EXHIBIT 2.2
[KMART LOGO]
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
In re: ) Case No. 02-02474
)
KMART CORPORATION, et al., ) (Jointly Administered)
) Chapter 11
)
Debtors. ) Hon. Susan Pierson Sonderby
DISCLOSURE STATEMENT WITH RESPECT TO
FIRST AMENDED JOINT PLAN OF REORGANIZATION
OF KMART CORPORATION AND ITS AFFILIATED
DEBTORS AND DEBTORS-IN-POSSESSION
John Wm. Butler, Jr.
J. Eric Ivester
Mark A. McDermott
Samuel S. Ory
SKADDEN, ARPS, SLATE, MEAGHER & FLOM (ILLINOIS) 333 West Wacker Drive Chicago,
Illinois 60606-1285
(312) 407-0700
Attorneys for Debtors and Debtors-in-Possession
Dated: February 25, 2003
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THE INFORMATION CONTAINED IN THIS DISCLOSURE STATEMENT (THE "DISCLOSURE
STATEMENT") IS INCLUDED HEREIN FOR PURPOSES OF SOLICITING ACCEPTANCES OF THE
FIRST AMENDED JOINT PLAN OF REORGANIZATION OF KMART CORPORATION AND ITS
AFFILIATED DEBTORS AND DEBTORS-IN-POSSESSION (THE "PLAN") AND MAY NOT BE RELIED
UPON FOR ANY PURPOSE OTHER THAN TO DETERMINE HOW TO VOTE ON THE PLAN. NO PERSON
MAY GIVE ANY INFORMATION OR MAKE ANY REPRESENTATIONS, OTHER THAN THE INFORMATION
AND REPRESENTATIONS CONTAINED IN THIS DISCLOSURE STATEMENT, REGARDING THE PLAN
OR THE SOLICITATION OF ACCEPTANCES OF THE PLAN.
ALL CREDITORS ARE ADVISED AND ENCOURAGED TO READ THIS DISCLOSURE
STATEMENT AND THE PLAN IN THEIR ENTIRETY BEFORE VOTING TO ACCEPT OR REJECT THE
PLAN. PLAN SUMMARIES AND STATEMENTS MADE IN THIS DISCLOSURE STATEMENT ARE
QUALIFIED IN THEIR ENTIRETY BY REFERENCE TO THE PLAN AND THE EXHIBITS ANNEXED TO
THE PLAN AND THIS DISCLOSURE STATEMENT. THE STATEMENTS CONTAINED IN THIS
DISCLOSURE STATEMENT ARE MADE ONLY AS OF THE DATE HEREOF, AND THERE CAN BE NO
ASSURANCE THAT THE STATEMENTS CONTAINED HEREIN WILL BE CORRECT AT ANY TIME AFTER
THE DATE HEREOF. IN THE EVENT OF ANY CONFLICT BETWEEN THE DESCRIPTION SET FORTH
IN THIS DISCLOSURE STATEMENT AND THE TERMS OF THE PLAN, THE TERMS OF THE PLAN
SHALL GOVERN.
THIS DISCLOSURE STATEMENT HAS BEEN PREPARED IN ACCORDANCE WITH SECTION
1125 OF THE UNITED STATES BANKRUPTCY CODE AND RULE 3016(b) OF THE FEDERAL RULES
OF BANKRUPTCY PROCEDURE AND NOT NECESSARILY IN ACCORDANCE WITH FEDERAL OR STATE
SECURITIES LAWS OR OTHER NON-BANKRUPTCY LAW. THIS DISCLOSURE STATEMENT HAS BEEN
NEITHER APPROVED NOR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION (THE
"SEC"), NOR HAS THE SEC PASSED UPON THE ACCURACY OR ADEQUACY OF THE STATEMENTS
CONTAINED HEREIN. PERSONS OR ENTITIES TRADING IN OR OTHERWISE PURCHASING,
SELLING OR TRANSFERRING SECURITIES OR CLAIMS OF KMART CORPORATION OR ANY OF ITS
DOMESTIC SUBSIDIARIES AND AFFILIATES SHOULD EVALUATE THIS DISCLOSURE STATEMENT
AND THE PLAN IN LIGHT OF THE PURPOSE FOR WHICH THEY WERE PREPARED.
AS TO CONTESTED MATTERS, ADVERSARY PROCEEDINGS AND OTHER ACTIONS OR
THREATENED ACTIONS, THIS DISCLOSURE STATEMENT SHALL NOT CONSTITUTE OR BE
CONSTRUED AS AN ADMISSION OF ANY FACT OR LIABILITY, STIPULATION OR WAIVER, BUT
RATHER AS A STATEMENT MADE IN SETTLEMENT NEGOTIATIONS. THIS DISCLOSURE STATEMENT
SHALL NOT BE ADMISSIBLE IN ANY NON-BANKRUPTCY PROCEEDING NOR SHALL IT BE
CONSTRUED TO BE CONCLUSIVE ADVICE ON THE TAX, SECURITIES, OR OTHER LEGAL EFFECTS
OF THE PLAN AS TO HOLDERS OF CLAIMS AGAINST, OR EQUITY INTERESTS IN, KMART
CORPORATION OR ANY OF ITS DOMESTIC SUBSIDIARIES AND AFFILIATES, DEBTORS AND
DEBTORS-IN-POSSESSION IN THESE CASES.
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NONE OF THE KMART AFFILIATES LOCATED OUTSIDE OF THE UNITED STATES HAVE
COMMENCED CHAPTER 11 CASES OR SIMILAR PROCEEDINGS IN ANY OTHER JURISDICTIONS.
THESE AFFILIATES ARE NOT AFFECTED BY THE CHAPTER 11 CASES AND CONTINUE TO
OPERATE THEIR BUSINESSES OUTSIDE OF BANKRUPTCY.
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I. SUMMARY OF PLAN
The following introduction and summary is a general overview only and
is qualified in its entirety by, and should be read in conjunction with, the
more detailed discussions, information, and financial statements and notes
thereto appearing elsewhere in this Disclosure Statement and the First Amended
Joint Plan of Reorganization of Kmart Corporation and its Affiliated Debtors and
Debtors-in-Possession (the "Plan"). All capitalized terms not defined in this
Disclosure Statement have the meanings ascribed to such terms in the Plan. A
copy of the Plan is annexed hereto as Appendix A.
This Disclosure Statement contains, among other things, descriptions
and summaries of provisions of the Plan being proposed by Kmart Corporation
("Kmart") and 37 of its domestic subsidiaries and affiliates (the "Affiliate
Debtors"), debtors and debtors-in-possession (collectively, the "Debtors"), as
filed on February 25, 2003, with the United States Bankruptcy Court for the
Northern District of Illinois, Eastern Division (the "Bankruptcy Court").
Certain provisions of the Plan, and thus the descriptions and summaries
contained herein, may be the subject of continuing negotiations among the
Debtors and various parties, have not been finally agreed upon, and may be
modified. Such modifications, however, will not have a material effect on the
distributions contemplated by the Plan.
A. BUSINESS OVERVIEW
Kmart is the successor to the business developed by its founder, S.S.
Kresge, who opened his first store in 1899. The first store using the Kmart name
was opened in March 1962. Since that time, Kmart has become the nation's third
largest discount retailer and the fourth largest general merchandise retailer.
As of the commencement of these Chapter 11 Cases, Kmart operated 2,114 stores,
primarily under the Big Kmart or Kmart Supercenter format, in all 50 United
States, Puerto Rico, the U.S. Virgin Islands and Guam. Approximately 75% of the
U.S. population shops at Kmart each year, and about 85% of the U.S. population
lives within 15 miles of a Kmart store. Kmart's retail operations are located in
over 300 of the 324 metropolitan statistical areas in the United States.
Kmart focuses its merchandising and marketing approach on its brand
positioning, pricing strategies, and presentation to build customer loyalty and
increase shopping frequency. Kmart does so by featuring popular national brands
at competitive prices combined with new, distinct brands to differentiate itself
in the marketplace. Kmart is continually focused on growing its exclusive
private brand product offerings, which is highlighted by important agreements
with nationally recognized names such as Martha Stewart, Disney, Sesame Street,
Joe Boxer, Route 66, Jaclyn Smith, Kathy Ireland, and Thalia.
Kmart's need to restructure its business through a Chapter 11
reorganization proceeding arose due to the combined effects of a number of
factors. Without limitation, these factors include the intense competition
experienced by all retailers in the discount retailing industry, a series of
unsuccessful sales and marketing initiatives, and the continuing recession.
Other factors, which arose quickly in the final days of 2001 and the very early
part of January 2002, included the rapid decline in Kmart's liquidity resulting
from below-plan sales and earnings performance in the fourth quarter of 2001.
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In light of these business issues, Kmart determined that Chapter 11
would afford the Company the best opportunity for restructuring its affairs and
for developing and implementing a long-term, go-forward, retail business
strategy. To this end, Kmart has worked to implement a number of key initiatives
during the time that the Company has been in Chapter 11. Kmart believes that it
has accomplished or will accomplish prior to emergence from Chapter 11 nearly
all of the actions which it required Chapter 11 to address, including, among
other things, elimination of unprofitable stores and leases, improvement of
store operations and inventory management, and the restructuring of its balance
sheet through the conversion of substantially all debt into equity.
A primary focus of Kmart and its constituents during these Chapter 11
Cases has been on rationalizing and optimizing the Company's store and lease
portfolio. To this end, Kmart will have reduced its total number of stores from
2,114 as of the Petition Date to 1,514 as of emergence from Chapter 11, which
constitutes a total reduction of 600 stores. Concurrent with Kmart's goal of
rationalizing and optimizing the store and lease portfolio, Kmart has also
obtained substantial value through the renegotiation and/or assumption of
significant executory contracts, including licensing agreements with its key
brand partners and a contract with Cardinal Health, Inc., Kmart's exclusive
supplier of pharmaceutical and related products.
Kmart's asset rationalization and optimization strategies have been
complemented throughout these Chapter 11 Cases by a number of business
initiatives designed to attract customers to Kmart stores, cement vendor
support, and increase sales and gross margins. Kmart has successfully expanded
and redesigned its weekly advertising circulars, and has implemented a strategic
marketing plan aimed at Hispanics and African Americans, who collectively
comprise one of the fastest-growing customer segments. The Company has had
positive results with its "Stuff of Life" advertising campaign featuring the
Martha Stewart Everyday and Jaclyn Smith brands. The Company has also commenced
implementation of a "store of the neighborhood" approach to servicing its
customers, which allows individual store managers to customize their merchandise
assortment to suit local community needs and allows greater focus on high volume
and advertised items.
Kmart's asset rationalization and optimization strategies, along with
the other business initiatives implemented throughout these Chapter 11 Cases,
have begun to bear positive results, including stabilization of the business and
improved liquidity. Although Kmart has accomplished many important goals through
the tools afforded by Chapter 11, Kmart believes that the prospects for further
operational improvement will be best achieved outside of Chapter 11. There are
continued costs of remaining in Chapter 11 that Kmart believes warrant emergence
at this time, including the administrative costs of the Chapter 11 process, and
the continued diversion of management time by the Chapter 11 proceedings.
As part of the process to emerge from Chapter 11, Kmart undertook a
thorough and detailed initiative to develop a five-year business plan. Under the
business plan, the current 2003 fiscal year, part of which will occur during the
Chapter 11 Cases and part of which will occur after emergence, will be a
transition year. Kmart will not return to profitability until 2004. Kmart
projects that the business will continue to recover and that EBITDA will grow to
$1.3 billion by 2007. Kmart believes that it is well-positioned to improve its
operating performance and compete effectively with the other large discount
retailers in the market. As a result of
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Kmart's rationalization and optimization of its store and real estate portfolio
during the Chapter 11 Cases, Kmart has substantially reduced the risk associated
with such portfolio. Kmart also expects to capture significant value as a result
of its recent rejection of its food and consumables supply contract with Fleming
Companies, Inc., Kmart's largest supplier, and Kmart's related decision to
self-distribute such products to all Kmart stores. The shift to
self-distribution, which is expected to occur by early March 2003, is estimated
to save Kmart in excess of $450 million through 2006.
Kmart remains focused on being the leading discount retailer with
promotional pricing and exclusive national brands. Post-emergence, Kmart
believes it can best maximize its performance and improve its market position by
continuing to focus on driving profitable sales growth, controlling costs and
streamlining overhead, and increasing asset productivity. Kmart's go-forward
retail strategy also is premised on Kmart's continued implementation of several
key initiatives begun during the Chapter 11 Cases, including the "store of the
neighborhood," "top sellers" program, and further testing of the "store of the
future." Marketing will focus on Kmart's exclusive brand identity. With the
continued support of its vendor partners through, among other things, the vendor
lien contemplated by the Plan and the $2 billion Exit Financing Facility, Kmart
anticipates being able to continue to improve its customer shopping experience
and ultimately returning to profitability.
When Kmart commenced these Chapter 11 Cases on January 22, 2002, it
announced its intention to pursue a "fast-track" reorganization and emerge from
Chapter 11 by July 2003. The Company recently announced its intention to emerge
from Chapter 11 on or about April 30, 2003, which is earlier than originally
projected. While Kmart believes that it has completed its Chapter 11 objectives,
Kmart's operational and financial turnaround will continue after emergence,
including during the remainder of the 2003 transition year. Kmart's early
emergence and implementation of its five-year business plan are subject to a
number of risks and uncertainties. Certain of such risks are discussed in detail
in Section VIII of this Disclosure Statement.
B. GENERAL STRUCTURE OF THE PLAN
Each of Kmart and its 37 debtor affiliates is a proponent of the Plan
within the meaning of Section 1129 of the Bankruptcy Code. The Plan provides for
the substantive consolidation of the Estates that comprise the Debtors for
distribution purposes only. The Plan contains separate classes and proposes
recoveries for holders of Claims against and Interests in the Debtors. After
careful review of the Debtors' current business operations, estimated recoveries
in a liquidation scenario, and the prospects of ongoing business, the Debtors
have concluded that the recovery to the Debtors' creditors will be maximized by
the reorganization of Kmart and the Affiliated Debtors as contemplated by the
Plan.
Specifically, the Debtors believe that their businesses and assets have
significant value that would not be realized in a liquidation, either in whole
or in substantial part. According to the valuation analysis prepared by the
Debtors' investment banker and financial advisor, Miller Buckfire Lewis & Co.,
LLC ("Miller Buckfire Lewis"), the liquidation analysis prepared by management
with the assistance of the Debtors' restructuring advisors, Alix Partners, LLC
("Alix Partners"), and the other analyses prepared by the Debtors with the
assistance of their
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financial advisors, the Debtors believe that the value of the Estates of the
Debtors is significantly greater in the proposed reorganization than in a
liquidation.
C. SUMMARY OF THE PLAN STRUCTURE
Set forth below is a brief summary of the Plan. The effectiveness of
the Plan, and thus the consummation of the distributions provided for in the
Plan, is subject to a number of conditions precedent. There can be no assurances
that these conditions will be satisfied. In addition, the Debtors have reserved
the right to amend or modify the Plan as to any particular Debtor.
Under the Plan, unsecured creditors whose claims will not be paid in
full or otherwise reinstated have been classified into four primary groups for
distribution purposes. The first such group is comprised of the Debtors'
pre-petition lenders who are owed approximately $1.08 billion. Kmart is directly
obligated on this indebtedness and several other Affiliate Debtors are
guarantors of this indebtedness. Certain parties, including other unsecured
creditors, have challenged the enforceability of the Affiliate Debtors'
guarantees. Although the lenders otherwise would be entitled to receive new
common stock on account of their claims under the plan, similar to the treatment
to be afforded other unsecured creditors, in settlement and compromise of the
issues relating to, among other things, the enforceability of the Affiliate
guarantees, the lenders will receive cash in an amount equal to forty percent
(40%) of the amount of their claims.
A portion of the cash to be utilized by Reorganized Kmart to make these
cash payments to the lenders will be provided by two significant creditors - ESL
Investments, Inc. ("ESL") and Third Avenue Trust, on behalf of certain of its
investment series (collectively, the "Plan Investors"). Specifically, The Plan
Investors have agreed to make a substantial investment in Kmart in furtherance
of Kmart's financial and operational restructuring pursuant to an Investment
Agreement dated as of January 24, 2003 (as amended, the "Investment Agreement").
In exchange for this investment, which will total up to $353 million (including
the conversion of debt as described below), the Plan Investors will receive
shares of stock (the "Total Investor Shares") and, under certain circumstances,
notes of Reorganized Kmart.
Of the total investment amount to be made by the Plan Investors,
approximately $153.4 million will be comprised of cash payable to ESL pursuant
to the Plan as a prepetition lender (and which will be deemed contributed by ESL
to the Debtors in exchange for the new shares), and $140 million represents an
additional investment to be made by the Plan Investors pursuant to the terms of
the Investment Agreement. In addition, ESL has agreed to invest up to an
additional $60 million in exchange for a convertible note or notes, all as more
fully set forth in the Investment Agreement.
The Plan Investors will own a significant percentage of the common
stock of Reorganized Kmart under the Plan. The Plan Investors will receive such
stock on account of the cash investments they intend to make pursuant to the
terms of the Investment Agreement. They also will receive stock on account of
the significant pre-petition claims that they hold against the Debtors. ESL
holds approximately $1.6 billion in unsecured debt claims, and Third Avenue owns
approximately $178 million in unsecured debt claims. Based on the amount of
these
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parties' cash investments and debt holdings, they could hold slightly in excess
of 50% of all shares of Reorganized Kmart's common stock on the Effective Date
of the Plan.
The second significant group of unsecured creditors whose claims will
be treated under the plan include holders of pre-petition notes and debentures
issued by Kmart in the total face amount of approximately $2.3 billion. This
amount does not include certain of such notes and debentures purchased by Kmart
prior to commencement of these Chapter 11 cases. Under the plan, holders of
prepetition notes and debentures, after giving effect to the subordination
provisions governing the trust preferred obligations, will share pro rata in
approximately 29% of the stock of Reorganized Kmart to be issued and outstanding
as of the Effective Date.
The third significant group of unsecured creditors whose claims will be
treated under the plan include trade creditors, service providers, vendors with
claims arising as a result of rejection of executory contracts, and landlords
with lease rejection claims. The Debtors estimate that such claims will be
allowed in the aggregate amount of approximately $4.3 billion. Under the plan,
holders of such claims will share pro rata in approximately 37% of the stock of
Reorganized Kmart on account of their claims.
The final significant group of creditors is comprised of personal
injury and other litigation claimants, governmental claimants, and other
contingent claim holders. Under the Plan, these claimants will receive a
deferred cash payment in an amount that will afford them a percentage recovery
on their claims which is generally comparable to the estimated percentage
recovery to holders of trade vendor claims, service provider claims, vendors
with claims arising as a result of rejection of executory contracts, and lease
rejection claims. However, such creditors may elect to be treated as trade
vendors, service providers, vendors with claims arising as a result of rejection
of executory contracts, and lease rejection claimants and therefore share in the
distribution of stock in Reorganized Kmart in lieu of cash, provided they agree
to an expedited procedure for estimating their claims for distribution purposes.
Under the Plan, there is a "convenience" class of creditors that affords
creditors with claims under $30,000 and creditors who elect to have their claims
limited to $30,000 the option to be paid a portion of their claim amounts in
cash.
Under the Plan, a trust will be established for the limited purpose of
pursuing causes of action arising out of the Debtors' accounting and stewardship
investigations, which are discussed in detail below. Any recoveries from claims
brought by the trust will be distributed pursuant to the terms of the Plan to
holders of (a) pre-petition notes and debentures; (b) trade creditors, service
providers, vendors with claims arising as a result of rejection of executory
contracts, and landlords with lease rejection claims; (c) holders of other
unsecured claims; and (d) subject to approval of the Plan by the holders of
certain trust preferred obligations, holders of certain trust preferred
obligations as well as holders of Kmart common stock.
Under the Plan, Kmart's restructured business will be owned and
operated through a new corporate structure. This new structure will be comprised
of a new holding company ("Reorganized Kmart") that will own a new operating
company ("New Operating Company") that will be an intermediary company that
houses upper-level management of the reorganized enterprise and that will in
turn own, directly or indirectly, various corporate and other entities that will
own and operate the business of the Reorganized Debtors. The New Operating
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Company and one or more of its subsidiaries may be comprised of existing Kmart
entities. This new corporate structure is being implemented for various business
planning reasons and is designed to assist the reorganized business to maximize
value for all constituents.
Although the reorganized enterprise will be operated through a new set
of corporate entities, each of the 38 Debtors in the Chapter 11 proceedings will
emerge from Chapter 11 under the Plan except that certain assets primarily
related to those stores that the Debtors intend to close in early 2003 shall
remain in Chapter 11 so that such assets may be disposed of consistent with
procedures approved by the Bankruptcy Court relating to sales of owned assets
and assignments of real property leases. Thus, pending such disposition, such
assets shall remain in the estates and not revest in the Debtors. The proceeds
from disposition of the closing store assets will be contributed to the
Reorganized Debtors and utilized consistent with the Plan. Creditor
classifications have been established under the Plan with respect to the Debtors
that own these assets and creditors of such Debtors, including landlords that
ultimately may hold lease rejection claims, will share in distributions
consistent with the Plan. Except as provided in the Plan, and with respect to
the closing store real estate only, the Debtors owning such assets will be
deemed to emerge from Chapter 11 as Reorganized Debtors and either dissolved in
accordance with applicable non-bankruptcy law or maintained consistent with the
corporate restructuring transactions contemplated by the Plan as the business
needs of the Reorganized Debtors warrant.
D. SUMMARY OF TREATMENT OF CLAIMS AND INTERESTS UNDER THE PLAN
As set forth above, the Plan constitutes a joint plan of reorganization
providing for the substantive consolidation of the Debtors' Estates for
distribution purposes. The Plan contains separate classes for holders of Claims
against and Interests in the Debtors. As required by the Bankruptcy Code,
Administrative Claims and Priority Tax Claims are not classified.
The table below summarizes the classification and treatment of the
principal prepetition Claims and Interests in the Plan. The classification and
treatment for all Classes are described in more detail in Section VII. The table
below also sets forth the Debtors' estimates of the amount of Claims that will
ultimately become Allowed in each Class based upon review by the Debtors of all
Claims scheduled by the Debtors, consideration of the provisions of the Plan
that affect the allowance of certain Claims, and a general estimate of the
amount by which Allowed Claims may ultimately exceed the amount of Claims
scheduled by the Debtors. The table below also includes an estimated percentage
recovery for holders of Claims in each Class. For purposes of estimating the
percentage recoveries as set forth below, the New Common Stock to be issued
pursuant to the Plan was assumed to be valued as provided for in the valuation
analysis attached hereto as Appendix D. The estimated percentage recoveries set
forth below that are based upon distributions of New Common Stock were
calculated using the mid-point of the valuation ranges.
The Debtors' investment banker and financial advisor, Miller Buckfire
Lewis, performed a valuation of the Reorganized Debtors and the New Common Stock
based on information and financial projections provided by the Debtors. The
valuation assumptions include, among other things, an assumption that the
results projected for the Reorganized Debtors will be achieved in all material
respects. However, no assurance can be given that the projected results will be
achieved. To the extent that the valuation assumptions are dependent upon the
achievement of the results projected by the Debtors, the valuation assumptions
must be considered speculative.
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The valuation assumptions also consider, among other matters, (i) market
valuation information concerning certain publicly traded securities of certain
other companies that are considered relevant, (ii) certain general economic and
industry information considered relevant to the business of the Reorganized
Debtors, and (iii) such other investigations and analyses as were deemed
necessary or appropriate. The Debtors and Miller Buckfire Lewis believe these
valuation assumptions are reasonable.
The foregoing valuation assumptions are not a prediction or reflection
of post-Confirmation trading prices of the New Common Stock or any other
securities. Such securities may trade at substantially higher or lower prices
because of a number of factors, including those discussed in Section VIII. The
trading prices of securities issued under a plan of reorganization are subject
to many unforeseeable circumstances and therefore cannot be predicted.
In addition, for certain Classes of Claims, the actual amounts of
Allowed Claims could materially exceed or could be materially less than the
estimated amounts shown in the table that follows. Accordingly, for these
reasons, no representation can be or is being made with respect to whether the
estimated percentage recoveries shown in the table below will actually be
realized by the holders of Allowed Claims in any particular Class. FOR PURPOSES
OF CALCULATING ESTIMATED RECOVERIES, THE FOLLOWING TABLE GIVES EFFECT TO THE
SUBORDINATION RIGHTS OF VARIOUS PARTIES, AND DOES NOT GIVE EFFECT TO THE
RECOVERIES, IF ANY, ON ACCOUNT OF CLAIMS OF THE DEBTORS ON ACCOUNT OF THE
STEWARDSHIP AND RELATED INVESTIGATIONS.
CLASS DESCRIPTION TREATMENT UNDER PLAN
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CLASS 1 - SECURED A secured claim includes any claim secured by a
CLAIMS lien on property in which Kmart or its affiliates
have an interest. A secured claim also includes a
claim that is subject to setoff. Kmart believes
that various real estate mortgages are the
primary secured claims in these proceedings,
although there also may be certain real estate
tax liens, mechanics' liens and personal property
tax liens as well as setoff claims asserted by
certain of Kmart's banks where Kmart maintains
deposit accounts. The claims of consignment
vendors who assert liens on consignment inventory
are not included in the Debtors' estimate of the
amount of secured claims under the Plan. However,
Kmart intends to assume the consignment
agreements with such vendors. Under the Plan, the
legal, equitable, and contractual rights of each
secured claim holder shall be reinstated, which
means that the claim holders' rights will be
unaltered and that Kmart will cure outstanding
payment defaults. Additionally, the liens,
including real estate mortgages, will survive the
Chapter 11 and will continue in accordance with
the contractual terms of the parties' underlying
agreements until the claims are paid in full. As
alternatives to the foregoing, under the Plan,
Kmart may (i) pay off a lien in cash, with the
amount of the payment equal to the value of the
collateral, (ii) surrender the collateral to the
claim holder, or (iii) agree to some other
arrangement with the lien holder. Kmart must make
one of the foregoing elections by the later of
the effective date of the Plan, or ten days after
the lien is allowed by
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CLASS DESCRIPTION TREATMENT UNDER PLAN
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the Bankruptcy Court, and must provide prompt
notice to the lienholder of the election.
However, in the event Kmart fails to make any
election, the lien will be reinstated. Kmart
anticipates that most, if not all, of its real
estate mortgages will be reinstated, and any
outstanding payment defaults will be cured.
ESTIMATED AMOUNT OF CLAIMS: $61,000,000
ESTIMATED PERCENTAGE RECOVERY: 100%
CLASS 2 - OTHER PRIORITY Other priority claims are primarily claims held
CLAIMS by current and former employees for unpaid wages,
salaries, bonuses, severance pay, vacation pay,
and other unpaid employee benefits. Upon
commencement of the Chapter 11 Cases, Kmart
obtained authority from the Bankruptcy Court to
pay such amounts in the ordinary course of
business. Kmart believes that it has in fact paid
all such amounts, and that there should not be a
significant amount of such claims, if any,
remaining unpaid. However, in the event there are
any valid claims for unpaid wages, salaries, and
other employee compensation, Kmart will either
pay such claims in full in cash or, if necessary,
agree with the claim holder to some other
mutually agreeable compensation arrangement.
ESTIMATED AMOUNT OF CLAIMS: $ 0
ESTIMATED PERCENTAGE RECOVERY: N/A
CLASS 3 - PREPETITION The prepetition lenders to Kmart are owed
LENDER CLAIMS $1,076,156,647.02. The prepetition lenders are
unsecured creditors of Kmart. Like all other
unsecured creditors, the prepetition lenders are
entitled to a pro rata share in the value of
reorganized Kmart. This value would otherwise
take the form of common stock in reorganized
Kmart, which is what most other unsecured
creditors will receive under the plan. However,
the prepetition lenders will not receive stock on
account of their claims, but will instead receive
cash. The cash payment is being made as a
settlement of a series of complex disputes among
the prepetition lenders and other creditor
constituencies. These disputes arise out of the
fact that several of Kmart's subsidiaries have
guaranteed Kmart's indebtedness to the
prepetition lenders. These subsidiaries have
substantial assets. Based upon these guarantees,
the lenders have asserted that they are entitled
to the full value of the subsidiaries before
other creditors may be entitled to any of such
value under the Plan. Other creditors have
disputed the lenders' claims, the enforceability
of the guaranties, and have also questioned
whether the subsidiaries should be deemed the
owners of the assets. As a result of extensive
negotiations among Kmart, the prepetition
lenders, and other creditor constituencies, and
in order to avoid costly litigation that will
delay Kmart's emergence from Chapter 11, a
settlement of these
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CLASS DESCRIPTION TREATMENT UNDER PLAN
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disputes has been reached whereby Kmart will
simply pay the prepetition lenders cash in an
amount equal to 40% of their claims, including
certain setoff claims that the lenders assert
against Kmart. Additionally, with respect to
letters of credit outstanding under the parties'
prepetition credit agreement, Kmart will either
(i) obtain replacement letters of credit, (ii)
provide cash collateral for such letters of
credit in an amount equal to 105% of the letters
of credit, or (iii) if the letters of credit have
been drawn, Kmart shall reimburse the lenders who
issued such letters of credit. ESL Investments,
Inc., the holder of a significant portion of the
prepetition lender claims, will be deemed to have
contributed back to Kmart the cash that ESL would
otherwise receive under the Plan in exchange for
common stock in reorganized Kmart. The allowed
amount of the claims stated below is the total
agreed amount of claims owed by Kmart to all of
the prepetition lenders, including ESL. The
estimated percentage recovery stated below
represents the 40% cash payment lenders are
entitled to receive under the Plan, although, as
explained above, ESL will not retain this cash
payment on account of any prepetition lender
claims currently owned by ESL, and instead will
be deemed to utilize its cash payment to purchase
stock in reorganized Kmart.
ALLOWED AMOUNT OF CLAIMS: $1,076,156,647.02
ESTIMATED PERCENTAGE RECOVERY: 40.0%
CLASS 4 - PREPETITION Prepetition note claims are comprised of
NOTE CLAIMS unsecured debentures and notes issued by Kmart
over the course of several years. The total
amount owed by Kmart on account of these
debentures and notes is $2,277,384,986.97. Under
the Plan, holders of debentures and notes will
receive two forms of consideration in settlement
of their claims. First, they will receive their
pro rata share of 25,008,573 shares of common
stock in reorganized Kmart. This represents
approximately 29% of all such common stock to be
issued under the Plan and Investment Agreement,
although this percentage amount is subject to
dilution on account of stock options and similar
rights that Kmart may later choose to grant to
members of management and other employees as
incentive compensation. According to a valuation
analysis prepared by Kmart's investment bankers
and financial advisors, the estimated, mid-range
value of Kmart's equity is approximately $1.128
billion. Twenty-nine percent of this amount is
approximately $327 million. The estimated
percentage recovery to prepetition noteholders
stated below is obtained by dividing the $327
million in estimated value by the total amount of
debenture and note claims. The stock that
noteholders will receive includes stock that
would otherwise have been distributed to holders
of trust preferred obligations of Kmart,
described below. However, pursuant to the
prepetition agreements governing the trust
preferred obligations and the compromise and
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CLASS DESCRIPTION TREATMENT UNDER PLAN
- ----------------- --------------------
settlement of claims by the prepetition lenders,
distributions on account of the trust preferred
obligations must be made to the lenders and the
noteholders. Under the global settlement
contemplated by the Plan, the lenders have agreed
that the noteholders will receive the stock that
the lenders otherwise would have received on
account of the trust preferred obligations. In
addition to the stock in reorganized Kmart, the
noteholders will also share in any recoveries on
account of claims by Kmart against certain former
members of its senior management and other
persons identified by Kmart in connection with
its investigations into certain accounting and
other matters pertaining to former management's
stewardship of the company, including events
immediately preceding Kmart's filing for Chapter
11. The noteholders are expected to share in any
such recoveries pro rata with holders of trade
vendor/lease rejection claims, holders of trust
preferred obligations and holders of other
unsecured claims (less up to 2.5% of such
recoveries for certain holders of Kmart common
stock). The anticipated recovery on account of
these claims is unknown, and therefore is not
included in the estimated percentage recovery
stated below.
ALLOWED AMOUNT OF CLAIMS: $2,277,384,986.97
ESTIMATED PERCENTAGE RECOVERY: 14.4 %
CLASS 5 - TRADE VENDOR/ Trade vendor/lease rejection claims are claims
LEASE REJECTION CLAIMS arising as a result of retail merchandise or
services provided by trade vendors or service
providers, rejection of executory contracts and
unexpired leases, guaranties related to
rejected executory contracts and unexpired
leases, guaranties with respect to industrial
revenue bonds, and unsecured deficiency claims,
if any. Kmart estimates that the total amount of
all such claims in this class will be
approximately $4.3 billion, although this
estimate could be materially different from the
amount of all such claims that are finally
allowed. Under the Plan, creditors in this class
with claims in amounts over $30,000 will receive
two forms of consideration (those with claims
under $30,000 are in class 7, described below).
First, they will receive their pro rata share of
31,945,161 shares of common stock in reorganized
Kmart. This represents approximately 37% of all
such common stock to be issued under the Plan,
although this percentage amount is subject to
dilution on account of stock options and similar
rights that Kmart may later choose to grant to
members of management and other employees as
incentive compensation. According to a valuation
analysis prepared by Kmart's investment bankers
and financial advisors, the estimated, mid-range
value of Kmart's equity is approximately $1.128
billion. Thirty-seven percent of this amount is
approximately $418 million. The estimated
percentage recovery to trade vendors and
rejection claims stated below is obtained by
dividing the $418 million in
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CLASS DESCRIPTION TREATMENT UNDER PLAN
- ----------------- --------------------
estimated value by the total amount of all
estimated claims of $4.3 billion. In addition to
the stock in reorganized Kmart, trade vendor and
rejection claimants will also share in any
recoveries on account of claims by Kmart against
certain former members of its senior management
and other persons identified by Kmart in
connection with its investigations as discussed
above in connection with Class 4. They are
expected to share in any such recoveries pro rata
with holders of prepetition notes claims, holders
of trust preferred obligations and holders of
other unsecured claims (less up to 2.5% of such
recoveries for certain holders of Kmart common
stock). The anticipated recovery on account of
these claims is unknown, and therefore is not
included in the estimated percentage recovery
stated below.
ESTIMATED AMOUNT OF CLAIMS: $4,300,000,000
ESTIMATED PERCENTAGE RECOVERY: 9.7%
CLASS 6 - OTHER The class of other unsecured claims is comprised
UNSECURED CLAIMS of personal injury and other litigation claimants
and claims by governmental entities on account
of anything other than taxes. A very large
percentage of these claims are unknown in amount
and disputed. However, based on Kmart's history
prior to these Chapter 11 cases in resolving
personal injury and other claims, Kmart
estimates that the total amount of claims in
this class will be approximately $200 million.
Holders of claims in this class may elect to
receive either cash or stock in reorganized
Kmart. Under the cash option, personal injury
and governmental claimants with claims greater
than $30,000 (those with claims under $30,000
are in Class 7, described below) will be
entitled to receive a cash payment on the third
anniversary after Kmart emerges from Chapter 11.
The cash payment will be in an amount which is
expected to approximate the percentage
distribution that trade vendor and lease
rejection claimants will receive in stock, which
is estimated to be 9.7% of their claims. Under
the stock option, personal injury and government
claimants may elect to be treated as class 5
trade vendor/lease rejection claimants, in which
case they will receive their pro rata share of
common stock in reorganized Kmart. However, if
they make this election, they will be deemed to
have agreed to an expedited procedure to be
approved by the Bankruptcy Court for the
estimation of their claims for all purposes
under the Plan. Thus, personal injury claimants
who make this election will effectively be
removed from the personal injury claims
resolution procedures previously approved by
this Court. Regardless of whether a personal
injury or other government creditor elects cash
or stock, the creditor also will share in any
recoveries on account of claims by Kmart against
certain former members of its senior management
and other persons identified by Kmart in
connection with its investigations as discussed
above in connection with Class 4. They are
expected to
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CLASS DESCRIPTION TREATMENT UNDER PLAN
- ----------------- --------------------
share in any such recoveries pro rata with
holders of prepetition notes claims, holders of
trade vendor and rejection claims and holders of
trust preferred obligations (less up to 2.5% of
such recoveries for certain holders of Kmart
common stock). The anticipated recovery on
account of these claims is unknown, and
therefore is not included in the estimated
percentage recovery stated below.
ESTIMATED AMOUNT OF CLAIMS: $200,000,000
ESTIMATED PERCENTAGE RECOVERY: 9.7%
CLASS 7 - GENERAL General unsecured convenience claims are claims
UNSECURED CONVENIENCE held by persons that would otherwise qualify for
CLAIMS treatment as class 5 or class 6 creditors, but
whose claims are in amounts equal to or less than
$30,000. Kmart estimates that the total amount of
claims in this class will be approximately $5
million. Such creditors with claims in amounts
equal to or less than $30,000 will receive cash
in an amount equal to 6.25% of the amount their
claims, payable on the earlier of Kmart's
emergence from Chapter 11 or as soon as
practicable after the amount of the claim is
finally determined. Class 5 and class 6 creditors
with claims in amounts greater than $30,000 may
elect to reduce their claims to $30,000, in which
event they will be entitled to receive cash in an
amount equal to $1,875 payable upon Kmart's
emergence from Chapter 11. Class 7 creditors may
elect, as an alternative to this treatment, to be
considered as a Class 5 creditor and receive the
treatment provided to Class 5 creditors. General
unsecured convenience claims are not entitled to
any other consideration under the Plant on
account of their claims.
ESTIMATED AMOUNT OF CLAIMS: $5,000,000
ESTIMATED PERCENTAGE RECOVERY: 6.25%
CLASS 8 - TRUST Trust preferred obligations are obligations on
PREFERRED OBLIGATIONS account of certain mandatorily redeemable
convertible preferred securities issued by Kmart
Financing I, one of Kmart's affiliates, and
guaranteed by Kmart pursuant to the terms of a
limited, subordinated guarantee. Kmart estimates
that the total amount of obligations in this
class is approximately $648 million. The
documents evidencing these obligations, including
certain underlying indentures, provide that
amounts payable to the holders of these
obligations in the event of insolvency
proceedings of Kmart shall be payable to the
prepetition lenders and the prepetition
noteholders until such creditors are paid in
full. Because these creditors will not be paid in
full under the Plan on account of their claims,
holders of the trust preferred obligations are
not otherwise entitled to a distribution under
the Plan. However, as part of the parties' global
compromise and settlement, the Plan provides that
if both the class of prepetition noteholders and
the class
-xv-
CLASS DESCRIPTION TREATMENT UNDER PLAN
- ----------------- --------------------
of trust preferred obligations vote to accept the
Plan, the holders of the trust preferred
obligations will share in any recoveries on
account of claims by Kmart against certain former
members of its senior management and other
persons identified by Kmart in connection with
its investigations as discussed above in
connection with Class 4. They will share in any
such recoveries pro rata with holders of
prepetition notes claims, holders of trade vendor
and rejection claims, and holders of other
unsecured claims. The anticipated recovery on
account of these claims is unknown and therefore
is not included in the estimated percentage
recovery below. If, however, either the class of
prepetition notes or the class of trust preferred
obligation holders votes against the plan, then
holders of trust preferred obligations shall not
receive or retain any property under the Plan on
account of the trust securities that they hold.
ESTIMATED AMOUNT OF OBLIGATIONS: $648,043,500
ESTIMATED PERCENTAGE RECOVERY: N/A
CLASS 9 - INTERCOMPANY An intercompany claim is a claim by one or more
CLAIMS of Kmart and its affiliates against other Kmart
affiliates on account of various matters,
including royalty obligations and obligations on
account of purchased inventory. Under the Plan,
at the option of Kmart, intercompany claims may
either be reinstated or eliminated. The ultimate
decision will be based upon business planning
reasons of the reorganized company.
ESTIMATED AMOUNT OF CLAIMS: N/A
ESTIMATED PERCENTAGE RECOVERY: N/A
CLASS 10 - SUBORDINATED A subordinated securities claim is a claim for
SECURITIES CLAIMS damages from the purchase or sale of Kmart common
stock, including claims asserting that Kmart's
public financial statements did not accurately
portray Kmart's financial condition. Under the
Bankruptcy Code, such claims have the same
priority as Kmart common stock. In the event all
other classes of creditors vote to accept the
Plan, the holders of subordinated securities
claims will be entitled to receive their pro rata
share of the right to recover 2.5% of the
recoveries, if any, on account of claims by Kmart
against certain former members of its senior
management and other persons identified by Kmart
in connection with its investigations as
discussed above in connection with Class 4. They
will share in any such recoveries pro rata with
holders of Kmart common stock. The anticipated
recovery on account of these claims is unknown,
and therefore is not included in the estimated
percentage recovery below. To the extent there is
any recovery on account of securities claims
against persons other than Kmart with respect to
the accounting and stewardship matters, then the
recovery to subordinated securities
-xvi-
CLASS DESCRIPTION TREATMENT UNDER PLAN
- ----------------- --------------------
claimants under the Plan will be reduced
accordingly. If any class of impaired creditors
votes to reject the Plan, then holders of
subordinated securities claims will not be
entitled to receive any property on account of
their claims.
ESTIMATED AMOUNT OF CLAIMS: N/A
ESTIMATED PERCENTAGE RECOVERY: N/A
CLASS 11 - EXISTING Under the Plan, existing Kmart common stock will
COMMON STOCK be cancelled. However, in the event all other
classes of creditors vote to accept the Plan, the
holders of Kmart common stock will be entitled to
receive their pro rata share of the right to
recover 2.5% of the recoveries, if any, on
account of claims by Kmart against certain former
members of its senior management and other
persons identified by Kmart in connection with
its investigations as discussed above in
connection with Class 4. They will share in any
such recoveries pro rata with holders of
subordinated securities claims. The anticipated
recovery on account of these claims is unknown,
and therefore is not included in the estimated
percentage recovery below. To the extent there is
any recovery on account of securities claims
against persons other than Kmart on account of
the accounting and stewardship matters, then the
recovery to holders of Kmart existing common
stock under the Plan will be reduced accordingly.
If any class of impaired creditors votes to
reject the Plan, then holders of Kmart common
stock will not be entitled to receive any
property on account of their claims.
ESTIMATED AMOUNT OF INTERESTS: N/A
ESTIMATED PERCENTAGE RECOVERY: N/A
CLASS 12 - OTHER Other Interests are comprised of all options,
INTERESTS warrants, call rights, puts, awards, or other
agreements to acquire Existing Common Stock.
Under the Plan, these interests will be cancelled
and the holders of these interests will not
receive or retain any property on account of such
interests under the Plan.
ESTIMATED AMOUNT OF INTERESTS: N/A
ESTIMATED PERCENTAGE RECOVERY: N/A
THE DEBTORS BELIEVE THAT THE PLAN PROVIDES THE BEST RECOVERIES POSSIBLE
FOR THE HOLDERS OF CLAIMS AGAINST AND INTERESTS IN THE DEBTORS, AS APPLICABLE.
EACH OF THE DEBTORS STRONGLY RECOMMENDS THAT YOU VOTE TO ACCEPT THE PLAN.
-xvii-
TABLE OF CONTENTS
PAGE
I. INTRODUCTION.................................................................................................1
II. BANKRUPTCY PLAN VOTING INSTRUCTIONS AND PROCEDURES..........................................................2
A. Definitions....................................................................................2
B. Notice to Holders of Claims and Interests .....................................................2
C. Solicitation Package...........................................................................3
D. General Voting Procedures, Ballots, and Voting Deadline........................................3
E. Questions About Voting Procedures..............................................................4
F. Confirmation Hearing and Deadline for Objections to Confirmation...............................4
III. HISTORY OF THE DEBTORS.....................................................................................6
A. Overview of Business Operations................................................................6
B. Recent Financial Results.......................................................................9
IV. PREPETITION CAPITAL STRUCTURE OF THE DEBTORS................................................................9
A. Prepetition Credit Facilities..................................................................9
B. Prepetition Notes and Related Obligations.....................................................10
C. Trust Securities..............................................................................11
D. Other Material Debt Obligations...............................................................12
E. Equity........................................................................................13
V. CORPORATE STRUCTURE OF THE DEBTORS..........................................................................13
A. Current Corporate Structure...................................................................13
B. Board of Directors of Kmart...................................................................13
C. Senior Management of Kmart....................................................................14
VI. THE CHAPTER 11 CASES.......................................................................................16
A. Events Leading to Commencement of the Chapter 11 Cases........................................16
B. Continuation of Business; Stay of Litigation..................................................16
C. Summary of Certain Relief Obtained at the Outset of the Chapter 11 Cases......................16
D. Post-Petition Financing.......................................................................19
E. Other Significant Events During the Chapter 11 Cases..........................................19
F. The Accounting, Stewardship and Related Investigations........................................39
G. Summary of Claims Process, Bar Date, Certain Claims, and Professional Fees....................53
H. Pension Issues................................................................................59
K. Management Compensation Incentive Plan........................................................65
VII. SUMMARY OF THE REORGANIZATION PLAN........................................................................66
A. Overall Structure of the Plan.................................................................66
B. Classification and Treatment of Claims and Interests..........................................77
C. Means for Implementation of the Plan..........................................................90
D. Unexpired Leases and Executory Contracts.....................................................105
E. Provisions Governing Distributions...........................................................108
F. Allowance and Payment of Certain Administrative Claims.......................................113
G. Kmart Creditor Trust.........................................................................115
H. Effect of the Plan on Claims and Interests...................................................120
-xviii-
PAGE
VIII. CERTAIN FACTORS TO BE CONSIDERED........................................................................125
A. General Considerations.......................................................................125
B. Certain Bankruptcy Considerations............................................................126
C. Business Factors and Competitive Conditions..................................................126
D. Seasonal Nature of Business..................................................................127
E. Inherent Uncertainty of Financial Projections................................................128
F. Access to Financing and Trade Terms..........................................................128
G. Claims Estimations...........................................................................129
H. Potential Dilution Caused by Options or Warrants.............................................129
I. Market for New Securities....................................................................130
J. Potential Ownership Change...................................................................130
K. Tax Planning.................................................................................130
L. Dividends....................................................................................130
M. Impact of Interest Rates.....................................................................131
IX. RESALE OF SECURITIES RECEIVED UNDER THE PLAN..............................................................131
A. Issuance of New Common Stock.................................................................131
B. Subsequent Transfers of New Common Stock.....................................................131
X. CERTAIN FEDERAL INCOME
TAX CONSEQUENCES OF THE PLAN..........................................................................132
A. United States Federal Income Tax Consequences to the Debtors.................................133
B. Federal Income Tax Consequences to Claimholders and Interestholders
of the Debtors...............................................................................135
C. Importance of Obtaining Professional Tax Assistance..........................................140
XI. FEASIBILITY OF THE PLAN AND THE BEST INTERESTS TEST.......................................................140
A. Feasibility of the Plan......................................................................140
B. Acceptance of the Plan.......................................................................141
C. Best Interests Test..........................................................................141
D. Estimated Valuation of the Reorganized Debtors...............................................142
E. Application of the Best Interests Test to the Liquidation Analysis and the
Valuation of the Reorganized Debtors.........................................................143
F. Confirmation Without Acceptance of All Impaired Classes: The 'Cramdown'
Alternative..................................................................................145
G. Conditions to Confirmation and Consummation of the Plan .....................................146
H. Waiver of Conditions to Confirmation and Consummation of the Plan............................147
I. Retention of Jurisdiction....................................................................147
XII. ALTERNATIVES TO CONFIRMATION AND
CONSUMMATION OF THE PLAN..............................................................................149
A. Continuation of the Bankruptcy Case..........................................................149
B. Alternative Plans of Reorganization..........................................................149
C. Liquidation Under Chapter 7 or Chapter 11....................................................149
-xix-
PAGE
XIII. VOTING REQUIREMENTS.....................................................................................150
A. Parties in Interest Entitled to Vote.........................................................151
B. Classes Impaired Under the Plan..............................................................152
XIV. CONCLUSION...............................................................................................154
A. Hearing on and Objections to Confirmation....................................................154
B. Recommendation...............................................................................154
-xx-
APPENDICES
Appendix A -- First Amended Joint Plan of Reorganization of Kmart
Corporation and Certain of Its Domestic Subsidiaries and
Affiliates, Debtors and Debtors-in-Possession
Appendix B -- Liquidation Analysis
Appendix C -- Pro Forma Financial Projections
Appendix D -- Reorganization Valuation Analysis
Appendix E -- Historical Financial Results
-xxi-
I. INTRODUCTION
Kmart Corporation ("Kmart") and 37 of its domestic subsidiaries and
affiliates (the "Affiliate Debtors"), debtors and debtors-in-possession
(collectively, the "Debtors"), submit this disclosure statement (the "Disclosure
Statement") pursuant to Section 1125 of Title 11 of the United States Code, 11
U.S.C. ss.ss. 101, et seq. (the "Bankruptcy Code") for use in the solicitation
of votes on the First Amended Joint Plan of Reorganization of Kmart Corporation
and its Affiliated Debtors and Debtors-in-Possession (the "Plan") proposed by
the Debtors and filed with the United States Bankruptcy Court for the Northern
District of Illinois, Eastern Division (the "Bankruptcy Court"), on February 25,
2003. A copy of the Plan is annexed as Appendix A hereto.
This Disclosure Statement sets forth certain information regarding the
Debtors' prepetition operating and financial history, the need to seek Chapter
11 protection, significant events that have occurred during the Chapter 11
Cases, and the anticipated organization and operations of the Reorganized
Debtors. This Disclosure Statement also describes terms and provisions of the
Plan, including certain alternatives to the Plan, certain effects of
confirmation of the Plan, certain risk factors associated with securities to be
issued under the Plan, and the manner in which distributions will be made under
the Plan. In addition, this Disclosure Statement discusses the confirmation
process and the voting procedures that Claimholders in Impaired Classes must
follow for their votes to be counted.
FOR A DESCRIPTION OF THE PLAN AND VARIOUS RISK AND OTHER
FACTORS PERTAINING TO THE PLAN AS IT RELATES TO HOLDERS OF CLAIMS AGAINST AND
INTERESTS IN THE DEBTORS, PLEASE SEE SECTION VII - SUMMARY OF THE REORGANIZATION
PLAN AND SECTION VIII - CERTAIN FACTORS TO BE CONSIDERED.
THIS DISCLOSURE STATEMENT CONTAINS SUMMARIES OF CERTAIN PROVISIONS OF
THE PLAN, CERTAIN STATUTORY PROVISIONS, CERTAIN DOCUMENTS RELATED TO THE PLAN,
CERTAIN EVENTS IN THE CHAPTER 11 CASES, AND CERTAIN FINANCIAL INFORMATION.
ALTHOUGH THE DEBTORS BELIEVE THAT SUCH SUMMARIES ARE FAIR AND ACCURATE, SUCH
SUMMARIES ARE QUALIFIED TO THE EXTENT THAT THEY DO NOT SET FORTH THE ENTIRE TEXT
OF SUCH DOCUMENTS OR STATUTORY PROVISIONS. FACTUAL INFORMATION CONTAINED IN THIS
DISCLOSURE STATEMENT HAS BEEN PROVIDED BY THE DEBTORS' MANAGEMENT, EXCEPT WHERE
OTHERWISE SPECIFICALLY NOTED. THE DEBTORS DO NOT WARRANT OR REPRESENT THAT THE
INFORMATION CONTAINED HEREIN, INCLUDING THE FINANCIAL INFORMATION, IS WITHOUT
ANY MATERIAL INACCURACY OR OMISSION.
1
II. BANKRUPTCY PLAN VOTING INSTRUCTIONS AND PROCEDURES
A. DEFINITIONS
Except as otherwise provided herein, capitalized terms not otherwise
defined in this Disclosure Statement have the meanings ascribed to them in the
Plan. In addition, all references in this Disclosure Statement to monetary
figures refer to United States of America currency unless otherwise expressly
provided.
B. NOTICE TO HOLDERS OF CLAIMS AND INTERESTS
This Disclosure Statement is being transmitted to certain Claimholders
for the purpose of soliciting votes on the Plan and to others for informational
purposes. The purpose of this Disclosure Statement is to provide adequate
information to enable the holder of a Claim against the Debtors to make a
reasonably informed decision with respect to the Plan prior to exercising the
right to vote to accept or reject the Plan.
By order entered on February 25, 2003, the Bankruptcy Court approved
this Disclosure Statement as containing information of a kind and in sufficient
and adequate detail to enable Claimholders that are entitled to vote on the Plan
to make an informed judgment with respect to acceptance or rejection of the
Plan. THE BANKRUPTCY COURT'S APPROVAL OF THIS DISCLOSURE STATEMENT DOES NOT
CONSTITUTE EITHER A GUARANTY OF THE ACCURACY OR COMPLETENESS OF THE INFORMATION
CONTAINED HEREIN OR AN ENDORSEMENT OF THE PLAN BY THE BANKRUPTCY COURT.
ALL CLAIMHOLDERS ARE ENCOURAGED TO READ THIS DISCLOSURE
STATEMENT AND ITS APPENDICES CAREFULLY AND IN THEIR ENTIRETY BEFORE
DECIDING TO VOTE EITHER TO ACCEPT OR TO REJECT THE PLAN. This Disclosure
Statement contains important information about the Plan, considerations
pertinent to acceptance or rejection of the Plan, and developments concerning
the Chapter 11 Cases.
THIS DISCLOSURE STATEMENT AND THE OTHER MATERIALS INCLUDED IN THE
SOLICITATION PACKAGE ARE THE ONLY DOCUMENTS AUTHORIZED BY THE COURT
TO BE USED IN CONNECTION WITH THE SOLICITATION OF VOTES ON THE PLAN. No
solicitation of votes may be made except after distribution of this Disclosure
Statement, and no person has been authorized to distribute any information
concerning the Debtors or the Plan other than the information contained herein.
CERTAIN OF THE INFORMATION CONTAINED IN THIS DISCLOSURE STATEMENT IS BY
ITS NATURE FORWARD-LOOKING AND CONTAINS ESTIMATES, ASSUMPTIONS AND PROJECTIONS
THAT MAY BE MATERIALLY DIFFERENT FROM ACTUAL, FUTURE RESULTS. Except with
respect to the projections set forth in Appendix D attached hereto (the
"Projections"), and except as otherwise specifically and expressly stated
herein, this Disclosure Statement does not reflect any events that may occur
subsequent to the date hereof and that may have a material impact on the
information contained in this Disclosure Statement. Neither the Debtors nor the
Reorganized Debtors intend to update the Projections for the purposes hereof;
thus, the Projections will not reflect the impact of any subsequent events not
already accounted for in the assumptions underlying
2
the Projections. Further, the Debtors do not anticipate that any amendments or
supplements to this Disclosure Statement will be distributed to reflect such
occurrences. Accordingly, the delivery of this Disclosure Statement does not
under any circumstance imply that the information herein is correct or complete
as of any time subsequent to the date hereof.
EXCEPT WHERE SPECIFICALLY NOTED, THE FINANCIAL INFORMATION CONTAINED
HEREIN HAS NOT BEEN AUDITED BY A CERTIFIED PUBLIC ACCOUNTANT AND MAY NOT HAVE
BEEN PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES.
C. SOLICITATION PACKAGE
Accompanying this Disclosure Statement are, among other things, copies
of (1) the Plan (Appendix A hereto); (2) the notice of, among other things, the
time for submitting Ballots to accept or reject the Plan; the date, time and
place of the hearing to consider the confirmation of the Plan and related
matters; and the time for filing objections to the confirmation of the Plan (the
"Confirmation Hearing Notice"); and (3) if you are entitled to vote, one or more
Ballots (and return envelopes) to be used by you in voting to accept or to
reject the Plan.
D. GENERAL VOTING PROCEDURES, BALLOTS, AND VOTING DEADLINE
After carefully reviewing the Plan, this Disclosure Statement, and (if
you are entitled to vote) the detailed instructions accompanying your Ballot,
please indicate your acceptance or rejection of the Plan by checking the
appropriate box on the enclosed Ballot. Please complete and sign your original
Ballot (copies will not be accepted) and return it in the envelope provided. You
must provide all of the information requested by the appropriate Ballot. Failure
to do so may result in the disqualification of your vote on such Ballot. Each
Ballot has been coded to reflect the Class of Claims it represents. Accordingly,
in voting to accept or reject the Plan, you must use only the coded Ballot or
Ballots sent to you with this Disclosure Statement.
IN ORDER FOR YOUR VOTE TO BE COUNTED, YOUR BALLOT MUST BE PROPERLY
COMPLETED AS SET FORTH ABOVE AND IN ACCORDANCE WITH THE VOTING INSTRUCTIONS ON
THE BALLOT AND ACTUALLY RECEIVED NO LATER THAN APRIL 4, 2003 AT 4:00 P.M.
(PREVAILING EASTERN TIME) (THE "VOTING DEADLINE") BY THE VOTING AGENT
RESPONSIBLE FOR COLLECTING BALLOTS PERTAINING TO YOUR CLAIM. THERE ARE TWO
VOTING AGENTS IN THIS CASE. INNISFREE M&A INCORPORATED IS THE VOTING AGENT FOR
ALL HOLDERS OF PREPETITION NOTE CLAIMS AND TRUST PREFERRED OBLIGATIONS. TRUMBULL
BANKRUPTCY SERVICES IS THE VOTING AGENT FOR ALL OTHER CLAIMHOLDERS VOTING ON THE
PLAN. YOUR BALLOT CONTAINS THE CONTACT INFORMATION FOR THE VOTING AGENT
RESPONSIBLE FOR COLLECTING BALLOTS PERTAINING TO YOUR CLAIM. THE CONTACT
INFORMATION FOR BOTH VOTING AGENTS IS LISTED BELOW.
BALLOTS RECEIVED AFTER THE VOTING DEADLINE WILL NOT BE COUNTED.
BALLOTS SHOULD NOT BE DELIVERED DIRECTLY TO THE DEBTORS, THE COURT, THE
STATUTORY COMMITTEES OR COUNSEL TO THE DEBTORS OR COUNSEL TO THE STATUTORY
COMMITTEES.
3
E. QUESTIONS ABOUT VOTING PROCEDURES
If (1) you have any questions about (a) the procedure for voting your
Claim, (b) the packet of materials that you have received, or (c) the amount of
your Claim holdings or (2) you wish to obtain an additional copy of the Plan,
this Disclosure Statement, or any appendices or exhibits to such documents
please contact:
Prepetition Note Claims and Prepetition Lender Claims, Trade Vendor/
Trust Preferred Obligations Lease Rejection Claims, and Other Unsecured Claims
Innisfree M&A Incorporated Trumbull Bankruptcy Services
501 Madison Avenue, 20th Floor P.O. Box 426
New York, New York 10022 Windsor, Connecticut 06095
Attn: Kmart Corporation Attn: Kmart Balloting Center
Telephone: (877) 750-2689 Telephone: (877) 876-2705
FOR FURTHER INFORMATION AND INSTRUCTION ON VOTING TO ACCEPT OR REJECT
THE PLAN, SEE SECTION XII - VOTING REQUIREMENTS.
F. CONFIRMATION HEARING AND DEADLINE FOR OBJECTIONS TO CONFIRMATION
Pursuant to Section 1128 of the Bankruptcy Code and Federal Rule of
Bankruptcy Procedure 3017(c), the Bankruptcy Court has scheduled the
Confirmation Hearing to begin on April 14, 2003, at 10:00 a.m. (prevailing
Central time) before the Honorable Susan Pierson Sonderby, United States
Bankruptcy Judge, at the Everett McKinley Dirksen Courthouse, 219 South Dearborn
Street, Chicago, Illinois 60604, Courtroom 1725. The Confirmation Hearing may be
adjourned from time to time by the Bankruptcy Court without further notice
except for the announcement of the adjournment date made at the Confirmation
Hearing or at any subsequent adjourned Confirmation Hearing. The Bankruptcy
Court has directed that objections, if any, to confirmation of the Plan be filed
with the Clerk of the Bankruptcy Court and served so that they are ACTUALLY
RECEIVED on or before April 4, 2003, at 4:00 p.m. (prevailing Central time) by:
Counsel for the Debtors
Skadden, Arps, Slate, Meagher & Flom (Illinois)
333 West Wacker Drive
Chicago, Illinois 60606-1285
Attn: John Wm. Butler, Jr., Esq.
United States Trustee
The Office of the United States Trustee
227 West Monroe Street, Suite 3350
Chicago, IL 60606
Attn: Kathryn M. Gleason, Esq.
4
Counsel for the Creditors' Committee
Otterbourg, Steindler, Houston & Rosen, P.C.
230 Park Avenue
New York, NY 10169
Attn: Glenn B. Rice, Esq.
Scott L. Hazan, Esq.
Winston & Strawn
35 West Wacker Drive
Chicago, IL 60601
Attn: Matthew J. Botica, Esq.
Counsel for the Financial Institutions' Committee
Jones Day
901 Lakeside Avenue
Cleveland, OH 44114
Attn: Richard M. Cieri, Esq.
Jones Day
77 West Wacker Drive
Chicago, IL 60601
Attn: Paul E. Harner, Esq.
Ray C. Schrock, Esq.
Counsel for the Equity Committee
Goldberg, Kohn, Bell, Black, Rosenbloom & Moritz, Ltd.
55 East Monroe Street
Suite 3700
Chicago, IL 60603
Attn: Randall L. Klein, Esq.
Counsel for the Prepetition Lenders
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, NY 10017
Attn: Peter V. Pantaleo, Esq.
Counsel for Plan Investors
Wachtell, Lipton, Rosen & Katz
51 West 52nd Street
New York, NY 10019
Attn: Scott K. Charles, Esq.
5
III. HISTORY OF THE DEBTORS
A. OVERVIEW OF BUSINESS OPERATIONS
1. Summary of the Debtors' Business History.
Kmart was incorporated under the laws of the State of Michigan on March
9, 1916, as the successor to the business developed by its founder, Sebastian
Spering Kresge, who opened his first store in 1899. When Kresge opened his first
store, he sold everything for five or ten cents. The low prices appealed to
shoppers and allowed him to expand to 85 stores by 1912, with annual sales of
more than $10 million. When war and financial depressions hit America over the
next several decades, the Kresge stores continued to offer families products at
prices they could afford and jobs to support American families. By the
mid-1920s, Kresge was opening locations that sold items for $1 or less, a
precursor to the current discount store. These "green-front" stores often were
right next to the traditional red-front, five-and-dime Kresge stores.
As the retail environment became more competitive, Kresge again blazed
the trail for future retailers by launching a newspaper advertising program to
entice shoppers to its stores. Those print ads were the precursor to radio
promotions, which followed 20 years later, and then television commercials which
began to air in 1968. Kmart continues to be the leading print promotional
retailer, with weekly circulars reaching more than 70 million households.
By the late 1950s, it was evident that the company needed to change to
continue to be a leader in the growingly competitive retail environment. That
change came through Harry B. Cunningham, who became President in 1959.
Cunningham had been studying other discount houses and developed a new strategy
for the organization. Under Cunningham's leadership, the first Kmart discount
department store opened in 1962 in Garden City, Michigan. Seventeen additional
Kmart stores opened that year, leading to corporate sales of more than $483
million. Just four years later in 1966, sales from 162 Kmart stores and 753
Kresge stores topped the $1 billion mark. In 1976, Kresge made history by
opening 271 Kmart stores in one year, becoming the first-ever retailer to launch
17 million square feet of sales space in a single year.
In 1977, nearly 95% of Kresge company sales were generated by Kmart
stores. To reflect this dramatic impact, the company officially changed its name
to Kmart Corporation. Ten years later, Kmart sold the remaining Kresge stores to
fully concentrate on discount merchandising. In 1990, Kmart unveiled a bold new
logo and a bold new plan: a five-year, $3.5 billion new-store opening,
enlargement, and modernization program to focus the business on its Kmart
stores. In 1991, as part of the new plan, Kmart opened the first Kmart
Supercenter in Medina, Ohio, offering a full-service grocery along with general
merchandise 24 hours a day, seven days a week.
Kmart began expanding its business operations in 1984 through the
acquisition of several specialty stores. In that year, Kmart acquired Walden
Book Company and Home Centers of America, which was subsequently renamed
Builders Square. Six years later in 1990, Kmart purchased The Sports Authority,
a chain of sporting goods super stores, and a 22% ownership interest in
OfficeMax (later increased to over 90% in 1991). In 1992, Kmart acquired
Borders, a chain of book super stores in the Midwest and Northeast. While Kmart
acquired interests in these businesses in order to diversify its business lines,
Kmart incurred a significant amount of debt in connection with the acquisitions
and
6
ultimately was diverted from its core business as a discount merchandise
retailer. In 1994, Kmart therefore began to divest itself of its interests in
certain of these entities by completing initial public offerings of portions of
its interests in The Sports Authority, OfficeMax, and Borders. In 1995 and 1997,
Kmart sold its remaining interests in The Sports Authority, OfficeMax, and
Builders Square. Although Kmart no longer has any interests in these specialty
stores, it remains obligated on significant lease guarantee obligations in
connection with these businesses. These liabilities are summarized in greater
detail in Section IV.D. of this Disclosure Statement.
In 1996, a complete redesign of the Kmart store was launched, making
them cleaner, brighter and easier to shop. A "Pantry" department, selling
frequently-purchased consumable goods, was moved toward the front of the store
and a new focus was placed on the Children's and Home Fashions departments.
These "big" changes were signified by a new name for the remodeled stores: "Big
Kmart." To further expand the reach of the company, in December 1999, Kmart,
with investment partners, launched a new Internet presence, BlueLight.com, which
operated an e-commerce site and provided internet service. By initially offering
free Internet service, BlueLight was able to register a record-breaking number
of users in its first few months. Shoppers now know the e-commerce and
information site as www.kmart.com.
2. The Debtors' Position in the Retail Industry; Exclusive Brands.
As of the commencement of these Chapter 11 Cases, Kmart was the
nation's second largest discount retailer and the third largest general
merchandise retailer, operating 2,114 stores, including 136 supercenters, with
locations in each of the 50 United States, Puerto Rico, the U.S. Virgin Islands
and Guam, and an e-commerce shopping site. As of October 15, 2002, Kmart's
retail operations were located in 308 of the 324 metropolitan statistical areas
in the United States.
Kmart employed approximately 234,000 employees nationwide, making it
one of the largest employers in the United States with annual payroll and
benefits of over $5 billion. For the fiscal year ended January 2002, Kmart had
consolidated net sales of approximately $36 billion, administered $14.3 billion
in assets at book value, and reported total liabilities of approximately $10
billion.
Kmart has relationships with more than 4,000 merchandise vendors
worldwide and is one of the country's largest purchasers of products. Kmart's
stores are generally one-floor, free-standing units ranging in size from 40,000
to 190,000 square feet. Most of Kmart's store locations are leased from
unrelated third parties. As of the commencement of these Chapter 11 Cases, Kmart
was a party to over 5,000 leases and subleases, had relationships with
approximately 3,240 landlords and subtenants, and was a party to over 6,300
additional executory contracts. Kmart had two principal equity investments,
including a 49% interest in substantially all of the Meldisco subsidiaries of
Footstar, Inc., operator of the footware departments in Kmart stores, and a 36%
interest in Penske Auto Centers, LLC, which formerly operated Penske auto
service centers at certain Kmart stores.
Kmart has several major competitors on a national level, including
Wal-Mart, Target, Sears, Kohl's, and J.C. Penney, and many competitors on a
local and regional level which compete with Kmart's individual stores. Success
in this competitive retail environment is based on factors such as price,
quality, service, product assortment and convenience. Due to the seasonal nature
of the retail industry, where merchandise sales and cash flows from operations
are historically higher in the fourth calendar quarter than any other period, a
disproportionate amount of revenues and operating cash flows
7
are generated during the holiday season. In preparation for the fourth quarter
holiday season, Kmart significantly increases its merchandise inventories, which
traditionally have been financed by cash flow from operations, bank lines of
credit, and trade credit from vendors. Kmart's profitability and cash flow are
primarily dependent upon the large sales volume generated during the fourth
quarter of its fiscal year. Fourth quarter sales represented over 30% of total
net sales in fiscal 2001.
A key component of Kmart's strategy is its investment in merchandising
and marketing initiatives that enhance its strategic position by offering
exclusive brands that differentiate Kmart from its competitors. Pursuant to this
strategy, Kmart has license agreements with Martha Stewart Living Omnimedia,
Inc. for Martha Stewart Everyday home, garden, housewares and seasonal products;
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
non-character apparel for infants and children; Sesame Workshop for Sesame
Street apparel for infants and children; Joe Boxer Licensing, LLC for Joe Boxer
apparel, accessories and home furnishings; Route 66, L.P. for Route 66 apparel
and accessories; Avmark, Inc. for Curtis Mathes consumer video, audio and
telecommunications products; and T Enterprises, LLC for the right to utilize the
name, likeness, and signature of Ariadna Sodi Miranda, professionally known as
Thalia.
[THALIA LOGO] [DISNEY LOGO] [KATHY IRELAND LOGO]
[MARTHA STEWART LIVING LOGO] [JOE BOXER LOGO] [ROUTE 66 LOGO]
[JACLYN SMITH LOGO] [SESAME STREET LOGO] [CURTIS MATHIS LOGO]
Kmart believes that focusing its merchandising and marketing approach
on quality name brands builds customer loyalty and increases shopping frequency.
Indeed, Martha Stewart is a leading brand for home fashions and is widely
recognized for quality. The Martha Stewart brand increases customer purchases of
other products and has significant product expansion opportunities for Kmart.
Similarly, the Jaclyn Smith line of products is Kmart's premier ladies
sportswear brand and has consistently ranked among the most recognizable in the
industry. The Kathy Ireland brand is Kmart's contemporary sportswear line and
generates substantial customer loyalty. The Disney brand has universal customer
appeal and very broad customer awareness. The Disney brand is repeatedly ranked
among the top consumer brands for quality and value, and is the leading brand
for children in the three to eleven age group. The Joe Boxer product launch in
August 2002 was the most successful in Kmart's history and creates a fun,
high-quality image among Generation Y shoppers.
8
The Sesame Street line of products represents the "gold standard" with
moms and kids, whereas the Route 66 line of products is a cross-divisional brand
offering trendy casual clothing. The Curtis Mathes line of products represents a
value brand that offers functionality equivalent to the leading national brands
yet provides Kmart with better than average gross margins. The Curtis Mathes
line of products consistently produces high sales volume. Finally, the Thalia
brand represents an opportunity to strengthen business among Hispanics. This
demographic group accounts for more than 17% of the Debtors' total sales and
represents the fastest growing segment of the population.
Kmart recently unveiled a new round of commercials focused on two of
its key assets: its high-quality, exclusive brands and its across-the-store
value proposition. The latest commercials in its "Stuff of Life" advertising
campaign include the Martha Stewart Everyday brand featuring Martha Stewart and
the Jaclyn Smith brand featuring Jaclyn Smith. These commercials were directed
by award-winning film maker Spike Lee. Other commercial spots focus on Kmart's
outstanding value-for-the-money proposition and the corporate branding message,
positioning Kmart as the one store where consumers can get all their everyday
needs and wants. Finally, Kmart recently unveiled a multi-faceted media campaign
including television, print and direct mail for Joe Boxer apparel. The Joe Boxer
media campaign focused on the fun, irreverent nature of the Joe Boxer brand.
B. RECENT FINANCIAL RESULTS
Set forth in Appendix E are the following selected financial data for
the Debtors: (i) statements of operations on a consolidated basis for the fiscal
years ended January 30, 2002, January 31, 2001, and January 26, 2000,
respectively; (ii) balance sheets on a consolidated basis for the fiscal years
ended January 30, 2002, and January 31, 2001, respectively; and (iii) statements
of cash flows on a consolidated basis for the fiscal years ended January 30,
2002, January 31, 2001, and January 26, 2000, respectively. The notes that
accompany the financial statements were contained in Kmart's Annual Report on
Form 10-K/A for the Fiscal Year Ended January 30, 2002 (the "Form 10-K/A"). The
footnotes are an integral component of these statements and should be read in
conjunction with the Form 10-K/A.
IV. PREPETITION CAPITAL STRUCTURE OF THE DEBTORS
Prior to the Petition Date, Kmart's liquidity depended primarily on
cash provided from its operations, access to capital markets, bank lines of
credit and sale/leaseback and other real estate financing transactions.
A. PREPETITION CREDIT FACILITIES
1. The Three-Year Credit Agreement.
Kmart entered into a credit agreement (as amended, supplemented,
restated or otherwise modified, the "Three-Year Credit Agreement"), dated as of
December 6, 1999, by and among Chase Securities, Inc., n/k/a JP Morgan
Securities, as lead arranger and book manager, The Chase Manhattan Bank, n/k/a
JP Morgan Chase Bank, as administrative agent, Bank of America, National
Association, as syndication agent, BankBoston N.S. and Bank of New York, as
co-documentation agents, and the lenders named therein. The Three-Year Credit
Agreement provided Kmart with a total revolving facility of $1,100,000,000 and
had a maturity date of December 6, 2002. This facility permitted Kmart
9
to borrow in U.S. dollars on a revolving credit basis and provided for a letter
of credit sub-facility. As of the Petition Date, Kmart was indebted to the
lenders under the Three-Year Credit Agreement in the principal amount of
approximately $684 million plus accrued interest and applicable costs, expenses,
and fees. In addition, approximately $129 million in letters of credit were
issued and outstanding under this facility. This combined indebtedness is
unsecured. Kmart's obligations under the Three-Year Credit Agreement are
guaranteed by certain of Kmart's subsidiaries. Certain parties-in-interest have
raised certain issues in connection with the enforceability of these guarantees
and Kmart's transfer of certain of its assets to the subsidiary-guarantors. See
Section VII.A. of this Disclosure Statement for a discussion of these issues.
2. The 364-Day Credit Agreement.
Kmart entered into a credit agreement (as amended, supplemented,
restated or otherwise modified, the "364-Day Credit Agreement"), dated as of
November 13, 2001, by and among Kmart, Credit Suisse First Boston, Fleet
National Bank and Bank of New York, as co-syndication agents, The Chase
Manhattan Bank, n/k/a JP Morgan Chase Bank, as administrative agent, J.P. Morgan
Securities, Inc., as advisor, arranger and bookrunner, and the lenders named
therein. The 364-Day Credit Agreement provided Kmart with a total revolving
facility of $400,000,000 and had a maturity date of November 12, 2002. This
facility permitted Kmart to borrow in U.S. dollars on a revolving credit basis.
As of the Petition Date, Kmart was indebted to the lenders under the 364-Day
Credit Agreement in the principal amount of approximately $393 million plus
accrued interest and applicable costs, expenses, and fees. This indebtedness is
unsecured. Kmart's obligations under the 364-Day Credit Agreement are guaranteed
by certain of Kmart's subsidiaries. Certain parties-in-interest have raised
certain issues in connection with the enforceability of these guarantees and
Kmart's transfer of certain of its assets to the subsidiary-guarantors. See
Section VII.A. of this Disclosure Statement for a discussion of these issues.
B. PREPETITION NOTES AND RELATED OBLIGATIONS
Kmart is a party to a number of indentures pursuant to which Kmart
issued various unsecured notes and debentures. In particular, Kmart owed
approximately $871 million principal amount of unsecured obligations issued
pursuant to that certain Indenture, dated as of February 1, 1985, as amended,
between Kmart and The Bank of New York, as original indenture trustee. These
obligations include the following:
MATURITY INSTRUMENT PRINCIPAL AMOUNT OF DEBT
DATE (US$ EQUIVALENT)
03/01/05 12 1/2% Debentures $100,000,000
12/01/06 8 1/8% Debentures $200,000,000
10/01/12 7 3/4% Debentures $157,257,000
01/01/22 8 1/4% Debentures $ 68,055,000
10
MATURITY INSTRUMENT PRINCIPAL AMOUNT OF DEBT
DATE (US$ EQUIVALENT)
07/01/22 8 3/8% Debentures $ 85,550,000
02/01/23 7.95% Debentures $259,800,000
Total $870,662,000
In addition, as of the Petition Date, Kmart owed approximately
$222,935,000 principal amount of unsecured Series C Medium Term Notes and Series
D Medium Term Notes pursuant to the Indenture under which the foregoing notes
and debentures were issued.
As of the Petition Date, Kmart owed another $1.13 billion principal
amount of unsecured obligations pursuant to that certain Indenture, dated as of
December 13, 1999, as amended, between Kmart and The Bank of New York, as
original indenture trustee. These obligations include the following:
MATURITY INSTRUMENT AGGREGATE PRINCIPAL
DATE AMOUNT OF DEBT (US$
EQUIVALENT)
12/01/04 8.375% Notes $ 300,000,000
02/01/06 9.375% Notes $ 400,000,000
06/15/08 9.875% Notes $ 430,000,000
Total $ 1,130,000,000
Lastly, Kmart is a party to that certain Commercial Development Revenue
Refunding Bonds (Kmart Corporation Project) Series 1994 in the aggregate
outstanding principal amount of $1,800,000.00, issued under or in connection
with the trust indenture dated as of November 1, 1994 by and between The County
Commission of Harrison County, as issuer, and JP Morgan Trust Company, N.A. (as
successor to Society National Bank), as indenture trustee, as thereafter
succeeded in that capacity by Wilmington Trust Company as successor indenture
trustee, and all of the right, title and interest of Harrison County in and
under the Loan Agreement and the Promissory Note made between Kmart and The
County Commission of Harrison County.
C. TRUST SECURITIES
In June 1996, Kmart Financing I, a Delaware business trust sponsored
and wholly-owned by Kmart, issued to the public 20,000,000 trust convertible
preferred securities in the face amount of $1 billion (the "Trust Securities").
The proceeds from the sale of the Trust Securities, together with the proceeds
of a sale of common trust securities to Kmart, were used to purchase from Kmart
7 3/4% subordinated convertible debentures due June 15, 2016 in the face amount
of $1 billion, which were issued pursuant to that certain Indenture, dated June
6, 1996, between Kmart and The Bank of New
11
York, as trustee. The debentures are the sole asset of the trust. The Trust
Securities accrue and pay cash distributions quarterly at a rate of 7 3/4% per
annum. Kmart guaranteed, on a subordinated basis, distributions and other
payments due on the Trust Securities. Kmart has stopped accruing distributions
on the Trust Securities. Contractual distributions for fiscal year 2001 on the
Trust Securities were $72 million.
The Trust Securities are convertible at the option of the holder at any
time at the rate of 3.3333 shares of Kmart common stock for each Trust Security,
and are mandatorily redeemable upon repayment of the debentures, either at
maturity on June 15, 2016, or upon their earlier redemption. The debentures
became callable at Kmart's option beginning June 15, 1999. During fiscal year
2000, Kmart repurchased approximately 2 million shares of Trust Securities at a
cost of approximately $84 million. After taking into consideration recent
conversions, the face value of the outstanding obligations as of January 1, 2003
was $648,043,500.
The rights of holders of the Trust Securities to certain distributions
in the event of reorganization proceedings of the Debtors are subordinated to
the rights of the lenders under the Three-Year Credit Agreement and the 364-Day
Credit Agreement, and to the rights of holders of the Prepetition Notes.
Pursuant to these subordination rights, distributions proposed to be made to
holders of the Trust Securities therefore must be made to holders of the
Prepetition Notes until their claims are paid in full.
D. OTHER MATERIAL DEBT OBLIGATIONS
As of October 30, 2002, Kmart 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., Borders Group, Inc., and Office
Max, Inc., some of which leases have been assigned pre-petition; (ii) a
contingent liability under real property leases assigned by Kmart pre-petition;
and (iii) guaranteed approximately $70 million of indebtedness of other parties
related to certain leased properties financed by industrial revenue bonds.
Kmart's rights and obligations with respect to its guarantee of leases of the
former subsidiaries as of October 30, 2002, which are detailed below, are
governed by Lease Guaranty, Indemnification and Reimbursement Agreements dated
as of November 23, 1994, November 9, 1994 and May 24, 1995, respectively, as
amended from time to time. The Debtors intend to move, pursuant to Rule 3018 of
the Bankruptcy Rules, that the Court estimate the claims related to these
guaranties at zero dollars.
Present Value of
Future Lease Gross Future
($ millions) Obligations @ 7% Lease Obligations
--------------- -----------------
The Sports Authority, Inc. $ 172 $ 292
Borders Group, Inc. 83 141
OfficeMax, Inc. 59 86
------- --------
Total $ 314 $ 519
12
E. EQUITY
As of December 17, 2002, there were 519,050,664 shares of common stock
of Kmart issued, outstanding and publicly traded. Prior to December 19, 2002,
Kmart's common stock was listed on the New York, Pacific and Chicago Stock
Exchanges. There were a number of continuing requirements that had to be
satisfied in order for Kmart's stock to remain eligible for quotation on the New
York Stock Exchange (the "NYSE"). On July 10, 2002, Kmart received notification
from the NYSE that Kmart was not in compliance with the requirements for
continued listing and, accordingly, that Kmart could be subject to trading
suspension and delisting. As of December 19, 2002, Kmart's common stock and the
trust preferred securities were suspended from trading by the NYSE and the
Pacific and Chicago Exchanges, and have subsequently been delisted from these
exchanges. The new ticker symbols KMRTQ and KMTPQ have been assigned to Kmart's
common stock and the trust preferred securities, respectively, by the
over-the-counter bulletin board (the "OTCBB"). Kmart's common stock and the
trust preferred securities are presently being quoted on the Pink Sheets
Electronic Quotation Service.
V. CORPORATE STRUCTURE OF THE DEBTORS
A. CURRENT CORPORATE STRUCTURE
Kmart is incorporated in Michigan. It is the parent corporation of 37
direct and indirect domestic subsidiaries, which are the Debtors in these
jointly administered Chapter 11 Cases. None of Kmart's foreign subsidiaries
filed for relief either in the United States or in their domicile and each are
continuing normal business operations.
B. BOARD OF DIRECTORS OF KMART
The following persons comprise the Board of Directors of Kmart.
NAME POSITION
---- --------
James B. Adamson Chairman of the Board
Lilyan H. Affinito Director
Richard G. Cline Director
Willie D. Davis Director
Joseph Flannery Director
Robert D. Kennedy Director
Robin B. Smith Director
Thomas Stallkamp Director
Richard J. Statuto Director
James B. Adamson, 54, Chairman of the Board of Kmart and former Chief
Executive Officer of Kmart. Former Chairman, Advantica Restaurant Group
(formerly Flagstar Corporation) (food services and restaurant franchises).
Previously served as Chief Executive Officer and President, Denny's Inc. and as
Chief Executive Officer, Chief Operating Officer and Retail President of Burger
King Corporation. Has served as a director of Kmart Corporation since 1996.
13
Lilyan H. Affinito, 71, Former Vice Chairman of the Board of Maxxam
Group Inc. (forest products operations, real estate management and development
and aluminum production). Director of Caterpillar, Inc. Has served as a director
of Kmart since 1990.
Richard G. Cline, 67, Chairman, Hawthorne Investors, Inc. (management
advisory services and private investments). Previously served as Chairman and
Chief Executive Officer and as Chairman, President and Chief Executive Officer
of Nicor, Inc. (natural gas distribution and containerized shipping) and as
Chairman, Hussmann International, Inc. (refrigerated merchandising equipment).
Director of Ryerson Tull, Inc. and PepsiAmericas, Inc. Chairman and Trustee of
Northern Funds and Northern Institutional Funds. Has served as a director of
Kmart since 1995.
Willie D. Davis, 68, President of All Pro Broadcasting, Inc. (radio
stations). Director of Alliance Bank, Bassett Furniture Industries,
Incorporated, Checkers, Inc., The Dow Chemical Company, Johnson Controls, Inc.,
MGM Mirage, Inc., MGM, Inc., Sara Lee Corporation, Strong Funds and Wisconsin
Energy Corporation. Has served as a director of Kmart since 1986.
Joseph P. Flannery, 70, Chairman of the Board, President and Chief
Executive Officer of Uniroyal Holding, Inc. (investment management company).
Director of ArvinMeritor, Inc., Ingersoll Rand Company, Newmont Mining
Corporation and The Scotts Company. Has served as a director of Kmart since
1985.
Robert D. Kennedy, 70, Former Chairman and Chief Executive Officer of
Union Carbide Corporation (chemicals and plastics manufacturer). Director of
Chase Industries, Inc., Hercules, Inc., International Paper, Inc. and Sunoco,
Inc. Has served as a director of Kmart since 1996.
Robin B. Smith, 63, Chairman of Publishers ClearingHouse (distribution
of publications). Previously served as President and Chief Executive Officer of
Publishers ClearingHouse. Director of BellSouth Corp. and of Prudential
Investments mutual funds. Has served as a director of Kmart since 1996.
Thomas T. Stallkamp, 56, Vice Chairman and Chief Executive Officer, MSX
International (provider of technology based business systems and services).
Previously served as Vice Chairman and as President of DaimlerChrysler
Corporation and as President of Chrysler Corporation. Director of Baxter
International, Inc. Has served as a director of Kmart since 1999.
Richard J. Statuto, 45, President and Chief Executive Officer of St.
Joseph Health Systems (provider of hospital, physician, homecare, wellness and
insurance services). Previously served as Chief Operating Officer and Vice
President of Marketing and Planning of St. Joseph Health Systems. Also
Vice-Chairman of Christus Health. Has served as a director of Kmart since 2001.
C. SENIOR MANAGEMENT OF KMART
The following persons comprise the senior management of Kmart.
Julian C. Day, 50, Chief Executive Officer and President. Mr. Day
joined Kmart on March 11, 2002 as President and Chief Operating Officer, and was
named Chief Executive Officer effective January 17, 2003. Prior to joining
Kmart, he was the Executive Vice President and Chief Operating
14
Officer at Sears Roebuck, Inc. from 1999 to 2002; Executive Vice President and
Chief Financial Officer at Safeway, Inc. from 1993 to 1998; and President and
Chief Executive Officer of Bradley Printing Company from 1991 to 1992.
Ronald B. Hutchison, 52, Executive Vice President, Chief Restructuring
Officer. Mr. Hutchison joined Kmart under his current title on January 17, 2002.
Prior thereto he was the Executive Vice President, Chief Financial Officer at
Advantica Restaurant Group from 1995 to 2002; and Vice President,
Treasurer/Taxes at Leaseway Corporation from 1980 to 1995.
Michael T. Macik, 56, Executive Vice President, Human Resources. Mr.
Macik joined Kmart under his current title on April 9, 2002. Prior thereto he
was the Executive Vice President, Chief Operating Officer at Right Management
Associates from 2001 to 2002 and the Vice President, Human Resources at Kmart
from 1992 to 2001.
William D. Underwood, 62, Executive Vice President, Kmart Sourcing and
Global Operations. Mr. Underwood joined Kmart in 1962 when it was still S.S.
Kresge Company, as a Management Trainee, thereafter working his way through
Store Manager, District Manager and other positions until becoming Senior Vice
President, Global Sourcing in 1997 through 1998; and Senior Vice President,
Global Operations, Corporate Brands and Quality Assurance in 1998 through 1999,
after which Mr. Underwood retired. Mr. Underwood rejoined Kmart in June 2002.
James E. Defebaugh, IV, 48, Senior Vice President, Chief Compliance
Officer and Secretary. Mr. Defebaugh assumed his current position in 2002. Prior
thereto he held the following positions at Kmart: Vice President, Associate
General Counsel and Secretary from 2001 to 2002; Vice President and Secretary
during 2001; and Vice President, Legal from 2000 to 2001.
Albert A. Koch, 60, Chief Financial Officer. Mr. Koch joined Kmart
under his current title on March 11, 2002 pursuant to an agreement between Kmart
and JA&A Services LLC, n/k/a AP Services, LLC, an affiliate of Jay Alix &
Associates, n/k/a Alix Partners, LLC. Prior thereto he held the following
positions at Jay Alix and Associates: Chairman from 2001 to the present and
Managing Principal from 1995 to 2001.
Richard J. Noechel, 34, Vice President, Controller. Mr. Noechel assumed
his current position in 2001. Prior thereto he was the Divisional Vice
President, Financial Reporting at Kmart in 2001; Senior Manager International
Accounting at DaimlerChrysler Corporation from 2000 to 2001; Forecast Team
Leader at DaimlerChrysler Corporation from 1998 to 2000; Accounting Research
Specialist at Chrysler Corporation from 1997 to 1998; and a manager at Price
Waterhouse LLP from 1996 to 1997.
Edward J. Stenger, 45, Treasurer. Mr. Stenger joined Kmart under his
current title on March 11, 2002 pursuant to an agreement between Kmart and JA&A
Services, LLC, n/k/a AP Services, LLC, an affiliate of Jay Alix & Associates,
n/k/a Alix Partners, LLC. Prior thereto he held the following positions at Jay
Alix & Associates: Co-Managing Director from 2000 to the present and a Principal
from 1992 to 2000.
15
VI. THE CHAPTER 11 CASES
A. EVENTS LEADING TO COMMENCEMENT OF THE CHAPTER 11 CASES
Kmart's decision to commence Chapter 11 reorganization cases was based
on a combination of factors. Some of these factors - including intense
competition in the discount retailing industry and a series of unsuccessful
sales and marketing initiatives - developed over a relatively long period of
time prior to the Chapter 11 filing. Other factors, however, arose in the final
days of 2001 and the very early part of January 2002. These factors included,
without limitation, a rapid decline in the Debtors' liquidity resulting from
below-plan sales and earnings performance in the fourth quarter of the 2001
fiscal year, the evaporation of the surety bond market, erosion of supplier
confidence, and volatility in the capital markets.
As a result of these factors, Kmart concluded that the commencement of
the Chapter 11 Cases was in the best interests of all stakeholders and was
necessary to protect the estates from the risk of remedial action by certain
creditors. Kmart also determined that it would be difficult, outside of
reorganization proceedings, for Kmart and its affiliated debtors to withstand
the downturn in the economic environment. Finally, Kmart determined that it
would benefit from orderly asset sales and lease dispositions under a process
supervised by the Bankruptcy Court. Based upon the foregoing, Kmart believed
that the commencement of the Chapter 11 Cases would enable the company to move
forward with a refocused strategic plan while restructuring certain of its
business operations.
B. CONTINUATION OF BUSINESS; STAY OF LITIGATION
On January 22, 2002, Kmart and 37 affiliate debtors filed voluntary
petitions in the Bankruptcy Court for reorganization relief under Chapter 11 of
the Bankruptcy Code. Since the Petition Date, the Debtors have continued to
operate as debtors-in-possession subject to the supervision of the Bankruptcy
Court and in accordance with the Bankruptcy Code. The Debtors are authorized to
operate their business in the ordinary course of business, with transactions out
of the ordinary course of business requiring Bankruptcy Court approval.
An immediate effect of the filing of the Debtors' bankruptcy petitions
was the imposition of the automatic stay under the Bankruptcy Code which, with
limited exceptions, enjoined the commencement or continuation of all collection
efforts by creditors, the enforcement of liens against property of the Debtors,
and the continuation of litigation against the Debtors. This relief provided the
Debtors with the "breathing room" necessary to assess and reorganize their
business. The automatic stay remains in effect, unless modified by the
Bankruptcy Court, until consummation of a plan of reorganization.
C. SUMMARY OF CERTAIN RELIEF OBTAINED AT THE OUTSET OF THE CHAPTER 11
CASES
1. First Day Orders.
On January 22, 2002, the Debtors filed several motions seeking the
relief provided by certain so-called "first day orders." First day orders are
intended to facilitate the transition between a debtor's prepetition and
postpetition business operations by approving certain regular business conduct
that may not be authorized specifically under the Bankruptcy Code or as to which
the Bankruptcy Code requires prior approval by the Bankruptcy Court.
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The first day orders in the Chapter 11 Cases, which were entered over
the course of several days after the January 22, 2002 petition date, authorized,
among other things:
- the retention of the following professionals to serve on
behalf of the Debtors: Skadden, Arps, Slate, Meagher & Flom
(Illinois) and its affiliated law practice entities as
restructuring counsel; PricewaterhouseCoopers LLP as financial
advisor; Dresdner Kleinwort Wasserstein, Inc. (the
restructuring practice of Dresdner Kleinwort Wasserstein was
spun off as an independent entity in July 2002 and is known as
Miller Buckfire Lewis & Co., LLC) as financial advisor and
investment banker; Rockwood Gemini Advisors as real estate
advisor; and Trumbull Services, LLC as claims and noticing
agent;
- the continued retention of professionals regularly employed by
the Debtors in the ordinary course of their business;
- the maintenance of the Debtors' bank accounts and operation of
their cash management systems substantially as such systems
existed prior to the Petition Date;
- the payment of employees' accrued prepetition wages and
employee benefit claims;
- the payment of certain prepetition obligations to customers
and the continuation of customer programs and practices;
- the payment of certain prepetition shipping and delivery
charges;
- the payment of prepetition obligations necessary to obtain
imported merchandise;
- payment of prepetition claims of certain critical trade
vendors;
- procedures for the resolution and payment of valid
reclamation, PACA and PASA claims;
- the payment of certain prepetition mechanics' liens of
contractors and services providers;
- the initial rejection of leases of dark stores;
- the continuation of utility services during the pendency of
the Chapter 11 Cases;
- the payment of certain prepetition tax claims; and
- the joint administration of each of the Debtors' bankruptcy
cases.
2. Appointment of Statutory Committees.
On January 31, 2002, the Office of the United States Trustee for the
Northern District of Illinois (Eastern Division) (the "United States Trustee")
appointed, pursuant to Section 1102 of the Bankruptcy
17
Code, an Official Unsecured Creditors' Committee (the "Creditors' Committee"),
which is generally comprised of trade vendors and other general unsecured
creditors, and an Official Financial Institutions' Committee, which is generally
comprised of certain of the Debtors' Prepetition Lenders and holders of
Prepetition Notes.
The following creditors were selected from the trade vendors and other
general unsecured creditors as members of the Creditors' Committee: (i) American
Greetings Corp.; (ii) Bridgeford Food of Illinois Corp.; (iii) Buena Vista Home
Video; (iv) Euler American Credit Indemnity Company; (v) Fuji Photo Film U.S.A.,
Inc.; (vi) GMAC Commercial Credit Corp.; (vii) Kimco Realty Corporation; (viii)
Mattel, Inc.; (ix) Newell Rubbermaid, Inc.; (x) the Pension Benefit Guaranty
Corporation; (xi) PepsiCo, Inc.; (xii) Sara Lee Corporation; (xiii) Twentieth
Century Fox Home Entertainment, Inc. Newell Rubbermaid resigned on October 9,
2002, and was replaced by The Gillette Company.
The Creditors' Committee is represented by Otterbourg, Steindler,
Houston & Rosen, P.C., whose office is located in New York, New York. Co-Counsel
to the Creditors' Committee is the law firm of Winston & Strawn of Chicago,
Illinois. The Creditors' Committee's financial advisor is KMPG LLP.
The following creditors were selected from the Prepetition Lenders and
Prepetition Noteholders as members of the Financial Institutions' Committee: (i)
Bank of New York; (ii) Credit Suisse First Boston; (iii) First Union National
Bank; (iv) Fleet National Bank; (v) HSBC Bank USA; (vi) JP Morgan Chase Bank;
and (vii) Wilmington Trust Company, as successor indenture trustee for the
Prepetition Notes. On March 21, 2002, the United States Trustee filed a notice
that HSBC Bank USA had resigned from the Financial Institutions' Committee. On
July 10, 2002, the United States Trustee filed a notice that Wachovia Bank
National Association (f/k/a First Union National Bank) and Credit Suisse First
Boston had resigned from the Financial Institutions' Committee, and that
Comerica Bank had been appointed as a member of the Financial Institutions'
Committee. On September 11, 2002, Third Avenue Value Fund and ESL Investments,
Inc. were each appointed members of the Financial Institutions' Committee.
Comerica Bank and Fleet National Bank thereafter resigned.
The Financial Institutions' Committee is represented by Jones Day,
whose offices principally involved in this case are located in Cleveland, Ohio,
Chicago, Illinois and Washington, D.C. The Financial Institutions' Committee's
financial advisor is FTI Consulting, Inc.
On June 17, 2002, the United States Trustee appointed an Official
Committee of Equity Holders (the "Equity Committee") pursuant to Section 1102 of
the Bankruptcy Code to represent the interests of all equity holders in these
cases. The following equity holders were selected to serve as members of the
Equity Committee: (i) Frank J. Howylak; (ii) Gerald J. Switzer; (iii) Paul Naz;
(iv) Peter Eide; (v) Trevor Stores, Inc.; (vi) Softbank Technology Ventures; and
(vii) Ronald W. Burkle. On January 17, 2003, Mr. Burkle notified the United
States Trustee that he resigned from the Equity Committee effective January 14,
2003.
The Equity Committee originally was represented by Traub, Bonacquist &
Fox, LLP in New York, New York. Co-Counsel to the Equity Committee is the law
firm of Goldberg, Kohn, Bell, Black, Rosenbloom & Moritz, Ltd. of Chicago,
Illinois. The Equity Committee's financial advisor was Saybrook Restructuring
Advisors. On January 20, 2003, Traub, Bonacquist and Saybrook resigned as
counsel and financial advisor, respectively, to the Equity Committee.
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D. POST-PETITION FINANCING
On January 25, 2002, the Debtors obtained interim approval from the
Bankruptcy Court for $1.15 billion of a $2 billion Revolving Credit and Guaranty
Agreement facility (the "DIP Facility") with JPMorgan Chase Bank as
administrative agent, collateral agent and co-collateral monitor, J.P. Morgan
Securities Inc. as co-lead arranger and joint bookrunner, Fleet Securities, Inc.
as co-lead arranger and joint bookrunner, Fleet Retail Finance Inc. as
co-collateral monitor and documentation agent, General Electric Capital
Corporation as co-syndication agent and co-collateral monitor, and Credit Suisse
First Boston, Cayman Islands Branch, as co-syndication agent. Under the terms of
the DIP Facility, the lenders party to the DIP Facility agreed to provide
financing to the Debtors in an amount up to $2 billion, subject to borrowing
base and other limitations. A final order with respect to the DIP Facility was
approved by the Bankruptcy Court on March 6, 2002.
The Debtors sought approval of the DIP Facility to ensure necessary
liquidity during the Chapter 11 Cases. The DIP Facility allowed the Debtors to
pay permitted prepetition claims, fulfill working capital needs, obtain letters
of credit, and pay for other general corporate matters. The funds available
under the DIP Facility also provided comfort to vendors and resulted in the
Debtors generally being able to obtain goods and services on the same terms as
prior to filing the Chapter 11 Cases. Specifically, the DIP Facility provided
the necessary security to the Debtors' vendors so that they would continue to do
business with the Debtors, thereby minimizing the harm to the Debtors'
businesses as the Debtors pursued their reorganization efforts. The DIP Facility
requires that the Debtors maintain certain financial covenants and restricts
liens, indebtedness, capital expenditures, dividend payments, and sales of
assets.
On August 29, 2002, the Bankruptcy Court approved an amendment to the
DIP Facility negotiated between the Debtors and the lenders parties to the DIP
Facility. The amendment to the DIP Facility modified certain financial covenants
in order to provide additional flexibility under the financial covenants
contained therein that require certain minimum levels of cumulative earnings
before interest, taxes, depreciation, amortization and other charges.
On January 28, 2003, the Bankruptcy Court approved a further amendment
to the DIP Facility. This second amendment further modified the financial
covenants related to earnings before interest, taxes, depreciation,
amortization, and other charges, and also modified other covenants to allow
closures of certain stores. Other modifications related to borrowing base
calculations and authorized use of proceeds from asset sales.
E. OTHER SIGNIFICANT EVENTS DURING THE CHAPTER 11 CASES
1. Vendor Relations.
Since the Petition Date, the Debtors have attempted to maintain and
improve their relationships with vendors (i) to ensure an uninterrupted supply
of goods for their retail stores and (ii) to rebuild and maintain sufficient
levels of trade credit. These efforts largely were made informally through
business contacts and have continued throughout the Chapter 11 Cases. In
addition, efforts were made to address specific issues relating to certain
groups of vendors.
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(a) Reclamation Claims Program.
Shortly before and after the Petition Date, a significant number of the
Debtors' vendors and factors asserted demands, pursuant to Section 2-702 of the
Uniform Commercial Code and Section 546(c) of the Bankruptcy Code (the
"Reclamation Claims"). Reclamation Claims were asserted by 693 entities in the
total face amount of $274.7 million. Certain vendors and factors indicated that
resolution of their Reclamation Claims would be critical to their ongoing
business relationships with the Debtors, including the provision of trade
credit. Thus, if unresolved, the Reclamation Claims posed a significant threat
to the Debtors' businesses and potentially represented a source of significant
and costly litigation.
To address these concerns, the Debtors sought approval of a
comprehensive program to reconcile, resolve consensually, and satisfy the
Reclamation Claims asserted against their estates. By final order dated February
27, 2002, the Bankruptcy Court established a streamlined procedure for
reconciling Reclamation Claims. In addition, by order dated September 25, 2002,
the Bankruptcy Court approved a process for payment of valid Reclamation Claims
by the voluntary election of the reclamation claimant of either (a) payment of
75% of the allowed Reclamation Claim during the 2002 holiday season, subject to
agreement to certain terms, including the reclamation claimant's agreement to
provide historical trade terms, or (b) payment of 100% of the allowed
Reclamation Claim upon the Debtors' emergence from Chapter 11.
As of December 17, 2002 the Debtors have settled 680 of the 693
entities' Reclamation Claims for a total of approximately $122.2 million. A
total of 164 reclamation claimants requested to participate in the early payment
plan, resulting in a savings to the Debtors of approximately $5.1 million.
(b) Return to Vendor Program.
As of the Petition Date, the Debtors' stores were stocked with seasonal
merchandise. Additionally, prior to the Petition Date, the Debtors had received
certain defective merchandise. Under established industry practice, as well as
the Debtors' agreements with their vendors, these items typically would be
subject to return to vendors in exchange for a credit equal to the Debtors'
invoiced cost for the merchandise. At the outset of the Chapter 11 Cases, the
Debtors determined that their ability to continue making such returns of
prepetition merchandise was critical to their successful operations. Among other
things, such returns would permit the Debtors to (a) balance their inventory
stocks, (b) dispose of merchandise that was unsaleable or had substantially
diminished value, (c) replace merchandise with current, more saleable
merchandise, and (d) normalize the Debtors' trade terms with vendors.
To accomplish these critical goals, the Debtors sought approval of a
voluntary program, pursuant to Section 546(g) of the Bankruptcy Code, to return
to their vendors seasonal, slow-moving, unsaleable or defective merchandise in
accordance with existing policies and practices in exchange for a full credit
against the vendors' prepetition claims at the invoiced cost. The voluntary
program gave vendors 20 days to decide whether to participate in the program,
which participation was subject to a vendor's agreement to postpetition trade
terms agreeable to the Debtors. In addition, for goods received prepetition to
qualify for the program, they must have (a) been originally shipped to Kmart on
credit, and (b) not have been paid for by Kmart. The amount of goods returned to
a vendor could not exceed the amount of goods of the same type shipped by the
vendor prepetition to Kmart that were in Kmart's
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possession on the Petition Date. Where the invoiced cost of returned merchandise
exceeded the amount of the vendors' prepetition claims, the Debtors' program
provided that the excess amount would be applied first against the vendors'
postpetition claims and, second, the excess would be returned as a cash refund.
This program was approved by the Bankruptcy Court pursuant to an order dated
February 13, 2002. As of December 16, 2002, 2,364 vendors agreed to participate
in the program, resulting in $142.8 million worth of goods being returned to
vendors by the Debtors.
(c) Consignment Vendor Program and Related Matters.
A significant portion of the items that the Debtors sell in their
retail stores is comprised of goods delivered to the Debtors on consignment.
Prior to the Petition Date, consigned goods were delivered to the Debtors for
resale by a number of consignment vendors who provide various goods to Kmart
stores, including jewelry, videos, CDs, DVDs, vacuum cleaners, car care
products, prescription pharmaceutical and related products, and a host of other
seasonal items such as sun glasses, sprinklers and electric blankets. Many of
the Debtors' consignment vendors depend upon their business with the Debtors,
including timely remittance of sales proceeds, to sustain their operations.
Likewise, the Debtors depend upon the availability of consigned goods on
favorable trade terms in order to offer the fullest range of retail goods to
their customers. Accordingly, on January 22, 2002, the Debtors filed a motion
seeking authority to pay prepetition claims of consignment vendors in the
ordinary course of business and approval of other procedures concerning
consigned goods (the "Consignment Motion").
Pursuant to the Consignment Motion, the Debtors requested that they be
permitted to continue to accept consigned goods from any consignment vendor
operating under a consignment agreement with the Debtors and to continue to pay
such consignment vendor in the ordinary course of the Debtors' business. In
addition, to the extent that the consignment vendors agreed to continue to
provide consigned goods to the Debtors under ordinary and customary trade terms,
the Debtors requested authority to pay such consignment vendors in the ordinary
course, including those consigned goods ordered and delivered, but not paid for,
prepetition.
On January 25, 2002, the Bankruptcy Court entered an interim order (the
"Interim Consignment Order") approving the Consignment Motion. Pursuant to the
terms of the Interim Consignment Order, the Debtors made a payment of $25
million to Universal Music and Video Distribution Company ("Universal") and
payments to a limited number of other consignment vendors. Thereafter, the
Creditors' Committee and the Financial Institutions' Committee filed objections
to the application of the Interim Consignment Order to unperfected consignment
vendors, including Universal. After lengthy negotiations, however, the parties
were able to resolve their issues surrounding the payment to Universal. On
October 3, 2002, the Debtors filed a motion to approve a settlement agreement
with Universal. As part of the settlement agreement, Universal retained the
payment, applied the payment to its prepetition consignment claim, and
effectively waived the balance of its remaining consignment claim. As of the
date of this Disclosure Statement, the objections of the Creditors' Committee
and the Financial Institutions' Committee to further payments under the Interim
Consignment Order have been continued and no payments are being made on these
claims.
During the Chapter 11 Cases, Kmart sought approval to assume modified
consignment agreements with two of its key jewelry consignment vendors, M.
Fabrikant & Sons, Inc. and Samuel Aaron International, Inc. Although the
Financial Institutions' Committee initially objected to the proposed assumption,
an agreed order was eventually entered by the Bankruptcy Court after these
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vendors agreed to provide further concessions to the estates, including
significant reductions in their prepetition consignment claims.
In addition to the Interim Consignment Order, the Debtors undertook
other actions during the Chapter 11 Cases to cement relationships with certain
key consignment vendors. For instance, Cardinal Health, Inc. provides to Kmart
stores substantially all prescription pharmaceutical and related products,
except for those Kmart stores located in Puerto Rico. Sales of these products
generated revenues of approximately $3 billion for the fiscal year ended January
2002. During the Chapter 11 Cases, Kmart and Cardinal agreed to modify the
parties' consignment arrangement to ensure Kmart's continued receipt of
pharmaceutical goods on consignment. Kmart obtained significant price and
related benefits as a result of this modification. The Bankruptcy Court approved
Kmart's assumption of this modified agreement on October 30, 2002.
The Debtors believe that certain of their consignment relationships
with their consignment vendors constitute executory contracts that the Debtors
may assume or reject under the Bankruptcy Code. Certain of the Debtors'
consignment vendors filed financing statements under the Uniform Commercial Code
prior to the Petition Date and therefore assert that the pre-petition claims
that they have against the Debtors on account of consignment inventory sold by
the Debtors constitute secured claims that must be paid in full under the
Bankruptcy Code. The aggregate amount of all such secured consignment claims as
of January 24, 2003, is approximately $70 million. The Debtors intend to assume
these consignment agreements as of the Effective Date, thereby leaving unaltered
the legal rights asserted by the secured consignment vendors. Of the approximate
$70 million amount, approximately $59 million will be rolled forward under the
agreements as outstanding consignment credit, meaning that only $11 million may
be paid as a cure amount. The Debtors therefore have not classified these claims
as secured claims under the Plan. The Debtors are in the process of evaluating
the consignment agreements with unperfected consignment vendors, and will make
assumption/rejection determinations in accordance with the Plan.
(d) Vendor Lien Program.
At the commencement of the Chapter 11 Cases, continued, immediate trade
support from Kmart's vendors was a key element to the Debtors' efforts to
reorganize successfully under Chapter 11 of the Bankruptcy Code. Accordingly,
Kmart prepared and sought approval of a trade vendor lien program (the "Trade
Vendor Lien Program") pursuant to which Kmart would grant to certain approved
trade creditors ("Approved Trade Creditors") liens on Kmart's merchandise junior
to the liens of the lenders under the DIP Facility on the same merchandise.
Approved Trade Creditor status was generally afforded to any vendor that (a) was
an authorized vendor of Kmart, (b) agreed to continue customary trade terms with
Kmart, (c) agreed to continue to participate in Kmart's electronic data
interchange program, (d) agreed to comply with Kmart's code of business conduct,
and (e) agreed not to restrict business operations with Kmart's subsidiaries or
international operations. The Trade Vendor Lien Program was approved by the
Bankruptcy Court on March 6, 2002. As of March 22, 2002, the date by which
vendors had to apply for the Program, approximately 841 of Kmart's vendors
applied for the Trade Vendor Lien Program, of which 747 were approved.
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(e) Critical Vendor Program.
The Debtors determined at the commencement of the Chapter 11 Cases that
their operations would have been critically jeopardized without a continuous
supply of new merchandise and services provided by a certain, select group of
vendors that are essential to the uninterrupted functioning of the Debtors'
business operations (the "Critical Vendors"). Specifically, the Debtors
determined that two specific and several categories of such Vendors were
critical to their reorganization efforts: (i) Fleming Companies, Inc.
("Fleming"), (ii) Handleman Company ("Handleman"), (iii) egg and dairy suppliers
(the "Egg and Dairy Vendors"), (iv) newspapers, printers, paper suppliers, and
other vendors who supply goods and services related to Kmart's advertising
program (the "Advertisers"), (v) foreign vendors, (vi) certain letter of credit
issuers, and (vii) liquor vendors. The Critical Vendors' importance to the
Debtors derived from many factors. Often, these vendors are the only source from
which the Debtors can procure certain goods or services. In addition, some of
these Vendors provide not only merchandise but also indispensable infrastructure
and support to certain of the Debtors' store operations. Accordingly, the
Debtors filed a motion seeking authority to pay prepetition claims of the
Critical Vendors (the "Critical Vendors Motion"), which the Bankruptcy Court
granted on January 25, 2002 (an order pertaining to the letter of credit issuers
and liquor vendors was entered on February 13, 2002). One creditor has appealed
the Bankruptcy Court's order. The Debtors are vigorously defending the Court's
determination to grant the Critical Vendor's Motion. In the event the order is
reversed on appeal, the estates may otherwise have claims against certain
recipients of the critical vendor payments for return of the amounts they
received.
(i) Fleming
As of the Petition Date, Fleming was Kmart's largest supplier and
distributed substantially all food and consumables to Kmart. Sales of Fleming
products accounted for 11% (or $4.2 billion) of the Debtors' total annual sales
as of the Petition Date. Fleming was owed approximately $76 million as of the
Petition Date, or 1.8% of Kmart's annual sales of Fleming products. Kmart has
made total payments to Fleming of approximately $76 million on account of
Fleming's pre-petition claim. On February 3, 2003, Kmart rejected its supply
agreement with Fleming. The parties have agreed to transition the distribution
of food and consumables from Fleming to Kmart pursuant to a transition agreement
that will conclude in early March 2003. Other matters concerning Fleming are
discussed in Section III.E.(2)(b) of this Disclosure Statement, "Rationalization
of Store Base and Distribution Centers."
(ii) Handleman
Handleman is Kmart's sole music vendor, accounting for 1.5% (or $500
million) of the Debtors' total annual sales as of the Petition Date. Handleman
furnishes the infrastructure for Kmart's music department. It places
geographically-sensitive merchandise orders for stores, stocks shelves, sets up
displays for new music releases, and operates the merchandise return process.
Handleman was owed approximately $65 million as of the Petition Date. Kmart has
made payments of $49 million to Handleman on account of Handleman's pre-petition
claim.
(iii) Egg and Dairy Vendors
Certain food items like eggs and dairy products drive the whole
"frequency" component of Kmart's business: approximately 8% of all Kmart
shoppers purchase this merchandise category on a
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given shopping trip to Kmart's stores. Egg and dairy sales account for
approximately $160 million of total sales by Kmart on an annual basis. Without
these items, shoppers would likely not choose Kmart for their daily shopping
needs. Egg and Dairy Vendors are generally small, and Kmart's failure to pay
these vendors could have threatened their ability and/or willingness to continue
supplying goods to Kmart. Kmart estimated that, as of the Petition Date, the Egg
and Dairy Vendors collectively were owed approximately $13.5 million. Kmart has
made total payments of approximately $5.2 million to Egg and Dairy Vendors on
account of their pre-petition claims.
(iv) Advertisers
Much of Kmart's sales volume is driven by its weekly advertising
circular program, which prints approximately 78 million circulars each week and
distributes them nationally via newspapers to Kmart's markets. As of the
Petition Date, advertised items accounted for approximately 30% (or $11 billion)
of Kmart's annual sales. Without this in-place advertising program continuing,
Kmart's overall business could have been severely jeopardized. Kmart has made
total payments of approximately $133.4 million to Advertisers on account of
their prepetition claims.
(v) Foreign Vendors
The Debtors imported approximately $2.2 billion of merchandise from
foreign vendors (the "Foreign Vendors") in 2001. Foreign Vendors provide the
Debtors with their key product offerings that are among the most profitable of
the Debtors' offerings, such as Martha Stewart, Jaclyn Smith, Kathy Ireland, Joe
Boxer and Sesame Street. Many of these goods were in transit as of the Petition
Date and could not readily be obtained from other sources.
As the Debtors prepared to file these Chapter 11 cases, they were
concerned that, despite the automatic stay, Foreign Vendors might not agree that
they would be subject to the jurisdiction of the Bankruptcy Court and might
withhold goods or initiate foreign actions to collect on the Debtors' unpaid
obligations. Additionally, the Debtors determined that if they did not remain
current on their foreign obligations, they would face the risk that the Foreign
Vendors, including foreign taxing and licensing authorities, might seize or
impound assets within their respective jurisdictions and seek to invoke civil or
criminal penalties against the Debtors and their local employees and agents.
Accordingly, the Bankruptcy Court granted the Debtors' request to pay the
pre-petition claims of Foreign Vendors. Pursuant to the terms of the order, the
Debtors made payments of approximately $16.8 million to Foreign Vendors.
(vi) Letters of Credit
Payment for much of the merchandise ordered from the Foreign Vendors is
arranged through the issuance of documentary letters of credit in favor of the
Foreign Vendors. Under this practice, the Debtors generally order goods from a
Foreign Vendor pursuant to a letter of credit issued by a bank. The Foreign
Vendor then presents the Debtors' purchase order and the Foreign Vendor's
invoice along with the ordered goods to the issuing bank (the "Issuer"). If the
goods conform to the purchase order and the invoice, the Issuer pays the Foreign
Vendor pursuant to the letter of credit agreement and the Debtors reimburse the
Issuer. As of the Petition Date, there were approximately 1,500 outstanding
letters of credit with a face value of approximately $190 million. In addition,
as of the Petition Date, the Debtors had not been able to pay the reimbursement
obligations to the Issuers in the amount of $6
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million. In order to prevent any delay by Issuers in honoring the documentary
letters of credit and to avoid shipping delays and garner support for the
Foreign Vendor letter of credit program, the Debtors sought Bankruptcy Court
approval to pay the $6 million reimbursement obligation. On February 13, 2002,
the Bankruptcy Court entered an order authorizing the Debtors to pay this
amount.
(vii) Liquor Vendors
Liquor is sold in most of Kmart's stores and is an integral component
of the Debtors' inventory mix. Inasmuch as liquor is a high-turnover item having
great popularity and customer draw, the Debtors determined that the elimination
of liquor sales would result in the loss of customers to the Debtors'
competitors who sell liquor. After the Petition Date, approximately 100 liquor
vendors, suppliers and wholesalers (the "Liquor Vendors") informed the Debtors
that certain state statutes and regulations relating to licensing of Liquor
Vendors prohibited them from extending credit on unpaid balances for the sale of
liquor. Accordingly, on February 13, 2002, the Bankruptcy Court entered an order
authorizing the Debtors to pay the prepetition claims of Liquor Vendors.
Pursuant to the terms of the order, the Debtors made payments of approximately
$2.0 million to Liquor Vendors.
2. Real Property and Related Matters.
(a) Extension of Time to Assume or Reject Unexpired
Leases.
Pursuant to a Bankruptcy Court order dated April 15, 2002, the
Bankruptcy Code Section 365(d)(4) deadline for assuming or rejecting the
majority of the Debtors' unexpired leases of nonresidential real property is the
earlier of confirmation of a plan of reorganization or July 31, 2003. For
certain other leases of nonresidential real property, the Debtors and the
landlords for such properties agreed to March 31, 2003 as the deadline for the
Debtors to assume or reject such leases, with certain landlords receiving
holiday protection in the form of the Debtors' agreement not to reject stores
between October 2002 through January 15, 2003. With respect to certain other of
the Debtors' leases, the Debtors and the landlords for those leases agreed to
various other deadlines for the Debtors to assume or reject such leases. On
February 11, 2003, the Debtors filed a motion requesting extension of the
assumption deadline for these and the March 31, 2003 leases through the
Confirmation Date of the Plan. On February 25, 2003, the Bankruptcy Court
entered an order granting this motion.
(b) Rationalization of Store Base and Distribution
Centers.
Prior to commencement of the Chapter 11 Cases, the Debtors engaged
Rockwood Gemini Advisors ("Rockwood") as real estate advisor to assist the
Debtors in analyzing and evaluating the Debtors' real estate properties,
including leases and owned real estate. The Bankruptcy Court approved the
retention of Rockwood on February 13, 2002. In addition, the Debtors retained
Abacus Advisory & Consulting Corp., LLC ("Abacus") as inventory valuation
consultant for the Debtors to assist the Debtors with the liquidation of the
inventory at a number of their stores. The Debtors' retention of Abacus was
approved by the Bankruptcy Court by order entered on March 8, 2002.
Thereafter, the Debtors, with the assistance of Miller Buckfire Lewis,
analyzed various aspects of the financial performance of all of their retail
store locations and certain other real properties. As a result of this review,
the Debtors decided to seek Bankruptcy Court approval on March 20, 2002 to close
283 stores in 40 states and Puerto Rico. The Debtors sought to close these
stores due to their
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diminishing profitability, because the stores were becoming a cash drain on the
Debtors, and because their performance was substantially undercutting the
overall performance of the Kmart stores. The decision to close these stores was
based on these financial considerations, and not on any strategic considerations
pertaining to the Debtors' operating plan.
In furtherance of their store closing efforts, the Debtors sought
approval from the Bankruptcy Court to conduct store closing sales at each of
these closed stores. On March 20, 2002, the Bankruptcy Court approved an order
authorizing Kmart to close these stores and conduct store closing sales at each
of these locations. To assist in the process of closing the stores, the Debtors,
with the assistance of Abacus, negotiated and entered into an agency agreement
with a joint venture comprised of SB Capital Group, LLC, The Nassi Group, LLC,
The Ozer Group, LLC, Buxbaum Group, Gordon Brothers Retail Partners, LLC, Hilco
Merchant Resources, LLC and Great American Group to assist with the conduct of
the store closing sales. By order dated March 20, 2002, the Bankruptcy Court
approved the agency agreement with the joint venture group. The liquidation of
the Debtors' inventory at the 283 closing stores was completed by June 2002. The
Debtors received approximately $633 million in net proceeds from the store
closing sales and from discontinued merchandise that was transferred to the
closing stores for liquidation.
After the 2002 holiday season, the Debtors, again with the assistance
of Miller Buckfire Lewis, analyzed the financial performance of all of their
other retail store locations. As a result of this review, the Debtors decided to
seek Bankruptcy Court approval to close up to an additional 317 stores in 44
states. As with the initial set of store closings, the Debtors sought to close
these additional stores due to their diminishing profitability, because the
stores were becoming a cash drain on the Debtors, because their performance was
substantially undercutting the overall performance of the Kmart stores, and
because these stores did not fit into the Debtors' long-term strategic operating
plan. Unlike the initial set of store closings, however, the Debtors based their
decision to close these on strategic considerations as well as financial
considerations, including an analysis of the competitive environment in local
and regional markets, distance from distribution centers, and the location and
number of other Kmart stores in the market. These store closures completed the
strategic review of the company's store base and distribution centers, which
Kmart has previously said it would undertake prior to emergence from Chapter 11.
In furtherance of these additional store closing efforts, the Debtors
sought and obtained approval from the Bankruptcy Court on January 28, 2003 to
conduct store closing sales for this set of stores. To assist in the process of
closing these stores, the Debtors negotiated and entered into an operating and
monitoring agreement with Abacus, with additional agents to be designated by
Abacus. The Debtors anticipate that the liquidation of the Debtors' inventory at
the stores will be completed by April, 2003. Proceeds from the liquidation will
be used to fund certain amounts under the Plan and for general corporate
purposes.
Prior to the store closings in 2003, Kmart entered into discussions
with Fleming, its largest supplier and the distributor of substantially all food
and consumables to Kmart, regarding possible modifications to their supply
relationship in order to reflect the rationalization of Kmart's store base and
distribution centers. The parties' supply relationship was evidenced by a ten
year supply agreement that could not have been clearly terminated by Kmart
without cause until the first quarter of 2007.
26
After concluding that the supply agreement could not be modified to
Kmart's satisfaction, on February 3, 2003, the Debtors filed a motion with the
Bankruptcy Court on notice to the United States Trustee and the Statutory
Committees, but not on notice to Fleming, requesting immediate rejection of the
supply agreement. On that day, the Bankruptcy Court authorized the rejection,
and the Debtors and Fleming announced that they had terminated the supply
relationship by means of the Debtors' rejection of the supply agreement. The
announcement stated that the parties had determined that continuation of the
supply agreement was no longer in either of their best interests.
The Debtors in particular exercised their business judgment to reject
the supply agreement because the Agreement had not met the Debtors' economic and
business expectations and operated in a manner that was inconsistent with the
Debtors' legitimate economic interests; Fleming had not performed in a manner
that was acceptable to the Debtors; the Agreement itself was inconsistent with
the Debtors' go-forward business plan, which forms the basis for the Debtors'
proposed emergence from Chapter 11; and Fleming's conduct in recent weeks had
created market, vendor and stakeholder uncertainty that had to be resolved
promptly and permanently. The Debtors also determined that given the change in
their store base, the supply agreement no longer met the Debtors' needs, that
the Debtors could realize substantial long-term savings by coordinating food and
consumable distributions themselves, and that rejection of the agreement
therefore was appropriate.
The Debtors and Fleming have implemented transition arrangements and
the Debtors expect to be fully self-distributing for core pantry and to have
agreements in place with other vendors and suppliers of food, consumables and
expanded dry goods by the middle of March 2003. The Debtors' business plan has
been prepared based on the assumption that the costs and other fees for the
Debtors' new distribution plan to replace Fleming will be no greater than such
costs and fees under the Fleming supply agreement. The Debtors anticipate
realizing substantial long-term savings by coordinating food and consumable
distributions themselves. The Debtors' estimate of total unsecured claims that
ultimately may be allowed in these proceedings includes an estimate of Fleming's
contemplated rejection damage claim. The parties expect to have discussions
concerning resolution of this and other claims under the agreement.
(c) Disposition of Closed Stores.
In order to maximize the value of the stores closed in early 2002 and
other real estate related assets, the Debtors engaged the joint venture of DJM
Asset Management, LLC and ChainLinks Retail Advisors, Inc. as the Debtors'
broker and disposition consultant for the purpose of marketing and selling
leases, fees and other real estate ownership interests of the Debtors related to
the 2002 closing stores. The Bankruptcy Court approved the brokers' retention on
April 24, 2002.
Concurrently with the liquidation of their inventory at the 2002
closing store locations, the Debtors commenced preparation for the disposition
of their real estate holdings for these stores. To that end, the Debtors devised
a strategy to maximize recoveries from these assets while minimizing potentially
substantial administrative rent charges that would be incurred following the
completion of the store closing sales. On April 15, 2002, the Debtors therefore
filed with the Bankruptcy Court a real estate disposition motion that set forth
disposition procedures for the sale of the exclusive rights to find buyers for
the Debtors' real property interests in the closed stores, which was approved by
the Bankruptcy Court on May 10, 2002.
27
Thereafter, certain of the Debtors entered into several Asset Purchase
and Designation Rights Agreements (the "Agreements") with Kimco Realty
Corporation, Schottenstein Stores Corporation, Klaff Realty, LP, and other
purchasers (the "Purchasers"). Under the terms of the Agreements, Kmart agreed
to sell to the Purchasers the designation rights with respect to 56 leaseholds
for closed stores and such Debtors' 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 the designation rights 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.
In consideration for the designation rights acquisitions, the
Purchasers agreed to pay $46 million, all of which was paid by 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, the Debtors may be entitled to additional proceeds in the event
that designation rights transactions exceed a specified level of proceeds.
With respect to the 317 store closings approved by the Bankruptcy Court
on January 28, 2003, the Debtors that own or lease real estate related to such
stores and Kimco Realty Corporation ("Kimco") have agreed to enter into an
agreement to jointly market the closing store real estate leases, owned
properties and related assets. The Debtors are considering a multi-faceted
approach to marketing this real estate, including direct sales of individual
properties or packages of properties to end users, sales of designation rights
in individual or packages of leases to purchasers that would in turn seek to
sell such rights to end users, and/or redevelopment of closing store properties.
As of the Effective Date, the Reorganized Debtors shall be obligated to provide
funds, as needed, to the estates of those Debtors that hold such leases in an
aggregate amount sufficient to pay Administrative and Cure Claims of such
estates, including obligations contemplated by section 365 of the Bankruptcy
Code, until such time as such leases have been assumed, rejected or otherwise
disposed of and the estates have been fully administered. Kimco will prepare and
submit to the Debtors for their approval budgets for the proposed marketing of
the assets, and the Debtors will retain final decision-making authority on all
asset dispositions. Insiders or affiliates of Kimco may bid on properties only
with the Debtors' consent. As compensation for its marketing efforts, Kimco will
receive up to 3.5% (on a sliding scale) of the aggregate net proceeds from the
property dispositions.
In order to assist the Debtors and Kimco in their joint marketing
efforts, on February 5, 2003, the Debtors filed with the Bankruptcy Court a
request that the Court extend the deadline by which the Debtors must assume or
reject unexpired leases of real property pertaining to the 2003 closing stores
to 270 days after the Effective Date of the Plan. This request was made to
enable the Debtors to adequately market this excess real estate in order to
maximize value for their creditors. As of the date of this Disclosure Statement,
this motion was still pending.
As explained above, the 2003 closing stores assets will not revest in
the Debtors after the Effective Date and will remain in the applicable Estates
so that the closing store real estate and inventory may be disposed of by the
Debtors and Kimco. The proceeds from disposition of the closing store assets
will be contributed to the Reorganized Debtors and utilized consistent with the
Plan. Upon final disposition of such assets, the estates will be closed.
28
(d) Significant Real Estate Rulings.
During the course of these Chapter 11 Cases, the Bankruptcy Court
issued significant rulings with respect to four real estate matters: (i) payment
of real estate taxes that accrued prepetition yet came due postpetition; (ii)
enforcement of "go-dark" lease provisions; (iii) attempts by landlords to
require the Debtors to establish escrow accounts for postpetition real estate
taxes not yet due and/or procure liability insurance; and (iv) payment of
percentage rent obligations that accrued prepetition yet came due postpetition.
(i) Accrued Real Estate Taxes
During these Chapter 11 Cases, many landlords filed motions seeking to
compel the Debtors to pay real estate taxes that accrued pre-petition but came
due post-petition, notwithstanding well-settled law in the Seventh Circuit in In
re Handy Andy Home Improvement Centers, Inc., 144 F.3d 1125, 1127-28 (7th Cir.
1998), that such taxes constitute prepetition claims and are not postpetition
obligations. On July 24, 2002, the Court denied a motion filed by a landlord
seeking to compel the Debtors to pay real estate taxes that accrued pre-petition
but were billed post-petition. In denying this motion, the Court concluded that
"the amount [of real estate taxes] due and owing [by the Debtors] is that amount
between the petition date and the date of rejection irrespective of what the
lease may provide." The Bankruptcy Court denied similar requests made by several
other landlords. The Court's ruling is significant in that Kmart has deferred
pre-petition tax obligations while restructuring its affairs in accordance with
established Seventh Circuit precedent.
(ii) Enforcement of "Go-Dark" Lease Provisions
Many of Kmart's store leases contain so-called "go-dark" provisions
that permit a landlord to terminate the lease upon Kmart's decision to
discontinue operations at such store. After the Debtors commenced their store
closing efforts in March 2002, several landlords filed motions seeking to modify
the automatic stay in order to exercise these "go-dark" provisions. The
Bankruptcy Court has ruled on several of these requests, denying each and every
one. In so ruling, the Court held that such a provision is "a de facto
restriction on assignment" and unenforceable during the Debtors' bankruptcy. The
Court also held, in the context of leases, the designation rights of which have
been sold to designation rights purchasers who often must cease store operations
while finding a suitable tenant, that the "go-dark" provision was an
unenforceable restraint on alienation under the Bankruptcy Code because (i) the
assignment depended on the suspension of the "go-dark" provision until the
end-user re-opened a store on the premises, and (ii) the enforcement of the
"go-dark" provision would prevent the Debtors from realizing the full value of
the lease. Certain of these rulings are on appeal.
(iii) Tax Escrows/Insurance Procurement
During these Chapter 11 cases, many landlords filed motions seeking to
compel the Debtors to procure liability insurance and/or establish escrow
accounts for estimated, post-petition real estate taxes not yet due. With
respect to the requests that the Debtors procure insurance, certain of the
landlords' leases authorize the Debtors to self-insure if their book net worth
exceeds $100 million. All of the Debtors' public filings reflected a positive
net worth exceeding $2.6 billion at the time these motions were filed. As for
the landlords' requests that the Debtors establish real estate tax escrows, none
of the Debtors' leases with these landlords contained provisions requiring such
escrows.
29
Had these landlord's requests been granted, the impact on the Debtors'
cashflows would have been significant. However, on August 29, 2002, the
Bankruptcy Court denied the requests. The Court found that the Debtors' book net
worth far exceeded the thresholds established in the leases authorizing the
Debtors to self-insure. With respect to the requests for tax escrows, the Court
found that none of these landlords' leases provided for tax escrows and that the
Debtors were current on their post-petition real estate tax obligations to these
landlords. Several of these landlords have appealed the Court's rulings.
(iv) Percentage Rent
Three landlords filed motions to compel the Debtors to pay, as a
postpetition obligation under Section 365(d)(3) of the Bankruptcy Code,
percentage rent that accrued prepetition but came due postpetition. At the time
of the filing of these motions, the Debtors determined such percentage rent
obligations by allocating a portion of the total percentage rent to the
postpetition period based on the number of postpetition days (the "Accrual
Method"). In contrast, these landlords took the position that where the
percentage rent accrued both prepetition and postpetition but came due
postpetition, the entire year's percentage rent is a postpetition expense (the
"Billing Date Method"). A third approach adopted by courts in determining such
percentage rent obligations is to presume that percentage rent obligations begin
to arise only after the existing obligation to pay percentage rent first becomes
fixed - that is, after a "breakpoint" is reached and the obligation is no longer
contingent (the "Breakpoint Method").
On September 25, 2002, the Bankruptcy Court issued a ruling on the
motions regarding the proper method of allocating percentage rent between the
pre-petition and post-petition periods. In that ruling, the Court adopted the
Breakpoint Method. Under the Court's ruling, if the breakpoint under a lease is
exceeded after the Petition Date, all percentage rent owing under the lease is
recoverable under Section 365(d)(3). If the breakpoint is exceeded prior to the
Petition Date and the lease ends after the Petition Date, only the percentage
rent from sales subsequent to the Petition Date is recoverable under Section
365(d)(3). Immediately after the Court's announcement of its ruling, the Debtors
began implementing procedures for calculating and making payments to landlords
consistent with the Court's ruling. Prior to the entry of the Court's order on
this issue, the Debtors had paid a total of $6,997,061.06 in percentage rent.
Using the breakpoint method pursuant to the Court's order, the Debtors have paid
an additional $3,931,090.09 in percentage rent. However, the Debtors have also
determined that in certain instances, percentage rent was overpaid based on the
breakpoint method. Therefore, the Debtors have offset such overpayments from
current lease obligations, such offsets amounting to a total of $1,667,132.68.
As of January 21, 2003, the Debtors believe that all payments due and owing to
landlords on account of post-petition percentage rent have been made in
accordance with the Court's ruling.
(e) Other Lease and Real Property Dispositions.
During the Chapter 11 Cases, the Debtors, with the assistance of their
advisors, disposed of a number of real estate leases through other transactions.
For instance, the Debtors (i) assumed and assigned leases to third parties for
various forms of consideration, including assumption of cure costs and cash
payments; (ii) terminated other leases pursuant to the agreement of the affected
landlords and/or subtenants; and (iii) rejected other leases that the Debtors
determined had no value to the estates.
30
3. Key License Agreements.
As explained above, the Debtors believe that focusing their
merchandising and marketing approach on quality name brands builds customer
loyalty and increases shopping frequency. A key component of Kmart's strategy
therefore is its investment in merchandising and marketing initiatives that
enhance its strategic position through exclusive brands that differentiate Kmart
from its competitors, including its license agreements with Martha Stewart
Living Omnimedia, Inc. for Martha Stewart Everyday home, garden, housewares and
seasonal products; 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; Sesame Workshop for Sesame
Street apparel for infants and children; Joe Boxer Licensing, LLC for Joe Boxer
apparel, accessories and home furnishings; Route 66, L.P. for Route 66 apparel
and accessories; Avmark, Inc. for Curtis Mathes consumer video, audio and
telecommunications products; and T Enterprises, LLC for the right to utilize the
name, likeness, and signature of Ariadna Sodi Miranda, professionally known as
Thalia.
Kmart believes that each of these brands fills a niche in Kmart's brand
portfolio and is critical to maintaining its customer base and attracting new
shoppers to Kmart stores. Also, Kmart believes that the combination of the
profit realized from the sale of the products with these national brands and the
continued association of quality products with Kmart will enhance the success of
the Debtors' reorganization. During the Chapter 11 Cases, Kmart therefore
received Court approval to assume and/or enter into these license agreements and
therefore continue its relationships with these key brand partners.
4. Surety Bond Settlement.
The Debtors conduct retail business in all 50 states and are subject to
numerous state regulations that require the Debtors to provide assurances to
state authorities of the Debtors' financial ability to meet their regulatory
obligations, including obligations relating to payment of workers' compensation
claims, utility charges, business licenses, and appeal and supersede as bonds.
Most prominent among these is the requirement to post bonds in favor of state
authorities so that the Debtors can maintain their self- insured status under
state workers' compensation laws, and so that they can maintain various business
licenses and permits necessary to the Debtors' retail operations. Prepetition,
the Debtors sought and received financial accommodations from certain sureties
in the form of surety bonds in order to ensure compliance with these
state-mandated requirements. However, just prior to the Petition Date, and in
light of the commencement of the Debtors' Chapter 11 Cases, certain of those
sureties attempted to cancel their surety bonds, which could have jeopardized
the Debtors' ability to do business in a number of states.
Rather than litigating the ability of the sureties to cancel their
respective surety bonds, the Debtors entered into a compromise and settlement
with the sureties whereby their prepetition financial accommodations would be
continued. Additionally, the sureties agreed to provide the Debtors with certain
additional postpetition financial accommodations in the form of new surety bonds
so that the Debtors' ability to conduct business would not be jeopardized. In
return, the Debtors issued letters of credit of $38.7 million in favor of the
sureties in order to secure certain obligations owed to the sureties related to
surety bonds, whether arising prepetition or postpetition. Any loss in excess of
the amount of the letters of credit will be treated as an unsecured claim to the
extent it relates to prepetition events and will be treated as an administrative
expense claim to the extent it relates to events occurring
31
postpetition. This compromise and settlement allowed the Debtors to save the
estates tens of millions of dollars that would otherwise have been incurred by
the Debtors if the Debtors were forced to obtain private insurance and
replacement bonds and avoided interruption of the Debtors' business operations.
On March 5, 2002, as supplemented on March 18, 2002, the Debtors filed
a motion (the "Surety Bond Motion") to approve the settlement of surety-related
claims, authorizing the continuation of their surety program, approving an
extension of surety credit, granting liens and superpriority administrative
expense claims in favor of the sureties and related entities, and seeking
related relief. On March 21, 2002, the Bankruptcy Court entered a final order
approving the relief sought in the Surety Bond Motion. This order is the subject
of a pending appeal by one of Kmart's general unsecured creditors. The agreement
between the Debtors and their sureties as memorialized in the order has a term
of one year from the date of entry of the order. As of the date of this
Disclosure Statement, the Debtors are in discussions with their sureties
regarding a continuation of the surety bond program.
5. Omnibus Procedures.
(a) Resolution of Personal Injury Claims.
On June 14, 2002, the Debtors filed a motion requesting approval of
procedures for (a) liquidating and settling certain specified personal injury
claims (the "Personal Injury Claims") through direct negotiation or alternative
dispute resolution and (b) modifying the automatic stay to the extent necessary
to allow orderly liquidation of the Personal Injury Claims. In so doing, the
Debtors sought to facilitate the efficient and inexpensive liquidation of the
Personal Injury Claims asserted against the Debtors prior to the Petition Date.
Such procedures are necessary in part because of the volume of such Claims. The
Debtors estimate that approximately 3,500 Personal Injury Claims were involved
in pending litigation as of the Petition Date, and that an additional 16,500
Personal Injury Claims had been asserted against the Debtors informally or in a
non-litigation fashion. On July 17, 2002, following requested amendments by the
Bankruptcy Court and negotiations with certain personal injury claimants, the
Bankruptcy Court approved the procedures for liquidating and settling Personal
Injury Claims.
The procedures contain different resolution processes for various
Claims based on the estimated amount of such Claims. For instance, the
procedures include a cost-effective, streamlined, telephonic settlement
procedure for Personal Injury Claims that are estimated to be allowed in amounts
equal to $5,000 or less. Such Claims and certain larger Claims also are subject
to a settlement process involving written questionnaires, response statements,
and replies. Additionally, Claims in estimated amounts in excess of $50,000 are
subject to mediation and arbitration. To the extent Personal Injury Claims are
not resolved through these procedures, claimants will be entitled to
modification of the automatic stay so that their Claims may be resolved in
non-bankruptcy forums.
Claims have been divided into four categories, based upon estimated
Claim amounts, for purposes of the foregoing procedures: (i) small claims as to
which the Debtors have reserved under $5,000; (ii) claims as to which the
Debtors have reserved between $5,001 and $50,000; (iii) claims over $50,001, and
(iv) judgment claims. The Debtors estimate that approximately 97% of all
Personal Injury Claims will be allowed in amounts equal to $50,000 or less.
Additionally, the Debtors estimate that approximately 80% of all such Claims
will be allowed in amounts equal to $5,000 or less.
32
For settlement amounts of $50,000 or less, the Debtors are authorized
to settle Personal Injury Claims up to an aggregate cap of $50 million without
further order of the Court or notice to any parties. For settlement amounts in
excess of $50,000, the Debtors are authorized to settle Personal Injury Claims
without further court order upon ten days' notice to certain notice parties,
which include the Statutory Committees, the Debtors' post-petition lenders, the
United States Trustee, and any other party that requests notice in accordance
with the procedure. Each settling Claimant is deemed to hold an allowed,
pre-petition general unsecured non-priority claim in the settled amount, to be
paid in accordance with the Plan.
The proofs of claim related to Personal Injury Claims filed in the
Chapter 11 Cases generally track the Debtors' expectations. As of January 3,
2003, a total of 7,778 timely proofs of claim have been filed. Of the proofs of
claim filed, 4,334 asserted amounts of $5,000 or less. A total of 3,406 proofs
of claim were filed asserting amounts in excess of $5,000. A total of 38 claims
were filed by judgment creditors. As of January 3, 2003, the Debtors had
resolved 1,404 of the 4,334 proofs of claim evidencing small Personal Injury
Claims for a total dollar amount of $2.4 million. That is an average of $1,733
each. Of the 3,406 Claims asserted in amounts greater than $5,000, the Debtors
had resolved a total of 591 as of January 3, 2003, for a total of $9 million, or
an average of approximately $15,363 per Claim.
On December 19, 2002, the Bankruptcy Court established a supplemental
bar date of January 22, 2003 with respect to approximately 4,000 personal injury
and related claimants who were only recently identified and who therefore did
not receive notice of the Bar Date. As of January 15, 2003, a total of 204 of
such claimants had filed proofs of claim with the Bankruptcy Court. The Debtors
have begun efforts to resolve the personal injury claims asserted in these
proofs of claim consistent with the omnibus claims resolution procedures.
(b) Resolution of Mechanics' Lien Claims.
As of June 6, 2002, the Debtors had received notices of 3,044
mechanics' lien claims (the "Mechanics Lien Claims") asserted against the
Debtors' leaseholds and other properties. Over 950 of the Debtors' operating
stores were affected by these Lien Claims, which could arguably have triggered
defaults under the Debtors' leases. Pursuant to the first day orders, the
Debtors were authorized to pay such Claims, but the volume of such Claims was
such that the Debtors needed a process for resolving them. Accordingly, the
Debtors devised detailed procedures for the orderly and efficient resolution of
Mechanics' Lien Claims. The Debtors thereafter filed a motion to establish
specific procedures for (a) liquidating and settling their Mechanics' Lien
Claims and (b) staying the enforcement of Mechanics' Lien Claims pending
resolution of disputed Claims to allow their orderly liquidation. After lengthy
negotiations with landlords about the terms of the procedures, on July 25, 2002,
the Bankruptcy Court approved the Debtors' proposed procedures.
The Mechanics' Lien Claim resolution procedures provide that if the
Debtors dispute a Mechanics' Lien Claim, they can send a notice (the "Dispute
Notice") to such Claim holder indicating the Debtors' dispute and containing a
payment proposal to discharge the asserted lien. The service of the Dispute
Notice by the Debtors on the claimant stays the enforcement of the Mechanics'
Lien Claim and any default arising therefrom until further order from the
Bankruptcy Court with respect to the Debtors and their landlords. Within 30 days
of service of the Dispute Notice, the claimant is required to respond in writing
indicating acceptance, rejection, or disagreement with the Debtors' proposal.
The
33
Debtors have 60 days thereafter to negotiate a settlement with the claimant.
If a Mechanics' Lien Claim is not resolved in that time period, the Debtors are
permitted to file an objection to such Claim with the Bankruptcy Court and the
dispute will be resolved by the Bankruptcy Court.
As noted above, approximately 3,000 Mechanics' Lien Claims have been
filed against the Debtors' properties; the total amount of the Claims is
approximately $89.4 million. As of December 11, 2002, the Debtors had resolved
approximately 2,500 of the Mechanics' Lien Claims and had paid approximately $63
million to such claim holders. This represents a savings of approximately $25.5
million for the Debtors' estates with respect to the resolved Mechanics' Lien
Claims. The Debtors continue to use the Mechanics' Lien Claim resolution
procedures to resolve the remaining Mechanics' Lien Claims.
(c) Resolution of Prepetition Claims.
On January 14, 2003, the Debtors filed a motion requesting authority
from the Bankruptcy Court to settle or compromise pre-petition claims, without
further Court approval, pursuant to a comprehensive claims resolution procedure.
On January 27, 2003, the Court entered an order granting the motion (the "Claims
Resolution Order"). Pursuant to such Order, the Court established certain
parameters by which the Debtors may reconcile and resolve prepetition claims in
these Chapter 11 Cases. Specifically, the Claims Resolution Order authorizes the
Debtors to settle disputed claims where the amount in controversy is $1 million
or less, so long as the aggregate amount in controversy resolved under such
authority does not exceed $1 billion, and also includes a mechanism for
resolving other claims through mediation. Of the 44,935 proofs of claim filed in
these Chapter 11 Cases, a total of 17,917 of such claims differ from the amounts
shown in the Debtors' books and records by amounts that are less than $1
million. These claims account for approximately 40% of all proofs of claim filed
and 12% of the total dollar amount of all of the claims filed in these Chapter
11 Cases. This approved mechanism provides a cost effective means of resolving
the many thousands of smaller claims in these Cases, thereby avoiding the undue
burden on the Court and unnecessary drain on the time, funds, and other
resources of the Debtors and Reorganized Debtors that would be caused by
requiring the Debtors to file motions to approve each settlement individually.
(d) Resolution of De Minimis Controversies.
On August 9, 2002, the Debtors filed a motion to authorize the Debtors
to compromise or settle certain classes of de minimis controversies that are
normal and expected in a business of the size of the Debtors. On August 29,
2002, the Bankruptcy Court approved procedures for the compromise and settlement
of (a) controversies where the amount originally claimed by the Debtors to be
due and owing to them is $2 million or less with respect to each matter or
related series of matters, (b) the final settlement of the controversy does not
exceed the sum of $2 million, and (c) the final settlement amounts of all
controversies outside the ordinary course does not exceed $75 million in the
aggregate.
(e) Sales of De Minimis Assets.
On August 29, 2002, the Bankruptcy Court approved procedures by which
the Debtors were authorized to sell miscellaneous surplus, non-core assets from
time to time and pay applicable broker commissions in the ordinary course of
business in connection with such sales without further Court approval. Pursuant
to these procedures, the Debtors were authorized to consummate sales of real
34
property and personal property outside the ordinary course of business where the
purchase price was $2 million or less for each transaction or in the aggregate
for a related series of transactions, up to an aggregate amount of $75 million
in net sales proceeds.
6. Employee Compensation Programs.
Prior to the commencement of these Chapter 11 Cases, the Debtors
constructed employee compensation programs (the "Compensation Programs")
designed to minimize management and other key employee turnover by providing
incentives for employees, including senior management, to remain in the Debtors'
employ and to maintain the value of the Debtors' estates during these
proceedings. Indeed, the Debtors' ability to maintain their business operations
and preserve value for their estates has been dependent upon the continued
employment, active participation, and dedication of the employees who possess
the knowledge, experience, and skills necessary to support the Debtors'
businesses. The Debtors and their financial and other advisors therefore
undertook a comprehensive analysis of their compensation systems and, as a
result, modified certain existing plans and developed and implemented new plans
designed to retain key employees. As a result of these efforts, the Debtors
sought and received authority from the Court to implement the following
Compensation Programs.
(a) The Key Employee Retention Program.
The Debtors instituted a Key Employee Retention Program (the "KERP")
which is designed to reduce employee turnover and the loss of industry
knowledge. Approximately 8,000 employees are eligible to participate in the
KERP. The KERP assigns classes of employees to organizational tiers which
determine eligibility and vesting requirements for the various components of the
KERP. A summary of those organizational tiers, including the estimated number of
employees in each tier as of January 1, 2003, follows (although certain
employees in certain tiers are parties to employment agreements that contain
provisions related to incentives and/or severance compensation that effectively
supercede the KERP):
(1) Chief Executive Officer ("Tier One") (one
employee);
(2) Executive Vice Presidents ("Tier Two")
(three employees);
(3) Senior Vice Presidents, Divisional
Presidents, certain Vice Presidents, certain
Divisional Vice Presidents and equivalents
("Tier Three") (22 employees);
(4) Vice Presidents, Regional Vice Presidents,
certain Divisional Vice Presidents and
equivalents ("Tier Four") (99 employees);
(5) Certain Divisional Vice Presidents,
Directors, District Managers and equivalents
("Tier Five") (652 employees);
(6) Corporate Managers (including, Pharmacy
District Managers) and equivalents ("Tier
Six") (1,551 employees);
35
(7) Corporate/Distribution Center Salaried
employees ("Tier Seven") (1,062 employees);
(8) Store Managers ("Tier Eight") (1,745
employees); and
(9) Pharmacists/Pharmacy Managers ("Tier Nine")
(2,710 employees).
(i) Corporate Annual Performance Plan.
The purpose of the Corporate Annual Performance Plan is to focus
participant attention on the Debtors' financial turn around and business
improvement. Employees in Tiers One through Seven are eligible to participate in
the Corporate Annual Performance Plan. Performance is measured based on the
Debtors' financial performance for each fiscal year. Employees in the
above-referenced Tiers become vested on January 31 of each respective year.
Awards, when earned, are payable as soon as practicable following the filing of
Kmart's report on Form 10-K with the Securities and Exchange Commission for the
fiscal year.
(ii) Stay Bonus.
The purpose of the Stay Bonus is to provide an incentive to key
employees to continue their employment with the Debtors during these Chapter 11
Cases. Employees in Tiers Three through Nine are eligible to participate in the
Stay Bonus. Progress payments are earned consistent with an established schedule
and conclude when the Debtors emerge from the Chapter 11 Cases. Employees
entitled to participate in the Stay Bonus received 30% of the Stay Bonus on
September 30, 2002, 20% of the Stay Bonus on January 1, 2003, and are entitled
to receive 20% of the Stay Bonus on the earlier of the Debtors' emergence from
Chapter 11 or June 30, 2003, with the remaining 30% of the Stay Bonus payable
upon emergence of the Debtors from Chapter 11. Employees who remain employed
with the Debtors throughout the measurement period and who attain at least a
"satisfactory" rating on their most recent performance evaluation are entitled
to the Stay Bonus amount for their respective tier.
(iii) Transition Payment Plan.
The purpose of the Transition Payment Plan is to provide management
with a discretionary program to incentivize selected employees (whose positions
were and will be terminated after a date certain, but whose services were
required during a transition period) to remain employed with the Debtors
throughout a specified period. Payments have been and will be authorized for a
period of time beginning upon notification to such employees that their current
positions were terminated, and end upon the Debtors' termination of the
participant's employment other than for cause. To be eligible for the Transition
Payment Plan, employees have to remain employed with the Debtors and remain in
good standing throughout the measurement period. Eligible employees in Tiers
Five, Six and Seven are eligible to receive (in addition to base salary) one
week's base salary for each week worked during the transition period. Eligible
Employees in Tier Nine and other selected employees are eligible to receive (in
addition to base salary) one-half of one week's base salary for each week worked
during the transition period. Payments under the Transition Payment Plan vest
upon the earlier of termination, other than for cause, or completion of a
transition period.
36
(iv) CEO Discretionary Pool.
The purpose of the CEO Discretionary Pool is to provide protection for
the Debtors against unnecessary employee turnover. Any employee deemed to be at
risk for voluntary termination of employment with the Debtors, as identified by
management and approved as a participant by the chief executive officer of
Kmart, is eligible for participation in the CEO Discretionary Pool. The CEO
Discretionary Pool was established in the amount of $1.5 million; authorized
payment dates and payment amounts are determined by the chief executive officer
of Kmart. As of January 1, 2003, awards totaling $765,000 have been made under
the CEO Discretionary Pool.
(b) Deferred Compensation Plans.
On February 14, 2002, the Debtors sought authority from the Bankruptcy
Court to modify two deferred compensation plans established prior to the
Petition Date (the "Deferred Compensation Plans") for the distribution of funds
to certain of their employee-beneficiaries. The beneficiaries of the Deferred
Compensation Plans included over 3,000 employees and directors who had
contributed a portion of their regular compensation to one of two trusts, one
for each of the Deferred Compensation Plans. These contributions were payable to
the employees at a later time in accordance with the terms of the respective
trusts. The trusts collectively held approximately $13 million in employee and
director contributions at the time the Debtors filed their request with
Bankruptcy Court.
The Financial Institutions' Committee objected to this request. The
Debtors thereafter engaged in extensive negotiations with the Financial
Institutions' Committee regarding the terms of the proposed distribution to
Kmart employees. As a result of these negotiations, the Debtors and the
Financial Institutions' Committee agreed on the terms of distributions from the
Deferred Compensation Plans. These terms were memorialized in an order submitted
to the Bankruptcy Court. On April 23, 2002, the Bankruptcy Court entered the
order, which authorized the distribution of trust assets of the Deferred
Compensation Plans in an amount equal to the lesser of the beneficiaries'
account balances or $10,000 to those beneficiaries that had not held the
position of senior vice president, divisional president, or higher with any of
the Debtors. Under the Plan, the Debtors propose to distribute the remaining
trust assets to the plan beneficiaries, other than certain beneficiaries who are
the subject of Trust Claims.
7. Senior Management Contracts.
Within the first 50 days of these Chapter 11 Cases, the Debtors
replaced almost all members of senior management. Prior to the Petition Date,
Mr. Charles C. Conaway was Chief Executive Officer, Mr. Mark S. Schwartz was
President, Mr. John T. McDonald was Executive Vice President and Chief Financial
Officer, and Mr. David P. Rots was Executive Vice President and Chief
Administrative Officer. On January 15, 2002, seven days prior to the Petition
Date, Mr. Schwartz was separated from his employment with Kmart. On March 11,
2002, Mr. Conaway, Mr. McDonald, and Mr. Rots were separated from their
employment with Kmart. Kmart did not assume any of the employment agreements
with any of the foregoing individuals and declined to pursue a separate
obligation to assume Mr. Conaway's contract. Further information concerning
Kmart's former management is contained in Section VI.F. of this Disclosure
Statement, "The Accounting, Stewardship, and Related Investigations."
Shortly after Mr. Schwartz's separation on January 15, 2002, Mr. James
B. Adamson, a member of Kmart's Board of Directors, was named Non-Executive
Chairman of the Board. On the Petition Date, Mr. Ronald B. Hutchison was named
Chief Restructuring Officer. On March 11, 2002, when the
37
employment relationships of Mr. Conaway, Mr. McDonald, and Mr. Rots were ended,
Mr. Adamson was named Chief Executive Officer. Also on that date, Mr. Albert A.
Koch was named Chief Financial Officer, and Mr. Edward J. Stenger was named
Treasurer. Mr. Julian C. Day also was named President and Chief Operating
Officer effective March 11, 2002. Michael T. Macik was appointed to the position
of Executive Vice President, Human Resources, effective April 8, 2002. William
Underwood was appointed to the position of Executive Vice President, Kmart
Sourcing & Global Operations of the Company, effective June 3, 2002.
The Debtors entered into employment agreements with each of Mr.
Adamson, Mr. Day and Mr. Hutchison. Under the terms of Mr. Adamson's employment
agreement, Mr. Adamson was to serve as Chief Executive Officer until April 30,
2004, subject to extension. Mr. Adamson received an annual base salary of
$1,500,000, and was eligible for annual reviews for increases. He also was
eligible for certain incentive awards and success payments. Effective January
17, 2003, Mr. Adamson was succeeded by Mr. Day as Chief Executive Officer. Mr.
Adamson will continue to serve as Non- Executive Chairman of the Board through
the final stages of the company's reorganization.
Under the terms of Mr. Day's original employment agreement as President
and Chief Operating Officer, Mr. Day was to serve as President and Chief
Operating Officer until April 30, 2004, subject to extension. Mr. Day received
an annual base salary of $775,000 in such capacity, and was eligible to receive
certain bonuses and incentives with respect to Kmart's performance and emergence
from Chapter 11. He received a lump sum payment of $775,000 upon execution of
his employment agreement.
In connection with his appointment as Chief Executive Officer effective
January 17, 2003, Mr. Day will enter into a restated employment agreement to
reflect his new responsibilities. Under the agreement, which will have a term
expiring January 31, 2006, Mr. Day will have an annual base salary of $1 million
dollars. In addition, Mr. Day will be entitled to a $1 million payment upon the
Effective Date of the Plan. The agreement will provide for the opportunity to
earn annual cash incentive bonuses. For fiscal year 2003, such bonus will be
determined in the discretion of the compensation committee of the Reorganized
Debtors' board of directors. In subsequent fiscal years, the bonus will be
expressed as a percentage of Mr. Day's base salary and will be based on
achievement against adjusted EBITDA targets included in the business plan
approved in connection with the Plan, with a target bonus opportunity of 100% of
base salary. The new contract will also provide for a 10-year stock option to
purchase a number of shares of common stock representing 1.5% of the Reorganized
Debtors' fully diluted equity at emergence. The option generally will vest
ratably over four years provided Mr. Day is employed by the Reorganized Debtors
on each vesting date.
The appointment of Mr. Day as Chief Executive Officer was made as Kmart
begins to implement a reorganized management structure and form an emergence
management team in anticipation of Kmart's exit from Chapter 11. The timing of
this announcement was designed to afford Mr. Day adequate time to select
additional key executives for Kmart's emergence team, including a chief merchant
and general counsel, as well as permanent finance leadership to succeed the
interim services provided by Albert A. Koch and Edward J. Stenger, principals of
Alix Partners.
Mr. Hutchison, as Chief Restructuring Officer, receives $475,000 in
annual compensation under his employment agreement. The term of his agreement
runs to the Effective Date of the Plan. He received a lump sum cash payment of
$250,000 upon execution of his employment agreement, and is
38
entitled to receive a lump sum cash payment of $1 million within ten days after
the Debtors' emergence from Chapter 11.
Mr. Macik entered into an employment agreement having a term that runs
to April 30, 2004, subject to extension. Mr. Macik's employment agreement
provides for a base salary of $425,000 and the opportunity to earn annual
bonuses and incentives related to the Debtors' emergence from Chapter 11. He
received a lump sum payment of $425,000 upon execution of his employment
agreement.
Mr. Underwood entered into an employment agreement having a term that
runs to June 2, 2004, subject to extension. Mr. Underwood's employment agreement
provides for a base salary of $485,000 and the opportunity to earn annual
bonuses and incentives related to the Debtors' emergence from Chapter 11.
8. Sale of Bluelight.com LLC Assets.
Bluelight.com LLC is a wholly-owned direct subsidiary of Kmart that
operates the Debtors' eCommerce business and operated its internet service
provider and private label internet access services. Bluelight provided low
cost, high quality dial-up internet access services covering areas that comprise
more than 90% of the U.S. population. Bluelight continues to operate an
e-commerce site.
After a comprehensive strategic review, the Debtors decided to sell
certain of the Debtors' assets related to Bluelight's business of providing
branded dial-up internet access and e-mail services and private label internet
access services. The Debtors determined that these businesses were not critical
to the reorganization efforts and, as such, should be sold if a reasonable offer
was received. Thereafter, Bluelight entered into an agreement, subject to higher
and better offers, with United Online, Inc. and its wholly-owned subsidiary,
NetBrands, Inc. for the purchase of these assets for $8.39 million. The
purchasers continue to offer internet services under the Bluelight name.
On October 7, 2002, the Debtors conducted an auction to sell the
Bluelight assets. United Online and NetBrands emerged as the winning bidders at
the conclusion of such auction. On October 30, 2002, the Bankruptcy Court
entered an order authorizing the sale of the assets to these purchasers.
9. Exclusivity.
Pursuant to an order of the Bankruptcy Court dated July 24, 2002, the
Bankruptcy Court extended the Debtors' exclusive period to propose a plan of
reorganization (the "Filing Period") through February 28, 2003, and to solicit
acceptances of such plan (the "Solicitation Period") to April 22, 2003. Pursuant
to a further order of the Court entered on February 25, 2003, the Filing Period
and Solicitation Period were further extended to June 30, 2003, and August 31,
2003, respectively.
F. THE ACCOUNTING, STEWARDSHIP AND RELATED INVESTIGATIONS
1. Introduction
On January 12, 2002, the Debtors received a copy of an anonymous letter
addressed to the Securities and Exchange Commission ("SEC"), dated January 9,
2002. The letter purported to be from Kmart employees who alleged that they had
been directed to make improper accounting entries in the
39
books and records of the company. On January 14, 2002 - one week after the
Debtors had retained the law firm of Skadden, Arps, Slate, Meagher and Flom LLP
("Skadden") to advise it in connection with a possible restructuring, and eight
days before the Debtors filed petitions for protection under Chapter 11 - the
board of directors instructed Skadden, under the supervision of the Audit
Committee, to conduct an internal investigation into the allegations contained
in the letter (the "Accounting Investigation"). The goal was to review
accounting matters raised by the anonymous letter and other issues identified in
the course of such an inquiry, with the intent of completing such an
investigation prior to the company's filing of its Form 10-K Annual Report for
Fiscal Year 2001, which it did on May 15, 2002.
Subsequent to January 2002, and continuing until as recently as the
month of February, 2003, the Debtors, Skadden, members of Kmart's board of
directors, the Statutory Committees and certain of their members, selected media
outlets and certain government entities received more than 70 additional
anonymous letters relating allegations of misfeasance and malfeasance by past
management. Skadden was directed by the Audit Committee to investigate the
allegations contained in these letters, as well as other matters that came to
Skadden's attention during the course of the inquiry. This phase of the inquiry,
which was taken up following the substantial completion of the Accounting
Investigation, was denominated the "Stewardship Investigation".
At the same time, the SEC and the United States Attorney's Office for
the Eastern District of Michigan ("USAO"), aided by the Federal Bureau of
Investigation and a federal grand jury, opened inquiries into events that
occurred at the Debtors leading up to the filing of the petitions (the
"Government Inquiries"). The board directed the company and Skadden to cooperate
fully with the SEC and USAO investigations. To facilitate this cooperation, the
company, through its counsel, entered into confidentiality agreements with the
SEC and the USAO.
In June 2002, the Debtors consulted with the three Statutory Committees
regarding the conduct and completion of the Investigations (as defined below).
Thereafter, with the approval of the board of directors, the Debtors invited
legal counsel and forensic accounting professionals retained by the three
Statutory Committees (the "Professional Advisors to the Committees") to
participate on a joint interest basis in the Investigations, subject to a
confidentiality agreement among all the participating parties. With the support
of the Debtors and the Statutory Committees, that agreement was incorporated in
an order of the Bankruptcy Court entered September 4, 2002 (the "Order"). The
Order also recognized the confidentiality agreements between the Debtors and the
SEC and the USAO. Pursuant to that agreement and that Order, the Professional
Advisors to the Committees were given substantial, confidential access to
investigatory materials, participated in witness interviews and depositions, and
reviewed documents collected in the course of the Investigations.
2. Scope and Conduct of the Investigations
In the conduct of the Accounting and Stewardship Investigations,
including with respect to all matters authorized by the Order and in connection
with responding to Government Inquiries (collectively the "Investigations"), the
Audit Committee and Kmart management have given Skadden unfettered access to the
Company's employees and records and directed the Company's management to
cooperate fully and to assist in the Investigations. Neither the board nor
management limited the scope of the Investigations in any way.
40
As of January 24, 2003, Skadden, assisted by forensic accountants from
the firms of Chicago Partners, LLC, and Ten Eyck Associates Inc., have conducted
more than 570 interviews of current and former Kmart employees; have collected,
reviewed and analyzed in excess of 1.5 million pages of documents, including
accounting records, audit work papers, company policies and electronic mail; and
have processed more than 620,000 pages of documents for production in response
to subpoenas and voluntary requests for documents from the SEC, the USAO and the
U.S. House of Representatives.
Generally, the allegations that were the subject of the Investigations
pertained to the following subjects, among others:
-- The accuracy of representations made by former management to
the board of directors, vendors and the public concerning the
financial condition of the Debtors in 2001
-- The payment of retention loans and retention bonuses to Kmart
managers in late 2001
-- The recording of vendor allowances (also known as vendor
rebates or vendor credits)
-- Management of inventory and inventory accounting
-- Relations with Kmart vendors, including whether certain
employees received improper payments from vendors
-- Hiring practices implemented by former management
-- Abuse of corporate aircraft privileges and other corporate
perquisites
-- Certain aspects of the Debtors' operations in the Caribbean
The Order also authorized the issuance of subpoenas pursuant to
Bankruptcy Rule 2004. Accordingly, the Debtors issued subpoenas for testimony
and documents to 20 former Kmart employees and three third-party witnesses. In
addition, the Statutory Committees issued subpoenas to three directors. The
table below identifies those deponents and the dates on which their depositions
occurred or are scheduled to occur.
=================================================================================================================
DEPONENT FORMER TITLE(S) DATE(S) DEPOSITION
OCCURRED OR IS SCHEDULED
TO OCCUR
=================================================================================================================
Al Abbood Divisional Vice President, Food and November 12, 2002
Consumables; Vice President, grocery,
merchandising and Procurement-Fleming
- -----------------------------------------------------------------------------------------------------------------
James B. Adamson Director, Chief Executive Officer February 21, 2003
- -----------------------------------------------------------------------------------------------------------------
Jeffrey Boyer Chief Financial Officer December 17, 2002,
January 20, 2003
- -----------------------------------------------------------------------------------------------------------------
41
=================================================================================================================
DEPONENT FORMER TITLE(S) DATE(S) DEPOSITION
OCCURRED OR IS SCHEDULED
TO OCCUR
=================================================================================================================
Ronald J. Chomiuk Senior Vice President, Pharmacy December 6, 2002
Operations; Vice President, General
Merchandise Manager, Drugstore
Businesses; Divisional Vice President,
Health and Beauty Care; Director of
Pharmacy Operations and Consumables,
Super K Divisional
- -----------------------------------------------------------------------------------------------------------------
Charles C. Conaway Chief Executive Officer January 22-23, 2003
- -----------------------------------------------------------------------------------------------------------------
Timothy M. Crow Senior Vice President, Human Resources December 18, 2002
Operations
- -----------------------------------------------------------------------------------------------------------------
Hector Dominguez Senior Vice President, Super Kmart Centers; December 18, 2002
Regional Manager, Western Divisional
- -----------------------------------------------------------------------------------------------------------------
Richard H. Donckers President, Retail Strategies International December 5, 2002
- -----------------------------------------------------------------------------------------------------------------
Anthony B. D'Onofrio Executive Vice President, Systems February 27-28, 2003
Capability and Chief Supply Chain Officer
- -----------------------------------------------------------------------------------------------------------------
Michael K. Frank Senior Vice President, General Merchandise December 12, 2002
Manager, Food and Consumables
- -----------------------------------------------------------------------------------------------------------------
Mark Glover Vice President, Replenishment December 2, 2002
- -----------------------------------------------------------------------------------------------------------------
Brett Green Director, General Compensation December 10, 2002
- -----------------------------------------------------------------------------------------------------------------
Joseph Hofmeister Divisional Vice President, Toy & Hobbies December 17, 2002
Department; Divisional Vice President,
Celebration; Merchandise Manager,
Sporting Goods.
- -----------------------------------------------------------------------------------------------------------------
John Iaciofano J.L. Lucas Associates, Inc. December 16, 2002
- -----------------------------------------------------------------------------------------------------------------
Cecil B. Kearse Executive Vice President, Merchandising December 6, 2002
- -----------------------------------------------------------------------------------------------------------------
Robert D. Kennedy Director February 13, 2003
- -----------------------------------------------------------------------------------------------------------------
John T. McDonald, Jr. Executive Vice President, Chief Financial December 5, 2002,
Officer, Vice President and Treasurer January 6, 2003
- -----------------------------------------------------------------------------------------------------------------
Enio A. Montini, Jr. Vice President, General Merchandise December 16, 2002
Manager, Drug Stores
- -----------------------------------------------------------------------------------------------------------------
David W. Montoya Senior Vice President, Specialty Operations, December 4, 2002
Executive Vice President, Store Operations
- -----------------------------------------------------------------------------------------------------------------
42
=================================================================================================================
DEPONENT FORMER TITLE(S) DATE(S) DEPOSITION
OCCURRED OR IS SCHEDULED
TO OCCUR
=================================================================================================================
John P. Owen Senior Vice President, General Merchandise December 12, 2002
Manager, Hardlines
- -----------------------------------------------------------------------------------------------------------------
David P. Rots Executive Vice President, Chief January 15, 2003
Administrative Officer; Executive Vice
President, Human Resources and
Administration
- -----------------------------------------------------------------------------------------------------------------
Mark S. Schwartz President and Chief Operating Officer; January 7-8, 2003
Executive Vice President, Store Operations
- -----------------------------------------------------------------------------------------------------------------
Thomas Stallkamp Director February 27, 2003
- -----------------------------------------------------------------------------------------------------------------
Jeffrey G. Stark Vice President, Pricing; Vice President of November 22, 2002
Finance; Merchandise Controller
- -----------------------------------------------------------------------------------------------------------------
H. Richard Troy, Jr. Buck Consultants, Inc. December 12, 2002
- -----------------------------------------------------------------------------------------------------------------
One witness - Mr. Rots - asserted his Fifth Amendment right not to
testify in response to any and all questions posed by counsel for the Debtors
and the Committees. Mr. Rots also refused to produce documents on the basis that
to do so could incriminate him. Three other witnesses - Messrs. Montoya,
Hofmeister, and Montini - interposed Fifth Amendment objections with respect to
questions on specific topics.
As the Rule 2004 depositions of former management were nearing
completion, the Debtors' Statutory Committees began depositions of certain
members of the Kmart board of directors in order to determine whether and to
what extent the board was apprised of certain events and activities that
occurred at the company, among other matters. Pursuant to a protocol established
between Skadden and the Statutory Committees, and in accordance with the Order,
counsel for the Statutory Committees are taking the lead in examining individual
directors, and Skadden is participating in those examinations, which are among
the final steps in the Investigations. The deposition of one director, Robert
Kennedy, took place on February 13, 2003. The deposition of James Adamson took
place on February 21, 2003 and the deposition of Thomas Stallkamp is scheduled
to occur on February 27, 2003.
The period for completion of the Investigations was extended to the
first quarter of 2003 due in part to the letter writers' insistence on remaining
anonymous. While the authors often provided useful and constructive information
to the Investigation, they failed to respond to several appeals from Skadden,
the Company and the USAO to come forward with "audit trails," audiotapes and
videotapes that they purported to possess substantiating their sometimes vague
or cryptic allegations. These appeals were made through electronic mail, at
company assemblies, and in Court filings and Court hearings. The letter writers,
moreover, were invited at their option to provide information and records either
to the company's new compliance officer, independent outside counsel, or the
government, and were given assurances from the company and the USAO that there
would be no retaliation against anyone for coming forward. Indeed, in
cooperation with the USAO, one such appeal was made as recently as the week of
January 12, 2003 via company-wide e-mail. Notwithstanding these assurances, and
notwithstanding warnings by the USAO that the withholding of such evidence, if
it exists, could
43
constitute obstruction of justice or violate other applicable laws, these
appeals have gone unheeded. Had such records been provided, and had the letter
writers come forward to elaborate on the allegations, the Investigations would
have been substantially expedited and the cost greatly reduced. It would still
be of tremendous assistance to the investigators if the letter writers were to
proffer their documents and information at this time.
3. Results.
a. Potential Legal Claims
The Debtors, after consultation with their Statutory Committees, have
determined that a Creditors' Litigation Trust (the "Trust") is the preferred
available mechanism for resolving any legal claims that may arise out of the
Investigations. As part of the Plan, the trustee of the Trust would be charged
with responsibility for determining which claims to pursue and litigating such
claims. Pursuant to the Plan, the Debtors will share with the trustee evidence
gathered and certain work product developed during the Investigations, as more
specifically set forth in the Trust Agreement. As noted above, certain
investigatory work is continuing, and nothing herein is intended to limit in any
way the causes of action that may exist or that the trustee may bring.
Based on evidence developed to date in the Investigations, the Debtors
believe that the estates may have, inter alia, legal claims against certain
former officers on grounds that they were grossly derelict in performing their
duties to the company, its associates, its vendors, and its investors. These
would include, without limitation, such claims as breach of the fiduciary duties
of due care, loyalty and candor, gross negligence, and certain
bankruptcy-related causes of action.
In addition, evidence developed during the Investigations indicates
that the Debtors' estates may have claims for breach of contract and related
misconduct against certain third party vendors who purported to provide
consulting services to Kmart.
It cannot be predicted at this date which claims the trustee will
determine exist or would choose to pursue. Nor can the outcome of any such
litigation be foreseen. Nor would it be in the estates' interest at this
juncture to lay out a road map for potential defendants by providing a detailed
report of the evidentiary basis for such claims. However, consistent with their
obligations under Section 1125 of the Bankruptcy Code, Skadden has reported to
the Debtors that credible and persuasive evidence adduced to date supports the
following findings, among others:
-- Beginning in September 2001, in an effort to avert a potential
liquidity crisis, former management of Kmart undertook a
program known internally as "Project Slow It Down", or
"Project SID", pursuant to which payments to vendors were
systematically deferred or reduced; vendors were purposefully
denied access to computerized accounts payable records; and
deceptive responses were given to vendors who inquired
concerning the reasons they were not being paid.
-- In October and November 2001, when the Compensation and
Incentives Committee of the board of directors was asked to
approve a $24 million retention loan program for senior
executives, management failed to disclose to the committee
certain information that the committee believes would have
been material to its decision making. Further,
44
the retention loan and bonus program implemented by former
management in December 2001 deviated in certain significant
respects from the program that the committee had approved. In
addition, management created purported committee documents
that varied materially from the loan program documents
submitted to the committee for approval, and these documents
were inserted in the Company's official board files
after-the-fact. Finally, in the course of the present
Investigations, certain former employees acted to
intentionally withhold information from Skadden relating to
the retention program.
-- Former senior managers frequently imposed gross margin and
vendor allowance target numbers on Kmart's merchandising
personnel, while being warned repeatedly that the numbers
imposed from the top were unattainable. Certain employees were
demoted or transferred when they resisted a manager's demand
to incorporate numbers they believed to be unrealistic into
the company forecasts and financial reports. As a result of
the "top down" imposition of numbers in this manner, a
substantially inflated forecast was submitted to the board
during the fourth quarter of 2001, at the time the
Compensation and Incentives Committee was considering final
approval of the retention loan program.
-- With respect to the booking of vendor payments and allowances,
the evidence disclosed that:
-- In 2001, the Kmart merchant community was under
extraordinary pressure from senior managers to record
incremental allowances, i.e., allowances that were in
excess of the plan for the year.
-- The Investigations identified at least $92 million in
allowances recorded during the first three quarters
of 2001 that were questionable, in that there were
failures to have appropriate signed documentation in
place or adequate records demonstrating that the
allowances were collectible, or were other indicia
that the allowances otherwise failed to comply with
Kmart's then-existing policies.
-- The company's net loss for fiscal year 2001 was
overstated by approximately $78 million due to vendor
allowances that were prematurely recorded in Kmart's
fiscal year 2000 fourth quarter results.
-- One substantial up-front payment from a vendor was
improperly recorded and required a significant
adjustment of the Company's financial statements for
the second and third quarters of 2001, due to the
existence of an undisclosed side agreement with the
vendor.
As accounting issues related to allowances and vendor payments
were identified in the course of the Investigations,
disclosure on appropriate restatements were made in the
Company's public filings, as discussed in detail below.
-- In the summer of 2001, a former senior executive directed
initiatives that resulted in the excessive purchases of
inventory without sufficient analysis and oversight, and
without appropriate consultation with the merchant community
or Kmart's treasury officials.
45
These purchases, which together amounted to approximately $850
million, substantially contributed to Kmart's liquidity crisis
in the fall of 2001.
-- In 2000-2001, former management hired numerous personnel into
the company without completion of formal applications,
submission of background information, or interviews by
appropriate personnel. Certain former managers often dictated
the terms and compensation packages to be offered to these
individuals, without consulting Human Resources officials. As
a result, their compensation packages far exceeded not only
Company norms but also the compensation they had received from
previous employers. Many of these hires proved unqualified for
their positions and ultimately were terminated.
-- One former executive received a substantial improper payment
from a consultant to the Company.
-- Former management in 2001 authorized the expenditure of $12
million to purchase corporate aircraft, notwithstanding that
moneys for the purchase were not included in the Company's
capital budget. Some former executives also abused an already
generous corporate aircraft policy by masking personal travel
as store visits and by loading aircraft with Kmart personnel
who otherwise had no need to travel, in order to avoid having
personal travel expenses imputed to their incomes.
b. Terminations
As noted above, through the Investigations, the Debtors discovered
information showing that certain former managers were responsible for
misfeasance and malfeasance, and/or violated Company policy, in connection with
the events that were the subject of the Investigations. All individuals so
identified either already had been terminated, or were terminated as a result of
the investigatory findings.
c. Retention Loans
A major subject of inquiry in the Investigations was the Company's
retention loan programs. In November 2000, the Compensation and Incentives
Committee of the Kmart board unanimously approved the Executive Leadership Team
Retention Program (the "2000 Retention Program"). Under the terms of the 2000
Retention Program, seven senior executives each received an up-front cash
payment, a grant of restricted stock (including an opportunity to earn
additional performance-based restricted shares of Kmart's common stock subject
to the attainment of applicable performance goals), and enhanced protection in
the event of a change-in-control, among other benefits. In return for these
benefits, the recipients committed to stay at Kmart for four years and executed
Confidentiality, Non-Competition and Non-Solicitation Agreements. If, under
certain specified circumstances, a recipient departed the company prior to four
years, he or she would be obligated to repay the cash payment.
In May 2001, the Compensation and Incentives Committee also approved a
special, one-time long-term compensation award for former Chief Executive
Officer Charles C. Conaway. Mr. Conaway's award consisted of a $5 million dollar
cash loan and a performance option grant in return for a commitment to stay at
the company.
46
In December 2001, former management of the Debtors implemented another
retention program pursuant to which a total of $23.89 million was paid to 24
senior managers in the form of forgivable loans (the "2001 Retention Program").
The 2001 Retention Program covered two groups of executives: CEO direct reports
and key Executive Vice Presidents ("EVPs") (Tier A) and other EVPs and Senior
Vice Presidents ("SVPs") (Tier B). With respect to Tier A recipients who
participated in the 2000 Retention Program, the 2001 Retention Program provided
that the special restricted stock grant under the 2000 Retention Program would
be converted into a four-year forgivable cash loan, and the existing share
performance restricted stock award opportunity would be converted into stock
options with performance vesting. Tier B of the 2001 Retention Program was
directed at other EVPs and SVPs, none of whom participated in the 2000 Retention
Program. Tier B provided for a three-year forgivable cash loan. Pursuant to the
terms of the loan agreements, the loans, otherwise forgivable, would be due and
owing upon termination of employment "for cause", as defined in each agreement.
The table below identifies those individuals who received Tier A and
Tier B retention loans; the amount of the loan; and the date they were separated
from the Company.
===============================================================================================
LOAN AMOUNT LAST DATE OF
RECIPIENT OF LOAN(S) POSITION SEPARATION
=================================================================================================
Charles C. Conaway $5 million Chief Executive Officer March 11, 2002
- -------------------------------------------------------------------------------------------------
Mark S. Schwartz $3 million President and Chief January 15, 2002
Operating Officer
- -------------------------------------------------------------------------------------------------
Anthony B. $2.5 million Executive Vice President, March 25, 2002
D'Onofrio Global Systems Capability
and Chief Supply Chain
Officer
- -------------------------------------------------------------------------------------------------
Cecil B. Kearse $2.5 million Executive Vice President, May 31, 2002
Merchandising
- -------------------------------------------------------------------------------------------------
John T. McDonald $2.5 million Chief Financial Officer March 11, 2002
- -------------------------------------------------------------------------------------------------
David P. Rots $2.5 million Executive Vice President, March 11, 2002
Chief Administrative
Officer
- -------------------------------------------------------------------------------------------------
Hector Dominguez $750,000 Senior Vice President, February 4, 2002
Super Kmart Centers
- -------------------------------------------------------------------------------------------------
Enio A. Montini, Jr. $750,000 Senior Vice President, May 10, 2002
General Merchandise
Manager, Drugstore
- -------------------------------------------------------------------------------------------------
David W. Montoya $750,000 Senior Vice President, March 22, 2002
Specialty Operations
- -------------------------------------------------------------------------------------------------
Lorna E. Nagler $750,000 Senior Vice President, April 8, 2002
General Merchandise voluntary separation
Manager, Apparel
- -------------------------------------------------------------------------------------------------
47
=================================================================================================
LOAN AMOUNT LAST DATE OF
RECIPIENT OF LOAN(S) POSITION SEPARATION
=================================================================================================
John P. Owen $750,000 Senior Vice President, March 22, 2002
General Merchandise
Manager, Hardlines
- -------------------------------------------------------------------------------------------------
Gregg S. Treadway $750,000 Executive Vice President, May 6, 2002
Store Operations
- -------------------------------------------------------------------------------------------------
William Wulfers $750,000 Divisional President, May 10, 2002
Southeast
- -------------------------------------------------------------------------------------------------
Paul Springthorpe $700,000 Senior Vice President, May 10, 2002
Distribution Operations
- -------------------------------------------------------------------------------------------------
Timothy M. Crow $640,000 Senior Vice President, April 8, 2002
Human Resources
- -------------------------------------------------------------------------------------------------
Leo Anguiano $500,000 Senior Vice President, March 25, 2002
Asset Protection
- -------------------------------------------------------------------------------------------------
Michael K. Frank $500,000 Senior Vice President, May 10, 2002
General Merchandise
Manager, Food and
Consumables
- -------------------------------------------------------------------------------------------------
Janet Kelley $500,000 Executive Vice President, January 15, 2003
General Counsel
- -------------------------------------------------------------------------------------------------
Douglas Meissner $500,000 Divisional President, West January 17, 2003
- -------------------------------------------------------------------------------------------------
Paula Paquette $500,000 Senior Vice President, January 17, 2003
General Merchandise
Manager, Hardlines and
Home
- -------------------------------------------------------------------------------------------------
Paul J. Hueber $400,000 Senior Vice President, October 7, 2002
Operations Administration
- -------------------------------------------------------------------------------------------------
Michael S. Jardina $400,000 Divisional President, Super May 11, 2002
K
- -------------------------------------------------------------------------------------------------
Mariana Keros $400,000 VP, Trend and Product January 17, 2003
Development
- -------------------------------------------------------------------------------------------------
John Foster $300,000 Senior Vice President, Real May 10, 2002
Estate Management
- -------------------------------------------------------------------------------------------------
Leland M. Viliborghi $300,000 Regional Vice President January 17, 2003
- -------------------------------------------------------------------------------------------------
As discussed above, credible and persuasive evidence developed during
the Investigations showed that the 2001 Retention Program for Tier A and B
recipients, as implemented by former management, varied in certain key respects
from the program that the Compensation and Incentives Committee was asked to
approve. Moreover, information was not
48
made known to the outside directors that they believe would have been material
to their decision-making at the time the program was approved.
Moreover, after implementing the 2001 Retention Program for Tier A and
B recipients, former management undertook to provide bonuses to certain
so-called "Tier C" and "Tier D" executives below the Senior Vice President
level. This program was partially implemented prior to the filing of the Chapter
11 petitions. It was not, however, approved by the Compensation and Incentives
Committee. When the board, through the Investigations, discovered the existence
of the Tier C and D program, the program was promptly cancelled and the Company
obtained repayment from all bonus recipients.
No Tier A or Tier B loan recipient is still employed by the Company.
Three former employees, Janet Kelley, Lorna Nagler and Leeland Viliborghi, have
repaid their loans. On January 13, 2003, the board of directors authorized the
Company to demand the return of the full loan amounts from any recipient who has
yet to repay them, which the Company currently is undertaking to do. The mere
fact that an individual received a loan or bonus, or that the Company demanded
repayment, or the separation of an employee from the Company should not in and
of itself be taken as indicia of wrongful conduct by any individual former
employee.
On January 17, 2003, the Company announced that it had severed
employment relationships with any remaining executives who received special
retention loans in 2001. The executives involved were Janet Kelley, Mariana
Keros, Douglas Meissner, Paula Paquette, and Leland Viliborghi. This action was
taken by the Company as it began to implement a reorganized management structure
and establish an emergence management team in anticipation of emergence from
Chapter 11 reorganization on or about April 30, 2003. In connection with these
separations, the Company acknowledged that, while these individuals had
independently made substantial contributions to Kmart, the Company felt it was
important to put the controversy surrounding employees involved in the special
Retention Loan Program behind it as the Company prepared to emerge from Chapter
11. Subject to the repayment of any outstanding special retention loans and
subject to findings that may be made in connection with the Investigations, if
any, the Company agreed to provide these five former executives with severance
packages equivalent to either one or two years of base salary, which is subject
to mitigation.
Moreover, on January 23, 2003, based on the investigatory results to
date, the Company determined that the following loan recipients had engaged in
conduct that would constitute a material breach of the termination "for cause"
provisions of their employment agreements: Mark S. Schwartz, Anthony B.
D'Onofrio, Cecil B. Kearse, John T. McDonald, David P. Rots, Enio A. Montini,
Jr., David W. Montoya, John P. Owen, Timothy M. Crow, and Michael K. Frank. The
Company is withholding a determination as to other individual recipients until
completion of the Investigations.
In addition, testimony was taken from former Chief Executive Officer
Charles C. Conaway on January 22 and 23, 2003 at a deposition attended by
Skadden and representatives of the Statutory Committees. Following that
deposition, on February 11, 2003, Skadden provided further information to the
Board of Directors regarding the results of its investigation into Mr. Conaway's
stewardship of the Company. On that same day, counsel to Mr. Conaway made a
presentation to the Board of Directors on Mr. Conaway's behalf. Following these
49
presentations, the Board of Directors concluded That there is credible and
persuasive evidence to support a finding that Mr. Conaway engaged in conduct
that should support the commencement of Trust Claims against Mr. Conaway and
which may also be subsumed within the contractual definition of "cause" as that
term is defined in the termination provisions of Mr. Conaway's prior employment
agreement with the Company.
Among other matters, the Board of Directors concluded that there is
credible and persuasive evidence that Mr. Conaway participated in the
implementation of a program to systematically suspend vendor payments in an
effort to avert an undisclosed potential liquidity crisis in the fall of 2001;
Mr. Conaway was aware that Kmart personnel were taking steps to preclude vendors
from learning the actual reasons why they were not being paid, and failed to act
to prevent it; Mr. Conaway failed to disclose to Kmart's outside directors and
others significant information pertaining to the nature and extent of the
Company's liquidity problems during the third and fourth quarters of fiscal year
2001; Mr. Conaway failed to perform his duties as Chief Executive Officer to
adequately supervise and direct other Company executives who reported directly
or indirectly to him; and Mr. Conaway permitted Company executives to receive
millions of dollars in retention loans and other payments that they would not
have received had all material information been disclosed.
In completing its examination of Mr. Conaway's stewardship of the
Company, the Board of Directors reaffirmed its earlier direction that the
Company not obtain approval from the Bankruptcy Court of any employment-related
agreements with Mr. Conaway and that the Company demand repayment of special
retention loans paid to all special loan recipients including Mr. Conaway. The
Board of Directors also reaffirmed its earlier conclusion that the appropriate
mechanism for pursuing whatever remedies that the Debtors may have against Mr.
Conaway and other subjects of Trust Claims is through the Kmart Creditor Trust
established in Article XI of the Plan, particularly in light of the Board of
Directors' prior direction that all information developed in connection with the
internal investigations conducted during 2002 and 2003 under the supervision of
the Audit Committee of the Board of Directors be made available to the trustee
of the Kmart Creditor Trust as provided for in the Plan for further action on
any and all legal theories that the Trustee independently determines are
appropriate and desirable to pursue.
d. Disclosures Pertaining to the Company's Financial
Results for FY 2001
Over the course of the Investigations, the Debtors developed
information concerning the accounting for certain transactions affecting the
previously-filed financial statements of the Company. Based in part on this
information, Kmart made certain disclosures in its public filings, and restated
certain interim period financial results for 2001, as follows:
- -- On May 15, 2002, Kmart filed its Annual Report on Form 10-K for the
fiscal year ended January 30, 2001, reporting that (1) an adjustment
should be made to previously reported quarterly results 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 of 2001 was
more appropriately designated as a second quarter event. The first item
resulted in a net reduction to operating results in
50
the second quarter of $42 million ($28 million after-tax), and an
increase in third quarter operating results of $15 million ($10 million
after-tax). The second item increased general liability reserves in the
second quarter, rather than the fourth quarter, by approximately $167
million ($112 million after-tax).
- -- Also, in its Annual Report on Form 10-K for the fiscal year ended
January 30, 2001, Kmart observed that embedded in an accounting change
adopted in the fourth quarter of the 2001 fiscal year was an adjustment
for an indeterminate amount of supplemental or "incremental" allowances
that were initially recorded in the first three quarters prior to
having been documented, or otherwise deemed appropriate, pursuant to
Kmart's historical policy. As reported by Kmart, during the fourth
quarter of fiscal 2001, Kmart adopted a new accounting policy effective
as of February 1, 2001, for interim financial reporting only, requiring
that the 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.
- -- Kmart reported further developments in its Investigation in the
Company's Form 10-Q for the period ended July 31, 2002, filed on
September 16, 2002. In particular, the Company reported that it had
learned that certain vendor allowances had been prematurely recorded in
Kmart's fiscal year 2000 fourth quarter results, and to a lesser
extent, in other prior fiscal periods, and that the Vendor Allowance
Tracking ("VAT") agreements with vendors relating to these transactions
did not in all cases reflect certain existing oral understandings or
separate written agreements with such vendors. As a result, Kmart noted
that its net loss for fiscal year 2000 was understated by
approximately $38 million ($26 million net of tax), while the net loss
reported for fiscal year 2001 was overstated by approximately $78
million (both before and after taxes). (The net loss for fiscal year
2000 was increased by $14 million, based on further review of certain
allowances in connection with the Quarterly Report on Form 10-Q for the
13- week period ended October 31, 2002.) Kmart also noted that
clearance markdowns of inventory in the second and third quarters of
fiscal year 2001 appeared low in relation to historic markdown
experience, apparently as a result, among other things, of decisions by
former management to minimize markdown activity in light of the
Company's operating performance during that period.
- -- Finally, in Kmart's Form 10-Q for the period ended October 30, 2002,
filed on December 23, 2002, the Company reported additional results of
the Investigations, including, among other things, that an inquiry into
certain selected allowances that were recorded during the first three
quarters of 2001 indicated that at least $92 million of these
allowances were questionable, in that there were failures to have
appropriate signed documentation in place, failures to have adequate
records demonstrating that the allowance was collectible, or that the
allowance otherwise failed to comply with Kmart's historic policies for
vendor rebates.
4. Enhanced Controls.
The Investigations and further review by current management made clear
the need for enhanced controls with respect to accounting for allowances,
inventory management, and corporate perquisites, among other areas of the
Debtors' operations. Current management has
51
taken steps to strengthen and tighten the applicable controls, even prior to
completion of the Investigations. Among the measures implemented are the
following:
a. Controls Over Vendor Allowances
In August 2002, Kmart strengthened its vendor allowance policy by,
among other things:
-- enhancing the VAT form itself to require the clear disclosure
of information needed to assess the propriety of the allowance
and when and how it should be recorded;
-- requiring that all pertinent contracts, correspondence or
other agreements with the vendor be appended to the VAT form
before the allowance is forwarded to the appropriate persons
for approval and processing;
-- requiring the Merchandise Controller's approval for all
allowances in excess of $500,000;
-- creating a standing Allowance Committee comprising senior
managers of the Merchandise Finance, Financial Reporting and
Vendor Allowance groups that meets monthly to review issues
concerning allowances; and
-- enhancing the responsibilities of the Company's Gross Margin
Council, which includes the Chief Financial Officer, Corporate
Controller and Merchandise Controller, who also review issues
pertaining to allowances and vendor credits at a weekly
meeting.
Moreover, all merchandise and merchandise finance personnel were
required to undergo training in the new allowance policies and procedures, which
training was designed to educate them about the proper procedures and accounting
treatments for allowances, as well as to sensitize them to the significance of
the information required by the VAT form in ensuring that allowances are given
appropriate accounting treatment. These personnel also were provided with a
detailed written allowance policy that includes, among other items, specific
guidance for documenting and accounting for a variety of types of allowances, as
well as directions about whom to contact should they have any questions about an
allowance. Finally, all Merchandise Divisional Vice Presidents, Finance
Divisional Vice Presidents, General Merchandise Managers and the Merchandise
Controller are now required to sign quarterly representation letters
acknowledging their responsibility for accurate financial information, including
information about vendor credits, and certifying compliance with the vendor
allowance policy.
b. Inventory Controls
Kmart also has put in place additional controls with respect to
inventory management and accounting, including periodic inventory quality
reviews, regular meetings of management to review clearance markdowns, exception
reporting for excess quantities of active replenished merchandise and reducing
the number of inventory categories to more effectively manage
52
inventory control quality through more focused exception reporting. Other
improvements include reducing the number of personnel authorized to approve new
purchase orders from more than 200 to less than 30, temporarily discontinuing
the ability of a merchant to issue replenishment orders if inventory on hand
does not support a repurchase, and adjusting the overall buy of seasonal
merchandise based on current trends in the business.
c. Certain Other Measures
-- Kmart has terminated the corporate executive lease car
program.
-- In October 2002, Kmart significantly revamped the management
and organization of its Audit Services Department, which
department is now undertaking a systematic review of the
Company's policies and controls with respect to capital
expenses, purchase orders for non-vendor items and other
significant compliance systems.
5. Remaining Steps.
The Debtors believe the Investigations into the issues identified above
are substantially complete, save for the remaining depositions of former
management and certain directors, as described above. The Company will continue
to cooperate with and respond to inquiries from the SEC, the USAO and other
governmental authorities. Moreover, the Investigations identified some remaining
subsidiary issues that are more efficiently pursued by the Company at this
juncture. Skadden, after consultation with the Statutory Committees, will
identify those issues to the Company's compliance officer. Finally, once a
trustee is appointed to oversee the Kmart Creditor Trust, the results of the
investigation will be turned over to the trustee.
G. SUMMARY OF CLAIMS PROCESS, BAR DATE, CERTAIN CLAIMS, AND PROFESSIONAL
FEES
1. Schedules and Statements of Financial Affairs.
On April 15, 2002, the Debtors filed with the Bankruptcy Court
Schedules of Assets and Liabilities and Statements of Financial Affairs
(collectively, the "Schedules and Statements"). Separate Schedules and
Statements were filed for the following ten Debtors: Kmart Corporation, Kmart of
Indiana, Kmart of Michigan, Inc., Kmart of North Carolina, LLC, Kmart of
Pennsylvania, LP, Kmart of Texas, LP, Kmart Overseas Corporation, Troy CMBS
Property, LLC, Bluelight.com, LLC, and The Coolidge Group, n/k/a, TC Group I,
LLC. A consolidated set of Schedules and Statements was filed reflecting
information for all thirty-eight (38) Debtors.
The Schedules and Statements of Kmart Corporation include information
for Kmart and each of the other twenty-eight Affiliate Debtors for which
separate Schedules and Statements were not prepared. Information, if any,
pertaining to such Affiliate Debtors was included in the Schedules and
Statements for Kmart because (i) such Debtors have de minimis assets,
liabilities, and operations, (ii) such Debtors' records reflect primarily
intercompany balances, and/or (iii) such Debtors hold an interest only in a
single asset (such as a shopping center).
53
Summarized below are the total amount of the Claims listed in each of
the eleven (11) sets of Schedules and Statements. For financial reporting
purposes, Kmart prepares consolidated financial statements that are filed with
the Securities and Exchange Commission and that are audited annually. Unlike
these consolidated financial statements, the Schedules and Statements reflect
the assets and liabilities of each Debtor as assigned to each Debtor on the
basis of the Debtors' non-audited book and tax records. Kmart does not, other
than annually for tax purposes, prepare detailed financial statements for
certain of its subsidiaries and affiliates, and the Debtors do not maintain
full, separate, stand-alone accounting records in their general ledger for
certain entities. This means that audited financial statements and supporting
schedules have not been prepared for each Debtor. The consolidated schedules
eliminate intercompany claims. Intercompany claims were listed in the schedules
for Kmart Corporation. For this reason, the total amount of claims in the Kmart
Corporation schedules, summarized below, exceeds the total amount of claims in
the consolidated schedules.
- ------------------------------------------------------------------------------------------------------
CLAIMS
-------------------------------------------------------------
DEBTOR
SECURED PRIORITY UNSECURED
- ------------------------------------------------------------------------------------------------------
Consolidated $72,830,542 $0 $6,009,184,238
- ------------------------------------------------------------------------------------------------------
Kmart Corporation $57,114,339 $0 $11,511,936,336
- ------------------------------------------------------------------------------------------------------
Bluelight.com LLC $0 $0 $1,143,235,482
- ------------------------------------------------------------------------------------------------------
The Coolidge Group, LLC $0 $0 $225,396,041
- ------------------------------------------------------------------------------------------------------
Kmart of Indiana $8,100,151 $0 $1,066,870,049
- ------------------------------------------------------------------------------------------------------
Kmart of Michigan, Inc. $0 $0 $1,066,870,048
- ------------------------------------------------------------------------------------------------------
Kmart of North Carolina LLC $0 $0 $1,066,870,049
- ------------------------------------------------------------------------------------------------------
Kmart Overseas Corporation $0 $0 $0
- ------------------------------------------------------------------------------------------------------
Kmart of Pennsylvania LP $7,616,051 $0 $1,566,870,049
- ------------------------------------------------------------------------------------------------------
Kmart of Texas L.P. $0 $0 $1,066,870,049
- ------------------------------------------------------------------------------------------------------
Troy C.M.B.S. Property, L.L.C. $0 $0 $273,702,141
- ------------------------------------------------------------------------------------------------------
2. Claims Bar Date.
On March 26, 2002, the Bankruptcy Court entered an order (the "Bar Date
Order") establishing the general deadline for filing proofs of claim against the
Debtors (the "Bar Date"). The deadline established by the Bankruptcy Court was
July 31, 2002 for Claims, including Claims of governmental units, but excluding
certain other Claims, including Claims based on the rejection of executory
contracts and unexpired leases as to which the bar date is the later of (i) the
Bar Date, or (ii) 30 days after the effective date of such rejection. The
Debtors' claims and notice agent provided notice of the Bar Date by mailing to
each person listed in the Schedules and Statements: (i) a notice of the Bar
Date; (ii) a proof of claim form; and (iii) statements which indicated whether
the Claim of each recipient was listed in the Schedules and Statements as either
unliquidated, contingent and/or disputed. In addition, the Debtors
54
published notice of the Bar Date in The New York Times (national edition), The
Wall Street Journal (national, European and Asian editions) and USA Today
(worldwide) on March 28, 2002. A supplemental bar date was established on
December 19, 2002 with respect to approximately 4,000 personal injury and
related claims that were not listed in the original Schedules and Statements.
The Schedules and Statements were amended at that time to include these claims.
3. Proofs of Claim and Other Claims.
According to information provided by the claims agent, a total of
44,935 proofs of claim have been filed against the Debtors asserting claims in
the total face amount of approximately $75.2 billion. In addition, numerous
claims were asserted by various alleged creditors in unliquidated amounts. The
Debtors believe that certain claims that have been asserted are without merit
and intend to object to all such claims. Moreover, there are many large,
duplicative claims that have been filed against the Debtors. For example, the
Pension Benefit Guaranty Corporation (the "PBGC"), which is the government
agency that affords certain guarantees of pension plan liabilities, has filed
contingent proofs of claim in the amount of $1,078,600,000, representing the
PBGC's estimate of the difference between liabilities to Kmart plan
beneficiaries and the current value of the plan assets (the "PBGC Claims"),
assuming Kmart's pension plan was terminated. The PBGC Claims were filed in each
Chapter 11 Case of each of the thirty-eight (38) Debtors in these proceedings,
meaning that the total, aggregate amount of the PBGC Claims is almost $41
billion. However, under Kmart's Plan of Reorganization, Kmart intends to
continue its pension plan unaltered. Thus, there will be no distributions under
the Plan on account of the PBGC Claims, and the PBGC will withdraw the PBGC
Claims on the Effective Date.
There are other classes of duplicative and disputed claims that have
been filed in these Chapter 11 Cases. For instance, the Debtors have identified
approximately $12.4 billion in claims that the Debtors believe are duplicates of
one another, or that represent the same claim filed against multiple different
Debtors, only one of whom may be liable on the asserted debt. These duplicate
claims, plus the duplicate PBGC claims, total over $53 billion, representing
approximately 70% of the face amount of all claims filed to date (although, as
noted above, there are many claims that were filed in unliquidated amounts,
i.e., claims that did not contain a specific dollar amount). Other significant
categories of disputed claims include claims in litigation, which include claims
in the total face amount of approximately $4.1 billion; claims for damages under
rejected real estate leases and executory contracts in the total face amount of
approximately $3.6 billion; and trade claims that exceed the amounts identified
on the Debtors' books and records by approximately $2 billion. The Debtors
dispute the litigation claims. The claims for damages for rejected real estate
contracts and executory contracts also are disputed because many of them exceed
the statutory limitations imposed by the Bankruptcy Code and/or pertain to
leases and contracts that have not, and will not, be rejected.
As a result of the foregoing preliminary analysis conducted by
AlixPartners, the Debtors do not believe that Allowed Claims in these Chapter 11
Cases will exceed approximately $8 billion in the aggregate. However, there can
be no assurance that the Debtors will be successful in contesting any of such
claims. The actual allowed amount of claims in these proceedings will impact the
estimated percentage distribution to creditors. Although the results of the
claims reconciliation process cannot be predicted with certainty, in February,
55
2003, the Bankruptcy Court entered orders on the Debtors' first omnibus
objection to claims disallowing certain duplicative and amended claims. On
January 21, 2003, the Debtors filed a second omnibus objection to approximately
6,300 claims filed against multiple Debtors in the aggregate face amount of over
$10 billion. Additional omnibus objections to claims will be prepared, filed,
and prosecuted in due course.
4. Securities and Related Claims
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 C. Conaway, former 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,
among other things, 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 November 1, 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 by virtue of the automatic stay.
On July 31, 2002, attorneys for plaintiffs in the pending class action
lawsuits filed a class proof of claim in the Bankruptcy Court (the "Class Proof
of Claim") on behalf of the plaintiffs and all purchasers of Kmart common stock
between May 17, 2001 and January 22, 2002, inclusive. The Class Proof of Claim,
which is asserted against the Debtors, reserved the right to identify additional
claimants or members of the class group in the future. In support of the Class
Proof of Claim, the claimants rely on the above-referenced class actions filed
against the former officers and directors of Kmart identified above. The
claimants state that the grounds for liability are alleged damages for
violations of federal securities laws, including the Securities Exchange Act of
1934, in connection with the purchase or acquisition of Kmart common stock by
the claimants during the class period. The Class Proof of Claim alleges that the
Debtors are liable to the claimants for damages in a sum not presently
determinable, but believed to be not less than $700 million in the aggregate,
plus interest, costs and allowed attorneys' fees.
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 the Employee Retirement Income Security Act for
excessive investment in Kmart stock; failure to provide complete and accurate
information about Kmart common stock; and failure to provide accurate
information about Kmart's 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
56
BlueLight.com, a subsidiary of Kmart, naming Charles C. Conaway, as former CEO
and Chairman of the Board of Kmart, as the sole defendant. The Complaint alleged
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 alleged violations of Section
10b-5 of the Securities and Exchange Act of 1934 and Section 410 of the Michigan
Uniform Securities Act. Kmart was not a defendant in this litigation. On January
16, 2003, the District Court dismissed the complaint. On February 14, 2003, suit
was filed by the Softbank Funds against Mr. Conaway in the Circuit Court of Cook
County, Illinois. This suit seeks $33,000,000 from the defendant for alleged
breach of fiduciary duty in connection with the failure of Kmart to cause the
registration of the plaintiffs' shares of Kmart common stock to become
effective. This claim is essentially the same as count I of the suit that was
dismissed on January 16, 2003.
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 million, 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.
Kmart is a defendant in six putative class actions and one
multi-plaintiff case pending in California, all relating to Kmart's
classification of assistant managers and various other employees as "exempt"
employees under the Federal Fair Labor Standards Act and the California Labor
Code and Kmart's 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 United States District Court for the Eastern District
of California, the United States District Court for the Central District of
California (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. If all of these cases were determined
adversely to Kmart, the resulting damages would have a material adverse impact
on its 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 Kmart's initial investigations, Kmart believes that it
has numerous defenses to each of these claims. As a result, Kmart currently is
unable to quantify the financial exposure of these cases.
Kmart currently is 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 Kmart's business. Some matters involve claims for large amounts of
damages as well as other relief. Kmart 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 liquidity, financial position or results of operations.
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In addition to the foregoing, there are numerous other matters filed
with the Bankruptcy Court in Kmart's reorganization proceedings by creditors,
landlords or other third parties related to Kmart's business operations or the
conduct of Kmart's 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, the company's 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.
5. Professional Fees
At the commencement of these Chapter 11 Cases, the Bankruptcy Court
entered an order establishing procedures for interim compensation and
reimbursement of expenses of professionals (the "Compensation Order"). The
Compensation Order requires professionals retained in these cases to submit
monthly fee statements to the Debtors and requires the Debtors to pay ninety
percent of the requested fees and one hundred percent of the requested expenses
pending interim approval by the Bankruptcy Court. The remaining ten percent of
fees requested in such fee statements are paid only upon further order of the
Bankruptcy Court (the "Holdback"). The Compensation Order requires the
professionals retained in these Chapter 11 Cases to file applications for
approval of their fees and expenses for the preceding four month period
approximately every four months.
On March 20, 2002, the Bankruptcy Court appointed a fee review
committee (the "Joint Fee Review Committee") consisting of (a) a representative
of the Office of the United States Trustee; (b) three representatives of the
Debtors; and (c) one representative from each of the Financial Institutions'
Committee, the Creditors' Committee and the Equity Committee. The Joint Fee
Review Committee's duties included reviewing the fee applications of retained
professionals, assisting with budgeting for anticipated fees, and providing
written reports to the Bankruptcy Court with recommendations regarding the fee
applications submitted.
On September 19, 2002, the Bankruptcy Court approved on an interim
basis the first interim fee applications for the period from January 22, 2002
through April 30, 2002, of certain professionals retained by the Debtors, the
Financial Institutions' Committee and the Creditors' Committee. During the first
interim fee application period, such professionals earned $21,958,471 in fees
and incurred $2,610,997 in expenses.
On December 19, 2002, the Bankruptcy Court approved on an interim basis
the second interim fee applications for the period from May 1, 2002 through
August 31, 2002, of certain professionals retained by the Debtors, the Financial
Institutions' Committee, the Creditors' Committee, and the Equity Committee.
However, the Bankruptcy Court continued the release of the Holdback until
further order of the Bankruptcy Court. In addition, the Bankruptcy Court
requested the appointment of a fee examiner to the Joint Fee Review Committee.
During the second interim fee application period, such professionals earned
$24,077,002 in fees and incurred $2,328,610 in expenses.
The third interim fee application period included the period from
September 1, 2002 through December 31, 2002. The third interim fee applications
for professional retained by the Debtors, the Financial Institutions' Committee,
the Creditors' Committee and the Equity Committee are due in March, 2003. Such
professionals, with the approval of the Joint Fee
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Review Committee, have budgeted their fees for the third interim fee application
period at $31,948,000. The Debtors plan to emerge from Chapter 11 during the
fourth interim fee application period, running from January 1, 2003 through
April 30, 2003. All fee applications filed in these cases are subject to final
approval by the Bankruptcy Court.
H. PENSION ISSUES
As noted above, Kmart has established and maintained a pension plan for
certain of its employees known as the Kmart Corporation Employee Pension Plan
(the "Pension Plan"). The Pension Plan is covered by Title IV of the Employee
Retirement Income Security Act of 1974, as amended, 29 U.S.C.ss.ss.1301, et seq.
("ERISA"). Effective January 31, 1996, the Pension Plan was frozen. As a result,
employees no longer accrue additional benefits under the Pension Plan except for
purposes of the subsidized early retirement program provided by the Pension
Plan. The Pension Plan's assets consist primarily of equity and fixed income
securities. The
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Debtors and all members of their controlled group, within the meaning of 29
U.S.C. ss. 1301(a)(14), are obligated to contribute to the Pension Plan at least
the amounts necessary to satisfy ERISA's minimum funding standards, found in
ERISA Section 302 and Internal Revenue Code Section 412. For the past eight
years, Kmart has not been required to make a contribution to the Pension Plan.
In light of the returns in the equity markets over the past several
years and the effect of such returns on the value of the Pension Plan's assets,
Kmart presently expects that it likely will be required to commence making
contributions to the Pension Plan in 2005, although it is possible that some
contributions could be required earlier. The Pension Plan may be terminated only
if the statutory requirements of either ERISA Section 4041 or 4042 are met. In
the event of a termination of the Pension Plan, the Debtors may be jointly and
severally liable for the unfunded benefit liabilities of the Pension Plan. See
ERISA Section 4062, 29 U.S.C. ss. 1362.
As noted above, the PBGC, which is the government agency that affords
certain guarantees of pension plan liabilities, has filed contingent proofs of
claim in the Chapter 11 Cases in the amount of $1,078,600,000.00 for each
Debtor, representing the PBGC's estimate of the difference between plan
liabilities to Pension Plan beneficiaries and the current value of the Pension
Plan assets.
Under Kmart's Plan of Reorganization, Kmart will continue the Pension
Plan, meaning that Kmart's obligations under applicable law with respect to
continued funding of the Pension Plan will remain unaltered. Therefore, the
liability of the Debtors and their controlled group to the Pension Plans, or to
the PBGC with respect to the Pension Plans, under ERISA, shall not be affected
in any way by this reorganization proceeding, including by discharge or release.
It is anticipated that, assuming the Pension Plan has not terminated, the PBGC
will withdraw its claims upon the effective date of the Plan of Reorganization.
Since the Pension Plan is frozen, the timing for the commencement of
future funding requirements will depend, in large part, on the future investment
performance of the Pension Plan's assets. Once Kmart's funding obligations
commence, Kmart presently anticipates that such obligations could continue for a
period of five or six years at an average rate of between $100 million and $200
million a year, or between $800 million and $900 million 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 Kmart's 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.
I. WORKERS' COMPENSATION CLAIMS
The Debtors maintain workers' compensation programs in all states in
which they operate pursuant to the applicable requirements of local law to
provide employees with workers' compensation coverage for claims arising from or
related to their employment with the Debtors.
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In certain states, the Debtors are qualifiedly self-insured pursuant to the laws
and regulations of such states, whereas in other states, the Debtors insure
their workers' compensation liabilities through a blanket deductible,
jurisdiction-specific workers' compensation insurance policies (the "Workers'
Compensation Programs"). In those states where the Debtors maintain qualified
self insurance, they have posted surety bonds and letters of credit with state
authorities to guarantee the Debtors' workers' compensation obligations. On
March 21, 2002, the Bankruptcy Court entered a final order approving, among
other things, the continuation of the Debtors' surety bond program and granting
liens and superpriority administrative expense claims in favor of certain
sureties who had posted bonds in connection with the Debtors' self-insurance
obligations. See Section III.E.4. of this Disclosure Statement, "Surety Bond
Settlement."
The Debtors' outstanding obligations relating to workers' compensation
arise from incurred but not paid claims and incurred but not reported ("IBNR")
claims. The Debtors estimate their IBNR claims through an actuarial process that
is common in the insurance industry. As of December 31, 2002, a total of 13,262
workers' compensation claims were pending against the Debtors arising out of
employees' alleged on-the-job injuries. The Debtors estimate that the aggregate
amount payable on account of incurred but not yet paid claims, IBNR claims
arising prior to December 31, 2002, and retrospectively rated premium rate
adjustments is approximately $288 million in undiscounted net reserves. The
Debtors expect that the cash payments related to workers' compensation claims
for the twelve months after the Effective Date will be approximately $118
million.
Upon confirmation and substantial consummation of the Plan, the
Reorganized Debtors shall continue the Workers' Compensation Programs in
accordance with applicable state laws. Nothing in the Plan shall be deemed to
discharge, release, or relieve the Debtors or Reorganized Debtors from any
current or future liability with respect to any of the Workers' Compensation
Programs. The Reorganized Debtors shall be responsible for all valid claims for
benefits and liabilities under the Workers' Compensation Programs regardless of
when the applicable injuries were incurred. Any and all obligations under the
Workers' Compensation Programs shall be paid in accordance with the terms and
conditions of Workers' Compensation Programs and in accordance with all
applicable laws.
J. ACCOMPLISHMENTS DURING THE CHAPTER 11; DEVELOPMENT AND SUMMARY OF THE
BUSINESS PLAN; AND KMART'S GO-FORWARD RETAIL STRATEGY
Kmart's need to restructure its business through a Chapter 11
reorganization proceeding arose due to the combination of a number of factors.
In light of these factors, Kmart concluded that commencement of these Chapter 11
Cases would afford the Company the best opportunity for restructuring its
affairs and for developing and implementing a long-term, go-forward, retail
business strategy. To this end, Kmart has successfully implemented a number of
key initiatives during the time that the Company has been in Chapter 11. Kmart
believes that it has accomplished or will accomplish prior to emergence from
Chapter 11 nearly all of the actions which it required Chapter 11 to address,
including, among other things, termination of unprofitable stores and leases and
restructuring its balance sheet through the conversion of substantially all debt
into equity.
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1. Optimization of Store and Real Estate Portfolio
A primary focus of Kmart and its constituents during these Chapter 11
Cases has been on rationalizing and optimizing the company's store and lease
portfolio. To this end, Kmart will have reduced its total number of stores from
2,114 as of the Petition Date to 1,514 as of emergence from Chapter 11, a total
reduction of 600 stores. Several factors were considered in the store closing
analysis, including historical and projected operating results; the anticipated
impact of current and future competition; future lease liability and real estate
value; store age, size, and capital spending requirements; the expected impact
of store closings on Kmart's competitive position; the estimated potential
savings from exiting markets and regions; the potential impact of store closings
on purchasing power and allowances; and the potential impact of store closings
on market coverage.
While Kmart's closure of under-performing stores has been a priority,
the Company believes that there are disadvantages to a substantially smaller
chain. There are significant economies of scale relating to purchasing,
advertising, distribution, and licensing that will be jeopardized if a large
number of additional stores are closed. The store closings to date have resulted
in increased sales and cash flow per remaining store, consistent with the
overall aim of optimizing the number of stores in the portfolio.
As of the commencement of these Chapter 11 Cases, Kmart employed
approximately 234,000 employees. As of January 21, 2003, approximately 32,000
employee relationships had been severed, most of them in connection with Kmart's
closure of 283 stores in the spring of 2002. Kmart anticipates that an
additional 35,000 employee relationships will be severed in connection with the
closure of up to 317 additional stores in early 2003. In part as a result of
these store closures and Kmart's overall cost-rationalization strategy, the
Company has significantly reduced its overhead costs during these Chapter 11
Cases through a reduction in the number of support employees located at its
headquarters in Troy, Michigan. Annual corporate selling, general, and
administrative costs ("SG&A") have been reduced from $1,044 million to $791
million, a reduction of over $250 million. However, as a percentage of sales,
SG&A increased in 2002 partially because of store closings and partially because
comparable store sales declined from 2001 to 2002. As part of these initiatives,
corporate management has been significantly reduced, including at the most
senior levels. Kmart anticipates further reductions in corporate overhead in
light of the closure of up to 317 additional stores in early 2003.
2. Strategic Initiatives
Kmart's asset rationalization and optimization strategies have been
complemented throughout these Chapter 11 Cases by a number of business
initiatives designed to attract customers to Kmart stores, cement vendor
support, and increase sales and gross margins. For instance, Kmart has obtained
substantial value through the renegotiation of, assumption of, and/or entry into
several significant executory contracts, including licensing agreements with key
brand partners that differentiate Kmart from its competitors. These include
license agreements relating to Martha Stewart Everyday home, garden, housewares
and seasonal products; Jaclyn Smith women's apparel, jewelry and accessories;
Kathy Ireland women's apparel, accessories and exercise equipment; Disney
apparel for infants and children; Sesame Street apparel for
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infants and children; Joe Boxer apparel, accessories and home furnishings; Route
66 apparel and accessories; Curtis Mathes consumer video, audio and
telecommunications products; and Thalia- branded products. They also include a
renegotiated contract with Cardinal Health, Inc., Kmart's exclusive supplier of
pharmaceutical and related products.
During the Chapter 11 Cases, Kmart also has significantly improved its
inventory management practices, resulting in noticeable progress in keeping its
store shelves stocked with popular items. Prior to filing these Chapter 11
Cases, Kmart had experienced a number of difficulties in keeping its shelves
properly stocked, which in turn seriously impacted the customer shopping
experience and hence, overall sales. Kmart has managed to reverse this negative
trend in part through improved inventory replenishment forecasting,
implementation of new controls on the inventory buying process, reduction in the
number of corporate employees authorized to give final approval to purchase
orders from 220 to 30, and increased ordering discretion granted to store
managers. As a result, weekly in-stock levels have improved throughout the
Chapter 11 Cases and since have consistently exceeded the corporate goal of 95%,
and inventory turns have increased from 3.73 to 4.02.
Kmart has also worked to improve store appearance and hence, the
overall customer shopping experience. The Company has returned to its strategy
as a "promotional" retailer focused on its exclusive brand merchandise, rather
than attempting to beat its competition solely based on pricing strategies.
Kmart has expanded and redesigned its weekly advertising circulars, and has
implemented a strategic marketing plan aimed at Hispanics and African-Americans
who collectively comprise one of the fastest-growing customer segments. The
Company has also implemented a "store of the neighborhood" approach to servicing
its customers, which allows individual store managers to customize their
merchandise assortment to suit local community needs and allows greater focus on
high volume and advertised items.
During the Chapter 11 Cases, Kmart has also begun aggressively testing
and implementing a number of other strategic initiatives. For instance, the
Company developed a "top sellers" program, which focuses on improving sales and
in-stock positions for each store's 300 top selling items. This program empowers
store managers with more discretion in terms of purchasing. It was initially
tested in a number of Chicago stores, and the results were very positive and
have been sustained. Comparable store sales increased by approximately 10% in
the test stores, especially with respect to sales of high volume items. It was
next tested in the Detroit market and met with early success, although such
success has not continually sustained itself as has occurred in the Chicago test
stores. The "top sellers" program was expanded to substantially all Kmart
markets in July 2002.
Kmart also has been testing a "store of the future" that focuses on
improving the in-store experience with new signs, a new color scheme, wider
aisles, better lighting, more accessible shelf and product layout, and a cleaner
overall experience. Customer feedback for the "store of the future" has been
positive. To date, Kmart has begun testing the "store of the future" through
five stores in various markets. Test stores have recorded various levels of
comparable store sales growth and margin increases over last year, with some of
them recording significant increases in these performance categories. New
layout, structural changes, carpeting and signage changes have improved gross
margin productivity in all apparel divisions; average
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gross margin rates of certain Martha Stewart product lines have improved
significantly per store; and the relocation of infant apparel to the front of
the stores has positively impacted sales and margin rates in these stores.
Kmart's next action steps with respect to the "store of the future" concept
include continued evaluation and adjustments to the test stores; completion of
consumer opinion evaluations; and possible future implementation of a modest
roll-out of the concept to a larger group of stores within the chain.
Finally, the company's "Have to Have It" advertising campaign, tested
in Chicago and Detroit, has focused on competitive pricing and Kmart's superior
product offers. Comparable store sales in the Chicago test market have exceeded
the rest of the Kmart store chain by approximately 5%. Other successful
advertising campaigns during the Chapter 11 Cases have included "Customer
Appreciation Days," which generated a 1.1% increase in comparable sales, and
Kmart's Joe Boxer product launch, which was the most successful in Kmart's
history, generating over $140 million in sales during the first 18 weeks and
$275 million in its first seven months.
3. Reasons for Emergence at This Time
Kmart's asset rationalization and optimization strategies, along with
the other business initiatives implemented throughout these Chapter 11 Cases,
have begun to bear positive results, including stabilization of the business and
improved liquidity. Although Kmart is confident that its performance will
continue to improve, the improvement has taken longer than expected to achieve.
And although Kmart has accomplished many important goals through the tools
afforded by Chapter 11, Kmart believes that the prospects for further
operational improvement will be best achieved outside of Chapter 11, and that
Chapter 11, in fact, is neither necessary nor conducive to moving forward with
the operational turnaround of the business.
Among Kmart's key remaining operational challenges are the
all-important goal of continued enhancement of the in-store shopping experience
and the establishment of a clearly-defined pricing strategy designed to drive
sales and improve margins. However, these challenges, in Kmart's judgment, do
not require Chapter 11 and, in fact, are better addressed outside of Chapter 11.
In this respect, there are continued costs to remaining in Chapter 11 that
warrant emergence at this time, including customer perception regarding Kmart's
long-term viability that impacts sales of larger items and Kmart's layaway
program; the reluctance of new exclusive brand partners to do business with
Kmart; the concern of employees over job security; the continued administrative
costs of the Chapter 11 process; and the continued diversion of management time
to the Chapter 11 process. Upon emergence from Chapter 11, management will be
free to focus their energies on systemwide implementation of strategic
initiatives.
4. Kmart's Future Retail Strategy
As part of the process to emerge from Chapter 11, Kmart undertook a
thorough and detailed initiative to develop a five-year business plan. The
business plan was developed "bottoms up," i.e., on a store-by-store basis
utilizing assumptions specific to each store and guidance from field
organization personnel as well as at the merchant level where category group
sales and margin plans were developed by line of business. After a detailed
review by
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local management, the business plan underwent a similar review by corporate
personnel, and finally a detailed review by Kmart's senior management. The
business plan includes the projections attached hereto as Appendix C.
Under the business plan, the current 2003 fiscal year, part of which
will occur during the Chapter 11 Cases and part of which will occur after
emergence, will be a transition year. Kmart will not return to profitability
until 2004. Kmart projects that the business will continue to recover and that
EBITDA will grow to $1.3 billion by 2007. The business plan assumes moderate
annual increases in comparable store sales. Kmart's business has been extremely
difficult to forecast, partly because of the impact of Chapter 11 on in-stock
levels, but mostly because the expected return of customer store traffic to
levels that existed when Kmart filed for Chapter 11 protection have thus far not
yet materialized. However, management is implementing a number of initiatives
that it hopes will control the variance around sales and gross margin, including
reconciling the expectations of the merchant group with those of the field
organization; evaluating daily the need for markdowns by region and merchandise
category; and taking into account advertising plans and historical selling
experience.
Kmart believes that it is well-positioned to improve its operating
performance and compete effectively with the other large discount retailers in
the market. As a result of Kmart's rationalization and optimization of its store
and real estate portfolio during the Chapter 11 Cases, Kmart has substantially
reduced the risk associated with such portfolio. In this regard, Kmart has
eliminated or will eliminate by emergence more than 950 real estate leases,
including 340 pertaining to dark stores; it has renegotiated over 80 real
property leases resulting in over $12 million in annual rent concessions; and it
has closed or identified for closing 29% of its leased stores, representing 49%
of its lease obligations on a gross basis. Average rent per square foot
therefore has decreased from approximately $4.40 to $3.99. Of the 600 stores
that have been closed during the Chapter 11 Cases, a total of 246 of such stores
were low-volume stores (stores with annual sales of less than $12 million).
The store closings are expected to increase average sales per store;
projected average earnings before interest, taxes, depreciation, and
amortization per store; and the projected average return on invested capital.
Kmart's business plan reflects normalized maintenance, and contains a capital
maintenance budget that addresses 100% of its stores through the 2007 projection
period. The budget also contemplates Kmart opening 70 new stores, plus the roll
out of a new store concept. Finally, the budget allows for approximately $175
million per year in other operating improvement projects, such as additional
pharmacies, one-hour photo labs, and information technology upgrades.
Kmart rejected its supply contract with Fleming and has decided to
self-distribute core pantry products to all Kmart stores. The shift to
self-distribution, which is expected to occur by the middle of March 2003,
should increase utilization of Kmart's existing distribution centers by
approximately 115 million cartons annually and reduce excess capacity by 89%.
Self-distribution should increase in-stock levels, particularly for advertised
goods, and Kmart estimates that it will save in excess of $450 million through
self-distribution through 2006. Self-distribution also will allow Kmart to
cement relationships with individual food and consumable vendors, and will allow
Kmart to control the vendor allowance process in accordance with its own plans.
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Kmart remains focused on being the leading discount retailer with
promotional pricing and exclusive national brands. Post-emergence, Kmart
believes it can best maximize its performance and improve its market position by
continuing to focus on driving profitable sales growth, controlling costs and
streamlining overhead, and increasing asset productivity. Kmart's action plans
for driving profitable sales growth include utilization of multiple price groups
and market basket pricing; expansion of its exclusive brand portfolio; tailoring
its product assortment by market based on demographics and climazone; improving
store appearance and lighting; developing basic and seasonal in-stock goals;
intensifying training for store managers; instilling discipline and price among
employees; and implementing electronic labor scheduling.
Kmart's go-forward retail strategy also is premised on Kmart's
continued implementation of several key initiatives begun during the Chapter 11
Cases, including the "store of the neighborhood," "top sellers" program, and
further testing of the "store of the future." It also is premised on continued
optimization of Kmart's merchandising through elimination of under-performing
stock keeping units ("SKU's"), or individual items of inventory, and the
continued reallocation of shelf-space to more profitable items. Marketing will
focus on Kmart's exclusive brand identity. With the continued support of its
vendor partners through, among other things, the vendor lien contemplated by the
Plan and the $2 billion Exit Financing Facility, Kmart anticipates being able to
continue to improve its customer shopping experience and ultimately returning to
profitability.
K. MANAGEMENT COMPENSATION INCENTIVE PLAN
The Reorganized Debtors' management compensation incentive plan shall
be an executive emergence and long-term incentive program approved by the board
of directors of the Reorganized Debtors and implemented for the benefit of the
Reorganized Debtors' employees, members of management, and directors and
designed to (i) recognize the experience, qualifications, and proven track
record of the Reorganized Debtors' management team and (ii) provide incentives
for the beneficiaries thereof to maximize value for stockholders after the
Effective Date. The Management Compensation Plan may reserve up to 10% of the
shares of New Holdings Company Common Stock to be offered as incentive
compensation.
VII. SUMMARY OF THE REORGANIZATION PLAN
THIS SECTION PROVIDES A SUMMARY OF THE STRUCTURE, CLASSIFICATION,
TREATMENT AND IMPLEMENTATION OF THE PLAN AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO THE PLAN, WHICH ACCOMPANIES THIS DISCLOSURE STATEMENT, AND TO THE
EXHIBITS ATTACHED THERETO.
ALTHOUGH THE STATEMENTS CONTAINED IN THIS DISCLOSURE STATEMENT INCLUDE
SUMMARIES OF THE PROVISIONS CONTAINED IN THE PLAN AND IN DOCUMENTS REFERRED TO
THEREIN, THIS DISCLOSURE STATEMENT DOES NOT PURPORT TO BE A PRECISE OR COMPLETE
STATEMENT OF ALL THE TERMS AND PROVISIONS OF THE PLAN OR DOCUMENTS REFERRED TO
THEREIN, AND REFERENCE IS MADE TO THE PLAN AND TO SUCH
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DOCUMENTS FOR THE FULL AND COMPLETE STATEMENTS OF SUCH TERMS
AND PROVISIONS.
THE PLAN ITSELF AND THE DOCUMENTS REFERRED TO THEREIN WILL CONTROL THE
TREATMENT OF CREDITORS AND EQUITY SECURITY HOLDERS UNDER THE PLAN AND WILL, UPON
THE EFFECTIVE DATE, BE BINDING UPON HOLDERS OF CLAIMS AGAINST, AND INTERESTS IN,
THE DEBTORS, THE REORGANIZED DEBTORS, AND OTHER PARTIES IN INTEREST.
A. OVERALL STRUCTURE OF THE PLAN
Shortly after filing for relief under Chapter 11 of the Bankruptcy
Code, the Debtors focused on the formulation of a plan of reorganization that
would allow them to quickly emerge from Chapter 11 and preserve their value as a
going concern. The Debtors recognize that in the competitive arena in which they
operate, a lengthy and uncertain Chapter 11 case would detrimentally affect the
confidence in the Debtors by their respective vendors and employees, further
impair their financial condition, and dim the prospects for a successful
reorganization. The terms of the Plan are based upon, among other things, the
Debtors' assessment of their ability to achieve the goals of the business plan,
make the distributions contemplated under the Plan, and pay their continuing
obligations in the ordinary course of the Reorganized Debtors' businesses.
If the Plan is confirmed by the Bankruptcy Court and consummated, (1)
the Claims in certain Classes will be reinstated or modified and will receive
distributions equal to the full amount of such Claims and (2) the Claims and
Interests in other Classes will be modified or extinguished and will receive
distributions constituting, in most instances, a partial recovery. At certain
times after the Effective Date, the Reorganized Debtors will distribute Cash,
securities and other property in respect of certain Classes of Claims as
provided in the Plan. The Classes of Claims against the Debtors created under
the Plan, the treatment of those Classes under the Plan, and the securities and
other property to be distributed under the Plan are described below.
1. Global Restructuring Settlement Proposal
(a) Background
As explained above, Kmart is obligated to the Prepetition Lenders
pursuant to the terms of the Prepetition Credit Agreements. As of the
commencement of these Chapter 11 Cases, the total amount owed by Kmart under
these Agreements was approximately $1.084 billion. Certain subsidiaries of
Kmart, each of whom are Debtors in these Cases, guaranteed Kmart's obligations
under the Prepetition Credit Agreements pursuant to the terms of written
guarantee agreements (the "Subsidiary Guarantees"). The subsidiaries include
Kmart of Indiana, Kmart of Michigan, Inc., Kmart of North Carolina LLC, Kmart of
Pennsylvania LP, and Kmart of Texas L.P. (collectively, the "Kmart of []
Subsidiaries").
From 1998 to 2000, Kmart transferred certain assets to the Kmart of []
Subsidiaries for various business planning reasons. Specifically, Kmart
transferred to each Kmart of []
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Subsidiary the assets constituting the business operations, including real
estate and inventory comprising the retail stores and certain distribution
centers, located in the respective states of each Kmart of [] Subsidiary. Thus,
for instance, the real estate and inventory located in the state of Michigan
were transferred to Kmart of Michigan, Inc. In exchange for the transfer of
these assets, Kmart became (either directly or indirectly) the owner of all of
the equity of the Kmart of [] Subsidiaries. At the time of the filing of these
Chapter 11 Cases, the assets held by the Kmart of [] Subsidiaries included 486
of Kmart's 2,114 stores. Thus, approximately 20% of the Debtors' aggregate real
estate and inventory were owned by the Kmart of [] Subsidiaries at that time.
In addition to the foregoing transfers by Kmart to the Kmart of []
Subsidiaries, by virtue of a series of transactions among Kmart and certain
subsidiaries, in October 2000, Kmart of Michigan, Inc. ("KMI") became the owner
of substantially all of the trademarks, service marks, and trade names used in
the Kmart business, including the name "Kmart," the big red K logo, "Super K"
and similar marks (collectively, the "Marks"). As with the other transfers to
the other Kmart of [] Subsidiaries, the transfers of the Marks were undertaken
for various business planning reasons. KMI licenses the Marks to Kmart and the
other Kmart of [] Subsidiaries in exchange for royalty fees at a contract rate
of approximately 1% of such entities' gross revenue. These royalty fees
presently average approximately $75 million per quarter. When Kmart pays KMI the
royalty fees, KMI immediately loans them back to Kmart (the "Royalty Loan"). As
of the commencement of these Chapter 11 Cases, KMI's total Intercompany Claim
against Kmart on account of the Royalty Loan was approximately $316 million. For
the period January 31, 2002 through October 30, 2002, KMI has loaned the sum of
$229,757,777 to Kmart pursuant to the Royalty Loan, which Loan may be subject to
certain offsets and other defenses. The Prepetition Lenders believe that the
post-petition loans made by KMI to Kmart under the Royalty Loan constitute
Administrative Claims by KMI against Kmart's Estate which must be paid in full
from Kmart to KMI in accordance with the Bankruptcy Code.
The Kmart of [] Subsidiaries do not owe any material debt to any third
parties other than the Prepetition Lenders, by virtue of the Subsidiary
Guaranties, and to the PBGC, by virtue of their statutory joint and several
liability for certain pension-related obligations of Kmart. Thus, the Kmart of
[] Subsidiaries do not have any material trade debt obligations. This is because
all of the inventory for the stores owned by the Kmart of [] Subsidiaries is
purchased by Kmart, and then sold by Kmart to the Kmart of [] Subsidiaries under
the terms of certain Sales and Distribution Agreements between them. As
inventory is purchased and delivered (on an almost daily basis), Kmart
effectively charges the respective Kmart of [] Subsidiaries pursuant to the
Sales and Distribution Agreements. These charges effectively are paid for by
daily sweeps of the cash held in the Kmart of [] Subsidiary store deposit
accounts, which collectively comprise a centralized cash management system
utilized by all of the Debtors. Although the Kmart of [] Subsidiaries do not
have any material trade debt obligations, certain of them have various
obligations arising out of leases, mortgages, and other matters.
In short, the Prepetition Lenders hold substantially all of the
pre-petition, impaired, unsecured claims against the Kmart of [] Subsidiaries.
The Prepetition Lenders therefore have asserted that they believe they are
entitled to substantially all value in the Kmart of [] Subsidiaries, and that
the Prepetition Lender Claims thus must be paid in full, before any value
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attributable to the assets of the Kmart of [] Subsidiaries may be upstreamed to
Kmart on account of its ownership interests in these Subsidiaries. As a result,
according to the Prepetition Lenders, creditors of Kmart, including trade
vendors and other unsecured creditors, may not be distributed any value from the
Kmart of [] Subsidiaries until the Prepetition Lenders are paid in full on
account of their claims against the Subsidiaries arising out of the Subsidiary
Guaranties.
However, the Unsecured Creditors' Committee and certain other creditors
have questioned the legal basis of the Prepetition Lenders' Claims, including
their asserted entitlement to the value of the Kmart of [] Subsidiaries and the
enforceability of the Subsidiary Guaranties. As a result, the Unsecured
Creditors' Committee believes that the Prepetition Lenders are entitled to
significantly less on account of their claims, and that general unsecured
creditors therefore are entitled to significantly more on account of their
claims.
(b) Fraudulent Transfer Law
The Unsecured Creditors' Committee bases their theory on two, general
types of challenges. The first challenge is based upon the law of fraudulent
transfers. In this regard, the Unsecured Creditors' Committee has asserted,
among other things, that (i) the transfers of Kmart's operating business assets
to the Kmart of [] Subsidiaries were fraudulent transfers that should be avoided
pursuant to ss. 544 and/or ss. 548 of the Bankruptcy Code, meaning that the
value of such assets would be available to all Kmart creditors, not just the
Prepetition Lenders; (ii) the transfer of the Marks to KMI was a fraudulent
transfer that also should be avoided pursuant to ss. 544 and/or ss. 548 of the
Bankruptcy Code, meaning that the value of the Marks also would be available to
all Kmart creditors, not just the Prepetition Lenders, and (iii) the Kmart of []
Subsidiaries' execution of the Subsidiary Guarantees each constituted fraudulent
transfers that should be avoided pursuant to ss. 544 and/or ss. 548 of the
Bankruptcy Code, meaning that the Prepetition Lenders would have no prior claim
to the value of the Kmart of [] Subsidiaries by virtue of the Guarantees.
In order to sustain an assertion that a particular transfer was a
fraudulent transfer under ss. 544 and/or ss. 548 of the Bankruptcy Code, the
Unsecured Creditors' Committee generally would have to establish, among other
things, that the transfer was not made for "reasonably equivalent value" or for
"less than fair consideration," and that the transfer was made at a time when
the transferor was insolvent; that the transfer rendered the transferor
insolvent; that the transfer left the transferor with an unreasonably small
capital; that the assets remaining with the transferor after the transfer were
unreasonably small in relation to the business to be operated by the transferor;
or that the transfer was made at a time when the transferor knew or should have
known that it would incur debts beyond its ability to pay as they came due.
In applying these legal principles to the assertions of the Unsecured
Creditors' Committee, the transfers of Kmart's operating business assets to the
Kmart of [] Subsidiaries would be fraudulent if, for instance, the Unsecured
Creditors' Committee established that Kmart did not receive "reasonably
equivalent value" or "fair consideration" from the Subsidiaries in exchange for
its transfer to them of the operating assets. One aspect of this argument is
that the transfers were not publicly announced; that general trade creditors
relied upon the creditworthiness of Kmart in extending trade terms; that such
creditors believed Kmart retained
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all operating assets; and that as a result, Kmart's transfer of the operating
assets to the Kmart of [] Subsidiaries, while incurring trade debt for their
benefit, resulted in Kmart not receiving "reasonably equivalent value" or "fair
consideration" in return for the transfer. The Prepetition Lenders could
counter, however, that Kmart did receive "reasonably equivalent value" and "fair
consideration" by its receipt of the ownership interests in the Kmart of []
Subsidiaries, and through its charge-back to the Kmart of [] Subsidiaries of the
costs of inventory that it acquired on their behalf. A similar analysis can be
made with respect to the transfer of the Marks to KMI; Kmart's receipt of the
stock of KMI; and the Intercompany Claims maintained between Kmart and KMI on
account of the Royalty Loan.
In applying the foregoing legal principles to the suggestion that the
Kmart of [] Subsidiaries' execution of the Subsidiary Guarantees each
constituted fraudulent transfers, meaning that the Prepetition Lenders should
have no prior claim to the value of the Kmart of [] Subsidiaries by virtue of
the Guarantees, the Unsecured Creditors' Committee would have to establish that
the Kmart of [] Subsidiaries did not receive "reasonably equivalent value" or
"fair consideration" for the debt obligations that they incurred when they
executed the Subsidiary Guarantees. One aspect of this argument is that a
Company does not necessarily derive any material benefit by agreeing to pay the
debts of another, especially where, as in the case of KMI, the guarantee was
executed after the primary obligor became indebted on the debt. This argument
could be countered, however, by the observation that affiliated entities like
the Kmart of [] Subsidiaries obtain benefits from jointly guaranteeing one
another's debts through the greater purchasing power afforded by a larger line
of credit that in turn complements the synergies of their operations. As for the
requirement that the transferor was "insolvent" at the time of the transfer, the
Unsecured Creditors' Committee would have to establish, for instance, that the
amount of each Kmart of [] Subsidiary's debts was greater than its assets as a
consequence of becoming obligated on the Subsidiary Guarantees. This would in
turn require estimated valuations of their assets at the time they executed the
Subsidiary Guarantees.
(c) The Law of Substantive Consolidation
The second challenge of the Unsecured Creditors' Committee to the legal
basis of the Prepetition Lenders' asserted entitlement to all the value of the
Kmart of [] Subsidiaries and the enforceability of the Subsidiary Guaranties is
based generally on notions of substantive consolidation. In particular, the
Unsecured Creditors' Committee has suggested that (i) the separate corporate
entities of Kmart and the Kmart of [] Subsidiaries should be disregarded
pursuant to "alter ego" and/or "piercing of the corporate veil" theories,
thereby resulting in a pooling of their assets for the benefit of all creditors,
not just the Prepetition Lenders, and (ii) each of the bankruptcy estates of
Kmart and the Kmart of [] Subsidiaries should be "substantively consolidated,"
again meaning that the assets of the various Kmart entities are pooled for the
benefit of all creditors. Because the legal standards for invoking these
doctrines are very similar, they are discussed in this Disclosure Statement
under the rubric of "substantive consolidation."
Generally, substantive consolidation of the estates of multiple debtors
in a bankruptcy case effectively combines the assets and liabilities of the
multiple debtors for certain purposes under a plan. The effect of consolidation
is the pooling of the assets of, and claims against, the
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consolidated debtors; satisfying liabilities from a common fund; and combining
the creditors of the debtors for purposes of receiving distributions under
reorganization plans. The authority of a Bankruptcy Court to order substantive
consolidation is found by most courts to be derived from its general equitable
powers under Section 105(a) of the Bankruptcy Code, which provides that the
court may issue orders necessary to carry out the provisions of the Bankruptcy
Code. In addition, courts have found that statutory authority exists for the
approval of substantive consolidation as a part of a plan of reorganization
under the terms of Section 1123(a)(5)(C) of the Bankruptcy Code. However, there
are no statutorily prescribed standards setting forth the parameters for when
substantive consolidation is appropriate. Instead, judicially developed
standards control whether substantive consolidation should be granted in any
given case.
Thus, the propriety of substantive consolidation must be evaluated on a
case-by-case basis based upon the particular facts and circumstances of the
estates in question. The extensive list of elements and factors frequently cited
and relied upon by courts in determining the propriety of substantive
consolidation may be viewed as variants on two critical factors, namely, (i)
whether creditors dealt with the entities as a single economic unit and did not
rely on their separate identity in extending credit or (ii) whether the affairs
of the debtors are so entangled that consolidation will benefit all creditors.
Some courts have viewed these elements and factors as examples of information
that may be useful to courts charged with deciding whether there is substantial
identity between the entities to be consolidated and whether consolidation is
necessary to avoid some harm or to realize some benefit.
In applying the foregoing principles to Kmart and the Kmart of []
Subsidiaries, the Unsecured Creditors' Committee could argue that most general
unsecured creditors dealt with the Kmart entities as a single economic unit, and
did not extend credit in reliance upon their separate corporate identities.
Indeed, the Kmart companies collectively operate retail store operations under
the "Kmart" brand name, and are essentially in the same line of business, or
conduct operations, or hold real estate or other assets that support such line
of business. The Committee also could argue that the affairs of the Kmart
entities are so entangled that they should be substantively consolidated and
therefore treated as a single entity for the benefit of all creditors. For
instance, the Debtors historically have issued consolidated financial statements
and filed consolidated federal tax returns through Kmart. Moreover, Kmart,
through its corporate department, provides services to all Kmart entities,
including accounting and bookkeeping, treasury, legal, tax, information systems,
administrative, real estate management, store planning, construction and design,
human resources administration, and similar "back office" corporate services.
Finally, the Kmart entities share a centralized cash management system. The
system allows Kmart to collect funds received by all Debtors through a series of
transactions and to disburse the funds through disbursement accounts to pay for
operating expenses related to all Debtors.
The Prepetition Lenders could counter, however, that not all creditors
dealt with the Kmart entities as a single economic unit - indeed, the
Prepetition Lenders obtained separate Subsidiary Guarantees from each Kmart of
[] Subsidiary - and that the affairs of the entities are not hopelessly
entangled. In fact, Kmart and the Kmart of [] Subsidiaries are each parties to
their own separately identified real estate leases and executory contracts, and
each owns its own inventory and real estate. Perhaps most importantly, the
Prepetition Lenders could argue that
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substantive consolidation would harm them in violation of one of the key
requirements that substantive consolidation be in the best interests of all
creditors. This is so because if the Kmart entities were substantively
consolidated, the Subsidiary Guarantees would be eliminated, and the Prepetition
Lenders' asserted priority entitlement to the value of the Kmart of []
Subsidiaries therefore would be lost. Instead, the Prepetition Lenders would
effectively have only one claim against the consolidated pool of assets, and
their anticipated recovery on that single claim would be diluted by the claims
of all other unsecured creditors.
(d) The Reasons for Settlement
It is apparent from the foregoing discussion that the histories of
Kmart's transfer of certain operating assets to the Kmart of [] Subsidiaries;
the transfer of the Marks to KMI; and the execution of the Subsidiary Guaranties
are long and complex. There are thousands of pages of documents evidencing the
various transfers. The legal theories relating to these matters, including the
law of fraudulent transfers and the law of substantive consolidation, are
particularly complicated as applied to the detailed facts evidencing these
transactions. Representatives of Kmart, the Prepetition Lenders, and the
Unsecured Creditors' Committee have devoted a significant amount of time
researching the facts and the law applicable to these matters, and have spent
innumerable hours analyzing, discussing, and negotiating with one another
regarding possible litigation and settlement of the issues.
Indeed, consistent with their fiduciary duty to maximize the value of
these Estates for all constituencies, the Debtors have carefully analyzed and
evaluated the various claims of the Prepetition Lenders and the Unsecured
Creditors' Committee. In the event litigation were to be commenced among the
parties concerning the Subsidiary Guaranties, the Debtors likely would take a
position in such litigation absent compromise by the parties upon terms such as
those proposed in the Plan.
Clearly, any litigation concerning these matters would be exceptionally
complicated and protracted, and given the magnitude of the values involved and
the amount of claims at stake, would be hotly contested and expensive. Such
litigation would in turn substantially prolong these Chapter 11 Cases, which all
constituencies believe is not in the best interests of the estates or Kmart's
long-term prospects for rehabilitation. The outcome of any such litigation is
not free from doubt for any party in interest, including Kmart, the Prepetition
Lenders, and the Unsecured Creditors' Committee, as there are strengths and
weaknesses in each of the parties' positions, and hence, risks to their
anticipated recoveries in litigating these matters to judgment. For instance, as
pointed out above in connection with the discussion of whether Kmart received
"reasonably equivalent value" in exchange for the transfer of certain operating
assets to the Kmart of [] Subsidiaries, each of the Prepetition Lenders and the
Unsecured Creditors' Committee have legitimate legal and factual points in
support of their respective positions. The situation is complicated by the added
uncertainty concerning each party's ability to prove historical values and
events that are long-since passed.
For these reasons, including, in particular, the need for Kmart to
emerge from Chapter 11 quickly so that going-concern value may be preserved for
the benefit of all constituencies, the Debtors propose a global settlement of
their claims, embodied by the Plan, that affords
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distributions to their constituencies commensurate with the risks of their
litigation positions. Under Section 1123(b)(3)(A) of the Bankruptcy Code and
Rule 9019 of the Bankruptcy Rules, a settlement such as the settlement proposed
in the Plan should be approved if it represents a reasonable compromise that is
in the collective best interests of all constituencies in light of the risks of
continued litigation. The settlement need not afford the best possible recovery
to any particular constituency, but instead need only represent a recovery that
falls within a reasonable range of litigation possibilities. Kmart believes that
the settlement contemplated by the Plan satisfies these standards.
An integral aspect of the global settlement is the Debtors' waiver of
certain Avoidance Claims. This component of the settlement is discussed in
Section VII.C.14 of this Disclosure Statement. Under the global settlement, the
Kmart entities will be substantively consolidated, but only for distribution
purposes. This means that, in order to assist implementation of the settlement,
each creditor will have only one claim against the pool of value reserved for
the particular class of which such creditor is a member. The actual assets of
the Kmart entities, however, will not be consolidated together, and the separate
legal identity of each Kmart Debtor will be maintained, subject to the various
corporate restructuring transactions contemplated by the Plan. Thus, for
instance, the Prepetition Lenders effectively have one claim for purposes of
distributing the value allocated to them under the Plan. This structure avoids
complications that arise in connection with calculating and making distributions
on account of their individual, separate claims against Kmart under the
Prepetition Credit Agreements and against the Kmart of [] Subsidiaries on
account of the Subsidiary Guarantees. In this fashion, there is a single, global
settlement with respect to each class of Claims under the Plan.
In order to implement the global settlement contemplated by the Plan,
unsecured creditors have been separately classified based upon their different
rights and the different attributes of their claims. First, the Prepetition
Lenders are in their own class because of their claims against Kmart and the
Kmart of [] Subsidiaries on account of the Subsidiary Guarantees. The fact that
the Prepetition Lenders hold significant guaranties against all of the Kmart of
[] Subsidiaries, as well as several of the Debtors' other subsidiaries, was a
significant factor considered by the parties in structuring this global
settlement pursuant to which the Prepetition Lenders will receive 40% of their
claims in a currency - cash - that is different than the currency - stock - to
be paid holders of other unsecured claims.
Second, holders of Prepetition Notes have been separately classified
because they are entitled to additional distributions on account of the
subordination agreement with the holders of the Trust Preferred Obligations.
Specifically, holders of the Prepetition Notes are entitled to receive the
distributions otherwise payable to holders of the Trust Preferred Obligations
pursuant to the indenture and related documents related to the Trust Preferred
Obligations. Third, holders of Trade Vendor/Lease Rejection Claims are
separately classified because their claims are for the most part liquidated or
easily liquidated. This class includes landlords with (i) leases with one Debtor
that are (ii) guaranteed by another Debtor. A landlord's dual claims on account
of a lease and its guarantee - one claim against each of two separate Debtors -
are treated as a single claim under the proposed settlement. They therefore are
not afforded additional consideration similar to that afforded the Prepetition
Lenders on account of the Subsidiary Guarantees. This treatment is appropriate
because it allows the Debtors to achieve the
73
compromise and settlement with the Prepetition Lenders who, unlike these
landlords, have guaranties from almost all of the Debtors. This settlement
allows the Debtors to make distributions available to other creditors that they
would otherwise be unable to make. Moreover, the Debtors believe that in the
event that landlords with guaranties receive distributions only from the Debtors
who are indebted to them, such distributions would not exceed the distributions
proposed to be made pursuant to the Plan. Finally, holders of Other Unsecured
Claims are separately classified because their claims are for the most part
unliquidated, disputed, and/or contingent. However, they will be compensated in
Cash rather than New Holding Company Common Stock. They can elect to take Stock
if they agree to an expedited procedure for estimating their claims.
2. The Plan Investor Transactions
(a) Description of the Plan Investors
As briefly summarized above, two entities - ESL Investments, Inc.
("ESL") and Third Avenue Trust, on behalf of certain of its investment series
("Third Avenue," and together with ESL, the "Plan Investors") - have agreed to
make a substantial investment in the Reorganized Debtors in furtherance of the
Debtors' financial and operational restructuring plan. The investment will be
made pursuant to an Investment Agreement dated as of January 24, 2003 (as
amended, the "Investment Agreement"), summarized below. A copy of the Investment
Agreement is attached as Exhibit E to the Plan. ESL and Third Avenue are members
of the Financial Institutions' Committee. ESL holds approximately $382 million
principal amount of Prepetition Lender Claims, approximately $1.177 billion
principal amount of Prepetition Note Claims, and approximately $61 million in
Trade Vendor/Lease Rejection Claims, and Trust Preferred Obligations; and Third
Avenue holds approximately $99 million principal amount of Prepetition Note
Claims and approximately $79 million in Trade Vendor/Lease Rejection Claims.
(b) Summary of the Plan Investor Investment Agreement
Under the Plan, Prepetition Lenders would be entitled to a share of the
New Holding Company Common Stock in satisfaction of the Prepetition Lender
Claims. Under the settlement contemplated by the Plan, however, the Prepetition
Lenders will receive Cash in an amount equal to forty percent (40%) of the
amount of their Claims. Under the Investment Agreement, the Plan Investors have
agreed to purchase shares of New Holding Company Common Stock with an aggregate
value of $140 million (the "Plan Investor Shares"), and ESL has agreed to
purchase additional shares of New Holding Company Common Stock with a value
equal to $152.8 million (the "ESL Prepetition Obligation Shares" and, together
with the Plan Investor Shares, the "Total Investor Shares"), for a total amount
of approximately $292.8 million. Of this amount, the $152.8 million will be
comprised of cash that would otherwise be received by ESL pursuant to the Plan
on account of its Prepetition Lender Claims (which amount may increase should
ESL acquire Additional Prepetition Lender Claims and elect to use the cash to be
received in a similar fashion) and the remaining $140 million represents an
additional investment to be made by the Plan Investors pursuant to the terms of
the Investment Agreement.
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ESL shall purchase 78.21% of the Plan Investor Shares, and Third Avenue
shall purchase 21.79% of the Plan Investor Shares. At the Effective Date, the
Reorganized Debtor shall have an unconditional and irrevocable right (the
"Initial Company Call"), exercisable in its sole discretion, to require ESL to
purchase from the Reorganized Debtor a note (the "Initial Called Note") in an
aggregate principal amount equal to the lesser of (i) $60 million (the "Maximum
Company Call Amount"), and (ii) the excess, if any, of $1.545 billion over the
Company's Liquidity (as hereinafter defined) at the Effective Date, reduced by
the amount of all payments and distributions to be made on the Effective Date of
the Plan or required to be paid in respect of prepetition and/or priority claims
(other than priority claims in respect of postpetition payables) pursuant to the
Plan, plus letters of credit contemplated by the Company's business plan to be
issued under the Exit Facility in an amount equal to $375 million, irrespective
of the actual issuance thereof, at a purchase price equal to the principal
amount of such note. If, however, the actual outstanding amount of letters of
credit issued under the Exit Facility on the Effective Date is less than $375
million, then the amount of the Initial Called Note shall be reduced by the Cash
Balance on the Effective Date after giving effect to the consummation of the
transactions contemplated hereby (including, without limitation, the making of
the payments and distributions described in clause (ii) above) at a purchase
price equal to the principal amount of the Initial Called Note. At the request
of ESL, the principal amount of the Initial Called Note may be increased to the
Maximum Company Call Amount. For purposes of the Investment Agreement, (i)
"Liquidity" shall mean, at any time, Excess Availability at such time plus the
Cash Balance at such time and (ii) "Cash Balance" shall mean, at any time, the
aggregate amount of Kmart's and its subsidiaries' unrestricted cash, cash
equivalents and short term investments at such time, calculated in the manner
consistent with the business plan (but exclusive of cash necessary for store
operations, which amount is agreed to be equal to three hundred million dollars
($300,000,000)).
Additionally, if the Reorganized Debtors discover, during the 90 day
period following the Effective Date, that the aggregate amount of payments
required to be made pursuant to the Plan in respect of prepetition and/or
priority claims are or will be in excess of those actually paid at the Effective
Date (such excess, the "Excess Distributions"), the Reorganized Debtors shall
have an unconditional and irrevocable right (the" Subsequent Company Call"), in
its sole discretion, to require ESL to purchase from the Reorganized Debtor a
subordinate, convertible note (the "Subsequent Called Note," and, together with
the Initial Called Note, the "Called Notes") in an aggregate principal amount
equal to the lesser of (i) the excess, if any, of (A) $1.545 billion over (B)
the Company's Liquidity at Closing (after giving effect to (x) all payments and
borrowings made at Closing other than in respect of postpetition trade payables
and (y) the issuance of letters of credit contemplated by the Business Plan to
be issued under the Exit Financing Facility in an amount equal to $375 million,
irrespective of the actual issuance thereof), reduced by the amount of any
Excess Distributions, and (ii) the excess, if any, of the Maximum Company Call
Amount over the principal amount of the Initial Called Note, at a purchase price
equal to the principal amount of such note. If, however, the actual outstanding
amount of letters of credit issued under the Exit Financing Facility on the
Closing Date is less than $375 million, then the amount of the Subsequent Called
Note shall be reduced by the Cash Balance on the Closing Date after giving
effect to the consummation of the transactions contemplated hereby (including,
without limitation, the making of the above-described payments under the Plan).
The aggregate amount of the Initial Called Note and the Subsequent Called Note
will not exceed $60
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million. The Debtors presently estimate that the amount of the Called Note will
be $35 million, although the actual amount will depend on the financial
condition of the Reorganized Debtors as of the Effective Date and the 90 days
thereafter and/or ESL's desire to increase the principal amount of the Initial
Called Note. Whether or not the Reorganized Debtors exercise the Initial Company
Call or the Subsequent Company Call, ESL shall have the option to purchase from
the company a note in an amount not to exceed the Maximum Company Call Amount,
subject to receipt of any consent required by the lenders under the Exit
Financing Facility.
In addition, as previously described above, ESL has agreed to purchase
additional shares of New Holding Company Common Stock with a value equal to (i)
the aggregate amount of cash that ESL is entitled to receive under the Plan
based on its holdings of Prepetition Lender Claims as of the date of the
Investment Agreement, and (ii) such portion as ESL may in its sole discretion
designate of the aggregate amount of cash that ESL is entitled to receive under
the Plan based on its holdings of Prepetition Lender Claims acquired after the
date of the Investment Agreement.
The purchase price that the Plan Investors will pay for the shares is
$10 per share, assuming a valuation for the New Holding Company Common Stock of
approximately $1 billion, less the amount of cash paid to Prepetition Lenders
pursuant to the Plan. The Investment Agreement provides ESL with a two-year
option to invest an additional $86 million through the purchase of shares of New
Holding Company Common Stock at an option price of $13 per share. ESL has also
agreed, from the Effective Date until the earlier of (i) the first anniversary
of the Effective Date and (ii) the date on which all of the Non-Lender Unsecured
Claims are reconciled, it will not transfer or otherwise dispose of more than
twenty percent (20%) of shares issued to it pursuant to the Investment Agreement
or the Plan, other than to any other Plan Investor or an Affiliate thereof or in
connection with a sale of the Reorganized Debtor in its entirety.
The Investment Agreement restricts the Debtors' ability to enter into
alternative agreements with other plan sponsors or investors. Until the earlier
of the Effective Date and the termination of the Investment Agreement, unless
the board of directors of Kmart determines in good faith that it is necessary or
desirable to authorize such actions in connection with the administration of the
Bankruptcy Cases or that it is required to authorize such actions to comply with
its fiduciary duties under applicable law, Kmart and the Affiliate Debtors are
not permitted to (i) solicit, initiate or take any other action designed to
solicit a proposal or offer for a restructuring transaction or plan of
reorganization or similar transaction, (ii) participate in discussions or
negotiations related thereto, (iii) enter into a letter of intent or other
agreement related thereto, or (iv) furnish non-public information, except in
limited circumstances. The foregoing notwithstanding, if Kmart receives an
unsolicited writing from a party indicating that such party is considering
making, or has made a bona fide alternative proposal or has notified Kmart prior
to the date of the Investment Agreement that it is considering making or has
made a bona fide alternative proposal, Kmart is permitted to enter into
discussions or negotiations with, or provide information to, such party. In
addition, Kmart may enter into an agreement with such party for an alternate
transaction, so long as (i) the alternative proposal provides a higher
transaction value or is otherwise more favorable to Kmart and its creditors,
(ii) the board of directors reasonably believes in good faith (after
consultation with its outside advisors) that
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authorizing the transaction is consistent with its fiduciary duties under
applicable law, and (iii) the Plan Investors fail to match any such offer.
As further conditions to the Plan Investors' Investment obligations
under the Investment Agreement, the proposed Exit Financing Facility must have
been executed and be in full force and effect, and the Reorganized Debtors must
have Liquidity of at least $1.25 billion and Adjusted Excess Negative
Availability of not more than $589,000,000. The Debtors presently estimate that
their Excess Availability as of the Effective Date of the Plan will be
sufficient to satisfy this condition. An additional condition to the Plan
Investors' Investment obligations under the Investment Agreement is that the
Plan be approved by the Bankruptcy Court pursuant to the Confirmation Order and
have an Effective Date no later than May 30, 2003.
There are certain fees and expenses payable to the Plan Investors under
the Investment Agreement. In particular, unless the Plan Investors are in
material breach of their obligations under the Investment Agreement or the
Investment Agreement is terminated in accordance with its terms (except for
termination by Kmart or by ESL as a result of or in connection with an alternate
transaction), Kmart is required to pay to ESL a commitment fee equal to $10
million upon the earlier of May 30, 2003, the Effective Date of the Plan and the
date of termination, if the Investment Agreement is terminated by Kmart or by
ESL as a result of or in connection with an alternate transaction. On February
25, 2003, the Bankruptcy Court entered an order approving payment of the
commitment fee upon satisfaction of the conditions for payment thereof under the
Investment Agreement.
The Investment Agreement also provides that Kmart will pay up to $5
million of ESL's expenses, which amounts will be required to be repaid if the
Investment Agreement is terminated due to a breach by the Plan Investors. Up to
$2 million of the expenses will be payable as of the date of the hearing
approving the commitment fee, with the remainder payable on the Effective Date
or the termination date of the Investment Agreement, other than as a result of
breach by the Plan Investors.
The Investment Agreement may be terminated if, among other things, the
Debtors do not meet certain deadlines, including obtaining entry of an order
approving the Disclosure Statement by February 28, 2003, obtaining entry of an
order confirming the Plan by May 16, 2003, and closing on the Investment
Agreement by May 30, 2003; the Debtors withdraw their support of the Investment
Agreement, recommend an alternative investment proposal, or enter into a written
agreement for an alternative investment proposal; certain conditions to closing
are not satisfied or waived by the Plan Investors or the Company; or certain
other conditions outlined in more detail in the Investment Agreement are not
fulfilled.
(c) Plan Investor Ownership of New Holding Company Common
Stock
As noted above, ESL holds approximately $1.6 billion in unsecured debt
claims. ESL has agreed that it will purchase shares of New Holding Company
Common Stock on account of the Prepetition Lender Claims that ESL holds as of
the date of the Investment Agreement. Thus, ESL will receive exclusively New
Holding Company Common Stock on account of such Claims. It will also receive
additional New Holding Company Common Stock based on its
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purchase of 78.21% of the Plan Investors' Shares, New Holding Company Common
Stock on account of its Prepetition Note Claims pursuant to the terms of the
Plan, and, in the discretion of ESL, New Holding Company Common Stock on account
of Prepetition Lender Claims that it acquires after the date of the Investment
Agreement. In addition, ESL will have the right (i) to convert the Called Notes
into New Holding Company Stock at its discretion and (ii) to invest an
additional $86 million through the purchase of shares of New Holding Company
Common Stock. Based on these assumptions and the amount of Claims held by ESL
and Third Avenue as of the date of the Investment Agreement, ESL and Third
Avenue collectively could hold slightly in excess of 50% of all shares of New
Holding Company Common Stock issued and outstanding as of the Effective Date.
B. CLASSIFICATION AND TREATMENT OF CLAIMS AND INTERESTS
Section 1122 of the Bankruptcy Code requires that a plan of
reorganization classify the claims of a debtor's creditors and the interests of
its equity holders. The Bankruptcy Code also provides that, except for certain
claims classified for administrative convenience, a plan of reorganization may
place a claim of a creditor or an interest of an equity holder in a particular
class only if such claim or interest is substantially similar to the other
claims of such class. The Bankruptcy Code also requires that a plan of
reorganization provide the same treatment for each claim or interest of a
particular class unless the holder of a particular claim or interest agrees to a
less favorable treatment of its claim or interest.
The Debtors believe that they have classified all Claims and Interests
in compliance with the requirements of the Bankruptcy Code. If a Creditor or
Interest holder challenges such classification of Claims or Interests and the
Bankruptcy Court finds that a different classification is required for the Plan
to be confirmed, the Debtors, to the extent permitted by the Bankruptcy Court,
intend to make such reasonable modifications of the classifications of Claims or
Interests under the Plan to provide for whatever classification might be
required by the Bankruptcy Court for confirmation.
EXCEPT TO THE EXTENT THAT SUCH MODIFICATION OF CLASSIFICATION ADVERSELY
AFFECTS THE TREATMENT OF A HOLDER OF A CLAIM OR INTEREST AND REQUIRES
RESOLICITATION, ACCEPTANCE OF THE PLAN BY ANY HOLDER OF A CLAIM PURSUANT TO THIS
SOLICITATION WILL BE DEEMED TO BE A CONSENT TO THE PLAN'S TREATMENT OF SUCH
HOLDER OF A CLAIM REGARDLESS OF THE CLASS AS TO WHICH SUCH HOLDER ULTIMATELY IS
DEEMED TO BE A MEMBER.
1. Treatment of Unclassified Claims
(a) Administrative Claims
An Administrative Claim is a Claim for payment of an administrative
expense of a kind specified in section 503(b) of the Bankruptcy Code and
entitled to priority pursuant to section 507(a)(1) of the Bankruptcy Code,
including, but not limited to, DIP Facility Claims, the actual, necessary costs
and expenses, incurred on or after the Petition Date, of preserving the Estates
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and operating the business of the Debtors, including wages, salaries or
commissions for services rendered after the commencement of the Chapter 11
Cases, Professional Claims, Key Ordinary Course Professional Claims, all fees
and charges assessed against the Estates under chapter 123 of title 28, United
States Code, and all Allowed Claims (including reclamation claims) that are
entitled to be treated as Administrative Claims pursuant to a Final Order of the
Bankruptcy Court under section 546(c)(2)(A) of the Bankruptcy Code.
Subject to the provisions of the Plan, on the first Distribution Date
occurring after the later of (a) the date an Administrative Claim becomes an
Allowed Administrative Claim or (b) the date an Administrative Claim becomes
payable pursuant to any agreement between a Debtor (or a Reorganized Debtor) and
the holder of such Administrative Claim, an Allowed Administrative Claimholder
in the Chapter 11 Cases shall receive, in full satisfaction, settlement,
release, and discharge of, and in exchange for, such Administrative Claim, (i)
Cash equal to the unpaid portion of such Allowed Administrative Claim or (ii)
such other treatment as to which the Debtors (or the Reorganized Debtors) and
such Claimholder shall have agreed upon in writing; provided, however, that (x)
Claimholders of Claims arising under the DIP Facility shall be deemed to have
Allowed Claims as of the Effective Date in such amount as to which the Debtors
and such Claimholders shall have agreed upon in writing or as determined by the
Bankruptcy Court, which DIP Facility Claims shall be paid in accordance with
Article 10.1 of the Plan, (y) the Plan Investors shall be deemed to have an
Allowed Plan Investor Claim arising under the Investment Agreement in such
amount as to which the Debtors and the Plan Investors shall have agreed upon in
writing or as fixed by the Bankruptcy Court, which Plan Investor Claim shall be
paid in full in Cash on the Effective Date, and (z) Allowed Administrative
Claims with respect to liabilities incurred by the Debtors in the ordinary
course of business during the Chapter 11 Cases shall be paid in the ordinary
course of business in accordance with the terms and conditions of any agreements
relating thereto.
(b) Priority Tax Claims
Commencing on the first Periodic Distribution Date occurring after the
later of (a) the date a Priority Tax Claim becomes an Allowed Priority Tax Claim
or (b) the date a Priority Tax Claim first becomes payable pursuant to any
agreement between a Debtor (or a Reorganized Debtor) and the holder of such
Priority Tax Claim, at the sole option of the Debtors (or the Reorganized
Debtors after the Effective Date), such Allowed Priority Tax Claimholder shall
be entitled to receive on account of such Priority Tax Claim, in full
satisfaction, settlement, release and discharge of, and in exchange for, such
Priority Tax Claim, (i) equal Cash payments on the last Business Day of each
three-month period following the Effective Date, during a period not to exceed
six years after the assessment of the tax on which such Claim is based, totaling
the aggregate amount of such Claim plus simple interest on any outstanding
balance from the Effective Date calculated at the interest rate available on
ninety (90) day United States Treasuries on the Effective Date, which the
Debtors believe is appropriate based on rates approved in other chapter 11
cases, (ii) such other treatment agreed to by the Allowed Priority Tax
Claimholder and the Debtors (or the Reorganized Debtors), provided such
treatment is on more favorable terms to the Debtors (or the Reorganized Debtors
after the Effective Date) than the treatment set forth in clause (i) hereof, or
(iii) payment in full in Cash. The Debtors estimate
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that Priority Tax Claims will total $190 million. These amounts have been
factored into the Debtors' go-forward business plan.
(c) PBGC Claims
Upon confirmation and substantial consummation of the Plan, the
Reorganized Debtors will continue the Kmart Corporation Employee Pension Plan in
accordance with applicable law, and the Debtors' obligations under applicable
law with respect to continued funding of the Kmart Corporation Employee Pension
Plan will remain unaltered. Nothing in the Plan shall be deemed to discharge,
release, or relieve the Debtors, the Reorganized Debtors, or their controlled
group of or from any current or future liability under applicable law with
respect to the Kmart Corporation Employee Pension Plan. Any and all obligations
under the Kmart Corporation Employee Pension Plan shall be paid in accordance
with the terms and conditions of the Kmart Corporation Employee Pension Plan and
in accordance with applicable law. On the Effective Date, the PBGC will be
deemed to have withdrawn the PBGC Claims with respect to the Kmart Corporation
Employee Pension Plan.
(d) Workers' Compensation Programs
Upon confirmation and substantial consummation of the Plan, the
Reorganized Debtors shall continue the Workers' Compensation Programs in
accordance with applicable state laws. The phrase "Workers' Compensation
Programs" means, collectively, the Debtors' workers' compensation programs in
all states in which they operate pursuant to which the Debtors provide their
employees with workers' compensation coverage for claims arising from or related
to their employment with the Debtors. Nothing in the Plan shall be deemed to
discharge, release, or relieve the Debtors or Reorganized Debtors from any
current or future liability with respect to any of the Workers' Compensation
Programs. The Reorganized Debtors shall be responsible for all valid claims for
benefits and liabilities under the Workers' Compensation Programs regardless of
when the applicable injuries were incurred. Any and all obligations under the
Workers' Compensation Programs shall be paid in accordance with the terms and
conditions of Workers' Compensation Programs and in accordance with all
applicable laws.
(e) Consignment Claims
Notwithstanding section 1141(c) or any other provision of the
Bankruptcy Code, all liens, if any, of Persons who provided goods to the Debtors
on consignment (i) prior to the Petition Date and who hold valid, enforceable,
and perfected liens in such goods (a) pursuant to a written agreement with the
Debtors and (b) in accordance with applicable law or (ii) after the Petition
Date pursuant to any order of the Bankruptcy Court shall, in each case, survive
the Effective Date and continue in accordance with the contractual terms of the
underlying agreements between the Debtors and such Persons and shall remain
enforceable as of the Effective Date with the same extent, validity, and
priority as existed as of the Petition Date or pursuant to such order, as the
case may be. All other Persons who provided goods to the Debtors on consignment
shall be deemed to hold Trade Vendor/Lease Rejection Claims under the Plan.
Pursuant to the Plan, no request for payment of an Administrative Claim need be
filed
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with respect to any Claim contemplated by this Section, which Claim shall be
payable by the Debtors in the ordinary course of business.
2. Treatment of Classified Claims and Interests
Pursuant to section 1122 of the Bankruptcy Code, set forth below is a
designation of classes of Claims against and Interests in the Debtors. A Claim
or Interest is placed in a particular Class for the purposes of voting on the
Plan and of receiving distributions pursuant to the Plan only to the extent that
such Claim or Interest is an Allowed Claim or an Allowed Interest in that Class
and such Claim or Interest has not been paid, released, or otherwise settled
prior to the Effective Date. In accordance with section 1123(a)(1) of the
Bankruptcy Code, Administrative Claims and Priority Tax Claims of the kinds
specified in sections 507(a)(1) and 507(a)(8) of the Bankruptcy Code have not
been classified and their treatment is set forth above. The Plan, though
proposed jointly, constitutes a separate plan proposed by each of the Debtors.
Therefore, except as expressly specified herein, the classifications set forth
below shall be deemed to apply separately with respect to each plan proposed by
each such Debtor.
(a) Classes of Claims that are Unimpaired
(i) Class 1 (Secured Claims).
Class 1 consists of separate subclasses for all Secured Claims that may
exist against a particular Debtor. A "Secured Claim" means a Claim secured by a
security interest in or a lien on property in which a Debtor's Estate has an
interest or that is subject to setoff under section 553 of the Bankruptcy Code,
to the extent of the value, as of the Effective Date or such other date as is
established by the Bankruptcy Court, of such Claimholder's interest in the
applicable Estate's interest in such property or to the extent of the amount
subject to setoff, as applicable, as determined by a Final Order of the
Bankruptcy Court pursuant to section 506(a) of the Bankruptcy Code or in the
case of setoff, pursuant to section 553 of the Bankruptcy Code, or as otherwise
agreed upon in writing by the Debtors and the Claimholder.
Except as otherwise provided in and subject to Article 9.8 of the Plan,
at the sole option of the Debtors or Reorganized Debtors, (i) the legal,
equitable, and contractual rights of each Allowed Secured Claimholder shall be
Reinstated or (ii) each Allowed Secured Claimholder shall receive, in full
satisfaction, settlement and release of, and in exchange for, its Allowed
Secured Claim (A) Cash in an amount equal to the value of the Secured
Claimholder's interest in the property of the Estate which constitutes
collateral for such Allowed Secured Claim, or (B) the property of the Estate
which constitutes collateral for such Allowed Secured Claim, or (C) such other
treatment as to which the Debtors (or the Reorganized Debtors) and the holder of
such Allowed Secured Claim have agreed upon in writing, provided that such
treatment is not more favorable than the treatment in clause (A) or clause (B)
above. The Debtors or the Reorganized Debtors, as the case may be, shall
determine which treatment of those set forth in the preceding sentence will be
provided to each Allowed Secured Claim on the later of (i) the Effective Date or
(ii) ten days after the date such Claim becomes an Allowed Secured Claim. The
Reorganized Debtors shall provide notice of the treatment to be provided to each
holder of an Allowed Secured Claim as soon as practicable after the later of (x)
the Effective Date or (y) ten days
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after the date such Claimholder's claim becomes an Allowed Secured Claim. In the
event the Debtors or the Reorganized Debtors, as the case may be, fail to
designate the treatment of an Allowed Secured Claim, the legal, equitable, and
contractual rights of the Allowed Secured Claimholder with respect to such
Allowed Secured Claim shall be Reinstated. The Debtors' failure to object to
such Secured Claims in their Chapter 11 Cases shall be without prejudice to the
Reorganized Debtors' right to contest or otherwise defend against such Claims in
the Bankruptcy Court or other appropriate non-bankruptcy forum (at the option of
the Debtors or the Reorganized Debtors) when and if such Claims are sought to be
enforced by the Secured Claimholder. Notwithstanding section 1141(c) or any
other provision of the Bankruptcy Code, all valid, enforceable, and perfected
prepetition liens on property of the Debtors held by or on behalf of the Secured
Claimholders with respect to such Claims shall survive the Effective Date and
continue in accordance with the contractual terms of the underlying agreements
with such Claimholders and/or applicable law until, as to each such Claimholder,
the Allowed Secured Claims of such Secured Claimholder are satisfied in
accordance with the provisions of this Section.
"Reinstated" or "Reinstatement" means (a) leaving unaltered the legal,
equitable and contractual rights to which a Claim entitles the Claimholder so as
to leave such Claim Unimpaired in accordance with section 1124 of the Bankruptcy
Code, or (b) notwithstanding any contractual provision or applicable law that
entitles the Claimholder to demand or receive accelerated payment of such Claim
after the occurrence of a default (i) curing any such default that occurred
before or after the Petition Date, other than a default of a kind specified in
section 365(b)(2) of the Bankruptcy Code; (ii) reinstating the maturity of such
Claim as such maturity existed before such default; (iii) compensating the
Claimholder for any damages incurred as a result of any reasonable reliance by
such Claimholder on such contractual provision or such applicable law; and (iv)
not otherwise altering the legal, equitable or contractual rights to which such
Claim entitles the Claimholder; provided, however, that any contractual right
that does not pertain to the payment when due of principal and interest on the
obligation on which such Claim is based, including, but not limited to,
financial covenant ratios, negative pledge covenants, covenants or restrictions
on merger or consolidation, "going dark" provisions, and affirmative covenants
regarding corporate existence prohibiting certain transactions or actions
contemplated by the Plan, or conditioning such transactions or actions on
certain factors, shall not be required to be cured or reinstated in order to
accomplish Reinstatement.
(ii) Class 2 (Other Priority Claims).
Class 2 consists of all Other Priority Claims that may exist against a
particular Debtor. An "Other Priority Claim" means a Claim entitled to priority
pursuant to section 507(a) of the Bankruptcy Code other than a Priority Tax
Claim or an Administrative Claim. Except as otherwise provided in and subject to
Article 9.8 of the Plan, on the first Periodic Distribution Date occurring after
the later of (i) the date an Other Priority Claim becomes an Allowed Other
Priority Claim or (ii) the date an Other Priority Claim becomes payable pursuant
to any agreement between the Debtors (or the Reorganized Debtors) and the holder
of such Other Priority Claim, each Allowed Other Priority Claimholder shall
receive, in full satisfaction, settlement, release, and discharge of, and in
exchange for, such Other Priority Claim, (a) Cash in an amount equal to the
amount of such Allowed Other Priority Claim or (b) such other treatment
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as to which the Debtors (or the Reorganized Debtors) and such Claimholder shall
have agreed upon in writing, provided that such treatment is not more favorable
than the treatment in clause (a) or clause (b) above. The Debtors' failure to
object to an Other Priority Claim in their Chapter 11 Cases shall be without
prejudice to the Reorganized Debtors' right to contest or otherwise defend
against such Claim in the Bankruptcy Court or other appropriate non-bankruptcy
forum (at the option of the Debtors or the Reorganized Debtors) when and if such
Claim is sought to be enforced by the Other Priority Claimholder.
(b) Classes of Claims that are Impaired
(i) Class 3 (Prepetition Lender Claims).
Class 3 consists of all Prepetition Lender Claims. The term
"Prepetition Lender Claims" means all Claims arising under or pursuant to the
Prepetition Credit Agreements, which include, collectively, (a) that certain
Three Year Credit Agreement, dated as of December 6, 1999, by and among Kmart,
J.P. Morgan Securities, Inc. (f/k/a Chase Securities, Inc.), as Lead Arranger
and Book Manager, JPMorgan Chase Bank (f/k/a The Chase Manhattan Bank), as
Administrative Agent, Bank of America, National Association, as Syndication
Agent, BankBoston, N.A., as Co-Documentation Agent, and Bank of New York, as
Co-Documentation Agent, as amended, supplemented or otherwise modified from time
to time, and all documents executed in connection therewith, and (b) that
certain 364 Day Credit Agreement, dated as of November 13, 2001, by and among
Kmart, JPMorgan Chase Bank (f/k/a The Chase Manhattan Bank), as Administrative
Agent, Credit Suisse First Boston, Fleet National Bank, and Bank of New York, as
Co-Documentation Agents, as amended, supplemented or otherwise modified from
time to time, and all documents executed in connection therewith. This Class is
applicable only to the Chapter 11 Cases of the following Debtors: Kmart, Kmart
Amsterdam, Kmart Holdings, Kmart-IN, Kmart-MI, Kmart-MPS, Kmart-NC, Kmart-PA,
Kmart-TX, Big Beaver Caguas, Big Beaver Development, Big Beaver Florida, Big
Beaver Guaynabo, Bluelight, and SFPR. Kmart is a direct obligor under the
Prepetition Credit Agreements, whereas the other Debtors identified in the
preceding sentence are guarantors of Kmart's obligations under such Agreements.
Upon the occurrence of the Effective Date, the Prepetition Lender
Claims are hereby Allowed in the aggregate amount of $1,076,156,647.02. On the
Effective Date, the Prepetition Lenders shall receive, in full satisfaction,
settlement, release, and discharge of, and in exchange for, their Prepetition
Lender Claims (including any prepetition setoff claims and setoff claims
assertable pursuant to the DIP Facility Order), Cash in an amount equal to forty
percent (40%) of the aggregate Allowed amount of the Prepetition Lender Claims,
with such consideration representing a compromise and settlement, pursuant to
section 1123(b)(3) of the Bankruptcy Code and Bankruptcy Rule 9019, of the
Prepetition Lender Claims, including such Claims relating to guarantees by
certain Affiliate Debtors of Kmart's obligations under the Prepetition Credit
Agreements and issues related to the substantive consolidation of the Debtors as
contemplated by the Plan, but solely for the purpose of the Plan, provided,
however, that, subject to the terms and conditions of the Investment Agreement,
the Plan Investors shall be deemed to utilize Cash that they are entitled to
receive pursuant to this Section, plus additional amounts to be paid by the Plan
Investors pursuant to the Investment Agreement, to purchase the Total
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Investor Shares pursuant to the terms of the Investment Agreement. In addition,
with respect to each letter of credit outstanding under the Prepetition Credit
Agreements as of February 20, 2003, the Reorganized Debtors shall, as soon as
practicable after the Effective Date, (i) obtain a replacement letter of credit,
(ii) provide cash collateral equal to 105% of the face amount of the letter of
credit, or (iii) if such letter of credit has been drawn, reimburse the
Prepetition Lenders (or issuing bank, as applicable) with respect to such drawn
letter of credit in full in Cash on the Effective Date. All distributions to
Prepetition Lenders other than the Plan Investors under this Section shall be
made to the Prepetition Agent under the Prepetition Credit Agreements for
immediate distribution to the Prepetition Lenders in accordance with the terms
of the Prepetition Credit Agreements.
(ii) Class 4 (Prepetition Note Claims).
Class 4 consists of all Prepetition Note Claims, including claims under
the Prepetition Notes and under the indentures for the Prepetition Notes. The
phrase "Prepetition Notes" means, collectively, (a)(i) the 12.5% Notes due March
1, 2005 in the aggregate principal amount of $100,000,000; (ii) the 8.125% Notes
due December 1, 2006 in the aggregate principal amount of $200,000,000; (iii)
the 7.75% Notes due October 1, 2012 in the aggregate principal amount of
$157,257,000; (iv) the 8.25% Notes due January 1, 2022 in the aggregate
principal amount of $68,055,000; (iv) the 8.375% Notes due July 1, 2022 in the
aggregate principal amount of $85,550,000; (v) the 7.95% Notes due February 1,
2023 in the aggregate principal amount of $259,800,000; and (vi) the Series C
Medium Term Notes and Series D Medium Term Notes in the aggregate principal
amount of $222,935,000, in each case issued by Kmart pursuant to that certain
indenture dated as of February 1, 1985, between Kmart and The Bank of New York,
as original indenture trustee, as thereafter succeeded in that capacity by
Wilmington Trust Company as successor indenture trustee, as such indenture may
have been amended, supplemented, or otherwise modified from time to time,
including, but not limited to, that certain First Supplemental Indenture dated
as of March 1, 1991; (b)(i) the 8.375% Notes due December 1, 2004 in the
aggregate principal amount of $300,000,000; (ii) the 9.375% Notes due February
1, 2006 in the aggregate principal amount of $400,000,000; and (iii) the 9.875%
Notes due June 15, 2008 in the aggregate principal amount of $430,000,000; in
each case issued by Kmart pursuant to that certain indenture dated as of
December 13, 1999, between Kmart and The Bank of New York, as original indenture
trustee, as thereafter succeeded in that capacity by Wilmington Trust Company as
successor indenture trustee, as such indenture may have been amended,
supplemented, or otherwise modified from time to time, including, but not
limited to, that certain First Supplemental Indenture dated as of December 13,
1999; that certain Second Supplemental Indenture, dated as of January 30, 2001;
and that certain Third Supplemental Indenture dated as of June 19, 2001; and (c)
the Commercial Development Revenue Refunding Bonds (Kmart Corporation Project)
Series 1994 in the aggregate outstanding principal amount of $1,800,000.00,
issued under or in connection with the trust indenture dated as of November 1,
1994 by and between The County Commission of Harrison County, as issuer, and JP
Morgan Trust Company, N.A. (as successor to Society National Bank), as indenture
trustee, as thereafter succeeded in that capacity by Wilmington Trust Company as
successor indenture trustee, and all of the right, title and interest of
Harrison County in and under the Loan Agreement and the Promissory Note made
between Kmart and The County Commission of Harrison County.
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The Prepetition Note Claims are Allowed Prepetition Note Claims in the
aggregate amount of $2,277,384,986.97. Each Prepetition Note Claimholder shall
receive, in full satisfaction, settlement, release, and discharge of, and in
exchange for, its Prepetition Note Claims, (a) on the Effective Date, its Pro
Rata share of the Prepetition Noteholder Shares (which means 25,008,573 shares
of New Holding Company Common Stock), subject to dilution, with the amount of
each Prepetition Note Claimholder's Pro Rata share equal to the total number of
Prepetition Noteholder Shares multiplied by a fraction, the numerator of which
is equal to the amount of such Prepetition Noteholder's Allowed Prepetition Note
Claim, and the denominator of which is equal to all Allowed Prepetition Note
Claims, with the amount of such Prepetition Noteholder Shares being inclusive of
New Holding Company Stock otherwise allocable to holders of Trust Preferred
Obligations under Article 5.8 of the Plan pursuant to the subordination
provisions of all documents pertaining to the Trust Preferred Securities and
evidencing the rights and obligations of the Trust Preferred Obligations, in
each case payable directly to the Servicer of the Prepetition Note Claims for
distribution to holders of the Prepetition Note Claims; (b) on the Effective
Date and in lieu of any claim under Article 10.3 of the Plan by or on behalf of
any indenture trustee for holders of Prepetition Note Claims, its Pro Rata share
(calculated as provided in clause (a) of this Section) of Cash in an amount
equal to the reasonable fees and expenses of any indenture trustee for the
Prepetition Notes, as approved by the Bankruptcy Court pursuant to Section
1129(a)(4) of the Bankruptcy Code, not to exceed $1,500,000; and (c) commencing
on the Distribution Date, its Pro Rata Share of the Trust Recoveries, if any,
other than the rights to such Trust Recoveries to which holders of Subordinated
Securities Claims and Existing Common Stock may be entitled pursuant to Article
5.10 and Article 5.11 of the Plan, with the amount of each Prepetition Note
Claimholder's Pro Rata share equal to the total amount of such rights multiplied
by a fraction, the numerator of which is equal to the amount of such Prepetition
Note Claimholder's Allowed Prepetition Note Claim, and the denominator of which
is equal to the sum of all Allowed Non-Lender Claims, with such consideration
representing a compromise and settlement, pursuant to section 1123(b)(3) of the
Bankruptcy Code and Bankruptcy Rule 9019, of the Prepetition Lender Claims,
including such Claims relating to guarantees by certain Affiliate Debtors of
Kmart's obligations under the Prepetition Credit Agreements and issues related
to the substantive consolidation of the Debtors as contemplated by the Plan.
Notwithstanding anything in this Section to the contrary, any Prepetition Note
Claims held by the Debtors shall be deemed cancelled as of the Effective Date,
and the Debtors shall not receive or retain any property or interest in property
on account of such Prepetition Note Claims under the Plan. The calculation of
the Pro Rata interests of other Prepetition Note Claimholders called for in this
Section shall be made as if the Prepetition Note Claims held by the Debtors were
not outstanding as of the time of such calculation. In the event that the Class
of Prepetition Notes rejects the Plan, holders of Trust Preferred Obligations
shall not receive or retain any property or interest in property on account of
such Obligations under the Plan.
The term "Trust Recoveries" means any and all proceeds received by the
Kmart Creditor Trust from (a) the prosecution to, and collection of, a final
judgment of a Trust Claim against a Person, or (b) the settlement or other
compromise of a Trust Claim against a Person; provided, however, that Trust
Recoveries shall exclude any payments made by the Debtors or Reorganized Debtors
pursuant to Article 11.3(d) of the Plan, including any payments related to the
Reorganized Debtors' continuing obligation to turn over funds repaid to them on
account of
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loans made pursuant to the 2001 Retention Program. The term "Trust Claim" means
any and all Causes of Action against any Person or entity arising from, in
connection with, or relating to the subject matters of the Investigations which,
for purposes hereof, means the Accounting and Stewardship Investigations,
including all matters authorized by order entered by the Bankruptcy Court on
September 4, 2002 approving the participation, on a joint interest basis, of the
Statutory Committees in said Investigations, and including all matters arising
from, in connection with, or relating to the subject matter of responses to the
Government Inquiries. Finally, the term "Non-Lender Claims" means the
Prepetition Note Claims, the Trade Vendor/Lease Rejection Claims, the Trust
Preferred Obligations, and Other Unsecured Claims.
(iii) Class 5 (Trade Vendor/Lease Rejection
Claims).
Class 5 consists of all Trade Vendor/Lease Rejection Claims that may
exist against a particular Debtor. A "Trade Vendor/Lease Rejection Claim" means
a Claim arising as a result of (i) retail merchandise or services provided by
trade vendors or service providers, (ii) rejection of executory contracts and
unexpired leases, (iii) guaranties related to rejected executory contracts and
unexpired leases, (iv) guaranties with respect to industrial revenue bonds, (v)
unsecured deficiency claims, if any, and (vi) Other Unsecured Claims that have
made the Other Unsecured Claim Election. Except as otherwise provided in and
subject to Article 9.8 of the Plan, commencing on the Distribution Date or first
Periodic Distribution Date occurring after the later of (i) the date a Trade
Vendor/Lease Rejection Claim becomes an Allowed Trade Vendor/Lease Rejection
Claim or (ii) the date a Trade Vendor/Lease Rejection Claim becomes payable
pursuant to any agreement between the Debtors (or the Reorganized Debtors) and
the holder of such Trade Vendor/Lease Rejection Claim, each Trade Vendor/Lease
Rejection Claimholder shall receive, in full satisfaction, settlement, release,
and discharge of, and in exchange for, such Allowed Trade Vendor/Lease Rejection
Claim, (a) its Pro Rata share of the Trade Vendor/Lease Rejection Shares (which
means 31,945,161 shares of New Holding Company Common Stock), subject to
dilution, with the amount of each Trade Vendor/Lease Rejection Claimholder's Pro
Rata share equal to the total number of Trade Vendor/Lease Rejection Shares
multiplied by a fraction, the numerator of which is equal to the amount of such
Trade Vendor/Lease Rejection Claimholder's Allowed Trade Vendor/Lease Rejection
Claim, and the denominator of which is equal to all Allowed Trade Vendor/Lease
Rejection Claims; and (b) its Pro Rata Share of the Trust Recoveries, if any,
other than the rights to such Trust Recoveries to which holders of Subordinated
Securities Claims and Existing Common Stock may be entitled pursuant to Article
5.10 and Article 5.11 of the Plan, with the amount of each Trade Vendor/Lease
Rejection Claimholder's Pro Rata share equal to the total amount of such rights
multiplied by a fraction, the numerator of which is equal to the amount of such
Trade Vendor/Lease Rejection Claimholder's Allowed Trade Vendor/Lease Rejection
Claim, and the denominator of which is equal to the sum of all Allowed
Non-Lender Claims, with such consideration representing a compromise and
settlement, pursuant to section 1123(b)(3) of the Bankruptcy Code and Bankruptcy
Rule 9019, of the Prepetition Lender Claims, including such Claims relating to
guarantees by certain Affiliate Debtors of Kmart's obligations under the
Prepetition Credit Agreements and issues related to the substantive
consolidation of the Debtors as contemplated by the Plan. The Debtors' failure
to object to a Trade Vendor/Lease Rejection Claim in their Chapter 11 Cases
shall be without prejudice to the Reorganized Debtors' right to contest or
otherwise defend against such Claim in the Bankruptcy Court or other appropriate
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non-bankruptcy forum (at the option of the Debtors or the Reorganized Debtors)
when and if such Claim is sought to be enforced by the Trade Vendor/Lease
Rejection Claimholder. All distributions to holders of Trade Vendor/Lease
Rejection Claims shall be made to the Disbursing Agent for immediate
distribution to holders of Trade Vendor/Lease Rejection Claims pursuant to the
terms of the Plan.
(iv) Class 6 (Other Unsecured Claims).
Class 6 consists of all Other Unsecured Claims that may exist against a
particular Debtor. An "Other Unsecured Claim" means a Claim that is not an
Administrative Claim, General Unsecured Convenience Claim, Intercompany Claim,
Other Priority Claim, PBGC Claim, Priority Tax Claim, Prepetition Lender Claim,
Prepetition Note Claim, Secured Claim, Subordinated Securities Claim, Trade
Vendor/Lease Rejection Claim, or Trust Preferred Obligation.
Except as otherwise provided in and subject to Article 9.8 of the Plan,
each Other Unsecured Claimholder holding an Allowed Other Unsecured Claim shall
receive, in full satisfaction, settlement, release, and discharge of, and in
exchange for, such Other Unsecured Claim, (a) on the third anniversary of the
Effective Date (or, if such date is not a Business Day, the next Business Day),
its Pro Rata share of the Other Unsecured Claim Cash Payment Amount to be paid
hereunder, with the amount of each Other Unsecured Claimholder's Pro Rata share
equal to the amount of the Other Unsecured Cash Payment Amount multiplied by a
fraction, the numerator of which is equal to the amount of such Other Unsecured
Claimant's Allowed Other Unsecured Claim, and the denominator of which is equal
to the aggregate amount of all Allowed Other Unsecured Claims, provided,
however, that, in the event an Other Unsecured Claimholder makes the Other
Unsecured Claim Election, such Other Unsecured Claimholder shall be deemed (i)
to be a Trade Vendor/Lease Rejection Claimholder and shall receive, in lieu of
its Pro Rata share of the Other Unsecured Claim Cash Payment Amount, the Trade
Vendor/Lease Rejection Claimholder treatment as provided for in the Plan, and
(ii) to consent to the Other Unsecured Claim Estimation Procedure, and (b)
commencing on the first Periodic Distribution Date occurring after the later of
(x) the date an Other Unsecured Claim becomes an Allowed Other Unsecured Claim
or (y) the date an Other Unsecured Claim becomes payable pursuant to any
agreement between the Debtors (or the Reorganized Debtors) and the holder of
such Other Unsecured Claim, its Pro Rata share of the Trust Recoveries, if any,
other than the rights to such Trust Recoveries to which holders of Subordinated
Securities Claims and Existing Common Stock may be entitled pursuant to Article
5.10 and Article 5.11 of the Plan, with the amount of each Other Unsecured
Claimholder's Pro Rata share equal to the total amount of such rights multiplied
by a fraction, the numerator of which is equal to the amount of such Other
Unsecured Claimholder's Allowed Other Unsecured Claim, and the denominator of
which is equal to the aggregate amount of all Allowed Non-Lender Claims, with
such consideration representing a compromise and settlement, pursuant to section
1123(b)(3) of the Bankruptcy Code and Bankruptcy Rule 9019, of the Prepetition
Lender Claims, including such Claims relating to guarantees by certain Affiliate
Debtors of Kmart's obligations under the Prepetition Credit Agreements and
issues related to the substantive consolidation of the Debtors as contemplated
by the Plan. Each of the Other Unsecured Claimholder's Pro Rata share of the
Other Unsecured Claim Cash Payment Amount shall be an obligation of New Holding
Company
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and New Operating Company. The right of a holder of an Allowed Other Unsecured
Claim to receive its Pro Rata share of the Other Unsecured Claim Cash Payment
Amount shall be personal to such holder and shall be non-transferable except
upon death of the interest holder or by operation of law.
The phrase "Other Unsecured Claim Cash Payment Amount" means the Cash
to be paid to all holders of Allowed Other Unsecured Claims on the third
anniversary of the Effective Date (or, if such date is not a Business Day, the
next Business Day), in an amount equal to (i) the product of (a) the estimated,
mid-range value (as set forth in the Disclosure Statement), of the New Holding
Company Common Stock to be distributed to holders of Trade Vendor/Lease
Rejection Claims multiplied by (b) a fraction, the numerator of which is equal
to the aggregate amount of all Allowed Other Unsecured Claims, and the
denominator of which is equal to the aggregate amount of all Allowed Trade
Vendor/Lease Rejection Claims and Allowed Other Unsecured Claims, plus (ii) an
amount equivalent to interest on the amount calculated pursuant to the preceding
clause at an annual rate of 4% from and after the Effective Date through and
including the third anniversary of the Effective Date. The Other Unsecured Claim
Cash Payment Amount shall be subject to such other terms and conditions as may
be necessary and appropriate to effectuate payment thereof or to comply with
applicable law.
(v) Class 7 (General Unsecured Convenience
Claims).
Class 7 consists of all General Unsecured Convenience Claims that may
exist against a particular Debtor. A "General Unsecured Convenience Claim" means
(i) a Trade Vendor/Lease Rejection Claim or an Other Unsecured Claim if the
Allowed amount of such Claim is less than or equal to $30,000 and (ii) a Trade
Vendor/Lease Rejection Claim or Other Unsecured Claim if, in either instance,
the Allowed amount of such Claim is greater than $30,000 and the holder of such
Claim has agreed to reduce the allowed amount of its Claim to $30,000 or less
and made the Convenience Class Election on the Ballot provided for voting on the
Plan within the time fixed by the Bankruptcy Court. The "Convenience Class
Election" means an election by a holder of a Trade Vendor/Lease Rejection Claim
or Other Unsecured Claim on its Ballot to be treated as a General Unsecured
Convenience Claim.
Except as otherwise provided in and subject to Article 9.8 of the Plan,
on the first Periodic Distribution Date occurring after the later of (i) the
date a General Unsecured Convenience Claim becomes an Allowed General Unsecured
Convenience Claim or (ii) the date a General Unsecured Convenience Claim becomes
payable pursuant to any agreement between the Debtors (or the Reorganized
Debtors) and the holder of such General Unsecured Convenience Claim, the holder
of an Allowed General Unsecured Convenience Claim shall receive, in full
satisfaction, settlement, release, and discharge of, and in exchange for, such
General Unsecured Convenience Claim, Cash equal to (a) six and one-quarter
percent (6.25%) of the amount of such Allowed Claim if the amount of such
Allowed Claim is less than or equal to $30,000 or (b) $1,875 if the amount of
such Allowed Claim is greater than $30,000 and the holder of such Claim has made
the Convenience Class Election. Any Trade Vendor/Lease Rejection Claims or Other
Unsecured Claims that are treated as General Unsecured Convenience Claims shall
not otherwise be treated as Trade Vendor/Lease Rejection Claims or Other
Unsecured Claims under the Plan; provided, however, that the holder of any
General
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Unsecured Convenience Claim that is in an amount equal to or less than $30,000
may elect to be treated as a Trade Vendor/Lease Rejection Claimholder and shall
receive, in lieu of any payment under Article 5.7 of the Plan, the Trade
Vendor/Lease Rejection treatment as provided for in the Plan.
(vi) Class 8 (Trust Preferred Obligations).
Class 8 consists of all Trust Preferred Obligations. The term "Trust
Preferred Obligations" means all obligations of the Debtors arising under or
pursuant to the Trust Preferred Securities and related Indenture by and between
Kmart Corporation and The Bank of New York, as Trustee, dated June 6, 1996, the
First Supplemental Indenture of the same date, and related documents.
Except as otherwise provided in and subject to Article 9.8 of the Plan,
commencing on the first Periodic Distribution Date occurring after the later of
(i) the date a Trust Preferred Obligation becomes an Allowed Trust Preferred
Obligation or (ii) the date a Trust Preferred Obligation becomes payable
pursuant to any agreement between the Debtors (or the Reorganized Debtors) and
the holder of such Trust Preferred Obligation, each Trust Preferred Obligation
holder (a) shall be deemed to receive, in full satisfaction, settlement,
release, and discharge of, and in exchange for, such Trust Preferred Obligation,
those shares of New Holding Company Common Stock that would have otherwise been
allocable to such Trust Preferred Obligation holder but for the subordination
provisions of all documents pertaining to the Trust Preferred Securities and
evidencing the rights and obligations of the Trust Preferred Obligations, but
which will, pursuant to such subordination provisions and Article 5.4 of the
Plan, be deemed to have been included in the Prepetition Noteholder Shares; and
(b) shall receive (i), in the event that the Class of Trust Preferred
Obligations votes to accept the Plan, their Pro Rata Share of the Trust
Recoveries, if any, other than the rights to such Trust Recoveries to which
holders of Subordinated Securities Claims and Existing Common Stock may be
entitled pursuant to Article 5.10 and Article 5.11 of the Plan, with the amount
of each Trust Preferred Obligation holder's Pro Rata share equal to the total
amount of such rights multiplied by a fraction, the numerator of which is equal
to the amount of such Trust Preferred Obligation holder's Allowed Trust
Preferred Obligation, and the denominator of which is equal to the sum of all
Allowed Non-Lender Claims, or, (ii) in the event that either (y) the Class of
Trust Preferred Obligations or (z) the Class of Prepetition Note Claims votes to
reject the Plan, Trust Preferred Obligation holders shall not be entitled to,
and shall not receive or retain any property or interest in property on account
of such Obligations under the Plan and the subordination provisions of all
documents pertaining to the Trust Preferred Securities will be enforced in all
respects, and any Trust Recoveries which Trust Preferred Obligation holders
would have received pursuant to clause (b)(i) of this Section shall be paid
directly to the Servicer of the Prepetition Note Claims for distribution to
holders of the Prepetition Note Claims pursuant to Article 5.4 of the Plan.
(vii) Class 9 (Intercompany Claims).
Class 9 consists of all Intercompany Claims that may exist against a
particular Debtor. An "Intercompany Claim" is a Claim by a Debtor, an Affiliate
of a Debtor, or a non-Debtor Affiliate against another Debtor, Affiliate of a
Debtor, or non-Debtor Affiliate. On the Effective
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Date, at the option of the Debtors or the Reorganized Debtors in connection with
the Restructuring Transactions contemplated by the Plan, the Intercompany Claims
of any Debtor against any other Debtor, including, but not limited to, any
Intercompany Claims arising as a result of rejection of an Intercompany
Executory Contract or Intercompany Unexpired Lease, shall either be (a)
Reinstated, in full or in part, or (b) cancelled and discharged, in full or in
part, in which case such discharged and satisfied portion shall be eliminated
and the holders thereof shall not be entitled to, and shall not receive or
retain, any property or interest in property on account of such portion under
the Plan.
(viii) Class 10 (Subordinated Securities Claims).
Class 10 consists of all Subordinated Securities Claims against Kmart.
A "Subordinated Securities Claim" is a Claim subject to subordination under
section 510(b) of the Bankruptcy Code, including, without limitation, any Claim
that arises from the rescission of a purchase or sale of a Security of any of
the Debtors (including, without limitation, Existing Common Stock), or for
damages arising from the purchase or sale of such a Security, or for
reimbursement, indemnification, or contribution allowed under section 502 of the
Bankruptcy Code on account of such Claim. Except as otherwise provided in and
subject to Article 9.8 of the Plan, (i) in the event that all Classes of
Impaired Claims and the Class of Trust Preferred Obligations vote to accept the
Plan, commencing on the first Periodic Distribution Date occurring after the
later of (a) the date a Subordinated Securities Claim becomes an Allowed
Subordinated Securities Claim or (b) the date a Subordinated Securities Claim
becomes payable pursuant to any agreement between the Debtors (or the
Reorganized Debtors) and the holder of such Claim, the holder of an Allowed
Subordinated Securities Claim shall receive, in full satisfaction, settlement,
release, and discharge of, and in exchange for, such Subordinated Securities
Claim, its Pro Rata Share of the right to 2.5% of the Trust Recoveries (other
than Designated Trust Recoveries), if any, with the amount of each Subordinated
Securities Claimholder's Pro Rata share equal to (y) the amount of such rights
of all holders of Subordinated Securities Claims multiplied by a fraction, the
numerator of which is equal to the lesser of (1) the total number of outstanding
shares of Existing Common Stock as of the Effective Date and (2) the total
number of shares represented by such Subordinated Securities Claimholder's
Claim, and the denominator of which is equal to the sum of the aggregate number
of all shares represented by Allowed Subordinated Securities Claims and the
aggregate number of shares represented by all Allowed Interests pertaining to
Existing Common Stock minus (z) the recoveries, if any, received by such
Subordinated Securities Claimholders from the Securities Actions, and (ii) in
the event that any Class of Impaired Claims or the Class of Trust Preferred
Obligations votes to reject the Plan, holders of Subordinated Securities Claims
shall not be entitled to, and shall not receive or retain any property or
interest in property on account of such Claims under the Plan.
(ix) Class 11 (Existing Common Stock).
Class 11 consists of all Existing Common Stock in Kmart and all
Interests that may exist with respect to an Affiliate Debtor. On the Effective
Date, the Existing Common Stock shall be cancelled. Except as otherwise provided
in and subject to Article 9.8 of the Plan, (i) in the event that all Classes of
Impaired Claims and the Class of Trust Preferred Obligations vote to accept the
Plan, on the first Periodic Distribution Date occurring after the later of (a)
the date an
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Interest pertaining to Existing Common Stock becomes an Allowed Interest or (b)
the date such Interest becomes payable pursuant to any agreement between the
Debtors (or the Reorganized Debtors) and the holder of such Interest, the holder
of such Allowed Interest shall receive, in full satisfaction, settlement,
release, and discharge of, and in exchange for, such Interest, its Pro Rata
Share of the right to 2.5% of the Trust Recoveries (other than Designated Trust
Recoveries), if any, with the amount of each Interestholder's Pro Rata share
equal to (y) the amount of such rights of all holders of Existing Common Stock
multiplied by a fraction, the numerator of which is equal to the number of
shares represented by such Interest, and the denominator of which is equal to
the sum of the aggregate number of shares represented by all such Allowed
Interests and Allowed Subordinated Securities Claims, minus (z) the recoveries,
if any, received by such Interestholders from the Securities Actions, and (ii)
in the event that any Class of Impaired Claims or the Class of Trust Preferred
Obligations votes to reject the Plan, holders of Existing Common Stock shall not
be entitled to, and shall not receive or retain any property or interest in
property under the Plan on account of their Interests, provided, however, that,
subject to the Restructuring Transactions contemplated by the Plan, and pursuant
to Article 7.9 of the Plan, on the Effective Date, all Interests in the
Affiliate Debtors (other than the Trust Preferred Securities with respect to
Kmart Financing) shall be Reinstated, and shall not be counted for purposes of
calculating distributions under this Section.
(x) Class 12 (Other Interests).
Class 12 consists of all Other Interests. The phrase "Other Interest"
means all options, warrants, call rights, puts, awards, or other agreements to
acquire Existing Common Stock. On the Effective Date, all Other Interests shall
be deemed cancelled and the holders of Other Interests shall not receive or
retain any property on account of such Other Interests under the Plan.
C. MEANS FOR IMPLEMENTATION OF THE PLAN
1. Continued Corporate Existence
(a) The Debtors
Subject to the Restructuring Transactions contemplated by the Plan,
each of the Debtors will continue to exist after the Effective Date as a
separate corporate entity, with all the powers of a corporation under applicable
law in the jurisdiction in which each applicable Debtor is incorporated or
otherwise formed and pursuant to its certificate of incorporation and bylaws or
other organizational documents in effect prior to the Effective Date, except to
the extent such certificate of incorporation and bylaws or other organizational
documents are amended by the Plan, without prejudice to any right to terminate
such existence (whether by merger or otherwise) under applicable law after the
Effective Date.
(b) New Holding Company and New Operating Company
Subject to the Restructuring Transactions contemplated by the Plan, on,
or as soon as reasonably practicable after, the Effective Date, all appropriate
actions shall be taken consistent
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with the Plan to (i) form New Holding Company and New Operating Company pursuant
to their respective Articles of Incorporation and By-Laws, (ii) contribute or
transfer all of the assets of the Debtors, other than the Qualifying Real Estate
and the Trust Assets, to New Operating Company and/or such other Reorganized
Debtors or Affiliates as contemplated by the Restructuring Transactions and as
is necessary to effect the Exit Financing Facility, and (iii) issue all of the
New Operating Company Common Stock to New Holding Company. The Qualifying Real
Estate shall be treated as specified in Article 12.1 of the Plan, and the Trust
Assets shall be transferred to the Kmart Creditor Trust as specified in Article
11.2 of the Plan. As of the Effective Date, the Reorganized Debtors shall be
obligated to provide funds, as needed, to the Estates of those Debtors that hold
Qualifying Real Estate in an aggregate amount sufficient to pay Administrative
and Cure Claims of such Estates, including obligations contemplated by section
365 of the Bankruptcy Code, until such time as the Qualifying Real Estate has
been disposed of pursuant to Article 12.1 of the Plan and such Estates have been
fully administered.
(c) Non-Debtors
There are certain Affiliates of the Debtors that are not Debtors in
these Chapter 11 Cases. The continued existence, operation and ownership of such
non-Debtor Affiliates is a material component of the Debtors' businesses, and,
as set forth in Article 12.1 of the Plan, all of the Debtors' equity interests
and other property interests in such non-Debtor Affiliates shall revest in the
applicable Reorganized Debtor or its successor on the Effective Date.
2. Substantive Consolidation
The Plan provides for the substantive consolidation of the Estates, but
only for purposes of effectuating the settlements contemplated by, and making
distributions to holders of Claims under, the Plan, and not for voting purposes.
For such limited purposes, on the Effective Date, (a) all guaranties of any
Debtor of the payment, performance, or collection of another Debtor with respect
to any Class of Claims or Interests shall be deemed eliminated and cancelled;
(b) any obligation of any Debtor and all guaranties with respect to any Class of
Claims or Interests executed by one or more of the other Debtors and any joint
or several liability of any of the Debtors shall be treated as a single
obligation, and any obligation of two or more Debtors, and all multiple Impaired
Claims against Debtors on account of such joint obligations, shall be treated
and Allowed only as a single Claim against the consolidated Debtors; and (c)
each Claim filed in the Chapter 11 Cases of any Debtor shall be deemed filed
against the consolidated Debtors and shall be deemed a Claim against and an
obligation of the consolidated Debtors. Except as set forth in this Article,
such substantive consolidation will not (other than for purposes related to the
Plan) (a) affect the legal and corporate structures of the Debtors or
Reorganized Debtors, subject to the right of the Debtors or Reorganized Debtors
to effect the Restructuring Transactions contemplated by the Plan, (b) cause any
Debtor to be liable for any Claim or Interest under the Plan for which it
otherwise is not liable, and the liability of any Debtor for any such Claim or
Interest will not be affected by such substantive consolidation, (c) except as
otherwise stated in the Plan, affect Intercompany Claims of Debtors against
Debtors, and (d) affect Interests in the Affiliate Debtors except as otherwise
may be required in connection with the Restructuring Transactions contemplated
by the Plan. Notwithstanding anything herein to
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the contrary, the Debtors may elect in their sole and absolute discretion, at
any time through and until the Effective Date, to substantively consolidate the
Estates for additional purposes, including for voting purposes; provided,
however, that such further substantive consolidation does not alter the
treatment of the Prepetition Lenders, holders of Prepetition Note Claims, or
holders of Trade Vendor/Lease Rejection Claims called for by the Plan as filed
on February 25, 2003, and; provided, further, that nothing herein shall impair
the Plan Investors' rights under the Investment Agreement. Should the Debtors
make such election, the Debtors will not, nor will they be required to,
resolicit votes with respect to the Plan. Substantive consolidation shall not
alter the distributions set forth herein. In the event that the Debtors do elect
to substantively consolidate the Estates, the Disclosure Statement and the Plan
shall be deemed to be a motion requesting that the Bankruptcy Court approve such
substantive consolidation.
3. Restructuring Transactions
On or prior to the Effective Date, the Debtors and Reorganized Debtors
shall take such actions as may be necessary or appropriate to effect the
relevant Restructuring Transactions. The term "Restructuring Transactions" means
a dissolution or winding up of the corporate existence of a Debtor or the
consolidation, merger, contribution of assets, or other transaction in which a
Reorganized Debtor merges with or transfers substantially all of its assets and
liabilities to a Reorganized Debtor or their Affiliates, on or after the
Effective Date, as set forth in the Restructuring Transaction Notice. The
Restructuring Transactions contemplated by the Plan include, but are not limited
to, all of the transactions described in the Plan. Such actions may also
include: (a) the execution and delivery of appropriate agreements or other
documents of merger, consolidation or reorganization containing terms that are
consistent with the terms of the Plan and that satisfy the requirements of
applicable law; (b) the execution and delivery of appropriate instruments of
transfer, assignment, assumption or delegation of any property, right,
liability, duty or obligation on terms consistent with the terms of the Plan;
(c) the filing of appropriate certificates of incorporation, merger or
consolidation with the appropriate governmental authorities under applicable
law; and (d) all other actions that such Debtors and Reorganized Debtors
determine are necessary or appropriate, including the making of filings or
recordings in connection with the relevant Restructuring Transaction. The form
of each Restructuring Transaction shall be determined by the boards of directors
of a Debtor or Reorganized Debtor party to any Restructuring Transaction. In the
event a Restructuring Transaction is a merger transaction, upon the consummation
of such Restructuring Transaction, each party to such merger shall cease to
exist as a separate corporate entity and thereafter the surviving Reorganized
Debtor shall assume and perform the obligations of each Reorganized Debtor under
the Plan. In the event a Reorganized Debtor is liquidated, the Reorganized
Debtors (or the Reorganized Debtor which owned the stock of such liquidating
Debtor prior to such liquidation) shall assume and perform such obligations.
Implementation of the Restructuring Transactions shall not affect the
distributions under the Plan.
4. Articles of Incorporation and by-Laws
The Articles of Incorporation and Bylaws of New Holding Company and
each of the other Reorganized Debtors shall be adopted and amended as may be
required in order that they are consistent with the provisions of the Plan and
the Bankruptcy Code. The Articles of
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Incorporation of New Holding Company shall, among other things: (a) authorize
five-hundred million (500,000,000) shares of New Holding Company Common Stock,
$0.01 par value per share; (b) authorize twenty million (20,000,000) shares of
New Holding Company Preferred Stock for future issuance upon terms to be
designated from time to time by the board of directors of New Holding Company;
and (c) provide, pursuant to section 1123(a)(6) of the Bankruptcy Code, for (i)
a provision prohibiting the issuance of non-voting equity securities for a
period of two (2) years from the Effective Date and, if applicable, (ii) a
provision setting forth an appropriate distribution of voting power among
classes of equity securities possessing voting power, including, in the case of
any class of equity securities having a preference over another class of equity
securities with respect to dividends, adequate provisions for the election of
directors representing such preferred class in the event of default in the
payment of such dividends. The Articles of Incorporation (or Certificate of
Incorporation or other similar documents, as the case may be) and By-Laws of New
Holding Company, New Operating Company, and the other Reorganized Debtors are
attached to the Plan as Exhibit A, Exhibit B, and Exhibit C. Any modification to
the such articles or certificates of incorporation as originally filed may be
filed after the Confirmation Date and may become effective on or prior to the
Effective Date. Notwithstanding anything to the contrary in this Section, the
form and content of all Articles of Incorporation and By-Laws shall be
reasonably acceptable to the Creditors' Committees.
5. Directors and Officers of New Holding Company
(a) Officers
The existing senior officers of the Debtors in office on the Effective
Date shall serve in their current capacities after the Effective Date, subject
to their employment contracts as assumed by the Plan and subject to the
authority of the board of directors of the Reorganized Debtors.
(b) Directors of New Holding Company
On the Effective Date, the term of the current members of the board of
directors of Kmart will expire upon the designation by such board, and the
approval by the Bankruptcy Court, of the Responsible Officer. The initial board
of directors of New Holding Company, whose term will commence upon the Effective
Date, shall consist of nine members. One member of senior management of the
Reorganized Debtors will serve on the initial board of directors of New Holding
Company. Other board members shall include (i) four directors selected by the
Plan Investors, at least one of whom shall not be an officer or employee of any
of the Plan Investors or a family member of any of the foregoing, (ii) two
directors selected by the Unsecured Creditors' Committee, and (iii) two
directors selected by the Financial Institutions' Committee, neither of which
shall be an officer or employee of ESL Investments, Inc. or a family member
thereof; provided that the board of directors, collectively, including any
required committee thereof, shall comply with any other qualification,
experience, and independence requirements under applicable law, including the
Sarbanes-Oxley Act of 2002 and the rules then in effect of the stock exchange or
quotation system (including the benefit of any transition periods available
under applicable law) on which the New Holding Company Common Stock is listed or
is
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anticipated to be listed, when such Stock is listed. The Persons responsible for
designating board members shall designate their board members by written notice
filed with the Bankruptcy Court by a date that is at least seven days prior to
the Voting Deadline, provided, however, that if they fail to file and give such
notice, the Debtors will initially designate such members by announcing their
identities at the Confirmation Hearing. Directors of New Holding Company
appointed in accordance with this Article shall serve an initial term for a
period from the Effective Date through the date of the second annual meeting
after the Effective Date. Thereafter, and subject to New Holding Company's
rights to amend its bylaws, directors shall serve one (1) year terms (with such
subsequent terms subject to election by shareholder vote) with each such term
expiring at the conclusion of the next annual meeting of shareholders. In the
event, prior to the Effective Date, a person designated to be a member of New
Holding Company's board of directors dies, is disabled, or otherwise becomes
unable to fulfill the role, the Person designating such member will designate a
replacement for such director. In the event, after the Effective Date and prior
to the second annual meeting that occurs after the Effective Date, of the death,
disability, resignation, or removal of a member of the board of directors, the
directors designated by the Person who designated the director whose vacancy is
sought to be filled will designate a replacement for such director, which
replacement will be reasonably satisfactory to New Holding Company.
6. Directors and Officers of Affiliate Debtors
The existing directors and officers of the Affiliate Debtors shall
continue to serve in their current capacities after the Effective Date,
provided, however that the Debtors reserve the right to identify new officers
and members of the board of directors of each of such Affiliate Debtors at any
time prior to the Confirmation Hearing, and provided further that New Holding
Company reserves the right to identify new officers and members of the board of
directors of each such Affiliate Debtor at any time thereafter.
7. Employment, Retirement, Indemnification, and Other Agreements
and Incentive Compensation Programs
To the extent that any of the Debtors have in place as of the Effective
Date employment, retirement, indemnification and other agreements with their
respective active directors, officers and employees who will continue in such
capacities (or similar capacities) after the Effective Date, or retirement
income plans, welfare benefit plans and other plans for such Persons, such
agreements, programs and plans shall remain in place after the Effective Date,
and the Reorganized Debtors will continue to honor such agreements, programs,
and plans. Such agreements and plans may include equity, bonus, and other
incentive plans in which officers and other employees of the Reorganized Debtors
may be eligible to participate; provided, however, that pursuant to the
Management Compensation Plan, there may be reserved for certain members of
management, directors, and other employees of the Reorganized Debtors up to 10%
of the shares of New Holding Company Common Stock, exclusive of any shares
offered as incentive compensation in any employment agreement of any officer
that is to be assumed pursuant to Article VIII of the Plan, and other securities
and other components of compensation to be paid to management after the
Effective Date; and provided further that the Debtors' existing deferred
compensation plans shall be terminated and the funds held pursuant
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thereto shall be distributed to the respective account holders other than any
account holder who the Trustee has identified as a potential defendant in any
Cause of Action arising out of the Trust Claims, in which case the funds of such
account holder shall be held in escrow by the Kmart Creditor's Trust pending
resolution of any Trust Claims against such account holder. After the Effective
Date, the Reorganized Debtors shall each have the authority, consistent with the
applicable agreements, to terminate, amend or enter into employment, retirement,
indemnification and other agreements with their respective active directors,
officers and employees and to terminate, amend or implement retirement income
plans, welfare benefit plans and other plans for active employees.
8. Issuance of New Holding Company Common Stock
(a) New Holding Company Common Stock
On the Effective Date, New Holding Company will authorize up to five
hundred million (500,000,000) shares of New Holding Company Common Stock. On or
before the Distribution Date, New Holding Company will be deemed to have issued
shares of New Holding Company Common Stock for distribution as follows: (i) the
Total Investor Shares to the Plan Investors in accordance with the Investment
Agreement and (ii) the Prepetition Noteholder Shares and the Trade Vendor/Lease
Rejection Claimholder Shares to holders of Allowed Prepetition Note Claims and
Allowed Trade Vendor/Lease Rejection Claims, respectively, as set forth in
Article V of the Plan. The issuance of the New Holding Company Common Stock and
the distribution thereof as described above will be in compliance with
applicable registration requirements or exempt from registration under
applicable securities laws pursuant to section 1145(a) of the Bankruptcy Code or
Section 4(2) of the Securities Act
(b) New Holding Company Preferred Stock
On the Effective Date, New Holding Company will authorize twenty
million (20,000,000) shares of New Holding Company Preferred Stock for future
issuance upon terms to be designated from time to time by the board of directors
of New Holding Company following the Effective Date. No shares of preferred
stock shall be issued pursuant to the Plan. The Certificates of Incorporation
and By-Laws of New Holding Company shall prohibit issuance of the New Holding
Company Preferred Stock earlier than six (6) months subsequent to the Effective
Date, and in any case only upon approval by a 2/3 majority of the board of
directors of New Holding Company.
(c) Registration Rights Agreement
Without limiting the effect of section 1145 of the Bankruptcy Code, as
of the Effective Date, New Holding Company will enter into a Registration Rights
Agreement with the Plan Investors.
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(d) Listing on Securities Exchange or Quotation System
New Holding Company will use its best efforts to list, as promptly as
practicable after the Effective Date, the New Holding Company Common Stock on a
national securities exchange or for quotation on a national automated
interdealer quotation system but will have no liability if it is unable to do
so. Persons receiving distributions of New Holding Company Common Stock, by
accepting such distributions, will have agreed to cooperate with New Holding
Company's reasonable requests to assist New Holding Company in its efforts to
list the New Holding Company Common Stock on a national securities exchange or
quotation system.
9. Reinstatement of Common Stock of Affiliate Debtors
Subject to the Restructuring Transactions, Interests in the Affiliate
Debtors (other than the Trust Preferred Securities with respect to Kmart
Financing) shall be Reinstated in exchange for New Holding Company's agreement
to cause the distribution of New Holding Company Common Stock and other
consideration provided for under the Plan to holders of Allowed Claims in
accordance with the terms of the Plan.
10. Cancellation of Existing Securities and Agreements
On the Effective Date, except as otherwise specifically provided for
herein, (a) the Existing Securities and any other note, bond, indenture, or
other instrument or document evidencing or creating any indebtedness or
obligation of or ownership interest in the Debtors, except such notes or other
instruments evidencing indebtedness or obligations of the Debtors that are
Reinstated under the Plan, will be cancelled, and (b) the obligations of, Claims
against, and/or Interests in the Debtors under, relating, or pertaining to any
agreements, indentures, certificates of designation, bylaws, or certificate or
articles of incorporation or similar documents governing the Existing Securities
and any other note, bond, indenture, or other instrument or document evidencing
or creating any indebtedness or obligation of the Debtors, except such notes or
other instruments evidencing indebtedness or obligations of the Debtors that are
Reinstated under the Plan, as the case may be, will be released and discharged;
provided, however, that any agreement that governs the rights of the Claimholder
and that is administered by an indenture trustee, an agent, or a servicer (each
hereinafter referred to as a "Servicer") will continue in effect solely for
purposes of (i) allowing such Servicer to make the distributions to be made on
account of such Claims under the Plan as provided in Article IX of the Plan and
(ii) permitting such Servicer to maintain any rights or liens it may have for
fees, costs, and expenses under such Indenture or other agreement; provided,
further, that the preceding proviso will not affect the discharge of Claims
against or Interests in the Debtors under the Bankruptcy Code, the Confirmation
Order, or the Plan, or result in any expense or liability to the Reorganized
Debtors. The Reorganized Debtors will not have any obligations to any Servicer
(or to any Disbursing Agent replacing such Servicer) for any fees, costs, or
expenses except as expressly provided in Article 9.5 of the Plan; provided,
however, that nothing herein will preclude any Servicer (or any Disbursing Agent
replacing such Servicer) from being paid or reimbursed for prepetition or
postpetition fees, costs, and expenses from the distributions being made by such
Servicer (or any Disbursing Agent replacing such Servicer) pursuant to such
agreement in accordance with the provisions set forth therein, all without
application to or approval by the Bankruptcy Court.
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11. Plan Investor Contributions/Limitations on Stock Transfers
Pursuant to the terms and conditions of the Investment Agreement, the
Plan Investors shall pay to the Debtors Cash in an amount equal to (i) Cash that
the Plan Investors are entitled to receive under the Plan on account of their
Prepetition Lender Claims as contemplated by, and subject to the terms and
conditions of, the Investment Agreement plus (ii) no less than $140 million (to
be utilized exclusively by the Reorganized Debtors to make distributions to
Allowed Prepetition Lender Claimholders pursuant to Article 5.3 of the Plan), in
exchange for which the Plan Investors shall receive the Total Investor Shares
and, in certain circumstances, a convertible note as provided in the Investment
Agreement. The rights of ESL to transfer its holdings of New Holding Company
Common Stock shall be restricted pursuant to the terms and conditions of the
Investment Agreement.
12. Post-Effective Date Financing
An integral aspect of the Debtors' emergence plan is a new, exit
financing facility designed to fund certain payments under the Debtors'
restructuring plan and to provide working capital to the reorganized enterprise.
In order to obtain such a facility, the Debtors, with the assistance of their
investment banker and financial advisor, Miller Buckfire Lewis, approached
several major financial institutions and solicited commitments for a $2 billion
exit financing facility upon terms acceptable to the Debtors and their creditor
constituencies. The Debtors obtained proposals from a number of such
institutions and devoted considerable time negotiating with the proponents about
the various proposed lending terms.
This process spanned several weeks during which the Debtors narrowed
the field of acceptable proposals. The process also was exceptionally
time-consuming and entailed intense discussions, all of which were at arms'
length and in good faith. After considering the various alternatives, the
Debtors, with the assistance of their advisors, determined to proceed with the
an exit financing proposal submitted by General Electric Capital Corporation
("GE Capital"), GECC Capital Markets Group, Inc., Fleet Retail Finance, Inc.,
Fleet Securities, Inc., Bank of America, N.A., and Banc of America Securities,
LLC (collectively, the "Exit Lenders") as containing the highest and best exit
financing terms available, consistent with the Debtors' anticipated working
capital and other needs as they emerge from Chapter 11.
To this end, on January 13, 2003, Kmart entered into a commitment
letter, a copy of which is attached to the Plan as Exhibit D-2 (the "Commitment
Letter") with the Exit Lenders for a senior secured revolving credit facility in
the amount of up to $2 billion (the "Exit Financing Facility") to be utilized by
the Reorganized Debtors to repay the DIP Facility Claims, make other payments
required to be made on the Effective Date, and conduct their post-reorganization
operations. On January 14, 2003, the Debtors filed a motion requesting authority
to accept the Commitment Letter and to pay certain fees, deposits, and other
expenses in connection therewith. On January 28, 2003, the Bankruptcy Court
entered an order granting the requested relief. The material terms of the Exit
Financing Facility are as follows:
Amount: $2,000,000,000 (including a letter of credit
sub-facility of up to $800,000,000 and a
swingline facility in an amount to be
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determined) or such lesser amount as the
Debtors may elect prior to the closing date.
A portion of the facility in an amount not
to exceed $200,000,000 may take the form of
a synthetic term loan facility using
credit-linked deposits.
Term: Thirty-six (36) months.
Availability: The lesser of (1) $2,000,000,000 and (2) the
sum of (a) the lesser of (i) 65% of the
Reorganized Debtors' gross eligible
inventory valued at the lower of cost (FIFO)
or market or (ii) 80% of the appraised net
going out of business value of the
Reorganized Debtors' gross inventory and (b)
the lesser of (i) 50% of the Reorganized
Debtors' eligible in-transit inventory
covered by letters of credit valued at the
lower of cost (FIFO) or market or (ii) 60%
of the appraised net going out of business
value of the Reorganized Debtors' gross
in-transit inventory covered by letters of
credit under the letter of credit
subfacility.
Use of Proceeds: Loans made at closing (the "Closing Date")
would be used to repay certain post-petition
secured indebtedness on the effective date,
to otherwise enable the Debtors to
consummate the plan of reorganization on the
effective date and to fund certain fees and
expenses associated with the financing.
Loans made after the Closing Date would be
used for the Reorganized Debtors' working
capital and other general corporate
purposes, including permitted capital
expenditures.
Interest: For all loans, at the Reorganized Debtors'
option, either (i) absent an event of
default, 1, 2, 3 or 6-month reserve-adjusted
LIBOR plus the applicable margin or (ii)
floating at the index rate (higher of prime
or 50 basis points over Fed Funds) plus the
applicable margin. The applicable margins
shall be per annum rates as set forth below:
Applicable Revolver Index Margin 2.50%
Applicable Revolver LIBOR Margin 3.50%
Applicable L/C Margin 3.50%
Fees: In addition to the fees payable to the
administrative agent (on behalf of itself
and the other Exit Lenders) as specified in
the Fee Letter (defined below), the
following fees would be payable to the
administrative agent under the financing
documentation:
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Unused facility fee equal to 0.50% per
annum (calculated on the basis of a
360-day year and actual days elapsed) on
the average unused daily balance of the
revolver, payable monthly in arrears.
Letter of credit fee equal to the
Applicable L/C Margin (calculated on the
basis of a 360-day year and actual days
elapsed) on the face amount of the
letters of credit, plus a fronting fee
of 0.25%, payable monthly in arrears,
plus any reasonable costs and expenses
incurred by the administrative agent in
arranging for the issuance or guaranty
of letters of credit not issued by an
Exit Lender plus any charges assessed by
the issuing bank.
Default Rates: Default interest and letter of credit fee at
2% above the rate otherwise applicable shall
accrue during the continuance of (i) any
payment or bankruptcy event of default or
(ii) any other event of default if the
administrative agent or the requisite
lenders have given the borrower written
notice during the continuance of such event
of default that the default rates shall
apply.
Security: To secure the financing and all obligations
of the Debtors in connection therewith, GE
Capital, as the administrative agent for
itself and for the ratable benefit of all
lenders, would receive a fully perfected
first priority security interest in all of
the following property, whether now existing
or hereafter arising, of the Reorganized
Debtors who are borrower(s) and guarantor(s)
(the "Collateral"): (a) all inventory of any
kind wherever located other than inventory
consigned to the borrower or any guarantor
("Inventory"); (b) all documents of title
for any Inventory; (c) all claims and causes
of action in any way relating to any of the
Inventory; (d) all bank accounts into which
any proceeds of Inventory are deposited
(including all cash and other funds on
deposit therein, but provided that the
administrative agent will not seeks to
perfect its security interest in local
depository accounts through control
agreements); (e) all books and records
relating to any of the foregoing; (f) all
general intangibles (other than intellectual
property, except to the extent of software
which is necessary or advisable, in the
administrative agent's opinion, to monitor,
sell or otherwise deal with the Collateral)
in any way related to any of the Inventory,
(g) to the extent not prohibited by
applicable law, customer scripts, including,
without limitation, customer prescription
lists relating to the pharmaceutical
inventory, (h) accounts receivable
constituting
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credit card receivables, and (i) all
substitutions, replacements, accessions,
products or proceeds (including, without
limitation, insurance proceeds and proceeds
constituting accounts receivable) of any of
the foregoing.
Syndication: The co-arrangers of the Exit Financing
Facility will initiate discussions with
potential lenders relating to the
syndication of the financing. It is
expressly understood by the Debtors that the
Exit Lenders, through the co-arrangers,
intend to syndicate the financing to allow
the Lenders to sell down the financing to
their respective desired hold positions. The
Debtors will agree to a syndication
timetable that allows for the primary
syndication of the financing prior to the
Closing Date. Notwithstanding anything
contained in this paragraph, but assuming
the Debtors' compliance with the terms
hereof,, the success of the syndication will
not be a condition precedent to the closing
of the financing. Interest rates, certain
fees and certain other terms of the
financing are subject to increase or other
change on the terms and conditions set forth
in the Syndication Letter (defined below)
relating to the Exit Lenders' efforts to
syndicate the exit financing facility.
As is customary of exit financing commitments, including those offered
by the institutions that the Debtors approached, GE Capital required payment of
an underwriting deposit in the amount of $500,000 so that it could begin due
diligence and a field audit (the "Underwriting Deposit"). The Debtors determined
that the amount of the Underwriting Deposit was fair, reasonable and typical for
financings of this nature. The Bankruptcy Court authorized the Debtors' payment
of the Underwriting Deposit on January 28, 2003.
Under the Commitment Letter, the Debtors further agreed to pay to each
Exit Lender and the co-lead arrangers of the facility, regardless of whether the
commitment is terminated or the financing closes, (i) a commitment fee as
required by a separate fee letter (the "Fee Letter"); (ii) all out-of-pocket
expenses which may be incurred by the Lenders in connection with the financing
(including all reasonable legal costs and fees incurred in the preparation of
the Commitment Letter, the Fee Letter, a separate letter regarding syndication
of the Exit Financing Facility (the "Syndication Letter"), and related matters)
and evaluation of and documentation of the financing; (ii) all out-of-pocket
appraisal costs and expenses; and (iv) a field examination fee of $750 per
person per day plus out-of-pocket expenses in connection with the conduct of GE
Capital's field audit. As with the Underwriting Deposit, the Debtors determined
that the commitment fee and other payment obligations are fair, reasonable, and
typical of financings of this nature. The Bankruptcy Court authorized the
Debtors' payment of these amounts in accordance with the Commitment Letter, Fee
Letter, and Syndication Letter on January 28, 2003.
Pursuant to the Bankruptcy Court's order authorizing the foregoing
transactions, GE Capital's right to receive reimbursement of all costs and
expenses incurred in connection with
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the financing, including those contemplated by the Fee Letter and the
Syndication Letter, shall be secured by and payable with the Underwriting
Deposit, and each Exit Lender's rights to receive the fees, deposits, and
reimbursement of costs and expenses incurred in connection with the financing,
including those contemplated by the Fee Letter and the Syndication Letter, shall
be entitled to priority as an administrative claim under Section 503(b)(1) of
the Bankruptcy Code and shall be payable upon demand by such Lender without any
further order of the Bankruptcy Court, whether or not the financing closes.
The Plan will authorize the Reorganized Debtors to enter into all
documents necessary and appropriate in connection with the Exit Financing
Facility. The principal documents with respect to such Facility shall be filed
by the Debtors with the Bankruptcy Court no later than the Exhibit Filing Date
and will be deemed attached to the Plan as Exhibit D-1. In the Confirmation
Order, the Bankruptcy Court shall approve the terms of the Exit Financing
Facility in substantially the form filed with the Bankruptcy Court (and with
such changes as to which the applicable Debtors and respective agents and
lenders parties thereto may agree) and authorize the applicable Reorganized
Debtors to execute the same together with such other documents as the applicable
Reorganized Debtors and the applicable lenders may reasonably require in order
to effectuate the treatment afforded to such parties under the Exit Financing
Facility.
13. Trade Vendors' Lien Program
On the Effective Date, the Reorganized Debtors shall grant to certain
vendors who provide retail merchandise to the Reorganized Debtors on credit
after the Effective Date, or who have provided merchandise to the Debtors after
the Petition Date and before the Effective Date on credit which is not paid for
as of the Effective Date, a Trade Vendors' Lien pursuant to the terms attached
to the Plan as Exhibit J-2 (and described in Exhibit J-1 to the Plan). Each
person or entity issuing securities under the Plan, any entity acquiring
property under the Plan, and any creditor and/or equity security holder of the
Debtors or Reorganized Debtors, shall be deemed to contractually subordinate any
present or future claim, right, or other interest it may have in and to any
proceeds received from the disposition, release, or liquidation of any real
properties subject to the Trade Vendors' Lien, to the claims of the parties
secured by the Trade Vendors' Lien; provided, however, that in no case shall the
lenders under the Exit Financing Facility be deemed subordinated in this regard;
and provided, further, that so long as the Trade Vendors' Lien has not been
terminated or has not expired, (i) neither the Debtors nor the Reorganized
Debtors may encumber, sell, lease, transfer or otherwise dispose of or take
other action to impair the subordination granted hereby with respect to more
than 20% in fair market value of the leases subject to this Section, and (ii)
any loan or investment by the Plan Investors will be subject to the
subordination set forth in this provision (except with respect to any loan or
investment to the extent that the amount of such loan or investment plus the
amount of all other investments made by the Plan Investors pursuant to the
Investment Agreement exceeds $280 million (giving credit for and including in
the calculation all investments and loans made by the Plan Investors or loans or
investments made by third parties and guaranteed by the Plan Investors, but
excluding the value of any Class 3, Class 4 and Class 5 claims which the Plan
Investors may hold)). Such contractual subordination shall terminate upon
termination or expiration of the Trade Vendors' Lien.
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14. Preservation of Causes of Action and Waiver of Avoidance
Claims
In accordance with section 1123(b)(3) of the Bankruptcy Code and except
as otherwise provided in the Plan with respect to the Kmart Creditor Trust, the
Reorganized Debtors will retain and may (but are not required to) enforce all
Retained Actions, except that the Debtors shall and do hereby waive all
Avoidance Claims as of the Effective Date; provided, however, that such waiver
does not include Avoidance Claims against Persons who are parties to Causes of
Action involving the Debtors pending on the Effective Date, nor does it include
Causes of Action against any Persons who may be the subject, at any time, of
Trust Claims. The phrase "Trust Claims" means any and all Causes of Action
against any Person or entity arising from, in connection with, or relating to
the subject matters of the Investigations which, for purposes hereof, means the
Accounting and Stewardship Investigations, including all matters authorized by
order entered by the Bankruptcy Court on September 4, 2002 approving the
participation, on a joint interest basis, of the Statutory Committees in said
Investigations, and including all matters arising from, in connection with, or
relating to the subject matter of responses to the Government Inquiries.
The Debtors or the Reorganized Debtors, in their sole and absolute
discretion, will determine whether to bring, settle, release, compromise, or
enforce such Retained Actions (or decline to do any of the foregoing), and will
not be required to seek further approval of the Bankruptcy Court for such
action. The Reorganized Debtors or any successors may pursue such litigation
claims in accordance with the best interests of the Reorganized Debtors or any
successors holding such rights of action.
In connection with the Debtors' waiver of Avoidance Claims other than
Trust Claims, the Debtors prepared an analysis of the estimated projected
recoveries on account of potential preference claims under Section 547 of the
Bankruptcy Code. As a general matter, a "preference" under the Bankruptcy Code
is a payment made by a debtor to a creditor within the 90 days prior to the
petition date if the payment is on account of a pre-existing debt owed by the
debtor to such creditor. A company as large as Kmart, with pre-petition annual
sales of almost $37 billion, over 200,000 employees, and relationships with over
4,000 merchandise vendors, can be expected to make a very large number of
payments within the 90-day preference period. For instance, Kmart made over $1
billion in payments to Fleming, at the time Kmart's largest supplier. Kmart also
made over $422 million in payments on account of taxes; over $410 million in
real estate lease payments; over $8.3 billion in intercompany transfers among
Kmart affiliates; over $2.2 billion in payments to the Prepetition Lenders on
account of revolver borrowings and loan paydowns; over $106 million in interest
on account of the Prepetition Notes; over $248 million to Kmart's joint venture
partner that operates the footwear departments in Kmart stores; and over $108
million in employee benefit payments (not including payroll). None of these
amounts include payments made to trade vendors and service providers.
Under the Bankruptcy Code, a debtor may attempt to recover such
"preferential transfers" by bringing suit against those vendors, suppliers,
lenders, and other creditors who received payment. However, the Bankruptcy Code
affords such persons a number of defenses to a preference suit. For instance, a
vendor that supplies a debtor with additional goods, but does not receive
payment for such goods, may in certain circumstances credit the unpaid value of
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such goods against any preference claim that the debtor may have. Such credit is
called "new value." Thus, as a general matter, a creditor that provides a debtor
with "new value" after the creditor has received a payment from the debtor,
which "new value" remains unpaid as of the petition date, can deduct the amount
of the "new value" from the previous preferential transfer. Similarly, payments
made by a debtor on account of goods and services acquired in the ordinary
course of the debtor's business, and paid in accordance with the ordinary course
of the debtor's and the creditor's business relationship and according to
ordinary terms in the parties' business, may be exempt from recovery by a debtor
under the preference statutes. This so-called "ordinary course" defense is
designed to protect vendors who continue to provide goods and services to a
debtor in the ordinary course of business, and who are paid in the ordinary
course of business. However, creditors whose payment terms vary - for instance,
if they are paid more quickly than was historically the case - may be precluded
from taking advantage of the "ordinary course" defense.
The Debtors identified all transfers made by them to all persons within
the 90-day preference period. Based upon this analysis, the Debtors identified
approximately $6 billion in preferential payments that could be subject to
recovery under the Bankruptcy Code. This amount does not include certain other
payments that could potentially qualify as preferential transfers. Specifically,
this amount was derived from a review of only those payments made to trade
vendors and service providers, and was not based on a review of certain other
payments in the categories identified above. Of the $6 billion in payments
identified by the Debtors, the Debtors determined that the creditors receiving
such payments could assert up to approximately $1.86 billion in "new value" that
they provided to the Debtors, and that they therefore could conceivably offset
such new value against the $6 billion in aggregate payments made to them by the
Debtors. Additionally, the Debtors determined that there is a risk that certain
of such creditors could successfully assert that as much as approximately $2.18
billion of the remaining payments of $4.14 billion were made in the "ordinary
course." However, the "ordinary course" defense requires a very fact-intensive
analysis, including calculation of the average days payable outstanding with
respect to each creditor and all creditors as a whole. Application of the
"ordinary course" defense therefore is subject to a number of uncertainties and
litigation risks, plus costs associated with filing complaints and prosecuting
preference actions against individual preference recipients. Moreover, it is
probable that the aggregate amount of ordinary course of business defenses
asserted by recipients of prepetition payments will exceed the number estimated
by the Debtors and/or certain defendants may challenge whether the Debtors were
insolvent at the time the alleged preferential payments were made.
After applying the estimated costs of litigation to the potential
preference actions, and after considering the risks of pursuing such litigation
against preference defendants, the Debtors estimate that the potential recovery
with respect to the payments that are net of possible "new value" and "ordinary
course" defenses is between 12% to 21%, or between $240 million and $405 million
in the aggregate, of the total potential preferential payments assuming the
Debtors' estimates with respect to potential defenses are correct. The Debtors
have assumed that in a liquidation under Chapter 7 of the Bankruptcy Code, a
Chapter 7 trustee would pursue such actions. This range of estimates therefore
has been included in the Liquidation Analysis attached to this Disclosure
Statement as Appendix B.
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As part of the global settlement contemplated by the Plan among
representatives of the Prepetition Lenders, holders of Prepetition Notes, and
holders of Trade Vendor/Lease Rejection Claims, the Debtors have agreed to waive
all Avoidance Claims as of the Effective Date. Such waiver does not include
Causes of Action pending on the Effective Date, nor does it include Causes of
Action against any Persons who may be the subject, at any time, of Trust Claims.
Although such waiver entails the release of the value of potential preference
recoveries, the Debtors believe that the reorganized business will derive more
value in the form of, among other things, go-forward credit support from trade
vendors and service providers, than if the Debtors retained and prosecuted
Avoidance Claims. This go-forward value inures to the benefit of all creditors
under the Plan insofar as solid trade credit support will assist in improving
cash flow and cementing business relationships which enhance the value of the
reorganized enterprise as a whole. The Debtors therefore believe that waiver of
the Avoidance Claims is in the collective best interests of all stakeholders.
In further support of the Debtors' business determination to waive such
Avoidance Claims, and in support of their determination that the value afforded
creditors under the Plan is greater than the estimated value to the creditors
under Chapter 7 of the Bankruptcy Code, including estimated recoveries on
Avoidance Claims, the Liquidation Analysis attached hereto as Appendix B
provides that, in the event the status quo is maintained - i.e., in the event
that the separate corporate identities of each Debtor is maintained and that the
estates therefore are not substantively consolidated - then the estimated total
recovery, including on account of Avoidance Claims, to holders of Prepetition
Note Claims would be between 0% and 2%, which is significantly less than the
14.4% in estimated value to be afforded such holders under the Plan. Similarly,
holders of Trade Vendor/Lease Rejection Claims are estimated to receive between
1% and 2% of their claims in a de-consolidated liquidation under Chapter 7,
which is significantly less than the 9.7% in estimated value to be afforded such
holders under the Plan.
The Debtors estimate that in a liquidation, total unsecured claims
could be between $11.7 billion and $18.2 billion. These amounts vastly exceed
the estimates of claims that the Debtors believe will become allowed under the
Plan in part because, in a liquidation, the Debtors would reject all of their
contracts and leases, thereby giving rise to significant rejection claims that
will be avoided under the Plan. Given the magnitude of estimated claims in a
liquidation, recoveries to holders of Prepetition Note Claims and Trade
Vendor/Lease Rejection Claims would not be materially enhanced unless the
estimated recovery on account of preference actions were increased by a very
significant amount. However, given the risks and costs involved in preference
litigation, there is no assurance that a Chapter 7 trustee could recover enough
in extra preference value to compensate creditors for the delays inherent in
Chapter 7 and in amounts that would exceed the estimated value for creditors
under the Plan.
As pointed out above, actual recoveries on preference actions are
difficult to estimate. The outcome of any particular preference action against a
preference defendant is not free from doubt. Recoveries in actual preference
litigation therefore could be materially higher or lower than the estimates
prepared by the Debtors. However the potential value of any such recoveries to
creditors if these Chapter 11 Cases were converted to Chapter 7 liquidations
could be significantly impacted by litigation over the substantive consolidation
of these estates that may ensue insofar as the global settlements contemplated
by the Plan will not become effective.
105
Such litigation could lead to significant delays in distributions to unsecured
creditors. Moreover, Chapter 7 leads to other inherent delays occasioned by the
limitations on a Chapter 7 trustee's ability to make interim distributions
before each and every claim is finally determined.
For all of the foregoing reasons, the Debtors believe that the
component of the global settlement contemplated by the Plan that entails waiver
of certain Avoidance Claims affords creditors greater recoveries of more certain
value than the estimated value available in a de-consolidated scenario under
Chapter 7 of the Bankruptcy Code
15. Corporate Action
Each of the matters provided for under the Plan involving the corporate
structure of any Debtor or Reorganized Debtor or corporate action to be taken by
or required of any Debtor or Reorganized Debtor shall, as of the Effective Date,
be deemed to have occurred and be effective as provided herein, and shall be
authorized, approved and, to the extent taken prior to the Effective Date,
ratified in all respects without any requirement of further action by
stockholders, creditors, or directors of any of the Debtors or the Reorganized
Debtors, provided, however, that nothing herein shall impair the Debtors' or
Plan Investors' rights under the Investment Agreement.
16. Effectuating Documents; Further Transactions
Each of the President and Chief Executive Officer, Chief Financial
Officer, Chief Restructuring Officer, and General Counsel of the Debtors, or
their respective designees, will be authorized to execute, deliver, file, or
record such contracts, instruments, releases, indentures, and other agreements
or documents, and take such actions as may be necessary or appropriate to
effectuate and further evidence the terms and conditions of the Plan or to
otherwise comply with applicable law. The secretary or assistant secretary of
the Debtors will be authorized to certify or attest to any of the foregoing
actions.
17. Exemption from Certain Transfer Taxes and Recording Fees
Pursuant to section 1146(c) of the Bankruptcy Code, any transfers from
a Debtor to a Reorganized Debtor or to any other Person or entity pursuant to
the Plan, or any agreement regarding the transfer of title to or ownership of
any of the Debtors' real or personal property will not be subject to any
document recording tax, stamp tax, conveyance fee, intangibles or similar tax,
mortgage tax, stamp act, real estate transfer tax, mortgage recording tax,
Uniform Commercial Code filing or recording fee, or other similar tax or
governmental assessment, and the Confirmation Order will direct the appropriate
state or local governmental officials or agents to forego the collection of any
such tax or governmental assessment and to accept for filing and recordation any
of the foregoing instruments or other documents without the payment of any such
tax or governmental assessment.
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D. UNEXPIRED LEASES AND EXECUTORY CONTRACTS
1. Assumed and Rejected Leases and Contracts
(a) Intercompany Executory Contracts and Unexpired Leases
Except as otherwise provided in Article 8.1(a), of the Plan, each
Intercompany Executory Contract and Intercompany Unexpired Lease to which the
Debtors are a party shall be deemed automatically assumed in accordance with the
provisions and requirements of sections 365 and 1123 of the Bankruptcy Code as
of the Effective Date, unless such Intercompany Executory Contract or
Intercompany Unexpired Lease (i) shall have been previously rejected by the
Debtors by order of the Bankruptcy Court, (ii) is the subject of a motion to
reject pending on or before the Effective Date, (iii) is listed on the schedule
of rejected Intercompany Executory Contracts and Intercompany Unexpired Leases
annexed to the Plan as Exhibit L-1, or (iv) is otherwise rejected pursuant to
the terms of the Plan. Entry of the Confirmation Order by the Bankruptcy Court
shall constitute approval of such assumptions and rejections pursuant to
sections 365 and 1123 of the Bankruptcy Code as of the Effective Date. Any claim
held by any Debtor on account of any Intercompany Executory Contract or
Intercompany Unexpired Lease that is assumed pursuant to this Section shall
either be (a) Reinstated, in full or in part, or (b) discharged and satisfied,
in full or in part. At the option of the Debtors or the Reorganized Debtors,
each Intercompany Executory Contract and Intercompany Unexpired Lease assumed
pursuant to this Section shall vest in and be fully enforceable by the
applicable Reorganized Debtor in accordance with its terms, except as modified
by the provisions of the Plan or any order of the Bankruptcy Court authorizing
or providing for its assumption or applicable federal law. The Debtors reserve
the right to file a motion on or before the Confirmation Date to assume or
reject any Intercompany Executory Contract or Intercompany Unexpired Lease.
(b) Employee-Related Agreements
Subject to Article 7.7 of the Plan, each Employee-Related Agreement as
to which any of the Debtors is a party shall be deemed automatically rejected in
accordance with the provisions and requirements of sections 365 and 1123 of the
Bankruptcy Code as of the Effective Date, unless such Employee-Related Agreement
(i) shall have been previously assumed by the Debtors by order of the Bankruptcy
Court, (ii) is the subject of a motion to assume pending on or before the
Effective Date, (iii) is listed on the schedule of assumed Employee-Related
Agreements annexed as Exhibit L-2 to the Plan or (iv) is otherwise assumed
pursuant to the terms of the Plan. Entry of the Confirmation Order by the
Bankruptcy Court shall constitute approval of the rejections and assumptions
contemplated hereby pursuant to sections 365 and 1123 of the Bankruptcy Code as
of the Effective Date. Notwithstanding the foregoing, all collective bargaining
agreements, as modified and/or amended from time to time, shall be deemed
automatically assumed in accordance with the provisions and requirements of
sections 365 and 1123 of the Bankruptcy Code as of the Effective Date. The
assumption of the collective bargaining agreements and the cure of all amounts
owed under such agreements in the ordinary course by the Reorganized Debtors
shall be in full satisfaction of all Claims and Interests arising under all
previous collective bargaining agreements between the parties thereto or their
predecessors-in-interest. Upon assumption, all proofs of claim filed by the
Debtors' unions will be deemed withdrawn, without prejudice to their pursuit in
the ordinary course by the unions and/or individuals and payment or satisfaction
in the ordinary course by the Reorganized
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Debtors of obligations under the assumed collective bargaining agreements. Each
Employee-Related Agreement assumed pursuant to this section shall vest in and
be fully enforceable by the applicable Reorganized Debtor in accordance with its
terms, except as modified by the provisions of the Plan, or any order of the
Bankruptcy Court authorizing or providing for its assumption or applicable
federal law. The Debtors reserve the right to file a motion on or before the
Confirmation Date to assume or reject any Employee-Related Agreement.
(c) Other Executory Contracts or Unexpired Leases
Except as otherwise provided in this Section, each Other Executory
Contract or Unexpired Lease as to which any of the Debtors is a party
(including, but not limited to, (x) any guaranties by any of the Debtors with
respect to real estate leases of former subsidiaries and businesses of any of
such Debtors, (y) any obligations under leases assigned by the Debtors prior to
the Petition Date (or agreements guarantying the payment of rent or performance
thereunder), and (z) those certain Lease Guaranty, Indemnification and
Reimbursement Agreements dated as of November 23, 1994, November 9, 1994, and
May 24, 1995) shall be deemed automatically rejected in accordance with the
provisions and requirements of sections 365 and 1123 of the Bankruptcy Code as
of the Effective Date, unless such Other Executory Contract or Unexpired Lease
(i) shall have been previously assumed by the Debtors by order of the Bankruptcy
Court, (ii) is the subject of a motion to assume pending on or before the
Effective Date, (iii) is listed on the schedule of assumed Other Executory
Contracts or Unexpired Leases annexed to the Plan as Exhibit L-3, or (iv) is
otherwise assumed pursuant to the terms of the Plan. Entry of the Confirmation
Order by the Bankruptcy Court shall constitute approval of the rejections and
assumptions contemplated hereby pursuant to sections 365 and 1123 of the
Bankruptcy Code as of the Effective Date. Each Other Executory Contract or
Unexpired Lease assumed pursuant to this Section shall vest in and be fully
enforceable by the applicable Reorganized Debtor in accordance with its terms,
except as modified by the provisions of the Plan, or any order of the Bankruptcy
Court authorizing or providing for its assumption or applicable federal law. The
Debtors reserve the right to file a motion on or before the Confirmation Date to
assume or reject any Other Executory Contract or Unexpired Lease, including any
Other Executory Contract or Unexpired Lease on Exhibit L-3 to the Plan.
Unexpired leases to be assumed under this Section shall be assumed by the
particular Debtor that was obligated on such lease as of the Petition Date,
without prejudice to the rights of such Debtor thereafter to assign such lease
in accordance with applicable law. Notwithstanding anything in the Plan to the
contrary, unexpired leases to be assumed under the Plan, other than Qualifying
Real Estate, shall be identified on Exhibit L-3 to the Plan by the Confirmation
Date, provided that the assumption of such unexpired leases shall be effective
as of the Effective Date. In the event the Effective Date does not occur, the
Court shall retain jurisdiction with respect to any request to extend the
deadline for assuming such unexpired leases pursuant to section 365(d)(4) of the
Bankruptcy Code.
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(d) Real Property Agreements
Each executory contract and unexpired lease that is assumed and relates
to the use, ability to acquire, or occupancy of real property shall include (a)
all modifications, amendments, supplements, restatements, or other agreements
made directly or indirectly by any agreement, instrument, or other document that
in any manner affect such executory contract or unexpired lease and (b) all
executory contracts or unexpired leases appurtenant to the premises, including
all easements, licenses, permits, rights, privileges, immunities, options,
rights of first refusal, powers, uses, reciprocal easement agreements, and any
other interests in real estate or rights in rem related to such premises, unless
any of the foregoing agreements has been rejected pursuant to a Final Order of
the Bankruptcy Court or is otherwise rejected as a part of the Plan.
2. Payments Related to Assumption of Executory Contracts and
Unexpired Leases
The provisions (if any) of each Intercompany Executory Contract,
Intercompany Unexpired Lease, Employee-Related Agreement, or Other Executory
Contract or Unexpired Lease to be assumed under the Plan which are or may be in
default shall be satisfied solely by Cure. Any Person claiming that a cure
amount is due in connection with the assumption of any executory contract or
unexpired lease as contemplated by section 365(b) of the Bankruptcy Code must
file a cure claim with the Bankruptcy Court asserting all alleged amounts
accrued through the Effective Date, if any (the "Cure Claim"), no later than
forty-five (45) days after the Effective Date or, in the case of Qualifying Real
Estate, the objection deadline associated with the motion seeking to, among
other things, assume such Qualifying Real Estate (the "Cure Claim Submission
Deadline"). Any party failing to submit a Cure Claim by the Cure Claim
Submission Deadline shall be forever barred from asserting, collecting, or
seeking to collect any amounts relating thereto against the Debtors or
Reorganized Debtors. In the case of a Cure Claim related to an unexpired lease
of non-residential real property, such Cure Claim must include a breakdown by
store by category of all amounts claimed, including, but not limited to, amounts
for real estate taxes, common area maintenance, and rent. The Debtors shall have
thirty (30) days from the Cure Claim Submission Deadline or the date a Cure
Claim is actually filed, whichever is later, to file an objection to the Cure
Claim. Any disputed Cure Claims shall be resolved either consensually by the
parties or by the Bankruptcy Court. Disputed Cure Claims shall be set for status
at each omnibus hearing following the Cure Claim Submission Deadline with
separate evidentiary hearings to be set by the Bankruptcy Court as needed. If
the Debtors do not dispute a Cure Claim, then the Debtors shall pay the Cure
Claim, if any, to the claimant within twenty (20) days of the Cure Claim
Submission Deadline. Disputed Cure Claims that are resolved by agreement or
Final Order shall be paid by the Debtors within twenty (20) days of such
agreement or Final Order. The provisions (if any) of each Intercompany Executory
Contract and Intercompany Unexpired Lease to be assumed under the Plan which are
or may be in default shall be satisfied in a manner to be agreed to by the
relevant Debtors and/or non-Debtor Affiliates.
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3. Rejection Damages Bar Date
If the rejection by the Debtors (pursuant to the Plan or otherwise) of
an Intercompany Executory Contract, Intercompany Unexpired Lease,
Employee-Related Agreement, or Other Executory Contract or Unexpired Lease
results in a Claim, then such Claim shall be forever barred and shall not be
enforceable against the Debtors, the Reorganized Debtors, the Plan Investors, or
such entities' properties unless a proof of claim is filed with the Claims Agent
and the Post-Effective Date Committee and served upon counsel to the Debtors,
the Plan Investors, and the Creditors' Committees within thirty (30) days after
service of the later of (a) notice of the Confirmation Order or (b) other notice
that the executory contract or unexpired lease has been rejected.
E. PROVISIONS GOVERNING DISTRIBUTIONS
1. Time of Distributions
Except as otherwise provided for herein or ordered by the Bankruptcy
Court, distributions under the Plan shall be made on a Periodic Distribution
Date.
2. No Interest on Claims or Interests
Unless otherwise specifically provided for in the Plan, Confirmation
Order, or the DIP Credit Agreement or a postpetition agreement in writing
between the Debtors and a Claimholder or Interestholder, postpetition interest
shall not accrue or be paid on Claims or Interests, and no Claimholder or
Interestholder shall be entitled to interest accruing on or after the Petition
Date on any Claim, right, or Interest. Additionally, and without limiting the
foregoing, interest shall not accrue or be paid on any Disputed Claim or
Disputed Interest in respect of the period from the Effective Date to the date a
final distribution is made when and if such Disputed Claim or Disputed Interest
becomes an Allowed Claim or Allowed Interest.
3. Disbursing Agent
The Disbursing Agent shall make all distributions required under the
Plan except with respect to a holder of a Claim whose distribution is governed
by an agreement and is administered by a Servicer, which distributions shall be
deposited with the appropriate Servicer, who shall deliver such distributions to
the holders of Claims in accordance with the provisions of the Plan and the
terms of the governing agreement; provided, however, that if any such Servicer
is unable to make such distributions, the Disbursing Agent, with the cooperation
of such Servicer, shall make such distributions.
4. Surrender of Securities or Instruments
On or before the Distribution Date, or as soon as practicable
thereafter, each holder of an instrument evidencing a Claim (a "Certificate")
shall surrender such Certificate to the Disbursing Agent, or, with respect to
indebtedness that is governed by an agreement and administered by a Servicer,
the respective Servicer, and such Certificate shall be cancelled solely with
respect to the Debtors and such cancellation shall not alter the obligations or
rights of any non-Debtor third parties vis-a-vis one another to such
instruments; provided, however, that this
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Section shall not apply to any Claims Reinstated pursuant to the terms of the
Plan. No distribution of property hereunder shall be made to or on behalf of any
such holder unless and until such Certificate is received by the Disbursing
Agent or the respective Servicer or the unavailability of such Certificate is
reasonably established to the satisfaction of the Disbursing Agent or the
respective Servicer. Any holder who fails to surrender or cause to be
surrendered such Certificate, or fails to execute and deliver an affidavit of
loss and indemnity reasonably satisfactory to the Disbursing Agent or the
respective Servicer prior to the second anniversary of the Effective Date, shall
be deemed to have forfeited all rights and Claims in respect of such Certificate
and shall not participate in any distribution hereunder, and all property in
respect of such forfeited distribution, including any dividends or interest
attributable thereto, shall revert to the Reorganized Debtors notwithstanding
any federal or state escheat laws to the contrary.
5. Services of Indenture Trustees, Agents, and Servicers
The services, with respect to implementation of the distributions
contemplated by the Plan, of Servicers under the relevant agreements that govern
the rights of Claimholders and Interestholders shall be as set forth elsewhere
in the Plan, and the Reorganized Debtors shall reimburse any Servicer for
reasonable and necessary services performed by it (including reasonable
attorneys' fees) as contemplated by, and in accordance with, the Plan, without
the need for the filing of an application with, or approval by, the Bankruptcy
Court.
6. Claims Administration Responsibility
(a) Reorganized Debtors
The Reorganized Debtors will retain responsibility for administering,
disputing, objecting to, compromising, or otherwise resolving and making
distributions (if any) with respect to all Claims against and Interests in the
Debtors.
(b) Filing of Objections
Unless otherwise extended by the Bankruptcy Court, any objections to
Claims or Interests shall be served and filed on or before the Claims/Interests
Objection Deadline. Notwithstanding any authority to the contrary, an objection
to a Claim or Interest shall be deemed properly served on the Claimholder or
Interestholder if the Debtors or the Reorganized Debtors effect service in any
of the following manners: (i) in accordance with Federal Rule of Civil Procedure
4, as modified and made applicable by Bankruptcy Rule 7004; (ii) to the extent
counsel for a Claimholder or Interestholder is unknown, by first class mail,
postage prepaid, on the signatory on the proof of claim or interest or other
representative identified on the proof of claim or interest or any attachment
thereto; or (iii) by first class mail, postage prepaid, on any counsel that has
appeared on the Claimholder's or Interestholder's behalf in the Chapter 11
Cases.
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(c) Determination of Claims and Interests
Except as otherwise agreed to by the Debtors, any Claim or Interest as
to which a proof of claim or proof of interest was timely filed in the Chapter
11 Cases may be determined and liquidated in accordance with the ADR Procedures.
Any Claim or Interest determined and liquidated pursuant to (i) the ADR
Procedures, (ii) an order of the Bankruptcy Court, or (iii) applicable
non-bankruptcy law (which determination has not been stayed, reversed or amended
and as to which determination (or any revision, modification or amendment
thereof) the time to appeal or seek review or rehearing has expired and as to
which no appeal or petition for review or rehearing was filed or, if filed,
remains pending) shall be deemed, to the extent applicable and subject to any
provision in the ADR Procedures to the contrary, an Allowed Claim or an Allowed
Interest, as the case may be, in such liquidated amount and satisfied in
accordance with the Plan (provided that, to the extent a Claim is an Allowed
Insured Claim, such Allowed Claim shall be paid from the insurance proceeds
available to satisfy such liquidated amount). Nothing contained in this Section
9.6 shall constitute or be deemed a waiver of any claim, right, or Cause of
Action that the Debtors or the Reorganized Debtors may have against any Person
in connection with or arising out of any Claim or Claims, including, without
limitation, any rights under section 157(b) of title 28 of the United States
Code.
7. Delivery of Distributions
Distributions to Allowed Claimholders or Allowed Interestholders shall
be made by the Disbursing Agent or the appropriate Servicer (a) at the addresses
set forth on the proofs of claim filed by such Claimholders or Interestholders
(or at the last known addresses of such Claimholders or Interestholders if no
proof of claim is filed or if the Debtors have been notified in writing of a
change of address), (b) at the addresses set forth in any written notices of
address changes delivered to the Disbursing Agent after the date of any related
proof of claim, (c) at the addresses reflected in the Schedules if no proof of
claim has been filed and the Disbursing Agent has not received a written notice
of a change of address, or (d) in the case of a Claimholder or Interestholder
whose Claim or Interest is governed by an agreement and administered by a
Servicer, at the addresses contained in the official records of such Servicer.
If any Claimholder's or Interestholder's distribution is returned as
undeliverable, no further distributions to such Claimholder or Interestholder
shall be made unless and until the Disbursing Agent or the appropriate Servicer
is notified of such Claimholder's or Interestholder's then-current address, at
which time all missed distributions shall be made to such Claimholder or
Interestholder without interest. Amounts in respect of undeliverable
distributions shall be returned to the Reorganized Debtors until such
distributions are claimed. All funds or other undeliverable distributions
returned to the Reorganized Debtors and not claimed within six months of return
shall be distributed to the other creditors of the Class of which the creditor
to whom the distribution was originally made is a member in accordance with the
provisions of the Plan applicable to distributions to that Class. If, at the
conclusion of distributions to a particular Class under the Plan and after
consultation with the Post-Effective Date Committee (solely with respect to
Trade Vendor/Lease Rejection Claims), the Reorganized Debtors reasonably
determine that any remaining New Holding Company Common Stock or Cash allocated
for such class is immaterial and would thus be too impractical to distribute or
would be of no benefit to its respective distributees, any such remaining New
Holding Company Common Stock or Cash will revert to the Reorganized Debtors.
Upon such reversion, the claim of any Claimholder or their
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successors with respect to such property shall be discharged and forever barred
notwithstanding any federal or state escheat laws to the contrary.
8. Procedures for Treating and Resolving Disputed and Contingent
Claims
(a) No Distributions Pending Allowance
No payments or distributions will be made with respect to all or any
portion of a Disputed Claim or Disputed Interest unless and until all objections
to such Disputed Claim or Disputed Interest have been settled or withdrawn or
have been determined by a Final Order, and the Disputed Claim or Disputed
Interest has become an Allowed Claim or Allowed Interest. All objections to
Claims or Interests must be filed on or before the Claims/Interests Objection
Deadline.
(b) Distribution Reserve
The Disbursing Agent will create a separate Distribution Reserve from
the property to be distributed in the Chapter 11 Cases after consultation with
the Post-Effective Date Committee, the amount of which shall be adjusted from
time to time after consultation with the Post-Effective Date Committee. The
amount of New Holding Company Common Stock withheld as a part of the
Distribution Reserve shall be equal to the number of shares the Reorganized
Debtors reasonably determine is necessary to satisfy the distributions required
to be made to Claimholders in the Chapter 11 Cases, when the allowance or
disallowance of each Disputed Claim is ultimately determined. The Disbursing
Agent, the Debtors, or the Reorganized Debtors may request estimation for any
Disputed Claim that is contingent or unliquidated (but is not required to do
so). The Disbursing Agent also shall place in the Distribution Reserve any
dividends, payments, or other distributions made on account of, as well as any
obligations arising from, the property initially withheld in the Distribution
Reserve, to the extent that such property continues to be withheld in the
Distribution Reserve at the time such distributions are made or such obligations
arise. The Claimholder or Interestholder shall not be entitled to receive or
recover any amount in excess of the amount provided in the Distribution Reserve
to pay such Claim or Interest. Nothing in the Plan or Disclosure Statement will
be deemed to entitle the Claimholder or Interestholder of a Disputed Claim or
Disputed Interest to postpetition interest on such Claim or Interest.
(c) Distributions After Allowance
Payments and distributions from the Distribution Reserve to each
respective Claimholder or Interestholder on account of a Disputed Claim or
Disputed Interest, to the extent that it ultimately becomes an Allowed Claim or
Allowed Interest, will be made in accordance with provisions of the Plan that
govern distributions to such Claimholder or Interestholder. On the first
Periodic Distribution Date following the date when a Disputed Claim or Disputed
Interest becomes undisputed, noncontingent and liquidated, the Disbursing Agent
will distribute to the Claimholder or Interestholder any Cash, New Holding
Company Common Stock, or other property, from the Distribution Reserve that
would have been distributed on the dates distributions were previously made to
Claimholders and Interestholders had such Allowed Claim
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or Allowed Interest been an Allowed Claim or Allowed Interest on such dates.
After a Final Order has been entered, or other final resolution has been reached
with respect to all Disputed Claims or Interests, any remaining Cash, New
Holding Company Common Stock, or other Property in the Distribution Reserve will
be distributed Pro Rata to Claimholders and Interestholders in accordance with
the other provisions of the Plan. Subject to Article 9.2 of the Plan, all
distributions made under this Article of the Plan on account of an Allowed Claim
or Allowed Interest will be made together with any dividends, payments, or other
distributions made on account of, as well as any obligations arising from, the
distributed property as if such Allowed Claim or Allowed Interest had been an
Allowed Claim or Allowed Interest on the dates distributions were previously
made to Allowed Claimholders and Allowed Interestholders included in the
applicable class. The Disbursing Agent shall be deemed to have voted any New
Holding Company Common Stock held in the Distribution Reserve in the same
proportion as shares previously disbursed by the Disbursing Agent. The Servicers
shall be deemed to have voted any New Holding Company Common Stock held by such
Servicer in the same proportion as shares previously disbursed by such
Servicers.
(d) De Minimis Distributions
Neither the Disbursing Agent nor any Servicer shall have any obligation
to make a distribution on account of an Allowed Claim or Allowed Interest from
any Distribution Reserve or otherwise if (i) the aggregate amount of all
distributions authorized to be made from such Distribution Reserve or otherwise
on the Periodic Distribution Date in question is or has a value less than
$250,000, or (ii) if the amount to be distributed to the specific holder of the
Allowed Claim or Allowed Interest on the particular Periodic Distribution Date
does not constitute a final distribution to such holder and is or has a value
less than $50.00, provided that this Section shall not apply to distributions to
be made pursuant to Article 5.10 and Article 5.11 of the Plan.
9. Fractional Securities; Fractional Dollars
Any other provision of the Plan notwithstanding, payments of fractions
of shares of New Holding Company Common Stock will not be made and shall be
deemed to be zero. Any other provision of the Plan notwithstanding, neither the
Reorganized Debtors nor the Disbursing Agent or Servicer shall be required to
make distributions or payments of fractions of dollars. Whenever any payment of
a fraction of a dollar under the Plan would otherwise be called for, the actual
payment shall reflect a rounding of such fraction to the nearest whole dollar
(up or down), with half dollars or less being rounded down.
F. ALLOWANCE AND PAYMENT OF CERTAIN ADMINISTRATIVE CLAIMS
1. DIP Facility Claims/Plan Investor Claims
On the Effective Date, the DIP Facility Claim and the Plan Investor
Claim shall be allowed in an amount to be agreed upon by the Debtors and, as
applicable, the DIP Lenders and the Plan Investors, or as ordered by the
Bankruptcy Court with notice to the Creditors' Committees, not less than five
(5) Business Days prior to the Effective Date, and all obligations (other than
contingent indemnity obligations) of the Debtors under the DIP Facility and with
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respect to the Plan Investor Claim shall be paid in full in Cash on the
Effective Date; provided, however, that with respect to letters of credit issued
under the DIP Facility, such claims may be satisfied in full by the cash
collateralization of such letters of credit or by procuring back-up letters of
credit. Upon compliance with the foregoing sentence, all liens and security
interests granted to secure such obligations shall be deemed cancelled and shall
be of no further force and effect. To the extent that the DIP Lenders or the DIP
Agent have filed or recorded publicly any liens and/or security interests to
secure the Debtors' obligations under the DIP Facility, the DIP Lenders or the
DIP Agent, as the case may be, shall take any commercially reasonable steps
requested by the Debtors that are necessary to cancel and/or extinguish such
publicly filed liens and/or security interests.
2. Professional Claims
(a) Final Fee Applications
All final requests for payment of Professional Claims, Key Ordinary
Course Professional Claims, and requests for reimbursement of expenses of
members of the Statutory Committees must be filed no later than the last day of
the second full month after the Effective Date. After notice and a hearing in
accordance with the procedures established by the Bankruptcy Code and prior
orders of the Bankruptcy Court, the allowed amounts of such Professional Claims,
Key Ordinary Course Professional Claims, and expenses shall be determined by the
Bankruptcy Court.
(b) Payment of Interim Amounts
Subject to the Holdback Amount, on the Effective Date, the Debtors or
Reorganized Debtors shall pay all amounts owing to Professionals, Key Ordinary
Course Professionals, and members of the Statutory Committees for all
outstanding amounts payable relating to prior periods through the Effective
Date. In order to receive payment on the Effective Date for unbilled fees and
expenses incurred through such date, the Professionals and Key Ordinary Course
Professionals shall estimate fees and expenses due for periods that have not
been billed as of the Effective Date and shall deliver such estimate to the
Debtors, counsel for the Statutory Committees, and the United States Trustee.
Within forty-five (45) days after the Effective Date, a Professional receiving
payment for the estimated period shall submit a detailed invoice covering such
period in the manner and providing the detail as set forth in the Professional
Fee Order or the Ordinary Course Professional Order, as applicable. Should the
estimated payment received by any Professional exceed the actual fees and
expenses for such period, this excess amount will be credited against the
Holdback Amount for such Professional or, if the award of the Holdback Amount
for such matter is insufficient, disgorged by such Professional.
(c) Holdback Amount
On the Effective Date, the Debtors or the Reorganized Debtors shall pay
to the Disbursing Agent, in order to fund the Holdback Escrow Account, Cash
equal to the aggregate Holdback Amount for all Professionals. The Disbursing
Agent shall maintain the Holdback Escrow Account in trust for the Professionals
with respect to whom fees have been held back
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pursuant to the Professional Fee Order. Such funds shall not be considered
property of the Debtors, the Reorganized Debtors or the Estates. The remaining
amount of Professional Claims owing to the Professionals shall be paid to such
Professionals by the Disbursing Agent from the Holdback Escrow Account when such
claims are finally allowed by the Bankruptcy Court. When all Professional Claims
and Key Ordinary Course Professional Claims have been paid in full, amounts
remaining in the Holdback Escrow Account, if any, shall be paid to the
Reorganized Debtors.
(d) Post-Effective Date Retention
Upon the Effective Date, any requirement that Professionals or Key
Ordinary Course Professionals comply with sections 327 through 331 of the
Bankruptcy Code in seeking retention or compensation for services rendered after
such date will terminate, and the Reorganized Debtors will employ and pay
Professionals and Key Ordinary Course Professionals in the ordinary course of
business.
3. Substantial Contribution Compensation and Expenses Bar Date
Any Person who requests compensation or expense reimbursement for
making a substantial contribution in the Chapter 11 Cases pursuant to sections
503(b)(3), (4), and (5) of the Bankruptcy Code must file an application with the
clerk of the Bankruptcy Court on or before the forty-fifth (45th) day after the
Effective Date (the "503 Deadline"), and serve such application on counsel for
the Debtors, the Plan Investors, and the Statutory Committees and as otherwise
required by the Bankruptcy Court and the Bankruptcy Code on or before the 503
Deadline, or be forever barred from seeking such compensation or expense
reimbursement.
4. Other Administrative Claims
All other requests for payment of an Administrative Claim (other than
as set forth in Article 10.1, Article 10.2 or Article 10.3 of the Plan) must be
filed, in substantially the form of the Administrative Claim Request Form
attached to the Plan as Exhibit M, with the Claims Agent and served on counsel
for the Debtors and the Plan Investors no later than forty-five (45) days after
the Effective Date. Any request for payment of an Administrative Claim pursuant
to this Section that is not timely filed and served shall be disallowed
automatically without the need for any objection from the Debtors or the
Reorganized Debtors. The Debtors or the Reorganized Debtors may settle an
Administrative Claim without further Bankruptcy Court approval, subject to
review by the Post-Effective Date Committee. Unless the Debtors or the
Reorganized Debtors object to an Administrative Claim by the Claims/Interests
Objection Deadline, such Administrative Claim shall be deemed allowed in the
amount requested. In the event that the Debtors or the Reorganized Debtors
object to an Administrative Claim, the Bankruptcy Court shall determine the
allowed amount of such Administrative Claim. Notwithstanding the foregoing, no
request for payment of an Administrative Claim need be filed with respect to an
Administrative Claim which is paid or payable by the Debtors in the ordinary
course of business.
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G. KMART CREDITOR TRUST
1. Appointment of Trustee
The Trustee for the Kmart Creditor Trust shall be designated by the
Unsecured Creditors' Committee, subject to the approval of the Bankruptcy Court
and the consent of the Debtors and the reasonable consent of the Financial
Institutions' Committee, which consent shall not be unreasonably withheld. The
Trustee shall be independent of the Debtors and the Reorganized Debtors. The
Unsecured Creditors' Committee shall file a notice on a date that is not less
than ten (10) days prior to the Confirmation Hearing designating the Person who
it has selected as Trustee and seeking approval of such designation. The Person
designated as Trustee shall file an affidavit demonstrating that such Person is
disinterested as defined by section 101(14) of the Bankruptcy Code. If approved
by the Bankruptcy Court, the Person so designated shall become the Trustee on
the Effective Date. The Trustee shall have and perform all of the duties,
responsibilities, rights and obligations set forth in the Trust Agreement.
2. Transfer of Trust Assets to the Kmart Creditor Trust
On the Effective Date, the Debtors' Estates shall transfer and shall be
deemed to have irrevocably transferred to the Kmart Creditor Trust, for and on
behalf of the beneficiaries of the Trust, with no reversionary interest in the
Debtors or the Reorganized Debtors, the Trust Assets; provided, however, that
nothing herein is intended to transfer all or any portion of any Retained Action
to the Kmart Creditor Trust. The term "Trust Assets" means any and all Causes of
Action of the Debtors against any Person, including Avoidance Claims, arising
out of the subject matter of the Investigations. Upon such transfer, the
Debtors, the Debtors' Estates, the Disbursing Agent and the Reorganized Debtors
shall have no other further rights or obligations with respect thereto.
Notwithstanding the foregoing, the Reorganized Debtors shall make available to
the Trustee reasonable access during normal business hours, upon reasonable
notice, to personnel and books and records of the Reorganized Debtors to enable
the Trustee to perform the Trustee's tasks under the Trust Agreement and the
Plan, and the Debtors and the Reorganized Debtors shall, in furtherance of the
Order of the Bankruptcy Court dated September 4, 2002, permit the Trustee and
the Trust Advisory Board reasonable access to evidence gathered and certain work
product developed during the Investigations, as more specifically set forth in
the Trust Agreement; provided, however, that the Reorganized Debtors will not be
required to make expenditures in response to such requests determined by them to
be unreasonable. The Reorganized Debtors shall not be entitled to compensation
or reimbursement (including reimbursement for professional fees) with respect to
fulfilling their obligations as set forth in this Article. The Bankruptcy Court
retains jurisdiction to determine the reasonableness of either a request for
assistance and/or a related expenditure. Any requests for assistance shall not
interfere with the Reorganized Debtors' business operations.
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3. The Kmart Creditor Trust
(a) The Kmart Trust Agreement
Without any further action of the directors or shareholders of the
Debtors, on the Effective Date, the Trust Agreement, substantially in the form
of Exhibit K to the Plan, shall become effective. The Trustee shall accept the
Kmart Creditor Trust and sign the Trust Agreement on the Effective Date and the
Kmart Creditor Trust will then be deemed created and effective.
(b) Interests in and Term of Kmart Creditor Trust
Interests in the Kmart Creditor Trust shall be uncertificated and shall
be non-transferable except upon death of the interest holder or by operation of
law. Holders of interests in the Kmart Creditor Trust shall have no voting
rights with respect to such interests. The Kmart Creditor Trust shall have a
term of three (3) years from the Effective Date, without prejudice to the rights
of the Trust Advisory Board to extend such term conditioned upon the Kmart
Creditor Trust's not then becoming subject to the Exchange Act. The terms of the
Trust may be amended by the Trustee or the Debtors to the extent necessary to
ensure that the Trust will not become subject to the Exchange Act.
(c) Authority of Trustee
The Trustee shall have full authority to take any steps necessary to
administer the Trust Agreement, including, without limitation, the duty and
obligation to liquidate Trust Assets, to administer the Other Unsecured Claim
Cash Payment Amount (including pursuant to a services agreement with the
Reorganized Debtors), to make distributions therefrom in accordance with the
provisions of the Plan and, if authorized by majority vote of those members of
the Trust Advisory Board authorized to vote, to pursue and settle any Trust
Claims. Upon such assignment, the Trustee, on behalf of the Kmart Creditor
Trust, will assume and be responsible for any responsibilities, duties, and
obligations of the Debtors with respect to the subject matter of the
assignments, and the Debtors, the Disbursing Agent, and the Reorganized Debtors
will have no further rights or obligations with respect thereto.
(d) Costs and Expenses
All costs and expenses associated with the administration of the Kmart
Creditor Trust, including those rights, obligations and duties described in the
Plan, shall be the responsibility of and paid by the Kmart Creditor Trust.
Notwithstanding the preceding sentence, on the Effective Date (or, in the case
of clause (iii), promptly following the first anniversary of the Effective
Date), the Reorganized Debtors shall contribute the following to the Kmart
Creditor Trust to be utilized to pay the costs and expenses associated with the
administration of the Kmart Creditor Trust: (i) $5 million, (ii) an amount equal
to any funds re-paid to the Debtors prior to the Effective Date on account of
loans made pursuant to the 2001 Retention Program (in addition, the Reorganized
Debtors shall have a continuing obligation to turn over to the Kmart Creditor
Trust any funds re-paid to them subsequent to the Effective Date on account of
loans made pursuant to the 2001 Retention Program), and (iii) an additional $5
million only in the event that the Debtors and Reorganized Debtors have not
reconciled at least 75% of the Trade Vendor/Lease Rejection Claims on or before
the first anniversary of the Effective Date (such percentage to be determined in
relation to the Face Amount of proofs of claim filed by
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Claimholders holding Trade Vendor/Lease Rejection Claims, or if no proof of
claim has been filed, as Scheduled, in either case excluding claims arising from
rejection of unexpired real property leases).
(e) Retention of Professionals
The Trustee may retain such law firms, accounting firms, experts,
advisors, consultants, investigators, appraisers, auctioneers or other
professionals as it may deem necessary (collectively, the "Trustee
Professionals"), in its sole discretion, to aid in the performance of its
responsibilities pursuant to the terms of the Plan including, without
limitation, the liquidation and distribution of Trust Assets.
(f) Classification of Kmart Creditor Trust
For federal income tax purposes, it is intended that the Kmart Creditor
Trust be classified as a liquidating trust under section 301.7701-4 of the
Procedure and Administration Regulations and that such trust is owned by its
beneficiaries. Accordingly, for federal income tax purposes, it is intended that
the beneficiaries be treated as if they had received a distribution of an
undivided interest in the Trust Assets and then contributed such interests to
the Kmart Creditor Trust.
(g) Tax Returns
The Trustee shall be responsible for filing all federal, state and
local tax returns for the Kmart Creditor Trust. The Trustee shall provide
holders of interests in the Kmart Creditor Trust with copies of annual, audited
financial statements and tax information, with such copies to be made available
on an Internet website to be maintained by the Trustee and notice of which shall
be given by the Trustee to such interest holders, unless the Trust Advisory
Board determines that maintenance of such website is no longer a cost-effective
means of communication of such statements to holders of interests in the Kmart
Creditor Trust.
4. The Trust Advisory Board
(a) Membership and Selection
The Trust Advisory Board shall be comprised of four (4) members, three
(3) of which shall be designated by the Unsecured Creditors' Committee, and one
(1) of which shall be designated by the Financial Institutions' Committee. The
Unsecured Creditors' Committee and the Financial Institutions' Committee shall
give the Debtors written notice of the identities of such members and file such
notice with the Bankruptcy Court on a date that is not less than ten (10) days
prior to the Confirmation Hearing; provided, however, that if said Committees
fail to file and give such notice, Kmart shall designate the members of the
Trust Advisory Board by announcing their identities at the Confirmation Hearing.
The Trustee shall consult regularly with the Trust Advisory Board when carrying
out the purpose and intent of the Kmart Creditor Trust. Members of the Trust
Advisory Board shall be entitled to compensation in accordance with the Trust
Agreement and to reimbursement of the reasonable and necessary expenses incurred
by
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them in carrying out the purpose of the Trust Advisory Board. Reimbursement of
the reasonable and necessary expenses of the members of the Trust Advisory Board
and their compensation to the extent provided for in the Trust Agreement shall
be payable by the Kmart Creditor Trust.
(b) Vacancies
In the case of an inability or unwillingness of any member of the Trust
Advisory Board to serve, such member shall be replaced by designation of the
remaining members of the Trust Advisory Board. If any position on the Trust
Advisory Board remains vacant for more than thirty (30) days, such vacancy shall
be filled within fifteen (15) days thereafter by the designation of the Trustee
without the requirement of a vote by the other members of the Trust Advisory
Board.
(c) Discharge of Duties
Upon the certification by the Trustee that all Trust Assets have been
distributed, abandoned or otherwise disposed of, the members of the Trust
Advisory Board shall resign their positions, whereupon they shall be discharged
from further duties and responsibilities.
(d) Settlement of Trust Claims
The Trust Advisory Board shall, by majority vote, approve all
settlements of Trust Claims which the Trustee or any member of the Trust
Advisory Board may propose, provided, however, that (i) no member of the Trust
Advisory Board may cast a vote with respect to any Trust Claim to which it is a
party; and (ii) the Trustee may seek Bankruptcy Court approval of a settlement
of a Trust Claim if the Trust Advisory Board fails to act on a proposed
settlement of such Trust Claim within thirty (30) days of receiving notice of
such proposed settlement by the Trustee or as otherwise determined by the
Trustee.
(e) Investment of Trust Assets
The Trust Advisory Board may, by majority vote, authorize the Trustee
to invest the corpus of the Trust in prudent investments other than those
described in section 345 of the Bankruptcy Code.
(f) Removal or Resignation of Trustee
The Trust Advisory Board may remove the Trustee in its discretion. In
the event the requisite approval is not obtained, the Trustee may be removed by
the Bankruptcy Court for cause shown. In the event of the resignation or removal
of the Trustee, the Trust Advisory Board shall, by majority vote, designate a
person to serve as successor Trustee. The successor Trustee shall file an
affidavit demonstrating that such Person is disinterested as defined by section
101(14) of the Bankruptcy Code.
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(g) Exculpation
Notwithstanding anything to the contrary in the Plan, neither the Trust
Advisory Board nor any of its members, designees, counsel, financial advisors or
any duly designated agent or representatives of any such party shall be liable
for the act, default or misconduct of any other member of the Trust Advisory
Board, nor shall any member be liable for anything other than such member's own
gross negligence or willful misconduct. The Trust Advisory Board may, in
connection with the performance of its duties, and in its sole and absolute
discretion, consult with its counsel, accountants or other professionals, and
shall not be liable for anything done or omitted or suffered to be done in
accordance with such advice or opinions. If the Trust Advisory Board determines
not to consult with its counsel, accountants or other professionals, it shall
not be deemed to impose any liability on the Trust Advisory Board, or its
members and/or designees.
(h) Adoption of By-Laws
The Trust Advisory Board shall govern its proceedings through the
adoption of by-laws, which the Trust Advisory Board may adopt by majority vote.
No provision of such by-laws shall supersede any express provision of the Plan
or the Trust Agreement.
5. Distributions of Trust Assets
Distributions of the Trust Recoveries to Claimholders and
Interestholders in accordance with their interests in the Kmart Creditor Trust
as set forth in the Plan shall be made at least semi-annually beginning with a
calendar quarter that is not later than the end of the second calendar quarter
after the Effective Date; provided, however, that the Trustee shall not be
required to make any such semiannual distribution in the event that the
aggregate proceeds and income available for distribution to such Claimholders
and Interestholders is not sufficient, in the Trustee's discretion (after
consultation with the Trust Advisory Board) to economically distribute monies,
and in any case, in connection with any interim (as opposed to final)
distribution, the Trustee shall retain at least the amount of funds paid to the
Kmart Creditor Trust pursuant to Article 11.3(d)(i) and Article 11.3(d)(ii) of
the Plan, provided, further, that with respect to distributions to
Interestholders that cannot be economically distributed as aforesaid, the
Trustee shall divide such aggregate amount of distributions into $50.00
increments and thereafter make such $50.00 distributions to Interestholders who
otherwise were entitled to, but did not receive, a distribution under Article
5.11 and who are randomly selected by Trustee. The Trustee will make continuing
efforts to prosecute or settle the Trust Claims, make timely distributions, and
not unduly prolong the duration of the Kmart Creditor Trust.
H. EFFECT OF THE PLAN ON CLAIMS AND INTERESTS
1. Revesting of Assets
Except as otherwise explicitly provided in the Plan, on the Effective
Date, all property comprising the Estates (including Retained Actions, but
excluding property that has been abandoned pursuant to an order of the
Bankruptcy Court) shall revest in each of the Debtors that owned such property
or interest in property as of the Effective Date, free and clear of all
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Claims, liens, charges, encumbrances, rights and Interests of creditors and
equity security holders, provided, however, that (i) the Trust Claims shall be
transferred to the Kmart Creditor Trust pursuant to Section 11.2 of the Plan and
(ii) Qualifying Real Estate shall remain property of the Estate of the Debtor
that owns such Qualifying Real Estate. The term "Qualifying Real Estate" means
any (i) real estate lease, including a capital lease, under which a Debtor is a
lessee, or (ii) real estate owned by a Debtor, in each case as identified on
Exhibit F to the Plan be filed on or before the Exhibit Filing Date. Qualifying
Real Estate includes, but is not limited to, real property interests pertaining
to stores to be closed pursuant to the Debtors' 2003 store closing program.
The Responsible Officer of the Estates of such Debtors shall have full
authority to assume and assign, reject, or otherwise dispose of the Qualifying
Real Estate consistent with procedures approved by the Bankruptcy Court and
sections 363 and 365 of the Bankruptcy Code. Landlords and other Persons, other
than the Debtors, with interests in the Qualifying Real Estate shall retain the
rights afforded them by sections 363 and 365 of the Bankruptcy Code through and
including disposition of the Qualifying Real Estate. All liens and security
interests, if any, in the Qualifying Real Estate shall remain intact and attach
to the net proceeds therefrom to the same extent, validity, and relative
priority as existed on the Effective Date, and all proceeds remaining in the
Estates of such Debtors after satisfaction of all Allowed Secured Claims, if
any, shall be transferred to the New Operating Company. As of the Effective
Date, the Reorganized Debtors may operate their businesses and use, acquire, and
dispose of property and settle and compromise Claims or Interests without
supervision of the Bankruptcy Court, free of any restrictions of the Bankruptcy
Code or Bankruptcy Rules, other than those restrictions expressly imposed by the
Plan and Confirmation Order.
2. Discharge of Debtors
Pursuant to section 1141(d) of the Bankruptcy Code, except as otherwise
specifically provided in the Plan or in the Confirmation Order, the
distributions and rights that are provided in the Plan shall be in complete
satisfaction, discharge, and release, effective as of the Confirmation Date (but
subject to the occurrence of the Effective Date), of Claims and Causes of
Action, whether known or unknown, against, liabilities of, liens on, obligations
of, rights against, and Interests in the Debtors or any of their assets or
properties, regardless of whether any property shall have been distributed or
retained pursuant to the Plan on account of such Claims, rights, and Interests,
including, but not limited to, Claims and Interests that arose before the
Confirmation Date, any liability (including withdrawal liability) to the extent
such Claims relate to services performed by employees of the Debtors prior to
the Petition Date and that arise from a termination of employment or a
termination of any employee or retiree benefit program, regardless of whether
such termination occurred prior to or after the Confirmation Date, and all debts
of the kind specified in sections 502(g), 502(h) or 502(i) of the Bankruptcy
Code, in each case whether or not (a) a proof of claim or interest based upon
such Claim, debt, right, or Interest is filed or deemed filed under section 501
of the Bankruptcy Code, (b) a Claim or Interest based upon such Claim, debt,
right, or Interest is allowed under section 502 of the Bankruptcy Code, or (c)
the holder of such a Claim, right, or Interest accepted the Plan. The
Confirmation Order shall be a judicial determination of the discharge of all
Claims against and Interests in the Debtors, subject to the Effective Date
occurring. Notwithstanding anything in
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this Article 12.2 to the contrary, nothing in this Article shall discharge the
Estate of any Debtor that holds Qualifying Real Estate from the obligations of
such Estate contemplated by Article 7.1(b) of the Plan, provided however, that
the satisfaction, discharge and release provided for in this Article 12.2 shall
apply to any Claims or Causes of Action related to any specific Qualifying Real
Estate immediately upon payment of all such obligations related to, and final
disposition of, such specific Qualifying Real Estate
3. Compromises and Settlements
In accordance with Article 9.6 of the Plan, pursuant to Bankruptcy Rule
9019(a), the Debtors may compromise and settle various (a) Claims against them
and (b) Causes of Action that they have against other Persons up to and
including the Effective Date, other than Trust Claims. After the Effective Date,
such right shall pass to the Reorganized Debtors as contemplated in Article 12.1
of the Plan, without the need for further approval of the Bankruptcy Court,
except as otherwise set forth in the Plan.
4. Release by Debtors of Certain Parties
Pursuant to section 1123(b)(3) of the Bankruptcy Code, but subject to
Article 12.10 of the Plan, effective as of the Effective Date, each Debtor, in
its individual capacity and as a debtor-in-possession for and on behalf of its
Estate, shall release and discharge and be deemed to have conclusively,
absolutely, unconditionally, irrevocably and forever released and discharged all
Released Parties for and from any and all claims or Causes of Action existing as
of the Effective Date in any manner arising from, based on or relating to, in
whole or in part, the Debtors, the subject matter of, or the transactions or
events giving rise to, any Claim or Interest that is treated in the Plan, the
business or contractual arrangements between any Debtor or any Released Party,
the restructuring of Claims and Interests prior to or in the Chapter 11 Cases,
or any act, omission, occurrence or event in any manner related to any such
Claims, Interests, restructuring or the Chapter 11 Cases.
The term "Released Parties" means, collectively, (i) all officers of
each of the Debtors, all members of the boards of directors of each of the
Debtors, and all employees of each of the Debtors, in each case, as of the date
of the commencement of the hearing on the Disclosure Statement, (ii) the
Statutory Committees and all members of the Statutory Committees in their
respective capacities as such, (iii) the DIP Agent in its capacity as such, (iv)
the DIP Lenders in their capacities as such, (v) The Bank of New York, as
original indenture trustee with respect to the Prepetition Notes, in its
capacity as such, and Wilmington Trust Company, as successor indenture trustee
with respect to the Prepetition Notes, in its capacity as such, (vi) the Plan
Investors in their capacities as such, (vii) the Prepetition Lenders in their
capacities as such, (viii) the Prepetition Agent in its capacity as such, (ix)
all Professionals, and (x) with respect to each of the above-named Persons, such
Person's affiliates, principals, employees, agents, officers, directors,
financial advisors, attorneys and other professionals, in their capacities as
such.
The Reorganized Debtors, the Kmart Creditor Trust, and any newly-formed
entities that will be continuing the Debtors' businesses after the Effective
Date shall be bound, to the same extent the Debtors are bound, by all of the
releases set forth above. Notwithstanding the
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foregoing, nothing in the Plan releases or shall be deemed to release any of the
Debtors or the Plan Investors or their Affiliates from their obligations under
the Investment Agreement or the transactions contemplated thereby.
5. Release by Holders of Claims and Interests
ON THE EFFECTIVE DATE, (a) EACH PERSON THAT VOTES TO ACCEPT THE PLAN;
AND (b) TO THE FULLEST EXTENT PERMISSIBLE UNDER APPLICABLE LAW, AS SUCH LAW MAY
BE EXTENDED OR INTERPRETED SUBSEQUENT TO THE EFFECTIVE DATE, EACH ENTITY (OTHER
THAN A DEBTOR), THAT HAS HELD, HOLDS OR MAY HOLD A CLAIM OR TRUST PREFERRED
OBLIGATION, IN CONSIDERATION FOR THE OBLIGATIONS OF THE DEBTORS AND THE
REORGANIZED DEBTORS UNDER THE PLAN AND THE CASH, NEW HOLDING COMPANY COMMON
STOCK, AND OTHER CONTRACTS, INSTRUMENTS, RELEASES, AGREEMENTS OR DOCUMENTS TO BE
DELIVERED IN CONNECTION WITH THE PLAN (EACH, A "RELEASE OBLIGOR"), SHALL HAVE
CONCLUSIVELY, ABSOLUTELY, UNCONDITIONALLY, IRREVOCABLY AND FOREVER, RELEASED AND
DISCHARGED EACH RELEASED PARTY FROM ANY CLAIM OR CAUSE OF ACTION EXISTING AS OF
THE EFFECTIVE DATE ARISING FROM, BASED ON OR RELATING TO, IN WHOLE OR IN PART,
THE SUBJECT MATTER OF, OR THE TRANSACTION OR EVENT GIVING RISE TO, THE CLAIM OR
TRUST PREFERRED OBLIGATION OF SUCH RELEASE OBLIGOR, AND ANY ACT, OMISSION,
OCCURRENCE OR EVENT IN ANY MANNER RELATED TO SUCH SUBJECT MATTER, TRANSACTION OR
OBLIGATION; PROVIDED, HOWEVER, THAT, (A) THIS ARTICLE 12.5 IS SUBJECT TO AND
LIMITED BY ARTICLE 12.10 OF THE PLAN; (B) THIS ARTICLE 12.5 SHALL NOT RELEASE
ANY RELEASED PARTY FROM ANY CAUSE OF ACTION HELD BY A GOVERNMENTAL ENTITY
EXISTING AS OF THE EFFECTIVE DATE, BASED ON (i) THE INTERNAL REVENUE CODE OR
OTHER DOMESTIC STATE, CITY OR MUNICIPAL TAX CODE, (ii) THE ENVIRONMENTAL LAWS OF
THE UNITED STATES OR ANY DOMESTIC STATE, CITY OR MUNICIPALITY, (iii) ANY
CRIMINAL LAWS OF THE UNITED STATES OR ANY DOMESTIC STATE, CITY OR MUNICIPALITY,
(iv) THE EXCHANGE ACT, THE SECURITIES ACT, OR OTHER SECURITIES LAWS OF THE
UNITED STATES OR ANY DOMESTIC STATE, CITY, OR MUNICIPALITY, OR (v) SECTIONS
1104-1109 AND 1342(D) OF THE EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974, AS
AMENDED; (C) THIS ARTICLE 12.5 SHALL NOT WAIVE, IMPAIR OR RELEASE ANY CLAIMS OR
CAUSES OF ACTION, IF ANY, THAT ANY RELEASE OBLIGOR MAY HAVE AGAINST ANY RELEASED
PARTY ARISING FROM A TRUST CLAIM; AND (D) THIS ARTICLE 12.5 SHALL NOT WAIVE,
IMPAIR OR RELEASE ANY SECURITIES ACTION, INCLUDING, WITHOUT LIMITATION, ALL
SUBORDINATED SECURITIES CLAIMS AGAINST ANY RELEASED PARTY, IF ANY.
6. Setoffs
Subject to Article 12.10 of the Plan, the Debtors may, but shall not be
required to, set off against any Claim, and the payments or other distributions
to be made pursuant to the Plan in respect of such Claim, claims of any nature
whatsoever that the Debtors may have against such Claimholder; but neither the
failure to do so nor the allowance of any Claim hereunder shall constitute a
waiver or release by the Debtors or the Reorganized Debtors of any such claim
that the Debtors or the Reorganized Debtors may have against such Claimholder.
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7. Subordination Rights
Except as otherwise specifically provided for in the Plan with respect
to the subordination provisions of all documents pertaining to the Trust
Preferred Securities, which provisions shall be specifically enforced as
provided for in Article V of the Plan, all Claims against the Debtors and all
rights and claims between or among Claimholders relating in any manner
whatsoever to distributions on account of Claims against or Interests in the
Debtors, based upon any claimed subordination rights, whether asserted or
unasserted, legal or equitable, shall be deemed satisfied by the distributions
under the Plan to Claimholders or Interestholders having such subordination
rights, and such subordination rights shall be deemed waived, released,
discharged, and terminated as of the Effective Date. Except as otherwise
specifically provided for in the Plan, distributions to the various Classes of
Claims and Interests hereunder shall not be subject to levy, garnishment,
attachment, or like legal process by any Claimholder or Interestholder by reason
of any subordination rights or otherwise, so that each Claimholder and
Interestholder shall have and receive the benefit of the distributions in the
manner set forth in the Plan.
8. Exculpation and Limitation of Liability
Subject to Article 12.10 of the Plan, the Debtors, the Reorganized
Debtors, the Statutory Committees, the members of the Statutory Committees in
their capacities as such, the DIP Lenders in their capacities as such, the DIP
Agent in its capacity as such, the Plan Investors in their capacities as such,
the Prepetition Agent in its capacity as such, the Prepetition Lenders in their
capacities as such, and any indenture trustee for the Prepetition Notes serving
after the Petition Date in its capacity as such, and any of such parties'
respective present or former members, officers, directors, employees, advisors,
attorneys, representatives, financial advisors, investment bankers, or agents
and any of such parties' successors and assigns, shall not have or incur, and
are hereby released from, any claim, obligation, Cause of Action, or liability
to one another or to any Claimholder or Interestholder, or any other
party-in-interest, or any of their respective agents, employees,
representatives, financial advisors, attorneys or Affiliates, or any of their
successors or assigns, for any act or omission in connection with, relating to,
or arising out of the Debtors' Chapter 11 Cases, negotiation and filing of the
Plan, filing the Chapter 11 Cases, the pursuit of confirmation of the Plan, the
consummation of the Plan, or the administration of the Plan or the property to
be distributed under the Plan, except for their willful misconduct and except
with respect to obligations arising under confidentiality agreements, joint
interest agreements, and protective orders entered during the Chapter 11 Cases,
and in all respects shall be entitled to reasonably rely upon the advice of
counsel with respect to their duties and responsibilities under the Plan. Other
than as provided in Article 12.10 of the Plan, no Claimholder or Interestholder,
or other party in interest, none of their respective agents, employees,
representatives, financial advisors, attorneys or affiliates, and no successors
or assigns of the foregoing, shall have any right of action against the parties
listed in this Article for any act or omission in connection with, relating to
or arising out of the Chapter 11 Cases, the pursuit of confirmation of the Plan,
the consummation of the Plan, or the administration of the Plan or the property
to be distributed under the Plan. Notwithstanding the foregoing, nothing in the
Plan shall be deemed to release any of the Debtors or the Plan Investors or
their Affiliates from their obligations under the Investment Agreement or the
transactions contemplated thereby
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9. Indemnification Obligations
The Plan contains provisions concerning the Indemnification Rights of
Indemnitees. The term "Indemnitee" means all present and former directors,
officers, employees, agents or representatives of the Debtors who are entitled
to assert Indemnification Rights. The term "Indemnification Rights" means any
obligations or rights of the Debtors to indemnify, reimburse, advance, or
contribute to the losses, liabilities or expenses of an Indemnitee pursuant to
the Debtor's certificate of incorporation, bylaws, policy of providing employee
indemnification, applicable law, or specific agreement in respect of any claims,
demands, suits, causes of action or proceedings against an Indemnitee based upon
any act or omission related to an Indemnitee's service with, for, or on behalf
of the Debtors. The term "Continuing Indemnification Rights" means those
Indemnification Rights held by any Indemnitee who is a Released Party and serves
as a director, officer or employee (or in any similar capacity) of the
Reorganized Debtors immediately following the occurrence of the Effective Date
together with any Indemnification Rights held by any Indemnitee on account of
events occurring on or after the Petition Date
Subject to Article 12.10 of the Plan, in satisfaction and compromise of
the Indemnitees' Indemnification Rights: (a) all Indemnification Rights shall be
released and discharged on and as of the Effective Date except for Continuing
Indemnification Rights (which shall remain in full force and effect to the
fullest extent allowed by law or contract on and after the Effective Date and
shall not be modified, reduced, discharged, or otherwise affected in any way by
the Chapter 11 Cases); (b) the Debtors or the Reorganized Debtors, as the case
may be, covenant to maintain directors' and officers' insurance providing
coverage for those Indemnitees currently covered by such policies for a period
of two years after the Effective Date, shall maintain tail coverage under
policies in existence as of the Effective Date, to the fullest extent permitted
by such provisions, in each case insuring such parties in respect of any claims,
demands, suits, Causes of Action, or proceedings against such Persons based upon
any act or omission related to such Person's service with, for, or on behalf of
the Debtors in at least the scope and amount as currently maintained by the
Debtors (the "Insurance Coverage") and hereby further indemnify such Indemnitees
without Continuing Indemnification Rights solely to pay for any deductible or
retention amount that may be payable in connection with any claim covered under
either the foregoing Insurance Coverage or any prior similar policy in an
aggregate amount not to exceed $5,000,000; (c) the insurers who issue the
Insurance Coverage are authorized to pay any professional fees and expenses
incurred in connection with any action relating to any Indemnification Rights
and Continuing Indemnification Rights; and (d) the Debtors or the Reorganized
Debtors, as the case may be, hereby indemnify Indemnitees with Continuing
Indemnification Rights and agree to pay for any deductible or retention amount
that may be payable in connection with any claim covered under either the
foregoing Insurance Coverage or any prior similar policy.
10. Exclusions and Limitation on Exculpation, Indemnification, and
Releases
Notwithstanding anything in the Plan to the contrary, no provision of
the Plan or the Confirmation Order, including, without limitation, any
exculpation, indemnification or release provision, shall modify, release, or
otherwise limit the liability of (i) any Person who is, or becomes, the subject
of a Trust Claim (to the extent, but only to the extent, related to such Trust
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Claim), or (ii) any Person not specifically released hereunder, including,
without limitation, any Person that is a co-obligor or joint tortfeasor of a
Released Party or that is otherwise liable under theories of vicarious or other
derivative liability, or (iii) any Person who is, or becomes, the subject of a
Securities Action (to the extent, but only to the extent, related to such
Securities Action); provided, however, that the Reorganized Debtors shall not
provide indemnification on account of (i) and (ii) above.
11. Injunction
Subject to Article 12.10 of the Plan, the satisfaction, release, and
discharge provisions of the Plan shall act as an injunction against any Person
commencing or continuing any action, employment of process, or act to collect,
offset, or recover any Claim or Cause of Action satisfied, released, or
discharged under the Plan to the fullest extent authorized or provided by the
Bankruptcy Code, including, without limitation, to the extent provided for or
authorized by sections 524 and 1141 thereof.
VIII. CERTAIN FACTORS TO BE CONSIDERED
The holder of a Claim against a Debtor should read and carefully
consider the following factors, as well as the other information set forth in
this Disclosure Statement (and the documents delivered together herewith and/or
incorporated by reference herein) before deciding whether to vote to accept or
to reject the Plan.
A. GENERAL CONSIDERATIONS
The formulation of a reorganization plan is the principal purpose of a
chapter 11 case. The Plan sets forth the means for satisfying the holders of
Claims against and Interests in the Debtors. Certain Claims may receive partial
distributions pursuant to the Plan, and in some instances, no distributions at
all. The recapitalization of the Debtors realizes the going concern value of the
Debtors for their Claimholders and Interestholders. Moreover, reorganization of
the Debtors' business and operations under the proposed Plan also avoids the
potentially adverse impact of a liquidation on the Debtors' employees and many
of its customers, trade vendors, suppliers of goods and services, and lessors.
Certain insurance carriers have asserted that confirmation of the Plan may void
coverage under the policies they have issued. The Debtors, however, reserve all
of their rights to dispute such assertions at the appropriate time.
B. CERTAIN BANKRUPTCY CONSIDERATIONS
If the Plan is not confirmed and consummated, there can be no assurance
that the Chapter 11 Cases will continue rather than be converted to a
liquidation or that any alternative plan of reorganization would be on terms as
favorable to the holders of Claims and Interests as the terms of the Plan. If a
liquidation or protracted reorganization were to occur, there is a substantial
risk that the value of the Debtors' enterprise would be substantially eroded to
the detriment of all stakeholders. See Appendix B attached to this Disclosure
Statement for a liquidation analysis of the Debtors.
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C. BUSINESS FACTORS AND COMPETITIVE CONDITIONS
1. General Economic Conditions
Kmart's five-year business plan has assumed that the general economic
conditions of the United States economy and the retail industry will improve
over the next several years. An improvement of economic conditions is subject to
many factors outside the Debtors' control, including interest rates, inflation,
unemployment rates, consumer spending, war and other such factors. Any one of
these or other economic factors could have a significant impact on the operating
performance of the Reorganized Debtors. There is no guarantee that economic
conditions will improve in the near term.
2. Business Factors
The Debtors' operating performance is tied to the Debtors' ability to,
among other things (i) accurately anticipate changes in consumer spending and
buying patterns and implement appropriate inventory strategies to accommodate
those changes, (ii) accurately anticipate marketplace demand for the products of
key brand partners, as well as the ability of the Reorganized Debtors to engage
appropriate new brand partners to keep up with changing trends, (iii) acquire
desired goods in appropriate quantities and fulfill labor needs at planned
costs, (iv) properly monitor inventory needs and in-stock levels, (v)
successfully implement business strategies and otherwise execute planned changes
in various aspects of the business, (vi) attract, motivate and/or retain key
executives and employees and (vii) attract and retain customers.
Any one of the above-referenced factors, many of which may be affected
by circumstances outside the Debtors' control, could have an impact on the
Reorganized Debtors' operating performance. In addition, should the Reorganized
Debtors experience a significant disruption of terms with vendors, margins fail
to improve, or the availability of capital is affected, compliance with
financial covenants and cash resources could be affected.
While the Debtors have succeeded in these Chapter 11 Cases in
reorganizing their capital structure, they have only begun, and not yet
completed, their operational restructuring. The Debtors believe that they will
succeed in implementing and executing their operational restructuring for the
benefit of all constituencies. However, there are risks that the goals of the
Debtors' go-forward business plan and operational restructuring strategy will
not be achieved. In such event, the Debtors may be forced to sell all or parts
of their business, develop and implement further restructuring plans not
contemplated herein, or become subject to further insolvency proceedings.
Because the claims of substantially all creditors will be converted into equity
in Reorganized Kmart under the Plan, in the event of further restructurings or
insolvency proceedings of Kmart, the equity interests of such persons could be
substantially diluted or even cancelled.
Finally, the Debtors' business plan was prepared by the Debtors'
present management in consultation with their advisors. As discussed herein, on
the Effective Date of the Plan, the Plan Investors could hold slightly in excess
of 50% of all shares of New Holding Company's common stock and will have the
right to select four (4) directors of the nine (9) member board of
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directors. The views of the board of the New Holding Company could be different
from those of existing management with respect to various business matters.
3. Competitive Conditions
In addition to uncertain economic and business conditions, the
Reorganized Debtors will likely face competitive pressures and other third party
actions, including pressures from pricing and other promotional activities of
competitors as well as new competitive store openings. The Reorganized Debtors'
anticipated operating performance will be impacted by these and other
unpredictable activities by competitors.
4. Other Factors
Other factors that holders of Claims should consider are potential
regulatory and legal developments that may impact the Debtors' business.
Although these and other such factors are beyond the Debtors' control and cannot
be determined in advance, they could have a significant impact on the
Reorganized Debtors' operating performance.
D. SEASONAL NATURE OF BUSINESS
Because of the seasonal nature of the Debtors' business and the retail
industry, merchandise sales and cash flows from operations are historically
higher in the fourth quarter than any other period. In addition, a
disproportionate amount of operating income and cash flows from operations are
earned in the fourth quarter. The Debtors' results of operations and cash flows
are primarily dependent upon the large sales volume generated during the fourth
quarter of the Debtors' fiscal year. In fiscal year 2001, for example, sales
during the fourth quarter represented over 30% of total net sales for the fiscal
year. Thus, operating performance for the interim periods is not necessarily
indicative of operating performance for the entire year.
In addition, weather conditions, including those which affect buying
patterns of the Debtors' customers, can have a significant impact on operating
performance for a particular season or fiscal year. As a result, depending on
the weather conditions during a peak shopping season or operating quarter,
operating performance may be positively or negatively impacted.
E. INHERENT UNCERTAINTY OF FINANCIAL PROJECTIONS
The Projections set forth in Appendix C annexed hereto cover the
operations of the Reorganized Debtors on a consolidated basis through fiscal
year 2007. These Projections are based on numerous assumptions including the
timing, confirmation, and consummation of the Plan in accordance with its terms,
the anticipated future performance of the Reorganized Debtors, general business
and economic conditions, and other matters, many of which are beyond the control
of the Reorganized Debtors and some or all of which may not materialize. In
addition, unanticipated events and circumstances occurring subsequent to the
date that this
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Disclosure Statement is approved by the Bankruptcy Court may affect the actual
financial results of the Debtors' operations.
Critical assumptions underlying the Debtors' five-year business plan
that will have a significant impact on the Reorganized Debtors' ability to
achieve projections, and that correspondingly have a material impact on value,
include the ability of the Company to (i) reverse significant comparable store
sales declines and achieve positive comparable store sales growth; (ii) improve
gross margins; (iii) reduce operating costs; and (iv) improve management of
working capital, including projected improvements in days payable outstanding.
The foregoing variations and assumptions may be material and may
adversely affect the ability of the Reorganized Debtors to make payments with
respect to post-Effective Date indebtedness and to achieve the Projections.
Because the actual results achieved throughout the periods covered by the
Projections can be expected to vary from the projected results, the Projections
should not be relied upon as a guaranty, representation, or other assurance that
the actual results will occur.
During the Chapter 11 Cases, the Debtors have not been able to
satisfactorily project their operating and financial performance, particularly
with respect to sales. Actual results achieved did not meet forecasts prepared
by the Company and shared with their Statutory Committees. The Debtors' gross
margin was significantly below the projections contained in the original Chapter
11 operating plan, and although certain covenants in the DIP Facility were re-
set pursuant to a new plan in September 2002 to lower such projections, the
Company missed these projections as well. The Debtors are still in the process
of developing and implementing a reliable mechanism for forecasting sales and
gross margin.
Except with respect to the Projections and except as otherwise
specifically and expressly stated herein, this Disclosure Statement does not
reflect any events that may occur subsequent to the date hereof and that may
have a material impact on the information contained in this Disclosure
Statement. Neither the Debtors nor the Reorganized Debtors intend to update the
Projections for the purposes hereof; thus, the Projections will not reflect the
impact of any subsequent events not already accounted for in the assumptions
underlying the Projections.
F. ACCESS TO FINANCING AND TRADE TERMS
The Debtors' operations are dependent on the availability and cost of
working capital financing and trade terms provided by vendors and may be
adversely affected by any shortage or increased cost of such financing and trade
vendor support. The Debtors' postpetition operations have been financed from
operating cash flow and borrowings pursuant to the DIP Facility. The Debtors
believe that substantially all of their needs for funds necessary to consummate
the Plan and for post-Effective Date working capital financing will be met by
projected operating cash flow, the Exit Financing Facility, and trade terms
supplied by vendors. Moreover, if the Debtors or the Reorganized Debtors require
working capital and trade financing greater than that provided by projected
operating cash flow, the Exit Financing Facility, and trade financing, they may
be required either to (a) obtain other sources of financing or (b) curtail their
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operations. The Debtors believe that the recapitalization to be accomplished
through the Plan will facilitate the ability to obtain additional or replacement
working capital financing.
No assurance can be given, however, that any additional replacement
financing will be available on terms that are favorable or acceptable to the
Debtors or the Reorganized Debtors. Kmart believes that it is important to its
go-forward business plan that its performance meet projected results in order to
ensure continued support from vendors and factors. There are risks to Kmart in
the event such support erodes after emergence from Chapter 11 that could be
alleviated by remaining in Chapter 11. Chapter 11 affords a debtor such as Kmart
the opportunity to close stores and liquidate assets relatively expeditiously,
tools that will not be available to Kmart upon emergence. However, the Debtors
believe that the benefits of emergence from Chapter 11 at this time outweigh the
potential costs of remaining in Chapter 11, and that emergence at this time is
in the long-term operational best interests of the Company.
G. CLAIMS ESTIMATIONS
There can be no assurance that the estimated Claim amounts set forth
herein are correct. The actual Allowed amount of Claims likely will differ in
some respect from the estimates. The estimated amounts are subject to certain
risks, uncertainties, and assumptions. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect, the
actual Allowed amount of Claims may vary from those estimated herein.
H. POTENTIAL DILUTION CAUSED BY OPTIONS OR WARRANTS
As stated above, the Management Compensation Plan may reserve for
certain members of management, directors, and other employees of the Reorganized
Debtors up to 10% of the shares of New Holding Company Common Stock, including
options or warrants to acquire such Stock upon terms outlined in the Management
Compensation Plan. Moreover, as noted above, the proposed agreement with Mr. Day
provides for a 10-year stock option to purchase a number of shares of common
stock representing 1.5% of the Reorganized Debtors' fully diluted equity at
emergence. Finally, ESL has certain options under the Investment Agreement to
purchase additional shares of New Holding Company Common Stock. If options or
warrants to purchase the New Holding Company Common Stock are exercised or other
equity interests are distributed to management as discussed above, such equity
interests will dilute the ownership percentage represented by the New Holding
Company Common Stock distributed on the Effective Date under the Plan.
I. MARKET FOR NEW SECURITIES
There can be no assurance that an active market for any of the
securities to be distributed pursuant to the Plan, including the New Holding
Company Common Stock, will develop and no assurance can be given as to the
prices at which such securities might be traded. Moreover, there can be no
assurances that the Reorganized Debtors will be successful in their attempt to
have the New Holding Company Common Stock listed on a national securities
exchange, a foreign securities exchange or a national quotation system such as
the Nasdaq National Market.
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The ultimate value of Reorganized Kmart will not be estimated until
such time as an active market for the New Holding Company Common Stock develops
and the securities begin to trade. The valuation of the Reorganized Debtors
could be substantially lower than that estimated by the Debtors in Appendix D to
this Disclosure Statement, and could be adversely impacted over time if the
Reorganized Debtors' business plan does not meet expectations or if factors
beyond the Reorganized Debtors' control materialize, including war, terrorist
attacks, recession, or further weakening of the economy. Because the Plan
provides for the waiver of all Avoidance Claims, other than Trust Claims, as of
the Effective Date, in any further insolvency proceedings of the Reorganized
Debtors, none of the value of such Avoidance Claims would be available for
distribution to creditors.
J. POTENTIAL OWNERSHIP CHANGE
Because the Plan Investors will hold a significant equity position in
the Reorganized Debtors following the consummation of the plan, if the Plan
Investors dispose of all or a significant amount of this position after the
Effective Date, it could cause the Reorganized Debtors to undergo an ownership
change (within the meaning of Internal Revenue Code section 382). This would
generally limit (or possibly eliminate) the Reorganized Debtors' ability to use
net operating losses and other tax attributes.
K. TAX PLANNING
Due to time and resource constraints resulting from the commencement of
the Chapter 11 Cases, the Debtors have used and may continue to use certain
estimating techniques in connection with their tax planning efforts (for
example, in determining the existence and magnitude of built-in gains or
losses). The use of such estimating techniques, while cost-effective,
necessarily results in lower confidence levels with respect to certain of the
tax analyses.
L. DIVIDENDS
The Debtors do not anticipate that cash dividends or other
distributions will be paid with respect to the New Holding Company Common Stock
in the foreseeable future.
M. IMPACT OF INTEREST RATES
Changes in interest rates and foreign exchange rates may affect the
fair market value of the Debtors' assets. Specifically, decreases in interest
rates will positively impact the value of the Debtors' assets and the
strengthening of the dollar will negatively impact the value of their net
foreign assets, although the value of such foreign assets is very small in
relation to the value of the Debtors' operations as a whole.
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IX. RESALE OF SECURITIES RECEIVED UNDER THE PLAN
A. ISSUANCE OF NEW COMMON STOCK
Section 1145(a)(1) of the Bankruptcy Code exempts the offer and sale of
securities under a plan of reorganization from registration under section 5 of
the Securities Act of 1933 (the "Securities Act") and state laws if three
principal requirements are satisfied: (i) the securities must be offered and
sold under a plan of reorganization and must be securities of the debtor, of an
affiliate participating in a joint plan with the debtor, or of a successor to
the debtor under the plan; (ii) the recipients of the securities must hold
prepetition or administrative expense claims against the debtor or interests in
the debtor; and (iii) the securities must be issued entirely in exchange for the
recipient's claim against or interest in the debtor, or principally in exchange
for such claims or interests and partly for cash or property. Except as noted
below, the Debtors believe that the offer and sale of the New Holding Company
Common Stock under the Plan to Claimholders satisfy the requirements of section
1145(a)(1) of the Bankruptcy Code and are, therefore, exempt from registration
under the Securities Act and state securities laws.
B. SUBSEQUENT TRANSFERS OF NEW COMMON STOCK
The New Holding Company Common Stock or other securities to be issued
pursuant to the Plan may be freely transferred by most recipients following
initial issuance under the Plan, and all resales and subsequent transactions in
the New Holding Company Common Stock or other securities so issued are exempt
from registration under federal and state securities laws, unless the holder is
an "underwriter" with respect to such securities. Section 1145(b) of the
Bankruptcy Code defines four types of "underwriters":
(i) persons who purchase a claim against, an interest in, or a
claim for an administrative expense against the debtor with a view to
distributing any security received in exchange for such claim or interest;
(ii) persons who offer to sell securities offered under a plan
for the holders of such securities;
(iii) persons who offer to buy such securities from the
holders of such securities, if the offer to buy is:
(A) with a view to distributing such securities; and
(B) under an agreement made in connection with the
plan, the consummation of the plan, or with the offer or sale of securities
under the plan; or
(iv) a person who is an "issuer" with respect to the
securities as the term "issuer" is defined in section 2(11) of the Securities
Act.
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Under section 2(11) of the Securities Act, an "issuer" includes any
person directly or indirectly controlling or controlled by the issuer, or any
person under direct or indirect common control of the issuer.
To the extent that Persons who receive New Holding Company Common Stock
pursuant to the Plan are deemed to be "underwriters," resales by such persons
would not be exempted by section 1145 of the Bankruptcy Code from registration
under the Securities Act or other applicable law. Persons deemed to be
underwriters would, however, be permitted to sell such New Holding Company
Common Stock or other securities without registration pursuant to the provisions
of Rule 144 under the Securities Act. These rules permit the public sale of
securities received by "underwriters" if current information regarding the
issuer is publicly available and if volume limitations and certain other
conditions are met.
Whether or not any particular person would be deemed to be an
"underwriter" with respect to the New Holding Company Common Stock or other
security to be issued pursuant to the Plan would depend upon various facts and
circumstances applicable to that person. Accordingly, the Debtors express no
view as to whether any particular Person receiving New Holding Company Common
Stock or other securities under the Plan would be an "underwriter" with respect
to such New Holding Company Common Stock or other securities.
Given the complex and subjective nature of the question of whether a
particular holder may be an underwriter, the Debtors make no representation
concerning the right of any person to trade in the New Holding Company Common
Stock or other securities. The Debtors recommend that potential recipients of
the New Holding Company Common Stock or other securities consult their own
counsel concerning whether they may freely trade New Holding Company Common
Stock or other securities without compliance with the Securities Act or the
Exchange Act.
X. CERTAIN FEDERAL INCOME
TAX CONSEQUENCES OF THE PLAN
A summary description of certain United States federal income tax
consequences of the Plan is provided below. This description is for
informational purposes only and, due to a lack of definitive judicial or
administrative authority or interpretation, substantial uncertainties exist with
respect to various tax consequences of the Plan as discussed herein. Only the
principal United States federal income tax consequences of the Plan to the
Debtors and to Claimholders who are entitled to vote to accept or reject the
Plan are described below. No opinion of counsel has been sought or obtained with
respect to any tax consequences of the Plan. No rulings or determinations of the
Internal Revenue Service (the "IRS") or any other tax authorities have been
sought or obtained with respect to any tax consequences of the Plan, and the
discussion below is not binding upon the IRS or such other authorities. No
representations are being made regarding the particular tax consequences of the
confirmation and consummation of the Plan to the Debtors or any Claimholder. No
assurance can be given that the IRS would not assert, or that a court would not
sustain, a different position from any discussed herein.
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The discussion of United States federal income tax consequences below
is based on the Internal Revenue Code of 1986, as amended (the "IRC"), Treasury
Regulations, judicial authorities, published positions of the IRS and other
applicable authorities, all as in effect on the date of this document and all of
which are subject to change or differing interpretations (possibly with
retroactive effect).
The following discussion does not address foreign, state or local tax
consequences of the Plan, nor does it purport to address the United States
federal income tax consequences of the Plan to special classes of taxpayers
(e.g., banks and certain other financial institutions, insurance companies,
tax-exempt organizations, governmental entities, the Plan Investors, persons
that are, or hold their Claims through, pass-through entities, persons whose
functional currency is not the United States dollar, foreign persons, dealers in
securities or foreign currency, employees, persons who received their Claims
pursuant to the exercise of an employee stock option or otherwise as
compensation and persons holding Claims that are a hedge against, or that are
hedged against, currency risk or that are part of a straddle, constructive sale
or conversion transaction). Furthermore, the following discussion does not
address United States federal taxes other than income taxes.
Each holder is strongly urged to consult its own tax advisor regarding
the United States federal, state, and local and any foreign tax consequences of
the transactions described herein and in the Plan.
A. UNITED STATES FEDERAL INCOME TAX CONSEQUENCES TO THE DEBTORS
1. Cancellation of Indebtedness Income.
Upon implementation of the Plan, the amount of the Debtors' aggregate
outstanding indebtedness will be substantially reduced. In general, the
discharge of a debt obligation in exchange for an amount of cash and other
property having a fair market value (or, in the case of a new debt instrument,
an "issue price") less than the "adjusted issue price" of the debt gives rise to
cancellation of indebtedness ("COD") income to the debtor. However, COD income
is not taxable to the debtor if the debt discharge occurs in a Title 11
bankruptcy case. Rather, under the IRC, such COD income instead will reduce
certain of the Debtors' tax attributes, generally in the following order: (a)
net operating losses ("NOLs") and NOL carryforwards; (b) general business credit
carryforwards; (c) minimum tax credit carryforwards; (d) capital loss
carryforwards; (e) the tax basis of the Debtors' depreciable and nondepreciable
assets (but not below the amount of its liabilities immediately after the
discharge); and (f) foreign tax credit carryforwards. A debtor may elect to
alter the preceding order of attribute reduction and, instead, first reduce the
tax basis of its depreciable assets (and, possibly, the depreciable assets of
its subsidiaries). The reduction in tax attributes occurs only after the tax for
the year of the debt discharge has been determined (i.e., such attributes may be
available to offset taxable income that accrues between the date of discharge
and the end of the Debtors' tax year). Any excess COD income over the amount of
available tax attributes is not subject to United States federal income tax and
has no other United States federal income tax impact.
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Because some of the Debtors' outstanding indebtedness will be satisfied
in exchange for New Holding Company Common Stock, the amount of COD income, and
accordingly the amount of tax attributes required to be reduced, will depend in
part on the fair market value of the New Holding Company Common Stock. This
value cannot be known with certainty until after the Effective Date. Thus,
although it is expected that the Debtors will be required to reduce their tax
attributes, the exact amount of such reduction cannot be predicted.
2. Net Operating Losses--Section 382.
The Debtors anticipate that they will experience an "ownership change"
(within the meaning of IRC section 382) on the Effective Date as a result of the
issuance of New Holding Company Common Stock to Claimholders and the Plan
Investors pursuant to the Plan. As a result, the Debtors' ability to use any
pre-Effective Date NOLs or other tax attributes to offset their income in any
post-Effective Date taxable year (and in the portion of the taxable year of the
ownership change following the Effective Date) to which such a carryforward is
made generally (subject to various exceptions and adjustments, some of which are
described below) will be limited to the sum of (a) a regular annual limitation
(prorated for the portion of the taxable year of the ownership change following
the Effective Date), (b) the amount of the "recognized built-in gain" for the
year which does not exceed the excess of their "net unrealized built-in gain,"
if any, over previously recognized built-in gains (as the quoted terms are
defined in IRC section 382(h)), and (c) any carryforward of unused amounts
described in (a) and (b) from prior years. IRC section 382 may also limit the
Debtors' ability to use "net unrealized built-in losses" to offset future
taxable income. Moreover, the Debtors' loss carryforwards will be subject to
further limitations if the Debtors experience additional future ownership
changes or if they do not continue their business enterprise for at least two
years following the Effective Date. The Debtors may not have any meaningful
pre-Effective Date NOLs following the Effective Date.
The operation and effect of IRC section 382 would be materially
different from that just described if the Debtors are subject to the special
rules for corporations in bankruptcy provided in IRC section 382(l)(5). In that
case, the Debtors' ability to utilize their pre-Effective Date NOLs would not be
limited as described in the preceding paragraph. However, several other
limitations would apply to the Debtors under IRC section 382(l)(5), including
(a) the Debtors' NOLs would be calculated without taking into account deductions
for interest paid or accrued in the portion of the current tax year ending on
the Effective Date and all other tax years ending during the three-year period
prior to the current tax year with respect to the Claims that are exchanged for
New Holding Company Common Stock pursuant to the Plan, and (b) if the Debtors
undergo another ownership change within two years after the Effective Date, the
Debtors' IRC section 382 limitation with respect to that ownership change will
be zero. It appears unlikely at this time that the provisions of IRC section
382(l)(5) would apply in the case of the ownership change that is expected to
occur as a result of the confirmation of the Plan. However, under IRC section
382(1)(5)(H), the Debtors may elect not to have the special rules of IRC section
382(l)(5) apply (in which case the IRC section 382 rules, described above,
generally will apply). The Debtors have not yet determined whether they would
elect to have the IRC section 382(l)(5) rules apply to the ownership change
arising from the consummation of the Plan (assuming IRC section 382(l)(5) would
otherwise apply).
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Because the Plan Investors will hold a significant equity position in
the Reorganized Debtors following the consummation of the plan, if the Plan
Investors dispose of all or a significant amount of this position after the
Effective Date, it could cause the Reorganized Debtors to undergo an ownership
change. This would generally limit (or possibly eliminate) the Reorganized
Debtors' ability to use NOLs and other tax attributes.
B. FEDERAL INCOME TAX CONSEQUENCES TO CLAIMHOLDERS AND INTERESTHOLDERS OF
THE DEBTORS
The following discusses certain United States federal income tax
consequences of the transactions contemplated by the Plan to Claimholders and
Interestholders that are "United States holders," as defined below. The United
States federal income tax consequences of the transactions contemplated by the
Plan to Claimholders (including the character, timing and amount of income, gain
or loss recognized) will depend upon, among other things, (1) whether the Claim
and the consideration received in respect thereof are "securities" for federal
income tax purposes; (2) the manner in which a holder acquired a Claim; (3) the
length of time the Claim has been held; (4) whether the Claim was acquired at a
discount; (5) whether the holder has taken a bad debt deduction with respect to
the Claim (or any portion thereof) in the current or prior years; (6) whether
the holder has previously included in its taxable income accrued but unpaid
interest with respect to the Claim; (7) the holder's method of tax accounting;
and (8) whether the Claim is an installment obligation for federal income tax
purposes. Therefore, Claimholders should consult their own tax advisors for
information that may be relevant to their particular situations and
circumstances and the particular tax consequences to them of the transactions
contemplated by the Plan. This discussion assumes that the holder has not taken
a bad debt deduction with respect to a Claim (or any portion thereof) in the
current or any prior year and such Claim did not become completely or partially
worthless in a prior taxable year. Moreover, the Debtors intend to claim
deductions to the extent they are permitted to deduct any amounts they pay in
cash, stock or other property pursuant to the Plan.
For purposes of the following discussion, a "United States holder" is a
Claimholder that is (1) a citizen or individual resident of the United States,
(2) a partnership or corporation created or organized in the United States or
under the laws of the United States or any political subdivision thereof, (3) an
estate the income of which is subject to United States federal income taxation
regardless of its source, or (4) a trust if (i) a court within the United States
is able to exercise primary supervision over the administration of the trust and
one or more United States fiduciaries have the authority to control all
substantial decisions of the trust or (ii) the trust was in existence on August
20, 1996 and properly elected to be treated as a United States person.
1. Holders of Secured Claims.
The holders of Secured Claims may recognize income, gain or loss for
United States federal income tax purposes with respect to the discharge of their
Claims, depending on whether their Claims are reinstated or, if not reinstated,
on the outcome of their negotiations with the Debtors. A holder whose Secured
Claim is reinstated pursuant to the Plan will not recognize gain or loss unless
either (i) such holder is treated as having received interest, damages or other
income in connection with the reinstatement or (ii) such reinstatement is
considered a "significant
137
modification" of the Claim. A holder who receives cash or other property in
exchange for its Claim pursuant to the Plan will generally recognize income,
gain or loss for United States federal income tax purposes in an amount equal to
the difference between (i) the amount of cash or fair market value of other
property, if any, received in exchange for its Claim and (ii) the holder's
adjusted tax basis in its Claim. The character of such gain or loss as capital
gain or loss or as ordinary income or loss will be determined by a number of
factors, including the tax status of the holder, the nature of the Claim in such
holder's hands, whether the Claim constitutes a capital asset in the hands of
the holder, whether the Claim was purchased at a discount, and whether and to
what extent the holder has previously claimed a bad debt deduction with respect
to its Claim.
(a) Accrued Interest
Under the Plan, cash or other property may be distributed or deemed
distributed to certain Claimholders with respect to their Claims for accrued
interest. Holders of Claims for accrued interest which previously have not
included such accrued interest in taxable income will be required to recognize
ordinary income equal to the amount of cash or other property received with
respect to such Claims for accrued interest. Holders of Claims for accrued
interest which have included such accrued interest in taxable income generally
may take an ordinary deduction to the extent that such Claim is not fully
satisfied under the Plan (after allocating the distribution between principal
and accrued interest), even if the underlying Claim is held as a capital asset.
The adjusted tax basis of any property received in exchange for Claim for
accrued interest will equal the fair market value of such property on the
Effective Date, and the holding period for the property will begin on the day
after the Effective Date. The extent to which consideration distributable under
the Plan is allocable to interest is not clear. Claimholders are advised to
consult their own tax advisors to determine the amount, if any, of consideration
received under the Plan that is allocable to interest.
(b) Market Discount
The market discount provisions of the IRC may apply to holders of
certain Claims. In general, a debt obligation other than a debt obligation with
a fixed maturity of one year or less that is acquired by a holder in the
secondary market (or, in certain circumstances, upon original issuance) is a
"market discount bond" as to that holder if its stated redemption price at
maturity (or, in the case of a debt obligation having original issue discount,
the revised issue price) exceeds the adjusted tax basis of the bond in the
holder's hands immediately after its acquisition. However, a debt obligation
will not be a "market discount bond" if such excess is less than a statutory de
minimis amount. Gain recognized by a creditor with respect to a "market discount
bond" will generally be treated as ordinary interest income to the extent of the
market discount accrued on such bond during the creditor's period of ownership,
unless the creditor elected to include accrued market discount in taxable income
currently. A holder of a market discount bond that is required under the market
discount rules of the IRC to defer deduction of all or a portion of the interest
on indebtedness incurred or maintained to acquire or carry the bond may be
allowed to deduct such interest, in whole or in part, on disposition of such
bond.
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2. Holders of Other Priority Claims and Prepetition Lender
Claims.
A holder whose Claim is paid in full or otherwise discharged on the
Effective Date will recognize income, gain or loss for United States federal
income tax purposes in an amount equal to the difference between (i) the amount
of cash received by such holder in respect of its Claim and (ii) the holder's
adjusted tax basis in the Claim. The character of such gain or loss as capital
gain or loss or as ordinary income or loss will be determined by a number of
factors, including the tax status of the holder, the nature of the Claim in such
holder's hands, whether the Claim constitutes a capital asset in the hands of
the holder, whether the Claim was purchased at a discount, and whether and to
what extent the holder has previously claimed a bad debt deduction with respect
to its Claim. A holder recognizing a loss as a result of the Plan may be
entitled to a bad debt deduction, either in the taxable year of the Effective
Date or a prior taxable year. In addition, the rules summarized above with
respect to accrued interest and market discount may also apply with respect to
the receipt of cash in discharge of a holder's Other Priority Claim or
Prepetition Lender Claim.
3. Holders of Non-Lender Claims.
A holder of Non-Lender Claims that receives New Holding Company Common
Stock and an interest in the Kmart Creditor Trust in exchange for its Claim
pursuant to the Plan will generally recognize income, gain or loss for United
States federal income tax purposes in an amount equal to the difference between
(1) the fair market value on the Effective Date of the New Holding Company
Common Stock received, plus the fair market value, if any, on the Effective Date
of its pro rata share of the Trust Assets deemed received, in exchange for its
Claim, and (2) the holder's adjusted tax basis in its Claim. The character of
such gain or loss as capital gain or loss or as ordinary income or loss will be
determined by a number of factors, including the tax status of the holder, the
nature of the Claim in such holder's hands, whether the Claim constitutes a
capital asset in the hands of the holder, whether the Claim was purchased at a
discount, and whether and to what extent the holder has previously claimed a bad
debt deduction with respect to its Claim. A holder recognizing a loss as a
result of the Plan may be entitled to a bad debt deduction, either in the
taxable year of the Effective Date or a prior taxable year. In addition, the
rules summarized above with respect to accrued interest and market discount may
also apply with respect to the receipt of New Holding Company Common Stock and
interests in the Kmart Creditor Trust in discharge of a holder's Non-Lender
Claim. A holder's aggregate tax basis in the New Holding Company Common Stock
and interest in the Kmart Creditor Trust it receives pursuant to the Plan would
generally be equal to the aggregate fair market value on the Effective Date of
such stock and its pro rata share of the Trust Assets. The holding period for
the New Holding Company Common Stock and the interest in the Kmart Creditor
Trust would begin on the day after the Effective Date.
4. Holders of Other Unsecured Claims.
Holders of Other Unsecured Claims who make the Other Unsecured Claim
Election will be treated as holders of Non-Lender Claims and will have the tax
consequences described above under the heading, "Holders of Non-Lender Claims."
Holders of Other Unsecured Claims who do not make the Other Unsecured Claim
Election will receive under the Plan a pro rata portion of the Other Unsecured
Claim Cash Payment Amount, which will be paid in cash on
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the third anniversary of the Effective Date. On the date that such an Other
Unsecured Claim becomes an Allowed Other Unsecured Claim or otherwise becomes
payable, a holder not making the election will recognize income, gain or loss
for United States federal income tax purposes in an amount equal to the
difference between (i) the fair market value, if any, of its pro rata portion of
the Other Unsecured Claim Cash Payment Amount and (ii) the holder's adjusted tax
basis in the Claim. The character of such gain or loss as capital gain or loss
or as ordinary income or loss will be determined by a number of factors,
including the tax status of the holder, the nature of the Claim in such holder's
hands, whether the Claim constitutes a capital asset in the hands of the holder,
whether the Claim was purchased at a discount, and whether and to what extent
the holder has previously claimed a bad debt deduction with respect to its
Claim. A holder recognizing a loss as a result of the Plan may be entitled to a
bad debt deduction. In addition, the rules summarized above with respect to
accrued interest and market discount may also apply with respect to the receipt
of a pro rata portion of the Other Unsecured Claim Cash Payment Amount in
discharge of a holder's Other Unsecured Claim. A holder will generally have a
tax basis in its pro rata portion of the Other Unsecured Claim Cash Payment
Amount received in exchange for its Other Unsecured Claims equal to its fair
market value, if any. Interest on the Other Unsecured Claim Cash Payment Amount
will be taxable to a holder as ordinary income at the time it is received or
accrued depending on the holder's method of accounting for United States federal
income tax purposes.
5. Holders of General Unsecured Convenience Claims.
A holder of General Unsecured Convenience Claims that receives cash in
discharge of its Claim pursuant to the Plan will generally recognize income,
gain or loss for United States federal income tax purposes in an amount equal to
the difference between (i) the amount of cash received in exchange for its Claim
and (ii) the holder's adjusted tax basis in its Claim. The character of such
gain or loss as capital gain or loss or as ordinary income or loss will be
determined by a number of factors, including the tax status of the holder, the
nature of the Claim in such holder's hands, whether the Claim constitutes a
capital asset in the hands of the holder, whether the Claim was purchased at a
discount, and whether and to what extent the holder has previously claimed a bad
debt deduction with respect to its Claim. A holder recognizing a loss as a
result of the Plan may be entitled to a bad debt deduction, either in the
taxable year of the Effective Date or a prior taxable year. In addition, the
rules summarized above with respect to accrued interest and market discount may
also apply with respect to the receipt of cash in discharge of a holder's
General Unsecured Convenience Claim.
6. Holders of Subordinated Securities Claims.
A holder of Subordinated Securities Claims will recognize income, gain
or loss for United States federal income tax purposes in an amount equal to the
difference between (i) the fair market value, if any, on the Effective Date of
its pro rata share of the Trust Assets deemed received by such holder, if any,
under the Plan and (ii) the holder's adjusted tax basis in the Claim. The
character of such gain or loss as capital gain or loss or as ordinary income or
loss will be determined by a number of factors, including the tax status of the
holder, the nature of the Claim in such holder's hands, whether the Claim
constitutes a capital asset in the hands of the holder, whether the Claim was
purchased at a discount, and whether and to what extent the
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holder has previously claimed a bad debt deduction with respect to its Claim. A
holder recognizing a loss as a result of the Plan may be entitled to a bad debt
deduction, either in the taxable year of the Effective Date or a prior taxable
year. In addition, the rules summarized above with respect to accrued interest
and market discount may also apply with respect to the receipt of an interest in
the Kmart Creditor Trust in discharge of a holder's Subordinated Securities
Claim. A holder that receives an interest in the Kmart Creditor Trust pursuant
to the Plan would have a tax basis in its interest that would generally be equal
to the fair market value on the Effective Date of its pro rata share of the
Trust Assets. The holding period for the interest in the Kmart Creditor Trust
would begin on the day after the Effective Date.
7. Existing Interestholders.
An existing Interestholder who holds existing common stock of Kmart
will generally recognize gain or loss for United States federal income tax
purposes in an amount equal to the difference between (i) the fair market value,
if any, on the Effective Date of its pro rata share of the Trust Assets deemed
received by such Interestholder, if any, under the Plan and (ii) such
stockholder's adjusted tax basis in its existing common stock cancelled under
the Plan. The character of such loss as capital loss or as ordinary loss will be
determined by a number of factors, including the tax status of the holder and
whether the Interestholder holds its common stock of Kmart as a capital asset.
An Interestholder that receives an interest in the Kmart Creditor Trust pursuant
to the Plan would have a tax basis in its interest that would generally be equal
to the fair market value on the Effective Date of its pro rata share of the
Trust Assets. The holding period for the interest in the Kmart Creditor Trust
would begin on the day after the Effective Date.
8. Other Interests.
A holder of an Other Interest that is deemed cancelled under the Plan
will recognize a loss for United States federal income tax purposes in an amount
equal to such holder's adjusted tax basis in the Interest. The character of such
loss as capital loss or as ordinary loss will be determined by a number of
factors, including the tax status of the holder and whether the holder holds its
Other Interest as a capital asset.
9. Other Claimholders.
To the extent certain Claimholders reach an agreement with the Debtors
to have their Claims satisfied, settled, released, exchanged or otherwise
discharged in a manner other than as discussed above, such holders should
consult with their own tax advisors regarding the tax consequences to them of
such treatment.
10. Information Reporting and Backup Withholding.
Certain payments, including payments in respect of accrued interest or
market discount, are generally subject to information reporting by the payor to
the IRS. Moreover, such reportable payments are subject to backup withholding
under certain circumstances. Under the IRC's backup withholding rules, a United
States holder may be subject to backup withholding at
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the applicable rate with respect to certain distributions or payments pursuant
to the Plan, unless the holder (a) comes within certain exempt categories (which
generally include corporations) and, when required, demonstrates this fact or
(b) provides a correct United States taxpayer identification number and
certifies under penalty of perjury that the holder is a U.S. person, the
taxpayer identification number is correct and that the holder is not subject to
backup withholding because of a failure to report all dividend and interest
income.
Backup withholding is not an additional tax. Amounts withheld under the
backup withholding rules may be credited against a holder's United States
federal income tax liability, and a holder may obtain a refund of any excess
amounts withheld under the backup withholding rules by filing an appropriate
claim for refund with the IRS.
C. IMPORTANCE OF OBTAINING PROFESSIONAL TAX ASSISTANCE
THE FOREGOING DISCUSSION IS INTENDED ONLY AS A SUMMARY OF CERTAIN
INCOME TAX CONSEQUENCES OF THE PLAN AND IS NOT A SUBSTITUTE FOR CAREFUL TAX
PLANNING WITH A TAX PROFESSIONAL. THE ABOVE DISCUSSION IS FOR INFORMATIONAL
PURPOSES ONLY AND IS NOT TAX ADVICE. THE TAX CONSEQUENCES ARE IN MANY CASES
UNCERTAIN AND MAY VARY DEPENDING ON A CLAIM HOLDER'S PARTICULAR CIRCUMSTANCES.
ACCORDINGLY, CLAIM HOLDERS ARE STRONGLY URGED TO CONSULT THEIR TAX ADVISORS
ABOUT THE UNITED STATES FEDERAL, STATE, LOCAL, AND APPLICABLE FOREIGN INCOME AND
OTHER TAX CONSEQUENCES OF THE PLAN, INCLUDING WITH RESPECT TO TAX REPORTING AND
RECORD KEEPING REQUIREMENTS.
XI. FEASIBILITY OF THE PLAN AND THE BEST INTERESTS TEST
A. FEASIBILITY OF THE PLAN
To confirm the Plan, the Bankruptcy Court must find that confirmation
of the Plan is not likely to be followed by the liquidation or the need for
further financial reorganization of the Debtors. This requirement is imposed by
Section 1129(a)(11) of the Bankruptcy Code and is referred to as the
"feasibility" requirement. The Debtors believe that they will be able to timely
perform all obligations described in the Plan, and, therefore, that the Plan is
feasible.
To demonstrate the feasibility of the Plan, the Debtors have prepared
financial Projections for Fiscal Years 2003 through 2007, as set forth in
Appendix C attached to this Disclosure Statement. The Projections indicate that
the Reorganized Debtors should have sufficient cash flow to pay and service
their debt obligations and to fund their operations. Accordingly, the Debtors
believe that the Plan satisfies the feasibility requirement of Section
1129(a)(11) of the Bankruptcy Code. As noted in the Projections, however, the
Debtors caution that no representations can be made as to the accuracy of the
Projections or as to the Reorganized Debtors' ability to achieve the projected
results. Many of the assumptions upon which the Projections are based are
subject to uncertainties outside the control of the Debtors.
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Some assumptions inevitably will not materialize, and events and circumstances
occurring after the date on which the Projections were prepared may be different
from those assumed or may be unanticipated, and may adversely affect the
Debtors' financial results. Therefore, the actual results can be expected to
vary from the projected results and the variations may be material and adverse.
See Section VIII, "Certain Factors to Be Considered," for a discussion of
certain risk factors that may affect financial feasibility of the Plan.
THE PROJECTIONS WERE NOT PREPARED WITH A VIEW TOWARD COMPLIANCE WITH
THE GUIDELINES ESTABLISHED BY THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC
ACCOUNTANTS, THE PRACTICES RECOGNIZED TO BE IN ACCORDANCE WITH GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES, OR THE RULES AND REGULATIONS OF THE SECURITIES
AND EXCHANGE COMMISSION REGARDING PROJECTIONS. FURTHERMORE, THE PROJECTIONS HAVE
NOT BEEN AUDITED BY THE DEBTORS' INDEPENDENT ACCOUNTANTS. ALTHOUGH PRESENTED
WITH NUMERICAL SPECIFICITY, THE PROJECTIONS ARE BASED UPON A VARIETY OF
ASSUMPTIONS, SOME OF WHICH IN THE PAST HAVE NOT BEEN ACHIEVED AND WHICH MAY NOT
BE REALIZED IN THE FUTURE, AND ARE SUBJECT TO SIGNIFICANT BUSINESS, ECONOMIC AND
COMPETITIVE UNCERTAINTIES AND CONTINGENCIES, MANY OF WHICH ARE BEYOND THE
CONTROL OF THE DEBTORS. CONSEQUENTLY, THE PROJECTIONS SHOULD NOT BE REGARDED AS
A REPRESENTATION OR WARRANTY BY THE DEBTORS, OR ANY OTHER PERSON, THAT THE
PROJECTIONS WILL BE REALIZED. ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE
PRESENTED IN THE PROJECTIONS.
B. ACCEPTANCE OF THE PLAN
As a condition to confirmation, the Bankruptcy Code requires that each
Class of Impaired Claims and Interests vote to accept the Plan, except under
certain circumstances. Section 1126(c) of the Bankruptcy Code defines acceptance
of a plan by a class of Impaired Claims as acceptance by holders of at least
two-thirds in dollar amount and more than one-half in number of Claims in that
Class, but for that purpose counts only those who actually vote to accept or to
reject the Plan. Thus, a Class of Claims will have voted to accept the Plan only
if two-thirds in amount and a majority in number actually voting cast their
Ballots in favor of acceptance. Under Section 1126(d) of the Bankruptcy Code, a
Class of Interests has accepted the Plan if holders of such Interests holding at
least two-thirds in amount actually voting have voted to accept the Plan.
Holders of Claims or Interests who fail to vote are not counted as either
accepting or rejecting the Plan.
C. BEST INTERESTS TEST
Even if a plan is accepted by each class of holders of claims and
interests, the Bankruptcy Code requires a bankruptcy court to determine that the
plan is in the "best interests" of all holders of claims and interests that are
impaired by the plan and that have not accepted the plan. The "best interests"
test, as set forth in Section 1129(a)(7) of the Bankruptcy Code, requires a
bankruptcy court to find either that (i) all members of an impaired class of
claims or
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interests have accepted the plan or (ii) the plan will provide a member who has
not accepted the plan with a recovery of property of a value, as of the
effective date of the plan, that is not less than the amount that such holder
would recover if the debtor were liquidated under Chapter 7 of the Bankruptcy
Code.
To calculate the probable distribution to members of each impaired
class of holders of claims and interests if the debtor were liquidated under
Chapter 7, a bankruptcy court must first determine the aggregate dollar amount
that would be generated from the debtor's assets if its Chapter 11 case were
converted to a Chapter 7 case under the Bankruptcy Code. This "liquidation
value" would consist primarily of the proceeds from a forced sale of the
debtor's assets by a Chapter 7 trustee.
The amount of liquidation value available to unsecured creditors would
be reduced by, first, the claims of secured creditors to the extent of the value
of their collateral, including the value of goods delivered on consignment to
the extent the consignment vendor properly perfected its rights in such goods in
accordance with applicable law, and, second, by the costs and expenses of
liquidation, as well as by other administrative expenses and costs of both the
Chapter 7 case and the Chapter 11 case. As a general matter, a liquidation under
Chapter 7 will not affect the rights of letter of credit beneficiaries,
including certain sureties who posted bonds that the Debtors purchased for
various business, litigation, and other reasons. Costs of liquidation under
Chapter 7 of the Bankruptcy Code would include the compensation of a trustee, as
well as of counsel and other professionals retained by the trustee, asset
disposition expenses, all unpaid expenses incurred by the debtor in its
bankruptcy case (such as compensation of attorneys, financial advisors, and
restructuring consultants) that are allowed in the Chapter 7 case, litigation
costs, and claims arising from the operations of the debtor during the pendency
of the bankruptcy case. The liquidation itself would trigger certain priority
payments that otherwise would be due in the ordinary course of business. Those
priority claims would be paid in full from the liquidation proceeds before the
balance would be made available to pay general unsecured claims or to make any
distribution in respect of equity interests. The liquidation also would prompt
the rejection of a large number of executory contracts and unexpired leases and
thereby create a significantly higher number of unsecured claims. As a general
matter, a liquidation under Chapter 7 will not affect the rights of letter of
credit beneficiaries, including certain sureties who posted bonds that the
Debtors purchased for various business, litigation, and other reasons.
Once the court ascertains the recoveries in liquidation of secured
creditors and priority claimants, it must determine the probable distribution to
general unsecured creditors and equity security holders from the remaining
available proceeds in liquidation. If such probable distribution has a value
greater than the distributions to be received by such creditors and equity
security holders under a debtor's plan, then such plan is not in the best
interests of creditors and equity security holders.
D. ESTIMATED VALUATION OF THE REORGANIZED DEBTORS
A copy of the reorganization valuation analysis is attached to this
Disclosure Statement as Appendix D.
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E. APPLICATION OF THE BEST INTERESTS TEST TO THE LIQUIDATION ANALYSIS AND
THE VALUATION OF THE REORGANIZED DEBTORS
1. Overview
A liquidation analysis prepared with respect to the Debtors is attached
as Appendix B to this Disclosure Statement. The Debtors believe that any
liquidation analysis is speculative. For example, the liquidation analysis
necessarily contains an estimate of the amount of Claims which will ultimately
become Allowed Claims. In preparing the liquidation analysis, the Debtors have
projected the amount of Allowed Claims based upon a review of their scheduled
and filed proofs of claim. No order or finding has been entered by the
Bankruptcy Court estimating or otherwise fixing the amount of Claims at the
projected amounts of Allowed Claims set forth in the liquidation analysis. In
preparing the liquidation analysis, the Debtors have projected a range for the
amount of Allowed Claims with the low end of the range the lowest reasonable
amount of Claims and the high end of the range the highest reasonable amount of
the Claims, thus allowing assessment of the most likely range of Chapter 7
liquidation dividends to the holders of the Allowed Claims. The estimate of the
amount of Allowed Claims set forth in the liquidation analysis should not be
relied on for any other purpose, including, without limitation, any
determination of the value of any distribution to be made on account of Allowed
Claims and Interests under the Plan. In addition, as noted above, the valuation
analysis of the Reorganized Debtors also contains numerous estimates and
assumptions. For example, the value of the New Holding Company Common Stock
cannot be determined with precision due to the absence of a public market for
the New Holding Company Common Stock.
Notwithstanding the difficulties in quantifying recoveries to creditors
with precision, the Debtors believe that, taking into account the liquidation
analysis and the valuation analysis of the Reorganized Debtors, the Plan meets
the "best interests" test of Section 1129(a)(7) of the Bankruptcy Code. The
Debtors believe that the members of each Impaired Class will receive at least as
much under the Plan than they would in a liquidation in a hypothetical chapter 7
case. Creditors and Interestholders will receive a better recovery through the
distributions contemplated by the Plan because the continued operation of the
Debtors as going concerns rather than a forced liquidation will allow the
realization of more value for the Debtors' assets. Moreover, creditors such as
the Debtors' employees would retain their jobs and most likely make few if any
other claims against the estate. Lastly, in the event of liquidation, the
aggregate amount of unsecured claims will no doubt increase significantly (as
reflected in the high range estimate), and such claims will be subordinated to
priority claims that will be created. For example, employees will file claims
for wages, pensions and other benefits, some of which will be entitled to
priority. Landlords will no doubt file large claims for both unsecured and
priority amounts. The resulting increase in both general unsecured and priority
claims will decrease percentage recoveries to unsecured creditors of the
Debtors. All of these factors lead to the conclusion that recoveries under the
Plan would be at least as much, and in many cases significantly greater, than
the recoveries available in a Chapter 7 liquidation.
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2. Comparison of Liquidation Analysis and Valuation Analysis.
The liquidation analysis attached hereto as Appendix B contains two
separate analyses: (i) a consolidated analysis and (ii) a de-consolidated
analysis. The consolidated analysis assumes that the Debtors are substantively
consolidated and that creditors share in the proceeds of all of the Debtors'
assets without regard to (a) the separate legal identity of each Debtor and (b)
which Debtors are obligated on particular claims. The de-consolidated analysis
assumes that the Debtors are liquidated through two entities. One of the
de-consolidated entities is the entity containing claims on account of the
Subsidiary Guaranties (the "Guarantee Entity") of the Prepetition Lender Claims.
As discussed above, the Prepetition Lenders and the PBGC are the primary
creditors of each of the Kmart of [] Subsidiaries. The Prepetition Lenders'
claims arise out of the guarantees of Kmart's indebtedness to the Prepetition
Lenders executed by the Kmart of [] Subsidiaries, and the PBGC's claims arise
out of joint and several liability of each of the Debtors to the PBGC under
applicable non-bankruptcy law. The Kmart of [] Subsidiaries do not have any
other material unsecured debt. The Guarantee Entity contains the five Kmart of
[] Subsidiaries as well as Bluelight.com LLC. The second de-consolidated entity
is the entity containing all Debtors that are not obligated on the Guaranties.
In a de-consolidated liquidation, the Prepetition Lenders and the PBGC
would be entitled to be paid in full from the proceeds of asset liquidations of
the Kmart of [] Subsidiaries before creditors of any of the other Debtors would
be entitled to any such proceeds. In a consolidated liquidation, however, the
Prepetition Lenders and the PBGC's separate claims against the Kmart of []
Subsidiaries would be deemed a single claim against the consolidated Debtors'
assets and would share in distributions with all other unsecured creditors of
each of the other Debtors. As a consequence, the estimated recovery of the
Prepetition Lenders and the PBGC, based on the assumptions contained in the
attached liquidation analysis, is higher in the de-consolidated scenario - 16%
to 21% for the Prepetition Lenders and 16% to 20% for the PBGC - and lower in
the consolidated scenario - 2% to 5% for the Prepetition Lenders and 2% to 4%
for the PBGC. Correspondingly, the recoveries of other unsecured creditors based
on such assumptions is lower in the de-consolidated scenario - 0% to 2% for
Prepetition Notes and 1% to 2% for general unsecured creditors - and higher in
the consolidated scenario - 2% to 5% for Prepetition Notes and 2% to 4% for
general unsecured creditors.
As explained above, any litigation concerning the substantive
consolidation of the Debtors would be exceptionally complicated and protracted,
and given the magnitude of the values involved and the amount of claims at
stake, would be hotly contested and expensive. Such litigation would in turn
substantially prolong these Chapter 11 Cases, which most constituencies believe
is not in the best interests of the estates or Kmart's long-term prospects for
rehabilitation. The outcome of any such litigation is not free from doubt. For
these reasons, the Debtors, the Prepetition Lenders, the Creditors' Committee,
and the Financial Institutions' Committee believe that the settlement
contemplated by the Plan is in the best interests of the estate and should be
approved.
More importantly, regardless of the outcome of any substantive
consolidation litigation, the valuation analysis attached hereto as Appendix E
leads to the conclusion that recoveries under the Plan would be at least as
much, and in many cases significantly greater, than the recoveries available in
a Chapter 7 liquidation, whether such liquidation were conducted on a
consolidated or de-consolidated basis. In particular, the Debtors estimate that
under the Plan,
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holders of Prepetition Lender Claims (other than ESL) will receive value equal
to 40% of their Claim; that holders of Prepetition Note Claims will receive
value equal to 14.4% of their Claims, and that holders of Trade Vendor/Lease
Rejection Claims and other Unsecured Claims will receive value equal to 9.7% of
their Claims.
F. CONFIRMATION WITHOUT ACCEPTANCE OF ALL IMPAIRED CLASSES: THE
'CRAMDOWN' ALTERNATIVE
Section 1129(b) of the Bankruptcy Code provides that a plan can be
confirmed even if it has not been accepted by all impaired classes as long as at
least one impaired class of Claims has accepted it. The Court may confirm the
Plan at the request of the Debtors notwithstanding the Plan's rejection (or
deemed rejection) by impaired Classes as long as the Plan "does not discriminate
unfairly" and is "fair and equitable" as to each impaired Class that has not
accepted it. A plan does not discriminate unfairly within the meaning of the
Bankruptcy Code if a dissenting class is treated equally with respect to other
classes of equal rank.
A plan is fair and equitable as to a class of secured claims that
rejects such plan if the plan provides (1)(a) that the holders of claims
included in the rejecting class retain the liens securing those claims, whether
the property subject to those liens is retained by the debtor or transferred to
another entity, to the extent of the allowed amount of such claims, and (b) that
each holder of a claim of such class receives on account of that claim deferred
cash payments totaling at least the allowed amount of that claim, of a value, as
of the effective date of the plan, of at least the value of the holder's
interest in the estate's interest in such property; (2) for the sale, subject to
Section 363(k) of the Bankruptcy Code, of any property that is subject to the
liens securing the claims included in the rejecting class, free and clear of the
liens, with the liens to attach to the proceeds of the sale, and the treatment
of the liens on proceeds under clause (1) or (2) of this paragraph; or (3) for
the realization by such holders of the indubitable equivalent of such claims.
A plan is fair and equitable as to a class of unsecured claims which
rejects a plan if the plan provides (1) for each holder of a claim included in
the rejecting class to receive or retain on account of that claim property that
has a value, as of the effective date of the plan, equal to the allowed amount
of such claim; or (2) that the holder of any claim or interest that is junior to
the claims of such rejecting class will not receive or retain on account of such
junior claim or interest any property at all.
A plan is fair and equitable as to a class of equity interests that
rejects a plan if the plan provides (1) that each holder of an interest included
in the rejecting class receive or retain on account of that interest property
that has a value, as of the effective date of the plan, equal to the greatest of
the allowed amount of any fixed liquidation preference to which such holder is
entitled, any fixed redemption price to which such holder is entitled, or the
value of such interest; or (2) that the holder of any interest that is junior to
the interest of such rejecting class will not receive or retain under the plan
on account of such junior interest any property at all.
The votes of holders of Subordinated Securities Claims, Existing Common
Stock, and Other Interests in Kmart are not being solicited because such holders
are not entitled to receive
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or retain under the Plan any interest in property on account of their Claims and
Interests. Such Classes therefore are deemed to have rejected the Plan pursuant
to Section 1126(g) of the Bankruptcy Code. Accordingly, the Debtors are seeking
confirmation of the Plan pursuant to Section 1129(b) of the Bankruptcy Code with
respect to such Classes, and may seek confirmation pursuant thereto as to other
Classes if such Classes vote to reject the Plan. Notwithstanding the deemed
rejection by such Classes, the Debtors believe that such Classes are being
treated fairly and equitably under the Bankruptcy Code. The Debtors therefore
believe the Plan may be confirmed despite its deemed rejection by these Classes.
G. CONDITIONS TO CONFIRMATION AND CONSUMMATION OF THE PLAN
1. Conditions to Confirmation.
The following are conditions precedent to confirmation of the Plan.
These conditions may be satisfied or waived by the Debtors in their sole
discretion, without notice to parties in interest or the Court, and without a
hearing:
(a) The Bankruptcy Court shall have approved by Final Order a
Disclosure Statement with respect to the Plan in form and substance
acceptable to the Debtors in their sole and absolute discretion.
(b) The Confirmation Order shall be in form and substance
acceptable to the Debtors, in their sole and absolute discretion.
2. Conditions to Consummation.
The following are conditions precedent to the occurrence of the
Effective Date, each of which may be satisfied or waived in accordance with
Section 13.3 of the Plan:
(a) The Reorganized Debtors shall have entered into the New
Kmart Exit Financing Facility and all conditions precedent to the
consummation thereof shall have been waived or satisfied in accordance
with the terms thereof.
(b) All conditions precedent to the funding obligations under
the Investment Agreement shall have been satisfied or waived in
accordance with the terms thereof and the funding under the Investment
Agreement shall have occurred.
(c) The Reorganized Debtors shall have entered into the Trust
Agreement and all documents evidencing the Trade Vendors' Lien and all
conditions precedent to the consummation thereof shall have been waived
or satisfied in accordance with the terms thereof.
(d) The Bankruptcy Court shall have entered one or more orders
(which may include the Confirmation Order) authorizing the assumption
and rejection of unexpired leases and executory contracts by the
Debtors as contemplated by Article 8.1 of the Plan.
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(f) The Confirmation Order shall have been entered by the
Bankruptcy Court and shall be a Final Order, the Confirmation Date
shall have occurred, and no request for revocation of the Confirmation
Order under section 1144 of the Bankruptcy Code shall have been made,
or, if made, shall remain pending.
(g) Each Exhibit, document or agreement to be executed in
connection with the Plan shall be in form and substance reasonably
acceptable to the Debtors.
H. WAIVER OF CONDITIONS TO CONFIRMATION AND CONSUMMATION OF THE PLAN
The conditions set forth in Article 13.1 and Article 13.2 of the Plan
may be waived, in whole or in part, by the Debtors, after consultation with the
Plan Investors and the Statutory Committees, without any notice to any other
parties in interest or the Bankruptcy Court and without a hearing. The failure
to satisfy or waive any condition to the Confirmation Date or the Effective Date
may be asserted by the Debtors in their sole discretion regardless of the
circumstances giving rise to the failure of such condition to be satisfied
(including any action or inaction by the Debtors in their sole discretion). The
failure of the Debtors to exercise any of the foregoing rights shall not be
deemed a waiver of any other rights, and each such right shall be deemed an
ongoing right, which may be asserted at any time.
I. RETENTION OF JURISDICTION
Pursuant to Sections 105(a) and 1142 of the Bankruptcy Code, the
Bankruptcy Court shall have exclusive jurisdiction of all matters arising out
of, and related to, the Chapter 11 Cases and the Plan, including, among others,
the following matters:
(i) to hear and determine motions for the assumption
or rejection of executory contracts or unexpired leases or the assumption and
assignment, as the case may be, of executory contracts or unexpired leases to
which any of the Debtors are a party or with respect to which any of the Debtors
may be liable, and to hear and determine the allowance of Claims resulting
therefrom including the amount of Cure, if any, required to be paid;
(ii) to adjudicate any and all adversary proceedings,
applications, and contested matters that may be commenced or maintained pursuant
to the Chapter 11 Cases or the Plan, proceedings to adjudicate the allowance of
Disputed Claims and Disputed Interests, and all controversies and issues arising
from or relating to any of the foregoing;
(iv) to ensure that distributions to Allowed
Claimholders and Allowed Interestholders are accomplished as provided herein;
(v) to hear and determine any and all objections to
the allowance or estimation of Claims and Interests filed, both before and after
the Confirmation Date, including any objections to the classification of any
Claim or Interest, and to allow or disallow any Claim or Interest, in whole or
in part;
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(vi) to enter and implement such orders as may be
appropriate if the Confirmation Order is for any reason stayed, revoked,
modified, or vacated;
(vii) to issue orders in aid of execution,
implementation, or consummation of the Plan;
(viii) to consider any modifications of the Plan, to
cure any defect or omission, or to reconcile any inconsistency in any order of
the Bankruptcy Court, including, without limitation, the Confirmation Order;
(ix) to hear and determine all applications for
allowance of compensation and reimbursement of Professional Claims under the
Plan or under Sections 330, 331, 503(b), 1103, and 1129(a)(4) of the Bankruptcy
Code;
(x) to determine requests for the payment of Claims
entitled to priority under Section 507(a)(1) of the Bankruptcy Code, including
compensation of and reimbursement of expenses of parties entitled thereto;
(xi) to hear and determine disputes arising in
connection with the interpretation, implementation, or enforcement of the Plan,
including disputes arising under agreements, documents, or instruments executed
in connection with the Plan;
(xii) to hear and determine all suits or adversary
proceedings to recover assets of the Debtors and property of their Estates,
wherever located;
(xiii) to hear and determine matters concerning
state, local, and federal taxes in accordance with Sections 346, 505, and 1146
of the Bankruptcy Code;
(xiv) to hear any other matter not inconsistent with
the Bankruptcy Code;
(xv) to hear and determine all disputes involving the
existence, nature, or scope of the Debtors' discharge, including any dispute
relating to any liability arising out of the termination of employment or the
termination of any employee or retiree benefit program, regardless of whether
such termination occurred prior to or after the Effective Date;
(xvi) to hear and determine disputes arising in
connection with the interpretation, implementation, or enforcement of the Kmart
Creditor Trust and the Trade Vendors' Lien Program;
(xvii) to enter a final decree closing the Chapter 11
Cases; and
(xviii) to enforce all orders previously entered by
the Bankruptcy Court.
150
Notwithstanding anything contained herein to the contrary, the
Bankruptcy Court retains exclusive jurisdiction to hear and determine disputes
concerning Retained Actions and Trust Claims and any motions to compromise or
settle such disputes. Despite the foregoing, if the Bankruptcy Court is
determined not to have jurisdiction with respect to the foregoing, or if
Reorganized Kmart or the Kmart Creditor Trust chooses to pursue any Retained
Action or Trust Claim (as applicable) in another court of competent
jurisdiction, Reorganized Kmart or the Kmart Creditor Trust (as applicable) will
have authority to bring such action in any other court of competent
jurisdiction.
XII. ALTERNATIVES TO CONFIRMATION AND
CONSUMMATION OF THE PLAN
The Debtors believe that the Plan affords holders of Claims and
Interests the potential for the greatest realization on the Debtors' assets and,
therefore, is in the best interests of such holders. If the Plan is not
confirmed, however, the theoretical alternatives include: (a) continuation of
the pending Chapter 11 Cases; (b) an alternative plan or plans of
reorganization; or (c) liquidation of the Debtors under Chapter 7 or Chapter 11
of the Bankruptcy Code.
A. CONTINUATION OF THE BANKRUPTCY CASE
If the Debtors remain in Chapter 11, they could continue to operate
their businesses and manage their properties as debtors-in-possession, but they
would remain subject to the restrictions imposed by the Bankruptcy Code. It is
not clear whether the Debtors could survive as a going concern in protracted
Chapter 11 Cases. In particular, the Debtors could have difficulty sustaining
the high costs and the erosion of market confidence which may be caused if the
Debtors remain Chapter 11 debtors-in-possession. And as further discussed in
Section VII.I., "Development and Summary of Business Plan," the Debtors believe
that they have accomplished the goals that Chapter 11 has allowed them to
achieve, and that Kmart's key remaining challenges are operational and therefore
do not require that the Company remain in Chapter 11.
B. ALTERNATIVE PLANS OF REORGANIZATION
If the Plan is not confirmed, the Debtors, or, after the expiration of
the Debtors' exclusive period in which to propose and solicit a reorganization
plan, any other party in interest in the Chapter 11 Cases, could propose a
different plan or plans. Such plans might involve either a reorganization and
continuation of the Debtors' businesses, or an orderly liquidation of their
assets, or a combination of both.
C. LIQUIDATION UNDER CHAPTER 7 OR CHAPTER 11
If no plan is confirmed, the Debtors' Chapter 11 Cases may be converted
to a case under Chapter 7 of the Bankruptcy Code. In a Chapter 7 case, a trustee
or trustees would be appointed to liquidate the assets of the Debtors. It is
impossible to predict precisely how the proceeds of the liquidation would be
distributed to the respective holders of Claims against or Interests in the
Debtors.
151
However, the Debtors believe that creditors would lose substantially
higher going concern value if the Debtors were forced to liquidate. In addition,
the Debtors believe that in liquidation under Chapter 7, before creditors
received any distribution, additional administrative expenses involved in the
appointment of a trustee or trustees and attorneys, accountants and other
professionals to assist such trustees would cause a substantial diminution in
the value of the Estates. The assets available for distribution to creditors
would be reduced by such additional expenses and by Claims, some of which would
be entitled to priority, which would arise by reason of the liquidation and from
the rejection of leases and other executory contracts in connection with the
cessation of operations and the failure to realize the greater going concern
value of the Debtors' assets.
The Debtors may also be liquidated pursuant to a Chapter 11 plan. In a
liquidation under Chapter 11, the Debtors' assets could be sold in an orderly
fashion over a more extended period of time than in a liquidation under Chapter
7. Thus, a Chapter 11 liquidation might result in larger recoveries than a
Chapter 7 liquidation, but the delay in distributions could result in lower
present values received and higher administrative costs. Because a trustee is
not required in a Chapter 11 case, expenses for professional fees could be lower
than in a Chapter 7 case, in which a trustee must be appointed. However, any
distribution to the Claimholders and Interestholders under a Chapter 11
liquidation plan probably would be delayed substantially.
The Debtors' liquidation analysis, prepared with their restructuring
advisors, is premised upon a hypothetical liquidation in a Chapter 7 case and is
attached as Appendix B to this Disclosure Statement. In the analysis, the
Debtors have taken into account the nature, status, and underlying value of
their assets, the ultimate realizable value of their assets, and the extent to
which such assets are subject to liens and security interests. The likely form
of any liquidation would be the sale of individual assets. Based on this
analysis, it is likely that a Chapter 7 liquidation of the Debtors' assets would
produce less value for distribution to creditors than that recoverable in each
instance under the Plan. In the opinion of the Debtors, the recoveries projected
to be available in a Chapter 7 liquidation are not likely to afford holders of
Claims and holders of Interests as great a realization potential as does the
Plan.
XIII. VOTING REQUIREMENTS
On February 25, 2003, the Bankruptcy Court approved an order (the
"Solicitation Procedures Order"), among other things, approving this Disclosure
Statement, setting voting procedures, and scheduling the hearing on confirmation
of the Plan. A copy of the Confirmation Hearing Notice is enclosed with this
Disclosure Statement. The Confirmation Hearing Notice sets forth in detail,
among other things, the voting deadlines and objection deadlines with respect to
the Plan. The Confirmation Hearing Notice and the instructions attached to the
Ballot should be read in connection with this section of this Disclosure
Statement.
If you have any questions about (i) the procedure for voting your Claim
with respect to the packet of materials that you have received, (ii) the amount
of your Claim holdings, or (iii) if you wish to obtain, at your own expense,
unless otherwise specifically required by Federal Rule of Bankruptcy Procedure
3017(d), an additional copy of the Plan, this Disclosure Statement, or any
exhibits to such documents, please contact:
152
<Caption>
Prepetition Note Claims and Prepetition Lender Claims, Trade Vendor/
Trust Preferred Obligations Lease Rejection Claims and Other Unsecured Claims
--------------------------- -------------------------------------------------
Innisfree M&A Incorporated Trumbull Bankruptcy Services
501 Madison Avenue, 20th Floor P.O. Box 426
New York, New York 10022 Windsor, Connecticut 06095
Attn: Kmart Corporation Attn: Kmart Balloting Center
Telephone: (877) 750-2689 Telephone: (877) 876-2705
The Bankruptcy Court may confirm the Plan only if it determines that
the Plan complies with the technical requirements of Chapter 11 of the
Bankruptcy Code and that the disclosures by the Debtors concerning the Plan have
been adequate and have included information concerning all payments made or
promised by the Debtors in connection with the Plan and the Chapter 11 Cases. In
addition, the Bankruptcy Court must determine that the Plan has been proposed in
good faith and not by any means forbidden by law, and under Federal Rule of
Bankruptcy Procedure 3020(b)(2), it may do so without receiving evidence if no
objection is timely filed.
In particular, and as described in more detail above, the Bankruptcy
Code requires the Bankruptcy Court to find, among other things, that (a) the
Plan has been accepted by the requisite votes of all Classes of impaired Claims
and Interests unless approval will be sought under Section 1129(b) of the
Bankruptcy Code in spite of the nonacceptance by one or more such Classes, (b)
the Plan is "feasible," which means that there is a reasonable probability that
the Debtors will be able to perform their obligations under the Plan and
continue to operate their businesses without further financial reorganization or
liquidation, and (c) the Plan is in the "best interests" of all Claimholders and
Interestholders, which means that such holders will receive at least as much
under the Plan as they would receive in a liquidation under chapter 7 of the
Bankruptcy Code.
THE BANKRUPTCY COURT MUST FIND THAT ALL CONDITIONS MENTIONED ABOVE ARE
MET BEFORE IT CAN CONFIRM THE PLAN. THUS, EVEN IF ALL THE CLASSES OF IMPAIRED
CLAIMS WERE TO ACCEPT THE PLAN BY THE REQUISITE VOTES, THE BANKRUPTCY COURT MUST
STILL MAKE AN INDEPENDENT FINDING THAT THE PLAN SATISFIES THESE REQUIREMENTS OF
THE BANKRUPTCY CODE, THAT THE PLAN IS FEASIBLE, AND THAT THE PLAN IS IN THE BEST
INTERESTS OF THE HOLDERS OF CLAIMS AGAINST AND INTERESTS IN THE DEBTORS.
UNLESS THE BALLOT BEING FURNISHED IS TIMELY SUBMITTED TO THE VOTING
AGENT ON OR PRIOR TO APRIL 4, 2003 AT 4:00 P.M. (PREVAILING EASTERN TIME)
TOGETHER WITH ANY OTHER DOCUMENTS REQUIRED BY SUCH BALLOT, THE DEBTORS MAY, IN
THEIR SOLE DISCRETION, REJECT SUCH BALLOT AS INVALID AND, THEREFORE, DECLINE TO
COUNT IT AS AN ACCEPTANCE OR REJECTION OF THE PLAN. IN NO CASE SHOULD A BALLOT
OR ANY OF THE CERTIFICATES BE DELIVERED TO THE DEBTORS OR ANY OF THEIR ADVISORS.
153
A. PARTIES IN INTEREST ENTITLED TO VOTE
Under Section 1124 of the Bankruptcy Code, a class of claims or
interests is deemed to be "impaired" under a plan unless (a) the plan leaves
unaltered the legal, equitable, and contractual rights to which such claim or
interest entitles the holder thereof or (b) notwithstanding any legal right to
an accelerated payment of such claim or interest, the plan cures all existing
defaults (other than defaults resulting from the occurrence of events of
bankruptcy) and reinstates the maturity of such claim or interest as it existed
before the default.
In general, a holder of a claim or interest may vote to accept or to
reject a plan if (1) the claim or interest is "allowed," which means generally
that no party in interest has objected to such claim or interest, and (2) the
claim or interest is impaired by the Plan. If the holder of an impaired claim or
impaired interest will not receive any distribution under the plan in respect of
such claim or interest, the Bankruptcy Code deems such holder to have rejected
the plan. If the claim or interest is not impaired, the Bankruptcy Code deems
that the holder of such claim or interest has accepted the plan and the plan
proponent need not solicit such holder's vote.
The holder of a Claim that is Impaired under the Plan is entitled to
vote to accept or reject the Plan if (1) the Plan provides a distribution in
respect of such Claim and (2) (a) the Claim has been scheduled by the respective
Debtor (and such Claim is not scheduled as disputed, contingent, or
unliquidated), (b) such Claimholder has timely filed a Proof of Claim as to
which no objection has been filed, or (c) such Claimholder has timely filed a
motion pursuant to Federal Rule of Bankruptcy Procedure 3018(a) seeking
temporary allowance of such Claim for voting purposes only and the Debtor has
not opposed the Motion or objected to the Claim, in which case the holder's vote
will be counted only upon order of the Court.
A vote may be disregarded if the Court determines, pursuant to Section
1126(e) of the Bankruptcy Code, that it was not solicited or procured in good
faith or in accordance with the provisions of the Bankruptcy Code. The
Solicitation Procedures Order also sets forth assumptions and procedures for
tabulating Ballots, including Ballots that are not completed fully or correctly.
B. CLASSES IMPAIRED UNDER THE PLAN
1. Voting Impaired Classes of Claims.
The following Classes are Impaired under, and are entitled to vote to
accept or reject, the Plan: Class 3 (Prepetition Lender Claims), Class 4
(Prepetition Note Claims), Class 5 (Trade Vendor/Lease Rejection Claims), Class
6 (Other Unsecured Claims), Class 7 (General Unsecured Convenience Claims), and
Class 8 (Trust Preferred Obligations).
2. Unimpaired Classes of Claims.
Class 1 (Secured Claims) and Class 2 (Other Priority Claims) are
Unimpaired under the Plan and deemed under Section 1126(f) of the Bankruptcy
Code to have accepted the Plan. Their votes to accept or reject the Plan will
not be solicited. Because all Debtors are proponents
154
of the Plan, Class 9 Intercompany Claims are deemed to have accepted the Plan.
The votes of holders of such Claims therefore will not be solicited.
3. Impaired Classes of Claims and Interests Deemed to Reject the
Plan.
Holders of Claims and Interests in Classes 10 and 11 are not entitled
to receive any distribution under the Plan on account of their Claims and
Interests unless Classes 3, 4, 5, 6, 7, and 8 vote to accept the Plan. Holders
of Interests in Class 12 are not entitled to receive any distribution under the
Plan under any circumstance on account of their Interests. Since none of the
holders of Claims and Interests in Class 10, Class 11, or Class 12 are
unconditionally entitled to receive a distribution under the Plan, pursuant to
Section 1126(g) of the Bankruptcy Code, each of such Classes is conclusively
presumed to have rejected the Plan, and the votes of Claimholders and
Interestholders in such Classes therefore will not be solicited.
4. Presumed Acceptance by Certain Classes of Interests.
Holders of Class 11 Interests in the Affiliate Debtors are conclusively
presumed to have accepted the Plan as such Interestholders are proponents of the
Plan and, as such, the votes of such Interestholders will not be solicited.
155
XIV. CONCLUSION
A. HEARING ON AND OBJECTIONS TO CONFIRMATION
1. Confirmation Hearing.
The hearing on confirmation of the Plan has been scheduled for April
14, 2003 at 10:00 a.m. (prevailing Central time). Such hearing may be adjourned
from time to time by announcing such adjournment in open court, all without
further notice to parties in interest, and the Plan may be modified by the
Debtors pursuant to Section 1127 of the Bankruptcy Code prior to, during, or as
a result of that hearing, without further notice to parties in interest.
2. Date Set for Filing Objections to Confirmation of the Plan.
The time by which all objections to confirmation of the Plan must be
filed with the Court and received by the parties listed in the Confirmation
Hearing Notice has been set for April 4, 2003, at 4:00 p.m. (prevailing Central
time). A copy of the Confirmation Hearing Notice is enclosed with this
Disclosure Statement.
B. RECOMMENDATION
The Plan provides for an equitable and early distribution to creditors
of the Debtors, preserves the value of the business as a going concern, and
preserves the jobs of employees. The Debtors believe that any alternative to
confirmation of the Plan, such as liquidation or attempts by another party in
interest to file a plan, could result in significant delays, litigation, and
costs, as well as the loss of jobs by the employees. Moreover, the Debtors
believe that their creditors will receive greater and earlier recoveries under
the Plan than those that would be achieved in liquidation or under an
alternative plan. FOR THESE REASONS, THE DEBTORS URGE YOU TO RETURN YOUR BALLOT
ACCEPTING THE PLAN.
Dated: Chicago, Illinois
February 25, 2003
Respectfully submitted,
KMART CORPORATION AND THE
DEBTOR AFFILIATES
By: /s/ Julian C. Day
-------------------------------------
Julian C. Day
Chief Executive Officer of Kmart
Corporation and authorized signatory
for each of the other Debtors
John Wm. Butler, Jr.
J. Eric Ivester
Mark A. McDermott
Samuel S. Ory
SKADDEN, ARPS, SLATE, MEAGHER
& FLOM (ILLINOIS)
333 West Wacker Drive, Suite 2100
Chicago, Illinois 60606-1285
(312) 407-0700
156
APPENDIX A
FIRST AMENDED JOINT PLAN OF REORGANIZATION OF
KMART CORPORATION AND CERTAIN OF ITS DOMESTIC SUBSIDIARIES
AND AFFILIATES, DEBTORS AND DEBTORS-IN-POSSESSION
APPENDIX B
LIQUIDATION ANALYSIS
APPENDIX B
LIQUIDATION ANALYSIS
A Chapter 11 plan cannot be confirmed unless it is in the 'best interests' of
all holders of claims and interests that are impaired by the plan and that have
not accepted the plan. The 'best interests' test is satisfied if a plan provides
to each member who has not accepted the plan with a recovery of property of a
value, as of the effective date of the plan, that is not less than the amount
that such holder would recover if the debtor were liquidated under Chapter 7 of
the Bankruptcy Code.
Conversion to Chapter 7 would likely result in additional costs to the Estates.
Costs of liquidation under Chapter 7 of the Bankruptcy Code would include the
compensation of a trustee, as well as of counsel and other professionals
retained by the trustee, asset dispositions expenses, all unpaid expenses
incurred by the debtor in its bankruptcy case (such as compensation of
attorneys, financial advisors, and restructuring consultants) that are allowed
in the Chapter 7 case, litigation costs, and claims arising from the operations
of the debtor during the pendency of the bankruptcy case.
The bankruptcy cases would likely be treated as separate bankruptcy estates
under a Chapter 7 liquidation and this `deconsolidation' would affect
recoveries. For example, the PBGC has the joint and several obligation of each
of the 38 estates. The PBGC claim against subsidiaries comes before the
interests of the holding company in the subsidiary and therefore before claims
that exist only against the holding company. In order to estimate the effect of
deconsolidation on the `best interests' test, we have looked at the hypothetical
recovery of certain affiliates and assigned premiums or discounts to creditor
recoveries based on these joint and several claims or subsidiary guarantees
where they exist.
The following is a summary of the estimated recoveries for claimants in a
hypothetical liquidation commencing April 30, 2003 under Chapter 7 of the
Bankruptcy Code.
---------------------------------------------------------------------------------
SUMMARY ALLOCATION TO UNSECURED CLAIMS DECONSOLIDATED
($ IN MILLIONS) CONSOLIDATED CASE DECONSOLIDATION ADJ. NET RECOVERY
- -------------------------------------- ----------------- -------------------- --------------
LOW HIGH LOW HIGH LOW HIGH
---- ---- --- ---- --- -----
Percentage Recovery 2% 4%
Bank Debt $ 20 $ 46
Subordination of Convertible 4 9
----- -----
Total Bank Recovery $ 24 $ 55 $ 152 $ 169 $ 176 $ 224
Percentage Recovery 2% 5% 16% 21%
Notes $ 42 $ 97
Subordination of Convertible 8 19
----- -----
Total Note Recovery $ 50 $ 116 $ (50) $ (75) $ - $ 40
Percentage Recovery 2% 5% 0% 2%
PBGC $ 14 $ 46 $ 114 $ 176 $ 128 $ 222
Percentage Recovery 2% 4% 16% 20%
Other Non-Interco. Unsecured Claims $ 128 $ 557 $ (34) $(269) $ 94 $ 288
Percentage Recovery 2% 4% 1% 2%
---------------------------------------------------------------------------------
The accompanying notes are an integral part of the Best Interests Analysis
B-1
APPENDIX B
LIQUIDATION ANALYSIS
Attached is the Best Interests Analysis (the "Analysis") of Kmart Corporation
and its 37 subsidiaries in bankruptcy proceedings (collectively "Kmart", the
"Company" or the "Debtors"). The Analysis was prepared as if the Debtors were
substantively consolidated. Although the Analysis was prepared after the
deadline for filing claims against the estates of the Debtors, those claims have
not been fully evaluated by the Company or adjudicated by the court and,
accordingly, the amount of the final allowed claims against the estates may
differ from the claim amounts used in this Analysis. Finally, the Analysis is
based on the Company's projected balance sheet as of April 30, 2003, (except as
indicated) and the actual amount of assets available to the estates as of the
date of liquidation may differ from the amount of assets used in this Analysis.
Management of the Company, with the assistance of AlixPartners, LLC, prepared
the Analysis. The Analysis presents management's estimated net value of the
Company's assets if the Debtors were to be liquidated under the provisions of
Chapter 7 of the United States Bankruptcy Code (the "Code") and the net proceeds
of the liquidation were to be applied in strict priority to satisfy claims
against the Debtors.
The purpose of the Analysis is to provide information in order that the
Bankruptcy Court may determine that the Plan of Reorganization ("POR") is in the
best interests of all classes of creditors and equity interest holders impaired
by the plan. The "best interests" test requires that the Bankruptcy Court find
that the Plan provides to each member of each impaired class of claims and
interests a recovery that has a value at least equal to the value of the
distribution each member would receive if the Debtors were liquidated under
Chapter 7 of the Code. The Analysis was prepared to assist the Bankruptcy Court
in making this determination, and it should not be used for any other purpose.
The presentation utilized in this Analysis is not designed for those who are not
informed about such matters.
The Analysis is limited to presenting information that was the representation of
management and does not include an evaluation of the support for the underlying
assumptions. The Analysis has not been examined or reviewed by independent
accountants in accordance with standards promulgated by the American Institute
of Certified Public Accountants. The estimates and assumptions, although
considered reasonable by management, are inherently subject to significant
uncertainties and contingencies beyond the control of management. Accordingly,
there can be no assurance that the results shown would be realized if the
Company were liquidated and actual results in such case could vary materially
from those presented. If actual results were lower than those shown, or if the
assumptions used in formulating the Analysis were not realized, distribution to
each member of each class of claims could be adversely affected.
Note 7, contained herein, describes the assumptions management has made
regarding recoveries arising from the exercise of avoiding powers under the Code
in this Analysis.
The accompanying notes are an integral part of the Best Interests Analysis
B-2
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
I. CALCULATION OF NET ESTIMATED PROCEEDS AVAILABLE FOR ALLOCATION
Projected Estimated
Balances @ Recovery Rate Impact on Unsecured See
4/30/2003 Range Creditor Recoveries Note
---------- --------------- -------------------------- ----
Low High Low High
------ ---- ------------ -----------
A. STATEMENT OF ASSETS
Cash and Equivalents $ 820,550 (a) 100% 100% $ 820,550 $ 820,550
Accounts Receivable 414,894 25% 40% 104,512 164,185 2
Inventories 4,581,433 (b) 53% 62% 2,447,229 2,845,873 3
Prepaid Expenses & Other Current Assets 166,223 45% 53% 74,032 88,465 4
Net P&E 4,633,995 13% 19% 593,359 878,996 5
Other Assets and Deferrals 182,989 19% 37% 53,607 70,462 6
---------- ----- --- ----------- -----------
Total Assets 10,800,084 38% 45% 4,093,290 4,868,531
B. RECOVERIES FROM EXERCISE OF AVOIDING POWERS 240,000 405,000 7
C. RECOVERIES FROM CLAIMS AGAINST CERTAIN
DIRECTORS, OFFICERS AND ADVISORS OF DEBTORS - -
D. OTHER PROCEEDS - Sale of Pharmacy Lists 152,000 192,000
----------- -----------
E. GROSS PROCEEDS 4,485,290 5,465,531
F. CREDITOR RECOVERY EXPENSES
Corporate Expenses (400,000) (450,000) 8
Six months store rent and occupancy following completion of GOB sale (498,668) (498,668)
Employee Retention and Severance (92,624) (92,624)
Chapter 7 Trustee Fees (3% of Gross Proceeds) (134,559) (163,966)
Other Professional Fees (80,000) (100,000)
----------- -----------
(1,205,852) (1,305,259)
NET ESTIMATED PROCEEDS AVAILABLE FOR ALLOCATION $ 3,279,438 $ 4,160,272
=========== ===========
NOTES:
- --------------------------------
(a) Cash and Equivalents is projected balance of cash (net of checks
outstanding) and marketable securities at 4/30/03 reduced for payment
of estimated professional fees of approximately $37.3 million.
(b) Inventories is projected balance of inventories at 4/30/03 increased
for estimated inventories secured by Trade Letters of Credit
outstanding as of the projected filing date (See Note 3 - Inventories).
The accompanying notes are an integral part of the Best Interests Analysis
B-3
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
II. ALLOCATION OF NET ESTIMATED PROCEEDS TO SECURED CLAIMS
Principal,
Accrued
Interest and
Adequate
Protection Estimated Recovery Estimated Unsecured
Payments on Collateral Claims
------------ -------------------- ---------------
SECURED CLAIMS: Low High Low High
------ ------ ----- ----
12.50% Texas Teachers (5 Mortgage Notes)
Principal Balance at 11/27/02 13,740 10,889 12,916 2,851 824
Prepetition Accrued Interest 397 - -
Accrued Interest from 1/22/02 through 1/30/2002 45 - -
Accrued Interest from 1/31/02 through 1/29/2003 1,737 - -
Adequate Protection payments through 12/31/02 (1,618) (1,618) (1,618)
Adequate Protection payments from 1/1/03 through 4/30/03 (924) (924) (924)
Accrued interest from 1/30/2003 through 4/30/2003 433 - -
------ ------ ----- -----
Net estimated additional secured payment/unsecured claims 8,347 10,374 2,851 824
7.50% Mortgage IRB for 1412
Principal Balance at 11/27/02 700 - - 700 700
Prepetition Accrued Interest (6) - -
Accrued Interest from 1/22/02 through 1/30/2002 1 - -
Accrued Interest from 1/31/02 through 1/29/2003 55 - -
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 13 - -
------ ------ ----- -----
Net estimated additional secured payment/unsecured claims - - 700 700
7.50% Mortgage IRB for 1414
Principal Balance at 11/27/02 745 - - 745 745
Prepetition Accrued Interest 17 - -
Accrued Interest from 1/22/02 through 1/30/2002 1 - -
Accrued Interest from 1/31/02 through 1/29/2003 55 - -
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 14 - -
------ ------ ----- -----
Net estimated additional secured payment/unsecured claims - - 745 745
7.00% Mortgage IRB for 7903
Principal Balance at 11/27/02 1,905 - - 1,905 1,905
Prepetition Accrued Interest 29 - -
Accrued Interest from 1/22/02 through 1/30/2002 3 - -
Accrued Interest from 1/31/02 through 1/29/2003 130 - -
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 32 - -
------ ------ ----- -----
Net estimated additional secured payment/unsecured claims - - 1,905 1,905
7.70% Mortgage IRB for 7341
Principal Balance at 11/27/02 1,800 264 813 1,536 987
Prepetition Accrued Interest 19 - -
Accrued Interest from 1/22/02 through 1/30/2002 4 - -
Accrued Interest from 1/31/02 through 1/29/2003 139 - -
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 35 - -
------ ------ ----- -----
Net estimated additional secured payment/unsecured claims 264 813 1,536 987
The accompanying notes are an integral part of the Best Interests Analysis
B-4
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
II. ALLOCATION OF NET ESTIMATED PROCEEDS TO SECURED CLAIMS
Principal,
Accrued
Interest and
Adequate
Protection Estimated Recovery Estimated Unsecured
Payments on Collateral Claims
------------ -------------------- ---------------
SECURED CLAIMS: Low High Low High
------ ------ ----- ----
12.80% Mortgage for KM 4108A (7906)
Principal Balance at 11/27/02 2,004 901 1,532 1,103 472
Prepetition Accrued Interest (7) - -
Accrued Interest from 1/22/02 through 1/30/2002 6 - -
Accrued Interest from 1/31/02 through 1/29/2003 237 - -
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 59 - -
------ ------ ------ ------
Net estimated additional secured payment/unsecured claims 901 1,532 1,103 472
8.40% Mortgage with Sun Life for KM 4108 & 7906
Principal Balance at 11/27/02 5,970 901 1,532 5,069 4,438
Prepetition Accrued Interest (13) - -
Accrued Interest from 1/22/02 through 1/30/2002 13 - -
Accrued Interest from 1/31/02 through 1/29/2003 507 - -
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 126 - -
------ ------ ------ ------
Net estimated additional secured payment/unsecured claims 901 1,532 5,069 4,438
12.50% Mortgage with General American for KM 3606 & 3607
Principal Balance at 11/27/02 3,146 1,732 2,315 1,415 831
Prepetition Accrued Interest 75 - -
Accrued Interest from 1/22/02 through 1/30/2002 9 - -
Accrued Interest from 1/31/02 through 1/29/2003 307 - -
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 76 - -
------ ------ ------ ------
Net estimated additional secured payment/unsecured claims 1,732 2,315 1,415 831
Mortgage for Ocala 8292
Principal Balance at 11/27/02 19,570 1,866 19,570 17,704 -
Prepetition Accrued Interest - - -
Accrued Interest from 1/22/02 through 1/30/2002 - - -
Accrued Interest from 1/31/02 through 1/29/2003 - - -
Adequate Protection payments through 12/31/02 (2,322) (2,322) (2,322)
Adequate Protection payments from 1/1/03 through 4/30/03 (1,032) (1,032) (1,032)
Accrued interest from 1/30/2003 through 4/30/2003 - - -
------ ------ ------ ------
Net estimated additional secured payment/unsecured claims (1,488) 16,216 17,704 -
12.60% Mortgage for Morrisville 8275
Principal Balance at 11/27/02 7,408 7,408 7,408 - -
Prepetition Accrued Interest 209 209 209
Accrued Interest from 1/22/02 through 1/30/2002 24 24 24
Accrued Interest from 1/31/02 through 1/29/2003 853 853 853
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 213 213 213
------ ------ ------ ------
Net estimated additional secured payment/unsecured claims 8,707 8,707 - -
12.55% Mortgage for KM 3371 A&B
Principal Balance at 11/27/02 4,422 4,422 4,422 - -
Prepetition Accrued Interest 30 30 30
Accrued Interest from 1/22/02 through 1/30/2002 14 14 14
Accrued Interest from 1/31/02 through 1/29/2003 544 544 544
Adequate Protection payments through 12/31/02 - - -
Adequate Protection payments from 1/1/03 through 4/30/03 - - -
Accrued interest from 1/30/2003 through 4/30/2003 136 116 136
------ ------ ------ ------
Net estimated additional secured payment/unsecured claims 5,126 5,146 - -
TOTALS 24,490 46,635 33,028 10,903
====== ====== ====== ======
The accompanying notes are an integral part of the Best Interests Analysis
B-5
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
II. ALLOCATION OF NET ESTIMATED PROCEEDS TO SECURED CLAIMS
Principal,
Accrued
Interest and
Adequate
Protection Estimated Recovery Estimated Unsecured
Payments on Collateral Claims
------------ -------------------------- ------------------
SECURED CLAIMS: Low High Low High
----------- ----------- ----- ----
NET ESTIMATED PROCEEDS AVAILABLE FOR ALLOCATION $ 3,279,438 $ 4,160,272
(Less Secured Claims in excess of adequate protection payments)
or plus excess of adequate protection payments over Secured Claims (24,490) (46,635)
----------- -----------
NET ESTIMATED PROCEEDS AFTER SECURED CLAIMS 3,254,949 4,113,637
=========== ===========
The accompanying notes are an integral part of the Best Interests Analysis
B-6
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
III. ALLOCATION OF NET ESTIMATED PROCEEDS TO ADMINISTRATIVE AND PRIORITY
CLAIMS
Estimated Estimated Proceeds
Allowable Available for
Claims Allocation
--------- -----------------------
Low High
--------- ---------
Net Estimated Proceeds After Secured Claims 3,254,949 4,113,637
LESS DIP FACILITY CLAIMS:
Revolver -
Term Loan -
<Caption>
Honored in Satisfied in
liquidation the ordinary
Letters of Credit - Stand-by Totals proceeding course
--------------------------------------- ------- ----------- ------------
Letter of Credit - Stand-by (a) 159,023 121,000 38,023 121,000
Letters of Credit - Trade (b) 216,004 - 216,004 -
-------
Total DIP Facility Claims 121,000 121,000
Recovery on DIP Facility Claims 100% 100%
--------- ---------
Net Estimated Proceeds After DIP Facility Claims 3,133,949 3,992,638
LESS VENDOR 2ND LIENS:
Vendor Liens 300,000 300,000
Recovery on Vendor Liens 100% 100%
--------- ---------
Net Estimated Proceeds After Vendor Liens 2,833,949 3,692,638
LESS OTHER CHAPTER 11 ADMINISTRATIVE CLAIMS:
Claims arising from license agreements and contracts assumed post-petition 331,873
Reclamation Claims 98,800
Reserve for Post-Petition Public Liability Claims 22,500
Pro Rated KERP Payment 21,048
Accounts Payable-Trade (c) 882,317
Accrued Expenses (d) 961,634
Other Contingency Reserve 100,000
-------
Total administrative claims 2,418,171 2,418,171
Recovery on Administrative Claims 100% 100%
--------- ---------
Net Estimated Proceeds After Secured, DIP Facility and Administrative Claims 415,778 1,274,467
LESS PRIORITY CLAIMS 200,000 500,000
Recovery on Priority Claims (e) 100% 100%
--------- ---------
Net Estimated Proceeds After Secured, DIP Facility, Administrative and Priority Tax Claims $ 215,778 $ 774,467
========= =========
NOTES:
- ---------------------------------------------------
(a) Of the projected $159 million in Stand-by Letters of Credit,
approximately $121 million is estimated to insure against Workers
Compensation claims. Post petition obligation of Workers Compensation
is estimated at $20 million. It is further assumed that the balance of
the Stand-by Letters of Credit will be drawn in satisfaction of
pre-petition Workers Compensation claims. See note on Workers
Compensation Claims at IV. General Unsecured Claims.
(b) Analysis assumes Trade Letters of Credit are issued to foreign vendors
and that all goods are shipped under Letters of Credit and paid in the
ordinary course of business (See Note 3 - Inventory).
(c) Accounts Payable - Trade is projected accounts payable at 4/30/03
increased for estimated inventories secured by Trade Letters of Credit
outstanding as of the projected filing date grossed-up for estimated
freight and insurance costs. Additionally, Accounts Payable has been
adjusted to reflect amounts paid under the Vendor 2nd Lien program.
(d) Accrued Expenses is projected accrued expense at 4/30/03 reduced for
payment of estimated professional fees of approximately $37.3 million.
(e) Priority Claims are priority tax claims with the estimated recovery
range being set as a range around the value of claims filed.
The accompanying notes are an integral part of the Best Interests Analysis
B-7
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
IV. ALLOCATION OF NET ESTIMATED PROCEEDS TO UNSECURED CLAIMS
Estimated Estimated
Allowable Estimated Value Recovery
Claims Range Range
-------------------------- --------------------- -----------
Low High Low High Low High
------------ ------------ --------- --------- ---- ----
Net Estimated Proceeds After Secured, Administrative
and Priority Claims $ 215,778 $ 774,467
Bank Debt (including pre-petition interest):
--------------------------------------------
3 Year - $1.1B Revolving Credit facility 686,671 686,671 12,622 29,241 2% 4%
1 Year $450MM Revolving Credit Facility 393,788 393,788 7,238 16,769 2% 4%
Contribution from Convertible Preferred 3,899 9,033 0% 1%
------------ ------------ --------- --------- ---- ---
1,080,459 1,080,459 23,760 55,044 2% 5%
Notes (including pre-petition interest):
----------------------------------------
9.88% Notes due June 15, 2008 434,457 434,457 7,986 18,501 2% 4%
9.38% Notes due February 1, 2006 417,749 417,749 7,679 17,789 2% 4%
7.95% Notes due February 1, 2023 269,496 269,496 4,954 11,476 2% 4%
8.38% Notes due December 1, 2004 303,666 303,666 5,582 12,931 2% 4%
12.5% Notes due March 1, 2005 104,895 104,895 1,928 4,467 2% 4%
8.13% Notes due December 1, 2006 202,266 202,266 3,718 8,613 2% 4%
7.75% Notes due October 1, 2012 160,999 160,999 2,959 6,856 2% 4%
8.25% Notes due January 1, 2022 68,361 68,361 1,257 2,911 2% 4%
8.38% Notes due July 1, 2022 85,941 85,941 1,580 3,660 2% 4%
8.13% Medium Term Notes Payable
(Estimated 8.125% avg interest) 224,779 224,779 4,132 9,572 2% 4%
Contribution from Convertible Preferred 8,202 19,001 0% 1%
------------ ------------ --------- --------- ---- ---
2,272,611 2,272,611 49,976 115,777 2% 5%
General Unsecured Claims:
-------------------------
Accounts Payable 2,464,200 3,147,200 45,296 134,020 2% 4%
Accrued Expenses and Other Current Liabilities 229,000 229,000 4,209 9,752 2% 4%
Other Liabilities 400,000 2,474,000 7,353 105,353 0% 4%
Pension (PBGC) (a) 785,000 1,086,000 14,430 46,246 2% 4%
Public Liability 150,000 1,430,000 2,757 60,895 2% 4%
Workers Compensation Claims (b) 79,000 215,000 1,452 9,156 2% 4%
PV of Potential Claims from Contingent
Liabilities (c) - 304,000 - 12,946 0% 4%
Claims Asserted After Preference Recoveries 240,000 405,000 4,412 17,247 2% 4%
Unsecured Amount of Certain Secured Claims 33,028 10,903 607 464 2% 4%
Real Estate Lease Rejection Claims 2,387,157 2,222,321 43,880 94,635 2% 4%
Other Rejection Claims (d) 960,000 2,652,000 17,646 112,933 2% 4%
------------ ------------ --------- --------- ---- ---
7,727,385 14,175,423 142,042 603,646 2% 4%
Convertible Preferred Stock
(including pre-petition interest): 658,322 658,322 12,101 28,034 2% 4%
------------------------------------
Contribution to Bank Debt (3,899) (9,033)
Contribution to Notes (8,202) (19,001)
------------ ------------ --------- --------- ---- ---
658,322 658,322 - - 0% 0%
------------ ------------ --------- --------- ---- ---
Total $ 11,738,777 $ 18,186,815 $ 215,778 $ 774,467 2% 4%
============ ============ ========= ========= ==== ===
NOTES:
- ---------------------------
(a) An actuarial analysis performed by the Company indicates that ultimate
value of the PBGC claim is likely to range from $785 million to $926
million. However, a high end of $1,086 million is used to reflect the
actual claim amount filed by the PBGC. In a liquidation, the final
claim of the PBGC could be higher than the $1,086 million filed as a
proof of claim.
(b) Prepetition Workers Compensation claims are estimated at $180 million
to $316 million. It is assumed that once administrative claims for
Workers Compensation are paid approximately $101 million of Stand-by
Letters of Credit issued post-petition will be used to pay pre-petition
claims and reduce the general unsecured liability to approximately $79
million and $215 million, respectively.
(c) PV of Potential Claims from Contingent Liabilities represents the
present value of only those potential liabilities that can be
calculated at this time. The Company has disclosed that there exist
additional contingent liabilities under real estate leases assigned by
the Company pre-petition. While the Company has not yet been able to
calculate the present value of such additional liability, management
believes that the additional amount of such contingent liability may be
significant.
(d) Low case estimate based on one year's non-real estate executory
contracts payments of approximately $960 million. High case estimate
based on management's best estimate of the maximum potential allowable
claims and potential damages awarded beyond statutory amounts.
The accompanying notes are an integral part of the Best Interests Analysis
B-8
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
V. NOTES
NOTE 1 OVERVIEW AND LIQUIDATION PERIOD
This Best Interests Analysis was prepared as if the Debtors were substantively
consolidated. Although the Analysis was prepared after the deadline for filing
claims against the estates of the Debtors, those claims have not been fully
evaluated by the Company or adjudicated by the court and, accordingly, the
amount of the final allowed claims against the estates may differ from the claim
amounts used in this Analysis. Finally, the Analysis is based on the Company's
projected balance sheet as of April 30, 2003, (except as indicated) and the
actual amount of assets available to the estates as of the date of liquidation
may differ from the amount of assets used in this Analysis.
Management of the Company, with the assistance of AlixPartners, LLC, prepared
the Analysis. The Analysis presents management's estimated net value of the
Company's assets if the Debtors were to be liquidated under the provisions of
Chapter 7 of the United States Bankruptcy Code (the "Code") and the net proceeds
of the liquidation were to be applied in strict priority to satisfy claims
against the debtors.
The Analysis is limited to presenting information that was the representation of
management and does not include an evaluation of the support for the underlying
assumptions. The Analysis has not been examined or reviewed by independent
accountants in accordance with standards promulgated by the American Institute
of Certified Public Accountants. The estimates and assumptions, although
considered reasonable by management, are inherently subject to significant
uncertainties and contingencies beyond the control of management. Accordingly,
there can be no assurance that the results shown would be realized if the
Company were liquidated and actual results in such case could vary materially
from those presented. If actual results were lower than those shown, or if the
assumptions used in formulating the Analysis were not realized, distribution to
each member of each class of claims could be adversely affected.
For purposes of this Analysis, management assumes a liquidation would require
three phases and would take place over 18 months. Phase I would comprise a
three-month period during which inventories would be sold in a
going-out-of-business sale ("GOB Sale") conducted by a third-party. By the end
of the GOB Sale substantially all store, distribution center and field
associates would be terminated. During Phase I, certain headquarters associates
would be terminated including, for instance, staff of merchandising, merchandise
finance, advertising, stores organization, loss prevention, maintenance,
accounts payable, training, communications and purchasing.
Phase II would comprise the next six month period (and would actually have
started during Phase I). During Phase II, the Company's real estate and most of
the Company's non-real estate fixed assets would be marketed. In addition,
headquarters operations would continue to wind-down and most remaining
headquarters associates would be terminated. Certain headquarters personnel,
such as staff in legal, finance & accounting and information technology would be
retained as necessary to support Phase III. Phase III would comprise a nine
month period after completion of the real estate marketing efforts during which
any remaining litigation would be pursued, final tax returns filed, bankruptcy
court reports and schedules filed and remaining assets disposed.
While the Analysis assumes an 18 month liquidation time frame, final resolution
of all preference actions is expected to extend 12 months beyond the 18 month
liquidation time frame. All professional fees associated with resolution of such
matters are contemplated in the estimated net recoveries from preference
actions.
The accompanying notes are an integral part of the Best Interests Analysis
B-9
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
NOTE 2 ACCOUNTS RECEIVABLE
Accounts receivable comprises a variety of accounts, the most sizeable being
Pharmacy Receivables, Store Receivables and Merchandise Allowance Receivables.
Pharmacy Receivables are receivables from third-party insurance companies in
connection with the filling of prescriptions. All accounts aged past 60 days are
fully reserved. Historical experience indicates that the Company's reserve
policy has been sufficient in estimating losses incurred with this account.
Store Receivables are a combination of layaway receivables and credit extended
at the store level by store management to customers. For purposes of the
Analysis, the account is assumed to be primarily comprised of credit extended to
customers and would be, in all likelihood, uncollectable.
Merchandise Allowance Receivables are allowances generated in connection with
food products purchased through Fleming.
Other Receivables are comprised of a number of miscellaneous accounts such as
rent due from subtenants and former subsidiaries, amounts due from landlords for
repairs and maintenance and amounts due from bad checks, etc. and have varying
degrees of estimated collectability.
Recovery Rate Estimated Proceeds
Range Range
Projected ---------------- ---------------------
Balance @
Accounts Receivable 4/30/2003 Low High Low High
------------------------------------------------ ---------------- ---------- ---------- ---------- -------------
Pharmacy Receivables (net) $100,000 90% 100% $ 90,000 $100,000
Store Receivables 86,000 0% 0% - -
Merchandise Allowance Receivables (net) 61,353 10% 35% 6,135 30,677
Other Receivables 167,540 5% 20% 8,377 33,508
-------- --------- ---------
Total Accounts Receivable $414,894 $104,512 $164,185
25% 40%
The accompanying notes are an integral part of the Best Interests Analysis
B-10
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
NOTE 3 INVENTORIES
Merchandise inventories are assumed to be disposed of through a lawful
"going-out-of-business sale" commencing May 1, 2003 with no restrictions on the
Company's ability to aggressively advertise the sale as a "going-out-of-business
sale" ("GOB Sale"). The GOB Sale assumptions reflect the Company's experience in
2002 when it closed 283 stores over a 10 week time period and are adjusted where
considered appropriate for the scale and timing of a mass liquidation, as well
as for the projected composition of Company inventory at the commencement of a
mass liquidation. The Low Recovery scenario assumes that the sale takes 13 weeks
and reflects a lowered net recovery resulting from deeper discounts and
increased direct expense. The High Recovery scenario assumes a 10 week sale
period and is more reflective of the results achieved in the 2002 store
closings. For purposes of the Analysis, GOB Sale Merchandise Inventory is the
sum of perpetual inventories, imports paid not received and merchandise letters
of credit outstanding under the Company's projections as of April 30, 2003.
<Table>
Projected Merchandise Inventories at Cost @ 4/30/03 $ 4,322,229
Add: Inventory Received after 4/30/03 259,204 (a)
---------------
GOB Sale Merchandise Inventories at Cost 4,581,433
Assumed Selling Value of Merchandise Inventories $ 6,737,402
Assumed Selling Value Gross Margin 32%
</Table>
2002 LOW HIGH
GOB SALE RECOVERY RECOVERY
------------ ----------- -----------
Merchandise Inventory @ Retail $1,415,469 $6,737,402 $ 6,737,402
Sales (Gross Recovery) 890,303.01 62.9% 4,042,312 60.0% 4,237,696 62.9%
Store Direct Expenses:
Total Employment Expense 118,479 8.4% 777,183 11.5% 603,774 9.0%
Rent & Occupancy 47,132 3.3% 320,279 4.8% 320,279 4.8%
Advertising 31,100 2.2% 204,005 3.0% 158,486 2.4%
Other SG&A 4,435 0.3% 82,667 1.2% 64,222 1.0%
------------ ----------- ------------
Total Store Direct Expenses 201,146 14.2% 1,384,134 20.5% 1,146,761 17.0%
Royalty Expense (b) NA 8,826 0.1% 9,252 0.1%
Liquidation Fees 58,423 4.1% 202,122 3.0% 235,809 3.5%
------------ ----------- ------------
Total GOB Expenses 259,569 18.3% 1,595,082 23.7% 1,391,823 20.7%
------------ ----------- ------------
Estimated Cash Proceeds From Sale $ 630,734 44.6% $2,447,229 36.3% $2,845,873 42.2%
============ =========== ============
NOTES:
(a) Projected Trade Letters of Credit at 4/30/03 ($216 million) are grossed-up
by 20% for insurance, freight and import fees and are assumed, for purposes of
this Analysis, to be issued to foreign vendors and that all goods secured by
Letters of Credit are shipped and paid in the normal course. Additionally, it is
assumed that all purchase orders for goods not secured by Trade Letters of
Credit would be cancelled as of the hypothetical filing date. While it may be
possible to cancel certain Trade Letters of Credit, it is assumed that any
potential cancellation would be offset by any goods on a non-secured purchase
order that are FOB. Accordingly, the estimated Trade Letter of Credit balance is
considered a reasonable estimate of the value of goods that would flow into a
GOB sale subsequent to the sale commencement date.
(b) Royalty Expense on Licensed Inventory is estimated using projected balances
of licensed inventories as of 4/30/03. Expense is calculated on those lines
where royalties are determined by sales. Royalty expense calculated on purchases
or receipts are assumed to have been booked prior to commencement of the GOB
Sale. Results of the 2002 GOB Sale were tracked only on a direct store expense
basis. Consequently, comparable information for royalty expense is not
available.
The accompanying notes are an integral part of the Best Interests Analysis
B-11
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
NOTE 4 PREPAID EXPENSES AND OTHER ASSETS
Prepaid Expenses and Other Assets comprises a variety of accounts, the most
sizeable being Prepaid Advertising, Prepaid Sales Taxes and Debt Restructure
Costs.
Prepaid advertising is comprised of paper purchased in advance for advertising
circulars and passouts and electronic media purchases. For purposes of the
analysis, it is assumed that there is negligible recovery value in the paper and
that some portion of the purchased but unused media advertising may be
recovered.
Prepaid sales taxes are prepayments of estimated store related sales taxes that
are reconciled and cleared upon the filing of sales tax returns.
Debt Restructure Costs holds the short term portion of the legal and other
expenses incurred in the restructuring of the Company's debt. None of the
expenses associated with Debt Restructure Costs is recoverable.
Other prepaid expenses and current assets are comprised of a variety of smaller
balances and include such items as real estate rents, insurance and store
related supplies.
Recovery Rate Estimated Proceeds
Range Range
Projected ---------------------- ----------------------
Balance @
Prepaid and Other Assets 4/30/2003 Low High Low High
------------------------------ --------------- -------------- -------------- ---------------- ----------------
Prepaid Advertising $ 28,000 10% 25% 2,800 7,000
Prepaid Sales Taxes 61,000 100% 100% 61,000 61,000
Debt Restructure Costs 9,008 0% 0% - -
Other 68,215 15% 30% 10,232 20,465
-------------- --------------- ---------------- ---------------- --------------
$166,223 45% 53% $ 74,032 $ 88,465
The accompanying notes are an integral part of the Best Interests Analysis
B-12
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
NOTE 5 NET P&E - OWNED AND LEASED
Net P&E includes owned land, buildings, furniture, fixtures and equipment at the
stores, distribution center and corporate resource center, net of depreciation.
Certain P&E is recorded as capitalized lease assets. Proceeds from the
disposition of owned real estate and real estate leasehold interests were
established using estimates provided by Rockwood Gemini Advisors.
Proceeds from the sale of furniture, fixtures and equipment are estimated based
on management's experience with store closings.
Recovery Rate Estimated Proceeds
Projected Range Range
NBV @ ----------------------------- ------------------------------
REAL ESTATE ASSETS 4/30/2003
------------------------------------- -------------------
Low High Low High
------------ ------------ ----------- --------------
Owned: (a)
Stores $ 193,529 $ 234,546
DCs 933 11,803
KRC 9,625 19,250
Other 57,020 65,569
------- ----------
1,208,392 22% 27% 261,107 331,168
Leased:
Capitalized Assets and LHI (a) (b) 1,703,830 17% 27% 293,238 461,536
NON-REAL ESTATE FIXED ASSETS
-------------------------------------
Furniture & Fixtures - Stores 1,229,244 3% 5% 36,877 61,462
Furniture & Fixtures - DCs 282,944 0% 5% - 14,147
Furniture & Fixtures - KRC 213,659 1% 5% 2,137 10,683
Other (4,074) 0% 0% - -
----------- --------- ---------
TOTALS $ 4,633,995 13% 19% $ 593,359 $ 878,996
============ ========== =========
NOTES:
- ---------------------------------------------
(a) Per discussions with the Company's real estate advisor, Rockwood Gemini
Advisors, appraised values have been reduced by 50% to reflect the
liquidation assumptions contemplated by this Analysis.
(b) For purposed of the Analysis, Capitalized Assets are considered to be
principally real estate assets and Leasehold Improvements are considered
as part of those assets. Anticipated recoveries on Capitalized Assets and
Leasehold Improvements are assumed to be through the sale of designation
rights.
The accompanying notes are an integral part of the Best Interests Analysis
B-13
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
NOTE 6 OTHER ASSETS & DEFERRED CHARGES
Other Assets & Deferred Charges comprises a variety of accounts, the most
sizeable being Investment - Meldisco, Bonuses Paid Upon Acquisition and Long
Term Property Held for Resale.
The Investment - Meldisco account holds the balance of the Company's investment
in Meldisco. Kmart has a 49% interest in all but approximately 36 footwear
departments. In liquidation, this asset is assumed to have no value.
Bonuses Paid Upon Acquisition are brokerage fees related to store leases and not
recoverable.
Long-Term Property Held for Resale is non-Kmart retail properties and outlot
parcels that are for sale but not expected to be sold within the next twelve
months. Per discussions with the Company's real estate advisor, Rockwood Gemini
Advisors, appraised values have been reduced by 50% to reflect the liquidation
assumptions contemplated by this Analysis.
Other account balances are comprised of deposits and other deferred charges with
varying degrees of recovery values.
Recovery Rate Estimated Proceeds
Range Range
Projected -------------------------------- ----------------------------------
Balance @
Other Assets & Deferred Charges 4/30/2003 Low High Low High
------------------------------------ ------------ --------------- ---------------- ---------------- ----------------
Investment - Meldisco 34,000 0% 0% - -
Bonuses Paid Upon Acquisition 52,607 0% 0% - -
Long-Term Property Held for Resale 56,387 84% 104% 47,608 58,464
Other 39,995 15% 30% 5,999 11,999
------------- --------------- ---------------- ---------------- ----------------
$182,989 19% 37% $ 53,607 $ 70,462
The accompanying notes are an integral part of the Best Interests Analysis
B-14
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
NOTE 7 RECOVERIES FROM AVOIDANCE ACTIONS
Debtors have identified certain pre-petition payments to third-parties and will
be seeking recovery of certain payments. It is likely in a Chapter 7 liquidation
that the trustee would seek to recover all such payments and they are listed in
the following table. The pre-petition payments listed below exclude vendor debit
balances, which are assumed to reside in Accounts Receivable. The schedule below
shows management's estimate of recoveries, net of recovery expenses, that would
be received after the beginning of Chapter 7 liquidation proceedings. It is
anticipated that such recoveries will take place over approximately 2.5 years.
The outcome of any particular preference action is subject to a number of
uncertainties. Moreover, the potential value of a preference action against a
particular preference defendant ultimately is dependent upon the specific
payment history and other facts and circumstances pertaining to that vendor and
its relationship with the Debtors. It is therefore difficult to extrapolate
generalized results for an entire class of preference claims from the individual
circumstances of each case. The Debtors have not undertaken an exhaustive
analysis of all potential preference claims in order to arrive at the estimates
contained herein. Rather, the analysis undertaken by the Debtors for purposes of
these estimates has been general in nature. The estimates contained herein
therefore may be materially different from actual results achieved.
Estimated
Recovery Rate Impact on Unsecured
Range Creditor Recoveries
-------------------------- -------------------------------
Pre-petition
Component payments Low High Low High
- ----------------------------------------- ---------------- ----------- ----------- ------------- -------------
Payments Made During Preference Period $ 8,061,742 3% 5% $ 240,000 $ 405,000
================ ============= =============
The accompanying notes are an integral part of the Best Interests Analysis
B-15
APPENDIX B
LIQUIDATION ANALYSIS
($ in 000s)
NOTE 8 CORPORATE EXPENSES
It is assumed that the creditor recovery process occurs over an eighteen-month
period. For purposes of the Analysis, corporate expenses include both
headquarters and distribution center related expense. A nearly full complement
of corporate expenses is assumed to be required during the first three months,
with declining amounts of corporate expenses required in the following months.
It is assumed, further, that there will be an additional compensation program
designed to retain key employees during the liquidation period.
Retention % of
2003 Discount Total & Severance Salaries &
Projections Rate Expense Estimate (a) Wages
-------------- ---------- ----------- ------------- ------------
PHASE I MONTHS 1-3 Corporate Rent & Occupancy $ 35,958 100% $ 35,958
Corporate Employment Expense (b) 165,527 79% 130,095 64,476 30%
Corporate SG&A 76,664 79% 60,254
------------- --------- -----------
278,150 81% 226,307
PHASE II MONTHS 4-6 Corporate Rent & Occupancy 35,958 83% 29,694
Corporate Employment Expense 165,527 28% 45,855 19,331 50%
Corporate SG&A 76,664 28% 21,238
-------------- --------- -----------
278,150 35% 96,787
MONTHS 7-9 Corporate Rent & Occupancy 35,958 83% 29,694
Corporate Employment Expense 165,527 5% 8,292 3,495 50%
Corporate SG&A 76,664 5% 3,840
-------------- --------- -----------
278,150 15% 41,826
PHASE III MONTHS 10-12 Corporate Rent & Occupancy 35,958 15% 5,543
Corporate Employment Expense 165,527 3% 4,209 1,774 50%
Corporate SG&A 76,664 3% 1,949
-------------- --------- -----------
278,150 4% 11,702
MONTHS 13-18 Corporate Rent & Occupancy 71,916 15% 11,087
Corporate Employment Expense 331,054 3% 8,418 3,549 50%
Corporate SG&A 153,329 3% 3,899
-------------- --------- -----------
556,299 4% 23,403
CALCULATED TOTAL CORPORATE EXPENSES $ 400,025
============
ESTIMATED CORPORATE EXPENSE RANGE
HIGH $ 450,000
LOW $ 400,000
NOTES:
- ---------------------------------------
(a) Estimated severance and retention is projected based on payroll dollars per
period at the rate indicated grossed-up by 10% for employer side taxes. An
additional $28.7 million (net) / $31.6 million (gross), which is equivalent to
the current estimate of the third scheduled KERP payment has been included and
is assumed to be paid as a bonus for achieving GOB results within an acceptable
range.
(b) Assumes WARN notices given to Distribution Centers on 4/30/03.
The accompanying notes are an integral part of the Best Interests Analysis
B-16
APPENDIX C
PRO FORMA FINANCIAL PROJECTIONS
KMART CORPORATION
(DEBTORS-IN-POSSESSION)
PROJECTED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS)
PROJECTED FRESH START &
FISCAL YEAR 3 MONTHS ENDING DEBT DISCHARGE 9 MONTHS ENDING FISCAL YEAR
2002 APRIL 30, 2003 ADJUSTMENTS JAN. 28, 2004 2003
----------- --------------- -------------- --------------- -----------
(PRE-EMERGENCE) (POST-EMERGENCE)
Net sales $ 30,808 $ 6,419 $ - $ 19,008 $ 25,427
Cost of sales, buying and occupancy 25,275 5,169 - 15,220 20,389
-------- -------- -------- -------- --------
Gross margin 5,533 1,250 - 3,788 5,038
Selling, general and administrative expenses 6,264 1,455 - 3,666 5,121
-------- -------- -------- -------- --------
Earnings before reorganization cost, fresh
start valuation charges, interest, income
taxes and extraordinary items (731) (205) - 122 (83)
Interest expense, net 147 57 - 70 127
-------- -------- -------- -------- --------
Earnings before reorganization cost, fresh start
valuation charges, income taxes and
extraordinary items (878) (262) - 52 (210)
Reorganization items, net 305 440 - 24 464
Non-comparable items 2,134 25 - - 25
Fresh start valuation charges - - 5,639 - 5,639
-------- -------- -------- -------- --------
(Loss) earnings before income taxes and
extraordinary item (3,317) (727) (5,639) 28 (6,338)
Income taxes (16) - - - -
-------- -------- -------- -------- --------
(Loss) earnings before extraordinary item (3,301) (727) (5,639) 28 (6,338)
Extraordinary gain on discharge of debt, net of
income taxes - - 5,639 - 5,639
Extraordinary gain - negative goodwill - - 413 - 413
-------- -------- -------- -------- --------
Net (loss) earnings from continuing operations (3,301) (727) 413 28 (286)
Discontinued Operations (37) - - - -
-------- -------- -------- -------- --------
Net (loss) earnings $ (3,264) $ (727) $ 413 $ 28 $ (286)
======== ======== ======== ======== ========
Depreciation and amortization 699 149 - 9 158
EBITDA (see Summary of Significant Assumptions) $ (32) $ (56) $ - $ 131 $ 75
======== ======== ======== ======== ========
KMART CORPORATION
(DEBTORS-IN-POSSESSION)
PROJECTED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS)
FISCAL YEAR
-------------------------------------
2004 2005 2006 2007
------- ------- ------- -------
Net sales $25,614 $26,981 $28,478 $30,170
Cost of sales, buying and occupancy 20,423 21,308 22,407 23,669
------- ------- ------- -------
Gross margin 5,191 5,673 6,071 6,501
Selling, general and administrative expenses 4,814 5,066 5,258 5,409
------- ------- ------- -------
Earnings before interest and income taxes 377 607 813 1,092
Interest expense, net 86 73 61 51
------- ------- ------- -------
Earnings before income taxes 291 534 752 1,041
Income taxes 110 202 287 397
------- ------- ------- -------
Net earnings $ 181 $ 332 $ 465 $ 644
======= ======= ======= =======
Depreciation and amortization 47 93 142 192
EBITDA (see Summary of Significant Assumptions) $ 424 $ 700 $ 955 $ 1,284
======= ======= ======= =======
KMART CORPORATION
(DEBTORS-IN-POSSESSION)
PROJECTED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
PROJECTED
FISCAL YEAR APRIL 30, FRESH START DEBT DISCHARGE APRIL 30, FISCAL YEAR
2002 2003 ADJUSTMENTS ADJUSTMENTS 2003 2003
----------- --------- ----------- -------------- --------- -----------
(PRE-EMERGENCE) (POST-EMERGENCE)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 504 $ 325 $ - $ (25) $ 300 $ 300
Merchandise inventories 4,843 4,053 211 - 4,264 4,048
Other current assets 713 585 220 - 805 739
------- ------- ------- ------- ------- -------
TOTAL CURRENT ASSETS $ 6,060 $ 4,963 $ 431 $ (25) $ 5,369 $ 5,087
Property and equipment, net 4,392 4,299 (4,299) - - 273
Other assets and deferred charges 587 585 (585) - - 12
------- ------- ------- ------- ------- -------
TOTAL ASSETS $11,039 $ 9,847 $(4,453) $ (25) $ 5,369 $ 5,372
======= ======= ======= ======= ======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Long-term debt due within one year $ - $ - $ - $ - $ - $ -
Accounts payable 1,238 923 - - 923 1,026
Other current liabilities 1,035 939 - 55 994 903
------- ------- ------- ------- ------- -------
TOTAL CURRENT LIABILITIES 2,273 1,862 - 55 1,917 1,929
Long-term debt - - - 115 115 115
Other long-term liabilities 863 641 310 1,087 2,038 2,003
------- ------- ------- ------- ------- -------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 3,136 2,503 310 1,257 4,070 4,047
LIABILITIES SUBJECT TO COMPROMISE 7,639 7,807 - (7,807) - -
Shareholders' equity 264 (463) (4,763) 6,525 1,299 1,325
------- ------- ------- ------- ------- -------
TOTAL LIABILITIES AND EQUITY $11,039 $ 9,847 $(4,453) $ (25) $ 5,369 $ 5,372
======= ======= ======= ======= ======= =======
KMART CORPORATION
(DEBTORS-IN-POSSESSION)
PROJECTED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
FISCAL YEAR
---------------------------------
2004 2005 2006 2007
------ ------ ------ ------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 300 $ 366 $ 566 $ 951
Merchandise inventories 3,995 3,925 3,910 3,872
Other current assets 658 681 708 739
------ ------ ------ ------
TOTAL CURRENT ASSETS $4,953 $4,972 $5,184 $5,562
Property and equipment, net 676 1,083 1,491 1,899
Other assets and deferred charges 12 14 16 17
------ ------ ------ ------
TOTAL ASSETS $5,641 $6,069 $6,691 $7,478
====== ====== ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Long-term debt due within one year $ - $ - $ - $ -
Accounts payable 1,357 1,505 1,570 1,684
Other current liabilities 962 1,187 1,538 1,828
------ ------ ------ ------
TOTAL CURRENT LIABILITIES 2,319 2,692 3,108 3,512
Long-term debt 19 - - -
Other long-term liabilities 1,797 1,539 1,279 1,019
------ ------ ------ ------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 4,135 4,231 4,387 4,531
Shareholders' equity 1,506 1,838 2,304 2,947
------ ------ ------ ------
TOTAL LIABILITIES AND EQUITY $5,641 $6,069 $6,691 $7,478
====== ====== ====== ======
KMART CORPORATION
(DEBTORS-IN-POSSESSION)
PROJECTED CONSOLIDATED STATEMENTS OF CASH FLOW
(DOLLARS IN MILLIONS)
FRESH START,
DEBT DISCHARGE
PROJECTED & NEGATIVE
FISCAL YEAR 3 MONTHS ENDING GOODWILL 9 MONTHS ENDING FISCAL YEAR
2002 APRIL 30, 2003 ADJUSTMENTS JAN. 28, 2004 2003
----------- --------------- -------------- --------------- -----------
(PRE-EMERGENCE) (POST-EMERGENCE)
OPERATING ACTIVITIES:
Net (loss) earnings $(3,264) $ (727) $ 413 $ 28 $ (286)
Adjustments to reconcile net loss
to net cash used for operating activities:
Gain from discontinued operations (37) - - - -
Restructuring, impairments and other charges 2,134 25 (413) - (388)
Reorganization items, net 305 440 - 24 464
Depreciation and amortization 742 183 - 9 192
Equity (income) loss in unconsolidated subsidiaries (44) (7) - (26) (33)
Dividends received from Meldisco 45 45 - - 45
Changes in Operating Assets and Liabilities:
Inventories (130) 790 - 217 1,007
Accounts payable 239 (315) - 103 (212)
Deferred income taxes and taxes payable (3) - - - -
Other assets 181 68 - 79 147
Other liabilities 181 51 - (140) (89)
Cash used for store closings and other charges (327) (596) - (33) (629)
------- ------- ------- ------- -------
NET CASH (USED FOR) PROVIDED BY OPERATING ACTIVITIES 22 (43) - 261 218
------- ------- ------- ------- -------
INVESTING ACTIVITIES:
Capital expenditures (263) (68) - (282) (350)
------- ------- ------- ------- -------
NET CASH USED FOR INVESTING ACTIVITIES (263) (68) - (282) (350)
------- ------- ------- ------- -------
FINANCING ACTIVITIES:
Proceeds from debt - - 55 60 115
Debt issuance costs (36) (55) - - (55)
Repurchase of common shares - - (140) - (140)
Proceeds from note - - 60 - 60
Payments on debt, net (371) - - - -
Payments on capital lease obligations (93) (13) - (39) (52)
------- ------- ------- ------- -------
NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES (500) (68) (25) 21 (72)
------- ------- ------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS (741) (179) (25) - (204)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,245 504 325 300 504
------- ------- ------- ------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 504 $ 325 $ 300 $ 300 $ 300
======= ======= ======= ======= =======
KMART CORPORATION
(DEBTORS-IN-POSSESSION)
PROJECTED CONSOLIDATED STATEMENTS OF CASH FLOW
(DOLLARS IN MILLIONS)
FISCAL YEAR
----------------------------------------
2004 2005 2006 2007
------- ------- ------- -------
OPERATING ACTIVITIES:
Net earnings $ 181 $ 332 $ 465 $ 644
Adjustments to reconcile net earnings
to net cash used for operating activities:
Depreciation and amortization 47 93 142 192
Equity income in unconsolidated subsidiaries (47) (48) (49) (50)
Dividends received from Meldisco 46 47 48 49
Changes in operating assets and liabilities:
Inventories 52 71 15 38
Accounts payable 331 148 65 114
Deferred income taxes and taxes payable 110 202 287 271
Other assets 82 (24) (27) (31)
Other liabilities (205) (184) (144) (190)
------- ------- ------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 597 637 802 1,037
------- ------- ------- -------
INVESTING ACTIVITIES:
Capital expenditures (450) (500) (550) (600)
------- ------- ------- -------
NET CASH USED FOR INVESTING ACTIVITIES (450) (500) (550) (600)
------- ------- ------- -------
FINANCING ACTIVITIES:
Payments on debt, net (95) (19) - -
Payments on capital lease obligations (52) (52) (52) (52)
------- ------- ------- -------
NET CASH USED FOR FINANCING ACTIVITIES (147) (71) (52) (52)
------- ------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS - 66 200 385
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 300 300 366 566
------- ------- ------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 300 $ 366 $ 566 $ 951
======= ======= ======= =======
SUMMARY OF SIGNIFICANT ASSUMPTIONS
The financial projections included in this Disclosure Statement (the
"Projections") are dependent on successful implementation of the business plans
of Kmart Corporation and its subsidiaries ("Kmart" or the "Company") and the
validity of the assumptions contained therein. These Projections reflect
numerous assumptions, including confirmation and consummation of the plan of
reorganization for Kmart as filed with the Bankruptcy Court.
The independent Accountants for Kmart have neither examined nor compiled the
Projections and accordingly, assume no responsibility for them. Moreover, the
Projections have not been prepared to comply with the guidelines established
with respect to Projections by the Securities and Exchange Commission or the
American Institute of Certified Public Accountants.
Fresh Start Accounting and Enterprise Value:
The Projections assume that Kmart will emerge from Chapter 11 on April 30, 2003,
and as required, adopt the provisions of Fresh Start Accounting prior thereto.
These principles are contained in the American Institute of Certified Public
Accountants Statement of Position 90-7, "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code," ("SOP 90-7"). Adoption of Fresh Start
Accounting requires that assets and liabilities be stated at their
reorganization value, which approximates fair value at the date of emergence
from Chapter 11. The Fresh Start Accounting adjustments are based upon the
enterprise valuation analysis completed by DrKW/MBL (Refer to Exhibit E). In
applying Fresh Start Accounting, significant adjustments are expected to be
recorded to write-down our long-lived assets, including intangibles. Adjustments
to reflect the fair value of assets and liabilities, on a net basis, result in
an excess of fair value of net assets over reorganization value ("negative
goodwill") of approximately $4.4 billion. This negative goodwill will be
allocated on a pro rata basis and serve to reduce the basis of our non-current
assets. The remaining negative goodwill of $0.4 billion will be recorded in the
income statement as an extraordinary gain. The restructuring of Kmart's capital
structure and resulting discharge of pre-petition debt will result in an
extraordinary gain of $5.6 billion. The Fresh Start Accounting adjustments
included in the following projections are preliminary estimates.
New Accounting Pronouncements:
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("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 on settlement will be recognized. The provisions of SFAS No. 143
will be adopted for our fiscal year beginning January 30, 2003. We are currently
quantifying 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 establishes that gains and losses from
extinguishment of debt will be classified as extraordinary items only if they
meet the criteria of unusual or infrequently occurring items. Kmart anticipates
that the gain from the extinguishments of our pre-petition debt will be
classified as an extraordinary item.
In November 2002, a consensus was reached on two issues included in Emerging
Issue Task Force ("EITF") 02-16, "Accounting by a Customer (including a
Reseller) for Certain Consideration Received from a Vendor," which addresses the
accounting by a reseller for consideration received from a vendor. First, cash
consideration received from a vendor is presumed to be a reduction of the price
of the vendor's product or service and should be classified as a reduction to
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. Second, performance-driven vendor rebates ("volume rebates") should be
recorded only if the payment is considered probable and should be measured on a
systematic and rational basis consistent with achieving the underlying
performance targets. The provisions related to volume rebates are already
effective for new arrangements and we have adopted the provisions, as required.
The provisions related to the first consensus will take effect the first day of
Kmart's fiscal 2003 year, or January 30, 2003, and as a result, Kmart
anticipates that a significant reclassification of amounts previously defined as
co-op advertising recoveries and included as a reduction of selling, general and
administrative expenses will now be classified as a reduction of cost of sales
expense.
The pro-forma financial statements do not take into consideration the potential
for changes in Kmart's accounting policies and procedures, as discussed in the
Amendment No. 1 to Kmart's Annual Report on Form 10-K/A for the period ended
January 30, 2002, in Item 7, Management's Discussion and Analysis of Results of
Operations and Financial Condition, "Critical Accounting Policies" and Item 8.
Financial Statements and Supplementary Data, Footnote 3, "Significant Accounting
Policies and Procedures." Kmart's adoption of policies and procedures that
differ from methods used historically could result in a significant difference
in actual valuation adjustments applied in Fresh Start Accounting.
Net Sales:
Net sales for 2003 vs. 2002 are projected to decrease by 17.5% due to the
closure of 283 stores in May 2002 and 319 stores in March 2003. Net sales are
expected to increase 0.7% in 2004, 5.3% in 2005, 5.5% in 2006 and 5.9% in 2007.
The increases in net sales for 2004 - 2007 are partially the result of 70 new
store openings, which are planned as follows: 10 each in 2004 and 2005, 20 in
2006 and 30 in 2007.
On a same-store basis, the Projections assume that same-store sales will
increase over prior years by 1.1%, 3.8%, 4.5%, 4.3% and 4.0% for 2003 - 2007,
respectively. The primary drivers of the same-store sales increases include the
continued improvement in operational execution, increased promotional
productivity and improved product flow.
As a result of improved product flow and allocation, SKU rationalization and
store closures, inventory turns are expected to improve from 4.0 in 2002 to 4.2
in 2003. Inventory turnover is expected to further improve to 5.0 by 2007 as a
result of right-size purchasing and flow path optimization.
Gross Margin:
Gross Margin as a percentage of net sales is projected to improve from 18.0% in
2002 to 21.5% in 2007. This improvement is driven by improved promotional
productivity, favorable product mix and markon improvement due to increased
import purchases. Additionally, as a result of recently implemented inventory
control and loss prevention programs, the Company has projected a return to
historical shrinkage rates. As discussed above, Kmart will reclassify credits
previously defined as co-op advertising recoveries to a reduction of cost of
sales resulting in an improvement in the gross margin rate. In addition, the
Projections assume lower depreciation of buildings and leasehold improvements as
a result of the write-down of assets for Fresh Start Accounting.
SG&A:
Selling, general and administrative expenses ("SG&A"), as a percentage of net
sales, are projected to remain relatively flat at approximately 20.0% from 2002
to 2003 as lower depreciation expense generated by Fresh Start Accounting
adjustments is mostly offset by the effects of store closings and the resulting
lower sales base. Thereafter, SG&A is expected to improve to 17.9% of net sales
by 2007. This improvement is primarily due to improved operating procedures and
productivity at the stores and cost control initiatives at Kmart Headquarters.
As discussed above, Kmart will reclassify credits previously defined as co-op
advertising recoveries to a reduction of cost of sales resulting in an increase
in SG&A as a percentage of sales.
Income Taxes:
The Projections assume that Kmart will substantially offset its unused net loss
carry forwards against the Company's cancellation of debt income at emergence.
The effective tax rate going forward is estimated at 38.0%. Tax benefits will be
fully reserved until utilization.
Reorganization and Non-Comparable Items:
Expenses and income directly incurred or realized as a result of the Chapter 11
Filings have been segregated from normal operations and are disclosed
separately. For 2003, the Projections assume $464 million of Chapter 11
Reorganization items primarily relating to the store closings, professional fees
and bonuses related to the Key Employee Retention Plan. Non-comparable items are
forecast to be $25 million, which relates to the sale of a Distribution Center
and the associated write-down of assets.
EBITDA:
EBITDA represents earnings from continuing operations before interest and
financing charges, income taxes, non-comparable charges, reorganization items,
depreciation and amortization and other charges. This presentation is not
intended to be a substitute for measures of profitability or cash flow required
by Generally Accepted Accounting Principles in the United States of America.
EBITDA, as measured by the Company, may not be comparable to EBITDA reported by
other companies.
Capital Expenditures:
In 2003, capital expenditures relate primarily to the general maintenance of
existing stores and distribution centers as well as a modest amount of new
investment in supply chain operations and information systems. The Projections
assume that annual capital expenditures build from $350 million in 2003 to $600
million in 2007. The increase is primarily related to new store openings (a
total of 70 from 2004 -- 2007) and updating the existing stores.
Working Capital & Liquidity:
The Projections assume the Company has sufficient liquidity with the peak
borrowing occurring in November of each year.
The Projections assume that the Company's level of vendor support represented by
average days accounts payable will increase over the projection period to
approximate historical levels.
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 the 2002 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 will be
required to commence making contributions to the plan in 2004 or 2005. The
Projections assume that $238 million is contributed to the plan in 2004 and
contributions of $202 million, $178 million and $160 million are made in 2005,
2006 and 2007, respectively. 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.
As a result of the returns on plan assets over recent years, expected decreases
in our annual discount rate and expected rate of return on assets for fiscal
year 2003, there will likely be an expense of $37 million recorded for 2003 as
opposed to income as has been recorded in recent years. As a result of the
funding described above and expected returns on plan assets going forward, the
Projections assume income of $4 million will be recorded beginning in 2005 and
reach income of $49 million in 2007.
Upon adoption of Fresh Start Accounting, we will recognize $938 million of
unamortized actuarial losses in our Statement of Operations; these losses were
previously included as a component of equity and classified as other
comprehensive income.
APPENDIX D
REORGANIZATION VALUATION ANALYSIS
APPENDIX D
REORGANIZATION VALUATION ANALYSIS
Miller Buckfire Lewis & Co., LLC (the "Financial Advisor") has advised
the Debtors with respect to the value of the Reorganized Debtors.
For purposes of the Plan, the reorganization value (the "Reorganization
Value") of the Reorganized Debtors is estimated to range from approximately
$2,250 million to $3,000 million. The Reorganization Value assumes an effective
date (the "Effective Date") of April 30, 2003 and reflects the going concern
value of the Debtors after giving effect to the implementation of the Plan. The
Reorganization Value does not include excess cash, if any, remaining in the
Reorganized Debtors after taking into account cash distributions required under
the Plan. The Debtors are of the view that such excess cash, if any, is
necessary to run the business and, therefore, should not be viewed as excess
cash for valuation purposes.
The equity value (the "Equity Value") of the Reorganized Debtors is
estimated to range from approximately $753 million to $1,503 million or from
approximately $8.74 per share to $17.43 per share assuming that a total of
86,236,457 shares of common stock are issued and outstanding on the Effective
Date. The Equity Value reflects the difference between the Reorganization Value
and the total amount of long-term net debt that is estimated to be outstanding
after giving effect to the Plan.
The Financial Advisor has assisted the Debtors in arriving at the
Reorganization Value. In doing so, the Financial Advisor has assumed and relied
on the accuracy and completeness of certain unaudited projections prepared by
the Debtors of the Debtors' results of operations, cash flow and related balance
sheets (the "Projections"). The Projections reflect numerous assumptions,
including assumptions with respect to the future performance of the Reorganized
Debtors, the performance of the industry, general business and economic
conditions and other matters, most of which are beyond the Debtors' control.
Numerous factors may affect the future financial performance of the Reorganized
Debtors and the accuracy of the Projections. Therefore, the actual results
achieved during the projection period will vary from the projected results, and
may vary substantially. No representations can be or are being made with respect
to the accuracy of the Projections, or the ability of the Reorganized Debtors to
achieve the projected results.
In arriving at the Reorganization Value, the Financial Advisor
performed certain quantitative analyses and made determinations as to the most
appropriate and relevant methods of financial and comparative analysis and the
application of those methods to the particular circumstances of the Reorganized
Debtors. The Financial Advisor did not assign any specific relative weight to
any analysis or factor considered but rather made qualitative judgments as to
the significance and relevance of each analysis and factor based on the Debtors'
circumstances, including their operating performance.
SET FORTH BELOW IS A SUMMARY OF THE MATERIAL FINANCIAL ANALYSES
PERFORMED BY THE FINANCIAL ADVISOR IN ESTIMATING THE VALUE OF THE REORGANIZED
DEBTORS.
1
1. Comparable Public Company Analysis
In a comparable public company analysis, a subject company is valued by
comparing it to publicly held companies in reasonably similar lines of business.
The comparable public companies are chosen based on, among other attributes,
their similarity to the subject company's business, presence in the market and
size. The price that an investor is willing to pay in the public markets for
each company's publicly traded securities represents that company's current and
future prospects as well as the rate of return required on the investment.
The analytical work performed includes, among other things, a detailed
financial comparison of selected metrics from each company's financial
statements. Numerous financial multiples and ratios were developed to measure
each company's valuation and relative performance. Some of the specific analyses
entailed comparing the enterprise value (defined as market value of equity plus
debt minus excess cash) for each of the comparable public companies to their
sales, EBITDA and EBIT as well as comparing their equity values to net income
and book value. Where appropriate, the Financial Advisor applied these multiples
to the projected financials of the Reorganized Debtors to determine an implied
range of enterprise and equity values for the Reorganized Debtors.
2. Discounted Cash Flow Analysis
The second valuation methodology used to value the Reorganized Debtors
was the discounted cash flow method. The discounted cash flow method relates the
value of an asset or business to the present value of expected future cash flows
to be generated by that asset or business. The discounted cash flow method is a
forward-looking approach that discounts the expected future cash flows by a
theoretical or observed discount rate. The Reorganized Debtors' projected cash
flows after debt service (as set forth in the Business Plan) were discounted to
a present value as of the Effective Date using a discount rate equal to the
weighted average cost of capital for the Reorganized Debtors. For purposes of
the valuation analysis, the Financial Advisor used a range of discount rates
between 20% and 25%, which reflects a number of company and market specific
factors, including business execution risk and the nature and derivation of the
projections set forth in the Business Plan as well as the cost of equity for
companies that the Financial Advisor deemed comparable.
3. Comparable Acquisition Analysis
The third valuation methodology used to estimate the value of the
Reorganized Debtors is the comparable acquisition analysis. The comparable
acquisition analysis entails calculating multiples of revenues, earnings and
book value based on prices paid (including any debt assumed and equity
purchased) in announced mergers and acquisitions involving companies viewed to
be similar to the Reorganized Debtors. These multiples were then applied, where
deemed relevant, to the projected financials of the Reorganized Debtors to
determine an implied range of enterprise and equity values.
In connection with their analysis of the value of the Reorganized
Debtors, the Financial Advisor (i) reviewed certain historical financial
information of the Debtors for recent years and interim periods, (ii) reviewed
the Projections and the assumptions underlying them, (iii) reviewed certain
2
internal financial and operating data of the Debtors, (iv) met with certain
members of management to discuss the Debtors' operations and future prospects
(including the operational changes contemplated by the Business Plan), (v)
reviewed publicly available financial data and (vi) considered certain economic
and industry information relevant to the Debtors' operating business and
conducted such other analyses as the Financial Advisor deemed appropriate.
As noted above, the Financial Advisor assumed and relied on the
accuracy and completeness of all financial and other information that was
provided to or discussed with it by the Debtors as well as publicly available
information, and did not assume any responsibility for independently verifying
this information. The Financial Advisor also assumed that all financial
information and analysis (including the financial projections and forecasts)
provided by the Debtors was prepared in good faith and on bases reflecting the
best currently available judgments and estimates of management of the Debtors.
The Financial Advisor has not expressed or are not expressing any
opinion with respect to the financial information, analyses and forecasts
provided by the Debtors or the assumptions on which they are based.
In addition, the Financial Advisor has not made or obtained an
independent valuation or appraisal of the assets or liabilities of the
Reorganized Debtors, and no such independent valuation or appraisal was provided
to the Financial Advisor in connection with the valuation analysis.
The valuation analysis prepared by the Financial Advisor is based on
economic and market conditions as they existed and could be evaluated as of
January 13, 2003. The Reorganization Value represents a hypothetical
going-concern value for the Reorganized Debtors. It was calculated solely for
the purpose of determining value available for distribution to creditors under
the Plan and evaluating whether the Plan satisfied the "best interests test"
under 1129(a)(7) of the Bankruptcy Code as well as establishing a reasonable
estimate of the initial stockholders' equity for fresh-start accounting. The
Reorganization Value does not purport to reflect or constitute an appraisal, a
liquidation value or an estimate of the actual market value that may be realized
through the sale of any securities to be issued pursuant to the Plan. The value
of the Debtors' business is subject to uncertainties and contingencies that are
difficult to predict. Consequently, the Reorganization Value is not necessarily
indicative of any actual value, which may be significantly more or less
favorable than the value set forth herein.
Additionally, the valuation of newly-issued securities is subject to
additional uncertainties and contingencies, all of which are difficult to
predict. Actual market prices of such securities at issuance will depend upon,
among other things, conditions in the financial markets, the anticipated initial
securities holdings of pre-petition creditors, some of which may prefer to
liquidate their investment rather than hold it on a long-term basis, and other
factors that generally influence the prices of securities. Actual market prices
of such securities also may be affected by the Debtors' history in Chapter 11,
conditions affecting the Debtors' competitors or the industry generally in which
the Debtors participate or by other factors not possible to predict.
Accordingly, the Reorganization Value does not necessarily reflect, and should
not be construed as reflecting, any value that will be attained in the public or
private markets. Finally, the Equity Value shown herein is based on the
Reorganized Debtors' assumption regarding their capitalization on the Effective
Date.
3
The valuation set forth herein reflects the assumption that the
operating results anticipated by management and reflected in the Business Plan
can be achieved in all material respects, including comparable store sales
growth and gross margin improvement. To the extent that the valuation is
dependent on the Debtors' achievement of the projections contained in the
Disclosure Statement, the valuation should be considered speculative. The
valuation also assumes (i) a successful and timely reorganization of the
Debtors' capital structure, (ii) the Plan becoming effective in accordance with
its proposed terms and (iii) the continuity of the present operating management
of the Debtors following consummation of the Plan.
Because of the uncertainties discussed herein, neither the Financial
Advisor nor the Debtors assumes any responsibility for the accuracy of the
valuation estimate.
4
APPENDIX E
HISTORICAL FINANCIAL RESULTS
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
YEARS ENDED JANUARY 30, 2002, JANUARY 31, 2001
AND JANUARY 26, 2000 2001 2000 1999
- ------------------------------------------------------------------- ----------- ---------- -----------
Sales .............................................................. $ 36,151 $ 37,028 $ 35,925
Cost of Sales, buying and occupancy ................................ $ 29,853 29,732 28,161
-------- -------- --------
Gross margin ....................................................... 6,298 7,296 7,764
Selling, general and administrative expenses ....................... 7,588 7,366 6,569
Equity income (loss) in unconsolidated subsidiaries ................ -- (13) 44
Restructuring, impairment and other charges ........................ 1,091 -- --
-------- -------- --------
Continuing (loss) income before interest, reorganization items
income taxes and dividends on convertible preferred
securities of subsidiary trust .................................. (2,381) (83) 1,239
Interest expense, net (contractual interest for fiscal year 2001 was
$352)............................................................ 344 287 280
Reorganization items ............................................... (183) -- --
(Benefit from) provision for income taxes .......................... -- (148) 315
Dividends on convertible preferred securities of subsidiary trust,
net of income taxes of $0, $25 and $27, respectively
(contractual dividend for fiscal year 2001 was $72) ............. 70 46 50
-------- -------- --------
Net (loss) income from continuing operations ....................... (2,612) (268) 594
Discontinued operations, net of income taxes of $0 and $124 ........ 166 -- (230)
-------- -------- --------
Net (loss) income .................................................. $ (2,446) $ (268) $ 364
======== ======== ========
BASIC EARNINGS (LOSS) PER COMMON SHARE
Net (loss) income from continuing operations ....................... $ (5.29) $ (0.53) $ 1.21
Discontinued operations ............................................ 0.34 -- (0.47)
-------- -------- --------
Net (loss) income .................................................. $ (4.95) $ (0.53) $ 0.74
======== ======== ========
DILUTED (LOSS) EARNINGS PER COMMON SHARE
Net (loss) income from continuing operations ....................... $ (5.29) $ (0.53) $ 1.15
Discontinued operations ............................................ 0.34 -- (0.41)
-------- -------- --------
Net (loss) income .................................................. $ (4.95) $ (0.53) $ 0.74
======== ======== ========
Basic weighted average shares (millions) ........................... 494.1 482.8 491.7
Diluted weighted average share (millions) .......................... 494.1 482.8 561.7
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
AS OF JANUARY 30, 2002 AND JANUARY 31, 2001 2001 2000
- -------------------------------------------------------------------------- ---------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents .................................................... $ 1,245 $ 401
Merchandise inventories ...................................................... 5,796 6,350
Other current assets ......................................................... 800 925
------- -------
TOTAL CURRENT ASSETS ......................................................... 7,841 7,676
Property and equipment, net .................................................. 6,093 6,522
Other assets and deferred charges ............................................ 249 617
------- -------
TOTAL ASSETS ................................................................. $14,183 $14,815
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Long-term debt due within one year ........................................... $ - $ 68
Accounts payable ............................................................. 89 2,190
Accrued payroll and other liabilities ........................................ 420 1,691
Taxes other than income taxes ................................................ 143 187
------- -------
TOTAL CURRENT LIABILITIES .................................................... 652 4,136
------- -------
Long-term debt and notes payable ............................................. 330 2,084
Capital lease obligations .................................................... 857 943
Other long-term liabilities .................................................. 132 883
------- -------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE .................................. 1,971 8,046
Liabilities subject to compromise ............................................ 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 of $898 and $898, respectively) ........ 889 887
Common stock, $1 par value, 1,500,000,000 shares authorized;
503,294,515 and 486,509,736 shares issued, respectively ...................... 503 487
Capital in excess of par value ............................................... 1,695 1,578
Retained earnings ............................................................ 1,032 3,817
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................................... $14,183 $14,815
======= =======
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
YEARS ENDED JANUARY 30, 2002, JANUARY 31, 2001 AND JANUARY 26, 2000 2001 2000 1999
- -------------------------------------------------------------------------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income ....................................................... (2,446) $ (268) $ 364
Adjustments to reconcile net income (loss) to net cash provided by
*operating activities:
Discontinued Operations ................................................. (166) - 230
Restructuring, impairment and other charges ............................. 1,254 728 -
Reorganization items, net ............................................... (183) - -
Depreciation and amortization ........................................... 824 777 770
Equity loss (income) in unconsolidated subsidiaries ..................... - 13 (44)
Dividends received from Meldisco ........................................ 51 44 38
Decrease (increase) in inventories ...................................... 560 335 (544)
Increase (decrease) in accounts payable ................................. 1046 (137) 169
Deferred income taxes and taxes payable ................................. (55) (204) 258
Changes in other assets ................................................. 295 29 (127)
Changes in other liabilities ............................................ (23) 14 133
Cash used for store closings ............................................ (128) (102) (80)
------- ------- -------
Net cash provided by continuing operations .............................. 1,029 1,229 1,167
Net cash used for discontinued operations ............................... (102) (115) (83)
------- ------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES ............................... 927 1,114 1,084
------- ------- -------
NET CASH USED FOR REORGANIZATION ITEMS .................................. (6) - -
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures .................................................... (1,385) (1,089) (1,277)
Investment in BlueLight.com ............................................. (45) (55) -
Acquisition of Caldor leases ............................................ - - (86)
------- ------- -------
NET CASH USED FOR INVESTING ACTIVITIES .................................. (1,430) (1,144) (1,363)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of debt ................................. 1,824 400 300
Payments on debt ............................................... (320) (73) (90)
Debt issuance costs ............................................ (49) (3) (3)
Payments on capital lease obligations .......................... (86) (78) (77)
Payments on dividends on preferred securities of subsidiary
trust ........................................................ (72) (73) (80)
Purchase of convertible preferred securities of subsidiary
trust ........................................................ - (84) -
Issuance of common shares ...................................... 56 53 63
Purchase of common shares ...................................... - (55) (200)
------- ------- -------
NET CASH PROVIDED BY (USED FOR) FINANCING
ACTIVITIES ........................................................... 1,353 87 (87)
------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS ................................. 844 57 (366)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ............................ 401 344 710
------- ------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR .................................. $ 1,245 $ 401 $ 344
======= ======= =======