<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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:
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
PRELIMINARY COPY DATED FEBRUARY 4, 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 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 series that are intended to
reflect the separate performance of the following specialty retail businesses
(collectively, the "Specialty Retail Stock"): Borders-Walden Group, Builders
Square Group, OfficeMax Group and The Sports Authority Group. Upon the first
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 separate 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 and to provide the Company greater flexibility with
regard to raising capital and structuring employee incentive plans with an
equity security related specifically 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
retain 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 to the
public for cash in separate offerings. 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 the Company would 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 attributed to each specialty retail business, as
determined by the Board at the time of such offering.
The Board of Directors 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
presently $.96 per share, is customarily reviewed at the April meeting of the
Board of Directors. 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 discount store business and
the Company as a whole.
In addition to the Specialty Retail Stock Proposal, stockholders will be
asked to consider and approve additional proposals that would effect certain
related and other amendments to the Company's Restated Articles of Incorporation
and stock-based employee benefit plans and would adopt certain new employee
benefit plans. THE BOARD OF DIRECTORS HAS CAREFULLY CONSIDERED THE SPECIALTY
RETAIL STOCK PROPOSAL AND SUCH ADDITIONAL PROPOSALS AND BELIEVES THEIR ADOPTION
IS IN THE BEST INTERESTS OF THE COMPANY. THE BOARD HAS UNANIMOUSLY APPROVED THE
SPECIALTY RETAIL STOCK PROPOSAL AND SUCH ADDITIONAL PROPOSALS 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> 3
PRELIMINARY COPY DATED FEBRUARY 4, 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 Article
III, Section A of the Company's Restated Articles of Incorporation, as set
forth in Annex III-A hereto, to, among other things, (a) increase the
number of authorized shares of Common Stock from 1.5 billion to 3.0
billion, (b) provide for the issuance of Common Stock in series by
resolution of the Board of Directors, of which 1.5 billion shares would
initially be designated as a new series of Kmart Group Common Stock, and
the balance of which would be available for designation by the Board 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, and (c) redesignate the Company's existing Common Stock as
Kmart Group Common Stock;
3. To act upon a proposal to amend Article III, Section B of the
Company's Restated Articles of Incorporation, as set forth in Annex III-B
hereto, relating to Preferred Stock issued in series by resolution of the
Board of Directors;
4. To act upon a proposal to amend Article VII of the Company's
Restated Articles of Incorporation, as set forth in Annex III-C hereto, 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;
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; and
14. To transact such other business as may properly come before the
meeting.
Proposals 4 through 9 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> 4
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
PROXY STATEMENT -- GENERAL INFORMATION............ 1
SUMMARY COMPARISON OF TERMS OF EXISTING COMMON
STOCK WITH TERMS OF KMART STOCK AND SPECIALTY
RETAIL STOCK.................................... 2
PROXY STATEMENT SUMMARY........................... 6
PRICE RANGES OF EXISTING COMMON STOCK, SERIES A
PREFERRED STOCK
AND SERIES B PREFERRED STOCK;
DIVIDENDS....................................... 21
Existing Common Stock........................... 21
Series A Preferred Stock........................ 22
Series B Preferred Stock........................ 22
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS... 23
PROPOSAL 1 -- ELECTION OF DIRECTORS............... 24
Information about Nominees and Directors........ 24
Stock Ownership of Officers and Directors....... 27
Committees of the Board......................... 27
Compensation of Directors....................... 28
Compensation of Officers........................ 29
Compensation and Incentive Committee
Report........................................ 32
PROPOSAL 2 -- THE SPECIALTY RETAIL STOCK
PROPOSAL........................................ 34
General......................................... 34
Special Considerations.......................... 35
Dividend Policy................................. 41
Management and Accounting Policies.............. 43
Description of Kmart Stock and Specialty Retail
Stock......................................... 45
Retained Interest of Kmart Group in Specialty
Retail Groups; Outstanding Interest
Fraction...................................... 56
Background and Reasons for the Specialty Retail
Stock Proposal................................ 59
Stock Exchange Listings......................... 60
Financial Advisors.............................. 60
Stock Transfer Agent and Registrar.............. 60
Restated Rights Agreement....................... 60
Effects on Preferred Stock...................... 62
Certain Federal Income Tax Considerations....... 63
Anti-takeover Considerations.................... 65
PROPOSAL 3 -- AMENDMENTS TO RESTATED ARTICLES OF
INCORPORATION RELATING TO ISSUANCE OF PREFERRED
STOCK IN SERIES BY RESOLUTION OF BOARD OF
DIRECTORS....................................... 67
PROPOSAL 4 -- AMENDMENTS TO RESTATED ARTICLES OF
INCORPORATION RELATING TO CERTAIN VOTING
PROVISIONS...................................... 69
PROPOSAL 5 -- ADOPTION OF
EMPLOYEE STOCK PURCHASE PLAN FOR EACH SPECIALTY
RETAIL GROUP.................................... 71
General......................................... 71
Additional Information Regarding Each Section
423 Plan...................................... 71
Description of Section 423 Plan................. 71
PROPOSAL 6 -- AMENDMENTS TO DIRECTORS STOCK PLAN
RELATING TO ISSUANCE OF SPECIALTY RETAIL
STOCK........................................... 75
General......................................... 75
Description of Amendments to Directors Plan..... 75
Additional Information Regarding Directors
Plan.......................................... 75
Description of Directors Plan as Proposed to be
Amended....................................... 75
<CAPTION>
PAGE
--------
<S> <C>
PROPOSAL 7 -- AMENDMENTS TO PERFORMANCE RESTRICTED
STOCK PLAN RELATING TO SUBSTITUTION OF SPECIALTY
RETAIL STOCK FOR CERTAIN OUTSTANDING AWARDS OF
EXISTING COMMON STOCK........................... 79
General......................................... 79
Description of Amendment to Performance Plan.... 79
Stock Subject to Performance Plan............... 79
Additional Information Regarding Performance
Plan.......................................... 80
Description of Performance Plan as Proposed to
be Amended.................................... 80
Amendments to or Discontinuance of Performance
Plans......................................... 80
Federal Income Tax Consequences................. 81
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......................................... 83
General......................................... 83
Description of Amendments to 1973 and 1981
Plans......................................... 83
Stock Subject to 1973 and 1981 Plans............ 84
Additional Information Regarding 1973 and 1981
Plans......................................... 84
Description of 1973 and 1981 Plans as Proposed
to be Amended................................. 84
Amendments to or Discontinuance of 1973 and 1981
Plans......................................... 84
Federal Income Tax Consequences................. 85
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...................................... 87
General......................................... 87
Additional Information Regarding 1992 Plan...... 88
Description of 1992 Plan as Proposed to be
Amended....................................... 88
PROPOSAL 10 -- AMENDMENTS TO 1992 STOCK OPTION
PLAN RELATING TO ADDING CERTAIN ALLOCATION
PROVISIONS...................................... 93
Description of Amendment to Add Allocation
Provisions.................................... 93
Additional Information Regarding 1992 Plan...... 94
PROPOSAL 11 -- ADOPTION OF MANAGEMENT STOCK
PURCHASE PLAN................................... 95
General......................................... 95
Additional Information Regarding Stock Purchase
Plan.......................................... 95
Description of Stock Purchase Plan.............. 95
PROPOSAL 12 -- ADOPTION OF ANNUAL INCENTIVE BONUS
PLAN............................................ 101
General......................................... 101
Additional Information Regarding the Annual
Bonus Plan.................................... 101
Description of Annual Bonus Plan................ 101
PROPOSAL 13 -- RATIFICATION OF APPOINTMENT OF
INDEPENDENT ACCOUNTANTS......................... 105
STOCKHOLDER PROPOSALS............................. 105
ANNEX I: GLOSSARY OF CERTAIN TERMS................ I-1
ANNEX II: ILLUSTRATIONS OF CERTAIN TERMS.......... II-1
</TABLE>
i
<PAGE> 5
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
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 ARTICLE
VII OF 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
ALLOCATIONS PROVISIONS.......................... IV-F-1
ANNEX IV-G: PROPOSAL 11 -- ADOPTION OF MANAGEMENT
STOCK PURCHASE PLAN............................. IV-G-1
ANNEX IV-H: PROPOSAL 12 -- ADOPTION OF ANNUAL
INCENTIVE BONUS
PLAN............................................ IV-H-1
ANNEX V: KMART CORPORATION........................ V-1
A: Selected Financial Data
B: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the Fiscal Year Ended January 27, 1993
C: Consolidated Financial Statements for the
Fiscal Year Ended January 27, 1993
D: Consolidated Financial Statements 39 Weeks
Ended October 27, 1993
E: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the 39 Weeks Ended October 27, 1993
ANNEX VI: KMART GROUP............................. VI-1
A: Selected Financial Data
B: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the Fiscal Year Ended January 27, 1993
C: Business Description
<CAPTION>
PAGE
--------
<S> <C>
D: Combined Financial Statements for the Fiscal
Year Ended January 27, 1993
E: Combined Financial Statements for the 39
Weeks Ended October 27, 1993
F: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the 39 Weeks Ended October 27, 1993
ANNEX VII: BORDERS-WALDEN GROUP................... VII-1
A: Selected Financial Data
B: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the Fiscal Year Ended January 24, 1993
C: Business Description
D: Combined Financial Statements for the 1992
Fiscal Year Ended January 24, 1993
E: Combined Financial Statements for the 39
Weeks Ended October 24, 1993
F: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the 39 Weeks Ended October 24, 1993
ANNEX VIII: BUILDERS SQUARE GROUP................. VIII-1
A: Selected Financial Data
B: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the Fiscal Year Ended January 24, 1993
C: Business Description
D: Combined Financial Statements for the Fiscal
Year Ended January 24, 1993
E: Combined Financial Statements for the 39
Weeks Ended October 24, 1993
F: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the 39 Weeks Ended October 24, 1993
ANNEX IX: OFFICEMAX GROUP......................... IX-1
A: Selected Financial Data
B: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the Fiscal Year Ended January 23, 1993
C: Business Description
D: Combined Financial Statements for the Fiscal
Year Ended January 23, 1993
E: Unaudited Pro Forma Combined Financial
Information
F: Financial Statements for the Fiscal Year
Ended July 27, 1991
G: BizMart, Inc. Consolidated Financial
Statements as of March 4, 1993
H: Combined Financial Statements for the 39
Weeks Ended October 23, 1993
I: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the 39 Weeks Ended October 23, 1993
ANNEX X: THE SPORTS AUTHORITY GROUP............... X-1
A: Selected Financial Data
B: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the Fiscal Year Ended January 24, 1993
C: Business Description
D: Combined Financial Statements for the Fiscal
Year Ended January 24, 1993
E: Combined Financial Statements for the 39
Weeks Ended October 24, 1993
F: Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the 39 Weeks Ended October 24, 1993
</TABLE>
ii
<PAGE> 6
PRELIMINARY COPY DATED FEBRUARY 4, 1994
KMART CORPORATION
PROXY STATEMENT
------------------------------
GENERAL INFORMATION
April , 1994
This 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 authority ("broker non-votes"). In tabulating the vote on the
election of directors and Proposals 5, 10 and 13, 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 and with the solicitation of proxies at a cost of
approximately $ plus 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- - . 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.
<PAGE> 7
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 issuance home improvement and home decor
of the relevant series of superstore business.
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.
ISSUANCE: -- Upon the first issuance of any Following approval by
series of Specialty Retail stockholders of the Specialty
Stock, the Existing Common Retail Stock Proposal, the
Stock would be redesignated as Company currently intends,
Kmart Stock. 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. 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.
DIVIDENDS: The most recent The Board currently intends The dividend policy applicable
dividend paid by the that the dividend policy to any series of Specialty
Company was at the applicable to the Kmart Stock Retail Stock would be
annual rate of $.96 would be substantially the same determined by the Board at the
per share. Dividends as the dividend policy time of issuance of such
are payable out of applicable to the Existing series. Dividends on each
all assets of the Common Stock, with the initial series of Specialty Retail
Company legally dividend rate on the Kmart Stock would be paid in the sole
available for Stock being the rate in effect discretion of the Board based
dividends. for the Existing Common Stock primarily upon the financial
at the time of the condition, results of
redesignation. The Company's operations and business
annual dividend rate, which is requirements of the relevant
currently $.96 per share, is Specialty Retail Group and the
customarily reviewed at the Company as a whole. Dividends
April meeting of the Board of on each series of Specialty
Directors. The Board believes Retail Stock would be payable
that implementation of the out of the lesser of (i) all
Specialty Retail Stock Proposal assets of the Company legally
would not adversely affect the available for dividends and
Company's ability to pay (ii) the Available Dividend
dividends on the Kmart Stock. Amount with respect to the
Determinations as to future relevant Specialty Retail
dividends on the Kmart Group.
</TABLE>
2
<PAGE> 8
<TABLE>
<CAPTION>
SPECIALTY RETAIL STOCK PROPOSAL
EXISTING ----------------------------------------------------------------
COMMON STOCK KMART STOCK SPECIALTY RETAIL STOCK
-------------------- ------------------------------- -------------------------------
<S> <C> <C> <C>
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. Dividends 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.
Subject to the restrictions on Subject to the restrictions on
the assets out of which the assets out of which
dividends on the Kmart Stock dividends on the Kmart Stock
and any and all series of and any and all series of
Specialty Retail Stock may be Specialty Retail Stock may be
paid, the Board could, in its paid, the Board could, in its
sole discretion, declare and sole discretion, declare and
pay dividends on all or less pay dividends on all or less
than all series of Common Stock than all series of Common Stock
in equal or unequal amounts, in 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, an amount that bears the
same relation to the aggregate
amount of such dividend as the
ratio of the relevant Number of
Shares Issuable with Respect to
Retained Interest of the Kmart
Group to the number of shares
of such series of Specialty
Retail Stock outstanding.
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 an
average daily ratio of the
Market Value of one share of
such series to one share of
Kmart Stock.
</TABLE>
3
<PAGE> 9
<TABLE>
<CAPTION>
SPECIALTY RETAIL STOCK PROPOSAL
EXISTING ----------------------------------------------------------------
COMMON STOCK KMART STOCK SPECIALTY RETAIL STOCK
-------------------- ------------------------------- -------------------------------
<S> <C> <C> <C>
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 a
time-weighted average of the
Market Value 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 a time-
weighted average of the Market
Value 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 a
together with the Specialty Retail Stock, the time-weighted average of the
Series A Preferred Series A Preferred Stock, the Market Value of one share of
Stock, the Series B Series B Preferred Stock and such series to one share of
Preferred Stock and any other series of Preferred Kmart 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, provided that
outstanding at the vote on all matters submitted no share of any series of
time of such vote to stockholders, other than Specialty Retail Stock would be
and so entitled to matters which would be required entitled to more than one vote
vote on all matters to be submitted to a separate prior to the Series A
submitted to class vote. Conversion Date, which will
stockholders, other occur on or before September
than matters which 15, 1994. Each outstanding
are required to be series of Specialty Retail
submitted to a Stock would vote as one class
separate class vote. 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 stockholders,
other than matters which would
be required to be submitted to
a separate class vote.
</TABLE>
4
<PAGE> 10
<TABLE>
<CAPTION>
SPECIALTY RETAIL STOCK PROPOSAL
EXISTING ----------------------------------------------------------------
COMMON STOCK KMART STOCK SPECIALTY RETAIL STOCK
-------------------- ------------------------------- -------------------------------
<S> <C> <C> <C>
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
dividend or distribution to certain exceptions, (i) any
holders of any other series of dividend or distribution to
Common Stock of any of the holders of any other series of
properties or assets of the Common Stock of any of the
Kmart Group, or of shares of properties or assets of the
Kmart Stock (or Convertible relevant Specialty Retail
Securities convertible into Group, or of shares of such
Kmart Stock) or of any security series of Specialty Retail
that represents an equity Stock (or Convertible
interest in an entity (other Securities convertible into
than the Company) that owns any such series) or of any security
of the properties or assets of that represents an equity
the Kmart Group, (ii) the use interest in an entity (other
of any properties or assets of than the Company) that owns any
the Kmart Group in any business of the properties or assets of
of the Company other than a the relevant Specialty Retail
business of the Kmart Group, or Group, other than a dividend or
(iii) any issuance or sale of distribution on the Kmart Stock
Kmart Stock (or Convertible of shares of such series (or
Securities convertible into Convertible Securities
Kmart Stock) for the account of convertible into shares of such
any Group other than the Kmart series) to the extent of the
Group. Kmart Group's Retained Interest
in such Specialty Retail Group,
(ii) the use of any properties
or assets of such Specialty
Retail Group in any business of
the Company other than a
business of such Specialty
Retail Group, or (iii) any
issuance or sale of shares of
such series of Specialty Retail
Stock (or Convertible
Securities convertible into
such series) for the account of
any Group other than the
relevant Specialty Retail Group
or, to the extent of the Kmart
Group's Retained Interest in
such Specialty Retail Group,
the Kmart 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>
5
<PAGE> 11
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;
- provide for the issuance of Common Stock in series by resolution of
the Board, of which 1.5 billion shares would initially be designated as
Kmart Group Common Stock ("Kmart Stock"), and the balance of which would
be available for designation by the Board as additional shares of Kmart
Stock and/or any of four series of Specialty Retail Stock, each such
series having the designations, relative rights, preferences and
limitations described herein; and
- redesignate the Existing Common Stock as Kmart Stock.
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 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
6
<PAGE> 12
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 Company's retail sporting goods megastore group ("The Sports
Authority Group"), which is comprised principally of the Company'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 first 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
separately the performance of the "Kmart Group", which is generally comprised of
(i) the Company's core Kmart discount store group, (ii) the 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 the Company and its 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 to the
public for cash in separate offerings (collectively, the "Offerings"). The
timing, sequence and size of such Offerings and the price at which such shares
would be sold would be determined by the Board at the time of each Offering
based upon then prevailing market and other conditions; however, it is currently
contemplated that the Company would 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. 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 of amendment to the Articles
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 first 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.
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 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 continue to be subject to risks associated with an investment in the
Company and all of its businesses, assets and liabilities.
7
<PAGE> 13
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; Fiduciary Duties. 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. See "Limited Separate Stockholder Voting Rights; Effects on Voting
Power" below. In addition, 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. 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.
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 the Offerings and subsequent 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.
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. 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
8
<PAGE> 14
Retail Group would transfer such excess cash to the Kmart Group. Such transfers
would generally be accounted for as short-term loans, unless the Board
determined that any such transfer should be accounted for as a long-term loan
or, in the case of a transfer of funds from the Kmart Group to a Specialty
Retail Group, as an equity contribution. Notwithstanding these cash management
policies, 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 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. 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 transfered 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 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. Although the increase in the relevant Number of Shares Issuable with
Respect to 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
9
<PAGE> 15
increase, although it is unlikely that during the foreseeable future the holders
of Kmart Stock would possess less than a majority of the total 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 for an increase in the
number of authorized shares of Common Stock from 1.5 billion to 3.0 billion, of
which 1.5 billion would be designated Kmart Stock and 1.5 billion would be
available for designation as Kmart Stock and/or any 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
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
stockholder approval, to increase or decrease the number of shares in 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
authorized 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 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 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.
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.
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
10
<PAGE> 16
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. Whether
or not the shares to be sold in any such Offering of a series of Specialty
Retail Stock are attributed to the Kmart Group's Retained Interest in the
relevant Specialty Retail Group, the Kmart Group's percentage interest in the
relevant Specialty Retail Group would be reduced. In addition, any other
issuance of any series of Specialty Retail Stock for the account of the Kmart
Group would 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 "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. 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 separately the 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 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.
11
<PAGE> 17
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" and "-- 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.
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.
12
<PAGE> 18
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 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 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), but
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 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 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
13
<PAGE> 19
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, including sales in the Offerings, 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. 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 and the allocation of the net proceeds of such Offering
between the Kmart Group and the relevant Specialty Retail Group 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. The relevant Number of Shares Issuable with Respect to Retained
Interest would be reduced if the net proceeds of an Offering were allocated to
the Kmart Group's Retained Interest in the relevant Specialty Retail Group. If
the net proceeds of an Offering were not allocated to the Kmart Group, the
relevant 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 bears the same relation to the aggregate amount of such dividend or
other distribution as the ratio of the relevant Number of Shares Issuable with
Respect to Retained Interest to the number of shares of such series of Specialty
Retail Stock 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
14
<PAGE> 20
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 accordingly.
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.
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 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 separately the 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
15
<PAGE> 21
Stock in addition to Kmart Stock would enhance stockholder value over the long
term and provide the Company greater flexibility with regard to raising capital
and structuring employee incentive plans with an equity security related
specifically 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 retain 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 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 THE SPECIALTY RETAIL STOCK
PROPOSAL AND BELIEVES ITS ADOPTION IS IN THE BEST INTERESTS OF THE COMPANY. THE
BOARD HAS UNANIMOUSLY APPROVED THE SPECIALTY RETAIL STOCK PROPOSAL 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 the amendments to Article III, Section B of the Articles 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 the amendments to Article VII of the Articles 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 would
permit a broad base of employees to purchase shares of the series of Specialty
Retail Stock relating to their 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.
16
<PAGE> 22
PROPOSAL 6 -- AMENDMENTS TO DIRECTOR STOCK PLAN RELATING TO
ISSUANCE OF OUTSTANDING SERIES 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.
PROPOSAL 7 -- AMENDMENTS TO PERFORMANCE RESTRICTED STOCK PLAN
RELATING TO SUBSTITUTION OF OUTSTANDING SERIES 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 OUTSTANDING SERIES 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 OUTSTANDING SERIES OF
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.
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.
17
<PAGE> 23
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,
certain 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 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.
18
<PAGE> 24
KMART CORPORATION
SUMMARY FINANCIAL DATA
The following summary financial data for the periods indicated has been
derived from the consolidated financial statements of the Company. 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 financial statements and notes thereto set forth in Annex V
hereto.
<TABLE>
<CAPTION>
1993 1992 1991 1990 1989* 1988
------- ------- ------- ------- ------- -------
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF INCOME DATA
Sales.................................. $ $31,031 $29,042 $28,133 $27,670 $25,947
Cost of merchandise sold, includes
buying and occupancy costs.......... 22,800 21,243 20,614 20,310 18,920
Selling, general and administrative
expenses............................ 6,875 6,603 6,435 6,277 5,877
Interest expense -- net................ 414 384 384 353 312
Income from continuing retail
operations before income taxes...... 1,327 1,189 1,070 444 1,185
Net income from continuing retail
operations.......................... 882 789 712 282 768
PER-SHARE DATA
Earnings per common and common
equivalent share from continuing
retail operations................... $ $ 1.93 $ 1.85 $ 1.78 $ .70 $ 1.91
Cash dividends declared per common
share............................... .92 .88 .86 .82 .66
Book value............................. 16.64 15.33 13.47 12.45 12.56
FINANCIAL DATA
Working capital........................ $ $ 5,014 $ 4,682 $ 3,519 $ 3,685 $ 3,654
Total assets........................... 18,931 15,999 13,899 13,145 12,126
Long-term obligations -- Debt.......... 3,237 2,287 1,701 1,480 1,358
-- Capital
leases.............................. 1,698 1,638 1,598 1,549 1,588
Shareholders' equity................... 7,536 6,891 5,384 4,972 5,009
Capital expenditures -- owned
property............................ 1,435 1,329 814 631 570
Depreciation and amortization.......... 600 509 470 444 424
Ending market capitalization........... 10,837 10,901 6,095 6,640 7,105
Weighted average shares outstanding.... 458 426 400 401 401
FINANCIAL RATIOS
Return on sales --
Income from continuing retail
operations before income taxes.... % 4.3% 4.1% 3.8% 1.6% 4.6%
Net income from continuing retail
operations........................ % 2.8% 2.7% 2.5% 1.0% 3.0%
Return on beginning assets from
continuing retail operations........ % 6.4% 6.6% 5.9% 2.5% 7.5%
Inventory turnover..................... 2.7 2.7 2.7 2.9 3.0
Return on beginning shareholders'
equity from continuing retail
operations.......................... % 13.2% 15.0% 14.7% 5.7% 17.7%
Return on beginning investment......... % 10.8% 11.2% 11.2% 6.4% 13.2%
Working capital ratio.................. 1.9 2.1 1.8 1.9 2.0
Debt and equivalent as a percentage of
total capitalization................ % 43.1% 37.3% 43.5% 43.4% 38.0%
Ratio of income to fixed charges....... 3.0 3.0 2.9 1.8 3.5
Employee compensation and benefits, per
sales dollar........................ % 14.7% 15.1% 15.2% 15.2% 14.7%
</TABLE>
- -------------------------
* Results of operations for 1989 include a pretax provision of $640 million for
restructuring of Kmart stores and other charges.
19
<PAGE> 25
KMART GROUP AND SPECIALTY RETAIL GROUPS
SUMMARY FINANCIAL DATA
The following summary data for fiscal 1993 reflect 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 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....................................
Gross margin.............................
Selling, general and administrative
expenses..............................
Operating income before pre-opening
expense and goodwill amortization.....
Pre-opening expense......................
Goodwill amortization....................
Operating income.........................
Interest expense.........................
Income from continuing retail operations
before retained interest and income
taxes.................................
Income before income taxes...............
Income taxes.............................
Net income related to retained interests
in Specialty Retail Groups(1).........
Net income...............................
Add back goodwill amortization...........
Less goodwill amortization...............
Kmart Corporation earnings attributable
to Group..............................
OTHER DATA:
Capital expenditures.....................
Depreciation and amortization............
End of year stores.......................
BALANCE SHEET DATA (END OF YEAR):
Working capital..........................
Total assets.............................
Total long-term obligations
-- Debt...............................
-- Capital leases.....................
Common equity............................
</TABLE>
- -------------------------
(1) Kmart Group's Retained Interest with respect to each Specialty Retail Group
is accounted for on the equity method and prior to any Offering or any
other issuance of any series of Specialty Retail Stock would represent 100%
of the Equity Value of such Specialty Retail Group.
20
<PAGE> 26
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 $225/8 $ .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 19 7/8 .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)................................. $ $ $
</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 -- Description of Kmart Stock and Specialty
Retail Stock -- Dividends".
21
<PAGE> 27
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 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)..............................
</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)........................................
</TABLE>
22
<PAGE> 28
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.
23
<PAGE> 29
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..............[ ]
24
<PAGE> 30
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..............[ ]
Also holds stock options exercisable for [ ] 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..............[ ]
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..............[ ]
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..............[ ]
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, The Scotts Company and Uniroyal Holding, Inc. 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..............[ ]
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..............[ ]
25
<PAGE> 31
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..............[ ]
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..............[ ]
Also holds stock options exercisable for [ ] 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.,
International Business Machines Corporation, 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..............[ ]
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., TBG, 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..............[ ]
Mr. Perkins also shares voting and investment power as to [ ] shares of
Existing Common Stock and [ ] $3.41 Depositary Shares representing
[ ] 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 ..............[ ]
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 ..............[ ]
Also holds stock options exercisable for [ ] shares.
26
<PAGE> 32
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, shares, or %, of the Existing Common
Stock of the Company (including shares owned by ). In addition,
certain officers had the right to acquire a total of shares within
60 days after March 1, 1994 through the exercise of stock options (including the
right of to acquire shares), and shares
voting and investment power as to shares of Existing Common Stock
and Depositary Shares, representing 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 shares or % of
Existing Common Stock, including % for , and would be
considered to beneficially own shares, or %, of Series A
Preferred Stock. ( disclaims beneficial ownership as to such
additional shares.) No other officer, director or nominee would be considered to
beneficially own over %.
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 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;
27
<PAGE> 33
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 the Directors Stock Plan, a director may elect to defer all or any portion
of his or her fee which is payable in cash or Existing Common Stock. Under these
Plans, deferred cash amounts earn interest at a rate equivalent to the ten-year
28
<PAGE> 34
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 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.
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 senior executive officers of the Company for services in
all capacities to the Company in fiscal 1991, 1992 and 1993.
<TABLE>
<CAPTION>
NAME AND
PRINCIPAL POSITION YEAR ANNUAL COMPENSATION LONG-TERM COMPENSATION
- ----------------------------------------------- ----- ------------------- ----------------------
<S> <C> <C> <C>
J. E. Antonini, ............................... 1991 $ $
Chairman of the Board, 1992
President and CEO 1993
</TABLE>
OPTION GRANTS IN FISCAL 1993. The following table shows all grants to the
named senior 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 in the
Compensation and Incentives Committee's Report below.)
NAME
- -----------------------------------------------
J. E. Antonini.................................
OPTION EXERCISES IN FISCAL 1993 AND OPTION VALUES AT FISCAL YEAR END. The
following table provides information as to options exercised by each of the
named senior executive officers in 1993 and the value of options held by such
executives at fiscal end measured in terms of the closing price of the Company's
Common Stock on January 26, 1994.
NAME
- -----------------------------------------------
J. E. Antonini.................................
LONG-TERM INCENTIVE PLAN AWARDS IN FISCAL 1993. The following table
describes the performance shares awarded under the Company's Performance
Restricted Stock Plan. The awards shown were granted under the Plan in 1993. The
awards cover a period of three years and specify a targeted number of shares of
Existing Common Stock for each year of the period which 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 which 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
29
<PAGE> 35
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.
<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........................
</TABLE>
EMPLOYEE PENSION PLANS. The Company's Employee Pension Plan, a defined
benefit plan qualified under the Internal Revenue Code, provides for the payment
of pension benefits upon retirement to employees of the Company or a subsidiary
to which the Plan has been extended who meet certain age and service
requirements. The Plan is non-contributory and provides pension credit on the
basis of compensation and service with full vesting after five years of service.
Benefits are 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 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.
An employee may elect an early retirement after attaining age 55 and
completing five years of service. In the event of an early retirement, the
amount of pension is reduced unless the sum of the employee's age and years of
service is at least 90 ("90 points" or "rule of 90" pension). The Plan also
permits various optional forms of pension payment and provides a disability
pension benefit if an active participant becomes totally and permanently
disabled after age 50 and completion of 10 years of service.
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 with respect to a pension to be paid only during the
lifetime of the retired employee is $574,291, as adjusted by any increase in the
urban consumer price index after January 1, 1994 to the date of retirement and
as reduced in the event of a survivor benefit or other optional form of pension
payment. The current ERISA maximum annual pension benefit is $115,641 for a
pension commencing at age 65.
The following table illustrates the estimated annual benefits payable under
the 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
30
<PAGE> 36
age 21 for those individuals named under Compensation of Officers herein are: J.
E. Antonini -- 29 years; ; ; ; and .
<TABLE>
<CAPTION>
FINAL AMOUNT OF PENSION FOR YEARS OF SERVICE SHOWN(2)
AVERAGE -----------------------------------------------
COMPENSATION(1) 20 YEARS 25 YEARS 30 YEARS 35 YEARS
- --------------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
$ 50,000...................... $ 15,000 $ 18,750 $ 22,500 $ 26,250
100,000...................... 30,000 37,500 45,000 52,500
200,000...................... 60,000 75,000 90,000 105,000
300,000...................... 90,000 112,500 135,000 157,500
400,000...................... 120,000 150,000 180,000 210,000
500,000...................... 150,000 187,500 225,000 262,500
600,000...................... 180,000 225,000 270,000 315,000
700,000...................... 210,000 262,500 315,000 367,500
800,000...................... 240,000 300,000 360,000 420,000
900,000...................... 270,000 337,500 405,000 472,500
1,000,000...................... 300,000 375,000 450,000 525,000
1,500,000...................... 450,000 562,500 574,291 574,291
2,000,000...................... 574,291 574,291 574,291 574,291
</TABLE>
- -------------------------
(1) Final Average Compensation is the average of the employee's five best
compensation years. Compensation covered by the Plans includes wages,
salary, incentive bonuses and commissions received from the Company or a
participating subsidiary. For the executive officers named under
Compensation of Officers herein, covered compensation includes their annual
salary and bonus as shown in that Table.
(2) 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 $8,127. Thus, the actual pension which an employee would receive
under the Plans at the time of retirement would be less than the amounts
shown.
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 approves as eligible to receive benefits under the
Plan. Benefits are determined by the Board 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.
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 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 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 7,400 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 officers named under
"Compensation of Officers" herein, as well as with the other executive
officers of the Company. These agreements, which are substantially similar,
provide that in the event of the officer's termination of employment under
certain circumstances following a "change in control" of the Company (as defined
in the agreements), the officer will be entitled to severance benefits.
31
<PAGE> 37
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 (36 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
will 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 Messrs. J. E. Antonini,
, , and were terminated in 1994
following a change in control of the Company, the total severance payments to
those persons under the agreements, as described in (i) above, would be
approximately $ net of income tax. In addition, the Company
has entered into an agreement with Mr. Mrkonic which provides that if his
employment is terminated by the Company other than for "cause" or "disability"
or if he terminates his employment for "good reason," he will be entitled to
receive severance payments equal to two times the sum of his annual base salary
at the time of termination, plus the annual on-plan bonus targeted for him for
the year in which termination occurred. These payments will be made in equal
monthly installments during a 24-month period following termination, and will be
reduced by the amount of compensation received by Mr. Mrkonic from other
employment after 12 months (he has an obligation to seek such other employment).
The Company estimates that if Mr. Mrkonic's employment were terminated in 1994
and severance payments were due him under this agreement, the total payments due
for the 24-month period (assuming no reduction for other employment) would be
approximately $ . In no event would Mr. Mrkonic receive
payments or benefits under both the change of control and severance agreements
described herein.
COMPENSATION AND INCENTIVES COMMITTEE REPORT
[To come.]
32
<PAGE> 38
Performance Graphs. Set forth below is a graph comparing the total returns
(assuming dividend reinvestment) of 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 , 1989.
[GRAPH]
33
<PAGE> 39
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;
- provide for the issuance of Common Stock in series by resolution of the
Board, of which 1.5 billion shares would initially be designated as Kmart
Stock, and the balance of which would be available for designation by the
Board as additional shares of Kmart Stock and/or any of four series of
Specialty Retail Stock, each such series having the designations, relative
rights, preferences and limitations described herein; and
- redesignate the Existing Common Stock as Kmart Stock.
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.
Upon the first 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
separately the 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 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. The timing, sequence and size of such
Offerings and the price at which such shares would be sold would be determined
by the Board at the time of each Offering based upon then prevailing market and
other conditions; however, it is currently contemplated that the Company would
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. 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
first 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
action by stockholders. Even after filing the Certificate of Amendment, the
Board could abandon one or more of the Offerings without further action by
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
34
<PAGE> 40
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 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 continue to 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 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; Fiduciary Duties. 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. See "Limited
Separate Stockholder Voting Rights; Effects on Voting Power" below. In addition,
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
35
<PAGE> 41
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. 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.
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 the Offerings and subsequent 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. Each of the foregoing
potential conflicts of interest is discussed below:
No Assurance of Payment of Dividends. 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 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, 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 Group Common Stock. At the
time of any sale of shares of any series of Specialty Retail Stock,
including sales in the Offerings, 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,
including sales in the Offerings, to the Kmart Group or to the relevant
Specialty Retail Group, in which event the net proceeds would be reflected
entirely in the financial
36
<PAGE> 42
statements of the Group to which such proceeds were allocated. 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 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 growth
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.
37
<PAGE> 43
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. 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. Such transfers would generally be
accounted for as short-term loans, unless the Board determined that any such
transfer should be accounted for as a long-term loan or, in the case of a
transfer of funds from the Kmart Group to a Specialty Retail Group, as an equity
contribution as described below. 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.
Notwithstanding these cash management policies, 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 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. 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. 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 each Group, the long-term business prospects for each Group, the
capital expenditure plans of the investment opportunities available to each
Group and the availability, cost and time associated with alternative financing
sources. Although the increase in the relevant Number of Shares Issuable with
Respect to 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
38
<PAGE> 44
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 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, but
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 would possess less than
a majority of the total 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 for an increase in the
number of authorized shares of Common Stock from 1.5 billion to 3.0 billion, of
which 1.5 billion would be designated Kmart Stock and 1.5 billion would be
available for designation as Kmart Stock and/or any 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
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
stockholder approval, to increase or decrease the number of shares in 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
authorized 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
39
<PAGE> 45
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.
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 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.
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 Offering would be intended to
represent approximately 20% to 30% of the Equity Value of the relevant Specialty
Retail Group. Whether or not the shares to be sold in any such Offering of a
series of Specialty Retail Stock are attributed to the Kmart Group's Retained
Interest in the relevant Specialty Retail Group, the Kmart Group's percentage
interest in the relevant Specialty Retail Group would be reduced. In addition,
any other issuance of any series of Specialty Retail Stock for the account of
the Kmart Group would 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. 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
40
<PAGE> 46
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 separately the 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 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 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.
41
<PAGE> 47
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.
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
42
<PAGE> 48
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 income from continuing retail
operations before Retained
Interests....................... $ -- -- -- --
Net income related to Retained
Interests in Specialty Retail
Groups.......................... (a) -- -- -- --
Net income........................ $ $ $ $
Add back of goodwill
amortization(b)................. --
Less goodwill amortization(c)..... -- -- -- --
Kmart Corporation earnings
attributable to Group...........
Outstanding Interest Fraction..... -- 25% 25% 25% 25%
Kmart Corporation earnings
attributable to outstanding
stock of Group.................. $ $ $ $ $
</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 of the Specialty Retail Groups prior to the adjustment
described in note (c) below.
(b) Adjusts net income 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 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 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 issuance of each series of Specialty Retail
Stock, cash management and allocation of principal corporate
43
<PAGE> 49
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.
(ii) 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
the excess cash to the Kmart Group. Such transfers would generally be
accounted for as short-term loans, unless the Board determined that any
such transfer should be accounted for as a long-term loan or, in the case
of a transfer of funds from the Kmart Group to a Specialty Retail Group, as
an equity contribution as described below.
(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. 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.
(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 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.
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.
44
<PAGE> 50
(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 issuance of
the relevant series of Specialty Retail Stock. In the historical financial
statements 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.
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 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 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
45
<PAGE> 51
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 issuance of any series of Specialty Retail Stock,
the Articles would be amended to authorize the issuance 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
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 $ ,
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
46
<PAGE> 52
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 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
47
<PAGE> 53
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.................... (1) (2) --
Borders-Walden Group........... 25%
Builders Square Group.......... 25%
OfficeMax Group................ 25%
The Sports Authority Group..... 25%
</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 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.
48
<PAGE> 54
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 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
49
<PAGE> 55
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 and 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 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.
50
<PAGE> 56
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
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.
51
<PAGE> 57
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 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 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
52
<PAGE> 58
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 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
53
<PAGE> 59
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; and provided further
that, 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 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
54
<PAGE> 60
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.
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 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
55
<PAGE> 61
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.
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.
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
56
<PAGE> 62
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.
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, including sales in the Offerings, 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. 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 and the allocation of the net proceeds of such Offering
between the Kmart Group and the relevant Specialty Retail Group 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. The relevant Number of Shares
Issuable with Respect to Retained Interest of the Kmart Group in such Specialty
Retail Group would be reduced if the net proceeds of an Offering were allocated
to the Kmart Group's Retained Interest in such Specialty Retail Group. If the
net proceeds of an Offering were not allocated to the Kmart Group, the relevant
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.
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
57
<PAGE> 63
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 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.
58
<PAGE> 64
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. Beginning in June 1993, the Board
began consideration of whether the Company would benefit from a capital
structure that included the issuance of "targeted stock" that is intended to
reflect separately the performance of each of the Specialty Retail Groups. At
meetings held between June and December 1993, the Board received reports from
management on its analysis of the targeted stock proposal and considered the
adoption of a targeted stock program. The Board authorized management to
continue to explore the possible adoption of such a program 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 and provide the Company greater flexibility with regard
to raising capital and structuring employee incentive plans with an equity
security related specifically to each of the Company's businesses. At the same
time, the proposal enables the Company to retain operational control over the
Specialty Retail Groups and enables each of the Company's businesses to retain
the benefits of being part of a single consolidated entity.
The Board believes that public offerings of four new series of Kmart
Corporation common stock enable the Company to achieve many of the benefits that
would be achieved by public offerings of stock of the Specialty Retail
Subsidiaries, such as the ability to raise capital through the Offerings and
through subsequent offerings and to make acquisitions, but without sacrificing
the advantages of maintaining a single consolidated entity, such as avoiding the
incremental increase in administrative costs that would result from the creation
of five separate companies and enjoying lower borrowing costs than would be
incurred by five separate entities. The Board also believes there will be
additional benefits, such as the ability to file consolidated tax returns.
In arriving at its recommendation and its determination that the Specialty
Retail Stock Proposal is in the best interests of the Company, the Board
considered carefully 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 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. The Board believes that each
series of Specialty Retail Stock 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.
In connection with its consideration of the Specialty Retail Stock
Proposal, the Board also evaluated the potential negative aspects of a targeted
stock program, 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 fact that implementation of a targeted stock plan
would, to a certain extent, make the capital structure of the Company more
complex and require additional disclosure to be made with respect to each of its
Specialty Retail Groups. The Board determined, however, that the positive
aspects of the Specialty Retail Stock
59
<PAGE> 65
Proposal outweighed any negative aspects and concluded that the Specialty Retail
Stock Proposal is in the best interests of the Company.
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. In
connection therewith, 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
therewith, the Company has paid Lehman Brothers $1.0 million for its services
and will pay Lehman Brothers an additional $1.0 million if the Specialty Retail
Stock Proposal is approved by the Company's 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.
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 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
60
<PAGE> 66
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.
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.
61
<PAGE> 67
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 II-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) has
been filed with the Securities and Exchange Commission (the "Commission") as an
Exhibit to this Proxy Statement and is incorporated herein by reference. 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 Restated Rights Agreement and the
Rights Agreement.
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
62
<PAGE> 68
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 CONDUCT 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 will 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 may be relevant to a stockholder in light of such stockholder's
particular tax circumstances and does not apply to certain types of stockholders
who may 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 MAY BE SUBJECT.
Existing Common Stock Redesignation. In the opinion of counsel, the
Kmart Stock will be common stock of the Company for Federal income tax
purposes, and the stockholders will not recognize income, gain or loss on
the Existing Common Stock Redesignation. The basis of the Existing Common
Stock will be carried over to the Kmart Stock and the holding period of the
Kmart Stock will include the holding period of the Existing Common Stock,
assuming that the Common Stock was a capital asset in the hands of the
stockholder on the date on which the Existing Common Stock Redesignation
became effective.
Although it is counsel's opinion that the Existing Common Stock
Redesignation will 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 Stocks. 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 will not issue any advance rulings regarding such
stock. It is possible, therefore, that the Service may claim that the Kmart
Stock or the Specialty Retail Stocks represent property other than stock of
the Company.
Sale or Exchange of Kmart Stock. Upon the taxable sale or exchange of
the Kmart Stock, a stockholder will recognize gain or loss equal to the
difference between (i) any cash received plus the fair
63
<PAGE> 69
market value of any other consideration received, and (ii) the tax basis of
the stock sold or exchanged. Such tax basis will be determined as described
in "Existing Common Stock Redesignation" above.
The excess of net long-term capital gains over net short-term capital
loss may 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
will 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, will 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 will 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 will 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 is effectively connected with a United
States trade or business of the United States Alien, (B) the United States
Alien is an individual who was present in the United States for a period or
periods of 183 days or more during the taxable year and certain other
conditions are met or (C) the stock sold or exchanged is 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 States Alien held such stock,
whichever time is shorter. The Kmart Stock will 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 is shorter, the Company
is 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 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 may be
subject to backup withholding at a rate of 31% on the payment of dividends
on such stock. Backup withholding will apply only if the holder (i) fails
to furnish its Taxpayer Identification Number ("TIN"), which, for an
individual, would be his Social Security number, (ii) furnishes an
incorrect TIN, (iii) is notified by the Service that it has failed to
properly report payments of interest or dividends, or (iv) under certain
circumstances, fails to certify under penalties of perjury that it has
furnished a correct TIN and has been notified by the Service that it is
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 the
Kmart Stock will be allowed as a credit against such stockholder's Federal
income tax liability and may entitle such stockholder to a refund, provided
that the required information is furnished to the Service.
Tax Implications to the Company. In the opinion of counsel, the Kmart Stock
and each series of Specialty Retail Stock will be Common Stock of the Company
and no gain or loss will be recognized by the
64
<PAGE> 70
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 may 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 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.
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
65
<PAGE> 71
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, ninety 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 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 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 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.
66
<PAGE> 72
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. The ability of the Board to make such
determinations with respect to future issuances of Preferred Stock, however,
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 THE AMENDMENTS TO THE ARTICLES MADE BY THIS 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.
67
<PAGE> 73
(This page intentionally left blank)
68
<PAGE> 74
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 THE AMENDMENTS TO THE ARTICLES MADE BY THIS 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.
69
<PAGE> 75
(This page intentionally left blank)
70
<PAGE> 76
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-G hereto. 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. Each Group's Section 423 Plan is designed to
encourage the purchase by a broad base of employees of the series of Specialty
Retail Stock relating to their Group. Each Section 423 Plan is intended to
comply with the requirements of Section 423 of the Code, and to assure the
participants of the tax advantages provided thereby (as described below in the
section entitled "Certain Federal Income Tax Consequences"). 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
subsidiaries of the Company are referred to herein as "employees" of the
indicated Group:
<TABLE>
<CAPTION>
SUBSIDIARY OF COMPANY SPECIALTY RETAIL GROUP
----------------------------- ---------------------------
<S> <C>
Borders, Inc. and
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 approximately employees who are
potential participants in the four Section 423 Plans, none of whom are currently
officers or directors of the Company or the Company's subsidiaries. The
description of each Section 423 Plan set forth herein is qualified in its
entirety by reference to the text of such Section 423 Plan.
ADDITIONAL INFORMATION REGARDING EACH SECTION 423 PLAN
Since the amount of benefits to be received by each participant is
determined by his or her elections, 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 which would have been
received by or allocated to any individual or group of individuals for fiscal
1993 if each Section 423 Plan had been in effect is not determinable.
DESCRIPTION OF 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 each Group's employees and
to enable such employees to develop and maintain ownership of the series of
Specialty Retail Stock relating to their 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 section entitled "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.
71
<PAGE> 77
Participation. Subject to certain procedural requirements, all employees of
each Specialty Retail Group who have at least one year of service and work more
than 20 hours per week would be eligible to participate in such 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. Designations of corporations participating
in a particular Section 423 Plan could be made from time to time by the
Committee from among the subsidiary corporations of the Company, including
corporations which become subsidiaries after the adoption and approval of such
Section 423 Plan.
Purchase of Shares. Pursuant to each Section 423 Plan, each eligible
employee would be permitted to purchase shares of the relevant series of
Specialty Retail Stock through regular payroll deductions equal to 2% to 10% of
the employee's base pay (as elected by the employee) for each payroll period
(and/or additional cash payments). Under each Section 423 Plan, the fair market
value of stock which could be purchased by any employee during any calendar year
could not exceed $25,000.
Stock Purchase Price. Participating employees would be able to purchase
shares of the series of Specialty Retail Stock relating to their Group with
payroll deductions (and/or cash payments) at the end of each quarter at a
purchase price equal to the lesser of: (i) 85 percent of the fair market value
of the relevant series of Specialty Retail Stock on the date the quarter begins
or (ii) 85 percent at the fair market value of the relevant series of Specialty
Retail Stock on the date the quarter ends.
Stock Subject to Each Section 423 Plan. The number of shares of each series
of Specialty Retail Stock which would be under the related Section 423 Plan,
upon the initial issuance of shares of such series, would be the number of
shares resulting from multiplying
(i) the sum of (x) the number of shares of each series outstanding
immediately after the initial issuance and (y) the Number of Shares
Issuable with Respect to Retained Interest in the related Specialty Retail
Group immediately after such issuance by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
SECTION 423 PLAN PERCENTAGES
--------------------------------------------------------- -----------
<S> <C>
Borders-Walden Group..................................... %
Builders Square Group.................................... %
OfficeMax Group.......................................... %
The Sports Authority Group............................... %
</TABLE>
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. Such shares could be either authorized and unissued
shares or shares which had been reacquired by the Company for the account of the
Group. 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 applicable Section 423 Plan.
Nontransferable Right to Purchase. A 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.
Term. No right to purchase shares could be granted under any Section 423
Plan with respect to any fiscal year after fiscal 2004. Rights to purchase
shares which would be granted before or during fiscal 2004, however, could
extend beyond the end of fiscal 2004, and the provisions of the relevant Section
423 Plan would continue to apply thereto.
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 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
72
<PAGE> 78
could be effective without the approval of stockholders entitled to vote
thereon. Additionally, the Board 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. Accordingly, a participant should consult a tax adviser
with respect to the tax aspects of transactions under the relevant Section 423
Plans.
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 shares 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 and (ii) one year after the exercise date for the related
purchase right (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 disposition 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 over its purchase price, and (ii) 15% of the market
value of the disposed share on the grant date for the option to which such
disposed share relates. In the case of a Qualifying Transfer, (a) the basis of
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 shares and the basis (as so
increased) for such shares.
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 such event, 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 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.
73
<PAGE> 79
(This page intentionally left blank)
74
<PAGE> 80
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"), which was adopted by the
Board on December 16, 1991 and approved by stockholders 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
, 1994, the shares of Existing Common Stock issued under the
Directors Plan were held by ten Directors.
DESCRIPTION OF AMENDMENTS TO DIRECTORS PLAN
On , the Board approved certain amendments to the Directors
Plan (the "Directors Plan Amendments"), as described herein and in Annex IV-B
hereto, subject to approval of this Proposal by stockholders, as well as
approval by stockholders and 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 herein is qualified in its entirety by
reference to the text of such Amendments.
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 the 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) by the aggregate Market Capitalization of all then
outstanding series of Common Stock.
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 April , 1994, the market value of Existing Common Stock which would
be available for awards under the Directors Plan was approximately $
(based upon the closing price of the Existing Common Stock on the NYSE Composite
Transactions 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 Securities Exchange Act of
1934 as amended.
Administration. The Directors Plan is administered by the Compensation and
Incentives Committee of the Board of Directors (the "Committee") which is
comprised solely of non-employee Directors. The
75
<PAGE> 81
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. As of , 1994, shares
of Existing Common Stock remain available for issuance under the Directors Plan.
If a series of Specialty Retail Stock is issued by the Company, the Existing
Common 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
resulting from multiplying
(i) the sum of (x) the number of shares of each such series
outstanding immediately after the initial issuance and (y) the Number of
Shares Issuable with Respect to Retained Interest in the related Specialty
Retail Group immediately after such issuance by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGES
----------
<S> <C>
Borders-Walden Stock...................................... %
Builders Square Stock..................................... %
OfficeMax Stock........................................... %
The Sports Authority Stock................................ %
</TABLE>
The number of such shares will be subject to adjustment by the Committee in
the event of a recapitalization, stock split, stock dividend or similar
corporate transaction. Such shares can 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 Directors
Plan.
Delivery or Deferral of Stock. For each calendar year prior to
implementation of the Specialty Retail Stock Proposal, each Director would
receive 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 would (unless deferred) be 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 each series of Common Stock on the
last business day preceding the Normal Stock Payment Date. After the initial
issuance of 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 is 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. Such percentage will 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.
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 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.
76
<PAGE> 82
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 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.
77
<PAGE> 83
(This page intentionally left blank)
78
<PAGE> 84
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 hereto. The Performance Plan was previously adopted
by the Board, 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 (herein, "Participants") of Performance Plan
awards. As of , 1994, the restricted shares of Existing Common Stock
issued under the Performance Plan were held by employees, of whom are
currently officers or directors. However, if the Specialty Retail Stock Proposal
is approved by stockholders and fully implemented by the Board, the Company does
not currently intend to make any additional awards thereunder. 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 , 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 into awards of restricted shares of various series of Specialty
Retail Stock, subject to approval of this Proposal by stockholders, as well as
approval of stockholders and 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.
It is expected that (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 restricted shares of Kmart Stock under the Performance
Plan into restricted shares of the series of Specialty Retail Stock which
relates to such Participant's Group, such conversion to take effect upon the
initial issuance of such series, and (ii) a Participant who is an employee of
the Kmart Group with responsibilities which include one or more Specialty Retail
Groups would be given an opportunity to convert a percentage of his or her
outstanding awards of restricted shares of Kmart Stock issued under the
Performance Plan into restricted shares of the various series of Specialty
Retail Stock, such conversion to take effect upon its or their respective
initial issuances. The aggregate percentage to be converted, and the particular
percentages attributable 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 and Kmart Stock.
The converted restricted shares would otherwise be subject to the same
terms (including the date the restrictions lapse) as the outstanding restricted
shares, except that the series of Common Stock 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 restricted shares originally
awarded.
STOCK SUBJECT TO PERFORMANCE PLAN
As of , 1994, shares of Existing Common Stock remain
available for issuance under the Performance Plan. If a series of Specialty
Retail Stock is issued by the Company, the Existing Common Stock would
automatically be redesignated as Kmart Stock. The Performance Plan Amendment
provides that the
79
<PAGE> 85
number of shares of each issued series of Specialty Retail Stock which would be
made available for issuance under the Performance Plan would be the number of
shares resulting from multiplying
(i) the sum of (x) the number of shares of each such series
outstanding immediately after such issuance and (y) the Number of Shares
Issuable with Respect to Retained Interest in the related Specialty Retail
Group immediately after such issuance by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGES
-----------
<S> <C>
Borders-Walden Stock....................................... %
Builders Square Stock...................................... %
OfficeMax Stock............................................ %
The Sports Authority Stock................................. %
</TABLE>
The number of such shares will be subject to adjustment by the Committee in
the event of a recapitalization, stock split, stock dividend or similar
corporate transaction. Such shares can 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 Performance
Plan.
ADDITIONAL INFORMATION REGARDING PERFORMANCE PLAN
The number of restricted shares for various series of Specialty Retail
Stock which can be issued in conversion of currently outstanding restricted
shares cannot be estimated by the Company, since any such conversions would be
made at the request of the individual Participants. No awards were made under
the Performance Plan in fiscal 1993 to executives of the Specialty Retail
subsidiaries. As of , 1994, there were restricted
shares of Existing Common Stock outstanding under the Performance Plan. The
aggregate market value of such shares was approximately $ (based upon the
closing price of the Existing Common Stock on the NYSE Composite Transactions
Tape on such date).
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
original awards would thereafter be granted under the Performance Plan. It is
proposed only, upon such approvals and such implementation, to provide an
opportunity to certain Participants to convert all or a portion of their
outstanding awards of restricted shares of Kmart Stock under the Performance
Plan into restricted shares of the series of stock of the related Specialty
Retail Group to which the Participant is assigned or the Specialty Retail Groups
for which the Participant has responsibilities. The converted restricted shares
would otherwise have the same terms and restrictions (including the date the
restrictions lapse) of the outstanding awards, except that the series of
restricted 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 restricted 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.
80
<PAGE> 86
FEDERAL INCOME TAX CONSEQUENCES
Information with respect to the Federal income tax consequences of certain
restricted stock transactions is set forth in Proposal 11 under the heading
"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 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.
81
<PAGE> 87
(This page intentionally left blank)
82
<PAGE> 88
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"), which plans were adopted by the Board and approved by
stockholders and became effective on June 22, 1973, and May 25, 1981,
respectively. The Company's ability to grant options under the 1973 Plan and the
1981 Plan expired on , 1983 and August 17, 1991, respectively.
These Plans are 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 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
an NQSO may not exceed ten years and two days and the maximum term of an ISO may
not exceed ten years. As of April , 1994, the expiration dates of the options
outstanding under these Plans range from to [July 31, 2001]. As of
, 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 , the Board approved an amendment to each of the 1973 and
1981 Plans, as described herein and in Annex IV-C hereto (the "1973 Plan
Amendment" and the "1981 Plan Amendment," respectively), to permit certain
optionees to convert part or all of their outstanding options for Kmart Stock
(the redesignated Existing Common 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 first 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 Amendments.
It is expected that (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 Kmart Stock under the 1973 and 1981 Plans (other than
ISOs) into options for the series of Specialty Retail Stock of the optionee's
Group 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 which 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 Kmart Stock into
options for the various series of Specialty Retail Stock with any such
conversion to take effect upon its or their respective 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 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 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.
83
<PAGE> 89
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. If a series of Specialty Retail Stock is
issued, the Existing Common Stock underlying any outstanding options granted
under the 1973 and 1981 Plans would automatically be redesignated as Kmart
Stock. 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 under the
respective Plans would be the number of shares resulting from multiplying
(i) the sum of (x) the number of shares of each such series
outstanding immediately after such issuance and (y) the Number of Shares
Issuable with Respect to Retained Interest in the related Specialty Retail
Group immediately after such issuance by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
1973 PLAN 1981 PLAN
--------- ---------
<S> <C> <C>
Borders-Walden Stock.............................
Builders Square Stock............................
OfficeMax Stock..................................
The Sports Authority Stock.......................
</TABLE>
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. Such shares can 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 either of the
Plans.
ADDITIONAL INFORMATION REGARDING 1973 AND 1981 PLANS
No future original grants of options would be made under the 1973 and 1981
Plans. The number of options for various series of Specialty Retail Stock which
can be issued in conversion of currently outstanding options cannot be estimated
by the Company, since any such conversions will be made at the request 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 [April , 1994,] there were options for
shares of Existing Common Stock outstanding under the 1973 Plan and options for
shares of Existing Common Stock outstanding under the 1981 Plan [at an average
option price per share of $ ]. The aggregate market value of such shares was
approximately $ (based upon the closing price of the Existing Common Stock
on the NYSE Composite Transactions Tape on such date).
DESCRIPTION OF 1973 AND 1981 PLANS AS PROPOSED TO BE AMENDED
As discussed above, no new options to purchase Existing Common Stock will
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
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.
84
<PAGE> 90
FEDERAL INCOME TAX CONSEQUENCES
Information with respect to the Federal income tax consequences of certain
option transactions is set forth in Proposal 9 under the heading "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.
85
<PAGE> 91
(This page intentionally left blank)
86
<PAGE> 92
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"), which was adopted by the Board
on January 21, 1992 and approved by stockholders 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 Company estimates
that there are approximately such 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.
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. 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. 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
, 1994, options for Existing Common Stock granted under the 1992 Plan
were held by employees; of whom are currently officers or directors.
Amendment Providing for Issuance of 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-D 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 implemented by the Board, it is
anticipated that generally (i) an employee of the related Specialty Retail Group
who is eligible to be granted options under the 1992 Plan will be granted only
options for the relevant series of Specialty Retail Stock, and (ii) an employee
of the Kmart Group with responsibilities which include one or more related
Specialty Retail Groups and who is eligible to be granted options under the 1992
Plan will be granted options for both shares of Kmart Stock and shares of one or
more issued series 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 will be
permitted to convert part or all of their pre-January 18, 1994 options for Kmart
Stock (other than any ISOs) into options for the various issued series of
Specialty Retail Stock. The converted options will generally have the same terms
(including the expiration date) of the outstanding options, except that the
underlying series of Common Stock will be changed and the number of shares and
the exercise price will 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.
87
<PAGE> 93
More specifically, it is expected that (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 Kmart Stock (other than any ISOs) under the 1992
Plan into options for the series of Specialty Retail Stock which relates to such
optionee's Group upon the initial issuance of such series, and (ii) an optionee
who is an employee of the Kmart Group, whose responsibilities include one or
more Specialty Retail Groups, would be given an opportunity to convert a
percentage of his or her options under the 1992 Plan for Kmart Stock (other than
ISOs) into options for the various series of Specialty Retail Stock upon their
respective initial issuances.
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 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) any such options of such an employee of the Kmart Group with
responsibilities for one or more of the Specialty Retail Groups would
automatically partially convert into options for the various series of Specialty
Retail Stock upon their respective initial issuances.
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 persons) received option grants covering shares of Existing Common Stock
(with a weighted average exercise price of $ per share) and all eligible
employees as a group (consisting of persons) received option grants covering
shares of Existing Common Stock (with a weighted average exercise price of $
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 , 1994, the market
value of Existing Common Stock underlying all outstanding and unexercised
options granted under the 1992 Plan was approximately $ (based upon the closing
price of the Existing Common Stock on the NYSE Composite Transactions 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 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 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. As of , 1994, there are shares of
Existing Common Stock remaining that may be subject to options or 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
88
<PAGE> 94
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
would be the number of shares resulting from multiplying
(i) the sum of (x) the number of shares of each such series
outstanding immediately after such issuance and (y) the Number of Shares
Issuable with Respect to Retained Interest in the related Specialty Retail
Group immediately after such issuance by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock................... %
Builders Square Stock.................. %
OfficeMax Stock........................ %
The Sports Authority Stock............. %
</TABLE>
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. Such shares can 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 1992 Plan.
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.
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 will consider 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 first issuance of a 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 which include one or more 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 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
89
<PAGE> 95
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
options for Kmart Stock under the 1992 Plan into options for the series of
Specialty Retail Stock of the optionee's Group, with any such conversion to take
effect upon the initial issuance of such series. 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 fair market value of the
shares of Kmart Stock underlying the original option, as of the date of
conversion, 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 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.
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 one or more 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 may be 100
percent in the case of an employee of a Specialty Retail Group) of any such
options would automatically convert into options for the series of Specialty
Retail Stock issued in respect of the related Specialty Retail Group or Groups
for which the optionee has responsibilities with respect to Kmart Group
employees with responsibilities for one or more Speciality Retail Groups, such
percentage 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. 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 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 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.
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
90
<PAGE> 96
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 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
91
<PAGE> 97
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.
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. Approval of Proposal 9 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.
92
<PAGE> 98
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 adding certain
allocation provisions to the 1992 Stock Option Plan (the "1992 Plan"). The 1992
Plan was adopted by the Board, and approved by stockholders, on May 27, 1992.
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 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 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), method of exercise and the term during which the option
may be exercised. 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, as
described herein and in Annex IV-F hereto (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.
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
93
<PAGE> 99
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 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 retains its discretion as to the timing and amount of
particular grants, and the establishment of the Maximum Annual Grant Limit set
forth above does not obligate 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
Certain additional information regarding the 1992 Plan is set forth in
Proposal 9 under the heading "Additional Information Regarding 1992 Plan".
A description of the 1992 Plan is set forth in Proposal 9.
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.
94
<PAGE> 100
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 hereto. The Stock Purchase Plan was adopted by the Board on
, 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.
As described in Proposal 12, the Company's Annual Incentive Bonus Plan (the
"Annual Bonus Plan") requires that part of a participant's annual incentive
bonus be used to purchase restricted stock issued in accordance with the terms
and conditions of the Stock Purchase Plan and permits participants to elect that
up to the entire amount of any annual incentive bonus be so used. 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 by the Committee will be required to use a minimum of 20 percent of
their annual incentive bonus, if any, to purchase restricted Common Stock. At
the election of each participant, he or she can use up to 100 percent of any
annual incentive bonus to purchase such restricted stock. The Company estimates
that there are approximately employees who are potential participants,
of whom are currently officers or directors of the Company.
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, then, upon the initial issuance of any of the various
series of Specialty Retail Stock, participants who are employees of the related
Specialty Retail Group and employees of Kmart Group with responsibilities for
one or more Specialty Retail Groups will be given certain opportunities
(described below) 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.
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.
95
<PAGE> 101
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 under the Stock
Purchase Plan would be the number of shares resulting from multiplying
(i) the sum of (x) the number of shares of each such series
outstanding immediately after the initial issuance and (y) the Number of
Shares Issuable with Respect to the Retained Interest in the related
Specialty Retail Group immediately after such issuance by
(ii) the applicable percentage set forth below:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
Borders-Walden Stock...................................... %
Builders Square Stock..................................... %
OfficeMax Stock........................................... %
The Sports Authority Stock................................ %
</TABLE>
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. Such shares can 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 the next to last
sentence of 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 will
be automatically redesignated as Kmart Stock upon the initial issuance of any
series of Specialty Retail Stock). Following approval by stockholders and
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 will 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 various 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.
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 of any annual incentive bonus to
purchase restricted shares of Existing Common Stock, and following approval by
stockholders and implementation by the Board of the Specialty Retail Stock
Proposal and initial issuance of the relevant series of Specialty Retail Stock,
to purchase such series of Common Stock of their related Group at the stock's
fair
96
<PAGE> 102
market value. At the election of each participant, he or she can use up to 100
percent of any annual incentive bonus to purchase such restricted shares. Any
such election 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.
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
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 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 stock. The participant must pay at the time of purchase, in
cash, 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 and/or salary to the purchase cost.
For each share of 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 may 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.
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 issuance 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 various
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 shares of all
issued series of Specialty Retail 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.
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, 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 and/or salary to the purchase cost.
Price of Restricted Stock. The price of the restricted stock being
purchased under the Stock Purchase Plan, for purposes of determining the number
of shares to be issued, would be their fair market value. For
97
<PAGE> 103
purposes of the Stock Purchase Plan, the "fair market value" of the Existing
Common Stock, and, subsequently, each issued series of Common Stock, will 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, net of 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
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 be automatically converted into restricted shares of such series of
Specialty Retail Stock upon the initial issuance of such series of stock. If a
participant who is an employee of the Kmart Group who has responsibilities for
one or more of the Specialty Retail Groups purchased such restricted shares of
Existing Common Stock prior to the 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 conversion would be based on the aggregate fair market value of the
Existing Common Stock on the date of grant 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 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 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; Forfeiture of Restricted Stock. The restricted period
for restricted stock purchases 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 at the time 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 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 (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 restricted shares at the time of their purchase.
Payment of Withholding Taxes. The Committee can, 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 optionee delivering other shares of Existing
Common Stock (or, after the first 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.
98
<PAGE> 104
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.
Restricted Stock. 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.
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.
99
<PAGE> 105
(This page intentionally left blank)
100
<PAGE> 106
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 hereto. The Annual Bonus Plan was unanimously adopted by the Board on March
15, 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 employees who are
potential participants in the Annual Bonus Plan, of whom are currently
officers or directors 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 would be Plan.
ADDITIONAL INFORMATION REGARDING THE 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 persons) received annual
incentive bonuses aggregating $ , and all eligible employees as a group
(consisting of persons) received annual incentive bonuses aggregating $
.
DESCRIPTION OF ANNUAL BONUS PLAN
The following is a description of the proposed Annual Bonus Plan.
101
<PAGE> 107
Purpose. The purpose of the Annual Bonus Plan would be 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 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 would be administered by the
Committee which is comprised solely of non-employee 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 would 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. However, as
described in the Compensation and Incentive Committee Report in this Proxy
Statement, the Committee has reserved the discretion to award a separate annual
incentive bonus to an employee in unusual circumstances when the Committee
determines that the bonus payable pursuant to the Annual Bonus Plan does not
adequately reward the employee. To the extent the provisions of Section 162(m)
of the Code would make such a discretionary bonus nondeductible by the Company,
the payment of any such bonus will be mandatorily deferred until such time as
Section 162(m) no longer prevents its deductibility.
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
operations, Super Kmart Centers or any Specialty Retail subsidiary, or any
combination of the foregoing. 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 that goals
with respect to fiscal 1994 can be established at any time prior to April 1,
1994.
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 salary
midpoint 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 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.
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
102
<PAGE> 108
(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.
103
<PAGE> 109
(This page intentionally left blank)
104
<PAGE> 110
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 A MAJORITY OF THE
OUTSTANDING SHARES OF EXISTING COMMON STOCK, SERIES A PREFERRED STOCK AND SERIES
B PREFERRED STOCK, VOTING TOGETHER AS ONE CLASS.
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.
105
<PAGE> 111
ANNEX I
GLOSSARY OF CERTAIN TERMS
<TABLE>
<CAPTION>
PAGE ON WHICH TERM
IS DEFINED IN THE
TERM PROXY STATEMENT
- ------------------------------------------------------------------------ ------------------
<S> <C>
Affected Group.......................................................... 13
Affected Stock.......................................................... 13
Articles................................................................ 6
Available Dividend Amount............................................... 46
Board................................................................... 6
Borders-Walden Group.................................................... 6
Borders-Walden Stock.................................................... 6
Builders Square Group................................................... 6
Builders Square Stock................................................... 6
Certificate of Amendment................................................ 7
Certificate of Designation.............................................. 6
Code.................................................................... 63
Commission.............................................................. 62
Common Stock............................................................ 1
Company................................................................. 1
Convertible Securities.................................................. Annex III-A-11
Depositary Shares....................................................... 1
Disposition............................................................. 49
Equity Value............................................................ 7
Exchange Act............................................................ 54
Existing Common Stock................................................... 1
Existing Common Stock Redesignation..................................... 63
Fair Market Value....................................................... 53
Group Subsidiary........................................................ 51
Groups.................................................................. 7
Incumbent............................................................... 24
Kmart Corporation Earnings Attributable to a Specialty Retail Group..... 47
Kmart Corporation Earnings Attributable to the Kmart Group.............. 47
Kmart Group............................................................. 7
Kmart Stock............................................................. 6
Market Capitalization................................................... Annex III-A-12
Market Value Ratio...................................................... Annex III-A-3
Market Value............................................................ Annex III-A-12
MBCA.................................................................... 12
Net Proceeds............................................................ 49
Number of Shares Issuable with Respect to Retained Interest............. 14
Nominee................................................................. 24
Offerings............................................................... 7
OfficeMax Group......................................................... 6
OfficeMax Stock......................................................... 6
Outstanding Interest Fraction........................................... 14
Preferred Stock......................................................... 45
Restated Rights Agreement............................................... 60
Retained Interest....................................................... 7
Retained Interest Fraction.............................................. 14
Rights Agreement........................................................ 60
</TABLE>
I-1
<PAGE> 112
<TABLE>
<CAPTION>
PAGE ON WHICH TERM
IS DEFINED IN THE
TERM PROXY STATEMENT
- ------------------------------------------------------------------------ ------------------
<S> <C>
Series A Conversion Date................................................ 13
Series A Preferred Stock................................................ 1
Series A Junior Preferred Stock......................................... 45
Series B Preferred Stock................................................ 1
Service................................................................. 63
Specialty Retail Groups................................................. 7
Specialty Retail Stock Proposal......................................... 7
Specialty Retail Stock.................................................. 6
The Sports Authority Group.............................................. 7
The Sports Authority Stock.............................................. 6
Trading Day............................................................. Annex III-A-16
</TABLE>
I-2
<PAGE> 113
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> 114
- 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> 115
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> 116
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> 117
- 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> 118
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> 119
- 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> 120
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> 121
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.
II-9
<PAGE> 122
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> 123
(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> 124
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> 125
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> 126
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 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> 127
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> 128
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
III-A-7
<PAGE> 129
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
III-A-8
<PAGE> 130
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
III-A-9
<PAGE> 131
(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
III-A-10
<PAGE> 132
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
III-A-11
<PAGE> 133
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
III-A-12
<PAGE> 134
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
III-A-13
<PAGE> 135
(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
III-A-14
<PAGE> 136
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
III-A-15
<PAGE> 137
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 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
III-A-16
<PAGE> 138
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."
III-A-17
<PAGE> 139
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."
* * *
III-B-1
<PAGE> 140
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."
* * *
III-C-1
<PAGE> 141
ANNEX IV-A
PROPOSAL 5 -- ADOPTION OF EMPLOYEE
STOCK PURCHASE PLAN FOR EACH
SPECIALTY RETAIL GROUP
[To come.]
IV-A-1
<PAGE> 142
ANNEX IV-B
PROPOSAL 6 -- AMENDMENTS TO DIRECTORS
STOCK PLAN RELATING TO ISSUANCE
OF OUTSTANDING SERIES OF SPECIALTY
RETAIL STOCK
[To come.]
IV-B-1
<PAGE> 143
ANNEX IV-C
PROPOSAL 7 -- AMENDMENTS TO PERFORMANCE
RESTRICTED STOCK PLAN RELATING TO
SUBSTITUTION OF OUTSTANDING SERIES
OF SPECIALTY RETAIL STOCK FOR CERTAIN
OUTSTANDING AWARDS OF EXISTING COMMON STOCK
[To come.]
IV-C-1
<PAGE> 144
ANNEX IV-D
PROPOSAL 8 -- AMENDMENTS TO 1973 AND 1981
STOCK OPTION PLANS RELATING TO SUBSTITUTION
OF OUTSTANDING SERIES OF SPECIALTY RETAIL
STOCK FOR EXISTING COMMON STOCK ISSUABLE
UPON EXERCISE OF CERTAIN OUTSTANDING OPTIONS
[To come.]
IV-D-1
<PAGE> 145
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
[To come.]
IV-E-1
<PAGE> 146
ANNEX IV-F
PROPOSAL 10 -- AMENDMENTS TO 1992 STOCK OPTION
PLAN RELATING TO ADDING CERTAIN
ALLOCATION PROVISIONS
[To come.]
IV-F-1
<PAGE> 147
ANNEX IV-G
PROPOSAL 11 -- ADOPTION OF MANAGEMENT STOCK
PURCHASE PLAN
[To come.]
IV-G-1
<PAGE> 148
ANNEX IV-H
PROPOSAL 12 -- ADOPTION OF ANNUAL INCENTIVE
BONUS PLAN
[To come.]
IV-H-1
<PAGE> 149
ANNEX V
KMART CORPORATION
<TABLE>
<S> <C> <C>
V-A: Selected Financial Data....................................................... V- 2
V-B: Management's Discussion and Analysis of Financial Condition and Results of
Operations for the Fiscal Year Ended January 27, 1993......................... V- 3
V-C: Consolidated Financial Statements for the Fiscal Year Ended January 27,
1993.......................................................................... V-14
V-D: Consolidated Financial Statements for the 39 Weeks Ended October 27, 1993..... V-39
V-E: Management's Discussion and Analysis of Financial Condition and Results of
Operations for the 39 Weeks Ended October 27, 1993............................ V-45
</TABLE>
V-1
<PAGE> 150
ANNEX V-A
KMART CORPORATION
CONSOLIDATED
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
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>
1993 1992 1991 1990 1989(1) 1988
------- ------- ------- ------- ------- -------
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Sales.................................. $ $31,031 $29,042 $28,133 $27,670 $25,947
Cost of merchandise sold............... 22,800 21,243 20,614 20,310 18,920
Selling, general and administrative
expenses............................ 6,875 6,603 6,435 6,277 5,877
Interest expense -- net................ 414 384 384 353 312
Income from continuing retail
operations before income taxes...... 1,327 1,189 1,070 444 1,185
Net income from continuing retail
operations.......................... 882 789 712 282 768
PER-SHARE DATA
Earnings per common and common
equivalent share from continuing
retail operations................... $ $ 1.93 $ 1.85 $ 1.78 $ .70 $ 1.91
Cash dividends declared per common
share............................... .92 .88 .86 .82 .66
Book value............................. 16.64 15.33 13.47 12.45 12.56
FINANCIAL DATA
Working capital........................ $ $ 5,014 $ 4,682 $ 3,519 $3,685 $ 3,654
Total assets........................... 18,931 15,999 13,899 13,145 12,126
Long-term obligations -- Debt.......... 3,237 2,287 1,701 1,480 1,358
-- Capital
leases.............................. 1,698 1,638 1,598 1,549 1,588
Shareholders' equity................... 7,536 6,891 5,384 4,972 5,009
Capital expenditures -- owned
property............................ 1,435 1,329 814 631 570
Depreciation and amortization.......... 600 509 470 444 424
Ending market capitalization........... 10,837 10,901 6,095 6,640 7,105
Weighted average shares outstanding.... 458 426 400 401 401
FINANCIAL RATIOS
Return on sales --
Income from continuing retail
operations before income taxes.... % 4.3% 4.1% 3.8% 1.6 % 4.6%
Net income from continuing retail
operations........................ % 2.8% 2.7% 2.5% 1.0 % 3.0%
Return on beginning assets from
continuing retail operations........ % 6.4% 6.6% 5.9% 2.5 % 7.5%
Inventory turnover..................... 2.7 2.7 2.7 2.9 3.0
Return on beginning shareholders'
equity from continuing retail
operations.......................... % 13.2% 15.0% 14.7% 5.7 % 17.7%
Return on beginning investment......... % 10.8% 11.2% 11.2% 6.4 % 13.2%
Working capital ratio.................. 1.9 2.1 1.8 1.9 2.0
Debt and equivalent as a percentage of
total capitalization................ % 43.1% 37.3% 43.5% 43.4 % 38.0%
Ratio of income to fixed charges....... 3.0 3.0 2.9 1.8 3.5
Employee compensation and benefits, per
sales dollar........................ % 14.7% 15.1% 15.2% 15.2 % 14.7%
</TABLE>
- -------------------------
(1) Results of operations for 1989 include a pretax provision of $640 million
for restructuring of Kmart stores and other charges.
V-2
<PAGE> 151
ANNEX V-B
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993
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 2,337 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 was sold in January 1994, each of which
have been presented as discontinued operations in the consolidated financial
statements.
Fiscal Years ended January 27, 1993 and January 29, 1992.
RESULTS OF CONSOLIDATED OPERATIONS
Sales increased 6.9% to a record $31.0 billion in 1992, compared to $29.0
billion in 1991. Consolidated comparable store sales increased 2.1% in 1992. The
Specialty Retail Groups comparable store sales increased 6.5% 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 73.5% in 1992 and 73.1% in 1991. The 0.4% increase 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 Kmart Corporation's domestic inventories are measured
using the last-in, first-out (LIFO) method of inventory valuation. In 1992, the
inflationary impact on inventories contributed to a pretax LIFO credit of $35
million, in contrast to pretax charges of $4 million in 1991. Kmart Corporation
measures inflation using internal price indices. The 1992 LIFO credit resulted
from reductions in Kmart Corporation's retail prices.
Selling, general and administrative expenses, including advertising, were
22.2% of sales in 1992 and 22.7% in 1991. The 1992 decrease in selling, general
and administrative 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 14.7% and 15.1% in
1992 and 1991, respectively.
Net interest expense reflects the following components:
<TABLE>
<CAPTION>
(MILLIONS) 1993 1992 1991
- ---------- ------- ------- -------
<S> <C> <C> <C>
Interest Expense on Debt......................................... $ $ 257 $ 217
Interest Income.................................................. 28 14
------- ------- -------
Net Interest Expense on Debt................................... $ $ 229 $ 203
------- ------- -------
------- ------- -------
</TABLE>
The increase in net interest expense 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
V-3
<PAGE> 152
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
total debt were 7.6% in 1992 and 8.5% in 1991. Weighted average interest rates
for short-term borrowings were 3.6% in 1992 and 6.1% in 1991.
Income from continuing retail operations before income taxes for the year
was $1,327 million, or 4.3% of sales, as compared to $1,189 million, or 4.1% of
sales, in 1991.
Income tax expense in 1992 was $445 million with an effective tax rate of
33.5% as compared to $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 from continuing retail operations in 1992 was $882 million, or
2.8% of sales, as compared to $789 million, or 2.7% of sales, in the prior year.
Net income from discontinued operations in 1992 was $59 million as compared
to net income of $70 million in the prior year. 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 (see Subsequent Events).
Net income for the year was $941 million, an increase of 9.5% from 1991 net
income of $859 million. Net income increased in 1992 due to improved sales and a
significant emphasis on cost control, partially offset by reduced earnings at
PACE and a one-time charge of $12 million, net of tax, related to Kmart
Corporation's guarantee of certain Bargain Harold's leases.
Earnings per share were $2.06 in 1992, compared with $2.02 in 1991, despite
a substantial profit shortfall at PACE and a 7.4% increase in weighted shares
outstanding, primarily as a result of the August 1991 conversion preferred share
offering.
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, because Kmart Corporation is refurbishing existing stores and
opening new stores, depreciation and amortization expense more closely
approximate current cost.
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 $852 million in 1992, compared with
$1,215 million in 1991. 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.
In U.S. Kmart stores, 1992 inventory increased 8.0% over 1991. 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.
V-4
<PAGE> 153
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
Net cash used for investing was $1,832 million in 1992, as compared to
$1,413 million in 1991. Cash used for investing was primarily comprised of
capital expenditures for owned property 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. Capital expenditures for the Kmart
Group, which included new distribution centers, refurbishments, expansions and
store openings, were $1,110 million and $1,035 million in 1992 and 1991,
respectively. The increase in Kmart Group capital expenditures in 1992 was due
to the Kmart store modernization program. Capital expenditures by the Specialty
Retail Groups were primarily for new store openings resulting from the Group's
aggressive expansion program, and totaled $325 million in 1992, as compared to
$294 million in 1991. Net cash used for 1992 acquisitions totaled $372 million.
Kmart Corporation is integrating the new Super Kmart Center concept into
the U.S. Kmart store modernization program. 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
in 1993, are expected to approximate 1992 levels in 1994 and will subsequently
increase again in 1995. The Kmart store modernization program is expected to be
substantially complete in 1996.
Net cash provided by financing was $1,026 million in 1992 and $485 million
in 1991. 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 1992 and
1991 were $1,136 million and $1,093 million, respectively. The maximum amount of
aggregate short-term borrowings outstanding during 1992 was $2,371 million,
compared with $1,509 million in 1991. Total short-term lines of credit available
and unused were $1,339 million and $789 million at the end of 1992 and 1991,
respectively.
Total dividends paid during 1992 were $448 million, compared with $375
million in 1991. Dividends paid per Kmart Corporation common share were $.91 and
$.87 in 1992 and 1991, respectively. Dividends paid in 1992 and 1991 per $3.41
Depositary Share (each representing one-quarter share of Series A conversion
preferred stock) were $3.41 and $1.06, respectively. Dividends paid per Series B
convertible preferred stock were $1.44 in 1992.
V-5
<PAGE> 154
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
CAPITAL STRUCTURE
The following three-year analysis of Kmart Corporation's capital structure
summarizes Kmart Corporation's total debt and equivalents and total
capitalization:
<TABLE>
<CAPTION>
($ MILLIONS) 1993 % 1992 % 1991 %
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Long-term debt due within one year.......... $ $ 117 0.8 $ 39 0.4
Capital lease obligations due within one
year...................................... 113 0.8 107 1.0
Notes payable............................... 590 4.3 -- --
Long-term debt.............................. 3,237 23.6 2,287 20.1
Capital lease obligations and other......... 1,862 13.6 1,802 15.8
------- ----- ------- ----- ------- -----
Total debt and equivalent.............. 5,919 43.1 4,235 37.3
Deferred income taxes....................... 268 2.0 234 2.0
Shareholders' equity........................ 7,536 54.9 6,891 60.7
------- ----- ------- ----- ------- -----
Total capitalization................... $ $13,723 100.0 $11,360 100.0
------- ----- ------- ----- ------- -----
------- ----- ------- ----- ------- -----
</TABLE>
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 $986 million.
FINANCIAL OBJECTIVE
Kmart Corporation's financial policy is designed to provide Kmart
Corporation and its shareholders with an optimum return on investment, a solid
capital structure and a high degree of financial flexibility. Obtaining optimum
return on investment requires deployment of Kmart Corporation's assets and
resources where they will provide the best long-term return. In seeking optimum
return, Kmart management continues to focus on high growth retail businesses
including potential retail investment opportunities, both domestically and
internationally, in addition to funding an improved merchandise mix, the
refurbishment, relocation and expansion of existing U.S. Kmart stores, and the
expansion and refurbishment of Kmart Corporation's specialty retail operations.
In addition, Kmart management sold or closed Kmart and specialty stores which
did not generate sufficient returns. Kmart management expects that future
funding required to finance refurbishment of existing stores, future expansions
and relocations and growth will be provided primarily by internally generated
funds, additional debt and equity offerings, the sale and leaseback or
mortgaging of owned properties and the leasing of land and buildings.
ANALYSIS OF KMART GROUP OPERATIONS
At January 26, 1994, the Kmart Group consisted of both domestic and
international operations. A total of 2,337 Kmart stores were located in the
United States and Puerto Rico, including 19 Super Kmart Centers, all in the
United States. Kmart's international operations include 128 Kmart stores in
Canada and 13 stores in the Czech Republic and Slovakia.
V-6
<PAGE> 155
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
A three-year summary of the Kmart Group's sales and operating income
follows:
<TABLE>
<CAPTION>
% %
(U.S.$ MILLIONS) 1993 CHANGE 1992 CHANGE 1991
- ---------------- ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C>
Sales
United States................................... $ $25,326 3.4 $24,488
International................................... 1,144 7.9 1,060
------- ------- -------
Total Sales.................................. $ $26,470 3.6 $25,548
------- ------- -------
------- ------- -------
Operating Income
United States................................... $ $ 1,454 9.8 $ 1,325
International................................... 46 -- 23
------- ------- -------
Total Operating Income....................... $ $ 1,500 11.4 $ 1,348
------- ------- -------
------- ------- -------
Capital Expenditures-Owned Property............... $ $ 1,110 $ 1,035
------- ------- -------
------- ------- -------
Capital Expenditures-Discontinued Operations...... $ $ 187 $ 210
------- ------- -------
------- ------- -------
</TABLE>
U.S. General Merchandise Operations
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
$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 1992.
Domestic Kmart store 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, Christmas remembrance and changed
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 1992, new Super Kmart Centers produced encouraging results. These
150,000 to 185,000-square-foot stores feature a full line of Kmart general
merchandise and groceries. At January 26, 1994, 19 Super Kmart Centers were in
operation, including two American Fare stores which were converted to Super
Kmart Centers during 1992. Within the context of the store modernization
program, the Kmart Group is analyzing the remaining stores to be updated as
potential relocations for Super Kmart Centers. Kmart Group will complete
approximately 200 store modernization projects during 1993. There is potential
to open several
V-7
<PAGE> 156
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
hundred Super Kmart Centers over the next five to seven years. Activity for the
U.S. Kmart store modernization program for the past three years is summarized in
the following table:
<TABLE>
<CAPTION>
TOTAL 1994
1991 1992 1993 COMPLETE PLAN
---- ---- ---- -------- ----
<S> <C> <C> <C> <C> <C>
New stores.................................................. 55 45
Store relocations........................................... 51 73
Store expansions............................................ 164 122
Store refurbishments........................................ 204 208
---- ---- ---- --- ----
Totals................................................. 474 448
---- ---- ---- --- ----
---- ---- ---- --- ----
</TABLE>
International General Merchandise Operations
International operations consist primarily of 128 Kmart stores in Canada
and 13 department stores located in the Czech Republic and Slovakia at January
26, 1994. 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.
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 impacted by a strong Christmas season partially offset by weak
economic conditions. Results in U.S. dollars were adversely affected by
deterioration of the Canadian exchange rate throughout the year. Czech Republic
and Slovak operations were profitable in 1992, and 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
0.8226 in 1992 and 0.8708 in 1991.
As part of its international expansion strategy, the Kmart Group has formed
joint ventures in Mexico and Singapore and expects to open stores in these
countries in 1994.
The following table highlights the Kmart Group's store activity during
1993:
<TABLE>
<CAPTION>
1993 ACTIVITY PLANNED
END END ------------------------------------- END
1991 1992 ACQUIRED OPENED CLOSED END 1994
----- ----- -------- ------ ------ ----- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Kmart
United States......................... 2,249 2,282
Canada................................ 126 127
Czech Republic and Slovakia............. -- 13
Other................................... 16 13
----- ----- -------- ------ ------ ----- -------
Total General Merchandise.......... 2,391 2,435
----- ----- -------- ------ ------ ----- -------
----- ----- -------- ------ ------ ----- -------
General Merchandise Selling Square Feet
(Millions)............................ 151 159
----- ----- -----
----- ----- -----
General Merchandise Store Sales per
Square Foot........................... $ 184 $ 179 $
----- ----- -----
----- ----- -----
</TABLE>
V-8
<PAGE> 157
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
ANALYSIS OF THE SPECIALTY RETAIL GROUPS' OPERATIONS
At January 26, 1994, the Specialty Retail Groups consist 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 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.................. 1,275 1,291
Builders Square Group................. 144 165
OfficeMax Group....................... 79 179
The Sports Authority Group............ 36 56
----- ----- -------- ------ ------ ------ -------
Total Specialty Retail Groups.... 1,534 1,691
----- ----- -------- ------ ------ ------ -------
----- ----- -------- ------ ------ ------ -------
Specialty Retail Groups' Selling
Square
Feet (Millions)..................... 17 22
</TABLE>
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............................................... $ $4,561 $3,495 30.5
------ ------ ------
------ ------ ------
Operating Income.................................... $ $ 138 $ 116 19.0
------ ------ ------
------ ------ ------
Comparable Store Sales Increase..................... % 6.5% 6.9%
Capital Expenditures -- Owned Property.............. $ $ 138 $ 85
------ ------ ------
------ ------ ------
</TABLE>
Sales and operating income have been restated to exclude discontinued
operations.
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 operating income for the Specialty Retail Groups increased
19.0% from $116 million in 1991 to $138 million in 1992 due to new and acquired
stores and improved operating leverage. The Specialty Retail Groups represented
14.7% of total 1992 consolidated sales and 8.4% of total 1992 consolidated
operating income.
Borders-Walden Group
Borders-Walden Group is a leading book retailer in the United States, and
is comprised of Borders, Inc. ("Borders") and Walden Book Company, Inc.
("Walden"). As of January 23, 1994, Borders operated 44 large format superstores
in 21 states and the District of Columbia, each of which is designed to be the
premier book retailer in its market, and Walden, which is the largest operator
of mall-based bookstores in the United States, operated 1,159 stores in 50
states and the District of Columbia.
V-9
<PAGE> 158
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
Borders-Walden Group's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales................................................... $1,202 $1,140 5.5%
------ ------
------ ------
Operating Income........................................ $ 47 $ 38 23.7%
------ ------
------ ------
Comparable Store Sales Increase
Borders............................................ 12.6% --
----- ---
----- ---
Walden............................................. 1.4% 5.8%
---- ----
---- ----
</TABLE>
Sales of Borders-Walden Group 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
$56.0 million in sales, and a 1.4% comparable store sales increase at Walden.
Operating income of Borders-Walden Group in 1992 was $47 million, or 3.9%
of sales, as compared to $38 million, or 3.3% of sales, in 1991, primarily as a
result of increased sales and gross margin, partially offset by higher selling,
general and administrative expense.
The foregoing table reflects the historical results of Borders-Walden Group
without giving effect to a restatement of such results as reflected in the
Borders-Walden Group combined financial statements which was necessitated by
certain changes in Walden's accounting policies adopted in fiscal 1993. The
effect of these changes on the Kmart consolidated financial statements will be
recorded in the fourth quarter of 1993.
Builders Square Group
The Builders Square Group is a leading specialty retailer of home
improvement and home decor products and services in the United States, operating
177 stores in 26 states and Puerto Rico at January 23, 1994.
Builders Square Group's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales................................................... $ $2,419 $2,049 18.1
------ ------ ------
------ ------ ------
Operating Income........................................ $ $ 80 $ 74 8.1
------ ------ ------
------ ------ ------
Comparable Store Sales Increase......................... % 8.5% 7.0%
--- ---- ----
--- ---- ----
</TABLE>
Sales of the Builders Square Group 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 8
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 the prior year closing of 14 underperforming stores,
partially offset by a $10 million LIFO charge in 1992 as compared to a LIFO
credit of $2 million in 1991 and increased pre-opening expense.
V-10
<PAGE> 159
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
OfficeMax Group
The OfficeMax Group is one of the largest operators of high-volume, deep
discount office products superstores in the United States, operating 328
superstores in 38 states as of January 23, 1994.
On June 30, 1992, OfficeMax, Inc. acquired OW Office Warehouse, Inc., a
41-store office products superstore chain with stores located primarily
throughout the Mid-Atlantic region, and, on March 4, 1993, OfficeMax acquired
BizMart, Inc., a 105-store national office products superstore chain with stores
located primarily in the Southwest, West and Pacific Northwest regions.
Immediately following each of these acquisitions, OfficeMax remodeled,
remerchandised and converted the acquired stores to the OfficeMax name and
format.
In November, 1990, Kmart acquired an initial 21.6% equity interest in
OfficeMax, Inc. and increased its equity interest in OfficeMax to 92.7% in
November 1991. Kmart has consolidated the results of the OfficeMax Group's
operations from November 21, 1991. Kmart currently has a % interest in Office
Max, Inc.
OfficeMax Group's results of operations from the November 21, 1991 date of
acquisition follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
----------------
1993 1992 1991 1993 1992
------ ---- ---- ------ ------
<S> <C> <C> <C> <C> <C>
Sales.................................................. $ $528 $ 65 --
------ ---- ----
------ ---- ----
Operating Income....................................... $ $ 1 $ 1 --
------ ---- ----
------ ---- ----
Comparable Store Sales Increase........................ 28.5% N/A
------ ---- ----
------ ---- ----
</TABLE>
The 1992, OfficeMax Group sales increase was due to the inclusion of a full
year of OfficeMax operations and 102 new stores, including 41 OW Office
Warehouse stores acquired on June 30, 1992. OfficeMax recorded $1 million
operating income in 1992 despite higher store opening costs resulting from an
aggressive expansion program during the year. On a pro forma basis, OfficeMax
Group comparable store sales increased 28.5% in 1992.
The Sports Authority Group
The Sports Authority Group is the largest operator of large format sporting
goods stores in the United States in terms of both sales and number of stores
and is also the largest full-line sporting goods retailer in the United States
in terms of sales, operating 80 sporting goods megastores at January 23, 1994.
The Sports Authority Group's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
---------------
1993 1992 1991 1993 1992
------ ---- ---- ------ -----
<S> <C> <C> <C> <C> <C>
Sales................................................... $ $412 $241 70.8
------ ---- ----
------ ---- ----
Operating Income........................................ $ $ 10 $ 3 --
------ ---- ----
------ ---- ----
Comparable Store Sales Increase......................... 8.3% 15.3%
------ ---- ----
------ ---- ----
</TABLE>
Sales of The Sports Authority Group 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 $77 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.
V-11
<PAGE> 160
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
Operating income of The Sports Authority Group 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 21.3% 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, 1992 equity in income of Coles Myer was $51 million
compared with $60 million in 1991. 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 1992 was $54 million compared with $50 million in
1991. 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.
SUBSEQUENT EVENTS
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by stockholders 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 separately the
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, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes. Net of taxes, the charge was
approximately $850 million. The provision includes anticipated costs associated
with Kmart stores which will be closed, relocated, enlarged or refurbished in
the U.S. and Canada as well as the relocation of certain Builders Square stores
and the closing of underperforming Walden stores. These costs, which represent
approximately 85% of the total reserve, include the estimated lease obligations
for store closings and relocations as well as estimated fixed asset write-offs,
primarily furniture and fixtures and inventory dispositions for all affected
stores. The remainder of the reserve is for costs
V-12
<PAGE> 161
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
related to re-engineering programs, a non-routine legal judgment and certain
changes to Walden's accounting policies to prepare for combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% for costs associated with Walden stores.
In March 1993, OfficeMax Group acquired BizMart, Inc., a 105-store national
office products superstore chain with stores located primarily in the Southwest,
West and Pacific Northwest regions.
In December 1993, Kmart Corporation entered into a definitive agreement to
sell Kmart's PayLess Drug Stores Northwest Inc. subsidiary to TCH Corporation,
the parent company of Thrifty Corporation. Under the terms of the agreement, TCH
will provide the Kmart Group with consideration consisting of $592 million of
cash, assumption or refinancing of approximately $170 million of debt, $100
million in subordinated debt securities and common stock representing 47% of the
equity of TCH. It is anticipated that the transaction will be completed by the
end of the first quarter of 1994. Based upon estimates, which are still being
reviewed, an after-tax charge of approximately $110 million will be incurred in
the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after-tax
charge to earnings related to this transaction will approximate $400 million.
PayLess and PACE are presented as discontinued operations in the
consolidated financial statements and accompanying footnotes.
V-13
<PAGE> 162
ANNEX V-C
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-14
<PAGE> 163
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 27, 1993 and the results of their
operations and their cash flows for each of the two years in the period ended
January 27, 1993, 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.
Price Waterhouse
Detroit, Michigan
January 31, 1994
V-15
<PAGE> 164
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.................................................... $ $31,031 $29,042
Licensee fees and rental income.......................... 280 267
Equity in income of affiliated retail companies.......... 105 110
----------- ----------- -----------
31,416 29,419
----------- ----------- -----------
Cost of merchandise sold includes buying and
occupancy costs........................................ 22,800 21,243
Selling, general and administrative expenses............. 6,875 6,603
Interest expense:
Debt -- net............................................ 229 203
Capital lease obligations.............................. 185 181
----------- ----------- -----------
30,089 28,230
----------- ----------- -----------
Income from continuing retail operations before income
taxes.................................................. 1,327 1,189
Income taxes............................................. 445 400
----------- ----------- -----------
Net income from continuing retail operations............. 882 789
Discontinued operations.................................. 59 70
----------- ----------- -----------
Net income............................................... $ $ 941 $ 859
----------- ----------- -----------
----------- ----------- -----------
Earnings per common and common equivalent share:
Net income from continuing retail operations........... $ $1.93 $1.85
Discontinued operations................................ .13 .17
----------- ----------- -----------
$ $2.06 $2.02
----------- ----------- -----------
----------- ----------- -----------
Weighted average shares.................................. 457.8 426.2
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
The consolidated statements of income for prior periods have been restated for
discontinued operations.
V-16
<PAGE> 165
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 $260)..................... $ $ 611
Merchandise inventories........................................... 8,752
Accounts receivable and other current assets...................... 1,146
----------- -----------
Total current assets................................................. 10,509
Investments in Affiliated Retail Companies........................... 597
Property and Equipment -- net........................................ 6,405
Other Assets and Deferred Charges.................................... 381
Goodwill -- net of accumulated amortization of $93................... 1,039
----------- -----------
$ $18,931
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Long-term debt due within one year................................ $ $ 117
Notes payable..................................................... 590
Accounts payable -- trade......................................... 2,959
Accrued payrolls and other liabilities............................ 1,215
Taxes other than income taxes..................................... 368
Income taxes...................................................... 246
----------- -----------
Total current liabilities............................................ 5,495
Capital Lease Obligations............................................ 1,698
Long-Term Debt....................................................... 3,237
Other Long-Term Liabilities (includes restructuring obligations)..... 697
Deferred Income Taxes................................................ 268
Shareholders' Equity:
Preferred stock, 10,000,000 shares authorized;
Series A, 5,750,000 shares authorized and issued................ 986
Series B, 796,827 shares authorized; 784,938 shares issued...... 157
Common stock, 1,500,000,000 shares authorized; shares issued
and 415,640,206, respectively........................ 416
Capital in excess of par value.................................... 506
Performance restricted stock deferred compensation................ (2)
Retained earnings................................................. 5,700
Treasury shares................................................... (122)
Foreign currency translation adjustment........................... (105)
----------- -----------
Total shareholders' equity........................................ 7,536
----------- -----------
$ $18,931
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
V-17
<PAGE> 166
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 from continuing retail operations......... $ $ 882 $ 789
Adjustments to reconcile net income to operating cash
flows:
Depreciation and amortization...................... 600 509
Restructuring of Kmart stores and other charges.... (27) (38)
Deferred income taxes.............................. 153 116
Undistributed equity income........................ (11) (26)
Increase in other long-term liabilities............ 63 31
Other -- net....................................... 60 81
Cash provided by (used for) current assets and
current liabilities:
Increase in inventories............................ (956) (620)
Increase in accounts payable....................... 167 371
Other -- net....................................... (223) (148)
----------- ----------- -----------
Total cash provided by continuing retail
operations...................................... 708 1,065
----------- ----------- -----------
Discontinued Operations
Income from discontinued operations................ 59 70
Items not affecting cash -- net.................... 85 80
----------- ----------- -----------
Total cash provided by discontinued operations..... 144 150
----------- ----------- -----------
Net cash provided by operations...................... 852 1,215
----------- ----------- -----------
INVESTING
Capital expenditures -- owned property............... (1,435) (1,329)
Acquisitions......................................... (372) (115)
Proceeds from the sale of assets..................... 25 70
Other -- net......................................... (50) (39)
----------- ----------- -----------
Net cash used for investing.......................... (1,832) (1,413)
----------- ----------- -----------
FINANCING
Proceeds from issuance of long-term debt and notes
payable............................................ 1,602 811
Reduction in long-term debt and notes payable........ (80) (896)
Reduction in capital lease obligations............... (113) (110)
Issuance of common stock............................. 57 67
Issuance of $3.41 Depositary Shares (each
representing 1/4 share Series A conversion
preferred)......................................... -- 986
Reissuance of treasury shares........................ 8 2
Dividends paid....................................... (448) (375)
----------- ----------- -----------
Net cash provided by financing....................... 1,026 485
----------- ----------- -----------
NET INCREASE IN CASH AND EQUIVALENTS.................... 46 287
Cash and Equivalents at Beginning of Year............ 565 278
----------- ----------- -----------
CASH AND EQUIVALENTS AT END OF YEAR..................... $ $ 611 $ 565
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
Certain prior year amounts have been restated for the effect of discontinued
operations.
V-18
<PAGE> 167
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 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 employee savings
plan............................................. 10
Foreign currency translation adjustment............
----- ----- ------ --------- --- --------
Balance at January 27, 1993.......................... 986 157 416 506 (2) 5,700
Net income for the year............................
Cash dividends declared, common, $.96 per share....
Cash dividends declared, $3.41 Depositary Share,
$3.41 per share..................................
Cash dividends declared, Series B convertible
preferred, $11.50 per share......................
Common issued under stock option plans.............
Common issued under performance restricted stock
plan.............................................
Treasury shares reissued to employee savings
plan.............................................
Foreign currency translation adjustment............
----- ----- ------ --------- --- --------
Balance at January 26, 1994.......................... $ $ $ $ $ $
----- ----- ------ --------- --- --------
----- ----- ------ --------- --- --------
</TABLE>
<TABLE>
<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 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 employee savings
plan............................................. 8 18
Foreign currency translation adjustment............ (62) (62)
-------- ---------- ------
Balance at January 27, 1993.......................... (122) (105) 7,536
Net income for the year............................
Cash dividends declared, common, $.96 per share....
Cash dividends declared, $3.41 Depositary Share,
$3.41 per share..................................
Cash dividends declared, Series B convertible
preferred, $11.50 per share......................
Common issued under stock option plans.............
Common issued under performance restricted stock
plan.............................................
Treasury shares reissued to employee savings
plan.............................................
Foreign currency translation adjustment............
-------- ---------- ------
Balance at January 26, 1994.......................... $ $ $
-------- ---------- ------
-------- ---------- ------
</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-19
<PAGE> 168
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 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 and Series B convertible preferred stock have 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.
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.
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 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.
V-20
<PAGE> 169
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Income Taxes: Deferred income taxes are provided on nonpermanent
differences between financial statement and taxable income. Kmart Corporation
accrues appropriate U.S. and foreign taxes payable on all of the earnings of
subsidiaries and affiliates, 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.
SUBSEQUENT EVENTS
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by stockholders 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 separately the
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 good 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.
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes. Net of taxes, the charge was
approximately $850. The provision includes anticipated costs associated with
Kmart stores which will be closed, relocated, enlarged or refurbished in the
U.S. and Canada as well as the relocation of certain Builders Square stores and
the closing of underperforming Walden stores. These costs, which represent
approximately 85% of the total reserve, include the estimated lease obligations
for store closings and relocations as well as estimated fixed asset write-offs,
primarily furniture and fixtures and inventory dispositions for all affected
stores. The remainder of the reserve is for costs related to re-engineering
programs, a non-routine legal judgment and certain changes to Walden's
accounting policies to prepare for combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% is for costs associated with Walden stores.
In March 1993, OfficeMax Group acquired BizMart, Inc., a 105-store national
office products superstore chain with stores located primarily in the Southwest,
West and Pacific Northwest regions.
In December 1993, Kmart Corporation entered into a definitive agreement to
sell Kmart's PayLess Drug Stores Northwest, Inc. subsidiary to TCH Corporation,
the parent company of Thrifty Corporation. Under the terms of the agreement, TCH
will provide the Kmart Corporation with consideration consisting of $592 of
V-21
<PAGE> 170
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
cash, assumption or refinancing of approximately $170 of debt, $100 in
subordinated debt securities and common stock representing 47 percent of the
equity of TCH. It is anticipated that the transaction will be completed by the
end of the first quarter of 1994. Based upon estimates, which are still being
reviewed, an after-tax charge of approximately $110 will be incurred in the
fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after-tax
charge to earnings related to this transaction will approximate $400.
PayLess and PACE are presented as discontinued operations in the
consolidated financial statements and accompanying footnotes.
ACQUISITIONS AND DISPOSITIONS
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 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.
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 $115.2 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 estimate's fair value of
the net assets acquired totaled $135 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 $XXX, $185 and $157 in 1993, 1992 and 1991,
respectively. Noncash charges related to store restructuring were $XX,
V-22
<PAGE> 171
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
$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).................................. $ $444 $411
------ ---- ----
------ ---- ----
Income taxes........................................................... $ $320 $260
------ ---- ----
------ ---- ----
</TABLE>
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.............................................. $ $7,456
First-in, first-out............................................. 1,296
------- -------
Total inventories.......................................... $ $8,752
------- -------
------- -------
Excess of current cost over stated LIFO value................... $ $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.......................................................... $ $ 204
Buildings..................................................... 657
Leasehold improvements........................................ 1,706
Furniture and fixtures........................................ 5,516
Construction in progress...................................... 85
Property under capital leases................................... 2,861
------- ----------------
11,029
Less-accumulated depreciation and amortization:
Property owned................................................ (3,206)
Property under capital leases................................. (1,418)
------- ----------------
Total...................................................... $ $ 6,405
------- ----------------
------- ----------------
</TABLE>
V-23
<PAGE> 172
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Accumulated depreciation for owned property includes $___ and $99 of the
1989 Kmart restructuring provision as of January 26, 1994 and January 27,
1993, 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 $___, $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......................................................... $ $54 $50
------ ---- ----
------ ---- ----
Dividends................................................................ $ $59 $51
------ ---- ----
------ ---- ----
</TABLE>
Meldisco companies' summarized financial information follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1993 1992 1991
------ ------ ------
<S> <C> <C> <C>
Net sales........................................................... $ $1,164 $1,145
------ ------ ------
------ ------ ------
Gross profit........................................................ $ $ 525 $ 505
------ ------ ------
------ ------ ------
Net income.......................................................... $ $ 111 $ 104
------ ------ ------
------ ------ ------
Inventory........................................................... $ $ 129 $ 132
Other current assets................................................ 123 131
Noncurrent assets................................................... 2 --
------ ------ ------
Total assets........................................................ 254 263
Current liabilities................................................. 47 46
------ ------ ------
Net assets.......................................................... $ $ 207 $ 217
------ ------ ------
------ ------ ------
Equity of Kmart Corporation......................................... $ $ 101 $ 106
------ ------ ------
------ ------ ------
</TABLE>
Coles Myer Ltd.
Kmart Corporation had a 21.3% equity interest at January 27, 1993 in Coles
Myer Ltd., the largest retailer in Australia.
V-24
<PAGE> 173
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Income earned under a license agreement with Coles Myer of $ in 1993, 1992
and 1991 is included in license 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.................................................... $ $ 51 $ 60
------ ------ ------
------ ------ ------
Dividends........................................................... $ $ 34 $ 33
------ ------ ------
------ ------ ------
Equity of Kmart Corporation......................................... $ $ 496 $ 488
------ ------ ------
------ ------ ------
Market value of Coles Myer common stock............................. $ $ 912 $1,082
------ ------ ------
------ ------ ------
</TABLE>
The cumulative effect of translating Kmart Corporation's equity in the
investment in Coles Myer was a reduction of $ , $90 and $45, respectively, as
of January 26, 1994, January 27, 1993 and January 29, 1992. The average exchange
rates from Australian to U.S. dollars were in 1993, 0.7367 in 1992 and
0.7776 in 1991.
Summarized financial information adjusted for conformity with U.S.
generally accepted accounting principles for Coles Myer's most recent fiscal
years follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------------
(U.S.$) JULY 25, 1993 JULY 26, 1992 JULY 28, 1991
- ------- ------------- ------------- -------------
<S> <C> <C> <C>
Net sales................................................ $ $11,634 $11,699
------------- ------------- -------------
------------- ------------- -------------
Net income............................................... $ $ 137 $ 254
------------- ------------- -------------
------------- ------------- -------------
Current assets........................................... $ $ 1,927 $ 1,776
Noncurrent assets........................................ 2,123 2,435
------------- ------------- -------------
Total assets............................................. $ $ 4,050 $ 4,211
------------- ------------- -------------
------------- ------------- -------------
Current liabilities...................................... $ $ 1,327 $ 1,327
Noncurrent liabilities................................... 663 1,019
Equity................................................... 2,060 1,865
------------- ------------- -------------
Total liabilities and equity........................... $ $ 4,050 $ 4,211
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
Unremitted earnings of unconsolidated affiliates included in consolidated
retained earnings were $ , $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................................................................. $ $1,261 $1,119
Foreign............................................................. 66 70
------ ------ ------
Total............................................................... $ $1,327 $1,189
------ ------ ------
------ ------ ------
</TABLE>
V-25
<PAGE> 174
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Current:
Federal............................................................... $ $240 $246
State and local....................................................... 58 46
Foreign............................................................... 15 8
Deferred:
Restructuring of Kmart stores and other charges....................... 29 49
Excess of tax over book depreciation.................................. 69 37
LIFO inventory........................................................ 39 36
Other................................................................. (5) (22)
---- ---- ----
Total income taxes...................................................... $ $445 $400
---- ---- ----
---- ---- ----
</TABLE>
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.............................. $ $451 $404 % 34.0% 34.0%
State and local taxes, net of federal tax benefit... 38 31 2.9 2.6
Tax credits......................................... (7) (8) (0.5) (0.7)
Equity in income of affiliated retail companies
subject to lower tax rates........................ (23) (32) (1.7) (2.7)
Other............................................... (14) 5 (1.2) 0.4
---- ---- ---- ---- ---- ----
Total income taxes........................... $ $445 $400 % 33.5% 33.6%
---- ---- ---- ---- ---- ----
---- ---- ---- ---- ---- ----
</TABLE>
The amounts shown on the consolidated balance sheets for deferred income
taxes result principally from the difference between financial statement and
income tax depreciation and cost of merchandise sold, reduced by the 1989 Kmart
store restructuring provision.
Undistributed earnings of subsidiaries totaled $ , $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 1993 resulting in a one-time credit of $45.
CURRENT NOTES PAYABLE, LINES OF CREDIT AND OTHER
Notes payable of $ and $590 were comprised entirely of Kmart
Corporation's commercial paper at January 26, 1994 and January 27, 1993,
respectively. The weighted average interest rate on short-term borrowings
outstanding on January 27, 1993 was 3.2%.
At January 27, 1993, Kmart Corporation had bank lines of credit aggregating
$1,339 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
V-26
<PAGE> 175
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
other lines require fees in lieu of compensating balances. Kmart Corporation is
free to withdraw the entire balance in its accounts at any time.
Kmart Corporation has entered into revolving credit agreements with various
banks in the aggregate amount of $ 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 27, 1993, 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 27,
1993, $4,237 of consolidated retained earnings were free of such restrictions.
At January 27, 1993, 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 1992 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 27, 1993, 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 27, 1993, there was $130
of borrowings outstanding under these agreements.
Kmart 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
under these arrangements, and other lease guarantees for certain facilities
previously sold, were $494 at January 27, 1993.
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 27, 1993, the amount guaranteed was $20.
Kmart Corporation has guaranteed indebtedness related to certain of its
leased properties financed by industrial revenue bonds. At January 27, 1993, the
total amount of such guaranteed indebtedness was $292, of which $94 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 $198 at January 27,
1993. However, no concentration of credit risk exists and Kmart Corporation does
not anticipate nonperformance by the other parties.
V-27
<PAGE> 176
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, JANUARY 27,
1994 1993
---------------- ----------------
<S> <C> <C>
8 3/8% debentures due 2017...................................... $ $ 291
10 1/2% debentures due 2017..................................... 200
8 1/8% debentures due 1997...................................... 199
12 1/8% notes due 1995.......................................... 150
8 1/8% notes due 2006........................................... 199
8 1/4% notes due 2022........................................... 99
12 1/2% debentures due 2005..................................... 100
8 3/8% debentures due 2022...................................... 99
7 3/4% debentures due 2012...................................... 198
7.95% debentures due 2023....................................... --
Notes Payable................................................... 300
Medium-term notes due 1993 through 2020 (8.41% weighted average
interest rate)................................................ 835
Mortgages....................................................... 522
Other........................................................... 162
------- -------
Total...................................................... 3,354
Portion due within one year..................................... 117
------- -------
Long-term debt.................................................. $ $3,237
------- -------
------- -------
</TABLE>
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 debentures are not redeemable prior to maturity. In July
1992, Kmart Corporation issued $100 of 8 3/8% debentures due July 1, 2022. The
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.
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.
V-28
<PAGE> 177
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Principal payments due on long-term debt for the five years subsequent to
1992 are: 1993 - $117; 1994 - $133; 1995 - $251; 1996 - $217; 1997 - $163.
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 $ 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.
V-29
<PAGE> 178
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
Lease Commitments: Future minimum lease payments with respect to capital
and operating leases as of January 27, 1993 follow:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1993.................................................................... $ 391 $ 719
1994.................................................................... 379 694
1995.................................................................... 371 665
1996.................................................................... 366 630
1997.................................................................... 355 585
Later years............................................................. 3,256 5,764
------- ---------
Total minimum lease payments....................................... 5,118 9,057
Less -- minimum sublease rental income.................................... -- (223)
------- ---------
Net minimum lease payments................................................ 5,118 $ 8,834
---------
---------
Less:
Estimated executory costs............................................... (1,547)
Amount representing interest............................................ (1,760)
-------
1,811
Portion due within one year............................................... 113
-------
Long-term lease obligations............................................... $ 1,698
-------
-------
</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......................................................... $ $635 $533
Percentage rentals...................................................... 50 53
Less -- sublease rentals................................................ (63) (55)
---- ---- ----
Total................................................................. $ $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................................ $ $ 113 $ 109
Interest expense related to obligations under capital leases.......... 185 181
---- ----- -----
Amounts charged to earnings........................................... 298 290
Related minimum lease payments net of executory
costs............................................................... (294) (283)
---- ----- -----
Excess of amounts charged over related minimum lease payments......... $ $ 4 $ 7
---- ----- -----
---- ----- -----
</TABLE>
Related minimum lease payments above exclude executory costs for 1993, 1992
and 1991 in the amounts of $ , $96 and $92, respectively.
V-30
<PAGE> 179
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>
TOTAL INCOME FROM
EQUITY IN REVENUES EQUITY IN CONTINUING
LICENSEE INCOME OF FROM INCOME OF 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) COMPANIES (EXPENSE) INCOME TAXES
---- ------- --------- ---------- ---------- --------- ---------- --------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Kmart Group:..... 1993 $xx,xxx $ xxx $xxx $ xx,xxx $ x,xxx $xxx $ xxx $x,xxx
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 x,xxx.x xxx.x -- x,xxx.x xx.x -- x.x xx.x
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 x,xxx.x -- -- x,xxx.x xx.x -- (x.x) xx.x
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 xxx.x -- -- xxx.x x.x -- x.x x.x
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 xxx.x x.x -- xxx.x xx.x -- (x.x) xx.x
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 $xx,xxx $ xxx $xxx $ xx,xxx $ x,xxx $xxx $ xxx $x,xxx
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>
V-31
<PAGE> 180
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
RETAINED INVESTMENTS
INTEREST IN IN CAPITAL
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 $ xx,xxx $ x,xxx $ xxx $x,xxx $ xx,xxx $ xxx $ x,xxx
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 x,xxx.x -- -- -- x,xxx.x xx.x xxx.x
1992 913.6 -- -- -- 913.6 35.6 33.5
1991 659.5 -- -- -- 659.5 33.2 20.3
Builders Square
Group:.............. 1993 xxx.x -- -- -- xxx.x xx.x xx.x
1992 876.8 -- -- -- 876.8 29.6 86.9
1991 679.8 -- -- -- 679.8 27.5 52.0
OfficeMax Group:...... 1993 xxx.x -- -- -- xxx.x x.x xx.x
1992 448.6 -- -- -- 448.6 9.9 21.2
1991 275.1 -- -- -- 275.1 1.1 5.8
The Sports Authority
Group:.............. 1993 xxx.x -- -- -- xxx.x x.x xx.x
1992 236.4 -- -- -- 236.4 7.2 26.5
1991 185.2 -- -- -- 185.2 4.4 16.3
Eliminations:......... 1993 -- xxxx -- -- xxxx -- --
1992 -- (1,412) -- -- (1,412) -- --
1991 -- (1,154) -- -- (1,154) -- --
Total Kmart
Corporation:........ 1993 $ xx,xxx $ -- $ xxx $x,xxx $ xx,xxx $ xxx $ x,xxx(a)
1992 18,266 -- 597 68 18,931 600 1,620
1991 15,330 -- 600 69 15,999 509 1,486
</TABLE>
- -------------------------
(a) Leased asset additions for Kmart Corporation were $ , $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 $ and $86 to its
principal pension plan during fiscal 1993 and fiscal 1991 respectively, but was
not required to contribute to its principal pension plan in fiscal 1992. Pension
expense was $ in 1993, $53 in 1992 and $53 in 1991.
V-32
<PAGE> 181
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, JANUARY 27, JANUARY 29,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits................. $ $(1,103) $ (984)
Estimated present value of non-vested benefits............. (148) (141)
----------- ----------- -----------
Accumulated benefit obligation............................. (1,251) (1,125)
Value of future pay increases.............................. (265) (170)
----------- ----------- -----------
Projected benefit obligation............................... (1,516) (1,295)
Estimated market value of plan assets........................ 1,388 1,307
----------- ----------- -----------
Plan assets over (under) projected benefit obligation........ (128) 12
Unrecognized net asset....................................... (111) (120)
Unrecognized prior service cost.............................. 55 60
Unrecognized net (gain) loss and other....................... 32 (57)
----------- ----------- -----------
Accrued pension costs........................................ $ $ (152) $ (105)
----------- ----------- -----------
----------- ----------- -----------
1993 1992 1991
Components of pension expense:
Normal service cost........................................ $ $ 56 $ 50
Interest cost on projected benefit obligation.............. 119 104
Return on plan assets...................................... (117) (194)
Net amortization and deferral of other components.......... (8) 88
----------- ----------- -----------
Total................................................. $ $ 50 $ 48
----------- ----------- -----------
----------- ----------- -----------
Actuarial assumptions at end of year:
Discount rates............................................. % 8.50% 8.75%
Expected return on plan assets............................. 9.50% 9.50%
Salary increases........................................... 5.00% 5.00%
</TABLE>
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 $77, or $.17 per share,
was included in net income as the effect of an accounting change in the first
quarter of 1993.
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. The effect of this statement is not
significant.
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
V-33
<PAGE> 182
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
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. Forty-six million 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 stockholders 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.
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-34
<PAGE> 183
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............................... 413,072,028 409,421,174
Sold under stock option plans....................... 2,500,110 3,548,640
Issued under performance restricted stock plan...... 101,820 117,836
Issued under directors stock plan................... 1,481 --
Forfeited or withheld under performance restricted
stock plan....................................... (35,233) (15,622)
Retirement of shares, at cost....................... -- --
----------- ----------- -----------
End of the year..................................... 415,640,206 413,072,028
----------- ----------- -----------
----------- ----------- -----------
Treasury Shares
Beginning of the year............................... 9,537,456 9,723,724
Retirement of shares, at cost....................... -- --
Reissue of shares for employee savings plan......... (780,634) (186,268)
----------- ----------- -----------
End of the year..................................... 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, 1991,
treasury shares of Kmart Common Stock were made available for
issuance or sale to the Trustee. As of January 26, 1994, common
shares remained available. Kmart Corporation's expense related to the Employee
Savings Plan was $ 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 27, 1993, outstanding awards and shares available for
grant totaled 836,999 and 3,038,247, respectively. Kmart Corporation recorded
$ , $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
V-35
<PAGE> 184
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
at no less than 100% of the fair market value of the common stock on the date of
grant. Such options may be 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........... $ 20,220,670 $6.44-$23.03
Granted.................................... 2,191,588 26.03
Exercised.................................. (2,564,045) 9.90- 21.94
Canceled................................... (358,346) 6.44- 26.03
---------- ------------
Outstanding at end of year................. $ 19,489,867 $9.90-$26.03
---------- ------------
---------- ------------
Exercisable at end of year................. $ 11,627,867 $9.90-$21.94
---------- ------------
---------- ------------
Available for grant at end of year......... 17,704,000
---------- ------------
---------- ------------
</TABLE>
V-36
<PAGE> 185
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Each of the quarters includes 13 weeks.
<TABLE>
<CAPTION>
QUARTER
------------------------------------
FIRST SECOND THIRD FOURTH
------ ------ ------ ------
<S> <C> <C> <C> <C>
1993
Gross revenue from continuing retail operations............. $ $ $ $
Cost of merchandise sold....................................
Net income from continuing retail operations before
extraordinary item and the effect of accounting changes...
Discontinued operations including the effect of accounting
changes, net of income tax................................
Extraordinary item, net of income tax.......................
Effect of accounting changes, net of income tax.............
------ ------ ------ ------
Net income.................................................. $ $ $ $
------ ------ ------ ------
------ ------ ------ ------
Earnings per common and common equivalent share:
Net income from continuing retail operations before
extraordinary item and the effect of accounting
changes................................................
Discontinued operations including the effect of accounting
changes, net of income tax.............................
Extraordinary item, net of income tax.....................
Effect of accounting changes, net of income tax...........
------ ------ ------ ------
Net income................................................ $ $ $ $
------ ------ ------ ------
------ ------ ------ ------
1992
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 8 6 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 $XX and $48, respectively.
Previously published quarterly financial data have been restated for
discontinued operations.
V-37
<PAGE> 186
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
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........................................................... 19 7/8 19 7/8 20 21
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>
As of January 26, 1994, there were Kmart Corporation shareholders
of record. Kmart Corporation common stock is listed on the New York, Pacific and
Chicago stock exchanges (trading symbol KM).
V-38
<PAGE> 187
ANNEX V-D
KMART CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
Sales.................................................................. $23,889 $21,588
Licensee fees and rental income........................................ 194 172
Equity in income of affiliated retail companies........................ 54 49
----------- -----------
24,137 21,809
----------- -----------
Cost of merchandise sold, includes buying and occupancy costs.......... 17,762 15,940
Selling, general and administrative expenses........................... 5,567 4,994
Interest expense:
Debt -- net.......................................................... 225 171
Capital lease obligations............................................ 144 135
----------- -----------
23,698 21,240
----------- -----------
Income from continuing retail operations before income taxes........... 439 569
Income taxes........................................................... 152 188
----------- -----------
Net income from continuing retail operations before extraordinary item
and the effect of accounting changes................................. 287 381
Discontinued operations including the effect of accounting changes,
net of income tax.................................................... (26) 25
Extraordinary item, net of income tax.................................. (10) --
Effect of accounting changes, net of income tax........................ (32) --
----------- -----------
Net income............................................................. $ 219 $ 406
----------- -----------
----------- -----------
Earnings per common and common equivalent share:
Net income from continuing retail operations before extraordinary item
and the effect of accounting changes................................. $ .61 $ .83
Discontinued operations including the effect of accounting changes, net
of
income tax........................................................... (.05) .06
Extraordinary item, net of income tax.................................. (.02) --
Effect of accounting changes, net of income tax........................ (.07) --
----- -----
$ .47 $ .89
----- -----
----- -----
Weighted average shares................................................ 463.9 456.6
----- -----
----- -----
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
The consolidated statements of income for prior periods have been restated for
discontinued operations.
V-39
<PAGE> 188
KMART CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash (includes temporary investments of $78 and $290,
respectively)..................................................... $ 534 $ 553
Merchandise inventories.............................................. 10,517 9,638
Accounts receivable and other current assets......................... 1,571 1,377
----------- -----------
Total current assets................................................... 12,622 11,568
Investments in Affiliated Retail Companies............................. 545 580
Property and Equipment -- net.......................................... 6,808 6,137
Other Assets and Deferred Charges...................................... 407 343
Goodwill -- net of accumulated amortization of $117 and $85,
respectively......................................................... 1,222 849
----------- -----------
$21,604 $19,477
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ 75 $ 114
Notes payable........................................................ 3,034 1,990
Accounts payable -- trade............................................ 3,857 3,448
Accrued payrolls and other liabilities............................... 1,201 1,094
Taxes other than income taxes........................................ 440 429
Income taxes......................................................... 97 106
----------- -----------
Total current liabilities.............................................. 8,704 7,181
Capital Lease Obligations.............................................. 1,732 1,642
Long-Term Debt......................................................... 2,757 2,802
Other Long-Term Liabilities (includes restructuring obligations)....... 774 631
Deferred Income Taxes.................................................. 239 230
Shareholders' Equity:
Preferred stock, 10,000,000 shares authorized;
Series A, 5,750,000 shares issued................................. 986 986
Series B, 796,827 shares authorized; 784,938 shares issued........ 157 --
Common stock, 1,500,000,000 shares authorized; shares issued
416,382,774 and 415,253,568, respectively......................... 416 415
Capital in excess of par value....................................... 532 499
Performance restricted stock deferred compensation................... (3) (2)
Retained earnings.................................................... 5,560 5,281
Treasury shares...................................................... (111) (123)
Foreign currency translation adjustment.............................. (139) (65)
----------- -----------
Total shareholders' equity........................................ 7,398 6,991
----------- -----------
$21,604 $19,477
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
V-40
<PAGE> 189
KMART CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income from continuing retail operations before extraordinary
item and the effect of accounting changes......................... $ 287 $ 381
Depreciation and amortization........................................ 515 449
Increase (decrease) in other long-term liabilities................... (27) 16
Other noncash charges to earnings.................................... 58 71
Cash used for current assets and current liabilities................. (1,328) (1,675)
----------- -----------
Total cash used for continuing operations............................ (495) (758)
----------- -----------
Discontinued Operations
Net income (loss) from discontinued operations....................... (26) 25
Items not affecting cash -- net...................................... 50 50
----------- -----------
Total cash provided by discontinued operations....................... 24 75
----------- -----------
Net cash used for operations......................................... (471) (683)
----------- -----------
INVESTING
Capital expenditures -- owned property............................... (838) (1,115)
Acquisitions......................................................... (272) (358)
Proceeds from the sale of assets..................................... 31 5
Other -- net......................................................... (37) (16)
----------- -----------
Net cash used for investing.......................................... (1,116) (1,484)
----------- -----------
FINANCING
Proceeds from issuance of long-term debt and notes payable........... 2,447 2,546
Reduction in long-term debt and notes payable........................ (522) (31)
Extraordinary item -- premium on bond redemption..................... (10) --
Reduction in capital lease obligations............................... (85) (81)
Issuance of common stock............................................. 12 39
Reissuance of treasury stock......................................... 23 16
Dividends paid....................................................... (355) (334)
----------- -----------
Net cash provided by financing....................................... 1,510 2,155
----------- -----------
NET DECREASE IN CASH AND EQUIVALENTS................................... (77) (12)
Cash and Equivalents at Beginning of Year............................ 611 565
----------- -----------
CASH AND EQUIVALENTS AT END OF PERIOD.................................. $ 534 $ 553
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
Certain prior year amounts have been restated for the effect of discontinued
operations.
V-41
<PAGE> 190
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
(UNAUDITED)
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements do not include
all information and footnotes necessary for the annual presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles.
In the opinion of Kmart Corporation, all adjustments necessary for a fair
statement of the results for the interim periods have been included. All
adjustments were of a normal and recurring nature.
SUBSEQUENT EVENTS
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by stockholders 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 separately the
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, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes. Net of taxes, the charge was
approximately $850. The provision includes anticipated costs associated with
Kmart stores which will be closed, relocated, enlarged or refurbished in the
U.S. and Canada as well as the relocation of certain Builders Square stores and
the closing of underperforming Walden stores. These costs, which represent
approximately 85% of the total reserve, include the estimated lease obligations
for store closings and relocations as well as estimated fixed asset write-offs,
primarily furniture and fixtures and inventory dispositions for all affected
stores. The remainder of the reserve is for costs related to re-engineering
programs, a non-routine legal judgment and certain changes to Walden's
accounting policies to prepare for combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% is for costs associated with Walden stores.
In December 1993, Kmart Corporation entered into a definitive agreement to
sell Kmart's PayLess Drug Stores Northwest, Inc. subsidiary to TCH Corporation,
the parent company of Thrifty Corporation. Under the
V-42
<PAGE> 191
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
(UNAUDITED)
terms of the agreement, TCH will provide the Kmart Group with consideration
consisting of $592 of cash, assumption or refinancing of approximately $170 of
debt, $100 in subordinated debt securities and common stock representing 47% of
the equity of TCH. It is anticipated that the transaction will be completed by
the end of the first quarter of 1994. Based upon estimates, which are still
being reviewed, an after-tax charge of approximately $110 will be incurred in
the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after-tax
charge to earnings related to this transaction will approximate $400.
PayLess and PACE are presented as discontinued operations in the
consolidated financial statements and accompanying footnotes.
EXTRAORDINARY ITEM AND ACCOUNTING CHANGES
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, the company 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.
Kmart Corporation adopted Financial Accounting Standard No. 109 "Accounting
for Income Taxes" (FAS 109) at the first quarter of 1993. 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 income tax rate. As a
result of the adjustment of deferred tax balances to the current enacted tax
rate, a benefit of $45, or $.10 per share, has been recorded as the cumulative
effect of the 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 Kmart Corporation
accrue for future postretirement medical benefits. In prior years, these claims
were expensed when paid. Net of applicable tax, a charge of $77, or $.17 per
share, 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 effect of
this statement was not significant.
ACQUISITIONS
In March 1993, OfficeMax, Inc. acquired BizMart, Inc. a 105-store national
office products superstore chain with stores located primarily in the Southwest,
West and Pacific Northwest regions.
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 shares.
Borders is headquartered in Ann Arbor, Michigan and at January 23, 1994 operated
a chain of 44 book
V-43
<PAGE> 192
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
(UNAUDITED)
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.
These acquisitions have been accounted for as purchases and, accordingly,
the results of operations have been consolidated from their respective dates of
acquisitions.
INVENTORIES AND COST OF MERCHANDISE SOLD
A substantial portion of the inventories is accounted for using the
last-in, first-out (LIFO) method. If the first-in, first-out (FIFO) method of
inventory accounting had been used by Kmart Corporation, inventories would have
been $1,045, $1,105 and $1,030 higher than reported at October 27, 1993, October
28, 1992 and January 27, 1993, respectively.
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.
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28, JANUARY 27,
1993 1992 1993
----------- ----------- -----------
<S> <C> <C> <C>
Preferred Stock -- 10,000,000 shares authorized:
Series A conversion preferred stock; shares authorized and
issued 5,750,000............................................. $ 986 $ 986 $ 986
Series A junior participating preferred stock; shares
designated 500,000; none issued.............................. None None None
Series B convertible preferred stock; 796,827 shares authorized
shares issued 784,938........................................ 157 -- 157
Common Stock -- 1,500,000,000 shares authorized; 46,000,000
shares reserved for conversion of Series A conversion preferred
stock; 5,092,050 shares reserved for conversion of Series B
convertible preferred stock; shares issued 416,382,774,
415,253,568 and 415,640,206, respectively...................... 416 415 416
Capital in Excess of Par Value................................... 532 499 506
Restricted Stock Deferred Compensation........................... (3) (2) (2)
Retained Earnings:
Balance at beginning of fiscal year............................ 5,700 5,214 5,214
Net income..................................................... 219 406 941
Cash dividends declared:
Common stock................................................. (293) (280) (374)
Series A conversion preferred stock.......................... (59) (59) (78)
Series B convertible preferred stock......................... (7) -- (3)
----------- ----------- -----------
Total Retained Earnings................................... 5,560 5,281 5,700
Less: Treasury Stock -- 7,731,825, 8,863,054 and 8,756,822
shares, at cost, respectively.................................. (111) (123) (122)
Cumulative Foreign Currency Translation Adjustment............... (139) (65) (105)
----------- ----------- -----------
Total Shareholders' Equity................................ $ 7,398 $ 6,991 $ 7,536
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
V-44
<PAGE> 193
ANNEX V-E
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
39 WEEKS ENDED OCTOBER 27, 1993 AND OCTOBER 28, 1992
RESULTS OF OPERATIONS
The following table presents Kmart Corporation's income statement, as a
percent of sales, for the periods presented.
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
<S> <C> <C>
Sales.................................................................. 100.0% 100.0%
Licensee fees and rental income........................................ 0.8 0.8
----------- -----------
Total operating revenues.......................................... 100.8 100.8
Cost of merchandise sold (includes buying and occupancy costs)......... 74.4 73.8
----------- -----------
Gross margin........................................................... 26.4 27.0
Selling, general and administrative expenses........................... 23.3 23.1
----------- -----------
Operating income from continuing retail operations..................... 3.1 3.9
Equity in income of affiliated retail companies........................ 0.2 0.2
Net interest expense................................................... 1.5 1.4
----------- -----------
Income from continuing retail operations before income taxes........... 1.8 2.7
Income taxes........................................................... 0.6 0.9
----------- -----------
Net income from continuing retail operations before extraordinary item
and the effect of accounting changes................................. 1.2 1.8
Discontinued operations including the effect of accounting changes, net
of taxes............................................................. (0.1) 0.1
Extraordinary item, net of income tax.................................. -- --
Effect of accounting changes, net of taxes............................. (0.2) --
----------- -----------
Net income........................................................ 0.9% 1.9%
----------- -----------
----------- -----------
</TABLE>
The Consolidated Statements of Income, as a percent of sales, have been
restated for discontinued operations.
V-45
<PAGE> 194
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
Kmart Corporation's store activity for the first 39 weeks is illustrated
below:
<TABLE>
<CAPTION>
JANUARY 27, OCTOBER 27,
1993 ACQUIRED OPENED CLOSED 1993
----------- --------- ------- ------- ------------
<S> <C> <C> <C> <C> <C>
Kmart Group:
United States............................... 2,282 89 55 2,316
Canada...................................... 127 -- -- 127
Czech Republic and Slovakia................... 13 -- -- 13
Other......................................... 13 -- -- 13
----------- ------- ------- ------
Total Kmart Group........................ 2,435 89 55 2,469
Specialty Retail Groups:
Borders-Walden Group........................ 1,291 -- 14 36 1,269
Builders Square Group....................... 165 -- 28 15 178
OfficeMax Group............................. 179 105 29 8 305
The Sports Authority Group.................. 56 -- 11 -- 67
----------- --- ------- ------- ------
Total Specialty Retail Groups............ 1,691 105 82 59 1,819
----------- --- ------- ------- ------
Total Stores............................. 4,126 105 171 114 4,288
----------- --- ------- ------- ------
----------- --- ------- ------- ------
</TABLE>
Sales for the 39 weeks ended October 27, 1993, were $23.9 billion, a $2.3
billion, or 10.7% increase, over sales of $21.6 billion in the same period in
the prior year (see table below). The 1993 sales increase was due primarily to
the net 162 stores opened in the first 39 weeks of 1993 and the inclusion of a
full 39 weeks sales for the net 157 stores opened in the prior year.
<TABLE>
<CAPTION>
SALES INCREASE %
OCTOBER 27, OCTOBER 28, -------------------------------------
SALES ($ MILLIONS) 1993 1992 ALL STORES COMPARABLE STORES
- ------------------------------------------ ----------- ----------- ---------------- -----------------
<S> <C> <C> <C> <C>
Kmart Group:
United States........................... $18,782 $17,643 6.5 3.9
International........................... 732 732 1.2*
----------- -----------
Total Kmart Group.................... 19,514 18,375 6.2 3.8
Specialty Retail Groups:
Borders-Walden Group.................... 874 740 18.1 N/A**
Builders Square Group................... 2,101 1,867 12.5 0.4
OfficeMax Group......................... 993 336 195.5 19.2
The Sports Authority Group.............. 407 270 50.7 2.3
----------- -----------
Total Specialty Retail Groups........ 4,375 3,213 36.2 3.0
----------- -----------
Consolidated.............................. $23,889 $21,588 10.7 3.7
----------- -----------
----------- -----------
</TABLE>
- -------------------------
* International comparable store sales change is calculated on sales in the
applicable local currency.
** On a pro forma basis, Borders comparable store sales increased 13.8% in the
first 39 weeks of 1993. Waldenbooks comparable store sales increased 1.0%
during this same period.
Cost of merchandise sold, including buying and occupancy costs, for the 39
weeks ended October 27, 1993, was $17,762 million as compared to $15,940 million
in the same period in the prior year. Gross margin as a percent of sales was
26.4% and 27.0% in 1993 and 1992, respectively. The decrease, as a percent of
sales, reflects a sales mix skewed toward lower-margined items in the U.S. Kmart
stores. The impact of inflation
V-46
<PAGE> 195
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
included in the cost of merchandise sold reduced pretax earnings by $11 million
for the first 39 weeks of 1993 and $37 million for the comparable period of
1992.
Selling, general and administrative expense for the 39 weeks ended October
27, 1993, was $5,567 million or 23.3% of sales, as compared to $4,994 million,
or 23.1% of sales, in the same period in the prior year. The increase as a
percent of sales resulted primarily from the effect of below-plan sales on fixed
expense.
Operating income from continuing retail operations for the 39 weeks ended
October 27, 1993, was $754 million, or 3.1% of sales, as compared to $826
million, or 3.9% of sales, in the same period in the prior year (see table
below). The decrease in operating income was due to lower LIFO gross margin and
an increase in selling, general and administrative expenses resulting from the
effect of below-plan sales on fixed expense.
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28,
OPERATING INCOME ($ MILLIONS) 1993 1992 %
- ---------------------------------------------------------------- ----------- ----------- -----
<S> <C> <C> <C>
Kmart Group:
United States................................................. $ 694 $ 766 (9.4)
International................................................. 16 16 --
----------- -----------
Total Kmart Group.......................................... 710 782 (9.2)
Specialty Retail Groups:
Borders-Walden Group.......................................... (13) (16) --
Builders Square Group......................................... 49 62 (21.0)
OfficeMax Group............................................... -- (5) --
The Sports Authority Group.................................... 8 3 166.7
----------- -----------
Total Specialty Retail Groups.............................. 44 44 --
----------- -----------
Consolidated.................................................... $ 754 $ 826 (8.7)
----------- -----------
----------- -----------
</TABLE>
Net interest expense for the 39 weeks ended October 27, 1993, was $369
million, or 1.5% of sales, as compared to $306 million, or 1.4% of sales, for
the same period in the prior year. The increase in interest expense was the
result of greater borrowings due to higher inventory levels in the 1993 period,
acquisitions made in 1992 and the acquisition of BizMart, Inc. in March 1993.
Income from continuing retail operations before income taxes for the 39
weeks ended October 27, 1993, was $439 million, or 1.8% of sales, as compared to
$569 million, or 2.7% of sales, in the same period last year.
Income tax expense for the 39 weeks ended October 27, 1993, was $152
million with an effective tax rate of 34.6% as compared to $188 million with an
effective tax rate of 33.0% in the same period of 1992. The increase in the rate
reflected the 1% increase in the federal corporate tax rate retroactive to
January 1, 1993, including the approximate $8 million effect on deferred tax
balances as required by Financial Accounting Standard No. 109.
Net income from continuing retail operations before extraordinary item and
the effect of accounting changes for the 39 weeks ended October 27, 1993, was
$287 million, or 1.2% of sales, as compared to $381 million, or 1.8% of sales,
in the same period last year.
Net loss from discontinued operations of the 39 weeks ended October 27,
1993, was $26 million, or (0.1%) of sales, as compared to net income of $25
million, or 0.1% of sales, in the same period in the prior year. 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 (see
Subsequent Events).
V-47
<PAGE> 196
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
Extraordinary item. 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 current enacted tax rate, 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 $77
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 were not material.
As the result of the foregoing factors, net income for the 39 weeks ended
October 27, 1993, was $219 million, or 0.9% of sales, as compared to $406
million, or 1.9% of sales, in the same period in the prior year.
Subsequent Events
The Board of Directors of Kmart Corporation (Board) has adopted a proposal
(the Specialty Retail Stock Proposal) which, if approved by stockholders 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 separately the
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 projects 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
Speciality Retail Groups.
V-48
<PAGE> 197
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes. Net of taxes, the charge was
approximately $850 million. The provision includes anticipated costs associated
with Kmart stores which will be closed, relocated, enlarged or refurbished in
the U.S. and Canada as well as the relocation of certain Builders Square stores
and the closing of underperforming Walden stores. These costs, which represent
approximately 85% of the total reserve, include the estimated lease obligations
for store closings and relocations as well as estimated fixed asset write-offs,
primarily furniture and fixtures and inventory dispositions for all affected
stores. The remainder of the reserve is for costs related to re-engineering
programs, a non-routine legal judgment and certain changes to Walden accounting
policies to prepare for combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% is for cost associated with Walden stores.
In December 1993, Kmart Corporation entered into a definitive agreement to
sell Kmart's Payless Drug Stores Northwest, Inc. subsidiary to TCH Corporation,
the parent company of Thrifty Corporation. Under the terms of the agreement, TCH
will provide the Kmart Group with consideration consisting of $592 million of
cash, assumption or refinancing of approximately $170 million of debt, $100
million in subordinated debt securities and common stock representing 47% of the
equity of TCH. It is anticipated that the transaction will be completed by the
end of the first quarter of 1994. Based upon estimates, which are still being
reviewed, an after-tax charge of approximately $110 million will be incurred in
the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after-tax
charge to earnings related to this transaction will approximate $400 million.
PayLess and PACE are presented as discontinued operations in the
consolidated financial statements and accompanying footnotes.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows generated by operating, investing and financing activities as
reported in the Consolidated Statements of Cash Flows for the 39 weeks ending
October 27, 1993, are summarized below. The net decrease in cash and equivalents
for the 39 weeks ended October 27, 1993, was $77 million as compared to a $12
million decrease in the same period in the prior year.
Net cash used for operations for the 39 weeks ended October 27, 1993, was
$471 million as compared to $683 million in the same period of 1992. This change
is primarily attributable to an increase in accounts payable resulting from an
improved ratio of merchandise payable to inventory offset by a decrease in
income from continuing retail operations before extraordinary item and the
effects of accounting changes and discontinued operations during the 39 weeks
ended October 27, 1993, in comparison to the same period in the prior year.
Merchandise inventories, which was primarily accounted for under the LIFO
method of inventory valuation, increased 9.1% to $10,517 million at October 27,
1993 from $9,638 million at October 28, 1992. This increase was largely the
result of the Borders and BizMart acquisitions, the Kmart store renewal program,
V-49
<PAGE> 198
KMART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
including new, relocated and enlarged stores, and aggressive new store opening
programs in the Specialty Retail Groups.
Net cash used for investing for the 39 weeks ended October 27, 1993, was
$1,116 million as compared to $1,484 million in the same period last year. This
decrease was due to lower planned capital expenditures as the company assessed
the potential impact of the Super Kmart Center program on its modernization
program and reduced acquisition expenditures.
Net cash provided by financing of $1,510 million during the 39 weeks ended
October 27, 1993 was attributable to a net increase in long-term debt and notes
payable of $1,925 million. The $2,155 million provided by financing during the
39 weeks ended October 28, 1992, was attributable to a $2,515 million net
increase in long-term debt and notes payable. The increases in notes payable
were due to the seasonal build-up of merchandise inventories and capital
expenditures for the store modernization program and acquisitions.
Kmart Corporation's working capital ratio was 1.5 at October 27, 1993, and
1.6 at October 28, 1992. Total working capital at October 27, 1993, was $3,918
million compared with $4,387 million at October 28, 1992, a decrease of $469
million.
V-50
<PAGE> 199
ANNEX VI
KMART GROUP
<TABLE>
<S> <C> <C>
VI-A: Selected Financial Data...................................................... VI- 2
VI-B: Management's Discussion and Analysis of Financial Condition and Results of
Operations for the Fiscal Year Ended January 27, 1993........................ VI- 3
VI-C: Business Description......................................................... VI-14
VI-D: Combined Financial Statements for the Fiscal Year Ended January 27, 1993..... VI-18
VI-E: Combined Financial Statements for the 39 Weeks Ended October 27, 1993........ VI-44
VI-F: Management's Discussion and Analysis of Financial Condition and Results of
Operations for the 39 Weeks Ended October 27, 1993........................... VI-49
</TABLE>
VI-1
<PAGE> 200
ANNEX VI-A
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 the Specialty Retail Stock pursuant to the
Specialty Retail Stock Proposal has not been reflected in these financial
statements.
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
-------------------------------------------------------
JAN. JAN. JAN. JAN. JAN.
26, 27, 29, 30, 31,
1994 1993 1992 1991 1990(1)
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (MILLIONS)
Sales....................................... $ $26,470 $25,548 $25,058 $24,865
Gross margin................................ 7,140 6,962 6,785 6,722
Selling, general and administrative
expenses.................................. 5,918 5,880 5,783 6,306
Operating income............................ 1,500 1,348 1,259 667
Interest expense -- net..................... 411 381 381 349
Income from continuing retail operations
before retained interest and income
taxes..................................... 1,194 1,077 991 423
Net income from continuing retail
operations(2)............................. 879 785 696 274
PERCENT OF SALES DATA
Gross margin................................ 27.0% 27.3% 27.1% 27.0%
Selling, general and administrative
expenses.................................. 22.4 23.0 23.1 25.4
Operating income............................ 5.7 5.3 5.0 2.7
Income from continuing retail operations
before retained interest and income
taxes..................................... 4.5 4.2 4.0 1.7
BALANCE SHEET DATA -- END OF PERIOD
(MILLIONS)
Working capital............................. $ $ 4,470 $ 4,108 $ 2,934 $ 3,164
Total assets................................ 17,869 15,354 13,456 12,721
Total debt.................................. 3,332 2,322 1,748 1,486
Kmart Group common equity................... 6,341 5,856 5,339 4,944
SELECTED FINANCIAL AND OPERATING DATA
End of year stores -- U.S. Kmart............ 2,282 2,249 2,205 2,194
Comparable store sales increase -- U.S.
Kmart..................................... 1.5% 2.2% 1.3% 2.0%
Weighted average sales per square foot --
U.S. Kmart................................ $ $ 181 $ 186 $ 189 $ 191
Capital expenditures -- owned property
(millions)................................ 1,297 1,245 750 569
Depreciation and amortization (millions).... 517 443 405 389
</TABLE>
- ------------------------
(1) Results of operations for fiscal 1989 include a pretax provision of $618
million for the restructuring of Kmart stores and other charges.
(2) Net income from continuing retail operations includes $ , $83, $66, $34 and
$31 in fiscal 1993, 1992, 1991, 1990 and 1989, respectively, of net income
related to Retained Interest in the Specialty Retail Groups.
VI-2
<PAGE> 201
ANNEX VI-B
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993
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 2,337 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. 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 was sold
in January 1994, each of which have been presented as discontinued operations in
the combined financial statements.
Fiscal Years Ended January 27, 1993 and January 29, 1992
RESULTS OF OPERATIONS
Sales increased 3.6% to a record $26.5 billion in 1992, compared to $25.5
billion in 1991. Comparable store sales increased 1.5% in 1992. 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 73.0% in 1992 and 72.7% in 1991. The 0.3% increase 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 1992, the
inflationary impact on inventories contributed to a pretax LIFO credit of $44
million, in contrast to a pretax charge of $8 million in 1991. The Kmart Group
measures inflation using internal price indices. The 1992 LIFO credit and lower
1991 LIFO charge resulted from reductions in the Kmart Group's retail prices.
Selling, general and administrative expenses, including advertising, were
22.4% of sales in 1992 and 23.0% in 1991. The 1992 decrease in selling, general
and administrative expense relative to sales was due to improved expense control
primarily in the U.S. Kmart stores division and lower advertising expense in
1992. As a percent of sales, employee compensation and benefits were 15.2% and
15.4% in 1992 and 1991, respectively.
Net interest expense reflects the following components:
<TABLE>
<CAPTION>
($ MILLIONS) 1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Interest Expense on Debt................................................ $ $256 $218
Interest Income......................................................... (25) (14)
---- ---- ----
Net Interest Expense on Debt....................................... $ $231 $204
---- ---- ----
---- ---- ----
</TABLE>
VI-3
<PAGE> 202
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
The increase in net interest expense 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 Group's weighted average
interest rates on total debt were 7.6% in 1992 and 8.5% in 1991. Weighted
average interest rates for short-term borrowings were 3.6% in 1992 and 6.1% in
1991.
Income from continuing retail operations before retained interests in the
Specialty Retail Groups and income taxes for the year was $1,194 million, or
4.5% of sales, as compared to $1,077 million, or 4.2% of sales, in 1991.
Net income related to retained interests in the Specialty Retail Groups was
$83 million and $66 million in 1992 and 1991, respectively.
Income tax expense in 1992 was $398 million with an effective tax rate of
33.3% as compared to $358 million with an effective tax rate of 33.3% in 1991.
Refer to the accompanying Notes to Combined Financial Statements for further
information regarding income taxes.
Net income from continuing retail operations in 1992 was $879 million, or
3.3% of sales, as compared to $785 million, or 3.1% of sales, in the prior year.
Net income from discontinued operations in 1992 was $59 million as compared
to net income of $70 million in the prior year. 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 (see Subsequent Events).
Net income for the year was $938 million, an increase of 9.7% from 1991 net
income of $855 million. Net income increased in 1992 due to improved sales and a
significant emphasis on cost control, partially offset by reduced earnings at
PACE and a one-time charge of $12 million, net of tax, related to the Kmart
Group's guarantee of certain Bargain Harold's leases.
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.
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 contain
additional information regarding the Combined Statements of Cash Flows.
Net cash provided by operations was $656 million, compared with $981
million in 1991. 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.
In U.S. Kmart stores, 1992 inventory increased 8.0% over 1991. 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.
VI-4
<PAGE> 203
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
Net cash used for investing was $1,652 million in 1992 and $1,233 million
in 1991. Cash used for investing was primarily comprised of capital expenditures
for owned property and, in 1992, the acquisition of Pay 'n Save assets and the
purchase of 13 department stores in the Czech Republic and Slovakia. Capital
expenditures for the general-merchandise operations, which included new
distribution centers, refurbishments, expansions and store openings, were $1,110
million and $1,035 million in 1992 and 1991, respectively. The increases in
capital expenditures in 1992 and 1991 were due to the Kmart store modernization
program. Net cash used for 1992 acquisitions totaled $300 million.
The Kmart Group is integrating the new Super Kmart Center concept into the
U.S. Kmart store modernization program. 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
in 1993, are expected to approximate 1992 levels in 1994 and will subsequently
increase again in 1995. The Kmart store modernization program is expected to be
substantially complete in 1996.
Net cash provided by financing was $1,050 million in 1992 and $489 million
in 1991. 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 1992 and
1991 were $1,136 million and $1,093 million, respectively. The maximum amount of
aggregate short-term borrowings outstanding during 1992 was $2,371 million,
compared with $1,509 million in 1991. Total short-term lines of credit available
and unused were $1,339 million at the end of 1992 and $789 million at the end of
1991.
Total Kmart Corporation dividends paid, which have been attributed to the
Kmart Group, during 1992 were $448 million, compared with $375 million in 1991.
Dividends paid per Kmart Corporation common share were $.91 and $.87 in 1992 and
1991, respectively. Dividends paid in 1992 and 1991 per $3.41 Depositary Share
(each representing one-quarter share of Series A conversion preferred stock)
were $3.41 and $1.06, respectively. Dividends paid per Series B convertible
preferred stock were $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 statement of the
Specialty Retail 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 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 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 equity
investment in such Specialty Retail Group.
If the Specialty Retail Stock Proposal is approved by stockholders and
implemented by the Board, all debt incurred or preferred stock issued by Kmart
Corporation and its subsidiaries would be specifically
VI-5
<PAGE> 204
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
attributed to and reflected on the financial statements of the Kmart Group,
unless otherwise determined by the Board of Directors.
Following the issuance of each series of stock 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 the excess cash to the Kmart Group. Such transfers would
generally be made as short-term loans, unless the Board of Directors determined
that any such transfer should be made as a long-term loan or, in the case of a
transfer of funds from the Kmart Group to a Specialty Retail Group, as an equity
contribution as described below. 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 of Directors 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 issuance of a series of Specialty Retail
Stock, the Board of Directors 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 contribution, (i) as a result of which 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 each Group, the
capital expenditure plans of each Group, the 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 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 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 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.
VI-6
<PAGE> 205
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
CAPITAL STRUCTURE
The following three-year analysis of the capital structure summarizes the
Kmart Group's total attributed debt and equivalents and total capitalization:
<TABLE>
<CAPTION>
($ MILLIONS) 1993 % 1992 % 1991 %
- -------------------------------------------- ------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Long-term debt due within one year.......... $ $ 117 0.9 $ 39 0.4
Capital lease obligations due within one
year...................................... 109 0.8 104 0.9
Notes payable............................... 590 4.4 -- --
Long-term debt.............................. 3,215 23.7 2,283 20.3
Capital lease obligations and other......... 1,803 13.3 1,769 15.7
------- ----- ------- ----- ------- -----
Total debt and equivalent................. 5,834 43.1 4,195 37.3
------- ----- ------- ----- ------- -----
Deferred income taxes....................... 231 1.7 198 1.8
Kmart Group equity.......................... 7,484 55.2 6,842 60.9
------- ----- ------- ----- ------- -----
Total capitalization...................... $ $13,549 100.0 $11,235 100.0
------- ----- ------- ----- ------- -----
------- ----- ------- ----- ------- -----
</TABLE>
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. 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. 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 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. 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. Net proceeds totaled $986 million.
FINANCIAL OBJECTIVE
The Kmart Group's financial policy is designed to provide the Kmart Group
and its shareholders with an optimum return on investment, a solid capital
structure and a high degree of financial flexibility. Obtaining optimum return
on investment requires deployment of the Kmart Group's assets and resources
where they will provide the best long-term return. In seeking optimum return,
the Kmart Group's management continues to focus on high growth retail businesses
including potential retail investment opportunities, both domestically and
internationally, in addition to funding an improved merchandise mix, the
refurbishment, relocation and expansion of existing U.S. Kmart stores. In
addition, Kmart management sold or closed Kmart stores which did not generate
sufficient returns. The Kmart Group's management expects that future funding
required to finance refurbishment of existing stores, future expansions and
relocations, and growth will be provided primarily by internally generated
funds, additional debt and equity offerings, the sale and leaseback or
mortgaging of owned properties and the leasing of land and buildings.
ANALYSIS OF KMART GROUP OPERATIONS
At January 26, 1994, the Kmart Group consisted of both domestic and
international operations. A total of 2,337 Kmart stores were located in the
United States and Puerto Rico, including 19 Super Kmart Centers, all
VI-7
<PAGE> 206
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
in the United States. The Kmart Group's international operations include 128
Kmart stores in Canada and 13 stores in the Czech Republic and Slovakia.
A three-year summary of the Kmart Group's sales and operating income
follows:
<TABLE>
<CAPTION>
% %
(MILLIONS U.S.$) 1993 CHANGE 1992 CHANGE 1991
- -------------------------------------------------- ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C>
Sales
United States................................... $ $25,326 3.4 $24,488
International................................... 1,144 7.9 1,060
------- ------- -------
Total Sales.................................. $ $26,470 3.6 $25,548
------- ------- -------
------- ------- -------
Operating Income
United States................................... $ $ 1,454 9.8 $ 1,325
International................................... 46 -- 23
------- ------- -------
Total Operating Income....................... $ $ 1,500 11.4 $ 1,348
------- ------- -------
------- ------- -------
Capital Expenditures -- Owned Property............ $ $ 1,110 $ 1,035
------- ------- -------
------- ------- -------
Capital Expenditures -- Discontinued Operations... $ $ 187 $ 210
------- ------- -------
------- ------- -------
</TABLE>
U.S. General Merchandise Operations
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
$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 1992.
Domestic Kmart store operating income increased 9.8% to $1,454 million in
1992 due primarily to an increased emphasis on cost control, which included the
Kmart Group's 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, Christmas
remembrance and changed 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 1992, new Super Kmart Centers produced encouraging results. These
150,000 to 185,000-square-foot stores feature a full line of Kmart store's
general merchandise and groceries. At January 26, 1994, 19 Super Kmart Centers
were in operation, including two American Fare stores which were converted to
Super Kmart Centers during 1992. Within the context of the store modernization
program, the Kmart Group is analyzing the remaining stores to be updated as
potential relocations for Super Kmart Centers. The Kmart Group completed
approximately 200 store modernization projects during 1993. There is potential
to open
VI-8
<PAGE> 207
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
several hundred Super Kmart Centers over the next five to seven years. Activity
for the U.S. Kmart store modernization program for the past three years is
summarized in the following table:
<TABLE>
<CAPTION>
TOTAL 1994
1991 1992 1993 COMPLETE PLAN
---- ---- ---- -------- ----
<S> <C> <C> <C> <C> <C>
New stores............................................... 55 45
Store relocations........................................ 51 73
Store expansions......................................... 164 122
Store refurbishments..................................... 204 208
---- ---- ---- -------- ----
Totals.............................................. 474 448
---- ---- ---- -------- ----
---- ---- ---- -------- ----
</TABLE>
International General Merchandise Operations
International operations consist primarily of 128 Kmart stores in Canada
and 13 department stores located in the Czech Republic and Slovakia at January
26, 1994. The Central European stores were acquired in mid-1992 and represent
the Kmart's Group's entry into that market. The Kmart Group is developing
advanced distribution and merchandising skills to modernize, refurbish and
streamline operations in the two Central European countries.
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 impacted by a strong Christmas season partially offset by weak
economic conditions. Results in U.S. dollars were adversely affected by
deterioration of the Canadian exchange rate throughout the year. Czech Republic
and Slovak operations were profitable in 1992, and 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
0.8226 in 1992 and 0.8708 in 1991.
As part of its international expansion strategy, the Kmart Group has formed
joint ventures in Mexico and Singapore and expects to open stores in these
countries in 1994.
The following table highlights the Kmart Group's store activity during
1993:
<TABLE>
<CAPTION>
1993 ACTIVITY PLANNED
END END ------------------------------------ END
1991 1992 ACQUIRED OPENED CLOSED END 1994
----- ----- -------- ------ ------ ---- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Kmart Group
United States.......................... 2,249 2,282
Canada................................. 126 127
Czech Republic and Slovakia.............. -- 13
Other.................................... 16 13
----- ----- -------- ------ ------ ---- -------
Total Kmart Group................... 2,391 2,435
----- ----- -------- ------ ------ ---- -------
----- ----- -------- ------ ------ ---- -------
Kmart Group Selling Square Feet
(millions)............................. 151 159
--- --- ----
--- --- ----
Kmart Group Store Sales per Square
Foot................................... $184 $179 $
---- ---- ----
---- ---- ----
</TABLE>
RETAINED INTERESTS IN SPECIALTY RETAIL GROUPS
At January 26, 1994, the Kmart Group was included a 100% retained interest
in each of the following: the Borders-Walden Group, the Builders Square Group,
the OfficeMax Group, and The Sports Authority Group.
VI-9
<PAGE> 208
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
This Retained Interest is accounted for under the equity method. The Specialty
Retail Groups continued their aggressive store expansion programs 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.................. 1,275 1,291
Builders Square Group................. 144 165
OfficeMax Group....................... 79 179
The Sports Authority Group............ 36 56
----- ----- -------- ------ ------ ------ -------
Total Specialty Retail Groups.... 1,534 1,691
----- ----- -------- ------ ------ ------ -------
----- ----- -------- ------ ------ ------ -------
Specialty Retail Groups' Selling
Square Feet (Millions).............. 17 22
-- --
-- --
</TABLE>
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................................................. $ $4,543 $3,495 30.0
------ ------ ------
------ ------ ------
Operating Income...................................... $ $ 133 $ 109 22.0
------ ------ ------
------ ------ ------
Comparable Store Sales Increase....................... % 6.5% 6.9%
--- --- ---
--- --- ---
Capital Expenditures -- Owned Property................ $ $ 133 $ 85
------ ------ ------
------ ------ ------
</TABLE>
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 operating income for the Specialty Retail Groups increased
22.0% from $109 in 1991 to $133 in 1992 due to new and acquired stores and
improved operating leverage.
Borders-Walden Group
Borders-Walden Group is a leading book retailer in the United States, and
is comprised of Borders, Inc. ("Borders") and Walden Book Company, Inc.
("Walden"). As of January 23, 1994 Borders operated 44 large format superstores
in 21 states and the District of Columbia, each of which is designed to be the
premier book retailer in its market, and Walden, which is the largest operator
of mall-based bookstores in the United States, operated 1,159 stores in 50
states and the District of Columbia.
Borders-Walden Group's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales................................................... $ $1,184 $1,140 3.9
------ ------ ------
------ ------ ------
Operating Income........................................ $ $ 42 $ 31 35.5
------ ------ ------
------ ------ ------
Comparable Store Sales Increase
Borders............................................... % 12.6% --%
--- --- ---
--- --- ---
Walden................................................ % 1.4% 5.8%
--- --- ---
--- --- ---
</TABLE>
Sales of Borders-Walden Group 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
partially offset by an
VI-10
<PAGE> 209
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
approximately $18 million reduction in net sales resulting from one less
reporting week in 1992 at Walden due to a change in year-end dates.
Operating income of Borders-Walden Group in 1992 was $42 million, or 3.5%
of sales, as compared to $31 million, or 2.7% of sales, in 1991, primarily as a
result of increased sales and gross margin, partially offset by higher selling,
general and administrative expenses.
Builders Square Group
The Builders Square Group is a leading specialty retailer of home
improvement and home decor products and services in the United States, operating
177 stores in 26 states and Puerto Rico at January 23, 1994.
Builders Square Group's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
------------
1993 1992 1991 1993 1992
------ ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Sales................................................... $ $2,419 $2,049 18.1
------ ------ ------
------ ------ ------
Operating Income........................................ $ $ 80 $ 74 8.1
------ ------ ------
------ ------ ------
Comparable Store Sales Increase......................... % 8.5% 7.0%
------ ------ ------
------ ------ ------
</TABLE>
Sales of Builders Square Group 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 8 Builders
Square 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 the prior year closing of 14 underperforming stores,
partially offset by a $10 million LIFO charge in 1992 as compared to a LIFO
credit of $2 million in 1991 and increased pre-opening expense.
OfficeMax Group
The OfficeMax Group is one of the largest operators of high-volume, deep
discount office products superstores in the United States, operating 328
superstores in 38 states as of January 23, 1994.
On June 30, 1992, OfficeMax, Inc. acquired OW Office Warehouse, Inc., a
41-store office products superstore chain with stores located primarily
throughout the Mid-Atlantic region, and, on March 4, 1993, OfficeMax acquired
BizMart, Inc., a 105-store national office products superstore chain with stores
located primarily in the Southwest, West and Pacific Northwest regions.
Immediately following each of these acquisitions, OfficeMax operationally
integrated, remodeled, remerchandised and converted the acquired stores to the
OfficeMax name and format.
In November, 1990, Kmart Corporation acquired an initial 21.6% equity
interest in OfficeMax, Inc., and increased its equity interest in OfficeMax to
92.7% in November 1991. Kmart has consolidated the results of OfficeMax
operations from November 21, 1991. Kmart Corporation currently has a %
interest in OfficeMax, Inc.
VI-11
<PAGE> 210
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
OfficeMax Group's results of operations from the November 21, 1991 date of
acquisition follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
----------------
1993 1992 1991 1993 1992
------ ---- ---- ------ ------
<S> <C> <C> <C> <C> <C>
Sales.................................................. $ $528 $ 65 --
------ ---- ----
------ ---- ----
Operating Income....................................... $ $ 1 $ 1 --
------ ---- ----
------ ---- ----
Comparable Store Sales Increase........................ 28.5% N/A
------ ---- ----
------ ---- ----
</TABLE>
The 1992 OfficeMax Group sales increase was due to the inclusion of a full
year of operations and 102 new stores, including 41 OW Office Warehouse, Inc.
stores acquired on June 30, 1992. OfficeMax recorded $1 million operating income
despite higher store opening costs resulting from an aggressive expansion
program during the year. On a proforma basis, OfficeMax Group comparable store
sales increased 28.5% in 1992.
The Sports Authority Group
The Sports Authority Group is the largest operator of large format sporting
goods stores in the United States in terms of both net sales and number of
stores and the largest full-line sporting goods retailer in the United States in
terms of net sales, operating 80 sporting goods megastores throughout the United
States as of January 23, 1994.
The Sports Authority Group's results of operations for the last three years
follow ($ millions):
<TABLE>
<CAPTION>
% CHANGE
---------------
1993 1992 1991 1993 1992
------ ---- ---- ------ -----
<S> <C> <C> <C> <C> <C>
Sales................................................... $ $412 $241 70.8
------ ---- ----
------ ---- ----
Operating Income........................................ $ $ 10 $ 3 --
------ ---- ----
------ ---- ----
Comparable Store Sales Increase......................... 8.3% 15.3%
------ ---- ----
------ ---- ----
</TABLE>
Sales of The Sports Authority Group 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 $77 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.
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
The Kmart Group holds a 21.3% 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, 1992 equity in income of Coles Myer was $51 million,
compared with $60 million in 1991. 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-12
<PAGE> 211
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 27, 1993 -- CONTINUED
Meldisco equity income in 1992 was $54 million, compared with $50 million
in 1991. In 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 the Kmart Group's equity investments.
SUBSEQUENT EVENTS
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes, of which approximately $870
million is attributed to the Kmart Group. Net of taxes, the charge was
approximately $850 million, of which approximately $565 million is attributed to
the Kmart Group. The provision includes anticipated costs associated with Kmart
stores which will be closed, relocated, enlarged or refurbished in the U.S. and
Canada as well as the relocation of certain Builders Square stores and the
closing of underperforming Walden stores. These costs, which represent
approximately 85% of the total reserve, include the estimated lease obligations
for store closings and relocations as well as estimated fixed asset write-offs,
primarily furniture and fixtures and inventory dispositions for all affected
stores. The remainder of the reserve is for costs related to re-engineering
programs, a non-routine legal judgment and certain changes to Walden's
accounting policies to prepare for combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% is for costs associated with Walden stores.
In December 1993, Kmart Corporation entered into a definitive agreement,
attributed to the Kmart Group, to sell Kmart's PayLess Drug Stores Northwest,
Inc. subsidiary to TCH Corporation, the parent company of Thrifty Corporation.
Under the terms of the agreement, TCH will provide the Kmart Group with
consideration consisting of $592 million of cash, assumption or refinancing of
approximately $170 million of debt, $100 million in subordinated debt securities
and common stock representing 47% of the equity of TCH. It is anticipated that
the transaction will be completed by the end of the first quarter of 1994. Based
upon estimates, which are still being reviewed, an after-tax charge of
approximately $110 million will be incurred in the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after-tax
charge to earnings related to this transaction will approximate $400 million.
PayLess and PACE are presented as discontinued operations in the combined
financial statements and accompanying notes.
VI-13
<PAGE> 212
ANNEX VI-C
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 2,337 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 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 was sold in January, 1994.
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 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, % of the U.S. Kmart Stores had been updated to this new
format, including 300 relocations, 430 expansions and 450 refurbishments.
During 1993, Kmart integrated the new Super K Center concept into its
modernization program and opened four 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. While
VI-14
<PAGE> 213
Kmart 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 2,337 Kmart Stores including 19 Super
Kmart 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 142 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 14 remaining S.S. Kresge stores. As of the
end of fiscal 1993, Kmart Canada had modernized 24 of the 128 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, 1993 operated 44 large
format book superstores, in 21 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
Appendix 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
Appendix 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 23, 1994. See Appendix IX.
- 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 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 Appendix X.
VI-15
<PAGE> 214
Businesses Subject to Disposition
In December 1993, Kmart Corporation entered into a definitive agreement,
attributed to the Kmart Group, to sell PayLess Drug Stores Northwest, Inc.
subsidiary to TCH Corporation, the parent company of Thrifty Corporation. Under
the terms of the agreement, TCH will provide the Kmart Group with consideration
consisting of $592 million of cash, assumption or refinancing of approximately
$170 million of debt, $100 million in subordinated debt securities and common
stock representing 47% of the equity of TCH. It is anticipated that the
transaction will be completed by the end of the first quarter of 1994. Based
upon estimates which are still being reviewed, an after-tax charge of
approximately $110 million will be incurred in the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in Janaury
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after-tax
charge to earnings related to this transaction will approximate $400 million.
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 21.3% 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.
STORE LOCATIONS
At January 26, 1994, the Kmart Group operated a total of 2,478 general
merchandise stores: 2,337 in the United States and Puerto Rico, 128 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 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.
VI-16
<PAGE> 215
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 USA. Kmart Corporation is the executive licensee of Kmart Corporation to use
these marks in the U.S.A. Whenever possible, Kmart Properties 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 materially affect the financial condition of Kmart
Group.
VI-17
<PAGE> 216
ANNEX VI-D
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
Chairman of the Board, President
and Chief Executive Officer
Thomas F. Murasky
Executive Vice President
and Chief Financial Officer
VI-18
<PAGE> 217
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 27, 1993, and the
results of their operations and their cash flows for each of the two years in
the period ended January 27, 1993, 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.
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
January 31, 1994
VI-19
<PAGE> 218
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........................................................ $ $26,470 $25,548
Licensee fees and rental income.............................. 278 266
Equity in income of affiliated retail companies.............. 105 110
----------- ----------- -----------
26,853 25,924
----------- ----------- -----------
Cost of merchandise sold, includes buying and occupancy
costs...................................................... 19,330 18,586
Selling, general and administrative expenses................. 5,918 5,880
Interest:
Debt -- expense............................................ 256 218
-- income............................................ (25) (14)
Capital lease obligations -- expense....................... 180 177
----------- ----------- -----------
25,659 24,847
----------- ----------- -----------
Income from continuing retail operations before retained
interests in the Specialty Retail Groups and income
taxes...................................................... 1,194 1,077
Net income related to retained interests in the Specialty
Retail Groups.............................................. 83 66
Income taxes................................................. 398 358
----------- ----------- -----------
Net income from continuing retail operations................. 879 785
Discontinued operations...................................... 59 70
----------- ----------- -----------
Net income................................................... $ $ 938 $ 855
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure (unaudited):
Earnings Per Kmart Group common and common equivalent Share
Net income from continuing retail operations............... $ $1.92 $1.84
Discontinued operations.................................... .13 .17
----- ----- -----
$ $2.05 $2.01
----- ----- -----
----- ----- -----
Net income................................................. $ $938 $855
----- ----- -----
Less: goodwill amortization of Specialty Retail Groups..... -- --
----- ----- -----
Kmart Corporation earnings attributable to the Kmart
Group................................................... $ $938 $855
----- ----- -----
----- ----- -----
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-20
<PAGE> 219
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 $260)........................ $ $ 542
Merchandise inventories.............................................. 7,557
Accounts receivable and other current assets......................... 1,019
----------- -----------
Total current assets................................................... 9,118
Retained interests in Specialty Retail Groups.......................... 1,412
Investments in Affiliated Retail Companies............................. 597
Property Owned:
Land................................................................. 190
Buildings............................................................ 603
Leasehold improvements............................................... 1,466
Furniture and fixtures............................................... 5,070
Construction in progress............................................. 59
Property under capital leases.......................................... 2,793
----------- -----------
10,181
Less-accumulated depreciation and amortization:
Property owned....................................................... (2,917)
Property under capital leases........................................ (1,404)
----------- -----------
Total Owned and Leased Property........................................ 5,860
Other Assets and Deferred Charges...................................... 373
Goodwill -- net of accumulated amortization of $52..................... 509
----------- -----------
$ $17,869
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ $ 117
Notes payable........................................................ 590
Accounts payable -- trade............................................ 2,377
Accrued payrolls and other liabilities............................... 1,005
Taxes other than income taxes........................................ 344
Income taxes......................................................... 215
----------- -----------
Total current liabilities.............................................. 4,648
Capital Lease Obligations.............................................. 1,639
Long-Term Debt......................................................... 3,215
Other Long-Term Liabilities (includes restructuring obligations)....... 652
Deferred Income Taxes.................................................. 231
Equity:
Preferred Stock Series A, 5,750,000 shares authorized and
issued........................................................... 986
Preferred Stock Series B, 796,827 authorized; 784,938 shares
issued........................................................... 157
Kmart Group Common Equity.............................................. 6,341
----------- -----------
Total Kmart Group Equity............................................... 7,484
----------- -----------
$ $17,869
----------- -----------
----------- -----------
Supplemental disclosure (unaudited):
Kmart Group Common Equity......................................... $ $ 6,341
Less accumulated goodwill amortization of Specialty Retail
Groups...........................................................
----------- -----------
Kmart Corporation equity attributable to the Kmart Group.......... $ $ 6,341
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-21
<PAGE> 220
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 from continuing retail operations.......... $ $ 879 $ 785
Adjustments to reconcile net income to operating cash
flows:
Net income related to retained interests in the
Specialty Retail Groups............................. (83) (66)
Depreciation and amortization....................... 517 443
Restructuring of Kmart stores and other charges..... (27) (44)
Deferred income taxes............................... 149 111
Undistributed equity income......................... (11) (26)
Increase (decrease) in other long-term
liabilities...................................... 63 (6)
Other -- net........................................ 54 78
Cash provided by (used for) current assets and current
liabilities:
Increase in inventories............................. (724) (581)
Increase (decrease) in accounts payable............. (22) 308
Other -- net........................................ (283) (171)
------------ ------------ ------------
Total cash provided by continuing retail
operations..................................... 512 831
------------ ------------ ------------
Discontinued Operations
Income from discontinued operations................. 59 70
Items not affecting cash -- net..................... 85 80
------------ ------------ ------------
Total cash provided by discontinued operations... 144 150
------------ ------------ ------------
Net cash provided by operations....................... 656 981
------------ ------------ ------------
INVESTING
Capital expenditures -- owned property................ (1,297) (1,245)
Acquisitions.......................................... (300) --
Proceeds from the sale of assets...................... 25 69
Net equity transactions with the Specialty Retail
Groups.............................................. (29) (12)
Other -- net.......................................... (51) (45)
------------ ------------ ------------
Net cash used for investing........................... (1,652) (1,233)
------------ ------------ ------------
FINANCING
Proceeds from issuance of long-term debt and notes
payable............................................. 1,589 811
Reduction in long-term debt and notes payable......... (46) (896)
Reduction in capital lease obligations................ (110) (106)
Issuance of common stock.............................. 57 67
Issuance of $3.41 Depositary Shares (each representing
1/4 share Series A conversion preferred)............ -- 986
Reissuance of treasury shares......................... 8 2
Dividends paid........................................ (448) (375)
------------ ------------ ------------
Net cash provided by financing........................ 1,050 489
------------ ------------ ------------
NET INCREASE IN CASH AND EQUIVALENTS..................... 54 237
Cash and Equivalents at Beginning of Year............. 488 251
------------ ------------ ------------
CASH AND EQUIVALENTS AT END OF YEAR...................... $ $ 542 $ 488
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-22
<PAGE> 221
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 stockholders 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 separately the
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, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the first 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 separately the performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) an interest in each Specialty Retail Group (a Retained Interest) other than
the interest represented by any outstanding shares of any 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 stockholders 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 to the
public for cash in separate offerings (collectively, the Offerings). The timing,
sequence and size of such Offerings and the price at which such shares would be
sold would be determined by the Board at the time of each Offering based upon
then prevailing market and other conditions; however, it is currently
contemplated that Kmart Corporation would 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 the Kmart Corporation
would retain and attribute to the Kmart Group a 70% to 80% Retained Interest in
each such Specialty Retail Group. 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 Kmart Corporation. 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 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
VI-23
<PAGE> 222
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Retail Stock Proposal. 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, accounted for
under the equity method. 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 stockholders 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), 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 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.
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.
If the Specialty Retail Stock Proposal is implemented, the initial dividend
policy applicable to the Kmart Stock would be consistent with the existing
dividend policy on Kmart Corporation common stock. Determinations to pay
dividends on Kmart Stock would continue to 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 the Kmart Stock dividends
on the 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.
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 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 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.
VI-24
<PAGE> 223
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 Kmart Group includes all majority owned
subsidiaries, except that the Specialty Retail Groups have been accounted for as
Retained Interest under the equity method, in the combined 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: Historical earnings per
share are omitted from the statement 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 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 Kmart
Corporation may be more or less than these amounts. Kmart Corporation 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 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 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.
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 70-80% Retained Interest in each Specialty Retail Group. The book
value associated with
VI-25
<PAGE> 224
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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. 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. The Kmart Group's Retained Interest in the
Specialty Retail Groups is shown in these historical financial statements under
the equity method of accounting.
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%-4% for buildings, 10%-14% for store fixtures and 5%-33% for
other fixtures and equipment. Accumulated depreciation for owned property
includes $ and $99 of the Kmart Group restructuring provision as of January 26,
1994 and January 27, 1993, 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.
Financial Instruments: With the exception of long-term debt, shareholders'
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 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 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
VI-26
<PAGE> 225
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
has been characterized as an adjustment of the Kmart Group's equity investment
(reflected as Retained Interest) in such Group in such historical financial
statements. Accordingly, no interest expense (other than in connection with
certain mortgages and capital leases) or 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 equity investment in such Specialty Retail
Group.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
Following the issuance of each series of Specialty Retail Stock 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 the excess cash to the Kmart Group. Such transfers
would generally be made as short-term loans, unless the Board of Directors
determined that any such transfer should be made as a long-term loan or, in the
case of a transfer of funds from the Kmart Group to a Specialty Retail Group, as
an equity contribution as described below. 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 of Directors
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 issuance of a series of Specialty Retail
Stock, the Board of Directors 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 contribution, 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 each Group, the
long-term business prospects for each Group, the capital expenditure plans of
each Group, the 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 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 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 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
VI-27
<PAGE> 226
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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.
Certain corporate, general and administrative costs (including certain
corporate borrowing, legal, tax, transportation and import, data processing,
employee benefit and self-insurance costs) would be 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 management of the Specialty Retail Groups would be 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 non-permanent differences between
financial statement and taxable income.
SUPPLEMENTAL DISCLOSURE -- KMART CORPORATION EQUITY ATTRIBUTABLE TO KMART GROUP
Kmart Corporation earnings attributable to 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 23, 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
VI-28
<PAGE> 227
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
amounts were deducted from the net income of the Kmart Group in arriving at
Kmart Corporation earnings attributable to 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 Kmart Group
following the initial issuance of shares of Specialty Retail Stock.
Kmart Corporation equity attributable to Kmart Group is Kmart Group Common
Equity for any period determined in accordance with generally accepted
accounting principles in effect at such time, 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 January 26, 1994 and
January 23, 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
Kmart Group Equity in arriving at Kmart Corporation equity attributable to 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 Kmart Group following the initial issuance of
shares of Specialty Retail Stock.
The method of calculating Kmart Corporation earnings attributable to Kmart
Group and Kmart Corporation equity attributable to Kmart Group reflects the
terms of the Certificate of Amendment which provide that the Kmart Group's
Available Dividend Amount, which, in turn, reflected the separately reported
Kmart Corporation Earnings Attributable to the Kmart Group, would be the source
for payment of dividends on Kmart Stock.
SUBSEQUENT EVENTS
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes of which approximately $870
is attributed to the Kmart Group. Net of taxes, the charge was approximately
$850 of which approximately $565 is attributed to the Kmart Group. The provision
includes anticipated costs associated with Kmart stores which will be closed,
relocated, enlarged or refurbished in the U.S. and Canada as well as the
relocation of certain Builders Square stores and the closing of underperforming
Walden stores. These costs, which represent approximately 85% of the total
reserve, include the estimated lease obligations for store closings and
relocations as well as estimated fixed asset write-offs, primarily furniture and
fixtures and inventory dispositions for all affected stores. The remainder of
the reserve is for costs related to re-engineering programs, a non-routine legal
judgment and certain changes to Walden accounting policies to prepare for
combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% is for costs associated with Walden stores.
In December 1993, Kmart Corporation entered into a definitive agreement,
attributed to the Kmart Group, to sell Kmart's PayLess Drug Stores Northwest,
Inc. subsidiary to TCH Corporation, the parent company of Thrifty Corporation.
Under the terms of the agreement, TCH will provide the Kmart Group with
VI-29
<PAGE> 228
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
consideration consisting of $592 of cash, assumption or refinancing of
approximately $170 of debt, $100 in subordinated debt securities and common
stock representing 47% of the equity of TCH. It is anticipated that the
transaction will be completed by the end of the first quarter of 1994. Based
upon estimates, which are still being reviewed, an after-tax charge of
approximately $110 will be incurred in the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after-tax
charge to earnings related to this transaction will approximate $400.
PayLess and PACE are presented as discontinued operations in the combined
financial statements and accompanying footnotes.
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 $ , $155 and $149 in 1993, 1992 and 1991,
respectively. Noncash charges related to store restructuring were $ , $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.
Cash paid for interest and income taxes follows:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Interest (net of amounts capitalized)..................... $ $438 $407
---- ---- ----
---- ---- ----
Income taxes.............................................. $ $285 $235
---- ---- ----
---- ---- ----
</TABLE>
MERCHANDISE INVENTORIES
For LIFO purposes, the Kmart Group uses internal price indices to measure
inflation in merchandise inventories.
VI-30
<PAGE> 229
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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..................................................... $ $ 6,553
First-in, first-out.................................................... 1,004
----------- -----------
Total inventories................................................. $ $ 7,557
----------- -----------
----------- -----------
Excess of current cost over stated LIFO value.......................... $ $ 937
----------- -----------
----------- -----------
</TABLE>
RETAINED INTERESTS IN 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, JANUARY 24, FEBRUARY 1,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Equity in income............................................. $ $23.1 $16.7
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The Borders-Walden Group summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, FEBRUARY 1,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $ $ 1,183.7 $ 1,140.1
----------- ----------- -----------
----------- ----------- -----------
Operating income............................................. $ $ 42.2 $ 31.1
----------- ----------- -----------
----------- ----------- -----------
Net income................................................... $ $ 23.1 $ 16.7
----------- ----------- -----------
----------- ----------- -----------
Inventory.................................................... $ $ 387.9 $ 328.8
Other current assets......................................... 41.9 30.2
Noncurrent assets............................................ 442.4 261.0
----------- ----------- -----------
Total assets............................................ 872.2 620.0
Current liabilities.......................................... 310.3 199.0
Noncurrent liabilities....................................... 40.8 32.9
----------- ----------- -----------
Borders-Walden Group equity.................................. $ $ 521.1 $ 388.1
----------- ----------- -----------
----------- ----------- -----------
Retained Interest of the Kmart Group......................... $ $ 521.1 $ 388.1
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
VI-31
<PAGE> 230
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Equity in income............................................. $ $54.9 $47.0
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The Builders Square Group summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $ $ 2,419.5 $ 2,048.5
----------- ----------- -----------
----------- ----------- -----------
Operating income............................................. $ $ 80.0 $ 73.8
----------- ----------- -----------
----------- ----------- -----------
Net income................................................... $ $ 54.9 $ 47.0
----------- ----------- -----------
----------- ----------- -----------
Inventory.................................................... $ $ 512.1 $ 410.3
Other current assets......................................... 110.9 75.2
Noncurrent assets............................................ 253.8 194.3
----------- ----------- -----------
Total assets............................................ 876.8 679.8
Current liabilities.......................................... 283.6 175.0
Noncurrent liabilities....................................... 99.3 57.9
----------- ----------- -----------
Builders Square Group equity................................. $ $ 493.9 $ 446.9
----------- ----------- -----------
----------- ----------- -----------
Retained Interest of the Kmart Group......................... $ $ 493.9 $ 446.9
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
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 23, 1994.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------- 9 WEEKS ENDED
JANUARY 22, JANUARY 23, JANUARY 25,
1994 1993 1992
----------- ----------- -------------
<S> <C> <C> <C>
Equity in income (loss)................................... $ $(0.8) $ 0.9
----------- ----------- -----
----------- ----------- -----
</TABLE>
VI-32
<PAGE> 231
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The OfficeMax Group's summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED 9 WEEKS
-------------------------- ENDED
JANUARY 22, JANUARY 23, JANUARY 25,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $ $ 528.2 $ 65.1
----------- ----------- -----------
----------- ----------- -----------
Operating income............................................. $ $ 0.5 $ 0.9
----------- ----------- -----------
----------- ----------- -----------
Net income (loss)............................................ $ $ (0.8) $ 0.9
----------- ----------- -----------
----------- ----------- -----------
Inventory.................................................... $ $ 178.2 $ 72.2
Other current assets......................................... 28.9 50.6
Noncurrent assets............................................ 241.5 152.3
----------- ----------- -----------
Total assets............................................ 448.6 275.1
Current liabilities.......................................... 176.5 78.9
Noncurrent liabilities....................................... 13.9 8.1
----------- ----------- -----------
OfficeMax Group equity....................................... $ $ 258.2 $ 188.1
----------- ----------- -----------
----------- ----------- -----------
Retained Interest of the Kmart Group......................... $ $ 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, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Equity in income............................................. $ $ 5.7 $ 1.3
----------- ----- -----
----------- ----- -----
</TABLE>
The Sports Authority Group's summarized financial information follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $ $ 411.5 $ 240.9
----------- ----------- -----------
----------- ----------- -----------
Operating income............................................. $ $ 10.1 $ 3.4
----------- ----------- -----------
----------- ----------- -----------
Net income................................................... $ $ 5.7 $ 1.3
----------- ----------- -----------
----------- ----------- -----------
Inventory.................................................... $ $ 113.7 $ 83.0
Other current assets......................................... 12.4 9.0
Noncurrent assets............................................ 110.3 93.2
----------- ----------- -----------
Total assets............................................ 236.4 185.2
Current liabilities.......................................... 91.6 50.6
Noncurrent liabilities....................................... 5.6 3.2
----------- ----------- -----------
The Sports Authority Group equity............................ $ $ 139.2 $ 131.4
----------- ----------- -----------
----------- ----------- -----------
Retained Interest of the Kmart Group......................... $ $ 139.2 $ 131.4
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
VI-33
<PAGE> 232
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 the Kmart Group and 51% owned by Melville. Fees and
income earned under the license agreements in 1993, 1992 and 1991 of $ , $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...................................................... $ $54 $50
---- ---- ----
---- ---- ----
Dividends............................................................. $ $59 $51
---- ---- ----
---- ---- ----
</TABLE>
Meldisco companies' summarized financial information follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1993 1992 1991
------ ------ ------
<S> <C> <C> <C>
Sales.......................................................... $ $1,164 $1,145
------ ------ ------
------ ------ ------
Gross profit................................................... $ $ 525 $ 505
------ ------ ------
------ ------ ------
Net income..................................................... $ $ 111 $ 104
------ ------ ------
------ ------ ------
Inventory...................................................... $ $ 129 $ 132
Other current assets........................................... 123 131
Noncurrent assets.............................................. 2 --
------ ------ ------
Total assets................................................. 254 263
Current liabilities............................................ 47 46
------ ------ ------
Net assets..................................................... $ $ 207 $ 217
------ ------ ------
------ ------ ------
Equity of the Kmart Group...................................... $ $ 101 $ 106
------ ------ ------
------ ------ ------
</TABLE>
Coles Myer Ltd.
The Kmart Group had a 21.3% equity interest at January 27, 1993 in Coles
Myer Ltd., the largest retailer in Australia.
Income earned under a license agreement with Coles Myer of $3 in 1992 and
1991 is included in licensee fees and rental income. Further information
regarding the Kmart Group's investment in Coles Myer follows:
<TABLE>
<CAPTION>
(U.S.$) 1993 1992 1991
- ----------------------------------------------------------------- ------ ---- ------
<S> <C> <C> <C>
Equity in income................................................. $ $ 51 $ 60
------ ---- ------
------ ---- ------
Dividends........................................................ $ $ 34 $ 33
------ ---- ------
------ ---- ------
Equity of Kmart Corporation...................................... $ $496 $ 488
------ ---- ------
------ ---- ------
Market value of Coles Myer common stock.......................... $ $912 $1,082
------ ---- ------
------ ---- ------
</TABLE>
The cumulative effect of translating the Kmart Group's equity in the
investment in Coles Myer was a reduction of $ , $90 and $45, respectively, as
of January 26, 1994, January 27, 1993 and January 29, 1992. The average exchange
rates from Australian to U.S. dollars were in 1993, 0.7367 in 1992
and 0.7776 in 1991.
VI-34
<PAGE> 233
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Summarized financial information adjusted for conformity with U.S.
generally accepted accounting principles for Coles Myer's most recent fiscal
years follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------
JULY 25, JULY 26, JULY 28,
(U.S.$) 1993 1992 1991
- ----------------------------------------------------------------- -------- -------- --------
<S> <C> <C> <C>
Net sales........................................................ $ $ 11,634 $ 11,699
-------- -------- --------
-------- -------- --------
Net income....................................................... $ $ 137 $ 254
-------- -------- --------
-------- -------- --------
Current assets................................................... $ $ 1,927 $ 1,776
Noncurrent assets................................................ 2,123 2,435
-------- -------- --------
Total assets................................................ $ $ 4,050 $ 4,211
-------- -------- --------
-------- -------- --------
Current liabilities.............................................. $ $ 1,327 $ 1,327
Noncurrent liabilities........................................... 663 1,019
Equity........................................................... 2,060 1,865
-------- -------- --------
Total liabilities and equity................................ $ $ 4,050 $ 4,211
-------- -------- --------
-------- -------- --------
</TABLE>
Unremitted earnings of unconsolidated affiliates included in the Kmart
Group's equity were $ , $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............................................................ $ $1,128 $1,007
Foreign........................................................ 66 70
------ ------ ------
Total.......................................................... $ $1,194 $1,077
------ ------ ------
------ ------ ------
</TABLE>
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Current:
Federal............................................................... $ $199 $217
State and local....................................................... 53 44
Foreign............................................................... 15 8
Deferred:
Restructuring of Kmart stores and other charges....................... 27 40
Excess of tax over book depreciation.................................. 66 37
LIFO inventory........................................................ 39 32
Other................................................................. (1) (20)
---- ---- ----
Total income taxes...................................................... $ $398 $358
---- ---- ----
---- ---- ----
</TABLE>
VI-35
<PAGE> 234
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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................................ $ $406 $366 % 34.0% 34.0%
State and local taxes, net of federal tax benefit..... 34 29 2.9 2.7
Tax credits........................................... (7) (8) (0.6) (0.7)
Equity in income of affiliated retail companies
subject to lower tax rates.......................... (23) (32) (1.9) (3.0)
Other................................................. (12) 3 (1.1) 0.3
---- ---- ---- ---- ---- ----
Total income taxes............................... $ $398 $358 % 33.3% 33.3%
---- ---- ---- ---- ---- ----
---- ---- ---- ---- ---- ----
</TABLE>
The amounts shown on the combined balance sheets for deferred income taxes
result principally from the difference between financial statement and income
tax depreciation and cost of merchandise sold, reduced by the 1989 Kmart store
restructuring provision.
Undistributed earnings of subsidiaries totaled $ , $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 $43.
CURRENT NOTES PAYABLE
Notes payable of $ 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 rate on
short-term borrowings outstanding on January 27, 1993 was 3.2%.
COMMITMENTS AND CONTINGENCIES
There are various claims, lawsuits, and pending actions against the Kmart
Corporation incident to the operations of the Kmart Group. Liability, if any,
associated with these matters is not determinable at January 31, 1994. It is the
opinion of management that the ultimate resolution of these matters will not
have a material effect on the Kmart Group's financial position or results of
operations.
At January 27, 1993, Kmart Corporation had bank lines of credit attributed
to the Kmart Group aggregating $1,339 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.
Kmart Corporation has entered into revolving credit agreements attributed
to the Kmart Group with various banks in the aggregate amount of $ 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 27, 1993,
Kmart Corporation had no outstanding borrowings under these agreements. The
revolving credit agreements contain certain restrictive provisions
VI-36
<PAGE> 235
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
regarding the maintenance of net worth, working capital, coverage ratios and
payment of cash dividends. At January 27, 1993, $4,237 of consolidated retained
earnings were free of such restrictions.
At January 27, 1993, 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 1992
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 27, 1993, 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 27, 1993, there was $130 of
borrowings outstanding under these agreements.
Kmart Corporation has also entered into certain real estate arrangements
whereby the Kmart Corporation is obligated to purchase completed projects if
alternate financing is not available to the developer. The Kmart Corporation's
aggregate guarantees attributed to the Kmart Group under these arrangements, and
other lease guarantees for certain facilities previously sold, were $494 at
January 27, 1993.
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 27, 1993, the amount guaranteed was
$20. 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 27, 1993, the
total amount of such guaranteed indebtedness was $292, of which $94 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 $198. However, no concentration of credit risk
exists and the Kmart Corporation does not anticipate nonperformance by the other
parties.
VI-37
<PAGE> 236
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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, JANUARY 27,
1994 1993
----------- -----------
<S> <C> <C>
8 3/8% debentures due 2017............................................. $ $ 291
10 1/2% debentures due 2017............................................ 200
8 1/8% debenture due 1997.............................................. 199
12 1/8% notes due 1995................................................. 150
8 1/8% notes due 2006.................................................. 199
8 1/4% notes due 2022.................................................. 99
12 1/2% debentures due 2005............................................ 100
8 3/8% debentures due 2022............................................. 99
7 3/4% debentures due 2012............................................. 198
7.95% debentures due 2023.............................................. --
Notes Payable.......................................................... 300
Medium-term notes due 1993 through 2020
(8.41% weighted average interest rate)............................... 835
Mortgages.............................................................. 500
Other.................................................................. 162
----------- -----------
Total............................................................. 3,332
Portion due within one year............................................ 117
----------- -----------
Long-term debt......................................................... $ $ 3,215
----------- -----------
----------- -----------
</TABLE>
In August 1993, Kmart Corporation called for early redemption 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 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, the 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, the 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.
VI-38
<PAGE> 237
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 1992 are: 1993 - $117; 1994 - $133; 1995 - $251; 1996 -
$216; 1997 - $163.
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 $ 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.
Lease Commitments: Future minimum lease payments with respect to capital
and operating leases as of January 27, 1993 follow:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1993.................................................................... $ 380 $ 484
1994.................................................................... 368 465
1995.................................................................... 360 444
1996.................................................................... 355 420
1997.................................................................... 345 392
Later years............................................................. 3,121 4,300
------- ---------
Total minimum lease payments......................................... 4,929 6,505
Less-minimum sublease rental income....................................... -- (211)
------- ---------
Net minimum lease payments................................................ 4,929 $ 6,294
---------
---------
Less:
Estimated executory costs............................................... (1,496)
Amount representing interest............................................ (1,685)
-------
1,748
Portion due within one year............................................... 109
-------
Long-term lease obligations............................................... $ 1,639
-------
-------
</TABLE>
VI-39
<PAGE> 238
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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................................................... $ $426 $380
Percentage rentals................................................ 38 42
Less-sublease rentals............................................. (63) (54)
------ ---- ----
Total........................................................ $ $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............................. $ $ 110 $ 107
Interest expense related to obligations under capital leases....... 180 177
------ ----- -----
Amounts charged to earnings........................................ 290 284
Related minimum lease payments net of executory costs.............. (286) (278)
------ ----- -----
Excess of amounts charged over related minimum lease payments...... $ $ 4 $ 6
------ ----- -----
------ ----- -----
</TABLE>
Related minimum lease payments above exclude executory costs for 1993, 1992
and 1991 in the amounts of $ , $94 and $91, respectively.
PENSION PLANS
The Kmart Group participates in the 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 attributable to the
Kmart Group is actuarially determined based on the attributes of its plan
participants. Plan assets and obligations are allocated based upon 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
VI-40
<PAGE> 239
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
year end. Under this basis, the following tables summarize the funded status,
components of pension cost and actuarial assumptions.
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 27, JANUARY 29,
1994 1993 1992
---------------- ---------------- ----------------
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits..... $ $ (1,085) $ (974)
Estimated present value of non-vested
benefits.................................... (142) (136)
---------------- ---------------- ----------------
Accumulated benefit obligation................. (1,227) (1,110)
Value of future pay increases.................. (252) (162)
---------------- ---------------- ----------------
Projected benefit obligation................... (1,479) (1,272)
Estimated market value of plan assets............ 1,354 1,284
---------------- ---------------- ----------------
Plan assets over (under) projected benefit
obligation..................................... (125) 12
Unrecognized net asset........................... (109) (117)
Unrecognized prior service cost.................. 54 58
Unrecognized net (gain) loss and other........... 31 (56)
---------------- ---------------- ----------------
Accrued pension costs............................ $ $ (149) $ (103)
---------------- ---------------- ----------------
---------------- ---------------- ----------------
</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............................ $ $ 53 $ 48
Interest cost on projected benefit
obligation.................................. 116 102
Return on plan assets.......................... (115) (191)
Net amortization and deferral of other
components.................................. (8) 87
---------------- ---------------- ----------------
Total....................................... $ $ 46 $ 46
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Actuarial assumptions at end of year:
Discount rates................................. % 8.50% 8.75%
Expected return on plan assets................. 9.50 9.50
Salary increases............................... 5.00 5.00
</TABLE>
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 $75 was included in net
income as the effect of an accounting change in the first quarter of 1993.
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.
VI-41
<PAGE> 240
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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................................. $ $ 5,856 $ 5,339
Net income................................................... 938 855
Kmart Group's portion of dividends........................... (455) (398)
Change in cumulative translation adjustment.................. (62) (9)
Kmart Corporation common shares issued under stock option
plans...................................................... 45 64
Other........................................................ 19 5
----------- ----------- -----------
Kmart Group Common Equity.................................... $ $ 6,341 $ 5,856
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
In October 1992, the 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
the Kmart Corporation after November 1, 1999 at a redemption rate based on the
then-current market price of the 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 the
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 the 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 the 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, the 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 the 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 stockholders 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 certificate of
incorporation.
VI-42
<PAGE> 241
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 the Kmart
Corporation 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.
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 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 $___ 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 the company 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 27, 1993, outstanding awards and
shares available for grant totaled 836,999 and 3,038,247 respectively. The Kmart
Group recorded $___, $4 and $3 of compensation expense related to the
Performance Restricted Stock Plan in 1993, 1992 and 1991, respectively.
VI-43
<PAGE> 242
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER-SHARE DATA)
SUPPLEMENTAL INFORMATION -- KMART GROUP EARNINGS PER SHARE (UNAUDITED)
Upon approval of the Specialty Retail Stock Proposal, the capital structure
of the 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 the 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 the 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 27,
1993
-----------------
<S> <C>
Earnings Per Common Share Assuming No Dilution
Net income from continuing retail operations............................... $ 879
Discontinued operations.................................................... 59
------
Net income................................................................. $ 938
------
------
Weighted average shares of Kmart Stock (based on redesignation of Kmart
Corporation common stock as Kmart Stock on a 1 for 1 basis)............. 451.7
Earnings Per Common Share assuming No Dilution
Net income from continuing retail operations............................... $1.95
Discontinued operations.................................................... 0.13
------
Net income................................................................. $2.08
------
------
Earnings Per Common and Common Equivalent Share
Net income from continuing retail operations............................... $ 879
Less-Series B convertible preferred shares dividend declared............... (3)
------
Adjusted net income from continuing retail operations...................... 876
Discontinued operations.................................................... 59
------
Adjusted net income........................................................ $ 935
------
------
Weighted average shares of Kmart Stock (based on redesignation of Kmart
Corporation common stock as Kmart Stock on a 1 for 1 basis)............. 455.6
Earnings Per Common and Common Equivalent Share
Adjusted net income from continuing retail operations...................... $1.92
Discontinued operations.................................................... 0.13
------
Adjusted net income........................................................ $2.05
------
------
Earnings Per Common and Common Equivalent Share Assuming Full Dilution
Net income from continuing retail operations............................... $ 879
Discontinued operations.................................................... 59
------
Net income................................................................. $ 938
------
------
Weighted average fully diluted shares of Kmart Stock (based on
redesignation of Kmart Corporation common stock as Kmart Group Stock on
a 1 for 1 basis)........................................................ 457.8
Earnings Per Common and Common Equivalent Share Assuming Full Dilution
Net income from continuing retail operations............................... $1.92
Discontinued operations.................................................... 0.13
------
Net income................................................................. $2.05
------
------
</TABLE>
VI-44
<PAGE> 243
ANNEX VI-E
KMART GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS,
EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
Sales.................................................................. $19,514 $18,375
Licensee fees and rental income........................................ 193 171
Equity in income of affiliated retail companies........................ 54 49
----------- -----------
19,761 18,595
----------- -----------
Cost of merchandise sold, includes buying and occupancy costs.......... 14,390 13,467
Selling, general and administrative expenses........................... 4,607 4,297
Interest:
Debt -- expense...................................................... 231 182
-- income....................................................... (8) (10)
Capital lease obligations -- expense................................. 138 132
----------- -----------
19,358 18,068
----------- -----------
Income from continuing retail operations before retained interests in
the Specialty Retail Groups and income taxes......................... 403 527
Net income related to retained interests in the Specialty Retail
Groups............................................................... 16 29
Income taxes........................................................... 135 174
----------- -----------
Net income from continuing retail operations before extraordinary item
and the effect of accounting changes................................. 284 382
Discontinued operations including the effect of accounting changes, net
of
income tax........................................................... (26) 25
Extraordinary item, net of income tax.................................. (10) --
Effect of accounting changes, net of income tax........................ (32) --
----------- -----------
Net income............................................................. $ 216 $ 407
----------- -----------
----------- -----------
Supplemental disclosure:
Earnings per Kmart Group common and common equivalent share
Net income from continuing retail operations before extraordinary
item and the effect of accounting changes......................... $ .61 $ .83
Discontinued operations including the effect of accounting changes,
net of
income tax........................................................ (.05) .06
Extraordinary item, net of income tax................................ (.02) --
Effect of accounting changes, net of income tax...................... (.07) --
----------- -----------
$ .47 $ .89
----------- -----------
----------- -----------
Net income........................................................... $ 216 $ 407
Less goodwill amortization of the Specialty Retail Groups............ -- --
----------- -----------
Kmart Corporation earnings attributable to the Kmart Group........... $ 216 $ 407
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-45
<PAGE> 244
KMART GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash (includes temporary investments of $77 and $290,
respectively)..................................................... $ 449 $ 497
Merchandise inventories.............................................. 8,847 8,408
Accounts receivable and other current assets......................... 1,366 1,223
----------- -----------
Total current assets................................................... 10,662 10,128
Retained interests in the Specialty Retail Groups...................... 2,033 1,354
Investments in Affiliated Retail Companies............................. 545 580
Property and Equipment -- net.......................................... 6,108 5,649
Other Assets and Deferred Charges...................................... 395 333
Goodwill -- net of accumulated amortization of $63 and $48,
respectively......................................................... 517 489
----------- -----------
$20,260 $18,533
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ 75 $ 113
Notes payable........................................................ 3,034 1,990
Accounts payable -- trade............................................ 3,033 2,884
Accrued payrolls and other liabilities............................... 989 930
Taxes other than income taxes........................................ 406 404
Income taxes......................................................... 85 106
----------- -----------
Total current liabilities.............................................. 7,622 6,427
Capital Lease Obligations.............................................. 1,648 1,586
Long-Term Debt......................................................... 2,735 2,785
Other Long-Term Liabilities (includes restructuring obligations)....... 708 597
Deferred Income Taxes.................................................. 209 192
Equity:
Preferred Stock Series A, 5,750,000 shares authorized and issued..... 986 986
Preferred Stock Series B, 796,827 authorized; 784,938 shares
issued............................................................ 157 --
Kmart Group Common Equity.............................................. 6,195 5,960
----------- -----------
Total Kmart Group equity............................................... 7,338 6,946
----------- -----------
$20,260 $18,533
----------- -----------
----------- -----------
Supplemental disclosure:
Kmart Group Common Equity............................................ $ 6,195 $ 5,960
Less goodwill amortization of the Specialty Retail Groups............ -- --
----------- -----------
Kmart Corporation equity attributable to the Kmart Group............. $ 6,195 $ 5,960
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-46
<PAGE> 245
KMART GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income from continuing retail operations before extraordinary
item and the effect of accounting changes......................... $ 284 $ 382
Net income related to retained interest in the Specialty Retail
Groups............................................................ (16) (29)
Depreciation and amortization........................................ 430 388
Increase (decrease) in other long-term liabilities................... (42) 18
Other noncash charges to earnings.................................... 65 69
Cash used for current assets and current liabilities................. (1,065) (1,547)
----------- -----------
Total net cash used for continuing operations........................ (344) (719)
Discontinued Operations:
Income (loss) from discontinued operations........................... (26) 25
Items not affecting cash -- net...................................... 50 50
----------- -----------
Total provided by discontinued operations......................... 24 75
----------- -----------
Net total cash used for operations................................... (320) (644)
----------- -----------
INVESTING
Capital expenditures -- owned property............................... (673) (1,039)
Acquisitions......................................................... -- (286)
Proceeds from the sale of assets..................................... 31 5
Net equity transactions with the Specialty Retail Groups............. (604) (171)
Other -- net......................................................... (40) (16)
----------- -----------
Net cash used for investing.......................................... (1,286) (1,507)
----------- -----------
FINANCING
Proceeds from issuance of long-term debt and notes payable........... 2,448 2,533
Reduction in long-term debt and notes payable........................ (522) (15)
Extraordinary item on bond redemption -- premium..................... (10) --
Reduction in capital lease obligations............................... (83) (79)
Issuance of common stock............................................. 12 39
Reissuance of treasury stock......................................... 23 16
Dividends paid....................................................... (355) (334)
----------- -----------
Net cash provided by financing....................................... 1,513 2,160
----------- -----------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS........................ (93) 9
Cash and Equivalents at Beginning of Year......................... 542 488
----------- -----------
CASH AND EQUIVALENTS AT END OF PERIOD.................................. $ 449 $ 497
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VI-47
<PAGE> 246
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
(UNAUDITED)
BASIS OF PRESENTATION
The accompanying unaudited combined financial statements do not include all
information and footnotes necessary for the annual presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles.
In the opinion of the Kmart Group management, all adjustments necessary for
a fair statement of the results for the interim periods have been included. All
adjustments were of a normal and recurring nature.
SUBSEQUENT EVENTS
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes of which approximately $870
is attributed to the Kmart Group. Net of taxes, the charge was approximately
$850 of which approximately $565 is attributed to the Kmart Group. The provision
includes anticipated costs associated with Kmart stores which will be closed,
relocated, enlarged or refurbished in the U.S. and Canada as well as the
relocation of certain Builders Square stores and the closing of underperforming
Walden stores. These costs, which represent approximately 85% of the total
reserve, include the estimated lease obligations for store closings and
relocations as well as estimated fixed asset write-offs, primarily furniture and
fixtures and inventory dispositions for all affected stores. The remainder of
the reserve is for costs related to re-engineering programs, a non-routine legal
judgment and certain changes to Walden's accounting policies to prepare for
combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% is for costs associated with Walden's
stores.
In December 1993, Kmart Corporation entered into a definitive agreement,
attributed to the Kmart Group, to sell Kmart's PayLess Drug Stores Northwest,
Inc. subsidiary to TCH Corporation, the parent company of Thrifty Corporation.
Under the terms of the agreement, TCH will provide the Kmart Group with
consideration consisting of $592 of cash, assumption of refinancing of
approximately $170 of debt, $100 in subordinated debt securities and common
stock representing 47% of the equity of TCH. It is anticipated that the
transaction will be completed by the end of the first quarter of 1994. Based
upon estimates, which are still being reviewed, an after tax charge of
approximately $110 will be incurred in the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with the sale of assets and discontinuance of
operations are still being reviewed, but it is estimated that the after tax
charge to earnings related to this transaction will approximate $400 million.
PayLess and PACE are presented as discontinued operations in the combined
financial statements and accompanying notes.
EXTRAORDINARY ITEM AND ACCOUNTING CHANGES
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
VI-48
<PAGE> 247
KMART GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
(UNAUDITED)
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.
The Kmart Group adopted Financial Accounting Standard No. 109 "Accounting
for Income Taxes" (FAS 109) at the first quarter of 1993. 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 income tax rate. As a
result of the adjustment of deferred tax balances to the current enacted tax
rate, a benefit of $43, has been recorded as the cumulative effect of the
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 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 $75 was included in
net income as the effect of an accounting change in the first quarter of 1993.
In addition, the Kmart Group adopted Financial Accounting Standard No. 112
"Employers' Accounting for Postemployment Benefits" (FAS 112). FAS 112 is an
extension of the concepts underlying FAS 106 for similar benefits provided to
terminated or laid-off employees. The effect of this statement on the Kmart
Group is not significant.
INVENTORIES AND COST OF MERCHANDISE SOLD
A substantial portion of the inventories is accounted for using the
last-in, first-out (LIFO) method. If the first-in, first-out (FIFO) method of
inventory accounting had been used by the Kmart Group, inventories would have
been $943, $1,010, and $937 higher than reported at October 27, 1993, October
28, 1992 and January 27, 1993, respectively.
KMART GROUP COMMON EQUITY
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
<S> <C> <C>
Balance at beginning of year......................................... $ 6,341 $ 5,856
Net income........................................................... 216 407
Kmart Group's portion of dividends................................... (359) (339)
Change in cumulative translation adjustment.......................... (34) (22)
Kmart Corporation common shares issued under stock option plans...... 26 48
Other................................................................ 5 10
----------- -----------
Kmart Group Common Equity............................................ $ 6,195 $ 5,960
----------- -----------
----------- -----------
</TABLE>
In October 1992, the 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 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. Each share of Series B preferred stock is
convertible by the holders at any time into 6.49 shares of Kmart Corporation
stock, subject to adjustment in certain events, and is redeemable into Kmart
Corporation stock by the Kmart Corporation after November 1, 1999 at a
redemption rate based on the then-current market price of the Kmart Corporation
stock.
VI-49
<PAGE> 248
ANNEX VI-F
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
39 Weeks Ended October 27, 1993 and October 28, 1992
RESULTS OF OPERATIONS
The following table presents the Kmart Group's income statement, as a
percent of sales, for the periods presented.
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 27, OCTOBER 28,
1993 1992
----------- -----------
<S> <C> <C>
Sales.................................................................. 100.0% 100.0%
Licensee fees and rental income........................................ 0.9 0.9
----------- -----------
Total operating revenues............................................... 100.9 100.9
Cost of merchandise sold (includes buying and occupancy costs)......... 73.7 73.3
----------- -----------
Gross margin........................................................... 27.2 27.6
Selling, general and administrative expenses........................... 23.6 23.4
----------- -----------
Operating income from continuing retail operations..................... 3.6 4.2
Equity in income of affiliated retail companies........................ 0.3 0.3
Net interest expense................................................... 1.8 1.7
----------- -----------
Income from continuing retail operations before retained interests in
the Specialty Retail Groups and income taxes......................... 2.1 2.8
Net income related to retained interests in the Specialty Retail
Groups............................................................... 0.1 0.2
Income taxes........................................................... 0.7 0.9
----------- -----------
Net income from continuing retail operations before extraordinary item
and the effect of accounting changes................................. 1.5 2.1
Discontinued operations including the effect of accounting changes, net
of income tax........................................................ (0.1) 0.1
Extraordinary item, net of income tax.................................. (0.1) --
Effect of accounting changes, net of income tax........................ (0.2) --
----------- -----------
Net income............................................................. 1.1% 2.2%
----------- -----------
----------- -----------
</TABLE>
The combined statements of income as a percent of sales have been restated
for discontinued operations.
Kmart Group's store activity for the first 39 weeks of 1993 is summarized
below:
<TABLE>
<CAPTION>
JANUARY 27, OCTOBER 27,
1993 OPENED CLOSED 1993
----------- ------ ------ -----------
<S> <C> <C> <C> <C>
Kmart
United States......................................... 2,282 89 55 2,316
Canada................................................ 127 -- -- 127
Czech Republic and Slovakia........................... 13 -- -- 13
Other................................................. 13 -- -- 13
----------- -- -- -----------
Total Kmart Group.................................. 2,435 89 55 2,469
----------- -- -- -----------
----------- -- -- -----------
</TABLE>
Sales for the 39 weeks ended October 27, 1993, were $19.5 billion, a $1.1
billion, or 6.2% increase, over sales of $18.4 billion in the same period in the
prior year (see table below). The 1993 sales increase was due
VI-50
<PAGE> 249
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
primarily to the net 34 stores opened in the first 39 weeks of 1993 and the
inclusion of a full 39 weeks sales for the net 45 stores opened in the prior
year.
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28, COMPARABLE STORES
1993 1992 SALES INCREASE %
----------- ----------- -----------------
($ MILLIONS)
<S> <C> <C> <C>
Sales
United States..................... $18,782 $17,643 3.9
International..................... 732 732 1.2*
------- -------
Total Kmart Group.............. $19,514 $18,375 3.8
------- -------
------- -------
</TABLE>
- -------------------------
* International comparable store sales change is calculated on sales in the
applicable local currency.
Cost of merchandise sold, including buying and occupancy costs, for the 39
weeks ended October 27, 1993, was $14,390 million as compared to $13,467 million
in the same period in the prior year. Gross margin as a percent of sales was
27.2% and 27.6% in 1993 and 1992, respectively. The decrease, as a percent of
sales, reflects a sales mix skewed toward lower-margined items in the U.S. Kmart
stores. The impact of inflation included in the cost of merchandise sold reduced
pretax earnings by $6 million for the first 39 weeks of 1993 and $35 million for
the comparable period of 1992.
Selling, general and administrative expenses for the 39 weeks ended October
27, 1993, was $4,607 million or 23.6% of sales, as compared to $4,297 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 effect of below-plan sales on fixed
expense.
Operating income from continuing retail operations for the 39 weeks ended
October 27, 1993, was $710 million, or 3.6% of sales, as compared to $782
million, or 4.2% of sales, in the same period in the prior year (see table
below). The decrease in operating income was due to lower LIFO gross margin and
an increase in selling, general and administrative expenses resulting from the
effect of below-plan sales on fixed expenses.
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28,
1993 1992 %
----------- ----------- ----
($ MILLIONS)
<S> <C> <C> <C>
Operating Income
United States............................... $ 694 $ 766 (9.4)
International............................... 16 16 --
----- -----
Total Kmart Group........................ $ 710 $ 782 (9.3)
----- -----
----- -----
</TABLE>
Net interest expense for the 39 weeks ended October 27, 1993, was $361
million, or 1.8% of sales, as compared to $304 million, or 1.7% of sales, for
the same period in the prior year. The increase in interest expense was the
result of greater borrowings due to higher inventory levels in the 1993 period,
acquisitions made in 1992 and net equity transactions with the Specialty Retail
Groups in the 1993 and 1992 periods.
Income from continuing retail operations before retained interests in the
Specialty Retail Groups and income taxes for the 39 weeks ended October 27,
1993, was $403 million, or 2.1% of sales, as compared to $527 million, or 2.8%
of sales, in the same period last year.
Net income related to Retained Interest in the Specialty Retail Groups for
the 39 weeks ended October 27, 1993, was $16 million, or 0.1% of sales, as
compared to $29 million, or 0.2% of sales, in the same period in the prior year.
The decrease was primarily the result of lower net income for the Builders
Square Group and a higher net loss for the Borders-Walden Group.
VI-51
<PAGE> 250
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
The Specialty Retail Groups' sales and net income for the 39 weeks ended
October 27, 1993 and October 28, 1992 are illustrated below:
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28, COMPARABLE STORES
1993 1992 SALES INCREASE %
----------- ----------- -----------------
($ MILLIONS)
<S> <C> <C> <C>
Sales
Borders-Walden Group................... $ 875 $ 736 (1)
Builders Square Group.................. 2,101 1,867 0.4
OfficeMax Group........................ 993 336 19.2
The Sports Authority Group............. 407 270 2.3
----------- -----------
Total Specialty Retail Groups....... $ 4,376 $ 3,209 3.0
----------- -----------
----------- -----------
</TABLE>
- -------------------------
(1) Comparable store sales for the period increased 13% and 1.0% for Borders and
Walden, respectively.
<TABLE>
<CAPTION>
OCTOBER 27, OCTOBER 28,
1993 1992 %
----------- ----------- -----------------
($ MILLIONS)
<S> <C> <C> <C>
Net Income
Borders-Walden Group................... $ (15.7) $(7.2) --
Builders Square Group.................. 29.1 39.0 (25.4)
OfficeMax Group........................ (1.6) (4.1) --
The Sports Authority Group............. 4.4 1.3 238.5
----------- -----------
Total Specialty Retail Groups....... $ 16.2 $29.0 (44.3)
----------- -----------
----------- -----------
</TABLE>
Income tax expense for the 39 weeks ended October 27, 1993, was $135
million with an effective tax rate of 33.5% as compared to $174 million with an
effective tax rate of 33.0% in the same period of 1992. The increase in the rate
reflected the 1% increase in the federal corporate tax rate retroactive to
January 1, 1993, including the approximate $8 million effect on the deferred tax
balance as required by Financial Accounting Standard No. 109.
Net income from continuing retail operations before extraordinary item and
the effect of accounting changes for the 39 weeks ended October 27, 1993, was
$284 million, or 1.5% of sales, as compared to $382 million, or 2.1% of sales,
in the same period last year.
Net loss from discontinued operations for the 39 weeks ended October 27,
1993, was $26 million, or (0.1%) of sales, as compared to a net income of $25
million, or 0.1% of sales, in the same period in the prior year. 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 (see
Subsequent Events).
Extraordinary item. 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,
the company 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
VI-52
<PAGE> 251
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
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, the Kmart Group has recorded a benefit of $43 million, net of applicable
tax, 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 $75 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 underlying FAS 106 for
similar benefits provided to terminated or laid-off employees. The financial
effects of this statement were not material.
As the result of the foregoing factors, net income for the 39 weeks ended
October 27, 1993, was $216 million, or 1.1% of sales, as compared to $407
million, or 2.2% of sales, in the same period in the prior year.
Subsequent Events
On January 5, 1994, Kmart Corporation announced a one-time charge to fourth
quarter 1993 earnings of $1.3 billion before taxes of which approximately $870
million is attributed to the Kmart Group. Net of taxes, the charge was
approximately $850 million of which approximately $565 million is attributed to
the Kmart Group. The provision includes anticipated costs associated with Kmart
stores which will be closed, relocated, enlarged or refurbished in the U.S. and
Canada as well as the relocation of certain Builders Square stores and the
closing of underperforming Walden stores. These costs, which represent
approximately 85% of the total reserve, include the estimated lease obligations
for store closings and relocations as well as estimated fixed asset write-offs,
primarily furniture and fixtures and inventory dispositions for all affected
stores. The remainder of the reserve is for costs related to re-engineering
programs, a non-routine legal judgment and certain changes to Walden's
accounting policies to prepare for combining with Borders.
The provision for restructuring will include the expenses to be incurred in
connection with stores that will be closed, relocated, enlarged or refurbished,
as well as other non-recurring charges. About 70% of the pretax restructuring
provision consists of costs associated with U.S. and Canadian Kmart stores.
Approximately 15% of the restructuring provision is for costs associated with
Builders Square stores and about 15% is for costs associated with Walden stores.
In December 1993, Kmart Corporation entered into a definitive agreement,
attributed to the Kmart Group, to sell Kmart's PayLess Drug Stores Northwest,
Inc. subsidiary to TCH Corporation, the parent company of Thrifty Corporation.
Under the terms of the agreement, TCH will provide the Kmart Group with
consideration consisting of $592 million of cash, assumption or refinancing of
approximately $170 million of debt, $100 million in subordinated debt securities
and common stock representing 47% of the equity of TCH. It is anticipated that
the transaction will be completed by the end of the first quarter of 1994. Based
upon estimates, which are still being reviewed, an after-tax charge of
approximately $110 million will be incurred in the fourth quarter of 1993.
In November 1993, PACE Membership Warehouse, Inc. entered into an agreement
to sell 93 of its warehouses to Sam's Club, a division of Wal-Mart Stores, Inc.
Included in the sale are all assets and lease obligations of the 93 warehouse
locations being sold as well as virtually all inventory and membership files in
the units not included in the transaction. The sale was completed in January
1994. The costs associated with
VI-53
<PAGE> 252
KMART GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 27, 1993
the sale of assets and discontinuance of operations are still being reviewed,
but it is estimated that the after-tax charge to earnings related to this
transaction will approximate $400 million.
PayLess and PACE are presented as discontinued operations in the combined
financial statements and accompanying notes.
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 ending
October 27, 1993, are summarized below. The net decrease in cash and equivalents
for the 39 weeks ended October 27, 1993, was $93 million as compared to a $9
million increase in the same period in the prior year.
Net cash used for operations for the 39 weeks ended October 27, 1993, was
$320 million as compared to $644 million in the same period of 1992. This change
is primarily attributable to an increase in accounts payable resulting from an
improved ratio of merchandise payable to inventory offset by a decrease in
income from continuing retail operations before extraordinary item and the
effects of accounting changes and discontinued operations during the 39 weeks
ended October 27, 1993, in comparison to the same period in the prior year.
Merchandise inventories, which are primarily accounted for under the LIFO
method of inventory valuation, increased 5.2% to $8,847 million at October 27,
1993 from $8,408 million at October 28, 1992. This increase was largely the
result of the Kmart store renewal program, including new, relocated and enlarged
stores.
Net cash used for investing for the 39 weeks ended October 27, 1993, was
$1,286 million as compared to $1,507 million in the same period last year. This
decrease was due to lower planned capital expenditures as the Kmart Group
assessed the potential impact of the Super Kmart Center program on its
modernization program and net equity transactions with the Specialty Retail
Groups.
Net cash provided by financing of $1,513 million during the 39 weeks ended
October 27, 1993 was attributable to a net increase in long-term debt and notes
payable of $1,926 million. The $2,160 million provided by financing during the
39 weeks ended October 28, 1992, was attributable to a $2,518 million net
increase in long-term debt and notes payable. The increases in notes payable
were due to the seasonal build-up of merchandise inventories and capital
expenditures for the store modernization program and acquisitions.
VI-54
<PAGE> 253
ANNEX VII
BORDERS-WALDEN GROUP
<TABLE>
<S> <C> <C>
VII-A: Selected Financial Data.................................................... VII- 2
VII-B: Management's Discussion and Analysis of Financial Condition and Results
of Operations for the Fiscal Year Ended January 24, 1993................... VII- 3
VII-C: Business Description....................................................... VII-10
VII-D: Combined Financial Statements for the Fiscal Year Ended January 24, 1993... VII-22
VII-E: Combined Financial Statements for the 39 Weeks Ended October 24, 1993...... VII-38
VII-F: Management's Discussion and Analysis of Financial Condition and Results
of Operations for the 39 Weeks Ended October 24, 1993...................... VII-42
</TABLE>
VII-1
<PAGE> 254
ANNEX VII-A
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 the Borders-Walden Stock pursuant to
the Specialty Retail Stock Proposal has not been reflected in these financial
statements.
<TABLE>
<CAPTION>
FISCAL YEARS 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................................................. $ $ 56.0 -- -- --
Mall bookstores............................................. 1,127.7 $1,140.1 $1,064.0 $991.7
-------- -------- -------- -------- ------
Total sales............................................... 1,183.7 1,140.1 1,064.0 991.7
Gross margin.................................................. 291.3 263.3 237.4 213.9
Selling, general and administrative expenses.................. 243.7 228.9 228.8 207.0
-------- -------- -------- -------- ------
Operating income before pre-opening expense and goodwill
amortization................................................ 47.6 34.4 8.6 6.9
Pre-opening expense........................................... 1.9 0.8 0.8 1.2
Goodwill amortization......................................... 3.5 2.5 2.5 2.5
-------- -------- -------- -------- ------
Operating income.............................................. 42.2 31.1 5.3 3.2
Interest expense -- net....................................... 0.6 0.5 0.5 0.5
-------- -------- -------- -------- ------
Income before income taxes.................................... 41.6 30.6 4.8 2.7
Income taxes.................................................. 18.5 13.9 3.2 2.4
-------- -------- -------- -------- ------
Net income................................................ $ $ 23.1 $ 16.7 $ 1.6 $ 0.3
-------- -------- -------- -------- ------
-------- -------- -------- -------- ------
Add back of goodwill amortization............................. 3.5 2.5 2.5 2.5
-------- -------- -------- -------- ------
Kmart Corporation earnings attributable to Borders-Walden
Group....................................................... $ $ 26.6 $ 19.2 $ 4.1 $ 2.8
-------- -------- -------- -------- ------
-------- -------- -------- -------- ------
PERCENT OF SALES DATA
Gross margin.................................................. % 24.6% 23.1% 22.3% 21.6 %
Selling, general and administrative expenses.................. 20.6 20.1 21.5 20.9
Operating income before pre-opening expense and goodwill
amortization................................................ 4.0 3.0 0.8 0.7
Income before income taxes.................................... 3.5 2.7 0.5 0.3
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital............................................... $ $119.5 $159.9 $233.5 $247.2
Total assets.................................................. 872.2 620.0 674.8 676.0
Total debt.................................................... 9.8 4.6 4.7 4.8
Borders-Walden Group equity................................... 521.1 388.1 483.1 498.0
SELECTED FINANCIAL AND OPERATING DATA
End of year stores:
Superstores................................................. 31 -- -- --
Mall bookstores(2).......................................... 1,202 1,217 1,209 1,205
-------- -------- -------- -------- ------
Total..................................................... 1,233 1,217 1,209 1,205
-------- -------- -------- -------- ------
-------- -------- -------- -------- ------
Comparable store sales increase:
Superstores................................................. % 12.6%(3) -- -- --
Mall bookstores............................................. 1.4 5.8% 6.2% 4.8 %
Weighted average sales per square foot(4):
Superstores................................................. $ $399 -- -- --
Mall bookstores............................................. 322 $316 $298 $284
Weighted average sales per store (millions)(5):
Superstores................................................. $ 6.1 $ -- $ -- $ --
Mall bookstores............................................. 0.9 0.9 0.8 0.8
Capital expenditures -- owned property (millions)............. 28.8 15.2 31.0 35.6
Depreciation and amortization (millions)...................... 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> 255
ANNEX VII-B
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993
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"). 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 $1.184 billion for the fiscal year ended January 24,
1993.
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 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.
RESTRUCTURING CHARGE
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 over the next two years. As a result,
Borders-Walden will record a pretax charge of $140.4 million in the fourth
quarter of 1993. The restructuring charge consists of $103.9 million for store
closings, relocations and expansions, $20.5 million for reengineering costs and
$16.0 million for other nonrecurring charges. Store closing costs include net
lease costs, estimated fixed asset and inventory dispositions and estimated
operating losses.
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
and $3.7 million in 1992 and 1991, respectively, and a reduction of retained
earnings at February 3, 1991 of $43.1 million.
VII-3
<PAGE> 256
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
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 that utilizes enhanced
statistical sampling techniques has been developed by management in conjunction
with independent statisticians. Beginning in 1992, physical inventories have
been 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 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>
ADJUSTMENT TO
COST OF GOODS SOLD
RETAIL SHRINKAGE RATE RETAIL SHRINKAGE RATE ------------------
ORIGINALLY REPORTED AS RESTATED
--------------------- --------------------- (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>
VII-4
<PAGE> 257
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
Fiscal Years Ended January 24, 1993 (Fiscal 1992) and February 1, 1992 (Fiscal
1991)
RESULTS OF OPERATIONS
The following table presents Borders-Walden's income statement data, as a
percent of sales, for the two most recent fiscal years.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------
JANUARY 24, FEBRUARY 1,
1993(1) 1992
----------- -----------
<S> <C> <C>
Sales.................................................................. 100.0% 100.0%
Cost of merchandise sold, includes buying and occupancy costs.......... 75.4 76.9
----- -----
Gross margin........................................................... 24.6 23.1
Selling, general and administrative expenses........................... 20.6 20.1
----- -----
Operating income before pre-opening expense and goodwill
amortization......................................................... 4.0 3.0
Pre-opening expense.................................................... 0.2 0.1
Goodwill amortization.................................................. 0.3 0.2
----- -----
Operating income....................................................... 3.5 2.7
Net interest expense................................................... --
----- -----
Income before income taxes............................................. 3.5 2.7
Income taxes........................................................... 1.5 1.2
----- -----
Net income............................................................. 2.0% 1.5%
----- -----
----- -----
</TABLE>
- -------------------------
(1) Includes Borders results of operations from the date of its acquisition by
Kmart in October, 1992.
Store Activity. Borders-Walden's store activity is summarized below:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
---------------------
JAN. 24, FEB. 1,
1993 1992
-------- -------
<S> <C> <C>
Borders Superstores
Beginning number of stores................................ 16 --
Openings.................................................. 15(1) --
Closings.................................................. 0 --
----- -----
Ending number of stores................................... 31 --
----- -----
----- -----
Walden Mall Bookstores(2)
Beginning number of stores................................ 1,217 1,209
Openings.................................................. 16 27
Closings.................................................. (31) (19)
----- -----
Ending number of stores................................... 1,202 1,217
----- -----
----- -----
</TABLE>
- -------------------------
(1) Includes the conversion of nine book superstores that had been opened by
Walden in fiscal 1992.
(2) Excludes 58 Walden Software stores operated in 1992 and 1991.
VII-5
<PAGE> 258
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
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 (SG&A) expense in 1992 was $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. 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.
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.
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. Pre-opening
expenses associated with opening a new store are expensed during the first full
month of operations and consist primarily of store payroll and grand opening
advertising expense.
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, 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 $41.2 million in 1992 and $111.7 million in 1991.
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the 51 weeks ending
January 24, 1993 and 52 weeks ending February 1, 1992
VII-6
<PAGE> 259
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
are summarized below. The net increases (decreases) in cash and cash equivalents
were $9.6 million and $(1.7) million in 1992 and 1991, respectively.
Net cash provided by operations was $97.4 million in 1992 as compared to
$125.3 million in 1991. 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.
Net cash used for investing in 1992 consists primarily of capital
expenditures relating to new store openings and the renovation of existing
stores. Capital expenditures totaled $28.8 million and $15.2 million in 1992 and
1991, respectively. Capital expenditures in 1992 resulted primarily from the
opening of 25 (16 mall and 9 superstores) new 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 $.2 million and $.4 million, depending on store
size and format.
Net cash used for financing was $59.0 million in 1992 and $111.8 in 1991
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 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 financial
statements of the Kmart Group and (ii) net cash used or provided by each
Specialty Group has been characterized as an adjustment of the Kmart Group's
equity 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 equity investment in Borders-Walden.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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 excess uses. Conversely,
if cash provided by Borders-Walden exceeds cash used by Borders-Walden,
Borders-Walden
VII-7
<PAGE> 260
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
would transfer the excess cash to the Kmart Group. Such transfers would
generally be made as short-term loans, unless the Board of Directors determined
that any such transfer should be made as a long-term loan or, in the case of a
transfer of funds from the Kmart Group to Borders-Walden, as an equity
contribution as described below. 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 of Directors 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 issuance of Borders-Walden Stock, the Board
of Directors 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 (i)
the number of shares issuable with respect to Kmart Group's Retained Interest in
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
(ii) the Kmart Group's interest in Borders-Walden would be increased and the
interest in Borders-Walden 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 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.
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
Borders-Walden, and the balance sheet of Borders-Walden would reflect as net
short-term and net long-term loans to or borrowings from the Kmart Group.
Similarly, the income statement 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 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 provide net cash 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.
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, which are presently accounted for on a cash basis. FAS 106 is
effective for fiscal years beginning after December 15, 1992. In the first
quarter of 1993, Borders-Walden recorded a $0.9 million charge, net of
applicable taxes, related to FAS 106 as the effect of an accounting change.
VII-8
<PAGE> 261
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
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 is effective for fiscal years
beginning after December 15, 1992. As a result of the adjustment of deferred tax
balances to the current enacted tax rate in the first quarter of 1993, Borders-
Walden recognized a $4.6 million charge to income as the cumulative 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 is effective for fiscal years beginning
after December 15, 1993. Borders-Walden adopted FAS 112 in the first quarter of
1993 and the effect was insignificant.
On a prospective basis, these new rules are not expected to have a material
impact on earnings.
THE OMNIBUS BUDGET RECONCILIATION ACT OF 1993
On August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 was
enacted which, among other things, increased the federal corporate income tax
rate by 1% retroactive to January 1, 1993 and also reinstated and extended the
targeted jobs tax credit. The effect of the 1% increase in the federal corporate
income tax rate on Borders-Walden's deferred tax balances was not material. The
1% increase in the federal corporate income tax rate will directly affect
Borders-Walden's fiscal 1993 effective income tax rate although this effect will
be partially offset by increased targeted job tax credits.
SEASONALITY AND INFLATION
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.
VII-9
<PAGE> 262
ANNEX VII-C
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 21 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 $1.184 billion for the fiscal
year ended January 24, 1993 ("fiscal 1992").
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 13 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 1992, Borders achieved annual average sales per book superstore
of $6.1 million, annual sales per square foot of $399 and inventory turnover of
2.5 times.
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-10
<PAGE> 263
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 reserve in the fourth quarter
of fiscal 1993 of approximately $140 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-11
<PAGE> 264
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 1992,
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 approximately $6.0 million and sales per gross square foot of
approximately $399. Comparable store sales for book superstores increased
approximately 15.6% in fiscal 1992. 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
VII-12
<PAGE> 265
various applications and databases, including the store's inventory,
through any combination of title words, authors or subjects and other
selection criteria.
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 acquired
Borders in October 1992, and has provided additional capital to fund Borders'
expansion program.
VII-13
<PAGE> 266
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......................................... 13 992,666 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 21 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-14
<PAGE> 267
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 fourteen 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 approximately $1.128 billion for fiscal 1992.
VII-15
<PAGE> 268
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 reserve in the fourth
quarter of fiscal 1993 of approximately $140 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-16
<PAGE> 269
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-17
<PAGE> 270
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-18
<PAGE> 271
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-19
<PAGE> 272
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-20
<PAGE> 273
<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
facilities have 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. Management
believes that no currently pending litigation to which either Borders or Walden
is a party will have a material adverse effect on Borders-Walden's financial
condition or its results of operations.
VII-21
<PAGE> 274
ANNEX VII-D
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.
<TABLE>
<S> <C>
Joseph E. Antonini Robert F. Di Romualdo
Kmart Corporation Borders-Walden Group
Chairman of the Board, President President and
and Chief Executive Officer Chief Executive Officer
George R. Mrkonic Richard L. Flanagan
Kmart Corporation Borders, Inc.
Executive Vice President President and
Specialty Retailing Chief Operating Officer
Thomas F. Murasky Charles R. Cumello
Kmart Corporation Walden Book Company, Inc.
Executive Vice President and President and
Chief Financial Officer Chief Executive Officer
</TABLE>
VII-22
<PAGE> 275
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 24, 1993
and the results of their operations and their cash flows for each of the two
years in the period ended January 24, 1993, 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.
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
January 31, 1994
VII-23
<PAGE> 276
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........................................................ $ $ 1,183.7 $ 1,140.1
Cost of merchandise sold, includes buying and occupancy
costs...................................................... 892.4 876.8
Selling, general and administrative expenses................. 243.7 228.9
Pre-opening expense.......................................... 1.9 0.8
Goodwill amortization........................................ 3.5 2.5
Interest:
Debt -- expense............................................ 0.6 0.5
---------- --------- ----------
1,142.1 1,109.5
---------- --------- ----------
Income before income taxes................................... 41.6 30.6
Income taxes................................................. 18.5 13.9
---------- --------- ----------
Net income................................................... $ $ 23.1 $ 16.7
---------- --------- ----------
---------- --------- ----------
Supplemental disclosure (unaudited):
Net income................................................. $ $ 23.1 $ 16.7
Add back of goodwill amortization.......................... 3.5 2.5
---------- --------- ----------
Kmart Corporation earnings attributable to Borders-Walden
Group................................................... $ $ 26.6 $ 19.2
---------- --------- ----------
---------- --------- ----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-24
<PAGE> 277
BORDERS-WALDEN GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
---------- ----------
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................................. $ $ 21.4
Merchandise inventories.............................................. 387.9
Accounts receivable and other current assets......................... 20.5
--------- --------
Total current assets................................................... 429.8
Property Owned:
Land................................................................. 10.1
Buildings............................................................ 44.2
Leasehold improvements............................................... 118.8
Furniture and fixtures............................................... 165.0
Construction in progress............................................. 2.2
--------- --------
340.3
Less-accumulated depreciation and amortization:
Property owned....................................................... (142.8)
--------- --------
Total Owned Property................................................... 197.5
Goodwill -- net of accumulated amortization of $22.4................... 244.9
--------- --------
$ $ 872.2
--------- --------
--------- --------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ $ 0.2
Accounts payable -- trade............................................ 181.6
Accrued payrolls and other liabilities............................... 102.7
Taxes other than income taxes........................................ 1.9
Income taxes......................................................... 23.9
--------- ---------
Total current liabilities.............................................. 310.3
Long-Term Debt......................................................... 9.6
Other Long-Term Liabilities............................................ 31.0
Deferred Income Taxes.................................................. 0.2
Borders-Walden Group Equity............................................ 521.1
--------- ---------
$ $ 872.2
--------- ---------
--------- ---------
Supplemental Disclosure (unaudited):
Borders-Walden Group Equity.......................................... $ $ 521.1
Add back of accumulated goodwill amortization........................ 22.4
--------- ---------
Kmart Corporation Equity attributable to Borders-Walden Group........ $ $ 543.5
--------- ---------
--------- ---------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-25
<PAGE> 278
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.................................................. $ $ 23.1 $ 16.7
Adjustments to reconcile net income to operating cash
flows:
Depreciation and amortization.......................... 33.3 30.9
Deferred income taxes.................................. (2.7) (1.9)
Increase (decrease) in other long-term liabilities..... (1.8) 6.8
Other -- net........................................... 2.6 0.9
Cash provided by (used for) current assets and current
liabilities:
(Increase) decrease in inventories..................... (20.3) 22.6
Increase in accounts payable........................... 23.3 13.5
Other -- net........................................... 39.9 35.8
--------- ------- --------
Net cash provided by operations........................... 97.4 125.3
--------- ------- --------
INVESTING
Capital expenditures -- owned property.................... (28.8) (15.2)
--------- ------- --------
Net cash used for investing............................... (28.8) (15.2)
--------- ------- --------
FINANCING
Repayment of long-term debt............................... (17.8) (0.1)
Net equity transactions with the Kmart Group.............. (41.2) (111.7)
--------- ------- --------
Net cash used for financing............................... (59.0) (111.8)
--------- ------- --------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS............. 9.6 (1.7)
Cash and equivalents at beginning of year................. 11.8 13.5
--------- ------- --------
CASH AND EQUIVALENTS AT END OF YEAR......................... $ $ 21.4 $ 11.8
--------- ------- --------
--------- ------- --------
Supplemental disclosures of cash flow information:
Interest paid............................................. $ $ 0.6 $ 0.5
Income taxes paid......................................... $ $ 12.3 $ 0.7
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-26
<PAGE> 279
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 stockholders 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 separately the
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. (Borders) and Walden Book Company, Inc.
(Waldenbooks) 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., % 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 first 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 separately the performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) an interest in each Specialty Retail Group (a Retained Interest) other than
the interest represented by any outstanding shares of any 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 stockholders 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 to the
public for cash in separate offerings (collectively, the Offerings). The timing,
sequence and size of such Offerings and the price at which such shares would be
sold would be determined by the Board at the time of each Offering based upon
then prevailing market and other conditions; however, it is currently
contemplated that Kmart Corporation would 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 the Kmart Corporation
would retain and attribute to the Kmart Group a 70% to 80% Retained Interest in
each such Specialty Retail Group. 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 Kmart Corporation. 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 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
VII-27
<PAGE> 280
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
to the management and accounting policies that would be applicable upon
implementation of the Specialty Retail Stock Proposal. 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, accounted for under the equity method. 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 stockholders 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),
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 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.
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 the 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 the 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 the
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.
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 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 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.
VII-28
<PAGE> 281
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 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 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.
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.
VII-29
<PAGE> 282
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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.
Financial Instruments: With the exception of long-term debt and
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 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 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 equity investment in
the Borders-Walden Group.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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. Such transfers would generally be
made as short-term loans, unless the Board of Directors determined that any such
transfer should be made as a long-term loan or, in the case of a transfer of
funds from the Kmart Group to the Borders-Walden Group, as an equity
contribution as described below. 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 of Directors 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,
VII-30
<PAGE> 283
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 issuance of Borders-Walden Stock, the Board
of Directors 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 contribution, 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.
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
Borders-Walden Group, and the balance sheet 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 substantial 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 the 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) would be charged to the
Borders-Walden Group based upon utilization and at negotiated rates. 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.
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.
VII-31
<PAGE> 284
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 non-permanent differences between
financial statement and taxable income.
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.
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Current:
Federal.............................................................. $ $15.9 $12.9
State and local...................................................... 4.2 2.8
Deferred:
Excess of tax over book depreciation................................. (0.3) 0.5
Inventory capitalization............................................. (1.5) (1.6)
Other................................................................ 0.2 (0.7)
----- ----- -----
Total income taxes.............................................. $ $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.............................. $ $14.2 $10.5 % 34.0% 34.0%
State and local taxes, net of federal tax benefit... 2.8 1.9 6.7 6.2
Goodwill amortization............................... 1.3 1.0 3.1 3.4
Other............................................... 0.2 0.5 0.6 1.8
----- ----- ----- ----- ---- ----
Total income taxes........................... $ $18.5 $13.9 % 44.4% 45.4%
----- ----- ----- ----- ---- ----
----- ----- ----- ----- ---- ----
</TABLE>
The amounts shown on the combined balance sheets for deferred income taxes
result principally from the temporary differences between financial statement
and income tax depreciation and cost of merchandise sold.
VII-32
<PAGE> 285
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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.
COMMITMENTS AND CONTINGENCIES
There are various claims, lawsuits, and pending actions against Walden and
Borders incident to the operations of the Borders-Walden Group. Liability, if
any, associated with these matters is not determinable at January 31, 1994. 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 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
Economic Development Corporation Bond, interest at 92% of bank's
prime rate per annum, variable monthly installments are payable
through November 2005................................................ 1.2
Mortgage payable to bank due September 1996, interest at 9.5% per annum
through 1993, thereafter, interest at .5% over prime per annum,
with variable monthly payments from 1993 through 1996................ 0.9
Mortgage payable to bank (subordinated to Economic Development
Corporation Bond) due August 1994, interest at 9.75% per annum....... 1.0
Mortgage payable to bank due 2009, interest at 9.92% per annum......... 4.5
----- -----
Total............................................................. 9.8
Portion due within one year............................................ 0.2
----- -----
Long-term debt......................................................... $ $ 9.6
----- -----
----- -----
</TABLE>
Principal payments due on long-term debt for the five years subsequent to
1992 are: 1993 -- $0.2; 1994 -- $1.2; 1995 -- $2.3; 1996 -- $1.1; 1997 -- $0.3;
1998 and thereafter $4.7.
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-33
<PAGE> 286
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Lease Commitments. Future minimum lease payments at January 23, 1993 were
as follows:
<TABLE>
<CAPTION>
MINIMUM
LEASE
PAYMENTS
-------
<S> <C>
Fiscal Year:
1993............................................................................ $101.7
1994............................................................................ 95.8
1995............................................................................ 88.7
1996............................................................................ 80.8
1997............................................................................ 67.8
Later years..................................................................... 250.8
------
Minimum lease payments............................................................ $685.6
------
------
</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...................................................... $ $ 93.4 $86.6
Percentage rentals................................................... 8.4 9.0
Less: sublease rentals............................................... (0.2) (0.2)
------ ------ -----
Total........................................................... $ $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
attributable to the Borders-Walden Group was actuarially determined based on the
attributes of the Borders-Walden Group's plan participants. Plan assets and
obligations were allocated based upon a method which management believes to be
reasonable.
The following table presents Borders-Walden Group's funded status based on
a proportionate share of fund assets, as described above, and amounts recognized
in the accompanying balance sheet at year end.
VII-34
<PAGE> 287
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Under this basis, the following tables summarize the funded status, components
of pension cost and actuarial assumptions:
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24, FEBRUARY 1,
1994 1993 1992
--------- ------- -----
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits................. $ $ (9.2) $(5.3)
Estimated present value of non-vested benefits............. (2.4) (1.4)
--------- ------- -----
Accumulated benefit obligation............................. (11.6) (6.7)
Value of future pay increases.............................. (5.7) (3.0)
--------- ------- -----
Projected benefit obligation............................... (17.3) (9.7)
Estimated market value of plan assets........................ 16.2 10.0
--------- ------- -----
Plan assets over (under) projected benefit obligation........ (1.1) 0.3
Unrecognized net asset....................................... (1.3) (0.9)
Unrecognized prior service cost.............................. 0.6 0.4
Unrecognized net (gain) loss and other....................... 0.4 (0.4)
--------- ------- -----
Accrued pension costs........................................ $ $ (1.4) $(0.6)
--------- ------- -----
--------- ------- -----
</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.................................................. $ $ 1.4 $ 1.0
Interest cost in projected benefit obligation........................ 1.3 0.8
Return on plan assets................................................ (1.2) (1.3)
Net amortization and deferral of other components.................... (0.1) 0.6
----- ----- -----
Total............................................................. $ $ 1.4 $ 1.1
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates....................................................... 8.50% 8.75%
Expected return on plan assets....................................... 9.50% 9.50%
Salary increases..................................................... 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 $0.9 was
included in net income as the effect of an accounting change in the first
quarter of 1993.
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.
VII-35
<PAGE> 288
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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................................. $ $ 388.1 $ 483.1
Net income................................................... 23.1 16.7
Net equity transactions with the Kmart Group................. 109.9 (111.7)
--------- ------- -------
Borders-Walden Group Equity.................................. $ $ 521.1 $ 388.1
--------- ------- -------
--------- ------- -------
</TABLE>
EMPLOYEE SAVINGS PLAN
Employees of the Borders-Walden Group who meet certain requirements as to
age and service are eligible to participate in the Kmart Corporation 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 $1.5 and $1.3 for 1992 and 1991, respectively.
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 the Kmart Corporation
consolidated financial statements. 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 $.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
Kmart Corporation'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, 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 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 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.
VII-36
<PAGE> 289
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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. 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.
SUBSEQUENT EVENT
In January 1994, Kmart Corporation announced plans to restructure a portion
of its operations, including Walden. As a result of this decision, the
Borders-Walden Group will record in the fourth quarter of 1993 a pretax
restructuring charge of approximately $140.4 primarily for costs associated with
the closure of approximately 200 underperforming Walden stores, including the
related net lease costs, estimated fixed asset and inventory write-downs and
estimated operating losses. In addition, the restructuring charge includes costs
related to the reengineering of Walden's business processes, the combination of
certain administrative functions of the Borders-Walden Group and certain other
non-recurring items.
VII-37
<PAGE> 290
ANNEX VII-E
BORDERS-WALDEN GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS 38 WEEKS
ENDED ENDED
----------- -----------
OCTOBER 24, OCTOBER 25,
1993 1992
--------- ---------
(UNAUDITED)
<S> <C> <C>
Sales.................................................................. $ 875.2 $ 736.0
Cost of merchandise sold, includes buying and occupancy costs.......... 671.3 573.5
Selling, general and administrative expenses........................... 213.2 172.4
Pre-opening expense.................................................... 1.5 0.3
Goodwill amortization.................................................. 5.4 2.2
Interest:
Debt -- expense...................................................... 0.8 0.4
------- -------
892.2 748.8
------- -------
Loss before income taxes and the effect of accounting changes.......... (17.0) (12.8)
Income taxes........................................................... 6.8 5.6
------- -------
Net loss before the effect of accounting changes....................... (10.2) (7.2)
Effect of accounting changes, net of income tax........................ (5.5) --
------- -------
Net loss............................................................. $ (15.7) $ (7.2)
------- -------
------- -------
Supplemental disclosure:
Net loss............................................................. $ (15.7) $ (7.2)
Add back of goodwill amortization.................................... 5.4 2.2
------- -------
Kmart Corporation earnings (loss) attributable to Borders-Walden
Group............................................................. $ (10.3) $ (5.0)
------- -------
------- -------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-38
<PAGE> 291
BORDERS-WALDEN GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 24, OCTOBER 25,
1993 1992
------- -------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash.................................................................. $ 20.0 $ 18.0
Merchandise inventories............................................... 488.0 428.1
Accounts receivable and other current assets.......................... 24.3 19.0
------- -------
Total current assets.................................................... 532.3 465.1
Property Owned:
Land.................................................................. 10.1 8.7
Buildings............................................................. 44.3 38.0
Leasehold improvements................................................ 134.2 113.6
Furniture and fixtures................................................ 186.4 158.5
Construction in progress.............................................. 15.1 3.0
------- -------
390.1 321.8
Less -- accumulated depreciation and amortization:
Property owned........................................................ (167.6) (143.2)
------- -------
Total Owned Property.................................................... 222.5 178.6
Goodwill -- net of accumulated amortization of $27.8 and $20.8,
respectively.......................................................... 240.0 74.7
------- -------
$ 994.8 $ 718.4
------- -------
------- -------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year.................................... $ 0.2 $ 0.1
Accounts payable -- trade............................................. 210.4 167.8
Accrued payrolls and other liabilities................................ 85.4 86.0
Taxes other than income taxes......................................... 2.2 1.1
Income taxes.......................................................... (2.9) (4.4)
------- -------
Total current liabilities............................................... 295.3 250.6
Long-Term Debt.......................................................... 9.4 4.5
Other Long-Term Liabilities............................................. 29.9 24.1
Deferred Income Taxes................................................... 5.3 2.6
Borders-Walden Group Equity............................................. 654.9 436.6
------- -------
$ 994.8 $ 718.4
------- -------
------- -------
Supplemental Disclosure:
Borders-Walden Group Equity........................................... $ 654.9 $ 436.6
Add back of accumulated goodwill amortization......................... 27.8 20.8
------- -------
Kmart Corporation equity attributable of Borders-Walden Group......... $ 682.7 $ 457.4
------- -------
------- -------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-39
<PAGE> 292
BORDERS-WALDEN GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS 38 WEEKS
ENDED ENDED
----------- -----------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net loss before the effect of accounting changes..................... $ (10.2) $ (7.2)
Adjustments to reconcile net loss to operating cash flows:
Depreciation and amortization..................................... 29.7 23.6
Deferred income taxes............................................. 0.5 (0.3)
Increase (decrease) in other long-term liabilities................ (2.0) (1.3)
Cash provided by (used for) current assets and current liabilities:
Increase in inventories........................................... (100.1) (99.3)
Increase in accounts payable...................................... 28.8 52.0
Other -- net...................................................... (47.6) (0.9)
------- -------
Net cash used for operations......................................... (100.9) (33.4)
------- -------
INVESTING
Capital expenditures -- owned property............................... (49.8) (16.0)
Other -- net......................................................... -- --
------- -------
Net cash used for investing.......................................... (49.8) (16.0)
------- -------
FINANCING
Reduction in long-term debt.......................................... (0.2) (0.1)
Net equity transactions with the Kmart Group......................... 149.5 55.7
------- -------
Net cash provided by financing....................................... 149.3 55.6
------- -------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS........................ (1.4) 6.2
Cash and Equivalents at Beginning of Year............................ 21.4 11.8
------- -------
CASH AND EQUIVALENTS AT END OF PERIOD.................................. $ 20.0 $ 18.0
------- -------
------- -------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VII-40
<PAGE> 293
BORDERS-WALDEN GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
BASIS OF PRESENTATION
The accompanying unaudited combined financial statements do not include all
information and footnotes necessary for the annual presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles. Due to the changes in Walden's fiscal year end
in 1992, the period ended October 25, 1992 included 38 weeks.
In the opinion of the Borders-Walden Group management, all adjustments
necessary for a fair statement of the results for the interim periods have been
included. All adjustments were of a normal and recurring nature.
ACCOUNTING CHANGES
The Borders-Walden Group 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 the Borders-Walden Group recorded a charge of
$4.6 as the cumulative effect of the accounting change.
The Borders-Walden 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
Borders-Walden Group accrue for future postretirement medical benefits. In prior
years, these claims were expensed when paid. Net of applicable tax, a charge of
$0.9 has been included in net income as the effect of an accounting change.
RESTATEMENT OF PRIOR PERIOD 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.
SUBSEQUENT EVENT
In January 1994, the Kmart Corporation announced plans to restructure a
portion of its operations, including Walden. As a result of this decision, the
Borders-Walden Group will record in the fourth quarter of 1993 a pre-tax
restructuring charge of approximately $140.4 primarily for the cost associated
with the closure of approximately 200 underperforming Walden stores, including
the related net lease costs, estimated fixed asset and inventory writedowns and
estimated operating losses. In addition, the restructuring charge includes costs
related to the reengineering of Walden's business processes, the combination of
certain Borders-Walden Group administration functions and other non-recurring
items.
BORDERS-WALDEN GROUP EQUITY
<TABLE>
<CAPTION>
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Balance at beginning of period...................... $ 521.1 $ 388.1
Net loss............................................ (15.7) (7.2)
Net equity transactions with the Kmart Group........ 149.5 55.7
------- -------
Borders-Walden Group Equity......................... $ 654.9 $ 436.6
------- -------
------- -------
</TABLE>
VII-41
<PAGE> 294
ANNEX VII-F
BORDERS-WALDEN GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE THIRTY NINE WEEKS ENDED OCTOBER 24, 1993
Period Ended October 24, 1993 and October 25, 1992
RESULTS OF OPERATIONS
The following table presents Borders-Walden Group's ("Borders-Walden")
income statement data, as a percent of sales, for the periods presented.
<TABLE>
<CAPTION>
39 WEEKS 38 WEEKS
ENDED ENDED
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Sales............................................................... 100.0% 100.0%
Cost of merchandise sold, includes buying and occupancy costs....... 76.7 77.9
----- -----
Gross margin........................................................ 23.3 22.1
Selling, general and administrative expenses........................ 24.4 23.4
----- -----
Operating loss before pre-opening expenses and goodwill
amortization...................................................... (1.1) (1.3)
----- -----
Pre-opening expense................................................. 0.2 0.1
Goodwill amortization............................................... 0.6 0.3
----- -----
Operating loss...................................................... (1.9) (1.7)
Net interest expense................................................ 0.1 --
----- -----
Loss before income taxes and accounting changes..................... (2.0) (1.7)
Income taxes........................................................ 0.8 0.7
----- -----
Net loss before the effect of accounting changes.................... (1.2) (1.0)
Effect of accounting changes, net of income tax..................... (0.6) --
----- -----
Net loss............................................................ (1.8)% (1.0)%
----- -----
----- -----
</TABLE>
Store Activity. Borders-Walden's store activity is summarized below:
<TABLE>
<CAPTION>
PERIOD ENDED
----------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Borders Superstores
Beginning number of stores.......................... 31(1) --
Openings............................................ 6 --
Closings............................................ -- --
----- -----
Ending number of stores............................. 37 --
----- -----
----- -----
Walden Mall Bookstores(2)
Beginning number of stores.......................... 1,202 1,217
Openings............................................ 6 16
Closings............................................ (33) (30)
----- -----
Ending number of stores............................. 1,175 1,203
----- -----
----- -----
</TABLE>
- -------------------------
(1) Includes the conversion of nine book superstores that had been opened by
Walden in fiscal 1992.
(2) Excludes 58 Walden Software stores operated in 1992 and 1991.
VII-42
<PAGE> 295
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> 296
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> 297
ANNEX VIII
BUILDERS SQUARE GROUP
<TABLE>
<CAPTION>
PAGE
--------
<S> <C> <C>
VIII-A: Selected Financial Data................................................... VIII- 2
VIII-B: Management's Discussion and Analysis of Financial Condition and Results
of Operations for the Fiscal Year Ended January 24, 1993.................. VIII- 3
VIII-C: Business Description...................................................... VIII-10
VIII-D: Combined Financial Statements for the Fiscal Year Ended January 24,
1993...................................................................... VIII-21
VIII-E: Combined Financial Statements for the 39 Weeks Ended October 24, 1993..... VIII-36
VIII-F: Management's Discussion and Analysis of Financial Condition and Results
of Operations for the 39 Weeks Ended October 24, 1993..................... VIII-40
</TABLE>
VIII-1
<PAGE> 298
ANNEX VIII-A
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 the 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........................................................... $ $2,419.5 $2,048.5 $1,906.5 $1,813.1
Gross margin.................................................... 564.5 488.1 457.6 412.2
Selling, general and administrative expenses(1)................. 470.4 405.0 392.8 393.5
-------- -------- -------- -------- --------
Operating income before pre-opening expense and goodwill
amortization.................................................. 94.1 83.1 64.8 18.7
Pre-opening expense............................................. 13.2 6.9 5.1 5.5
Goodwill amortization........................................... 0.9 2.4 3.6 3.4
-------- -------- -------- -------- --------
Operating income................................................ 80.0 73.8 56.1 9.8
Interest expense - net.......................................... 3.5 2.7 2.9 4.3
-------- -------- -------- -------- --------
Income before income taxes...................................... 76.5 71.1 53.2 5.5
Income taxes.................................................... 21.6 24.1 18.2 4.5
-------- -------- -------- -------- --------
Net income...................................................... $ $ 54.9 $ 47.0 $ 35.0 $ 1.0
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Add back amortization of goodwill............................... 0.9 2.4 3.6 3.4
-------- -------- -------- -------- --------
Kmart Corporation earnings attributable to Builders Square
Group......................................................... $ $ 55.8 $ 49.4 $ 38.6 $ 4.4
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
PERCENT OF SALES DATA
Gross margin.................................................... % 23.3% 23.8% 24.0% 22.7%
Selling, general and administrative expenses.................... 19.4 19.8 20.6 21.7
Operating income before pre-opening expense and goodwill
amortization.................................................. 3.9 4.1 3.4 1.0
Income before income taxes...................................... 3.2 3.5 2.8 0.3
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital................................................. $ $339.4 $310.6 $322.7 $274.6
Total assets.................................................... 876.8 679.8 655.8 619.4
Total debt...................................................... 13.5 -- -- --
Builders Square Group equity.................................... 493.9 446.9 463.6 401.9
SELECTED FINANCIAL AND OPERATING DATA
End of year stores(2):
Builders Square II............................................ 8 -- -- --
Builders Square I............................................. 157 144 144 141
-------- -------- -------- -------- --------
Total....................................................... 165 144 144 141
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Comparable store sales increase(3).............................. % 8.5% 7.0% 3.6% 0.5%
Weighted average sales per square foot(4)....................... $ $210 $197 $185 $181
Weighted average sales per store (millions)(5).................. 15.7 14.5 13.5 13.1
Average sale per transaction.................................... 30.45 28.80 28.04 28.43
Capital expenditures -- owned property (millions)............... 57.2 44.8 21.3 17.4
Depreciation and amortization (millions)........................ 29.6 27.5 26.8 22.4
</TABLE>
- -------------------------
(1) Includes store closing expense, in millions, of $1.5, $16.6 and $20.6 for
the fiscal years 1992, 1991 and 1989, respectively.
(2) In fiscal year 1993, Builders Square determined that it would open all new
stores in its new Builders Square II format (BSQ II) and convert virtually
all of its existing stores to the new format by fiscal 1997.
(3) Comparable store sales include the sales of a store beginning in its
fourteenth full month of operations.
(4) Sales for the period divided by the effective weighted average number of
selling square feet in stores operated during the period.
(5) Sales for the period divided by the effective weighted average number of
stores operated during the period.
VIII-2
<PAGE> 299
ANNEX VIII-B
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993
GENERAL
At January 23, 1994, 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 profits 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, Builders Square announced that, based on favorable
sales and profit performance of the BSQ II Stores, Builders Square plans to
convert virtually all of its stores to the new format by 1997. The BSQ II Stores
have an easier-to-shop layout that utilizes a "store-within-a-store" format with
substantially increased customer service levels. Including 16 stores closed or
relocated in 1993, plans call for the closing and relocation of approximately 90
BSQ I Stores. There are currently 177 Builders Square stores in operation, of
which 47 are in the BSQ II Store format. As a result of the foregoing, Builders
Square will record a pre-tax charge of $207 million in the fourth quarter of
1993 primarily to provide for the expense associated with stores that will be
closed or relocated and for a non-routine legal judgment.
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.
In connection with this clustering strategy, Builders Square is closing
selected BSQ I Stores, converting the balance of existing BSQ I Stores to the
BSQ II Stores format and filling in existing and contiguous markets with BSQ II
Stores. During 1993 and over the next four years, Builders Square currently
expects to phase out 144 BSQ I Stores by closing 16 stores, relocating 74 stores
and renovating 54 stores. In addition, Builders Square plans to open
approximately 10-20 new BSQ II Stores during each of the next two years.
Builders Square's 1992 and 1991 fiscal years each consisted of 52 weeks and
ended on 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
<PAGE> 300
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
Fiscal Years Ended January 24, 1993 (fiscal 1992) and January 25, 1992 (fiscal
1991)
RESULTS OF OPERATIONS
The following table presents Builders Square's income statement data, as a
percent of sales, for the periods presented.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------
JANUARY 24, JANUARY 26,
1993 1992
----------- -----------
<S> <C> <C>
Sales.................................................................. 100.0% 100.0%
Cost of merchandise sold, includes buying and occupancy costs.......... 76.7 76.2
----------- -----------
Gross margin........................................................... 23.3 23.8
Selling, general and administrative expenses........................... 19.4 19.8
----------- -----------
Operating income before pre-opening expense and goodwill
amortization......................................................... 3.9 4.0
Pre-opening expense.................................................... 0.6 0.3
Goodwill amortization.................................................. -- 0.1
----------- -----------
Operating income....................................................... 3.3 3.6
Net interest expense................................................... 0.1 0.1
----------- -----------
Income before income taxes............................................. 3.2 3.5
Income taxes........................................................... 0.9 1.2
----------- -----------
Net income............................................................. 2.3% 2.3%
----------- -----------
----------- -----------
</TABLE>
Store Activity. Builders Square's store activity is summarized below:
<TABLE>
<CAPTION>
1992 1991
---- ----
<S> <C> <C>
Beginning number of stores.............................. 144 144
Openings................................................ 22 14
Closings................................................ (1) (14)
---- ----
Ending number of stores................................. 165 144
---- ----
---- ----
</TABLE>
Builders Square BSQ I and BSQ II store activity for fiscal 1992 is summarized
below:
<TABLE>
<CAPTION>
BSQ I BSQ II TOTAL
----- ------ -----
<S> <C> <C> <C>
Beginning number of stores..................... 144 0 144
Openings, including relocations................ 14 8 22
Conversions.................................... 0 0 0
Closings....................................... (1) 0 (1)
----- - -----
Ending number of stores........................ 157 165
8
----- - -----
----- - -----
</TABLE>
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 8 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
VIII-4
<PAGE> 301
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
$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 (SG&A) expense in 1992 was $470.4
million, or 19.4% of sales, as compared to $405.0 million, or 19.8% of sales, in
1991. SG&A decreased 0.4% of sales in 1992 due primarily to lower store closing,
store operating and advertising expense relative to sales as a result of the
8.5% comparable store sales increase.
Operating income before pre-opening expense and goodwill amortization in
1992 was $94.1 million, or 3.9% of sales, as compared with $83.1 million, or
4.0% of sales, in the prior year. The decrease of 0.1% of sales in 1992 was the
result of increased sales which was offset by lower gross margins and higher
SG&A costs.
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 in 1992 was $0.9 million as compared to $2.4 million
in 1991. The decrease resulted from the full amortization of a portion of the
goodwill attributed to non-compete agreements during 1991. Goodwill amortization
is expected to approximate 1992 levels for the next several years.
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.
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 Internal Revenue Service (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
24, 1993 and January 25, 1992 are summarized below. The net increase in cash and
equivalents was $12.0 million and $5.5 million in 1992 and 1991, respectively.
Net cash provided by operations was $67.8 million in 1992, as compared to
$110.4 million in 1991. The decrease in net cash provided by operations in 1992
was a result of an increase in inventory net of accounts payable and to a
decrease in other long-term liabilities, partially offset by higher net income
before non-cash
VIII-5
<PAGE> 302
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
depreciation and amortization expenses. Depreciation and amortization expense
resulted primarily from goodwill, leasehold improvements and store fixtures.
Net cash used for investing consists primarily of capital expenditures
relating to new store openings and the renovation of existing stores. Capital
expenditures totaled $57.2 million and $44.8 million in 1992 and 1991,
respectively. 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. During 1993 and over the next four years,
Builders Square is expected to phase out approximately 144 BSQ I stores by
closing 16 stores, relocating 74 stores and renovating 54 stores.
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 financing was $3.7 million in 1992 and consisted of
$13.5 million from 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 the 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 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 each Specialty
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 equity investment in Builders Square.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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 excess uses. Conversely, if cash
provided by the Builders Square Group exceeds cash used by Builders Square,
Builders Square would transfer the excess cash to the Kmart Group. Such
transfers would generally be made as short-term loans, unless the Board of
Directors determined that any such transfer should be made as a long-term loan
or, in the case of a transfer of funds from the Kmart Group to Builders Square,
as an equity contribution as described below. 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 of Directors
VIII-6
<PAGE> 303
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
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 issuance of Builders Square Stock, the
Board of Directors 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 (i) the number of shares issuable with respect to the Kmart
Group's Retained Interest in 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 (ii) the Kmart Group's interest in Builders Square
would be increased and the interest in Builders Square 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 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.
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
Builders Square, and the balance sheet of Builders Square 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 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 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 provide substantial
net cash 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 the
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 it 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.
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, which are presently accounted for on a cash basis. FAS 106 is
effective for fiscal years beginning after December 15,
VIII-7
<PAGE> 304
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE FISCAL YEAR ENDED JANUARY 24, 1993 -- CONTINUED
1992. In the first quarter of 1993, Builders Square recorded a $1.3 million
charge, net of applicable taxes, related to FAS 106 as the effect of an
accounting change.
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 is effective for fiscal years
beginning after December 15, 1992. Builders Square adopted FAS 109 as the
cumulative effect of an accounting change in the first quarter of 1993 resulting
in one time credit to income of $2.9 million.
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 is effective for fiscal years beginning
after December 15, 1993. The effect of this statement on Builders Square was not
significant.
THE OMNIBUS BUDGET RECONCILIATION ACT OF 1993
On August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 was
enacted which, among other things, increased the federal corporate income tax
rate by 1% retroactive to January 1, 1993 and also reinstated and extended the
targeted jobs tax credit. The effect of the 1% increase in the federal corporate
income tax rate on Builders Square's deferred tax balances was $0.4 million. The
1% increase in the federal corporate income tax rate will directly effect
Builders Square's fiscal 1993 effective income tax rate although this effect
will be partially offset by increased targeted job tax credits.
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. In fiscal 1992, 28.4% and 25.7% of Builders Square's
sales and 33.1% and 25.5% of its operating income before pre-opening expense and
goodwill amortization occurred in the second and third quarters, respectively.
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 1992 QUARTER ENDED
------------------------------------
APRIL JULY OCTOBER JANUARY
----- ----- ------- -------
<S> <C> <C> <C> <C>
Sales........................................................ 23.1% 28.4% 25.7% 22.8%
Operating income before pre-opening expense and goodwill
amortization............................................... 20.5% 33.1% 25.5% 20.9%
</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.
VIII-8
<PAGE> 305
ANNEX VIII-C
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 $2.4 billion for the fiscal year ended
January 24, 1993 ("fiscal 1992"). Builders Square has achieved compound annual
growth in net sales of 10.5% during the period from fiscal 1989 to fiscal 1992.
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
VIII-9
<PAGE> 306
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 Builder 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 grow 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 be 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
VIII-10
<PAGE> 307
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 and 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
VIII-11
<PAGE> 308
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:
[Diagram of store layout.]
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,
VIII-12
<PAGE> 309
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
VIII-13
<PAGE> 310
layout and focus. The BSQ I Stores do not contain a center court or an Idea
Center and are not organized using a "racetrack" 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.
VIII-14
<PAGE> 311
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>
VIII-15
<PAGE> 312
W
<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 144 BSQ I Stores by closing
approximately 16 stores, relocating approximately 74 stores and converting
approximately 54 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
VIII-16
<PAGE> 313
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-17
<PAGE> 314
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-18
<PAGE> 315
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 is 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 financial condition or results of operations.
VIII-19
<PAGE> 316
ANNEX VIII-D
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 Frank G. Felicella
Kmart Corporation Builders Square, Inc.
Chairman of the Board, President President and
and Chief Executive Officer Chief Executive Officer
George R. Mrkonic J. Kent Fortner
Kmart Corporation Builders Square, 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
VIII-20
<PAGE> 317
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 24,
1993 and the results of their operations and their cash flows for each of the
two years in the period ended January 24, 1993, 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.
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
San Antonio, Texas
January 31, 1994
VIII-21
<PAGE> 318
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........................................................ $ $ 2,419.5 $ 2,048.5
Cost of merchandise sold, includes buying and occupancy
costs...................................................... 1,855.0 1,560.4
Selling, general and administrative expenses................. 468.9 388.4
Pre-opening expense.......................................... 13.2 6.9
Store closing expense........................................ 1.5 16.6
Goodwill amortization........................................ 0.9 2.4
Interest:
Debt -- expense............................................ 0.4 --
-- income............................................. (1.7) (0.5)
Capital lease obligations -- expense....................... 4.8 3.2
----------- ----------- -----------
2,343.0 1,977.4
----------- ----------- -----------
Income before income taxes................................... 76.5 71.1
Income taxes................................................. 21.6 24.1
----------- ----------- -----------
Net income................................................... $ $ 54.9 $ 47.0
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure (unaudited):
Net income................................................. $ $ 54.9 $ 47.0
Add back of goodwill amortization.......................... 0.9 2.4
----------- ----------- -----------
Kmart Corporation earnings attributable to
Builders Square Group................................... $ $ 55.8 $ 49.4
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-22
<PAGE> 319
BUILDERS SQUARE GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24,
1994 1993
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................................. $ $ 30.6
Merchandise inventories (LIFO)
At replacement cost............................................... 548.8
Less -- LIFO reserve.............................................. (36.7)
----------- -----------
512.1
Accounts receivable and other current assets......................... 48.4
Property held for resale............................................. 31.9
----------- -----------
Total current assets................................................... 623.0
Property Owned:
Land................................................................. 4.4
Buildings............................................................ 9.8
Leasehold improvements............................................... 83.3
Furniture and fixtures............................................... 167.7
Construction in progress............................................. 23.4
Property under capital leases.......................................... 75.2
----------- -----------
363.8
Less -- accumulated depreciation and amortization:
Property owned....................................................... (118.3)
Property under capital leases........................................ (23.3)
----------- -----------
Total owned and leased property........................................ 222.2
Other Assets and Deferred Charges...................................... 4.7
Goodwill -- net of accumulated amortization of $7.1.................... 26.9
----------- -----------
$ $ 876.8
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ $ 0.2
Current portion of capital lease obligations......................... 2.3
Accounts payable -- trade............................................ 226.2
Accrued payrolls and other liabilities............................... 41.2
Taxes other than income taxes........................................ 12.4
Income taxes......................................................... 1.3
----------- -----------
Total current liabilities.............................................. 283.6
Capital Lease Obligations.............................................. 57.9
Long-Term Debt......................................................... 13.3
Other Long-Term Liabilities (includes restructuring obligations)....... 17.2
Deferred Income Taxes.................................................. 10.9
Builders Square Group Equity........................................... 493.9
----------- -----------
$ $ 876.8
----------- -----------
----------- -----------
Supplemental disclosure (unaudited):
Builders Square Group Equity......................................... $ $ 493.9
Add back of accumulated goodwill amortization........................ 7.1
----------- -----------
Kmart Corporation equity attributable to Builders Square Group....... $ $ 501.0
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-23
<PAGE> 320
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................................................. $ $ 54.9 $ 47.0
Adjustments to reconcile net income to operating cash
flows:
Depreciation and amortization........................... 29.6 27.5
Store closing charges................................... 0.2 6.0
Deferred income taxes................................... 2.4 5.3
Increase (decrease) in other long-term liabilities...... (1.4) 30.1
Other -- net............................................ 5.5 3.3
Cash provided by (used for) current assets and current
liabilities:
Increase in inventories................................. (107.4) (6.0)
Increase in accounts payable............................ 103.0 18.5
Other -- net............................................ (19.0) (21.3)
----------- ----------- -----------
Net cash provided by operations............................ 67.8 110.4
----------- ----------- -----------
INVESTING
Capital expenditures -- owned property..................... (57.2) (44.8)
Other -- net............................................... (2.3) 5.1
----------- ----------- -----------
Net cash used for investing................................ (59.5) (39.7)
----------- ----------- -----------
FINANCING
Proceeds from issuance of long-term debt................... 13.5 --
Net equity transactions with the Kmart Group............... (7.9) (63.7)
Reduction in capital lease obligations..................... (1.9) (1.5)
----------- ----------- -----------
Net cash provided by (used for) financing.................. 3.7 (65.2)
----------- ----------- -----------
NET INCREASE IN CASH AND EQUIVALENTS......................... 12.0 5.5
Cash and Equivalents at Beginning of Year.................. 18.6 13.1
----------- ----------- -----------
CASH AND EQUIVALENTS AT END OF YEAR.......................... $ $ 30.6 $ 18.6
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure of cash flow information:
Interest paid.............................................. $ $ 4.9 $ 2.9
Income taxes paid.......................................... $ $ 22.4 $ 22.6
Capital lease obligations incurred......................... $ $ 29.7 $ 7.2
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-24
<PAGE> 321
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 stockholders 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 separately the
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 in tended 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 first 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 separately the performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) an interest in each Specialty Retail Group (a Retained Interest) other than
the interest represented by any outstanding shares of any 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 stockholders 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 to the
public for cash in separate offerings (collectively, the Offerings). The timing,
sequence and size of such Offerings and the price at which such shares would be
sold would be determined by the Board at the time of each Offering based upon
then prevailing market and other conditions; however, it is currently
contemplated that Kmart Corporation would 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 the Kmart Corporation
would retain and attribute to the Kmart Group a 70% to 80% Retained Interest in
each such Specialty Retail Group. 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
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 Kmart Corporation. 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 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
VIII-25
<PAGE> 322
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Retail Stock Proposal. 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 accounted for
under the equity method. 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 stockholders 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),
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 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.
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 the 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.
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 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 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.
VIII-26
<PAGE> 323
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 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 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.
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.
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.
VIII-27
<PAGE> 324
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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.
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 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 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 equity investment in
the Builders Square Group.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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. Such transfers would generally be
made as short-term loans, unless the Board of Directors determined that any such
transfer should be made as a long-term loan or, in the case of a transfer of
funds from the Kmart Group to the Builders Square Group, as an equity
contribution as described below. 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 of Directors 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 issuance of Builders Square Stock, the
Board of Directors could determine that funds to be transferred from the Kmart
Group to the Builders Square Group represent an
VIII-28
<PAGE> 325
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 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.
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
Builders Square Group, and the balance sheet 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 substantial 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
Retail Stock Proposal and issuance of the 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) would be charged to the Builders
Square Group based upon utilization and at negotiated rates. 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.
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
VIII-29
<PAGE> 326
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 non-permanent differences between
financial statement and taxable income.
SUBSEQUENT EVENT
On January 5, 1994, the Builders Square Group announced that based on the
favorable sales and profit performance of the 109,000 square foot Builders
Square II format stores, the Builders Square Group plans to convert virtually
all of its stores to the new 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. Including 16 stores closed or
relocated in 1993, plans call for the closing and relocation of approximately 90
Builders Square I stores. There are currently 177 Builders Square stores in
operation, of which 47 are in the Builders Square II format. As a result of the
foregoing, Builders Square will record a pre-tax charge of $207 in the fourth
quarter of 1993 primarily to provide for the expense associated with stores that
will be closed or relocated and for a non-routine legal judgment.
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Current:
Federal.............................................................. $ $19.1 $11.4
State and local...................................................... 1.1 0.3
Deferred:
Store closing charges................................................ 1.9 9.1
Excess of tax over book depreciation................................. 0.4 0.9
LIFO inventory....................................................... (0.2) 3.9
Other................................................................ (0.7) (1.5)
----- ----- -----
Total income taxes................................................ $ $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.............................. $ $26.0 $24.2 % 34.0% 34.0%
State and local taxes, net of federal tax benefit... 0.7 -- 0.9 --
Reversal of tax reserves............................ (4.8) -- (6.3) --
Other............................................... (0.3) (0.1) (0.4) (0.1)
----- ----- ----- ---- ---- ----
Total income taxes............................. $ $21.6 $24.1 % 28.2% 33.9%
----- ----- ----- ---- ---- ----
----- ----- ----- ---- ---- ----
</TABLE>
The amounts shown on the combined balance sheets for deferred income taxes
result principally from the temporary differences between financial statement
and income tax depreciation and cost of merchandise sold, reduced by store
closing reserves.
VIII-30
<PAGE> 327
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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. 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.
Liability, if any, associated with these matters is not determinable at January
31, 1994. It is the opinion of management that the ultimate resolution of these
matters will not have a material effect on Builders Square Group's 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
approximates $14.8.
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).
VIII-31
<PAGE> 328
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
Lease Committments: Future minimum lease payments at January 24, 1993 were
as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1993.................................................................... $ 10.3 $ 67.5
1994.................................................................... 10.3 65.8
1995.................................................................... 10.3 65.2
1996.................................................................... 10.2 63.5
1997.................................................................... 10.1 61.7
Later years............................................................. 134.9 683.0
------- ---------
Total minimum lease payments......................................... 186.1 1,006.7
Less-minimum sublease rental income....................................... -- (1.9)
------- ---------
Net minimum lease payments................................................ 186.1 $ 1,004.8
---------
---------
Less:
Estimated executory costs............................................... (51.5)
Amount representing interest............................................ (74.4)
-------
60.2
Portion due within one year............................................... 2.3
-------
Long-term lease obligations............................................... $ 57.9
-------
-------
</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........................................................ $ $68.4 $60.7
Percentage rentals..................................................... 3.1 2.3
----- ----- -----
Total............................................................. $ $71.5 $63.0
----- ----- -----
----- ----- -----
</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................................. $ $ 2.4 $ 1.7
Interest expense related to obligations under capital leases........... 4.8 3.2
----- ----- -----
Amounts charged to earnings............................................ 7.2 4.9
Related minimum lease payments net of executory costs.................. (6.7) (4.7)
----- ----- -----
Excess of amounts charged over related minimum lease payments.......... $ $ 0.5 $ 0.2
----- ----- -----
----- ----- -----
</TABLE>
Related minimum lease payments above exclude executory costs for 1992 and
1991 in the amounts of $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
VIII-32
<PAGE> 329
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 attributable to the
Builders Square Group was actuarially determined based on the attributes of the
Builders Square Group's plan participants. Plan assets and obligations were
allocated based upon a method which management believes to be reasonable.
The following table presents Builders Square Group's funded status based on
a proportionate share of fund assets, as described above, and amounts recognized
in the accompanying balance sheet at year end. Under this basis, the following
tables summarize the funded status, components of pension cost and actuarial
assumptions.
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits................. $ $ (8.7) $ (4.3)
Estimated present value of non-vested benefits............. (3.4) (3.4)
----------- ----------- -----------
Accumulated benefit obligation............................. (12.1) (7.7)
Value of future pay increases.............................. (6.3) (4.4)
----------- ----------- -----------
Projected benefit obligation............................... (18.4) (12.1)
Estimated market value of plan assets........................ 17.2 12.5
----------- ----------- -----------
Plan assets over (under) projected benefit obligation........ (1.2) 0.4
Unrecognized net asset....................................... (1.4) (1.2)
Unrecognized prior service cost.............................. 0.7 0.6
Unrecognized net (gain) loss and other....................... 0.4 (0.5)
----------- ----------- -----------
Accrued pension costs........................................ $ $ (1.5) $ (0.7)
----------- ----------- -----------
----------- ----------- -----------
</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.................................................. $ $ 1.7 $ 1.3
Interest cost on projected benefit obligation........................ 1.4 0.9
Return on plan assets................................................ (1.3) (1.6)
Net amortization and deferral of other components.................... (0.1) 0.7
----- ----- -----
Total............................................................. $ $ 1.7 $ 1.3
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates....................................................... % 8.50% 8.75%
Expected return on plan assets....................................... % 9.50% 9.50%
Salary increases..................................................... % 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.
VIII-33
<PAGE> 330
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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. 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 the Kmart Corporation Employee
Savings Plan. The Builders Square Group's expense related to the Employee
Savings Plan was $1.8 and $1.4 for 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 the Kmart Corporation
consolidated financial statements. The Builders Square Group's allocation of
compensation expense related to the Performance Restricted Stock Plan was not
material.
BUILDERS SQUARE GROUP EQUITY
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year................................. $ $ 446.9 $ 463.6
Net income................................................... 54.9 47.0
Net equity transactions with the Kmart Group................. (7.9) (63.7)
----------- ----------- -----------
Builders Square Group Equity................................. $ $ 493.9 $ 446.9
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
VIII-34
<PAGE> 331
ANNEX VIII-E
BUILDERS SQUARE GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
Sales.................................................................. $ 2,100.6 $ 1,867.0
Cost of merchandise sold, includes buying and occupancy costs.......... 1,620.3 1,435.4
Selling, general and administrative expenses........................... 410.5 357.2
Pre-opening expense.................................................... 20.1 12.2
Goodwill amortization.................................................. 0.6 0.6
Interest:
Debt -- expense...................................................... 1.0 --
-- income....................................................... (0.4) (1.6)
Capital lease obligations -- expense................................. 5.3 3.4
----------- -----------
2,057.4 1,807.2
----------- -----------
Income before income taxes and the effect of accounting changes........ 43.2 59.8
Income taxes........................................................... 15.7 20.8
----------- -----------
Net income before the effect of accounting changes..................... 27.5 39.0
Effect of accounting changes, net of income tax........................ (1.6) --
----------- -----------
Net income............................................................. $ 29.1 $ 39.0
----------- -----------
----------- -----------
Supplemental disclosure:
Net income........................................................... $ 29.1 $ 39.0
Add back of goodwill amortization.................................... 0.6 0.6
----------- -----------
Kmart Corporation earnings attributable to Builders Square Group..... $ 29.7 $ 39.6
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-35
<PAGE> 332
BUILDERS SQUARE GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................................. $ 38.0 $ 27.7
Merchandise inventories (LIFO)
At replacement cost............................................... 678.7 568.3
Less -- LIFO reserve.............................................. (44.8) (32.6)
----------- -----------
633.9 535.7
Accounts receivable and other current assets......................... 76.5 51.6
Property held for resale............................................. 63.6 61.9
----------- -----------
Total current assets................................................... 812.0 676.9
Property Owned:
Land................................................................. 5.0 4.7
Buildings............................................................ 9.8 9.8
Leasehold improvements............................................... 91.9 81.9
Furniture and fixtures............................................... 203.4 160.9
Construction in progress............................................. 31.5 4.1
Property under capital leases.......................................... 102.7 72.6
----------- -----------
444.3 334.0
Less -- accumulated depreciation and amortization:
Property owned....................................................... (139.7) (112.2)
Property under capital leases........................................ (24.8) (23.5)
----------- -----------
Total owned and leased property........................................ 279.8 198.3
Other assets and deferred charges...................................... 5.1 3.5
Goodwill -- net of accumulated amortization of $7.7 and $6.9,
respectively......................................................... 26.3 27.2
----------- -----------
$ 1,123.2 $ 905.9
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ 0.2 $ 0.2
Current portion of capital lease obligations......................... 3.3 2.9
Accounts payable -- trade............................................ 294.2 247.0
Accrued payrolls and other liabilities............................... 31.7 34.6
Taxes other than income taxes........................................ 10.3 15.0
Income taxes......................................................... 8.7 4.2
----------- -----------
Total current liabilities.............................................. 348.4 303.9
Capital Lease Obligations.............................................. 82.5 55.3
Long-Term Debt......................................................... 13.2 13.3
Other Long-Term Liabilities (includes restructuring obligations)....... 19.2 16.3
Deferred Income Taxes.................................................. 11.5 8.4
Builders Square Group Equity........................................... 648.4 508.7
----------- -----------
$ 1,123.2 $ 905.9
----------- -----------
----------- -----------
Supplemental disclosure:
Builders Square Group Equity......................................... $ 648.4 $ 508.7
Add back of accumulated goodwill amortization........................ 7.7 6.9
----------- -----------
Kmart Corporation equity attributable to Builders Square Group....... $ 656.1 $ 515.6
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-36
<PAGE> 333
BUILDERS SQUARE GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income before the effects of accounting changes.................. $ 27.5 $ 39.0
Adjustments to reconcile net income to operating cash flows:
Depreciation and amortization..................................... 26.0 21.3
Deferred income taxes............................................. 0.6 (0.1)
Increase (decrease) in other long-term liabilities................ 3.6 (2.4)
Cash provided by (used for) current assets and current liabilities:
Increase in inventories........................................... (121.8) (125.4)
Increase in accounts payable...................................... 68.2 123.8
Other -- net...................................................... (64.1) (53.2)
----------- -----------
Net cash provided by (used for) operations........................... (60.0) 3.0
----------- -----------
INVESTING
Capital expenditures -- owned property............................... (58.2) (28.6)
Other -- net......................................................... 2.2 (0.2)
----------- -----------
Net cash used for investing.......................................... (56.0) (28.8)
----------- -----------
FINANCING
Proceeds from issuance of long-term debt............................. -- 13.5
Reduction in long-term debt.......................................... (0.1) --
Net equity transactions with the Kmart Group......................... 125.4 22.8
Reduction in capital lease obligations............................... (1.9) (1.4)
----------- -----------
Net cash provided by financing....................................... 123.4 34.9
----------- -----------
NET INCREASE IN CASH AND EQUIVALENTS................................... 7.4 9.1
Cash and Equivalents at Beginning of Year............................ 30.6 18.6
----------- -----------
CASH AND EQUIVALENTS AT END OF PERIOD.................................. $ 38.0 $ 27.7
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
VIII-37
<PAGE> 334
BUILDERS SQUARE GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
(UNAUDITED)
BASIS OF PRESENTATION
The accompanying unaudited combined financial statements do not include all
information and footnotes necessary for the annual presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles.
In the opinion of the Builders Square Group management, all adjustments
necessary for a fair statement of the results for the interim periods have been
included. All adjustments were of a normal and recurring nature.
ACCOUNTING CHANGES
The Builders Square Group adopted Financial Accounting Standard No. 109
"Accounting for Income Taxes" (FAS 109) at the first quarter of fiscal 1993. 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 income
tax rate. A credit of $2.9 has been included in net income as an effect of an
accounting change.
The Builders Square Group also 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 that the Builders Square
Group accrue for future postretirement medical benefits. In prior years, these
claims were expensed when paid. Net of applicable tax, a charge of $1.3 has been
included in net income as the effect of an accounting change.
SUBSEQUENT EVENT
On January 5, 1994, the Builders Square Group announced that based on the
favorable sales and profit performance of the 109,000 square foot Builders
Square II format stores, the Builders Square Group plans to convert virtually
all of its stores to the new 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. Including 16 stores closed or
relocated in 1993, plans call for the closing and relocation of approximately 90
Builders Square stores. There are currently 177 Builders Square stores in
operation, of which 47 are in the Builders Square II format. As a result of the
foregoing, Builders Square will record a pre-tax charge of $207 in the fourth
quarter of 1993 primarily to provide for the expense associated with stores that
will be closed or relocated and for a non-routine legal judgment.
BUILDERS SQUARE GROUP EQUITY
<TABLE>
<CAPTION>
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Balance at beginning of period......................................... $ 493.9 $ 446.9
Net income............................................................. 29.1 39.0
Net equity transactions with the Kmart Group........................... 125.4 22.8
----------- -----------
Builders Square Group Equity........................................... $ 648.4 $ 508.7
----------- -----------
----------- -----------
</TABLE>
VIII-38
<PAGE> 335
ANNEX VIII-F
BUILDERS SQUARE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE 39 WEEKS ENDED OCTOBER 24, 1993
39 Weeks Ended October 24, 1993 and October 25, 1992
RESULTS OF OPERATIONS
The following table presents the Builders Square Group's ("Builders
Square") income statement data as a percent of sales, for the periods presented.
<TABLE>
<CAPTION>
39 WEEKS ENDED
----------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Sales................................................................ 100.0% 100.0%
Cost of merchandise sold, includes buying and occupancy costs........ 77.1 76.9
----------- -----------
Gross margin......................................................... 22.9 23.1
Selling, general and administrative expenses......................... 19.5 19.1
----------- -----------
Operating income before pre-opening expense and goodwill
amortization....................................................... 3.4 4.0
Pre-opening expense.................................................. 1.0 0.7
Goodwill amortization................................................ -- --
----------- -----------
Operating income..................................................... 2.4 3.3
Net interest expense................................................. 0.3 0.1
----------- -----------
Income before income taxes and the effect of accounting changes...... 2.1 3.2
Income taxes......................................................... 0.8 1.1
----------- -----------
Net income before the effect of accounting changes................... 1.3 2.1
Effect of accounting changes, net of income tax...................... (0.1) --
----------- -----------
Net income........................................................... 1.4% 2.1%
----------- -----------
----------- -----------
</TABLE>
Builders Square's store activity for the first 39 weeks of 1993 and 1992 is
summarized below:
<TABLE>
<CAPTION>
39 WEEKS ENDED
----------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Beginning number of stores........................................... 165 144
Openings............................................................. 28 21
Closings............................................................. (15) --
--- ---
Ending number of stores.............................................. 178 165
--- ---
--- ---
</TABLE>
Builders Square's BSQ I and BSQ II store activity for the 39 weeks ended October
24, 1993:
<TABLE>
<CAPTION>
BSQ I BSQ II TOTAL
----- ------ -------
<S> <C> <C> <C>
Beginning number of stores........................................ 157 8 165
Openings, including relocations................................... 0 28 28
Conversions....................................................... (8) 8 0
Closings.......................................................... (15) 0 (15)
----- -- -------
Ending number of stores........................................... 134 44 178
----- -- -------
----- -- -------
</TABLE>
Sales for the 39 weeks ended October 24, 1993 were $2,100.6 million, a
$233.6 million, or 12.5% increase, over sales of $1,867.0 million in the same
period in the prior year. The 1993 sales increase was due to the 28 stores
opened, all of which were BSQ II Stores, in the first 39 weeks of 1993 and the
inclusion of a full
VIII-39
<PAGE> 336
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> 337
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> 338
ANNEX IX
OFFICEMAX GROUP
<TABLE>
<S> <C> <C>
IX-A: Selected Financial Data...................................................... IX- 2
IX-B: Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Fiscal Year Ended January 23, 1993............. IX- 3
IX-C: Business Description......................................................... IX-10
IX-D: Combined Financial Statements for the Fiscal Year Ended January 23, 1993..... IX-18
IX-E: Unaudited Pro Forma Combined Financial Information........................... IX-33
IX-F: Financial Statements for the Fiscal Year Ended July 27, 1991................. IX-34
IX-G: Bizmart, Inc. Consolidated Financial Statements as of March 4, 1993.......... IX-41
IX-H: Combined Financial Statements for the 39 Weeks Ended October 23, 1993........ IX-53
IX-I: Management's Discussion and Analysis of Financial Condition and
Results of Operations for the 39 Weeks Ended October 23, 1993................ IX-57
</TABLE>
IX-1
<PAGE> 339
ANNEX IX-A
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 the 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)
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (MILLIONS)
Sales................................................ $ $528.2 $245.0 $176.4 $ 65.4
Gross margin......................................... 116.8 52.0 38.7 14.8
Selling, general and administrative expenses......... 107.2 50.6 37.3 13.7
------- ------- ------- ------- -------
Operating income before pre-opening expense and
goodwill amortization.............................. 9.6 1.4 1.4 1.1
Pre-opening expense.................................. 4.7 2.7 2.0 1.2
Goodwill amortization................................ 4.4 1.0 0.5 0.1
------- ------- ------- ------- -------
Operating income (loss).............................. 0.5 (2.3 ) (1.1 ) (0.2 )
Interest (income) -- net............................. (0.5 ) (2.1 ) (2.0 ) (0.7 )
------- ------- ------- ------- -------
Income (loss) before income taxes.................... 1.0 (0.2 ) 0.9 0.5
Income taxes......................................... 1.8 0.8 0.5 0.2
------- ------- ------- ------- -------
Net income (loss).................................... $ $ (0.8 ) $ (1.0 ) $ 0.4 $ 0.3
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Add back of goodwill amortization.................... 4.4 1.0 -- --
------- ------- ------- ------- -------
Kmart Corporation earnings attributable to OfficeMax
Group.............................................. $ $ 3.6 $ -- -- --
------- ------- ------- ------- -------
------- ------- ------- ------- -------
PERCENT OF SALES DATA
Gross margin......................................... 22.1 % 21.2 % 21.9 % 22.6 %
Selling, general and administrative expenses......... 20.3 20.6 21.1 20.9
Operating income before pre-opening expense and
goodwill amortization.............................. 1.8 0.6 0.8 1.7
Income (loss) before income taxes.................... 0.2 (0.1 ) 0.5 0.8
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital...................................... $ 30.6 $ 43.9 $ 53.2 $ 22.2
Total assets......................................... 448.6 275.1 119.7 67.2
Total debt........................................... -- -- -- --
OfficeMax Group equity............................... 258.2 188.1 79.9 44.0
SELECTED FINANCIAL AND OPERATING DATA
End of year stores................................... 179 79 60 31
Comparable store sales increase(5)................... 28.5 % 20.2 % 14.3 % 53.2 %
Capital expenditures -- owned property (millions).... $ 21.2 $ 8.9 $ 4.8 $ 2.8
Depreciation and amortization (millions)............. $ 9.9 $ 3.3 $ 2.2 $ 0.8
</TABLE>
- -------------------------
(1) Data for the period ended January 22, 1994 reflect the acquisition of
BizMart, Inc. on March 4, 1993.
(2) Data for the period ended January 23, 1993 reflect 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%. Kmart Corporation
currently has a % interest in OfficeMax, Inc.
(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. 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> 340
ANNEX IX-B
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 23, 1993
GENERAL
OfficeMax Group ("OfficeMax") is one of the largest operators of
high-volume, deep discount office products superstores in the United States. At
January 23, 1994, OfficeMax operated 328 superstores, averaging approximately
23,000 square feet in 38 states. OfficeMax had net sales of $528.2 million for
the fiscal year ended January 23, 1993.
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
with 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. In March 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.
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 will be
reduced to approximately 14.4% (12.5% on a fully diluted basis), upon
consummation of an agreement of Corporate Express to purchase 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. Management estimates that OfficeMax's cash requirements, exclusive of
pre-opening expenses, will be approximately $1.0 million for each additional
store. These expenditures include an average of approximately $0.4 million for
leasehold improvements, fixtures, point-of-sale terminals and other equipment in
the stores, as well as approximately $0.6 million for the portion of the 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 the date on which Kmart increased its equity interest in
OfficeMax to 92.7%, OfficeMax, Inc.'s fiscal year ended on the last Saturday in
July. OfficeMax's 1992 fiscal year consisted of 52 weeks ended January 23, 1993.
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 initial acquisition of a 21.6%
interest in OfficeMax, Inc. The results of operations for these periods were
determined on differing bases of accounting and, accordingly, the comparability
of the results to other periods is limited. Kmart currently has a %
interest in OfficeMax, Inc.
IX-3
<PAGE> 341
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 23, 1993 -- CONTINUED
Fiscal Year Ended January 23, 1993 (fiscal 1992) and 52 Weeks Ended January 25,
1992 (1991)
RESULTS OF OPERATIONS
The following table presents OfficeMax's income statement data and such
data as a percent of sales, for the periods presented:
<TABLE>
<CAPTION>
FISCAL YEAR 52 WEEKS
ENDED ENDED
JANUARY 23, % OF JANUARY % OF
1993 SALES 25, 1992 SALES
--------- ----- ---------- -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
Sales............................................ $ 528.2 100.0% $245.0 100.0%
Cost of merchandise sold, includes buying and
occupancy costs................................ 411.4 77.9 193.0 78.8
--------- ----- -------- -----
Gross margin..................................... 116.8 22.1 52.0 21.2
Selling, general and administrative expenses..... 107.2 20.3 50.6 20.6
--------- ----- -------- -----
Operating income before pre-opening expense and
goodwill amortization.......................... 9.6 1.8 1.4 0.6
Pre-opening expense.............................. 4.7 0.9 2.7 1.1
Goodwill amortization............................ 4.4 0.8 1.0 0.4
--------- ----- -------- -----
Operating income (loss).......................... 0.5 0.1 (2.3) (0.9)
Net interest income.............................. 0.5 0.1 2.1 0.8
--------- ----- -------- -----
Income (loss) before income taxes................ 1.0 0.2 (0.2) (0.1)
Income taxes..................................... 1.8 0.3 0.8 0.3
--------- ----- -------- -----
Net loss......................................... $ (0.8) (0.1)% $ (1.0) (0.4)%
--------- ----- -------- -----
--------- ----- -------- -----
</TABLE>
Store Activity. OfficeMax's store activity is summarized below:
<TABLE>
<CAPTION>
FISCAL YEAR 52 WEEKS
ENDED ENDED
JANUARY 23, JANUARY
1993 25, 1992
------------ ----------
<S> <C> <C>
Beginning number of stores.......................................... 79 46
Openings............................................................ 61 33
Acquisitions........................................................ 41 --
Closings............................................................ (2) --
--- --
Ending number of stores............................................. 179 79
--- --
--- --
</TABLE>
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 and the inclusion of a full year of 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.
IX-4
<PAGE> 342
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 23, 1993 -- CONTINUED
Selling, general and administrative (SG&A) expenses in 1992 was $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.
Operating income before pre-opening expense and goodwill amortization in
fiscal 1992 was $9.6 million, or 1.8% of sales, as compared to $1.4 million, or
0.6% of sales, in the prior year. The increase was the 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.
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.
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.
IX-5
<PAGE> 343
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 23, 1993 -- CONTINUED
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 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 fiscal year ended
January 23, 1993, the nine weeks ended January 25, 1992 and the 17 weeks ended
November 20, 1991 are summarized below. The net use of cash and equivalents was
$31.2 million for 1992, as compared to a net increase of $8.5 million and $10.2
million for the nine weeks ended January 25, 1992 and the 17 weeks ended
November 20, 1991, respectively.
Net cash provided by operations was $6.8 million, $12.5 million and $16.2
million for the fiscal year ended January 23, 1993, the nine weeks ended January
25, 1992 and the 17 weeks ended November 20, 1991, respectively. The change in
the fiscal year ended January 23, 1993 was due primarily to an increase in
merchandise inventories net of trade payables, partially offset by increased
non-cash depreciation and amortization expenses. The increase in inventory in
the fiscal year ended January 23, 1993 was due to the acquisition of 41 OW
Office Warehouse, Inc. stores in June 1992 and the opening of 61 new OfficeMax
stores. Cash provided by operations during the nine weeks ended January 25, 1992
and the 17 weeks ended November 20, 1991 reflects the higher levels of sales
normally associated with the back-to-school and holiday seasons which occur
during these periods, offset in part by the requisite increase in inventories
supporting the higher level of sales.
Net cash used for investing was $92.4 million, $3.9 million and $3.4
million for the fiscal year ended January 23, 1993, the nine weeks ended January
25, 1992 and the 17 weeks ended November 20, 1991, respectively. Cash used for
investing for the fiscal year ended January 23, 1993, was primarily comprised of
$71.7 million for the acquisition of 41 OW Office Warehouse, Inc. stores in June
1992 and capital expenditures for leasehold improvements and store fixtures
relating to both new store openings and the renovation of existing stores.
Capital expenditures were $21.2 million, $3.9 million and $3.2 million for the
fiscal year ended January 23, 1993, the nine weeks ended January 25, 1992 and
the 17 weeks ended November 20, 1991, respectively.
Net cash provided by financing was $54.4 million for the fiscal year ended
January 23, 1993 as compared to net cash used by financing of $0.1 million and
$2.6 million for the nine weeks ended January 25, 1992 and the 17 weeks ended
November 20, 1991, respectively. The cash provided by financing for the fiscal
year ended January 23, 1993, was primarily due to net equity transactions with
the Kmart Group which resulted in the net receipt of $70.9 million by OfficeMax
primarily used to fund the OW Office Warehouse, Inc. acquisition in June 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,
IX-6
<PAGE> 344
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 23, 1993 -- CONTINUED
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 equity 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 equity investment in
OfficeMax.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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 excess uses. Conversely, if cash provided by
OfficeMax exceeds cash used by OfficeMax, OfficeMax would transfer the excess
cash to the Kmart Group. Such transfers would generally be made as short-term
loans, unless the Board of Directors determined that any such transfer should be
made as a long-term loan or, in the case of a transfer of funds from the Kmart
Group to OfficeMax, as an equity contribution as described below. 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 of
Directors 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 issuance of OfficeMax Stock, the Board of
Directors 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 (i) the number of
shares issuable with respect to the Kmart Group's Retained Interest in 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 (ii) the Kmart Group's
interest in OfficeMax 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 expenditure plans of
and 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 sheet of the Kmart Group would
reflect its net short-term and net long-term loans to or borrowings from
OfficeMax, and the balance sheet of OfficeMax would reflect its net
IX-7
<PAGE> 345
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 23, 1993 -- CONTINUED
short-term and net long-term loans to or borrowings from the Kmart Group.
Similarly, the 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 outstanding. In view of the
anticipated cash needs of OfficeMax over the next several years, it is currently
expected that the Kmart Group would provide substantial net cash 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 the 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.
INFLATION AND SEASONALITY
OfficeMax management does not believe inflation had a material impact on
the financial statements for the periods presented. 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.
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 is 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 is 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 is effective for fiscal years beginning
after December 15, 1993. The effect of this statement on OfficeMax was not
significant.
THE OMNIBUS BUDGET RECONCILIATION ACT OF 1993
On August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 was
enacted which, among other things, increased the federal corporate income tax
rate by 1% retroactive to January 1, 1993 and also reinstated
IX-8
<PAGE> 346
OFFICEMAX GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 23, 1993 -- CONTINUED
and extended the targeted jobs tax credit. The effect of the 1% increase in the
federal corporate income tax rate on OfficeMax's deferred tax balances is not
significant. The 1% increase in the federal corporate income tax rate will
directly affect OfficeMax's fiscal 1993 effective income tax rate although this
effect will be partially offset by increased targeted job tax credits.
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-9
<PAGE> 347
ANNEX IX-C
OFFICEMAX GROUP
GENERAL
OfficeMax, Inc. ("OfficeMax") is one of the largest operators of
high-volume, deep discount office products superstores in the United States. At
January 23, 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 catalog or 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 $528.2 million for the fiscal
year ended January 23, 1993.
OfficeMax has experienced rapid growth in the last five years as a result
of its organic store growth 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 7 stores. In November
1990, Kmart Corporation ("Kmart") acquired an initial 21.6% equity interest in
OfficeMax and increased its equity interest in OfficeMax to 92.7% in November
1991. Kmart currently has a % interest in OfficeMax, Inc. 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 two 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 23, 1993 of 28.5%.
OfficeMax believes its success is largely attributable to the consistent
execution of its business strategy in every OfficeMax store. Management believes
that it 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, as well as 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 operate small stores offering a limited selection of in-stock
merchandise purchased from wholesalers or other distributors and sold to the
ultimate consumer at catalog or 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 catalog or 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.
IX-10
<PAGE> 348
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
its 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 catalog or
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. 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 with an aggregate of
158 stores. 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 chain with stores located
primarily throughout the Mid-Atlantic region, and, in March, 1993, OfficeMax
acquired
IX-11
<PAGE> 349
BizMart, Inc., a 105-store national 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.
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 already existing OfficeMax locations. The
real estate selection model analyzes a number of factors including the
location's size, visibility, access and parking capacity, potential
cannibalizing effects on existing OfficeMax stores and relevant demographic
information, such as the number of small and medium-sized businesses, the income
and education levels in the area and future trends.
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
will be 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 November 23, 1993, Corporate Express signed a
definitive agreement to acquire the office products division of Hanson, plc. The
combination of Corporate Express and Hanson's office products division will
create 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 as well as sharing information relating to distribution, delivery and
computer systems.
As part of its agreement with Corporate Express, should OfficeMax's
investment be diluted to 11% (on a fully diluted basis), OfficeMax has the right
to increase its ownership to its original 17.5% (on a fully diluted basis)
interest. In addition, OfficeMax has the right in 1997, under certain
circumstances, to increase its
IX-12
<PAGE> 350
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 23, JANUARY 25,
MERCHANDISE GROUP 1993 1992
------------------------------------------------- ----------- -----------
<S> <C> <C>
Office Supplies(a)............................... 47.6% 49.4%
Electronics, business machines, computers,
software and related products.................. 39.2 36.7
Office Furniture................................. 13.2 13.9
----------- -----------
100.0% 100.0%
----------- -----------
----------- -----------
</TABLE>
- -------------------------
(a) Includes business service center revenues.
OfficeMax's merchandise strategy emphasizes a wide selection of name-brand
office products, packaged and sold within 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 where management believes brand recognition is not a key
determinant of customer satisfaction. These commodity items include 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.
Management believes 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
IX-13
<PAGE> 351
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 which is 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 independent cross-docking, flow-through distribution 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. By the end of 1994, management expects that the
majority of OfficeMax merchandise will be processed through five cross-docking,
flow-through centers strategically located throughout 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 as well as 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, 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 radio
frequency portable 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 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.
IX-14
<PAGE> 352
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 both students
as well as 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 an
OfficeMax store's breadth and depth of merchandise. The catalog features
available next business day delivery at each store and "1-800" 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 15 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-15
<PAGE> 353
As of January 23, 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 is
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 large selections 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 catalog
or manufacturers' list prices. OfficeMax believes that
IX-16
<PAGE> 354
it successfully competes in the small 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 believes that its
stores will 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
financial condition or results of operations.
IX-17
<PAGE> 355
ANNEX IX-D
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-18
<PAGE> 356
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 23, 1993, and
the results of its operations and its cash flows for the fiscal year ended
January 23, 1993, 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 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.
As discussed in the Subsequent Events note to these financial statements,
on March 4, 1993, the OfficeMax Group purchased all of the outstanding shares of
BizMart, Inc. for $272.4 million.
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
Cleveland, Ohio
January 31, 1994
IX-19
<PAGE> 357
OFFICEMAX GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED 9 WEEKS 17 WEEKS
-------------------------- ENDED ENDED
JANUARY 22, JANUARY 23, JANUARY 25, NOVEMBER 20,
1994 1993 1992 1991
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Sales............................................ $ $ 528.2 $65.1 $ 84.6
Cost of merchandise sold, includes buying and
occupancy costs................................ 411.4 51.2 67.5
Selling, general and administrative expenses..... 107.2 11.6 18.7
Pre-opening expense.............................. 4.7 0.8 0.6
Goodwill amortization............................ 4.4 0.6 0.2
Interest:
Debt -- income................................. (0.6) (0.3) (0.7)
Capital lease obligations -- expense........... 0.1 -- 0.1
----------- ----------- ----------- ------
527.2 63.9 86.4
----------- ----------- ----------- ------
Income (loss) before income taxes................ 1.0 1.2 (1.8)
Income taxes..................................... 1.8 0.3 0.1
----------- ----------- ----------- ------
Net income (loss)................................ $ $ (0.8) $ 0.9 $ (1.9)
----------- ----------- ----------- ------
----------- ----------- ----------- ------
Supplemental disclosure (unaudited):
Net income (loss).............................. $ $ (0.8) $ 0.9
Add back of goodwill amortization.............. 4.4 0.6
----------- ----------- -----------
Kmart Corporation earnings attributable to
OfficeMax Group............................. $ $ 3.6 $ 1.5
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-20
<PAGE> 358
OFFICEMAX GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 22, JANUARY 23,
1994 1993
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................................. $ $ 14.1
Merchandise inventories.............................................. 178.2
Accounts receivable and other current assets......................... 14.8
----------- -----------
Total current assets................................................... 207.1
Property Owned:
Leasehold improvements............................................... 16.7
Furniture and fixtures............................................... 35.7
----------- -----------
52.4
Less -- accumulated depreciation and amortization...................... (6.0)
----------- -----------
Total Owned Property................................................... 46.4
Other Assets and Deferred Charges...................................... 1.2
Goodwill -- net of accumulated amortization of $5.0.................... 193.9
----------- -----------
$ $ 448.6
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable -- trade............................................ $ $ 119.3
Accrued payrolls and other liabilities............................... 34.8
Advertising payable.................................................. 15.3
Taxes other than income taxes........................................ 7.1
----------- -----------
Total current liabilities.............................................. 176.5
Other Long-Term Liabilities............................................ 13.9
OfficeMax Group Equity................................................. 258.2
----------- -----------
$ $ 448.6
----------- -----------
----------- -----------
Supplemental disclosure (unaudited):
OfficeMax Group Equity............................................... $ $ 258.2
Add back of accumulated goodwill amortization........................ 5.0
----------- -----------
Kmart Corporation equity attributable to OfficeMax Group............. $ $ 263.2
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-21
<PAGE> 359
OFFICEMAX GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED 9 WEEKS 17 WEEKS
-------------------------- ENDED 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)................................ $ $(0.8) $ 0.9 $ (1.9)
Adjustments to reconcile net income (loss) to
operating cash flows:
Depreciation and amortization............... 9.9 1.1 0.9
Deferred income taxes....................... 1.5 (0.1) --
Increase in other long-term liabilities..... 1.3 0.6 0.9
Other -- net................................ 0.8 0.2 (0.2)
Cash provided by (used for) current assets and
current liabilities:
Increase in inventories..................... (72.0) (5.7) (14.3)
Increase in accounts payable................ 45.2 10.8 17.3
Other -- net................................ 20.9 4.7 13.5
----------- ----------- ----------- ------
Net cash provided by operations................ 6.8 12.5 16.2
----------- ----------- ----------- ------
INVESTING
Capital expenditures -- owned property......... (21.2) (3.9) (3.2)
Acquisitions................................... (71.7) -- --
Other -- net................................... 0.5 -- (0.2)
----------- ----------- ----------- ------
Net cash used for investing.................... (92.4) (3.9) (3.4)
----------- ----------- ----------- ------
FINANCING
Reduction in long-term debt.................... (16.0) -- --
Net equity transactions with the Kmart Group... 70.9 -- --
Reduction in capital lease obligations......... (0.6) (0.1) (0.2)
Other -- net................................... 0.1 -- (2.4)
----------- ----------- ----------- ------
Net cash provided by (used for) financing...... 54.4 (0.1) (2.6)
----------- ----------- ----------- ------
NET INCREASE (DECREASE) IN CASH AND
EQUIVALENTS.................................... (31.2) 8.5 10.2
Cash and Equivalents at Beginning of Period.... 45.3 36.8 26.6
----------- ----------- ----------- ------
CASH AND EQUIVALENTS AT END OF PERIOD............ $ $14.1 $45.3 $ 36.8
----------- ----------- ----------- ------
----------- ----------- ----------- ------
Supplemental disclosure of cash flow information:
Interest paid.................................. $ $ 0.1 $ -- $0.1
Income taxes paid.............................. -- -- 0.2
Liabilities assumed in acquisitions............ 46.5 -- --
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-22
<PAGE> 360
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 stockholders 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 separately the
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, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the first 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 separately the performance of the Kmart Group, which is
generally comprised of (i) Kmart Corporation's core Kmart discount store group,
(ii) an interest in each Specialty Retail Group (a Retained Interest) other than
the interest represented by any outstanding shares of any 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 stockholders 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 to the
public for cash in separate offerings (collectively, the Offerings). The timing,
sequence and size of such Offerings and the price at which such shares would be
sold would be determined by the Board at the time of each Offering based upon
then prevailing market and other conditions; however, it is currently
contemplated that Kmart Corporation would 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 the Kmart Corporation
would retain and attribute to the Kmart Group a 70% to 80% Retained Interest in
each such Specialty Retail Group. 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 Kmart Corporation. In
addition to or in lieu of any Offering, the Board reserves the right to issue
shares of any series of Speciality Retail Stock as a distribution on the Kmart
Stock, although the Board has no current intention to do so.
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. The separate Group financial statements
have been prepared on a basis that
IX-23
<PAGE> 361
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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, accounted for under the equity method. 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 stockholders 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),
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 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.
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 the 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.
If the Specialty Retail Stock Proposal is implemented, the dividend policy
applicable to the 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 the 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.
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 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 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.
IX-24
<PAGE> 362
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 date on which Kmart Corporation increased its equity interest in
OfficeMax, Inc. to 92.7%, OfficeMax, Inc.'s fiscal year ended on the last
Saturday in July. Kmart Corporation currently has a % interest in
OfficeMax, Inc.
On November 21, 1991, Kmart Corporation increased its equity interest in
the OfficeMax Group to 92.7%. 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 financial statements of the OfficeMax
Group include the financial position, results of operations and cash flows of
the OfficeMax Group. All significant intercompany transactions have been
eliminated.
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 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 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 Speciality 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 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: Merchandise inventories are valued on a first-in, first-out
(FIFO) basis at the lower of average cost or market.
IX-25
<PAGE> 363
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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.
Financial Instruments: With the exception of OfficeMax Group equity, 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 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 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
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 equity investment in the OfficeMax Group.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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. Such transfers would generally be made as short-term loans, unless the
Board of Directors determined that any such transfer should be made as a
long-term loan or, in the case of a transfer of funds from the Kmart Group to
the OfficeMax Group, as an equity contribution as described below. 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
of Directors determined that a transfer of funds between the Kmart Group and the
OfficeMax Group should be
IX-26
<PAGE> 364
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 issuance of OfficeMax Stock, the Board of
Directors 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 contribution, 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 sheet 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 sheet 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
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 the
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) would be charged to the OfficeMax
Group based upon utilization and at negotiated rates. 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.
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.
IX-27
<PAGE> 365
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 non-permanent differences between
financial statement and taxable income.
SUBSEQUENT EVENTS
On March 4, 1993, OfficeMax purchased all of the outstanding shares of
BizMart, Inc. ("BizMart"), a chain of 105 office products superstores, for
$272.4 in cash. During 1993, BizMart was completely integrated into OfficeMax
Group operations and BizMart stores converted to the OfficeMax format. The
BizMart acquisition was accounted for under the purchase method of accounting.
On October 26, 1993, 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
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 Group'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 Group has the right in 1997, under
certain circumstances, to increase its holdings in Corporate Express to between
51% and 100%.
ACQUISITIONS
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 $65.7 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 OfficeMax Group's
operations assuming the acquisitions of BizMart and OW Office Warehouse had
occurred at the beginning of the fiscal year ended January 23, 1993:
<TABLE>
<CAPTION>
(UNAUDITED)
----------------------
1993 1992
-------- --------
<S> <C> <C>
Sales......................................... $ $1,239.4
Net loss...................................... $ $ (13.4)
</TABLE>
IX-28
<PAGE> 366
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The above amounts are based upon actual sales and gross profit results for
the OfficeMax Group, BizMart and OW Office Warehouse, Inc. during the applicable
periods. 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 and OW Office Warehouse, Inc. acquisitions 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 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 $133.1 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 on the new basis of accounting arising from the acquisition. The
financial statements for the 17-week period ended November 20, 1991 are
presented on OfficeMax, Inc.'s previous basis of accounting. Kmart Corporation
currently has a % interest in OfficeMax, Inc.
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED 9 WEEKS 17 WEEKS
-------------------------- ENDED ENDED
JANUARY 22, JANUARY 23, JANUARY 25, NOVEMBER 20,
1994 1993 1992 1991
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Current:
Federal........................................ $ $ -- $ 0.1 $ --
State and local................................ -- 0.1 0.1
Deferred:
Excess of tax over book depreciation........... 1.7 -- --
Bonus and vacation accruals.................... (0.5) -- --
Store closing reserves......................... 0.4 -- --
Other.......................................... 0.2 0.1 --
----------- ----------- ----- -----
Total income taxes.......................... $ $ 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
FISCAL YEAR ENDED ENDED 17 WEEKS FISCAL YEAR ENDED 9 WEEKS 17 WEEKS
-------------------- JAN. ENDED -------------------- ENDED ENDED
JAN. 22, JAN. 23, 25, NOV. 20, JAN. 22, JAN. 23, JAN. 25, NOV. 20,
1994 1993 1992 1991 1994 1993 1992 1991
-------- -------- ------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Federal statutory rate..... $ $0.3 $ 0.4 $ (0.6) % 34.0% 34.0% (34.0)%
State and local taxes, net
of federal tax benefit... -- 0.1 0.1 -- 8.0 5.6
Goodwill amortization...... 1.5 0.2 -- 146.0 17.0 --
Other...................... -- (0.4) -- -- (34.0) --
Addition to net operating
loss carryforward........ -- -- 0.6 -- -- 34.0
-------- -------- ------- -------- -------- -------- -------- --------
Total income taxes.... $ $1.8 $ 0.3 $ 0.1 % 180.0% 25.0% 5.6%
-------- -------- ------- -------- -------- -------- -------- --------
-------- -------- ------- -------- -------- -------- -------- --------
</TABLE>
IX-29
<PAGE> 367
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
The OfficeMax Group has tax net operating loss carryforwards of
approximately $30.5 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, Inc. Such
carryforwards can only be used to offset the OfficeMax Group's future taxable
income and are not available for use by Kmart. Utilization of these
carryforwards is limited to $3.8 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 $4.2 at January 23, 1993 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. Liability, if any,
associated with these matters is not determinable at January 31, 1994. It is the
opinion of management that the ultimate resolution of these matters will not
have a material effect on the OfficeMax Group's 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 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%.
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 $6.2 at January 23, 1993.
LEASES
Description of Leasing Arrangements: The OfficeMax Group conducts
operations primarily in leased facilities. Store leases are generally for terms
of 10 to 15 years with multiple five-year renewal options which allow the
OfficeMax Group the option to extend the life of the lease up to 10 years beyond
the initial noncancellable term.
IX-30
<PAGE> 368
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 Committments. Future minimum lease payments at January 23, 1993 were
as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE PAYMENTS
----------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1993................................................................... $ 0.6 $ 43.6
1994................................................................... 0.5 45.2
1995................................................................... 0.2 45.4
1996................................................................... -- 44.2
1997................................................................... -- 42.1
Later years............................................................ -- 282.8
----- -------
Net minimum lease payments............................................... 1.3 $ 503.3
-------
-------
Less:
Amount representing interest........................................... (0.1)
-----
1.2
Portion due within one year.............................................. 0.5
-----
Long-term lease obligations.............................................. $ 0.7
-----
-----
</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............................ $ $30.2 $ 2.9 $ 5.1
Percentage rentals......................... 0.2 -- --
-------- ----- ------ -----
Total................................. $ $30.4 $ 2.9 $ 5.1
-------- ----- ------ -----
-------- ----- ------ -----
</TABLE>
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..... $ $ 0.7 $ 0.1 $ 0.2
Interest expense related to obligations
under capital leases..................... 0.1 -- 0.1
-------- ----- ------ -----
Amounts charged to earnings................ 0.8 0.1 0.3
Related minimum lease payments net of
executory costs.......................... (0.8) (0.1) (0.2)
-------- ----- ------ -----
Excess of amounts charged over related
minimum lease payments................... $ $ -- $ -- $ 0.1
-------- ----- ------ -----
-------- ----- ------ -----
</TABLE>
IX-31
<PAGE> 369
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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, OfficeMax 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. All such
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 23, 1993 there were 1,075 vested options outstanding
at option prices ranging between $1.67 and $440.00 per share.
It is OfficeMax's intention to convert these stock options into stock
options of the OfficeMax Group upon the initial public offering of OfficeMax
Group common stock.
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............................ $ $ 188.1 $ 35.5
Net income (loss)......................................... (0.8) 0.9
Net equity transactions with the Kmart Group.............. 70.9 151.7
--------- ------- -------
OfficeMax Group Equity.................................... $ $ 258.2 $ 188.1
--------- ------- -------
--------- ------- -------
</TABLE>
IX-32
<PAGE> 370
ANNEX IX-E
OFFICEMAX GROUP
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION (DOLLARS IN MILLIONS)
The following unaudited pro forma financial information for the fiscal year
ended January 23, 1993 and the 39 weeks ended October 23, 1993 has been prepared
assuming that the OfficeMax Group's acquisitions of BizMart, Inc. and OW Office
Warehouse, Inc. had taken place at the beginning of the periods presented. The
pro forma combined financial information reflects adjustments for (i) the
application of purchase accounting adjustments to BizMart, Inc.'s and OW Office
Warehouse, Inc.'s historical basis of accounting, (ii) the elimination of
BizMart, Inc.'s and OW Office Warehouse, Inc.'s corporate facilities, offset by
increases in the OfficeMax Group's corporate staff, (iii) the elimination of
non-recurring charges, (iv) the elimination of OW Office Warehouse, Inc.'s
annual interest charge on notes payable and (v) 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. OW Office Warehouse, Inc. pro forma financial information was derived
from the accounting records of OW Office Warehouse, Inc.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS FOR THE FISCAL YEAR ENDED
JANUARY 23, 1993
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL
OFFICEMAX HISTORICAL OW OFFICE PRO FORMA PRO FORMA
GROUP BIZMART WAREHOUSE ADJUSTMENTS COMBINED
--------- ---------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Sales......................................... $ 528.2 $634.7 $76.5 $ -- $1,239.4
Cost of merchandise sold, includes buying and
occupancy costs............................. 411.4 515.0 60.2 -- 986.6
Selling, general and administrative
expenses.................................... 111.9 132.5 17.8 (4.7)(1) 257.5
Goodwill amortization......................... 4.4 6.8 -- (1.4)(2) 9.8
Interest expense (income)..................... (0.5) 1.3 1.0 (1.0)(3) 0.8
------- ------ ----- ----- --------
Income (loss) before income taxes............. 1.0 (20.9) (2.5) 7.1 (15.3)
Income taxes.................................. 1.8 -- -- (3.7)(4) (1.9)
------- ------ ----- ----- --------
Net income (loss)............................. $ (0.8) $(20.9) $(2.5) $10.8 $ (13.4)
------- ------ ----- ----- --------
------- ------ ----- ----- --------
</TABLE>
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS FOR THE 39 WEEKS ENDED
OCTOBER 23, 1993
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PRO FORMA PRO FORMA
OFFICEMAX BIZMART ADJUSTMENTS COMBINED
--------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Sales.................................................. $ 993.2 $ 59.9 $ -- $1,053.1
Cost of merchandise sold, includes buying and
occupancy costs...................................... 780.3 49.2 829.5
Selling, general and administrative expenses........... 205.8 12.4 (0.7)(1) 217.5
Goodwill amortization.................................. 6.7 0.6 (0.2)(2) 7.1
Interest expense....................................... 0.2 0.0 -- 0.2
------- ------ ----- --------
Income (loss) before income taxes...................... 0.2 (2.3) 0.9 (1.2)
Income taxes........................................... 1.8 0.0 (0.3)(4) 1.5
------- ------ ----- --------
Net income (loss)...................................... $ (1.6) $ (2.3) $ 1.2 $ (2.7)
------- ------ ----- --------
------- ------ ----- --------
</TABLE>
- -------------------------
(1) To eliminate (i) corporate overhead expenses related to duplicate
headquarters facilities at BizMart, Inc. and OW Office Warehouse, Inc. of
$0.7 and $1.9 for the 39 weeks ended October 23, 1993 and fiscal year ended
January 23, 1993, respectively and (ii) non-recurring charges included in
BizMart Inc.'s historical financial statements for the fiscal years ended
January 23, 1993 related to BizMart's settlement of obligations with its
franchises of $2.8.
(2) To record additional amortization of goodwill as if the OfficeMax Group had
acquired BizMart, Inc. and OW Office Warehouse, Inc. at the beginning of the
period and to reverse the amortization of goodwill recognized in the BizMart
historical financial statements.
(3) To reverse the interest expense recognized in the OW Office Warehouse, Inc.
historical financial statements related to its indebtedness.
(4) To record the tax effect of the above entries at the statutory rate for the
39 weeks ended October 23, 1993 and for the 52 weeks ended January 23, 1993,
respectively, and to recognize the tax benefit associated with the combined
loss.
IX-33
<PAGE> 371
ANNEX IX-F
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-34
<PAGE> 372
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-35
<PAGE> 373
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-36
<PAGE> 374
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-37
<PAGE> 375
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-38
<PAGE> 376
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-39
<PAGE> 377
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-40
<PAGE> 378
ANNEX IX-G
BIZMART, INC.
CONSOLIDATED FINANCIAL STATEMENTS
MARCH 4, 1993
IX-41
<PAGE> 379
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-42
<PAGE> 380
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-43
<PAGE> 381
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-44
<PAGE> 382
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-45
<PAGE> 383
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-46
<PAGE> 384
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
$272.4 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-47
<PAGE> 385
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.
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,
$1,658,000 were capitalized in the Company's inventory balance at March 4, 1993.
The intercompany payable balance to Intelligent Electronics primarily
comprised inventory purchases by the Company and cash advances made by
Intelligent Electronics to the Company to fund store openings, partially offset
by payments of cash generated from operations, returns of merchandise and
credits received for vendor rebate programs through Intelligent Electronics.
Interest was not charged on intercompany account balances.
IX-48
<PAGE> 386
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
A summary of activity in the intercompany payable account follows:
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS
ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992
------------- ---------------- ----------------
($ 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.
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.
IX-49
<PAGE> 387
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
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.
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
IX-50
<PAGE> 388
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
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 $45,000, purchased all of its
inventories from the Company at 5.25% above the Company's cost, and paid the
Company a royalty of 5.5% of cost upon sale of merchandise. The Company provided
franchisees with merchandising, advertising, distribution and store support
functions. Franchisees retained the right to terminate the franchise arrangement
during its seventh through twelfth months. Upon termination, the Company
refunded the initial franchise fee and repurchased the franchisee's inventories
at the franchisee's cost. Initial franchise fees were recognized in income on
the first anniversary of the franchise agreement. The Company established a
reserve for returns of franchise inventories when the original sale was
recorded.
The Company sold franchises in a total of 74 stores; 69 of these
franchisees had exercised their right to terminate the agreement by March 4,
1993. In connection with the OfficeMax acquisition, Intelligent Electronics has
agreed to indemnify the Company against costs to terminate remaining franchises.
A summary of amounts reflected in the Company's results of operations
pertaining to franchise operations follows:
<TABLE>
<CAPTION>
FIVE WEEKS 52 WEEKS 33 WEEKS
ENDED ENDED ENDED
MARCH 4, 1993 JANUARY 30, 1993 FEBRUARY 1, 1992
------------- ---------------- ----------------
($ 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.
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 $1,675,285 during the five weeks ended March 4, 1993, the 52 weeks ended
January 30, 1993, the 33 weeks ended February 1, 1992 and the seven weeks ended
June 18, 1991, respectively.
IX-51
<PAGE> 389
BIZMART, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Capital leases are recorded in the Company's consolidated financial
statements as property and equipment together with the related obligation. At
March 4, 1993, annual future minimum rental payments were as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE PAYMENTS OPERATING CAPITAL
-------------------------------------------------- --------- -------
($ 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 credit card arrangement can be terminated
by the Company or 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-52
<PAGE> 390
ANNEX IX-H
OFFICEMAX GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 23, OCTOBER 24,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
Sales.................................................................. $ 993.2 $ 335.9
Cost of merchandise sold (includes buying and occupancy costs)......... 780.3 264.3
Selling, general and administrative expenses........................... 203.7 71.6
Pre-opening expense.................................................... 2.1 2.3
Goodwill amortization.................................................. 6.7 3.0
Interest:
Debt -- income....................................................... -- (0.6)
Capital lease obligations -- expense................................. 0.2 0.1
------- -------
993.0 340.7
------- -------
Income (loss) before income taxes...................................... 0.2 (4.8)
Income taxes........................................................... 1.8 (0.7)
------- -------
Net loss.......................................................... $ (1.6) $ (4.1)
------- -------
------- -------
Supplemental disclosure:
Net loss............................................................. $ (1.6) $ (4.1)
Add back of goodwill amortization.................................... 6.7 3.0
------- -------
Kmart Corporation earnings (loss) attributable to OfficeMax Group.... $ 5.1 $ (1.1)
------- -------
------- -------
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-53
<PAGE> 391
OFFICEMAX GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 23, OCTOBER 24,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................................. $ 23.9 $ 7.5
Merchandise inventories.............................................. 390.4 154.4
Accounts receivable and other current assets......................... 24.6 5.2
--------- ---------
Total current assets................................................... 438.9 167.1
Property Owned:
Leasehold improvements............................................... 55.8 13.4
Furniture and fixtures............................................... 69.1 33.1
--------- ---------
124.9 46.5
Less-accumulated depreciation and amortization......................... (17.1) (4.3)
--------- ---------
Total Owned Property................................................... 107.8 42.2
Other Assets and Deferred Charges...................................... 6.4 1.9
Goodwill -- net of accumulated amortization of $11.7 and $4.4,
respectively......................................................... 373.6 192.9
-------- ---------
$ 926.7 $ 404.1
-------- ---------
-------- ---------
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable -- trade............................................ $ 244.2 $ 100.7
Accrued payrolls and other liabilities............................... 56.0 26.6
Advertising payable.................................................. 21.8 8.5
Taxes other than income taxes........................................ 16.9 5.1
--------- ---------
Total current liabilities.............................................. 338.9 140.9
Other Long-Term Liabilities............................................ 23.9 12.1
OfficeMax Group Equity................................................. 563.9 251.1
--------- ---------
$ 926.7 $ 404.1
--------- ---------
--------- ---------
Supplemental disclosure:
OfficeMax Group Equity............................................... $ 563.9 $ 251.1
Add back of accumulated goodwill amortization........................ 11.7 4.4
--------- ---------
Kmart Corporation equity attributable to OfficeMax Group............. $ 575.6 $ 255.5
--------- ----------
--------- ----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-54
<PAGE> 392
OFFICEMAX GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 23, OCTOBER 24,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net loss............................................................... $ (1.6) $ (4.1)
Adjustments to reconcile net loss to operating cash flows:
Depreciation and amortization..................................... 19.8 6.7
Deferred income taxes............................................. -- 2.0
Increase (decrease) in other long-term liabilities................ 2.9 (0.5)
Other -- net...................................................... -- 1.0
Cash provided by (used for) current assets and current liabilities:
Increase in inventories........................................... (87.9) (48.1)
Increase in accounts payable...................................... 72.7 26.7
Other -- net...................................................... 3.3 11.4
--------- ---------
Net cash provided by (used for) operations........................... 9.2 (4.9)
--------- ---------
INVESTING
Capital expenditures -- owned property............................... (34.4) (12.0)
Acquisitions......................................................... (272.4) (71.7)
Other -- net......................................................... 0.7 0.3
--------- ---------
Net cash used for investing.......................................... (306.1) (83.4)
--------- ---------
FINANCING
Net equity transactions with the Kmart Group......................... 307.3 67.1
Reduction in long-term debt.......................................... -- (16.0)
Reduction in capital lease obligations............................... (0.6) (0.5)
Other -- net......................................................... -- --
--------- ---------
Net cash provided by financing....................................... 306.7 50.6
--------- ---------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS........................ 9.8 (37.7)
Cash and Equivalents at Beginning of Period.......................... 14.1 45.2
--------- ---------
CASH AND EQUIVALENTS AT END OF PERIOD.................................. $ 23.9 $ 7.5
--------- ---------
--------- ---------
</TABLE>
See accompanying Notes to Combined Financial Statements.
IX-55
<PAGE> 393
OFFICEMAX GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
(UNAUDITED)
BASIS OF PRESENTATION
The accompanying unaudited combined financial statements do not include all
information and footnotes necessary for the annual presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles.
In the opinion of the OfficeMax Group management, all adjustments necessary
for a fair statement of the results for the interim periods have been included.
All adjustments were of a normal and recurring nature.
SUBSEQUENT EVENT
On October 26, 1993, 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
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 Group'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 Group has the right in 1997, under
certain circumstances, to increase its holdings in Corporate Express to between
51% and 100%.
ACQUISITIONS
On March 4, 1993, OfficeMax Group purchased all of the outstanding shares
of BizMart, Inc. ("BizMart"), a chain of 105 office products superstores, for
$272.4. During 1993, BizMart was completely integrated into OfficeMax Group
operations and BizMart stores converted to the OfficeMax format. The BizMart
acquisition is being accounted for under the purchase method of accounting. The
following presents unaudited pro forma results of OfficeMax Group's operations
assuming the acquisition of BizMart had occurred at the beginning of the 39
weeks ended October 23, 1993.
Sales............. $1,053.1
Net loss.......... (2.7)
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 $65.7 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.
OFFICEMAX GROUP EQUITY
The following table presents the activity of Kmart Group's % interest
in OfficeMax, Inc.
<TABLE>
<CAPTION>
OCTOBER 23, OCTOBER 24,
1993 1992
----------- -----------
<S> <C> <C>
Balance at beginning of period........................ $ 258.2 $ 188.1
Net loss.............................................. (1.6) (4.1)
Net equity transactions with the Kmart Group.......... 307.3 67.1
----------- -----------
OfficeMax Group Equity................................ $ 563.9 $ 251.1
----------- -----------
----------- -----------
</TABLE>
IX-56
<PAGE> 394
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> 395
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> 396
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> 397
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> 398
ANNEX X
THE SPORTS AUTHORITY GROUP
<TABLE>
<CAPTION>
PAGE
--------
<S> <C> <C>
X-A: Selected Financial Data................................................... X- 2
X-B: Management's Discussion and Analysis of Financial Condition and Results
of Operations for the Fiscal Year Ended January 24, 1993.................. X- 3
X-C: Business Description...................................................... X- 9
X-D: Combined Financial Statements for the Fiscal Year Ended January 24,
1993...................................................................... X-20
X-E: Combined Financial Statements for the 39 Weeks Ended October 24, 1993..... X-34
X-F: Management's Discussion and Analysis of Financial Condition and Results
of Operations for the 39 Weeks Ended October 24, 1993..................... X-38
</TABLE>
X-1
<PAGE> 399
ANNEX X-A
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........................................................... $ $ 411.5 $ 240.9 $109.0
Gross margin.................................................... 114.8 67.0 29.6
Selling, general and administrative expenses.................... 95.6 56.7 28.6
-------- -------- -------- -------
Operating income before pre-opening expense and goodwill
amortization.................................................. 19.2 10.3 1.0
Pre-opening expense............................................. 7.0 4.8 2.7
Goodwill amortization........................................... 2.1 2.1 1.6
-------- -------- -------- -------
Operating income (loss)......................................... 10.1 3.4 (3.3)
Interest expense -- net......................................... 0.1 0.2 0.2
-------- -------- -------- -------
Income (loss) before income taxes............................... 10.0 3.2 (3.5)
Income taxes.................................................... 4.3 1.9 (0.4)
-------- -------- -------- -------
Net income (loss).......................................... $ $ 5.7 $ 1.3 $ (3.1)
-------- -------- -------- -------
-------- -------- -------- -------
Add back of goodwill amortization............................... 2.1 2.1 1.6
-------- -------- -------- -------
Kmart Corporation earnings (loss) attributable to The Sports
Authority Group............................................... $ $ 7.8 $ 3.4 $ (1.5)
-------- -------- -------- -------
-------- -------- -------- -------
PERCENT OF SALES DATA
Gross margin.................................................... % 27.9% 27.8% 27.2%
Selling, general and administrative expenses.................... 23.2 23.5 26.2
Operating income before pre-opening expense and goodwill
amortization.................................................. 4.7 4.3 0.9
Income (loss) before income taxes............................... 2.4 1.3 (3.2)
BALANCE SHEET DATA -- END OF PERIOD (MILLIONS)
Working capital................................................. $ $ 34.5 $ 41.5 $ 16.8
Total assets.................................................... 236.4 185.2 121.1
Total debt...................................................... -- -- --
The Sports Authority Group equity............................... 139.2 131.4 96.7
SELECTED FINANCIAL AND OPERATING DATA
End of year stores.............................................. 56 36 19
Comparable store sales increase(2).............................. % 8.3% 15.3% 4.9%
Weighted average sales per square foot(3)....................... $ $ 222 $ 217 $ 194
Weighted average sales per store (millions)(4).................. 9.5 9.1 8.2
Inventory net of accounts payable per store (millions).......... 1.0 1.3 1.0
Average sale per transaction.................................... 39.78 38.48 37.61
Capital expenditures -- owned property (millions)............... 25.9 15.6 4.5
Depreciation and amortization (millions)........................ 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> 400
ANNEX X-B
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL YEAR
ENDED JANUARY 24, 1993
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 98%
during the period from fiscal 1989 to fiscal 1992, increasing sales from $53.4
million in 1989 to $411.5 million in 1992.
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 above table.
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 two fiscal years, opening 17 stores and 20 stores in 1991 and 1992,
respectively. The Sports Authority opened 24 stores in 1993 and 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.
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 $31.1 million as compared to $ 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 decreasing capital required to operate each store and to improved
inventory turnover. The Sports Authority has increased its retail inventory
turnover to 2.6 times in 1992 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.
X-3
<PAGE> 401
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL YEAR
ENDED JANUARY 24, 1993 -- CONTINUED
The Sports Authority's 1992 and 1991 fiscal years each consisted of 52
weeks and ended on 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.
Fiscal Years Ended January 24, 1993 (Fiscal 1992) and January 26, 1992 (Fiscal
1991)
RESULTS OF OPERATIONS
The following table presents The Sports Authority's income statement data
as a percent of sales for the periods presented.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------
JANUARY 24, JANUARY 26,
1993 1992
----------- -----------
<S> <C> <C>
Sales.................................................................. 100.0% 100.0%
Licensee fees and rental income........................................ 0.2 0.2
----------- -----------
Total operating revenues............................................... 100.2 100.2
Cost of merchandise sold, includes buying and occupancy costs.......... 72.3 72.4
----------- -----------
Gross margin........................................................... 27.9 27.8
Selling, general and administrative expenses........................... 23.2 23.5
----------- -----------
Operating income before pre-opening expense and goodwill
amortization......................................................... 4.7 4.3
Pre-opening expense.................................................... 1.7 2.0
Goodwill amortization.................................................. 0.5 0.9
----------- -----------
Operating income....................................................... 2.4 1.4
Interest expense....................................................... -- 0.1
----------- -----------
Income before income taxes............................................. 2.4 1.3
Income taxes........................................................... 1.0 0.8
----------- -----------
Net income............................................................. 1.4% 0.5%
----------- -----------
----------- -----------
</TABLE>
During 1992, The Sports Authority opened 20 new stores as compared to the
17 new stores opened in 1991. The Sports Authority operated 56 stores at the end
of 1992 as compared to 36 stores at the end of 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.
X-4
<PAGE> 402
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL YEAR
ENDED JANUARY 24, 1993 -- CONTINUED
Selling, general and administrative (SG&A) expense in 1992 was $95.6
million, or 23.2% of sales, as compared to $56.7 million, or 23.5% of sales, in
1991. The 0.3% 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.
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.
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.
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% decrease in the effective tax rate, 14.8% was 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 flows from operations
and, to a lesser extent, by equity contributions from Kmart Corporation. Kmart
Corporation made net equity contributions to The Sports Authority of $2.1
million in 1992 and $33.4 million in 1991.
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the 52 weeks ended January
24, 1993 and January 26, 1992 are summarized below. The net increase in cash and
equivalents was $0.4 million in 1992 as compared to a $1.0 million increase in
cash and equivalents in the prior year.
Net cash provided by operations was $22.5 million in 1992 as compared to
net cash used for operations of $16.6 million in 1991. This change resulted from
increased income before non-cash depreciation and amortization expenses, a
slower rate of increase in inventories net of accounts payable and an increase
in accrued payroll and other liabilities resulting from a greater number of
stores in operation in 1992 than in 1991. 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.
X-5
<PAGE> 403
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL YEAR
ENDED JANUARY 24, 1993 -- CONTINUED
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 1992 when 20 stores were opened as compared to a $27.5 million
increase in 1991 when 17 stores were opened.
Net cash used for investing in 1992 was $23.7 million as compared to $15.2
million in the prior year. The 1992 increase was due to capital expenditures
associated with a greater number of conversions of previously owned structures
into The Sports Authority stores, three more store openings than in 1991, the
higher cost of expenditures for new stores in the Northeast and expansion of the
headquarters facility.
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 attributable 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 equity 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 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 equity investment in The Sports Authority.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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 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. Such transfers would generally be made as short-term loans, unless
the Board of Directors determined that any such transfer should be made as a
long-term loan or, in the case of a transfer of funds from the Kmart Group to
The Sports Authority, as an equity contribution as described below. 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
of Directors 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
X-6
<PAGE> 404
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL YEAR
ENDED JANUARY 24, 1993 -- CONTINUED
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 issuance of The Sports Authority Stock,
the Board of Directors 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, (i) the number of shares issuable with
respect to the Kmart Group's Retained Interest in 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 (ii) the Kmart
Group's interest in The Sports Authority would be increased and the interest in
The Sports Authority 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, 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 sheet 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 sheet of The Sports Authority 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 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 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 provide net cash 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.
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
X-7
<PAGE> 405
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL YEAR
ENDED JANUARY 24, 1993 -- CONTINUED
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 are 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 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.
THE OMNIBUS BUDGET RECONCILIATION ACT OF 1993
On August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 was
enacted which, among other things, increased the federal corporate income tax
rate by 1% retroactive to January 1, 1993 and also reinstated and extended the
targeted jobs tax credit. The effect of the 1% increase in the federal corporate
income tax rate on The Sports Authority's deferred tax balances is not
significant. The 1% increase in the federal corporate income tax rate will
directly affect The Sports Authority's fiscal 1993 effective income tax rate
although this effect will be partially offset by increased targeted job tax
credits.
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
1992, 60.4% of The Sports Authority's operating income before pre-opening
expense and goodwill amortization and 34.4% of its sales 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>
1992 FISCAL QUARTER ENDED
------------------------------------
APRIL JULY OCTOBER JANUARY
----- ---- ------- -------
<S> <C> <C> <C> <C>
Sales.......................................................... 19.8% 22.2% 23.6% 34.4%
Operating income before pre-opening expense and goodwill
amortization................................................. 16.7% 17.7% 5.2% 60.4%
</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 The Sports Authority.
X-8
<PAGE> 406
ANNEX X-C
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 15, 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 $411.5 million for the fiscal year ended January 24, 1993
(fiscal "1992").
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 its continual
investment in infrastructure and technology. The Sports Authority has achieved
compound annual growth in sales of 98% during the period from fiscal 1989 to
fiscal 1992.
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 inventory
turnover (calculated by dividing sales by the average month end retail inventory
for 12 months) from 2.4 times in fiscal 1989 to 2.6 times in fiscal 1992. 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 (the
"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
X-9
<PAGE> 407
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.
X-10
<PAGE> 408
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/St. Petersburg.................... 3 --
Southeast Florida....................... 10 --
-- --
SUBTOTAL SOUTHEAST................. 29 --
-- --
</TABLE>
X-11
<PAGE> 409
<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 COAST
Los Angeles Metro....................... 1 --
San Francisco Metro..................... -- 1
-- --
SUBTOTAL WEST COAST................ 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
X-12
<PAGE> 410
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
X-13
<PAGE> 411
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.
X-14
<PAGE> 412
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
X-15
<PAGE> 413
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 an automatic replenishment 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.
X-16
<PAGE> 414
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.
X-17
<PAGE> 415
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
X-18
<PAGE> 416
of 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 financial condition or results of operations.
X-19
<PAGE> 417
ANNEX X-D
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>
X-20
<PAGE> 418
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 24,
1993, and the results of their operations and their cash flows for each of the
two years in the period ended January 24, 1993, 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
Ft. Lauderdale, Florida
January 31, 1994
X-21
<PAGE> 419
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........................................................ $ $ 411.5 $ 240.9
Licensee fees and rental income.............................. 0.9 0.4
----------- ----------- -----------
412.4 241.3
----------- ----------- -----------
Cost of merchandise sold, includes buying and occupancy
costs...................................................... 297.6 174.3
Selling, general and administrative expenses................. 95.6 56.7
Pre-opening expense.......................................... 7.0 4.8
Goodwill amortization........................................ 2.1 2.1
Interest:
Capital lease obligations -- expense....................... 0.1 0.2
----------- ----------- -----------
402.4 238.1
----------- ----------- -----------
Income before income taxes................................... 10.0 3.2
Income taxes................................................. 4.3 1.9
----------- ----------- -----------
Net income................................................... $ $ 5.7 $ 1.3
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure (unaudited):
Net income................................................. $ $ 5.7 $ 1.3
Add back of goodwill amortization.......................... 2.1 2.1
----------- ----------- -----------
Kmart Corporation earnings attributable to The Sports
Authority Group......................................... $ $ 7.8 $ 3.4
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
X-22
<PAGE> 420
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................................................................. $ $ 2.2
Merchandise inventories.............................................. 113.7
Accounts receivable and other current assets......................... 10.2
----------- -----------
Total current assets................................................... 126.1
Property Owned:
Leasehold improvements............................................... 20.9
Furniture and fixtures............................................... 29.7
Property under capital leases.......................................... 2.5
----------- -----------
53.1
Less -- accumulated depreciation and amortization:
Property owned....................................................... (7.7)
Property under capital leases........................................ (1.5)
----------- -----------
Total owned and leased property........................................ 43.9
Other Assets and Deferred Charges...................................... 1.8
Goodwill -- net of accumulated amortization of $5.7.................... 64.6
----------- -----------
$ $ 236.4
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable -- trade............................................ $ $ 55.1
Accrued payrolls and other liabilities............................... 31.9
Taxes other than income taxes........................................ 2.5
Income taxes......................................................... 2.1
----------- -----------
Total current liabilities.............................................. 91.6
Other Long-Term Liabilities............................................ 5.6
The Sports Authority Group Equity...................................... 139.2
----------- -----------
$ $ 236.4
----------- -----------
----------- -----------
Supplemental disclosure (unaudited):
The Sports Authority Group Equity at beginning of year............... $ $ 139.2
Add back of accumulated goodwill amortization........................ 5.7
----------- -----------
Kmart Corporation equity attributable to The Sports Authority
Group............................................................. $ $ 144.9
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
X-23
<PAGE> 421
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............................................ $ $ 5.7 $ 1.3
Adjustments to reconcile net income to operating cash
flows:
Depreciation and amortization...................... 7.2 4.4
Increase in other long-term liabilities............ 2.4 1.5
Cash provided by (used for) current assets and current
liabilities:
Increase in inventories............................ (30.7) (47.3)
Increase in accounts payable....................... 19.0 19.8
Other -- net....................................... 18.9 3.7
----------- ----------- -----------
Net cash provided by (used for) operations............ 22.5 (16.6)
----------- ----------- -----------
INVESTING
Capital expenditures -- owned property................ (25.9) (15.6)
Other -- net.......................................... 2.2 0.4
----------- ----------- -----------
Net cash used for investing........................... (23.7) (15.2)
----------- ----------- -----------
FINANCING
Net equity transactions with the Kmart Group.......... 2.1 33.4
Reduction in capital lease obligations................ (0.5) (0.6)
----------- ----------- -----------
Net cash provided by financing........................ 1.6 32.8
----------- ----------- -----------
NET INCREASE IN CASH AND EQUIVALENTS.................... 0.4 1.0
Cash and Equivalents at Beginning of Year............. 1.8 0.8
----------- ----------- -----------
CASH AND EQUIVALENTS AT END OF YEAR..................... $ $ 2.2 $ 1.8
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosures of cash flow information:
Interest paid......................................... $ $ 0.1 $ 0.2
Income taxes paid..................................... $ $ 0.6 $ 2.0
Capital lease obligations incurred.................... $ $ 0.6 $ 0.7
</TABLE>
See accompanying Notes to Combined Financial Statements.
X-24
<PAGE> 422
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 stockholders 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 separately the
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, Builders Square Group, OfficeMax Group and
The Sports Authority Group are sometimes referred to collectively herein as the
Specialty Retail Groups.
Upon the first 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 separately the performance of the core Kmart Group, which
is generally comprised of (i) Kmart Corporation's core Kmart discount store
group, (ii) an interest in each Specialty Retail Group (a Retained Interest)
other than the interest represented by any outstanding shares of any 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 stockholders 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 to the
public for cash in separate offerings (collectively, the Offerings). The timing,
sequence and size of such Offerings and the price at which such shares would be
sold would be determined by the Board at the time of each Offering based upon
then prevailing market and other conditions. However, it is currently
contemplated that Kmart Corporation would 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 the Kmart Corporation
would retain and attribute to the Kmart Group a 70% to 80% Retained Interest in
each such Specialty Retail Group. 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 Kmart Corporation. 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 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
X-25
<PAGE> 423
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
to the management and accounting policies that would be applicable upon
implementation of the Specialty Retail Stock Proposal. 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, accounted for under the equity method. 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 stockholders 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),
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 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.
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 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
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 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.
X-26
<PAGE> 424
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 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 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.
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.
Expenditures for owned properties, primarily self-developed locations,
which The Sports Authority Group intends to sell and lease-back within one year
are included in accounts receivable and other current assets.
X-27
<PAGE> 425
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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.
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 full month of operations. 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 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 Sports Authority. Until the 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 equity investment in The
Sports Authority.
If the Specialty Retail Stock Proposal is approved by stockholders 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 of Directors.
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. Such transfers would
generally be made as short-term loans, unless the Board of Directors determined
that any such transfer should be made as a long-term loan or, in the case of a
transfer of funds from the Kmart Group to The Sports Authority Group, as an
equity contribution as described below. 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 of Directors 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,
X-28
<PAGE> 426
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 issuance of The Sports Authority Stock,
the Board of Directors 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 contribution, 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, 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 sheet 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 sheet 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 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, transportation and import, data processing,
employee benefit and self-insurance costs) would be charged to The Sports
Authority Group based upon utilization and at negotiated rates. A portion of
certain other corporate, general and administrative costs specifically related
to management of the Specialty Retail Groups would be allocated equally among
the Specialty Retail Groups.
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.
X-29
<PAGE> 427
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 non-permanent differences between
financial statement and taxable income.
INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
1993 1992 1991
----- ----- -----
<S> <C> <C> <C>
Current:
Federal.............................................................. $ $ 4.6 $ 1.3
State and local...................................................... 0.2 0.1
Deferred:
Excess of tax over book depreciation................................. 0.7 0.7
Other................................................................ (1.2) (0.2)
----- ----- -----
Total income taxes................................................ $ $ 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................................ $ $3.4 $1.1 % 34.0% 34.0%
State and local taxes, net of federal tax benefit..... 0.1 0.1 1.0 3.1
Other................................................. 0.8 0.7 8.0 22.3
---- ---- ---- ---- ---- ----
Total income taxes............................... $ $4.3 $1.9 % 43.0% 59.4%
---- ---- ---- ---- ---- ----
---- ---- ---- ---- ---- ----
</TABLE>
The amounts shown on the combined balance sheets for deferred income taxes
result principally from the temporary differences between financial statement
and income tax depreciation.
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.
Liability, if any, associated with these matters is not determinable at January
31, 1994. 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
financial position or results of operations.
X-30
<PAGE> 428
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 24, 1993 were
as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1993..................................................................... $ 0.7 $ 22.4
1994..................................................................... 0.4 21.9
1995..................................................................... 0.2 21.4
1996..................................................................... -- 21.9
1997..................................................................... -- 22.0
Later years.............................................................. -- 247.0
------- ---------
Total minimum lease payments.......................................... 1.3 356.6
Less - minimum sublease rental income...................................... -- (10.1)
------- ---------
Net minimum lease payments................................................. 1.3 $ 346.5
---------
---------
Less:
Amount representing interest............................................. (0.1)
-------
1.2
Portion due within one year................................................ 0.7
-------
Long-term lease obligations................................................ $ 0.5
-------
-------
</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....................................................... $ $17.2 $10.2
Percentage rentals.................................................... 0.2 --
------ ----- -----
Total............................................................ $ $17.4 $10.2
------ ----- -----
------ ----- -----
</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................................ $ $ 0.6 $ 0.6
Interest expense related to obligations under capital leases.......... 0.1 0.2
------ ----- -----
Amounts charged to earnings........................................... 0.7 0.8
Related minimum lease payments net of executory costs................. (0.7) (0.7)
------ ----- -----
Excess of amounts charged over related minimum lease payments......... $ $ -- $ 0.1
------ ----- -----
------ ----- -----
</TABLE>
X-31
<PAGE> 429
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 attributable to The Sports Authority Group was actuarially
determined based on the attributes of The Sports Authority Group's plan
participants. Plan assets and obligations were allocated based upon 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 fund assets, as described above, and amounts
recognized in the accompanying balance sheet at year end. Under this basis, the
following tables summarize the funded status, components of pension cost and
actuarial assumptions.
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested benefits................. $ $ (0.1) $ (0.1)
Estimated present value of non-vested benefits............. (0.2) (0.2)
----------- ----------- -----------
Accumulated benefit obligation............................. (0.3) (0.3)
Value of future pay increases.............................. (0.3) (0.3)
----------- ----------- -----------
Projected benefit obligation............................... (0.6) (0.6)
Estimated market value of plan assets........................ 0.6 0.6
----------- ----------- -----------
Plan assets over (under) projected benefit obligation........ -- --
Unrecognized net asset....................................... (0.1) --
Unrecognized prior service cost.............................. -- --
Unrecognized net (gain) loss and other....................... -- --
----------- ----------- -----------
Accrued pension costs........................................ $ $ (0.1) $ --
----------- ----------- -----------
----------- ----------- -----------
</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................................................. $ $ 0.1 $ 0.1
Interest cost on projected benefit obligation....................... -- --
Return on plan assets............................................... -- --
Net amortization and deferral of other components................... -- --
----- ----- -----
Total............................................................ $ $ 0.1 $ 0.1
----- ----- -----
----- ----- -----
Actuarial assumptions at end of year:
Discount rates...................................................... % 8.50% 8.75%
Expected return on plan assets...................................... % 9.50% 9.50%
Salary increases.................................................... % 5.00% 5.00%
</TABLE>
X-32
<PAGE> 430
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS)
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 the Kmart Corporation Employee
Savings Plan. The Sports Authority Group's expense related to the Employee
Savings Plan was $0.5 and $0.3 for 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 the Kmart Corporation
consolidated financial statements. The Sports Authority Group's allocation of
compensation expense related to the Performance Restricted Stock Plan was not
material.
THE SPORTS AUTHORITY GROUP EQUITY
<TABLE>
<CAPTION>
JANUARY 23, JANUARY 24, JANUARY 26,
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year................................. $ $ 131.4 $ 96.7
Net income................................................... 5.7 1.3
Net equity transactions with the Kmart Group................. 2.1 33.4
----------- ----------- -----------
The Sports Authority Group Equity............................ $ $ 139.2 $ 131.4
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
X-33
<PAGE> 431
ANNEX X-E
THE SPORTS AUTHORITY GROUP
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
Sales.................................................................. $ 407.1 $ 270.2
Licensee fees and rental income........................................ 0.4 0.2
----------- -----------
407.5 270.4
----------- -----------
Cost of merchandise sold, includes buying and occupancy costs.......... 299.4 197.3
Selling, general and administrative expenses........................... 95.6 65.5
Pre-opening expense.................................................... 3.1 3.4
Goodwill amortization.................................................. 1.6 1.6
Interest:
Capital lease obligations -- expense................................. -- 0.1
----------- -----------
399.7 267.9
----------- -----------
Income before income taxes............................................. 7.8 2.5
Income taxes........................................................... 3.4 1.2
----------- -----------
Net income............................................................. $ 4.4 $ 1.3
----------- -----------
----------- -----------
Supplemental disclosure:
Net income........................................................... $ 4.4 $ 1.3
Add back of goodwill amortization.................................... 1.6 1.6
----------- -----------
Kmart Corporation earnings attributable to The Sports Authority
Group............................................................. $ 6.0 $ 2.9
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
X-34
<PAGE> 432
THE SPORTS AUTHORITY GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................................. $ 3.1 $ 2.0
Merchandise inventories.............................................. 157.0 110.5
Accounts receivable and other current assets......................... 13.3 15.3
----------- -----------
Total current assets................................................... 173.4 127.8
Property Owned:
Leasehold improvements............................................... 24.3 17.7
Furniture and fixtures............................................... 39.0 23.4
Construction in progress............................................. 2.7 0.4
Property under capital leases.......................................... 1.5 2.5
----------- -----------
67.5 44.0
Less -- accumulated depreciation and amortization
Property owned....................................................... (13.1) (6.2)
Property under capital leases........................................ (1.4) (1.9)
----------- -----------
Total owned and leased property........................................ 53.0 35.9
Other Assets and Deferred Charges...................................... 1.7 3.6
Goodwill -- net of accumulated amortization of $7.3 and $5.3,
respectively......................................................... 63.1 65.2
----------- -----------
$ 291.2 $ 232.5
----------- -----------
----------- -----------
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable -- trade............................................ $ 75.3 $ 49.0
Accrued payrolls and other liabilities............................... 38.2 17.3
Taxes other than income taxes........................................ 3.8 3.0
Income taxes......................................................... 1.4 --
----------- -----------
Total current liabilities.............................................. 118.7 69.3
Other Long-Term Liabilities............................................ 7.0 5.2
The Sports Authority Group Equity...................................... 165.5 158.0
----------- -----------
$ 291.2 $ 232.5
----------- -----------
----------- -----------
Supplemental Disclosure:
The Sports Authority Group Equity.................................... $ 165.5 $ 158.0
Add back of accumulated goodwill amortization........................ 7.3 5.3
----------- -----------
Kmart Corporation equity attributable to The Sports Authority
Group............................................................. $ 172.8 $ 163.3
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
X-35
<PAGE> 433
THE SPORTS AUTHORITY GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
39 WEEKS ENDED
----------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
(UNAUDITED)
<S> <C> <C>
CASH PROVIDED BY (USED FOR):
OPERATIONS
Net income......................................................... $ 4.4 $ 1.3
Adjustments to reconcile net income to operating cash flows:
Depreciation and amortization................................... 7.2 5.0
Increase in other long-term liabilities......................... 1.7 2.3
Cash provided by (used for) current assets and current liabilities:
Increase in inventories......................................... (43.3) (27.5)
Increase in accounts payable.................................... 20.2 12.9
Other -- net.................................................... 4.3 (2.2)
----------- -----------
Net cash used for operations....................................... (5.5) (8.2)
----------- -----------
INVESTING
Capital expenditures -- owned property............................. (15.4) (16.8)
Other -- net....................................................... 0.9 0.3
----------- -----------
Net cash used for investing........................................ (14.5) (16.5)
----------- -----------
FINANCING
Net equity transactions with the Kmart Group....................... 21.9 25.3
Reduction in capital lease obligations............................. (1.0) (0.4)
----------- -----------
Net cash provided by financing..................................... 20.9 24.9
----------- -----------
NET INCREASE IN CASH AND EQUIVALENTS................................. 0.9 0.2
Cash and Equivalents at Beginning of Year.......................... 2.2 1.8
----------- -----------
CASH AND EQUIVALENTS AT END OF PERIOD................................ $ 3.1 $ 2.0
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Combined Financial Statements.
X-36
<PAGE> 434
THE SPORTS AUTHORITY GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
(UNAUDITED)
BASIS OF PRESENTATION
The accompanying unaudited combined financial statements do not include all
information and footnotes necessary for the annual presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles.
In the opinion of The Sports Authority Group management, all adjustments
necessary for a fair statement of the results for the interim periods have been
included. All adjustments were of a normal and recurring nature.
THE SPORTS AUTHORITY GROUP EQUITY
<TABLE>
<CAPTION>
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Balance at beginning of period......................................... $ 139.2 $ 131.4
Net income............................................................. 4.4 1.3
Net equity transactions with the Kmart Group........................... 21.9 25.3
----------- -----------
The Sports Authority Group Equity...................................... $ 165.5 $ 158.0
----------- -----------
----------- -----------
</TABLE>
X-37
<PAGE> 435
ANNEX X-F
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FOR THE 39 WEEKS ENDED OCTOBER 24, 1993
39 Weeks Ended October 24, 1993 and October 25, 1992
RESULTS OF OPERATIONS
The following table presents The Sports Authority Group's (The Sports
Authority) income statement, as a percent of sales, for the periods presented.
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------
OCTOBER 24, OCTOBER 25,
1993 1992
----------- -----------
<S> <C> <C>
Sales.................................................................. 100.0% 100.0%
Licensee fees and rental income........................................ 0.1 --
----------- -----------
Total operating revenue.............................................. 100.1 100.0
Cost of merchandise sold, includes buying and occupancy costs.......... 73.5 73.0
----------- -----------
Gross margin........................................................... 26.6 27.0
Selling, general and administrative expenses........................... 23.5 24.2
----------- -----------
Operating income before pre-opening expense and goodwill
amortization......................................................... 3.1 2.8
Pre-opening expense.................................................... 0.8 1.3
Goodwill amortization.................................................. 0.4 0.6
----------- -----------
Operating income....................................................... 1.9 0.9
Interest expense....................................................... -- --
----------- -----------
Income before income taxes............................................. 1.9 0.9
Income taxes........................................................... 0.8 0.4
----------- -----------
Net income............................................................. 1.1% 0.5%
----------- -----------
----------- -----------
</TABLE>
The Sports Authority opened 11 new stores in the 39 weeks ended October 24,
1993, as compared to 10 new stores opened in the same period of 1992. The Sports
Authority operated 67 stores at October 24, 1993 as compared to 46 stores open
at October 25, 1992.
Sales for the 39 weeks ended October 24, 1993 were $407.1 million, a $136.9
million, or 50.7%, increase over sales of $270.2 million for the same period in
the prior year. Of the 50.7% increase in sales, 2.3%, or $6.2 million, was
produced by comparable store sales growth and 48.4%, or $130.7 million, was
produced by the 11 new stores opened in the first 39 weeks of 1993 and the
inclusion of full 39 weeks sales for the 10 stores opened in 1992. Comparable
store sales increased 2.3% and 10.2% in the first 39 weeks of 1993 and 1992,
respectively. Comparable store sales for the first 39 weeks of 1993 were
adversely effected by the severe winter storm which occurred in March 1993 and
reduced consumer demand for higher margin apparel. Excluding sales from stores
cannibalized by new store openings, comparable store sales increased 4.8% in the
first 39 weeks of 1993 as compared to 13.9% in the same period of last year.
Licensee fees and rental income for the 39 weeks ended October 24, 1993 was
$0.4 million as compared to $0.2 million for the same period 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.
X-38
<PAGE> 436
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 24, 1993
Cost of merchandise sold, including buying and occupancy costs, for the 39
weeks ended October 24, 1993 was $299.4 million, or 73.5% of sales, as compared
to $197.3 million, or 73.0% of sales, for the same period in the prior year. As
a percent of sales, gross margin was 26.6% in the first 39 weeks of 1993 as
compared to 27.0% in the same period last year. The decrease of 0.4% of sales in
the first 39 weeks of 1993 was due primarily to a lower proportion of higher
margin apparel in the sales mix and higher occupancy costs resulting from The
Sports Authority's expansion into the Northeast region.
Selling, general and administrative (SG&A) expense for the 39 weeks ended
October 24, 1993 was $95.6 million, or 23.5% of sales, as compared to $65.5
million, or 24.2% of sales, in the same period in the prior year. The 0.7% of
sales reduction in SG&A expense was due to the leveraging of The Sports
Authority's corporate overhead and advertising expense with higher sales volume,
partially offset by higher depreciation expense as a percent of sales due to
increased capital expenditures and the timing of store openings.
Operating income before pre-opening expense and goodwill amortization was
$12.5 million, or 3.1% of sales, for the 39 weeks ended October 24, 1993 as
compared to $7.6 million, or 2.8% of sales, for the same period of the prior
year.
Pre-opening expense for the 39 weeks ended October 24, 1993 was $3.1
million, or 0.8% of sales, as compared to $3.4 million, or 1.3% of sales, in the
same period in the prior year. Preopening expenses consist principally of store
payroll expense for associate training and store preparation prior to the store
opening and for grand-opening advertising expenditures. The Sports Authority
opened 11 stores in the current 39 week period as compared to 10 stores in the
same period in the 1992 year. Pre-opening expense decreased by $0.3 million in
the 1993 period due to reduced grand opening advertising expense per unit as
seven of the 11 openings were backfills in existing markets.
Goodwill amortization for the 39 weeks ended October 24, 1993 was $1.6
million, or 0.4% of sales, as compared to $1.6 million, or 0.6% of sales, for
the same period in the prior year. The decrease of 0.2% of sales is due to
higher sales volume.
Operating income for the 39 weeks ended October 24, 1993 was $7.8 million,
or 1.9% of sales, as compared to $2.6 million, or 0.9% of sales, in the same
period in the prior year. The improvement was a result of increased sales
volume, increased gross profit, lower pre-opening expense and management of
store and administrative expenses.
Income tax expense for the 39 weeks ended October 24, 1993 was $3.4 million
with an effective tax rate of 43.6% as compared to $1.2 million with an
effective tax rate of 48.0% in the same period of 1992. The 4.4% 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 the first 39
weeks of 1993 as compared to the same period of 1992, partially offset by the
1.0% increase in the federal corporate tax rate retroactive to January 1, 1993
and slightly higher state and local tax rates.
As a result of the foregoing factors, net income for the 39 weeks ended
October 24, 1993 was $4.4 million, or 1.1% of sales, as compared to $1.3
million, or 0.5% of sales, in the same period in the prior year.
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 flows from operations
and by equity contributions from Kmart Corporation. Since acquiring The Sports
Authority in March 1990, Kmart Corporation has made aggregate equity
contributions of $73.6 million.
X-39
<PAGE> 437
THE SPORTS AUTHORITY GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- CONTINUED
FOR THE 39 WEEKS ENDED OCTOBER 24, 1993
Cash flows generated by operating, investing and financing activities as
reported in the Combined Statements of Cash Flows for the 39 weeks ending
October 24, 1993 are summarized below. The net increase in cash and equivalents
for the 39 weeks ended October 24, 1993 was $0.9 million as compared to a $0.2
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
$5.5 million as compared to $8.2 million in the same period of 1992. The change
resulted from increased net income, non-cash depreciation expense and net cash
provided by other working capital items, partially offset by a greater rate of
increase in inventories net of accounts payable resulting from more stores in
operation at October 24, 1993 than October 25, 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 detailed below.
Net cash used for investing for the 39 weeks ended October 24, 1993 was
$14.5 million as compared to $16.5 million in the same period last year and was
comprised primarily of capital expenditures. Capital expenditures were lower in
the first 39 weeks of 1993 by $1.4 million due to additional expenditures
associated with the expansion of the home office in 1992.
Net cash provided by financing of $20.9 million and $24.9 million in the 39
weeks ended October 24, 1993 and October 25, 1992, respectively, were comprised
almost entirely of equity contributions by the Kmart Group to fund The Sports
Authority's long-term and short-term capital requirements.
The Sports Authority currently plans to open 24 stores in 1993 and
approximately 25 stores in 1994, with 21 of the 1994 openings concentrated in
existing 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 $31.1 million. The Sports Authority intends to continue to
finance new stores with long-term operating leases.
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 attributable 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.
X-40
<PAGE> 438
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 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 EACH OF
PROPOSALS 2-13, AS SET FORTH IN THE PROXY STATEMENT DATED APRIL __, 1994.
HAS YOUR ADDRESS CHANGED? DO YOU HAVE ANY COMMENTS?
__________________________ __________________________
__________________________ __________________________
__________________________ __________________________
__________________________ __________________________
<PAGE> 439
/X/ PLEASE MARK VOTES AS IN THIS EXAMPLE.
<TABLE>
<CAPTION>
The Board of Directors recommends a vote FOR the election The Board of Directors recommends a vote FOR Proposals 2-13.
of each of directors listed below.
For All
Nominees
For Withheld 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 8 / / / / / /
Joseph A. Califano, Jr., Enrique C. Falla, David B. Proposal 3 / / / / / / Proposal 9 / / / / / /
Harper, J. Richard Munro and Joseph R. Thomas
If you do not wish your shares to be voted Proposal 4 / / / / / / Proposal 10 / / / / / /
"FOR" a particular nominee, mark the "For All
Nominees Except" box and strike a line through
the nominee(s) name. Your shares will be voted Proposal 5 / / / / / / Proposal 11 / / / / / /
for the remaining nominee(s).
Proposal 6 / / / / / / Proposal 12 / / / / / /
[NAME AND ADDRESS OF STOCKHOLDER.] Proposal 7 / / / / / / Proposal 13 / / / / / /
PLEASE BE SURE TO SIGN AND DATE THIS
PROXY. DATE:_______________________ Mark box at right if comments or address change have / /
been noted on the reverse side of this card.
(Signature) X: ______________________________________________ (Signature) X: ______________________________________________
</TABLE>
- -------------------------------------------------------------------------------
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
Article III, Section A of 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) provide for the issuance of Common Stock in
series by resolution of the Board of Directors, of which 1.5 billion shares
would initially be designated as a new series of Kmart Group Common Stock, and
the balance of which would be available for designation by the Board as
additional shares of Kmart Group Common Stock and/or any of four new series of
Specialty Retail Group Common Stock, each with designations, relative rights,
preferences and limitations as set forth in the Proxy Statement dated April __,
1994 and (c) redesignate the Company's existing Common Stock as Kmart Group
Common Stock.
Proposal 3. To act upon a proposal to amend Article III, Section B
of 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 Article VII of 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.
Proposal 11. To act upon a proposal to adopt Management Stock
Purchase Plan.
Proposal 12. To act upon a proposal to adopt Annual Incentive Bonus
Plan.
Proposal 13. To ratify the appointment of Price Waterhouse as
independent accountants of the Company for the 1994 fiscal year.
<PAGE> 440
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 Kmart Corporation Series A Conversion Preferred Stock represented by
the Kmart Corporation $3.41 Depositary Shares of the signer(s) 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 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 EACH OF
PROPOSALS 2-13, AS SET FORTH IN THE PROXY STATEMENT DATED APRIL __, 1994.
HAS YOUR ADDRESS CHANGED? DO YOU HAVE ANY COMMENTS?
____________________________ _________________________________
____________________________ _________________________________
____________________________ _________________________________
____________________________ _________________________________
<PAGE> 441
/X/ PLEASE MARK VOTES AS IN THIS EXAMPLE.
<TABLE>
<CAPTION>
The Board of Directors recommends a vote FOR the election The Board of Directors recommends a vote FOR Proposals 2-13.
of each of directors listed below.
For All
Nominees
For Withheld 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 8 / / / / / /
Joseph A. Califano, Jr., Enrique C. Falla, David B Proposal 3 / / / / / / Proposal 9 / / / / / /
Harper, J. Richard Munro and Joseph R. Thomas
If you do not wish your shares to be voted Proposal 4 / / / / / / Proposal 10 / / / / / /
"FOR" a particular nominee, mark the "For All
Nominees Except" box and strike a line through
the nominee(s) name. Your shares will be voted Proposal 5 / / / / / / Proposal 11 / / / / / /
for the remaining nominee(s).
Proposal 6 / / / / / / Proposal 12 / / / / / /
[NAME AND ADDRESS OF STOCKHOLDER.] Proposal 7 / / / / / / Proposal 13 / / / / / /
PLEASE BE SURE TO SIGN AND DATE THIS
PROXY. DATE:_______________________ Mark box at right if comments or address change have / /
been noted on the reverse side of this card.
(Signature) X: ____________________________________________ (Signature) X: ____________________________________________
</TABLE>
- -------------------------------------------------------------------------------
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
Article III, Section A of 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) provide for the issuance of Common Stock in
series by resolution of the Board of Directors, of which 1.5 billion shares
would initially be designated as a new series of Kmart Group Common Stock, and
the balance of which would be available for designation by the Board as
additional shares of Kmart Group Common Stock and/or any of four new series of
Specialty Retail Group Common Stock, each with designations, relative rights,
preferences and limitations as set forth in the Proxy Statement dated April __,
1994 and (c) redesignate the Company's existing Common Stock as Kmart Group
Common Stock.
Proposal 3. To act upon a proposal to amend Article III, Section B
of 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 Article VII of 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.
Proposal 11. To act upon a proposal to adopt Management Stock
Purchase Plan.
Proposal 12. To act upon a proposal to adopt Annual Incentive
Bonus Plan.
Proposal 13. To ratify the appointment of Price Waterhouse as
independent accountants of the Company for the 1994 fiscal year.
