SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2003
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from ______________ to _____________
Commission File No. 000-50278
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KMART HOLDING CORPORATION
-------------------------
(Exact name of registrant as specified in its charter)
Delaware 32-0073116
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3100 West Big Beaver Road -- Troy, Michigan 48084
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (248) 463-1000
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed, by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes X No
--- ---
As of May 30, 2003, 89,677,509 shares of Common Stock of Kmart Holding
Corporation were outstanding.
INDEX
PART I FINANCIAL INFORMATION PAGE
- ------ --------------------- ----
Item 1. Financial Statements
Condensed Consolidated Statements of Operations (Unaudited) -- 3
Predecessor Company -- for the 13-weeks ended April 30, 2003 and May 1, 2002
Condensed Consolidated Balance Sheets (Unaudited) -- 4
Successor Company -- as of April 30, 2003
Predecessor Company -- as of May 1, 2002 and January 29, 2003
Condensed Consolidated Statements of Cash Flows (Unaudited) -- 5
Predecessor Company -- for the 13-weeks ended April 30, 2003 and May 1, 2002
Notes to Unaudited Condensed Consolidated Financial Statements 6-21
Item 2. Management's Discussion and Analysis of Results of Operations and Financial 22-28
Condition
Item 3. Quantitative and Qualitative Disclosures about Market Risk 29
Item 4. Controls and Procedures 29
PART II OTHER INFORMATION
- ------- -----------------
Item 1. Legal Proceedings 30
Item 2. Changes in Securities and Use of Proceeds 30
Item 3. Defaults Upon Senior Securities 30
Item 5. Other Information 30-31
Item 6. Exhibits and Reports on Form 8-K 31-32
Signatures 33
Certifications 34-36
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
PREDECESSOR COMPANY
------------------------
13 WEEKS ENDED
APRIL 30, MAY 1,
2003 2002
---------- ---------
Sales $ 6,181 $ 7,181
Cost of sales, buying and occupancy 4,762 6,436
------- -------
Gross margin 1,419 745
Selling, general and administrative expenses 1,421 1,670
Restructuring, impairment and other charges 37 --
Equity income in unconsolidated subsidiaries 7 5
------- -------
Loss before interest, reorganization items, income taxes and
discontinued operations (32) (920)
Interest expense, net (contractual interest for 13 week periods ended
April 30, 2003 and May 1, 2002 was $124 and $102, respectively) 57 33
Reorganization items, net 769 251
Benefit from income taxes (6) (12)
------- -------
Loss before discontinued operations (852) (1,192)
Discontinued operations (10) (250)
------- -------
Net loss $ (862) $(1,442)
======= =======
Basic/diluted loss before discontinued operations $ (1.63) $ (2.37)
Discontinued operations (0.02) (0.50)
------- -------
Basic/diluted net loss per common share $ (1.65) $ (2.87)
======= =======
Basic/diluted weighted average shares (millions) 522.7 502.9
See accompanying Notes to unaudited Condensed Consolidated Financial Statements.
3
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
SUCCESSOR PREDECESSOR
COMPANY COMPANY
------------ ------------------------
APRIL 30, MAY 1, JANUARY 29,
2003 2002 2003
------------ -------- -----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,232 $ 1,829 $ 613
Merchandise inventories 4,431 5,255 4,825
Receivable from Plan Investors 187 - -
Accounts receivable 382 316 473
Other current assets 322 281 191
-------- -------- --------
TOTAL CURRENT ASSETS 6,554 7,681 6,102
Property and equipment, net 10 5,972 4,892
Other assets and deferred charges 96 219 244
-------- -------- --------
TOTAL ASSETS $ 6,660 $ 13,872 $ 11,238
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Long-term debt due within one year $ 8 $ - $ -
Accounts payable 1,160 1,658 1,248
Accrued payroll and other liabilities 1,321 659 710
Taxes other than income taxes 274 237 162
-------- -------- --------
TOTAL CURRENT LIABILITIES 2,763 2,554 2,120
Long-term debt and notes payable 108 - -
Capital lease obligations 415 694 623
Pension obligation 854 - -
Other long-term liabilities 807 140 181
-------- -------- --------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 4,947 3,388 2,924
LIABILITIES SUBJECT TO COMPROMISE - 7,805 7,969
Company obligated mandatorily redeemable convertible preferred
securities of a subsidiary trust holding solely 7 3/4% convertible
junior subordinated debentures of Predecessor Company
(redemption value $898 and $648, respectively) - 889 646
Successor preferred stock 20,000,000 shares authorized;
0 outstanding - - -
Predecessor common stock $1 par value, 1,500,000,000 shares
authorized; 502,689,273 and 519,123,988 shares outstanding, respectively - 503 519
Successor common stock $0.01 par value, 500,000,000 shares
authorized, 89,677,509 shares outstanding 1 - -
Capital in excess of par value 1,712 1,697 1,922
Accumulated deficit - (410) (2,742)
-------- -------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 6,660 $ 13,872 $ 11,238
-------- -------- --------
See accompanying Notes to unaudited Condensed Consolidated Financial Statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
PREDECESSOR COMPANY
----------------------
13 WEEKS ENDED
APRIL 30, MAY 1,
2003 2002
----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (862) $(1,442)
Adjustments to reconcile net loss
to net cash provided by operating activities:
Discontinued operations non-cash charges 40 247
Restructuring, impairments and other charges 2 558
Reorganization items, net 769 251
Depreciation and amortization 177 181
Equity income in unconsolidated subsidiaries (7) (5)
Dividends received from Meldisco 36 45
Cash used for store closings and other charges (64) (39)
Change in:
Inventories 480 (109)
Accounts payable (117) 1,104
Deferred income taxes and taxes payable (16) (9)
Other assets 125 198
Other liabilities 32 40
------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 595 1,020
------- -------
NET CASH (USED FOR) PROVIDED BY REORGANIZATION ITEMS (19) 12
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of property and equipment 64 -
Capital expenditures (4) (52)
------- -------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES 60 (52)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on DIP Credit Facility - (300)
Payments on debt (1) (47)
Debt issuance costs - (30)
Payments on capital lease obligations (16) (19)
------- -------
NET CASH USED FOR FINANCING ACTIVITIES (17) (396)
------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS 619 584
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 613 1,245
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,232 $ 1,829
======= =======
See accompanying Notes to unaudited Condensed Consolidated Financial Statements.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
1. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
CHAPTER 11 REORGANIZATION
On January 22, 2002 ("Petition Date"), Kmart Corporation
("Predecessor Company") and 37 of its U.S. subsidiaries (collectively,
the "Debtors") filed voluntary petitions for reorganization under
Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or
"Chapter 11") in the United States Bankruptcy Court for the Northern
District of Illinois ("Court") under case numbers 02 B 02462 through 02
B 02499. On January 24, 2003, the Debtors filed a Plan of
Reorganization and related Disclosure Statement and on February 25,
2003, filed an Amended Joint Plan of Reorganization (the "Plan of
Reorganization") and related amended Disclosure Statement with the
Court. The Plan of Reorganization received the formal endorsement of
the statutory creditors committees and, as modified, was confirmed by
the Court by order docketed on April 23, 2003 ("Confirmation Date").
During the reorganization proceedings, the Debtors continued to operate
their business as debtors-in-possession under the jurisdiction of the
Court and in accordance with the applicable provisions of the
Bankruptcy Code and orders of the Court.
On May 6, 2003, ("Effective Date") the Predecessor Company
emerged from reorganization proceedings under Chapter 11 pursuant to
the terms of the Debtors' Plan of Reorganization and became a
wholly-owned subsidiary of Kmart Management Corporation, which is a
newly-formed, wholly-owned subsidiary of a newly-created holding
company, Kmart Holding Corporation ("Kmart," "we," "us," "our," the
"Company" or "Successor Company"). Kmart is the nation's third largest
discount retailer and the sixth largest general merchandise retailer.
In connection with our emergence from bankruptcy, we reflected
the terms of the Plan of Reorganization in our consolidated financial
statements applying the terms of 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") with
respect to financial reporting upon emergence from Chapter 11
("Fresh-Start accounting"). Upon applying Fresh-Start accounting, a new
reporting entity (the Successor Company) is deemed to be created and
the recorded amounts of assets and liabilities are adjusted to reflect
their estimated fair values (see Note 3 -- Fresh-Start Accounting). The
reported historical financial statements of the Predecessor Company for
periods prior to April 30, 2003 generally are not comparable to those
of the Successor Company. In this Quarterly Report on Form 10-Q,
references to our 2003 and 2002 results of operations refer to the
Predecessor Company.
PLAN INVESTORS
At the time of emergence, 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"), made a
substantial investment in the Successor Company in furtherance of our
financial and operational restructuring plan. The Plan Investors and
their affiliates received approximately 32 million shares of Kmart
Holding Corporation's new common stock in satisfaction of pre-petition
claims they held and we issued 14 million shares of new common stock to
affiliates of ESL and Third Avenue, in exchange for $127, net of $13 of
commitment fees and Plan Investor expenses. In addition, we issued a
9%, $60 principal amount convertible note to affiliates of ESL. The
principal and accrued interest in respect to the 9% convertible note is
convertible at any time, at the option of the holder, into new common
shares at a conversion price equal to $10 per share. ESL was also
granted the option, exercisable at its own discretion prior to May 6,
2005, to purchase from the Successor Company approximately 6.6 million
new common shares at a price of $13 per share. A portion of the option
was assigned to Third Avenue. The investment was made pursuant to the
Investment Agreement dated January 24, 2003 (as amended, the
"Investment Agreement").
ESL and its affiliates beneficially own over 50% of the common
stock of the Successor Company, including shares received in exchange
for pre-petition obligations, as well as shares obtainable upon
exercise of options and conversion of the $60 convertible note issued
to affiliates of ESL. Each of the Plan Investors is represented on our
Board of Directors.
6
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
DISCHARGE OF LIABILITIES
(all amounts in actual dollars unless otherwise noted)
On the Effective Date, all then-outstanding equity securities
of the Predecessor Company, as well as substantially all of its
pre-petition liabilities, were cancelled. New common stock of the
Successor Company was issued in satisfaction of certain of those
claims. The new securities of the Successor Company issued on the
Effective Date pursuant to the Plan of Reorganization and related
transactions, consisted of 89,677,509 shares of new common stock and
options to purchase 8,324,883 shares of new common stock. All of the
shares of common stock issued on May 6, 2003 were or will be
distributed pursuant to the Plan of Reorganization in satisfaction of
pre-petition claims, except for 14 million shares issued to affiliates
of ESL and Third Avenue in exchange for $127 million, net of $13
million of commitment fees and Plan Investor expenses. All such shares
were issued without registration under the Securities Act of 1933 in
reliance on the provisions of Section 1145 of the Bankruptcy Code and
Section 4(2) of the Securities Act of 1933. In addition, as part of the
Plan of Reorganization, Kmart has established an independent creditor
litigation trust ("Creditor Trust") for the benefit of the Predecessor
Company's pre-petition creditors and equity holders, to pursue claims
which arose from the Predecessor Company's prior accounting and
stewardship investigations. The following table outlines the discharge
of the Predecessor Company's Liabilities subject to compromise pursuant
to the Plan of Reorganization:
TYPE OF CLAIM/SECURITY TREATMENT UNDER THE PLAN OF REORGANIZATION
---------------------- ------------------------------------------
Class 1 - Secured Claims 100% cash recovery.
Class 3 - Pre-petition Lender Claims Issued 18,723,775 shares of new common stock of the
Successor Company and cash recovery of $243 million.
Class 4 - Pre-petition Note Claims Issued 25,008,573 shares of new common stock of the
Successor Company.
Class 5 - Trade Vendor and Lease Rejection Issued 31,945,161 shares of new common stock of the
Claims over $30,000 Successor Company.
Class 6 - Other Unsecured Claims over $30,000 Claim holders will receive their pro-rata share of the
"Other Unsecured Claims Cash Payment" on the third anniversary
of the effective date of the Plan of Reorganization.
Class 7 - General Unsecured Convenience Claims Recovery to be paid in cash equal to 6.25% of allowed
less than or equal to $30,000 claims or $1,825 if the amount of such allowed claims
is greater than $30,000 and the holder of such claim has made
the convenience claim election. In addition, the holder of any
General Unsecured Convenience Claim may elect to be treated, in
lieu of payment, as a Trade Vendor/Lease Rejection claim
holder.
Class 8 - Trust Preferred Obligations These obligations were cancelled upon emergence.
Holders may receive, as described below, recoveries
under the Creditor Trust.
Class 10 - Subordinated Security Claims Current holders, together with those who held common
stock of the Predecessor Company, may receive up to
2.5% of the recoveries under the Creditor Trust.
Class 11 - Existing Common Stock The Predecessor Company's stock was cancelled upon
emergence. Holders, together with those who hold
Subordinated Security Claims, may receive up to 2.5% of
the recoveries under the Creditor Trust.
Class 12 - Other Interests Cancelled -- no recovery.
7
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
Holders of Pre-petition Note Claims, Trade Vendor and Lease
Rejection Claims over $30,000, Other Unsecured Claims over $30,000 and
Trust Preferred Obligations will receive their pro-rata share of
recoveries in the Creditor Trust (excluding up to 2.5% of such
recoveries, which may be payable to holders of Subordinated Securities
Claims and Predecessor Company's Common Stock).
In addition to the classes described above, the Plan of
Reorganization allows for two additional classes of claims, Class 2 --
Other Priority Claims and Class 9 -- Intercompany Claims. The Class 2
claims are primarily claims held by current and former employees for
unpaid wages, salaries, bonuses, severance pay, vacation pay and other
unpaid employee benefits. We believe we have paid all such amounts and
therefore should be no significant amount of such claims if any, that
remain unpaid. The Class 9 claims are claims by one or more of Kmart
and its affiliates against other Kmart affiliates on account of various
matters. Kmart, at its option, may either reinstate or eliminate
intercompany claims.
There are also other unclassified claims, including
administrative claims, priority tax claims, Pension Benefit Guarantee
Corporation claims, workers' compensation programs and consignment
claims. Administrative claims will receive a 100 % cash recovery;
priority tax claims will receive a 100% cash recovery, paid over a
six-year period beginning on their assessment date; and the Pension
Benefit Guarantee Corporation claims, workers' compensation programs
and consignment claims were assumed by the Successor Company.
CLAIMS RESOLUTION
We continue to make progress in the reconciliation and
settlement of the various classes of claims. On June 11, 2003, we filed
a motion with the Bankruptcy Court requesting approval to make an
interim distribution to approximately 12,472 claims with an allowed
claim amount of approximately $730.2 on the first distribution date
specified in the Plan of Reorganization as June 30, 2003. In addition,
the court has previously entered orders allowing claims aggregating
approximately $389 million that, subject to the approval of the motions
by the court, will receive an interim distribution on June 30, 2003.
These two claims will also receive an interim distribution on June 30,
2003. If the above and related motions are approved by the Bankruptcy
Court, we anticipate distributing approximately 4.2 million shares to
the holders of Class 5 claims from the shares previously issued to us
as disbursing agent with respect to such claims and approximately $1.7
in cash to holders of Class 7 claims. Due to the significant volume of
claims filed to-date and the anticipated receipt of additional claims
by June 20, 2003 (the bar date for certain cure claims and
administrative claims), it is premature to estimate the ultimate
allowed amount of such claims for each class of claims under the Plan
of Reorganization.
2. BASIS OF PRESENTATION
These interim unaudited Condensed Consolidated Financial
Statements have been prepared in accordance with the rules and
regulations of the Securities Exchange Commission. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for
complete financial statements. In the opinion of management, all
adjustments (which include normal recurring adjustments) considered
necessary for a fair presentation have been included. All significant
intercompany accounts and transactions have been eliminated. Operating
results for the interim period are not necessarily indicative of the
results that may be expected for the full year. Readers of these
statements should refer to the Predecessor Company's audited
consolidated financial statements and notes thereto which are included
in its Annual Report on Form 10-K for the year ended January 29, 2003.
Certain reclassifications of prior period financial statements have
been made to conform to the current interim period presentation.
SOP 90-7 requires that the financial statements for the period
following the Chapter 11 filing through the Confirmation Date
distinguish transactions and events that are directly associated with
the reorganization from the ongoing operations of the business.
Accordingly, revenues, expenses, realized gains and losses and
provisions for losses directly associated with the reorganization and
restructuring of the business are reported separately as Reorganization
items, net in the unaudited Condensed Consolidated Statement of
Operations. The unaudited Condensed Consolidated Balance Sheet
distinguishes pre-petition liabilities subject to compromise from both
those pre-petition liabilities that are not subject to compromise and
from post-petition liabilities. Liabilities subject to compromise are
reported at the amounts expected to be allowed, even if they may be
settled for lesser amounts. In addition, cash used for reorganization
items is disclosed separately in the unaudited Condensed Consolidated
Statements of Cash Flows.
8
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
In accordance with SOP 90-7, we adopted Fresh-Start accounting
as of the Confirmation Date. However, in light of the proximity of such
date to our quarter end, for accounting purposes, the effects of
Fresh-Start accounting and the Plan of Reorganization, including the
cancellation of the existing common stock and the issuance of the new
common stock, have been reported "as if" they occurred on April 30,
2003. References to the Successor Company in the unaudited Condensed
Consolidated Financial Statements and the Notes thereto refer to the
Company on and after April 30, 2003, after giving effect to the
provisions of the Plan of Reorganization and the application of
Fresh-Start accounting. The April 30, 2003 Successor Company financial
statements are unaudited. In connection with subsequent filings with
the Securities and Exchange Commission, we have engaged
PricewaterhouseCoopers LLP as the independent accountants to audit
these financial statements.
3. FRESH-START ACCOUNTING
FRESH-START ADJUSTMENTS
In accordance with Fresh-Start accounting, all assets and
liabilities are recorded at their respective fair market values. Such
fair values represent our best estimates based on independent
appraisals and valuations.
To facilitate the calculation of the enterprise value of the
Successor Company, we developed a set of financial projections. Based
on these financial projections, the enterprise value was determined by
the Company, with assistance of a financial advisor, using various
valuation methods, including (i) a comparison of the Company and its
projected performance to the market values of comparable companies,
(ii) a review and analysis of several recent transactions of companies
in similar industries to the Company, and (iii) a calculation of the
present value of the future cash flows under the projections. The
estimated enterprise value is highly dependent upon achieving the
future financial results set forth in the projections as well as the
realization of certain other assumptions which are not guaranteed. The
estimated enterprise value of Kmart was calculated to be approximately
$2.3 billion to $3.0 billion. We selected the midpoint of the range,
$2.6 billion, as the estimated enterprise value. In applying
Fresh-Start accounting, adjustments to reflect the fair value of assets
and liabilities, on a net basis, and the write-off of the Predecessor
Company's equity accounts resulted in a charge of $5.6 billion. The
restructuring of Kmart's capital structure and resulting discharge of
pre-petition debt resulted in gain of $5.6 billion. The charge for the
revaluation of the assets and liabilities and the gain on the discharge
of pre-petition debt are recorded in Reorganization items, net in the
unaudited Condensed Consolidated Statement of Operations. In addition,
the excess of fair value of net assets over reorganization value
("negative goodwill") was allocated on a pro-rata basis and reduced our
non-current assets, with the exception of financial instruments, to $10
in accordance with SFAS No. 141.
As part of the provisions of SOP 90-7, we are required to
adopt, for the current reporting period, all accounting guidance that
is effective within a twelve-month period. See Note 20 - Recently
Adopted Accounting Pronouncements for a discussion of the impact on our
financial statements of the accounting guidance we were required to
adopt.
CHANGES TO SIGNIFICANT ACCOUNTING POLICIES
Fresh-Start accounting requires the selection of appropriate
accounting policies for the Successor Company. The significant
accounting policies disclosed in the Predecessor Company's Annual
Report on Form 10-K for the year ended January 29, 2003 will continue
to be used by the Successor Company except for the policy related to
merchandise inventories. We have elected to change the method of
accounting for our merchandise inventories from the last-in, first-out
("LIFO") method to the first-in, first out ("FIFO") method. We believe
that this change is preferable to provide a better matching of expenses
and revenues given falling product costs that have resulted in the
value of inventories under the LIFO method to be approximately equal to
their replacement cost on a FIFO basis. As part of the provisions of
Fresh-Start accounting, we did not restate our financial statements for
prior periods.
9
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
The following table reflects the reorganization adjustments to Kmart's
unaudited Condensed Consolidated Balance Sheet as of April 30, 2003:
PREDECESSOR SUCCESSOR
COMPANY COMPANY
APRIL 30, FRESH START APRIL 30,
2003 ADJUSTMENTS RECAPITALIZATION 2003
---------- ----------- ---------------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,232 $ - $ - $ 1,232
Merchandise inventories 4,446 (15) - 4,431
Other current assets 528 168 (1) 195 (2) 891
---------- --------- ------- ----------
TOTAL CURRENT ASSETS $ 6,206 $ 153 $ 195 $ 6,554
Property and equipment, net 4,623 (4,613) (1) - 10
Other assets and deferred charges 212 (154) (1) 38 (2) 96
---------- --------- ------- ----------
TOTAL ASSETS $ 11,041 $ (4,614) $ 233 $ 6,660
========== ========= ======= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Long-term debt due within one year $ - $ - $ 8 (2) $ 8
Accounts payable 1,151 - 9 (2) 1,160
Other current liabilities 915 117 (1) 563 (2) 1,595
---------- --------- ------- ----------
TOTAL CURRENT LIABILITIES $ 2,066 $ 117 $ 580 $ 2,763
Long-term debt - - 108 (2) 108
Capital lease obligations 415 - - 415
Other long-term liabilities 174 279 (1) 1,208 (2) 1,661
---------- --------- ------- ----------
TOTAL LIABILITIES NOT 2,655 396 1,896 4,947
SUBJECT TO COMPROMISE
LIABILITIES SUBJECT TO COMPROMISE 8,896 114 (1) (9,010) (2) -
Trust convertible securities 387 (387) (1) - -
Other comprehensive income (908) 908 (1) - -
Common stock 537 (537) (1) 1 (3) 1
Other equity (526) (5,108) (1) 7,346 (4) 1,712
---------- --------- ------- ----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY (DEFICIT) $ 11,041 $ (4,614) $ 233 $ 6,660
========== ========= ======= ==========
1. To adjust assets and liabilities to fair market value ("FMV"),
and reflect the writeoff of Predecessor Company's equity and
the application of negative goodwill to long-lived assets.
2. To record assumption or discharge of Liabilities subject to
compromise and cash to be received from the Plan Investors.
3. To record par value of new common stock for the Successor
Company.
4. To record gain on discharge of liabilities subject to
compromise and additional paid-in-capital of new common stock
for the Successor Company.
10
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
4. DISCONTINUED OPERATIONS
During the first quarter of fiscal 2003 and the second quarter
of fiscal 2002, we closed 316 and 283 stores, respectively. SFAS No.
144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets," requires closed stores to be classified as
discontinued operations when the operations and cash flows of the
stores have been (or will be) eliminated from ongoing operations and
the Company no longer has any significant continuing involvement in
the operations associated with the stores after closure. The Company
determined that it has met the second criteria, as upon closure of the
stores, operations cease and the Company has no continuing
involvement. To determine if cash flows have been or will be
eliminated from ongoing operations, the Company evaluated a number of
qualitative and quantitative factors, including: proximity to a
remaining open store, physical location within a metropolitan or
non-metropolitan statistical area and transferability of sales between
open and closed trade areas. Based on these criteria, we identified a
small number of stores closed in fiscal 2002 that met the criteria for
discontinued operations; however, in management's opinion they were
not considered material to our consolidated results of operations and
were not separately presented. Upon closure of the 316 stores in 2003,
which included a substantial exit of the state of Texas, we
reevaluated the 283 stores that were closed in 2002 and the 316 stores
closed in 2003 to identify stores that should be accounted for as
discontinued operations. This analysis resulted in a total of 121
stores receiving discontinued operations treatment for all periods
presented in our unaudited Condensed Consolidated Statements of
Operations. The table below sets forth the components of the net loss
associated with the discontinued operations for the 13-weeks ended
April 30, 2003 and May 1, 2002.
13 Weeks Ended
April 30, May 1,
2003 2002
---------- ----------
Sales $ 232 $ 458
Cost of sales, buying and occupancy 150 585
---------- ----------
Gross margin 82 (127)
Selling, general and administrative expenses 43 100
Restructurings, impairments and other charges 5 -
Reorganization items, net 44 23
---------- ----------
Net loss from discontinued operations $ (10) $ (250)
========== =========
5. DEBT RESTRUCTURING
Exit Financing Facility
On May 6, 2003, our $2 billion exit credit agreement (the
"Exit Financing Facility"), which was an integral part of the Plan of
Reorganization, syndicated by General Electric Capital Corporation,
Fleet Retail Finance Inc. and Bank of America, N.A became effective.
Debt issuance costs associated with the Exit Financing Facility totaled
$58 and will be amortized through May 2006. The Exit Financing Facility
is a revolving credit facility under which Kmart Corporation is the
borrower and contains an $800 letter of credit subfacility.
Availability under the Exit Financing Facility is also subject to an
inventory borrowing base formula. The Exit Financing Facility is
guaranteed by the Successor Company, Kmart Management Corporation,
Kmart Services Corporation (a subsidiary of Kmart Management
Corporation) and Kmart Corporation's direct and indirect domestic
subsidiaries. The Exit Financing Facility is secured by first liens on
inventory, the proceeds thereof and certain related assets of Kmart
Corporation and the guarantors. Borrowings under the Exit Financing
Facility currently bear interest at either the Prime rate plus 2.5% per
annum or the LIBOR rate plus 3.5% per annum, at our discretion, which
interest rate margin may be reduced after the first anniversary of the
effective date of the Exit Financing Facility if Kmart meets certain
earnings before interest, taxes, depreciation, amortization and other
charges ("EBITDA") targets. In addition, we are required to pay a fee
based on the unutilized commitment under the Exit Credit Facility equal
to 0.75% per annum.
The Exit Financing Facility financial covenants include a
requirement that Kmart maintain minimum availability of $100 under the
facility and a restriction on capital spending. In the event that Kmart
fails to maintain certain specified excess availability minimums under
the Exit Financing Facility, Kmart will also be required to maintain
minimum levels of EBITDA. The Exit Financing Facility also contains
other customary covenants, including certain reporting requirements and
covenants that restrict our ability to incur or create liens,
indebtedness and guarantees, make investments, pay dividends or make
other equity distributions, sell or dispose of stock or assets, change
11
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
the nature of our business and enter into affiliate transactions,
mergers and consolidations. Failure to satisfy these covenants would
(in some cases, after the receipt of notice and/or the expiration of a
grace period) result in an event of default that could result in our
inability to access the funds necessary to maintain our operations.
Predecessor Company Debt
Borrowings of the Predecessor Company were available through
the Court-approved $2 billion debtor-in-possession financing facility
("DIP Credit Facility") for the payment of permitted pre-petition
claims, working capital needs, letters of credit and other general
corporate purposes. Debt issuance costs of $71 were amortized through
April 30, 2003. The DIP Credit Facility was a revolving credit facility
under which the Predecessor Company was the borrower and the rest of
the Debtors were guarantors, and was collateralized by first liens on
substantially all of the Debtors assets (subject to valid and
unavoidable pre-petition liens and certain other permitted liens).
Borrowings under the DIP Credit Facility were denominated in U.S.
dollars bearing interest at the Prime Rate plus 2.5% per annum, or at
the Predecessor Company's option, in Eurodollars bearing interest at
the LIBOR rate plus 3.5% per annum. On May 6, 2003, in connection with
the Debtors' emergence from Chapter 11, the DIP Credit Facility was
terminated.
Due to its filing for Chapter 11, the Predecessor Company was
in default on all of its debt agreements entered into prior to January
22, 2002. While operating under Chapter 11, the Predecessor Company was
prohibited from paying interest on unsecured pre-petition debts.
Included in Interest expense, net in the unaudited Condensed
Consolidated Statements of Operations is interest income of $1, for the
13-week periods ended April 30, 2003 and May 1, 2002. On the Petition
Date, we stopped accruing interest on all unsecured pre-petition debt
in accordance with SOP 90-7. Contractual interest expense not accrued
or recorded on certain pre-petition debt totaled $67 and $69 for the
13-week periods ended April 30, 2003 and May 1, 2002, respectively.
6. SPECIAL CHARGES
Special charges are transactions which, in management's
judgment, may make meaningful comparisons of operating results between
reporting periods difficult. In determining what amounts constitute a
special charge, management considers the nature, magnitude and
frequency of their occurrence. During fiscal 2002, we instituted
certain restructuring actions to improve our operations and executed
significant inventory liquidations as a result of the stores closed
under Kmart's Chapter 11 proceedings. Their effect on the 13-weeks
ended April 30, 2003 and May 1, 2002 are summarized below.
Accelerated Depreciation
During the fourth quarter of fiscal 2002, we analyzed our
stores based on profitability, lease terms and geographic areas. As a
result of the analysis we decided to close 316 stores, and in light of
the shortened recoverability period in the stores to be closed,
recorded $52 during the 13 week-period ended April 30, 2003 for
accelerated depreciation on unimpaired assets to be disposed of
following the store closings. Of the charge, $47 is included in
Restructurings, impairments and other charges and $5 is included in
Discontinued operations in the unaudited Condensed Consolidated
Statements of Operations.
Corporate Cost Reduction Initiatives
During the fourth quarter of 2002, we announced our intention
to eliminate positions at our corporate headquarters and positions
nationally that provide corporate support in the first quarter of 2003.
As a result of the expected job eliminations, we recorded a charge of
$36 during the fourth quarter of fiscal 2002. For the 13 week-period
ended April 30, 2003 we recorded a credit of $10 as a result of a
change in our estimated expense. This credit is included in
Restructurings, impairments and other charges in the accompanying
unaudited Condensed Consolidated Statements of Operations.
Markdowns for Inventory Liquidation
During the first quarter of fiscal 2002, we recorded a charge
of $758 to write-down inventory to be liquidated at our 283 closing
stores to net realizable value. Of the charge, $542 is included in Cost
of sales, buying and occupancy and
12
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
$216 is included in Discontinued operations in the accompanying
unaudited Condensed Consolidated Statements of Operations.
Of the charge, $384 relates to the write-down of inventory to
estimated selling value in connection with liquidation sales in the 283
stores for which we received Court approval to close on March 20, 2002.
The liquidation sales and store closings were completed on June 2,
2002. In addition, a charge of $266 was recorded related to the
acceleration of markdowns on approximately 107,000 stock keeping units
(SKUs) of inventory items that were transferred from our remaining open
stores to the 283 closing stores and included in the liquidation sales.
The SKUs were no longer carried as part of our product assortment in
our remaining open stores and were reduced to estimated selling value.
The remaining $108 of the charge related to liquidation fees and
expenses associated with the disposition of inventory through the
liquidation sales at the 283 closing stores.
7. REORGANIZATION ITEMS, NET
Reorganization items represent amounts the Predecessor Company
incurred as a result of Chapter 11, and are presented separately in the
unaudited Condensed Consolidated Statements of Operations. For the
13-week periods ended April 30, 2003, and May 1, 2002, the following
have been recorded:
April 30, May 1,
2003 2002
------- -------
Gain on extinguishment of debt $(5,642) $ -
Revaluation of assets and liabilities 5,642 -
Fleming settlement 385 -
2003 store closings 158 -
Estimated claims for rejected executory contracts 200 -
2002 store closings - 203
Other 26 48
------- -------
Reorganization items, net $ 769 $ 251
======= =======
The following paragraphs provide additional information
relating to costs that were recorded in the line Reorganization items,
net in our unaudited Condensed Consolidated Statement of Operations for
the 13-week periods ended April 30, 2003 and May 1, 2002:
Gain on extinguishment of debt/Revaluation of assets and liabilities
See Note 3 -- Fresh-Start Accounting for a discussion on the
extinguishment of debt and the revaluation of assets and liabilities.
Fleming settlement
On February 3, 2003, we announced that we had terminated our
supply relationship with Fleming by means of a rejection of the 2001
contract through the Debtor's Chapter 11 reorganization. As part of the
bankruptcy proceedings, Fleming filed a claim of $1.5 billion on March
11, 2003. Kmart and Fleming came to an agreement on a settlement of
Fleming's claims, and on March 27, 2003, the Court approved our
settlement of all claims asserted by Fleming. Under the settlement,
Kmart paid Fleming $15 of Fleming's net post-petition administrative
claim, which exceeded $30. Additionally, Fleming's general unsecured
claim was reduced from approximately $1.5 billion to $385, which was
recorded in the first quarter of 2003.
2003 store closings
On January 28, 2003, the Court approved the closure of 326
stores located in 40 states, which number was later reduced to 316.
Stores were selected by evaluating the market and financial performance
of every store and the terms of every lease. 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. Shortly after receiving Court
approval, we
13
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
commenced store closing sales which were completed by April 13, 2003.
In accordance with SFAS No. 144, 66 of the 316 closed stores were
considered discontinued operations (see Note 4 -- Discontinued
Operations). As a result of our decision to close the 316 stores, we
charged to our closed store reserve $214 for lease terminations and
other costs, of which $56 was recorded to discontinued operations and
the remaining $158 was recorded to Reorganization items, net in the
unaudited Condensed Consolidated Statements of Operations. In addition,
we reclassified $181 of capital lease obligations to the closed store
reserve. The reserve for estimated costs was recorded in accordance
with SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities." On April 30, 2003, upon adoption of Fresh-Start
accounting, this reserve was discharged in accordance with the Plan of
Reorganization, see Note 1 -- Proceedings under Chapter 11 of the
Bankruptcy Code.
2002 store closings
On March 20, 2002, the Court approved the closure of 283
stores. Stores were selected by evaluating the market and financial
performance of every store and the terms of every lease. Candidates for
closure were stores that did not meet our financial requirements for
ongoing operations. In accordance with SFAS No. 144, 55 of the 283
closed stores are considered discontinued operations (see Note 4 --
Discontinued Operations). As a result of our decision to close the 283
stores, we charged to our closed store reserve $228 for lease
terminations and other costs, of which $25 was recorded to Discontinued
operations and the remaining $203 was recorded to Reorganization items,
net in the unaudited Condensed Consolidated Statements of Operations. In
addition, we reclassified $144 of capital lease obligations to the
closed store reserve. The closed store reserve is included in the line
Liabilities subject to compromise in our unaudited Condensed
Consolidated Balance Sheet as of May 1, 2002. The reserve for estimated
costs was recorded in accordance with EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". On
April 30, 2003, upon adoption of Fresh-Start accounting, this reserve
was discharged in accordance with the Plan of Reorganization, see Note 1
-- Proceedings under Chapter 11 of the Bankruptcy Code.
As a result of both store closing actions, Kmart's existing
store base has been reduced from 2,114 stores prior to the announcement
of the 2002 store closings to 1,513 upon completion of the 2003 store
closings.
Estimated claims for rejected executory contracts
For the 13-weeks ended April 30, 2003, we recorded expense of
$200 for estimated allowable claims for rejected executory contracts,
primarily equipment leases and service contracts. The estimate was based
on a review of each class of contract. Our estimate of claims may be
different from amounts filed by our creditors. Differences between
amounts filed and our estimate will be investigated and resolved in
connection with our claims resolution process. In this regard, it should
be noted that the claims reconciliation process may result in material
adjustments to current estimates of allowable claims. On April 30, 2003,
upon adoption of Fresh-Start accounting, these liabilities were
discharged in accordance with the Plan of Reorganization, see Note 1 --
Proceedings under Chapter 11 of the Bankruptcy Code.
Other reorganization items
For the 13-weeks ended April 30, 2003, we recorded
professional fees of $43, employee costs of $66 relating to the Key
Executive Retention Plan ("KERP"), a gain of $17 for the sale of
pharmacy lists, income of $65 for lease auction proceeds related to the
2003 and 2002 closed stores, a gain of $15 for the settlement of
pre-petition liabilities and net expenses of $14 for other
miscellaneous reorganization items. For the 13-weeks ended May 1, 2002,
we recorded professional fees of $38, employee costs of $26, a gain of
$14 for the sale of pharmacy lists, a gain of $5 for the settlement of
pre-petition liabilities and net expense of $3 for other miscellaneous
reorganization items.
14
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
8. RESTRUCTURING RESERVE ACTIVITY
The following table provides information regarding reserve
activity during the 13 week periods ended April 30, 2003 and May 1,
2002. As part of Fresh-Start accounting, reserves established in
connection with certain restructurings were discharged in accordance
with the Plan of Reorganization. See Note 3 - Fresh-Start Accounting
for a detailed discussion of the discharge of Liabilities subject to
compromise under the Plan of Reorganization.
13 Weeks Ended
----------------------------------------------------------------------------------
April 30, 2003 May 1, 2002
2002 2002 2000 2002 2001 2001 2000
Employee Store Strategic Store BlueLight Supply Strategic
Severance Closings Actions Closings .com Chain Actions
--------- -------- --------- -------- --------- ------ ---------
Balance, beginning of year $ 69 $294 $ 95 $ - $ 18 $ 11 $ 98
Additions charged to 7 - - 228 - - -
operations
Reclassifications - - - 144 - - -
---- ---- ---- ---- ---- ---- ---
Total additions 7 - - 372 - - -
Reductions:
Cash payments:
Lease obligations - - - - - - 3
Employee costs 40 - - - - 4 -
Contractual obligations - - - - 1 - -
Non-cash reductions:
Discharge of liabilities - 294 95 - - - -
---- ---- ---- ---- ---- ---- ---
Balance, end of period $ 36 $ - $ - $372 $ 17 $ 7 $ 95
==== ==== ==== ==== ==== ==== ====
9. TRADE VENDORS' LIEN PROGRAM
On May 6, 2003, the post-emergence Trade Vendors' Lien Program
became effective. Under this program, certain vendors who provide
retail merchandise to us on credit after May 6, 2003, or who had
provided merchandise to us on credit after the Petition Date and before
May 6, 2003 which was not paid for as of May 6, 2003, were granted
mortgages on certain unencumbered owned and operated real properties
(the "Trade Vendor Lien"). The Trade Vendor Lien expires by its terms
on May 6, 2005, and may be terminated at the sole discretion of Kmart
on or after May 6, 2004.
In addition, under the Plan of Reorganization, any person or
entity acquiring property under the Plan of Reorganization, and any
creditor and/or equity security holder of the Debtors or the
reorganized Kmart entities is deemed to have contractually subordinated
any existing or future claim, right or interest they may have in and to
any proceeds received from the disposition, release or liquidation of
any of Kmart's and Kmart's subsidiaries' leasehold interests in any
open and operating stores as of May 6, 2003 to the claims of the trade
vendors participating in the Trade Vendors' Lien Program. The lenders
under the Exit Financing Facility and certain other parties are not
subordinated in this regard. So long as the Trade Vendors' Lien is
still effective (i) we may not encumber, sell, lease, transfer or
otherwise dispose of or take other action to impair the subordination
granted under the program with respect to more than 20% of the fair
market value of the leases subject to the program, and (ii) any loan or
investment under a certain amount by ESL or Third Avenue is subject to
the subordination set forth in the provision. This claims subordination
terminates upon termination or expiration of the Trade Vendors' Lien.
10. PROPERTY HELD FOR SALE
Included in Other current assets in our unaudited Condensed
Consolidated Balance Sheet for the period ended April 30, 2003, is $160
of property held for sale, accounted for in accordance with SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
The $160 consists primarily of 11 closed store locations and
undeveloped property. We are actively marketing the properties and
expect to sell them within one year. For the 13-week period ended April
30, 2003, we recorded a $7 loss on the impairment of certain property
held for sale. The loss is
15
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
recorded in Selling, general and administrative expenses in our
unaudited Condensed Consolidated Statements of Operations.
11. WORKERS' COMPENSATION
In March 2002, the Court issued an order providing for the
continuation of our existing surety bond coverage, which permits us to
self-insure our workers' compensation programs in various states. We
have recently begun discussions with certain of the issuers of the
surety bonds regarding the further continuation of the bonds, either on
the terms as set forth in the Court's surety order or on other terms
acceptable to us. If our discussions prove unsuccessful and the
existing surety bonds were to be cancelled, we could lose our
self-insured status in the states covered by the surety bonds and be
required to pursue alternative workers' compensation issuance programs.
These alternative programs include (i) retaining self-insurance
privileges in certain states using alternative forms of security, (ii)
purchasing insurance policies to cover our workers' compensation
liabilities in certain states, and (iii) as a last resort,
participating in state-assigned risk and/or state fund insurance
programs. Although it is too soon to predict the likelihood that we
would have to implement an alternative workers' compensation program,
or to estimate the cost of any resulting program, we expect any such
costs would exceed levels incurred historically. However, we do not
expect any such additional costs to have a material adverse effect on
our financial position or results of operation.
12. INCOME TAXES
We recorded a full valuation allowance against our net
deferred tax assets in accordance with SFAS No. 109, "Accounting for
Income Taxes," as realization of such assets in future years is
uncertain. Accordingly, we have not recognized any tax benefit from our
losses in the first quarters of 2003 and 2002. The $6 tax benefit
recorded in the first quarter of fiscal 2003 relates to a special
provision of the Internal Revenue Code that allows a 10-year carryback
of certain losses. The $12 tax benefit recorded in the first quarter of
fiscal 2002 related primarily to amounts refunded to Kmart as a result
of the Job Creation and Worker Assistance Act of 2002, which was
enacted in the first quarter of fiscal 2002.
13. LOSS PER SHARE
We calculate loss per share in accordance with SFAS No. 128,
"Earnings Per Share." Basic and dilutive earnings per share information
is presented in the unaudited Condensed Consolidated Statements of
Operations. For the 13-week periods ended April 30, 2003 and May 1,
2002, a net loss was incurred, therefore dilutive common stock
equivalents were not used in the calculation of earnings per share as
they would have an anti-dilutive effect. For the 13-week period ended
April 30, 2003, dilutive common stock equivalents include options to
purchase 43.3 million shares of common stock at prices ranging from
4.86 to 24.03 and potential conversion of certain trust preferred
securities of 25.5 million common shares. All outstanding stock options
and trust convertible securities of the Predecessor Company were
cancelled in accordance with the Plan of Reorganization. For the
13-week period ended May 1, 2002, dilutive common stock equivalents
include options to purchase 54.6 million shares of common stock at
prices ranging from $4.86 to $26.03 and potential conversion of certain
trust convertible preferred securities of 59.9 million common shares.
At the time of emergence, we issued stock options to ESL and our Chief
Executive Officer.
14. STOCK BASED COMPENSATION
In December 2002, the FASB issued SFAS No. 148, "Accounting
for Stock-Based Compensation -- Transition and Disclosure, an Amendment
of FASB Statement No. 123" ("SFAS No. 148"), which provides three
alternative methods of transition to the fair value method of
accounting for stock options. SFAS No. 148 also amends the disclosure
requirements of SFAS No. 123, "Accounting for Stock-Based
Compensation."
The Predecessor Company accounted for stock options using the
intrinsic value method in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees (APB No. 25)"
and related interpretations. The intrinsic value method does not
require the recognition of expense for the fair value of stock-based
compensation. As previously discussed all outstanding stock options of
the Predecessor Company were cancelled in accordance with the Plan of
Reorganization.
16
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
In accordance with the disclosure requirements of SFAS No.
148, the pro forma effects of recognizing compensation expense on net
loss and loss per share, had we applied the fair value method, is as
follows:
13 Weeks Ended
April 30, 2003 May 1, 2002
-------------- -----------
Net loss, as reported ($ 862) ($1,442)
Deduct: Total stock-based employee compensation income
(expense) determined under the fair value-based method
for all awards, net of related tax effects 38 (11)
------ -------
Pro forma net loss ($ 824) ($1,453)
====== =======
Basic/diluted loss per share:
As reported ($1.65) ($ 2.87)
====== =======
Pro forma ($1.58) ($ 2.89)
====== =======
No stock options of the Predecessor Company were granted
following the Predecessor Company's Chapter 11 filing. Upon emergence
from Chapter 11, all outstanding awards of the Predecessor Company's
stock-based compensation programs were cancelled. Pro-forma stock-based
employee compensation income of $38 for 2003 is due to the reversal of
expense for options that were not vested upon cancellation of the
outstanding stock awards of the Predecessor Company.
15. COMPREHENSIVE LOSS
Comprehensive loss represents net loss, adjusted for the
effect of other items that are recorded directly to shareholders'
equity. For the 13-week period ended April 30, 2003, comprehensive loss
included a minimum pension liability adjustment of $94 which was
subsequently eliminated through the application of Fresh-Start
accounting. Comprehensive loss and net loss are equivalent for the
13-week period ended May 1, 2002.
16. RELATED PARTY TRANSACTIONS
Commencing March 2002, Kmart engaged various services of AP
Services (formerly known as JA&A Services), a consulting firm, whose
Chairman and another Principal held executive officer positions within
Kmart. Specifically, their Chairman, Albert A. Koch, previously served
as our Chief Financial Officer, and another Principal, Edward J.
Stenger, previously served as our Treasurer. We recorded expenses of $7
and paid fees of $5 for the 13-weeks ended April 30, 2003, and recorded
expenses of $3 and paid fees of $1 for the 13-weeks ended May 1, 2002,
respectively, to the firm for services rendered under the consulting
agreement, including the services of Messrs. Koch and Stenger.
17. INVENTORIES AND COST OF MERCHANDISE SOLD
For the periods ended January 29, 2003 and May 1, 2002, our
inventory is accounted for using the LIFO method. Inventories valued on
LIFO at January 29, 2003 and May 1, 2002 were $190 and $269 lower,
respectively, than the amounts that would have been reported under the
FIFO method. As required by SOP 90-7, inventories at April 30, 2003
were stated at fair value. As previously discussed, we elected to
change our method of accounting for merchandise inventories from LIFO
to FIFO, see Note 3 -- Fresh Start Accounting.
18. INVESTMENTS IN AFFILIATED RETAIL COMPANIES
Meldisco
Kmart footwear departments are operated under a license
agreement with the Meldisco subsidiaries of Footstar, Inc. ("FTS"),
substantially all of which are 49% owned by Kmart and 51% owned by FTS.
We are aware that FTS will be restating its financial statements for
prior periods. As a result, we have not received final financial
statements for fiscal 2002 or the first quarter of fiscal 2003 for
Meldisco at the time of our filing of this Quarterly Report on Form
10-Q. For the 13-weeks ended April 30, 2003, we have received
preliminary financial statements and believe they provide a reliable
basis for making a reasonable estimate of $7 of equity income. For the
13-week period ended April 30, 2003, Meldisco had net sales of $246.
For the 13-week period ended May 1, 2002, Meldisco had net sales of
$307, gross profit of $139 and net income of $17. We do not expect the
restatement to have a material effect on our equity income from
Meldisco.
17
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
19. OTHER COMMITMENTS AND CONTINGENCIES
Contingent Liabilities
The Predecessor Company had (i) guaranteed obligations for
real property leases of certain Debtors and former subsidiaries of
Kmart including, but not limited to, The Sports Authority, Inc.,
OfficeMax, Inc. and Borders Group, Inc., some of which leases were
assigned pre-petition; (ii) contingent liabilities under real property
leases assigned by Kmart pre-petition; and (iii) guaranteed
indebtedness of other parties related to certain of our leased
properties financed by industrial revenue bonds. To the extent not
expressly assumed or reinstated under the Plan of Reorganization these
guarantees were discharged subject to pre-petition claims
administration.
Legal Proceedings
Fair Labor Standards Litigation
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 ("FLSA")
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
(Henderson v. Kmart), the United States District Court for the Central
District of California (Gulley v. Kmart, the multi-plaintiff case,
which was originally brought in state court) and the Superior Courts of
the State of California for the Counties of Alameda, Los Angeles and
Riverside (Panossian v. Kmart, Wallace v. Kmart, Pierce v. Kmart,
Hancock v. Kmart, Pryor v. Kmart). If all of these cases were
determined adversely to Kmart, the resulting damages could have a
material adverse impact on our results of operations and financial
condition. However, there have been no class certifications, all of the
cases are stayed and enjoined as a result of Kmart's Chapter 11
proceedings and confirmation of the Plan and, based on our initial
investigations, we believe that we have meritorious defenses to each of
these claims. We presently do not expect to have any material financial
exposure as a result of these cases.
Kmart is a defendant in a putative class action pending in
Oklahoma relating to the proper payment of overtime to hourly
associates under the FLSA. The plaintiff claims he represents a class
of all current and former Kmart employees who have been improperly
denied overtime pay. This case was filed on March 4, 2003 and is
currently pending in the U.S. District Court for the Northern District
of Oklahoma. At this time, the likelihood of a material unfavorable
outcome is not considered probable.
There is an increasing trend of high profile class action
litigation, particularly in the retail industry, against employers of
large numbers of people which allege violations of the FLSA. Other
companies against which these cases have been filed have paid
significant settlements and/or had significant judgments entered
against them. Kmart has a large employee base; however no FLSA class
actions against Kmart have yet been certified. The actions described
above are the only FLSA related matters that are currently pending
against Kmart.
To the extent that any awards are granted to the respective
plaintiffs, the Successor Company will be responsible only for any
portion of any such award relating to a post-petition period. Any
portion of any such award that is a monetary claim relating to a
pre-petition period will be addressed in accordance with the Plan of
Reorganization.
Securities Action Litigation
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 the Predecessor
Company's common stock and seek, among other things, damages under
Section 10b-5 of the Securities and Exchange Act of 1934. On October
15, 2002, an amended consolidated complaint was filed that enlarged the
class of persons on whose behalf the action was brought to include
purchasers of the
18
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
Predecessor Company's securities between March 13, 2001 and May 15,
2002, and added former officers and PricewaterhouseCoopers LLP as
defendants. Kmart is not a defendant in this litigation.
On July 31, 2002, attorneys for plaintiffs in the then pending
class action lawsuits filed a class proof of claim in the Court (the
"Class Proof of Claim") on behalf of the plaintiffs and all purchasers
of the Predecessor Company's 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 parties 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 the Predecessor
Company's 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 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 the
Predecessor Company's stock; failure to provide complete and accurate
information about the Predecessor Company's common stock; and failure
to provide accurate information regarding our financial condition.
Subsequently, amended complaints were filed that added additional
current and former employees and directors of Kmart as defendants.
Kmart is not a defendant in this litigation. On July 29, 2002, the
plaintiffs filed proofs of claim with the Court in an aggregate amount
equal to $180.
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 (the "Softbank Funds") that purchased stock of
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 alleges that Mr. Conaway breached his fiduciary duty,
took certain actions and made certain misrepresentations that induced
plaintiffs to exchange their Bluelight.com stock for the Predecessor
Company's stock and prevented plaintiffs from realizing the market
value of their stock. The complaint also alleges violations of Section
10b-5 of the Securities and Exchange Act of 1934 and Section 410 of the
Michigan Uniform Securities Act. Kmart was not a defendant in this
litigation. On January 16, 2003, the District Court dismissed the
complaint. On February 14, 2003, a lawsuit was filed by the Softbank
Funds against Mr. Conaway in the Circuit Court of Cook County,
Illinois. This lawsuit seeks $33 from the defendant for alleged breach
of fiduciary duty in connection with the failure of the Predecessor
Company to cause the registration of the plaintiffs' shares of the
Predecessor Company's common stock to become effective. This claim is
essentially the same as count I of the lawsuit that was dismissed on
January 16, 2003. On May 2, 2002, the plaintiffs filed proofs of claim
with the Court in an aggregate amount equal to $56.
The foregoing actions, which were brought by or on behalf of
holders of common stock of the Predecessor Company and are referred to
as "Securities Actions" under the Plan of Reorganization, were brought
against persons other than the Company and, therefore, were not
extinguished when we emerged from Chapter 11. Accordingly, to the
extent that any awards are granted to the respective plaintiffs under
these actions and a claim is allowed against the Predecessor Company
under the proofs of claim previously filed with the Court, the allowed
claim, to the extent not covered by insurance, will be addressed in
accordance with the Plan of Reorganization. Except as noted above, the
foregoing actions relate to periods occurring prior to the Petition
Date. Any obligations which we may have with respect to a claim for
indemnification by any of the defendants will be governed by the terms
of the Plan of Reorganization.
Other and Routine Actions
Kmart is a defendant in a putative class action pending in
Colorado relating to proper access to facilities for the disabled under
the Americans with Disabilities Act ("ADA"). The plaintiff claims he
represents a class of disabled customers who have been improperly
denied access to facilities required under the ADA. This case was filed
on October 1, 1999 and is currently pending in the United States
District Court in Denver, Colorado. This action has been stayed
pursuant to the automatic bankruptcy stay and the plan injunction. No
class has been certified. At this time, the likelihood of a material
unfavorable outcome is not considered probable.
We are a party to a substantial number of other claims,
lawsuits and pending actions which are routine and incidental to our
business. To the extent that any claim relates to a contract which was
assumed by us when we emerged or
19
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
relates to a time period occurring after the Petition Date, the
Successor Company shall be responsible for any damages which may
result. In addition, certain contracts allow for damage provisions or
other repayments as a result of our termination of the contracts.
We assess the likelihood of potential losses on an ongoing
basis and when they are considered probable and reasonably estimable,
record an estimate of the ultimate outcome. If there is no single point
estimate of loss that is considered more likely than others, an amount
representing the low end of the range of possible outcomes is recorded.
Our balance sheet as of April 30, 2003 only reflects potential losses
for which the Successor Company may have ultimate responsibility.
Investigative Matters
Kmart has been provided with copies of anonymous letters that
were sent to the SEC, our auditors, directors, legal counsel and
others, expressing concern with respect to various matters. The letters
purported to be sent by certain of our employees. The letters were
referred to the Predecessor Company's Audit Committee of the Board of
Directors, which engaged outside counsel to review and investigate the
matters set forth in the letters. We are cooperating with the SEC and
the U. S. Attorney's office for the Eastern District of Michigan with
respect to the investigations of these matters. The staff of the SEC
has expressed concerns with respect to the manner in which we recorded
vendor allowances prior to the change in accounting principles at the
end of fiscal 2001, as well as the Staff's intention to continue to
pursue its investigation of these matters. The United States Attorney
for the Eastern District of Michigan also is undertaking an inquiry
into these matters. A detailed discussion of the investigation and
stewardship review, as well as the results of such investigation and
review, is contained in the Disclosure Statement, which we filed as
Exhibit 2.2 to our Current Report on Form 8-K dated March 7, 2003.
After consultation with the statutory committees in our
Chapter 11 proceedings, we have determined that the Creditor Trust is
the preferred available mechanism for resolving any legal claims that
arose out of these investigations. As part of the Plan of
Reorganization, the trustee of the trust is charged with responsibility
for determining which claims to pursue and, thereafter, litigating such
claims. Pursuant to the Plan of Reorganization and various
confidentiality orders issued by the Court, we will share with the
trustee evidence gathered and certain work product developed during the
investigations.
20. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board
("FASB") issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS No. 143"). SFAS No. 143 requires a liability for
the cost of an asset retirement obligation be recognized and measured
initially at fair value in the period in which the liability is
incurred. The asset retirement costs are capitalized as part of the
long-lived asset and depreciated over the asset's life. The provisions
of SFAS No. 143 were effective for this fiscal year beginning January
30, 2003. The adoption of SFAS No. 143 did not have a material effect
on our financial statements.
In June 2002, the FASB issued SFAS No. 146, which supercedes
EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in Restructuring)." The new standard requires a
liability for a cost associated with an exit or disposal activity to be
recognized and measured initially at fair value in the period in which
the liability is incurred, rather than at the time of commitment to an
exit plan. SFAS No. 146 was effective for exit or disposal activities
that were initiated after December 31, 2002. As a result of adopting
the provisions of this standard, certain lease termination and other
restructuring costs were recognized in the first quarter of 2003 that
otherwise would have been recognized in the fourth quarter of 2002.
In November 2002, the EITF reached a final consensus on EITF
Issue No. 02-16, "Accounting by a Customer (Including a Reseller) for
Certain Consideration Received from a Vendor." This issue addressed the
income statement classification of cash consideration received from a
vendor and the recognition criteria for performance-driven vendor
rebates or refunds. This consensus, effective for the Predecessor
Company's fiscal year ended January 29, 2003, resulted in certain co-op
advertising recoveries which would previously have been recorded as a
reduction of SG & A, being recorded as a reduction of Cost of sales,
buying and occupancy.
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN No. 46"). FIN No.
46 provides guidance on the identification and consolidation of
variable interest entities ("VIEs"). VIEs
20
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
are defined in FIN No. 46 as entities that have insufficient equity at
risk or have equity investors who lack characteristics of a financial
controlling interest. This Interpretation requires the primary
beneficiary of an unconsolidated variable interest entity to
consolidate the VIE if the entity does not effectively disperse risks
among the parties involved. We have performed an analysis, and we have
determined that there were no entities that require consolidation upon
adoption of this standard.
In April 2003, the FASB issued SFAS No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS
No. 149"). This statement amends and clarifies the accounting for
derivative instruments and hedging activities under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." As
required by SOP 90-7, the Company must adopt, as of the current
reporting period, all accounting guidance that would otherwise become
effective within the next twelve months. We have adopted SFAS No. 149
effective April 30, 2003. There was no impact to the Company upon the
adoption of SFAS No. 149 as we currently do not hold any derivative
instruments or participate in hedging activities.
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities
and Equity" ("SFAS No. 150"). SFAS No. 150 requires certain financial
instruments with characteristics of both liabilities and equity to be
classified as liabilities. As required by SOP 90-7, we are required to
adopt, as of the current reporting period, all accounting guidance that
is effective within the next twelve month period. We have adopted SFAS
No. 150 effective April 30, 2003. We did not have any financial
instruments that were classified as equity prior to the adoption of
SFAS No. 150 that were required to be reclassified to liabilities.
21. SUBSEQUENT EVENTS
On June 4, 2003, Martha Stewart was indicted in the United
States District Court of the Southern District of New York. The Martha
Stewart brand is considered a distinctive brand for Kmart and we
currently sell Martha Stewart home, garden, colors, baby, kitchen,
keeping and decorating product lines, along with candles and
accessories. Martha Stewart has resigned her position as Chairman and
Chief Executive Officer of Martha Stewart Omnimedia, Inc.; however, she
will serve as the Chief Creative Officer and remain on the Board of
Directors. To-date, we have not experienced any significant adverse
impact from this matter on the sales of Martha Stewart brand product
lines.
On June 10, 2003 our common stock began trading on the NASDAQ
National Market System under the symbol KMRT. The common stock had
previously traded on the OTC Bulletin Board.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-Q, as well as other statements or reports made by
or on behalf of Kmart, may contain or may incorporate by reference
material which includes forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995 that reflect,
when made, Kmart's current views with respect to current events and
financial performance. Statements, other than those based on historical
facts, which address activities, events or developments that we expect
or anticipate may occur in the future are forward-looking statements,
which are based upon a number of assumptions concerning future
conditions that may ultimately prove to be inaccurate. Such
forward-looking statements are and will be, as the case may be, subject
to many risks, uncertainties and factors relating to Kmart's operations
and business environment which may cause the actual results of Kmart to
be materially different from any future results, express or implied, by
such forward-looking statements. Factors that could cause actual
results to differ materially from these forward-looking statements
include, but are not limited to, the following:
o general economic conditions,
o weather conditions, including those which affect buying
patterns of our customers,
o marketplace demand for the products of our key brand partners,
as well as the engagement of appropriate new brand partners,
o changes in consumer spending and our ability to anticipate
buying patterns and implement appropriate inventory
strategies,
o competitive pressures and other third party actions, including
pressures from pricing and other promotional activities of
competitors, as well as new competitive store openings,
o the impact of external forces, such as the severe acute
respiratory syndrome, on our business,
o the resolution of allowed claims for which we are obligated to
pay cash under the Plan of Reorganization,
o our ability to timely acquire desired goods in appropriate
quantities and/or fulfill labor needs at planned costs,
o our ability to properly monitor our inventory needs and remain
in-stock,
o our ability to successfully implement business strategies and
otherwise execute planned changes in various aspects of the
business,
o our ability to operate pursuant to our Exit Financing
Facility,
o regulatory and legal developments,
o our ability to attract, motivate and/or retain key executives
and associates,
o our ability to attract and retain customers,
o our ability to offset the negative effects that filing for
reorganization under Chapter 11 has had on our business,
including the loss in customer traffic and the impairment of
vendor relations,
o our ability to obtain and maintain normal terms with vendors
and service providers,
o our ability to maintain contracts, including leases, that are
critical to our operations,
o our ability to implement our long-term strategy and/or develop
a market niche,
o our ability to fund and execute our business plan, and
o other factors affecting business beyond our control.
Consequently, all of the forward-looking statements are
qualified by these cautionary statements and there can be no assurance
that the results or developments anticipated will be realized or that
they will have the expected effects on our business or operations. The
forward-looking statements contained herein or otherwise that we make
or are made on our behalf speak only as of the date of this report, or
if not contained herein, as of the date when made, and we do not
undertake to update these risk factors or such forward-looking
statements.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
OVERVIEW
On the Petition Date, Kmart Corporation (the Predecessor
Company), and 37 of its U.S. subsidiaries filed voluntary petitions for
reorganization under Chapter 11. On January 24, 2003, the Debtors filed
a Plan of Reorganization and related Disclosure Statement and on
February 25, 2003, filed the Plan of Reorganization and a related
amended Disclosure Statement with the Court. The Plan of Reorganization
received the formal endorsement of the statutory creditors committees
and, as modified, was confirmed by the Court by order docketed on April
23, 2003.
On the Effective Date, the Predecessor Company emerged from
reorganization proceedings under Chapter 11 pursuant to the terms of
the Debtors' Plan of Reorganization and became a wholly-owned
subsidiary of Kmart Management Corporation, which is a newly-formed,
wholly-owned subsidiary of a newly-created holding company, Kmart
Holding Corporation (the Successor Company). Kmart is the nation's
third largest discount retailer and the sixth largest general
merchandise retailer.
In accordance with SOP 90-7, we adopted Fresh-Start accounting
as of the Confirmation Date. However, in light of the proximity of such
date to our fiscal quarter end, we have applied, for accounting
purposes, the effects of Fresh-Start accounting and the Plan of
Reorganization, including the cancellation of the existing common stock
and the issuance of the new common stock, "as if" they occurred on
April 30, 2003. Upon applying Fresh-Start accounting, a new reporting
entity (the Successor Company) is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their
estimated fair values (see Note 3 -- Fresh-Start Accounting). The
reported historical financial statements of the Predecessor Company for
periods prior to April 30, 2003 generally are not comparable to those
of the Successor Company. In this Quarterly Report on Form 10-Q,
references to our 2003 and 2002 results of operations refer to the
Predecessor Company.
At the time of emergence, the Plan Investors made a
substantial investment in the Successor Company in furtherance of our
financial and operational restructuring plan. The Plan Investors and
their affiliates received approximately 32 million shares of Kmart
Holding Corporation's new common stock in satisfaction of pre-petition
claims they held and we issued 14 million shares of new common stock to
affiliates of ESL and Third Avenue, in exchange for $127, net of $13 of
commitment fees and Plan Investor expenses. In addition, we issued a
9%, $60 principal amount convertible note to the affiliates of ESL. The
principal and unpaid interest in respect to the 9% convertible note is
convertible at any time, at the option of the holder, into new common
shares at a conversion price equal to $10 per share. ESL also was
granted the option, exercisable in its own discretion prior to May 6,
2005, to purchase from the Successor Company approximately 6.6 million
new Common Shares at a price of $13 per share. A portion of the option
was assigned to Third Avenue. The investment was made pursuant to the
Investment Agreement.
ESL and its affiliates beneficially own over 50% of the common
stock of the Successor Company, including shares received in exchange
for pre-petition obligations, as well as shares obtainable upon
exercise of options and conversion of the $60 convertible note issued
to affiliates of ESL. Each of the Plan Investors is represented on our
Board of Directors.
The Plan of Reorganization became effective on May 6, 2003, at
which time all then-outstanding equity securities of the Predecessor
Company, as well as substantially all of its pre-petition liabilities,
were cancelled. Holders of the Predecessor Company's stock may receive
up to 2.5% of the recoveries under the Creditor Trust, see Note 1 --
Proceedings under Chapter 11 of the Bankruptcy Code. New common stock
of the Successor Company was issued in satisfaction of certain of those
pre-petition liability claims, see Note 1 -- Proceedings under Chapter
11 of the Bankruptcy Code. The new securities of the Successor Company
issued on the Effective Date pursuant to the Plan of Reorganization and
related transactions, consisted of 89,677,509 shares of new common
stock and options to purchase 8,324,883 shares of new common stock. All
of the shares of common stock issued on May 6, 2003 were or will be
distributed pursuant to the Plan of Reorganization in satisfaction of
pre-petition claims, except for 14 million shares of common stock of
the Successor Company issued to affiliates of ESL and Third Avenue in
exchange for $127, net $13 of commitment fees and Plan Investor
expenses. All such shares were issued without registration under the
Securities Act of 1933 in reliance on the provisions of Section 1145 of
the Bankruptcy Code and Section 4(2) of the Securities Act of 1933. In
addition, as part of the Plan of Reorganization, Kmart has established
a Creditor Trust for the benefit of the Predecessor Company's
pre-petition
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
creditors and equity holders, to pursue claims which arose from the
Predecessor Company's prior accounting and stewardship investigations.
The ability of Kmart to continue as a going concern is
predicated upon numerous issues, including our ability to achieve the
following:
o implementing our business plan and returning Kmart to
profitability;
o taking appropriate action to offset the negative effects
that the Chapter 11 filing has had on our business,
including the loss in customer traffic and the impairment of
vendor relations;
o operating within the framework of our $2 billion Exit
Financing Facility, including its limitations on capital
expenditures, its financial covenants, our ability to
generate cash flows from operations or seek other sources of
financing and the availability of projected vendor terms;
and
o attracting, motivating and/or retaining key executives and
associates.
These challenges are in addition to those operational and
competitive challenges faced by Kmart in connection with our business
as a discount retailer. See "Cautionary Statement Regarding
Forward-Looking Information" above.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements requires that we make
estimates and assumptions that affect the reported amounts of assets
and liabilities at the date of the financial statements and revenues
and expenses during the period. We base our estimates on historical
experience and other assumptions that we believe to be reasonable under
the circumstances, the results of which form the basis for making
judgments about carrying values of assets and liabilities that are not
readily apparent from other sources. We continually evaluate the
information used to make these estimates as our business and the
economic environment change. We have disclosed our critical accounting
policies and estimates in the Predecessor Company's Annual Report on
Form 10-K for the year ended January 29, 2003, filed with the
Securities Exchange Commission on March 24, 2003. See Note 3 -- Fresh
Start Accounting for a discussion of our change from the Last-in
First-Out method of inventory valuation to the First-in First-Out
method for our accounting for merchandise inventories.
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis ("MD&A")
discussion provides a comparative analysis of operating results as
reported for the 13-weeks ended April 30, 2003 and May 1, 2002.
Same-store sales and total sales decreased 3.2% and 13.9%,
respectively, for the 13-weeks ended April 30, 2003 as compared to the
same period from the previous year. The decrease in same store sales is
primarily due to sluggish retail sales as a result of consumer concerns
over the war with Iraq, general economic factors and unseasonable
weather conditions. Same-store sales include sales of all open stores
that have been open for greater than 13 full months. The decrease in
total sales is attributable to the decrease in same-store sales and the
closure of 283 stores during the second quarter of 2002.
Gross margin increased $674 to $1,419, for the 13-weeks ended
April 30, 2003, from $745 for the 13-weeks ended May 1, 2002. Gross
margin, as a percentage of sales, increased to 23.0% for the 13-weeks
ended April 30, 2003, from 10.4% for the 13-week period ended May 1,
2002. The increase in gross margin is primarily related to the charge
of $542 recorded in the first quarter of 2002 in conjunction with the
store closing liquidation sales. In addition, our gross margin rate was
positively affected by a favorable gross margin rate realized from
closing store liquidation sales, a decrease in sales of food and
consumables, which carry lower margins and a decrease in promotional
markdowns, partially offset by the impact of clearance markdowns.
Selling, general and administrative expenses ("SG&A"), which
includes advertising costs (net of co-op recoveries of $69 in fiscal
2002) decreased $249 for the 13-weeks ended April 30, 2003 to $1,421,
or 23.0% of sales, from $1,670, or 23.3% of sales, for the 13-weeks
ended May 1, 2002. The decrease in SG&A is primarily the result of the
closure of 283 stores in the second quarter of 2002 and lower payroll
and other related expenses in the first quarter of 2003 stemming from
corporate headquarters cost reduction initiatives. In addition, SG&A
was favorably impacted by a decrease in utility expenses and electronic
media advertising, and lower depreciation expense as a result of the
impairment charge recorded in the fourth quarter of fiscal 2002. These
decreases were partially offset by co-op recoveries
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
recorded to SG&A in 2002, that are recorded to cost of sales, buying
and occupancy in 2003, resulting from the application of EITF 02-16,
"Accounting by a customer (Including a Reseller) for Certain
Consideration Received from a Vendor," an increase in pension expense,
and higher premiums for our workers' compensation insurance.
Operating loss for the 13-weeks ended April 30, 2003 was $32,
or (0.5%) of sales, as compared to operating loss of $920, or (12.8%)
of sales, for the same period of the prior year. The decrease in
operating loss was primarily due to the 2002 charge for accelerated
inventory markdowns of $542 in conjunction with store closing
liquidations in the first quarter of fiscal 2002 and the decrease in
SG&A as discussed above.
Net interest expense for the 13-weeks ended April 30, 2003 and
May 1, 2002 was $57 and $33, respectively. The increase in interest
expense is due to accelerated amortization on debt issuance costs
related to our DIP Credit Facility in connection with our emergence
from Chapter 11. Included in net interest expense is interest income of
$1 for the 13-weeks ended April 30, 2003 and May 1, 2002. Interest at
the stated contractual amount on unsecured debt that was not charged to
earnings for the 13-weeks ended April 30, 2003 and May 1, 2002 was $67
and $69, respectively.
Effective income tax rate was (0.7%) and (1.0%) for the
13-weeks ended April 30, 2003 and May 1, 2002, respectively, see Note
12 -- Income Taxes.
Significant changes were made to our unaudited Condensed
Consolidated Balance Sheet to reflect the application of Fresh-Start
accounting. See Note 3 -- Fresh Start Accounting for further details of
the adjustments.
LIQUIDITY AND FINANCIAL CONDITION
On May 6, 2003, our $2 billion Exit Financing Facility
financed by General Electric Capital Corporation, Fleet Retail Finance,
Inc. and Bank of America, N.A. became effective. Debt issuance costs
associated with the Exit Financing Facility totaled $58 and will be
amortized through May 2006. The Exit Financing Facility is a revolving
credit facility under which Kmart Corporation is the debtor and its
parent entities and most direct and indirect subsidiaries are
guarantors. The Exit Financing Facility is collateralized by first
liens on inventory, the proceeds thereof, and certain intellectual
property necessary to realize the value of the inventory. Borrowings
under the Exit Financing Facility currently bear interest at either the
Prime rate plus 2.5% per annum or the LIBOR rate plus 3.5% per annum,
at our discretion, which interest rate margin may be reduced after the
first anniversary of the effective date of the Exit Financing Facility
if Kmart meets certain EBITDA targets. In addition, we are required to
pay a fee based on the unutilized commitment under the Exit Financing
Facility equal to 0.75% per annum. The Exit Financing Facility
financial covenants include a requirement that Kmart maintain minimum
availability of $100 under the facility and a restriction on capital
spending. In the event that Kmart fails to maintain certain specified
excess availability minimums under the Exit Financing Facility, Kmart
will also be required to maintain minimum levels of EBITDA. The Exit
Financing Facility also contains other customary covenants, including
certain reporting requirements and covenants that restrict our ability
to incur or create liens, indebtedness and guarantees, make
investments, pay dividends or make other equity distributions, sell or
dispose of stock or assets, change the nature of our business and enter
into affiliate transactions, mergers and consolidations. Failure to
satisfy these covenants would (in some cases, after the receipt of
notice and/or the expiration of a grace period) result in an event of
default that could result in our inability to access the funds
necessary to maintain our operations.
Following the Petition Date and prior to emergence, the
Predecessor Company utilized cash flows from operations and the
Debtor-in-Possession Credit Facility ("DIP Credit Facility") as its
primary sources of working capital. The DIP Credit Facility was a
revolving credit facility under which the Predecessor Company was the
borrower and the rest of the Debtors were guarantors.
Net cash provided by operating activities for the 13-weeks
ended April 30, 2003 was $595 compared to net cash provided by
operating activities of $1,020 for the same period in 2002. The
decrease in cash provided by operating activities was primarily due to
increased payments on accounts payable in the first quarter of 2003 as
compared to the first quarter of 2002 due to the stay on pre-petition
liabilities following our filing for protection under Chapter 11.
Net cash used for reorganization items was $19 for the
13-weeks ended April 30, 2003 compared to net cash provided by
reorganization items of $12 for the same period in 2002. The change in
cash used for reorganization items
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
relates primarily to 2003 payments under the Key Employee Retention
Program ("KERP") and payments to retain bankruptcy advisors.
Net cash provided by investing activities was $60 for the
13-weeks ended April 30, 2003 compared to net cash used for investing
activities of $52 for the same period in 2002. The change in net cash
provided by investing activities is due to proceeds of $45 from the
sale of four owned Kmart store locations, $18 from the sale of
furniture and fixtures from our closed store locations, and a reduction
in capital expenditures from $52 in 2002 to $4 in 2003.
Net cash used for financing activities was $17 for the
13-weeks ended April 30, 2003 compared to net cash used for financing
activities of $396 for the comparable period in 2002. The decrease in
cash used for financing activities is primarily the result of the
repayment of $330, including debt issuance costs, on our DTP Credit
Facility in 2002.
Due to the seasonal nature of the retail industry, where
merchandise sales and cash flows from operations are historically
higher in the fourth quarter than any other period, a disproportionate
amount of operating income and cash flows from operations are earned in
the fourth quarter. Our results of operations and cash flows are
primarily dependent upon the large sales volume generated during the
fourth quarter of our fiscal year. Fourth quarter sales represented
over 29% of total net sales in fiscal 2002. As a result, operating
performance for the interim periods is not necessarily indicative of
operating performance for the entire year. To support the higher
seasonal sales volume we experience a seasonal inventory build in
October and November and, as a result, our usage of credit lines is
higher for this period of the year. We believe that our Exit Financing
Facility will be adequate to support our forecasted seasonal borrowing
needs.
Our cash needs are satisfied through working capital generated
by our business and funds available under our Exit Financing Facility.
The level of cash generated by our business is dependent, in
significant part, on our level of sales and the credit extended by our
vendors. Since our filing for reorganization under Chapter 11, most of
our vendors have resumed normal trade terms. Should, however, we
experience a significant disruption of terms with our vendors, sales
fail to improve, the Exit Financing Facility for any reason becomes
unavailable and/or actual results differ materially from those
projected, our compliance with financial covenants and our cash
resources could be adversely affected.
Inflation
Inflation has not had a significant impact on our business
over the past three years and we do not expect it to have a significant
impact on operations in the foreseeable future, unless global or
geo-political factors substantially affect the world economy.
Future Liquidity Items
We expect to make payments of approximately $640 in
conjunction with our emergence from Chapter 11. The actual amounts
will depend upon the Reconciliation of Claims entitled to cash
payments. We will fund these cash payments with existing cash balances
and cash contributions received from the Plan Investors, including $60
aggregate principal amount of convertible notes and $127, net of $13 of
commitment fees and Plan Investor expenses, for the purchase of new
common shares of the Successor Company.
We do not expect to borrow from the Exit Financing Facility
except in the normal course of business to fund the seasonal inventory
build-up for the fourth quarter, as discussed above.
Pension Plan
Prior to 1996, Kmart maintained defined benefit pension plans
covering eligible associates. Effective January 31, 1996, the pension
plans were frozen, and associates no longer earn additional benefits
under the plans (except for purposes of the subsidized early retirement
program provided by the plan). The plans' assets consist primarily of
equity and fixed income securities. For the past nine years, the
Predecessor Company has not been required to make contributions to the
plans.
In light of returns in the equity markets in 2003 and prior
years, and the effect of such returns on the value of the plans'
assets, we presently expect that we will be required to commence making
significant contributions to the plans in 2005 or 2006, although it is
possible that contributions could be required earlier. Given that the
plans are frozen, the timing for the commencement of our future funding
requirements will depend, in large part, on the future investment
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
performance of the plans' assets. Once funding obligations commence, we
presently anticipate that such obligations could continue for a period
of five or six years at an average rate of between $100 and $200 a
year, or between $700 and $1 billion in the aggregate. The actual level
of contributions will depend upon a number of factors, including actual
demographic experience, pension fund returns and other changes
affecting valuations.
In addition to the funding described above, as a result of the
returns over the most recent years, decreases in our annual discount
rate and expected rate of return on assets, we recorded pension expense
in the first quarter, as opposed to income as has been recorded in the
most recent years.
FRESH-START ADJUSTMENTS
In accordance with Fresh-Start accounting, all assets and
liabilities are recorded at their respective fair market values. Fair
values used represent our best estimates based on independent
appraisals and valuations.
To facilitate the calculation of the enterprise value of the
Successor Company, we developed a set of financial projections. Based
on these financial projections, the enterprise value was determined by
the Company, with assistance of a financial advisor, using various
valuation methods, including (i) a comparison of the Company and its
projected performance to the market values of comparable companies,
(ii) a review and analysis of several recent transactions of companies
in similar industries to the Company, and (iii) a calculation of the
present value of the future cash flows under the projections. The
estimated enterprise value is highly dependent upon achieving the
future financial results set forth in the projections as well as the
realization of certain other assumptions which are not guaranteed. The
estimated enterprise value of Kmart was calculated to be approximately
$2.3 billion to $3.0 billion. We selected the midpoint of the range,
$2.6 billion, as the estimated enterprise value. In applying
Fresh-Start accounting, adjustments to reflect the fair value of assets
and liabilities, on a net basis, and the write-off of the Predecessor
Company's equity accounts resulted in a charge of $5.6 billion. The
restructuring of Kmart's capital structure and resulting discharge of
pre-petition debt resulted in gain of $5.6 billion. The charge for the
revaluation of the assets and liabilities and the gain on the discharge
of pre-petition debt are recorded in Reorganization items, net in the
unaudited Condensed Consolidated Statement of Operations. In addition,
the excess of fair value of net assets over reorganization value
("negative goodwill") was allocated on a pro-rata basis and reduced our
non-current assets, with the exception of financial instruments, to $10
in accordance with SFAS No. 141.
DISCONTINUED OPERATIONS
During the first quarter of fiscal 2003 and the second quarter
of fiscal 2002, we closed 316 and 283 stores, respectively. We
identified 121 stores that met the criteria for discontinued operations
(see Note 4 - Discontinued Operations). The results of operations for
these 121 closed stores have been classified as discontinued operations
for all periods presented in our unaudited Condensed Consolidated
Statements of Operations. The table below sets forth the components of
the net loss associated with the discontinued operations for the
13-weeks ended April 30, 2003 and May 1, 2002.
13 Weeks Ended
-----------------------------------
April 30, 2003 May 1, 2002
--------------- ---------------
Sales $ 232 $ 458
Cost of sales, buying and occupancy 150 585
--------------- ---------------
Gross margin 82 (127)
Selling, general and administrative expenses 43 100
Restructurings, impairments and other charges 5 -
Reorganization items, net 44 23
--------------- ---------------
Net loss from discontinued operations $ (10) $ (250)
=============== ===============
Of the 599 stores that were closed in 2003 and 2002, 478 are
included in continuing operations, as they did not meet the criteria
for discontinued operations. For the 13-week period ended April 30,
2003, total sales, gross margin and SG&A for the 250 stores that were
closed in fiscal 2003 and reported in continuing operations are $854,
$291 and $125, respectively. For the 13-week period ended May 1, 2002,
total sales, gross margin and SG&A for the 478 stores that were closed
in fiscal 2003 and 2002 and reported in continuing operations were
$1,674, ($267) and $373, respectively.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
SPECIAL CHARGES
Special charges are transactions which, in management's
judgment, may make meaningful comparisons of operating results between
reporting periods difficult. In determining what amounts constitute a
special charge, management considers the nature, magnitude and
frequency of their occurrence. During fiscal 2002, we instituted
certain restructuring actions to improve our operations and executed
significant inventory liquidations as a result of the stores closed
under Kmart's Chapter 11 proceedings. For the 13-weeks ended April 30,
2003 and May 1, 2002 we recorded special charges of $42 and $758,
respectively. For a comprehensive discussion see Note 6 -- Special
Charges.
REORGANIZATION ITEMS, NET
Reorganization items represent amounts the Predecessor Company
incurred as a result of Chapter 11, and are presented separately in the
unaudited Condensed Consolidated Statements of Operations. We recorded
$769 and $251 for the 13-week periods ended April 30, 2003 and May 1,
2002, respectively, for reorganization items. The increase in
Reorganization items, net is primarily due to the Fleming settlement of
$385 and expense of $200 for estimated claims for rejected executory
contracts. For a comprehensive discussion see Note 7 -- Reorganization
items, net.
OTHER MATTERS
Contingent Liabilities
The Predecessor Company had (i) guaranteed obligations for
real property leases of certain Debtors and former subsidiaries of
Kmart including, but not limited to, The Sports Authority, Inc.,
OfficeMax, Inc. and Borders Group, Inc., some of which leases were
assigned pre-petition; (ii) contingent liabilities under real property
leases assigned by Kmart pre-petition; and (iii) guaranteed
indebtedness of other parties related to certain of our leased
properties financed by industrial revenue bonds. To the extent not
expressly assumed or reinstated under the Plan of Reorganization these
guarantees were discharged subject to pre-petition claims
administration.
OTHER
On June 4, 2003, Martha Stewart was indicted in the United
States District Court of the Southern District of New York. The Martha
Stewart brand is considered a distinctive brand for Kmart and we
currently sell Martha Stewart home, garden, colors, baby, kitchen,
keeping and decorating product lines, along with candles and
accessories. Martha Stewart has resigned her position as Chairman and
Chief Executive Officer of Martha Stewart Omnimedia, Inc.; however, she
will serve as the Chief Creative Officer and remain on the Board of
Directors. To-date, we have not experienced any significant adverse
impact from this matter on the sales of Martha Stewart brand products.
Although product sales have not been significantly affected by past
events, the Company is not able to determine the potential effects
these events may have on the future sales of its Martha Stewart brand
products.
On June 10, 2003, our common stock began trading on the
NASDAQ National Market System under the symbol KMRT. The common stock
had previously traded on the OTC Bulletin Board.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At April 30, 2003, we did not have any derivative instruments
that increased our exposure to market risks for interest rates, foreign
currency rates, commodity prices or other market price risks. We do not
use derivatives for speculative purposes. Currently, our exposure to
market risks results primarily from changes in interest rates,
principally with respect to the Exit Financing Facility, which is a
variable rate financing agreement. We do not use swaps or other
interest rate protection agreements to hedge this risk.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the date of filing this
report, we carried out an evaluation, under the supervision of our
management Disclosure Committee (which includes the Chief Executive
Officer and Acting Chief Financial Officer), of the effectiveness of
the design and operation of our disclosure controls and procedures
pursuant to Exchange Act Rules 13a-14 and 15d-14. Based upon this
evaluation, the Chief Executive Officer and Acting Chief Financial
Officer concluded that our disclosure controls and procedures are
effective to ensure that information required to be disclosed in our
periodic SEC reports is recorded, processed, summarized, and reported
as and when required.
There have not been any significant changes to our internal
controls or any other factors that could significantly affect these
controls subsequent to the date of management's evaluation.
29
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 19 of the Notes to unaudited Condensed Consolidated
Financial Statements for information concerning legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Plan of Reorganization became effective on May 6, 2003, at
which time all then-outstanding equity securities of the Predecessor
Company, as well as substantially all pre-petition liabilities, were
cancelled. New common stock of the Successor Company was issued in
satisfaction of certain of those claims. Information concerning the new
securities is summarized in Part I, Item 1, above, in Note 1 of
the Notes to unaudited Condensed Consolidated Financial Statements and
in our Registration Statement on Form 8-A filed May 6, 2003.
The new securities of the Successor Company issued on May 6,
2003 pursuant to the Plan of Reorganization and related transactions,
consisted of 89,677,509 shares of common stock of the Successor
Company, options to purchase 8,324,883 shares of common stock of the
Successor Company and $60 million aggregate principal amount of
convertible notes. The principal and accrued interest in respect to the
9% convertible note is convertible at any time, at the option of the
holder, into new common shares at a conversion price equal to $10 per
share. All of the shares of common stock issued on May 6, 2003 were or
will be distributed pursuant to the Plan of Reorganization in
satisfaction of pre-petition claims, except for 14 million shares of
common stock of the Successor Company, which were issued in exchange
for $127 million, net of $13 million of commitment fees and Plan
Investors expenses. All such shares were issued without registration
under the Securities Act of 1933 in reliance on the provisions of
Section 1145 of the Bankruptcy Code and Section 4(2) of the Securities
Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As a result of its Chapter 11 filing, the Predecessor Company
did not make principal or interest payments on unsecured indebtedness
incurred prior to January 22, 2002. In addition, the Predecessor
Company was not permitted to pay dividends on its trust convertible
preferred securities. As of May 6, 2003, all unsecured indebtedness
incurred by the Predecessor Company and the trust convertible preferred
securities were cancelled.
ITEM 5. OTHER INFORMATION
Upon emergence from Chapter 11, the Board of Directors of
Kmart Holding Corporation was fixed at nine. The members of the Board
are: E. David Coolidge III, William C. Crowley, Julian C. Day, William
Foss, Edward S. Lampert, Steven T. Mnuchin, Ann Reese, Brandon Stranzl
and Thomas J. Tisch. Biographical information about our directors can
be found on our web site www.kmart.com. Edward S. Lampert was appointed
Chairman of the Board of Directors.
The Board of Directors established the following committees:
the Audit Committee, the Compensation Committee, the Nominating and
Governance Committee and the Finance Committee. The members of the
committees are set forth below:
Audit Committee:
Ann Reese, Chair
E. David Coolidge III
Brandon Stranzl
Compensation and Incentives Committee:
Edward S. Lampert, Chair
Ann Reese
Thomas J. Tisch
Corporate Governance Committee:
Steven T. Mnuchin, Chair
William Foss
30
Thomas J. Tisch
Finance Committee:
Edward S. Lampert, Chair
William C. Crowley
Julian C. Day
Steven T. Mnuchin
Mr. Harold W. Lueken was appointed to the position of Senior
Vice President, General Counsel and Secretary, effective May 12, 2003,
and in connection with his appointment, entered into an employment
agreement dated May 6, 2003.
The employment of Mr. Ronald B. Hutchison as Chief
Restructuring Officer with Kmart terminated May 31, 2003. The
employment of Michael T. Macik as Executive Vice President of Human
Resources terminated effective May 1, 2003, pursuant to the terms of a
separation agreement dated June 3, 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as a part of this report:
Exhibit 1.1 -- Amended and Restated Certificate of Incorporation of Kmart Holding Corporation
Exhibit 1.2 -- By-Laws of Kmart Holding Corporation
Exhibit 4.1 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to CRK Partners, L.P.
Exhibit 4.2 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to CRK Partners II, L.P.
Exhibit 4.3 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to ESL Institutional Partners,
L.P.
Exhibit 4.4 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to ESL Investors, L.L.C.
Exhibit 4.5 -- Registration Rights Agreement, dated May 6, 2003, by and among Kmart Holding Corporation, ESL
Investments, Inc. and Third Avenue Trust, on behalf of certain of its investment series.
Exhibit 4.6 -- Guarantee Agreement, dated May 6, 2003, by and among Kmart Corporation, CRK Partners, L.P., CRK
Partners II, L.P., ESL Institutional Partners, L.P. and ESL Investors L.L.C.
Exhibit 4.7 -- Kmart Creditor Trust Agreement, dated as of April 30, 2003, by and among Kmart Corporation, the
other Affiliated Debtors party thereto and Douglas J. Smith, as Trustee.
Exhibit 4.8 -- First Amendment to Kmart Creditor Trust Agreement, dated as of May 6, 2003, by and among Kmart
Corporation, the other Affiliated Debtors party thereto and Douglas J. Smith, as Trustee.
Exhibit 10.1 --Credit Agreement, dated as of May 6, 2003, among Kmart Corporation, as Borrower, the other Credit
Parties signatory thereto, as Credit Parties, the Lenders signatory thereto, from time to time, as
Lenders, and General Electric Capital Corporation, as Administrative Agent, Co-Collateral Agent and
Lender, GECC Capital Markets Group, Inc., as Co-Lead Arranger and Co-Book Runner, Fleet Retail
Finance Inc., as Co-Syndication Agent, Co-Collateral Agent and Lender Fleet Securities, Inc., as
Co-Lead Arranger and Co-Book Runner, Bank of America, N.A., as Co-Syndication Agent and Lender,
Banc of America Securities LLC, as Co-Lead Arranger and Co-Book Runner, GMAC Commercial Finance
LLC, as Co-Documentation Agent and Foothill Capital Corporation, as Co-Documentation Agent.
31
Exhibit 10.2 --Assignment and Assumption Agreement, dated as of May 6, 2003, between Kmart Holding Corporation
and Kmart Corporation assigning Julian C. Day's Employment Agreement to Kmart Holding Corporation.
Exhibit 10.3 --Kmart Holding Corporation Nonqualified Stock Option Agreement between Kmart Holding Corporation
and Julian C. Day.
Exhibit 10.4 --Employment Agreement, dated as of May 6, 2003, between Kmart Management Corporation and Harold W.
Lueken.
Exhibit 10.5 --Michael T. Macik Separation Agreement.
Exhibit 99.1 --Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K: We filed the following Current Reports on
Form 8-K with the SEC:
1. On March 7, 2003, the Predecessor Company filed a
Current Report on Form 8-K to report the filing of
the Joint Plan of Reorganization and Disclosure
Statement with the Bankruptcy Court.
2. On March 24, 2003, the Predecessor Company filed a
Current Report on Form 8-K to report fourth quarter
2002 operating results.
3. On March 24, 2003, the Predecessor Company filed
Current Reports on Form 8-K to report the filing of
Monthly Operating Reports for the months of January
and February with the Bankruptcy Court.
4. On April 17, 2003, the Predecessor Company filed a
Current Report on Form 8-K to report certain
financial information that was disclosed in the
Bankruptcy Court as well as the First Amended Plan of
Reorganization.
5. On April 30, 2003, the Predecessor Company filed a
Current Report on Form 8-K to report the filing of
the Findings of Fact, Conclusions of Law, and Order
Under 11 U.S.C. Sections 1129(a) and (b) and Fed. R.
Rule Bankr. P. 3020 Confirming the First Amended
Joint Plan of Reorganization of Kmart Corporation and
Its Affiliated Debtors and Debtors-in-Possession, as
modified, dated April 22, 2003, and docketed by the
Court on April 23, 2003.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized.
The signatory hereby acknowledges and adopts the typed form of his/her
name in the electronic filing of this document with the Securities and
Exchange Commission.
Date: June 16, 2003
Kmart Holding Corporation
----------------------------------------------
(Registrant)
By: /s/ Julian C. Day
----------------------------------------------
Julian C. Day
PRESIDENT AND CHIEF
EXECUTIVE OFFICER
(Principal Executive Officer)
/s/ Richard J. Noechel
----------------------------------------------
Richard J. Noechel
VICE PRESIDENT AND
CONTROLLER
(Principal Accounting Officer and Co-Principal
Financial Officer)
33
CERTIFICATIONS
I, Julian C. Day, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kmart
Holding Corporation;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in the quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: June 16, 2003
/s/ Julian C. Day
-----------------
Julian C. Day
Chief Executive Officer
34
CERTIFICATIONS
I, Richard J. Noechel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kmart Holding
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in the
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: June 16, 2003
/s/ Richard J. Noechel
- ----------------------
Richard J. Noechel
Vice President and Controller (as Co-Principal Financial Officer)
35
CERTIFICATIONS
I, James F. Gooch, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kmart Holding
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in the
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: June 16, 2003
/s/ James F. Gooch
- ------------------
James F. Gooch
Vice President and Treasurer (as Co-Principal Financial Officer)
36
Exhibit Index
-------------
Exhibit No. Description
----------- -----------
Exhibit 1.1 -- Amended and Restated Certificate of Incorporation of Kmart Holding Corporation
Exhibit 1.2 -- By-Laws of Kmart Holding Corporation
Exhibit 4.1 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to CRK Partners, L.P.
Exhibit 4.2 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to CRK Partners II, L.P.
Exhibit 4.3 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to ESL Institutional Partners,
L.P.
Exhibit 4.4 -- 9% Convertible Subordinated Note issued by Kmart Holding Corporation to ESL Investors, L.L.C.
Exhibit 4.5 -- Registration Rights Agreement, dated May 6, 2003, by and among Kmart Holding Corporation, ESL
Investments, Inc. and Third Avenue Trust, on behalf of certain of its investment series.
Exhibit 4.6 -- Guarantee Agreement, dated May 6, 2003, by and among Kmart Corporation, CRK Partners, L.P., CRK
Partners II, L.P., ESL Institutional Partners, L.P. and ESL Investors L.L.C.
Exhibit 4.7 -- Kmart Creditor Trust Agreement, dated as of April 30, 2003, by and among Kmart Corporation, the
other Affiliated Debtors party thereto and Douglas J. Smith, as Trustee.
Exhibit 4.8 -- First Amendment to Kmart Creditor Trust Agreement, dated as of May 6, 2003, by and among Kmart
Corporation, the other Affiliated Debtors party thereto and Douglas J. Smith, as Trustee.
Exhibit 10.1 --Credit Agreement, dated as of May 6, 2003, among Kmart Corporation, as Borrower, the other Credit
Parties signatory thereto, as Credit Parties, the Lenders signatory thereto, from time to time, as
Lenders, and General Electric Capital Corporation, as Administrative Agent, Co-Collateral Agent and
Lender, GECC Capital Markets Group, Inc., as Co-Lead Arranger and Co-Book Runner, Fleet Retail
Finance Inc., as Co-Syndication Agent, Co-Collateral Agent and Lender Fleet Securities, Inc., as
Co-Lead Arranger and Co-Book Runner, Bank of America, N.A., as Co-Syndication Agent and Lender,
Banc of America Securities LLC, as Co-Lead Arranger and Co-Book Runner, GMAC Commercial Finance
LLC, as Co-Documentation Agent and Foothill Capital Corporation, as Co-Documentation Agent.
Exhibit 10.2-- Assignment and Assumption Agreement, dated as of May 6, 2003, between Kmart Holding Corporation
and Kmart Corporation assigning Julian C. Day's Employment Agreement to Kmart Holding Corporation.
Exhibit 10.3 --Kmart Holding Corporation Nonqualified Stock Option Agreement between Kmart Holding Corporation
and Julian C. Day.
Exhibit 10.4 --Employment Agreement, dated as of May 6, 2003, between Kmart Management Corporation and Harold W.
Lueken.
Exhibit 10.5 --Michael T. Macik Separation Agreement.
Exhibit 99.1 --Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.