-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CmASroe5Omqd+kNOfIExpCfgGDQurQ0CyUtWpQwTQMZTtuCOgQYZGngiuTr8zRXg yYCEvzanhx8xaMVZipADBg== 0000950124-02-002075.txt : 20020612 0000950124-02-002075.hdr.sgml : 20020612 20020612171659 ACCESSION NUMBER: 0000950124-02-002075 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20011031 FILED AS OF DATE: 20020612 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KMART CORP CENTRAL INDEX KEY: 0000056824 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-VARIETY STORES [5331] IRS NUMBER: 380729500 STATE OF INCORPORATION: MI FISCAL YEAR END: 0129 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-00327 FILM NUMBER: 02677626 BUSINESS ADDRESS: STREET 1: 3100 W BIG BEAVER RD CITY: TROY STATE: MI ZIP: 48084 BUSINESS PHONE: 2486431000 MAIL ADDRESS: STREET 1: 3100 W BIG BEAVER ROAD CITY: TROY STATE: MI ZIP: 48084 FORMER COMPANY: FORMER CONFORMED NAME: KRESGE S S CO DATE OF NAME CHANGE: 19770921 10-Q/A 1 k70154ce10vqza.txt AMENDMENT NO. 1 TO FORM 10-Q 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 October 31, 2001 ---------------- 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. 1-327 ----- KMART CORPORATION ----------------- (Exact name of registrant as specified in its charter) Michigan 38-0729500 - -------------------------------------------------------------------------------- (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 --------- ------- As of October 31, 2001, 498,416,655 shares of Common Stock of Kmart Corporation were outstanding. 1 INDEX
PART I FINANCIAL INFORMATION PAGE - ------ --------------------- ---- Item 1. Financial Statements Consolidated Statements of Operations-- 4 13 and 39 weeks ended October 31, 2001 (restated) and October 25, 2000 Consolidated Balance Sheets-- 5 October 31, 2001 (restated), October 25, 2000 and January 31, 2001 Consolidated Statements of Cash Flows-- 6 39 weeks ended October 31, 2001 (restated) and October 25, 2000 Notes to Consolidated Financial Statements 7-14 Item 2. Management's Discussion and Analysis of Results of 15-25 Operations and Financial Condition PART II OTHER INFORMATION - ------- ----------------- Item 6. Exhibits and Reports on Form 8-K 26 Signatures 27
2 Explanatory Statement On January 22, 2002 ("Petition Date"), subsequent to the initial filing of our Quarterly Report on Form 10-Q for the 13 and 39 weeks ended October 31, 2001, Kmart and 37 of its U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or "Chapter 11") in the United States Bankruptcy Court for the Northern District of Illinois ("Court"). The reorganization is being jointly administered under the caption "In re Kmart Corporation, et al. Case No. 02 B 02474." We decided to seek judicial reorganization based upon a rapid decline in our liquidity resulting from our below-plan sales and earnings performance in the fourth quarter, the evaporation of the surety bond market and erosion of supplier confidence. Other factors included intense competition in the discount retailing industry, unsuccessful sales and marketing initiatives, the continuing recession, and recent capital market volatility. As a debtor-in-possession, Kmart is authorized to continue to operate as an ongoing business, but may not engage in transactions outside the ordinary course of business without the approval of the Court, after notice and an opportunity for a hearing. At this time, it is not possible to predict the effect of the Chapter 11 reorganization on our business, various creditors and security holders or when we will be able to exit Chapter 11. Our future results are dependent upon our confirming and implementing, on a timely basis, a plan of reorganization. A more detailed description of the bankruptcy filing and its effect on Kmart is set forth in Kmart's Annual Report on Form 10-K for the fiscal year ended January 30, 2002 filed with the Securities Exchange Commission ("SEC") on May 15, 2002. Given our bankruptcy filing in the fourth quarter, the increased uncertainty relating to vendor rebates and allowances ("allowances") and the corresponding difficulty in reliably estimating such amounts in the future, we concluded that it would be preferable to change our accounting method for interim recognition of such cost recoveries from vendors. Under the new methodology, Kmart will recognize a cost recovery from vendors only when a formal agreement for such amount has been obtained and the underlying activity for which the amount was provided has been performed. This change in methodology does not affect the results that otherwise would have been reported for the full fiscal year, but rather affects the interim recognition of allowances during the year. We believe this new method is preferable because it provides higher precision, better verifiability, reduced reliance on estimates and is consistent with an analogous application of Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." While this change in method was adopted in the fourth quarter of fiscal 2001, generally accepted accounting principles require the restatement of the first three quarters of fiscal 2001 to reflect this change. Additionally, in January 2002, Kmart announced that we had received an anonymous letter sent to the SEC, our auditors and directors expressing concern with respect to various matters. Accordingly, the Board of Directors instructed that an internal investigation be undertaken under the supervision of the Audit Committee by outside legal counsel, with the assistance of independent accounting advisors. Based on the results of the investigation to date, as well as the results of our new management team's review of Kmart's accounting policies and methods, we concluded that (1) an adjustment should be made with respect to the accounting for up-front consideration in a transaction from a vendor which more appropriately should have been deferred and recognized over the life of the contract and (2) the recording of additional general liability reserves in the fourth quarter was more appropriately designated as a second quarter event. Our financial statements for the 13 and 39 weeks ended October 31, 2001 have been restated herein to reflect the change in accounting method and the foregoing adjustments. The pro forma effect of the change in accounting method on the financial statements for the 13 and 39 weeks ended October 25, 2000 is also presented herein. 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS KMART CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED)
13 WEEKS ENDED 39 WEEKS ENDED ----------------------------- ----------------------------- OCTOBER 31, OCTOBER 31, 2001 2001 (RESTATED, OCTOBER 25, (RESTATED, OCTOBER 25, SEE NOTE 1) 2000 SEE NOTE 1) 2000 ----------- ----------- ------------ ------------- Sales $ 8,019 $ 8,199 $ 25,273 $ 25,392 Cost of sales, buying and occupancy 6,434 6,518 20,521 20,530 ----------- ----------- ------------ ------------- Gross margin 1,585 1,681 4,752 4,862 Selling, general and administrative expenses 1,826 1,697 5,566 5,379 Charges for BlueLight.com and other 5 -- 120 -- ----------- ----------- ------------ ------------- Loss before interest, income taxes and dividends on convertible preferred securities of subsidiary trust (246) (16) (934) (517) Interest expense, net 96 71 267 205 Income tax benefit (118) (31) (390) (263) Dividends on convertible preferred securities of subsidiary trust, net of income taxes of $6, $6, $18 and $18, respectively 11 11 34 34 ----------- ----------- ------------ ------------- Net loss $ (235) $ (67) $ (845) $ (493) =========== =========== ============ ============= Basic/Diluted loss per common share $ (0.47) $ (0.14) $ (1.72) $ (1.00) =========== =========== ============ ============= Basic/Diluted weighted average shares (millions) 497.8 482.1 492.4 481.9 Pro forma amounts assuming the new accounting policy was applied retroactively: Net loss $ (235) $ (143) $ (845) $ (764) =========== =========== ============ ============= Basic/Diluted loss per common share $ (0.47) $ (0.29) $ (1.72) $ (1.56) =========== =========== ============ =============
See accompanying Notes to Consolidated Financial Statements. 4 KMART CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED) ------------------------------- OCTOBER 31, 2001 (RESTATED, OCTOBER 25, JANUARY 31, SEE NOTE 1) 2000 2001 ---------------- ------------- --------------- Current Assets: Cash and cash equivalents $ 366 $ 285 $ 401 Merchandise inventories 8,318 7,878 6,412 Other current assets 730 909 939 ---------------- ------------- --------------- Total current assets 9,414 9,072 7,752 Property and equipment, net 6,968 6,481 6,557 Other assets and deferred charges 483 487 523 ---------------- ------------- --------------- Total Assets $ 16,865 $ 16,040 $ 14,832 ================ ============= =============== Current Liabilities: Long-term debt due within one year $ 478 $ 295 $ 68 Trade accounts payable 3,686 2,555 2,159 Accrued payroll and other liabilities 1,131 1,515 1,587 Taxes other than income taxes 271 267 187 ---------------- ------------- --------------- Total current liabilities 5,566 4,632 4,001 Long-term debt and notes payable 3,310 2,835 2,084 Capital lease obligations 881 956 943 Other long-term liabilities 865 911 834 Company obligated mandatorily redeemable convertible preferred securities of a subsidiary trust holding solely 7 3/4% convertible junior subordinated debentures of Kmart (redemption value $898, $898 and $898, respectively) 890 886 887 Common stock, $1 par value, 1,500,000,000 shares authorized; 498,416,655, 483,391,211 and 486,509,736 shares outstanding, respectively 498 483 487 Capital in excess of par value 1,682 1,567 1,578 Retained earnings 3,173 3,770 4,018 ---------------- ------------- --------------- Total Liabilities and Shareholders' Equity $ 16,865 $ 16,040 $ 14,832 ================ ============= ===============
See accompanying Notes to Consolidated Financial Statements. 5 KMART CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
39 WEEKS ENDED ------------------------------------- OCTOBER 31, 2001 (RESTATED, OCTOBER 25, SEE NOTE 1) 2000 ------------------ ---------------- CASH FLOW FROM OPERATING ACTIVITIES Net loss from continuing operations $ (845) $ (493) Adjustments to reconcile net loss from continuing operations to net cash used for operating activities: Restructuring, impairments and other charges 268 728 Depreciation and amortization 618 584 Equity loss in unconsolidated subsidiaries 14 2 Dividends received from Meldisco 51 44 Cash used for store closings (90) (46) Increase in inventories (1,901) (1,142) Increase in trade accounts payable 1,586 525 Deferred income taxes and taxes payable (348) (357) Changes in other assets 10 (134) Changes in other liabilities 262 (34) ------------------ ---------------- Net cash used for continuing operations (375) (323) Net cash used for discontinued operations (67) (75) ------------------ ---------------- Net cash used for operating activities (442) (398) ------------------ ---------------- CASH FLOW FROM INVESTING ACTIVITIES Capital expenditures (1,084) (699) Investment in BlueLight.com (45) (55) ------------------ ---------------- Net cash used for investing activities (1,129) (754) ------------------ ---------------- CASH FLOW FROM FINANCING ACTIVITIES Proceeds from issuance of debt 1,887 1,366 Issuance of common shares 40 41 Purchase of convertible preferred securities of subsidiary trust - (84) Purchase of common shares - (56) Payments on debt (275) (61) Payments on capital lease obligations (62) (58) Payments of dividends on preferred securities of subsidiary trust (54) (55) ------------------ ---------------- Net cash provided by financing activities 1,536 1,093 ------------------ ---------------- Net decrease in cash and cash equivalents (35) (59) Cash and cash equivalents, beginning of year 401 344 ------------------ ---------------- Cash and cash equivalents, end of period $ 366 $ 285 ================== ================
See accompanying Notes to Consolidated Financial Statements. 6 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) 1. RESTATEMENT OF FINANCIAL STATEMENTS On January 22, 2002, subsequent to the initial filing of our Quarterly Report on Form 10-Q for the 13 and 39 weeks ended October 31, 2001, Kmart and 37 of its U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or "Chapter 11") in the United States Bankruptcy Court for the Northern District of Illinois ("Court"). A more detailed discussion of our Chapter 11 filing is included in our Annual Report on Form 10-K for the fiscal year ended January 30, 2002. Given our bankruptcy filing in the fourth quarter, the increased uncertainty relating to vendor rebates and allowances ("allowances") and the corresponding difficulty in reliably estimating such amounts in the future, we concluded that it would be preferable to change our accounting method for interim recognition of such cost recoveries from vendors. For interim reporting periods in fiscal 2000, as well as with respect to the interim reporting periods in fiscal 2001 which were previously reported, our policy was to record allowances not yet subject to a written agreement during the first three quarters of a fiscal year based upon our estimate of annual allowances ("the plan") as determined by historical experience and current understandings with our vendors. These amounts were supplemented by allowances obtained that were not contemplated in such plan. While many agreements are finalized throughout the year, significant activity occurs in the fourth quarter to finalize outstanding agreements and collect allowances. During the fourth quarter of fiscal 2001 we adopted a new accounting policy effective as of February 1, 2001, for interim financial reporting only, requiring that cost recoveries from vendors be recognized only when a formal agreement for such amount has been obtained and the underlying activity for which the amount was provided has been performed. This change in methodology does not affect the results that otherwise would have been reported for the full fiscal year, but rather affects the interim recognition of allowances during the year. We believe this new method is preferable because it provides higher precision, better verifiability, reduced reliance on estimates and is consistent with an analogous application of Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." Embedded in the accounting change that gives effect to the change in interim financial reporting for allowances is an adjustment for an indeterminate amount of supplemental or "incremental" allowances that were initially recorded in the first three quarters of fiscal 2001 prior to having been documented, or otherwise deemed appropriate, pursuant to our historical policy. Kmart concluded that it is not practicable to determine the impact on prior quarters. It should be noted, however, that the restated interim information reflects such allowances only to the extent they are supported by formal agreements or otherwise deemed appropriate in the quarter recognized. Additionally, in January 2002, Kmart announced that we had received an anonymous letter sent to the Securities and Exchange Commission ("SEC"), our auditors and directors expressing concern with respect to various matters. Accordingly, the Board of Directors instructed that an internal investigation be undertaken under the supervision of the Audit Committee by outside legal counsel, with the assistance of independent accounting advisors. Based on the results of the investigation to date, as well as the results of our new management team's review of Kmart's accounting policies and methods, we concluded that (1) an adjustment should be made with respect to up-front consideration in a single transaction from a vendor which more appropriately should have been deferred and recognized over the life of the contract and (2) the recording of additional general liability reserves in the fourth quarter was more appropriately designated as a second quarter event. Accordingly, adjustments were made for such transactions, including restatements of previously reported quarterly financial statements for fiscal 2001. Our financial statements for the 13 and 39 weeks ended October 31, 2001 have been restated to reflect the change in accounting method and the foregoing adjustments. The pro forma effect of the change in accounting method on the financial statements for the 13 and 39 weeks ended October 25, 2000 is also presented herein. 7 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (UNAUDITED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) The following table illustrates the effects of the accounting change and adjustments on the financial statements for the 13 and 39 weeks ended October 31, 2001.
13 Weeks Ended October 31, 2001 -------------------------------------------------------------------------------- Adjustments ------------------------------ Change in As previously Up-front General accounting reported consideration liability method As restated -------------------------------------------------------------------------------- Sales $8,019 $0 $0 $0 $8,019 Cost of sales, buying and occupancy $6,425 ($15) $0 $24 $6,434 --------------- ---------------- ------------- ---------------- ---------------- Gross margin $1,594 $15 $0 ($24) $1,585 Selling, general and administrative expenses $1,818 $0 $0 $8 $1,826 Operating (loss) income ($229) $15 $0 ($32) ($246) Net (loss) income ($224) $10 $0 ($21) ($235) ================================================================================ Basic/Diluted (loss) earnings per common share ($0.45) $0.02 $0 ($0.04) ($0.47) ================================================================================
39 Weeks Ended October 31, 2001 -------------------------------------------------------------------------------- Adjustments ------------------------------ Change in As previously Up-front General accounting reported consideration liability method As restated -------------------------------------------------------------------------------- Sales $25,273 $0 $0 $0 $25,273 Cost of sales, buying and occupancy $20,091 $27 $0 $403 $20,521 -------------------------------------------------------------------------------- Gross margin $5,182 ($27) $0 ($403) $4,752 Selling, general and administrative expenses $5,248 $0 $167 $151 $5,566 Operating loss ($186) ($27) ($167) ($554) ($934) Net loss ($344) ($18) ($112) ($371) ($845) ================================================================================ Basic/Diluted loss per common share ($0.70) ($0.04) ($0.23) ($0.75) ($1.72) ================================================================================
2. BASIS OF PRESENTATION These interim unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the SEC, and, in the opinion of management, reflect all adjustments (which include normal recurring adjustments) necessary for a fair statement of the results for the interim periods. These consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K filed for the fiscal year ended January 31, 2001. Certain reclassifications of prior period financial statements have been made to conform to the current year presentation. 8 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) 3. LOSS PER SHARE
13 Weeks Ended 39 Weeks Ended ---------------------------- ---------------------------------- October 31, October 31, 2001 2001 (Restated, October 25, (Restated, October 25, see Note 1) 2000 see Note 1) 2000 -------------- ------------ -------------- ------------- Net Loss $ (235) $ (67) $ (845) $ (493) Add: Discount on redemption of preferred securities, net - 1 - 10 Adjusted net loss available to common shareholders $ (235) $ (66) $ (845) $ (483) Basic/Diluted weighted average shares (millions) 497.8 482.1 492.4 481.9 ============= ============ ============== ============== Basic/Diluted loss per common share $ (0.47) $ (0.14) $ (1.72) $ (1.00) ============= ============ ============== ==============
In each period, certain outstanding stock options were excluded from the computation of diluted earnings per share because they would have been anti-dilutive. As of October 31, 2001, options to purchase 58.8 million shares of common stock at prices ranging from $5.34 to $26.03 were excluded from the 13 and 39 week calculations. As of October 25, 2000, options to purchase 46.8 million shares of common stock at prices ranging from $5.34 to $26.03 were excluded from the 13 and 39 week calculations. The calculations also exclude the effect of trust convertible preferred securities and written put options. For the 13 and 39 week periods ended October 31, 2001, diluted shares outstanding exclude approximately 59.9 million common shares from potential conversion of certain trust convertible preferred securities due to their anti-dilutive effect. For the 13 and 39 week periods ended October 25, 2000, diluted shares outstanding exclude approximately 60.2 million and 61.3 million common shares, respectively, from potential conversion of certain trust convertible preferred securities due to their anti-dilutive effect. For the 39 week period ended October 25, 2000, diluted shares outstanding exclude approximately 0.5 million common shares from the potential conversion of written put options due to their anti-dilutive effect. 4. INVENTORIES AND COST OF MERCHANDISE SOLD A substantial portion of our inventory is accounted for using the last-in, first-out ("LIFO") method. Since LIFO costs can only be determined at the end of each fiscal year when inflation rates and inventory levels are finalized, estimates are used for LIFO purposes in the interim consolidated financial statements. Inventories valued on LIFO at October 31, 2001, October 25, 2000 and January 31, 2001 were $194, $202 and $194 lower, respectively, than the amounts that would have been reported under the first-in, first-out method. 5. INTEREST INCOME Interest income is included in the line Interest expense, net in the Consolidated Statements of Operations. For the 13 week periods ended October 31, 2001 and October 25, 2000 interest income was $1 and $8, respectively. For the 39 week periods ended October 31, 2001, and October 25, 2000 interest income was $3 and $15, respectively. 9 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) 6. RESTRUCTURINGS SUPPLY CHAIN OPERATIONS On September 6, 2001 we announced that we would restructure certain aspects of our supply chain infrastructure, including the reconfiguration of our distribution center network and implementation of new operating software across our supply chain. Completion of these actions is expected by the end of the second quarter of 2002. In conjunction with these actions, we will record special charges totaling $189 ($120 after-tax), of which $148 ($94 after-tax) is recorded in the third quarter. We recorded a $92 charge related to the planned disposal of supply chain software and hardware and other assets that will no longer be utilized, in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." As certain components of our supply chain software will continue to be utilized until replaced, depreciation will be accelerated to reflect the revised useful lives and these assets will be fully-amortized by mid-2002. In the third quarter we recorded a charge of $9 related to the accelerated depreciation on these assets. The expected incremental depreciation aggregates $14 in the fourth quarter of 2001, and $27 in 2002. Subsequent to the initial filing of this Form 10-Q, we early adopted the provisions of SFAS No. 144, "Accounting for the Impairment and Disposal of Long-Lived Assets," retroactively for all periods in 2001. The charge described herein was not affected by this retroactive adoption. A $47 charge was provided for lease terminations and contractual employment obligations for staff reductions of 956 employees at our distribution centers in accordance with EITF 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The majority of the employees will be severed in the fourth quarter of fiscal year 2001, with the remaining employees severed in the first quarter of fiscal year 2002. No costs were paid and charged against the reserve during the quarter. The following table summarizes the significant components and presentation, in the Consolidated Statements of Operations, of the charge for the restructuring of our supply chain operations during the third quarter of 2001.
Cost of sales, buying and occupancy SG&A Total -------------- ------------- -------------- Lease obligations $ 37 $ - $ 37 Accelerated depreciation of software 9 - 9 Asset impairment 5 87 92 Contractual employment obligations 10 - 10 -------------- ------------- -------------- Total $ 61 $ 87 $ 148 ============== ============= ==============
10 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) BLUELIGHT.COM We recorded a $92 charge ($73 after-tax) related to our e-commerce site, BlueLight.com, in the second quarter, comprised of $41 for the impairment of our investment in BlueLight.com and $51 for the restructuring of our e-commerce business. These charges are included in the line Charges for BlueLight.com and other in the Consolidated Statements of Operations. Based upon the changed environment for internet businesses, in which the ability for internet businesses to raise capital became restricted, management's revised future cash flow projections and the potential need for significant additional cash advances, we adopted a multi-step plan to substantially restructure the operations of BlueLight.com. The initial step was executed by acquiring the remaining 40% interest in BlueLight.com, LLC, through the purchase of all outstanding common and preferred stock of BlueLight.com, Inc., a holding company. BlueLight.com, Inc. and BlueLight.com LLC (hereinafter together or individually, "BlueLight.com") then became wholly-owned subsidiaries of Kmart, which allowed us to execute the subsequent steps of our plan. The purchase price of the additional interest was $85, with $69 being satisfied through the issuance of 6.1 million unregistered shares of Kmart common stock and $16 paid in cash. Based upon the revised cash flow projections for the business, we recorded a $41 charge to write-down our investment in BlueLight.com to estimated fair value in accordance with SFAS No. 121. Fair value was estimated using the present value of estimated future cash flows. In conjunction with the transaction, the return of capital puts for $62.5 and the 4.4 million warrants for Kmart stock originally granted to SOFTBANK Venture Capital (currently Mobius Venture Capital) and other investors, previously disclosed, were terminated. The $62.5 liability for the return of capital puts, recorded due to the uncertainties surrounding a start-up operation in the highly competitive e-commerce industry, was relieved. Of the $51 restructuring charge, $29 related to assets impaired as a result of the restructuring. These assets represent furniture and fixtures, leasehold improvements, and computer software and hardware, the majority of which were located in the headquarters of BlueLight.com, and have not been utilized in the restructured operations. These assets were reduced to the lower of carrying amount or fair value less cost to sell in accordance with SFAS No. 121. Fair value was determined using the present value of estimated future cash flows. Liabilities for lease terminations, contract terminations and other costs totaling $22 were established in accordance with EITF 94-3 as a result of the decision to exit the BlueLight.com headquarters building and outsource certain aspects of our overall e-commerce business, including fulfillment, technology and customer service. During the third quarter, we continued executing our restructuring plan, including formally communicating to 114 employees at the BlueLight.com headquarters expected severance dates and the severance benefit amount they will receive when they are terminated. In conjunction with this communication, we recorded an additional $5 ($3 after-tax) charge to provide for these costs. These charges are included in the line Charges for BlueLight.com and other in the Consolidated Statements of Operations. Seventy-three employees were terminated during the quarter. We also outsourced the hosting of our site, fulfillment of e-commerce orders and all related customer service. We have substantially completed our restructuring plan and expect to accomplish the remaining steps in the fourth quarter of this year. Subsequent to the initial filing of this Quarterly Report on Form 10-Q, we early adopted the provisions of SFAS No. 144, "Accounting for the Impairment and Disposal of Long-Lived Assets," retroactively for all periods in 2001. The charge described herein was not affected by this retroactive adoption. 11 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) The following table provides information regarding liabilities established during the 39 week periods ending October 31, 2001 and October 25, 2000, with respect to the fiscal year 2000 strategic actions charge, the fiscal year 2001 BlueLight.com restructuring charge and the fiscal year 2001 supply chain restructuring charge. The liabilities aggregated $213 and $288 at October 31, 2001 and October 25, 2000, respectively.
39 Weeks Ended ---------------------------------------------------------------- October 31, October 25, 2001 2000 ----------------------------------------------- ----------- 2001 2001 2000 2000 Supply BlueLight Strategic Strategic Chain .com Actions Total Actions ----- ---- ------- ----- ------- Balance, beginning of period $ -- $ -- $177 $177 $ -- Additions charged to earnings: Second quarter -- 92 -- 92 740 Third quarter 148 5 -- 153 -- ---- ---- ---- ---- ---- Total Additions 148 97 -- 245 740 Reductions: Cash payments: Lease obligations -- 1 31 32 -- Employee costs -- 3 -- 3 -- Contractual obligations -- 2 -- 2 -- Other costs -- 1 -- 1 -- Non-cash reductions: Adjustments -- -- -- -- 12 Asset writedowns 101 70 -- 171 440 ---- ---- ---- ---- ---- Balance, end of period $ 47 $ 20 $146 $213 $288 ==== ==== ==== ==== ====
7. OTHER CHARGES During the first quarter of 2001, we realigned our organization and reduced our workforce by 350 employees through a voluntary early retirement program ("VERP") and other employee separations. The total cost of the realignment aggregated $23 ($15, net of tax) which is included in our unaudited Condensed Consolidated Statement of Operations for the quarter ended May 2, 2001 in the line item Charge for employee severance and VERP. Of the charge, $19 was reserved for and will be paid out of our general corporate assets, the remaining $4 will be paid out of the Kmart Employee Pension Plan. The charge relates to 130 employees that accepted the VERP offer, with costs aggregating $6. The remaining 220 employees were severed and given post-employment benefits including severance, outplacement services, continuation of healthcare benefits and other benefits totaling $17. Our first quarter cash payments in fiscal 2001 associated with these actions were $9. 12 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) 8. COMPREHENSIVE (LOSS) INCOME Comprehensive (loss) income represents net (loss) income, adjusted for the effect of other items that are recorded directly to shareholders' equity. Net (loss) income and comprehensive (loss) income are equivalent for all periods presented. 9. EFFECTIVE TAX RATE The effective tax benefit rates for the 13 and 39 week periods ended October 31, 2001, as restated, were 34.5% and 32.5%, respectively. In 2001, the actual tax benefit rates are lower than the statutory rate due to the preclusion of recording certain tax benefits related to our acquisition of the remaining interest in BlueLight.com. 10. INVESTMENTS IN AFFILIATED RETAIL COMPANIES MELDISCO For the 13 week period ended October 31, 2001, Meldisco had net sales of $293, gross profit of $138 and net income of $22. For the 13 week period ended October 25, 2000, Meldisco had net sales of $305, gross profit of $144 and net income of $23. For the 39 week period ended October 31, 2001, Meldisco had net sales of $904, gross profit of $434 and net income of $69. For the 39 week period ended October 25, 2000, Meldisco had net sales of $946, gross profit of $448 and net income of $72. BLUELIGHT.COM For the 13 week period ended October 25, 2000, BlueLight.com had net sales of $2, no gross profit and a net loss of $21. For the period from February 1, 2001 to July 31, 2001, BlueLight.com had net sales of $8, gross profit of $1 and a net loss of $55. For the 39 week period ended October 25, 2000, BlueLight.com had net sales of $3, gross profit of $1 and a net loss of $58. BlueLight.com's operations were fully consolidated into our financial statements commencing July 31, 2001. 11. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," effective for all business combinations initiated after June 30, 2001. This statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or thereafter. Also, in June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS No. 143, "Accounting for Asset Retirement Obligations," effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 141 and SFAS No. 142 are not expected to have a material impact on our earnings or financial position. We are currently assessing the impact that the application of the provisions of SFAS No. 143 will have on our Consolidated Financial Statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," effective for fiscal years beginning after December 15, 2001. Subsequent to the initial filing of this Quarterly Report on Form 10-Q, we early adopted the provisions of SFAS No. 144. There was no effect on the financial statements for the 13 and 39 weeks ended October 31, 2001. 13 KMART CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) 12. SHARE REPURCHASE PROGRAMS In July 2001, we terminated the common stock repurchase program that was initiated in April 1999. Under the program we repurchased approximately 22 million shares of common stock during 1999 and 2000 at a cost of approximately $255. We also terminated the trust convertible preferred securities repurchase program that was initiated in February 2000. Under the program we repurchased approximately 2 million shares of trust convertible securities at a cost of approximately $84. 13. OTHER COMMITMENTS AND CONTINGENCIES LEASE GUARANTEES As of October 31, 2001, we had outstanding guarantees for real property leases of certain former subsidiaries as follows:
Present Value of Gross Future Future Lease Lease Obligations @ 7% Obligations ----------------- ----------- The Sports Authority, Inc. $188 $318 Borders Group, Inc. 90 153 OfficeMax, Inc. 69 101 ---- ---- Total $347 $572 ==== ====
Kmart's contingent obligation is dependent on the future operating results of the guarantees and is subject to settlement under a plan of reorganization to be voted upon by the creditors and equity holders and approved by the court. Should a reserve be required, it would be recorded at the time the obligation was determined to be both probable and estimable. Our rights and obligations with respect to our guarantee of The Sports Authority, Inc., OfficeMax, Inc., and Borders Group, Inc. leases are governed by Lease Guaranty, Indemnification and Reimbursement Agreements dated as of November 23, 1994, November 9, 1994 and May 24, 1995, respectively, as amended from time to time. OTHER We are a party to a substantial number of other claims, lawsuits, and pending actions, most of which are routine and all of which are incidental to our business. Some matters involve claims for large amounts of damages as well as other relief. The Company assesses the likelihood of potential losses on an ongoing basis and when they are considered probable and reasonably estimable, records an estimate of the ultimate outcome. If there is no single point estimate of loss that is considered more likely than others, an amount representing the low end of the range of possible outcomes is recorded. Although the final consequences of these proceedings are not presently determinable, in the opinion of management, they are not expected to have a material adverse effect on our liquidity, financial position or results of operations. 14 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) ITEM 2. CHANGE IN ACCOUNTING POLICY AND OTHER ADJUSTMENTS Given our bankruptcy filing in the fourth quarter, the increased uncertainty relating to vendor rebates and allowances ("allowances") and the corresponding difficulty in reliably estimating such amounts in the future, we concluded that it would be preferable to change our accounting method for interim recognition of such cost recoveries from vendors. Under the new methodology, Kmart will recognize a cost recovery from vendors only when a formal agreement for such amount has been obtained and the underlying activity for which the amount was provided has been performed. This change in methodology does not affect the results that otherwise would have been reported for the full fiscal year, but rather affects the interim recognition of allowances during the year. We believe this new method is preferable because it provides higher precision, better verifiability, reduced reliance on estimates and is consistent with an analogous application of Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." While this change in method was adopted in the fourth quarter of fiscal 2001, generally accepted accounting principles require the restatement of the first three quarters of fiscal 2001 to reflect this change. Embedded in the accounting change that gives effect to the change in interim financial reporting for allowances is an adjustment for an indeterminate amount of supplemental or "incremental" allowances that were initially recorded in the first three quarters of fiscal 2001 prior to having been documented, or otherwise deemed appropriate, pursuant to our historical policy. Kmart concluded that it is not practicable to determine the impact on prior quarters. It should be noted, however, that the restated interim information reflects such allowances only to the extent they are supported by formal agreements or otherwise deemed appropriate in the quarter recognized. Additionally, in January 2002, Kmart announced that we had received an anonymous letter sent to the Securities and Exchange Commission ("SEC"), our auditors and directors expressing concern with respect to various matters. Accordingly, the Board of Directors instructed that an internal investigation be undertaken under the supervision of the Audit Committee by outside legal counsel, with the assistance of independent accounting advisors. Based on the results of the investigation to date, as well as the results of our new management team's review of Kmart's accounting policies and methods, we concluded that (1) an adjustment should be made with respect to the accounting for up-front consideration in a transaction from a vendor which more appropriately should have been deferred and recognized over the life of the contract and (2) the recording of additional general liability reserves in the fourth quarter was more appropriately designated as a second quarter event. Accordingly, adjustments were made for such transactions, including restatements of previously reported quarterly financial statements for fiscal 2001 as reflected herein. 15 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) The following tables illustrate the effects of the accounting change and adjustments on the financial statements for the 13 and 39 weeks ended October 31, 2001.
13 Weeks Ended October 31, 2001 ------------------------------------------------------------------------------------- Adjustments ------------------------------ Change in As previously Up-front General accounting reported consideration liability method As restated -------- ------------- --------- ------ ----------- Sales $ 8,019 $ 0 $ 0 $ 0 $ 8,019 Cost of sales, buying and occupancy $ 6,425 ($ 15) $ 0 $ 24 $ 6,434 -------- -------- -------- -------- -------- Gross margin $ 1,594 $ 15 $ 0 ($ 24) $ 1,585 Selling, general and administrative expenses $ 1,818 $ 0 $ 0 $ 8 $ 1,826 Operating (loss) income ($ 229) $ 15 $ 0 ($ 32) ($ 246) Net (loss) income ($ 224) $ 10 $ 0 ($ 21) ($ 235) ======== ======== ======== ======== ======== Basic/Diluted (loss) earnings per common share ($ 0.45) $ 0.02 $ 0 ($ 0.04) ($ 0.47) ======== ======== ======== ======== ======== 39 Weeks Ended October 31, 2001 ------------------------------------------------------------------------------------- Adjustments ------------------------------ Change in As previously Up-front General accounting reported consideration liability method As restated -------- ------------- --------- ------ ----------- Sales $ 25,273 $ 0 $ 0 $ 0 $ 25,273 Cost of sales, buying and occupancy $ 20,091 $ 27 $ 0 $ 403 $ 20,521 -------- -------- -------- -------- -------- Gross margin $ 5,182 ($ 27) $ 0 ($ 403) $ 4,752 Selling, general and administrative expenses $ 5,248 $ 0 $ 167 $ 151 $ 5,566 Operating loss ($ 186) ($ 27) ($ 167) ($ 554) ($ 934) Net loss ($ 344) ($ 18) ($ 112) ($ 371) ($ 845) ======== ======== ======== ======== ======== Basic/Diluted loss per common share ($ 0.70) ($ 0.04) ($ 0.23) ($ 0.75) ($ 1.72) ======== ======== ======== ======== ========
16 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) ANALYSIS OF OPERATIONS EXCLUDING NON-COMPARABLE ITEMS The following table segregates operating (loss) income excluding non-comparable items from operating loss as reported in the Consolidated Statements of Operations. Information is also provided concerning the pro forma effect of the change in accounting method on the comparable periods in fiscal year 2000.
13 WEEKS 39 WEEKS ----------------------------------------------- ----------------------------------------------- OCTOBER 31, OCTOBER 25, OCTOBER 31, OCTOBER 25, 2001 OCTOBER 25, 2000 2001 OCTOBER 25, 2000 (as restated) 2000 (pro forma) (as restated) 2000 (pro forma) -------------- -------------- --------------- -------------- -------------- -------------- Sales $ 8,019 $ 8,199 $ 8,199 $ 25,273 $ 25,392 $ 25,392 Cost of sales, buying and occupancy 6,373 6,518 6,595 20,460 20,165 20,441 -------- -------- -------- -------- -------- -------- Gross margin 1,646 1,681 1,604 4,813 5,227 4,951 Selling, general and administrative 1,739 1,709 1,745 5,479 5,016 5,143 -------- -------- -------- -------- -------- -------- Operating (loss) income excluding non-comparable items (93) (28) (141) (666) 211 (192) Charge for supply chain restructuring 148 -- -- 148 -- -- Charge for BlueLight.com 5 -- -- 97 -- -- Charge for employee severance and VERP -- -- -- 23 -- -- Strategic actions -- (12) (12) -- 728 728 -------- -------- -------- -------- -------- -------- Operating loss $ (246) $ (16) $ (129) $ (934) $ (517) $ (920) ======== ======== ======== ======== ======== ======== Same-store sales % (1.5%) 1.4% 1.4% 0.4% 0.7% 0.7% Net loss per share including non-comparable items $ (0.47) $ (0.14) $ (0.29) $ (1.72) $ (1.00) $ (1.56) ======== ======== ======== ======== ======== ========
The information set forth below relating to Gross margin; Selling, general and administrative expenses; and Operating loss compares restated results for fiscal year 2001 with results, prepared on a pro forma basis giving effect to the change in accounting method, for the comparable periods in fiscal year 2000. SALES for the 13 weeks ended October 31, 2001 were $8,019, a decrease of 2.2% from sales of $8,199 for the 13 weeks ended October 25, 2000. Sales for the 39 weeks ended October 31, 2001 were $25,273, a decrease of 0.5% from sales of $25,392 for the 39 weeks ended October 25, 2000. The decrease in total sales is due in part to the reduction in the number of Kmart stores from 2,163 at October 25, 2000 to 2,113 at October 31, 2001. Same-store sales decreased 1.5% for the 13 week period ended October 31, 2001 and increased 0.4% for the 39 week period ended October 31, 2001. The decrease in same-store sales for the 13 weeks ended October 31, 2001 is due primarily to the effect of prior year clearance sales of discontinued merchandise, the deflationary effect of our BlueLight Always program, under which we lowered prices on approximately 30,000 high-frequency items, and fewer sales transactions due to reduced promotional activity. Same-store sales include sales of all stores open, that have been open for greater than 13 full months. Divisions showing particular strength on a year-to-date basis included pharmacy, beauty and health care, home entertainment and food and consumables. We opened 16 stores and closed 8 stores during the 39 weeks ended October 31, 2001. 17 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) GROSS MARGIN increased $42 to $1,646, for the 13 weeks ended October 31, 2001, from $1,604 for the 13 weeks ended October 25, 2000. Gross margin, as a percentage of sales, was 20.5% and 19.6% for the 13 weeks ended October 31, 2001 and October 25, 2000, respectively. The increase in gross margin is primarily attributable to an increase in vendor allowances, unfavorable prior year distribution center physical inventory results, and lower food and consumables distribution costs under our arrangement with Fleming, partially offset by lower margin attributable to the BlueLight Always program, and an increase in sales, as a percentage of total sales, of food and consumables, which carry a lower margin. For the 39 week period ended October 31, 2001, gross margin decreased $138 to $4,813 from $4,951 for the 39 week period ended October 25, 2000. Gross margin, as a percentage of sales, was 19.0% and 19.5% for the 39 week periods ended October 31, 2001 and October 25, 2000, respectively. The decrease in gross margin is attributable to the pricing effects of our BlueLight Always program and an increase in sales, as a percentage of total sales, of food and consumables, which carry a lower margin, partially offset by an increase in vendor allowances, reduced store shrinkage, unfavorable prior year distribution center physical inventory results and lower distribution costs under our arrangement with Fleming. The pro forma effect of the change in accounting on the interim results for fiscal year 2000 was to increase cost of goods sold by $77 and $276 for the 13 and 39 weeks ended October 25, 2000, respectively, and, thereby, reduce Gross margin, as a percentage of sales, from 20.5% to 19.6% for the 13 week period ended October 25, 2000 and from 20.6% to 19.5% for the 39 week period ended October 25, 2000. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") decreased $6 for the 13 weeks ended October 31, 2001 to $1,739, or 21.7% of sales, from $1,745, or 21.3% of sales, for the 13 weeks ended October 25, 2000. The decrease in SG&A primarily relates to a decrease in advertising, net of co-op allowances, partially offset by wage rate increases and additional investment in store labor. SG&A expenses increased $336 for the 39 weeks ended October 31, 2001 to $5,479, or 21.7% of sales, from $5,143, or 20.3% of sales, for the 39 weeks ended October 25, 2000. The increase is due primarily to increased expenses for general liability claims as reserves were increased in the second quarter of fiscal year 2001 following significant analysis and actuarial studies, wage rate increases, and additional investment in store labor and utility rate increases, which were partially offset by reductions in advertising costs. The pro forma effect of the change in accounting on the interim results for fiscal year 2000 was to increase SG&A by $36 and $127 for the 13 and 39 weeks ended October 25, 2000, respectively. OPERATING LOSS for the 13 weeks ended October 31, 2001 was $93, or 1.2% of sales, as compared to an operating loss of $141, or 1.7% of sales, for the same period of the prior year. The decrease in the loss is primarily due to increased vendor allowances. For the 39 week period ended October 31, 2001, operating loss was $666, or 2.6% of sales, as compared to $192, or 0.8% of sales, for the comparable period of the previous year. The increase in the loss for the 39 weeks ended October 31, 2001 is primarily related to the pricing effects of our BlueLight Always program and an increase in sales, as a percentage of total sales, of food and consumables, which carry a lower margin, and increased expenses for general liability claims as reserves were increased by approximately $167 in the second quarter of fiscal year 2001 following significant analysis and actuarial studies. NET INTEREST EXPENSE for the 13 weeks ended October 31, 2001 and October 25, 2000 was $96 and $71, respectively. For the 39 week periods ended October 31, 2001 and October 25, 2000, net interest expense was $267 and $205, respectively. Net interest expense increased as a result of the issuance in January 2001 of $400 of 9.375% Notes due January 2006, the issuance in June 2001 of $430 of 9 7/8% Notes due June 2008 and increased borrowings under our Revolving Credit Agreement ("Revolver"). See "Liquidity and Financial Condition." 18 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) LIQUIDITY AND FINANCIAL CONDITION Our primary sources of working capital are cash flows from operations and borrowings under our credit facilities. We had working capital of $3,849, $4,440 and $3,751 at October 31, 2001, October 25, 2000 and January 31, 2001, respectively. Working capital fluctuates in relation to profitability, seasonal inventory levels net of trade accounts payable (net inventory) and the level of store openings and closings. There were $1.46 billion borrowings outstanding under our $1.60 billion Revolver at the end of the third quarter of fiscal 2001. There were $1.37 billion borrowings outstanding under our existing credit facilities at the end of the third quarter of fiscal 2000. Net cash used for operating activities for the 39 weeks ended October 31, 2001 was $442 as compared to net cash used for operating activities of $398 for the same period in 2000. The increase in cash used for operating activities as compared to the same period of the prior year was primarily the result of lower net earnings, excluding non-comparable items, and higher inventory purchases. Inventory increase by $1,906 during the first 39 weeks of fiscal year 2001 due to seasonal inventory fluctuations and actions taken to improve our overall in-stock position. Net cash used for investing activities was $1,129 for the 39 weeks ended October 31, 2001 compared to $754 for the same period in 2000. The increase in cash used for investing activities was primarily due to higher capital expenditures for the expansion of Kmart stores to Kmart Super Centers, construction of new Kmart Super Centers, expansion of midways to provide easier traffic flow for our customers and to increase visibility of promotional items and an investment in point-of-sale equipment. Net cash provided by financing activities was $1,536 for the 39 weeks ended October 31, 2001 compared to net cash provided by financing activities of $1,093 for the comparable period in 2000. The increase in cash provided was primarily the result of the issuance of $430 of 9 7/8% Notes due June 2008 and increased borrowings under the Revolver partially offset by the pay down of $262 Collateralized Mortgage Backed Securities in July. In July 2001, we terminated the common stock repurchase program that was initiated in April 1999 and the trust convertible preferred securities repurchase program initiated in February 2000. We repurchased approximately 22 million shares of common stock at a cost of approximately $55 and $200 in fiscal years 2000 and 1999, respectively. Under the trust convertible preferred securities repurchase program, we repurchased approximately 2 million shares of trust convertible securities at a cost of approximately $84. On November 15, 2001, we signed an agreement for the renewal of our unsecured 364-Day Credit Facility ("Facility") for the amount of $400. The Facility is scheduled to fund concurrent with the expiration of the current facility on or before December 2, 2001. On January 22, 2002 ("Petition Date"), subsequent to the initial filing of our Quarterly Report on Form 10-Q for the 13 and 39 weeks ended October 31, 2001, Kmart and 37 of its U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or "Chapter 11") in the United States Bankruptcy Court for the Northern District of Illinois ("Court"). We decided to seek judicial reorganization based upon a rapid decline in our liquidity resulting from our below-plan sales and earnings performance in the fourth quarter, the evaporation of the surety bond market and erosion of supplier confidence. Other factors included intense competition in the discount retailing industry, unsuccessful sales and marketing initiatives, the continuing recession, and recent capital market volatility. As a debtor-in-possession, Kmart is authorized to continue to operate as an ongoing business, but may not engage in transactions outside the ordinary course of business without the approval of the Court, after notice and an opportunity for a hearing. 19 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) At this time, it is not possible to predict the effect of the Chapter 11 reorganization on our business, various creditors and security holders or when we will be able to exit Chapter 11. Our future results are dependent upon our confirming and implementing, on a timely basis, a plan of reorganization. A more detailed description of the bankruptcy filing and its effect on the Company is set forth in the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 2002. SEASONALITY Due to the seasonal nature of the retail industry, where merchandise sales and cash flows from operations are historically higher in the fourth quarter than any other period, a disproportionate amount of operating cash flows are generated in the fourth quarter. In preparation for the fourth quarter holiday season, we significantly increase our merchandise inventories, which traditionally have been financed by cash flows from operations, bank lines of credit, trade credit and terms from vendors. Our profitability and cash flows are primarily dependent upon the large sales volume generated during the fourth quarter of our fiscal year. DESCRIPTION OF NON-COMPARABLE ITEMS During the first nine months of fiscal years 2000 and 2001, we have instituted certain restructuring actions to improve our operations. These actions are summarized below: SUPPLY CHAIN OPERATIONS On September 6, 2001 we announced that we would restructure certain aspects of our supply chain operations. This restructuring program focuses on the supply chain infrastructure, including the reconfiguration of our distribution center ("DC") network and implementation of new operating software across our supply chain. As a result of these actions, we recorded a pre-tax charge of $148 during the third quarter of 2001. Reconfiguration of the distribution center network entails the replacement of two aging distribution centers with two state-of-the-art facilities. The existing distribution centers are not properly fitted for softline DC operations and require significant investment to upgrade. Replacing the facilities will enable increased throughput and quicker inventory turns. In addition, the distribution of slower-moving goods are being centralized at one newly designated center, to improve efficiency across all other centers and facilitate the expansion of our BlueLight Always campaign. During the third quarter we recorded a pre-tax charge of $37 for a reserve for future lease obligations related to the closing of the two aging distribution centers and a $10 charge to provide for contractual employee obligations. These charges are included in Cost of sales, buying and occupancy in the Consolidated Statements of Operations. There were no reductions to the reserve during the third quarter. We recorded an $87 charge for the disposal of computer equipment and software, leasehold improvements and other assets that will no longer be utilized. These charges are included in Selling, general and administrative expenses in the Consolidated Statements of Operations. In addition, we recorded a $5 charge for other supply chain assets which are included in Cost of sales, buying and occupancy in the Consolidated Statements of Operations. New real-time distribution software will be implemented across our supply chain improving product flow and efficiency while enabling a world class distribution network. The current warehouse management software system does not provide adequate performance reporting and is not cost effective to upgrade. Due to increased efficiency associated with the new software we will be able to increase productivity through improved cube management while reducing labor costs. Completion of the implementation is expected by the end of the second quarter of fiscal 2002. The existing supply chain software will continue to be utilized until replaced in 2002. Depreciation will be accelerated to reflect the remaining revised useful lives. We recorded a charge of $9 related to the accelerated depreciation for these assets in the third quarter. These charges are included in Cost of sales, buying and occupancy in the Consolidated Statements of Operations. 20 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) As a result of these actions we expect earnings before income taxes to increase by approximately $15 per year. These savings will be achieved through reductions in labor costs, depreciation expense and maintenance costs, and increased productivity. The following table summarizes the significant components and presentation, in the Consolidated Statements of Operations, of the charge for the restructuring of our supply chain operations during the third quarter of 2001.
Cost of sales, buying and (in millions) occupancy SG&A Total ---------- ---- ----- Lease obligations $ 37 $ -- $ 37 Accelerated depreciation of software 9 -- 9 Asset impairment 5 87 92 Contractual employment obligations 10 -- 10 ---- ---- ---- Total $ 61 $ 87 $148 ==== ==== ====
BLUELIGHT.COM As a result of the changed environment for internet businesses, in which the ability for internet businesses to raise capital became restricted, management's revised future cash flow projections and the potential need for significant additional cash advances, we adopted a multi-step plan to substantially restructure the operations of BlueLight.com. At the end of the second quarter, we acquired the remaining 40% interest in BlueLight.com, giving us control of the entity. To acquire the 40% interest, we issued $69 in shares of Kmart common stock and paid $16 in cash for a total purchase price of $85. In connection with the acquisition, the return of capital put rights were terminated, the related $62.5 liability was relieved, and the 4.4 million warrants for Kmart common stock issued to SOFTBANK (currently Mobius Venture Capital) and other investors were cancelled. As a result of these activities, we recorded a $92 charge ($73 after-tax) in the second quarter. Of the charge, $41 related to the impairment of our investment in BlueLight.com, which was written down to fair value. This charge was recorded based upon our revised cash flow projections for the business in accordance with SFAS No. 121. The remaining $51 of the charge related to the restructuring of our e-commerce business. Of the $51 restructuring charge, $29 related to assets impaired as a result of the restructuring. These assets represent furniture and fixtures, leasehold improvements, and computer software and hardware, the majority of which were in the headquarters of BlueLight.com, and have not been utilized in the restructured operations. This charge was recorded in accordance with SFAS No. 121. Liabilities for lease terminations, contract terminations and other costs totaling $22 were established as a result of the decision to exit the BlueLight.com headquarters building and outsource certain aspects of our overall e-commerce business, including fulfillment, technology and customer service. During the quarter, $5 has been paid and charged against the liability. Subsequent to the initial filing of this Quarterly Report on Form 10-Q, we adopted SFAS No. 144 retroactively to all periods in fiscal year 2001. The charge described herein was not affected by the adoption of SFAS No. 144. During the third quarter, we continued executing our restructuring plan, including formally communicating severance benefits to 114 employees at the BlueLight.com headquarters and terminating seventy-three of those employees during the quarter. We recorded an additional $5 ($3 after-tax) charge to provide for these costs, $2 of which has been paid and charged against the liability during the quarter. 21 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) We also outsourced the hosting of our site, fulfillment of e-commerce orders and all related customer service. We have substantially completed our restructuring plan and expect to accomplish the remaining steps in the fourth quarter of fiscal year 2001. We expect the restructuring will reduce the operating costs of BlueLight.com by over 80%, which will improve our e-commerce results of operations by over $30 in 2002 from 2001 levels. All charges for the restructuring and impairment of the investment are included in the line Charges for BlueLight.com and other in the Consolidated Statements of Operations. The results of BlueLight.com's operations are fully consolidated in our financial statements commencing July 31, 2001. EMPLOYEE SEVERANCE AND VERP During the first quarter of 2001, we realigned our organization around our three strategic imperatives: to dramatically improve retail execution to achieve World Class Execution throughout our business, to create a Customer Centric Culture so our behaviors are linked to serving our customers, and to aggressively pursue Sales and Marketing Opportunities to define a market position differentiating Kmart from our competitors. As a result of our realignment, our workforce was reduced by 350 employees in the first quarter through a voluntary early retirement program ("VERP") and other employee separations. The total cost of the realignment aggregated $23 ($15, net of tax) which is included in our Consolidated Statements of Operations in the line Charges for BlueLight.com and other. The charge relates to 130 employees that accepted the VERP offer, with costs aggregating $6. The remaining 220 employees were severed and given post-employment benefits including severance, outplacement services, continuation of healthcare benefits and other benefits totaling $17. Payments associated with these actions have aggregated $16. An additional $3 will be paid to employees in accordance with the terms of the related severance agreements. Benefit payments to employees accepting the VERP are paid from the Kmart Employee Pension Plan, except certain payments for highly compensated employees which we pay directly. 2000 STRATEGIC ACTIONS In the second quarter of 2000, we announced a series of strategic actions aimed at strengthening financial performance by achieving improvements in return on invested capital. These actions included deciding to close certain Kmart and Kmart Super Center stores, accelerating certain inventory reductions and redefining our information technology strategy. As a result of these actions, we recorded a pre-tax charge of $740 ($471 after-tax) during the second quarter of 2000. During the third quarter of fiscal year 2000, we reduced this charge by $12 ($8 after-tax) due to reducing the number of scheduled store closings from 72 to 69, thus reducing the reserve for closed stores from $300 to $288. There were no other adjustments to the reserve during the period. 22 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) The impact of these restructuring charges on our effective tax rate for the 13 and 39 week periods ended October 31, 2001 is summarized in the following tables.
13 Weeks ended October 31, 2001 --------------------------------------------------- As BlueLight Supply Excluding Restated .com Chain Charges -------- ---- ----- ------- Loss before interest, income tax and dividends on convertible preferred securities of subsidiary trust $(246) $ (5) $(148) $ (93) Interest expense, net 96 -- -- 96 Income tax benefit (118) (2) (54) (62) Dividends on convertible preferred securities of subsidiary trust, net of income taxes 11 -- -- 11 ----- ----- ----- ----- Net loss $(235) $ (3) $ (94) $(138) ===== ===== ===== ===== Effective tax benefit rate 34.5% 36.5% 36.5% 33.0% ===== ===== ===== ===== 39 Weeks ended October 31, 2001 ----------------------------------------------------------------- As BlueLight Supply Other Excluding Restated .com Chain Charges Charges -------- ---- ----- ------- ------- Loss before interest, income tax and dividends on convertible preferred securities of subsidiary trust $(934) $ (97) $(148) $ (23) $(666) Interest expense, net 267 -- -- -- 267 Income tax benefit (390) (20) (54) (8) (308) Dividends on convertible preferred securities of subsidiary trust, net of income taxes 34 -- -- -- 34 ----- ----- ----- ----- ----- Net loss $(845) $ (77) $ (94) $ (15) $(659) ===== ===== ===== ===== ===== Effective tax benefit rate 32.5% 21.1% 36.5% 33.0% 33.0% ===== ===== ===== ===== =====
OTHER MATTERS OTHER ADJUSTMENTS Included in 2001 quarterly operating results are amounts related to adjustments to our asset and liability accounts that reduced operating results reported in 2001 by $15 in the first quarter, $21 in the second quarter, and $2 in the third quarter. These adjustments were recorded when identified by the Company in the ordinary course of events and substantially relate to prior years. LEASE GUARANTEES We have guaranteed leases for properties operated by certain former subsidiaries including Borders Group, Inc., OfficeMax, Inc., and The Sports Authority, Inc. The present value of the lease obligations we guaranteed is approximately $347. Kmart's contingent obligation is dependent on the future operating results of the guarantees and is subject to settlement under a plan of reorganization to be voted upon by the creditors and equity holders and approved by the court. 23 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) OTHER We are a party to a substantial number of claims, lawsuits, and pending actions, most of which are routine and all of which are incidental to our business. Some matters involve claims for large amounts of damages as well as other relief. The Company assesses the likelihood of potential losses on an ongoing basis and when they are considered probable and reasonably estimable, records an estimate of the ultimate outcome. If there is no single point estimate of loss that is considered more likely than others, an amount representing the low end of the range of possible outcomes is recorded. Although the final consequences of these proceedings are not presently determinable, in the opinion of management, they are not expected to have a material adverse effect on our liquidity, financial position or results of operations. 24 KMART CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This quarterly report, as well as other statements or reports made by or on behalf of Kmart, may contain or may incorporate by reference which includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that reflect, when made, Kmart's current views with respect to current events and financial performance. Statements, other than those based on historical facts, which address activities, events or developments that we expect or anticipate may occur in the future are forward-looking statements, which are based upon a number of assumptions concerning future conditions that may ultimately prove to be inaccurate. Such forward-looking statements are and will be, as the case may be, subject to many risks, uncertainties and factors relating to Kmart operations and business environment which may cause the actual results of Kmart to be materially different from any future results, express or implied, by such forward-looking statements include, but are not limited to, the following: General Factors - - general economic conditions, - - weather conditions, including those which affect buying patterns of our customers, - - changes in consumer spending and our ability to anticipate buying patterns and implement appropriate inventory strategies, - - competitive pressures and other third party actions, - - ability to timely acquire desired goods and/or fulfill labor needs at planned costs, - - ability to successfully implement business strategies and otherwise execute planned changes in various aspects of the business, - - regulatory and legal developments, - - our ability to attract, motivate and/or retain key executives and associates, - - our ability to attract and retain customers, - - other factors affecting business beyond our control, Bankruptcy Related Factors - - our ability to continue as a going concern, - - our ability to operate pursuant to the terms of the DIP Credit Facility, - - our ability to obtain Court approval with respect to motions in the Chapter 11 proceeding prosecuted by it from time to time, - - our ability to develop, prosecute, confirm and consummate one or more plans of reorganization with respect to the Chapter 11 cases, - - risks associated with third parties seeking and obtaining court approval to terminate or shorten the exclusivity period that we have to propose and confirm one or more plans of reorganization, for the appointment of a Chapter 11 trustee or to convert the cases to Chapter 7 cases, - - our ability to obtain and maintain normal terms with vendors and service providers, - - our ability to maintain contracts that are critical to our operations, - - the potential adverse impact of the Chapter 11 cases on our liquidity or results of operations, and - - our ability to fund and execute our business plan. 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. Similarly, these and other factors, including the terms of any reorganization plan ultimately confirmed, can affect the value of our various pre-petition liabilities, common stock and/or other equity securities. No assurance can be given as to what values, if any, will be ascribed in the bankruptcy proceedings to each of these constituencies. A plan of reorganization could result in holders of Kmart common stock receiving no value for their interests. Because of such possibilities, the value of the common stock is highly speculative. Accordingly, we urge that appropriate caution be exercised with respect to existing and future investments in any of these liabilities and/or securities. 25 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as a part of this report: Exhibit 10 - Special Supplemental Executive Retirement Plan (A) (incorporated by reference to Exhibit 10 to Kmart's Quarterly Report on Form 10-Q for the quarter ended October 31, 2001 filed on November 27, 2001) Exhibit 10.1 - Long Term Cash Incentive Plan (A) (incorporated by reference to Exhibit 10.1 to Kmart's Quarterly Report on Form 10-Q for the quarter ended October 31, 2001 filed on November 27, 2001) Exhibit 18 - Preferability Letter from PricewaterhouseCoopers LLP (incorporated by reference to Exhibit 18 to Kmart's Annual Report on Form 10-K for the fiscal year ended January 30, 2002 filed on May 15, 2002) (A) This document is a management contract or compensation plan. In reliance upon Item 601(B)(4)(iii)(A) of Regulation S-K, various instruments defining the rights of holders of long-term debt of the registrant are not being filed herewith because the total amount of securities authorized under each such instrument does not exceed 10% of the total assets of Kmart. We agree to furnish a copy to the Commission upon request of the following instruments defining the rights of holders of long-term debt: 9 7/8% Notes Due 2008 (b) Reports on Form 8-K: We filed a Current Report on Form 8-K dated September 6, 2001 to report, under Item 5, that Kmart Corporation issued a press release announcing the restructuring of our supply chain operations and related charge to earnings and to furnish, under Item 7, a copy of the press release. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. The signatory hereby acknowledges and adopts the typed form of his/her name in the electronic filing of this document with the Securities and Exchange Commission. Date: June 12, 2002 Kmart Corporation ---------------------------------- (Registrant) By: /s/ A. A. Koch ---------------------------------- A. A. Koch CHIEF FINANCIAL OFFICER (Principal Financial Officer) /s/ Richard J. Noechel ---------------------------------- Richard J. Noechel VICE PRESIDENT AND CONTROLLER (Principal Accounting Officer) 27 -----END PRIVACY-ENHANCED MESSAGE-----