SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
X QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2001
----------------
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
-----
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 October 31, 2001, 498,416,655 shares of Common Stock of Kmart Corporation
were outstanding.
1
INDEX
PART I FINANCIAL INFORMATION PAGE
- ------ --------------------- ----
Item 1. Financial Statements
Consolidated Statements of Operations-- 4
13 and 39 weeks ended October 31, 2001 (restated) and
October 25, 2000
Consolidated Balance Sheets-- 5
October 31, 2001 (restated), October 25, 2000 and
January 31, 2001
Consolidated Statements of Cash Flows-- 6
39 weeks ended October 31, 2001 (restated) and
October 25, 2000
Notes to Consolidated Financial Statements 7-14
Item 2. Management's Discussion and Analysis of Results of 15-25
Operations and Financial Condition
PART II OTHER INFORMATION
- ------- -----------------
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
2
Explanatory Statement
On January 22, 2002 ("Petition Date"), subsequent to the initial filing
of our Quarterly Report on Form 10-Q for the 13 and 39 weeks ended October 31,
2001, Kmart and 37 of its U.S. subsidiaries 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"). The reorganization is being jointly administered
under the caption "In re Kmart Corporation, et al. Case No. 02 B 02474." 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, 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 recent 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 this time, it is not possible to predict the effect of the Chapter
11 reorganization on our business, various creditors and security holders or
when we will be able to exit Chapter 11. Our future results are dependent upon
our confirming and implementing, on a timely basis, a plan of reorganization. A
more detailed description of the bankruptcy filing and its effect on Kmart is
set forth in Kmart's Annual Report on Form 10-K for the fiscal year ended
January 30, 2002 filed with the Securities Exchange Commission ("SEC") on May
15, 2002.
Given our bankruptcy filing in the fourth quarter, the increased
uncertainty relating to vendor rebates and allowances ("allowances") and the
corresponding difficulty in reliably estimating such amounts in the future, we
concluded that it would be preferable to change our accounting method for
interim recognition of such cost recoveries from vendors. Under the new
methodology, Kmart will recognize a cost recovery from vendors only when a
formal agreement for such amount has been obtained and the underlying activity
for which the amount was provided has been performed. This change in methodology
does not affect the results that otherwise would have been reported for the full
fiscal year, but rather affects the interim recognition of allowances during the
year. We believe this new method is preferable because it provides higher
precision, better verifiability, reduced reliance on estimates and is consistent
with an analogous application of Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements." While this change in method was adopted in
the fourth quarter of fiscal 2001, generally accepted accounting principles
require the restatement of the first three quarters of fiscal 2001 to reflect
this change.
Additionally, in January 2002, Kmart announced that we had received an
anonymous letter sent to the SEC, our auditors and directors expressing concern
with respect to various matters. Accordingly, the Board of Directors 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. Based on the results of the investigation to date, as well
as the results of our new management team's review of Kmart's accounting
policies and methods, we concluded that (1) an adjustment should be made with
respect to the accounting for up-front consideration in a transaction from a
vendor which more appropriately should have been deferred and recognized over
the life of the contract and (2) the recording of additional general liability
reserves in the fourth quarter was more appropriately designated as a second
quarter event.
Our financial statements for the 13 and 39 weeks ended October 31, 2001
have been restated herein to reflect the change in accounting method and the
foregoing adjustments. The pro forma effect of the change in accounting method
on the financial statements for the 13 and 39 weeks ended October 25, 2000 is
also presented herein.
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KMART CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
13 WEEKS ENDED 39 WEEKS ENDED
----------------------------- -----------------------------
OCTOBER 31, OCTOBER 31,
2001 2001
(RESTATED, OCTOBER 25, (RESTATED, OCTOBER 25,
SEE NOTE 1) 2000 SEE NOTE 1) 2000
----------- ----------- ------------ -------------
Sales $ 8,019 $ 8,199 $ 25,273 $ 25,392
Cost of sales, buying and occupancy 6,434 6,518 20,521 20,530
----------- ----------- ------------ -------------
Gross margin 1,585 1,681 4,752 4,862
Selling, general and administrative expenses 1,826 1,697 5,566 5,379
Charges for BlueLight.com and other 5 -- 120 --
----------- ----------- ------------ -------------
Loss before interest, income taxes and dividends
on convertible preferred securities of subsidiary trust (246) (16) (934) (517)
Interest expense, net 96 71 267 205
Income tax benefit (118) (31) (390) (263)
Dividends on convertible preferred securities of subsidiary
trust, net of income taxes of $6, $6, $18 and $18,
respectively 11 11 34 34
----------- ----------- ------------ -------------
Net loss $ (235) $ (67) $ (845) $ (493)
=========== =========== ============ =============
Basic/Diluted loss per common share $ (0.47) $ (0.14) $ (1.72) $ (1.00)
=========== =========== ============ =============
Basic/Diluted weighted average shares (millions) 497.8 482.1 492.4 481.9
Pro forma amounts assuming the new accounting policy
was applied retroactively:
Net loss $ (235) $ (143) $ (845) $ (764)
=========== =========== ============ =============
Basic/Diluted loss per common share $ (0.47) $ (0.29) $ (1.72) $ (1.56)
=========== =========== ============ =============
See accompanying Notes to Consolidated Financial Statements.
4
KMART CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
-------------------------------
OCTOBER 31,
2001
(RESTATED, OCTOBER 25, JANUARY 31,
SEE NOTE 1) 2000 2001
---------------- ------------- ---------------
Current Assets:
Cash and cash equivalents $ 366 $ 285 $ 401
Merchandise inventories 8,318 7,878 6,412
Other current assets 730 909 939
---------------- ------------- ---------------
Total current assets 9,414 9,072 7,752
Property and equipment, net 6,968 6,481 6,557
Other assets and deferred charges 483 487 523
---------------- ------------- ---------------
Total Assets $ 16,865 $ 16,040 $ 14,832
================ ============= ===============
Current Liabilities:
Long-term debt due within one year $ 478 $ 295 $ 68
Trade accounts payable 3,686 2,555 2,159
Accrued payroll and other liabilities 1,131 1,515 1,587
Taxes other than income taxes 271 267 187
---------------- ------------- ---------------
Total current liabilities 5,566 4,632 4,001
Long-term debt and notes payable 3,310 2,835 2,084
Capital lease obligations 881 956 943
Other long-term liabilities 865 911 834
Company obligated mandatorily redeemable convertible preferred
securities of a subsidiary trust holding solely 7 3/4% convertible
junior subordinated debentures of Kmart (redemption value
$898, $898 and $898, respectively) 890 886 887
Common stock, $1 par value, 1,500,000,000 shares authorized;
498,416,655, 483,391,211 and 486,509,736 shares outstanding,
respectively 498 483 487
Capital in excess of par value 1,682 1,567 1,578
Retained earnings 3,173 3,770 4,018
---------------- ------------- ---------------
Total Liabilities and Shareholders' Equity $ 16,865 $ 16,040 $ 14,832
================ ============= ===============
See accompanying Notes to Consolidated Financial Statements.
5
KMART CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
39 WEEKS ENDED
-------------------------------------
OCTOBER 31,
2001
(RESTATED, OCTOBER 25,
SEE NOTE 1) 2000
------------------ ----------------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss from continuing operations $ (845) $ (493)
Adjustments to reconcile net loss from continuing operations
to net cash used for operating activities:
Restructuring, impairments and other charges 268 728
Depreciation and amortization 618 584
Equity loss in unconsolidated subsidiaries 14 2
Dividends received from Meldisco 51 44
Cash used for store closings (90) (46)
Increase in inventories (1,901) (1,142)
Increase in trade accounts payable 1,586 525
Deferred income taxes and taxes payable (348) (357)
Changes in other assets 10 (134)
Changes in other liabilities 262 (34)
------------------ ----------------
Net cash used for continuing operations (375) (323)
Net cash used for discontinued operations (67) (75)
------------------ ----------------
Net cash used for operating activities (442) (398)
------------------ ----------------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures (1,084) (699)
Investment in BlueLight.com (45) (55)
------------------ ----------------
Net cash used for investing activities (1,129) (754)
------------------ ----------------
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from issuance of debt 1,887 1,366
Issuance of common shares 40 41
Purchase of convertible preferred securities of subsidiary trust - (84)
Purchase of common shares - (56)
Payments on debt (275) (61)
Payments on capital lease obligations (62) (58)
Payments of dividends on preferred securities of subsidiary trust (54) (55)
------------------ ----------------
Net cash provided by financing activities 1,536 1,093
------------------ ----------------
Net decrease in cash and cash equivalents (35) (59)
Cash and cash equivalents, beginning of year 401 344
------------------ ----------------
Cash and cash equivalents, end of period $ 366 $ 285
================== ================
See accompanying Notes to Consolidated Financial Statements.
6
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
1. RESTATEMENT OF FINANCIAL STATEMENTS
On January 22, 2002, subsequent to the initial filing of our Quarterly
Report on Form 10-Q for the 13 and 39 weeks ended October 31, 2001, Kmart
and 37 of its U.S. subsidiaries 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"). A more detailed discussion of our Chapter 11
filing is included in our Annual Report on Form 10-K for the fiscal year
ended January 30, 2002.
Given our bankruptcy filing in the fourth quarter, the increased
uncertainty relating to vendor rebates and allowances ("allowances") and the
corresponding difficulty in reliably estimating such amounts in the future,
we concluded that it would be preferable to change our accounting method for
interim recognition of such cost recoveries from vendors.
For interim reporting periods in fiscal 2000, as well as with respect to
the interim reporting periods in fiscal 2001 which were previously reported,
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 ("the plan") as determined by historical experience and
current understandings with our vendors. These amounts were supplemented by
allowances obtained that were not contemplated in such plan. While many
agreements are finalized throughout the year, significant activity occurs in
the fourth quarter to finalize outstanding agreements and collect
allowances.
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. This change
in methodology does not affect the results that otherwise would have been
reported for the full fiscal year, but rather affects the interim
recognition of allowances during the year. We believe this new method is
preferable because it provides higher precision, better verifiability,
reduced reliance on estimates and is consistent with an analogous
application of Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements."
Embedded in the accounting change that gives effect to the change in
interim financial reporting for allowances is an adjustment for an
indeterminate amount of supplemental or "incremental" allowances that were
initially recorded in the first three quarters of fiscal 2001 prior to
having been documented, or otherwise deemed appropriate, pursuant to our
historical policy. Kmart concluded that it is not practicable to determine
the impact on prior quarters. It should be noted, however, that the restated
interim information reflects such allowances only to the extent they are
supported by formal agreements or otherwise deemed appropriate in the
quarter recognized.
Additionally, in January 2002, Kmart announced that we had received an
anonymous letter sent to the Securities and Exchange Commission ("SEC"), our
auditors and directors expressing concern with respect to various matters.
Accordingly, the Board of Directors 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. Based on the results of the investigation to date, as well as the
results of our new management team's review of Kmart's accounting policies
and methods, we concluded that (1) an adjustment should be made with respect
to up-front consideration in a single transaction from a vendor which more
appropriately should have been deferred and recognized over the life of the
contract and (2) the recording of additional general liability reserves in
the fourth quarter was more appropriately designated as a second quarter
event. Accordingly, adjustments were made for such transactions, including
restatements of previously reported quarterly financial statements for
fiscal 2001.
Our financial statements for the 13 and 39 weeks ended October 31, 2001
have been restated to reflect the change in accounting method and the
foregoing adjustments. The pro forma effect of the change in accounting
method on the financial statements for the 13 and 39 weeks ended October 25,
2000 is also presented herein.
7
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
The following table illustrates the effects of the accounting change
and adjustments on the financial statements for the 13 and 39 weeks ended
October 31, 2001.
13 Weeks Ended October 31, 2001
--------------------------------------------------------------------------------
Adjustments
------------------------------
Change in
As previously Up-front General accounting
reported consideration liability method As restated
--------------------------------------------------------------------------------
Sales $8,019 $0 $0 $0 $8,019
Cost of sales, buying and
occupancy $6,425 ($15) $0 $24 $6,434
--------------- ---------------- ------------- ---------------- ----------------
Gross margin $1,594 $15 $0 ($24) $1,585
Selling, general and
administrative expenses $1,818 $0 $0 $8 $1,826
Operating (loss) income ($229) $15 $0 ($32) ($246)
Net (loss) income ($224) $10 $0 ($21) ($235)
================================================================================
Basic/Diluted (loss) earnings per
common share ($0.45) $0.02 $0 ($0.04) ($0.47)
================================================================================
39 Weeks Ended October 31, 2001
--------------------------------------------------------------------------------
Adjustments
------------------------------
Change in
As previously Up-front General accounting
reported consideration liability method As restated
--------------------------------------------------------------------------------
Sales $25,273 $0 $0 $0 $25,273
Cost of sales, buying and
occupancy $20,091 $27 $0 $403 $20,521
--------------------------------------------------------------------------------
Gross margin $5,182 ($27) $0 ($403) $4,752
Selling, general and
administrative expenses $5,248 $0 $167 $151 $5,566
Operating loss ($186) ($27) ($167) ($554) ($934)
Net loss ($344) ($18) ($112) ($371) ($845)
================================================================================
Basic/Diluted loss per common
share ($0.70) ($0.04) ($0.23) ($0.75) ($1.72)
================================================================================
2. BASIS OF PRESENTATION
These interim unaudited consolidated financial statements have been
prepared in accordance with the rules and regulations of the SEC, and, in
the opinion of management, reflect all adjustments (which include normal
recurring adjustments) necessary for a fair statement of the results for
the interim periods. These consolidated financial statements should be read
in conjunction with the financial statements and the notes thereto included
in our Annual Report on Form 10-K filed for the fiscal year ended January
31, 2001.
Certain reclassifications of prior period financial statements have
been made to conform to the current year presentation.
8
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
3. LOSS PER SHARE
13 Weeks Ended 39 Weeks Ended
---------------------------- ----------------------------------
October 31, October 31,
2001 2001
(Restated, October 25, (Restated, October 25,
see Note 1) 2000 see Note 1) 2000
-------------- ------------ -------------- -------------
Net Loss $ (235) $ (67) $ (845) $ (493)
Add: Discount on redemption of
preferred securities, net - 1 - 10
Adjusted net loss available to
common shareholders $ (235) $ (66) $ (845) $ (483)
Basic/Diluted weighted average
shares (millions) 497.8 482.1 492.4 481.9
============= ============ ============== ==============
Basic/Diluted loss per common share $ (0.47) $ (0.14) $ (1.72) $ (1.00)
============= ============ ============== ==============
In each period, certain outstanding stock options were excluded from
the computation of diluted earnings per share because they would have been
anti-dilutive. As of October 31, 2001, options to purchase 58.8 million
shares of common stock at prices ranging from $5.34 to $26.03 were excluded
from the 13 and 39 week calculations. As of October 25, 2000, options to
purchase 46.8 million shares of common stock at prices ranging from $5.34
to $26.03 were excluded from the 13 and 39 week calculations. The
calculations also exclude the effect of trust convertible preferred
securities and written put options. For the 13 and 39 week periods ended
October 31, 2001, diluted shares outstanding exclude approximately 59.9
million common shares from potential conversion of certain trust
convertible preferred securities due to their anti-dilutive effect. For the
13 and 39 week periods ended October 25, 2000, diluted shares outstanding
exclude approximately 60.2 million and 61.3 million common shares,
respectively, from potential conversion of certain trust convertible
preferred securities due to their anti-dilutive effect. For the 39 week
period ended October 25, 2000, diluted shares outstanding exclude
approximately 0.5 million common shares from the potential conversion of
written put options due to their anti-dilutive effect.
4. 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
consolidated financial statements. Inventories valued on LIFO at October
31, 2001, October 25, 2000 and January 31, 2001 were $194, $202 and $194
lower, respectively, than the amounts that would have been reported under
the first-in, first-out method.
5. INTEREST INCOME
Interest income is included in the line Interest expense, net in the
Consolidated Statements of Operations. For the 13 week periods ended
October 31, 2001 and October 25, 2000 interest income was $1 and $8,
respectively. For the 39 week periods ended October 31, 2001, and October
25, 2000 interest income was $3 and $15, respectively.
9
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
6. RESTRUCTURINGS
SUPPLY CHAIN OPERATIONS
On September 6, 2001 we announced that we would restructure 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. Completion of these actions is expected by the end
of the second quarter of 2002. In conjunction with these actions, we will
record special charges totaling $189 ($120 after-tax), of which $148 ($94
after-tax) is recorded in the third quarter.
We recorded a $92 charge related to the planned disposal of supply chain
software and hardware and other assets that will no longer be utilized, in
accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of." As certain components of our supply chain
software will continue to be utilized until replaced, depreciation will be
accelerated to reflect the revised useful lives and these assets will be
fully-amortized by mid-2002. In the third quarter we recorded a charge of $9
related to the accelerated depreciation on these assets. The expected
incremental depreciation aggregates $14 in the fourth quarter of 2001, and
$27 in 2002. Subsequent to the initial filing of this Form 10-Q, we early
adopted the provisions of SFAS No. 144, "Accounting for the Impairment and
Disposal of Long-Lived Assets," retroactively for all periods in 2001. The
charge described herein was not affected by this retroactive adoption.
A $47 charge was provided for lease terminations and contractual
employment obligations for staff reductions of 956 employees at our
distribution centers in accordance with EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The
majority of the employees will be severed in the fourth quarter of fiscal
year 2001, with the remaining employees severed in the first quarter of
fiscal year 2002. No costs were paid and charged against the reserve during
the quarter.
The following table summarizes the significant components and
presentation, in the Consolidated Statements of Operations, of the charge
for the restructuring of our supply chain operations during the third
quarter of 2001.
Cost of
sales,
buying and
occupancy SG&A Total
-------------- ------------- --------------
Lease obligations $ 37 $ - $ 37
Accelerated depreciation of software 9 - 9
Asset impairment 5 87 92
Contractual employment obligations 10 - 10
-------------- ------------- --------------
Total $ 61 $ 87 $ 148
============== ============= ==============
10
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
BLUELIGHT.COM
We recorded a $92 charge ($73 after-tax) related to our e-commerce
site, BlueLight.com, in the second quarter, comprised of $41 for the impairment
of our investment in BlueLight.com and $51 for the restructuring of our
e-commerce business. These charges are included in the line Charges for
BlueLight.com and other in the Consolidated Statements of Operations.
Based upon the changed environment for internet businesses, in which
the ability for internet businesses to raise capital became 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 by acquiring the remaining 40% interest in BlueLight.com, LLC, 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 the subsequent steps of our 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 a $41 charge to write-down our investment in BlueLight.com
to estimated fair value in accordance with SFAS No. 121. Fair value was
estimated using the present value of estimated future cash flows.
In conjunction with the transaction, the return of capital puts 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,
previously disclosed, were terminated. The $62.5 liability for the return of
capital puts, recorded due to the 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 have not been
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.
121. 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, we continued executing our restructuring
plan, including formally communicating to 114 employees at the BlueLight.com
headquarters expected severance dates and the severance benefit amount they will
receive when they are terminated. In conjunction with this communication, we
recorded an additional $5 ($3 after-tax) charge to provide for these costs.
These charges are included in the line Charges for BlueLight.com and other in
the Consolidated Statements of Operations. Seventy-three employees were
terminated during the quarter.
We also outsourced the hosting of our site, fulfillment of e-commerce
orders and all related customer service. We have substantially completed our
restructuring plan and expect to accomplish the remaining steps in the fourth
quarter of this year.
Subsequent to the initial filing of this Quarterly Report on Form 10-Q,
we early adopted the provisions of SFAS No. 144, "Accounting for the Impairment
and Disposal of Long-Lived Assets," retroactively for all periods in 2001. The
charge described herein was not affected by this retroactive adoption.
11
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The following table provides information regarding liabilities
established during the 39 week periods ending October 31, 2001 and October 25,
2000, with respect to the fiscal year 2000 strategic actions charge, the fiscal
year 2001 BlueLight.com restructuring charge and the fiscal year 2001 supply
chain restructuring charge. The liabilities aggregated $213 and $288 at October
31, 2001 and October 25, 2000, respectively.
39 Weeks Ended
----------------------------------------------------------------
October 31, October 25,
2001 2000
----------------------------------------------- -----------
2001 2001 2000 2000
Supply BlueLight Strategic Strategic
Chain .com Actions Total Actions
----- ---- ------- ----- -------
Balance, beginning of period $ -- $ -- $177 $177 $ --
Additions charged to earnings:
Second quarter -- 92 -- 92 740
Third quarter 148 5 -- 153 --
---- ---- ---- ---- ----
Total Additions 148 97 -- 245 740
Reductions:
Cash payments:
Lease obligations -- 1 31 32 --
Employee costs -- 3 -- 3 --
Contractual obligations -- 2 -- 2 --
Other costs -- 1 -- 1 --
Non-cash reductions:
Adjustments -- -- -- -- 12
Asset writedowns 101 70 -- 171 440
---- ---- ---- ---- ----
Balance, end of period $ 47 $ 20 $146 $213 $288
==== ==== ==== ==== ====
7. OTHER CHARGES
During the first quarter of 2001, we realigned our organization and
reduced our workforce 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 May 2, 2001 in the line item Charge for employee severance and VERP.
Of the charge, $19 was reserved for and will be paid out of our general
corporate assets, the remaining $4 will be paid out of the Kmart Employee
Pension Plan. The charge relates 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. Our first quarter cash payments in fiscal 2001 associated with these
actions were $9.
12
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
8. COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income represents net (loss) income, adjusted for
the effect of other items that are recorded directly to shareholders'
equity. Net (loss) income and comprehensive (loss) income are equivalent for
all periods presented.
9. EFFECTIVE TAX RATE
The effective tax benefit rates for the 13 and 39 week periods ended
October 31, 2001, as restated, were 34.5% and 32.5%, respectively. In 2001,
the actual tax benefit rates are lower than the statutory rate due to the
preclusion of recording certain tax benefits related to our acquisition of
the remaining interest in BlueLight.com.
10. INVESTMENTS IN AFFILIATED RETAIL COMPANIES
MELDISCO
For the 13 week period ended October 31, 2001, Meldisco had net sales
of $293, gross profit of $138 and net income of $22. For the 13 week period
ended October 25, 2000, Meldisco had net sales of $305, gross profit of $144
and net income of $23.
For the 39 week period ended October 31, 2001, Meldisco had net sales
of $904, gross profit of $434 and net income of $69. For the 39 week period
ended October 25, 2000, Meldisco had net sales of $946, gross profit of $448
and net income of $72.
BLUELIGHT.COM
For the 13 week period ended October 25, 2000, BlueLight.com had net
sales of $2, no gross profit and a net loss of $21.
For the period from February 1, 2001 to July 31, 2001, BlueLight.com
had net sales of $8, gross profit of $1 and a net loss of $55. For the 39
week period ended October 25, 2000, BlueLight.com had net sales of $3, gross
profit of $1 and a net loss of $58.
BlueLight.com's operations were fully consolidated into our financial
statements commencing July 31, 2001.
11. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," effective for all business combinations initiated after June
30, 2001. This statement also applies to all business combinations accounted
for using the purchase method for which the date of acquisition is July 1,
2001 or thereafter. Also, in June 2001, the FASB issued SFAS No. 142,
"Goodwill and Other Intangible Assets," and SFAS No. 143, "Accounting for
Asset Retirement Obligations," effective for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 141 and SFAS No. 142 are not
expected to have a material impact on our earnings or financial position. We
are currently assessing the impact that the application of the provisions of
SFAS No. 143 will have on our Consolidated Financial Statements. In August
2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," effective for fiscal years beginning after
December 15, 2001. Subsequent to the initial filing of this Quarterly Report
on Form 10-Q, we early adopted the provisions of SFAS No. 144. There was no
effect on the financial statements for the 13 and 39 weeks ended October 31,
2001.
13
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
12. SHARE REPURCHASE PROGRAMS
In July 2001, we terminated the common stock repurchase program that
was initiated in April 1999. Under the program we repurchased approximately
22 million shares of common stock during 1999 and 2000 at a cost of
approximately $255. We also terminated the trust convertible preferred
securities repurchase program that was initiated in February 2000. Under the
program we repurchased approximately 2 million shares of trust convertible
securities at a cost of approximately $84.
13. OTHER COMMITMENTS AND CONTINGENCIES
LEASE GUARANTEES
As of October 31, 2001, we had outstanding guarantees for real property
leases of certain former subsidiaries as follows:
Present Value of Gross Future
Future Lease Lease
Obligations @ 7% Obligations
----------------- -----------
The Sports Authority, Inc. $188 $318
Borders Group, Inc. 90 153
OfficeMax, Inc. 69 101
---- ----
Total $347 $572
==== ====
Kmart's contingent obligation is dependent on the future operating
results of the guarantees and is subject to settlement under a plan of
reorganization to be voted upon by the creditors and equity holders and
approved by the court. Should a reserve be required, it would be recorded
at the time the obligation was determined to be both probable and estimable.
Our rights and obligations with respect to our guarantee of The Sports
Authority, Inc., OfficeMax, Inc., and Borders Group, Inc. leases are
governed by Lease Guaranty, Indemnification and Reimbursement Agreements
dated as of November 23, 1994, November 9, 1994 and May 24, 1995,
respectively, as amended from time to time.
OTHER
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. The Company assesses the likelihood of potential
losses on an ongoing basis and when they are considered probable and
reasonably estimable, records 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.
14
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
ITEM 2.
CHANGE IN ACCOUNTING POLICY AND OTHER ADJUSTMENTS
Given our bankruptcy filing in the fourth quarter, the increased
uncertainty relating to vendor rebates and allowances ("allowances") and the
corresponding difficulty in reliably estimating such amounts in the future, we
concluded that it would be preferable to change our accounting method for
interim recognition of such cost recoveries from vendors. Under the new
methodology, Kmart will recognize a cost recovery from vendors only when a
formal agreement for such amount has been obtained and the underlying activity
for which the amount was provided has been performed. This change in methodology
does not affect the results that otherwise would have been reported for the full
fiscal year, but rather affects the interim recognition of allowances during the
year. We believe this new method is preferable because it provides higher
precision, better verifiability, reduced reliance on estimates and is consistent
with an analogous application of Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements." While this change in method was adopted in
the fourth quarter of fiscal 2001, generally accepted accounting principles
require the restatement of the first three quarters of fiscal 2001 to reflect
this change.
Embedded in the accounting change that gives effect to the change in
interim financial reporting for allowances is an adjustment for an indeterminate
amount of supplemental or "incremental" allowances that were initially recorded
in the first three quarters of fiscal 2001 prior to having been documented, or
otherwise deemed appropriate, pursuant to our historical policy. Kmart concluded
that it is not practicable to determine the impact on prior quarters. It should
be noted, however, that the restated interim information reflects such
allowances only to the extent they are supported by formal agreements or
otherwise deemed appropriate in the quarter recognized.
Additionally, in January 2002, Kmart announced that we had received an
anonymous letter sent to the Securities and Exchange Commission ("SEC"), our
auditors and directors expressing concern with respect to various matters.
Accordingly, the Board of Directors 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.
Based on the results of the investigation to date, as well as the
results of our new management team's review of Kmart's accounting policies and
methods, we concluded that (1) an adjustment should be made with respect to the
accounting for up-front consideration in a transaction from a vendor which more
appropriately should have been deferred and recognized over the life of the
contract and (2) the recording of additional general liability reserves in the
fourth quarter was more appropriately designated as a second quarter event.
Accordingly, adjustments were made for such transactions, including restatements
of previously reported quarterly financial statements for fiscal 2001 as
reflected herein.
15
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
The following tables illustrate the effects of the accounting change
and adjustments on the financial statements for the 13 and 39 weeks ended
October 31, 2001.
13 Weeks Ended October 31, 2001
-------------------------------------------------------------------------------------
Adjustments
------------------------------
Change in
As previously Up-front General accounting
reported consideration liability method As restated
-------- ------------- --------- ------ -----------
Sales $ 8,019 $ 0 $ 0 $ 0 $ 8,019
Cost of sales, buying and occupancy
$ 6,425 ($ 15) $ 0 $ 24 $ 6,434
-------- -------- -------- -------- --------
Gross margin $ 1,594 $ 15 $ 0 ($ 24) $ 1,585
Selling, general and
administrative expenses $ 1,818 $ 0 $ 0 $ 8 $ 1,826
Operating (loss) income ($ 229) $ 15 $ 0 ($ 32) ($ 246)
Net (loss) income ($ 224) $ 10 $ 0 ($ 21) ($ 235)
======== ======== ======== ======== ========
Basic/Diluted (loss) earnings
per common share ($ 0.45) $ 0.02 $ 0 ($ 0.04) ($ 0.47)
======== ======== ======== ======== ========
39 Weeks Ended October 31, 2001
-------------------------------------------------------------------------------------
Adjustments
------------------------------
Change in
As previously Up-front General accounting
reported consideration liability method As restated
-------- ------------- --------- ------ -----------
Sales $ 25,273 $ 0 $ 0 $ 0 $ 25,273
Cost of sales, buying and occupancy $ 20,091 $ 27 $ 0 $ 403 $ 20,521
-------- -------- -------- -------- --------
Gross margin $ 5,182 ($ 27) $ 0 ($ 403) $ 4,752
Selling, general and
administrative expenses $ 5,248 $ 0 $ 167 $ 151 $ 5,566
Operating loss ($ 186) ($ 27) ($ 167) ($ 554) ($ 934)
Net loss ($ 344) ($ 18) ($ 112) ($ 371) ($ 845)
======== ======== ======== ======== ========
Basic/Diluted loss per
common share ($ 0.70) ($ 0.04) ($ 0.23) ($ 0.75) ($ 1.72)
======== ======== ======== ======== ========
16
KMART CORPORATION
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
The following table segregates operating (loss) income excluding
non-comparable items from operating loss as reported in the Consolidated
Statements of Operations. Information is also provided concerning the pro forma
effect of the change in accounting method on the comparable periods in fiscal
year 2000.
13 WEEKS 39 WEEKS
----------------------------------------------- -----------------------------------------------
OCTOBER 31, OCTOBER 25, OCTOBER 31, OCTOBER 25,
2001 OCTOBER 25, 2000 2001 OCTOBER 25, 2000
(as restated) 2000 (pro forma) (as restated) 2000 (pro forma)
-------------- -------------- --------------- -------------- -------------- --------------
Sales $ 8,019 $ 8,199 $ 8,199 $ 25,273 $ 25,392 $ 25,392
Cost of sales,
buying and occupancy 6,373 6,518 6,595 20,460 20,165 20,441
-------- -------- -------- -------- -------- --------
Gross margin 1,646 1,681 1,604 4,813 5,227 4,951
Selling, general and
administrative 1,739 1,709 1,745 5,479 5,016 5,143
-------- -------- -------- -------- -------- --------
Operating (loss) income
excluding non-comparable
items (93) (28) (141) (666) 211 (192)
Charge for supply chain
restructuring 148 -- -- 148 -- --
Charge for BlueLight.com 5 -- -- 97 -- --
Charge for employee
severance and VERP -- -- -- 23 -- --
Strategic actions -- (12) (12) -- 728 728
-------- -------- -------- -------- -------- --------
Operating loss $ (246) $ (16) $ (129) $ (934) $ (517) $ (920)
======== ======== ======== ======== ======== ========
Same-store sales % (1.5%) 1.4% 1.4% 0.4% 0.7% 0.7%
Net loss per share
including non-comparable
items $ (0.47) $ (0.14) $ (0.29) $ (1.72) $ (1.00) $ (1.56)
======== ======== ======== ======== ======== ========
The information set forth below relating to Gross margin; Selling,
general and administrative expenses; and Operating loss compares restated
results for fiscal year 2001 with results, prepared on a pro forma basis giving
effect to the change in accounting method, for the comparable periods in fiscal
year 2000.
SALES for the 13 weeks ended October 31, 2001 were $8,019, a decrease
of 2.2% from sales of $8,199 for the 13 weeks ended October 25, 2000. Sales for
the 39 weeks ended October 31, 2001 were $25,273, a decrease of 0.5% from sales
of $25,392 for the 39 weeks ended October 25, 2000. The decrease in total sales
is due in part to the reduction in the number of Kmart stores from 2,163 at
October 25, 2000 to 2,113 at October 31, 2001. Same-store sales decreased 1.5%
for the 13 week period ended October 31, 2001 and increased 0.4% for the 39 week
period ended October 31, 2001. The decrease in same-store sales for the 13 weeks
ended October 31, 2001 is due primarily to the effect of prior year clearance
sales of discontinued merchandise, the deflationary effect of our BlueLight
Always program, under which we lowered prices on approximately 30,000
high-frequency items, and fewer sales transactions due to reduced promotional
activity. Same-store sales include sales of all stores open, that have been open
for greater than 13 full months.
Divisions showing particular strength on a year-to-date basis included
pharmacy, beauty and health care, home entertainment and food and consumables.
We opened 16 stores and closed 8 stores during the 39 weeks ended October 31,
2001.
17
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
GROSS MARGIN increased $42 to $1,646, for the 13 weeks ended October
31, 2001, from $1,604 for the 13 weeks ended October 25, 2000. Gross margin, as
a percentage of sales, was 20.5% and 19.6% for the 13 weeks ended October 31,
2001 and October 25, 2000, respectively. The increase in gross margin is
primarily attributable to an increase in vendor allowances, unfavorable prior
year distribution center physical inventory results, and lower food and
consumables distribution costs under our arrangement with Fleming, partially
offset by lower margin attributable to the BlueLight Always program, and an
increase in sales, as a percentage of total sales, of food and consumables,
which carry a lower margin.
For the 39 week period ended October 31, 2001, gross margin decreased
$138 to $4,813 from $4,951 for the 39 week period ended October 25, 2000. Gross
margin, as a percentage of sales, was 19.0% and 19.5% for the 39 week periods
ended October 31, 2001 and October 25, 2000, respectively. The decrease in gross
margin is attributable to the pricing effects of our BlueLight Always program
and an increase in sales, as a percentage of total sales, of food and
consumables, which carry a lower margin, partially offset by an increase in
vendor allowances, reduced store shrinkage, unfavorable prior year distribution
center physical inventory results and lower distribution costs under our
arrangement with Fleming.
The pro forma effect of the change in accounting on the interim results
for fiscal year 2000 was to increase cost of goods sold by $77 and $276 for the
13 and 39 weeks ended October 25, 2000, respectively, and, thereby, reduce Gross
margin, as a percentage of sales, from 20.5% to 19.6% for the 13 week period
ended October 25, 2000 and from 20.6% to 19.5% for the 39 week period ended
October 25, 2000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") decreased $6 for
the 13 weeks ended October 31, 2001 to $1,739, or 21.7% of sales, from $1,745,
or 21.3% of sales, for the 13 weeks ended October 25, 2000. The decrease in SG&A
primarily relates to a decrease in advertising, net of co-op allowances,
partially offset by wage rate increases and additional investment in store
labor.
SG&A expenses increased $336 for the 39 weeks ended October 31, 2001 to
$5,479, or 21.7% of sales, from $5,143, or 20.3% of sales, for the 39 weeks
ended October 25, 2000. The increase is due primarily to increased expenses for
general liability claims as reserves were increased in the second quarter of
fiscal year 2001 following significant analysis and actuarial studies, wage rate
increases, and additional investment in store labor and utility rate increases,
which were partially offset by reductions in advertising costs.
The pro forma effect of the change in accounting on the interim results
for fiscal year 2000 was to increase SG&A by $36 and $127 for the 13 and 39
weeks ended October 25, 2000, respectively.
OPERATING LOSS for the 13 weeks ended October 31, 2001 was $93, or 1.2%
of sales, as compared to an operating loss of $141, or 1.7% of sales, for the
same period of the prior year. The decrease in the loss is primarily due to
increased vendor allowances. For the 39 week period ended October 31, 2001,
operating loss was $666, or 2.6% of sales, as compared to $192, or 0.8% of
sales, for the comparable period of the previous year. The increase in the loss
for the 39 weeks ended October 31, 2001 is primarily related to the pricing
effects of our BlueLight Always program and an increase in sales, as a
percentage of total sales, of food and consumables, which carry a lower margin,
and increased expenses for general liability claims as reserves were increased
by approximately $167 in the second quarter of fiscal year 2001 following
significant analysis and actuarial studies.
NET INTEREST EXPENSE for the 13 weeks ended October 31, 2001 and
October 25, 2000 was $96 and $71, respectively. For the 39 week periods ended
October 31, 2001 and October 25, 2000, net interest expense was $267 and $205,
respectively. Net interest expense increased as a result of the issuance in
January 2001 of $400 of 9.375% Notes due January 2006, the issuance in June 2001
of $430 of 9 7/8% Notes due June 2008 and increased borrowings under our
Revolving Credit Agreement ("Revolver"). See "Liquidity and Financial
Condition."
18
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
LIQUIDITY AND FINANCIAL CONDITION
Our primary sources of working capital are cash flows from operations
and borrowings under our credit facilities. We had working capital of $3,849,
$4,440 and $3,751 at October 31, 2001, October 25, 2000 and January 31, 2001,
respectively. Working capital fluctuates in relation to profitability, seasonal
inventory levels net of trade accounts payable (net inventory) and the level of
store openings and closings. There were $1.46 billion borrowings outstanding
under our $1.60 billion Revolver at the end of the third quarter of fiscal 2001.
There were $1.37 billion borrowings outstanding under our existing credit
facilities at the end of the third quarter of fiscal 2000.
Net cash used for operating activities for the 39 weeks ended October
31, 2001 was $442 as compared to net cash used for operating activities of $398
for the same period in 2000. The increase in cash used for operating activities
as compared to the same period of the prior year was primarily the result of
lower net earnings, excluding non-comparable items, and higher inventory
purchases. Inventory increase by $1,906 during the first 39 weeks of fiscal year
2001 due to seasonal inventory fluctuations and actions taken to improve our
overall in-stock position.
Net cash used for investing activities was $1,129 for the 39 weeks
ended October 31, 2001 compared to $754 for the same period in 2000. The
increase in cash used for investing activities was primarily due to higher
capital expenditures for the expansion of Kmart stores to Kmart Super Centers,
construction of new Kmart Super Centers, expansion of midways to provide easier
traffic flow for our customers and to increase visibility of promotional items
and an investment in point-of-sale equipment.
Net cash provided by financing activities was $1,536 for the 39 weeks
ended October 31, 2001 compared to net cash provided by financing activities of
$1,093 for the comparable period in 2000. The increase in cash provided was
primarily the result of the issuance of $430 of 9 7/8% Notes due June 2008 and
increased borrowings under the Revolver partially offset by the pay down of $262
Collateralized Mortgage Backed Securities in July.
In July 2001, we terminated the common stock repurchase program that
was initiated in April 1999 and the trust convertible preferred securities
repurchase program initiated in February 2000. We repurchased approximately 22
million shares of common stock at a cost of approximately $55 and $200 in fiscal
years 2000 and 1999, respectively. Under the trust convertible preferred
securities repurchase program, we repurchased approximately 2 million shares of
trust convertible securities at a cost of approximately $84.
On November 15, 2001, we signed an agreement for the renewal of our unsecured
364-Day Credit Facility ("Facility") for the amount of $400. The Facility is
scheduled to fund concurrent with the expiration of the current facility on or
before December 2, 2001.
On January 22, 2002 ("Petition Date"), subsequent to the initial filing
of our Quarterly Report on Form 10-Q for the 13 and 39 weeks ended October 31,
2001, Kmart and 37 of its U.S. subsidiaries 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"). 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, 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 recent 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.
19
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
At this time, it is not possible to predict the effect of the Chapter
11 reorganization on our business, various creditors and security holders or
when we will be able to exit Chapter 11. Our future results are dependent upon
our confirming and implementing, on a timely basis, a plan of reorganization. A
more detailed description of the bankruptcy filing and its effect on the Company
is set forth in the Company's Annual Report on Form 10-K for the fiscal year
ended January 30, 2002.
SEASONALITY
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 cash flows
are generated in the fourth quarter. In preparation for the fourth quarter
holiday season, we significantly increase our merchandise inventories, which
traditionally have been financed by cash flows from operations, bank lines of
credit, trade credit and terms from vendors. Our profitability and cash flows
are primarily dependent upon the large sales volume generated during the fourth
quarter of our fiscal year.
DESCRIPTION OF NON-COMPARABLE ITEMS
During the first nine months of fiscal years 2000 and 2001, we have
instituted certain restructuring actions to improve our operations. These
actions are summarized below:
SUPPLY CHAIN OPERATIONS
On September 6, 2001 we announced that we would restructure certain
aspects of our supply chain operations. This restructuring program focuses on
the supply chain infrastructure, including the reconfiguration of our
distribution center ("DC") network and implementation of new operating software
across our supply chain. As a result of these actions, we recorded a pre-tax
charge of $148 during the third quarter of 2001.
Reconfiguration of the distribution center network entails the
replacement of two aging distribution centers with two state-of-the-art
facilities. The existing distribution centers are not properly fitted for
softline DC operations and require significant investment to upgrade. Replacing
the facilities will enable increased throughput and quicker inventory turns. In
addition, the distribution of slower-moving goods are being centralized at one
newly designated center, to improve efficiency across all other centers and
facilitate the expansion of our BlueLight Always campaign. During the third
quarter we recorded a pre-tax charge of $37 for a reserve for future lease
obligations related to the closing of the two aging distribution centers and a
$10 charge to provide for contractual employee obligations. These charges are
included in Cost of sales, buying and occupancy in the Consolidated Statements
of Operations. There were no reductions to the reserve during the third quarter.
We recorded an $87 charge for the disposal of computer equipment and software,
leasehold improvements and other assets that will no longer be utilized. These
charges are included in Selling, general and administrative expenses in the
Consolidated Statements of Operations. In addition, we recorded a $5 charge for
other supply chain assets which are included in Cost of sales, buying and
occupancy in the Consolidated Statements of Operations.
New real-time distribution software will be implemented across our
supply chain improving product flow and efficiency while enabling a world class
distribution network. The current warehouse management software system does not
provide adequate performance reporting and is not cost effective to upgrade. Due
to increased efficiency associated with the new software we will be able to
increase productivity through improved cube management while reducing labor
costs. Completion of the implementation is expected by the end of the second
quarter of fiscal 2002. The existing supply chain software will continue to be
utilized until replaced in 2002. Depreciation will be accelerated to reflect the
remaining revised useful lives. We recorded a charge of $9 related to the
accelerated depreciation for these assets in the third quarter. These charges
are included in Cost of sales, buying and occupancy in the Consolidated
Statements of Operations.
20
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
As a result of these actions we expect earnings before income taxes to
increase by approximately $15 per year. These savings will be achieved through
reductions in labor costs, depreciation expense and maintenance costs, and
increased productivity.
The following table summarizes the significant components and
presentation, in the Consolidated Statements of Operations, of the charge for
the restructuring of our supply chain operations during the third quarter of
2001.
Cost of
sales,
buying and
(in millions) occupancy SG&A Total
---------- ---- -----
Lease obligations $ 37 $ -- $ 37
Accelerated depreciation of software 9 -- 9
Asset impairment 5 87 92
Contractual employment obligations 10 -- 10
---- ---- ----
Total $ 61 $ 87 $148
==== ==== ====
BLUELIGHT.COM
As a result of the changed environment for internet businesses, in
which the ability for internet businesses to raise capital became 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.
At the end of the second quarter, we acquired the remaining 40%
interest in BlueLight.com, giving us control of the entity. To acquire the 40%
interest, we issued $69 in shares of Kmart common stock and paid $16 in cash for
a total purchase price of $85. In connection with the acquisition, the return of
capital put rights were terminated, the related $62.5 liability was relieved,
and the 4.4 million warrants for Kmart common stock issued to SOFTBANK
(currently Mobius Venture Capital) and other investors were cancelled.
As a result of these activities, we recorded a $92 charge ($73
after-tax) in the second quarter. Of the charge, $41 related to the impairment
of our investment in BlueLight.com, which was written down to fair value. This
charge was recorded based upon our revised cash flow projections for the
business in accordance with SFAS No. 121. The remaining $51 of the charge
related to the restructuring of our e-commerce business.
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 in the headquarters of BlueLight.com, and have not been utilized in
the restructured operations. This charge was recorded in accordance with SFAS
No. 121. Liabilities for lease terminations, contract terminations and other
costs totaling $22 were established 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 quarter, $5 has been paid and charged against the liability.
Subsequent to the initial filing of this Quarterly Report on Form 10-Q, we
adopted SFAS No. 144 retroactively to all periods in fiscal year 2001. The
charge described herein was not affected by the adoption of SFAS No. 144.
During the third quarter, we continued executing our restructuring
plan, including formally communicating severance benefits to 114 employees at
the BlueLight.com headquarters and terminating seventy-three of those employees
during the quarter. We recorded an additional $5 ($3 after-tax) charge to
provide for these costs, $2 of which has been paid and charged against the
liability during the quarter.
21
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
We also outsourced the hosting of our site, fulfillment of e-commerce
orders and all related customer service. We have substantially completed our
restructuring plan and expect to accomplish the remaining steps in the fourth
quarter of fiscal year 2001. We expect the restructuring will reduce the
operating costs of BlueLight.com by over 80%, which will improve our e-commerce
results of operations by over $30 in 2002 from 2001 levels.
All charges for the restructuring and impairment of the investment are
included in the line Charges for BlueLight.com and other in the Consolidated
Statements of Operations. The results of BlueLight.com's operations are fully
consolidated in our financial statements commencing July 31, 2001.
EMPLOYEE SEVERANCE AND VERP
During the first quarter of 2001, we realigned our organization around
our three strategic imperatives: to dramatically improve retail execution to
achieve World Class Execution throughout our business, to create a Customer
Centric Culture so our behaviors are linked to serving our customers, and to
aggressively pursue Sales and Marketing Opportunities to define a market
position differentiating Kmart from our competitors. As a result of our
realignment, our workforce was reduced by 350 employees in the first quarter
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 Consolidated Statements of Operations in the line
Charges for BlueLight.com and other. The charge relates 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. Payments associated with these actions have aggregated $16. An
additional $3 will be paid to employees in accordance with the terms of the
related severance agreements. Benefit payments to employees accepting the VERP
are paid from the Kmart Employee Pension Plan, except certain payments for
highly compensated employees which we pay directly.
2000 STRATEGIC ACTIONS
In the second quarter of 2000, we announced a series of strategic
actions aimed at strengthening financial performance by achieving improvements
in return on invested capital. These actions included deciding to close certain
Kmart and Kmart Super Center stores, accelerating certain inventory reductions
and redefining our information technology strategy. As a result of these
actions, we recorded a pre-tax charge of $740 ($471 after-tax) during the second
quarter of 2000. During the third quarter of fiscal year 2000, we reduced this
charge by $12 ($8 after-tax) due to reducing the number of scheduled store
closings from 72 to 69, thus reducing the reserve for closed stores from $300 to
$288. There were no other adjustments to the reserve during the period.
22
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
The impact of these restructuring charges on our effective tax rate for
the 13 and 39 week periods ended October 31, 2001 is summarized in the following
tables.
13 Weeks ended October 31, 2001
---------------------------------------------------
As BlueLight Supply Excluding
Restated .com Chain Charges
-------- ---- ----- -------
Loss before interest, income tax and dividends on
convertible preferred securities of subsidiary trust $(246) $ (5) $(148) $ (93)
Interest expense, net 96 -- -- 96
Income tax benefit (118) (2) (54) (62)
Dividends on convertible preferred securities of
subsidiary trust, net of income taxes 11 -- -- 11
----- ----- ----- -----
Net loss $(235) $ (3) $ (94) $(138)
===== ===== ===== =====
Effective tax benefit rate 34.5% 36.5% 36.5% 33.0%
===== ===== ===== =====
39 Weeks ended October 31, 2001
-----------------------------------------------------------------
As BlueLight Supply Other Excluding
Restated .com Chain Charges Charges
-------- ---- ----- ------- -------
Loss before interest, income tax and dividends on
convertible preferred securities of subsidiary trust $(934) $ (97) $(148) $ (23) $(666)
Interest expense, net 267 -- -- -- 267
Income tax benefit (390) (20) (54) (8) (308)
Dividends on convertible preferred securities of
subsidiary trust, net of income taxes 34 -- -- -- 34
----- ----- ----- ----- -----
Net loss $(845) $ (77) $ (94) $ (15) $(659)
===== ===== ===== ===== =====
Effective tax benefit rate 32.5% 21.1% 36.5% 33.0% 33.0%
===== ===== ===== ===== =====
OTHER MATTERS
OTHER ADJUSTMENTS
Included in 2001 quarterly operating results are amounts related to
adjustments to our asset and liability accounts that reduced operating results
reported in 2001 by $15 in the first quarter, $21 in the second quarter, and $2
in the third quarter. These adjustments were recorded when identified by the
Company in the ordinary course of events and substantially relate to prior
years.
LEASE GUARANTEES
We have guaranteed leases for properties operated by certain former
subsidiaries including Borders Group, Inc., OfficeMax, Inc., and The Sports
Authority, Inc. The present value of the lease obligations we guaranteed is
approximately $347. Kmart's contingent obligation is dependent on the future
operating results of the guarantees and is subject to settlement under a plan of
reorganization to be voted upon by the creditors and equity holders and approved
by the court.
23
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
OTHER
We are a party to a substantial number of 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. The Company assesses the likelihood of potential losses on an
ongoing basis and when they are considered probable and reasonably estimable,
records 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.
24
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This quarterly report, as well as other statements or reports made by
or on behalf of Kmart, may contain or may incorporate by reference 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 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 include, but are not limited to, the following:
General Factors
- - general economic conditions,
- - weather conditions, including those which affect buying patterns of our
customers,
- - changes in consumer spending and our ability to anticipate buying patterns
and implement appropriate inventory strategies,
- - competitive pressures and other third party actions,
- - ability to timely acquire desired goods and/or fulfill labor needs at
planned costs,
- - 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 prosecuted by it from time to time,
- - our ability to develop, prosecute, 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 obtain and maintain normal terms with vendors and service
providers,
- - our ability to maintain contracts that are critical to our operations,
- - the potential adverse impact of the Chapter 11 cases on our liquidity or
results of operations, and
- - our ability to fund and execute our business plan.
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.
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 value for their
interests. Because of such possibilities, the value of the common stock is
highly speculative. Accordingly, we urge that appropriate caution be exercised
with respect to existing and future investments in any of these liabilities
and/or securities.
25
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as a part of this report:
Exhibit 10 - Special Supplemental Executive Retirement Plan (A)
(incorporated by reference to Exhibit 10 to Kmart's
Quarterly Report on Form 10-Q for the quarter ended
October 31, 2001 filed on November 27, 2001)
Exhibit 10.1 - Long Term Cash Incentive Plan (A) (incorporated by
reference to Exhibit 10.1 to Kmart's Quarterly Report
on Form 10-Q for the quarter ended October 31, 2001
filed on November 27, 2001)
Exhibit 18 - Preferability Letter from PricewaterhouseCoopers LLP
(incorporated by reference to Exhibit 18 to Kmart's
Annual Report on Form 10-K for the fiscal year ended
January 30, 2002 filed on May 15, 2002)
(A) This document is a management contract or compensation plan.
In reliance upon Item 601(B)(4)(iii)(A) of Regulation S-K, various
instruments defining the rights of holders of long-term debt of the
registrant are not being filed herewith because the total amount of
securities authorized under each such instrument does not exceed 10% of
the total assets of Kmart. We agree to furnish a copy to the Commission
upon request of the following instruments defining the rights of
holders of long-term debt:
9 7/8% Notes Due 2008
(b) Reports on Form 8-K:
We filed a Current Report on Form 8-K dated September 6, 2001 to
report, under Item 5, that Kmart Corporation issued a press release
announcing the restructuring of our supply chain operations and related
charge to earnings and to furnish, under Item 7, a copy of the press
release.
26
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: June 12, 2002
Kmart Corporation
----------------------------------
(Registrant)
By: /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)
27