UNITED STATES
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 28, 2004
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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
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(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
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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 14, 2004, 89,638,293 shares of Common Stock of the Registrant were
outstanding.
1
INDEX
PART I FINANCIAL INFORMATION PAGE
---------------------
Item 1. Financial Statements
Condensed Consolidated Statements of Operations (Unaudited) -- 3
Successor Company -- for the 13-weeks ended April 28, 2004
Predecessor Company -- for the 13-weeks ended April 30, 2003
Condensed Consolidated Balance Sheets (Unaudited) -- 4
Successor Company -- as of April 28, 2004, January 28, 2004 and April 30, 2003
Condensed Consolidated Statements of Cash Flows (Unaudited) -- 5
Successor Company -- for the 13-weeks ended April 28, 2004
Predecessor Company -- for the 13-weeks ended April 30, 2003
Notes to Unaudited Condensed Consolidated Financial Statements 6-15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of 16-20
Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Item 4. Controls and Procedures 21
PART II OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SUCCESSOR COMPANY PREDECESSOR COMPANY
----------------- -------------------
13-WEEKS ENDED 13-WEEKS ENDED
APRIL 28, 2004 APRIL 30, 2003
----------------- -------------------
Sales $ 4,615 $ 6,181
Cost of sales, buying and occupancy 3,478 4,762
----------------- -------------------
Gross margin 1,137 1,419
Selling, general and administrative expenses 1,004 1,421
Net gains on sales of assets (32) -
Restructuring, impairment and other charges - 37
----------------- -------------------
Operating income (loss) 165 (39)
Interest expense, net 26 57
Bankruptcy-related recoveries (7) -
Equity income in unconsolidated subsidiaries (3) (7)
Reorganization items, net - 769
----------------- -------------------
Income (loss) from continuing operations before income taxes 149 (858)
Provision for (benefit from) income taxes 56 (6)
----------------- -------------------
Income (loss) from continuing operations 93 (852)
Discontinued operations (net of income taxes of $0) - (10)
----------------- -------------------
Net income (loss) $ 93 $ (862)
================= ===================
Basic income (loss) per common share from continuing operations $ 1.04 $ (1.63)
Discontinued operations - (0.02)
----------------- -------------------
Basic net income (loss) per common share $ 1.04 $ (1.65)
================= ===================
Diluted income (loss) per common share from continuing operations $ 0.94 $ (1.63)
Discontinued operations - (0.02)
----------------- -------------------
Diluted net income (loss) per common share $ 0.94 $ (1.65)
================= ===================
Basic weighted average shares (millions) 89.5 522.7
Diluted weighted average shares (millions) 100.3 522.7
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
3
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
SUCCESSOR COMPANY
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APRIL 28, 2004 JANUARY 28, 2004 APRIL 30, 2003
-------------- ---------------- --------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,228 $ 2,088 $ 1,232
Merchandise inventories 3,394 3,238 4,431
Accounts receivable, net 237 301 382
Other current assets 169 184 509
------------- ---------------- -------------
TOTAL CURRENT ASSETS 6,028 5,811 6,554
Property and equipment, net 190 153 10
Other assets and deferred charges 95 120 96
------------- ---------------- -------------
TOTAL ASSETS $ 6,313 $ 6,084 $ 6,660
============= ================ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Mortgages payable due within one year $ 4 $ 4 $ 8
Accounts payable 985 820 1,160
Accrued payroll and other liabilities 660 671 1,321
Taxes other than income taxes 276 281 274
------------- ---------------- -------------
TOTAL CURRENT LIABILITIES 1,925 1,776 2,763
LONG-TERM LIABILITIES
Long-term debt and mortgages payable 102 103 108
Capital lease obligations 360 374 415
Pension obligation 877 873 854
Unfavorable operating leases 329 342 344
Other long-term liabilities 435 424 463
------------- ---------------- -------------
TOTAL LIABILITIES 4,028 3,892 4,947
SHAREHOLDERS' EQUITY
Preferred stock 20,000,000 shares authorized; no shares
outstanding - - -
Common stock $0.01 par value, 500,000,000 shares
authorized; 89,638,293, 89,633,760 and 89,677,509
shares issued, respectively 1 1 1
Treasury stock, at cost (1) (1) -
Capital in excess of par value 1,944 1,943 1,712
Retained earnings 341 248 -
Accumulated other comprehensive income - 1 -
------------- ---------------- -------------
TOTAL SHAREHOLDERS' EQUITY 2,285 2,192 1,713
------------- ---------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 6,313 $ 6,084 $ 6,660
============= ================ =============
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
SUCCESSOR COMPANY PREDECESSOR COMPANY
----------------- -------------------
13-WEEKS 13-WEEKS
ENDED ENDED
APRIL 28, 2004 APRIL 30, 2003
----------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 93 $ (862)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 7 177
Net gains on sales of assets (32) -
Deferred income taxes 19 -
Equity income in unconsolidated subsidiaries (3) (7)
Restructuring, impairments and other charges - 44
Reorganization items, net - 769
Dividends received from Meldisco 3 36
Cash used for store closings and other charges - (64)
Cash used for payments of exit costs and other
reorganization items - (19)
Change in:
Merchandise inventories (156) 480
Accounts receivable 26 114
Accounts payable 165 (117)
Taxes payable 33 (16)
Other assets 32 9
Other liabilities (45) 32
----------------- -----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 142 576
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of assets 66 64
Capital expenditures (55) (4)
----------------- -----------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 11 60
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on capital lease obligations (12) (16)
Payments on mortgages (1) (1)
----------------- -----------------
NET CASH USED FOR FINANCING ACTIVITIES (13) (17)
----------------- -----------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 140 619
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,088 613
----------------- -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,228 $ 1,232
================= =================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Kmart Holding Corporation ("Kmart," "we," "us," "our," the "Company" or
the "Successor Company") is the nation's third largest discount retailer.
We operate in the general merchandise retailing industry through 1,505
Kmart discount stores and Supercenters with locations in 49 states, Puerto
Rico, the U.S. Virgin Islands, Guam and through our e-commerce shopping
site, www.kmart.com.
These interim Unaudited Condensed Consolidated Financial Statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission ("SEC"). Accordingly, they do not
include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (which
include normal recurring adjustments) considered necessary for a fair
presentation have been included. 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 interim period statements should refer to the
audited consolidated financial statements and notes thereto which are
included in our Annual Report on Form 10-K for the year ended January 28,
2004. Certain prior period amounts have been reclassified to conform to the
current interim period presentation.
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") requires that the financial statements for
the period following filing for Chapter 11 bankruptcy protection through
the date a plan of reorganization is confirmed 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 reorganization and restructuring of the business during the
Predecessor Company's (defined below) bankruptcy proceedings have been
reported separately as Reorganization items, net in the Unaudited Condensed
Consolidated Statements of Operations. See below for a more detailed
discussion of the Company's Chapter 11 proceedings.
2. EMERGENCE FROM CHAPTER 11 BANKRUPTCY PROTECTION AND FRESH-START ACCOUNTING
Confirmation of Plan of Reorganization
On May 6, 2003 (the "Effective Date"), Kmart Corporation (the
"Predecessor Company") emerged from reorganization proceedings under
Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or "Chapter
11") pursuant to the terms of the Plan of Reorganization (defined below).
The Predecessor Company became a wholly-owned subsidiary of Kmart
Management Corporation, which is a wholly-owned subsidiary of Kmart Holding
Corporation.
On January 22, 2002 (the "Petition Date"), the Predecessor Company and
37 of its U.S. Subsidiaries (collectively the "Debtors") filed voluntary
petitions for reorganization under Chapter 11 in the United States
Bankruptcy Court for the Northern District of Illinois (the "Court").
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 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.
6
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
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 our newly issued common stock
("Common Stock") in satisfaction of pre-petition claims they held, and we
issued 14 million shares of Common Stock to affiliates of ESL and to Third
Avenue, in exchange for $127 million, net of commitment fees and Plan
Investor expenses of $13 million. In addition, we issued a 9 percent, $60
million principal convertible note (the "Note") to affiliates of ESL. The
term of the Note was extended two years to May 2006 by notice given in
December 2003, consistent with the terms of the agreement. With respect to
the Note, the principal is convertible at any time, at the option of the
holder, into shares of Common Stock at a conversion price equal to $10 per
share. ESL was also granted the option to purchase, prior to May 6, 2005,
approximately 6.6 million shares of Common Stock at a price of $13 per
share. A portion of the option was assigned to Third Avenue. The investment
was made pursuant to an Investment Agreement dated January 24, 2003, as
amended (the "Investment Agreement").
Each of the Plan Investors is represented on our Board of Directors.
Discharge of Liabilities
Under Chapter 11, actions by creditors to collect indebtedness owed
prior to the Petition Date were stayed and certain other pre-petition
contractual obligations were not enforced against the Debtors. The
Predecessor Company received approval from the Court to pay certain
pre-petition liabilities including employee salaries and wages, benefits
and other employee obligations.
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. Common Stock was issued in satisfaction of
certain of those claims. On the Effective Date, 89,677,509 shares of Common
Stock and 8,173,145 options to purchase shares of Common Stock were issued
pursuant to the Plan of Reorganization. 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 that 14
million shares were issued to affiliates of ESL and to Third Avenue
pursuant to the Investment Agreement described above. The options to
purchase shares of Common Stock were issued to the Plan Investors and the
Successor Company's Chief Executive Officer. All 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, an
independent creditor litigation trust was established for the benefit of
the Predecessor Company's pre-petition creditors and equity holders, and to
pursue claims which arose from the Predecessor Company's prior accounting
and stewardship investigations.
Fresh-Start Adjustments
In connection with our emergence from Chapter 11, we reflected the
terms of the Plan of Reorganization in our consolidated financial
statements, applying the terms of SOP 90-7 with respect to financial
reporting. 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.
The reported historical financial statements of the Predecessor Company for
periods ended prior to May 1, 2003 generally are not comparable to those of
the Successor Company. In this Quarterly Report on Form 10-Q, references to
the 13-weeks ended April 30, 2003 and prior periods refer to the
Predecessor Company. References to the Successor Company 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.
7
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
To facilitate the calculation of the enterprise value of the Successor
Company, we developed a set of financial projections. Based on these
financial projections and with the assistance of a financial advisor, we
determined the enterprise value 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 the Company 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 fair value
adjustments included the recognition of approximately $2.2 billion of
intangible assets that were previously not recorded in the Predecessor
Company's financial statements, such as favorable leasehold interests,
Kmart brand rights, pharmacy customer relationships and other lease and
license agreements. The restructuring of the Predecessor Company's capital
structure and resulting discharge of pre-petition debt resulted in a 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
Statements of Operations. In addition, the excess of fair value of net
assets over reorganization value (i.e., "negative goodwill") of
approximately $5.6 billion was allocated on a pro-rata basis reducing our
non-current, non-financial instrument assets, including the previously
unrecorded intangible assets, to $10 million as of April 30, 2003.
Refer to our Annual Report on Form 10-K for the year ended January 28,
2004 for a more detailed discussion.
Claims Resolution
We continue to make progress in the reconciliation and settlement of
the various classes of claims associated with the discharge of the
Predecessor Company's liabilities subject to compromise pursuant to the
Plan of Reorganization. Since June 30, 2003, the first distribution date
established in the Plan of Reorganization, approximately 15.6 million
shares of the 31.9 million shares previously issued to us as disbursing
agent with respect to such claims have been distributed to holders of Class
5 claims and approximately $2.6 million in cash has been distributed to
holders of Class 7 claims. Due to the significant volume of claims filed
to-date, it is premature to estimate with any degree of accuracy the
ultimate allowed amount of such claims for each class of claims under the
Plan of Reorganization. Accordingly, we have maintained a distribution
reserve of approximately 30 percent of shares issued for claim settlements.
The shares in the distribution reserve will be issued to claimants on a
pro-rata basis if, upon settlement of all claims, the ultimate amount
allowed for Class 5 and Class 7 claims is consistent with the Plan of
Reorganization. Differences between amounts filed and our estimates are
being investigated and will be 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.
The next scheduled distribution under the Plan of Reorganization is
expected to commence on or about July 1, 2004.
Bankruptcy-Related Recoveries
For the 13-weeks ended April 28, 2004, we recognized $7 million of
recoveries from vendors who had received cash payments for pre-petition
obligations.
3. NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 132
(revised 2003), "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS No. 132 (R)"). SFAS No. 132 (R) revises the
annual and interim disclosure requirements about pension and other
postretirement benefits. We have complied with the new interim disclosure
requirements in this Quarterly Report on Form 10-Q.
8
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
In December 2003, the SEC issued Staff Accounting Bulletin ("SAB") No.
104, "Revenue Recognition" ("SAB 104"). SAB 104 supercedes SAB 101,
"Revenue Recognition in Financial Statements" to include the guidance from
Emerging Issues Task Force Issue 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." The primary purpose of SAB 104 is
to rescind accounting guidance contained in SAB 101 related to multiple
element revenue arrangements. There was no impact to the Company upon
adoption of SAB 104.
4. PENSION PLAN
The following table summarizes the net periodic benefit cost recognized
for our qualified employee pension plan.
Successor Predecessor
Company Company
-------------- --------------
13-Weeks Ended 13-Weeks Ended
(dollars in millions) April 28, 2004 April 30, 2003
--------------------- -------------- --------------
Components of Net Periodic Expense
Interest costs $ 38 $ 38
Expected return on plan assets (34) (33)
Net loss recognition - 18
Amortization of unrecognized transition asset - (2)
-------------- --------------
Net periodic expense $ 4 $ 21
============== ==============
Contributions to the plan were not required for the 13-weeks ended
April 28, 2004 or April 30, 2003. The estimated contribution for fiscal
2004 is $11 million.
5. EARNINGS PER SHARE
Basic earnings per share is calculated by dividing net income by the
weighted average number of common shares outstanding during each period.
Diluted earnings per share assumes the exercise of stock options, the
conversion of convertible debt and the impact of restricted stock when
dilutive.
A reconciliation of basic weighted average common shares outstanding to
diluted weighted average common shares outstanding for the 13-weeks ended
April 28, 2004 is as follows:
Successor
Company
--------------
13-Weeks Ended
(in millions) April 28, 2004
------------- --------------
Basic weighted average common shares 89.5
Dilutive effect of stock options 4.8
9% convertible note 6.0
--------------
Diluted weighted average common shares 100.3
==============
A reconciliation of net income available to common shareholders to net
income available to common shareholders with assumed conversions for the
13-weeks ended April 28, 2004 is as follows:
Successor
Company
--------------
13-Weeks Ended
(dollars in millions) April 28, 2004
--------------------- --------------
Net income available to common shareholders $ 93
Interest on 9% convertible note, net of tax 1
--------------
Income available to common shareholders with
assumed conversions $ 94
==============
9
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Common stock equivalents of the Predecessor Company were excluded from
the calculation of diluted earnings per share for the 13-weeks ended April
30, 2003 as they were anti-dilutive. Upon our emergence from bankruptcy,
all common stock equivalents of the Predecessor Company were cancelled.
6. DEBT
Credit Facility
Our credit agreement (the "Credit Facility") is a revolving $1.5
billion credit facility with an $800 million letter of credit sub-limit
under which Kmart Corporation is the borrower. Availability under the
Credit Facility is subject to an inventory borrowing base formula. The
Credit 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 Credit Facility is secured primarily by first liens on
inventory, the proceeds thereof and certain related assets of Kmart
Corporation and the guarantors.
Borrowings under the Credit Facility currently bear interest at either
(i) the Prime rate plus 1.5% per annum or (ii) the LIBOR rate plus 2.5% per
annum, at our discretion, and utilization of the letter of credit
sub-facility currently bears interest at 1.25% to 2.50% per annum. These
interest rate margins may be adjusted after July 31, 2004 depending on our
earnings before interest, taxes, depreciation, amortization and other
charges ("EBITDA") levels. In addition, we are required to pay a fee based
on the unutilized commitment under the Credit Facility equal to 0.50% per
annum until July 31, 2004, and 0.375% to 0.50% thereafter, depending on our
EBITDA levels. The Credit Facility gives the Company the ability to
repurchase up to $500 million of the Company's Common Stock, depending on
our EBITDA levels and subject to the approval of the Company's Board of
Directors.
As of April 28, 2004, we had utilized $356 million of the Credit
Facility for letters of credit issued for ongoing import purchasing
operations, and contractual and regulatory purposes, including letters of
credit utilized as collateral to support our self-insurance programs.
During the first quarter of fiscal 2004, we replaced letters of credit used
as collateral for certain programs with cash collateral to reduce
utilization fees on our letters of credit. We continue to classify the cash
collateral in Cash and cash equivalents due to our ability to convert the
cash to letters of credit at any time at our discretion. As of April 28,
2004, $71 million of cash was posted as collateral.
Total availability under the Credit Facility as of April 28, 2004 was
$1.144 billion.
The Credit Facility financial covenants include a requirement that we
maintain certain availability minimums, and failure to do so triggers
additional required minimum levels of EBITDA. The Credit 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. As of April 28, 2004, and in all periods since our emergence from
Chapter 11, we have been in compliance with all Credit Facility covenants.
Predecessor Company Debt
Borrowings of the Predecessor Company during Chapter 11 proceedings
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. 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 under the Bankruptcy Code from paying interest on unsecured
pre-petition debts. On the Petition Date, the Predecessor Company stopped
accruing interest on all unsecured pre-petition debt until it emerged from
bankruptcy in accordance with SOP 90-7. Contractual interest expense not
accrued or recorded by the Predecessor Company on certain pre-petition debt
totaled $67 million for the 13-weeks ended April 30, 2003.
10
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Interest Expense, Net
Included in Interest expense, net in the Unaudited Condensed
Consolidated Statements of Operations is interest income of $5 million and
$1 million for the 13-weeks ended April 28, 2004 and April 30, 2003,
respectively. Debt issuance costs of $4 million and $37 million were
amortized during the 13-weeks ended April 28, 2004 and April 30, 2003,
respectively, and are included in Interest expense, net. Cash paid for
interest was $4 million and $2 million for the 13-weeks ended April 28,
2004 and April 30, 2003, respectively.
7. INCOME TAXES
We recorded a tax provision of $56 million during the 13-weeks ended
April 28, 2004 based on the estimated effective tax rate for fiscal 2004 of
37.6%.
The Predecessor Company recorded a full valuation allowance against net
deferred tax assets in accordance with SFAS No. 109, "Accounting for Income
Taxes," as realization of such assets in future years was uncertain.
Accordingly, no tax benefit was realized from the Predecessor Company's
losses in the first quarter of fiscal 2003. The $6 million tax benefit
recorded during the first quarter of fiscal 2003 relates to an Internal
Revenue Code provision allowing for the 10-year carryback of certain
losses.
Cash paid for income taxes was $1 million for the 13-weeks ended April
28, 2004 and cash received was $2 million for the 13-weeks ended April 30,
2003.
8. TREASURY STOCK
On August 28, 2003, the Company's Board of Directors approved the
repurchase of up to $10 million of the Company's outstanding stock for the
purpose of providing restricted stock grants to certain employees. During
fiscal 2003, we repurchased 128,400 shares of Common Stock
(weighted-average price of $28.87 per share) for this purpose at a cost of
approximately $4 million. During the 13-weeks ended April 28, 2004, we
issued 14,952 shares of restricted stock; see Note 9 -- Stock-Based
Compensation. There were 39,216 and 43,749 shares in treasury as of April
28, 2004 and January 28, 2004, respectively.
9. STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the fair value
method. Total stock-based compensation expense for options of approximately
$1 million will be recognized in fiscal 2004.
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" and related interpretations,
which did not require the recognition of expense for the fair value of
stock-based compensation.
In accordance with the disclosure requirements of SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure, an
Amendment of FASB Statement No. 123" the pro forma effects of recognizing
stock-based compensation income on net loss and loss per share had the
Predecessor Company applied the fair value method to stock options granted
by the Predecessor Company, are as follows:
Predecessor Company
-------------------
13-Weeks Ended
(dollars in millions, except per share data) April 30, 2003
-------------------------------------------- --------------
Net loss, as reported $ (862)
Deduct: Total stock-based employee compensation
income determined under the fair value-based
method for all awards, net of related tax effects 38
----------------
Pro forma net loss $ (824)
===============
Basic/diluted loss per share:
As reported $ (1.65)
===============
Pro forma $ (1.58)
===============
11
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Pro forma stock-based employee compensation income of $38 million for
the 13-weeks ended April 30, 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.
Upon our emergence from Chapter 11, all outstanding stock options of
the Predecessor Company were cancelled in accordance with the Plan of
Reorganization.
During the first quarter of fiscal 2004, we issued 14,952 shares of
restricted stock at a grant price of $33.44. We accounted for this
restricted stock grant as a fixed award, and recorded deferred employee
compensation in Capital in excess of par value. The deferred employee
compensation is being amortized to compensation expense on a straight-line
basis over the vesting period of three years.
10. REAL ESTATE TRANSACTIONS INCLUDING PROPERTY HELD FOR SALE
Property held for sale was $50 million, $56 million and $160 million as
of April 28, 2004, January 28, 2004 and April 30, 2003, respectively, and
is included within Other current assets in our Unaudited Condensed
Consolidated Balance Sheets. During the 13-weeks ended April 28, 2004, we
sold $2 million of these assets for their book value.
The Company also sold certain other assets, resulting in a net gain of
$32 million for the 13-weeks ended April 28, 2004. Included within this
gain was $12 million related to the sale of our corporate airplanes, $17
million related to the sale of the Kmart Trinidad subsidiary and its
associated property and $3 million related to various other asset sales.
During this same time period, the Company acquired eleven previously leased
properties for $33 million.
11. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) represents net income or loss, adjusted for
the effect of other items that are recorded directly to shareholders'
equity. For the 13-weeks ended April 28, 2004, we recorded an adjustment to
shareholders' equity in accordance with SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," of $1 million to reduce
the value of our investment in certain available-for-sale equity securities
to current market value. For the 13-weeks ended April 30, 2003,
comprehensive loss included a minimum pension liability adjustment of $94
million.
12. INVESTMENTS IN AFFILIATED RETAIL COMPANIES
Kmart footwear departments are operated under a license agreement with
certain Meldisco subsidiaries of Footstar, Inc. ("FTS"), substantially all
of which are 49% owned by Kmart and 51% owned by FTS. On March 2, 2004, FTS
and its direct and indirect subsidiaries, including all Meldisco
subsidiaries, filed for Chapter 11 protection in the United States
Bankruptcy Court for the Southern District of New York. FTS continues to
operate its businesses and manage its properties as debtors-in-possession.
Given the profitability of the Meldisco subsidiaries with which we do
business, and the likelihood of future receipts of the amounts due from
those Meldisco subsidiaries, no valuation reserve has been established for
amounts due to us from FTS.
On May 7, 2004, FTS sold 353 of its Footaction stores to Foot Locker,
Inc. for $225 million. Following the sale of the Footaction stores, FTS
will consist primarily of the Meldisco business.
We have been advised that FTS will be restating its financial
statements for certain prior periods. As a result, we have not received
final financial statements for fiscal 2002, 2003 or the first quarter of
fiscal 2004 for the Meldisco subsidiaries with which we do business at the
time of our filing of this Quarterly Report on Form 10-Q. We received
preliminary financial statements from FTS which we believe provide a
reliable basis to estimate equity income as recognized in all periods
presented in our Unaudited Condensed Consolidated Statements of Operations.
For the 13-weeks ended April 28, 2004 and April 30, 2003, those Meldisco
subsidiaries had net sales at our footwear departments of $186 million and
$246 million, respectively. For the 13-weeks ended April 28, 2004 and April
30, 2003, our equity income in those Meldisco subsidiaries was $3 million
and $7 million, respectively. Although there can be no assurance until FTS
restates its financial statements, at this time, we do not expect the
restatement to have a material effect on our equity income or other fees
earned from the Meldisco subsidiaries.
12
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
13. DISCONTINUED OPERATIONS
During the first quarter of fiscal 2003, the Predecessor Company closed
316 stores, of which 66 stores met the criteria to be accounted for as
discontinued operations. The Company applied the provisions of SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
which 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 table below sets forth the components of the net
loss associated with the discontinued operations for the 13-weeks ended
April 30, 2003.
Predecessor Company
-------------------
13-Weeks Ended
(dollars in millions) April 30, 2003
--------------------- -------------------
Sales $ 232
Cost of sales, buying and occupancy 150
-----------------
Gross margin 82
Selling, general and administrative expenses 43
Restructurings, impairments and other charges 5
Reorganization items, net 44
-----------------
Discontinued operations, net of tax $ (10)
=================
14. 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, the Predecessor Company instituted certain
restructuring actions to improve operations and executed significant
inventory liquidations as a result of the stores closed under Chapter 11
proceedings. The effects of these actions on the 13-weeks ended April 30,
2003 are summarized below.
Corporate Cost Reduction Initiatives
During fiscal 2002 and the 13-weeks ended April 30, 2003, the
Predecessor Company eliminated approximately 950 positions with an initial
charge of $50 million recorded in fiscal 2002. The Predecessor Company
reduced its reserve for such corporate cost reductions by $10 million in
the 13-weeks ended April 30, 2003, as a result of a change in the estimated
expenses. This reduction is included in Restructuring, impairment and other
charges in the Unaudited Condensed Consolidated Statements of Operations.
Accelerated Depreciation
The Predecessor Company recorded charges of $52 million during the
13-weeks ended April 30, 2003 for accelerated depreciation on unimpaired
assets to be disposed of following the 316 store closings. Of the $52
million recorded, $47 million is included in Restructurings, impairments
and other charges and $5 million is included in Discontinued operations in
the Unaudited Condensed Consolidated Statements of Operations.
Reserve Activity
As part of Fresh-Start accounting, reserves established in connection
with certain restructurings were discharged as of April 30, 2003 in
accordance with the Plan of Reorganization. See Note 2 -- Emergence from
Chapter 11 Bankruptcy Protection and Fresh-Start Accounting for a detailed
discussion of the discharge of Liabilities subject to compromise under the
Plan of Reorganization.
13
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Restructuring reserves related to the fiscal 2002 employee severance
program were assumed by the Successor Company. Payments made against the
reserve were $1 million for the 13-weeks ended April 28, 2004. In addition,
we recorded non-cash reductions of $2 million to the reserve during the
first quarter of fiscal 2004. As of April 28, 2004, January 28, 2004 and
April 30, 2003, the liability for the fiscal 2002 employee severance
program was $1 million, $4 million and $36 million, respectively.
15. REORGANIZATION ITEMS, NET
Reorganization items represent amounts the Predecessor Company incurred
as a result of its Chapter 11 reorganization, and are presented separately
in the Unaudited Condensed Consolidated Statements of Operations. For the
13-weeks ended April 30, 2003, the following have been recorded:
Predecessor Company
-------------------
13-Weeks Ended
(dollars in millions) April 30, 2003
--------------------- --------------
Gain on extinguishment of debt $ (5,642)
Revaluation of assets and liabilities 5,642
Fleming settlement 385
Estimated claims for rejected executory contracts 200
2003 store closings 158
Other 26
---------------
Reorganization items, net $ 769
===============
The following paragraphs provide additional information relating to
costs that were recorded in Reorganization items, net in the Unaudited
Condensed Consolidated Statement of Operations for the 13-weeks ended April
30, 2003.
Gain on extinguishment of debt/Revaluation of assets and liabilities
See Note 2 -- Emergence from Chapter 11 Bankruptcy Protection and
Fresh-Start Accounting for a discussion on the extinguishment of debt and
the revaluation of assets and liabilities.
Fleming settlement
On February 3, 2003, the Predecessor Company announced the termination
of the supply relationship with Fleming Companies, Inc. ("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. The Predecessor Company and
Fleming came to an agreement on a settlement of Fleming's claims, and on
March 27, 2003, the Court approved the settlement of all claims asserted by
Fleming. Under the settlement, the Predecessor Company paid Fleming $15
million of Fleming's net post-petition administrative claim, which exceeded
$30 million. Additionally, Fleming's general unsecured claim was reduced
from approximately $1.5 billion to $385 million, which was recorded in the
first quarter of fiscal 2003.
Estimated claims for rejected executory contracts
For the 13-weeks ended April 30, 2003, the Predecessor Company recorded
expense of $200 million 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. On April 30,
2003, upon adoption of Fresh-Start accounting, these liabilities were
discharged in accordance with the Plan of Reorganization; see Note 2 --
Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting.
2003 store closings
As a result of the decision to close the 316 stores, the Predecessor
Company recorded a charge of $214 million in the first quarter of fiscal
2003 for lease terminations and other costs, of which $56 million is
included in Discontinued operations and the remaining $158 million is
included in Reorganization items, net in the Unaudited Condensed
Consolidated Statements of Operations.
14
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Other reorganization items
For the 13-weeks ended April 30, 2003, the Predecessor Company recorded
professional fees of $43 million, employee costs of $66 million relating to
the Key Executive Retention Program, a gain of $17 million for the sale of
pharmacy lists, income of $65 million for lease auction proceeds related to
the 2003 and 2002 closed stores, a gain of $15 million for the settlement
of pre-petition liabilities and net expenses of $14 million for other
miscellaneous reorganization items.
16. COMMITMENTS AND CONTINGENCIES
On February 11, 2004, the Company filed a suit in the Bankruptcy Court
for the Northern District of Illinois (the "Bankruptcy Court") against MSO
IP Holdings, Inc. ("MSO"), a subsidiary of Martha Stewart Living Omnimedia,
Inc., pertaining to the License Agreement between MSO and Kmart Corporation
(the "Agreement"). The Agreement was assumed by the Company as part of the
Chapter 11 proceedings. The parties sought interpretation of the royalty
structure of the Agreement. As a result of a settlement the Company reached
with MSO, the Company dismissed the suit with prejudice on April 23, 2004.
The settlement amends several terms of the Agreement, including extending
the Agreement two years, through 2009; expanding the scope of the Agreement
to include several new product categories; eliminating the product category
minimum guarantee; reducing the aggregate minimum guarantee in future
years; and making certain other adjustments.
One of our past providers of surety bonds, Fireman's Fund Insurance
Company ("Fireman's Fund"), elected not to participate in the continuation
of our surety program during the pendency of the Predecessor Company's
bankruptcy case. Fireman's Fund has now filed a motion with the Bankruptcy
Court seeking (i) recovery of $34 million that Fireman's Fund alleges it
has paid pursuant to pre-petition surety bonds it issued with regard to the
Predecessor Company's workers' compensation insurance programs, and (ii) an
order obligating us to make all payments of Fireman's Fund's future
obligations under the bonds, which Fireman's Fund contends could be in
excess of $35 million. We have filed an opposition to the motion
contending, among other things, that Fireman's Fund's claim is an unsecured
pre-petition claim that was resolved under the Plan of Reorganization that
was approved by the Bankruptcy Court, and therefore Fireman's Fund has the
same rights as any other general unsecured creditor under that Plan. A
hearing on the motion has been tentatively scheduled for June 15, 2004.
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 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, we 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 Unaudited
Condensed Balance Sheet as of April 28, 2004 only reflects potential losses
for which the Successor Company may have ultimate responsibility.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
Part I, Item 2 of this report should be read in conjunction with Part
II, Item 7 of our Annual Report on Form 10-K for the year ended January 28,
2004. The information contained herein is not a comprehensive discussion and
analysis of the financial condition and results of operations of the Company,
but rather an update of the previous disclosures.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-Q, as well as other statements or reports made by or on
behalf of Kmart, which address activities, events or developments that we expect
or anticipate may occur in the future are 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. Such forward-looking statements are based upon assumptions
concerning future conditions that may ultimately prove to be inaccurate and
involve risks, uncertainties and factors that could cause actual results to
differ materially from any anticipated 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, factors relating to Kmart's internal operations and the external
environment in which it operates; Kmart's ability to successfully implement
business strategies and otherwise fund and execute planned changes in various
aspects of the business; marketplace demand for the products of Kmart's key
brand partners, as well as the engagement of appropriate new brand partners;
changes in consumer spending and Kmart's ability to anticipate buying patterns
and implement appropriate inventory strategies; Kmart's ability to reverse its
negative same-store sales trend; competitive pressures and other third party
actions, including pressures from pricing and other promotional activities of
competitors, as well as new competitive store openings; the resolution of
allowed claims for which we are obligated to pay cash under the Plan of
Reorganization; Kmart's ability to properly monitor its inventory needs in order
to timely acquire desired goods in appropriate quantities and/or fulfill labor
needs at planned costs; Kmart's ability to attract and retain customers; Kmart's
ability to maintain normal terms with vendors and service providers; Kmart's
ability to maintain contracts, including leases, that are critical to its
operations; Kmart's ability to develop a market niche; regulatory and legal
developments; general economic conditions; weather conditions, including those
which affect buying patterns of Kmart's customers; other factors affecting
business beyond Kmart's control; and Kmart's ability to attract, motivate and/or
retain key executives and associates. Kmart undertakes no obligation to release
publicly the results of any revisions to these forward-looking statements to
reflect events or circumstances after the date such statements were made.
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.
RESULTS OF OPERATIONS
Due to the application of Fresh-Start accounting upon our emergence
from bankruptcy, the reported historical financial statements of the Predecessor
Company for periods prior to May 1, 2003 generally are not comparable to those
of the Successor Company.
13-WEEKS ENDED APRIL 28, 2004 COMPARED TO 13-WEEKS ENDED APRIL 30, 2003
Same-store sales and total sales decreased 12.9% and 25.3%,
respectively, for the 13-weeks ended April 28, 2004 as compared to the 13-weeks
ended April 30, 2003. Same-store sales include sales of all open stores that
have been open for more than 13 full months. The decrease in same-store sales is
due primarily to several Company-wide promotional events occurring in the first
quarter of fiscal 2003 along with a reduction in advertising, including the
frequency of mid-week circulars in the current year. The decrease in total sales
is attributable to the decrease in same-store sales and the closure of 316
stores in the first quarter of fiscal 2003.
Gross margin decreased $282 million to $1.14 billion, for the 13-weeks
ended April 28, 2004, from $1.42 billion for the 13-weeks ended April 30, 2003.
Gross margin, as a percentage of sales, increased to 24.6% for the 13-weeks
ended April 28, 2004, from 23.0% for the 13-weeks ended April 30, 2003.
Favorably affecting the gross margin rate were fewer clearance markdowns and
reduced depreciation as a result of the write-off of long-lived assets in
conjunction with the application of Fresh-Start accounting.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-(CONTINUED)
Selling, General and Administrative Expenses ("SG&A") decreased $417
million to $1.0 billion, or 21.8% of sales for the 13-weeks ended April 28,
2004, from $1.42 billion, or 23.0% of sales, for the 13-weeks ended April 30,
2003. The decrease in SG&A resulted from reduced payroll and related expenses in
our stores during the current quarter, as well as the effect of store closings
and corporate cost reduction initiatives implemented in the first quarter of
fiscal 2003. Also affecting the decline was a reduction in advertising expenses
and lower depreciation as a result of the write-off of long-lived assets in
conjunction with the application of Fresh-Start accounting.
Operating income for the 13-weeks ended April 28, 2004 was $165
million, or 3.6% of sales, as compared to a loss of $39 million, or (0.6%) of
sales, for the same period in the prior year. The improvement was primarily due
to the decrease in SG&A and the improvement in our gross margin rate, as
discussed above, partially offset by an overall decline in gross margin dollars
due to our reduced store base. Operating income was also affected by net gains
on sales of assets of $32 million in the current quarter and Restructuring,
impairment and other charges of $37 million in the first quarter of fiscal 2003.
Interest expense, net for the 13-weeks ended April 28, 2004 and April
30, 2003 was $26 million and $57 million, respectively. During the 13-weeks
ended April 28, 2004, $12 million of interest expense was recorded for the
accretion of obligations recorded at net present value. Included in interest
expense for the 13-weeks ended April 30, 2003 was $37 million of amortization of
debt issuance costs associated with the Predecessor Company's Court-approved $2
billion debtor-in-possession financing facility. Interest at the stated
contractual amount on unsecured debt that was not charged to earnings for the
13-weeks ended April 30, 2003 was $67 million. Interest expense is net of
interest income of $5 million and $1 million for the 13-weeks ended April 28,
2004 and April 30, 2003, respectively.
Effective income tax rate was 37.6% and (0.7%) for the 13-weeks ended
April 28, 2004 and April 30, 2003, respectively, see Note 7 -- Income Taxes.
LIQUIDITY AND FINANCIAL CONDITION
Our cash needs are satisfied through working capital generated by our
business and availability under our Credit 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 emergence from Chapter 11, most of our
vendors continue to support us and have resumed normal trade terms. We continue
to focus on maintaining our favorable vendor relationships and do not expect to
experience any significant disruption of terms with our vendors. Should we
experience a significant disruption of terms with our vendors, sales fail to
improve, the Credit 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.
In the normal course of business, the Company considers opportunities
to purchase leased operating properties, as well as offers to sell owned or if
leased, assign operating and non-operating properties. These transactions may,
individually or in the aggregate, result in material proceeds or outlays of
cash. In addition, the Company reviews leases that will expire in the short-term
in order to determine the appropriate action to take in respect with the lease.
CREDIT FACILITY
Our Credit Facility is a revolving $1.5 billion credit facility with an
$800 million letter of credit sub-limit under which Kmart Corporation is the
borrower. Availability under the Credit Facility is subject to an inventory
borrowing base formula. The Credit 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 Credit Facility is secured primarily by first liens
on inventory, the proceeds thereof and certain related assets of Kmart
Corporation and the guarantors.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-(CONTINUED)
Borrowings under the Credit Facility currently bear interest at either
(i) the Prime rate plus 1.5% per annum or (ii) the LIBOR rate plus 2.5% per
annum, at our discretion, and utilization of the letter of credit sub-facility
currently bears interest at 1.25% to 2.50% per annum. These interest rate
margins may be adjusted after July 31, 2004 depending on our EBITDA levels. In
addition, we are required to pay a fee based on the unutilized commitment under
the Credit Facility equal to 0.50% per annum until July 31, 2004, and 0.375% to
0.50% thereafter, depending on our EBITDA levels. The Credit Facility gives the
Company the ability to repurchase up to $500 million of the Company's Common
Stock, depending on our EBITDA levels and subject to the approval of the
Company's Board of Directors.
As of April 28, 2004, we had utilized $356 million of the Credit
Facility for letters of credit issued for ongoing import purchasing operations,
and contractual and regulatory purposes, including letters of credit utilized as
collateral to support our self-insurance programs. During the first quarter of
fiscal 2004, we replaced letters of credit used as collateral for certain
programs with cash collateral to reduce utilization fees on our letters of
credit. We continue to classify the cash collateral in Cash and cash equivalents
due to our ability to convert the cash to letters of credit at any time at our
discretion. As of April 28, 2004, $71 million of cash was posted as collateral.
Total availability under the Credit Facility as of April 28, 2004 was
$1.144 billion.
The Credit Facility financial covenants include a requirement that we
maintain certain availability minimums, and failure to do so triggers additional
required minimum levels of EBITDA. The Credit 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. As of April 28, 2004 and in all periods since our emergence
from Chapter 11, we have been in compliance with all Credit Facility covenants.
CASH FLOWS
Net cash provided by operating activities was $142 million for the
13-weeks ended April 28, 2004 compared to $576 million for the 13-weeks ended
April 30, 2003. The Company's net income drove the operating cash flow for the
first quarter of fiscal 2004. Favorable working capital changes also impacted
cash flow from operations during this period. For the 13-weeks ended April 30,
2003, a decrease in inventory due to liquidation sales in conjunction with store
closings and improved inventory management, partially offset by a decrease in
accounts payable, had a favorable effect on operating cash flow.
For the 13-weeks ended April 28, 2004 and the 13-weeks ended April 30,
2003, investing activities of the Company generated $11 million and $60 million,
respectively. Proceeds of $66 million in the current period primarily related to
the sale of $38 million of non-core assets and were partially offset by capital
expenditures of $55 million for the purchase of 11 previously leased store
locations and store maintenance. In the prior year period, proceeds of $64
million were received from the sale of four owned Kmart store locations and the
sale of furniture and fixtures from closed store locations.
Payments on capital leases and mortgage obligations of $13 million and
$17 million were the primary uses of cash for financing activities for the
13-weeks ended April 28, 2004 and the 13-weeks ended April 30, 2003,
respectively.
In fiscal 2003, the Company's Board of Directors approved the
repurchase of up to $10 million of the Company's outstanding stock for the
purpose of providing restricted stock grants to certain employees. As of April
28, 2004, we had repurchased approximately $4 million of Common Stock in
relation to this program.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-(CONTINUED)
FUTURE LIQUIDITY ITEMS
PENSION PLAN
Prior to 1996, the Predecessor Company 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. No contributions have been made to the plan for the past
eight years.
Contributions to the plans were not required for the 13-weeks ended
April 28, 2004 or April 30, 2003. The estimated contribution for fiscal 2004 is
$11 million.
Pension expense was $4 million and $21 million for the 13-weeks ended
April 28, 2004 and April 30, 2003, respectively.
OTHER
In light of the Company's liquidity position and subject to compliance
with our Credit Facility, we may consider various uses of cash and other
resources in the future which could include investments in various forms of
securities, share repurchases, the acquisition of related or unrelated
businesses, and the payment of dividends.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our financial statements, certain of our accounting
policies require considerable judgment to select the appropriate assumptions to
calculate financial estimates. By their nature, these estimates are complex and
subject to an inherent degree of uncertainty. We base our estimates on
historical experience, terms of existing contracts, our evaluation of trends and
other assumptions that we believe to be reasonable under the circumstances. We
continually evaluate the information used to make these estimates as our
business and the economic environment change.
Management believes the current assumptions and other considerations
used to estimate amounts reflected in our financial statements are appropriate.
However, if actual experience differs from the assumptions and other
considerations used in estimating amounts, the resulting changes could have a
material adverse effect on our consolidated results of operations, and in
certain situations, could have a material adverse effect on our financial
condition. We have disclosed our critical accounting policies and estimates,
which include inventory valuation, self insurance reserves, pension accounting
and deferred taxes, in our Annual Report on Form 10-K for the year ended January
28, 2004.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
For a comprehensive discussion see Note 3 -- New Accounting
Pronouncements.
DISCONTINUED OPERATIONS
During the first quarter of fiscal 2003, the Predecessor Company closed
316 stores. Of the total store closings, 66 met the criteria for discontinued
operations. For a comprehensive discussion see Note 13 -- Discontinued
Operations.
For the 13-weeks ended April 30, 2003, 250 of the 316 stores closed
were accounted for in continuing operations as they did not meet the criteria
for discontinued operations. Total sales, gross margin and SG&A for these 250
stores were $854 million, $301 million and $146 million, respectively.
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. For the
13-weeks ended April 30, 2003, the Predecessor Company recorded special charges
of $42 million. For a comprehensive discussion see Note 14 -- Special Charges.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-(CONTINUED)
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
as required by SOP 90-7. The Predecessor Company recorded $813 million for
the 13-weeks ended April 30, 2003 for reorganization items.
For a comprehensive discussion see Note 15 -- Reorganization Items, net.
OTHER MATTERS
In March 2002, the Court issued an order providing for the continuation
of the Predecessor Company's existing surety bond coverage, which permitted the
Predecessor Company to self-insure its workers' compensation programs in various
states. Discussions have been ongoing with the issuers of pre-petition surety
bonds regarding the further continuation of the bonds. To date, we have reached
agreements with Liberty Mutual Insurance Company, historically the Predecessor
Company's largest provider of surety bonds, as well as RLI Insurance, on the
terms and conditions of a continuation of their respective bonds. In addition,
we currently have agreements in principle with Westchester Fire Insurance
Company and with XL Insurance, the remaining issuers of pre-petition surety
bonds that participated in the continuation of our surety program during the
pendency of the Predecessor Company's bankruptcy case. If such negotiations
prove unsuccessful and the applicable surety bonds were to be cancelled, we
could lose our self-insured status in the states covered by those surety bonds
and be required to pursue alternative workers' compensation insurance programs
in the affected states. 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) participating in state-assigned risk
and/or state funded insurance programs. We do not expect that any such
alternative programs would result in additional costs having a material adverse
effect on our financial position or results of operations.
On June 4, 2003, Martha Stewart was indicted in the United States
District Court of the Southern District of New York. She was convicted on March
5, 2004 of conspiracy, obstruction of justice and two counts of making false
statements to federal investigators. Ms. Stewart filed a motion for a new trial,
which was denied on May 5, 2004. Sentencing in the matter is currently scheduled
for June 17, 2004. The Martha Stewart Everyday brand is considered a distinctive
brand for Kmart and we currently sell Martha Stewart Everyday home, garden,
colors, baby, kitchen, keeping and decorating product lines, along with candles
and accessories. Ms. Stewart has resigned her positions as Chairman, Chief
Executive Officer and Chief Creative Officer of Martha Stewart Living Omnimedia,
Inc., and her seat on the company's Board of Directors. She has assumed the
position of Founding Editorial Director. To date, we have not experienced any
significant adverse impact from this matter on the sales of Martha Stewart
Everyday brand products. Although product sales have not been significantly
affected by past events, the Company is not able to determine the potential
effects that these events may have on the future sales of its Martha Stewart
Everyday brand products.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At April 28, 2004, 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 Credit
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
Under the supervision of, and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as
of the end of the period covered by this report (the "Evaluation Date"). Based
on this evaluation, our principal executive officer and principal financial
officer concluded that, as of the Evaluation Date, our disclosure controls and
procedures were effective in alerting them on a timely basis to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in the Company's periodic filings under the Exchange
Act.
No changes in the Company's internal controls have come to management's
attention that occurred during the Company's last fiscal quarter that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 16 of the Notes to Unaudited Condensed Consolidated Financial
Statements for information concerning legal proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 31.1 Chief Executive Officer Certification pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as Amended
Exhibit 31.2 Chief Financial Officer Certification pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as Amended
Exhibit 32.1 Certifications pursuant to 18 U.S.C. Section 1350, as
adopted 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 8, 2004, Kmart Holding Corporation furnished a Current
Report on Form 8-K to announce the hiring of a Senior Vice
President.
2. On March 18, 2004, Kmart Holding Corporation filed a Current
Report on Form 8-K to report the fourth quarter 2004 operating
results.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
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: MAY 17, 2004
Kmart Holding Corporation
-----------------------------
(Registrant)
By: /s/ Julian C. Day
-----------------------------
Julian C. Day
Chief Executive Officer
(Principal Executive Officer)
/s/ James D. Donlon, III
-----------------------------
James D. Donlon, III
Chief Financial Officer
(Principal Financial Officer)
/s/ Richard J. Noechel
-----------------------------
Richard J. Noechel
Vice President and Controller
(Principal Accounting Officer)
23
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
Exhibit 31.1 Certification of Chief Executive Officer pursuant
to Section 302
Exhibit 31.2 Certification of Chief Financial Officer pursuant
to Section 302
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002