports Authority, Inc., Office Max,
Inc., and Borders Group, Inc., which are detailed below, are governed by
Lease Guarantee, Indemnification and Reimbursement Agreements dated as of
November 23, 1994, November 9, 1994 and May 24, 1995, respectively, as they
may be amended from time to time. Kmart's contingent obligations, described
above, which are not reflected in our financial statements, are dependent
on the future performance by the parties whose obligations we guarantee and
are subject to settlement under a plan of reorganization to be voted upon
by creditors and equity holders and approved by the Court.
As of October 30, 2002, our outstanding guarantees for real property
leases of The Sports Authority, Inc., Office Max, Inc., and Borders Group,
Inc. were as follows:
Present Value of
Future Lease Gross Future
Obligations @ 7% Lease Obligations
---------------- -----------------
The Sports Authority, Inc. $ 172 $ 292
Borders Group, Inc. 83 141
OfficeMax, Inc. 59 86
---------------- -----------------
Total $ 314 $ 519
================ =================
22
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Bankruptcy Proceedings
On the Petition Date, Kmart and 37 of its U.S. subsidiaries filed
voluntary petitions for reorganization under Chapter 11 of the Bankruptcy
Code in the Court. The reorganization is being jointly administered under
the caption "In re Kmart Corporation, et al., case No. 02 B 02474."
Included in the unaudited Condensed Consolidated Financial Statements are
subsidiaries operating outside of the United States, which have not
commenced Chapter 11 cases or other similar proceedings elsewhere, and are
not debtors. The assets and liabilities and results of operations of such
non-filing subsidiaries are not considered material to the unaudited
Condensed Consolidated Financial Statements. We retain control of our
assets and are authorized to operate the business as a debtor-in-possession
while being subject to the jurisdiction of the Court. As of the Petition
Date, most pending litigation is stayed, and absent further order of the
Court, substantially all pre-petition liabilities are subject to settlement
under a plan of reorganization. At this time, it is not possible to predict
the outcome of the Chapter 11 cases or their effect on our business. If it
is determined that the liabilities subject to compromise in the Chapter 11
cases exceed the fair value of the assets, unsecured claims may be
satisfied at less than 100% of their fair value and the equity interests of
our shareholders may have no value. See Note 3. Proceedings Under Chapter
11 of the Bankruptcy Code.
Legal Proceedings
Since February 21, 2002, five separate purported class actions have
been filed on behalf of purchasers of Kmart common stock. The initial
complaints were filed on behalf of purchasers of common stock between May
17, 2001 and January 22, 2002, inclusive, and named Charles Conaway as CEO
and Chairman of the Board of Kmart as the sole defendant. The complaints
filed in the United States District Court for the Eastern District of
Michigan allege that Mr. Conaway made material misstatements or omissions
during the alleged class period that inflated the trading prices of Kmart's
common stock and seek, among other things, damages under Section 10b-5 of
the Securities and Exchange Act of 1934. On October 15, 2002, an amended
consolidated complaint was filed that enlarged the class of persons on
whose behalf the action was brought to include purchasers of Kmart
securities between March 13, 2001 and May 15, 2002, and added former
officers Jeffrey N. Boyer, Mark S. Schwartz, Matthew F. Hilzinger, Martin
E. Welch III, and PricewaterhouseCoopers LLP as defendants. Kmart is not a
defendant in this litigation.
In connection with the investigation by the United States Attorney in
Puerto Rico of alleged actions by Kmart's employees following the 1998
Hurricane Georges, on October 28, 2002, Kmart's wholly owned subsidiary,
S.F.P.R., Inc. a Puerto Rico corporation, pled guilty to one count of mail
fraud in violation of 18 U.S.C. Sections 1341 and 1342 pursuant to a plea
agreement providing for a three year probation period, a fine in the amount
of $2 and other agreements. Kmart has agreed to fund the payment of the
fine and to take certain other actions, none of which are anticipated to
have any material adverse effect on Kmart's liquidity, financial position
or results of operations.
On March 18, 2002, a purported class action was filed in the United
States District Court for the Eastern District of Michigan on behalf of
participants or beneficiaries of the Kmart Corporation Retirement Savings
Plan against various current and former employees and directors of Kmart
alleging breach of fiduciary duty under ERISA for excessive investment in
company stock; failure to provide complete and accurate information about
Kmart common stock and failure to provide accurate information regarding
our financial condition. On October 15, 2002, an amended complaint was
filed that added additional current and former employees and directors of
Kmart as defendants. Kmart is not a defendant in this litigation.
On April 26, 2002, a lawsuit was filed in the United States District
Court for the Eastern District of Michigan on behalf of three limited
partnerships that purchased stock of BlueLight.com, a subsidiary of Kmart,
naming Charles C. Conaway, as CEO and Chairman of the Board of Kmart, as
the sole defendant. The Complaint alleges that Mr. Conaway breached his
fiduciary duty, took certain actions and made certain misrepresentations
that induced plaintiffs to exchange their Bluelight.com stock for Kmart
stock and prevented plaintiffs from realizing the market value of their
stock. The complaint also alleges violations of Section 10b-5 of the
Securities and Exchange Act of 1934 and Section 410 of the Michigan Uniform
Securities Act. Kmart is not a defendant in this litigation. A ruling from
the court on a motion filed by Mr. Conaway to dismiss the lawsuit is
pending.
23
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Kmart is a defendant in six putative class actions and one
multi-plaintiff case pending in California, all relating to our
classification of assistant managers and various other employees as
"exempt" employees under the federal Fair Labor Standards Act and the
California Labor Code and our alleged failure to pay overtime wages as
required by these laws. These seven wage-and-hour cases were all filed
during 2001 and are currently pending in the U.S. District Court for the
Eastern District of California (Henderson v. Kmart), the U.S. District
Court for the Central District of California (Gulley v. Kmart, the
multi-plaintiff case, which was originally brought in state court) and the
Superior Courts of the State of California for the Counties of Alameda, Los
Angeles and Riverside (Panossian v. Kmart, Wallace v. Kmart, Pierce v.
Kmart, Hancock v. Kmart, Pryor v. Kmart). If all of these cases were
determined adversely to Kmart, the resulting damages would have a material
adverse impact on our results of operations and financial condition.
However, there have been no class certifications, all of the cases are
stayed as a result of Kmart's bankruptcy and, based on our initial
investigations, we believe that we have numerous defenses to each of these
claims. As a result, we are currently unable to quantify the financial
exposure of these cases.
We are a party to a substantial number of other claims, lawsuits, and
pending actions, most of which are routine and all of which are incidental
to our business. Some matters involve claims for large amounts of damages
as well as other relief. We assess the likelihood of potential losses on an
ongoing basis and when they are considered probable and reasonably
estimable, record an estimate of the ultimate outcome. If there is no
single point estimate of loss that is considered more likely than others,
an amount representing the low end of the range of possible outcomes is
recorded. Although the final consequences of these proceedings are not
presently determinable, in the opinion of management, they are not expected
to have a material adverse effect on our liquidity, financial position or
results of operations.
In addition to the foregoing, there are numerous other matters filed
with the Court in our reorganization proceedings by creditors, landlords or
other third parties related to our business operations or the conduct of
our reorganization activities. Although none of these individual matters
which have been filed to date have had or are expected to have a material
adverse effect on Kmart, our ability to successfully manage the
reorganization process and develop an acceptable reorganization plan could
be negatively impacted by adverse determinations by the Court on certain of
these matters.
Investigative Matters
Kmart has been provided with copies of anonymous letters sent to the
SEC, our auditors, directors, legal counsel and others, expressing concern
with respect to various matters. The letters purport to be sent by certain
of our employees. The letters have been referred to the Audit Committee,
which has engaged outside counsel to review and investigate the matters set
forth in the letters. We are cooperating with the SEC and the U. S.
Attorney's office for the Eastern District of Michigan, and with our three
statutory committees, with respect to the investigations of these matters.
The staff of the SEC has expressed concerns with respect to the manner in
which we recorded vendor allowances prior to the change in accounting
principle at the end of fiscal 2001, as well as the Staff's intention to
continue to pursue its investigation of these matters. The bar date with
respect to the filing of claims by the SEC has been extended to January 9,
2003, with our consent, and may be further extended to April 29, 2003 by
stipulation to be filed with the Court. In addition, in July of 2002 The
United States House Energy and Commerce Committee (the "House Committee")
requested that numerous public companies, including Kmart, provide
documentation regarding certain governance matters. We are cooperating with
the House Committee with respect to their inquiry.
During the Fall of 2002 and in response to inquiries from the staff of
the SEC, Kmart reviewed its historical practices for the recording of
allowances prior to the adoption in the fourth quarter of fiscal year 2001
of a new accounting policy, effective February 1, 2001, for the interim
financial reporting of vendor allowances. The effect of these practices
relates only to Kmart's interim financial statements. See "Internal
Investigation - Developments Since Filing of 2001 Form 10-K - Vendor
Allowance Matters - Premature Recording of Vendor Allowances" in the
section entitled "Management's Discussion and Analysis of Results of
Operations and Financial Condition" for a description of the impact of
the premature recording of certain vendor allowances on Kmart's audited
financial statements.
For interim reporting periods in fiscal 2000 and prior, our policy was
to record allowances not yet subject to a written agreement during the
first three quarters of a fiscal year based upon our estimate of annual
allowances ("our plan") as determined by historical experience and current
understandings with our vendors. These amounts were supplemented by
allowances obtained that were not contemplated in our plan
("incrementals"). During the fourth quarter of fiscal 2001, we adopted a
new accounting policy, effective as of February 1, 2001, for interim
financial reporting only, requiring that cost recoveries from vendors be
recognized only when a formal agreement for such amount has been obtained
and the underlying activity for which the amount was provided has been
performed.
As part of its review of allowances, the current management of Kmart
observed that the total level of allowances originally recorded during the
first three quarters of fiscal year 2001 appeared high, given the
challenges that faced the business in fiscal year 2001 and the fact that
sales failed to increase as originally contemplated in Kmart's business
plan. In that regard, it was noted that had Kmart recorded allowances
during the first three quarters of fiscal year 2001 at rates which
corresponded to more historical rates, Kmart would have recorded fewer
allowances.
During the first three quarters of fiscal year 2001, Kmart
characterized and recorded as incremental allowances $110, $163 and $50,
respectively. Kmart selectively identified for review certain of such
allowances that had been characterized and recorded as incrementals prior
to the adoption of the new accounting policy. Of those reviewed, the amount
of allowances, other than those previously disclosed, which appeared to be
questionable were $27, $42 and $23, respectively. The questions about
these allowances relate to, among other things, the failure to have
appropriate signed documentation in place, the failure to have adequate
records demonstrating that the allowance was collectible or the failure
to otherwise comply with Kmart's historical policies. Based on the
investigation, it appears that some of these allowances may have been
reported in error in the quarterly financial statements. Given, however,
that Kmart's review of allowances was selective, as well as the
difficulties of confirming on a retroactive basis whether an incremental
allowance is supplemental to the plan, Kmart cannot exclude the
possibility that there may be additional incremental allowances in fiscal
year 2001 which could be subject to question.
Any errors, as described in the preceding paragraphs, concerning the
recording of allowances that were reflected in our fiscal year 2001 interim
unaudited financial statements prior to the change in accounting policy
were no longer reflected in our restated financial statements as filed with
the SEC on May 15, 2002. This results from the change in accounting policy,
given that under the new accounting policy there is no longer a distinction
between planned and incremental allowances, no allowances are recognized
absent a formal agreement and the recording of allowances is no longer
based on a plan.
Key Brand Partners
On March 20, 2002, the Court authorized our business relationships
with several key brand partners. Motions were approved allowing Kmart to
assume our license agreements with Martha Stewart Living Omnimedia, Inc.
for Martha Stewart Everyday home, garden, colors, baby, kitchen, keeping
and decorating products, along with candles and accessories; Jaclyn Smith
G.H. Production, Inc. for Jaclyn Smith women's apparel, jewelry and
accessories; Kathy Ireland World Wide, Inc. for Kathy Ireland women's
apparel, accessories and exercise equipment; Disney Enterprises, Inc. for
Disney apparel for infants and children; and Joe Boxer Licensing, LLC. for
JOE BOXER apparel, accessories and home furnishings.
24
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
On May 29, 2002, the Court authorized our business relationship with
Sesame Workshop. Motions were approved allowing Kmart to assume our license
agreement with Sesame Workshop for Sesame Street infants and children's
apparel.
On July 24, 2002 the Court approved our motion allowing Kmart to
assume our license agreement for our proprietary Route 66 apparel line.
On September 25, 2002 the Court approved our motion allowing Kmart to
enter into a licensing agreement with Thalia for junior's and women's
apparel, jewelry and accessories.
20. SUBSEQUENT EVENTS
BlueLight.com entered into an agreement to sell certain of the assets
of its Internet Service Provider ("ISP") and e-mail business to Netbrands,
a unit of United Online, Inc., for approximately $8, subject to certain
favorable working capital adjustments and Court approval. The sale of these
assets was the subject of a competitive bidding process in which Netbrands
was the winning bidder. The sale was approved by the Court on October 30,
2002, closed on November 4, 2002 and resulted in a gain of $4, which will
be recorded in the fourth quarter of 2002. The sale of the ISP assets will
not affect the Kmart.com online shopping site.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-Q, as well as other statements or reports made by or on
behalf of Kmart Corporation and its subsidiaries ("Kmart," "we" or "our"), may
contain or may incorporate by reference material which includes forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 that reflect, when made, Kmart's current views with respect to current
events and financial performance. Statements, other than those based on
historical facts, which address activities, events or developments that we
expect or anticipate may occur in the future are forward-looking statements,
which are based upon a number of assumptions concerning future conditions that
may ultimately prove to be inaccurate. Such forward-looking statements are and
will be, as the case may be, subject to many risks, uncertainties and factors
relating to Kmart's operations and business environment which may cause the
actual results of Kmart to be materially different from any future results,
express or implied, by such forward-looking statements. Factors that could cause
actual results to differ materially from these forward-looking statements
include, but are not limited to, the following:
General Factors
- - general economic conditions,
- - weather conditions, including those which affect buying patterns of our
customers,
- - marketplace demand for the products of our key brand partners, as well
as the engagement of appropriate new brand partners,
- - changes in consumer spending and our ability to anticipate buying
patterns and implement appropriate inventory strategies,
- - competitive pressures and other third party actions, including
pressures from pricing and other promotional activities of competitors,
- - our ability to timely acquire desired goods in appropriate quantities
and/or fulfill labor needs at planned costs,
- - our ability to properly monitor our inventory needs and remain in-stock,
- - our ability to successfully implement business strategies and otherwise
execute planned changes in various aspects of the business,
- - regulatory and legal developments,
- - our ability to attract, motivate and/or retain key executives and associates,
- - our ability to attract and retain customers,
- - other factors affecting business beyond our control,
Bankruptcy Related Factors
- - our ability to continue as a going concern,
- - our ability to operate pursuant to the terms of the DIP Credit Facility,
- - our ability to obtain Court approval with respect to motions in the
Chapter 11 proceeding from time to time,
- - our ability to develop, confirm and consummate one or more plans of
reorganization with respect to the Chapter 11 cases,
- - risks associated with third parties seeking and obtaining court
approval to terminate or shorten the exclusivity period that we have to
propose and confirm one or more plans of reorganization, for the
appointment of a Chapter 11 trustee or to convert the cases to Chapter
7 cases,
- - our ability to offset the negative effects that the filing for
reorganization under Chapter 11 has had on our business, including the
loss in customer traffic and the constraints placed on available capital,
- - our ability to obtain and maintain normal terms with vendors and
service providers,
- - the ability of our vendors to obtain satisfactory credit terms from
factors and other financing sources,
- - our ability to maintain contracts, including leases, that are critical
to our operations,
- - the potential adverse impact of the Chapter 11 cases on our liquidity
or results of operations,
- - our ability to develop a long-term strategy and/or market niche, and
- - our ability to fund and execute our business plan.
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Consequently, all of the forward-looking statements are qualified by
these cautionary statements and there can be no assurance that the results or
developments anticipated will be realized or that they will have the expected
effects on our business or operations. The forward-looking statements contained
herein or otherwise that we make or are made on our behalf speak only as of the
date of this report, or if not contained herein, as of the date when made, and
we do not undertake to update these risk factors or such forward-looking
statements.
Similarly, these and other factors, including the terms of any
reorganization plan ultimately confirmed, can affect the value of our various
pre-petition liabilities, common stock and/or other equity securities. No
assurance can be given as to what values, if any, will be ascribed in the
bankruptcy proceedings to each of these constituencies.
A plan of reorganization could result in holders of Kmart common stock
receiving no distribution on account of their interests and cancellation of
their interests. Holders of Kmart common stock should assume that they could
receive little or no value as part of a plan of reorganization. In addition,
under certain conditions specified in the Bankruptcy Code, a plan of
reorganization may be confirmed notwithstanding its rejection by an impaired
class of creditors or equity holders and notwithstanding the fact that equity
holders do not receive or retain property on account of their equity interests
under the plan. In light of the foregoing, Kmart considers the value of the
common stock to be highly speculative and cautions equity holders that the
stock may ultimately be determined to have no value. Accordingly, Kmart urges
that appropriate caution be exercised with respect to existing and future
investments in Kmart common stock or any claims relating to pre-petition
liabilities and/or other Kmart securities.
The following discussion and analysis should be read in conjunction
with the audited Consolidated Financial Statements and Notes to Consolidated
Financial Statements in Item 8. Financial Statements and Supplementary Data, of
Amendment No. 1 to our Annual Report on Form 10-K/A for the fiscal year ended
January 30, 2002, to be filed with the SEC as soon as practicable.
RESTATEMENT OF PRIOR PERIODS
As part of the review and preparation of this report on Form 10-Q for
the 13 and 39 week periods ended October 30, 2002, we identified certain
adjustments that were recorded out-of-period, while others were previously
identified and described in our second quarter report on Form 10-Q, filed with
the Securities and Exchange Commission ("SEC") on September 16, 2002. Upon
review of the aggregate impact of the new, as well as the previously disclosed
and recorded adjustments, we concluded that restating our financial statements
for the prior periods was appropriate because the aggregate impact was material
to the current estimate of our 2002 fiscal year results.
The net effect of these adjustments on the 26 week period ended
July 31, 2002 was to decrease our previously reported net loss by $92.
The tables below show the results of the restatements on reported
earnings for the prior periods presented in this Form 10-Q and which relate
primarily to:
a) Lease accrual adjustments - An understatement of historical accruals
for certain leases with varying rent payments and a related
understatement of historical rent expense.
b) Accounts payable adjustments - A software programming error in Kmart's
accounts payable system that resulted in some paid invoices awaiting a
store report of delivery not being appropriately treated in our
financial statements. This error, restricted to a single vendor with
unique billing arrangements, resulted in an understatement of Cost of
sales, buying and occupancy since 1999.
c) Inventory loads - Adjustments, as previously disclosed in the 2002
second quarter report on Form 10-Q, for certain costs formerly
capitalized into inventory. Inventory included amounts added for
internal purposes to analyze gross margin on a comparable basis across
all business units and to optimize purchasing decisions. These amounts
are commonly referred to in the retail industry as "inventory loads,"
and should have been eliminated for external reporting purposes to the
extent the related inventory remained unsold at the end of the period.
d) Vendor allowances - The premature recording, as previously disclosed in
the 2002 second quarter report on Form 10-Q, of vendor allowance
transactions in fiscal year 2000 and prior fiscal years.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
In addition, given the restatement for the items noted above, Kmart
is adjusting previously reported financial results for miscellaneous immaterial
items that were identified and previously recorded in the ordinary course of
business. These items are now being recorded in the appropriate fiscal periods.
The summary of the effects of the restatement on reported results for
each of the following years is presented in the table below.
Impact on
Earnings retained
Increase (Decrease) earnings
----------------------------------------------------- --------------
Fiscal Fiscal Fiscal January 30,
(Dollars in Millions) 2001 2000 1999 1999
----------- ----------- ----------- -----------
Lease accrual adjustments ($ 5) ($ 4) ($ 10) ($ 37)
Accounts payable adjustments ($ 42) ($ 9) ($ 1) $ 0
Inventory loads ($ 7) ($ 12) ($ 21) ($ 17)
Vendor allowances $ 94 ($ 52) ($ 33) ($ 28)
Other items $ 47 $ 39 $ 3 ($ 135)
----------- ----------- ----------- -----------
Pre-tax impact of restatement $ 87 ($ 38) ($ 62) ($ 217)
(Benefit from) provision for income taxes $ 115 ($ 14) ($ 22) ($ 79)
----------- ----------- ----------- -----------
Total impact of restatement ($ 28) ($ 24) ($ 40) ($ 138)
=========== =========== =========== ===========
The summary of the effects of the restatement on the 13 and 39 weeks
ended October 31, 2001 are presented in the tables below.
13 Weeks Ended October 31, 2001
-----------------------------------------------------------------------------------------------
Adjustments
-------------------------------------------------------------------
As Lease Accounts
previously accrual payable Inventory Vendor As
reported* adjustments adjustments loads allowances Other restated
-----------------------------------------------------------------------------------------------
Sales $8,019 $-- $-- $-- $-- $-- $8,019
Cost of sales, buying
and occupancy $6,434 $1 $14 $15 ($20) $19 $6,463
-----------------------------------------------------------------------------------------------
Gross margin $1,585 ($1) ($14) ($15) $20 ($19) $1,556
Selling, general and
administrative expenses $1,837 $-- $-- $4 $-- ($10) $1,831
Operating (loss) income ($246) ($1) ($14) ($19) $20 ($9) ($269)
(Benefit from) provision for
income taxes ($118) $-- ($5) ($7) $7 ($4) ($127)
-----------------------------------------------------------------------------------------------
Net (loss) income ($235) ($1) ($9) ($12) $13 ($5) ($249)
===============================================================================================
Basic/Diluted (loss) earnings per
common share ($0.47) ($0.00) ($0.02) ($0.02) $0.02 ($0.01) ($0.50)
===============================================================================================
*- As previously reported in the Form 10-Q/A for the third quarter 2001 filed on
June 12, 2002.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
39 Weeks Ended October 31, 2001
-----------------------------------------------------------------------------------------------
Adjustments
-------------------------------------------------------------------
As Lease Accounts
previously accrual payable Inventory Vendor As
reported* adjustments adjustments loads allowances Other restated
-----------------------------------------------------------------------------------------------
Sales $25,273 $-- $-- $-- $-- $-- $25,273
Cost of sales, buying
and occupancy $20,521 $4 $30 $6 ($84) ($26) $20,451
-----------------------------------------------------------------------------------------------
Gross margin $4,752 ($4) ($30) ($6) $84 $26 $4,822
Selling, general and
administrative expenses $5,553 $-- $-- ($6) $-- ($1) $5,546
Operating (loss) income ($934) ($4) ($30) $-- $84 $27 ($857)
(Benefit from) provision for
income taxes ($390) ($1) ($11) $-- $31 $9 ($362)
-----------------------------------------------------------------------------------------------
Net (loss) income ($845) ($3) ($19) $-- $53 $18 ($796)
===============================================================================================
Basic/Diluted (loss) earnings per
common share ($1.72) $-- ($0.04) $-- $0.11 $0.03 ($1.62)
===============================================================================================
* - As previously reported in the Form 10-Q/A for the third quarter 2001 filed
on June 12, 2002.
The following is a summary of the effects of the restatement on our unaudited
Condensed Consolidated Balance Sheets for all amounts that changed by 5% or
more for the periods ended October 31, 2001 and January 30, 2002.
As
previously As
reported* restated
-------------- --------------
January 30, 2002*
Accounts payable $ 103 $ 89
Accrued payroll and other liabilities $ 378 $ 420
Other long-term liabilities $ 79 $ 132
Retained earnings $ 1,261 $ 1,032
October 31, 2001**
Other assets and deferred charges $ 483 $ 562
Other long-term liabilities $ 865 $ 916
* - As previously reported in the Form 10-K filed on May 15, 2002.
** - As previously reported in the Form 10-Q/A for the third quarter 2001 filed
on June 12, 2002.
We expect to file Amendment No. 1 to our Annual Report on Form 10-K/A for the
2001 fiscal year and Quarterly Reports on Form 10-Q/A for the first two
quarters of the 2002 fiscal year as soon as practicable.
OVERVIEW
On January 22, 2002 ("Petition Date"), Kmart and 37 of its U.S.
subsidiaries (collectively, the "Debtors") filed voluntary petitions for
reorganization under Chapter 11 of the federal bankruptcy laws ("Bankruptcy
Code" or "Chapter 11") in the United States Bankruptcy Court for the Northern
District of Illinois ("Court") under case numbers 02 B 02462 through 02 B 02499.
The reorganization is being jointly administered under the caption "In re Kmart
Corporation, et al. Case No. 02 B 02474."
Under Chapter 11, we are operating our business as a
debtor-in-possession. As of the Petition Date, actions to collect pre-petition
indebtedness as well as most other pending litigation, are stayed and other
pre-petition contractual obligations generally may not be enforced against
Kmart. In addition, under the Bankruptcy Code we may assume or reject executory
contracts and unexpired leases, subject to approval of the Court and our
satisfaction of certain other requirements. Parties affected by these rejections
may file claims against the debtor in accordance with the reorganization
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
process. Absent an order of the Court, substantially all pre-petition
liabilities are subject to settlement under a plan of reorganization to be voted
upon by creditors and equity holders and approved by the Court. Under a timeline
reviewed with our Board of Directors and the three independent statutory
committees in our Chapter 11 reorganization case, we plan to complete a
five-year business plan by the end of our 2002 fiscal year. Thereafter, we also
intend to file a proposed plan of reorganization with the Court on or before
February 24, 2003 and, subject to approval by the Court and the attainment of
all requisite approvals, emerge from bankruptcy as soon thereafter as
practicable.
The United States Trustee has appointed an unsecured creditors'
committee, a financial institutions' committee and an equity holders' committee.
These official committees and their legal representatives often take positions
on matters that come before the Court, and are the most likely entities with
which Kmart will negotiate the terms of a plan of reorganization. There can be
no assurance that these committees will support Kmart's positions in the
bankruptcy proceedings or the plan of reorganization once proposed, and
disagreements between Kmart and these committees could protract the bankruptcy
proceedings, could negatively impact our ability to operate during bankruptcy
and could delay our emergence from bankruptcy.
Kmart understands that, as a result of the trading in claims against
us, certain entities or groups may have accumulated significant positions in
various classes of claims. The existence of such positions, which may change
from time to time, could affect our ability to obtain confirmation of a plan or,
possibly, the terms thereof.
On September 11, 2002, the United States Trustee filed an amended
notice of appointment for the official committee of financial institutions
pursuant to which two holders of Kmart's bond debt were added to the financial
institutions committee. These holders, ESL Investments and Third Avenue Value
Fund, have indicated to us that they have acquired a significant amount of our
pre-petition balance sheet debt and are actively participating in the statutory
committee process and the Chapter 11 cases, including with respect to supporting
our emergence from Chapter 11 on the expedited timeframe we previously reported.
There can be no assurance that a reorganization plan or plans will be
proposed by the Debtors or confirmed by the Court, or that any such plan(s) will
be consummated; in addition, the timing of such actions may be other than
currently planned by Kmart. If the Debtors fail to file a plan of reorganization
during the exclusivity period described above (as such period may be extended)
or if such plan is not accepted by the required number of creditors and equity
holders, any party in interest may subsequently file its own plan of
reorganization. A plan of reorganization cannot become effective until confirmed
by the Court, upon certain findings being made by the Court which are required
by the Bankruptcy Code. The Court may confirm a plan notwithstanding the
non-acceptance of the plan by an impaired class of creditors or equity security
holders if certain requirements of the Bankruptcy Code are met. A plan of
reorganization cannot become effective until confirmed by the Court, upon
certain findings being made by the Court which are required by the Bankruptcy
Code. The Court may confirm a plan notwithstanding the non-acceptance of the
plan by an impaired class of creditors or equity security holders if certain
requirements of the Bankruptcy Code are met. If it is determined that
liabilities subject to compromise in the Chapter 11 cases exceed the fair value
of the assets available to satisfy them, unsecured claims may be satisfied at
less than 100% of their face value and the equity interests of Kmart's
shareholders may have no value.
In connection with the preparation of a plan of reorganization, we have
engaged and intend to continue to engage in discussions and/or negotiations with
the various statutory committees, and, to the extent appropriate, with
significant holders of claims or other third parties concerning the possible
terms of a plan of reorganization. Kmart may also engage in discussions with
such parties to determine their level of interest in facilitating a plan of
reorganization. Under the possible terms of a plan of reorganization being
discussed with the statutory committees representing Kmart's creditors, those
creditors would not receive a full recovery of their claim amounts, the Kmart
common stock would be cancelled, and the holders of such common stock would
receive little or no consideration. We expect that the equity holders' committee
would vigorously oppose any plan that provides no consideration to equity
holders and that both creditors committees would oppose any plan that would
provide other than nominal consideration to such holders. Kmart expects
discussions to continue among ourselves, the various statutory committees,
including the equity holders' committee and other third parties as to the terms
of any such consideration and we cannot predict the value of the consideration,
if any, that may be received by the holders of Kmart common stock pursuant to a
plan of reorganization. Accordingly, we consider the value of the Kmart common
stock to be highly speculative and caution equity holders that the stock may
ultimately be determined to have no value.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
On March 20, 2002, the Court approved the closure of 283 stores, or
approximately 13% of our 2,114 stores. Stores were selected by evaluating the
market and financial performance of every store and the terms of every lease.
Candidates for closure were stores that did not meet our financial requirements
for ongoing operations. Renegotiation of lease terms was also explored to
improve store profitability and to avoid the need for closure. Shortly after
receiving Court approval we commenced store closing sales, which were completed
by June 2, 2002. Approximately 22,000 associates were impacted by the closures.
On April 4, 2002, we announced that we had contracted with a firm to
assist in the disposition of the leases for the 283 stores. Under the agreement,
the firm assisted our internal real estate staff in identifying retailers and
investors interested in an assignment and landlords interested in a termination
of the leases for the closing stores.
We will continue to review the store base as part of the reorganization
process and anticipate making definitive decisions in the near term about
additional store closings after considering, among other things, the results of
the holiday season. Any future decision to close stores will require us to incur
additional charges, which could be significant. At the appropriate time, we will
seek appropriate waivers from our lenders in connection with such closings
including but not limited to a waiver to permit the disposition of assets in
conjunction with such closings.
On June 18, 2002, we completed an auction, in which 57 of the 283
leases for the closed stores were sold. On June 28, 2002, the Court approved the
auction and we were authorized to sell one lease and designation rights on 56
leases for consideration totaling $46. We may be entitled to additional proceeds
in the event that our designation rights Purchaser of 54 leases achieves a
certain level of proceeds on its sale of these leases. Designation rights allow
the purchasers to put the leases back to Kmart prior to any assignment or
termination of such leases. If a lease is put back to Kmart, we retain the
option of rejecting the lease in Court with no obligation to return the
proceeds. Of the 56 leases for which we were authorized to sell designation
rights, 22 have been assigned, four have been terminated or rejected under
landlord agreements and seven have been excluded. Five of the excluded leases
were rejected before the end of the third quarter of 2002. The three remaining
excluded leases have been or will be assigned, terminated or rejected in the
fourth quarter. The Purchaser of our interest in the remaining closed store
leasehold defaulted under its Agreement and the lease was rejected. In addition,
pursuant to the auction and bidding procedures, we entered into lease
termination agreements for 10 of the 283 leases for the aggregate amount of $20
and the waiver of certain leasehold and rejection damages claims. There was no
successful bidder on the remaining leases which were rejected.
Prior to December 19, 2002, our common stock was listed on the New
York, Pacific and Chicago Stock Exchanges. There are a number of continuing
requirements that must be satisfied in order for a company's stock to remain
eligible for quotation on the New York Stock Exchange ("NYSE"). On July 10,
2002, we received notification from the NYSE that we were not in compliance
with the requirements for continued listing and, accordingly, that we could be
subject to trading suspension and delisting. On December 16, 2002 the NYSE
informed us that prior to the market opening on December 19, 2002 it would
suspend trading of our common stock and convertible trust preferred securities
and will commence proceedings to delist these securities. As of December 19,
2002, our common stock and trust preferred securities were suspended for
trading by the NYSE and the Pacific and Chicago Exchanges. The new ticker
symbols KMRTQ and KMTPQ have been assigned to our common stock and trust
preferred securities, respectively, by the over-the-counter bulletin board (the
"OTCBB"). Our common stock and the trust preferred securities are presently
being quoted on the Pink Sheets Electronic Quotation Service maintained by the
National Quotation Bureau, Inc. The OTCBB has indicated that quotation of the
common stock and the trust preferred securities on the OTCBB will be delayed in
light of the restatement of our financial statements for prior periods.
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
The ability of Kmart to continue as a going concern is predicated upon
numerous issues, including our ability to achieve the following:
- developing a long-term strategy and/or market niche to revitalize our
business and return Kmart to profitability;
- taking appropriate action to offset the negative effects that the
Chapter 11 filing has had on our business, including the loss in
customer traffic and the impairment of vendor relations;
- operating within the framework of our DIP Credit Facility, including
its limitations on capital expenditures, its financial covenants, our
ability to generate cash flows from operations or seek other sources of
financing and the availability of projected vendor credit terms;
- attracting, motivating and/or retaining key executives and associates;
and
- developing and, thereafter, having confirmed by the Court, a plan of
reorganization.
These challenges are in addition to those operational and competitive
challenges faced by Kmart in connection with our business as a discount
retailer. See "Cautionary Statement Regarding Forward-Looking Information"
above.
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
ANALYSIS OF OPERATIONS EXCLUDING NON-COMPARABLE ITEMS DESCRIBED BELOW
The following tables segregate non-comparable items from operating
income as reported in the unaudited Condensed Consolidated Statements of
Operations:
13 Weeks Ended 39 Weeks Ended
---------------------------- ----------------------------
(as restated - (as restated -
October 30, October 31, October 30, October 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Sales $ 6,729 $ 8,019 $ 21,887 $ 25,273
Cost of sales, buying and occupancy 5,586 6,402 18,001 20,390
------------ ------------ ------------ ------------
Gross margin 1,143 1,617 3,886 4,883
Selling, general and administrative expenses 1,511 1,744 4,886 5,459
Equity income (loss) in unconsolidated subsidiaries 8 11 27 (13)
------------ ------------ ------------ ------------
Operating loss before non-comparable items (360) (116) (971) (589)
Non-comparable items:
2002 inventory markdowns - - 785 -
Accelerated depreciation on the 2002 store closings - - 18 -
2002 cost reduction initiative - - 15 -
Charge for supply chain restructuring - 148 9 148
Charge (credit) for BlueLight.com (6) 5 (6) 97
Charge for employee severance and VERP - - - 23
------------ ------------ ------------ ------------
Operating loss before reorganization items, net $ (354) $ (269) $ (1,794) $ (857)
============ ============ ============ ============
Same store sales % (7.6%) (1.5%) (10.2%) 0.4%
Prior to the restatement, gross margin, as a percentage sales was 20.5%
and 19.0% for the 13 and 39 weeks ended October 31, 2001, respectively. Selling,
general and administrative expenses ("SG&A"), as a percentage of sales, was
21.7% and 21.7% for the 13 and 39 weeks ended October 31, 2001, respectively,
and Operating loss, as a percentage of sales, was (1.2%) and (2.6%) for the 13
and 39 weeks ended October 31, 2001, respectively.
Management uses operating loss before non-comparable items, among other
metrics, to measure operating performance. It supplements and is not intended to
represent a measure of performance in accordance with disclosures required by
accounting principles generally accepted in the United States. The following
discussion excludes non-comparable items. See the table above for a
reconciliation to reported amounts and the section titled Description of
non-comparable items described below:
SAME-STORE SALES AND TOTAL SALES decreased (7.6%) and (16.1%),
respectively, for the 13 weeks ended October 30, 2002 and (10.2%) and (13.4%),
respectively, for the 39 weeks ended October 30, 2002, as compared to the
comparable periods in the prior year. In addition to negative customer
perception stemming from our Chapter 11 filing, the decrease in same-store sales
is primarily due, among other factors, to lower sales transactions brought on by
poor in-stock levels during the first half of the year and continued competitive
pressures. Same-store sales include sales of all open stores, that have been
open for greater than 13 full months. The decrease in total sales is
attributable to the decrease in same-store sales and the closure of 283 stores
during the second quarter of fiscal 2002.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
GROSS MARGIN decreased $474 to $1,143, for the 13 weeks ended October
30, 2002, from $1,617 for the 13 weeks ended October 31, 2001 and decreased
$997 to $3,886, for the 39 weeks ended October 30, 2002, from $4,883 for the
39 weeks ended October 31, 2001. The decrease in gross margin for the 13 and 39
week periods ended October 30, 2002, is primarily attributable to the decrease
in sales and the decrease in margin rate, as described below.
Gross margin, as a percent of sales, decreased to 17.0% from 20.2% for
the 13 weeks ended October 30, 2002 as compared to the same period from the
previous year. The decrease is primarily related to an increase in promotional
markdowns designed to bring customers back to our stores, an increase in
clearance markdowns to improve sell-through on seasonal apparel, and a decrease
in vendor allowances. The decrease was partially offset by improved margin due
to the reduction of our BlueLight Always program. See further discussion on 2001
clearance markdowns under "Internal Investigation - Developments Since
Filing of 2001 Form 10-K."
For the 39 week period ended October 30, 2002, gross margin, as a
percent of sales, decreased to 17.8% from 19.3%. The decrease in gross margin as
a percentage of sales is due primarily to an increase in clearance and
promotional markdowns and shrinkage, partially offset by improved margin due to
the reduction of our BlueLight Always program, and a decrease in sales of food
and consumables, which carry lower margins.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES which includes advertising
costs (net of co-op recoveries of $112 in fiscal 2002 and $111 in fiscal 2001)
decreased $233 for the 13 week period ended October 30, 2002 compared to the
same period from the previous year. For the 13 weeks ended October 30, 2002,
SG&A was $1,511, or 22.5% of sales, as compared to $1,744, or 21.7% of sales,
for the 13 weeks ended October 31, 2001. The decrease in SG&A for the 13 week
period ended October 30, 2002, as compared to the previous year, is primarily
attributable to lower payroll and benefits due to the closure of 283 stores in
the second quarter of fiscal 2002, a reduction in electronic media and direct
mail advertising, employee reductions at our corporate headquarters in the third
quarter of fiscal 2002 and lower depreciation expense due to an impairment
charge recorded in the fourth quarter of fiscal 2001 and lower current year
capital spending.
SG&A, including advertising costs (net of co-op recoveries of $255 in
fiscal 2002 and $274 in fiscal 2001) decreased $573 for the 39 weeks ended
October 30, 2002 compared to the same period from the previous year. For the 39
week period ended October 30, 2002, SG&A was $4,886, or 22.3% of sales, as
compared to $5,459, or 21.6% of sales, for the 39 week period ended October 31,
2001. The decrease in SG&A for the 39 week period ended October 30, 2002, as
compared to the previous year, is primarily attributable to lower payroll and
benefits due to the closure of 283 stores in the second quarter of fiscal 2002,
decreases in expenses for general liability claims due to a second quarter 2001
adjustment of $167 to align general liability reserves with actuarial findings,
lower depreciation expense due to an impairment charge recorded in the fourth
quarter of fiscal 2001, a decrease in advertising expense and lower expenses for
employee bonus programs.
The increase in SG&A, as a percentage of sales, for the 13 and 39 week
periods ended October 30, 2002 is primarily attributable to the decrease in
total sales compared to the same period for the previous year.
OPERATING LOSS for the 13 weeks ended October 30, 2002 was ($360), or
(5.3%) of sales, as compared to operating loss of ($116), or (1.4%) of sales,
for the same period of the prior year. Operating loss for the 39 weeks ended
October 30, 2002 was ($973), or (4.4%) of sales, as compared to operating loss
of ($589), or (2.3%) of sales, for the same period of the previous year. The
increase in operating loss for the 13 and 39 week periods ended October 30,
2002, is attributable to lower sales and a lower gross margin rate, partially
offset by a decrease in SG&A expenses as discussed above.
34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
INTEREST EXPENSE, NET for the 13 weeks ended October 30, 2002 and
October 31, 2001 was $37 and $96, respectively. Included in net interest expense
for both the 13 weeks ended October 30, 2002 and October 31, 2001, is interest
income of $1. Interest expense, net for the 39 weeks ended October 30, 2002 and
October 31, 2001 was $102 and $267, respectively. Included in net interest
expense for both the 39 weeks ended October 30, 2002 and October 31, 2001 is
interest income of $3.
EFFECTIVE INCOME TAX rate was (1.8%) and (34.6%) for the 13 weeks ended
October 30, 2002 and October 31, 2001, respectively. For the 39 week periods
ending October 30, 2002 and October 31, 2001, the effective income tax rate was
(0.9%) and (32.2%), respectively. In the fourth quarter of fiscal 2001, we
recorded a valuation allowance against our net deferred tax assets, in
accordance with SFAS No. 109, "Accounting for Income Taxes," as realization of
such assets in future years is uncertain. We have continued to maintain a
valuation allowance against our net deferred tax assets, and accordingly, we
have not recognized any tax benefit from our losses in fiscal 2002. The $19 tax
benefit recorded in the 39 week period ended October 30, 2002 relates primarily
to $12 for amounts now refundable to Kmart as a result of the Job Creation and
Worker Assistance Act of 2002 which was enacted in the first quarter of fiscal
2002 and $14 related to a special provision of the Internal Revenue Code that
allows a ten-year carryback of certain losses, partially offset by $7 of expense
related to income taxes paid to foreign jurisdictions.
LIQUIDITY AND FINANCIAL CONDITION
Shortly after the Petition Date, in conjunction with our filing under
Chapter 11, we entered into a $2 billion debtor-in-possession financing facility
("DIP Credit Facility"). On the Petition Date, the Court gave interim approval
authorizing borrowings up to $1.15 billion of the DIP Credit Facility for the
payment of certain pre-petition claims and the funding of working capital and
other general operating needs. On March 6, 2002, the Court approved the entire
$2 billion DIP Credit Facility. The DIP Credit Facility is a revolving credit
facility under which Kmart is the borrower and the rest of the Debtors are
guarantors. The DIP Credit Facility has been afforded superpriority claim status
in the Chapter 11 case and is collateralized by first liens on substantially all
of the Debtors' assets (subject to valid and unavoidable pre-petition liens and
certain other permitted liens) and provides that proceeds be used for working
capital needs and other general corporate purposes. The DIP Credit Facility
requires that we maintain certain financial covenants, including minimum levels
of earnings before interest, taxes, depreciation, amortization and other charges
("EBITDA"), and restrict liens, indebtedness, capital expenditures, dividend
payments and sale of assets. On August 29, 2002 we received approval from our
lenders and the Court for an amendment to certain EBITDA covenants in the
agreement governing our DIP Credit Facility. We are currently in compliance with
the amended DIP Credit Facility financial covenants. Following the Petition
Date, we have utilized cash flows from operations and the DIP Credit Facility as
our primary sources of working capital. As of October 30, 2002 we had $575 of
borrowings outstanding under the DIP Credit Facility and had utilized $332 for
letters of credit issued for ongoing import purchasing operations, contractual
and regulatory purposes. Total availability under the DIP Credit Facility as of
October 30, 2002 was $993.
As of October 30, 2002, there were $393 and $652 borrowings outstanding
under our $400 credit facility and $1.1 billion credit facility, respectively.
These borrowings, which certain of our subsidiaries guaranteed, are included in
Liabilities subject to compromise in our unaudited Condensed Consolidated
Balance Sheet as of October 30, 2002 as these obligations were stayed upon our
filing for Chapter 11 reorganization.
Net cash used for operating activities for the 39 weeks ended October
30, 2002 was $675 as compared to net cash used for operating activities of $442
for the same period in 2001. The increase in cash used for operating activities
as compared to the same period of the prior year was primarily the result of
higher net losses.
Net cash used for reorganization items for the 39 weeks ended October
30, 2002, was $113. This spending relates primarily to payments under the Key
Employee Retention Program ("KERP") and payments to retained bankruptcy
advisors.
Net cash used for investing activities was $206 for the 39 weeks ended
October 30, 2002 compared to $1,129 for the same period in 2001. The decrease in
cash used for investing activities was primarily due to restrictions on capital
expenditures mandated by our DIP Credit Facility.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Net cash provided by financing activities was $130 for the 39 weeks
ended October 30, 2002 compared to net cash provided by financing activities of
$1,536 for the comparable period in 2001. The decrease in cash provided by
financing activities in fiscal 2002 as compared to fiscal 2001 is primarily
attributable to our bankruptcy filing for reorganization under Chapter 11. As of
the Petition Date, pre-petition indebtedness was stayed resulting in substantial
increases in cash balances during fiscal 2002 which funded working capital needs
and capital expenditures. Borrowings under the DIP Credit Facility have been
used primarily to fund planned inventory purchases in anticipation of the
holiday season. During the first 39 weeks of fiscal 2001, we borrowed $764 under
our $1.6 billion credit facility and issued $430 of 9 7/8% Notes due June 2008
to finance our operations, and to paydown certain Collateralized Mortgage Backed
Securities in July 2001.
Due to the seasonal nature of the retail industry, where merchandise
sales and cash flows from operations are historically higher in the fourth
quarter than any other period, a disproportionate amount of operating income and
cash flows from operations is earned in the fourth quarter. Our results of
operations and cash flows are primarily dependent upon the large sales volume
generated during the fourth quarter of our fiscal year. Fourth quarter sales
represented over 30% of total net sales in fiscal 2001. As a result, operating
performance for the interim periods is not necessarily indicative of operating
performance for the entire year. To support the higher seasonal sales volume we
experience a seasonal inventory build in October and November and, as a result,
our usage of credit lines is higher for this period of the year. We believe that
our DIP Credit Facility will be adequate to support our forecasted seasonal
borrowing needs.
Our cash needs are satisfied through working capital generated by our
business and funds available under our DIP Credit Facility. The level of cash
generated by our business is dependent, in significant part, on our level of
sales, the margins generated by such sales and the credit extended by our
vendors. Since our filing for reorganization under Chapter 11, most of our
vendors have resumed normal trade terms. In addition, during October, while
margins have been weaker than planned, same-store sales comparisons with prior
periods have improved. Kmart is continuing its efforts to stabilize and
revitalize the business. However, should we experience a significant disruption
of terms with our vendors, margins fail to improve, and/or the availability of
resources under the DIP Credit Facility is affected, and/or actual results
differ materially from those projected, our compliance with financial covenants
and cash resources could be adversely affected.
Pension Plan
Prior to 1996, Kmart maintained a defined benefit pension plan covering
eligible associates. Effective January 31, 1996, the pension plan was frozen,
and associates no longer earn additional benefits under the plan (except for
purposes of the subsidized early retirement program provided by the plan). The
plan's assets consist primarily of equity and fixed income securities. For the
past 8 years, Kmart has not been required to make a contribution to the plan.
In light of returns in the equity markets since the beginning of our
fiscal year and the effect of such returns, as well as returns over the past
several years, on the value of the plan's assets, we presently expect that we
likely will be required to commence making contributions to the plan in 2005,
although it is possible that some contributions could be required earlier. Given
that the plan is frozen, the timing for the commencement of our future funding
requirements will depend, in large part, on the future investment performance of
the plan's assets. Once funding obligations commence, we presently anticipate
that such obligations could continue for a period of five or six years at an
average rate of between $100 and $200 a year or between $800 and $900 in the
aggregate. The actual level of contributions, however, will depend upon a number
of factors, including the actual demographic and other changes affecting
valuations.
In addition to the funding described above, as a result of the returns
over the most recent years, expected decreases in our annual discount rate and
expected rate of return on assets, there will likely be an expense recorded for
2003 as opposed to income as has been recorded in the most recent years.
36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
DESCRIPTION OF NON-COMPARABLE ITEMS
During the 39 week periods ended October 30, 2002 and October 31, 2001,
respectively, we have instituted certain restructuring actions to improve our
operations. A more detailed description of these non-comparable items is as
follows:
2002 Markdowns for Inventory Liquidation
For the 39 week period ended October 30, 2002, we recorded charges of
$785 to write-down inventory liquidated at our 283 closing stores to net
realizable value, given the accelerated liquidation strategy. This charge is
included in Cost of sales, buying and occupancy in the unaudited Condensed
Consolidated Statements of Operations.
For the year, $348 of the charge was recorded relating to the
write-down of inventory initially existing at the closing stores to its
estimated selling value in connection with liquidation sales in the 283 stores.
During the liquidation sale the actual markdowns required to liquidate the
inventory were lower than expected. As a result, in the second quarter, we
recorded a credit of $36 to adjust our original estimate of $384. In addition,
$117 of the charge related to liquidation fees and expenses associated with the
disposition of inventory through the liquidation sales at the 283 closing
stores.
The remaining $320 was recorded relating to the acceleration of
markdowns on approximately 107,000 stock keeping units ("SKUs"), the majority of
which were transferred from our remaining open stores to the 283 closing stores
and included in the liquidation sales. The liquidation of these SKUs required
higher markdowns than anticipated, accordingly, an adjustment of $54 was
recorded in the second quarter of 2002 to adjust our original estimate of $266.
The following table summarizes the components of the charge for
markdowns for inventory liquidation during fiscal year 2002:
Writedown of Accelerated
Inventory in Markdown
the 283 Liquidator of
Closing Fees and Discontinued
Stores Expenses SKUs Total
-------------- ------------- ------------- -------------
First Quarter $ 384 $ 108 $ 266 $ 758
Second Quarter
Adjustments for actual selling values (36) -- 54 18
Additional fees and expenses -- 9 -- 9
------------- ------------- ------------- -------------
Total $ 348 $ 117 $ 320 $ 785
============= ============= ============= =============
2002 Cost Reduction Initiative
On August 19, 2002, we announced a cost reduction initiative aimed at
realigning our organization to reflect our current business needs following the
completion of the closure of 283 stores. We eliminated approximately 400
positions at our corporate headquarters and approximately 50 positions
nationally that provided corporate support. As a result of the job eliminations
we recorded a charge of $15 during the second quarter of fiscal 2002. The charge
includes severance, outplacement services and continuation of healthcare
benefits in accordance with the severance plan provisions of our KERP, which was
approved by the Court in March 2002. This charge is included in the line
Restructuring, impairment and other charges in our unaudited Condensed
Consolidated Statements of Operations.
Accelerated Depreciation on 2002 Store Closings
In the fourth quarter of fiscal 2001 we recorded a non-cash charge of
$971 for the impairment of long-lived assets in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 144 "Accounting for the
37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Impairment or Disposal of Long-Lived Assets," ("SFAS No. 144"). Included in the
charge was the write-down to fair value of long-lived assets at our 283 stores
for which we later received Court approval to close. We recorded charges
totaling $0 and $18 for the 13 and 39 week periods ended October 30, 2002,
respectively related to the accelerated depreciation of the remaining assets in
these stores. All assets were fully depreciated with the closure of the stores
in the second quarter of 2002.
Supply Chain Operations
On September 6, 2001 we restructured certain aspects of our supply
chain infrastructure, including the reconfiguration of our distribution center
network and implementation of new operating software across our supply chain. In
conjunction with these actions, we recorded a charge of $148 ($94, net of tax)
in the third quarter of fiscal 2001.
We recorded a $92 charge related to the planned disposal of supply
chain software and hardware and other assets that are no longer utilized, in
accordance with SFAS No. 144.
Operating software was replaced at four of our distribution centers in
2002; however, we have suspended the replacement initiative at our other
fourteen distribution centers. Accordingly we have discontinued the acceleration
of depreciation at these centers and any remaining net book value of assets will
be depreciated over the original useful lives. There was $9 related to
accelerated depreciation in the 39 weeks ended October 30, 2002 of which $7 and
$2 was included in Cost of sales, buying and occupancy and SG&A, respectively.
A $47 charge was recorded for lease terminations and contractual
employment obligations for staff reductions of 956 employees at our distribution
centers in accordance with Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity" ("EITF 94-3").
The following table summarizes the significant components and
presentation, in the unaudited Condensed Consolidated Statements of Operations,
of the charge for the restructuring of our supply chain operations during the
third quarter of fiscal 2001.
Cost of
sales, buying
and occupancy SG&A Total
------------ ------------ ------------
Asset impairments $ 5 $ 87 $ 92
Lease obligations 37 -- 37
Contractual employment obligations 10 -- 10
Accelerated depreciation on software 9 -- 9
------------ ------------ ------------
Total $ 61 $ 87 $ 148
============ ============ ============
In the second quarter of fiscal 2002, we recorded a credit of $5 in
Reorganization items, net related to lease settlement agreements with our
landlords.
Restructuring of BlueLight.com
We recorded a $92 charge ($73, net of tax) related to
our e-commerce site, BlueLight.com, in the second quarter
of fiscal 2001, comprised of $41 for the impairment of our investment in
BlueLight.com and $51 for the restructuring of our e-commerce business.
Based upon the changing environment for the internet businesses, in
which the ability for such businesses to raise capital was restricted,
management's revised future cash flow projections and the potential need for
significant additional cash advances, we adopted a multi-step plan to
substantially restructure the operations of BlueLight.com.
The initial step was executed in the second quarter of 2001, by
acquiring the remaining 40% interest in BlueLight.com, LLC, principally through
the purchase of all outstanding common and preferred stock of BlueLight.com,
Inc., a holding company. BlueLight.com,
38
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Inc. and BlueLight.com LLC (hereinafter together or individually,
"BlueLight.com") then became wholly-owned subsidiaries of Kmart, which allowed
us to execute our restructuring plan. The purchase price of the additional
interest was $85, with $69 being satisfied through the issuance of 6.1 million
unregistered shares of Kmart common stock and $16 paid in cash. Based upon the
revised cash flow projections for the business, we recorded in the second
quarter of fiscal 2001 a $41 charge to write-down our investment in
BlueLight.com to fair value in accordance with SFAS No. 144. Fair value was
determined using the present value of estimated future cash flows. In connection
with the transaction, the return of capital put rights for $62.5 and the 4.4
million warrants for Kmart stock originally granted to SOFTBANK Venture Capital
(currently Mobius Venture Capital) and other investors were terminated. The
$62.5 liability for the return of capital puts, recorded due to uncertainties
surrounding a start-up operation in the highly competitive e-commerce industry,
was relieved.
Of the $51 restructuring charge, $29 related to assets impaired as a
result of the restructuring. These assets represent furniture and fixtures,
leasehold improvements, and computer software and hardware, the majority of
which were located in the headquarters of BlueLight.com, and were not utilized
in the restructured operations. These assets were reduced to the lower of
carrying amount or fair value less cost to sell in accordance with SFAS No. 144.
Fair value was determined using the present value of estimated future cash
flows. Liabilities for lease terminations, contract terminations and other costs
totaling $22 were established in accordance with EITF 94-3 as a result of the
decision to exit the BlueLight.com headquarters building and outsource certain
aspects of our overall e-commerce business, including fulfillment, technology
and customer service.
During the third quarter of 2001, we continued executing our
restructuring plan, including formally communicating severance benefits to 114
employees at the BlueLight.com headquarters. We recorded an additional $5 ($3,
net of tax) charge to provide for these costs.
In the third quarter of fiscal 2002 we reduced the reserves established
for BlueLight.com contract terminations by $6 based on our revised estimates for
the remaining obligations. All charges related to the impairment of our
investment and restructuring of BlueLight.com are included in the line
Restructuring, impairment and other charges in the unaudited Condensed
Consolidated Statements of Operations.
Additionally, during the third quarter of 2002, we reversed, through
Reorganization items, net, $4 of the charge for lease terminations to reduce the
reserve to the amount of the estimated allowed claim under the Bankruptcy Code.
The results of BlueLight.com's operations are fully consolidated in our
financial statements commencing July 31, 2001.
BlueLight.com entered into an agreement to sell certain of the assets
of its Internet Service Provider ("ISP") and email business to Netbrands, a unit
of United Online, Inc., for approximately $8, subject to certain favorable
working capital adjustments and Court approval. The sale of these assets was the
subject of a competitive bidding process in which Netbrands was the winning
bidder. The sale was approved by the Court on October 30, 2002, closed on
November 4, 2002 and resulted in a gain of $4, which will be recorded in the
fourth quarter of 2002. The sale of the ISP assets will not affect the Kmart.com
online shopping site.
39
Employee Severance and VERP
During the first quarter of 2001, our workforce was reduced by 350
employees through a voluntary early retirement program ("VERP") and other
employee separations. The total cost of the realignment aggregated $23 ($15, net
of tax), which is included in our unaudited Condensed Consolidated Statement of
Operations for the quarter ended October 31, 2001 in the line item
Restructuring, impairments and other charges. The charge related to 130
employees that accepted the VERP offer, with costs aggregating $6. The remaining
220 employees were severed and given post-employment benefits including
severance, outplacement services, continuation of healthcare benefits and other
benefits totaling $17. Of the charge, $19 was reserved for and paid out of our
general corporate assets, including benefits for highly-compensated employees
accepting the VERP offer, and the remaining $4 was paid out of the Kmart
Employee Pension Plan.
REORGANIZATION ITEMS, NET
Reorganization items, net represent amounts we incurred as a direct
result of our Chapter 11 filing and are presented separately in the unaudited
Condensed Consolidated Statements of Operations. For the 13 and 39 week periods
ended October 30, 2002, the following have been recorded:
13 Weeks 39 Weeks
Ended Ended
--------- ---------
2002 store closings $ 4 $ 222
Employee costs 20 83
Professional fees 14 81
Settlement of pre-petition liabilities (24) (58)
Lease auction (19) (21)
Sale of pharmacy lists -- (18)
Interest income (1) (10)
Other 6 (1)
--------- ---------
Reorganization items, net $ -- $ 278
========= =========
The following paragraphs provide additional information relating to
costs that were reported in the line Reorganization items, net in our unaudited
Condensed Consolidated Statement of Operations for the 13 and 39 week periods
ended October 30, 2002:
2002 Store Closings
On March 20, 2002, the Court approved the closure of 283 stores. Stores
were selected by evaluating the market and financial performance of every store
and the terms of every lease. Candidates for closure were stores that did not
meet our financial requirements for ongoing operations. All of the stores were
closed as of June 2, 2002.
SFAS No. 144 requires closed stores to be classified as discontinued
operations when a) the operations and cash flows of the stores have been (or
will be) eliminated from our ongoing operations and b) we will not have any
significant continuing involvement in the operations of the stores after the
closure. Based on these criteria, we evaluated the 283 stores closed during the
second quarter and determined that in substantially all the cases, the
operations and cash flows of the stores should not be eliminated from our
ongoing operations. The results of operations for 28 stores were considered to
be discontinued operations under the criteria set forth in SFAS No. 144,
however; total Sales, Gross margin, and SG&A for these stores represented less
than 1% of Kmart's total Sales, Gross margin and SG&A, and were not considered
material for separate presentation in the unaudited Condensed Consolidated
Statement of Operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
In conjunction with these 283 store closings, we recorded charges of $4
and $222 for expenses related to store closings during the 13 and 39 week
periods ended October 30, 2002, respectively. These charges are included in
Reorganization items, net in the unaudited Condensed Consolidated Statement of
Operations. We charged $228 to our closed store reserve for allowable claims
related to lease terminations and other costs and reclassified $144 of capital
lease obligations to the closed store reserve during the first quarter of fiscal
2002. During the second and third quarters of fiscal 2002, we recorded a credit
of $10 and a charge of $4, respectively, to adjust our estimated allowable
claims. The reserve for estimated costs was recorded in accordance with EITF
94-3.
Employee Costs
In March 2002, we received Court approval to implement the KERP which
provides cash incentives and certain benefits to key members of our salaried
management team. The retention program provisions of the KERP are expected to
encourage employees to continue their employment with Kmart through the
reorganization process. For the 13 and 39 week periods ended October 30, 2002,
we recorded charges of $20 and $83, respectively, for the KERP benefits and
other employee benefits for associates in our 283 stores that were closed are
not covered under the KERP.
Professional Fees
For the 13 and 39 week periods ended October 30 2002, we recorded $14
and $81, respectively, for professional fees. Professional fees include
financial, legal, real estate and valuation services directly associated with
our reorganization process.
Settlement of Pre-petition Liabilities
For the 13 and 39 week periods ended October 30, 2002, we recorded
gains of $24 and $58, respectively, representing the difference between the
settlement value of certain pre-petition obligations and the estimated amounts
recorded for allowable claims, primarily related to lease termination agreements
between Kmart and its landlords.
Lease Auction
Kmart and certain subsidiaries entered into several Asset Purchase and
Designation Rights Agreements ("Agreements") with Kimco Realty Corporation,
Schottenstein Stores Corporation and Klaff Realty, LP and other purchasers
("Purchasers"), in accordance with the bidding procedures order entered by the
Court on May 10, 2002. Under terms of the Agreements we agreed to sell to the
Purchasers the designation rights with respect to 56 leaseholds for closed
stores and our interest in the leasehold for one closed store, the Purchaser of
which defaulted under its Agreement and the lease was rejected. During the
designation period, as defined under the Agreements, the Purchaser of
designation rights shall have the sole, exclusive and continuing right to
select, identify and designate (i) which leases shall be assumed and assigned
(and if assigned to whom), or terminated, and (ii) which properties shall be
excluded from the transaction. During fiscal 2002, the leaseholds on the 283
stores not covered by the Agreements have been rejected or terminated.
In consideration for the designation rights acquisitions, the
Purchasers are obligated to pay $46, of which $14 and $26 was paid in cash
during the 13 and 39 week periods ended October 30, 2002, respectively. The
remaining $20 is to be paid as the Purchaser of the designation rights with
respect to 54 leaseholds receives net proceeds from the sale or assignment of
the properties, but not later than December 31, 2002. The Purchasers are
responsible for paying all carrying costs related to such properties during the
designation period, in accordance with the Agreements. In addition, we may be
entitled to additional proceeds in the event that designation rights
transactions exceed a specified level of proceeds.
A pro-rata portion of the guaranteed proceeds of $46 will be recognized
into income at either the effective date of the property assignment or
termination, when we are informed by the Purchasers of their intention to
exclude certain leaseholds from future assignments or terminations, or upon
expiration of the designation rights period. At the time we are legally released
as the primary obligor under the lease agreement, the allowed claim amount
established in connection with the Court's approval of our plan to close the
store and reject the lease will be reversed. Both the income from the sale of
the designation rights and the reversal of allowed claim amounts are reported as
Reorganization items, net in the unaudited Condensed Consolidated Statement of
Operations.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
During fiscal 2002, 22 leases under the Agreements have been assigned,
four have been terminated or rejected under landlord agreements and seven have
been excluded. Five of the excluded leases were rejected before the end of the
third quarter of 2002. The two remaining excluded leases have been or will be
assigned, terminated or rejected in the fourth quarter. For the 13 and 39 week
periods ended October 30, 2002 we recognized $19 and $21 of proceeds,
respectively, from the sale of designation rights. The remaining funds received
have been deferred and will be recognized in our unaudited Condensed
Consolidated Statement of Operations as described above.
Other Reorganization Items
For the 13 and 39 week periods ended October 30, 2002, we recorded $0
and $18 of income, respectively, for the sale of pharmacy lists and $1 and $10,
respectively, for interest income earned on excess cash balances. For the 13 and
39 week periods ended October 30, 2002, we recorded expenses of $6 and a credit
of $1, respectively, for other reorganization items.
DISCONTINUED OPERATIONS
For the 13 and 39 week periods ended October 30, 2002, we credited
income for $1 and $37, respectively, primarily to reduce estimated reserves for
our remaining lease obligations for the Builder's Square, Inc., Hechinger
Company, Pace Membership Warehouse, Inc. and Furr's Restaurants locations. These
amounts primarily related to lease settlement agreements with our landlords,
adjustments to our estimated allowable claims for the lease obligations and
income related to the recovery of claims through the bankruptcy of Hechinger
Company.
INTERNAL INVESTIGATION - DEVELOPMENTS SINCE FILING OF 2001 FORM 10-K
The following sets forth developments that have occurred since the
filing of Kmart's Annual Report on Form 10-K for fiscal year 2001, dated May 15,
2002 (the "Original 2001 10-K") in connection with the internal investigation
and related stewardship review being conducted under the supervision of the
Audit Committee of the Board of Directors. As previously disclosed, following
the receipt of anonymous letters, the Board of Directors had instructed that an
internal investigation be undertaken under the supervision of the Audit
Committee by outside legal counsel, with the assistance of independent
accounting advisors. The Original 2001 10-K had reflected, as of the date of
filing, the results of the investigation with respect to various accounting
matters. As of the date of the filing, we believed that the investigation was
complete with respect to accounting matters affecting the financial statements
in the Original 2001 10-K. Set forth below is a discussion of certain matters
relating to vendor allowances and inventories that have been investigated since
the filing of the Original 2001 10-K. These matters were previously reported
in our Quarterly Report on Form 10-Q for the period ended July 31, 2002 or our
original 2001 10-K.
Vendor Allowance Matters
Premature Recognition of Vendor Allowances
Since the filing of our Original 2001 10-K we became aware of documents
that indicated that there were certain vendor allowance transactions prematurely
recorded in our fiscal year 2000 fourth quarter financial statements that
required investigation. We also determined that such early recognition of vendor
allowances occurred in other prior fiscal periods, although the impact of these
transactions on our financial statements was less significant. We described the
effect of these items in our Report on Form 10-Q for the 13 week period ended
July 31, 2002 that we filed with the SEC on September 16, 2002. In addition, we
recently became aware of allowances received from a vendor aggregating $14 which
previously had been recognized in our fiscal year 2000 financial statements and
that we have determined should more appropriately been recognized over the
five-year life of the contract that we entered into with this vendor.
42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
It is important to note that although we have conducted all procedures
we deemed reasonable under the circumstances to identify and quantify vendor
allowances that were prematurely recorded, and which were restated to correct
and record such allowances in the appropriate period, there can be no assurance
that we have captured all of such allowance transactions. Furthermore, we
believe that our ability to accurately identify prematurely recorded allowance
transactions diminishes with the passage of time. We have taken actions to
strengthen our internal controls concerning vendor allowance transactions and
have restated our prior period financial statements for these adjustments.
2001 Interim Allowance Recognition
During the Fall of 2002 and in response to inquiries from the staff of
the SEC, Kmart reviewed its historical practices for the recording of allowances
prior to the adoption in the fourth quarter of fiscal year 2001 of a new
accounting policy, effective February 1, 2001, for the interim financial
reporting of vendor allowances. The effect of these practices relates only to
Kmart's interim financial statements. See "Internal Investigation - Developments
Since Filing of 2001 Form 10-K - Vendor Allowance Matters" for a description of
the impact of the premature recording of certain vendor allowances on Kmart's
audited financial statements.
For interim reporting periods in fiscal 2000 and prior, our policy was
to record allowances not yet subject to a written agreement during the first
three quarters of a fiscal year based upon our estimate of annual allowances
("our plan") as determined by historical experience and current understandings
with our vendors. These amounts were supplemented by allowances obtained that
were not contemplated in our plan ("incrementals"). During the fourth quarter of
fiscal 2001, we adopted a new accounting policy, effective as of February 1,
2001, for interim financial reporting only, requiring that cost recoveries from
vendors be recognized only when a formal agreement for such amount has been
obtained and the underlying activity for which the amount was provided has been
performed.
As part of its review of allowances, the current management of Kmart
observed that the total level of allowances originally recorded during the first
three quarters of fiscal year 2001 appeared high, given the challenges that
faced the business in fiscal year 2001 and the fact that sales failed to
increase as originally contemplated in Kmart's business plan. In that regard, it
was noted that had Kmart recorded allowances during the first three quarters of
fiscal year 2001 at rates which corresponded to more historical rates, Kmart
would have recorded fewer allowances.
During the first three quarters of fiscal year 2001, Kmart
characterized and recorded as incremental allowances $110, $163 and $50,
respectively. Kmart selectively identified for review certain of such allowances
that had been characterized and recorded as incrementals prior to the adoption
of the new accounting policy. Of those reviewed, the amount of allowances, other
than those previously disclosed, which appeared to be questionable were $27, $42
and $23, respectively. The questions about these allowances relate to, among
other things, the failure to have appropriate signed documentation in place, the
failure to have adequate records demonstrating that the allowance was
collectible or the failure to otherwise comply with Kmart's historical policies.
Based on the investigation, it appears that some of these allowances may have
been reported in error in the quarterly financial statements. Given, however,
that Kmart's review of allowances was selective, as well as the difficulties of
confirming on a retroactive basis whether an incremental allowance is
supplemental to the plan, Kmart cannot exclude the possibility that there may be
additional incremental allowances in fiscal year 2001 which could be subject to
question.
Any errors, as described in the preceding paragraphs, concerning the
recording of allowances that were reflected in our fiscal year 2001 interim
unaudited financial statements prior to the change in accounting policy were no
longer reflected in our restated financial statements as filed with the SEC on
May 15, 2002. This results from the change in accounting policy, given that
under the new accounting policy there is no longer a distinction between planned
and incremental allowances, no allowances are recognized absent a formal
agreement and the recording of allowances is no longer based on a plan.
Inventory Matters
Following the filing of the original 2001 10-K and in response to
inquiries from the staff of the SEC, we have conducted an internal inventory
quality review with respect to our 1999, 2000 and 2001 fiscal years. We continue
to believe, following the conclusion of this review, that our inventory balances
during these periods were, in all material respects, appropriately valued at the
lower of cost or market and that, therefore, our financial statements require no
adjustment for inventory quality matters. However, we have provided the
following additional information with respect to our historical inventory
markdown and reserve practices so as to enhance a reader's understanding of our
financial statements as presented in Management's Discussion and Analysis in the
original 2001 10-K and to be contained in Amendment No. 1 to the Annual Report
on Form 10-K/A for the 2001 fiscal year, to be filed with the SEC as soon as
practicable.
2000 Strategic Actions Charge and Related Matters
During the second quarter of fiscal year 2000, we reported a $740
charge for strategic actions including the closure of certain stores,
acceleration of certain inventory reductions and redefining our information
technology strategy. The $740 charge included $290 for the estimated loss on
disposal for the accelerated liquidation of certain discontinued product, which
was characterized in Management's Discussion and Analysis of our 2001 10-K as a
"non-comparable" item. During the course of the recent internal inventory
review, we analyzed the assumptions of the charge related to the accelerated
liquidation of the discontinued merchandise, including historical markdown
cadences, or the timing for recognizing markdowns in our financial statements,
for discontinued product. In carrying out such review, current management
observed that the effect of an accelerated markdown cadence, combined with
certain transfer costs, approximated $156. In light of these observations with
respect to accelerated markdown cadences, current management noted that
approximately $134, the remaining portion of the charge, could have been viewed
as an operating item and, as such, not reported as a "non-comparable" item.
Similarly, current management observes that if the $134 portion of the charge
had been reflected as an operating item, it could have been recorded against an
existing inventory reserve.
Inventory Valuation Reserves
At the end of fiscal year 1999, Kmart had designated valuation reserves
related to its discontinued and aged seasonal merchandise inventories of $63, as
well as general reserves existing in its LIFO provision of $158. In light of
these reserves, the inventory at the end of fiscal 1999 was, in the judgment of
current management, properly stated at the lower of cost or market in accordance
with generally accepted accounting principles. During the fourth quarter of
fiscal year 2000, the $158 general reserve that existed in our LIFO valuation
was recharacterized within inventory reserves as a reserve for markdowns on
discontinued and aged seasonal merchandise.
During the first quarter of 2001, we changed our method of recording
the effect of permanent markdowns and began to record them as a direct reduction
in the carrying value of the related inventory instead of being estimated and
recorded as a valuation reserve. At that time, the then existing reserves of
$172 for permanent markdowns on discontinued and aged seasonal merchandise were
applied directly to the marked-down merchandise. Accordingly, a permanent
markdown accrual was no longer necessary.
2001 Clearance Markdowns
As indicated in our 2001 10-K, inventory valuation is considered to be
one of our critical accounting policies as significant judgments and estimates
are required in determining merchandise markdowns, among other reasons. A number
of factors are considered in determining the timing and amount of merchandise
markdowns including rate of
43
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
product sell-through, projected future demand, and market conditions and weather
conditions. The timing of such decisions may have a significant effect on
quarterly financial results.
During our recent internal inventory review, we noted that levels of
clearance markdowns in the second and third quarter of 2001 appeared low in
relation to historical markdown experience apparently as a result of, among
other things, decisions to minimize markdown activity and related charges in
light of Kmart's then operating performance. Although current management found
that inventory balances had been properly stated, in all material respects,
under our policy of valuing inventory at the lower of cost or market value
during each of the quarterly periods of 2001, current management noted that the
fewer markdowns in the second and third quarters of 2001 served to increase
reported earnings in those quarters, and increase markdowns and decrease
reported earnings in the first and fourth quarters. For example, we observed
that had markdowns been taken in each quarter of 2001 in a manner which, on a
percentage of sales basis, corresponded to the average of the markdowns taken,
on a quarterly basis, during fiscal years 1998, 1999 and 2000, excluding the
effect of special events such as store closings, the level of clearance
markdowns in 2001 could have been increased by $55 and $105 in the second and
third quarters, respectively, and reduced by $40 and $120 in the first and
fourth quarters, respectively. The actual effect, however, that a different
markdown practice could have had on our quarterly net income for the full fiscal
year is difficult to predict, given the numerous other factors, estimates and
assumptions that would affect our results.
OTHER MATTERS
Contingent Liabilities
As of October 30, 2002, we had (i) guaranteed obligations for real
property leases of certain current and former subsidiaries of Kmart including,
but not limited to, The Sports Authority, Inc., OfficeMax, Inc. and Borders
Group, Inc., some of which leases have been assigned pre-petition; (ii)
contingent liability under real property leases assigned by Kmart pre-petition;
and (iii) guaranteed $70 of indebtedness of other parties related to certain of
our leased properties financed by industrial revenue bonds. Our rights and
obligations with respect to our guarantee of leases of the former subsidiaries
The Sports Authority, Inc., Office Max, Inc., and Borders Group, Inc., which are
detailed below, are governed by Lease Guarantee, Indemnification and
Reimbursement Agreements dated as of November 23, 1994, November 9, 1994 and May
24, 1995, respectively, as they may be amended from time to time. Kmart's
contingent obligations, described above, which are not reflected in our
financial statements, are dependent on the future performance by the parties
whose obligations we guarantee and are subject to settlement under a plan of
reorganization to be voted upon by creditors and equity holders and approved by
the Court.
As of October 30, 2002, our outstanding guarantees for real property
leases of The Sports Authority, Inc., Office Max, Inc., and Borders Group, Inc.
were as follows:
Present Value of
Future Lease Gross Future
Obligations @ 7% Lease Obligations
---------------- -----------------
The Sports Authority, Inc. $172 $292
Borders Group, Inc. 83 141
OfficeMax, Inc. 59 86
---- ----
Total $314 $519
==== ====
Key Brand Partners
On March 20, 2002, the Court authorized our business relationships with
several key brand partners. Motions were approved allowing Kmart to assume our
license agreements with Martha Stewart Living Omnimedia, Inc. for Martha Stewart
Everyday home, garden, colors, baby, kitchen, keeping and decorating products,
along with candles and accessories; Jaclyn Smith G.H. Production, Inc. for
Jaclyn Smith women's apparel, jewelry and accessories; Kathy Ireland
44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
World Wide, Inc. for Kathy Ireland women's apparel, accessories and exercise
equipment; Disney Enterprises, Inc. for Disney apparel for infants and children;
and Joe Boxer Licensing, LLC. for JOE BOXER apparel, accessories and home
furnishings.
On May 29, 2002, the Court authorized our business relationship with
Sesame Workshop. Motions were approved allowing Kmart to assume our license
agreement with Sesame Workshop for Sesame Street infants and children's apparel.
On July 24, 2002 the Court approved our motion allowing Kmart to assume
our license agreement for our proprietary Route 66 apparel line.
On September 25, 2002 the Court approved our motion allowing Kmart to
enter into a licensing agreement with Thalia for junior's and women's apparel,
jewelry and accessories.
Our key brand partners will continue to be a key element in our
merchandising and marketing initiatives. As a result, a decline in the demand
for our key brands or their failure to achieve or maintain broad market
acceptance, could have a material effect on our results of operations.
Penske
On April 9, 2002, we reached an agreement with Penske Corporation,
Penske Auto Centers, Inc., and Penske Auto Centers, LLC (collectively "Penske")
whereby all parties would work together to achieve an orderly wind-down of
operations at auto service centers at more than 563 Kmart stores in 44 states
following Penske's unilateral decision to close the business as of April 6,
2002. This matter has not had a material adverse effect on our liquidity,
financial position or results of operations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At October 30, 2002, we did not have any derivative instruments that
increased our exposure to market risks for interest rates, foreign currency
rates, commodity prices or other market price risks. We do not use derivatives
for speculative purposes. Currently, our exposure to market risks result
primarily from changes in interest rates, principally with respect to the DIP
Credit Facility, which is a variable rate financing agreement. We do not use
swaps or other interest rate protection agreements to hedge this risk.
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ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the date of filing this report, we
carried out an evaluation, under the supervision of our recently formed
management Disclosure Committee (which includes the Chief Executive Officer and
the Chief Financial Officer) of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Exchange Act Rules 13a-14 and
15d-14. Based upon this evaluation, the Chief Executive Officer and the Chief
Financial Officer concluded that our disclosure controls and procedures are
effective to ensure that information required to be disclosed in our periodic
SEC reports is recorded, processed, summarized, and reported as and when
required.
As discussed earlier in this Quarterly Report on Form 10-Q, we have
implemented changes to our business processes to address the issues described
herein that were identified in connection with the preparation of the financial
statements contained herein. Specifically, we have implemented manual procedures
to ensure that our invoice accruals for a significant vendor are properly
recorded until we are able to implement a programmatic change to the logic of
our accounts payable invoice accrual program. Also, we have implemented
additional management review procedures relative to all new property leases or
amendments to such leases. We do not consider these corrective actions to be
taken as a result of significant deficiencies or material weaknesses in our
internal control structure.
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PART II. OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As a result of its Chapter 11 filing, Kmart has not made principal or
interest payments on unsecured indebtedness incurred prior to January 22, 2002.
In addition, Kmart is not permitted to pay dividends on its trust convertible
preferred securities. The dividend arrearage on the trust convertible securities
from December 18, 2001 through October 30, 2002 is approximately $52. Interest
at the stated contractual amount on unsecured debt that was not charged to
results of operations for the 13 and 39 week periods ended October 30, 2002 was
approximately $67 and $204, respectively.
ITEM 5. OTHER INFORMATION
Since the filing of its Quarterly Report on Form 10-Q for the period
ended July 31, 2002, the employment of Randy L. Allen was terminated, effective
October 7, 2002. Ms. Allen had assumed the role of Senior Vice President,
Strategic Planning and Business Initiatives effective July 15, 2002 and
previously served as Executive Vice President, Strategic Initiatives and Chief
Diversity Officer. Kmart has notified Ms. Allen that it is reserving the right
to determine its rights and obligations in connection with the termination of
Ms. Allen's employment.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as a part of this report:
Exhibit 99.1 - CEO Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 99.2 - CFO Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K: We filed the following Current Reports on Form 8-K
with the SEC during the 13 weeks ended October 30, 2002:
1. September 16, 2002 - Monthly Operating Report for the period
from June 27, 2002 to July 31, 2002, as filed with the
Bankruptcy Court.
2. September 16, 2002 - Monthly Operating Report for the period
from August 1, 2002 to August 28, 2002, as filed with the
Bankruptcy Court.
3. October 21, 2002 - Monthly Operating Report for the period
from August 29, 2002 to September 25, 2002, as filed with the
Bankruptcy Court.
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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.
The signatory hereby acknowledges and adopts the typed form of his/her name in
the electronic filing of this document with the Securities and Exchange
Commission.
Date: December 23, 2002
Kmart Corporation
---------------------------------------------------
(Registrant)
By: /s/ James B. Adamson
---------------------------------------------------
James B. Adamson
CHAIRMAN OF THE BOARD AND CHIEF
EXECUTIVE OFFICER
(Principal Executive Officer)
/s/ A. A. Koch
---------------------------------------------------
A. A. Koch
CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
/s/ Richard J. Noechel
---------------------------------------------------
Richard J. Noechel
VICE PRESIDENT AND
CONTROLLER
(Principal Accounting Officer)
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CERTIFICATIONS
CEO Certification
I, James B. Adamson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kmart Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in the
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 23, 2002 /s/ James B. Adamson
-------------------------
James B. Adamson
Chairman of the Board and
Chief Executive Officer
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CFO Certification
I, Albert A. Koch, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kmart Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in the
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 23, 2002 /s/ Albert A. Koch
-----------------------
Albert A. Koch
Chief Financial Officer
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10-Q EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
EX-99.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
EX-99.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
52