UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year ended January 28, 2004
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
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
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE SECURITIES EXCHANGE ACT
OF 1934:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE SECURITIES EXCHANGE ACT
OF 1934:
Common Stock, $0.01 par value
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K/A or any
amendment to this Form 10-K/A. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) YES [X] NO [ ]
The aggregate market value of Common Stock held by non-affiliates of the
Registrant on July 30, 2003 was $1,001,020,122.
As of March 15, 2004, 89,633,760 shares of Common Stock of the Registrant were
outstanding.
Indicate by check mark whether the Registrant has filed all documents and
reports to be filed by Section 12, 13 of 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 [ ]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Registrant's Annual Meeting
of Shareholders to be held on May 25, 2004 have been incorporated by reference
into Part III of this Annual Report on Form 10-K/A.
1
EXPLANATORY NOTE
The purpose of this Amendment No. 1 to Annual Report on Form 10-K/A
is to restate the audited financial statements of Kmart Holding Corporation and
its subsidiaries (the "Company," "we" or "our") for the year ended January 28,
2004, filed with the Securities and Exchange Commission ("SEC") on Form 10-K on
March 18, 2004.
In conjunction with their review of Sears Holdings Corporation's
registration statement on Form S-4 in connection with the pending merger between
Kmart and Sears, Roebuck and Company ("Sears"), the SEC reviewed Kmart's Form
10-K for the year ended January 28, 2004. Upon shareholder approvals of the
merger transaction, Sears Holdings Corporation will be a new retail company
resulting from the merger of Kmart and Sears. As a result of this review, it has
been determined that the Company did not reflect an embedded beneficial
conversion feature of the convertible note issued upon emergence from
bankruptcy.
The accounting treatment of the note is based on the determination
of a commitment date as defined by Emerging Issues Task Force No. 00-27
"Application of Issue No. 98-5 to Certain Convertible Instruments" ("EITF
00-27"). A commitment date occurs when, amongst other things, an agreement is
binding on both parties and the agreement specifies all significant terms,
including the quantity to be exchanged. The Company believed that it had met
these qualifications as of the initial agreement date and accounted for the note
accordingly. The SEC believes that at the time of the agreement these conditions
had not been met, and therefore a commitment date did not occur until issuance
of the note. After discussions with the SEC, the Company has agreed to restate
its financial statements. This amendment reflects a May 6, 2003 commitment date,
resulting in a portion of the note being allocated to stockholders' equity, as
required by EITF 00-27. The restatement resulted in a non-cash charge to
interest expense of $22 million due to the amortization of the debt discount
during the 39-weeks ended January 28, 2004.
See Note 4 to the Consolidated Financial Statements for further
explanation and a discussion of the impact to the Company's net income and
earnings per share.
The Items of our Annual Report on Form 10-K for the fiscal year
ended January 28, 2004 which are amended and restated herein are:
1. Item 6 - Selected Financial Data
2. Item 7 - Management's Discussion and Analysis
3. Item 8 - Financial Statements and Supplementary Data
4. Item 9A - Controls and Procedures
Except as otherwise expressly noted herein, this Amendment No. 1 to
Annual Report on Form 10-K/A does not reflect events occurring after the March
18, 2004 filing of our Annual Report on Form 10-K in any way, except those
required to reflect the effects of this restatement of our financial statements
for the periods presented or as deemed necessary in connection with the
completion of restated financial statements.
The remaining Items contained within this Amendment No. 1 to our
Annual Report on Form 10-K/A consist of all other Items originally contained in
our Annual Report on Form 10-K for the fiscal year ended January 28, 2004 in the
form filed with the SEC on March 18, 2004. These remaining Items are not amended
hereby, but are included for the convenience of the reader. In order to preserve
the nature and character of the disclosures set forth in such Items as
originally filed, except as expressly noted herein, this report continues to
speak as of the date of the original filing, and we have not updated the
disclosures in this report to speak as of a later date. The Company is also
filing amended 10-Qs for the three periods subsequent to the original date of
this filing. These amended 10-Qs speak to events that occurred after the date of
this filing and should be read in conjunction with this amended 10-K.
While this report primarily relates to the historical periods covered, events
may have taken place since the original filing that might have been reflected in
this report if they had taken place prior to the original filing.
2
PART I
Item 1. Business
HISTORY
Although Kmart Holding Corporation ("Kmart," "we," "us," "our," the
"Company" or the "Successor Company") was incorporated in Delaware in April
2003, the businesses conducted by our predecessors began in 1899. Kmart
Corporation (the "Predecessor Company") was incorporated under the laws of the
State of Michigan on March 9, 1916, as the successor to the business developed
by its founder, S.S. Kresge, who opened his first store in 1899. Kresge was the
first retailer to launch a newspaper advertising program to entice shoppers to
its stores. After operating Kresge department stores for over 45 years, our
store program commenced with the opening of the first Kmart store in March 1962.
In 1977, Kresge Corporation officially changed its name to Kmart Corporation. In
1991, Kmart opened the first Kmart Supercenter in Medina, Ohio, offering a
full-service grocery along with general merchandise twenty-four hours a day,
seven days a week.
We are the nation's third largest discount retailer. Our principal
executive offices are located at 3100 West Big Beaver Road, Troy, Michigan
48084.
On January 22, 2002, the Predecessor Company and 37 of its U.S.
subsidiaries (collectively, "Debtors") filed voluntary petitions for
reorganization under Chapter 11 of the federal bankruptcy laws ("Chapter 11").
The Debtors decided to seek bankruptcy reorganization based upon a rapid decline
in their liquidity resulting from below-plan sales and earnings performance in
the fourth quarter of fiscal 2001, the evaporation of the surety bond market, an
erosion of supplier confidence, intense competition, unsuccessful sales and
marketing initiatives, the continuing recession and capital market volatility.
The Predecessor Company utilized Chapter 11 to strengthen its balance sheet and
reduce debt, focus its store portfolio on the most productive locations and
terminate leases for closed stores, develop a more efficient organization and
lower overall operating costs.
Kmart emerged from Chapter 11 on May 6, 2003 (the "Effective Date"),
pursuant to the terms of the Amended Joint Plan of Reorganization (the "Plan of
Reorganization"), and related amended Disclosure Statement, which received
formal endorsement of the statutory creditors' committee and, as modified, was
confirmed by the United States Bankruptcy Court of the Northern District of
Illinois (the "Court") on April 23, 2003.
Pursuant to our Plan of Reorganization, we:
- Paid secured claim holders a 100% cash recovery;
- Issued shares of our newly-issued common stock and cash
payments totaling $243 million to certain of our
pre-petition creditors;
- Issued shares of our newly-issued common stock to
certain of our pre-petition note holders, trade vendors
and landlords; and
- Compromised or cancelled many of our pre-petition
liabilities.
Our ability to operate successfully now that we have emerged from
Chapter 11 is dependent on many factors, including our ability to:
- Execute our business plan, sustain profitability and
otherwise offset the negative effects that the Chapter
11 proceedings have had on our business, including the
loss of customer traffic;
- Operate within the framework of our $1.5 billion credit
agreement, as amended (the "Credit Facility"); and
- Provide perceptibly better service to our customers and
differentiate our merchandise assortment in order to
attract additional customers from our competitors.
OPERATIONS
We operate in the general merchandise retailing industry through
1,511 Kmart discount stores and Supercenters with locations in 49 states, Puerto
Rico, the U.S. Virgin Islands and Guam as of January 28, 2004, and through our
e-commerce shopping site, www.kmart.com. Our general merchandise retail
operations are located in 286 of the 331 Metropolitan Statistical Areas in the
United States. Kmart stores are generally one-floor, free-standing units ranging
in size from 40,000 to 194,000 square feet with an average size of 95,000 square
feet.
Our 60 Kmart Supercenters combine a full grocery, deli, and bakery
along with the general merchandise selection of a Kmart discount store.
3
Our fiscal year ends on the last Wednesday in January.
STRATEGY
Following the Company's recent emergence from Chapter 11, we have
primarily focused on building a professional senior management team and
establishing the fundamentals we need to run an efficient and effective retail
organization. In 2004, our new senior management team will continue the active
management of such process improvement initiatives, focusing on the generation
of profitable sales, controlling costs and streamlining overhead, increasing
asset productivity and improving customer service.
Kmart will continue to improve the customer store experience,
providing quality products at attractive pricing, and enhancing our service
culture. By improving our logistics and allocation process, we will be able to
allow stores to provide their particular customers with a more customized
merchandise offering. Kmart is already an important part of its communities,
with over $23 billion in sales and over 2 million customer visits per day, and
intends to build on its existing customer relationships, attract customers back
who left during bankruptcy, and offer an experience that will bring new
customers to Kmart. We will build on a historical core competency in designing
and sourcing apparel. We also believe that focusing our merchandising and
marketing approach on quality name brands will further differentiate us from our
competition, build customer loyalty and increase the frequency of customer
visits. Our current brands include Martha Stewart Everyday, JOE BOXER, Jaclyn
Smith, Sesame Street and Thalia Sodi, among others.
We believe that the execution of the strategies noted above will
provide our current customers with an improved shopping experience, allow us to
win back customers we have disappointed in the past and help sustain
profitability.
We do not currently plan to open new stores in 2004 as we focus on
these strategies.
COMPETITION
Our business is conducted under highly competitive conditions in the
discount store retail market. We have several major competitors on a national
level, including Wal-Mart, Target, Sears, Kohl's and J.C. Penney, and many
competitors on a local and regional level along with Internet and catalog
businesses which handle similar lines of merchandise. Success in this
competitive market is based on factors such as price, quality, service, product
assortment and convenience. We have experienced a decrease in market share in
part due to our store closings and the aggressive growth of our major
competitors. We expect that this trend will continue due to our limited growth
plans and to the projected store openings of our major competitors.
DISTRIBUTION
We have 16 active distribution centers as of January 28, 2004.
Approximately 66% of our merchandise is received directly at these distribution
centers which then ship the product to individual stores up to five times a
week. The remaining merchandise is shipped by our vendors or their distributors
directly to our stores.
SEASONALITY
Due to the seasonal nature of the general merchandise retail
industry, where merchandise sales and cash flows from operations are
historically higher in the fourth calendar quarter than any other period, a
disproportionate amount of revenues and operating cash flows are generated in
the fourth quarter. In preparation for the fourth quarter holiday season, we
significantly increase our merchandise inventories, which traditionally have
been financed by cash flows from operations, bank lines of credit, trade credit
and terms from vendors. Our profitability and cash flows are primarily dependent
upon the large sales volume generated during the fourth quarter of our fiscal
year. Fourth quarter sales represented 28% of same-store sales in fiscal 2003.
EMPLOYEES
As of January 28, 2004, we employed approximately 158,000
associates.
4
OUR WEBSITE AND AVAILABILITY OF SEC REPORTS
Our website address is www.kmartcorp.com. We make available free of
charge through our website our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and all amendments to those reports as
soon as reasonably practicable after such material is electronically filed with
or furnished to the Securities and Exchange Commission.
Item 2. Properties
At January 28, 2004, we operated a total of 1,511 general
merchandise stores located in the United States, Puerto Rico, the U.S. Virgin
Islands and Guam. We lease our store facilities, with the exception of 135
stores that we own. Our store leases are generally for terms of 25 years with
multiple five-year renewal options that allow us the option to extend the life
of the lease up to 50 years beyond the initial non-cancelable term.
We own our headquarters building in Troy, Michigan and lease an
administrative building in Royal Oak, Michigan. We own 3 distribution centers
and lease 13 other distribution centers in the United States with initial terms
of 10 to 30 years and options to renew for additional terms.
A description of our leasing arrangements appears in Note 13 in Item
8 of this Form 10-K/A.
Item 3. Legal Proceedings
We discuss certain legal proceedings pending against the Company in
Part II, and refer you to that discussion for important information concerning
those legal proceedings, including the basis for such action and relief sought.
See Note 22 in Item 8 of this Form 10-K/A for this discussion.
Item 4. Submission of Matters to a Vote of Security Holders
None.
5
PART II
Item 5. Market for Kmart's Common Equity and Related Stockholder Matters
Our common stock is presently being quoted on the NASDAQ National
Market under the ticker symbol KMRT. There were approximately 2,220 shareholders
of record of Kmart Holding Corporation common stock as of March 1, 2004.
The quarterly high and low sales prices for the Predecessor
Company's common stock and the Successor Company's common stock for the two most
recent fiscal years are set forth below:
2003
-------------------------------------------------
Predecessor
Company Successor Company
----------- ----------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- --------- ----------
Common stock price
High $ 0.14 $ 26.99 $ 30.67 $ 32.74
Low $ 0.06 $ 12.85 $ 23.35 $ 23.00
2002
-------------------------------------------------
Predecessor Company
-------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- --------- ----------
Common stock price
High $ 1.78 $ 1.22 $ 0.72 $ 0.71
Low $ 0.89 $ 0.52 $ 0.38 $ 0.10
As of December 19, 2002, the common stock and trust preferred
securities of the Predecessor Company were suspended from trading by the New
York Stock Exchange and the Pacific and Chicago Exchanges, and thereafter,
delisted from such exchanges. For the first quarter of fiscal 2003, the
Predecessor Company stock was quoted on the Pink Sheets Electronic Quotation
Service maintained by the National Quotation Bureau, Inc. Upon emergence from
Chapter 11, all then-outstanding equity securities of the Predecessor Company
were cancelled, and common stock of the Successor Company was issued.
We have not paid dividends on our common stock since our emergence
from Chapter 11.
6
Item 6. Selected Financial Data
The table below summarizes the Successor Company's and Predecessor
Company's recent financial information. The data set forth below should be read
in conjunction with "Management's Discussion and Analysis of Financial
Condition" and the Company's consolidated financial statements and notes
thereto.
As discussed in the Explanatory Note, the audited financial
statements of Kmart as of April 30, 2003, January 28, 2004 and for the 39-week
period ended January 28, 2004 have been restated since their original filing on
Form 10-K on March 18, 2004. Please read the Explanatory Note and also Note 4 in
Item 8 of this Form 10-K/A for additional information about these restatements.
The selected financial data that follows has been adjusted to reflect these
restatements.
Successor
Company Predecessor Company
---------------- ----------------------------------------------------------------
39-Weeks 13-Weeks Fiscal
Ended Ended -----------------------------------------------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) January 28, 2004 April 30, 2003 2002 2001 2000 1999
- -------------------------------------------- ---------------- -------------- ------------ ---------- ------- --------
SUMMARY OF OPERATIONS (AS RESTATED)
Total sales (1) $ 17,072 $ 6,181 $ 29,352 $ 34,180 $35,027 $ 33,960
Comparable sales % (2) (9.5%) (3.2%) (10.1%) (0.1%) 1.1% 4.8%
Income (loss) before interest expense,
reorganization items, income taxes
and discontinued operations (3) 505 (32) (2,277) (2,146) (65) 1,182
Income (loss) before discontinued operations (3) 234 (852) (2,771) (2,377) (256) 557
Discontinued operations - (10) (448) (69) (12) (193)
Net income (loss)(3) 234 (862) (3,219) (2,446) (268) 364
PER COMMON SHARE
Basic:
Continuing (loss) income $ 2.61 $ (1.63) $ (5.47) $ (4.81) $ (0.51) $ 1.13
Discontinued operations $ - $ (0.02) $ (0.89) $ (0.14) $ (0.02) $ (0.39)
Net (loss) income $ 2.61 $ (1.65) $ (6.36) $ (4.95) $ (0.53) $ 0.74
Diluted:(4)
Continuing (loss) income $ 2.51 $ (1.63) $ (5.47) $ (4.81) $ (0.51) $ 1.08
Discontinued operations $ - $ (0.02) $ (0.89) $ (0.14) $ (0.02) $ (0.34)
Net (loss) income $ 2.51 $ (1.65) $ (6.36) $ (4.95) $ (0.53) $ 0.74
Successor Company Predecessor Company
--------------------------- ---------------------------------------------
(AS RESTATED) (AS RESTATED)
Book value per common share $ 24.64 $ 19.45 $ (0.58) $ 6.42 $ 12.09 $ 12.73
FINANCIAL DATA
Total assets $ 6,074 $ 6,660 $ 11,238 $ 14,183 $ 14,815 $ 15,192
Long-term debt(5) 76 59 - 330 2,084 1,759
Long-term capital lease obligations 374 415 623 857 943 1,014
Trust convertible preferred securities - - 646 889 887 986
Capital expenditures (Predecessor Company for the
13-weeks ended April 30, 2003) 108 4 252 1,385 1,089 1,277
Number of Stores 1,511 1,513 1,829 2,114 2,105 2,171
(1) Our fiscal year ends on the last Wednesday in January. Fiscal 2000
consisted of 53 weeks.
(2) Comparable store sales for fiscal 2000 are based on the 52-week period
ended January 24, 2001.
(3) Results include the following non-comparable items: in the 13-weeks ended
April 30, 2003, a $47 million charge for accelerated depreciation on
unimpaired assets to be disposed of following store closings, a $10
million credit as a result of a change in the estimated expenses for the
2002 cost reduction initiatives; in fiscal 2002, $1,019 million for
inventory write-downs in conjunction with accelerated mark-downs due to
store closings, $533 million for asset impairments, $50 million for cost
reduction initiatives, and $33 million for other items; in fiscal 2001,
$827 million for asset impairments, $163 million for supply chain
restructuring, $97 million for the restructuring/impairment of
BlueLight.com, and $23 million for Voluntary Early Retirement
Program/Severance; in fiscal 2000, $712 million for strategic initiatives;
and in fiscal 1999, $11 million to reflect the cumulative effect of a
change in accounting method for layaway sales.
(4) Consistent with the requirements of Statement of Financial Accounting
Standards No. 128, "Earnings per Share," options to purchase common stock,
restricted stock and Trust convertible preferred securities were not
included in the calculation of diluted earnings per share for the 13-week
period ended April, 30, 2003, fiscal years 2002, 2001, and 2000 due to
their anti-dilutive effect. Upon emergence, all then-outstanding equity
securities of the Predecessor Company and the Trust convertible preferred
securities were cancelled.
(5) For fiscal years 2002 and 2001 long-term debt does not include liabilities
classified as subject to compromise.
7
MANAGEMENT DISCUSSION AND ANALYSIS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Item 7. Management's Discussion and Analysis
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-K/A, 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, expressed 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; and 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.
EXECUTIVE SUMMARY
Management Overview
We operate in the general merchandise retailing industry through
1,511 Kmart discount stores and Supercenters with locations in 49 states, Puerto
Rico, the U.S. Virgin Islands and Guam as of January 28, 2004, and through our
e-commerce shopping site, www.kmart.com. Our business is conducted under highly
competitive conditions in the discount store retail market. We compete with
large national chains, local stores and Internet and catalog businesses which
handle similar lines of merchandise. Success in this competitive market is based
on factors such as price, quality, service, product assortment and convenience.
Our general merchandise retail operations are located in 286 of the 331
Metropolitan Statistical Areas in the United States. Kmart stores are generally
one-floor, free-standing units ranging in size from 40,000 to 194,000 square
feet with an average size of 95,000 square feet.
Following the Company's recent emergence from Chapter 11, we have
primarily focused on building a professional senior management team and
establishing the fundamentals we need to run an efficient and effective retail
organization. In 2004, our new senior management team will continue the active
management of such process improvement initiatives, focusing on the generation
of profitable sales, controlling costs and streamlining overhead, increasing
asset productivity and improving customer service.
8
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
Kmart will continue to improve the customer store experience,
providing quality products at attractive pricing, and enhancing our service
culture. By improving our logistics and allocation process, we will be able to
allow stores to provide their particular customers with a more customized
merchandise offering. Kmart is already an important part of its communities,
with over $23 billion in sales and over 2 million customer visits per day, and
intends to build on its existing customer relationships, attract customers back
who left during bankruptcy, and offer an experience that will bring new
customers to Kmart. We will build on a historical core competency in designing
and sourcing apparel. We also believe that focusing our merchandising and
marketing approach on quality name brands will further differentiate us from our
competition, build customer loyalty and increase the frequency of customer
visits. Our current brands include Martha Stewart Everyday, JOE BOXER, Jaclyn
Smith, Sesame Street and Thalia Sodi, among others.
We have identified the following areas as critical to our future
success:
- maintaining our strong liquidity position;
- reversing the negative same-store sales trend;
- sustaining positive cash flow from operations on a
long-term basis;
- operating within the framework of our Credit Facility,
its financial covenants, and our ability to generate
cash flows from operations or seek other sources of
financing;
- obtaining a customer and service driven culture
throughout our organization;
- remerchandising to improve our market basket;
- differentiating ourselves from our competitors by
offering exclusive brands and tailoring merchandise
assortments to serve the unique needs of customers in
local markets; and
- improving relations with our vendors and business
partners.
Emergence from Chapter 11 Bankruptcy Protection
On the May 6, 2003 (the "Effective Date"), Kmart Corporation (the
"Predecessor Company") emerged from Chapter 11, as a subsidiary of a
newly-created holding company, Kmart Holding Corporation ("Kmart," "we," "us,"
"our," the "Company" or the "Successor Company"). The Predecessor Company's
emergence was pursuant to the terms of the Amended Joint Plan of Reorganization
(the "Plan" or "Reorganization") and related amended Disclosure Statement, which
received formal endorsement of the statutory creditors' committee and, as
modified, was confirmed by the United States Bankruptcy Court for the Northern
District of Illinois (the "Court") on April 23, 2003.
The bankruptcy filing on January 22, 2002 was a result of several
factors, which included the rapid decline in the Predecessor Company's liquidity
resulting from below-plan sales and earnings performance in the fourth quarter
of fiscal 2001, the evaporation of the surety bond market, an erosion of
supplier confidence, intense competition, unsuccessful sales and marketing
initiatives, the continuing recession and capital market volatility.
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 pursuant to an
Investment Agreement dated January 24, 2003. The Plan Investors and their
affiliates received approximately 32 million shares of the Successor Company's
newly issued common stock ("Common Stock") in satisfaction of pre-petition
claims they held. We issued 14 million shares of Common Stock to affiliates of
ESL and to Third Avenue, in exchange for $127 million, net of expenses, and in
addition issued a 9%, $60 million principal amount convertible note to
affiliates of ESL, the principal of which is convertible to equity at any time
at the option of the holder (the "Note"). ESL was also granted an option to
purchase, prior to May 6, 2005, 6.6 million new shares of Common Stock at a
price of $13 per share. A portion of that option was assigned to Third Avenue.
Upon applying the criteria of Emerging Issues Task Force Issue No. 00-27,
"Application of Issue No. 98-5 to Certain Convertible Instruments" ("EITF
00-27"), the Company allocated the proceeds received from the Plan Investors,
net of expenses, of $187 million to the Note, Common Stock and stock options
based on their relative fair values. An effective conversion price was then
calculated and used to measure the intrinsic value of the embedded conversion
feature. The resulting discount of $49 million reduced the initial carrying
amount of the Note to $11 million, with a corresponding increase in Capital in
excess of par value. The debt discount was amortized to interest expense over
one year using the effective interest method through December 2003, at which
time the Plan Investors elected to extend the term of the Note an additional two
years through May 6, 2006. The remaining debt discount as of December 2003 is
being recognized over the additional two year term.
ESL and its affiliates beneficially own over 50% of the Common
Stock, including shares received in exchange for pre-petition obligations, as
well as shares obtainable upon exercise of options and conversion of the Note.
Each of the Plan Investors is represented on our Board of Directors.
9
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
In connection with emergence from Chapter 11, 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 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 Annual Report on Form 10-K/A, references to the
13-weeks ended April 30, 2003 and prior fiscal periods refer to the Predecessor
Company.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described more fully in Note
2 to the consolidated financial statements. 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.
Although the use of estimates is pervasive throughout our financial statements,
we consider an accounting estimate to be critical if:
- It requires assumptions to be made about matters that
were highly uncertain at the time the estimate was made,
and
- Changes in the estimate that are reasonably likely to
occur from period to period or different estimates that
could have been selected would have a material impact on
our financial condition, changes in financial condition
or results of operations.
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.
Management has discussed the development and selection of these
critical accounting estimates with the Audit Committee of our Board of Directors
and the Audit Committee has reviewed the disclosure presented below relating to
the selection of these estimates.
In addition, there are other accounting estimates within our
financial statements that require estimation, but are not deemed to be critical.
These include allowances for doubtful accounts receivable, long-lived asset
impairments, legal reserves, and reserves for store closings and other
management actions. Although not significant in recent years, changes in
estimates used in these and other items could have a significant effect on our
consolidated financial statements.
The following is a summary of our most critical estimates.
VALUATION OF INVENTORY
Our inventories are valued at the lower of cost or market determined
primarily using the retail inventory method ("RIM") on a FIFO basis. RIM is an
averaging method that is widely used in the retail industry due to its
practicality. To determine inventory cost under RIM, inventory at its retail
selling value is segregated into groupings of merchandise having similar
characteristics, which are then converted to a cost basis by applying specific
average cost factors for each grouping of merchandise. Cost factors represent
the average cost-to-retail ratio for each merchandise group based upon the
fiscal year purchase activity for each store location. Accordingly, a
significant assumption under the retail method is that inventory in each group
is similar in terms of its cost-to-retail relationship and has similar turnover
rates. Management monitors the content of merchandise in these groupings to
prevent distortions that would have a material effect on inventory valuation.
RIM inherently requires management judgment and certain estimates
that may significantly impact the ending inventory valuation as well as gross
margin. Among others, two of the most significant estimates are permanent, or
clearance markdowns used to clear unproductive or slow-moving inventory and
shrinkage. Amounts are charged to Cost of sales, buying and occupancy at the
time the retail value of inventory is lowered through the use of permanent
markdowns.
10
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
Factors considered in the determination of permanent markdowns
include: current and anticipated demand, customer preferences, age of the
merchandise, fashion trends and weather conditions. In addition, inventory is
also evaluated against corporate pre-determined historical markdown cadences.
When a decision is made to permanently markdown merchandise, the resulting gross
margin reduction is recognized in the period the markdown is recorded. The
timing of the decision, particularly surrounding the balance sheet date, can
have a significant impact on the results of operations.
Shrinkage is estimated as a percentage of sales for the period from
the last physical inventory date to the end of the fiscal year. Physical
inventories are taken at least annually for all stores on a staggered basis
throughout the year and inventory records are adjusted accordingly. The
shrinkage rate from the most recent physical inventory, in combination with
historical experience, is used as the standard for the shrinkage accrual
following the physical inventory.
SELF INSURANCE RESERVES
We self-insure or retain a portion of the exposure for losses
related to workers compensation, health care benefits and general liability
costs. General liability costs relate primarily to litigation that arises from
store operations. Self-insurance reserves include actuarial estimates of both
claims filed carried at their expected ultimate settlement value and claims
incurred but not yet reported. Our estimated claim amounts are discounted using
a rate that approximates the duration of our portfolio.
Reserves are actuarially determined based upon the development of
historical losses to their ultimate levels over time, actual paid claims data,
and lag time for claims reporting. These projections are subject to a high
degree of variability based upon future inflation rates, litigation trends,
legal interpretations, benefit level changes and claims settlement patterns,
including the effect of the bankruptcy proceedings. Overall reserves can change
based upon the selection of the appropriate discount rate, and may vary based on
different actuarial valuation techniques utilized.
Reserves for estimated self-insurance liabilities were as follows:
$404 million as of January 28, 2004, $366 million as of April 30, 2003, $465
million as of January 29, 2003, and are included in Accrued payroll and other
liabilities, Other long-term liabilities and Liabilities subject to compromise
in the Consolidated Balance Sheets. Expenses for the 39-weeks ended January 28,
2004, the 13-weeks ended April 30, 2003 and fiscal years ended 2002 and 2001,
respectively totaled $295 million, $104 million, $443 million, and $622 million,
and were included in Selling, general and administrative expenses in the
Consolidated Statements of Operations.
As part of the selection of the appropriate estimate for these
reserves the actuaries determine an appropriate range of values that could be
anticipated for these liabilities. Had management recorded reserves to either
the high end or the low end of the ranges, these liabilities would have been $33
million higher or $31 million lower than amounts currently recorded.
PENSION ACCOUNTING
The fundamental components of pension accounting consist of the
compensation cost of benefits paid, the interest costs from deferring the
payment of these benefits, and the results of investing assets to fund the
pension benefit obligation. Pension benefits are earned by employees ratably
over their years of service. In our case, effective January 31, 1996, our
pension plans were frozen, and associates no longer earn additional benefits
under the plans, therefore there are no assumptions related to future
compensation costs.
Our actuarial valuations utilize key assumptions including discount
rates and expected returns on plan assets. We are required to consider current
market conditions, including changes in interest rates and plan asset investment
returns, in determining these assumptions. Actuarial assumptions may differ
materially from actual results due to changing market and economic conditions,
changes in investment strategies and higher or lower withdrawal rates or longer
or shorter life spans of participants. The discount rate and expected return on
plan assets used for the January 28, 2004 actuarial valuation were six percent
and eight percent, respectively. A quarter percentage point change in the
discount rate would impact Kmart's pension expense by approximately $1 million
on a pre-tax basis. A quarter percentage point change in the expected long-term
rate of return would impact Kmart's pension expense by approximately $4 million
on a pre-tax basis.
11
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
DEFERRED TAXES
Kmart accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes"
("SFAS No. 109") which requires that deferred tax assets and liabilities be
recognized using enacted tax rates for the effect of temporary differences
between the financial reporting and tax bases of recorded assets and
liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a
valuation allowance if it is more likely than not that some portion of or all of
the deferred tax asset will not be realized.
During the 39-weeks ended January 28, 2004, we utilized $203 million
of pre-emergence deferred tax assets and, accordingly, recorded an adjustment to
Capital in excess of par value. We evaluated the realizability of the remaining
Predecessor Company's deferred tax assets and have maintained a full valuation
allowance against such assets, as ultimate realization is uncertain. Should we
determine in the future that the Predecessor Company's deferred tax assets will
be utilized, the allowance would be reversed by adjusting Capital in excess of
par value, in accordance with SOP 90-7. We recorded $49 million of deferred tax
assets as of January 28, 2004, and have not provided a valuation allowance for
such assets based on the profitability of the Successor Company post-emergence,
evaluation of our current fiscal 2004 projections, and the likelihood that such
benefits will be realized in a short period of time. Our assumptions regarding
future realization may change due to future operating performance and other
factors. Should we determine that a portion or this entire asset is not
realizable, an allowance would be established at that time and additional tax
expense would be recorded.
RESULTS OF OPERATIONS
The results of operations presented below reflect certain
restatements to our previously reported results of operations for the 39-weeks
ended January 28, 2004. See Note 4 in Item 8 of this Form 10-K/A for this
discussion.
As previously discussed, due to the application of Fresh-Start
accounting, 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. Therefore, the Results of Operations and the Liquidity
and Financial Condition of the Successor Company have not been combined with
those of the Predecessor Company in this Management's Discussion and Analysis.
The following table is presented solely to complement management's
discussion and analysis of results of operations.
SUCCESSOR
COMPANY PREDECESSOR COMPANY
---------------- ------------------------------------------------
39-WEEKS ENDED 39-WEEKS ENDED 13-WEEKS ENDED 13-WEEKS ENDED
(dollars in millions) JANUARY 28, 2004 JANUARY 29, 2003 APRIL 30, 2003 MAY 1, 2002
- --------------------- ---------------- ---------------- -------------- --------------
(AS RESTATED)
Sales $ 17,072 $ 22,171 $ 6,181 $ 7,181
Cost of sales, buying and occupancy 13,084 18,323 4,762 6,519
-------- -------- -------- --------
Gross margin 3,988 3,848 1,419 662
Selling, general and administrative expenses 3,577 4,572 1,421 1,670
Restructuring, impairment and other charges - 574 37 -
Net (gains) losses on sales of assets (89) 5 - -
Equity income in unconsolidated subsidiaries (5) (29) (7) (5)
-------- -------- -------- --------
Income (loss) before interest, reorganization items,
income taxes and discontinued operations 505 (1,274) (32) (1,003)
Interest expense, net 127 122 57 33
Reorganization items, net - 112 769 251
-------- -------- -------- --------
Income (loss) before income taxes and discontinued 378 (1,508) (858) (1,287)
operations Provision for (benefit from) income taxes 144 (12) (6) (12)
-------- -------- -------- --------
Income (loss) before discontinued operations 234 (1,496) (852) (1,275)
Discontinued operations - (281) (10) (167)
-------- -------- -------- --------
Net income (loss) $ 234 $ (1,777) $ (862) $ (1,442)
======== ======== ======== ========
12
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
39-WEEKS ENDED JANUARY 28, 2004 COMPARED TO 39-WEEKS ENDED JANUARY 29, 2003
SAME-STORE SALES AND TOTAL SALES decreased 9.5% and 23.0%,
respectively, for the 39-weeks ended January 28, 2004 as compared to the
39-weeks ended January 29, 2003. Same-store sales include sales of all open
stores that have been open for greater than 13 full months. The decrease in
same-store sales is due primarily to several Company-wide promotional events
occurring in the prior year 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 during the first quarter of fiscal 2003.
GROSS MARGIN increased $140 million to $3,988 million, for the
39-weeks ended January 28, 2004, from $3,848 million for the 39-weeks ended
January 29, 2003. Gross margin, as a percentage of sales, increased to 23.4% for
the 39-weeks ended January 28, 2004, from 17.4% for the 39-weeks ended January
29, 2003. Impacting the gross margin rate in the prior period are inventory
markdowns of $498 million, primarily related to our fiscal 2003 store closings.
The markdowns were charged to Cost of sales, buying and occupancy in the fourth
quarter of fiscal 2002 when the decision to close the stores was made. Also
favorably impacting gross margin is a decrease in distribution costs, lower
depreciation expense resulting from impairment charges taken while operating in
bankruptcy and as a result of the write-off of long-lived assets in conjunction
with the application of Fresh-Start accounting, less inventory shrinkage,
supplier cost reductions and an improved sales mix as a result of a decrease in
promotional activity as referenced in the sales summary above. Gross margin also
benefited from the reclassification of co-op advertising recoveries from
Selling, general and administrative expenses ("SG&A") to Cost of sales, buying
and occupancy beginning in the fourth quarter of fiscal 2002 in accordance with
Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting by a Customer
(Including a Reseller) for Certain Consideration Received from a Vendor" ("EITF
02-16"). These improvements in the gross margin rate were partially offset by
the impact of clearance markdowns.
SG&A, which includes advertising costs (net of co-op recoveries of
$199 million in 2002) decreased $995 million for the 39-weeks ended January 28,
2004 to $3,577 million, or 21.0% of sales, from $4,572 million, or 20.6% of
sales, for the 39-weeks ended January 29, 2003. The decrease in SG&A is
primarily due to the reduction of our store base after closing 316 stores during
the first quarter of fiscal 2003, as well as a decrease in payroll and other
related expenses from corporate headquarters' cost reduction initiatives. In
addition, lower depreciation expense resulting from impairment charges taken
while operating in bankruptcy and the write-off of long-lived assets in
conjunction with Fresh-Start accounting combined with a decrease in advertising
expense contributed to the improvement in SG&A expenses. Collectively, these
reductions were partially offset by the impact of the reclassification of co-op
advertising recoveries, as discussed above.
INCOME BEFORE INTEREST, REORGANIZATION ITEMS, INCOME TAXES AND
DISCONTINUED OPERATIONS for the 39-weeks ended January 28, 2004 was $505 million
or 3.0% of sales, as compared to a loss of $1,274 million, or (5.7%) of sales,
for the same period of the prior year. The improvement from the comparable
period in the prior year was primarily due to the decrease in SG&A and the
increase in gross margin as discussed above, a charge of $574 million in the
prior period to Restructuring, impairment and other charges and net gains on
sales of assets of $89.
INTEREST EXPENSE, NET for the 39-weeks ended January 28, 2004 and
January 29, 2003 was $127 million and $122 million, respectively. The increase
in interest expense was due primarily to the accretion of $72 million for
obligations recorded at net present value and $22 million of debt discount
amortization recognized on the beneficial conversion feature of our Note. The
increase was partially offset by a decrease in capital lease interest as a
result of store closings and a decrease in credit facility borrowings. In
December 2003, we voluntarily reduced the size of our $2 billion credit
agreement to $1.5 billion to reduce the overall cost of the facility. In
conjunction with this action, we accelerated the amortization of $12 million of
the associated debt issuance costs. This expense is included in Interest
expense, net for the 39-weeks ended January 28, 2004. Interest expense is net of
interest income of $10 million and $3 million for the 39-weeks ended January 28,
2004 and January 29, 2003, respectively.
EFFECTIVE INCOME TAX rate was 38.1% and (0.8%) for the 39-weeks
ended January 28, 2004 and January 29, 2003, respectively. The Predecessor
Company did not record a provision for income taxes in fiscal 2002 due to the
Company's net loss and uncertainty surrounding future utilization of net
operating losses. As such, tax benefits recorded during fiscal 2002 related
primarily to an Internal Revenue Code provision allowing for the 10-year
carryback of certain losses, and refunds resulting from the Job Creation and
Worker Assistance Act of 2002. The benefit recognized for these items in 2002
was partially offset by expense paid to foreign jurisdictions.
13
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
13-WEEKS ENDED APRIL 30, 2003 COMPARED TO 13-WEEKS ENDED 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 13-weeks
ended May 1, 2002. The decrease in same-store sales was 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 was attributable to the decrease in
same-store sales and the closure of 283 stores during the second quarter of
2002.
GROSS MARGIN increased $757 million to $1,419 million, for the
13-weeks ended April 30, 2003, from $662 million 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 9.2% for the 13-weeks ended May 1, 2002. The
increase in gross margin was primarily related to a charge of $625 million
recorded in the first quarter of fiscal 2002 in conjunction with the store
closing liquidation sales. Also impacting gross margin was the affect of a
favorable gross margin rate realized during store closing liquidation sales, a
decrease in the sale of food and consumables, which carry lower margins, and a
decrease in promotional markdowns. The impact of these items was partially
offset by higher clearance markdowns.
SG&A, which includes advertising costs (net of co-op recoveries of
$67 million in fiscal 2002) decreased $249 million for the 13-weeks ended April
30, 2003 to $1,421 million, or 23.0% of sales, from $1,670 million, or 23.3% of
sales, for the 13-weeks ended May 1, 2002. The decrease in SG&A was primarily
the result of the closure of 283 stores in the second quarter of fiscal 2002 and
lower payroll and other related expenses in the first quarter of fiscal 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. Offsetting the positive
impact of these items was an increase in pension and workers' compensation
expense and the impact of the previously discussed reclassification of co-op
advertising recoveries.
LOSS BEFORE INTEREST, REORGANIZATION ITEMS, INCOME TAXES AND
DISCONTINUED OPERATIONS for the 13-weeks ended April 30, 2003 was $32 million,
or (0.5%) of sales, as compared to a loss of $1,003 million, or (14.0%) 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 $625
million and the decrease in SG&A as previously discussed.
INTEREST EXPENSE, NET for the 13-weeks ended April 30, 2003 and May
1, 2002 was $57 million and $33 million, respectively. In connection with our
emergence from Chapter 11, we accelerated $12 million of the amortization of
debt issuances costs related to the Court-approved $2 billion
debtor-in-possession financing facility ("DIP Credit Facility") and recognized
the expense in the 13-weeks ended April, 30, 2003. 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 million and $69 million,
respectively. Interest expense is net of interest income of $1 million for each
of the 13-weeks ended April 30, 2003 and May 1, 2002.
EFFECTIVE INCOME TAX rate was (0.7%) and (0.9%) for the 13-weeks
ended April 30, 2003 and May 1, 2002, respectively.
2002 COMPARED TO 2001
In fiscal years 2002 and 2001 there were certain significant
restructuring efforts that drove the major changes in the operating results
including two store closing programs that drove significant inventory markdowns
in fiscal 2002, impairments of long-lived assets and reductions in workforce. In
fiscal 2001, significant actions included restructuring of our e-commerce
business and supply chain. See Note 6 in Item 8 of this Form 10-K/A.
SAME-STORE SALES AND TOTAL SALES for fiscal 2002 decreased 10.1% and
14.1%, respectively. In addition to negative customer perception stemming from
the Predecessor Company's Chapter 11 filing, the decrease in same-store sales is
primarily due to lower sales transactions associated with a loss of customers
and continued competitive pressures. The decrease in total sales is attributable
to the decrease in same-store sales and the closure of 283 stores during the
second quarter of fiscal 2002.
14
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
GROSS MARGIN was $4,510 million and decreased $1,477 million from
$5,987 million in 2001. Gross margin, as a percentage of sales, was 15.4% in
fiscal 2002 and 17.5% in fiscal 2001. The decrease in gross margin as a
percentage of sales is primarily related to a fiscal 2002 charge for accelerated
inventory markdowns of $1,019 million in conjunction with store closing
liquidations, an increase in promotional markdowns designed to drive customer
traffic, an increase in clearance markdowns for seasonal apparel, and increased
shrinkage, partially offset by a higher regular gross margin rate due to the
elimination of the BlueLight Always initiative which began in fiscal 2001, a
decrease in sales of food and consumables, which carry lower margins,
approximately $200 million of vendor credits which would otherwise have been
recorded as co-op advertising recoveries in SG&A as a result of the adoption of
EITF 02-16 in the fourth quarter of fiscal 2002, a difference in the LIFO
inventory valuation adjustment of $154 million and the prior year supply chain
restructuring charge of $75 million.
GROSS MARGIN also decreased as a result of a decrease in total sales
due to the closure of 283 stores in the second quarter of fiscal 2002 and a
decrease in same-store sales.
SG&A, which includes advertising costs (net of co-op recoveries of
$266 million in fiscal 2002 and $427 million in fiscal 2001), was 21.3% of sales
in fiscal 2002 versus 21.0% in fiscal 2001. The decrease of $935 million from
the prior year is due primarily to decreased payroll and benefits due to the
closure of 283 stores in the second quarter of fiscal 2002, decreases in
expenses for general liability claims due to a fiscal 2001 adjustment of $167
million to align general liability reserves with actuarial findings, lower
depreciation expense due to an impairment charge recorded in fiscal 2001, a
fiscal 2001 supply chain restructuring charge of $88 million and a reduction in
electronic media and direct mail advertising; partially offset by approximately
$200 million of co-op recoveries reclassified to gross margin in accordance with
EITF 02-16 in the fourth quarter of fiscal 2002 and an increase in weekly
circular advertising.
LOSS BEFORE INTEREST, REORGANIZATION ITEMS, INCOME TAXES AND
DISCONTINUED OPERATIONS was $2,277 million, or (7.8%) of sales, for fiscal 2002
compared to a loss of $2,146 million, or (6.3%) of sales, for fiscal 2001. The
increase in loss is attributable to lower gross margin partially offset by a
reduction in SG&A, lower impairment charges in the current year and the prior
year restructuring charges for the Predecessor Company's e-commerce business and
supply chain.
INTEREST EXPENSE, NET was $155 million and $344 million in fiscal
years 2002 and 2001, respectively. Included in interest expense, net is interest
income of $4 million for fiscal years 2002 and 2001. Interest expense, net
decreased by $189 million as a result of the Chapter 11 filing. As of the
Petition Date, the Predecessor Company stopped accruing interest on unsecured
debt classified as Liabilities subject to compromise in its Consolidated Balance
Sheet in accordance with SOP 90-7. Interest at the stated contractual amount on
unsecured debt that was not charged to earnings was $271 million and $8 million
for fiscal years 2002 and 2001, respectively.
EFFECTIVE INCOME TAX RATE was (0.9%) and 0.0% in fiscal years 2002
and 2001, respectively. In the fourth quarter of fiscal 2001, the Predecessor
Company recorded a valuation allowance against its net deferred tax assets, in
accordance with SFAS No. 109 as realization of such assets in future years was
uncertain. We continued to maintain a valuation allowance against the net
deferred tax assets in 2002, and accordingly, did not recognize any tax benefit
from net losses in fiscal 2002.
LIQUIDITY AND FINANCIAL CONDITION
CREDIT FACILITY
Our cash needs are satisfied through working capital generated by
our business and availability under our Credit Facility (defined below). 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 the Predecessor
Company's filing for reorganization under Chapter 11, most of our vendors have
continued to support us and have resumed normal trade terms. We continue to
focus on our 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, our sales fail to improve, the
Credit Facility becomes unavailable for any reason, and/or actual results differ
materially from those projected, our compliance with financial covenants and our
cash resources could be adversely affected.
15
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
On the Effective Date, our credit agreement (the "Credit Facility")
syndicated by General Electric Capital Corporation, Fleet Retail Finance Inc.
and Bank of America, N.A., became effective. Debt issuance costs associated with
the Credit Facility totaled $60 million of which $48 million was paid during
fiscal 2003 and all of which will be amortized through May 2006. The Credit
Facility, which had an initial capacity of $2 billion, is a revolving credit
facility under which Kmart Corporation is the borrower and contains an $800
million letter of credit sub-limit. Availability under the Credit Facility is
also 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. In December 2003, we
voluntarily reduced the size of the Credit Facility to $1.5 billion to reduce
the overall cost of the Credit Facility. This resulted in the accelerated
amortization of $12 million of the Credit Facility debt issuance costs in the
fourth quarter of fiscal 2003.
The Credit Facility was also amended in December 2003 to reduce
interest rates, among other things. 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 as defined in the Credit Facility. 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 amendment also gave the Company
the ability to repurchase up to $250 million of the Company's Common Stock,
subject to the approval of the Company's Board of Directors.
As of January 28, 2004 we had utilized $420 million of the Credit
Facility for letters of credit issued for ongoing import purchasing operations,
and contractual and regulatory purposes. Collateral in the form of letters of
credit is provided to support our self-insurance programs. As collateral
requirements change periodically, we continue to evaluate the amount and form of
collateral under these programs. Total availability under the Credit Facility at
January 28, 2004 was approximately $1.1 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 necessary to maintain our operations.
CASH FLOWS
Net cash provided by operating activities was $736 million for the
39-weeks ended January 28, 2004 compared to $576 million for the 13-weeks ended
April 30, 2003, $88 million in fiscal 2002 and $879 million in fiscal 2001. Net
cash provided for the 39-weeks ended January 28, 2004 was primarily driven by
the reduction of merchandise inventories. Merchandise inventories decreased $1.2
billion on a same-store basis. Also contributing to cash provided by operating
activities was our net income for the 39-weeks ended January 28, 2004 of $248
million. These items were partially offset by payments of $481 million for
bankruptcy exit costs and reorganization items. The payments for exit costs and
reorganization items include $243 million to pre-petition lenders, $89 million
for reclamation claims settlements, $81 million to retained bankruptcy advisors
and $68 million under the Key Employee Retention Program ("KERP"). Net cash
provided by operating activities for the 13-weeks ended April 30, 2003 was
primarily driven by a decrease in inventory of $480 million due to store
liquidation sales and improved inventory management, partially offset by a
decrease in accounts payable. Net cash provided by operating activities for
fiscal 2002 was impacted by decreased payments on accounts payable due to the
stay of pre-petition liabilities following the Predecessor Company's filing for
protection under Chapter 11. Net cash provided by operating activities for
fiscal 2001 was impacted by the net loss partially offset by a decrease in
inventories, net of accounts payable.
16
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
Net cash provided by investing activities was $74 million for the
39-weeks ended January 28, 2004 and $60 million for the 13-weeks ended April 30,
2003 compared to cash flows used for investing activities of $223 million and
$1,388 million in fiscal years 2002 and 2001, respectively. Net cash provided
for the 39-weeks ended January 28, 2004 was due primarily to proceeds of $108
million from the sale of property classified as held for sale (see Note 8 in
Item 8 of this Form 10-K/A), partially offset by $108 million of capital
expenditures primarily related to the purchase of 17 stores and one distribution
center that were previously leased and store maintenance capital. Net cash
provided for the 13-weeks ended April 30, 2003 was the result of proceeds of $64
million from the sale of four Kmart owned store locations and the sale of
furniture and fixtures from closed store locations. Net cash used for fiscal
2002 was primarily due to capital expenditures for store improvements. Net cash
used for fiscal 2001 was due primarily to capital expenditures for the
conversion and expansion of Kmart stores to Kmart Supercenters, expansion of
aisles to facilitate off-shelf sale of promotional items and an investment in
point-of-sale equipment.
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. In addition,
the Company reviews leases due to expire in the short-term in order to determine
the appropriate action to take with respect to the lease. We consider the merits
of each action and execute transactions considered to be favorable to the
Company only after appropriate due diligence. As of January 28, 2004, the
Company had 1,511 locations, of which 135 were owned.
Net cash provided by financing activities was $46 million for the
39-weeks ended January 28, 2004 compared to net cash used of $17 million for the
13-weeks ended April 30, 2003, $497 million used in fiscal 2002 and $1,353
million provided in fiscal 2001. For the 39-weeks ended January 28, 2004, the
Company received proceeds of $140 million from the issuance of Common Stock to
the Plan Investors and proceeds of $60 million from the issuance of the
convertible note to affiliates of ESL upon emergence from Chapter 11. The
positive impact of these items was partially offset by payments made for other
financing arrangements, including capital lease obligations and mortgages on
properties we own. Net cash used during the 13-weeks ended April 30, 2003 was
primarily due to payments on debt and capital lease obligations. Net cash used
in fiscal 2002 was due primarily to the repayment of the DIP Credit Facility and
payments on capital leases. In fiscal 2001, net cash provided by financing
activities was primarily related to proceeds from debt issuances and the DIP
Credit Facility, partially offset by payments on long-term debt and capital
leases.
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 (weighted-average price of $28.87 per share)
of Common Stock at a cost of approximately $4 million. We subsequently issued
111,540 restricted shares to employees; see Note 17 in Item 8 of this Form
10-K/A.
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 earned 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.
In light of negative returns in the equity markets during 2001 and
2002 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 beginning in either May 2004 or May 2006, depending
on whether new legislation regarding pension funding requirements is enacted.
This proposed legislation would allow the basic pension funding requirement to
be determined using a corporate bond rate instead of a Treasury Bond rate as in
the past, resulting in significantly lower contributions over the next two
years. Should the pending legislation not pass, we will be required to
contribute approximately $150 million in fiscal 2004. Once funding obligations
commence, we presently anticipate that such obligations could continue for a
period of five years at an average rate of between $100 million and $200 million
a year, or between $600 million and $750 million in the aggregate. The actual
level of contributions will depend upon a number of factors, including
legislative changes to funding requirements, the actual demographic experience,
pension fund returns and other changes affecting valuations.
In addition to the funding described above, as a result of the
investment 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
39-weeks ended January 28, 2004 as opposed to income as has been recorded in the
most recent years.
17
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT 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, the Predecessor Company instituted certain restructuring actions to
improve operations and executed significant inventory liquidations as a result
of the stores closed under the Chapter 11 proceedings. For the 13-weeks ended
April 30, 2003, and fiscal years 2002 and 2001, the Predecessor Company recorded
special charges of $42 million, $1,628 million and $1,110 million, respectively.
For a comprehensive discussion see Note 6 in Item 8 of this Form 10-K/A.
REORGANIZATION ITEMS, NET
Reorganization items represent amounts the Predecessor Company
incurred as a result of Chapter 11, and are presented separately in the
accompanying Consolidated Statements of Operations as required by SOP 90-7. The
Predecessor Company recorded $769 million, $363 million and ($183) million for
the 13-weeks ended April 30, 2003, fiscal years 2002 and 2001, respectively, for
reorganization items. The net increase in Reorganization items for the 13-weeks
ended April 30, 2003 as compared to fiscal 2002, is primarily due to the
settlement with Fleming Corporation ("Fleming") of its $1.5 billion claim
against the Predecessor Company for $385 million, expense of $200 million for
estimated claims for rejected executory contracts and the charge of $158 million
for store closings in fiscal 2003, partially offset by the charge of $185
million for store closings in fiscal 2002. For a comprehensive discussion see
Note 7 in Item 8 of this Form 10-K/A.
DISCONTINUED OPERATIONS
During the first quarter of fiscal 2003 and the second quarter of
fiscal 2002, the Predecessor Company closed 316 and 283 stores, respectively. Of
the total store closings 121 met the criteria for discontinued operations. For a
comprehensive discussion see Note 5 in Item 8 of this Form 10-K/A.
Of the 599 stores that were closed in fiscal years 2003 and 2002,
478 are included in continuing operations, as they did not meet the criteria for
discontinued operations. For the 13-weeks ended April 30, 2003, 250 of the 316
stores closed were accounted for in continuing operations. Total sales, gross
margin and SG&A for these 250 stores were $854 million, $301 million and $146
million, respectively. For fiscal 2002, total sales, gross margin and SG&A for
the 478 closed stores that were reported in continuing operations were $4,946
million, $890 million and $1,016 million, respectively. For fiscal 2001, total
sales, gross margin and SG&A for the 478 stores that were reported in continuing
operations were $7,260 million, $1,157 million and $1,453 million, respectively.
18
MANAGEMENT DISCUSSION AND ANALYSIS -(CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
Information concerning our obligations and commitments to make
future payments under contracts such as debt and lease agreements, and under
contingent commitments is aggregated in the following tables.
PAYMENTS DUE BY PERIOD
------------------------------------------------
WITHIN 1 AFTER 5
CONTRACTUAL OBLIGATIONS (DOLLARS IN MILLIONS) TOTAL YEAR 2-3 YEARS 4-5 YEARS YEARS
- --------------------------------------------- ------ -------- --------- --------- -------
Operating leases $4,709 $ 454 $ 827 $ 698 $2,730
Purchase obligations 1,229 1,203 26 - -
Capital lease obligations 991 128 205 154 504
Royalty license fees 815 112 172 167 364
Pension obligations 736 152 388 196 -
Long-term debt 107 4 68 10 25
------ ------ ------ ------ ------
Total contractual cash obligations $8,587 $2,053 $1,686 $1,225 $3,623
====== ====== ====== ====== ======
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
--------------------------------------------------
WITHIN 1 AFTER 5
OTHER COMMERCIAL COMMITMENTS (DOLLARS IN MILLIONS) TOTAL YEAR 2-3 YEARS 4-5 YEARS YEARS
- -------------------------------------------------- ----- -------- --------- --------- -------
Standby letters of credit $324 $324 $ - $ - $ -
Trade letters of credit 96 96 - - -
---- ---- --- --- ---
Total commercial commitments $420 $420 $ - $ - $ -
==== ==== === === ===
Purchase obligations consist of services and goods the Company is
committed to purchasing in the ordinary course of business, primarily
merchandise inventories. Purchase obligations do not include contracts the
Company can terminate without cause, on 30 to 60 days notice, with little or no
penalty to the Company.
Pension obligations do not consider pending legislation that would
serve to delay significant funding requirements until fiscal 2006. Such
obligations may increase or decrease based on actual returns on assets
previously contributed to the pension plan.
OTHER MATTERS
Lawsuits, Investigations and Other Contingent Liabilities
We are a party to 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 the Successor Company upon emergence from
Chapter 11 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. For a comprehensive discussion see
Note 22 in Item 8 of this Form 10-K/A.
Other
On March 2, 2004, Footstar, Inc. ("FTS") and its direct and indirect
subsidiaries, including the Meldisco subsidiaries, filed for Chapter 11
protection in the United States Bankruptcy Court for the Southern District of
New York. Kmart footwear departments are operated under a license agreement with
the Meldisco subsidiaries of FTS, substantially all of which are 49% owned by
Kmart and 51% owned by FTS. The Meldisco subsidiaries lease space in our stores
and operate our footwear departments. We have a master agreement with FTS which
provides the Meldisco subsidiaries with a non-transferable, exclusive right and
license to operate our footwear departments.
Pursuant to this bankruptcy, FTS may assume or reject our agreement
at any time.
19
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
The impact (if any) of the FTS bankruptcy filing, including
potential business interruption, on our future financial results will depend
upon whether FTS assumes or rejects our agreement and upon the success of FTS
reorganization. At the time of our filing, FTS has not filed its plan of
reorganization with the bankruptcy court. If FTS assumes our agreement and
obtains bankruptcy court approval of its plan of reorganization, then it is
likely that our future financial results will not be impacted. If, however, FTS
rejects our agreement or, to the contrary, assumes our agreement but fails to
obtain bankruptcy court approval of a plan of reorganization, then we will
pursue alternative arrangements including directly sourcing footwear
merchandise.
On August 6, 2003, we announced the launch of the Thalia Sodi
Collection. The Collection captures the personal style and attitude of the
Hispanic actress and singer, Thalia Sodi, and her culture. It includes branded
apparel for women and girls, as well as footwear, accessories, jewelry,
intimates, hosiery and bed and bath products. The Thalia Sodi Collection is
available in 335 Kmart stores including those in the New York City, Los Angeles,
San Francisco, Miami, Denver, Las Vegas, Phoenix, San Diego, Chicago and Puerto
Rico areas. Sales of the Thalia Sodi Collection were $17 million and $8 million
for the 39-weeks ended January 28, 2004 and 13-weeks ended April 30, 2003,
respectively.
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. 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 will
assume 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.
On February 11, 2004, the Company filed a suit 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 its Chapter 11
proceedings, on March 20, 2002. Two contractual interpretation issues are in
dispute. The first issue involves the royalty structure of the Agreement whereby
Kmart must pay to MSO certain "royalties based on Sales...at the royalty rates
set forth" in Schedules attached to and incorporated into the Agreement. In
Section V(2), the Agreement sets forth "certain guaranteed royalty amounts as of
each January 31" for each of four product categories (Home, Garden, Houseware,
and Seasonal), as well as a guaranteed royalty amount in the aggregate. After
Kmart calculates and pays MSO royalties based on sales of relevant products,
Kmart is obligated to determine whether there are any shortfalls in achieving
the minimum guaranteed royalties set forth in Schedule V(2). Kmart must then pay
any shortfall to MSO. However, instead of accepting from Kmart the difference
between royalties on sales and the Aggregate minimum royalty (which includes the
shortfall from the guaranteed royalties on the Product categories), MSO has
demanded that Kmart pay it the shortfall on the aggregate minimum royalty added
to any shortfall from the guaranteed royalties in each of the product
categories. This would cost the Company approximately $4 million in additional
royalties for fiscal 2003. In addition, MSO is demanding that Kmart incur annual
advertising expenditures in Martha Stewart Living media properties far in excess
of those that the Agreement contemplates. The complaint alleges breach of the
covenant of good faith and fair dealing and seeks declaratory relief on the two
contractual interpretation issues.
The Capital One and Capital Factors lawsuits, each more fully
described in Note 22 in Item 8 of this Form 10-K/A, together have the potential
to have a material favorable effect on our financial statements. At the current
time, the ultimate amount of recovery on each of these matters cannot be
determined and any individual recovery may not have a material effect on our
financial statements.
20
MANAGEMENT DISCUSSION AND ANALYSIS - (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
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 agreement with Liberty Mutual, historically the
Predecessor Company's largest provider of surety bonds, on the terms and
conditions of a 2 to 2-1/2 year continuation of their bonds. We are continuing
our discussions with the remaining issuers of pre-petition surety bonds. If
negotiations with remaining providers prove unsuccessful and the applicable
surety bonds were to be cancelled, the Company could lose its 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 fund 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.
STORE ACTIVITY
Due primarily to the closure of 316 stores in fiscal 2003, we ended
the year with a 17% decrease in our number of stores, from 1,829 at the end of
fiscal 2002 compared to 1,511 at the end of fiscal 2003. The fiscal 2003
closures included 261 Kmart discount stores and 57 Kmart Supercenters in 45
states. In addition, leases on 2 stores expired during fiscal 2003.
NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("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 had to adopt, upon emergence from Chapter 11, all
accounting guidance that would otherwise become effective within the next twelve
months. We adopted SFAS No. 149 effective April 30, 2003. There was no impact to
the Company upon the adoption of SFAS No. 149.
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, the Company had to adopt, upon emergence from Chapter
11, all accounting guidance that would otherwise become effective within the
next twelve months. We 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.
In December 2003, the Emerging Issues Task Force ("EITF") issued
EITF Issue No. 03-10, "Application of EITF Issue No. 02-16, `Accounting by a
Customer (Including a Reseller) for Certain Consideration Received from a
Vendor', by Resellers to Sales Incentives Offered to Consumers by Manufacturers"
("EITF 03-10"). According to EITF 03-10, manufacturers' coupons that meet
certain criteria should be recorded gross-basis as revenue, and are not subject
to the guidance in EITF 02-16. The provisions of the consensus will be
applicable to Kmart for new and modified arrangements we enter into in fiscal
2004. We do not anticipate any impact upon adoption of EITF 03-10 as Kmart's
current accounting for manufacturers' coupons conforms to this requirement.
In December 2003 the FASB issued 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 disclosure requirements that were effective for fiscal years ending
after December 15, 2003 in this Annual Report on Form 10-K/A. Additional
disclosure required for interim reporting and fiscal years beginning after June
15, 2004 will be disclosed when required.
We have reviewed all new applicable guidance and do not deem any
other standards to have a significant effect on the Company's financial
statements.
21
MANAGEMENT DISCUSSION AND ANALYSIS -(CONTINUED)
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
At January 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 our Credit
Facility, which is a variable rate financing agreement. We do not use swaps or
other interest rate protection agreements to hedge this risk.
22
Item 8. Financial Statements and Supplementary Data
The following information is submitted pursuant to the requirements of Item 8:
Page
----
Consolidated Statements of Operations
Successor Company - for the 39-weeks ended January 28, 2004 (as restated)
Predecessor Company - for the 13-weeks ended April 30, 2003 and
Years Ended January 29, 2003 and January 30, 2002...................... 24
Consolidated Balance Sheets
Successor Company - as of January 28, 2004 (as restated)
Successor Company - as of April 30, 2003 (as restated)
Predecessor Company - as of January 29, 2003............................. 25
Consolidated Statements of Cash Flows
Successor Company - for the 39-weeks ended January 28, 2004 (as restated)
Predecessor Company - for the 13-weeks ended April 30, 2003 and
Years Ended January 29, 2003 and January 30, 2002...................... 26
Consolidated Statements of Shareholders' Equity (Deficit)
Successor Company - for the 39-weeks ended January 28, 2004 (as restated)
Predecessor Company - for the 13-weeks ended April 30, 2003 and
Years Ended January 29, 2003 and January 30, 2002...................... 27
Notes to Consolidated Financial Statements............................... 28
Schedule II - Valuation and Qualifying Accounts.......................... 61
Reports of Independent Accountants....................................... 63
23
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
SUCCESSOR COMPANY PREDECESSOR COMPANY
----------------- ----------------------------------------
39-WEEKS ENDED 13-WEEKS ENDED FISCAL YEAR FISCAL YEAR
JANUARY 28, 2004 APRIL 30, 2003 2002 2001
----------------- -------------- ----------- -----------
(AS RESTATED)
Sales $ 17,072 $ 6,181 $ 29,352 $ 34,180
Cost of sales, buying and occupancy 13,084 4,762 24,842 28,193
-------- -------- -------- --------
Gross margin 3,988 1,419 4,510 5,987
Selling, general and administrative expenses 3,577 1,421 6,242 7,177
Restructuring, impairment and other charges - 37 574 947
Net (gains) losses on sales of assets (89) - 5 9
Equity income in unconsolidated subsidiaries (5) (7) (34) -
-------- -------- -------- --------
Income (loss) before interest expense,
reorganization items, income
taxes and discontinued operations 505 (32) (2,277) (2,146)
Interest expense, net 127 57 155 344
Reorganization items, net - 769 363 (183)
-------- -------- -------- --------
Income (loss) before income taxes and 378 (858) (2,795) (2,307)
discontinued operations
Provision for (benefit from) income taxes 144 (6) (24) -
Dividends on convertible preferred
securities of subsidiary trust - - - 70
-------- -------- -------- --------
Income (loss) before discontinued 234 (852) (2,771) (2,377)
operations
Discontinued operations (net of income
taxes of $0 ) - (10) (448) (69)
-------- -------- -------- --------
Net income (loss) $ 234 $ (862) $ (3,219) $ (2,446)
======== ======== ======== ========
Basic income (loss) per common share $ 2.61 $ (1.63) $ (5.47) $ (4.81)
before discontinued operations
Discontinued operations - (0.02) (0.89) (0.14)
-------- -------- -------- --------
Basic net income (loss) per common share $ 2.61 $ (1.65) $ (6.36) $ (4.95)
======== ======== ======== ========
Diluted income (loss) per common share $ 2.51 $ (1.63) $ (5.47) $ (4.81)
before discontinued operations
Discontinued operations - (0.02) (0.89) (0.14)
-------- -------- -------- --------
Diluted net income (loss) per common share $ 2.51 $ (1.65) $ (6.36) $ (4.95)
======== ======== ======== ========
Basic weighted average shares (millions) 89.6 522.7 506.4 494.1
Diluted weighted average shares (millions) 93.3 522.7 506.4 494.1
See accompanying Notes to Consolidated Financial Statements
24
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS EXCEPT SHARE DATA)
PREDECESSOR
SUCCESSOR COMPANY COMPANY
-------------------------------- ----------------
JANUARY 28, 2004 APRIL 30, 2003 JANUARY 29, 2003
---------------- -------------- ----------------
(AS RESTATED) (AS RESTATED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,088 $ 1,232 $ 613
Merchandise inventories 3,238 4,431 4,825
Accounts receivable 301 382 473
Other current assets 184 509 191
------------- ------------- ---------------
TOTAL CURRENT ASSETS 5,811 6,554 6,102
Property and equipment, net 153 10 4,892
Other assets and deferred charges 110 96 244
------------- ------------- ---------------
TOTAL ASSETS $ 6,074 $ 6,660 $ 11,238
============= ============= ===============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Mortgages payable due within one year $ 4 $ 8 $ -
Accounts payable 820 1,160 1,248
Accrued payroll and other 671 1,321 710
liabilities
Taxes other than income taxes 281 274 162
------------- ------------- ---------------
TOTAL CURRENT LIABILITIES 1,776 2,763 2,120
------------- ------------- ---------------
LONG-TERM LIABILITIES
Long-term debt and mortgages payable 76 59 -
Capital lease obligations 374 415 623
Pension obligation 873 854 -
Unfavorable operating leases 342 344 -
Other long-term liabilities 424 481 181
------------- ------------- ---------------
TOTAL LONG-TERM LIABILITIES 2,089 2,153 804
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 3,865 4,916 2,924
LIABILITIES SUBJECT TO COMPROMISE - - 7,969
Predecessor Company obligated mandatorily redeemable convertible
preferred securities - - 646
SHAREHOLDERS' EQUITY (DEFICIT)
Successor Company preferred stock 20,000,000 shares authorized;
no shares outstanding - - -
Predecessor Company common stock $1 par value, 1,500,000,000
shares authorized; 519,123,988 shares issued and outstanding - - 519
Successor Company common stock $0.01 par value, 500,000,000
shares authorized; 89,633,760 and 89,677,509 shares issued,
respectively 1 1 -
Treasury stock, at cost (1) - -
Capital in excess of par value 1,974 1,743 1,922
Retained earnings (Accumulated deficit) 234 - (1,835)
Accumulated other comprehensive income (loss) 1 - (907)
------------- ------------- ---------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) 2,209 1,744 (301)
------------- ------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 6,074 $ 6,660 $ 11,238
============= ============= ===============
See accompanying Notes to Consolidated Financial Statements
25
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
SUCCESSOR
COMPANY PREDECESSOR COMPANY
---------------- ---------------------------------------------
39-WEEKS 13-WEEKS
ENDED ENDED FISCAL YEAR FISCAL YEAR
JANUARY 28, 2004 APRIL 30,2003 2002 2001
---------------- ------------- ----------- -----------
(AS RESTATED)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 234 $ (862) $ (3,219) $(2,446)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Restructuring, impairments and other charges - 44 2,036 1,095
Reorganization items, net - 769 363 (183)
Depreciation and amortization 53 177 737 824
Net (gains) losses on sales of assets (89) - 5 9
Equity income in unconsolidated subsidiaries (5) (7) (34) -
Dividends received from Meldisco - 36 45 51
Cash used for store closings and other charges (15) (64) (134) (230)
Cash used for payments of exit costs and other
reorganization items (481) (19) (135) (6)
Change in:
Merchandise inventories 1,193 480 (168) 560
Accounts payable (340) (117) 401 1,046
Deferred income taxes and taxes payable (60) (16) 23 (55)
Other assets 120 123 101 237
Other liabilities 126 32 67 (23)
------- -------- -------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 736 576 88 879
------- -------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of property and equipment 182 64 29 42
Capital expenditures (108) (4) (252) (1,385)
Investment in BlueLight.com - - - (45)
------- -------- -------- -------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES 74 60 (223) (1,388)
------- -------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on debt (37) (1) (31) (320)
Purchase of treasury stock (4) - - -
Debt issuance costs (48) - (42) (49)
Payments on capital lease obligations (75) (16) (94) (86)
Fees paid to Plan Investors (13) - - -
Proceeds from issuance of debt 83 - - 1,494
Issuance of common shares 140 - - -
Net (payments) proceeds from DIP Credit Facility - - (330) 330
Payments of dividends on preferred securities of - - - (72)
subsidiary trust
Issuance of Predecessor Company common shares - - - 56
------- -------- -------- -------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 46 (17) (497) 1,353
------- -------- -------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS 856 619 (632) 844
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,232 613 1,245 401
------- -------- -------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,088 $ 1,232 $ 613 $ 1,245
======= ======== ======== =======
See accompanying Notes to Consolidated Financial Statements
26
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(DOLLARS AND SHARES IN MILLIONS)
CAPITAL RETAINED ACCUMULATED
IN EXCESS EARNINGS/ OTHER
NUMBER COMMON TREASURY OF PAR (ACCUMULATED COMPREHENSIVE
OF SHARES STOCK STOCK VALUE DEFICIT) INCOME (LOSS) TOTAL
--------- --------- --------- ----------- ------------ ------------- --------
BALANCE AT JANUARY 31, 2001 - PREDECESSOR COMPANY 487 $ 487 $ - $ 1,578 $ 3,830 $ (13) $ 5,882
Comprehensive Loss
Net loss - - - - (2,446) - (2,446)
Additional minimum pension
liability adjustment - - - - - (339) (339)
-------
TOTAL COMPREHENSIVE LOSS (2,785)
Shares issued to employee benefit plans 9 9 - 44 - - 53
Shares issued for stock option plans 1 1 - 9 - - 10
Shares issued to acquire BlueLight.com 6 6 - 63 - - 69
Other - - - 1 - - 1
------- ----- ---- ------- ------- ------- -------
BALANCE AT JANUARY 30, 2002 - PREDECESSOR COMPANY 503 503 - 1,695 1,384 (352) 3,230
Comprehensive Loss
Net loss - - - - (3,219) - (3,219)
Additional minimum pension
liability adjustment - - - - - (554) (554)
Market value adjustment for investments - - - - - (1) (1)
-------
TOTAL COMPREHENSIVE LOSS (3,774)
Conversion of preferred securities 17 17 - 227 - - 244
Cancellation of restricted stock (1) (1) - - - - (1)
------- ----- ---- ------- ------- ------- -------
BALANCE AT JANUARY 29, 2003 - PREDECESSOR COMPANY 519 519 - 1,922 (1,835) (907) (301)
Comprehensive Loss
Net loss excluding Plan of Reorganization and
Fresh-Start Accounting Adjustments - - - - (855) - (855)
-------
TOTAL COMPREHENSIVE LOSS (855)
Conversion of preferred securities 18 18 - 241 - - 259
------- ----- ---- ------- ------- ------- -------
BALANCE PRIOR TO APPLICATION OF
FRESH-START ACCOUNTING 537 537 - 2,163 (2,690) (907) (897)
Adjust pension plan to fair market value (94) (94)
Cancellation of Predecessor Company equity and
application of Fresh-Start accounting (537) (537) - (2,163) 2,690 1,001 991
Capitalization of Successor Company ( AS RESTATED) 90 1 - 1,743 - - 1,744
------- ----- ---- ------- ------- ------- -------
(AS RESTATED)
BALANCE AT APRIL 30, 2003 - SUCCESSOR COMPANY 90 1 - 1,743 - - 1,744
Comprehensive Income
Net income (AS RESTATED) - - - - 234 - 234
Market value adjustment for investments - - - - - 1 1
-------
TOTAL COMPREHENSIVE INCOME 235
Issuance of restricted stock - - 3 (3) - - -
Pre-petition tax settlements/valuation
reserve adjustments - - - 233 - - 233
Purchase of treasury stock - - (4) - - - (4)
Other - - - 1 - - 1
------- ----- ---- ------- ------- ------- -------
(AS RESTATED)
BALANCE AT JANUARY 28, 2004 - SUCCESSOR COMPANY 90 $ 1 $ (1) $ 1,974 $ 234 $ 1 $ 2,209
------- ----- ---- ------- ------- ------- -------
See accompanying Notes to Consolidated Financial Statements
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1) EMERGENCE FROM CHAPTER 11 BANKRUPTCY PROTECTION
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 (as hereinafter defined). The Predecessor
Company became a wholly-owned subsidiary of Kmart Management Corporation, which
is a wholly-owned subsidiary of a newly-created holding company, Kmart Holding
Corporation ("Kmart" "we," "us" or "our" or the "Successor Company"). Kmart is
the nation's third largest discount retailer.
On January 22, 2002 ("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 ("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 ("Confirmation Date").
In connection with emergence from Chapter 11, 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
ended prior to May 1, 2003 generally are not comparable to those of the
Successor Company. In this Annual Report on Form 10-K/A, references to the
13-weeks ended April 30, 2003 and prior periods 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 our newly issued common stock ("Common Stock") in satisfaction of
pre-petition claims they held, and we issued 14 million shares 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 new 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 the Investment Agreement dated January 24, 2003, as amended
(the "Investment Agreement"). See Note 4, Restatement, for further discussion of
the Note and the related embedded beneficial conversion feature.
Each of the Plan Investors is represented on our Board of Directors.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Discharge of Liabilities
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
Common Stock and options to purchase 8,324,883 shares of Common Stock of which,
151,738 options to purchase such shares were cancelled during the third quarter
of fiscal 2003. 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 to 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, an independent
creditor litigation trust ("Creditor 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. 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 Common Stock and cash
recovery of $243 million.
Class 4 - Pre-petition Note Claims Issued 25,008,573 shares of Common Stock. Holders may
also receive, as described below, recoveries under the
Creditor Trust.
Class 5 - Trade Vendor and Lease Rejection Issued 31,945,161 shares of Common Stock. Holders may
Claims over $30,000 also receive, as described below, recoveries under the
Creditor Trust.
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. In addition, the holder of any Other
Unsecured claim may elect to be treated, in lieu of payment,
as a Trade Vendor/Lease Rejection claim holder. Holders
may also receive, as described below, recoveries under the
Creditor Trust.
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 $1,875 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 that would
otherwise constitute a Trade Vendor/Lease Rejection 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 Those who held common stock of the Predecessor Company
may receive their pro-rata share of up to 2.5% of the
recoveries under the Creditor Trust.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 their
pro-rata share of up to 2.5% of the recoveries under
the Creditor Trust.
Class 12 - Other Interests Cancelled - no recovery.
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 valid and otherwise allowable amounts, and therefore, there 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 regarding various matters. Kmart elected to eliminate these
intercompany claims during the fourth quarter of fiscal 2003.
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.
Trade Vendors Lien Program
On May 6, 2003, the post-emergence Trade Vendors' Lien Program became
effective. Under this program, certain vendors were granted mortgages on
specified 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. On December
30, 2003, we gave notice of our intent to terminate the program effective May 6,
2004.
Claims Resolution
We continue to make progress in the reconciliation and settlement of the
various classes of claims. On May 30, 2003, the Bankruptcy Court confirmed and
established May 6, 2003 as the record date for purposes of establishing the
persons that are claimholders of record to receive distributions in accordance
with the terms of the Plan of Reorganization. Since June 30, 2003, the first
distribution date established in the Plan of Reorganization, approximately 13.3
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 $2.4 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.
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 amount of each quarterly distribution will depend on the amount of the
claims allowed and the reserve established for disputed claims, in either
instance as of the respective distribution date. The next scheduled distribution
under the Plan of Reorganization is expected to commence on or about April 1,
2004. In January 2004, we reduced the distribution reserve significantly,
resulting in the distribution of approximately 3 million additional shares to
claimants who had previously received shares for allowed claims.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations: Kmart operates discount department stores located in
49 states, Puerto Rico, the U.S. Virgin Islands, and Guam. We have one operating
segment that comprises our retail business.
Basis of Consolidation: The Consolidated Financial Statements include all
majority-owned subsidiaries in which we exercise control. Investments in which
we exercise significant influence, but which we do not control (generally 20% to
50% ownership interest), are accounted for under the equity method of
accounting. All material intercompany transactions and balances have been
eliminated.
Cash: Cash and cash equivalents include money market funds and all
highly-liquid investments with maturities of three months or less. Included are
temporary investments of $1.9 billion, $981 million and $323 million and
receivables for credit card sales transactions of $30 million, $47 million and
$41 million, at January 28, 2004, April 30, 2003 and January 29, 2003,
respectively. Also included in cash and cash equivalents is $5 million of
restricted cash at April 30, 2003 and January 29, 2003.
Merchandise Inventories: Merchandise inventories are stated at the lower
of cost or market, primarily under the retail inventory accounting method using
the first-in, first-out (FIFO) basis. The Predecessor Company method of
accounting for merchandise inventories was the last-in, first-out (LIFO) method.
In connection with Fresh-Start accounting, we have elected the FIFO method of
accounting for merchandise inventories. We believe that this change provides a
better matching of expenses and revenues given falling product costs that have
resulted in the value of merchandise inventories under the LIFO method
approximating 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 for the change in accounting method.
At January 29, 2003 the LIFO method was used to determine the cost for
$4,730 million of $4,825 million of merchandise inventories, which was $190
million lower than the amount 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. The Predecessor Company recorded a LIFO credit of $25 million and
$79 million to decrease the LIFO reserve in the 13-weeks ended April, 30, 2003
and fiscal 2002, respectively. A charge of $75 million was recorded in fiscal
2001 to increase the LIFO reserve.
Allowance for Doubtful Accounts: The Company provides an allowance for
doubtful accounts based on historical experience and on a specific
identification basis. Allowances for doubtful accounts on accounts receivable
balances were $78 million, $80 million and $67 million as of January 28, 2004,
April 30, 2003 and January 29, 2003, respectively.
Property and Equipment: Property and equipment are recorded at cost.
Additions and betterments are capitalized and include expenditures that
materially extend the useful lives of existing facilities and equipment.
Maintenance and repairs that do not materially improve or extend the lives of
the respective assets are expensed as incurred. In conjunction with Fresh-Start
accounting, our property and equipment at April 30, 2003 was adjusted to fair
value. See Note 3 - Fresh-Start Accounting.
Long-lived Assets: Long-lived assets consist primarily of land, buildings,
furniture, fixtures and equipment and leasehold improvements. It is our policy
to review our long-lived assets for possible impairment whenever events or
circumstances indicate that the carrying amount of an asset may not be
recoverable and annually when no such event has occurred. We review assets held
and used on a store-level basis, which is the lowest level of assets for which
there are identifiable cash flows. An impairment of long-lived assets exists
when future undiscounted cash flows are less than an asset groups' carrying
value over the estimated remaining useful life of the store. Impairment is
measured as the difference between carrying value and fair market value. Fair
market value is based on appraised value or estimated sales values of similar
assets in recent transactions. Assets to be disposed of are reported at the
lower of carrying amount or fair value less the cost to sell.
Capitalized Software Costs: Costs associated with the acquisition or
development of software for internal use are capitalized and amortized using the
straight-line method over the expected useful life of the software, which ranges
from 3 to 7 years.
Depreciation and Amortization: Depreciation and amortization, including
depreciation of property held under capital leases, are computed based upon the
estimated useful lives of the respective assets using the straight-line method
for financial statement purposes, and accelerated methods for tax purposes. The
range of lives are generally 25 to 50 years for buildings, 5 to 25 years for
leasehold improvements, 3 to 20 years for furniture, fixtures and equipment, and
3 to 7 years for computer systems and computer equipment.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Credit Risk: Financial instruments which potentially subject us to
concentration of credit risk consist principally of temporary cash investments
and accounts receivable. We place our cash and cash equivalents in
investment-grade, short-term instruments with high quality financial
institutions and, by policy, limit the amount of credit exposure in any one
financial instrument. We perform ongoing credit evaluations of our customers'
financial condition and generally, require no collateral from our customers.
Financial Instruments: Cash and cash equivalents, accounts receivable,
trade accounts payable, credit facilities and accrued liabilities are reflected
in our financial statements at cost, which approximates fair value due to the
short-term nature of these instruments. The fair value of our debt and other
financial instruments is discussed in Note 11 - Long-Term Debt and Mortgages
Payable.
Derivative Instruments and Hedging Activities: We do not engage in hedging
transactions or invest in derivative instruments.
Self-insurance: We self-insure or retain a portion of the exposure for
losses related to workers compensation, health care benefits and general
liability costs. It is our policy to record our self-insurance reserves, as
determined actuarially, based upon claims filed and an estimate of claims
incurred but not yet reported.
Revenue Recognition: We recognize revenue from the sale of merchandise at
the time the merchandise is sold, net of anticipated returns. We defer the
recognition of layaway sales and profit until the period the merchandise is
delivered to the customer. Our deferred revenue is recorded in Accrued payroll
and other liabilities in the accompanying Consolidated Balance Sheets.
Vendor Rebates and Allowances: Payments from vendors in the form of buy
downs, volume or other purchase discounts that are evidenced by signed
agreements are reflected in the carrying value of the merchandise inventories
when earned and as a component of Cost of sales, buying and occupancy as the
merchandise is sold. Up-front consideration received from vendors linked to
purchases or other commitments is initially deferred and amortized ratably to
Cost of sales, buying and occupancy over the life of the contract or as
performance of the activities specified by the vendor to earn the fee is
completed. Upon the adoption of Emerging Issues Task Force ("EITF") Issue No.
02-16, "Accounting by a Customer (Including a Reseller) for Certain
Consideration Received from a Vendor" ("EITF 02-16") in the fourth quarter of
fiscal 2002, we began classifying co-op advertising credits as a reduction to
Cost of sales, buying and occupancy. Prior to the adoption of EITF 02-16, these
costs were classified as a reduction to advertising expense in Selling, general
and administrative expenses ("SG&A").
Pre-Opening Costs: The costs of start-up activities are expensed in the
period in which they occur.
Advertising Costs: Advertising costs are expensed as incurred and amounted
to $429 million, $182 million, $625 million and $623 million for the 39-week
period ended January 28, 2004, the 13-week period ended April 30, 2003, and
fiscal years 2002 and 2001, respectively. These costs are included in SG&A in
the accompanying Consolidated Statements of Operations. Advertising costs are
net of co-op recoveries from vendors of $276 million and $427 million for 2002
and 2001, respectively. Fiscal 2003 co-op recoveries are classified in Cost of
sales, buying & occupancy in accordance with EITF 02-16 as noted above.
Income Taxes: Deferred income taxes are provided for temporary differences
between financial statement and taxable income. We accrue U.S. and foreign taxes
payable on our pro rata share of the earnings of subsidiaries, except with
respect to earnings that are intended to be permanently reinvested, or expected
to be distributed free of additional tax by operation of relevant statutes
currently in effect, and by utilization of available tax credits and deductions.
The Predecessor Company recorded a full valuation allowance against net deferred
tax assets in accordance with Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes," ("SFAS No.109"), as realization
of such assets in future years was uncertain. Adequacy of the valuation
allowance is reevaluated periodically based on the expected timing of
utilization of the related assets and the likelihood of future taxable income.
See Note 18 - Income Taxes.
Stock-based Compensation: In the second quarter, we voluntarily elected to
account for stock-based compensation using the fair value method on a
prospective basis as permitted by SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment of FASB Statement No.
123" ("SFAS No. 148"). The impact of the election was not material to the
results of operations for any period presented. During the second quarter of
fiscal 2003, approximately 1.7 million options to purchase shares of common
stock of the Successor Company were granted, of which 151,738 options were
cancelled during the third quarter.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Prior to the adoption of SFAS No. 148, stock options were accounted for
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, 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, the pro
forma effects of recognizing compensation income (expense) on net loss and loss
per share, had the Predecessor Company applied the fair value method of
accounting for stock options is as follows:
Fiscal Year
13-Weeks Ended ------------------------
(dollars in millions, except per share data) April 30, 2003 2002 2001
- --------------------------------------------------------- -------------- --------- ----------
Net loss, as reported $ (862) $ (3,219) $ (2,446)
Deduct: Total stock-based employee compensation
income (expense) determined under the fair value
based method for all awards, net of related tax effects 38 (14) (55)
--------- -------- ---------
Pro forma net loss $ (824) $ (3,233) $ (2,501)
========= ======== =========
Basic/diluted loss per share:
As reported $ (1.65) $ (6.36) $ (4.95)
========= ======== =========
Pro forma $ (1.58) $ (6.39) $ (5.06)
========= ======== =========
To determine these amounts, the fair value of each stock option was
estimated on the date of grant using a Black-Scholes option-pricing model with
the following assumptions for fiscal 2001: risk-free rate of 4.84%, dividend
yield of 0%, expected volatility of 0.44 and an expected life of the options of
5 years. The weighted average value of the options granted in fiscal 2001 was
$3.84. No options were granted in the 13-weeks ended April 30, 2003 or fiscal
2002.
All outstanding stock options of the Predecessor Company were cancelled in
accordance with the Plan of Reorganization.
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.
Earnings (Loss) 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 average common shares outstanding to diluted
average common shares outstanding for the 39-weeks ended January 28, 2004 is as
follows:
Successor
Company
----------------
39-Weeks Ended
(in millions) January 28, 2004
- -------------------------------- ----------------
(as restated)
Basic weighted average shares 89.6
Dilutive effect of stock options 3.7
----
Diluted weighted average shares 93.3
====
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Note, convertible into 6 million shares of the Company's Common Stock,
was excluded from the calculation of diluted earnings per share for the 39-weeks
ended January 28, 2004 as it was anti-dilutive. 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 and fiscal years 2002 and 2001 as
they were anti-dilutive. Upon emergence from bankruptcy, all common stock
equivalents of the Predecessor Company were cancelled.
Use of Estimates: The preparation of the Consolidated Financial Statements
in conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Significant estimates are
required as part of inventory valuation, allowance for doubtful accounts,
restructuring charges, long-lived asset impairments, self-insurance reserves,
pension benefits, legal reserves, and valuation allowances on deferred income
taxes. Actual amounts, particularly with respect to matters impacted by the
proceedings under Chapter 11, could differ from those estimates.
Reclassifications: Certain reclassifications of prior period amounts have
been made to conform to the current period presentation.
New Accounting Pronouncements: 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 had to adopt, upon emergence from Chapter 11, all
accounting guidance that would otherwise become effective within the next twelve
months. We adopted SFAS No. 149 effective April 30, 2003. There was no impact to
the Company upon the adoption of SFAS No. 149.
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, the Company had to adopt, upon emergence from Chapter
11, all accounting guidance that would otherwise become effective within the
next twelve months. We 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.
In December 2003, the EITF issued EITF Issue No. 03-10, "Application of
EITF Issue No. 02-16, `Accounting by a Customer (Including a Reseller) for
Certain Consideration Received from a Vendor', by Resellers to Sales Incentives
Offered to Consumers by Manufacturers" ("EITF 03-10"). According to EITF 03-10,
manufacturers' coupons that meet certain criteria should be recorded gross-basis
as revenue, and are not subject to the guidance in EITF 02-16. The provisions of
the consensus will be applicable to Kmart for new and modified arrangements we
enter into in fiscal 2004. We do not anticipate any impact upon adoption of EITF
03-10 as Kmart's current accounting for manufacturers' coupons conforms to this
requirement.
In December 2003 the FASB issued 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
disclosure requirements that were effective for fiscal years ending after
December 15, 2003 in this Annual Report on Form 10-K/A. Additional disclosure
required for interim reporting and fiscal years beginning after June 15, 2004
will be disclosed when required.
We have reviewed all new applicable guidance and do not deem any other
standards to have a significant effect on the Company's financial statements.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3) FRESH-START ACCOUNTING
Fresh-Start Adjustments
In accordance with Fresh-Start accounting, all assets and liabilities were
recorded at their respective fair market values upon emergence from Chapter 11.
Such fair values represented our best estimates based on independent appraisals
and valuations. Immaterial differences between estimated pre-petition
liabilities assumed by the Successor Company and the final settlement amounts
are recognized as they occur.
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, the enterprise value
was determined by the Company, 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 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 Consolidated Statements of Operations. In
addition, the excess of fair value of net assets over reorganization value
("negative goodwill") of approximately $5.6 billion was allocated on a pro-rata
basis reducing our non-current, non-financial instrument assets to $10 million
as of April 30, 2003.
As part of the provisions of SOP 90-7, we were required to adopt on April
30, 2003 all accounting guidance that was going to be effective within a
twelve-month period. See Note 2 - Summary of Significant Accounting Policies for
a discussion of the impact on our financial statements of the accounting
guidance we adopted.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table reflects the reorganization adjustments to the Consolidated
Balance Sheet as of April 30, 2003:
PREDECESSOR SUCCESSOR
COMPANY COMPANY
APRIL 30, 2003 ADJUSTMENTS RECAPITALIZATION APRIL 30, 2003
-------------- ----------- ---------------- --------------
(AS RESTATED) (AS RESTATED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,232 $ - $ - $ 1,232
Merchandise inventories 4,446 (15)1 - 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 LIABILITIES
Long-term debt - - 59 2 59
Capital lease obligations 415 - - 415
Other long-term liabilities 174 279 1 1,226 2 1,679
------------- ----------- ------------- -------------
TOTAL LONG-TERM LIABILITIES 589 279 1,285 2,153
TOTAL LIABILITIES NOT
SUBJECT TO COMPROMOSE 2,655 396 1,865 4,916
LIABILITIES SUBJECT TO COMPROMISE 8,896 114 1 (9,010)2 -
Trust convertible securities 387 (387)1 - -
SHAREHOLDERS' EQUITY (DEFICIT)
Accumulated other comprehensive income (907) 907 1 - -
Common stock 537 (537)1 1 3 1
Other equity (527) (5,107)1 7,377 4 1,743
------------- ----------- ------------- -------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) (897) (4,737) 7,378 1,744
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 write-off of the 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 received from the Plan Investors.
3. To record par value of new common stock of the Successor Company.
4. To record gain on discharge of liabilities subject to compromise and
additional paid-in-capital of new common stock of the Successor Company
and to record $31 million related to the beneficial conversion feature of
the Note with the Plan Investors.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
4. RESTATEMENT
The accompanying consolidated financial statements as of January 28, 2004,
and April 30, 2003 and for the 39-weeks ended January 28, 2004 have been
restated. The restatement reflects the recognition of an embedded beneficial
conversion feature of the Company's convertible Note with the Plan Investors.
Accounting for the embedded beneficial conversion feature and the resulting
recognition of additional interest expense is in accordance with Emerging Issues
Task Force Issue No. 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments" ("EITF 00-27").
As discussed in Note 1, the Note with the Plan Investors is convertible
into shares of Common stock at a conversion price equal to $10 per share. The
accounting treatment of the Note is based on the determination of a commitment
date as defined by EITF 00-27. A commitment date occurs when, amongst other
things, an agreement is binding on both parties and the agreement specifies all
significant terms , including the quantity to be exchanged. For purposes of
calculating the intrinsic value of the embedded beneficial conversion feature,
the Company initially determined that the commitment date was January, 24, 2003,
the date the Investment Agreement with the Plan Investors was signed. It was
subsequently determined that the commitment date was May 6, 2003, the date the
Note was issued and when the quoted market price of the Company's Common stock
was $15.
Upon applying the criteria of EITF 00-27, the Company first allocated
the proceeds received from the Plan Investors, net of expenses, of $187 million
to the Note, Common stock and stock options issued pursuant to the Investment
Agreement and based on their relative fair values. The Company used a
Black-Scholes model to value the stock options with the following assumptions:
no dividend yield, option life of two years, volatility of 45 percent and an
interest rate of 2.76 percent. The fair value of the options was $32 million as
of May 6. 2003. The fair value of the convertible debt was based on the market
price of our Common stock of $15 on the issuance date, and was $90 million as of
May 6. 2003.
An effective conversion price was then calculated and used to measure the
intrinsic value of the embedded beneficial conversion feature. The resulting
discount of $49 million reduced the initial carrying amount of the Note to $11
million, with a corresponding increase in Capital in excess of par value. In
addition, the Company recognized a related deferred tax liability of $18 million
due to the difference between the book and tax basis of the Note, with a
corresponding decrease in Capital in excess of par value. The debt discount was
amortized to interest expense over one year using the effective interest method
through December 2003, at which time the Plan Investors elected to extend the
term of the Note an additional two years through May 6, 2006. The remaining debt
discount as of December 2003 will be recognized over the additional two year
term.
We recognized an additional $22 million of interest expense due to the
amortization of the discount in the 39-weeks ended January 28, 2004.
Following is the effect of our restatement on our Consolidated Statement
of Operations for the 39-weeks ended January 28, 2004 and on our Consolidated
Balance Sheets as of April 30, 2003 and January 28, 2004.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
EFFECT OF THE RESTATEMENTS ON THE CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
39-WEEKS ENDED JANUARY 28, 2004
---------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
Income before interest expense and income taxes $ 505 $ - $ 505
Interest expense, net 105 22 127
-------------- ----------- ----------
Income before income taxes 400 (22) 378
Provision for income taxes 152 (8) 144
-------------- ----------- ----------
Net income $ 248 $ (14) $ 234
============== =========== ==========
Basic net income per common share $ 2.77 $ (0.16) $ 2.61
============== =========== ==========
Diluted net income per common share $ 2.52 $ (0.01) $ 2.51
============== =========== ==========
Diluted weighted average shares (millions) 99.3 (6.0) 93.3
============== =========== ==========
The restatement had no effect on the Predecessor Company's consolidated
financial statements for the 13-weeks ended April 30, 2003, fiscal 2002 or
fiscal 2001.
EFFECT OF THE RESTATEMENTS ON THE CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
JANUARY 28, 2004
------------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
ASSETS
Other assets and deferred charges $ 120 $ (10) $ 110
============== ========= ==========
Total Assets $ 6,084 $ (10) $ 6,074
============== ========= ==========
LIABILITIES
Long-term debt and mortgages payable $ 103 $ (27) $ 76
============== ========= ==========
Total long-term liabilities $ 2,116 $ (27) $ 2,089
============== ========= ==========
Total liabilities not subject to compromise $ 3,892 $ (27) $ 3,865
============== ========= ==========
SHAREHOLDERS' EQUITY
Capital in excess of par value $ 1,943 $ 31 $ 1,974
============== ========= ==========
Retained earnings $ 248 $ (14) $ 234
============== ========= ==========
Total shareholders' equity $ 2,192 $ 17 $ 2,209
============== ========= ==========
Total Liabilities and Shareholders' Equity $ 6,084 $ (10) $ 6,074
============== ========= ==========
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
APRIL 30, 2003
------------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
LIABILITIES
Long-term debt and mortgages payable $ 108 $ (49) $ 59
============== ========= ==========
Other long-term liabilities $ 463 $ 18 $ 481
============== ========= ==========
Total long-term liabilities $ 2,184 $ (31) $ 2,153
============== ========= ==========
Total liabilities not subject to compromise $ 4,947 $ (31) $ 4,916
============== ========= ==========
SHAREHOLDERS' EQUITY
Capital in excess of par value $ 1,712 $ 31 $ 1,743
============== ========= ==========
Total shareholders' equity $ 1,713 $ 31 $ 1,744
============== ========= ==========
The deferred tax liability was offset with the Company's other deferred
tax liabilities and assets for each period and presented as a single amount in
the Consolidated Balance Sheet. The Company had a net deferred tax liability as
of April 30, 2003 which was classified in Other long-term liabilities. The
Company had a net deferred tax asset as of January 28, 2004 which was classified
in Other assets and deferred charges.
5) DISCONTINUED OPERATIONS
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, the Predecessor Company
commenced store closing sales which were completed by April 13, 2003.
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 certain financial requirements for ongoing operations. All the stores were
closed as of June 2, 2002.
SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets," ("SFAS No. 144") 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 met the second criteria, as
upon closure of the stores, operations ceased and the Company had no continuing
involvement. To determine if cash flows had been or would 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 fiscal 2003, which
included a substantial exit of the state of Texas, we reevaluated the 283 stores
that were closed in fiscal 2002 and the 316 stores closed in fiscal 2003 to
identify stores that should be accounted for as discontinued operations. This
analysis resulted in a total of 121 stores identified as meeting the criteria
for discontinued operations treatment for all periods presented in our
Consolidated Statements of Operations, comprised of 66 of the 316 stores closed
in fiscal 2003 and 55 of the 283 stores closed in fiscal 2002. The table below
sets forth the components of the net loss for the discontinued operations for
the 13-weeks ended April 30, 2003 and fiscal years 2002 and 2001.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
13-Weeks Ended Fiscal Year
---------------------
(dollars in millions) April 30, 2003 2002 2001
- --------------------------------------------------------- ------------------ --------- --------
Sales $ 232 $ 1,410 $ 1,971
Cost of sales, buying and occupancy 150 1,416 1,660
---------- --------- --------
Gross margin 82 (6) 311
Selling, general and administrative expenses 43 297 402
Restructurings, impairments and other charges 5 165 144
Reorganization items, net 44 23 -
---------- --------- --------
Discontinued operations from 2002 and 2003 store closings (10) (491) (235)
Previous discontinued operations - 43 166
---------- --------- --------
Discontinued operations, net of tax $ (10) $ (448) $ (69)
========== ========= ========
In connection with the Predecessor Company's bankruptcy filing, the
Predecessor Company recorded primarily non-cash credits in fiscal years 2002 and
2001 of $43 million and $166 million, respectively, for the reduction of
existing lease obligations for previously reported discontinued operations for
owned subsidiaries, due to the rejection of such leases, to the amount of the
allowed claim under the Bankruptcy Code. The fiscal 2002 amounts also include
income related to the recovery of claims through the bankruptcy of the Hechinger
Company.
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, the
Predecessor Company instituted certain restructuring actions to improve
operations and executed significant inventory liquidations as a result of the
stores closed under the Chapter 11 proceedings. Also, in accordance with SFAS
No. 144, the Predecessor Company recorded impairment charges in fiscal years
2002 and 2001. The effect of these actions on the 13-weeks ended April 30, 2003
and fiscal years 2002 and 2001 are summarized below.
2002 Markdowns for Inventory Liquidation
During fiscal 2002, the Predecessor Company recorded charges aggregating
$1,256 million related to inventory that was liquidated at the 316 stores that
were closed during the first quarter of fiscal 2003 and the 283 stores that were
closed in the second quarter of fiscal 2002. Of the charge, $1,019 million is
included in Cost of sales, buying and occupancy and $237 million is included in
Discontinued operations in the accompanying Consolidated Statements of
Operations.
Of the charge, $779 million was recorded to write-down inventory to its
estimated selling value in connection with the liquidation sales in the closing
stores. During the liquidation sales for the 283 stores closed in the second
quarter of fiscal 2002, the actual markdowns required to liquidate the inventory
were lower than expected. As a result, a credit of $36 million was recorded to
adjust the original estimate. In addition, $193 million of liquidator fees and
expenses were incurred as result of the disposition of the inventory.
The remaining $320 million was recorded as acceleration of markdowns on
approximately 107,000 stock keeping units ("SKUs"), the majority of which were
transferred from the remaining open stores to the 283 closed stores and included
in the liquidation sales. The liquidation of these SKUs required higher
markdowns than anticipated, and accordingly, additional markdowns of $54 million
were recorded in the second quarter of 2002 in addition to the $266 million
original estimate.
Long-lived Asset Impairments
During fiscal 2002, a non-cash charge of $695 million was recorded in
accordance with SFAS No. 144 for long-lived assets in the 316 closed store
locations. Of the charge, $533 million is included in Restructuring, impairment
and other charges and $162 million is included in Discontinued operations in the
accompanying Consolidated Statements of Operations.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
During fiscal 2001, a non-cash charge of $971 million was recorded in
accordance with SFAS No. 144, of which $921 million related to long-lived assets
in stores, and $50 million related to capital projects that were cancelled due
to capital expenditure restrictions in the Predecessor Company's DIP Credit
Facility. Of the charge, $827 million is included in Restructuring, impairment
and other charges and $144 million is included in Discontinued operations in the
accompanying Consolidated Statements of Operations.
Corporate Cost Reduction Initiatives
During fiscal 2002 and the 13-weeks ended April 30, 2003, the Predecessor
Company eliminated approximately 950 positions at the corporate headquarters and
positions nationally that provided corporate support. As a result of the job
eliminations, a charge of $50 million was recorded in fiscal 2002, which was
later reduced by $10 million in the 13-weeks ended April 30, 2003 as a result of
a change in the estimated expenses. An additional $50 million was incurred
related to the severance plan provisions of the Predecessor Company's KERP, in
accordance with SFAS No. 112, "Employers' Accounting for Postemployment
Benefits" ("SFAS No. 112"). These items are included in the line Restructuring,
impairment and other charges in the accompanying Consolidated Statements of
Operations.
Supply Chain Operations
During fiscal 2001 the Predecessor Company announced the restructuring of
certain aspects of its supply chain infrastructure and recorded a charge of $163
million. The charge consisted of $93 million for the disposal of supply chain
software and hardware and other assets that were no longer utilized and $23
million for accelerated depreciation related to operating software the company
anticipated replacing in its distribution centers. An additional $47 million was
recorded for lease terminations and contractual employment obligations for staff
reductions of 956 employees at the distribution centers in accordance with EITF
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity" ("EITF 94-3"). Of the charge, $88 million
for asset impairments was recorded in SG&A, and the remainder of the charge is
included in Cost of sales, buying and occupancy.
An additional $9 million of accelerated depreciation was recorded in
2002 of which $7 million and $2 million were included in Cost of sales, buying
and occupancy and SG&A, respectively, before the replacement initiative was
suspended and the remaining net book value of assets was depreciated over the
original useful lives.
Restructuring of BlueLight.com
During fiscal 2001, the Predecessor Company recorded a $97 million charge
related to its e-commerce site, BlueLight.com (currently kmart.com), comprised
of $41 million for the impairment of the investment in BlueLight.com, $51
million for the restructuring of the e-commerce business and $5 million of
severance benefits to 114 employees at the BlueLight.com headquarters. The
results of BlueLight.com's operations have been fully consolidated in the
financial statements commencing July 31, 2001, when the remaining 40% interest
in BlueLight.com was acquired.
In fiscal 2002, the Predecessor Company reduced the reserves established
for BlueLight.com contract terminations by $6 million based on revised estimates
for the remaining obligations. All charges related to the impairment of the
investment and restructuring of BlueLight.com are included in the line
Restructuring, impairment and other charges in the Consolidated Statements of
Operations.
Other
Employee Severance and VERP
During fiscal 2001, the Predecessor Company's workforce was reduced by 350
employees through a voluntary early retirement program ("VERP") and other
employee separations. The total cost of the realignment totaled $23 million,
which is included in the line Restructuring, impairment and other charges in the
Consolidated Statements of Operations.
Accelerated Depreciation
The Predecessor Company recorded $52 million and $30 million during the
13-weeks ended April, 30, 2003 and fiscal 2002, respectively, for accelerated
depreciation on unimpaired assets to be disposed of following the 316 and 283
store closings. The $30 million recorded in fiscal 2002 is included in the line
Cost of sales, buying and occupancy in the Consolidated Statements of
Operations. Of the $52 million recorded in the 13-weeks ended April 30, 2003,
$47 million is included in Restructurings, impairments and other charges and $5
million is included in Discontinued operations in the Consolidated Statements of
Operations.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Reserve Activity
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 Consolidated Statements of Operations. In
addition, the Predecessor Company reclassified $181 million 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."
As a result of the decision to close the 283 stores, the Predecessor
Company recorded net charges of $207 million during fiscal 2002, of which $22
million is included in Discontinued operations and the remaining $185 million is
included in Reorganization items, net in the Consolidated Statements of
Operations. In addition, the Predecessor Company reclassified $144 million of
capital lease obligations to the closed store reserve. The reserve for estimated
costs was recorded in accordance with EITF 94-3.
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 1 - Emergence from Chapter 11 Bankruptcy
Protection for a detailed discussion of the discharge of Liabilities subject to
compromise under the Plan of Reorganization.
The following table provides information regarding reserve activity:
2003 2002 2002 2001 2001 2000
Store Employee Store Supply BlueLight Strategic
(dollars in millions) Closings Severance Closings Chain .com Actions
- ---------------------------------- -------- --------- -------- --------- --------- ---------
Balance as of January 30, 2002 $ - $ - $ - $ 11 $ 18 $ 98
Additions charged to operations - 101 228 1 - -
Reclassifications - - 140 - - -
-------- --------- -------- --------- --------- ---------
Total additions - 101 368 1 - -
Reductions:
Cash payments:
Lease obligations - - 11 - 1 2
Employee costs - 31 - 5 - -
Contractual obligations - - - - 1 -
Non-cash reductions:
Adjustments - - 21 - 6 1
Pre-petition liability settlements - 1 42 5 4 -
-------- --------- -------- --------- --------- ---------
Balance as of January 29, 2003 - 69 294 2 6 95
Additions charged to operations 214 7 - - - -
Reclassifications 181 - - - - -
-------- --------- -------- --------- --------- ---------
Total additions 395 7 - - - -
Reductions:
Cash payments for employee costs - 40 - - - -
Non-cash reductions:
Discharge of liabilities 395 - 294 2 6 95
Adjustments - - - - - -
-------- --------- -------- --------- --------- ---------
Balance as of April 30, 2003 $ - $ 36 $ - $ - $ - $ -
======== ========= ======== ========= ========= =========
Restructuring reserves related to the fiscal 2002 employee severance
program of $36 million were assumed by the Successor Company. Payments made
against this reserve were $28 million during the during the 39-week period ended
January 28, 2004. In addition, we recorded non-cash reductions of $4 million to
the reserve during the 39-week period ended January 28, 2004. As of January 28,
2004, the liability for the 2002 employee severance program is $4 million.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
7) 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
accompanying Consolidated Statements of Operations as required by SOP 90-7.
Fiscal Year
13-Weeks Ended -------------------
(dollars in millions) April 30, 2003 2002 2001
- ------------------------------------------------- -------------- ------ --------
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 - -
2002 store closings - 185 -
Other 26 178 (183)
-------------- ------ --------
Reorganization items, net $ 769 $ 363 $ (183)
============== ====== ========
The following paragraphs provide additional information relating to costs
that were reported in the line Reorganization items, net in our Consolidated
Statements of Operations for all periods presented:
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, the Predecessor Company announced that it had
terminated the supply relationship with Fleming by means of a rejection of the
2001 contract through the 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 1 - Emergence from Chapter 11 Bankruptcy
Protection.
2003 store closings
As discussed in Note 6 - Special Charges, the Predecessor Company recorded
a charge of $214 million for lease terminations and other costs associated with
the 316 stores closed in fiscal 2003. Of the charge, $158 million is included in
Reorganization items, net in the Consolidated Statements of Operations, and the
remaining $56 million is included in Discontinued operations.
2002 store closings
As discussed in Note 6 - Special Charges, the Predecessor Company recorded
net charges of $207 million associated with the 283 stores closed in fiscal
2002. Of the charge, $185 million is included in Reorganization items, net in
the Consolidated Statements of Operations and the remaining $22 million is
included in Discontinued operations.
43
NOTES TO 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 Employees Retention Program ("KERP"), a gain of $17 million for the sale of
pharmacy lists for closed stores, income of $65 million for lease auction
proceeds related to the fiscal years 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.
For fiscal 2002, the Predecessor Company recorded employee costs of $143
million relating to the KERP, professional fees of $112 million, $51 million of
expense to revise its estimated pre-petition obligation for general liability
claims, a gain of $100 million for the settlement of pre-petition liabilities,
income of $27 million for lease auction proceeds related to the 2002 closed
stores, a gain of $14 million for the sale of pharmacy lists and net expenses of
$13 million for other miscellaneous reorganization items.
For fiscal 2001, the Predecessor Company recorded a credit of $174 million
for the reduction of the estimated obligation for general liability claims based
upon the actuarial determination of the effect of the bankruptcy process on the
ultimate development of case reserves and claims incurred but not reported,
professional fees of $8 million, and a gain of $17 million for other
miscellaneous reorganization items.
8) OTHER CURRENT ASSETS
Other current assets included in the accompanying Consolidated
Balance Sheets consist of the following:
Predecessor
Successor Company Company
-------------------------- -----------
January 28, April 30, January 29,
(dollars in millions) 2004 2003 2003
- ------------------------------- ----------- --------- -----------
Property held for sale $ 56 $ 160 $ -
Prepaid sales tax 27 54 42
Supplies inventory 18 19 22
Deposit on real estate purchase 17 - -
Current deferred tax asset 16 - -
Debt issuance costs 15 19 48
Receivable from Plan Investors - 187 -
Other 35 70 79
----------- --------- -----------
Total $ 184 $ 509 $ 191
=========== ========= ===========
During the first quarter of fiscal 2003, the Predecessor Company
classified $160 million of property as held for sale in accordance with SFAS No.
144. During the last three quarters of fiscal 2003, we sold $104 million of
these assets, for a gain of $4 million. Property held for sale consists
primarily of closed store locations and undeveloped property that we are
actively marketing and expect to sell within one year.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
9) PROPERTY AND EQUIPMENT
Predecessor
Successor Company Company
-------------------------- -----------
January 28, April 30, January 29,
(dollars in millions) 2004 2003 2003
- ------------------------------------------- ------------ --------- -----------
Land $ 22 $ - $ 426
Buildings 27 1 1,086
Leasehold improvements 29 3 2,882
Furniture, fixtures and equipment 67 6 5,178
Construction in progress 14 - 81
------------ --------- -----------
159 10 9,653
Property under capital lease - - 1,243
------------ --------- -----------
159 10 10,896
Less:
Accumulated depreciation and amortization (6) - (5,116)
Accumulated depreciation on capital leases - - (888)
------------ --------- -----------
Total $ 153 $ 10 $ 4,892
============ ========= ===========
See Note 3 - Fresh-Start Accounting for a discussion of the write-off of
property and equipment upon adoption of Fresh-Start accounting.
The following table provides a breakdown of the number of stores leased
compared to owned as of January 28, 2004, April 30, 2003 and January 29, 2003:
Predecessor
Successor Company Company
-------------------------- -----------
January 28, April 30, January 29,
(dollars in millions) 2004 2003 2003
- ------------------------------------------- ------------ --------- -----------
Number of Kmart stores owned 135 118 133
Number of Kmart stores leased 1,376 1,395 1,696
----- ----- -----
Total 1,511 1,513 1,829
===== ===== =====
10) ACCRUED PAYROLL AND OTHER LIABILITIES
Accrued payroll and other liabilities included in the accompanying
Consolidated Balance Sheets consist of the following:
Predecessor
Successor Company Company
-------------------------- -----------
January 28, April 30, January 29,
(dollars in millions) 2004 2003 2003
- ------------------------------------------------------------- ------------ ---------- -----------
Accrued payroll and related liabilities $ 222 $ 211 $ 172
Accrued expenses 155 276 177
Current portion of workers compensation and general liability 101 77 68
Current portion of capital lease obligation 47 58 68
Income taxes payable 37 134 40
Gift certificates 29 29 37
Accrued emergence and reclamation payments 12 422 -
Employee severance 7 41 75
Other liabilities 61 73 73
---------- -------- ---------
Total $ 671 $ 1,321 $ 710
========== ======== =========
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
11) LONG-TERM DEBT AND MORTGAGES PAYABLE
Predecessor
Successor Company Company
------------------------- -----------
Fiscal Year Interest January 28, April 30, January 29,
(dollars in millions) Maturity Rates 2004 2003 2003
- ----------------------------------------- ----------- ------------- ------------ --------- -----------
(as restated) (as restated)
Convertible subordinated notes, net 2006 9.00% $ 33 $ 11 $ -
Mortgages payable 2005-2017 7.53% - 12.50% 47 56 61
Predecessor Company credit facilities 2002 Floating - - 1,069
Debentures 2004-2023 7.75% - 12.50% - - 1,995
Medium-term notes 2002-2020 7.33% - 9.00% - - 223
------- ------ ------
Total 80 67 3,348
Less amounts subject to compromise - - (3,348)
Less current portion of mortgages payable 4 8 -
------- ------ -------
Long-term debt and mortgages payable $ 76 $ 59 $ -
======= ====== =======
Credit Facility
On May 6, 2003, our Credit Facility, syndicated by General Electric
Capital Corporation, Fleet Retail Finance Inc. and Bank of America, N.A., became
effective. Debt issuance costs associated with the Credit Facility totaled $60
million of which $48 million was paid during fiscal 2003 and all of which will
be amortized through May 2006. The Credit Facility is a revolving credit
facility under which Kmart Corporation is the borrower and contains an $800
million letter of credit sub-limit. 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. In December 2003, we
voluntarily reduced the size of the Credit Facility to $1.5 billion to reduce
the overall cost of the facility. In conjunction with the reduction of our
Credit Facility, we accelerated the amortization of the associated debt issuance
costs of approximately $12 million.
The Credit Facility was also amended in December 2003 to reduce interest
rates, among other things. 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 amendment also gave the Company the ability to use surplus cash, as defined
in the Credit Facility of up to $250 million for the purchase of the Company's
common stock.
As of January 28, 2004 we had utilized $420 million of the Credit Facility
for letters of credit issued for ongoing import purchasing operations, and
contractual and regulatory purposes. Collateral in the form of letters of credit
is provided to support our self-insurance programs. As collateral requirements
change periodically, we continue to evaluate the amount and form of collateral
under these programs. Total availability under the Credit Facility at January
28, 2004 was approximately $1.1 billion.
The Credit Facility financial covenants include a requirement that Kmart
maintain certain specified excess 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 necessary to maintain our operations.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Predecessor Company Debt
Borrowings of the Predecessor Company were available through the 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 million 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.
Other
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 and
accordingly, 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 on certain pre-petition debt totaled $67
million, $271 million and $8 million for the 13-week period ended April 30,
2003, and fiscal years 2002 and 2001, respectively.
Included in Interest expense, net in the accompanying Consolidated
Statements of Operations is interest income of $10 million, $1 million, $4
million, and $4 million, for the 39-week period ended January 28, 2004, the
13-week period ended April 30, 2003, and fiscal years 2002 and 2001,
respectively.
The contractual principal maturities of long-term debt for the five years
subsequent to fiscal 2003 are: 2004 - $4 million; 2005 - $4 million; 2006 - $64
million; 2007 - $5 million; 2008 - $5 million and 2009 and later - $25 million.
Cash paid for interest was $8 million, $7 million and $205 million for the
39-week period ended January 28, 2004, and fiscal years 2002 and 2001,
respectively. No interest was paid for the 13-week period ended April 30, 2003.
The estimated fair value of the convertible notes at January 28, 2004 and
April 30, 2003 was $169 million and $90 million, respectively. The estimated
fair market value of debentures included in long-term debt classified in
Liabilities subject to compromise, was approximately $332 million at January 29,
2003. The estimated fair market value was based on the quoted market prices for
the same or similar issues or on the current rates offered to Kmart for debt of
the same remaining maturities. Fair market value for medium-term notes
classified in Liabilities subject to compromise could not be reasonably
estimated at January 29, 2003. The estimated fair value of our mortgages payable
approximated carrying value for all periods presented.
12) CONVERTIBLE PREFERRED SECURITIES
In June 1996, a trust sponsored and wholly-owned by the Predecessor
Company issued to the public 20,000,000 trust convertible preferred securities
("Preferred Securities"). The proceeds from the sale of the Preferred
Securities, together with the proceeds of a sale of common trust securities to
the Predecessor Company, were used to purchase from the Predecessor Company 7
3/4% subordinated convertible debentures due June 15, 2016. The debentures were
the sole asset of the trust.
The Preferred Securities accrued and paid cash distributions quarterly at
a rate of 7 3/4% per annum. The Predecessor Company stopped accruing
distributions on the Preferred Securities in accordance with SOP 90-7.
Contractual distributions on the Preferred Securities for the 13-week period
ended April 30, 2003, and fiscal years 2002 and 2001 were $11 million, $65
million and $72 million, respectively.
Upon emergence, all convertible preferred securities of the Predecessor
Company were cancelled.
13) LEASES
We conduct our operations primarily in leased facilities. Our store leases
are generally for terms of 25 years with multiple five-year renewal options that
allow us the option to ext end the life of the lease up to 50 years beyond the
initial non-cancelable term. In certain Kmart leased facilities, selling space
has been sublet to other retailers, including Olan Mills, Inc. and the Meldisco
subsidiaries of Footstar, Inc. ("FTS").
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Minimum Lease
Commitments
As of January 28, 2004 ----------------------
(dollars in millions) Capital Operating
- ------------------------------------------------- ------- ---------
Fiscal Year:
2004 $ 128 $ 454
2005 114 425
2006 91 402
2007 79 366
2008 75 332
Later years 504 2,730
------- ---------
Total minimum lease payments 991 $ 4,709
=========
Less:
Estimated executory costs (303)
Amount representing interest (267)
-------
421
Less current portion of capital lease obligations (47)
-------
Capital lease obligations $ 374
=======
In connection with the application of Fresh-Start accounting we recorded a
liability of $390 million representing the net present value of unfavorable
lease terms for operating leases. This amount was determined based upon a third
party appraisal. As of January 28, 2004 the liability balance was $367 million.
Successor Predecessor Company
Company --------------------------------
---------------- Fiscal Year
39-Weeks Ended 13-Weeks Ended -------------
Rent Expense (dollars in millions) January 28, 2004 April 30, 2003 2002 2001
- ---------------------------------- ---------------- -------------- ---- ----
Minimum rentals $ 402 $ 141 $694 $771
Percentage rentals 17 6 30 39
Less-sublease rentals (125) (54) (229) (248)
---------------- -------------- ---- ----
Total $ 294 $ 93 $495 $562
================ ============== ==== ====
14) INVESTMENTS IN AFFILIATED COMPANIES
Meldisco
Kmart footwear departments are operated under a license agreement with the
Meldisco subsidiaries of 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
the Meldisco subsidiaries, filed for Chapter 11 protection in the United States
Bankruptcy Court for the Southern District of New York. FTS will continue to
operate its businesses and manage its properties as debtors in possession. At
the time of the filing, FTS and the Meldisco subsidiaries owed Kmart
approximately $13 million for certain fees due in accordance with the license
agreement, which were based upon the profits earned by the Meldisco subsidiaries
relating to periods prior to FTS' filing for Chapter 11 protection. In exchange
for Kmart's remittance to FTS of the weekly sales proceeds (net of fees and
expenses) generated by the Kmart footwear departments immediately prior to the
FTS filing, Kmart will retain $3 million of such proceeds to be applied against
the amounts owed to the Company by FTS. In addition, we will receive liens and a
superpriority claim against FTS property for $18 million. Kmart will continue to
remit weekly sales proceeds relating to the period subsequent to FTS' filing for
Chapter 11 protection.
The impact (if any) of the FTS bankruptcy filing, including potential
business interruption, on our future financial results will depend upon whether
FTS assumes or rejects our agreement and upon the success of FTS'
reorganization. At the time of our filing, FTS has not filed its plan of
reorganization with the bankruptcy court. Given the profitability of the
Meldisco subsidiaries, and the likelihood of future receipts of the amounts due
from the Meldisco subsidiaries, no valuation reserve has been established for
amounts due to us from FTS.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Prior to FTS filing for bankruptcy, we were 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 years 2002 or 2003 for
Meldisco at the time of our filing of this Annual Report on Form 10-K. We have
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 Consolidated Statements of Operations.
The following amounts are current estimates based upon all information
that was available to Kmart as of the date of our filing.
For the 39-weeks ended January 28, 2004, the 13-weeks ended April 30,
2003, and fiscal 2002 and 2001, Meldisco had net sales of $629 million, $246
million, $1,134 million and $1,209 million, respectively.
The table below lists the fees, rental and income earned from Meldisco,
dividend payments received from equity Meldisco, and unremitted equity earnings
from our minority ownership in Meldisco for the 39 -weeks ended January 28,
2004, the 13-weeks ended April 30, 2003 and fiscal years 2002 and 2001,
respectively.
Successor Company Predecessor Company
----------------- -----------------------------------
39-Weeks Ended 13-Weeks Ended Fiscal Year
(dollars in millions) January 28, 2004 April 30, 2003 2002 2001
- --------------------------- ----------------- -------------- ------ ------
Income earned $ 109 $ 49 $ 216 $ 255
Dividend payments received - 36 45 51
Unremitted equity earnings 12 7 34 46
Although there can be no assurance until Meldisco completes the
restatement of its financial statements, at this time, we do not expect the
restatement to have a material effect on our equity income from Meldisco.
As of January 28, 2004, ESL had a 9.9% ownership in the common stock of
FTS.
15) LIABILITIES SUBJECT TO COMPROMISE
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.
Except for secured debt and capital lease obligations, all pre-petition
liabilities have been classified as Liabilities subject to compromise in the
Consolidated Balance Sheets as of January 29, 2003. On the Effective Date,
substantially all of the pre-petition liabilities were cancelled. See Note 1 -
Emergence from Chapter 11 Bankruptcy Protection for a discussion of the
discharge of pre-petition liabilities.
The following table summarizes the components of the Predecessor Company's
Liabilities subject to compromise in the accompanying Consolidated Balance Sheet
as of January 29, 2003:
(dollars in millions)
- --------------------------------------------
Debt and notes payable $ 3,348
Accounts payable 2,343
Closed store reserve 722
Pension obligation 741
General liability and workers compensation 320
Taxes payable 285
Other liabilities 210
----------
Total liabilities subject to compromise $ 7,969
==========
Following is a reconciliation of the changes in the Liabilities subject to
compromise for the period from the Petition Date through April 30, 2003:
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Cumulative
since Petition
(dollars in millions) Date
- -------------------------------------------------------------------------------- --------------
Balance, Petition Date $ 8,585
Additional minimum pension liability 554
Adjustments to closed store reserves 475
Fleming settlement 385
Estimated claims for rejected executory contracts 200
Fair value adjustments 114
Revisions to estimated allowable claim amounts 31
First day court orders authorizing payment of employee wages, benefits and other
employee obligations, sales and use taxes and payments to critical vendors (868)
Gain on settlement of pre-petition liabilities (136)
Adjustment to general liability and workers compensation accruals (123)
Court order authorizing payment of additional trade accounts payable (85)
Other (122)
Application of Fresh-Start accounting (9,010)
-----------
Balance, April 30, 2003 $ -
===========
16) 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. We
subsequently issued 111,540 restricted shares to employees; see Note 17 -
Stock-Based Compensation.
In addition, on October 2, 2003 we repurchased a total of 26,889 shares
(at a price of $25.68 per share) of Common Stock relating to withholding taxes
for certain former associates that were part of the Class 5 claimholders
distribution, see Note 1 -Emergence from Chapter 11 Bankruptcy Protection.
There are 43,749 shares in treasury as of January 28, 2004.
17) STOCK-BASED COMPENSATION
Stock Options
During the second quarter of fiscal 2003, approximately 1.7 million
options to purchase shares of common stock of the Successor Company were
granted, of which 151,738 options were cancelled during the third quarter.
Two-thirds of the options had a grant price of $10 and one-third had a grant
price of $20. The options become vested and exercisable 25 percent per year
commencing May 6, 2003, and expire 10 years from the date of grant.
Stock options of the Predecessor Company were granted under various plans
and had exercise prices equal to the average of the highest and lowest prices at
which the Predecessor Company's common stock was traded on the New York Stock
Exchange on the date of grant. Upon emergence from Chapter 11, all outstanding
stock options of the Predecessor Company were cancelled in accordance with the
Plan of Reorganization.
The following table summarizes information about the stock options
outstanding as of January 28, 2004, January 29, 2003 and January 30, 2002:
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Successor Company Predecessor Company
---------------------------- -----------------------------------------------------------
Stock Option Plans 2003 2002 2001
Shares in (000's) Shares Option Price Shares Option Price Shares Option Price
- ------------------- ------ ----------------- ------- ---------------- ------ ----------------
Outstanding - 59,973 $ 4.86 - $ 26.03 46,255 $ 5.34 - $ 26.03
Granted 1,709 $ 10.00 - $ 20.00 - 20,763 $ 4.86 - $ 13.18
Exercised - - (1,235) $ 5.91 - $ 12.13
Forfeited/Cancelled (152) $ 10.00 - $ 20.00 (15,088) $ 4.86 - $ 26.03 (5,810) $ 4.86 - $ 26.03
------ ------- ------
Outstanding 1,557 $ 10.00 - $ 20.00 44,885 $ 4.86 - $ 24.06 59,973 $ 4.86 - $ 26.03
Exercisable - 38,638 $ 4.86 - $ 24.06 31,653 $ 5.34 - $ 26.03
Available for Grant n/a 32,944 23,273
Restricted Stock
During the 39-weeks ended January 28, 2004, we issued 111,540 shares of
restricted stock at market prices ranging from $23.00 to $29.65. Since the grant
of restricted stock relates to future service, the total compensation expense is
recorded as unearned compensation, which is recorded in Paid-in-capital. The
restricted stock generally vests over three years, during which time we will
recognize total compensation expense of approximately $3 million.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
18) INCOME TAXES
Successor
Company Predecessor Company
---------------- ---------------------------------------------
(dollars in millions) Fiscal Year
- --------------------------------- 39-Weeks Ended 13 Weeks Ended -------------------------
Income (Loss) Before Income Taxes January 28, 2004 April 30, 2003 2002 2001
- --------------------------------- ---------------- -------------- -------- --------
(as restated)
U.S. $ 364 $ (851) $ (2,779) $ (2,334)
Foreign 14 (7) (16) 27
-------- -------- -------- --------
Total $ 378 $ (858) $ (2,795) $ (2,307)
======== ======== ======== ========
Income Tax Expense (Benefit)
Current:
Federal $ 4 $ (6) $ (20) $ (29)
State and local 2 - 3 -
Foreign 1 - (7) 10
-------- -------- -------- --------
7 (6) (24) (19)
Deferred:
Federal 120 - - 22
State and local 17 - - (3)
-------- -------- -------- --------
Total $ 144 $ (6) $ (24) $ -
======== ======== ======== ========
Effective Tax Rate Reconciliation
Federal income tax rate 35.0% (35.0%) (35.0%) (35.0%)
State and local taxes,
net of federal tax benefit 3.0% (1.1%) (1.0%) (1.0%)
Tax credits (0.5%) (0.1%) (0.2%) 0.1%
Equity in net income
of affiliated companies (0.4%) (0.2%) (0.2%) (0.5%)
Valuation allowance -% 34.5% 34.3% 37.3%
Other 1.0% 1.2% 1.2% (0.9%)
-------- -------- -------- --------
38.1% (0.7%) (0.9%) -%
======== ======== ======== ========
Predecessor
Successor Company Company
-------------------------- -----------
Deferred Tax Assets January 28, April 30, January 29,
and Liabilities (dollars in millions) 2004 2003 2003
- ------------------------------------- ----------- --------- -----------
(as restated) (as restated)
Deferred tax assets:
Federal benefit for state and foreign taxes $ 17 $ 1 $ 9
Discontinued operations - - 60
Accruals and other liabilities 625 700 506
Property and equipment 1,378 1,528 139
Capital leases 147 165 108
Store closings 2 14 170
Credit carryforwards 236 247 239
NOL carryforwards 1,414 1,544 1,143
Other 123 104 92
-------- -------- --------
Total deferred tax assets 3,942 4,303 2,466
Valuation allowance (2,036) (2,474) (2,348)
-------- -------- --------
Net deferred tax assets 1,906 1,829 118
Deferred tax liabilities:
Inventory 187 174 90
Cancellation of indebtedness 1,654 1,654 -
Other 16 19 28
-------- -------- --------
Total deferred tax liabilities 1,857 1,847 118
-------- -------- --------
Net deferred tax asset (liability) $ 49 $ (18) $ -
======== ======== ========
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 or fiscal year 2002. If, in the future the
Company makes the determination that the pre-emergence net deferred tax asset
will more likely than not be realized, a reduction in the valuation allowance
will be recorded. The reduction in this valuation allowance (if any) will
increase Capital in excess of par. The Successor Company has recorded a net
deferred tax liability of $18 million as of April 30, 2003 and a net deferred
tax asset of $49 million as of January 28, 2004. It is the Company's position
that this net deferred asset will be utilized in the near future and no
valuation allowance is required. The Successor Company recorded a provision for
taxes of $144 million for the 39-weeks ending January 28, 2004 (successor
period).
Tax benefits recorded during the 13-weeks ended April 30, 2003 and fiscal
year 2002 related primarily to an Internal Revenue Code provision allowing for
the 10-year carryback of certain losses, and refunds resulting from the Job
Creation and Worker Assistance Act of 2002. The benefit recognized in fiscal
2002 was partially offset by expense paid to foreign jurisdictions.
During the 39-weeks ended January 28, 2004, we utilized $203 million of
pre-emergence deferred tax assets. Such utilization reduced the valuation
allowance previously established. During the third and fourth quarters of fiscal
2003, we reduced our reserves for Predecessor Company income tax liabilities by
$30 million, primarily due to favorable claims settlements. In accordance with
SOP 90-7, subsequent to emergence from Chapter 11, any benefit realized from the
reduction of the pre-emergence valuation allowance or any benefit realized from
an adjustment to pre-confirmation income tax liabilities shall be recorded as an
addition to Capital in excess of par, not as income to the Company. We recorded
this adjustment to Capital in excess of par in our Consolidated Balance Sheet as
of January 28, 2004.
In connection with the reorganization, the Successor Company realized
income from the extinguishment of certain indebtedness. This income will not be
taxable since the income resulted from reorganization under the Bankruptcy Code.
However, the Company will be required as of the beginning of its 2004 taxable
year, to reduce certain of its tax attributes. At this time, management believes
that net operating loss ("NOL"), general business credit and minimum tax credit
carryforwards will be the only tax attributes which must be reduced.
The reorganization of the Company on the Effective Date constituted an
ownership change under section 382 of the Internal Revenue Code and accordingly,
the use of any of the Company's NOLs and tax credits generated prior to the
ownership change, as well as certain subsequently recognized "built-in" losses
and deductions, if any, existing as of the date of the ownership change that are
not reduced pursuant to the provisions discussed above, will be subject to an
overall annual limitation.
At January 28, 2004, we have unused NOL carryforwards of approximately
$3,803 million. The federal tax benefits of these NOL carryforwards will expire
in 2021, 2022 and 2023 and the state tax benefits will predominantly expire
between 2016 and 2023. Additionally, we have (i) available foreign tax credit
carryforwards of approximately $59 million, which would expire as follows: 2004
- - $17 million, 2005 - $20 million, 2006 - $10 million, 2007 - $6 million and
2008 - $6 million; (ii) general business tax credit carryforwards of
approximately $74 million, which would expire as follows: 2011 - $6 million,
2017 - $7 million, 2018 - $10 million, 2019 - $12 million, 2020 - $14 million,
2021 - $13 million, 2022 - $8 million and 2023 - $4 million, and (iii) AMT
credit carryforwards of approximately $103 million which may be carried forward
indefinitely.
Cash received for income taxes was $1 million, $2 million, $31 million and
$69 million in the 39-weeks ended January 28, 2004, 13-weeks ended April 30,
2003, and fiscal years 2002 and 2001, respectively.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
19) PENSION PLANS AND OTHER POST-RETIREMENT BENEFITS
Prior to 1996, the Predecessor Company had a tax-qualified and a
non-qualified defined benefit pension plan, which covered eligible associates
who met certain requirements of age, length of service, and hours worked per
year. Effective January 31, 1996, the pension plans were frozen, and associates
no longer earn additional benefits under the plans. As part of the Plan of
Reorganization, the plans remained in place after the Effective Date, and we
will continue to honor the plans.
The following tables summarize the change in benefit obligation, change in
plan assets, funded status, amounts recognized and actuarial assumptions for our
qualified employee pension plan.
Predecessor
Successor Company Company
-------------------------- -----------
January 28, April 30, January 29,
(dollars in millions) 2004 2003 2003
- ------------------------------------------------- ----------- --------- -----------
Change in benefit obligation:
Benefit obligation at beginning of period $ 2,501 $ 2,344 $ 2,085
Interest costs 114 38 148
Actuarial (gain)/loss 88 144 234
Benefits paid including VERP (98) (25) (123)
-------- -------- --------
Benefit obligation at end of period $ 2,605 $ 2,501 $ 2,344
======== ======== ========
Change in plan assets:
Fair value of plan assets at beginning of period $ 1,647 $ 1,603 $ 1,890
Actual return on plan assets 238 69 (164)
Benefits paid including VERP (98) (25) (123)
-------- -------- --------
Fair value of plan assets at end of period $ 1,787 $ 1,647 $ 1,603
======== ======== ========
January 28, April 30, January 29,
2004 2003 2003
----------- --------- -----------
Funded status $ (818) $ (854) $ (741)
Unrecognized net (gain)/loss (55) - 928
Unrecognized transition asset - - (25)
------ ------ ------
Pension (liability)/prepaid benefit cost (873) (854) 162
Accumulated other comprehensive income - - (903)
------ ------ ------
Accrued liability recognized in the Consolidated Balance Sheets $ (873) $ (854) $ (741)
====== ====== ======
Successor
Company Predecessor Company
---------------- ----------------------------------------------
Fiscal Year
39-Weeks Ended 13-Weeks Ended -------------------------
(dollars in millions) January 28, 2004 April 30, 2003 2002 2001
- ----------------------------------------------- ---------------- -------------- ------- -------
Components of Net Periodic (Benefit)/Expense
Interest costs $ 114 $ 38 $ 148 $ 144
Expected return on plan assets (94) (33) (174) (209)
Net loss recognition - 18 14 -
Amortization of unrecognized transition asset - (2) (8) (7)
------- ------- ------- -------
Net periodic expense (benefit) $ 20 $ 21 $ (20) $ (72)
======= ======= ======= =======
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
January 28, April 30, January 29,
2004 2003 2003
----------- --------- -----------
Disclosure assumptions
For determining benefit obligations at period end:
Discount rate 6.00% 6.25% 6.50%
For determining net periodic cost for period:
Discount rate 6.25% 6.50% 7.25%
Expected return on plan assets 8.00% 8.00% 9.50%
Measurement date 2/1/2004 4/30/2003 2/1/2003
Target January 28, April 30, January 29,
Fiscal 2004 2004 2003 2003
----------- ----------- --------- -----------
Weighted-average plan asset allocation:
Asset category
Equity securities 45% 48% 46% 57%
Fixed income and debt securities 45% 42% 49% 29%
Hedge funds/other 10% 10% 5% 14%
--- --- --- ---
Total 100% 100% 100% 100%
The projected benefit obligation is equal to the accumulated benefit
obligation for all periods presented. The fair value of plan assets was $1,787
million on January 28, 2004, $1,647 million on April 30, 2003 and $1,603 million
on January 29, 2003. As a result of the application of Fresh-Start accounting,
there are no amounts related to the pension plan recorded in other comprehensive
income at January 28, 2004.
The investment goals of Kmart Corporation Employees Pension Plans are to
invest in a mix of assets that will generate, over the long term, a minimum
annualized real return of 5%, an absolute annualized return that ranks in the
top third of a universe of defined benefit plan returns, and exceeds its market
benchmark return by 0.5% on a net-of-fee basis. The strategic asset mix for the
Plan is 45% in the fixed income asset class, 45% in the equity asset class and
10% in the hedge fund asset class, but may vary within 5 percent above or below
each such target allocation. The allocation among these asset classes is
controlled by the Finance Committee, which receives recommendations from the
Company's Employee Benefit Plans Investment Committee.
To reduce the volatility of returns, the reliance upon any one investment
manager, and the dependence of any one investment manager upon Kmart's account,
the equity funds are deployed in a manner such that no external equity manager,
except for passive index fund or enhanced index fund managers, will have more
than 20% of the total assets of the Pension Plan, and the funds placed with any
manager will not represent more than 20% of the tax-exempt assets managed by the
manager, except for small capitalization equity managers. Additionally, except
for passive index fund or enhanced index fund managers, in no event will more
than $400 million be invested with any one investment manager. We believe that
the selection of equity managers with different management styles and different
investment criteria collectively will provide adequate diversification for the
Pension Plan. Therefore, it will not be necessary for individual investment
managers to be concerned with diversification outside their asset class or
investment style.
The expected return, variance, and correlation of return with other asset
classes are determined for each class of assets in which the plan is invested.
That information is combined with the target asset allocation to create a
distribution of expected returns. The assumption falls within the best estimate
range, being the range in which it is reasonably anticipated that the actual
results are more likely to fall than not.
Contributions to the plans were not required during fiscal years 2003,
2002 or 2001. In light of negative returns in the equity markets during 2001 and
2002 and the effect of such returns on the value of the plan's assets, we
presently expect that we will be required to commence making significant
contributions to the plans beginning in either May 2004 or May 2006, depending
on whether new legislation regarding pension funding requirements is enacted.
This proposed legislation would allow the basic pension funding requirement to
be determined using a corporate bond rate instead of a Treasury Bond rate as in
the past, resulting in significantly lower contributions over the next two
years. Should the pending legislation not pass we will be required to contribute
approximately $150 million in fiscal 2004. Once funding obligations commence, we
presently anticipate that such obligations could continue for a period of five
years at an average rate of between $100 million and $200 million a year, or
between $600 million and $750 million in the aggregate. The actual level of
contributions will depend upon a number of factors, including legislative
changes to funding requirements, actual demographic experience, pension fund
returns and other changes affecting valuations.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The non-qualified plan is for certain current and former associates of the
Company, which is funded as benefits are paid. The benefit obligation was $2
million, $2 million and $22 million at January 28, 2004, April 30, 2003 and
January 29, 2003, respectively, which have been accrued in the Consolidated
Balance Sheets. The benefit obligation was reduced by $20 million for the
13-weeks ended April 30, 2003 in accordance with the Plan of Reorganization.
Full-time associates who have worked 10 years and who have retired after
age 55 have the option of participation in Kmart's medical plan until age 65.
The plan is contributory, with retiree contributions adjusted annually. The
accounting for the plan anticipates future cost-sharing changes that are
consistent with our expressed intent to increase the retiree contribution rate
annually. The accrued post-retirement benefit costs were $3 million, $4 million
and $32 million as of January 28, 2004, April 30, 2003 and fiscal 2002,
respectively.
20) RETIREMENT SAVINGS PLANS
The Retirement Savings Plans provide that associates of Kmart who have
completed 1,000 hours of service within a twelve month period can invest from 1%
to 25% of their earnings in their choice of various investments. For each dollar
the participant contributes up to 6% of earnings, we contribute an additional 50
cents, which is invested in available investment funds offered by the Plans, as
elected by each participant.
Total expense related to the Retirement Savings Plans was $9 million for
the 39-week period ended January 28, 2004, $8 million for the 13-week period
ended April 30, 2003 and $31 million and $39 million in fiscal years 2002 and
2001, respectively.
21) RELATED PARTY DISCLOSURE
During fiscal 2003, the Company hired certain employees of ESL. William C.
Crowley assumed the position of Senior Vice President, Finance at the Company to
assist primarily with financial matters while continuing in his current role as
President and Chief Operating Officer of ESL and as a Director of Kmart Holding
Corporation. ESL's Vice President - Research, assumed the role of Vice President
- - Real Estate for the Company and a former independent contractor of ESL was
hired to assist with our operational strategy and business development.
22) COMMITMENTS AND CONTINGENCIES
Contingent Liabilities
The Predecessor Company had (i) guaranteed obligations for real property
leases of certain Debtors and certain of its former subsidiaries, 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 the Predecessor Company
pre-petition; and (iii) guaranteed indebtedness of other parties related to
certain 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, and to
the extent expressly assumed or reinstated, such guarantees are not considered
to have a material adverse effect on the Successor Company's financial position
or results of operations.
Legal Proceedings
Fair Labor Standards Litigation
The Predecessor Company was a defendant in five putative class actions
pending in California, all relating to the 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 its alleged failure to
pay overtime wages as required by these laws. These wage-and-hour cases were all
filed during 2001 and were dismissed during the third and fourth quarters of
fiscal 2003.
The Predecessor Company was also a defendant in a putative class action
case in Oklahoma relating to the proper payment of overtime to hourly associates
under the FLSA. This case was also dismissed during the fourth quarter of fiscal
2003.
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.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Securities Action Litigation
Since February 21, 2002, five separate purported class actions have been
filed on behalf of purchasers of the Predecessor Company's common stock. The
initial complaints were filed in the United States District Court for the
Eastern District of Michigan on behalf of purchasers of common stock between May
17, 2001 and January 22, 2002, inclusive, and named Charles C. Conaway, former
Chief Executive Officer and Chairman of the Board of the Predecessor Company as
the sole defendant. On September 19, 2003, these complaints were dismissed with
prejudice.
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. 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 million in the aggregate, plus interest, costs and allowed
attorneys' fees.
On April 26, 2002, a lawsuit was filed in the United States District Court
for the Eastern District of Michigan ("District Court") on behalf of three
limited partnerships (the "Softbank Funds") that purchased stock of
Bluelight.com, a subsidiary of the Predecessor Company, naming Charles C.
Conaway, as former CEO and Chairman of the Board of the Predecessor Company, as
the sole defendant. The Predecessor Company was not a defendant in this
litigation. 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 10(b) of the Securities Exchange
Act of 1934, Rule 10b-5 promulgated thereunder and Section 410 of the Michigan
Uniform Securities Act. 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 ("Cook County
Circuit Court"). This lawsuit seeks $33 million 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 District Court lawsuit that was dismissed on January 16, 2003.
On June 26, 2003, the Cook County Circuit Court dismissed the complaint without
prejudice. The Softbank Funds filed a First Amended Complaint seeking $33
million from Mr. Conaway and a motion for Voluntary Dismissal of the Complaint
on July 25, 2003. On August 4, 2003, the Cook County Circuit Court dismissed the
First Amended Complaint without prejudice. On July 31, 2003, the Softbank Funds
filed a Petition for Discovery Before Suit to Identify Responsible Persons (the
"Petition") against Conaway and other parties (but not Kmart) involved in the
Bluelight.com transaction. In response to the Petition, the Cook County Circuit
Court entered an order allowing limited discovery by the Softbank Funds pursuant
to an agreement as to the scope of the pre-suit discovery agreed to by the
parties served with the Petition.
On May 2, 2002, the Softbank Funds filed proofs of claim with the Court in
an aggregate amount equal to $56 million.
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 upon emergence 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 and
treated solely 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.
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 Corporation 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 the Predecessor Company's
financial condition. Subsequently, amended complaints were filed that added
additional current and former employees and directors of the Predecessor Company
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 million. On August 20, 2003, the defendants' motion to dismiss the
purported class action in the United States District Court for the Eastern
District of Michigan was denied.
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Other and Routine Actions
Kmart is a defendant in a pre-petition putative nationwide class action
pending in Colorado and a post-petition putative class action involving eight
stores in New York relating to proper access to facilities for the disabled
under the Americans with Disabilities Act ("ADA"). The Colorado class action is
pending in the United States District Court in Denver, Colorado and the New York
class action is pending in the United States District Court for the Eastern
District of New York. The parties are awaiting the court's decision on class
certification and responsibility for attorney fees. At this time, the likelihood
of a material unfavorable outcome is not considered probable. We have
experienced an increase in ADA public accommodation lawsuits filed against Kmart
stores since emergence from bankruptcy.
On November 7, 2003, the Company filed suit in the United States District
Court for the Eastern District of Michigan against Capital One Bank, Capital
One, F.S.B., and Capital One Services, Inc. (collectively, "Capital One"). The
complaint alleges breach of contract, breach of the covenant of good faith and
fair dealing, unjust enrichment, promissory estoppel and tortious interference
with business relationships and prospective economic advantage arising out of
Capital One's alleged failure to market and support a co-branded credit card
under an agreement the parties had with respect to a Kmart MasterCard. Kmart is
seeking monetary damages. On December 26, 2003 Kmart voluntarily dismissed the
federal court complaint and refiled the complaint in Oakland County Circuit
Court (State of Michigan) based on a lack of diversity of citizenship amongst
the parties. On January 29, 2004 Capital One filed a petition for removal of the
state court action back to the federal court and, in response, Kmart filed a
motion to remand on February 9, 2004. On February 4, 2004 Capital One filed a
motion to dismiss the claims of unjust enrichment, breach of the implied
covenant of good faith and fair dealing and tortious interference.
On November 18, 2003, the Creditor Trust filed suit in the Oakland County
Circuit Court against six former executives of the Predecessor Company (the
"Officer Defendants") and PricewaterhouseCoopers LLP, the Predecessor Company's
independent auditor. The allegations against the Officer Defendants include,
among other things, violations of their fiduciary duty, their duty of good faith
and loyalty, and their duty of care, and breach of contract related to the
Officer Defendants' employment agreements with the Predecessor Company.
Allegations against PricewaterhouseCoopers LLP include, among other things,
breach of duty of care owed to the Predecessor Company and breach of contract
arising out of consulting agreements between PricewaterhouseCoopers LLP and the
Predecessor Company. Kmart is not a defendant in this litigation.
The Creditor Trust has also filed complaints in the Court against four of
the Predecessor Company's former executives to recover amounts paid out as
retention loans. The amount in controversy is approximately $2.15 million. The
former executives filed Counterclaims/Third Party Complaints against the
Creditor Trust and Kmart Corporation requesting that the Court set-off whatever
contractual severance they were entitled to against the retention loan proceeds
that the Creditor Trust was trying to recover. Kmart has filed motions to
dismiss the Counterclaims. The Court has not yet ruled on these motions.
In Capital Factors v. Kmart Corporation, the United States District Court
for the Northern District of Illinois ruled that the Court did not have the
authority to authorize the payment of pre-petition claims of certain trade
vendors by the Company. That ruling was appealed by the Company to the Seventh
Circuit Court of Appeals. Oral arguments were heard by the Seventh Circuit on
January 22, 2004 and an opinion was issued on February 24, 2004. The Seventh
Circuit upheld the decision of the District Court. We have decided not to appeal
this ruling, although other parties in the case may choose to do so. In order to
satisfy our fiduciary responsibility to pursue claims against the critical
vendors during the pendancy of the appeal to the Circuit Court, on January 26,
2004 we filed 45 lawsuits against a total of 1,189 vendors that received these
payments. Based on the recent ruling of the Court, we are severing these
lawsuits and will be refiling them against individual defendants as needed. The
lawsuits seek to recover critical vendor payments in excess of $174 million. The
Company recently notified affected vendors that we are willing to settle these
claims for a percentage of the money they received, based on the amount of the
claim. The ultimate amount of recovery can not be determined at this time.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
On February 11, 2004, the Company filed a suit in the 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 its bankruptcy
on March 20, 2002. Two contractual interpretation issues are primarily in
dispute. The first issue involves the royalty structure of the Agreement whereby
Kmart must pay to MSO certain "royalties based on Sales...at the royalty rates
set forth" in Schedules attached to and incorporated into the Agreement. In
Section V(2), the Agreement sets forth "certain guaranteed royalty amounts as of
each January 31" for each of four product categories (Home, Garden, Houseware,
and Seasonal), as well as a guaranteed royalty amount in the Aggregate. After
Kmart calculates and pays MSO royalties based on sales of relevant products,
Kmart is obligated to determine whether there are any shortfalls in achieving
the minimum guaranteed royalties set forth in Schedule V(2). Kmart must then pay
any shortfall to MSO. However, instead of accepting from Kmart the difference
between royalties on sales and the Aggregate minimum royalty (which includes the
shortfall from the guaranteed royalties on the Product categories), MSO has
demanded that Kmart pay it the shortfall on the Aggregate minimum royalty added
to any shortfall from the guaranteed royalties in each of the Product
categories. This would cost the Company approximately $4 million in additional
royalties for this year alone. In addition, MSO is demanding that Kmart incur
annual advertising expenditures in Martha Stewart Living media properties far in
excess of those that the Agreement contemplates. The complaint alleges breach of
the covenant of good faith and fair dealing and seeks declaratory relief on the
two contractual interpretation issues.
The Company recently became aware of reporting violations of the Emergency
Planning and Community Right to Know Act ("EPCRA") at our distribution centers.
Subsequently, we completed a comprehensive environmental audit of each
distribution center and are submitting the required EPCRA reports to the United
States Environmental Protection Agency. At the current time, we cannot, with
reasonable certainty, estimate the penalty that may be imposed, but are working
closely with the Environmental Protection Agency to resolve this matter.
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 balance sheet as of January 28, 2004
only reflects potential losses for which the Successor Company may have ultimate
responsibility.
Investigative Matters
Prior to emergence, the Predecessor Company had been provided with copies
of anonymous letters that were sent to the SEC, the Predecessor Company's
independent 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 United States 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 about and is investigating the manner in which we recorded
vendor allowances before the change in accounting principles at the end of
fiscal 2001 and about the disclosure of certain events bearing on the
Predecessor Company's liquidity in the fall of 2001. The U.S. 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 the Chapter 11
proceedings, the Predecessor Company determined that the Creditor Trust was the
preferred available mechanism for resolving any legal claims that the Company
might have based on information from these investigations. As part of the Plan
of Reorganization, the trustee of the Creditor Trust is charged with
responsibility for determining which claims to pursue and, thereafter,
litigating such claims. As discussed above, the Creditor Trust has begun
litigation against former officers based on information from these
investigations.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
23) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2003
----------------------------------------------------------
Predecessor
Company Successor Company
----------- --------------------------------------------
First Second Third Fourth
(dollars in millions, except per share data) Quarter Quarter Quarter Quarter
- ---------------------------------------------------------- ----------- ------------ ------------ ------------
Sales $ 6,181 $ 5,652 $ 5,092 $ 6,328
Cost of sales, buying and occupancy $ 4,762 $ 4,419 $ 3,925 $ 4,740
Selling, general and administrative expenses $ 1,421 $ 1,225 $ 1,179 $ 1,173
Net income (loss) as originally reported $ (862) $ (5) $ (23) $ 276
Restatement - $ (3) $ (5) $ (6)
Net income (loss), as restated $ (862) $ (8) $ (28) $ 270
Basic net income (loss) per share as originally reported $ (1.65) $ (0.06) $ 0.26) $ 3.08
Restatement - $ (0.03) $ (0.05) $ (0.06)
Basic net income (loss) per share, as restated $ (1.65) $ (0.09) $ (0.31) $ 3.02
Diluted net income (loss) per share as originally reported $ (1.65) $ (0.06) $ (0.26) $ 2.78
Restatement - $ (0.03) $ (0.05) $ -
Diluted net income (loss) per share, as restated $ (1.65) $ (0.09) $ (0.31) $ 2.78
2002
-------------------------------------
Predecessor Company
-------------------------------------
First Second Third Fourth
(dollars in millions, except per share data) Quarter Quarter Quarter Quarter
- ------------------------------------------- ------- ------- ------- -------
Sales $ 7,181 $ 7,183 $ 6,459 $ 8,529
Cost of sales, buying and occupancy $ 6,519 $ 5,912 $ 5,353 $ 7,058
Selling, general and administrative expenses $ 1,670 $ 1,535 $ 1,449 $ 1,588
Net loss $(1,442) $ (293) $ (383) $(1,101)
Basic/diluted net loss per share $ (2.87) $ (0.58) $ (0.76) $ (2.13)
See Note 4 -- Restatement for further discussion of the restated amounts.
Interest expense was increased in the second, third and fourth quarters of
fiscal 2003 by $5 million, $8 million, and $9 million, respectively, due to the
restatement. As a result, net income, basic net income (loss) per
share and diluted net income (loss) per share have been restated as disclosed
above.
Fourth Quarter Items:
Earnings per share amounts for each quarter are required to be computed
independently and may not equal the amount computed for the total year. In the
fourth quarter of fiscal 2003 the Company executed certain real estate
transactions, resulting in a net gain of $86 million. $56 million of this gain
was the result of the assignment of four operating leases, and $22 million of
the gain was due to the sale of two owned properties. The remaining net gain of
$8 million was from the sale of other various fixed assets. In the fourth
quarter of fiscal 2002, the Predecessor Company recorded charges for asset
impairments of $695 million, in accordance with SFAS No. 144, a charge for
inventory write-downs in conjunction with store closings of $471 million, a
charge of $93 million for a change in workers' compensation and general
liability reserves ($51 million related to reorganization), a LIFO credit of $79
million and $64 million relating to the realignment of our organization to
reflect our current business needs as a result of store closings and other cost
reduction initiatives to improve profitability.
60
Kmart Holding Corporation
Schedule II - Valuation and Qualifying Accounts
39-Weeks Ended January 28, 2004, 13-Weeks Ended April 30, 2003,
Fiscal Years 2002 and 2001
Additions Additions
Balance at charged to charged to Balance at
beginning of cost, expenses, other end of
(Dollars in millions) Period revenues accounts Deductions Period
- ---------------------------------- ------------ --------------- ---------- ---------- ----------
Description
Allowance for Doubtful Accounts:
Sucessor Company
39-weeks ended January 28, 2004 $ 80 $ 96 $ - $ 98 $ 78
Predecessor Company
13-weeks ended April 30, 2003 67 61 - 48 80
Fiscal 2002 49 102 - 84 67
Fiscal 2001 96 74 - 121 49
Allowance for Deferred Tax Assets:
Sucessor Company
39-weeks ended January 28, 2004 $ 2,474 $ - $ - $ 438 $ 2,036
Predecessor Company
13-weeks ended April 30, 2003 2,348 - 126 - 2,474
Fiscal 2002 1,032 1,122 194 - 2,348
Fiscal 2001 - 914 118 - 1,032
61
MANAGEMENT'S RESPONSIBILITY
FOR FINANCIAL STATEMENTS
Management is responsible for the preparation and integrity of our
consolidated financial statements and other information appearing in this
report. These financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America on a
consistent basis applying certain estimates and judgments based upon currently
available information and management's view of current conditions and
circumstances. On this basis, we believe that these financial statements
reasonably present our financial position and results of operations.
To fulfill our responsibility, we maintain comprehensive systems of
internal controls designed to provide reasonable assurance that assets are
safeguarded and transactions are executed in accordance with established
procedures. The concept of reasonable assurance is based upon recognition that
the cost of the controls should not exceed the benefit derived. We believe our
systems of internal controls provide this reasonable assurance. We continually
review, improve and modify these systems of controls in response to changes in
our business conditions and operations and to recommendations made by our
internal audit department and the external auditors.
We have adopted a code of conduct to guide our management in the continued
observance of high ethical standards of honesty, integrity, and fairness in the
conduct of business and in accordance with the law. Compliance with the
guidelines and standards is periodically reviewed and is acknowledged by all
management associates.
The firm of BDO Seidman, LLP, independent public accountants was engaged
to render a professional opinion on our consolidated financial statements for
the 39-weeks ended January 28, 2004. Their report contains an opinion based on
their audit, which was made in accordance with auditing standards generally
accepted in the United States of America and procedures which they believed were
sufficient to provide reasonable assurance that the consolidated financial
statements, considered in their entirety, are not misleading and do not contain
material errors. The financial statements for the 13-weeks ended April 30, 2003,
and fiscal years ended January 29, 2003 and January 30, 2002, were audited by
other auditors whose report expressed an unqualified opinion for the 13-weeks
ended April 30, 2003 and an unqualified opinion with an emphasis on going
concern for the years ended January 29, 2003 and January 30, 2002. The going
concern emphasis was due to our filing of the voluntary petition for
reorganization under Chapter 11 of the United States Bankruptcy Code on January
22, 2002. This emphasis was removed in the opinion rendered for the 13-weeks
ended April 30, 2003 in connection with our emergence from bankruptcy on May 6,
2003 and improved liquidity position.
Our Board of Directors has an Audit Committee consisting solely of
independent directors. The duties of the Audit Committee include keeping
informed of the financial condition of Kmart and reviewing our financial
policies and procedures, our internal accounting controls, and the objectivity
of our financial reporting. Both our independent accountants and the internal
auditors have free access to the Audit Committee and meet with the Audit
Committee periodically, with and without management present.
/s/ Aylwin B. Lewis
- ----------------------------
Aylwin B. Lewis
President and Chief Executive Officer
/s/ James D. Donlon, III
- -----------------------------
James D. Donlon, III
Senior Vice President, Chief Financial Officer
62
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - BDO Seidman, LLP
To the Board of Directors of
Kmart Holding Corporation
Troy, Michigan
We have audited the accompanying consolidated balance sheet of Kmart
Holding Corporation and subsidiaries (Successor Company) as of January 28, 2004
and the related consolidated statements of operations, shareholders' equity, and
cash flows for the 39-weeks ended January 28, 2004. We have also audited the
schedule, listed in the accompanying index, for the 39-weeks ended January 28,
2004. These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements and schedule are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements and schedule. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial
statements and schedule. We believe that our audit provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Kmart
Holding Corporation and subsidiaries (Successor Company) at January 28, 2004 and
the results of their operations and their cash flows for each of the 39-weeks
ended January 28, 2004, in conformity with accounting principles generally
accepted in the United States of America.
Also, in our opinion, the schedule for the 39-weeks ended January 28,
2004, presents fairly, in all material respects, the information set forth
therein.
As discussed in Note 4 to the consolidated financial statements, the
financial statements have been restated to account for the beneficial conversion
feature associated with the convertible note.
/s/ BDO Seidman, LLP
- -----------------------------
BDO Seidman, LLP
Troy, Michigan
March 12, 2004, except for Note 4, as to which
the date is February 11, 2005
63
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM -
PRICEWATERHOUSECOOPERS LLP
To the Shareholders and
Board of Directors of
Kmart Holding Corporation:
In our opinion, the accompanying consolidated balance sheet presents
fairly, in all material respects, the financial position of Kmart Holding
Corporation and its subsidiaries (Successor Company) at April 30, 2003 in
conformity with accounting principles generally accepted in the United States of
America. This financial statement is the responsibility of the Company's
management; our responsibility is to express an opinion on this financial
statement based on our audit. We conducted our audit of this statement in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the balance sheet is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the balance sheet, assessing the accounting
principles used and significant estimates made by management, and evaluating the
overall balance sheet presentation. We believe that our audit of the balance
sheet provides a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the
United States Bankruptcy Court for the Northern District of Illinois confirmed
the Company's Amended Joint Plan of Reorganization (the "plan") on April 23,
2003. Confirmation of the plan and the Company's emergence from bankruptcy
resulted in the discharge of claims against the Company that arose before
January 22, 2002 and the cancellation of equity interests as provided for in the
plan. The plan was substantially consummated on April 23, 2003 and the Company
emerged from bankruptcy on May 6, 2003. In connection with its emergence from
bankruptcy, the Company adopted fresh start accounting as of April 30, 2003.
As discussed in Note 4 to the consolidated financial statements, the
balance sheet has been restated to account for the beneficial conversion feature
associated with the convertible note.
/s/PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Detroit, Michigan
August 8, 2003, except for Note 4, as to which
the date is February 11, 2005
64
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM -
PricewaterhouseCoopers, LLP
To the Shareholders and
Board of Directors of
Kmart Holding Corporation:
In our opinion, the accompanying consolidated balance sheet and the
related consolidated statements of operations, of shareholders' equity (deficit)
and of cash flows present fairly, in all material respects, the financial
position of Kmart Holding Corporation and its subsidiaries (Predecessor Company)
at January 29, 2003 and the results of their operations and their cash flows for
the period from January 30, 2003 to April 30, 2003, and for each of the two
years in the period ended January 29, 2003 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the accompanying financial statement schedule presents fairly, in
all material respects, the information set forth therein for the period from
January 30, 2003 to April 30, 2003, and for each of the two years in the period
ended January 29, 2003, when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the
Company filed a petition on January 22, 2002 with the United States Bankruptcy
Court for the Northern District of Illinois for reorganization under the
provisions of Chapter 11 of the Bankruptcy Code. The Company's Amended Plan of
Reorganization was substantially consummated on April 23, 2003 and the Company
emerged from bankruptcy on May 6, 2003. In connection with its emergence from
bankruptcy, the Company adopted fresh start accounting.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Detroit, Michigan
August 8, 2003
65
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
On October 8, 2003, the Company's Independent Audit Committee approved the
discontinuance of the Company's relationship with PricewaterhouseCoopers LLP as
its independent accountants. PricewaterhouseCoopers LLP was notified on October
9, 2003. The Company has engaged BDO Seidman, LLP as its new independent
accountants effective October 8, 2003. This action was previously reported as
the Company filed a report on Form 8-K dated October 9, 2003 disclosing this
change.
Item 9A. Controls and Procedures
Under the supervision of, and with the participation of our management,
including our Chief Executive Officer and Chief 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 Chief Executive Officer and Chief 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. Notwithstanding the
foregoing, a control system, no matter how well designed and operated, can
provide only reasonable, not absolute, assurance that it will uncover or detect
failures within the Company to disclose material information otherwise required
to be set forth in the Company's periodic reports.
As a result of the Securities and Exchange Commission's ("SEC") review of
our Form 10-K for the year ended January 28, 2004, it was determined that the
Company did not reflect an embedded beneficial conversion feature of the
convertible note issued upon the Company's emergence from bankruptcy as required
by Emerging Issues Task Force No. 00-27 "Application of Issue No. 98-5 to
Certain Convertible Instruments" ("EITF 00-27"). This review was performed in
conjunction with the SEC's review of Sears Holdings Corporation's registration
statement on Form S-4 in connection with the pending merger between Kmart and
Sears, Roebuck and Company ("Sears"). Upon shareholder approvals of the merger
transaction, Sears Holdings Corporation will be a new retail company resulting
from the merger of Kmart and Sears. According to EITF 00-27, the accounting
treatment of the note is based on the determination of a commitment date. A
commitment date occurs when, amongst other things, an agreement is binding on
both parties and the agreement specifies all significant terms, including the
quantity to be exchanged. The Company believed that it had met these
qualifications as of the initial agreement date and accounted for the note
accordingly. The SEC believes that at the time of the agreement, these
conditions had not been met, and therefore the commitment date did not occur
until the issuance of the note. After discussions with the SEC, the Company has
agreed to restate its financial statements.
The determination that the commitment date was at the issuance of the note
rather than when the agreement was signed effected the valuation of the
beneficial conversion feature as a result of a change in the fair value of the
Company's common stock between these two periods. The restatement is further
discussed in "Explanatory Note" in the forepart of this Form 10-K/A, and in Note
4, "Restatement" in the Notes to the Consolidated Financial Statements in Item
8. In management's opinion, given the interpretive nature of the restatement,
such restatement did not change its conclusion that the Company's controls and
procedures are effective.
No changes in the Company's internal controls over financial reporting
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.
PART III
Information required by Part III (Items 10, 11, 12, 13 and 14) of this
Form 10-K/A is incorporated by reference from the Company's definitive Proxy
Statement for its 2004 Annual Meeting of Shareholders, except that certain
information required by Item 10 with respect to executive officers of the
Company is included herein. The annual meeting will be held May 25, 2004. The
Proxy Statement will be filed with the Securities and Exchange Commission,
pursuant to Regulation 14A, not later than 120 days after the end of the our
fiscal year covered by this report on Form 10-K.
EXECUTIVE OFFICERS OF THE REGISTRANT
Karen A. Austin, 42, Senior Vice President, Chief Information Officer. Ms.
Austin has been with the Company since 1984. She previously served as Vice
President, IT Applications from 2001 to 2002 and as Divisional Vice President,
Supply Chain Applications from 1999 to 2001.
66
William C. Crowley 46, Senior Vice President, Finance. Mr. Crowley has
served as an officer of the Company since 2003. He is also a member of our Board
of Directors. Mr. Crowley also serves as the President and Chief Operating
Officer of ESL Investments, Inc., a private investment firm, from 1999 to
present. Mr. Crowley also serves as a director of AutoNation, Inc.
Julian C. Day, 51, President and Chief Executive Officer. Mr. Day joined
Kmart as President and Chief Operating Officer in March 2002, and was promoted
to his current position in January 2003. Mr. Day is also a member of the Board
of Directors. In March 1999, Mr. Day joined Sears, Roebuck & Co. as Executive
Vice President and Chief Financial Officer, and was promoted to Chief Operating
Officer and a member of the Office of the Chief Executive. Before joining Sears,
he served as Executive Vice President and Chief Financial Officer for Safeway,
Inc. from 1993 to 1998. Mr. Day also serves as a director of PETCO Animal
Supplies, Inc.
James E. Defebaugh IV, 49, Senior Vice President, Deputy General Counsel,
Chief Privacy Officer and Assistant Secretary. Mr. Defebaugh has been with the
Company since 1983. He previously served as Senior Vice President, Chief
Compliance Officer and Secretary during 2002 and 2003, Vice President, Associate
General Counsel and Secretary during 2001 and 2002, Vice President and Secretary
during 2000 and 2001, and Vice President, Legal in 1999.
James D. Donlon III, 57, Senior Vice President, Chief Financial Officer.
Mr. Donlon joined the Company in January 2004. He spent 25 years at Daimler
Chrysler Corporation, retiring from there in 2003 after serving as Controller
from1992 to 1993, Vice President and Controller from 1993 to 1998 and Senior
Vice President & Controller from 1998 to 2003.
James F. Gooch, 36, Vice President, Treasurer, Financial Planning &
Analysis. Mr. Gooch has been with the Company since 1996. He previously served
as Vice President, Financial Planning & Analysis from March 2002 to March 2003,
Divisional Vice President - Financial Planning & Analysis from November 2001 to
March 2002, Assistant Treasurer from April to November 2001, Divisional Vice
President - Merchandise Finance from April 1999 to November 2001 and Director -
Merchandise Finance from September 1996 to April 1999.
John D. Goodman, 39, Senior Vice President, Chief Apparel Officer. Mr.
Goodman joined the Company in December 2003. He previously served as a Senior
Vice President from October 2001 to November 2003 and Vice President from March
2000 to October 2001 with Gap, Inc., and as Divisional Merchandise
Manager/Senior Director at Banana Republic from 1998 to 2000.
Paul Guyardo, 42, Senior Vice President, Chief Marketing Officer. Mr.
Guyardo joined the Company in March 2004. He previously served as Executive Vice
President of Television & Marketing for the Home Shopping Network from 1996 to
2004.
W. Bruce Johnson, 52, Senior Vice President, Supply Chain and Operations.
Mr. Johnson joined the Company in October 2003. He previously served as
Director, Organization and Systems for Carrefour S.A. from March 1998 to October
2003.
Harold W. Lueken, 41, Senior Vice President, General Counsel and
Secretary. Mr. Lueken joined the Company in May 2003. He previously served as a
Managing Director in the Legal Department at Banc of America Securities, LLC
from April 2000 to May 2003, as a Principal in the Legal Department at Morgan
Stanley & Company from September 1994 to April 2000, and a Corporate Associate
with Cravath, Swaine & Moore from January 1989 to August 1994.
James P. Mixon, 59, Senior Vice President, Logistics. Mr. Mixon was
previously employed with the Company as Senior Vice President, Logistics from
June 1997 to October 2000. He served as Executive Vice President of The Return
Exchange from June 2001 to May 2002. He returned to the Company as Senior Vice
President, Logistics in May 2002.
Richard J. Noechel, 35, Vice President, Controller. Mr. Noechel has been
with the Company since January 2001, serving as Vice President, Controller since
August 2001 and as Divisional Vice President, Financial Reporting from January
2001 to August 2001. He previously served as Senior Manager, International
Accounting in 2000 and held other positions with Daimler Chrysler Corporation
from 1997 to 2000. Prior thereto he served as Manager, Audit and Business
Advisory Services at Price Waterhouse, LLP, holding positions of increasing
responsibility from 1991 to 1997.
Lisa Schultz, 49, Senior Vice President, Chief Creative Officer. Ms.
Schultz joined the Company in September 2003. She previously served as Executive
Vice President Product Development and Design from 1987 to 2001 for Gap, Inc.
CODE OF ETHICS
The company has long maintained a Code of Business Conduct that applies to
all Kmart associates, including our Chief Executive Officer, Chief Financial
Officer, and Principal Accounting Officer. We have posted our Code of Business
Conduct in the Corporate Governance section of our corporate website,
www.kmart.com.
67
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements
Financial statements filed as part of this Form 10-K/A are listed under Part II,
Item 8.
2. Financial Statement Schedules
Financial statement schedules filed as part of this Form 10-K/A are listed under
Part II, Item 8.
The separate financial statements and summarized financial information of
majority-owned subsidiaries not consolidated and of 50% or less owned persons
have been omitted because they are not required pursuant to conditions set forth
in Rules 3-09 and 1-02(w) of Regulation S-X.
All other schedules have been omitted because they are not required under the
instructions contained in Regulation S-X because the information called for is
contained in the financial statements and notes thereto.
3. Exhibits
The following documents are filed as part of this report or are incorporated by
reference to exhibits previously filed with the SEC.
Exhibit 1.1 - Amended and Restated Certificate of Incorporation of Kmart Holding
Corporation (previously filed as Exhibit 1.1 to the Company's Quarterly Report
on Form 10-Q, for the period ended April 30, 2003, and incorporated herein by
reference)
Exhibit 1.2 - By-Laws of Kmart Holding Corporation (previously filed as Exhibit
1.2 to the Company's Quarterly Report on Form 10-Q, for the period ended April
30, 2003, and incorporated herein by reference)
Exhibit 4.1 - Investment Agreement (previously filed as Exhibit 4.1 to the
Predecessor Company's Current Report on Form 8-K, dated January 24, 2003, and
incorporated herein by reference)
Exhibit 4.2 - Amendment to Investment Agreement, dated as of February 21, 2003
(previously filed as Exhibit 4.9 to the Predecessor Company's Annual Report on
Form 10-K, dated January 29, 2003, and incorporated herein by reference)
Exhibit 4.3 - 9% Convertible Subordinated Note issued by Kmart Holding
Corporation to CRK Partners, L.P. (previously filed as Exhibit 4.1 to the
Company's Quarterly Report on Form 10-Q, for the period ended April 30, 2003,
and incorporated herein by reference)
Exhibit 4.4 - 9% Convertible Subordinated Note issued by Kmart Holding
Corporation to CRK Partners II, L.P. (previously filed as Exhibit 4.2 to the
Company's Quarterly Report on Form 10-Q, for the period ended April 30, 2003,
and incorporated herein by reference)
Exhibit 4.5 - 9% Convertible Subordinated Note issued by Kmart Holding
Corporation to ESL Institutional Partners, L.P. (previously filed as Exhibit 4.3
to the Company's Quarterly Report on Form 10-Q, for the period ended April 30,
2003, and incorporated herein by reference)
Exhibit 4.6 - 9% Convertible Subordinated Note issued by Kmart Holding
Corporation to ESL Investors, L.L.C. (previously filed as Exhibit 4.4 to the
Company's Quarterly Report on Form 10-Q, for the period ended April 30, 2003,
and incorporated herein by reference)
Exhibit 4.7 - 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. (previously filed as Exhibit 4.5 to
the Company's Quarterly Report on Form 10-Q, for the period ended April 30,
2003, and incorporated herein by reference)
Exhibit 4.8 - 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. (previously filed as Exhibit 4.6 to the
Company's Quarterly Report on Form 10-Q, for the period ended April 30, 2003,
and incorporated herein by reference)
68
Exhibit 4.9 - 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. (previously filed as Exhibit 4.7 to the Company's
Quarterly Report on Form 10-Q, for the period ended April 30, 2003, and
incorporated herein by reference)
Exhibit 4.10 - 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. (previously filed as Exhibit 4.8 to
the Company's Quarterly Report on Form 10-Q, for the period ended April 30,
2003, and incorporated herein by reference)
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 (previously filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q, for the period ended April 30, 2003,
and incorporated herein by reference)
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 (previously filed as
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q, for the period
ended April 30, 2003, and incorporated herein by reference)
Exhibit 10.3 - Kmart Holding Corporation Nonqualified Stock Option Agreement
between Kmart Holding Corporation and Julian C. Day (previously filed as Exhibit
10.3 to the Company's Quarterly Report on Form 10-Q, for the period ended April
30, 2003, and incorporated herein by reference)
Exhibit 10.4 - Employment Agreement, dated as of May 6, 2003, between Kmart
Management Corporation and Harold W. Lueken. (previously filed as Exhibit 10.4
to the Company's Quarterly Report on Form 10-Q, for the period ended April 30,
2003, and incorporated herein by reference)
Exhibit 10.5 - Michael T. Macik Separation Agreement. (previously filed as
Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q, for the period
ended April 30, 2003, and incorporated herein by reference)
Exhibit 10.6 - Letter Agreement to Credit Agreement (previously filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q, for the period ended July
30, 2003, and incorporated herein by reference)
Exhibit 10.7 - Kmart Holding Corporation Annual Incentive Bonus Plan (previously
filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q, for the
period ended July 30, 2003, and incorporated herein by reference)
Exhibit 10.8 - First Amendment to Credit Agreement (previously filed as Exhibit
10.3 to the Company's Quarterly Report on Form 10-Q, for the period ended July
30, 2003, and incorporated herein by reference)
Exhibit 10.9 - Employment Agreement, dated as of September 15, 2003, between
Kmart Management Corporation and Bruce Johnson (previously filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q, for the period ended October 29,
2003, and incorporated herein by reference)
Exhibit 10.10 - Employment Agreement dated as of September 3, 2003, between
Kmart Management Corporation and Janet L. Kelly (previously filed as Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q, for the period ended
October 29, 2003, and incorporated herein by reference)
Exhibit 10.11 - Employment Agreement dated as of September 3, 2003, between
Kmart Management Corporation and Lisa Schultz (previously filed as Exhibit 10.3
to the Company's Quarterly Report on Form 10-Q, for the period ended October 29,
2003, and incorporated herein by reference)
Exhibit 10.12 - Kmart Management Corporation Restricted Stock Agreement with
Bruce Johnson (previously filed as Exhibit 10.4 to the Company's Quarterly
Report on Form 10-Q, for the period ended October 29, 2003, and incorporated
herein by reference)
Exhibit 10.13 - Kmart Management Corporation Restricted Stock Agreement with
Janet L. Kelly (previously filed as Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q, for the period ended October 29, 2003, and incorporated
herein by reference)
69
Exhibit 10.14 - Kmart Management Corporation Restricted Stock Agreement with
Lisa Schultz (previously filed as Exhibit 10.6 to the Company's Quarterly Report
on Form 10-Q, for the period ended October 29, 2003, and incorporated herein by
reference)
Exhibit 10.15 - Kmart Management Corporation Restricted Stock Agreement with
Harold Lueken (previously filed as Exhibit 10.7 to the Company's Quarterly
Report on Form 10-Q, for the period ended October 29, 2003, and incorporated
herein by reference)
Exhibit 10.16 - Amendment No. 1 to the May 6, 2003 Nonqualified Stock Option
Agreement between Kmart Holding Corporation and Julian C. Day (previously filed
as Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q, for the period
ended October 29, 2003, and incorporated herein by reference)
Exhibit 10.17 - Form of Kmart Holding Corporation Long Term Incentive Award
Agreement (previously filed as Exhibit 10.9 to the Company's Quarterly Report on
Form 10-Q, for the period ended October 29, 2003, and incorporated herein by
reference)
Exhibit 10.18 - Amended and Restated Employment Agreement for Julian C. Day,
dated as of January 17, 2003, between Kmart Corporation and Julian C. Day
(previously filed as Exhibit 99.2 to the Predecessor Company's Current Report on
Form 8-K, dated January 17, 2003 and incorporated herein by reference)
Exhibit 10.19 - Employment Agreement dated as of January 1, 2004, between Kmart
Management Corporation and James D. Donlon, III (previously filed as Exhibit
10.19 to the Company's Annual Report on Form 10-K, dated March 18, 2004 and
incorporated herein by reference)
Exhibit 10.20 - Employment Agreement dated as of January 1, 2004, between Kmart
Management Corporation and John Goodman (previously filed as Exhibit 10.20 to
the Company's Annual Report on Form 10-K, dated March 18, 2004 and incorporated
herein by reference)
Exhibit 10.21 - Employment Agreement dated as of February 27, 2004, between
Kmart Management Corporation and Paul Guagliardo "Guyardo" (previously filed as
Exhibit 10.19 to the Company's Annual Report on Form 10-K, dated March 18, 2004
and incorporated herein by reference)
Exhibit 10.22 - Kmart Management Corporation Restricted Stock Agreement with
James D. Donlon, III (previously filed as Exhibit 10.22 to the Company's Annual
Report on Form 10-K, dated March 18, 2004 and incorporated herein by reference)
Exhibit 10.23 - Kmart Management Corporation Restricted Stock Agreement with
John Goodman (previously filed as Exhibit 10.23 to the Company's Annual Report
on Form 10-K, dated March 18, 2004 and incorporated herein by reference)
Exhibit 10.24 - Second Amendment to the Credit Agreement (previously filed as
Exhibit 10.24 to the Company's Annual Report on Form 10-K, dated March 18, 2004
and incorporated herein by reference)
Exhibit 10.25 - Third Amendment to the Credit Agreement (previously filed as
Exhibit 10.25 to the Company's Annual Report on Form 10-K, dated March 18, 2004
and incorporated herein by reference)
Exhibit 21 - Kmart Holding Corporation List of Significant Subsidiaries
Exhibit 31.1 - Certification Pursuant to Rule 13a-15(e)/15d-15(e) of the
Securities Exchange Act of 1934, as Amended
Exhibit 31.2 - Certification Pursuant to Rule 13a-15(e)/15d-15(e) of the
Securities Exchange Act of 1934, as Amended
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
(b).Reports on Form 8-K
We filed and furnished the following Current Reports on Form 8-K and
with the SEC:
1. On December 1, 2003, Kmart Holding Corporation furnished a
Current Report on Form 8-K to announce hiring of two Senior
Vice Presidents.
2. On December 5, 2003, Kmart Holding Corporation filed a Current
Report on Form 8-K to report the third quarter 2003 operating
results.
70
3. On January 5, 2004, Kmart Holding Corporation filed a Current
Report on Form 8-K announcing expected results for the first
two months of the fourth quarter of its fiscal year ending on
January 28, 2004.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on February 11, 2005.
Each signatory hereby acknowledges and adopts the typed form of his or her
name in the electronic filing of this document with the Securities and Exchange
Commission.
Kmart Holding Corporation
By: /s/ Aylwin B. Lewis
----------------------------------------------
Aylwin B. Lewis
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ James D. Donlon, III
----------------------------------------------
James D. Donlon, III
Senior Vice President, Chief Financial Officer
(Principal Financial Officer)
By: /s/ James F. Gooch
----------------------------------------------
James F. Gooch
Vice President, Controller
(Principal Accounting Officer)
72
EXHIBIT INDEX
Exhibit
Number Description
- ----- -----------
21 Kmart Holding Corporation List of Significant Subsidiaries
31.1 Certification Pursuant to Rule 13A-15(e)/15d-15(e) of the Securities Exchange Act of 1934, as Amended
31.2 Certification Pursuant to Rule 13A-15(e)/15d-15(e) of the Securities Exchange Act of 1934, as Amended
32.1 Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
73