UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended July 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
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (248) 463-1000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed, by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes X No
----- -----
As of August 6, 2004, 89,647,641 shares of Common Stock of the Registrant were
outstanding.
1
EXPLANATORY NOTE
The purpose of this Amendment No. 1 to Quarterly Report on Form
10-Q/A is to restate the unaudited financial statements of Kmart Holding
Corporation and its subsidiaries (the "Company," "we" or "our") filed with
the Securities and Exchange Commission ("SEC") on Form 10-Q on August 16,
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
$2 million, $5 million and $4 million due to the amortization of the
discount in the 13-weeks ended July 28, 2004 and July 30, 2003, and the
26-weeks ended July 28, 2004, respectively.
See Note 3 to the unaudited Condensed 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 Quarterly Report on Form 10-Q for the quarterly
period ended July 28, 2004 which are amended and restated herein are:
1. Part 1, Item 1 - Financial Statements
2. Part 1, Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
3. Part 1. Item 4 - Controls and Procedures
Except as otherwise expressly noted herein, this Amendment No. 1
to Quarterly Report on Form 10-Q/A does not reflect events occurring after
the August 16, 2004 filing of our Quarterly Report on Form 10-Q in any way,
except as 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
Quarterly Report on Form 10-Q/A consist of all other Items originally
contained in our Quarterly Report on Form 10-Q for the quarterly period
ended July 28, 2004 in the form filed with the SEC on August 16, 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. 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
INDEX
PAGE
-----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations (Unaudited) --
for the 13-weeks ended July 28, 2004 (As restated) and
July 30, 2003 (As restated) 4
Condensed Consolidated Statements of Operations (Unaudited) --
Successor Company - for the 26-weeks ended July 28, 2004 (As
restated) and 13-weeks ended July 30, 2003 (As restated)
Predecessor Company - for the 13-weeks ended April 30, 2003 5
Condensed Consolidated Balance Sheets (Unaudited)-- as of July
28, 2004 (As restated), January 28, 2004 (As restated) and
July 30, 2003 (As restated) 6
Condensed Consolidated Statements of Cash Flows (Unaudited) --
Successor Company - for the 26-weeks ended July 28, 2004 (As
restated) and the 13-weeks ended July 30, 2003 (As
restated)
Predecessor Company - for the 13-weeks ended April 30, 2003 7
Notes to Unaudited Condensed Consolidated Financial Statements 8-23
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 24-31
Item 3. Quantitative and Qualitative Disclosures about Market Risk 32
Item 4. Controls and Procedures 32
PART II OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 6. Exhibits and Reports on Form 8-K 33-34
Signatures 35
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
13-WEEKS ENDED 13-WEEKS ENDED
JULY 28, 2004 JULY 30, 2003
-------------- --------------
(AS RESTATED) (AS RESTATED)
Sales $4,785 $5,652
Cost of sales, buying and occupancy 3,543 4,419
------ ------
Gross margin 1,242 1,233
Selling, general and administrative expenses 1,039 1,225
Net gains on sales of assets (72) (2)
------ ------
Operating income 275 10
Interest expense, net 33 26
Bankruptcy-related recoveries (5) --
Equity income in unconsolidated subsidiaries -- (2)
------ ------
Income (loss) from operations before income taxes 247 (14)
Provision for (benefit from) income taxes 93 (6)
------ ------
Net income (loss) $ 154 $ (8)
====== ======
Basic net income (loss) per common share $ 1.72 $(0.09)
====== ======
Diluted net income (loss) per common share $ 1.54 $(0.09)
====== ======
Basic weighted average shares (millions) 89.5 89.7
Diluted weighted average shares (millions) 101.5 89.7
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
PREDECESSOR
SUCCESSOR COMPANY COMPANY
------------------------------- --------------
26-WEEKS ENDED 13-WEEKS ENDED 13-WEEKS ENDED
JULY 28, 2004 JULY 30, 2003 APRIL 30, 2003
-------------- -------------- --------------
(AS RESTATED) (AS RESTATED)
Sales $9,400 $5,652 $6,181
Cost of sales, buying and occupancy 7,021 4,419 4,762
------ ------ ------
Gross margin 2,379 1,233 1,419
Selling, general and administrative expenses 2,043 1,225 1,421
Net gains on sales of assets (104) (2) --
Restructuring, impairment and other charges -- -- 37
------ ------ ------
Operating income (loss) 440 10 (39)
Interest expense, net 61 26 57
Bankruptcy-related recoveries (12) -- --
Equity income in unconsolidated subsidiaries (3) (2) (7)
Reorganization items, net -- -- 769
------ ------ ------
Income (loss) from continuing operations before income taxes 394 (14) (858)
Provision for (benefit from) income taxes 149 (6) (6)
------ ------ ------
Income (loss) from continuing operations 245 (8) (852)
Discontinued operations (net of income taxes of $0) -- -- (10)
------ ------ ------
Net income (loss) $ 245 $ (8) $ (862)
====== ====== ======
Basic income (loss) per common share from continuing operations $ 2.74 $(0.09) $(1.63)
Discontinued operations -- -- (0.02)
------ ------ ------
Basic net income (loss) per common share $ 2.74 $(0.09) $(1.65)
====== ====== ======
Diluted income (loss) per common share from continuing operations $ 2.47 $(0.09) $(1.63)
Discontinued operations -- -- (0.02)
------ ------ ------
Diluted net income (loss) per common share $ 2.47 $(0.09) $(1.65)
====== ====== ======
Basic weighted average shares (millions) 89.5 89.7 522.7
Diluted weighted average shares (millions) 101.1 89.7 522.7
See accompanying Notes to Unaudited Condensed
Consolidated Financial Statements.
5
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
JULY 28, 2004 JANUARY 28, 2004 JULY 30, 2003
------------- ---------------- -------------
(AS RESTATED) (AS RESTATED) (AS RESTATED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $2,626 $2,088 $1,200
Merchandise inventories 3,212 3,238 4,063
Accounts receivable, net 225 301 305
Other current assets 130 184 254
------ ------ ------
TOTAL CURRENT ASSETS 6,193 5,811 5,822
Property and equipment, net 240 153 43
Other assets and deferred charges 212 110 90
------ ------ ------
TOTAL ASSETS $6,645 $6,074 $5,955
====== ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Long-term debt and mortgages payable due within one year $ 4 $ 4 $ 22
Accounts payable 977 820 1,083
Accrued payroll and other liabilities 772 671 652
Taxes other than income taxes 291 281 333
------ ------ ------
TOTAL CURRENT LIABILITIES 2,044 1,776 2,090
LONG-TERM LIABILITIES
Long-term debt and mortgages payable 80 76 51
Capital lease obligations 335 374 401
Pension obligations 880 873 861
Unfavorable operating leases 316 342 334
Other long-term liabilities 439 424 482
------ ------ ------
TOTAL LIABILITIES 4,094 3,865 4,219
SHAREHOLDERS' EQUITY
Preferred stock 20,000,000 shares authorized; no shares outstanding -- -- --
Common stock $0.01 par value, 500,000,000 shares authorized;
89,647,641, 89,633,760 and 89,677,509 shares issued, respectively 1 1 1
Treasury stock, at cost (1) (1) --
Capital in excess of par value 2,072 1,974 1,743
Retained earnings (Accumulated deficit) 479 234 (8)
Accumulated other comprehensive income -- 1 --
------ ------ ------
TOTAL SHAREHOLDERS' EQUITY 2,551 2,209 1,736
------ ------ ------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,645 $6,074 $5,955
====== ====== ======
See accompanying Notes to Unaudited Condensed
Consolidated Financial Statements.
6
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
PREDECESSOR
SUCCESSOR COMPANY COMPANY
----------------------------- --------------
26-WEEKS 13-WEEKS 13-WEEKS
ENDED ENDED ENDED
JULY 28, 2004 JULY 30, 2003 APRIL 30, 2003
------------- ------------- --------------
(AS RESTATED) (AS RESTATED)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 245 $ (8) $ (862)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization 28 10 177
Store closings inventory charges 17 -- --
Net gains on sales of assets (104) (2) --
Deferred income taxes 21 (2) --
Equity income in unconsolidated subsidiaries (3) (2) (7)
Restructuring, impairments and other charges -- -- 44
Reorganization items, net -- -- 769
Dividends received from Meldisco 3 -- 36
Cash used for store closings and other charges -- (5) (64)
Cash used for payments of exit costs and other
reorganization items -- (451) (19)
Change in:
Merchandise inventories 10 368 480
Accounts receivable 41 75 114
Accounts payable 156 (77) (117)
Taxes payable 133 (11) (16)
Other assets 13 26 9
Other liabilities (24) (93) 32
------ ------ ------
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES 536 (172) 576
------ ------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of assets 153 44 64
Capital expenditures (124) (27) (4)
------ ------ ------
NET CASH PROVIDED BY INVESTING ACTIVITIES 29 17 60
------ ------ ------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on capital lease obligations (25) (14) (16)
Payments on mortgages (2) (4) (1)
Proceeds from issuance of debt -- 60 --
Debt issuance costs -- (46) --
Fees paid to Plan Investors -- (13) --
Issuance of common shares -- 140 --
------ ------ ------
NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES (27) 123 (17)
------ ------ ------
NET CHANGE IN CASH AND CASH EQUIVALENTS 538 (32) 619
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,088 1,232 613
------ ------ ------
CASH AND CASH EQUIVALENTS, END OF PERIOD $2,626 $1,200 $1,232
====== ====== ======
See accompanying Notes to Unaudited Condensed
Consolidated Financial Statements.
7
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Kmart Holding Corporation ("Kmart," "we," "us," "our," the
"Company" or the "Successor Company") is the nation's third largest
discount retailer. We operate in the general merchandise retailing industry
through 1,503 Kmart discount stores and Supercenters with locations in 49
states, Puerto Rico, the U.S. Virgin Islands, Guam and through our
e-commerce shopping site, www.kmart.com.
These interim Unaudited Condensed Consolidated Financial
Statements have been prepared in accordance with the rules and regulations
of the Securities and Exchange Commission ("SEC"). Accordingly, they do not
include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (which
include normal recurring adjustments) considered necessary for a fair
presentation have been included. All significant intercompany accounts and
transactions have been eliminated. Operating results for the interim period
are not necessarily indicative of the results that may be expected for the
full year. Readers of these interim period statements should refer to the
audited consolidated financial statements and notes thereto which are
included in our Annual Report on Form 10-K/A for the year ended January 28,
2004. Certain prior period amounts have been reclassified to conform to the
current interim period presentation.
The American Institute of Certified Public Accountants Statement
of Position 90-7, "Financial Reporting by Entities in Reorganization under
the Bankruptcy Code" ("SOP 90-7") requires that the financial statements
for the period following filing for Chapter 11 bankruptcy protection
through the date a plan of reorganization is confirmed distinguish
transactions and events that are directly associated with the
reorganization from the ongoing operations of the business. Accordingly,
revenues, expenses, realized gains and losses and provisions for losses
directly associated with reorganization and restructuring of the business
during the Predecessor Company's (defined below) bankruptcy proceedings
have been reported separately as Reorganization items, net in the Unaudited
Condensed Consolidated Statements of Operations. See below for a more
detailed discussion of the Company's Chapter 11 proceedings.
2. EMERGENCE FROM CHAPTER 11 BANKRUPTCY PROTECTION AND FRESH-START ACCOUNTING
Confirmation of Plan of Reorganization
On May 6, 2003 (the "Effective Date"), Kmart Corporation (the
"Predecessor Company") emerged from reorganization proceedings under
Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or "Chapter
11") pursuant to the terms of the Plan of Reorganization (defined below).
The Predecessor Company became a wholly-owned subsidiary of Kmart
Management Corporation, which is a wholly-owned subsidiary of Kmart Holding
Corporation.
On January 22, 2002 (the "Petition Date"), the Predecessor
Company and 37 of its U.S. Subsidiaries (collectively the "Debtors") filed
voluntary petitions for reorganization under Chapter 11 in the United
States Bankruptcy Court for the Northern District of Illinois (the
"Court"). During the reorganization proceedings, the Debtors continued to
operate their business as debtors-in-possession under the jurisdiction of
the Court and in accordance with the applicable provisions of the
Bankruptcy Code and orders of the Court. On January 24, 2003, the Debtors
filed a Plan of Reorganization and related Disclosure Statement and on
February 25, 2003, filed an Amended Joint Plan of Reorganization (the "Plan
of Reorganization") and related amended Disclosure Statement with the
Court. The Plan of Reorganization received the formal endorsement of the
statutory creditors' committees and, as modified, was confirmed by the
Court by order docketed on April 23, 2003.
8
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
Plan Investors
At the time of emergence, ESL Investments, Inc. ("ESL") and Third
Avenue Trust, on behalf of certain of its investment series ("Third
Avenue," and together with ESL, the "Plan Investors") made a substantial
investment in the Successor Company in furtherance of our financial and
operational restructuring plan. The Plan Investors and their affiliates
received approximately 32 million shares of our newly issued common stock
("Common Stock") in satisfaction of pre-petition claims they held, and we
issued 14 million shares of Common Stock to affiliates of ESL and to Third
Avenue, in exchange for $127 million, net of commitment fees and Plan
Investor expenses of $13 million. In addition, we issued a 9 percent, $60
million principal convertible note (the "Note") to affiliates of ESL. The
term of the Note was extended two years to May 2006 by notice given in
December 2003, consistent with the terms of the agreement. With respect to
the Note, the principal is convertible at any time, at the option of the
holder, into 6 million shares of Common Stock at a conversion price equal
to $10 per share. ESL was also granted the option to purchase, prior to May
6, 2005, approximately 6.6 million shares of Common Stock at a price of $13
per share. A portion of the option was assigned to Third Avenue. The
investment was made pursuant to an Investment Agreement dated January 24,
2003, as amended (the "Investment Agreement"). See Note 3 - 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.
Discharge of Liabilities
Under Chapter 11, actions by creditors to collect indebtedness
owed prior to the Petition Date were stayed and certain other pre-petition
contractual obligations were not enforced against the Debtors. The
Predecessor Company received approval from the Court to pay certain
pre-petition liabilities including employee salaries and wages, benefits
and other employee obligations.
On the Effective Date, all then-outstanding equity securities of
the Predecessor Company, as well as substantially all of its pre-petition
liabilities, were cancelled. Common Stock was issued in satisfaction of
certain of those claims. On the Effective Date, 89,677,509 shares of Common
Stock and 8,173,145 options to purchase shares of Common Stock were issued
pursuant to the Plan of Reorganization. All of the shares of Common Stock
issued on May 6, 2003 were or will be distributed pursuant to the Plan of
Reorganization in satisfaction of pre-petition claims, except that 14
million shares were issued to affiliates of ESL and to Third Avenue
pursuant to the Investment Agreement described above. The options to
purchase shares of Common Stock were issued to the Plan Investors and the
Successor Company's Chief Executive Officer. All shares were issued without
registration under the Securities Act of 1933 in reliance on the provisions
of Section 1145 of the Bankruptcy Code and Section 4(2) of the Securities
Act of 1933. In addition, as part of the Plan of Reorganization, an
independent creditor litigation trust was established for the benefit of
the Predecessor Company's pre-petition creditors and equity holders, and to
pursue claims which arose from the Predecessor Company's prior accounting
and stewardship investigations.
Fresh-Start Adjustments
In connection with our emergence from Chapter 11, we reflected
the terms of the Plan of Reorganization in our consolidated financial
statements, applying the terms of SOP 90-7 with respect to financial
reporting. Upon applying Fresh-Start accounting, a new reporting entity
(the Successor Company) is deemed to be created and the recorded amounts of
assets and liabilities are adjusted to reflect their estimated fair values.
The reported historical financial statements of the Predecessor Company for
periods ended prior to May 1, 2003 generally are not comparable to those of
the Successor Company. In this Quarterly Report on Form 10-Q/A, references
to the 13-weeks ended April 30, 2003 and prior periods refer to the
Predecessor Company. References to the Successor Company refer to the
Company on and after April 30, 2003 after giving effect to the provisions
of the Plan of Reorganization and the application of Fresh-Start
accounting.
9
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
To facilitate the calculation of the enterprise value of the
Successor Company, we developed a set of financial projections. Based on
these financial projections and with the assistance of a financial advisor,
we determined the enterprise value using various valuation methods,
including (i) a comparison of the Company and its projected performance to
the market values of comparable companies, (ii) a review and analysis of
several recent transactions of companies in similar industries to the
Company, and (iii) a calculation of the present value of the future cash
flows under the projections. The estimated enterprise value is highly
dependent upon achieving the future financial results set forth in the
projections as well as the realization of certain other assumptions which
are not guaranteed. The estimated enterprise value of the Company was
calculated to be approximately $2.3 billion to $3.0 billion. We selected
the midpoint of the range, $2.6 billion, as the estimated enterprise value.
In applying Fresh-Start accounting, adjustments to reflect the fair value
of assets and liabilities, on a net basis, and the write-off of the
Predecessor Company's equity accounts resulted in a charge of $5.6 billion.
The fair value adjustments included the recognition of approximately $2.2
billion of intangible assets that were previously not recorded in the
Predecessor Company's financial statements, such as favorable leasehold
interests, Kmart brand rights, pharmacy customer relationships and other
lease and license agreements. The restructuring of the Predecessor
Company's capital structure and resulting discharge of pre-petition debt
resulted in a gain of $5.6 billion. The charge for the revaluation of the
assets and liabilities and the gain on the discharge of pre-petition debt
are recorded in Reorganization items, net in the Unaudited Condensed
Consolidated Statements of Operations. In addition, the excess of fair
value of net assets over reorganization value (i.e., "negative goodwill")
of approximately $5.6 billion was allocated on a pro-rata basis reducing
our non-current, non-financial instrument assets, including the previously
unrecorded intangible assets, to $10 million as of April 30, 2003.
Refer to our Annual Report on Form 10-K/A for the year ended
January 28, 2004 for a more detailed discussion.
Claims Resolution
We continue to make progress in the reconciliation and settlement
of the various classes of claims associated with the discharge of the
Predecessor Company's liabilities subject to compromise pursuant to the
Plan of Reorganization. Since June 30, 2003, the first distribution date
established in the Plan of Reorganization, approximately 19.7 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 $4.1 million in cash has been distributed to
holders of Class 7 claims. Due to the significant volume of claims filed
to-date, it is premature to estimate with any degree of accuracy the
ultimate allowed amount of such claims for each class of claims under the
Plan of Reorganization. Accordingly, our current distribution reserve for
claim settlements is approximately 20 percent of shares issued. 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.
During the second quarter of fiscal 2004, we reduced the
distribution reserve from 30 percent to 20 percent, resulting in the
distribution of approximately 2.2 million shares to claimants who had
previously received shares for allowed claims. The remaining shares in the
distribution reserve will be issued to claimants on a pro-rata basis if,
upon settlement of all claims, the ultimate amount allowed for Class 5
claims is consistent with the Plan of Reorganization.
The next scheduled distribution under the Plan of Reorganization
is expected to commence on or about October 1, 2004.
Bankruptcy-Related Recoveries
For the 13-weeks and 26-weeks ended July 28, 2004, we recognized
recoveries of $5 million and $12 million, respectively, from vendors who
had received cash payments for pre-petition obligations or preference
payments. See Note 19 - Commitments and Contingencies for a more detailed
discussion.
10
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
3. RESTATEMENT
The accompanying unaudited condensed consolidated financial
statements for the 13-weeks ended July 28, 2004 and July 30, 2003 and the
26-weeks ended July 28, 2004 and as of July 28, 2004, January 28, 2004 and
July 30, 2003 have been restated. The restatement reflects the recognition
of an embedded beneficial conversion feature of the Company's 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 2, 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 $2 million, $5 million and $4 million
of interest expense due to the amortization of the discount in the 13-weeks
ended July 28, 2004 and July 30, 2003, and the 26-weeks ended July 28,
2004, respectively.
Following is the effect of our restatement on our unaudited
condensed consolidated financial statements.
11
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
EFFECT OF THE RESTATEMENTS ON THE CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
13-WEEKS ENDED JULY 28, 2004
--------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
Operating income $ 275 $ -- $ 275
Interest expense, net 31 2 33
Bankruptcy-related recoveries (5) -- (5)
----- ------ -----
Income from operations before income taxes 249 (2) 247
Provision for income taxes 94 (1) 93
----- ------ -----
Net income $ 155 $ (1) $ 154
===== ====== =====
Basic net income per common share $1.73 $(0.01) $1.72
===== ====== =====
Diluted net income per common share $1.54 $ -- $1.54
===== ====== =====
13-WEEKS ENDED JULY 30, 2003
--------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
Operating income $ 10 $ -- $ 10
Interest expense, net 21 5 26
Equity income in unconsolidated subsidiaries (2) -- (2)
------ ------ ------
Loss from operations before income taxes (9) (5) (14)
Benefit from income taxes (4) (2) (6)
------ ------ ------
Net loss $ (5) $ (3) $ (8)
====== ====== ======
Basic and diluted net loss per common share $(0.06) $(0.03) $(0.09)
====== ====== ======
26-WEEKS ENDED JULY 28, 2004
--------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
Operating income $ 440 $ -- $ 440
Interest expense, net 57 4 61
Bankruptcy-related recoveries (12) -- (12)
Equity income in unconsolidated subsidiaries (3) -- (3)
----- ------ -----
Income from operations before income taxes 398 (4) 394
Provision for income taxes 150 (1) 149
----- ------ -----
Net income $ 248 $ (3) $ 245
===== ====== =====
Basic net income per common share $2.77 $(0.03) $2.74
===== ====== =====
Diluted net income per common share $2.47 $ -- $2.47
===== ====== =====
12
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The restatement had no effect on the Predecessor Company's unaudited
Condensed Consolidated Statement of Operations for the 13-weeks ended April 30,
2003.
EFFECT OF THE RESTATEMENTS ON THE CONDENSED
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
JULY 28, 2004
--------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
LIABILITIES
Long-term debt and mortgages payable $ 103 $(23) $ 80
====== ==== ======
Other long-term liabilities $ 430 $ 9 $ 439
====== ==== ======
Total liabiliites $4,108 $(14) $4,094
====== ==== ======
SHAREHOLDERS' EQUITY
Capital in excess of par value $2,041 $ 31 $2,072
====== ==== ======
Retained earnings $ 496 $(17) $ 479
====== ==== ======
Total shareholders' equity $2,537 $ 14 $2,551
====== ==== ======
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 liabilities $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
====== ==== ======
13
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JULY 30, 2003
--------------------------------------------------
As previously reported Adjustments As restated
---------------------- ----------- -----------
LIABILITIES
Long-term debt and mortgages payable due within one year $ 66 $(44) $ 22
====== ==== ======
Accrued payroll and other liabilities $ 636 $ 16 $ 652
====== ==== ======
Total current liabilities $2,118 $(28) $2,090
====== ==== ======
Total liabilities $4,247 $(28) $4,219
====== ==== ======
SHAREHOLDERS' EQUITY
Capital in excess of par value $1,712 $ 31 $1,743
====== ==== ======
Accumulated deficit $ (5) $ (3) $ (8)
====== ==== ======
Total shareholders' equity $1,708 $ 28 $1,736
====== ==== ======
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 Sheets. The Company had a net
deferred tax liability as of July 28, 2004 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.
The Company had a net deferred tax liability as of July 30, 2003 which was
classified in Accrued payroll and other liabilities.
4. NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the SEC issued Staff Accounting Bulletin
("SAB") No. 104, "Revenue Recognition" ("SAB 104"). SAB 104 supercedes SAB
101, "Revenue Recognition in Financial Statements" ("SAB 101") to include
the guidance from Emerging Issues Task Force Issue No. 00-21, "Accounting
for Revenue Arrangements with Multiple Deliverables." The primary purpose
of SAB 104 is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements. There was no impact to the
Company upon adoption of SAB 104.
5. REAL ESTATE AND PROPERTY TRANSACTIONS
Home Depot U.S.A., Inc.
On June 3, 2004, the Company entered into multiple definitive
agreements with Home Depot U.S.A., Inc. (a subsidiary of The Home Depot,
Inc.) ("Home Depot") to sell up to four owned properties and assign up to
20 leased properties for a maximum purchase price of $365 million in cash.
Pursuant to the first of these agreements, on June 15, 2004, the Company
completed the sale of four owned properties to Home Depot for $59 million
in cash, resulting in a net gain of $43 million. On August 10, 2004, the
second agreement was amended, which limited the number of leased properties
to be assigned to not more than 15 properties with a maximum purchase price
of $230 million in cash. We completed the assignment of nine of these
properties on August 13, 2004, resulting in proceeds to the Company of $114
million in cash. We anticipate that Home Depot may close on the remaining
six leases by the end of August 2004, subject to closing conditions being
satisfied. In the event Home Depot does not close on certain of these
properties, we have the option to assign up to two of these properties to
Home Depot for a maximum of $42 million in cash.
14
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Sears, Roebuck and Co.
On June 29, 2004, the Company entered into an agreement with
Sears, Roebuck and Co. ("Sears") to sell up to two owned properties and
assign up to 52 leased properties for a maximum purchase price of $621
million in cash. Pursuant to this agreement, certain closing conditions for
a minimum of 43 of the properties must be satisfied by August 31, 2004.
However, if the closing conditions have not been satisfied by August 31,
2004, the Company, at its option, may give written notice to Sears by
September 9, 2004 to proceed with the closing with respect to those
properties for which closing conditions have been satisfied. In the event
the closing conditions for the 43 properties have not been satisfied by
August 31, 2004 and written notice has not been given to Sears by the
Company, either party may terminate the purchase agreement subsequent to
September 9, 2004, but prior to the date closing conditions are satisfied
for at least 43 properties. Assuming such conditions are met, the Company
will receive 30% of the purchase price in September 2004. The remaining 70%
of the purchase price will be received when Sears has been assigned the
leases and occupies the properties, which shall take place no later than
April 15, 2005.
Other
The Company also sold certain other assets, resulting in net
gains of $29 million and $61 million for the 13-weeks and 26-weeks ended
July 28, 2004, respectively. Included within this gain for the 26-week
period was $17 million related to the sale of the Company's Trinidad
subsidiary and its associated property, $12 million related to the sale of
the Company's corporate airplanes and $32 million from sales of other real
and personal property. During this same time period, the Company acquired
22 previously-leased properties for $84 million.
6. PENSION PLAN
The following table summarizes the net periodic benefit cost
recognized for our qualified employee pension plan.
Predecessor
Successor Company Company
------------------------------------------------ --------------
26-Weeks Ended 13-Weeks Ended 13-Weeks Ended 13-Weeks Ended
(dollars in millions) July 28, 2004 July 28, 2004 July 30, 2003 April 30, 2003
--------------------- -------------- -------------- -------------- --------------
Components of Net Periodic Expense
Interest costs $ 77 $ 39 $ 38 $ 38
Expected return on plan assets (69) (35) (29) (33)
Net loss recognition -- -- -- 18
Amortization of unrecognized transition asset -- -- -- (2)
---- ---- ---- ----
Net periodic expense $ 8 $ 4 $ 9 $ 21
==== ==== ==== ====
During the 13-weeks and 26-weeks ended July 28, 2004
contributions to the plan were approximately $1 million. Contributions to
the plan were not required for the 13-weeks ended July 30, 2003 or April
30, 2003. The estimated contribution for fiscal 2004 is $11 million.
7. EARNINGS PER SHARE
Basic earnings per share is calculated by dividing net income by
the weighted average number of common shares outstanding during each
period. Diluted earnings per share assumes the exercise of stock options,
the conversion of convertible debt and the impact of restricted stock when
dilutive.
A reconciliation of basic weighted average common shares
outstanding to diluted weighted average common shares outstanding is as
follows:
13-Weeks Ended 26-Weeks Ended
(in millions) July 28, 2004 July 28, 2004
------------- -------------- --------------
Basic weighted average common shares 89.5 89.5
Dilutive effect of stock options 6.0 5.6
9% convertible note 6.0 6.0
----- -----
Diluted weighted average common shares 101.5 101.1
===== =====
15
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
A reconciliation of net income available to common shareholders
to net income available to common shareholders with assumed conversions is
as follows:
13-Weeks Ended 26-Weeks Ended
(dollars in millions) July 28, 2004 July 28, 2004
--------------------- -------------- --------------
(as restated) (as restated)
Net income available to common shareholders $154 $245
Interest and accretion of debt discount on 9%
convertible note, net of tax 2 5
---- ----
Income available to common shareholders with
assumed conversions $156 $250
==== ====
Common stock equivalents were excluded from the calculation of
diluted earnings per share for the 13-weeks ended July 30, 2003 and April
30, 2003 as they were anti-dilutive. Upon our emergence from bankruptcy,
all common stock equivalents of the Predecessor Company were cancelled.
8. DEBT
Credit Facility
Our credit agreement (the "Credit Facility") is a $1.0 billion
revolving credit facility with an $800 million letter of credit sub-limit
under which Kmart Corporation is the borrower. From its inception, we have
only used the Credit Facility to support issuances of letters of credit. In
July 2004, we voluntarily reduced the size of the Credit Facility from $1.5
billion to $1.0 billion to reduce the overall cost of the facility. In
conjunction with the reduction of our Credit Facility, we accelerated the
amortization of $9 million of the associated debt issuance costs.
Availability under the Credit Facility is subject to an inventory borrowing
base formula. The Credit Facility is guaranteed by the Successor Company,
Kmart Management Corporation, Kmart Services Corporation (a subsidiary of
Kmart Management Corporation) and Kmart Corporation's direct and indirect
domestic subsidiaries. The Credit Facility is secured primarily by first
liens on inventory, the proceeds thereof and certain related assets of
Kmart Corporation and the guarantors.
Borrowings under the Credit Facility are subject to a sliding
pricing scale based on our earnings before interest, taxes, depreciation,
amortization and other charges ("EBITDA") levels and such adjustments are
implemented quarterly. Borrowings 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 in
support of trade and standby letters of credit currently bears interest at
1.25% and 2.50% per annum, respectively. In addition, we are currently
required to pay a fee based on the unutilized commitment under the Credit
Facility equal to 0.50% per annum. The Credit Facility gives the Company
the ability to repurchase up to $500 million of the Company's Common Stock,
depending on our EBITDA levels and subject to the approval of the Company's
Board of Directors.
As of July 28, 2004, we had utilized $341 million of the Credit
Facility for letters of credit issued for ongoing import purchasing
operations, and contractual and regulatory purposes, including letters of
credit utilized as collateral to support our self-insurance programs.
During the first six months of fiscal 2004, we replaced letters of credit
used as collateral for certain programs with cash collateral to reduce fees
on our letters of credit. We continue to classify the cash collateral in
Cash and cash equivalents due to our ability to convert the cash to letters
of credit at any time at our discretion. As of July 28, 2004, $214 million
of cash was posted as collateral.
Total availability under the Credit Facility as of July 28, 2004
was approximately $630 million.
The Credit Facility financial covenants include a requirement
that we maintain certain availability minimums, and failure to do so
triggers additional required minimum levels of EBITDA. The Credit Facility
also contains other customary covenants, including certain reporting
requirements and covenants that restrict our ability to incur or create
liens, indebtedness and guarantees, make investments, pay dividends or make
other equity distributions, sell or dispose of stock or assets, change the
nature of our business and enter into affiliate transactions, mergers and
consolidations. Failure to satisfy these covenants would (in some cases,
after the receipt of notice and/or the expiration of a grace period) result
in an event of default that could result in our inability to access the
funds. As of July 28, 2004, and in all periods since our emergence from
Chapter 11, we have been in compliance with all Credit Facility covenants.
16
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Predecessor Company Debt
Borrowings of the Predecessor Company during Chapter 11
proceedings were available through the Court-approved $2 billion
debtor-in-possession financing facility ("DIP Credit Facility") for the
payment of permitted pre-petition claims, working capital needs, letters of
credit and other general corporate purposes. On May 6, 2003, in connection
with the Debtors' emergence from Chapter 11, the DIP Credit Facility was
terminated.
Due to its filing for Chapter 11, the Predecessor Company was in
default on all of its debt agreements entered into prior to January 22,
2002. While operating under Chapter 11, the Predecessor Company was
prohibited under the Bankruptcy Code from paying interest on unsecured
pre-petition debts. On the Petition Date, the Predecessor Company stopped
accruing interest on all unsecured pre-petition debt until it emerged from
bankruptcy in accordance with SOP 90-7. Contractual interest expense not
accrued or recorded by the Predecessor Company on certain pre-petition debt
totaled $67 million for the 13-weeks ended April 30, 2003.
Interest Expense, Net
Predecessor
Successor Company Company
------------------------------------------------ --------------
26-Weeks Ended 13-Weeks Ended 13-Weeks Ended 13-Weeks Ended
(dollars in millions) July 28, 2004 July 28, 2004 July 30, 2003 April 30, 2003
--------------------- -------------- -------------- -------------- --------------
(as restated) (as restated) (as restated)
Components of Interest Expense, Net
Interest expense $ 32 $15 $23 $21
Accretion of obligations at net present value 25 13 --- ---
Amortization of debt issuance costs 16 12 5 37
Interest income (12) (7) (2) (1)
---- --- --- ---
Interest expense, net $ 61 $33 $26 $57
==== === === ===
Cash paid for interest was $28 million, $13 million, $17 million
and $19 million for the 26-weeks ended July 28, 2004 and the 13-weeks ended
July 28, 2004, July 30, 2003 and April 30, 2003, respectively.
9. INCOME TAXES
We recorded a tax provision of $93 million and $149 million
during the 13-weeks and 26-weeks ended July 28, 2004, respectively, based
on the estimated effective tax rate for fiscal 2004 of 37.8%. We recorded a
$6 million tax benefit from our losses during the 13-weeks ended July 30,
2003 based upon the estimated effective tax rate for the 39-weeks ended
January 28, 2004 (successor period). The $6 million tax benefit recorded
during the first quarter of fiscal 2003 relates to an Internal Revenue Code
provision allowing for the 10-year carryback of certain losses.
The Predecessor Company recorded a full valuation allowance
against its 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. Given the
Company's actual and forecasted levels of profitability in fiscal 2004,
management believes that a portion of the pre-emergence net deferred tax
assets will more likely than not be realized. As such, the Company reduced
the valuation allowance on its pre-emergence net deferred tax assets by $92
million in the second quarter of fiscal 2004 to reflect its estimated
utilization through the end of fiscal 2004. The Company will continue to
assess the likelihood of realization of its pre-emergence net deferred tax
assets and would reduce the valuation allowance on such assets in the
future if it becomes more likely than not that the net deferred tax assets
will be utilized. In accordance with SOP 90-7, subsequent to emergence from
Chapter 11, the benefit from the reduction of the valuation allowance is
recorded as a direct credit to Capital in excess of par value with no
impact on the Company's earnings or cash flows.
During the 26-weeks ended July 28, 2004, we reduced our reserves
for Predecessor Company income tax liabilities by $5 million, primarily due
to favorable claims settlements. We recorded this adjustment to Capital in
excess of par value in our Unaudited Condensed Consolidated Balance Sheet
as of July 28, 2004.
As of July 28, 2004, the Company has post-emergence net deferred
tax assets of $57 million. It is the Company's position that this net
deferred tax asset will be utilized in the near future and no valuation
allowance is required.
17
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Cash paid for income taxes was $2 million, $1 million and $1
million for the 26-weeks ended July 28, 2004, and the 13-weeks ended July
28, 2004 and July 30, 2003, respectively. Cash received for tax refunds and
credits was $2 million for the 13-weeks ended April 30, 2003.
10. 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
primary purpose of providing restricted stock grants to certain employees.
On June 29, 2004, the Company's Board of Directors increased the existing
share repurchase authorization to $100 million and broadened the scope of
future repurchases to include the repurchase of shares in furtherance of
general corporate purposes. During fiscal 2003, we repurchased 128,400
shares of Common Stock (weighted-average price of $28.87 per share)
primarily for the purpose of providing restricted stock grants, at a cost
of approximately $4 million. We issued 17,109 and 32,061 shares of
restricted stock during the 13-weeks and 26-weeks ended July 28, 2004,
respectively; see Note 11 - Stock-Based Compensation. There were 29,868 and
43,749 shares in treasury as of July 28, 2004 and January 28, 2004,
respectively. There were no shares in treasury as of July 30, 2003.
11. STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the fair
value method. Total stock-based compensation expense of approximately $1
million will be recognized in fiscal 2004 for outstanding stock options.
The Predecessor Company accounted for stock options using the
intrinsic value method in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations, which did not require the recognition of expense for the
fair value of stock-based compensation.
In accordance with the disclosure requirements of SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, an
Amendment of FASB Statement No. 123" the pro forma effects of recognizing
the fair value of stock-based compensation on net loss and loss per share
had the Predecessor Company applied the fair value method to stock options
granted by the Predecessor Company would have resulted in a pro forma
adjustment of $38 million for stock-based employee compensation income, a
pro forma net loss of $824 million and a pro forma basic/diluted loss per
share of $1.58 for the 13-weeks ended April 30, 2003. Pro forma stock-based
employee compensation income of $38 million for the 13-weeks ended April
30, 2003 is due to the reversal of expense for options that were not vested
upon cancellation of the outstanding stock awards of the Predecessor
Company.
Upon our emergence from Chapter 11, all outstanding stock options
of the Predecessor Company were cancelled in accordance with the Plan of
Reorganization.
During the 26-weeks ended July 28, 2004, we issued 32,061 shares
of restricted stock at grant prices ranging from $29.23 to $33.44. We
accounted for these restricted stock grants as fixed awards, and recorded
deferred employee compensation to Capital in excess of par value. Deferred
employee compensation of $1 million is being amortized to compensation
expense on a straight-line basis over the vesting period of three years for
these grants.
12. PROPERTY HELD FOR SALE
Property held for sale was $35 million, $56 million and $117
million as of July 28, 2004, January 28, 2004 and July 30, 2003,
respectively, and is included within Other current assets in our Unaudited
Condensed Consolidated Balance Sheets. During the 13-weeks and 26-weeks
ended July 28, 2004, we sold $15 million and $17 million of these assets
for their book value, respectively. During the second quarter of fiscal
2003, we sold $43 million of these assets for a net gain of $1 million.
13. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) represents net income or loss,
adjusted for the effect of other items that are recorded directly to
shareholders' equity. During the 26-weeks ended July 28, 2004, we sold
available-for-sale equity securities and in conjunction with these sales,
reduced accumulated other comprehensive income by $1 million. Comprehensive
income and net income are equivalent for the 13-weeks ended July 28, 2004.
For the 13-weeks ended April 30, 2003, comprehensive loss included a
minimum pension liability adjustment of $94 million. No adjustments were
made to comprehensive income (loss) for the 13-weeks ended July 30, 2003.
18
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
14. INVESTMENTS IN AFFILIATED RETAIL COMPANIES
Kmart footwear departments are operated under a master agreement
and license agreement with certain Meldisco subsidiaries of Footstar, Inc.
("FTS"), substantially all of which are 49% owned by Kmart and 51% owned by
FTS. On March 2, 2004, FTS and its direct and indirect subsidiaries,
including all Meldisco subsidiaries, filed for Chapter 11 protection in the
United States Bankruptcy Court for the Southern District of New York. FTS
continues to operate its businesses and manage its properties as
debtors-in-possession. Given the profitability of the Meldisco subsidiaries
with which we do business, and the likelihood of future receipts of the
amounts due from those Meldisco subsidiaries, no valuation reserve has been
established for $24 million due to us from FTS as of July 28, 2004. On
August 12, 2004, FTS filed a motion with the Bankruptcy Court to assume the
master agreement and the license agreements. In order to effect such
assumption, FTS must cure all past defaults. FTS asserts that the amount
required to cure past defaults is $18 million, and that such amount should
be reduced by overpayments FTS alleges it made to the Company for certain
fees. We filed a proof of claim in the FTS bankruptcy case for an amount in
excess of our recorded receivable; however, at this time, we are not able
to accurately determine the ultimate amount to be realized as we have not
received all information from FTS necessary for us to complete our claim.
The Company believes the cure amount may be substantially in excess of $18
million. If no resolution is achieved consensually with FTS with respect to
the assumption of the master agreement and the license agreements and the
cure amount, the issue will be resolved by the Bankruptcy Court.
On May 7, 2004, FTS sold 353 of its Footaction stores to Foot
Locker, Inc. for $225 million. Following the sale of the Footaction stores,
FTS consists primarily of the Meldisco business.
We have been advised that FTS will be restating its financial
statements for certain prior periods. As a result, we have not received
final financial statements for fiscal 2002, 2003 or the first and second
quarters of fiscal 2004 for the Meldisco subsidiaries with which we do
business at the time of our filing of this Quarterly Report on Form 10-Q.
We have received preliminary financial results from FTS which we believe
provide a reliable basis to estimate equity income as recognized in all
periods presented in our Unaudited Condensed Consolidated Statements of
Operations. For the 26-weeks ended July 28, 2004 and the 13-weeks ended
July 28, 2004, July 30, 2003 and April 30, 2003, those Meldisco
subsidiaries had net sales at our footwear departments of $384 million,
$198 million, $222 million and $246 million, respectively. We had no equity
income from the Meldisco subsidiaries for the 13-weeks ended July 28, 2004.
For the 26-weeks ended July 28, 2004 and the 13-weeks ended July 30, 2003
and April 30, 2003, our equity income in those Meldisco subsidiaries was $3
million, $2 million and $7 million, respectively. Although there can be no
assurance until FTS restates its financial statements, at this time, we do
not expect the restatement to have a material effect on our equity income
or other fees earned from the Meldisco subsidiaries.
The Company has reviewed FTS' monthly operating reports for
periods following their Chapter 11 filing, and noted that FTS has allocated
certain of their reorganization costs to the Meldisco business. These
charges have adversely impacted our estimated earnings recorded in fiscal
2004. We disagree with their approach and have notified FTS of our
position.
15. RELATED PARTY TRANSACTIONS
During the second quarter of fiscal 2004, ESL hired an employee
of the Company. This employee has assumed the role of Vice President of
ESL, and will continue to serve Kmart as Vice President - In-Store Business
Development.
As further discussed in the Company's MD&A, the Company is
considering various uses of its cash, including investments in various
forms of securities. The Board of Directors of the Company has delegated
authority to invest the Company's surplus cash to Edward Lampert, subject
to various limitations including those in the Company's existing Credit
Facility as well as additional limitations that have been or may be from
time to time adopted by the Board of Directors and/or the Finance Committee
of the Board of Directors. Mr. Lampert is Chairman of the Company's Board
of Directors and is the Chairman and Chief Executive Officer of ESL.
Neither Mr. Lampert nor ESL will receive compensation for any such
investment activities undertaken on behalf of the Company.
19
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Further, to clarify the expectations that the Board of Directors
has with respect to the investment of our surplus cash, the Board has
renounced, in accordance with Delaware law, any interest or expectancy of
the Company associated with any investment opportunities in securities that
may come to the attention of Mr. Lampert or any employee, officer, director
or adviser to ESL and its affiliated investment entities who also serves as
an officer or director of the Company (each, a "Covered Party") other than
(a) investment opportunities that come to such Covered Party's attention
directly and exclusively in such Covered Party's capacity as a director of,
officer or employee of the Company, (b) control investments in companies in
the mass merchandise or discount retailing industry and (c) investment
opportunities in companies or assets with a significant role in the
Company's retailing business, including investment in real estate currently
leased by the Company or in suppliers for which the Company is a
substantial customer representing over 10% of such companies' revenues,
unless in any such instance ESL has a pre-existing investment.
16. DISCONTINUED OPERATIONS
During the first quarter of fiscal 2003, the Predecessor Company
closed 316 stores, of which 66 stores met the criteria to be accounted for
as discontinued operations. The Company applied the provisions of SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
which requires closed stores to be classified as discontinued operations
when the operations and cash flows of the stores have been (or will be)
eliminated from ongoing operations and the company no longer has any
significant continuing involvement in the operations associated with the
stores after closure. The table below sets forth the components of the net
loss associated with the discontinued operations for the 13-weeks ended
April 30, 2003.
Predecessor Company
-------------------
13-Weeks Ended
(dollars in millions) April 30, 2003
--------------------- -------------------
Sales $232
Cost of sales, buying and occupancy 150
----
Gross margin 82
Selling, general and administrative expenses 43
Restructurings, impairments and other charges 5
Reorganization items, net 44
----
Discontinued operations, net of tax $(10)
====
17. SPECIAL CHARGES
Special charges are transactions which, in management's judgment,
may make meaningful comparisons of operating results between reporting
periods difficult. In determining what amounts constitute a special charge,
management considers the nature, magnitude and frequency of their
occurrence. During fiscal 2002, the Predecessor Company instituted certain
restructuring actions to improve operations and executed significant
inventory liquidations as a result of the stores closed under Chapter 11
proceedings. The effects of these actions on the 13-weeks ended April 30,
2003 are summarized below.
Corporate Cost Reduction Initiatives
During fiscal 2002 and the 13-weeks ended April 30, 2003, the
Predecessor Company eliminated approximately 950 positions with an initial
charge of $50 million recorded in fiscal 2002. The Predecessor Company
reduced its reserve for such corporate cost reductions by $10 million in
the 13-weeks ended April 30, 2003, as a result of a change in the estimated
expenses. This reduction is included in Restructuring, impairment and other
charges in the Unaudited Condensed Consolidated Statements of Operations.
Accelerated Depreciation
The Predecessor Company recorded charges of $52 million during
the 13-weeks ended April 30, 2003 for accelerated depreciation on
unimpaired assets to be disposed of following the 316 store closings. Of
the $52 million recorded, $47 million is included in Restructurings,
impairments and other charges and $5 million is included in Discontinued
operations in the Unaudited Condensed Consolidated Statements of
Operations.
20
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
Reserve Activity
As part of Fresh-Start accounting, reserves established in
connection with certain restructurings were discharged as of April 30, 2003
in accordance with the Plan of Reorganization. See Note 2 - Emergence from
Chapter 11 Bankruptcy Protection and Fresh-Start Accounting for a detailed
discussion of the discharge of Liabilities subject to compromise under the
Plan of Reorganization.
Restructuring reserves related to the fiscal 2002 employee
severance program were assumed by the Successor Company. There was no
activity to the reserve for the 13-weeks ended July 28, 2004. Payments made
against the reserve were $1 million and $19 million for the 26-weeks ended
July 28, 2004 and the 13-weeks ended July 30, 2003, respectively. During
the 13-weeks ended April 30, 2003, the Predecessor Company recorded
non-cash reductions of $2 million and decreased the reserve by $10 million,
as noted above. As of July 28, 2004, January 28, 2004 and July 30, 2003,
the liability for the fiscal 2002 employee severance program was $1
million, $4 million and $17 million, respectively.
18. REORGANIZATION ITEMS, NET
Reorganization items represent amounts the Predecessor Company
incurred as a result of its Chapter 11 reorganization, and are presented
separately in the Unaudited Condensed Consolidated Statements of
Operations. For the 13-weeks ended April 30, 2003, the following were
recorded:
Predecessor Company
-------------------
13-Weeks Ended
(dollars in millions) April 30, 2003
--------------------- -------------------
Gain on extinguishment of debt $(5,642)
Revaluation of assets and liabilities 5,642
Fleming settlement 385
Estimated claims for rejected executory contracts 200
2003 store closings 158
Other 26
-------
Reorganization items, net $ 769
=======
The following paragraphs provide additional information relating
to costs that were recorded in Reorganization items, net in the Unaudited
Condensed Consolidated Statement of Operations for the 13-weeks ended April
30, 2003.
Gain on extinguishment of debt/Revaluation of assets and liabilities
See Note 2 - Emergence from Chapter 11 Bankruptcy Protection and
Fresh-Start Accounting for a discussion on the extinguishment of debt and
the revaluation of assets and liabilities.
Fleming settlement
On February 3, 2003, the Predecessor Company announced the
termination of the supply relationship with Fleming Companies, Inc.
("Fleming") by means of a rejection of the 2001 contract through the
Debtor's Chapter 11 reorganization. As part of the bankruptcy proceedings,
Fleming filed a claim of $1.5 billion on March 11, 2003. The Predecessor
Company and Fleming came to an agreement on a settlement of Fleming's
claims, and on March 27, 2003, the Court approved the settlement of all
claims asserted by Fleming. Under the settlement, the Predecessor Company
paid Fleming $15 million of Fleming's net post-petition administrative
claim, which exceeded $30 million. Additionally, Fleming's general
unsecured claim was reduced from approximately $1.5 billion to $385
million, which was recorded in the first quarter of fiscal 2003.
21
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
Estimated claims for rejected executory contracts
For the 13-weeks ended April 30, 2003, the Predecessor Company
recorded expense of $200 million for estimated allowable claims for
rejected executory contracts, primarily equipment leases and service
contracts. The estimate was based on a review of each class of contract. On
April 30, 2003, upon adoption of Fresh-Start accounting, these liabilities
were discharged in accordance with the Plan of Reorganization; see Note 2 -
Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting.
2003 store closings
As a result of the decision to close the 316 stores, the
Predecessor Company recorded a charge of $214 million in the first quarter
of fiscal 2003 for lease terminations and other costs, of which $56 million
is included in Discontinued operations and the remaining $158 million is
included in Reorganization items, net in the Unaudited Condensed
Consolidated Statements of Operations.
Other reorganization items
For the 13-weeks ended April 30, 2003, the Predecessor Company
recorded professional fees of $43 million, employee costs of $66 million
relating to the Key Executive Retention Program, a gain of $17 million for
the sale of pharmacy customer lists, income of $65 million for lease
auction proceeds related to the 2003 and 2002 closed stores, a gain of $15
million for the settlement of pre-petition liabilities and net expenses of
$14 million for other miscellaneous reorganization items.
19. COMMITMENTS AND CONTINGENCIES
Securities Action Litigation
On March 18, 2002, a 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 former 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 former 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. That court certified the class
on April 16, 2004, but the class has yet to be defined.
Other and Routine Actions
Two of our past providers of surety bonds, Fireman's Fund
Insurance Company ("Fireman's Fund"), and the Hartford Insurance Company
("Hartford") elected not to participate in the continuation of our surety
program during the pendency of the Predecessor Company's bankruptcy case.
Fireman's Fund has now filed a motion with the Bankruptcy Court seeking (i)
recovery of $34 million that Fireman's Fund alleges it has paid pursuant to
pre-petition surety bonds it issued with regard to the Predecessor
Company's workers' compensation insurance programs, and (ii) an order
obligating us to make all payments of Fireman's Fund's future obligations
under the bonds, which Fireman's Fund contends could be in excess of $35
million. We have filed an opposition to the motion contending, among other
things, that Fireman's Fund's claim is an unsecured pre-petition claim that
was resolved under the Plan of Reorganization that was approved by the
Bankruptcy Court, and therefore Fireman's Fund has the same rights as any
other general unsecured creditor under that Plan. Kmart has been advised by
Hartford that they may file a similar motion.
22
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
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. The case was remanded to the
Oakland County Circuit Court on June 10, 2004 and is scheduled for trial on
March 1, 2005.
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. A critical vendor sought a rehearing by the Seventh Circuit, which
was denied, and a petition for Writ of Certiorari was filed in the Supreme
Court of the United States that is currently pending. Kmart is not involved
in the motion for a rehearing and will not further appeal the Seventh
Circuit's ruling. In order to satisfy our fiduciary responsibility to
pursue claims against the critical vendors during the pendency of the
appeal, on January 26, 2004 we filed 45 lawsuits against a total of 1,189
vendors that received these payments. Subsequently, many of the cases were
severed into lawsuits against individual defendants although all cases are
proceeding on a common pretrial procedural track. The lawsuits seek to
recover critical vendor payments in excess of $174 million. The Company
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. As of
July 28, 2004, Kmart has settled 179 critical vendor claims.
We are a party to a substantial number of other claims, lawsuits
and pending actions which are routine and incidental to our business. To
the extent that any claim relates to a contract which was assumed by us
when we emerged or relates to a time period occurring after the Petition
Date, the Successor Company shall be responsible for any damages which may
result. In addition, certain contracts allow for damage provisions or other
repayments as a result of our termination of the contracts.
We assess the likelihood of potential losses on an ongoing basis,
and when they are considered probable and reasonably estimable, we record
an estimate of the ultimate outcome. If there is no single point estimate
of loss that is considered more likely than others, an amount representing
the low end of the range of possible outcomes is recorded. Our Unaudited
Condensed Balance Sheet as of July 28, 2004 only reflects potential losses
for which the Successor Company may have ultimate responsibility.
20. SUBSEQUENT EVENTS
Corporate Cost Reductions
We initiated a corporate cost reduction program in August 2004,
and in connection with this program, eliminated approximately 250 positions
at our corporate headquarters in Troy, Michigan. Severance benefits,
outplacement services and continuing health insurance benefits, which
amounts are based on employees' years of service and job grade, aggregating
$6 million will be paid to affected employees primarily over the next six
months. The anticipated annual savings of this action is $18 million on a
pre-tax basis. We are also continuing efforts to reduce other corporate
non-payroll expenses.
Letter of Credit Facility
On August 13, 2004, the Company entered into a letter of credit
agreement (the "LC Agreement") with a commitment amount of up to $200
million through January 7, 2005 and increasing to $600 million thereafter.
The standby letters of credit issued under the LC Agreement bear interest
at 0.20% per annum. The LC Agreement is subject to a pledge and security
agreement pursuant to which, after January 7, 2005, the Company must post
as collateral cash in an amount equal to 100.5% of the face value of
letters of credit outstanding under the LC Agreement. Prior to January 7,
2005, the collateral posted by the Company is a leasehold mortgage on
certain properties leased by the Company.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
Part I, Item 2 of this report should be read in conjunction with
Part II, Item 7 of our Annual Report on Form 10-K/A for the year ended
January 28, 2004. The information contained herein is not a comprehensive
discussion and analysis of the financial condition and results of
operations of the Company, but rather an update of the previous
disclosures.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-Q/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, express or implied by such forward-looking statements. Factors
that could cause actual results to differ materially from these
forward-looking statements include, but are not limited to, factors
relating to Kmart's internal operations and the external environment in
which it operates; Kmart's ability to successfully implement business
strategies and otherwise fund and execute planned changes in various
aspects of the business; marketplace demand for the products of Kmart's key
brand partners, as well as the engagement of appropriate new brand
partners; changes in consumer spending and Kmart's ability to anticipate
buying patterns and implement appropriate inventory strategies; Kmart's
ability to reverse its negative same-store sales trend; competitive
pressures and other third party actions, including pressures from pricing
and other promotional activities of competitors, as well as new competitive
store openings; the resolution of allowed claims for which we are obligated
to pay cash under the Plan of Reorganization; Kmart's ability to properly
monitor its inventory needs in order to timely acquire desired goods in
appropriate quantities and/or fulfill labor needs at planned costs; Kmart's
ability to attract and retain customers; Kmart's ability to maintain normal
terms with vendors and service providers; Kmart's ability to maintain
contracts, including leases, that are critical to its operations; Kmart's
ability to develop a market niche; regulatory and legal developments;
general economic conditions; weather conditions, including those which
affect buying patterns of Kmart's customers; other factors affecting
business beyond Kmart's control; and Kmart's ability to attract, motivate
and/or retain key executives and associates. Kmart undertakes no obligation
to release publicly the results of any revisions to these forward-looking
statements to reflect events or circumstances after the date such
statements were made.
Consequently, all of the forward-looking statements are qualified
by these cautionary statements and there can be no assurance that the
results or developments anticipated will be realized or that they will have
the expected effects on our business or operations. The forward-looking
statements contained herein or otherwise that we make or are made on our
behalf speak only as of the date of this report, or if not contained
herein, as of the date when made, and we do not undertake to update these
risk factors or such forward-looking statements.
RESULTS OF OPERATIONS
The results of operations presented below reflect certain
restatements to our previously reported results of operations for the
13-weeks ended July 28, 2004 and July 30, 2003 and the 26-weeks ended July
28, 2004. See Note 3 - Restatement for a discussion of the restatement.
Due to the application of Fresh-Start accounting upon our
emergence from bankruptcy, the reported historical financial statements of
the Predecessor Company for periods prior to May 1, 2003 generally are not
comparable to those of the Successor Company.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - (CONTINUED)
The following table is presented solely to complement
management's discussion and analysis.
PREDECESSOR
SUCCESSOR COMPANY COMPANY
------------------------------------------------ --------------
13-WEEKS ENDED 13-WEEKS ENDED 13-WEEKS ENDED 13-WEEKS ENDED
(dollars in millions) JULY 28, 2004 JULY 30, 2003 APRIL 28, 2004 APRIL 30, 2003
--------------------- -------------- -------------- -------------- --------------
(AS RESTATED) (AS RESTATED) (AS RESTATED)
Sales $4,785 $5,652 $4,615 $6,181
Cost of sales, buying and occupancy 3,543 4,419 3,478 4,762
------ ------ ------ ------
Gross margin 1,242 1,233 1,137 1,419
Selling, general and administrative expenses 1,039 1,225 1,004 1,421
Net gains on sales of assets (72) (2) (32) --
Restructuring, impairment and other charges -- -- -- 37
------ ------ ------ ------
Operating income (loss) 275 10 165 (39)
Interest expense, net 33 26 28 57
Bankruptcy related recoveries (5) -- (7) --
Equity income in unconsolidated subsidiaries -- (2) (3) (7)
Reorganization items, net -- -- -- 769
------ ------ ------ ------
Income (loss) from continuing operations
before income taxes 247 (14) 147 (858)
Provision for (benefit from) income taxes 93 (6) 56 (6)
------ ------ ------ ------
Income (loss) from continuing operations 154 (8) 91 (852)
Discontinued operations -- -- -- (10)
------ ------ ------ ------
Net income (loss) $ 154 $ (8) $ 91 $ (862)
====== ====== ====== ======
13-WEEKS ENDED JULY 28, 2004 COMPARED TO 13-WEEKS ENDED JULY 30, 2003
Same-store sales and total sales decreased 14.9% and 15.3%,
respectively, for the 13-weeks ended July 28, 2004 as compared to the
13-weeks ended July 30, 2003. Same-store sales include sales of all open
stores that have been open for more than 13 full months. Factors affecting
same-store sales and total sales included reductions in promotional events
and newspaper advertising; the effect of unseasonably cool weather in the
current quarter on sales of summer seasonal products including lawn and
garden merchandise; and a transition in our apparel lines leading up to
back-to-school product launches.
Gross margin increased $9 million to $1.24 billion, for the
13-weeks ended July 28, 2004, from $1.23 billion for the 13-weeks ended
July 30, 2003. Gross margin, as a percentage of sales, increased to 26.0%
for the 13-weeks ended July 28, 2004, from 21.8% in the prior year. The
improvement in our gross margin rate was primarily attributable to reduced
markdowns on promotions and clearance items and improvements in shrinkage
at our distribution centers and stores. Included in gross margin was a $16
million charge recorded in the second quarter of fiscal 2004 in conjunction
with the store closings inventory liquidations.
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - (CONTINUED)
Selling, general and administrative expenses ("SG&A") decreased
$186 million to $1.04 billion, or 21.7% of sales for the 13-weeks ended
July 28, 2004, from $1.23 billion, also 21.7% of sales, for the 13-weeks
ended July 30, 2003. The decline resulted from a reduction in store payroll
and related expenditures due to increased operating efficiencies and
reduced sales volume at our stores, and to reductions in our weekly and
mid-week circular advertising, partially offset by an increase in
electronic media advertising. The remaining net reduction in SG&A is due to
continued efforts to reduce our operating expenses.
Operating income for the 13-weeks ended July 28, 2004 was $275
million, or 5.7% of sales, as compared to $10 million, or 0.2% of sales,
for the same period in the prior year. Operating income increased primarily
due to the decrease in SG&A and the increase in the gross margin rate,
partially offset by reduced gross margin dollars as a result of lower
same-store sales, as discussed above. Also increasing Operating income were
net gains of $72 million from sales of real and personal property,
including $43 million of net gains from the sale of four owned properties
to Home Depot; see Note 5 - Real Estate and Property Transactions for a
more detailed discussion.
Interest expense, net for the 13-weeks ended July 28, 2004 and
July 30, 2003 was $33 million and $26 million, respectively. In July 2004,
we voluntarily reduced the size of our credit agreement from $1.5 billion
to $1.0 billion to reduce the overall cost of the facility. In conjunction
with this action, we accelerated the amortization of $9 million of the
associated debt issuance costs, which is included in Interest expense, net
for the 13-weeks ended July 28, 2004. During the 13-weeks ended July 28,
2004, $13 million of interest expense was recorded for the accretion of
obligations recorded at net present value. Interest expense is net of
interest income of $7 million and $2 million for the 13-weeks ended July
28, 2004 and July 30, 2003, respectively.
The effective income tax rate was 37.7% and (42.9%) for the
13-weeks ended July 28, 2004 and July 30, 2003, respectively; see Note 9 -
Income Taxes for a more detailed discussion.
13-WEEKS ENDED APRIL 28, 2004 COMPARED TO 13-WEEKS ENDED APRIL 30, 2003
Same-store sales and total sales decreased 12.9% and 25.3%,
respectively, for the 13-weeks ended April 28, 2004 as compared to the
13-weeks ended April 30, 2003. The decrease in same-store sales is due
primarily to several Company-wide promotional events occurring in the first
quarter of fiscal 2003 along with a reduction in advertising, including the
frequency of mid-week circulars in the current year. The decrease in total
sales is attributable to the decrease in same-store sales and the closure
of 316 stores in the first quarter of fiscal 2003.
Gross margin decreased $282 million to $1.14 billion, for the
13-weeks ended April 28, 2004, from $1.42 billion for the 13-weeks ended
April 30, 2003. Gross margin, as a percentage of sales, increased to 24.6%
for the 13-weeks ended April 28, 2004, from 23.0% for the 13-weeks ended
April 30, 2003. Favorably affecting the gross margin rate were fewer
clearance markdowns and reduced depreciation as a result of the write-off
of long-lived assets in conjunction with the application of Fresh-Start
accounting.
SG&A decreased $417 million to $1.0 billion, or 21.8% of sales
for the 13-weeks ended April 28, 2004, from $1.42 billion, or 23.0% of
sales, for the 13-weeks ended April 30, 2003. The decrease in SG&A resulted
from reduced payroll and related expenses in our stores during the first
quarter of the current year, as well as the effect of store closings and
corporate cost reduction initiatives implemented in the first quarter of
fiscal 2003. Also affecting the decline was a reduction in advertising
expenses and lower depreciation as a result of the write-off of long-lived
assets in conjunction with the application of Fresh-Start accounting.
Operating income for the 13-weeks ended April 28, 2004 was $165
million, or 3.6% of sales, as compared to a loss of $39 million, or (0.6%)
of sales, for the same period in the prior year. The improvement was
primarily due to the decrease in SG&A and the improvement in our gross
margin rate, as discussed above, partially offset by an overall decline in
gross margin dollars due to our reduced store base. Operating income was
also affected by net gains on sales of assets of $32 million in the first
quarter of the current year and Restructuring, impairment and other charges
of $37 million in the first quarter of fiscal 2003.
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - (CONTINUED)
Interest expense, net for the 13-weeks ended April 28, 2004 and
April 30, 2003 was $28 million and $57 million, respectively. During the
13-weeks ended April 28, 2004, $12 million of interest expense was recorded
for the accretion of obligations recorded at net present value. Included in
interest expense for the 13-weeks ended April 30, 2003 was $37 million of
amortization of debt issuance costs associated with the Predecessor
Company's Court-approved $2 billion debtor-in-possession financing
facility. Interest at the stated contractual amount on unsecured debt that
was not charged to earnings for the 13-weeks ended April 30, 2003 was $67
million. Interest expense is net of interest income of $5 million and $1
million for the 13-weeks ended April 28, 2004 and April 30, 2003,
respectively.
The effective income tax rate was 38.1% and (0.7%) for the
13-weeks ended April 28, 2004 and April 30, 2003, respectively; see Note 9
- Income Taxes for a more detailed discussion.
26-WEEKS ENDED JULY 28, 2004 (SUCCESSOR COMPANY)
Total sales were $9.40 billion for the 26-weeks ended July 28,
2004. Same-store sales decreased 13.9%. Reductions in promotions and
advertising, including the frequency of mid-week circulars in the current
year, have affected same-store sales and total sales.
Gross margin for the 26-weeks ended July 28, 2004 was $2.38
billion or 25.3% of sales. A reduction in clearance markdowns and
improvements in shrinkage at our distribution centers and stores favorably
affected gross margin in the current period. Included in gross margin was a
$17 million charge in conjunction with the store closings inventory
liquidations.
SG&A was $2.04 billion, or 21.7% of sales for the period. Reduced
payroll and related expenses at our stores, as well as a reduction in
advertising expenses favorably affected SG&A for the period.
Operating income for the 26-weeks ended July 28, 2004 was $440
million, or 4.7% of sales. Operating income was favorably affected by the
gross margin improvements and reductions in SG&A, as discussed above. Also
included in operating income are net gains of $104 million from sales of
real and personal property, including $43 million of net gains from the
sale of four owned properties to Home Depot; see Note 5 - Real Estate and
Property Transactions.
Interest expense, net for the 26-weeks ended July 28, 2004 was
$61 million. In July 2004, we voluntarily reduced the size of our credit
agreement from $1.5 billion to $1.0 billion to reduce the overall cost of
the facility. In conjunction with this action, we accelerated the
amortization of $9 million of the associated debt issuance costs, which is
included in Interest expense, net for the 26-weeks ended July 28, 2004.
During the 26-weeks ended July 28, 2004, $25 million of interest expense
was recorded for the accretion of obligations recorded at net present
value. Interest expense is net of interest income of $12 million.
The effective income tax rate was 37.8% for the 26-weeks ended
July 28, 2004; see Note 9 - Income Taxes for a more detailed discussion.
LIQUIDITY AND FINANCIAL CONDITION
Kmart continued to maintain strong liquidity for the 26-weeks
ended July 28, 2004 with cash flow from operations of $536 million and $153
million from proceeds from asset sales. Our principal cash needs are for
our operations and capital expenditures, which are satisfied through
working capital generated by our business and our existing $2.6 billion
balance in cash and cash equivalents as of July 28, 2004. Working capital
generated by our business, is significantly affected by our level of sales
and the credit extended by our vendors. In addition, we have funds
available under our $1.0 billion Credit Facility as of July 28, 2004. From
its inception, we have only used the Credit Facility to support issuances
of letters of credit. However, should we experience significant negative
sales trends, a significant disruption of terms with our vendors, the
Credit Facility for any reason becomes unavailable and/or actual results
differ materially from those projected, our compliance with financial
covenants and our cash resources could be adversely affected.
In the normal course of business, the Company considers
opportunities to purchase leased operating properties, as well as offers to
sell owned or if leased, assign operating and non-operating properties.
These transactions may, individually or in the aggregate, result in
material proceeds or outlays of cash. In addition, the Company reviews
leases that will expire in the short-term in order to determine the
appropriate action to take with respect to the lease.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - (CONTINUED)
CREDIT FACILITY
Our Credit Facility is a $1.0 billion revolving credit facility
with an $800 million letter of credit sub-limit under which Kmart
Corporation is the borrower. From its inception, we have only used the
Credit Facility to support issuances of letters of credit. In July 2004, we
voluntarily reduced the size of the Credit Facility from $1.5 billion to
$1.0 billion to reduce the overall cost of the facility. Availability under
the Credit Facility is subject to an inventory borrowing base formula. The
Credit Facility is guaranteed by the Successor Company, Kmart Management
Corporation, Kmart Services Corporation (a subsidiary of Kmart Management
Corporation) and Kmart Corporation's direct and indirect domestic
subsidiaries. The Credit Facility is secured primarily by first liens on
inventory, the proceeds thereof and certain related assets of Kmart
Corporation and the guarantors.
Borrowings under the Credit Facility are subject to a pricing
grid based on our earnings before interest, taxes, depreciation,
amortization and other charges ("EBITDA") levels and such adjustments are
implemented quarterly. Borrowings 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 in
support of trade and standby letters of credit currently bears interest at
1.25% and 2.50% per annum, respectively. In addition, we are currently
required to pay a fee based on the unutilized commitment under the Credit
Facility equal to 0.50% per annum. The Credit Facility gives the Company
the ability to repurchase up to $500 million of the Company's Common Stock,
depending on our EBITDA levels and subject to the approval of the Company's
Board of Directors.
In accordance with the terms and conditions of the Credit
Facility, we are submitting the required information to support a reduction
in the current interest rates. We anticipate borrowings, if any, under the
Credit Facility will bear interest at either (i) the Prime rate plus 1.0%
per annum or (ii) the LIBOR rate plus 2.0% per annum, at our discretion,
and utilization of the letter of credit sub-facility in support of trade
and standby letters of credit will bear interest at 1.25% and 2.00% per
annum, respectively. The unutilized commitment fee will equal 0.375% per
annum.
As of July 28, 2004, we had utilized $341 million of the Credit
Facility for letters of credit issued for ongoing import purchasing
operations, and contractual and regulatory purposes, including letters of
credit utilized as collateral to support our self-insurance programs.
During the first six months of fiscal 2004, we replaced letters of credit
used as collateral for certain programs with cash collateral to reduce fees
on our letters of credit. We continue to classify the cash collateral in
Cash and cash equivalents due to our ability to convert the cash to letters
of credit at any time at our discretion. As of July 28, 2004, $214 million
of cash was posted as collateral.
Total availability under the Credit Facility as of July 28, 2004
was approximately $630 million.
The Credit Facility financial covenants include a requirement
that we maintain certain availability minimums, and failure to do so
triggers additional required minimum levels of EBITDA. The Credit Facility
also contains other customary covenants, including certain reporting
requirements and covenants that restrict our ability to incur or create
liens, indebtedness and guarantees, make investments, pay dividends or make
other equity distributions, sell or dispose of stock or assets, change the
nature of our business and enter into affiliate transactions, mergers and
consolidations. Failure to satisfy these covenants would (in some cases,
after the receipt of notice and/or the expiration of a grace period) result
in an event of default that could result in our inability to access the
funds. As of July 28, 2004 and in all periods since our emergence from
Chapter 11, we have been in compliance with all Credit Facility covenants.
CASH FLOWS
Operating activities provided net cash of $536 million and $576
million for the 26-weeks ended July 28, 2004 and the 13-weeks ended April
30, 2003, respectively. During the 13-weeks ended July 30, 2003, operating
activities used $172 million of net cash. Improved net earnings and a
reduction in working capital primarily drove the cash flow increase for the
26-weeks ended July 28, 2004. For the 13-weeks ended July 30, 2003, the use
of cash was primarily due to payments of $451 million for exit costs and
reorganization items, partially offset by a reduction of inventory, net of
accounts payable. For the 13-weeks ended April 30, 2003, a decrease in
inventory due to liquidation sales in conjunction with store closings and
improved inventory management, partially offset by a decrease in accounts
payable, had a favorable affect on operating cash flow.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - (CONTINUED)
Investing activities generated $29 million, $17 million and $60
million for the 26-weeks ended July 28, 2004 and the 13-weeks ended July
30, 2003 and April 30, 2003, respectively. During the current period, we
received proceeds of $153 million from sales of real and personal property,
including $59 million from the sale of four owned properties to Home Depot.
We have not received any other proceeds as of July 28, 2004 for the sale
and assignment of other properties to Home Depot or Sears as remaining
transactions had not yet been consummated. See Note 5 - Real Estate and
Property Transactions and Note 12 - Property Held for Sale for a more
detailed discussion of these transactions. During the 26-weeks ended July
28, 2004, we purchased 22 previously-leased operating properties for $84
million. Proceeds of $64 million were received during the 13-weeks ended
April 30, 2003, from the sale of four owned Kmart store locations and the
sale of furniture and fixtures from closed store locations.
Payments on capital lease obligations and mortgages of $27
million and $17 million were the uses of cash for financing activities
during the 26-weeks ended July 28, 2004 and the 13-weeks ended April 30,
2003, respectively. Financing activities provided $123 million in cash for
the 13-weeks ended July 30, 2003. Upon emergence from bankruptcy in May
2003, the Company received net proceeds of $127 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. The positive affect
of these items was partially offset by payments made for other financing
arrangements. Refer to Note 2 - Emergence from Chapter 11 Bankruptcy
Protection and Fresh-Start Accounting for a more detailed discussion.
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
primary purpose of providing restricted stock grants to certain employees.
On June 29, 2004, the Company's Board of Directors increased the existing
share repurchase authorization to $100 million and broadened the scope of
future repurchases to include the repurchase of shares in furtherance of
general corporate purposes. As of July 28, 2004, we had repurchased
approximately $4 million of Common Stock.
FUTURE LIQUIDITY ITEMS
PENSION PLAN
Prior to 1996, the Predecessor Company maintained defined benefit
pension plans covering eligible associates. Effective January 31, 1996, the
pension plans were frozen, and associates no longer earn additional
benefits under the plans (except for purposes of the subsidized early
retirement program provided by the plan). The plans' assets consist
primarily of equity and fixed income securities. Prior to 2004, no
contributions had been made to the plans for the past eight years.
During the 13-weeks and 26-weeks ended July 28, 2004
contributions to the plans were approximately $1 million. The estimated
contribution for fiscal 2004 is $11 million. Contributions to the plans
were not required for the 13-weeks ended July 30, 2003 or April 30, 2003.
Pension expense was $8 million, $4 million, $9 million and $21
million for the 26-weeks ended July 28, 2004 and the 13-weeks ended July
28, 2004, July 30, 2003 and April 30, 2003, respectively.
REAL ESTATE TRANSACTIONS
Home Depot U.S.A., Inc.
On June 3, 2004, the Company entered into multiple definitive
agreements with Home Depot U.S.A., Inc. (a subsidiary of The Home Depot,
Inc.) ("Home Depot") to sell up to four owned properties and assign up to
20 leased properties for a maximum purchase price of $365 million in cash.
Pursuant to the first of these agreements, on June 15, 2004, the Company
completed the sale of four owned properties to Home Depot for $59 million
in cash, resulting in a net gain of $43 million. On August 10, 2004 the
second agreement was amended, which limited the number of leased properties
to be assigned to not more than 15 properties with a maximum purchase price
of $230 million in cash. We completed the assignment of nine of these
properties on August 13, 2004, resulting in proceeds to the Company of $114
million in cash. We anticipate that Home Depot may close on the remaining
six leases by the end of August 2004, subject to certain closing conditions
being satisfied. In the event Home Depot does not close on certain of these
properties, we have the option to assign up to two of these properties to
Home Depot for a maximum of $42 million in cash.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - (CONTINUED)
Sears, Roebuck and Co.
On June 29, 2004, the Company entered into an agreement with
Sears, Roebuck and Co. ("Sears") to sell up to two owned properties and
assign up to 52 leased properties for a maximum purchase price of $621
million in cash. Pursuant to this agreement, certain closing conditions for
a minimum of 43 of the properties must be satisfied by August 31, 2004.
However, if the closing conditions have not been satisfied by August 31,
2004, the Company, at its option, may give written notice to Sears by
September 9, 2004 to proceed with the closing with respect to those
properties for which closing conditions have been satisfied. In the event
the closing conditions for the 43 properties have not been satisfied by
August 31, 2004 and written notice has not been given to Sears by the
Company, either party may terminate the purchase agreement subsequent to
September 9, 2004, but prior to the date closing conditions are satisfied
for at least 43 properties. Assuming such conditions are met, the Company
will receive 30% of the purchase price in September 2004. The remaining 70%
of the purchase price will be received when Sears has been assigned the
leases and occupies the properties, which shall take place no later than
April 15, 2005.
OTHER
In light of the Company's liquidity position and subject to
compliance with our Credit Facility, we may consider various uses of cash
and other resources in the future which could include investments in
various forms of securities, share repurchases, the acquisition of related
or unrelated businesses, and the payment of dividends.
STORE ACTIVITY
During the 26-weeks ended July 28, 2004 the Company purchased 22
previously leased store locations; closed four operating stores; and
allowed leases to expire on four stores. As of July 28, 2004, we operated
1,503 stores.
In the second quarter of fiscal 2003, we closed one store. In the
first quarter of fiscal 2003, the Predecessor Company closed 316 stores.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our financial statements, certain of our accounting
policies require considerable judgment to select the appropriate
assumptions to calculate financial estimates. By their nature, these
estimates are complex and subject to an inherent degree of uncertainty. We
base our estimates on historical experience, terms of existing contracts,
our evaluation of trends and other assumptions that we believe to be
reasonable under the circumstances. We continually evaluate the information
used to make these estimates as our business and the economic environment
change.
Management believes the current assumptions and other
considerations used to estimate amounts reflected in our financial
statements are appropriate. However, if actual experience differs from the
assumptions and other considerations used in estimating amounts, the
resulting changes could have a material adverse effect on our consolidated
results of operations, and in certain situations, could have a material
adverse effect on our financial condition. We have disclosed our critical
accounting policies and estimates, which include inventory valuation,
self-insurance reserves, pension accounting and deferred taxes, in our
Annual Report on Form 10-K/A for the year ended January 28, 2004.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
For a comprehensive discussion see Note 4 - New Accounting
Pronouncements.
DISCONTINUED OPERATIONS
During the first quarter of fiscal 2003, the Predecessor Company
closed 316 stores. Of the total stores closed, 66 met the criteria for
discontinued operations. For a comprehensive discussion see Note 16 -
Discontinued Operations.
For the 13-weeks ended April 30, 2003, 250 of the 316 stores
closed were accounted for in continuing operations as they did not meet the
criteria for discontinued operations. Total sales, gross margin and SG&A
for these 250 stores were $854 million, $301 million and $146 million,
respectively.
30
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - (CONTINUED)
SPECIAL CHARGES
Special charges are transactions which, in management's judgment,
may make meaningful comparisons of operating results between reporting
periods difficult. In determining what amounts constitute a special charge,
management considers the nature, magnitude and frequency of their
occurrence. For the 13-weeks ended April 30, 2003, the Predecessor Company
recorded special charges of $42 million. For a comprehensive discussion see
Note 17 - Special Charges.
REORGANIZATION ITEMS, NET
Reorganization items represent amounts the Predecessor Company
incurred as a result of Chapter 11, and are presented separately in the
Unaudited Condensed Consolidated Statements of Operations as required by
SOP 90-7. The Predecessor Company recorded $813 million for the 13-weeks
ended April 30, 2003 for reorganization items. For a comprehensive
discussion see Note 18 - Reorganization Items, net.
OTHER MATTERS
Martha Stewart was convicted on March 5, 2004 of conspiracy,
obstruction of justice and two counts of making false statements to federal
investigators. Ms. Stewart has been sentenced to five months in prison,
five months of home confinement and two years probation. Ms. Stewart is
appealing the sentence. 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. 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.
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. We have reached agreements with
four issuers of pre-petition surety bonds on the terms and conditions of a
continuation of their respective bonds.
31
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At July 28, 2004, we did not have any derivative instruments that
increased our exposure to market risks for interest rates, foreign currency
rates, commodity prices or other market price risks. We do not use
derivatives for speculative purposes. Currently, our exposure to market
risks results primarily from changes in interest rates, principally with
respect to the Credit Facility, which is a variable rate financing
agreement. We do not use swaps or other interest rate protection agreements
to hedge this risk.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision of, and with the participation of our
management, including our 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-Q/A, and in Note 3, "Restatement" in the Notes to the
Unaudited Condensed Consolidated Financial Statements in Item 1. 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.
32
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 19 of the Notes to Unaudited Condensed Consolidated
Financial Statements for information concerning legal proceedings.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
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
primary purpose of providing restricted stock grants to certain employees.
On June 29, 2004, the Company's Board of Directors increased the existing
share repurchase authorization to $100 million and broadened the scope of
future repurchases to include the repurchase of shares in furtherance of
general corporate purposes. We have the authorization to repurchase
approximately $96 million of Common Stock under the program as of July 28,
2004.
Total Approximate
Number of Shares Dollar Value
Average Purchased as Part of Shares that
Total Price of Publicly May Yet Be
Number of Shares Paid per Announced Purchased Under
Period Purchased (1) Share Program the Program
------------------------------ ---------------- -------- ----------------- ---------------
April 29, 2004 to May 26, 2004 -- -- -- $ 6,000,000
May 27, 2004 to June 23, 2004 7,761 $65.00 -- $ 6,000,000
June 24, 2004 to July 28, 2004 -- -- -- $96,000,000
(1) During the second quarter of fiscal 2004, the Company repurchased
7,761 shares of Common Stock for purposes of paying withholding taxes
for certain former associates that were part of the Class 5
claimholders incremental distribution.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following information is furnished with respect to the 2004
Annual Meeting of Shareholders of Kmart Holding Corporation held on May 25,
2004.
The shareholders voted to ratify the appointment of BDO Seidman,
LLP as independent auditors of the Corporation for fiscal year 2004. The
vote was 65,656,595 for, 225,751 against and 51,686 abstentions. There were
no broker non-votes.
The shareholders also voted to approve the Company's incentive
plans and grant of shares. The vote was 57,932,608 for, 501,452 against and
72,004 abstentions. There were 7,427,968 broker non-votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 10.1 Employment Agreement dated as of June 1, 2004, between
Kmart Management Corporation and David Whipple
(previously filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q, for the period ended July
28, 2004, and incorporated herein by reference)
Exhibit 10.2 Asset Purchase Agreement dated as of June 29, 2004
between Kmart Corporation and Sears, Roebuck and Co.
(previously filed as Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q, for the period ended July
28, 2004, and incorporated herein by reference)
33
Exhibit 10.3 Letter of Credit Agreement dated as of August 13, 2004
among Kmart Corporation, Bank of America, National
Association and Fleet National Bank as issuing banks
(previously filed as Exhibit 10.3 to the Company's
Quarterly Report on Form 10-Q, for the period ended July
28, 2004, and incorporated herein by reference)
Exhibit 31.1 Chief Executive Officer Certification pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as Amended
Exhibit 31.2 Chief Financial Officer Certification pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as Amended
Exhibit 32.1 Certifications pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
(b) Reports on Form 8-K:
We filed the following Current Reports on Form 8-K with the SEC:
1. On May 17, 2004, Kmart Holding Corporation furnished a Current
Report on Form 8-K to report the first quarter 2004 operating
results.
2. On June 4, 2004, Kmart Holding Corporation furnished a Current
Report on Form 8-K to announce it has signed definitive
agreements to sell up to 24 stores to The Home Depot, Inc.
3. On June 30, 2004, Kmart Holding Corporation furnished a Current
Report on Form 8-K to announce it has signed a definitive
agreement to sell up to 54 store to Sears, Roebuck and Co. and to
announce that the Company's Board of Directors has increased the
Company's existing share repurchase authorization to $100
million.
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
The signatory hereby acknowledges and adopts the typed form of his/her name in
the electronic filing of this document with the Securities and Exchange
Commission.
Date: FEBRUARY 11, 2005
Kmart Holding Corporation
(Registrant)
By: /s/ Aylwin B. Lewis
----------------------------------------------
Aylwin B. Lewis
President and Chief Executive Officer
(Principal Executive Officer)
/s/ James D. Donlon, III
----------------------------------------------
James D. Donlon, III
Senior Vice President, Chief Financial Officer
(Principal Financial Officer)
/s/ James F. Gooch
----------------------------------------------
James F. Gooch
Vice President, Controller
(Principal Accounting Officer)
35
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
31.1 Chief Executive Officer Certification pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as Amended
31.2 Chief Financial Officer Certification pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as Amended
32.1 Certifications pursuant to 18 U. S. C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002