<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
SCHEDULE 14A
(RULE 14A-101)
INFORMATION REQUIRED IN
PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF
THE SECURITIES EXCHANGE ACT OF 1934
Filed by the registrant /X/
Filed by a party other than the registrant / /
Check the appropriate box:
/X/ Preliminary proxy statement
/ / Definitive proxy statement
/ / Definitive additional materials
/ / Soliciting material pursuant to Rule 14a-11(c) or Rule 14a-12
KMART CORPORATION
(Name of registrant as specified in its charter)
KMART CORPORATION
(Name of Person(s) Filing Proxy Statement)
Payment of filing fee (Check the appropriate box):
/X/*$125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-6(i)(1), or 14a-6(i)(2)
/ / $500 per each party to the controversy pursuant to Exchange Act Rule
14a-6(i)(3)
/ / Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and
0-11.
(1) Title of each class of securities to which transaction applies:
(2) Aggregate number of securities to which transaction applies:
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:
(4) Proposed maximum aggregate value of transaction:
/ / Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number, or
the form or schedule and the date of its filing.
(1) Amount previously paid:
(2) Form, schedule or registration statement no.:
(3) Filing party:
(4) Date filed:
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* Previously paid.
<PAGE> 2
KMART CORPORATION
ANNUAL REPORT TO STOCKHOLDERS
NOTICE OF ANNUAL MEETING AND PROXY STATEMENT
ANNUAL MEETING OF STOCKHOLDERS
MAY 24, 1994
THE SPORTS AUTHORITY [LOGO] BUILDERS SQUARE [LOGO]
KMART [LOGO]
BORDERS [LOGO]
WALDENBOOKS [LOGO] OFFICEMAX [LOGO]
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PROXY STATEMENT
ANNEX I: GLOSSARY OF CERTAIN TERMS
ANNEX II: ILLUSTRATIONS OF CERTAIN TERMS
ANNEX III: PROPOSED AMENDMENTS TO RESTATED ARTICLES OF INCORPORATION
ANNEX IV: EMPLOYEE BENEFIT PLAN PROPOSALS
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BOOK ONE OF TWO
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<PAGE> 3
PRELIMINARY COPY DATED MARCH 22, 1994
KMART CORPORATION
INTERNATIONAL HEADQUARTERS
TROY, MICHIGAN 48084
April , 1994
Dear Stockholder:
I cordially invite you to attend your Company's 1994 Annual Meeting of
Stockholders on Tuesday, May 24, 1994. The meeting will be held at Kmart
International Headquarters in Troy, Michigan and will begin at 9:00 a.m., local
time. The annual report, formal notice of meeting, proxy statement and form of
proxy accompany this letter and describe in detail the matters to be acted upon
at the meeting.
In addition to the election of directors, other important proposals are
being submitted to a vote of stockholders at this year's meeting, including the
Specialty Retail Stock Proposal (Proposal No. 2) which gives the Board of
Directors the authority to issue Common Stock in four series that are intended
to reflect the performance of each of the following specialty retail businesses
(collectively, the "Specialty Retail Stock"): Borders-Walden, Builders Square,
OfficeMax and The Sports Authority. Upon the initial issuance of any series of
Specialty Retail Stock, the existing Common Stock would be redesignated as Kmart
Group Common Stock ("Kmart Stock"), which is intended to reflect the performance
of the Company's core Kmart discount store business and remaining businesses, as
well as a retained interest in the specialty retail businesses.
The Specialty Retail Stock Proposal is intended to enhance stockholder
value over the long term by permitting separate market valuations of each series
of Specialty Retail Stock, which would result in greater market recognition of
the value of each of the specialty retail businesses, and by fostering an
ownership culture that would encourage superior performance by management and
employees of each specialty retail business. The Specialty Retail Stock Proposal
also provides the Company greater flexibility with regard to raising capital and
structuring employee incentive plans with an equity security specifically
related to each of the Company's businesses. At the same time, the proposal
enables the Company to retain operational control over the specialty retail
businesses and enables each of the Company's businesses to preserve the benefits
of being part of a single consolidated entity.
Following approval by stockholders of the Specialty Retail Stock Proposal,
the Company currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate initial public offerings and to allocate the net proceeds of such
offerings to the Kmart Group to repay outstanding indebtedness of the Company
and for general corporate purposes. The timing, sequence and size of such public
offerings and the price at which such shares would be sold would be determined
by the Board of Directors at the time of each offering based upon then
prevailing market and other conditions; however, it is currently contemplated
that shares intended to represent 20% to 30% of the equity value attributed to
each specialty retail business would initially be offered to the public.
Additional authorized shares of each series of Specialty Retail Stock could be
offered in the future at the discretion of the Board of Directors.
The Board of Directors currently intends that the dividend policy
applicable to the Kmart Stock would be the same as the dividend policy
applicable to the existing Common Stock, with the initial dividend rate on the
Kmart Stock being the rate in effect for the existing Common Stock at the time
of the redesignation of the Existing Common Stock as Kmart Stock.
It is important to note that holders of Kmart Stock and of each series of
Specialty Retail Stock would be holders of Common Stock of the Company and would
be subject to risks associated with an investment in the Company and all of its
businesses, assets and liabilities.
In addition to the Specialty Retail Stock Proposal, stockholders will be
asked to consider and approve additional proposals to amend the Company's
Restated Articles of Incorporation and employee benefit plans and adoption of
certain new employee benefit plans. THE BOARD OF DIRECTORS HAS CAREFULLY
CONSIDERED AND UNANIMOUSLY APPROVED THE SPECIALTY RETAIL STOCK PROPOSAL AND SUCH
ADDITIONAL PROPOSALS, BELIEVES THEIR ADOPTION IS IN THE BEST INTERESTS OF THE
COMPANY AND RECOMMENDS THAT THE STOCKHOLDERS VOTE IN FAVOR OF ALL OF SUCH
PROPOSALS.
As a stockholder, your vote is important. I encourage you to execute and
return your proxy promptly whether or not you plan to attend so that we may have
as many shares as possible represented at the meeting. Returning your completed
proxy will not prevent you from voting in person at the meeting if you wish to
do so.
Thank you for your cooperation and continued support and interest in Kmart
Corporation.
Sincerely,
[SIG]
Joseph E. Antonini
Chairman of the Board
President and Chief Executive Officer
<PAGE> 4
PRELIMINARY COPY DATED MARCH 22, 1994
KMART CORPORATION
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD MAY 24, 1994
TO THE STOCKHOLDERS OF
KMART CORPORATION
The Annual Meeting of Stockholders of Kmart Corporation (the "Company")
will be held at Kmart International Headquarters, 3100 West Big Beaver Road,
Troy, Michigan 48084, on Tuesday, the 24th day of May, 1994, at 9:00 a.m., local
time, for the following purposes:
1. To elect five Class II directors for a term expiring in 1997 as
set forth in the accompanying Proxy Statement;
2. To act upon the Specialty Retail Stock Proposal to amend the
Company's Restated Articles of Incorporation, as set forth in Annex III-A,
to, among other things, (a) increase the number of authorized shares of
Common Stock from 1.5 billion to 3.0 billion, (b) redesignate 1.5 billion
shares of the Company's existing Common Stock as Kmart Group Common Stock;
and (c) authorize 1.5 billion shares of Common Stock to be available for
designation in series by resolution of the Board of Directors as additional
shares of Kmart Group Common Stock and/or any of four new series of
Specialty Retail Group Common Stock, each with the designations, relative
rights, preferences and limitations set forth in the accompanying Proxy
Statement;
3. To act upon a proposal to amend the Company's Restated Articles of
Incorporation, as set forth in Annex III-B, relating to Preferred Stock
issued in series by resolution of the Board of Directors;
4. To act upon a proposal to amend the Company's Restated Articles of
Incorporation, as set forth in Annex III-C, to conform certain provisions
regarding the vote required for removal of directors and related amendments
to the voting provisions applicable to the various series of Common Stock
pursuant to the Specialty Retail Stock Proposal;
5. To act upon a proposal to adopt an Employee Stock Purchase Plan
for each Specialty Retail Group;
6. To act upon a proposal to provide for the issuance of Specialty
Retail Stock under the Directors Stock Plan;
7. To act upon a proposal to provide for the substitution of
Specialty Retail Stock for certain outstanding awards of existing Common
Stock under the Performance Restricted Stock Plan;
8. To act upon a proposal to provide for the substitution of
Specialty Retail Stock for existing Common Stock issuable upon exercise of
certain options granted under the 1973 and 1981 Stock Option Plans;
9. To act upon a proposal to provide for the substitution of
Specialty Retail Stock for existing Common Stock issuable upon exercise of
certain options granted under the 1992 Stock Option Plan and certain other
plan amendments;
10. To act upon a proposal to add certain allocation provisions to the
1992 Stock Option Plan in order to comply with certain recently enacted
provisions of the Internal Revenue Code;
11. To act upon a proposal to adopt the Management Stock Purchase
Plan;
12. To act upon a proposal to adopt the Annual Incentive Bonus Plan;
13. To ratify the appointment of Price Waterhouse as independent
accountants of the Company for the 1994 fiscal year;
14. To act upon a stockholder proposal as set forth in the
accompanying Proxy Statement, which proposal is opposed by the Board of
Directors; and
15. To transact such other business as may properly come before the
meeting.
Proposals 4 through 9 concern Specialty Retail Stock and, therefore, are
each conditioned upon approval of Proposal 2 and will not be implemented if
Proposal 2 is not approved by stockholders and implemented by the Board.
Accordingly, a vote against Proposal 2 will have the effect of a vote against
each of Proposals 4 through 9.
Stockholders of record of Common Stock, Series A Conversion Preferred Stock
and Series B Convertible Preferred Stock at the close of business on April 8,
1994 will be entitled to vote at the meeting.
You are cordially invited to attend the meeting in person. However, whether
you plan to attend or not, we urge you to complete, date, sign and return the
enclosed proxy promptly in the envelope provided, to which no postage need be
affixed if mailed in the United States, in order that as many shares as possible
may be represented at the meeting.
By order of the Board of Directors,
Troy, Michigan Nancie W. LaDuke,
April , 1994 Vice President and Secretary
<PAGE> 5
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
ANNUAL REPORT AND PROXY STATEMENT -- GENERAL
INFORMATION..................................... 1
STRUCTURE OF KMART CORPORATION SPECIALTY RETAIL
STOCK PROPOSAL.................................. 2
SUMMARY COMPARISON OF TERMS OF EXISTING COMMON
STOCK WITH TERMS OF KMART STOCK AND SPECIALTY
RETAIL STOCK.................................... 3
PROXY STATEMENT SUMMARY........................... 7
PRICE RANGES OF EXISTING COMMON STOCK, SERIES A
PREFERRED STOCK
AND SERIES B PREFERRED STOCK;
DIVIDENDS....................................... 24
Existing Common Stock........................... 24
Series A Preferred Stock........................ 25
Series B Preferred Stock........................ 25
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS... 26
PROPOSAL 1 -- ELECTION OF DIRECTORS............... 27
Information about Nominees and Directors........ 27
Stock Ownership of Officers and Directors....... 30
Committees of the Board......................... 30
Compensation of Directors....................... 31
Compensation and Incentives Committee Report on
Executive Compensation........................ 32
Compensation of Officers........................ 36
Performance Graphs.............................. 39
PROPOSAL 2 -- THE SPECIALTY RETAIL STOCK
PROPOSAL........................................ 49
General......................................... 49
Special Considerations.......................... 49
Dividend Policy................................. 51
Management and Accounting Policies.............. 53
Description of Kmart Stock and Specialty Retail
Stock......................................... 56
Retained Interest of Kmart Group in Specialty
Retail Groups; Outstanding Interest
Fraction...................................... 67
Background and Reasons for the Specialty Retail
Stock Proposal................................ 69
Shares Issuable Under Employee Benefit Plan..... 71
Stock Exchange Listings......................... 72
Financial Advisors.............................. 72
Stock Transfer Agent and Registrar.............. 72
Restated Rights Agreement....................... 72
Effects on Preferred Stock...................... 75
Certain Federal Income Tax Considerations....... 75
Anti-takeover Considerations.................... 77
PROPOSAL 3 -- AMENDMENTS TO RESTATED ARTICLES OF
INCORPORATION RELATING TO ISSUANCE OF PREFERRED
STOCK IN SERIES BY RESOLUTION OF BOARD OF
DIRECTORS....................................... 81
PROPOSAL 4 -- AMENDMENTS TO RESTATED ARTICLES OF
INCORPORATION RELATING TO CERTAIN VOTING
PROVISIONS...................................... 83
PROPOSAL 5 -- ADOPTION OF
EMPLOYEE STOCK PURCHASE PLAN FOR EACH SPECIALTY
RETAIL GROUP.................................... 85
General......................................... 85
Additional Information Regarding Each Section
423 Plan...................................... 85
Description of Each Section 423 Plan............ 85
PROPOSAL 6 -- AMENDMENTS TO DIRECTORS STOCK PLAN
RELATING TO ISSUANCE OF SPECIALTY RETAIL
STOCK........................................... 89
General......................................... 89
Description of Amendments to Directors Plan..... 89
<CAPTION>
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<S> <C>
Additional Information Regarding Directors
Plan.......................................... 89
Description of Directors Plan as Proposed to be
Amended....................................... 89
PROPOSAL 7 -- AMENDMENTS TO PERFORMANCE RESTRICTED
STOCK PLAN RELATING TO SUBSTITUTION OF SPECIALTY
RETAIL STOCK FOR CERTAIN OUTSTANDING AWARDS OF
EXISTING COMMON STOCK........................... 93
General......................................... 93
Description of Amendment to Performance Plan.... 93
Stock Subject to Performance Plan............... 93
Additional Information Regarding Performance
Plan.......................................... 94
Description of Performance Plan as Proposed to
be Amended.................................... 94
Amendments to or Discontinuance of Performance
Plan.......................................... 94
Federal Income Tax Consequences................. 95
PROPOSAL 8 -- AMENDMENTS TO 1973 AND 1981 STOCK
OPTION PLANS RELATING TO SUBSTITUTION OF
SPECIALTY RETAIL STOCK FOR EXISTING COMMON STOCK
ISSUABLE UPON EXERCISE OF CERTAIN OUTSTANDING
OPTIONS......................................... 97
General......................................... 97
Description of Amendments to 1973 and 1981
Plans......................................... 97
Stock Subject to 1973 and 1981 Plans............ 97
Additional Information Regarding 1973 and 1981
Plans......................................... 98
Description of 1973 and 1981 Plans as Proposed
to be Amended................................. 98
Amendments to or Discontinuance of 1973 and 1981
Plans......................................... 98
Federal Income Tax Consequences................. 99
PROPOSAL 9 -- AMENDMENTS TO 1992 STOCK OPTION PLAN
RELATING TO SUBSTITUTION OF SPECIALTY RETAIL
STOCK FOR EXISTING COMMON STOCK ISSUABLE UPON
EXERCISE OF CERTAIN OPTIONS AND CERTAIN OTHER
PLAN AMENDMENTS................................. 101
General......................................... 101
Additional Information Regarding 1992 Plan...... 102
Description of 1992 Plan as Proposed to be
Amended....................................... 102
PROPOSAL 10 -- AMENDMENTS TO 1992 STOCK OPTION
PLAN RELATING TO ADDING CERTAIN ALLOCATION
PROVISIONS...................................... 107
Description of Amendment to Add Allocation
Provisions.................................... 107
Additional Information Regarding 1992 Plan...... 108
PROPOSAL 11 -- ADOPTION OF MANAGEMENT STOCK
PURCHASE PLAN................................... 109
General......................................... 109
Additional Information Regarding Stock Purchase
Plan.......................................... 109
Description of Stock Purchase Plan.............. 109
PROPOSAL 12 -- ADOPTION OF ANNUAL INCENTIVE BONUS
PLAN............................................ 115
General......................................... 115
Additional Information Regarding Annual Bonus
Plan.......................................... 115
Description of Annual Bonus Plan................ 115
PROPOSAL 13 -- RATIFICATION OF APPOINTMENT OF
INDEPENDENT ACCOUNTANTS......................... 119
PROPOSAL 14 -- STOCKHOLDER PROPOSAL............... 121
Stockholder's Supporting Statement.............. 121
STOCKHOLDER PROPOSALS............................. 121
</TABLE>
i
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<TABLE>
<CAPTION>
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<S> <C>
ANNEX I: GLOSSARY OF CERTAIN TERMS................ I-1
ANNEX II: ILLUSTRATIONS OF CERTAIN TERMS.......... II-1
ANNEX III-A: PROPOSAL 2 -- AMENDMENTS TO RESTATED
ARTICLES OF INCORPORATION RELATING TO SPECIALTY
RETAIL STOCK PROPOSAL........................... III-A-1
ANNEX III-B: PROPOSAL 3 -- AMENDMENTS TO RESTATED
ARTICLES OF INCORPORATION RELATING TO ISSUANCE
OF PREFERRED STOCK IN SERIES BY RESOLUTION OF
BOARD OF DIRECTORS.............................. III-B-1
ANNEX III-C: PROPOSAL 4 -- AMENDMENTS TO RESTATED
ARTICLES OF INCORPORATION RELATING TO CERTAIN
VOTING PROVISIONS............................... III-C-1
ANNEX IV-A: PROPOSAL 5 -- ADOPTION OF EMPLOYEE
STOCK PURCHASE PLAN FOR EACH SPECIALTY RETAIL
GROUP........................................... IV-A-1
ANNEX IV-B: PROPOSAL 6 -- AMENDMENTS TO DIRECTORS
STOCK PLAN RELATING TO ISSUANCE OF SPECIALTY
RETAIL STOCK.................................... IV-B-1
ANNEX IV-C: PROPOSAL 7 -- AMENDMENTS TO
PERFORMANCE RESTRICTED STOCK PLAN RELATING TO
SUBSTITUTION OF SPECIALTY RETAIL STOCK FOR
CERTAIN OUTSTANDING AWARDS OF EXISTING COMMON
STOCK........................................... IV-C-1
ANNEX IV-D: PROPOSAL 8 -- AMENDMENTS TO 1973 AND
1981 STOCK OPTION PLANS RELATING TO SUBSTITUTION
OF SPECIALTY RETAIL STOCK FOR EXISTING COMMON
STOCK ISSUABLE UPON EXERCISE OF CERTAIN
OUTSTANDING OPTIONS............................. IV-D-1
ANNEX IV-E: PROPOSAL 9 -- AMENDMENTS TO 1992 STOCK
OPTION PLAN RELATING TO SUBSTITUTION OF
SPECIALTY RETAIL STOCK FOR EXISTING COMMON STOCK
ISSUABLE UPON EXERCISE OF CERTAIN OPTIONS AND
CERTAIN OTHER PLAN AMENDMENTS................... IV-E-1
ANNEX IV-F: PROPOSAL 10 -- AMENDMENTS TO 1992
STOCK OPTION PLAN RELATING TO ADDING CERTAIN
ALLOCATION PROVISIONS........................... IV-F-1
ANNEX IV-G: PROPOSAL 11 -- ADOPTION OF MANAGEMENT
STOCK PURCHASE PLAN............................. IV-G-1
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<S> <C>
ANNEX IV-H: PROPOSAL 12 -- ADOPTION OF ANNUAL
INCENTIVE BONUS PLAN............................ IV-H-1
ANNEX V: KMART CORPORATION........................ V-1
Selected Financial Data
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Consolidated Financial Statements
ANNEX VI: KMART GROUP............................. VI-1
Selected Financial Data
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Business Description
Combined Financial Statements
ANNEX VII: BORDERS-WALDEN GROUP................... VII-1
Selected Financial Data
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Business Description
Combined Financial Statements
ANNEX VIII: BUILDERS SQUARE GROUP................. VIII-1
Selected Financial Data
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Business Description
Combined Financial Statements
ANNEX IX: OFFICEMAX GROUP......................... IX-1
Selected Financial Data
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Business Description
Combined Financial Statements
Unaudited Pro Forma Combined Financial
Information
OfficeMax, Inc. Financial Statements
BizMart, Inc. Consolidated Financial Statements
ANNEX X: THE SPORTS AUTHORITY GROUP............... X-1
Selected Financial Data
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Business Description
Combined Financial Statements
</TABLE>
ii
<PAGE> 7
PRELIMINARY COPY DATED MARCH 22, 1994
KMART CORPORATION
ANNUAL REPORT AND PROXY STATEMENT
------------------------------
GENERAL INFORMATION
April , 1994
This Annual Report and Proxy Statement (the "Proxy Statement") is furnished
in connection with the solicitation of proxies by the Board of Directors of
Kmart Corporation (the "Company") to be used at the Annual Meeting of
Stockholders to be held on Tuesday, May 24, 1994, at 9:00 A.M., local time, at
Kmart International Headquarters, 3100 West Big Beaver Road, Troy, Michigan
48084, or any adjournment thereof. This Proxy Statement and accompanying form of
proxy are first being mailed to stockholders on or about the date shown above.
Any proxy given pursuant to this solicitation may be revoked by the person
giving it at any time before its exercise by notice in writing to the Secretary
of the Company prior to the Annual Meeting, by submitting a subsequent proxy or
by attending and voting in person at the meeting. Unless the proxy is revoked,
the shares represented thereby (including shares held in the Company's Dividend
Reinvestment Plan, if any) will be voted as specified in such proxy at the
Annual Meeting or any adjournment thereof. Shares for which proxies are marked
"abstain" will be treated as shares present for purposes of determining the
presence of a quorum on all matters. Proxies relating to "street name" shares
that are voted by brokers on only some of the Proposals will nevertheless be
treated as present for purposes of determining the presence of a quorum on all
matters, but will not be entitled to vote on any Proposal as to which the broker
does not have discretionary voting power and has not received instructions from
the beneficial owner ("broker non-votes"). In tabulating the vote on the
election of directors and Proposals 5, 10, 13 and 14, abstentions and broker
non-votes will be disregarded, which will have the effect of reducing the total
number of shares from which any required majority is calculated. With regard to
Proposals 2, 3 and 4, abstentions and broker non-votes will have the same effect
as votes against a Proposal. With regard to Proposals 6, 7, 8, 9, 11 and 12,
abstentions will have the same effect as votes against a Proposal and broker
non-votes will be disregarded, which will have the effect of reducing the total
number of shares from which any required majority is calculated.
The Company has adopted a policy providing for confidential voting.
Pursuant to that policy, stockholder proxies will be tabulated by
representatives of NBD Bank, N.A. and, subject to certain limited exceptions,
how a stockholder voted will not be disclosed to the Company prior to final
tabulation of the vote at the Annual Meeting.
The voting securities of the Company consist of common stock, par value
$1.00 per share ("Common Stock"), Series A conversion preferred stock, no par
value per share ("Series A Preferred Stock") and Series B convertible preferred
stock, no par value per share ("Series B Preferred Stock"). At the close of
business on April 8, 1994, the record date for the Annual Meeting, there were
shares of Common Stock outstanding, each of which is entitled to one
vote, 5,750,000 shares of Series A Preferred Stock outstanding, each of which is
entitled to one vote, and 784,938 shares of Series B Preferred Stock
outstanding, each of which is entitled to one vote. The Series A Preferred Stock
is held by First Chicago Trust Company of New York as Depositary for holders of
the Company's $3.41 Depositary Shares, each of which represents one-quarter of a
share of Series A Preferred Stock (the "Depositary Shares"). The presence of the
holders of a majority of the outstanding shares of Common Stock, Series A
Preferred Stock and Series B Preferred Stock, represented in person or by proxy
at the Annual Meeting, will constitute a quorum at the Annual Meeting. Prior to
implementation of the Specialty Retail Stock Proposal and redesignation of such
stock as Kmart Group Common Stock, the shares of Common Stock are referred to
hereinafter as "Existing Common Stock".
Under applicable Michigan law, none of the holders of Existing Common
Stock, Series A Preferred Stock or Series B Preferred Stock has appraisal rights
in connection with any Proposal to be acted upon at the Annual Meeting.
The entire cost of soliciting proxies will be borne by the Company. Proxies
may be solicited by mail, telecopy, telegraph or telex, or by directors,
officers and regular employees of the Company in person or by telephone. The
Company has retained Georgeson & Company, Inc. to assist in the distribution of
proxy solicitation materials at a cost of approximately $15,000 plus handling
charges and out-of-pocket expenses. The Company will also reimburse brokerage
houses and other custodians, nominees and fiduciaries for their reasonable
out-of-pocket expenses for forwarding soliciting material to the beneficial
owners of the stock of the Company.
------------------------
Questions concerning the Proposals to be acted upon at the Annual Meeting
should be directed to the Company's Information Agent, Georgeson & Company,
Inc., toll-free at 1-800-233-2064. Additional copies of this Proxy Statement or
the Proxy Card may be obtained from the Information Agent or the Company's
Investor Relations Department at its principal office.
------------------------
This Proxy Statement constitutes the Company's 1993 Annual Report to
Stockholders pursuant to Rule 14a-3(b)(11) of the Exchange Act.
<PAGE> 8
STRUCTURE OF KMART CORPORATION SPECIALTY RETAIL STOCK PROPOSAL
[GRAPH]
2
<PAGE> 9
SUMMARY COMPARISON OF TERMS OF EXISTING
COMMON STOCK WITH TERMS OF
KMART STOCK AND SPECIALTY RETAIL STOCK
The following is a summary of the terms of the Company's Existing Common
Stock under the Restated Articles of Incorporation as currently in effect and
the terms of the Kmart Stock and the four series of Specialty Retail Stock under
the Restated Articles of Incorporation as proposed to be amended pursuant to the
Specialty Retail Stock Proposal. This summary is qualified in its entirety by
the more detailed information contained in this Proxy Statement and the Annexes
hereto. See "Proxy Statement Summary" and "Proposal 2 -- The Specialty Retail
Stock Proposal -- Description of Kmart Stock and Specialty Retail Stock". Unless
otherwise defined herein, capitalized terms used in this summary have the
respective meanings ascribed to them elsewhere in this Proxy Statement. See
Annex I -- Glossary of Certain Terms. Stockholders are urged to read carefully
this Proxy Statement and the Annexes hereto in their entirety.
<TABLE>
<CAPTION>
SPECIALTY RETAIL STOCK PROPOSAL
EXISTING ----------------------------------------------------------------
COMMON STOCK KMART STOCK SPECIALTY RETAIL STOCK
-------------------- ------------------------------- -------------------------------
<S> <C> <C> <C>
BUSINESSES: All businesses of Primarily the Kmart discount Borders-Walden Group -- retail
the Company. store business. The Kmart Group bookstore business.
would also include all of the
businesses of each Specialty Builders Square Group -- retail
Retail Group until the initial home improvement and home decor
issuance of the relevant series superstore business.
of Specialty Retail Stock,
following which the Kmart Group OfficeMax Group -- retail
would include a Retained office products superstore
Interest in the relevant business.
Specialty Retail Group. The Sports Authority Group --
retail sporting goods megastore
business.
The Kmart Stock is intended to Each series of Specialty Retail
reflect the separate Stock is intended to reflect
performance of the foregoing the separate performance of the
businesses; however, holders of related specialty retail
Kmart Stock would be holders of business; however, holders of
Common Stock of the Company and each series of Specialty Retail
would continue to be subject to Stock would be holders of
risks associated with an Common Stock of the Company and
investment in the Company and would be subject to risks
all of its businesses, assets associated with an investment
and liabilities. in the Company and all of its
businesses, assets and
liabilities.
ISSUANCE: The diagram Upon the initial issuance of Following approval by
preceding this any series of Specialty Retail stockholders of the Specialty
summary illustrates Stock, the Existing Common Retail Stock Proposal, the
the current Common Stock would be redesignated as Company currently intends,
Stock structure of Kmart Stock. The diagram subject to prevailing market
the Company. See preceding this summary and other conditions, to offer
"Structure of Kmart illustrates the capital shares of each series of
Corporation structure of the Company under Specialty Retail Stock for cash
Specialty Retail the Specialty Retail Stock in public offerings and to
Stock Proposal -- Proposal. See "Structure of allocate the net proceeds of
Current Structure." Kmart Corporation Specialty the offerings to the Kmart
Retail Stock Proposal -- Group to be used to repay
Specialty Retail Stock outstanding indebtedness of the
Structure." Company and for general
corporate purposes. In addition
to or in lieu of any such
offering, the Board reserves
the right to issue shares of
any series of Specialty Retail
Stock as a distribution on the
Kmart Stock, although the Board
has no current intention to do
so. The diagram preceding this
summary illustrates the capital
structure of the Company under
the Specialty Retail Stock
Proposal. See "Structure of
Kmart Corporation Specialty
Retail Stock Proposal --
Specialty Retail Stock
Structure."
</TABLE>
3
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<TABLE>
<CAPTION>
SPECIALTY RETAIL STOCK PROPOSAL
EXISTING ----------------------------------------------------------------
COMMON STOCK KMART STOCK SPECIALTY RETAIL STOCK
-------------------- ------------------------------- -------------------------------
<S> <C> <C> <C>
DIVIDENDS: The Company's annual The Board currently intends The dividend policy applicable
dividend rate is that the dividend policy to each series of Specialty
presently $.96 per applicable to the Kmart Stock Retail Stock would be
share of Common would be the same as the determined by the Board at the
Stock. Dividends are dividend policy applicable to time of issuance of such
payable out of all the Existing Common Stock, with series. Dividends on each
assets of the the initial dividend rate on series of Specialty Retail
Company legally the Kmart Stock being the rate Stock would be paid in the sole
available for in effect for the Existing discretion of the Board based
dividends. Common Stock at the time of the primarily upon the financial
redesignation of the Existing condition, results of
Common Stock as Kmart Stock. operations and business
The Board believes that requirements of the relevant
implementation of the Specialty Specialty Retail Group and the
Retail Stock Proposal would not Company as a whole and would be
adversely affect the Company's payable out of the lesser of
ability to pay dividends on the (i) all assets of the Company
Kmart Stock. Determinations as legally available for dividends
to future dividends on the and (ii) the Available Dividend
Kmart Stock would be based Amount with respect to the
primarily upon the financial relevant Specialty Retail
condition, results of Group.
operations and business
requirements of the Kmart Group
and the Company as a whole and
would be payable out of the
lesser of (i) all assets of the
Company legally available for
dividends and (ii) the
Available Dividend Amount with
respect to the Kmart Group.
The Board could, in its sole The Board could, in its sole
discretion, declare and pay discretion, declare and pay
dividends on all or less than dividends on all or less than
all series of Common Stock in all series of Common Stock in
equal or unequal amounts, equal or unequal amounts,
notwithstanding the amount of notwithstanding the amount of
assets available for dividends assets available for dividends
on any series, the amount of on any series, the amount of
prior dividends declared on any prior dividends declared on any
series or any other factor. series or any other factor.
To the extent that the Company
pays a dividend on outstanding
shares of any series of
Specialty Retail Stock, the
relevant Specialty Retail Group
would be charged with, and the
Kmart Group would be credited
with, a proportionate amount.
DIVIDEND,
REDEMPTION AND
EXCHANGE RIGHTS
ON DISPOSITION: None. None. If the Company were to dispose
of all or substantially all of
the properties and assets of
any Specialty Retail Group, the
Company would be required to
either (i) distribute to
holders of the relevant series
of Specialty Retail Stock an
amount equal to their
proportionate interest in the
Net Proceeds of such
disposition, either by special
dividend or by redemption of
all or part of the outstanding
shares of such series; or (ii)
exchange each outstanding share
of such series of Specialty
Retail Stock for shares of
Kmart Stock equal to 110% of
the ratio of
</TABLE>
4
<PAGE> 11
<TABLE>
<CAPTION>
SPECIALTY RETAIL STOCK PROPOSAL
EXISTING ----------------------------------------------------------------
COMMON STOCK KMART STOCK SPECIALTY RETAIL STOCK
-------------------- ------------------------------- -------------------------------
<S> <C> <C> <C>
the Market Value over a period
of time of one share of such
series to one share of Kmart
Stock.
The Company could, in the sole
discretion of the Board, at any
time prior to the first
anniversary of a dividend on or
a partial redemption of the
outstanding shares of any
series of Specialty Retail
Stock following a sale of all
or substantially all of the
properties and assets of the
relevant Specialty Retail
Group, exchange each remaining
outstanding share of such
series of Specialty Retail
Stock for shares of Kmart Stock
equal to 110% of the ratio of
the Market Value over a period
of time of one share of such
series to one share of Kmart
Stock.
OTHER EXCHANGE
RIGHTS: None. None. The Company could, in the sole
discretion of the Board, at any
time, exchange each outstanding
share of any series of
Specialty Retail Stock for
shares of Kmart Stock equal to
115% of the ratio of the Market
Value over a period of time of
one share of such series to one
share of Kmart Stock.
The Company could, in the sole
discretion of the Board, at any
time, exchange shares of any
series of Specialty Retail
Stock for shares of any wholly
owned subsidiary that holds all
of the assets and liabilities
of the relevant Specialty
Retail Group.
VOTING RIGHTS: The Existing Common The Kmart Stock would be Each series of Specialty Retail
Stock is entitled to entitled to one vote per share, Stock would be entitled to a
one vote per share, voting as one class together variable number of votes per
voting as one class with the outstanding series of share equal to the ratio of the
together with the Specialty Retail Stock, the Market Value over a period of
Series A Preferred Series A Preferred Stock, the time of one share of such
Stock, the Series B Series B Preferred Stock and series to one share of Kmart
Preferred Stock and any other series of Preferred Stock, and could have more
any other series of Stock outstanding at the time than, less than or exactly one
Preferred Stock of such vote and so entitled to vote per share. This formula is
outstanding at the vote on all matters submitted intended to equate the
time of such vote to stockholders, other than proportionate voting rights of
and so entitled to matters which would be required each series of Common Stock to
vote on all matters by law or the Articles to be their respective Market Values
submitted to submitted to a separate class at the time of any vote.
stockholders, other vote. However, no share of any series
than matters which of Specialty Retail Stock would
are required by law be entitled to more than one
or the Articles to vote prior to the Series A
be submitted to a Conversion Date, which will
separate class vote. occur on or before September
15, 1994. Each outstanding
series of Specialty Retail
Stock would vote as one class
together with the Kmart Stock,
the Series A Preferred Stock,
the Series B Preferred Stock
and any other series of
Preferred Stock outstanding at
the time of such vote and so
entitled to vote on all matters
submitted to
</TABLE>
5
<PAGE> 12
<TABLE>
<CAPTION>
SPECIALTY RETAIL STOCK PROPOSAL
EXISTING ----------------------------------------------------------------
COMMON STOCK KMART STOCK SPECIALTY RETAIL STOCK
-------------------- ------------------------------- -------------------------------
<S> <C> <C> <C>
stockholders, other than
matters which would be required
by law or the Articles to be
submitted to a separate class
vote.
The approval of the holders of The approval of the holders of
at least two-thirds of the at least two-thirds of any
outstanding Kmart Stock, voting outstanding series of Specialty
as a separate class, would be Retail Stock, voting as a
required to approve, subject to separate class, would be
certain exceptions, (i) any required to approve, subject to
direct or indirect dividend or certain exceptions, (i) any
distribution to holders of any direct or indirect dividend or
other series of Common Stock of distribution to holders of any
any of the properties or assets other series of Common Stock of
of the Kmart Group, or of any of the properties or assets
shares of Kmart Stock, (ii) the of the relevant Specialty
use of any properties or assets Retail Group, or of shares of
of the Kmart Group in any such series of Specialty Retail
business of the Company other Stock, other than a
than a business of the Kmart proportionate payment to the
Group, or (iii) any direct or Kmart Group in respect of such
indirect issuance or sale of dividend, (ii) the use of any
Kmart Stock for the account of properties or assets of such
any Group other than the Kmart Specialty Retail Group in any
Group. business of the Company other
than a business of such
Specialty Retail Group, or
(iii) any direct or indirect
issuance or sale of shares of
such series of Specialty Retail
Stock for the account of any
Group other than the relevant
Specialty Retail Group or the
Kmart Group, to the extent of
the Kmart Group's Retained
Interest in such Group.
LIQUIDATION: Holders of Existing Holders of Kmart Stock would be Holders of each outstanding
Common Stock are entitled to receive the net series of Specialty Retail
entitled to receive assets of the Company, if any, Stock would be entitled to
the net assets of remaining for distribution to receive the net assets of the
the Company, if any, holders of Common Stock with Company, if any, remaining for
remaining for holders of each outstanding distribution to holders of
distribution to series of Specialty Retail Common Stock with holders of
holders of Common Stock based upon the relative the Kmart Stock and each other
Stock. Market Capitalizations of the outstanding series of Specialty
Kmart Stock and each Retail Stock based upon the
outstanding series of Specialty relative Market Capitalizations
Retail Stock. of the Kmart Stock and each
outstanding series of Specialty
Retail Stock.
STOCK EXCHANGE
LISTINGS: NYSE, CSE and PSE Application will be made to the The Company intends to apply
under the symbol NYSE, CSE and PSE for approval for the listing of each series
"KM." of the proposed redesignation of Specialty Retail Stock on
of the Existing Common Stock as such stock exchange as the
Kmart Stock, which would Board deems appropriate at the
continue to trade under the time of the issuance of such
symbol "KM." series.
</TABLE>
6
<PAGE> 13
PROXY STATEMENT SUMMARY
The following is a summary of certain information contained elsewhere in
this Proxy Statement and the Annexes hereto. Reference is made to, and this
Proxy Statement Summary is qualified in its entirety by, the more detailed
information contained in this Proxy Statement and the Annexes hereto. In
particular, see "Summary Comparison of Terms of Existing Common Stock with Terms
of Kmart Stock and Specialty Retail Stock" and "Proposal 2 -- The Specialty
Retail Stock Proposal." Unless otherwise defined herein, capitalized terms used
in this Proxy Statement Summary have the respective meanings ascribed to them
elsewhere in this Proxy Statement. See Annex I -- Glossary of Certain Terms.
Stockholders are urged to read carefully this Proxy Statement and the Annexes
hereto in their entirety.
PROPOSAL 1 -- ELECTION OF DIRECTORS
In accordance with the recommendation of its Nominating Committee, the
Company's Board of Directors (the "Board") has nominated each of the existing
Class II directors, Messrs. Joseph A. Califano, Jr., Enrique C. Falla, David B.
Harper, J. Richard Munro and Joseph R. Thomas, for three-year terms expiring at
the 1997 Annual Meeting of Stockholders.
Directors are elected by a plurality of the votes cast by the holders of
Existing Common Stock, Series A Preferred Stock and Series B Preferred Stock
present in person or represented by proxy and entitled to vote at the Annual
Meeting, voting together as one class.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE RE-ELECTION OF MESSRS.
CALIFANO, FALLA, HARPER, MUNRO AND THOMAS TO THE BOARD. SEE "PROPOSAL 1 --
ELECTION OF DIRECTORS".
PROPOSAL 2 -- THE SPECIALTY RETAIL STOCK PROPOSAL
GENERAL
The stockholders are being asked to consider and approve a proposal (the
"Specialty Retail Stock Proposal") to amend the Company's Restated Articles of
Incorporation (the "Articles") as described herein and in Annex III-A hereto, to
authorize the Board to issue any of four series of Common Stock (collectively,
the "Specialty Retail Stock") designated KM-Borders-Walden Group Common Stock
("Borders-Walden Stock"), KM-Builders Square Group Common Stock ("Builders
Square Stock"), KM-OfficeMax Group Common Stock ("OfficeMax Stock") and KM-The
Sports Authority Group Common Stock ("The Sports Authority Stock") by the filing
of a certificate of designation ("Certificate of Designation") setting forth
certain information, including the number of shares constituting such series.
Such amendments would, among other things:
- increase the number of authorized shares of Common Stock from 1.5 billion
to 3.0 billion;
- redesignate 1.5 billion shares of Existing Common Stock as Kmart Group
Common Stock ("Kmart Stock"); and
- authorize 1.5 billion shares of Common Stock to be available for
designation in series by resolution of the Board as additional shares of
Kmart Stock and/or any of four new series of Specialty Retail Stock, each
with the designations, relative rights, preferences and limitations
described herein.
While each series of Specialty Retail Stock would constitute Common Stock
of the Company, each is intended to reflect the separate performance of each
specialty retail business. The Borders-Walden Stock is intended to reflect the
performance of the Company's retail bookstore group (the "Borders-Walden
Group"), which is comprised principally of the Company's Borders, Inc. and
Walden Book Company, Inc. subsidiaries. The Builders Square Stock is intended to
reflect the performance of the Company's retail home improvement and home decor
superstore group (the "Builders Square Group"), which is comprised principally
of the Company's Builders Square, Inc. subsidiary. The OfficeMax Stock is
intended to reflect the performance of the Company's retail office products
superstore group (the "OfficeMax Group"), which is comprised principally of the
Company's interest in OfficeMax, Inc., a % owned subsidiary of the Company.
The Sports
7
<PAGE> 14
Authority Stock is intended to reflect the performance of the Company's retail
sporting goods megastore group ("The Sports Authority Group"), which is
comprised principally of the Company's The Sports Authority, Inc. subsidiary.
Borders-Walden Group, Builders Square Group, OfficeMax Group and The Sports
Authority Group are sometimes referred to collectively herein as the "Specialty
Retail Groups".
Upon the initial issuance of any series of Specialty Retail Stock, the
Existing Common Stock would be redesignated as Kmart Stock. The Kmart Stock,
while constituting Common Stock of the Company, is intended to reflect the
separate performance of the "Kmart Group", which is comprised of (i) the
Company's core Kmart discount store group, (ii) the Company's interest in each
Specialty Retail Group (a "Retained Interest"), which excludes the interest
represented by any outstanding shares of any series of Specialty Retail Stock
and (iii) all other businesses in which the Company and its other subsidiaries
are engaged. The Kmart Group and the Specialty Retail Groups are referred to
collectively herein as the "Groups".
Following approval by stockholders of the Specialty Retail Stock Proposal,
the Company currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate initial public offerings (collectively, the "Offerings") and to
allocate the net proceeds of the Offerings to the Kmart Group to repay
outstanding indebtedness of the Company and for general corporate purposes. The
timing, sequence and size of such Offerings and the price at which such shares
would be sold would be determined by the Board, without further approval of
stockholders, at the time of each Offering; however, it is currently
contemplated that the Company would initially offer to the public shares of each
series of Specialty Retail Stock that would be intended to represent
approximately 20% to 30% of the equity value of the Company attributed to the
relevant Specialty Retail Group as determined by the Board ("Equity Value") at
the time of such Offering. The terms of each Offering would be determined by the
Board and the underwriters of such Offering based upon prevailing market and
other conditions; the financial condition and results of operations of the
relevant Specialty Retail Group; the history of and prospects for the relevant
Specialty Retail Group; the specialty retail industry and the segment of that
industry in which the relevant Specialty Retail Group competes; the management
and operations of the relevant Specialty Retail Group; the progress of the
relevant Specialty Retail Group in implementing its business strategy; the
foregoing factors in relation to market values of other companies engaged in
similar businesses; and the financial condition of the Company as a whole. In
addition to or in lieu of any Offering, the Board reserves the right to issue
shares of any series of Specialty Retail Stock as a distribution on the Kmart
Stock, although the Board has no current intention to do so. The determination
of whether to proceed with an Offering of any series of Specialty Retail Stock
would be made by the Board based on, among other things, the proposed terms of
such Offering and then prevailing market and other conditions. The Board
reserves the right not to proceed with any or all of the Offerings if it
determines that consummation of such Offering or Offerings is not in the best
interests of the Company.
Notwithstanding approval by stockholders of the Specialty Retail Stock
Proposal, the Company would not file a certificate containing the amendments to
the Articles contemplated by Proposals 2 and 4 (the "Certificate of Amendment")
with the Michigan Department of Commerce until immediately prior to consummation
of the initial Offering or other issuance of any series of Specialty Retail
Stock.
IF THE SPECIALTY RETAIL STOCK PROPOSAL IS NOT APPROVED BY STOCKHOLDERS OR
NONE OF THE OFFERINGS IS CONSUMMATED AND NO OTHER DISTRIBUTION OF SPECIALTY
RETAIL STOCK IS MADE, THE CERTIFICATE OF AMENDMENT WILL NOT BE FILED, THE
SPECIALTY RETAIL STOCK WILL NOT BE ISSUED, THE EXISTING COMMON STOCK WILL NOT BE
REDESIGNATED AS KMART STOCK AND THE AMENDMENTS TO AND ADOPTION OF THE RELATED
BENEFIT PLANS WILL NOT BE IMPLEMENTED.
SPECIAL CONSIDERATIONS
Stockholders of One Company; Financial Effects on One Group Could Affect
Other Groups. Notwithstanding the allocation of assets and liabilities
(including contingent liabilities), stockholders' equity and items of income and
expense among the Groups for purposes of preparing their respective financial
statements, the change in the capital structure of the Company contemplated by
the Specialty Retail Stock Proposal would
8
<PAGE> 15
not affect the respective legal title to assets or responsibility for
liabilities of the Company or any of its subsidiaries. The Specialty Retail
Stock Proposal would not affect the rights of creditors of the Company or any
Specialty Retail Subsidiary. The Company and its subsidiaries would each
continue to be responsible for their respective liabilities. Holders of Kmart
Stock and of each series of Specialty Retail Stock would be holders of Common
Stock of the Company and would be subject to risks associated with an investment
in the Company and all of its businesses, assets and liabilities.
Financial effects arising from any Group that affect the Company's
consolidated results of operations or financial condition could affect the
results of operations or financial condition of the other Groups or the market
price of shares of any or all series of Common Stock. In addition, net losses of
any Group, dividends and distributions on any series of Common Stock or
Preferred Stock, repurchases of any series of Common Stock and certain
repurchases of Preferred Stock would reduce the assets of the Company legally
available for dividends on all series of Common Stock.
Limited Additional Stockholder Rights. Under the Specialty Retail Stock
Proposal, holders of Kmart Stock and holders of each series of Specialty Retail
Stock would have only the rights of holders of Common Stock and would not be
provided any rights specifically related to their separate series, other than
(i) the two-thirds separate class vote requirements under certain limited
circumstances, as described under "Proposal 2 -- The Specialty Retail Stock
Proposal -- Description of Kmart Stock and Specialty Retail Stock -- Voting
Rights", (ii) the dividend/redemption/exchange provisions described under
"Proposal 2 -- The Specialty Retail Stock Proposal -- Description of Kmart Stock
and Specialty Retail Stock -- Exchange and Redemption" and (iii) certain limited
class voting rights provided under Michigan law. Similarly, separate meetings
for the holders of Common Stock or any series thereof would not be held. See
"Limited Separate Stockholder Voting Rights; Effects on Voting Power" below.
Potential Conflicts of Interest. The existence of separate series of Common
Stock could give rise to occasions when the interests of the holders of one
series and of the holders of any other series might diverge or appear to
diverge. Examples include determinations by the Board to (i) pay or omit the
payment of dividends on any series of Common Stock, (ii) allocate the proceeds
of issuances of any series of Specialty Retail Stock either to the Kmart Group
in respect of its Retained Interest or to the equity of the relevant Specialty
Retail Group, (iii) allocate consideration to be received by holders of Common
Stock in connection with a merger or consolidation involving the Company among
holders of different series of Common Stock, (iv) exchange Kmart Stock for any
series of Specialty Retail Stock at a premium, (v) approve dispositions of
assets of any of the Groups and (vi) make operational and financial decisions
with respect to one Group that could be considered to be detrimental to another
Group, including whether to make transfers of funds between Groups as described
below. When making decisions with regard to matters that create potential
conflicts of interest, the Board would act in accordance with the terms of the
Articles, the management and accounting policies described in "Proposal 2 -- The
Specialty Retail Stock Proposal -- Management and Accounting Policies," to the
extent applicable, and its fiduciary duties. The Board could also from time to
time refer to an existing committee or one or more new committees of the Board
to review matters raising conflict issues and to have such committee report to
the Board on such matters.
Fiduciary Duties of the Board of Directors. Although the Company is aware
of no precedent concerning the manner in which Michigan law would be applied to
a board of directors' duties in the context of multiple classes of common stock
with divergent interests, the Company believes that a Michigan court would hold
that a board of directors owes an equal duty to all stockholders regardless of
class or series and does not have separate or additional duties to any group of
stockholders. That duty is the fiduciary duty to act in good faith and in the
honest belief that its actions are in the Company's best interests. The Company
believes that, under Michigan law, a good faith determination by a disinterested
and adequately informed board, or a committee thereof, which the directors
honestly believe is in the best interests of the corporation, would be a defense
to any challenge by or on behalf of the holders of any class or series of stock
to a board determination that could have a disparate effect on different classes
or series of stock.
Disproportionate ownership interests of members of the Board in some or all
series of Common Stock or disparate values of some or all series of Common Stock
could create or appear to create potential conflicts of
9
<PAGE> 16
interest when directors are faced with decisions that could have different
implications for different series. See "Potential Conflicts of Interest" above.
Nevertheless, the Company believes that a director would be able to discharge
his or her fiduciary responsibilities even if his or her interests in shares of
various series of Common Stock were disproportionate and/or had disparate
values. Under the terms of the Company's Directors Stock Plan, as proposed to be
amended pursuant to Proposal 6, if the Specialty Retail Stock Proposal is
approved by stockholders and implemented by the Board, non-employee directors
would receive shares of each outstanding series of Common Stock in order to give
them an ownership interest in all series of Common Stock.
Transfers of Funds between Kmart Group and Specialty Retail Groups;
Additional Equity Contributions from Kmart Group. Following implementation of
the Specialty Retail Stock Proposal by the Board, all debt incurred or Preferred
Stock issued by the Company and its subsidiaries would be specifically
attributed to and reflected on the financial statements of the Kmart Group,
unless otherwise determined by the Board. The Board could determine from time to
time that debt or Preferred Stock and the proceeds thereof should be
specifically attributed to and reflected on the financial statements of a
Specialty Retail Group to the extent that the debt is incurred or the Preferred
Stock is issued for the benefit of such Specialty Retail Group. If cash used by
a Specialty Retail Group exceeded cash provided by such Specialty Retail Group,
the Kmart Group would transfer to such Specialty Retail Group the cash necessary
to fund such excess uses. Conversely, if cash provided by a Specialty Retail
Group exceeded cash used by such Specialty Retail Group, such Specialty Retail
Group would transfer such excess cash to the Kmart Group. All cash transfers
between Groups would be accounted for as short-term loans unless the Board made
a specific determination that a given transfer (or type of transfer) should be
accounted for as a long-term loan or, in the case of a transfer from the Kmart
Group to a Specialty Retail Group, an equity contribution. There are no specific
criteria to determine when a cash transfer would be classified as a long-term
loan or, in the case of a transfer from the Kmart Group to a Specialty Retail
Group, an equity contribution, rather than a short-term loan. Such determination
would be made by the Board in the exercise of its business judgment at the time
of such transfer (or the first of such type of transfer) based upon all relevant
circumstances, including the financing needs and objectives of the recipient
Group, the investment objectives of the transferring Group, the availability,
cost and time associated with alternative financing sources, prevailing interest
rates and general economic conditions. Such determination would affect the
amount of interest expense and interest income reflected in the financial
statements of the relevant Groups if such transfer were made as a short-term
loan or long-term loan and, in the case of a transfer from the Kmart Group to a
Specialty Retail Group as an equity contribution, the amount of stockholders'
equity of such Specialty Retail Group and Retained Interest of the Kmart Group.
Determinations as to whether to provide funds to any Specialty Retail Group
would continue to be made at the discretion of the Board. Nothing in the
foregoing policies obligates the Board to cause the Kmart Group to provide funds
to any Specialty Retail Group if the Board determines it is in the best interest
of the Company not to do so.
In view of the anticipated cash needs of the Specialty Retail Groups over
the next several years, it is currently expected that the Kmart Group would in
the aggregate provide net cash to the Specialty Retail Groups. After considering
all relevant factors, the Kmart Group would obtain such funds from internal
operations, excess cash from other Specialty Retail Groups, external debt
financing or additional equity issuances. If a Specialty Retail Group to which
net cash had been provided as loans were unable to repay such amounts, the
effects would be reflected on the Kmart Group Financial Statements. Moreover, in
the event that the rate of interest charged by the Kmart Group on a transfer
accounted for as a short-term loan or a long-term loan to a Specialty Retail
Group would be more or less than the Company's actual cost of funds, the Kmart
Group's financial statements would reflect the effect of the differential. For
example, if the Kmart Group transferred such funds as a short-term loan to a
Specialty Retail Group at the Company's short-term borrowing rate, but, at the
time of such loan, the Company had predominantly long-term debt financing at an
interest rate higher than the Company's short-term borrowing rate, the Kmart
Group financial statements would reflect higher average interest expense on
funds borrowed by it compared to the interest income received on such funds from
such Specialty Retail Group.
Under the management policies adopted by the Board, the Board could, in its
sole discretion, determine from time to time that a transfer of funds from the
Kmart Group to a Specialty Retail Group be accounted for as an equity
contribution, rather than a loan, thereby increasing the Kmart Group's Retained
Interest in such
10
<PAGE> 17
Specialty Retail Group. Although any increase in the Kmart Group's Retained
Interest would be determined by reference to the then current Market Value of a
share of the relevant series of Specialty Retail Stock, such a contribution
could occur at a time when such shares could be considered undervalued and the
holders of outstanding shares of such series would not have an opportunity to
similarly increase their equity investment in such Specialty Retail Group.
Moreover, any such increase in the Retained Interest of the Kmart Group would
reduce the Outstanding Interest Fraction applicable to the relevant series of
Specialty Retail Stock.
Limited Separate Stockholder Voting Rights; Effects on Voting Power. Under
the Specialty Retail Stock Proposal, subject to certain limited exceptions,
holders of Kmart Stock, each series of Specialty Retail Stock, Series A
Preferred Stock, Series B Preferred Stock and any other series of Preferred
Stock outstanding at the time of such vote and so entitled to vote would vote as
one class on all matters coming before any meeting of stockholders. Holders of
Common Stock or of any series thereof would not have any right to vote on
matters as a separate class or series (except pursuant to (i) the two-thirds
separate class vote requirements under certain limited circumstances, as
described under "Proposal 2 -- The Specialty Retail Stock Proposal --
Description of Kmart Stock and Specialty Retail Stock -- Voting Rights" and (ii)
certain limited class voting rights provided under Michigan law). Similarly,
separate meetings for the holders of Common Stock or of any series thereof would
not be held.
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, holders of Kmart Stock would continue to be entitled
to a substantial majority of the total votes to which the then outstanding
voting stock of the Company is entitled. In the event that there would be a
significant increase in the Market Value of some or all of the outstanding
series of Specialty Retail Stock relative to the Market Value of the Kmart Stock
or if additional shares of such series of Specialty Retail Stock were issued,
the number of votes to which such outstanding series of Specialty Retail Stock
would be entitled would increase, although it is unlikely that during the
foreseeable future the holders of Kmart Stock as a group would possess less than
a majority of the total number of votes to which the outstanding voting stock of
the Company would be entitled. See "Proposal 2 -- The Specialty Retail Stock
Proposal -- Description of Kmart Stock and Specialty Retail Stock -- Voting
Rights".
Limited Stockholder Approval Rights for Future Authorizations and Issuances
of Stock. The Specialty Retail Stock Proposal provides that (i) the number of
authorized shares of Common Stock would be increased from 1.5 billion to 3.0
billion, (ii) 1.5 billion shares of Existing Common Stock would be redesignated
as Kmart Stock and (iii) 1.5 billion shares would be available for designation
as Kmart Stock and/or any of four new series of Specialty Retail Stock. The
authorized but unissued shares of Common Stock would be available for issuance
from time to time by the Company at the sole discretion of the Board for any
proper corporate purpose, which could include raising capital, providing
compensation or benefits to employees, paying stock dividends or acquiring
companies or businesses. Such issuances could include shares of Kmart Stock or
any series of Specialty Retail Stock. Under applicable Michigan law, such future
issuances would not require the further approval of stockholders, and the
Company would not seek approval of stockholders unless such approval would be
required by stock exchange regulations, would be in conjunction with a further
amendment to the Articles or would otherwise be deemed advisable by the Board.
Furthermore, the Board could elect, in its sole discretion and without further
approval of stockholders, to increase or decrease the number of designated
shares of any series of Common Stock, but not below the number of outstanding
shares of such series, and not in excess of the number which, when added to the
aggregate number of designated shares of all other series of Common Stock, would
exceed the total authorized number of shares of Common Stock; except that, under
Michigan law, the Board could, in its sole discretion, amend the Articles to
increase the authorized shares of Kmart Stock and Common Stock to the number
that would be sufficient, when added to the previously authorized but unissued
shares of Kmart Stock and Common Stock, to enable the Company to deliver shares
of Kmart Stock to holders of any series of Specialty Retail Stock upon the
exchange thereof. See "Proposal 2 -- The Specialty Retail Stock Proposal --
Description of Kmart Stock and Specialty Retail Stock -- Exchange and
Redemption".
Allocation of Goodwill for Purposes of Determining Available Dividend
Amount. The Certificate of Amendment provides that each Group's Available
Dividend Amount would be the source for the payment of dividends on the relevant
series of Common Stock, although the liquidation rights with respect to such
series
11
<PAGE> 18
or legally available assets of the Company could be more or less than such
amount. The "Available Dividend Amount" for each Group is (a) the Group's net
equity, adjusted, in the case of each Specialty Retail Group, to exclude the
cumulative effects of amortization of goodwill arising from acquisitions on
behalf of such Specialty Retail Group prior to the initial issuance of the
relevant series of Specialty Retail Stock and, in the case of the Kmart Group,
to include the cumulative effects of such amortization to the extent not already
reflected in net equity of the Kmart Group as a result of its Retained Interest
in such Specialty Retail Group, times (b) the Outstanding Interest Fraction with
respect to such Group. The goodwill adjustment referred to above would result in
a decrease in the Available Dividend Amount with respect to the Kmart Group and
an increase in the Available Dividend Amount with respect to such Specialty
Retail Group.
Dilution. The issuance of the various series of Specialty Retail Stock
would result in some dilution of the voting rights of the holders of Existing
Common Stock; however, it is unlikely that during the foreseeable future the
holders of Kmart Stock as a group would possess less than a majority of the
total number of votes to which the outstanding voting stock of the Company would
be entitled. See "Limited Stockholder Approval Rights for Future Authorizations
and Issuances of Stock" and "Limited Stockholder Rights; Effects on Voting
Power" above.
The Company believes that implementation of the Specialty Retail Stock
Proposal would not result in meaningful dilution to the holders of Existing
Common Stock on an earnings per share basis. The Company currently intends that
the Kmart Group would initially have a 70-80% retained interest in each
Specialty Retail Group, resulting in 70-80% of the earnings of each Specialty
Retail Group being attributed to the Kmart Group. In addition, the Company
currently intends to allocate the net proceeds of the sale of each series of
Specialty Retail Stock in the Offerings to the Kmart Group to, among other
things, repay outstanding indebtedness of the Company, resulting in reduced debt
service obligations attributable to the Kmart Group.
Following implementation of the Specialty Retail Stock Proposal, if the
Company exchanged any outstanding series of Specialty Retail Stock for Kmart
Stock under the terms of the Specialty Retail Stock, such exchange would be
effected at a premium to the then current price of the relevant series of
Specialty Retail Stock, which would dilute the interests of the holders of Kmart
Stock in the Company. See "Potential Effects of Exchange of Series of Specialty
Retail Stock" below. In addition, the issuance of shares of Specialty Retail
Stock pursuant to the Company's employee benefit plans would reduce the Kmart
Group's percentage interests in the Specialty Retail Groups and, in some cases,
reduce the Number of Shares Issuable with Respect to Retained Interest. See
"Proposal 2 -- the Specialty Retail Stock Proposal -- Shares Issuable Under
Employee Benefit Plans."
Management and Accounting Policies Subject to Change. The Board has adopted
certain management and accounting policies described herein with respect to cash
management, corporate expenses, allocation of assets and liabilities (including
contingent liabilities) and inter-Group transactions, any and all of which could
be modified or rescinded in the sole discretion of the Board without the
approval of stockholders, although there is no present intention to do so. The
Board could also adopt additional policies depending upon the circumstances. Any
determination by the Board to modify or rescind such policies, or to adopt
additional policies, including any such decision that could have disparate
effects upon holders of different series of Common Stock, would be made by the
Board in good faith and in the honest belief that such decision is in the best
interests of the Company. In addition, generally accepted accounting principles
would require that changes in accounting policy must be preferable (in
accordance with such principles) to the policy previously in place. See
"Proposal 2 -- The Specialty Retail Stock Proposal -- Management and Accounting
Policies."
Reduced Interest of Kmart Group in Specialty Retail Groups. Prior to any
Offering or any other issuance of any series of Specialty Retail Stock, the
Kmart Group's Retained Interest in each Specialty Retail Group would represent
100% of the Equity Value of such Specialty Retail Group. It is currently
contemplated that the number of shares of each series of Specialty Retail Stock
to be issued and sold to the public in each Offering would be intended to
represent approximately 20% to 30% of the Equity Value of the relevant Specialty
Retail Group. It is further contemplated that the shares to be sold in any such
Offering of a series of Specialty Retail Stock would be allocated to the Kmart
Group's Retained Interest in the relevant Specialty Retail Group. As a result,
the Kmart Group's Retained Interest and its percentage interest in the relevant
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<PAGE> 19
Specialty Retail Group would be reduced accordingly. Any other issuance of any
series of Specialty Retail Stock (i) whether or not for the account of the Kmart
Group, would reduce the Kmart Group's percentage interest in the relevant
Specialty Retail Group and (ii) if for the account of the Kmart Group, would
also reduce the Kmart Group's Retained Interest in the relevant Specialty Retail
Group. See "Illustrations of Certain Terms" in Annex II hereto.
Potential Effects of Exchange of Series of Specialty Retail Stock. The
terms of the various series of Specialty Retail Stock permit the exchange of all
outstanding shares of any series of Specialty Retail Stock for Kmart Stock upon
the terms described under "Proposal 2 -- The Specialty Retail Stock Proposal --
Description of Kmart Stock and Specialty Retail Stock -- Exchange and
Redemption". Since any such exchange would be at a premium to the then current
market price of the series of Specialty Retail Stock being exchanged, the
issuance of additional shares of Kmart Stock in connection with such an exchange
would dilute the interest of holders of Kmart Stock in the Company. See
"Dilution" above. The Company cannot predict the impact of the potential for
such exchanges or of any issuance of additional shares of Kmart Stock in
connection with such an exchange on the market price of any series of Common
Stock.
No Assurance as to Market Price. Since there has been no prior market for
any series of Specialty Retail Stock, there can be no assurance as to the price
to be received by the Company upon the sale thereof. It is also not possible to
predict the impact of the sale of any series of Specialty Retail Stock on the
market price of the Kmart Stock and, accordingly, there can be no assurance that
the market price of the Kmart Stock would equal or exceed the market price of
the Existing Common Stock prior to the Company's announcement or implementation
of the Specialty Retail Stock Proposal. Furthermore, there can be no assurance
that investors would assign values to the Kmart Stock and any series of
Specialty Retail Stock based on the reported financial results and prospects of
the relevant Group or the dividend policies established by the Board with
respect to such Group. Accordingly, financial effects of any Group that affect
the Company's consolidated results of operations or financial condition could
affect the market price of shares of all series of Common Stock. In addition,
the Company cannot predict the impact on the market price of any series of
Common Stock of certain terms of such securities, such as the ability of the
Company to exchange shares of a series of Specialty Retail Stock for Kmart
Stock, the discretion of the Board to make various determinations and the
minority voting power of the various series of Specialty Retail Stock.
Limitations on Potential Unsolicited Acquisitions. If each of the Groups
were separate independent companies, any person interested in acquiring one
Group without negotiation with management could seek control of that Group by
obtaining control of its outstanding voting stock. Although full implementation
of the Specialty Retail Stock Proposal would create five series of Common Stock
that are intended to reflect the separate performance of each of the Groups, a
person interested in acquiring only one Group without negotiation with the
Company's management could obtain control of that Group only by obtaining
control of the outstanding voting stock of the entire Company, including series
of Common Stock related to other Groups. See "Proposal 2 -- The Specialty Retail
Stock Proposal -- Special Considerations -- Limited Separate Stockholder Voting
Rights; Effects on Voting Power" and "-- Description of Kmart Stock and
Specialty Retail Stock -- Voting Rights".
For further discussion of the foregoing and certain other considerations,
see "Proposal 2 -- The Specialty Retail Stock Proposal -- Special
Considerations".
DIVIDEND POLICY
The Company's annual dividend rate is presently $.96 per share of Common
Stock. The Board currently intends that the dividend policy applicable to the
Kmart Stock would be the same as the dividend policy applicable to the Existing
Common Stock, with the initial dividend rate on the Kmart Stock being the rate
in effect for the Existing Common Stock at the time of the redesignation of the
Existing Common Stock as Kmart Stock. The Board believes that implementation of
the Specialty Retail Stock Proposal would not adversely affect the Company's
ability to pay dividends on the Kmart Stock. In reaching this conclusion, the
Board considered the following: (i) the Company currently intends that the Kmart
Group would initially have a 70-80% Retained Interest in each Specialty Retail
Group, resulting in the Kmart Group being credited with
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<PAGE> 20
an amount proportionate to dividends paid on each series of Specialty Retail
Stock; (ii) the Company currently intends to allocate the net proceeds of the
Offerings to the Kmart Group to, among other things, repay outstanding
indebtedness of the Company, resulting in reduced debt service obligations
attributable to the Kmart Group; and (iii) the Company does not expect initially
to pay significant dividends on the various series of Specialty Retail Stock.
Determinations as to future dividends on the Kmart Stock would be based
primarily upon the financial condition, results of operations and business
requirements of the Kmart Group and the Company as a whole. See "Proposal 2 --
The Specialty Retail Stock Proposal -- Dividend Policy", "-- Description of
Kmart Stock and Specialty Retail Stock -- Dividends" and "-- Special
Considerations -- Allocation of Goodwill for Purposes of Determining Available
Dividend Amount".
DESCRIPTION OF KMART STOCK AND SPECIALTY RETAIL STOCK
Dividends. Dividends on the Kmart Stock and each series of Specialty Retail
Stock would be subject to the same limitations as dividends on the Existing
Common Stock, which are limited to legally available assets of the Company, and,
as provided under the Michigan Business Corporation Act ("MBCA"), are subject to
the prior payment of dividends on outstanding shares of Series A Preferred Stock
and Series B Preferred Stock (and any new series of Preferred Stock with similar
preferential dividend rights). In addition, net losses of any Group, dividends
and distributions on any series of Common Stock or Preferred Stock, repurchases
of any series of Common Stock and certain repurchases of Preferred Stock would
reduce the assets of the Company legally available for dividends on all series
of Common Stock.
Dividends on the Kmart Stock and each series of Specialty Retail Stock
would be further limited to an amount not in excess of the Available Dividend
Amount with respect to the relevant Group, which is equal to (a) the Group's net
equity, adjusted, in the case of each Specialty Retail Group, to exclude the
cumulative effects of amortization of goodwill arising from acquisitions on
behalf of such Specialty Retail Group prior to the issuance of the relevant
series of Specialty Retail Stock and, in the case of the Kmart Group, to include
the cumulative effects of such amortization to the extent not already reflected
in the net equity of the Kmart Group as a result of its Retained Interest in
such Specialty Retail Group, times (b) the Outstanding Interest Fraction with
respect to such Group. The goodwill adjustment referred to above would result in
a decrease in the Available Dividend Amount with respect to the Kmart Group and
an increase in the Available Dividend Amount with respect to such Specialty
Retail Group. See "Proposal 2 -- The Specialty Retail Stock Proposal -- Special
Considerations -- Allocation of Goodwill for Purposes of Determining Available
Dividend Amount." For an example of the calculation of Available Dividend Amount
for each Group, see the chart included in "Proposal 2 -- The Specialty Retail
Stock Proposal -- Description of Kmart Stock and Specialty Retail Stock --
Dividends".
Exchange and Redemption. The Articles do not provide for either mandatory
or optional exchange or redemption of the Existing Common Stock. The Specialty
Retail Stock Proposal would permit the exchange of shares of each series of
Specialty Retail Stock upon the terms described below, subject to certain
conditions.
The Company could, in the sole discretion of the Board, at any time,
exchange each outstanding share of any series of Specialty Retail Stock for
shares of Kmart Stock equal to 115% of the ratio of a time-weighted average of
the Market Value of one share of such Specialty Retail Stock to one share of
Kmart Stock. This option provides the Company with flexibility to alter its
capital structure if warranted by future facts and circumstances.
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<PAGE> 21
If the Company were to dispose of all or substantially all of the
properties and assets of any Specialty Retail Group, the Company would be
required, subject to certain exceptions and conditions, to:
(i) distribute to the holders of the relevant series of Specialty
Retail Stock an amount equal to their proportionate interest in the Net
Proceeds of such disposition, either by special dividend or by redemption
of all or part of the outstanding shares of such series; or
(ii) exchange each outstanding share of such series of Specialty
Retail Stock for shares of Kmart Stock equal to 110% of an average daily
ratio of the Market Value of one share of such series of Specialty Retail
Stock to one share of Kmart Stock calculated during a specified ten-Trading
Day period following the consummation of such disposition.
For the definition of "substantially all of the properties and assets" of
the Specialty Retail Group, see paragraph A.3.(a)(i) of Annex III-A hereto.
The Company could, in the sole discretion of the Board, within one year
after a dividend or partial redemption pursuant to clause (i) above, exchange
each remaining outstanding share of such series of Specialty Retail Stock for
shares of Kmart Stock equal to 110% of the ratio of a time-weighted average of
the Market Value of one share of such Specialty Retail Stock to one share of
Kmart Stock. For information concerning the ratios used to calculate the number
of shares of Kmart Stock to be received in the exchanges described above, see
the definition of "Market Value Ratio" in paragraph A.3.(a)(iv) of Annex III-A
hereto.
At any time on or after the date on which all of the assets and liabilities
of any Specialty Retail Group (and no other assets or liabilities) are held
directly or indirectly by a wholly owned subsidiary of the Company, the
outstanding shares of the relevant series of Specialty Retail Stock could be
exchanged, in the sole discretion of the Board, for shares of common stock of
such subsidiary.
Voting Rights. The Articles currently provide that holders of Common Stock
and each series of Preferred Stock, voting together as one class, have one vote
per share on all matters coming before any meeting of stockholders, other than a
matter with respect to which the Common Stock or any series of Preferred Stock
would be entitled to vote as a separate class under express provisions of the
Articles or Michigan law. The Specialty Retail Stock Proposal provides that the
holders of all series of Common Stock, Series A Preferred Stock, Series B
Preferred Stock and any other series of Preferred Stock outstanding at the time
of such vote and so entitled to vote would vote together as one class on all
matters coming before any meeting of stockholders other than a matter with
respect to which the Common Stock, the Preferred Stock or any series of either
would be entitled to vote as a separate class under express provisions of the
Articles or under Michigan law. For all matters on which all series of Common
Stock and the eligible Preferred Stock vote together as one class, each
outstanding share of Kmart Stock, Series A Preferred Stock and Series B
Preferred Stock would be entitled to one vote, and each outstanding share of any
series of Specialty Retail Stock would be entitled to a variable number of votes
equal to the ratio of a time-weighted average of the Market Value of one share
of such series of Specialty Retail Stock to one share of Kmart Stock (calculated
during a specified period prior to the record date). This formula is intended to
equate the proportionate voting rights of each series of Common Stock to their
respective Market Values at the time of any vote. However, no share of any
series of Specialty Retail Stock would be entitled to more than one vote per
share prior to the date on which the Series A Preferred Stock is converted into
shares of Kmart Stock (the "Series A Conversion Date"), which will occur on or
before September 15, 1994. Any action required by the MBCA, the Articles or the
By-laws to be taken by the vote of a specified percentage of the outstanding
shares entitled to vote would also require the same specified percentage of the
aggregate number of votes to which such shares are entitled.
The approval of the holders of at least two-thirds of the Kmart Stock or
any outstanding series of Specialty Retail Stock, as the case may be ("Affected
Stock"), voting as a separate class, would be required to approve, subject to
certain exceptions as described under "Proposal 2 -- The Specialty Retail Stock
Proposal -- Description of Kmart Stock and Specialty Retail Stock -- Voting
Rights", (i) any dividend or distribution to the holders of any other series of
Common Stock of any of the properties or assets of the relevant Group (the
"Affected Group"), or of shares of the Affected Stock (or Convertible Securities
convertible into or exercisable for the Affected Stock) or of any security that
represents an equity interest in
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<PAGE> 22
an entity (other than the Company) that owns any of the properties or assets of
the Affected Group, other than a dividend or distribution on Kmart Stock of
shares of the Affected Stock (or Convertible Securities convertible into or
exercisable for Affected Stock) to the extent of the Kmart Group's Retained
Interest in the Affected Group, (ii) the use of any properties or assets of the
Affected Group in any business of the Company other than a business of the
Affected Group or (iii) any issuance or sale of Affected Stock (or Convertible
Securities convertible into or exercisable for Affected Stock) for the account
of any Group other than the Affected Group, or the Kmart Group to the extent of
its Retained Interest in the Affected Group.
Liquidation. The Articles currently provide that, in the event of a
liquidation, dissolution or winding-up of the Company, after payment, or
provision for payment, of the debts and other liabilities of the Company and the
amounts to which the holders of the Preferred Stock (including Series A
Preferred Stock and Series B Preferred Stock) are entitled, holders of the
Existing Common Stock would be entitled to share ratably in the remaining net
assets of the Company. Under the Specialty Retail Stock Proposal, the holders of
shares of each outstanding series of Common Stock would be entitled to share
such remaining net assets with the holders of shares of all other outstanding
series of Common Stock in proportion to the relative time-weighted average
Market Capitalization of each series.
RETAINED INTEREST OF KMART GROUP IN SPECIALTY RETAIL GROUPS; OUTSTANDING
INTEREST FRACTION
Since it is currently contemplated that the number of shares of each series
of Specialty Retail Stock to be issued and sold in an Offering would be intended
to represent approximately 20% to 30% of the Equity Value of the relevant
Specialty Retail Group, the Company would retain and attribute to the Kmart
Group a 70% to 80% Retained Interest in each such Specialty Retail Group. The
"Outstanding Interest Fraction" with respect to any such Specialty Retail Group
means the percentage interest in such Group intended to be represented at any
time by the outstanding shares of the relevant series of Specialty Retail Stock,
and the "Retained Interest Fraction" with respect to such Group means the
remaining percentage interest in such Group that is attributed to the Kmart
Group. The sum of the Outstanding Interest Fraction and the Retained Interest
Fraction with respect to any Specialty Retail Group would always equal 100%. The
Kmart Group's Retained Interest in any Specialty Retail Group would not be
represented by actual shares of the relevant series of Specialty Retail Stock
and could not be voted by the Kmart Group. The "Number of Shares Issuable with
Respect to Retained Interest" is the number of shares of the relevant series of
Specialty Retail Stock that could be sold or otherwise issued by the Company for
the account of the Kmart Group in respect of its Retained Interest.
At the time of any sale of a series of Specialty Retail Stock, the Board
would, in its sole discretion, determine the allocation of the net proceeds of
such sale between the Kmart Group and the relevant Specialty Retail Group. The
Board could allocate 100% of the net proceeds of a sale of any series of
Specialty Retail Stock to the Kmart Group or to the relevant Specialty Retail
Group, in which event the net proceeds would be reflected entirely in the
financial statements of the Group to which such proceeds would be allocated. The
Company currently intends to allocate the net proceeds of the Offerings to the
Kmart Group to repay outstanding indebtedness of the Company and for general
corporate purposes. Because the percentage of the Equity Value of a Specialty
Retail Group to be sold to the public in an Offering of the relevant series of
Specialty Retail Stock would not be determined until the time of such Offering,
the Retained Interest Fraction with respect to such Specialty Retail Group
following such Offering cannot yet be determined; however, the Company currently
anticipates that the Retained Interest Fraction with respect to each Specialty
Retail Group following the relevant Offering would be 70-80%. The relevant
Number of Shares Issuable with Respect to Retained Interest would be reduced if
the net proceeds of any offering of such series of Specialty Retail Stock were
allocated to the Kmart Group's Retained Interest in the relevant Specialty
Retail Group. If the net proceeds of such an offering were not allocated to the
Kmart Group, the Number of Shares Issuable with Respect to Retained Interest in
the relevant Specialty Retail Group would not be reduced, but the Retained
Interest Fraction with respect to the relevant Specialty Retail Group would
nonetheless be reduced, and the Outstanding Interest Fraction with respect to
such Specialty Retail Group would increase accordingly.
In the event of any dividend or other distribution on the outstanding
shares of any series of Specialty Retail Stock (including any dividend of or
redemption with Net Proceeds from a Disposition), the relevant Specialty Retail
Group would be charged with, and the Kmart Group would be credited with, an
amount that
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<PAGE> 23
bears the same relation to the aggregate amount of such dividend or other
distribution as the relevant Number of Shares Issuable with Respect to Retained
Interest bears to the number of shares of such series then outstanding.
Cash or other property of the Kmart Group could be contributed as
additional equity to a Specialty Retail Group, which would increase the Number
of Shares Issuable with Respect to Retained Interest in such Specialty Retail
Group (based on the then current Market Value of shares of the relevant series
of Specialty Retail Stock), and, accordingly, would increase the Retained
Interest Fraction and decrease the Outstanding Interest Fraction with respect to
such Specialty Retail Group. The Board could determine, in its sole discretion,
to make such contribution after consideration of a number of factors, including,
among others, the relative levels of internally generated cash flow of the
Groups, the capital expenditures plans of and the investment opportunities
available to each Group, and the availability, cost and time associated with
alternative financing sources.
The Company would not be permitted to transfer cash or other property of a
Specialty Retail Group to the Kmart Group in consideration of a decrease in the
Kmart Group's Retained Interest with respect to such Specialty Retail Group,
except that, in connection with (i) any offer by the Company to purchase
outstanding shares of any series of Specialty Retail Stock in a tender or
exchange offer made by the Company to all holders of shares of such series, or
(ii) any repurchase by the Company of outstanding shares of such series in a
publicly announced open market repurchase program, in each case the payment for
which is attributed to the relevant Specialty Retail Group, the Board could, in
its sole discretion, determine to transfer to the Kmart Group from such
Specialty Retail Group funds in an amount proportionate to the amount offered to
be paid in such tender or exchange offer or the amount paid in such repurchase
program, in consideration of a reduction of the Kmart Group's Retained Interest
with respect to such Specialty Retail Group. In the event of such a tender or
exchange offer or open market repurchase program, the Retained Interest Fraction
with respect to such Specialty Retail Group would increase, decrease or remain
the same depending upon the number of outstanding shares tendered, exchanged or
repurchased and the extent to which the Board determined to cause the Kmart
Group to reduce its Retained Interest in such Specialty Retail Group. If the
Board determined not to reduce proportionately the Kmart Group's Retained
Interest, the Retained Interest Fraction with respect to such Specialty Retail
Group would increase to the extent that shares of holders of such series of
Specialty Retail Stock were tendered, exchanged or repurchased.
For a further discussion and illustrations of the calculation of the
Retained Interest Fraction, the Outstanding Interest Fraction and the Number of
Shares Issuable with Respect to Retained Interest and the effects thereon of
dividends on, and issuances and repurchases of, shares of a series of Specialty
Retail Stock, and transfers of cash or other property attributed to the Kmart
Group as equity contributions to any Specialty Retail Group, see "Proposal 2 --
The Specialty Retail Stock Proposal -- Description of Kmart Stock and Specialty
Retail Stock -- Retained Interest of Kmart Group in Specialty Retail Groups;
Outstanding Interest Fraction" and "Illustrations of Certain Terms" in Annex II
hereto.
SHARES ISSUABLE UNDER EMPLOYEE BENEFIT PLANS
One of the principal purposes of the Specialty Retail Stock Proposal is to
enable the Company to structure employee benefit plans with an equity security
specifically related to each of the Company's businesses. In this regard, the
Company is submitting for stockholder approval the employee benefit plan
amendments and new employee benefit plans described in Proposals 5 through 9 and
in Proposal 11, each of which provides for employee ownership of Specialty
Retail Stock (the "SRS Plans"). The aggregate percentage interest in the Equity
Value of the Specialty Retail Groups represented by the shares issuable pursuant
to the SRS Plans would be as follows: Borders-Walden Group, 19.75%; Builders
Square Group, 11.95%; OfficeMax Group, 9.45%; and The Sports Authority Group,
10.65%. The percentage interest represented by the number of shares actually
issued pursuant to the SRS Plans could be considerably less depending on the
degree to which awards are made, vested and exercised pursuant to such SRS
Plans.
The Company believes that issuance of shares of Specialty Retail Stock
pursuant to the SRS Plans would not result in a meaningful reduction of the
Kmart Group's Retained Interest in each Specialty Retail Group.
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<PAGE> 24
The aggregate percentage interest in the Equity Value of the Specialty Retail
Groups represented by shares issuable pursuant to the SRS Plans that would
reduce the Number of Shares Issuable with Respect to Retained Interest in the
relevant Specialty Retail Group would be less than 2% with respect to each
Specialty Retail Group. The extent to which the issuance of shares of Specialty
Retail Stock pursuant to the SRS Plans would actually reduce the Number of
Shares Issuable with Respect to Retained Interest would be dependent upon the
extent to which participants elect to convert their interests in Existing Common
Stock (or, after the redesignation, Kmart Stock) under the SRS Plans into
interests in Specialty Retail Stock. In addition, such conversions by
participants would result in cancellation of the participants' rights to receive
Existing Common Stock (or, after the redesignation, Kmart Stock) and any
proceeds received upon the issuance of such shares of Special Retail Stock would
be allocated to the Kmart Group.
EFFECTS ON CONVERTIBLE PREFERRED STOCK
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, upon redesignation of the Existing Common Stock as
Kmart Stock, each outstanding security of the Company that is convertible into
shares of Existing Common Stock, including the Series A Preferred Stock and the
Series B Preferred Stock, automatically would become convertible into a number
of shares of Kmart Stock equal to the number of shares of Existing Common Stock
that the holder thereof would have received if conversion had occurred
immediately prior to such redesignation.
STOCK EXCHANGE LISTINGS
Application will be made to the New York Stock Exchange ("NYSE"), Chicago
Stock Exchange ("CSE") and Pacific Stock Exchange ("PSE") for approval of the
proposed redesignation of the Existing Common Stock as Kmart Stock. The Company
intends to apply for the listing of each series of Specialty Retail Stock on
such stock exchanges as the Board deems appropriate at the time of initial
issuance of shares of such series.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The Company has been advised by tax counsel that no gain or loss would be
recognized by the Company or its stockholders on either the redesignation of the
Existing Common Stock as Kmart Stock or the issuance and sale of any series of
Specialty Retail Stock in the Offerings. However, there are no current court
decisions bearing directly on transactions similar to the Specialty Retail Stock
Proposal, and the Internal Revenue Service has had under study since 1987 the
federal income tax consequences of transactions similar to the Specialty Retail
Stock Proposal. See "Proposal 2 -- The Specialty Retail Stock Proposal --
Certain Federal Income Tax Considerations".
REASONS FOR THE SPECIALTY RETAIL STOCK PROPOSAL
The Specialty Retail Stock Proposal gives the Board the authority to issue
Common Stock in series that are intended to reflect the separate performance of
the Company's core Kmart discount store business and certain specialty retail
businesses. The Board believes the ability to issue separate series of Specialty
Retail Stock in addition to Kmart Stock would enhance stockholder value over the
long term by permitting separate market valuations of each series of Specialty
Retail Stock, which would result in greater market recognition of the value of
each of the specialty retail businesses, and by fostering an ownership culture
that would encourage superior performance by management and employees of each
specialty retail business. The Specialty Retail Stock Proposal also provides the
Company greater flexibility with regard to raising capital and structuring
employee incentive plans with an equity security specifically related to each of
the Company's businesses. At the same time, the Specialty Retail Stock Proposal
enables the Company to retain operational control over the Specialty Retail
Groups and enables each of the Company's businesses to preserve the benefits of
being part of a single consolidated entity.
Approval of the Specialty Retail Stock Proposal will require the
affirmative vote of the holders of a majority of the outstanding shares of
Existing Common Stock, Series A Preferred Stock and Series B
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Preferred Stock entitled to vote, voting together as one class, as well as the
holders of a majority of the outstanding shares of Existing Common Stock and
Series B Preferred Stock, each voting separately as a class.
THE BOARD OF DIRECTORS HAS CAREFULLY CONSIDERED AND UNANIMOUSLY APPROVED
THE SPECIALTY RETAIL STOCK PROPOSAL, BELIEVES ITS ADOPTION IS IN THE BEST
INTERESTS OF THE COMPANY AND RECOMMENDS A VOTE FOR SUCH PROPOSAL.
------------------------
PROPOSAL 3 -- AMENDMENTS TO RESTATED ARTICLES OF INCORPORATION
RELATING TO ISSUANCE OF PREFERRED STOCK IN SERIES BY RESOLUTION OF BOARD OF
DIRECTORS
The stockholders are being asked to consider and approve a proposal to
amend Article III, Section B of the Articles, as set forth in Annex III-B
hereto, relating to the Board's authority to designate the relative rights,
preferences, limitations and restrictions of Preferred Stock issued in series by
resolution of the Board.
Approval of Proposal 3 will require the affirmative vote of the holders of
a majority of the outstanding shares of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class, as
well as the holders of a majority of the outstanding shares of Existing Common
Stock and Series B Preferred Stock, each voting separately as a class.
PROPOSAL 4 -- AMENDMENTS TO RESTATED ARTICLES OF INCORPORATION
RELATING TO CERTAIN VOTING PROVISIONS
The stockholders are being asked to consider and approve a proposal to
amend Article VII of the Articles, as set forth in Annex III-C hereto, to
conform certain provisions regarding the vote required for the removal of
directors to the voting rights of the various series of Common Stock under the
Specialty Retail Stock Proposal.
Approval of Proposal 4 will require the affirmative vote of the holders of
at least 58% of the outstanding shares of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
PROPOSAL 5 -- ADOPTION OF EMPLOYEE STOCK PURCHASE PLAN
FOR EACH SPECIALTY RETAIL GROUP
The stockholders are being asked to consider and approve a proposal to
adopt an Employee Stock Purchase Plan for each Specialty Retail Group that is
designed to encourage the purchase of shares of the series of Specialty Retail
Stock by a broad base of employees of the relevant Specialty Retail Group.
Approval of Proposal 5 will require the affirmative vote of the holders of
a majority of the votes cast by the holders of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
PROPOSAL 6 -- AMENDMENTS TO DIRECTORS STOCK PLAN RELATING TO
ISSUANCE OF SPECIALTY RETAIL STOCK
The stockholders are being asked to consider and approve a proposal to
amend the terms of the Company's Directors Stock Plan to provide for, among
other things, a pro rata portion of a non-employee director's compensation in
shares of all outstanding series of Specialty Retail Stock.
Approval of Proposal 6 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class.
19
<PAGE> 26
PROPOSAL 7 -- AMENDMENTS TO PERFORMANCE RESTRICTED STOCK PLAN
RELATING TO SUBSTITUTION OF SPECIALTY RETAIL STOCK
FOR CERTAIN OUTSTANDING AWARDS OF EXISTING COMMON STOCK
The stockholders are being asked to consider and approve a proposal to
amend the terms of the Company's Performance Restricted Stock Plan to provide
for the substitution of outstanding series of Specialty Retail Stock for certain
outstanding awards of Existing Common Stock.
Approval of Proposal 7 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class.
PROPOSAL 8 -- AMENDMENTS TO 1973 AND 1981 STOCK OPTION PLANS RELATING TO
SUBSTITUTION OF SPECIALTY RETAIL STOCK
FOR EXISTING COMMON STOCK ISSUABLE UPON EXERCISE OF CERTAIN OUTSTANDING OPTIONS
The stockholders are being asked to consider and approve a proposal to
amend the Company's 1973 and 1981 Stock Option Plans to provide for the
substitution of outstanding series of Specialty Retail Stock for Existing Common
Stock issuable upon exercise of certain outstanding options granted under such
Plans.
Approval of Proposal 8 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class.
PROPOSAL 9 -- AMENDMENTS TO 1992 STOCK OPTION PLAN RELATING TO GRANT
OF CERTAIN OPTIONS EXERCISABLE FOR
SPECIALTY RETAIL STOCK AND CERTAIN OTHER PLAN AMENDMENTS
The stockholders are being asked to consider and approve a proposal to
amend the Company's 1992 Stock Option Plan to provide for, among other things,
the grant of certain options exercisable for outstanding series of Specialty
Retail Stock.
Approval of Proposal 9 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class.
PROPOSAL 10 -- AMENDMENTS TO 1992 STOCK OPTION PLAN
RELATING TO ADDING ALLOCATION PROVISIONS
The stockholders are being asked to consider and approve a proposal to
amend the Company's 1992 Stock Option Plan to establish maximum annual
allocations of option grants to certain executives in order for the Company to
comply with certain recently enacted provisions of the Internal Revenue Code.
Approval of Proposal 10 will require the affirmative vote of the holders of
a majority of the votes cast by the holders of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
20
<PAGE> 27
PROPOSAL 11 -- ADOPTION OF MANAGEMENT STOCK PURCHASE PLAN
The stockholders are being asked to consider and approve a proposal to
adopt the Management Stock Purchase Plan that would permit a portion of a
participant's annual bonus otherwise payable in cash pursuant to the Company's
Annual Incentive Bonus Plan to be paid in the form of restricted stock and would
permit certain one-time purchases of restricted stock in connection with the
initial issuance of each series of Specialty Retail Stock.
Approval of Proposal 11 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class.
PROPOSAL 12 -- ADOPTION OF ANNUAL INCENTIVE BONUS PLAN
The stockholders are being asked to consider and approve a proposal to
adopt the Annual Incentive Bonus Plan that would provide for the payment of
annual incentive bonus awards to participants if, and only to the extent that,
specified performance goals are met.
Approval of Proposal 12 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class.
PROPOSAL 13 -- RATIFICATION OF APPOINTMENT OF INDEPENDENT ACCOUNTANTS
Subject to stockholder ratification, the firm of Price Waterhouse has been,
upon recommendation of the Audit Committee, appointed by the Board as
independent accountants to audit the Company's books for fiscal year 1994.
Representatives of Price Waterhouse will be present at the Annual Meeting of
Stockholders, will have the opportunity to make a statement if they desire to do
so and will be available to respond to appropriate questions from stockholders.
Approval of Proposal 13 will require the affirmative vote of the holders of
a majority of the votes cast by the holders of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSALS 3 THROUGH 13.
------------------------
Proposals 4 through 9 concern Specialty Retail Stock and, therefore, are
each conditioned upon approval of Proposal 2 and will not be implemented if
Proposal 2 is not approved by stockholders and implemented by the Board.
Accordingly, a vote against Proposal 2 will have the effect of a vote against
each of Proposals 4 through 9.
Under applicable Michigan law, none of the holders of Existing Common
Stock, Series A Preferred Stock or Series B Preferred Stock has appraisal rights
in connection with any proposal to be acted upon at the meeting.
21
<PAGE> 28
KMART CORPORATION
SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated has been
derived from the consolidated financial statements of the Kmart Corporation.
Operating results and affected ratios have been restated to exclude discontinued
operations. The information set forth below should be read in conjunction with
the Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements and notes thereto set forth
in Annex V hereto.
<TABLE>
<CAPTION>
1993(1) 1992 1991 1990 1989(2) 1988
------- ------- ------- ------- ------- -------
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Sales........................................... $34,156 $31,031 $29,042 $28,133 $27,670 $25,947
Cost of merchandise sold, includes buying and
occupancy costs............................... 25,646 22,800 21,243 20,614 20,310 18,920
Selling, general and administrative expenses.... 7,636 6,875 6,603 6,435 6,277 5,877
Interest expense -- net......................... 477 414 384 384 353 312
Income (loss) from continuing retail operations
before income taxes........................... (550) 1,327 1,189 1,070 444 1,185
Net income (loss) from continuing retail
operations.................................... (328) 882 789 712 282 768
Net income (loss)............................... (974) 941 859 756 323 803
PER-SHARE DATA
Earnings per common and common equivalent share
from continuing retail operations............. $ (0.73) $ 1.93 $ 1.85 $ 1.78 $ 0.70 $ 1.91
Cash dividends declared per common share........ 0.96 0.92 0.88 0.86 0.82 0.66
Book value...................................... 13.39 16.64 15.33 13.47 12.45 12.56
FINANCIAL DATA
Working capital................................. $ 4,123 $ 5,014 $ 4,682 $ 3,519 $ 3,685 $ 3,654
Total assets.................................... 17,504 18,931 15,999 13,899 13,145 12,126
Long-term obligations -- Debt................... 2,227 3,237 2,287 1,701 1,480 1,358
-- Capital leases........... 1,720 1,698 1,638 1,598 1,549 1,588
Shareholders' equity............................ 6,093 7,536 6,891 5,384 4,972 5,009
Capital expenditures -- owned property.......... 1,022 1,435 1,329 814 631 570
Depreciation and amortization................... 703 600 509 470 444 424
Ending market capitalization.................... 9,333 10,837 10,901 6,095 6,640 7,105
Weighted average shares outstanding............. 457 456 426 400 401 401
FINANCIAL RATIOS
Return on sales --
Income (loss) from continuing retail
operations before income taxes.............. (1.6)% 4.3% 4.1% 3.8% 1.6% 4.6%
Net income (loss) from continuing retail
operations.................................. (1.0)% 2.8% 2.7% 2.5% 1.0% 3.0%
Return on beginning assets from continuing
retail operations............................. (2.0)% 6.4% 6.6% 5.9% 2.5% 7.5%
Inventory turnover.............................. 2.9 2.7 2.7 2.7 2.9 3.0
Return on beginning shareholders' equity from
continuing retail operations.................. (4.4)% 13.2% 15.0% 14.7% 5.7% 17.7%
Return on beginning investment from continuing
retail operations............................. (0.1)% 10.8% 11.2% 11.2% 6.4% 13.2%
Working capital ratio........................... 1.7 1.9 2.1 1.8 1.9 2.0
Debt and equivalent as a percentage of total
capitalization................................ 48.9% 43.1% 37.3% 43.5% 43.4% 38.0%
Ratio of income from continuing retail
operations to fixed charges(3)................ -- 3.0 3.0 2.9 1.8 3.5
Employee compensation and benefits, per sales
dollar........................................ 14.6% 14.7% 15.1% 15.2% 15.2% 14.7%
</TABLE>
- -------------------------
(1) Results of operations for 1993 include a pre-tax provision of $1,348
million ($862 million net of tax) for store restructuring and other
charges.
(2) Results of operations for 1989 include a pre-tax provision of $640 million
($422 million net of tax) for store restructuring and other charges.
(3) The deficiency of income from continuing retail operations compared to
fixed charges was $581 million for the fiscal year ended January 26, 1994.
22
<PAGE> 29
KMART GROUP AND SPECIALTY RETAIL GROUPS
SELECTED FISCAL 1993 FINANCIAL DATA
The following selected data for fiscal 1993 reflects the historical results
of operations, financial condition and operating data of the businesses which
comprise the Kmart Group and each of the Specialty Retail Groups and should be
read in conjunction with the Selected Financial Data, Combined Financial
Statements and notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations of each of the Groups contained in
Annexes VI through X hereto.
<TABLE>
<CAPTION>
BORDERS- BUILDERS THE SPORTS
KMART WALDEN SQUARE OFFICEMAX AUTHORITY
GROUP GROUP GROUP GROUP GROUP
------------ -------- -------- --------- ----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Sales................................... $ 28,039 $1,370.6 $2,718.8 $1,421.8 $606.9
Gross margin............................ 7,064 350.6 618.3 312.8 167.7
Selling, general and administrative
expenses(1).......................... 6,338 293.8 556.6 284.2 144.6
Goodwill amortization................... -- 6.9 0.9 8.6 2.1
Store restructuring and other charges... 904 142.8 226.5 -- --
Operating income (loss)................. 110 (92.9) (165.7) 20.0 21.0
Interest expense -- net................. 467 0.9 8.7 0.1 --
Loss from continuing retail operations
before Retained Interests in the
Specialty Retail Groups and income
taxes................................ (247) -- -- -- --
Income (loss) of Specialty Retail
Groups............................... -- (93.8) (174.4) 19.9 21.0
Income taxes............................ (110) (38.2) (65.8) 9.1 8.2
Net loss related to Retained Interests
in Specialty Retail Groups(2)........ (145) -- -- -- --
Net income (loss)....................... (925) (61.2) (107.0) 10.8 12.8
Add back of goodwill amortization....... -- 6.9 0.9 8.6 2.1
Kmart Corporation earnings (losses)
attributable to Group................ (925) (54.3) (106.1) 19.4 14.9
BALANCE SHEET DATA -- END OF PERIOD
Working capital......................... 3,467 60.2 481.5 113.6 37.4
Total assets............................ 15,865 1,001.6 1,130.1 1,009.7 297.8
Total debt.............................. 2,591 9.5 16.7 -- --
Group equity............................ 6,093 457.5 531.9 608.5 147.9
OTHER DATA:
End of year stores...................... 2,323 1,203 177 328 80
Capital expenditures -- owned
property............................. $ 793 $ 71.0 $ 77.7 $ 57.3 $ 23.5
Depreciation and amortization........... 591 41.0 35.3 26.3 10.2
</TABLE>
- -------------------------
(1) Includes pre-opening expense.
(2) Net income or loss of the Specialty Retail Groups Attributable to the Kmart
Group Retained Interest is reflected as "Net income (loss) related to
Retained Interests in the Specialty Retail Groups" in the combined
statements of income.
23
<PAGE> 30
PRICE RANGES OF EXISTING COMMON STOCK,
SERIES A PREFERRED STOCK AND
SERIES B PREFERRED STOCK; DIVIDENDS
EXISTING COMMON STOCK
The following table sets forth the high and low closing sales prices of the
Existing Common Stock on the New York Stock Exchange Composite Tape (the
"Composite Tape") and the dividends paid per share of the Existing Common Stock
during the periods indicated. On January 4, 1994, the day prior to the Company's
announcement of the Specialty Retail Stock Proposal, and April , 1994, the
closing sale price of the Existing Common Stock, as reported on the Composite
Tape, was $21 1/2 and $ , respectively. As of April , 1994, there were
shares of Existing Common Stock outstanding and holders of record of
Existing Common Stock.
<TABLE>
<CAPTION>
CLOSING SALE
PRICES
---------------- DIVIDENDS
HIGH LOW PAID
---- --- ---------
<S> <C> <C> <C>
1992
First Quarter.............................................. $27 $22 5/8 $ .22
Second Quarter............................................. 26 1/2 21 3/8 .23
Third Quarter.............................................. 25 1/2 21 1/2 .23
Fourth Quarter............................................. 27 3/4 23 7/8 .23
1993
First Quarter.............................................. 25 22 3/8 .23
Second Quarter............................................. 23 5/8 19 7/8 .24
Third Quarter.............................................. 24 1/4 20 .24
Fourth Quarter............................................. 24 7/8 21 .24
1994
First Quarter
(through April , 1994)................................ .24
</TABLE>
Subject to the prior rights of the holders of Preferred Stock, including
Series A Preferred Stock and Series B Preferred Stock, such dividends as may be
determined by the Board may be declared and paid on the Existing Common Stock
from time to time out of any assets legally available therefor. The Board
currently intends that the dividend policy applicable to the Kmart Stock would
be substantially the same as the dividend policy applicable to the Existing
Common Stock, with the initial dividend rate on the Kmart Stock being the rate
in effect for the Existing Common Stock at the time of the redesignation. The
Company's annual dividend rate, which is currently $.96 per share, is
customarily reviewed at the April meeting of the Board. The Board believes that
implementation of the Specialty Retail Stock Proposal would not adversely affect
the Company's ability to pay dividends on the Kmart Stock. Determinations as to
future dividends on the Kmart Stock would be based primarily upon the financial
condition, results of operations and business requirements of the Kmart Group
and the Company as a whole. Under the terms of the Specialty Retail Stock
Proposal, dividends on the Kmart Stock would be payable out of the lesser of (i)
all assets of the Company legally available for such dividends and (ii) the
Available Dividend Amount with respect to the Kmart Group. See "Proposal 2 --
The Specialty Retail Stock Proposal -- Dividend Policy" and "-- Description of
Kmart Stock and Specialty Retail Stock -- Dividends".
24
<PAGE> 31
SERIES A PREFERRED STOCK
The following table sets forth the high and low closing sale prices of the
Depositary Shares (each of which represents 1/4 share of Series A Preferred
Stock) on the Composite Tape and the dividends paid per Depositary Share during
the periods indicated. On January 4, 1994, the day prior to the Company's
announcement of the Specialty Retail Stock Proposal, and on April , 1994, the
closing sale price of the Depositary Shares, as reported on the Composite Tape,
was $ and $ , respectively. As of April 8, 1994, there were 23,000,000
Depositary Shares outstanding (representing 5,750,000 shares of Series A
Preferred Stock) and five record holders of Depositary Shares. On September 15,
1994, each Depositary Share automatically converts into two shares of Existing
Common Stock, subject to adjustment in certain events, unless sooner redeemed by
the Company for shares of Existing Common Stock.
<TABLE>
<CAPTION>
CLOSING SALE
PRICES
------------ DIVIDENDS
HIGH LOW PAID
---- ---- ---------
<S> <C> <C> <C>
1992
First Quarter...................................................... $ 49 $45 3/4 $ .85
Second Quarter..................................................... 48 1/2 43 7/8 .85
Third Quarter...................................................... 50 3/8 44 5/8 .85
Fourth Quarter..................................................... 51 5/8 48 1/8 .85
1993
First Quarter...................................................... 50 5/8 47 1/8 .85
Second Quarter..................................................... 49 41 7/8 .85
Third Quarter...................................................... 49 42 7/8 .85
Fourth Quarter..................................................... 50 1/4 43 3/4 .85
1994
First Quarter (through April , 1994).............................. .85
</TABLE>
SERIES B PREFERRED STOCK
The Series B Preferred Stock, which was issued during the fourth quarter of
fiscal 1992, is not publicly traded. As of April , 1994, there were 784,938
shares of Series B Preferred Stock outstanding and record holders of Series B
Preferred Stock. Each share of Series B Preferred Stock is convertible by the
holder thereof at any time into 6.49 shares of Existing Common Stock, subject to
adjustment in certain events, and is redeemable by the Company for Existing
Common Stock after November 1, 1999 at a rate based on the then current market
price of the Existing Common Stock. The following table sets forth the dividend
paid per share of the Series B Preferred Stock during the periods indicated:
<TABLE>
<CAPTION>
DIVIDENDS PAID
--------------
<S> <C>
1992
Fourth Quarter............................................................... $1.44
1993
First Quarter................................................................ 2.875
Second Quarter............................................................... 2.875
Third Quarter................................................................ 2.875
Fourth Quarter............................................................... 2.875
1994
First Quarter (through April , 1994)........................................ 2.875
</TABLE>
25
<PAGE> 32
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
To the knowledge of the Company, no person beneficially owns 5% or more of
the outstanding shares of Existing Common Stock.
The following table sets forth certain information concerning persons who,
to the knowledge of the Company, beneficially own 5% or more of the outstanding
Preferred Stock of the Company as of December 31, 1993:
<TABLE>
<CAPTION>
NAME AND ADDRESS NUMBER OF SHARES PERCENT
OF BENEFICIAL OWNER TITLE OF CLASS BENEFICIALLY OWNED OF CLASS
-------------------------------------------- -------------- ------------------ --------
<S> <C> <C> <C>
Thomas P. Borders
411 East Washington,
Ann Arbor, MI 48104....................... Preferred 351,780(a)(b) 5.38%
Louis H. Borders
325 Lytton Avenue,
Palo Alto, CA 94301....................... Preferred 411,158(c) 6.29%
</TABLE>
- -------------------------
(a) Represents shares of Series B Preferred Stock held by Thomas P. Borders, as
Trustee under the Thomas P. Borders Trust Agreement. Thomas P. Borders and
Louis H. Borders, who are brothers, together beneficially own 97.2% of the
outstanding Series B Preferred Stock.
(b) Excludes 15,000 shares of Series B Preferred Stock that were transferred to
a trust of which the wife of Thomas P. Borders is Trustee.
(c) Represents shares of Series B Preferred Stock held by Louis H. Borders, as
Trustee under the Louis H. Borders Trust Agreement. Thomas P. Borders and
Louis H. Borders, who are brothers, together beneficially own 97.2% of the
outstanding Series B Preferred Stock.
26
<PAGE> 33
PROPOSAL 1 -- ELECTION OF DIRECTORS
The Company's Articles and By-laws provide that the number of directors, as
determined from time to time by the Board, shall be not less than seven nor more
than twenty-one. The Board has fixed the number of directors at thirteen. The
Articles and By-laws further provide that directors shall be divided into three
classes (Class I, Class II and Class III) serving staggered three-year terms,
with each class to be as nearly equal in number as possible.
In accordance with the recommendation of its Nominating Committee, the
Board has nominated Messrs. Joseph A. Califano, Jr., Enrique C. Falla, David B.
Harper, J. Richard Munro and Joseph R. Thomas. All nominees are presently
directors of the Company whose terms expire at the annual meeting. Other
directors who are remaining on the Board will continue in office in accordance
with their previous elections until the expiration of their terms at the 1995 or
1996 annual meeting, as the case may be.
It is the intention of the persons named in the enclosed form of proxy to
vote such proxies for the election of the nominees listed herein. The proposed
nominees are willing to be elected and serve, but in the event any nominee at
the time of election is unable to serve or is otherwise unavailable for
election, it is intended that votes will be cast pursuant to the accompanying
proxy for substitute nominees designated by the Board, unless the Board reduces
the number of directors to be elected. Directors are elected by a plurality of
votes cast by holders of the Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock, voting together as one class, who are present in
person or represented by proxy at the meeting.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE ELECTION OF MESSRS.
CALIFANO, FALLA, HARPER, MUNRO AND THOMAS AS DIRECTORS OF THE COMPANY.
INFORMATION ABOUT NOMINEES AND DIRECTORS
The following information is furnished for each person who is nominated for
election as a director or who is continuing as an incumbent director: name; age;
whether such person is a nominee for election ("Nominee") or an incumbent
director whose term does not expire at this meeting ("Incumbent"); the year in
which his or her term is to expire; principal occupation and employment during
the past five years; boards of directors of other publicly owned companies on
which he or she serves; how long he or she has served as a director of the
Company; committees of the Board of the Company of which he or she is a member;
and shares of Existing Common Stock of the Company owned as of March 1, 1994.
Included for directors who are officers of the Company are shares in which they
have a beneficial interest under the Company's Employee Savings Plan and the
Company's Performance Restricted Stock Plan, as well as shares not presently
owned but which are subject to stock options exercisable within 60 days after
March 1, 1994.
LILYAN H. AFFINITO, 62 (Incumbent -- Term to expire in 1995)
Former Vice Chairman of the Board of Maxxam Group Inc. (forest products
operations, real estate management and development and aluminum production).
Previously served as President and Chief Operations Officer of Maxxam Group,
Inc.; Director of Caterpillar, Inc., Chrysler Corporation, Jostens Inc., Lillian
Vernon Corporation, New York Telephone Company and Tambrands, Inc. Has served as
a director of Kmart Corporation since 1990. Member of Audit, Executive/Finance
and Health Care Committees.
Shares of Existing Common Stock owned..............[4,709]
27
<PAGE> 34
JOSEPH E. ANTONINI, 52 (Incumbent -- Term to expire in 1996)
Chairman of the Board, President and Chief Executive Officer of Kmart
Corporation. Previously served as President and Chief Operating Officer,
Executive Vice President and Senior Vice President of the Company. Director of
Chrysler Corporation and Shell Oil Company. Has served as a director of Kmart
Corporation since 1986. Member of Executive/Finance and Health Care Committees.
Shares of Existing Common Stock owned..............[165,832]
Also holds stock options exercisable for [974,200] shares
JOSEPH A. CALIFANO, JR., 62 (Nominee -- Term to expire in 1997)
Chairman and President, Center on Addiction and Substance Abuse at Columbia
University; author and health care consultant. Formerly Senior Partner, Law Firm
of Dewey Ballantine. Director of Authentic Fitness Corp., Automatic Data
Processing, Inc., Chrysler Corporation, New York Telephone Company, The
Travelers Inc. and Warnaco, Inc. Has served as a director of Kmart Corporation
since 1990. Member of Compensation and Incentives, Health Care and Public Issues
Committees.
Shares of Existing Common Stock owned..............[2,968]
WILLIE D. DAVIS, 59 (Incumbent -- Term to expire in 1995)
President of All Pro Broadcasting, Inc. (radio stations). Director of Alliance
Bank, The Dow Chemical Company, Johnson Controls, Inc., L.A. Gear, Inc., MGM
Grand, Inc., Sara Lee Corporation and WICOR. Has served as a director of Kmart
Corporation since 1986. Member of Audit, Nominating and Public Issues
Committees.
Shares of Existing Common Stock owned..............[2,052]
ENRIQUE C. FALLA, 54 (Nominee -- Term to expire in 1997)
Executive Vice President and Chief Financial Officer of The Dow Chemical
Company. Director of The Dow Chemical Company and Marion Merrill Dow, Inc. Has
served as a director of Kmart Corporation since 1992. Member of Audit,
Executive/Finance and Nominating Committees.
Shares of Existing Common Stock owned..............[2,101]
JOSEPH P. FLANNERY, 62 (Incumbent -- Term to expire in 1995)
Chairman of the Board, President and Chief Executive Officer of Uniroyal
Holding, Inc. (investment management company). Previously served as Partner,
Clayton and Dubilier, Inc. (investment firm). Director of APS Holding Corp.,
Arvin Industries, Inc., Ingersoll Rand Company, Newmont Gold Company, Newmont
Mining Corporation and The Scotts Company. Has served as a director of Kmart
Corporation since 1985. Member of Compensation and Incentives, Executive/Finance
and Health Care Committees.
Shares of Existing Common Stock owned..............[3,098]
DAVID B. HARPER, 60 (Nominee -- Term to expire in 1997)
President, David B. Harper Management Co., Inc. (management services); also
President, New Age Bancorporation. Director of New Age Bancorporation and
Student Loan Marketing Association. Has served as a director of Kmart
Corporation since 1975. Member of Audit, Executive/Finance and Public Issues
Committees.
Shares of Existing Common Stock owned..............[1,968]
28
<PAGE> 35
F. JAMES MCDONALD, 71 (Incumbent -- Term to expire in 1996)
Retired President and Chief Operating Officer of General Motors Corporation. Has
served as a director of Kmart Corporation since 1987. Member of Compensation and
Incentives, Executive/Finance and Nominating Committees.
Shares of Existing Common Stock owned..............[8,430]
RICHARD S. MILLER, 54 (Incumbent -- Term to expire in 1995)
Executive Vice President, Super Kmart Centers. Previously served as Senior Vice
President and Vice President of the Company. Has served as a director of Kmart
Corporation since 1988. Member of Health Care and Public Issues Committee.
Shares of Existing Common Stock owned..............[74,027]
Also holds stock options exercisable for [424,600] shares.
J. RICHARD MUNRO, 63 (Nominee -- Term to expire in 1997)
Chairman of the Executive Committee of Time Warner Inc. (entertainment and
communications). Previously served as Co-Chairman of the Board and Co-Chief
Executive Officer of Time Warner Inc. and as Chairman of the Board and Chief
Executive Officer of Time Inc. (communications). Director of Genentech, Inc.,
Kellogg Company, Mobil Corporation, Time Warner Inc. and Trustee of Rand
Corporation. Has served as a director of Kmart Corporation since 1990. Member of
Compensation and Incentives, Nominating and Public Issues Committees.
Shares of Existing Common Stock owned..............[2,923]
DONALD S. PERKINS, 66 (Incumbent -- Term to expire in 1996)
Retired Chairman of the Board of Jewel Companies, Inc. (diversified retailer).
Director of American Telephone and Telegraph Company, Aon Corporation, Cummins
Engine Company, Inc., Illinois Power Company, Inland Steel Industries, Inc.,
LaSalle Street Fund, Inc., Springs Industries, Inc., Time Warner Inc. and
Trustee of the Putnam Funds. Has served as a director of Kmart Corporation since
1986. Member of Compensation and Incentives, Executive/Finance and Nominating
Committees.
Shares of Existing Common Stock owned..............[8,423]
Mr. Perkins also shares voting and investment power as to [5,283,700] shares of
Existing Common Stock and [927,500] $3.41 Depositary Shares representing
[231,845] shares of Series A Preferred Stock, owned by one or more of the Putnam
Funds of which he is a Trustee. Mr. Perkins disclaims beneficial ownership of
these shares.
GLORIA M. SHATTO, 62 (Incumbent -- Term to expire in 1996)
President, Berry College. Director of Becton Dickinson and Company, Georgia
Power Company, Texas Instruments, Inc. and The Southern Company. Has served as a
director of Kmart Corporation since 1983. Member of Audit, Nominating and Public
Issues Committees.
Shares of Existing Common Stock owned ..............[2,052]
JOSEPH R. THOMAS, 58 (Nominee -- Term to expire in 1997)
Executive Vice President, U.S. Kmart Stores. Previously served as Vice President
of the Company. Has served as a director of Kmart Corporation since 1987. Member
of Public Issues Committee.
Shares of Existing Common Stock owned ..............[84,523]
Also holds stock options exercisable for [558,000] shares.
29
<PAGE> 36
STOCK OWNERSHIP OF OFFICERS AND DIRECTORS
All officers and directors of the Company as a group owned directly and
indirectly as of March 1, 1994, [766,185] shares, or 0.19%, of the Existing
Common Stock of the Company (including [37,895] shares owned by G.R. Mrkonic).
In addition, certain officers had the right to acquire a total of 3,611,782
shares within 60 days after March 1, 1994 through the exercise of stock options
(including the right of Mrs. Mrkonic to acquire 12,000 shares), and Mr. Perkin's
shared voting and investment power as to 5,283,700 shares of Existing Common
Stock and 927,500 Depositary Shares, representing 231,845 shares of Series A
Preferred Stock, owned by one or more of The Putnam Funds of which he is a
Trustee. If such additional shares were included, officers and directors as a
group would be considered to beneficially own 9,661,667 shares or 2.36% of
Existing Common Stock, including 1.29% for Mr. Perkins, and Mr. Perkins would be
considered to beneficially own 231,845 shares, or 4.0%, of Series A Preferred
Stock. (Mr. Perkins disclaims beneficial ownership as to such additional
shares.) No other officer, director or nominee would be considered to
beneficially own over 0.28%.
COMMITTEES OF THE BOARD
Following are the committees of the Board, the members of each committee as
of the date hereof, the number of meetings held by each committee during the
Company's fiscal year ended January 26, 1994, and a brief description of the
functions performed by each committee.
AUDIT COMMITTEE
Members: Lilyan H. Affinito (Chair), Willie D. Davis, Enrique C. Falla,
David B. Harper and Gloria M. Shatto. (This committee is comprised solely of
non-employee directors.)
Number of Meetings: 4
Functions: Recommending to the Board the selection of independent
accountants: approving the nature and scope of services performed by the
independent accountants and reviewing the range of fees for such services;
conferring with the independent accountants and reviewing the results of their
audit; reviewing the Company's internal auditing, accounting and financial
controls; and providing assistance to the Board with respect to the corporate
and reporting practices of the Company.
COMPENSATION AND INCENTIVES COMMITTEE
Members: F. James McDonald (Chair), Joseph A. Califano, Jr., Joseph P.
Flannery, J. Richard Munro and Donald S. Perkins. (This Committee is comprised
solely of non-employee directors.)
Number of Meetings: 8
Functions: Determining the nature and amount of compensation of all senior
officers of the Company and its specialty retail subsidiaries; and administering
the Company's stock option, performance restricted stock and directors stock
plans. This Committee has retained an independent consultant which reports
directly to the Committee.
EXECUTIVE/FINANCE COMMITTEE
Members: Joseph E. Antonini (Chair), Lilyan H. Affinito, Enrique C. Falla,
Joseph P. Flannery, David B. Harper, F. James McDonald, Donald S. Perkins and
Thomas F. Murasky, Executive Vice President and Chief Financial Officer.
Number of Meetings: 0
Functions: Exercising the power and authority of the Board as may be
necessary during the intervals between meetings of the Board, subject to such
limitations as provided by law or by resolution of the Board; reviewing
financial policies and procedures of the Company, making recommendations to the
Board on dividend policy, corporate financing, the issuance and sale of Company
securities and the investment of assets;
30
<PAGE> 37
and reviewing the management of the Employee Pension Plan and Pension Fund and
the Employee Savings Plan.
HEALTH CARE COMMITTEE
Members: Joseph A. Califano, Jr. (Chair), Lilyan H. Affinito, Joseph E.
Antonini, Joseph P. Flannery, Richard S. Miller, Kevin Browett, Vice President,
Hardlines Merchandising, Frederic M. Comins, Jr., Senior Vice President,
Executive and Organization Resources, and Donald L. Morford, Director, Employee
Benefits.
Number of Meetings: 1
Functions: Reviewing and monitoring the Company's health care programs,
their adequacy and cost effectiveness; and making recommendations regarding the
Company's health care programs to management and the Board.
NOMINATING COMMITTEE
Members: Donald S. Perkins (Chair), Willie D. Davis, Enrique C. Falla, F.
James McDonald, J. Richard Munro and Gloria M. Shatto. (This Committee is
comprised solely of non-employee directors.)
Number of Meetings: 2
Functions: Recommending to the Board nominees for election as directors. In
performing this function, the committee will consider nominees recommended by
stockholders. Such recommendation should be submitted in writing to the
Secretary of the Company and should include a description of the proposed
nominee's qualifications, other relevant biographical data and the written
consent of the proposed nominee. In addition, the By-laws of the Company
establish certain procedures concerning stockholder nominations for election of
directors. The By-laws require that notice of such nominations be delivered to
the Secretary of the Company within the following specified time limits prior to
the stockholders' meeting at which the directors are to be elected: 90 days in
advance of an annual meeting, and the tenth day following the date on which
notice of a special meeting is first given to stockholders. Each notice of
nomination is required to contain the name and address of the stockholder who
intends to make the nomination; the name, age, business address and written
consent of each nominee; and such other information as would be required to be
disclosed with respect to the nominee in a proxy solicitation.
PUBLIC ISSUES COMMITTEE
Members: Willie D. Davis (Chair), Joseph A. Califano, Jr., David B. Harper,
Richard S. Miller, J. Richard Munro, Gloria M. Shatto and Joseph R. Thomas.
Number of Meetings: 2
Functions: Considering the extent to which Company policies relate to and
are in proper accord with the public interest; and making appropriate
recommendations in that regard to management and the Board.
There were 17 meetings of the Board during the fiscal year ended January
26, 1994. Each director attended at least 75% of the total number of Board and
committee meetings held while he or she served as a director or member of the
committee, except for Mr. Califano due to illness in 1993.
COMPENSATION OF DIRECTORS
Directors who are not employees of the Company or its subsidiaries receive
an annual retainer of $50,000, with no additional amount payable for attending
meetings. Twenty percent (and at the election of the director, up to 50%) of the
annual retainer is paid in Existing Common Stock in lieu of cash pursuant to the
Directors Stock Plan.
Under the Company's Deferred Compensation Plan for Non-Employee Directors
and Directors Stock Plan, a director may elect to defer all or any portion of
his or her annual retainer which is payable in cash or Existing Common Stock.
Under these Plans, deferred cash amounts earn interest at a rate equivalent to
the
31
<PAGE> 38
ten-year U.S. Treasury Note rate plus 5% and deferred shares of Existing Common
Stock are credited with an amount equal to the dividends payable on such shares,
which are converted on a quarterly basis to additional shares. Under the
Company's Director Retirement Plan, non-employee directors who have served on
the Board (i) until they have reached the mandatory retirement age established
by the Company for such directors (currently the date of expiration of his or
her then current term of office following age 72), or (ii) at least 10 years,
will upon retirement from the Board or age 65, whichever is later, receive an
annual benefit equal to the annual retainer at the time of retirement. The
benefit is payable to the director (or surviving spouse) for the lesser of 10
years or a period equal to the director's period of service on the Board.
Directors who are employees of the Company or its subsidiaries do not
receive the aforesaid fee or retirement benefit.
32
<PAGE> 39
COMPENSATION OF OFFICERS
SUMMARY COMPENSATION TABLE. The following table sets forth information
regarding the compensation of the Chief Executive Officer and each of the four
most highly compensated executive officers of the Company for services in all
capacities to the Company in fiscal years 1991, 1992 and 1993.
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
ANNUAL COMPENSATION ---------------------------------
------------------------------------- PERFORMANCE ALL OTHER
NAME AND STOCK RESTRICTED SHARE COMPENSATION
PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTIONS (#) PAYOUTS ($)(1) ($)(2)
- ----------------------------------------- ----- ---------- --------- ----------- ------------------ ------------
<S> <C> <C> <C> <C> <C> <C>
J. E. Antonini,.......................... 1993 $ 893,000 $ -0- 125,000 $ -0- $ 23,293
Chairman of the Board, 1992 850,000 604,901 20,000 663,875 57,622
President and CEO 1991 750,000 795,784 44,600 684,094 31,863
G. R. Mrkonic,........................... 1993 410,000 [270,187] -0- [285,842] 22,995
Executive Vice President, 1992 465,000 403,125 -0- 122,153 18,752
Specialty Retailing 1991 425,000 340,945 12,000 341,144 2,125
J. R. Thomas,............................ 1993 447,498 155,218 50,000 -0- 17,946
Executive Vice President, 1992 410,000 236,810 8,000 279,650 27,965
U.S. Kmart Stores 1991 375,000 264,963 21,800 285,589 14,083
R. S. Miller,............................ 1993 500,000 -0- 62,500 -0- 13,039
Executive Vice President, 1992 475,000 202,618 10,000 198,669 24,960
Super Kmart Centers 1991 440,000 255,708 24,000 241,695 13,752
G. B. Smith,............................. 1993 425,000 -0- 50,000 -0- 15,551
Executive Vice President, 1992 400,000 172,226 8,000 124,127 22,943
Merchandising(3) 1991 330,000 241,477 9,000 92,600 12,335
</TABLE>
- -------------------------
(1) The amounts in this column are the value of performance restricted shares of
the Company's Existing Common Stock issued under the Company's Performance
Restricted Stock Plan (based on the market price of the stock as of the
date of issue) which were earned through the achievement of specified
income goals for, or awarded in, the fiscal year indicated. When earned,
the shares are issued in the name of the executive and held in the custody
of the Company for a specified period of up to three years. They are
subsequently issued free and clear to the executive if he or she continues
in the employ of the Company or a subsidiary until the end of the period.
If employment does not continue for such period, the shares are forfeited.
Dividends are payable on the restricted shares from their respective dates
of issue. (Additional information on the Company's Performance Restricted
Stock Plan is contained in the "Long Term Incentive Plan Awards" table on
page 36 and the Compensation and Incentives Committee's Report on page 30.)
As of January 26, 1994, the number and value of all performance restricted
stock holdings of the named executive officers were as follows: Mr.
Antonini 63,250/$1,249,188; Mr. Mrkonic [37,895/$748,426]; Mr. Thomas
23,144/$457,094; Mr. Miller 23,862/$471,275; and Mr. Smith 11,690/$230,878.
(2) "All Other Compensation" consists of employer contributions credited under
the Company's Employee Savings Plan and Supplemental Savings Plan. The
Employee Savings Plan is qualified under the Internal Revenue Code. The
Supplemental Savings Plan provides benefits to the extent that the Employee
Retirement Income Security Act limits the amount of employer contributions
to which a participant would otherwise be entitled under the Employee
Savings Plan absent such limitation.
(3) Mr. Smith retired from the Company as of January 31, 1994.
33
<PAGE> 40
OPTION GRANTS IN FISCAL YEAR 1993. The following table shows all grants to
the named executive officers of the Company in fiscal 1993. (Stock Appreciation
Rights are not permitted under the Company's Stock Option Plans. Additional
information on the Company's Stock Option Plans is contained below in the
Compensation and Incentives Committee's Report on Executive Compensation.)
<TABLE>
<CAPTION>
% OF TOTAL
OPTIONS
GRANTED TO GRANT DATE
OPTIONS EMPLOYEES IN EXERCISE EXPIRATION PRESENT
NAME GRANTED (#)(1) FISCAL 1993 PRICE ($/SH)(2) DATE VALUE ($)(3)
- -------------------------------- -------------- ------------ --------------- ---------- ------------
<S> <C> <C> <C> <C> <C>
J. E. Antonini.................. 125,000 3.4% $ 24.06 3/02/03 $902,250
G. R. Mrkonic................... -0- -- -- -- --
J. R. Thomas.................... 50,000 1.36 24.06 3/02/03 360,900
R. S. Miller.................... 62,500 1.7 24.06 3/02/03 451,125
G. B. Smith(4).................. 50,000 1.36 24.06 3/02/03 360,900
</TABLE>
- -------------------------
(1) All options will become exercisable on March 2, 1996.
(2) All options were granted at a price equal to 100% of the market value of the
Company's Existing Common Stock on the date of grant (March 2, 1993). The
exercise price may be paid in cash, already owned shares or a combination
of both.
(3) This column represents the present value of the options on the date of grant
using the Black-Scholes option pricing model for the Company's Existing
Common Stock, utilizing the following assumptions: five-year stock price
volatility of .277; 1 year average dividend yield of 3.8%; 10 year option
term; 7% interest rate and no adjustment for non-transferability or
forfeiture. The actual value, if any, that an executive may realize will
depend on the excess of the market price over the exercise price on the
date the option is exercised so that there is no assurance that the value
realized by an executive will be at or near the value estimated by the
Black-Scholes model, which is based on arbitrary assumptions as to the
variables of stock price volatility, future dividend yield, interest rate,
etc.
(4) Mr. Smith retired from the Company as of January 31, 1994.
OPTION EXERCISES IN FISCAL YEAR 1993 AND OPTION VALUES AT FISCAL YEAR
END. The following table provides information as to options exercised by each of
the named executive officers in 1993 and the value of options held by such
executives at fiscal year end measured in terms of the closing price of the
Company's common stock on January 26, 1994.
<TABLE>
<CAPTION>
NUMBER OF VALUE OF
UNEXERCISED UNEXERCISED
OPTIONS AT OPTIONS AT
SHARES AGGREGATE ANNUALIZED 1/26/94 (#) 1/26/94 ($)(3)
ACQUIRED ON VALUE VALUE
EXERCISE REALIZED REALIZED EXERCISABLE/ EXERCISABLE/
NAME (#) ($)(1) ($)(2) UNEXERCISABLE UNEXERCISABLE
- ----------------------------- ----------- --------- ---------- ---------------- --------------
<S> <C> <C> <C> <C> <C>
J. E. Antonini............... -0- $ -- $ -- 974,200/145,000 $1,417,760/-0-
G. R. Mrkonic................ -0- -- -- 12,000/-0- -0-/-0-
J. R. Thomas................. -0- -- -- 558,000/58,000 1,441,640/-0-
R. S. Miller................. -0- -- -- 424,000/72,500 621,288/-0-
G. B. Smith(4)............... 11,400 92,400 11,974 197,600/-0- 344,452/-0-
</TABLE>
- -------------------------
(1) This column shows the aggregate gain realized as a result of the exercise of
stock options during the Company's 1993 fiscal year based on the market
value on the date of exercise less the exercise price of the option.
(2) This column represents the amount of the aggregate gain annualized over the
period of time which the executive held the option since the date of grant.
(3) Value is based on the excess of the market price of the Company's Existing
Common Stock as of the end of the Company's 1993 fiscal year ($19.75) over
the option price of the unexercised options.
(4) Mr. Smith retired from the Company as of January 31, 1994.
34
<PAGE> 41
LONG TERM INCENTIVE PLAN AWARDS IN FISCAL YEAR 1993.
<TABLE>
<CAPTION>
PERFORMANCE ESTIMATED FUTURE PAYOUTS
NUMBER OF PERIOD (POTENTIAL SHARES)
PERFORMANCE UNTIL ------------------------------
SHARES MATURATION THRESHOLD TARGET MAXIMUM
NAME AWARDED OR PAYOUT (#) (#) (#)
- ------------------------------------------- ----------- ----------- --------- ------ -------
<S> <C> <C> <C> <C> <C>
J. E. Antonini............................. -0- -- -- -- --
G. R. Mrkonic.............................. 20,832 3 years 10,416 20,832 31,248
J. R. Thomas............................... -0- -- -- -- --
R. S. Miller............................... -0- -- -- -- --
G. B. Smith(1)............................. -0- -- -- -- --
</TABLE>
- -------------------------
(1) Mr. Smith retired from the Company as of January 31, 1994.
The foregoing table describes the performance shares awarded under the
Company's Performance Restricted Stock Plan in fiscal 1993. As discussed in the
Compensation and Incentives Committee Report on pages 30-33, 1993 awards under
the Plan were made only to executives with responsibility for the Company's
specialty retail subsidiaries. The awards cover a period of three years and
specify a targeted number of shares of the Company's Existing Common Stock for
each year of the period that will be issued if specified corporate income
performance goals are met. The number of shares shown in the "Performance Shares
Awarded" column is the total number of targeted shares for the entire three-year
period. If the performance goals are achieved, the "Target" number of shares is
issued in the name of the executive as restricted stock. If the goals are not
achieved, a lesser number of shares is issued, with no shares issued if
achievement is below 90% of goal -- "Threshold". And if the goals are exceeded,
a greater number of shares is issued up to 150% of the targeted amount --
"Maximum". The "earned" shares of restricted stock that are issued are held in
the custody of the Company for a specified period up to three years, and
subsequently issued free and clear to the executive if he or she continues in
the employ of the Company or a subsidiary until the end of the period; if
employment does not continue for such period, the shares are forfeited. The
employment requirement will be deemed satisfied if the executive dies or becomes
disabled. In addition, the Compensation and Incentives Committee may in its
discretion eliminate or reduce a restriction, such as in the event of the
executive's retirement.
PENSION PLAN TABLE(1)
<TABLE>
<CAPTION>
YEARS OF SERVICE(3)
--------------------------------------------------------------------
REMUNERATION(2) 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS
- ---------------------------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
$ 125,000................... $ 28,125 $ 37,500 $ 46,975 $ 56,250 $ 65,625
150,000.................. 33,750 45,000 56,250 67,500 78,750
175,000.................. 39,375 52,500 65,625 78,750 91,875
200,000.................. 45,000 60,000 75,000 90,000 105,000
225,000.................. 50,625 67,500 84,375 101,250 118,125
250,000.................. 56,250 75,000 93,750 112,500 131,250
300,000.................. 47,500 90,000 112,500 135,000 157,500
400,000.................. 90,000 120,000 150,000 180,000 210,000
450,000.................. 101,250 135,000 168,750 202,500 236,250
500,000.................. 112,500 150,000 187,500 225,000 262,500
600,000.................. 135,000 180,000 225,000 270,000 315,000
700,000.................. 157,500 210,000 262,500 315,000 367,500
800,000.................. 180,000 240,000 300,000 360,000 420,000
900,000.................. 202,500 270,000 337,500 405,000 472,500
1,000,000.................. 225,000 300,000 375,000 450,000 525,000
1,500,000.................. 335,500 450,000 562,500 571,300 591,320
</TABLE>
- -------------------------
(1) The Company's tax-qualified Employee Pension Plan provides benefits computed
under (i) a career average formula at 1.25% of the employee's compensation
for each year of credited service, or (ii) a final average compensation
formula at 1.50% of the average of the employee's best five compensation
years
35
<PAGE> 42
multiplied by years of service after age 21 up to 35 years minus 2% of the
employee's Social Security benefit for each year of service up to 30 years,
whichever formula provides the greater benefit.
The Company has also adopted a Supplemental Pension Benefit Plan which
provides benefits to the extent that ERISA limits the pension to which an
employee would otherwise be entitled under the Employee Pension Plan absent
such limitation; provided, however, that the maximum annual benefit payable
under the Plans on a combined basis is $591,320, as adjusted by any
increase in the urban consumer price index after January 1, 1994 to the
date of retirement.
Since the "final average compensation formula" provides the greater benefit
to the individuals named under Compensation of Officers herein, the Pension
Plan Table illustrates the estimated annual benefits payable under the
combined Plans upon retirement at age 65 under the final average
compensation formula (prior to the applicable Social Security reduction)
for employees at various levels of compensation and years of service after
age 21 and assumes that the Plans will continue in their present form until
the employee's retirement and that the employee will continue in the employ
of the Company or a participating subsidiary until age 65. The amounts
shown are based on the pension being paid only during the lifetime of the
retired employee and would be reduced on an actuarially equivalent basis in
the event of a survivor benefit or other optional form of payment. The
years of service after age 21 for those individuals named under
Compensation of Officers herein are: J. E. Antonini -- 30 years; G. R.
Mrkonic -- 3 years; J. R. Thomas -- 37 years; R. S. Miller -- 33 years; and
G. B. Smith -- 40 years (who retired from the Company as of January 31,
1994).
(2) "Remuneration" is the final average compensation of an employee.
Compensation covered by the Plans for the individuals named under
Compensation of Officers herein is the sum of their annual salary and
bonus, as shown in the Summary Compensation Table.
(3) The pension amounts shown in the table are subject to reduction by 2% of the
employee's Social Security benefit for each year of service up to a maximum
of 30 years of service. The maximum reduction at age 65 is currently
$8,262.
The Company also has adopted a Supplemental Executive Retirement Plan for
the purpose of providing supplemental retirement income to executive officers of
the Company who retire prior to age 65 or who are hired by the Company later in
their careers, whom the Board of Directors approves as eligible to receive
benefits under the Plan. Benefits are determined by the Board of Directors based
on the position, responsibilities and rate of compensation of the employee,
benefits payable or which would have been payable under other plans, and such
other factors as the Board may deem relevant. No individual named in
Compensation of Officers herein is currently a participant.
EMPLOYMENT AND SEVERANCE ARRANGEMENTS. The Company has adopted a Special
Severance Plan which provides for the payment of certain benefits in the event a
covered employee is involuntarily terminated other than for cause within a
two-year period following a "change in control" of the Company (as defined in
the Plan). The Plan covers only certain salaried and headquarters employees
(none of whom are currently executive officers or directors of the Company)
since the Company believes it is unlikely that other employees would be affected
by a change in control of the Company. In the event of such involuntary
termination of employment, covered salaried employees will be entitled to
receive an amount equal to the sum of (i) two weeks of compensation for each
full year of employment with the Company, and (ii) one week of compensation for
each full $10,000 of annual compensation. Non-salaried headquarters employees
will be entitled to receive an amount equal to the sum of (i) one week of
compensation for each full year of employment with the Company, and (ii) one
week of compensation for each full $5,000 of annual compensation. In no event
will an employee receive a benefit greater than one year of compensation with
respect to salaried employees, or six months of compensation with respect to
headquarters employees. There are approximately 7,680 employees covered by the
Plan.
The Special Severance Plan does not cover the Company's executive officers,
and the Company has entered into agreements with the executive officers named
under "Compensation of Officers" herein, as well as with 28 other executive
officers of the Company. The Board of Directors took action on March 15, 1994 to
allow the agreements to expire effective January 25, 1995. These agreements,
which are substantially similar, provide that in the event of the officer's
termination of employment under certain circumstances following a
36
<PAGE> 43
"change in control" of the Company (as defined in the agreements), the officer
would be entitled to severance benefits. These severance benefits include: (i) a
cash payment of two times (three times, in the case of Mr. Antonini) the sum of
(A) the officer's salary in effect either on the date of his or her termination
or on the date of the change in control, whichever is greater, plus (B) the
officer's most recent annual bonus paid either to the date of termination or
prior to the date of the change in control, whichever is greater; (ii) life and
health insurance benefits for a 24-month period (36-month period, in the case of
Mr. Antonini) month period after termination; (iii) a cash payment equal to the
value inherent in the officer's stock options; and (iv) for an officer who is
within five points of the "rule of 90" under the Employee Pension Plan, payment
of an amount equal to the difference between the "rule of 90" pension and the
one the officer is actually entitled to on the date of termination. The
agreements also provide for a tax gross-up payment to the officer to insure that
the severance benefits will not be subject to a net reduction due to the
imposition of excise taxes which may be payable under the Internal Revenue Code.
Each of the agreements is subject to an automatic annual extension unless prior
notice is given by the Company that it does not wish to extend the agreement,
provided that the agreement continues for two years following a change in
control. The circumstances under which severance benefits would be payable are a
termination by the officer for "good reason" or by the Company other than for
"cause" at any time within two years following a change in control. The Company
estimates that if the employment of Messrs. Antonini, Mrkonic, Thomas and Miller
were terminated in 1994 following a change in control of the Company, the total
severance payments to those persons under the agreements, as described above,
would be approximately $12,900,000 net of income tax. In addition, the Company
has entered into employment agreements with the executive officers named under
"Compensation of Officers" herein, as well as 28 other executive officers of the
Company which provide that if employment is terminated by the Company other than
for "cause" or "disability" or if an officer terminates employment for "good
reason," he or she will be entitled to receive severance payments equal to his
or her monthly base salary at the time of termination, plus 1/12 the annual
on-plan bonus targeted for the year in which termination occurred. These
payments will be made in equal monthly installments during a 12-month period
(24-month period, in the case of Messrs. Antonini and Mrkonic) following
termination, and will be reduced by the amount of compensation received from
other employment (he or she has an obligation to seek such other employment).
The Company estimates that if the employment of Messrs. Antonini, Mrkonic,
Thomas and Miller were terminated in 1994, and severance payments were due them
under the agreement, the total payments due for the entire payment period
(assuming no reduction for other employment) would be approximately $6,150,000.
In no event would any officer receive payments or benefits under both the change
of control and employment agreements described herein.
COMPENSATION AND INCENTIVES COMMITTEE REPORT ON EXECUTIVE COMPENSATION
Compensation Strategy and Objectives
The Company's executive compensation program is administered by the
Compensation and Incentives Committee of the Board of Directors. The Committee
is composed of five independent non-employee directors.
The Company has a long-standing philosophy that compensation of executive
officers (and others) should be directly and materially linked to the Company's
operating performance. The Committee believes that the achievement of
performance objectives over time is the primary determinant of share price. To
this end, executive compensation is weighted towards compensation paid on the
basis of performance. Therefore, in years when corporate performance has been
superior, executives have been well compensated, and in years when performance
has been below targeted goals, compensation has been negatively affected.
The underlying objectives of the Committee's compensation strategy are to
attract and retain the best possible executive talent, to motivate those
executives to achieve optimum operating performance for the Company, to link
executive and shareholder interests through equity based plans and to provide a
compensation package that recognizes individual contributions as well as overall
business results.
Each year the Committee conducts a full review of the Company's executive
compensation program, assisted by an independent compensation consultant
retained by the Committee on an on-going basis, in order that the Committee may
assure that the Company's compensation program is properly integrated with both
37
<PAGE> 44
the Company's annual and long-term objectives and is competitive with
compensation programs of other companies with which the Company must directly
compete for executive talent.
The key components of the Company's executive compensation consist of base
salary, annual incentive bonus and stock options. The Committee's policies with
respect to each of these elements, including the basis for the compensation
awarded to Mr. Antonini for fiscal 1993, are discussed below. Through these
programs, a very significant portion of the Company's executive compensation is
linked to performance. For example, the Committee decided in 1993 that the
long-term compensation of Mr. Antonini, as well as the vast majority of Company
executive officers, would consist solely of stock options, which by their terms
are performance-based. In addition, approximately 39% of Mr. Antonini's targeted
1993 short-term compensation consisted of performance-based elements and
therefore was "at risk." Consequently, because of the difficult year experienced
by the Company and the failure to achieve the financial performance goals
approved by the Committee at the beginning of fiscal 1993, Mr. Antonini received
no annual incentive bonus for 1993 and therefore received only 61% of his
targeted short-term compensation.
The Committee also adopted a policy that, while maintaining an
appropriately competitive compensation program, it would endeavor to assure that
all compensation paid to executive officers will be tax deductible to the
Company under recently enacted Section 162(m) of the Internal Revenue Code.
Base Salary
The base salary of executive officers is initially determined by analyzing
and evaluating the responsibilities of the position. Each position is then
matched to a comparable position in the competitive marketplace or, for
positions unique to the Company, to a position with a comparable level of
responsibility within the Company, and it is slotted into a structure of
graduated salary levels that has been established by reference to an annual
executive compensation survey in which the Company and other multi-billion
dollar U.S. retailers participate. (There are currently ten multi-billion dollar
U.S. retailers participating in the survey; this number may vary slightly from
year to year as the participating companies change from time to time.) The range
for each position consists of minimum, mid-point and maximum salary levels.
Generally, the salary goal for executive officers is targeted at the 50th
percentile of salaries for comparable positions. An annual salary adjustment,
within each applicable position/salary level, is determined by evaluating the
performance of the individual (including the achievement of his or her annual
objectives). The retail companies included in the survey represent a narrower
group than the companies included in the Standard & Poor's Retail Stores
Composite Index, contained in the Company's stock performance graphs on page 38
and 39. The Committee believes that the means by which comparative salary levels
are determined are appropriate since they enable the Company's executive salary
structure to reflect the practices of retailers that are comparable to the
Company in size and complexity. The Committee intends periodically to assess the
continued suitability of this approach and to modify it if appropriate.
In setting Mr. Antonini's 1993 base salary, the Committee took into account
a comparison of base salaries of chief executive officers of retailers
participating in the above-described annual executive compensation survey, the
Company's success in meeting the prior year's specified financial performance
objectives and its assessment of Mr. Antonini's personal performance and
accomplishments. Under Mr. Antonini's leadership, the Company had achieved
record sales and earnings in fiscal 1992, as well as accomplished the initiation
of the Super Kmart Center program, the expansion of Kmart stores into new
markets outside the United States and the continuing enhancement of the U.S.
Kmart store refurbishment program. As of February 1, 1993, Mr. Antonini was
granted a base salary of $893,000, which represented an increase of
approximately 5% over his 1992 base salary of $850,000. This placed Mr.
Antonini's salary at the 50th percentile of salaries for chief executive
officers of retailers participating in the above-described annual executive
compensation survey.
Annual Incentive Bonus
Executive officers and other executives must achieve specified annual
financial performance objectives to be eligible for an annual incentive bonus.
Generally, these specific corporate and business unit financial performance
objectives are recommended by the Company and reviewed and approved by the
Committee at
38
<PAGE> 45
the commencement of the fiscal year. Eligible executives are assigned threshold,
target and maximum bonus levels. The target incentive bonus may be earned for
the fiscal year if the annual financial objectives are achieved, declining
incrementally to zero if achievement is below the threshold level of 90% of the
financial objective, and increasing incrementally from 50% of the targeted bonus
at 90% achievement to a maximum of 225% of the targeted bonus to the extent that
the annual financial objectives are exceeded.
Generally, the annual incentive bonus opportunity for each executive
officer is based on a percentage of the midpoint of the salary range for a
comparable position within the companies participating in the above-described
annual executive compensation survey -- with the largest bonus opportunity being
granted to the Chairman (67% of midpoint of salary range) and the bonus
opportunity granted to other executive officers decreasing incrementally based
on their position/salary level down to 27% of midpoint of salary range.
In 1993, 100% of the annual incentive bonus of executive officers was based
on achievement of corporate or business unit income. For eligible executives
below the executive officer level, individual performance measures were also
considered in determining bonus but did not constitute a basis for more than 40%
of any incentive bonus award.
Mr. Antonini was awarded no 1993 incentive bonus because the applicable
1993 corporate income objective approved by the Committee was not met. This was
in comparison to 1992 when Mr. Antonini was awarded an annual incentive bonus of
$604,001 based on the Company's achievement in 1992 of all-time record sales and
earnings. Likewise, only 5 of the 32 executive officers of the Company were
awarded 1993 incentive bonuses (ranging in value from 14% to 56% of 1993 base
salary), based on the achievement of the 1993 income objectives for their
specific areas of responsibility.
Stock Options and Performance Shares
The Company's long-term incentive plans for executive officers and other
key executives consist of the Stock Option Plan and, to a lesser extent, the
Performance Restricted Stock Plan. The objectives of the plans are to align
executive and shareholder long-term interests by creating a direct link between
executive compensation and shareholder return and to enable executives to
develop and maintain a substantial stock ownership position in the Company's
Existing Common Stock.
Under the 1992 Stock Option Plan, which was approved by shareholders,
options for the Existing Common Stock are granted annually to eligible
executives. Generally, the award of option shares of executive officers is based
on a percentage of the midpoint of the salary range for a comparable position
within the companies participating in the above-described annual executive
compensation survey--with the largest number of option shares being granted to
the Chairman (110% of midpoint of salary range) and the number of option shares
granted to other executives decreasing incrementally based on their
position/salary level down to 50% of midpoint of salary range. The number of
option shares granted may also be impacted by the executive's performance
review. Stock options are granted with an exercise price equal to the market
price of the Existing Common Stock on the date of grant, have a three year cliff
vesting period and expire after ten years.
In 1993, Mr. Antonini, whose performance for fiscal 1992 had been rated
outstanding, was granted options to purchase 125,000 shares of Existing Common
Stock at an exercise price of $24.06 per share, compared with 1992 options for
20,000 shares of Existing Common Stock at an exercise price of $26.03 per share.
The increase in the number of option shares granted to Mr. Antonini reflected
the Committee's decision, in 1993, to utilize stock options as the sole form of
long-term incentive compensation for executive officers of the Company, as
compared to 1992 when Mr. Antonini had been granted an award of 30,000
performance shares of Existing Common Stock under the Performance Restricted
Stock Plan in addition to the award of option shares. The Committee had
concluded that, generally, stock options more effectively align the interests of
executive officers and other key executives of the Company with those of
shareholders since the benefit of a stock option cannot be realized unless the
stock price appreciates. The value of the 1993 award of option shares for Mr.
Antonini was well below the 50th percentile of long-term compensation awards for
chief executive officers of retailers participating in the above-described
annual executive compensation survey.
39
<PAGE> 46
Under the Performance Restricted Stock Plan, which was approved by
shareholders, the Committee may grant performance awards of Existing Common
Stock to key executives. Generally, the awards cover a period of three years and
specify for each executive a targeted number of shares for each year of the
award period. The targeted number of shares is issued annually based solely upon
the achievement of the applicable annual income goal and only if the applicable
annual income goal is achieved, declining incrementally to zero shares if the
achievement of such goal is below a threshold level of 90% of the income goal,
and increasing incrementally from 50% of the targeted number of shares at 90%
achievement to a maximum of 150% of the targeted number of shares to the extent
that the income goal is exceeded. The shares are issued in the name of the
executive as restricted stock and are held in the custody of the Company for a
specified period of up to three years. The shares do not vest until the end of
such period, and are forfeited if the executive leaves the Company during that
time. In this way, the number of performance shares is tied both to income
performance during a three-year period and to executive retention.
No performance shares were awarded to Mr. Antonini or other executives of
the Company in 1993 except for executives with responsibility for the Company's
specialty retail subsidiaries. If shareholders approve the Specialty Retail
Stock Proposal and related benefit plan proposals, which provide for incentive
plans that are specifically tied to the performance of each specialty retail
business, awards to specialty retail executives under the proposed plans will
replace the program of awards under the Performance Restricted Stock Plan.
As of March, 1994, Mr. Antonini owned 165,832 shares of Existing Common
Stock, and held options to purchase an additional 974,200 shares. The Committee
believes that significant equity interests in the Company held by the Company's
management align the interests of stockholders and management.
Compensation and Incentives Committee
F. J. McDonald, Chair
J. A. Califano, Jr.
J. P. Flannery
J. R. Munro
D. S. Perkins
40
<PAGE> 47
PERFORMANCE GRAPHS
Set forth below is a graph comparing the total returns (assuming dividend
reinvestment) of the Company's Existing Common Stock, the Standard & Poor's
("S&P") 500 Composite Index and the S&P Retail Stores Composite Index for the
five-year period commencing January 31, 1989.
COMPARISON OF CUMULATIVE TOTAL RETURN/JANUARY 1989 TO JANUARY 1994*
<TABLE>
<CAPTION>
S&P RETAIL
COMPANY'S S&P 500 STORES
MEASUREMENT PERIOD EXISTING COMPOSITE COMPOSITE
(FISCAL YEAR COVERED) COMMON STOCK INDEX INDEX
- ----------------------------------------------------------------------
<S> <C> <C> <C>
100.00 100.00 100.00
APR-89 107.60 110.03 108.00
JUL-89 120.22 125.84 121.79
OCT-89 99.68 121.95 120.75
JAN-90 97.17 118.37 117.69
- ----------------------------------------------------------------------
APR-90 96.87 125.85 119.27
JUL-90 100.67 139.05 129.56
OCT-90 72.20 108.22 111.68
JAN-91 94.22 137.61 126.42
- ----------------------------------------------------------------------
APR-91 124.69 165.46 140.23
JUL-91 147.91 179.83 146.14
OCT-91 135.40 173.40 149.09
JAN-92 156.68 194.18 157.02
- ----------------------------------------------------------------------
APR-92 161.68 190.20 159.93
JUL-92 161.59 198.21 164.79
OCT-92 174.76 216.68 163.89
JAN-93 157.00 231.28 172.69
- ----------------------------------------------------------------------
APR-93 153.49 211.14 174.66
JUL-93 139.78 215.11 179.11
OCT-93 168.80 228.28 188.29
JAN-94 137.46 218.05 191.71
- ----------------------------------------------------------------------
Assumes $100 invested on January 31, 1989 + Company's Existing Common Stock
in the Company's Existing Common Stock, 0 S&P 500 Composite Index
S&P 500 Composite Index and S&P Retail []S&P Retail Stores Composite Index
Stores Composite Index
*Total Return Assumes Reinvestment of Dividends.
</TABLE>
41
<PAGE> 48
Set forth below is a graph comparing the total returns (assuming dividend
reinvestment) of the Company's Existing Common Stock, the S&P 500 Composite
Index and the S&P Retail Stores Composite Index for the four year period
commencing January 31, 1990. In February 1990, Kmart Corporation announced a
Kmart Store Renewal Program that, over a six-year period ending January 1996,
would result in the modernization of its entire U.S. Kmart store base. This
represented a major strategic initiative to improve the performance of the U.S.
Kmart division. From the time of the announcement of the Renewal Program through
the third quarter of 1993, the Company's Existing Common Stock outperformed the
S&P 500 Composite Index and, except in the fourth quarter of 1992, tracked the
S&P Retail Stores Composite Index very closely. Subsequently, the Existing
Common Stock has generally underperformed the S&P Retail Stores Composite Index,
in part reflecting lower earnings during 1993.
COMPARISON OF CUMULATIVE TOTAL RETURN/JANUARY 1990 TO JANUARY 1994*
<TABLE>
<CAPTION>
S&P RETAIL
COMPANY'S S&P 500 STORES
MEASUREMENT PERIOD EXISTING COMPOSITE COMPOSITE
(FISCAL YEAR COVERED) COMMON STOCK INDEX INDEX
- ----------------------------------------------------------------------
<S> <C> <C> <C>
100.00 100.00 100.00
APR-90 99.68 106.32 101.34
JUL-90 103.59 117.47 110.09
OCT-90 74.30 91.43 94.89
JAN-91 96.96 116.26 107.41
- ----------------------------------------------------------------------
APR-91 126.32 139.78 119.14
JUL-91 152.21 151.92 124.17
OCT-91 139.34 146.50 126.68
JAN-92 161.24 164.05 133.41
- ----------------------------------------------------------------------
APR-92 166.38 160.69 135.88
JUL-92 166.28 167.45 140.02
OCT-92 179.84 183.06 139.25
JAN-93 161.57 195.39 146.73
- ----------------------------------------------------------------------
APR-93 157.95 178.38 148.41
JUL-93 143.85 181.73 152.18
OCT-93 173.71 192.86 159.98
JAN-94 141.45 184.21 162.89
- ----------------------------------------------------------------------
Assumes $100 invested on January 31, 1990 + Company's Existing Common Stock
in the Company's Existing Common Stock, 0 S&P 500 Composite Index
S&P 500 Composite Index and S&P Retail [] S&P Retail Stores Composite Index
Stores Composite Index
*Total Return Assumes Reinvestment of Dividends
</TABLE>
The graphs and related disclosure contained in this section of the Proxy
Statement should not be incorporated by reference into any prior filings by the
Company under the Securities Act of 1933 or the Securities Act of 1934 which
incorporate future filings or portions thereof.
42
<PAGE> 49
PROPOSAL 2 -- THE SPECIALTY RETAIL STOCK PROPOSAL
GENERAL
The stockholders are being asked to consider and approve the Specialty
Retail Stock Proposal to amend the Articles, as described herein and in Annex
III-A hereto, to authorize the Board to issue any of four series of Specialty
Retail Stock by the filing of a Certificate of Designation setting forth certain
information, including the number of shares constituting such series. Such
amendments would, among other things:
- increase the number of authorized shares of Common Stock from 1.5 billion
to 3.0 billion;
- redesignate 1.5 billion shares of Existing Common Stock as Kmart Stock;
and
- authorize 1.5 billion shares of Common Stock to be available for
designation in series by resolution of the Board as additional shares of
Kmart Stock and/or any of four new series of Specialty Retail Stock, each
with the designations, relative rights, preferences and limitations
described herein.
While each series of Specialty Retail Stock would constitute Common Stock
of the Company, each is intended to reflect separately the performance of the
relevant Specialty Retail Group. The Borders-Walden Stock is intended to reflect
the performance of the Borders-Walden Group, which is comprised principally of
the Company's Borders, Inc. and Walden Book Company, Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of the Builders
Square Group, which is comprised principally of the Company's Builders Square,
Inc. subsidiary. The OfficeMax Stock is intended to reflect the performance of
the OfficeMax Group, which is comprised principally of the Company's interest in
OfficeMax, Inc., a % owned subsidiary of the Company. The Sports Authority
Stock is intended to reflect the performance of The Sports Authority Group,
which is comprised principally of the Company's The Sports Authority, Inc.
subsidiary. The foregoing subsidiaries of the Company are sometimes collectively
referred to herein as the "Specialty Retail Subsidiaries". In addition to the
businesses, assets and liabilities of the relevant Specialty Retail Subsidiary,
each Specialty Retail Group would also include (i) any assets and liabilities of
the Company attributed to such Specialty Retail Group, (ii) any assets and
properties contributed from the Kmart Group to such Specialty Retail Group
resulting in an increase in the Number of Shares Issuable with Respect to
Retained Interest in such Specialty Retail Group, and (iii) the interest of the
Company in any businesses, assets and liabilities acquired by the Company for
such Specialty Retail Group. See the definition of each Group in Annex III-A.
The financial statements of each Specialty Retail Group included in the Annexes
to this Proxy Statement reflect the assets, liabilities and earnings of the
relevant Specialty Retail Subsidiary (including charges based on utilization
with respect to certain corporate, general and administrative expenses) and an
allocable portion of corporate, general and administrative expenses related
specifically to management of the Specialty Retail Groups. See "Management and
Accounting Policies" below for a discussion of the manner in which corporate,
general and administrative expenses are allocated among the Groups.
Upon the initial issuance of any series of Specialty Retail Stock, the
Existing Common Stock would be redesignated as Kmart Stock. The Kmart Stock,
while constituting Common Stock of the Company, is intended to reflect the
separate performance of the Kmart Group, which is generally comprised of (i) the
Company's core Kmart discount store group, (ii) a Retained Interest in each
Specialty Retail Group and (iii) all other businesses in which the Company and
its other subsidiaries are engaged.
Following approval by stockholders of the Specialty Retail Stock Proposal,
the Company currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock to the
public for cash in separate Offerings and to allocate the net proceeds of the
Offerings to the Kmart Group to repay outstanding indebtedness of the Company
and for general corporate purposes. The timing, sequence and size of such
Offerings and the price at which such shares would be sold would be determined
by the Board, without further approval of stockholders, at the time of each
Offering; however, it is currently contemplated that the Company would initially
offer to the public shares of each series of Specialty Retail Stock that would
be intended to represent approximately 20% to 30% of the Equity Value of the
relevant Specialty Retail Group at the time of such Offering. The terms of each
Offering would be determined by the Board and the underwriters of such Offering
based upon prevailing market and other conditions; the
43
<PAGE> 50
financial condition and results of operations of the relevant Specialty Retail
Group; the history of and prospects for the relevant Specialty Retail Group, the
specialty retail industry and the segment of that industry in which the relevant
Specialty Retail Group competes; the management and operations of the relevant
Specialty Retail Group; the progress of the relevant Specialty Retail Group in
implementing its business strategy; the foregoing factors in relation to market
values of other companies engaged in similar businesses; and the financial
condition of the Company as a whole. In addition to or in lieu of any Offering,
the Board reserves the right to issue shares of any series Specialty Retail
Stock as a distribution on the Kmart Stock, although the Board has no current
intention to do so.
Notwithstanding approval by stockholders of the Specialty Retail Stock
Proposal, the Company would not file the Certificate of Amendment with the
Michigan Department of Commerce until immediately prior to consummation of the
initial Offering or other issuance of any series of Specialty Retail Stock. At
such time, the Company would also file with the Michigan Department of Commerce
a Certificate of Designation relating to such series. At any time prior to such
filing, notwithstanding approval of the Specialty Retail Stock Proposal by
stockholders, the Board could, in its sole discretion, abandon the entire
Specialty Retail Stock Proposal or one or all of the Offerings without further
approval of stockholders. Even after filing the Certificate of Amendment, the
Board could abandon one or more of the Offerings without further approval of
stockholders. The determination of whether to proceed with an Offering of any
series of Specialty Retail Stock would be made by the Board based on, among
other things, the proposed terms of such Offering and then prevailing market and
other conditions. The Board reserves the right not to proceed with any or all of
the Offerings if it determines that consummation of such Offering or Offerings
is not in the best interests of the Company.
IF THE SPECIALTY RETAIL STOCK PROPOSAL IS NOT APPROVED BY STOCKHOLDERS OR
NONE OF THE OFFERINGS IS CONSUMMATED AND NO OTHER DISTRIBUTION OF SPECIALTY
RETAIL STOCK IS MADE, THE CERTIFICATE OF AMENDMENT WILL NOT BE FILED, THE
SPECIALTY RETAIL STOCK WILL NOT BE ISSUED, THE EXISTING COMMON STOCK WILL NOT BE
REDESIGNATED AS KMART STOCK AND THE AMENDMENTS TO AND ADOPTION OF THE RELATED
BENEFIT PLANS WILL NOT BE IMPLEMENTED.
SPECIAL CONSIDERATIONS
Stockholders of One Company; Financial Effects on One Group Could Affect
Other Groups. Notwithstanding the allocation of assets and liabilities
(including contingent liabilities), stockholders' equity and items of income and
expense among the Groups for purposes of preparing their respective financial
statements, the change in the capital structure of the Company contemplated by
the Specialty Retail Stock Proposal would not affect the respective legal title
to assets or responsibility for liabilities of the Company or any of its
subsidiaries. The Specialty Retail Stock Proposal would not affect the rights of
creditors of the Company or any Specialty Retail Subsidiary. The Company and its
subsidiaries would each continue to be responsible for their respective
liabilities. Holders of Kmart Stock and of each series of Specialty Retail Stock
would be holders of Common Stock of the Company and would be subject to risks
associated with an investment in the Company and all of its businesses, assets
and liabilities.
Financial effects arising from any Group that affect the Company's
consolidated results of operations or financial condition could affect the
results of operations or financial condition of the other Groups or the market
price of shares of any or all series of Common Stock. In addition, net losses of
any Group, dividends and distributions on any series of Common Stock or
Preferred Stock, repurchases of any series of Common Stock and certain
repurchases of Preferred Stock would reduce the assets of the Company legally
available for dividends on all series of Common Stock.
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, following issuance of any series of Specialty Retail
Stock, the Company would provide to holders of Kmart Stock and each outstanding
series of Specialty Retail Stock separate financial statements, management's
discussion and analysis of financial condition and results of operations,
business descriptions and other information for the relevant Group and for the
consolidated Company. The financial statements of each Group
44
<PAGE> 51
would principally reflect the financial position, results of operations and cash
flows of the businesses included therein. However, such Group financial
statements could also include allocated portions of the Company's corporate
assets and liabilities (including contingent liabilities) that are not
separately identified with the operations of a specific Group. Upon request, the
Company would provide to any holder of Kmart Stock or any series of Specialty
Retail Stock a copy of the separate financial statements of any other Group.
Limited Additional Stockholder Rights. Under the Specialty Retail Stock
Proposal, holders of Kmart Stock and holders of each series of Specialty Retail
Stock would have only the rights of holders of Common Stock and would not be
provided any rights specifically related to their separate series, other than
(i) the two-thirds separate class vote requirements under certain limited
circumstances, as described under "Description of Kmart Stock and Specialty
Retail Stock -- Voting Rights" below, (ii) the dividend/redemption/exchange
provisions described under "Description of Kmart Stock and Specialty Retail
Stock -- Exchange and Redemption" below and (iii) certain limited class voting
rights provided under Michigan law. Similarly, separate meetings for the holders
of Common Stock or any series thereof would not be held. See "Limited Separate
Stockholder Voting Rights; Effects on Voting Power" below.
Potential Conflicts of Interest. The existence of separate series of Common
Stock could give rise to occasions when the interests of the holders of one
series and of the holders of any other series might diverge or appear to
diverge. Examples include determinations by the Board to (i) pay or omit the
payment of dividends on any series of Common Stock, (ii) allocate the proceeds
of issuances of any series of Specialty Retail Stock either to the Kmart Group
in respect of its Retained Interest or to the equity of the relevant Specialty
Retail Group, (iii) allocate consideration to be received by holders of Common
Stock in connection with a merger or consolidation involving the Company among
holders of different series of Common Stock, (iv) exchange Kmart Stock for any
series of Specialty Retail Stock at a premium, (v) approve dispositions of
assets of any of the Groups and (vi) make operational and financial decisions
with respect to one Group that could be considered to be detrimental to another
Group, including whether to make transfers of funds between Groups as described
below. When making decisions with regard to matters that create potential
conflicts of interest, the Board would act in accordance with the terms of the
Articles, the management and accounting policies described in "Management and
Accounting Policies" below, to the extent applicable, and its fiduciary duties.
The Board could also from time to time refer to an existing committee or one or
more new committees of the Board to review matters raising conflict issues and
to have such committee report to the Board on such matters. Each of the
foregoing potential conflicts of interest is discussed below:
No Assurance of Payment of Dividends. The Company's annual dividend
rate is presently $.96 per share. The Board currently intends that the
dividend policy applicable to the Kmart Stock would be the same as the
dividend policy applicable to the Existing Common Stock, with the initial
dividend rate on the Kmart Stock being the rate in effect for the Existing
Common Stock at the time of the redesignation of the Existing Common Stock
as Kmart Stock. The Board believes that implementation of the Specialty
Retail Stock Proposal would not adversely affect the Company's ability to
pay dividends on the Kmart Stock. In reaching this conclusion, the Board
considered the following: (i) the Company currently intends that the Kmart
Group would initially have a 70-80% Retained Interest in each Specialty
Retail Group, resulting in the Kmart Group being credited with an amount
proportionate to dividends paid on each series of Specialty Retail Stock;
(ii) the Company currently intends to allocate the proceeds of the
Offerings to the Kmart Group to, among other things, repay outstanding
indebtedness of the Company, resulting in reduced debt service obligations
attributable to the Kmart Group; and (iii) the Company does not expect
initially to pay significant dividends on the various series of Specialty
Retail Stock. Determinations as to the future dividends on the Kmart Stock
would be based primarily upon the financial condition, results of
operations and business requirements of the Kmart Group and the Company as
a whole. Under the terms of the Kmart Stock, dividends on the Kmart Stock
would be payable out of the lesser of (i) all assets of the Company legally
available for dividends and (ii) the Available Dividend Amount with respect
to the Kmart Group. Nevertheless, the Board reserves the right to declare
and pay dividends on the Kmart Stock and any series of Specialty Retail
Stock in any amount, and could, in its sole discretion, declare and pay
dividends on all or less than all series of Common Stock in equal or
unequal amounts, notwithstanding the amount of assets available for
dividends on each series,
45
<PAGE> 52
the amount of prior dividends declared on each series or any other factor.
In addition, net losses of any Group, dividends and distributions on any
series of Common Stock or Preferred Stock, repurchases of any series of
Common Stock and certain repurchases of Preferred Stock would reduce the
assets of the Company legally available for dividends on shares of all
series of Common Stock. See "Dividend Policy" and "Description of Kmart
Stock and Specialty Retail Stocks -- Dividends" below. Moreover, the
Available Dividend Amount with respect to the Kmart Group would be reduced
by the allocation among the Groups of certain goodwill amortization. See
"Allocation of Goodwill Amortization for Purposes of Determining Available
Dividend Amount" below.
Allocation of Proceeds upon Issuance of Specialty Retail Group Common
Stock. At the time of any sale of shares of any series of Specialty Retail
Stock the Board would, in its sole discretion, determine the allocation of
the proceeds of such sale between the Kmart Group and the relevant
Specialty Retail Group. The Board could allocate 100% of the net proceeds
of a sale of any series of Specialty Retail Stock to the Kmart Group or to
the relevant Specialty Retail Group, in which event the net proceeds would
be reflected entirely in the financial statements of the Group to which
such proceeds were allocated. The Company currently intends to allocate the
net proceeds of the Offerings to the Kmart Group to repay outstanding
indebtedness of the Company and for general corporate purposes. See
"Retained Interest of Kmart Group in Specialty Retail Groups; Outstanding
Interest Fraction" below.
Allocation of Proceeds of Mergers or Consolidations. The Certificate
of Amendment does not contain any provisions governing how consideration to
be received by holders of Common Stock in connection with a merger or
consolidation involving the Company is to be allocated among holders of
different series of Common Stock. In any such merger or consolidation, the
percentage of the consideration to be allocated to holders of any series of
Common Stock under the method of allocation chosen by the Board may be
materially more or less than that which might have been allocated to such
holders had the Board chosen a different method of allocation. See "Limited
Separate Stockholder Voting Rights; Effects on Voting Power" below.
Optional Exchange of Series of Specialty Retail Stock. The Board
could, in its sole discretion, determine to exchange shares of any series
of Specialty Retail Stock for shares of Kmart Stock at a 15% premium at any
time or a 10% premium following any dividend or partial redemption
undertaken in connection with a Disposition of all or substantially all of
the properties or assets of the relevant Specialty Retail Group. This
determination could be made at a time when either or both the Kmart Stock
and the relevant series of Specialty Retail Stock may be considered to be
overvalued or undervalued. In addition, any such exchange at either the 10%
or the 15% premium would dilute the interests of the holders of Kmart Stock
and would preclude holders of such exchanged Specialty Retail Stock from
retaining their investment in a security that is intended to reflect
separately the performance of the relevant Specialty Retail Group. See
"Description of Kmart Stock and Specialty Retail Stock -- Exchange and
Redemption" below.
Dispositions of Specialty Retail Group Assets. Assuming the assets of
a Specialty Retail Group continue to represent less than substantially all
of the properties and assets of the Company, the Board could, in its sole
discretion and without stockholder approval, approve sales and other
dispositions of any amount of the properties and assets of any Specialty
Retail Group since Michigan law requires stockholder approval only for a
sale or other disposition of all or substantially all of the properties and
assets of the entire Company. However, the Specialty Retail Stock Proposal
contains provisions which, in the event of a Disposition of all or
substantially all of the properties and assets of the relevant Specialty
Retail Group, require the Company to either (i) distribute by dividend or
redemption to the holders of the relevant series of Specialty Retail Stock
an amount equal to their proportionate interest in the Net Proceeds of such
Disposition or (ii) exchange the outstanding shares of such series of
Specialty Retail Stock for a number of shares of Kmart Stock equal to 110%
of an average daily ratio of the Market Value
46
<PAGE> 53
of one share of such Specialty Retail Stock to one share of Kmart Stock.
See "Description of Kmart Stock and Specialty Retail Stock -- Exchange and
Redemption" below.
Operational and Financial Decisions. The Board could, in its sole
discretion, from time to time, make operational and financial decisions
that affect disproportionately the businesses of the Kmart Group and the
various Specialty Retail Groups, such as transfers of funds between Groups,
the allocation of funds for capital expenditures, the determination to
engage in store expansion or refurbishment programs and the allocation of
prime retail space that may be suitable for stores of more than one Group.
The decision to provide funds to one Group may adversely affect the ability
of another Group to obtain funds sufficient to implement its business
strategies. Moreover, the core Kmart discount store business offers some
merchandise that is similar to merchandise offered by certain of the
Specialty Retail Groups, creating the potential for conflicts of interest
regarding, for example, corporate opportunities and purchasing and pricing
policies. Currently, marketing, purchasing and pricing decisions are made
independently by employees of each Group, and the Company expects to
maintain such practice. The Board could, in its sole discretion, from time
to time, establish one or more committees of the Board to review matters
raising conflict issues and to report to the Board on such matters. For
further discussion of potential conflicts of interest arising from
financial decisions, see "Transfers of Funds between Kmart Group and
Specialty Retail Groups; Additional Equity Contributions from Kmart Group"
below.
Fiduciary Duties of the Board of Directors. Although the Company is aware
of no precedent concerning the manner in which Michigan law would be applied to
a board of directors' duties in the context of multiple classes of common stock
with divergent interests, the Company believes that a Michigan court would hold
that a board of directors owes an equal duty to all stockholders regardless of
class or series and does not have separate or additional duties to any group of
stockholders. That duty is the fiduciary duty to act in good faith and in the
honest belief that its actions are in the Company's best interests. The Company
believes that, under Michigan law, a good faith determination by a disinterested
and adequately informed board, or a committee thereof, which the directors
honestly believe is in the best interests of the corporation, would be a defense
to any challenge by or on behalf of the holders of any class or series of stock
to a board determination that could have a disparate effect on different classes
or series of stock.
Disproportionate ownership interests of members of the Board in some or all
series of Common Stock or disparate values of some or all series of Common Stock
could create or appear to create potential conflicts of interest when directors
are faced with decisions that could have different implications for different
series. See "Potential Conflicts of Interest" above. Nevertheless, the Company
believes that a director would be able to discharge his or her fiduciary
responsibilities even if his or her interests in shares of various series of
Common Stock were disproportionate and/or had disparate values. Under the terms
of the Company's Directors Stock Plan, as proposed to be amended pursuant to
Proposal 6, if the Specialty Retail Stock Proposal is approved by stockholders
and implemented by the Board, non-employee directors would receive shares of
each outstanding series of Common Stock in order to give them an ownership
interest in all series of Common Stock.
Transfers of Funds between Kmart Group and Specialty Retail Groups;
Additional Equity Contributions from Kmart Group. Following implementation of
the Specialty Retail Stock Proposal by the Board, all debt incurred or Preferred
Stock issued by the Company and its subsidiaries would be specifically
attributed to and reflected on the financial statements of the Kmart Group,
unless otherwise determined by the Board. The Board could determine from time to
time that debt or Preferred Stock and the proceeds thereof should be
specifically attributed to and reflected on the financial statements of a
Specialty Retail Group to the extent that the debt is incurred or the Preferred
Stock is issued for the benefit of such Specialty Retail Group. If cash used by
a Specialty Retail Group exceeded cash provided by such Specialty Retail Group,
the Kmart Group would transfer to such Specialty Retail Group the cash necessary
to fund such excess uses. Conversely, if cash provided by a Specialty Retail
Group exceeded cash used by such Specialty Retail Group, such Specialty Retail
Group would transfer such excess cash to the Kmart Group. All cash transfers
between Groups would be accounted for as short-term loans unless the Board made
a specific determination that a given transfer (or type of transfer) should be
accounted for as a long-term loan or, in the case of a transfer from the Kmart
Group to a Specialty Retail Group, an equity contribution. There are no specific
criteria to determine when a cash transfer would be classified as a long-term
loan or, in the case of a transfer from the Kmart Group to a
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<PAGE> 54
Specialty Retail Group, an equity contribution, rather than a short-term loan.
Such determination would be made by the Board in the exercise of its business
judgment at the time of such transfer (or the first of such type of transfer)
based upon all relevant circumstances, including the financing needs and
objectives of the recipient Group, the investment objectives of the transferring
Group, the availability, cost and time associated with alternative financing
sources, prevailing interest rates and general economic conditions. Such
determination would affect the amount of interest expense and interest income
reflected in the financial statements of the relevant Groups if such transfer
were made as a short-term loan or long-term loan and, in the case of a transfer
from the Kmart Group to a Specialty Retail Group as an equity contribution, the
amount of stockholders' equity of such Specialty Retail Group and Retained
Interest of the Kmart Group. Any such short-term loans between the Kmart Group
and the Specialty Retail Groups would bear interest at the Company's daily
short-term borrowing rate. In the event that the Board determined that a
transfer of funds between the Kmart Group and a Specialty Retail Group should be
accounted for as a long-term loan, the Board would establish the terms on which
such loan would be made, including interest rate, amortization schedule,
maturity and redemption terms. Such terms would generally reflect the then
prevailing terms upon which the Company could borrow funds on a similar basis.
Determinations as to whether to provide funds to any Specialty Retail Group
would continue to be made at the discretion of the Board. Nothing in the
foregoing policies obligates the Board to cause the Kmart Group to provide funds
to any Specialty Retail Group if the Board determines it is in the best interest
of the Company not to do so.
In view of the anticipated cash needs of the Specialty Retail Groups over
the next several years, it is currently expected that the Kmart Group would in
the aggregate provide net cash to the Specialty Retail Groups. After considering
all relevant factors, the Kmart Group would obtain such funds from internal
operations, excess cash from other Specialty Retail Groups, external debt
financing or additional equity issuances. If a Specialty Retail Group to which
net cash had been provided as loans would be unable to repay such amounts, the
effects would be reflected on the Kmart Group Financial Statements. Moreover, in
the event that the rate of interest charged by the Kmart Group on a transfer
accounted for as a short-term loan or a long-term loan to a Specialty Retail
Group would be more or less than the Company's actual cost of funds, the Kmart
Group's financial statements would reflect the effect of the differential. For
example, if the Kmart Group transferred funds as a short-term loan to a
Specialty Retail Group at the Company's short-term borrowing rate, but, at the
time of such loan, the Company had predominantly long-term debt financing at an
interest rate higher than the Company's short-term borrowing rate, the Kmart
Group financial statements would reflect higher average interest expense on
funds borrowed by it compared to the interest income received on such funds from
such Specialty Retail Group.
Under management policies adopted by the Board, the Board could, in its
sole discretion, determine from time to time that a transfer of funds from the
Kmart Group to a Specialty Retail Group be accounted for as an equity
contribution, rather than a loan, thereby increasing the Kmart Group's Retained
Interest in such Specialty Retail Group. Although any increase in the Kmart
Group's Retained Interest would be determined by reference to the then current
Market Value of a share of the relevant series of Specialty Retail Stock, such a
contribution could occur at a time when such shares could be considered
undervalued and the holders of outstanding shares of such series would not have
an opportunity to similarly increase their equity investment in such Specialty
Retail Group. Moreover, any such increase in the Retained Interest of the Kmart
Group would reduce the Outstanding Interest Fraction applicable to the relevant
series of Specialty Retail Stock.
Limited Separate Stockholder Voting Rights; Effects on Voting Power. Under
the Specialty Retail Stock Proposal, subject to certain limited exceptions,
holders of Kmart Stock, each series of Specialty Retail Stock, Series A
Preferred Stock, Series B Preferred Stock and any other series of Preferred
Stock outstanding at the time of such vote and so entitled to vote would vote as
one class on all matters coming before any meeting of stockholders. Holders of
Common Stock or of any series thereof would not have any right to vote on
matters as a separate class or series (except pursuant to (i) the two-thirds
separate class vote requirements under certain limited circumstances, as
described under "Description of Kmart Stock and Specialty Retail Stock -- Voting
Rights" below and (ii) certain limited class voting rights provided under
Michigan law). Similarly, separate meetings for the holders of Common Stock or
of any series thereof would not be held. Certain matters on which the Common
Stock could be so entitled to vote as part of one class could involve a
divergence or the appearance of a divergence of the interests of the various
series of Common Stock. When a vote is taken on
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<PAGE> 55
any matter as to which all stock is voting together as one class, any series of
Common Stock that is entitled to more than the number of votes required to
approve such matter would be in a position to control the outcome of the vote on
such matter.
For example, the Company's Restated Articles do not require that a merger
or consolidation of the Company be approved by a separate vote of holders of any
series of Common Stock, and Michigan law requires such approval only in certain
circumstances. As a result, if the holders of Common Stock having a majority of
the voting power of all shares of Common Stock outstanding approved a merger or
consolidation of the Company, then (a) the merger or consolidation could be
consummated even if the holders of a majority of any series of Common Stock had
voted against the merger or consolidation and (b) the amount to be received by
the holders of such series of Common Stock in the merger or consolidation might
be materially less than the amount such holders would have received had the
approval of the holders of a majority of such series of Common Stock been
required. See "Potential Conflicts of Interest -- Allocation of Proceeds of
Mergers or Consolidations" above.
The relative voting power of shares of Kmart Stock and each series of
Specialty Retail Stock would fluctuate from time to time, with each share of
Kmart Stock having one vote and each share of a series of Specialty Retail Stock
having a variable number of votes, based upon the relative Market Value of one
share of Kmart Stock to one share of such series of Specialty Retail Stock. This
formula is intended to equate the proportionate voting rights of each series of
Common Stock to their respective Market Values at the time of any vote. However,
no share of any series of Specialty Retail Stock would have more than one vote
per share prior to the Series A Conversion Date, which is expected to occur on
or prior to September 15, 1994. If the Specialty Retail Stock Proposal is
approved by stockholders and implemented by the Board, holders of Kmart Stock
would continue to be entitled to a substantial majority of the total votes to
which the then outstanding voting stock of the Company is entitled. In the event
that there would be a significant increase in the Market Value of some or all of
the outstanding series of Specialty Retail Stock relative to the Market Value of
the Kmart Stock or if additional shares of such series of Specialty Retail Stock
were issued, the number of votes to which such outstanding series of Specialty
Retail Stock would be entitled would increase, although it is unlikely that
during the foreseeable future the holders of Kmart Stock as a group would
possess less than a majority of the total number of votes to which the
outstanding voting stock of the Company would be entitled. See "Description of
Kmart Stock and Specialty Retail Stock -- Voting Rights" below.
Limited Stockholder Approval Rights for Future Authorizations and Issuances
of Stock. The Specialty Retail Stock Proposal provides that (i) the number of
authorized shares of Common Stock would be increased from 1.5 billion to 3.0
billion, (ii) 1.5 billion shares of Existing Common Stock would be redesignated
as Kmart Stock and (iii) 1.5 billion shares would be available for designation
as Kmart Stock and/or any of four new series of Specialty Retail Stock. The
authorized but unissued shares of Common Stock would be available for issuance
from time to time by the Company at the sole discretion of the Board for any
proper corporate purpose, which could include raising capital, providing
compensation or benefits to employees, paying stock dividends or acquiring
companies or businesses. Such issuances could include shares of Kmart Stock or
any series of Specialty Retail Stock. Under applicable Michigan law, such future
issuances would not require the further approval of stockholders, and the
Company would not seek approval of stockholders unless such approval would be
required by stock exchange regulations, would be in conjunction with a further
amendment to the Articles or would otherwise be deemed advisable by the Board.
Furthermore, the Board could elect, in its sole discretion without further
approval of stockholders, to increase or decrease the number of designated
shares of any series of Common Stock, but not below the number of outstanding
shares of such series, and not in excess of the number which, when added to the
aggregate number of designated shares of all other series of Common Stock, would
exceed the total authorized number of shares of Common Stock; except that, under
Michigan law, the Board could, in its sole discretion, amend the Articles to
increase the authorized shares of Kmart Stock and Common Stock to the number
that would be sufficient, when added to the previously authorized but unissued
shares of Kmart Stock and Common Stock, to enable the Company to deliver shares
of Kmart Stock to holders of any series of Specialty Retail Stock upon the
exchange thereof. See "Description of Kmart Stock and Specialty Retail Stock --
Exchange and Redemption" below.
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<PAGE> 56
Allocation of Goodwill for Purposes of Determining Available Dividend
Amount. The Certificate of Amendment provides that each Group's Available
Dividend Amount would be the source for the payment of dividends on the relevant
series of Common Stock, although the liquidation rights with respect to such
series or legally available assets of the Company could be more or less than
such amount. The Available Dividend Amount for each Group is (a) the Group's net
equity, adjusted, in the case of each Specialty Retail Group, to exclude the
cumulative effects of amortization of goodwill arising from acquisitions on
behalf of such Specialty Retail Group prior to the initial issuance of the
relevant series of Specialty Retail Stock and, in the case of the Kmart Group,
to include the cumulative effects of such amortization to the extent not already
reflected in the net equity of the Kmart Group as a result of its Retained
Interest in the Specialty Retail Group, times (b) the Outstanding Interest
Fraction with respect to such Group. The goodwill adjustment referred to above
would result in a decrease in the Available Dividend Amount with respect to the
Kmart Group and an increase in the Available Dividend Amount with respect to
such Specialty Retail Group. See "Description of Kmart Stock and Specialty
Retail Stock -- Dividends" below.
Dilution. The issuance of the various series of Specialty Retail Stock
would result in some dilution of the voting rights of the holders of Existing
Common Stock; however, it is unlikely that during the foreseeable future the
holders of Kmart Stock as a group would possess less than a majority of the
total number of votes to which the outstanding voting stock of the Company would
be entitled. See "Limited Stockholder Approval Rights for Future Authorizations
and Issuances of Stock" and "Limited Stockholder Rights; Effects on Voting
Power" above.
The Company believes that implementation of the Specialty Retail Stock
Proposal would not result in meaningful dilution to the holders of Existing
Common Stock on an earnings per share basis. The Company currently intends that
the Kmart Group would initially have a 70-80% Retained Interest in each
Specialty Retail Group, resulting in 70-80% of the earnings of each Specialty
Retail Group being attributed to the Kmart Group. In addition, the Company
currently intends to allocate the net proceeds of the sale of each series of
Specialty Retail Stock in the Offerings to the Kmart Group to, among other
things, repay outstanding indebtedness of the Company, resulting in reduced debt
service obligations attributable to the Kmart Group.
Following implementation of the Specialty Retail Stock Proposal, if the
Company exchanged any outstanding series of Specialty Retail Stock for Kmart
Stock under the terms of the Specialty Retail Stock, such exchange would be
effected at a premium to the then current price of the relevant series of
Specialty Retail Stock, which would dilute the interests of the holders of Kmart
Stock in the Company. See "Potential Effects of Exchange of Series of Specialty
Retail Stock" below. In addition, the issuance of shares of Specialty Retail
Stock pursuant to the Company's employee benefit plans would reduce the Kmart
Group's percentage interest in the Specialty Retail Groups and, in some cases,
reduce the Number of Shares Issuable with Respect to Retained Interest. See
"Shares Issuable Under Employee Benefit Plans" below.
Management and Accounting Policies Subject to Change. The Board has adopted
certain management and accounting policies described herein with respect to cash
management, corporate expenses, allocation of assets and liabilities (including
contingent liabilities) and inter-Group transactions, any and all of which could
be modified or rescinded in the sole discretion of the Board without the
approval of stockholders, although there is no present intention to do so. The
Board could also adopt additional policies depending upon the circumstances. Any
determination by the Board to modify or rescind such policies, or to adopt
additional policies, including any such decision that could have disparate
effects upon holders of different series of Common Stock, would be made by the
Board in good faith and in the honest belief that such decision is in the best
interests of the Company. In addition, generally accepted accounting principles
would require that changes in accounting policy must be preferable (in
accordance with such principles) to the policy previously in place. See
"Management and Accounting Policies" below.
Reduced Interest of Kmart Group in Specialty Retail Groups. Prior to any
Offering or any other issuance of any series of Specialty Retail Stock, the
Kmart Group's Retained Interest in each Specialty Retail Group would represent
100% of the Equity Value of such Specialty Retail Group. It is currently
contemplated that the number of shares of each series of Specialty Retail Stock
to be issued and sold to the public in each
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<PAGE> 57
Offering would be intended to represent approximately 20% to 30% of the Equity
Value of the relevant Specialty Retail Group. It is further contemplated that
the shares to be sold in any such Offering of a series of Specialty Retail Stock
would be allocated to the Kmart Group's Retained Interest in the relevant
Specialty Retail Group. As a result, the Kmart Group's Retained Interest and its
percentage interest in the relevant Specialty Retail Group would be reduced
accordingly. Any other issuance of any series of Specialty Retail Stock (i)
whether or not for the account of the Kmart Group; would reduce the Kmart
Group's percentage interest in the relevant Specialty Retail Group and (ii) if
for the account of the Kmart Group, would also reduce the Kmart Group's Retained
Interest in the relevant Specialty Retail Group.
Potential Effects of Exchange of Series of Specialty Retail Stock. The
terms of the various series of Specialty Retail Stock permit the exchange of all
outstanding shares of any series of Specialty Retail Stock for Kmart Stock upon
the terms described under "Description of Kmart Stock and Specialty Retail Stock
- -- Exchange and Redemption" below. Since any such exchange would be at a premium
to the then current market price of the series of Specialty Retail Stock being
exchanged, the issuance of additional shares of Kmart Stock in connection with
such an exchange would dilute the interest of holders of Kmart Stock in the
Company. See "Dilution" above. The Company cannot predict the impact of the
potential for such exchanges or of any issuance of additional shares of Kmart
Stock in connection with such an exchange on the market price of any series of
Common Stock.
No Assurance as to Market Price. Since there has been no prior market for
any series of Specialty Retail Stock, there can be no assurance as to the price
to be received by the Company upon the sale thereof. It is also not possible to
predict the impact of the sale of any series of Specialty Retail Stock on the
market price of the Kmart Stock and, accordingly, there can be no assurance that
the market price of the Kmart Stock would equal or exceed the market price of
the Existing Common Stock prior to the Company's announcement or implementation
of the Specialty Retail Stock Proposal. See "Price Ranges of Existing Common
Stock, Series A Preferred Stock and Series B Preferred Stock; Dividends".
The market prices of the Kmart Stock and any or all series of Specialty
Retail Stock would be determined in the trading markets and could be influenced
by many factors, including the consolidated results of the Company, as well as
the respective performances of the Kmart Group and the Specialty Retail Groups,
investors' expectations for the Company as a whole, the Kmart Group and each
Specialty Retail Group, trading volume and general economic and market
conditions. There can be no assurance that investors would assign values to the
Kmart Stock and any series of Specialty Retail Stock based on the reported
financial results and prospects of the relevant Group or the dividend policies
established by the Board with respect to such Group. Accordingly, financial
effects of any Group that affect the Company's consolidated results of
operations or financial condition could affect the market price of shares of all
series of Common Stock. In addition, the Company cannot predict the impact on
the market price of any series of Common Stock of certain terms of such
securities, such as the ability of the Company to exchange shares of a series of
Specialty Retail Stock for Kmart Stock, the discretion of the Board to make
various determinations and the minority voting power of the various Specialty
Retail Stock.
Limitations on Potential Unsolicited Acquisitions. If each of the Groups
were separate independent companies, any person interested in acquiring one
Group without negotiation with management could seek control of that Group by
obtaining control of its outstanding voting stock. Although full implementation
of the Specialty Retail Stock Proposal would create five series of Common Stock
that are intended to reflect the separate performance of each of the Groups, a
person interested in acquiring only one Group without negotiation with the
Company's management could obtain control of that Group only by obtaining
control of the outstanding voting stock of the entire Company, including series
of Common Stock related to other Groups. See "Limited Separate Voting Rights;
Effects on Voting Power" above and "Description of Kmart Stock and Specialty
Retail Stock -- Voting Rights" below.
DIVIDEND POLICY
General. The Company's annual dividend rate is presently $.96 per share of
Common Stock. The Board currently intends that the dividend policy applicable to
the Kmart Stock would be the same as the dividend policy applicable to the
Existing Common Stock, with the initial dividend rate on the Kmart Stock being
the
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<PAGE> 58
rate in effect for the Existing Common Stock at the time of the redesignation of
the Existing Common Stock as Kmart Stock. The Board believes that implementation
of the Specialty Retail Stock Proposal would not adversely affect the Company's
ability to pay dividends on the Kmart Stock. In reaching this conclusion, the
Board considered the following: (i) the Company currently intends that the Kmart
Group would initially have a 70-80% Retained Interest in each Specialty Retail
Group, resulting in the Kmart Group being credited with an amount proportionate
to dividends paid on each series of Specialty Retail Stock; (ii) the Company
currently intends to allocate the net proceeds of the Offerings to the Kmart
Group to, among other things, repay outstanding indebtedness of the Company,
resulting in reduced debt service obligations attributable to the Kmart Group;
and (iii) the Company does not expect initially to pay significant dividends on
the various series of Specialty Retail Stock.
Determinations as to future dividends on the Kmart Stock would be based
primarily upon the financial condition, results of operations and business
requirements of the Kmart Group and the Company as a whole. Under the terms of
the Kmart Stock, dividends would be payable in the sole discretion of the Board
out of the lesser of (i) all assets of the Company legally available for
dividends and (ii) the Available Dividend Amount with respect to the Kmart
Group. See "Special Considerations -- Allocation of Goodwill for Purposes of
Determining Available Dividend Amount" above. For an illustration of the
calculation of the Available Dividend Amount for the Kmart Group, see
"Description of Kmart Stock and Specialty Retail Stock -- Dividends" below.
The dividend policy applicable to any series of Specialty Retail Stock
would be determined by the Board at the time of issuance of such series.
Determinations to pay dividends on any series of Specialty Retail Stock would be
based primarily upon the respective financial condition, results of operations
and business requirements of the relevant Specialty Retail Group and the Company
as a whole. Under the terms of the various series of Specialty Retail Stock,
dividends would be payable in the sole discretion of the Board out of the lesser
of (i) all assets of the Company legally available for dividends and (ii) the
Available Dividend Amount with respect to the relevant Specialty Retail Group.
For an illustration of the calculation of the Available Dividend Amount for the
Specialty Retail Groups, see "Description of Kmart Stock and Specialty Retail
Stock -- Dividends" below.
Calculation of Earnings Per Share. In making its dividend decisions with
respect to both the Kmart Stock and the various series of Specialty Retail
Stock, the Board would rely on the financial statements of the Kmart Group and
each Specialty Retail Group, respectively. See Annexes VI through X for the
historical Financial Statements of the Kmart Group and each of the Specialty
Retail Groups. The method of calculating earnings per share for the Kmart Stock
and each series of Specialty Retail Stock would reflect the terms of the
Certificate of Amendment, which provide that each Group's Available Dividend
Amount, which, in turn, would reflect the separately reported Kmart Corporation
Earnings Attributable to the Kmart Group, in the case of the Kmart Group, and
Kmart Corporation Earnings Attributable to a Specialty Retail Group, in the case
of a Specialty Retail Group, would be the source for payment of dividends for
each series of Common Stock, although liquidation rights of these series of
stock and legally available assets of the Company may be more or less than these
amounts. The Company would compute earnings per share of Kmart Stock by dividing
Kmart Corporation Earnings Attributable to the Kmart Group by the weighted
average number of shares of Kmart Stock and dilutive Kmart Stock equivalents
outstanding during the applicable period. In determining the weighted average
number of fully diluted shares of Kmart Stock outstanding, the Series A
Preferred Stock and Series B Preferred Stock would be treated as Kmart Stock
equivalents, if dilutive. The Company would compute earnings per share of a
series of Specialty Retail Stock by dividing the product of the Outstanding
Interest Fraction for the relevant Specialty Retail Group and Kmart Corporation
Earnings Attributable to a Specialty Retail Group with respect to the such
Specialty Retail Group by the weighted average number of shares of such series
of Specialty Retail Stock and dilutive Specialty Retail Stock equivalents
outstanding during the applicable period. For the definitions of Kmart
Corporation Earnings Attributable to the Kmart Group and Kmart Corporation
Earnings Attributable to a Specialty Retail Group, see "Description of Kmart
Stock and Specialty Retail Stock -- Dividends" below.
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For example, assuming that (i) the Company had outstanding shares of each
series of Specialty Retail Stock representing an Outstanding Interest Fraction
of 25% with respect to the respective Specialty Retail Groups as of January 26,
1994, (but without giving effect to any use of the proceeds from the issuance of
such shares), (ii) such shares were the only shares of each series of Specialty
Retail Stock outstanding during the fiscal year then ended and (iii) the
amortization adjustments in the definitions of Kmart Corporation Earnings
Attributable to the Kmart Group and Kmart Corporation Earnings Attributable to a
Specialty Retail Group were made with respect to amortization of goodwill during
such fiscal year relating to acquisitions made prior to January 26, 1994, then
Kmart Corporation Earnings Attributable to the Kmart Group and Kmart Corporation
Earnings Attributable to a Specialty Retail Group with respect to each Specialty
Retail Group for such fiscal year, and Kmart Corporation earnings attributable
to the shares of Kmart Stock and the relevant series of Specialty Retail Stock
assumed to be outstanding, would have been calculated as follows (for an
illustration of the calculation of the Available Dividend Amount, see
"Description of Kmart Stock and Specialty Retail Stock -- Dividends" below):
<TABLE>
<CAPTION>
THE SPORTS
BORDERS-WALDEN BUILDERS SQUARE OFFICEMAX AUTHORITY
KMART GROUP GROUP GROUP GROUP GROUP
----------- -------------- --------------- --------- ----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Net (loss) before Retained
Interests....................... $(780.0) $ -- $ -- $ -- $ --
Net (loss) related to Retained
Interests in Specialty Retail
Groups.......................... (108.5)(a) -- -- -- --
Net income (loss)................. (888.5) (61.2) (107.0) 10.8 12.8
Add back of goodwill
amortization(b)................. -- 6.9 0.9 8.6 2.1
Less goodwill amortization(c)..... (4.6) -- -- -- --
Kmart Corporation earnings
(losses) attributable to
Group........................... (893.1) (54.3) (106.1) 19.4 14.9
Outstanding Interest Fraction..... -- 25% 25% 25% 25%
Kmart Corporation earnings
(losses) attributable to
outstanding stock of Group...... $(893.1) $(13.6) $ (26.5) $ 4.9 $ 3.7
</TABLE>
- -------------------------
(a) The adjustment to Kmart Group earnings related to the Retained Interest in
each Specialty Retail Group assumes the issuance of shares of each series
of Specialty Retail Stock representing an Outstanding Interest Fraction of
25%, resulting in a Retained Interest Fraction of 75%. Included in earnings
related to Kmart Group's assumed 75% Retained Interest is 75% of the
aggregate of the amounts of amortization of goodwill arising from
acquisitions made by the Company on or before January 26, 1994 included in
the net income (loss) of the Specialty Retail Groups prior to the
adjustment described in note (c) below.
(b) Adjusts net income (loss) of each Specialty Retail Group for the fiscal
year ended January 26, 1994 to exclude amortization of goodwill for such
period arising from acquisitions made by the Company on or before January
26, 1994.
(c) Adjusts net income (loss) of the Kmart Group for the remaining 25% of the
amount of amortization of goodwill for the fiscal year ended January 26,
1994 arising from acquisitions made by the Company on or before January 26,
1994 included in the net income of the Specialty Retail Groups. See note
(a) above.
MANAGEMENT AND ACCOUNTING POLICIES
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, the Company would continue to prepare financial
statements in accordance with generally accepted accounting principles,
consistently applied, for each of the Groups, and these financial statements,
taken together, would comprise all of the accounts included in the corresponding
consolidated financial statements of the Company. The financial statements of
each of the Groups principally reflect the financial position, results of
operations
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and cash flows of the businesses included therein. Consistent with the Articles
and relevant policies, such Group financial statements could also include
allocated portions of the Company's corporate assets and liabilities (including
contingent liabilities) that are not separately identified with the operations
of a specific Group. Notwithstanding such allocations for the purpose of
preparing Group financial statements, holders of Kmart Stock or any series of
Specialty Retail Stock would continue to be subject to risks associated with an
investment in the Company and all of its businesses, assets and liabilities. See
"Special Considerations -- Stockholders of One Company; Financial Effects on One
Group Could Affect Other Groups" above.
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, upon initial issuance of each series of Specialty
Retail Stock, cash management and allocation of principal corporate activities
between the relevant Specialty Retail Group and the Kmart Group would be based
upon methods management believes to be reasonable and would be reflected in
their respective Group financial statements as follows:
(i) All debt incurred or Preferred Stock issued by the Company and its
subsidiaries would be specifically attributed to and reflected on the
financial statements of the Kmart Group, unless otherwise determined by the
Board. The Board could determine from time to time that debt or Preferred
Stock and the proceeds thereof should be specifically attributed to and
reflected on the financial statements of a Specialty Retail Group to the
extent that the debt is incurred or the Preferred Stock is issued for the
benefit of such Specialty Retail Group.
(ii) If cash used by a Specialty Retail Group exceeds cash provided by
such Specialty Retail Group, the Kmart Group would transfer to such
Specialty Retail Group the cash necessary to fund such excess uses.
Conversely, if cash provided by a Specialty Retail Group exceeds cash used
by such Specialty Retail Group, such Specialty Retail Group would transfer
the excess cash to the Kmart Group. All cash transfers between Groups would
be accounted for as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be
accounted for as a long-term loan or, in the case of a transfer from the
Kmart Group to a Specialty Retail Group, an equity contribution. There are
no specific criteria to determine when a cash transfer would be classified
as a long-term loan or, in the case of a transfer from the Kmart Group to a
Specialty Retail Group, an equity contribution, rather than a short-term
loan. Such determination would be made by the Board in the exercise of its
business judgment at the time of such transfer (or the first of such type
of transfer) based upon all relevant circumstances, including the financing
needs and objectives of the recipient Group, the investment objectives of
the transferring Group, the availability, cost and time associated with
alternative financing sources, prevailing interest rates and general
economic conditions.
(iii) Such short-term loans between the Kmart Group and the Specialty
Retail Groups would bear interest at the Company's daily short-term
borrowing rate. In the event that the Board determined that a transfer of
funds between the Kmart Group and a Specialty Retail Group should be
accounted for as a long-term loan, the Board would establish the terms on
which such loan would be made, including interest rate, amortization
schedule, maturity and redemption terms. Such terms would generally reflect
the then prevailing terms upon which the Company could borrow funds on a
similar basis.
(iv) From time to time following the initial issuance of a series of
Specialty Retail Stock, the Board could determine that funds to be
transferred from the Kmart Group to a Specialty Retail Group represent an
equity contribution to such Specialty Retail Group rather than a loan. In
such event, the Kmart Group's Retained Interest in such Specialty Retail
Group would be increased by the amount of such contribution, as a result of
which (a) the Number of Shares Issuable with Respect to Retained Interest
with regard to the relevant Specialty Retail Group would be increased by an
amount equal to the amount of such contribution divided by the Market Value
of a share of the relevant series of Specialty Retail Stock and (b) the
Kmart Group's Retained Interest Fraction with regard to the relevant
Specialty Retail Group would be increased and the Outstanding Interest
Fraction with regard to such Specialty Retail Group would be decreased
accordingly.
(v) As a result of the foregoing, the balance sheet of the Kmart Group
would reflect its net short-term and net long-term loans to or borrowings
from the Specialty Retail Groups, and the balance sheet of
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each Specialty Retail Group would reflect its net short-term and net
long-term loans to or borrowings from the Kmart Group. Similarly, the
respective income statements of the Kmart Group and the Specialty Retail
Groups would reflect interest income or expense, as the case may be,
associated with such loans or borrowings and the respective statements of
cash flows of the Kmart Group and the Specialty Retail Groups would reflect
changes in the amounts thereof deemed outstanding. In view of the
anticipated cash needs of the Specialty Retail Groups over the next several
years, it is currently expected that the Kmart Group would be making
substantial net transfers to the Specialty Retail Groups. After considering
all relevant factors, the Kmart Group would obtain such funds from internal
operations, excess cash from other Specialty Retail Groups, external debt
financing or additional equity issuances.
(vi) Certain corporate, general and administrative costs (including
certain corporate borrowing, legal, tax, transportation, import, data
processing, employee benefit and self-insurance costs) would be charged to
the Specialty Retail Groups based upon utilization and at negotiated rates.
The balance of such costs would be reflected on the financial statements of
the Kmart Group. A portion of certain other corporate, general and
administrative costs related specifically to management of the Specialty
Retail Groups would be allocated equally among the Specialty Retail Groups.
(vii) Federal income taxes for the Company are paid on a consolidated
basis; however, each Group would calculate income taxes on a separate basis
with the following modifications to reflect consolidated results. Credits,
losses or benefits of a Group not used separately would be recognized by
such Group if they could be used in filing a consolidated tax return.
Deferred federal income taxes would be recorded on each Group's books, and
current federal taxes payable would be deemed to be remitted to the Company
as agent for each Group. Any adjustments to federal income tax liabilities
for years after fiscal 1992 would be paid by the Company and charged or
credited to the appropriate Group. For financial statement provision and
tax settlement purposes, tax benefits resulting from attributes
(principally net operating losses), which could not be utilized by one of
the Groups on a separate return basis but which could be utilized on a
consolidated basis in any given year, would be allocated to the Group which
generated the attributes. However, if such tax benefits could not be
utilized on a consolidated basis in that year or a carry back year, such
consolidated tax effect would be adjusted in a subsequent year to the
extent necessary to allocate tax benefits to the Group that would have
realized the tax benefits on a separate basis.
The foregoing reflect the management and accounting policies that would be
applicable to the Kmart Group and each Specialty Retail Group upon initial
issuance of the relevant series of Specialty Retail Stock. In the historical
financial information included in this Proxy Statement and the Annexes hereto
(i) debt incurred by the Company and its subsidiaries, other than certain
capital leases and mortgages related specifically to the Specialty Retail
Groups, has been reflected on the financial statements of the Kmart Group and
(ii) net cash used or provided by each Specialty Retail Group has been
characterized as an adjustment of the Kmart Group's equity investment (reflected
as Retained Interest) in such Specialty Retail Group. Accordingly, no
inter-Group interest expense or inter-Group interest income is reflected in the
historical financial statements of the Specialty Retail Groups. Until the
issuance of a series of Specialty Retail Stock, the net cash used or provided by
the relevant Specialty Retail Group will continue to be characterized as an
adjustment to the Kmart Group's equity investment in such Specialty Retail
Group. The historical financial information included in this Proxy Statement and
the Annexes hereto account for certain corporate, general and administrative
costs as reflected in clause (vi) above and account for federal income taxes as
reflected in clause (vii) above. See Annexes VI through X for the historical
financial statements of the Kmart Group and each Specialty Retail Group.
Notwithstanding the policies described above, determinations to provide
funds to the Specialty Retail Groups would continue to be made at the discretion
of the Board. Nothing in the foregoing policies obligates the Board to cause the
Kmart Group to provide funds to any Specialty Retail Group if the Board
determines it is in the best interest of the Company not to do so.
The above management and accounting policies could be modified or rescinded
by the Board, in its sole discretion, without approval of stockholders, although
there is no present intention to do so. The Board could
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<PAGE> 62
also adopt additional policies depending upon the circumstances. Any
determination of the Board to modify or rescind such policies, or to adopt
additional policies, including any such decision that could have disparate
effects upon holders of different series of Common Stock, would be made by the
Board in good faith and in the honest belief that such decision is in the best
interests of the Company. In addition, generally accepted accounting principles
would require that changes in accounting policy must be preferable (in
accordance with such principles) to the policy previously in place.
DESCRIPTION OF KMART STOCK AND SPECIALTY RETAIL STOCK
THE FOLLOWING DESCRIPTION IS QUALIFIED BY REFERENCE TO ANNEX III-A TO THIS
PROXY STATEMENT, WHICH CONTAINS THE FULL TEXT OF THE PROPOSED AMENDMENTS TO
ARTICLE THREE OF THE ARTICLES PURSUANT TO THE SPECIALTY RETAIL STOCK PROPOSAL.
General. The Articles currently provide that the Company is authorized to
issue 1,510,000,000 shares of capital stock, consisting of 1,500,000,000 shares
of Common Stock, par value $1 per share, and 10,000,000 shares of Preferred
Stock, no par value per share, issuable in series by the Board ("Preferred
Stock"). The Preferred Stock consists of 500,000 shares designated as Series A
Junior Participating Preferred Stock ("Series A Junior Preferred Stock"),
5,750,000 shares designated as Series A Preferred Stock and 796,827 shares
designated as Series B Preferred Stock. As of April 8, 1994, the Company had
issued and outstanding shares of Existing Common Stock, 5,750,000 shares of
Series A Preferred Stock and 784,938 shares of Series B Preferred Stock.
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, upon initial issuance of any series of Specialty
Retail Stock, the Articles would be amended to authorize a total of
3,010,000,000 shares of capital stock, consisting of 3,000,000,000 shares of
Common Stock, par value $1 per share, issuable in series by resolution of the
Board, and 10,000,000 shares of Preferred Stock, no par value per share,
issuable in series by resolution of the Board, with 500,000 shares designated as
Series A Junior Preferred Stock, 5,750,000 shares designated as Series A
Preferred Stock and 796,827 shares designated as Series B Preferred Stock. Upon
the initial issuance of shares of any series of Specialty Retail Stock,
1,500,000,000 shares of Existing Common Stock automatically would be
redesignated as Kmart Stock, and 1,500,000,000 shares of newly authorized Common
Stock would be available for designation from time to time, in the sole
discretion of the Board, as Kmart Stock and/or any of four series of Specialty
Retail Stock. With respect to each series of Specialty Retail Stock, the Board
would have the authority to designate, at the time of the initial issuance of
such series, the total number of authorized shares comprising such series, the
number of shares which, immediately prior to the initial issuance of shares of
such series, would be deemed to represent 100% of the Equity Value of the
relevant Specialty Retail Group and any other terms which would be consistent
with applicable law and the Articles. The Board would have the authority to
increase or decrease from time to time the total number of authorized shares
comprising each series of Common Stock but, except in certain limited
circumstances, not above a number which, when added to the aggregate number of
authorized shares of all other series of Common Stock, would exceed the total
authorized number of shares of Common Stock, and not below the number of shares
of such series then outstanding.
The authorized but unissued shares of Common Stock would be available for
issuance from time to time by the Company, in the sole discretion of the Board,
for any proper corporate purpose, which could include raising capital, providing
compensation or benefits to employees, paying stock dividends or acquiring
companies or businesses. The issuance of such shares would not be subject to
approval by the stockholders except as might be required by the MBCA or
applicable stock exchange listing requirements. Any net proceeds from the
issuance of Kmart Stock or any series of Specialty Retail Stock (other than
shares issuable with respect to the Retained Interest of the Kmart Group in the
relevant Specialty Retail Group) would be attributed to the Kmart Group or the
relevant Specialty Retail Group, respectively.
Dividends. Dividends on the Kmart Stock and each series of Specialty Retail
Stock would be subject to the same limitations as dividends on the Existing
Common Stock, which are limited to legally available assets of the Company (as
provided under the MBCA), and are subject to the prior payment of dividends on
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outstanding shares of Series A Preferred Stock and Series B Preferred Stock (and
any new series of Preferred Stock with similar preferential dividend rights).
Under the MBCA, no distribution may be made to stockholders if, after giving
effect to such distribution, the Company would not be able to pay its debts as
they become due in the usual course of business or the Company's total assets
would be less than its total liabilities plus, subject to certain exceptions,
any amounts necessary to satisfy the preferential rights upon dissolution of
stockholders whose preferential rights are superior to those of the stockholders
receiving the distribution. Based on the balance sheet of the Company as of
January 26, 1994, the Company had legally available assets of $6,093 million,
subject to the Company's ability to continue to pay its debts as they became due
in the usual course of business after having distributed any such amount.
Dividends on the Kmart Stock and each series of Specialty Retail Stock
would be further limited to an amount not in excess of the Available Dividend
Amount with respect to the relevant Group. There can be no assurance that there
would be an Available Dividend Amount with respect to any Group.
The "Available Dividend Amount", on any date (the "calculation date") with
respect to any series of Common Stock (the "subject group stock") issued with
reference to any Group (the "subject group"), means the excess of:
(i) the product of (x) the Outstanding Interest Fraction with respect
to the subject group as of such calculation date and (y) an amount equal to
the total assets of the subject group less its total liabilities as of such
calculation date determined either (1) in accordance with generally
accepted accounting principles as in effect at such time applied on a basis
consistent with that applied in determining, as applicable, Kmart
Corporation Earnings Attributable to the Kmart Group and Kmart Corporation
Earnings Attributable to a Specialty Retail Group with respect to the
subject group, or (2) at the option of the Board, in accordance with
Michigan law applied as if the subject group were treated as a corporation
for these purposes under Michigan law, in either case reduced, in the case
of Kmart Stock, by the aggregate of the amounts, with respect to all
Specialty Retail Groups as of the calculation date, of amortization of
goodwill through the calculation date arising from acquisitions made by the
Company or any of its subsidiaries with respect to all Specialty Retail
Groups with stock issued and outstanding before the date of filing of the
applicable Certificate of Designation (excluding the portion thereof, if
any, already applied to reduce net income or increase net loss of the Kmart
Group for such period by virtue of its Retained Interest in such Specialty
Retail Groups), and increased, in the case of any series of Specialty
Retail Stock, by the amount with respect to such Specialty Retail Group of
amortization of goodwill through the calculation date arising from
acquisitions made by the Company or any of its subsidiaries with respect to
such subject group before the date of filing of the applicable Certificate
of Designation, over
(ii) except to the extent that the Articles provide otherwise, the
amount that would be needed to satisfy the preferential rights to which
holders of Preferred Stock attributed to the subject group are entitled
upon dissolution of the Company;
provided, that such excess must be reduced by an amount, if any, sufficient to
ensure that the subject group will be able to pay its debts as they become due
in the usual course of business.
"Kmart Corporation Earnings Attributable to a Specialty Retail Group" means
the net income or loss of the relevant Specialty Retail Group for the relevant
period determined in accordance with generally accepted accounting principles in
effect at such time, reflecting income and expense of the Company allocated to
such Specialty Retail Group, increased by the amount of amortization of goodwill
of such Specialty Retail Group during such period arising from acquisitions made
by the Company or any of its subsidiaries with respect to such Specialty Retail
Group before the date of filing of the applicable Certificate of Designation,
determined in accordance with generally accepted accounting principles in effect
at such time applied on a basis substantially consistent with that applied in
determining Kmart Corporation Earnings Attributable to a Specialty Retail Group
with regard to the other Specialty Retail Groups.
"Kmart Corporation Earnings Attributable to the Kmart Group" means the net
income or loss of the Kmart Group for the relevant period determined in
accordance with generally accepted accounting principles
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in effect at such time, reflecting income and expense of the Company allocated
to the Kmart Group, reduced by the aggregate of the amounts, with respect to all
Specialty Retail Groups as of the date of calculation, of amortization during
such period of goodwill arising from acquisitions made by the Company or any of
its subsidiaries with respect to all Specialty Retail Groups with stock issued
and outstanding before the date of filing of the applicable Certificate of
Designation determined in accordance with generally accepted accounting
principles in effect at such time applied on a basis substantially consistent
with that applied in determining Kmart Corporation Earnings Attributable to a
Specialty Retail Group with respect to the Specialty Retail Groups (excluding
the portion thereof, if any, already applied to reduce net income or increase
net loss of the Kmart Group for such period by virtue of its Retained Interest
in such Specialty Retail Groups). When determining Kmart Corporation Earnings
Attributable to a Specialty Retail Group and Kmart Corporation Earnings
Attributable to the Kmart Group for fiscal periods of the Company commencing
prior to the date of filing of the applicable Certificate of Designation, all
amounts shall be calculated on a pro forma basis as if the date of filing of
such Certificate of Designation were the first day of the relevant period.
Assuming that (i) the Company had outstanding shares of each series of
Specialty Retail Stock representing an Outstanding Interest Fraction of 25% with
respect to each respective Specialty Retail Group as of January 26, 1994, (but
without giving effect to any use of the proceeds from the issuance of such
shares), (ii) such shares were the only shares of each series of Specialty
Retail Stock outstanding during the fiscal year then ended, (iii) the
amortization adjustments in the definitions of Kmart Corporation Earnings
Attributable to the Kmart Group and Kmart Corporation Earnings Attributable to a
Specialty Retail Group were made with respect to amortization of goodwill during
such fiscal year relating to acquisitions made prior to January 26, 1994, and
assuming that each Group would have been able to continue to pay its debts as
they became due in the usual course of business following the payment of any
such amounts, the Available Dividend Amount with respect to each Group at such
date would have been calculated as follows:
<TABLE>
<CAPTION>
KMART
CUMULATIVE CORPORATION
TOTAL GOODWILL EQUITY OUTSTANDING AVAILABLE
ASSETS LESS AMORTIZATION ATTRIBUTABLE INTEREST DIVIDEND
GROUP TOTAL LIABILITIES ADJUSTMENT TO GROUP FRACTION AMOUNT
----------------- ------------ ------------ ----------- ---------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Kmart Group.................... $ 5,656.6(1) $(14.7)(2) $5,641.9 -- $ 5,641.9
Borders-Walden Group........... 457.5 29.3 486.8 25% 121.7
Builders Square Group.......... 531.9 8.0 539.9 25% 135.0
OfficeMax Group................ 608.5 13.6 622.1 25% 155.5
The Sports Authority Group..... 147.9 7.8 155.7 25% 38.9
</TABLE>
- -------------------------
(1) Equals Kmart Group's net equity at January 26, 1994 minus 25% Retained
Interest (reflecting the assumption that Specialty Retail Stock intended to
represent 25% of all Specialty Retail Groups is outstanding).
(2) Equals 25% of the cumulative amortization arising from all applicable
Specialty Retail Group acquisitions (which is the portion of such
amortization not already reflected in Kmart Group's total assets less total
liabilities by virtue of its assumed 75% Retained Interest).
The MBCA limits the amount of distributions on Common Stock to the legally
available assets of the Company, which are determined on the basis of the entire
Company, and not just the respective Groups. Consequently, the amount of legally
available assets would reflect the amount of any net losses of any Group and any
distributions on, and repurchases of, Kmart Stock or any series of Specialty
Retail Stock, and any distributions on, and certain repurchases of, Preferred
Stock. Dividend payments on the Kmart Stock or on any series of Specialty Retail
Stock could be precluded because of the unavailability of legally available
assets under the MBCA, even though the Available Dividend Amount test with
respect to the relevant Group was met.
Subject to the prior payment of dividends on outstanding shares of
Preferred Stock and the foregoing limitations, the Board could, in its sole
discretion, declare and pay dividends on all or less than all series of
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Common Stock in equal or unequal amounts, notwithstanding the respective amount
of assets available for dividends on each series, the amount of prior dividends
declared on each series or any other factor.
At the time of any dividend, redemption or other distribution on the
outstanding shares of any series of Specialty Retail Stock (including any
dividend of or redemption with Net Proceeds from the Disposition of all or
substantially all of the properties and assets of the relevant Specialty Retail
Group), the Kmart Group's financial statements would be credited with, and such
Specialty Retail Group's financial statements would be charged with, an amount
equal to the product of (i) the aggregate amount of such dividend, redemption
payment or distribution paid or distributed in respect of the outstanding shares
of such Specialty Retail Stock times (ii) a fraction, the numerator of which is
the Number of Shares Issuable with Respect to Retained Interest in such
Specialty Retail Group and the denominator of which is the number of shares of
such Specialty Retail Stock then outstanding.
See Annex II for illustrations of the calculation of the Retained Interest
in a Specialty Retail Group and the related effects of dividends on shares of a
series of Specialty Retail Stock.
Exchange and Redemption. The Articles do not provide for either mandatory
or optional exchange or redemption of the Existing Common Stock.
Kmart Stock. The Specialty Retail Stock Proposal does not provide for
either mandatory or optional exchange or redemption of the Kmart Stock.
Specialty Retail Stock. The Specialty Retail Stock Proposal would
permit the exchange and redemption of shares of each series of Specialty
Retail Stock upon the terms described below.
Upon the sale, transfer, assignment or other disposition (whether by
merger, consolidation, sale or contribution of assets or stock or otherwise), in
one transaction or a series of related transactions (a "Disposition") by the
Company and/or its subsidiaries of all or substantially all of the properties
and assets of a Specialty Retail Group to one or more persons or entities
(subject to certain exceptions), the Company would be required, on or prior to
the 75th Trading Day following the consummation of such Disposition, to:
(A) declare and pay a dividend in cash and/or in securities or other
property received as proceeds of such Disposition to the holders of
outstanding shares of such series of Specialty Retail Stock, subject to the
limitations on dividends on such series of Specialty Retail Stock set forth
under "Dividends" above, in an aggregate amount equal to the product of the
Outstanding Interest Fraction with respect to such Specialty Retail Group
and the Net Proceeds of such Disposition; or
(B) to the extent that there are assets of the Company legally
available therefor, redeem the number of outstanding whole shares of such
series of outstanding Specialty Retail Stock that has an aggregate average
Market Value, during the ten-Trading Day period beginning on the sixth
Trading Day following such consummation, closest to the value of the
product of the Outstanding Interest Fraction with respect to such Specialty
Retail Group and the Net Proceeds of such Disposition, for cash and/or for
securities or other property received as proceeds of such Disposition in an
amount equal to such product; or
(C) exchange each outstanding whole share of such series of Specialty
Retail Stock for a number of shares of Kmart Stock equal to 110% of the
average daily ratio (calculated to the nearest five decimal places) of the
Market Value of one share of such series of Specialty Retail Stock to the
Market Value of one share of Kmart Stock during the ten-Trading Day period
beginning on the sixth Trading Day following such consummation.
For these purposes, "substantially all of the properties and assets" of any
Specialty Retail Group means a portion of such properties and assets (1) that
represents at least 80% of the then-current market value of the properties and
assets of such Specialty Retail Group or (2) from which were derived at least
80% of the aggregate revenues for the immediately preceding twelve fiscal
quarterly periods. That term would have a different meaning in the context of
determining whether there had been a sale of all or substantially all of the
assets of the Company necessitating a stockholder vote under the MBCA and the
Company's By-laws and, under current circumstances, such stockholder vote
requirements would not apply with respect to a sale of all
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or substantially all of the property and assets of any Specialty Retail Group
because such sale would not involve the sale of all or substantially all of the
property and assets of the Company. Under the MBCA, a sale or other disposition
of substantially all the property and assets of the Company, with or without
goodwill, if not in the usual and regular course of the Company's business,
would require approval of the holders of a majority of the outstanding shares of
the Kmart Stock, each series of Specialty Retail Stock and each series of
Preferred Stock then outstanding and entitled to vote with the Common Stock,
voting together as one class. Under the By-laws of the Company as currently in
effect, the sale of the entire assets, business and goodwill of the Company
requires approval of the holders of not less than three-fourths of the
outstanding capital stock of the Company.
The "Net Proceeds" of a Disposition of any of the properties and assets of
any Group means an amount, if any, equal to the gross proceeds of such
Disposition after any payment of, or reasonable provision for, (i) any taxes
payable by the Company in respect of such Disposition, (ii) any taxes payable by
the Company in respect of any resulting dividend or redemption, (iii) any
transaction costs, including, without limitation, any legal, investment banking
and accounting fees and expenses and (iv) any liabilities (contingent or
otherwise) of, or allocated to, such Group, including, without limitation, any
liabilities for deferred taxes or any indemnity or guarantee obligations which
are outstanding or incurred in connection with the Disposition or any
liabilities for future purchase price adjustments and any preferential amounts
plus any accumulated and unpaid dividends in respect of Preferred Stock
attributed to such Group. In connection with any dividend or redemption referred
to in clause (A) or (B) above following a Disposition, the Board could, in its
sole discretion, pay the dividend or redemption price referred to in clause (A)
or (B) above in cash even if securities or other non-cash properties were
received as proceeds of such Disposition.
The option described in clause (C) above provides the Company with
additional flexibility by allowing the Company to deliver consideration in the
form of shares of Kmart Stock rather than cash or securities or other properties
received as proceeds of a Disposition. This alternative could be used, for
example, in circumstances when the Company did not have sufficient legally
available assets under the MBCA to pay the full amount of the dividend or
redemption described in clause (A) or (B) above or when the Company desired to
retain such proceeds.
If less than substantially all of the properties and assets of any
Specialty Retail Group were disposed of by the Company in one transaction (even
if an additional transaction were consummated at a later time in which
additional properties and assets of such Specialty Retail Group were disposed of
by the Company, which, together with the properties and assets disposed of in
the first transaction, would have constituted substantially all of the
properties and assets of such Specialty Retail Group at the time of the first
transaction) the Company would not be required to pay a dividend on, redeem or
exchange, the outstanding shares of the relevant series of Specialty Retail
Stock, unless such transactions constituted a series of related transactions.
The second transaction, however, could trigger such requirement if, at the time
of the second transaction, the properties and assets disposed of in such
transaction constituted at least substantially all of the properties and assets
of such Specialty Retail Group at such time. If less than substantially all of
the properties and assets of such Specialty Retail Group were disposed of by the
Company, the holders of the relevant series of Specialty Retail Stock would not
be entitled to receive any dividend or have their shares redeemed or exchanged
for Kmart Stock, although the Board could determine, in its sole discretion, to
pay a dividend on such series of Specialty Retail Stock in an amount related to
the proceeds of such disposition. However, subject to certain permitted
inter-Group transfers, such proceeds could not be used in the business of the
Kmart Group or any other Specialty Retail Group without the approval of holders
of at least two-thirds of the votes to which the outstanding shares of such
series of Specialty Retail Stock were entitled, as set forth under "Voting
Rights" below.
The Board could, in its sole discretion, within one year after a dividend
or partial redemption, described in clause (A) or (B) above, exchange each
outstanding share of such series of Specialty Retail Stock for a number of
shares of Kmart Stock equal to 110% of the highest of certain average or
time-weighted average ratios of the Market Value of one share of such series of
Specialty Retail Stock to the Market Value of one share of Kmart Stock measured
during certain periods prior to the date notice of such exchange is mailed to
such holders. Any such exchange would dilute the interest of holders of Kmart
Stock and would preclude
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<PAGE> 67
holders of such series of Specialty Retail Stock from retaining their investment
in a security reflecting separately the business of the relevant Specialty
Retail Group. In determining whether to effect any such exchange following such
a dividend or partial redemption, the Board, in its sole discretion, could, in
addition to other matters, consider whether the remaining properties and assets
of the relevant Specialty Retail Group continue to constitute a viable business.
Other considerations could include the number of shares of such series of
Specialty Retail Stock remaining issued and outstanding, the per share market
price of such series of Specialty Retail Stock and the cost of maintaining
stockholder accounts.
The Board also could, in its sole discretion, at any time, declare that
each of the outstanding shares of any series of Specialty Retail Stock be
exchanged for a number of shares of Kmart Stock equal to 115% of the highest of
certain average or time-weighted average ratios of the Market Value of one share
of such Specialty Retail Stock to the Market Value of one share of Kmart Stock
measured during certain periods prior to the date notice of such exchange is
mailed to such holders. Any such exchange would dilute the interest of holders
of Kmart Stock and would preclude holders of such series of Specialty Retail
Stock from retaining their investment in a security reflecting separately the
business of the relevant Specialty Retail Group.
For information concerning the ratios used to calculate the number of
shares of Kmart Stock to be received in either of the exchanges described in the
two preceding paragraphs, see the definition of "Market Value Ratio" in Section
3(a)(iv) of Annex III-A.
Under Section 303 of the MBCA, upon the prior approval of stockholders, a
board of directors may amend a corporation's articles of incorporation to
increase the number of authorized shares of any class or series of stock to the
number that will be sufficient, when added to the previously authorized but
unissued shares of such class or series, to satisfy the conversion privileges of
any convertible securities of the corporation. This includes conversions at the
option of the corporation such as the exchanges of the various series of
Specialty Retail Stock for Kmart Stock described above. Accordingly, in order to
give effect to any such exchange of any series of Specialty Retail Stock for
Kmart Stock, the Board would have the authority to amend the Articles to
increase the authorized shares of Common Stock and of Kmart Stock to the number
that would be sufficient, when added to the previously authorized but unissued
shares of Common Stock and Kmart Stock, to give effect to such exchange.
At any time on or after the date on which all of the assets and liabilities
of any Specialty Retail Group (and no other assets or liabilities) are held
directly or indirectly by a wholly owned subsidiary of the Company (with respect
to each such Specialty Retail Group, the "Group Subsidiary"), the Board could,
in its sole discretion, provided there were assets of the Company legally
available therefor, exchange all of the outstanding shares of the relevant
series of Specialty Retail Stock for a number of shares of common stock of the
Group Subsidiary equal to the product of the Outstanding Interest Fraction with
respect to such Specialty Retail Group and the number of all of the outstanding
shares of common stock of the Group Subsidiary, on a pro rata basis. The Company
would retain and attribute to the Kmart Group any balance of the outstanding
shares of the Group Subsidiary in lieu of the Retained Interest of the Kmart
Group in such Specialty Retail Group, if any.
General Exchange and Redemption Provisions. Not earlier than the 16th
Trading Day and not later than the 20th Trading Day following the consummation
of a sale of all or substantially all of the properties and assets of a
Specialty Retail Group, the Company would be required to publish an announcement
in all editions of a daily newspaper with a national circulation as to which of
the actions specified in clause (A), (B) or (C) above it had irrevocably
determined to take. If the Company determined to pay a dividend pursuant to
clause (A) above, the Company would promptly cause to be given to each holder of
the relevant series of Specialty Retail Stock and of Convertible Securities
convertible into or exercisable for such series of Specialty Retail Stock a
notice setting forth (A) the record date for determining holders entitled to
receive such dividend, which shall be not earlier than the 30th Trading Day and
not later than the 40th Trading Day following the consummation of such
Disposition, (B) the anticipated payment date of such dividend, (C) the kind and
aggregate amount of shares of capital stock, cash and/or other securities or
other property to be distributed in respect of outstanding shares of such series
of Specialty Retail Stock, (D) the number of outstanding shares of such series
of Specialty Retail Stock and the number of shares of such series of Specialty
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Retail Stock into or for which outstanding Convertible Securities are then
convertible or exercisable and (E) a statement to the effect that holders of
such Convertible Securities would only be entitled to receive such dividend if
such Convertible Securities are converted into or exercised for such Specialty
Retail Stock prior to the record date. If the Company determined to undertake a
redemption pursuant to clause (B) above, the Company would promptly cause to be
given to each holder of record of outstanding shares of the relevant series of
Specialty Retail Stock and of Convertible Securities convertible into or
exercisable for such series of Specialty Retail Stock a notice setting forth (A)
a date not earlier than the 30th Trading Day and not later than the 40th Trading
Day following the consummation of such Disposition which shall be the date as of
which such series of Specialty Retail Stock then outstanding would be subject to
redemption, (B) the anticipated Redemption Date, (C) the kind and per share
amount of shares of capital stock, cash and/or securities or property to be paid
as a redemption price in respect of outstanding shares of such series of
Specialty Retail Stock, (D) the number of shares of such series of Specialty
Retail Stock to be redeemed, (E) the number of outstanding shares of such series
of Specialty Retail Stock and the number of shares of such series of Specialty
Retail Stock into or for which outstanding Convertible Securities are then
convertible or exercisable and (F) a statement to the effect that holders of
such Convertible Securities would only be eligible to participate in such
redemption if such Convertible Securities were converted into or exercised for
such series of Specialty Retail Stock prior to the date referred to in clause
(A) of this sentence, and a statement as to what, if anything, such holder would
be eligible to receive pursuant to the terms of such Convertible Securities and
the Articles if such holder converted or exercised such Convertible Securities.
In the event of any exchange or redemption described above, the Company
would promptly cause to be given to each holder of record of the series of
Specialty Retail Stock to be so exchanged or redeemed and, in the case of an
exchange, of Convertible Securities convertible into or exercisable for shares
of such series of Specialty Retail Stock, a further notice setting forth (A) a
statement that such series of Specialty Retail Stock would be exchanged or
redeemed, as the case may be, (B) the Exchange Date or the Redemption Date, as
the case may be, (C) in the event of a partial redemption of such series of
Specialty Retail Stock, the number of shares of such series of Specialty Retail
Stock to be redeemed, (D) the kind and per share amount of capital stock, cash
and/or other securities or other properties to be distributed to such holder
with respect to each share of such series of Specialty Retail Stock, including
details as to the calculation thereof, (E) the place or places where
certificates for shares of such series of Specialty Retail Stock, properly
endorsed or assigned for transfer (unless the Company waives such requirement)
would be surrendered for delivery of certificates for shares of such capital
stock, cash and/or securities or other property, (F) a statement to the effect
that, except for dividends or distributions declared prior to the record date
for the exchange or redemption, dividends on shares of such series of Specialty
Retail Stock would cease to be paid as of such Exchange Date or Redemption Date,
as the case may be, and (G) in the case of an exchange, a statement to the
effect that a holder of Convertible Securities would only be entitled to receive
shares of Kmart Stock upon such exchange if such holder converted or exercised
such Convertible Securities on or prior to such Exchange Date, and a statement
as to what, if anything, such holder would be entitled to receive pursuant to
the terms of such Convertible Securities and the Articles if such holder
converted or exercised such Convertible Securities. Such notice would be sent by
first-class mail, postage prepaid, not less than 25 nor more than 35 Trading
Days prior to the Exchange Date or Redemption Date, as the case may be, and, in
any case, to each holder of record of outstanding shares of the series of
Specialty Retail Stock to be exchanged or redeemed and, in the case of an
exchange, to each holder of record of outstanding Convertible Securities
convertible into or exercisable for shares of such series of Specialty Retail
Stock at such holder's address as the same appears on the stock transfer books
of the Company. Neither the failure to mail such notice to any particular holder
of shares of such series of Specialty Retail Stock or of such Convertible
Securities nor any defect therein would affect the sufficiency thereof with
respect to any other holder of outstanding shares of such series of Specialty
Retail Stock or of outstanding Convertible Securities convertible into or
exercisable for shares of such series of Specialty Retail Stock.
If less than all of the outstanding shares of any series of Specialty
Retail Stock were to be redeemed as described above, such shares would be
redeemed by the Company pro rata or by lot or by such other method as determined
by the Board to be equitable, from among the holders of outstanding shares of
such series of
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Specialty Retail Stock at the close of business on the date referred to in
clause (A) of the last sentence in the second preceding paragraph.
No adjustments in respect of dividends would be made upon the exchange or
redemption of any shares of any series of Specialty Retail Stock; provided,
however, that if such shares were exchanged or redeemed by the Company after the
record date for determining holders of such series of Specialty Retail Stock
entitled to any dividend or distribution thereon, such dividend or distribution
would be payable to the holders of such shares at the close of business on such
record date notwithstanding such exchange or redemption, in each case without
interest.
Before any holder of any series of Specialty Retail Stock would be entitled
to receive certificates representing shares of any kind of capital stock, cash
and/or other securities or property to be distributed to such holder with
respect to any exchange or redemption of shares of such series of Specialty
Retail Stock, such holder would be required to surrender at such place as the
Company specified certificates for shares of such series of Specialty Retail
Stock, properly endorsed or assigned for transfer (unless the Company waived
such requirement). As soon as practicable after the Company's receipt of
certificates for such shares of such series of Specialty Retail Stock, the
Company would deliver to the person for whose account such shares were so
surrendered, or to the nominee or nominees of such person, certificates
representing the number of whole shares of the kind of capital stock, cash
and/or other securities or property to which such person was entitled, together
with any fractional payment referred to below, in each case without interest. If
less than all of the shares of any series of Specialty Retail Stock represented
by any one certificate were to be redeemed, the Company would issue and deliver
a new certificate for the shares of such series of Specialty Retail Stock not
redeemed.
The Company would not be required to issue or deliver fractional shares of
any capital stock or of any other securities to any holder of any series of
Specialty Retail Stock upon any exchange, redemption, dividend or other
distribution described above. If more than one share of any series of Specialty
Retail Stock were held at the same time by the same holder, the Company could
aggregate the number of shares of any capital stock that would be issuable or
any other securities that would be distributable to such holder upon any such
exchange, redemption, dividend or other distribution (including any fractional
shares). If there are fractional shares of any capital stock or of any other
securities remaining to be issued or distributed to any holder of any series of
Specialty Retail Stock, the Company would, if such fractional shares were not
issued or distributed to such holder, pay cash in respect of such fractional
shares in an amount equal to the fair market value of such fractional shares on
the fifth Trading Day prior to the date such payment was to be made (without
interest). For purposes of the preceding sentence, "fair market value" of any
fractional share means (i) in the case of any fractional share of capital stock
of the Company, the product of such fractional share and the Market Value of one
share of such capital stock and (ii) in the case of any fractional share of any
other security, such value as is determined by the Board.
From and after any exchange or redemption of shares of a series of
Specialty Retail Stock, all rights of a holder of shares of such series of
Specialty Retail Stock that were exchanged or redeemed would cease except for
the right, upon surrender of the certificates representing such shares of such
series of Specialty Retail Stock, to receive certificates representing shares of
the kind and amount of capital stock and/or other securities or any cash or
other property for which such shares were exchanged or redeemed, together with
any fractional payment or rights to dividends as provided above, in each case
without interest. No holder of a certificate that immediately prior to the
exchange of any series of Specialty Retail Stock represented shares of such
series would be entitled to receive any dividend or other distribution with
respect to shares of Kmart Stock for which shares of such series of Specialty
Retail Stock were exchanged until surrender of such holder's certificate in
exchange for a certificate or certificates representing shares of Kmart Stock.
Upon such surrender, there would be paid to the holder the amount of any
dividends or other distributions (without interest) which theretofore became
payable with respect to a record date occurring after the exchange, but which
were not paid by reason of the foregoing, with respect to the number of whole
shares of Kmart Stock represented by the certificate or certificates issued upon
such surrender. From and after an exchange for any series of Specialty Retail
Stock, the Company would, however, be entitled to treat the certificates for
such series of Specialty Retail Stock that were not yet surrendered for exchange
as evidencing the ownership of the
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number of whole shares of Kmart Stock for which the shares of such series of
Specialty Retail Stock represented by such certificates should have been
exchanged, notwithstanding the failure to surrender such certificates.
The Company would pay any and all documentary, stamp or similar issue or
transfer taxes that might be payable in respect of the issue or delivery of any
shares of capital stock and/or other securities on exchange or redemption of
shares of any series of Specialty Retail Stock pursuant hereto. The Company
would not, however, be required to pay any tax that might be payable in respect
of any transfer involved in the issue and delivery of any shares of capital
stock and/or other securities in a name other than that in which the shares of
such series of Specialty Retail Stock so exchanged or redeemed were registered,
and no such issue or delivery would be made unless and until the person
requesting such issue paid to the Company the amount of any such tax, or
established to the satisfaction of the Company that such tax had been paid.
Voting Rights. The Articles currently provide that holders of Common Stock
and each series of Preferred Stock, voting together as one class, have one vote
per share on all matters coming before any meeting of stockholders, other than a
matter with respect to which the Common Stock or any series of Preferred Stock
would be entitled to vote as a separate class under express provisions of the
Articles or Michigan law. The Specialty Retail Stock Proposal provides that the
holders of all series of Common Stock, Series A Preferred Stock, Series B
Preferred Stock and any other series of Preferred Stock outstanding at the time
of such vote and so entitled to vote would vote together as one class on all
matters coming before any meeting of stockholders other than a matter with
respect to which the Common Stock or any series thereof or the Preferred Stock
or any series thereof would be entitled to vote as a separate class under
express provisions of the Articles or Michigan law. On all such matters, (i)
each outstanding share of Kmart Stock, Series A Preferred Stock and Series B
Preferred Stock would be entitled to one vote; and (ii) each outstanding share
of any series of Specialty Retail Stock would have a number of votes (including
a fractional vote) equal to the quotient (calculated to the nearest three
decimal places), as of the fifth Trading Day prior to the applicable record date
or as of any other applicable date, of (A) the sum of (1) four times the average
ratio of the Market Value of one share of such series of Specialty Retail Stock
("SR") to the Market Value of one share of Kmart Stock ("KM") for the
five-Trading Day period ending on such fifth Trading Day, (2) three times the
average ratio of SR to KM for the next preceding five-Trading Day period, (3)
two times the average ratio of SR to KM for the next preceding five-Trading Day
period and (4) the average ratio of SR to KM for the next preceding five-Trading
Day period, divided by (B) ten; provided that until any such series of Common
Stock has been traded after issuance on a national securities exchange or the
National Association of Securities Dealers Automated Quotations National Market
System for at least 25 Trading Days, each outstanding share of such series of
Common Stock would have a number of votes equal to the average ratio (calculated
to the nearest three decimal places) of the Market Value of one share of such
series of Common Stock to the Market Value of one share of Kmart Stock for each
Trading Day during the period commencing on the date such series is initially so
traded and ending on the last Trading Day on or before the applicable record
date or other applicable date. This formula is intended to equate the
proportionate voting rights of each series of Common Stock to their respective
Market Values at the time of any vote. However, no share of any such series of
Common Stock would be entitled to more than one vote prior to the Series A
Conversion Date, which will occur on or before September 15, 1994. If shares of
only one series of Common Stock were outstanding, each share of that series
would have one vote. On matters where any series of Common Stock was entitled to
vote as a separate class, each share of that series would be entitled to one
vote in the separate vote on such matter.
To illustrate the foregoing, if the weighted average Market Values for
Kmart Stock, one series of Specialty Retail Stock ("SR1 Stock") and a second
series of Specialty Retail Stock ("SR2 Stock"), (assuming shares of only two
series of Specialty Retail Stock and no series of Preferred Stock were then
outstanding), as determined using the above formula, were $4.00, $2.00 and
$1.00, respectively, each share of Kmart Stock would have one vote, each share
of SR1 Stock would have .5 of a vote ($2.00 / $4.00), and each share of SR2
Stock would have .25 of a vote ($1.00 / $4.00). In voting on any proposal where
all series of Common Stock are entitled to vote, voting together as one class,
and assuming there were issued and outstanding 500 shares of Kmart Stock, 100
shares of SR1 Stock and 100 shares of SR2 Stock, the shares of
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Kmart Stock, SR1 Stock and SR2 Stock would represent 87%, 9% and 4%,
respectively, of the total votes to which all series of Common Stock were
entitled. If, in the foregoing example, the weighted average Market Value for
the Kmart Stock remained at $4.00 and such Market Values for SR1 Stock and SR2
Stock increased to $6.00 and $3.00, respectively, each share of Kmart Stock
would have one vote, each share of SR1 Stock would have 1.5 votes ($6.00 /
$4.00), and each share of SR2 Stock would have .75 of a vote ($3.00 / $4.00).
Assuming the same number of issued and outstanding shares set forth above, the
shares of Kmart Stock, SR1 Stock and SR2 Stock would represent 69%, 21% and 10%,
respectively, of the total votes to which all series of Common Stock would be
entitled.
Based on the net assets of each Group as of January 26, 1994, the Company
believes that, had shares of each series of Specialty Retail Stock intended to
represent all of the Equity Value of each Specialty Retail Group been
outstanding on such date, the Kmart Stock would have continued to represent a
majority of the votes to which all series of Common Stock were entitled.
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, upon issuance of any series of Specialty Retail Stock,
the Company would set forth the number of outstanding shares of Kmart Stock and
each outstanding series of Specialty Retail Stock in its Annual and Quarterly
Reports filed pursuant to the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and would disclose in any proxy statement for a stockholder
meeting the number of outstanding shares and per share voting rights of the
Kmart Stock and each outstanding series of Specialty Retail Stock.
The relative voting rights of the Kmart Stock and each series of Specialty
Retail Stock could fluctuate as described above so that a holder's voting rights
could more closely reflect the Market Value of such holder's equity investment
in the Company. Fluctuations in the relative voting rights of the Kmart Stock
and each series of Specialty Retail Stock could influence an investor interested
in acquiring a fixed percentage of the votes to which all of the capital stock
of the Company is entitled to acquire such percentage of all series of Common
Stock, and would limit the ability of investors in one series to acquire for the
same consideration relatively more or less votes per share than investors in the
other series.
The MBCA, the Articles and the By-laws currently require the affirmative
vote of certain percentages either of the votes cast of shares entitled to vote
or of the outstanding shares entitled to vote at a stockholders meeting for
approval of matters that are submitted to a vote of the Company's stockholders.
The Specialty Retail Stock Proposal provides that, in addition to the vote
required by the MBCA, the Articles or the By-laws, the affirmative vote of the
same relevant percentages of the aggregate votes to which such shares are
entitled will be required for approval of such matters.
Following implementation of the Specialty Retail Stock Proposal, neither
the holders of Common Stock as a class nor the holders of Kmart Stock or any
series of Specialty Retail Stock would have any rights to vote separately as a
class on any matter coming before stockholders of the Company, except (i) the
two-thirds separate class vote requirements under certain limited circumstances
provided under the terms of the Certificate of Amendment and (ii) certain
limited class voting rights provided under Michigan law, each of which is
described in greater detail below.
Under the Specialty Retail Stock Proposal, in addition to such other vote
or consent as shall then be required by the MBCA, the Articles or the By-laws,
the affirmative vote of at least 66 2/3% of all of the shares of any series of
Common Stock (the "Affected Stock") issued with reference to any Group (the
"Affected Group") then outstanding, voting as a separate class, would be
necessary for any of the following transactions, except as provided below or as
otherwise permitted by the terms of the Articles:
(i) the declaration or payment of any dividend on, or the making of
any other payment or distribution with respect to, any shares of any other
series of Common Stock, if such dividend, payment or distribution were to
be made with (A) any of the properties and assets of the Affected Group or
(B) shares of Affected Stock (or Convertible Securities convertible into or
exercisable for Affected Stock) or (C) any security that represents an
equity interest in an entity (other than the Company) that owns any of the
properties or assets of the Affected Group, other than any shares of
Affected Stock (or Convertible Securities convertible into or exercisable
for Affected Stock) issued by the Company as a
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dividend or distribution on Kmart Stock, provided that any such payment,
dividend or distribution may in any case only be made to the extent that
the sum of the number of shares of Affected Stock so issued (or the number
of such shares which would be issuable upon conversion or exercise of the
Convertible Securities to be so issued), and the number of shares which are
issuable upon conversion or exercise of any Convertible Securities then
outstanding which are attributed to the Kmart Group is less than or equal
to the Number of Shares Issuable With Respect to Retained Interest of the
Kmart Group in the Affected Group;
(ii) the use of any of the properties and assets of the Affected Group
in any business of the Company other than a business of the Affected Group,
unless such use arises from a transfer for value of such properties or
assets from one Group to another; or
(iii) any issuance or sale of shares of Affected Stock, or Convertible
Securities convertible into or exercisable for Affected Stock, for the
account of any Group other than (x) the Affected Group or (y) if the
Affected Group is any Specialty Retail Group, the Kmart Group but only if
the sum of the number of shares of Affected Stock to be so issued or sold,
or the number of shares of Affected Stock into or for which such
Convertible Securities to be issued or sold would be convertible or
exercisable at such time, and the number of shares which are issuable upon
conversion or exercise of any other Convertible Securities then outstanding
which are attributed to the Kmart Group would not exceed the Number of
Shares Issuable With Respect to Retained Interest of the Kmart Group in
such Affected Group.
Notwithstanding the foregoing, no such separate class vote would be
required for a transfer accounted for as a loan by an Affected Group to any
other Group at a rate determined in a manner consistent with the Company's
policy with respect to loans between Groups at such time. See "Management and
Accounting Policies" above.
The approval of a majority of the outstanding shares of any class of
capital stock of the Company voting as a separate class would currently be
required under the MBCA for any amendment to the Articles to increase or
decrease the aggregate number of authorized shares of the class, or alter or
change the powers, preferences or special rights of the class or of other
classes so as to affect such class adversely, and, for such amendment to alter
or change the powers, preferences or special rights of a class so as to affect
adversely one or more series of a class, but not the entire class, then approval
would be required only of the shares of the one or more series, each voting as a
separate class. In addition, the MBCA requires that any amendment to the
Articles which would alter or change the powers, preferences or special rights
of any series so as to affect adversely one or more other series, would
necessitate the approval of the shares of the adversely affected series, each
voting as a separate class.
Liquidation. The Articles currently provide that, in the event of a
liquidation, dissolution or winding-up of the Company, after payment, or
provision for payment, of the debts and other liabilities of the Company and the
amounts to which the holders of the Preferred Stock (including Series A
Preferred Stock and Series B Preferred Stock) are entitled, holders of Existing
Common Stock would be entitled to share ratably in the remaining net assets of
the Company. Under the Specialty Retail Stock Proposal, the holders of shares of
each outstanding series of Common Stock would be entitled to share such
remaining net assets, and each would be entitled to receive a fraction of such
assets equal to the quotient of (A) the sum of (1) four times the average ratio
of the Market Capitalization of such series of Common Stock ("x") to the
aggregate Market Capitalization of all other outstanding series of Common Stock
("y") for the five-Trading Day period ending on the Trading Day prior to the
date of the first public announcement of (i) a voluntary liquidation,
dissolution or winding-up by the Company or (ii) the institution of any
proceeding for the involuntary liquidation, dissolution or winding-up of the
Company, (2) three times the average ratio of x to y for the next preceding
five-Trading Day period, (3) two times the average ratio of x to y for the next
preceding five-Trading Day period and (4) the average ratio of x to y for the
next preceding five-Trading Day period, divided by (B) ten.
Neither the merger nor consolidation of the Company into or with any other
corporation, nor the merger or consolidation of any other corporation into or
with the Company, nor a sale, transfer or lease of all or any part of the assets
of the Company, would be deemed a liquidation, dissolution or winding-up for
these purposes.
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Determinations by the Board. If the Specialty Retail Stock Proposal is
approved by stockholders and implemented by the Board, the Articles would
provide that any determinations made in good faith by the Board under Article
III of the Articles or in any Certificate of Designation filed pursuant thereto,
and any determinations with respect to any Group or the rights of holders of
shares of any series of Common Stock made pursuant to or in furtherance of
Article III of the Articles, would be final and binding on all stockholders of
the Company, subject to the rights of stockholders under applicable Michigan law
and under the federal securities laws.
Preemptive Rights. Neither the holders of the Kmart Stock nor the holders
of any series of Specialty Retail Stock would have any preemptive rights to
subscribe for any additional shares of capital stock or other obligations
convertible into or exercisable for shares of capital stock that may hereafter
be issued by the Company.
RETAINED INTEREST OF KMART GROUP IN SPECIALTY RETAIL GROUPS; OUTSTANDING
INTEREST FRACTION
Since it is currently contemplated that the number of shares of each series
of Specialty Retail Stock to be issued and sold in an Offering would be intended
to represent approximately 20% to 30% of the Equity Value of the relevant
Specialty Retail Group, the Company would retain and attribute to the Kmart
Group a 70% to 80% Retained Interest in such Specialty Retail Group. The
"Outstanding Interest Fraction" with respect to any such Specialty Retail Group
means the percentage interest in such Group intended to be represented at any
time by the outstanding shares of the relevant series of Specialty Retail Stock,
and the "Retained Interest Fraction" with respect to such Group means the
remaining percentage interest in such Group that is attributed to the Kmart
Group. The sum of the Outstanding Interest Fraction and the Retained Interest
Fraction with respect to any Specialty Retail Group would always equal 100%. The
Kmart Group's Retained Interest in any Specialty Retail Group would not be
represented by actual shares of the relevant series of Specialty Retail Stock
and could not be voted by the Kmart Group. The "Number of Shares Issuable with
Respect to Retained Interest" means the number of shares of the relevant series
of Specialty Retail Stock that could be sold or otherwise issued by the Company
for the account of the Kmart Group in respect of its Retained Interest. The
authorized shares of the relevant series of Specialty Retail Stock in excess of
the total number of shares of such series outstanding immediately after the date
of initial issuance of such shares would be available for issuance without
further approval by stockholders (including under various benefit plans, as
amended or adopted pursuant to Proposals 5 through 12 set forth below) and could
be issued at any time at prices that could dilute the value of the then
outstanding shares of such series of Specialty Retail Stock. See "Special
Considerations -- Dilution" above.
At the time of any sale of a series of Specialty Retail Stock, the Board
would, in its sole discretion, determine the allocation of the net proceeds of
such sale between the Kmart Group and the relevant Specialty Retail Group. The
Board could allocate 100% of the net proceeds of a sale of any series of
Specialty Retail Stock to the Kmart Group or to the relevant Specialty Retail
Group, in which event the net proceeds would be reflected entirely in the
financial statements of the Group to which such proceeds would be allocated. The
Company currently intends to allocate the net proceeds of the Offerings to the
Kmart Group, to be used to repay outstanding indebtedness of the Company and for
general corporate purposes. Because the percentage of the Equity Value of a
Specialty Retail Group to be sold to the public in an Offering of the relevant
Specialty Retail Stock would not be determined until the time of such Offering,
the amount of the Retained Interest in such Specialty Retail Group that would be
attributed to the Kmart Group following an Offering cannot yet be determined;
however, the Company currently anticipates that the Retained Interest Fraction
with respect to each Specialty Retail Group following the relevant Offering
would be 70-80%. The relevant Number of Shares Issuable with Respect to Retained
Interest would be reduced if the net proceeds of any subsequent offering of such
series of Specialty Retail Stock were allocated to the Kmart Group's Retained
Interest in such Specialty Retail Group. If the net proceeds of such an offering
were not allocated to the Kmart Group, the Number of Shares Issuable with
Respect to Retained Interest in the relevant Specialty Retail Group would not be
reduced, but the Retained Interest Fraction with respect to the relevant
Specialty Retail Group would nonetheless be reduced, and the Outstanding
Interest Fraction with respect to such Specialty Retail Group would be increased
accordingly.
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If any shares of such series of Specialty Retail Stock were subsequently
issued from time to time by the Company, the Company would identify (i) the
number of shares of such series of Specialty Retail Stock issued for the account
of the Kmart Group with respect to its Retained Interest, the net proceeds of
which would be reflected entirely in the financial statements of the Kmart
Group, and (ii) the number of such shares issued for the account of the relevant
Specialty Retail Group as additional equity in such Specialty Retail Group, the
net proceeds of which would be reflected entirely in the financial statements of
such Specialty Retail Group. Such determination would be made by the Board, in
its sole discretion, after consideration of a number of factors, including,
among others, the relative levels of internally generated cash flow of each
Group, the capital expenditure plans of and investment opportunities available
to each Group, the long-term business prospects for each Group and the
availability, cost and time associated with alternative financing sources.
As additional shares of any series of Specialty Retail Stock were issued,
the Retained Interest Fraction with respect to the relevant Specialty Retail
Group would decrease, and the Outstanding Interest Fraction with respect to such
Specialty Retail Group would increase accordingly.
If the Company issued shares of such series of Specialty Retail Stock for
the account of the Kmart Group, the relative voting power of holders of shares
of such series of Specialty Retail Stock immediately prior to such issuance
would be diluted even though any consideration received for such shares would
not be attributed to such Specialty Retail Group. At any time that all shares of
any series of Specialty Retail Stock that were issuable with respect to the
Retained Interest in such Specialty Retail Group were issued, the Retained
Interest would be zero and shares of such series of Specialty Retail Stock could
no longer be issued for the account of the Kmart Group.
In the event of any dividend or other distribution on outstanding shares of
any series of Specialty Retail Stock (including any dividend of, or redemption
with, Net Proceeds from a Disposition), while the Kmart Group has a Retained
Interest in such Specialty Retail Group, the Kmart Group's financial statements
would be credited with, and such Specialty Retail Group's financial statements
would be charged with, an amount equal to the product of (i) the aggregate
amount paid in respect of such dividend or other distribution, times (ii) a
fraction, the numerator of which is the Number of Shares Issuable with Respect
to Retained Interest in the relevant Specialty Retail Group and the denominator
of which is the number of shares of such series of Specialty Retail Stock then
outstanding.
In the event that the Company repurchases shares of any series of Specialty
Retail Stock for consideration that is attributed to the Kmart Group, the Number
of Shares Issuable with Respect to Retained Interest and the Retained Interest
Fraction with respect to the relevant Specialty Retail Group would increase, and
the Outstanding Interest Fraction with respect to such Specialty Retail Group
would decrease accordingly.
The Company would not be permitted to transfer cash or other property of a
Specialty Retail Group to the Kmart Group in consideration of a decrease in the
Kmart Group's Retained Interest in such Specialty Retail Group, except in
connection with (i) any offer by the Company to purchase outstanding shares of
any series of Specialty Retail Stock in a tender or exchange offer made by the
Company to all holders of shares of such series, or (ii) any repurchase by the
Company of outstanding shares of such series in a publicly announced open market
repurchase program, in each case the payment for which is attributed to the
relevant Specialty Retail Group. In the event of a tender or exchange offer, the
Board could, in its sole discretion, determine to transfer to the Kmart Group
from such Specialty Retail Group funds in an amount determined as of a day
within five Trading Days after consummation of such tender or exchange offer and
which does not exceed the product of (x) the aggregate amount offered to holders
of outstanding shares of such series of Specialty Retail Stock and (y) a
fraction (determined as of such day) the numerator of which is equal to the
Number of Shares Issuable with Respect to Retained Interest in such Specialty
Retail Group and the denominator of which is the number of shares of the
relevant series of Specialty Retail Stock then outstanding. In the event of an
open market repurchase program, the Board could, in its sole discretion,
determine to transfer to the Kmart Group from such Specialty Retail Group funds
in an amount which does not exceed the product of (x) the amount paid to holders
of outstanding shares of such series of Specialty Retail Stock in connection
with such open market repurchase program and (y) a fraction the numerator of
which is the
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Number of Shares Issuable with Respect to Retained Interest in such Specialty
Retail Group and the denominator of which is the number of shares of the
relevant series of Specialty Retail Stock then outstanding. Determinations to so
transfer funds to the Kmart Group in connection with an open market repurchase
program would be made by the Board from time to time with respect to prospective
repurchases of outstanding shares of such series of Specialty Retail Stock
pursuant to such program. Each of the transfers described above is referred to
herein as a "Permitted Transfer". In the event of a Permitted Transfer, the
Number of Shares Issuable with Respect to Retained Interest in such Specialty
Retail Group would be reduced by the number equal to the value (as determined by
the Board) of assets or properties so transferred by such Specialty Retail Group
to the Kmart Group divided by the average per share value (as determined by the
Board) of the consideration paid to holders of outstanding shares of such series
of Specialty Retail Stock in connection with the repurchases with respect to
which such Permitted Transfer was made.
The Board would, in its sole discretion, determine whether repurchases of
any series of Specialty Retail Stock should be made with consideration
attributable to the Kmart Group or the relevant Specialty Retail Group, by
considering a number of factors, including, among others, the relative levels of
internally generated cash flow of each Group, the capital expenditure plans of
each Group, the investment opportunities available to each Group, the long-term
business prospects for each Group, the availability, costs and time associated
with alternative financing sources.
The Board could, in its sole discretion, determine from time to time to
contribute cash or other property of the Kmart Group as additional equity to a
Specialty Retail Group, which would increase the Kmart Group's Retained Interest
in such Specialty Retail Group and, accordingly, would increase the Retained
Interest Fraction and decrease the Outstanding Interest Fraction with respect to
such Specialty Retail Group. The Board could determine, in its sole discretion,
to make such contribution after consideration of a number of factors, including,
among others, the relative levels of internally generated cash flow of the
Groups, the long-term business prospects for each Group, the capital expenditure
plans of and the investment opportunities available to each Group, and the
availability, cost and time associated with alternative financing sources.
For further discussion of, and illustrations of the calculation of the
Retained Interest Fraction, the Outstanding Interest Fraction and the Number of
Shares Issuable with Respect to Retained Interest and the effects thereon of
dividends on, and issuances and repurchases of, shares of a series of Specialty
Retail Stock, and transfers of cash or other property attributed to the Kmart
Group to any Specialty Retail Group, see Annex II hereto.
BACKGROUND AND REASONS FOR THE SPECIALTY RETAIL STOCK PROPOSAL
The Board continually reviews each of the Company's businesses to determine
the best way to realize their inherent values. As a result of this review
process, the Company determined to sell both its PACE Membership Warehouse and
PayLess Drug Store businesses and, beginning in June 1993, began to evaluate
various restructuring alternatives involving the specialty retail businesses,
including possible sales or spin-offs of the Specialty Retail Subsidiaries,
equity offerings of stock of the Specialty Retail Subsidiaries and equity
offerings of "targeted stock" of the Company that would be intended to reflect
the performance of the specialty retail businesses. Because of their potential
for substantial future growth and because of the Company's commitment to
specialty retailing, the Board determined not to sell or spin-off the Specialty
Retail Subsidiaries and to explore ways to maintain control of the specialty
retail businesses while realizing the benefits of their continued growth.
The Board considered the sale of stock of the Specialty Retail Subsidiaries
rather than targeted stock of the Company. However, upon the recommendation of
management and after extensive consultation with its investment bankers and
legal advisors, the Board determined that the sale of targeted stock would be
preferable to selling stock of the Specialty Retail Subsidiaries because, among
other things, sales of targeted stock would preserve certain favorable operating
and tax attributes, which sales of stock in the Specialty Retail Subsidiaries
would not. These attributes include lower borrowing and other administrative
costs and more favorable tax treatment for the Company (including the specialty
retail businesses), more flexibility to implement a different capital structure
in the future and maintenance of control by the Company of the
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specialty retail businesses. At meetings held between June and December 1993,
the Board met with management, the Company's investment bankers and its outside
legal counsel regarding their analyses of the targeted stock proposal and
considered the sale of targeted stock. The Board authorized management to
continue to explore the possible sale of targeted stock and to finalize the
details of a definitive proposal. On January 18, 1994, the Board reviewed the
Specialty Retail Stock Proposal and determined that the Specialty Retail Stock
Proposal was in the best interests of the Company and unanimously resolved to
recommend that the Company's stockholders vote to adopt the Specialty Retail
Stock Proposal.
The Specialty Retail Stock Proposal is intended to enhance stockholder
value over the long term by permitting separate market valuations of each series
of the Specialty Retail Stock, which would result in greater market recognition
of the value of each of the specialty retail businesses, and by fostering an
ownership culture that would encourage superior performance by management and
employees at each specialty retail business.
In arriving at its recommendation and its determination that the Specialty
Retail Stock Proposal is in the best interests of the Company, the Board, with
the assistance of its financial and legal advisers, considered various aspects
of the proposal at its meetings. In addition to the considerations described
above, the Board considered, among other things, the following:
- The Specialty Retail Stock Proposal would allow employee benefit and
incentive plans to be structured so that they are tied more directly to
the performance of each Group. The Board believes that this would serve to
align executive and stockholder long-term interests by creating a direct
link between executive compensation and stockholder return.
- The sale of series of Specialty Retail Stock in the Offerings would
enable the Company to raise significant additional capital that would
reduce the Company's debt-to-equity ratio.
- Stocks of specialty retailers comparable to the Specialty Retail Groups
typically trade at higher price/earnings multiples than stocks of discount
retailers. The Board, after consultation with its investment bankers,
believes that the Specialty Retail Stock would be perceived by the
securities markets to be similar to stocks of comparable specialty
retailers and, as a result, could trade at a higher price/earnings
multiple than the Existing Common Stock, thereby providing increased
financial flexibility and a lower cost of equity capital.
- The separate recording of the financial results for each Group and
separate trading of each series of Specialty Retail Stock could result in
more focused equity research coverage by financial analysts, which should
enable the investment community to gain a better understanding of each
Group and could serve as an additional discipline on the performance of
each Group.
- From a credit perspective, the Kmart Group and each of the Specialty
Retail Groups would benefit from the credit rating of the Company as a
whole and, therefore, each Group would continue to benefit from being part
of the Kmart organization.
The Board also evaluated the potential negative aspects of the Specialty
Retail Stock Proposal, including the uncertainty with respect to the proceeds to
be realized in the Offerings and their impact on the market price of the
Existing Common Stock, as well as the facts that implementation of the Specialty
Retail Stock Proposal would make the capital structure of the Company more
complex, would require additional disclosure with respect to each of its
Specialty Retail Groups and would expand the Board's responsibility to oversee
the interests of stockholders by creating five series of Common Stock. The Board
determined, however, that the positive aspects of the Specialty Retail Stock
Proposal outweighed any negative aspects and concluded that the Specialty Retail
Stock Proposal is in the best interests of the Company.
Following approval by stockholders of the Specialty Retail Stock Proposal,
the Company currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate Offerings and to allocate the net proceeds of the Offerings to the
Kmart Group to repay outstanding indebtedness of the Company and for general
corporate purposes. The timing, sequence and size of such Offerings and the
price at which such shares would be sold would be determined by the Board,
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without further approval of stockholders, at the time of each Offering; however,
it is currently contemplated that the Company would initially offer to the
public shares of each series of Specialty Retail Stock that would be intended to
represent approximately 20% to 30% of the Equity Value of the relevant Specialty
Retail Group at the time of such Offering. The terms of each Offering would be
determined by the Board and the underwriters of such Offering based upon
prevailing market conditions; the financial condition and results of operations
of the relevant Specialty Retail Group; the history of and prospects for the
relevant Specialty Retail Group, the specialty retail industry and the segment
of that industry in which the relevant Specialty Retail Group competes; the
management and operations of the relevant Specialty Retail Group; the progress
of the relevant Specialty Retail Group in implementing its business strategy;
the foregoing factors in relation to market values of other companies engaged in
similar businesses; and the financial condition of the Company as a whole. In
addition to or in lieu of any Offering, the Board reserves the right to issue
shares of any series of Specialty Retail Stock as a distribution on the Kmart
Stock, although the Board has no current intention to do so.
SHARES ISSUABLE UNDER EMPLOYEE BENEFIT PLANS
One of the principal purposes of the Specialty Retail Stock Proposal is to
enable the Company to structure employee benefit plans with an equity security
specifically related to each of the Company's businesses. In this regard, the
Company is submitting for stockholder approval the SRS Plan, each of which
provides for employee ownership of Specialty Retail Stock. The aggregate
percentage interest in the Equity Value of the Specialty Retail Groups
represented by the shares issuable pursuant to the SRS Plans would be as
follows: Borders-Walden Group, 19.75%; Builders Square Group, 11.95%; OfficeMax
Group 9.45%; and The Sports Authority Group 10.65%. The percentage interest
represented by the number of shares actually issued pursuant to the SRS Plans
could be considerably less depending on the degree to which awards are made,
vested and exercised pursuant to such SRS Plans.
The shares of Common Stock to be issued pursuant to the SRS Plans could be
issued out of authorized but unissued shares or out of shares reacquired by the
Company. To the extent that shares of Specialty Retail Stock issuable pursuant
to the SRS Plans relate to conversions of outstanding restricted shares or stock
options that relate to Existing Common Stock, the issuance of such shares of
Specialty Retail Stock would be attributed to the Kmart Group in respect of its
Retained Interest in the relevant Specialty Retail Group and would reduce the
Number of Shares Issuable with Respect to Retained Interest in such Specialty
Retail Group. Accordingly, the Retained Interest Fraction with respect to the
relevant Specialty Retail Group would be reduced and the Outstanding Interest
Fraction with respect to such Specialty Retail Group would be increased
proportionately.
To the extent that shares of Specialty Retail Stock issuable pursuant to
the SRS Plans relate to restricted shares or stock options not currently
outstanding, the issuance of such shares would be attributed to the relevant
Specialty Retail Group, and would not reduce the Number of Shares Issuable with
Respect to Retained Interest in the relevant Specialty Retail Group. However,
the Retained Interest Fraction with respect to the relevant Specialty Retail
Group would nonetheless be reduced and the Outstanding Interest Fraction with
respect to such Specialty Retail Group would be increased proportionately.
The Company believes that issuance of shares of Specialty Retail Stock
pursuant to the SRS Plans would not result in a meaningful reduction of the
Kmart Group's Retained Interest in each Specialty Retail Group. The aggregate
percentage interest in the Equity Value of the Specialty Retail Groups
represented by shares issuable pursuant to the SRS Plans that would reduce the
Number of Shares Issuable with Respect to Retained Interest in the relevant
Specialty Retail Group would be less than 2% with respect to each Specialty
Retail Group. The extent to which the issuance of shares of Specialty Retail
Stock pursuant to the SRS Plans would actually reduce the Number of Shares
Issuable with Respect to Retained Interest would be dependent upon the extent to
which participants elect to convert their interests in Existing Common Stock
(or, after the redesignation, Kmart Stock) under the SRS Plans into interests in
Specialty Retail Stock. In addition, such conversions by participants would
result in cancellation of the participants' rights to receive Existing Common
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Stock (or, after the redesignation, Kmart Stock) and any proceeds received upon
the issuance of such shares of Specialty Retail Stock would be allocated to the
Kmart Group.
STOCK EXCHANGE LISTINGS
Application will be made to the NYSE, CSE and PSE for the approval of the
proposed redesignation of the Existing Common Stock as Kmart Stock. The Company
intends to apply for the listing of each series of Specialty Retail Stock on
such stock exchanges as the Board deems appropriate at the time of issuances of
shares of such series.
FINANCIAL ADVISORS
The Company has engaged Goldman, Sachs & Co. as its primary strategic
financial advisor in connection with the Specialty Retail Stock Proposal.
Goldman, Sachs & Co. assisted the Company in its analysis and consideration of
various financial alternatives relating to all or part of the specialty retail
businesses, including possible spin-offs or sales of stock of the Specialty
Retail Subsidiaries and the adoption of a targeted stock program. Goldman, Sachs
& Co. is further assisting the Company with regard to the implementation of the
Specialty Retail Stock Proposal. The Company has paid Goldman, Sachs & Co. $2.0
million for its services. The Company has also agreed to reimburse Goldman,
Sachs & Co. for certain reasonable out-of-pocket expenses (including fees and
expenses of its legal counsel) and has agreed to indemnify Goldman, Sachs & Co.
against certain liabilities, including liabilities under the federal securities
laws. In addition, the Company has agreed that, in the event of certain of the
Offerings, Goldman, Sachs & Co. may, at its option, act as lead manager or
agent.
The Company has engaged Lehman Brothers as its primary targeted stock
advisor in connection with the Specialty Retail Stock Proposal. In connection
with the Specialty Retail Stock Proposal, Lehman Brothers provided the Company
with assistance regarding, among other things, securities structure, valuation
analysis and preparation of documentation, and is continuing to assist the
Company with regard to implementation of the Specialty Retail Stock Proposal.
The Company has paid Lehman Brothers $1.0 million for its services. Because
Lehman Brothers has been engaged to provide advice specifically relating to the
Specialty Retail Stock Proposal, the Company will pay Lehman Brothers an
additional $1.0 million if the Specialty Retail Stock Proposal is approved by
stockholders. The Company has also agreed to reimburse Lehman Brothers for
certain reasonable out-of-pocket expenses (including fees and expenses of its
legal counsel) and has agreed to indemnify Lehman Brothers against certain
liabilities, including liabilities under the federal securities laws. In
addition, the Company has agreed that, in the event of certain of the Offerings,
Lehman Brothers may, at its option, act as co-manager or agent.
Neither Goldman, Sachs & Co. nor Lehman Brothers will participate in the
solicitation of proxies.
STOCK TRANSFER AGENT AND REGISTRAR
NBD Bank, N.A. is the registrar and transfer agent for the Existing Common
Stock. If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, the registrar and transfer agent for each series of
Specialty Retail Stock would be selected at the time of any Offering or other
distribution of each series of Specialty Retail Stock as the Board deems
appropriate.
The First Chicago Trust Company of New York is the registrar and transfer
agent for the Series A Preferred Stock. The Company is the registrar and
transfer agent for the Series B Preferred Stock.
RESTATED RIGHTS AGREEMENT
On May 17, 1988, the Company declared a dividend distribution to holders of
Existing Common Stock of one right for each share of Existing Common Stock. Each
right entitles the registered holder to purchase from the Company a unit
consisting of one one-thousandth of a share of Series A Junior Preferred Stock,
no par value per share, at a purchase price of $110 per Unit, subject to
adjustment from time to time to prevent dilution. The description and terms of
the Rights are set forth in the Rights Agreement, as previously
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amended (the "Rights Agreement"), between the Company and National Bank of
Detroit, (the "Rights Agent"). If the Specialty Retail Stock Proposal is
approved by stockholders and implemented by the Board, upon issuance of any
series of Specialty Retail Stock, the Rights Agreement would be amended and
restated to reflect the change in the capital structure of the Company, and the
Board would authorize and declare a distribution on any series of Specialty
Retail Stock that might be issued from time to time of one additional right (an
"Additional Right") for each outstanding share of any series of Specialty Retail
Stock. Each existing right, without any action by the holder thereof, would,
upon issuance of any series of Specialty Retail Stock and redesignation of the
Existing Common Stock as Kmart Group Stock, become a Kmart Group right (a "Kmart
Group Right"). The Rights Agreement, as amended and restated (the "Restated
Rights Agreement"), would provide that each Kmart Group Right and each
Additional Right (each, a "Right") would entitle the registered holder to
purchase from the Company a unit consisting of one one-hundredth of a share (a
"Unit") of Series A Junior Preferred Stock, no par value, at a purchase price of
$110.00 in cash per Unit, subject to adjustment from time to time to prevent
dilution.
The Rights would not be exercisable until the Distribution Date (defined
below) and, unless earlier redeemed by the Company as described below, the
Rights Agreement would expire no later than 30 days after the Company's May 1995
Annual Meeting, unless stockholders should approve continuation of the Rights
Agreement at that meeting.
The Restated Rights Agreement would provide that, prior to a Distribution
Date, the Kmart Group Rights and the Additional Rights would attach to all
certificates representing shares of Kmart Stock or Specialty Retail Stock,
respectively, then outstanding and no separate Rights certificates would be
distributed. Each share of Kmart Stock would represent one Kmart Group Right and
each share of Specialty Retail Stock would represent one Additional Right. The
Kmart Stock and each outstanding series of Specialty Retail Stock are sometimes
hereinafter referred to together as the "Voting Common Stock." The Rights would
separate from the Voting Common Stock and a "Distribution Date" would occur upon
the earlier of (i) 10 Business Days (as defined in the Restated Rights
Agreement) following a public announcement that a person or group of affiliated
or associated persons (an "Acquiring Person") had acquired (except pursuant to a
Qualifying Offer (defined in the Restated Rights Agreement as an all-cash tender
offer for all outstanding shares of Voting Stock (as defined below) meeting
certain prescribed requirements)), or had obtained the right to acquire,
beneficial ownership of Voting Stock representing 20% or more of the total votes
to which all outstanding shares of Voting Stock were entitled (the "Stock
Acquisition Date"), (ii) 10 Business Days (or upon such later date as may be
determined by the Board) following the commencement of a tender offer or
exchange offer (other than a Qualifying Offer) that would result in a person or
group beneficially owning Voting Stock representing 20% or more of the total
voting power of all outstanding shares of Voting Stock or (iii) 10 Business Days
following a determination by the Board that a Person (as defined in the Restated
Rights Agreement) had become an Adverse Person (as defined in the Restated
Rights Agreement). For purposes of the Restated Rights Agreement, Voting Stock
shall include all shares of capital stock of the Company entitled to vote on
matters submitted to the stockholders of the Company generally and total votes
to which the Voting Stock is entitled would be determined based upon the most
recent calculation announced by the Company. See "Description of Kmart Stock and
Specialty Retail Stock -- Voting Rights." If a person inadvertently becomes the
beneficial owner of Voting Stock representing 20% or more of the total votes to
which all outstanding shares of Voting Stock were entitled due to the
recalculation by the Company of the votes to which the Kmart Stock was entitled
and to which any series of Specialty Retail Stock was entitled, such person
would not be an Acquiring Person unless and until such person acquired
additional shares of Voting Stock.
Until the Distribution Date, (i) the Rights would be evidenced by the
Voting Common Stock certificates and would be transferred with and only with
such Voting Common Stock certificates, (ii) new Voting Common Stock certificates
(including Common Stock certificates representing the Kmart Stock and any series
of Specialty Retail Stock) would contain a notation incorporating the Rights
Agreement by reference and (iii) the surrender and transfer of any certificates
for Voting Common Stock outstanding would also constitute the transfer of the
Rights associated therewith.
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In the event that (i) a person or group becomes the beneficial owner of
Voting Stock representing 20% or more of the total votes to which all
outstanding shares of Voting Stock are entitled (except pursuant to a Qualifying
Offer) or (ii) the Board determines that a person is an Adverse Person, the
Rights would "flip-in" and entitle each holder of a Right (other than the
Acquiring Person and certain related parties) to receive, upon exercise, Kmart
Stock or the relevant series of Specialty Retail Stock, as the case may be (or,
in certain circumstances, cash, property or other securities of the Company),
having a value equal to two times the exercise price of the Kmart Group Right or
such Additional Right, respectively. Notwithstanding the foregoing, following
the occurrence of any of the events set forth in this paragraph, all Rights that
were, or (under certain circumstances specified in the Rights Agreement) had
been, beneficially owned by an Acquiring Person or Adverse Person would be null
and void. However, Rights would not be exercisable until such time as the Rights
were no longer redeemable by the Company as set forth below.
In the event that, at any time following the Stock Acquisition Date, (i)
the Company is acquired in a merger or other business combination transaction in
which the Company is not the surviving corporation (other than a merger that
follows a Qualifying Offer), (ii) any person consolidates with, or merges with
or into, the Company, and the Company is the surviving corporation and, in
connection therewith, all or part of the outstanding shares of Voting Common
Stock are changed into or exchanged for stock or other securities of any person
or cash or any other property, or (iii) more than 50% of the Company's assets,
earning power or cash flow is sold or transferred, the Rights would "flip-over"
and entitle each holder of a Right (other than the Acquiring Person and certain
related parties) to receive, upon exercise, common stock of the acquiring
company having a value equal to two times the exercise price of the Right.
At any time until 10 Business Days following the Stock Acquisition Date
(subject to extension), the Company could redeem the Rights in whole, but not in
part, at a price of $0.01 per whole Right payable in stock or cash or any other
form of consideration deemed appropriate by the Board in its sole discretion
(the "Redemption Price"). Immediately upon the action of the Board ordering
redemption of the Rights, the Rights would terminate and the only right of the
holders of Rights would be to receive the Redemption Price.
Prior to the Distribution Date, the Company would issue Kmart Group Rights
on each share of Kmart Stock and Additional Rights on each share of each series
of Specialty Retail Stock so that all such shares would have attached Rights.
Until a Right is exercised, the holder thereof, as such, would have no rights as
a stockholder of the Company, including without limitation, the right to vote or
to receive dividends.
Other than those provisions relating to the principal economic terms of the
Rights, any of the provisions of the Rights Agreement would be subject to
amendment by the Board prior to the Distribution Date. After the Rights
Distribution Date, the provisions of the Rights Agreement would only be subject
to amendment by the Board in order to cure any ambiguity, to make changes which
do not adversely affect the interests of holders of Rights or to shorten or
lengthen any time period under the Rights Agreement; provided, however, that no
amendment to adjust the time period governing redemption would be made at such
time as the Rights are not redeemable.
In addition, under the terms of the Certificate of Amendment, from and
after the redesignation of the Existing Common Stock as Kmart Stock, all
references to "Common Stock" in the provisions relating to dividends and
distributions on and redemption of the Series A Junior Preferred Stock and
certain rights of such Series A Junior Preferred Stock upon consolidation,
merger or other combination of the Company would be deemed to be references to
the Kmart Stock. See Annex III-A hereto.
A copy of the form of the Restated Rights Agreement (which includes as
Exhibit B-1 thereto the Form of Rights Certificate for Kmart Group Rights and as
Exhibit B-2 thereto the Form of Rights Certificate for Additional Rights) will
be filed with the Securities and Exchange Commission (the "Commission") upon
implementation of the Specialty Retail Stock Proposal. A copy of the Rights
Agreement has previously been filed with the Commission as an Exhibit to a
Registration Statement on Form 8-A, and is incorporated herein by reference. A
copy of the Rights Agreement is available free of charge from the Rights Agent.
The foregoing description of the Rights is a summary only and is qualified in
its entirety by reference to the Rights Agreement.
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EFFECTS ON PREFERRED STOCK
Under the terms of the Certificate of Amendment, from and after the
redesignation of the Existing Common Stock as Kmart Stock, the conversion rates
applicable to the Series A Preferred Stock and the Series B Preferred Stock
would be adjusted, pursuant to the anti-dilution provisions of such securities,
so that the holder of a share of Series A Preferred Stock or Series B Preferred
Stock would be entitled to receive on conversion of such share the number of
shares of Kmart Stock equal to the number of shares of Existing Common Stock
that such holder would have been entitled to receive had such share of Series A
Preferred Stock or Series B Preferred Stock, as the case may be, been
surrendered for conversion at the conversion rate in effect immediately prior to
such redesignation. Subject to certain limited exceptions set forth in the
Certificate of Amendment, from and after the effectiveness of such adjustment,
all references to "Common Stock" in the provisions of the Articles relating to
the conversion or redemption of the Series A Preferred Stock or the Series B
Preferred Stock would be deemed to be references to the Kmart Stock. See Annex
III-A.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following summary of the Federal income tax consequences of the
Specialty Retail Stock Proposal and the redesignation of the Existing Common
Stock as Kmart Stock (the "Existing Common Stock Redesignation") is based on the
opinion of Skadden, Arps, Slate, Meagher & Flom, special counsel to the Company.
The discussion is based on the Internal Revenue Code of 1986, as amended to the
date hereof (the "Code"), Treasury Department regulations, published positions
of the Internal Revenue Service (the "Service") and court decisions now in
effect, all of which are subject to change. In particular, Congress could enact
legislation affecting the treatment of stock with characteristics similar to the
Specialty Retail Stock and the Kmart Stock or the Treasury Department could
change the current law in future regulations, including regulations issued
pursuant to its authority under section 337(d) of the Code. Any future
legislation or regulations could be enacted or promulgated so as to apply
retroactively to the Specialty Retail Stock Proposal. However, upon advice of
counsel, the Company believes that, as a practical matter, it is unlikely that
such legislation or regulations would apply retroactively.
The Company has not applied for an advance tax ruling from the Service
because the Service announced in 1987 that it will not issue advance rulings on
the classification of stock with characteristics similar to the Specialty Retail
Stock and the Kmart Stock.
IT IS IMPORTANT TO NOTE THAT THE OPINION OF COUNSEL CONTAINED HEREIN IS
BASED UPON THE LAW IN EFFECT AS OF THE DATE HEREOF. THE SPECIALTY RETAIL STOCK
PROPOSAL CONTEMPLATES THE POSSIBILITY OF THE PASSAGE OF TIME BETWEEN THE DATE
HEREOF, THE COMPANY'S 1994 ANNUAL MEETING AND EACH, IF ANY, OFFERING. THEREFORE,
THE COMPANY WILL HAVE TAX COUNSEL UPDATE THIS OPINION WITH AN APPROPRIATE
REASSESSMENT OF THE LAW PRIOR TO THE ANNUAL MEETING AND THE ISSUANCE OF EACH
SERIES OF SPECIALTY RETAIL STOCK.
Tax Implications to Stockholders. This discussion addresses only those
stockholders who hold the Existing Common Stock and would hold the Kmart Stock
as a capital asset within the meaning of Section 1221 of the Code and is
included for general information only. It does not discuss all aspects of
Federal income taxation that could be relevant to a stockholder in light of such
stockholder's particular tax circumstances and does not apply to certain types
of stockholders who could be subject to special treatment under the Federal
income tax laws. STOCKHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS WITH REGARD
TO THE APPLICATION OF THE FEDERAL INCOME TAX LAWS TO THEIR PARTICULAR SITUATION,
AS WELL AS TO THE APPLICABILITY AND EFFECT OF ANY STATE, LOCAL, OR FOREIGN TAX
LAWS TO WHICH THEY COULD BE SUBJECT.
Existing Common Stock Redesignation. In the opinion of counsel, the
Kmart Stock would be common stock of the Company for Federal income tax
purposes, and the stockholders would not recognize income, gain or loss on
the Existing Common Stock Redesignation. The basis of the Existing Common
Stock would be carried over to the Kmart Stock and the holding period of
the Kmart Stock would include the holding period of the Existing Common
Stock, assuming that the Existing Common Stock is a capital asset in the
hands of the stockholder on the date on which the Existing Common Stock
Redesignation becomes effective.
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<PAGE> 82
Although it is counsel's opinion that the Existing Common Stock
Redesignation would not result in the recognition of any income, gain or
loss or the receipt of a taxable dividend by stockholders, there are no
Federal income tax regulations, court decisions or published Service
rulings bearing directly on the effect of the dividend and liquidation
features of the Kmart Stock and the Specialty Retail Stock. In addition,
the Service announced in 1987 that it is studying the Federal income tax
consequences of stock which has certain voting and liquidation rights in an
issuing corporation, but whose dividend rights are determined by reference
to the earnings and profits of a segregated portion of the issuing
corporation's assets, and would not issue any advance rulings regarding
such stock. It is possible, therefore, that the Service could claim that
the Kmart Stock or the various series of Specialty Retail Stock represent
property other than stock of the Company.
If the Kmart Stock or any series of Specialty Retail Stock were
treated as property other than stock of the Company, either the
redesignation of the Existing Common Stock as Kmart Stock or a distribution
of any series of Specialty Retail Stock could be taxed as a dividend to
stockholders in an amount equal to the fair market value of the Kmart Stock
or the relevant series of Specialty Retail Stock, as the case may be. In
addition, if either the Kmart Stock or any series of Specialty Retail Stock
were treated as property other than stock of the Company, the Company could
recognize gain on the redesignation of the Existing Common Stock as Kmart
Stock, or the offering for sale or the distribution of any series of
Specialty Retail Stock, in an amount equal to the difference between the
fair market value of the Kmart Stock or the relevant series of Specialty
Retail Stock, as the case may be, and the Company's tax basis in such
property. However, as indicated above, tax counsel is of the opinion that
the Kmart Stock and the Specialty Retail Stock would be treated as stock of
the Company. The Company will have tax counsel update this opinion with an
appropriate reassessment of the law prior to the Annual Meeting and prior
to the issuance of each series of Specialty Retail Stock.
Sale or Exchange of Kmart Stock. Upon the taxable sale or exchange of
the Kmart Stock, a stockholder would recognize gain or loss equal to the
difference between (i) any cash received plus the fair market value of any
other consideration received, and (ii) the tax basis of the stock sold or
exchanged. Such tax basis would be determined as described in "Existing
Common Stock Redesignation" above.
The excess of net long-term capital gains over net short-term capital
loss could be taxed at a lower rate than ordinary income for certain
noncorporate taxpayers. A capital gain is long-term if the asset is held
for more than one year and is short-term if held for one year or less. The
distinction between capital gain or loss and ordinary income is also
relevant for purposes of, among other things, the limitation on the
deductibility of capital losses.
Adjustments to Convertible Securities. If the Specialty Retail Stock
Proposal is approved by stockholders and the Existing Common Stock is
redesignated as Kmart Stock, any outstanding Convertible Securities
convertible into or exercisable for Existing Common Stock automatically
would become convertible into shares of Kmart Stock equal to the number of
shares of Existing Common Stock that the holder thereof would have received
if conversion had occurred immediately prior to such redesignation. In
counsel's opinion, this adjustment and, therefore, the Existing Common
Stock Redesignation, would not result in a deemed taxable stock
distribution to the holders of Convertible Securities.
United States Alien Holders. Dividend payments received by a United
States Alien (as defined below) holder of Kmart Stock would be subject to
United States Federal withholding tax in the same manner as such holder is
subject to Federal withholding tax on Existing Common Stock. A United
States Alien holder would not be subject to United States Federal income or
withholding tax on any gain realized on the taxable sale or exchange of any
such stock, unless (A) such gain was effectively connected with a United
States trade or business of the United States Alien, (B) the United States
Alien was an individual who had been present in the United States for a
period or periods of 183 days or more during the taxable year and certain
other conditions were met or (C) the stock sold or exchanged was a "United
States Real Property Interest" as defined in section 897(c)(1) of the Code
at any time during the five years prior to the sale or exchange of the
stock or at any time during the time that the United
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<PAGE> 83
States Alien held such stock, whichever time was shorter. The Kmart Stock
would be a United States Real Property Interest only if, at any time during
the five years prior to the sale or exchange of such stock or at any time
during the period that the United States Alien held such stock, whichever
time was shorter, the Company had been a "United States real property
holding corporation" as defined in section 897(c)(2) of the Code and the
United States Alien directly or constructively had owned more than 5% of
the Kmart Stock. The Company has determined that it is not and has not been
and does not believe that it will become a "United States real property
holding corporation" for Federal income tax purposes.
A "United States Alien" is any person who, for United States Federal
income tax purposes, is a foreign corporation, a nonresident alien
individual, a nonresident alien fiduciary or a foreign estate or trust, or
a foreign partnership that includes as a member any of the foregoing
persons.
Backup Withholding. Certain noncorporate holders of Kmart Stock could
be subject to backup withholding at a rate of 31% on the payment of
dividends on such stock. Backup withholding would apply only if the holder
(i) failed to furnish its Taxpayer Identification Number ("TIN"), which,
for an individual, would be his or her Social Security number, (ii)
furnished an incorrect TIN, (iii) was notified by the Service that it had
failed to properly report payments of interest or dividends, or (iv) under
certain circumstances, failed to certify under penalties of perjury that it
had furnished a correct TIN and had been notified by the Service that it
was subject to backup withholding for failure to report payments of
interest or dividends. Stockholders should consult their tax advisors
regarding their qualification for exemption from backup withholding and the
procedures for obtaining such an exemption if applicable.
The amount of any backup withholding from a payment to a holder of
Kmart Stock would be allowed as a credit against such stockholder's Federal
income tax liability and could entitle such stockholder to a refund,
provided that the required information was furnished to the Service.
Tax Implications to the Company. In the opinion of counsel, Kmart Stock and
each series of Specialty Retail Stock would be Common Stock of the Company and
no gain or loss would be recognized by the Company on either the Existing Common
Stock Redesignation or the issuance and sale of any series of Specialty Retail
Stock in the Offerings. If, however, either the Kmart Stock or any series of
Specialty Retail Stock were treated as property other than stock of the Company,
the Company could recognize gain on the issuance of such stock in an amount
equal to the difference between the fair market value of such stock and its tax
basis in the hands of the Company. If any series of Specialty Retail Stock (or
Kmart Stock) were issued and treated as stock of a subsidiary of the Company,
and not as Common Stock of the Company, depending upon the amount of stock
issued, the relevant Group would not be includable in the Company's consolidated
Federal income tax return, and any dividends paid or deemed to be paid to the
Company by that Group would be taxed to the Company. Although it is possible
that the Service could claim that the Specialty Retail Stock (or Kmart Stock) is
not stock of the Company, it is the opinion of Skadden, Arps, Slate, Meagher &
Flom that such a position, if asserted, would not prevail.
ANTI-TAKEOVER CONSIDERATIONS
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, the Articles would provide for the issuance of Common
Stock in series, in each case at the discretion of the Board without further
action by the stockholders of the Company (except as provided by Michigan law or
the rules or regulations of any securities exchange on which any series of
outstanding Common Stock may then be listed).
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, there would be an additional 1.5 billion shares of
Common Stock available for future issuance without further stockholder approval.
One of the effects of the existence of unissued and unreserved Common Stock and
Preferred Stock could be to enable the Board to issue shares to persons friendly
to current management which could render more difficult or discourage an attempt
to obtain control of the Company by means of a merger, tender offer, proxy
contest or otherwise, and thereby protect the continuity of the Company's
management. Such additional shares also could be used to dilute the stock
ownership of persons seeking to obtain control of the Company.
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<PAGE> 84
Pursuant to the Articles, the Board is authorized without any further
action by the stockholders to determine the rights, preferences, privileges and
restrictions of the unissued Preferred Stock subject to certain restrictions
contained in the current Articles. If Proposal 3 is approved by stockholders,
the Articles would be amended to provide the Board with greater flexibility to
designate the terms of series of Preferred Stock without being subject to
certain limitations under the current Articles. See "Proposal 3 -- Amendments to
Restated Articles of Incorporation Relating to the Issuance of Preferred Stock
in Series by Resolution of Board of Directors". The purpose of authorizing the
Board to determine such rights, preferences, privileges and restrictions is to
eliminate delays associated with a stockholder vote on specific issuances. The
Board could, in its sole discretion, issue series of Common Stock or Preferred
Stock with voting and/or conversion rights which could dilute the relative
voting power of any or all series of Common Stock, and which could, among other
things, have the effect of delaying, deterring or preventing a change in control
of the Company.
The Company is subject to Chapter 7A of the MBCA, which provides that
business combinations subject to Chapter 7A between a Michigan corporation and a
beneficial owner of shares entitled to 10% or more of the voting power of such
corporation generally require the affirmative vote of 90% of the votes of each
class of stock entitled to vote, and not less than 2/3 of each class of stock
entitled to vote (excluding voting shares owned by such 10% owner), voting as a
separate class. Such requirements do not apply if (i) the corporation's board of
directors approves the transaction prior to the time the 10% owner becomes such
or (ii) the transaction satisfies certain fairness standards, certain other
conditions are met and the 10% owner has been such for at least five years.
Chapter 7B of the MBCA provides that, unless a corporation's articles of
incorporation or bylaws provide that Chapter 7B does not apply, "control shares"
of a corporation acquired in a control share acquisition have no voting rights
except as granted by the stockholders of the corporation. "Control shares" are
shares which, when added to shares previously owned by a stockholder, increase
such stockholder's ownership of voting stock to more than 20% but less than
33 1/3%, more than 33 1/3% but less than a majority, or more than a majority, of
the votes to which all of the capital stock of the corporation is entitled. A
control share acquisition must be approved by the affirmative vote of a majority
of all shares entitled to vote excluding voting shares owned by the acquiror and
certain officers and directors. However, no such approval is required for gifts
or other transactions not involving consideration, for a merger to which the
corporation is a party or certain other transactions described in Chapter 7B.
The By-laws of the Company currently contain a provision pursuant to which the
Company has opted not to be subject to Chapter 7B, but the Board may, in its
sole discretion, elect to become subject to Chapter 7B, although the Company has
no present intention to do so.
The Company's By-laws establish an advance notice procedure for
stockholders to make nominations of candidates for election as directors, or to
bring other business before an annual meeting of stockholders of the Company.
The By-laws provide that only persons who are nominated by, or at the direction
of, the Board or any committee designated by the Board, or by a stockholder who
has given timely written notice to the Secretary of the Company prior to the
meeting at which directors are to be elected, will be eligible for election as
directors of the Company. The By-laws also provide that in order to properly
submit any business to an annual meeting of stockholders, a stockholder must
give timely written notice to the Secretary of the Company of such stockholder's
intention to bring such business before such meeting. Generally, for notice of
stockholder nominations or other business to be made at an annual meeting to be
timely under the By-laws, such notice must be received by the Company (i) with
respect to an annual meeting of stockholders, 90 days in advance of such
meeting; provided, however, that if the annual meeting is not held on or within
eight days of the date set forth in Article 1, Section 1 of the By-laws and if
less than 100 days' notice or public disclosure of the date of the meeting is
given to stockholders, such notice by a stockholder must be not later than the
tenth day following the date on which notice or public disclosure of the date of
the meeting was first given to stockholders; and (ii) with respect to a special
meeting of stockholders, such notice by a stockholder must be not later than the
tenth day following the date on which notice or public disclosure of the date of
the meeting was first given to stockholders. A stockholder's notice must also
contain certain information specified in the By-laws.
The Rights Agreement permits disinterested stockholders to acquire
additional shares of the Company or of an acquiring company at a substantial
discount in the event of certain described changes in control. If the
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<PAGE> 85
Specialty Retail Stock Proposal is approved by stockholders and implemented by
the Board, the Rights Agreement is proposed to be amended as described herein.
See "Proposal 2 -- Specialty Retail Stock Proposal -- Restated Rights
Agreement".
Certain provisions described above may have the effect of delaying
stockholder actions with respect to certain business combinations and the
election of new members to the Board. As such, the provisions could have the
effect of discouraging open market purchases of Kmart Stock or any series of
Specialty Retail Stock because they may be considered disadvantageous by a
stockholder who desires to participate in a business combination or elect a new
director.
------------------------
APPROVAL OF PROPOSAL 2 WILL REQUIRE THE AFFIRMATIVE VOTE OF THE HOLDERS OF
A MAJORITY OF THE OUTSTANDING SHARES OF EXISTING COMMON STOCK, SERIES A
PREFERRED STOCK AND SERIES B PREFERRED STOCK, VOTING TOGETHER AS ONE CLASS, AS
WELL AS THE HOLDERS OF A MAJORITY OF THE OUTSTANDING SHARES OF EACH OF THE
EXISTING COMMON STOCK AND SERIES B PREFERRED STOCK, EACH VOTING AS A SEPARATE
CLASS.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE SPECIALTY RETAIL STOCK
PROPOSAL.
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PROPOSAL 3 -- AMENDMENTS TO
RESTATED ARTICLES OF INCORPORATION
RELATING TO ISSUANCE OF PREFERRED STOCK IN
SERIES BY RESOLUTION OF BOARD OF DIRECTORS
The stockholders are being asked to consider and approve a proposal to
amend the provisions of Article III, Section B of the Articles, as described
herein and in Annex III-B hereto, to modify the Board's authority to designate
the relative rights, preferences, limitations and restrictions of Preferred
Stock issued in series by resolution of the Board.
Article III, Section B of the Articles currently provides that the Board
may by resolution issue Preferred Stock in one or more series, subject to
certain limitations with regard to the terms of any Preferred Stock so issued.
Such limitations include (i) restrictions on the ability to create a sinking
fund for the redemption or purchase of shares of a series of Preferred Stock
unless provision for a sinking fund is provided for all other shares of
Preferred Stock, (ii) a requirement that the Preferred Stock of each series rank
equally with respect to the payment of dividends, (iii) a requirement that the
holders of Preferred Stock be entitled to one vote per share, voting together
with the holders of Common Stock as one class and (iv) a requirement that the
default provisions with respect to preferred dividends be as set forth in the
current Articles. If Proposal 3 is adopted by stockholders, the Articles would
be amended to provide that the Board shall be authorized to fix for each series
of Preferred Stock such voting powers, full or limited, or no voting powers, and
such designations, relative rights, preferences, limitations and restrictions as
shall be determined by the Board, in its sole discretion, and set forth in
resolutions adopted by the Board. The amended provisions would not apply to any
outstanding series of Preferred Stock, which would continue to be governed by
the current terms of Article III, Section B of the Articles. However, any shares
of any series of Preferred Stock issued in the future would be governed by the
foregoing provisions.
The amendment reflected in Proposal 3 is designed to provide the Board with
greater flexibility by eliminating limitations on the Board's authority that
were originally included in the Articles pursuant to requirements of the MBCA
that have since been repealed. Adoption by the Company of the foregoing
amendments to the Articles would have no immediate impact on the holders of
Existing Common Stock and Preferred Stock. It would, however, enable the Board,
among other things, to issue from time to time Preferred Stock having voting
rights greater than the voting rights of Existing Common Stock and outstanding
Preferred Stock, although there is no current intention to do so. The ability of
the Board to make future issuances of Preferred Stock could render more
difficult or discourage attempts to effect a change of control of the Company.
See "Proposal 2 -- Specialty Retail Stock Proposal -- Anti-takeover
Considerations".
APPROVAL OF PROPOSAL 3 WILL REQUIRE THE AFFIRMATIVE VOTE OF THE HOLDERS OF
A MAJORITY OF THE OUTSTANDING SHARES OF EXISTING COMMON STOCK, SERIES A
PREFERRED STOCK AND SERIES B PREFERRED STOCK, VOTING TOGETHER AS ONE CLASS, AS
WELL AS THE HOLDERS OF A MAJORITY OF THE OUTSTANDING SHARES OF EXISTING COMMON
STOCK AND SERIES B PREFERRED STOCK, EACH VOTING SEPARATELY AS A CLASS.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 3.
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PROPOSAL 4 -- AMENDMENTS TO RESTATED ARTICLES OF INCORPORATION
RELATING TO CERTAIN VOTING PROVISIONS
The stockholders are being asked to consider and approve a proposal to
amend Article VII of the Articles, as described herein and in Annex III-C
hereto, to conform certain provisions regarding the removal of directors to the
voting rights of the various series of Common Stock under the Specialty Retail
Stock Proposal. See "Proposal 2 -- Specialty Retail Stock Proposal --
Description of Kmart Stock and Specialty Retail Stock -- Voting Rights". Article
VII of the Articles currently provides that any director may be removed from
office at any time either by a vote of the holders of a majority of the shares
entitled to vote in the election of directors, but only for cause, or by a vote
of a majority of the other directors, with or without cause. Article VII also
provides that the affirmative vote of at least 58% of the outstanding shares
entitled to vote, voting as one class, shall be required to amend, repeal or
adopt any provision inconsistent with Article VII.
Under the terms of the Specialty Retail Stock Proposal, each share of any
outstanding series of Specialty Retail Stock would not necessarily be entitled
to one vote but could, depending on the relative Market Values of a share of
Kmart Stock and a share of any outstanding series of Specialty Retail Stock, be
entitled to one vote, or more or less than one vote (but no share of any series
of Specialty Retail Stock would be entitled to more than one vote prior to the
Series A Conversion Date). Thus, the Board believes that, upon implementation of
the Specialty Retail Stock Proposal, it would be desirable to amend Article VII
to provide that the stockholder vote required for removal of directors or
amendment of Article VII should be based upon the votes to which the shares are
entitled rather than the number of shares. Since the MBCA currently requires
that amendments to the Articles must be approved by the affirmative vote of not
less than a majority of the outstanding shares entitled to vote, that statutory
standard, unless amended, would remain the minimum vote required for adoption of
such amendments. Under Proposal 4, however, the Articles would be amended to
require that any amendment to Article VII or any removal of a director by
stockholders receive the affirmative vote of the requisite percentage of the
aggregate votes to which the outstanding shares of the Company's capital stock
would be entitled. The Board believes that such an approach is consistent with
the present intent of Article VII. Failure to so amend Article VII could result
in a series of Specialty Retail Stock being entitled to a number of votes with
respect to the removal of directors and/or the amendment of Article VII which is
disproportionate to the relative Market Value of the number of shares of such
series.
APPROVAL OF PROPOSAL 4 WILL REQUIRE THE AFFIRMATIVE VOTE OF THE HOLDERS OF
AT LEAST 58% OF THE OUTSTANDING SHARES OF EXISTING COMMON STOCK, SERIES A
PREFERRED STOCK AND SERIES B PREFERRED STOCK, VOTING TOGETHER AS ONE CLASS.
PROPOSAL 4 IS CONDITIONED UPON APPROVAL OF PROPOSAL 2 AND WILL NOT BE
IMPLEMENTED IF PROPOSAL 2 IS NOT APPROVED BY STOCKHOLDERS AND IMPLEMENTED BY THE
BOARD. ACCORDINGLY, A VOTE AGAINST PROPOSAL 2 WILL HAVE THE EFFECT OF A VOTE
AGAINST PROPOSAL 4.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 4.
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PROPOSAL 5 -- ADOPTION OF AN EMPLOYEE STOCK
PURCHASE PLAN FOR EACH SPECIALTY RETAIL GROUP
GENERAL
The stockholders are being asked to consider and approve an Employee Stock
Purchase Plan (a "Section 423 Plan") for each of the four Specialty Retail
Groups, as described herein and in Annex IV-A. The four Section 423 Plans were
adopted by the Board on , 1994, subject to approval of this Proposal by
stockholders, as well as approval by stockholders and subsequent implementation
by the Board of the Specialty Retail Stock Proposal. Each Section 423 Plan would
become effective upon the initial issuance of the relevant series of Specialty
Retail Stock and is designed to encourage the purchase of such series of
Specialty Retail Stock by a broad base of employees of the relevant Specialty
Retail Group. Each Section 423 Plan is intended to comply with the requirements
of Section 423 of the Code, and to assure the participants the tax advantages
provided thereby (as described under "Certain Federal Income Tax Consequences"
below). In order for the transfer of stock under each Section 423 Plan to
qualify for this treatment, each Section 423 Plan must be approved by
stockholders within 12 months of such plan's adoption.
For ease of reference in this Proposal, employees of the following
Specialty Retail Subsidiaries are referred to herein as "employees" of the
indicated Specialty Retail Group:
<TABLE>
<CAPTION>
SPECIALTY RETAIL SUBSIDIARY SPECIALTY RETAIL GROUP
----------------------------- ---------------------------
<S> <C>
Borders, Inc. Borders-Walden Group
Walden Book Company, Inc. Borders-Walden Group
Builders Square, Inc. Builders Square Group
OfficeMax, Inc. OfficeMax Group
The Sports Authority, Inc. The Sports Authority Group
</TABLE>
The Company estimates that there are an aggregate of approximately 40,000
employees who are potential participants in the four Section 423 Plans, none of
whom are currently officers or directors of the Company or the Specialty Retail
Subsidiaries. The description of each Section 423 Plan set forth below is
qualified in its entirety by reference to the text of such Section 423 Plan as
set forth in Annex IV-A.
ADDITIONAL INFORMATION REGARDING EACH SECTION 423 PLAN
As more fully described below, the amount of benefits to be received by
each participant would be determined by his or her elections; accordingly, the
amount of future benefits to be allocated to any individual or group of
individuals under each Section 423 Plan is not determinable. Similarly, the
amount of benefits that would have been received by or allocated to any
individual or group of individuals for fiscal 1993 had each Section 423 Plan
been in effect is not determinable.
DESCRIPTION OF EACH SECTION 423 PLAN
The following is a description of each proposed Section 423 Plan.
Purpose. The purpose of each Section 423 Plan is to align employee and
stockholder long-term interests by facilitating the purchase of the relevant
series of Specialty Retail Stock by a broad base of employees of each Specialty
Retail Group. An additional purpose of each Section 423 Plan is to comply with
the requirements of Section 423 of the Code, and thus to obtain for the
participating employees the tax advantages provided thereby See "Certain Federal
Income Tax Consequences" below.
Administration. Each Section 423 Plan would be administered by the
Compensation and Incentives Committee of the Board (the "Committee") which is
comprised solely of non-employee directors who are not eligible to participate
in any Section 423 Plan. The Committee could make such rules and regulations and
establish such procedures for the administration of each Section 423 Plan as it
deems appropriate.
Participation. Subject to certain procedural requirements, all employees of
each Specialty Retail Group who have at least one year of service and work at
least 1,000 hours per year would be eligible to participate in
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such Specialty Retail Group's Section 423 Plan, except that employees who are
both "highly compensated" within the meaning of Section 414(q) of the Code and
designated by the Committee as participants in the Management Stock Purchase
Plan, and employees who are five percent or more stockholders of the Company or
any subsidiary of the Company, would not be eligible to participate. The
Committee could from time to time designate other subsidiaries of the Company to
be participating corporations in a particular Section 423 Plan, including
corporations which become subsidiaries after the adoption and approval of such
Section 423 Plan; provided that any such participating corporation must be part
of the relevant Specialty Retail Group.
Purchase of Shares. Pursuant to each Section 423 Plan, each eligible
employee would have the right to purchase shares of the relevant series of
Specialty Retail Stock through regular payroll deductions equal to 1% to 10% of
the employee's base pay (as elected by the employee) for each payroll period
and, in addition, through reinvestment of cash dividends on the Specialty Retail
Stock held in the employee's account (and, at the employee's election,
additional cash payments). Under each Section 423 Plan, the fair market value of
Specialty Retail Stock which could be purchased by any employee during any
calendar year will not exceed $25,000.
Stock Purchase Price. Participating employees would be able to purchase
shares of the relevant series of Specialty Retail Stock at the end of each
quarter at a purchase price equal to 85 percent of the fair market value of
shares of the relevant series of Specialty Retail Stock on the date the quarter
ends; provided, however, for purposes of the first Exercise Date, the purchase
price shall be equal to 85% of the initial public offering price per share.
Stock Subject to Each Section 423 Plan. The number of shares of each series
of Specialty Retail Stock that would be available for purchase under the related
Section 423 Plan, upon the initial issuance of shares of such series, would be
the number of shares equal to the product of:
(i) the sum of (x) the number of shares of such series outstanding
immediately after such initial issuance and (y) the Number of Shares
Issuable with Respect to Retained Interest in the relevant Specialty Retail
Group immediately after such initial issuance, multiplied by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
SECTION 423 PLAN PERCENTAGES
----------------- -----------
<S> <C>
Borders-Walden Group..................................... 5.00%
Builders Square Group.................................... 5.00%
OfficeMax Group.......................................... 4.00%
The Sports Authority Group............................... 4.00%
</TABLE>
The foregoing percentages were determined based upon the relative number of
employees of each Specialty Retail Group and assumptions regarding the level of
participation to be expected from such employees. The number of such shares
would be subject to adjustment by the Committee in the event of a
recapitalization, stock split, stock dividend or similar corporate transaction.
Shares issued under each Section 423 Plan could be either authorized and
unissued shares or shares which had been reacquired by the Company. The proceeds
of the sale of shares pursuant to each Section 423 Plan would be allocated to
the relevant Specialty Retail Group. Upon the issuance of such shares, the
Number of Shares Issuable with Respect to Retained Interest in the relevant
Specialty Retail Group would not be reduced; however, the Retained Interest
Fraction with respect to the relevant Specialty Retail Group would nonetheless
be reduced, and the Outstanding Interest Fraction with respect to such Specialty
Retail Group would be increased accordingly. See "Proposal 2 -- The Specialty
Retail Stock Proposal -- Retained Interest of Kmart Group in Specialty Retail
Groups; Outstanding Interest Fraction," and "Shares Issuable Pursuant to
Employee Benefit Plans."
Nontransferable Right to Purchase. Except as otherwise provided by law,
right to purchase shares which is granted to a participant under any Section 423
Plan would not be transferable otherwise than by will or the laws of descent and
distribution, and would be exercisable, during the participant's lifetime, only
by the participant.
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<PAGE> 93
Term. Unless terminated earlier in the sole discretion of the Board, each
Section 423 Plan will terminate December 31, 2004.
Amendments to or Discontinuance of each Section 423 Plan. The Board could
from time to time amend or terminate any Section 423 Plan; provided, however,
that (i) no such amendment or termination could adversely affect the rights of
any participant which vested prior to such amendment or termination without the
consent of such participant and (ii) to the extent required by Section 423 of
the Code or any other law, regulation or stock exchange rule, no such amendment
could be effected without the approval of stockholders entitled to vote thereon.
Additionally, the Committee could make such amendments as it deems necessary to
comply with applicable laws, rules and regulations.
Certain Federal Income Tax Consequences. The following discussion is a
brief summary of the principal United States federal income tax consequences
under current federal income tax laws relating to awards under each Section 423
Plan. This summary is not intended to be exhaustive or to constitute tax advice,
and, among other things, does not describe state, local or foreign income and
other tax consequences.
Each Section 423 Plan would be intended to qualify as an "employee stock
purchase plan" as defined in Section 423 of the Code. Assuming such
qualification, a participant would not recognize any taxable income as a result
of participating in any Section 423 Plan, exercising the right to make purchases
pursuant to such Section 423 Plan or receiving shares purchased pursuant to such
plan. A participant could, however, be required to recognize taxable income as
described below.
If a participant disposed of any share purchased pursuant to any Section
423 Plan after the later to occur of (i) two years from the grant date for the
related purchase right (which would be the first day of the relevant quarter)
and (ii) one year after the date of purchase (such disposition, a "Qualifying
Transfer"), or if he or she died (whenever occurring) while owning any share
purchased under such Section 423 Plan, the participant generally would recognize
compensation income, for the taxable year in which such Qualifying Transfer or
death occurs, in an amount equal to the lesser of (i) the excess of the market
value of the disposed share at the time of such disposition or death over its
purchase price, and (ii) 15% of the market value of the disposed share on the
grant date for the related purchase right. In the case of a Qualifying Transfer,
(a) the participant's tax basis in the disposed share would be increased by an
amount equal to the amount of compensation income so recognized, and (b) the
participant would recognize a capital gain or loss, as the case may be, equal to
the difference between the amount realized from the disposition of the share and
his or her tax basis (as so increased) in such share. If the participant
disposed of any share other than by a Qualifying Transfer, the participant
generally would recognize compensation income in an amount equal to the excess
of the market value of the disposed share on the date of disposition over its
purchase price.
In the event of a disposition by a participant of shares acquired under a
Section 423 Plan other than pursuant to a Qualifying Transfer, the Company would
be entitled to a tax deduction equal to the amount of compensation income
recognized by the participant. Otherwise, the Company would not be entitled to
any tax deduction with respect to the grant or exercise of purchase rights under
any Section 423 Plan or the subsequent sale by participants of shares purchased
pursuant to any such Section 423 Plan. A transfer by the estate of the
participant of shares purchased by the participant under a Section 423 Plan has
the same federal income tax effects on the Company as a Qualifying Transfer.
Approval of Proposal 5 will require the affirmative vote of the holders of
a majority of the votes cast by the holders of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
Proposal 5 concerns Specialty Retail Stock and, therefore, is conditioned upon
approval of Proposal 2 and will not be implemented if Proposal 2 is not approved
by stockholders and implemented by the Board. Accordingly a vote against
Proposal 2 will have the effect of a vote against Proposal 5.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 5.
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PROPOSAL 6 -- AMENDMENTS TO DIRECTORS STOCK PLAN
RELATING TO ISSUANCE OF SPECIALTY RETAIL STOCK
GENERAL
The stockholders are being asked to consider and approve certain amendments
to the Directors Stock Plan (the "Directors Plan"), as described herein and in
Annex IV-B. The Directors Plan was previously adopted by the Board on December
16, 1991 and was approved by stockholders and became effective on May 27, 1992.
The Directors Plan is administered by the Compensation and Incentives Committee
(the "Committee"), which is comprised solely of non-employee directors. In this
Proposal 6, a non-employee director is referred to as a "Director". As of March
1, 1994, the shares of Existing Common Stock issued under the Directors Plan
were held by ten Directors.
DESCRIPTION OF AMENDMENTS TO DIRECTORS PLAN
On , 1994, the Board approved certain amendments to the Directors
Plan (the "Directors Plan Amendments") subject to approval of this Proposal by
stockholders, as well as approval by stockholders and subsequent implementation
by the Board of the Specialty Retail Stock Proposal. The amendments would become
effective upon the initial issuance of shares of any series of Specialty Retail
Stock. The description of the Directors Plan Amendments set forth below is
qualified in its entirety by reference to the text of such Amendments as set
forth in Annex IV-B.
Amendment Relating to Stock Portion of Annual Retainer. In calendar years
beginning with 1995, if any series of Specialty Retail Stock has been issued on
or before the last business day preceding the Normal Stock Payment Date (as
hereinafter defined), the portion of a Director's annual retainer that is paid
to the Director in Common Stock (whether mandatorily or by the Director's
election and whether delivered on the Normal Stock Payment Date or deferred)
would be comprised of shares of each series of Common Stock that is outstanding
on the last business day preceding the Normal Stock Payment Date. The aggregate
fair market value of all such shares would be equal to the cash amount for which
such stock payment is substituted. The number of shares of any series of
Specialty Retail Stock (or Kmart Stock) to be included in any such stock payment
would be determined by dividing (i) an amount equal to a certain percentage of
the cash amount for which such series of stock is to be substituted by (ii) the
fair market value per share of such series of stock on the last business day
preceding the Normal Stock Payment Date. Such percentage will be determined by
dividing the Market Capitalization of the relevant series of Specialty Retail
Stock (or Kmart Stock) as of such day by the aggregate Market Capitalization of
all then outstanding series of Common Stock as of such day.
Amendment Relating to One-Time Award. In order to balance the Directors
ownership among all series of Common Stock (at present consisting only of
Existing Common Stock), upon the initial issuance of each series of Specialty
Retail Stock, each Director would be awarded shares of such series equal in
value to $5,000.
ADDITIONAL INFORMATION REGARDING DIRECTORS PLAN
As of March 1, 1994, the market value of Existing Common Stock which would
be available for awards under the Directors Plan was approximately $7,323,479
(based upon the closing price of the Existing Common Stock on the Composite Tape
on such date).
DESCRIPTION OF DIRECTORS PLAN AS PROPOSED TO BE AMENDED
The following is a description of the Directors Plan as proposed to be
amended by this Proposal.
Purpose. The purpose of the Directors Plan is to increase the proprietary
interest in the various businesses of the Company of non-employee members of the
Board by providing that a portion of their compensation will be in the form of
each issued series of Common Stock, thus increasing their incentive to
contribute to the success of each business unit of the Company. The Directors
Plan is intended to comply with Rule 16b-3 under the Exchange Act.
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<PAGE> 96
Administration. The Directors Plan is administered by the Committee which
is comprised solely of non-employee Directors. The Committee can make such rules
and regulations and establish such procedures for the administration of the
Directors Plan as it deems appropriate.
Stock Subject to Directors Plan. Out of 400,000 shares of Existing Common
Stock that were initially available for issuance under the Directors Plan, there
remain, as of March 1, 1994, 382,927 shares of Existing Common Stock so
available for issuance which, upon initial issuance of any series of Specialty
Retail Stock, would automatically be redesignated as Kmart Stock. The number of
shares of each issued series of Specialty Retail Stock which would be made
available for issuance under the Directors Plan would be the number of shares
equal to the product of:
(i) the sum of (x) the number of shares of such series outstanding
after such initial issuance and (y) the Number of Shares Issuable with
Respect to Retained Interest in the relevant Specialty Retail Group
immediately after such initial issuance, multiplied by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGES
----------
<S> <C>
Borders-Walden Stock...................................... 0.05%
Builders Square Stock..................................... 0.05%
OfficeMax Stock........................................... 0.05%
The Sports Authority Stock................................ 0.05%
</TABLE>
The foregoing percentages were determined based upon the number of outside
directors and assumptions regarding the degree to which (i) such directors'
annual retainers would be paid in stock and (ii) such stock payment would
consist of the various series of Specialty Retail Stock. The number of such
shares would be subject to adjustment by the Committee in the event of a
recapitalization, stock split, stock dividend or similar corporate transaction.
Shares issued under the Directors Plan could be either authorized and
unissued shares or shares which have been reacquired by the Company. The
issuance of such shares would be attributable to the relevant Specialty Retail
Group. Upon such issuance, the Number of Shares Issuable with Respect to
Retained Interest in the relevant Specialty Retail Group would not be reduced;
however, the Retained Interest Fraction with respect to the relevant Specialty
Retail Group would nonetheless be reduced, and the Outstanding Interest Fraction
with respect to such Specialty Retail Group would be increased accordingly. See
"Proposal 2 -- The Specialty Retail Stock Proposal -- Retained Interest of Kmart
Group in Specialty Retail Groups; Outstanding Interest Fraction" and "Shares
Issuable Pursuant to Employee Benefit Plans."
Delivery or Deferral of Stock. For each calendar year prior to
implementation of the Specialty Retail Stock Proposal, each Director receives 20
percent (and, at the election of the Director, up to 50 percent) of his or her
annual retainer fee in shares of Existing Common Stock in lieu of cash. Such
shares are (unless deferred) delivered to the Director on July 10 of such
calendar year (the "Normal Stock Payment Date"), with the number of shares to be
based on the closing price of the existing Common Stock on the last business day
preceding the Normal Stock Payment Date. After the initial issuance of any
series of Specialty Retail Stock, the stock portion of the Director's annual
retainer fee would include shares of all series of Common Stock outstanding on
the last business day preceding the Normal Stock Payment Date. The aggregate
fair market value of all such shares would be equal to the cash amount for which
such stock payment was substituted. The number of the shares of any series of
Common Stock to be included in any such stock payment would be determined by
dividing (i) an amount equal to a certain percentage of the cash amount for
which stock is to be substituted by (ii) the fair market value per share of the
relevant series of Common Stock as of such day. Such percentage would be
determined by dividing the Market Capitalization of the relevant series of
Common Stock by the aggregate Market Capitalization of all then outstanding
series of Common Stock as of such day.
Directors may elect to defer the actual receipt of all or a portion of the
shares of stock otherwise deliverable on the Normal Stock Payment Date. Deferred
shares of each series would be credited with an
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<PAGE> 97
amount equal to the dividends payable on such shares, which would be converted
on a quarterly basis into additional shares of the same series of Common Stock.
In addition, upon initial issuance of each series of Specialty Retail
Stock, each Director would be awarded shares of such series equal in value to
$5,000.
If it is determined by the Board that a Director engaged in any activity or
association in competition with or adverse to the interest of the Company or if
there is a change in control of the Company, any deferred shares would be
immediately distributed.
Amendments to or Discontinuance of Directors Plan. The Board can from time
to time alter, amend, suspend or terminate the Directors Plan in whole or in
part.
Term of Directors Plan. The Directors Plan will remain in effect until the
earlier to occur of December 15, 2006 or a change in control of the Company,
unless sooner terminated by the Board.
Approval of Proposal 6 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class. Proposal 6 concerns Specialty Retail Stock and,
therefore, is conditioned upon approval of Proposal 2 and will not be
implemented if Proposal 2 is not approved by stockholders and implemented by the
Board. Accordingly, a vote against Proposal 2 will have the effect of a vote
against Proposal 6.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 6.
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PROPOSAL 7 -- AMENDMENTS TO PERFORMANCE RESTRICTED STOCK PLAN RELATING TO
SUBSTITUTION OF SPECIALTY RETAIL STOCK FOR CERTAIN OUTSTANDING AWARDS OF
EXISTING COMMON STOCK
GENERAL
The stockholders are being asked to consider and approve an amendment to
the Performance Restricted Stock Plan (the "Performance Plan"), as described
herein and in Annex IV-C-1. The Performance Plan was previously adopted by the
Board, and was approved by stockholders and became effective on May 24, 1988.
The Company's ability to issue awards of restricted shares of Existing Common
Stock under the plan will expire on March 21, 1998. The Performance Plan is
administered by the Compensation and Incentives Committee (the "Committee"),
which is comprised solely of non-employee directors who are not eligible to
receive awards under the Performance Plan. The Committee has sole discretion, in
accordance with the provisions of the Performance Plan, to determine the size,
terms, conditions and recipients of Performance Plan awards. As of March 1,
1994, the restricted shares of Existing Common Stock issued under the
Performance Plan were held by 122 participants, 28 of whom are currently
officers or directors. If the Specialty Retail Stock Proposal is approved by
stockholders and fully implemented by the Board, the Company does not currently
intend to continue its program of regular awards thereunder. However, the
Company believes it is desirable to amend the Performance Plan as herein
provided in order to convert any outstanding awards for Existing Common Stock of
employees of, or with responsibility for, the Specialty Retail Groups into
awards for the various series of Specialty Retail Stock. For ease of reference
in this Proposal, employees of the Company and the Company's subsidiaries who
have work responsibilities with respect to Kmart Group or a Specialty Retail
Group are sometimes referred to herein as "employees" of the relevant Group.
DESCRIPTION OF AMENDMENT TO PERFORMANCE PLAN
On , 1994, the Board approved an amendment to the Performance
Plan (the "Performance Plan Amendment") to permit certain Participants to
convert part or all of their outstanding awards of restricted shares of Existing
Common Stock (or, after the redesignation, Kmart Stock) which are restricted
from share transfer for up to three years (the "performance shares") into awards
of performance shares of various series of Specialty Retail Stock, subject to
approval of this Proposal by stockholders, as well as approval by stockholders
and subsequent implementation by the Board of the Specialty Retail Stock
Proposal. The Performance Plan Amendment would become effective upon the initial
issuance of shares of any series of Specialty Retail Stock. The description of
the Performance Plan Amendment set forth herein is qualified in its entirety by
reference to the text of such Amendment as set forth in Annex IV-C-1.
Under the terms of the Performance Plan as proposed to be amended, (i) a
Participant who is an employee of a Specialty Retail Group would be given an
opportunity to convert all of his or her outstanding awards of performance
shares of Existing Common Stock (or, after the redesignation, Kmart Stock) under
the Performance Plan into performance shares of the relevant series of Specialty
Retail Stock, such conversion to take effect upon the initial issuance of shares
of such series, and (ii) a Participant who is an employee of the Kmart Group
with responsibilities that include one or more Specialty Retail Groups would be
given an opportunity to convert a percentage of his or her outstanding awards of
performance shares of Existing Common Stock (or, after the redesignation, Kmart
Stock) issued under the Performance Plan into performance shares of the various
series of Specialty Retail Stock, such conversion to take effect upon its or
their respective initial issuances. The percentages of such awards to be
converted into each series of Specialty Retail Stock would be discretionarily
determined by the Committee based on such factors as the Committee may find
relevant, which may include, without limitation, the employee's responsibilities
and the Market Capitalization of the various series of Specialty Retail Stock
and Existing Common Stock (or, after the redesignation, Kmart Stock).
The converted performance shares would otherwise be subject to the same
terms (including the date on which the restrictions lapse) as the outstanding
performance shares, except that the series of Common Stock
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subject to the restrictions would be changed and the number of shares would be
equitably adjusted to preserve the aggregate value on the date of conversion of
the performance shares originally awarded.
STOCK SUBJECT TO PERFORMANCE PLAN
Out of 4,000,000 shares of Existing Common Stock that were initially
available for issuance under the Performance Plan, there remain, as of March 1,
1994, 3,210,533 shares of Existing Common Stock so available for issuance,
which, upon initial issuance of any series of Specialty Retail Stock, would
automatically be redesignated as Kmart Stock. The Performance Plan Amendment
provides that the number of shares of each issued series of Specialty Retail
Stock that would be made available for issuance under the Performance Plan would
be the number of shares equal to the product of:
(i) the sum of (x) the number of shares of each such series
outstanding immediately after such initial issuance and (y) the Number of
Shares Issuable with Respect to Retained Interest in the relevant Specialty
Retail Group immediately after such initial issuance, multiplied by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGES
-----------
<S> <C>
Borders-Walden Stock....................................... 0.20%
Builders Square Stock...................................... 0.30%
OfficeMax Stock............................................ 0.10%
The Sports Authority Stock................................. 0.30%
</TABLE>
The foregoing percentages were determined based upon the relative number of
employees of each Specialty Retail Group and assumptions regarding the level of
participation to be expected from such employees. The number of such shares
would be subject to adjustment by the Committee in the event of a
recapitalization, stock split, stock dividend or similar corporate transaction.
Shares issued under the Performance Plan could be either authorized and
unissued shares or shares which have been reacquired by the Company. The
issuance of such shares would be attributable to the Kmart Group's Retained
Interest in the relevant Specialty Retail Groups. Upon such issuance, the Number
of Shares Issuable with Respect to Retained Interest in the relevant Specialty
Retail Group would be reduced. Accordingly, the Retained Interest Fraction would
be reduced and the Outstanding Interest Fraction would be proportionately
increased. The extent to which the issuance of shares of Specialty Retail Stock
pursuant to the Performance Plan would result in a reduction in the Number of
Shares Issuable with Respect to Retained Interest would be dependent upon the
extent to which participants elect to convert their interest in Existing Common
Stock under the Performance Plan into interest in Specialty Retail Stock.
Moreover, such conversions by participants would result in cancellation of the
participant's current performance shares of Existing Common Stock (or, after the
redesignation, Kmart Stock). See "Proposal 2 -- The Specialty Retail Stock
Proposal -- Retained Interest of Kmart Group in Specialty Retail Groups;
Outstanding Interest Fraction" and "-- Shares Issuable Under Employee Benefit
Plans."
ADDITIONAL INFORMATION REGARDING PERFORMANCE PLAN
The number of restricted shares of the various series of Specialty Retail
Stock that can be issued upon conversion of currently outstanding restricted
shares cannot be determined, since any such conversions would be made at the
election of the individual Participants. No awards were made under the
Performance Plan in fiscal 1993 except to executives of or with responsibility
for the Specialty Retail Subsidiaries. As of March 1, 1994, there were 277,510
restricted shares of Existing Common Stock outstanding under the Performance
Plan. The aggregate market value of such shares was approximately $5,239,389
(based upon the closing price of the Existing Common Stock on the Composite Tape
on such date).
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<PAGE> 101
DESCRIPTION OF PERFORMANCE PLAN AS PROPOSED TO BE AMENDED
As discussed above, if the Specialty Retail Proposal is approved by
stockholders and fully implemented by the Board, it is anticipated that no new
awards would thereafter be granted under the Performance Plan. It is proposed
only to provide an opportunity to certain Participants to convert all or a
portion of their outstanding awards of performance shares of Existing Common
Kmart Stock under the Performance Plan into performance shares of the series of
Specialty Retail Stock related to the Specialty Retail Group of which such
Participant is an employee or for which such Participant has responsibilities.
The converted performance shares would otherwise have the same terms and
restrictions (including the date on which the restrictions lapse) of the
outstanding awards, except that the series of Common Stock would be changed and
the number of shares would be equitably adjusted to preserve the aggregate value
on the date of the conversion of the performance shares originally awarded.
AMENDMENTS TO OR DISCONTINUANCE OF PERFORMANCE PLAN
The Board can from time to time alter, amend, suspend or discontinue the
Performance Plan; provided, however, that no amendment which requires
stockholder approval in order for the exemptions available under Rule 16b-3 to
be applicable to the amended plan will be effective unless it is approved by
stockholders entitled to vote thereon. Additionally, the Board can make such
amendments as it deems necessary to comply with applicable laws, rules and
regulations.
FEDERAL INCOME TAX CONSEQUENCES
For information with respect to the Federal income tax consequences of
certain restricted stock transactions see "Proposal 11 -- Adoption of Management
Stock Purchase Plan -- Federal Income Tax Consequences".
Approval of Proposal 7 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock, present, or represented, and entitled to vote, voting
together as one class. Proposal 7 concerns Specialty Retail Stock and,
therefore, is conditioned upon approval of Proposal 2 and will not be
implemented if Proposal 2 is not approved by stockholders and implemented by the
Board. Accordingly a vote against Proposal 2 will have the effect of a vote
against Proposal 7.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 7.
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PROPOSAL 8 -- AMENDMENTS TO 1973 AND 1981 STOCK OPTION PLANS
RELATING TO SUBSTITUTION OF SPECIALTY
RETAIL STOCK FOR EXISTING COMMON STOCK ISSUABLE
UPON EXERCISE OF CERTAIN OUTSTANDING OPTIONS
GENERAL
The stockholders are being asked to consider and approve certain amendments
to the 1973 Stock Option Plan (the "1973 Plan") and the 1981 Stock Option Plan
(the "1981 Plan") as described herein and in Annex IV-D. The 1973 Plan and the
1981 Plan were adopted by the Board and approved by stockholders and became
effective on June 22, 1973 and May 25, 1982, respectively. The Company's ability
to grant options under the 1973 Plan and the 1981 Plan expired on August 17,
1991. However, the Company believes it is desirable to amend the plans as herein
provided in order to convert any outstanding stock options of employees of or
with responsibility for, the Specialty Retail Groups into awards for the various
series of Specialty Retail Stock. These Plans are administered by the
Compensation and Incentives Committee (the "Committee"), which is comprised
solely of non-employee directors who were not eligible to receive options under
the 1973 and 1981 Plans. Outstanding options under these Plans include options
qualifying as incentive stock options under the Code ("ISOs") and nonqualified
stock options ("NQSOs"). The maximum term of a NQSO may not exceed ten years and
two days and the maximum term of an ISO may not exceed ten years. As of March 1,
1994, the expiration dates of the options outstanding under these Plans range
from to [July 31, 2001]. As of March 1, 1994, the outstanding options
were held by employees, of whom are currently officers or directors.
For ease of reference in this Proposal, employees of the Company and the
Company's subsidiaries who have work responsibilities with respect to Kmart
Group or a Specialty Retail Group are sometimes referred to herein as
"employees" of the relevant Group.
DESCRIPTION OF AMENDMENTS TO 1973 AND 1981 PLANS
On , 1994, the Board approved an amendment to each of the 1973
and 1981 Plans, (the "1973 Plan Amendment" and the "1981 Plan Amendment,"
respectively), to permit certain optionees to convert part or all of their
outstanding options for Existing Common Stock (or, redesignation, Kmart Stock)
into options for various series of Specialty Retail Stock, subject to approval
of this Proposal by stockholders, as well as the approval by stockholders and
subsequent implementation by the Board of the Specialty Retail Stock Proposal.
The Amendments would become effective upon the initial issuance of shares of any
series of Specialty Retail Stock. The description of such Amendments set forth
herein is qualified in its entirety by reference to the text of such Amendment
as set forth in Annex IV-D.
Under the terms of each of the 1973 Plan and the 1981 Plan, as proposed to
be amended, (i) an optionee who is an employee of a Specialty Retail Group would
be given an opportunity to convert all of his or her outstanding options for
Existing Common Stock (or, after the redesignation, Kmart Stock) under the 1973
and 1981 Plans (other than ISOs) into options for the relevant series of
Specialty Retail Stock with any such conversion to take effect upon the initial
issuance of shares of such series, and (ii) an optionee who is an employee of
the Kmart Group with responsibilities that include one or more Specialty Retail
Groups would be given an opportunity to convert a percentage of his or her
outstanding options under the 1973 and 1981 Plans (other than ISOs) for Existing
Common Stock (or, after the redesignation, Kmart Stock) into options for the
various series of Specialty Retail Stock, with any such conversion to take
effect upon its or their respective initial issuances. The percentage of such
options to be converted into each series of Specialty Retail Stock, would be
discretionarily determined by the Committee, based on such factors as the
Committee may find relevant, which may include, without limitation, the
employee's responsibilities and the proportionate Market Capitalization of the
various series of Specialty Retail Stock and Existing Common Stock (or, after
the redesignation, Kmart Stock).
The converted options would generally have the same terms (including the
expiration date) as the outstanding options, except that the underlying series
of Common Stock would be changed and the number of shares and the exercise price
would be equitably adjusted to preserve the aggregate "spread" between the
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<PAGE> 104
then-current aggregate value of the shares underlying the outstanding options
and the aggregate exercise price of such outstanding options on the date of the
conversion.
STOCK SUBJECT TO 1973 AND 1981 PLANS
The Company's ability to grant options for Existing Common Stock under the
1973 and 1981 Plans has expired. The 1973 Plan Amendment and the 1981 Plan
Amendment provide that the number of shares of each issued series of Specialty
Retail Stock which would be made available for conversion of certain outstanding
options for Existing Kmart Stock, which, upon the initial issuance of any series
of Specialty Retail Stock would automatically be redesignated as Kmart Stock
under the respective Plans would be the number of shares equal to the product
of:
(i) the sum of (x) the number of shares of each such series
outstanding immediately after such initial issuance and (y) the Number of
Shares Issuable with Respect to Retained Interest in the relevant Specialty
Retail Group immediately after such initial issuance, multiplied by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
1973 PLAN 1981 PLAN
--------- ---------
<S> <C> <C>
Borders-Walden Stock............................. 1.40% 0.30%
Builders Square Stock............................ 1.00% 0.20%
OfficeMax Stock.................................. 0.30% 0.10%
The Sports Authority Stock....................... 0.50% 0.10%
</TABLE>
The foregoing percentages were determined based upon the relative number of
employees of each Specialty Retail Group and assumptions regarding the level of
participation to be expected from such employees. The number of such shares
would be subject to adjustment by the Committee in the event of a
recapitalization, stock split, stock dividend or similar corporate transaction.
Shares issued under both the 1973 Plan and the 1981 Plan could be either
authorized and unissued shares or shares which have been reacquired by the
Company. The issuance of such shares would be attributable to the Kmart Group's
Retained Interest in the relevant Specialty Retail Group. Upon such issuance,
the Number of Shares Issuable with Respect to Retained Interest in the relevant
Specialty Retail Group would be reduced. Accordingly, the Retained Interest
Fraction would be reduced and the Outstanding Interest Fraction would be
proportionately increased. The extent to which the issuance of shares of
Specialty Retail Stock pursuant to the 1973 and 1981 Plans would result in a
reduction of the Number of Shares Issuable with Respect to Retained Interest
would be dependent upon the extent to which participants elect to convert their
options for Existing Common Stock under the 1973 and 1981 Plans into interests
in Specialty Retail Stock. Moreover, such conversions by participants would
result in cancellation of the participant's current options for Existing Common
Stock (or, after the redesignation, Kmart Stock). See "Proposal 2 -- The
Specialty Retail Stock Proposal -- Retained Interest of Kmart Group in Specialty
Retail Groups; Outstanding Interest Fraction," and "-- Shares Issuable Pursuant
to Employee Benefit Plans."
ADDITIONAL INFORMATION REGARDING 1973 AND 1981 PLANS
No future original grants of options can be made under the 1973 and 1981
Plans. The number of options for various series of Specialty Retail Stock that
can be issued upon conversion of currently outstanding options cannot be
determined, since any such conversions will be made at the election of the
individual optionees and since the future market values of the various series of
Specialty Retail Stock are unknown. No options have been issued under either
Plan since August 17, 1991. As of March 1, 1994, there were options for
10,111,700 shares of Existing Common Stock outstanding under the 1973 Plan and
options for 6,127,167 shares of Existing Common Stock outstanding under the 1981
Plan. The aggregate market value of such shares was approximately $320,717,623
(based upon the closing price of the Existing Common Stock on the Composite Tape
on such date).
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DESCRIPTION OF 1973 AND 1981 PLANS AS PROPOSED TO BE AMENDED
As discussed above, no new options to purchase Existing Common Stock can be
granted under these Plans. It is proposed only, upon approval of this Proposal
by stockholders, as well as the approval by stockholders and the subsequent
implementation by the Board of the Specialty Retail Stock Proposal, to provide
an opportunity to certain optionees to convert all or a portion of their
outstanding options under these Plans into options for the series of stock of
the Specialty Retail Group to which the optionee is assigned or the Specialty
Retail Groups for which the optionee has responsibilities. The converted options
would otherwise have the same terms (including the expiration date) of the
outstanding options, except that the underlying series of Common Stock would be
changed and the number of shares and the exercise price would be equitably
adjusted to preserve the aggregate "spread" between the then-current aggregate
value of the shares underlying the outstanding options and the aggregate
exercise price of such outstanding options on the date of the conversion.
AMENDMENTS TO OR DISCONTINUANCE OF 1973 AND 1981 PLANS
The Board can from time to time alter, amend, suspend or discontinue the
1973 Plan or 1981 Plan; provided, however, that no amendment which requires
stockholder approval in order for the exemptions available under Rule 16b-3 to
be applicable to the amended Plan will be effective unless it is approved by
stockholders entitled to vote thereon.
FEDERAL INCOME TAX CONSEQUENCES
For information with respect to the Federal income tax consequences of
certain option transactions, see "Proposal 9 -- Amendments to 1992 Stock Option
Plan Relating to Substitution of Specialty Retail Stock for Existing Common
Stock Issuable Upon Exercise of Certain Options and Certain Other Plan
Amendments -- Federal Income Tax Consequences."
Approval of Proposal 8 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock, present, or represented, and entitled to vote, voting
together as one class. Approval of Proposal 8 is conditioned upon approval of
Proposal 2 and will not be implemented if Proposal 2 is not approved by
stockholders and implemented by the Board. Accordingly, a vote against Proposal
2 will have the effect of a vote against Proposal 8.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 8.
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PROPOSAL 9 -- AMENDMENTS TO 1992 STOCK OPTION PLAN
RELATING TO SUBSTITUTION OF SPECIALTY RETAIL STOCK FOR EXISTING
COMMON STOCK ISSUABLE UPON EXERCISE OF CERTAIN OPTIONS AND
CERTAIN OTHER PLAN AMENDMENTS
GENERAL
The stockholders are being asked to consider and approve certain amendments
to the 1992 Stock Option Plan (the "1992 Plan") as described herein and in Annex
IV-C. The 1992 Plan was adopted by the Board on January 21, 1992 and was
approved by stockholders and became effective on May 27, 1992. The 1992 Plan
provides for the grant of options for Existing Common Stock to officers and
other key employees of the Company and the Company's subsidiaries, including
directors who are full-time employees, at a price not less than the fair market
value of the Existing Common Stock on the date of grant. . The 1992 Plan is
administered by the Compensation and Incentives Committee (the "Committee"),
which is comprised solely of non-employee directors who are not eligible to
receive options under the Plan. Options granted under the 1992 Plan may be
options qualifying as incentive stock options under the Code ("ISOs") or
nonqualified stock options ("NQSOs"). The maximum term of an NQSO may not exceed
ten years and two days and the maximum term of an ISO may not exceed ten years.
As of the date hereof, there are no ISOs outstanding under the 1992 Plan. As of
March 1, 1994, options for Existing Common Stock granted under the 1992 Plan
were held by 5,490 employees; 32 of whom are currently officers or directors.
For ease of reference in this Proposal, employees of the Company and the
Company's subsidiaries who have work responsibilities with respect to Kmart
Group or a Specialty Retail Group are sometimes referred to herein as
"employees" of the relevant Group.
DESCRIPTION OF AMENDMENTS TO 1992 PLAN
Amendment Providing for Issuance of Options for Specialty Retail Stock. The
Company believes it is desirable to maintain its flexibility to use option
grants to attract, retain and reward exceptional personnel. In light of the
Specialty Retail Stock Proposal, the Company believes that the usefulness of the
1992 Plan as a continuing source of employee incentives will be impaired if the
amendments to the 1992 Plan described herein and in Annex IV-C hereto (the "1992
Plan Amendments") are not approved. In this regard, the Company believes that,
if a series of Specialty Retail Stock is issued by the Company, options for that
series of Specialty Retail Stock will provide a more effective and direct
incentive for the employees of the related Specialty Retail Group than options
for Existing Common Stock.
If this Proposal is approved by stockholders, and the Specialty Retail
Proposal is approved by stockholders and subsequently implemented by the Board,
(i) an employee of a Specialty Retail Group who is eligible to be granted
options under the 1992 Plan would be granted options only for the relevant
series of Specialty Retail Stock, and (ii) an employee of the Kmart Group with
responsibilities that include the Specialty Retail Groups and who is eligible to
be granted options under the 1992 Plan would be granted options for both shares
of Kmart Stock and shares of Specialty Retail Stock, the respective series and
the portion of such options to be represented by each series to be determined by
the Committee, in its sole discretion.
Amendment Regarding Outstanding Options. In connection with the initial
issuance of various series of Specialty Retail Stock, certain optionees would be
permitted to convert part or all of their pre-January 18, 1994 options for
Existing Common Stock (or, after the redesignation, Kmart Stock) into options
for the various issued series of Specialty Retail Stock. The converted options
would generally have the same terms (including the expiration date) as the
outstanding options, except that the underlying series of Common Stock would be
changed and the number of shares and the exercise price would be equitably
adjusted to preserve the aggregate "spread" between the then-current aggregate
value of the shares underlying the outstanding options and the aggregate
exercise price of the outstanding options on the date of the conversion.
More specifically, (i) an optionee who is an employee of a Specialty Retail
Group would be given an opportunity to convert all of his or her outstanding
options for Existing Common Stock (or, after the redesignation, Kmart Stock)
under the 1992 Plan into options for the relevant series of Specialty Retail
Stock
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upon the initial issuance of such series, and (ii) an optionee who is an
employee of the Kmart Group, whose responsibilities include the Specialty Retail
Groups, would be given an opportunity to convert a percentage of his or her
options under the 1992 Plan for Existing Common Stock (or, after the
redesignation, Kmart Stock) into options for the various series of Specialty
Retail Stock upon their respective initial issuances, the percentage of such
options to be available for conversion into the various series to be determined
by the Committee in its sole discretion based on such factors as the Committee
may find relevant, which may include, without limitation, the employee's
responsibilities and the proportionate Market Capitalization of the various
series of Specialty Retail Stock and Kmart Stock.
Additionally, with respect to any options granted to employees of a
Specialty Retail Group and employees of the Kmart Group with responsibilities
including one or more Specialty Retail Group(s), during the period between
January 18, 1994 and the initial issuance of the relevant series of Specialty
Retail Stock(s), it is anticipated that (i) any such options of an employee of a
Specialty Retail Group would automatically convert wholly into options for the
relevant series of Specialty Retail Stock upon initial issuance of such series,
and (ii) a percentage of any such options of such an employee of the Kmart Group
with responsibilities for the Specialty Retail Groups would automatically
convert into options for the various series of Specialty Retail Stock upon their
respective initial issuances, the percentage of such options to so convert into
each series to be determined by the Committee in its sole discretion based on
such factors as the Committee may find relevant, which may include, without
limitation, the employee's responsibilities and the proportionate Market
Capitalization of the various series of Specialty Retail Stock and Kmart Stock.
The number of shares of each series of Specialty Retail Stock underlying the
converted option would be determined by dividing an amount equal to the
aggregate exercise price of the shares of Kmart Stock underlying the original
option (or the percentage thereof being converted) by the exercise price per
share of such series of Specialty Retail Stock underlying the converted option,
which would be the initial offering price per share less underwriting fees and
commissions. The converted options would generally have the same terms
(including the expiration date) as the outstanding options, except that the
underlying series and number of shares of Common Stock and the exercise price of
the converted options would be changed as described above.
ADDITIONAL INFORMATION REGARDING 1992 PLAN
Stock options are granted by the Committee in its sole discretion, and,
therefore, the amount of future benefits to be allocated to any individual or
group of individuals under the 1992 Plan is not determinable. During fiscal
1993, four of the five persons named in the summary compensation table in this
Proxy Statement received certain options under the 1992 Plan. For the details of
such grants, see the section entitled "Proposal 1 -- Election of Directors --
Compensation of Officers-Option Grants in Fiscal 1993."
In fiscal 1993, all then current executive officers as a group (consisting
of 32 persons) received option grants covering 773,000 shares of Existing Common
Stock (with a weighted average exercise price of $19.88 per share) and all
eligible employees as a group (consisting of 5,184 persons) received option
grants covering shares of Existing Common Stock (with a weighted average
exercise price of $24.03 per share). Directors who are not full-time employees
of the Company are not eligible to receive grants under the 1992 Plan. The
exercise price of options granted under the 1992 Plan is equal in each case to
the fair market value of Existing Common Stock on the date of grant. As of March
1, 1994, the market value of Existing Common Stock underlying all outstanding
and unexercised options granted under the 1992 Plan was approximately
$482,831,031 (based upon the closing price of the Existing Common Stock on the
Composite Tape on such date).
DESCRIPTION OF 1992 PLAN AS PROPOSED TO BE AMENDED
The following is a description of the 1992 Plan as proposed to be amended
by this Proposal and Proposal 10 (entitled "Amendments to 1992 Stock Option Plan
Relating to Adding Certain Allocation Provisions").
Purpose. The purpose of the 1992 Plan is to attract and retain
highly-qualified officers and other key employees, to increase their proprietary
interest in the Company, to provide incentives to such persons to
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contribute to the success of the Company's business and to align executive and
stockholder long-term interests by creating a direct link between executive
compensation and stockholder return.
Administration. The 1992 Plan is administered by the Committee, which is
comprised solely of non-employee directors who are not eligible to receive
options under the 1992 Plan. The Committee has discretion, in accordance with
the provisions of the 1992 Plan, to determine to whom an option is granted, the
number of shares optioned (subject to the allocation provisions set forth in
Proposal 10 and to the overall share limit of the 1992 Plan) and the terms and
conditions of the option, including but not limited to, the option price (which
cannot be less than fair market value, except in connection with certain
conversions of options), method of exercise and the term during which the option
may be exercised. The Committee can make such rules and regulations and
establish such procedures for the administration of the 1992 Plan as it deems
appropriate.
Stock Subject to 1992 Plan. Out of 20,000,000 shares that were initially
available for options under the 1992 Plan, there remain, as of March 1, 1994,
10,992,000 shares of Existing Common Stock that may be subject to options issued
under the 1992 Plan. If a series of Specialty Retail Stock is issued, such
Existing Common Stock would be automatically redesignated as Kmart Stock. The
1992 Plan Amendment provides that the number of shares of each issued series of
Specialty Retail Stock which would be subject to options or issuance under the
1992 Plan (except for shares used in converting outstanding shares and stock
appreciation rights under the existing stock-based plans of Borders-Walden Group
and OfficeMax Group) would be the number equal to the product of:
(i) the sum of (x) the number of shares of each such series
outstanding immediately after such initial issuance and (y) the Number of
Shares Issuable with Respect to Retained Interest in the relevant Specialty
Retail Group immediately after such initial issuance multiplied by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock................... 9.93%
Builders Square Stock.................. 6.50%
OfficeMax Stock........................ 7.16%
The Sports Authority Stock............. 8.40%
</TABLE>
The foregoing percentages were determined based upon the relative number of
employees of each Specialty Retail Group and assumptions regarding the level of
participation to be expected from such employees. Borders-Walden Group and
OfficeMax Group each have their own stock based plans for their employees.
Effective as of the dates of the initial public offerings of Borders-Walden
Stock and OfficeMax Stock, the interests of employee participants in such plans
may be converted into options under the 1992 Plan to acquire 4.17% and 2.24% of
the Borders-Walden Stock and OfficeMax Stock, respectively, which percentages
are in addition to the above percentages. The number of such shares would be
subject to adjustment by the Committee in the event of a recapitalization, stock
split, stock dividend or similar corporate transaction.
Shares issued under the 1992 Plan could be either authorized and unissued
shares or shares which have been reacquired by the Company. In the event that an
outstanding option expires or is cancelled or forfeited, the shares covered
thereby would again be available for the grant of options under the Plan. The
issuance of shares upon the exercise of options (other than pursuant to the
Borders-Walden Group and OfficeMax Group stock-based plans referred to above)
granted under the 1992 Plan would be attributable to (i) the Kmart Group's
Retained Interest in the relevant Specialty Retail Group in the case of options
for Existing Common Stock (or after the redesignation, Kmart Stock) granted
prior to January 18, 1994, and converted as described above into options for
Specialty Retail Stock, and (ii) the relevant Specialty Retail Group in the case
of options for Specialty Retail Stock granted after the initial issuance of the
relevant series of Specialty Retail Stock. Upon issuance of shares as described
in clause (i), the relevant Number of Shares Issuable with Respect to Retained
Interest would be reduced. Upon the issuance of shares as described in either
clause (i) or clause (ii), the relevant Retained Interest Fraction would be
reduced and the relevant
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Outstanding Interest Fraction would be increased. The extent to which the
issuance of shares of Specialty Retail Stock pursuant to the 1992 Plan would
result in a reduction of the Number of Shares Issuable with Respect to Retained
Interest would be dependent upon the extent to which participants elect to
convert their options for Existing Common Stock under the 1992 Plan into
interest in Specialty Retail Stock. The issuance of shares pursuant to the
Borders-Walden Group and OfficeMax Group stock-based plans would be attributable
to the relevant Specialty Retail Group. Upon such issuance, the relevant
Retained Interest Fraction would be reduced and the relevant Outstanding
Interest Fraction would be increased. Moreover, such conversions by participants
would result in cancellation of the participant's current options for Existing
Common Stock (or, after the redesignation, Kmart Stock). See "Proposal 2 -- The
Specialty Retail Stock Proposal -- Retained Interest of the Kmart Group in the
Specialty Retail Groups; Outstanding Interest Fraction" and "-- Shares Issuable
Under Employee Benefit Plans."
Grant of Options. The Committee can grant options under the Plan to
officers and other key employees of the Company or the Company's subsidiaries,
including directors who are full-time employees. The Company estimates that
there are approximately such employees, of whom are currently
officers or directors. The Committee has discretion, in accordance with the
provisions of the 1992 Plan, to determine to whom an option is granted, the
number of shares optioned (subject to the allocation provisions set forth in
Proposal 10 and to the overall share limit of the 1992 Plan), and the terms and
conditions of the option, including, but not limited to, the option price (which
cannot be less than fair market value, except as may be necessary in order to
implement certain conversions of options), method of exercise and the term
during which the option may be exercised. In making such determinations, the
Committee considers the position and responsibilities of the employee, the
nature and value to the Company of his or her service and accomplishments, his
or her present and potential contribution to the success of the Company and such
other factors as the Committee may deem relevant. No option may be granted to an
employee who owns more than 5% of the outstanding Existing Common Stock.
An option granted under the 1992 Plan may be either an incentive stock
option ("ISO") or a non-qualified stock option ("NQSO"). An ISO is intended to
meet the requirements of Section 422 of the Internal Revenue Code.
Stock Appreciation Rights are not provided under the 1992 Plan.
Option Price. Except as described in the section hereof entitled
"Conversion of Options", the option price will not be less than the fair market
value of the Existing Common Stock (or the relevant series of Common Stock after
the initial issuance of any series of Specialty Retail Stock) on the date of the
grant of the option. With respect to options covering a particular series of
Specialty Retail Stock in connection with the initial issuance of such series,
the fair market value would be deemed to be the initial offering price, less
underwriting fees and commissions.
Conversion of Options. In connection with the initial issuance of any
series of Specialty Retail Stock, an optionee who is an employee of the Kmart
Group with responsibilities that include the Specialty Retail Groups would be
given an opportunity to convert a percentage of his or her outstanding
pre-January 18, 1994 options under the 1992 Plan for Kmart Stock into options
for the various series of Specialty Retail Stock, with any such conversion to
take effect upon its or their respective initial issuances. The percentage of
such options that could be converted into each series of Specialty Retail Stock
would be discretionarily determined by the Committee, based on such factors as
the Committee may find relevant, which may include, without limitation, the
employee's responsibilities and the Market Capitalization of the various series
of Specialty Retail Stock and Kmart Stock. Similarly, an optionee who is an
employee of a Specialty Retail Group would be given an opportunity to convert
all of his or her outstanding pre-January 18, 1994 options for Kmart Stock under
the 1992 Plan into options for the relevant series of Specialty Retail Stock,
with any such conversion to take effect upon the initial issuance of such
series. The converted options would generally have the same terms (including the
expiration date) as the outstanding options, except that the underlying series
of Common Stock would be changed and the number of shares and the exercise price
would be equitably adjusted to preserve the aggregate "spread" between the
then-current aggregate value of the shares underlying the outstanding options
and the aggregate exercise price of such outstanding options on the date of the
conversion.
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Additionally, with respect to any options granted to employees of a
Specialty Retail Group and employees of the Kmart Group who have
responsibilities which include the Specialty Retail Groups, during the period
between January 18, 1994 and the issuance of the relevant series of Specialty
Retail Stock(s), it is anticipated that a percentage (which is expected to be
100 percent in the case of an employee of a Specialty Retail Group) of any such
options would automatically convert into options for a single series of
Specialty Retail Stock (in the case of an employee of a Specialty Retail Group)
or for the relevant series of Specialty Retail Stocks issued in respect of the
related Specialty Retail Group or Groups for which the optionee has
responsibilities with respect to (in the case of Kmart Group employees with
responsibilities for the Speciality Retail Groups), such percentage to be
discretionarily determined by the Committee based on such factors as the
Committee may find relevant, which may include, without limitation, the
employee's responsibilities and the Market Capitalization of the various series
of Specialty Retail Stock and Kmart Stock. The number of shares of each series
of Specialty Retail Stock underlying the converted option would be determined by
dividing an amount equal to the aggregate exercise price of the shares of Kmart
Stock underlying the original option (or the percentage thereof being converted)
by the exercise price per share of such series of Specialty Retail Stock
underlying the converted option, which would be the initial offering price per
share less underwriting fees and commissions. The converted options would
generally have the same terms (including the expiration date) as the outstanding
options, except that the underlying series and number of Shares of Common Stock
and the exercise price of the converted options would be changed, as described
above.
Duration and Exercise of Options. An option granted under the 1992 Plan
cannot be exercised later than the date specified by the Committee, which can be
a maximum of ten years from the date of grant as to an ISO and a maximum of ten
years and two days from the date of grant as to an NQSO. An option generally may
not be exercised prior to three years from the date of grant (or such other
period as may be determined by the Committee), except that this limitation will
be removed in the event of death or total and permanent disability of the
optionee, retirement by the optionee at or after age 65 with at least ten years
of full time service with the Company or a subsidiary, a change of control of
the Company, or if and to the extent the Committee so determines in its
discretion.
An option may be exercised only during the optionee's employment or within
three months after termination of employment and only if it is vested; provided,
however, if employment terminates as a result of death or total and permanent
disability or if the optionee has ten or more years of full time service with
the Company or a Company subsidiary, such three-month period is extended to
three years. All rights with respect to an option will be terminated if it is
determined that the optionee engaged in fraud, dishonesty, conduct in violation
of Company policy or similar acts.
Exercise and Payment. Payment by an optionee for the underlying shares of
any series of Common Stock purchased upon the exercise of an option would be
made in full at the option price by delivering to the Company cash or other
shares of Common Stock of the same series which have a current market value
equivalent to the option price and which have been held by the optionee for at
least six months, or a combination of both cash and such stock. The Committee
may in its discretion permit an optionee to pay all or a portion of any taxes
arising in connection with the exercise of an option by having the applicable
employer withhold shares of the stock underlying the exercised option or by the
optionee delivering other shares of Common Stock of the same series having a
market value equal to the amount of taxes to be withheld.
Term. No option may be granted under the Plan after January 20, 2002.
Options granted prior thereto, however, may extend beyond such date and the
provisions of the 1992 Plan will continue to apply thereto.
Amendments to or Discontinuance of 1992 Plan. The Board can from time to
time alter, amend, suspend or discontinue the 1992 Plan; provided, however, that
no amendment which requires stockholder approval in order for the exemptions
available under Rule 16b-3 to be applicable to the 1992 Plan will be effective
unless it is approved by stockholders entitled to vote thereon. Additionally,
the Board can make such amendments as it deems necessary to comply with
applicable laws, rules and regulations.
Federal Income Tax Consequences. The following is a brief summary of the
principal Federal income tax consequences of transactions under the 1992 Plan
based on current Federal income tax laws. The summary is not intended to
constitute tax advice and, among other things, does not address possible state,
local or foreign
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tax consequences. Accordingly, a participant should consult a tax adviser with
respect to the tax aspects of transactions under the 1992 Plan.
Nonqualified Options. No income would be realized by an optionee upon grant
of a nonqualified option. Upon exercise of a nonqualified option, the optionee
would recognize ordinary compensation income in an amount equal to the excess,
if any, of the fair market value of the underlying stock over the option
exercise price (the "Spread") at the time of exercise. The Spread would be
deductible by the Company for Federal income tax purposes (i) provided that
applicable Federal income tax withholding requirements are satisfied and (ii)
subject to the possible limitations on deductibility under Section 162(m) of the
Code of compensation paid to the executives designated in that Section. The
optionee's basis in shares of the underlying stock acquired by exercise of a
nonqualified option would equal the exercise price plus the amount taxable as
compensation to the optionee. Upon a sale of the shares received by the optionee
upon exercise of the nonqualified option, any gain or loss is generally
long-term or short-term capital gain or loss, depending on the holding period.
The required holding period for long-term capital gain is presently more than
one year. The optionee's holding period for shares acquired pursuant to the
exercise of a nonqualified option would begin on the date of exercise of such
option. The excess of the net long-term capital gain over net short-term capital
loss is taxable at a maximum stated tax rate of 28%.
Pursuant to applicable rules under Section 16(b) of the Exchange Act, the
grant of an option (and not its exercise) to a person who is subject to the
reporting and short-swing profit provisions under Section 16 of the Exchange Act
begins the six-month period of potential short-swing liability. The taxable
event for the exercise of an option that has been outstanding at least six
months ordinarily would be the date of exercise. If an option is exercised
within six months after the date of the grant, however, taxation ordinarily
would be deferred until the date which is six months after the date of grant,
unless the person has filed an election pursuant to Section 83(b) of the Code to
be taxed on the date of exercise.
The payment by an optionee of the exercise price, in full or in part, with
shares of previously acquired Common Stock of the same series would not affect
the tax treatment of the exercise as described above. With respect to such
exchange, no gain or loss generally would be recognized to the optionee upon the
surrender of the previously acquired shares to the Company, and shares received
by the optionee, equal in number to the previously surrendered shares, would
have the same basis as the shares surrendered to the Company and will have a
holding period that includes the holding period of the shares surrendered. The
value of shares received by the optionee in excess of the number of shares
surrendered to the Company would be taxable to the optionee. Such additional
shares would have a basis equal to the fair market value of such additional
shares as of the date ordinary income is recognized, and will have a holding
period that begins on the date ordinary income is recognized. The conversion of
nonqualified options should have no tax effect on either the optionee or the
Company.
Incentive Stock Options. The Code requires that, for incentive stock option
("ISO") treatment, shares acquired through exercise of an ISO cannot be disposed
of before two years from the date of grant and one year from the date of
exercise. ISO holders generally incur no Federal income tax liability at the
time of grant or upon exercise of such options. However, the Spread will be an
"item of tax preference" which may give rise to "alternative minimum tax"
liability at the time of exercise. If the optionee does not dispose of the
shares before two years from the date of grant and one year from the date of
exercise, the difference between the exercise price and the amount realized upon
disposition of the shares would constitute long-term capital gain or loss, as
the case may be. Assuming both holding periods are satisfied, no deduction would
be allowable to the Company for Federal income tax purposes in connection with
the grant or exercise of the option. If, within two years of the date of grant
or within one year from the date of exercise, the holder of shares acquired
through exercise of an ISO disposes of such shares after exercise of the ISO,
the optionee would generally realize ordinary taxable compensation at the time
of such disposition equal to the difference between the exercise price and the
lesser of the fair market value of the stock on the date of initial exercise or
the amount realized on the subsequent disposition, and the amount realized upon
such disposition would be deductible by the Company (or the Company subsidiary
employing the optionee, if applicable) for Federal income tax purposes, subject
to the possible limitations on deductibility under Section 162(m) of the Code of
compensation paid to executives designated in that Section.
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If the optionee pays the exercise price, in full or in part, with shares of
previously acquired Common Stock of the same series, proposed Internal Revenue
Service regulations would provide the following rules. If the shares surrendered
in payment of the exercise price of an ISO are "statutory option stock"
(including stock acquired pursuant to the exercise of an ISO) and if, at the
time of surrender, the applicable holding period for such shares had not been
met, any gain realized on such transfer would be taxable to the optionee, as
discussed above. Otherwise, when shares of Common Stock of the same series are
surrendered upon exercise of an ISO, in general (i) no gain or loss would be
recognized as a result of the exchange, (ii) the number of shares received that
is equal in number to the shares surrendered would have a basis equal to the
shares surrendered and would have a holding period that includes the holding
period of the shares exchanged, and (iii) any additional shares received would
be a zero basis and would have a holding period that begins on the date of the
exchange. If any of the shares received are disposed of within two years from
the date of grant of the ISO or within one year from the date of exercise, the
shares with the lowest basis will be deemed to be disposed of first, and such
disposition will be a disqualifying disposition giving rise to ordinary income
as discussed above.
In the case of a disqualifying disposition, the Company would generally be
entitled to a deduction in the amount of an optionee's income at the time such
income is recognized by the optionee, subject to the possible limitations on
deductibility under Section 162(m) of the Code of compensation paid to
executives designated in that Section.
Approval of Proposal 9 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class. Proposal 9 concerns Specialty Retail Stock and therefore
its approval is conditioned upon approval of Proposal 2 and will not be
implemented if Proposal 2 is not approved by stockholders and implemented by the
Board. Accordingly, a vote against Proposal 2 will have the effect of a vote
against Proposal 9.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 9.
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PROPOSAL 10 -- AMENDMENTS TO 1992 STOCK OPTION PLAN RELATING TO ADDING CERTAIN
ALLOCATION PROVISIONS
DESCRIPTION OF AMENDMENT TO ADD ALLOCATION PROVISIONS
The stockholders are being asked to consider and approve amendments to the
1992 Stock Option Plan (the "1992 Plan") that add certain allocation provisions
in order to comply with certain requirements of the Code, as described herein
and in Annex IV-F. The 1992 Plan was adopted by the Board, and was approved by
stockholders and become effective, on May 27, 1992. The 1992 Plan is
administered by the Compensation and Incentives Committee (the "Committee") of
the Board, which is comprised solely of non-employee directors who are not
eligible to receive options under the 1992 Plan. Options granted under the 1992
Plan may be options qualifying as incentive stock options under the Code
("ISOs") or nonqualified stock options ("NQSOs"). The maximum term of an NQSO
may not exceed ten years and two days and the maximum term of an ISO may not
exceed ten years. For ease of reference in this Proposal, employees of the
Company and the Company's subsidiaries who have work responsibilities with
respect to Kmart Group or a Specialty Retail Group are sometimes referred to
herein as "employees" of the relevant Group.
On , the Board approved an amendment to the 1992 Plan, to
establish maximum allocations of option grants to certain executive officers
(the "Allocation Amendment"), subject to approval by stockholders. The
description of the Allocation Amendment set forth herein is qualified in its
entirety by reference to the text of such Amendment as set forth in Annex IV-F.
The Allocation Amendment sets forth certain allocations of the maximum
number of shares that may be the subject of option grants under the 1992 Plan.
The Committee (or, if necessary for tax purposes, a subcommittee thereof) will
continue to have the discretion to determine officers and key employees eligible
to receive option grants under the 1992 Plan. The Committee will, however, be
limited in the number of shares of the Existing Common Stock subject to options
and, if Proposals 2 and 9 are approved by stockholders and Proposal 2 is
implemented by the Board, in the number of shares of the various series of
Common Stock subject to options (the "Allocation Limit") to be granted to any
optionee under the 1992 Plan.
The proposed allocation provisions do not otherwise modify the availability
of the 1992 Plan to designated individuals. Such provisions are intended to
address certain possible limitations on the deductibility of executive
compensation under Section 162(m) of the Code, as amended by the Omnibus Budget
Reconciliation Act of 1993, which was signed into law on August 10, 1993 (the
"Revenue Act"). The Revenue Act limits the deductibility of certain compensation
in excess of $1 million per year paid by a publicly traded corporation to the
following individuals who are employed as of the end of the corporation's tax
year: the chief executive officer and the four other executive officers named in
the summary compensation table of the corporation's proxy statement. However,
compensation which qualifies as "performance-based" compensation is exempt from
the $1 million deductibility limitation. In order for compensation provided upon
the exercise of options granted pursuant to the 1992 Plan to qualify for this
exemption, the material terms under which the compensation is to be paid
(including the maximum number of options that can be awarded to any employee
during a specified period) must be disclosed to and approved by stockholders in
a separate vote prior to payment. The 1992 Plan as previously approved by
stockholders did not include a provision setting forth a maximum number of
options that could be granted to an employee. In an effort to comply with the
provisions of the Revenue Act and to qualify the compensation payable to certain
executives upon the exercise of options granted under the 1992 Plan as
compensation eligible for exclusion from the deduction limit, the Allocation
Amendment to the 1992 Plan is being submitted as a separate proposal to
stockholders for approval at the Annual Meeting.
The Allocation Amendment provides that, effective as of January 1, 1994, no
employee of the Company may be granted options under the 1992 Plan in any
calendar year which are in excess of 10 percent of the total number of options
granted in such calendar year with respect to any or all series of Common Stock
(including, for this purpose, shares of the various series of Specialty Retail
Stock if Proposals 2 and 9 are approved by stockholders and Proposal 2 is
implemented by the Board) and, if such approvals and implementation occur, no
employee of a Specialty Retail Group may be granted options under the 1992 Plan
in any calendar year
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which are in excess of 25 percent of the total number of options granted in such
calendar year with respect to the relevant series of Specialty Retail Stock (the
"Maximum Annual Grant Limit").
The Committee has discretion, in accordance with the provisions of the 1992
Plan, to determine to whom an option is granted, the number of shares optioned
(subject to the allocation provisions set forth herein and to the overall share
limit of the 1992 Plan) and the terms and conditions of the option, including
but not limited to the option price (which cannot be less than fair market
value, except in connection with certain conversions and certain grants (which
will not be made to any executive officer of the Company) in connection with
purchases of restricted stock pursuant to the Kmart Corporation Management Stock
Purchase Plan), method of exercise and the term during which the option may be
exercised. The Committee retains its discretion as to the terms of grants as set
forth above and is not obligated to cause the Committee to grant options to any
employee equal to the maximum number of options which can be granted without
exceeding such Limit.
ADDITIONAL INFORMATION REGARDING 1992 PLAN
For certain additional information regarding the 1992 Plan, see "Proposal 9
- -- Amendments to 1992 Stock Option Plan Relating to Substitution of Specialty
Retail Stock for Existing Common Stock Issuable Upon Exercise of Certain Options
and Certain Other Plan Amendments." and "Additional Information Regarding 1992
Plan".
Approval of Proposal 10 will require the affirmative vote of the holders of
a majority of the votes cast by the holders of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 10.
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PROPOSAL 11 -- ADOPTION OF MANAGEMENT STOCK PURCHASE PLAN
GENERAL
The stockholders are being asked to consider and approve the Management
Stock Purchase Plan (the "Stock Purchase Plan"), as described herein and in
Annex IV-G. The Stock Purchase Plan was adopted by the Board on 1994,
subject to approval by stockholders. The Stock Purchase Plan will be
administered by the Compensation and Incentives Committee (the "Committee"),
which is comprised solely of non-employee directors who will not be eligible to
receive or purchase stock under the Stock Purchase Plan. For ease of reference
in this Proposal, employees of the Company and the Company's subsidiaries who
have work responsibilities with respect to the Kmart Group or a Specialty Retail
Group are sometimes referred to herein as "employees" of the relevant Group.
The participants in the Stock Purchase Plan will consist of all Company
officers, all Company group and divisional vice presidents and such key
employees of the Company and the Company's subsidiaries as are designated as
participants in the Company's Annual Incentive Bonus Plan (the "Annual Bonus
Plan"), a separate plan described in Proposal 12. Although the Stock Purchase
Plan and the Annual Bonus Plan are separate plans, the same individuals
participate in each plan. Each participant will be required to use a minimum of
20 percent, and at his or her election will be permitted to use up to 100
percent, of the annual incentive bonus, if any, earned by the participant under
the Annual Bonus Plan to purchase restricted Common Stock under the Stock
Purchase Plan at a price equal to its fair market value on the date of purchase.
The shares of Common Stock so purchased will be restricted from sale or transfer
for a period of at least three years from the date of purchase (the "Restricted
Stock" or "Restricted Shares").
If the Specialty Retail Stock Proposal is approved by stockholders and
subsequently implemented by the Board, then, upon the initial issuance of any
series of Specialty Retail Stock, participants who are employees of the related
Specialty Retail Group and employees of Kmart Group with responsibilities for
the Specialty Retail Group will be given certain opportunities to purchase
additional Restricted Shares of such series of Specialty Retail Stock at a 20
percent discount from the stock's initial offering price, net of underwriting
fees and commissions and, in the case of employees of such Specialty Retail
Group, to receive related grants of stock options in connection with such
purchases.
The description of the Stock Purchase Plan set forth herein is qualified in
its entirety by reference to the text of the Stock Purchase Plan as set for the
Annex IV-G.
ADDITIONAL INFORMATION REGARDING STOCK PURCHASE PLAN
Since the amount of benefits to be received by each participant is
determined by his or her annual incentive bonus (which cannot be determined
until fiscal year-end), by his or her election (if any) to increase
participation beyond the mandatory 20 percent and by certain participants'
elections (if any) to take advantage of the opportunity to acquire shares of any
or all of the various series of Specialty Retail Stock in connection with the
initial issuances of such series, the amount of future benefits to be allocated
to any individual or group of individuals under the Stock Purchase Plan is not
determinable. Similarly, the benefits which would have been received by or
allocated to any individual or group of individuals for fiscal 1993 if the Stock
Purchase Plan had been in effect is not determinable. As of , 1994,
the market value of Existing Common Stock which would be available for purchase
under the Stock Purchase Plan was approximately $ (based upon the closing
price of the Existing Common Stock on the NYSE Composite Transactions Tape on
such date).
DESCRIPTION OF STOCK PURCHASE PLAN
The following is a description of the proposed Stock Purchase Plan.
Purpose. The purpose of the Stock Purchase Plan is to attract and retain
highly-qualified officers and other key employees, to increase their proprietary
interest in the Company, to provide incentives to such persons to contribute to
the success of the Company's business and, to align executive and stockholder
long-term interests by creating a direct link between executive compensation and
stockholder return.
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Administration. The Stock Purchase Plan will be administered by the
Committee which is comprised solely of non-employee directors who are not
eligible to participate in the Stock Purchase Plan. The Committee can make such
rules and regulations and establish such procedures for the administration of
the Stock Purchase Plan as it deems appropriate.
Stock Subject to Stock Purchase Plan. The number of shares of each issued
series of Specialty Retail Stock which would be made available for purchase
under the Stock Purchase Plan would be the number of shares equal to the product
of:
(i) the sum of (x) the number of shares of each such series
outstanding immediately after initial issuance and (y) the Number of Shares
Issuable with Respect to the Retained Interest in the relevant Specialty
Retail Group immediately after such initial issuance, multiplied by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock...................................... 1.10%
Builders Square Stock..................................... 1.10%
OfficeMax Stock........................................... 1.50%
The Sports Authority Stock................................ 1.10%
</TABLE>
The foregoing percentages were determined based upon the relative number of
employees of each Specialty Retail Group and assumptions regarding the level of
participation to be expected from such employees. The number of such shares
would be subject to adjustment by the Committee in the event of a
recapitalization, stock split, stock dividend or similar corporate transaction.
Shares issued under the Stock Purchase Plan could be either authorized and
unissued shares or shares which have been reacquired by the Company. The
interest of holders of a series of Specialty Retail Stock would be diluted to
the extent of any issuance of authorized and unissued shares of such series
under the Stock Purchase Plan. In the event that any restricted shares are
cancelled before their restrictions lapse, such shares would again be available
for purchase and issuance under the Stock Purchase Plan, provided that no
dividends or other benefits therefrom have been paid to the applicable
participant.
Series of Stock Subject to Purchase. Except as provided in this paragraph
(with respect to Kmart Group employees whose responsibilities include the
various Specialty Retail Groups), stock purchases required or permitted to be
made under the Stock Purchase Plan by participants who are Company officers or
Company group or divisional vice presidents and such other key employees of the
Company and the Company's subsidiaries as are designated by the Committee would
be made in Existing Common Stock (which, upon the initial issuance of any series
of Specialty Retail Stock would be automatically redesignated as Kmart Stock).
Following approval by stockholders and subsequent implementation by the Board of
the Specialty Retail Stock Proposal, stock purchases required or permitted to be
made under the Stock Purchase Plan by participants who are key employees of a
Specialty Retail Group would be made in the relevant series of Specialty Retail
Stock after there has been an issuance of such series. Stock purchases required
or permitted to be made under the Stock Purchase Plan by such Specialty Retail
Group participants prior to any such issuance will be made in Existing Common
Stock, which would be subject to automatic conversion (as described below) to
the applicable series of Specialty Retail Stock upon the initial issuance of
such series. After the initial issuance of one or more series of Specialty
Retail Stock, certain percentages of the stock purchases under the Stock
Purchase Plan required or permitted to be made by participants who are employees
of the Kmart Group with responsibilities which include the Specialty Retail
Groups and who are designated by the Committee, would be for shares of the
relevant then outstanding series of Common Stock (including Kmart Stock). Such
percentages would be discretionarily determined by the Committee, based on such
factors as the Committee may find relevant, which may include, without
limitation, the employee's responsibilities and the Market Capitalization of the
various series of Specialty Retail Stock and Kmart Stock. As described in more
detail in the following three sections, employees who receive annual incentive
bonuses under the Annual Bonus Plan are required to use 20 percent, and at their
election are permitted to use up to 100 percent, of such annual incentive
bonuses (less applicable payroll deductions) to purchase Restricted
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Shares of Common Stock pursuant to, and subject to the terms and conditions of,
the Stock Purchase Plan. Also, a participant in the Stock Purchase Plan who is
designated by the Committee is permitted, at his or her election, to make
certain additional purchases of Restricted Shares of Common Stock under the
Stock Purchase Plan.
Annual Purchase of Restricted Stock with Annual Incentive Bonus. All
Company officers, all Company group and divisional vice presidents and such key
employees of the Company and the Company's subsidiaries as are designated by the
Committee would be required to use 20 percent, and at the participant's option
could elect to use up to 100 percent, of any annual incentive bonus (less
applicable payroll deductions) to purchase Restricted Shares of Existing Common
Stock, and following approval by stockholders and subsequent implementation by
the Board of the Specialty Retail Stock Proposal and initial issuance of the
relevant series of Specialty Retail Stock, to purchase Restricted Shares of such
series of Common Stock of their related Group at the stock's fair market value.
Any election to purchase additional Restricted Shares by a person who is subject
to the reporting and short-swing profit provisions under Section 16 of the
Exchange Act (a "Section 16 Person") must be made at least six months prior to
the day the amount of the annual incentive bonus is finally determined by the
Committee.
Opportunity for One-time Purchase of Restricted Stock by Specialty Retail
Group Employees. Except as otherwise determined by the Committee, in connection
with the initial issuance of a series of Specialty Retail Stock, any key
executive of the relevant Specialty Retail Group who is designated by the
Committee would be given a one-time opportunity to invest up to $1 million in
the purchase of Restricted Shares of such series of Specialty Retail Stock at a
20 percent discount from the initial offering price net of underwriting fees and
commissions.
For this purpose, subject to limitations imposed by the Committee with
respect to a particular series of Specialty Retail Stock, such a participant can
apply up to 100 percent of his or her targeted annual incentive bonus for the
year in which the initial issuance occurs and/or up to 100 percent of his or her
base salary (less applicable payroll deductions) for the subsequent 12-month
period (less customary payroll deductions) and/or may also utilize his or her
own personal funds, toward the purchase of such Restricted Stock. The
participant must pay at the time of purchase, in cash, from his or her personal
funds, the difference between the aggregate purchase cost and the sum of the
targeted annual incentive bonus and salary so applied. At the time the actual
incentive bonus for the year is determined, the participant must pay, in cash,
any balance of the purchase cost remaining after application of such incentive
bonus, salary and/or personal funds to the purchase cost.
For each share of Restricted Stock so purchased, the participant would be
granted an option under the 1992 Plan to acquire a share of the applicable
series of Specialty Retail Stock at the initial offering price, net of
underwriting fees and commissions, provided that, except as discretionarily
provided by the Committee in unusual circumstances, the number of options so
granted could not exceed (i) the number of options granted to such participant
in 1994 for shares of Existing Common Stock, as such options are converted to
options for the applicable series of such Specialty Retail Stock (as discussed
more fully in Proposal 9), or (ii) if no options for shares of Existing Common
Stock were granted to such participant in 1994, the number of options for shares
of the relevant series of Specialty Retail Stock granted to such participant in
connection with the initial issuance of such series.
Opportunity for One-time Purchase of Restricted Stock by Kmart Group
Employees with Specialty Retail Group Responsibilities. Except as otherwise
determined by the Committee, in connection with the initial issuances of the
various series of Specialty Retail Stock, each participant in the Stock Purchase
Plan who is an employee of the Kmart Group with responsibilities which include
the Specialty Retail Groups and who is designated by the Committee, would be
given a one-time opportunity to invest up to $1 million in the purchase of
Restricted Shares of all issued series of Common Stock at a 20 percent discount
from their respective initial offering prices net of underwriting fees and
commissions. The portion of the aggregate purchase price to be applied to each
series of Specialty Retail Stock would be discretionarily determined by the
Committee, based on such factors as the Committee may find relevant, which may
include, without limitation, the employee's responsibilities and the Market
Capitalization of the various series of Specialty Retail Stock.
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For this purpose, subject to limitations imposed by the Committee with
respect to a particular series of Specialty Retail Stock, such a participant
could apply up to 100 percent of his or her targeted annual incentive bonus for
the year in which the initial issuance of a series of Specialty Retail Stock
occurs and/or up to 100 percent of his or her base salary for the subsequent
12-month period (less customary payroll deductions), and/or may also utilize his
or her own personal funds, toward the purchase of the various issued series of
Specialty Retail Stock. The participant must pay at the time of each purchase,
in cash from his or her personal funds, the difference between the aggregate
purchase cost for shares of each series and the sum of the targeted annual
incentive bonus and the salary so applied. At the time the actual incentive
bonus for the year is determined, the participant must pay, in cash, any balance
of the purchase cost remaining after application of such bonus, salary and/or
personal funds to the purchase cost.
Price of Restricted Stock. Other than for purposes of the one-time purchase
opportunities described above, the price of the Restricted Share purchased under
the Stock Purchase Plan, for purposes of determining the number of shares to be
issued, would be their fair market value. In connection with such one-time
purchase opportunities, the price of the Restricted Stock would be discounted 20
percent from its "fair market value" (other than the portion of the Restricted
Stock deemed purchased with the annual bonus). For purposes of the Stock
Purchase Plan, the "fair market value" of the Existing Common Stock, and,
subsequently, each issued series of Common Stock, would be the average of the
closing prices on the NYSE Composite Transactions Tape (or its equivalent if the
relevant stock is not traded on the New York Stock Exchange) for the five
Trading Days prior to the date of purchase of such stock, except that when a
purchase is made in connection with the initial issuance of a series of
Specialty Retail Stock, the "fair market value" of a share of such series will
be the initial offering price, less underwriting fees and commissions.
Conversion of Restricted Stock. If a participant who is a key employee of a
Specialty Retail Group purchased Restricted Shares of Existing Common Stock or
Kmart Stock under the Stock Purchase Plan prior to the initial issuance of his
or her Group's series of Specialty Retail Stock, such shares of Existing Common
Stock would automatically convert into Restricted Shares of such series of
Specialty Retail Stock upon the initial issuance of such series. If a
participant who is an employee of the Kmart Group who has responsibilities for
all the Specialty Retail Groups purchased such Restricted Shares of Existing
Common Stock or Kmart Stock prior to the initial issuance of the various series
of Specialty Retail Stock, such shares would be automatically partially
converted into Restricted Shares of a series of Specialty Retail Stock upon its
initial issuance. In the case of total conversion into one series of Specialty
Retail Stock, the number of shares of the series of Specialty Retail Stock to be
issued upon such conversion would be based on the aggregate fair market value of
the Existing Common Stock or Kmart Stock on the date of [grant] [initial
issuance of such series of Specialty Retail Stock] divided by the initial
offering price of such series of Specialty Retail Stock, net of underwriting
fees and commissions. In the case of a partial conversion into a particular
series of Specialty Retail Stock, the conversion mechanism would be similar, but
the percentage of the shares of Existing Common Stock or Kmart Stock to be
converted would be discretionarily determined by the Committee, based on such
factors as the Committee may find relevant, which may include, without
limitation, the respective employee's responsibilities and the Market
Capitalization of the various series of Specialty Retail Stock and Kmart Stock.
In each case, the converted Restricted Shares would otherwise have the same
terms (including the date the restrictions lapse) as the original Restricted
Shares, except that the underlying stock and the number of shares would be
adjusted as aforesaid.
Restricted Period; Disposition of Stock Upon Termination of Employment
During Restricted Period. The restricted period for Restricted Stock purchased
under the Stock Purchase Plan would generally be three years from the date of
purchase. Except as provided below in this section, if employment terminates
during the restricted period, the participant would receive unrestricted shares
of stock (or cash in the discretion of the Committee) equal to the lesser in
value of (i) the Restricted Shares at their then-current fair market value or
(ii) 80% of the fair market value of such Restricted Shares on the date of their
purchase.
If during the restricted period, termination of employment of a participant
results from death or total and permanent disability or a participant terminates
his or her employment at or after age 65 with ten or more years of full time
service or in the event of a change in control of the Company, the restrictions
would
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immediately lapse. In addition, the Committee may in its discretion accelerate
the lapse of such restrictions under such other circumstances as it may deem
appropriate.
If during the restricted period, a participant's employment is terminated
by the Company without cause (defined generally as fraud, dishonesty, conduct in
violation of company policy or similar acts), the participant would receive
unrestricted shares of stock (and/or cash in the discretion of the Committee)
equal in value to (i) the then-current value of a percentage of the Restricted
Shares, such percentage to be based on the number of months of employment
completed during the restricted period, plus (ii) as to the balance of the
Restricted Shares, the lesser of the then-current value of such shares or 80% of
the fair market value of such shares on the date of their purchase.
Payment of Withholding Taxes. The Committee could, in its discretion and on
such terms and conditions as it determines, permit a participant to pay all or a
portion of any taxes arising in connection with the purchase or the lapse of
restrictions with respect thereto by having the applicable employer withhold
shares of the stock or by the participant delivering other shares of Existing
Common Stock (or, after the initial issuance of a series of Specialty Retail
Stock, shares of Common Stock of the same series) having a market value equal to
the amount of taxes to be withheld.
Term. No purchase could be made under the Stock Purchase Plan after March
15, 2004. Holdings of Restricted Stock acquired prior thereto, however, could
extend beyond such date and the provisions of the Stock Purchase Plan will
continue to apply thereto.
Amendments to or Discontinuance of Stock Purchase Plan. The Board could
from time to time alter, amend, suspend or discontinue the Stock Purchase Plan;
provided, however, that no amendment which requires stockholder approval in
order for the exemptions available under Rule 16b-3 to be applicable to the
Stock Purchase Plan will be effective unless it is approved by stockholders
entitled to vote thereon. Additionally, the Committee could make such amendments
as it deems necessary to comply with applicable laws, rules and regulations.
Federal Income Tax Consequences. The following is a brief summary of the
principal Federal income tax consequences of transactions under the Stock
Purchase Plan based on current Federal income tax laws. The summary is not
intended to constitute tax advice and, among other things, does not address
possible state, local or foreign tax consequences. Accordingly, a participant
should consult a tax adviser with respect to the tax aspects of transactions
under the Stock Purchase Plan.
A participant generally must include as ordinary income the fair market
value of the Restricted Stock (less any amounts paid for such stock, except
pre-tax amounts) at the earlier of the time such Restricted Stock is either
transferable or no longer subject to a substantial risk of forfeiture
("Forfeiture Period") within the meaning of Section 83 of the Code (including,
in the case of a Section 16 Person, any period during which such Section 16
Person would be subject to potential liability). Any participant (including a
Section 16 Person) can elect pursuant to Section 83(b) of the Code to include as
ordinary income, in the year of transfer of the Restricted Stock by the
applicable employer to such person, an amount equal to the fair market value of
the Restricted Stock (less any amounts paid for such stock, except pre-tax
amounts) on the date of such transfer (as if the Restricted Stock were
unrestricted and could be sold immediately); such an election must be made
within 30 days of the date of such transfer. A participant's basis in Restricted
Stock is equal to the amount paid for such stock plus the amount includible in
income with respect to such Restricted Stock. With respect to the sale of
Restricted Stock after the expiration of the Forfeiture Period, any gain or loss
would generally be treated as long-term or short-term, depending on the holding
period. The holding period for capital gains treatment would begin when the
Forfeiture Period expires, unless the participant has made a Section 83(b)
election, in which event the holding period would commence just after the date
of transfer of the Restricted Stock by the applicable employer to such person.
The Company generally would be entitled to a deduction in the amount of a
participant's income at the time such income is recognized as described above,
provided that applicable Federal income tax withholding requirements are
satisfied, and subject to possible limitations on deductibility under Section
162(m) of the Code of compensation paid to executives designated in that
Section. The automatic conversion of certain Restricted Shares of the Existing
Common Stock (or Kmart Stock) to Restricted Shares of one or more series of
Specialty Retail Stock should not have any Federal income tax consequences.
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Approval of Proposal 11 will require the affirmative vote of the holders of
a majority of shares of Existing Common Stock, Series A Preferred Stock and
Series B Preferred Stock present, or represented, and entitled to vote, voting
together as one class.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 11.
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PROPOSAL 12 -- ADOPTION OF ANNUAL INCENTIVE BONUS PLAN
GENERAL
The stockholders are being asked to consider and approve the Annual
Incentive Bonus Plan (the "Annual Bonus Plan"), as described herein and in Annex
IV-H. The Annual Bonus Plan was unanimously adopted by the Board on
, 1994, subject to approval by stockholders. The Annual Bonus
Plan is designed to address certain possible limitations on the deductibility of
executive compensation under Section 162(m) of the Code, as amended by the
Omnibus Budget Reconciliation Act of 1993, which was signed into law on August
10, 1993 (the "Revenue Act"). The Revenue Act limits the deductibility of
certain compensation in excess of $1 million per year paid by a publicly traded
corporation to the following individuals who are employed as of the end of the
corporation's tax year: the chief executive officer and the four other executive
officers named in the summary compensation table of the corporation's proxy
statement. However, compensation which qualifies as "performance-based"
compensation is exempt from the $1 million deductibility limitation. In order
for compensation granted pursuant to the Annual Bonus Plan to qualify for this
exemption, the material terms under which the compensation is to be paid must be
disclosed to and approved by stockholders in a separate vote prior to payment,
and the compensation must be paid solely on account of the attainment of
preestablished, objective performance goals and must be computed by a
preestablished, objective formula or standard. For ease of reference in this
Proposal, employees of the Company and the Company's subsidiaries who have work
responsibilities with respect to Kmart Group or a Specialty Retail Group are
sometimes referred to as "employees" of the relevant Group.
All Company officers, all Company group and divisional vice presidents and
such key employees of the Company and the Company's subsidiaries as are
designated by the Compensation and Incentives Committee of the Board (the
"Committee") will participate in the Annual Plan. All participants are required
to use 20 percent of their annual bonus to purchase restricted Common Stock of
the Company (whether Existing Common Stock, Kmart Stock and/or a series of
Specialty Retail Stock) issued in accordance with the terms and conditions of
the Management Stock Purchase Plan described in Proposal 11, if such Proposal is
approved by stockholders. At the election of each participant (made in
accordance with the terms and conditions of the Management Stock Purchase Plan),
he or she may use up to 100 percent of the annual bonus to purchase such
restricted stock. The Annual Bonus Plan provides for the payment of annual
incentive awards to participants if, and only to the extent that, performance
goals established by the Committee are met.
The Company estimates that there are approximately 150 employees who are
potential participants in the Annual Bonus Plan, 32 of whom are currently
executive officers of the Company.
The description of the Annual Bonus Plan set forth herein is qualified in
its entirety by reference to the text of the Annual Plan as set forth in Annex
IV-H.
ADDITIONAL INFORMATION REGARDING ANNUAL BONUS PLAN
Since the amount of benefits to be received by each participant would be
determined by his or her annual bonus (which cannot be determined until fiscal
year-end), the amount of future benefits to be allocated to any individual or
group of individuals under the Annual Bonus Plan is not determinable. Similarly,
the amount of benefits which would have been received by or allocated to any
individual or group of individuals for fiscal 1993 if the Annual Bonus Plan had
been in effect is not determinable. However, during fiscal 1993, the five
persons named in the summary compensation table in this Proxy Statement received
the annual incentive bonuses set forth in such table. See the section of this
Proxy Statement entitled "Proposal 1 -- Election of Directors -- Compensation of
Officers -- Summary Compensation Table." For fiscal 1993, all then current
executive officers as a group (consisting of 32 persons) received annual
incentive bonuses aggregating $556,123, and all eligible employees as a group
(consisting of 129 persons) received annual incentive bonuses aggregating
$4,072,545.
DESCRIPTION OF ANNUAL BONUS PLAN
The following is a description of the proposed Annual Bonus Plan.
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Purpose. The purpose of the Annual Bonus Plan is to attract and retain
highly-qualified executives by providing appropriate performance-based
short-term incentive awards, to align executive and shareholder long-term
interests by creating a direct link between executive compensation and
shareholder return and to enable executives, through the mandatory and optional
stock purchase features of the plan, to develop and maintain a substantial stock
ownership position in Existing Common Stock and/or the various series of
Specialty Retail Stock. An additional purpose of the Annual Bonus Plan would be
to serve as a qualified performance-based compensation program under Section
162(m) of the Internal Revenue Code of 1986, as amended, in order to preserve
the Company's tax deduction for compensation paid under the Annual Bonus Plan to
named executive officers.
Administration. The Annual Bonus Plan will be administered by the Committee
which is comprised solely of outside directors who are not eligible to
participate in the Annual Bonus Plan. The Committee can make such rules and
regulations and establish such procedures for the administration of the Annual
Bonus Plan as it deems appropriate.
Participation. All Company officers, all Company group and divisional vice
presidents and such key employees of the Company and the Company's subsidiaries
as are designated by the Committee will be eligible to participate in the Annual
Bonus Plan.
Performance Goal Attainment Required for Award Payment. Except as otherwise
provided in the Annual Bonus Plan, the Annual Bonus Plan would provide for the
payment of annual incentive awards to participants if, and only to the extent
that, performance goals established by the Committee are met.
Performance Goals. The goals established by the Committee can be expressed
in terms of the Company's Return on Equity, and either pre-tax or after-tax
profit levels of the Company, any of the various Groups or subdivisions thereof,
including, without limitation, United States Kmart Stores, Kmart International
Retail operations, Super Kmart Centers, any other division, or any combination
of the foregoing; expense reduction levels; or implementation of critical
projects or processes. The goals can include standards for minimum attainment,
target attainment and maximum attainment. The goals established by the Committee
can be (but need not be) different each year and different goals may be
applicable to different participants. The goals with respect to a particular
year must be established before that year begins (except as otherwise permitted
by Code Section 162(m)), except that goals with respect to fiscal 1994 can be
established at any time prior to April 1, 1994. The performance goals for 1994
include pre-tax and after-tax profit levels of the Company, the Specialty Retail
Group(s) or the Kmart Group or subdivisions thereof, including the United States
Kmart Stores, Kmart International Retail Operations, Super Kmart Centers, Kmart
Fashions and Kmart Hardlines, or any combination of the foregoing.
Bonuses. A participant's target bonus for each year is generally expressed
as either a dollar amount or as a percentage of the participant's annual base
salary at the beginning of the year. The actual amount of bonus payable under
the Annual Bonus Plan is generally expressed in terms of a percentage of the
participant's target bonus, which percentage will vary depending upon the extent
to which the performance goals have been attained. However, the annual bonus of
the Company's Chief Executive Officer under the Annual Bonus Plan may not exceed
three times the salary midpoint for that salary grade at the beginning of such
year, as determined by the Committee prior to the beginning of each year based
on competitive data, including a survey of comparable companies, and the annual
bonus for each other participant under the Annual Bonus Plan may not exceed two
times the salary midpoint for such participant's salary grade at the beginning
of such year.
Limitation on Committee's Discretion. The amount of the award payable to
executive officers upon attainment of a performance goal cannot be increased
discretionarily by the Committee, but the Committee may discretionarily reduce
or eliminate the amount payable to such individuals and other participants.
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Committee Certification of Performance Goal Attainment. Before any awards
for a particular year can be paid, the Committee must certify the extent to
which performance goals and any other material terms were satisfied.
Use of Part or All of Annual Incentive Bonus to Purchase Restricted
Stock. All participants are required to use 20 percent of their annual incentive
bonus to purchase restricted Common Stock of the Company (whether Existing
Common Stock, Kmart Stock and/or a series of Specialty Retail Stock) in
accordance with the terms and conditions of the Management Stock Purchase Plan.
At the election of each participant (made in accordance with the terms and
conditions of the Management Stock Purchase Plan), he or she may use up to 100
percent of his or her annual bonus to purchase such Restricted Stock in
accordance with such terms and conditions.
No Stock Subject to Annual Bonus Plan. No shares of any Common Stock of the
Company will be issued under the Annual Bonus Plan. To the extent that annual
bonuses are paid in Restricted Shares of the Common Stock of the Company, such
Restricted Shares will be issued under, and subject to the terms and conditions
of, the Management Stock Purchase Plan.
Term. No award may be granted under the Annual Bonus Plan with respect to
any fiscal year after fiscal 1998. Awards made with respect to fiscal 1998 or
prior years, however, may extend beyond fiscal 1998 and the provisions of the
Annual Bonus Plan will continue to apply thereto.
Amendments to or Discontinuance of Annual Bonus Plan. The Board may from
time to time alter, amend, suspend or discontinue the Annual Bonus Plan;
provided, however, that no amendment which requires stockholder approval in
order for the Annual Bonus Plan to continue to comply with Code Section 162(m)
will be effective without the requisite vote of stockholders entitled to vote
thereon. Additionally, the Committee may make such amendments as it deems
necessary to comply with other applicable laws, rules and regulations.
Approval of Proposal 12 will require the affirmative vote of the holders of
a majority of votes cast by the holders of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 12.
119
<PAGE> 126
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120
<PAGE> 127
PROPOSAL 13 -- RATIFICATION OF APPOINTMENT
OF INDEPENDENT ACCOUNTANTS
Subject to stockholder ratification, the firm of Price Waterhouse has been
appointed by the Board as independent accountants to audit the Company's books
for fiscal 1994, upon recommendation of the Audit Committee. Representatives of
Price Waterhouse will be present at the Annual Meeting of Stockholders, will
have the opportunity to make a statement if they desire to do so and will be
available to respond to appropriate questions from stockholders.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL 13.
APPROVAL OF THE RATIFICATION OF THE APPOINTMENT OF PRICE WATERHOUSE AS
INDEPENDENT ACCOUNTANTS WILL REQUIRE THE AFFIRMATIVE VOTE OF THE HOLDERS OF A
MAJORITY OF VOTES CAST BY THE HOLDERS OF EXISTING COMMON STOCK, SERIES A
PREFERRED STOCK AND SERIES B PREFERRED STOCK, VOTING TOGETHER AS ONE CLASS.
121
<PAGE> 128
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122
<PAGE> 129
PROPOSAL 14 -- STOCKHOLDER PROPOSAL
The Company has been advised that Gerald J. Switzer, 17866 Beverly Road,
Birmingham, Michigan 48025, who is the beneficial owner of 12,892 shares of
common stock of the Company, intends to present the following proposal at the
Annual Meeting of Stockholders, which proposal is opposed by the Board of
Directors:
"RESOLVED: That [it is recommended that the Board approve and submit to
stockholders for approval amendments to the] Bonus and Restrictive Performance
Stock Plans for Executive Vice Presidents and above be restructured as follows:
1. One half of the targeted bonus will be based on Company performance
requiring a 10% increase in Earnings Per Share to qualify for the
full amount of this portion. Percentages above or below 10% will
increase or decrease this part of the bonus proportionately.
2. One half of the targeted bonus will be based on Common Stock
performance as measured from year to year at the close of business
on the last day of the Company's fiscal year. An increase of 10%
will be required to qualify for the full amount of this portion.
Percentages above or below 10% will increase or decrease this part
proportionately.
3. The percentage change in Return on Beginning Assets as measured
from year to year at the close of business on the last day of the
Company's fiscal year shall increase or decrease the bonus as
calculated under 1 and 2 above by that percentage change.
4. Restrictive Performance Stock will not be issued unless Earnings
Per Share and/or Stock performance surpass previous Company highs
by 5%."
STOCKHOLDER'S SUPPORTING STATEMENT
"Over the last two years (1991-1992) the compensation of top management,
including salary, bonus and performance restricted share payouts, has increased
over 60%. During the same period Kmart stock and Company earnings have both
remained relatively flat and dividends have increased only 7%. Management should
be well compensated when they are creating significant increases in shareholder
value. Conversely, management compensation should be kept in line when increases
in shareholder value fail to materialize.
The following proposal emphasizes both earnings and stock performance.
Emphasis is placed on stock performance to discourage dilution of existing
shareholder equity and to assure management shares in the rise and fall of the
stock price. Additionally, this proposal encourages better management of
shareholder assets such as inventories by increasing bonus payouts when the
Return on Beginning Assets ratio rises and decreasing bonus payouts when it
falls."
-------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE AGAINST THIS PROPOSAL. The Company
strongly believes that the compensation of its executive officers should be
closely tied to the performance of the Company. For that reason, the
Compensation and Incentives Committee of the Board of Directors, which is
composed of five independent non-employee directors, has carefully structured
the Company's executive compensation program so that a significant portion is
based on "pay for performance," that is, compensation is earned only if
specified performance objectives are achieved. However, the Company does not
believe that the application of rigid performance criteria, as suggested by the
proposal, is an appropriate manner to structure an effective executive
compensation program. For example, the proposal bases a significant portion of
the bonus for a full year's performance on the stock price on one day of the
year.
The resolution is, in large measure moot, as it relates to grants of
performance restricted stock since, as the Compensation and Incentives Committee
stated in its report contained in last year's proxy statement, with very limited
exceptions, the Committee has discontinued awards under the Performance
Restricted Stock Plan.
123
<PAGE> 130
With respect to annual incentive bonuses, the Company's current plan is
strictly performance-based and, in the opinion of the Board of Directors, is
more effective than the proposed approach. Currently, at the onset of each
fiscal year, the Compensation and Incentives Committee reviews and approves
annual financial performance objectives which the Committee feels most
accurately reflect the current needs of the Company and best measure the
performance of its executive officers. In 1993, for example, annual incentive
bonuses of executive officers were based on the achievement of specified levels
of corporate or business unit income. The "pay for performance" structure and
the effectiveness of the plan were clearly demonstrated when only 5 of the
Company's 32 executive officers received 1993 incentive bonuses because the
specified financial performance objectives were not achieved.
The proposed resolution fails to take into account the need for the Company
to remain competitive in the market for executive talent, it lacks flexibility
and it links incentive bonus to factors which may be beyond the control of the
executive officer. For instance, stock price is affected by the performance of
the stock market overall as well as a multitude of other internal and external
circumstances. While the Board of Directors agrees that the factors enumerated
in this proposal are extremely important, the Board believes that the approach
espoused in the proposal does not allow the Compensation and Incentives
Committee the flexibility to tailor the annual performance goals to the specific
responsibilities of each executive officer and to the current needs of the
Company and therefore it is not in the best interests of the Company and its
shareholders.
Approval of Proposal 14 will require the affirmative vote of the holders of
a majority of votes cast by the holders of Existing Common Stock, Series A
Preferred Stock and Series B Preferred Stock, voting together as one class.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE AGAINST THIS PROPOSAL.
STOCKHOLDER PROPOSALS
Pursuant to the General Rules under the Securities Exchange Act of 1934,
proposals of stockholders intended to be presented to the 1995 Annual Meeting of
Stockholders must be received by the Secretary of the Company on or before
December , 1994 to be considered for inclusion in the proxy materials for that
meeting. In addition, the By-laws of the Company contain requirements relating
to the timing and content of the notice which stockholders must provide to the
Secretary of the Company for any matter to be properly presented at a
stockholders meeting. See "Anti-takeover Considerations".
No person is authorized to give any information or to make any
representation other than that contained in this Proxy Statement, and if given
or made, such information may not be relied upon as having been authorized.
124
<PAGE> 131
ANNEX I
GLOSSARY OF CERTAIN TERMS
<TABLE>
<CAPTION>
PAGE ON WHICH TERM
IS DEFINED IN THE
TERM PROXY STATEMENT
- ----- ------------------
<S> <C>
Affected Group.......................................................... 15
Affected Stock.......................................................... 15
Articles................................................................ 7
Available Dividend Amount............................................... 57
Board................................................................... 7
Borders-Walden Group.................................................... 7
Borders-Walden Stock.................................................... 7
Builders Square Group................................................... 7
Builders Square Stock................................................... 7
Certificate of Amendment................................................ 8
Certificate of Designation.............................................. 7
Code.................................................................... 75
Commission.............................................................. 74
Common Stock............................................................ 1
Company................................................................. 1
Convertible Securities.................................................. Annex III-A-11
Depositary Shares....................................................... 1
Disposition............................................................. 59
Equity Value............................................................ 8
Exchange Act............................................................ 65
Existing Common Stock................................................... 1
Existing Common Stock Redesignation..................................... 63
Fair Market Value....................................................... 63
Group Subsidiary........................................................ 61
Groups.................................................................. 8
Incumbent............................................................... 27
Kmart Corporation Earnings Attributable to a Specialty Retail Group..... 57
Kmart Corporation Earnings Attributable to the Kmart Group.............. 57
Kmart Group............................................................. 8
Kmart Stock............................................................. 7
Market Capitalization................................................... Annex III-A-12
Market Value Ratio...................................................... Annex III-A-3
Market Value............................................................ Annex III-A-12
MBCA.................................................................... 13
Net Proceeds............................................................ 60
Number of Shares Issuable with Respect to Retained Interest............. 16
Nominee................................................................. 27
Offerings............................................................... 8
OfficeMax Group......................................................... 7
OfficeMax Stock......................................................... 7
Outstanding Interest Fraction........................................... 16
Preferred Stock......................................................... 56
Restated Rights Agreement............................................... 73
Retained Interest....................................................... 8
Retained Interest Fraction.............................................. 16
Rights Agreement........................................................ 73
</TABLE>
I-1
<PAGE> 132
<TABLE>
<CAPTION>
PAGE ON WHICH TERM
IS DEFINED IN THE
TERM PROXY STATEMENT
- ------ ------------------
<S> <C>
Series A Conversion Date................................................ 15
Series A Preferred Stock................................................ 1
Series A Junior Preferred Stock......................................... 56
Series B Preferred Stock................................................ 1
Service................................................................. 75
Specialty Retail Groups................................................. 8
Specialty Retail Stock Proposal......................................... 7
Specialty Retail Stock.................................................. 7
The Sports Authority Group.............................................. 8
The Sports Authority Stock.............................................. 7
Trading Day............................................................. Annex III-A-16
</TABLE>
I-2
<PAGE> 133
ANNEX II
ILLUSTRATIONS OF CERTAIN TERMS
The following illustrations demonstrate the calculations of the Kmart
Group's Retained Interest in a single Specialty Retail Group (such Group
referred to in this Annex II as the "Specialty Retail Group") based on the
assumptions set forth herein. In the illustrations below, (i) 500 shares of the
relevant series of Specialty Retail Stock (such series referred to in this Annex
II as "Specialty Retail Stock") are assumed to be designated and authorized for
issuance and (ii) 100 shares are assumed to be the number of shares of Specialty
Retail Stock initially issuable with respect to the Kmart Group's Retained
Interest in the Specialty Retail Group (the "Number of Shares Issuable with
Respect to Retained Interest"). Unless otherwise specified, each illustration
below should be read independently as if none of the other transactions referred
to below had occurred. Actual calculations may be slightly different due to
rounding.
At any given time, the fractional interest in the equity value of the
Company determined by the Board of Directors to be attributable to the Specialty
Retail Group ("Equity Value") that is intended to be represented by the
outstanding shares of Specialty Retail Stock (the "Outstanding Interest
Fraction") would be equal to:
Outstanding Shares of
Specialty Retail Stock
------------------------------------------------------------------------
Outstanding Shares of Specialty Retail Stock + Number of Shares
Issuable with Respect to Retained Interest
The balance of the Equity Value of the Specialty Retail Group is intended
to be represented by the Kmart Group's Retained Interest and, at any given time,
the fractional interest in the Equity Value of the Specialty Retail Group that
is intended to be represented by the Retained Interest (the "Retained Interest
Fraction") would be equal to:
Number of Shares Issuable with
Respect to Retained Interest
------------------------------------------------------------------------
Outstanding Shares of Specialty Retail Stock + Number of Shares
Issuable with Respect to Retained Interest
The sum of the Outstanding Interest Fraction and the Retained Interest
Fraction would always equal 100%.
INITIAL PUBLIC OFFERING OF SPECIALTY RETAIL STOCK
The following illustrations reflect an assumed sale by the Company of 25
shares of Specialty Retail Stock in the initial public offering of Specialty
Retail Stock.
Offering for Account of Kmart Group
Assume all of such shares are identified as sold for the account of
the Kmart Group in respect of its Retained Interest, with the net proceeds
reflected entirely in the financial statements of the Kmart Group.
<TABLE>
<S> <C>
Shares previously issued and outstanding...................... 0
Newly issued shares for account of Kmart Group................ 25
----
Total issued and outstanding after initial public
offering................................................. 25
----
----
</TABLE>
II-1
<PAGE> 134
- The Number of Shares Issuable with Respect to Retained Interest would
decrease by the number of shares of Specialty Retail Stock issued in the
initial public offering for the account of the Kmart Group.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to initial public offering............................ 100
Shares issued in initial public offering...................... 25
----
Number of Shares Issuable with Respect to Retained Interest
after initial public offering............................... 75
----
----
</TABLE>
- As a result, the issued and outstanding shares (25) would represent an
Outstanding Interest Fraction of 25%, calculated as follows:
25
------------------
25 + 75
The Retained Interest Fraction would accordingly be 75%.
- In this case, in the event of any dividend or other distribution paid on
the outstanding shares of Specialty Retail Stock (other than a dividend or
other distribution payable in shares of Specialty Retail Stock), the
financial statements of the Kmart Group would be credited, and the
financial statements of the Specialty Retail Group would be charged, with
an amount equal to 300% (representing the ratio of the Number of Shares
Issuable with Respect to Retained Interest (75) to the total number of
shares of Specialty Retail Stock issued and outstanding following the
initial public offering (25)) of the aggregate amount of such dividend or
distribution. If, for example, a dividend of $1.00 per share were declared
and paid on the 25 shares of Specialty Retail Stock outstanding (an
aggregate of $25), the Kmart Group financial statements would be credited
with $75, and the Specialty Retail Group financial statements would be
charged with that amount in addition to the $25 dividend paid to the
holders of Specialty Retail Stock (a total of $100).
- The Company would have 475 authorized and unissued shares of such
Specialty Retail Stock remaining (500 minus 25 issued and outstanding).
Offering for Account of Specialty Retail Group
Assume all of such shares are identified as sold for the account of
the Specialty Retail Group as an increase in its equity, with the net
proceeds reflected entirely in the financial statements of the Specialty
Retail Group.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 0
Newly issued shares for account of Specialty Retail Group...... 25
---
Total issued and outstanding after initial public offering... 25
---
---
</TABLE>
- The Number of Shares Issuable with Respect to Retained Interest (100)
would remain unchanged.
- As a result, the issued and outstanding shares (25) would represent an
Outstanding Interest Fraction of 20%, calculated as follows:
25
------------------
25 + 100
The Retained Interest Fraction would accordingly be 80%.
- In this case, in the event of any dividend or other distribution paid on
the outstanding shares of Specialty Retail Stock (other than a dividend or
other distribution payable in shares of Specialty Retail Stock), the
financial statements of the Kmart Group would be credited, and the
financial statements of the Specialty Retail Group would be charged, with
an amount equal to 400% (representing the ratio of
II-2
<PAGE> 135
the Number of Shares Issuable with Respect to Retained Interest (100) to
the total number of shares of Specialty Retail Stock issued and
outstanding following the initial public offering (25)) of the aggregate
amount of such dividend or distribution.
- The Company would have 475 authorized and unissued shares of such
Specialty Retail Stock remaining (500 minus 25 issued and outstanding).
ADDITIONAL OFFERINGS OF SPECIALTY RETAIL STOCK
The following illustrations reflect an assumed sale by the Company of an
additional 25 shares of Specialty Retail Stock after the assumed initial
issuance of 25 shares of Specialty Retail Stock for the account of the Kmart
Group.
Additional Offering for Account of Kmart Group
Assume all of such shares are identified as sold for the account of
the Kmart Group in respect of its Retained Interest, with the net proceeds
reflected entirely in the financial statements of the Kmart Group.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 25
Newly issued shares for account of Kmart Group................. 25
---
Total issued and outstanding after additional public
offering.................................................. 50
---
---
</TABLE>
- The Number of Shares Issuable with Respect to Retained Interest would
decrease by the number of any shares of Specialty Retail Stock issued for
the account of the Kmart Group.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to additional public offering.......................... 75
Shares issued in additional public offering.................... 25
---
Number of Shares Issuable with Respect to Retained Interest
after additional public offering............................. 50
---
---
</TABLE>
- As a result, the total issued and outstanding shares (50) would in the
aggregate represent an Outstanding Interest Fraction of 50%, calculated as
follows:
50
------------------
50 + 50
The Retained Interest Fraction would accordingly be reduced to 50%.
- In this case, in the event of any dividend or other distribution paid on
Specialty Retail Stock (other than a dividend or other distribution
payable in shares of Specialty Retail Stock), the financial statements of
the Kmart Group would be credited, and the financial statements of the
Specialty Retail Group would be charged, with an amount equal to 100%
(representing the ratio of the Number of Shares Issuable with Respect to
Retained Interest (50) to the total number of shares of Specialty Retail
Stock issued and outstanding following the public offering (50)) of the
aggregate amount of such dividend or distribution.
- The Company would have 450 authorized and unissued shares of such
Specialty Retail Stock remaining (500 minus 50 issued and outstanding).
II-3
<PAGE> 136
Additional Offering for Account of Specialty Retail Group
Assume all of such shares are identified as sold for the account of
the Specialty Retail Group as an increase in its equity, with the net
proceeds reflected entirely in the financial statements of the Specialty
Retail Group.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 25
Newly issued shares for account of Specialty Retail Group...... 25
---
Total issued and outstanding after additional public
offering.................................................. 50
---
---
</TABLE>
- The Number of Shares Issuable with Respect to Retained Interest (75)
would remain unchanged.
- As a result, the total issued and outstanding shares (50) would in the
aggregate represent an Outstanding Interest Fraction of 40%, calculated as
follows:
50
------------------
50 + 75
The Retained Interest Fraction would accordingly be reduced to 60%.
- In this case, in the event of any dividend or other distribution paid on
Specialty Retail Stock (other than a dividend or other distribution
payable in shares of Specialty Retail Stock), the financial statements of
the Kmart Group would be credited, and the financial statements of the
Specialty Retail Group would be charged, with an amount equal to 150%
(representing the ratio of the Number of Shares Issuable with Respect to
Retained Interest (75) to the total number of shares of Specialty Retail
Stock issued and outstanding following the public offering (50)) of the
aggregate amount of such dividend or distribution.
- The Company would have 450 authorized and unissued shares of such
Specialty Retail Stock remaining (500 minus 50 issued and outstanding).
Offerings of Convertible Securities
If the Company were to issue any Convertible Securities convertible
into or exercisable for shares of Specialty Retail Stock, the Outstanding
Interest Fraction and the Retained Interest Fraction would be unchanged at
the time of such issuance. If any shares of Specialty Retail Stock were
issued upon conversion or exercise of such Convertible Securities, however,
then the Outstanding Interest Fraction and the Retained Interest Fraction
would be affected as shown above under "Additional Offering for Account of
Kmart Group", if such Convertible Securities were attributed to the Kmart
Group, or under "Additional Offering for Account of Specialty Retail
Group", if such Convertible Securities were attributed to the Specialty
Retail Group.
REPURCHASES OF SPECIALTY RETAIL STOCK
The following illustrations reflect an assumed repurchase by the Company of
5 shares of Specialty Retail Stock for the account of the Kmart Group.
Repurchase for the Account of Kmart Group
Assume all of such shares are identified as repurchased for the
account of the Kmart Group as an increase in its Retained Interest in the
Specialty Retail Group, with the financial statements of the Kmart Group
being charged entirely with the consideration paid for such shares.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 25
Shares repurchased for account of Kmart Group.................. 5
---
Total issued and outstanding after repurchase................ 20
---
---
</TABLE>
II-4
<PAGE> 137
- The Number of Shares Issuable with Respect to Retained Interest would be
increased by the number of any shares of Specialty Retail Stock
repurchased for the account of the Kmart Group.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to repurchase.......................................... 75
Number of shares repurchased for the account of Kmart Group.... 5
---
Number of Shares Issuable with Respect to Retained Interest
after repurchase............................................. 80
---
---
</TABLE>
- As a result, the total issued and outstanding shares (20) would in the
aggregate represent an Outstanding Interest Fraction of 20%, calculated as
follows:
20
------------------
20 + 80
The Retained Interest Fraction would accordingly be increased to 80%.
- The Company would have 480 authorized and unissued shares of such
Specialty Retail Stock (500 minus 20 issued and outstanding).
Repurchase for Account of Specialty Retail Group without Participation by
Kmart Group
Assume all of such shares are identified as repurchased for the
account of the Specialty Retail Group, with the financial statements of the
Specialty Retail Group being charged entirely with the consideration paid
for such shares. Further assume that either (i) the repurchase is not made
in connection with a tender or exchange offer open to all holders of
outstanding shares of Specialty Retail Stock or a publicly announced open
market repurchase program undertaken by the Company so that the Board would
not be permitted to transfer cash or property to the Kmart Group in respect
of a reduction in its Retained Interest in the Specialty Retail Group, or
(ii) if it is made in connection with such a tender or exchange offer or
repurchase program, that the Board elects not to so transfer any cash to
the Kmart Group in respect of a reduction in such Retained Interest.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 25
Shares repurchased for account of Specialty Retail Group....... 5
---
Total issued and outstanding after repurchase................ 20
---
---
</TABLE>
- The Number of Shares Issuable with Respect to Retained Interest (75)
would remain unchanged.
- As a result, the total issued and outstanding shares (20) would in the
aggregate represent an Outstanding Interest Fraction of 21%, calculated as
follows:
20
------------------
20 + 75
The Retained Interest Fraction would accordingly be increased to 79%.
- The Company would have 480 authorized and unissued shares of such
Specialty Retail Stock (500 minus 20 issued and outstanding).
Repurchase for Account of Specialty Retail Group with Participation by
Kmart Group
Assume all of such shares are identified as repurchased for the
account of the Specialty Retail Group, with the financial statements of the
Specialty Retail Group being charged with the consideration paid for such
shares. Further assume that the repurchase is made in connection with a
tender or exchange
II-5
<PAGE> 138
offer or open market repurchase program described above, for 5, or 20%, of
the then outstanding shares, at a price of $20 per share.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 25
Shares repurchased for account of Specialty Retail Group....... 5
---
Total issued and outstanding after repurchase................ 20
---
---
</TABLE>
- In connection with such tender or exchange offer or open market
repurchase program, the Board would be permitted to transfer from the
Specialty Retail Group to the Kmart Group an amount of cash or other
property of up to 300% (representing the ratio of the Number of Shares
Issuable with Respect to Retained Interest (75) to the total number of
shares of Specialty Retail Stock issued and outstanding (25), in each case
immediately prior to the repurchase) of the aggregate amount of the cash
offered, in the case of such a tender or exchange offer, or paid, in the
case of such an open market repurchase program to holders of outstanding
shares of Specialty Retail Stock ($100), or a total permitted amount of
$300.
- Assuming that the Board transferred the full $300 permitted amount from
the Specialty Retail Group to the Kmart Group, the Number of Shares
Issuable with Respect to Retained Interest (75) would decrease by the
amount of cash so transferred ($300) divided by the price per share paid
to holders of outstanding shares of the Specialty Retail Stock in
connection with the tender or exchange offer or repurchase program ($20),
or 15 shares.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to transfer............................................ 75
Adjustment to reflect transfer to Kmart Group of funds
theretofore allocated to Specialty Retail Group.............. 15
---
Number of Shares Issuable with Respect to Retained Interest
after transfer............................................... 60
---
---
</TABLE>
- As a result, the total issued and outstanding shares (20) would in the
aggregate continue to represent an Outstanding Interest Fraction of 25%,
calculated as follows:
20
------------------
20 + 60
The Retained Interest Fraction would accordingly continue to be 75%.
- Assuming that the Board transferred only half of the $300 permitted
amount, or $150, from the Specialty Retail Group to the Kmart Group, the
Number of Shares Issuable with Respect to Retained Interest (75) would
decrease by the amount of cash so transferred ($150) divided by the price
per share paid to holders of outstanding shares of the Specialty Retail
Stock in connection with the tender or exchange offer or repurchase
program ($20), or 7.5 shares.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to transfer........................................... 75.0
Adjustment to reflect transfer to Kmart Group of cash
theretofore allocated to Specialty Retail Group............. 7.5
----
Number of Shares Issuable with Respect to Retained Interest
after transfer.............................................. 67.5
----
----
</TABLE>
II-6
<PAGE> 139
- In that case, as a result, the total issued and outstanding shares (20)
would in the aggregate represent an Outstanding Interest Fraction of
22.9%, calculated as follows:
20
------------------
20 + 67.5
The Retained Interest Fraction would accordingly be increased to 77.1%.
- In either case, the Company would have 480 authorized and unissued shares
of such Specialty Retail Stock remaining (500 minus 20 issued and
outstanding).
SPECIALTY RETAIL STOCK DIVIDENDS
The following illustrations reflect assumed dividends of Specialty Retail
Stock on outstanding shares of Kmart Stock and outstanding shares of Specialty
Retail Stock, respectively, after the assumed initial issuance of 25 shares of
Specialty Retail Stock for the account of the Kmart Group.
Specialty Retail Stock Dividend on Kmart Stock
Assume 1,000 shares of Kmart Stock are outstanding and the Company
declares a dividend of 1/20 of a share of Specialty Retail Stock on each
outstanding share of Kmart Stock.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 25
Newly issued shares for account of Kmart Group................. 50
---
Total issued and outstanding after dividend.................. 75
---
---
</TABLE>
- Any dividend of shares of Specialty Retail Stock to the holders of shares
of Kmart Stock would be treated as a dividend of shares issuable with
respect to the Kmart Group's Retained Interest. As a result, the Number of
Shares Issuable with Respect to Retained Interest would decrease by the
number of shares of Specialty Retail Stock distributed to the holders of
Kmart Stock.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to dividend............................................ 75
Number of shares dividended on outstanding shares of Kmart
Stock........................................................ 50
---
Number of Shares Issuable with Respect to Retained Interest
after dividend............................................... 25
---
---
</TABLE>
- As a result, the total issued and outstanding shares (75) would in the
aggregate represent an Outstanding Interest Fraction of 75%, calculated as
follows:
75
------------------
75 + 25
The Retained Interest Fraction would accordingly be reduced to 25%. Note,
however, that after the dividend, the holders of Kmart Stock would also
hold 50 shares of Specialty Retail Stock, which would be intended to
represent a 50% interest in the Equity Value attributable to the Specialty
Retail Group (together with the 25% Retained Interest of the Kmart Group).
- The Company would have 425 authorized and unissued shares of such
Specialty Retail Stock (500 minus 75 issued and outstanding).
II-7
<PAGE> 140
Specialty Retail Stock Dividend on Specialty Retail Stock
Assume the Company declares a dividend of 1/5 of a share of Specialty
Retail Stock on each outstanding share of Specialty Retail Stock.
<TABLE>
<S> <C>
Shares previously issued and outstanding....................... 25
Newly issued shares for account of Specialty Retail Group...... 5
---
Total issued and outstanding after dividend.................. 30
---
---
</TABLE>
- The Number of Shares Issuable with Respect to Retained Interest would be
increased proportionately to reflect the stock dividend payable in shares
of Specialty Retail Stock to holders of shares of Specialty Retail Stock.
That is, the Number of Shares Issuable with Respect to Retained Interest
would be increased by a number equal to 300% (representing the ratio of
the Number of Shares Issuable with Respect to Retained Interest (75) to
the number of shares of Specialty Retail Stock issued and outstanding
(25), in each case immediately prior to such dividend) of the aggregate
number of shares issued in connection with such dividend or outstanding
shares of Specialty Retail Stock (5), or 15.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to dividend............................................ 75
Proportionate increase to reflect dividend of shares on
outstanding shares of Specialty Retail Stock................. 15
---
Number of Shares Issuable with Respect to Retained Interest
after dividend............................................... 90
---
---
</TABLE>
- As a result, the total issued and outstanding shares (30) would in the
aggregate continue to represent an Outstanding Interest Fraction of 25%,
calculated as follows:
30
---------------
30 + 90
The Retained Interest Fraction would accordingly continue to be 75%.
- The Company would have 470 designated and unissued shares of Specialty
Retail Stock (500 minus 30 issued and outstanding).
TRANSFERS OF ASSETS BETWEEN KMART GROUP AND SPECIALTY RETAIL GROUPS
Contribution of Assets from Kmart Group to Specialty Retail Group
The following illustration reflects the assumed contribution by the
Kmart Group to the Specialty Retail Group, after the assumed initial
issuance of 25 shares of Specialty Retail Stock for the account of the
Kmart Group, of $40 of assets allocated to the Kmart Group on a date on
which the Market Value of the Specialty Retail Stock is $20 per share.
<TABLE>
<S> <C>
Shares previously issued and outstanding...................... 25
Newly issued shares........................................... 0
----
Total issued and outstanding after contribution............. 25
----
----
</TABLE>
- The Number of Shares Issuable with Respect to Retained Interest would be
increased to reflect the contribution to the Specialty Retail Group of
assets theretofore allocated to Kmart Group by the
II-8
<PAGE> 141
number equal to the value of the assets contributed ($40) divided by the
Market Value of the Specialty Retail Stock at that time ($20), or 2
shares.
<TABLE>
<S> <C>
Number of Shares Issuable with Respect to Retained Interest
prior to contribution....................................... 75
Increase to reflect contribution to Specialty Retail Group of
assets allocated to Kmart Group............................. 2
----
Number of Shares Issuable with Respect to Retained Interest
after contribution.......................................... 77
----
----
</TABLE>
- As a result, the total issued and outstanding shares (25) would in the
aggregate represent an Outstanding Interest Fraction of 24.5%, calculated
as follows:
25
------------------
25 + 77
The Retained Interest Fraction would accordingly be increased to 75.5%.
- The Company would have 475 authorized and unissued shares of Specialty
Retail Stock (500 minus 25 issued and outstanding).
Permitted Transfer from Specialty Retail Group to Kmart Group
The Company would only be permitted to transfer assets from the
Specialty Retail Group to the Kmart Group with a resulting reduction in its
Retained Interest in the Specialty Retail Group in connection with a tender
or exchange offer or open market repurchase program undertaken by the
Company, the consideration for which is attributed to the Specialty Retail
Group. For examples concerning such "Permitted Transfers" of assets from a
Specialty Retail Group to the Kmart Group, see "Repurchases of Specialty
Retail Stock -- Repurchase for Account of Specialty Retail Group without
Participation by Kmart Group" and "-- Repurchase for Account of Specialty
Retail Group with Participation by Kmart Group" above.
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<PAGE> 142
ANNEX III-A
PROPOSAL 2 -- AMENDMENTS TO THE
RESTATED ARTICLES OF INCORPORATION
PURSUANT TO THE SPECIALTY
RETAIL STOCK PROPOSAL
Article III of the Restated Articles of Incorporation of the Company is
proposed to be amended by deleting the first and second paragraphs and Section A
of Article III in their entirety and substituting in lieu thereof the following:
"The total authorized capital stock of the Company is 3,000,000,000 shares
of Common Stock, par value $1.00 per share, issuable in series (hereinafter
called the "Common Stock"), and 10,000,000 shares of Preferred Stock, of no par
value per share, issuable in series (hereinafter called the "Preferred Stock").
A statement of all or any of the designations, relative rights, preferences and
limitations of the Common Stock and the Preferred Stock of the Company, or the
method of designating the same, is as follows:
A. COMMON STOCK
1. Issuance of Common Stock in Series; Designation. The Board of Directors shall
have the authority to divide and issue shares of Common Stock from time to time
in series. One series shall be designated as Kmart Group Common Stock ("Kmart
Stock"), consisting of 1,500,000,000 shares. Other series of Common Stock shall
be designated as: KM-Borders-Walden Group Common Stock ("Borders-Walden Stock"),
KM-Builders Square Group Common Stock ("Builders Square Stock"), KM-OfficeMax
Group Common Stock ("OfficeMax Stock") and KM-The Sports Authority Group Common
Stock ("The Sports Authority Stock", and collectively with the Borders-Walden
Stock, Builders Square Stock and OfficeMax Stock, the "Specialty Retail Stock").
With respect to each series of Specialty Retail Stock, the Board of Directors
shall have the authority to designate, prior to the time of the first issuance
of shares of such series, the total number of authorized shares comprising such
series, the number which, immediately prior to such first issuance, will
constitute the Number of Shares Issuable with Respect to the Retained Interest
in the Specialty Retail Group with reference to which such series is being
issued and any other terms which are consistent with applicable law and the
provisions of this Article III. The Board of Directors shall have the authority
to increase or decrease from time to time the total number of authorized shares
comprising any series of Common Stock but, except as provided in subparagraph
3(c) of this Section A, not above a number which, when added to the aggregate
number of authorized shares of all other series of Common Stock, would exceed
the total number of authorized shares of Common Stock and not below the number
of shares of such series then outstanding.
2. Dividends. Subject to the express terms of any outstanding series of
Preferred Stock, the holders of any series of Common Stock shall be entitled to
receive upon the terms provided below, when and as declared by the Board of
Directors, dividends payable either in cash, property or Common Stock, as may be
fixed by the Board of Directors. No dividends (other than dividends payable in
Common Stock) shall be paid on Common Stock if cash dividends in full on all
outstanding shares of Preferred Stock to which the holders thereof are entitled
shall not have been paid or declared and set apart for payment or any sinking
fund for the Preferred Stock is in arrears.
(a) Dividends on Common Stock. Dividends on any series of Common Stock
may be declared and paid only out of the lesser of (i) assets of the
Company legally available therefor and (ii) the Available Dividend Amount
with respect to such series.
(b) Discrimination Between or Among Series of Common Stock. The Board
of Directors, subject to the provisions of subparagraph 2(a) of this
Section A, shall have the authority to declare and pay dividends on all or
less than all series of Common Stock in equal or unequal amounts,
notwithstanding the amount of assets available for dividends on any series,
the respective voting and liquidation rights of any series, the amount of
prior dividends declared on any series or any other factor.
III-A-1
<PAGE> 143
(c) Share Dividends. The Board of Directors shall have the authority
to issue shares of any series of Specialty Retail Stock (or Convertible
Securities convertible into or exercisable for shares of such series of
Specialty Retail Stock) as a dividend on shares of Kmart Stock, but only if
the sum of (i) the number of shares of such series of Specialty Retail
Stock to be so issued (or the number of such shares which would be issuable
upon conversion or exercise of any Convertible Securities to be so issued)
and (ii) the number of such shares that would be issuable at such time upon
conversion or exercise of any Convertible Securities then outstanding that
are attributed to the Kmart Group is less than or equal to the Number of
Shares Issuable with Respect to the Retained Interest in the Specialty
Retail Group with reference to which such shares of such series of
Specialty Retail Stock (or such Convertible Securities) are being issued.
3. Exchange and Redemption of Specialty Retail Stock. Shares of each series of
Specialty Retail Stock are subject to exchange or redemption, as the case may
be, upon the terms provided below with respect to each such series.
(a) Exchange and Redemption Provisions.
(i) In the event of the Disposition, in one transaction or a series
of related transactions, by the Company and/or its subsidiaries of all
or substantially all of the properties and assets of any Specialty
Retail Group to one or more persons or entities (other than (x) in
connection with the Disposition by the Company of all of the Company's
properties and assets in one transaction or a series of related
transactions which results in a liquidation, dissolution or winding-up
of the Company referred to in paragraph 5 of this Section A, (y) on a
pro rata basis to (1) the holders of all outstanding shares of the
series of Specialty Retail Stock issued with reference to such Specialty
Retail Group and (2) the Company for the benefit of the Kmart Group with
respect to the Number of Shares Issuable with Respect to the Retained
Interest in such Specialty Retail Group, or (z) to any person or entity
controlled by the Company), the Company shall, on or prior to the 75th
Trading Day following the consummation of such Disposition:
(A) subject to subparagraph 2(a) of this Section A, declare and
pay a dividend in cash and/or in securities or other property
received as proceeds of such Disposition to the holders of
outstanding shares of such series of Specialty Retail Stock in an
amount equal to the product of the Outstanding Interest Fraction with
respect to such Specialty Retail Group and the Net Proceeds of such
Disposition; or
(B) to the extent that there are assets of the Company legally
available therefor, redeem the number of whole outstanding shares of
such series of Specialty Retail Stock that has an aggregate average
Market Value, during the ten-Trading Day period beginning on the
sixth Trading Day following such consummation, closest to the value
of the product of the Outstanding Interest Fraction with respect to
such Specialty Retail Group and the Net Proceeds of such Disposition,
for cash and/or for securities or other property received as proceeds
of such Disposition in an amount equal to such product; or
(C) exchange each outstanding share of such series of Specialty
Retail Stock for a number of fully paid and nonassessable shares of
Kmart Stock equal to 110% of the average daily ratio (calculated to
the nearest five decimal places) of the Market Value of one share of
such series of Specialty Retail Stock to the Market Value of one
share of Kmart Stock during the ten-Trading Day period beginning on
the sixth Trading Day following such consummation.
For purposes of this subparagraph 3(a)(i):
(x) as of any date, "substantially all of the properties and
assets" of any Specialty Retail Group shall mean a portion of
such properties and assets (1) that represents at least 80% of
the then-current market value (as determined by the Board of
Directors) as of such date of the properties and assets of such
Specialty Retail Group as of such date, or (2) from which were
derived at least 80% of the aggregate revenues for the
immediately preceding twelve fiscal quarterly periods of the
Company (calculated on a pro forma basis
III-A-2
<PAGE> 144
to include revenues derived from any of such properties and
assets acquired during such period) derived from the properties
and assets of such Specialty Retail Group as of such date;
(y) in the case of a Disposition of properties and assets in
a series of related transactions, such Disposition shall not be
deemed to have been consummated until the consummation of the
last of such transactions; and
(z) the Board of Directors shall have the authority to pay
the dividend or redemption price referred to in clause (A) or (B)
of this subparagraph 3(a)(i) in cash even if securities or other
non-cash properties are received as proceeds of any Disposition
referred to in this subparagraph 3(a)(i).
(ii) After the payment of any dividend or redemption price with
respect to any series of Specialty Retail Stock pursuant to clause (A)
or (B), respectively, of subparagraph 3(a)(i) of this Section A, the
Board of Directors shall have the authority to declare that each
remaining outstanding share of such series of Specialty Retail Stock
shall be exchanged, on an Exchange Date prior to the first anniversary
of the payment of such dividend or redemption price (as set forth in a
notice delivered in accordance with subparagraph 3(b)(ii) of this
Section A to holders of such series of Specialty Retail Stock and
Convertible Securities convertible into or exercisable for shares of
such series of Specialty Retail Stock), for a number of fully paid and
nonassessable shares of Kmart Stock equal to 110% of the Market Value
Ratio as of the fifth Trading Day prior to the date such notice is
mailed to such holders.
(iii) At any time, the Board of Directors shall have the authority
to declare that each outstanding share of any series of Specialty Retail
Stock shall be exchanged, on an Exchange Date set forth in a notice
delivered in accordance with subparagraph 3(b)(ii) of this Section A to
holders of such series of Specialty Retail Stock and Convertible
Securities convertible into or exercisable for shares of such series of
Specialty Retail Stock, for a number of fully paid and nonassessable
shares of Kmart Stock equal to 115% of the Market Value Ratio as of the
fifth Trading Day prior to the date such notice is mailed to such
holders.
(iv) For purposes of subparagraph 3(a)(ii) and (iii) of this
Section A, the "Market Value Ratio", as of any date, shall mean the
highest of the following (calculated to the nearest five decimal
places): (A) the average ratio of the Market Value of one share of such
series of Specialty Retail Stock (hereinafter "SR") to the Market Value
of one share of Kmart Stock (hereinafter "KM") for the five-Trading Day
period ending on such date, (B) the quotient of (1) the sum of (w) four
times the average ratio of SR to KM for the five-Trading Day period
ending on such date, (x) three times the average ratio of SR to KM for
the next preceding five-Trading Day period, (y) two times the average
ratio of SR to KM for the next preceding five-Trading Day period and (z)
the average ratio of SR to KM for the next preceding five-Trading Day
period, divided by (2) ten and (C) if the dividend pursuant to clause
(A) of subparagraph 3(a)(i) of this Section A was declared and paid or
the redemption pursuant to clause (B) of subparagraph 3(a)(i) of this
Section A was made prior to the commencement of the most recently
completed fiscal quarter of the Company, the average ratio of SR to KM
for such fiscal quarter.
(v) At any time on or after the date on which all of the assets and
liabilities of any Specialty Retail Group (and no other assets or
liabilities) are held directly or indirectly by a wholly-owned
subsidiary of the Company (with respect to any such Specialty Retail
Group, the "Specialty Retail Group Subsidiary"), the Board of Directors
shall have the authority, provided that there are assets of the Company
legally available therefor, to declare that all of the outstanding
shares of the relevant series of Specialty Retail Stock shall be
exchanged, on an Exchange Date set forth in a notice delivered in
accordance with subparagraph 3(b)(ii) of this Section A to holders of
such series of Specialty Retail Stock and Convertible Securities
convertible into or exercisable for shares of such series of Specialty
Retail Stock, for the number of outstanding shares of common stock of
such Specialty Retail Group Subsidiary equal to the product of the
Outstanding Interest Fraction with
III-A-3
<PAGE> 145
respect to such Specialty Retail Group and the number of all outstanding
shares of common stock of such Specialty Retail Group Subsidiary, on a
pro rata basis, each of which shall, upon such issuance, be fully paid
and nonassessable.
(vi) After any Exchange Date or Redemption Date on which all
outstanding shares of any series of Specialty Retail Stock were
exchanged or redeemed, any share of such series of Specialty Retail
Stock that is issued on conversion or exercise of any Convertible
Securities shall, immediately upon issuance pursuant to such conversion
or exercise and without any notice or any other action on the part of
the Company or its Board of Directors or the holder of such share of
Specialty Retail Stock:
(A) in the event then-outstanding shares of such series of
Specialty Retail Stock were exchanged for Kmart Stock on such
Exchange Date pursuant to subparagraph 3(a)(i)(C), 3(a)(ii) or
3(a)(iii) of this Section A, be exchanged for the kind and amount of
shares of capital stock, cash and/or other securities or property
that a holder of such Convertible Security would have been entitled
to receive pursuant to the terms of such Convertible Security had
such terms provided that the conversion or exercise privilege in
effect immediately prior to any exchange by the Company of any of its
capital stock for shares of any other capital stock of the Company
would be adjusted so that the holder of any such Convertible Security
thereafter surrendered for conversion or exercise would be entitled
to receive the kind and amount of shares of capital stock, cash
and/or other securities or property such holder would have received
immediately following such action had such Convertible Security been
converted or exercised immediately prior thereto; or
(B) in the event then-outstanding shares of such series of
Specialty Retail Stock were redeemed in whole pursuant to clause (B)
of subparagraph 3(a)(i) of this Section A or exchanged for common
stock of the relevant Specialty Retail Group Subsidiary pursuant to
subparagraph 3(a)(v) of this Section A, be redeemed, to the extent of
assets of the Company legally available therefor, for $.01 per share
in cash.
The provisions of clauses (A) and (B) of this subparagraph 3(a)(vi)
shall not apply to the extent that adjustments in respect of such
exchange or redemption are otherwise made pursuant to the provisions of
such Convertible Securities.
(b) Notice and Other Provisions.
(i) Not earlier than the 16th Trading Day and not later than the
20th Trading Day following the consummation of a Disposition referred to
in subparagraph 3(a)(i) of this Section A, the Company shall publish an
announcement in all editions of a daily newspaper with a national
circulation that publishes financial news as to which of the actions
specified in clauses (A), (B) or (C) of subparagraph 3(a)(i) of this
Section A it has irrevocably determined to take. If the Company
determines to pay a dividend pursuant to clause (A) of subparagraph
3(a)(i) of this Section A, the Company shall promptly cause to be given
to each holder of outstanding shares of the relevant series of Specialty
Retail Stock and of outstanding Convertible Securities convertible into
or exercisable for such series of Specialty Retail Stock a notice
setting forth (A) the record date for determining holders entitled to
receive such dividend, which shall be not earlier than the 30th Trading
Day and not later than the 40th Trading Day following the consummation
of such Disposition, (B) the anticipated payment date of such dividend,
(C) the kind and aggregate amount of shares of capital stock, cash
and/or other securities or property to be distributed in respect of
outstanding shares of such series of Specialty Retail Stock, (D) the
number of outstanding shares of such series of Specialty Retail Stock
and the number of shares of such series of Specialty Retail Stock into
or for which outstanding Convertible Securities are then convertible or
exercisable, and (E) a statement to the effect that holders of such
Convertible Securities shall only be entitled to receive such dividend
if they convert such Convertible Securities into or exercise them for
such series of Specialty Retail Stock prior to the record date referred
to in clause (A) of this sentence. If the Company determines to
undertake a redemption pursuant to clause (B) of subparagraph 3(a)(i)
III-A-4
<PAGE> 146
of this Section A, the Company shall promptly cause to be given to each
holder of record of outstanding shares of the relevant series of
Specialty Retail Stock and of Convertible Securities convertible into or
exercisable for such series of Specialty Retail Stock a notice setting
forth (A) a date not earlier than the 30th Trading Day and not later
than the 40th Trading Day following the consummation of such Disposition
which shall be the date as of which such series of Specialty Retail
Stock then outstanding would be subject to redemption, (B) the
anticipated Redemption Date, (C) the kind and per share amount of shares
of capital stock, cash and/or other securities or property to be paid as
a redemption price in respect of outstanding shares of such series of
Specialty Retail Stock, (D) the number of shares of such series of
Specialty Retail Stock to be redeemed, (E) the number of outstanding
shares of such series of Specialty Retail Stock and the number of shares
of such series of Specialty Retail Stock into or for which outstanding
Convertible Securities are then convertible or exercisable and (F) a
statement to the effect that holders of such Convertible Securities
shall only be eligible to participate in such redemption if they convert
such Convertible Securities into or exercise them for such series of
Specialty Retail Stock prior to the record date referred to in clause
(A) of this sentence, and a statement as to what, if anything, such
holders shall be eligible to receive pursuant to the terms of such
Convertible Securities and this Section A if such holder thereafter
converted or exercised such Convertible Securities.
(ii) In the event of any exchange or redemption pursuant to this
paragraph 3 (other than subparagraph 3(a)(vi) of this Section A), the
Company shall promptly cause to be given to each holder of record of the
series of Specialty Retail Stock to be so exchanged or redeemed and, in
the case of an exchange, of Convertible Securities convertible into or
exercisable for shares of such series of Specialty Retail Stock a notice
setting forth (A) a statement that shares of such series of Specialty
Retail Stock shall be exchanged or redeemed, as the case may be, (B) the
Exchange Date or the Redemption Date, as the case may be, (C) in the
event of a partial redemption of any series of Specialty Retail Stock
pursuant to clause (B) of subparagraph 3(a)(i) of this Section A, the
number of shares of such series of Specialty Retail Stock to be
redeemed, (D) the kind and per share amount of capital stock, cash
and/or other securities or property to be distributed to such holder
with respect to each share of such series of Specialty Retail Stock,
including details as to the calculation thereof, (E) the place or places
where certificates for shares of such series of Specialty Retail Stock,
properly endorsed or assigned for transfer (unless the Company shall
waive such requirement), are to be surrendered for delivery of
certificates for shares of such capital stock, cash and/or other
securities or property, (F) a statement to the effect that, subject to
subparagraph 3(b)(v) of this Section A, dividends on such shares of such
series of Specialty Retail Stock shall cease to be paid as of such
Exchange Date or Redemption Date, as the case may be, and (G) in the
case of an exchange, a statement to the effect that a holder of
Convertible Securities shall only be entitled to receive shares of Kmart
Stock upon such exchange if such holder converts or exercises such
Convertible Securities on or prior to such Exchange Date, and a
statement as to what, if anything, such holder shall be entitled to
receive pursuant to the terms of such Convertible Securities and this
Section A if such holder thereafter converts or exercises such
Convertible Securities. Such notice shall be sent by first-class mail,
postage prepaid, not less than 25 Trading Days nor more than 35 Trading
Days prior to the Exchange Date or Redemption Date, as the case may be,
and, in any case, to each holder of record of outstanding shares of the
series of Specialty Retail Stock to be exchanged or redeemed and, in the
case of an exchange, to each holder of record of outstanding Convertible
Securities convertible into or exercisable for shares of such series of
Specialty Retail Stock, at such holder's address as the same appears on
the transfer books of the Company. Neither the failure to mail such
notice to any particular holder of such series of Specialty Retail Stock
or of such Convertible Securities nor any defect therein shall affect
the sufficiency thereof with respect to any other holder of outstanding
shares of such series of Specialty Retail Stock or of outstanding
Convertible Securities convertible into or exercisable for shares of
such series of Specialty Retail Stock.
(iii) If less than all of the outstanding shares of any series of
Specialty Retail Stock are to be redeemed pursuant to clause (B) of
subparagraph 3(a)(i) of this Section A, such shares shall be
III-A-5
<PAGE> 147
redeemed by the Company pro rata or by lot or by such other method as
may be determined by the Board of Directors to be equitable, from among
the holders of outstanding shares of such series of Specialty Retail
Stock at the close of business on the record date referred to in clause
(A) of the last sentence of subparagraph 3(b)(i) of this Section A.
(iv) The Company shall not be required to issue or deliver
fractional shares of any capital stock or of any other securities to any
holder of any series of Specialty Retail Stock upon any exchange,
redemption, dividend or other distribution pursuant to this paragraph 3.
If more than one share of any series of Specialty Retail Stock shall be
held at the same time by the same holder, the Company may aggregate the
number of shares of any capital stock that shall be issuable or any
other securities that shall be distributable to such holder upon any
exchange, redemption, dividend or other distribution (including any
fractional shares). If there are fractional shares of any capital stock
or of any other securities remaining to be issued or distributed to any
holder of any series of Specialty Retail Stock, the Company shall, if
such fractional shares are not issued or distributed to such holder, pay
cash in respect of such fractional shares in an amount equal to the fair
market value thereof on the fifth Trading Day prior to the date such
payment is to be made (without interest). For purposes of the preceding
sentence, "fair market value" shall be (A) in the case of any fractional
share of capital stock of the Company, the product of such fractional
share and the Market Value of one share of such capital stock and (B) in
the case of any fractional share of any other security, such value as is
determined by the Board of Directors.
(v) No adjustments in respect of dividends shall be made upon the
exchange or redemption of any shares of any series of Specialty Retail
Stock; provided, however, that if the Exchange Date or Redemption Date,
as the case may be, with respect to any shares of any series of
Specialty Retail Stock shall be subsequent to the record date for the
payment of a dividend or other distribution thereon or with respect
thereto, the holders of such shares of such series of Specialty Retail
Stock at the close of business on such record date shall be entitled to
receive the dividend or other distribution payable on or with respect to
such shares on the date set for payment of such dividend or other
distribution, in each case without interest, notwithstanding the
subsequent exchange or redemption of such shares or the Company's
default in payment of the dividend or distribution due on such date.
(vi) Before any holder of any series of Specialty Retail Stock
shall be entitled to receive certificates representing shares of any
capital stock, cash and/or other securities or property to be
distributed to such holder with respect to such shares of such series of
Specialty Retail Stock pursuant to this paragraph 3, such holder shall
surrender at such place as the Company shall specify certificates for
such shares of such series of Specialty Retail Stock, properly endorsed
or assigned for transfer (unless the Company shall waive such
requirement). The Company shall as soon as practicable after receipt of
certificates representing such shares of such series of Specialty Retail
Stock deliver to the person for whose account such shares of such series
of Specialty Retail Stock were so surrendered, or to such person's
nominee or nominees, certificates representing the number of whole
shares of the kind of capital stock, cash and/or other securities or
property to which such person shall be entitled as aforesaid, together
with any fractional payment contemplated by subparagraph 3(b)(iv) of
this Section A, in each case without interest. If less than all of the
shares of any series of Specialty Retail Stock represented by any one
certificate are to be redeemed, the Company shall issue and deliver a
new certificate for the shares of such series of Specialty Retail Stock
not redeemed.
(vii) From and after any applicable Exchange Date or Redemption
Date, as the case may be, all rights of a holder of shares of any series
of Specialty Retail Stock that were exchanged or redeemed shall cease
except for the right, upon surrender of the certificates representing
such shares of such series of Specialty Retail Stock, to receive
certificates representing shares of the kind and amount of capital
stock, cash and/or other securities or property for which such shares
were exchanged or redeemed, together with any fractional payment
contemplated by subparagraph 3(b)(iv) and rights to dividends as
provided in subparagraph 3(b)(v) of this Section A, in each case without
interest. No holder of a certificate that immediately prior to the
applicable
III-A-6
<PAGE> 148
Exchange Date for any series of Specialty Retail Stock represented
shares of such series of Specialty Retail Stock, shall be entitled to
receive any dividend or other distribution with respect to shares of
Kmart Stock for which shares of such series of Specialty Retail Stock
was exchanged until surrender of such certificate in exchange for a
certificate or certificates representing shares of Kmart Stock. Upon
such surrender, there shall be paid to the holder the amount of any
dividends or other distributions (without interest) which theretofore
became payable with respect to a record date after the Exchange Date,
but that were not paid by reason of the foregoing, with respect to the
number of whole shares of Kmart Stock represented by the certificate or
certificates issued upon such surrender. From and after an Exchange Date
for any series of Specialty Retail Stock, the Company shall, however, be
entitled to treat the certificates for such series of Specialty Retail
Stock that have not yet been surrendered for exchange as evidencing the
ownership of the number of whole shares of Kmart Stock for which the
shares of such series of Specialty Retail Stock represented by such
certificates shall have been exchanged, notwithstanding the failure to
surrender such certificates.
(viii) The Company shall pay any and all documentary, stamp or
similar issue or transfer taxes that may be payable in respect of the
issue or delivery of any shares of capital stock and/or other securities
on exchange or redemption of shares of any series of Specialty Retail
Stock pursuant hereto. The Company shall not, however, be required to
pay any tax that may be payable in respect of any transfer involved in
the issue and delivery of any shares of capital stock and/or other
securities in a name other than that in which the shares of such series
of Specialty Retail Stock so exchanged or redeemed were registered, and
no such issue or delivery shall be made unless and until the person
requesting such issue has paid to the Company the amount of any such
tax, or has established to the satisfaction of the Company that such tax
has been paid.
(c) Increase in Authorized Shares in Connection with Exchange. In
order to give effect to any exchange of any series of Specialty Retail
Stock for Kmart Stock as contemplated by subparagraphs 3(a)(i)(C),
3(a)(ii), 3(a)(iii) and 3(a)(vi) of this Section A, the Board of Directors
shall have the authority pursuant to Section 303(3) of the MBCA, or any
successor provision, to amend these Restated Articles of Incorporation to
increase the authorized shares of Common Stock and of Kmart Stock to the
number that will be sufficient, when added to the previously authorized but
unissued shares of Common Stock and of Kmart Stock, to give effect to the
exchange of such series of Specialty Retail Stock. For purposes of this
Section A of this Article III, the foregoing exchange provisions shall be
deemed to be a "conversion privilege" of the shares of each series of
Specialty Retail Stock within the meaning of Section 303(3) of the MBCA, or
any successor provision.
4. Voting Rights.
(a) At every meeting of stockholders, the holders of each series of
Common Stock and the holders of each series of Preferred Stock entitled to
vote together with the holders of Common Stock shall have the right to vote
in the election of directors and upon each other matter coming before any
meeting of the stockholders. Subject to the provisions of subparagraph (c)
of this paragraph 4 and of paragraphs 3 and 5 of Section B below and except
as otherwise provided by law or by the terms of any outstanding series of
Preferred Stock, the holders of each series of Common Stock and of any such
series of Preferred Stock shall vote together as one class. At every
meeting of stockholders, the holders of any series of Common Stock shall be
entitled to (i) for each outstanding share of Kmart Stock, one vote, (ii)
for each outstanding share of any other series of Common Stock, a number of
votes (including any fractional vote) equal to the quotient (calculated to
the nearest three decimal places), as of the fifth Trading Day prior to the
applicable record date or as of any other applicable date, of (A) the sum
of (1) four times the average ratio of the Market Value of one share of
such series of Common Stock ("SR") to the Market Value of one share of
Kmart Stock ("KM") for the five-Trading Day period ending on such fifth
Trading Day, (2) three times the average ratio of SR to KM for the next
preceding five-Trading Day period, (3) two times the average ratio of SR to
KM for the next preceding five-Trading Day period and (4) the average ratio
of SR to KM for the next preceding five-Trading Day period, divided by (B)
ten; provided that until any such series of Common Stock has been traded
after issuance on a national securities exchange or the National
Association of Securities Dealers Automated Quotations National Market
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System for at least 25 Trading Days, each outstanding share of such series
of Common Stock shall be entitled to a number of votes equal to the average
ratio (calculated to the nearest three decimal places) of the Market Value
of a share of such series of Common Stock to the Market Value of a share of
Kmart Stock for each Trading Day during the period commencing on the date
such series is initially so traded and ending on the last Trading Day on or
before the applicable record date or other applicable date; and provided
further that, notwithstanding anything herein to the contrary, no share of
any such series of Common Stock shall be entitled to more than one vote at
any time during which any shares of Series A Conversion Preferred Stock
remain outstanding. If shares of only one series of Common Stock are
outstanding, each share of that series shall be entitled to one vote. If
any series of Common Stock is entitled to vote separately as a series with
respect to any matter, each share of that series shall be entitled to one
vote in the separate vote on such matter.
(b) Any action to be taken by the holders of each series of Common
Stock and the holders of each series of Preferred Stock entitled to vote
with the holders of each series of Common Stock, voting together as one
class, shall require, in addition to the vote or consent of a majority or
other proportion of shares required by law, these Restated Articles of
Incorporation or the By-laws, the vote or consent of such majority or other
proportion of the votes to which such shares of Common Stock and of
Preferred Stock are entitled.
(c) In addition to such other vote or consent as shall then be
required by law, these Restated Articles of Incorporation or the By-laws,
the vote or consent of the holders of at least 66 2/3% of all of the shares
of any series of Common Stock (the "Affected Stock") issued with reference
to any Group (the "Affected Group") then outstanding, voting as a separate
class, shall be necessary for any of the following transactions, except as
provided below or as otherwise permitted by the terms of this Section A:
(i) the declaration or payment of any dividend on, or the making of
any other payment or distribution with respect to, any shares of any
other series of Common Stock, if such dividend, payment or distribution
is to be made with (A) any of the properties and assets of the Affected
Group or (B) shares of Affected Stock (or Convertible Securities
convertible into or exercisable for Affected Stock) or (C) any security
that represents an equity interest in an entity (other than the Company)
that owns any of the properties or assets of the Affected Group, other
than any shares of any series of Specialty Retail Stock (or Convertible
Securities convertible into or exercisable for such series of Specialty
Retail Stock) issued by the Company as a dividend or distribution on the
Kmart Stock to the extent permitted by subparagraph 2(c) of this Section
A;
(ii) the use of any of the properties and assets of the Affected
Group in any business of the Company other than a business of the
Affected Group, unless such use arises from a transfer for value of such
properties or assets from one Group to another;
(iii) any issuance or sale of shares of Affected Stock, or
Convertible Securities convertible into or exercisable for Affected
Stock, for the account of any Group other than (x) the Affected Group or
(y) if the Affected Group is a Specialty Retail Group, the Kmart Group
but only if the sum of the number of shares of Affected Stock to be so
issued or sold, or the number of shares of Affected Stock into which or
for which such Convertible Securities to be so issued or sold would be
convertible or exercisable at such time, and the number of shares which
are issuable upon conversion or exercise of any other Convertible
Securities then outstanding which are attributed to the Kmart Group
would not exceed the Number of Shares Issuable with Respect to the
Retained Interest in such Specialty Retail Group;
provided that, notwithstanding the foregoing, no such vote shall be required for
a transfer accounted for as a loan by an Affected Group to any other Group at a
rate determined in a manner consistent with the Company's policy with respect to
such loans between Groups at such time.
5. Liquidation Rights. In the event of the voluntary or involuntary
liquidation, dissolution or winding-up of the Company, after payment or
provision for payment of the debts and other liabilities of the Company and the
full preferential amounts (including any accumulated and unpaid dividends) to
which the holders of
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Preferred Stock are entitled, the holders of the outstanding shares of each
series of Common Stock shall be entitled to receive a fraction of the assets of
the Company remaining for distribution to its stockholders, where such fraction
is equal to the quotient of (A) the sum of (1) four times the average ratio of
the Market Capitalization of such series of Common Stock ("x") to the aggregate
Market Capitalization of all outstanding series of Common Stock ("y") for the
five-Trading Day period ending on the Trading Day prior to the date of the first
public announcement of (I) a voluntary liquidation, dissolution or winding-up by
the Company or (II) the institution of a proceeding for the involuntary
liquidation, dissolution or winding-up of the Company, (2) three times the
average ratio of x to y for the next preceding five-Trading Day period, (3) two
times the average ratio of x to y for the next preceding five-Trading Day period
and (4) the average ratio of x to y for the next preceding five-Trading Day
period, divided by (B) ten. Neither the merger nor consolidation of the Company
into or with any other corporation, nor the merger or consolidation of any other
corporation into or with the Company, nor a sale, transfer or lease of all or
any part of the assets of the Company, shall be deemed a liquidation,
dissolution or winding-up for purposes of this paragraph 5.
6. Preemptive Rights. The holders of shares of any series of Common Stock
shall have no preemptive right to subscribe for any additional shares of capital
stock or other obligations convertible into shares of capital stock which may
hereafter be issued by the Company.
7. Determinations by the Board of Directors. Any determinations made in
good faith by the Board of Directors under any provision in this Section A or in
any certificate of designation filed pursuant hereto, and any determinations
with respect to any Group or the rights of holders of any series of Common Stock
made pursuant to or in furtherance of this Section A, shall be final and binding
on all stockholders.
8. Definitions. As used in this Section A of this Article III, the
following terms shall have the following meanings (with terms defined in the
singular having comparable meaning when used in the plural and vice versa),
unless another definition is provided or the context otherwise requires. As used
in paragraph 8 of this Section A, a "contribution" or "transfer" of assets or
properties from one Group to another shall be deemed to refer to the
reattribution of such assets or properties from the contributing or transferring
Group to the other Group (and correlative phrases shall have correlative
meanings).
"Available Dividend Amount", on any date (the "calculation date") with
respect to any series of Common Stock (the "subject group stock") issued with
reference to any Group (the "subject group"), shall mean the excess of:
(i) the product of (x) the Outstanding Interest Fraction with respect
to the subject group as of such calculation date and (y) an amount equal to
the total assets of the subject group less its total liabilities as of such
calculation date determined either (1) in accordance with generally
accepted accounting principles as in effect at such time applied on a basis
consistent with that applied in determining Kmart Corporation Earnings
Attributable to the Kmart Group and Kmart Corporation Earnings Attributable
to a Specialty Retail Group with respect to each Specialty Retail Group, or
(2) at the option of the Board of Directors, in accordance with Michigan
law applied as if the subject group were treated as a corporation for
purposes of determining assets legally available for the payment of
dividends under Michigan law, in either case reduced, in the case of Kmart
Stock, by the aggregate of the amounts, with respect to all Specialty
Retail Groups as of the calculation date, of amortization of goodwill
during the periods from the respective dates of acquisition through the
calculation date arising from acquisitions made by the Company or any of
its subsidiaries before the Effective Date with respect to each such
Specialty Retail Group (determined as set forth in clause (ii) of the
definition of Kmart Corporation Earnings Attributable to the Kmart Group
and, as in such clause (ii), excluding the portion thereof, if any, already
applied to reduce net income or increase net loss of the Kmart Group for
such period by virtue of its proportionate interest during such period in
the businesses, assets and liabilities of each Specialty Retail Group equal
to the Retained Interest Fraction with respect to such Specialty Retail
Group), and increased, in the case of any Specialty Retail Stock, by the
amount of amortization of goodwill during such period arising from
acquisitions made by the Company or any of its subsidiaries before the
Effective Date with respect to the subject group (determined as set forth
in clause (ii) of the definition of Kmart Corporation Earnings Attributable
to a Specialty Retail Group with respect to the subject group); over
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(ii) except to the extent that these Restated Articles of
Incorporation permit otherwise, the amount that would be needed to satisfy
any preferential rights to which holders of Preferred Stock attributed to
the subject group are entitled upon dissolution of the Company;
provided that such excess shall be reduced by an amount, if any, sufficient to
ensure that the subject group shall be able to pay its debts as they become due
in the usual course of business.
"Borders-Walden Group" shall mean, from and as of the date Borders-Walden
Stock is first issued:
(i) the interest of the Company or of any of its subsidiaries in (x)
all of the businesses in which any of Borders, Inc. and Walden Book
Company, Inc. (or any of their predecessors or successors) (the
"Borders-Walden companies") is or has been engaged, directly or indirectly,
and (y) all of the assets and liabilities of the Borders-Walden companies;
(ii) all assets and liabilities of the Company or any of its
subsidiaries to the extent attributed to any of the businesses or assets of
the Borders-Walden companies, whether or not such assets or liabilities are
or were assets and liabilities of the Borders-Walden companies;
(iii) all assets and properties contributed to the Borders-Walden
Group from the Kmart Group resulting in an increase in the Number of Shares
Issuable with Respect to the Retained Interest in the Borders-Walden Group;
and
(iv) the interest of the Company or any of its subsidiaries in the
businesses, assets and liabilities acquired by the Company or any of its
subsidiaries for the Borders-Walden Group, as determined by the Board of
Directors;
provided that, (a) from and after any dividend, distribution or redemption with
respect to any shares of Borders-Walden Stock (other than a dividend or
distribution payable in shares of Borders-Walden Stock, or Convertible
Securities convertible into or exercisable for shares of Borders-Walden Stock),
the Borders-Walden Group shall no longer include an amount of assets or
properties equal to the aggregate amount of such kind of assets or properties so
paid in respect of such dividend, distribution or redemption with respect to
shares of Borders-Walden Stock multiplied by a fraction, the numerator of which
is equal to the Number of Shares Issuable with Respect to the Retained Interest
in the Borders-Walden Group and the denominator of which is equal to the number
of outstanding shares of Borders-Walden Stock at such time, and (b) from and
after any Permitted Transfer with respect to the Borders-Walden Group, the
Borders-Walden Group shall no longer include the amount of assets or properties
transferred to the Kmart Group in connection therewith.
"Builders Square Group" shall mean, from and as of the date Builders Square
Stock is first issued:
(i) the interest of the Company and its subsidiaries in (x) all of the
businesses in which Builders Square, Inc. (or any of its predecessors or
successors) (the "Builders Square companies") is or has been engaged,
directly or indirectly, and (y) all of the assets and liabilities of the
Builders Square companies;
(ii) all assets and liabilities of the Company or any of its
subsidiaries to the extent attributed to any of the businesses or assets of
the Builders Square companies, whether or not such assets or liabilities
are or were assets and liabilities of the Builders Square companies;
(iii) all assets and properties contributed to the Builders Square
Group from the Kmart Group resulting in an increase in the Number of Shares
Issuable With Respect to the Retained Interest in the Builders Square
Group; and
(iv) the interest of the Company or any of its subsidiaries in the
businesses, assets and liabilities acquired by the Company or any of its
subsidiaries for the Builders Square Group, as determined by the Board of
Directors;
provided that, (a) from and after any dividend, distribution or redemption with
respect to any shares of Builders Square Stock (other than a dividend or
distribution payable in shares of Builders Square Stock or in Convertible
Securities convertible into or exercisable for shares of Builders Square Stock),
the Builders Square Group shall no longer include an amount of assets or
properties equal to the aggregate amount of such
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kind of assets or properties so paid in respect of such dividend, distribution
or redemption with respect to shares of Builders Square Stock multiplied by a
fraction, the numerator of which is equal to the Number of Shares Issuable With
Respect to the Retained Interest in the Builders Square Group and the
denominator of which is equal to the number of outstanding shares of Builders
Square Stock at such time and (b) from and after any Permitted Transfer with
respect to the Builders Square Group, the Builders Square Group shall no longer
include the amount of assets or properties transferred to the Kmart Group in
connection therewith.
"Convertible Securities" shall mean any securities of the Company that are
convertible into or exercisable for or evidence the right to acquire any shares
of any series of Common Stock, whether at such time or upon the occurrence of
certain events, pursuant to antidilution provisions of such securities or
otherwise.
"Disposition" shall mean a sale, transfer, assignment or other disposition
(whether by merger, consolidation, sale or contribution of assets or stock or
otherwise).
"Effective Date" shall mean, with respect to the Kmart Group, the date on
which this Certificate of Amendment designating the Kmart Stock shall become
effective, and, with respect to any Specialty Retail Group, the date on which
the certificate of designation with respect to the series of Specialty Retail
Stock issued with reference to such Specialty Retail Group shall become
effective.
"Exchange Date" shall mean any date fixed for an exchange of shares of any
series of Specialty Retail Stock, as set forth in a notice to holders of such
series of Specialty Retail Stock or of Convertible Securities convertible into
or exercisable for shares of such series of Specialty Retail Stock pursuant to
subparagraph 3(b)(ii) of this Section A.
"Group" shall mean, as of any date, the Kmart Group or any of the Specialty
Retail Groups with reference to which shares of the relevant series of Specialty
Retail Stock have been issued and are outstanding as of such date.
"Kmart Corporation Earnings Attributable to the Kmart Group", for any
period through any date (the "calculation date"), shall mean (i) the net income
or loss of the Kmart Group for such period (or for fiscal periods of the Company
commencing prior to the Effective Date with respect to the Kmart Group, the pro
forma net income or loss of the Kmart Group for such period as if the Effective
Date had been the first day of such period) determined in accordance with
generally accepted accounting principles in effect at such time, reflecting
income and expense of the Company attributed to the Kmart Group on a basis
substantially consistent with attributions made with respect to the other
Groups, including, without limitation, corporate administrative costs, net
interest and other financial costs and income taxes, reduced by (ii) the
aggregate of the amounts, with respect to all Specialty Retail Groups as of the
calculation date, of amortization of goodwill during such period (such amount
calculated for fiscal periods of the Company commencing prior to the Effective
Date with respect to any such Specialty Retail Group on a pro forma basis as if
the Effective Date with respect to such Specialty Retail Group had been the
first day of such period) arising from acquisitions made by the Company or any
of its subsidiaries before the Effective Date with respect to each such
Specialty Retail Group, determined in accordance with generally accepted
accounting principles in effect at such time applied on a basis substantially
consistent with that applied in determining Kmart Corporation Earnings
Attributable to a Specialty Retail Group with respect to each of the other
Specialty Retail Groups (excluding the portion thereof, if any, already applied
to reduce net income or increase net loss of the Kmart Group for such period by
virtue of its proportionate interest in the businesses, assets and liabilities
of each Specialty Retail Group equal to the Retained Interest Fraction with
respect to such Specialty Retail Group).
"Kmart Corporation Earnings Attributable to a Specialty Retail Group", for
any period through any date with respect to any Specialty Retail Group, shall
mean (i) the net income or loss of such Specialty Retail Group for such period
(or for the fiscal periods of the Company commencing prior to the Effective Date
with respect to such Specialty Retail Group the pro forma net income or loss of
such Specialty Retail Group for such period as if the Effective Date had been
the first day of such period) determined in accordance with generally accepted
accounting principles in effect at such time, reflecting income and expense of
the Company attributed to such Specialty Retail Group on a basis substantially
consistent with attributions made with
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respect to the other Groups, including, without limitation, corporate
administrative costs, net interest and other financial costs and income taxes,
increased by (ii) the amount of amortization of goodwill of such Specialty
Retail Group during such period (such amount calculated for fiscal periods of
the Company commencing prior to the Effective Date with respect to such
Specialty Retail Group on a pro forma basis as if the Effective Date with
respect to such Specialty Retail Group had been the first day of such period)
arising from acquisitions made by the Company or any of its subsidiaries before
the Effective Date with respect to such Specialty Retail Group, determined in
accordance with generally accepted accounting principles in effect at such time
applied on a basis substantially consistent with that applied in determining
Kmart Corporation Earnings Attributable to a Specialty Retail Group with respect
to the other Specialty Retail Groups.
"Kmart Group" shall mean, as of any date:
(i) the interest of the Company or any of its subsidiaries in all of
the businesses in which the Company or any of its subsidiaries (or any of
their predecessors or successors) (the "Kmart companies") is or have been
engaged, directly or indirectly, and the respective assets and liabilities
of the Kmart companies, other than any businesses, assets or liabilities of
any Specialty Retail Group with reference to which shares of Specialty
Retail Stock have been issued and continue to be outstanding as of such
date;
(ii) a proportionate interest in the businesses, assets and
liabilities of each Specialty Retail Group as of such date equal to the
Retained Interest Fraction with respect to such Specialty Retail Group;
(iii) from and after any dividend, distribution or redemption with
respect to any shares of any series of Specialty Retail Stock (other than a
dividend or distribution payable in shares of such series of Specialty
Retail Stock or in Convertible Securities convertible into or exercisable
for shares of such series of Specialty Retail Stock), an amount of assets
or properties of such Specialty Retail Group equal to the aggregate amount
of such kind of assets or properties so paid in respect of such dividend,
distribution or redemption with respect to shares of such series of
Specialty Retail Stock multiplied by a fraction, the numerator of which is
equal to the Number of Shares Issuable with Respect to the Retained
Interest in such Specialty Retail Group and the denominator of which is
equal to the number of shares of such series of Specialty Retail Stock
outstanding at such time; and
(iv) from and after any Permitted Transfer with respect to any
Specialty Retail Group, the amount of assets or properties transferred from
such Specialty Retail Group to the Kmart Group in connection therewith;
provided that, from and after any contribution of any assets or properties from
the Kmart Group to any Specialty Retail Group resulting in an increase in the
Number of Shares Issuable with Respect to the Retained Interest in such
Specialty Retail Group, the Kmart Group shall no longer include such assets or
properties so contributed (other than pursuant to its interest in such Specialty
Retail Group pursuant to clause (ii) above).
"Market Capitalization" of any series of Common Stock on any date shall
mean the product of (i) the Market Value of one share of such series of Common
Stock on such date and (ii) the number of shares of such series of Common Stock
outstanding on such date.
"Market Value" of a share of any class or series of capital stock of the
Company on any Trading Day shall mean the average of the high and low reported
sales prices regular way of such share of such class or series on such Trading
Day or in case no such reported sale takes place on such Trading Day the average
of the reported closing bid and asked prices regular way of a share of such
class or series on such Trading Day, in either case on the New York Stock
Exchange Composite Tape, or if the shares of such class or series are not listed
or admitted to trading on such Exchange on such Trading Day, on the principal
national securities exchange in the United States on which the shares of such
class or series are listed or admitted to trading, or if not listed or admitted
to trading on any national securities exchange on such Trading Day, on the
National Association of Securities Dealers Automated Quotations National Market
System, or if the shares of such class or series are not listed or admitted to
trading on any national securities exchange or quoted on such National Market
System on such Trading Day, the average of the closing bid and asked prices of a
share of such class or series in the over-the-counter market on such Trading Day
as furnished by any New York Stock
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Exchange member firm selected from time to time by the Company, or if such
closing bid and asked prices are not made available by any such New York Stock
Exchange member firm on such Trading Day, the market value of a share of such
class or series as determined by the Board of Directors; provided that, for
purposes of determining the ratios set forth in subparagraphs 3(a)(i), 3(a)(ii),
3(a)(iii), 4(a) and 5 of this Section A, as calculated over any period, (i) the
"Market Value" of any share of any series of Common Stock on any day prior to
the "ex" date or any similar date occurring during such period for any dividend
or distribution paid or to be paid with respect to such series of Common Stock
shall be reduced by the fair market value of the per share amount of such
dividend or distribution and (ii) the "Market Value" of any share of any series
of Common Stock on any day prior to (A) the effective date of any subdivision
(by stock split or otherwise) or combination (by reverse stock split or
otherwise) of outstanding shares of such series of Common Stock occurring during
such period or (B) the "ex" date or any similar date occurring during such
period for any dividend or distribution with respect to such series of Common
Stock in shares of such series of Common Stock shall be appropriately adjusted
to reflect such subdivision, combination, dividend or distribution. For the
purposes of the foregoing clause (i) the Board of Directors shall determine the
fair market value of any dividend or distribution.
"Net Proceeds" shall mean, as of any date with respect to any Disposition
of any of the properties and assets of any Group, an amount, if any, equal to
the gross proceeds of such Disposition after any payment of, or reasonable
provision for, (i) any taxes payable by the Company in respect of such
Disposition, (ii) any taxes payable by the Company in respect of any dividend or
redemption pursuant to clause (A) or (B), respectively, of subparagraph 3(a)(i)
of this Section A, (iii) any transaction costs, including, without limitation,
any legal, investment banking and accounting fees and expenses and (iv) any
liabilities (contingent or otherwise) of, attributed to, or related to, such
Group, including, without limitation, any liabilities for deferred taxes or any
indemnity or guarantee obligations of the Company with respect to such Group,
incurred in connection with the Disposition or otherwise; or any liabilities for
future purchase price adjustments and any preferential amounts plus any
accumulated and unpaid dividends in respect of Preferred Stock attributed to
such Group. For purposes of this definition, any properties and assets of such
Group remaining after such Disposition shall constitute "reasonable provision"
for such amount of taxes, costs and liabilities (contingent or otherwise) as can
be supported by such properties and assets. To the extent the proceeds of any
Disposition include any securities or other property other than cash, the Board
of Directors shall determine the value of such securities or property, including
for the purpose of determining the cash equivalent thereof if the Board of
Directors determines to pay a dividend or redemption price in cash as provided
in subparagraph 3(a)(i)(z) of this Section A.
"Number of Shares Issuable with Respect to the Retained Interest" in any
Specialty Retail Group shall initially be the number set forth in the
certificate of designation with respect to the relevant series of Specialty
Retail Stock in accordance with paragraph 1 of this Section A; provided,
however, that such number from time to time shall be:
(i) adjusted as appropriate to reflect subdivisions (by stock split or
otherwise) and combinations (by reverse stock split or otherwise) of such
series of Specialty Retail Stock and dividends or distributions of shares
of such series of Specialty Retail Stock to holders thereof and other
reclassifications of such series of Specialty Retail Stock;
(ii) decreased by (A) the number of shares of such series of Specialty
Retail Stock issued or sold by the Company, the proceeds of which are
attributed to the Kmart Group, (B) the number of shares of such series of
Specialty Retail Stock issued upon conversion or exercise of Convertible
Securities which are attributed to the Kmart Group, (C) the number of
shares of such series of Specialty Retail Stock issued by the Company as a
dividend or distribution or by reclassification or exchange to holders of
Kmart Stock and (D) the number (rounded, if necessary, to the nearest whole
number) equal to the aggregate fair value (as determined by the Board of
Directors) of assets or properties transferred from such Specialty Retail
Group to the Kmart Group in connection with a Permitted Transfer divided by
the average per share value (as determined by the Board of Directors) of
the consideration paid to holders of outstanding shares of such series of
Specialty Retail Stock in connection with the repurchases with respect to
which such Permitted Transfer is being made; and
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(iii) increased by (A) the number of outstanding shares of such series
of Specialty Retail Stock repurchased by the Company, the consideration for
which is attributed to the Kmart Group and (B) the number (rounded, if
necessary, to the nearest whole number) equal to the fair value (as
determined by the Board of Directors) of assets or properties theretofore
attributed to the Kmart Group that are contributed as additional equity to
such Specialty Retail Group divided by the Market Value of one share of
such series of Specialty Retail Stock as of the date of such contribution.
"OfficeMax Group" shall mean, from and as of the date the OfficeMax
Stock is first issued:
(i) the interest of the Company or any of its subsidiaries in (x) all
of the businesses in which OfficeMax, Inc. (or any of its predecessors or
successors) (the "OfficeMax companies") is or has been engaged, directly or
indirectly, and (y) all of the assets and liabilities of the OfficeMax
companies;
(ii) all assets and liabilities of the Company or any of its
subsidiaries to the extent attributed to any of the businesses or assets of
the OfficeMax companies, whether or not such assets or liabilities are or
were assets and liabilities of the OfficeMax companies;
(iii) all assets and properties contributed to the OfficeMax Group
from the Kmart Group resulting in an increase in the Number of Shares
Issuable with Respect to the Retained Interest in the OfficeMax Group; and
(iv) the interest of the Company or any of its subsidiaries in the
businesses, assets and liabilities acquired by the Company or any of its
subsidiaries for the OfficeMax Group, as determined by the Board of
Directors;
provided that, (a) from and after any dividend, distribution or redemption with
respect to any shares of OfficeMax Stock (other than a dividend or distribution
payable in shares of OfficeMax Stock or in Convertible Securities convertible
into or exercisable for shares of OfficeMax Stock), the OfficeMax Group shall no
longer include an amount of assets or properties equal to the aggregate amount
of such kind of assets or properties so paid in respect of such dividend,
distribution or redemption with respect to shares of OfficeMax Stock multiplied
by a fraction, the numerator of which is equal to the Number of Shares Issuable
with Respect to the Retained Interest in the OfficeMax Group and the denominator
of which is equal to the number of outstanding shares of OfficeMax Stock at such
date, and (b) from and after any Permitted Transfer with respect to the
OfficeMax Group, the OfficeMax Group shall no longer include the amount of
assets or properties transferred to the Kmart Group in connection therewith.
"Outstanding Interest Fraction", with respect to the Kmart Group, as of any
date, is 1, and with respect to any Specialty Retail Group, as of any date, is a
fraction the numerator of which shall be the number of shares of the series of
Specialty Retail Stock issued with reference to such Specialty Retail Group
outstanding on such date and the denominator of which shall be the sum of the
number of outstanding shares of such series of Specialty Retail Stock
outstanding on such date and the Number of Shares Issuable with Respect to the
Retained Interest in such Specialty Retail Group on such date. A statement
setting forth the Outstanding Interest Fraction with respect to each Specialty
Retail Group shall be filed with the Secretary of the Company within 30 days
after the end of each fiscal quarter of the Company.
"Permitted Transfer" shall mean, with respect to any Specialty Retail
Group, a transfer from such Specialty Retail Group to the Kmart Group of assets
or properties:
(i) of the kind being offered at such time in either (x) a tender or
exchange offer made by the Company to all holders of outstanding shares of
the series of Specialty Retail Stock issued with reference to such
Specialty Retail Group or (y) a publicly announced open market repurchase
program for shares of such series of Specialty Retail Stock, the
consideration for which in either case is attributed to such Specialty
Retail Group;
(ii) in the case of a tender or exchange offer, the amount of which is
determined as of a date within five Trading Days after consummation of such
tender or exchange offer and which equals the product of (x) the amount of
assets or properties offered to holders of outstanding shares of such
series of Specialty Retail Stock in connection with such tender or exchange
offer and (y) a fraction determined as of such
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date which does not exceed the fraction the numerator of which is equal to
the Number of Shares Issuable with Respect to the Retained Interest in such
Specialty Retail Group and the denominator of which is equal to the number
of outstanding shares of such series of Specialty Retail Stock, in each
case immediately prior to the repurchase effected in connection with such
tender or exchange offer; and
(iii) in the case of an open market repurchase program, the amount of
which is determined as of a date within five Trading Days after the end of
the fiscal quarter during which any such open market repurchases are made
and which equals the product of (x) the amount of assets or properties paid
to holders of outstanding shares of such series of Specialty Retail Stock
in connection with such open market repurchase program during such fiscal
quarter and (y) a fraction determined prior to any such repurchase which
does not exceed the fraction the numerator of which is equal to the Number
of Shares Issuable with Respect to the Retained Interest in such Specialty
Retail Group and the denominator of which is equal to the number of
outstanding shares of such series of Specialty Retail Stock, in each case
either on the date of commencement of such open market repurchase program
(if such open market program commences during such fiscal quarter) or on
the first Trading Day of such fiscal quarter (if such open market
repurchase program has commenced prior thereto).
"Redemption Date" shall mean any date fixed for a redemption of shares of
any series of Specialty Retail Stock, as set forth in a notice to holders
thereof pursuant to subparagraph 3(b)(ii) of this Section A.
"Retained Interest Fraction", as of any date with respect to any Specialty
Retail Group, shall mean a fraction the numerator of which shall be the Number
of Shares Issuable with Respect to the Retained Interest in such Specialty
Retail Group as of such date and the denominator of which shall be the sum of
the number of shares of the series of Specialty Retail Stock issued with
reference to such Specialty Retail Group and outstanding as of such date and the
Number of Shares Issuable with Respect to the Retained Interest in such
Specialty Retail Group as of such date.
"Specialty Retail Group" shall mean, as of any date, any of the
Borders-Walden Group, Builders Square Group, OfficeMax Group and The Sports
Authority Group with reference to which shares of the relevant Specialty Retail
Stock have been issued and are outstanding as of such date.
"Specialty Retail Group Subsidiary" shall have the meaning set forth in
subparagraph 3(a)(v) of this Section A.
"The Sports Authority Group" shall mean, from and as of the date The Sports
Authority Stock is first issued:
(i) the interest of the Company or any of its subsidiaries in (x) all
of the businesses in which The Sports Authority, Inc. (or any of its
predecessors or successors) ("The Sports Authority companies") is or has
been engaged, directly or indirectly, and (y) all of the assets and
liabilities of The Sports Authority companies;
(ii) all assets and liabilities of the Company or any of its
subsidiaries to the extent attributed to any of the businesses or assets of
The Sports Authority companies, whether or not such assets or liabilities
are or were assets and liabilities of The Sports Authority companies;
(iii) all assets and properties contributed to The Sports Authority
Group from the Kmart Group resulting in an increase in the Number of Shares
Issuable with Respect to the Retained Interest in The Sports Authority
Group; and
(iv) the interest of the Company or any of its subsidiaries in the
businesses, assets and liabilities acquired by the Company or any of its
subsidiaries for The Sports Authority Group, as determined by the Board of
Directors;
provided that, (a) from and after any dividend, distribution or redemption with
respect to any shares of The Sports Authority Stock (other than a dividend or
distribution payable in shares of The Sports Authority Stock or in Convertible
Securities convertible into or exercisable for shares of The Sports Authority
Stock), The Sports Authority Group shall no longer include an amount of assets
or properties equal to the aggregate
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amount of such kind of assets or properties so paid in respect of such dividend,
distribution or redemption with respect to shares of The Sports Authority Stock
multiplied by a fraction, the numerator of which is equal to the Number of
Shares Issuable with Respect to the Retained Interest in The Sports Authority
Group, and the denominator of which is equal to the number of outstanding shares
of The Sports Authority Stock at such date and (b) from and after any Permitted
Transfer with respect to The Sports Authority Group, The Sports Authority Group
shall no longer include the amount of assets or properties transferred to the
Kmart Group in connection therewith.
"Trading Day" shall mean each weekday other than any day on which any
relevant series of Common Stock is not traded on any national securities
exchange or the National Association of Securities Dealers Automated Quotations
National Market System or in the over-the-counter market."
* * *
Redesignation. (a) Upon the effectiveness of this Amendment, and without
any further action on the part of the Company, its stockholders or the Board of
Directors, each share of Common Stock, par value $1.00 per share, then issued
and undesignated as to series (including shares held in the treasury of the
Company) shall automatically be redesignated, changed and converted into one
fully paid and nonassessable share of Kmart Stock (the "Redesignation"). Except
as expressly provided herein, references to Common Stock in the Restated
Articles of Incorporation shall be deemed to be references to the class of
Common Stock, undesignated as to series.
(b) From and after the Redesignation pursuant to subparagraph (a) above,
all references to "Common U.S. Stock" in paragraphs 2, 7 and 8 of Section C of
Article III of the Restated Articles of Incorporation shall be deemed to be
references to "Kmart Stock".
(c) From and after the Redesignation pursuant to subparagraph (a) above, in
accordance with the terms of paragraph 3(d)(i)(4) of Section D of Article III of
the Restated Articles of Incorporation, the Common Equivalent Rate in effect
immediately prior to such Redesignation shall automatically be adjusted so that
the holder of a share of Series A Conversion Preferred Stock shall be entitled
to receive on the conversion of such share the number of shares of Kmart Stock
which such holder would have been entitled to receive as a result of the
Redesignation had such share of Series A Conversion Preferred Stock been
surrendered for conversion at the Common Equivalent Rate in effect immediately
prior to such Redesignation. To implement such adjustment in accordance with
such terms, from and after the effectiveness of such adjustment, all references
to "Common Stock" in paragraph 3 of Section D of Article III of the Restated
Articles of Incorporation shall be deemed to be references to "Kmart Stock,"
except as to the following:
(i) subparagraph (d)(i)(4) of said paragraph 3 shall be amended in its
entirety to read as follows: "issue by reclassification of its shares of
Kmart Stock shares of Kmart Stock or any such other series of Common
Stock"; and
(ii) the fourth line following subparagraph (d)(i)(4) of said
paragraph 3 shall be amended to delete therefrom the words "shares of
Common Stock" and to insert in lieu thereof the words "shares of Kmart
Stock or, in the event of a reclassification, such other series of Common
Stock".
(d) From and after the Redesignation pursuant to subparagraph (a) above, in
accordance with the terms of paragraph 3(c)(i)(4) and paragraph 5 of Section E
of Article III of the Restated Articles of Incorporation, the Conversion Rate in
effect immediately prior to such Redesignation shall automatically be adjusted
so that the holder of a share of Series B Convertible Preferred Stock shall be
entitled to receive on the conversion of such share the number of shares of
Kmart Stock which such holder would have been entitled to receive as a result of
the Redesignation had such share of Series B Preferred Stock been surrendered
for conversion at the Conversion Rate in effect immediately prior to such
Redesignation. To implement such adjustment in accordance with such terms, from
and after the effectiveness of such adjustment, all references to "Common
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Stock" in paragraphs 2, 3, 4, 5, 6 and 9 of Section E of Article III of the
Restated Articles of Incorporation shall be deemed to be references to "Kmart
Stock," except as to the following:
(i) subparagraph (c)(i)(4) of said paragraph 3 shall be amended in its
entirety to read as follows: "issue by reclassification of its shares of
Kmart Stock shares of Kmart Stock or any such other series of Common
Stock;" and
(ii) the fourth line following subparagraph (c)(i)(4) of said
paragraph 3 shall be amended to delete therefrom the words "shares of
Common Stock" and to insert in lieu thereof the words "shares of Kmart
Stock or, in the event of a reclassification, such other series of Common
Stock."
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ANNEX III-B
PROPOSAL 3 -- AMENDMENTS TO
RESTATED ARTICLES OF INCORPORATION
RELATING TO ISSUANCE OF PREFERRED STOCK IN
SERIES BY RESOLUTION OF BOARD OF DIRECTORS
Section B of Article III of the Articles is proposed to be amended by adding the
following:
"6. Notwithstanding anything to the contrary contained in paragraphs
III(B)(1), (2) and (3) above (which provisions shall continue to apply to any
heretofore issued and outstanding shares of any series of Preferred Stock), the
Board of Directors shall have authority to divide and issue shares of Preferred
Stock into series, and to fix and determine the relative designations, rights,
preferences and limitations of the shares of any series so established,
including, without limitation, voting rights, full or limited, or no voting
rights, and such distinctive designations, preferences and relative,
participating, optional or other special rights and such qualifications,
limitations or restrictions thereof, as shall be designated by the Board of
Directors and as may be permitted by the MBCA. There may be variations between
different series as fixed and determined by the Board of Directors, including,
without limitation: (a) the rate of dividend (which may be cumulative or non-
cumulative) and upon such conditions, and at such times, and whether payable in
preference to, or in such relation to, dividends payable on any other class or
classes or any other series; (b) the price and terms upon which shares are
redeemable; (c) the amount payable upon shares in the event of voluntary or
involuntary liquidation; (d) sinking fund provisions for the redemption or
purchase of shares and (e) the terms and conditions on which shares may be
converted or exchanged."
* * *
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ANNEX III-C
PROPOSAL 4 -- AMENDMENTS TO
RESTATED ARTICLES OF INCORPORATION
RELATING TO CERTAIN VOTING PROVISIONS
The fourth and sixth paragraphs of Article VII of the Articles are proposed
to be amended and restated in their entirety as follows, respectively:
"Any director may be removed from office at any time either (a) by a
vote of the holders of a majority of the number of votes to which the
shares entitled to vote on the election of directors are entitled, voting
together as one class, but only for cause, or (b) by a vote of a majority
of the other directors, with or without cause."
"Notwithstanding anything contained in these Restated Articles of
Incorporation or the By-laws of the Company to the contrary, the
affirmative vote of at least 58% of the number of votes to which the shares
entitled to vote on the issue are entitled, voting together as one class,
shall be required to amend, repeal or adopt any provision inconsistent with
this Article VII."
* * *
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ANNEX IV-A
PROPOSAL 5 -- ADOPTION OF EMPLOYEE
STOCK PURCHASE PLAN FOR EACH
SPECIALTY RETAIL GROUP
FORM OF
EMPLOYEE STOCK PURCHASE PLAN
1. Purpose. The [Specialty Retail Group] Employee Stock Purchase Plan (the
"Plan") is being established for the benefit of employees of [Specialty Retail
Subsidiary], and any other subsequently designated subsidiaries of Kmart
Corporation, a Michigan corporation and the parent corporation of [Specialty
Retail Subsidiary] (the "Company"), collectively hereinafter sometimes called
the "Group". The Plan is intended to provide the employees of each corporate
member of the Group an opportunity to purchase, through accumulated payroll
deductions, cash dividends on stock held in the employee's account under the
Plan, and/or the employee's cash payments under the Plan, shares of the series
of common stock of the Company related to the Group. It is the intention of the
Company that the Plan qualify as an "employee stock purchase plan" within the
meaning of Section 423 of the Code, and the provisions of the Plan shall be
construed in a manner consistent with the requirements of such Section of the
Code.
2. Definitions.
a. "Board" shall mean the Board of Directors of the Company.
b. "Change in Capitalization" shall mean any (i) increase, reduction,
or change or exchange of shares of Group Stock for a different number,
series or kind of shares or other securities of the Company by reason of a
reclassification, recapitalization, merger, consolidation, reorganization,
stock dividend, stock split or reverse stock split, combination or exchange
of shares, repurchase of shares, change in corporate structure or otherwise
or (ii) exchange of Group Stock for common stock of a subsidiary of the
Company that, at the time of such exchange, owns all assets and liabilities
of the Group.
c. "Change in Control" of the Company shall be deemed to occur upon
the first to occur of the following:
(i) "beneficial ownership" (as defined in Rule 13d-3 under the
Exchange Act) of securities representing more than 33% of the combined
voting power of the Company is acquired by any "person," as defined in
sections 13(d) and 14(d) of the Exchange Act (other than the Company,
any trustee or other fiduciary holding securities under an employee
benefit plan of the Company, or any corporation owned, directly or
indirectly, by the Company's stockholders in substantially the same
proportions as their ownership of stock of the Company), or
(ii) the stockholders of the Company approve a definitive agreement
to merge or consolidate the Company with or into another corporation or
to sell or otherwise dispose of all or substantially all of its assets,
or adopt a plan of liquidation, or
(iii) during any period of three consecutive years, individuals who
at the beginning of such period were members of the Board cease for any
reason to constitute at least a majority thereof (unless the election,
or the nomination for election by the Company's stockholders, of each
new director was approved by a vote of at least a majority of the
directors then still in office who were directors at the beginning of
such period or whose election or nomination was previously so approved).
d. "Code" shall mean the Internal Revenue Code of 1986, as amended.
e. "Committee" shall mean the Compensation and Incentives Committee or
any other committee of members of the Board appointed by the Board to
administer the Plan and to perform the functions set forth herein.
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f. "Company" shall mean Kmart Corporation, a corporation organized
under the laws of the State of Michigan, or any successor corporation.
g. "Compensation" shall mean the fixed salary, wages, overtime pay and
bonuses paid by the employer to an Employee as reported by the employer to
the United States government for Federal income tax purposes, including an
Employee's portion of salary deferral contributions pursuant to Section
401(k) of the Code and any amount excludable pursuant to Section 125 of the
Code, but excluding any foreign service allowance, severance pay, expenses
or other special emolument or any credit or benefit under any employee plan
maintained by the Company or the employer (if other than the Company).
h. "Continuous Status as an Employee" shall mean the absence of any
interruption or termination of service as an Employee. Continuous Status as
an Employee shall not be considered interrupted in the case of a leave of
absence agreed to in writing by the Employee's employer (including, but not
limited to, military leave or short-term disability leave), if such leave
is for a period of not more than 90 days or reemployment upon the
expiration of such leave is guaranteed by contract or statute.
i. "Designated Subsidiaries" shall mean the subsidiaries of the
Company that have been designated by the Board from time to time in its
sole discretion as eligible to participate in the Plan, which may include
corporations which become subsidiaries of the Company after the adoption of
the Plan, but may include only corporations the businesses of which are
part of the Group.
j. "Employee" shall mean any person, including an officer, who is
regularly employed by any member of the Group, who has maintained
Continuous Status as an Employee for at least one year and is regularly
scheduled to work more than 1,000 hours in a Plan Year, except any person
who is both "highly compensated" within the meaning of Section 414(q) of
the Code and designated by the Committee as a participant in the Company's
Management Stock Purchase Plan.
k. "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.
l. "Exercise Date" shall mean the last business day of each Offering
Period in which payroll deductions are made under the Plan.
m. "Fair Market Value" per share as of a particular date shall mean
(i) the closing sales price per share of Group Stock on the national
securities exchange on which the Group Stock is principally traded, on such
date or on the last preceding date on which there was a sale of such Group
Stock on such exchange, (ii) if the shares of Group Stock are not then
listed on a national securities exchange, the average of the closing bid
and ask prices in the over-the-counter market on such date or on the last
preceding date on which there was a sale of such Group Stock, or (iii) if
the shares of Group Stock are not then listed on a national securities
exchange or traded in an over-the-counter market, such value as the
Committee, in its sole discretion, shall determine; provided, however,
that, in connection with the initial issuance of the Group Stock, the "Fair
Market Value" of a share of Group Stock shall be the initial public
offering price per share.
n. "Group" shall mean [Specialty Retail Subsidiary] and any Designated
Subsidiary of the Company.
o. "Group Stock" shall mean shares of common stock of the Company
designated KM -- [Specialty Retail Group] Common Stock and any other
securities issued in respect of such shares pursuant to a Change in
Capitalization. "Number of Shares Issuable with Respect to Retained
Interest" means the number of shares of Group Stock that could be sold or
otherwise issued by the Company for the account of the Kmart Group in
respect of its Retained Interest in the Group.
p. "Offering Date" shall mean any one of the following: January 1,
April 1, July 1 or October 1 of each Plan Year.
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q. "Offering Period" shall mean any calendar quarter beginning with an
Offering Date prior to the end of the Term of the Plan; provided, however,
that the Committee shall have the power to change the duration of Offering
Periods.
r. "Parent" shall mean any corporation (other than the Company) in an
unbroken chain of corporations ending with the Company if, at the time of
granting an option, each of the corporations other than the Company owns
stock possessing fifty percent (50%) or more of the total combined voting
power of all classes of stock in one of the other corporations in such
chain.
s. "Participant" shall mean an Employee who participates in the Plan.
t. "Plan" shall mean the [Specialty Retail Group] Employee Stock
Purchase Plan, as amended from time to time.
u. "Plan Year" shall mean the calendar year.
v. "Subsidiary" shall mean any corporation in an unbroken chain of
corporations beginning with the Company if, at the time of granting an
option, each of the corporations other than the last corporation in the
unbroken chain owns stock possessing fifty percent (50%) or more of the
total combined voting power of all classes of stock in one of the other
corporations in such chain.
3. Eligibility.
a. Subject to the requirements of Section 4.b. hereof, any person who
is an Employee as of an Offering Date shall be eligible to participate in
the Plan and be granted an option for the Offering Period commencing on
such Offering Date.
b. Notwithstanding any provisions of the Plan to the contrary, no
Employee shall be granted an option under the Plan (i) if, immediately
after the grant, such Employee (or any other person whose stock would be
attributed to such Employee pursuant to Section 424(d) of the Code) would
own stock and/or hold outstanding options to purchase stock possessing five
percent (5%) or more of the total combined voting power or value of all
classes of stock of the Company or of any Subsidiary or Parent of the
Company, or (ii) which permits such Employee's right to purchase stock
under all employee stock purchase plans (as described in Section 423 of the
Code) of the Company and any Subsidiary or Parent of the Company to accrue
at a rate which exceeds twenty-five thousand dollars ($25,000) of Fair
Market Value of such stock (determined at the time such option is granted)
for any calendar year in which such option is outstanding at any time.
4. Grant of Option; Participation; Price.
a. On each Offering Date, the Company shall commence an offer by
granting each eligible Employee an option to purchase shares of Group
Stock, subject to the limitations set forth in Sections 3.b. and 10 hereof.
b. Each eligible Employee may elect to become a Participant in the
Plan with respect to an Offering Period, by filing an agreement with the
Company authorizing payroll deductions and investment of cash dividends in
accordance with Section 5 hereof. Such authorization shall remain in effect
for subsequent Offering Periods, until modified or terminated by the
Participant. Additionally, Participants may participate to a greater extent
by making cash payments to be credited to their accounts under the Plan in
accordance with Section 5 hereof.
c. The option price per share of the Group Stock subject to an
offering shall be 85% of the Fair Market Value of a share of Group Stock on
the Exercise Date provided, however, for purposes of the first Exercise
Date following the effectiveness of the Plan, the option price per share of
Group Stock shall be 85% of the initial public offering price per share.
Notwithstanding the foregoing, in no event shall the price per share be
less than the par value per share.
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5. Payroll Deductions and Cash Payments.
a. Subject to Section 4.b. hereof, a Participant may, in accordance
with rules and procedures adopted by the Committee, authorize a payroll
deduction of any whole percentage from 1 percent to 10 percent of such
Participant's Compensation for each pay period (the permissable range
within such percentages to be determined by the Committee from time to
time). A Participant may increase or decrease such payroll deduction
(including a cessation of payroll deductions) at any time, but not more
frequently than once each Offering Period, by filing a new authorization
form with the Company. All payroll deductions made by a Participant shall
be credited to such Participant's account under the Plan.
b. Additionally, in accordance with Section 4.b. hereof, and in
accordance with rules and procedures adopted by the Committee, a
Participant may also make cash payments to be credited to his or her
account under the Plan.
6. Exercise of Option.
a. Unless a Participant withdraws from the Plan as provided in Section
8 hereof, such Participant's election to purchase shares shall be exercised
automatically on the Exercise Date, and the maximum number of full shares
subject to such option shall be purchased for such Participant at the
applicable option price with (i) the accumulated payroll deductions, (ii)
cash dividends paid on Group Stock which have been credited to the
Participant's account under the Plan pursuant to Section 9 hereof, and
(iii) any additional cash payments made by the Participant and credited to
the Participant's account under the Plan in accordance with Section 5
hereof.
b. Any cash balance remaining in a Participant's account after the
termination of an Offering Period shall be carried forward to the
Participant's account for the purchase of Group Stock during the next
Offering Period if the Participant has elected to continue to participate
in the Plan. Otherwise the Participant shall receive a cash payment equal
to the balance of his or her account.
c. The shares of Group Stock purchased upon exercise of an option
hereunder shall be credited to the Participant's account under the Plan and
shall be deemed to be transferred to the Participant on the Exercise Date
and, except as otherwise provided herein, the Participant shall have all
rights of a stockholder with respect to such shares.
7. Delivery of Group Stock.
a. As promptly as practicable after receipt by the Company of a
written request for withdrawal of Group Stock from any Participant, the
Company shall arrange the delivery to such Participant of a stock
certificate representing the shares of Group Stock which the Participant
requests to withdraw. Subject to Section 7.b. hereof, withdrawals may be
made no more frequently than once each Offering Period. Shares of Group
Stock received upon stock dividends or stock splits shall be treated as
having been purchased on the Exercise Date of the shares to which they
relate.
b. Notwithstanding anything in Section 7.a. hereof to the contrary,
Group Stock may be withdrawn by a Participant more than once during an
Offering Period under the following circumstances: (i) within sixty (60)
days following a Change in Control of the Company or (ii) upon the approval
of the Committee, in its sole discretion.
8. Withdrawal; Termination of Employment.
a. A Participant may withdraw at any time all, but not less than all,
cash amounts in his or her account under the Plan that have not been used
to purchase shares of Group Stock (including, without limitation, the
payroll deductions, cash dividends and cash payments credited to such
Participant's account) by giving written notice to the Company received
prior to the next occurring Exercise Date. All such payroll deductions,
cash dividends and cash payments credited to such Participant's account
shall be paid to such Participant promptly after receipt of such
Participant's notice of withdrawal and such Participant's option for the
Offering Period in which the withdrawal occurs shall be automatically
terminated. No further payroll deductions for the purchase of shares of
Group Stock shall be made for
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such Participant during such Offering Period, and any additional cash
dividends during the Offering Period shall be distributed to the
Participant.
b. Upon termination of a Participant's Continuous Status as an
Employee during the Offering Period for any reason, including voluntary
termination, retirement or death, the payroll deductions, cash dividends
and cash payments credited to such Participant's account (that have not
been used to purchase shares of Group Stock) shall be returned (and any
future cash dividends shall be distributed) to such Participant or, in the
case of such Participant's death, to the person or persons entitled thereto
under Section 12 hereof, and such Participant's option shall be
automatically terminated.
c. A Participant's withdrawal from an offering shall not have any
effect upon such Participant's eligibility to participate in a succeeding
offering or in any similar plan which may hereafter be adopted by the
Company.
9. Dividends and Interest.
a. Cash dividends paid on Group Stock held in a Participant's account
shall be credited to such Participant's account and used in addition to
payroll deductions to purchase shares of Group Stock on the Exercise Date.
Dividends paid in Group Stock or stock splits of the Group Stock shall be
credited to the accounts of Participants. Dividends paid in property other
than cash or Group Stock shall be distributed to Participants as soon as
practicable.
b. No interest shall accrue on or be payable with respect to the
payroll deductions or credited cash dividends or cash payments of a
Participant in the Plan.
10. Stock.
a. The maximum number of shares of Group Stock which shall be reserved
for sale under the Plan shall be the number of shares equal to the product
of: (A) the sum of (i) the Number of shares of Group Stock outstanding
immediately after the initial issuance of the Group Stock and (ii) the
Number of Shares Issuable with Respect to Retained Interest with regard to
the Group, by (B) [the percentage specified for the particular Group in
Proposal 5 of the Proxy Statement]. Such shares shall be either authorized
and unissued shares or shares which have been reacquired by the Company for
the account of the Group. The maximum number of reserved shares shall be
subject to adjustment upon Changes in Capitalization of the Company as
provided in Section 16 hereof. If the total number of shares which would
otherwise be subject to options granted pursuant to Section 4.a. hereof on
an Offering Date exceeds the number of shares then available under the Plan
(after deduction of all shares for which options have been exercised or are
then outstanding), the Committee shall make a pro rata allocation of the
shares remaining available for option grant in as uniform a manner as shall
be practicable and as it shall determine to be equitable. In such event,
the Committee shall give written notice to each Participant of such
reduction of the number of option shares affected thereby and shall
similarly reduce the rate of payroll deductions, if necessary.
b. Shares of Group Stock to be delivered to a Participant under the
Plan shall be registered in the name of the Participant or, at the election
of the Participant, in the name of the Participant and another person as
joint tenants with rights of survivorship.
11. Administration. The Plan shall be administered by the Committee, and
the Committee may select an administrator to whom its duties and
responsibilities hereunder may be delegated. The Committee shall have full power
and authority, subject to the provisions of the Plan, to promulgate such rules
and regulations as it deems necessary for the proper administration of the Plan,
to interpret the provisions and supervise the administration of the Plan, and to
take all action in connection therewith or in relation thereto as it deems
necessary or advisable. Any decision reduced to writing and signed by a majority
of the members of the Committee shall be fully effective as if it had been made
at a meeting duly held. [Except as otherwise provided by the Committee, the
Group shall be charged with all expenses incurred in the administration of the
Plan.] No member of the Committee shall be personally liable for any action,
determination, or interpretation made in good faith with respect to the Plan,
and all members of the Committee shall be fully indemnified by the Company with
respect to any such action, determination or interpretation. All decisions,
determinations
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and interpretations of the Committee shall be final and binding on all persons,
including the Company, the Participant (or any person claiming any rights under
the Plan from or through any Participant) and any stockholder.
12. Designation of Beneficiary.
a. A Participant may file with the Company, on forms supplied by the
Company, a written designation of a beneficiary who is to receive any
shares and cash remaining in such Participant's account under the Plan in
the event of the Participant's death.
b. Such designation of beneficiary may be changed by the Participant
at any time by written notice to the Company, on forms supplied by the
Company. In the event of the death of a Participant and in the absence of a
beneficiary validly designated under the Plan who is living at the time of
such Participant's death, the Company shall deliver such shares and/or cash
to the executor or administrator of the estate of the Participant or, if no
such executor or administrator has been appointed (to the knowledge of the
Company), the Company, in its discretion, may deliver such shares and/or
cash to the spouse or to any one or more dependents or relatives of the
Participant, or if no spouse, dependent or relative is known to the
Company, then to such other person as the Company may designate.
13. Transferability. Neither payroll deductions credited to a Participant's
account nor any rights with regard to the exercise of an option or to receive
shares under the Plan may be assigned, transferred, pledged or otherwise
disposed of in any way by the Participant (other than by will, the laws of
descent and distribution or as provided in Section 12 hereof). Any such attempt
at assignment, transfer, pledge or other disposition shall be without effect,
except that the Company may treat such act as an election to withdraw funds in
accordance with Section 8 hereof.
14. Use of Funds. All payroll deductions and additional cash payments
received or held by the Company under the Plan may be used by the Company for
any corporate purpose, and the Company shall not be obligated to segregate such
payroll deductions and additional cash payments.
15. Reports. Individual accounts will be maintained for each Participant in
the Plan. Statements of account shall be given to Participants as soon as
practicable following each Offering Period, which statements will set forth the
amounts of payroll deductions, dividends reinvestments and additional cash
payments, the per share purchase price, the number of shares of Group Stock
purchased, the aggregate shares in the Participant's account and the remaining
cash balance, if any.
16. Effect of Certain Changes. In the event of a Change in Capitalization
or the distribution of an extraordinary dividend, the Committee shall
conclusively determine the appropriate equitable adjustments, if any, to be made
under the Plan, including without limitation adjustments to the number of shares
of Group Stock which have been authorized for issuance under the Plan but have
not yet been placed under option, as well as the price per share of Group Stock
covered by each option under the Plan which has not yet been exercised. In the
event of a Change in Control of the Company, the Offering Period shall terminate
unless otherwise provided by the Committee.
17. Term of Plan. Subject to the Board's right to terminate the Plan (and
thereby end its Term) pursuant to Section 18 hereof, the Term of the Plan (and
its last Offering Period) shall end on December 31, 2004. Upon any termination
of the Plan, unless the Committee shall determine otherwise, any assets
remaining in the Participants' accounts under the Plan shall be delivered to the
respective Participant (or the Participant's legal representative) as soon as
practicable.
18. Amendment or Termination. The Board may at any time terminate or amend
the Plan. Except as provided in Section 16 hereof, no such termination may
adversely affect options previously granted and no amendment may make any change
in any option theretofore granted which adversely affects the rights of any
Participant. No amendment shall be effective unless approved by the stockholders
of the Company if stockholder approval of such amendment is required to comply
with Rule 16b-3 under the Exchange Act or Section 423 of the Code or to comply
with any other law, regulation or stock exchange rule.
IV-A-6
<PAGE> 167
19. Notices. All notices or other communications by a Participant to the
Company under or in connection with the Plan shall be deemed to have been duly
given when received in the form specified by the Company at the location, or by
the person, designated by the Company for the receipt thereof.
20. Regulations and Other Approvals; Governing Law.
a. This Plan and the rights of all persons claiming hereunder shall be
construed and determined in accordance with the laws of the State of
Michigan without giving effect to the choice of law principles thereof,
except to the extent that such law is preempted by federal law.
b. The obligation of the Company to sell or deliver shares of Group
Stock with respect to options granted under the Plan shall be subject to
all applicable laws, rules and regulations, including all applicable
federal and state securities laws, and the obtaining of all such approvals
by governmental agencies as may be deemed necessary or appropriate by the
Committee.
c. The Plan is intended to comply with Rule 16b-3 under the Exchange
Act and the Committee shall interpret and administer the provisions of the
Plan in a manner consistent therewith. Any provisions inconsistent with
such Rule shall be inoperative and shall not affect the validity of the
Plan.
21. Withholding of Taxes. If the Participant makes a disposition, within
the meaning of Section 424(c) of the Code and regulations promulgated
thereunder, of any share or shares issued to such Participant pursuant to such
Participant's exercise of an option, and such disposition occurs within the
two-year period commencing on the day after the Offering Date or within the
one-year period commencing on the day after the Exercise Date, such Participant
shall, within ten (10) days of such disposition, notify the Company thereof and
thereafter immediately deliver to the Company any amount of Federal, state or
local income taxes and other amounts which the Company informs the Participant
the Company is required to withhold.
22. Effective Date. The Plan shall take effect as of the date of the
initial issuance of the Group Stock, subject to the approval of the holders of a
majority of the securities of the Company present, or represented, and entitled
to vote at a meeting of stockholders held in accordance with applicable law,
which approval must occur within twelve months of the date that the Plan is
adopted by the Board.
IV-A-7
<PAGE> 168
ANNEX IV-B
PROPOSAL 6 -- AMENDMENTS TO DIRECTORS
STOCK PLAN RELATING TO ISSUANCE
OF SPECIALTY RETAIL STOCK
Subject to paragraph 6 hereof, The Kmart Corporation Directors Stock Plan
(the "Plan") is amended by action of the Board of Directors of Kmart Corporation
(the "Company") on , 1994, as follows:
1. Section 1.1 of the Plan is hereby amended to read, in its entirety, as
follows:
1.1 The Kmart Corporation Directors Stock Plan (the "Plan") is
intended to increase the proprietary interest of nonemployee members of
the Board of Directors (the "Board") of Kmart Corporation (the
"Company") by providing further opportunity for ownership of the common
stock, par value $1.00 per share, of the Company (the "Stock") which
includes the existing common stock (the "Existing Common Stock") and,
following the initial issuance of the first additional series of common
stock of the Company, shares of each issued and outstanding series of
common stock of the Company. By means of such increased proprietary
interest, the Plan is intended to increase the incentive of such members
to contribute to the success of the Company's businesses.
2. Section 3 is hereby amended to read, in its entirety, as follows:
3. SHARES OF STOCK
3.1 Shares Reserved. The Existing Common Stock shall automatically
be redesignated as Kmart Stock upon the initial issuance of any
additional series of Stock. Shares of each such additional issued and
outstanding series of Stock relating to one particular "Specialty Retail
Group" are referred to herein as shares of a series of "Specialty Retail
Stock." The term "Group" means any one of the following: Borders-Walden
Group, Builders Square Group, OfficeMax Group, The Sports Authority
Group or Kmart Group (as defined in the Company's Restated Articles of
Incorporation, as amended at the time of the initial issuance of any
series of Specialty Retail Stock). Each of the first four Groups so
listed is a "Specialty Retail Group."
The maximum number of shares of Existing Common Stock (and, after
the redesignation, Kmart Stock) which shall be reserved for grant under
the Plan shall not exceed 400,000 shares. The maximum number of shares
of each issued and outstanding series of Specialty Retail Stock which
shall be reserved for grant under the Plan shall be the number of shares
equal to the product of: (i) the sum of (x) the number of shares of such
series outstanding immediately after its initial issuance and (y) Number
of Shares Issuable with Respect to Retained Interest (as defined in the
Company's Restated Articles of Incorporation, as amended at the time of
the initial issuance of any series of Specialty Retail Stock) in the
relevant Specialty Retail Group multiplied by (ii) the applicable
percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock........................................... .05%
Builders Square Stock.......................................... .05%
OfficeMax Stock................................................ .05%
The Sports Authority Stock..................................... .05%
</TABLE>
The number of shares of Existing Common Stock (and, after the
redesignation, Kmart Stock) and the various series of Specialty Retail
Stock determined in accordance with this Section 3.1 shall be subject to
adjustment as provided in Section 3.2 hereof. Such shares may be either
authorized but unissued shares or shares that shall have been or may be
reacquired by the Company.
3.2 Capital Adjustments. In the event of any extraordinary
dividend, stock dividend, recapitalization, merger, consolidation, stock
split, warrant or rights issuance, or combination or exchange of such
shares, or other similar transactions, the maximum number of shares of
each series of Stock
IV-B-1
<PAGE> 169
available under the Plan and the number (and, if necessary, the series
and class) of such shares to be delivered hereunder shall be equitably
adjusted by the Committee to reflect such event; provided, however, that
any fractional shares resulting from such adjustment shall be
eliminated.
3. Section 4.1 is hereby amended by adding the following at the end of
the first paragraph thereof:
Commencing with the Normal Stock Payment Date in 1995, if any series
of Specialty Retail Stock has been issued on or before the last
business day preceding the Normal Stock Payment Date, the shares so
delivered or deferred shall be comprised of shares of each series of
Stock that is outstanding on the last business day preceding the
Normal Stock Payment Date. The number of shares of any series of
Stock to be included in any such Stock payment shall be determined by
dividing (i) an amount equal to a certain percentage of the cash
amount for which Stock is to be substituted by (ii) the "Share Value
Price" (as defined below) of the relevant series of Stock. Such
percentage shall be determined by dividing the "Market
Capitalization" (as defined below) of the relevant series of Stock as
of the last business day preceding the Normal Stock Payment Date by
the aggregate Market Capitalization of all outstanding series of
Stock as of such date. The "Market Capitalization" of a series of
Stock as of such date shall mean the product of (i) the Share Value
Price of such series of Stock on such date and (ii) the number of
shares of such series of Stock outstanding on such date.
4. Section 4.2 is hereby amended by the insertion of the following
before the last sentence thereof:
Commencing with the Normal Stock Payment Date in 1995, if any series
of Specialty Retail Stock has been issued on or before the last
business day preceding the Normal Stock Payment Date, the shares so
delivered or deferred shall be comprised of shares of each series of
Stock that is outstanding on the last business day preceding the
Normal Stock Payment Date. The number of shares of any series of
Stock to be included in any such Stock payment shall be determined by
dividing (i) an amount equal to a certain percentage of the cash
amount for which Stock is to be substituted by (ii) the Share Value
Price of the relevant series of Stock. Such percentage shall be
determined by dividing the Market Capitalization of the relevant
series of Stock as of the last business day preceding the Normal
Stock Payment Date by the aggregate Market Capitalization of all
outstanding series of Stock as of such date.
5. The Plan is hereby amended by the insertion of the following new
Section 5 and appropriate re-numbering of the existing Sections 5, 6 and 7,
their subsections and any cross-references thereto:
5. AWARD UPON INITIAL ISSUANCE OF EACH SERIES
Upon the initial issuance of each series of Specialty Retail Stock,
each Director shall be awarded a whole number of shares of such series
determined by dividing (a) $5,000 by (b) the initial public offering
price per share of such series less underwriting fees and commissions,
with any fractional shares being disregarded.
6. The foregoing amendments are subject to stockholder approval at the
Company's 1994 Annual Meeting of Stockholders. In the event such
stockholder approval is not obtained, the foregoing amendments shall be of
no force and effect, and the Plan (as in effect without regard to such
amendments) shall continue in effect.
IV-B-2
<PAGE> 170
ANNEX IV-C
PROPOSAL 7 -- AMENDMENTS TO PERFORMANCE
RESTRICTED STOCK PLAN RELATING TO
SUBSTITUTION OF SPECIALTY RETAIL STOCK FOR CERTAIN
OUTSTANDING AWARDS OF EXISTING COMMON STOCK
Subject to Paragraph hereof, the Kmart Corporation Performance Restricted
Stock Plan (the "Plan") is amended by action of the Board of Directors of Kmart
Corporation (the "Company") on , 1994 as follows:
1. Section 1 is hereby amended to read, in its entirety, as follows:
1. Purpose
The Kmart Corporation Performance Restricted Stock Plan (the
"Plan") is intended (i) to attract and retain officers and other key
senior executive employees of Kmart Corporation (the "Company") and its
Subsidiaries (corporations of which a majority of the stock is owned
directly or indirectly by the Company and other business entities, a
majority of which is owned directly or indirectly by the Company); (ii)
to increase the proprietary interest in the Company of such persons by
providing further opportunity for ownership of the Company's common
stock, par value $1.00 per share (the "Stock") which includes the
existing common stock (the "Existing Common Stock") and, after the
initial issuance of any additional series of common stock of the
Company, shares of each issued and outstanding series of common stock of
the Company; and (iii) to increase the incentives to such persons to
contribute to the success of the Company's business.
2. Section 3.1 is hereby amended by the addition of the following
sentence at the end thereof:
For ease of reference, the employees of the Company or its
Subsidiaries who may have been granted Awards hereunder and who have
work responsibilities with respect to a particular "Group" are
sometimes referred to herein as "employees" of the relevant Group.
The term "Group" means any one of the following: Borders-Walden
Group, Builders Square Group, OfficeMax Group, The Sports Authority
Group and Kmart Group (as defined in the Company's Restated Articles
of Incorporation, as amended at the time of the initial issuance of
any series of Specialty Retail Stock). Each of the first four Groups
so listed is a "Specialty Retail Group."
3. Section 3.2 is amended by the addition of the following after the
first sentence thereof:
The Committee shall also have discretion to permit conversions
(described in Section 4.2 hereof) of restricted shares of Existing
Common Stock (and, after the redesignation, Kmart Stock) (as defined
in Section 4.1 hereof) which are subject to outstanding Awards under
the Plan to restricted shares of Specialty Retail Stock (as defined
in Section 4.1 hereof).
4. Section 4 is hereby amended to read, in its entirety, as follows:
4. Shares of Stock
4.1 Shares Reserved. The Existing Common Stock shall automatically
be redesignated as "Kmart Stock" upon the initial issuance of any
additional series of Stock. Shares of each such additional issued and
outstanding series of Stock relating to one particular Specialty Retail
Group are referred to herein as shares of "Specialty Retail Stock."
The number of shares of Existing Common Stock (and, after the
redesignation, Kmart Stock) that shall be reserved for grant under the
Plan shall not exceed 4,000,000 shares. The number of shares of each
issued and outstanding series of Specialty Retail Stock that shall be
reserved for
IV-C-1
<PAGE> 171
conversion of Awards under the Plan shall be the number of shares equal
to the product of: (i) the sum of (x) the number of shares of such
series outstanding immediately after its initial issuance and (y) the
Number of Shares Issuable with Respect to Retained Interest (as defined
in the Company's Restated Articles of Incorporation, as amended at the
time of the initial issuance of any series of Specialty Retail Stock) in
the relevant Specialty Retail Group; multiplied by (ii) the applicable
percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock................................. 0.20%
Builders Square Stock................................ 0.30%
OfficeMax Stock...................................... 0.10%
The Sports Authority Stock........................... 0.30%
</TABLE>
The maximum number of shares of Existing Common Stock (and, after
the redesignation, Kmart Stock) and the various series of Specialty
Retail Stock determined in accordance with this Section 4.1 shall be
subject to adjustment as provided in Section 7 hereof. Such shares may
be either authorized but unissued shares or shares that shall have been
or may be reacquired by the Company. In the event that any Award or
portion thereof is forfeited, or any shares of restricted stock are
forfeited and reacquired by the Company, the shares forfeited or
allocable to such forfeiture shall again become available for use under
the Plan to the extent permitted by Rule 16b-3 under the Exchange Act.
4.2 Conversions of Restricted Stock
The Committee shall have discretion to permit a Participant who
is an employee of a Specialty Retail Group, upon such terms and
conditions as the Committee may establish, to convert all of his or
her restricted shares of Existing Common Stock (or Kmart Stock, as
the case may be) subject to outstanding Awards hereunder into
restricted shares of the series of Specialty Retail Stock that
relates to such Participant's Specialty Retail Group. Any such
conversion shall take effect upon the initial issuance of shares of
such series of Specialty Retail Stock.
The Committee shall have discretion to permit a Participant who
is an employee of the Kmart Group with responsibilities that include
the Specialty Retail Groups to convert a percentage of his or her
restricted shares of Existing Common Stock (or Kmart Stock, as the
case may be) subject to outstanding Awards hereunder into restricted
shares of the various series of Specialty Retail Stock. Any such
conversion shall take effect upon the initial issuance of the
respective series of Specialty Retail Stock. The aggregate percentage
to be converted, and the particular percentages attributable to each
series of Specialty Retail Stock, shall be determined by the
Committee in its discretion, based on such factors as the Committee
may find relevant, which may include, without limitation, the
Participant's responsibilities and the "Market Capitalization" of the
various series of Stock. The "Market Capitalization" of a series of
Stock on any date shall mean the product of (i) the "Fair Market
Value" of one share of such series of Stock on such date and (ii) the
number of shares of such series of Stock outstanding on such date.
"Fair Market Value" of a share of any series of Stock on any date
shall mean the closing price per share of such series as reported on
the Composite Transactions reporting system, or if not so reported,
as reported by the New York Stock Exchange; provided, however, that,
solely for purposes of determining Market Capitalization hereunder in
connection with the initial issuance of any series of Specialty
Retail Stock, the Fair Market Value of such Specialty Retail Stock
shall be deemed to be the initial public offering price.
All such converted restricted shares shall be subject to the
same terms (including the date on which the restrictions lapse) as
the originally restricted shares, except that the series of the
restricted stock shall be changed and the number of restricted shares
shall be equitably adjusted by the Committee so that the aggregate
Fair Market Value of the converted restricted shares on
IV-C-2
<PAGE> 172
the date of any such conversion is equal to the aggregate Fair
Market Value of the original restricted shares on such date.
5. Section 7 is hereby amended, to read, in its entirety, as follows:
7. Capital Adjustments
In the event of any extraordinary dividend, stock dividend,
recapitalization, merger, consolidation, stock split, warrant or
rights issuance, or combination or exchange of such shares, or other
similar transactions, the maximum number (and, if necessary, the
Series and class) of shares of each series of Stock which may be
issued under the Plan or which are subject to outstanding Awards
shall be equitably adjusted by the Committee to reflect such event;
provided, however, that any fractional shares resulting from such
adjustment shall be eliminated.
6. This Amendment shall take effect as of the date of the initial
issuance of the Group Stock, subject to the approval of the holders of a
majority of the securities of the Company present, or represented, and
entitled to vote at a meeting of stockholders held in accordance with
applicable law, which approval must occur within twelve months of the date
that the Plan is adopted by the Board.
IV-C-3
<PAGE> 173
ANNEX IV-D
PROPOSAL 8 -- AMENDMENTS TO 1973 AND 1981
STOCK OPTION PLANS RELATING TO SUBSTITUTION
OF SPECIALTY RETAIL
STOCK FOR EXISTING COMMON STOCK ISSUABLE
UPON EXERCISE OF CERTAIN OUTSTANDING OPTIONS
AMENDMENTS TO
KMART CORPORATION 1973 STOCK OPTION PLAN
The Kmart Corporation 1973 Stock Option Plan (the "Plan") is amended by
action of the Board of Directors of Kmart Corporation (the "Company") on March
14, 1994, as follows:
1. Section 1 is hereby amended by the following addition at the end
thereof:
The term "Stock" (as used in the Plan) includes the existing Common
Stock, par value $1.00 per share (the "Existing Common Stock") and,
after the initial issuance of any additional series of Common Stock of
the Company, shares of each issued and outstanding series of Common
Stock of the Company. For ease of reference, the employees of the
Company or its Subsidiaries who have been granted awards hereunder and
who have work responsibilities with respect to a particular "Group" are
sometimes referred to herein as "employees" of the relevant Group (or
individuals "employed by" the relevant Group). The term "Group" means
any one of the following: Borders-Walden Group, Builders Square Group,
OfficeMax Group, The Sports Authority Group and Kmart Group. Each of the
first four Groups so listed is a "Specialty Retail Group."
2. Section 3 is hereby amended by the following addition at the end
thereof:
The Existing Common Stock shall automatically be redesignated as
"Kmart Group Common Stock" (hereinafter, "Kmart Stock") upon the initial
issuance of any additional series of Stock. Shares of each such
additional issued and outstanding series of Stock relating to one
particular Specialty Retail Group are referred to herein as shares of
"Specialty Retail Stock."
The maximum number of shares of each issued and outstanding series
of Specialty Retail Stock which shall be reserved for conversion of
Awards under the Plan shall be the number of shares resulting from
multiplying (i) the sum of (x) the number of shares of such Specialty
Retail Stock outstanding immediately after its initial issuance and (y)
the number of shares of such Specialty Retail Stock that could be sold
or otherwise issued by the Company immediately after the date of initial
issuance of such Specialty Retail Stock for the account of the Kmart
Group in respect of the interest in such Specialty Retail Group (other
than the interest represented by the outstanding shares of such
Specialty Retail Stock) by (ii) the applicable percentage set forth
below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock...................................... 1.40%
Builders Square Stock..................................... 1.00%
OfficeMax Stock........................................... 0.30%
The Sports Authority Stock................................ 0.50%
</TABLE>
The maximum number of shares of the various series of Specialty
Retail Stock determined in accordance with this Section 3 shall be
subject to adjustment as provided in Section 6 hereof. Such shares may
be either authorized but unissued shares or shares that shall have been
or may be reacquired by the Company.
IV-D-1
<PAGE> 174
3. Section 4 is hereby amended by the following addition at the end
thereof:
The Committee shall have discretion to permit an employee of a
Specialty Retail Group to convert all of his or her options (other than
Incentive options) for shares of Existing Common Stock (or Kmart Stock,
as the case may be) into options for shares of the series of Specialty
Retail Stock which relates to such employee's Specialty Retail Group.
Any such conversion shall take effect upon the initial issuance of such
series.
The Committee shall have discretion to permit an employee of the
Kmart Group who has responsibilities which include all the Specialty
Retail Groups to convert a percentage of his or her options (other than
Incentive options) for shares of Existing Common Stock (or Kmart Stock,
as the case may be) into options for shares of the various series of
Specialty Retail Stock. Any such conversion shall take effect upon the
initial issuance of the respective series. The aggregate percentage to
be converted, and the particular percentages attributable to each series
of Specialty Retail Stock, shall be determined by the Committee in its
discretion, based on such factors as the Committee may find relevant,
which may include, without limitation, the Participant's
responsibilities and the "Market Capitalization" of the various series
of Stock. The "Market Capitalization" of a series of Stock on any date
shall mean the product of (i) the "Fair Market Value" of one share of
such series of Stock on such date and (ii) the number of shares of such
series of Stock outstanding on such date. "Fair Market Value" of a share
of any series of Stock on any date shall mean the closing price per
share of such series as reported on the Composite Transactions reporting
system, or if not so reported, as reported by the New York Stock
Exchange; provided, however, that, solely for purposes of determining
Market Capitalization hereunder in connection with the initial issuance
of any series of Specialty Retail Stock, the Fair Market Value of such
Specialty Retail Stock shall be deemed to be the initial public offering
price less underwriting fees and commissions.
All such converted options shall be subject to the same terms
(including the date on which the option becomes exercisable) as the
originally outstanding options, except that the underlying series of
Stock shall be changed and the number of shares and the exercise price
shall be equitably adjusted to preserve the aggregate "spread" between
the then-current aggregate value of the shares underlying the
outstanding options and the aggregate exercise price of the outstanding
options on the date of the conversion.
5. The foregoing amendments are subject to stockholder approval at the
1994 annual meeting. In the event such stockholder approval is not
obtained, the foregoing amendments shall be of no force and effect and the
Plan (as in effect without regard to such amendments) will continue in
effect.
AMENDMENTS TO
KMART CORPORATION 1981 STOCK OPTION PLAN
The Kmart Corporation 1981 Stock Option Plan (the "Plan") is amended by
action of the Board of Directors of Kmart Corporation (the "Company") on March
14, 1994, as follows:
1. Section 1 is hereby amended by the following addition at the end
thereof:
The term "Stock" (as used in the Plan) includes the existing Common
Stock, par value $1.00 per share (the "Existing Common Stock") and,
after the initial issuance of any additional series of Common Stock of
the Company, shares of each issued and outstanding series of Common
Stock of the Company. For ease of reference, the employees of the
Company or its Subsidiaries who have been granted awards hereunder and
who have work responsibilities with respect to a particular "Group" are
sometimes referred to herein as "employees" of the relevant Group (or
individuals "employed by" the relevant Group). The term "Group" means
any one of the following: Borders-Walden Group, Builders Square Group,
OfficeMax Group, The Sports Authority Group and Kmart Group. Each of the
first four Groups so listed is a "Specialty Retail Group."
IV-D-2
<PAGE> 175
2. Section 3 is hereby amended by the following addition at the end
thereof:
The Existing Common Stock shall automatically be redesignated as
"Kmart Group Common Stock" (hereinafter, "Kmart Stock") upon the initial
issuance of any additional series of Stock. Shares of each such
additional issued and outstanding series of Stock relating to one
particular Specialty Retail Group are referred to herein as shares of
"Specialty Retail Stock."
The maximum number of shares of each issued and outstanding series
of Specialty Retail Stock which shall be reserved for conversion of
Awards under the Plan shall be the number of shares resulting from
multiplying (i) the sum of (x) the number of shares of such Specialty
Retail Stock outstanding immediately after its initial issuance and (y)
the number of shares of such Specialty Retail Stock that could be sold
or otherwise issued by the Company immediately after the date of initial
issuance of such Specialty Retail Stock for the account of the Kmart
Group in respect of the interest in such Specialty Retail Group (other
than the interest represented by the outstanding shares of such
Specialty Retail Stock) by (ii) the applicable percentage set forth
below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock........................................... 0.30%
Builders Square Stock.......................................... 0.20%
OfficeMax Stock................................................ 0.10%
The Sports Authority Stock..................................... 0.10%
</TABLE>
The maximum number of shares of the various series of Specialty
Retail Stock determined in accordance with this Section 3 shall be
subject to adjustment as provided in Section 6 hereof. Such shares may
be either authorized but unissued shares or shares that shall have been
or may be reacquired by the Company.
3. Section 4 is hereby amended by the following addition at the end
thereof:
The Committee shall have discretion to permit an employee of a
Specialty Retail Group to convert all of his or her options (other than
Incentive options) for shares of Existing Common Stock (or Kmart Stock,
as the case may be) into options for shares of the series of Specialty
Retail Stock which relates to such employee's Specialty Retail Group.
Any such conversion shall take effect upon the initial issuance of such
series.
The Committee shall have discretion to permit an employee of the
Kmart Group who has responsibilities which include all the Specialty
Retail Groups to convert a percentage of his or her options (other than
Incentive options) for shares of Existing Common Stock (or Kmart Stock,
as the case may be) into options for shares of the various series of
Specialty Retail Stock. Any such conversion shall take effect upon the
initial issuance of the respective series. The aggregate percentage to
be converted, and the particular percentages attributable to each series
of Specialty Retail Stock, shall be determined by the Committee in its
discretion, based on such factors as the Committee may find relevant,
which may include, without limitation, the Participant's
responsibilities and the "Market Capitalization" of the various series
of Stock. The "Market Capitalization" of a series of Stock on any date
shall mean the product of (i) the "Fair Market Value" of one share of
such series of Stock on such date and (ii) the number of shares of such
series of Stock outstanding on such date. "Fair Market Value" of a share
of any series of Stock on any date shall mean the closing price per
share of such series as reported on the Composite Transactions reporting
system, or if not so reported, as reported by the New York Stock
Exchange; provided, however, that, solely for purposes of determining
Market Capitalization hereunder in connection with the initial issuance
of any series of Specialty Retail Stock, the Fair Market Value of such
Specialty Retail Stock shall be deemed to be the initial public offering
price less underwriting fees and commissions.
All such converted options shall be subject to the same terms
(including the date on which the option becomes exercisable) as the
originally outstanding options, except that underlying series of Stock
shall be changed and the number of shares and the exercise price shall
be equitably adjusted
IV-D-3
<PAGE> 176
to preserve the aggregate "spread" between the then-current aggregate
value of the shares underlying the outstanding options and the aggregate
exercise price of the outstanding options on the date of the conversion.
5. The foregoing amendments are subject to stockholder approval at the
1994 annual meeting. In the event such stockholder approval is not
obtained, the foregoing amendments shall be of no force and effect and the
Plan (as in effect without regard to such amendments) will continue in
effect.
IV-D-4
<PAGE> 177
ANNEX IV-E
PROPOSAL 9 -- AMENDMENTS TO 1992 STOCK OPTION
PLAN RELATING TO SUBSTITUTION OF SPECIALTY RETAIL STOCK
FOR EXISTING COMMON STOCK ISSUABLE UPON
EXERCISE OF CERTAIN OPTIONS AND CERTAIN OTHER PLAN AMENDMENTS
The Kmart Corporation 1992 Stock Option Plan (the "Plan") is amended by
action of the Board of Directors of Kmart Corporation (the "Company") on March
14, 1994, as follows:
1. Section 1 is hereby amended to read, in its entirety, as follows:
1. Purpose. The Kmart Corporation 1992 Stock Option Plan (the
"Plan") is intended (i) to attract and retain officers and other key
senior executive employees of Kmart Corporation (the "Company") and its
Subsidiaries (corporations of which a majority of the stock is owned
directly or indirectly by the Company and other business entities, a
majority of which is owned directly or indirectly by the Company); (ii)
to increase the proprietary interest in the Company of such persons by
providing further opportunity for ownership of the Company's common
stock (the "Stock") which includes the existing common stock, par value
$1.00 per share (the "Existing Common Stock") and, after the initial
issuance of any additional series of common stock of the Company, shares
of each issued and outstanding series of common stock of the Company;
and (iii) to increase the incentives to such persons to contribute to
the success of the Company's business. For ease of reference, the
employees of the Company or its Subsidiaries who may be granted, or may
have been granted, awards hereunder and who have work responsibilities
with respect to a particular "Group" are sometimes referred to herein as
"employees" of the relevant Group (or individuals "employed by" the
relevant Group). The term "Group" means any one of the following:
Borders-Walden Group, Builders Square Group, OfficeMax Group, The Sports
Authority Group and Kmart Group. Each of the first four Groups so listed
is a "Specialty Retail Group."
2. Section 3 is hereby amended to read, in its entirety, as follows:
3. Stock. The Existing Common Stock shall automatically be
redesignated as "Kmart Group Common Stock" (hereinafter, "Kmart Stock")
upon the initial issuance of any additional series of Stock. Shares of
each such additional issued and outstanding series of Stock relating to
one particular Specialty Retail Group are referred to herein as shares
of "Specialty Retail Stock."
The maximum number of shares of Existing Common Stock which shall
be reserved for grant under the Plan shall not exceed 20,000,000 shares.
The maximum number of shares of each issued and outstanding series of
Specialty Retail Stock which shall be reserved for Awards and conversion
of Awards under the Plan shall be the number of shares resulting from
the product of (i) the sum of (x) the number of shares of such Series
outstanding immediately after its initial issuance and (y) the number of
shares of such Specialty Retail Stock that could be sold or otherwise
issued by the Company immediately after the date of initial issuance of
such Specialty Retail Stock for the account of the Kmart Group in
respect of the interest in such Specialty Retail Group (other than the
interest represented by the outstanding shares of such Specialty Retail
Stock) multiplied by (ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock...................................... 9.93%
Builders Square Stock..................................... 6.50%
OfficeMax Stock........................................... 7.16%
The Sports Authority Stock................................ 8.40%
</TABLE>
IV-E-1
<PAGE> 178
The maximum number of shares of the Existing Common Stock and the
various series of Specialty Retail Stock determined in accordance with
this Section 3 shall be subject to adjustment as provided in Section 6
hereof. Such shares may be either authorized but unissued shares or
shares that shall have been or may be reacquired by the Company. No
option may be granted under the Plan to an employee who owns more than
five percent of the outstanding Stock. In the event that any outstanding
option or portion thereof expires or is cancelled, surrendered or
terminated for any reason, including by reason of conversion hereunder,
the shares of Stock allocable to the unexercised portion of such option
may again be subjected to an option or be issued under the Plan.
3. Section 4 is hereby amended to read, in its entirety, as follows:
4. Award and Conversion of Options.
(a) General Powers of Committee. The Committee may grant options
to purchase Stock to officers and other key employees of the Company
or its Subsidiaries, including directors who are full-time employees.
The Committee shall have the discretion, in accordance with the
provisions of the Plan, to determine to whom an option is granted,
the number and series of shares of Stock optioned, the terms and
conditions of the option and, in the case of conversions, the series
and number of shares of Specialty Retail Stock into which an optionee
may convert. In making such determinations, the Committee shall
consider the position and responsibilities of the employee, the
nature and value to the Company of his or her services and
accomplishments, his or her present and potential contribution to the
success of the Company, the Specialty Retail Group which employs the
employee (or the Specialty Retail Groups over which such employee has
management or other responsibilities), and such other factors as the
Committee may deem relevant.
(b) Types of Options. Each option granted under the Plan shall
be designated by the Committee at the time of grant as either an
incentive stock option (an "Incentive" option) or a non-qualified
stock option (a "Non-Qualified" option). An Incentive option is
intended to meet the requirements of Section 422 of the Internal
Revenue Code. The aggregate Fair Market Value (determined at the time
the option is granted) of the Stock as to which Incentive options are
exercisable for the first time by the optionee during any calendar
year shall not exceed $100,000 (as determined in accordance with the
rules set forth in Section 422 of the Internal Revenue Code).
(c) General Provisions. Options granted under the Plan shall be
subject to and governed by the provisions of the Plan and by the
terms and conditions set forth in Section 5 hereof and by such other
terms and conditions, not inconsistent with the Plan, as shall be
determined by the Committee. The date on which an option shall be
granted shall be the date that the optionee, the series and number of
shares of Stock optioned and the terms and conditions of the option
are determined by the Committee, provided, however, that if an option
or any term or condition of an option is rejected or not accepted by
an optionee or if an option is not granted in accordance with the
provisions of the Plan, such option shall be deemed to have not been
granted and shall be in no effect. Each option shall be evidenced by
a Stock Option Agreement in such form as the Committee may from time
to time approve.
(d) Options for Various Series of Stock. After the initial
issuance of various series of Specialty Retail Stock, the Committee
shall have discretion to determine that an employee of a particular
Specialty Retail Group who is eligible to be granted options under
the Plan shall be granted only options for the related series of
Specialty Retail Stock. The Committee shall also have discretion to
determine that an eligible employee of Kmart Group with
responsibilities which include all the Specialty Retail Groups shall
be granted options for shares of various series of Stock, the
respective series and the portion of such options to be represented
by each series to be determined by the Committee, in its sole
discretion.
IV-E-2
<PAGE> 179
(e) Conversion of Outstanding Options. The Committee shall have
discretion to permit an employee of a Specialty Retail Group to
convert all of his or her options (other than Incentive options)
which were granted before January 18, 1994 for shares of Existing
Common Stock (or Kmart Stock, as the case may be) into options for
shares of the series of Specialty Retail Stock which relates to such
employee's Specialty Retail Group. The Committee shall also have
discretion to require that all options granted to such an employee on
or after January 18, 1994 (and before the initial issuance of the
relevant series of Specialty Retail Stock) for shares of Existing
Common Stock (or Kmart Stock, as the case may be) shall be converted
into options for shares of the relevant series of Specialty Retail
Stock. Any such conversion shall take effect upon the initial
issuance of such series.
The Committee shall have discretion to permit an employee of the
Kmart Group who has responsibilities which include all the Specialty
Retail Groups to convert a percentage of his or her options (other
than Incentive options) which were granted before January 18, 1994
for shares of Existing Common Stock (or Kmart Stock, as the case may
be) into options for shares of the various series of Specialty Retail
Stock. The Committee shall also have discretion to require that a
percentage of the options granted to such an employee on or after
January 18, 1994 (and before the initial issuance of the various
series of Specialty Retail Stock) for shares of Existing Common Stock
(or Kmart Stock, as the case may be) shall be converted into options
for shares of the various series of Specialty Retail Stock. Any such
conversion shall take effect upon the initial issuance of the
respective series. The aggregate percentage to be converted, and the
particular percentages attributable to each series of Specialty
Retail Stock, shall be determined by the Committee in its discretion,
based on such factors as the Committee may find relevant, which may
include, without limitation, the Participant's responsibilities and
the "Market Capitalization" of the various series of Stock. The
"Market Capitalization" of a series of Stock on any date shall mean
the product of (i) the "Fair Market Value" of one share of such
series of Stock on such date and (ii) the number of shares of such
series of Stock outstanding on such date. "Fair Market Value" of a
share of any series of Stock on any date shall mean the closing price
per share of such series as reported on the Composite Transactions
reporting system, or if not so reported, as reported by the New York
Stock Exchange; provided, however, that, solely for purposes of
determining Market Capitalization hereunder in connection with the
initial issuance of any series of Specialty Retail Stock, the Fair
Market Value of such Specialty Retail Stock shall be deemed to be the
initial offering price less underwriting fees and commissions.
All such converted pre-January 18, 1994 options shall be subject
to the same terms (including the date on which the option becomes
exercisable) as the originally outstanding options, except that
underlying series of Stock shall be changed and the number of shares
and the exercise price shall be equitably adjusted to preserve the
aggregate "spread" between the then-current aggregate value of the
shares underlying the outstanding options and the aggregate exercise
price of the outstanding options on the date of the conversion. As to
outstanding options granted on or after January 18, 1994, the
converted options would generally have the same terms (including the
expiration date) as the outstanding options, except that the
underlying series and number of shares of Common Stock and the
exercise price of the converted options would be changed as described
in the following sentence. The number of shares of each series of
Specialty Retail Stock underlying the converted option would be
determined by dividing an amount equal to the aggregate exercise
price of the shares of Kmart Stock underlying the original option (or
the percentage thereof being converted) by the exercise price per
share of such series of Specialty Retail Stock underlying the
converted option, which would be the initial offering price per share
less underwriting fees and commissions.
IV-E-3
<PAGE> 180
4. Section 5.A. of the Plan is hereby amended by the addition of the
following sentence at the end thereof:
Notwithstanding the foregoing provisions of this Section, with
respect to any option granted in connection with both (i) the initial
issuance of a particular series of Specialty Retail Stock, and (ii)
certain purchases of restricted stock pursuant to the Kmart Corporation
Management Stock Purchase Plan], the Fair Market Value of a share of
such series of Specialty Retail Stock shall be deemed to be the initial
offering price, less underwriting fees and commissions.
5. The foregoing amendments are subject to stockholder approval at the
1994 annual meeting. In the event such stockholder approval is not
obtained, the foregoing amendments shall be of no force and effect and the
Plan (as in effect without regard to such amendments) will continue in
effect.
IV-E-4
<PAGE> 181
ANNEX IV-F
PROPOSAL 10 -- AMENDMENTS TO 1992 STOCK OPTION
PLAN RELATING TO ADDING CERTAIN
ALLOCATION PROVISIONS
ALLOCATION AMENDMENT TO KMART CORPORATION 1992 STOCK OPTION PLAN
The Kmart Corporation 1992 Stock Option Plan (the "Plan") is amended by
action of the Board of Directors of Kmart Corporation (the "Company") on March
14, 1994, as follows:
1. The following new Section 14 is hereby added to the Plan:
14. Limitation on Size of Grants. Effective as of January 1, 1994,
no employee of the Company shall be granted options in any calendar year
which are in excess of 10 percent of the total number of options granted
in such calendar year with respect to all series of Stock. Additionally,
after an initial issuance of a series of Stock related to a particular
Specialty Retail Group, no employee of the Company or its Subsidiaries
whose work responsibilities relate solely to that Specialty Retail Group
shall be granted options in any calendar year with respect to the
related series of Specialty Retail Stock which are in excess of 25
percent of the total number of options granted in such calendar year
with respect to such series of Specialty Retail Stock.
2. The foregoing amendment is subject to stockholder approval at the
1994 annual meeting. In the event such stockholder approval is not
obtained, the foregoing amendment shall be of no force and effect and the
Plan (as in effect without regard to such amendment) will continue in
effect.
IV-F-1
<PAGE> 182
ANNEX IV-G
PROPOSAL 11 -- ADOPTION OF MANAGEMENT STOCK
PURCHASE PLAN
1. PURPOSES; TYPES OF GRANTS; CONSTRUCTION.
The purposes of the Kmart Corporation Management Stock Purchase Plan (the
"Plan") are to attract and retain highly-qualified executives, to align
executive and stockholder long-term interests by creating a direct link between
executive compensation and stockholder return and to enable executives to
purchase stock in order to develop and maintain a substantial stock ownership
position in Kmart Corporation (the "Company"). The provisions of the Plan are
intended to satisfy the requirements of Section 16(b) of the Securities Exchange
Act of 1934, and shall be interpreted in a manner consistent with the
requirements thereof, as now or hereafter construed, interpreted and applied by
regulations, rulings and cases.
2. DEFINITIONS.
As used in this Plan, the following words and phrases shall have the
meanings indicated:
(a) "Agreement" shall mean an agreement entered into between the
Company and a Participant in connection with a grant under the Plan.
(b) "Board" shall mean the Board of Directors of the Company.
(c) "Annual Bonus" shall mean the bonus earned by a Participant under
the Annual Plan.
(d) "Annual Plan" shall mean the Kmart Corporation Annual Incentive
Bonus Plan, as amended from time to time.
(e) "Cause" shall mean the Participant's fraud, dishonesty, conduct in
violation of Company policy, willful and continued failure to substantially
perform his or her duties with the Company or willful engaging in conduct
which is demonstrably and materially injurious to the Company, monetarily
or otherwise.
(f) "Change in Control" shall mean the occurrence of an event
described in Article 10 hereof.
(g) "Code" shall mean the Internal Revenue Code of 1986, as amended
from time to time.
(h) "Committee" shall mean the Compensation and Incentives Committee
of the Board.
(i) "Company" shall mean Kmart Corporation, a corporation organized
under the laws of the State of Michigan, or any successor corporation.
(j) "Disability" shall mean a Participant's total and permanent
inability to perform his or her duties with the Company or any of its
affiliates by reason of any medically determinable physical or mental
impairment, as determined by a physician selected by the Participant and
acceptable to the Company.
(k) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended from time to time, and as now or hereafter construed, interpreted
and applied by regulations, rulings and cases.
(l) "Existing Common Stock" shall mean shares of common stock of the
Company issued and outstanding at the time of the Board's adoption of the
Plan, par value $1.00 per share. Upon the initial issuance of any
additional series of common stock of the Company, the Existing Common Stock
shall automatically be redesignated as "Kmart Group Common Stock" (the
"Kmart Stock").
(m) "Fair Market Value" per share as of a particular date shall mean
(i) the closing sales price per share of Stock on the national securities
exchange on which the Stock is principally traded, on such date or on the
last preceding date on which there was a sale of such Stock on such
exchange, (ii) if the shares
IV-G-1
<PAGE> 183
of Stock are not then listed on a national securities exchange, the average
of the closing bid and ask prices in the over-the-counter market on such
date or on the last preceding date on which there was a sale of such Stock,
or (iii) if the shares of Stock are not then listed on a national
securities exchange or traded in an over-the-counter market, such value as
the Committee, in its sole discretion, shall determine; provided, however,
that, in connection with the initial issuance of the Stock, the "Fair
Market Value" of a share of Stock shall be the initial public offering
price per share, less underwriting discounts and commissions.
(n) "Group" shall mean any of the following: Borders-Walden Group,
Builders Square Group, OfficeMax Group, The Sports Authority Group (each, a
"Specialty Retail Group") or Kmart Group.
(o) "Group Employees" (and variants thereof) shall mean employees of
the Company and the Company's specialty retail Subsidiaries who have work
responsibilities with respect to the relevant Group(s).
(p) "Kmart Stock," upon and after the initial issuance of any series
of Specialty Retail Stock, shall mean shares of the series of common stock
of the Company relating to the Kmart Group.
(q) "Market Capitalization" of a series of Stock on any date shall
mean the product of (i) the Fair Market Value of one share of such series
of Stock on such date and (ii) the number of shares of such series of Stock
outstanding on such date; provided, however, that, solely for purposes of
determining Market Capitalization hereunder in connection with the initial
issuance of any series of Specialty Retail Stock, the Fair Market Value of
such Specialty Retail Stock shall be deemed to be the initial offering
price.
(r) "Participant" shall mean a person who receives a grant of
Restricted Stock under the Plan; all such grants are sometimes referred to
herein as purchases.
(s) "Plan" shall mean this Kmart Corporation Management Stock Purchase
Plan, as amended from time to time.
(t) "Restricted Period" shall have the meaning given in Section 9(d)
hereof.
(u) "Restricted Stock" or "Restricted Shares" shall mean the shares of
Stock granted hereunder subject to restrictions.
(v) "Rule 16b-3" shall mean Rule 16b-3, as in effect from time to
time, promulgated by the Securities and Exchange Commission under Section
16 of the Exchange Act, including any successor to such Rule.
(w) "Section 16 Person" shall mean a Participant who is subject to the
reporting and short-swing liability provisions of Section 16 of the
Exchange Act.
(x) "Stock" shall mean shares of Existing Common Stock and, upon and
after the initial issuance of any additional series of common stock of the
Company, shares of one or more of the issued and outstanding series of
common stock of the Company, as the context requires.
(y) "1992 Stock Option Plan" shall mean the Kmart Corporation 1992
Stock Option Plan, as amended from time to time.
(z) "Specialty Retail Stock" shall mean shares of each issued and
outstanding series of common stock of the Company relating to a particular
Specialty Retail Group.
(aa) "Subsidiary" shall mean any subsidiary of the Company (whether or
not a subsidiary at the date the Plan is adopted) which is designated by
the Committee or Board to participate in the Plan.
3. STOCK.
The maximum number of shares of the Existing Common Stock which shall be
reserved for the grant of Restricted Stock under the Plan shall be 4,000,000
shares of Existing Common Stock. The Existing Common
IV-G-2
<PAGE> 184
Stock shall automatically be redesignated as Kmart Stock, upon the initial
issuance of any series of Specialty Retail Stock.
The maximum number of shares of each issued and outstanding series of
Specialty Retail Stock which shall be reserved for grant under the Plan shall be
the number of shares resulting from the product of (i) the sum of (x) the number
of shares of such series outstanding immediately after its initial issuance and
(y) the number of shares of such series of Specialty Retail Stock that could be
sold or otherwise issued by the Company immediately after the date of initial
issuance of such series of Specialty Retail Stock from the shares issuable with
respect to the Kmart Group is Retained Interest in such Specialty Retail Group
(other than the interest represented by the outstanding shares of such Specialty
Retail Stock) multiplied by (ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock............................................... 1.10%
Builders Square Stock.............................................. 1.10%
OfficeMax Stock.................................................... 1.50%
The Sports Authority Stock......................................... 1.10%
</TABLE>
The number of shares of Existing Common Stock and the various series of
Specialty Retail Stock determined in accordance with the foregoing provisions of
this Article 3 shall be subject to adjustment as provided in Article 11 hereof.
Such shares may be either authorized but unissued shares or shares that shall
have been or may be reacquired by the Company.
If any outstanding grant of Restricted Stock under the Plan should, for any
reason be cancelled or be forfeited before all its restrictions lapse, the
shares of Stock allocable to the cancelled or terminated portion of such grant
shall (unless the Plan shall have been terminated) become available for
subsequent grants under the Plan; provided, however, that shares of Restricted
Stock with respect to which dividends have been paid or accrued shall not be
available for subsequent grants hereunder unless, in the case of shares with
respect to which dividends were accrued but unpaid, such dividends are also
cancelled or forfeited.
4. ELIGIBILITY.
All senior officers of the Company, all Company group and divisional vice
presidents and certain other Participants in the Annual Plan are required to
receive at least 20 percent of their Annual Bonuses in Restricted Stock granted
pursuant to, and subject to the terms and conditions of, this Plan. At the
election of any Annual Plan participant, up to 100 percent of the participant's
Annual Bonus (less applicable payroll deductions) shall be paid in Restricted
Stock granted pursuant to, and subject to the terms and conditions of, this
Plan. Any such election shall be made in accordance with rules established by
the Committee; provided, however, that any such election by a Section 16 Person
must be made at least six months prior to the day the amount of the Section 16
Person's Annual Bonus is finally determined under the Annual Plan. Since the
Restricted Stock is "purchased" with part or all of the Annual Bonus, all
Restricted Stock grants under this Plan are sometimes referred to herein as
"purchases."
Further, in connection with the initial issuance of each of the various
series of Specialty Retail Stock, the Committee, in its discretion, may
designate certain Participants who are employees of the Kmart Group with
responsibilities for the Specialty Retail Groups as eligible to be given the
one-time purchase opportunity described in Article 8 hereof. Additionally, in
connection with the initial issuance of a series of Specialty Retail Stock, the
Committee may designate a Participant who is a key employee of the related
Specialty Retail Group as eligible to be given the one-time purchase opportunity
described in Article 7 hereof. In determining the individuals who shall be so
designated and size of the purchase opportunity to be given pursuant to Article
7 or 8 hereof, the Committee shall take into account the duties of the
respective individuals, their present and potential contributions to the success
of the Company and/or the relevant Specialty Retail Group(s), and such other
factors as the Committee shall deem relevant in connection with accomplishing
the purposes of the Plan.
IV-G-3
<PAGE> 185
5. SERIES OF STOCK SUBJECT TO PURCHASE BY VARIOUS PARTICIPANTS.
Until the initial issuance of a series of Specialty Retail Stock of the
Company, Stock purchases by all Participants under the Plan shall be made in
Existing Common Stock.
If a Participant is an employee of a Specialty Retail Group, the
Participant shall be permitted to purchase only Restricted Shares of Existing
Common Stock (or, after the initial issuance of a series of Specialty Retail
Stock of the Company, of Kmart Stock) under the Plan until the initial issuance
of the particular Specialty Retail Stock related to the Group employing the
Participant occurs. Thereafter, the Participant shall be permitted to purchase
only Restricted Shares of that particular series of Specialty Retail Stock under
the Plan. Stock purchases of Existing Common Stock or Kmart Stock made under the
Plan by such Participant prior to the initial issuance of that particular series
of Specialty Retail Stock shall be subject to automatic conversion (described in
Article 6 hereof) to Restricted Shares of that particular series of Specialty
Retail Stock upon its subsequent initial issuance.
If a Participant is an Employee of the Kmart Group, the Participant shall
be permitted to purchase only Restricted Shares of Existing Common Stock (or,
after the initial issuance of a series of Specialty Retail Stock of the Company,
of Kmart Stock) under the Plan. However, certain percentages of the Restricted
Stock purchases under the Plan of certain Participants who are Kmart Group
Employees, who have responsibilities for the Specialty Retail Groups and who are
designated by the Committee may be for Restricted Shares of all the various
outstanding series of Specialty Retail Stock. Such percentages shall be
determined by the Committee in its discretion, based on such factors as the
Committee may find relevant, which may include, without limitation, the most
recent available information as to the proportionate Market Capitalization of
the Stock of the related Specialty Retail Group compared to the aggregate Market
Capitalization of all then outstanding series of Stock.
6. CONVERSION OF RESTRICTED STOCK.
If a Participant who is a Specialty Retail Group Employee purchases
Restricted Shares of Existing Common Stock or Kmart Stock under the Plan prior
to the issuance of the series of Specialty Retail Stock of his or her related
Group, such shares of Existing Common Stock or Kmart Stock shall be
automatically converted into Restricted Shares of such series of Specialty
Retail Stock upon the initial issuance of such series. The number of Restricted
Shares of the series of Specialty Retail Stock to be issued upon such conversion
shall equal the quotient obtained by dividing the aggregate Fair Market Value of
such Existing Common Stock (or Kmart Stock, as the case may be) on the date of
[grant] [the initial public offering of the relevant series of Specialty Retail
Stock] by the initial offering price of such series net of underwriting fees and
commissions, with any fractional shares being disregarded. The converted
Restricted Shares shall otherwise have the same terms (including the date the
restrictions lapse) as the original Restricted Shares, except that the
underlying series of Stock and the number of shares shall be adjusted as
aforesaid.
If a Participant who is a Kmart Group Employee who has responsibilities for
the Specialty Retail Groups purchases Restricted Shares of Existing Common Stock
or Kmart Stock prior to the issuance of the various series of Specialty Retail
Stock, a percentage of such Restricted Shares shall be automatically converted
into Restricted Shares of each series of Specialty Retail Stock upon the initial
issuance of each such series. The percentage of such Restricted Shares of
Existing Common Stock or Kmart Stock to be converted shall be determined by the
Committee in its discretion, based on such factors as the Committee may find
relevant, which may include, without limitation, the respective Participant's
responsibilities and the Market Capitalization of the various series of Stock.
The number of Restricted Shares of each series of Specialty Retail Stock to be
issued upon such conversion shall equal the quotient obtained by dividing the
aggregate Fair Market Value of such percentage of Existing Common Stock (or
Kmart Stock, as the case may be) on the date of [grant] [the initial public
offering of the relevant series of Specialty Retail Stock] by the initial
offering price of such series, net of underwriting fees and commissions, with
any fractional shares being disregarded. The converted Restricted Shares shall
otherwise have the same terms (including the date the restrictions lapse) as the
original Restricted Shares, except that the underlying series of Stock and the
number of shares shall be adjusted as aforesaid.
IV-G-4
<PAGE> 186
7. OPPORTUNITY FOR ONE-TIME PURCHASE OF RESTRICTED SPECIALTY RETAIL STOCK BY
SPECIALTY RETAIL GROUP EMPLOYEES.
(a) UP TO $1 MILLION PURCHASE. Except as otherwise determined by the
Committee, in connection with the initial public offering of a series of
Specialty Retail Stock, each Participant who is a key employee of the related
Group and who is designated by the Committee shall be given a one-time
opportunity to purchase Restricted Shares of such series of Specialty Retail
Stock. The number of Restricted Shares of a series of Specialty Retail Stock as
to which such purchase opportunity is given shall be the number having an
aggregate Fair Market Value on the date of the initial public offering of the
relevant series equal to $1 million.
(b) SOURCE OF FUNDS. Subject to any limitations imposed by the Committee in
its discretion with respect to any particular series of Specialty Retail Stock,
a Participant who is designated pursuant to Section 7(a) hereof may utilize one
or more of the following as sources for funds to purchase Restricted Shares: (1)
up to 100 percent of his or her targeted Annual Bonus (less applicable payroll
deductions) for the year in which the initial public offering occurs; (2) up to
100 percent of his or her base salary (less applicable payroll deductions) for
the 12-month period immediately following such initial public offering; and (3)
his or her own personal funds.
(c) TIME OF PAYMENT. A Participant shall pay at the time of purchase, in
cash (from the Participant's personal funds), the difference between the
aggregate purchase cost of the Stock and the sum of the targeted Annual Bonus
and salary which the Participant has elected to be applied to such purchase. At
the time the actual Annual Bonus for the year is determined, the Participant
must pay, in cash, any balance of the purchase cost of the Stock remaining after
application to such purchase cost of the actual Annual Bonus (or the percentage
of the targeted Annual Bonus elected by the Participant for application to such
purchase at the time of purchase, if that is a lesser amount), salary elected
for application by the Participant to such purchase at the time of such purchase
and/or personal funds paid at the time of purchase.
(d) FAILURE TO PAY. Except as otherwise determined by the Committee, if a
Participant fails to make full payment in accordance with Section 7(c) hereof
for a purchase of Restricted Shares hereunder, the Participant shall forfeit all
such Restricted Shares except a percentage thereof determined by dividing the
amount actually paid by the Participant on account of such purchase by the total
purchase cost. Such percentage of Restricted Shares shall remain subject to the
provisions of this Plan. Fractional shares shall be disregarded.
(e) ASSOCIATED OPTION GRANT UNDER 1992 STOCK OPTION PLAN. For each share of
Stock purchased pursuant to Section 7(a) hereof, the Participant shall be
granted an option under the 1992 Stock Option Plan to acquire a share of the
applicable series of Specialty Retail Stock at the initial offering price (less
underwriting fees and commissions; provided, however, that, except as
discretionarily determined by the Committee in unusual circumstances, the number
of options so granted may not exceed (i) the number of options granted to such
Participant in 1994 for shares of Existing Common Stock (or Kmart Stock, as the
case may be), as such options are converted to options for the applicable series
of such Specialty Retail Stock under the 1992 Stock Option Plan, or (ii) if no
options for shares of Existing Common Stock or Kmart Stock were granted to such
Participant in 1994, the number of options for shares of the relevant series of
Specialty Retail Stock granted to such Participant under the 1992 Stock Option
Plan in connection with the initial public offering of such series. An option
granted under the 1992 Stock Option Plan pursuant to this Section 7(e) shall
become exercisable no earlier than the date on which full and timely payment for
the related Restricted Stock purchase hereunder has been made pursuant to
Section 7(c) hereof and to the extent the Participant shall fail to make such
full and timely payment, any such option shall be immediately forfeited.
8. OPPORTUNITY FOR ONE-TIME PURCHASE OF RESTRICTED SPECIALTY RETAIL STOCK BY
KMART GROUP EMPLOYEES WITH RESPONSIBILITIES FOR SPECIALTY RETAIL GROUPS.
(a) UP TO $1 MILLION PURCHASE. Except as otherwise determined by the
Committee, in connection with the initial public offering of the various series
of Specialty Retail Stock, each Participant in the Plan who (i) is an employee
of the Kmart Group, (ii) has responsibilities which include the Specialty Retail
Groups and (iii) is designated by the Committee, shall be given a one-time
opportunity to purchase
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Restricted Shares of all issued series of Specialty Retail Stock. The maximum
opportunity for each such Participant shall be the purchase of Restricted Shares
of the various outstanding series of Specialty Retail Stock having an aggregate
Fair Market Value as of the respective dates of their initial public offerings
equal to $1 million. The number of Restricted Shares of a particular series of
Specialty Retail Stock as to which such purchase opportunity is given shall be
determined by the Committee in its discretion, based upon such factors as the
Committee may find relevant, which may include, without limitation, the
employee's responsibilities and the most recent available information as to the
proportionate Market Capitalizations of the various series of Stock.
(b) SOURCE OF FUNDS. Subject to limitations imposed by the Committee with
respect to any particular series of Specialty Retail Stock, a Participant who is
designated pursuant to Section 8(a) hereof may utilize one or more of the
following as sources for funds to purchase Restricted Shares of the various
series of Specialty Retail Stock: (1) up to 100 percent of his or her targeted
Annual Bonus (less applicable payroll deductions) for the year in which the
relevant initial public offering occurs; (2) up to 100 percent of his or her
base salary for the 12-month period immediately following such initial public
offering (less applicable payroll deductions); and (3) his or her own personal
funds.
(c) TIME OF PAYMENT. The Participant must pay at the time of purchase, in
cash (from the Participant's personal funds), the difference between the
aggregate purchase cost of Restricted Shares of each series and the sum of the
targeted Annual Bonus and salary which the Participant has elected to be applied
to such purchase. At the time the actual Annual Bonus for the year is
determined, the Participant must pay, in cash, any balance of the purchase cost
of the Restricted Stock remaining after application to the purchase cost of the
actual Annual Bonus (or the percentage of the targeted Annual Bonus elected by
the Participant for application to such purchase at the time of purchase, if
that is a lesser amount), salary elected by the Participant to such purchase at
the time of purchase and/or personal funds paid at the time of purchase.
(d) FAILURE TO PAY. Except as otherwise determined by the Committee, if a
Participant fails to make full payment in accordance with Section 8(c) hereof
for a purchase of Restricted Shares hereunder, the Participant shall forfeit all
such Restricted Shares except a percentage thereof determined by dividing the
amount actually paid by the Participant on account of such purchase by the total
purchase cost. Such percentage of Restricted Shares shall remain subject to the
provisions of this Plan. Fractional shares shall be disregarded.
9. RESTRICTED STOCK.
Each grant of Restricted Stock under the Plan shall be evidenced by a
written Agreement between the Company and the Participant, in such form as the
Committee shall from time to time approve, and shall comply with the following
terms and conditions (and with such other terms and conditions not inconsistent
with the terms of this Plan as the Committee, in its discretion, shall
establish):
(a) NUMBER OF SHARES. Each Agreement shall state the number of shares
of Restricted Stock to be subject to a grant. Each Agreement shall also
state whether the shares subject thereto have been granted pursuant to a
purchase made under Article 7 or Article 8 hereof, a required purchase
under Article 4 hereof, an elective purchase under Article 4 hereof or a
conversion under Article 6 hereof.
(b) PRICE. Other than for purposes of the purchases described in
Article 7 or 8 hereof, the price of each share of Restricted Stock
purchased under the Plan shall be its Fair Market Value. In the case of
purchases described in Article 7 or 8 hereof, the price of each share of
Restricted Stock shall generally be discounted 20 percent from its Fair
Market Value; provided, however, that the price of the portion of
Restricted Shares purchased pursuant to Article 7 or 8 hereof with a
Participant's Annual Bonus shall be the Fair Market Value of such
Restricted Shares. Notwithstanding any other provision of the Plan, in no
event shall the price per share be less than the par value per share of the
applicable series of Stock.
(c) RESTRICTIONS. Shares of Restricted Stock may not be sold,
assigned, transferred, pledged, hypothecated or otherwise disposed of,
except by will or the laws of descent and distribution, during the
Restricted Period. The Committee may also impose such other restrictions
and conditions on the shares
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as it deems appropriate. Upon the issuance of shares of Restricted Stock, a
stock certificate or certificates representing such shares shall be
registered in the Participant's name, shall bear an appropriate legend
referring to the restrictions applicable thereto, and shall be held in
custody by an escrow agent appointed by the Committee, and any attempt to
dispose of any such shares of Stock in contravention of such restrictions
shall be null and void and without effect.
(d) RESTRICTED PERIOD. Subject to such exceptions as may be determined
by the Committee in its discretion, the Restricted Period for Restricted
Stock purchased under the Plan shall be three years from the date of its
purchase. The restrictions shall immediately lapse upon the termination of
a Participant's employment which either (i) occurs after the Participant
has attained the age of 65 years with at least ten years of full-time
service or (ii) results from the Participant's death or Disability.
(e) TERMINATION DURING RESTRICTED PERIOD. Except as provided in
paragraph or in Section 9(d) or 9(g) hereof, if during the Restricted
Period a Participant's employment is terminated by the Company without
Cause, the Participant shall receive unrestricted shares of Stock, valued
at the then-current Fair Market Value (and/or, in the discretion of the
Committee, cash), equal in value to (i) the then-current Fair Market Value
of a percentage of the Restricted Shares, such percentage to be determined
by dividing the number of months of employment completed during the
Restricted Period by the total number of months in the Restricted Period,
plus (ii) as to the balance of the Restricted Shares, the lesser in value
of (x) such Restricted Shares at their then-current Fair Market Value or
(y) 80 percent of the Fair Market Value of such Restricted Shares on the
date of their purchase. Any additional value shall be forfeited.
If, during an applicable Restricted Period, a Participant terminates
his or her employment voluntarily or a Participant has his or her
employment terminated for Cause, the Participant shall receive unrestricted
shares of Stock, valued at then-current Fair Market Value (and/or, in the
discretion of the Committee, cash), equal to the lesser in value of (i) the
Participant's Restricted Shares at their then-current Fair Market Value or
(ii) 80 percent of the Fair Market Value of such Restricted Shares on the
date of their purchase. Any additional value shall be forfeited.
(f) OWNERSHIP. During the Restricted Period the Participant shall
possess all incidents of ownership of such shares, including the right to
vote and to receive dividends with respect to such shares, subject to the
restrictions and limitations described in this Article.
(g) ACCELERATED LAPSE OF RESTRICTIONS. Upon the occurrence of a Change
in Control, all restrictions then outstanding with respect to shares of
Restricted Stock granted hereunder shall automatically expire and be of no
further force and effect. Additionally, the Committee shall have the
authority (and the Agreement may so provide) to cancel all or any portion
of any outstanding restrictions prior to the expiration of the Restricted
Period with respect to any or all of the shares of Restricted Stock on such
terms and conditions as the Committee shall deem appropriate.
10. CHANGE IN CONTROL OF THE COMPANY.
The first to occur of any of the following events shall be deemed a Change
in Control of the Company:
(i) the "beneficial ownership" (as defined in Rule 13d-3 under the
Exchange Act) of securities representing more than 33% of the combined
voting power of the Company is acquired by any "person," as defined in
sections 13(d) and 14(d) of the Exchange Act (other than the Company, any
trustee or other fiduciary holding securities under an employee benefit
plan of the Company, or any corporation owned, directly or indirectly, by
the stockholders of the Company in substantially the same proportions as
their ownership of stock of the Company), or
(ii) the stockholders of the Company approve a definitive agreement to
merge or consolidate the Company with or into another corporation or to
sell or otherwise dispose of all or substantially all of its assets, or
adopt a plan of liquidation, or
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(iii) during any period of three consecutive years, individuals who at
the beginning of such period were members of the Board cease for any reason
to constitute at least a majority thereof (unless the election, or the
nomination for election by the Company's stockholders, of each new director
was approved by a vote of at least a majority of the directors then still
in office who were directors at the beginning of such period or whose
election or nomination was previously so approved).
11. EFFECT OF CERTAIN CHANGES.
In the event of any extraordinary dividend, stock dividend,
recapitalization, merger, consolidation, stock split, warrant or rights
issuance, or combination or exchange of such shares, or other similar
transactions, the number of shares of each series of Stock available for grants
and the number of such shares covered by outstanding grants shall be equitably
adjusted by the Committee to reflect such event and preserve the value of such
grants and the Committee may make such other adjustments to the terms of
outstanding grants as it may deem equitable under the circumstances; provided,
however, that any fractional shares resulting from such adjustment shall be
eliminated.
12. PAYMENT OF WITHHOLDING TAXES.
The Committee shall have discretion to permit or require a Participant, on
such terms and conditions as it determines, to pay all or a portion of any taxes
arising in connection with a purchase of Restricted Shares hereunder or the
lapse of restrictions with respect thereto by having the applicable employer
withhold shares of the Stock or by the Participant's delivering other shares of
Existing Common Stock (or, after the initial issuance of any series of Specialty
Retail Stock, shares of the same series as the shares with respect to which the
tax is arising) having a then-current Fair Market Value equal to the amount of
taxes to be withheld.
13. RIGHTS AS A STOCKHOLDER.
Except as provided in Section 9(f) hereof, a Participant shall have no
rights as a stockholder with respect to any shares covered by the grant until
the date of the issuance of a stock certificate to him or her for such shares.
No adjustment shall be made for dividends (ordinary or extraordinary, whether in
cash, securities or other property) or distribution of other rights for which
the record date is prior to the date such stock certificate is issued, except as
provided in Article 11 hereof.
14. NO RIGHTS TO EMPLOYMENT.
Nothing in the Plan or in any grant made or Agreement entered into pursuant
hereto shall confer upon any Participant the right to continue in the employ of
the Company or any Subsidiary or to be entitled to any remuneration or benefits
not set forth in the Plan or such Agreement or to interfere with, or limit in
any way, the right of the Company or any such Subsidiary to terminate such
Participant's employment. Grants made under the Plan shall not be affected by
any change in duties or position of a Participant as long as such Participant
continues to be employed by the Company or any Subsidiary.
15. ADMINISTRATION.
The Plan shall be administered by the Committee. The Committee shall
consist of two or more persons each of whom is a "disinterested person" within
the meaning of Rule 16b-3 under the Exchange Act. The Committee shall have the
authority in its discretion, subject to and not inconsistent with the express
provisions of the Plan, to administer the Plan and to exercise all the powers
and authorities either specifically granted to it under the Plan or necessary or
advisable in the administration of the Plan, including, without limitation, to
interpret the Plan; to prescribe, amend and rescind rules and regulations
relating to the Plan; to determine the terms and provisions of the Agreements
(which need not be identical); and to make all other determinations deemed
necessary or advisable for the administration of the Plan.
The Board shall fill all vacancies, however caused, in the Committee. The
Board may from time to time appoint additional members to the Committee, and may
at any time remove one or more Committee members and substitute others. The
Committee may appoint a chairperson and a secretary and make such rules and
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regulations for the conduct of its business as it shall deem advisable, and
shall keep minutes of its meetings. The Committee shall hold its meetings at
such times and places as it shall deem advisable. All determinations of the
Committee shall be made by a majority of its members either present in person or
participating by conference telephone at a meeting or by written consent. The
Committee may delegate to one or more of its members or to one or more agents
such administrative duties as it may deem advisable, and the Committee or any
person to whom it has delegated duties as aforesaid may employ one or more
persons to render advice with respect to any responsibility the Committee or
such person may have under the Plan. All decisions, determinations and
interpretations of the Committee shall be final and binding on all persons,
including the Company, the Participant (or any person claiming any rights under
the Plan from or through any Participant) and any stockholder.
No member of the Board or Committee shall be liable for any action taken or
determination made in good faith with respect to the Plan or any grant
hereunder.
16. AMENDMENT AND TERMINATION OF THE PLAN.
The Board at any time and from time to time may suspend, terminate, modify
or amend the Plan; provided, however, that an amendment which requires
stockholder approval in order for the Plan to continue to comply with Rule 16b-3
or any other law, regulation or stock exchange requirement shall not be
effective unless approved by the requisite vote of stockholders. Except as
provided in Article 11 hereof, no suspension, termination, modification or
amendment of the Plan may adversely affect any grant previously made, unless the
written consent of the Participant is obtained.
17. GOVERNING LAW.
The Plan and the rights of all persons claiming hereunder shall be
construed and determined in accordance with the laws of the State of Michigan
without giving effect to the choice of law principles thereof, except to the
extent that such law is preempted by federal law.
18. APPROVAL OF STOCKHOLDERS.
The Plan shall take effect upon its adoption by the Board but the Plan (and
any grants made prior to the stockholder approval described in this Article 18)
shall be subject to the approval of the holders of a majority of the securities
of the Company present, or represented, and entitled to vote at a meeting of
stockholders held in accordance with applicable law, which approval must occur
within twelve months of the date that the Plan is adopted by the Board.
19. PERIOD DURING WHICH GRANTS ("PURCHASES") MAY BE MADE.
Purchases may be made pursuant to the Plan from time to time until March
15, 2004. No purchases shall be made thereafter. However, the Restricted Period
of Restricted Stock purchased hereunder prior to such date may extend beyond
such date, and the provisions of the Plan shall continue to apply to such
Restricted Stock.
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ANNEX IV-H
PROPOSAL 12 -- ADOPTION OF
ANNUAL INCENTIVE BONUS PLAN
KMART CORPORATION
ANNUAL INCENTIVE BONUS PLAN
1. PURPOSES.
The purposes of the Kmart Corporation Annual Incentive Bonus Plan (the
"Plan") are to increase the profitability of Kmart Corporation (the "Company")
and its Subsidiaries by attracting and retaining highly-qualified executives by
providing appropriate performance-based short-term incentive awards and to align
executive and stockholder long-term interests by enabling executives to develop
and maintain a substantial stock ownership position in the Company's Stock (as
defined herein) by paying bonus, in whole or in part, in such stock. An
additional purpose of the Plan is to serve as a qualified performance-based
compensation program under Section 162(m) of the Internal Revenue Code of 1986,
as amended, in order to preserve the Company's tax deduction for compensation
paid under the Plan to Covered Employees (as defined herein).
2. DEFINITIONS.
The following terms, as used herein, shall have the following meanings:
(a) "Board" shall mean the Board of Directors of the Company.
(b) "Bonus" shall mean any annual incentive bonus award granted
pursuant to the Plan; the payment of any such award shall be contingent
upon the attainment of Performance Goals with respect to a Plan Year
(c) "Change in Control" shall mean the occurrence of an event
described in Section 6(e) hereof.
(d) "Code" shall mean the Internal Revenue Code of 1986, as amended.
(e) "Committee" shall mean the Compensation and Incentives Committee
of the Board.
(f) "Company" shall mean Kmart Corporation, a corporation organized
under the laws of the State of Michigan, or any successor corporation.
(g) "Covered Employee" shall have the meaning set forth in Section
162(m)(3) of the Code (or any successor provision).
(h) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.
(i) "Group" shall mean any of the following: Borders-Walden Group,
Builders Square Group, OfficeMax Group, The Sports Authority Group (each, a
"Specialty Retail Group") or Kmart Group.
(j) "Management Stock Purchase Plan" shall mean the Kmart Corporation
Management Stock Purchase Plan, as amended from time to time.
(k) "Participant" shall mean an officer or other employee of the
Company or one of its Subsidiaries who is eligible to participate herein
pursuant to Section 3 of the Plan and for whom a target Bonus is
established with respect to the relevant Plan Year.
(l) "Performance Goal(s)" shall mean the criteria and objectives which
must be met during the Plan Year as a condition of the Participant's
receipt of payment with respect to a Bonus, as described in Section 5
hereof.
(m) "Plan" shall mean the Kmart Corporation Annual Incentive Bonus
Plan.
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(n) "Plan Year" shall mean the Company's fiscal year.
(o) "Restricted Stock" or "Restricted Shares" shall mean the shares of
Stock in which a Bonus is partially or wholly payable pursuant to Section
6(d) hereof; such Restricted Shares are issuable pursuant to the Management
Stock Purchase Plan.
(p) "Stock" shall mean shares of common stock of the Company already
issued at the time of the Board's adoption of the Plan, par value $1.00 per
share, and, upon and after the initial issuance of any additional series of
common stock of the Company, shares of the various issued series of common
stock of the Company.
(q) "Subsidiary" shall mean any subsidiary of the Company which is
designated by the Board or the Committee to have any one or more of its
employees participate in the Plan.
3. ELIGIBILITY.
All senior officers of the Company and all Company group and divisional
vice presidents shall participate in the Plan. Additionally, Bonuses may be
granted to such key employees of the Company and Subsidiaries as are designated
by the Committee. In determining the persons to whom Bonuses shall be granted,
the Committee shall take into account such factors as the Committee shall deem
relevant in connection with accomplishing the purposes of the Plan.
4. NO STOCK SUBJECT TO THE PLAN.
No shares of any Stock of the Company shall be reserved for, or issued
under, the Plan. To the extent that annual bonuses are paid in Restricted Shares
of Stock, such Restricted Shares shall be issued under, and subject to the terms
and conditions of, the Management Stock Purchase Plan.
5. PERFORMANCE GOALS.
Performance Goals may be expressed in terms of (i) the Company's return on
equity, assets, capital or investment (ii) pre-tax or after-tax profit levels of
the Company, the Subsidiaries the Specialty Retail Groups or the Kmart Group or
subdivisions thereof, or any combination of the foregoing, (iii) expense
reduction levels; or (iv) implementation of critical projects or processes. To
the extent applicable, any such Performance Goal shall be determined in
accordance with generally accepted accounting principles and reported upon by
the Company's independent accountants. Performance Goals shall include a
threshold level of performance below which no Bonus payment shall be made,
levels of performance at which specified percentages of the target Bonus shall
be paid, and a maximum level of performance above which no addition Bonus shall
be paid. The Performance Goals established by the Committee may be (but need not
be) different each Plan Year and different goals may be applicable to different
Participants.
6. BONUSES.
(a) In General. For each Plan Year, the Committee shall specify the
Performance Goals applicable to each Participant for such Plan Year and the
amount of, or the formula for determining, the target Bonus for each Participant
with respect to such Plan Year. A Participant's target Bonus for each Plan Year
shall be expressed as either a dollar amount or as a percentage of the
Participant's Annual Base Salary. Unless otherwise provided by the Committee in
its discretion in connection with terminations of employment, or except as set
forth in Section 6(e) hereof, payment of a Bonus for a particular Plan Year
shall be made only if and to the extent the Performance Goals with respect to
such Plan Year are attained and only if the Participant is employed by the
Company or one of its Subsidiaries on the last day of the Plan Year. The actual
amount of a Bonus payable under the Plan shall be determined as a percentage of
the Participant's target Bonus, which percentage shall vary depending upon the
extent to which the Performance Goals have been attained. The Committee may, in
its discretion, reduce or eliminate the amount payable to any Participant
(including a Covered Employee), in each case based upon such factors as the
Committee may deem relevant, but shall not increase the amount payable to any
Covered Employee.
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(b) Special Limitation on Certain Bonuses. Notwithstanding anything to the
contrary contained in this Section 6, the actual Bonus paid to the Company's
Chief Executive Officer under the Plan for any Plan Year may not exceed three
times the salary midpoint for the salary grade of the Chief Executive Officer,
as determined by the Committee prior to the beginning of such Plan Year based on
competitive data, including a survey of comparable companies; and the Bonus for
each other Covered Employee under the Plan may not exceed two times the salary
midpoint (as of the beginning of such Plan Year) for such Covered Employee's
salary grade, as so determined by the Committee prior to the beginning of such
Plan Year.
(c) Time of Payment. Unless otherwise determined by the Committee, or
except as provided in Section 6(e) hereof, all payments in respect of Bonuses
granted under this Section 6 shall be made within a reasonable period after the
end of the Plan Year. In the case of Participants who are Covered Employees,
unless otherwise determined by the Committee in connection with terminations of
employment and except as provided in Section 6(e) hereof, such payments shall be
made only after achievement of the Performance Goals has been certified by the
Committee.
(d) Form of Payment. Except as provided in Section 6(e) hereof, payment of
at least 20 percent of each Participant's Bonus for any Plan Year shall be made
in Restricted Stock pursuant to, and subject to the terms and conditions of, the
Management Stock Purchase Plan. At the election of each Participant (made in
accordance with the terms and conditions of the Management Stock Purchase Plan),
up to 100 percent of the Participant's Bonus for any Plan Year (less payroll
deductions) shall be paid in Restricted Stock pursuant to, and subject to the
terms and conditions of, the Management Stock Purchase Plan. The number of
shares of Restricted Stock to be paid shall be calculated in accordance with the
Management Stock Purchase Plan, based on the Fair Market Value (as defined
therein) of such shares as of the date of payment. Payment of the balance of the
Participant's Bonus for any Plan Year shall be made in cash. Payments of
portions of any Bonuses made in Restricted Stock pursuant to the Management
Stock Purchase Plan may be referred to therein as "purchases" of such Stock.
(e) Change in Control. Notwithstanding any other provision of the Plan to
the contrary, (i) if a "Change in Control" of the Company (as defined in this
Section 6(e)) shall occur following a Plan Year as to which the Committee has
determined the actual Bonuses to be paid (but such Bonuses have not yet been
paid), such Bonuses shall be paid immediately in cash, (ii) if a Change in
Control shall occur following a Plan Year as to which the Committee has not yet
determined the actual Bonuses to be paid, such Bonuses shall be immediately
determined and paid in cash, and (iii) if a Change in Control shall occur during
a Plan Year as to which target Bonuses have been established (but the actual
Bonuses to be paid have not yet been determined), such Plan Year shall be deemed
to have been completed, the target levels of performance set forth under the
respective Performance Goals shall be deemed to have been attained and a pro
rata portion of the Bonus so determined for each Participant for such partial
Plan Year (based on the number of full and partial months which have elapsed
with respect to such Plan Year) shall be paid immediately in cash to each
Participant for whom a target Bonus for such Plan Year was established.
For purposes of this Section 6, a Change in Control of the Company shall
occur upon the first to occur of the following:
(i) the "beneficial ownership" (as defined in Rule 13d-3 under the
Exchange Act) of securities representing more than 33% of the combined
voting power of the Company is acquired by any "person," as defined in
sections 13(d) and 14(d) of the Exchange Act (other than the Company, any
trustee or other fiduciary holding securities under an employee benefit
plan of the Company, or any corporation owned, directly or indirectly, by
the stockholders of the Company in substantially the same proportions as
their ownership of stock of the Company), or
(ii) the stockholders of the Company approve a definitive agreement to
merge or consolidate the Company with or into another corporation or to
sell or otherwise dispose of all or substantially all of its assets, or
adopt a plan of liquidation, or
(iii) during any period of three consecutive years, individuals who at
the beginning of such period were members of the Board cease for any reason
to constitute at least a majority thereof (unless the
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election, or the nomination for election by the Company's stockholders, of
each new director was approved by a vote of at least a majority of the
directors then still in office who were directors at the beginning of such
period or whose election or nomination was previously so approved).
7. ADMINISTRATION.
The Plan shall be administered by the Committee. The Committee shall have
the authority in its sole discretion, subject to and not inconsistent with the
express provisions of the Plan, to administer the Plan and to exercise all the
powers and authorities either specifically granted to it under the Plan or
necessary or advisable in the administration of the Plan, including, without
limitation, the authority to grant Bonuses; to determine the persons to whom and
the time or times at which Bonuses shall be granted; to determine the terms,
conditions, restrictions and performance criteria relating to any Bonus; to make
adjustments in the Performance Goals in response to changes in applicable laws,
regulations, or accounting principles, except as otherwise provided in Section
6(a) hereof, to adjust compensation payable upon attainment of Performance
Goals; to construe and interpret the Plan and any Bonus; to prescribe, amend and
rescind rules and regulations relating to the Plan; and to make all other
determinations deemed necessary or advisable for the administration of the Plan.
The Committee shall consist of two or more persons each of whom is an
"outside director" within the meaning of Section 162(m) of the Code. The
Committee may appoint a chairperson and a secretary and may make such rules and
regulations for the conduct of its business as it shall deem advisable, and
shall keep minutes of its meetings. All determinations of the Committee shall be
made by a majority of its members either present in person or participating by
conference telephone at a meeting or by unanimous written consent. The Committee
may delegate to one or more of its members or to one or more agents such
administrative duties as it may deem advisable, and the Committee or any person
to whom it has delegated duties as aforesaid may employ one or more persons to
render advice with respect to any responsibility the Committee or such person
may have under the Plan. All decisions, determinations and interpretations of
the Committee shall be final and binding on all persons, including the Company,
the Participant (or any person claiming any rights under the Plan from or
through any Participant) and any stockholder.
No member of the Board or the Committee shall be liable for any action
taken or determination made in good faith with respect to the Plan or any Bonus
granted hereunder.
8. GENERAL PROVISIONS.
(a) Compliance with Legal Requirements. The Plan and the granting of
Bonuses, and the other obligations of the Company under the Plan shall be
subject to all applicable federal and state laws, rules and regulations, and to
such approvals by any regulatory or governmental agency as may be required.
(b) No Right To Continued Employment. Nothing in the Plan or in any Bonus
granted shall confer upon any Participant the right to continue in the employ of
the Company or any of its Subsidiaries or to be entitled to any remuneration or
benefits not set forth in the Plan or to interfere with or limit in any way the
right of the Company to terminate such Participant's employment.
(c) Withholding Taxes. The Company or Subsidiary employing any Participant
shall deduct from all payments and distributions under the Plan any taxes
required to be withheld by federal, state or local governments.
(d) Amendment and Termination of the Plan. The Board may at any time and
from time to time alter, amend, suspend, or terminate the Plan in whole or in
part; provided, however, that no amendment which requires stockholder approval
in order for the Plan to continue to comply with Code Section 162(m) shall be
effective unless the same shall be approved by the requisite vote of the
stockholders of the Company. Additionally, the Committee may make such
amendments as it deems necessary to comply with other applicable laws, rules and
regulations. Notwithstanding the foregoing, no amendment shall affect adversely
any of the rights of any Participant, without such Participant's consent, under
any Bonus theretofore granted under the Plan.
IV-H-4
<PAGE> 195
(e) Participant Rights. No Participant shall have any claim to be granted
any Bonus under the Plan, and there is no obligation for uniformity of treatment
for Participants.
(f) Unfunded Status of Bonuses. The Plan is intended to constitute an
"unfunded" plan for incentive compensation. With respect to any payments which
at any time are not yet made to a Participant pursuant to a Bonus, nothing
contained in the Plan or any Bonus shall give any such Participant any rights
that are greater than those of a general creditor of the Company.
(g) Governing Law. The Plan and the rights of all persons claiming
hereunder shall be construed and determined in accordance with the laws of the
State of Michigan without giving effect to the choice of law principles thereof,
except to the extent that such law is preempted by federal law.
(h) Effective Date. The Plan shall take effect upon its adoption by the
Board, but the Plan (and any grants of Bonuses made prior to the stockholder
approval mentioned herein) shall be subject to the requisite approval of the
stockholders of the Company. In the absence of such approval, such Bonuses shall
be null and void.
(i) Interpretation. The Plan is designed and intended to comply with
Section 162(m) of the Code, to the extent applicable, and all provisions hereof
shall be construed in a manner to so comply.
IV-H-5
<PAGE> 196
KMART CORPORATION
ANNUAL REPORT TO STOCKHOLDERS
NOTICE OF ANNUAL MEETING AND PROXY STATEMENT
ANNUAL MEETING OF STOCKHOLDERS
MAY 24, 1994
THE SPORTS AUTHORITY [LOGO] BUILDERS SQUARE [LOGO]
KMART [LOGO]
BORDERS [LOGO]
WALDENBOOKS [LOGO] OFFICEMAX [LOGO]
- --------------------------------------------------------------------------------
ANNEX V: KMART CORPORATION
ANNEX VI: KMART GROUP
ANNEX VII: BORDERS-WALDEN GROUP
ANNEX VIII: BUILDERS SQUARE GROUP
ANNEX IX: OFFICEMAX GROUP
ANNEX X: THE SPORTS AUTHORITY GROUP
- --------------------------------------------------------------------------------
------------------------------------------------------------
BOOK TWO OF TWO
------------------------------------------------------------
<PAGE> 197
ANNEX V
KMART CORPORATION
<TABLE>
<S> <C>
Selected Financial Data.............................................................. V- 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations......................................................................... V- 3
Consolidated Financial Statements.................................................... V-20
</TABLE>
V-1
<PAGE> 198
KMART CORPORATION
CONSOLIDATED
SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated has been
derived from the consolidated financial statements of Kmart Corporation.
Operating results and affected ratios have been restated to exclude discontinued
operations. The information set forth below should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the financial statements and notes thereto included in this Annex
V.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------------------------
1993(1) 1992 1991 1990 1989(2) 1988
------- ------- ------- ------- ------- -------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Sales..................................................... $34,156 $31,031 $29,042 $28,133 $27,670 $25,947
Cost of merchandise sold.................................. 25,646 22,800 21,243 20,614 20,310 18,920
Selling, general and administrative expenses.............. 7,636 6,875 6,603 6,435 6,277 5,877
Interest expense -- net................................... 477 414 384 384 353 312
Income (loss) from continuing retail operations before
income taxes............................................ (550) 1,327 1,189 1,070 444 1,185
Net income (loss) from continuing retail operations....... (328) 882 789 712 282 768
Net income (loss)......................................... (974) 941 859 756 323 803
PER-SHARE DATA
Earnings (loss) per common and common equivalent share
from continuing retail operations....................... $ (0.73) $ 1.93 $ 1.85 $ 1.78 $ 0.70 $ 1.91
Cash dividends declared per common share.................. 0.96 0.92 0.88 0.86 0.82 0.66
Book value................................................ 13.39 16.64 15.33 13.47 12.45 12.56
FINANCIAL DATA
Working capital........................................... $ 4,123 $ 5,014 $ 4,682 $ 3,519 $ 3,685 $ 3,654
Total assets.............................................. 17,504 18,931 15,999 13,899 13,145 12,126
Long-term obligations -- Debt............................. 2,227 3,237 2,287 1,701 1,480 1,358
-- Capital leases.................... 1,720 1,698 1,638 1,598 1,549 1,588
Shareholders' equity...................................... 6,093 7,536 6,891 5,384 4,972 5,009
Capital expenditures -- owned property.................... 1,022 1,435 1,329 814 631 570
Depreciation and amortization............................. 703 600 509 470 444 424
Ending market capitalization.............................. 9,333 10,837 10,901 6,095 6,640 7,105
Weighted average shares outstanding....................... 457 456 426 400 401 401
FINANCIAL RATIOS
Return on sales --
Income (loss) from continuing retail operations before
income taxes.......................................... (1.6)% 4.3% 4.1% 3.8% 1.6% 4.6%
Net income (loss) from continuing retail operations..... (1.0)% 2.8% 2.7% 2.5% 1.0% 3.0%
Return on beginning assets from continuing retail
operations.............................................. (2.0)% 6.4% 6.6% 5.9% 2.5% 7.5%
Inventory turnover........................................ 2.9 2.7 2.7 2.7 2.9 3.0
Return on beginning shareholders' equity from continuing
retail operations....................................... (4.4)% 13.2% 15.0% 14.7% 5.7% 17.7%
Return on beginning investment from continuing retail
operations.............................................. (0.1)% 10.8% 11.2% 11.2% 6.4% 13.2%
Working capital ratio..................................... 1.7 1.9 2.1 1.8 1.9 2.0
Debt and equivalent as a percentage of total
capitalization.......................................... 48.9% 43.1% 37.3% 43.5% 43.4% 38.0%
Ratio of income from continuing retail operations to fixed
charges(3).............................................. -- 3.0 3.0 2.9 1.8 3.5
Employee compensation and benefits, per sales dollar...... 14.6% 14.7% 15.1% 15.2% 15.2% 14.7%
</TABLE>
- -------------------------
(1) Results of operations for 1993 include a pre-tax provision of $1,348 million
($862 million net of tax) for store restructuring and other charges.
(2) Results of operations for 1989 include a pre-tax provision of $640 million
($422 million net of tax) for store restructuring and other charges.
(3) The deficiency of income from continuing retail operations versus fixed
charges was $581 million for the fiscal year ended January 26, 1994.
V-2
<PAGE> 199
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Kmart Corporation ("Kmart") is one of the world's largest mass merchandise
retailers. The dominant portion of Kmart Corporation's business consists of the
Kmart Group which operates a chain of 2,323 Kmart discount stores with locations
in each of the 50 United States and Puerto Rico at January 26, 1994.
Internationally, the Kmart Group has operations in Canada, the Czech Republic
and Slovakia and has formed joint ventures in Mexico and Singapore. The Central
European stores were acquired in mid-1992 and represent Kmart's entry into that
market. Kmart is developing advanced distribution methods and merchandising
skills to modernize, refurbish and streamline operations in the two Central
European countries. Kmart also holds significant equity interests in Coles Myer
Ltd., Australia's largest retailer, and substantially all of the Meldisco
subsidiaries of Melville Corporation, which operate the footwear departments in
domestic Kmart stores. Kmart's Specialty Retail Groups consist of the
Borders-Walden Group, the Builders Square Group, the OfficeMax Group and The
Sports Authority Group. The Kmart Group also includes the operations of PayLess
Drug Stores, which is subject to a definitive sale agreement, and PACE
Membership Warehouse, substantially all of which assets were sold in January
1994, each of which have been presented as discontinued operations in the
consolidated financial statements.
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue any of four series
of common stock (collectively, the Specialty Retail Stock) designated
KM-Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of the relevant specialty retail business. The Borders-Walden Stock
is intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company, Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, the Builders Square Group, the OfficeMax
Group and The Sports Authority Group are sometimes referred to collectively
herein as the Specialty Retail Groups.
RESULTS OF CONSOLIDATED OPERATIONS
Sales increased 10.1% to $34.2 billion in 1993, compared to $31.0 billion
in 1992 and $29.0 billion in 1991. Consolidated comparable store sales increased
3.6% and 2.1% in 1993 and 1992, respectively. The Specialty Retail Groups'
aggregate comparable store sales increased 3.5% in 1993 versus a 6.5% increase
in 1992. Refer to analysis of the Kmart Group and the Specialty Retail Groups
operations below.
Cost of merchandise sold, including buying and occupancy costs, as a
percent of sales, was 75.1% in 1993, as compared with 73.5% in 1992 and 73.1% in
1991. Although there was competitive pricing pressure in both hardlines and
softlines throughout the year, the increase of 1.6% of sales in 1993 resulted
primarily from the U.S. Kmart inventory reduction program and increased
markdowns at the Kmart Fashions division. As a result of Kmart's inventory
management program, which included the use of automated replenishment
V-3
<PAGE> 200
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
systems in hardline departments, 1993 gross margins were effected by the
significant 1993 inventory reduction and the resulting change in the mix of
merchandise purchased, primarily in the fourth quarter of 1993, as compared to
1992. At January 26, 1994, first-in, first-out (FIFO) inventory of the U.S.
Kmart stores was down $720 million, or 10.4%, from the prior year. In addition,
the sales mix in U.S. Kmart stores was more skewed toward lower margin items in
1993 than in the prior year. The 0.4% increase in cost of merchandise sold as a
percent of sales in 1992 was due to increased clearance markdowns of spring and
summer merchandise lines in U.S. Kmart stores, especially apparel, and
competitive pressure on gross margins.
Substantially all of Kmart Corporation's domestic inventories are measured
using the last-in, first-out (LIFO) method of inventory valuation. In 1993 and
1992, the inflationary impact on inventories contributed to pre-tax LIFO credits
of $55 million and $35 million, respectively, in contrast to a pre-tax charge of
$4 million in 1991. Kmart Corporation measures inflation using internal price
indices. The 1993 and 1992 LIFO credits resulted from reductions in Kmart
Corporation's retail prices.
Selling, general and administrative ("SG&A") expenses, including
advertising, were 22.4% of sales in 1993 as compared to 22.2% and 22.7% in 1992
and 1991, respectively. The increase in SG&A expenses relative to sales in 1993
was primarily a result of lower than expected sales combined with increased
store operating expenses and depreciation expense, partially offset by lower
advertising and employee compensation and benefits per sales dollar. The 1992
decrease in SG&A expenses relative to sales was due to improved expense control,
primarily in U.S. Kmart stores, and lower advertising expense. As a percent of
sales, employee compensation and benefits were 14.6%, 14.7% and 15.1% in 1993,
1992 and 1991, respectively. Advertising expense comprised 1.4%, 1.5% and 1.8%
of sales in 1993, 1992 and 1991, respectively. The shift of the U.S. Kmart
stores toward an everyday low price strategy over the past few years has allowed
the chain to more effectively utilize each advertising dollar by reducing the
frequency and size of circulars.
On January 5, 1994, the Board of Directors approved a restructuring plan
involving the Kmart Group, (including Kmart Canada), the Builders Square Group
and the Borders-Walden Group. As a result, in the fourth quarter of 1993, Kmart
Corporation recorded a charge (Store Restructuring and Other Charges) to
earnings of $1,348 million before taxes. Net of taxes, the charge was $862
million. The provision included anticipated costs associated with Kmart stores
which will be closed and relocated, enlarged or refurbished in the U.S. and
Canada, the closing and relocation of certain Builders Square stores and the
closing of underperforming Walden stores. These costs, which represent
approximately 85% of the total, include lease obligations for store closings as
well as fixed asset writedowns, primarily furniture and fixtures, and inventory
dispositions for all affected stores. The remainder of the charge is for costs
related to certain changes to Walden's accounting policies in connection with
combination with Borders, re-engineering programs (principally severance) and a
non-routine legal contingency accrual. See below for additional detail regarding
the fourth quarter 1993 charge, and also refer to the U.S. General Merchandise
Operations and International General Merchandise Operations sections of the
Analysis of Kmart Group Operations and to the Builders Square Group and the
Borders-Walden Group sections of the Analysis of Specialty Retail Groups'
Operations of this annex.
<TABLE>
<CAPTION>
STORE RESTRUCTURING
(MILLIONS) AND OTHER CHARGES
- ---------------------------------------------------------------------------- -------------------
<S> <C>
Kmart Group -- U.S. General Merchandise Operations.......................... $ 865
-- International General Merchandise Operations.............. 39
Builders Square Group....................................................... 226
Borders-Walden Group........................................................ 218
-------
Total Kmart Corporation..................................................... $ 1,348
-------
-------
</TABLE>
V-4
<PAGE> 201
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Net interest expense on debt reflects the following components:
<TABLE>
<CAPTION>
(MILLIONS) 1993 1992 1991
- -------------------------------------------------------------------------- ---- ---- ----
<S> <C> <C> <C>
Interest Expense on Debt.................................................. $297 $257 $218
Interest Income........................................................... 12 28 15
---- ---- ----
Net Interest Expense on Debt.................................... $285 $229 $203
---- ---- ----
---- ---- ----
</TABLE>
Net interest expense on debt in 1993 was $285 million, up 24.5% from $229
million in 1992. The 1993 increase was a result of greater borrowings resulting
from higher inventory levels in the first nine months of 1993, acquisitions made
in 1992 and the acquisition of BizMart in March 1993, partially offset by lower
interest rates on long-term and short-term borrowings. The increase in net
interest expense on debt in 1992 was due to higher average borrowings as a
result of capital expenditures related to the Kmart store modernization program,
acquisitions and increased inventory, partially offset by lower interest rates
on commercial paper. Kmart Corporation's weighted average interest rates on
total debt were 6.7% in 1993, 7.6% in 1992 and 8.5% in 1991. Weighted average
interest rates for short-term borrowings were 3.2% in 1993, 3.6% in 1992 and
6.1% in 1991.
Income (loss) from continuing retail operations before income taxes for the
year was $(550) million, as compared to $1,327 million and $1,189 million in
1992 and 1991, respectively. Excluding the store restructuring and other charges
of $1,348 million, 1993 income from continuing operations before income taxes
was $798 million, or 2.3% of sales.
Income tax (benefit) expense was $(222) million with an effective tax rate
of 40.4% in 1993 as compared with $445 million with an effective tax rate of
33.5% in 1992 and $400 million with an effective tax rate of 33.6% in 1991.
Refer to the accompanying Notes to Consolidated Financial Statements for further
information regarding income taxes.
Net income (loss) from continuing retail operations in 1993 was $(328)
million, as compared to $882 million and $789 million in 1992 and 1991,
respectively. Excluding the net of tax $862 million store restructuring and
other charges, 1993 net income from continuing retail operations was $534
million, or 1.6% of sales, in 1993, as compared to 2.8% of sales and 2.7% of
sales in 1992 and 1991, respectively. The decrease in net income from continuing
retail operations in 1993, exclusive of the store restructuring and other
charges, resulted primarily from the inventory reduction program and gross
margin pressure in U.S. Kmart stores. Net income from continuing retail
operations increased in 1992 due to improved sales and a significant emphasis on
cost control, partially offset by a one-time charge of $12 million, net of tax,
related to Kmart Corporation's guarantee of certain Bargain Harold's leases.
Net income (loss) from discontinued operations in 1993 was $(81) million,
as compared to $59 million and $70 million in 1992 and 1991, respectively.
Discontinued operations include the results of PayLess Drug Stores Northwest,
Inc. and PACE Membership Warehouse, Inc. which have been reclassified to reflect
their respective plans for disposition announced in the fourth quarter of 1993.
The $81 million after-tax loss from the operation of discontinued businesses in
1993 was the result of a significant net operating loss at PACE which more than
offset the net income from PayLess. Additionally, in 1993, an after-tax loss of
$503 million was realized from the disposal of discontinued businesses.
In January 1994, PACE sold the assets and lease obligations of 93 of its
warehouses and virtually all of the inventory and membership files in the 34
warehouses not included in the transaction to Sam's Club, a division of
Wal*Mart, for $774 million. The book value of the assets sold to Wal*Mart was
$624 million. Operations of the 34 remaining PACE sites not included in the
transaction were discontinued and PACE is in the process of evaluating and
marketing these leased sites as well as leased premises for unopened warehouses
and corporate facilities. Included in the loss on the disposal of PACE was
unamortized goodwill, expected
V-5
<PAGE> 202
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
remaining lease obligations in the warehouses not sold, other PACE liabilities
and a provision for additional costs anticipated during the wind-down of PACE
operations.
In addition, Kmart Corporation entered into an agreement to sell its
PayLess Drug Stores subsidiary to TCH Corporation for $592 million in cash, $100
million in subordinated debt and 47% of the common equity of TCH Corporation.
The book value of PayLess' net assets to be sold was $1,186 million at January
26, 1994. It is anticipated that the transaction will be completed by the end of
the first quarter of 1994. The structure of the sale was designed to maximize
value received for PayLess. It is Kmart Corporation's intention to divest its
47% interest in TCH within one year or as soon as practicable after considering
all relevant factors including the value to be received upon such disposition.
Management expects the disposition to be achieved either through a private
offering or other alternative means. Accordingly, Kmart Corporation has reported
PayLess as a discontinued operation and has recorded its investment in TCH at
net realizable value.
Both businesses have been accounted for as discontinued operations in these
financial statements.
Extraordinary items. Subject to the completion of the sale of its PayLess
business, which is expected to be finalized in the first quarter of 1994, Kmart
Corporation intends to call for early redemption of all $300 million of 8 3/8%
debentures due January 15, 2017 using the proceeds of the sale to redeem the
issues. The resulting redemption premium and associated cost of $18 million, net
of applicable income taxes, was recorded in 1993. In August 1993, Kmart
Corporation called for early redemption of all $200 million of its 8 1/8%
debentures due January 1, 1997. The debentures were redeemed at 100% of the
principal amount plus interest accrued to the date of redemption. In April 1993,
Kmart Corporation called for early redemption of all $200 million of its 10 1/2%
Sinking Fund Debentures due December 1, 2017. The resulting redemption premium
of $10 million, net of applicable income taxes, has been reported as an
extraordinary item.
Effect of accounting changes. Kmart Corporation adopted Financial
Accounting Standard No. 109 "Accounting for Income Taxes" (FAS 109) in the first
quarter of 1993. FAS 109 requires that deferred taxes be calculated using the
liability approach rather than the deferred method. As a result of the
adjustment of deferred tax balances to the enacted tax rate at the date of
adoption, Kmart Corporation has recorded a benefit of $45 million, as the
cumulative effect of an accounting change.
Kmart Corporation also adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. This statement requires that Kmart
Corporation accrue for future postretirement medical benefits. In prior years,
these claims were expensed when paid. Net of applicable tax, a charge of $79
million has been included in net income as the effect of an accounting change.
In addition, Kmart Corporation adopted Financial Accounting Standard No.
112 "Employers' Accounting for Postemployment Benefits" (FAS 112) in the first
quarter of 1993. FAS 112 is an extension of the concepts underlying FAS 106 for
similar benefits provided to terminated or laid-off employees. The financial
effects of this statement on Kmart Corporation were not material.
Net income (loss) in 1993 was $(974) million, as compared with $941 million
in 1992 and $859 million in 1991.
Earnings (loss) per share in 1993 was $(2.15), as compared with $2.06 in
1992 and $2.02 in 1991.
EFFECTS OF INFLATION
Kmart Corporation's financial statements have been prepared on a historical
cost basis under generally accepted accounting principles. Kmart Corporation
uses the LIFO method of inventory valuation in its historical financial
statements; therefore, the cost of merchandise sold approximates current cost.
In addition,
V-6
<PAGE> 203
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
because Kmart Corporation is refurbishing existing stores and opening new
stores, depreciation and amortization expense more closely approximate current
cost.
FINANCIAL OBJECTIVE
Kmart Corporation's financial policy is designed to provide Kmart
Corporation and its shareholders with an optimum return on investment, a solid
capital structure and a high degree of financial flexibility. Obtaining optimum
return on investment requires deployment of Kmart Corporation's assets and
resources where they will provide the best long-term return. In seeking optimum
return, Kmart management continues to focus on high growth retail businesses
including potential retail investment opportunities, both domestically and
internationally, in addition to funding an improved merchandise mix, the
refurbishment, relocation and expansion of existing U.S. Kmart stores, and the
expansion and refurbishment of Kmart Corporation's specialty retail operations.
In addition, Kmart Corporation sold or closed Kmart and specialty retail stores
which did not generate sufficient returns. Kmart Corporation anticipates that
the cash required to fund the Kmart modernization and Super Kmart Center
programs and the Specialty Retail Groups' expansion will be provided primarily
by operations. Additional cash proceeds expected in 1994 from the sale of
PayLess, and, assuming shareholder approval, the offering of shares intended to
represent 20% to 30% of the equity value attributed to each Specialty Retail
business will be used to reduce debt and for other general corporate purposes.
On an ongoing basis, Kmart Corporation utilizes commercial paper and revolving
credit to cover peak working capital requirements. Kmart Corporation also
believes that it will continue to have access to long-term debt capital and
plans to fund its new store program using primarily lease financing.
CASH FLOW
Kmart Corporation funds generated by operations, investing and financing
activities as reported in the Consolidated Statements of Cash Flows are
summarized below. The accompanying Notes to Consolidated Financial Statements
contains additional information regarding the Consolidated Statements of Cash
Flows.
Net cash provided by operations was $1,948 million in 1993 and $852 million
in 1992, compared with $1,215 million in 1991. The increase in 1993 was due
primarily to the $720 million decrease in U.S. Kmart FIFO inventory, increased
accounts payable financing of inventory, proceeds from sale of PACE assets and
increased depreciation and amortization expense. The decrease in 1992 was due
primarily to an increase in merchandise inventories net of trade payables and an
increase in property held for resale, partially offset by increased net income
and depreciation.
Inventory turnover was 2.9 in 1993, as compared with 2.7 in each of 1992
and 1991, as restated for the discontinuance of PACE and PayLess. The
improvement in inventory turnover in 1993 was attributable to the U.S. Kmart
division. In U.S. Kmart stores, 1993 FIFO inventory decreased 10.4%, as compared
to an 8.0% increase in 1992. The 1993 decrease was primarily a result of
increased focus on inventory management in U.S. Kmart stores including the
increased use of automatic replenishment systems in hardline departments. The
1992 change resulted from increased U.S. Kmart inventory for new and enlarged
stores and a slight increase in comparable store inventory levels from 1991.
Depreciation and amortization expense are recognized in determining net
income, but do not require cash outlays. These expenses have been steadily
rising each year and are expected to continue to increase, due to larger capital
expenditures for the Kmart store modernization program and the Specialty Retail
Groups' aggressive expansion program.
Kmart Corporation anticipates that after-tax cash flows related to store
restructuring and other charges will approximate $89 million, $79 million and
$70 million in 1994, 1995 and 1996, respectively, and will result primarily from
the payment of leases and re-engineering costs (principally severance).
V-7
<PAGE> 204
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Net cash used for investing was $1,342 million in 1993, $1,832 million in
1992, and $1,413 million in 1991. Cash used for investing was primarily
comprised of capital expenditures for store modernization, the acquisition of
BizMart in 1993 and, in 1992, the acquisition of Pay'n Save assets and OW Office
Warehouse, Inc. and the purchase of 13 department stores in the Czech Republic
and Slovakia. Excluding discontinued operations, capital expenditures for the
Kmart Group, which included new distribution centers, refurbishments, expansions
and store openings, were $793 million, $1,110 million and $1,035 million in
1993, 1992 and 1991, respectively. The decrease in the Kmart Group capital
expenditures in 1993 was due to a reduction in the number of U.S. Kmart
modernization projects as the Kmart Group integrated the Super Kmart Center
concept into the program as described below. Capital expenditures by the
Specialty Retail Groups were primarily for new store openings resulting from the
Groups' aggressive expansion programs and totaled $229 million, $138 million and
$85 million in 1993, 1992 and 1991, respectively. Net cash used for acquisitions
totaled $268 million in 1993, $372 million in 1992 and $115 million in 1991.
Additional information regarding the U.S. Kmart modernization and Super
Kmart Center programs and the expansion of the Specialty Retail Groups is
included in the Analysis of Kmart Group Operations and Analysis of the Specialty
Retail Groups' Operations sections of this report.
Kmart Corporation anticipates that the cash required to fund the Kmart
store modernization and Super Kmart Center programs and the Specialty Retail
Groups expansion will be provided primarily by operations. In 1994, additional
funds are expected to be provided by the sale of PayLess and, assuming
shareholder approval, the offering of shares intended to represent 20% to 30% of
the equity value attributed to each of the four Specialty Retail businesses.
Net cash used for financing was $768 million in 1993 as compared with net
cash provided by financing of $1,026 million in 1992 and $485 million in 1991.
The 1993 change resulted primarily from a $197 million net decrease in long-term
debt and notes payable in 1993 as compared with a net increase of $1,522 million
in 1992. The decrease in cash provided by financing in 1993 was primarily a
result of lower U.S. Kmart inventory levels in 1993. The 1992 change was due
primarily to a $590 million increase in notes payable and proceeds of $1,012
million from 1992 debt issuances and mortgage financing. Fiscal 1991 included
$986 million in proceeds from the Series A conversion preferred stock offering
and $700 million in proceeds from the issuance of medium-term notes and
long-term debt, offset by a reduction in notes payable.
Due to the seasonal nature of the retail industry, Kmart Corporation
continues to utilize commercial paper and revolving credit to cover peak working
capital requirements. Average short-term borrowings outstanding during 1993,
1992 and 1991 were $2,079 million, $1,136 million and $1,093 million,
respectively. The maximum amount of aggregate short-term borrowings outstanding
during 1993 was $3,220 million as compared with $2,371 million in 1992 and
$1,509 million in 1991. Total short-term lines of credit available and unused
were $1,473 million, $1,339 million and $789 million at the end of 1993, 1992
and 1991, respectively.
Total dividends paid during 1993 were $465 million, compared with $448
million and $375 million in 1992 and 1991, respectively. Dividends paid per
Kmart Corporation existing common share were $0.95, $0.91 and $0.87 in 1993,
1992 and 1991, respectively. Dividends paid in 1993, 1992 and 1991 per $3.41
Depositary Share (each representing one-quarter share of Series A conversion
preferred stock) were $3.41, $3.41 and $1.06, respectively. Dividends paid per
Series B convertible preferred stock were $11.50 in 1993 and $1.44 in 1992.
V-8
<PAGE> 205
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
CAPITAL STRUCTURE
The following three-year analysis of Kmart Corporation's capital structure
summarizes Kmart Corporation's total debt and equivalent and total
capitalization:
<TABLE>
<CAPTION>
($ MILLIONS) 1993 % 1992 % 1991 %
- -------------------------------------------- ------- ----- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Long-term debt due within one year.......... $ 390 3.4 $ 117 0.8 $ 39 0.4
Capital lease obligations due within one
year...................................... 116 1.0 113 0.8 107 1.0
Notes payable............................... 918 8.0 590 4.3 -- --
Long-term debt.............................. 2,227 19.5 3,237 23.6 2,287 20.1
Capital lease obligations and other......... 1,936 17.0 1,862 13.6 1,802 15.8
------- ----- -------- ----- -------- -----
Total debt and equivalent.............. 5,587 48.9 5,919 43.1 4,235 37.3
------- ----- -------- ----- -------- -----
Deferred income taxes....................... (264) (2.3) 268 2.0 234 2.0
Shareholders' equity........................ 6,093 53.4 7,536 54.9 6,891 60.7
------- ----- -------- ----- -------- -----
Total capitalization................... $11,416 100.0 $ 13,723 100.0 $ 11,360 100.0
------- ----- -------- ----- -------- -----
------- ----- -------- ----- -------- -----
</TABLE>
Total debt and equivalent as a percentage of total capitalization was 48.9%
in 1993, 43.1% in 1992 and 37.3% in 1991. The increase in 1993 resulted from
lower shareholders' equity and a change in deferred taxes as a result of the
1993 store restructuring and other charges, partially offset by reduced debt
outstanding. The increase in 1992 resulted from higher levels of debt
outstanding.
On October 30, 1992, Kmart Corporation issued 784,938 shares of Series B
convertible preferred stock in exchange for all of the outstanding stock of
Borders, Inc. Subject to adjustment in certain events, each share of Series B
convertible preferred stock is convertible into 6.49 shares of common stock.
In August 1991, Kmart Corporation issued 23,000,000 $3.41 Depositary
Shares, each representing one-quarter of a share of Series A conversion
preferred stock, for $44 per Depositary Share. Net proceeds to Kmart Corporation
totaled $986 million.
ANALYSIS OF KMART GROUP OPERATIONS
At January 26, 1994, the Kmart Group consisted of both domestic and
international operations. A total of 2,323 Kmart stores were located in the
United States and Puerto Rico, including 19 Super Kmart Centers, all in the
United States. The Kmart Group's international operations included 127 Kmart
stores in Canada and 13 stores in the Czech Republic and Slovakia.
A three-year summary of the Kmart Group's sales and operating income
follows:
<TABLE>
<CAPTION>
% %
(U.S. $ MILLIONS) 1993 CHANGE 1992 CHANGE 1991
- -------------------------------------------------- -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C>
Sales
United States................................... $ 26,949 6.4 $ 25,326 3.4 $ 24,488
International................................... 1,090 (4.7 ) 1,144 7.9 1,060
-------- -------- --------
Total Sales................................ $ 28,039 5.9 $ 26,470 3.6 $ 25,548
-------- -------- --------
-------- -------- --------
Operating Income(1)
United States................................... $ 966 (33.6 ) $ 1,454 9.8 $ 1,325
International................................... 48 4.3 46 -- 23
-------- -------- --------
Total Operating Income..................... $ 1,014 (32.4 ) $ 1,500 11.4 $ 1,348
-------- -------- --------
-------- -------- --------
Capital Expenditures--Owned Property(2)........... $ 793 $ 1,110 $ 1,035
-------- -------- --------
-------- -------- --------
</TABLE>
- ------------------------
(1) 1993 operating income excludes store restructuring and other charges of $865
million and $39 million for United States and International operations,
respectively.
(2) Excludes capital expenditures of discontinued operations.
V-9
<PAGE> 206
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
U.S. General Merchandise Operations
Domestic Kmart store sales increased 6.4% in 1993 as a result of a 3.8%
comparable store sales increase and an increasing number of stores in operation,
partially offset by a 2.4% decrease in the average selling price of merchandise
resulting primarily from competitive factors. Sales in domestic Kmart stores
increased 3.4% in 1992 due to a 1.5% comparable store sales increase, store
openings and improved sales in the prescription drug, jewelry and home fashions
departments. Sales per square foot in U.S. Kmart stores, including
unconsolidated Kmart store licensee sales, were $182 in 1993 and $181 in 1992.
Both comparable store sales and sales per square foot were affected by
competition, lower selling prices and interruption caused by the store
modernization program.
In 1993, modernized stores (including new stores, relocations, expansions
and refurbishments) outperformed non-modernized stores by 17% in sales, 12% in
customer count, 16% in units sold and 6% in transaction amounts, and the Super
Kmart Center stores open the full year averaged in excess of $55 million in
sales. Based upon the successful results of the modernized stores and the
favorable results of the new Super Kmart Centers, the Kmart Group will integrate
the Super Kmart Center program into the remaining U.S. Kmart store modernization
program. The following table indicates the current status of the U.S. Kmart
store modernization program:
<TABLE>
<CAPTION>
PROJECTS
COMPLETED PROJECTS
THROUGH 1993 REMAINING
------------ ---------
<S> <C> <C>
Relocations............................................. 313 503
Expansions.............................................. 430 265
Refurbishments.......................................... 448 235
------ ---------
Total................................................. 1,191 1,003
------ ---------
------ ---------
</TABLE>
On January 5, 1994, the Board approved a restructuring plan to modernize
the remaining stores and, as a result, the Kmart Group recorded a pre-tax charge
of $865 million in the fourth quarter of 1993 relating to U.S. General
Merchandise Operations. The charge is principally for specifically-identified
relocations which will result in replacing smaller, less productive stores with
larger stores in better locations. These new stores are expected to generate
improved sales and gross margin which will be partially offset by increased
store occupancy and depreciation expense. The Kmart Group also expects that
there will be continued sales and profitability improvement at the stores
modernized to date. These larger stores are a key part of the Kmart Group's
strategy to compete effectively in the marketplace. The Kmart Group anticipates
that the store modernization program will be substantially complete by the end
of fiscal 1996.
Of the total charge, $795 million or 92% relates to the store relocations,
expansions and refurbishments. These costs include lease obligations for store
relocations totaling $464 million as well as fixed asset writedowns to net
realizable value totaling $141 million (primarily furniture and fixtures and
leasehold improvements) and inventory disposition costs during the final stage
of the project totaling $190 million for all affected stores. Such charge does
not include any provision for store occupancy, depreciation expense or normal
inventory markdowns prior to the closing or completion date of a project. The
remainder of the charge relates to the implementation of re-engineering programs
(principally severance) totaling $45 million and other non-recurring charges.
Operating income, excluding the store restructuring and other charges of
$865 million, in domestic Kmart stores decreased 33.6% to $966 million in 1993
due primarily to gross margin pressure. Although there was competitive pricing
pressure in both hardlines and softlines throughout the year, the lower gross
margin in 1993 was primarily related to the U.S. Kmart inventory reduction
program and increased markdowns at the
V-10
<PAGE> 207
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Kmart Fashions division. As a result of a domestic Kmart inventory management
program, which included the increased use of automatic replenishment systems in
hardline departments, gross margins were significantly effected by the inventory
reduction and resulting change in the mix of merchandise purchased, primarily in
the fourth quarter of 1993, as compared to 1992. Domestic Kmart operating income
increased 9.8% to $1,454 million in 1992 due primarily to an increased emphasis
on cost control, which included the ability to reduce product procurement costs,
and a LIFO credit, partially offset by a decline in gross margin due to
increased competitive pricing pressure and spring and summer seasonal clearance
activity. In 1992, operating income also benefited from U.S. Kmart cost control
measures, such as better controlled store hours due to improved labor
scheduling, revised human resource initiatives, including elimination of Sunday
overtime and Christmas remembrance, changes in vacation policies and reduced
promotional advertising expense. As many of the cost control programs were
implemented in late 1991, the full impact on lowering expense was realized in
1992.
During 1993, the Kmart Group temporarily reduced the pace of its U.S. Kmart
modernization program as it assessed both the Super Kmart Center program and the
remaining stores to be modernized. In 1993, the Kmart Group opened 14 new Super
Kmart Center stores. A 150,000 to 185,000 square-foot Super Kmart Center
features a full line of Kmart general merchandise and groceries as well as a
variety of ancillary services including dry cleaning, hair care, optical and
floral shops. While the Super Kmart Center program is still in its early stages,
Kmart plans to open approximately 55 Super Kmart Center stores in 1994 and
believes there is potential to open several hundred Super Kmart Center stores
over the next several years. The Kmart Group anticipates that the new Super
Kmart Center stores will be financed with lease financing. The average cost of
each site's inventory, net of expected payable financing, furniture and fixtures
and leasehold improvements is expected to approximate $6 million.
Excluding Super Kmart Centers, the Kmart Group completed 177 modernization
projects in 1993 as compared with 444 projects and 474 projects completed in
1992 and 1991, respectively. Kmart Corporation anticipates completion of
approximately 170-200 U.S. Kmart discount store modernization projects in 1994
including approximately 80 new discount stores. U.S. Kmart capital expenditures
for owned property are expected to approximate 1992 levels in 1994 as compared
with $0.8 billion in 1993, $1.1 billion in 1992 and $1.0 billion in 1991.
Activity for the U.S. Kmart store modernization program for the past three
years is summarized in the following table:
<TABLE>
<CAPTION>
TOTAL
1991 1992 1993 COMPLETE
---- ---- ---- --------
<S> <C> <C> <C> <C>
New stores (including relocations)
Kmart stores.................................................... 106 114 116 429
Super Kmart Centers............................................. -- 5 14 19
Store expansions.................................................. 164 122 51 430
Store refurbishments.............................................. 204 208 10 448
---- ---- ---- --------
Totals..................................................... 474 449 191 1,326
---- ---- ---- --------
---- ---- ---- --------
</TABLE>
International General Merchandise Operations
At January 26, 1994, international operations consisted of 127 Kmart stores
in Canada and 13 department stores located in the Czech Republic and Slovakia.
The Central European stores were acquired in mid-1992 and represent the Kmart
Group's entry into that market. The Kmart Group is developing advanced
distribution methods and merchandising skills to modernize, refurbish and
streamline operations in the two Central European countries.
V-11
<PAGE> 208
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
International sales decreased 4.7% in 1993 due primarily to lower Kmart
Canada sales resulting from unfavorable exchange rates relative to the U.S.
dollar, weak consumer spending attributed to increased taxes in Ontario where
approximately two-thirds of Canadian stores are located and unfavorable weather
in the eastern provinces of Canada during the first half of the year.
International sales increased 7.9% in 1992 primarily as a result of the purchase
of the Central European stores in mid-1992. Kmart Canada's 1992 sales were
positively effected by a strong Christmas season partially offset by weak
economic conditions and deterioration of the Canadian exchange rate throughout
the year. Czech Republic and Slovak operating income improved in 1993 while
Kmart Canada's operating income approximated prior year levels. Czech Republic
and Slovak operations were profitable in 1992, and 1992 operating profit at
Kmart Canada improved significantly over 1991 due to the excellent Christmas
season and strong expense control. The Canadian average dollar exchange rates
were 0.7745 in 1993, 0.8226 in 1992 and 0.8708 in 1991.
On January 5, 1994, the Board approved a restructuring plan to modernize
the remaining Kmart stores in Canada and, as a result, the Kmart Group recorded
a pre-tax charge of $39 million in the fourth quarter of 1993. Of the total
charge, $34 million is for specifically-identified store modernization projects
including store relocations, enlargements and refurbishments. These costs
include lease obligations for store relocations totaling $15 million, (primarily
furniture and fixtures) fixed asset writedowns to net realizable value totaling
$9 million and inventory disposition costs during the final stage of the project
totaling $10 million for all affected stores. Such charge does not include any
provision for store occupancy, depreciation expense or normal inventory
markdowns prior to the closing or completion date of a project. The remainder of
the charge relates to the implementation of re-engineering programs (principally
severance).
As part of its international expansion strategy, the Kmart Group has formed
joint ventures in Mexico and Singapore and, in 1994, expects to open five stores
in Mexico and two stores in Singapore.
The following table highlights the Kmart Group's store activity during
1993:
<TABLE>
<CAPTION>
1993 ACTIVITY PLANNED
END END ------------------------- END
1991 1992 OPENED CLOSED END 1994
----- ----- ------ ------ ----- -------
<S> <C> <C> <C> <C> <C> <C>
Kmart
United States.................................. 2,249 2,281 130 (88) 2,323 2,364
Canada......................................... 126 127 1 (1) 127 131
Czech Republic and Slovakia...................... -- 13 -- -- 13 13
Mexico........................................... -- -- -- -- -- 5
Singapore........................................ -- -- -- -- -- 2
Other............................................ 16 14 13 (4) 23 14
----- ----- ------ ------ ----- -------
Total General Merchandise.............. 2,391 2,435 144 (93) 2,486 2,529
----- ----- ------ ------ ----- -------
----- ----- ------ ------ ----- -------
General Merchandise Selling Square Feet
(Millions)..................................... 151 159 168
General Merchandise Store Sales per Square
Foot........................................... $184 $179 $179
</TABLE>
V-12
<PAGE> 209
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
ANALYSIS OF THE SPECIALTY RETAIL GROUPS' OPERATIONS
At January 26, 1994, the Specialty Retail Groups consisted of the
Borders-Walden Group, the Builders Square Group, the OfficeMax Group and The
Sports Authority Group. The Specialty Retail Groups continued their aggressive
store expansion programs and closed or relocated underperforming stores as
illustrated in the following table:
<TABLE>
<CAPTION>
1993 ACTIVITY PLANNED
END END ------------------------------------- END
1991 1992 ACQUIRED OPENED CLOSED END 1994
----- ----- -------- ------ ------ ----- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Borders-Walden Group
Borders............................... -- 31 -- 15 (2) 44 71
Walden*............................... 1,217 1,202 -- 7 (50) 1,159 1,044
Builders Square Group................... 144 165 -- 28 (16) 177 186
OfficeMax Group......................... 79 179 105 53 (9) 328 373
The Sports Authority Group.............. 36 56 -- 24 -- 80 108
----- ----- --- ------ ------ ----- -------
Total Specialty Retail
Groups...................... 1,476 1,633 105 127 (77) 1,788 1,782
----- ----- --- ------ ------ ----- -------
----- ----- --- ------ ------ ----- -------
Specialty Retail Groups' Selling
Square Feet (Millions)................ 17 22 28
----- ----- -----
----- ----- -----
</TABLE>
* Excludes 57, 58 and 58 Walden Software stores operated in 1993, 1992 and 1991,
respectively.
Combined capital expenditures by the Specialty Retail Groups were $229
million, $138 million and $85 million in 1993, 1992 and 1991, respectively, and
were primarily to fund new stores. Combined Specialty Retail Groups' capital
expenditures are expected to approximate $285 million in 1994. Financing for the
Specialty Retail Groups' investing activities will be provided primarily by
their operations, lease financing for new stores and corporate financing
activities.
A three-year summary of the Specialty Retail Groups' aggregate sales and
operating income follows ($ millions):
<TABLE>
<CAPTION>
% CHANGE
-------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales.............................................. $6,118 $4,561 $3,495 34.1 30.5
------ ------ ------
------ ------ ------
Operating Income(1)................................ $ 152 $ 138 $ 116 10.1 19.0
------ ------ ------
------ ------ ------
Comparable Store Sales Increase.................... 3.5% 6.5% 6.9%
------ ------ ------
------ ------ ------
Capital Expenditures -- Owned Property............. $ 229 $ 138 $ 85
------ ------ ------
------ ------ ------
</TABLE>
- -------------------------
(1) 1993 operating income excludes store restructuring and other charges of $444
million.
Aggregate Specialty Retail Group sales increased 34.1% to $6,118 million in
1993 as a result of 127 new or relocated stores, the March acquisition of 105
BizMart stores by OfficeMax and a 3.5% comparable store sales increase. The
Specialty Retail Groups' aggregate sales increased 30.5% to $4,561 million in
1992 due to 128 new stores, 63 stores acquired through the expansion of two
Groups within existing lines of business and a 6.5% comparable store sales
increase. Total 1993 operating income for the Specialty Retail Groups, excluding
the store restructuring and other charges, increased 10.1% to $152 million from
$138 million in 1992 and $116 million in 1991 due to new and acquired stores and
improved operating leverage. The Specialty Retail Groups represented 17.9% of
1993 consolidated sales and 13.0% of total 1993 consolidated operating income
before the store restructuring and other charges.
V-13
<PAGE> 210
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Borders-Walden Group
The Borders-Walden Group ("Borders-Walden") is a leading book retailer in
the United States and is comprised of Borders, Inc. ("Borders") and Walden Book
Company, Inc. ("Walden"). As of January 23, 1994, Borders operated 44 large
format superstores in 22 states and the District of Columbia, each of which is
designed to be the premier book retailer in its market, and Walden, which is the
largest operator of mall-based bookstores in the United States, operated 1,159
stores in 50 states and the District of Columbia.
Although Borders and Walden will continue to operate independently, Borders
and Walden recently have been combined under common executive leadership in
order to realize synergies in certain areas, including in the development of
inventory control systems and in merchandise distribution.
Borders-Walden's business strategy is to accelerate the growth of its books
and music superstore business and to increase profitability at Walden.
Borders-Walden intends to accomplish this by (i) opening at least 20-25 Borders
Books and Music superstores in each of the next two fiscal years and
reconfiguring or expanding virtually all of Borders' existing book superstores
to the Borders Books and Music format, (ii) increasing Walden's profitability by
reducing inventory shrinkage, containing expenses and, with the implementation
of Borders' sophisticated inventory management technology, improving sales per
store and inventory productivity over the long term and (iii) continuing to
develop and refine Borders' sophisticated inventory management system.
On January 5, 1994, the Board approved a restructuring plan involving the
closing of approximately 200 underperforming Walden stores. Management believes
that these closures will better enable Borders-Walden to compete effectively in
the mall-based arena. Management expects the closure of these stores will be
substantially completed in 1994 and that total sales levels will decrease
proportionally and that overall operating expenses, including employee costs,
occupancy expenses and depreciation charges will decrease further resulting in
improved earnings levels compared with the prior year.
As a result of the restructuring plan, Borders-Walden recorded a pre-tax
charge of $143 million ($85 million net of tax) in the fourth quarter of 1993
for store closing costs and other non-recurring charges. Of the total pre-tax
charge, $122 million is for store closures. These costs include $74 million
principally for lease buyout costs, $21 million for the writedown of inventory
to be liquidated during the final closing of each store, and $27 million for the
writedown of fixed assets, primarily furniture and fixtures, to net realizable
value. Of the remaining charge, $15 million relates to costs associated with
combining certain operations of Borders and Walden, including inventory
reduction costs and costs of consolidating redundant distribution center
functions. The remaining $6 million relates to re-engineering programs
(principally severance). In addition, a pre-tax charge of $75 million related to
certain changes to Walden's accounting policies was recorded in connection with
combination with Borders including a change in the method of inventory valuation
for Walden from last-in, first-out (LIFO) to first-in, first out (FIFO) to
conform Walden's inventory accounting and conform the accounting policies of
Walden and Borders in the areas of fixed asset capitalization and revenue
recognition.
V-14
<PAGE> 211
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Borders-Walden results of operations for the last three years follow ($
millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales.................................................. $1,370 $1,202 $1,140 14.0 5.5
------ ------ ------
------ ------ ------
Operating Income(1).................................... $ 50 $ 46 $ 38 8.7 21.1
------ ------ ------
------ ------ ------
Comparable Store Sales Increase
Borders........................................... 14.8% 12.6% --
------ ------ ------
------ ------ ------
Walden............................................ 0.7% 1.4% 5.8%
------ ------ ------
------ ------ ------
</TABLE>
- ------------------------
(1) Borders-Walden 1993 operating income excludes store restructuring and other
charges of $218 million.
Sales in 1993 were $1,370 million, a 14.0% increase, over sales of $1,202
million in the prior year. The 1993 sales increase was primarily due to the
inclusion of a full year of sales for the Borders stores versus three months in
the prior year. Comparable Walden store sales increased 0.7% in 1993 versus a
1.4% increase in 1992. The slower rate of Walden comparable store sales growth
was a result of increased competition from superstores in several markets and
sluggish mall traffic. In 1993, Borders-Walden reported an operating loss of
$168 million, inclusive of the store restructuring and other charges of $218
million. Excluding store restructuring and other charges, 1993 operating income
was $50 million, or 3.6% of sales, as compared to operating income of $46
million, or 3.8% of sales, in the prior year. The 1993 increase resulted
primarily from higher sales and improved gross margins, partially offset by
increased goodwill amortization as a result of the acquisition of Borders by
Kmart Corporation.
Sales of Borders-Walden in 1992 were $1,202 million, a $62 million, or 5.5%
increase over sales of $1,140 million in 1991. The increase was attributable to
the acquisition of Borders in October 1992, which contributed $56 million in
sales, and a 1.4% comparable store sales increase at Walden. Operating income of
Borders-Walden in 1992 was $46 million, or 3.8% of sales, as compared to $38
million, or 3.3% of sales, in 1991, primarily as a result of increased sales and
gross margin, partially offset by higher selling, general and administrative
expenses.
Builders Square Group
At January 23, 1994, the Builders Square Group ("Builders Square") operated
177 home improvement stores in 26 states and Puerto Rico, of which 130 were
Builders Square I Stores ("BSQ I Stores") and 47 were Builders Square II Stores
("BSQ II Stores"). The business strategy of Builders Square is to phase out its
self-service warehouse-style home improvement stores and operate large format
superstores that emphasize customer service and provide an extensive selection
of quality products and services to repair, remodel, redecorate and maintain
both home and garden. Builders Square's goal is to have virtually all stores in
the BSQ II Store format by the end of fiscal 1997.
On January 5, 1994, the Board approved a restructuring plan to convert
virtually all of the existing Builders Square stores to the new Builders Square
II format by 1997. The Builders Square II stores have an easier-to-shop layout
that utilizes a "store-within-a-store" format with substantially increased
customer service levels. In connection with the restructuring plan, Builders
Square is closing selected Builders Square I stores, converting the balance of
existing Builders Square I stores to the Builders Square II format and filling
in existing and contiguous markets with Builders Square II stores. During the
next four years, Builders Square currently expects to phase out 117 Builders
Square I stores by closing 8 stores, relocating 66 stores and renovating 43
stores. In addition, Builders Square plans to open approximately 10-20 new
Builders Square II stores during each of the next two years.
V-15
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KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
As a result of the restructuring plan, Builders Square recorded a pre-tax
charge of $226 million ($141 million, net of tax) in the fourth quarter of 1993
for the estimated cost of closing, relocating or converting all Builders Square
I stores to the Builders Square II format. Of the total pre-tax charge, $214
million is for specifically-identified store relocations and renovations. These
costs include $144 million for lease obligations, a $37 million for the
writedown of inventory to be liquidated during the final closing of each store
and $33 million for the writedown of fixed assets, primarily furniture and
fixtures, to net realizable value. Such charge does not include any provision
for store occupancy, depreciation expense or normal inventory markdowns prior to
the closing or completion date of a project. The remainder of the charge relates
to a $12 million accrual for a non-routine legal judgment resulting from the
insolvency of the insurer.
Builders Square's results of operations for the last three years follow ($
millions):
<TABLE>
<CAPTION>
% CHANGE
-------------
1993 1992 1991 1993 1992
------ ------ ------ ----- ----
<S> <C> <C> <C> <C> <C>
Sales................................................. $2,719 $2,419 $2,049 12.4 18.1
------ ------ ------
------ ------ ------
Operating Income(1)................................... $ 61 $ 80 $ 74 (23.7) 8.1
------ ------ ------
------ ------ ------
Comparable Store Sales Increase....................... 0.9% 8.5% 7.0%
------ ------ ------
------ ------ ------
</TABLE>
- -------------------------
(1) Builders Square's 1993 operating income excludes store restructuring and
other charges of $226 million.
Sales in 1993 were $2,719 million, a 12.4% increase, over sales of $2,419
million in 1992. The 1993 sales increase was due to the 28 stores opened, all of
which were BSQ II Stores, in 1993 and the inclusion of a full year of sales for
the 22 stores opened in 1992. Comparable store sales increased 0.9% in 1993
versus an 8.5% increase in 1992. The slower rate of comparable store sales
growth in 1993 was a result of increased competition in the Northeast and
Midwest, severe winter weather conditions that continued into the spring selling
season and the strong comparable store sales growth reported in the Southeast
region in 1992 as the result of rebuilding in the aftermath of Hurricane Andrew.
Inclusive of store restructuring and other charges of $226 million, operating
loss in 1993 was $166 million. Excluding store restructuring and other charges,
Builders Square 1993 operating income was $61 million, or 2.2% of sales, as
compared to $80 million, or 3.3% of sales, in the prior year. The decrease in
operating profit in 1993 resulted primarily from lower than expected sales,
higher occupancy costs and increased payroll expenses associated with improving
the level of customer service in the store.
Sales of Builders Square in 1992 were $2,419 million, a $370 million, or
18.1%, increase over sales of $2,049 million in 1991. The 1992 sales increase
was due to the opening of 22 new stores during the year, including eight BSQ II
Stores, and to an 8.5% comparable store sales increase which resulted from
strong sales in the Southeast in the aftermath of Hurricane Andrew, an improved
merchandise mix and in-stock position, a continuing shift to an everyday fair
price position and to higher average sales per transaction. Operating income
increased 8.1% in 1992 due primarily to increased sales, well controlled costs
and in the prior year, the closing of 14 underperforming stores, partially
offset by a $10 million LIFO charge in 1992 as compared to a LIFO credit of $2
million in 1991 and increased pre-opening expense.
OfficeMax Group
The OfficeMax Group ("OfficeMax") is one of the largest operators of
high-volume, deep discount office products superstores in the United States,
operating 328 superstores in 38 states as of January 22, 1994. OfficeMax plans
to open approximately 60 to 70 stores in each of the next two years. Management
estimates that OfficeMax's cash requirements, exclusive of pre-opening expenses,
will be approximately $1.0 million for each additional store. These requirements
include an average of approximately $0.4 million for leasehold
V-16
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KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
improvements, fixtures, point-of-sale terminals and other equipment in the
stores and approximately $0.6 million for the portion of the store inventory
that is not financed by vendors.
On March 4, 1993, OfficeMax acquired BizMart, Inc., a 105-store national
office products superstore chain with stores located primarily in the Southwest,
West and Pacific Northwest regions, for a purchase price of $268 million. On
June 30, 1992, OfficeMax acquired OW Office Warehouse, Inc., a 41-store office
products superstore chain with stores located primarily throughout the
Mid-Atlantic region. Immediately following each of these acquisitions, OfficeMax
operationally integrated, remodeled, remerchandised and converted the acquired
stores to the OfficeMax name and format.
In November 1990, Kmart Corporation acquired an initial 21.6% equity
interest in OfficeMax, Inc. and increased its equity interest in OfficeMax to
92.7% in November 1991. Kmart Corporation has consolidated the results of
OfficeMax operations from November 21, 1991. Kmart Corporation currently has a
% interest in OfficeMax.
OfficeMax's results of operations from the November 21, 1991 date of
acquisition follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales................................................... $1,422 $ 528 $ 65 169.3 --
------ ------ ------
------ ------ ------
Operating Income........................................ $ 20 $ 1 $ 1 -- --
------ ------ ------
------ ------ ------
Comparable Store Sales Increase......................... 18.2% 28.5% --
------ ------ ------
------ ------ ------
</TABLE>
Sales for fiscal 1993 were $1,422 million, an $894 million, or 169.3%,
increase over fiscal 1992 sales of $528 million. The increase was due to the
opening of 53 new stores, the acquisition of 105 BizMart stores in March 1993,
the inclusion of a full year of sales for the 41 OW Office Warehouse, Inc.
stores acquired in June 1992 and the 61 new stores opened during fiscal 1992,
and an 18.2 % comparable store sales increase in fiscal 1993. Operating income
was $20 million in fiscal 1993, or 1.4% of sales, as compared to $1 million in
fiscal 1992, or 0.1% of sales, as a result of effective cost control and the
leveraging of selling, general and administrative expenses, pre-opening
expenses, and goodwill amortization as a result of increased store sales
volumes.
The 1992 OfficeMax sales increase was due to the inclusion of a full year
of OfficeMax operations and 102 new stores, including 41 OW Office Warehouse,
Inc. stores acquired on June 30, 1992. OfficeMax recorded $1 million operating
income in 1992 despite higher store opening costs resulting from an aggressive
expansion program during the year. On a pro forma basis, OfficeMax comparable
store sales increased 28.5% in 1992.
The Sports Authority Group
The Sports Authority Group ("The Sports Authority") is the largest operator
of large format sporting goods stores in the United States in terms of both
sales and number of stores and is also the largest full-line sporting goods
retailer in the United States in terms of sales, operating 80 sporting goods
megastores at January 23, 1994. The Sports Authority has consistently increased
its rate of store expansion in the last three fiscal years, opening 24 stores,
20 stores and 17 stores in 1993, 1992 and 1991, respectively. The Sports
Authority currently plans to open approximately 25 stores in 1994, with 21 of
the 1994 openings concentrated in existing markets. The remaining four of the
planned 1994 openings are expected to be concentrated within three new markets.
V-17
<PAGE> 214
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
The Sports Authority's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
--------------
1993 1992 1991 1993 1992
---- ---- ---- ----- ----
<S> <C> <C> <C> <C> <C>
Sales.................................................. $607 $412 $241 47.5 70.8
---- ---- ----
---- ---- ----
Operating Income....................................... $ 21 $ 10 $ 3 110.0 --
---- ---- ----
---- ---- ----
Comparable Store Sales Increase........................ 2.6% 8.3% 15.3%
---- ---- ----
---- ---- ----
</TABLE>
Sales in 1993 were $607 million, a $195 million, or 47.5%, increase over
sales of $412 million in 1992. Of the 47.5% increase in sales, 2.6%, or $11
million, was produced by comparable store sales growth, 23.4%, or $96 million,
was produced by the 20 stores opened in 1992 which had no comparable store sales
in the prior year and 21.5%, or $88 million, was produced by the 24 new stores
opened in 1993. Comparable store sales increased 2.6% and 8.3% in 1993 and 1992,
respectively. Comparable store sales in 1993 were adversely effected by the
severe winter storm which occurred in March 1993 and reduced consumer demand for
higher priced apparel. Excluding sales from stores cannibalized by new store
openings, comparable store sales increased 5.1% in 1993 as compared to 11.4% in
the prior year. Operating income in 1993 was $21 million, or 3.5% of sales, as
compared to $10 million, or 2.4% of sales, in 1992. The improvement was a result
of increased sales volume, lower pre-opening expense and goodwill amortization
as a percent of sales and management of store and administrative expenses.
Sales of The Sports Authority in 1992 were $412 million, a $171 million, or
70.8%, increase over sales of $241 million in 1991. Of the 70.8% increase in
sales in 1992, 8.3%, or $20 million, was produced by comparable store sales
growth; 32.1%, or $78 million, was produced by 17 stores opened in 1991 which
had no comparable store sales in the prior year and 30.4%, or $73 million, was
produced by the 20 new stores opened in 1992. Comparable store sales increased
8.3% in 1992. Excluding the effect of stores in which sales were cannibalized by
new openings within the same market, comparable store sales increased by 11.4%
in 1992. Operating income of The Sports Authority in 1992 was $10 million, or
2.4% of sales, as compared to $3 million, or 1.4% of sales, in the prior year.
The increase of $7 million, or 1.0% of sales, in 1992 was the result of
increased sales, lower advertising expense and goodwill amortization as a
percent of sales and management of store and administrative expenses.
LICENSEE OPERATIONS AND EQUITY INVESTMENTS
Kmart Corporation owns a 21.5% equity interest in Coles Myer Ltd.,
Australia's largest retailer, and a 49.0% equity interest in substantially all
of the Meldisco subsidiaries of Melville Corporation, which operates domestic
Kmart footwear departments.
In U.S. dollars, 1993 equity in income of Coles Myer was $58 million
compared with $51 million in 1992 and $60 million in 1991. The increase in Coles
Myer equity income in 1993 was due to improved gross margin, expense control and
a 6% reduction in the Australian corporate tax rate. The 1992 Coles Myer equity
income decline was a result of losses on the sale of certain New Zealand food
operations and part of Sandhurst Dairies operations earlier in the year and the
continued weak Australian economy.
Meldisco equity income in 1993 was $52 million compared with $54 million in
1992 and $50 million in 1991. Lower 1993 Meldisco equity income was a result of
unfavorable weather in early 1993 and increased competition. 1992 Meldisco
equity income increased due to increased sales, combined with improved gross
profit margin as a result of lower purchasing costs and the merchandise mix.
Refer to the accompanying Notes to Consolidated Financial Statements for further
results of Kmart Corporation's equity investments.
V-18
<PAGE> 215
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS
Compliance with federal, state and local provisions which have been enacted
or adopted regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had, and is not
expected to have, a material effect on the capital expenditures, earnings or
competitive position of Kmart Corporation.
V-19
<PAGE> 216
KMART CORPORATION
REPORT BY MANAGEMENT
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Kmart Corporation management is responsible for the integrity of the
information and representations contained in its interim and annual financial
statements. This responsibility includes making informed estimates and judgments
in selecting the appropriate accounting principles. Management believes the
financial statements conform with generally accepted accounting principles
applied on a consistent basis.
To assist management in fulfilling these obligations, several tools are
utilized, which include the following:
A system of internal accounting controls is maintained to provide for
the integrity of information for purposes of preparing financial statements
and to assure that assets are properly accounted for and safeguarded. This
concept of reasonable assurance is based on the recognition that the cost
of the system is related to the benefits to be derived and modified for
changing conditions. Management believes its system provides reasonable
assurance of this appropriate balance.
As part of the internal control system, a policy of Standards of
Business Conduct and Management Integrity Statements is in effect. All
officers and key employees periodically submit a signed statement regarding
compliance with these policies.
An Internal Audit Department is maintained to evaluate, test and
report on the application of internal accounting controls in conformity
with standards of the practice of internal auditing.
The financial statements have been examined by independent accountants
whose report is contained herein. This examination includes, among other
things, a review of the system of internal controls as required by
generally accepted auditing standards.
The Audit Committee of the Board of Directors, consisting solely of outside
directors, meets regularly with management, internal auditors and the
independent accountants to assure that each is carrying out its
responsibilities. The internal auditors and independent accountants both have
full and free access to the Audit Committee, with and without the presence of
management.
Joseph E. Antonini
Chairman of the Board, President
and Chief Executive Officer
Thomas F. Murasky
Executive Vice President
and Chief Financial Officer
V-20
<PAGE> 217
KMART CORPORATION
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Kmart Corporation
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of Kmart
Corporation and its subsidiaries at January 26, 1994 and January 27, 1993, and
the results of their operations and their cash flows for each of the three years
in the period ended January 26, 1994, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
As discussed in the notes to the consolidated financial statements, Kmart
Corporation adopted Statement of Financial Accounting Standard No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions" and
Statement of Financial Accounting Standard No. 109, "Accounting for Income
Taxes," at the beginning of fiscal 1993.
Price Waterhouse
Detroit, Michigan
March 15, 1994
V-21
<PAGE> 218
KMART CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------
JANUARY 26, JANUARY 27, JANUARY 29,
1994 1993 1992
------------ ------------ ------------
<S> <C> <C> <C>
Sales...................................................... $ 34,156 $ 31,031 $ 29,042
Licensee fees and rental income............................ 291 280 267
Equity in income of affiliated retail companies............ 110 105 110
------------ ------------ ------------
34,557 31,416 29,419
------------ ------------ ------------
Cost of merchandise sold (includes buying and occupancy
costs)................................................... 25,646 22,800 21,243
Selling, general and administrative expenses............... 7,636 6,875 6,603
Store restructuring and other charges...................... 1,348 -- --
Interest expense:
Debt -- net.............................................. 285 229 203
Capital lease obligations................................ 192 185 181
------------ ------------ ------------
35,107 30,089 28,230
------------ ------------ ------------
Income (loss) from continuing retail operations before
income taxes............................................. (550) 1,327 1,189
Income taxes............................................... (222) 445 400
------------ ------------ ------------
Net income (loss) from continuing retail operations before
extraordinary items and the effect of accounting
changes.................................................. (328) 882 789
Discontinued operations including the effect of accounting
changes, net of income taxes of $(19), $40 and $42,
respectively............................................. (81) 59 70
Loss on disposal of discontinued operations,
net of income taxes of $(239)............................ (503) -- --
Extraordinary items, net of income taxes of $(15).......... (28) -- --
Effect of accounting changes, net of income taxes of
$(37).................................................... (34) -- --
------------ ------------ ------------
Net income (loss).......................................... $ (974) $ 941 $ 859
------------ ------------ ------------
------------ ------------ ------------
Earnings per common and common equivalent share:
Net income (loss) from continuing retail operations
before extraordinary items and the effect of
accounting changes.................................... $ (.73) $ 1.93 $ 1.85
Discontinued operations including the effect of
accounting changes, net of income taxes............... (.18) .13 .17
Loss on disposal of discontinued operations, net of
income taxes.......................................... (1.10) -- --
Extraordinary items, net of income taxes................. (.06) -- --
Effect of accounting changes, net of income taxes........ (.08) -- --
------------ ------------ ------------
$ (2.15) $ 2.06 $ 2.02
------------ ------------ ------------
------------ ------------ ------------
Weighted average shares.................................... 456.7 455.6 426.2
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
The consolidated statements of income for prior periods have been restated for
discontinued operations.
V-22
<PAGE> 219
KMART CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 27,
1994 1993
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash (includes temporary investments of $32 and $260,
respectively)..................................................... $ 449 $ 611
Merchandise inventories.............................................. 7,252 8,752
Accounts receivable and other current assets......................... 1,235 1,146
Discontinued operations.............................................. 911 --
----------- -----------
Total current assets................................................... 9,847 10,509
Investments in Affiliated Retail Companies............................. 606 597
Property and Equipment -- net.......................................... 5,886 6,405
Other Assets and Deferred Charges...................................... 469 381
Goodwill -- net of accumulated amortization of $59 and $93,
respectively......................................................... 696 1,039
----------- -----------
$17,504 $18,931
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ 390 $ 117
Notes payable........................................................ 918 590
Accounts payable -- trade............................................ 2,763 2,959
Accrued payrolls and other liabilities............................... 1,347 1,215
Taxes other than income taxes........................................ 271 368
Income taxes......................................................... 35 246
----------- -----------
Total current liabilities.............................................. 5,724 5,495
Capital Lease Obligations.............................................. 1,720 1,698
Long-Term Debt......................................................... 2,227 3,237
Other Long-Term Liabilities (includes store restructuring
obligations)......................................................... 1,740 697
Deferred Income Taxes.................................................. -- 268
Shareholders' Equity:
Preferred stock, 10,000,000 shares authorized;
Series A, 5,750,000 shares authorized and issued.................. 986 986
Series B, 796,827 shares authorized; 784,938 shares issued........ 157 157
Common stock, 1,500,000,000 shares authorized; shares issued
416,546,780 and 415,640,206, respectively......................... 417 416
Capital in excess of par value....................................... 538 506
Performance restricted stock deferred compensation................... (3) (2)
Retained earnings.................................................... 4,237 5,700
Treasury shares...................................................... (109) (122)
Foreign currency translation adjustment.............................. (130) (105)
----------- -----------
Total shareholders' equity............................................. 6,093 7,536
----------- -----------
$17,504 $18,931
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
V-23
<PAGE> 220
KMART CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 26, JANUARY 27, JANUARY 29,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income (loss) from continuing retail operations before
extraordinary items and the effect of accounting
changes................................................. $ (328) $ 882 $ 789
Adjustments to reconcile net income (loss) to operating
cash flows:
Depreciation and amortization........................... 703 600 509
Store restructuring and other charges................... 1,149 (27) (38)
Deferred income taxes................................... (528) 153 116
Undistributed equity income............................. (15) (11) (26)
Increase in other long-term liabilities................. 286 63 31
Other -- net............................................ 54 25 5
Cash provided by (used for) current assets and current
liabilities:
(Increase) decrease in inventories...................... 249 (956) (620)
Increase in accounts payable............................ 258 167 371
Other -- net............................................ (339) (188) (72)
----------- ----------- -----------
Total cash provided by continuing retail operations........ 1,489 708 1,065
----------- ----------- -----------
Discontinued Operations
Loss on disposal of discontinued operations............. (503) -- --
Income (loss) from discontinued operations.............. (81) 59 70
Items not affecting cash -- net......................... 1,043 85 80
----------- ----------- -----------
Total cash provided by discontinued operations............. 459 144 150
----------- ----------- -----------
Net cash provided by operations............................ 1,948 852 1,215
----------- ----------- -----------
INVESTING
Capital expenditures -- owned property..................... (1,022) (1,435) (1,329)
Acquisitions............................................... (268) (372) (115)
Proceeds from the sale of assets........................... 20 25 70
Other -- net............................................... (72) (50) (39)
----------- ----------- -----------
Net cash used for investing................................ (1,342) (1,832) (1,413)
----------- ----------- -----------
FINANCING
Proceeds from issuance of long-term debt and notes
payable................................................. 736 1,602 811
Reduction in long-term debt and notes payable.............. (933) (80) (896)
Reduction in capital lease obligations..................... (123) (113) (110)
Issuance of common stock................................... 32 57 67
Issuance of $3.41 Depositary Shares (each representing 1/4
share Series A conversion preferred).................... -- -- 986
Reissuance of treasury shares.............................. 13 8 2
Extraordinary items for bond redemptions................... (28) -- --
Dividends paid............................................. (465) (448) (375)
----------- ----------- -----------
Net cash provided by (used for) financing.................. (768) 1,026 485
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS.............. (162) 46 287
Cash and Equivalents at Beginning of Year.................. 611 565 278
----------- ----------- -----------
CASH AND EQUIVALENTS AT END OF YEAR.......................... $ 449 $ 611 $ 565
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
Certain prior year amounts have been restated for the effect of discontinued
operations.
V-24
<PAGE> 221
KMART CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
PERFORMANCE
SERIES A SERIES B CAPITAL RESTRICTED
CONVERSION CONVERTIBLE IN EXCESS STOCK
PREFERRED PREFERRED COMMON OF PAR DEFERRED RETAINED
STOCK STOCK STOCK VALUE COMPENSATION EARNINGS
---------- ----------- ------ --------- ------------ --------
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 30, 1991........................ $ -- $ -- $205 $ 593 $ (2) $4,753
Net income for the year............................ 859
Cash dividends declared, common, $.88 per share.... (354)
Cash dividends declared, $3.41 Depositary Share
(1/4 share Series A conversion preferred), $1.91
per share........................................ (44)
$3.41 Depositary Shares issued..................... 986
Common issued under stock option plans............. 2 62
Common issued under performance restricted stock
plan............................................. 2
Treasury shares reissued to the Employee Savings
Plan............................................. 2
Two-for-one stock split............................ 206 (206)
Foreign currency translation adjustment............
----- ----- ------ --------- --- --------
BALANCE AT JANUARY 29, 1992........................ 986 -- 413 453 (2) 5,214
Net income for the year............................ 941
Cash dividends declared, common, $.92 per share.... (374)
Cash dividends declared, $3.41 Depositary Share,
$3.41 per share.................................. (78)
Cash dividends declared, Series B convertible
preferred, $4.31 per share....................... (3)
Series B convertible preferred stock issued........ 157
Common issued under stock option plans............. 3 42
Common issued under performance restricted stock
plan............................................. 1
Treasury shares reissued to the Employee Savings
Plan............................................. 10
Foreign currency translation adjustment............
----- ----- ------ --------- --- --------
BALANCE AT JANUARY 27, 1993........................ 986 157 416 506 (2) 5,700
Net loss for the year.............................. (974)
Cash dividends declared, common, $.96 per share.... (392)
Cash dividends declared, $3.41 Depositary Share,
$3.41 per share.................................. (78)
Cash dividends declared, Series B convertible
preferred, $11.50 per share...................... (9)
Minimum pension liability in excess of intangible
pension asset.................................... (10)
Common issued under stock option plans............. 1 14
Common issued under performance restricted stock
plan............................................. 2 (1)
Treasury shares reissued to the Employee Savings
Plan............................................. 16
Foreign currency translation adjustment............
----- ----- ------ --------- --- --------
BALANCE AT JANUARY 26, 1994........................ $986 $ 157 $417 $ 538 $ (3) $4,237
----- ----- ------ --------- --- --------
----- ----- ------ --------- --- --------
<CAPTION>
FOREIGN
CURRENCY TOTAL
TREASURY TRANSLATION SHAREHOLDERS'
SHARES ADJUSTMENT EQUITY
-------- ----------- -------------
<S> <C> <C> <C>
BALANCE AT JANUARY 30, 1991........................ $ (131) $ (34) $ 5,384
Net income for the year............................ 859
Cash dividends declared, common, $.88 per share.... (354)
Cash dividends declared, $3.41 Depositary Share
(1/4 share Series A conversion preferred), $1.91
per share........................................ (44)
$3.41 Depositary Shares issued..................... 986
Common issued under stock option plans............. 64
Common issued under performance restricted stock
plan............................................. 2
Treasury shares reissued to the Employee Savings
Plan............................................. 1 3
Two-for-one stock split............................ --
Foreign currency translation adjustment............ (9) (9)
-------- ----------- ------
BALANCE AT JANUARY 29, 1992........................ (130) (43) 6,891
Net income for the year............................ 941
Cash dividends declared, common, $.92 per share.... (374)
Cash dividends declared, $3.41 Depositary Share,
$3.41 per share.................................. (78)
Cash dividends declared, Series B convertible
preferred, $4.31 per share....................... (3)
Series B convertible preferred stock issued........ 157
Common issued under stock option plans............. 45
Common issued under performance restricted stock
plan............................................. 1
Treasury shares reissued to the Employee Savings
Plan............................................. 8 18
Foreign currency translation adjustment............ (62) (62)
-------- ----------- ------
BALANCE AT JANUARY 27, 1993........................ (122) (105) 7,536
Net loss for the year.............................. (974)
Cash dividends declared, common, $.96 per share.... (392)
Cash dividends declared, $3.41 Depositary Share,
$3.41 per share.................................. (78)
Cash dividends declared, Series B convertible
preferred, $11.50 per share...................... (9)
Minimum pension liability in excess of intangible
pension asset.................................... (10)
Common issued under stock option plans............. 15
Common issued under performance restricted stock
plan............................................. 1
Treasury shares reissued to the Employee Savings
Plan............................................. 13 29
Foreign currency translation adjustment............ (25) (25)
-------- ----------- ------
BALANCE AT JANUARY 26, 1994........................ $ (109) $(130) $ 6,093
-------- ----------- ------
-------- ----------- ------
</TABLE>
Common stock, authorized 1,500,000,000 shares, $1 par value. Preferred stock,
authorized 10,000,000 shares, no par value.
See accompanying Notes to Consolidated Financial Statements.
V-25
<PAGE> 222
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Kmart Corporation's significant accounting policies, which conform to
generally accepted accounting principles applied on a consistent basis between
years, are described below.
Fiscal Year: Kmart Corporation's fiscal years end on the last Wednesday in
January. Fiscal years 1993, 1992 and 1991 each consisted of 52 weeks and ended
on January 26, 1994, January 27, 1993 and January 29, 1992, respectively.
Basis of Consolidation: Kmart Corporation includes all majority owned
subsidiaries in the consolidated financial statements. Investments in affiliated
retail companies owned 20% or more are accounted for by the equity method using
their December financial statements. Intercompany transactions and accounts have
been eliminated in consolidation.
Earnings Per Common and Common Equivalent Share: Kmart Corporation computes
earnings per common and common equivalent share by dividing net income less
dividends paid on Series B convertible preferred stock by the weighted average
number of shares of common stock and dilutive common stock equivalents
outstanding during each year. In determining the weighted average number of
fully diluted common shares outstanding, the Series A conversion preferred stock
has been treated as common stock.
Foreign Operations: Foreign currency assets and liabilities are translated
into U.S. dollars at the exchange rates in effect at the balance sheet date.
Results of operations are translated at average exchange rates during the period
for revenues and expenses. Translation gains and losses resulting from
fluctuations in the exchange rates are accumulated as a separate component of
shareholders' equity.
Inventories: Merchandise inventories are valued at the lower of cost or
market, primarily using the retail method, on the last-in, first-out (LIFO)
basis for substantially all domestic inventories and the first-in, first-out
basis for the remainder.
Property Owned and Depreciation: Land, buildings, leasehold improvements
and equipment are recorded at cost, including a provision for capitalized
interest. Depreciation is provided over the estimated useful lives of related
assets on the straight-line method for financial statement purposes and on
accelerated methods for income tax purposes. Most store properties are leased
and improvements are amortized over the term of the lease but not more than 25
years. Other annual rates used in computing depreciation for financial statement
purposes are 2% to 4% for buildings, 10% to 14% for store fixtures and 5% to 33%
for other fixtures and equipment.
Expenditures for owned properties, primarily self-developed locations,
which Kmart Corporation intends to sell and lease-back within one year are
included in accounts receivable and other current assets.
Goodwill: Excess of cost over the net assets of acquired companies is
amortized using the straight-line method over 40 years. Kmart Corporation
evaluates the recoverability of goodwill and reviews the amortization period on
an annual basis. Several factors are used to evaluate goodwill, including but
not limited to: management's plans for future operations; recent operating
results and each business' projected undiscounted cash flows.
Financial Instruments: With the exception of long-term debt, shareholders'
equity and equity investments, Kmart Corporation records all financial
instruments, including accounts receivable, accounts payable and marketable
securities at, or approximating, market value.
Licensee Sales: Kmart Corporation's policy is to exclude sales of licensed
departments from total sales. Sales from licensed departments are primarily
comprised of sales from the Meldisco subsidiaries of Melville Corporation.
V-26
<PAGE> 223
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Pre-Opening and Closing Costs: Costs associated with the opening of a new
store are expensed during the first full month of operations. When the decision
to close a retail unit is made, Kmart Corporation provides for the future net
lease obligation, nonrecoverable investment in fixed assets, other expenses
directly related to discontinuance of operations and estimated operating loss
through the expected closing dates.
Income Taxes: Deferred income taxes are provided on temporary differences
between financial statement and taxable income. Kmart Corporation accrues
appropriate U.S. and foreign taxes payable on all of the earnings of
subsidiaries, except with respect to earnings that are intended to be
permanently reinvested, or are expected to be distributed free of additional tax
by operation of relevant statutes currently in effect and by utilization of
available tax credits and deductions.
SPECIALTY RETAIL STOCK PROPOSAL
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue any of four series
of common stock (collectively, the Specialty Retail Stock) designated KM-
Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of the relevant specialty retail business. The Borders-Walden Stock
is intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company, Inc., subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, the Builders Square Group, the OfficeMax
Group and The Sports Authority Group are sometimes referred to collectively
herein as the Specialty Retail Groups.
STORE RESTRUCTURING AND OTHER CHARGES
On January 5, 1994, the Board approved a restructuring plan involving the
Kmart Group, (including Kmart Canada), the Builders Square Group and the
Borders-Walden Group. As a result, in the fourth quarter of 1993, Kmart
Corporation recorded a charge (Store Restructuring and Other Charges) to
earnings of $1,348 before taxes. Net of taxes, the charge was $862. The
provision included anticipated costs associated with Kmart stores which will be
closed and relocated, enlarged or refurbished in the U.S. and Canada, the
closing and relocation of certain Builders Square stores and the closing of
underperforming Walden stores. These costs, which represent approximately 85% of
the total, include lease obligations for store closings as well as fixed asset
writedowns, primarily furniture and fixtures, and inventory dispositions for all
affected stores. The remainder of the charge is for costs related to certain
changes to Walden's accounting policies in connection with combination with
Borders, re-engineering programs (principally severance) and an accrual for a
non-routine legal judgment resulting from the insolvency of the insurer.
V-27
<PAGE> 224
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
DISCONTINUED OPERATIONS
Discontinued operations include the results of PayLess Drug Stores
Northwest, Inc. and PACE Membership Warehouse, Inc. which have been reclassified
to reflect their respective plans for disposition announced in the fourth
quarter of 1993. In January 1994, PACE sold the assets and lease obligations of
93 of its warehouses and virtually all of the inventory and membership files in
the 34 warehouses not included in the transaction to Sam's Club, a division of
Wal*Mart for approximately $774 in cash. The book value of the assets sold to
Wal*Mart was $624. Operations of the 34 remaining PACE sites not included in the
transaction were discontinued and PACE is in the process of evaluating and
marketing these leased sites as well as leased premises for unopened warehouses
and corporate facilities. Included in the loss on the disposal of PACE was
unamortized goodwill, expected remaining lease obligations in the warehouses not
sold, other PACE liabilities and a provision for additional costs anticipated
during the wind-down of PACE operations.
In addition, Kmart Corporation entered into an agreement to sell its
PayLess Drug Stores subsidiary to TCH Corporation for approximately $592 in
cash, $100 in subordinated debt and 47% of the common equity of TCH Corporation.
The book value of PayLess' net assets to be sold was $1,186 at January 26, 1994.
It is anticipated that the transaction will be completed by the end of the first
quarter of 1994. It is Kmart Corporation's intention to divest its 47% interest
in TCH within one year or as soon as practicable after considering all relevant
factors including the value to be received upon such disposition. Management
expects the disposition to be achieved either through a private offering or
other alternative means. Accordingly, Kmart Corporation has reported PayLess as
a discontinued operation and has recorded its investment in TCH at net
realizable value.
Both businesses have been accounted for as discontinued operations in the
1993 financial statements. There was an $81 after-tax loss from the operation of
discontinued businesses in 1993, as the significant net operating loss at PACE
more than offset the net income from PayLess. The after-tax loss on disposal of
discontinued operations was $503. Sales applicable to these discontinued
operations were $6,874, $6,692 and $5,538 for 1993, 1992 and 1991, respectively.
EXTRAORDINARY ITEMS
Subject to the completion of the sale of its PayLess business which is
expected to be finalized in the first quarter of 1994, Kmart Corporation intends
to call for early redemption $300 of 8 3/8% debentures due January 15, 2017
using the proceeds of the sale to redeem the issues. The resulting redemption
premium and associated cost of $18, net of applicable income taxes, was recorded
in 1993 as an extraordinary item and, accordingly, the $300 principal amount has
been included in the current portion of long-term debt. In August 1993, Kmart
Corporation called for early redemption of all $200 of its 8 1/8% debentures due
January 1, 1997. The debentures were redeemed at 100% of the principal amount
plus interest accrued to the date of redemption. In April 1993, Kmart
Corporation called for early redemption of all $200 of its 10 1/2% Sinking Fund
Debentures due December 1, 2017. The resulting redemption premium of $10, net of
applicable income taxes, has been reported as an extraordinary item.
ACQUISITIONS AND DISPOSITIONS
On March 4, 1993, OfficeMax, Inc. purchased all of the outstanding shares
of BizMart, Inc. (BizMart), a chain of 105 office products superstores, for $268
in cash. During 1993, BizMart was completely integrated into OfficeMax
operations and BizMart stores converted to the OfficeMax format. The excess of
the cost over fair value of the assets acquired totaled $186.
In October 1992, Kmart Corporation acquired Borders, Inc. in a
stock-for-stock exchange in which Kmart issued 784,938 shares of Series B
convertible preferred stock in exchange for all outstanding Borders
V-28
<PAGE> 225
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
shares. Borders is headquartered in Ann Arbor, Michigan and at January 23, 1994
operated 44 book superstores in the Midwest and Northeast United States which
emphasize customer service and feature over 128,000 titles per store. Excess of
cost over the fair value of the assets acquired totaled $172.
In June 1992, OfficeMax, Inc. acquired OW Office Warehouse, Inc., a
41-store office products superstore chain with stores located primarily
throughout the Mid-Atlantic region. The excess of the purchase price over the
fair value of the net assets acquired was $61 on January 22, 1994.
In May 1992, Kmart Corporation acquired three companies which operate a
total of 13 department stores located in the Czech Republic and Slovakia. The
acquisition marks Kmart Corporation's initial entry into the Central European
retail market. No goodwill resulted from the transaction.
Net cash used in 1992 for the acquisition of Pay'n Save assets, OW Office
Warehouse, Inc. and the 13 department stores located in the Czech Republic and
Slovakia totaled $372.
In November 1991, Kmart Corporation acquired additional shares resulting in
a 92.7% equity interest in OfficeMax, Inc. for $115 in cash, with the remaining
interest owned by the co-founders and senior management of OfficeMax, Inc. The
acquisition was accounted for under the purchase method of accounting. The
excess of the cumulative purchase price over the estimated fair value of the net
assets acquired totaled $129 on January 22, 1994 and was recorded as goodwill.
Kmart Corporation currently has a % interest in OfficeMax, Inc.
With the exception of the original OfficeMax equity purchase, the above
acquisitions have been accounted for as purchases and, accordingly, the results
of operations have been consolidated from their respective dates of acquisition.
In October 1990, Kmart Canada Limited sold its Bargain Harold's Discount
Limited subsidiary to Quebec Equity Capital at book value. Under the terms of
the sale, Kmart Canada Limited guaranteed certain Bargain Harold's store leases
and a revolving credit agreement. During 1992, Bargain Harold's was placed in
bankruptcy. In 1992, Kmart Corporation recorded a net of tax, one-time charge of
$12 related to Kmart Canada's guarantee of certain Bargain Harold's leases.
SUPPLEMENTAL CASH FLOW INFORMATION
Kmart Corporation incurred capital lease obligations to obtain store
facilities and equipment of $177, $185 and $157 in 1993, 1992 and 1991,
respectively. Noncash charges related to store restructuring were $1,120, $21
and $63 in 1993, 1992 and 1991, respectively. Kmart Corporation acquired
Borders, Inc. in a stock-for-stock exchange in 1992. These noncash transactions
have been excluded from the Consolidated Statements of Cash Flows.
Kmart Corporation considers cash on hand in stores, deposits in banks,
certificates of deposit and short-term marketable securities with maturities of
90 days or less as cash and cash equivalents for the purposes of the statement
of cash flows. The effect of changes in foreign exchange rates on cash balances
is not material.
Cash paid for interest and income taxes follows:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Interest (net of amounts capitalized)................................... $465 $444 $411
---- ---- ----
---- ---- ----
Income taxes............................................................ $270 $320 $260
---- ---- ----
---- ---- ----
</TABLE>
V-29
<PAGE> 226
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
MERCHANDISE INVENTORIES
For LIFO purposes, Kmart Corporation uses internal price indices to measure
inflation in merchandise inventories.
A summary of inventories, at lower of cost or market, by method of pricing
and the excess of current cost over stated LIFO value due to inflation follows:
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 27,
1994 1993
----------- -----------
<S> <C> <C>
Last-in, first-out..................................................... $ 5,874 $ 7,456
First-in, first-out.................................................... 1,378 1,296
----------- -----------
Total inventories............................................ $ 7,252 $ 8,752
----------- -----------
----------- -----------
Excess of current cost over stated LIFO value.......................... $ 861 $ 1,030
----------- -----------
----------- -----------
</TABLE>
PROPERTY AND EQUIPMENT
The components of property and equipment are:
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 27,
1994 1993
----------- -----------
<S> <C> <C>
Property owned:
Land................................................................. $ 144 $ 204
Buildings............................................................ 451 657
Leasehold improvements............................................... 1,705 1,706
Furniture and fixtures............................................... 5,488 5,516
Construction in progress............................................. 125 85
Property under capital leases.......................................... 2,949 2,861
----------- -----------
10,862 11,029
Less-accumulated depreciation and amortization:
Property owned....................................................... (3,508) (3,206)
Property under capital leases........................................ (1,468) (1,418)
----------- -----------
Total........................................................ $ 5,886 $ 6,405
----------- -----------
----------- -----------
</TABLE>
Accumulated depreciation for owned property includes $282 and $99 of the
store restructuring provision as of January 26, 1994 and January 27, 1993,
respectively. Interest costs capitalized were $11, $14 and $10 in 1993, 1992 and
1991, respectively.
INVESTMENTS IN AFFILIATED RETAIL COMPANIES
Meldisco Subsidiaries of Melville Corporation
All U.S. Kmart footwear departments are operated under license agreements
with the Meldisco subsidiaries of Melville Corporation, substantially all of
which are 49% owned by Kmart Corporation and 51% owned by Melville. Fees and
income earned under the license agreements in 1993, 1992 and 1991 of $195,
V-30
<PAGE> 227
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
$200 and $192, respectively, are included in licensee fees and rental income.
Kmart Corporation's equity in the income of footwear departments in Kmart stores
and dividends received were as follows:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Equity in income........................................................... $52 $54 $50
---- ---- ----
---- ---- ----
Dividends.................................................................. $55 $59 $51
---- ---- ----
---- ---- ----
</TABLE>
Meldisco companies' summarized financial information follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1993 1992 1991
------ ------ ------
<S> <C> <C> <C>
Net sales........................................................... $1,175 $1,164 $1,145
------ ------ ------
------ ------ ------
Gross profit........................................................ $ 525 $ 525 $ 505
------ ------ ------
------ ------ ------
Net income.......................................................... $ 97 $ 111 $ 104
------ ------ ------
------ ------ ------
Inventory........................................................... $ 137 $ 129 $ 132
Other current assets................................................ 85 123 131
Noncurrent assets................................................... 2 2 --
------ ------ ------
Total assets........................................................ 224 254 263
Current liabilities................................................. 30 47 46
------ ------ ------
Net assets.......................................................... $ 194 $ 207 $ 217
------ ------ ------
------ ------ ------
Equity of Kmart Corporation......................................... $ 94 $ 101 $ 106
------ ------ ------
------ ------ ------
</TABLE>
Coles Myer Ltd.
Kmart Corporation had a 21.5% equity interest at January 26, 1994 in Coles
Myer Ltd., the largest retailer in Australia.
Income earned under a license agreement with Coles Myer of $3 in 1993, 1992
and 1991 is included in licensee fees and rental income. Further information
regarding Kmart Corporation's investment in Coles Myer follows:
<TABLE>
<CAPTION>
(U.S.$) 1993 1992 1991
- -------------------------------------------------------------------- ------ ------ ------
<S> <C> <C> <C>
Equity in income.................................................... $ 58 $ 51 $ 60
------ ------ ------
------ ------ ------
Dividends........................................................... $ 36 $ 34 $ 33
------ ------ ------
------ ------ ------
Equity of Kmart Corporation......................................... $ 512 $ 496 $ 488
------ ------ ------
------ ------ ------
Market value of Coles Myer common stock............................. $1,011 $ 912 $1,082
------ ------ ------
------ ------ ------
</TABLE>
The cumulative effect of translating Kmart Corporation's equity in the
investment in Coles Myer was a reduction of $100, $90 and $45, respectively, as
of January 26, 1994, January 27, 1993 and January 29, 1992. The average exchange
rates from Australian to U.S. dollars were 0.6815 in 1993, 0.7367 in 1992 and
0.7776 in 1991.
V-31
<PAGE> 228
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Summarized financial information adjusted for conformity with U.S.
generally accepted accounting principles for Coles Myer's most recent fiscal
years follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------
JULY 25, JULY 26, JULY 28,
(U.S.$) 1993 1992 1991
- ----------------------------------------------------------------- -------- -------- --------
<S> <C> <C> <C>
Net sales........................................................ $ 10,649 $ 11,634 $ 11,699
-------- -------- --------
-------- -------- --------
Net income....................................................... $ 236 $ 137 $ 254
-------- -------- --------
-------- -------- --------
Current assets................................................... $ 1,982 $ 1,927 $ 1,776
Noncurrent assets................................................ 2,013 2,123 2,435
-------- -------- --------
Total assets..................................................... $ 3,995 $ 4 ,050 $ 4,211
-------- -------- --------
-------- -------- --------
Current liabilities.............................................. $ 1,310 $ 1,327 $ 1,327
Noncurrent liabilities........................................... 719 663 1,019
Equity........................................................... 1,966 2,060 1,865
-------- -------- --------
Total liabilities and equity..................................... $ 3,995 $ 4,050 $ 4,211
-------- -------- --------
-------- -------- --------
</TABLE>
Unremitted earnings of unconsolidated affiliates included in consolidated
retained earnings were $362, $346 and $336 at January 26, 1994, January 27, 1993
and January 29, 1992, respectively.
INCOME TAXES
Components of income from continuing retail operations before income taxes
follow:
<TABLE>
<CAPTION>
1993 1992 1991
----- ------ ------
<S> <C> <C> <C>
U.S................................................................. $(621) $1,261 $1,119
Foreign............................................................. 71 66 70
----- ------ ------
Total............................................................... $(550) $1,327 $1,189
----- ------ ------
----- ------ ------
</TABLE>
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
----- ------ ------
<S> <C> <C> <C>
Current:
Federal........................................................... $ 24 $ 240 $ 246
State and local................................................... (7) 58 46
Foreign........................................................... 26 15 8
Deferred:
Store restructuring and other charges............................. (385) 29 49
Excess of tax over book depreciation.............................. 72 69 37
LIFO inventory.................................................... 82 39 36
Property taxes.................................................... (16) (12) (15)
Other............................................................. (18) 7 (7)
----- ------ ------
Total income taxes.................................................. $(222) $ 445 $ 400
----- ------ ------
----- ------ ------
</TABLE>
V-32
<PAGE> 229
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
A reconciliation of the federal statutory rate to Kmart Corporation's
effective tax rate from continuing retail operations follows:
<TABLE>
<CAPTION>
1993 1992 1991 1993 1992 1991
----- ---- ---- ------ ----- -----
<S> <C> <C> <C> <C> <C> <C>
Federal statutory rate.................... $(192) $451 $404 (35.0)% 34.0% 34.0%
State and local taxes, net of federal tax
benefit................................. (17) 38 31 (3.2) 2.9 2.6
Tax credits............................... (8) (7) (8) (1.3) (0.5) (0.7)
Equity in income of affiliated retail
companies subject to lower tax rates.... (23) (23) (32) (4.1) (1.7) (2.7)
Enacted federal tax rate change........... 11 -- -- 2.0 -- --
Other..................................... 7 (14) 5 1.2 (1.2) 0.4
----- ---- ---- ------ ----- -----
Total income taxes.............. $(222) $445 $400 (40.4)% 33.5% 33.6%
----- ---- ---- ------ ----- -----
----- ---- ---- ------ ----- -----
</TABLE>
Deferred tax assets and liabilities resulted from the following:
<TABLE>
<CAPTION>
JANUARY 26,
1994
-----------
<S> <C>
Deferred tax assets:
Federal benefit for state and foreign deferred................................. $ 33
Discontinued operations........................................................ 137
Accruals and other liabilities................................................. 214
Capital leases................................................................. 145
Store restructuring obligations................................................ 490
Other.......................................................................... 30
-----------
Total deferred tax assets.............................................. 1,049
-----------
Deferred tax liabilities:
Inventory................................................................... 338
Property and equipment...................................................... 472
Other....................................................................... 5
-----------
Total deferred tax liabilities......................................... 815
-----------
Net deferred tax assets................................................ $ 234
-----------
-----------
</TABLE>
Undistributed earnings of subsidiaries totaled $189, $195 and $188 at
January 26, 1994, January 27, 1993 and January 29, 1992, respectively.
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax liabilities to
reflect enacted changes in the statutory federal income tax rate. Kmart
Corporation adopted FAS 109 as the cumulative effect of an accounting change in
the first quarter of fiscal 1993 resulting in a one-time credit of $45.
CURRENT NOTES PAYABLE, LINES OF CREDIT AND OTHER
Notes payable of $918 and $590 were comprised entirely of Kmart
Corporation's commercial paper at January 26, 1994 and January 27, 1993,
respectively. The weighted average interest rates on short-term borrowings
outstanding on January 26, 1994 and January 27, 1993 were 3.4% and 3.2%,
respectively.
At January 26, 1994, Kmart Corporation had bank lines of credit aggregating
$1,473 which provide for interest rates not exceeding the "prime" lending rate
on any borrowings thereunder. In support of certain lines
V-33
<PAGE> 230
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
of credit, it is expected that compensating balances will be maintained on
deposit with the banks, which will average 10% of the line to the extent that it
is not in use and an additional 10% on the portion in use, whereas other lines
require fees in lieu of compensating balances. Kmart Corporation is free to
withdraw the entire balance in its accounts at any time. Additional seasonal
bank lines of credit totaling $1,260 were available during the period September
1, 1993 to December 31, 1993.
Kmart Corporation has entered into revolving credit agreements with various
banks in the aggregate amount of $790 as of January 26, 1994, and $770 as of
January 27, 1993. The agreements provide for borrowings at an interest rate
based on the prime rate, "CD-based rate" or "LIBOR-based rate" at Kmart
Corporation's election. As of January 26, 1994, Kmart Corporation had no
outstanding borrowings under these agreements. The revolving credit agreements
contain certain restrictive provisions regarding the maintenance of net worth,
working capital, coverage ratios and payment of cash dividends. At January 26,
1994, $1,859 of consolidated retained earnings were free of such restrictions.
At January 26, 1994, Kmart Corporation had an interest rate swap agreement
outstanding with a commercial bank. The agreement will expire in January 1995.
Under this agreement, Kmart Corporation pays interest on a $50 notional
principal amount based on a fixed rate. The variable rate is a calculated bond
equivalent rate based on the 30-day commercial paper rate. Kmart Corporation's
effective interest rate on this agreement during 1993 was 7.9%. Kmart
Corporation has limited exposure to credit loss for the differential between
interest rates in the event of nonperformance by the other parties.
At January 26, 1994, Kmart Corporation had a $200 line of credit and had
guaranteed an additional $200 line of credit, the proceeds of which will be used
by certain of Kmart Corporation's real estate development joint ventures. The
agreement provides for interest on the borrowings calculated on a "LlBOR-based
rate". In addition, Kmart Corporation guaranteed a related interest rate swap
with a notional principal amount of $50. As of January 26, 1994, there was $191
of borrowings outstanding under these agreements.
Kmart Corporation has also entered into certain real estate arrangements
whereby Kmart is obligated to purchase completed projects if alternate financing
is not available to the developer. Kmart Corporation's aggregate guarantees
under these arrangements, and other lease guarantees for certain facilities
previously sold, were $426 at January 26, 1994.
Kmart Corporation and Coles Myer have guaranteed indebtedness related to
certain properties in Australia on a joint and several basis. Coles Myer
subsequently indemnified Kmart Corporation from any liability incurred pursuant
to the Kmart guarantees. As of January 26, 1994, the amount guaranteed was $19.
Kmart Corporation has guaranteed indebtedness related to certain of its
leased properties financed by industrial revenue bonds. At January 26, 1994, the
total amount of such guaranteed indebtedness was $284, of which $92 was included
in capital lease obligations. The agreements will expire during fiscal years
2004 to 2009. Kmart Corporation's exposure to credit loss, in the event of
nonperformance by the other parties to the agreements, was $192 at January 26,
1994. However, no concentration of credit risk exists and Kmart Corporation does
not anticipate nonperformance by the other parties.
There are various claims, lawsuits, and pending actions against Kmart
Corporation incident to its operations. It is the opinion of management that the
ultimate resolution of these matters will not have a material effect on Kmart
Corporation's liquidity, financial position or results of operations.
V-34
<PAGE> 231
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
LONG-TERM DEBT
Kmart Corporation's long-term debt, net of unamortized discount, is
comprised of the following:
<TABLE>
<CAPTION>
JANUARY 26, 1994 JANUARY 27, 1993
---------------- ----------------
<S> <C> <C>
8 3/8% debentures due 2017...................................... $ 300 $ 291
10 1/2% debentures due 2017..................................... -- 200
8 1/8% debentures due 1997...................................... -- 199
12 1/8% notes due 1995.......................................... 150 150
8 1/8% notes due 2006........................................... 199 199
8 1/4% notes due 2022........................................... 99 99
12 1/2% debentures due 2005..................................... 100 100
8 3/8% debentures due 2022...................................... 99 99
7 3/4% debentures due 2012...................................... 198 198
7.95% debentures due 2023....................................... 299 --
Notes payable................................................... -- 300
Medium-term notes due 1994 through 2020
(8.33% weighted average interest rate)..................... 745 835
Mortgages....................................................... 330 522
Other........................................................... 98 162
------- -------
Total................................................. 2,617 3,354
Portion due within one year..................................... 390 117
------- -------
Long-term debt.................................................. $2,227 $3,237
------- -------
------- -------
</TABLE>
Kmart Corporation plans to call for early redemption in the first quarter
of 1994 of all $300 of its 8 3/8% debentures due January 15, 2017. The resulting
redemption premium and associated cost of $18, net of applicable taxes, has been
reported as an extraordinary item.
In August 1993, Kmart Corporation called for early redemption of all $200
of its 8 1/8% debentures due January 1, 1997. The debentures were redeemed at
100% of the principal amount plus interest accrued to the date of redemption. In
April 1993, Kmart Corporation called for early redemption of all $200 of its
10 1/2% Sinking Fund Debentures due December 1, 2017. The resulting redemption
premium of $10, net of applicable income taxes, has been reported as an
extraordinary item.
In February 1993, Kmart Corporation issued $300 of 7.95% debentures due
February 1, 2023. These debentures are not redeemable prior to maturity.
During fiscal 1992, Kmart Corporation issued mortgage notes payable of
$211. The notes bear a weighted average interest rate of 8.41%. For most of
these mortgage notes, interest is payable semiannually, and principal is payable
annually through the year 2022. The notes are secured by various owned
properties.
In October 1992, Kmart Corporation issued $200 of 7 3/4% debentures due
October 1, 2012. The 7 3/4% debentures are not redeemable prior to maturity. In
July 1992, Kmart Corporation issued $100 of 8 3/8% debentures due July 1, 2022.
The 8 3/8% debentures are not redeemable prior to July l, 2002. On or after that
date, the debentures are redeemable in whole or in part, at any time at the
option of Kmart Corporation, at prices declining from 103.9% to 100% of the
principal amount. At January 27, 1993, Kmart Corporation's revolving credit
agreements supported $300 of commercial paper which has been classified as
long-term debt. Amounts classified as long-term debt are based on Kmart
Corporation's intention and ability to maintain at least that amount of similar
debt for a minimum of one year.
V-35
<PAGE> 232
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
During 1992, Kmart Corporation issued $200 of medium-term notes with a
weighted average interest rate of 7.38% with maturity dates from seven to 12
years.
Principal payments due on long-term debt for the five years subsequent to
1993 are: 1994 -- $390; 1995 -- $233; 1996 -- $8; 1997 -- $153; 1998 -- $122.
Based on the quoted market prices for the same, or similar issues, or on
the current rates offered to Kmart Corporation for debt of the same remaining
maturities, the fair value of long-term debt was $2,923 and $3,656 at January
26, 1994 and January 27, 1993, respectively.
LEASES
Description of Leasing Arrangements: Kmart Corporation conducts operations
primarily in leased facilities. Kmart store leases are generally for terms of 25
years with multiple five-year renewal options which allow Kmart Corporation the
option to extend the life of the lease up to 50 years beyond the initial
noncancellable term. Substantially all specialty retail units are leased,
generally for terms varying from five to 25 years with varying renewal options.
Certain leases provide for additional rental payments based on a percent of
sales in excess of a specified base. Also, certain leases provide for the
payment by the lessee of executory costs (taxes, maintenance and insurance).
Some selling space has been sublet to other retailers in certain of Kmart
Corporation's leased facilities.
Lease Commitments: Future minimum lease payments with respect to capital
and operating leases as of January 26, 1994 follow:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1994................................................................. $ 393 $ 776
1995................................................................. 384 746
1996................................................................. 379 704
1997................................................................. 368 661
1998................................................................. 352 630
Later years.......................................................... 3,221 6,643
------- ---------
Total minimum lease payments.................................... 5,097 10,160
Less-minimum sublease rental income....................................... -- 173
------- ---------
Net minimum lease payments................................................ 5,097 $ 9,987
---------
---------
Less:
Estimated executory costs............................................ (1,488)
Amount representing interest......................................... (1,773)
-------
1,836
Portion due within one year............................................... 116
-------
Long-term lease obligations............................................... $ 1,720
-------
-------
</TABLE>
V-36
<PAGE> 233
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Rental Expense: A summary of operating lease rental expense and short-term
rentals follows:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Minimum rentals...................................................... $ 815 $ 635 $ 533
Percentage rentals................................................... 47 50 53
Less-sublease rentals................................................ (94) (63) (55)
----- ----- -----
Total................................................................ $ 768 $ 622 $ 531
----- ----- -----
----- ----- -----
</TABLE>
Reconciliation of Capital Lease Information: The impact of recording
amortization and interest expense versus rent expense on capital leases follows:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Amortization of capital lease property............................... $ 117 $ 113 $ 109
Interest expense related to obligations under capital leases......... 192 185 181
----- ----- -----
Amounts charged to earnings.......................................... 309 298 290
Related minimum lease payments net of executory costs................ (306) (294) (283)
----- ----- -----
Excess of amounts charged over related minimum lease payments........ $ 3 $ 4 $ 7
----- ----- -----
----- ----- -----
</TABLE>
Related minimum lease payments above exclude executory costs for 1993, 1992
and 1991 in the amounts of $91, $96 and $92, respectively.
V-37
<PAGE> 234
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
BUSINESS GROUP INFORMATION
Upon approval and implementation by the Board of the Specialty Retail Stock
Proposal, the capital structure of Kmart Corporation will be modified to provide
for the issuance of five series of common stock: Kmart Stock, Borders-Walden
Stock, Builders Square Stock, OfficeMax Stock and The Sports Authority Stock,
which are each intended to reflect the performance of the respective business.
Kmart Corporation's historical business group operating results have been
revised to conform to the Specialty Retail Stock Proposal. Business group
information follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME (LOSS)
TOTAL FROM
EQUITY IN REVENUES EQUITY IN CONTINUING
LICENSEE INCOME OF FROM INCOME OF NET RETAIL OPERATIONS
FEES AND AFFILIATED CONTINUING OPERATING AFFILIATED INTEREST BEFORE RETAINED
OTHER RETAIL RETAIL INCOME RETAIL INCOME INTEREST AND
YEAR SALES INCOME COMPANIES OPERATIONS (LOSS)(A) COMPANIES (EXPENSE) INCOME TAXES
----- ------- --------- ---------- ----------- ---------- ---------- ---------- -----------------
Kmart
Group:...... 1993 $28,039 $ 288 $110 $28,437 $ 110 $110 $ (467) $ (247)
1992 26,470 278 105 26,853 1,500 105 (411) 1,194
1991 25,548 266 110 25,924 1,348 110 (381) 1,077
Borders-Walden
Group:...... 1993 1,370.0 0.6 -- 1,370.6 (167.8) -- (0.9) (168.7)
1992 1,201.9 1.4 -- 1,203.3 46.1 -- (0.6) 45.5
1991 1,139.4 0.7 -- 1,140.1 37.6 -- (0.5) 37.1
Builders
Square
Group:...... 1993 2,718.8 -- -- 2,718.8 (165.7) -- (8.7) (174.4)
1992 2,419.5 -- -- 2,419.5 80.0 -- (3.5) 76.5
1991 2,048.5 -- -- 2,048.5 73.8 -- (2.7) 71.1
OfficeMax
Group:...... 1993 1,421.8 -- -- 1,421.8 20.0 -- (0.1) 19.9
1992 528.2 -- -- 528.2 0.5 -- 0.5 1.0
1991 65.1 -- -- 65.1 0.9 -- 0.3 1.2
The Sports
Authority
Group:...... 1993 606.9 1.7 -- 608.6 21.0 -- -- 21.0
1992 411.5 0.9 -- 412.4 10.1 -- (0.1) 10.0
1991 240.9 0.4 -- 241.3 3.4 -- (0.2) 3.2
Total Kmart
Corporation:... 1993 $34,156 $ 291 $110 $34,557 $ (183) $110 $ (477) $ (550)
1992 31,031 280 105 31,416 1,636 105 (414) 1,327
1991 29,042 267 110 29,419 1,463 110 (384) 1,189
</TABLE>
- -------------------------
(a) Operating income (loss) includes store restructuring and other charges of
$904, $218, $226 and $1,348 for the Kmart Group, the Borders-Walden Group,
the Builders Square Group and Kmart Corporation, respectively.
V-38
<PAGE> 235
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
RETAINED INVESTMENTS
INTEREST IN IN CAPITAL
THE SPECIALTY AFFILIATED ASSETS OF DEPRECIATION EXPENDITURES--
IDENTIFIABLE RETAIL RETAIL DISCONTINUED TOTAL AND OWNED AND
YEAR ASSETS GROUPS COMPANIES OPERATIONS ASSETS AMORTIZATION LEASED
---- ------------ ------------- ----------- ------------ -------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Kmart Group:......... 1993 $ 12,602 $ 1,746 $ 606 $911 $ 15,865 $ 591 $ 936
1992 15,792 1,412 597 68 17,869 517 1,452
1991 13,531 1,154 600 69 15,354 443 1,391
Borders-Walden
Group:............. 1993 1,001.6 -- -- -- 1,001.6 41.0 71.0
1992 913.6 -- -- -- 913.6 35.6 33.5
1991 659.5 -- -- -- 659.5 33.2 20.3
Builders Square
Group:............. 1993 1,130.1 -- -- -- 1,130.1 35.3 111.5
1992 876.8 -- -- -- 876.8 29.6 86.9
1991 679.8 -- -- -- 679.8 27.5 52.0
OfficeMax
Group:............. 1993 1,009.7 -- -- -- 1,009.7 26.3 57.3
1992 448.6 -- -- -- 448.6 9.9 21.2
1991 275.1 -- -- -- 275.1 1.1 5.8
The Sports
Authority Group:... 1993 297.8 -- -- -- 297.8 10.2 23.5
1992 236.4 -- -- -- 236.4 7.2 26.5
1991 185.2 -- -- -- 185.2 4.4 16.3
Eliminations:........ 1993 (53.9)(a) (1,746) -- -- (1,800.0) -- --
1992 -- (1,412) -- -- (1,412) -- --
1991 -- (1,154) -- -- (1,154) -- --
Total Kmart
Corporation:....... 1993 $ 15,987 -- $ 606 $911 $ 17,504 $ 703 $ 1,199(b)
1992 18,266 -- 597 68 18,931 600 1,620
1991 15,330 -- 600 69 15,999 509 1,486
</TABLE>
- -------------------------
(a) Represents reclassification of deferred tax balances for individual
financial statements.
(b) Leased asset additions for Kmart Corporation were $177, $185 and $157 for
1993, 1992 and 1991, respectively.
PENSION PLANS
Kmart Corporation and its domestic subsidiaries have non-contributory
pension plans covering most employees who meet certain requirements of age,
length of service and hours worked per year. Benefits paid to retirees are based
upon age at retirement, years of credited service and earnings. Kmart Canada
Limited employees are covered by a defined contribution plan. Kmart
Corporation's policy is to fund at least the minimum amounts required by the
Employee Retirement Income Security Act of 1974. The plans' assets consist
primarily of equity securities, fixed income securities, guaranteed insurance
contracts and real estate. Kmart Corporation contributed $86 to its principal
pension plan during fiscal 1991 but was not required to contribute to its
principal pension plan in fiscal 1993 or fiscal 1992. Pension expense was $68 in
1993, $53 in 1992 and $53 in 1991.
V-39
<PAGE> 236
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
For Kmart Corporation's principal pension plans, the following tables
summarize the funded status, components of pension cost and actuarial
assumptions:
<TABLE>
<CAPTION>
JANUARY 26, 1994
----------------------------------
PLANS WHOSE PLANS WHOSE
ASSETS EXCEEDED ACCUMULATED
ACCUMULATED BENEFITS
BENEFITS EXCEEDED ASSETS JANUARY 27, 1993
--------------- --------------- ----------------
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits...... $(1,438) $ (32) $ (1,103)
Estimated present value of non-vested
benefits..................................... (156) (3) (148)
--------------- --------------- ----------------
Accumulated benefit obligation.................. (1,594) (35) (1,251)
Value of future pay increases................... (247) (4) (265)
--------------- --------------- ----------------
Projected benefit obligation.................... (1,841) (39) (1,516)
Estimated market value of plan assets............. 1,490 -- 1,388
--------------- --------------- ----------------
Plan assets under projected benefit obligation.... (351) (39) (128)
Unrecognized net asset............................ (106) 3 (111)
Unrecognized prior service cost................... 46 4 55
Unrecognized net loss and other................... 227 14 32
Adjustment required to recognize minimum
liability....................................... -- (17) --
--------------- --------------- ----------------
Accrued pension costs............................. $ (184) $ (35) $ (152)
--------------- --------------- ----------------
--------------- --------------- ----------------
</TABLE>
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Components of pension expense:
Normal service cost................................................ $ 65 $ 56 $ 50
Interest cost on projected benefit obligation...................... 132 119 104
Return on plan assets.............................................. (159) (117) (194)
Net amortization and deferral of other components.................. 27 (8) 88
----- ----- -----
Total................................................................ $ 65 $ 50 $ 48
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates..................................................... 7.25% 8.50% 8.75%
Expected return on plan assets..................................... 9.50% 9.50% 9.50%
Salary increases................................................... 4.50% 5.00% 5.00%
</TABLE>
Under the provisions of Financial Accounting Standard No. 87 (FAS 87),
"Employers' Accounting for Pensions," Kmart Corporation is required to record an
unfunded pension liability when accumulated benefit obligation exceeds plan
assets. This liability is partially offset by an intangible pension asset, with
the intangible asset being limited to the amount of unrecognized prior service
cost, including unamortized transition obligation. At January 26, 1994, the
unfunded pension liability exceeded the intangible pension asset by $10. FAS 87
requires this excess to be recorded as a reduction in shareholders' equity.
OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS
Kmart Corporation adopted Financial Accounting Standard No. 106 "Employers'
Accounting for Postretirement Benefits Other Than Pensions" (FAS 106) at the
beginning of fiscal 1993. This statement requires Kmart Corporation to accrue
for future postretirement medical benefits. In prior years, these claims were
expensed when paid. Net of applicable tax, a charge of $79, or $.18 per share,
was included in net income as the effect of an accounting change in 1993.
V-40
<PAGE> 237
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
In addition to Kmart Corporation's defined benefit pension plan, Kmart
Corporation sponsors a defined benefit health care plan that offers
postretirement medical benefits to full-time employees who have worked 10 years
and who have retired after age 55, with the option of participation in Kmart
Corporation's medical plan, until age 65. The plan is contributory, with retiree
contributions adjusted annually. The accounting for the plan anticipates future
cost-sharing changes to the written plan that are consistent with Kmart
Corporation's expressed intent to increase the retiree contribution rate
annually for the expected general inflation rate for that year. In 1993, Kmart
Corporation amended its plan to limit retiree benefits to 150% of average per
capita benefits.
The following table sets forth the plans' funded status reconciled with
amounts shown in the balance sheet.
<TABLE>
<CAPTION>
JANUARY 26,
1994
-----------
<S> <C>
Accumulated postretirement benefit obligation:
$ 7
Retirees........................................................................
24
Fully eligible active plan participants.........................................
43
Other active plan participants..................................................
-----------
74
--
Plan assets at fair value.........................................................
-----------
74
Accumulated postretirement benefit obligation in excess of plan assets............
41
Unrecognized prior service cost...................................................
(6)
Unrecognized net gain.............................................................
-----------
$ 109
Accrued postretirement benefit cost...............................................
-----------
-----------
1993
Net periodic postretirement benefit cost includes the following components:
-----------
$ 3
Service cost......................................................................
7
Interest cost.....................................................................
--
Actual return on plan assets......................................................
(4)
Net amortization and deferral.....................................................
-----------
$ 6
Net periodic postretirement benefit cost........................................
-----------
-----------
</TABLE>
The weighted-average annual assumed rate of increase in the per capita cost
of covered benefits (i.e., health care cost trend rate) is 11.3% in 1994. This
rate is assumed to decrease gradually to 5.25% by 2002 and remain at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amounts reported. For example, increasing the assumed health care cost
trend rates by one percentage point in each year would increase the accumulated
postretirement benefit obligations as of January 26, 1994, by 0.2%, and the
aggregate of the service and interest cost components of net periodic
postretirement benefit cost for fiscal 1993 by 2.28%.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation at January 26, 1994 was 7.25%.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106 for similar benefits provided to
terminated or laid-off employees such as salary extension, severance, disability
and supplemental unemployment benefits. The effect of this statement is not
significant.
V-41
<PAGE> 238
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
SHAREHOLDERS' EQUITY
In October 1992, Kmart Corporation issued 784,938 shares of Series B
convertible preferred stock in exchange for all the outstanding stock of
Borders, Inc. Each share of Series B preferred stock is convertible by the
holders at any time into 6.49 shares of common stock, subject to adjustment in
certain events, and is redeemable into common stock by Kmart Corporation after
November 1, 1999 at a redemption rate based on the then-current market price of
the common stock. In addition, the holders of such stock have the right to
compel Kmart Corporation to call 50% of the outstanding stock for redemption
into common stock after November 1, 1997, and to call 100% of the outstanding
stock after November 1, 2002, at a redemption rate based on the then-current
market price of the common stock. The preferential dividend is $11.50 per share,
subject to adjustment between November 1, 1996 and October 31, 1998 if the
market price of the common stock reaches a specified level. Common shares
totaling 5,092,050 have been reserved for the conversion or redemption of the
Series B convertible preferred shares.
In August 1991, Kmart Corporation sold 23,000,000 $3.41 Depositary Shares,
each representing one-quarter of a share of Series A conversion preferred stock,
for $44 per Depositary Share. Unless called for redemption prior to September
15, 1994, each of the outstanding Depositary Shares will automatically convert
into two shares of common stock of Kmart Corporation, subject to adjustment in
certain events, on that date. The mandatory conversion factor and Kmart's
criteria for redemption of the Depositary Shares have been adjusted to reflect
the common stock split distributed June 5, 1992. A total of 46,000,000 shares of
common stock have been reserved for the conversion or redemption of the Series A
conversion preferred shares.
The holders of the Depositary Shares have the right to direct the
Depositary to vote the Series A conversion preferred shares represented by their
Depositary Shares in the election of directors and upon each matter coming
before the meeting of the shareholders on the basis of one vote for every four
Depositary Shares held. The holders of Series B convertible preferred stock have
the right to vote upon such matters on the basis of one vote per share held. The
holders of Series A conversion preferred stock, the holders of Series B
convertible preferred stock and the holders of common stock vote together as one
class except as otherwise required by the Articles of Incorporation.
The Series A conversion preferred stock and the Series B convertible
preferred stock rank senior to the common stock upon liquidation with respect to
the amounts to which such preferred shareholders are entitled.
Ten million shares of no par value preferred stock with voting and
cumulative dividend rights are authorized; 5,750,000 are issued as Series A
conversion preferred stock, 784,938 are issued as Series B convertible preferred
stock and 3,465,062 are unissued. Of the unissued, 500,000 shares have been
designated Series A junior participating preferred stock.
Each share of outstanding common stock includes a right which entitles the
holder to one-thousandth of a share of Series A junior participating preferred
stock at an exercise price of $110, or to purchase, at the right's then-current
exercise price, common shares having a value twice the right's exercise price.
The rights are exercisable only if a person or group acquires, or attempts to
acquire, ownership of 20% or more of Kmart Corporation's common stock, or, if
the person or group acquires 10% of Kmart Corporation's common stock and the
Board of Directors of Kmart Corporation determines that such ownership is
adverse to the long-term interests of Kmart Corporation and its shareholders.
V-42
<PAGE> 239
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Common and treasury shares outstanding and related changes for the three
years ended January 26, 1994, January 27, 1993 and January 29, 1992 are as
follows:
<TABLE>
<CAPTION>
1993 1992 1991
---------- ---------- ----------
<S> <C> <C> <C>
Common Shares -- Including Treasury Shares
Beginning of the year............................. 415,640,206 413,072,028 409,421,174
Sold under stock option plans..................... 741,053 2,500,110 3,548,640
Issued under performance restricted stock plan.... 192,526 101,820 117,836
Issued under directors stock plan................. 1,950 1,481 --
Forfeited or withheld under performance restricted
stock plan..................................... (28,955) (35,233) (15,622)
Retirement of shares, at cost..................... -- -- --
---------- ---------- ----------
End of the year................................... 416,546,780 415,640,206 413,072,028
---------- ---------- ----------
---------- ---------- ----------
Treasury Shares
Beginning of the year............................. 8,756,822 9,537,456 9,723,724
Retirement of shares, at cost..................... -- -- --
Reissue of shares for the Employee Savings Plan... (1,288,258) (780,634) (186,268)
---------- ---------- ----------
End of the year................................... 7,468,564 8,756,822 9,537,456
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
EMPLOYEE SAVINGS PLAN
The Employee Savings Plan provides that employees of Kmart Corporation and
certain subsidiaries who have attained age 21 and completed one "Year of
Service" can invest from 2% to 16% of their earnings in the employee's choice of
a growth equity fund, a balanced equity fund, a managed income fund or a Kmart
common stock fund. For each dollar the employee invests up to 6% of his or her
earnings, Kmart Corporation will contribute an additional 50 cents which is
invested in the Employee Stock Ownership Plan (ESOP).
As of June 17, 1986, 11,035,500 shares of Kmart common stock were made
available for issuance or sale to the Trustee, consisting of 5,035,500 treasury
shares and 6,000,000 authorized but unissued shares and, as of January 18, 1994,
7,467,600 treasury shares of Kmart common stock were made available for issuance
or sale to the Trustee. As of January 26, 1994, 13,468,564 common shares
remained available. Kmart Corporation's expense related to the Employee Savings
Plan was $48 for 1993, $47 for 1992 and $45 for 1991.
PERFORMANCE RESTRICTED STOCK PLAN
Under the Performance Restricted Stock Plan, the Compensation and
Incentives Committee may grant awards for up to 4,000,000 shares of common stock
to officers and other key employees of Kmart Corporation and its subsidiaries
through March 21, 1998. The shares are issued only if specified performance
goals are achieved. The shares are issued as restricted stock and are held in
the custody of Kmart Corporation for a period up to three years. If conditions
or terms under which an award is granted are not satisfied, the shares are
forfeited. At January 26, 1994, outstanding awards and shares available for
grant totaled 839,602 and 2,891,298 respectively. Kmart Corporation recorded $3,
$4 and $3 of compensation expense related to the Performance Restricted Stock
Plan in 1993, 1992 and 1991, respectively.
STOCK OPTION PLANS
Under the 1992 Stock Option Plan, the Compensation and Incentives Committee
may grant options to acquire shares of common stock to officers and other key
employees of Kmart Corporation and its subsidiaries at no less than 100% of the
fair market value of the common stock on the date of grant. Such options may be
V-43
<PAGE> 240
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
either incentive stock options (ISOs) with a maximum term of ten years pursuant
to Section 422 of the Internal Revenue Code or non-qualified stock options with
a maximum term of 10 years and two days (NQSOs). Options become exercisable
three years after the date of grant for the 1992 Stock Option Plan and two years
after the date of grant for the 1973 and 1981 Stock Option Plans. The ability to
grant options under the 1973 and 1981 Plans expired in August 1991 according to
the terms of those Plans.
Shares of common stock authorized for issuance under the 1992, 1981 and
1973 Stock Option Plans were 20,000,000, 24,000,000 and 21,000,000,
respectively. Payment upon exercise of an option may be made in cash, already
owned shares or a combination of both according to the terms of those Plans.
Pertinent information covering the Plans follows:
<TABLE>
<CAPTION>
1993 1992
-------------------------- --------------------------
NUMBER OPTION PRICE NUMBER OPTION PRICE
OF SHARES PER SHARE OF SHARES PER SHARE
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year......... 19,489,867 $9.90-$26.03 20,220,670 $6.44-$23.03
Granted.................................. 3,700,600 24.06 2,191,588 26.03
Exercised................................ (791,425) 9.90-21.94 (2,564,045) 9.90-21.94
Cancelled................................ (303,875) 9.90-26.03 (358,346) 6.44-26.03
---------- ----------
Outstanding at end of year............... 22,095,167 $9.90-$26.03 19,489,867 $9.90-$26.03
---------- ----------
---------- ----------
Exercisable at end of year............... 16,238,867 $9.90-$23.41 11,627,867 $9.90-$21.94
---------- ----------
---------- ----------
Available for grant at end of year....... 14,143,700 17,704,000
---------- ----------
---------- ----------
</TABLE>
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Each of the quarters includes 13 weeks.
<TABLE>
<CAPTION>
QUARTER
----------------------------------------
1993 FIRST SECOND THIRD FOURTH
- ------------------------------------------------------- ------ ------ ------ -------
<S> <C> <C> <C> <C>
Gross revenue from continuing retail operations........ $7,415 $8,539 $8,183 $10,420
Cost of merchandise sold............................... 5,466 6,309 5,987 7,884
Net income (loss) from continuing retail operations
before extraordinary items and the effect of
accounting changes................................... 58 125 104 (615)
Discontinued operations including the effect of
accounting changes, net of income taxes.............. 7 (23) (10) (55)
Loss on disposal of discontinued operations, net of
income taxes......................................... -- -- -- (503)
Extraordinary items, net of income taxes............... (10) -- -- (18)
Effect of accounting changes, net of income taxes...... (32) -- -- (2)
------ ------ ------ -------
Net income (loss)...................................... $ 23 $ 102 $ 94 $(1,193)
------ ------ ------ -------
------ ------ ------ -------
Earnings per common and common equivalent share:
Net income (loss) from continuing retail operations
before extraordinary items and the effect of
accounting changes................................ $ .12 $ .27 $ .22 $ (1.35)
Discontinued operations including the effect of
accounting changes, net of income taxes........... .02 (.05) (.02) (.12)
Loss on disposal of discontinued operations, net of
income taxes...................................... -- -- -- (1.10)
Extraordinary items, net of income taxes............. (.02) -- -- (.04)
Effect of accounting changes, net of income taxes.... (.07) -- -- --
------ ------ ------ -------
Net income (loss).................................... $ .05 $ .22 $ .20 $ (2.61)
------ ------ ------ -------
------ ------ ------ -------
</TABLE>
V-44
<PAGE> 241
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
QUARTER
----------------------------------------
1992 FIRST SECOND THIRD FOURTH
- ------------------------------------------------------- ------ ------ ------ -------
<S> <C> <C> <C> <C>
Gross revenue from continuing retail operations........ $6,880 $7,663 $7,266 $ 9,607
Cost of merchandise sold............................... 5,017 5,613 5,311 6,859
Net income from continuing retail operations........... 106 160 116 500
Discontinued operations................................ .10 .08 .06 .35
------ ------ ------ -------
Net income............................................. $ 116 $ 168 $ 122 $ 535
------ ------ ------ -------
------ ------ ------ -------
Earnings per common and common equivalent share:
Net income from continuing retail operations......... $ .24 $ .35 $ .26 $ 1.08
Discontinued operations.............................. .02 .02 .01 .07
------ ------ ------ -------
Net income........................................... $ .26 $ .37 $ .27 $ 1.15
------ ------ ------ -------
------ ------ ------ -------
</TABLE>
Net income for the fourth quarters of 1993 and 1992 include net LIFO
credits of $44 and $48, respectively.
Previously published quarterly financial data have been restated for
discontinued operations.
Quarterly Stock Market Information and Dividend Highlights:
<TABLE>
<CAPTION>
QUARTER
----------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
<S> <C> <C> <C> <C>
1993
Dividends paid per common share.................................. $.23 $.24 $.24 $.24
Common stock price range*
High........................................................... 25 23 5/8 24 1/4 24 7/8
Low............................................................ 22 3/8 19 7/8 20 21
</TABLE>
<TABLE>
<CAPTION>
QUARTER
----------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
<S> <C> <C> <C> <C>
1992
Dividends paid per common share.................................. $.22 $.23 $.23 $.23
Common stock price range*
High........................................................... 27 26 1/2 25 1/2 27 3/4
Low............................................................ 22 5/8 21 3/8 21 1/2 23 7/8
</TABLE>
- -------------------------
* Calendar quarters.
As of January 26, 1994, there were 85,920 Kmart Corporation shareholders of
record. Kmart Corporation common stock is listed on the New York, Pacific and
Chicago stock exchanges (trading symbol KM).
V-45
<PAGE> 242
ANNEX VI
KMART GROUP
<TABLE>
<S> <C>
Selected Financial Data........................................................... VI- 2
Management's Discussion and Analysis of Financial Condition and Results of VI- 3
Operations......................................................................
Business Description.............................................................. VI-21
Combined Financial Statements..................................................... VI-25
</TABLE>
VI-1
<PAGE> 243
KMART GROUP
SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated reflect the
results of operations and financial position of the businesses that comprise the
Kmart Group. The information set forth below should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the combined financial statements and notes thereto included in
this Annex VI. The issuance of Kmart Stock pursuant to the Specialty Retail
Stock Proposal has not been reflected in these financial statements.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
---------------------------------------------------
JAN. JAN. JAN. JAN. JAN.
26, 27, 29, 30, 31,
1994(1) 1993 1992 1991 1990(2)
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (MILLIONS)
Sales.......................................... $28,039 $26,470 $25,548 $25,058 $24,865
Gross margin................................... 7,064 7,140 6,962 6,785 6,722
Selling, general and administrative expenses... 6,338 5,918 5,880 5,783 5,688
Operating income............................... 110 1,500 1,348 1,259 667
Interest expense -- net........................ 467 411 381 381 349
Income (loss) from continuing retail operations
before Retained Interests in the Specialty
Retail Groups and income taxes............... (247) 1,194 1,077 991 423
Net income (loss) from continuing retail
operations before extraordinary items and the
effect of accounting changes (3)............. (282) 879 785 696 274
Net income (loss).............................. (925) 938 855 741 315
PERCENT OF SALES DATA
Gross margin................................... 25.2% 27.0% 27.3% 27.1% 27.0%
Selling, general and administrative expenses... 22.6 22.4 23.0 23.1 22.9
Operating income............................... 0.4 5.7 5.3 5.0 2.7
Income (loss) from continuing retail operations
before Retained Interests in the Specialty
Retail Groups and income taxes............... (0.9) 4.5 4.2 4.0 1.7
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital................................ $ 3,467 $ 4,470 $ 4,108 $ 2,934 $ 3,164
Total assets................................... 15,865 17,869 15,354 13,456 12,721
Total debt..................................... 2,591 3,332 2,322 1,748 1,486
Kmart Group equity............................. 6,093 7,484 6,842 5,339 4,944
SELECTED FINANCIAL AND OPERATING DATA
End of year stores -- U.S. Kmart............... 2,323 2,281 2,249 2,205 2,194
Comparable store sales increase -- U.S.
Kmart........................................ 3.8% 1.5% 2.2% 1.3% 2.0%
Weighted average sales per square foot --
U.S. Kmart................................... $ 182 $ 181 $ 186 $ 189 $ 191
Capital expenditures -- owned property
(millions)................................... 793 1,297 1,245 750 569
Depreciation and amortization (millions)....... 591 517 443 405 389
</TABLE>
- -------------------------
(1) Results of operation for fiscal 1993 include a pre-tax provision of $904
million ($578 million net of tax) for store restructuring and other charges.
(2) Results of operations for fiscal 1989 include a pre-tax provision of $618
million ($408 million net of tax) for store restructuring and other charges.
(3) Net income (loss) from continuing retail operations before extraordinary
items and the effect of accounting changes, includes ($145 million), $83
million, $66 million, $34 million and $1 million in fiscal 1993, 1992, 1991,
1990 and 1989, respectively, of net income (loss) related to Retained
Interests in the Specialty Retail Groups.
VI-2
<PAGE> 244
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The Kmart Group is one of the world's largest mass merchandise retailers.
The dominant portion of the Kmart Group's business is the operation of a chain
of 2,323 Kmart discount stores with locations in each of the 50 United States
and Puerto Rico at January 26, 1994. Internationally, the Kmart Group has
operations in Canada, the Czech Republic and Slovakia and has formed joint
ventures in Mexico and Singapore. The Central European stores were acquired in
mid-1992 and represent the Kmart Group's entry into that market. The Kmart Group
is developing advanced distribution methods and merchandising skills to
modernize, refurbish and streamline operations in the two Central European
countries. The Kmart Group also holds significant equity interests in Coles Myer
Ltd., Australia's largest retailer, and substantially all of the Meldisco
subsidiaries of Melville Corporation, which operate the footwear departments in
domestic Kmart stores. The Kmart Group is also attributed a 100% Retained
Interest in each of the following Specialty Retail Groups: the Borders-Walden
Group, the Builders Square Group, the OfficeMax Group and The Sports Authority
Group. The Kmart Group also includes the operations of PayLess Drug Stores,
which is subject to a definitive sale agreement, and PACE Membership Warehouse
substantially all of which assets were sold in January 1994, each of which have
been presented as discontinued operations in the combined financial statements.
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue any of four series
of common stock (collectively, the Specialty Retail Stock) designated
KM-Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of the relevant specialty retail business. The Borders-Walden Stock
is intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company, Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, the Builders Square Group, the OfficeMax
Group and The Sports Authority Group are sometimes referred to collectively
herein as the Specialty Retail Groups.
RESULTS OF OPERATIONS
Sales increased 5.9% to a record $28.0 billion in 1993, compared to $26.5
billion in 1992 and $25.5 billion in 1991. Comparable store sales increased 3.6%
and 1.5% in 1993 and 1992, respectively. Refer to the analysis of the Kmart
Group's operations below.
Cost of merchandise sold, including buying and occupancy costs, as a
percent of sales was 74.8% in 1993 as compared with 73.0% in 1992 and 72.7% in
1991. Although there was competitive pricing pressure in both hardlines and
softlines throughout the year, the increase of 1.8% of sales in 1993 resulted
primarily from the U.S. Kmart inventory reduction program and increased
markdowns at the Kmart Fashions division. As a result of Kmart's inventory
management program, which included the use of automated replenishment systems in
hardline departments, 1993 gross margins were effected by the significant 1993
inventory reduction and the resulting change in the mix of merchandise
purchased, primarily in the fourth quarter of 1993, as
VI-3
<PAGE> 245
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
compared to 1992. At January 26, 1994, first-in, first-out (FIFO) inventory of
the U.S. Kmart stores was down $720 million, or 10.4%, from the prior year. In
addition, the sales mix in U.S. Kmart stores was more skewed toward lower margin
items in 1993 than in the prior year. The 0.3% increase in cost of merchandise
sold as a percent of sales from 1991 was due to increased clearance markdowns of
spring and summer merchandise lines in U.S. Kmart stores, especially apparel,
and competitive pressure on gross margins.
Substantially all of the Kmart Group's domestic inventories are measured
using the last-in, first-out (LIFO) method of inventory valuation. In 1993 and
1992, the inflationary impact on inventories contributed to pre-tax LIFO credits
of $66 million and $44 million, respectively, in contrast to a pre-tax charge of
$8 million in 1991. The Kmart Group measures inflation using internal price
indices. The 1993 and 1992 LIFO credits resulted primarily from reductions in
the Kmart Group's retail prices.
Selling, general and administrative ("SG&A") expenses, including
advertising, were 22.6% of sales in 1993 as compared to 22.4% and 23.0% in 1992
and 1991, respectively. The increase in SG&A expenses relative to sales in 1993
was primarily a result of lower than expected sales combined with increased
store operating expenses and depreciation expense, partially offset by lower
advertising and employee compensation and benefits per sales dollar. The 1992
decrease in SG&A expenses relative to sales was due to improved expense control
primarily in the U.S. Kmart stores division and lower advertising expense in
1992. As a percent of sales, employee compensation and benefits were 15.2%,
15.2% and 15.4% in 1993, 1992 and 1991, respectively. Advertising expense
comprised 1.3%, 1.5% and 1.8% of sales in 1993, 1992 and 1991, respectively. The
shift of the U.S. Kmart stores toward an everyday low price strategy over the
past few years has allowed the chain to more effectively utilize each
advertising dollar by reducing the frequency and size of circulars.
On January 5, 1994, the Board approved a restructuring plan involving the
Kmart Group, including Kmart Canada. As a result, in the fourth quarter of 1993,
the Kmart Group recorded a charge (Store Restructuring and Other Charges) to
earnings of $904 million before taxes. Net of taxes, the charge was $578
million. The provision included anticipated costs associated with Kmart stores
which will be closed and relocated, enlarged or refurbished in the U.S. and
Canada. These costs, which represent approximately 94% of the total, include
lease obligations for store closings as well as fixed asset writedowns and
inventory dispositions for all affected stores. The remainder of the charge is
for costs related to re-engineering programs (principally severance) and other
non-recurring charges. See below for additional detail regarding the fourth
quarter 1993 charge, and also refer to the U.S. General Merchandise Operations
and International General Merchandise Operations sections of the Analysis of
Kmart Group Operations.
<TABLE>
<CAPTION>
STORE RESTRUCTURING
(MILLIONS) AND OTHER CHARGES
- --------------------------------------------------------------------- -------------------
<S> <C>
U.S. General Merchandise Operations.................................. $ 865
International General Merchandise Operations......................... 39
------
Total Kmart Group.................................................... $ 904
------
------
</TABLE>
Net interest expense on debt reflects the following components:
<TABLE>
<CAPTION>
(MILLIONS) 1993 1992 1991
- ------------------------------------------------------------------------ ---- ---- ----
<S> <C> <C> <C>
Interest Expense on Debt................................................ $295 $256 $218
Interest Income......................................................... 12 25 14
---- ---- ----
Net Interest Expense on Debt.................................. $283 $231 $204
---- ---- ----
---- ---- ----
</TABLE>
VI-4
<PAGE> 246
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Net interest expense on debt in 1993 was $283 million, up 22.5% from $231
million in 1992. The 1993 increase was a result of greater borrowings resulting
from higher inventory levels in the first nine months of 1993 and acquisitions
made in 1992 partially offset by lower interest rates on long-term and
short-term borrowings. The increase in net interest expense on debt in 1992 was
due to higher average borrowings as a result of capital expenditures related to
the Kmart store modernization program, acquisitions and increased inventory,
partially offset by lower interest rates on commercial paper. The Kmart Group's
weighted average interest rates on total debt were 6.7% in 1993, 7.6% in 1992
and 8.5% in 1991. Weighted average interest rates for short-term borrowings were
3.2% in 1993, 3.6% in 1992 and 6.1% in 1991.
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions, between the Specialty Retail Groups and the
Kmart Group had been accounted for as short-term loans, on a pro forma basis,
the Kmart Group would have been credited with aggregate inter-Group interest
income of $8 million during 1993. Such pro forma interest income has been
calculated on daily average borrowings outstanding using Kmart Corporation's
weighted average short-term borrowing rate. Such pro forma interest income is
not necessarily indicative of the results that would have occured had such
offerings been completed on such date, or what the interest income would be
prospectively.
Income (loss) from continuing retail operations before Retained Interests
in the Specialty Retail Groups and income taxes for the year was $(247) million,
or (0.9)% of sales, as compared to $1,194 million, or 4.5% of sales, and $1,077
million, or 4.2% of sales, in 1992 and 1991, respectively. Excluding the store
restructuring and other charges of $904 million, 1993 income from continuing
operations before Retained Interests in the Specialty Retail Groups and income
taxes was $657 million, or 2.3% of sales.
Net income (loss) related to Retained Interests in the Specialty Retail
Groups was $(145) million in 1993 as compared to $83 million and $66 million in
1992 and 1991, respectively. Refer to the analysis of the Retained Interests in
the Specialty Retail Groups below.
Income tax (benefit) expense in 1993 was $(110) million with an effective
tax rate of 44.5% as compared with $398 million in 1992 and $358 million in 1991
with an effective tax rate of 33.3% in each such year. Refer to the accompanying
Notes to Combined Financial Statements for further information regarding income
taxes.
Net income (loss) from continuing retail operations before extraordinary
items and the effect of accounting changes in 1993 was $(282) million, as
compared to $879 million and $785 million in 1992 and 1991, respectively.
Excluding the net of tax $578 million store restructuring and other charges,
1993 net income from continuing retail operations was $296 million, or 1.1% of
sales, in 1993, as compared to 3.3% of sales and 3.1% of sales in 1992 and 1991,
respectively. The decrease in net income from continuing retail operations in
1993, exclusive of store restructuring and other charges, resulted primarily
from the inventory reduction program and gross margin pressure in U.S. Kmart
stores. Net income from continuing retail operations increased in 1992 due to
improved sales and a significant emphasis on cost control, partially offset by a
one-time charge of $12 million, net of tax, related to Kmart Corporation's
guarantee of certain Bargain Harold's leases.
Net income (loss) from discontinued operations in 1993 was $(81) million,
as compared to $59 million and $70 million in 1992 and 1991, respectively.
Discontinued operations include the results of PayLess Drug Stores Northwest,
Inc. and PACE Membership Warehouse, Inc. which have been classified to reflect
their
VI-5
<PAGE> 247
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
respective plans for disposition announced in the fourth quarter of 1993. The
$81 million after-tax loss from the operation of discontinued businesses in 1993
was the result of a significant net operating loss at PACE which more than
offset the net income from PayLess. Additionally, in 1993, an after-tax loss of
$503 million was realized from the disposal of discontinued businesses.
In January 1994, PACE sold the assets and lease obligations of 93 of its
warehouses and virtually all of the inventory and membership files in the 34
warehouses not included in the transaction to Sam's Club, a division of
Wal*Mart, for $774 million. The book value of the assets sold to Wal*Mart was
$624 million. Operations of the 34 remaining PACE sites not included in the
transaction were discontinued and PACE is in the process of evaluating and
marketing these leased sites as well as leased premises for unopened warehouses
and corporate facilities. Included in the loss on the disposal of PACE was
unamortized goodwill, expected remaining lease obligations in the warehouses not
sold, other PACE liabilities and a provision for additional costs anticipated
during the wind-down of PACE operations.
In addition, Kmart Corporation entered into an agreement, attributed to the
Kmart Group, to sell its PayLess Drug Stores subsidiary to TCH Corporation for
$592 million in cash, $100 million in subordinated debt and 47% of the common
equity of TCH Corporation. The book value of PayLess' net assets to be sold was
$1,186 million at January 26, 1994. It is anticipated that the transaction will
be completed by the end of the first quarter of 1994. The structure of the sale
was designed to maximize value received for PayLess. It is Kmart Corporation's
intention to divest its 47% interest in TCH within one year or as soon as
practicable after considering all relevant factors including the value to be
received upon such disposition. Management expects the disposition to be
achieved either through a private offering or other alternative means.
Accordingly, Kmart Corporation has reported PayLess as a discontinued operation
and has recorded its investment in TCH, attributed to the Kmart Group, at net
realizable value.
Both businesses have been accounted for as discontinued operations in these
financial statements.
Extraordinary items. Subject to the completion of the sale of its PayLess
business, which is expected to be finalized in the first quarter of 1994, Kmart
Corporation intends to call for early redemption of all $300 million of 8 3/8%
debentures due January 15, 2017 attributed to the Kmart Group using the proceeds
of the sale to redeem the issues. The resulting redemption premium and
associated cost of $18 million, net of applicable income taxes, was recorded in
1993. In August 1993, Kmart Corporation called for early redemption of all $200
million of its 8 1/8% debentures due January 1, 1997 attributed to the Kmart
Group. The debentures were redeemed at 100% of the principal amount plus
interest accrued to the date of redemption. In April 1993, Kmart Corporation
called for early redemption of all $200 million of its 10 1/2% Sinking Fund
Debentures due December 1, 2017 attributed to the Kmart Group. The resulting
redemption premium of $10 million, net of applicable income taxes, has been
reported as an extraordinary item.
Effect of accounting changes. The Kmart Group adopted Financial Accounting
Standard No. 109 "Accounting for Income Taxes" (FAS 109) in the first quarter of
1993. FAS 109 requires that deferred taxes be calculated using the liability
approach rather than the deferred method. As a result of the adjustment of
deferred tax balances to the enacted tax rate at the date of adoption, the Kmart
Group has recorded a benefit of $46 million, as the cumulative effect of an
accounting change.
The Kmart Group also adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. This statement requires that the Kmart
Group accrue for future postretirement medical benefits. In prior years, these
claims were expensed when paid. Net of applicable tax, a charge of $77 million
has been included in net income as the effect of an accounting change.
In addition, the Kmart Group adopted Financial Accounting Standard No. 112
"Employers' Accounting for Postemployment Benefits" (FAS 112) in the first
quarter of 1993. FAS 112 is an extension of the concepts
VI-6
<PAGE> 248
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
underlying FAS 106 for similar benefits provided to terminated or laid-off
employees. The financial effects of this statement on the Kmart Group were not
material.
Net income (loss) in 1993 was $(925) million, as compared with $938 million
in 1992 and $855 million in 1991.
EFFECTS OF INFLATION
The Kmart Group's financial statements have been prepared on a historical
cost basis under generally accepted accounting principles. The Kmart Group uses
the LIFO method of inventory valuation in its historical financial statements;
therefore, the cost of merchandise sold approximates current cost. In addition,
because the Kmart Group is refurbishing existing stores and opening new stores,
depreciation and amortization expense more closely approximate current cost.
FINANCIAL OBJECTIVE
The Kmart Group's financial policy is designed to provide the Kmart Group
and its shareholders with an optimum return on investment, a solid capital
structure and a high degree of financial flexibility. Obtaining optimum return
on investment requires deployment of the Kmart Group's assets and resources
where they will provide the best long-term return. In seeking optimum return,
the Kmart Group's management continues to focus on high growth retail businesses
including potential retail investment opportunities, both domestically and
internationally, in addition to funding an improved merchandise mix, the
refurbishment, relocation and expansion of existing U.S. Kmart stores. In
addition, the Kmart Group sold or closed Kmart stores which did not generate
sufficient returns. The Kmart Group anticipates that the cash required to fund
the Kmart modernization and Super Kmart Center programs will be provided
primarily by operations. Additional cash proceeds expected in 1994 from the sale
of PayLess, and, assuming shareholder approval, the offering of shares intended
to represent 20% to 30% of the equity value attributed to each Specialty Retail
business will be used to reduce debt and for other general corporate purposes.
On an ongoing basis, the Kmart Group utilizes commercial paper and revolving
credit to cover peak working capital requirements. The Kmart Group also believes
that it will continue to have access to long-term debt capital and plans to fund
its new store program using primarily lease financing.
CASH FLOW
The Kmart Group funds generated by operations, investing and financing
activities as reported in the Combined Statements of Cash Flows are summarized
below. The accompanying Notes to Combined Financial Statements contains
additional information regarding the Combined Statements of Cash Flows.
Net cash provided by operations was $1,897 million in 1993 and $656 million
in 1992, compared with $981 million in 1991. The increase in 1993 was due
primarily to the $720 million decrease in U.S. Kmart FIFO inventory, increased
accounts payable financing of inventory, proceeds from sale of PACE assets and
increased depreciation and amortization expense. The decrease in 1992 was due
primarily to an increase in merchandise inventories net of trade payables and an
increase in property held for resale, partially offset by increased net income
and depreciation.
Inventory turnover was 2.9 in 1993, as compared with 2.7 in 1992 and 2.8 in
1991. The improvement in inventory turnover in 1993 was attributable to the U.S.
Kmart division. In U.S. Kmart stores, 1993 FIFO inventory decreased 10.4%, as
compared to an 8.0% increase in 1992. The 1993 decrease was primarily a result
of an increased focus on inventory management in U.S. Kmart stores including the
increased use of automatic replenishment systems in hardline departments. The
1992 change resulted from increased U.S. Kmart inventory for new and enlarged
stores and a slight increase in comparable store inventory levels from 1991.
VI-7
<PAGE> 249
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Depreciation and amortization expense are recognized in determining net
income, but do not require cash outlays. These expenses have been steadily
rising each year and are expected to continue to increase, due to larger capital
expenditures for the Kmart store modernization program.
The Kmart Group anticipates that after-tax cash flows related to store
restructuring and other charges will approximate $28 million, $46 million and
$50 million in 1994, 1995 and 1996, respectively, and will result primarily from
the payment of leases and re-engineering costs (principally severance).
Net cash used for investing was $1,308 million in 1993, $1,652 million in
1992, and $1,233 million in 1991. Cash used for investing was primarily
comprised of capital expenditures for store modernization, the contribution of
equity to the OfficeMax Group for the acquisition of BizMart in 1993, and, in
1992, the acquisition of Pay'n Save assets and the purchase of 13 department
stores in the Czech Republic and Slovakia. Excluding discontinued operations,
capital expenditures for the Kmart Group, which included new distribution
centers, refurbishments, expansions and store openings, were $793 million,
$1,110 million and $1,035 million in 1993, 1992 and 1991, respectively. The
decrease in the Kmart Group capital expenditures in 1993 was due to a reduction
in the number of U.S. Kmart modernization projects as the Kmart Group integrated
the Super Kmart Center concept into the program as described below. Net cash
used for acquisitions totaled $300 million in 1992.
During 1993, Kmart assessed the remaining stores to be updated as potential
relocations to Super Kmart Centers. A Super Kmart Center features a full line of
Kmart general merchandise along with groceries. As a result of this assessment,
capital expenditures decreased to $793 million in 1993, are expected to
approximate 1992 capital expenditures of $1,110 million in 1994 and are
anticipated to subsequently increase again in 1995. The Kmart store
modernization program is expected to be substantially complete in 1996.
Kmart Corporation anticipates that the cash required to fund the Kmart
store modernization and Super Kmart Center programs will be provided primarily
by operations. In 1994, additional funds are expected to be provided by the sale
of PayLess, and, assuming shareholder approval, the offering of shares intended
to represent 20% to 30% of the equity value attributed to each of the four
Specialty Retail businesses.
Net cash used for financing was $766 million in 1993 as compared with net
cash provided by financing of $1,050 million in 1992 and $489 million in 1991.
The 1993 change resulted primarily from a $201 million net decrease in long-term
debt and notes payable in 1993 as compared with a net increase of $1,543 million
in 1992. The decrease in cash provided by financing in 1993 was primarily a
result of lower U.S. Kmart inventory levels in 1993. The 1992 change was due
primarily to a $590 million increase in notes payable and proceeds of $999
million from 1992 debt issuances and mortgage financing. Fiscal 1991 included
$986 million in proceeds from the Series A conversion preferred stock offering
and $700 million in proceeds from the issuance of medium-term notes and
long-term debt, offset by a reduction in notes payable.
Due to the seasonal nature of the retail industry, the Kmart Group
continues to utilize commercial paper and revolving credit to cover peak working
capital requirements. Average short-term borrowings outstanding during 1993,
1992 and 1991 were $2,079 million, $1,136 million and $1,093 million,
respectively. The maximum amount of aggregate short-term borrowings outstanding
during 1993 was $3,220 million as compared with $2,371 million in 1992 and
$1,509 million in 1991. Total short-term lines of credit available and unused
were $1,473 million, $1,339 million and $789 million at the end of 1993, 1992
and 1991, respectively.
Total dividends paid during 1993 were $465 million, compared with $448
million and $375 million in 1992 and 1991, respectively. Dividends paid per
Kmart Corporation existing common share were $0.95, $0.91 and $0.87 in 1993,
1992 and 1991, respectively. Dividends paid in 1993, 1992 and 1991 per $3.41
Depositary Share (each representing one-quarter share of Series A conversion
preferred stock) were $3.41, $3.41 and
VI-8
<PAGE> 250
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
$1.06, respectively. Dividends paid per Series B convertible preferred stock
were $11.50 in 1993 and $1.44 in 1992.
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt, and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of each Group are
remitted to Kmart Corporation and cash disbursements of each Group are funded by
Kmart Corporation on a daily basis. In the historical financial statements of
the Groups, (i) debt incurred by Kmart Corporation and its subsidiaries, other
than certain capital leases and mortgages related specifically to the Specialty
Retail Groups, has been reflected on the financial statements of the Kmart Group
and (ii) net cash used or provided by each Specialty Retail Group has been
characterized as an adjustment of the Kmart Group's investment (reflected as
Retained Interest) in each Specialty Retail Group. Accordingly, no inter-Group
interest expense or inter-Group interest income is reflected in the historical
financial statements of any Specialty Retail Group. Until the issuance of a
series of Specialty Retail Stock, the net cash used for or provided by such
Specialty Retail Group will continue to be characterized as an adjustment to the
Kmart Group's investment in such Specialty Retail Group.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group to the extent that the debt is
incurred or the preferred stock is issued for the benefit of such Specialty
Retail Group.
Following the issuance of each series of stock, if cash used by a Specialty
Retail Group exceeds cash provided by such Specialty Retail Group, the Kmart
Group would transfer to such Specialty Retail Group the cash necessary to fund
such excess uses. Conversely, if cash provided by a Specialty Retail Group
exceeds cash used by such Specialty Retail Group, such Specialty Retail Group
would transfer the excess cash to the Kmart Group. All cash transfers between
Groups would be accounted for as short-term loans unless the Board makes a
specific determination that a given transfer (or type of transfer) should be
accounted for as a long-term loan or, in the case of a transfer from the Kmart
Group to a Specialty Retail Group, an equity contribution. There are no specific
criteria to determine when a cash transfer would be classified as a long-term
loan or, in the case of a transfer from the Kmart Group to a Specialty Retail
Group, an equity contribution, rather than a short-term loan. Such determination
would be made by the Board in the exercise of its business judgment at the time
of such transfer (or the first of such type of transfer) based upon all relevant
circumstances, including the financing needs and objectives of the recipient
Group, the investment objectives of the transferring Group, prevailing interest
rates and general economic conditions. Such determination would affect the
amount of interest expense and interest income reflected in the financial
statements of the relevant Groups if such transfer were made as a short-term
loan or long-term loan and, in the case of a transfer from the Kmart Group to a
Specialty Retail Group as an equity contribution, the amount of such Specialty
Retail Group equity and Retained Interest of the Kmart Group. Short-term loans
between the Kmart Group and a Specialty Retail Group would bear interest at
Kmart Corporation's daily short-term borrowing rate. In the event that the Board
determined that a transfer of funds between the Kmart Group and a Specialty
Retail Group should be made as a long-term loan, the Board would establish the
terms on which such loan would be made, including interest rate, amortization
schedule, maturity and redemption terms. Such terms would generally reflect the
then prevailing terms upon which Kmart Corporation could borrow funds on a
similar basis.
From time to time, following the initial issuance of a series of Specialty
Retail Stock, the Board could determine that funds to be transferred from the
Kmart Group to a Specialty Retail Group represent an equity
VI-9
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KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
contribution to such Specialty Retail Group rather than a loan. In such event,
the Kmart Group's Retained Interest in such Specialty Retail Group would be
increased by the amount of such contribution, as a result of which (a) the
Number of Shares Issuable with Respect to the Kmart Group's Retained Interest
with regard to such Specialty Retail Group would be increased by an amount equal
to the amount of such contribution divided by the Market Value of a share of the
relevant series of Specialty Retail Stock and (b) the Kmart Group's Retained
Interest Fraction with regard to the Specialty Retail Group would be increased
and the Outstanding Interest Fraction with regard to the Specialty Retail Group
would be decreased accordingly. The Board could determine, in its sole
discretion, to make such contribution after consideration of a number of
factors, including, among others, the relative levels of internally generated
cash flows of the Groups, the long-term business prospects for each Group, the
capital expenditure plans of and investment opportunities available to each
Group, and the availability, cost and time associated with alternative financing
sources.
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from the
Specialty Retail Groups, and the balance sheets of each Specialty Retail Group
would reflect its net short-term and net long-term loans to or borrowings from
the Kmart Group. Similarly, the respective income statements of the Kmart Group
and the Specialty Retail Groups would reflect interest income or expense, as the
case may be, associated with such loans or borrowings and the statements of cash
flows of the Kmart Group and the Specialty Retail Groups would reflect changes
in the amounts thereof deemed outstanding. In view of the anticipated cash needs
of the Specialty Retail Groups over the next several years, it is currently
expected that the Kmart Group would be making net transfers to the Specialty
Retail Groups. After considering all relevant factors, the Kmart Group would
obtain such funds from internal operations, excess cash from Specialty Retail
Groups, external debt financing or additional equity issuances. Accordingly,
unlike these historical financial statements, following implementation of the
Specialty Retail Stock Proposal and issuance of a series of Specialty Retail
Stock, the financial statements of such Specialty Retail Group would reflect
interest expense related to net cash provided by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to the Specialty Retail Groups would continue to be made at the
discretion of the Board. Nothing in the foregoing policies obligates the Board
to cause the Kmart Group to provide funds to any Specialty Retail Group if the
Board determines it is in the best interest of Kmart Corporation not to do so.
ANALYSIS OF KMART GROUP OPERATIONS
At January 26, 1994, the Kmart Group consisted of both domestic and
international operations. A total of 2,323 Kmart stores were located in the
United States and Puerto Rico, including 19 Super Kmart Centers, all in the
United States. The Kmart Group's international operations included 127 Kmart
stores in Canada and 13 stores in the Czech Republic and Slovakia.
VI-10
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KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
A three-year summary of the Kmart Group's sales and operating income
follows:
<TABLE>
<CAPTION>
% %
(U.S. $ MILLIONS) 1993 CHANGE 1992 CHANGE 1991
- ------------------------------------------------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Sales
United States.................................. $26,949 6.4 $25,326 3.4 $24,488
International.................................. 1,090 (4.7) 1,144 7.9 1,060
------- ------- -------
Total Sales............................... $28,039 5.9 $26,470 3.6 $25,548
------- ------- -------
------- ------- -------
Operating Income(1)
United States.................................. $ 966 (33.6) $ 1,454 9.8 $ 1,325
International.................................. 48 4.3 46 -- 23
------- ------- -------
Total Operating Income.................... $ 1,014 (32.4) $ 1,500 11.4 $ 1,348
------- ------- -------
------- ------- -------
Capital Expenditures -- Owned Property(2)........ $ 793 $ 1,110 $ 1,035
------- ------- -------
------- ------- -------
</TABLE>
- -------------------------
(1) 1993 operating income excludes store restructuring and other charges of $865
million and $39 million for United States and International operations,
respectively.
(2) Excludes capital expenditures of discontinued operations.
U.S. General Merchandise Operations
Domestic Kmart store sales increased 6.4% in 1993 as a result of a 3.8%
comparable store sales increase and an increasing number of stores in operation,
partially offset by a 2.4% decrease in the average selling price of merchandise
resulting primarily from competitive factors. Sales in domestic Kmart stores
increased 3.4% in 1992 due to a 1.5% comparable store sales increase, store
openings and improved sales in the prescription drug, jewelry and home fashions
departments. Sales per square foot in U.S. Kmart stores, including
unconsolidated Kmart store licensee sales, were $182 in 1993 and $181 in 1992.
Both comparable store sales and sales per square foot were affected by
competition, lower selling prices and interruption caused by the store
modernization program.
In 1993, modernized stores (including new stores, relocations, expansions
and refurbishments) outperformed non-modernized stores by 17% in sales, 12% in
customer count, 16% in units sold and 6% in transaction amounts and the Super
Kmart Center stores open the full year averaged in excess of $55 million in
sales. Based upon the successful results of the modernized stores and the
favorable results of the new Super Kmart Centers, the Kmart Group will integrate
the Super Kmart Center program into the remaining U.S. Kmart store modernization
program. The following table indicates the current status of the U.S. Kmart
store modernization program:
<TABLE>
<CAPTION>
PROJECTS
COMPLETED PROJECTS
THROUGH 1993 REMAINING
------------ ---------
<S> <C> <C>
Relocations............................................. 313 503
Expansions.............................................. 430 265
Refurbishments.......................................... 448 235
------ ---------
Total.............................................. 1,191 1,003
------ ---------
------ ---------
</TABLE>
On January 5, 1994, the Board approved a restructuring plan to modernize
the remaining stores and, as a result, the Kmart Group recorded a pre-tax charge
of $865 million in the fourth quarter of 1993 relating to U.S. General
Merchandise Operations. The charge is principally for specifically-identified
relocations which
VI-11
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KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
will result in replacing smaller, less productive stores with larger stores in
better locations. These new stores are expected to generate improved sales and
gross margin which will be partially offset by increased store occupancy and
depreciation expense. The Kmart Group also expects that there will be continued
sales and profitability improvement at the stores modernized to date. These
larger stores are a key part of the Kmart Group's strategy to compete
effectively in the marketplace. The Kmart Group anticipates that the store
modernization program will be substantially complete by the end of fiscal 1996.
Of the total charge, $795 million or 92% relates to the store relocations,
expansions and refurbishments. These costs include lease obligations for store
relocations totaling $464 million as well as fixed asset writedowns to net
realizable value totaling $141 million (primarily furniture and fixtures and
leasehold improvements) and inventory disposition costs during the final stage
of the project totaling $190 million for all affected stores. Such charge does
not include any provision for store occupancy, depreciation expense or normal
inventory markdowns prior to the closing or completion date of a project. The
remainder of the charge relates to the implementation of re-engineering programs
(principally severance) totaling $45 million and other non-recurring charges.
Operating income, excluding the store restructuring and other charges of
$865 million, in domestic Kmart stores decreased 33.6% to $966 million in 1993
due primarily to gross margin pressure. Although there was competitive pricing
pressure in both hardlines and softlines throughout the year, the lower gross
margin in 1993 primarily related to the U.S. Kmart inventory reduction program
and increased markdowns at the Kmart Fashions division. As a result of the Kmart
Group's inventory management program, which included the increased use of
automatic replenishment systems in hardline departments, gross margins were
significantly effected by the inventory reduction and resulting change in the
mix of merchandise purchased, primarily in the fourth quarter of 1993 as
compared to 1992. Domestic Kmart operating income increased 9.8% to $1,454
million in 1992 due primarily to an increased emphasis on cost control, which
included the ability to reduce product procurement costs, and a LIFO credit,
partially offset by a decline in gross margin due to increased competitive
pricing pressure and spring and summer seasonal clearance activity. In 1992,
operating income also benefited from U.S. Kmart cost control measures, such as
better controlled store hours due to improved labor scheduling, revised human
resource initiatives, including elimination of Sunday overtime and Christmas
remembrance, changes in vacation policies and reduced promotional advertising
expense. As many of the cost control programs were implemented in late 1991, the
full impact on lowering expense was realized in 1992.
During 1993, the Kmart Group temporarily reduced the pace of its U.S. Kmart
modernization program as it assessed both the Super Kmart Center program and the
remaining stores to be modernized. In 1993, the Kmart Group opened 14 new Super
Kmart Center stores. A 150,000 to 185,000 square-foot Super Kmart Center
features a full line of Kmart general merchandise and groceries as well as a
variety of ancillary services including dry cleaning, hair care, optical and
floral shops. While the Super Kmart Center program is still in its early stages,
Kmart plans to open approximately 55 Super Kmart Center stores in 1994 and
believes there is potential to open several hundred Super Kmart Center stores
over the next several years. The Kmart Group anticipates that the new Super
Kmart Center stores will be financed with lease financing. The average cost of
each site's inventory, net of expected payable financing, furniture and fixtures
and leasehold improvements is expected to approximate $6 million.
Excluding Super Kmart Centers, the Kmart Group completed 177 modernization
projects in 1993 as compared with 444 projects and 474 projects completed in
1992 and 1991, respectively. The Kmart Group anticipates completion of
approximately 170-200 U.S. Kmart discount store modernization projects in 1994
including approximately 80 new discount stores. U.S. Kmart capital expenditures
for owned property, are expected to approximate 1992 levels in 1994 as compared
with $0.8 billion in 1993, $1.1 billion in 1992 and $1.0 billion in 1991.
VI-12
<PAGE> 254
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Activity for the U.S. Kmart store modernization program for the past three
years is summarized in the following table:
<TABLE>
<CAPTION>
TOTAL
1991 1992 1993 COMPLETE
---- ---- ---- --------
<S> <C> <C> <C> <C>
New stores (including relocations)
Kmart stores.................................................... 106 114 116 429
Super Kmart Centers............................................. -- 5 14 19
Store expansions.................................................. 164 122 51 430
Store refurbishments.............................................. 204 208 10 448
---- ---- ---- --------
Totals.................................................. 474 449 191 1,326
---- ---- ---- --------
---- ---- ---- --------
</TABLE>
International General Merchandise Operations
At January 26, 1994, international operations consisted of 127 Kmart stores
in Canada and 13 department stores located in the Czech Republic and Slovakia.
The Central European stores were acquired in mid-1992 and represent the Kmart
Group's entry into that market. The Kmart Group is developing advanced
distribution methods and merchandising skills to modernize, refurbish and
streamline operations in the two Central European countries.
International sales decreased 4.7% in 1993 due primarily to lower Kmart
Canada sales resulting from unfavorable exchange rates relative to the U.S.
dollar, weak consumer spending attributed to increased taxes in Ontario where
approximately two-thirds of Canadian stores are located, and unfavorable weather
in the eastern provinces of Canada during the first half of the year.
International sales increased 7.9% in 1992 primarily as a result of the purchase
of the Central European stores in mid-1992. Kmart Canada's 1992 sales were
positively effected by a strong Christmas season partially offset by weak
economic conditions and deterioration of the Canadian exchange rate throughout
the year. Czech Republic and Slovak operating income improved in 1993 while
Kmart Canada's operating income approximated prior year levels. Czech Republic
and Slovak operations were profitable in 1992, and 1992 operating profit at
Kmart Canada improved significantly over 1991 due to the excellent Christmas
season and strong expense control. The Canadian average dollar exchange rates
were 0.7745 in 1993, 0.8226 in 1992 and 0.8708 in 1991.
On January 5, 1994, the Board approved a restructuring plan to modernize
the remaining Kmart stores in Canada and, as a result, the Kmart Group recorded
a pre-tax charge of $39 million in the fourth quarter of 1993. Of the total
charge, $34 million is for specifically-identified store modernization projects
including store relocations, enlargements and refurbishments. These costs
include lease obligations for store relocations totaling $15 million, (primarily
furniture and fixtures) fixed asset writedowns to net realizable value totaling
$9 million and inventory disposition costs during the final stage of the project
totaling $10 million for all affected stores. Such charge does not include any
provision for store occupancy, depreciation expense or normal inventory
markdowns prior to the closing or completion date of a project. The remainder of
the charge relates to the implementation of re-engineering programs (principally
severance).
As part of its international expansion strategy, the Kmart Group has formed
joint ventures in Mexico and Singapore and, in 1994, expects to open five stores
in Mexico and two stores in Singapore.
VI-13
<PAGE> 255
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
The following table highlights the Kmart Group's store activity during
1993:
<TABLE>
<CAPTION>
1993 ACTIVITY PLANNED
END END ------------------------- END
1991 1992 OPENED CLOSED END 1994
----- ----- ------ ------ ----- -------
<S> <C> <C> <C> <C> <C> <C>
Kmart
United States.................................. 2,249 2,281 130 (88) 2,323 2,364
Canada......................................... 126 127 1 (1) 127 131
Czech Republic and Slovakia...................... -- 13 -- -- 13 13
Mexico........................................... -- -- -- -- -- 5
Singapore........................................ -- -- -- -- -- 2
Other............................................ 16 14 13 (4) 23 14
----- ----- ------ ------ ----- -------
Total General Merchandise.............. 2,391 2,435 144 (93) 2,486 2,529
----- ----- ------ ------ ----- -------
----- ----- ------ ------ ----- -------
General Merchandise Selling Square Feet
(Millions)..................................... 151 159 168
----- ----- -----
----- ----- -----
General Merchandise Store Sales per Square
Foot........................................... $ 184 $ 179 $ 179
----- ----- -----
----- ----- -----
</TABLE>
RETAINED INTERESTS IN THE SPECIALTY RETAIL GROUPS
At January 26, 1994, the Specialty Retail Groups consisted of the
Borders-Walden Group, the Builders Square Group, the OfficeMax Group and The
Sports Authority Group. The Specialty Retail Groups continued their aggressive
store expansion programs and closed or relocated underperforming stores as
illustrated in the following table:
<TABLE>
<CAPTION>
1993 ACTIVITY PLANNED
END END ------------------------------------- END
1991 1992 ACQUIRED OPENED CLOSED END 1994
----- ----- -------- ------ ------ ----- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Borders-Walden Group
Borders............................... -- 31 -- 15 (2) 44 71
Walden*............................... 1,217 1,202 -- 7 (50) 1,159 1,044
Builders Square Group................... 144 165 -- 28 (16) 177 186
OfficeMax Group......................... 79 179 105 53 (9) 328 373
The Sports Authority Group.............. 36 56 -- 24 -- 80 108
----- ----- --- ------ ------ ----- -------
Total Specialty Retail
Groups...................... 1,476 1,633 105 127 (77) 1,788 1,782
----- ----- --- ------ ------ ----- -------
----- ----- --- ------ ------ ----- -------
Specialty Retail Groups' Selling
Square Feet (Millions)................ 17 22 28
----- ----- -----
----- ----- -----
</TABLE>
- -------------------------
* Excludes 57, 58 and 58 Walden Software stores operated in 1993, 1992 and 1991,
respectively.
Combined capital expenditures by the Specialty Retail Groups were $229
million, $133 million and $80 million in 1993, 1992 and 1991, respectively, and
were primarily to fund new stores. Combined Specialty Retail Groups' capital
expenditures are expected to approximate $285 million in 1994. Financing for the
Specialty Retail Groups' investing activities will be provided primarily by
their operations, lease financing for new stores and corporate financing
activities.
VI-14
<PAGE> 256
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
A three-year summary of the Specialty Retail Groups' aggregate sales and
operating income follows ($ millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales................................................... $6,118 $4,543 $3,495 34.7 30.0
------ ------ ------
------ ------ ------
Operating Income(1)..................................... $ 152 $ 133 $ 109 14.3 22.0
------ ------ ------
------ ------ ------
Comparable Store Sales Increase......................... 3.5% 6.5% 6.9%
------ ------ ------
------ ------ ------
Capital Expenditures -- Owned Property.................. $ 229 $ 133 $ 80
------ ------ ------
------ ------ ------
</TABLE>
- -------------------------
(1) 1993 operating income excludes store restructuring and other charges of $370
million.
Aggregate Specialty Retail Group sales increased 34.7% to $6,118 million in
1993 as a result of 127 new or relocated stores, the March acquisition of 105
BizMart stores by OfficeMax and a 3.5% comparable store sales increase. The
Specialty Retail Groups' aggregate sales increased 30.0% to $4,543 million in
1992 due to 128 new stores, 63 stores acquired through the expansion of two
Groups within existing lines of business and a 6.5% comparable store sales
increase. Total 1993 operating income, excluding store restructuring and other
charges, for the Specialty Retail Groups increased 14.3% to $152 million from
$133 million in 1992 and $109 million in 1991 due to new and acquired stores and
improved operating leverage. The Specialty Retail Groups represented 17.9% of
1993 consolidated sales and 13.0% of 1993 consolidated operating income before
one-time restructuring charges.
Borders-Walden Group
The Borders-Walden Group ("Borders-Walden") is a leading book retailer in
the United States and is comprised of Borders, Inc. ("Borders") and Walden Book
Company, Inc. ("Walden"). As of January 23, 1994, Borders operated 44 large
format superstores in 22 states and the District of Columbia, each of which is
designed to be the premier book retailer in its market, and Walden, which is the
largest operator of mall-based bookstores in the United States, operated 1,159
stores in 50 states and the District of Columbia.
Although Borders and Walden will continue to operate independently, Borders
and Walden recently have been combined under common executive leadership in
order to realize synergies in certain areas, including in the development of
inventory control systems and in merchandise distribution.
Borders-Walden's business strategy is to accelerate the growth of its books
and music superstore business and to increase profitability at Walden.
Borders-Walden intends to accomplish this by (i) opening at least 20-25 Borders
Books and Music superstores in each of the next two fiscal years and
reconfiguring or expanding virtually all of Borders' existing book superstores
to the Borders Books and Music format, (ii) increasing Walden's profitability by
reducing inventory shrinkage, containing expenses and, with the implementation
of Borders' sophisticated inventory management technology, improving sales per
store and inventory productivity over the long term and (iii) continuing to
develop and refine Borders' sophisticated inventory management system.
On January 5, 1994, the Board approved a restructuring plan involving the
closing of approximately 200 underperforming Walden stores. Management believes
that these closures will better enable Borders-Walden to compete effectively.
Management expects the closure of these stores will be substantially completed
in 1994, and that total sales levels will decrease proportionally and that
overall operating expenses, including employee costs, occupancy expenses and
depreciation charges will decrease further resulting in improved earnings levels
compared with the prior year.
VI-15
<PAGE> 257
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
As a result of the restructuring plan, Borders-Walden recorded a pre-tax
charge of $143 million ($85 million net of tax) in the fourth quarter of 1993
for store closing costs and other non-recurring charges. Of the total pre-tax
charge, $122 million is for store closures. These costs include $74 million
principally for lease buyout costs, $21 million for the writedown of inventory
to be liquidated during the final closing of each store, and $27 million for the
writedown of fixed assets, primarily furniture and fixtures, to net realizable
value. Of the remaining charge, $15 million relates to costs associated with
combining certain operations of Borders and Walden, including inventory
reduction costs and costs of consolidating redundant distribution center
functions. The remaining $6 million relates to re-engineering programs
(principally severance).
Borders-Walden's results of operations for the last three years follow ($
millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales................................................... $1,370 $1,184 $1,140 15.7 3.9
------ ------ ------
------ ------ ------
Operating Income(1)..................................... $ 50 $ 42 $ 31 19.0 35.5
------ ------ ------
------ ------ ------
Comparable Store Sales Increase
Borders............................................... 14.8% 12.6% --
------ ------ ------
------ ------ ------
Walden................................................ 0.7% 1.4% 5.8%
------ ------ ------
------ ------ ------
</TABLE>
- ---------------
(1) Borders-Walden 1993 operating income excludes store restructuring and other
charges of $143 million.
Sales in 1993 were $1,370 million, a 15.7% increase, over sales of $1,184
million in the prior year. The 1993 sales increase was primarily due to the
inclusion of a full year sales for the Borders stores versus three months in the
prior year. Comparable Walden store sales increased 0.7% in 1993 versus a 1.4%
increase in 1992. The slower rate of Walden comparable store sales growth was a
result of increased competition from superstores in several markets and sluggish
mall traffic. In 1993, Borders-Walden reported an operating loss of $93 million,
inclusive of the store restructuring and other charges of $143 million.
Excluding the store restructuring and other charges, 1993 operating income was
$50 million, or 3.6% of sales, as compared to operating income of $42 million,
or 3.5% of sales, in the prior year. The 1993 increase resulted primarily from
higher sales and improved gross margins, partially offset by increased goodwill
amortization as a result of the acquisition of Borders by Kmart Corporation.
Sales of Borders-Walden in 1992 were $1,184 million, a $44 million, or 3.9%
increase over sales of $1,140 million in 1991. The increase was attributable to
the acquisition of Borders in October 1992, which contributed $56 million in
sales, and a 1.4% comparable store sales increase at Walden. Operating income of
Borders-Walden in 1992 was $42 million, or 3.5% of sales, as compared to $31
million, or 2.7% of sales, in 1991, primarily as a result of increased sales and
gross margin, partially offset by higher selling, general and administrative
expenses.
Builders Square Group
At January 23, 1994, the Builders Square Group ("Builders Square") operated
177 home improvement stores in 26 states and Puerto Rico, of which 130 were
Builders Square I Stores ("BSQ I Stores") and 47 were Builders Square II Stores
("BSQ II Stores"). The business strategy of Builders Square is to phase out its
self-service warehouse-style home improvement stores and operate large format
superstores that emphasize customer service and provide an extensive selection
of quality products and services to repair, remodel, redecorate and maintain
both home and garden. Builders Square's goal is to have virtually all stores in
the BSQ II Store format by the end of fiscal 1997.
VI-16
<PAGE> 258
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
On January 5, 1994, the Board approved a restructuring plan to convert
virtually all of the existing Builders Square stores to the new Builders Square
II format by 1997. The Builders Square II stores have an easier-to-shop layout
that utilizes a "store-within-a-store" format with substantially increased
customer service levels. In connection with the restructuring plan, Builders
Square is closing selected Builders Square I stores, converting the balance of
existing Builders Square I stores to the Builders Square II format and filling
in existing and continuous markets with Builders Square II stores. During the
next four years, Builders Square currently expects to phase out 117 Builders
Square I stores by closing 8 stores, relocating 66 stores and renovating 43
stores. In addition, Builders Square plans to open approximately 10-20 new
Builders Square II stores during each of the next two years.
As a result of the restructuring plan, Builders Square recorded a pre-tax
charge of $226 million ($141 million, net of tax) in the fourth quarter of 1993
for the estimated cost of closing, relocating or converting all Builders Square
I stores to the Builders Square II format. Of the total pre-tax charge, $214
million is for specifically-identified store relocations and renovations. These
costs include $144 million for lease obligations, a $37 million for the
writedown of inventory to be liquidated during the final closing of each store
and $33 million for the writedown of fixed assets, primarily furniture and
fixtures, to net realizable value. Such charge does not include any provision
for store occupancy, depreciation expense or normal inventory markdowns prior to
the closing or completion date of a project. The remainder of the charge relates
to a $12 million accrual for a non-routine legal judgment resulting from the
insolvency of the insurer.
Builders Square's results of operations for the last three years follow ($
millions):
<TABLE>
<CAPTION>
% CHANGE
---------------
1993 1992 1991 1993 1992
------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C>
Sales................................................. $2,719 $2,419 $2,049 12.4 18.1
------ ------ ------
------ ------ ------
Operating Income(1)................................... $ 61 $ 80 $ 74 (23.7) 8.1
------ ------ ------
------ ------ ------
Comparable Store Sales Increase....................... 0.9% 8.5% 7.0%
------ ------ ------
------ ------ ------
</TABLE>
- -------------------------
(1) Builders Square's 1993 operating income excludes store restructuring and
other charges of $226 million.
Sales in 1993 were $2,719 million, a 12.4% increase, over sales of $2,419
million in 1992. The 1993 sales increase was due to the 28 stores opened, all of
which were BSQ II Stores, in 1993 and the inclusion of a full year sales for the
22 stores opened in 1992. Comparable store sales increased 0.9% in 1993 versus
an 8.5% increase in 1992. The slower rate of comparable store sales growth in
1993 was a result of increased competition in the Northeast and Midwest, severe
winter weather conditions that continued into the spring selling season and the
strong comparable store sales growth reported in the Southeast region in 1992 as
the result of rebuilding in the aftermath of Hurricane Andrew. Inclusive of
store restructuring and other charges of $226 million, operating loss in 1993
was $166 million. Excluding store restructuring and other charges, Builders
Square 1993 operating income was $61 million, or 2.2% of sales, as compared to
$80 million, or 3.3% of sales, in the prior year. The decrease in operating
profit in 1993 resulted primarily from lower than expected sales, higher
occupancy costs and increased payroll expenses associated with improving the
level of customer service in the store.
Sales of Builders Square in 1992 were $2,419 million, a $370 million, or
18.1%, increase over sales of $2,049 million in 1991. The 1992 sales increase
was due to the opening of 22 new stores during the year, including eight BSQ II
Stores, and to an 8.5% comparable store sales increase which resulted from
strong sales in the Southeast in the aftermath of Hurricane Andrew, an improved
merchandise mix and in-stock position, a continuing shift to an everyday fair
price position and to higher average sales per transaction. Operating income
increased 8.1% in 1992 due primarily to increased sales, well controlled costs,
and in the
VI-17
<PAGE> 259
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
prior year, the closing of 14 underperforming stores, partially offset by a $10
million LIFO charge in 1992 as compared to a LIFO credit of $2 million in 1991
and increased pre-opening expense.
OfficeMax Group
The OfficeMax Group ("OfficeMax") is one of the largest operators of
high-volume, deep discount office products superstores in the United States,
operating 328 superstores in 38 states as of January 22, 1994. OfficeMax plans
to open approximately 60 to 70 stores in each of the next two years. Management
estimates that OfficeMax's cash requirements, exclusive of pre-opening expenses,
will be approximately $1 million for each additional store. These requirements
include an average of approximately $0.4 million for leasehold improvements,
fixtures, point-of-sale terminals and other equipment in the stores and
approximately $0.6 million for the portion of the store inventory that is not
financed by vendors.
On March 4, 1993, OfficeMax acquired BizMart, Inc., a 105-store national
office products superstore chain with stores located primarily in the Southwest,
West and Pacific Northwest regions and, on June 30, 1992, OfficeMax acquired OW
Office Warehouse, Inc., a 41-store office products superstore chain with stores
located primarily throughout the Mid-Atlantic region. Immediately following each
of these acquisitions, OfficeMax operationally integrated, remodeled,
remerchandised and converted the acquired stores to the OfficeMax name and
format.
In November 1990, Kmart Corporation acquired an initial 21.6% equity
interest in OfficeMax, Inc. and increased its equity interest in OfficeMax to
92.7% in November 1991. Kmart Corporation has consolidated the results of
OfficeMax's operations from November 21, 1991. Kmart Corporation currently has a
% interest in OfficeMax, Inc.
OfficeMax's results of operations from the November 21, 1991 date of
acquisition follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
---------------
1993 1992 1991 1993 1992
------ ------ ------ ----- -----
<S> <C> <C> <C> <C> <C>
Sales............................................. $1,422 $ 528 $ 65 169.3 --
------ ------ ------
------ ------ ------
Operating Income.................................. $ 20 $ 1 $ 1 -- --
------ ------ ------
------ ------ ------
Comparable Store Sales Increase................... 18.2% 28.5% --
------ ------ ------
------ ------ ------
</TABLE>
Sales for fiscal 1993 were $1,422 million, an $894 million, or 169.3%,
increase over fiscal 1992 sales of $528 million. The increase was due to the
opening of 53 new stores, the acquisition of 105 BizMart stores in March 1993,
the inclusion of a full year of sales for the 41 OW Office Warehouse, Inc.
stores acquired in June 1992, the 61 new stores opened during fiscal 1992 and an
18.2% comparable store sales increase in fiscal 1993. Operating income was $20
million in fiscal 1993, or 1.4% of sales, as compared to $1 million in fiscal
1992, or 0.1% of sales, as a result of effective cost control and the leveraging
of selling, general and administrative expenses, pre-opening expenses, and
goodwill amortization as a result of increased store sales volumes.
The 1992 OfficeMax sales increase was due to the inclusion of a full year
of OfficeMax operations and 102 new stores, including 41 OW Office Warehouse,
Inc. stores acquired on June 30, 1992. OfficeMax recorded $1 million operating
income in 1992 despite higher store opening costs resulting from an aggressive
expansion program during the year. On a pro forma basis, OfficeMax comparable
store sales increased 28.5% in 1992.
The Sports Authority Group
The Sports Authority Group ("The Sports Authority") is the largest operator
of large format sporting goods stores in the United States in terms of both
sales and number of stores and is also the largest
VI-18
<PAGE> 260
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
full-line sporting goods retailer in the United States in terms of sales,
operating 80 sporting goods megastores at January 23, 1994. The Sports Authority
has consistently increased its rate of store expansion in the last three fiscal
years, opening 24 stores, 20 stores and 17 stores in 1993, 1992 and 1991,
respectively. The Sports Authority currently plans to open approximately 25
stores in 1994, with 21 of the 1994 openings concentrated in existing markets.
The remaining four of the planned 1994 openings are expected to be concentrated
within three new markets.
The Sports Authority's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
--------------
1993 1992 1991 1993 1992
---- ---- ---- ----- -----
<S> <C> <C> <C> <C> <C>
Sales...................................................... $607 $412 $241 47.5 70.8
---- ---- ----
---- ---- ----
Operating Income........................................... $ 21 $ 10 $ 3 110.0 --
---- ---- ----
---- ---- ----
Comparable Store Sales Increase............................ 2.6% 8.3% 15.3%
---- ---- ----
---- ---- ----
</TABLE>
Sales in 1993 were $607 million, a $195 million, or 47.5%, increase over
sales of $412 million in 1992. Of the 47.5% increase in sales, 2.6%, or $11
million, was produced by comparable store sales growth, 23.4%, or $96 million,
was produced by the 20 stores opened in 1992 which had no comparable store sales
in the prior year and 21.5%, or $88 million, was produced by the 24 new stores
opened in 1993. Comparable store sales increased 2.6% and 8.3% in 1993 and 1992,
respectively. Comparable store sales in 1993 were adversely effected by the
severe winter storm which occurred in March 1993 and reduced consumer demand for
higher priced apparel. Excluding sales from stores cannibalized by new store
openings, comparable store sales increased 5.1% in 1993 as compared to 11.4% in
the prior year. Operating income in 1993 was $21 million, or 3.5% of sales, as
compared to $10 million, or 2.4% of sales, in 1992. The improvement was a result
of increased sales volume, lower pre-opening expense and goodwill amortization
as a percent of sales and management of store and administrative expenses.
Sales of The Sports Authority in 1992 were $412 million, a $171 million, or
70.8% increase, over sales of $241 million in 1991. Of the 70.8% increase in
sales in 1992, 8.3%, or $20 million, was produced by comparable store sales
growth; 32.1%, or $78 million, was produced by 17 stores opened in 1991 which
had no comparable store sales in the prior year and 30.4%, or $73 million, was
produced by the 20 new stores opened in 1992. Comparable store sales increased
8.3% in 1992. Excluding the effect of stores in which sales were cannibalized by
new openings within the same market, comparable store sales increased by 11.4%
in 1992. Operating income of The Sports Authority in 1992 was $10 million, or
2.4% of sales, as compared to $3 million, or 1.4% of sales, in the prior year.
The increase of $7 million, or 1.0% of sales, in 1992 was the result of
increased sales, lower advertising expense and goodwill amortization as a
percent of sales and management of store and administrative expenses.
LICENSEE OPERATIONS AND EQUITY INVESTMENTS
Kmart Corporation owns a 21.5% equity interest in Coles Myer Ltd.,
Australia's largest retailer, and a 49.0% equity interest in substantially all
of the Meldisco subsidiaries of Melville Corporation, which operates domestic
Kmart footwear departments and has attributed its interests to the Kmart Group.
In U.S. dollars, 1993 equity in income of Coles Myer was $58 million
compared with $51 million in 1992 and $60 million in 1991. The increase in Coles
Myer equity income in 1993 was due to improved gross margin, expense control and
a 6% reduction in the Australian corporate tax rate. The 1992 Coles Myer equity
income decline was a result of losses on the sale of certain New Zealand food
operations and part of Sandhurst Dairies operations earlier in the year and the
continued weak Australian economy.
VI-19
<PAGE> 261
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Meldisco equity income in 1993 was $52 million compared with $54 million in
1992 and $50 million in 1991. Lower 1993 Meldisco equity income was a result of
unfavorable weather in early 1993 and increased competition. 1992 Meldisco
equity income increased due to increased sales, combined with improved gross
profit margin as a result of lower purchasing costs and the merchandise mix.
Refer to the accompanying Notes to Combined Financial Statements for further
results of Kmart Corporation's equity investments.
EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS
Compliance with federal, state and local provisions which have been enacted
or adopted regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had, and is not
expected to have, a material effect on the capital expenditures, earnings or
competitive position of the Kmart Group.
VI-20
<PAGE> 262
KMART GROUP
GENERAL
As part of the Kmart Corporation, the Kmart Group is one of the world's
largest mass merchandise retailers. The dominant portion of the Kmart Group's
business is the operation of a chain of 2,323 Kmart discount stores
(collectively, the "Kmart Stores") with locations in each of the 50 states of
the United States and Puerto Rico at January 26, 1994. Included in the above
total are 19 Super Kmart Centers ("Super K Centers"), all of which are presently
in the United States. Internationally, the Kmart Group has operations in Canada,
the Czech Republic and Slovakia and has formed joint ventures in Mexico and
Singapore. The Central European stores were acquired in mid-1992 and represent
the Kmart Group's entry into that market. The Kmart Group is developing advanced
distribution methods and merchandising skills to modernize, refurbish and
streamline operations in the two European countries.
The Kmart Group includes a 100% Retained Interest in each of the Specialty
Retail Groups which is comprised of the Borders-Walden Group, the Builders
Square Group, the OfficeMax Group and The Sports Authority Group. In addition,
the Kmart Group holds significant equity interests in Coles Myer Ltd.,
Australia's largest retailer, and substantially all of the Meldisco subsidiaries
of Melville Corporation which operate the footwear departments in domestic Kmart
stores. The Kmart Group also includes the operations of PayLess Drug Stores
which is subject to a definitive sale agreement, and PACE Membership Warehouse,
substantially all of which assets were sold in January 1994 each of which have
been presented as discontinued operations in the combined financial statements.
In 1990, the Kmart Group embarked on a renewal plan to modernize its U.S.
and Canadian Kmart stores through relocation, expansion and refurbishment. To
build on the success of the 110,000 square foot prototype Kmart store and Super
Kmart Centers, the Kmart Group recently enhanced the renewal plan to include a
larger number of relocations and expansions. At the end of fiscal 1993, the
Kmart Group had completed the modernization of approximately half of its
existing stores and expects to have the entire store modernization program
substantially completed by the end of 1996.
The Kmart Corporation's predecessor was founded in Michigan by S.S. Kresge
who opened his first store in 1899 and subsequently founded the Kmart
Corporation in 1916. After operating Kresge department stores for over 40 years,
the Kmart store program commenced with the opening of the first Kmart store in
March 1962.
OPERATIONS
U.S. General Merchandise Operations
The dominant portion of Kmart operations is in a single industry: retailing
general merchandise through the operation of the Kmart Stores in all 50 states
and Puerto Rico. Kmart Stores are generally one-floor, free-standing units
ranging in size from 40,000 to 120,000 gross square feet. Full-size stores
operate in the most densely populated urban areas, and are geographically
located to increase customer awareness and maximize customer convenience and
accessibility.
In February 1990, the Kmart Group commenced its renewal program for all
U.S. Kmart Stores, under which it is expanding, relocating or closing smaller
stores. Substantially all other locations are being refurbished to bring their
layout, fixtures and merchandise assortment up to new store standards. At the
end of fiscal 1993, 57% of the U.S. Kmart Stores had been updated to this new
format, including 313 relocations, 430 expansions and 448 refurbishments.
During 1993, Kmart integrated the new Super K Center concept into its
modernization program and opened 14 new Super K Centers, each of which produced
encouraging results in terms of customer acceptance. A Super K Center occupies
from 150,000 to 185,000 square feet, is open 24 hours a day, seven days a week,
and features a modern grocery store as well as a full line of Kmart general
merchandise as well as a variety of ancillary services including dry cleaning,
hair care, optical and floral shops. While the Kmart
VI-21
<PAGE> 263
Group is still studying and experimenting with Super K Centers, management
believes that there is a potential to open several hundred Super K Centers over
the next five to seven years.
At January 26, 1994, Kmart operated 2,323 Kmart Stores including 19 Super K
Centers. In the United States, Kmart's general merchandise retail operations are
located in 50 states and in 258 of the country's 261 Metropolitan Statistical
Areas (MSAs) as well as in 67 of the 71 Primary Metropolitan Statistical Areas
(PMSAs). In addition, Kmart's stores are located in three of the four MSAs and
both PMSAs in Puerto Rico.
International General Merchandise Operations
- Canada. At January 26, 1994, Kmart Canada Limited operated 136 Kmart and
S.S. Kresge stores located in all ten provinces. The Kmart Stores in Canada
range in size from 45,000 to 97,000 square feet and offer a wide variety of
general merchandise at discount prices. Similar to its domestic counterpart, in
January 1994, Kmart Canada expanded its renewal plan to include the
modernization of all of its Kmart Stores through relocation, expansion or
refurbishment and the closing of the 9 remaining S.S. Kresge stores. As of the
end of fiscal 1993, Kmart Canada had modernized 24 of the 127 Kmart Stores in
Canada.
- Czech Republic and Slovakia. In 1992, the Kmart Group acquired over 93%
of a Czech Republic company which operated one of the largest department stores
in Prague, as well as two companies which operated 12 department stores located
in the Czech Republic and Slovakia. These acquisitions mark the Kmart Group's
initial entry into the Central European retail market. The Kmart Group plans to
develop advanced distribution methods and merchandising skills to modernize,
refurbish and streamline operations in these countries.
- Mexico. In 1993, the Kmart Group entered into a joint venture with El
Puerto de Liverpool, S.A. de C.V. to build and operate grocery and general
merchandise stores in Mexico that are patterned after the Super K Centers in the
United States. Kmart currently anticipates opening approximately two to five
stores in Mexico in fiscal 1994. Kmart believes that this joint venture in
Mexico, and the joint venture in Singapore described below, puts it at the
forefront of international retailing with only a nominal investment.
- Singapore. In 1993, the Company entered into a joint venture with Metro
(Private) Limited to open Kmart stores in Singapore. Kmart currently anticipates
opening approximately two to six stores in Singapore in fiscal 1994.
Specialty Retail Groups
Kmart currently has a 100% Retained Interest in the following Specialty
Retail Groups:
- Borders-Walden Group. The Borders-Walden bookstore group consists of the
Borders book store business which, as of January 23, 1994 operated 44 large
format book superstores, in 22 states and the District of Columbia, each of
which is designed to be the premier book retailer in its market, and Walden Book
Company, which is the largest operator of mall-based bookstores in the United
States in terms of the number of stores and sales, operating 1,159 stores,
excluding Walden Software stores, in 50 states and the District of Columbia. See
Annex VII.
- Builders Square Group. Builders Square is a leading specialty retailer of
home improvement and home decor products and services, operating 177 home
improvement stores in 26 states and Puerto Rico at January 23, 1994. See Annex
VIII.
- OfficeMax Group. OfficeMax is one of the largest operators of high
volume, deep discount office products superstores in the United States,
operating 328 superstores in 38 states as of January 22, 1994. See Annex IX.
- The Sports Authority Group. The Sports Authority is one of the largest
operators of large format sporting goods stores in the United States in terms of
both net sales and number of stores and the largest full-line sporting goods
retailer in the United States in terms of net sales, operating 80 sporting goods
megastores as of January 23, 1994. See Annex X.
VI-22
<PAGE> 264
Discontinued Operations
In January 1994, PACE Membership Warehouse, Inc. sold the assets and lease
obligations of 93 of its warehouses and virtually all of the inventory and
membership files in the 34 warehouses not included in the transaction to Sam's
Club, a division of Wal*Mart, for $774 million. The book value of the assets
sold to Wal*Mart was $624 million. Operations of the 34 remaining PACE sites not
included in the transaction were discontinued and PACE is in the process of
evaluating and marketing these leased sites as well as leased premises for
unopened warehouses and corporate facilities. Included in the loss on the
disposal of PACE was unamortized goodwill, expected remaining lease obligations
in the warehouses not sold, other PACE liabilities and a provision for
additional costs anticipated during the wind-down of PACE operations.
In addition, Kmart Corporation entered into an agreement to sell its
PayLess Drug Stores subsidiary to TCH Corporation for $592 million in cash, $100
million in subordinated debt and 47% of the common equity of TCH Corporation.
The book value of PayLess' net assets to be sold was $1,186 million at January
26, 1994. It is anticipated that the transaction will be completed by the end of
the first quarter of 1994. It is Kmart Corporation's intention to divest its 47%
interest in TCH within one year or as soon as practicable after considering all
relevant factors including the value to be received upon such disposition.
Management expects the disposition to be achieved either through a private
offering or other alternative means. Accordingly, Kmart Corporation has reported
PayLess as a discontinued operation and has recorded its investment in TCH,
attributed to the Kmart Group at net realizable value.
Investments in Affiliated Retail Operations
- Meldisco. All U.S. Kmart footwear departments are operated under license
agreements with the Meldisco subsidiaries of Melville Corporation, substantially
all of which are 49% owned by Kmart and 51% owned by Melville. Meldisco also
operates footwear departments in PayLess Drug Stores under a license agreement.
- Coles Myer Ltd. Kmart Corporation has a 21.5% equity interest in Coles
Myer Ltd., Australia's largest retailer. At July 25, 1993, Coles Myer operated
500 supermarket, food service and liquor stores, 232 discount stores (including
147 Kmart stores), 72 department stores and 867 specialty retail stores
primarily in Australia.
COMPETITION
The Kmart Group's principal business is general-merchandise retailing with
a significant retained interest in specialty merchandise retailing. The Kmart
Group is one of the world's largest mass merchandise retailers and has several
major competitors on a national level, including Dayton-Hudson, J.C. Penney,
Sears and Wal*Mart, and many competitors on a local level which compete with the
Kmart Group's individual stores. Success in the competitive market is based on
factors such as price, quality, service, product mix and convenience.
SEASONALITY
The business is highly seasonal and depends to a significant extent on the
results of operations for the last quarter of the fiscal year.
CREDIT SALES
The Kmart Group does not have a significant customer credit function of its
own. However, substantially all the Kmart Group's stores do accept major bank
credit cards as payment for merchandise.
EMPLOYEES
The Kmart Corporation and its subsidiaries employ approximately 344,000
persons as of January 26, 1994.
VI-23
<PAGE> 265
STORE LOCATIONS
At January 26, 1994, the Kmart Group operated a total of 2,486 general
merchandise stores: 2,337 in the United States and Puerto Rico, 136 in Canada,
and 13 stores in the Czech Republic and Slovakia.
PROPERTY AND LEASES
With the exception of the 168 stores that are either partially or wholly
owned, Kmart Group leases its store facilities. For the 430 Kmart stores
recently expanded in the store modernization program, Kmart Group generally owns
the expanded portion of the building. Kmart stores are generally leased for
terms of 25 years with options to renew for additional terms.
Kmart Group owns its International Headquarters and one administrative
building in Troy, Michigan and leases administrative buildings in Royal Oak,
Michigan and North Bergen, New Jersey. Kmart Group leases 19 United States
distribution and port centers for initial terms of 10 to 30 years with options
to renew for additional terms. In addition, Kmart Group owns or leases 358
parcels not currently used for store operations, the majority of which are
rented to others.
Kmart Canada Limited owns its administrative office building in Brampton,
Ontario, Canada. In addition, Kmart Canada leases four distribution centers and
owns one distribution center. Kmart Group owns 13 department stores and various
other properties in the Czech Republic and Slovakia.
TRADEMARKS, SERVICE MARKS AND LICENSES
Kmart Properties, Inc., a wholly owned subsidiary of Kmart Corporation,
owns and has registered the Kmart and Kmart Logo trademarks and service marks in
the U.S. Kmart Corporation is the exclusive licensee of Kmart Properties, Inc.
to use these marks in the U.S. Whenever possible, Kmart Properties, Inc. and/or
Kmart Corporation has registered the Kmart marks with the state or locality
where Kmart has stores.
LITIGATION
Kmart Corporation is a party to a substantial number of legal proceedings,
most of which are routine and all of which are incidental to its business. Some
matters involve claims for large amounts of damages as well as other relief.
Although the consequences are not presently determinable, in the opinion of
management, they will not have a material effect on the Kmart Group's liquidity,
financial position or results of operations.
VI-24
<PAGE> 266
KMART GROUP
REPORT BY MANAGEMENT
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Kmart Corporation and Kmart Group management are responsible for the
integrity of the information and representations contained in interim and annual
financial statements. This responsibility includes making informed estimates and
judgments in selecting the appropriate accounting principles. Management
believes the financial statements conform with generally accepted accounting
principles applied on a consistent basis.
To assist management in fulfilling these obligations, several tools are
utilized, which include the following:
A system of internal accounting controls is maintained to provide for
the integrity of information for purposes of preparing financial statements
and to assure that assets are properly accounted for and safeguarded. This
concept of reasonable assurance is based on the recognition that the cost
of the system is related to the benefits to be derived and modified for
changing conditions. Management believes its system provides reasonable
assurance of this appropriate balance.
As part of the internal control system, a policy of Standards of
Business Conduct and Management Integrity Statements is in effect. All
officers and key employees periodically submit a signed statement regarding
compliance with these policies.
An Internal Audit Department is maintained to evaluate, test and
report on the application of internal accounting controls in conformity
with standards of the practice of internal auditing.
The financial statements have been examined by independent accountants
whose report is contained herein. This examination includes, among other
things, a review of the system of internal controls as required by
generally accepted auditing standards.
The Audit Committee of the Board of Directors, consisting solely of outside
directors, meets regularly with management, internal auditors and the
independent accountants to assure that each is carrying out its
responsibilities. The internal auditors and independent accountants both have
full and free access to the Audit Committee, with and without the presence of
management.
Joseph E. Antonini
Kmart Corporation
Chairman of the Board, President
and Chief Executive Officer
Thomas F. Murasky
Kmart Corporation
Executive Vice President
and Chief Financial Officer
VI-25
<PAGE> 267
KMART GROUP
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Kmart Corporation
In our opinion, the accompanying combined balance sheets and the related
combined statements of income, and of cash flows present fairly, in all material
respects, the financial position of the Kmart Group at January 26, 1994 and
January 27, 1993, and the results of its operations and its cash flows for each
of the three years in the period ended January 26, 1994, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of Kmart Corporation management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the notes to the combined financial statements, the Kmart
Group adopted Statement of Financial Accounting Standard No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions" and Statement of
Financial Accounting Standard No. 109, "Accounting for Income Taxes," at the
beginning of fiscal 1993.
The Kmart Group is a business group of Kmart Corporation (as described in
the Basis of Presentation note to these financial statements); accordingly, the
combined financial statements of the Kmart Group should be read in conjunction
with the consolidated financial statements of Kmart Corporation.
Price Waterhouse
Detroit, Michigan
March 15, 1994
VI-26
<PAGE> 268
KMART GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 26, JANUARY 27, JANUARY 29,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $28,039 $26,470 $25,548
Licensee fees and rental income.............................. 288 278 266
Equity in income of affiliated retail companies.............. 110 105 110
----------- ----------- -----------
28,437 26,853 25,924
----------- ----------- -----------
Cost of merchandise sold (includes buying and occupancy
costs)..................................................... 20,975 19,330 18,586
Selling, general and administrative expenses................. 6,338 5,918 5,880
Store restructuring and other charges........................ 904 -- --
Interest:
Debt -- expense............................................ 295 256 218
-- income............................................ (12) (25) (14)
Capital lease obligations -- expense....................... 184 180 177
----------- ----------- -----------
28,684 25,659 24,847
----------- ----------- -----------
Income (loss) from continuing retail operations before
Retained Interests in the Specialty Retail Groups and
income taxes............................................... (247) 1,194 1,077
Net income (loss) related to Retained Interests in the
Specialty Retail Groups.................................... (145) 83 66
Income taxes................................................. (110) 398 358
----------- ----------- -----------
Net income (loss) from continuing retail operations before
extraordinary items and the effect of accounting changes... (282) 879 785
Discontinued operations including the effect of accounting
changes, net of income taxes of $(19), $40 and $42,
respectively............................................... (81) 59 70
Loss on disposal of discontinued operations,
net of income taxes of $(239).............................. (503) -- --
Extraordinary items, net of income taxes of $(15)............ (28) -- --
Effect of accounting changes, net of income taxes of $(35)... (31) -- --
----------- ----------- -----------
Net income (loss)............................................ $ (925) $ 938 $ 855
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure (unaudited):
Net income (loss)....................................... $ (925) $ 938 $ 855
Less goodwill amortization of the Specialty Retail
Groups................................................ -- -- --
----------- ----------- -----------
Kmart Corporation earnings (losses) attributable to the
Kmart Group........................................... $ (925) $ 938 $ 855
----------- ----------- -----------
----------- ----------- -----------
Pro forma (unaudited):
Earnings per Kmart Group common and common equivalent
share:
Net income (loss) from continuing retail operations
before extraordinary items and the effect of
accounting changes.................................... $ (.62) $ 1.92 $ 1.84
Discontinued operations including the effect of
accounting changes, net of income taxes............... (.18) .13 .17
Loss on disposal of discontinued operations, net of
income
taxes................................................. (1.10) -- --
Extraordinary items, net of income taxes................ (.06) -- --
Effect of accounting changes, net of income taxes....... (.07) -- --
----------- ----------- -----------
$ (2.03) $ 2.05 $ 2.01
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-27
<PAGE> 269
KMART GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 27,
1994 1993
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash (includes temporary investments of $32 and $260,
respectively).................................................... $ 365 $ 542
Merchandise inventories............................................. 5,641 7,557
Accounts receivable and other current assets........................ 1,007 1,019
Discontinued operations............................................. 911 --
------------ ------------
Total current assets.................................................. 7,924 9,118
Retained Interests in the Specialty Retail Groups..................... 1,746 1,412
Investments in Affiliated Retail Companies............................ 606 597
Property Owned:
Land................................................................ 131 190
Buildings........................................................... 405 603
Leasehold improvements.............................................. 1,398 1,466
Furniture and fixtures.............................................. 4,947 5,070
Construction in progress............................................ 87 59
Property under capital leases......................................... 2,843 2,793
------------ ------------
9,811 10,181
Less-accumulated depreciation and amortization:
Property owned...................................................... (3,110) (2,917)
Property under capital leases....................................... (1,444) (1,404)
------------ ------------
Total Owned and Leased Property....................................... 5,257 5,860
Other Assets and Deferred Charges..................................... 332 373
Goodwill -- net of accumulated amortization of $52.................... -- 509
------------ ------------
$ 15,865 $ 17,869
------------ ------------
------------ ------------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year.................................. $ 384 $ 117
Notes payable....................................................... 918 590
Accounts payable -- trade........................................... 1,943 2,377
Accrued payrolls and other liabilities.............................. 957 1,005
Taxes other than income taxes....................................... 227 344
Income taxes........................................................ 28 215
------------ ------------
Total current liabilities............................................. 4,457 4,648
Capital Lease Obligations............................................. 1,632 1,639
Long-Term Debt........................................................ 2,207 3,215
Other Long-Term Liabilities (includes store restructuring
obligations)........................................................ 1,476 652
Deferred Income Taxes................................................. -- 231
Equity:
Preferred Stock Series A, 5,750,000 shares authorized and
issued.......................................................... 986 986
Preferred Stock Series B, 796,827 shares authorized; 784,938
shares issued................................................... 157 157
Kmart Group Common Equity........................................... 4,950 6,341
------------ ------------
Total Kmart Group Equity.............................................. 6,093 7,484
------------ ------------
$ 15,865 $ 17,869
------------ ------------
------------ ------------
Supplemental disclosure (unaudited):
Kmart Group Equity.................................................. $ 6,093 $ 7,484
Less accumulated goodwill amortization of the Specialty Retail
Groups........................................................... -- --
------------ ------------
Kmart Corporation equity attributable to the Kmart Group............ $ 6,093 $ 7,484
------------ ------------
------------ ------------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-28
<PAGE> 270
KMART GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 26, JANUARY 27, JANUARY 29,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income (loss) from continuing retail operations before
extraordinary items and the effect of accounting
changes................................................. $ (282) $ 879 $ 785
Adjustments to reconcile net income (loss) to operating
cash flows:
Net (income) loss related to Retained Interests in the
Specialty Retail Groups............................... 145 (83) (66)
Depreciation and amortization........................... 591 517 443
Store restructuring and other charges................... 819 (27) (44)
Deferred income taxes................................... (396) 149 111
Undistributed equity income............................. (15) (11) (26)
Increase (decrease) in other long-term liabilities...... 259 63 (6)
Other -- net............................................ 37 54 78
Cash provided by (used for) current assets and current
liabilities:
(Increase) decrease in inventories...................... 558 (724) (581)
Increase (decrease) in accounts payable................. 84 (22) 308
Other -- net............................................ (362) (283) (171)
----------- ----------- -----------
Total cash provided by continuing retail operations........ 1,438 512 831
----------- ----------- -----------
Discontinued Operations
Loss on disposal of discontinued operations............. (503) -- --
Income (loss) from discontinued operations.............. (81) 59 70
Items not affecting cash -- net......................... 1,043 85 80
----------- ----------- -----------
Total cash provided by discontinued operations............. 459 144 150
----------- ----------- -----------
Net cash provided by operations............................ 1,897 656 981
----------- ----------- -----------
INVESTING
Capital expenditures -- owned property..................... (793) (1,297) (1,245)
Acquisitions............................................... -- (300) --
Proceeds from the sale of assets........................... 11 25 69
Net equity transactions with the Specialty Retail Groups... (478) (29) (12)
Other -- net............................................... (48) (51) (45)
----------- ----------- -----------
Net cash used for investing................................ (1,308) (1,652) (1,233)
----------- ----------- -----------
FINANCING
Proceeds from issuance of long-term debt and notes
payable................................................. 731 1,589 811
Reduction in long-term debt and notes payable.............. (932) (46) (896)
Reduction in capital lease obligations..................... (117) (110) (106)
Issuance of common stock................................... 32 57 67
Issuance of $3.41 Depositary Shares (each representing 1/4
share Series A conversion preferred).................... -- -- 986
Reissuance of treasury shares.............................. 13 8 2
Extraordinary items for bond redemptions................... (28) -- --
Dividends paid............................................. (465) (448) (375)
----------- ----------- -----------
Net cash provided by (used for) financing.................. (766) 1,050 489
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS.............. (177) 54 237
Cash and Equivalents at Beginning of Year.................. 542 488 251
----------- ----------- -----------
CASH AND EQUIVALENTS AT END OF YEAR.......................... $ 365 $ 542 $ 488
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-29
<PAGE> 271
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
BASIS OF PRESENTATION
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue four new series of
common stock (collectively, the Specialty Retail Stock) designated
KM-Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of each specialty retail business. The Borders-Walden Stock is
intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company, Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the initial issuance of any series of Specialty Retail Stock, the
existing common stock would be redesignated as Kmart Group Common Stock (Kmart
Stock). The Kmart Stock, while constituting common stock of Kmart Corporation,
is intended to reflect the separate performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) Kmart Corporation's interest in each Specialty Retail Group (a Retained
Interest) which excludes the interest represented by any outstanding shares of
any series of Specialty Retail Stock and (iii) all other businesses in which
Kmart Corporation and its subsidiaries are engaged. The Kmart Group and the
Specialty Retail Groups are referred to collectively herein as the Groups.
Following approval by shareholders of the Specialty Retail Stock Proposal,
Kmart Corporation currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate initial public offerings (collectively, the Offerings) and to allocate
the proceeds of the Offerings to the Kmart Group to repay outstanding
indebtedness of Kmart Corporation, resulting in reduced debt service obligations
attributable to the Kmart Group. The timing, sequence and size of such Offerings
and the price at which such shares would be sold would be determined by the
Board, without the further approval of shareholders, at the time of each
Offering; however, it is currently contemplated that Kmart Corporation would
initially offer to the public shares of each series of Specialty Retail Stock
that would be intended to represent approximately 20% to 30% of the equity value
of Kmart Corporation attributed to the relevant Specialty Retail Group as
determined by the Board (Equity Value) at the time of such Offering. Therefore,
it is expected that Kmart Corporation would retain and attribute to the Kmart
Group a 70% to 80% Retained Interest in each such Specialty Retail Group. The
terms of each Offering would be determined by the Board and the underwriters of
such Offering based upon prevailing market conditions; the financial condition
and results of operations of the relevant Group; the history of and prospects
for the relevant Group; the specialty retail industry and the segment of that
industry in which the relevant Group competes; the management and operations of
the relevant Group; the progress of the relevant Group in implementing its
business strategy; the foregoing factors in relation to market values of other
companies engaged in similar businesses; and the financial condition of Kmart
Corporation as a whole. In addition to or in lieu of any Offering, the Board
reserves the right to issue shares of any series of Specialty Retail Stock as a
distribution on
VI-30
<PAGE> 272
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Kmart Stock, although the Board has no current intention to do so. The
determination of whether to proceed with an Offering of any series of Specialty
Retail Stock would be made by the Board based on, among other things, the
proposed terms of such Offering and the then prevailing market and other
conditions. The Board reserves the right not to proceed with any or all of the
Offerings, without further approval of shareholders, if it determines that
consummation of such Offering or Offerings is not in the best interests of Kmart
Corporation.
The financial statements of the Groups comprise all of the accounts
included in the corresponding consolidated financial statements of Kmart
Corporation. The separate Group financial statements give effect to the
management and accounting policies that would be applicable upon implementation
of the Specialty Retail Stock Proposal, except that no inter-Group interest
expense or inter-Group interest income is reflected, as more fully described
under "Corporate Activities" below. However, following implementation of the
Specialty Retail Stock Proposal and issuance of each Specialty Retail Stock, the
financial statements of each Specialty Retail Group would reflect interest
expense related to net cash provided by Kmart Corporation. The separate Group
financial statements have been prepared on a basis that management believes to
be reasonable and appropriate and include (i) the combined historical financial
position, results of operations and cash flows of the businesses that comprise
each of the Groups, (ii) a portion of the assets and liabilities (including
contingent liabilities) and related transactions of Kmart Corporation that are
not separately identified with the operations of a specific Group and (iii) with
respect to the Kmart Group, a Retained Interest in each of the Specialty Retail
Groups. The effects of the issuance of the equity securities described above
have not been reflected in these historical financial statements.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, following issuance of any series of Specialty Retail
Stock, Kmart Corporation would provide to holders of Kmart Stock separate
financial statements, management's discussion and analysis of financial
condition and results of operations, business descriptions and other information
for the Kmart Group and for Kmart Corporation. Notwithstanding the allocation of
assets and liabilities (including contingent liabilities), shareholders' equity
and items of income and expense among the Groups for purposes of preparing their
respective financial statements, the change in the capital structure of Kmart
Corporation contemplated by the Specialty Retail Stock Proposal would not affect
the respective legal title to assets or responsibility for liabilities of Kmart
Corporation or any of its subsidiaries. Kmart Corporation and its subsidiaries
would each continue to be responsible for their respective liabilities. Holders
of Kmart Stock and of each other series of common stock of Kmart Corporation
would be holders of common stock of Kmart Corporation and would continue to be
subject to risks associated with an investment in Kmart Corporation and all of
its businesses, assets and liabilities. The Specialty Retail Stock Proposal
would not affect the rights of creditors of Kmart Corporation.
Financial effects arising from any Group that affect the consolidated
results of operations or financial condition of Kmart Corporation could affect
the results of operations or financial condition of the Kmart Group or the
market price of shares of Kmart Stock. In addition, net losses of any Group,
dividends and distributions on any series of common stock or preferred stock,
repurchases of any series of common stock and certain repurchases of preferred
stock would reduce the assets of Kmart Corporation legally available for
dividends on all series of common stock. Accordingly, Kmart Corporation
consolidated financial information should be read in conjunction with the Kmart
Group financial information.
The dividend policy applicable to Kmart Stock would be determined by the
Board at the time of issuance of such stock. Determinations to pay dividends on
Kmart Stock would be based primarily upon the financial condition, results of
operations and business requirements of the Kmart Group and Kmart Corporation as
a whole. Under the terms of Kmart Stock, dividends on Kmart Stock would be
payable at the sole discretion of the Board out of the lesser of (i) all assets
of Kmart Corporation legally available for dividends and (ii) the Available
Dividend Amount with respect to the Kmart Group.
VI-31
<PAGE> 273
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The management and accounting policies applicable to the preparation of the
financial statements of the Kmart Group could be modified or rescinded by the
Board, in its sole discretion and without the approval of shareholders, although
there is no present intention to do so. The Board could also adopt additional
policies depending upon the circumstances. Any determination by the Board to
modify or rescind such policies, or to adopt additional policies, including any
such decision that could have disparate effects upon holders of different series
of common stock, would be made by the Board in good faith and in the honest
belief that such decision is in the best interests of Kmart Corporation. In
addition, generally accepted accounting principles require that changes in
accounting policy must be preferable (in accordance with such principles) to the
policy previously in place.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Kmart Group's significant accounting policies, which conform to
generally accepted accounting principles applied on a consistent basis between
years, are described below.
Fiscal Year: The Kmart Group's fiscal years end on the last Wednesday in
January. Fiscal years 1993, 1992 and 1991 each consisted of 52 weeks and ended
on January 26, 1994, January 27, 1993 and January 29, 1992, respectively.
Basis of Consolidation: The combined financial statements include the
businesses comprising the Kmart Group. Kmart Group's earnings attributable to
the Specialty Retail Groups are discussed below. Investments in affiliated
retail companies which the Kmart Corporation has significant influence in
management and control are accounted for using the equity method using their
December financial statements. These investments have been attributed to the
Kmart Group. Intercompany transactions and accounts have been eliminated in
consolidation.
Earnings Per Common and Common Equivalent Share: Historical earnings per
share are omitted from the statements of income as Kmart Stock was not part of
the capital structure of Kmart Corporation for the periods presented. Following
implementation of the Specialty Retail Stock Proposal, the method of calculating
earnings per share for Kmart Stock and each series of Specialty Retail Stock
would reflect the terms of the Certificate of Amendment which provide that each
Group's Available Dividend Amount, which, in turn, would reflect the separately
reported Kmart Corporation Earnings Attributable to the Kmart Group, in the case
of the Kmart Group, and Kmart Corporation Earnings Attributable to a Specialty
Retail Group, in the case of a Specialty Retail Group, would be the source for
payment of dividends for each series of common stock, although liquidation
rights of these series of stock and legally available assets of Kmart
Corporation may be more or less than these amounts. Kmart Corporation would
compute earnings per share of Kmart Stock by dividing the product of the
Outstanding Interest Fraction and Kmart Corporation Earnings Attributable to the
Kmart Group by the weighted average number of shares of Kmart Stock and dilutive
Kmart Stock equivalents outstanding during the applicable period. In determining
the weighted average number of fully diluted shares of Kmart Stock outstanding,
the Series A conversion preferred stock and Series B convertible preferred stock
would be treated as Kmart Stock equivalents, if dilutive. Kmart Corporation
Earnings Attributable to the Kmart Group would equal the Kmart Group's net
income or loss for the relevant period determined in accordance with generally
accepted accounting principles in effect at such time, reflecting income and
expenses of Kmart Corporation allocated to the Kmart Group, decreased by
amortization of goodwill arising from Specialty Retail Group acquisitions before
the first issuance of the relevant Specialty Retail Stock (but only to the
extent not already reflected in net income of the Kmart Group by virtue of
accounting for its Retained Interests under the equity method). See "Proposal
2 -- The Specialty Retail Stock Proposal -- Dividend Policy -- Calculation of
Earnings Per Share" of Kmart Corporation Proxy Statement for an example of the
calculation of Kmart Corporation Earnings Attributable to a Specialty Retail
Group with respect to Kmart Stock.
VI-32
<PAGE> 274
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Foreign Operations: Foreign currency assets and liabilities are translated
into U.S. dollars at the exchange rates in effect at the balance sheet date.
Results of operations are translated at average exchange rates during the period
for revenues and expenses. Translation gains and losses resulting from
fluctuations in the exchange rates are accumulated as a component of Kmart Group
equity.
Inventories: Merchandise inventories are valued at the lower of cost or
market, primarily using the retail method, on the last-in, first-out (LIFO)
basis for substantially all domestic inventories and the first-in, first-out
basis for the remainder.
Retained Interest: Under the Specialty Retail Stock Proposal, prior to any
Offerings or any other issuance of Specialty Retail Stock, the Kmart Group would
have a 100% Retained Interest in each of the Specialty Retail Groups. Following
completion of such Offerings, it is currently anticipated that the Kmart Group
would have a 70% to 80% Retained Interest in each Specialty Retail Group. For
purposes of these combined financial statements, the Kmart Group's Retained
Interest in the equity value of the Company attributed to the Specialty Retail
Groups has been reflected as "Retained Interests in the Specialty Retail Groups"
in the combined balance sheets. Similarly, the net income or losses of the
Specialty Retail Groups attributable to the Kmart Group Retained Interest are
reflected as "Net income (loss) related to Retained Interests in the Specialty
Retail Groups" in the combined statements of income. Accordingly, all amounts
corresponding to the Kmart Group's Retained Interests in the Specialty Retail
Groups in these combined financial statements represent the Kmart Group's
proportional interest in the businesses, assets and liabilities and income and
expenses of each of the relevant Specialty Retail Groups. See the "Retained
Interests in the Specialty Retail Groups" note for summarized financial
information on each Group.
The book value associated with the Kmart Group's Retained Interest in each
Specialty Retail Group would be increased proportionally for net income (or
decreased for net loss) of such Specialty Retail Group. In addition, in the
event of any dividend or other distribution on the relevant series of Specialty
Retail Stock an amount that is proportionate to the aggregate amount so paid in
respect of shares of such series of Specialty Retail Stock would be transferred
to the Kmart Group from such Specialty Retail Group with respect to its Retained
Interest and would reduce the related book value. In addition to the effect of
the Offerings, the fractional amount of the Kmart Group's Retained Interest in
each Specialty Retail Group would be (i) decreased in the case of any issuance
of shares of the relevant series of Specialty Retail Stock, (ii) increased to
the extent that any funds advanced to such Specialty Retail Group from the Kmart
Group are deemed to be equity contributions and, (iii) decreased to the extent
that cash or other assets are transferred from such Specialty Retail Group to
the Kmart Group in connection with a tender or exchange offer or stock
repurchase program relating to shares of the relevant series of Specialty Retail
Stock.
Property Owned and Depreciation: Land, buildings, leasehold improvements
and equipment are recorded at cost, including a provision for capitalized
interest. Depreciation is provided over the estimated useful lives of related
assets on the straight-line method for financial statement purposes and on
accelerated methods for income tax purposes. Most store properties are leased
and improvements are amortized over the term of the lease but not more than 25
years. Other annual rates used in computing depreciation for financial statement
purposes are 2% to 4% for buildings, 10% to 14% for store fixtures and 5% to 33%
for other fixtures and equipment. Accumulated depreciation for owned property
includes $227 and $99 of the Kmart Group store restructuring provision as of
January 26, 1994 and January 27, 1993, respectively. Interest costs capitalized
were $11, $14 and $10 in 1993, 1992 and 1991, respectively.
Expenditures for owned properties, primarily self-developed locations,
which the Kmart Group intends to sell and lease-back within one year are
included in accounts receivable and other current assets.
Goodwill: Excess of cost over the net assets of acquired companies is
amortized using the straight-line method over 40 years. The Kmart Group
evaluates the recoverability of goodwill and reviews the amortization
VI-33
<PAGE> 275
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
period on an annual basis. Several factors are used to evaluate goodwill,
including, but not limited to: management's plans for future operations; recent
operating results and each business' projected, undiscounted cash flows.
Financial Instruments: With the exception of long-term debt, the Kmart
Group equity and equity investments, the Kmart Group records all financial
instruments, including accounts receivable, accounts payable and marketable
securities at, or approximating, market value.
Licensee Sales: The Kmart Group's policy is to exclude sales of licensed
departments from total sales. Sales from licensed departments are primarily
comprised of sales from the Meldisco subsidiaries of Melville Corporation.
Pre-Opening and Closing Costs: Costs associated with the opening of a new
store are expensed during the first full month of operations. When the decision
to close a retail unit is made, the Kmart Group provides for the future the net
lease obligation, nonrecoverable investment in fixed assets, other expenses
directly related to discontinuance of operations and estimated operating loss
through the expected closing dates.
CORPORATE ACTIVITIES
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of each Group are
remitted to Kmart Corporation and cash disbursements of the Kmart Group are
funded by Kmart Corporation on a daily basis. In the historical financial
statements of the Groups, (i) debt incurred by Kmart Corporation and its
subsidiaries, other than certain capital leases and mortgages related
specifically to the Specialty Retail Groups, has been reflected on the financial
statements of the Kmart Group and (ii) net cash used or provided by each
Specialty Retail Group has been characterized as an adjustment of the Kmart
Group's investment (reflected as Retained Interest) in such Specialty Retail
Group. Accordingly, no inter-Group interest expense or inter-Group interest
income is reflected in the historical financial statements of the Specialty
Retail Groups. Until the issuance of each series of Specialty Retail Stock, the
net cash used or provided by the relevant Specialty Retail Group will continue
to be characterized as an adjustment to the Kmart Group's investment in such
Specialty Retail Group.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group when the debt is incurred or
the preferred stock is issued for the benefit of such Specialty Retail Group.
Following the issuance of each series of Specialty Retail Stock, if cash
used by a Specialty Retail Group exceeds cash provided by such Specialty Retail
Group, the Kmart Group would transfer to such Specialty Retail Group the cash
necessary to fund excess uses. Conversely, if cash provided by a Specialty
Retail Group exceeds cash used by such Specialty Retail Group, such Specialty
Retail Group would transfer the excess cash to the Kmart Group. Such transfers
would generally be made as short-term loans, unless the Board determines that
any such transfer should be made as a long-term loan or, in the case of a
transfer from the Kmart Group to a Specialty Retail Group, as an equity
contribution, as described below.
All cash transfers between Groups would be accounted for as short-term
loans unless the Board makes a specific determination that a given transfer (or
type of transfer) should be accounted for as a long-term loan or, in the case of
a transfer from the Kmart Group to the Specialty Retail Groups, an equity
contribution.
VI-34
<PAGE> 276
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
There are no specific criteria to determine when a cash transfer would be
classified as a long-term loan or, in the case of a transfer from the Kmart
Group to a Specialty Retail Group, an equity contribution, rather than a
short-term loan. Such determination would be made by the Board in the exercise
of its business judgment at the time of such transfer (or the first of such type
of transfer) based upon all relevant circumstances, including the financing
needs and objectives of the recipient Group, the investment objectives of the
transferring Group, prevailing interest rates and general economic conditions.
Such determination would affect the amount of interest expense and interest
income reflected in the financial statements of the relevant Groups if such
transfer were made as a short-term loan or long-term loan and, in the case of a
transfer from the Kmart Group to a Specialty Retail Group as an equity
contribution, the amount of such Specialty Retail Group equity and Retained
Interest of the Kmart Group. Short-term loans between the Kmart Group and a
Specialty Retail Group would bear interest at Kmart Corporation's daily
short-term borrowing rate. In the event that the Board determined that a
transfer of funds between the Kmart Group and a Specialty Retail Group should be
made as a long-term loan, the Board would establish the terms on which such loan
would be made, including interest rate, amortization schedule, maturity and
redemption terms. Such terms would generally reflect the then prevailing terms
upon which Kmart Corporation could borrow funds on a similar basis.
From time to time, following the initial issuance of a series of Specialty
Retail Stock, the Board could determine that funds to be transferred from the
Kmart Group to a Specialty Retail Group represent an equity contribution to such
Specialty Retail Group rather than a loan. In such event, the Kmart Group's
Retained Interest in such Specialty Retail Group will be increased by the amount
of such contributions, as a result of which (i) the Number of Shares Issuable
with Respect to the Kmart Group's Retained Interest in such Specialty Retail
Group would be increased by an amount equal to the amount of such contribution
divided by the Market Value of a share of relevant series of Specialty Retail
Stock and (ii) the Kmart Group's interest in the Specialty Retail Group would be
increased and the interest in the Specialty Retail Group represented by
outstanding shares of such Specialty Retail Stock would be decreased
accordingly. The Board could determine, in its sole discretion, to make such
contribution after consideration of a number of factors, including, among
others, the relative levels of internally generated cash flow of the Groups, the
long-term business prospects for each Group, the capital expenditure plans of
and investment opportunities available to each Group, and the availability, cost
and time associated with alternative financing sources.
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from the
Specialty Retail Groups, and the balance sheets of each Specialty Retail Group
would reflect its net short-term and net long-term loans to or borrowings from
the Kmart Group. Similarly, the income statements of the Kmart Group and the
Specialty Retail Groups would reflect interest income or expense, as the case
may be, associated with such loans or borrowings and the statements of cash
flows of the Kmart Group and the Specialty Retail Groups would reflect changes
in the amounts thereof deemed outstanding. In view of the anticipated cash needs
of the Specialty Retail Groups over the next several years, it is currently
expected that the Kmart Group would provide substantial net cash to the
Specialty Retail Groups. After considering all relevant factors, the Kmart Group
would obtain such funds from internal operations, excess cash from other
Specialty Retail Groups, external debt financing or additional equity issuances.
Accordingly, unlike these historical financial statements, following
implementation of the Specialty Retail Stock Proposal and issuance of each
Specialty Retail Stock, the financial statements of each Specialty Retail Group
would reflect interest expense related to net cash provided by Kmart
Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to the Specialty Retail Groups would continue to be made at the
discretion of the Board. Nothing in the foregoing policies obligates the Board
to cause the Kmart Group to provide funds to any Specialty Retail Group if the
Board determines it is in the best interest of Kmart Corporation not to do so.
VI-35
<PAGE> 277
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Certain corporate, general and administrative costs (including certain
corporate borrowing, legal, tax, transportation and import, data processing,
employee benefit and self-insurance costs) have been charged to the Specialty
Retail Groups based upon utilization and at negotiated rates. A portion of
certain other corporate, general and administrative costs related specifically
to the management of the Specialty Retail Groups has been allocated equally
among the Specialty Retail Groups. The balance of the corporate, general and
administrative costs have been reflected on the financial statements of the
Kmart Group.
Income Taxes: All members of the Kmart Corporation consolidated group are
included in the consolidated United States federal income tax return filed by
Kmart Corporation. Accordingly, the provision for federal income taxes and the
related payments or refunds of tax are determined on a consolidated basis. The
financial statement provision and related tax payments or refunds have been
reflected in the individual Groups in accordance with Kmart Corporation's tax
allocation policy for such Groups. In general, such policy provides that the
consolidated tax provision is allocated among the Groups for individual Group
financial statement purposes based principally upon the financial income,
taxable income, credits, preferences and other amounts directly related to the
respective Groups.
For financial statement provision and tax settlement purposes, tax benefits
resulting from attributes (principally net operating losses), which cannot be
utilized by one of the Groups on a separate return basis but which can be
utilized on a consolidated basis in any given year, are allocated to the Group
which generates the attributes. However, if such tax benefits cannot be utilized
on a consolidated basis in that year or in a carry back year, such consolidated
tax effect is adjusted in a subsequent year to the extent necessary to allocate
tax benefits to the Group that would have realized the tax benefits on a
separate return basis.
The allocated Group amounts are not necessarily comparable to those that
would have resulted if the Groups had filed separate tax returns and, in certain
situations, could result in any of the Groups incurring more or less income tax
expense for financial reporting purposes.
Deferred income taxes are provided on temporary differences between
financial statement and income tax basis of assets and liabilities.
SUPPLEMENTAL DISCLOSURE -- KMART CORPORATION EQUITY ATTRIBUTABLE TO KMART GROUP
Kmart Corporation earnings attributable to the Kmart Group for any period
is the net income (or loss) of the Kmart Group for such period determined in
accordance with generally accepted accounting principles in effect at such time,
reflecting income and expenses of Kmart Corporation allocated to the Kmart
Group, decreased by the aggregate of the products of (i) the respective amounts
of amortization of goodwill during such period arising from acquisitions with
respect to each Specialty Retail Group before the initial issuance of the
relevant series of Specialty Retail Stock and (ii) the Outstanding Interest
Fraction with respect to the relevant Specialty Retail Group, in accordance with
the terms of the Certificate of Amendment. During the fiscal years ended January
26, 1994 and January 27, 1993, no shares of any series of Specialty Retail Stock
were outstanding and the Kmart Group included a 100% Retained Interest in each
Specialty Retail Group. Therefore, the Outstanding Interest Fraction with
respect to each Specialty Retail Group was zero. No amounts were deducted from
the net income of the Kmart Group in arriving at Kmart Corporation earnings
attributable to the Kmart Group for such fiscal years because 100% of the
respective amounts of amortization of goodwill are reflected in the Kmart
Group's Retained Interest in the Specialty Retail Groups. See "Proposal 2 -- The
Specialty Retail Stock Proposal -- Dividend Policy -- Calculation of Earnings
Per Share" of Kmart Corporation Proxy Statement for an example of the
calculation of Kmart Earnings attributable to the Kmart Group following the
initial issuance of shares of Specialty Retail Stock.
Kmart Corporation equity attributable to the Kmart Group is Kmart Group
Common Equity for any period determined in accordance with generally accepted
accounting principles in effect at such time,
VI-36
<PAGE> 278
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
decreased by the aggregate of the products of (i) accumulated goodwill
amortization through the date of determination arising from acquisitions with
respect to each Specialty Retail Group before the initial issuance of shares of
the relevant series of Specialty Retail Stock and (ii) the Outstanding Interest
Fraction with respect to the relevant Specialty Retail Group at such dates, in
accordance with the terms of the Certificate of Amendment. During the fiscal
years ended January 26, 1994 and January 27, 1993, no shares of any series of
Specialty Retail Stock were outstanding and the Kmart Group included a 100%
Retained Interest in each Specialty Retail Group. Therefore, the Outstanding
Interest Fraction with respect to each Specialty Retail Group was zero. No
amounts were deducted from the Kmart Group Equity in arriving at Kmart
Corporation equity attributable to the Kmart Group for such fiscal years because
100% of the accumulated amortization of goodwill is reflected in the Kmart
Group's Retained Interest in the Specialty Retail Groups. See "Proposal 2 -- The
Specialty Retail Stock Proposal -- Description of Kmart Stock and Specialty
Retail Stock -- Dividends" of Kmart Corporation Proxy Statement for an example
of the calculation of Kmart Corporation equity attributable to the Kmart Group
following the initial issuance of shares of Specialty Retail Stock.
The method of calculating Kmart Corporation earnings attributable to the
Kmart Group and Kmart Corporation equity attributable to the Kmart Group
reflects the terms of the Certificate of Amendment which provide that the Kmart
Group's Available Dividend Amount, which, in turn, reflects the separately
reported Kmart Corporation Earnings Attributable to the Kmart Group, would be
the source for payment of dividends on Kmart Stock.
STORE RESTRUCTURING AND OTHER CHARGES
On January 5, 1994, the Board approved a restructuring plan involving the
Kmart Group, including Kmart Canada. As a result, in the fourth quarter of 1993,
the Kmart Group recorded a charge (Store Restructuring and Other Charges) to
earnings of $904 before taxes. Net of taxes, the charge was $578. The provision
included anticipated costs associated with Kmart stores which will be closed and
relocated, enlarged or refurbished in the U.S. and Canada. These costs, which
represent approximately 94% of the total, include lease obligations for store
closings as well as fixed asset writedowns, primarily furniture and fixtures,
and inventory dispositions for all affected stores. The remainder of the charge
is for costs related to re-engineering programs (principally severance) and
other non-recurring charges.
DISCONTINUED OPERATIONS
Discontinued operations include the results of PayLess Drug Stores
Northwest, Inc. and PACE Membership Warehouse, Inc. which have been classified
to reflect their respective plans for disposition announced in the fourth
quarter of 1993. In January 1994, PACE sold the assets and lease obligations of
93 of its warehouses and virtually all of the inventory and membership files in
the 34 warehouses not included in the transaction to Sam's Club, a division of
Wal*Mart for approximately $774 in cash. The book value of the assets sold to
Wal*Mart was $624. Operations of the 34 remaining PACE sites not included in the
transaction were discontinued and PACE is in the process of evaluating and
marketing these leased sites as well as leased premises for unopened warehouses
and corporate facilities. Included in the loss on the disposal of PACE was
unamortized goodwill, expected remaining lease obligations in the warehouses not
sold, other PACE liabilities and a provision for additional costs anticipated
during the wind-down of PACE operations.
In addition, Kmart Corporation entered into an agreement to sell its
PayLess Drug Stores subsidiary to TCH Corporation for approximately $592 in
cash, $100 in subordinated debt and 47% of the common equity of TCH Corporation.
The book value of PayLess' net assets to be sold was $1,186 at January 26, 1994.
It is anticipated that the transaction will be completed by the end of the first
quarter of 1994. It is Kmart Corporation's intention to divest its 47% interest
in TCH within one year or as soon as practicable after considering all relevant
factors including the value to be received upon such disposition. Management
expects
VI-37
<PAGE> 279
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
the disposition to be achieved either through a private offering or other
alternative means. Accordingly, Kmart Corporation has reported PayLess as a
discontinued operation and has recorded its investment in TCH, attributed to the
Kmart Group, at net realizable value.
Both businesses have been accounted for as discontinued operations in the
1993 financial statements. There was an $81 after-tax loss from the operation of
discontinued businesses in 1993, as the significant net operating loss at PACE
more than offset the net income from PayLess. The after-tax loss on disposal of
discontinued operations was $503. Sales applicable to these discontinued
operations were $6,874, $6,692 and $5,538 for 1993, 1992 and 1991, respectively.
EXTRAORDINARY ITEMS
Subject to the completion of the sale of its PayLess business which is
expected to be finalized in the first quarter of 1994, Kmart Corporation intends
to call for early redemption of all $300 of 8 3/8% debentures due January 15,
2017 using the proceeds of the sale to redeem the issues. The resulting
redemption premium and associated cost of $18, net of applicable income taxes,
was recorded in 1993 as an extraordinary item and, accordingly, the $300
principal amount has been included in the current portion of long-term debt. In
August 1993, Kmart Corporation called for early redemption of all $200 of its
8 1/8% debentures due January 1, 1997. The debentures were redeemed at 100% of
the principal amount plus interest accrued to the date of redemption. In April
1993, Kmart Corporation called for early redemption of all $200 of its 10 1/2%
Sinking Fund Debentures due December 1, 2017. The resulting redemption premium
of $10 net of applicable income taxes, has been reported as an extraordinary
item.
ACQUISITIONS AND DISPOSITIONS
In May 1992, the Kmart Group acquired three companies which operate a total
of 13 department stores located in the Czech Republic and Slovakia. The
acquisition marks the Kmart Group's initial entry into the Central European
retail market. No goodwill resulted from the transaction.
The acquisition has been accounted for as a purchase and, accordingly, the
results of operations have been consolidated from the date of acquisition. Net
cash used in 1992 for the acquisition of Pay 'n Save assets and the 13
department stores located in the Czech Republic and Slovakia totaled $300.
In October 1990, Kmart Canada Limited sold its Bargain Harold's Discount
Limited subsidiary to Quebec Equity Capital at book value. Under the terms of
the sale, Kmart Canada Limited guaranteed certain Bargain Harold's store leases
and a revolving credit agreement. During 1992, Bargain Harold's was placed in
bankruptcy. In 1992, the Kmart Group recorded a net of tax, one-time charge of
$12 related to Kmart Canada's guarantee of certain Bargain Harold's leases.
SUPPLEMENTAL CASH FLOW INFORMATION
The Kmart Group incurred capital lease obligations to obtain store
facilities and equipment of $143, $155 and $149 in 1993, 1992 and 1991,
respectively. Noncash charges related to store restructuring were $780, $15 and
$53 in 1993, 1992 and 1991, respectively. These noncash transactions have been
excluded from the Combined Statements of Cash Flows.
The Kmart Group considers cash on hand in stores, deposits in banks,
certificates of deposit and short-term marketable securities with maturities of
90 days or less as cash and cash equivalents for the purposes of the statement
of cash flows. The effect of changes in foreign exchange rates on cash balances
is not material.
VI-38
<PAGE> 280
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Cash paid for interest and income taxes follows:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Interest (net of amounts capitalized)................................... $455 $438 $407
---- ---- ----
---- ---- ----
Income taxes............................................................ $238 $285 $235
---- ---- ----
---- ---- ----
</TABLE>
MERCHANDISE INVENTORIES
For LIFO purposes, the Kmart Group uses internal price indices to measure
inflation in merchandise inventories.
A summary of inventories, at lower of cost or market, by method of pricing
and the excess of current cost over stated LIFO value due to inflation follows:
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 27,
1994 1993
----------- -----------
<S> <C> <C>
Last-in, first-out.................................................... $ 5,265 $ 6,553
First-in, first-out................................................... 376 1,004
----------- -----------
Total inventories........................................... $ 5,641 $ 7,557
----------- -----------
----------- -----------
Excess of current cost over stated LIFO value......................... $ 813 $ 937
----------- -----------
----------- -----------
</TABLE>
RETAINED INTERESTS IN THE SPECIALTY RETAIL GROUPS
Borders-Walden Group
The Kmart Group includes a 100.0% Retained Interest in the Borders-Walden
Group. At January 23, 1994, the Borders-Walden Group maintained operations of 44
book superstores and 1,159 mall bookstores, excluding Walden Software stores.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
---------------------------------------------------------
JANUARY 23, 1994 JANUARY 24, 1993 FEBRUARY 1, 1992
---------------- ---------------- -----------------
<S> <C> <C> <C>
Equity in income (loss).......................... $(61.2) $ 23.1 $16.7
------- ------ ------
------- ------ ------
</TABLE>
VI-39
<PAGE> 281
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The Borders-Walden Group summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
---------------------------------------------------------
JANUARY 23, 1994 JANUARY 24, 1993 FEBRUARY 1, 1992
---------------- ---------------- -----------------
<S> <C> <C> <C>
Sales............................................ $1,370.6 $1,183.7 $ 1,140.1
---------------- ---------------- -----------------
---------------- ---------------- -----------------
Operating income (loss).......................... $ (92.9) $ 42.2 $ 31.1
---------------- ---------------- -----------------
---------------- ---------------- -----------------
Net income (loss)................................ $ (61.2) $ 23.1 $ 16.7
---------------- ---------------- -----------------
---------------- ---------------- -----------------
Inventory........................................ $ 435.8 $ 387.9 $ 328.8
Other current assets............................. 110.1 41.9 30.2
Noncurrent assets................................ 455.7 442.4 261.0
---------------- ---------------- -----------------
Total assets........................... 1,001.6 872.2 620.0
Current liabilities.............................. 485.7 310.3 199.0
Noncurrent liabilities........................... 58.4 40.8 32.9
---------------- ---------------- -----------------
Borders-Walden Group Equity...................... $ 457.5 $ 521.1 $ 388.1
---------------- ---------------- -----------------
---------------- ---------------- -----------------
Retained Interest of the Kmart Group............. $ 457.5 $ 521.1 $ 388.1
---------------- ---------------- -----------------
---------------- ---------------- -----------------
</TABLE>
Builders Square Group
The Kmart Group includes a 100.0% Retained Interest in the Builders Square
Group. The Builders Square Group operated a chain of 177 large format home
improvement and home decor superstores at January 23, 1994.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------------------
JANUARY 23, 1994 JANUARY 24, 1993 JANUARY 26, 1992
---------------- ---------------- ----------------
<S> <C> <C> <C>
Equity in income (loss).......................... $ (107.0) $ 54.9 $ 47.0
---------------- ------ ------
---------------- ------ ------
</TABLE>
The Builders Square Group summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------------------
JANUARY 23, 1994 JANUARY 24, 1993 JANUARY 26, 1992
---------------- ---------------- ----------------
<S> <C> <C> <C>
Sales............................................ $2,718.8 $2,419.5 $2,048.5
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Operating income (loss).......................... $ (165.7) $ 80.0 $ 73.8
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Net income (loss)................................ $ (107.0) $ 54.9 $ 47.0
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Inventory........................................ $ 609.2 $ 512.1 $ 410.3
Other current assets............................. 191.1 110.9 75.2
Noncurrent assets................................ 329.8 253.8 194.3
---------------- ---------------- ----------------
Total assets........................... 1,130.1 876.8 679.8
Current liabilities.............................. 318.8 283.6 175.0
Noncurrent liabilities........................... 279.4 99.3 57.9
---------------- ---------------- ----------------
Builders Square Group Equity..................... $ 531.9 $ 493.9 $ 446.9
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Retained Interest of the Kmart Group............. $ 531.9 $ 493.9 $ 446.9
---------------- ---------------- ----------------
---------------- ---------------- ----------------
</TABLE>
VI-40
<PAGE> 282
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
OfficeMax Group
The Kmart Group includes a 100.0% Retained Interest in the OfficeMax Group.
The OfficeMax Group operated a chain of 328 office products superstores at
January 22, 1994.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------------------- 9 WEEKS ENDED
JANUARY 22, 1994 JANUARY 23, 1993 JANUARY 25, 1992
----------------- ----------------- -----------------
<S> <C> <C> <C>
Equity in income (loss)......................... $10.8 $(0.8) $ 0.9
------ ------ -----
------ ------ -----
</TABLE>
The OfficeMax Group's summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------------------- 9 WEEKS ENDED
JANUARY 22, 1994 JANUARY 23, 1993 JANUARY 25, 1992
----------------- ----------------- -----------------
<S> <C> <C> <C>
Sales........................................... $ 1,421.8 $ 528.2 $ 65.1
----------------- ------- -------
----------------- ------- -------
Operating income................................ $ 20.0 $ 0.5 $ 0.9
----------------- ------- -------
----------------- ------- -------
Net income (loss)............................... $ 10.8 $ (0.8) $ 0.9
----------------- ------- -------
----------------- ------- -------
Inventory....................................... $ 409.0 $ 178.2 $ 72.2
Other current assets............................ 77.3 28.9 50.6
Noncurrent assets............................... 523.4 241.5 152.3
----------------- ------- -------
Total assets.................................. 1,009.7 448.6 275.1
Current liabilities............................. 372.7 176.5 78.9
Noncurrent liabilities.......................... 28.5 13.9 8.1
----------------- ------- -------
OfficeMax Group Equity.......................... $ 608.5 $ 258.2 $ 188.1
----------------- ------- -------
----------------- ------- -------
Retained Interest of the Kmart Group............ $ 608.5 $ 258.2 $ 188.1
----------------- ------- -------
----------------- ------- -------
</TABLE>
The Sports Authority Group
The Kmart Group includes a 100.0% Retained Interest in The Sports Authority
Group. The Sports Authority Group operated a chain of 80 sporting goods
megastores at January 23, 1994.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------------------------
JANUARY 23, 1994 JANUARY 24, 1993 JANUARY 26, 1992
----------------- ----------------- -----------------
<S> <C> <C> <C>
Equity in income................................ $12.8 $ 5.7 $ 1.3
------ ----- -----
------ ----- -----
</TABLE>
VI-41
<PAGE> 283
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The Sports Authority Group's summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------------------------
JANUARY 23, 1994 JANUARY 24, 1993 JANUARY 26, 1992
----------------- ----------------- -----------------
<S> <C> <C> <C>
Sales........................................... $ 606.9 $ 411.5 $ 240.9
------- ------- -------
------- ------- -------
Operating income................................ $ 21.0 $ 10.1 $ 3.4
------- ------- -------
------- ------- -------
Net income...................................... $ 12.8 $ 5.7 $ 1.3
------- ------- -------
------- ------- -------
Inventory....................................... $ 157.3 $ 113.7 $ 83.0
Other current assets............................ 22.9 12.4 9.0
Noncurrent assets............................... 117.6 110.3 93.2
------- ------- -------
Total assets.................................. 297.8 236.4 185.2
Current liabilities............................. 142.8 91.6 50.6
Noncurrent liabilities.......................... 7.1 5.6 3.2
------- ------- -------
The Sports Authority Group Equity............... $ 147.9 $ 139.2 $ 131.4
------- ------- -------
------- ------- -------
Retained Interest of the Kmart Group............ $ 147.9 $ 139.2 $ 131.4
------- ------- -------
------- ------- -------
</TABLE>
INVESTMENTS IN AFFILIATED RETAIL COMPANIES
Meldisco Subsidiaries of Melville Corporation
All U.S. Kmart footwear departments are operated under license agreements
with the Meldisco subsidiaries of Melville Corporation, substantially all of
which are 49% owned by Kmart Corporation and attributed to the Kmart Group and
51% owned by Melville. Fees and income earned under the license agreements in
1993, 1992 and 1991 of $195, $200 and $192, respectively, are included in
licensee fees and rental income. The Kmart Group's equity in the income of
footwear departments in Kmart stores and dividends received were as follows:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Equity in income........................................................... $52 $54 $50
---- ---- ----
---- ---- ----
Dividends.................................................................. $55 $59 $51
---- ---- ----
---- ---- ----
</TABLE>
Meldisco companies' summarized financial information follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1993 1992 1991
------ ------ ------
<S> <C> <C> <C>
Net sales........................................................... $1,175 $1,164 $1,145
------ ------ ------
------ ------ ------
Gross profit........................................................ $ 525 $ 525 $ 505
------ ------ ------
------ ------ ------
Net income.......................................................... $ 97 $ 111 $ 104
------ ------ ------
------ ------ ------
Inventory........................................................... $ 137 $ 129 $ 132
Other current assets................................................ 85 123 131
Noncurrent assets................................................... 2 2 --
------ ------ ------
Total assets........................................................ 224 254 263
Current liabilities................................................. 30 47 46
------ ------ ------
Net assets.......................................................... $ 194 $ 207 $ 217
------ ------ ------
------ ------ ------
Equity of the Kmart Group........................................... $ 94 $ 101 $ 106
------ ------ ------
------ ------ ------
</TABLE>
VI-42
<PAGE> 284
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Coles Myer Ltd.
Kmart Corporation had a 21.5% equity interest at January 26, 1994 in Coles
Myer Ltd., the largest retailer in Australia which was attributed to the Kmart
Group.
Income earned under a license agreement with Coles Myer of $3 in 1993, 1992
and 1991 is included in licensee fees and rental income. Further information
regarding the Kmart Group's investment in Coles Myer follows:
<TABLE>
<CAPTION>
(U.S. $) 1993 1992 1991
- --------------------------------------------------------------------- ------ ---- ------
<S> <C> <C> <C>
Equity in income..................................................... $ 58 $ 51 $ 60
------ ---- ------
------ ---- ------
Dividends............................................................ $ 36 $ 34 $ 33
------ ---- ------
------ ---- ------
Equity of the Kmart Group............................................ $ 512 $496 $ 488
------ ---- ------
------ ---- ------
Market value of Coles Myer common stock.............................. $1,011 $912 $1,082
------ ---- ------
------ ---- ------
</TABLE>
The cumulative effect of translating the Kmart Group's equity in the
investment in Coles Myer was a reduction of $100, $90 and $45, respectively, as
of January 26, 1994, January 27, 1993 and January 29, 1992. The average exchange
rates from Australian to U.S. dollars were 0.6815 in 1993, 0.7367 in 1992 and
0.7776 in 1991.
Summarized financial information adjusted for conformity with U.S.
generally accepted accounting principles for Coles Myer's most recent fiscal
years follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------------
(U.S. $) JULY 25, 1993 JULY 26, 1992 JULY 28, 1991
- -------------------------------------------------------- -------------- -------------- --------------
<S> <C> <C> <C>
Net sales............................................... $ 10,649 $ 11,634 $ 11,699
-------------- -------------- --------------
-------------- -------------- --------------
Net income.............................................. $ 236 $ 137 $ 254
-------------- -------------- --------------
-------------- -------------- --------------
Current assets.......................................... $ 1,982 $ 1,927 $ 1,776
Noncurrent assets....................................... 2,013 2,123 2,435
-------------- -------------- --------------
Total assets............................................ $ 3,995 $ 4,050 $ 4,211
-------------- -------------- --------------
-------------- -------------- --------------
Current liabilities..................................... $ 1,310 $ 1,327 $ 1,327
Noncurrent liabilities.................................. 719 663 1,019
Equity.................................................. 1,966 2,060 1,865
-------------- -------------- --------------
Total liabilities and equity............................ $ 3,995 $ 4,050 $ 4,211
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
Unremitted earnings of unconsolidated affiliates included in the Kmart
Group's equity were $362, $346 and $336 at January 26, 1994, January 27, 1993
and January 29, 1992, respectively.
INCOME TAXES
Components of income from continuing retail operations before income taxes
follow:
<TABLE>
<CAPTION>
1993 1992 1991
----- ------ ------
<S> <C> <C> <C>
U.S................................................................. $(318) $1,128 $1,007
Foreign............................................................. 71 66 70
----- ------ ------
Total............................................................... $(247) $1,194 $1,077
----- ------ ------
----- ------ ------
</TABLE>
VI-43
<PAGE> 285
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
----- ---- ----
<S> <C> <C> <C>
Current:
Federal.............................................................. $ 7 $199 $217
State and local...................................................... (7) 53 44
Foreign.............................................................. 26 15 8
Deferred:
Store restructuring and other charges................................ (272) 27 40
Excess of tax over book depreciation................................. 79 66 37
LIFO inventory....................................................... 68 39 32
Property taxes....................................................... (16) (12) (15)
Other................................................................ 5 11 (5)
----- ---- ----
Total income taxes..................................................... $(110) $398 $358
----- ---- ----
----- ---- ----
</TABLE>
A reconciliation of the federal statutory rate to the Kmart Group's
effective tax rate for continuing retail operations follows:
<TABLE>
<CAPTION>
1993 1992 1991 1993 1992 1991
----- ---- ---- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Federal statutory rate.............................. $ (87) $406 $366 (35.0)% 34.0% 34.0%
State and local taxes, net of federal tax benefit... (4) 34 29 (1.7) 2.9 2.7
Tax credits......................................... (7) (7) (8) (2.8) (0.6) (0.7)
Equity in income of affiliated retail companies
subject to lower tax rates........................ (23) (23) (32) (9.3) (1.9) (3.0)
Enacted federal tax rate change..................... 11 -- -- 4.3 -- --
Other............................................... -- (12) 3 -- (1.1) 0.3
----- ---- ---- ----- ---- ----
Total income taxes................................ $(110) $398 $358 (44.5)% 33.3% 33.3%
----- ---- ---- ----- ---- ----
----- ---- ---- ----- ---- ----
</TABLE>
Deferred tax assets and liabilities resulted from the following:
<TABLE>
<CAPTION>
JANUARY 26,
1994
-----------
<S> <C>
Deferred tax assets:
Federal benefit for state and foreign deferred................................. $ 20
Discontinued operations........................................................ 137
Accruals and other liabilities................................................. 162
Capital leases................................................................. 142
Store restructuring obligations................................................ 352
Other.......................................................................... 15
-----------
Total deferred tax assets................................................... 828
-----------
Deferred tax liabilities:
Inventory...................................................................... 307
Property and equipment......................................................... 444
Other.......................................................................... 4
-----------
Total deferred tax liabilities.............................................. 755
-----------
Net deferred tax assets..................................................... $ 73
-----------
-----------
</TABLE>
VI-44
<PAGE> 286
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Undistributed earnings of subsidiaries totaled $189, $195 and $188 at
January 26, 1994, January 27, 1993 and January 29, 1992, respectively.
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax liabilities to
reflect enacted changes in the statutory federal income tax rate. The Kmart
Group adopted FAS 109 as the cumulative effect of an accounting change in the
first quarter in fiscal 1993 resulting in a one-time credit of $46.
CURRENT NOTES PAYABLE, LINES OF CREDIT AND OTHER
Notes payable of $918 and $590 were comprised entirely of Kmart
Corporation's commercial paper attributed to the Kmart Group at January 26, 1994
and January 27, 1993, respectively. The weighted average interest rates on
short-term borrowings outstanding on January 26, 1994 and January 27, 1993 were
3.4% and 3.2%, respectively.
At January 26, 1994, Kmart Corporation had bank lines of credit attributed
to the Kmart Group aggregating $1,473 which provide for interest rates not
exceeding the "prime" lending rate on any borrowings thereunder. In support of
certain lines of credit, it is expected that compensating balances will be
maintained on deposit with the banks, which will average 10% of the line to the
extent that it is not in use and an additional 10% on the portion in use,
whereas other lines require fees in lieu of compensating balances. Kmart
Corporation is free to withdraw the entire balance in its accounts at any time.
Additional seasonal bank lines of credit totaling $1,260 were available during
the period September 1, 1993 to December 31, 1993.
Kmart Corporation has entered into revolving credit agreements attributed
to the Kmart Group with various banks in the aggregate amount of $790 as of
January 26, 1994, and $770 as of January 27, 1993. The agreements provide for
borrowings at an interest rate based on the prime rate, "CD-based rate" or
"LIBOR-based rate" at Kmart Corporation's election. As of January 26, 1994,
Kmart Corporation had no outstanding borrowings under these agreements. The
revolving credit agreements contain certain restrictive provisions regarding the
maintenance of net worth, working capital, coverage ratios and payment of cash
dividends. At January 26, 1994, $1,859 of consolidated retained earnings were
free of such restrictions.
At January 26, 1994, Kmart Corporation had an interest rate swap agreement
attributed to the Kmart Group outstanding with a commercial bank. The agreement
will expire in January 1995. Under this agreement, Kmart Corporation pays
interest on a $50 notional principal amount based on a fixed rate. The variable
rate is a calculated bond equivalent rate based on the 30-day commercial paper
rate. Kmart Corporation's effective interest rate on this agreement during 1993
was 7.9%. Kmart Corporation has limited exposure to credit loss for the
differential between interest rates in the event of nonperformance by the other
parties.
At January 26, 1994, Kmart Corporation had a $200 line of credit attributed
to the Kmart Group and had guaranteed an additional $200 line of credit
attributed to the Kmart Group, the proceeds of which will be used by certain of
Kmart Corporation's real estate development joint ventures. The agreement
provides for interest on the borrowings calculated on a "LlBOR-based rate." In
addition, Kmart Corporation guaranteed a related interest rate swap with a
notional principal amount of $50. As of January 26, 1994, there was $191 of
borrowings outstanding under these agreements.
Kmart Corporation has also entered into certain real estate arrangements
whereby Kmart Corporation is obligated to purchase completed projects if
alternate financing is not available to the developer. Kmart Corporation's
aggregate guarantees attributed to the Kmart Group under these arrangements, and
other lease guarantees for certain facilities previously sold, were $426 at
January 26, 1994.
VI-45
<PAGE> 287
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Kmart Corporation and Coles Myer have guaranteed indebtedness related to
certain properties in Australia on a joint and several basis. Coles Myer
subsequently indemnified the Kmart Corporation from any liability incurred
pursuant to the guarantees. As of January 26, 1994, the amount guaranteed was
$19. These guarantees have been attributed to the operations of the Kmart Group.
Kmart Corporation has guaranteed indebtedness related to certain of its
leased properties financed by industrial revenue bonds. At January 26, 1994, the
total amount of such guaranteed indebtedness was $284, of which $92 was included
in capital lease obligations of the Kmart Group. The agreements will expire
during fiscal years 2004 to 2009. The Kmart Corporation's exposure to credit
loss attributed to the Kmart Group, in the event of nonperformance by the other
parties to the agreements, is $192 at January 26, 1994. However, no
concentration of credit risk exists and Kmart Corporation does not anticipate
nonperformance by the other parties.
There are various claims, lawsuits and pending actions against Kmart
Corporation incident to the operations of the Kmart Group. It is the opinion of
management that the ultimate resolution of these matters will not have a
material effect on the Kmart Group's liquidity, financial position or results of
operations.
LONG-TERM DEBT
The Kmart Group's specifically attributed long-term debt, net of
unamortized discount, is comprised of the following:
<TABLE>
<CAPTION>
JANUARY 26, 1994 JANUARY 27, 1993
---------------- ----------------
<S> <C> <C>
8 3/8% debentures due 2017...................................... $ 300 $ 291
10 1/2% debentures due 2017..................................... -- 200
8 1/8% debentures due 1997...................................... -- 199
12 1/8% notes due 1995.......................................... 150 150
8 1/8% notes due 2006........................................... 199 199
8 1/4% notes due 2022........................................... 99 99
12 1/2% debentures due 2005..................................... 100 100
8 3/8% debentures due 2022...................................... 99 99
7 3/4% debentures due 2012...................................... 198 198
7.95% debentures due 2023....................................... 299 --
Notes payable................................................... -- 300
Medium-term notes due 1994 through 2020 (8.33% weighted average
interest rate)................................................ 745 835
Mortgages....................................................... 307 500
Other........................................................... 95 162
------- -------
Total................................................. 2,591 3,332
Portion due within one year..................................... 384 117
------- -------
Long-term debt.................................................. $2,207 $3,215
------- -------
------- -------
</TABLE>
Kmart Corporation plans to call for early redemption in the first quarter
of 1994 of all $300 of its 8 3/8% debentures due January 15, 2017 attributed to
the Kmart Group. The resulting redemption premium and associated cost of $18,
net of applicable taxes, has been reported as an extraordinary item.
In August 1993, Kmart Corporation called for early redemption of all $200
of its 8 1/8% debentures due January 1, 1997 attributed to the Kmart Group. The
debentures were redeemed at 100% of the principal amount plus interest accrued
to the date of redemption. In April 1993, Kmart Corporation called for early
redemption all $200 of its 10 1/2% Sinking Fund Debentures due December 1, 2017
attributed to the Kmart
VI-46
<PAGE> 288
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Group. The resulting redemption premium of $10, net of applicable income taxes,
has been reported as an extraordinary item.
In February 1993, Kmart Corporation issued $300 of 7.95% debentures due
February 1, 2023 attributed to the Kmart Group. These debentures are not
redeemable prior to maturity.
During fiscal 1992, Kmart Corporation issued mortgage notes payable of $197
attributed to the Kmart Group. The notes bear a weighted average interest rate
of 8.40%. For most of these mortgage notes, interest is payable semiannually,
and principal is payable annually through the year 2022. The notes are secured
by various owned properties.
In October 1992, Kmart Corporation issued $200 of 7 3/4% debentures due
October 1, 2012 attributed to the Kmart Group. The 7 3/4% debentures are not
redeemable prior to maturity. In July 1992, Kmart Corporation issued $100 of
8 3/8% debentures due July 1, 2022 attributed to the Kmart Group. The 8 3/8%
debentures are not redeemable prior to July 1, 2002. On or after that date, the
debentures are redeemable in whole or in part, at any time at the option of
Kmart Corporation, at prices declining from 103.9% to 100% of the principal
amount. At January 27, 1993, Kmart Corporation's revolving credit agreements
supported $300 of commercial paper which has been classified as long-term debt.
Amounts classified as long-term debt are based on Kmart Corporation's intention
and ability to maintain at least that amount of similar debt for a minimum of
one year.
During 1992, Kmart Corporation issued $200 of medium-term notes attributed
to the Kmart Group with a weighted average interest rate of 7.38% with maturity
dates from seven to 12 years.
Principal payments due on specifically attributed long-term debt for the
five years subsequent to 1993 are: 1994 -- $384; 1995 -- $231; 1996 -- $7;
1997 -- $152; 1998 -- $122.
Based on the quoted market prices for the same, or similar issues, or on
the current rates offered to the Kmart Corporation for debt of the same
remaining maturities, the fair value of long-term debt attributed to the Kmart
Group was $2,893 and $3,631 at January 26, 1994 and January 27, 1993,
respectively.
LEASES
Description of Leasing Arrangements: The Kmart Group conducts operations
primarily in leased facilities. Kmart store leases are generally for terms of 25
years with multiple five-year renewal options which allow the Kmart Group the
option to extend the life of the lease up to 50 years beyond the initial
noncancellable term.
Certain leases provide for additional rental payments based on a percent of
sales in excess of a specified base. Also, certain leases provide for the
payment by the lessee of executory costs (taxes, maintenance and insurance).
Some selling space has been sublet to other retailers in certain of the Kmart
Group's leased facilities.
VI-47
<PAGE> 289
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Lease Commitments: Future minimum lease payments with respect to capital
and operating leases as of January 26, 1994 follow:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1994.................................................................... $ 378 $ 453
1995.................................................................... 370 434
1996.................................................................... 365 410
1997.................................................................... 355 385
1998.................................................................... 339 369
Later years............................................................. 3,028 4,526
------- ---------
Total minimum lease payments.................................... 4,835 6,577
Less -- minimum sublease rental income.................................... -- (150)
------- ---------
Net minimum lease payments................................................ 4,835 $ 6,427
---------
---------
Less:
Estimated executory costs............................................... (1,434)
Amount representing interest............................................ (1,657)
-------
1,744
Portion due within one year............................................... 112
-------
Long-term lease obligations............................................... $ 1,632
-------
-------
</TABLE>
Rental Expense: A summary of operating lease rental expense and short-term
rentals follows:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Minimum rentals...................................................... $ 516 $ 426 $ 380
Percentage rentals................................................... 37 38 42
Less -- sublease rentals............................................. (93) (63) (54)
----- ----- -----
Total................................................................ $ 460 $ 401 $ 368
----- ----- -----
----- ----- -----
</TABLE>
Reconciliation of Capital Lease Information: The impact of recording
amortization and interest expense versus rent expense on capital leases follows:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Amortization of capital lease property............................... $ 112 $ 110 $ 107
Interest expense related to obligations under capital leases......... 185 180 177
----- ----- -----
Amounts charged to earnings.......................................... 297 290 284
Related minimum lease payments net of executory costs................ (295) (286) (278)
----- ----- -----
Excess of amounts charged over related minimum lease payments........ $ 2 $ 4 $ 6
----- ----- -----
----- ----- -----
</TABLE>
Related minimum lease payments above exclude executory costs for 1993, 1992
and 1991 in the amounts of $90, $94 and $91, respectively.
VI-48
<PAGE> 290
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
PENSION PLANS
The Kmart Group participates in Kmart Corporation's non-contributory
pension plans which cover most domestic employees who meet certain requirements
of age, length of service and hours worked per year. Benefits paid to retirees
are based upon age at retirement, years of credited service and earnings. Kmart
Corporation's policy is to fund at lease the minimum amounts required by the
Employee Retirement Income Security Act of 1974. The plans' assets consist
primarily of equity securities, fixed income securities, guaranteed insurance
contracts and real estate. The portion of pension expense and plan assets and
obligations attributable to the Kmart Group is actuarially determined based on
the attributes of the Kmart Group's plan participants, a method which management
believes to be reasonable.
The following table presents the Kmart Group's funded status based on a
proportionate share of fund assets and plan liabilities, as described above, and
amounts recognized in the accompanying balance sheet at year end:
<TABLE>
<CAPTION>
JANUARY 26, 1994
----------------------------------
PLANS WHOSE PLANS WHOSE
ASSETS EXCEEDED ACCUMULATED
ACCUMULATED BENEFITS JANUARY 27,
BENEFITS EXCEEDED ASSETS 1993
--------------- --------------- -----------
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits.......... $(1,402) $ (32) $(1,085)
Estimated present value of non-vested benefits...... (148) (3) (142)
--------------- ------ -----------
Accumulated benefit obligation...................... (1,550) (35) (1,227)
Value of future pay increases....................... (237) (4) (252)
--------------- ------ -----------
Projected benefit obligation........................ (1,787) (39) (1,479)
Estimated market value of plan assets................. 1,448 -- 1,354
--------------- ------ -----------
Plan assets under projected benefit obligation........ (339) (39) (125)
Unrecognized net (asset) liability.................... (103) 3 (109)
Unrecognized prior service cost....................... 45 4 54
Unrecognized net loss and other....................... 220 14 31
Adjustment required to recognize minimum liability.... -- (17) --
--------------- ------ -----------
Accrued pension costs................................. $ (177) $ (35) $ (149)
--------------- ------ -----------
--------------- ------ -----------
</TABLE>
The following table summarizes allocated pension costs and actuarial
assumptions:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Components of pension expense:
Normal service cost................................................ $ 60 $ 53 $ 48
Interest cost on projected benefit obligation...................... 129 116 102
Return on plan assets.............................................. (155) (115) (191)
Net amortization and deferral of other components.................. 26 (8) 87
----- ----- -----
Total................................................................ $ 60 $ 46 $ 46
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates..................................................... 7.25% 8.50% 8.75%
Expected return on plan assets..................................... 9.50% 9.50% 9.50%
Salary increases................................................... 4.50% 5.00% 5.00%
</TABLE>
VI-49
<PAGE> 291
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Under the provisions of Financial Accounting Standard No. 87 (FAS 87),
"Employers' Accounting for Pensions," the Kmart Group is required to record an
unfunded pension liability when accumulated benefit obligation exceeds plan
assets. This liability is partially offset by an intangible pension asset, with
the intangible asset being limited to the amount of unrecognized prior service
cost, including unamortized transition obligation. At January 26, 1994, the
unfunded pension liability exceeded the intangible pension asset by $10. FAS 87
requires this excess to be recorded as a reduction in the Kmart Group's equity.
OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS
The Kmart Group adopted Financial Accounting Standard No. 106 "Employers'
Accounting for Postretirement Benefits Other Than Pensions" (FAS 106) at the
beginning of fiscal 1993. This statement requires the Kmart Group to accrue for
future postretirement medical benefits. In prior years, these claims were
expensed when paid. Net of applicable tax, a charge of $77 was included in net
income as the effect of an accounting change in 1993.
In addition to Kmart Corporation's defined benefit pension plan, Kmart
Corporation sponsors a defined benefit health care plan that offers
postretirement medical benefits to full-time employees who have worked 10 years
and who have retired after age 55, with the option of participation in Kmart
Corporation's medical plan, until age 65. The plan is contributory, with retiree
contributions adjusted annually. The accounting for the plan anticipates future
cost-sharing changes to the written plan that are consistent with Kmart
Corporation's expressed intent to increase the retiree contribution rate
annually for the expected general inflation rate for that year. In 1993, Kmart
Corporation amended its plan to limit retiree benefits to 150% of average per
capita benefits.
The following table sets forth the plans' funded status reconciled with amounts
shown in the balance sheet.
<TABLE>
<CAPTION>
JANUARY 26,
1994
-----------
<S> <C>
Accumulated postretirement benefit obligation:
Retirees....................................................................... $ 7
Fully eligible active plan participants........................................ 24
Other active plan participants................................................. 41
-----------
72
Plan assets at fair value........................................................ --
-----------
Accumulated postretirement benefit obligation in excess of plan assets........... 72
Unrecognized prior service cost.................................................. 39
Unrecognized net gain............................................................ (6)
-----------
Accrued postretirement benefit cost.............................................. $ 105
-----------
-----------
</TABLE>
Net periodic postretirement benefit cost includes the following components:
<TABLE>
<CAPTION>
1993
----------------
<S> <C>
Service cost.................................................................. $ 3
Interest cost................................................................. 7
Actual return................................................................. --
Net amortization and deferral................................................. (4)
---
Net periodic postretirement benefit cost............................ $ 6
---
---
</TABLE>
The weighted-average annual assumed rate of increase in the per capita cost
of covered benefits (i.e., health care cost trend rate) is 11.3% in 1994. This
rate is assumed to decrease gradually to 5.25% by 2002 and
VI-50
<PAGE> 292
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
remain at that level thereafter. The health care cost trend rate assumption has
a significant effect on the amounts reported. For example, increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation as of January 26,
1994, by 0.2%, and the aggregate of the service and interest cost components of
net periodic postretirement benefit cost for fiscal 1993 by 2.28%.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation at January 26, 1994 was 7.25%.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106 for similar benefits provided to
terminated or laid-off employees such as salary extension, severance, disability
and supplemental unemployment benefits. The effect of this statement on the
Kmart Group is not significant.
EMPLOYEE SAVINGS PLAN
The Employee Savings Plan provides that employees of the Kmart Group who
have attained age 21 and completed one "Year of Service" can invest from 2% to
16% of their earnings in the employee's choice of a growth equity fund, a
balanced equity fund, a managed income fund or a Kmart Corporation stock fund.
For each dollar the employee invests up to 6% of his or her earnings, the Kmart
Group will contribute an additional 50 cents which is invested in the Employee
Stock Ownership Plan (ESOP). The Kmart Group's expense related to the Employee
Savings Plan was $44 for 1993, $43 for 1992 and $42 for 1991.
PERFORMANCE RESTRICTED STOCK PLAN
Under the Performance Restricted Stock Plan, the Compensation and
Incentives Committee may grant awards for up to 4,000,000 shares of Kmart stock
to officers and other key employees through March 21, 1998. The shares are
issued only if specified performance goals are achieved. The shares are issued
as restricted stock and are held in the custody of Kmart Corporation for a
period up to three years. If conditions or terms under which an award is granted
are not satisfied, the shares are forfeited. At January 26, 1994, outstanding
awards and shares available for grant totaled 839,602 and 2,891,298
respectively. The Kmart Group recorded $3, $4 and $3 of compensation expense
related to the Performance Restricted Stock Plan in 1993, 1992 and 1991,
respectively.
KMART GROUP COMMON EQUITY
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 26, JANUARY 27, JANUARY 29,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year................................. $ 6,341 $ 5,856 $ 5,339
Net income (loss)............................................ (925) 938 855
Kmart Group's portion of dividends........................... (479) (455) (398)
Minimum pension liability in excess of intangible pension
asset...................................................... (10) -- --
Change in cumulative translation adjustment.................. (25) (62) (9)
Kmart Corporation common shares issued under stock option
plans...................................................... 15 45 64
Other........................................................ 33 19 5
----------- ----------- -----------
Kmart Group Common Equity.................................... $ 4,950 $ 6,341 $ 5,856
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
VI-51
<PAGE> 293
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
In October 1992, Kmart Corporation issued 784,938 shares of Series B
convertible preferred stock in exchange for all the outstanding stock of
Borders, Inc. The Series B convertible preferred stock has been specifically
attributed to the Kmart Group. Subject to adjustment in certain events, each
share of Series B convertible preferred stock is convertible into 6.49 shares of
Kmart Corporation common stock and is redeemable into Kmart Corporation stock by
Kmart Corporation after November 1, 1999 at a redemption rate based on the
then-current market price of Kmart Corporation stock. Upon first issuance of any
series of Specialty Retail Stock, outstanding shares of Kmart Corporation's
common stock would be redesignated as Kmart Stock and the outstanding shares of
Series B convertible preferred stock would become exchangeable for shares of
Kmart Stock. In addition, the holders of such stock have the right to compel
Kmart Corporation to call 50% of the outstanding stock for redemption into Kmart
Corporation stock after November 1, 1997, and to call 100% of the outstanding
stock after November 1, 2002, at a redemption rate based on the then-current
market price of Kmart Corporation stock. The preferential dividend is $11.50 per
share, subject to adjustment between November 1, 1996 and October 31, 1998 if
the market price of Kmart Corporation stock reaches a specified level. Kmart
Corporation shares totaling 5,092,050 have been reserved for the conversion or
redemption of the Series B convertible preferred shares.
In August 1991, Kmart Corporation sold 23,000,000 $3.41 Depositary Shares,
each representing one-quarter of a share of Series A conversion preferred stock,
for $44 per Depositary Share. The Series A conversion preferred stock has been
specifically attributed to the Kmart Group. Upon first issuance of any series of
Specialty Retail Stock, outstanding shares of Kmart Corporation's common stock
would be redesignated as Kmart Stock and the outstanding shares of Series A
conversion preferred stock would become exchangeable for shares of Kmart Stock.
Unless called for redemption prior to September 15, 1994, each of the
outstanding Depositary Shares will automatically convert into two shares of
Kmart Corporation stock, subject to adjustment in certain events, on that date.
The mandatory conversion factor and Kmart Corporation's criteria for redemption
of the Depositary Shares have been adjusted to reflect the Kmart Corporation
stock split distributed June 5, 1992. Kmart Corporation shares totaling
46,000,000 have been reserved for the conversion or redemption of the Series A
conversion preferred shares.
The holders of the Depositary Shares shall have the right to direct the
Depositary to vote the Series A conversion preferred shares represented by their
Depositary Shares in the election of directors and upon each matter coming
before the meeting of the shareholders on the basis of one vote for every four
Depositary Shares held. The holders of Series B convertible preferred stock have
the right to vote upon such matters on the basis of one vote per share held. The
holders of Series A conversion preferred stock, the holders of Series B
convertible preferred stock and the holders of Kmart Corporation stock vote
together as one class except as otherwise required by the Articles of
Incorporation.
The Series A conversion preferred stock and the Series B convertible
preferred stock rank senior to the Kmart Corporation stock upon liquidation with
respect to the amounts to which such preferred shareholders are entitled.
Ten million shares of no par value preferred stock with voting and
cumulative dividend rights are authorized; 5,750,000 are issued as Series A
conversion preferred stock, 784,938 are issued as Series B convertible preferred
stock and 3,465,062 are unissued. Of the unissued, 500,000 shares have been
designated Series A junior participating preferred stock.
Each share of outstanding Kmart Corporation stock includes a right which
entitles the holder to one-thousandth of a share of Series A junior
participating preferred stock at an exercise price of $110, or to purchase, at
the right's then-current exercise price, Kmart Corporation shares having a value
twice the right's exercise price. The rights are exercisable only if a person or
group acquires, or attempts to acquire, ownership of 20% or more of the Kmart
Corporation stock, or, if the person or group acquires 10% of Kmart Corporation
VI-52
<PAGE> 294
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
stock and the Board of Directors of Kmart Corporation determines that such
ownership is adverse to the long-term interests of the Kmart Corporation and its
shareholders.
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions between the Specialty Retail Groups and the Kmart
Group had been accounted for as short-term loans, on a pro forma basis the Kmart
Group would have been credited inter-Group interest income of $8 during 1993.
Such pro forma interest income has been calculated on daily average borrowings
outstanding using Kmart Corporation's weighted average short-term borrowing
rate. Such pro forma interest income is not necessarily indicative of the
results that would have occured had such offerings been completed on such date,
or what the interest income would be prospectively.
PRO FORMA INFORMATION -- KMART GROUP EARNINGS PER SHARE (UNAUDITED)
Upon approval of the Specialty Retail Stock Proposal, the capital structure
of Kmart Corporation will be modified to provide for the issuance of five series
of common stock. Four additional series of common stock (Borders-Walden Stock,
Builders Square Stock, OfficeMax Stock and The Sports Authority Stock,
collectively referred to as the Specialty Retail Stocks) would be available for
issuance by Kmart Corporation and, upon first issuance of any series of
Specialty Retail Stock, outstanding shares of Kmart Corporation's common stock
would be redesignated as Kmart Stock. Supplemental earnings per share are based
on the assumption that Kmart Stock under the Specialty Retail Stock Proposal was
outstanding as of the beginning of the period presented, Kmart Group held a 100%
Retained Interest for the entire fiscal year and it does not assume the use of
any proceeds from issuance. The supplemental earnings per share are not
necessarily indicative of results that would have occurred if Kmart Stock had
been outstanding as of the beginning of the period presented or of the future
earnings per share of the Kmart Group.
<TABLE>
<CAPTION>
FISCAL YEAR
ENDED
JANUARY 26, 1994
----------------
<S> <C>
Earnings Per Common Share Assuming No Dilution
Net loss from continuing retail operations.................................. $ (282)
Discontinued operations..................................................... (81)
Loss on disposal of discontinued operations................................. (503)
Extraordinary item, net of income taxes..................................... (28)
Effect of accounting changes, net of income taxes........................... (31)
-------
Net loss.................................................................... $ (925)
-------
-------
</TABLE>
<TABLE>
<S> <C>
Weighted average shares of Kmart Stock (based on redesignation of Kmart
Corporation common stock as Kmart Stock on a 1 for 1 basis).............. 454.1
Earnings Per Common Share assuming No Dilution
Net loss from continuing retail operations.................................. $ (.62)
Discontinued operations..................................................... (.18)
Loss on disposal of discontinued operations................................. (1.11)
Extraordinary item, net of income taxes..................................... (.06)
Effect of accounting changes, net of income taxes........................... (.07)
-------
Net loss.................................................................... $(2.04)
-------
-------
</TABLE>
VI-53
<PAGE> 295
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR
ENDED
JANUARY 26, 1994
----------------
<S> <C>
Earnings Per Common and Common Equivalent Share
Net loss from continuing retail operations.................................. $ (282)
Less -- Series B convertible preferred shares dividend declared............. (9)
-------
Adjusted net loss from continuing retail operations......................... (291)
Discontinued operations..................................................... (81)
Loss on disposal of discontinued operations................................. (503)
Extraordinary item, net of income taxes..................................... (28)
Effect of accounting changes, net of income taxes........................... (31)
-------
Adjusted net loss........................................................... $ (934)
-------
-------
Weighted average shares of Kmart Stock (based on redesignation of Kmart
Corporation common stock as Kmart Stock on a 1 for 1 basis).............. 456.7
Earnings Per Common and Common Equivalent Share
Adjusted net loss from continuing retail operations......................... $ (.64)
Discontinued operations..................................................... (.18)
Loss on disposal of discontinued operations................................. (1.10)
Extraordinary item, net of income taxes..................................... (.06)
Effect of accounting changes, net of income taxes........................... (.07)
-------
Adjusted net loss........................................................... $(2.05)
-------
-------
</TABLE>
VI-54
<PAGE> 296
ANNEX VII
BORDERS-WALDEN GROUP
<TABLE>
<S> <C>
Selected Financial Data.............................................................. VII- 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations......................................................................... VII- 3
Business Description................................................................. VII-12
Combined Financial Statements........................................................ VII-24
</TABLE>
VII-1
<PAGE> 297
BORDERS-WALDEN GROUP
SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated reflect the
results of operations and financial position of the businesses that comprise the
Borders-Walden Group. The information set forth below should be read in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations and the combined financial statements and notes thereto
included in this Annex VII. The issuance of Borders-Walden Stock pursuant to the
Specialty Retail Stock Proposal has not been reflected in these financial
statements.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------------------------
JAN. 23, JAN. 24, FEB. 1, FEB. 2, FEB. 3,
1994 1993(1) 1992 1991 1990
-------- ----------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (MILLIONS)
Sales:
Superstores...................................................... $ 224.8 $ 56.0 $ -- $ -- $ --
Mall bookstores.................................................. 1,145.8 1,127.7 1,140.1 1,064.0 991.7
-------- ----------- -------- -------- --------
Total sales................................................ 1,370.6 1,183.7 1,140.1 1,064.0 991.7
Gross margin....................................................... 350.6 291.3 263.3 237.4 213.9
Selling, general and administrative expenses....................... 291.2 243.7 228.9 228.8 207.0
Pre-opening expense................................................ 2.6 1.9 0.8 0.8 1.2
Goodwill amortization.............................................. 6.9 3.5 2.5 2.5 2.5
Store restructuring and other charges.............................. 142.8 -- -- -- --
-------- ----------- -------- -------- --------
Operating income (loss)............................................ (92.9) 42.2 31.1 5.3 3.2
Interest expense -- net............................................ 0.9 0.6 0.5 0.5 0.5
-------- ----------- -------- -------- --------
Income (loss) before income taxes and effect of accounting
changes.......................................................... (93.8) 41.6 30.6 4.8 2.7
Income taxes....................................................... (38.2) 18.5 13.9 3.2 2.4
Effect of accounting changes, net of income taxes.................. 5.6 -- -- -- --
-------- ----------- -------- -------- --------
Net income (loss).................................................. $ (61.2) $ 23.1 $ 16.7 $ 1.6 $ 0.3
-------- ----------- -------- -------- --------
-------- ----------- -------- -------- --------
Add back of goodwill amortization.................................. 6.9 3.5 2.5 2.5 2.5
-------- ----------- -------- -------- --------
Kmart Corporation earnings (losses) attributable to Borders-Walden
Group............................................................ $ (54.3) $ 26.6 $ 19.2 $ 4.1 $ 2.8
-------- ----------- -------- -------- --------
-------- ----------- -------- -------- --------
PERCENT OF SALES DATA
Gross margin....................................................... 25.6% 24.6% 23.1% 22.3% 21.6%
Selling, general and administrative expenses....................... 21.3 20.6 20.1 21.5 20.9
Operating income (loss)............................................ (6.8) 3.5 2.7 0.5 0.3
Income (loss) before income taxes and effect of accounting
changes.......................................................... (6.9) 3.5 2.7 0.5 0.3
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital.................................................... $ 60.2 $ 119.5 $ 159.9 $ 233.5 $ 247.2
Total assets....................................................... 1,001.6 872.2 620.0 674.8 676.0
Total debt......................................................... 9.5 9.8 4.6 4.7 4.8
Borders-Walden Group equity........................................ 457.5 521.1 388.1 483.1 498.0
SELECTED FINANCIAL AND OPERATING DATA
Operating income before pre-opening expense, goodwill amortization
and store restructuring and other charges (millions)............. $ 59.4 $ 47.6 $ 34.4 $ 8.6 $ 6.9
End of year stores:
Superstores...................................................... 44 31 -- -- --
Mall bookstores(2)............................................... 1,159 1,202 1,217 1,209 1,205
-------- ----------- -------- -------- --------
Total...................................................... 1,203 1,233 1,217 1,209 1,205
-------- ----------- -------- -------- --------
-------- ----------- -------- -------- --------
Comparable store sales increase:
Superstores...................................................... 14.8% 12.6%(3) -- -- --
Mall bookstores.................................................. 0.7% 1.4% 5.8% 6.2% 4.8%
Weighted average sales per square foot(4):
Superstores...................................................... $ 354 $ 399 $ -- $ -- $ --
Mall bookstores.................................................. 320 322 316 298 284
Weighted average sales per store (millions)(5):
Superstores...................................................... 6.4 6.1 -- -- --
Mall bookstores.................................................. 0.9 0.9 0.9 0.8 0.8
Capital expenditures -- owned property (millions).................. 71.0 28.8 15.2 31.0 35.6
Depreciation and amortization (millions)........................... 41.0 33.3 30.9 30.3 26.9
</TABLE>
- ------------------------
(1) Data for fiscal year 1992 includes the results for Borders, Inc. from
October 30, 1992, the date of its acquisition by Kmart Corporation. Walden's
1992 fiscal year consisted of 51 weeks due to a change in reporting period.
(2) Excludes Walden Software stores.
(3) The 12.6% comparable store sales increase reflects sales of the 13 week
period in which Borders was owned by Kmart Corporation in fiscal 1992, as
compared to the same period of the prior year.
(4) Sales for the period divided by the effective weighted average number of
gross square footage in stores operated during the period.
(5) Sales for the period divided by the effective weighted average number of
stores operated during the period.
VII-2
<PAGE> 298
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The Borders-Walden Group ("Borders-Walden") is a leading book retailer in
the United States, and is comprised of Borders, Inc. ("Borders") and Walden Book
Company, Inc. ("Walden"), both of which are wholly owned subsidiaries of Kmart
Corporation ("Kmart"). Borders was acquired by Kmart on October 30, 1992 and, as
of January 23, 1994, operated 44 large format superstores, each of which is
designed to be the premier book retailer in its market. Walden, which was
purchased by Kmart in 1984, is the largest operator of mall-based bookstores in
the United States and, as of January 23, 1994, operated 1,159 bookstores.
Although Borders and Walden will continue to operate independently, Borders and
Walden recently have been combined under common executive leadership in order to
realize synergies in certain areas, including in the development of inventory
control systems and in merchandise distribution. Borders-Walden had combined
sales of approximately $1.4 billion for the fiscal year ended January 23, 1994.
Borders-Walden's business strategy is to accelerate the growth of its books
and music superstore business and to increase profitability at Walden.
Borders-Walden intends to accomplish this by (i) opening at least 20-25 Borders
Books and Music superstores in each of the next two fiscal years and
reconfiguring or expanding virtually all of Borders' existing book superstores
to the Borders Books and Music format, (ii) increasing Walden's profitability by
reducing inventory shrinkage, containing expenses and, with the implementation
of Borders' sophisticated inventory management technology, improving sales per
store and inventory productivity over the long term and (iii) continuing to
develop and refine Borders' sophisticated inventory management system.
Borders-Walden's 1993 fiscal year consisted of the 52 weeks ending January
23, 1994. Borders-Walden's 1992 fiscal year consisted of 51 weeks ended January
24, 1993, as Walden changed its year end to conform with the rest of the
Specialty Retail Groups, and its 1991 fiscal year consisted of 52 weeks ended
February 1, 1992. References herein to years are to Borders-Walden's fiscal
years which end on the last Sunday preceding the last Wednesday in January of
the following calendar year. Borders' results of operations have been included
in the Borders-Walden financial statements from the date of its acquisition on
October 30, 1992.
On January 5, 1994, the Board of Directors ("Board") approved a
restructuring plan involving the closing of approximately 200 underperforming
Walden stores. Management believes that these closures will better enable
Borders-Walden to compete effectively. Management expects the closure of these
stores will be substantially complete in 1994, and that total sales levels will
decrease proportionally and that overall operating expenses, including employee
costs, occupancy expenses and depreciation charges will decrease further
resulting in improved earnings levels compared with the prior year.
As a result of the restructuring plan, Borders-Walden recorded a pre-tax
charge of $142.8 million ($85.4 million net of tax) in the fourth quarter of
1993 for store closing costs and other non-recurring charges. Of the total
pre-tax charge, $122.3 million is for store closures. These costs include $73.7
million principally for lease buyout costs, $21.3 million for the writedown of
inventory to be liquidated during the final closing of each store, and $27.3
million for the writedown of fixed assets, primarily furniture and fixtures, to
net realizable value. Of the remaining charge, $15.0 million relates to costs
associated with combining certain operations of Borders and Walden, including
inventory reduction costs and costs of consolidating redundant distribution
center functions. The remaining $5.5 million relates to re-engineering programs
(principally severance). The restructuring and other charges when aggregated
with accounting restatements referred to in the "Restatement of Prior Years'
Amounts" section below equals the restructuring and other charges for Borders-
Walden included in the Kmart Corporation consolidated financial statements.
VII-3
<PAGE> 299
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
RESTATEMENT OF PRIOR YEARS' AMOUNTS
The results of operations for Borders-Walden have been restated from
amounts previously included in Kmart Corporation's consolidated financial
statements in order to (i) reflect a change in the method of inventory valuation
for Walden from last-in, first-out (LIFO) to first-in, first-out (FIFO) to
conform Walden's inventory accounting method with Borders, (ii) correct prior
period results with respect to inventory shrinkage and lease accounting and
(iii) conform the accounting policies of Walden and Borders in the areas of
fixed asset capitalization and revenue recognition.
The total impact of the restatement was a reduction in net income of $2.6
million and $3.7 million in 1992 and 1991, respectively, and a reduction of
retained earnings at February 3, 1991 of $43.1 million.
Inventory Method Change
Walden and Borders previously accounted for inventory on the LIFO and FIFO
basis, respectively. To conform accounting policies in the combined
Borders-Walden financial statements, Walden has restated its results for all
periods presented to a FIFO basis.
Inventory Shrinkage
In 1993, management determined that Walden's method of estimating shrinkage
produced inaccurate results. Historically, Walden has relied on a sampling
technique based on detailed receiving and reporting at approximately 60 stores.
The degree of precision of this method is highly dependent on receiving accurate
information from the sample stores. Merchandise received in the non-sample
stores is not detailed. The receiving experience in the 60 sample stores is
extrapolated to the non-sample stores to adjust vendor payments and for
calculating inventory shrinkage. Management's analysis indicated that methods
used to estimate shrinkage were affected by receiving inaccuracies in the 60
sample stores and the resulting extrapolations to the non-sample stores. During
the years 1988 through 1991, physical inventories were taken throughout the year
in approximately half of the stores each year.
Management is taking corrective actions to address shrinkage and has
initiated a number of operational and accounting controls designed to improve
Walden's ability to accurately measure and control inventory shrinkage. A more
accurate methodology for calculating inventory shrinkage using the 60 sample
stores that utilizes enhanced statistical sampling techniques has been developed
by management in conjunction with independent statisticians. Beginning in 1992,
physical inventories are taken at least once a year in every store. In addition,
Walden is currently testing detailed receiving at store level utilizing
automated scanning equipment and management anticipates complete implementation
of this process for accounting purposes, in all stores, by the end of 1995.
Walden has also installed Electronic Article Surveillance (EAS) in over 100
stores and plans to install EAS in another 100 stores in 1994. Management
expects these enhancements, among others, will bring Walden's controls with
respect to shrinkage to more acceptable standards. Until full implementation
occurs, inventory shrinkage calculations will be dependent upon management's
best judgment in making assumptions and using statistical sampling techniques.
While management believes the shrinkage rates as restated are reasonable, there
can be no assurances that Walden will not experience high shrinkage
VII-4
<PAGE> 300
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
rates in the future. The following table shows the history of shrinkage by year
as originally reported, as restated using the new methodology and the amount of
the adjustment to cost of goods sold.
<TABLE>
<CAPTION>
RETAIL SHRINKAGE RATE RETAIL SHRINKAGE RATE ADJUSTMENT TO
ORIGINALLY REPORTED AS RESTATED COST OF GOODS SOLD
---------------------- ---------------------- -------------------
(MILLIONS)
<S> <C> <C> <C>
1988 and prior years................... $26.8
1989................................... 3.51% 5.18% 10.9
1990................................... 4.74 4.48 (0.7)
1991................................... 3.25 4.34 8.0
1992................................... 4.64 4.19 (1.9)
------
Total........................ $43.1
------
------
</TABLE>
RESULTS OF OPERATIONS
The following table presents Borders-Walden's income statement data, as a
percent of sales, for the three most recent fiscal years.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
----------------------------------------
JANUARY 23, JANUARY 24, FEBRUARY 1,
1994 1993(1) 1992
----------- ----------- ----------
<S> <C> <C> <C>
Sales...................................................... 100.0% 100.0% 100.0%
Cost of merchandise sold, includes buying and occupancy
costs.................................................... 74.4 75.4 76.9
----------- ----------- ----------
Gross margin............................................... 25.6 24.6 23.1
Selling, general and administrative expenses............... 21.3 20.6 20.1
Pre-opening expense........................................ 0.2 0.2 0.1
Goodwill amortization...................................... 0.5 0.3 0.2
Store restructuring and other charges...................... 10.4 -- --
----------- ----------- ----------
Operating income (loss).................................... (6.8) 3.5 2.7
Interest expense -- net.................................... 0.1 -- --
----------- ----------- ----------
Income (loss) before income taxes and effect of
accounting changes....................................... (6.9) 3.5 2.7
Income taxes............................................... (2.8) 1.5 1.2
----------- ----------- ----------
Net income (loss) before effect of accounting changes...... (4.1) 2.0 1.5
Effect of accounting changes, net of income taxes.......... 0.4 -- --
----------- ----------- ----------
Net income (loss).......................................... (4.5)% 2.0% 1.5%
----------- ----------- ----------
----------- ----------- ----------
</TABLE>
- ------------------------
(1) Includes Borders' results of operations from the date of its acquisition by
Kmart on October 30, 1992.
VII-5
<PAGE> 301
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Store Activity. Borders-Walden's store activity is summarized below:
<TABLE>
<CAPTION>
JAN. 23, JAN. 24, FEB. 1,
1994 1993 1992
-------- -------- -------
<S> <C> <C> <C>
Borders Superstores
Beginning number of stores....................................... 31 16 --
Openings......................................................... 15 15(1) --
Closings(2)...................................................... (2) -- --
-------- -------- -------
Ending number of stores.......................................... 44 31 --
-------- -------- -------
-------- -------- -------
Walden Mall Bookstores(3)
Beginning number of stores....................................... 1,202 1,217 1,209
Openings......................................................... 7 16 27
Closings......................................................... (50) (31) (19)
-------- -------- -------
Ending number of stores.......................................... 1,159 1,202 1,217
-------- -------- -------
-------- -------- -------
</TABLE>
- ------------------------
(1) Includes the conversion of nine book superstores that had been opened by
Walden in fiscal 1992.
(2) Two book superstores were closed and relocated as books and music
superstores.
(3) Excludes 57, 58 and 58 Walden Software stores operated in 1993, 1992 and
1991, respectively.
Fiscal Years Ended January 23, 1994 (fiscal 1993) and January 24, 1993 (fiscal
1992)
Sales in 1993 were $1,370.6 million, a 15.8% increase, over sales of
$1,183.7 million in the prior year. The 1993 sales increase was primarily due to
the inclusion of a full year of sales for the Borders stores versus three months
in the prior year. Comparable Walden store sales increased 0.7% in 1993 versus a
1.4% increase in 1992. The slower rate of Walden comparable store sales growth
was a result of increased competition from superstores in several markets and
sluggish mall traffic.
Cost of merchandise sold, including buying and occupancy costs, in 1993 was
$1,020.0 million as compared to $892.4 million in the prior year. Gross margin
as a percent of sales was 25.6% and 24.6% in 1993 and 1992, respectively. The
increase in 1993, as a percent of sales, was due to the inclusion of Borders,
which has slightly higher margins and lower occupancy costs as a percent of
sales than Walden's mall bookstores, and improved margins at Walden.
Selling, general and administrative ("SG&A") expenses in 1993 were $291.2
million, or 21.3% of sales, as compared to $243.7 million, or 20.6% of sales, in
the prior year. The increase as a percent of sales resulted primarily from the
inclusion of Borders in 1993, which has higher store operating costs including
store payroll and advertising, and to higher Walden store salary expense.
Borders has invested in its management team, information systems and
merchandising organization in order to execute its aggressive expansion
strategy. Management believes this investment in infrastructure will enable it
to successfully execute its expansion strategy and may result in decreasing
general and administrative expense as a percent of sales in the future.
Pre-opening expense in 1993 was $2.6 million as compared to $1.9 million in
the prior year with the increase attributable primarily to 15 superstore
openings in 1993. Pre-opening expenses consist principally of grand-opening
advertising expense, store payroll and supply expense. Pre-opening costs are
expensed in the first full month of operations following opening.
Goodwill amortization in 1993 was $6.9 million, or 0.5% of sales, as
compared to $3.5 million, or 0.3% of sales, in 1992 with the increase
attributable to a full year of Borders goodwill amortization in 1993 versus
three months in 1992.
VII-6
<PAGE> 302
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Store restructuring and other charges in 1993 was $142.8 million or 10.4%
of sales. See discussion in General above.
As a result of the foregoing, operating income (loss) in 1993 was $(92.9)
million. Excluding the 1993 store restructuring and other charges, operating
income was $49.9 million, or 3.6% of sales, as compared to operating income of
$42.2 million, or 3.5% of sales, in the prior year. Operating profit before
pre-opening expenses, goodwill amortization and store restructuring and other
charges in 1993 was $59.4 million, or 4.3% of sales, as compared to $47.6
million, or 4.0% of sales, in 1992, primarily as a result of higher sales and
improved gross margins.
Net interest expense in 1993 was $0.9 million as compared to $0.6 million
in 1992. The increase in interest expense was attributable to Borders.
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions, between the Specialty Retail Groups and the
Kmart Group had been accounted for as short-term loans, on a pro forma basis
Borders-Walden would have been charged inter-Group interest of $2.6 million
during 1993. Such pro forma interest expense has been calculated on daily
average borrowings outstanding using Kmart Corporation's weighted average
short-term borrowing rate. Such pro forma interest expense is not necessarily
indicative of the results which would occur had such offerings occurred on such
date, or what the interest expense would be prospectively.
Income (loss) before income taxes and the effect of accounting changes in
1993 was $(93.8) million. Excluding the 1993 store restructuring and other
charges, income before income taxes and the effect of accounting changes in 1993
was $49.0 million, or 3.6% of sales, as compared to $41.6 million, or 3.5% of
sales, in the prior year.
Income tax expense (benefit) in 1993 was $(38.2) million with an effective
tax rate of 40.7% as compared to $18.5 million with an effective tax rate of
44.4% in 1992.
Net income (loss) before the effect of accounting changes in 1993 was
$(55.6) million. Excluding the 1993 store restructuring and other charges, net
income before the effect of accounting changes in 1993 was $29.8 million, or
2.2% of sales, as compared to $23.1 million, or 2.0% of sales, in the prior
year.
Effect of accounting changes, net of income taxes. Borders-Walden adopted
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS 109) at
the beginning of fiscal 1993. FAS 109 requires that deferred taxes be calculated
using the liability approach rather than the deferred method. As a result of the
adjustment of deferred tax balances to the current enacted tax rate,
Borders-Walden has recorded a charge of $4.6 million as the cumulative effect of
an accounting change.
Borders-Walden also adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. This statement requires that
Borders-Walden accrue for future postretirement medical benefits. In prior
years, these claims were expensed when paid. Net of applicable tax, a charge of
$1.0 million has been included in net income as the effect of an accounting
change.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying
VII-7
<PAGE> 303
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
FAS 106, requiring that benefits provided to terminated or laid-off employees be
recorded on an accrual basis rather than a cash basis. The statement was
effective for fiscal years beginning after December 15, 1993. The effect of this
statement on Borders-Walden was not significant.
The ongoing effect of these statements is not expected to be material.
As the result of the foregoing factors, net income (loss) in 1993 was
$(61.2) million. Excluding the 1993 store restructuring and other charges, net
income in 1993 was $24.2 million, or 1.8% of sales, as compared to $23.1
million, or 2.0% of sales, in the prior year.
Fiscal Years Ended January 24, 1993 (fiscal 1992) and February 1, 1992 (fiscal
1991)
Sales in 1992 were $1,183.7 million, a $43.6 million, or 3.8%, increase
over sales of $1,140.1 million in 1991. The increase was attributable to the
acquisition of Borders in October 1992, which contributed $56.0 million in
sales, and a 1.4% comparable store sales increase at Walden, partially offset by
an approximately $18 million reduction in sales resulting from one less
reporting week in 1992 at Walden due to a change in year-end dates.
Cost of merchandise sold, including buying and occupancy costs, in 1992 was
$892.4 million, as compared to $876.8 million in 1991. As a percent of sales,
gross margin was 24.6% in 1992 and 23.1% in 1991. This increase was primarily
attributable to favorable results of Walden's Preferred Reader Program and to
lower inventory acquisition costs obtained by increasing the percentage of
product distributed through Walden's distribution centers.
Selling, general and administrative expenses in 1992 were $243.7 million,
or 20.6% of sales, as compared to $228.9 million, or 20.1% of sales in 1991. The
increase in SG&A as a percentage of sales resulted primarily from a higher
expense ratio at Borders and increased store expenses at Walden relative to
sales.
Pre-opening expense in 1992 was $1.9 million as compared to $0.8 million in
1991. This increase was primarily due to the opening of superstores.
Goodwill amortization in 1992 was $3.5 million, or 0.3% of sales, as
compared to $2.5 million, or 0.2% of sales, in 1991. The increase resulted
primarily from goodwill amortization arising from Kmart's October 30, 1992
acquisition of Borders.
Operating income in 1992 was $42.2 million, or 3.5% of sales, as compared
to $31.1 million, or 2.7% of sales, in 1991. Operating income before pre-opening
expense and goodwill amortization in 1992 was $47.6 million, or 4.0% of sales,
as compared to $34.4 million, or 3.0% of sales, in 1991, primarily as a result
of increased sales and gross margin, partially offset by higher SG&A.
Income tax expense in 1992 was $18.5 million, or 1.5% of sales, as compared
to $13.9 million, or 1.2% of sales, in 1991. The effective income tax rate
decreased to 44.4% in 1992 from 45.4% in 1991.
As a result of the foregoing factors, net income in 1992 was $23.1 million,
or 2.0% of sales, as compared to $16.7 million, or 1.5% of sales, in 1991.
LIQUIDITY AND CAPITAL RESOURCES
Borders-Walden's principal capital requirements are to fund working capital
needs, the opening of new stores and the refurbishment of existing stores.
During the periods presented, Borders-Walden has generated cash in excess of its
own requirements and has provided these excess funds to the Kmart Group through
equity transactions. Borders-Walden has made net equity contributions to the
Kmart Group of $2.4 million in 1993, $41.2 million in 1992 and $111.7 million in
1991.
VII-8
<PAGE> 304
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for 1993, 1992 and 1991 are
summarized below. The net increases (decreases) in cash and cash equivalents
were $8.8 million, $9.6 million and $(1.7) million in 1993, 1992 and 1991,
respectively.
Net cash provided by operations was $82.5 million, $97.4 million and $125.3
million in 1993, 1992 and 1991, respectively. The decrease in 1993 resulted
primarily from an increase in property held for resale, an increase in taxes
paid and to a lesser degree from cash charges relating to the restructuring
charge. These items were partially offset by an improvement in cash provided by
inventories net of accounts payable resulting primarily from store closings. The
decrease in net cash provided by operations in 1992 was primarily the result of
an increase in inventory net of accounts payable. Depreciation expense resulted
primarily from leasehold improvements and store fixtures.
Borders-Walden anticipates that after-tax cash flows related to store
restructuring and other charges will approximate $41.0 million primarily in 1994
and will result from the payment of lease buyout and re-engineering costs
(principally severance).
Net cash used for investing consists primarily of capital expenditures
relating to new store openings and the renovation of existing stores. Capital
expenditures totaled $71.0 million, $28.8 million and $15.2 million in 1993,
1992 and 1991, respectively. The increase in capital expenditures in 1993
resulted from the opening of 22 new stores (15 superstores and 7 mall stores) an
increased number of mall expansions, the timing of expenditures related to new
stores and expansions and other miscellaneous expenditures related to data
processing equipment, distribution centers and headquarter relocations. Capital
expenditures in 1992 resulted primarily from the opening of 22 new stores (6
superstores and 16 mall stores) as compared to 27 mall store openings in 1991
and an upgrade of computer equipment in stores.
Borders-Walden currently plans to open approximately 20 to 25 Borders
stores and 15 Walden mall stores in 1994. The average amount of capital
expenditures required to open a new Borders store is $1.1 million and to open a
new Walden store ranges between $0.2 million and $0.4 million, depending on
store size and format. Borders-Walden has budgeted capital expenditures of
approximately $86 million for fiscal 1994.
Net cash used for financing was $2.7 million, $59.0 million and $111.8 in
1993, 1992 and 1991, respectively, and consisted primarily of the excess cash
provided by operations which was provided to the Kmart Group through equity
transactions. In addition $17.8 million of external long-term debt was repaid in
1992.
Due to the Walden store restructuring strategy announced in January 1994
and the Borders store expansion program, Borders-Walden is expected to require
capital in excess of the funds generated from operations. Such excess is
expected to be funded by the Kmart Group. Borders-Walden also could obtain funds
from external debt financing and, following implementation of the Specialty
Retail Stock Proposal, from the sale of shares of Borders-Walden Stock with the
proceeds attributable to Borders-Walden. Borders-Walden believes that funds
generated from operations, together with the sources of capital described above,
will be sufficient to provide the liquidity and capital resources necessary to
fund its anticipated capital requirements for at least the next two to three
years.
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt, and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of Borders-Walden are
remitted to Kmart Corporation and cash disbursements of Borders-Walden are
funded by Kmart Corporation on a daily basis. In the historical financial
statements of the Groups, (i) debt incurred by Kmart Corporation and its
subsidiaries, other than certain capital leases and mortgages related
specifically to the Specialty Retail Groups, has been reflected on the
VII-9
<PAGE> 305
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
financial statements of the Kmart Group and (ii) net cash used or provided by
each Specialty Retail Group has been characterized as an adjustment of the Kmart
Group's investment (reflected as Retained Interest) in each Specialty Retail
Group. Accordingly, no inter-Group interest expense or inter-Group interest
income is reflected in the historical financial statements of Borders-Walden.
Until the issuance of Borders-Walden Stock, the net cash used or provided by
Borders-Walden will continue to be characterized as an adjustment to the Kmart
Group's investment in Borders-Walden.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group to the extent that the debt is
incurred or the preferred stock is issued for the benefit of such Specialty
Retail Group.
Following the issuance of Borders-Walden Stock, if cash used by
Borders-Walden exceeds cash provided by Borders-Walden, the Kmart Group would
transfer to Borders-Walden the cash necessary to fund such excess uses.
Conversely, if cash provided by Borders-Walden exceeds cash used by
Borders-Walden, Borders-Walden would transfer the excess cash to the Kmart
Group. All cash transfers between Groups would be accounted for as short-term
loans unless the Board makes a specific determination that a given transfer (or
type of transfer) should be accounted for as a long-term loan or, in the case of
a transfer from the Kmart Group to Borders-Walden, an equity contribution. There
are no specific criteria to determine when a cash transfer would be classified
as a long-term loan or, in the case of a transfer from the Kmart Group to
Borders-Walden, an equity contribution, rather than a short-term loan. Such
determination would be made by the Board in the exercise of its business
judgment at the time of such transfer (or the first of such type of transfer)
based upon all relevant circumstances, including the financing needs and
objectives of the recipient Group, the investment objectives of the transferring
Group, prevailing interest rates and general economic conditions. Such
determination would affect the amount of interest expense and interest income
reflected in the financial statements of the relevant Groups if such transfer
were made as a short-term loan or long-term loan and, in the case of a transfer
from the Kmart Group to Borders-Walden as an equity contribution, the amount of
Borders-Walden Group equity and Retained Interest of the Kmart Group. Short-term
loans between the Kmart Group and Borders-Walden would bear interest at Kmart
Corporation's daily short-term borrowing rate. In the event that the Board
determined that a transfer of funds between the Kmart Group and Borders-Walden
should be made as a long-term loan, the Board would establish the terms on which
such loan would be made, including interest rate, amortization schedule,
maturity and redemption terms. Such terms would generally reflect the then
prevailing terms upon which Kmart Corporation could borrow funds on a similar
basis.
From time to time, following the initial issuance of Borders-Walden Stock,
the Board could determine that funds to be transferred from the Kmart Group to
Borders-Walden represent an equity contribution to Borders-Walden rather than a
loan. In such event, the Kmart Group's Retained Interest in Borders-Walden would
be increased by the amount of such contribution, as a result of which (a) the
Number of Shares Issuable with Respect to the Kmart Group's Retained Interest
with regard to Borders-Walden would be increased by an amount equal to the
amount of such contribution divided by the Market Value of a share of
Borders-Walden Stock and (b) the Kmart Group's Retained Interest Fraction with
regard to Borders-Walden would be increased and the Outstanding Interest
Fraction with regard to Borders-Walden would be decreased accordingly. The Board
could determine, in its sole discretion, to make such contribution after
consideration of a number of factors, including, among others, the relative
levels of internally generated cash flows of the Groups, the long-term business
prospects for Borders-Walden, the capital expenditure plans of and investment
opportunities available to Borders-Walden, and the availability, cost and time
associated with alternative financing sources.
VII-10
<PAGE> 306
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from
Borders-Walden, and the balance sheets of Borders-Walden would reflect its net
short-term and net long-term loans to or borrowings from the Kmart Group.
Similarly, the respective income statements of the Kmart Group and
Borders-Walden would reflect interest income or expense, as the case may be,
associated with such loans or borrowings and the statements of cash flows of the
Kmart Group and Borders-Walden would reflect changes in the amount thereof
deemed outstanding. In view of the anticipated cash needs of Borders-Walden over
the next several years, it is currently expected that the Kmart Group would be
making net transfers to Borders-Walden. After considering all relevant factors,
the Kmart Group would obtain such funds from internal operations, excess cash
from other Specialty Retail Groups, external debt financing or additional equity
issuances. Accordingly, unlike these historical financial statements, following
implementation of the Specialty Retail Stock Proposal and issuance of
Borders-Walden Stock, the financial statements of Borders-Walden would reflect
interest expense related to net cash provided by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to Borders-Walden would continue to be made at the discretion of
the Board. Nothing in the foregoing policies obligates the Board to cause the
Kmart Group to provide funds to Borders-Walden if the Board determines it is in
the best interest of Kmart Corporation not to do so.
SEASONALITY AND INFLATION
As illustrated in the following table, Borders-Walden's business is highly
seasonal, with sales significantly higher in the fourth quarter and virtually
all of operating profit realized during the fourth quarter, which includes the
Christmas selling season. Borders-Walden management does not believe inflation
has a material impact on the financial statements for the periods presented.
<TABLE>
<CAPTION>
FISCAL 1993 QUARTER ENDED
--------------------------------------------
($ MILLIONS) APRIL JULY OCTOBER JANUARY
- ----------------------------------------------------- ------ ------ ------- -------
<S> <C> <C> <C> <C>
Sales................................................ $286.6 $289.4 $ 299.2 $ 495.4
% of full year....................................... 20.9% 21.1% 21.8% 36.2%
Operating income excluding store restructuring and
other charges in January........................... $ (7.2) $ (5.5) $ (3.5) $ 66.1
% of full year....................................... (14.4)% (11.0)% (7.0)% 132.5%
</TABLE>
EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS
Compliance with federal, state and local provisions which have been enacted
or adopted regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had, and is not
expected to have, a material effect on the capital expenditures, earnings or
competitive position of Borders-Walden.
VII-11
<PAGE> 307
BORDERS-WALDEN GROUP
GENERAL
Borders-Walden Group ("Borders-Walden") is a leading book retailer in the
United States, and is comprised of Borders, Inc. ("Borders") and Walden Book
Company, Inc. ("Walden"), both of which are wholly owned subsidiaries of Kmart
Corporation ("Kmart"). As of January 23, 1994, Borders operated 44 large format
superstores in 22 states and the District of Columbia, each of which is designed
to be the premier book retailer in its market. Walden, which was purchased by
Kmart in 1984, is the largest operator of mall-based bookstores in the United
States, and as of January 23, 1994, operated 1,159 bookstores in 50 states and
the District of Columbia. Although Borders and Walden will continue to operate
independently, Borders and Walden recently have been combined under common
executive leadership in order to realize synergies in certain areas, including
in the development of inventory control systems and in merchandise distribution.
In addition, Borders-Walden will offer associates equity incentives related to
the performance of the combined business, which management believes will serve
to more closely align the interests of Borders' and Walden's employees.
Borders-Walden had combined sales of approximately $1.4 billion for the fiscal
year ended January 23, 1994 ("fiscal 1993").
In 1991, management began to investigate the concept of a large format book
superstore, which had become and remains the fastest growing segment of the
retail book market. Believing Borders to be the premier operator of book
superstores in its markets, Kmart acquired Borders in October 1992, which at the
time operated 22 superstores. Since the acquisition, Borders has grown at an
accelerated rate, converting nine Walden-owned book superstores to Borders'
superstore format and opening 15 new superstores in fiscal 1993. Borders
currently plans to open at least 20-25 new stores in each of the next two fiscal
years. In fiscal 1993, Borders achieved annual average sales per book superstore
of $6.4 million and annual sales per square foot of $354.
Borders recently has expanded its store format by adding to its extensive
selection of books a similarly broad selection of recorded music, with a special
emphasis on hard-to-find recordings in categories such as jazz, classical and
foreign music. Borders believes that, as is the case in the retail book market,
music consumers respond favorably to an extensive selection of merchandise in an
inviting and comfortable environment with superior customer service. In
addition, Borders believes that its sophisticated inventory management system
will enable it to offer a more productive assortment of music titles, and that
offering books and music together under one roof provides Borders with unique
opportunities to cross-sell merchandise to both its book and music customers. In
1992, Borders opened its first two Borders books and music ("Borders Books and
Music") superstores. Based on the favorable customer acceptance of these two
stores, Borders is opening all of its new stores in the Borders Books and Music
format and is in the process of reconfiguring or expanding virtually all of its
existing book superstores to the Borders Books and Music format. As of January
23, 1994, there were 18 Borders Books and Music superstores.
Borders-Walden's business strategy is to accelerate the growth of its books
and music superstore business and to increase profitability at Walden.
Borders-Walden intends to accomplish this by (i) opening at least 20-25 Borders
Books and Music superstores in each of the next two fiscal years and
reconfiguring or expanding virtually all of Borders' existing book superstores
to the Borders Books and Music format, (ii) increasing Walden's profitability by
reducing inventory shrinkage, containing expenses and, with the implementation
of Borders' sophisticated inventory management technology, improving sales per
store and inventory productivity over the long term and (iii) continuing to
develop and refine Borders' sophisticated inventory management system.
INDUSTRY OVERVIEW
The retail book industry in the United States is growing and is
characterized by fragmented competition. The Book Industry Study Group ("BISG")
estimates that the total market size for books sold through retail stores in
1992 was approximately $14.9 billion (excluding textbook sales and sales of
trade books through book
VII-12
<PAGE> 308
clubs and mail order) and grew at an annual compound rate of approximately 9.4%
for the five years ended 1992. BISG expects the retail book market to grow
approximately 8.2% per annum through 1997.
Management believes that the retail book industry will continue to grow
based on certain demographic trends. According to the United States Bureau of
Census, 35 to 54 year olds represent the largest segment of retail book
consumers in the United States and this segment is expected to grow over the
next five years. In addition, management anticipates that sales of children's
books, which is a growing segment of the retail book market, will continue to
increase.
Superstore book retailers represent a rapidly increasing percentage of the
retail book market in the United States. According to publicly available
information, over the past four years the top two superstore book retailers
(including Borders) have reported that sales in their superstores have grown
from approximately $70 million to approximately $458 million in net sales, a
compound annual increase of approximately 86.7%, while over the same period the
entire retail book market grew at an annual compound rate of approximately 7.5%.
The superstore sales of these top superstore book retailers accounted for
approximately 3.1% of total retail book sales in 1992. These book retailers have
also experienced substantial increases in total book sales when they have opened
superstores in markets where they also have existing mall bookstores.
The retail sound recording market in the United States is also growing and
is characterized by fragmented competition. The Recording Industry Association
of America ("RIAA") estimates that in 1992 the total market size for sound
recordings grew over 15% to approximately $9 billion, based upon the shipment of
approximately 895 million units of records, tapes, CDs and music videos.
BUSINESS STRATEGY
Borders-Walden's business strategy is to accelerate the growth of its books
and music superstore business and to increase profitability at Walden by:
- Rapidly Expanding Books and Music Superstores. Management believes that
Borders is the premier operator of large format books and music superstores in
each of its markets, offering customers an extremely large assortment of books
and music with superior customer service, in an inviting and comfortable
environment. Borders believes that its ability to consistently execute its
business strategy has resulted in its superior financial performance. Borders
recently expanded its store format by adding to its extensive selection of books
a similarly broad selection of recorded music, with a special emphasis on
hard-to-find recordings in categories such as jazz, classical and foreign music.
Based on the favorable customer acceptance of the initial Borders Books and
Music superstores, Borders is opening all of its new stores in the Borders Books
and Music format and is in the process of reconfiguring or expanding virtually
all of its existing book superstores to the Borders Books and Music format.
Management intends to open at least 20-25 Borders Books and Music superstores in
each of the next two years in new and existing markets.
- Increasing the Profitability of Walden. Management believes that as the
leading operator of mall-based bookstores, Walden is well positioned to achieve
improvement in operating profit. Management expects to further increase
profitability at Walden by reducing inventory shrinkage, containing expenses
and, with the implementation of Borders' sophisticated inventory management
technology, improving sales per store and inventory productivity over the long
term. In order to better position Walden for continued growth in profitability
and to focus its efforts on its core mall bookstore format, Walden also will
close approximately 200 underperforming stores (including many of the non-core
format Walden & More bookstores), and has taken a charge in the fourth quarter
of fiscal 1993 of $142.8 million, which includes costs relating to these
closings and other non-recurring charges. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." In order to maximize
sales per store and inventory productivity over the long term, Walden is
substantially upgrading its inventory control systems and is in the process of
adapting Borders' inventory management technology for use at Walden.
- Continuing to Develop Borders' Sophisticated Inventory Management
System. Over the past two decades Borders has developed what it believes is the
most sophisticated inventory management system in the retail book industry and
believes that this proprietary system is one of the main reasons for Borders'
superior
VII-13
<PAGE> 309
performance. This system uses artificial intelligence principles to analyze
hundreds of variables to forecast sales and automatically recommend inventory
levels for each book title in each store, for a particular point in time, to
reflect local customers' tastes and buying patterns. Borders continually
develops and refines its inventory management system.
BORDERS
General. Borders believes that it is the premier operator of large format
books and music superstores in each of its markets, offering customers an
extremely large assortment of books and music with superior customer service in
an inviting and comfortable environment. At January 23, 1994, Borders had 44
stores, 18 of which were in the Borders Books and Music format. For fiscal 1993,
Borders' stores achieved average annual sales per book superstore for stores
opened 12 months or more (which did not include any Borders Books and Music
superstores) of $6.4 million and sales per gross square foot of $354. Comparable
store sales for book superstores increased 14.8% in fiscal 1993. Borders
believes that it has significant opportunities to expand its market presence and
to continue to increase the number of stores it operates.
Borders believes that the key elements of its success are the following:
Broad Selection of Books. Each Borders superstore offers an average of
128,000 book SKUs, ranging from approximately 85,000 to 170,000 SKUs. Each
Borders superstore typically offers the broadest selection of book titles
in its market, offering titles across numerous categories including many
hard-to-find books, and continuously tailors the title selection in each
superstore to the tastes and buying patterns of the local market. Borders
believes that this ability to tailor the merchandise selection in each of
its stores helps to position it as the premier book retailer in its market.
Wide Assortment of Music. Borders' recently-developed Borders Books
and Music format combines its extensive selection of books with a similarly
broad selection of recorded music, with a special emphasis on hard-to-find
recordings in categories such as jazz, classical and foreign music. Borders
currently has 18 Borders Books and Music superstores, of which two were
opened in fiscal 1992 and 16 in fiscal 1993. Each superstore offers
approximately 57,000 SKUs of music, consisting principally of compact discs
and audio cassettes. Borders is in the process of implementing its
sophisticated inventory management system, including the Borders "expert"
system, to manage its music inventory.
Sophisticated Expert Inventory Management System. Borders' inventory
management system is a fully-integrated system that accurately tracks each
title from the moment it is ordered through its sale. The inventory
management system includes a highly sophisticated centrally-controlled
"expert" system. This system uses artificial intelligence principles to
analyze hundreds of variables to forecast sales and automatically recommend
inventory levels for each book title in each store, for a particular point
in time, to reflect local customers' tastes and buying patterns. Management
believes that Borders' inventory management system results in higher
in-stock positions, inventory turnover, sales per store and sales per
square foot, while simultaneously reducing costs by providing each Borders
store with a more productive inventory assortment. Borders continually
develops and refines its inventory management system.
Exceptional Customer Service. Borders believes that its commitment to
exceptional customer service distinguishes it from its superstore
competitors and serves to build customer loyalty, as well as promote sales.
To provide exceptional customer service, Borders focuses on the expertise
of its sales associates. Borders staffs each store primarily with full-time
associates, the substantial majority of whom have college degrees, and many
of whom have some graduate level education. Over 84% of Borders' sales
associates are full-time. Borders believes that many of its sales
associates are book or music enthusiasts and Borders requires all
prospective sales associates to take a written examination to determine the
breadth and depth of their knowledge of literature or music, as
appropriate, which management believes results in a more dedicated and
knowledgeable sales staff. Borders also has implemented a title
applications software based on client/server technology that enables sales
associates to assist customers who are seeking a particular book, but are
unsure of the title or author. The system permits associates to access
various applications and databases, including the store's inventory,
through any combination of title words, authors or subjects and other
selection criteria.
VII-14
<PAGE> 310
Attractive Ambiance. In order to attract customers and build customer
loyalty, Borders designs each store to be a destination store with an
inviting and comfortable environment. The stores are tastefully appointed
with oak fixtures and carpeted floors, and benches and chairs are placed
throughout to encourage browsing. To add to the attractive ambiance, books
and music are arranged on wooden shelves, classical or jazz music is played
in the background, and currently 36 stores offer an espresso bar. Each new
Borders Books and Music superstore will feature an espresso bar.
Convenient Store Location. Borders seeks to establish its stores in
high traffic, high visibility locations, populated by an educated reading
public. The stores are typically located in strip shopping centers or
free-standing structures. Borders selects sites based on regional access,
lease terms, co-tenancy, visibility, relevant demographics and proximity to
competition.
Community Involvement. Borders encourages each of its stores to be
involved in its local community through specifically tailored community
events. Borders designs its stores to include space for events open to the
public and many stores have a children's play and reading area. Each store
plans its own community-based events, such as author signings, children's
storytelling, poetry reading and live music. Management believes that the
extensive degree to which its stores relate to their local community serves
to build customer loyalty and encourage word of mouth publicity and free
media coverage, and helps to provide customers a sense that they are in a
one-of-a-kind store, as opposed to a chain store.
Value Pricing. In order to provide value to its customers, Borders
discounts substantially all hardcover books, including bestsellers, from
the publishers' suggested retail price. Currently, Borders generally sells
hardcover bestsellers at 30% off the publishers' suggested retail price and
sells other hardcovers at 10% off the publishers' suggested retail price.
In addition, Borders offers a wide selection of sale books at deep
discounts from the publishers' suggested retail price. For recorded music,
Borders generally sells albums that appear on Billboard magazine's top 20
lists for various genres of music at a discount from the manufacturer's
suggested retail price. Borders' policy on pricing takes into account the
value provided by both the extensive selection of merchandise offered and
the high level of customer service. Borders believes that its pricing
policies enable it to be competitive.
Expansion Strategy. Borders maintains high standards of site selection and
store operating performance. As a result, over 93% of Borders' bookstores have
been profitable (before allocation of central overhead) in their first twelve
months of operation. In order to maintain these high standards, Borders has a
carefully considered expansion strategy and currently plans to open at least
20-25 new stores in each of the next two years in new and existing markets.
Borders opened its first store in February 1971 in Ann Arbor, Michigan.
Since opening its second store in 1985, Borders has opened an additional 42
bookstores (including nine Walden-owned book superstores converted to the
Borders' superstore format after Kmart's acquisition on October 30, 1992)
through January 23, 1994, and increased its total square footage of store space
to approximately 992,666 square feet. In addition, over the next 2-3 years
Borders plans to convert the substantial majority of those stores that do not
currently carry music to the Borders Books and Music format, which in certain
instances will require the existing superstore to be physically expanded. To
date, Borders has converted four superstores to the Borders Books and Music
format and has not closed any store other than for relocation. Kmart has
provided additional capital to fund Borders' expansion program.
VII-15
<PAGE> 311
The table below sets forth certain information concerning Borders'
expansion program during the five most recent fiscal years:
<TABLE>
<CAPTION>
FISCAL NEW GROSS SQUARE FEET NO. OF STORES
YEAR STORES AT YEAR END(1) AT YEAR END(2)
- ------ ------ ----------------- --------------
<S> <C> <C> <C>
1989......................................... 3 108,240 8
1990......................................... 5 188,815 13
1991......................................... 3 230,765 16
1992......................................... 15(3) 520,736 31
1993......................................... 15 992,666 44
</TABLE>
- -------------------------
(1) Includes expanded square footage for existing stores.
(2) Includes 18 books and music superstores opened in fiscal 1992 and fiscal
1993.
(3) Includes the conversion of nine book superstores acquired from Walden that
had been initially opened by Walden in fiscal 1992.
Borders employs a rigorous process to select and evaluate new sites.
Borders maintains an in-house staff of experienced real estate personnel to work
with local developers and brokers to identify potential store locations. Borders
also utilizes the services of a professional sales forecasting firm to prepare
forecasted data used in evaluating the potential financial return for each
location.
Borders selects sites based on the availability of prime real estate, lease
terms, co-tenancy, visibility, access, relevant demographics, proximity to
competition and the potential for future store development in the proposed
market. The rate of Borders' expansion will be affected by general economic and
business conditions affecting consumer spending, the availability of desirable
locations and the negotiation of acceptable lease terms.
Although the costs of opening a store may vary, on an operating lease basis
Borders estimates that, with respect to a typical Borders Books and Music
superstore of approximately 30,000 square feet, the cost of the initial
inventory is approximately $2.0 million, with average vendor payables equal to
approximately 60% of the initial inventory, for a net investment of
approximately $0.8 million. The costs of leasehold improvements, store fixtures
and electronic equipment are approximately $1.1 million (with some tenant
improvements included in occupancy costs), and pre-opening expenses, which are
expensed in the first full month of operations, typically average $140,000.
Stores and Store Operations. Borders' 44 stores are located in 22 states
and the District of Columbia, in both suburban and urban areas. The Borders
Books and Music superstores average approximately 30,000 square feet including
approximately 10,000 square feet devoted to the music section, with the
remaining book superstores generally ranging in size from approximately 15,000
square feet to approximately 25,000 square feet. Each store is distinctive in
appearance and architecture, and is designed to complement its local
surroundings, although Borders utilizes certain standardized specifications to
increase the speed and lower the cost of new store openings.
Each Borders store has an average of approximately 128,000 book SKUs as its
base inventory. In addition, for the Borders Books and Music format, each store
has an average of approximately 57,000 SKUs of music. The Borders Books and
Music superstores also include a video section that offers for sale an average
of approximately 9,300 SKUs of prerecorded video tapes.
VII-16
<PAGE> 312
The table below sets forth the states in which Borders' 44 superstores are
located and the number of stores in each state as of January 23, 1994:
<TABLE>
<CAPTION>
TOTAL
STATE STORES
- ------------------------ ------
<S> <C>
Arizona................. 1
Connecticut............. 1
District of Columbia.... 1
Florida................. 1
Georgia................. 1
Hawaii.................. 1
Illinois................ 2
Indiana................. 1
<CAPTION>
TOTAL
STATE STORES
- ------------------------ ------
<S> <C>
Iowa.................... 1
Kansas.................. 1
Maryland................ 2
Massachusetts........... 1
Michigan................ 4
Minnesota............... 2
New Jersey.............. 3
New York................ 6
<CAPTION>
TOTAL
STATE STORES
- ------------------------ ------
<S> <C>
North Carolina.......... 1
Ohio.................... 3
Pennsylvania............ 5
Rhode Island............ 1
Texas................... 2
Virginia................ 2
Wisconsin............... 1
</TABLE>
Borders stores are generally open seven days a week, up to 14 hours a day.
Most Borders superstores are staffed by a store manager, five assistant
managers, a community relations coordinator, a staff trainer, three office and
special order personnel and approximately 29 full-time book and music sales
associates. Borders believes in a decentralized management approach and gives
each store manager responsibility and autonomy in staffing, display, community
involvement and selected promotions. Borders encourages each store manager to
observe local market conditions and sales trends, and to communicate any special
needs of the store to the central purchasing department.
Borders relies heavily on the expertise of its sales associates. As a
result of its focus on providing superior customer service, Borders primarily
hires full-time sales associates and, as a screening tool, all prospective sales
associates are given a written examination in either literature or music, as
appropriate. Borders' hiring and training policies are designed to result in
dedicated and knowledgeable sales associates who are able to be responsive to
customers' requests and identify authors or works that may be of interest to
customers. The stores also have reference desks, where sales associates can
access Borders' sophisticated on-line inventory management system to assist
customers with information requests.
Merchandising and Marketing. The merchandising strategy of Borders is to
carry the broadest selection of books in all subjects and to continuously tailor
the book selection of each store to the local market. With respect to music,
Borders' merchandising strategy is to carry a broad selection of recorded music,
with a special emphasis on hard-to-find recordings in categories such as jazz,
classical and foreign music. Each Borders bookstore offers a broad selection of
books, typically averaging approximately 128,000 SKUs, with each Borders Books
and Music superstore also carrying approximately 57,000 SKUs of music. The
Borders Books and Music superstores also include a video section that offers for
sale an average of approximately 9,300 SKUs of prerecorded video tapes.
Borders relies primarily on its broad title selection, commitment to
exceptional customer service, comfortable store ambiance and word-of-mouth
advertising to attract and retain customers. Each Borders store hosts a variety
of events such as author signings, poetry reading, children's storytelling and
live music. The community relations director for each store is responsible for
coordinating community activities sponsored by the store, including arranging
for authors to speak and children's storytelling hours. The community relations
director has an advertising budget and works with news agencies on articles
published about the store. The community relations director may also publish a
newsletter and coordinates the local mailing list for Borders' holiday catalog.
Borders also utilizes a corporate level marketing staff to assist the stores in
their marketing plans and to plan the use of cooperative advertising funds
provided by publishers.
WALDEN
General. Walden is the largest operator of mall bookstores in the United
States in terms of both sales and number of stores. As of January 23, 1994,
Walden operated 1,159 bookstores in 50 states and the District of Columbia.
Walden had sales of $1.1 billion for fiscal 1993.
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<PAGE> 313
Management believes that, as the leading operator of mall-based bookstores,
Walden is well positioned to achieve improvement in operating profits.
Management expects to further increase profitability at Walden by reducing
inventory shrinkage, containing expenses and, with the implementation of
Borders' sophisticated inventory management technology, improving sales per
store and inventory productivity. In 1993, with the assistance of an outside
consulting firm, management embarked upon a process re-engineering effort to
reduce costs, which included streamlining store receiving operations, home
office functions and distribution center operations. Management also believes
that the combination of Walden and Borders will enable it to realize synergies
in certain areas, including the development of inventory control systems and in
merchandise distribution.
In order to better position Walden for continued growth in profitability
and to focus its efforts on its core mall bookstore format, Walden will close
approximately 200 underperforming stores, and has taken a charge in the fourth
quarter of fiscal 1993 of $142.8 million, which includes costs relating to these
closings and other non-recurring charges. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The stores to be
closed will include approximately 144 of Walden's 1,061 "Waldenbooks"
bookstores, approximately 12 of Walden's 27 "Walden & More" bookstores and
approximately 44 of Walden's 71 "Brentano's" bookstores. As part of Walden's
efforts to focus on its core mall-based store strategy, Walden does not plan to
open any additional Walden & More bookstores. The costs associated with closing
a store include the write-off of fixed assets, lease termination costs, employee
severance costs, expected loss through date of closing and merchandise
markdowns.
In order to maximize sales per store and inventory productivity over the
long term, Walden is substantially upgrading its inventory control systems and
is in the process of adapting Borders' inventory management technology.
Stores and Store Operations. Walden operates 1,159 bookstores in a number
of different store formats using common executive management, purchasing and
operating staff. Walden's 1,061 bookstores operating under the name
"Waldenbooks" average approximately 3,300 square feet and carry between 15,000
and 30,000 titles. Walden also operates 71 bookstores under the name
"Brentano's," which average approximately 4,800 square feet, carry between
25,000 and 35,000 titles and are designed to present a more upscale appearance.
Walden's 27 bookstores operating under the name "Walden & More" average
approximately 8,700 square feet and carry between 25,000 to 75,000 titles
depending on the size of the store and are free-standing book stores.
Walden also has 57 "Walden Software" stores that sell a wide variety of
video games and selected computer software and miscellaneous computer-related
equipment. Consistent with management's initiatives to focus on its core mall
stores, Walden Software stores are now managed under contract by a third-party,
and over the next seven years as store leases expire, each Walden Software store
will be closed.
The following table sets forth information concerning the opening and
closing of Walden's bookstores (excluding Walden Software stores) during the
five most recent fiscal years:
<TABLE>
<CAPTION>
FISCAL NUMBER OF STORES
YEAR OPENINGS CLOSINGS AT YEAR END
-------------------------------------------- -------- -------- ----------------
<S> <C> <C> <C>
1989........................................ 51 34 1,205
1990........................................ 32 28 1,209
1991........................................ 27 19 1,217
1992........................................ 16 31 1,202
1993........................................ 7 50 1,159
</TABLE>
In fiscal 1993, Walden opened seven new stores (two of which were larger
format mall-based stores described below), closed 50 stores and expanded 18
stores. For fiscal 1994, Walden currently intends to open 15 new stores, close
approximately 200 underperforming stores and expand 15 stores. Management is
currently analyzing the performance of the larger mall-based bookstores as part
of its exploration of alternatives for growth in Walden's mall-based operations.
Walden believes that its well established tradenames, financial performance and
merchandise selection make it a highly desirable tenant, and will continue to
enable it to secure highly desirable locations.
VII-18
<PAGE> 314
In order to meet the desires of some developers to include a larger format
bookstore in malls, including in many cases where developers plan to include
only one bookstore in a mall, as well as in order to take advantage of what
management believes is the desire by mall customers for greater selection and
service, Walden recently has developed an alternative mall-based bookstore
utilizing a larger format. The new format consists of 6,000 to 8,000 square feet
and carries between 43,000 and 48,000 titles. The format typically includes a
double store front with separate entrances to distinct "Waldenbooks" and
"Waldenkids" areas, and contains between 1,000 and 1,500 square feet dedicated
to a much-expanded selection of children's books and related merchandise. As of
January 23, 1994, 22 of the larger format stores had been opened (including 19
stores in malls where Walden currently operates the only bookstore) and Walden
anticipates opening approximately 5 new larger format stores in fiscal 1994 and
expanding 15 existing mall bookstores to the larger format.
The cost of opening a new store consists primarily of the investment in
initial inventory, the cost of furniture, fixtures, leasehold improvements,
equipment and pre-opening expenses, such as the costs associated with training
employees. The initial inventory for a new store is estimated to cost
approximately $220,000 (approximately $400,000 for the larger format mall-based
store), with vendor payables equal to approximately 36% for all stores (although
Walden has limited vendor payable experience for larger format bookstores) for a
net investment of approximately $140,000 (approximately $250,000 for the larger
format mall-based stores). The cost of furniture, fixtures and equipment for a
new store is approximately $180,000 (approximately $440,000 for the larger
format mall-based store). Pre-opening expenses, which are expensed in the first
full month of operations, typically average $15,000 for all stores.
Walden's stores are generally open seven days a week, up to twelve hours a
day. Most Walden bookstores employ one store manager, one or two assistant
managers and approximately three full-time equivalent book sellers.
Merchandising and Marketing. Walden's bookstores carry hardcover and
paperback bestsellers, new releases, and children's books. In addition, Walden
bookstores typically carry a focused assortment of books in a broad range of
categories, including fiction, bargain books, science fiction, romance and
business, an assortment of books recorded on audio cassettes, as well as
videotapes, calendars and magazines. Each store, in addition to carrying books
relating to current events and seasonal interests, seeks to tailor its
merchandise to the demographics of the surrounding community, as well as the
larger region or market of such store.
Walden relies primarily on impulse, point-of-sale, storefront signage and
other mall and in-store promotions to attract mall customers. Walden also uses
its Preferred Reader(R) program to attract customers and build customer loyalty.
For a small membership fee, Walden Preferred Readers(R) currently receive 10%
off all purchases (except magazines) and an additional $5 discount certificate
for every $100 spent, and are able to participate in special Walden Preferred
Reader(R) offers. In addition, Walden maintains a Walden Preferred Reader(R)
database that allows it to conduct targeted direct mailings in order to increase
store traffic.
INVENTORY CONTROL
Borders
Inventory Management System. Over the past two decades Borders has
developed what it believes is the most sophisticated inventory management system
in the retail book industry and believes that this proprietary system is a
principal reason for Borders' superior performance. The inventory management
system is a fully-integrated system that tracks each title from the moment it is
ordered through its sale. The inventory management system includes a
centrally-controlled "expert" system. This system uses artificial intelligence
principles in applying sophisticated rules to analyze hundreds of variables in
order to forecast sales and automatically recommend inventory levels for each
book title in each store, for a particular point in time, to reflect local
customers' tastes and buying patterns. Management believes that Borders'
inventory management system results in higher in-stock positions, increased
inventory turnover, sales per store and sales per square foot, while
simultaneously reducing costs by providing each Borders store with a more
productive inventory assortment. Borders works to continually develop and refine
its inventory management system.
VII-19
<PAGE> 315
Borders' inventory management system has continually been improved and
refined since it was first developed in 1974, and in 1990, utilizing AS/400
computers and personal computers, Borders substantially enhanced its inventory
management system to make it an "expert" system that allows it to tailor
merchandise to meet customer preferences.
Borders has also implemented title applications software based on
client/server technology that enables sales associates to assist customers who
are seeking a particular book, but are unsure of the title or author. The system
permits associates to access the various applications and databases, including
the store's inventory, through any combination of title words, authors or
subjects and other selection criteria.
Borders' inventory management system utilizes store level point-of-sale
("POS") terminals and bar code scanners that increase a store's efficiency and
the accuracy of sales information and provide such information more quickly to
the central inventory management system. In addition, computer terminals on the
store floor may be used by sales associates for all applications, including book
title searches (including those not currently carried by Borders), special
orders, and the operation of all office automation software.
The Borders' Expert System. In addition to tracking inventory, the
inventory management system provides critical information to Borders' buyers,
who decide which books to purchase, in what quantity and for which stores.
Borders has developed an "expert" system which interprets the information
compiled by the inventory management system for its buyers and recommends which
titles and quantities should be purchased for each store. The Borders' "expert"
system considers a vast amount of information in order to make its detailed
purchase recommendations. Buyers then review the system's recommendations, make
modifications as the buyers deem necessary based on the buyers' own analysis of
current events and popular trends, as well as input received from individual
stores, and finally instruct the system to issue the purchase order. As a
result, the inventory selection is continuously customized and refined for each
store, based on the buying patterns of the local market, in order to provide the
most attractive selection for the local market.
Walden
Inventory Management System. Walden currently utilizes POS terminals and
personal computers in all of its stores, which provide price look-up, title
look-up and special order capabilities, and, in addition, provide timely
information to Walden's buying staff. In 1993, Walden began to develop and test
a fully-integrated perpetual store level inventory management system that will
enable it to better manage and control its inventory from the point of receipt
through the point of sale. The inventory management system is expected to be
implemented from a merchandising point of view by the end of fiscal 1994 and,
from a financial point of view by the end of fiscal 1995.
Adaptation of the Borders' Expert System. A fully-integrated inventory
management system will allow the implementation of an adapted version of the
Borders' "expert" system, which management anticipates will be implemented
during fiscal 1995. Management believes that the implementation of an expert
system at Walden will enable Walden to more effectively tailor the assortment of
book titles in each store to meet customer preferences, thereby increasing both
sales per store and inventory turnover.
PURCHASING
Borders. Borders' purchasing department is located in Ann Arbor, Michigan,
and is comprised of approximately 28 buyers and 16 support staff. Each buyer
specializes in one or more subject areas, such as fiction, history, architecture
or science, which allows the buyers to develop expertise in their particular
field. The buying staff is responsible for ordering the initial inventory
required upon the opening of each store, for monitoring inventory levels of all
stores and for reordering books from the publishers as required. Borders
purchases its books from over 1,300 vendors and no vendor represents more than
7.5% of Borders' book purchases. Borders transmits purchase orders via
electronic data interchange ("EDI"), which shortens the time to process a
purchase order, reduces labor costs, shrinks the inventory cycle and reduces
Borders' out-of-stock position. In fiscal 1993, approximately 95% of the dollar
value of Borders' book orders were transmitted electronically. With respect to
music, Borders currently purchases its music inventory through a distributor,
who ships the music directly to Borders superstores.
VII-20
<PAGE> 316
Walden. Walden's centralized buying staff is located in Stamford,
Connecticut, and is comprised of approximately 32 buyers and inventory planners.
The centralized buying staff works with eight regional buyers and store
management, in tailoring selection for each store, monitoring inventory levels
and reordering books. For fiscal 1992, Walden's top five largest suppliers
represented approximately 35% of Walden's inventory purchases expressed in
dollars and no single supplier represented in excess of 11% of inventory
purchases expressed in dollars.
DISTRIBUTION
Borders. Borders believes that its centralized distribution system
significantly enhances its ability to manage its inventory on a store-by-store
basis. Books are shipped directly from the publishers to one of Borders' two
distribution centers, located in Ann Arbor, Michigan and Harrisburg,
Pennsylvania. Approximately 95% of the books carried by Borders are processed
through its distribution facilities. At each distribution facility, employees
process the merchandise from the publishers and write out claims for short
orders, damaged books, incorrect shipments and incorrect billings. Employees
also label books with proprietary bar code stickers identifying the book title,
price and subject area. During the non-holiday selling season, approximately
85%-90% of the trade inventory that arrives from publishers is processed within
48 hours for shipment to the stores. Newly released titles and rush orders are
processed within 24 hours. A small percentage of books ordered by local stores
is ordered from independent distributors, generally for special orders. With
respect to music, the distributor currently ships music directly to each Borders
Book and Music superstore. Borders is in the process of shifting towards
purchasing music directly from the manufacturers and utilizing its distribution
centers to ship a majority of its music inventory to its stores.
In general, books can be returned to their publishers at cost. Borders'
stores return books to Borders' centralized returns department in Ann Arbor to
be processed for return to the publishers. Borders believes that its returns to
publishers are substantially lower than the industry average, which Borders
believes is due to the sophistication of its inventory management system. As a
result, Borders is able to reduce its handling, carrying and freight expenses.
In general, Borders has limited rights to return music to its distributor,
although Borders has experienced minimal returns of music to date.
Borders benefits from a relatively lower cycle time for replenishing its
book inventory due to its centralized distribution system. As a result, Borders
is able to offer a broader selection of book titles at its stores. In addition,
local stores are required to devote only a small amount of their management time
and store space to inventory, purchasing and distribution. Consequently, Borders
is able to maximize the use of its retail space and store personnel can focus
their primary efforts on the customer. Borders believes that, as it increases
the number of its stores, it may need to expand the size or number of its
distribution centers.
Walden. Approximately 49% of the number of books carried by Walden's stores
are shipped directly to each store from publishers and jobbers, with the balance
being shipped to one of Walden's two distribution centers, located in Ontario,
California and Nashville, Tennessee. Walden's management has increased the
percentage of merchandise processed through its distribution centers from
approximately 45% in fiscal 1990 to approximately 51% in fiscal 1992. In order
to process returns on a cost effective basis, Walden's Nashville, Tennessee
facility also serves as a centralized return center. In general, books can be
returned to their publishers at cost.
PUBLISHING
Walden owns and publishes, under the name Longmeadow Press, a selection of
books and calendars for distribution through its stores and sale to both
third-parties and affiliates. Walden publishes an average of 150-200 titles per
year and has a backlist of over 500 active titles. Publishing books for sale
through its own retail stores enables Walden to lower costs substantially and
thereby increase margins. For fiscal 1992, approximately 3% of Walden's sales
were derived from Longmeadow Press.
VII-21
<PAGE> 317
COMPETITION
The retail book business is highly competitive. Competition within the
retail book industry is fragmented with Borders facing direct competition from
other superstores, such as Barnes & Noble, Inc., Books-A-Million and Crown Books
Corporation. Eighty percent of Borders superstores currently face direct
competition from other large format book superstores. Walden faces direct
competition from the B. Dalton division of Barnes & Noble, Inc., as well as
regional chains and superstores. In addition, Borders and Walden compete with
each other, as well as specialty retail stores, that offer books in a particular
area of specialty, independent single store operators, variety discounters, drug
stores, warehouse clubs and mass merchandisers. In the future, Borders and
Walden may face additional competition from other categories of retailers
entering the retail book market, in particular music retailers.
The music business is also highly competitive and Borders faces competition
from large established music chains, such as Tower Records and Musicland, as
well as specialty retail stores, variety discounters, warehouse clubs and mass
merchandisers.
PROPERTIES
Borders. Borders leases all of its stores, except the Columbus, Ohio and
Indianapolis, Indiana stores. Borders' store leases have an average initial term
of 10-15 years with several five-year renewal options. At present, the average
unexpired term under Borders' 42 existing store leases is 10 years prior to the
exercise of any options.
Borders owns its main headquarters and distribution facility, located on 11
acres of land outside of Ann Arbor, Michigan. This facility has approximately
41,000 square feet dedicated to distribution, and to a lesser extent
warehousing, and approximately 16,800 square feet dedicated to corporate offices
and general administration.
Walden. Walden leases all of its stores. Walden's store leases have an
average term of 10 years. At present, the average unexpired term under Walden's
1,159 existing store leases is 4.3 years. The terms of Walden's mall-based
bookstores leases for its 1,159 leased bookstores open as of January 23, 1994
expire as follows:
<TABLE>
<CAPTION>
LEASE TERMS TO EXPIRE DURING
12 MONTHS ENDING ON OR ABOUT
JANUARY 31 NUMBER OF MALL STORES
------------------------------- ---------------------
<S> <C>
1994................................... 161*
1995................................... 154
1996................................... 114
1997-1999.............................. 366
2000 and later......................... 364
</TABLE>
- -------------------------
* Includes 42 leases that expired prior to the end of fiscal 1993, many of which
are currently being renegotiated.
The table below sets forth the states in which Walden's 1,159 stores are
located and the number of stores in each state as of January 23, 1994:
<TABLE>
<CAPTION>
TOTAL
STATE STORES
------
<S> <C>
Alabama................ 10
Alaska................. 7
Arizona................ 20
Arkansas............... 9
California............. 140
Colorado............... 20
Connecticut............ 23
Delaware............... 4
Dist. of Columbia...... 4
<CAPTION>
TOTAL
STATE STORES
------
<S> <C>
Florida................ 71
Georgia................ 31
Hawaii................. 19
Idaho.................. 5
Illinois............... 48
Indiana................ 27
Iowa................... 13
Kansas................. 10
Kentucky............... 14
<CAPTION>
TOTAL
STATE STORES
------
<S> <C>
Louisiana.............. 15
Maine.................. 2
Maryland............... 26
Massachusetts.......... 27
Michigan............... 33
Minnesota.............. 11
Mississippi............ 7
Missouri............... 25
Montana................ 5
</TABLE>
VII-22
<PAGE> 318
<TABLE>
<CAPTION>
TOTAL
STATE STORES
------
<S> <C>
Nebraska............... 7
Nevada................. 6
New Hampshire.......... 3
New Jersey............. 27
New Mexico............. 6
New York............... 69
N. Carolina............ 36
N. Dakota.............. 3
<CAPTION>
TOTAL
STATE STORES
------
<S> <C>
Ohio................... 53
Oklahoma............... 15
Oregon................. 12
Pennsylvania........... 63
Rhode Island........... 5
S. Carolina............ 17
S. Dakota.............. 2
Tennessee.............. 24
<CAPTION>
TOTAL
STATE STORES
------
<S> <C>
Texas.................. 79
Utah................... 6
Vermont................ 2
Virginia............... 39
Washington............. 25
W. Virginia............ 13
Wisconsin.............. 19
Wyoming................ 2
</TABLE>
Walden owns its headquarters in Stamford, Connecticut and leases both of
its distribution facilities located in Ontario, California and Nashville,
Tennessee. The California facility has approximately 237,600 square feet
dedicated to distribution and warehousing and approximately 9,400 square feet
dedicated to corporate offices and general administration. The Tennessee
facility has approximately 494,500 square feet dedicated to distribution and
warehousing and approximately 25,500 square feet dedicated to corporate offices
and general administration.
ASSOCIATES
Borders. As of January 23, 1994, Borders had a total of approximately 1,900
full-time associates and approximately 300 part-time associates, including nine
in executive positions, 44 store managers and approximately 2,200 in sales,
clerical and other store, office or warehouse positions. Borders has experienced
very low turnover among its store managers, and Borders endeavors to promote new
store managers internally through a management training program. None of
Borders' associates is covered by a collective bargaining agreement or is
represented by a labor union. Borders believes that its relations with its
associates are good.
Walden. As of January 23, 1994, Walden had a total of approximately 6,300
full-time associates and approximately 5,150 part-time associates, including 50
in executive positions, approximately 1,400 store managers and approximately
10,000 in sales, clerical and other store, office or warehouse positions. None
of Walden's associates is covered by a collective bargaining agreement or is
represented by a labor union. Walden believes that its relations with its
associates are good.
TRADE MARKS AND SERVICE MARKS
Borders(R), Borders Book Shop(R), and Borders Books & Music(R), among other
marks, are all registered trademarks and service marks of Borders.
Brentano's(R), Coopersmith's(R), Longmeadow Press(R), Walden Book Store(R),
Waldenbooks(R), Waldenbooks Preferred Reader(R), Waldenkids(R),
Waldensoftware(R) and Waldenvideo(R), among other marks, are all registered
trademarks and service marks of Walden. Both Borders and Walden use their
respective service marks as a trade name in connection with their business
operations. Whenever possible, both Borders and Walden have registered their
respective names as a trade name with the state or locality where they have
stores.
LITIGATION
Both Borders and Walden are from time to time involved in routine
litigation incidental to the conduct of their respective businesses.
Borders-Walden believes that no currently pending litigation to which either
Borders or Walden is a party will have a material adverse effect on its
liquidity, financial position or results of operations.
VII-23
<PAGE> 319
BORDERS-WALDEN GROUP
REPORT BY MANAGEMENT
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Kmart Corporation and Borders-Walden Group management are responsible for
the integrity of the information and representations contained in interim and
annual financial statements. This responsibility includes making informed
estimates and judgments in selecting the appropriate accounting principles.
Management believes the financial statements conform with generally accepted
accounting principles applied on a consistent basis.
To assist management in fulfilling these obligations, several tools are
utilized, which include the following:
A system of internal accounting controls is maintained to provide for
the integrity of information for purposes of preparing financial statements
and to assure that assets are properly accounted for and safeguarded. This
concept of reasonable assurance is based on the recognition that the cost
of the system is related to the benefits to be derived and modified for
changing conditions. Management believes its system provides reasonable
assurance of this appropriate balance.
As part of the internal control system, a policy of Standards of
Business Conduct and Management Integrity Statement is in effect. All
officers and key employees periodically submit a signed statement regarding
compliance with these policies.
An Internal Audit Department is maintained to evaluate, test and
report on the application of internal accounting controls in conformity
with standards of the practice of internal auditing.
The financial statements have been examined by independent accountants
whose report is contained herein. This examination includes, among other
things, a review of the system of internal controls as required by
generally accepted auditing standards.
The Audit Committee of the Board of Directors, consisting solely of outside
directors, meets regularly with management, internal auditors and the
independent accountants to assure that each is carrying out its
responsibilities. The internal auditors and independent accountants both have
full and free access to the Audit Committee, with and without the presence of
management.
Joseph E. Antonini
Kmart Corporation
Chairman of the Board, President
and Chief Executive Officer
George R. Mrkonic
Kmart Corporation
Executive Vice President
Specialty Retailing
Thomas F. Murasky
Kmart Corporation
Executive Vice President and
Chief Financial Officer
Robert F. Di Romualdo
Borders-Walden Group
President and
Chief Executive Officer
Richard L. Flanagan
Borders, Inc.
President and
Chief Operating Officer
Charles R. Cumello
Walden Book Company, Inc.
President and
Chief Executive Officer
VII-24
<PAGE> 320
BORDERS-WALDEN GROUP
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Kmart Corporation
In our opinion, the accompanying combined balance sheets and the related
combined statements of income and of cash flows present fairly, in all material
respects, the financial position of the Borders-Walden Group at January 23, 1994
and January 24, 1993 and the results of its operations and its cash flows for
each of the three years in the period ended January 23, 1994, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of Kmart Corporation management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the notes to the combined financial statements, the
Borders-Walden Group adopted Statement of Financial Accounting Standard No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions" and
Statement of Financial Accounting Standard No. 109, "Accounting for Income
Taxes," at the beginning of fiscal 1993.
Borders-Walden Group is a business group of Kmart Corporation (as described
in the Basis of Presentation note to these financial statements); accordingly,
the combined financial statements of the Borders-Walden Group should be read in
conjunction with the consolidated financial statements of Kmart Corporation.
Price Waterhouse
Detroit, Michigan
March 15, 1994
VII-25
<PAGE> 321
BORDERS-WALDEN GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, FEBRUARY 1,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $1,370.6 $1,183.7 $1,140.1
Cost of merchandise sold, includes buying and occupancy
costs...................................................... 1,020.0 892.4 876.8
Selling, general and administrative expenses................. 291.2 243.7 228.9
Pre-opening expense.......................................... 2.6 1.9 0.8
Goodwill amortization........................................ 6.9 3.5 2.5
Store restructuring and other charges........................ 142.8 -- --
----------- ----------- -----------
Operating income (loss)...................................... (92.9) 42.2 31.1
Interest:
Debt -- expense............................................ 0.9 0.6 0.5
----------- ----------- -----------
Income (loss) before income taxes and the effect of
accounting changes......................................... (93.8) 41.6 30.6
Income taxes................................................. (38.2) 18.5 13.9
----------- ----------- -----------
Net income (loss) before the effect of accounting changes.... (55.6) 23.1 16.7
Effect of accounting changes, net of income taxes............ 5.6 -- --
----------- ----------- -----------
Net income (loss)............................................ $ (61.2) $ 23.1 $ 16.7
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure (unaudited):
Net income (loss).......................................... $ (61.2) $ 23.1 $ 16.7
Add back of goodwill amortization.......................... 6.9 3.5 2.5
----------- ----------- -----------
Kmart Corporation earnings (losses) attributable to
Borders-Walden Group.................................... $ (54.3) $ 26.6 $ 19.2
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-26
<PAGE> 322
BORDERS-WALDEN GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash............................................................. $ 30.2 $ 21.4
Merchandise inventories.......................................... 435.8 387.9
Accounts receivable and other current assets..................... 44.2 20.5
Deferred income taxes............................................ 35.7 --
------------ ------------
Total current assets................................................ 545.9 429.8
Property Owned:
Land............................................................. 10.1 10.1
Buildings........................................................ 38.2 44.2
Leasehold improvements........................................... 127.0 118.8
Furniture and fixtures........................................... 213.6 165.0
Construction in progress......................................... 8.5 2.2
------------ ------------
397.4 340.3
Less-accumulated depreciation and amortization...................... (202.1) (142.8)
------------ ------------
Total owned property................................................ 195.3 197.5
Deferred income taxes............................................... 10.8 --
Goodwill -- net of accumulated amortization of $29.3 and $22.4,
respectively..................................................... 249.6 244.9
------------ ------------
$1,001.6 $ 872.2
------------ ------------
------------ ------------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year............................... $ 5.2 $ 0.2
Accounts payable -- trade........................................ 257.8 181.6
Accrued payrolls and other liabilities........................... 118.7 102.7
Store restructuring reserve...................................... 96.7 --
Taxes other than income taxes.................................... 2.1 1.9
Income taxes..................................................... 5.2 23.9
------------ ------------
Total current liabilities........................................... 485.7 310.3
Long-Term Debt...................................................... 4.3 9.6
Other Long-Term Liabilities......................................... 54.1 31.0
Deferred Income Taxes............................................... -- 0.2
Borders-Walden Group Equity......................................... 457.5 521.1
------------ ------------
$1,001.6 $ 872.2
------------ ------------
------------ ------------
Supplemental disclosure (unaudited):
Borders-Walden Group Equity...................................... $ 457.5 $ 521.1
Add back of accumulated goodwill amortization.................... 29.3 22.4
------------ ------------
Kmart Corporation equity attributable to Borders-Walden Group.... $ 486.8 $ 543.5
------------ ------------
------------ ------------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-27
<PAGE> 323
BORDERS-WALDEN GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------
JANUARY 23, JANUARY 24, FEBRUARY 1,
1994 1993 1992
------------ ------------ ------------
<S> <C> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income (loss) before effect of accounting changes..... $(55.6) $ 23.1 $ 16.7
Adjustments to reconcile net income (loss) to operating
cash flows:
Store restructuring and other charges.................. 125.3 -- --
Depreciation and amortization.......................... 41.0 33.3 30.9
Deferred income taxes.................................. (36.7) (2.7) (1.9)
Increase (decrease) in other long-term liabilities..... (4.0) (1.8) 6.8
Other -- net........................................... 5.5 2.6 0.9
Cash provided by (used for) current assets and current
liabilities:
(Increase) decrease in inventories..................... (47.9) (20.3) 22.6
Increase in accounts payable........................... 76.2 23.3 13.5
Other -- net........................................... (21.3) 39.9 35.8
------------ ------------ ------------
Net cash provided by operations........................ 82.5 97.4 125.3
------------ ------------ ------------
INVESTING
Capital expenditures -- owned property.................... (71.0) (28.8) (15.2)
------------ ------------ ------------
Net cash used for investing............................... (71.0) (28.8) (15.2)
------------ ------------ ------------
FINANCING
Repayment of long-term debt............................... (0.3) (17.8) (0.1)
Net equity transactions with the Kmart Group.............. (2.4) (41.2) (111.7)
------------ ------------ ------------
Net cash used for financing............................... (2.7) (59.0) (111.8)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS............. 8.8 9.6 (1.7)
Cash and Equivalents at Beginning of Year................. 21.4 11.8 13.5
------------ ------------ ------------
CASH AND EQUIVALENTS AT END OF YEAR......................... $ 30.2 $ 21.4 $ 11.8
------------ ------------ ------------
------------ ------------ ------------
Supplemental disclosures of cash flow information:
Interest paid............................................. $ 0.9 $ 0.6 $ 0.5
Income taxes paid......................................... $ 18.6 $ 12.3 $ 0.7
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-28
<PAGE> 324
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
BASIS OF PRESENTATION
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue four new series of
common stock (collectively, the Specialty Retail Stock) designated KM-
Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of each specialty retail business. The Borders-Walden Stock is
intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company, Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the initial issuance of any series of Specialty Retail Stock, the
existing common stock would be redesignated as Kmart Group Common Stock (Kmart
Stock). The Kmart Stock, while constituting common stock of Kmart Corporation,
is intended to reflect the separate performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) Kmart Corporation's interest in each Specialty Retail Group (a Retained
Interest) other than the interest represented by any outstanding shares of any
series of Specialty Retail Stock and (iii) all other businesses in which Kmart
Corporation and its subsidiaries are engaged. The Kmart Group and the Specialty
Retail Groups are referred to collectively herein as the Groups.
Following approval by shareholders of the Specialty Retail Stock Proposal,
Kmart Corporation currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate initial public offerings (collectively, the Offerings) and to allocate
the proceeds of the Offerings to the Kmart Group to repay outstanding
indebtedness of Kmart Corporation, resulting in reduced debt service obligations
attributable to the Kmart Group. The timing, sequence and size of such Offerings
and the price at which such shares would be sold would be determined by the
Board, without further approval of shareholders, at the time of each Offering;
however, it is currently contemplated that Kmart Corporation would initially
offer to the public shares of each series of Specialty Retail Stock that would
be intended to represent approximately 20% to 30% of the equity value of Kmart
Corporation attributed to the relevant Specialty Retail Group as determined by
the Board (Equity Value) at the time of such Offering. Therefore, it is expected
that Kmart Corporation would retain and attribute to the Kmart Group a 70% to
80% Retained Interest in each such Specialty Retail Group. The terms of each
Offering would be determined by the Board and the underwriters of such Offering
based upon prevailing market conditions; the financial condition and results of
operations of the relevant Group; the history of and prospects for the relevant
Group; the specialty retail industry and the segment of that industry in which
the relevant Group competes; the management and operations of the relevant
Group; the progress of the relevant Group in implementing its business strategy;
the foregoing factors in relation to market values of other companies engaged in
similar businesses; and the financial condition of Kmart Corporation as a whole.
In addition to or in lieu of any Offering, the Board reserves the right to issue
shares of any series of Specialty Retail Stock as a distribution on
VII-29
<PAGE> 325
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Kmart Stock, although the Board has no current intention to do so. The
determination of whether to proceed with an Offering of any series of Specialty
Retail Stock would be made by the Board based on, among other things, the
proposed terms of such Offering and the then prevailing market and other
conditions. The Board reserves the right not to proceed with any or all of the
Offerings, without further approval of shareholders, if it determines that
consummation of such Offering or Offerings is not in the best interests of Kmart
Corporation.
The financial statements of the Groups comprise all of the accounts
included in the corresponding consolidated financial statements of Kmart
Corporation. The separate Group financial statements give effect to the
management and accounting policies that would be applicable upon implementation
of the Specialty Retail Stock Proposal, except that no inter-Group interest
expense or inter-Group interest income is reflected, as more fully described
under "Corporate Activities" below. However, following implementation of the
Specialty Retail Stock Proposal and issuance of each Specialty Retail Stock, the
financial statements of each Specialty Retail Group would reflect interest
expense related to net cash provided by Kmart Corporation. The separate Group
financial statements have been prepared on a basis that management believes to
be reasonable and appropriate and include (i) the combined historical financial
position, results of operations and cash flows of the businesses that comprise
each of the Groups and (ii) a portion of the assets and liabilities (including
contingent liabilities) and related transactions of Kmart Corporation that are
not separately identified with the operations of a specific Group. The effects
of the issuance of the equity securities described above have not been reflected
in these historical financial statements.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, following issuance of any series of Specialty Retail
Stock, Kmart Corporation would provide to holders of Borders-Walden Stock
separate financial statements, management's discussion and analysis of financial
condition and results of operations, business descriptions and other information
for the Borders-Walden Group and for Kmart Corporation. Notwithstanding the
allocation of assets and liabilities (including contingent liabilities),
shareholders' equity and items of income and expense among the Groups for
purposes of preparing their respective financial statements, the change in the
capital structure of Kmart Corporation contemplated by the Specialty Retail
Stock Proposal would not affect the respective legal title to assets or
responsibility for liabilities of Kmart Corporation or any of its subsidiaries.
Kmart Corporation and its subsidiaries would each continue to be responsible for
their respective liabilities. Holders of Borders-Walden Stock and of each other
series of common stock of Kmart Corporation would be holders of common stock of
Kmart Corporation and would continue to be subject to risks associated with an
investment in Kmart Corporation and all of its businesses, assets and
liabilities. The Specialty Retail Stock Proposal would not affect the rights of
creditors of Kmart Corporation.
Financial effects arising from any Group that affect the consolidated
results of operations or financial condition of Kmart Corporation could affect
the results of operations or financial condition of the Borders-Walden Group or
the market price of shares of Borders-Walden Stock. In addition, net losses of
any Group, dividends and distributions on any series of common stock or
preferred stock, repurchases of any series of common stock and certain
repurchases of preferred stock would reduce the assets of Kmart Corporation
legally available for dividends on all series of common stock. Accordingly,
Kmart Corporation consolidated financial information should be read in
conjunction with the Borders-Walden Group financial information.
The dividend policy applicable to Borders-Walden Stock would be determined
by the Board at the time of issuance of such stock. Determinations to pay
dividends on Borders-Walden Stock would be based primarily upon the financial
condition, results of operations and business requirements of the Borders-Walden
Group and Kmart Corporation as a whole. Under the terms of Borders-Walden Stock,
dividends would be payable at the sole discretion of the Board out of the lesser
of (i) all assets of Kmart Corporation legally available for dividends and (ii)
the Available Dividend Amount with respect to the Borders-Walden Group.
VII-30
<PAGE> 326
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The management and accounting policies applicable to the preparation of the
financial statements of the Borders-Walden Group could be modified or rescinded
by the Board, in its sole discretion and without the approval of shareholders,
although there is no present intention to do so. The Board could also adopt
additional policies depending upon the circumstances. Any determination by the
Board to modify or rescind such policies, or to adopt additional policies,
including any such decision that could have disparate effects upon holders of
different series of common stock, would be made by the Board in good faith and
in the honest belief that such decision is in the best interests of Kmart
Corporation. In addition, generally accepted accounting principles require that
changes in accounting policy must be preferable (in accordance with such
principles) to the policy previously in place.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Borders-Walden Group's significant accounting policies, which conform
to generally accepted accounting principles applied on a consistent basis
between years, are described below.
Fiscal Year: The Borders-Walden Group fiscal year ends on the Sunday prior
to the last Wednesday in January. The Borders-Walden Group changed its fiscal
year at the end of fiscal 1992 to conform with the other Specialty Retail
Groups. Accordingly, fiscal 1992 consisted of 51 weeks and ended on January 24,
1993. Fiscal 1993 and 1991 each consisted of 52 weeks and ended on January 23,
1994 and February 1, 1992, respectively.
Earnings Per Common and Common Equivalent Share: Historical earnings per
share are omitted from the statements of income as Borders-Walden Stock was not
part of the capital structure of Kmart Corporation for the periods presented.
Following implementation of the Specialty Retail Stock Proposal, the method of
calculating earnings per share for Kmart Stock and each series of Specialty
Retail Stock would reflect the terms of the Certificate of Amendment which
provide that each Group's Available Dividend Amount, which, in turn, would
reflect the separately reported Kmart Corporation Earnings Attributable to the
Kmart Group, in the case of the Kmart Group, and Kmart Corporation Earnings
Attributable to a Specialty Retail Group, in the case of a Specialty Retail
Group, would be the source for payment of dividends for each series of common
stock, although liquidation rights of these series of stock and legally
available assets of Kmart Corporation may be more or less than these amounts.
Kmart Corporation would compute earnings per share of Borders-Walden Stock by
dividing the product of the Outstanding Interest Fraction and Kmart Corporation
Earnings Attributable to a Specialty Retail Group with respect to the
Borders-Walden Group by the weighted average number of shares of Borders-Walden
Stock and dilutive Borders-Walden Stock equivalents outstanding during the
applicable period. Kmart Corporation Earnings Attributable to a Specialty Retail
Group with respect to the Borders-Walden Group would generally equal the
Borders-Walden Group's net income or loss for the relevant period determined in
accordance with generally accepted accounting principles in effect at such time,
reflecting income and expenses of Kmart Corporation allocated to the
Borders-Walden Group increased by the amount of amortization of goodwill of the
Borders-Walden Group during such period arising from acquisitions made by Kmart
Corporation or its subsidiaries with respect to the Borders-Walden Group before
the first issuance of Borders-Walden Stock. The Outstanding Interest Fraction
with respect to the Borders-Walden Group is the percentage interest in the
Borders-Walden Group intended to be represented at any time by the outstanding
shares of Borders-Walden Stock. See "Proposal 2 -- The Specialty Retail Stock
Proposal -- Dividend Policy -- Calculation of Earnings per Share" of Kmart
Corporation Proxy Statement for an example of the calculation of Kmart
Corporation Earnings Attributable to a Specialty Retail Group with respect to
Borders-Walden Stock.
Cash and Equivalents: Kmart Corporation considers cash on hand in stores,
deposits in banks, certificates of deposit and short-term marketable securities
with maturities of 90 days or less as cash and cash equivalents for the purposes
of the statement of cash flows.
VII-31
<PAGE> 327
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Inventories: Merchandise inventories are valued on a first-in, first-out
(FIFO) basis at the lower of cost or market using the retail inventory method.
In fiscal 1993, Walden changed its method from last-in, first-out (LIFO) to the
FIFO method. (See "Restatement of Prior Years' Amounts" below).
Property Owned and Depreciation: Land, buildings, leasehold improvements
and equipment are recorded at cost including a provision for capitalized
interest. Depreciation is provided over the estimated useful lives of related
assets on the straight-line method for financial statement purposes and on
accelerated methods for income tax purposes. Most store properties are leased
and improvements are amortized over the term of the lease but not more than 20
years. Other annual rates used in computing depreciation for financial statement
purposes are 2%-3% for buildings and 10%-20% for other fixtures and equipment.
Expenditures for owned properties, primarily self-developed locations,
which the Borders-Walden Group intends to sell and lease-back within one year
are included in accounts receivable and other current assets.
Goodwill: The excess of cost over the fair value of net assets of the
Borders-Walden Group as of the respective dates of acquisition of Borders, Inc.
and Walden Book Company, Inc. by Kmart Corporation was capitalized and is being
amortized over 40 years using the straight-line method. Borders was acquired
October 30, 1992, and Walden was acquired August 9, 1984. The Borders-Walden
Group evaluates the recoverability of goodwill and reviews the amortization
period on an annual basis. Several factors are used to evaluate goodwill,
including but not limited to: management's plans for future operations; recent
operating results and each business' projected, undiscounted cash flows.
Financial Instruments: With the exception of long-term debt and the
Borders-Walden Group equity, the Borders-Walden Group records all financial
instruments, including accounts receivable, accounts payable and marketable
securities at, or approximating, market value.
Pre-Opening and Closing Costs: Costs associated with the opening of a new
store are expensed during the first full month of the store's operations. When
the decision to close a retail unit is made, the Borders-Walden Group provides
for the future net lease obligation, nonrecoverable investment in fixed assets,
other expenses directly related to discontinuance of operations and estimated
operating loss through the expected closing dates.
Preferred Reader Program: Walden sells memberships in its Preferred Reader
Program which offers members discounts on purchases and other benefits.
Membership fees are deferred and recognized over the twelve-month membership
period.
CORPORATE ACTIVITIES
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt, and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of the Borders-Walden
Group are remitted to Kmart Corporation and cash disbursements of the
Borders-Walden Group are funded by Kmart Corporation on a daily basis. In the
historical financial statements of the Groups, (i) debt incurred by Kmart
Corporation and its subsidiaries, other than certain capital leases and
mortgages related specifically to the Specialty Retail Groups, has been
reflected on the financial statements of the Kmart Group and (ii) net cash used
or provided by each Specialty Retail Group has been characterized as an
adjustment of the Kmart Group's investment (reflected as Retained Interest) in
such Specialty Retail Group. Accordingly, no inter-Group interest expense or
inter-Group interest income is reflected in the historical financial statements
of the Borders-Walden Group. Until the issuance of Borders-Walden Stock, the net
cash used or provided by the Borders-Walden Group will continue to be
characterized as an adjustment to the Kmart Group's investment in the
Borders-Walden Group.
VII-32
<PAGE> 328
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group when the debt is incurred or
the preferred stock is issued for the benefit of such Specialty Retail Group.
Following the issuance of Borders-Walden Stock, if cash used by the
Borders-Walden Group exceeds cash provided by the Borders-Walden Group, the
Kmart Group would transfer to the Borders-Walden Group the cash necessary to
fund excess uses. Conversely, if cash provided by the Borders-Walden Group
exceeds cash used by the Borders-Walden Group, the Borders-Walden Group would
transfer the excess cash to the Kmart Group. All cash transfers between Groups
would be accounted for as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be accounted
for as a long-term loan or, in the case of a transfer from the Kmart Group to
the Borders-Walden Group, an equity contribution. There are no specific criteria
to determine when a cash transfer would be classified as a long-term loan or, in
the case of a transfer from the Kmart Group to the Borders-Walden Group, an
equity contribution, rather than a short-term loan. Such determination would be
made by the Board in the exercise of its business judgment at the time of such
transfer (or the first of such type of transfer) based upon all relevant
circumstances, including the financing needs and objectives of the recipient
Group, the investment objectives of the transferring Group, prevailing interest
rates and general economic conditions. Such determination would affect the
amount of interest expense and interest income reflected in the financial
statements of the relevant Groups if such transfer were made as a short-term
loan or long-term loan and, in the case of a transfer from the Kmart Group to
the Borders-Walden Group as an equity contribution, the amount of the Borders-
Walden Group equity and Retained Interest of the Kmart Group. Short-term loans
between the Kmart Group and the Borders-Walden Group would bear interest at
Kmart Corporation's daily short-term borrowing rate. In the event that the Board
determined that a transfer of funds between the Kmart Group and the Borders-
Walden Group should be made as a long-term loan, the Board would establish the
terms on which such loan would be made, including interest rate, amortization
schedule, maturity and redemption terms. Such terms would generally reflect the
then prevailing terms upon which Kmart Corporation could borrow funds on a
similar basis.
From time to time, following the initial issuance of Borders-Walden Stock,
the Board could determine that funds to be transferred from the Kmart Group to
the Borders-Walden Group represent an equity contribution to the Borders-Walden
Group rather than a loan. In such event, the Kmart Group's Retained Interest in
the Borders-Walden Group would be increased by the amount of such contributions,
as a result of which, (i) the Number of Shares Issuable with Respect to the
Kmart Group's Retained Interest in the Borders-Walden Group would be increased
by an amount equal to the amount of such contribution divided by the Market
Value of a share of Borders-Walden Stock and (ii) the Kmart Group's interest in
the Borders-Walden Group would be increased and the interest in the
Borders-Walden Group represented by outstanding shares of Borders-Walden Stock
would be decreased accordingly. The Board could determine, in its sole
discretion, to make such contribution after consideration of a number of factors
including, among others, the relative levels of internally generated cash flow
of the Groups, the long-term business prospects for the Borders-Walden Group,
the capital expenditure plans of and investment opportunities available to the
Borders-Walden Group and the availability, cost and time associated with
alternative financing sources.
VII-33
<PAGE> 329
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from the
Borders-Walden Group, and the balance sheets of the Borders-Walden Group would
reflect its net short-term and net long-term loans to or borrowings from the
Kmart Group. Similarly, the income statements of the Kmart Group and the
Borders-Walden Group would reflect interest income or expense, as the case may
be, associated with such loans or borrowings and the statements of cash flows of
the Kmart Group and the Borders-Walden Group would reflect changes in the
amounts thereof deemed outstanding. In view of the anticipated cash needs of the
Borders-Walden Group over the next several years, it is currently expected that
the Kmart Group would provide net cash to the Borders-Walden Group. After
considering all relevant factors, the Kmart Group would obtain such funds from
internal operations, excess cash from other Specialty Retail Groups, external
debt financing or additional equity issuances. Accordingly, unlike these
historical financial statements, following implementation of the Specialty
Retail Stock Proposal and issuance of Borders-Walden Stock, the financial
statements of the Borders-Walden Group would reflect interest expense related to
net cash provided by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to the Borders-Walden Group would continue to be made at the
discretion of the Board. Nothing in the foregoing policies obligates the Board
to cause the Kmart Group to provide funds to the Borders-Walden Group if the
Board determines it is in the best interest of Kmart Corporation not to do so.
Certain corporate, general and administrative costs (including certain
corporate borrowing, legal, tax, transportation and import, data processing,
employee benefit and self-insurance costs) have been charged to the Specialty
Retail Groups based upon utilization and at negotiated rates which management
believes approximate the rates which each of the Specialty Retail Groups would
incur as stand-alone entities. The Borders-Walden Group financial statements
also include an allocation, which management believes to be reasonable, of
corporate, general and administrative costs related specifically to the
management of the Specialty Retail Groups and allocated equally among the
Specialty Retail Groups of $0.1 in each of 1993, 1992 and 1991. Amounts
allocated in these historical financial statements were calculated on the same
basis as would be used prospectively, and management believes that the
historical allocation of such amounts is representative of the amounts which
would be allocated to each of the Specialty Retail Groups prospectively.
Income Taxes: All members of the Kmart Corporation consolidated group are
included in the consolidated United States federal income tax return filed by
Kmart Corporation. Accordingly, the provision for federal income taxes and the
related payments or refunds of tax are determined on a consolidated basis. The
financial statement provision and related tax payments or refunds have been
reflected in the individual Groups in accordance with Kmart Corporation's tax
allocation policy for such Groups. In general, such policy provides that the
consolidated tax provision is allocated among the Groups for individual Group
financial statement purposes based principally upon the financial income,
taxable income, credits, preferences and other amounts directly related to the
respective Groups.
For financial statement provision and tax settlement purposes, tax benefits
resulting from attributes (principally net operating losses), which cannot be
utilized by one of the Groups on a separate return basis but which can be
utilized on a consolidated basis in any given year, are allocated to the Group
which generates the attributes. However, if such tax benefits cannot be utilized
on a consolidated basis in that year or in a carry back year, such consolidated
tax effect is adjusted in a subsequent year to the extent necessary to allocate
tax benefits to the Group that would have realized the tax benefits on a
separate return basis.
The allocated Group amounts are not necessarily comparable to those that
would have resulted if the Groups had filed separate tax returns and, in certain
situations, could result in any of the Groups incurring more or less income tax
expense for financial reporting purposes.
Deferred income taxes are provided on temporary differences between the
financial statement and income tax basis of assets and liabilities.
VII-34
<PAGE> 330
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
RESTATEMENT OF PRIOR YEARS' AMOUNTS
The results of operations for the Borders-Walden Group have been restated
from amounts previously included in Kmart Corporation's consolidated financial
statements in order to (i) reflect a change in the method of inventory valuation
for Walden from last-in, first-out (LIFO) to first-in, first-out (FIFO) to
conform Walden's inventory accounting method with Borders, (ii) correct prior
period results with respect to inventory shrinkage and lease accounting and
(iii) conform the accounting policies of Walden and Borders in the areas of
fixed asset capitalization and revenue recognition. Of the items mentioned
above, the most significant amounts relate to the change from LIFO to FIFO which
increased retained earnings $34.9 and a correction of inventory shrinkage
estimates which decreased retained earnings by $24.4 at the end of fiscal 1990,
respectively. The total impact of the restatement was a reduction in net income
of $2.6 and $3.7 in 1992 and 1991, respectively, and a reduction of retained
earnings at February 3, 1991 of $43.1.
STORE RESTRUCTURING AND OTHER CHARGES
On January 5, 1994, the Board approved a restructuring plan involving the
closing of approximately 200 underperforming Walden stores. Management believes
that these closures will better enable the Borders-Walden Group to compete
effectively. Management expects the closure of these stores will be
substantially completed in 1994, and that total sales levels will decrease
proportionally and that overall operating expenses, including employee costs,
occupancy expenses and depreciation charges will decrease further resulting in
improved earnings levels compared with the prior year.
As a result of the restructuring plan, the Borders-Walden Group recorded a
pre-tax charge of $142.8 ($85.4 net of tax) in the fourth quarter of 1993 for
store closing costs and other non-recurring charges. Of the total pre-tax
charge, $122.3 is for store closures. These costs include $73.7 principally for
lease buyout costs, $21.3 for the writedown of inventory to be liquidated during
the final closing of each store, and $27.3 for the writedown of fixed assets,
primarily furniture and fixtures, to net realizable value. Of the remaining
charge, $15.0 relates to costs associated with combining certain operations of
Borders and Walden, including inventory reduction costs of consolidating
redundant distribution center functions. The remaining $5.5 relates to re-
engineering programs (principally severance). The charge for restructuring and
other items when aggregated with accounting restatements referred to in the
"Restatement of Prior Years' Amounts" section above equals the charge for the
Borders-Walden Group included in the Kmart Corporation consolidated financial
statements.
ACQUISITION
On October 30, 1992, Kmart Corporation acquired Borders, Inc. in a
stock-for-stock exchange in which Kmart Corporation issued 784,938 shares of
Series B convertible preferred stock in exchange for all outstanding Borders
shares. Borders is headquartered in Ann Arbor, Michigan and at January 23, 1994
operated 44 book superstores in the Midwest and Northeast United States. The
transaction was accounted for as a purchase by Kmart Corporation and the excess
of cost over fair value of assets acquired of $171.8 was recorded as goodwill.
The results of operations of Borders, Inc. have been included in the
Borders-Walden Group financial statements from the date of acquisition.
VII-35
<PAGE> 331
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
------ ----- -----
<S> <C> <C> <C>
Current:
Federal........................................................... $ (3.0) $15.9 $12.9
State and local................................................... (1.2) 4.2 2.8
Deferred:
Store restructuring and other charges............................. (51.2) -- --
Excess of tax over (under) book depreciation...................... (1.5) (0.3) 0.5
Inventory capitalization.......................................... 15.8 (1.5) (1.6)
Other............................................................. 2.9 0.2 (0.7)
------ ----- -----
Total income taxes............................................. $(38.2) $18.5 $13.9
------ ----- -----
------ ----- -----
</TABLE>
A reconciliation of the federal statutory rate to the Borders-Walden
Group's effective tax rate follows:
<TABLE>
<CAPTION>
1993 1992 1991 1993 1992 1991
------ ----- ----- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Federal statutory rate........................... $(32.8) $14.2 $10.5 (35.0)% 34.0% 34.0%
State and local taxes, net of federal tax
benefit........................................ (8.1) 2.8 1.9 (8.6) 6.7 6.2
Goodwill amortization............................ 2.3 1.3 1.0 2.5 3.1 3.4
Other............................................ 0.4 0.2 0.5 0.4 0.6 1.8
------ ----- ----- ----- ---- ----
Total income taxes.......................... $(38.2) $18.5 $13.9 (40.7)% 44.4% 45.4%
------ ----- ----- ----- ---- ----
------ ----- ----- ----- ---- ----
</TABLE>
Deferred tax assets and liabilities resulted from the following:
<TABLE>
<CAPTION>
JANUARY 23,
1994
-----------
<S> <C>
Deferred tax assets:
Federal benefit for state deferred taxes....................................... $ 7.3
Accruals and other liabilities................................................. 26.6
Store restructuring and store closing reserves................................. 51.1
Other.......................................................................... 0.1
-----------
Total deferred tax assets................................................... 85.1
-----------
Deferred tax liabilities:
Inventory...................................................................... 21.0
Property and equipment......................................................... 17.5
Other.......................................................................... 0.1
-----------
Total deferred tax liabilities.............................................. 38.6
-----------
Net deferred tax assets..................................................... $46.5
-----------
-----------
</TABLE>
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax liabilities to
reflect enacted changes in the statutory federal income tax rate. The
Borders-Walden Group adopted FAS 109 as the cumulative effect of an accounting
change in the first quarter of fiscal 1993 resulting in a one-time charge to
income of $4.6.
VII-36
<PAGE> 332
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
COMMITMENTS AND CONTINGENCIES
There are various claims, lawsuits and pending actions against Walden Book
Company, Inc. and Borders, Inc. incident to the operations of the Borders-Walden
Group. It is the opinion of management that the ultimate resolution of these
matters will not have a material effect on the Borders-Walden Group's liquidity,
financial position or results of operations.
LONG-TERM DEBT
Long-term debt incurred directly by the Borders-Walden Group is comprised
of the following:
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
----------- -----------
<S> <C> <C>
Mortgage payable to bank due July 1995, interest at 10.38% per annum... $ 2.2 $ 2.2
Economic Development Corporation Bond, interest at 92% of bank's prime
rate per annum, variable monthly installments are payable through
November 2005........................................................ 1.1 1.2
Mortgage payable to bank due September 1996, interest at 9.5% per annum
through 1993, thereafter, interest at 0.5% over prime per annum, with
variable monthly payments from 1993 through 1996..................... 0.8 0.9
Mortgage payable to bank (subordinated to Economic Development
Corporation Bond) due August 1994, interest at 9.75% per annum....... 1.0 1.0
Mortgage payable to bank due 2009, interest at 9.92 % per annum........ 4.4 4.5
----- -----
Total........................................................ 9.5 9.8
Portion due within one year............................................ 5.2 0.2
----- -----
Long-term debt......................................................... $ 4.3 $ 9.6
----- -----
----- -----
</TABLE>
Principal payments due on long-term debt for the five years subsequent to
1993 are: 1994 -- $5.2; 1995 -- $0.1; 1996 -- $0.1; 1997 -- $0.1; 1998 -- $0.1;
1999 and thereafter $3.9. In fiscal 1994, certain of the underlying properties
securing the above debt are expected to be sold. Accordingly, the related debt
has been classified in current liabilities.
LEASES
Description of Leasing Arrangements: The Borders-Walden Group conducts
operations primarily in leased facilities. Store leases are generally for terms
of 10 to 15 years. Borders leases generally contain multiple five-year renewal
options which allow Borders the option to extend the life of the leases up to 20
years beyond the initial noncancellable term. Walden's leases do not contain
renewal options.
Certain leases provide for additional rental payments based on a percent of
sales in excess of a specified base. Also, certain leases provide for the
payment by the lessee of executory costs (taxes, maintenance and insurance).
VII-37
<PAGE> 333
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Lease Commitments: Future minimum lease payments at January 23, 1994 were
as follows:
<TABLE>
<CAPTION>
MINIMUM
LEASE
PAYMENTS
---------
<S> <C>
Fiscal Year:
1994............................................................................ $ 110.6
1995............................................................................ 102.6
1996............................................................................ 93.6
1997............................................................................ 81.6
1998............................................................................ 71.6
Later years..................................................................... 317.7
---------
Minimum lease payments............................................................ $ 777.7
---------
---------
</TABLE>
Rental Expense: A summary of operating lease rental expense and short-term
rentals follows:
<TABLE>
<CAPTION>
1993 1992 1991
------ ------ -----
<S> <C> <C> <C>
Minimum rentals...................................................... $107.9 $ 93.4 $86.6
Percentage rentals................................................... 7.2 8.4 9.0
Less -- sublease rentals............................................. (0.1) (0.2) (0.2)
------ ------ -----
Total...................................................... $115.0 $101.6 $95.4
------ ------ -----
------ ------ -----
</TABLE>
PENSION PLANS
The Borders-Walden Group participates in Kmart Corporation's
non-contributory pension plans which cover most domestic employees who meet
certain requirements of age, length of service and hours worked per year.
Benefits paid to retirees are based upon age at retirement, years of credited
service and earnings. Kmart Corporation's policy is to fund at least the minimum
amounts required by the Employee Retirement Income Security Act of 1974. The
plans' assets consist primarily of equity securities, fixed income securities,
guaranteed insurance contracts and real estate. The portion of pension expense
and plan assets and obligations attributable to the Borders-Walden Group are
actuarially determined based on the attributes of the Borders-Walden Group's
plan participants, a method which management believes to be reasonable.
VII-38
<PAGE> 334
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The following table presents the Borders-Walden Group's funded status based
on a proportionate share of plan assets, as described above, and amounts
recognized in the accompanying balance sheet at year end:
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
----------- -----------
<S> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits........................... $ (16.2) $ (9.2)
Estimated present value of non-vested benefits....................... (3.0) (2.4)
----------- -----------
Accumulated benefit obligation....................................... (19.2) (11.6)
Value of future pay increases........................................ (4.5) (5.7)
----------- -----------
Projected benefit obligation......................................... (23.7) (17.3)
Estimated market value of plan assets.................................. 18.3 16.2
----------- -----------
Plan assets under projected benefit obligation......................... (5.4) (1.1)
Unrecognized net asset................................................. (1.2) (1.3)
Unrecognized prior service cost........................................ 0.7 0.6
Unrecognized net loss and other........................................ 3.2 0.4
----------- -----------
Accrued pension costs.................................................. $ (2.7) $ (1.4)
----------- -----------
----------- -----------
</TABLE>
The following table summarizes allocated pension costs and actuarial
assumptions:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Components of pension expense:
Normal service cost................................................ $ 1.8 $ 1.4 $ 1.0
Interest cost in projected benefit obligation...................... 1.6 1.3 0.8
Return on plan assets.............................................. (1.7) (1.2) (1.3)
Net amortization and deferral of other components.................. 0.3 (0.1) 0.6
----- ----- -----
Total................................................................ $ 2.0 $ 1.4 $ 1.1
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates..................................................... 7.25% 8.50% 8.75%
Expected return on plan assets..................................... 9.50% 9.50% 9.50%
Salary increases................................................... 4.50% 5.00% 5.00%
</TABLE>
OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS
The Borders-Walden Group adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other than Pensions" (FAS
106) at the beginning of fiscal 1993. FAS 106 requires the Borders-Walden Group
to accrue for future postretirement medical benefits. In prior years, these
claims were expensed when paid. Net of applicable tax, a charge of $1.0 was
included in net income as the effect of an accounting change in the first
quarter of 1993.
In addition to Kmart Corporation's defined benefit pension plan, Kmart
Corporation sponsors a defined benefit health care plan that offers
postretirement medical benefits to full-time employees who have worked 10 years
and who have retired after age 55, with the option of participation in Kmart
Corporation's medical plan, until age 65. The plan is contributory, with retiree
contributions adjusted annually. The accounting for the plan anticipates future
cost-sharing changes to the written plan that are consistent with Kmart
Corporation's expressed intent to increase the retiree contribution rate
annually for the expected general inflation rate for that year. The portion of
postretirement benefit costs attributable to the Borders-Walden Group are
actuarially determined based on the attributes of the Borders-Walden Group's
plan participants, a method which
VII-39
<PAGE> 335
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
management believes to be reasonable. In 1993, Kmart Corporation amended its
plan to limit retiree benefits to 150% of average per capita benefits.
The following table sets forth the plan's funded status reconciled with
amounts shown in the balance sheet.
<TABLE>
<CAPTION>
JANUARY 23,
1994
-----------
<S> <C>
Accumulated postretirement benefit obligation:
Retirees......................................................................... $ --
Fully eligible active plan participants.......................................... (0.1)
Other active plan participants................................................... (0.9)
-----------
(1.0)
Plan assets at fair value........................................................ --
-----------
Accumulated postretirement benefit obligation in excess of plan assets........... (1.0)
Unrecognized prior service cost.................................................. (0.5)
Unrecognized net loss............................................................ 0.1
-----------
Accrued postretirement benefit cost.............................................. $(1.4)
-----------
-----------
<CAPTION>
1993
-----------
<S> <C>
Net periodic postretirement benefit cost includes the following components:
Service cost..................................................................... $ 0.1
Interest costs................................................................... 0.1
Actual return on plan assets..................................................... --
Net amortization and deferral.................................................... (0.1)
-----------
Net periodic postretirement benefit cost....................................... $ 0.1
-----------
-----------
</TABLE>
The weighted-average annual assumed rate of increase in the per capita cost
of covered benefits (i.e., health care cost trend rate) is 11.3% in 1994. This
rate is assumed to decrease gradually to 5.25% by 2002 and remain at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amounts reported. For example, increasing the assumed health care cost
trend rates by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of January 23, 1994, by 0.2%, and the
aggregate of the service and interest cost components of net periodic
postretirement benefit cost for fiscal 1993 by 2.28%.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation at January 23, 1994 was 7.25%.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106 for similar benefits provided to
terminated or laid-off employees such as salary extension, severance, disability
and supplemental unemployment benefits. The effect of this statement on the
Borders-Walden Group was not significant.
EMPLOYEE SAVINGS PLAN
Employees of the Borders-Walden Group who meet certain requirements as to
age and service are eligible to participate in Kmart Corporation's Employee
Savings Plan. Employees of Borders, Inc. who meet certain requirements as to age
and service are eligible to participate in the Borders, Inc. Employee Retirement
and Profit Sharing Plan. The Borders-Walden Group's expense related to these
aforementioned plans was $2.2, $1.5 and $1.3 for 1993, 1992 and 1991,
respectively.
VII-40
<PAGE> 336
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
PERFORMANCE RESTRICTED STOCK PLAN
Certain officers and employees of the Borders-Walden Group participate in
Kmart Corporation's Performance Restricted Stock Plan and Stock Option Plan.
These plans are discussed in the respective footnotes to Kmart Corporation
consolidated financial statements. The Borders-Walden Group allocation of
compensation expense related to the Performance Restricted Stock Plan was not
material.
EMPLOYEE STOCK OPTION PLANS
Upon the effective date of the purchase by Kmart, Borders, Inc. had two
separate stock option plans, the 1989 plan and 1992 plan. At this date the 1989
plan had 315,645 options outstanding with an exercise price of $0.583 per share
and the 1992 plan had 542,854 options outstanding with exercise prices ranging
between $12.00 and $15.71 per share. The rights under these plans were preserved
having the same exercise price and vesting period as the original plans. It is
the Borders-Walden Group's intention to convert these effective stock options
into stock options relating to the Borders-Walden Group upon the initial
offering of Borders-Walden Stock.
SERIES B OPTIONS
Under the terms of the purchase agreement for the acquisition of Borders,
11,889 options in Kmart Series B convertible preferred stock were granted at an
exercise price of $7.42 per share. Each share of Series B preferred stock is
convertible by the holders at any time into 6.49 shares of Kmart common stock
and had a fair market value at the date of grant of $200.00 per share. A reserve
of $2.2 was established for the difference between the exercise price and the
fair value at the time of the purchase.
EMPLOYEE CASH BONUS PROGRAM
In conjunction with the Kmart Corporation purchase, Borders, Inc. adopted a
Cash Bonus Program that covered all active employees. A reserve of $4.5 was
established for purposes of the program at the time of purchase. Employee
accounts are credited on the last day of each calendar quarter with an amount
equivalent to interest computed at the rate of 5 3/4% per annum. Amounts
credited to employee accounts vest 25% on October 30 for each of the next three
years, and employees still in the employ of the Borders-Walden Group, Kmart
Corporation, or any of Kmart's subsidiaries are entitled to a distribution of
vested amounts and interest at each October 30. Upon termination of employment
with the Borders-Walden Group, Kmart Corporation, or any of Kmart's
subsidiaries, any unvested amounts remaining in the employee's account shall be
forfeited.
BORDERS-WALDEN GROUP EQUITY
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, FEBRUARY 1,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year................................. $ 521.1 $ 388.1 $ 483.1
Net income (loss)............................................ (61.2) 23.1 16.7
Net equity transactions with the Kmart Group:
Cash management, excluding items shown below............... (18.4) (63.1) (124.5)
Corporate, general and administrative expense allocation... 0.1 0.1 0.1
Participation in centrally managed employee benefit and
self-insurance programs................................. 15.9 13.6 12.7
Acquisition of Borders..................................... -- 159.3 --
----------- ----------- -----------
Balance at end of year....................................... $ 457.5 $ 521.1 $ 388.1
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
VII-41
<PAGE> 337
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions, between the Specialty Retail Groups and the
Kmart Group had been accounted for as short-term loans, on a pro forma basis the
Borders-Walden Group would have been charged inter-Group interest of $2.6 during
1993. Such pro forma interest expense has been calculated on daily average
borrowings outstanding using Kmart Corporation's weighted average short-term
borrowing rate. Such pro forma interest expense is not necessarily indicative of
the results which would occur had such offerings occurred on such date, or what
the interest expense would be prospectively.
VII-42
<PAGE> 338
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THIRTY NINE WEEKS ENDED OCTOBER 24, 1993 -- CONTINUED
Sales for the period ended October 24, 1993 were $875.2 million, a $139.2
million, or 18.9% increase, over sales of $736.0 million in the same period in
the prior year. The 1993 sales increase was primarily due to the inclusion of a
full 39 weeks sales for the Borders stores as a result of the acquisition on
October 30, 1992 versus no sales in the prior year. Comparable Walden store
sales increased 1.0% in 1993 versus a 2.3% increase for the same period last
year. The slower rate of Walden comparable store sales growth was a result of
increased competition from superstores in several markets and sluggish mall
traffic.
Cost of merchandise sold, including buying and occupancy costs, for the
period ended October 24, 1993 was $671.3 million as compared to $573.5 million
in the same period in the prior year. Gross margin as a percent of sales was
23.3% and 22.1% in the 1993 period and 1992 period, respectively. The increase
in the 1993 period, as a percent of sales, was primarily due to the inclusion of
Borders for the period. Borders' superstores have slightly higher margins and
lower occupancy costs as a percent of sales than Walden's mall bookstores.
Selling, general and administrative expense for the period ended October
24, 1993 was $213.2 million or 24.4% of sales, as compared to $172.4 million, or
23.4% of sales, in the same period in the prior year. The increase as a percent
of sales resulted primarily from the inclusion of Borders in 1993, which has
higher store operating costs including store payroll and advertising, and to
higher Walden Store salary expense, partially offset by a slight reduction in
Walden administrative salaries and expense.
Operating loss before pre-opening expenses and goodwill amortization
improved for the period ended October 24, 1993 to $9.3 million from $9.9 million
for the same period in 1992 primarily as a result of higher sales and improved
gross margins.
Pre-opening expense for the period ended October 24, 1993 was $1.5 million
as compared to $0.3 million in the same period in the prior year with the
increase attributable primarily to the superstore openings in 1993. Pre-opening
expenses consist principally of grand-opening advertising expense, store payroll
and supply expense. Pre-opening costs are expensed in the first full month of
operations following opening.
Goodwill amortization for the period ended October 24, 1993 was $5.4
million, as compared to $2.2 million for the same period in the prior year with
the increase attributable to goodwill resulting from the Borders acquisition.
As a result of the foregoing, operating loss for the period ended October
24, 1993 was $(16.2) million, or (1.9)% of sales, as compared to $(12.4)
million, or (1.7)% of sales, in the same period in the prior year.
Net interest expense for the period ended October 24, 1993 was $0.8 million
as compared to $0.4 million for the same period in the prior year. The increase
in interest expense was attributable to Borders.
Loss before income taxes and the effect of accounting changes for the
period ended October 24, 1993 was $(17.0) million, or (2.0)% of sales, as
compared to $(12.8) million, or (1.7)% of sales, in the same period last year.
Income tax benefit for the period ended October 24, 1993 was $6.8 million
with an effective tax rate of 40.0% as compared to $5.6 million with an
effective tax rate of 43.8% in the same period of 1992.
Net loss before the effect of accounting changes for the period ended
October 24, 1993 was $(10.2) million, or (1.2)% of sales, as compared to $(7.2)
million, or (1.0)% of sales, in the same period last year.
Effect of accounting changes, net of income tax, Borders-Walden adopted
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS 109) at
the beginning of fiscal 1993. FAS 109 requires that deferred taxes be calculated
using the liability approach rather than the deferred method. As a result of the
VII-43
<PAGE> 339
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THIRTY NINE WEEKS ENDED OCTOBER 24, 1993 -- CONTINUED
adjustment of deferred tax balances to the current enacted tax rate,
Borders-Walden has recorded a charge of $4.6 million as the cumulative effect of
an accounting change.
Borders-Walden also adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. This statement requires that
Borders-Walden accrue for future postretirement medical benefits. In prior
years, these claims were expensed when paid. Net of applicable tax, a charge of
$0.9 million has been included in net income as the effect of an accounting
change.
As the result of the foregoing factors, net loss for the period ended
October 24, 1993 was $(15.7) million, or (1.8)% of sales, as compared to $(7.2)
million, or (1.0)% of sales, in the same period in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the period ended October
24, 1993 are summarized below. The net decrease in cash and equivalents for the
period ended October 24, 1993 was $(1.4) million as compared to a $6.2 million
increase in cash and equivalents in the same period in the prior year.
Net cash used for operations for the period ended October 24, 1993 was
$100.9 million as compared to $33.4 million in the same period of 1992. The
change resulted primarily from a lower rate of increase in accounts payable in
the 1993 period than in the prior year and a change in the timing of accrued
liabilities.
Net cash used for investing for the period ended October 24, 1993 was $49.8
million as compared to $16.0 million in the same period last year and was
comprised of capital expenditures. The increase of $33.8 million was due
primarily to the Borders superstore openings.
Net cash provided by financing of $149.3 million and $55.6 million in 1993
and 1992, respectively, were comprised almost entirely of equity contributions
by the Kmart Group to fund Borders-Walden's capital requirements primarily for
new store growth.
Due to the Walden restructuring strategy announced in January 1994 and the
Borders store expansion program, Borders-Walden is expected to require capital
in excess of the funds generated from operations. Such excess is expected to be
funded by the Kmart Group. Borders-Walden also could obtain funds from external
debt financing and, following implementation of the Specialty Retail Stock
Proposal, from the sale of shares of Borders-Walden Stock with the proceeds
attributable to Borders-Walden. Borders-Walden believes that funds generated
from operations, together with the sources of capital described above, will be
sufficient to provide the liquidity and capital resources necessary to fund its
anticipated capital requirements for at least the next two to three years.
VII-44
<PAGE> 340
ANNEX VIII
BUILDERS SQUARE GROUP
<TABLE>
<CAPTION>
<S> <C>
Selected Financial Data.......................................................... VIII- 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... VIII- 3
Business Description............................................................. VIII-11
Combined Financial Statements.................................................... VIII-22
</TABLE>
VIII-1
<PAGE> 341
BUILDERS SQUARE GROUP
SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated reflect the
results of operations and financial position of the businesses that comprise the
Builders Square Group. The information set forth below should be read in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations and the combined financial statements and notes thereto
included in this Annex VIII. The issuance of Builders Square Stock pursuant to
the Specialty Retail Stock Proposal has not been reflected in these financial
statements.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------------------
JAN. 23, JAN. 24, JAN. 26, JAN. 27, JAN. 28,
1994 1993 1992 1991 1990
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (MILLIONS)
Sales................................................................ $2,718.8 $2,419.5 $2,048.5 $1,906.5 $1,813.1
Gross margin......................................................... 618.3 564.5 488.1 457.6 412.2
Selling, general and administrative expenses......................... 537.2 468.9 389.9 395.5 375.4
Pre-opening expense.................................................. 19.4 13.2 6.9 5.1 5.5
Goodwill amortization................................................ 0.9 0.9 0.9 0.9 0.9
Store restructuring and other charges................................ 226.5 1.5 16.6 -- 20.6
-------- -------- -------- -------- --------
Operating income (loss).............................................. (165.7) 80.0 73.8 56.1 9.8
Interest expense -- net.............................................. 8.7 3.5 2.7 2.9 4.3
-------- -------- -------- -------- --------
Income (loss) before income taxes and effect of accounting changes... (174.4) 76.5 71.1 53.2 5.5
Income taxes......................................................... (65.8) 21.6 24.1 18.2 4.5
-------- -------- -------- -------- --------
Net income (loss) before the effect of accounting changes............ (108.6) 54.9 47.0 35.0 1.0
Effect of accounting changes, net of income taxes.................... (1.6) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss).................................................... $ (107.0) $ 54.9 $ 47.0 $ 35.0 $ 1.0
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Add back of goodwill amortization.................................... 0.9 0.9 0.9 0.9 0.9
-------- -------- -------- -------- --------
Kmart Corporation earnings (losses) attributable to Builders Square
Group.............................................................. $ (106.1) $ 55.8 $ 47.9 $ 35.9 $ 1.9
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
PERCENT OF SALES DATA
Gross margin......................................................... 22.7% 23.3% 23.8% 24.0% 22.7%
Selling, general and administrative expenses......................... 19.8 19.4 19.0 20.7 20.7
Operating income (loss).............................................. (6.1) 3.3 3.6 2.9 0.5
Income (loss) before income taxes and effect of accounting changes... (6.4) 3.2 3.5 2.8 0.3
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital...................................................... $ 481.5 $ 339.4 $ 310.6 $ 322.7 $ 274.6
Total assets......................................................... 1,130.1 876.8 679.8 655.8 619.4
Total debt........................................................... 16.7 13.5 -- -- --
Builders Square Group equity......................................... 531.9 493.9 446.9 463.6 401.9
SELECTED FINANCIAL AND OPERATING DATA
Operating income (loss) before pre-opening expense, goodwill
amortization and store restructuring and other charges
(millions)......................................................... $ 81.1 $ 95.6 $ 98.2 $ 62.1 $ 36.8
End of year stores(1):
Builders Square II................................................. 47 8 -- -- --
Builders Square I.................................................. 130 157 144 144 141
-------- -------- -------- -------- --------
Total.......................................................... 177 165 144 144 141
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Comparable store sales increase(2)................................... 0.9% 8.5% 7.0% 3.6% 0.5%
Weighted average sales per square foot(3)............................ $ 201 $ 210 $ 197 $ 185 $ 181
Weighted average sales per store (millions)(4)....................... 15.4 15.7 14.5 13.5 13.1
Average sale per transaction......................................... 31.61 30.45 28.80 28.04 28.43
Capital expenditures -- owned property (millions).................... 77.7 57.2 44.8 21.3 17.4
Depreciation and amortization (millions)............................. 35.3 29.6 27.5 26.8 22.4
</TABLE>
- -------------------------
(1) In fiscal year 1993, Builders Square determined that it would open all new
stores in its Builders Square II format (BSQ II) and convert virtually all
of its existing stores to the BSQ II format by fiscal 1997.
(2) Comparable store sales include the sales of a store beginning in its
fourteenth full month of operations.
(3) Sales for the period divided by the effective weighted average number of
selling square feet in stores operated during the period.
(4) Sales for the period divided by the effective weighted average number of
stores operated during the period.
VIII-2
<PAGE> 342
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
At January 23, 1994, the Builders Square Group ("Builders Square") operated
177 home improvement stores in 26 states and Puerto Rico, of which 130 were
Builders Square I Stores ("BSQ I Stores") and 47 were Builders Square II Stores
("BSQ II Stores"). The business strategy of Builders Square is to phase out its
self-service warehouse-style home improvement stores and operate large format
superstores that emphasize customer service and provide an extensive selection
of quality products and services to repair, remodel, redecorate and maintain
both home and garden. Builders Square's goal is to have virtually all stores in
the BSQ II Store format by the end of fiscal 1997.
The BSQ II Store format, which provides full customer service and
emphasizes home decor products and services and lawn and garden products and
services, has produced higher average sales per transaction than the BSQ I
Stores format. In addition, BSQ II Stores have experienced higher average gross
margins and increased gross profit dollars since home decor and outdoor lawn and
garden products generally sell at higher margins than home repair products and
building materials. BSQ II Stores generally have higher operating expenses as a
result of higher payroll and inventory expenses associated with their increased
square footage and related occupancy costs, increased service levels and more
extensive product mix.
On January 5, 1994, the Board of Directors ("Board") approved a
restructuring plan to convert virtually all of the existing Builders Square
stores to the new Builders Square II format by 1997. The Builders Square II
stores have an easier-to-shop layout that utilizes a "store-within-a-store"
format with substantially increased customer service levels. In connection with
the restructuring plan, Builders Square is closing selected Builders Square I
stores, converting the balance of existing Builders Square I stores to the
Builders Square II format and filling in existing and continguous markets with
Builders Square II stores. During the next four years, Builders Square currently
expects to phase out 117 Builders Square I stores by closing 8 stores,
relocating 66 stores and renovating 43 stores. In addition, Builders Square
plans to open approximately 10-20 new Builders Square II stores during each of
the next two years.
As a result of the restructuring plan, Builders Square recorded a pre-tax
charge of $226.5 million ($141.3 million, net of tax) in the fourth quarter of
1993 for the estimated cost of closing, relocating or converting all Builders
Square I stores to the Builders Square II format. Of the total pre-tax charge,
$214.5 million is for specifically-identified store relocations and renovations.
These costs include $144.2 million for lease obligations, a $37.1 million for
the writedown of inventory to be liquidated during the final closing of each
store and $33.2 million for the writedown of fixed assets, primarily furniture
and fixtures, to net realizable value. Such charge does not include any
provision for store occupancy, depreciation expense or normal inventory
markdowns prior to the closing or completion date of a project. The remainder of
the charge relates to a $12.0 million accrual for a non-routine legal judgment
resulting from the insolvency of the insurer.
The focus of Builders Square's expansion strategy is to increase market
share in existing markets by clustering its BSQ II Stores. This clustering
strategy enables Builders Square to leverage management personnel, advertising
costs and distribution expenses, thereby achieving greater economies of scale
and improving margins as well as enhancing customer awareness. Although Builders
Square's strategy of locating multiple stores within a market can result in some
cannibalization, management believes that achieving greater market penetration
will allow it to grow successfully and compete more effectively over the long
term.
Builders Square's 1993, 1992 and 1991 fiscal years each consisted of 52
weeks and ended on January 23, 1994, January 24, 1993 and January 26, 1992,
respectively. References herein to years are to Builders Square's fiscal years
which end on the Sunday preceding the last Wednesday in January of the following
calendar year.
VIII-3
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BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
RESULTS OF OPERATIONS
The following table presents Builders Square's income statement data, as a
percent of sales, for the three most recent fiscal years.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
---------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales......................................................... 100.0% 100.0% 100.0%
Cost of merchandise sold (includes buying and occupancy
costs)...................................................... 77.3 76.7 76.2
----------- ----------- -----------
Gross margin.................................................. 22.7 23.3 23.8
Selling, general and administrative expenses.................. 19.8 19.4 19.0
Pre-opening expense........................................... 0.7 0.6 0.3
Goodwill amortization......................................... -- -- 0.1
Store restructuring and other charges......................... 8.3 -- 0.8
----------- ----------- -----------
Operating income (loss)....................................... (6.1) 3.3 3.6
Net interest expense.......................................... 0.3 0.1 0.1
----------- ----------- -----------
Income (loss) before taxes and effect of accounting changes... (6.4) 3.2 3.5
Income taxes.................................................. (2.4) 0.9 1.2
----------- ----------- -----------
Net income (loss) before effect of accounting changes......... (4.0) 2.3 2.3
Effect of accounting changes, net of income taxes............. (0.1) -- --
----------- ----------- -----------
Net income (loss)............................................. (3.9)% 2.3% 2.3%
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Store Activity. Builders Square's store activity is summarized below:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Beginning number of stores.................................................. 165 144 144
Openings.................................................................... 28 22 14
Closings.................................................................... (16) (1) (14)
---- ---- ----
Ending number of stores..................................................... 177 165 144
---- ---- ----
---- ---- ----
</TABLE>
Builders Square BSQ I and BSQ II store activity for fiscal 1993 is
summarized below:
<TABLE>
<CAPTION>
BSQ I BSQ II TOTAL
----- ------ -----
<S> <C> <C> <C>
Beginning number of stores............................................... 157 8 165
Openings, including relocations.......................................... -- 28 28
Conversions.............................................................. (11) 11 --
Closings, including relocations.......................................... (16) -- (16)
----- ----- -----
Ending number of stores.................................................. 130 47 177
----- ----- -----
----- ----- -----
</TABLE>
Fiscal Years Ended January 23, 1994 (fiscal 1993) and January 24, 1993 (fiscal
1992)
Sales in 1993 were $2,718.8 million, a $299.3 million, or 12.4%, increase
over sales of $2,419.5 million in 1992. The 1993 sales increase was due to the
28 stores opened, all of which were BSQ II Stores, in 1993 and the inclusion of
a full year sales for the 22 stores opened in 1992. Comparable store sales
increased 0.9% in 1993 versus an 8.5% increase in 1992. The slower rate of
comparable store sales growth in 1993 was a result of increased competition in
the Northeast and Midwest, severe winter weather conditions that continued into
the spring selling season and the strong comparable store sales growth reported
in the Southeast region in 1992 period as the result of rebuilding in the
aftermath of Hurricane Andrew.
VIII-4
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BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Cost of merchandise sold, including buying and occupancy costs, in 1993 was
$2,100.5 million as compared to $1,855.0 million in the prior year. Gross margin
as a percent of sales was 22.7% in 1993 as compared to 23.3% in 1992. The 1993
decrease in gross margin percent was primarily due to increased occupancy costs
as a result of more BSQ II Stores, partially offset by improved merchandise
margins in 1993 resulting from the sale of a greater proportion of higher margin
products in the BSQ II Stores. Gross margin as a percent of sales on a first-in,
first-out (FIFO) basis was 23.1% and 23.7% in 1993 and 1992, respectively.
Selling, general and administrative ("SG&A") expenses in 1993 were $537.2
million or 19.8% of sales, as compared to $468.9 million, or 19.4% of sales, in
the prior year. The increase as a percent of sales resulted primarily from
increased store payroll expense associated with improving the level of customer
service in the stores, partially offset by the leveraging of administrative
salaries and expense over higher sales volume.
Pre-opening expense in 1993 was $19.4 million as compared to $13.2 million
in the prior year. Pre-opening expenses consist principally of grand-opening
advertising expense, store payroll and supply expense. Pre-opening costs are
expensed at the time of a store's grand opening. The increase was due to 28
store openings in 1993 as compared to 22 openings in 1992 and to the higher
pre-opening costs associated with the BSQ II Stores.
Goodwill amortization was $0.9 million in 1993 and 1992.
Store restructuring and other charges in 1993 was $226.5 million, or 8.3%
of sales. See discussion in General above.
As a result of the foregoing, operating income (loss) in 1993 was $(165.7)
million, or (6.1)% of sales, as compared to $80.0 million, or 3.3% of sales in
the prior year. Operating income before pre-opening expense, goodwill
amortization and store restructuring and other charges in 1993 was $81.1
million, or 3.0% of sales, as compared with $95.6 million, or 4.0% of sales, in
1992. The decrease of 1.0% was the result of lower gross margins and higher SG&A
costs.
Net interest expense in 1993 was $8.7 million, or 0.3% of sales, as
compared to $3.5 million, or 0.1% of sales, in the prior year. The increase in
interest expense was due to the mortgage of the home office in the fourth
quarter of 1992, increased capital lease interest as a result of store openings,
and the lower interest income resulting from the inclusion of interest income on
a one-time Internal Revenue Service (IRS) settlement in the 1992 period.
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions, between the Specialty Retail Groups and the
Kmart Group had been accounted for as short-term loans, on a pro forma basis
Builders Square would have been charged inter-Group interest of $2.5 million
during 1993. Such pro forma interest expense has been calculated on daily
average borrowings outstanding using Kmart Corporation's weighted average
short-term borrowing rate. Such pro forma interest expense is not necessarily
indicative of the results which would occur had such offerings occurred on such
date, or what the interest expense would be prospectively.
Income (loss) before income taxes and the effect of accounting changes in
1993 was $(174.4) million, or (6.4)% of sales, as compared to $76.5 million, or
3.2% of sales, in 1992. Excluding the store restructuring and other charges,
1993 income before income taxes and effect of accounting changes was $52.1
million or 1.9% of sales.
VIII-5
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BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Income tax expense (benefit) in 1993 was $(65.8) million with an effective
tax rate of (37.7)% as compared to $21.6 million with an effective tax rate of
28.2% in 1992. The increase in the effective tax rate in the 1993 period
reflected the 1.0% increase in the federal corporate tax rate retroactive to
January 1, 1993 and a lower effective tax rate in 1992 as the result of the
reversal of a tax accrual upon completion of an IRS audit cycle.
Net income (loss) before the effect of accounting changes in 1993 was
$(108.6) million, or (4.0)% of sales, as compared to $54.9 million, or 2.3% of
sales, in the prior year. Excluding the store restructuring and other charges,
1993 net income before the effect of accounting changes was $32.7 million or
1.2% of sales.
Effect of accounting changes, net of income taxes. Builders Square adopted
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS 109) in
the first quarter of 1993. FAS 109 requires that deferred taxes be calculated
using the liability approach rather than the deferred method. A credit of $2.9
million has been included in net income as the effect of an accounting change.
Builders Square also adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. This statement requires that Builders
Square accrue for future postretirement medical benefits. In prior years, these
claims were expensed when paid. Net of applicable tax, a charge of $1.3 million
has been included in net income as the effect of an accounting change.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106, requiring that benefits
provided to terminated or laid-off employees be recorded on an accrual basis
rather than a cash basis. The statement was effective for fiscal years beginning
after December 15, 1993. The effect of this statement on Builders Square was not
significant.
As the result of the foregoing factors, net income (loss) in 1993 was
$(107.0) million, or (3.9)% of sales, as compared to $54.9 million, or 2.3% of
sales, in the prior year. Excluding the store restructuring and other charges,
1993 net income was $34.3 million, or 1.3% of sales.
Fiscal Years Ended January 24, 1993 (fiscal 1992) and January 26, 1992 (fiscal
1991)
Sales in 1992 were $2,419.5 million, a $371.0 million, or 18.1%, increase
over sales of $2,048.5 million in 1991. The 1992 sales increase was due to the
opening of 22 new stores during the year, including eight BSQ II Stores, and to
an 8.5% comparable store sales increase which resulted from strong sales in the
Southeast in the aftermath of Hurricane Andrew, an improved merchandise mix and
in-stock position, a continuing shift to an everyday fair price position and to
higher average sales per transaction.
Cost of merchandise sold, including buying and occupancy costs in 1992 was
$1,855.0 million as compared to $1,560.4 million in 1991. Gross margin as a
percent of sales was 23.3% and 23.8% in 1992 and 1991, respectively. The
decrease in gross margin was primarily due to a last-in, first-out (LIFO) charge
of $10.0 million in 1992, as compared to a LIFO credit of $1.5 million in 1991.
Gross margin as a percent of sales on a first-in, first-out (FIFO) basis was
relatively stable at 23.7% and 23.8% in 1992 and 1991, respectively. Builders
Square uses the LIFO method of inventory valuation using an internal price index
to measure inflation. The higher LIFO charge in 1992 resulted primarily from an
increase in lumber prices and, to a lesser extent, from lower gross margin in
electrical and paint products as a result of Builders Square's everyday fair
pricing policy.
Selling, general and administrative expenses in 1992 were $468.9 million,
or 19.4% of sales, as compared to $389.9 million, or 19.0% of sales, in 1991.
SG&A included a one-time credit of 0.8% of sales, in 1991 as a result of a
reduction in property taxes. Excluding the effect of this reduction, SG&A
decreased 0.4% of sales in
VIII-6
<PAGE> 346
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
1992 due primarily to lower store opening and advertising expenses relative to
sales as a result of the 8.5% comparable store sales increase.
Pre-opening expense in 1992 was $13.2 million, or 0.6% of sales, as
compared to $6.9 million, or 0.3% of sales, in the prior year. Pre-opening
expenses consist principally of grand-opening advertising expense, store payroll
and supply expenses. The 1992 increase resulted from the opening of 22 new
stores in 1992 as compared to 14 new stores in the prior year and to increased
grand-opening advertising.
Goodwill amortization was $0.9 million in 1992 and 1991.
Store restructuring and other charges in 1992 was $1.5 million, as compared
to $16.6 million in 1991. The decrease was due to one closed store in 1992
compared to 14 closings in 1991.
As a result of the foregoing factors, operating income was $80.0 million in
1992, or 3.3% of sales, as compared to $73.8 million, or 3.6% of sales, in 1991.
Operating income before pre-opening expense, goodwill amortization and store
restructuring and other charges in 1992 was $95.6 million, or 4.0% of sales, as
compared with $98.2 million, or 4.8% of sales, in the prior year. The decrease
of 0.8% of sales in 1992 was the result of increased sales which was offset by
lower gross margins and higher SG&A costs.
Net interest expense in 1992 was $3.5 million, or 0.1% of sales, as
compared to $2.7 million, or 0.1% of sales, in 1991. The 1992 increase resulted
from interest expense on the new headquarters mortgage and interest expense
related to additional stores under capital lease, partially offset by interest
income related to a one-time IRS settlement.
Income taxes in 1992 was $21.6 million, or 0.9% of sales, as compared to
$24.1 million, or 1.2% of sales in 1991. The effective income tax rate was 28.2%
and 33.9% in 1992 and 1991, respectively. The lower effective income tax rate in
1992 was the result of the reversal of a tax accrual upon completion of an IRS
audit cycle.
As the result of the foregoing factors, net income in 1992 was $54.9
million, or 2.3% of sales, as compared to $47.0 million, or 2.3% of sales, in
1991.
LIQUIDITY AND CAPITAL RESOURCES
Builders Square's principal capital requirements are to fund working
capital needs, the opening of new stores and the refurbishment of existing
stores. During the periods presented, these capital requirements have generally
been satisfied by cash flows from operations or equity contributions from Kmart
Corporation.
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the 52 weeks ended January
23, 1994, January 24, 1993 and January 26, 1992 are summarized below. The net
increases (decreases) in cash and equivalents were $(16.5) million, $12.0
million and $5.5 million in 1993, 1992 and 1991, respectively.
Net cash provided by (used for) operations was $(92.7) million in 1993, as
compared to $67.8 million in 1992 and $110.4 million in 1991. The 1993 change
resulted primarily from a greater rate of increase in inventory net of accounts
payable in 1993 as a result of a shift in the merchandise mix and increased
carryover of seasonal merchandise. Inventory turnover was 3.1, 3.3 and 3.1 in
1993, 1992 and 1991, respectively. The decrease in net cash provided by
operations in 1992 was a result of an increase in inventory net of accounts
payable and a decrease in other long-term liabilities, partially offset by
higher net income before non-cash depreciation and amortization expenses.
Depreciation and amortization expense resulted primarily from goodwill,
leasehold improvements and store fixtures.
VIII-7
<PAGE> 347
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Builders Square anticipates that after-tax cash flows related to "Store
Restructuring and Other Charges" will approximate $20.0 million, $33.0 million
and $20.0 million in 1994, 1995 and 1996, respectively, and will result from the
payment of leases.
Net cash used for investing consists primarily of capital expenditures
relating to new store openings and the renovation of existing stores. Capital
expenditures totaled $77.7 million, $57.2 million and $44.8 million in 1993,
1992 and 1991, respectively. Capital expenditures increased in 1993 due to 6
more store openings, the conversion of existing stores to the BSQ II format and
expansion of data processing capacity. The increase in capital expenditures in
1992 resulted primarily from the opening of 22 new stores, as compared to 14
openings in 1991, and the refurbishment of existing stores. Over the next four
years, Builders Square is expected to phase out approximately 117 BSQ I stores
by closing 8 stores, relocating 66 stores and renovating 43 stores.
On an operating lease basis, the cost of opening a new BSQ II Store
consists primarily of the investment in inventory, the cost of furniture,
fixtures and equipment and pre-opening expenses, such as the costs associated
with training employees. The cost of converting or relocating an existing store
consists primarily of the cost of additional inventory, plus in the case of
converting, the cost of improvements or, in the case of relocation, furniture,
fixtures, equipment, moving and lease termination costs. Inventory for a new
store is estimated to cost approximately $3.5 million, with average vendor
payables equal to approximately 45% of the initial inventory, for a net
investment of approximately $1.9 million. Additional inventory for a converted
or relocated store is estimated to cost approximately $750,000, with average
vendor payables equal to approximately 45% of such inventory, for a net
additional investment of approximately $412,500. The cost of furniture, fixtures
and equipment for a new store is approximately $1.8 million, and the additional
cost of furniture, fixtures, equipment and moving for a relocated store is
approximately $1.6 million. Pre-opening expenses for a new store, which are
expensed in the month the store is opened, typically average $725,000, which is
the same for relocating an existing store.
During fiscal 1994, Builders Square intends to close or relocate
approximately 31 stores. The costs associated with each closing are
approximately $2.1 million per store and consist of furniture and fixture write-
offs, inventory liquidation costs, operating expenses during the closing period,
and on-going occupancy expenses until a new tenant can be located.
Due to the BSQ II strategy announced in January 1994, Builders Square is
expected to require capital in excess of funds generated from operations. Such
excess is expected to be funded by the Kmart Group. Builders Square also could
obtain funds from external debt financing and, following implementation of the
Specialty Retail Stock Proposal, from the sale of shares of Builders Square
Stock with the proceeds attributable to Builders Square. Builders Square
believes that funds generated from operations, together with the sources of
capital described above, will be sufficient to provide the liquidity and capital
resources necessary to fund its anticipated capital requirements for at least
the next two to three years.
Net cash provided by (used for) financing was $145.7 million and $3.7
million in 1993 and 1992, respectively. Net cash provided by financing in 1993
consisted primarily of equity contribution from the Kmart Group. In 1992, $13.5
million was provided by the mortgage of the San Antonio headquarters, partially
offset by net cash provided to the Kmart Group through equity transactions of
$7.9 million. Net cash used for financing in 1991 totaled $65.2 million and
consisted primarily of the excess cash provided by operations over capital
expenditures which was provided to the Kmart Group through equity transactions.
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt, and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of Builders Square
are remitted to Kmart Corporation and cash disbursements of Builders Square are
funded by Kmart Corporation on a daily basis. In the historical financial
statements of the Groups, (i) debt incurred by Kmart Corporation and its
subsidiaries, other than certain capital leases and mortgages related
specifically to the Specialty Retail Groups, has been reflected on the
VIII-8
<PAGE> 348
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
financial statements of the Kmart Group and (ii) net cash used or provided by
each Specialty Retail Group has been characterized as an adjustment of the Kmart
Group's investment (reflected as Retained Interest) in each Specialty Retail
Group. Accordingly, no inter-Group interest expense or inter-Group interest
income is reflected in the historical financial statements of Builders Square.
Until the issuance of Builders Square Stock, the net cash used or provided by
Builders Square will continue to be characterized as an adjustment to the Kmart
Group's investment in Builders Square.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group to the extent that the debt is
incurred or the preferred stock is issued for the benefit of such Specialty
Retail Group.
Following the issuance of Builders Square Stock, if cash used by Builders
Square exceeds cash provided by Builders Square, the Kmart Group would transfer
to Builders Square the cash necessary to fund such excess uses. Conversely, if
cash provided by Builders Square exceeds cash used by Builders Square, Builders
Square would transfer the excess cash to the Kmart Group. All cash transfers
between Groups would be accounted for as short-term loans unless the Board makes
a specific determination that a given transfer (or type of transfer) should be
accounted for as a long-term loan or, in the case of a transfer from the Kmart
Group to Builders Square, an equity contribution. There are no specific criteria
to determine when a cash transfer would be classified as a long-term loan or, in
the case of a transfer from the Kmart Group to Builders Square, an equity
contribution, rather than a short-term loan. Such determination would be made by
the Board in the exercise of its business judgment at the time of such transfer
(or the first of such type of transfer) based upon all relevant circumstances,
including the financing needs and objectives of the recipient Group, the
investment objectives of the transferring Group, prevailing interest rates and
general economic conditions. Such determination would affect the amount of
interest expense and interest income reflected in the financial statements of
the relevant Groups if such transfer were made as a short-term loan or long-term
loan and, in the case of a transfer from the Kmart Group to Builders Square as
an equity contribution, the amount of Builders Square Group equity and Retained
Interest of the Kmart Group. Short-term loans between the Kmart Group and
Builders Square would bear interest at Kmart Corporation's daily short-term
borrowing rate. In the event that the Board determined that a transfer of funds
between the Kmart Group and Builders Square should be made as a long-term loan,
the Board would establish the terms on which such loan would be made, including
interest rate, amortization schedule, maturity and redemption terms. Such terms
would generally reflect the then prevailing terms upon which Kmart Corporation
could borrow funds on a similar basis.
From time to time, following the initial issuance of Builders Square Stock,
the Board could determine that funds to be transferred from the Kmart Group to
Builders Square represent an equity contribution to Builders Square rather than
a loan. In such event, the Kmart Group's Retained Interest in Builders Square
would be increased by the amount of such contribution, as a result of which (a)
the Number of Shares Issuable with Respect to the Kmart Group's Retained
Interest with regard to Builders Square would be increased by an amount equal to
the amount of such contribution divided by the Market Value of a share of
Builders Square Stock and (b) the Kmart Group's Retained Interest Fraction with
regard to Builders Square would be increased and the Outstanding Interest
Fraction with regard to Builders Square would be decreased accordingly. The
Board could determine, in its sole discretion, to make such contribution after
consideration of a number of factors, including, among others, the relative
levels of internally generated cash flows of the Groups, the long-term business
prospects for Builders Square, the capital expenditure plans of and investment
opportunities available to Builders Square, and the availability, cost and time
associated with alternative financing sources.
VIII-9
<PAGE> 349
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from
Builders Square, and the balance sheets of Builders Square would reflect its net
short-term and net long-term loans to or borrowings from the Kmart Group.
Similarly, the respective income statements of the Kmart Group and Builders
Square would reflect interest income or expense, as the case may be, associated
with such loans or borrowings and the statements of cash flows of the Kmart
Group and Builders Square would reflect changes in the amounts thereof deemed
outstanding. In view of the anticipated cash needs of Builders Square over the
next several years, it is currently expected that the Kmart Group would be
making net transfers to Builders Square. After considering all relevant factors,
the Kmart Group would obtain such funds from internal operations, excess cash
from other Specialty Retail Groups, external debt financing or additional equity
issuances. Accordingly, unlike these historical financial statements, following
implementation of the Specialty Retail Stock Proposal and issuance of Builders
Square Stock, the financial statements of Builders Square would reflect interest
expense related to net cash provided by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to Builders Square would continue to be made at the discretion of
the Board. Nothing in the foregoing policies obligates the Board to cause the
Kmart Group to provide funds to Builders Square if the Board determines it is in
the best interest of Kmart Corporation not to do so.
EFFECTS OF INFLATION
Builders Square's financial statements have been prepared on a historical
cost basis under generally accepted accounting principles. Builders Square uses
the LIFO method of inventory valuation in its historical financial statements,
therefore, the cost of merchandise sold more closely approximates current cost.
Management does not believe inflation had a material impact on the financial
statements for the periods presented.
SEASONALITY
As illustrated in the following table, the Builders Square business
exhibits only slight seasonality, with sales levels generally higher in the
second and third quarters and lower in the first and fourth quarters and, unlike
many retailers, Builders Square's business is not highly dependent on the
Christmas selling season. Builders Square's expansion program generally is
weighted with store openings in the second half of the fiscal year. In the
future, changes in the magnitude and timing of these store openings may change
prior period seasonality trends.
<TABLE>
<CAPTION>
FISCAL 1993 QUARTER ENDED
-----------------------------------------------------
($ MILLIONS) APRIL JULY OCTOBER JANUARY
- -------------------------------------------- ------ ------ ------- -------
<S> <C> <C> <C> <C>
Sales....................................... $602.3 $793.8 $ 704.4 $ 618.3
% of full year............................ 22.2% 29.2% 25.9% 22.7%
Operating income before store restructuring
and other charges in January.............. $ 0.4 $ 30.7 $ 18.1 $ 11.6
% of full year............................ 0.7% 50.5% 29.7% 19.1%
</TABLE>
EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS
Compliance with federal, state and local provisions which have been enacted
or adopted regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had, and is not
expected to have, a material effect on the capital expenditures, earnings or
competitive position of Builders Square.
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BUILDERS SQUARE GROUP
GENERAL
Builders Square Group ("Builders Square") is a leading specialty retailer
of home improvement and home decor products and services in the United States.
Builders Square's strategy is to operate large format superstores emphasizing
customer service and providing do-it-yourself, buy-it-yourself and professional
contractor customers an extensive selection of quality products and services to
repair, remodel, redecorate and maintain both home and garden. At January 23,
1994, Builders Square operated 177 stores in 26 states and Puerto Rico. Builders
Square had net sales of approximately $2.7 billion for the fiscal year ended
January 23, 1994 ("fiscal 1993"). Builders Square has achieved compound annual
growth in net sales of 11.8% during the period from fiscal 1989 to fiscal 1993.
Builders Square is comprised principally of Builders Square, Inc., a wholly
owned subsidiary of Kmart Corporation ("Kmart"). Builders Square Inc. was
founded in 1983 and was acquired by Kmart in 1984. Prior to 1992, Builders
Square's business strategy was to operate self-service warehouse-style home
improvement stores and to expand into markets where it would be the first large
format home improvement retailer to enter that market. In 1992, significant
changes were made to the senior management team, including the hiring of a new
chief executive officer, senior vice president of merchandising and senior vice
president of marketing. This new management team, with the assistance of outside
consultants, conducted extensive research into consumer preferences and industry
trends. Based on these studies, Builders Square determined that home improvement
consumers desire (i) superior customer service from knowledgeable salespeople
who are experts in their field, (ii) a broad selection of competitively priced
merchandise with an emphasis on home decor and lawn and garden products and
services and (iii) an easy shopping environment where they can satisfy all of
their home improvement and home decor needs. Additionally, Builders Square
concluded that no single major retailer was adequately serving the home decor
market by providing a broad selection of home decor products and services all
under one roof. As a result, in order to better position Builders Square within
the home improvement market as well as to enter the home decor retail market,
management developed the Builders Square II Store format (the "BSQ II Stores")
to replace its existing self-service, warehouse-style home improvement stores
(the "BSQ I Stores").
Unlike the smaller 60,000 to 94,000 square foot BSQ I Stores (including
approximately 8,000 to 14,000 square feet of outdoor lawn and garden and lumber
and building material space), the BSQ II Stores average approximately 146,300
square feet (including approximately 36,500 square feet of outdoor lawn and
garden and lumber and building material space) and employ a "specialty stores
within a store" concept to provide the service and selection of a number of
smaller specialty stores all in one location. In order to provide superior
customer service and advice, Builders Square staffs all of its BSQ II Stores
with knowledgeable sales associates, including certified or degreed experts in
interior design and decorating, and in many cases other professionals in various
home improvement trades (including electricians, plumbers and carpenters). In
addition, each BSQ II Store places greater emphasis on home decor, which
management believes distinguishes it from its competitors, by having an
approximately 21,000 square foot center court dedicated to home decor products
and services. As part of Builders Square's focus on home decor services, experts
in interior design and decorating utilize in-store computer-aided design systems
("CAD Systems") located at various stations within the store. In addition, each
BSQ II Store includes an expanded lawn and garden space, which Builders Square
believes also distinguishes it from its competitors. Management believes that
the BSQ II Store format better addresses customer preferences and has resulted
in increased customer loyalty and higher average sales per transaction. The BSQ
II Store format also has resulted in increased gross margins and profitability,
as home decor and outdoor lawn and garden products generally command higher
margins than home repair products and building materials.
In July 1992, Builders Square opened its first BSQ II Store in Sunrise,
Florida and continued to refine the BSQ II Store format during 1992 by opening
seven additional BSQ II Stores in various parts of the country. Based upon the
financial results of the BSQ II Stores, management decided in the first quarter
of
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1993 to implement the BSQ II Store format on a company-wide basis for all new
Builders Square stores. In January 1994, based upon continued favorable
financial results and customer response, Builders Square adopted a plan to
convert all existing BSQ I Stores to the BSQ II Store format, and set a goal of
having virtually all of the Builders Square stores be BSQ II Stores by the end
of fiscal 1997. At the same time, Builders Square revised its expansion strategy
to focus on increasing market share in existing markets by clustering its BSQ II
Stores. This clustering strategy enables Builders Square to leverage management
personnel, advertising and distribution expenditures, thereby improving
profitability as well as enhancing customer awareness. In addition, Builders
Square adopted a strategy of locating all new or relocated stores in prime real
estate locations, thereby abandoning its prior strategy in many cases of
selecting previously occupied buildings in secondary locations.
INDUSTRY OVERVIEW
The home improvement and home decor industries together represent one of
the largest segments of the retail market in the United States and is growing
faster than the retail market as a whole. According to The Farnsworth Group,
Inc., an independent marketing consulting firm, the market for home improvement
products and services (which does not include home decor and home furnishings)
grew from approximately $122.0 billion in 1989 to approximately $126.7 billion
in 1992. The relatively flat growth between 1989 and 1992 is reflective of the
sluggish new housing market and existing home sales market experienced during
the 1990 and 1991 period in particular. From a broader perspective, between 1982
to 1992, the industry grew 7%-8% a year compared to the 1%-2% growth per year
during the 1989 to 1992 time frame. The market is estimated to have grown to
$132.5 billion in 1993, an increase of close to 5% over 1992. Based on The
Farnsworth Group's estimates, this market is expected to grow 7% in 1994. Over
the four-year period from 1989 to 1992, the three leading large format warehouse
home improvement retailers (including Builders Square) have increased their
market share from 3.1% to 5.7%. Although these large format warehouse home
improvement retailers have grown dramatically over this period, the home
improvement industry remains predominantly fragmented.
In addition, according to The Farnsworth Group, the market for home decor
products and services was approximately $68.3 billion in 1992 and is estimated
to have been approximately $72.4 billion in 1993. The market for home decor
products and services is expected to grow approximately 8% in 1994 (and 7% in
1995), which is faster than the expected growth for the market for home
improvement products and services. Management believes that this industry is
even more fragmented than the home improvement industry with no single other
major retailer adequately serving the home decor market by providing a broad
selection of home decor products and services all under one roof.
BUSINESS STRATEGY
Builders Square's strategy is to operate large format superstores
emphasizing customer service and providing do-it-yourself, buy-it-yourself and
professional remodeling contractor customers an extensive selection of quality
products and services to repair, remodel, redecorate and maintain both home and
garden. Builders Square plans to implement this strategy through the use of the
BSQ II Store format and intends to have virtually all Builders Square stores in
the BSQ II Store format by the end of fiscal 1997. The key elements of the BSQ
II Store format are as follows:
- Easy-to-Shop Store Concept. Each BSQ II Store is designed to appeal to a
wide variety of potential customers. The BSQ II Stores feature expansive,
well-lit aisles, with the focal point of each store being the centrally located
center court, which contains an Idea Center where interior design and decorating
specialists assist customers in envisioning, designing and planning home
improvement projects and home decor. Typically, interior design and decorating
specialists also assist customers in identifying and purchasing the necessary
items to complete these projects from the various "specialty stores" included in
each BSQ II Store. The Idea Center showcases approximately 9,000 square feet of
full scale samples of various designs of kitchens, bathrooms and entertainment
rooms, numerous types of cabinetry and a wide selection of plumbing fixtures. To
create ease of shopping, the center court is surrounded by a "race track" style
tile floor that provides easy access to the surrounding "specialty stores" which
are positioned with logical merchandise
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adjacencies to promote convenience and multiple purchases of related items. The
"specialty stores" consist of a Floor Coverings and Flooring Shop, Wall
Coverings and Window Treatment Shop, Paint Shop, Lighting Shop, Tool Shop,
Lumber and Millwork Shop, Lawn and Garden Shop, Plumbing Shop, Seasonal Shop and
Basic Repair Shop.
- Exceptional Customer Service. A fundamental goal of Builders Square is to
provide exceptional service. Unlike the original Builders Square strategy, which
focused on providing a self-service environment, Builders Square now staffs its
stores with knowledgeable sales associates, virtually all of whom have a minimum
of 30 months' experience in home improvement and/or home decor products sales or
are professionals in a particular trade (such as electricians, plumbers,
carpenters, interior designers and decorators). In order to maintain a highly
motivated sales force, Builders Square recently implemented a financial
incentive program for all managers and many of its sales associates based on
customer service levels as well as sales targets. Based on its consumer
research, Builders Square believes that the availability of expert advice from a
highly motivated sales force, particularly with respect to the design and
implementation of home improvement and home decor projects, attracts new
customers to BSQ II Stores and increases the frequency of repeat visits. During
its peak selling season, Builders Square staffs each BSQ II Store with an
average of approximately 133 associates, or an average of approximately 20 more
associates than each BSQ I Store.
- Broad Selection of Home Improvement and Home Decor Products and
Services. Each BSQ II Store offers a broad and deep selection of quality home
improvement and home decor products and services. Each BSQ II Store offers
approximately 31,000 active SKUs, plus access on a special-order basis to
thousands of additional items available from a wide variety of manufacturers. In
contrast to a BSQ I Store, the product offering of a BSQ II Store emphasizes
higher margin merchandise, such as home decor and lawn and garden products, and
offers more services such as those described below under "Specialized Services."
- Prime Locations. Builders Square's strategy is to focus on increasing
market share in existing markets by clustering its BSQ II Stores in prime
locations. In determining the location for a new BSQ II Store, Builders Square
identifies prime real estate locations by evaluating a number of factors,
including the size of the location, its visibility, access and parking capacity,
proximity to competition, the cannibalizing effects on existing Builders Square
stores and relevant demographic information. As part of this strategy, Builders
Square plans to relocate most of its BSQ I Stores to more desirable locations in
the same market while converting them to the BSQ II Store format.
- Everyday Fair Prices. Builders Square's pricing policy is to maintain
everyday fair prices that are below those of traditional home improvement
retailers. In addition, Builders Square seeks to offer competitively low prices
on selected high visibility items. Builders Square complements its everyday fair
price policy with customer awareness promotions in conjunction with store
openings and in order to increase customer traffic and sales.
STORE FORMAT AND MERCHANDISE
Each BSQ II Store averages approximately 146,300 square feet (including
approximately 36,500 square feet of outdoor lawn and garden and lumber and
building material space). In addition, the location for each BSQ II Store
includes available space to expand the store by an additional approximately
14,000 gross square feet, which provides management with flexibility to increase
the size of the interior of its stores. Approximately 90% of the gross square
feet of each BSQ II Store is dedicated to selling merchandise, with the balance
used for merchandise unloading and office space. BSQ II Stores are generally
open seven days a week from approximately 7:00 a.m. to 9:00 p.m. Monday through
Saturday and approximately 9:00 a.m. to 6:00 p.m. on Sunday.
The interior of each BSQ II Store features as its focal point a center
court where interior design and decorating specialists assist customers in
envisioning, designing and planning home improvement and home decor projects. To
create ease of shopping, the center court is surrounded by a "race track" style
tile floor that provides easy access to each of Builders Square's "specialty
stores," which are positioned with logical merchandise adjacencies to promote
convenience and multiple purchases of related items. The "specialty stores"
consist of a Floor Coverings and Flooring Shop, Wall Coverings and Window
Treatment Shop, Paint
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Shop, Lighting Shop, Tool Shop, Lumber and Millwork Shop, Lawn and Garden Shop,
Plumbing Shop, Seasonal Shop and Basic Repair Shop.
The following is the layout of a typical BSQ II Store:
Builders Square specifically tailors its merchandise assortment to better
meet the needs of its customers as determined in customer surveys instead of
merely carrying the broadest assortment possible. The following is a description
of each of the "specialty stores" and the merchandise categories found in each
BSQ II Store:
- Center Court. The focal point of each BSQ II Store is the center
court which houses the Idea Center, the Floor Coverings and Flooring Shop,
the Wall Coverings and Window Treatment Shop and the Paint Shop:
Idea Center. The Idea Center showcases approximately 9,000 square
feet of full scale samples of various designs of kitchens, bathrooms and
entertainment rooms, numerous types of cabinetry and a wide selection of
plumbing fixtures. In the Idea Center, interior design and decorating
specialists assist customers in envisioning, designing and planning home
decor and home improvement projects.
Floor Coverings and Flooring Shop. The Floor Coverings and Flooring
Shop features over 20 styles of wooden floors (including parquet, oak
and exotic hardwoods) and over 800 SKUs of floor linoleum and tiling. In
addition, this shop carries over 94 different styles of carpeting in
over 700 colors. Name brand floor coverings include Armstrong, American
Rug/Mohawk, Beaulieu, Hartco, Tilepak and Dupont Stainmaster.
Wall Coverings and Window Treatment Shop. The Wall Coverings and
Window Treatment Shop stocks over 220 different styles of wallpaper and,
through special order from over 68 in-store catalogs, each Builders
Square store can special order over 5,000 styles and colors of wall
paper.
Paint Shop. The Paint Shop features a broad variety of indoor and
outdoor paints and stains. This shop carries a wide variety of brand
name paints, including Glidden, Dutch Boy, Olympic and Krylon, as well
as competitively priced private label paints, and brand name stains and
sealants,
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including Thompson's Water Seal, Formby's, Minwax, Wagner and Rustoleum.
Each BSQ II Store has the capability, through the use of a computer, to
match any color paint. This shop stocks over 144 different styles and
sizes of paint brushes and other miscellaneous items such as drop
cloths, painter's masking tape, rollers and ladders. Each BSQ II Store
features over 300 styles of window treatments, including blinds, shades
and curtains. Name brand window treatments include Levolor, Hunter
Douglas, Bali and Graber.
- Lighting Shop. Each BSQ II Store's approximately 5,000 square foot
Lighting Shop offers over 700 styles of indoor and outdoor lighting
fixtures. The Lighting Shop includes ceiling fans as well as light fixtures
that range from inexpensive fixtures to high priced chandeliers. Name
brands carried by the Lighting Shop include Collins, Imperial, Catalina,
Cheyenne, Hunter, Legacy, Lithonia/Home-Vue, Thomas and M.G. Products.
- Tool Shop. Each BSQ II Store's approximately 6,000 square foot Tool
Shop carries most major brands of hand tools for the do-it-yourselfer, such
as Stanley, Black & Decker, Arrow, Crescent, Lufkin and Alltrade, as well
as a wide variety of tools used by professional contractors, such as
Stanley, Contractor Grade, Estwing and Plumb & Ekline. The Tool Shop
carries various name brand power tools and accessories, including Black &
Decker, Delta, Makita, Skil, DeWalt, Milwaukee, Ryobi, Vermont-American,
Stanley-Bostich and Quantum.
- Lumber and Millwork Shop. Each BSQ II Store's approximately 33,000
square foot Lumber and Millwork Shop carries a full line of millwork,
windows and doors, including such brands as Pella, Castlegate and Croft.
Each store also stocks between 100 and 150 different types and sizes of
lumber and plywood for construction and other building projects from such
manufacturers as Weyerhaeuser, Georgia Pacific, Canfor, Louisiana Pacific
and Champion International. Building materials include roofing, gypsum,
insulation and other basic building products from such manufacturers as
USG, Owens Corning, National Gypsum, Quikrete and Macklanburg Duncan.
- Lawn and Garden Shop. Each BSQ II Store's approximately 38,000
square foot Lawn and Garden Shop carries a broad variety of brand name hand
and power gardening and lawn tools, fertilizers, sprays and chemicals. The
Lawn and Garden Shop also carries a wide variety of seasonal nursery
plants, shrubbery and bedding plants, as well as various merchandise for
patios and decks. The Lawn and Garden Shop carries many name brand lawn and
garden supplies and products, such as Scotts/Hyponex, Ortho/Roundup,
Spectracide, Stern's Miracle Gro, Raid/Off, Murray, Black & Decker,
Homelite and Lawn Boy.
- Plumbing Shop. Each BSQ II Store's approximately 7,500 square foot
Plumbing Shop contains over 200 brand name faucets, valves and showerheads,
including Delta, Moen, Price Pfister and Sterling. Over 150 plumbing
fixtures are carried from six major manufacturers, including American
Standard, Sterling, Kohler, Crane, Novi-American and Titan. Additionally,
the Plumbing Shop is able to special order merchandise from most
manufacturers and can custom cut and thread pipe for customers.
- Seasonal Shop. Each BSQ II Store's approximately 5,000 square foot
Seasonal Shop carries seasonal items, including Christmas trees and
decorations, air conditioners, lawn mowers, grills and patio furniture.
Name brands carried in the Seasonal Shop include Rubbermaid, Sunbeam,
Weber, Kingsford, Rainbird, Glad, Whirlpool, 3-M, Dap, Honeywell and Toro.
- Basic Repair Shop. Each BSQ II Store's Basic Repair Shop features
basic electric supplies, such as sockets, light switches, wires and fuses,
and basic plumbing supplies, such as gaskets, stems and miscellaneous parts
for faucets and valves, as well as full lines of plastic, galvanized and
copper pipe products. The Basic Repair Shop also carries basic home
improvement products, such as nails, screws, nuts, bolts, hooks and a wide
range of decorative hardware products. Name brands include Leviton, Raco,
3M, Waxman, Kwikset, Schlage, Masterlock and Macklanburg Duncan.
Each BSQ I Store has approximately 60,000 to 94,000 square feet (including
approximately 8,000 to 14,000 square feet of outdoor lawn and garden and lumber
and building material space). While the BSQ I Stores generally stock the same
categories of merchandise as the BSQ II Stores, the stores are different in
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layout and focus. The BSQ I Stores do not contain a center court or an Idea
Center and are not organized using a "race track" layout. In addition, BSQ I
Stores do not focus on home decor and lawn and garden products and services.
Approximately 90% of the gross square feet of each BSQ I Store is dedicated to
selling merchandise, with the balance used for merchandise unloading and storage
and office space. BSQ I Stores are generally open seven days a week from
approximately 7:00 a.m. to 9:00 p.m. Monday through Saturday and 9:00 a.m. to
6:00 p.m. on Sunday.
SPECIALIZED SERVICES
As part of Builders Square's strategy to provide exceptional customer
service, Builders Square offers a wide variety of services that are generally
associated with specialty stores. These services include:
- The Idea Center. Each BSQ II Store features an Idea Center, where
interior design and decorating specialists are available to assist
customers in designing home improvement and home decor projects and to
suggest ideas for such projects. The Idea Center staff utilizes a CAD
System to aid the customer in visualizing and developing a wide range of
home improvement and home decor projects, primarily for the kitchen,
bathroom and entertainment rooms.
- CAD Systems. Builders Square's CAD Systems assist in designing
projects, such as building and remodeling decks, closets and garages.
Builders Square is expanding the use of its computer modeling to the lawn
and garden department to assist customers in developing landscape designs.
- Customization. Each Builders Square store offers customers the
opportunity, at no charge, to have merchandise purchased at BSQ II Stores
custom cut and in some instances custom made. These services are available
for a wide range of merchandise, including lumber, fencing, chain, hose,
rope, window and door screens and glass.
- Installed Sales. Each Builders Square store offers customers the
option of having all merchandise purchased installed for them. Management
believes Builders Square is the only large format home improvement and home
decor retailer that offers customers these services at every store. These
services are offered at competitive prices and are performed by reputable
independent contractors, who are each initially required to meet quality
standards established by Builders Square. Thereafter, Builders Square
continuously requires each independent contractor to maintain certain
quality standards, such as the level of customer service, which Builders
Square monitors through the use of customer surveys.
- Delivery. At no charge, or for a small fee, each Builders Square
store will deliver any merchandise purchased. Deliveries are made in trucks
operated by each Builders Square store. Builders Square also provides its
commercial accounts with "ZIP Service," whereby orders can be called or
faxed to a Builders Square store and the store will either hold the
merchandise for pick-up or deliver such merchandise.
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STORES AND EXPANSION
Builders Square has 177 stores in 26 states and Puerto Rico. Builders
Square stores typically are either freestanding or anchor tenants in shopping
centers. Set forth below is a list of the number of stores by market as of the
dates identified:
<TABLE>
<CAPTION>
ESTIMATED
JAN. 24, 1993 JAN. 23, 1994 JAN. 22, 1995
--------------- --------------- ---------------
REGION/MARKET BSQ I BSQ II BSQ I BSQ II BSQ I BSQ II
- ------------------------------------------------- ----- ------ ----- ------ ----- ------
<S> <C> <C> <C> <C> <C> <C>
NORTHEAST
Albany......................................... 1 0 1 1 0 2
Buffalo........................................ 1 1 0 2 0 2
Philadelphia................................... 5 0 5 0 1 4
Pittsburgh..................................... 3 0 3 1 3 1
Washington, D.C................................ 2 0 2 1 2 1
Single Stores.................................. 9 1 3 2 1 5
----- - ----- -- ----- ------
Northeast Totals.......................... 21 2 14 7 7 15
----- - ----- -- ----- ------
----- - ----- -- ----- ------
SOUTHEAST
Miami.......................................... 5 1 4 4 2 8
Orlando........................................ 1 1 1 3 1 3
Palm Beach..................................... 1 0 0 1 0 1
Richmond....................................... 2 0 1 0 0 0
Tidewater...................................... 3 0 3 0 3 0
Tampa.......................................... 4 0 4 1 4 1
Single Stores.................................. 7 0 5 2 4 3
----- - ----- -- ----- ------
Southeast Totals.......................... 23 2 18 11 14 16
----- - ----- -- ----- ------
----- - ----- -- ----- ------
MIDWEST
Akron.......................................... 2 0 2 1 2 1
Chicago........................................ 20 0 17 3 10 13
Cincinnati..................................... 2 0 2 1 2 1
Cleveland...................................... 6 0 6 0 3 3
Columbus....................................... 3 0 3 0 2 1
Dayton......................................... 2 0 2 0 2 0
Detroit........................................ 11 0 9 2 5 7
Flint.......................................... 3 0 3 0 2 1
Grand Rapids................................... 2 0 2 0 0 2
Indianapolis................................... 3 0 3 0 1 2
Kansas City.................................... 3 0 2 1 1 2
Milwaukee...................................... 3 0 3 1 3 2
Minneapolis.................................... 4 1 4 1 4 1
St. Louis...................................... 5 0 5 0 2 3
Toledo......................................... 2 0 2 0 2 0
Single Stores.................................. 8 0 8 1 4 6
----- - ----- -- ----- ------
Midwest Totals............................ 79 1 73 11 45 45
----- - ----- -- ----- ------
----- - ----- -- ----- ------
SOUTHWEST
Austin......................................... 2 0 2 1 1 2
Houston........................................ 7 1 5 4 2 7
Oklahoma City.................................. 2 0 2 0 1 1
Rio Grande..................................... 2 1 2 2 0 4
San Antonio.................................... 4 1 2 4 0 5
Texas Panhandle................................ 2 0 1 1 0 2
Tulsa.......................................... 2 0 2 0 0 2
Wichita........................................ 2 0 1 1 1 1
Single Stores.................................. 1 0 0 1 0 1
----- - ----- -- ----- ------
Southwest Totals............................ 24 3 17 14 5 25
----- - ----- -- ----- ------
----- - ----- -- ----- ------
</TABLE>
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<TABLE>
<CAPTION>
ESTIMATED
JAN. 24, 1993 JAN. 23, 1994 JAN. 22, 1995
--------------- --------------- ---------------
REGION/MARKET BSQ I BSQ II BSQ I BSQ II BSQ I BSQ II
- ------------------------------------------------- ----- ------ ----- ------ ----- ------
<S> <C> <C> <C> <C> <C> <C>
WEST/ROCKY MOUNTAIN
Denver......................................... 5 0 4 1 3 2
Portland....................................... 2 0 2 0 2 0
Single Stores.................................. 3 0 2 1 2 1
----- - ----- -- ----- ------
West/Rocky Mountain Totals.................. 10 0 8 2 7 3
----- - ----- -- ----- ------
----- - ----- -- ----- ------
PUERTO RICO...................................... 0 0 0 2 0 4
----- - ----- -- ----- ------
TOTAL....................................... 157 8 130 47 78 108
----- - ----- -- ----- ------
----- - ----- -- ----- ------
</TABLE>
The focus of Builders Square's expansion strategy is to increase market
share in existing markets by clustering its BSQ II Stores. This clustering
strategy enables Builders Square to leverage management personnel, advertising
and distribution expenditures, thereby improving profitability as well as
enhancing customer awareness. Although Builders Square's strategy of locating
multiple stores within a market can result in some cannibalization, management
believes that achieving greater market penetration will allow it to grow
successfully and compete more effectively over the long term. Builders Square
believes that the successful implementation of its expansion strategy will be
dependent upon general economic and business conditions affecting consumer
spending, the availability of desirable locations and the negotiation of
acceptable lease terms.
In connection with this clustering strategy, Builders Square is closing
selected BSQ I Stores and converting the balance of existing BSQ I Stores to the
BSQ II Store format as well as filling in existing and contiguous markets with
new BSQ II Stores. Over the period from fiscal 1993 through fiscal 1997,
Builders Square intends to phase out approximately 117 BSQ I Stores by closing
approximately 8 stores, relocating approximately 66 stores and renovating
approximately 43 stores. Management plans that this phaseout will be
accomplished generally in accordance with the following schedule:
<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL FISCAL FISCAL
1993 1994 1995 1996 1997 TOTAL
------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Close................................................ 8 2 4 1 1 16
Relocate............................................. 8 29 20 7 10 74
Convert.............................................. 11 21 21 1 0 54
</TABLE>
Builders Square plans to open approximately 10-20 new BSQ II Stores in each of
the next 2 years. Although Builders Square currently has no plans to expand into
new non-contiguous markets in the next 2-3 years, it will evaluate and consider
new markets in the future.
A major focus of Builders Square's expansion strategy is to open new stores
and relocate existing stores in prime real estate locations. In connection with
this strategy, Builders Square's management utilizes real estate consultants to
assist in evaluating markets and potential store sites. In this regard,
management considers a number of factors, including availability of prime real
estate (based on criteria such as visibility, size, access and parking
capacity), cannibalizing effects on existing stores and demographic information
(based on criteria such as income and education levels, new and used housing
market, age, occupation and growth trends). In determining whether to expand or
remodel a BSQ I Store rather than relocate it, Builders Square also evaluates,
on a store-by-store basis, the relative costs associated with each alternative.
On an operating lease basis, the cost of opening a new BSQ II Store
consists primarily of the investment in inventory, the cost of furniture,
fixtures and equipment and pre-opening expenses, such as the costs associated
with training employees. The cost of converting or relocating an existing store
consists primarily of the cost of additional inventory, plus in the case of
converting, the cost of improvements or, in the case of relocation, furniture,
fixtures, equipment, moving and lease termination costs. Inventory for a new
store is estimated to cost approximately $3.5 million, with average vendor
payables equal to approximately 45% of the initial inventory, for a net
investment of approximately $1.9 million. Additional inventory for a converted
or relocated store is estimated to cost approximately $750,000, with average
vendor payables equal to
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approximately 45% of such inventory, for a net additional investment of
approximately $412,500. The cost of furniture, fixtures and equipment for a new
store is approximately $1.8 million, and the additional cost of furniture,
fixtures, equipment and moving for a relocated store is approximately $1.6
million. Pre-opening expenses for a new store, which are expensed in the month
the store is opened, typically average $725,000, which is the same for
relocating an existing store.
During fiscal 1994, Builders Square intends to close or relocate
approximately 31 stores. The costs associated with each closing are
approximately $2.1 million per store and consist of furniture and fixture write-
offs, inventory liquidation costs, operating expenses during the closing period,
and on-going occupancy expenses until a new tenant can be located.
PURCHASING AND DISTRIBUTION
Builders Square maintains its own central buying staff, comprised of one
general merchandise manager, four divisional merchandise managers (home decor,
home remodeling, home repair and outdoor living and seasonal), five regional
lumber managers, four regional garden managers and 21 buyers. Using a detailed
merchandise planning system, the merchandise offering for each category is
selected by the central buying staff in consultation with store managers and
regional managers. The merchandise planning system allows Builders Square to
plan all components of merchandise by store.
Before opening a store, each store manager is provided a merchandise plan
to be used as a guide for the initial quantities and set-up of merchandise.
Thereafter, to maintain the highest in-stock levels at the lowest possible
costs, Builders Square uses a decentralized store-level replenishment system.
This computer-based system tracks sales and replenishment patterns and trends of
merchandise over short and long-terms and generates a recommended order quantity
for each item of merchandise. Computer-generated orders are reviewed by store
personnel and electronically transmitted to suppliers.
Builders Square currently purchases from over 1,500 vendors and, in fiscal
1993, no vendor accounted for more than 3% of the cost of Builders Square's
total merchandise purchased. Builders Square does not maintain any long-term or
exclusive commitments or arrangements to purchase from any vendor. Builders
Square believes that it has a good relationship with each of its vendors and
expects that such relationships will continue.
Builders Square currently transmits electronic purchase orders to
approximately 650 vendors, or 80% of its purchase orders in terms of dollars,
and exchanges acknowledgements and invoices electronically with approximately
230 vendors, or 46% of its purchase orders expressed in terms of dollars.
Builders Square currently receives advance shipping notices from 31 vendors,
which enables Builders Square to efficiently scan merchandise upon receipt,
thereby lowering costs.
Merchandise is shipped directly to stores by each vendor; as a result
Builders Square does not have a central distribution center. However, Builders
Square uses small public contract break-bulk operators and public warehouse
facilities to take advantage of full truck load discounts. The use of
direct-store shipments allows Builders Square to open stores without the
geographic constraints associated with a central distribution facility. Builders
Square is currently undertaking to study the costs and benefits of using a
cross-dock method of merchandise distribution or an SKU based distribution
system to improve margins and inventory turnover.
MANAGEMENT INFORMATION SYSTEMS
Builders Square has established a strong technical infrastructure. A
satellite network provides a data and video link between all Builders Square
stores and the corporate headquarters. Sales information, including department,
category and SKU data, is captured at point-of-sale terminals equipped with
bar-code scanners. This information is used to update store-level perpetual
inventory levels on a SKU basis each night and is also transmitted from in-store
processors to a host system located at Builders Square's corporate headquarters,
where a proprietary information system provides management with up-to-date store
and merchandise performance analysis.
VIII-19
<PAGE> 359
Builders Square's information system is designed to provide for strong
financial control and tight inventory management. This system integrates
purchasing, receiving, sales reporting and perpetual inventory reporting and can
be accessed on-line both at Builders Square's corporate headquarters and by
store management. Management believes that this system allows it to gain a
thorough understanding of its entire business and provides it with a strategic
advantage by enabling it to continuously focus management's attention on areas
of high return.
Each Builders Square store has wireless point-of-sale capability to allow
for the addition of portable checkouts during peak sales periods. Hand-held
radio frequency terminals are used to look-up sales, profit and inventory data
from anywhere in a store.
Builders Square utilizes an advanced receiving system, which combines
carton/pallet label scanning and electronic advance shipping notices from
vendors to automatically close-out purchase orders and update perpetual
inventory. Consequently, Builders Square's store personnel can focus their
primary efforts on customers.
CREDIT
Builders Square has a private label credit card for retail customers. This
card is issued by a division of Household Finance Corp. which also bears the
credit risk. Builders Square also provides commercial credit and itemized
billing for its professional contractor customers, whose accounts must be paid
in full each month. All commercial credit decisions and policies are established
centrally by Builders Square's credit department. In fiscal 1993, approximately
11.4% of sales were through these two credit programs. Builders Square also
accepts most major credit cards, including Visa, MasterCard, Discover and
American Express.
ADVERTISING AND PROMOTION
Builders Square employs an advertising program that utilizes a combination
of broadcast and print advertising on a weekly, bi-weekly and monthly basis to
increase customer awareness and generate traffic in its stores. A prime focus of
the Builders Square advertising program is to associate Builders Square with
exceptional customer service and project selling. Builders Square believes that
broadcast advertising is more cost-effective than its past print advertising
programs and has been shifting its spending toward broadcast advertising, with
its current advertising mix consisting of 35% broadcast and 65% print
advertising.
COMPETITION
The market for home improvement and home decor products and services is
highly competitive. Competition within the home improvement and home decor
industry is highly fragmented and consists principally of large format home
improvement stores, traditional hardware stores, plumbing and electrical supply
outlets and lumberyards, home centers, discount retail stores and certain
specialty stores. Builders Square competes on the basis of customer service,
ease of shopping, location, depth and breadth of merchandise and price.
Builders Square faces competition in a large majority of its markets from
one or more large format home improvement retailers, such as Hechinger, Home
Base (a division of Waban, Inc.), Home Quarters (a subsidiary of Hechinger,
Inc.), Lowe's, Menards, Payless Cashways and The Home Depot. Builders Square
also faces competition from traditional hardware stores, plumbing and electrical
supply outlets, lumberyards, home centers, discount retail stores and certain
specialty stores, although typically these types of competitors do not offer
both the breadth and depth of selection of merchandise and the everyday fair
prices that are offered by Builders Square.
PROPERTIES
Most of the BSQ I Stores and BSQ II Stores have long-term leases. The
leases typically provide for an initial 25 year term with 10 five-year renewal
options. For store locations by state, see "Stores and Expansion" above.
VIII-20
<PAGE> 360
Builders Square owns (subject to a mortgage) its headquarters located at
9725 Datapoint Drive, San Antonio, Texas, containing approximately 200,000
square feet.
ASSOCIATES
As of January 23, 1994, Builders Square had a total of approximately 14,300
full-time and 7,900 part-time associates, 21,500 of whom were employed in
Builders Square stores and 700 of whom were employed in corporate office
positions. None of Builders Square's associates are covered by collective
bargaining agreements. Store managers have been employed by Builders Square an
average of six years and Builders Square endeavors to promote new store managers
internally through a management training program. Builders Square believes that
its relationship with its associates is good.
TRADEMARKS AND SERVICE MARKS
Builders Square(R) and the Builders Square logo are registered trademarks
and service marks of Builders Square. Builders Square uses its mark as a trade
name in connection with its business operations. Whenever possible, Builders
Square has registered its mark as a trade name with the state or locality where
Builders Square has a store.
LITIGATION
Builders Square is from time to time involved in routine litigation
incidental to the conduct of its business. Builders Square believes that no
currently pending litigation to which it is a party will have a material adverse
effect on its liquidity, financial position or results of operations.
VIII-21
<PAGE> 361
BUILDERS SQUARE GROUP
REPORT BY MANAGEMENT
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Kmart Corporation and Builders Square Group management are responsible for
the integrity of the information and representations contained in interim and
annual financial statements. This responsibility includes making informed
estimates and judgments in selecting the appropriate accounting principles.
Management believes the financial statements conform with generally accepted
accounting principles applied on a consistent basis.
To assist management in fulfilling these obligations, several tools are
utilized, which include the following:
A system of internal accounting controls is maintained to provide for
the integrity of information for purposes of preparing financial statements
and to assure that assets are properly accounted for and safeguarded. This
concept of reasonable assurance is based on the recognition that the cost
of the system is related to the benefits to be derived and modified for
changing conditions. Management believes its system provides reasonable
assurance of this appropriate balance.
As part of the internal control system, a policy of Standards of
Business Conduct and Management Integrity Statements is in effect. All
officers and key employees periodically submit a signed statement regarding
compliance with these policies.
An Internal Audit Department is maintained to evaluate, test and
report on the application of internal accounting controls in conformity
with standards of the practice of internal auditing.
The financial statements have been examined by independent accountants
whose report is contained herein. This examination includes, among other
things, a review of the system of internal controls as required by
generally accepted auditing standards.
The Audit Committee of the Board of Directors, consisting solely of outside
directors, meets regularly with management, internal auditors and the
independent accountants to assure that each is carrying out its
responsibilities. The internal auditors and independent accountants both have
full and free access to the Audit Committee, with and without the presence of
management.
Joseph E. Antonini
Kmart Corporation
Chairman of the Board, President
and Chief Executive Officer
George R. Mrkonic
Kmart Corporation
Executive Vice President
Specialty Retailing
Thomas F. Murasky
Kmart Corporation
Executive Vice President
and Chief Financial Officer
Frank G. Felicella
Builders Square, Inc.
President and
Chief Executive Officer
J. Kent Fortner
Builders Square, Inc.
Executive Vice President
and Chief Financial Officer
VIII-22
<PAGE> 362
BUILDERS SQUARE GROUP
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Kmart Corporation
In our opinion, the accompanying combined balance sheets and the related
combined statements of income and of cash flows present fairly, in all material
respects, the financial position of the Builders Square Group at January 23,
1994 and January 24, 1993, and the results of its operations and its cash flows
for each of the three years in the period ended January 23, 1994, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of Kmart Corporation management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the notes to the combined financial statements, the
Builders Square Group adopted Statement of Financial Accounting Standard No.
106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" and
Statement of Financial Accounting Standard No. 109, "Accounting for Income
Taxes," at the beginning of fiscal 1993.
The Builders Square Group is a business group of Kmart Corporation (as
described in the Basis of Presentation note to these financial statements);
accordingly, the combined financial statements of the Builders Square Group
should be read in conjunction with the consolidated financial statements of
Kmart Corporation.
Price Waterhouse
Detroit, Michigan
March 15, 1994
VIII-23
<PAGE> 363
BUILDERS SQUARE GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $ 2,718.8 $ 2,419.5 $ 2,048.5
Cost of merchandise sold (includes buying and occupancy
costs)..................................................... 2,100.5 1,855.0 1,560.4
Selling, general and administrative expenses................. 537.2 468.9 389.9
Pre-opening expense.......................................... 19.4 13.2 6.9
Goodwill amortization........................................ 0.9 0.9 0.9
Store restructuring and other charges........................ 226.5 1.5 16.6
----------- ----------- -----------
Operating income (loss)...................................... (165.7) 80.0 73.8
Interest:
Debt -- expense............................................ 1.5 0.4 --
-- income............................................. (0.5) (1.7) (0.5)
Capital lease obligations -- expense....................... 7.7 4.8 3.2
----------- ----------- -----------
Income (loss) before income taxes and the effect of
accounting changes......................................... (174.4) 76.5 71.1
Income taxes................................................. (65.8) 21.6 24.1
----------- ----------- -----------
Net income (loss) before the effect of accounting changes.... (108.6) 54.9 47.0
Effect of accounting changes, net of income taxes............ (1.6) -- --
----------- ----------- -----------
Net income (loss)............................................ $ (107.0) $ 54.9 $ 47.0
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure (unaudited):
Net income (loss).......................................... $ (107.0) $ 54.9 $ 47.0
Add back of goodwill amortization.......................... 0.9 0.9 0.9
----------- ----------- -----------
Kmart Corporation earnings (losses) attributable to
Builders Square Group................................... $ (106.1) $ 55.8 $ 47.9
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-24
<PAGE> 364
BUILDERS SQUARE GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash.............................................................. $ 14.1 $ 30.6
Merchandise inventories (LIFO)
At replacement cost............................................. 657.3 548.8
Less -- LIFO reserve............................................ (48.1) (36.7)
----------- -----------
609.2 512.1
Accounts receivable and other current assets...................... 73.4 48.4
Deferred income taxes............................................. 34.8 --
Property held for resale.......................................... 68.8 31.9
----------- -----------
Total current assets................................................. 800.3 623.0
Property Owned:
Land.............................................................. 3.4 4.4
Buildings......................................................... 7.7 9.8
Leasehold improvements............................................ 92.0 83.3
Furniture and fixtures............................................ 204.8 167.7
Construction in progress.......................................... 29.3 23.4
Property under capital leases........................................ 109.0 75.2
----------- -----------
446.2 363.8
Less-accumulated depreciation and amortization:
Property owned.................................................... (158.2) (118.3)
Property under capital leases..................................... (27.4) (23.3)
----------- -----------
Total Owned and Leased Property...................................... 260.6 222.2
Other Assets and Deferred Charges.................................... 4.7 4.7
Deferred income taxes................................................ 38.4 --
Goodwill -- net of accumulated amortization of $8.0 and $7.1,
respectively...................................................... 26.1 26.9
----------- -----------
$ 1,130.1 $ 876.8
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year................................ $ 1.1 $ 0.2
Current portion of capital lease obligations...................... 2.9 2.3
Accounts payable -- trade......................................... 235.1 226.2
Accrued payrolls and other liabilities............................ 63.9 41.2
Taxes other than income taxes..................................... 15.8 12.4
Income taxes...................................................... -- 1.3
----------- -----------
Total current liabilities............................................ 318.8 283.6
Capital Lease Obligations............................................ 88.5 57.9
Long-Term Debt....................................................... 15.6 13.3
Other Long-Term Liabilities (includes store restructuring
obligations)...................................................... 175.3 17.2
Deferred Income Taxes................................................ -- 10.9
Builders Square Group Equity......................................... 531.9 493.9
----------- -----------
$ 1,130.1 $ 876.8
----------- -----------
----------- -----------
Supplemental disclosure (unaudited):
Builders Square Group Equity...................................... $ 531.9 $ 493.9
Add back of accumulated goodwill amortization..................... 8.0 7.1
----------- -----------
Kmart Corporation equity attributable to Builders Square Group.... $ 539.9 $ 501.0
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-25
<PAGE> 365
BUILDERS SQUARE GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income (loss) before the effect of accounting
changes................................................. $(108.6) $ 54.9 $ 47.0
Adjustments to reconcile net income to operating cash
flows:
Depreciation and amortization........................... 35.3 29.6 27.5
Store restructuring and other charges................... 205.4 0.2 6.0
Deferred income taxes................................... (80.7) 2.4 5.3
Increase (decrease) in other long-term liabilities...... 3.6 (1.4) 30.1
Other -- net............................................ 6.2 5.5 3.3
Cash provided by (used for) current assets and current
liabilities:
Increase in inventories................................. (110.5) (107.4) (6.0)
Increase in accounts payable............................ 9.0 103.0 18.5
Other -- net............................................ (52.4) (19.0) (21.3)
----------- ----------- -----------
Net cash provided by (used for) operations................. (92.7) 67.8 110.4
----------- ----------- -----------
INVESTING
Capital expenditures -- owned property..................... (77.7) (57.2) (44.8)
Proceeds from sale of assets............................... 8.2 -- --
Other -- net............................................... -- (2.3) 5.1
----------- ----------- -----------
Net cash used for investing................................ (69.5) (59.5) (39.7)
----------- ----------- -----------
FINANCING
Proceeds from issuance of long-term debt................... 3.9 13.5 --
Reduction in long-term debt................................ (0.6) -- --
Net equity transactions with the Kmart Group............... 145.0 (7.9) (63.7)
Reduction in capital lease obligations..................... (2.6) (1.9) (1.5)
----------- ----------- -----------
Net cash provided by (used for) financing.................. 145.7 3.7 (65.2)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS.............. (16.5) 12.0 5.5
Cash and Equivalents at Beginning of Year.................. 30.6 18.6 13.1
----------- ----------- -----------
CASH AND EQUIVALENTS AT END OF YEAR.......................... $ 14.1 $ 30.6 $ 18.6
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure of cash flow information:
Interest paid.............................................. $ 9.0 $ 4.9 $ 2.9
Income taxes paid.......................................... $ 9.6 $ 22.4 $ 22.6
Capital lease obligations incurred......................... $ 33.8 $ 29.7 $ 7.2
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-26
<PAGE> 366
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
BASIS OF PRESENTATION
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue four new series of
common stock (collectively, the Specialty Retail Stock) designated KM-
Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of each specialty retail business. The Borders-Walden Stock is
intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the initial issuance of any series of Specialty Retail Stock, the
existing common stock would be redesignated as Kmart Group Common Stock (Kmart
Stock). The Kmart Stock, while constituting common stock of Kmart Corporation,
is intended to reflect the separate performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) Kmart Corporation's interest in each Specialty Retail Group (a Retained
Interest) other than the interest represented by any outstanding shares of any
series of Specialty Retail Stock and (iii) all other businesses in which Kmart
Corporation and its subsidiaries are engaged. The Kmart Group and the Specialty
Retail Groups are referred to collectively herein as the Groups.
Following approval by shareholders of the Specialty Retail Stock Proposal,
Kmart Corporation currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate initial public offerings (collectively, the Offerings) and to allocate
the proceeds of the Offerings to the Kmart Group to repay outstanding
indebtedness of Kmart Corporation, resulting in reduced debt service obligations
attributable to the Kmart Group. The timing, sequence and size of such Offerings
and the price at which such shares would be sold would be determined by the
Board, without further approval of shareholders, at the time of each Offering;
however, it is currently contemplated that Kmart Corporation would initially
offer to the public shares of each series of Specialty Retail Stock that would
be intended to represent approximately 20% to 30% of the equity value of Kmart
Corporation attributed to the relevant Specialty Retail Group as determined by
the Board (Equity Value) at the time of such Offering. Therefore, it is expected
that Kmart Corporation would retain and attribute to the Kmart Group a 70% to
80% Retained Interest in each such Specialty Retail Group. The terms of each
Offering would be determined by the Board and the underwriters of such Offering
based upon prevailing market conditions; the financial condition and results of
operations of the relevant Group; the history of and prospects for the relevant
Group; the specialty retail industry and the segment of that industry in which
the relevant Group competes; the management and operations of the relevant
Group; the progress of the relevant Group in implementing its business strategy;
the foregoing factors in relation to market values of other companies engaged in
similar businesses; and the financial condition of Kmart Corporation as a whole.
In addition to or in lieu of any Offering, the Board reserves the right to issue
shares of any series of Specialty Retail Stock as a distribution on
VIII-27
<PAGE> 367
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Kmart Stock, although the Board has no current intention to do so. The
determination of whether to proceed with an Offering of any series of Specialty
Retail Stock would be made by the Board based on, among other things, the
proposed terms of such Offering and the then prevailing market and other
conditions. The Board reserves the right not to proceed with any or all of the
Offerings, without further approval of shareholders, if it determines that
consummation of such Offering or Offerings is not in the best interests of Kmart
Corporation.
The financial statements of the Groups comprise all of the accounts
included in the corresponding consolidated financial statements of Kmart
Corporation. The separate Group financial statements give effect to the
management and accounting policies that would be applicable upon implementation
of the Specialty Retail Stock Proposal, except that no inter-Group interest
expense or inter-Group interest income is reflected , as more fully described
under "Corporate Activities" below. However, following implementation of the
Specialty Retail Stock Proposal and issuance of each Specialty Retail Stock, the
financial statements of each Specialty Retail Group would reflect interest
expense related to net cash provided by Kmart Corporation. The separate Group
financial statements have been prepared on a basis that management believes to
be reasonable and appropriate and include (i) the combined historical financial
position, results of operations and cash flows of the businesses that comprise
each of the Groups and (ii) a portion of the assets and liabilities (including
contingent liabilities) and related transactions of Kmart Corporation that are
not separately identified with the operations of a specific Group. The effects
of the issuance of the equity securities described above have not been reflected
in these historical financial statements.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, following issuance of any series of Specialty Retail
Stock, Kmart Corporation would provide to holders of Builders Square Stock
separate financial statements, management's discussion and analysis of financial
condition and results of operations, business descriptions and other information
for the Builders Square Group and for Kmart Corporation. Notwithstanding the
allocation of assets and liabilities (including contingent liabilities),
shareholders' equity and items of income and expense among the Groups for
purposes of preparing their respective financial statements, the change in the
capital structure of Kmart Corporation contemplated by the Specialty Retail
Stock Proposal would not affect the respective legal title to assets or
responsibility for liabilities of Kmart Corporation or any of its subsidiaries.
Kmart Corporation and its subsidiaries would each continue to be responsible for
their respective liabilities. Holders of Builders Square Stock and of each other
series of common stock of Kmart Corporation would be holders of common stock of
Kmart Corporation and would continue to be subject to risks associated with an
investment in Kmart Corporation and all of its businesses, assets and
liabilities. The Specialty Retail Stock Proposal would not affect the rights of
creditors of Kmart Corporation.
Financial effects arising from any Group that affect the consolidated
results of operations or financial condition of Kmart Corporation could affect
the results of operations or financial condition of the Builders Square Group or
the market price of shares of the Builders Square Stock. In addition, net losses
of any Group, dividends and distributions on any series of common stock or
preferred stock, repurchases of any series of common stock and certain
repurchases of preferred stock would reduce the assets of Kmart Corporation
legally available for dividends on all series of common stock. Accordingly,
Kmart Corporation consolidated financial information should be read in
conjunction with the Builders Square Group financial information.
The dividend policy applicable to Builders Square Stock would be determined
by the Board at the time of issuance of such stock. Determinations to pay
dividends on Builders Square Stock would be based primarily upon the financial
condition, results of operations and business requirements of the Builders
Square Group and Kmart Corporation as a whole. Under the terms of the Builders
Square Stock, dividends would be payable at the sole discretion of the Board out
of the lesser of (i) all assets of Kmart Corporation legally available for
dividends and (ii) the Available Dividend Amount with respect to the Builders
Square Group.
VIII-28
<PAGE> 368
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The management and accounting policies applicable to the preparation of the
financial statements of the Builders Square Group could be modified or rescinded
by the Board, in its sole discretion and without the approval of shareholders,
although there is no present intention to do so. The Board could also adopt
additional policies depending upon the circumstances. Any determination by the
Board to modify or rescind such policies, or to adopt additional policies,
including any such decision that could have disparate effects upon holders of
different series of common stock, would be made by the Board in good faith and
in the honest belief that such decision is in the best interests of Kmart
Corporation. In addition, generally accepted accounting principles require that
changes in accounting policy must be preferable (in accordance with such
principles) to the policy previously in place.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Builders Square Group's significant accounting policies, which conform
to generally accepted accounting principles applied on a consistent basis
between years, are described below.
Fiscal Year: The Builders Square Group's fiscal year ends on the Sunday
prior to the last Wednesday in January. Fiscal years 1993, 1992 and 1991 each
consisted of 52 weeks and ended on January 23, 1994, January 24, 1993 and
January 26, 1992, respectively.
Earnings Per Common and Common Equivalent Share: Historical earnings per
share are omitted from the statements of income as Builders Square Stock was not
part of the capital structure of Kmart Corporation for the periods presented.
Following implementation of the Specialty Retail Stock Proposal, the method of
calculating earnings per share for Kmart Stock and each series of Specialty
Retail Stock would reflect the terms of the Certificate of Amendment which
provide that each Group's Available Dividend Amount, which, in turn, would
reflect the separately reported Kmart Corporation Earnings Attributable to the
Kmart Group, in the case of the Kmart Group, and Kmart Corporation Earnings
Attributable to a Specialty Retail Group, in the case of a Specialty Retail
Group, would be the source for payment of dividends for each series of common
stock, although liquidation rights of these series of stock and legally
available assets of Kmart Corporation may be more or less than these amounts.
Kmart Corporation would compute earnings per share of Builders Square Stock by
dividing the product of the Outstanding Interest Fraction and Kmart Corporation
Earnings Attributable to a Specialty Retail Group with respect to the Builders
Square Group by the weighted average number of shares of Builders Square Stock
and dilutive Builders Square Stock equivalents outstanding during the applicable
period. Kmart Corporation Earnings Attributable to a Specialty Retail Group with
respect to the Builders Square Group would generally equal the Builders Square
Group's net income or loss for the relevant period determined in accordance with
generally accepted accounting principles in effect at such time, reflecting
income and expenses of Kmart Corporation allocated to the Builders Square Group,
increased by the amount of amortization of goodwill of the Builders Square Group
during such period arising from acquisitions made by Kmart Corporation or its
subsidiaries with respect to the Builders Square Group before the first issuance
of Builders Square Stock. The Outstanding Interest Fraction with respect to the
Builders Square Group is the percentage interest in the Builders Square Group
intended to be represented at any time by the outstanding shares of Builders
Square Stock. See "Proposal 2 -- The Specialty Retail Stock Proposal -- Dividend
Policy -- Calculation of Earnings Per Share" of Kmart Corporation Proxy
Statement for an example of the calculation of Kmart Corporation Earnings
Attributable to a Specialty Retail Group with respect to Builders Square Stock.
Cash and Equivalents: Kmart Corporation considers cash on hand in stores,
deposits in banks, certificates of deposit and short-term marketable securities
with maturities of 90 days or less as cash and cash equivalents for the purposes
of the statement of cash flows.
VIII-29
<PAGE> 369
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Inventories: Merchandise inventories are valued on a last-in, first-out
(LIFO) basis at the lower of cost or market using the retail inventory method
and internal price indices to measure inflation in merchandise inventories.
Property Owned and Depreciation: Land, buildings, leasehold improvements
and equipment are recorded at cost, including a provision for capitalized
interest. Depreciation is provided over the estimated useful lives of related
assets on the straight-line method for financial statement purposes and on
accelerated methods for income tax purposes. Most store properties are leased
and improvements are amortized over the term of the lease but not more than 25
years. Other annual rates used in computing depreciation for financial statement
purposes are 2% for buildings, 14%-33% for store fixtures and 14%-33% for other
fixtures and equipment.
Expenditures for owned properties, primarily self-developed locations,
which the Builders Square Group intends to sell and lease-back within one year
are included in property held for resale.
Goodwill: The excess of cost over the fair value of net assets of the
Builders Square Group as of the September 23, 1984 date of acquisition of
Builders Square, Inc. by Kmart Corporation was capitalized and is being
amortized over 40 years using the straight-line method. The Builders Square
Group evaluates the recoverability of goodwill and reviews the amortization
period on an annual basis. Several factors are used to evaluate goodwill,
including but not limited to: management's plans for future operations; recent
operating results and each business' projected, undiscounted cash flows.
Financial Instruments: With the exception of long-term debt and Builders
Square Group equity, the Builders Square Group records all financial
instruments, including accounts receivable, accounts payable and marketable
securities at, or approximating, market value.
Pre-Opening and Closing Costs: Costs associated with the opening of a new
store are expensed at the time of a store's grand opening. When the decision to
close a retail unit is made, the Builders Square Group provides for the future
net lease obligation, nonrecoverable investment in fixed assets, other expenses
directly related to discontinuance of operations and estimated operating loss
through the expected closing dates.
CORPORATE ACTIVITIES
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of the Builders
Square Group are remitted to Kmart Corporation and cash disbursements of the
Builders Square Group are funded by Kmart Corporation on a daily basis. In the
historical financial statements of the Groups, (i) debt incurred by Kmart
Corporation and its subsidiaries, other than certain capital leases and
mortgages related specifically to the Specialty Retail Groups, has been
reflected on the financial statements of the Kmart Group and (ii) net cash used
or provided by each Specialty Retail Group has been characterized as an
adjustment of the Kmart Group's investment (reflected as Retained Interest) in
such Specialty Retail Group. Accordingly, no inter-Group interest expense or
inter-Group interest income is reflected in the historical financial statements
of the Builders Square Group. Until the issuance of Builders Square Stock, the
net cash used or provided by the Builders Square Group will continue to be
characterized as an adjustment to the Kmart Group's investment in the Builders
Square Group.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group when the debt is incurred or
the preferred stock is issued for the benefit of such Specialty Retail Group.
VIII-30
<PAGE> 370
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Following the issuance of Builders Square Stock, if cash used by the
Builders Square Group exceeds cash provided by the Builders Square Group, the
Kmart Group would transfer to the Builders Square Group the cash necessary to
fund excess uses. Conversely, if cash provided by the Builders Square Group
exceeds cash used by the Builders Square Group, the Builders Square Group would
transfer the excess cash to the Kmart Group. All cash transfers between Groups
would be accounted for as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be accounted
for as a long-term loan or, in the case of a transfer from the Kmart Group to
the Builders Square Group, an equity contribution. There are no specific
criteria to determine when a cash transfer would be classified as a long-term
loan or, in the case of a transfer from the Kmart Group to the Builders Square
Group, an equity contribution, rather than a short-term loan. Such determination
would be made by the Board in the exercise of its business judgment at the time
of such transfer (or the first of such type of transfer) based upon all relevant
circumstances, including the financing needs and objectives of the recipient
Group, the investment objectives of the transferring Group, prevailing interest
rates and general economic conditions. Such determination would affect the
amount of interest expense and interest income reflected in the financial
statements of the relevant Groups if such transfer were made as a short-term
loan or long-term loan and, in the case of a transfer from the Kmart Group to
the Builders Square Group as an equity contribution, the amount of Builders
Square Group equity and Retained Interest of the Kmart Group. Short-term loans
between the Kmart Group and the Builders Square Group would bear interest at
Kmart Corporation's daily short-term borrowing rate. In the event that the Board
determined that a transfer of funds between the Kmart Group and the Builders
Square Group should be made as a long-term loan, the Board would establish the
terms on which such loan would be made, including interest rate, amortization
schedule, maturity and redemption terms. Such terms would generally reflect the
then prevailing terms upon which Kmart Corporation could borrow funds on a
similar basis.
From time to time, following the initial issuance of Builders Square Stock,
the Board could determine that funds to be transferred from the Kmart Group to
the Builders Square Group represent an equity contribution to the Builders
Square Group rather than a loan. In such event, the Kmart Group's Retained
Interest in the Builders Square Group would be increased by the amount of such
contributions, as a result of which (i) the Number of Shares Issuable with
Respect to the Kmart Group's Retained Interest in the Builders Square Group
would be increased by an amount equal to the amount of such contribution divided
by the Market Value of a share of Builders Square Stock and (ii) the Kmart
Group's interest in the Builders Square Group would be increased and the
interest in the Builders Square Group represented by outstanding shares of
Builders Square Stock would be decreased accordingly. The Board could determine,
in its sole discretion, to make such contribution after consideration of a
number of factors including, among others, the relative levels of internally
generated cash flow of the Groups, the long-term business prospects for the
Builders Square Group, the capital expenditure plans of and investment
opportunities available to the Builders Square Group and the availability, cost
and time associated with alternative financing sources.
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from the
Builders Square Group, and the balance sheets of the Builders Square Group would
reflect its net short-term and net long-term loans to or borrowings from the
Kmart Group. Similarly, the income statements of the Kmart Group and the
Builders Square Group would reflect interest income or expense, as the case may
be, associated with such loans or borrowings and the statements of cash flows of
the Kmart Group and the Builders Square Group would reflect changes in the
amounts thereof deemed outstanding. In view of the anticipated cash needs of the
Builders Square Group over the next several years, it is currently expected that
the Kmart Group would provide net cash to the Builders Square Group. After
considering all relevant factors, the Kmart Group would obtain such funds from
internal operations, excess cash from other Specialty Retail Groups, external
debt financing or additional equity issuances. Accordingly, unlike these
historical financial statements, following implementation of the Specialty
VIII-31
<PAGE> 371
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Retail Stock Proposal and issuance of Builders Square Stock, the financial
statements of the Builders Square Group would reflect interest expense related
to net cash provided by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to the Builders Square Group would continue to be made at the
discretion of the Board. Nothing in the foregoing policies obligates the Board
to cause the Kmart Group to provide funds to the Builders Square Group if the
Board determines it is in the best interest of Kmart Corporation not to do so.
Certain corporate, general and administrative costs (including certain
corporate borrowing, legal, tax, transportation and import, data processing,
employee benefit and self-insurance costs) have been charged to the Specialty
Retail Groups based upon utilization and at negotiated rates which management
believes approximate the rates which each of the Specialty Retail Groups would
incur as stand-alone entities. The Builders Square Group financial statements
also include an allocation, which management believes to be reasonable, of
corporate, general and administrative costs related specifically to the
management of the Specialty Retail Groups and allocated equally among the
Specialty Retail Groups of $0.1 in each of 1993, 1992 and 1991. Amounts
allocated in these historical financial statements were calculated on the same
basis as would be used prospectively, and management believes that the
historical allocation of such amounts is representative of the amounts which
would be allocated to each of the Specialty Retail Groups prospectively.
Income Taxes: All members of the Kmart Corporation consolidated group are
included in the consolidated United States federal income tax return filed by
Kmart Corporation. Accordingly, the provision for federal income taxes and the
related payments or refunds of tax are determined on a consolidated basis. The
financial statement provision and related tax payments or refunds have been
reflected in the individual Groups in accordance with Kmart Corporation's tax
allocation policy for such Groups. In general, such policy provides that the
consolidated tax provision is allocated among the Groups for individual Group
financial statement purposes based principally upon the financial income,
taxable income, credits, preferences and other amounts directly related to the
respective Groups.
For financial statement provision and tax settlement purposes, tax benefits
resulting from attributes (principally net operating losses), which cannot be
utilized by one of the Groups on a separate return basis but which can be
utilized on a consolidated basis in any given year, are allocated to the Group
which generates the attributes. However, if such tax benefits cannot be utilized
on a consolidated basis in that year or in a carry back year, such consolidated
tax effect is adjusted in a subsequent year to the extent necessary to allocate
tax benefits to the Group that would have realized the tax benefits on a
separate return basis.
The allocated Group amounts are not necessarily comparable to those that
would have resulted if the Groups had filed separate tax returns and, in certain
situations, could result in any of the Groups incurring more or less income tax
expense for financial reporting purposes.
Deferred income taxes are provided on temporary differences between the
financial reporting and tax basis of assets and liabilities.
STORE RESTRUCTURING AND OTHER CHARGES
On January 5, 1994, the Board approved a restructuring plan to convert
virtually all of the existing Builders Square stores to the new Builders Square
II format by 1997. The Builders Square II stores have an easier-to-shop layout
that utilizes a "store-within-a-store" format with substantially increased
customer service levels. In connection with the restructuring plan, the Builders
Square Group is closing selected Builders Square I stores, converting the
balance of existing Builders Square I stores to the Builders Square II format
and filling in existing and contiguous markets with Builders Square II stores.
During the next four years, the Builders Square Group currently expects to phase
out 117 Builders Square I stores by
VIII-32
<PAGE> 372
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
closing 8 stores, relocating 66 stores and renovating 43 stores. In addition,
the Builders Square Group plans to open approximately 10-20 new Builders Square
II stores during each of the next two years.
As a result of the restructuring plan, the Builders Square Group recorded a
pre-tax charge of $226.5 ($141.3, net of tax) in the fourth quarter of 1993 for
the estimated cost of closing, relocating or converting all Builders Square I
stores to the Builders Square II format. Of the total pre-tax charge, $214.5 is
for specifically-identified store relocations and renovations. These costs
include $144.2 for lease obligations, a $37.1 for the writedown of inventory to
be liquidated during the final closing of each store and $33.2 for the writedown
of fixed assets, primarily furniture and fixtures, to net realizable value. Such
charge does not include any provision for store occupancy, depreciation expense
or normal inventory markdowns prior to the closing or completion date of a
project. The remainder of the charge relates to a $12.0 accrual for a non-
routine legal judgment resulting from the insolvency of the insurer.
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
------ ----- -----
<S> <C> <C> <C>
Current:
Federal............................................................. $ 9.2 $19.1 $11.4
State and local..................................................... 1.1 1.1 0.3
Deferred:
Store restructuring and other charges............................... (79.7) 1.9 9.1
Excess of tax over book depreciation................................ 1.4 0.4 0.9
LIFO inventory...................................................... (0.2) (0.2) 3.9
Other............................................................... 2.4 (0.7) (1.5)
------ ----- -----
Total income taxes.................................................... $(65.8) $21.6 $24.1
------ ----- -----
------ ----- -----
</TABLE>
A reconciliation of the federal statutory rate to the Builders Square
Group's effective tax rate follows:
<TABLE>
<CAPTION>
1993 1992 1991 1993 1992 1991
------ ----- ----- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Federal statutory rate............................ $(61.0) $26.0 $24.2 (35.0)% 34.0% 34.0%
State and local taxes, net of federal tax
benefit......................................... (5.2) 0.7 -- (3.0) 0.9 --
Reversal of tax reserves.......................... -- (4.8) -- -- (6.3) --
Other............................................. 0.4 (0.3) (0.1) 0.3 (0.4) (0.1)
------ ----- ----- ----- ---- ----
Total income taxes...................... $(65.8) $21.6 $24.1 (37.7)% 28.2% 33.9%
------ ----- ----- ----- ---- ----
------ ----- ----- ----- ---- ----
</TABLE>
VIII-33
<PAGE> 373
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Deferred tax assets and liabilities resulted from the following:
<TABLE>
<CAPTION>
JANUARY 23,
1994
-----------
<S> <C>
Deferred tax assets:
Accruals and other liabilities................................................. $ 7.6
Capital leases................................................................. 2.9
Store restructuring obligations................................................ 82.7
Other.......................................................................... 2.1
-----------
Total deferred tax assets.............................................. 95.3
-----------
Deferred tax liabilities:
Inventory...................................................................... 10.7
Property and equipment......................................................... 10.7
Other.......................................................................... 0.7
-----------
Total deferred tax liabilities......................................... 22.1
-----------
Net deferred tax assets................................................ $73.2
-----------
-----------
</TABLE>
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax liabilities to
reflect enacted changes in the statutory federal income tax rate. The Builders
Square Group adopted FAS 109 as a cumulative effect of an accounting change in
the first quarter of 1993 resulting in a one-time credit to income of $2.9.
COMMITMENTS AND CONTINGENCIES
There are various claims, lawsuits and pending actions against the Builders
Square, Inc. incident to the operations of the Builders Square Group. It is the
opinion of management that the ultimate resolution of these matters will not
have a material effect on the Builders Square Group's liquidity, financial
position or results of operations.
LONG-TERM DEBT
Long-term debt is comprised of a mortgage secured by the Builders Square
Group's headquarters building in San Antonio, Texas. The terms of the debt
require semi-annual payments of $0.7 including principal and accruing interest
monthly at an annual rate of 8.59%, through October 1, 2004, at which time the
balance of $10.9 is due. Management believes the current fair value of the note
based upon current market conditions approximates $14.8.
In August 1993, the Builders Square Group entered into a note agreement
with the issuer of Builders Square Group's private label credit cards, for $3.9.
The terms of the note require daily interest, calculated at the prime rate, and
principal payments equal to 0.80% of the daily charges from the private label
credit card program to be paid on a monthly basis. If principal payments are not
sufficient to retire the note by September 1996, the remaining principal balance
will be due in full. Management believes based upon the short duration of the
note, the payment stream and credit market rates, that the carrying value of the
note approximates the current value.
VIII-34
<PAGE> 374
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
LEASES
Description of Leasing Arrangements: The Builders Square Group conducts
operations primarily in leased facilities. Store leases are generally for terms
of 25 years with multiple five-year renewal options which allow the Builders
Square Group the option to extend the life of the lease up to 50 years beyond
the initial noncancellable term.
Certain leases provide for additional rental payments based on a percent of
sales in excess of a specified base. Also, certain leases provide for the
payment by the lessee of executory costs (taxes, maintenance and insurance).
Lease Commitments: Future minimum lease payments at January 23, 1994 were
as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1994................................................................... $ 13.8 $ 85.0
1995................................................................... 13.8 84.5
1996................................................................... 13.7 83.0
1997................................................................... 13.4 81.2
1998................................................................... 12.9 79.5
Later years............................................................ 192.9 977.5
------- ---------
Total minimum lease payments........................................... 260.5 1,390.7
Less -- minimum sublease rental income................................... -- (13.9)
------- ---------
Net minimum lease payments............................................... 260.5 $ 1,376.8
---------
---------
Less:
Estimated executory costs.............................................. (53.7)
Amount representing interest........................................... (115.4)
-------
91.4
Portion due within one year.............................................. 2.9
-------
Long-term lease obligations.............................................. $ 88.5
-------
-------
</TABLE>
Rental Expense: A summary of operating lease rental expense and short-term
rentals follows:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Minimum rentals........................................................ $86.8 $68.4 $60.7
Percentage rentals..................................................... 2.6 3.1 2.3
----- ----- -----
Total.................................................................. $89.4 $71.5 $63.0
----- ----- -----
----- ----- -----
</TABLE>
VIII-35
<PAGE> 375
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Reconciliation of Capital Lease Information: The impact of recording
amortization and interest expense versus rent expense on capital leases follows:
<TABLE>
<CAPTION>
1993 1992 1991
------ ----- -----
<S> <C> <C> <C>
Amortization of capital lease property................................ $ 3.8 $ 2.4 $ 1.7
Interest expense related to obligations under capital leases.......... 7.7 4.8 3.2
------ ----- -----
Amounts charged to earnings........................................... 11.5 7.2 4.9
Related minimum lease payments net of executory costs................. (10.3) (6.7) (4.7)
------ ----- -----
Excess of amounts charged over related minimum lease payments......... $ 1.2 $ 0.5 $ 0.2
------ ----- -----
------ ----- -----
</TABLE>
Related minimum lease payments above exclude executory costs for 1993, 1992
and 1991 in the amounts of $1.5, $1.8 and $1.3, respectively.
PENSION PLANS
The Builders Square Group participates in Kmart Corporation's
non-contributory pension plans which cover most domestic employees who meet
certain requirements of age, length of service and hours worked per year.
Benefits paid to retirees are based upon age at retirement, years of credited
service and earnings. Kmart Corporation's policy is to fund at least the minimum
amounts required by the Employee Retirement Income Security Act of 1974. The
plans' assets consist primarily of equity securities, fixed income securities,
guaranteed insurance contracts and real estate. The portion of pension expense
and plan assets and obligations attributable to the Builders Square Group are
actuarially determined based on the attributes of the Builders Square Group's
plan participants, a method which management believes to be reasonable.
The following table presents the Builders Square Group's funded status
based on a proportionate share of plan assets, as described above, and amounts
recognized in the accompanying balance sheet at year end:
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
----------- -----------
<S> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits........................... $ (19.1) $ (8.7)
Estimated present value of non-vested benefits....................... (4.6) (3.4)
----------- -----------
Accumulated benefit obligation....................................... (23.7) (12.1)
Value of future pay increases........................................ (5.3) (6.3)
----------- -----------
Projected benefit obligation......................................... (29.0) (18.4)
Estimated market value of plan assets.................................. 22.7 17.2
----------- -----------
Plan assets under projected benefit obligation......................... (6.3) (1.2)
Unrecognized net asset................................................. (1.5) (1.4)
Unrecognized prior service cost........................................ 0.8 0.7
Unrecognized net loss and other........................................ 3.8 0.4
----------- -----------
Accrued pension costs........................................ $ (3.2) $ (1.5)
----------- -----------
----------- -----------
</TABLE>
VIII-36
<PAGE> 376
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The following table summarizes allocated pension costs and actuarial
assumptions:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Components of pension expense:
Normal service cost.................................................. $ 1.8 $ 1.7 $ 1.3
Interest cost on projected benefit obligation........................ 1.5 1.4 0.9
Return on plan assets................................................ (1.6) (1.3) (1.6)
Net amortization and deferral of other components.................... 0.3 (0.1) 0.7
----- ----- -----
Total.................................................................. $ 2.0 $ 1.7 $ 1.3
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates....................................................... 7.25% 8.50% 8.75%
Expected return on plan assets....................................... 9.50% 9.50% 9.50%
Salary increases..................................................... 4.50% 5.00% 5.00%
</TABLE>
OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS
The Builders Square Group adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. FAS 106 requires the Builders Square Group
to accrue for future postretirement medical benefits. In prior years, these
claims were expensed when paid. Net of applicable tax, a charge of $1.3 was
included in net income as the effect of an accounting change in the first
quarter of 1993.
In addition to Kmart Corporation's defined benefit pension plan, Kmart
Corporation sponsors a defined benefit health care plan that offers
postretirement medical benefits to full-time employees who have worked 10 years
and who have retired after age 55, with the option of participation in Kmart
Corporation's medical plan, until age 65. The plan is contributory, with retiree
contributions adjusted annually. The accounting for the plan anticipates future
cost-sharing changes to the written plan that are consistent with Kmart
Corporation's expressed intent to increase the retiree contribution rate
annually for the expected general inflation rate for that year. The portion of
postretirement expense and obligations attributable to the Builders Square Group
are actuarially determined based on the attributes of the Builders Square
Group's plan participants, a method which management believes to be reasonable.
In 1993, Kmart Corporation amended its plan to limit retiree benefits to 150% of
average per capita benefits.
VIII-37
<PAGE> 377
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The following table sets forth the plan's funded status reconciled with
amounts shown in the balance sheet.
<TABLE>
<CAPTION>
JANUARY 23,
1994
-----------
<S> <C>
Accumulated postretirement benefit obligation:
Other active plan participants................................................. $(1.3)
Plan assets at fair value........................................................ --
-----------
Accumulated postretirement benefit obligation in excess of plan assets........... (1.3)
Unrecognized prior service cost.................................................. (0.7)
Unrecognized net loss............................................................ 0.1
-----------
Accrued postretirement benefit cost.............................................. $(1.9)
-----------
-----------
</TABLE>
<TABLE>
<CAPTION>
1993
-----------
<S> <C>
Net periodic postretirement benefit cost includes the following components:
Service cost..................................................................... $ 0.2
Interest cost.................................................................... 0.1
Actual return on plan assets..................................................... --
Net amortization and deferral.................................................... (0.1)
-----------
Net periodic postretirement benefit cost.................................... $ 0.2
-----------
-----------
</TABLE>
The weighted-average annual assumed rate of increase in the per capita cost
of covered benefits (i.e., health care cost trend rate) is 11.3% in 1994. This
rate is assumed to decrease gradually to 5.25% by 2002 and remain at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amounts reported. For example, increasing the assumed health care cost
trend rates by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of January 23, 1994, by 0.2%, and the
aggregate of the service and interest cost components of net periodic
postretirement benefit cost for fiscal 1993 by 2.28%.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation at January 23, 1994 was 7.25%.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106 for similar benefits provided to
terminated or laid-off employees such as salary extension, severance, disability
and supplemental unemployment benefits. The effect of this statement on the
Builders Square Group is not significant.
EMPLOYEE SAVINGS PLAN
Employees of the Builders Square Group who meet certain requirements as to
age and service are eligible to participate in Kmart Corporation's Employee
Savings Plan. The Builders Square Group's expense related to the Employee
Savings Plan was $2.0, $1.8 and $1.4 for 1993, 1992 and 1991, respectively.
PERFORMANCE RESTRICTED STOCK PLAN
Certain officers and employees of the Builders Square Group participate in
Kmart Corporation's Performance Restricted Stock Plan and Stock Option Plan.
These plans are discussed in the respective footnotes to Kmart Corporation
consolidated financial statements. The Builders Square Group's allocation of
compensation expense related to the Performance Restricted Stock Plan was not
material.
VIII-38
<PAGE> 378
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
BUILDERS SQUARE GROUP EQUITY
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year................................. $ 493.9 $ 446.9 $ 463.6
Net income (loss)............................................ (107.0) 54.9 47.0
Net equity transactions with the Kmart Group:
Cash management, excluding items shown below............... 111.6 (42.0) (89.3)
Corporate, general and administrative expense allocation... 0.1 0.1 0.1
Participation in centrally managed employee benefit and
self-insurance programs................................. 33.3 34.0 25.5
----------- ----------- -----------
Balance at end of year....................................... $ 531.9 $ 493.9 $ 446.9
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions, between the Specialty Retail Groups and the
Kmart Group had been accounted for as short-term loans, on a pro forma basis the
Builders Square Group would have been charged inter-Group interest of $2.5
during 1993. Such pro forma interest expense has been calculated on daily
average borrowings outstanding using Kmart Corporation's weighted average
short-term borrowing rate. Such pro forma interest expense is not necessarily
indicative of the results which would occur had such offerings occurred on such
date, or what the interest expense would be prospectively.
VIII-39
<PAGE> 379
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE 39 WEEKS ENDED OCTOBER 24, 1993 -- CONTINUED
39 weeks sales for the 21 stores opened in the prior year. Comparable store
sales increased 0.4% in the first 39 weeks of 1993 versus an 8.7% increase for
the same period last year. The slower rate of comparable store sales growth in
the first 39 weeks of 1993 was a result of increased competition in the
Northeast and Midwest, severe winter weather conditions that continued into the
spring selling season and the strong comparable store sales growth reported in
the Southeast region in 1992 period as the result of rebuilding in the aftermath
of Hurricane Andrew.
Cost of merchandise sold, including buying and occupancy costs, for the 39
weeks ended October 24, 1993 was $1,620.3 million as compared to $1,435.4
million in the same period in the prior year. Gross margin as a percent of sales
was 22.9% in the first 39 weeks of 1993 as compared to 23.1% in the same period
in the prior year. The decrease in the 1993 period, as a percent of sales, was
primarily due to increased occupancy costs as a result of more BSQ II Stores,
and an increased last-in, first-out (LIFO) charge, partially offset by improved
merchandise margins in the 1993 period resulting from the sale of a greater
proportion of higher margin products in the BSQ II Stores. Gross margin as a
percent of sales on a first-in, first-out (FIFO) basis was 23.3% and 23.4% in
the 1993 and 1992 periods, respectively.
Selling, general and administrative (SG&A) expenses for the 39 weeks ended
October 24, 1993 was $410.5 million or 19.5% of sales, as compared to $357.2
million, or 19.1% of sales, in the same period in the prior year. The increase
as a percent of sales resulted primarily from increased store payroll expense
associated with improving the level of customer service in the stores, partially
offset by the leveraging of administrative salaries and expense over higher
sales volume.
Operating income before pre-opening expense and goodwill amortization in
1993 was $69.8 million, or 3.4% of sales, as compared with $74.4 million, or
4.0% of sales in 1992. The decrease of 0.6% was the result of lower gross
margins and higher SG&A costs.
Pre-opening expense for the 39 weeks ended October 24, 1993 was $20.1
million as compared to $12.2 million in the same period in the prior year.
Pre-opening expenses consist principally of grand-opening advertising expense
and store payroll and supply expense. Pre-opening costs are expensed at the time
of a store's grand opening. The increase was due to 28 store openings in the
first 39 weeks of 1993 as compared to 21 openings in the same period of 1992 and
to the higher pre-opening costs associated with the BSQ II Stores.
Goodwill amortization for the 39 weeks ended October 24, 1993 was $0.6
million in both the 1992 and 1991 periods.
As a result of the foregoing, operating income for the 39 weeks ended
October 24, 1993 was $49.1 million, or 2.4% of sales, as compared to $61.6
million, or 3.3% of sales, in the same period in the prior year.
Net interest expense for the 39 weeks ended October 24, 1993 was $5.9
million, or 0.3% of sales, as compared to $1.8 million, or 0.1% of sales, for
the same period in the prior year. The increase in interest expense was due to
the mortgage of the home office in the fourth quarter of 1992, increased capital
lease interest as a result of store openings, and the lower interest income
resulting from the inclusion of interest on a one-time IRS settlement in the
1992 period.
Income before income taxes and the effect of accounting changes for the 39
weeks ended October 24, 1993 was $43.2 million, or 2.1% of sales, as compared to
$59.8 million, or 3.2% of sales, in the same period last year.
Income tax expense for the 39 weeks ended October 24, 1993 was $15.7
million with an effective tax rate of 36.3% as compared to $20.8 million with an
effective tax rate of 34.8% in the same period of 1992. The increase in the
effective tax rate in the 1993 period reflected the 1.0% increase in the federal
corporate tax rate retroactive to January 1, 1993.
VIII-40
<PAGE> 380
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE 39 WEEKS ENDED OCTOBER 24, 1993 -- CONTINUED
Net income before the effect of accounting changes for the 39 weeks ended
October 24, 1993 was $27.5 million, or 1.3% of sales, as compared to $39.0
million, or 2.1% of sales, in the same period last year.
Effect of accounting changes, net of income tax. Builders Square adopted
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS 109) in
the first quarter of 1993. FAS 109 requires that deferred taxes be calculated
using the liability approach rather than the deferred method. A credit of $2.9
million has been included in net income as the effect of an accounting change.
Builders Square also adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. This statement requires that Builders
Square accrue for future postretirement medical benefits. In prior years, these
claims were expensed when paid. Net of applicable tax, a charge of $1.3 million
has been included in net income as the effect of an accounting change.
As the result of the foregoing factors, net income for the 39 weeks ended
October 24, 1993 was $29.1 million, or 1.4% of sales, as compared to $39.0
million, or 2.1% of sales, in the same period in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the 39 weeks ended October
24, 1993 are summarized below. The net increase in cash and equivalents for the
39 weeks ended October 24, 1993 was $7.4 million as compared to a $9.1 million
increase in cash and equivalents in the same period in the prior year.
Net cash used for operations for the 39 weeks ended October 24, 1993 was
$60.0 million as compared to net cash provided by operations of $3.0 million in
the same period of 1992. The change resulted primarily from a greater rate of
increase in inventory net of accounts payable in the 1993 period than in the
prior year as a result of a shift in the merchandise mix and increased carryover
of seasonal merchandise.
Net cash used for investing for the 39 weeks ended October 24, 1993 was
$56.0 million as compared to $28.8 million in the same period last year and was
comprised primarily of capital expenditures. Capital expenditures increased in
the first 39 weeks of 1993 due to seven more store openings in the 1993 period,
the conversion of existing stores to the BSQ II format and expansion of data
processing capacity.
Net cash provided by financing of $123.4 million and $34.9 million in the
first 39 weeks of 1993 and 1992, respectively, were comprised almost entirely of
equity contributions by the Kmart Group to fund Builders Square's long-and
short-term capital requirements and, in the first 39 weeks of 1992, $13.5
million in proceeds from the mortgage of the San Antonio headquarters building.
Due to the BSQ II strategy announced in January 1994, Builders Square is
expected to require capital in excess of funds generated from operations. Such
excess is expected to be funded by the Kmart Group. Builders Square also could
obtain funds from external debt financing and, following implementation of the
Specialty Retail Stock Proposal, from the sale of shares of Builders Square
Stock with the proceeds attributable to Builders Square. Builders Square
believes that funds generated from operations, together with the sources of
capital described above, will be sufficient to provide the liquidity and capital
resources necessary to fund its anticipated capital requirements for at least
the next two to three years.
VIII-41
<PAGE> 381
ANNEX IX
OFFICEMAX GROUP
<TABLE>
<S> <C>
Selected Financial Data............................................................. IX- 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................ IX- 3
Business Description................................................................ IX-11
Combined Financial Statements....................................................... IX-19
Unaudited Pro Forma Combined Financial Information.................................. IX-36
Financial Statements for the Fiscal Year Ended July 27, 1991........................ IX-37
Bizmart, Inc. Consolidated Financial Statements as of March 4, 1993................. IX-44
</TABLE>
IX-1
<PAGE> 382
OFFICEMAX GROUP
SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated reflect the
results of operations and financial position of the businesses that comprise the
OfficeMax Group. The information set forth below should be read in conjunction
with Management's Discussion and Analysis of Financial Condition and Results of
Operations and the combined financial statements and notes thereto included in
this Annex IX. The issuance of OfficeMax Stock pursuant to the Specialty Retail
Stock Proposal has not been reflected in these financial statements.
<TABLE>
<CAPTION>
52 WEEKS ENDED
---------------------------------------------------
JAN. JAN. JAN. JULY JULY
22, 23, 25, 27, 28,
1994(1) 1993(2) 1992(3) 1991(4) 1990(4)
------- ------- ------- ------- -------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Sales.............................................................. $1,421.8 $528.2 $245.0 $176.4 $ 65.4
Gross margin....................................................... 312.8 116.8 52.0 38.7 14.8
Selling, general and administrative expenses....................... 279.9 107.2 50.6 37.3 13.7
Pre-opening expense................................................ 4.3 4.7 2.7 2.0 1.2
Goodwill amortization.............................................. 8.6 4.4 1.0 0.5 0.1
------- ------- ------- ------- -------
Operating income (loss)............................................ 20.0 0.5 (2.3 ) (1.1 ) (0.2 )
Interest (income) expense-net...................................... 0.1 (0.5 ) (2.1 ) (2.0 ) (0.7 )
------- ------- ------- ------- -------
Income (loss) before income taxes.................................. 19.9 1.0 (0.2 ) 0.9 0.5
Income taxes....................................................... 9.1 1.8 0.8 0.5 0.2
------- ------- ------- ------- -------
Net income (loss).................................................. $ 10.8 $ (0.8 ) $ (1.0 ) $ 0.4 $ 0.3
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Add back of goodwill amortization.................................. 8.6 4.4 1.0
------- ------- -------
Kmart Corporation earnings attributable to OfficeMax Group......... $ 19.4 $ 3.6 $ --
------- ------- -------
------- ------- -------
PERCENT OF SALES DATA
Gross margin....................................................... 22.0% 22.1 % 21.2 % 21.9 % 22.6 %
Selling, general and administrative expenses....................... 19.7 20.3 20.6 21.1 20.9
Operating income (loss)............................................ 1.4 0.1 (0.9 ) (0.6 ) (0.3 )
Income (loss) before income taxes.................................. 1.4 0.2 (0.1 ) 0.5 0.8
BALANCE SHEET DATA -- END OF PERIOD
Working capital.................................................... $ 113.6 $ 30.6 $ 43.9 $ 53.2 $ 22.2
Total assets....................................................... 1,009.7 448.6 275.1 119.7 67.2
OfficeMax Group equity............................................. 608.5 258.2 188.1 79.9 44.0
SELECTED FINANCIAL AND OPERATING DATA
Operating income before pre-opening expense and goodwill
amortization..................................................... $ 32.9 $ 9.6 $ 1.4 $ 1.4 $ 1.1
End of year stores................................................. 328 179 79 60 31
Comparable store sales increase(5)................................. 18.2% 28.5 % 20.2 % 14.3 % 53.2 %
Capital expenditures -- owned property............................. $ 57.3 $ 21.2 $ 8.9 $ 4.8 $ 2.8
Depreciation and amortization...................................... 26.3 9.9 3.3 2.2 0.8
</TABLE>
- -------------------------
(1) Data for the period ended January 22, 1994 reflects the acquisition of
BizMart, Inc. on March 4, 1993.
(2) Data for the period ended January 23, 1993 reflects the acquisition of OW
Office Warehouse, Inc. on June 30, 1992.
(3) Data for the 52 weeks ended January 25, 1992 combine the 43 week period
ended November 20, 1991 with the nine week period ended January 25, 1992,
which are periods before and after the date on which Kmart Corporation
increased its equity interest in OfficeMax to 92.7%.
(4) The results of operations for the periods ended July 27, 1991 and July 28,
1990 represent historical results of operations for OfficeMax, Inc. before
Kmart Corporation's initial acquisition of a 21.6% equity interest in
OfficeMax, Inc. Data regarding Kmart Corporation earnings attributable to
OfficeMax Group are, therefore, not presented for these periods.
(5) Comparable store sales include the sales of a store beginning on the first
day of the 53rd week of operation.
IX-2
<PAGE> 383
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The OfficeMax Group ("OfficeMax") is one of the largest operators of
high-volume, deep discount office products superstores in the United States. At
January 22, 1994, OfficeMax operated 328 superstores, averaging approximately
23,000 square feet in 38 states. OfficeMax had net sales of $1,421.8 million and
$528.2 million for the fiscal years ended January 22, 1994 and January 23, 1993,
respectively.
Since its inception in 1988, OfficeMax has pursued an aggressive expansion
strategy which has included growth both through the opening of 170 net new
stores and through the acquisition of four office products superstore chains
operating an aggregate of 158 stores. In 1990, OfficeMax acquired Office World,
Inc., a deep discount office products retailer operating seven stores in the
Greater Chicago area and Office Square, a division of Kmart Corporation
("Kmart") which operated five deep discount office products superstores in
Chicago and Akron/Canton markets. In June 1992, OfficeMax acquired OW Office
Warehouse, Inc. which operated 41 deep discount office products superstores
located primarily throughout the Mid-Atlantic region. After each of these
acquisitions, the acquired stores were immediately operationally integrated,
remodeled, remerchandised and converted to the OfficeMax name and format. In
March 1993, OfficeMax purchased all of the outstanding shares of BizMart, Inc.,
a chain of 105 office products superstores, for $267.7 million. During 1993,
BizMart stores were operationally integrated, remodeled, remerchandised and
converted to the OfficeMax name and format.
On October 26, 1993, OfficeMax purchased a 19.9% (17.5% on a fully diluted
basis) equity interest in Corporate Express, Inc. ("Corporate Express"), a
Colorado-based contract stationer, for $23.5 million, which interest was diluted
to approximately 14.4% (12.5% on a fully diluted basis) on February 28, 1994
upon the acquisition by Corporate Express of the office products division of
Hanson, PLC. As part of OfficeMax's agreement with Corporate Express, OfficeMax
has the right in 1997, under certain circumstances, to increase its holdings in
Corporate Express to between 51% and 100%. The Corporate Express investment is
being accounted for under the cost method of accounting.
OfficeMax plans to open approximately 60 to 70 stores in each of the next
two years, subject to the availability of desirable locations and the
negotiation of acceptable lease terms. Management estimates that OfficeMax's
cash requirements, exclusive of pre-opening expenses, will be approximately $1.0
million for each additional store. These requirements include an average of
approximately $0.4 million for leasehold improvements, fixtures, point-of-sale
terminals and other equipment in the stores, and approximately $0.6 million for
the portion of store inventory that is not financed by vendors.
OfficeMax's fiscal year ends on the Saturday prior to the last Wednesday in
January. Prior to November 21, 1991 OfficeMax, Inc.'s fiscal year ended on the
last Saturday in July. OfficeMax's 1993 and 1992 fiscal years consisted of the
52 weeks ended on January 22, 1994 and January 23, 1993, respectively. OfficeMax
information for the 52 weeks ended January 25, 1992 combines the 43 week period
ended November 20, 1991 with the nine week period ended January 25, 1992, which
are periods before and after Kmart's acquisition of a 92.7% interest in
OfficeMax, Inc., respectively. Goodwill amortization may not be comparable with
prior periods. The impact of this difference is discussed below.
IX-3
<PAGE> 384
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
RESULTS OF OPERATIONS
The following table presents OfficeMax's income statement data and such
data as a percent of sales, for the three most recent periods:
<TABLE>
<CAPTION>
FISCAL YEAR FISCAL YEAR 52 WEEKS
ENDED ENDED ENDED
JANUARY 22, % OF JANUARY 23, % OF JANUARY 25, % OF
1994 SALES 1993 SALES 1992 SALES
----------- ----- ----------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN MILLIONS)
Sales................................ $1,421.8 100.0% $ 528.2 100.0% $ 245.0 100.0%
Cost of merchandise sold, includes
buying and occupancy costs......... 1,109.0 78.0 411.4 77.9 193.0 78.8
----------- ----- ----------- ----- ----------- -----
Gross margin......................... 312.8 22.0 116.8 22.1 52.0 21.2
Selling, general and administrative
expenses........................... 279.9 19.7 107.2 20.3 50.6 20.6
Pre-opening expense.................. 4.3 0.3 4.7 0.9 2.7 1.1
Goodwill amortization................ 8.6 0.6 4.4 0.8 1.0 0.4
----------- ----- ----------- ----- ----------- -----
Operating income (loss).............. 20.0 1.4 0.5 0.1 (2.3) (0.9)
Net interest (income) expense........ 0.1 -- (0.5) (0.1) (2.1) (0.8)
----------- ----- ----------- ----- ----------- -----
Income (loss) before income taxes.... 19.9 1.4 1.0 0.2 (0.2) (0.1)
Income taxes......................... 9.1 0.6 1.8 0.3 0.8 0.3
----------- ----- ----------- ----- ----------- -----
Net income (loss).................... $ 10.8 0.8% $ (0.8) (0.1)% $ (1.0) (0.4)%
----------- ----- ----------- ----- ----------- -----
----------- ----- ----------- ----- ----------- -----
</TABLE>
Store Activity. OfficeMax's store activity is summarized below:
<TABLE>
<CAPTION>
FISCAL YEAR FISCAL YEAR 52 WEEKS
ENDED ENDED ENDED
JANUARY 22, JANUARY 23, JANUARY 25,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Beginning number of stores.................................. 179 79 46
Openings.................................................... 53 61 33
Acquisitions................................................ 105 41 --
Closings.................................................... (9) (2) --
--- --- --
Ending number of stores..................................... 328 179 79
--- --- --
--- --- --
</TABLE>
Fiscal Years Ended January 22, 1994 (fiscal 1993) and January 23, 1993 (fiscal
1992)
Sales for fiscal 1993 were $1,421.8 million, an $893.6 million, or 169.2%,
increase over fiscal 1992 sales of $528.2 million. The increase was due to the
opening of 53 new stores, the acquisition of 105 BizMart stores in March 1993,
the inclusion of a full year sales for the OW Office Warehouse, Inc. stores
acquired in June 1992, the 61 new stores opened during fiscal 1992 and an 18.2%
comparable store sales increase in fiscal 1993.
Cost of merchandise sold, including buying and occupancy costs, increased
to 78.0% of sales in fiscal 1993 from 77.9% in fiscal 1992. As a percent of
sales, gross margin was 22.0% in fiscal 1993, as compared to 22.1% in fiscal
1992. The decrease in gross margin was attributable to a change in the
merchandise mix offset by improved gross margin and the leveraging of occupancy
costs. Approximately 70% of the shift in merchandise mix was due to the
acquisition of BizMart, whose historical computer sales as a percentage of total
sales were substantially higher than those of OfficeMax. Through the conversion
and remerchandising of these stores to
IX-4
<PAGE> 385
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
the OfficeMax concept, computer sales in the BizMart stores as a percentage of
total sales have, during the year, decreased significantly relative to
pre-acquisition levels.
Despite the decrease in total gross margin due to mix, gross margins on
each of computer and non-computer office products increased during fiscal 1993
compared to fiscal 1992. In addition, OfficeMax continued to benefit from
enhanced operating leverage with respect to occupancy costs due to increased
store sales volume in fiscal 1993.
Selling, general and administrative ("SG&A") expenses decreased to 19.7% of
sales in fiscal 1993 from 20.3% of sales in the prior year as a result of
expense control and leveraging of OfficeMax corporate overhead. This improvement
was partially offset by the opening of 53 new stores during fiscal 1993. In
general, new stores generate lower sales than established stores, resulting in
higher selling and store operating expenses as a percentage of sales. In
addition, OfficeMax acquired BizMart in 1993 and integrated 105 stores and all
of its operations, including general and administration functions, resulting in
operations and overhead efficiencies. SG&A expenses consist primarily of store
payroll and operating expenses, OfficeMax corporate overhead and advertising.
General and administrative expenses decreased as a percent of sales to 1.9% in
fiscal 1993 from 2.5% in the prior year due to the leveraging of OfficeMax
corporate overhead as a result of increased store sales volumes.
Pre-opening expense was $4.3 million in fiscal 1993, as compared to $4.7
million in the prior year reflecting the opening of 53 new stores, excluding
acquired stores, versus 61 new stores, in the prior year. On a per store basis,
the average cost per new store remained relatively constant at $0.1 million.
Pre-opening expenses consist principally of store payroll and supplies, and are
expensed during the first full month of the store's operation. No pre-opening
expense is associated with acquired stores.
Goodwill amortization was $8.6 million in fiscal 1993, as compared to $4.4
million in the prior year. The increase resulted from the inclusion of
amortization of goodwill associated with the March 1993 acquisition of BizMart
and a full year of amortization related to the acquisition of 41 OW Office
Warehouse, Inc. stores in June 1992. Goodwill is capitalized and amortized over
40 years using the straight-line method.
Operating income was $20.0 million in fiscal 1993, or 1.4% of sales, as
compared to $0.5 million in fiscal 1992, or 0.1% of sales, as a result of the
aforementioned effective cost control and the leveraging of selling, general and
administrative expenses, pre-opening expense, and goodwill amortization as a
result of increased store sales volumes.
Net interest (income) expense was $0.1 million in fiscal 1993, as compared
to $(0.5) million in the prior year primarily due to the reduction of interest
bearing short-term cash investments. These investments were primarily funded
with proceeds from Kmart's initial acquisition of a 21.6% equity interest in
OfficeMax, Inc. in November 1990 and were reduced to fund operating and capital
expenditure needs since then.
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board of Directors ("Board")
makes a specific determination that a given transfer (or type of transfer)
should be made as a long-term loan or, in the case of a transfer from the Kmart
Group to a Specialty Retail Group, an equity contribution. These historical
financial statements present all cash transfers between the Specialty Retail
Groups and the Kmart Group as equity transactions with the Kmart Group. Had the
offerings been completed on February 1, 1993, and assuming that all cash
transactions, except those relating to acquisitions, between the Specialty
Retail Groups and the Kmart Group had been accounted for as short-term loans, on
a pro forma basis OfficeMax would have been charged inter-Group interest of $2.1
million during 1993. Such pro forma interest expense has been calculated on
daily average borrowings outstanding using Kmart Corporation's weighted average
short-term borrowing rate. Such pro forma interest expense is not necessarily
indicative of the results which would occur had such offerings occurred on such
date, or what the interest expense would be prospectively.
IX-5
<PAGE> 386
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Income tax expense was $9.1 million with an effective rate of 45.7% in
fiscal 1993, as compared to $1.8 million with an effective rate of 180.0% in the
prior year. The effective tax rates for both periods were different from the
statutory income tax rate due primarily to non-deductible goodwill amortization
expense.
As a result of the foregoing factors, net income (loss) in fiscal 1993 was
$10.8 million, or 0.8% of sales, as compared to $(0.8) million, or (0.1)% of
sales in the prior year.
Fiscal Year Ended January 23, 1993 (fiscal 1992) and 52 Weeks Ended January 25,
1992 (1991)
Sales in fiscal 1992 were $528.2 million, a $283.2 million, or 115.6%,
increase over sales of $245.0 million in the prior year. The increase was
primarily due to the opening of 61 new stores, the acquisition of 41 OW Office
Warehouse, Inc. stores, the inclusion of a full year sales relating to 33 stores
opened during the prior year and a 28.5% comparable store sales increase.
Cost of merchandise sold, including buying and occupancy costs in fiscal
1992 was $411.4 as compared to $193.0 million in the same period in the prior
year. Gross margin, as a percent of sales, was 22.1% in fiscal 1992, as compared
to 21.2% in the same period in the prior year. The increase in gross margin was
primarily due to cost reductions resulting from increased purchasing power which
yielded volume discounts and leveraging of occupancy expenses which is a
function of increased store sales volumes.
Selling, general and administrative expenses in fiscal 1992 were $107.2
million, or 20.3% of sales, as compared to $50.6 million, or 20.6% of sales, in
the prior year as a result of expense control and the leveraging of OfficeMax
corporate overhead and advertising expenses as a result of increased store sales
volumes. This improvement was partially offset by the opening of 61 new stores
during fiscal 1992. In general, new stores generate lower sales than established
stores, resulting in higher selling and store operating expenses as a percent of
sales. The opening of new stores also resulted in an increase in certain
operating expenses, but this increase was offset by the leveraging of
advertising expense with increased sales volume. In addition, OfficeMax acquired
OW Office Warehouse, Inc. in 1992 and integrated 41 stores and all of its
operations, including general and administrative functions, resulting in
operational and overhead efficiencies. SG&A expenses consist primarily of store
payroll and operating expenses, OfficeMax corporate overhead and advertising.
General and administrative expenses decreased as a percent of sales to 2.5% in
fiscal 1992 from 2.9% in the same period in the prior year due to the leveraging
of OfficeMax corporate overhead as a result of increased store sales volumes.
Pre-opening expense in fiscal 1992 was $4.7 million, or 0.9% of sales, as
compared to $2.7 million, or 1.1% of sales, in the prior year, reflecting the
opening of 61 new stores in fiscal 1992 as compared to 33 new stores in the
prior year. On a per store basis, the average cost per new store remained
relatively constant at $0.1 million. Pre-opening expenses consist principally of
store payroll and supplies and are expensed during the first full month of the
store's operation. No pre-opening expense is associated with acquired stores.
Goodwill amortization in fiscal 1992 was $4.4 million, as compared to $1.0
million in the prior year. The increase resulted from the goodwill associated
with the June 1992 OW Office Warehouse, Inc. acquisition and the inclusion of a
full year of amortization resulting from Kmart's increase in its equity interest
in OfficeMax, Inc. in November 1991 to 92.7%. Kmart currently has a %
interest in OfficeMax, Inc.
Operating income (loss) in fiscal 1992 was $0.5 million, as compared to
$(2.3) million in the prior year, as a result of the aforementioned gross margin
improvement, effective cost control and the leveraging of selling, general and
administrative expenses as a result of increased store sales volumes.
IX-6
<PAGE> 387
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Net interest income in fiscal 1992 was $0.5 million, or 0.1% of sales, as
compared to $2.1 million, or 0.8% of sales, in the prior year, primarily due to
the reduction of interest bearing short-term cash investments. These investments
were primarily funded with proceeds from Kmart's initial acquisition of a 21.6%
equity interest in OfficeMax, Inc. in November 1990 and have been reduced to
fund operating and capital expenditure needs since then.
Income tax expense in fiscal 1992 was $1.8 million, or 0.3% of sales, as
compared to a $0.8 million, or 0.3% of sales in the prior year. The effective
tax rates for both years were different from the statutory income tax rate due
primarily to non-deductible goodwill amortization expense.
As a result of the foregoing factors, net loss for fiscal 1992 was $0.8
million, or 0.1% of sales, as compared to $1.0 million, or 0.4% of sales, in the
prior year.
LIQUIDITY AND CAPITAL RESOURCES
OfficeMax's principal capital requirements have been to fund working
capital needs, the opening of new stores and acquisitions. During the periods
presented, these capital requirements have generally been satisfied by equity
contributions from Kmart Corporation and, to a lesser extent, by cash flows from
operations.
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the two fiscal years ended
January 22, 1994 and January 23, 1993 are summarized below. The net cash and
equivalents increases (decreases) were $17.6 million in 1993 and $(31.2) million
for 1992.
Net cash provided by operations in 1993 was $27.3 million as compared to
$6.8 million in the prior year. The change resulted from the net impact of a
number of factors including increased net income as a result of continued growth
and improvement in OfficeMax's operations. Depreciation and amortization expense
increased $16.4 million due to increased amortization and increased depreciation
of a growing base of leasehold improvements and fixtures. The other significant
items affecting cash from operations are the net effect of expanding the store
base by 53 new store locations and increased sales in existing locations, which
resulted in increased net inventory requirements. This is reflected in the
increase in both inventories and accounts payable.
Net cash used for investing in 1993 was $348.5 million as compared to $92.4
million in 1992. Net cash used for investing in 1993 consisted primarily of
$267.7 million for the BizMart acquisition, $57.3 million of capital
expenditures relating to 53 new store openings and the renovation of existing
stores, and $23.5 million for the equity investment in Corporate Express. Net
cash used for investing in 1992 consisted primarily of $71.7 million for the OW
Office Warehouse, Inc. acquisition and $21.2 million for capital expenditures.
During fiscal 1993 and fiscal 1992, OfficeMax completed its acquisitions of
BizMart and OW Office Warehouse, respectively. Subsequent to each acquisition,
the acquired stores were operationally integrated, remodeled, remerchandised and
converted to the OfficeMax name and format. OfficeMax does not anticipate
significant future expenditures for conversion or remodeling of acquired stores.
Net cash provided by financing of $338.8 million and $54.4 million in 1993
and 1992, respectively, was comprised almost entirely of net equity transactions
with the Kmart Group primarily to fund acquisitions and capital expenditures.
On March 4, 1993, OfficeMax purchased all of the outstanding shares of
BizMart, Inc., a chain of 105 office products superstores, for $267.7 million.
During 1993, BizMart stores were operationally integrated, remodeled,
remerchandised and converted to the OfficeMax name and format. The BizMart
acquisition is being accounted for under the purchase method of accounting.
Excess of cost over the fair value of the assets
IX-7
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OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
acquired totaled $185.5 million and was recorded as goodwill. Goodwill resulting
from this acquisition is being amortized on a straight-line basis over 40 years.
On June 30, 1992, OfficeMax purchased all of the outstanding shares of OW
Office Warehouse, Inc. a chain of 41 office products superstores, for $71.7
million. The OW Office Warehouse, Inc. acquisition is being accounted for under
the purchase method of accounting. Excess of cost over the fair value of the
assets acquired totaled $60.7 million on January 22, 1994 and was recorded as
goodwill. Goodwill resulting from this acquisition is being amortized on a
straight-line basis over 40 years.
OfficeMax plans to open approximately 60 to 70 stores in each of the next
two years, subject to the availability of desirable locations and the
negotiation of acceptable lease terms. Management estimates that OfficeMax's
cash requirements, exclusive of pre-opening expenses, will be approximately $1.0
million for each additional store. These requirements include an average of
approximately $0.4 million for leasehold improvements, fixtures, point-of-sale
terminals and other equipment in the stores, and approximately $0.6 million for
the portion of store inventory that is not financed by vendors.
Due to OfficeMax's aggressive expansion strategy, OfficeMax is expected to
require capital in excess of the funds generated from operations. Such excess is
expected to be funded by the Kmart Group. OfficeMax also could obtain funds from
external debt financing and, following implementation of the Specialty Retail
Stock Proposal, from the sale of shares of OfficeMax Stock with the proceeds
attributable to OfficeMax. OfficeMax believes that funds generated from
operations, together with the sources of capital described above, will be
sufficient to provide the liquidity and capital resources necessary to fund its
anticipated capital requirements for at least the next two to three years.
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt, and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of OfficeMax are
remitted to Kmart Corporation and cash disbursements of OfficeMax are funded by
Kmart Corporation on a daily basis. In the historical financial statements of
the Groups, (i) debt incurred by Kmart Corporation and its subsidiaries, other
than certain capital leases and mortgages related specifically to the Specialty
Retail Groups, has been reflected on the financial statements of the Kmart Group
and (ii) net cash used or provided by each Specialty Retail Group has been
characterized as an adjustment of the Kmart Group's investment (reflected as
Retained Interest) in each Specialty Retail Group. Accordingly, no inter-Group
interest expense or inter-Group interest income is reflected in the historical
financial statements of OfficeMax. Until the issuance of OfficeMax Stock, the
net cash used or provided by OfficeMax will continue to be characterized as an
adjustment to the Kmart Group's investment in OfficeMax.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group to the extent that the debt is
incurred or the preferred stock is issued for the benefit of such Specialty
Retail Group.
Following the issuance of OfficeMax Stock, if cash used by OfficeMax
exceeds cash provided by OfficeMax, the Kmart Group would transfer to OfficeMax
the cash necessary to fund such excess uses. Conversely, if cash provided by
OfficeMax exceeds cash used by OfficeMax, OfficeMax would transfer the excess
cash to the Kmart Group. All cash transfers between Groups would be accounted
for as short-term loans unless the Board makes a specific determination that a
given transfer (or type of transfer) should be accounted for as a long-term loan
or, in the case of a transfer from the Kmart Group to OfficeMax, an equity
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OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
contribution. There are no specific criteria to determine when a cash transfer
would be classified as a long-term loan or, in the case of a transfer from the
Kmart Group to OfficeMax, an equity contribution, rather than a short-term loan.
Such determination would be made by the Board in the exercise of its business
judgment at the time of such transfer (or the first of such type of transfer)
based upon all relevant circumstances, including the financing needs and
objectives of the recipient Group, the investment objectives of the transferring
Group, prevailing interest rates and general economic conditions. Such
determination would affect the amount of interest expense and interest income
reflected in the financial statements of the relevant Groups if such transfer
were made as a short-term loan or long-term loan and, in the case of a transfer
from the Kmart Group to OfficeMax as an equity contribution, the amount of
OfficeMax Group equity and Retained Interest of the Kmart Group. Short-term
loans between the Kmart Group and OfficeMax would bear interest at Kmart
Corporation's daily short-term borrowing rate. In the event that the Board
determined that a transfer of funds between the Kmart Group and OfficeMax should
be made as a long-term loan, the Board would establish the terms on which such
loan would be made, including interest rate, amortization schedule, maturity and
redemption terms. Such terms would generally reflect the then prevailing terms
upon which Kmart Corporation could borrow funds on a similar basis.
From time to time, following the initial issuance of OfficeMax Stock, the
Board could determine that funds to be transferred from the Kmart Group to
OfficeMax represent an equity contribution to OfficeMax rather than a loan. In
such event, the Kmart Group's Retained Interest in OfficeMax would be increased
by the amount of such contribution, as a result of which (a) the Number of
Shares Issuable with Respect to the Kmart Group's Retained Interest with regard
to OfficeMax would be increased by an amount equal to the amount of such
contribution divided by the Market Value of a share of OfficeMax Stock and (b)
the Kmart Group's Retained Interest Fraction with regard to OfficeMax would be
increased and the Outstanding Interest Fraction with regard to OfficeMax would
be decreased accordingly. The Board could determine, in its sole discretion, to
make such contribution after consideration of a number of factors, including,
among others, the relative levels of internally generated cash flows of the
Groups, the long-term business prospects for OfficeMax, the capital expenditure
plans of and investment opportunities available to OfficeMax, and the
availability, cost and time associated with alternative financing sources.
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from
OfficeMax, and the balance sheets of OfficeMax would reflect its net short-term
and net long-term loans to or borrowings from the Kmart Group. Similarly, the
respective income statements of the Kmart Group and OfficeMax would reflect
interest income or expense, as the case may be, associated with such loans or
borrowings and the statements of cash flows of the Kmart Group and OfficeMax
would reflect changes in the amounts thereof deemed outstanding. In view of the
anticipated cash needs of OfficeMax over the next several years, it is currently
expected that the Kmart Group would be making net transfers to OfficeMax. After
considering all relevant factors, the Kmart Group would obtain such funds from
internal operations, excess cash from other Specialty Retail Groups, external
debt financing or additional equity issuance. Accordingly, unlike these
historical financial statements, following implementation of the Specialty
Retail Stock Proposal and issuance of OfficeMax Stock, the financial statements
of OfficeMax would reflect interest expense related to net cash provided by
Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to OfficeMax would continue to be made at the discretion of the
Board. Nothing in the foregoing policies obligates the Board to cause the Kmart
Group to provide funds to OfficeMax if the Board determines it is in the best
interest of Kmart Corporation not to do so.
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OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
INFLATION AND SEASONALITY
OfficeMax management does not believe inflation had a material impact on
the financial statements for the periods presented. As illustrated in the
following table, OfficeMax's business is somewhat seasonal with sales higher in
the third and fourth quarters which, respectively, include the important
Back-to-School period and the holiday selling season followed by the traditional
new year office supply restocking month of January. Sales in the second
quarter's summer months are the slowest of the year primarily because of lower
office supplies consumption due to many people vacationing during this period.
<TABLE>
<CAPTION>
FISCAL 1993 QUARTER ENDED
--------------------------------------
($ MILLIONS) APRIL JULY OCTOBER JANUARY
- ----------- ------ ------ ------- -------
<S> <C> <C> <C> <C>
Sales...................................................... $289.5 $310.0 $ 393.7 $ 428.6
% of full year............................................. 20.4% 21.8% 27.7% 30.1%
Operating income........................................... $ 0.3 $ (5.7) $ 5.8 $ 19.6
% of full year............................................. 1.5% (28.5)% 29.0% 98.0%
</TABLE>
RECENT ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued Financial Accounting
Standard No. 106 "Employers' Accounting for Postretirement Benefits Other Than
Pensions" (FAS 106) in December 1990. This statement requires employers to
accrue for future postretirement benefits, such as health care and life
insurance. FAS 106 was effective for fiscal years beginning after December 15,
1992. OfficeMax adopted FAS 106 at the beginning of 1993. The effect of this
statement on OfficeMax was not significant.
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax balances for enacted
changes in statutory income tax rates. FAS 109 was effective for fiscal years
beginning after December 15, 1992. OfficeMax adopted FAS 109 at the beginning of
1993. The effect of this statement on OfficeMax was not significant.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106, requiring that benefits
provided to terminated or laid-off employees be recorded on an accrual basis
rather than a cash basis. The statement was effective for fiscal years beginning
after December 15, 1993. The effect of this statement on OfficeMax was not
significant.
EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS
Compliance with federal, state and local provisions which have been enacted
or adopted regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had, and is not
expected to have, a material effect on the capital expenditures, earnings or
competitive position of OfficeMax.
IX-10
<PAGE> 391
OFFICEMAX GROUP
GENERAL
OfficeMax Group ("OfficeMax") is one of the largest operators of
high-volume, deep discount office products superstores in the United States. At
January 22, 1994, OfficeMax operated 328 superstores, each averaging
approximately 23,000 square feet in 38 states. OfficeMax plans to continue its
rapid growth by opening approximately 60 to 70 stores in each of the next two
years. OfficeMax stores provide an extensive selection of quality name-brand and
private label merchandise at deep discount prices, with prices generally 30% to
70% below manufacturers' list prices. OfficeMax sells its merchandise primarily
to small and medium-sized businesses, home office customers and individual
consumers. OfficeMax had net sales of $1,421.8 million for the fiscal year ended
January 22, 1994.
OfficeMax has experienced rapid growth in the last five years as a result
of new store openings and strategic acquisitions. OfficeMax, which was
co-founded by Mr. Michael Feuer, its current President and Chief Executive
Officer, opened its first store in suburban Cleveland, Ohio in 1988. During the
next 28 months, OfficeMax opened 28 stores and acquired seven stores. In
November 1990, Kmart Corporation ("Kmart") acquired a 21.6% equity interest in
OfficeMax. In November 1991, Kmart increased its equity interest to 92.7%. Kmart
currently has a % interest in OfficeMax. Since the initial investment in
November 1990, Kmart has provided additional capital to fund OfficeMax's
aggressive expansion program, which included the opening of 142 new stores and
the acquisition of three office product superstore chains with an aggregate of
151 stores. Immediately following each of these acquisitions, OfficeMax
operationally integrated, remodeled, remerchandised and converted the acquired
stores to the OfficeMax name and format. During the three fiscal years ended
January 22, 1994, OfficeMax achieved compound annual growth in net sales of
126%. In addition, OfficeMax has achieved growth in comparable store sales for
the fiscal year ended January 22, 1994 of 18.2%.
OfficeMax believes its success is largely attributable to the consistent
execution of its business strategy in every OfficeMax store. Management believes
that OfficeMax has significant opportunities to increase sales and profits
through the growth and maturation of its relatively immature stores, most of
which have been opened or acquired by OfficeMax within the last three years, and
through the continued execution of its expansion strategy.
INDUSTRY OVERVIEW
Over the last several years, the industry has experienced rapid growth,
which OfficeMax believes is due primarily to a shift in the United States to a
more service oriented economy and the increasing utilization of technology, such
as computers and fax machines, in businesses and homes. OfficeMax believes that
these trends will continue to further expand the office products industry and,
in particular, will create opportunities for continued expansion in market share
for high-volume office products superstores.
Small and Medium-Sized Business Segment
OfficeMax's primary target market consists of small and medium-sized
businesses, employing between one and 100 employees, individual consumers and
home office customers. Prior to the growth of office products superstores, this
market was primarily served by traditional office products retailers which
typically operated small stores offering a limited selection of in-stock
merchandise purchased from wholesalers or other distributors and sold to the
ultimate consumer at manufacturers' list prices. Conversely, office products
superstores, such as OfficeMax, feature a wide selection of name-brand
merchandise purchased directly from the manufacturer and sold at deep discount
prices that are typically 30% to 70% below manufacturers' list prices. As a
result of their ability to offer selection, service and discount prices, office
products superstores represent a rapidly increasing percentage of the retail
office products market in the United States.
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Large Business Segment
Large businesses, employing over 100 people, have typically been served
primarily by traditional commercial office suppliers, known as "contract
stationers," which purchase a wide selection of office products directly from
manufacturers and distribute merchandise to large businesses generally for
next-day delivery. Contract stationers typically utilize an in-house,
commissioned sales force to solicit orders from the purchasing departments of
their customers who order merchandise from the contract stationers' or the
wholesalers' catalogs. Management believes that the large business segment of
the office products industry is more fragmented than the small and medium-sized
business segment.
BUSINESS STRATEGY
OfficeMax's business strategy is to consistently offer its customers an
extensive selection of quality name-brand and private label office products at
everyday low prices. The key elements of OfficeMax's business strategy are as
follows:
- Extensive Selection of Merchandise. Each OfficeMax store offers over
6,000 stock-keeping units ("SKUs"), providing a breadth and depth of
in-stock name-brand and private label merchandise not offered by
traditional office products retailers, specialty office products retailers,
mass merchandisers or wholesale clubs. OfficeMax carries a broad range of
office supplies, both in multi-unit packages for the business customer and
single units for the individual shopper, as well as business electronics,
office furniture and computers. OfficeMax stores also feature ancillary
business services such as faxing, printing and copying.
- Everyday Low Prices. OfficeMax's everyday low pricing policy is to
offer deep discount prices that are typically 30% to 70% below
manufacturers' list prices. In addition, OfficeMax features a low price
guarantee which provides that OfficeMax will match local competitors'
advertised prices on identical items or refund the difference if an
identical item was purchased from OfficeMax within seven days of a
competitor's advertisement.
- Customer Service. OfficeMax has a customer-oriented culture that
demands a high standard of customer service from each associate in order to
build customer loyalty and promote sales. Towards that end, management has
centralized most administrative functions to enable in-store associates to
focus primarily on customer service. In addition, OfficeMax stores are
designed to facilitate customer convenience through the use of wide aisles,
open ceilings, bright lighting, dramatic merchandise presentation, colorful
directional signage and bold graphics. Management believes that a bright
and attractive merchandise presentation enhances customer convenience,
promotes impulse buying and increases incremental sales.
- Focused Expansion Strategy. OfficeMax seeks to be a leading office
products retailer in each of its markets and pursues a store expansion
strategy that primarily focuses on clustering stores in existing markets
where OfficeMax can achieve economies of scale as a result of reduced
advertising, freight and management expenses as a percentage of sales. In
addition, OfficeMax will continue to open new stores in new markets which
provide multi-location opportunities and single stores in relatively small
markets where management believes it can become the first and primary
office products superstore. OfficeMax plans to continue its rapid growth by
opening approximately 60 to 70 stores in each of the next two years.
EXPANSION
Small and Medium-Sized Business Segment
Since its inception, OfficeMax has pursued an aggressive expansion strategy
which has included growth through the opening of 170 net new stores and through
the acquisition of four office products superstore chains operating 158 stores
in the aggregate. In 1990, OfficeMax acquired Office World, Inc. which operated
seven stores in the Chicago area, and Office Square, a former division of Kmart,
which operated five stores in the Chicago and Akron/Canton markets. In 1992,
OfficeMax acquired OW Office Warehouse, Inc., a 41-store office product
superstore chain with stores located primarily throughout the Mid-Atlantic
region, and, in
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March, 1993, OfficeMax acquired BizMart, Inc., a 105-store national office
product superstore chain with stores located primarily in the Southwest, West
and Pacific Northwest regions. Immediately following each of these acquisitions,
OfficeMax operationally integrated, remodeled, remerchandised and converted the
acquired stores to the OfficeMax name and format. As a result of these
acquisitions, as well as new store openings, OfficeMax has rapidly achieved a
national presence.
Today, as a national office products superstore operator, OfficeMax's
expansion strategy focuses primarily on new store growth. OfficeMax opened 53
stores in 1993 and intends to continue its rapid growth by opening approximately
60 to 70 new stores in each of the next two years. OfficeMax's expansion
strategy focuses on clustering new stores in existing markets, entering new
markets which provide multi-store opportunities and, to a lesser extent, opening
single stores in smaller secondary markets where OfficeMax believes it can
become the first and primary office products superstore. Although this strategy
of clustering additional stores in existing markets can result in some temporary
sales transfers between existing and new stores, OfficeMax believes that
clustering of stores increases its overall market share and, ultimately,
profitability. The rate of OfficeMax's expansion will depend upon general
economic and business conditions affecting consumer spending, the availability
of desirable locations and the negotiation of acceptable lease terms and the
availability of adequate funding.
To determine the best locations for new stores, OfficeMax has developed a
proprietary pinpoint locator real estate selection model which assesses
potential store locations, incorporates computer-generated mapping and detailed
business and demographic characteristics and analyzes a variety of factors that
have contributed to the success of existing OfficeMax locations. The real estate
selection model analyzes a number of factors including the location's size,
visibility, accessibility and parking capacity, potential cannibalizing effects
on existing OfficeMax stores and relevant demographic information, such as the
number of small and medium-sized businesses and the income and education levels
in the area.
Large Business Segment
OfficeMax has undertaken several initiatives to better service the needs of
its larger customers. OfficeMax has established "DirectMax Plus," a corporate
monthly purchase order and billing system which enables large businesses to
purchase from OfficeMax using their own internally generated purchase orders. In
contrast to the typical cash and carry focus of OfficeMax superstores, DirectMax
Plus enables large businesses to purchase from OfficeMax on much the same basis
as contract stationers and other traditional office product suppliers. In
addition, OfficeMax services the needs of large businesses through its expanded
220 page full-color catalog. The OfficeMax catalog, which is distributed
periodically to businesses and other customers, features toll free "1-800"
ordering and next business day delivery. In order to service its large business
customers more efficiently, OfficeMax has entered into a relationship with a
national logistics and transportation concern to develop, in conjunction with
OfficeMax's existing delivery centers, a network of independent delivery centers
in the major markets OfficeMax serves. These delivery centers, in combination
with OfficeMax's catalog, will enable OfficeMax to efficiently service its
largest customers. The first of these independent delivery centers was opened in
Chicago in August 1993.
In October 1993, OfficeMax purchased a 19.9% (17.5% on a fully diluted
basis) equity interest in Corporate Express for $23.5 million, which interest
was reduced to approximately 14.4% (12.5% on a fully diluted basis) upon
consummation of the Hanson transaction described below. Corporate Express'
business strategy is to create a national network of regional distributor
warehouses primarily through the acquisition of traditional contract stationers
in new and existing markets. On February 28, 1994, Corporate Express acquired
the office products division of Hanson, PLC. The combination of Corporate
Express and Hanson's office products division creates one of the largest
contract stationers in the U.S. in terms of sales. Since establishing a business
relationship in October 1993, OfficeMax and Corporate Express have been
developing synergistic buying and merchandising programs and sharing information
relating to distribution, delivery and computer systems.
As part of its agreement with Corporate Express, if OfficeMax's investment
is diluted to 11%, on a fully diluted basis, OfficeMax has the right to increase
its ownership to its original 17.5% interest. In addition,
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OfficeMax has the right in 1997, under certain circumstances, to increase its
ownership holdings in Corporate Express to between 51% and 100%. OfficeMax's
President and Chief Executive Officer serves on Corporate Express' five-member
board of directors.
STORES
OfficeMax superstores approximate 23,000 square feet with wide aisles, open
ceilings, bright lighting and fixtures, bold graphics and attractive easy to
find merchandise displays designed to facilitate customer convenience, promote
impulse buying and increase sales. OfficeMax stores are generally destination
stores located in high-traffic, suburban strip-mall shopping centers that
provide customers easy access and ample store-front parking. Each store displays
merchandise in accordance with a corporate-developed plan-o-gram to ensure that
each store utilizes optimal display techniques and to provide a consistent and
attractive shopping environment. OfficeMax continues to analyze and refine its
store layout and merchandise presentation in order to increase productivity and
customer shopping convenience and satisfaction.
Management believes that a fundamental element of its success is its
customer-oriented culture that demands a high-level of customer service from
each of its associates. In order to provide superior customer service,
management has centralized most administrative functions to enable in-store
associates to focus primarily on customer service. Each OfficeMax store is
staffed by a Store Manager, an Assistant Store Manager, a Receiving Manager and
a Customer Service Manager, each of whom has significant experience with store
operations. The remaining staff is comprised of full and part-time hourly
associates.
MERCHANDISING
OfficeMax's merchandising strategy focuses on offering an extensive
selection of quality, name-brand and private label office products at deep
discount prices. OfficeMax offers a breadth and depth of merchandise, featuring
over 6,000 SKUs generally in the categories of office supplies, computers,
business electronics and office furniture.
The following table sets forth the approximate percentage of net sales
attributable to each merchandise group for the periods presented:
<TABLE>
<CAPTION>
52 WEEKS ENDED
---------------------------------------------
JANUARY 22, JANUARY 23, JANUARY 25,
MERCHANDISE GROUP 1994 1993 1992
- -------------------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Office Supplies(a)...................................... 44.0% 47.6% 49.4%
Electronics, business machines, computers, software and
related products...................................... 44.1 39.2 36.7
Office Furniture........................................ 11.9 13.2 13.9
----------- ----------- -----------
100.0% 100.0% 100.0%
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
- -------------------------
(a) Includes business service center revenues.
The increase in sales attributable to the electronics, business machines,
computers, software and related products category is primarily due to increased
computer sales resulting from the BizMart acquisition. In fiscal 1992, computers
represented 9.2% of OfficeMax sales. In fiscal 1993, computer sales increased
slightly in the comparable stores, but on an overall basis, approximately 70% of
OfficeMax's increase in computer sales in fiscal 1993 is attributable to the
BizMart acquisition. At the date it was acquired, approximately 29.5% of
BizMart's prior years sales were in the computers category. During fiscal 1993,
the mix of computer sales in the stores acquired from BizMart decreased to
20.6%.
OfficeMax's merchandise strategy emphasizes a wide selection of name-brand
office products, packaged and sold in multi-unit packages for the business
customer and single units for the individual shopper. In addition to offering
name-brand products, OfficeMax offers private label products under the
"OfficeMax" label in order to provide customers additional savings on selected
commodity products for which management believes brand recognition is not a key
determinant of customer satisfaction. These commodity items include
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<PAGE> 395
various paper products such as computer and copy paper, legal pads and
notebooks, envelopes, fasteners, paper clips and a wide variety of other similar
functional items. OfficeMax's merchandising staff routinely evaluates new
name-brand and private label merchandise for profit opportunities and to provide
customers with the best value.
OfficeMax's everyday low pricing is a key element of its business strategy.
In order to maintain deep discount prices, OfficeMax systematically monitors
competitors' prices in every market in which it operates and, when appropriate,
authorizes immediate price changes. In addition, OfficeMax features a low price
guarantee which provides that OfficeMax will match local competitors' advertised
prices on identical items or refund the difference if an identical item was
purchased from OfficeMax within seven days of a competitor's advertisement.
PURCHASING AND DISTRIBUTION
OfficeMax maintains a centralized buying group comprised of merchandise
managers and buyers who average approximately 17 years of retail buying
experience. Using a detailed merchandise planning system, this centralized
corporate buying group selects the merchandise mix for each store in conjunction
with systematically frequent input from field management and store personnel.
During 1993, OfficeMax developed and implemented a proprietary merchandise
replenishment system, "ForeMax," which automatically forecasts each store's
merchandise replenishment requirements and which is utilized by OfficeMax's
centralized buying group to prepare merchandise replenishment reorders.
Management believes that ForeMax will permit it to continue to improve its
in-stock inventory position and inventory turnover.
OfficeMax purchases goods from approximately 180 vendors. No vendor
accounted for more than 10% of OfficeMax's total merchandise purchased.
OfficeMax believes that it has good relationships with its vendors and does not
consider itself dependent on any single source for its merchandise. As the
number of stores increases pursuant to its store expansion plan, OfficeMax
believes that it will be able to continue to obtain sufficient merchandise for
all of its stores on a timely basis.
Until recently, OfficeMax purchased virtually all of its office products
directly from manufacturers who delivered merchandise directly to the stores. In
late 1993, OfficeMax entered into an exclusive relationship with a leading
national logistics firm to develop and operate independent cross-docking,
flow-through centers, the first of which was opened in the southern United
States. The use of these flow-through centers will enable OfficeMax to take
advantage of the expertise of a leading logistics firm and realize savings in
distribution without investing in its own distribution facilities. Management
expects that the majority of OfficeMax merchandise will be processed through
five cross-docking, flow-through centers strategically located around the
country and that these centers will enhance store productivity and reduce
inbound freight costs.
MANAGEMENT INFORMATION SYSTEMS
Since its inception, OfficeMax has created and developed comprehensive
operational and administrative controls and a centralized computer system which
rapidly collects and disseminates information between corporate headquarters and
each store. These systems have enabled OfficeMax to achieve strong financial
controls, while enabling management to react quickly and efficiently to critical
store-level information.
In 1993, OfficeMax installed a state-of-the-art Unix-based parallel
processor at its suburban Cleveland headquarters which centrally controls
merchandise, replenishment and accounting systems. OfficeMax believes that this
"open system" architecture, utilizing microprocessors, provides lower operating
costs, quicker processing speed and reduced investment in upgrades, and
possesses the capacity to support more than 650 stores.
OfficeMax has developed a proprietary in-store computer system called
"StoreMax," which is an internally designed Unix-based software application that
allows the daily tracking of inventory receipts through the use of portable
radio frequency terminals. In-store point-of-sale registers capture sales
information at the time of each transaction at the category and SKU level with
the use of bar-code scanners and update store-level perpetual inventory levels
on a SKU basis each night. This information is transmitted on a daily
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basis to corporate headquarters where the data is evaluated and utilized in
merchandise and purchasing decisions. In addition, StoreMax is used to transmit
data to each store relating to its key day-to-day operations. OfficeMax believes
that its technical infrastructure has enabled management to maintain strong
financial controls and to effectively manage its inventory.
MARKETING, PROMOTIONS AND ADVERTISING
OfficeMax employs a multi-media marketing strategy using newspapers,
seasonal television and radio, direct mail, outdoor billboards and an extensive
full-color merchandise catalog, all of which highlight OfficeMax's price
savings, extensive merchandise selection and shopping convenience. In December
1993, during its peak selling season, OfficeMax introduced its first national
television campaign. OfficeMax's marketing strategy is designed to attract new
customers and to enhance name recognition and customer loyalty by featuring
themes such as "Take Your Business To The Max."
Throughout the year, OfficeMax focuses its marketing efforts on its primary
target market: small and medium-sized businesses. In addition, OfficeMax takes
advantage of seasonal opportunities and the holiday selling season to attract
these and other customers to its stores. For example, in August and September,
OfficeMax aggressively markets its back-to-school merchandise to students and
educational institutions. During the Thanksgiving to Christmas holiday season,
OfficeMax targets the gift-buying customer by promoting itself as the "Toy Store
for Adults," highlighting electronics, fine-quality briefcases, writing
instruments and other selected gifts. In January, OfficeMax "goes back to
basics" to promote commodity products and other basic office supplies as
businesses spend budget allocations and restock for the coming year. OfficeMax
also takes advantage of seasonal opportunities during the Mother's Day, Father's
Day and Graduation selling period, featuring such items as pen sets, briefcases
and business electronics. During these peak sales periods, OfficeMax also
employs additional advertising techniques including the use of periodic
newspaper pre-print inserts that enable OfficeMax to advertise a broad selection
of seasonally-timed merchandise. OfficeMax utilizes television and radio
advertisements during various seasonal periods to supplement its regular
advertising efforts.
In December 1993, OfficeMax launched its new 220 page full-color catalog
which is targeted to business customers and is designed to illustrate the
breadth and depth of merchandise available at OfficeMax stores. The catalog
features available next business day delivery at each store and toll free
ordering through OfficeMax's two processing call centers. OfficeMax periodically
distributes catalogs through direct mailing programs to small and medium-sized
businesses, and catalogs are also available in each store.
PROPERTIES
OfficeMax stores are relatively immature, with 282 of the stores opened or
acquired by OfficeMax within the last three years. OfficeMax continually refines
the layout and product display of its stores and currently intends to refurbish
each store approximately every 36 to 48 months. Management believes that
attractive and up-to-date stores contribute to customer satisfaction and
loyalty.
All of OfficeMax's stores have long term leases. These leases generally
have initial lease terms ranging from 10 to 20 years with renewal options. Most
of these leases require OfficeMax to pay minimum rents, subject to periodic
adjustments, plus other charges including utilities, real estate taxes, common
area maintenance and in some cases, contingent rentals based on sales.
IX-16
<PAGE> 397
As of January 22, 1994, OfficeMax had 328 stores in 38 states. The
following table details the number of OfficeMax stores by state:
<TABLE>
<CAPTION>
NUMBER
STATE OF STORES
- -------------------------------- ---------
<S> <C>
Alabama......................... 3
Arizona......................... 11
Arkansas........................ 1
California...................... 15
Colorado........................ 8
Connecticut..................... 4
Florida......................... 19
Georgia......................... 11
Idaho........................... 1
Illinois........................ 27
Indiana......................... 6
Iowa............................ 3
Kansas.......................... 4
Massachusetts................... 11
Michigan........................ 20
Minnesota....................... 12
Missouri........................ 9
Nebraska........................ 1
Nevada.......................... 3
<CAPTION>
NUMBER
STATE OF STORES
- -------------------------------- ---------
<S> <C>
New Hampshire................... 3
New Jersey...................... 12
New Mexico...................... 2
New York........................ 21
North Carolina.................. 6
North Dakota.................... 1
Ohio............................ 18
Oklahoma........................ 1
Oregon.......................... 4
Pennsylvania.................... 21
Rhode Island.................... 2
South Carolina.................. 5
South Dakota.................... 1
Tennessee....................... 9
Texas........................... 29
Utah............................ 7
Virginia........................ 9
Washington...................... 3
Wisconsin....................... 5
</TABLE>
CREDIT
OfficeMax provides revolving credit payment terms to its customers through
its own private label credit card program which is administered by an
independent financial services company specializing in managing private label
credit cards. In addition, OfficeMax accepts most major credit cards, including
Visa, Mastercard, American Express and Discover.
ASSOCIATES
As of January 22, 1994, OfficeMax had 6,585 full-time and 8,252 part-time
associates, 365 of whom were employed at its corporate headquarters and 14,472
of whom were employed in OfficeMax stores. None of OfficeMax's associates are
subject to a collective bargaining agreement. OfficeMax also provides an
extensive store training program, product training sessions and quarterly
national meetings at its corporate headquarters. In addition, OfficeMax
currently has a stock option plan and a bonus plan, which enables OfficeMax to
attract, retain and motivate key executives and middle managers. Management
believes that its relationship with its associates is good.
COMPETITION
The retail office products industry is highly competitive and, in general,
consists of two distinct market segments: the small and medium-sized business
segment consisting of businesses employing between one and 100 employees, the
home office customer and the individual consumer, and the large-sized business
segment consisting of large businesses employing more than 100 employees. The
small and medium-sized business segment is comprised of the following categories
of retailers: (i) traditional office products retailers, which have a limited
selection of office products and which, because their merchandise is purchased
from wholesalers or distributors, offer prices substantially above those of
OfficeMax; (ii) specialty office products retailers, such as consumer
electronics stores and computer stores, which feature a large selection of a
narrow class of office products; (iii) high-volume office products superstores
similar to OfficeMax; (iv) mass merchandisers and wholesale clubs, which are
large stores that carry a narrow selection of office products; and (v) direct
mail order houses which utilize a variety of catalogs and other programs to
offer a range of office supplies and furniture at prices discounted from
manufacturers' list prices. OfficeMax competes in the small
IX-17
<PAGE> 398
and medium-sized business segment by offering a combination of in-stock
merchandise selection, low prices, convenient locations, and customer service.
The high-volume superstore segment of the office products industry is
comprised principally of three national office products superstore chains:
OfficeMax, Office Depot, Inc. and Staples, Inc. Office Depot and Staples have
core businesses which are similar to OfficeMax's. While not all OfficeMax stores
currently compete with Office Depot or Staples, OfficeMax stores will likely
face increasing competition from one or both of these companies as OfficeMax and
each of these companies expand their operations. OfficeMax believes that it
competes favorably with these chains through the consistent execution of its
business strategy.
The large business customer segment of the office products market is highly
fragmented and has historically been served primarily by contract stationers.
OfficeMax has begun to compete in this segment by offering services designed to
meet the needs of the large business customer and by investing in Corporate
Express.
TRADEMARKS AND SERVICE MARKS
"OfficeMax(R);" "CheckMax Pricing(R);" "OfficeMax Superstores(R);"
"QuickMax(R);" "QuickMax Catalog(R), The Next Best Way To Shop OfficeMax(R);"
"MaxBrite(R);" "MaxAssurance(R);" "DirectMax Plus(R);" "MaxPerks(R);" "Savings
Is The Bottom Line(R);" "Take your business to the Max(R)" and "Take your
Savings to the Max(R)" are all registered or pending trademarks or service marks
of OfficeMax. Whenever possible, OfficeMax registers its name as a trade name
with the state or locality where it has a store.
LITIGATION
OfficeMax is from time to time involved in routine litigation incidental to
the conduct of its business. OfficeMax believes that no currently pending
litigation to which it is a party will have a material adverse effect on its
liquidity, financial position or results of operations.
IX-18
<PAGE> 399
OFFICEMAX GROUP
REPORT BY MANAGEMENT
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Kmart Corporation and OfficeMax Group management are responsible for the
integrity of the information and representations contained in interim and annual
financial statements. This responsibility includes making informed estimates and
judgments in selecting the appropriate accounting principles. Management
believes the financial statements conform with generally accepted accounting
principles applied on a consistent basis.
To assist management in fulfilling these obligations, several tools are
utilized, which include the following:
A system of internal accounting controls is maintained to provide for the
integrity of information for purposes of preparing financial statements and to
assure that assets are properly accounted for and safeguarded. This concept of
reasonable assurance is based on the recognition that the cost of the system is
related to the benefits to be derived and modified for changing conditions.
Management believes its system provides reasonable assurance of this appropriate
balance.
As part of the internal control system, a policy of Standards of Business
Conduct and Management Integrity Statements is in effect. All officers and key
employees periodically submit a signed statement regarding compliance with these
policies.
An Internal Audit Department is maintained to evaluate, test and report on
the application of internal accounting controls in conformity with standards of
the practice of internal auditing.
The financial statements have been examined by independent accountants
whose report is contained herein. This examination includes, among other things,
a review of the system of internal controls as required by generally accepted
auditing standards.
The Audit Committee of the Board of Directors, consisting solely of outside
directors, meets regularly with management, internal auditors and the
independent accountants to assure that each is carrying out its
responsibilities. The internal auditors and independent accountants both have
full and free access to the Audit Committee, with and without the presence of
management.
<TABLE>
<S> <C>
Joseph E. Antonini Michael Feuer
Kmart Corporation OfficeMax, Inc.
Chairman of the Board, President President and
and Chief Executive Officer Chief Executive Officer
George R. Mrkonic Edward Cornell
Kmart Corporation OfficeMax, Inc.
Executive Vice President Executive Vice President
Specialty Retailing and Chief Financial Officer
Thomas F. Murasky
Kmart Corporation
Executive Vice President
and Chief Financial Officer
</TABLE>
IX-19
<PAGE> 400
OFFICEMAX GROUP
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Kmart Corporation
In our opinion, the accompanying combined balance sheets and the related
combined statements of income and of cash flows present fairly, in all material
respects, the financial position of the OfficeMax Group at January 22, 1994 and
January 23, 1993, and the results of its operations and its cash flows for each
of the two years in the period ended January 22, 1994, the nine weeks ended
January 25, 1992 and the seventeen weeks ended November 20, 1991, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of Kmart Corporation management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the Acquisitions note to these combined financial
statements, on November 21, 1991, Kmart Corporation increased its investment in
the OfficeMax Group. The financial statements for periods subsequent to November
21, 1991 have been prepared on the basis of accounting arising from this
acquisition. The financial statements for the seventeen weeks ended November 20,
1991 are presented on OfficeMax, Inc.'s previous basis of accounting.
OfficeMax Group is a business group of Kmart Corporation (as described in
the Basis of Presentation note to these financial statements); accordingly, the
combined financial statements of the OfficeMax Group should be read in
conjunction with the consolidated financial statements of Kmart Corporation.
Price Waterhouse
Detroit, Michigan
March 15, 1994
IX-20
<PAGE> 401
OFFICEMAX GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------- 9 WEEKS ENDED 17 WEEKS ENDED
JANUARY 22, JANUARY 23, JANUARY 25, NOVEMBER 20,
1994 1993 1992 1991
----------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Sales................................ $1,421.8 $ 528.2 $65.1 $ 84.6
Cost of merchandise sold, includes
buying and occupancy costs......... 1,109.0 411.4 51.2 67.5
Selling, general and administrative
expenses........................... 279.9 107.2 11.6 18.7
Pre-opening expense.................. 4.3 4.7 0.8 0.6
Goodwill amortization................ 8.6 4.4 0.6 0.2
----------- ----------- ------ ------
Operating income (loss).............. 20.0 0.5 0.9 (2.4)
Interest:
Debt -- income..................... (0.1) (0.6) (0.3) (0.7)
Capital lease
obligations -- expense.......... 0.2 0.1 -- 0.1
----------- ----------- ------ ------
Income (loss) before income taxes.... 19.9 1.0 1.2 (1.8)
Income taxes......................... 9.1 1.8 0.3 0.1
----------- ----------- ------ ------
Net income (loss).................... $ 10.8 $ (0.8) $ 0.9 $ (1.9)
----------- ----------- ------ ------
----------- ----------- ------ ------
Supplemental disclosure (unaudited):
Net income (loss).................. $ 10.8 $ (0.8) $ 0.9
Add back of goodwill
amortization.................... 8.6 4.4 0.6
----------- ----------- ------
Kmart Corporation earnings
attributable to OfficeMax
Group........................... $ 19.4 $ 3.6 $ 1.5
----------- ----------- ------
----------- ----------- ------
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-21
<PAGE> 402
OFFICEMAX GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 22, JANUARY 23,
1994 1993
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash........................................................... $ 31.7 $ 14.1
Merchandise inventories........................................ 409.0 178.2
Accounts receivable............................................ 25.2 11.0
Other current assets........................................... 20.4 3.8
----------- -----------
Total current assets.............................................. 486.3 207.1
Property Owned:
Leasehold improvements......................................... 60.1 16.7
Furniture and fixtures......................................... 78.6 35.7
----------- -----------
138.7 52.4
Less -- accumulated depreciation and amortization................. (22.9) (6.0)
----------- -----------
Total owned property.............................................. 115.8 46.4
Other Assets and Deferred Charges................................. 45.6 1.2
Goodwill -- net of accumulated amortization of $13.6 and $5.0,
respectively................................................... 362.0 193.9
----------- -----------
$1,009.7 $ 448.6
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable -- trade...................................... $ 239.0 $ 119.3
Accrued payrolls and other liabilities......................... 77.7 34.8
Advertising payable............................................ 33.7 15.3
Taxes other than income taxes.................................. 22.3 7.1
----------- -----------
Total current liabilities......................................... 372.7 176.5
Other Long-Term Liabilities....................................... 28.5 13.9
OfficeMax Group Equity............................................ 608.5 258.2
----------- -----------
$1,009.7 $ 448.6
----------- -----------
----------- -----------
Supplemental disclosure (unaudited):
OfficeMax Group Equity......................................... $ 608.5 $ 258.2
Add back of accumulated goodwill amortization.................. 13.6 5.0
----------- -----------
Kmart Corporation equity attributable to OfficeMax Group....... $ 622.1 $ 263.2
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-22
<PAGE> 403
OFFICEMAX GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------- 9 WEEKS ENDED 17 WEEKS ENDED
JANUARY 22, JANUARY 23, JANUARY 25, NOVEMBER 20,
1994 1993 1992 1991
----------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income (loss)......................... $ 10.8 $ (0.8) $ 0.9 $ (1.9)
Adjustments to reconcile net income
(loss) to operating cash flows:
Depreciation and amortization........ 26.3 9.9 1.1 0.9
Deferred income taxes................ 11.1 1.8 0.1 --
Increase in other long-term
liabilities........................ 5.2 1.3 0.6 0.9
Other -- net......................... (0.4) -- -- (0.2)
Cash provided by (used for) current
assets and current liabilities:
Increase in inventories.............. (110.1) (72.0) (5.7) (14.3)
Increase in accounts payable......... 56.8 45.2 10.8 17.3
Other -- net......................... 27.6 21.4 4.7 13.5
----------- ----------- ------ ------
Net cash provided by operations......... 27.3 6.8 12.5 16.2
----------- ----------- ------ ------
INVESTING
Capital expenditures -- owned
property............................. (57.3) (21.2) (3.9) (3.2)
Acquisitions............................ (267.7) (71.7) -- --
Other -- net............................ (23.5) 0.5 -- (0.2)
----------- ----------- ------ ------
Net cash used for investing............. (348.5) (92.4) (3.9) (3.4)
----------- ----------- ------ ------
FINANCING
Reduction in long-term debt............. -- (16.0) -- --
Net equity transactions with the Kmart
Group................................ 339.5 70.9 -- --
Reduction in capital lease
obligations.......................... (0.7) (0.6) (0.1) (0.2)
Other -- net............................ -- 0.1 -- (2.4)
----------- ----------- ------ ------
Net cash provided by (used for)
financing............................ 338.8 54.4 (0.1) (2.6)
----------- ----------- ------ ------
NET INCREASE (DECREASE) IN CASH AND
EQUIVALENTS............................. 17.6 (31.2) 8.5 10.2
Cash and Equivalents at Beginning of
Period............................... 14.1 45.3 36.8 26.6
----------- ----------- ------ ------
CASH AND EQUIVALENTS AT END OF PERIOD..... $ 31.7 $ 14.1 $45.3 $ 36.8
----------- ----------- ------ ------
----------- ----------- ------ ------
Supplemental disclosure of cash flow
information:
Interest paid........................... $ 0.2 $ 0.1 $ -- $ 0.1
Income taxes paid....................... -- -- -- $ 0.2
Liabilities assumed in acquisitions..... $ 116.9 $ 46.5 -- --
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-23
<PAGE> 404
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
BASIS OF PRESENTATION
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue four new series of
common stock (collectively, the Specialty Retail Stock) designated
KM-Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of each specialty retail business. The Borders-Walden Stock is
intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company, Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the initial issuance of any series of Specialty Retail Stock, the
existing common stock would be redesignated as Kmart Group Common Stock (Kmart
Stock). The Kmart Stock, while constituting common stock of Kmart Corporation,
is intended to reflect the separate performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) Kmart Corporation's interest in each Specialty Retail Group (a Retained
Interest) other than the interest represented by any outstanding shares of any
series of Specialty Retail Stock and (iii) all other businesses in which Kmart
Corporation and its subsidiaries are engaged. The Kmart Group and the Specialty
Retail Groups are referred to collectively herein as the Groups.
Following approval by shareholders of the Specialty Retail Stock Proposal,
Kmart Corporation currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate initial public offerings (collectively, the Offerings) and to allocate
the proceeds of the Offerings to the Kmart Group to repay outstanding
indebtedness of Kmart Corporation, resulting in reduced debt service obligations
attributable to the Kmart Group. The timing, sequence and size of such Offerings
and the price at which such shares would be sold would be determined by the
Board, without further approval of shareholders, at the time of each Offering;
however, it is currently contemplated that Kmart Corporation would initially
offer to the public shares of each series of Specialty Retail Stock that would
be intended to represent approximately 20% to 30% of the equity value of Kmart
Corporation attributed to the relevant Specialty Retail Group as determined by
the Board (Equity Value) at the time of such Offering. Therefore, it is expected
that Kmart Corporation would retain and attribute to the Kmart Group a 70% to
80% Retained Interest in each such Specialty Retail Group. The terms of each
Offering would be determined by the Board and the underwriters of such Offering
based upon prevailing market conditions; the financial condition and results of
operations of the relevant Group; the history of and prospects for the relevant
Group; the specialty retail industry and the segment of that industry in which
the relevant Group competes; the management and operations of the relevant
Group; the progress of the relevant Group in implementing its business strategy;
the foregoing factors in relation to market values of other companies engaged in
similar businesses; and the financial condition of Kmart Corporation as a whole.
In addition to or in lieu of any
IX-24
<PAGE> 405
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Offering, the Board reserves the right to issue shares of any series of
Specialty Retail Stock as a distribution on Kmart Stock, although the Board has
no current intention to do so. The determination of whether to proceed with an
Offering of any series of Specialty Retail Stock would be made by the Board
based on, among other things, the proposed terms of such Offering and the then
prevailing market and other conditions. The Board reserves the right not to
proceed with any or all of the Offerings, without further approval of
shareholders, if it determines that consummation of such Offering or Offerings
is not in the best interests of Kmart Corporation.
The financial statements of the Groups comprise all of the accounts
included in the corresponding consolidated financial statements of Kmart
Corporation. The separate Group financial statements give effect to the
management and accounting policies that would be applicable upon implementation
of the Specialty Retail Stock Proposal, except that no inter-Group interest
expense or inter-Group interest income is reflected, as more fully described
under "Corporate Activities" below. However, following implementation of the
Specialty Retail Stock Proposal and issuance of each Specialty Retail Stock, the
financial statements of each Specialty Retail Group would reflect interest
expense related to net cash provided by Kmart Corporation. The separate Group
financial statements have been prepared on a basis that management believes to
be reasonable and appropriate and include (i) the combined historical financial
position, results of operations and cash flows of the businesses that comprise
each of the Groups and (ii) a portion of the assets and liabilities (including
contingent liabilities) and related transactions of Kmart Corporation that are
not separately identified with the operations of a specific Group. The effects
of the issuance of the equity securities described above have not been reflected
in these historical financial statements.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, following issuance of any series of Specialty Retail
Stock, Kmart Corporation would provide to holders of OfficeMax Stock separate
financial statements, management's discussion and analysis of financial
condition and results of operations, business descriptions and other information
for the OfficeMax Group and for Kmart Corporation. Notwithstanding the
allocation of assets and liabilities (including contingent liabilities),
shareholders' equity and items of income and expense among the Groups for
purposes of preparing their respective financial statements, the change in the
capital structure of Kmart Corporation contemplated by the Specialty Retail
Stock Proposal would not affect the respective legal title to assets or
responsibility for liabilities of Kmart Corporation or any of its subsidiaries.
Kmart Corporation and its subsidiaries would each continue to be responsible for
their respective liabilities. Holders of OfficeMax Stock and of each other
series of common stock of Kmart Corporation would be holders of common stock of
Kmart Corporation and would continue to be subject to risks associated with an
investment in Kmart Corporation and all of its businesses, assets and
liabilities. The Specialty Retail Stock Proposal would not affect the rights of
creditors of Kmart Corporation.
Financial effects arising from any Group that affect the consolidated
results of operations or financial condition of Kmart Corporation could affect
the results of operations or financial condition of the OfficeMax Group or the
market price of shares of OfficeMax Stock. In addition, net losses of any Group,
dividends and distributions on any series of common stock or preferred stock,
repurchases of any series of common stock and certain repurchases of preferred
stock would reduce the assets of Kmart Corporation legally available for
dividends on all series of common stock. Accordingly, Kmart Corporation
consolidated financial information should be read in conjunction with the
OfficeMax Group financial information.
The dividend policy applicable to OfficeMax Stock would be determined by
the Board at the time of issuance of such stock. Determinations to pay dividends
on OfficeMax Stock would be based primarily upon the financial condition,
results of operations and business requirements of the OfficeMax Group and Kmart
Corporation as a whole. Under the terms of OfficeMax Stock, dividends would be
payable at the sole discretion of the Board out of the lesser of (i) all assets
of Kmart Corporation legally available for dividends and (ii) the Available
Dividend Amount with respect to the OfficeMax Group.
IX-25
<PAGE> 406
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The management and accounting policies applicable to the preparation of the
financial statements of the OfficeMax Group could be modified or rescinded by
the Board, in its sole discretion and without the approval of shareholders,
although there is no present intention to do so. The Board could also adopt
additional policies depending upon the circumstances. Any determination by the
Board to modify or rescind such policies, or to adopt additional policies,
including any such decision that could have disparate effects upon holders of
different series of common stock, would be made by the Board in good faith and
in the honest belief that such decision is in the best interests of Kmart
Corporation. In addition, generally accepted accounting principles require that
changes in accounting policy must be preferable (in accordance with such
principles) to the policy previously in place.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The OfficeMax Group's significant accounting policies, which conform to
generally accepted accounting principles applied on a consistent basis between
years, are described below.
Fiscal Year: The OfficeMax Group's fiscal year ends on the Saturday prior
to the last Wednesday in January. Fiscal years 1993 and 1992 each consisted of
52 weeks and ended on January 22, 1994, and January 23, 1993, respectively.
Prior to the acquisition of a 92.7% interest in OfficeMax, Inc. by Kmart
Corporation, OfficeMax Inc.'s fiscal year ended on the last Saturday in July.
On November 21, 1991, Kmart Corporation increased its equity investment in
the OfficeMax Group to 92.7% of OfficeMax, Inc. outstanding common stock. The
financial statements for periods subsequent to November 21, 1991 have been
prepared on the basis of accounting arising from this acquisition. The financial
statements for the seventeen week period ended November 20, 1991 are presented
on OfficeMax, Inc.'s previous basis of accounting.
Principles of Consolidation: The combined financial statements include the
accounts of OfficeMax, Inc.
Earnings Per Common and Common Equivalent Share: Historical earnings per
share are omitted from the statements of income as OfficeMax Stock was not part
of the capital structure of Kmart Corporation for the periods presented.
Following implementation of the Specialty Retail Stock Proposal, the method of
calculating earnings per share for Kmart Stock and each series of Specialty
Retail Stock would reflect the terms of the Certificate of Amendment which
provide that each Group's Available Dividend Amount, which, in turn, would
reflect the separately reported Kmart Corporation Earnings Attributable to the
Kmart Group, in the case of the Kmart Group, and Kmart Corporation Earnings
Attributable to a Specialty Retail Group, in the case of a Specialty Retail
Group, would be the source for payment of dividends for each series of common
stock, although liquidation rights of these series of stock and legally
available assets of Kmart Corporation may be more or less than these amounts.
Kmart Corporation would compute earnings per share of OfficeMax Stock by
dividing the product of the Outstanding Interest Fraction and Kmart Corporation
Earnings Attributable to a Specialty Retail Group with respect to the OfficeMax
Group by the weighted average number of shares of OfficeMax Stock and dilutive
OfficeMax Stock equivalents outstanding during the applicable period. Kmart
Corporation Earnings Attributable to a Specialty Retail Group with respect to
the OfficeMax Group would generally equal the OfficeMax Group's net income or
loss for the relevant period determined in accordance with generally accepted
accounting principles in effect at such time, reflecting income and expenses of
Kmart Corporation allocated to the OfficeMax Group, increased by the amount of
amortization of goodwill of the OfficeMax Group during such period arising from
acquisitions made by Kmart Corporation or its subsidiaries with respect to the
OfficeMax Group before the first issuance of OfficeMax Stock. The Outstanding
Interest Fraction with respect to the OfficeMax Group is the percentage interest
in the OfficeMax Group intended to be represented at any time by the outstanding
shares of OfficeMax Stock. See "Proposal 2 -- The Specialty Retail Stock
Proposal -- Dividend Policy -- Calculation of Earnings Per
IX-26
<PAGE> 407
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Share" of Kmart Corporation Proxy Statement for an example of the calculation of
Kmart Corporation Earnings Attributable to a Specialty Retail Group with respect
to OfficeMax Stock.
Cash and Equivalents: Kmart Corporation considers cash on hand in stores,
deposits in banks, certificates of deposit and short-term marketable securities
with maturities of 90 days or less as cash and cash equivalents for the purposes
of the statement of cash flows.
Inventories: Inventories are valued on a first-in, first-out (FIFO) basis
at the lower of average cost or market.
Property Owned and Depreciation: Leasehold improvements and equipment are
recorded at cost. Depreciation is provided over the estimated useful lives of
related assets on the straight-line method for financial statement purposes and
on accelerated methods for income tax purposes. Most store properties are leased
and improvements are amortized over the term of the lease but not more than 15
years. Other annual rates used in computing depreciation for financial statement
purposes are 14%-20% for store fixtures and 20%-33% for other fixtures and
equipment.
Goodwill: The excess of cost over the fair value of net assets of the
OfficeMax Group as of November 21, 1991, the date on which Kmart Corporation
increased its equity interest in OfficeMax, Inc. to 92.7%, was capitalized and
is being amortized over 40 years using the straight-line method. Excess of cost
over the net assets of acquired companies is amortized using the straight-line
method over 40 years. The OfficeMax Group evaluates the recoverability of
goodwill and reviews the amortization period on an annual basis. Several factors
are used to evaluate goodwill, including but not limited to: management's plans
for future operations; recent operating results and each business' projected,
undiscounted cash flows.
Financial Instruments: With the exception of the OfficeMax Group equity
and investment in Corporate Express, the OfficeMax Group records all financial
instruments, including accounts receivable, accounts payable and marketable
securities at, or approximating, market value.
Pre-Opening and Closing Costs: Costs associated with the opening of a new
store are expensed during the first full month of the store's operations. When
the decision to close a retail unit is made, the OfficeMax Group provides for
the future net lease obligation, nonrecoverable investment in fixed assets,
other expenses directly related to discontinuance of operations and estimated
operating loss through the expected closing dates.
CORPORATE ACTIVITIES
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of the OfficeMax
Group are remitted to Kmart Corporation and cash disbursements of the OfficeMax
Group are funded by Kmart Corporation on a daily basis. In the historical
financial statements of the Groups, (i) debt incurred by Kmart Corporation and
its subsidiaries, other than certain capital leases and mortgages related
specifically to the Specialty Retail Groups, has been reflected on the financial
statements of the Kmart Group and (ii) net cash used or provided by each
Specialty Retail Group has been characterized as an adjustment of the Kmart
Group's investment (reflected as Retained Interest) in such Specialty Retail
Group. Accordingly, no inter-Group interest expense or inter-Group interest
income is reflected in the historical financial statements of the OfficeMax
Group. Until the issuance of OfficeMax Stock, the net cash used or provided by
the OfficeMax Group will continue to be characterized as an adjustment to the
Kmart Group's investment in the OfficeMax Group.
IX-27
<PAGE> 408
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group when the debt is incurred or
the preferred stock is issued for the benefit of such Specialty Retail Group.
Following the issuance of OfficeMax Stock, if cash used by the OfficeMax
Group exceeds cash provided by the OfficeMax Group, the Kmart Group would
transfer to the OfficeMax Group the cash necessary to fund excess uses.
Conversely, if cash provided by the OfficeMax Group exceeds cash used by the
OfficeMax Group, the OfficeMax Group would transfer the excess cash to the Kmart
Group. All cash transfers between Groups would be accounted for as short-term
loans unless the Board makes a specific determination that a given transfer (or
type of transfer) should be accounted for as a long-term loan or, in the case of
a transfer from the Kmart Group to the OfficeMax Group, an equity contribution.
There are no specific criteria to determine when a cash transfer would be
classified as a long-term loan or, in the case of a transfer from the Kmart
Group to the OfficeMax Group, an equity contribution, rather than a short-term
loan. Such determination would be made by the Board in the exercise of its
business judgment at the time of such transfer (or the first of such type of
transfer) based upon all relevant circumstances, including the financing needs
and objectives of the recipient Group, the investment objectives of the
transferring Group, prevailing interest rates and general economic conditions.
Such determination would affect the amount of interest expense and interest
income reflected in the financial statements of the relevant Groups if such
transfer were made as a short-term loan or long-term loan and, in the case of a
transfer from the Kmart Group to the OfficeMax Group as an equity contribution,
the amount of OfficeMax Group equity and Retained Interest of the Kmart Group.
Short-term loans between the Kmart Group and the OfficeMax Group would bear
interest at Kmart Corporation's daily short-term borrowing rate. In the event
that the Board determined that a transfer of funds between the Kmart Group and
the OfficeMax Group should be made as a long-term loan, the Board would
establish the terms on which such loan would be made, including interest rate,
amortization schedule, maturity and redemption terms. Such terms would generally
reflect the then prevailing terms upon which Kmart Corporation could borrow
funds on a similar basis.
From time to time, following the initial issuance of OfficeMax Stock, the
Board could determine that funds to be transferred from the Kmart Group to the
OfficeMax Group represent an equity contribution to the OfficeMax Group rather
than a loan. In such event, the Kmart Group's Retained Interest in the OfficeMax
Group would be increased by the amount of such contributions, as a result of
which (i) the Number of Shares Issuable with Respect to the Kmart Group's
Retained Interest in the OfficeMax Group would be increased by an amount equal
to the amount of such contribution divided by the Market Value of a share of
OfficeMax Stock and (ii) the Kmart Group's interest in the OfficeMax Group would
be increased and the interest in the OfficeMax Group represented by outstanding
shares of OfficeMax Stock would be decreased accordingly. The Board could
determine, in its sole discretion, to make such contribution after consideration
of a number of factors including, among others, the relative levels of
internally generated cash flow of the Groups, the long-term business prospects
for the OfficeMax Group, the capital expenditure plans of and the investment
opportunities available to the OfficeMax Group and the availability, cost and
time associated with alternative financing sources.
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from the
OfficeMax Group, and the balance sheets of the OfficeMax Group would reflect its
net short-term and net long-term loans to or borrowings from the Kmart Group.
Similarly, the income statements of the Kmart Group and the OfficeMax Group
would reflect interest income or expense, as the case may be, associated with
such loans or borrowings and the statements of cash flows of the Kmart Group and
the OfficeMax Group would reflect changes in the amounts thereof deemed
IX-28
<PAGE> 409
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
outstanding. In view of the anticipated cash needs of the OfficeMax Group over
the next several years, it is currently expected that the Kmart Group would
provide net cash to the OfficeMax Group. After considering all relevant factors,
the Kmart Group would obtain such funds from internal operations, excess cash
from other Specialty Retail Groups, external debt financing or additional equity
issuances. Accordingly, unlike these historical financial statements, following
implementation of the Specialty Retail Stock Proposal and issuance of OfficeMax
Stock, the financial statements of the OfficeMax Group would reflect interest
expense related to net cash provided by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to the OfficeMax Group would continue to be made at the discretion
of the Board. Nothing in the foregoing policies obligates the Board to cause the
Kmart Group to provide funds to the OfficeMax Group if the Board determines it
is in the best interest of Kmart Corporation not to do so.
Certain corporate, general and administrative costs (including certain
corporate borrowing, legal, tax, transportation and import, data processing,
employee benefit and self-insurance costs) have been charged to the Specialty
Retail Groups based upon utilization and at negotiated rates which management
believes approximate the rates which each of the Specialty Retail Groups would
incur as stand-alone entities. The OfficeMax Group financial statements also
include an allocation, which management believes to be reasonable, of corporate,
general and administrative costs related specifically to the management of the
Specialty Retail Groups and allocated equally among the Specialty Retail Groups
of $0.1 in each of 1993 and 1992. Amounts allocated in these historical
financial statements were calculated on the same basis as would be used
prospectively, and management believes that the historical allocation of such
amounts is representative of the amounts which would be allocated to each of the
Specialty Retail Groups prospectively.
Income Taxes: All members of the Kmart Corporation consolidated group are
included in the consolidated United States federal income tax return filed by
Kmart Corporation. Accordingly, the provision for federal income taxes and the
related payments or refunds of tax are determined on a consolidated basis. The
financial statement provision and related tax payments or refunds have been
reflected in the individual Groups in accordance with Kmart Corporation's tax
allocation policy for such Groups. In general, such policy provides that the
consolidated tax provision is allocated among the Groups for individual Group
financial statement purposes based principally upon the financial income,
taxable income, credits, preferences and other amounts directly related to the
respective Groups.
For financial statement provision and tax settlement purposes, tax benefits
resulting from attributes (principally net operating losses), which cannot be
utilized by one of the Groups on a separate return basis but which can be
utilized on a consolidated basis in any given year, are allocated to the Group
which generates the attributes. However, if such tax benefits cannot be utilized
on a consolidated basis in that year or in a carry back year, such consolidated
tax effect is adjusted in a subsequent year to the extent necessary to allocate
tax benefits to the Group that would have realized the tax benefits on a
separate return basis.
The allocated Group amounts are not necessarily comparable to those that
would have resulted if the Groups had filed separate tax returns and, in certain
situations, could result in any of the Groups incurring more or less income tax
expense for financial reporting purposes.
Deferred income taxes are provided on temporary differences between
financial statement and income tax basis of assets and liabilities.
IX-29
<PAGE> 410
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
ACQUISITIONS
On March 4, 1993, the OfficeMax Group purchased all of the outstanding
shares of BizMart, Inc. ("BizMart"), a chain of 105 office products superstores,
for $267.7 in cash. During 1993, BizMart was completely integrated into the
OfficeMax Group operations and BizMart stores converted to the OfficeMax format.
The BizMart acquisition was accounted for under the purchase method of
accounting. Accordingly, the purchase price was allocated to the assets acquired
and liabilities assumed based upon their estimated fair values. The excess of
the purchase price over the estimated fair value of the net assets acquired
totaled $185.5 and was recorded as goodwill. The results of BizMart operations
are included in the OfficeMax Group's combined financial statements beginning on
March 5, 1993.
On October 26, 1993, the OfficeMax Group acquired an initial 19.9% (17.5%
on a fully diluted basis) minority interest in Corporate Express, Inc.
("Corporate Express"), a Colorado-based contract stationer, for $23.5. The
Corporate Express investment is being accounted for under the cost method of
accounting. On February 28, 1994, Corporate Express acquired the office products
division of Hanson, PLC. A portion of the purchase price was funded through the
issuance of additional equity of Corporate Express. As a result, the OfficeMax
Group's equity interest in Corporate Express was diluted to approximately 14.4%
(12.5% on a fully diluted basis) on February 28, 1994. As part of its agreement
with Corporate Express, the OfficeMax Group has the right in 1997, under certain
circumstances, to increase its holdings in Corporate Express to between 51% and
100%.
On June 30, 1992, the OfficeMax Group purchased all of the outstanding
shares of OW Office Warehouse, Inc. ("OW Office Warehouse"), a chain of 41
office products superstores, for $71.7 in cash. In connection with the
acquisition, the OfficeMax Group retired $16.0 of OW Office Warehouse
indebtedness. The OW Office Warehouse acquisition was accounted for under the
purchase method of accounting. Accordingly, the purchase price was allocated to
the assets acquired and liabilities assumed based upon their estimated fair
values. The excess of the purchase price over the estimated fair value of the
net assets acquired totaled $60.7 on January 22, 1994 and was recorded as
goodwill. The results of OW Office Warehouse operations are included in the
OfficeMax Group's combined financial statements beginning on July 1, 1992.
The following presents unaudited pro forma results of the OfficeMax Group's
operations assuming the acquisition of BizMart had occurred at the beginning of
the fiscal year ended January 22, 1994:
<TABLE>
<CAPTION>
1993
-----------
<S> <C>
(UNAUDITED)
Sales.......................................................................... $1,481.7
Net income..................................................................... $ 9.8
</TABLE>
The above amounts are based upon actual sales and gross profit results for
the OfficeMax Group and BizMart during the applicable period. Operational and
store expenses are based upon certain assumptions and estimates which management
of the OfficeMax Group believes are reasonable. The pro forma results do not
necessarily represent results which would have occurred if the BizMart
acquisition had taken place on the basis assumed above, and are not necessarily
indicative of the results of future combined operations.
On November 21, 1990, Kmart Corporation acquired a 21.6% equity interest in
OfficeMax, Inc. for $35.5. On November 21, 1991, Kmart Corporation acquired
additional shares resulting in a 92.7% equity interest in OfficeMax, Inc. for
$115.2 in cash with the remaining 7.3% of the shares owned by the co-founders
and senior management of OfficeMax, Inc. The acquisition was accounted for under
the purchase method of accounting. The excess of the cumulative purchase price
over the estimated fair value of the net assets acquired totaled $129.4 on
January 22, 1994 and was recorded as goodwill. The OfficeMax Group's financial
statements for periods subsequent to the November 21, 1991 acquisition by Kmart
Corporation are presented
IX-30
<PAGE> 411
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
on the new basis of accounting arising from the acquisition. The financial
statements for the seventeen week period ended November 20, 1991 are presented
on OfficeMax, Inc.'s previous basis of accounting.
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------- 9 WEEKS ENDED 17 WEEKS ENDED
JANUARY 22, JANUARY 23, JANUARY 25, NOVEMBER 20,
1994 1993 1992 1991
----------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Current:
Federal................................. $(2.1) $ -- $ 0.1 $ --
State and local......................... 1.0 -- 0.1 0.1
Deferred:
Excess of tax over book depreciation.... 1.0 1.7 -- --
Bonus and vacation accruals............. (0.8) (0.5) -- --
Store closing reserves.................. 2.3 0.4 -- --
Insurance reserves...................... (2.1) (0.2) 0.1 --
Purchase accounting valuation reserves
and other accruals................... 8.7 -- -- --
NOL utilization......................... 1.5 -- -- --
Enacted federal tax rate change......... (1.4) -- -- --
Other................................... 1.0 0.4 -- --
----------- ----------- ----- -----
Total income taxes................... $ 9.1 $ 1.8 $ 0.3 $0.1
----------- ----------- ----- -----
----------- ----------- ----- -----
</TABLE>
A reconciliation of the federal statutory rate to the OfficeMax Group's
effective tax rate follows:
<TABLE>
<CAPTION>
9 WEEKS 9 WEEKS
FISCAL YEAR ENDED ENDED 17 WEEKS FISCAL YEAR ENDED ENDED 17 WEEKS
-------------------- JAN. ENDED -------------------- JAN. ENDED
JAN. 22, JAN. 23, 25, NOV. 20, JAN. 22, JAN. 23, 25, NOV. 20,
1994 1993 1992 1991 1994 1993 1992 1991
-------- -------- ------- -------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Federal statutory
rate................. $ 7.0 $0.3 $ 0.4 $ (0.6) 35.0% 34.0% 34.0% (34.0)%
State and local taxes,
net of federal tax
benefit.............. 0.7 -- 0.1 0.1 3.5 -- 8.0 5.6
Goodwill
amortization......... 3.0 1.5 0.2 -- 15.1 146.0 17.0 --
Enacted federal tax
rate change.......... (1.4) -- -- -- (7.0) -- -- --
Addition to net
operating loss
carryforward......... -- -- -- 0.6 -- -- -- 34.0
Other.................. (0.2) -- (0.4) -- (0.9) -- (34.0) --
-------- -------- ------- -------- -------- -------- ------- --------
Total income
taxes........... $ 9.1 $1.8 $ 0.3 $ 0.1 45.7% 180.0% 25.0% 5.6%
-------- -------- ------- -------- -------- -------- ------- --------
-------- -------- ------- -------- -------- -------- ------- --------
</TABLE>
IX-31
<PAGE> 412
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Deferred tax assets resulted from the following:
<TABLE>
<CAPTION>
JANUARY 22,
1994
-----------
<S> <C>
Deferred tax assets:
Federal tax loss carryforwards................................................ $ 9.8
Inventory..................................................................... 2.9
Property and equipment........................................................ 6.4
Accruals and other liabilities................................................ 13.5
Store closing reserves........................................................ 6.7
Other......................................................................... 1.6
-----------
Total deferred tax assets.................................................. $40.9
-----------
-----------
</TABLE>
The OfficeMax Group has tax net operating loss carryforwards of
approximately $28.1 which are available to offset future taxable income through
2007. These tax net operating loss carryforwards represent pre-acquisition
losses of acquired companies, primarily of OW Office Warehouse. The utilization
of these carryforwards may be further limited if certain changes in ownership of
OfficeMax, Inc. occur. Such carryforwards can only be used to offset the
OfficeMax Group's future taxable income and are not available for use by Kmart
Corporation. Utilization of these carryforwards is limited to $5.9 annually.
Benefits received from utilization of these carryforwards will be recorded as a
reduction of goodwill and will not impact the OfficeMax Group's income tax
provision or benefit.
Deferred income taxes of $40.9 and $4.2 at January 22, 1994 and January 23,
1993, respectively, result principally from the temporary differences between
financial statement and income tax depreciation and the difference in financial
statement and tax bases arising from purchase accounting.
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax liabilities to
reflect enacted changes in the statutory federal income tax rate. The OfficeMax
Group adopted FAS 109 as the cumulative effect of an accounting change in the
first quarter of fiscal 1993. The accounting change was not significant to the
OfficeMax Group.
COMMITMENTS AND CONTINGENCIES
There are various claims, lawsuits and pending actions against OfficeMax,
Inc. incident to the operations of the OfficeMax Group. It is the opinion of
management that the ultimate resolution of these matters will not have a
material effect on the OfficeMax Group's liquidity, financial position or
results of operations.
PRIVATE LABEL CREDIT CARD PROGRAM
The OfficeMax Group has an arrangement with a financial services company
(the "Issuer") whereby the Issuer issues the OfficeMax Group's private label
credit card. The credit card accounts, and receivables generated thereby, are
owned by the Issuer. The OfficeMax Group pays the Issuer a fee which is designed
to cover the Issuer's cost of providing credit to the OfficeMax Group's
customers, including bad debt losses. The fee is subject to annual adjustment
for bad debt experience. In addition, the fee is adjusted monthly based on the
difference between prevailing short-term interest rates and levels specified in
the agreement. The fee paid resulted in expense of $2.3 and $3.0 at January 22,
1994 and January 23, 1993, respectively. The arrangement provides for a reserve
account, funded from fees paid to the Issuer, which must be maintained at a
minimum level. The credit card arrangement can be terminated by the OfficeMax
Group or the Issuer. In the event of a termination, the OfficeMax Group is
required to repurchase receivables at a defined price, ranging from face value
up to a maximum premium of 5.2%.
IX-32
<PAGE> 413
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The OfficeMax Group's maximum exposure to off-balance sheet and credit risk
is represented by the outstanding balance of private label credit card
receivables, which totaled approximately $29.3 and $6.2 at January 22, 1994 and
January 23, 1993, respectively.
LEASES
Description of Leasing Arrangements: The OfficeMax Group conducts
operations primarily in leased facilities. Store leases are generally for terms
of 10 to 20 years with multiple five to ten year renewal options which allow the
OfficeMax Group the option to extend the life of the lease up to 20 years beyond
the initial noncancellable term.
Certain leases provide for additional rental payments based on a percent of
sales in excess of a specified base. Also, certain leases provide for the
payment by the lessee of executory costs (taxes, maintenance and insurance).
Lease Commitments: Future minimum lease payments at January 22, 1994 were
as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE PAYMENTS
-------------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1994.............................................................. $ 0.5 $ 89.9
1995.............................................................. 0.3 89.8
1996.............................................................. -- 83.1
1997.............................................................. -- 79.6
1998.............................................................. -- 76.5
Later years......................................................... -- 459.4
------- ---------
Total minimum lease payments........................................ 0.8 $ 878.3
---------
---------
Less:
Amount representing interest...................................... (0.1)
-------
0.7
Portion due within one year......................................... 0.4
-------
Long-term lease obligations......................................... $ 0.3
-------
-------
</TABLE>
Rental Expense: A summary of operating lease rental expense and short-term
rentals follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------- 9 WEEKS ENDED 17 WEEKS ENDED
JANUARY 22, JANUARY 23, JANUARY 25, NOVEMBER 20,
1994 1993 1992 1991
----------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Minimum rentals........................... $75.3 $30.2 $ 2.9 $5.1
Percentage rentals........................ 0.2 0.2 -- --
----------- ----------- ----- -----
Total..................................... $75.5 $30.4 $ 2.9 $5.1
----------- ----------- ----- -----
----------- ----------- ----- -----
</TABLE>
IX-33
<PAGE> 414
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Reconciliation of Capital Lease Information: The impact of recording
amortization and interest expense versus rent expense on capital leases follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------- 9 WEEKS ENDED 17 WEEKS ENDED
JANUARY 22, JANUARY 23, JANUARY 25, NOVEMBER 20,
1994 1993 1992 1991
----------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Amortization of capital lease property.... $ 0.4 $ 0.7 $ 0.1 $ 0.2
Interest expense related to obligations
under capital leases.................... 0.2 0.1 -- 0.1
----------- ----------- ------ ------
Amounts charged to earnings............... 0.6 0.8 0.1 0.3
Related minimum lease payments net of
executory costs......................... (0.8) (0.8) (0.1) (0.2)
----------- ----------- ------ ------
Excess of amounts charged over (under)
related minimum lease payments.......... $(0.2) $ -- $ -- $ 0.1
----------- ----------- ------ ------
----------- ----------- ------ ------
</TABLE>
OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS
The OfficeMax Group adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. FAS 106 requires the OfficeMax Group to
accrue for future postretirement medical benefits. The effect of this statement
on the OfficeMax Group is not significant.
In addition, Financial Accounting Standards No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106 for similar benefits provided to
terminated or laid-off employees such as salary extension, severance, disability
and supplemental unemployment benefits. The effect of this statement on the
OfficeMax Group is not significant.
STOCK OPTION PLANS
In October 1992, OfficeMax, Inc.'s Board of Directors approved the
OfficeMax, Inc. Employee Non-Qualified Share Option Plan (the "1992 Plan"),
which provides for the granting of 15,000 stock options to the OfficeMax Group's
officers and certain key employees. The options become exercisable at a rate of
25% of the optioned shares each year, beginning two years and not exceeding 10
years from the date granted. The exercise price for such stock options is based
on the fair market price of the OfficeMax Group's stock as of the date of grant.
During the year ended January 23, 1993, the OfficeMax Group granted 8,475
options with option prices of $565.00 per share; subsequent to that date, an
additional 4,180 options were granted with an option price of $1,494.00 per
share. A total of 12,655 options remain outstanding at January 22, 1994.
Under a stock option plan adopted in 1988, (the "1988 Plan"), a maximum of
6,000 incentive, non-qualified and qualified stock options may be granted to
officers and certain key employees. The options may be granted at prices not
less than 100 percent of the fair market value at the date of option grant. The
options become exercisable over a period not exceeding 10 years from the date
granted and vest immediately upon certain events. No further grants may be made
under this plan. At January 22, 1994 there were 1,075 vested options outstanding
at option prices ranging between $1.67 and $440.00 per share.
It is the OfficeMax Group's intention to convert these stock options into
stock options of the OfficeMax Group upon the initial public offering of
OfficeMax Group common stock.
IX-34
<PAGE> 415
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
OFFICEMAX GROUP EQUITY
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------- 9 WEEKS ENDED
JANUARY 22, JANUARY 23, JANUARY 25,
1994 1993 1992
----------- ----------- -------------
<S> <C> <C> <C>
Balance at beginning of period........................... $ 258.2 $ 188.1 $ 35.5
Net income (loss)........................................ 10.8 (0.8) 0.9
Net equity transactions with the Kmart Group:
Cash management, excluding items shown below........... 40.2 (11.5) --
Corporate, general and administrative expense
allocation.......................................... 0.1 0.1 --
Participation in centrally managed employee benefit and
self-insurance programs............................. 0.5 0.1 --
Acquisitions*.......................................... 298.7 82.2 --
Purchase of additional equity investment............... -- -- 151.7
----------- ----------- -------------
Balance at end of period................................. $ 608.5 $ 258.2 $ 188.1
----------- ----------- -------------
----------- ----------- -------------
</TABLE>
- -------------------------
* Includes the BizMart acquisition and Corporate Express investment in 1993 and
the OW Office Warehouse acquisition in 1992.
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions, between the Specialty Retail Groups and the
Kmart Group had been accounted for as short-term loans, on a pro forma basis the
OfficeMax Group would have been charged inter-Group interest of $2.1 during
1993. Such pro forma interest expense has been calculated on daily average
borrowings outstanding using Kmart Corporation's weighted average short-term
borrowing rate. Such pro forma interest expense is not necessarily indicative of
the results which would occur had such offerings occurred on such date, or what
the interest expense would be prospectively.
IX-35
<PAGE> 416
OFFICEMAX GROUP
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION (DOLLARS IN MILLIONS)
The following unaudited pro forma combined financial information for the
fiscal year ended January 22, 1994 has been prepared assuming that the OfficeMax
Group's acquisition of BizMart, Inc. had taken place at the beginning of the
year. The pro forma combined financial information reflects adjustments for (i)
the application of purchase accounting adjustments to BizMart, Inc.'s historical
basis of accounting, (ii) the elimination of BizMart, Inc.'s corporate
facilities, offset by increases in the OfficeMax Group's corporate staff, and
(iii) the federal income tax effect of the foregoing adjustments. The pro forma
combined financial information should be read in conjunction with the combined
financial statements of the OfficeMax Group and consolidated financial
statements of BizMart, Inc., included elsewhere herein.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS FOR THE FISCAL YEAR ENDED
JANUARY 22, 1994
<TABLE>
<CAPTION>
HISTORICAL
OFFICEMAX HISTORICAL PRO FORMA PRO FORMA
GROUP BIZMART ADJUSTMENTS COMBINED
--------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Sales.............................................. $1,421.8 $ 59.9 $ -- $1,481.7
Cost of merchandise sold, includes buying and
occupancy costs.................................. 1,109.0 49.2 -- 1,158.2
Selling, general and administrative expenses....... 284.2 12.4 (0.7)(1) 295.9
Goodwill amortization.............................. 8.6 0.6 (0.2)(2) 9.0
Interest expense................................... 0.1 -- -- 0.1
--------- ---------- ----------- ---------
Income (loss) before income taxes.................. 19.9 (2.3) 0.9 18.5
Income taxes....................................... 9.1 -- (0.4)(3) 8.7
--------- ---------- ----------- ---------
Net income (loss).................................. $ 10.8 $ (2.3) $ 1.3 $ 9.8
--------- ---------- ----------- ---------
--------- ---------- ----------- ---------
</TABLE>
- -------------------------
(1) To eliminate corporate overhead expenses related to duplicate leased
headquarters facilities at BizMart, Inc.
(2) To record additional amortization of goodwill as if the OfficeMax Group had
acquired BizMart, Inc. at the beginning of the year and to reverse the
amortization of goodwill recognized in the BizMart, Inc. historical
financial statements.
(3) To record the tax effect of the above entries at the statutory rate and to
recognize tax expense associated with the combined pre-tax income.
IX-36
<PAGE> 417
OFFICEMAX, INC.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of OfficeMax, Inc.
We have audited the accompanying statements of income and of cash flows of
OfficeMax, Inc. (an Ohio Corporation) for the fiscal year ended July 27, 1991.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of the Company's operations and cash flows
for the fiscal year ended July 27, 1991 in conformity with generally accepted
accounting principles.
Arthur Andersen & Co.
Cleveland, Ohio
October 15, 1991
IX-37
<PAGE> 418
OFFICEMAX, INC.
STATEMENT OF INCOME
(MILLIONS)
<TABLE>
<CAPTION>
FOR THE 52 WEEKS ENDED
----------------------
JULY 27, 1991
----------------------
<S> <C>
Sales................................................................... $176.4
Cost of goods sold, including occupancy costs........................... 137.7
-------
Gross Profit....................................................... 38.7
-------
Operating Expenses
Store operating and selling expenses.................................. 32.8
Pre-opening expenses.................................................. 2.0
General and administrative expenses................................... 5.0
-------
Total Operating Expenses........................................... 39.8
-------
Operating Loss.......................................................... (1.1)
Other income (expense)
Interest income....................................................... 2.2
Interest expense...................................................... (0.2)
-------
Total Other Income (Expense)....................................... 2.0
-------
Income before income taxes.............................................. 0.9
Income taxes............................................................ 0.5
-------
Net income......................................................... $ 0.4
-------
-------
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
IX-38
<PAGE> 419
OFFICEMAX, INC.
STATEMENT OF CASH FLOWS
(MILLIONS)
<TABLE>
<CAPTION>
FOR THE 52 WEEKS ENDED
JULY 27, 1991
----------------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.............................................................. $ 0.4
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization........................................... 2.2
Changes in assets and liabilities:
Increase in merchandise inventories................................ (20.5)
Decrease in prepaid expenses....................................... 0.4
Increase in other assets........................................... (8.9)
Increase in accounts payable....................................... 11.7
Increase in accrued expenses....................................... 4.2
-------
Net cash provided by operating activities............................. (10.5)
CASH FLOWS FROM INVESTING ACTIVITIES
Net payments for Office Square purchase............................... (6.3)
Net additions to leasehold improvements & equipment................... (4.8)
-------
Net cash used in investing activities................................. (11.1)
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from private placement of preferred stock................ 35.4
Payments & retirements of capital lease obligations................... (0.4)
-------
Net cash provided by financing activities............................. 35.0
-------
Net increase in cash & cash equivalents............................... 13.4
Cash & cash equivalents at beginning of period........................ 13.2
-------
Cash & cash equivalents at end of period.............................. $ 26.6
-------
-------
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
IX-39
<PAGE> 420
OFFICEMAX, INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OfficeMax's significant accounting policies, which conform to generally
accepted accounting policies applied on a consistent basis between years are
described below.
Company Background: OfficeMax, Inc. (OfficeMax) was incorporated in the
state of Ohio on January 27, 1988 with the purpose of developing a chain of
deep-discount office supply stores. The Company commenced operations on April 5,
1988, and opened its first store on July 5, 1988.
Fiscal Year: The Company reports its operating results on a 52-53 week
fiscal year which ends on the last Saturday in July. Fiscal years are identified
according to the calendar year in which they end.
Inventory: Inventory is stated at the lower of average cost or market.
Depreciation: Depreciation is provided by charges to operations using the
straight-line method over the estimated useful lives of the assets. Depreciable
lives used for property items within each property classification are as
follows:
<TABLE>
<CAPTION>
CLASSIFICATION LIFE
-------------------------------------------------------- ----------
<S> <C>
Leasehold Improvements.................................. 5-10 Years
Furniture, Fixtures & Equipment......................... 5-7 Years
Equipment Under Capital Leases.......................... 4-5 Years
</TABLE>
Expenditures for repairs, maintenance, and minor improvements are charged
against current operations; major improvements are capitalized. Accelerated
methods of depreciation are used for federal income tax purposes.
Store Pre-Opening Expenses: Pre-opening expenses related to new store
openings are charged to operations as incurred.
Vendor Programs: Provisions for discounts or rebates attributable to volume
purchases and other incentive agreements with vendors are recorded as a
reduction of cost of sales or advertising expense at the time the Company has
qualified for such discounts.
Goodwill: Goodwill is being amortized on a straight-line method over 40
years.
Statements of Cash Flow: For the purpose of the statements of cash flows,
the Company considers all temporary cash investments purchased with a maturity
of three months or less to be cash equivalents. Net cash flows from operating
activities reflect cash payments for interest of $.2 million and income taxes of
$.1 million in 1991.
Income Taxes: The Company provides for federal and state income taxes
currently payable as well as for those deferred because of timing differences
between financial statement and taxable income in accordance with Accounting
Principles Board Opinion No. 11, Accounting for Income Taxes.
2. OFFICE SQUARE ACQUISITION
On November 3, 1990, the Company purchased from Builders Square, a Kmart
Corporation (Kmart) subsidiary, the leasehold rights, inventory and certain
other assets of Builders Square's five Office Square stores. The purchase was
accounted for under the purchase method of accounting. The purchase price of
approximately $6.3 million has been allocated to the tangible and identifiable
intangible assets acquired based upon their estimated fair values.
IX-40
<PAGE> 421
OFFICEMAX, INC.
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
3. LEASE COMMITMENTS AND CONTINGENCIES
The Company conducts its operations in various leased facilities that have
initial lease terms ranging from 5 to 15 years. Most lease agreements contain
renewal options and rent escalation clauses and require the Company to pay
utilities, real estate taxes, common area maintenance and, in some instances,
contingent rentals based on sales. The escalating rent expenses are recognized
on a straight-line basis over the respective terms of the leases. Amounts
accrued relative to these rent escalations are recognized as long-term lease
commitments.
The Company currently subleases a small amount of space in four of its
stores to subtenants whose operations are intended to compliment the Company's
merchandise presentation. Aggregate future minimum sublease rentals as of July
27, 1991 are $.2 million.
In addition, certain equipment used in the Company's operations is leased
under operating leases. Minimum rental expense for 1991 is summarized as
follows:
<TABLE>
<CAPTION>
1991
----------
(MILLIONS)
<S> <C>
Contingent Rentals........................................ $ .1
All Other Rental Expense.................................. 10.3
Less: Sublease Rentals.................................... (.1)
----------
$ 10.3
----------
----------
</TABLE>
Leased property under capital leases, with accumulated amortization of $.6
million at July 27, 1991, consists of store and computer equipment. Minimum
rental commitments under capital and operating leases of stores and facilities
open and in use at July 27, 1991 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
(MILLIONS)
<S> <C> <C>
1992....................................................................... $ .5 $ 13.9
1993....................................................................... .3 14.4
1994....................................................................... .1 14.2
1995....................................................................... .0 14.1
1996....................................................................... .0 13.2
Thereafter................................................................. .0 78.4
------- ---------
Total Minimum Lease Payments............................................... $ .9 $ 148.2
---------
---------
Amount representing interest............................................... (.1)
-------
Present Value of Net Minimum Lease Payments................................ $ .8
-------
-------
</TABLE>
In addition, the Company has also entered into lease commitments for future
new stores to be opened after July 27, 1991.
4. CAPITAL STOCKS
On November 21, 1990, the Company issued shares of its Class H Convertible
Preferred Stock to Kmart. The agreement resulted in Kmart owning a 21.6% of the
interest of the Company, with options to acquire additional equity in the
Company within specified time frames.
IX-41
<PAGE> 422
OFFICEMAX, INC.
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
5. LINE OF CREDIT
At July 27, 1991 the Company has a $10.0 million unsecured line of credit
agreement with a commercial bank. The agreement provides for $10.0 million of
available credit with interest payable, at the Company's option, at an interest
rate at the bank's base-lending rate (prime) or reserve adjusted LIBOR plus 125
basis points. In addition, the agreement provides for a commitment fee payable
at the rate of one quarter of one percent per annum for any quarter the line is
not utilized. The line is subject to certain financial covenants and is
available through October 31, 1991. The line was not drawn upon during the
fiscal year.
Additionally, on February 8, 1991 the Company entered into a Master Lease
Agreement with a commercial financial services corporation. The agreement
provides for equipment sale-leaseback financing not to exceed $4.4 million. This
agreement expires on December 31, 1991. During fiscal 1991, the Company did not
utilize the financing provided by the agreement.
6. INCOME TAXES
The components of the Company's income tax provision are summarized as
follows:
<TABLE>
<CAPTION>
1991
----------
(MILLIONS)
<S> <C>
Currently payable:
Federal................................................. $ .4
State................................................... .1
---
$ .5
---
---
</TABLE>
A reconciliation of the federal statutory and effective income tax rates
follows:
<TABLE>
<CAPTION>
1991
-----
<S> <C>
Statutory rate............................................... 34.0%
State taxes.................................................. 4.8
Goodwill..................................................... 18.8
Alternative Minimum Tax...................................... 24.5
Net operating loss carryforward and other.................... (29.9)
-----
Effective rate........................................ 52.2%
-----
-----
</TABLE>
The Company has tax net operating loss carryforwards of approximately $7.1
million which are available to offset future taxable income through 2005. These
tax net operating loss carryforwards were acquired through acquisition and
annual utilization is limited by federal tax regulations to approximately $2.1
million.
For financial reporting purposes the Company has utilized all of the net
operating loss carryforwards available to offset future income tax provisions.
The major difference between tax and financial reporting net operating losses
results from limitations imposed on the recognition of purchased tax benefits
for financial reporting purposes. Future utilization of these acquired benefits
will result in adjustment to the Company's
IX-42
<PAGE> 423
OFFICEMAX, INC.
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
goodwill balance. Additional differences result from temporary differences in
the recognition of revenues and expenses for tax and financial reporting
purposes. The components of these differences in 1991 are as follows:
<TABLE>
<CAPTION>
1991
----------
(MILLIONS)
<S> <C>
Rental Expense............................................ $ (1.9)
Non Deductible Reserves................................... .2
Depreciation.............................................. .8
----------
$ (.9)
----------
----------
</TABLE>
The Tax Reform Act of 1986 enacted an alternative minimum tax system for
corporations. The Company has alternative minimum tax credits available to
offset future tax obligations. For financial reporting purposes these credits
have not been benefited as their future realization is not assured.
7. SUBSEQUENT EVENT
On October 15, 1991, the Company signed a letter of intent with Kmart
Corporation pursuant to which a wholly owned subsidiary of Kmart will be merged
into the Company, with the result that Kmart will own approximately 92% of the
outstanding capital stock of the Company following the merger. The remaining
approximately 8% would be held by the Company's founders. The proposed
transaction is subject to the satisfaction of a number of conditions, including
approval by Company shareholders.
IX-43
<PAGE> 424
BIZMART, INC.
CONSOLIDATED FINANCIAL STATEMENTS
MARCH 4, 1993
IX-44
<PAGE> 425
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Shareholders of BizMart, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of cash flows and of shareholders' equity
present fairly, in all material respects, the financial position of BizMart,
Inc. and its subsidiary at March 4, 1993, and the results of their operations
and their cash flows for the five weeks ended March 4, 1993, the 52 weeks ended
January 30, 1993, the 33 weeks ended February 1, 1992 and the seven weeks ended
June 18, 1991, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 1, on June 18, 1991, the Company was acquired by
Intelligent Electronics, Inc.; the financial statements for periods subsequent
to June 18, 1991 are presented on the accounting basis arising from the
acquisition. On March 4, 1993, OfficeMax, Inc. acquired the Company; the
accompanying financial statements do not reflect any adjustments for the
application of purchase accounting with respect to the OfficeMax acquisition.
PRICE WATERHOUSE
Cleveland, Ohio
October 15, 1993
IX-45
<PAGE> 426
BIZMART, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
MARCH 4,
1993
-------------
($ THOUSANDS)
<S> <C>
ASSETS
Current assets:
Cash......................................................................... $ 7,568
Merchandise inventories...................................................... 141,609
Accounts receivable, net..................................................... 14,629
Other current assets......................................................... 5,808
-------------
Total current assets........................................................... 169,614
-------------
Property and equipment:
Computer equipment........................................................... 9,962
Furniture and fixtures....................................................... 20,519
Leasehold improvements....................................................... 30,929
-------------
61,410
Less -- accumulated depreciation and amortization............................ (12,605)
-------------
48,805
-------------
Goodwill, net of accumulated amortization of $11,106........................... 125,889
-------------
$ 344,308
-------------
-------------
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Accounts payable............................................................. $ 61,962
Accrued expenses............................................................. 16,521
Current portion of capital lease obligations................................. 253
-------------
Total current liabilities...................................................... 78,736
Capital lease obligations, less current portion................................ 940
Other long-term liabilities.................................................... 2,648
Intercompany payables.......................................................... 97,560
Commitments and contingencies..................................................
-------------
179,884
-------------
Shareholder's equity:
Common stock (par value $.01, 1,000 shares authorized, issued and
outstanding).............................................................. --
Additional paid-in capital................................................... 187,815
Accumulated deficit.......................................................... (23,391)
-------------
Total shareholder's equity..................................................... 164,424
-------------
$ 344,308
-------------
-------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
IX-46
<PAGE> 427
BIZMART, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS SEVEN WEEKS
ENDED ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992 JUNE 18, 1991
------------- ---------------- ---------------- -------------
($ THOUSANDS)
<S> <C> <C> <C> <C>
Sales.................................. $59,876 $634,652 $333,472 $45,515
------------- ---------------- ---------------- -------------
Cost of merchandise sold (includes
occupancy costs)..................... 49,186 515,044 271,297 35,320
Selling, general and administrative
expenses............................. 11,229 118,148 52,036 8,806
Advertising............................ 1,762 21,079 8,027 1,365
Interest expense (income).............. 46 1,268 (26) (134)
------------- ---------------- ---------------- -------------
62,223 655,539 331,334 45,357
------------- ---------------- ---------------- -------------
Income (loss) before income taxes...... (2,347) (20,887) 2,138 158
Tax benefit allocated to goodwill...... -- -- (2,295) --
------------- ---------------- ---------------- -------------
Net income (loss)...................... $(2,347) $(20,887) $ (157) $ 158
------------- ---------------- ---------------- -------------
------------- ---------------- ---------------- -------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
IX-47
<PAGE> 428
BIZMART, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS SEVEN WEEKS
ENDED ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992 JUNE 18, 1991
------------- ---------------- ---------------- -------------
($ THOUSANDS)
<S> <C> <C> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income (loss).................... $(2,347) $(20,887) $ (157) $ 158
Adjustments to reconcile net income
(loss) to operating cash flows:
Depreciation and amortization..... 1,660 15,774 7,199 728
Tax benefit allocated to
goodwill........................ -- -- 2,295 --
Cash provided by (used for) current
assets and current liabilities:
(Increase) decrease in
inventories..................... 329 (39,445) (38,338) (2,216)
(Increase) decrease in
receivables..................... 4,852 (943) (14,606) (920)
(Increase) decrease in other
current assets.................. 789 (1,447) 2,271 (8,538)
Increase (decrease) in accounts
payable and other liabilities... (8,685) 15,691 18,375 6,454
------------- ---------------- ---------------- -------------
Net cash used for operations........... (3,402) (31,257) (22,961) (4,334)
------------- ---------------- ---------------- -------------
INVESTING
Capital expenditures................. (637) (23,687) (16,586) (1,221)
Proceeds from sale of investments.... -- -- 20,401 191
------------- ---------------- ---------------- -------------
Net cash provided by (used for)
investing............................ (637) (23,687) 3,815 (1,030)
------------- ---------------- ---------------- -------------
FINANCING
Reduction in capital lease
obligations....................... (27) (389) (368) (109)
Net proceeds of intercompany
advances.......................... 2,554 60,741 25,531
------------- ---------------- ---------------- -------------
Net cash provided by (used for)
financing............................ 2,527 60,352 25,163 (109)
------------- ---------------- ---------------- -------------
Net increase (decrease) in cash and
cash equivalents..................... (1,512) 5,408 6,017 (5,473)
Cash and cash equivalents at beginning
of period............................ 9,080 3,672 (2,345) 3,128
------------- ---------------- ---------------- -------------
Cash and cash equivalents at end of
period............................... $ 7,568 $ 9,080 $ 3,672 $(2,345)
------------- ---------------- ---------------- -------------
------------- ---------------- ---------------- -------------
Supplemental cash flow information:
Interest paid........................ $ 59 $ 1,430 $ 55 $ 13
------------- ---------------- ---------------- -------------
------------- ---------------- ---------------- -------------
Income taxes paid.................... $ -- $ 135 $ 92 $ --
------------- ---------------- ---------------- -------------
------------- ---------------- ---------------- -------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
IX-48
<PAGE> 429
BIZMART, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON PAID-IN TREASURY ACCUMULATED SHAREHOLDERS'
STOCK CAPITAL SHARES DEFICIT EQUITY
------ ---------- -------- ----------- ------------
($ THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance at April 27, 1991................. $114 $ 78,077 $ (150) $ (7,209) $ 70,832
Net income for the period................. -- -- -- 158 158
------ ---------- -------- ----------- ------------
Balance at June 18, 1991.................. $114 $ 78,077 $ (150) $ (7,051) $ 70,990
------ ---------- -------- ----------- ------------
------ ---------- -------- ----------- ------------
- ------------------------------------------------------------------------------------------------------------
Acquisition by Intelligent Electronics,
Inc..................................... $ -- $ 187,815 $ -- $ -- $187,815
Net loss for the period................... -- -- -- (157) (157)
------ ---------- -------- ----------- ------------
Balance at February 1, 1992............... -- 187,815 -- (157) 187,658
Net loss for the period................... -- -- -- (20,887) (20,887)
------ ---------- -------- ----------- ------------
Balance at January 30, 1993............... -- 187,815 -- (21,044) 166,771
Net loss for the period................... -- -- -- (2,347) (2,347)
------ ---------- -------- ----------- ------------
Balance at March 4, 1993.................. $ -- $ 187,815 $ -- $ (23,391) $164,424
------ ---------- -------- ----------- ------------
------ ---------- -------- ----------- ------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
IX-49
<PAGE> 430
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION, ACQUISITIONS AND NATURE OF BUSINESS
BizMart, Inc. (the "Company") was incorporated in the State of Delaware on
September 30, 1987, and operates high-volume office products superstores
specializing in the sale of office products and computers at discount prices.
The Company opened its first store in May 1988 and had 59 stores in operation at
June 18, 1991, 71 stores in operation at February 1, 1992 and 105 stores in
operation at January 30, 1993 and March 4, 1993.
On June 18, 1991, Intelligent Electronics, Inc. ("Intelligent Electronics")
acquired all of the outstanding common stock and stock options of the Company
for $195.8 million in cash (the "IE acquisition"). The IE acquisition was
recorded using the purchase method and, accordingly, the purchase price was
allocated to the Company's assets and liabilities based on their estimated fair
values. The excess of purchase price over the fair value of the Company's net
assets of $139.7 million was recorded as goodwill. From June 19, 1991 to March
4, 1993, the Company operated as a wholly-owned subsidiary of Intelligent
Electronics.
The accompanying financial statements present the results of operations for
the seven-week period ended June 18, 1991 on the Company's historical basis of
accounting prior to its acquisition by Intelligent Electronics. The periods from
June 18, 1991 to March 4, 1993 are presented on the new accounting basis
resulting from the IE acquisition.
On December 3, 1992, Intelligent Electronics entered into a stock purchase
agreement (the "Stock Purchase Agreement") with OfficeMax, Inc. ("OfficeMax"),
whereby OfficeMax acquired all of the Company's outstanding common stock for
$267.7 million in cash (the "OfficeMax Acquisition"). The Stock Purchase
Agreement allowed OfficeMax to exclude up to $12,000,000 of inventory from the
purchase (the "Excluded Inventory"). The return of the Excluded Inventory to
Intelligent Electronics was recorded as a reduction of the Intercompany payable
balance with Intelligent Electronics and a reduction in inventory at January 30,
1993. The OfficeMax acquisition was completed on March 4, 1993.
The accompanying financial statements do not reflect any adjustments which
will result from the application of purchase accounting with respect to the
OfficeMax acquisition.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year: Prior to its acquisition by Intelligent Electronics, the
Company's fiscal year ended on the last Saturday of April. Subsequent to this
acquisition, the Company's fiscal year ended on the last Saturday in January, to
comprise a 52-week fiscal year.
Basis of Consolidation: The accompanying consolidated financial statements
of the Company include the accounts of its wholly-owned subsidiary, BizMart
(Texas), Inc. All significant intercompany accounts and transactions have been
eliminated.
Inventories: Merchandise inventories are stated at the lower of cost or
market, applied on a departmental basis. Cost is determined using the average
cost method.
Property and Equipment: Leasehold improvements, fixtures and computer
equipment are recorded at cost. Depreciation is provided over the estimated
useful life of the related assets on a straight-line basis for financial
reporting purposes and using accelerated methods for tax purposes. Store
properties are leased and improvements are amortized over the term of the lease
but not more than ten years. Other annual rates used in computing depreciation
for financial statement purposes are 20% for fixtures and 33% for computer
equipment.
Vendor rebate programs: Provisions for vendor rebates attributable to
volume purchases are recorded as a reduction of such purchases and reduce the
carrying cost of the related inventory. Discounts attributable to
IX-50
<PAGE> 431
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
advertising rebate programs are recorded as a reduction of advertising expense
at the time it is probable that the Company has earned such discounts.
Pre-Opening and Closing Costs: Pre-opening expenses, which consist
primarily of labor and supplies cost incurred prior to each new store's opening
and promotional cost incurred during the grand opening period, are capitalized
and amortized over the first three full months the store is open. When the
decision to close a retail unit is made, the Company provides for the future net
lease obligation, nonrecoverable investment in fixed assets, other expenses
directly related to cessation of operations and estimated operating losses
through the closing date.
Fair Value of Financial Instruments: The recorded values of the Company's
financial instruments, including accounts receivable and accounts payable,
approximate their respective fair values.
Goodwill: The Company amortizes goodwill arising from its acquisition by
Intelligent Electronics on a straight-line basis over 20 years.
Statement of Cash Flows: The Company considers highly liquid investments
with an original maturity of three months or less to be cash equivalents. During
the 52-week period ended January 30, 1993, the Company incurred capital lease
obligations to obtain new computer equipment in the amount of $1,436,000.
Income Taxes: Prior to June 18, 1991, deferred income taxes were provided
on timing differences between financial statement and taxable income in
accordance with Accounting Principles Board Opinion No. 11, Accounting for
Income Taxes.
The Company has adopted Statement of Financial Accounting Standard No. 109,
Accounting for Income Taxes (SFAS 109), with retroactive effect to June 18,
1991. SFAS 109 requires deferred taxes to be recognized using the liability
method, whereby tax rates are applied to cumulative temporary differences based
on when and how they are expected to affect the tax return.
While the Company was a wholly-owned subsidiary of Intelligent Electronics,
it was included in the Intelligent Electronics consolidated federal income tax
return. The Company calculates its income tax provisions for financial reporting
purposes, however, on a separate return basis.
NOTE 3 -- TRANSACTIONS WITH INTELLIGENT ELECTRONICS
While the Company was owned by Intelligent Electronics, it purchased
certain merchandise inventories, consisting primarily of computer products and
related accessories, from Intelligent Electronics; such purchases were made at
Intelligent Electronics cost, plus 2%. These purchases were financed by
intercompany payable balances and the related merchandise was recorded in the
Company's consolidated financial statements at the cost paid to Intelligent
Electronics. The elimination of Intelligent Electronics as a supplier to the
Company following the Company's acquisition by OfficeMax has not had a material
impact on the earnings of the Company.
Intelligent Electronics also provided and operated a warehouse for the
Company and billed the Company for actual costs incurred. Included in the
consolidated statements of income are warehousing expenses charged to the
Company by Intelligent Electronics in the amounts of $578,000, $4,226,000 and
$998,000 for the five weeks ended March 4, 1993, the 52 weeks ended January 30,
1993 and the 33 weeks ended February 1, 1992, respectively. These warehouse
charges were treated as an inventory cost by the Company and, accordingly,
$1,658,000 were capitalized in the Company's inventory balance at March 4, 1993.
The intercompany payable balance to Intelligent Electronics primarily
comprised inventory purchases by the Company and cash advances made by
Intelligent Electronics to the Company to fund store openings, partially offset
by payments of cash generated from operations, returns of merchandise and
credits received for
IX-51
<PAGE> 432
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
vendor rebate programs through Intelligent Electronics. Interest was not charged
on intercompany account balances.
A summary of activity in the intercompany payable account follows:
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS
ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992
------------- ---------------- ----------------
($ THOUSANDS)
<S> <C> <C> <C>
Beginning balance.................................. $95,006 $ 34,265 $ --
Inventory purchases, net of returns................ 341 37,911 61,543
Warehousing cost billed............................ 503 5,372 1,585
Cash advances...................................... 1,713 17,542 (28,738)
Other activity, net................................ (3) (84) (125)
------------- ---------------- ----------------
Ending balance..................................... $97,560 $ 95,006 $ 34,265
------------- ---------------- ----------------
------------- ---------------- ----------------
Average intercompany balance during the period..... $96,283 $ 64,636 $ 17,133
------------- ---------------- ----------------
------------- ---------------- ----------------
</TABLE>
The Company maintained its own corporate offices throughout the periods it
was owned by Intelligent Electronics, and corporate services provided by
Intelligent Electronics to the Company were not significant. Accordingly, any
allocations of corporate overhead costs from Intelligent Electronics would have
been minimal.
NOTE 4 -- ACCOUNTS RECEIVABLE
Accounts receivable comprised the following:
<TABLE>
<CAPTION>
MARCH 4, 1993
--------------
($ THOUSANDS)
<S> <C>
Vendor receivables............................................... $ 12,772
Other............................................................ 2,457
Allowance for doubtful accounts.................................. (600)
--------------
Total accounts receivable, net................................... $ 14,629
--------------
--------------
</TABLE>
NOTE 5 -- ACCRUED EXPENSES
Accrued expenses comprised the following:
<TABLE>
<CAPTION>
MARCH 4, 1993
--------------
($ THOUSANDS)
<S> <C>
Payroll.......................................................... $ 4,561
Sales tax........................................................ 4,921
Other............................................................ 7,039
--------------
Total accrued expenses........................................... $ 16,521
--------------
--------------
</TABLE>
NOTE 6 -- INCOME TAXES
During the period ended February 1, 1992, the Company utilized deductions
generated by the retirement of stock options in connection with the acquisition
by Intelligent Electronics, and certain other tax benefits existing at the
acquisition date, to offset its current tax liability. As the benefit of these
deductions was not recorded at the acquisition date, their subsequent
realization has been reflected as a reduction of goodwill.
IX-52
<PAGE> 433
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The Company utilized net operating loss carryforwards to offset taxable
income for the period ended June 18, 1991. Consequently, differences between
pre-tax financial reporting income and taxable income were not significant.
A reconciliation of the provision calculated at the federal statutory rate
to the Company's recorded provision follows:
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS 7 WEEKS
ENDED ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992 JUNE 18, 1991
------------- ---------------- ---------------- -------------
($ THOUSANDS)
<S> <C> <C> <C> <C>
Provision (benefit) at statutory
rates................................ $(798) $ (7,102) $ 727 $ 54
State and local taxes.................. (47) (418) 43 --
Goodwill amortization.................. 215 2,436 1,496 --
Addition to (utilization of) net
operating loss carryforward.......... 218 4,736 -- (54)
Other.................................. 412 348 29 --
------------- ---------------- ------- ------
$ -- $ -- $2,295 $ --
------------- ---------------- ------- ------
------------- ---------------- ------- ------
</TABLE>
The following summarizes temporary differences giving rise to deferred tax
assets and liabilities at the dates indicated:
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS
ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992
------------- ---------------- ----------------
($ THOUSANDS)
<S> <C> <C> <C>
Net operating loss carryforward.................... $ 6,147 $ 5,929 $ 1,193
Inventory reserves................................. 1,715 1,452 1,001
Fixed asset write-offs............................. -- -- 1,359
Accrued expenses................................... 1,505 1,546 2,389
Depreciation....................................... 1,286 1,194 304
Deferred rent...................................... 940 873 232
Other.............................................. 122 243 311
------------- ---------------- ----------------
Gross deferred asset............................... 11,715 11,237 6,789
Valuation allowance................................ (11,575) (10,944) (5,903)
------------- ---------------- ----------------
Net deferred asset................................. 140 293 886
------------- ---------------- ----------------
Deferred preopening costs.......................... (77) (145) (223)
Acquisition costs.................................. -- -- (462)
Other.............................................. (63) (148) (201)
------------- ---------------- ----------------
Gross deferred liability........................... (140) (293) (886)
------------- ---------------- ----------------
Net deferred taxes................................. $ -- $ -- $ --
------------- ---------------- ----------------
------------- ---------------- ----------------
</TABLE>
Changes in the deferred tax asset valuation allowance are a result of
uncertainties surrounding future utilization of such temporary differences in
future periods.
At March 4, 1993, the Company had net operating loss carryforwards of
$17,074,000, calculated on a stand-alone basis, expiring through 2009. These
carryforwards will not be available to offset BizMart's future taxable income
due to previous utilization by Intelligent Electronics.
IX-53
<PAGE> 434
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 7 -- LINE OF CREDIT AGREEMENT
On February 3, 1992, the Company, Intelligent Electronics and other
subsidiaries of Intelligent Electronics (the "Obligors") entered into a
financing agreement with a finance company to provide up to $50,000,000 in
working capital financing subject to a collateral formula based on inventory and
eligible receivables. Borrowings under this facility bear interest at prime (6%
at March 4, 1993) plus 1.125% and are secured by all of the Obligors' assets. In
addition, the agreement requires that the Obligors comply with certain financial
covenants and ratios. At March 4, 1993, the Company had open letters of credit
of approximately $1,246,000 outstanding against this line of credit. As a result
of the Company's acquisition by OfficeMax, it is no longer an Obligor under the
financing agreement and letters of credit outstanding were funded by OfficeMax
or have expired.
NOTE 8 -- FRANCHISE OPERATIONS
In September 1991, the Company initiated a program to franchise the
computer departments in its stores. Under the franchise program, the franchisee
paid the Company an initial franchise fee of up to $45,000, purchased all of its
inventories from the Company at 5.25% above the Company's cost, and paid the
Company a royalty of 5.5% of cost upon sale of merchandise. The Company provided
franchisees with merchandising, advertising, distribution and store support
functions. Franchisees retained the right to terminate the franchise arrangement
during its seventh through twelfth months. Upon termination, the Company
refunded the initial franchise fee and repurchased the franchisee's inventories
at the franchisee's cost. Initial franchise fees were recognized in income on
the first anniversary of the franchise agreement. The Company established a
reserve for returns of franchise inventories when the original sale was
recorded. OfficeMax believes that the low gross margins associated with the sale
of computers was the principal reason the Company's franchise program was
unsuccessful. The Company is not considering and has no future plans to
implement franchise programs in the future.
The Company sold franchises in a total of 74 stores; 69 of these
franchisees had exercised their right to terminate the agreement by March 4,
1993. In connection with the OfficeMax acquisition, Intelligent Electronics has
agreed to indemnify the Company against costs to terminate remaining franchises.
A summary of amounts reflected in the Company's results of operations
pertaining to franchise operations follows:
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS
ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992
------------- ---------------- ----------------
($ THOUSANDS)
<S> <C> <C> <C>
Initial franchise fees recognized.................. $ -- $ -- $ --
Sales to franchisees, net of returns............... 1,013 67,896 57,507
Gross margin on sales to franchisees............... 70 1,306 1,106
Other franchise fees earned, included in gross
margin in the statement of operations............ 60 4,473 1,342
</TABLE>
NOTE 9 -- LEASES
The Company has entered into lease agreements for the use of administrative
office facilities and retail store locations with remaining terms ranging from 2
to 17 years. Some of the retail store lease arrangements have one or more
options to extend the lease term for five years at fair market value or rents
pre-determined under the respective leases. These leases generally require the
Company to pay all executory costs (such as property taxes, maintenance and
insurance) and may contain contingent rentals based upon sales levels of the
respective stores.
IX-54
<PAGE> 435
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The Company has recorded deferred rents to the extent lease expense
computed on a straight-line basis over the lease term exceeds actual amounts
paid under such lease. Such deferred amounts are included in the accompanying
consolidated balance sheet as other non-current liabilities. The Company
incurred rent expense on operating leases of $2,797,000, $24,163,000, $9,461,000
and $1,675,285 during the five weeks ended March 4, 1993, the 52 weeks ended
January 30, 1993, the 33 weeks ended February 1, 1992 and the seven weeks ended
June 18, 1991, respectively.
Capital leases are recorded in the Company's consolidated financial
statements as property and equipment together with the related obligation. At
March 4, 1993, annual future minimum rental payments were as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE PAYMENTS OPERATING CAPITAL
-------------------------------------------------- --------- -------
($ THOUSANDS)
<S> <C> <C>
Fiscal year
1993............................................ $ 21,539 $ 329
1994............................................ 23,246 322
1995............................................ 23,278 322
1996............................................ 22,848 322
1997............................................ 22,651 322
Thereafter...................................... 113,532 134
--------- -------
Total minimum lease payments...................... $ 227,094 1,751
---------
---------
Less: imputed interest............................ (558)
-------
Present value of capital lease obligations........ 1,193
Less: current portion............................. (253)
-------
$ 940
-------
-------
</TABLE>
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
There are currently two actions pending against the Company involving
claims by former franchisees. The Company believes that it has substantive
defenses in both actions and intends to defend itself vigorously. Further,
pursuant to the Stock Purchase Agreement, Intelligent Electronics has
indemnified OfficeMax with respect to claims by franchisees.
The Company is party to a number of other claims and legal proceedings
arising in the normal course of its operations. The Company does not believe
that these matters, individually or in the aggregate, will have a material
impact on its financial position or results of operations.
NOTE 11 -- PRIVATE LABEL CREDIT CARDS
The Company has an arrangement with a financial services company (the
"Issuer") whereby the Issuer issues the Company's private label credit card. The
credit card accounts, and receivables generated thereby, are owned by the
Issuer. The Company pays the Issuer a fee which is designed to cover the
Issuer's cost of providing credit to the Company's customers, including bad debt
losses. The fee is subject to annual adjustment for bad debt experience. In
addition, the fee is adjusted monthly based on the difference between prevailing
short-term interest rates and levels specified in the agreement. The arrangement
provides for a reserve account, funded from fees paid to the Issuer, which must
be maintained at a minimum level. The fee paid resulted in expense in the
amounts of $94,000, $995,000, $248,000 and $34,000 for the five weeks ended
March 4, 1993, the 52 weeks ended January 30, 1993, the 33 weeks ended February
1, 1992 and the seven weeks ended June 18, 1991, respectively. The credit card
arrangement can be terminated by the Company or
IX-55
<PAGE> 436
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
the Issuer. In the event of a termination, the Company is required to repurchase
receivables at a defined price, ranging from face value up to a maximum premium
of 5.2%.
The Company's maximum exposure to off-balance sheet and credit risk is
represented by the outstanding balance of private label credit card receivables,
which totaled approximately $12,942,000 at March 4, 1993.
IX-56
<PAGE> 437
ANNEX IX-I
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE 39 WEEKS ENDED OCTOBER 23, 1993
39 Weeks Ended October 23, 1993 and October 24, 1992
RESULTS OF OPERATIONS
The following table presents the OfficeMax Group's ("OfficeMax") income
statement as a percent of sales for the periods presented.
<TABLE>
<CAPTION>
39 WEEKS ENDED
-----------------------
OCTOBER 23, OCTOBER 24,
1993 1992
-------- --------
<S> <C> <C>
Sales.................................................................. 100.0% 100.0%
Cost of merchandise sold (includes buying and occupancy costs)......... 78.6 78.7
-------- --------
Gross margin........................................................... 21.4 21.3
Selling, general and administrative expenses........................... 20.5 21.3
-------- --------
Operating income before pre-opening expense and goodwill
amortization......................................................... 0.9 --
Pre-opening expense.................................................... 0.2 0.7
Goodwill amortization.................................................. 0.7 0.9
-------- --------
Operating income (loss)................................................ -- (1.6)
Net interest expense (income).......................................... -- (0.2)
-------- --------
Income (loss) before income taxes...................................... -- (1.4)
Income taxes........................................................... 0.2 (0.2)
-------- --------
Net loss............................................................... (0.2) (1.2)
-------- --------
-------- --------
</TABLE>
Store Activity. OfficeMax's store activity for the first 39 weeks of 1993
and 1992 is summarized below:
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 23, OCTOBER 24,
1993 1992
-------- --------
<S> <C> <C>
Beginning number of stores..................... 179 79
Openings....................................... 29 32
Acquisitions................................... 105 41
Closings....................................... (8) (2)
--- ---
Ending number of stores........................ 305 150
--- ---
--- ---
</TABLE>
Sales for the 39 weeks ended October 23, 1993, were $993.2 million, a
$657.3 million, or 195.6%, increase over sales of $335.9 million for the same
period in the prior year. The increase was primarily due to the opening of 29
new stores, the acquisition of the 105 BizMart stores in March 1993, the
inclusion of a full 39 weeks sales for the 41 OW Office Warehouse, Inc. stores
acquired in June 1992 and 61 new stores opened during fiscal 1992. The sales
increase also reflects the 19.2% increase in comparable store sales in the 39
weeks ended October 23, 1993.
Cost of merchandise sold, including buying and occupancy costs, decreased
to 78.6% of sales in the first 39 weeks of 1993 from 78.7% in the same period of
the prior year. As a percent of sales, gross margin was 21.4% in the first 39
weeks of 1993, as compared to 21.3% in the same period in the prior year. The
increase
IX-57
<PAGE> 438
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE 39 WEEKS ENDED OCTOBER 23, 1993 -- CONTINUED
was primarily due to cost reductions resulting from increased purchasing power
which yielded volume discounts and leveraging of occupancy expenses with
increased store sales volumes.
Selling, general and administrative expenses decreased to 20.5% of sales
for the first 39 weeks of 1993 from 21.3% of sales in the same period of the
prior year as a result of expense control and leveraging of OfficeMax corporate
overhead and advertising expenses which was a result of increased store sales
volumes. This improvement was partially offset by the opening of 29 new stores
during the first 39 weeks of 1993. In general, new stores generate lower sales
than established stores, resulting in higher selling and store operating
expenses as percentage of sales. In addition, OfficeMax acquired BizMart in 1993
and integrated 105 stores and all of its operations, including general and
administration functions, resulting in operational and overhead efficiencies.
Selling, general and administrative expenses consist primarily of store payroll
and operating expenses, OfficeMax corporate overhead and advertising. OfficeMax
corporate and administrative expenses decreased as a percent of sales to 2.3% in
the first 39 weeks of 1993 from 2.8% in the same period last year due to
leveraging of corporate overhead as a result of increased store sales volumes.
Operating income before pre-opening expense and goodwill amortization was
$9.2 million, or 0.9% of sales, in the first 39 weeks of 1993, as compared to
none in the prior year period. The increase was the result of the aforementioned
gross margin improvement, effective cost control and the leverage of selling,
general and administrative expenses as a result of increased store sales
volumes.
Pre-opening expense was $2.1 million in the first 39 weeks of 1993, as
compared to $2.3 million in the same period of the prior year reflecting the
opening of 29 new stores, excluding acquired stores, versus 32 new stores, in
the prior period. On a per store basis, the average cost per new store remained
relatively constant at $0.1 million. Pre-opening expenses consist principally of
payroll and supplies, and are expensed during the first full month of the
store's operation. No pre-opening expense is associated with acquired stores.
Goodwill amortization was $6.7 million for the first 39 weeks of 1993, as
compared to $3.0 million in the same period of the prior year. The increase
resulted from the inclusion of amortization of goodwill resulting from goodwill
associated with the March 1993 acquisition of BizMart and the acquisition of 41
OW Office Warehouse stores in June 1992. Goodwill is capitalized and amortized
over 40 years using the straight-line method.
Operating income (loss) was $0.4 million for the 39 weeks ended October 23,
1993, as compared to $(5.3) million for the same period last year as a result of
the aforementioned gross margin improvement, effective cost control and the
leverage of selling, general and administrative expenses as a result of
increased store sales volumes.
Net interest expense (income) was $0.2 million for the first 39 weeks of
1993, as compared to $(0.5) million in the prior year primarily due to the
reduction of interest bearing short-term cash investments. These investments
were primarily funded with proceeds from Kmart Corporation's initial acquisition
of an 21.6% equity interest in OfficeMax, Inc. in November 1990 and have been
reduced to fund operating and capital expenditure needs since then.
Income tax expense was $1.8 million for the first 39 weeks of 1993, as
compared to a $0.7 million credit in the same period last year. The effective
tax rates for both periods were different from the statutory income tax rate due
primarily to non-deductible goodwill amortization expense.
As a result of the foregoing factors, net loss for the 39 weeks ended
October 23, 1993 was $(1.6) million, as compared to $(4.1) million for the same
period in the prior year.
IX-58
<PAGE> 439
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE 39 WEEKS ENDED OCTOBER 23, 1993 -- CONTINUED
ACQUISITION
On October 26, 1993, OfficeMax acquired an initial 19.9% (17.5% on a fully
diluted basis) minority interest in Corporate Express, Inc. ("Corporate
Express"), a Colorado-based contract stationer, for $23.5 million. The Corporate
Express investment is being accounted for under the cost method of accounting.
On November 23, 1993, Corporate Express signed a definitive agreement to acquire
the office products division of Hanson, plc. A portion of the purchase price
will be funded through the issuance of additional equity of Corporate Express.
As a result, OfficeMax's equity interest in Corporate Express will be reduced to
approximately 14.4% (12.5% on a fully diluted basis). As part of its agreement
with Corporate Express, OfficeMax has the right in 1997, under certain
circumstances, to increase its holdings in Corporate Express to between 51% and
100%.
LIQUIDITY AND CAPITAL RESOURCES
OfficeMax's principal capital requirements have been to fund working
capital needs, the opening of new stores and strategic acquisitions. During the
periods presented, these capital requirements have generally been satisfied by
equity contributions from Kmart Corporation and, to a lesser extent, by cash
flows from operations. Including its initial investment in OfficeMax, Inc. in
November 1990, Kmart Corporation has made aggregate equity contributions of
$565.5 million.
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the 39 weeks ended October
23, 1993 are summarized below. The net increase in cash and equivalents was $9.8
million for the 39 weeks ended October 23, 1993 as compared to a net use of
$37.7 million in cash and equivalents in the same period last year.
Net cash provided by operations for the 39 weeks ended October 23, 1993 was
$9.2 million as compared to a net use of $4.9 million in the same period of last
year. The change resulted from increased income before depreciation and
amortization expenses which are recognized in determining net income but do not
require cash outlays and a slower rate of increase in inventories net of
accounts payable. Depreciation and amortization expense resulted primarily from
goodwill leasehold, improvements and store fixtures.
Net cash used for investing for the 39 weeks ended October 23, 1993 was
$306.1 million as compared to $83.4 million for the same period last year. Net
cash used for investing in the first 39 weeks of 1993 consisted primarily of
$272.4 million for the BizMart acquisition and $34.4 million of capital
expenditures relating to new store openings and the renovation of existing
stores. Net cash used for investing in the first 39 weeks of 1992 consisted
primarily of $71.7 million for the OW Office Warehouse, Inc. acquisition and
$12.0 million for capital expenditures.
Net cash provided by financing of $306.7 million and $50.6 million for the
39 weeks ended October 23, 1993 and the 39 weeks ended October 24, 1992,
respectively, was comprised almost entirely of net equity transactions with the
Kmart Group primarily to fund acquisitions and capital expenditures.
On March 4, 1993, OfficeMax purchased all of the outstanding shares of
BizMart, Inc., a chain of 105 office products superstores, for $272.4 million.
During 1993, BizMart stores were operationally integrated, remodeled,
remerchandised and converted to the OfficeMax name and format. The BizMart
acquisition is being accounted for under the purchase method of accounting.
On June 30, 1992, OfficeMax purchased all of the outstanding shares of OW
Office Warehouse, a chain of 41 office products superstores, for $71.7 million.
The OW Office Warehouse acquisition is being accounted for under the purchase
method of accounting. Excess of cost over the fair value of the assets acquired
totaled $65.7 million and was recorded as goodwill. Goodwill resulting from this
acquisition is being amortized on a
IX-59
<PAGE> 440
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE 39 WEEKS ENDED OCTOBER 23, 1993 -- CONTINUED
straight-line basis over 40 years and resulted in expense of $1.2 million for
the 39 weeks ended October 23, 1993 and $0.6 million for the 39 weeks ended
October 24, 1992.
OfficeMax plans to open approximately 60 to 70 new stores during fiscal
1994, which, exclusive of pre-opening expenses and inventory, will require
approximately $25.0 to $30.0 million in capital expenditures. These expenditures
include fixtures, point-of-sale terminals and other store equipment. Due to
OfficeMax's aggressive expansion strategy, OfficeMax is expected to require
capital in excess of the funds generated from operations. Such excess is
expected to be funded by the Kmart Group. OfficeMax also could obtain funds from
external debt financing and, following implementation of the Specialty Retail
Stock Proposal, from the sale of shares of OfficeMax Stock with the proceeds
attributable to OfficeMax. OfficeMax believes that funds generated from
operations, together with the sources of capital described above, will be
sufficient to provide the liquidity and capital resources necessary to fund its
anticipated capital requirements for at least the next two to three years.
IX-60
<PAGE> 441
ANNEX X
THE SPORTS AUTHORITY GROUP
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Selected Financial Data............................................................ X- 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................... X- 3
Business Description............................................................... X-11
Combined Financial Statements...................................................... X-22
</TABLE>
X-1
<PAGE> 442
THE SPORTS AUTHORITY GROUP
SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated reflect the
results of operations and financial position of the businesses that comprise The
Sports Authority Group. The information set forth below should be read in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations and the combined financial statements and notes thereto
included in this Annex X. The issuance of The Sports Authority Stock pursuant to
the Specialty Retail Stock Proposal has not been reflected in these financial
statements.
<TABLE>
<CAPTION>
52 WEEK
PERIOD
FISCAL YEARS ENDED ENDED
-------------------------------- --------
JAN. 23, JAN. 24, JAN. 26, JAN. 27,
1994 1993 1992 1991(1)
-------- -------- -------- --------
<S> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (MILLIONS)
Sales............................................................ $606.9 $411.5 $240.9 $109.0
Gross margin..................................................... 167.7 114.8 67.0 29.6
Selling, general and administrative expenses..................... 137.0 95.6 56.7 28.6
Pre-opening expense.............................................. 7.6 7.0 4.8 2.7
Goodwill amortization............................................ 2.1 2.1 2.1 1.6
-------- -------- -------- --------
Operating income (loss).......................................... 21.0 10.1 3.4 (3.3)
Interest expense................................................. -- 0.1 0.2 0.2
-------- -------- -------- --------
Income (loss) before income taxes................................ 21.0 10.0 3.2 (3.5)
Income taxes..................................................... 8.2 4.3 1.9 (0.4)
-------- -------- -------- --------
Net income (loss)................................................ $ 12.8 $ 5.7 $ 1.3 $ (3.1)
-------- -------- -------- --------
-------- -------- -------- --------
Add back of goodwill amortization................................ 2.1 2.1 2.1 1.6
-------- -------- -------- --------
Kmart Corporation earnings (losses) attributable to The Sports
Authority Group................................................ $ 14.9 $ 7.8 $ 3.4 $ (1.5)
-------- -------- -------- --------
-------- -------- -------- --------
PERCENT OF SALES DATA
Gross margin..................................................... 27.7% 27.9% 27.8% 27.2%
Selling, general and administrative expenses..................... 22.6 23.2 23.5 26.2
Operating income (loss).......................................... 3.5 2.4 1.4 (3.0)
Income (loss) before income taxes................................ 3.5 2.4 1.3 (3.2)
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital.................................................. $ 37.4 $ 34.5 $ 41.5 $ 16.8
Total assets..................................................... 297.8 236.4 185.2 121.1
The Sports Authority Group equity................................ 147.9 139.2 131.4 96.7
SELECTED FINANCIAL AND OPERATING DATA
Operating income before pre-opening expense and goodwill
amortization (millions)........................................ $ 30.7 $ 19.2 $ 10.3 $ 1.0
End of year stores............................................... 80 56 36 19
Comparable store sales increase(2)............................... 2.6% 8.3% 15.3% 4.9%
Weighted average sales per square foot(3)........................ $ 217 $ 222 $ 217 $ 194
Weighted average sales per store (millions)(4)................... 9.3 9.5 9.1 8.2
Inventory net of accounts payable per store (millions)........... 0.9 1.0 1.3 1.0
Average sale per transaction..................................... 41.55 39.78 38.48 37.61
Capital expenditures -- owned property (millions)................ 23.5 25.9 15.6 4.5
Depreciation and amortization (millions)......................... 10.2 7.2 4.4 2.8
</TABLE>
- -------------------------
(1) Data for the 52 weeks ended January 27, 1991 combines the 48 week period
ended January 27, 1991 with the 4 week period ended February 25, 1990 which
are periods after and before Kmart Corporation's acquisition of The Sports
Authority, respectively. The acquisition was accounted for under the
purchase method of accounting. The excess of the cumulative purchase price
over the estimated fair value of the net assets acquired was recorded as
goodwill.
(2) Comparable store sales include the sales of a store beginning in its
fourteenth month of operations.
(3) Sales for the period divided by the effective weighted average number of
gross square footage in stores operated during the period.
(4) Sales for the period divided by the effective weighted average number of
stores operated during the period.
X-2
<PAGE> 443
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Since the opening of the first The Sports Authority store in Fort
Lauderdale, Florida in 1987, The Sports Authority Group ("The Sports Authority")
has become the largest operator of large format sporting goods stores in the
United States in terms of both sales and number of stores and is also the
largest full-line sporting goods retailer in the United States in terms of
sales. At January 23, 1994, The Sports Authority operated 80 sporting goods
megastores, each occupying in excess of 40,000 gross square feet, in 20 states
in the Northeast, Southeast, Midwest, Southwest, and West regions of the United
States. The Sports Authority has achieved compound annual growth in sales of 84%
during the period from fiscal 1989 to fiscal 1993, increasing sales from $53.4
million in 1989 to $606.9 million in 1993.
The Sports Authority's expansion strategy is to primarily focus on
multi-store markets where it can achieve significant market penetration and
leverage its management personnel and advertising expenses. Following entry into
a large market, The Sports Authority's strategy is generally to aggressively
backfill that market with additional new stores. As a result of this strategy,
The Sports Authority has been able to consistently maintain its gross margins
amidst weak consumer spending and intensifying competition and to leverage many
purchasing, management, advertising and other costs over a higher sales volume,
resulting in an improvement in operating margin as evidenced in the table set
forth below. Although The Sports Authority's strategy of locating multiple
stores within a market can result in some cannibalization, management believes
that achieving greater market penetration will enable it to compete more
effectively and increase profitability and return on capital over the long term.
The Sports Authority believes that its success in executing its business
strategy results from a culture that demands high standards of performance
throughout the entire organization.
The Sports Authority has consistently increased its rate of store expansion
in the last three fiscal years, opening 24 stores, 20 stores and 17 stores in
1993, 1992 and 1991, respectively. The Sports Authority currently plans to open
approximately 25 stores in 1994, with 21 of the 1994 openings concentrated in
existing markets. The remaining four planned 1994 openings are expected to be
concentrated within three new markets.
New stores are primarily built to The Sports Authority's specifications on
property owned by the developer. The Sports Authority, to a lesser extent,
leases existing structures and underlying land at rates below the cost of new
construction. Capital expenditures required to convert previously owned
structures into The Sports Authority format approximate $1.0 million per
location. However, for projected higher volume stores in densely populated urban
areas (New York City and Chicago, for example) retrofit costs may be
significantly higher. Total capital expenditures for new stores in 1994 are
estimated to be $28.5 million as compared to $18.9 million in 1993 and $18.7
million in 1992. The Sports Authority intends to continue to finance new stores
with long-term operating leases.
Since its inception, The Sports Authority has continually invested in its
management team, information systems, purchasing and distribution systems and
merchandising organization. This investment in infrastructure and technology has
resulted in decreased capital required to operate each store and improved
inventory turnover. The Sports Authority has increased its retail inventory
turnover to 2.7 times in 1993 from 2.4 times in 1989. The Sports Authority
management believes that it has in place the infrastructure needed to
successfully implement its expansion strategy over the next few years without
the need for substantial additional capital expenditures.
The Sports Authority's 1993, 1992 and 1991 fiscal years each consisted of
52 weeks and ended on January 23, 1994, January 24, 1993 and January 26, 1992,
respectively. References herein to years are to The Sports Authority's fiscal
years which end on the Sunday preceding the last Wednesday in January of the
following calendar year.
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<PAGE> 444
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
RESULTS OF OPERATIONS
The following table presents The Sports Authority's income statement data
as a percent of sales for the three most recent fiscal years.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ 100.0% 100.0% 100.0%
Licensee fees and rental income.............................. 0.3 0.2 0.2
----------- ----------- -----------
Total operating revenues..................................... 100.3 100.2 100.2
Cost of merchandise sold, includes buying and occupancy
costs...................................................... 72.6 72.3 72.4
----------- ----------- -----------
Gross margin................................................. 27.7 27.9 27.8
Selling, general and administrative expenses................. 22.6 23.2 23.5
Pre-opening expense.......................................... 1.3 1.7 2.0
Goodwill amortization........................................ 0.3 0.6 0.9
----------- ----------- -----------
Operating income............................................. 3.5 2.4 1.4
Interest expense............................................. -- -- 0.1
----------- ----------- -----------
Income before income taxes................................... 3.5 2.4 1.3
Income taxes................................................. 1.4 1.0 0.8
----------- ----------- -----------
Net income................................................... 2.1% 1.4% 0.5%
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Store Activity. The following table illustrates The Sports Authority's
store opening program for the last three years. No stores were closed during the
three year period.
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Beginning number of stores................................................. 56 36 19
Openings................................................................... 24 20 17
---- ---- ----
Ending number of stores.................................................... 80 56 36
---- ---- ----
---- ---- ----
</TABLE>
Fiscal Years Ended January 23, 1994 (fiscal 1993) and January 24, 1993 (fiscal
1992)
Sales in 1993 were $606.9 million, a $195.4 million, or 47.5%, increase
over sales of $411.5 million in 1992. Of the 47.5% increase in sales, 2.6%, or
$10.7 million, was produced by comparable store sales growth, 23.4% or $96.2
million was produced by the 20 stores opened in 1992 which had no comparable
store sales in the prior year and 21.5%, or $88.5 million, was produced by the
24 new stores opened in 1993. Comparable store sales increased 2.6% and 8.3% in
1993 and 1992, respectively. Comparable store sales in 1993 were adversely
affected by the severe winter storm which occurred in March 1993 and reduced
consumer demand for higher priced apparel. Excluding sales from stores
cannibalized by new store openings, comparable store sales increased 5.1% in
1993 as compared to 11.4% in the prior year. A store is considered cannibalized
when a new store's sales adversely affect its sales due to an overlap of primary
trade areas. The cannibalized stores' sales are excluded from the calculation of
total comparable sales for up to a 12 month period. In 1993 sales for 17 stores
were excluded.
Licensee fees and rental income in 1993 was $1.7 million as compared to
$0.9 million in the prior year. The snow ski merchandise departments in The
Sports Authority stores are operated pursuant to a licensee agreement with a
third-party under which The Sports Authority receives a fee of approximately 10%
of licensee snow ski merchandise sales in The Sports Authority stores. Snow ski
merchandise sales are not included in The Sports Authority's sales.
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<PAGE> 445
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Cost of merchandise sold, including buying and occupancy costs, in 1993 was
$440.9 million, or 72.6% of sales, as compared to $297.6 million, or 72.3% of
sales, in the prior year. As a percent of sales, gross margin was 27.7% in 1993
as compared to 27.9% in 1992. The decrease of 0.2% of sales in 1993 was due
primarily to higher occupancy costs resulting from The Sports Authority's
expansion into the Northeast region partially offset by improved merchandise
margins resulting from an improved mix of merchandise sold, higher cumulative
markons and reduced retail markdowns.
Selling, general and administrative ("SG&A") expenses in 1993 were $137.0
million, or 22.6% of sales, as compared to $95.6 million, or 23.2% of sales, in
the prior year. The 0.6% of sales reduction in SG&A expense was due to the
leveraging of The Sports Authority's corporate overhead with higher sales volume
and lower store operating expenses, partially offset by higher depreciation
expense as a percent of sales due to increased capital expenditures and the
timing of store openings.
Pre-opening expense in 1993 was $7.6 million, or 1.3% of sales, as compared
to $7.0 million, or 1.7% of sales, in 1992. Pre-opening expenses consist
principally of store payroll expense for associate training and store
preparation prior to the store opening and for grand-opening advertising
expenditures. Pre-opening expense increased by $0.6 million due to the opening
of 24 stores in 1993 as compared to the 20 stores opened in 1992.
Goodwill amortization was $2.1 million in 1993 and 1992.
Operating income in 1993 was $21.0 million, or 3.5% of sales, as compared
to $10.1 million, or 2.4% of sales, in 1992. Operating income before pre-opening
expense and goodwill amortization was $30.7 million, or 5.1% of sales, in 1993
as compared to $19.2 million, or 4.7% of sales, in 1992. The increase of 0.4% of
sales in 1993 was the result of increased sales and management of store and
administrative expenses.
Interest expense was insignificant during both periods.
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board of Directors ("Board")
makes a specific determination that a given transfer (or type of transfer)
should be made as a long-term loan or, in the case of a transfer from the Kmart
Group to a Specialty Retail Group, an equity contribution. These historical
financial statements present all cash transfers between the Specialty Retail
Groups and the Kmart Group as equity transactions with the Kmart Group. Had the
offerings been completed on February 1, 1993, and assuming that all cash
transactions, except those relating to acquisitions, between the Specialty
Retail Groups and the Kmart Group had been accounted for as short-term loans, on
a pro forma basis The Sports Authority would have been charged inter-Group
interest of $0.5 million during 1993. Such pro forma interest expense has been
calculated on daily average borrowings outstanding using Kmart Corporation's
weighted average short-term borrowing rate. Such pro forma interest expense is
not necessarily indicative of the results which would occur had such offerings
occurred on such date, or what the interest expense would be prospectively.
Income tax expense in 1993 was $8.2 million with an effective tax rate of
39.0% as compared to $4.3 million with an effective tax rate of 43.0% in 1992.
The 4.0% point decrease in the effective tax rate was due to the fact that
non-deductible goodwill expense represented a smaller proportion of income
before income taxes in 1993 than in 1992, partially offset by the 1.0% point
increase in the federal corporate tax rate retroactive to January 1, 1993 and
higher state and local tax rates.
As a result of the foregoing factors, net income in 1993 was $12.8 million,
or 2.1% of sales, as compared to $5.7 million, or 1.4% of sales, in 1992.
X-5
<PAGE> 446
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Fiscal Years Ended January 24, 1993 (fiscal 1992) and January 26, 1992 (fiscal
1991)
Sales in 1992 were $411.5 million, a $170.6 million, or 70.8%, increase
over sales of $240.9 million in 1991. Of the 70.8% increase in sales in 1992,
8.3%, or $20.0 million, was produced by comparable store sales growth; 32.1%, or
$77.4 million, was produced by 17 stores opened in 1991 which had no comparable
store sales in the prior year and 30.4%, or $73.2 million, was produced by the
20 new stores opened in 1992. Comparable store sales increased 8.3% in 1992.
Excluding the effect of stores in which sales were cannibalized by new openings
within the same market, comparable store sales increased by 11.4% in 1992.
Licensee fees and rental income was $0.9 million and $0.4 million in 1992
and 1991, respectively. The snow ski merchandise departments in The Sports
Authority stores are operated pursuant to a third-party licensee agreement under
which The Sports Authority receives a fee of approximately 10% of licensee snow
ski merchandise sales in The Sports Authority stores. Snow ski merchandise sales
are not included in The Sports Authority's sales.
Cost of merchandise sold, including buying and occupancy costs, in 1992 was
$297.6 million as compared to $174.3 million in 1991. Gross margin as a percent
of sales was 27.9% and 27.8% in 1992 and 1991, respectively. The increase of
0.1% of sales in 1992 was due primarily to the leveraging of store occupancy
costs with increased sales volume.
Selling, general and administrative expenses in 1992 were $95.6 million, or
23.2% of sales, as compared to $56.7 million, or 23.5% of sales, in 1991. The
0.3% point reduction in SG&A expense as a percent of sales in 1992 was due to
the leveraging of The Sports Authority's corporate overhead salary expense and
advertising expense with higher sales volume, partially offset by higher
depreciation expense as a percent of sales due to capital expenditures for store
fixtures and equipment in 1992 and in the latter half of 1991.
Pre-opening expense in 1992 was $7.0 million, or 1.7% of sales, as compared
to $4.8 million, or 2.0% of sales, in the prior year. Pre-opening expense is
comprised of store payroll expense for associate training and store preparation
prior to the store opening and for grand-opening advertising expenditures. Of
the $2.2 million increase in 1992, $1.0 million was the result of opening 20
stores in 1992 as compared to the 17 stores opened in 1991. The remaining $1.2
million of the increase was due to the opening of six stores in the Northeast
region where advertising and store payroll expenses are generally higher.
Operating income in 1992 was $10.1 million, or 2.4% of sales, as compared
to $3.4 million, or 1.4% of sales, in the prior year. The increase of $6.7
million, or 1.0% of sales, in 1992, was the result of increased sales, lower
advertising expense and goodwill amortization as a percent of sales and
management of store and administrative expenses. Operating income before
pre-opening expense and goodwill amortization in 1992 was $19.2 million, or 4.7%
of sales, as compared to $10.3 million, or 4.3% of sales, in the prior year. The
increase of 0.4% of sales in 1992 was the result of increased sales, lower
advertising expense as a percent of sales and management of store and
administrative expenses.
Income tax expense in 1992 was $4.3 million with an effective tax rate of
43.0% as compared to $1.9 million with an effective tax rate of 59.4% in 1991.
Of the 16.4% point decrease in the effective tax rate, 14.8% points were due to
the fact that non-deductible goodwill expense represented a smaller proportion
of income before income taxes in 1992 than in 1991.
As a result of the foregoing factors, net income in 1992 was $5.7 million,
or 1.4% of sales, as compared to $1.3 million, or 0.5% of sales, in 1991.
LIQUIDITY AND CAPITAL RESOURCES
The Sports Authority's principal capital requirements are to fund working
capital needs and the opening of new stores. During the periods presented, these
capital requirements have generally been satisfied by cash
X-6
<PAGE> 447
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
flows from operations and, to a lesser extent, by equity contributions from
Kmart Corporation. The Sports Authority made a net return of equity to Kmart
Corporation of $4.1 million in 1993. Kmart Corporation made net equity
contributions to The Sports Authority of $2.1 million and $33.4 million in 1992
and 1991, respectively.
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for 1993, 1992, and 1991 are
summarized below. The net increase in cash and equivalents was $6.0 million in
1993 as compared to $0.4 million in 1992 and $1.0 million in 1991.
Net cash provided by operations was $33.7 million and $22.5 million in 1993
and 1992, respectively, as compared to net cash used for operations of $16.6
million in 1991. The favorable 1993 change resulted from increased income before
non-cash depreciation and amortization expenses and an increase in accrued
payroll and other liabilities resulting from a greater number of stores in
operation in 1993 than in 1992. Depreciation and amortization expense resulted
primarily from goodwill, leasehold improvements and store fixtures. Depreciation
expense is expected to continue to increase during the next few years due to new
store openings.
As a result of The Sports Authority's continuing effort to improve
inventory productivity, inventory net of accounts payable increased only $11.7
million in 1993 when 24 stores were opened as compared to an $11.7 million
increase in 1992 when 20 stores were opened and a $27.5 million increase in 1991
when 17 stores were opened. Also, retail inventory turnover increased to 2.7
times in 1993 from 2.6 times in 1992 (calculated by dividing sales by the
average month end retail inventory for twelve months).
Net cash used for investing was $22.5 million, $23.7 million and $15.2
million in 1993, 1992 and 1991, respectively. The 1993 decrease was due to
reduced capital expenditures resulting from fewer conversions of previously
owned structures into The Sports Authority stores, partially offset by four
additional new store openings in 1993.
Net cash used for financing of $5.2 million in 1993 was comprised of equity
payments to the Kmart Group and reductions in capital lease obligations. Net
cash provided by financing of $1.6 million and $32.8 million in 1992 and 1991,
respectively, was comprised almost entirely of equity contributions by the Kmart
Group.
The Sports Authority believes that funds generated from operations will
provide a majority of the funds necessary to satisfy its capital needs for the
next twelve months. The balance of the necessary funds is expected to be
obtained from the Kmart Group. The Sports Authority also could obtain funds from
external debt financing and, following implementation of the Specialty Retail
Stock Proposal, from the sale of shares of The Sports Authority Stock with the
proceeds attributed to The Sports Authority. The Sports Authority believes that
funds generated from operations, together with the sources of capital described
above, will be sufficient to provide The Sports Authority with the liquidity and
capital resources necessary to fund its anticipated capital requirements for at
least the next two to three years.
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt, and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of The Sports
Authority are remitted to Kmart Corporation and cash disbursements of The Sports
Authority are funded by Kmart Corporation on a daily basis. In the historical
financial statements of the Groups, (i) debt incurred by Kmart Corporation and
its subsidiaries, other than certain capital leases and mortgages related
specifically to the Specialty Retail Groups, has been reflected on the financial
statements of the Kmart Group and (ii) net cash used or provided by each
Specialty Retail Group has been characterized as an adjustment of the Kmart
Group's investment (reflected as Retained Interest) in each Specialty Retail
Group. Accordingly, no inter-Group interest expense or inter-Group interest
income is reflected in the historical financial statements of The Sports
Authority. Until the
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<PAGE> 448
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
issuance of The Sports Authority Stock, the net cash used or provided by The
Sports Authority will continue to be characterized as an adjustment to the Kmart
Group's investment in The Sports Authority.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically attributed to and reflected on the
financial statements of a Specialty Retail Group to the extent that the debt is
incurred or the preferred stock is issued for the benefit of such Specialty
Retail Group.
Following the issuance of The Sports Authority Stock, if cash used by The
Sports Authority exceeds cash provided by The Sports Authority, the Kmart Group
would transfer to The Sports Authority the cash necessary to fund such excess
uses. Conversely, if cash provided by The Sports Authority exceeds cash used by
The Sports Authority, The Sports Authority would transfer the excess cash to the
Kmart Group. All cash transfers between Groups would be accounted for as
short-term loans unless the Board makes a specific determination that a given
transfer (or type of transfer) should be accounted for as a long-term loan or,
in the case of a transfer from the Kmart Group to The Sports Authority, an
equity contribution. There are no specific criteria to determine when a cash
transfer would be classified as a long-term loan or, in the case of a transfer
from the Kmart Group to The Sports Authority, an equity contribution, rather
than a short-term loan. Such determination would be made by the Board in the
exercise of its business judgment at the time of such transfer (or the first of
such type of transfer) based upon all relevant circumstances, including the
financing needs and objectives of the recipient Group, the investment objectives
of the transferring Group, prevailing interest rates and general economic
conditions. Such determination would affect the amount of interest expense and
interest income reflected in the financial statements of the relevant Groups if
such transfer were made as a short-term loan or long-term loan and, in the case
of a transfer from the Kmart Group to The Sports Authority as an equity
contribution, the amount of The Sports Authority Group equity and Retained
Interest of the Kmart Group. Short-term loans between the Kmart Group and The
Sports Authority would bear interest at Kmart Corporation's daily short-term
borrowing rate. In the event that the Board determined that a transfer of funds
between the Kmart Group and The Sports Authority should be made as a long-term
loan, the Board would establish the terms on which such loan would be made,
including interest rate, amortization schedule, maturity and redemption terms.
Such terms would generally reflect the then prevailing terms upon which Kmart
Corporation could borrow funds on a similar basis.
From time to time, following the initial issuance of The Sports Authority
Stock, the Board could determine that funds to be transferred from the Kmart
Group to The Sports Authority represent an equity contribution to The Sports
Authority rather than a loan. In such event, the Kmart Group's Retained Interest
in The Sports Authority would be increased by the amount of such contribution,
as a result of which (a) the Number of Shares Issuable with Respect to the Kmart
Group's Retained Interest with regard to The Sports Authority would be increased
by an amount equal to the amount of such contribution divided by the Market
Value of a share of The Sports Authority Stock and (b) the Kmart Group's
Retained Interest Fraction with regard to The Sports Authority would be
increased and the Outstanding Interest Fraction with regard to The Sports
Authority would be decreased accordingly. The Board could determine, in its sole
discretion, to make such contribution after consideration of a number of
factors, including, among others, the relative levels of internally generated
cash flows of the Groups, the long-term business prospects for The Sports
Authority, the capital expenditure plans of and investment opportunities
available to The Sports Authority, and the availability, cost and time
associated with alternative financing sources.
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from The
Sports Authority, and the balance sheets of The Sports Authority would reflect
its net short-term and net long-term loans to or borrowings from the Kmart
Group.
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<PAGE> 449
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
Similarly, the respective income statements of the Kmart Group and The Sports
Authority would reflect interest income or expense, as the case may be,
associated with such loans or borrowings and the statements of cash flows of the
Kmart Group and The Sports Authority would reflect changes in the amounts
thereof deemed outstanding. In view of the anticipated cash needs of The Sports
Authority over the next several years, it is currently expected that the Kmart
Group would be making net transfers to The Sports Authority. After considering
all relevant factors, the Kmart Group would obtain such funds from internal
operations, excess cash from other Specialty Retail Groups, external debt
financing or additional equity issuances. Accordingly, unlike these historical
financial statements, following implementation of the Specialty Retail Stock
Proposal and issuance of The Sports Authority Stock, the financial statements of
The Sports Authority would reflect interest expense related to net cash provided
by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to The Sports Authority would continue to be made at the
discretion of the Board. Nothing in the foregoing policies obligates the Board
to cause the Kmart Group to provide funds to The Sports Authority if the Board
determines it is in the best interest of the Kmart Corporation not to do so.
EFFECTS OF INFLATION
Management does not believe inflation had a material impact on the
financial statements for the periods presented.
SEASONALITY
The Sports Authority's business exhibits seasonality, with sales levels
generally higher in the fourth quarter and lower in the first quarter. In fiscal
1993, 32.9% of The Sports Authority's sales and 62.4% of its operating income
occurred in the fourth quarter. The Sports Authority's expansion program
generally is weighted with store openings in the second half of the fiscal year.
In the future, changes in the magnitude and timing of these store openings may
change prior period seasonality trends.
<TABLE>
<CAPTION>
1993 FISCAL QUARTER ENDED
--------------------------------------
($ MILLIONS) APRIL JULY OCTOBER JANUARY
-------------- ------ ------ ------- -------
<S> <C> <C> <C> <C>
Sales....................................................... $119.4 $145.6 $ 142.1 $ 199.8
% of full year.............................................. 19.7% 24.0% 23.4% 32.9%
Operating income............................................ $ 0.7 $ 5.6 $ 1.6 $ 13.1
% of full year.............................................. 3.3% 26.7% 7.6% 62.4%
</TABLE>
RECENT ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued Financial Accounting
Standard No. 106 "Employers' Accounting for Postretirement Benefits Other Than
Pensions" (FAS 106) in December 1990. This statement requires employers to
accrue for future postretirement benefits such as health care and life
insurance.
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax balances for enacted
changes in statutory income tax rates.
FAS 106 and FAS 109 were effective for fiscal years beginning after
December 15, 1992.
In addition, Financial Accounting Standard No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying
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<PAGE> 450
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
FAS 106, requiring that benefits provided to terminated or laid-off employees be
recorded on an accrual basis rather than a cash basis. The statement is
effective for fiscal years beginning after December 15, 1993.
The Sports Authority adopted these statements in the first quarter of 1993
and the cumulative effect was insignificant. On a prospective basis, the new
rules are not expected to have a material impact on earnings.
EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS
Compliance with federal, state and local provisions which have been enacted
or adopted regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had, and is not
expected to have, a material effect on the capital expenditures, earnings or
competitive position of The Sports Authority.
X-10
<PAGE> 451
THE SPORTS AUTHORITY GROUP
GENERAL
The Sports Authority Group ("The Sports Authority") is the largest operator
of large format sporting goods stores in the United States in terms of both
sales and number of stores and is also the largest full-line sporting goods
retailer in the United States in terms of sales. At January 23, 1994, The Sports
Authority operated 80 sporting goods megastores, each of which had in excess of
40,000 gross square feet. The Sports Authority's business strategy is to offer
customers extensive selections of quality, name brand sporting equipment,
athletic footwear and apparel, everyday fair prices and premium customer
service. The Sports Authority has engaged in an aggressive expansion program,
pursuant to which it opened 24 stores in fiscal 1993 and expects to open
approximately 25 stores in fiscal 1994. With stores in 20 states and in each of
the Northeast, Southeast, Midwest, Southwest and West regions of the United
States, The Sports Authority believes it is the only large format sporting goods
retailer that has achieved a national presence. The Sports Authority had sales
of approximately $606.9 million for the fiscal year ended January 23, 1994
("fiscal 1993").
The Sports Authority Group is comprised principally of The Sports
Authority, Inc., a wholly owned subsidiary of Kmart. The Sports Authority was
founded by Mr. Jack A. Smith, its current President and Chief Executive Officer,
who opened the first store in Fort Lauderdale, Florida in 1987. During the next
two years, The Sports Authority opened nine more stores. In 1990, The Sports
Authority was acquired by Kmart Corporation ("Kmart"), which has provided
additional capital to fund the company's expansion program as well as its
continual investment in infrastructure and technology. The Sports Authority has
achieved compound annual growth in sales of 84% during the period from fiscal
1989 to fiscal 1993.
The Sports Authority believes that a fundamental element of its success has
been the consistent execution of its business strategy in each of its markets.
Over 96% of The Sports Authority's stores have achieved profitability (before
allocation of central overhead) within the first full fiscal year of operation.
In addition, The Sports Authority has consistently increased its retail
inventory turnover (calculated by dividing sales by the average month end retail
inventory for 12 months) from 2.4 times in fiscal 1989 to 2.7 times in fiscal
1993. These favorable results have been achieved during a period of rapid
growth. The Sports Authority believes its success in executing its business
strategy results from its culture that demands high standards of performance
throughout the entire organization.
INDUSTRY OVERVIEW
The sporting goods market represents a large segment of the retail market
in the United States. According to the National Sporting Goods Association
("NSGA"), total U.S. retail sales of sporting goods (including sporting
equipment, athletic footwear and apparel) were approximately $29 billion in 1992
and industry sales are estimated to have been approximately $31 billion in 1993.
The retail sporting goods industry is comprised of four principal categories of
retailers: (i) traditional sporting goods retailers, (ii) specialty sporting
goods retailers, (iii) large format sporting goods retailers and (iv) mass
merchandisers.
Large format sporting goods retailers represent a rapidly increasing
percentage of the retail sporting goods market in the United States. During the
period from 1988 to 1992, the top five large format sporting goods retailers
(including The Sports Authority) for which information is publicly available
(which The Sports Authority believes represent a substantial majority of large
format sporting goods sales) have grown from approximately $261 million to
approximately $1.1 billion in net sales, a compound annual growth rate of
approximately 43%. In 1992, net sales for these top five large format sporting
goods retailers represented approximately 3.8% of total retail sporting goods
sales.
The sporting goods industry in the United States is characterized by
fragmented competition, limited assortments from traditional sporting goods
retailers, customer preference for one-stop shopping convenience, reduced mall
shopping and a growing importance of delivering value to the customer through
selection, service
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and price. Management believes that these characteristics of the sporting goods
industry make the large format operators particularly well suited to grow and
increase their market share relative to the traditional sporting goods
retailers, specialty sporting goods retailers and mass merchandisers.
BUSINESS STRATEGY
The Sports Authority's business strategy is to consistently offer the
extensive selection and competitive pricing associated with "category killer"
retailers while, at the same time, offering the name brands and professional
service associated with smaller specialty shops and pro shops. The key elements
of this strategy are as follows:
- Megastore Format. The Sports Authority operates only large format
stores having in excess of 40,000 gross square feet. This megastore format
enables The Sports Authority to provide under one roof an extensive
selection of merchandise for sports and leisure activities that ordinarily
are associated with specialty shops and pro shops, such as golf, tennis,
skiing, hunting, fishing, boating and water sports, as well as in areas
ordinarily associated with traditional sporting goods retailers, such as
team sports, physical fitness, men's and women's athletic apparel and
athletic footwear. Each megastore offers approximately 45,000 active SKUs
(without regard to color and size and excluding discontinued items) across
16 major departments. The Sports Authority's megastore format provides ease
of shopping through pleasant and well designed store layouts, informative
and easily identifiable signage, individual price ticketing of each
product, speedy and courteous check-out, easy store access and convenient
customer parking.
- Quality Name Brand Sporting Goods. The Sports Authority's
merchandising strategy is to offer the largest breadth and depth of
selection in quality name brand sporting goods in each of its over 1,200
merchandise categories. The Sports Authority's comprehensive merchandise
assortment includes over 900 name brands, including Reebok, Huffy, Prince,
Wilson, Rawlings, Coleman, Spalding, Ektelon, Asics, Rollerblade, Columbia,
Nutmeg Mills, Champion, Russell, K2 and Rossignol. The Sports Authority
utilizes a sophisticated inventory management system in conjunction with
strong store operating controls to achieve optimal in-stock levels of name
brand merchandise.
- High Level of Customer Service. The Sports Authority seeks to
differentiate itself from other large format sporting goods retailers,
traditional sporting goods retailers and mass merchandisers by providing
higher levels of service that are generally associated with smaller
specialty stores and pro shops. To that end, The Sports Authority staffs
each store with sales associates who are knowledgeable about the
merchandise they sell. In addition to hiring many sales associates who are
sports enthusiasts skilled in various disciplines, The Sports Authority
provides extensive training for its sales associates and offers pay
incentives that reward achievement of customer service goals in addition to
sales and profitability goals.
- Everyday Fair Prices. The Sports Authority maintains a policy of
consistent everyday fair pricing that focuses on depth and breadth of
merchandise and customer service relative to price and is designed to
assure customers that they will receive good value at The Sports Authority
stores. In addition, The Sports Authority also seeks to be a price leader
on certain highly identifiable items. Unlike many of its large format
competitors, The Sports Authority does not run sales ("was-is" pricing).
Through the offering of special purchase merchandise and selected
promotional events, The Sports Authority creates higher levels of customer
awareness and sales.
- Focus on Multi-Store Markets. The Sports Authority seeks to be the
leading sporting goods retailer in each of its markets and pursues a store
expansion strategy that primarily focuses on multi-store markets, typically
locating stores in major metropolitan areas that can accommodate several
megastores. This focus enables The Sports Authority to obtain significant
market penetration and to leverage management personnel and advertising
expense, thereby achieving greater economies of scale. In addition, The
Sports Authority believes this multi-store expansion strategy results in
greater name recognition and enhanced customer convenience in each market.
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EXPANSION
The Sports Authority expects to have in excess of 100 stores by late 1994
and currently plans to open approximately 25 new stores in each of the next 2-3
years, primarily in existing markets. The table below sets forth certain
information regarding The Sports Authority's expansion program during the five
most recent fiscal years:
<TABLE>
<CAPTION>
FISCAL NEW GROSS SQUARE FEET NO. OF STORES
YEAR STORES AT YEAR END AT YEAR END
- ------ ------ ----------------- -------------
<S> <C> <C> <C>
1989.......................................... 7 423,714 10
1990.......................................... 9 798,743 19
1991.......................................... 17 1,528,205 36
1992.......................................... 20 2,394,682 56
1993.......................................... 24 3,461,143 80
</TABLE>
Since its inception, The Sports Authority has continually invested in its
management team, information systems, purchasing and distribution systems and
merchandising organization. Management believes that The Sports Authority has in
place the infrastructure needed to successfully implement its expansion strategy
over the next few years without substantial additional capital expenditures.
The Sports Authority primarily focuses on multi-store markets where it can
achieve significant market penetration and leverage its management personnel and
advertising expense. Although The Sports Authority's strategy of locating
multiple stores within a market can result in some cannibalization, management
believes that achieving greater market penetration will enable it to compete
more effectively and increase profitability and return on capital over the long
term.
The following table sets forth certain information as of January 23, 1994
regarding the markets in which The Sports Authority currently has stores and in
which it anticipates opening new stores in fiscal 1994:
<TABLE>
<CAPTION>
NUMBER OF STORES
NUMBER OF EXPECTED TO BE OPENED IN
REGION/MARKET EXISTING STORES FISCAL 1994
------------------------------------------ --------------- ------------------------
<S> <C> <C>
NORTHEAST
Boston.................................. 2 3
Western Massachusetts................... -- 1
Providence.............................. 2 --
Hartford/Danbury........................ 2 1
New York Metro.......................... 10 7
Philadelphia Metro...................... 7 --
Washington, D.C. Metro.................. 6 1
Baltimore............................... 2 1
-- --
SUBTOTAL NORTHEAST................. 31 14
-- --
SOUTHEAST
Norfolk/Hampton......................... 3 --
Charlotte............................... 1 --
Atlanta................................. 7 --
Jacksonville............................ 2 --
Orlando................................. 3 --
Tampa/Clearwater........................ 3 --
Southeast Florida....................... 10 --
-- --
SUBTOTAL SOUTHEAST................. 29 --
-- --
</TABLE>
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<PAGE> 454
<TABLE>
<CAPTION>
NUMBER OF STORES
NUMBER OF EXPECTED TO BE OPENED IN
REGION/MARKET EXISTING STORES FISCAL 1994
------------------------------------------ --------------- ------------------------
<S> <C> <C>
MIDWEST
Detroit................................. 5 1
Chicago................................. 5 4
St. Louis............................... 3 1
-- --
SUBTOTAL MIDWEST................... 13 6
-- --
SOUTHWEST
Las Vegas............................... 2 --
Phoenix................................. 3 2
Tucson.................................. -- 1
-- --
SUBTOTAL SOUTHWEST................. 5 3
-- --
NORTHWEST
Anchorage............................... -- 1
Seattle/Tacoma.......................... -- 3
-- --
SUBTOTAL NORTHWEST................. -- 4
-- --
WEST
Los Angeles Metro....................... 1 --
San Francisco Metro..................... -- 1
-- --
SUBTOTAL WEST...................... 1 1
-- --
HAWAII 1 --
-- --
TOTAL.............................. 80 28
-- --
-- --
</TABLE>
While The Sports Authority's expansion strategy is primarily focused on
multi-store markets, the company will enter smaller markets where the
anticipated returns justify opening a single store. In addition, The Sports
Authority believes that the direct shipment of merchandise to each of its stores
provides it with the flexibility to pursue new markets, without the geographic
constraints associated with a central distribution facility. The Sports
Authority currently is investigating expansion into Puerto Rico and selected
international markets, including Canada, Great Britain and Japan. The rate of
The Sports Authority's expansion will depend upon general economic and business
conditions affecting consumer spending, the availability of desirable locations
and the negotiation of acceptable lease terms.
The Sports Authority employs a rigorous process to select and evaluate all
new sites. The Sports Authority maintains an in-house staff to work with local
developers and brokers to identify potential store locations. The Sports
Authority also utilizes the services of a professional sales forecasting firm to
prepare sales projections used in evaluating the potential financial return for
each location.
In analyzing a new market, The Sports Authority evaluates that market's
potential in terms of total number of store locations. It then pursues sites in
a manner and sequence which is intended to minimize cannibalization as locations
are added. Sites are selected based on regional access, co-tenancy, visibility,
parking, demographics (such as income levels and distribution, age and family
size), population and proximity to competition.
The Sports Authority generally intends to obtain new store locations
through long-term operating leases negotiated with developers. On an operating
lease basis, the cost of opening a new store consists primarily of the
investment in inventory, the cost of furniture, fixtures and equipment and
pre-opening expenses, such as the costs associated with training employees and
stocking the store. Inventory for a new store is estimated to cost approximately
$2.2 million, with average vendor payables equal to approximately 50% of the
initial inventory, for a net investment of approximately $1.1 million. The cost
of furniture, fixtures and equipment for a new store is approximately $0.5
million, pre-opening expenses, which are expensed as incurred, typically average
approximately $0.2 million and grand opening advertising expenses average
approximately $0.1
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<PAGE> 455
million per store. If the site requires a retrofit of an existing building,
costs (excluding furniture, fixtures and equipment) approximate $1.0 million.
However, for projected higher volume stores in densely populated urban areas
(New York City and Chicago, for example) retrofit costs may be significantly
higher. The Sports Authority has budgeted approximately $31.1 million for total
capital expenditures relating to store openings in fiscal 1994.
STORES
The Sports Authority megastores average approximately 42,700 gross square
feet. The stores are located primarily in regional strip or power centers,
centers with strong, value-oriented large format retailers, and a small
percentage are located in malls and stand alone locations. Unlike warehouse
stores, the interior of each The Sports Authority store creates a pleasant
shopping environment, with carpet and linoleum floor coverings, high ceilings,
bright lighting, wide aisles, extensive category signage, high perimeter "H"
frame type racks and fashion apparel fixtures that are comparable to those used
in department stores. Each store displays merchandise in accordance with
centrally developed presentation standards. These standards are designed to
provide logical department adjacencies to promote convenience and multiple
purchases of related items. The layouts for each department are also centrally
developed to ensure that each store utilizes display techniques to highlight
merchandise and present a consistent and attractive shopping environment.
Approximately 88% of the gross square feet of each store is dedicated to selling
space (with the balance used for merchandise storage and office space), which
The Sports Authority believes is a greater percentage than any other large
format sporting goods retailer. The Sports Authority believes that its sales per
gross square foot and inventory turnover are enhanced due to the manner in which
it uses its square footage for sales purposes.
The Sports Authority believes customers want an easy shopping environment
and therefore seeks to make shopping at its stores as convenient as possible.
The Sports Authority continues to refine its store layout and signage, and in
particular is increasing point-of-purchase product information. The Sports
Authority also continually evaluates its fixtures to make them more appealing
and accessible to customers. Furthermore, as part of its commitment to a high
level of customer service, The Sports Authority continues to individually price
ticket each item.
Stores are typically staffed with one manager, two assistant managers and
eight department managers, and the operations of each store are supervised by a
district manager, of whom there are currently 15. Each district manager reports
to the Senior Vice President of Stores. As The Sports Authority continues to
expand, it currently plans to establish two regional managers who will report
directly to the Senior Vice President of Stores and to whom district managers
will then report. In all cases, The Sports Authority endeavors to locate
management in markets with which they are familiar.
The Sports Authority places great emphasis on the training of store-level
management. The Sports Authority's general policy is to build its management
organization from within. Prior to opening a store, all store personnel,
including store and department managers, go through an in-depth training program
in an effort to have each new store achieve the same superior execution and
customer service levels achieved at stores that have been open for many years.
Newly hired or promoted store managers and assistant store managers are placed
in a training program for approximately fourteen weeks prior to the store
opening. As part of this training, these managers receive ten days of
orientation and classes at The Sports Authority's headquarters. The balance of
their training is spent at a designated training store where they receive
extensive hands-on experience in the opening and day-to-day running of a The
Sports Authority store. Newly promoted or hired department managers are placed
in a training program approximately eight weeks prior to store opening and
receive training in their specialty at a designated training store.
Additionally, newly promoted or hired personnel in key hourly positions are
trained in the same manner.
MERCHANDISING
The Sports Authority's merchandising strategy focuses on offering a broader
and deeper selection of quality, name brand merchandise than is generally
available elsewhere, including other large format sporting goods retailers. The
Sports Authority's comprehensive merchandise assortment consists of a wide
variety of
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<PAGE> 456
sports equipment, apparel, footwear and accessories and is designed to meet all
of the sporting goods needs of its customers, from the serious to the weekend
athlete. Each megastore offers approximately 45,000 active SKUs (without regard
to color and size and excluding discontinued items) across 16 major departments.
The Sports Authority stores offer an extensive selection of both
hard-lines, which consist of team sports equipment, fitness equipment, hunting,
fishing and camping equipment, golf and racquet sports equipment, cycling
equipment, water sports and marine and general merchandise, and soft-lines,
which consist of athletic apparel and footwear. The following table sets forth
the approximate percentage of sales attributable to hard-lines and soft-lines
for the fiscal years presented:
<TABLE>
<CAPTION>
PERCENTAGE OF NET
SALES
----------------------
MERCHANDISE GROUP 1993 1992 1991
- ----------------- ---- ---- ----
<S> <C> <C> <C>
Hard-lines.................................... 56% 55% 54%
Soft-lines:
Apparel..................................... 21 23 25
Footwear.................................... 23 22 21
---- ---- ----
Subtotal Soft-lines......................... 44 45 46
---- ---- ----
Total......................................... 100% 100% 100%
---- ---- ----
---- ---- ----
</TABLE>
The hard-lines and soft-lines sold by The Sports Authority include the
following merchandise categories:
Athletic Footwear. The Sports Authority carries one of the most complete
lines of athletic footwear for a wide variety of activities and for a broad
range of experience levels. A typical The Sports Authority store carries more
than 600 styles of footwear. This footwear selection includes athletic shoes for
running, football, basketball, baseball, tennis, wrestling, aerobics, walking,
cycling, soccer, cross-training, hiking, hunting, bowling and golf, as well as
skates (inline, four wheel, hockey and figure).
Men's and Ladies' Athletic Apparel. The Sports Authority carries both
general active and leisure apparel and apparel designed and fabricated for
specific sports. General active and leisure apparel includes t-shirts, fleece,
warm-ups, shorts and polo shirts from vendors such as Reebok, Adidas, Russell,
Puma and Champion. Apparel for specific sports range from entry level to highly
technical for golf, tennis, running, aerobics, biking, swimming, weight lifting,
baseball, football, soccer, lacrosse, volleyball, hockey and skiing.
Licensed Apparel. This category includes hats, t-shirts, shorts, pants,
sweatshirts and outerwear from prominent colleges and the professional sports of
baseball, basketball, football and hockey. Additionally, both replica and
authentic jerseys are available for professional and college sports teams.
Team Sports Equipment. The Sports Authority carries a full range of
merchandise for basketball, football, soccer, baseball, ice and street hockey,
volleyball, table tennis, bowling, darts and lawn games.
Hunting, Fishing and Camping. A vast assortment of merchandise is carried
in The Sports Authority stores to satisfy the needs of outdoor sports
enthusiasts of all levels of experience. Camping and backpacking merchandise
includes tents, sleeping bags, lanterns, flashlights, grills, coolers and
accessories. For fishing and hunting, The Sports Authority sells rods, reels,
fishing line, terminal tackle, tackle boxes, fishing nets, firearms, ammunition,
scopes, binoculars, archery equipment and accessories.
Fitness Equipment. A wide range of fitness equipment is offered at each The
Sports Authority store, including treadmills, stationary bicycles, home gyms,
weight benches, stair climbers, steppers, treadmills, rowing machines, free
weights, dumbbells and a broad selection of handheld exercise equipment. Also
carried in this category are food supplements.
Golf and Racquet Sports. The Sports Authority carries a broad selection of
merchandise for golf and racquet sport enthusiasts. For the golfer, The Sports
Authority stocks golf clubs, golf bags, golf balls, golf accessories, putting
machines and instructional videos. The Sports Authority also carries a variety
of tennis, racquetball, squash and badminton rackets, as well as tennis balls,
racquet balls, squash balls, shuttlecocks, tennis nets, badminton nets and
replacement grips. The Sports Authority offers customers the option of having
their tennis racquets strung by stringers certified by the United States Racket
Stringers Association.
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<PAGE> 457
Cycling. The Sports Authority sells a wide variety of bicycles for various
types of cycling, including mountain bikes, road racing bikes, hybrid bikes (for
on and off road) and tandem bikes. In addition, The Sports Authority carries
replacement equipment for bikes, such as wheels, handlebars, seats, chains and
brake pads, as well as accessories such as cycling gloves, helmets and water
bottles.
Water Sports and Marine. Water sports and marine merchandise includes an
array of merchandise for boating and for water sports such as swimming, water
skiing, jet skiing, SCUBA and snorkeling. This merchandise includes water skis,
surfboards, bogey boards, ocean and river kayaks, wetsuits, SCUBA gear, fins,
masks, snorkels, towable inflatables and life vests.
General Merchandise. The Sports Authority carries a wide variety of general
merchandise to complement its comprehensive selection of sport specific
merchandise. This merchandise includes licensed team novelties, such as mugs,
clocks, helmets, pennants, bumper stickers and key chains; videos, magazines,
books, sun glasses and watches.
Snow Ski Department. The snow ski department is operated by a group of
regional licensees, all operating under the overview of the principal licensee,
Green Mountain Sports. All licensees also operate their own specialty snow ski
shops. These licensees are responsible for assorting, pricing and merchandising
the snow ski department in each The Sports Authority store as well as staffing
and maintenance and tuning of ski equipment. Determination of assortment,
pricing, inventory levels and merchandise presentation is done in conjunction
with The Sports Authority merchandising management. The Sports Authority
believes that, as a result of the practice of using licensees to operate the
snow ski department, The Sports Authority stores have a broader selection of
higher quality, name brand snow ski products in both apparel and hardgoods
categories than other sporting goods retailers.
The Sports Authority emphasizes quality name brand merchandise and carries
over 900 name brands. The following list represents some of the name brands
offered by The Sports Authority:
Abu-Garcia
Academy Broadway
Adidas
Allied Golf
American Camper
Asics
Avia
Bauer
Berkley
Bike
BMI
Bollinger
Brine
Browning
Brunswick
Bushnell
CCM
Century
Champion
Coleman
Columbia
Converse
Cooper
CSA
Cycle Products
Danskin
Dexter
Discus
Diversified Products
Dolfin
Dunlop
Easton
Eastpak
Ebonite
Ektelon
ERO
Etonic
Everlast
Fila
Footjoy
Franklin
Freestyle USA
General Sportcraft
Gilda Marx
Gold Eagle
Golds Gym
Harvard
Head
Hi Tec
Hind
Huffy Bicycle
Igloo
Insport
Ixspa
Jack LaLanne
Jansport
Jantzen
Jogbra
Johnson
Keds
Koho
K-Swiss
L.A. Gear
Le Coq Sportif
Life Fitness
Logo 7
Louisville Slugger
Marika
Maxfli
Mitre
Mizuno
Mossberg
Moving Comfort
Munsingwear
Murray
Mylec
New Balance
Nutmeg Mills
O'Brien International
Pacer
Penn Athletic
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<PAGE> 458
Penn Fishing
Pony
Prince
Pro Kennex
Proform
Puma
Rawlings
Rayban
Reebok
Ridgeview
Roadmaster
Rockport
Roller Derby
Rollerblade
Royce Union Bicycles
Russell
Ryka
Salem
Saucony
Shimano
Sideout Sport
Southbend
Spalding
Specialized
Speedo
Sports Specialties
Stiga
Sergio Tacchini
Tail
Taurus
The Game
Thorlo
Tinley
Titleist
Tunturi
Umbro
Variflex
Walls Industries
Weekend Exercise
Weider
Wilson
Winchester
Wolverine
Worth Sports
The Sports Authority's merchandising strategy focuses on geographical
merchandising by recognizing the difference in merchandise assortment and store
space allocation that is driven by the specific location of each store. It
tailors each store's merchandise selection and space allocation to fit the
specific preferences of customers at each store location, not merely by
recognizing obvious differences related to the region or market in which such
store is located, but also by recognizing more subtle differences related to the
demographics of the surrounding communities. This store-by-store merchandising
involves differences in brands, sizes, colors, fabrication and timing of the
assortment and the space allocated to present such merchandise.
PURCHASING AND DISTRIBUTION
The Sports Authority maintains its own central buying staff, comprised of
one general merchandise manager, two divisional merchandise managers and 14
buyers. Using a detailed merchandise planning system, the merchandise mix for
each store is selected by the central buying staff in consultation with district
and store managers. The merchandise planning system allows The Sports Authority
to manage its sales and inventory levels by store at the subclass level. This
system is also used by The Sports Authority to establish detailed assortment
plans, using product attributes such as price, size, color, fabrication and any
other attributes which buyers feel have an impact on sales. In 1994, The Sports
Authority will expand its use of the system to include purchase order generation
and allocation of items not included in its automated replenishment system. The
Sports Authority believes that utilizing this method to distribute merchandise
will reduce markdowns and inventory levels while simultaneously improving
in-stock levels.
The Sports Authority also utilizes a system that automatically replenishes
approximately 25% of its active assortment based upon specific in-stock
requirements utilizing statistically based sales forecasting. This automatic
replenishment system optimally balances the need to provide high in-stock
positions to satisfy customer demand with the costs associated with carrying
such inventory. The Sports Authority believes that this automatic replenishment
system substantially reduces the costs associated with carrying inventory. By
the end of fiscal 1994, the number of items on the automatic replenishment
system is expected to be increased to approximately 50% of the active
assortment.
The Sports Authority currently purchases merchandise from over 850 vendors
and, in fiscal 1993, no vendor accounted for more than 7.5% of The Sports
Authority's total merchandise purchased. The Sports Authority does not maintain
any long-term or exclusive commitments or arrangements to purchase from any
vendor. The Sports Authority is either the largest or one of largest customers
for many of its vendors, which often allows it to obtain favorable pricing and
other terms in making purchases. For most vendors, The Sports Authority is the
largest per store seller of that vendor's merchandise, which The Sports
Authority believes enhances its relationship with vendors that seek brand
awareness. As the number of stores increases pursuant to its store expansion
plan, The Sports Authority believes it will be able to continue to obtain
sufficient merchandise for all of its stores on a timely basis.
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<PAGE> 459
The Sports Authority currently does not carry merchandise from Nike, Inc.,
one of the leading manufacturers of athletic footwear and apparel, or Starter
Corporation, one of the leading manufacturers of team logo apparel. Due to the
breadth and depth of its merchandise assortment, the absence of the Nike and
Starter lines has not prevented The Sports Authority from successfully growing
its business in these categories and achieving significant market share and
profitability. For example, notwithstanding the absence of Nike footwear, The
Sports Authority believes it has achieved the highest annual sales of athletic
footwear per store among the large format sporting goods retailers.
The Sports Authority currently exchanges purchase orders and
acknowledgements electronically with approximately 135 vendors representing
approximately 54% of its purchase order volume, expressed in dollars. By the end
of fiscal 1994, The Sports Authority's goal is to create an electronic data
interchange with 275 vendors, representing in excess of 75% of its purchase
order volume, expressed in dollars. In addition, during fiscal 1994, The Sports
Authority will begin to exchange invoices and advance shipping notices with
vendors to increase efficiency in stocking merchandise upon receipt and to
reduce the cost of entering invoice data for the automated matching of invoices
to merchandise receipts.
More than 97% of The Sports Authority's merchandise is shipped directly to
each store by vendors. As a result, The Sports Authority does not require a
central distribution center. In addition, The Sports Authority uses a small
contract break bulk operation located in North Carolina to distribute certain
orders, primarily for the athletic footwear department. The use of direct store
shipments allows The Sports Authority to pursue new markets without the
geographic constraints associated with a central distribution facility. The
Sports Authority is in the process of establishing an offsite receiving
operation in New Jersey to service its new stores in the New York metropolitan
area because of the limited space for receiving in such locations. The Sports
Authority is also currently studying the benefits of using a cross dock method
of distribution.
MANAGEMENT INFORMATION SYSTEMS
Since its inception, The Sports Authority has implemented sophisticated
management information systems that integrate purchasing, receiving, sales and
perpetual inventory data on a daily basis. These systems have enabled The Sports
Authority to maintain strong financial controls and have improved its ability to
manage its inventory, thereby reducing inventory costs and improving margins.
The inventory management systems manage all aspects of inventory control from
order placement through elimination of aged inventory. These systems include the
functions of automated replenishment, automated merchandising planning and
allocation, electronic data interchange and daily tracking of in-stock levels by
item and location. Management believes that these systems also have sufficient
capacity and flexibility to enable The Sports Authority to systematically manage
the implementation of its expansion strategy. In late 1993, The Sports Authority
installed a satellite communication system in each of its stores. The Sports
Authority intends to expand use of its satellite communications system in fiscal
1994 to include audio broadcast for music and in-house commercials and in the
future may utilize it for video transmission and training, product reviews and
general communication.
The Sports Authority currently employs point-of-sale terminals in all of
its stores, which provide price look-up capabilities and SKU-level sales data,
capture customer zip code data and initiate requests for authorization of the
different credit and check tenders accepted by The Sports Authority. The Sports
Authority also utilizes CRT's and printers at store level, which communicate
with central site IBM AS/400 computers, via the satellite network, to record
merchandise receipts, produce price tickets, provide time keeping information
and for general data inquiry.
The Sports Authority has recently decided to install small IBM AS/400
computers as in-store processors in all of its stores. This implementation will
be completed in 1994. These processors are intended to provide local management
with the ability to more closely manage inventory productivity and merchandise
space planning, as well as reduce the amount of employee time spent on
non-selling functions.
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ADVERTISING AND PROMOTION
The Sports Authority seeks to maintain name recognition and market
penetration through television, radio, newspaper, inserts, billboards and direct
mail advertising, with approximately 60% of The Sports Authority's advertising
expenditures devoted to non-print advertising. In addition, The Sports Authority
believes that its depth and breadth of high quality name brand merchandise,
superior customer service and everyday fair prices create substantial "word of
mouth" advertising. In connection with entering a new market, The Sports
Authority uses extensive billboard, television and radio advertising to
establish name recognition in that market. Since The Sports Authority focuses on
multi-store markets, it is able to leverage its advertising costs.
COMPETITION
The retail sporting goods industry is highly competitive and is comprised
of the following four principal categories of retailers:
- Traditional Sporting Goods Retailers. Traditional sporting goods
retailers tend to have relatively small stores, ranging in size from 5,000
to 20,000 square feet, frequently located in malls or strip centers (e.g.,
Herman's and Oshman's). These stores typically carry limited quantities of
each item in their assortment and generally offer a more limited selection
at higher prices than large format stores.
- Specialty Sporting Goods Retailers. Specialty sporting goods
retailers include specialty shops, ranging in size from 1,000 to 10,000
square feet, frequently located in malls (e.g., Foot Locker and Champs),
and also include pro shops that often are single store operations. These
stores typically carry a wide assortment of one specific product category,
such as athletic shoes or golf or tennis equipment and generally have
higher prices than large format stores.
- Large Format Sporting Goods Retailers. Large format stores such as
The Sports Authority generally range in size from 30,000 to 50,000 square
feet and offer a broad selection of name brand sporting goods merchandise
and tend to be either an anchor store in a strip mall or free-standing
(e.g., SportsTown, SportMart and Sports & Recreation).
- Mass Merchandisers. Mass merchandisers are large stores,
approximately 50,000 to 200,000 square feet, that feature sporting
equipment as only a small portion of the total merchandise carried, and are
located primarily in strip centers or free-standing locations (e.g., Kmart
and Wal*Mart). These stores have limited selection and fewer name brands
and also do not offer the customer service offered by sporting goods
retailers.
The Sports Authority believes that, although it will continue to face
competition from retailers in each of the categories described above, over the
long term the most significant competition will be from the large format
sporting goods retailers. Of The Sports Authority's 80 stores, 25 already face
direct competition from such large format sporting goods retailers. For example,
The Sports Authority competes with Sports & Recreation in Tampa, SportsTown in
Atlanta and SportMart in Chicago, each of which has multiple large format stores
in such markets. The Sports Authority believes that the principal strengths with
which it competes are customer service, merchandise assortment, ease of shopping
and everyday fair pricing.
PROPERTIES
The Sports Authority's stores have been open an average of two years. The
Sports Authority continually enhances merchandise presentation, and annually
spends an average of $15,000 per store upgrading fixtures. Additionally, to
maintain its high level of presentation standards, management intends to
refurbish its stores at four-year intervals, including replacing all carpet and
worn fixtures and performing all major merchandise presentation upgrades which
were not performed in the intervening four-year period.
All of The Sports Authority's stores have long-term leases. The leases
typically provide for an initial 20 year term with multiple five-year renewal
options. In most cases, The Sports Authority's leases provide for minimum annual
rent subject to periodic adjustments, plus other charges, including a
proportionate share of
X-20
<PAGE> 461
taxes, insurance and common area maintenance. The Sports Authority leases a
building at 3383 N. State Road 7, Fort Lauderdale, Florida, containing
approximately 82,000 square feet, that houses its corporate offices, with a
remaining primary term of four years with three 10 year renewal options.
ASSOCIATES
As of January 23, 1994, The Sports Authority had a total of approximately
3,100 full-time and approximately 2,900 part-time associates, 5,700 of whom were
employed in The Sports Authority's stores and approximately 300 of whom were
employed in corporate office positions. None of The Sports Authority's
associates is covered by collective bargaining agreements. The Sports
Authority's store managers have an average of 14 years retail management
experience. The Sports Authority endeavors to promote new store managers
internally through a management training program. The Sports Authority believes
that its relationship with its associates is very good.
TRADEMARKS AND SERVICE MARKS
The Sports Authority(R) and The Sports Authority logo are registered
trademarks and service marks of The Sports Authority. The Sports Authority uses
its mark as a trade name in connection with its business operations. Whenever
possible, The Sports Authority has registered its mark as a trade name with the
state or locality where The Sports Authority has a store.
LITIGATION
The Sports Authority is from time to time involved in routine litigation
incidental to the conduct of its business. The Sports Authority believes that no
currently pending litigation to which it is a party will have a material adverse
effect on its liquidity, financial position or results of operations.
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<PAGE> 462
THE SPORTS AUTHORITY GROUP
REPORT BY MANAGEMENT
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Kmart Corporation and The Sports Authority Group management are responsible
for the integrity of the information and representations contained in the
interim and annual financial statements. This responsibility includes making
informed estimates and judgments in selecting the appropriate accounting
principles. Management believes the financial statements conform with generally
accepted accounting principles applied on a consistent basis.
To assist management in fulfilling these obligations, several tools are
utilized, which include the following:
A system of internal accounting controls is maintained to provide for
the integrity of information for purposes of preparing financial statements
and to assure that assets are properly accounted for and safeguarded. This
concept of reasonable assurance is based on the recognition that the cost
of the system is related to the benefits to be derived and modified for
changing conditions. Management believes its system provides reasonable
assurance of this appropriate balance.
As part of the internal control system, a policy of Standards of
Business Conduct and Management Integrity Statements is in effect. All
officers and key employees periodically submit a signed statement regarding
compliance with these policies.
An Internal Audit Department is maintained to evaluate, test and
report on the application of internal accounting controls in conformity
with standards of the practice of internal auditing.
The financial statements have been examined by independent accountants
whose report is contained herein. This examination includes, among other
things, a review of the system of internal controls as required by
generally accepted auditing standards.
The Audit Committee of the Board of Directors, consisting solely of outside
directors, meets regularly with management, internal auditors and the
independent accountants to assure that each is carrying out its
responsibilities. The internal auditors and independent accountants both have
full and free access to the Audit Committee, with and without the presence of
management.
<TABLE>
<S> <C>
Joseph E. Antonini Jack A. Smith
Kmart Corporation The Sports Authority, Inc.
Chairman of the Board, President President and
and Chief Executive Officer Chief Executive Officer
George R. Mrkonic Richard J. Lynch, Jr.
Kmart Corporation The Sports Authority, Inc.
Executive Vice President Senior Vice President
Specialty Retailing and Chief Financial Officer
Thomas F. Murasky
Kmart Corporation
Executive Vice President
and Chief Financial Officer
</TABLE>
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<PAGE> 463
THE SPORTS AUTHORITY GROUP
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Kmart Corporation
In our opinion, the accompanying combined balance sheets and the related
combined statements of income, and of cash flows present fairly, in all material
respects, the financial position of The Sports Authority Group at January 23,
1994 and January 24, 1993, and the results of its operations and its cash flows
for each of the three years in the period ended January 23, 1994, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Kmart Corporation management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The Sports Authority Group is a business group of Kmart Corporation (as
described in the Basis of Presentation note to these financial statements);
accordingly, the combined financial statements of The Sports Authority Group
should be read in conjunction with the consolidated financial statements of
Kmart Corporation.
Price Waterhouse
Detroit, Michigan
March 15, 1994
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<PAGE> 464
THE SPORTS AUTHORITY GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $ 606.9 $ 411.5 $ 240.9
Licensee fees and rental income.............................. 1.7 0.9 0.4
----------- ----------- -----------
608.6 412.4 241.3
----------- ----------- -----------
Cost of merchandise sold, includes buying and occupancy
costs...................................................... 440.9 297.6 174.3
Selling, general and administrative expenses................. 137.0 95.6 56.7
Pre-opening expense.......................................... 7.6 7.0 4.8
Goodwill amortization........................................ 2.1 2.1 2.1
----------- ----------- -----------
Operating income............................................. 21.0 10.1 3.4
Interest:
Capital lease obligations -- expense....................... -- 0.1 0.2
----------- ----------- -----------
Income before income taxes................................... 21.0 10.0 3.2
Income taxes................................................. 8.2 4.3 1.9
----------- ----------- -----------
Net income................................................... $ 12.8 $ 5.7 $ 1.3
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure (unaudited):
Net income................................................. $ 12.8 $ 5.7 $ 1.3
Add back of goodwill amortization.......................... 2.1 2.1 2.1
----------- ----------- -----------
Kmart Corporation earnings attributable to The Sports
Authority Group............................................ $ 14.9 $ 7.8 $ 3.4
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
X-24
<PAGE> 465
THE SPORTS AUTHORITY GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................................. $ 8.2 $ 2.2
Merchandise inventories.............................................. 157.3 113.7
Accounts receivable and other current assets......................... 14.7 10.2
----------- -----------
Total current assets................................................. 180.2 126.1
Property Owned:
Leasehold improvements............................................... 27.6 20.9
Furniture and fixtures............................................... 45.3 29.7
Property under capital leases.......................................... 1.3 2.5
----------- -----------
74.2 53.1
Less-accumulated depreciation and amortization:
Property owned....................................................... (15.4) (7.7)
Property under capital leases........................................ (1.2) (1.5)
----------- -----------
Total owned and leased property........................................ 57.6 43.9
Other Assets and Deferred Charges...................................... 1.4 1.8
Goodwill -- net of accumulated amortization of $7.8 and $5.7,
respectively......................................................... 58.6 64.6
----------- -----------
$ 297.8 $ 236.4
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable -- trade............................................ $ 87.0 $ 55.1
Accrued payrolls and other liabilities............................... 48.2 31.9
Taxes other than income taxes........................................ 3.6 2.5
Income taxes......................................................... 4.0 2.1
----------- -----------
Total current liabilities.............................................. 142.8 91.6
Other Long-Term Liabilities............................................ 7.1 5.6
The Sports Authority Group Equity...................................... 147.9 139.2
----------- -----------
$ 297.8 $ 236.4
----------- -----------
----------- -----------
Supplemental disclosure (unaudited):
The Sports Authority Group Equity.................................... $ 147.9 $ 139.2
Add back of accumulated goodwill amortization........................ 7.8 5.7
----------- -----------
Kmart Corporation equity attributable to The Sports Authority
Group............................................................. $ 155.7 $ 144.9
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
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<PAGE> 466
THE SPORTS AUTHORITY GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income................................................. $ 12.8 $ 5.7 $ 1.3
Adjustments to reconcile net income to operating cash
flows:
Depreciation and amortization........................... 10.2 7.2 4.4
Increase in other long-term liabilities................. 1.9 2.4 1.5
Other -- net............................................ 5.1 -- --
Cash provided by (used for) current assets and current
liabilities:
Increase in inventories................................. (43.6) (30.7) (47.3)
Increase in accounts payable............................ 31.9 19.0 19.8
Other -- net............................................ 15.4 18.9 3.7
----------- ----------- -----------
Net cash provided by (used for) operations................. 33.7 22.5 (16.6)
----------- ----------- -----------
INVESTING
Capital expenditures -- owned property..................... (23.5) (25.9) (15.6)
Other -- net............................................... 1.0 2.2 0.4
----------- ----------- -----------
Net cash used for investing................................ (22.5) (23.7) (15.2)
----------- ----------- -----------
FINANCING
Net equity transactions with the Kmart Group............... (4.1) 2.1 33.4
Reduction in capital lease obligations..................... (1.1) (0.5) (0.6)
----------- ----------- -----------
Net cash provided by (used for) financing.................. (5.2) 1.6 32.8
----------- ----------- -----------
NET INCREASE IN CASH AND EQUIVALENTS......................... 6.0 0.4 1.0
Cash and Equivalents at Beginning of Year.................. 2.2 1.8 0.8
----------- ----------- -----------
CASH AND EQUIVALENTS AT END OF YEAR.......................... $ 8.2 $ 2.2 $ 1.8
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosures of cash flow information:
Interest paid.............................................. $ -- $ 0.1 $ 0.2
Income taxes paid.......................................... $ 4.3 $ 0.2 $ --
Capital lease obligations incurred......................... $ -- $ 0.6 $ 0.7
</TABLE>
See accompanying Notes to Combined Financial Statements.
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<PAGE> 467
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
BASIS OF PRESENTATION
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by shareholders and
implemented by the Board, would authorize the Board to issue four new series of
common stock (collectively, the Specialty Retail Stock) designated
KM-Borders-Walden Group Common Stock (Borders-Walden Stock), KM-Builders Square
Group Common Stock (Builders Square Stock), KM-OfficeMax Group Common Stock
(OfficeMax Stock) and KM-The Sports Authority Group Common Stock (The Sports
Authority Stock). While each series of Specialty Retail Stock would constitute
common stock of Kmart Corporation, each is intended to reflect the separate
performance of each specialty retail business. The Borders-Walden Stock is
intended to reflect the performance of Kmart Corporation's retail bookstore
group (the Borders-Walden Group), which is comprised principally of Kmart
Corporation's Borders, Inc. and Walden Book Company, Inc. subsidiaries. The
Builders Square Stock is intended to reflect the performance of Kmart
Corporation's retail home improvement and home decor superstore group (the
Builders Square Group), which is comprised principally of Kmart Corporation's
Builders Square, Inc. subsidiary. The OfficeMax Stock is intended to reflect the
performance of Kmart Corporation's retail office products superstore group (the
OfficeMax Group), which is comprised principally of Kmart Corporation's interest
in OfficeMax, Inc., a % owned subsidiary of Kmart Corporation. The Sports
Authority Stock is intended to reflect the performance of Kmart Corporation's
retail sporting goods megastore group (The Sports Authority Group), which is
comprised principally of Kmart Corporation's The Sports Authority, Inc.
subsidiary. The Borders-Walden Group, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the initial issuance of any series of Specialty Retail Stock, the
existing common stock would be redesignated as Kmart Group Common Stock (Kmart
Stock). The Kmart Stock, while constituting common stock of Kmart Corporation,
is intended to reflect the separate performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) Kmart Corporation's interest in each Specialty Retail Group (a Retained
Interest) other than the interest represented by any outstanding shares of any
series of Specialty Retail Stock and (iii) all other businesses in which Kmart
Corporation and its subsidiaries are engaged. The Kmart Group and the Specialty
Retail Groups are referred to collectively herein as the Groups.
Following approval by shareholders of the Specialty Retail Stock Proposal,
Kmart Corporation currently intends, subject to prevailing market and other
conditions, to offer shares of each series of Specialty Retail Stock for cash in
separate initial public offerings (collectively, the Offerings) and to allocate
the proceeds of the Offerings to the Kmart Group to repay outstanding
indebtedness of Kmart Corporation, resulting in reduced debt service obligations
attributable to the Kmart Group. The timing, sequence and size of such Offerings
and the price at which such shares would be sold would be determined by the
Board, without further approval of shareholders, at the time of each Offering;
however, it is currently contemplated that Kmart Corporation would initially
offer to the public shares of each series of Specialty Retail Stock that would
be intended to represent approximately 20% to 30% of the equity value of Kmart
Corporation attributed to the relevant Specialty Retail Group as determined by
the Board (Equity Value) at the time of such Offering. Therefore, it is expected
that Kmart Corporation would retain and attribute to the Kmart Group a 70% to
80% Retained Interest in each such Specialty Retail Group. The terms of each
Offering would be determined by the Board and the underwriters of such Offering
based upon prevailing market conditions; the financial condition and results of
operations of the relevant Group; the history of and prospects for the relevant
Group; the specialty retail industry and the segment of that industry in which
the relevant Group competes; the management and operations of the relevant
Group; the progress of the relevant Group in implementing its business strategy;
the foregoing factors in relation to market values of other companies engaged in
similar businesses; and the financial condition of Kmart Corporation as a whole.
In addition to or in lieu of any
X-27
<PAGE> 468
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Offering, the Board reserves the right to issue shares of any series of
Specialty Retail Stock as a distribution on Kmart Stock, although the Board has
no current intention to do so. The determination of whether to proceed with an
Offering of any series of Specialty Retail Stock would be made by the Board
based on, among other things, the proposed terms of such Offering and the then
prevailing market and other conditions. The Board reserves the right not to
proceed with any or all of the Offerings, without further approval of
shareholders, if it determines that consummation of such Offering or Offerings
is not in the best interests of Kmart Corporation.
The financial statements of the Groups comprise all of the accounts
included in the corresponding consolidated financial statements of Kmart
Corporation. The separate Group financial statements give effect to the
management and accounting policies that would be applicable upon implementation
of the Specialty Retail Stock Proposal, except that no inter-Group interest
expense or inter-Group interest income is reflected, as more fully described
under "Corporate Activities" below. However, following implementation of the
Specialty Retail Stock Proposal and issuance of each Specialty Retail Stock, the
financial statements of each Specialty Retail Group would reflect interest
expense related to net cash provided by Kmart Corporation. The separate Group
financial statements have been prepared on a basis that management believes to
be reasonable and appropriate and include (i) the combined historical financial
position, results of operations and cash flows of the businesses that comprise
each of the Groups and (ii) a portion of the assets and liabilities (including
contingent liabilities) and related transactions of Kmart Corporation that are
not separately identified with the operations of a specific Group. The effects
of the issuance of the equity securities described above have not been reflected
in these historical financial statements.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, following issuance of any series of Specialty Retail
Stock, Kmart Corporation would provide to holders of The Sports Authority Stock
separate financial statements, management's discussion and analysis of financial
condition and results of operations, business descriptions and other information
for The Sports Authority Group and for Kmart Corporation. Notwithstanding the
allocation of assets and liabilities (including contingent liabilities),
shareholders' equity and items of income and expense among the Groups for
purposes of preparing their respective financial statements, the change in the
capital structure of Kmart Corporation contemplated by the Specialty Retail
Stock Proposal would not affect the respective legal title to assets or
responsibility for liabilities of Kmart Corporation or any of its subsidiaries.
Kmart Corporation and its subsidiaries would each continue to be responsible for
their respective liabilities. Holders of The Sports Authority Stock and of each
other series of common stock of Kmart Corporation would be holders of common
stock of Kmart Corporation and would continue to be subject to risks associated
with an investment in Kmart Corporation and all of its businesses, assets and
liabilities. The Specialty Retail Stock Proposal would not affect the rights of
creditors of Kmart Corporation.
Financial effects arising from any Group that affect the consolidated
results of operations or financial condition of Kmart Corporation could affect
the results of operations or financial condition of The Sports Authority Group
or the market price of shares of The Sports Authority Stock. In addition, net
losses of any Group, dividends and distributions on any series of common stock
or preferred stock, repurchases of any series of common stock and certain
repurchases of preferred stock would reduce the assets of Kmart Corporation
legally available for dividends on all series of common stock. Accordingly,
Kmart Corporation consolidated financial information should be read in
conjunction with The Sports Authority Group financial information.
The dividend policy applicable to The Sports Authority Stock would be
determined by the Board at the time of issuance of such stock. Determinations to
pay dividends on The Sports Authority Stock would be based primarily upon the
financial condition, results of operations and business requirements of The
Sports Authority Group and Kmart Corporation as a whole. Under the terms of The
Sports Authority Stock, dividends would be payable at the sole discretion of the
Board out of the lesser of (i) all assets of Kmart
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<PAGE> 469
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Corporation legally available for dividends and (ii) the Available Dividend
Amount with respect to The Sports Authority Group.
The management and accounting policies applicable to the preparation of the
financial statements of The Sports Authority Group could be modified or
rescinded by the Board, in its sole discretion and without the approval of
shareholders, although there is no present intention to do so. The Board could
also adopt additional policies depending upon the circumstances. Any
determination by the Board to modify or rescind such policies, or to adopt
additional policies, including any such decision that could have disparate
effects upon holders of different series of common stock, would be made by the
Board in good faith and in the honest belief that such decision is in the best
interests of Kmart Corporation. In addition, generally accepted accounting
principles require that changes in accounting policy must be preferable (in
accordance with such principles) to the policy previously in place.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Sports Authority Group's significant accounting policies, which conform
to generally accepted accounting principles applied on a consistent basis
between years, are described below.
Fiscal Year: The Sports Authority Group's fiscal year ends on the Sunday
prior to the last Wednesday in January. Fiscal years 1993, 1992 and 1991 each
consisted of 52 weeks and ended on January 23, 1994, January 24, 1993 and
January 26, 1992, respectively.
Earnings Per Common and Common Equivalent Share: Historical earnings per
share are omitted from the statements of income as The Sports Authority Stock
was not part of the capital structure of Kmart Corporation for the periods
presented. Following implementation of the Specialty Retail Stock Proposal, the
method of calculating earnings per share for Kmart Stock and each series of
Specialty Retail Stock would reflect the terms of the Certificate of Amendment
which provide that each Group's Available Dividend Amount, which, in turn, would
reflect the separately reported Kmart Corporation Earnings Attributable to the
Kmart Group, in the case of the Kmart Group, and Kmart Corporation Earnings
Attributable to a Specialty Retail Group, in the case of a Specialty Retail
Group, would be the source for payment of dividends for each series of common
stock, although liquidation rights of these series of stock and legally
available assets of Kmart Corporation may be more or less than these amounts.
Kmart Corporation would compute earnings per share of The Sports Authority Stock
by dividing the product of the Outstanding Interest Fraction and Kmart
Corporation Earnings Attributable to a Specialty Retail Group with respect to
The Sports Authority Group by the weighted average number of shares of The
Sports Authority Stock and dilutive The Sports Authority Stock equivalents
outstanding during the applicable period. Kmart Corporation Earnings
Attributable to a Specialty Retail Group with respect to The Sports Authority
Group would generally equal The Sports Authority Group's net income or loss for
the relevant period determined in accordance with generally accepted accounting
principles in effect at such time, reflecting income and expenses of Kmart
Corporation allocated to The Sports Authority Group, increased by the amount of
amortization of goodwill of The Sports Authority Group during such period
arising from acquisitions made by Kmart Corporation or its subsidiaries with
respect to The Sports Authority Group before the first issuance of The Sports
Authority Stock. The Outstanding Interest Fraction with respect to The Sports
Authority Group is the percentage interest in The Sports Authority Group
intended to be represented at any time by the outstanding shares of The Sports
Authority Stock. See "Proposal 2 -- The Specialty Retail Stock
Proposal -- Dividend Policy -- Calculation of Earnings Per Share" of Kmart
Corporation Proxy Statement for an example of the calculation of Kmart
Corporation Earnings Attributable to a Specialty Retail Group with respect to
The Sports Authority Stock.
Cash and Equivalents: Kmart Corporation considers cash on hand in stores,
deposits in banks, certificates of deposit and short-term marketable securities
with maturities of 90 days or less as cash and cash equivalents for the purposes
of the statement of cash flows.
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<PAGE> 470
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Inventories: Merchandise inventories are valued on a first-in, first-out
(FIFO) basis at the lower of cost or market using the retail inventory method.
Property Owned and Depreciation: Leasehold improvements and equipment are
recorded at cost, including a provision for capitalized interest. Depreciation
is provided over the estimated useful lives of related assets on the
straight-line method for financial statement purposes and on accelerated methods
for income tax purposes. Store properties are leased and improvements are
amortized over the term of the lease but not more than 10 years. Other annual
rates used in computing depreciation for financial statement purposes are 14%
for store fixtures and 20% for other fixtures and equipment.
Goodwill: The excess of cost over the fair value of net assets of The
Sports Authority Group as of the March 2, 1990 date of acquisition of The Sports
Authority, Inc. by Kmart Corporation was capitalized and is being amortized over
40 years using the straight-line method. The Sports Authority Group evaluates
the recoverability of goodwill and reviews the amortization period on an annual
basis. Several factors are used to evaluate goodwill, including but not limited
to: management's plans for future operations; recent operating results and each
business' projected, undiscounted cash flows.
Financial Instruments: With the exception of The Sports Authority Group
equity, The Sports Authority Group records all financial instruments, including
accounts receivable, accounts payable and marketable securities at, or
approximating, market value.
Licensee Sales: Snow ski merchandise is sold through a licensee agreement.
The Sports Authority Group receives a percentage of snow ski sales for rent and
services. Snow ski sales are excluded from total sales.
Pre-Opening and Closing Costs: Costs associated with the opening of a new
store are expensed in the first month of operation. When the decision to close a
retail unit is made, The Sports Authority Group provides for the future net
lease obligation, non recoverable investment in fixed assets, other expenses
directly related to discontinuance of operations and estimated operating loss
through the expected closing dates. As of January 23, 1994, The Sports Authority
Group had not closed a retail unit.
CORPORATE ACTIVITIES
Kmart Corporation manages most treasury activities on a centralized,
consolidated basis. Such activities include the investment of surplus cash, the
issuance, repayment and repurchase of short-term and long-term debt and the
issuance and repurchase of common stock and preferred stock. Under this
centralized cash management system, domestic cash receipts of The Sports
Authority Group are remitted to Kmart Corporation and cash disbursements of The
Sports Authority Group are funded by Kmart Corporation on a daily basis. In the
historical financial statements of the Groups, (i) debt incurred by Kmart
Corporation and its subsidiaries, other than certain capital leases and
mortgages related specifically to the Specialty Retail Groups, has been
reflected on the financial statements of the Kmart Group and (ii) net cash used
or provided by each Specialty Retail Group has been characterized as an
adjustment of the Kmart Group's investment (reflected as Retained Interest) in
such Specialty Retail Group. Accordingly, no inter-Group interest expense or
inter-Group interest income is reflected in the historical financial statements
of The Sports Authority Group. Until the issuance of The Sports Authority Stock,
the net cash used or provided by The Sports Authority Group will continue to be
characterized as an adjustment to the Kmart Group's investment in The Sports
Authority Group.
If the Specialty Retail Stock Proposal is approved by shareholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically attributed to and
reflected on the financial statements of the Kmart Group, unless otherwise
determined by the Board. The Board could determine from time to time that debt
or preferred stock should be specifically
X-30
<PAGE> 471
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
attributed to and reflected on the financial statements of a Specialty Retail
Group when the debt is incurred or the preferred stock is issued for the benefit
of such Specialty Retail Group.
Following the issuance of The Sports Authority Stock, if cash used by The
Sports Authority Group exceeds cash provided by The Sports Authority Group, the
Kmart Group would transfer to The Sports Authority Group the cash necessary to
fund excess uses. Conversely, if cash provided by The Sports Authority Group
exceeds cash used by The Sports Authority Group, The Sports Authority Group
would transfer the excess cash to the Kmart Group. All cash transfers between
Groups would be accounted for as short-term loans unless the Board makes a
specific determination that a given transfer (or type of transfer) should be
accounted for as a long-term loan or, in the case of a transfer from the Kmart
Group to The Sports Authority Group, an equity contribution. There are no
specific criteria to determine when a cash transfer would be classified as a
long-term loan or, in the case of a transfer from the Kmart Group to The Sports
Authority Group, an equity contribution, rather than a short-term loan. Such
determination would be made by the Board in the exercise of its business
judgment at the time of such transfer (or the first of such type of transfer)
based upon all relevant circumstances, including the financing needs and
objectives of the recipient Group, the investment objectives of the transferring
Group, prevailing interest rates and general economic conditions. Such
determination would affect the amount of interest expense and interest income
reflected in the financial statements of the relevant Groups if such transfer
were made as a short-term loan or long-term loan and, in the case of a transfer
from the Kmart Group to The Sports Authority Group as an equity contribution,
the amount of The Sports Authority Group equity and Retained Interest of the
Kmart Group. Short-term loans between the Kmart Group and The Sports Authority
Group would bear interest at Kmart Corporation's daily short-term borrowing
rate. In the event that the Board determined that a transfer of funds between
the Kmart Group and The Sports Authority Group should be made as a long-term
loan, the Board would establish the terms on which such loan would be made,
including interest rate, amortization schedule, maturity and redemption terms.
Such terms would generally reflect the then prevailing terms upon which Kmart
Corporation could borrow funds on a similar basis.
From time to time, following the initial issuance of The Sports Authority
Stock, the Board could determine that funds to be transferred from the Kmart
Group to The Sports Authority Group represent an equity contribution to The
Sports Authority Group rather than a loan. In such event, the Kmart Group's
Retained Interest in The Sports Authority Group would be increased by the amount
of such contributions, as a result of which (i) the Number of Shares Issuable
with Respect to the Kmart Group's Retained Interest in The Sports Authority
Group would be increased by an amount equal to the amount of such contribution
divided by the Market Value of a share of The Sports Authority Stock and (ii)
the Kmart Group's interest in The Sports Authority Group would be increased and
the interest in The Sports Authority Group represented by outstanding shares of
The Sports Authority Stock would be decreased accordingly. The Board could
determine, in its sole discretion, to make such contribution after consideration
of a number of factors including, among others, the relative levels of
internally generated cash flow of the Groups, the long-term business prospects
for The Sports Authority Group, the capital expenditure plans of and investment
opportunities available to The Sports Authority Group, and the availability,
cost and time associated with alternative financing sources.
As a result of the foregoing, the balance sheets of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from The
Sports Authority Group, and the balance sheets of The Sports Authority Group
would reflect its net short-term and net long-term loans to or borrowings from
the Kmart Group. Similarly, the income statements of the Kmart Group and The
Sports Authority Group would reflect interest income or expense, as the case may
be, associated with such loans or borrowings and the statements of cash flows of
the Kmart Group and The Sports Authority Group would reflect changes in the
amounts thereof deemed outstanding. In view of the anticipated cash needs of The
Sports Authority Group over the next several years, it is currently expected
that the Kmart Group would provide net cash to The Sports Authority
X-31
<PAGE> 472
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Group. After considering all relevant factors, the Kmart Group would obtain such
funds from internal operations, excess cash from other Specialty Retail Groups,
external debt financing or additional equity issuances. Accordingly, unlike
these historical financial statements, following implementation of the Specialty
Retail Stock Proposal and issuance of The Sports Authority Stock, the financial
statements of The Sports Authority Group would reflect interest expense related
to net cash provided by Kmart Corporation.
Notwithstanding the management policies described above, determinations to
provide funds to The Sports Authority Group would continue to be made at the
discretion of the Board. Nothing in the foregoing policies obligates the Board
to cause the Kmart Group to provide funds to The Sports Authority Group if the
Board determines it is in the best interest of Kmart Corporation not to do so.
Certain corporate, general and administrative costs (including certain
corporate borrowing, legal, tax and employee benefit costs) have been charged to
the Specialty Retail Groups based upon utilization and at negotiated rates which
management believes approximate the rates which each of the Specialty Retail
Groups would incur as stand-alone entities. The Sports Authority Group financial
statements also include an allocation, which management believes to be
reasonable, of corporate, general and administrative costs related specifically
to the management of the Specialty Retail Groups and allocated equally among the
Specialty Retail Groups of $0.1 in each of 1993, 1992 and 1991. Amounts
allocated in these historical financial statements were calculated on the same
basis as would be used prospectively, and management believes that the
historical allocation of such amounts is representative of the amounts which
would be allocated to each of the Specialty Retail Groups prospectively.
Income Taxes: All members of the Kmart Corporation consolidated group are
included in the consolidated United States federal income tax return filed by
Kmart Corporation. Accordingly, the provision for federal income taxes and the
related payments or refunds of tax are determined on a consolidated basis. The
financial statement provision and related tax payments or refunds have been
reflected in the individual Groups in accordance with Kmart Corporation's tax
allocation policy for such Groups. In general, such policy provides that the
consolidated tax provision is allocated among the Groups for individual Group
financial statement purposes based principally upon the financial income,
taxable income, credits, preferences and other amounts directly related to the
respective Groups.
For financial statement provision and tax settlement purposes, tax benefits
resulting from attributes (principally net operating losses), which cannot be
utilized by one of the Groups on a separate return basis but which can be
utilized on a consolidated basis in any given year, are allocated to the Group
which generates the attributes. However, if such tax benefits cannot be utilized
on a consolidated basis in that year or in a carry back year, such consolidated
tax effect is adjusted in a subsequent year to the extent necessary to allocate
tax benefits to the Group that would have realized the tax benefits on a
separate return basis.
The allocated Group amounts are not necessarily comparable to those that
would have resulted if the Groups had filed separate tax returns and, in certain
situations, could result in any of the Groups incurring more or less income tax
expense for financial reporting purposes.
Deferred income taxes are provided on temporary differences between
financial statement and income tax basis of assets and liabilities.
X-32
<PAGE> 473
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Current:
Federal.............................................................. $ 6.7 $ 4.6 $ 1.3
State and local...................................................... 0.9 0.2 0.1
Deferred:
Excess of tax over book depreciation................................. 1.2 0.7 0.7
Other................................................................ (0.6) (1.2) (0.2)
----- ----- -----
Total income taxes........................................... $ 8.2 $ 4.3 $ 1.9
----- ----- -----
----- ----- -----
</TABLE>
A reconciliation of the federal statutory rate to The Sports Authority
Group's effective tax rate follows:
<TABLE>
<CAPTION>
1993 1992 1991 1993 1992 1991
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Federal statutory rate.................................. $7.4 $3.4 $1.1 35.0% 34.0% 34.0%
State and local taxes, net of federal tax benefit....... 0.6 0.1 0.1 2.9 1.0 3.1
Other................................................... 0.2 0.8 0.7 1.1 8.0 22.3
---- ---- ---- ---- ---- ----
Total income taxes............................ $8.2 $4.3 $1.9 39.0% 43.0% 59.4%
---- ---- ---- ---- ---- ----
---- ---- ---- ---- ---- ----
</TABLE>
Deferred tax assets and liabilities resulted from the following:
<TABLE>
<CAPTION>
JANUARY 23,
1994
-----------
<S> <C>
Deferred tax assets:
Inventory...................................................................... $ 0.4
Accruals and other liabilities................................................. 2.0
Other.......................................................................... 0.8
-----
Total deferred tax assets................................................... 3.2
-----
Deferred tax liabilities:
Property and equipment......................................................... 2.9
-----
Total deferred tax liabilities.............................................. 2.9
-----
Net deferred tax assets..................................................... $ 0.3
-----
-----
</TABLE>
Financial Accounting Standard No. 109 "Accounting for Income Taxes" (FAS
109) was issued in February 1992. FAS 109 requires that deferred taxes be
calculated using the liability approach rather than the deferred method. In
addition, the standard requires adjustment of deferred tax liabilities to
reflect enacted changes in the statutory federal income tax rate. The Sports
Authority Group adopted FAS 109 as the cumulative effect of an accounting change
in the first quarter of 1993. The cumulative effect of the accounting change was
insignificant.
COMMITMENTS AND CONTINGENCIES
There are various claims, lawsuits and pending actions against The Sports
Authority, Inc. incident to the operations of The Sports Authority Group. It is
the opinion of management that the ultimate resolution of these matters will not
have a material effect on The Sports Authority Group's liquidity, financial
position or results of operations.
X-33
<PAGE> 474
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
LEASES
Description of Leasing Arrangements: The Sports Authority Group conducts
operations primarily in leased facilities. Store leases are generally for terms
of 20 to 25 years with multiple five-year renewal options which allow The Sports
Authority Group the option to extend the life of the lease up to 25 years beyond
the initial noncancellable term.
Certain leases provide for additional rental payments based on a percent of
sales in excess of a specified base. Also, certain leases provide for the
payment by the lessee of executory costs (taxes, maintenance and insurance).
Some selling space has been sublet to other retailers in certain of the leased
facilities.
Lease Commitments: Future minimum lease payments at January 23, 1994 were
as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1994.................................................................. $ 0.1 $ 35.0
1995.................................................................. -- 34.6
1996.................................................................. -- 34.7
1997.................................................................. -- 34.1
1998.................................................................. -- 33.5
Later years........................................................... -- 361.6
------- ---------
Total minimum lease payments........................................ 0.1 533.5
Less -- minimum sublease rental income..................................... -- (9.1)
------- ---------
Net minimum lease payments................................................. 0.1 $ 524.4
---------
---------
Less:
Amount representing interest............................................. --
-------
0.1
Portion due within one year................................................ 0.1
-------
Long-term lease obligations................................................ $ --
-------
-------
</TABLE>
Rental Expense: A summary of operating lease rental expense and short-term
rentals follows:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Minimum rentals........................................................ $29.4 $17.2 $10.2
Percentage rentals..................................................... 0.3 0.2 --
Less -- sublease rentals............................................... (0.9) -- --
----- ----- -----
Total................................................................ $28.8 $17.4 $10.2
----- ----- -----
----- ----- -----
</TABLE>
X-34
<PAGE> 475
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Reconciliation of Capital Lease Information: The impact of recording
amortization and interest expense versus rent expense on capital leases follows:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Amortization of capital lease property................................. $ 0.3 $ 0.6 $ 0.6
Interest expense related to obligations under capital leases........... -- 0.1 0.2
----- ----- -----
Amounts charged to earnings............................................ 0.3 0.7 0.8
Related minimum lease payments net of executory costs.................. (0.5) (0.7) (0.7)
----- ----- -----
Excess of amounts charged over related minimum lease payments.......... $(0.2) $ -- $ 0.1
----- ----- -----
----- ----- -----
</TABLE>
PENSION PLANS
The Sports Authority Group participates in Kmart Corporation's
non-contributory pension plans which cover most domestic employees who meet
certain requirements of age, length of service and hours worked per year.
Benefits paid to retirees are based upon age at retirement, years of credited
service and earnings. The Kmart Corporation's policy is to fund at least the
minimum amounts required by the Employee Retirement Income Security Act of 1974.
The plans' assets consist primarily of equity securities, fixed income
securities, guaranteed insurance contracts and real estate. The portion of
pension expense and plan assets and obligations attributable to The Sports
Authority Group are actuarially determined based on the attributes of The Sports
Authority Group's plan participants, a method which management believes to be
reasonable.
The following table presents The Sports Authority Group's funded status
based on a proportionate share of plan assets, as described above, and amounts
recognized in the accompanying balance sheet at year end:
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
----------- -----------
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits................. $(0.5) $(0.1)
Estimated present value of non-vested benefits............. (0.6) (0.2)
----------- -----------
Accumulated benefit obligation............................. (1.1) (0.3)
Value of future pay increases.............................. (0.4) (0.3)
----------- -----------
Projected benefit obligation............................... (1.5) (0.6)
Estimated market value of plan assets........................ 1.1 0.6
----------- -----------
Plan assets under projected benefit obligation............... (0.4) --
Unrecognized net asset....................................... (0.1) (0.1)
Unrecognized prior service cost.............................. 0.1 --
Unrecognized net loss and other.............................. 0.2 --
----------- -----------
Accrued pension costs........................................ $(0.2) $(0.1)
----------- -----------
----------- -----------
</TABLE>
X-35
<PAGE> 476
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The following table summarizes allocated pension costs and actuarial
assumptions:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Components of pension expense:
Normal service cost.................................................. $ 0.3 $ 0.1 $ 0.1
Interest cost on projected benefit obligation........................ 0.1 -- --
Return on plan assets................................................ (0.1) -- --
Net amortization and deferral of other components.................... -- -- --
----- ----- -----
Total............................................................. $ 0.3 $ 0.1 $ 0.1
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates....................................................... 7.25% 8.50% 8.75%
Expected return on plan assets....................................... 9.50% 9.50% 9.50%
Salary increases..................................................... 4.50% 5.00% 5.00%
</TABLE>
OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS
The Sports Authority Group adopted Financial Accounting Standard No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS
106) at the beginning of fiscal 1993. FAS 106 requires The Sports Authority
Group to accrue for future postretirement medical benefits. The effect of this
statement on The Sports Authority Group is not significant.
In addition, Financial Accounting Standards No. 112 "Employers' Accounting
for Postemployment Benefits" (FAS 112) was issued in November 1992. FAS 112 is
an extension of the concepts underlying FAS 106 for similar benefits provided to
terminated or laid-off employees such as salary extension, severance, disability
and supplemental unemployment benefits. The effect of this statement on The
Sports Authority Group is not significant.
EMPLOYEE SAVINGS PLAN
Employees of The Sports Authority Group who meet certain requirements as to
age and service are eligible to participate in Kmart Corporation's Employee
Savings Plan. The Sports Authority Group's expense related to the Employee
Savings Plan was $0.4, $0.3 and $0.3 for 1993, 1992 and 1991, respectively.
PERFORMANCE RESTRICTED STOCK PLAN
Certain officers and employees of The Sports Authority Group participate in
Kmart Corporation's Performance Restricted Stock Plan and Stock Option Plan.
These plans are discussed in the respective footnotes to Kmart Corporation
consolidated financial statements. The Sports Authority Group's allocation of
compensation expense related to the Performance Restricted Stock Plan was not
material.
X-36
<PAGE> 477
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
THE SPORTS AUTHORITY GROUP EQUITY
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year................................. $ 139.2 $ 131.4 $ 96.7
Net income................................................... 12.8 5.7 1.3
Net equity transactions with the Kmart Group:
Cash management, excluding items shown below............... (8.9) (1.1) 31.7
Corporate, general and administrative expense allocation... 0.1 0.1 0.1
Participation in centrally managed employee benefit
programs................................................ 4.7 3.1 1.6
----------- ----------- -----------
Balance at end of year....................................... $ 147.9 $ 139.2 $ 131.4
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Under the Specialty Retail Stock Proposal, all cash transfers between
Groups would be made as short-term loans unless the Board makes a specific
determination that a given transfer (or type of transfer) should be made as a
long-term loan or, in the case of a transfer from the Kmart Group to a Specialty
Retail Group, an equity contribution. These historical financial statements
present all cash transfers between the Specialty Retail Groups and the Kmart
Group as equity transactions with the Kmart Group. Had the offerings been
completed on February 1, 1993, and assuming that all cash transactions, except
those relating to acquisitions, between the Specialty Retail Groups and the
Kmart Group had been accounted for as short-term loans, on a pro forma basis The
Sports Authority Group would have been charged inter-Group interest of $0.5
during 1993. Such pro forma interest expense has been calculated on daily
average borrowings outstanding using Kmart Corporation's weighted average
short-term borrowing rate. Such pro forma interest expense is not necessarily
indicative of the results which would occur had such offerings occurred on such
date, or what the interest expense would be prospectively.
X-37
<PAGE> 478
APPENDIX
Appendix of Graphic Materials Pursuant to Regulation S-T Item 304(a)
<TABLE>
<CAPTION>
Page Number Description of Graphic or Image
- ----------- -------------------------------
<S> <C>
2 Diagrams comparing current common stock
structure with the proposed specialty
retail stock structure
VIII-14 Diagram of a typical BSQ II store
floorplan
</TABLE>
<PAGE> 479
KMART CORPORATION
PROXY FOR ANNUAL MEETING OF STOCKHOLDERS
To Be Held May 24, 1994
The signer(s) hereby appoint(s) Joseph E. Antonini, Nancie W. LaDuke
and Anthony N. Palizzi, or any one of them, with power of substitution in each,
proxies to vote all common stock of the signer(s) in Kmart Corporation
(including stock held in the Dividend Reinvestment Plan, if any) at the Annual
Meeting of Stockholders to be held at 3100 West Big Beaver Road, Troy, Michigan
48084, on Tuesday, May 24, 1994 at 9:00 a.m. (local time), and at all
adjournments thereof, as specified on the matters indicated on the reverse side
hereof and in their discretion on any other business that may properly come
before the Meeting. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF
DIRECTORS.
Please vote, date and sign on the other side. Signature(s) should be
exactly as appears on reverse side. Joint owners should each sign. When
signing as Attorney, Executor, Administrator, Personal Representative, Trustee,
Officer of a corporation or Guardian, please give full title as such.
THE SHARES REPRESENTED BY THIS PROXY WILL BE VOTED AS DIRECTED BY THE
STOCKHOLDER(S) ON THE REVERSE SIDE HEREOF. IF THIS PROXY IS SIGNED AND
RETURNED BUT NO DIRECTION IS INDICATED, THIS PROXY WILL BE VOTED FOR THE
ELECTION OF DIRECTORS AND EACH OF PROPOSALS 2-13, AND AGAINST PROPOSAL 14, AS
SET FORTH IN THE PROXY STATEMENT DATED APRIL __, 1994.
HAS YOUR ADDRESS CHANGED? DO YOU HAVE ANY COMMENTS?
__________________________ __________________________
__________________________ __________________________
__________________________ __________________________
__________________________ __________________________
<PAGE> 480
/X/ PLEASE MARK VOTES LIKE THIS.
<TABLE>
<CAPTION>
The Board of Directors recommends a vote FOR Item 1. The Board of Directors recommends a vote FOR Proposals 2-13.
Withhold For All
For From All Except For Against Abstain For Against Abstain
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1. ELECTION OF DIRECTORS / / / / / / Proposal 2 / / / / / / Proposal 10 / / / / / /
Joseph A. Califano, Jr., Enrique C. Falla, David B. Proposal 3 / / / / / / Proposal 11 / / / / / /
Harper, J. Richard Munro and Joseph R. Thomas
Proposal 4 / / / / / / Proposal 12 / / / / / /
If you do not wish your shares to be voted
"FOR" a particular nominee, mark the "For All Proposal 5 / / / / / / Proposal 13 / / / / / /
Nominees Except" box and strike a line through
the nominee(s) name. Your shares will be voted Proposal 6 / / / / / /
for the remaining nominee(s).
Proposal 7 / / / / / / THE BOARD OF DIRECTORS RECOMMENDS
A VOTE AGAINST PROPOSAL 14.
Proposal 8 / / / / / /
[NAME AND ADDRESS OF STOCKHOLDER.] Proposal 14 / / / / / /
Proposal 9 / / / / / /
PLEASE BE SURE TO SIGN AND DATE THIS
PROXY. DATE:_______________________
Mark box at right if comments or address change have / /
been noted on this card.
Shareholder Sign Here Co-owners Sign Here
</TABLE>
- -------------------------------------------------------------------------------
DETACH AND
RETURN CARD KMART CORPORATION - PROPOSALS
Proposal 1. To elect each of Joseph A. Califano, Jr., Enrique C.
Falla, David B. Harper, J. Richard Munro and Joseph R. Thomas as directors for a
term expiring in 1997.
Proposal 2. To act upon the Specialty Retail Stock Proposal to amend
the Company's Restated Articles of Incorporation to, among other things, (a)
increase the number of authorized shares of Common Stock from 1.5 billion to 3.0
billion, (b) redesignate 1.5 billion shares of the Company's existing Common
Stock as Kmart Group Common Stock; and (c) authorize 1.5 billion shares of
Common Stock to be available for designation in series by resolution of the
Board of Directors as additional shares of Kmart Group Common Stock and/or any
of four new series of Specialty Retail Group Common Stock, each with the
designations, relative rights, preferences and limitations set forth in the
Proxy Statement dated April ____, 1994.
Proposal 3. To act upon a proposal to amend the Company's Restated
Articles of Incorporation relating to Preferred Stock issued in series by
resolution of the Board of Directors.
Proposal 4. To act upon a proposal to amend the Company's Restated
Articles of Incorporation to conform certain provisions regarding the vote
required for removal of directors and related amendments to the voting
provisions applicable to the various series of Common Stock pursuant to the
Specialty Retail Stock Proposal.
Proposal 5. To act upon a proposal to adopt an Employee Stock
Purchase Plan for each Specialty Retail Group.
Proposal 6. To act upon a proposal to provide for the issuance of
Specialty Retail Stock under the Directors Stock Plan.
Proposal 7. To act upon a proposal to provide for the substitution
of Specialty Retail Stock for certain outstanding awards of Existing Common
Stock under the Performance Restricted Stock Plan.
Proposal 8. To act upon a proposal to provide for substitution of
Specialty Retail Stock for existing Common Stock issuable upon exercise of
certain options granted under the 1973 and 1981 Stock Option Plans.
Proposal 9. To act upon a proposal to provide for the substitution
of Specialty Retail Stock for existing Common Stock issuable upon exercise of
certain options granted under the 1992 Stock Option Plan and
certain other plan amendments.
Proposal 10. To act upon a proposal to add certain allocation
provisions to the 1992 Stock Option Plan in order to comply with certain
recently enacted provisions of the Internal Revenue Code.
Proposal 11. To act upon a proposal to adopt the Management Stock
Purchase Plan.
Proposal 12. To act upon a proposal to adopt the Annual Incentive
Bonus Plan.
Proposal 13. To ratify the appointment of Price Waterhouse as
independent accountants of the Company for the 1994 fiscal year.
Proposal 14. To act upon a stockholder proposal as set forth in the
Proxy Statement dated April ____, 1994, which proposal is opposed by the Board
of Directors.
<PAGE> 481
KMART CORPORATION
PROXY FOR ANNUAL MEETING OF STOCKHOLDERS
To Be Held May 24, 1994
The signer(s) hereby instructs First Chicago Trust Company of New York,
as Depositary, to appoint Joseph E. Antonini, Nancie W. LaDuke and Anthony N.
Palizzi, or any one of them, with power of substitution in each, proxies to
vote all Series A Conversion Preferred Stock represented by the Kmart
Corporation $3.41 Depositary Shares of the signer(s) in Kmart Corporation at
the Annual Meeting of Stockholders to be held at 3100 West Big Beaver Road,
Troy, Michigan 48084, on Tuesday, May 24, 1994 at 9:00 a.m. (local time), and
at all adjournments thereof, as specified on the matter indicated hereon, and
in their discretion on any other business that may properly come before the
Meeting. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
(Please vote, date and sign on the other side. Signature(s) should be
exactly as appears on reverse side. Joint owners should each sign. When
signing as Attorney, Executor, Administrator, Personal Representative, Trustee,
Officer of a corporation or Guardian, please give full title as such.)
THE SHARES REPRESENTED BY THIS PROXY WILL BE VOTED AS DIRECTED BY THE
STOCKHOLDER(S) ON THE REVERSE SIDE HEREOF. IF THIS PROXY IS SIGNED AND
RETURNED BUT NO DIRECTION IS INDICATED, THIS PROXY WILL BE VOTED FOR THE
ELECTION OF DIRECTORS AND EACH OF PROPOSALS 2-13 AND AGAINST PROPOSAL 14, AS
SET FORTH IN THE PROXY STATEMENT DATED APRIL __, 1994.
HAS YOUR ADDRESS CHANGED? DO YOU HAVE ANY COMMENTS?
____________________________ _________________________________
____________________________ _________________________________
____________________________ _________________________________
<PAGE> 482
/X/ PLEASE MARK VOTES LIKE THIS.
<TABLE>
<CAPTION>
The Board of Directors recommends a vote FOR Item 1. The Board of Directors recommends a vote FOR Proposals 2-13.
Withhold For All
For From All Except For Against Abstain For Against Abstain
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1. ELECTION OF DIRECTORS / / / / / / Proposal 2 / / / / / / Proposal 10 / / / / / /
Joseph A. Califano, Jr., Enrique C. Falla, David B. Proposal 3 / / / / / / Proposal 11 / / / / / /
Harper, J. Richard Munro and Joseph R. Thomas
Proposal 4 / / / / / / Proposal 12 / / / / / /
If you do not wish your shares to be voted
"FOR" a particular nominee, mark the "For All Proposal 5 / / / / / / Proposal 13 / / / / / /
Nominees Except" box and strike a line through
the nominee(s) name. Your shares will be voted Proposal 6 / / / / / /
for the remaining nominee(s).
Proposal 7 / / / / / / THE BOARD OF DIRECTORS RECOMMENDS
A VOTE AGAINST PROPOSAL 14.
Proposal 8 / / / / / /
[NAME AND ADDRESS OF STOCKHOLDER.] Proposal 14 / / / / / /
Proposal 9 / / / / / /
PLEASE BE SURE TO SIGN AND DATE THIS
PROXY. DATE:_______________________
Mark box at right if comments or address change have / /
been noted on this card.
Shareholder Sign Here Co-owners Sign Here
</TABLE>
- -------------------------------------------------------------------------------
DETACH AND
RETURN CARD KMART CORPORATION - PROPOSALS
Proposal 1. To elect each of Joseph A. Califano, Jr., Enrique C.
Falla, David B. Harper, J. Richard Munro and Joseph R. Thomas as directors for a
term expiring in 1997.
Proposal 2. To act upon the Specialty Retail Stock Proposal to amend
the Company's Restated Articles of Incorporation to, among other things, (a)
increase the number of authorized shares of Common Stock from 1.5 billion to 3.0
billion, (b) redesignate 1.5 billion shares of the Company's existing Common
Stock as Kmart Group Common Stock; and (c) authorize 1.5 billion shares of
Common Stock to be available for designation in series by resolution of the
Board of Directors as additional shares of Kmart Group Common Stock and/or any
of four new series of Specialty Retail Group Common Stock, each with the
designations, relative rights, preferences and limitations set forth in the
Proxy Statement dated April ____, 1994.
Proposal 3. To act upon a proposal to amend the Company's Restated
Articles of Incorporation relating to Preferred Stock issued in series by
resolution of the Board of Directors.
Proposal 4. To act upon a proposal to amend the Company's Restated
Articles of Incorporation to conform certain provisions regarding the vote
required for removal of directors and related amendments to the voting
provisions applicable to the various series of Common Stock pursuant to the
Specialty Retail Stock Proposal.
Proposal 5. To act upon a proposal to adopt an Employee Stock
Purchase Plan for each Specialty Retail Group.
Proposal 6. To act upon a proposal to provide for the issuance of
Specialty Retail Stock under the Directors Stock Plan.
Proposal 7. To act upon a proposal to provide for the substitution
of Specialty Retail Stock for certain outstanding awards of Existing Common
Stock under the Performance Restricted Stock Plan.
Proposal 8. To act upon a proposal to provide for substitution of
Specialty Retail Stock for existing Common Stock issuable upon exercise of
certain options granted under the 1973 and 1981 Stock Option Plans.
Proposal 9. To act upon a proposal to provide for the substitution
of Specialty Retail Stock for existing Common Stock issuable upon exercise of
certain options granted under the 1992 Stock Option Plan and
certain other plan amendments.
Proposal 10. To act upon a proposal to add certain allocation
provisions to the 1992 Stock Option Plan in order to comply with certain
recently enacted provisions of the Internal Revenue Code.
Proposal 11. To act upon a proposal to adopt the Management Stock
Purchase Plan.
Proposal 12. To act upon a proposal to adopt the Annual Incentive
Bonus Plan.
Proposal 13. To ratify the appointment of Price Waterhouse as
independent accountants of the Company for the 1994 fiscal year.
Proposal 14. To act upon a stockholder proposal as set forth in the
Proxy Statement dated April ____, 1994, which proposal is opposed by the Board
of Directors.
