<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 8-K
CURRENT REPORT PURSUANT
TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of report (Date of earliest event reported) June 10, 1996
------------------------
KMART CORPORATION
(Exact Name of Registrant as Specified in its Charter)
MICHIGAN
(State or Other Jurisdiction of Incorporation)
1-327 38-0729500
(Commission File Number) (I.R.S. Employer Identification No.)
3100 WEST BIG BEAVER ROAD, TROY, MICHIGAN 48084
(Address of Principal Executive Offices) (Zip Code)
(810) 643-1000
(Registrant's Telephone Number, Including Area Code)
N/A
(Former Name or Former Address, if Changed Since Last Report)
<PAGE> 2
ITEM 5. OTHER EVENTS
In April 1996, Kmart Corporation sold approximately 30% of its investment in
the common stock of Thrifty PayLess Holdings, Inc. ("TPH"). As a result of
management's intent to dispose of its remaining interest within a one-year time
frame, the Company has accounted for its investment in TPH and PayLess Drug
Stores Northwest, Inc., which was sold to TPH in the first quarter of 1994, as
a discontinued operation and has restated its 1995 Annual Report attached hereto
as Exhibit 99.1.
<PAGE> 3
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
KMART CORPORATION
(Registrant)
By: /s/ Martin E. Welch III
----------------------------
Martin E. Welch III
Senior Vice President
and Chief Financial Officer
Date: June 10, 1996
3
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- ------------
<S> <C>
23 Consent of Independent Accountants
99.1 Restated 1995 Annual Report
</TABLE>
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus Supplement constituting
part of the Registration Statement on Form S-3 (No. 33-64905) of our report
dated March 7, 1996, except that the restatement discussed in the first
paragraph of Note 2, which affects disclosure for all years presented, which is
as of June 5, 1996, relating to the consolidated financial statements of Kmart
Corporation, which appears in such Prospectus Supplement. We also consent
to the reference to us under the heading "Experts" in the Prospectus and
Prospectus Supplement. We also consent to the reference to us under the
headings "Summary Historical Consolidated Financial Information" and "Selected
Historical Consolidated Financial Information" in the Prospectus Supplement.
However, it should be noted that Price Waterhouse LLP has not prepared or
certified such "Summary Historical Consolidated Financial Information" or
"Selected Historical Consolidated Financial Information."
/s/ Price Waterhouse LLP
Price Waterhouse LLP
Detroit, MI
June 5, 1996
<PAGE> 1
EXHIBIT 99.1
KMART CORPORATION
CONSOLIDATED SELECTED FINANCIAL DATA
The following selected financial data for the periods indicated has been
derived from the consolidated financial statements of Kmart Corporation.
Information for all years has been restated to exclude discontinued operations
of Borders Group, Inc., OfficeMax, Inc., The Sports Authority, Inc., PACE
Membership Warehouse, Inc., Thrifty PayLess Holdings, Inc., PayLess Drug Stores
Northwest, Inc. and Coles Myer, Ltd. The information set forth below should be
read in conjunction with Management's Discussion and Analysis of Results of
Operations and Financial Condition and the financial statements and notes
thereto.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED(1)
-------------------------------------------------------------------
JANUARY 31, JANUARY 25, JANUARY 26, JANUARY 27, JANUARY 29,
1996(2) 1995 1994(3) 1993 1992
----------- ----------- ----------- ----------- -----------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Sales....................................... $34,389 $32,514 $30,757 $28,890 $27,596
Cost of merchandise sold, including buying
and occupancy costs....................... 26,996 24,868 23,075 21,179 20,152
Selling, general and administrative
expenses.................................. 7,554 7,376 6,896 6,409 6,289
Interest expense:
Debt, net................................. 220 258 284 229 203
Capital lease obligations and other....... 226 235 192 185 180
Income (loss) from continuing retail
operations before income taxes and equity
income.................................... (750) 63 (532) 1,165 1,037
Equity in net income of unconsolidated
companies................................. 38 52 52 53 50
Net income (loss) from continuing retail
operations................................ (490) 104 (288) 805 705
Net income (loss)........................... (571) 296 (974) 941 859
PER SHARE DATA
Earnings (loss) per common share from
continuing retail operations.............. $ (1.08) $ 0.21 $ (0.65) $ 1.76 $ 1.66
Cash dividends declared per common
share(4).................................. 0.36 0.96 0.96 0.92 0.88
Book value per common share................. 10.99 13.15 13.39 16.64 15.33
FINANCIAL DATA
Working capital............................. $ 5,558 $ 3,562 $ 3,793 $ 5,014 $ 4,682
Total assets................................ 15,397 16,642 16,433 17,140 14,654
Long-term obligations -- Debt............... 3,935 2,003 2,223 3,008 2,067
-- Capital leases.... 1,629 1,777 1,720 1,669 1,608
Shareholders' equity........................ 5,280 6,032 6,093 7,536 6,891
Capital expenditures........................ 578 1,125 871 1,167 1,081
Depreciation and amortization............... 729 680 626 547 470
Ending market capitalization................ 2,858 6,345 9,333 10,837 10,901
Weighted average shares outstanding
(millions)(5)............................. 460 457 457 456 426
FINANCIAL RATIOS
Inventory turnover.......................... 3.4x 3.2x 3.0x 2.7x 2.8x
Debt as a percentage of total
capitalization............................ 51.9% 44.7% 46.8% 42.1% 35.6%
Ratio of income from continuing retail
operations to fixed charges(6)............ -- 1.2x -- 3.0x 3.0x
</TABLE>
- ------------
(1) The Company's fiscal year ends on the last Wednesday in January. Fiscal 1995
consisted of 53 weeks and ended on January 31, 1996.
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(2) Results of operations for fiscal 1995 include a pretax provision of $532
million ($390 million net of tax) related to the adoption of Financial
Accounting Standard No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of".
(3) Results of operations for the fiscal year ended January 26, 1994 include a
pretax provision of $1,130 million ($723 million net of tax) for store
restructuring and other charges.
(4) The Company suspended dividends on Kmart Common Stock in December 1995.
(5) As of January 31, 1996, there were 480,628,478 shares of Kmart Common Stock
outstanding.
(6) Fixed charges represent total interest charges, a portion of operating
rentals representative of the interest factor, and amortization of debt
discount and expense. The deficiency of income from continuing retail
operations versus fixed charges was $733 million and $494 million for fiscal
years 1995 and 1993, respectively.
2
<PAGE> 3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
OVERVIEW
Over the past three years, the Company has undertaken a number of
initiatives intended to strengthen its performance and improve operating
results.
In January 1994, the Company approved a restructuring plan to expand the
store modernization program begun in 1989. The fiscal 1993 modernization program
focused on creating larger-format discount stores and Super Kmart Centers. See
"-- Store Restructuring and Other Charges." As a result of the restructuring
plan, Kmart recorded a pre-tax charge of $1,130 million in the fourth quarter of
1993.
In mid 1994, the Company returned its focus to the core domestic discount
store business. Since November 1994, the Company has completed the divestiture
of The Sports Authority, Inc. ("The Sports Authority"), OfficeMax, Inc.
("OfficeMax"), Borders Group, Inc. ("Borders Group") and Coles Myer, Ltd.
("Coles Myer"), resulting in aggregate proceeds to the Company of approximately
$2.9 billion. The Company also divested ownership and operation of its former
automotive service business located in or adjacent to approximately 860 domestic
Kmart stores. The Company recently sold two subsidiaries operating 13 stores in
the Czech and Slovak Republics for aggregate proceeds of approximately $115
million and sold 5,290,648 shares of common stock of Thrifty PayLess Holdings,
Inc. ("TPH") for approximately $70 million.
In late 1994, the Company began to recruit senior executives from outside
Kmart with the goal of bringing fresh perspective and leadership to address
Kmart's operational problems. To address Kmart's operating weaknesses,
management began to focus on improving merchandise flow, reducing out-of-stock
inventory problems, tightening control over capital expenditures, reducing costs
and improving the Company's information systems. A new chief executive officer
was hired in June 1995, filling a vacancy that had existed for several months.
During the remainder of 1995 and continuing into early 1996, the new chief
executive officer focused on building a management team to return Kmart to
profitability. To that end, a number of senior executives were hired, including
a new president and chief merchandising officer of U.S. Kmart stores, who was
hired in December 1995 to revitalize Kmart's merchandising efforts.
The Company's operating results deteriorated in 1995 as a result of
aggressive clearance of $700 million (at retail value) in aged, discontinued
inventory and continued heavy promotional discounting. Results in 1995 were also
adversely affected by operating losses at Builders Square, Inc. ("Builders
Square") and at the Company's Canadian operations. In fiscal 1995, Kmart
reported a net loss from continuing operations of $100 million (excluding the
effect of a pretax provision of $532 million ($390 million net of tax) related
to the adoption of Financial Accounting Standard No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("FAS 121").
At the end of October 1995, primarily due to disappointing operating
results and a review by rating agencies of its long-term debt, Kmart experienced
a general tightening of credit conditions, including the elimination of its
commercial paper program and certain uncommitted letter of credit facilities. In
early 1996, Kmart's long-term senior unsecured debt rating was downgraded to
non-investment grade (BB by Standard & Poor's and Ba2 by Moody's). As a result
of the ratings downgrade, certain of the Company's real estate related debt
could have been required to be repaid, either by its terms or at the option of
the holders, and the payment of such debt would have accelerated any outstanding
borrowings under the Company's bank credit facilities. As of February 29, 1996,
based on an agreement in principle reached in December 1995, Kmart executed
definitive agreements to restructure such real estate related debt and bank
credit facilities which relieved much of the immediate-term liquidity pressure
on Kmart. Pursuant to these agreements, the maturities of Kmart's current
seasonal bank credit facility and certain of the real estate related debt were
extended to February 1997, and the maturity of all other current bank credit
facilities remained at October 1997.
In view of the limitations the debt restructuring placed on Kmart's ability
to attempt a business turnaround, Kmart initiated negotiations to secure a new
$3.7 billion, three-year New Credit Agreement and to pursue an offering of
Convertible Preferred Securities to increase its financial flexibility. The New
Credit Agreement will replace the Company's current bank credit facilities and
certain real estate related debt
3
<PAGE> 4
aggregating $2.9 billion. The Convertible Preferred Securities offering and the
New Credit Agreement will recapitalize the Company with a more traditional,
flexible and stable capital structure. Based on its current operating plan, the
Company believes that the Convertible Preferred Securities, the New Credit
Agreement and cash generated from operations, will provide sufficient funds to
meet its cash needs through 1999. The closing of the Convertible Preferred
Securities offering and funding under the New Credit Agreement are each
conditioned upon one another.
GENERAL
Kmart Corporation (the "Company" or "Kmart") is one of the world's largest
mass merchandise retailers. The dominant portion of Kmart's business consists of
its domestic general merchandise group which operates a chain of 2,161 Kmart
discount stores with locations in each of the 50 United States, Puerto Rico, the
U.S. Virgin Islands and Guam, including 87 Super Kmart Centers, all in the
United States, at January 31, 1996. Internationally, the general merchandise
group has operations in Canada, the Czech and Slovak Republics (see Note 2 of
Notes to Consolidated Financial Statements) and joint ventures in Mexico and
Singapore. Kmart's remaining specialty retail operation consists of Builders
Square which operates 167 home improvement stores. Kmart also hold 49% equity
interest in substantially all of the Meldisco subsidiaries of Melville
Corporation, which operate the footwear departments in domestic Kmart stores.
In April 1996, Kmart sold approximately 30% of its investment in the common
stock of TPH, an entity which resulted primarily from the combination of Kmart's
former subsidiary PayLess Drug Stores Northwest, Inc. ("PayLess") with Thrifty
Drug Stores after PayLess was sold to TPH. During 1995, public offerings were
completed for Borders Group and the Company's remaining interests in OfficeMax
and The Sports Authority. The results of the aforementioned operations have been
restated as discontinued operations in the financial statements for all years
presented. Discontinued operations also include PACE Membership Warehouse, Inc.
("PACE"), substantially all of which assets were sold in January 1994, and a
21.5% equity interest in Coles Myer, Australia's largest retailer, which was
sold in November 1994.
RESULTS OF CONSOLIDATED OPERATIONS
A three-year summary of sales and operating income (loss) follows:
<TABLE>
<CAPTION>
% CHANGE % CHANGE
FISCAL YEAR ------------------- FISCAL YEAR ------------------- FISCAL YEAR
ENDED ALL COMPARABLE ENDED ALL COMPARABLE ENDED
JANUARY 31, 1996 STORES STORES(1) JANUARY 25, 1995 STORES STORES JANUARY 26, 1994
---------------- ------ ---------- ---------------- ------ ---------- ----------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
Sales
United States........... $ 30,429 7.2 5.6 $ 28,386 5.3 1.4 $ 26,948
International........... 1,284 9.1 3.0(2) 1,177 8.0 4.2(2) 1,090
Builders Square......... 2,676 (9.3) (8.7) 2,951 8.5 5.9 2,719
-------- -------- --------
Total Sales........... $ 34,389 5.8 4.3 $ 32,514 5.7 1.9 $ 30,757
======== ======== ========
Operating Income (Loss)(3)
United States........... $ 262 (48.1) $ 505 (47.7) $ 966
International........... (17) (173.9) 23 (52.1) 48
Builders Square......... (17) (160.7) 28 (53.3) 60
-------- -------- --------
Total Operating
Income.............. $ 228 (59.0) $ 556 (48.2) $ 1,074
======== ======== ========
</TABLE>
- -------------------------
(1) Comparable store sales for the fiscal year ended January 31, 1996 are based
on the 52-week period ended January 24, 1996.
(2) International comparable store sales change is calculated on sales in the
applicable local currency.
(3) Operating income (loss) for the fiscal year ended January 31, 1996 excludes
charges of $370 million and $162 million related to the adoption of
Financial Accounting Standard No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" regarding the
accounting for impairment of long-lived assets of Builders Square and
certain international operations, respectively. Operating income for the
fiscal year ended January 26, 1994 excludes store restructuring and
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<PAGE> 5
other charges of $865 million, $39 million and $226 million for United
States operations, international operations and Builders Square,
respectively.
The following table highlights the store activity during fiscal 1995:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FISCAL 1995 ACTIVITY PLANNED
----------------------------------- ----------------------- END
JANUARY 26, 1994 JANUARY 25, 1995 OPENED CLOSED END 1996
---------------- ---------------- ------ ------ ----- -------
<S> <C> <C> <C> <C> <C> <C>
Kmart
United States........................ 2,323 2,316 59 (214) 2,161 2,142
Canada............................... 127 128 2 (3) 127 115
Czech and Slovak Republics............. 13 13 -- -- 13 --
Mexico................................. -- 2 2 -- 4 4
Singapore.............................. -- 2 1 -- 3 3
Other.................................. 23 20 -- (18) 2 --
------ ------ -- ----- ----- -----
Total General Merchandise......... 2,486 2,481 64 (235) 2,310 2,264
------ ------ -- ----- ----- -----
Builders Square........................ 177 166 16 (15) 167 169
------ ------ -- ----- ----- -----
Total Stores........................... 2,663 2,647 80 (250) 2,477 2,433
====== ====== == ===== ===== =====
General Merchandise Selling Square Feet
(Millions)........................... 168 175 169
====== ====== =====
General Merchandise Store Sales
per Selling Square Foot.............. $ 179 $ 179 $ 192
====== ====== =====
General Merchandise Capital
Expenditures -- Owned Property....... $ 793 $1,021 $ 540
====== ====== =====
</TABLE>
FISCAL 1995 COMPARED TO FISCAL 1994
SALES
Consolidated sales increased 5.8% during 1995 driven by comparable store
sales growth of 4.3% and the opening of 80 new stores during the past year,
partially offset by the closing of 250 stores primarily during the first and
third quarters of the year. Comparable store sales increases are attributed to
continued maturation of domestic and international stores opened during and
prior to 1994, increased levels of promotional activity and related customer
traffic, improved merchandise in-stock position and a larger average transaction
size. Total sales and comparable store sales declines at Builders Square reflect
increased competition in major markets, generally weak sales in the industry
segment and deflation in lumber prices.
GROSS MARGIN
Cost of merchandise sold, including buying and occupancy costs, as a
percentage of sales, was 78.5% in 1995 as compared with 76.5% in 1994. Gross
margin in 1995 was significantly affected by the aggressive clearance of
discontinued inventory, particularly in the third quarter, and by substantially
higher levels of promotional activity. International, particularly Canada, and
Builders Square costs of merchandise sold, as a percentage of sales, were
significantly affected by competitive pressures.
While continued pursuit of sales volumes, including high-frequency
strategies, could potentially cause some erosion of gross margin rates in 1996,
Kmart plans to offset this margin pressure through a reduction in the level of
clearance items and an improved balance between promotional and non-promotional
sales achieved through new advertising initiatives and a more customer pleasing
merchandise assortment.
Substantially all of Kmart's domestic inventories are measured using the
last-in, first-out (LIFO) method of inventory valuation. A reduction in
inventory levels, together with deflation in internal price indices, contributed
to pretax LIFO credits of $36 million and $57 million in 1995 and 1994,
respectively.
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses, including advertising, were 22.0% of sales in 1995 as
compared to 22.7% in 1994. This decrease relative to sales reflected continuing
cost-cutting efforts, leveraging of fixed costs over a higher sales base and a
number of one-time charges taken in the fourth quarter of 1994. These charges,
totaling $61 million, included a provision for the closings of regional offices
and the Kmart Fashions division headquarters, the cancellation of certain real
estate projects that did not meet new, more stringent return on investment
requirements and the sale of corporate aircraft. SG&A expense dollars were
higher than 1994 levels due primarily to the opening of 20 additional Super
Kmart Centers during 1995, full-year expenses related to 48 Super Kmart Centers
opened in 1994 and increased levels of advertising. Kmart continues to
aggressively pursue opportunities to reduce its overall operating cost
structure.
OTHER EXPENSES AND OTHER INCOME
Asset impairment charges. Kmart adopted Financial Accounting Standard No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" ("FAS 121") in the fourth quarter of 1995. This
statement requires companies to record impairments of long-lived assets, certain
identifiable intangibles, and associated goodwill on an exception basis, when
there is evidence that events or changes in circumstances have made recovery of
an asset's carrying value unlikely. In conducting its asset review, management
considered, among other things, current and expected operating cash flows from
the asset together with a judgment as to the fair value the Company could
receive upon sale of such asset. Based on this review, Kmart recorded a $532
million pretax charge ($390 million aftertax) relating to Builders Square and
certain international operations.
Gain on pension curtailment. Kmart recorded a gain on pension curtailment
of $124 million during the first quarter of 1995. This gain resulted from the
decision to replace the existing defined benefit pension plans with a profit
sharing program under the Retirement Savings Plan. Effective January 31, 1996,
the pension plans were frozen and associates no longer accrue additional
benefits under the plans. The curtailment gain is attributable to the change in
net liabilities resulting from the decision to freeze the pension plans. The new
profit sharing program, effective January 1, 1995, requires a minimum annual
contribution of $32 million.
Net interest expense on debt during 1995 was $220 million, down 14.7% from
$258 million in 1994. Net interest expense consisted of $270 million of expense
and $50 million of income in 1995 and $285 million of expense and $27 million of
income in 1994. The interest income increase was due primarily to $17 million of
interest income resulting from a favorable Internal Revenue Service litigation
settlement. The decrease in interest expense was due primarily to the scheduled
retirement of $150 million of 12 1/8% notes and lower average short-term
borrowings due to the application of proceeds from the disposal of discontinued
operations. This decrease was partially offset by higher average interest rates
on short-term borrowings. Kmart's weighted average interest rate on total debt
was 7.8% in 1995 and 7.0% in 1994. Weighted average interest rates for
short-term borrowings were 6.4% in 1995 and 4.6% in 1994. Interest rates were
higher due to market conditions and lower ratings of Kmart debt by the rating
agencies. Capital lease obligations and other interest expense was down slightly
in 1995 due to capital lease expirations and terminations.
Income tax provision (credit) was a $222 million credit in 1995 as compared
to an $11 million provision in 1994. The Company's effective tax rate was 31.2%
in 1995 compared to an effective tax rate of 9.6% in 1994. Effective tax rates
in each year were favorably impacted by tax credits and equity income relative
to income levels. The effective tax rate for 1995 was negatively affected by the
provision of a valuation allowance associated with the tax benefits recorded on
the international portion of the asset impairment charge. Due primarily to
losses in 1993 and 1995, Kmart recognized net tax benefits of approximately $255
million consisting of refundable taxes and anticipated future tax benefits.
Kmart expects to realize a portion of these tax benefits during 1996 and intends
to continue to evaluate its deferred tax assets through analysis of the need for
any valuation allowance in relation to actual operating performance, executed or
proposed tax strategies and other changes in facts or circumstances. See Note 12
of Notes to Consolidated Financial Statements for additional information.
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<PAGE> 7
Net loss from continuing retail operations before extraordinary items and
the effect of accounting changes was $490 million in 1995 as compared to net
income, on the same basis, of $104 million in 1994. Excluding the asset
impairment charges, the net loss from continuing retail operations for 1995
would have been $100 million.
Discontinued operations during 1995 resulted in a $30 million loss from
disposal and included the sale of the Borders Group and remaining equity
interests in OfficeMax and The Sports Authority. Discontinued operations during
1994 resulted in income of $75 million from operations and included the Borders
Group, OfficeMax, The Sports Authority and Coles Myer. The gain on the disposal
of discontinued operations of $117 million in 1994 included a $101 million
aftertax gain resulting from the Initial Public Offerings ("IPO's") of shares in
OfficeMax and The Sports Authority and a $48 million aftertax gain realized from
the sale of Coles Myer, partially offset by an aftertax charge of $32 million
for sublease exposure related to lease guarantees on properties sublet to Furr's
cafeteria chains. Kmart sold these cafeteria chains in 1986. See Note 3 of Notes
to Consolidated Financial Statements for additional information.
Extraordinary item, net of income taxes. Kmart entered into agreements
whereby holders of approximately $550 million of certain real estate related
debt agreed to eliminate put features which would have required Kmart to
purchase the debt from the holders if Kmart's long-term debt rating was lowered
to non-investment grade or the lowest level of investment grade rating in
certain cases. As a result, Kmart recorded an extraordinary noncash charge of
$51 million, net of income taxes, primarily relating to the make-whole premiums
payable under such agreements. See "Liquidity and Financial Condition" below for
additional information.
As a result of the combination of the foregoing factors, the net loss for
1995 was $571 million, or 1.7% of sales, as compared to net income for 1994 of
$296 million, or 0.9% of sales. Excluding the asset impairment charges and the
extraordinary item, the net loss for 1995 would have been $130 million, or 0.4%
of sales.
FISCAL 1994 COMPARED TO FISCAL 1993
SALES
Consolidated sales increased 5.7% during 1994 driven by comparable store
sales growth of 1.9% and an increase in overall selling square footage due to
the addition of larger-format stores and Super Kmart Centers. Comparable store
sales were adversely affected by competition, resulting in lower selling prices,
weak sales of apparel merchandise and, particularly during the first part of the
year, inventory mix adjustments and reductions made in late 1993 and early 1994,
which resulted in lower customer traffic. International and Builders Square
sales increases were attributable to the performance of new and remodeled
stores.
GROSS MARGIN
Cost of merchandise sold, including buying and occupancy costs, as a
percentage of sales, was 76.5% in 1994 as compared with 75.0% in 1993. This
increase of 1.5% of sales in 1994 reflected a mix of both apparel and hardline
merchandise more heavily weighted toward promotional items and lower-margined
merchandise and higher fixed occupancy costs on relatively level sales per
square foot. Additionally, a more aggressive markdown policy on discontinued and
seasonal merchandise implemented in the fourth quarter of 1994 reduced gross
margins by $171 million. As a result of cycle inventory counts and the year-end
physical inventory count, Kmart accrued an additional $17 million in the fourth
quarter of 1994 for inventory shrinkage. International, particularly Canada, and
Builders Square costs of merchandise sold, as a percentage of sales, were
affected by competitive pressures.
Substantially all of Kmart's domestic inventories are measured using the
LIFO method of inventory valuation. The deflation impact in certain internal
price indices contributed to pretax LIFO credits of $57 million and $55 million
in 1994 and 1993, respectively.
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<PAGE> 8
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses, including advertising, were 22.7% of sales in 1994 as
compared to 22.4% in 1993. The 1994 increase relative to sales reflected the
small rise in comparable store sales, the cost of professional services for the
strategic review of Kmart's operations and processes and certain one-time
charges taken in the fourth quarter of 1994. SG&A expenses were also negatively
affected by start-up operations in Mexico and Singapore and costs associated
with the opening and expansion of certain Builders Square stores.
OTHER EXPENSES AND OTHER INCOME
Net interest expense on debt during 1994 was $258 million, down 9.2% from
$284 million in 1993. Net interest expense consisted of $285 million of expense
and $27 million of income in 1994 and $296 million of expense and $12 million of
income in 1993. The decrease in net interest expense was due primarily to lower
aggregate short-term borrowings, a result of applying the proceeds from the
IPO's of shares in OfficeMax and The Sports Authority and the sale of the
Company's equity interest in Coles Myer, and the early retirement of long-term
debt as a result of applying the proceeds from the sale of PayLess, partially
offset by higher interest rates resulting from market conditions and lower
ratings of the Company's debt by the rating agencies. Kmart's weighted average
interest rate on total debt was 7.0% in 1994 and 6.7% in 1993. Weighted average
interest rates for short-term borrowings were 4.6% in 1994 and 3.2% in 1993.
Capital lease obligations and other interest expense increased in 1994 primarily
as a result of $40 million in interest expense related to the discounting of
closed store lease obligations included in the 1993 store restructuring reserve.
Income tax provision (credit) was an $11 million provision with an
effective tax rate of 9.6% in 1994 as compared to a credit of $192 million with
an effective tax rate of 40.0% in 1993. Effective tax rates in each year were
favorably impacted by tax credits and equity income relative to income levels.
Changes in state tax rates also impacted the overall effective tax rates. See
Note 12 of Notes to Consolidated Financial Statements.
Net income from continuing retail operations before extraordinary items and
the effect of accounting changes was $104 million in 1994 as compared to a net
loss, on the same basis, of $288 million in 1993. Excluding store restructurings
and other charges, net income from continuing retail operations for 1993 would
have been $435 million.
Discontinued operations during 1994 resulted in income of $75 million from
operations as compared to a loss of $126 million from operations in 1993.
Discontinued operations included the Borders Group, OfficeMax, The Sports
Authority, Coles Myer and PACE. The $126 million aftertax loss in 1993 was the
result of significant net operating losses of the Borders Group and PACE which
more than offset the net operating income of PayLess, OfficeMax and The Sports
Authority and the equity in net income of Coles Myer.
The gain on the disposal of discontinued operations of $117 million in 1994
included a $101 million after tax gain resulting from the IPO's of shares in
OfficeMax and The Sports Authority, a $48 million aftertax gain realized from
the sale of the Company's equity interest in Coles Myer, partially offset by an
aftertax charge of $32 million for exposure related to lease guarantees on
properties sublet to Furr's cafeteria chains. In 1993, an aftertax loss of $521
million was realized from the disposal of discontinued businesses including the
sale of substantially all of its assets by PACE and the divestiture of PayLess.
See Note 3 of Notes to Consolidated Financial Statements for additional
information.
Extraordinary item, net of income taxes. In August 1993, Kmart called for
early redemption of all $200 million aggregate principal amount 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 called for early redemption of all $200 million aggregate principal amount
of its 10 1/2% Sinking Fund Debentures due December 1, 2017. The resulting
redemption premium of $10 million, net of applicable income taxes, was reported
as an extraordinary item.
Effect of accounting changes, net of income taxes. Effective in the first
quarter of 1993, Kmart adopted Financial Accounting Standard No. 109 "Accounting
for Income Taxes" ("FAS 109"). FAS 109 is an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in a company's
financial statements or tax returns. In
8
<PAGE> 9
estimating future tax consequences, FAS 109 generally considers all expected
future events other than enactment of changes in the tax law or rates. The
adoption of FAS 109 resulted in the recording of a one time credit, as the
cumulative effect of an accounting change, of $49 million in the first quarter
of 1993.
Kmart adopted Financial Accounting Standard No. 106 "Employers' Accounting
for Postretirement Benefits Other Than Pensions" ("FAS 106") at the beginning of
1993. This standard requires Kmart to accrue for future postretirement medical
benefits. In prior years, these claims were expensed when paid. As a result of
adopting FAS 106, Kmart recorded an aftertax charge of $78 million, as the
cumulative effect of an accounting change, in 1993.
Store restructuring and other charges. In January 1994, the Kmart Board of
Directors approved a restructuring plan involving domestic and Canadian Kmart
stores, Builders Square and the Walden division of the Borders Group. As a
result, in the fourth quarter of 1993, Kmart recorded a pretax charge of $1,348
million, $862 million after tax. The portion of the charge associated with the
Borders Group, $218 million pretax and $139 million aftertax, has subsequently
been restated as discontinued operations. The remaining restructuring provision
included anticipated costs of $1,130 million associated with Kmart stores which
were to be closed and relocated, enlarged or refurbished in the U.S. and Canada
and relocation of certain Builders Square stores. The 1993 restructuring
provision also included $20 million to increase the reserve for lease
obligations for stores closed as part of Kmart's 1989 restructuring plan. Other
charges included the estimated costs of $76 million for re-engineering programs
(principally severance) and other non-recurring charges and an accrual of $12
million for a non-routine legal judgment resulting from the insolvency of an
insurer.
The 1993 restructuring plan assumed closure of 503 additional domestic
stores and expansion or refurbishment of the remaining 500 unmodernized domestic
stores, as well as specific plans for the modernization of the remaining
unmodernized Canadian Kmart stores and conversion of virtually all of the
existing Builders Square stores to the new BSQ II format by the end of 1997. The
following table outlines the original 1993 restructuring plan for domestic Kmart
stores and planned and completed projects by fiscal year:
<TABLE>
<CAPTION>
COMPLETED
1993 PLANNED PROJECTS BY YEAR PROJECTS BY YEAR
RESTRUCTURING ---------------------------- ---------------------
PLAN 1994 1995 1996 1997 1994 1995 TOTAL
------------- ---- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Closings and Relocations................ 503 100 150 175 78 120 214 334
Expansions.............................. 265 55 84 96 30 48 12 60
Refurbishments.......................... 235 35 100 100 21 6 27
----- ---
Total.............................. 1,003 421
===== ===
</TABLE>
Kmart closed 214 domestic Kmart stores during 1995, as compared to the
original 1993 plan of 150. The acceleration of closings is partially due to the
Company not replacing all stores closed with either a new Kmart store or Super
Kmart Center, as originally planned. The number of new stores being opened, 59
in 1995 as compared to 113 in 1994, has been reduced due in part to reductions
in capital spending resulting from lower than projected operational results. As
a result, Kmart has closed stores sooner than planned as there was no need to
keep such stores open until the new store was built. During 1995, Kmart
substantially completed its restructuring plans for Builders Square and Canada.
Due in part to the change in the Company's management, Kmart is re-evaluating
the current store base and store design and merchandise assortments and has
effectively canceled its expansion and refurbishment program.
For 1996, Kmart is planning to close approximately 50 stores, including
approximately 35 stores to be replaced with either a new Kmart store or Super
Kmart Center. The original plan called for 425 store closings through 1996 as
compared to projected actual closings of 384 through 1996. The decrease is due
in part to the new management team's continuing evaluation of the current store
base and store design and merchandise assortments, which management plans to
extensively review during 1996.
9
<PAGE> 10
The following table sets forth the consolidated 1993 restructuring
provision established in fiscal 1993 and related activity through January 31,
1996:
<TABLE>
<CAPTION>
ACTIVITY THROUGH JANUARY 31, 1996
-------------------------------------------------------
CASH NONCASH COSTS RESERVE AT
PROVISION COSTS AND CHANGES IN JANUARY 31,
RECORDED INCURRED ASSET WRITEDOWNS ESTIMATE 1996
--------- -------- ---------------- ---------- -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
1993 Restructuring Plan:
Lease obligation costs................ $ 577 $166 $(75)(a) $(57) $ 429
Asset writedowns...................... 181 -- 201 49 29
Inventory disposition costs and
related operating losses........... 264 35 159 13 83
Re-engineering and other non-recurring
charges............................ 76 54 25 12 9
Non-routine legal accrual............. 12 7 -- (5) --
------- ---- ---- ---- -----
$ 1,110 $262 $310 $ 12 $ 550
======= ==== ==== ==== =====
</TABLE>
- -------------------------
(a) Represents $35 million and $40 million for interest expense accreted during
1995 and 1994 on discounted lease obligations.
The fiscal 1995 and 1994 activity included $127 million and $39 million,
respectively, of cash outlays for lease obligation costs incurred once a store
is closed, until it can be either sublet, assigned, bought-out or terminated,
net of any sublease income. Asset writedowns of $124 million for 1995 and $77
million for 1994 represent primarily furniture and fixture and leasehold
improvement writedowns to net realizable value in the stores closed and expanded
or refurbished. The inventory disposition costs for 1995 and 1994 of $70 million
and $89 million, respectively, represent total liquidation costs for the stores
closed. Due to favorable sublease and termination experience for stores closed
to date, Kmart lowered the estimate of net lease obligation costs for domestic
and Canadian Kmart stores and Builders Square stores by $44 million and $13
million in 1995 and 1994, respectively. These favorable results have been offset
by higher than planned inventory disposition costs for Builders Square stores to
date and increased fixed asset disposition costs for domestic Kmart stores
primarily due to the acceleration of the closing of stores originally planned to
be closed in later years. As a result, Kmart increased the reserve for fixed
asset disposal writedowns by $31 million and $18 million in 1995 and 1994,
respectively. A $12 million addition to the provision was made in 1994 for the
increased fixed asset disposal writedowns net of the decrease of $5 million
relating to a non-routine legal settlement. In addition, with the decision to
suspend the expansion and refurbishment plan, the excess reserve for the
canceled projects, which relate to inventory disposition and fixed asset
writedowns, will be allocated to closing stores. Kmart continues to believe that
the Company is on track in total dollars incurred to date compared to the
original estimates made in 1993. Actual results were in line with the original
reserve in total dollars of $226 million and $39 million for Builders Square and
Canada, respectively.
Also included in the 1993 charge was $45 million, for domestic Kmart
operations, in severance and related benefits as part of re-engineering
programs. During 1994, Kmart had a workforce reduction of approximately 660
salaried and 430 hourly positions as part of implementing the re-engineering
programs. Of the total incurred, $23 million was paid in 1994 and $22 million
was paid in 1995. During 1995, the Company allocated an additional $12 million
to re-engineering and other non-recurring charges for the domestic and Canadian
operations due to higher than planned re-engineering costs.
Kmart has completed 1,581 domestic store modernization projects since
program inception in 1989, including 533 new Kmart stores, 87 Super Kmart
Centers, 490 expansions and 471 refurbishments. In 1995, average sales per store
at the modernized Kmart stores were approximately 24% higher than non-modernized
stores and the 67 Super Kmart Center stores open the full year averaged in
excess of $42 million in sales per store. The remaining unmodernized store base
contributed approximately $23 million, $26 million and $95 million to aftertax
earnings from continuing operations in 1995, 1994 and 1993, respectively.
10
<PAGE> 11
During 1995 and 1994, Kmart closed certain stores that were previously
modernized and therefore not part of the original stores to be closed. As market
conditions change, Kmart has substituted and will substitute stores that were
not included in the original provision. Management does not believe the
substitution of stores has or will have a material impact on the original
restructuring charge.
The 1989 restructuring plan, including the $20 million added in 1993,
included $385 million for 310 closed/relocated stores and $141 million for 1,880
expanded/refurbished stores. Relating to the 1989 restructuring plan, Kmart
closed/relocated 323 stores and expanded/refurbished 874 stores and has charged
against the reserve $435 million and $74 million relating to these store
closures/relocations and expansions/refurbishments, respectively. Actual costs
on a per store basis have been higher than the original estimate for the
closed/relocated component of the 1989 restructuring plan due primarily to
higher than expected lease termination costs and lower sublease revenues. The
actual costs for expansions/refurbishments, on a per store basis, have been
slightly higher than the original estimate due primarily to fixed asset
write-offs related to store refurbishments. The closure and relocation costs
above original estimates were charged to the reserve for expansions and
refurbishments, and no changes to the original reserve were recorded prior to
the fourth quarter of 1993 when the additional $20 million was recorded.
As a result of the combination of the foregoing factors, net income for
1994 was $296 million, or 0.9% of sales, as compared to a net loss in 1993 of
$974 million or 3.2% of sales.
LIQUIDITY AND FINANCIAL CONDITION
Historically, Kmart's primary sources of working capital have been cash
flows from operations and borrowings through its commercial paper program. Kmart
had working capital of $5,558, $3,562 and $3,793 million at year end 1995, 1994
and 1993, respectively. Working capital ratios were 2.7:1, 1.7:1 and 1.8:1,
respectively, at the same dates. Kmart's working capital fluctuates in relation
to (i) profitability, (ii) inventory levels during the course of the year due to
seasonality, (iii) the number and timing of new store openings and closings and
(iv) the nature of Kmart's working capital borrowings.
At the end of October 1995, primarily due to disappointing operating
results and a review by rating agencies of its long-term debt, Kmart experienced
a general tightening of credit conditions, including the elimination of its
commercial paper program and certain uncommitted letter of credit facilities. As
a result, Kmart has used its revolving bank credit facilities as its primary
source of short-term liquidity and intends to use the New Credit Agreement for
short-term liquidity and for funding a portion of its continuing letter of
credit requirements. As of March 7, 1996, Kmart had $1,988 million borrowed
under its credit lines.
In early 1996, Kmart's long-term senior unsecured debt rating was
downgraded to non-investment grade (BB by Standard & Poor's and Ba2 by Moody's).
As a result of the ratings downgrade, higher interest rates became effective on
Kmart's bank debt. Kmart entered into agreements (a) with a group of debt
holders to eliminate ratings downgrade put features from approximately $550
million aggregate principal amount of certain real estate related debt in
exchange for repayment of such debt, including make-whole premiums on certain
debt, in October 1997 or such earlier date as the debt matures or is refinanced
and (b) with its banks, to modify the terms of its bank credit facilities. The
maturities of Kmart's seasonal bank credit facility and certain of the real
estate debt were extended to February 1997, and the maturity of all other bank
credit facilities remained at October 1997. Kmart recorded an extraordinary
noncash charge of $51 million, net of income taxes, in the fourth quarter of
1995 associated with these agreements, primarily relating to make-whole premiums
due upon maturity of the real estate related debt.
The Convertible Preferred Securities which the Company intends to offer and
a $3.7 billion, three year New Credit Agreement will recapitalize the Company
with a more traditional, flexible and stable capital structure. The New Credit
Agreement includes a $2.5 billion Revolving Credit Facility designed to provide
the borrowing capacity to meet Kmart's seasonal working capital needs over its
term, and a $1.2 billion Term Loan Facility, which will be fully drawn upon the
initial funding of the New Credit Agreement. The New Credit Agreement will
replace the current bank credit facilities and certain real estate related debt
aggregating $2.9 billion and maturing in 1997. The New Credit Agreement will be
secured by a first lien on the material unencumbered domestic assets of the
Company and will contain certain financial and other covenants
11
<PAGE> 12
described under "New Credit Agreement" herein. Based on its current operating
plan, Kmart believes that the Convertible Preferred Securities, the New Credit
Agreement and cash generated from operations will provide it with sufficient
funds to meet its cash needs through 1999.
Subsequent to the completion of an offering of Convertible Preferred
Securities and funding under the New Credit Agreement, management intends to
seek long-term financing for approximately $1 billion of recently opened real
estate facilities which are either owned or refinanced or purchased upon funding
under the New Credit Agreement. The net proceeds realized from such financing
will depend on the loan to value ratios offered by the respective lenders.
Proceeds from this real estate financing, together with proceeds from the
divestiture of certain other non-core assets, will be used to pay down the term
loan facility under the New Credit Agreement. In addition, the Company intends
to seek long-term financing for its new store program. If such financing is not
available, the Company must either rely on funding available under the New
Credit Agreement, find alternative funding or possibly curtail its new store
program.
Kmart remains generally current with trade vendors, continues to receive
and honor usual and customary trade terms and remains in compliance with all
bank covenants. While the New Credit Agreement will provide a lien to the
secured lenders on the material unencumbered domestic assets of the Company,
management also has the ability, at its discretion, to grant a second lien on
the Company's inventory to vendors. Together with the increased borrowing
capacity represented by the New Credit Agreement, management believes that the
lien will improve its ongoing relationships with the Company's vendors. However,
should Kmart's operating performance deteriorate or should providers of goods
and services to Kmart tighten credit terms, Kmart may need to consider
alternative sources of funds, a reduction in capital expenditures or additional
restructuring of its capital structure.
Net cash provided by (used for) operations was $(189) million in 1995 and
$(96) million in 1994 compared to cash provided by operations of $777 million in
1993. The use of $189 million in 1995 was primarily due to the loss from
operations, cash outlays for lease obligation costs of closed stores, together
with income tax paid in 1995, most of which has been recouped in 1996, and a
reduction in accounts payable resulting from the 53rd week of operations, only
partially offset by a reduction in inventory. The decrease in 1994 from 1993 was
due primarily to lower net income from continuing retail operations, excluding
store restructuring and other charges, a $510 million increase in U.S. Kmart
first-in, first-out (FIFO) inventory, partially offset by a decrease in cash
used for PACE obligations and noncash items related to the sale of the Company's
equity interest in Coles Myer.
Inventory turnover was 3.4 in 1995, as compared with 3.2 in 1994 and 3.0 in
1993, as restated for discontinued operations. The improvement in inventory
turnover in 1995 and 1994 was due to a continuing focus on inventory management,
the aggressive clearance of discontinued inventory, the continued impact of
higher turnover for the Super Kmart Center operations and an increase in sales
mix of higher volume, lower-margined consumables and commodities.
Kmart anticipates that after-tax cash outflows related to store
restructuring and other charges will approximate $85 million, $70 million and
$65 million in 1996, 1997 and 1998, respectively, and will result primarily from
the payment of lease obligation costs for closed stores. The pretax cash
outflows related to store restructuring and other charges will approximate $125
million, $110 million, and $95 million in 1996, 1997 and 1998, respectively.
Further cash outlays for lease obligation costs for closed stores (including
property taxes, maintenance and utilities) have been estimated based upon the
payments required under the lease and the estimated time period between a store
closing and the date the lease is assigned, sublet, terminated or expires. At
January 31, 1996, the total remaining gross lease obligation costs for closed
stores relating to the U.S. Kmart 1993 restructuring plan aggregated
approximately $1.1 billion. Based upon historical results, management estimates
that approximately $600 million of the remaining gross lease obligation costs
will be recovered through subleasing. Other means of lease disposition have been
considered in developing such estimate but are not material. Kmart has
discounted future net cash flows using a 7% discount rate. At January 31, 1996,
the effect of such discounting was to reduce lease obligation costs for closed
stores by $110 million. Future cash outlays are based upon management's estimate
of the period of time between store closing and the ultimate
12
<PAGE> 13
disposition of the lease obligation. Management believes the estimates used to
develop the timing and amount of cash flow related to net lease obligation costs
for closed stores are reliably determinable.
Net cash provided by (used for) investing was $406 million in 1995, $1,077
million in 1994 and $(155) million in 1993. Cash provided by investing in 1995
was primarily comprised of proceeds from asset sales and subsidiary public
offerings, partially offset by capital expenditures. Cash provided by investing
in 1994 was primarily comprised of proceeds from the OfficeMax and The Sports
Authority IPO's, the divestiture of PayLess and the sale of Kmart's equity
interest in Coles Myer, partially offset by capital expenditures for store
modernization. Capital expenditures for the general merchandise group, which
included new distribution centers, refurbishments, expansions and store
openings, were $540 million, $1,021 million and $793 million in 1995, 1994 and
1993, respectively. The decrease in the general merchandise group capital
expenditures in 1995 was due to a decrease in store openings as a result of
management's ongoing assessment of modernization results. The increase in the
general merchandise group capital expenditures in 1994 was due to the opening of
stores in Mexico and Singapore in 1994 and the greater number of larger-format
Super Kmart Centers in the store modernization program as compared to the prior
year.
Approximately 20 new discount stores and 11 Super Kmart Center stores are
currently planned to be opened in 1996. U.S. Kmart consolidated capital
expenditures are expected to be approximately $350 million in 1996 as compared
with $464 million, $767 million and $727 million in 1995, 1994 and 1993,
respectively. Kmart anticipates that the cash required to fund planned 1996
capital spending will be provided primarily by operations and borrowings
available pursuant to the New Credit Agreement.
Melville Corporation has announced a restructuring and potential spinoff of
its footwear businesses, including its 51% interest in its Meldisco
subsidiaries, which operate the footwear departments in U.S. Kmart stores. It is
not anticipated that any restructuring or spinoff of Meldisco will have a
material impact on Kmart's financial position or results of operations. Kmart
has received $50 million as a one-time dividend payment from Meldisco during
1996.
Net cash provided by (used for) financing was $525 million in 1995,
$(1,007) million in 1994 and $(808) million in 1993. Cash provided by financing
in 1995 was primarily comprised of net proceeds from long-term debt and notes
payable of $963 million, compared to net reductions in long-term debt and notes
payable of $453 million and $284 million in 1994 and 1993, respectively. The net
cash provided by financing in 1995 was primarily the result of higher
outstanding borrowings under the current bank credit facilities and certain real
estate related debt due to repayment restrictions contained in such agreements.
Cash used for financing in 1994 was due to a reduction in aggregate short-term
borrowings, as a result of applying the proceeds from the IPO's of OfficeMax and
The Sports Authority and the sale of the Company's equity interest in Coles
Myer, and the early retirement of long-term debt, as a result of applying the
proceeds from the divestiture of PayLess. The net reduction in 1993 was
primarily due to lower short-term borrowings as a result of lower U.S. Kmart
inventory levels.
Total dividends paid during 1995 were $283 million, compared with $474
million and $465 million in 1994 and 1993, respectively. In April 1995, the
quarterly dividend on Kmart Common Stock was reduced from 24 cents per share to
12 cents per share. In December 1995, as part of the agreements to remove put
features from certain real estate related debt, the Kmart Common Stock dividend
was eliminated. Dividends paid per share of existing Kmart Common Stock were
$0.60, $0.96 and $0.95 in 1995, 1994 and 1993, respectively. Dividends paid in
1994 and 1993 per $3.41 Depositary Share (each representing one-quarter share of
Kmart Series A conversion preferred stock) were $2.56 and $3.41, respectively.
Dividends paid per Kmart Series C convertible preferred share were $11.50 in
1995 and 1994, and $11.50 per Kmart Series B convertible preferred share in
1993.
Total debt as a percentage of total capitalization was 51.9% in 1995, 44.7%
in 1994 and 46.8% in 1993. The increase in 1995 was due to higher levels of
borrowings outstanding under the bank credit facility and real estate related
financing agreements due to repayment restrictions contained in such agreements.
The decrease in 1994 was primarily due to lower levels of debt outstanding and
the reduction of notes payable with cash proceeds received from the OfficeMax
and The Sports Authority IPO's, the sale of the Company's equity interest in
Coles Myer and the divestiture of PayLess.
13
<PAGE> 14
KMART CORPORATION
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation of the Company's consolidated
financial statements and related information appearing in this annual report.
These financial statements have been prepared in conformity with generally
accepted accounting principles on a consistent basis, except for the adoption of
Financial Accounting Standard No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," applying certain
estimates and judgments based upon currently available information and
management's view of current conditions and circumstances. On this basis, we
believe that these financial statements reasonably present the Company's
financial position and results of operations.
To fulfill our responsibility, we maintain comprehensive systems of
internal controls designed to provide reasonable assurance that assets are
safeguarded and transactions are executed in accordance with established
procedures. The concept of reasonable assurance is based upon a recognition that
the cost of the controls should not exceed the benefit derived. We believe our
systems of internal controls provide this reasonable assurance.
The Board of Directors of the Company has an Audit Committee, consisting
solely of outside directors. The duties of the Committee include keeping
informed of the financial condition of the Company and reviewing its financial
policies and procedures, its internal accounting controls and the objectivity of
its financial reporting. Both the Company's independent accountants and the
internal auditors have free access to the Audit Committee and meet with the
Committee periodically, with and without management present.
FLOYD HALL MARTIN E. WELCH III
Chairman of the Board, Senior Vice President
President and Chief Executive Officer and Chief Financial Officer
14
<PAGE> 15
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 operations, of shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Kmart Corporation and its subsidiaries at January 31, 1996 and January 25, 1995,
and the results of their operations and their cash flows for each of the three
years in the period ended January 31, 1996, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the notes to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standard No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," in fiscal 1995.
PRICE WATERHOUSE LLP
Detroit, Michigan
March 7, 1996, except that the
restatement discussed in the
first paragraph of Note 2,
which affects disclosures for
all years presented,
is as of June 5, 1996
15
<PAGE> 16
KMART CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 31, JANUARY 25, JANUARY 26,
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Sales........................................................ $34,389 $32,514 $30,757
Licensee fees and other income............................... 265 286 288
------- ------- -------
34,654 32,800 31,045
------- ------- -------
Cost of merchandise sold, including buying and occupancy
costs...................................................... 26,996 24,868 23,075
Selling, general and administrative expenses................. 7,554 7,376 6,896
Store restructuring and other charges........................ -- -- 1,130
Asset impairment charges..................................... 532 -- --
Gain on pension curtailment.................................. (124) -- --
Interest expense:
Debt, net.................................................. 220 258 284
Capital lease obligations and other........................ 226 235 192
------- ------- -------
35,404 32,737 31,577
------- ------- -------
Income (loss) from continuing retail operations before income
taxes and equity income.................................... (750) 63 (532)
Equity in net income of unconsolidated companies............. 38 52 52
Income tax provision (credit)................................ (222) 11 (192)
------- ------- -------
Net income (loss) from continuing retail operations before
extraordinary items and the effect of accounting changes... (490) 104 (288)
Discontinued operations including the effect of accounting
changes, net of income taxes of $59 and $(49),
respectively............................................... -- 75 (126)
Gain (loss) on disposal of discontinued operations, net of
income taxes of $88, $282 and $(248), respectively......... (30) 117 (521)
Extraordinary items, net of income taxes of $(27) and $(6),
respectively............................................... (51) -- (10)
Effect of accounting changes, net of income taxes of $(36)... -- -- (29)
------- ------- -------
Net income (loss)............................................ $ (571) $ 296 $ (974)
======= ======= =======
Earnings (loss) per common share:
Continuing retail operations............................... $ (1.08) $ .21 $ (.65)
Discontinued operations.................................... -- .16 (.28)
Gain (loss) on disposal of discontinued operations......... (.06) .26 (1.14)
Extraordinary items........................................ (.11) -- (.02)
Effect of accounting changes............................... -- -- (.06)
------- ------- -------
Net income (loss)............................................ $ (1.25) $ .63 $ (2.15)
======= ======= =======
459.9 456.6 456.7
Weighted average shares (millions)........................... ======= ======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
The Consolidated Statements of Operations for prior periods
have been restated for discontinued operations.
16
<PAGE> 17
KMART CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 31, JANUARY 25,
1996 1995
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash (including temporary investments of $637 and $32,
respectively)..................................................... $ 1,095 $ 353
Merchandise inventories.............................................. 6,635 6,853
Other current assets................................................. 1,092 1,204
Net current assets of discontinued operations........................ -- 455
------- -------
Total current assets................................................... 8,822 8,865
Investments in affiliated retail companies............................. 94 108
Property and equipment, net............................................ 5,301 6,011
Other assets and deferred charges...................................... 866 583
Net long-term assets of discontinued operations........................ 314 1,075
------- -------
$15,397 $16,642
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Long-term debt due within one year................................... $ 7 $ 235
Notes payable........................................................ -- 748
Trade accounts payable............................................... 1,993 2,638
Accrued payrolls and other liabilities............................... 1,076 1,158
Taxes other than income taxes........................................ 188 268
Income taxes......................................................... -- 256
------- -------
Total current liabilities.............................................. 3,264 5,303
Capital lease obligations.............................................. 1,629 1,777
Long-term debt and notes payable....................................... 3,935 2,003
Other long-term liabilities............................................ 1,289 1,527
Shareholders' Equity:
Preferred stock, 10,000,000 shares authorized; Series C, 790,287
shares authorized; 658,315 shares issued at January 25, 1995...... -- 132
Common stock, 1,500,000,000 shares authorized; 486,511,184 and
464,549,561 shares issued, respectively........................... 486 465
Capital in excess of par value....................................... 1,624 1,505
Retained earnings.................................................... 3,326 4,074
Treasury shares and restricted stock................................. (92) (86)
Foreign currency translation adjustment.............................. (64) (58)
------- -------
Total shareholders' equity............................................. 5,280 6,032
------- -------
$15,397 $16,642
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
The Consolidated Balance Sheet for the prior period has been restated for
discontinued operations.
17
<PAGE> 18
KMART CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 31, JANUARY 25, JANUARY 26,
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) from continuing retail operations before
extraordinary items and the effect of accounting changes... $ (490) $ 104 $ (288)
Adjustments to reconcile net income (loss) from continuing
retail operations to net cash from operating activities:
Extraordinary item......................................... (51) -- --
Asset impairment charges................................... 532 -- --
Depreciation and amortization.............................. 729 680 626
Cash used for store restructuring and other charges........ (231) (133) (87)
Store restructuring and other charges...................... -- -- 1,130
Deferred income taxes...................................... (9) 40 (252)
Undistributed equity income................................ 14 (15) 7
Other, net................................................. 39 (158) (111)
Increase (decrease) in other long-term liabilities......... (12) 112 72
(Increase) decrease in inventories......................... 236 (628) 448
Increase (decrease) in accounts payable.................... (645) 420 138
Changes in certain assets and liabilities.................. (342) 285 (238)
------ ------- -------
Net cash provided by (used for) continuing retail
operations................................................. (230) 707 1,445
------ ------- -------
Discontinued Operations:
Income (loss) from discontinued operations................. -- 75 (126)
Gain (loss) on disposal of discontinued operations......... (30) 117 (521)
Cash used for discontinued operations...................... (22) (362) (268)
Items not affecting cash, net.............................. 93 (633) 247
------ ------- -------
Net cash provided by (used for) discontinued operations.... 41 (803) (668)
------ ------- -------
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES....... (189) (96) 777
------ ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures....................................... (578) (1,125) (871)
Proceeds from asset sales and subsidiary public
offerings............................................... 1,245 2,431 793
Other, net................................................. (261) (229) (77)
------ ------- -------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES....... 406 1,077 (155)
------ ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt and notes
payable................................................. 1,948 62 644
Reduction in long-term debt and notes payable.............. (985) (515) (928)
Reduction in capital lease obligations..................... (173) (124) (123)
Capital contributions from minority interest............... 15 15 29
Issuance of common stock................................... 3 6 32
Reissuance of treasury shares.............................. -- 23 13
Extraordinary item for bond redemptions.................... -- -- (10)
Dividends paid............................................. (283) (474) (465)
------ ------- -------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES....... 525 (1,007) (808)
------ ------- -------
NET INCREASE (DECREASE) IN CASH.............................. 742 (26) (186)
CASH, BEGINNING OF YEAR...................................... 353 379 565
------ ------- -------
CASH, END OF YEAR............................................ $1,095 $ 353 $ 379
====== ======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
The Consolidated Statements of Cash Flows for prior periods
have been restated for discontinued operations.
18
<PAGE> 19
KMART CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
TREASURY
SERIES B, C SHARES AND
SERIES A AND D PERFORMANCE FOREIGN
CONVERSION CONVERTIBLE CAPITAL IN RESTRICTED STOCK CURRENCY TOTAL
PREFERRED PREFERRED COMMON EXCESS OF RETAINED DEFERRED TRANSLATION SHAREHOLDERS'
STOCK STOCK STOCK PAR VALUE EARNINGS COMPENSATION ADJUSTMENT EQUITY
---------- ----------- ------ ---------- -------- ---------------- ----------- -------------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY
27, 1993........... $ 986 $ 157 $416 $ 506 $5,700 $(124) $(105) $7,536
Net loss for the
year............... (974) (974)
Cash dividends
declared, common,
$.96 per share..... (392) (392)
Cash dividends
declared, $3.41
Depositary Share,
$3.41 per share.... (78) (78)
Cash dividends
declared, Series B
convertible
preferred, $11.50
per share.......... (9) (9)
Minimum pension
liability in excess
of intangible
pension asset...... (10) (10)
Common issued under
stock option
plans.............. 1 14 15
Common issued under
Performance
Restricted Stock
Plan............... 2 (1) 1
Treasury shares
reissued to the
Employee Savings
Plan............... 16 13 29
Foreign currency
translation
adjustment......... (25) (25)
----- ----- ---- ------ ------ ----- ----- ------
BALANCE AT JANUARY
26, 1994........... 986 157 417 538 4,237 (112) (130) 6,093
Net income for the
year............... 296 296
Cash dividends
declared, common,
$.96 per share..... (418) (418)
Cash dividends
declared, $3.41
Depositary Share,
$1.71 per share.... (39) (39)
Cash dividends
declared, Series C
convertible
preferred, $11.50
per share.......... (9) (9)
Decrease in
additional minimum
pension liability
in excess of
intangible pension
asset.............. 7 7
Common issued under
stock option
plans.............. 2 2
Common issued under
Performance
Restricted Stock
Plan............... (1) 3 2
Common issued from
conversion of
Series A conversion
preferred.......... (986) 46 940 --
Common issued from
redemption of
Series C
convertible
preferred.......... (25) 2 23 --
Treasury shares
reissued to the
Employee Savings
Plan............... 3 23 26
Foreign currency
translation
adjustment......... 72 72
----- ----- ---- ------ ------ ----- ----- ------
BALANCE AT JANUARY
25, 1995........... -- 132 465 1,505 4,074 (86) (58) 6,032
Net loss for the
year............... (571) (571)
Cash dividends
declared, common,
$.36 per share..... (165) (165)
Cash dividends
declared, Series C
convertible
preferred, $11.50
per share.......... (6) (6)
Increase in
additional minimum
pension liability
in excess of
intangible pension
asset.............. (6) (6)
Common issued under
Performance
Restricted Stock
Plan............... 1 7 (6) 2
Common issued from
redemption of
Series C and D
convertible
preferred.......... (132) 20 112 --
Foreign currency
translation
adjustment......... (6) (6)
----- ----- ---- ------ ------ ----- ----- ------
BALANCE AT JANUARY
31, 1996........... $ -- $ -- $486 $1,624 $3,326 $ (92) $ (64) $5,280
===== ===== ==== ====== ====== ===== ===== ======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
Common stock, authorized 1,500,000,000 shares, $1 par value.
Preferred stock, authorized 10,000,000 shares, no par value.
19
<PAGE> 20
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Kmart Corporation's ("the Company" or "Kmart") significant accounting
policies, which conform to generally accepted accounting principles applied on a
consistent basis between years, except for the adoption of Financial Accounting
Standard No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("FAS 121"), are described below.
Nature of Operations: The Company's operations consist principally of
discount department stores located in all 50 states, Puerto Rico, the U.S.
Virgin Islands and Guam. Kmart also operates discount stores in Canada, the
Czech and Slovak Republics (see Note 2 of Notes to Consolidated Financial
Statements) and has joint ventures in Mexico and Singapore. Kmart's operations
also include Builders Square, Inc. ("Builders Square"), a chain of home
improvement stores. Kmart's equity investments consist of 49% of substantially
all of the Meldisco subsidiaries of Melville Corporation, which operate the
footwear departments in domestic Kmart stores, and an approximate 46% interest
in Thrifty PayLess Holdings, Inc. ("TPH"), a drugstore chain located in the
western United States (see Note 2 of Notes to Consolidated Financial
Statements).
Basis of Consolidation: Kmart 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
fiscal year-end financial statements. Intercompany transactions and accounts
have been eliminated in consolidation.
Fiscal Year: The Company's fiscal years end on the last Wednesday in
January. Fiscal year 1995 consisted of 53 weeks and ended on January 31, 1996.
Fiscal years 1994 and 1993 each consisted of 52 weeks and ended on January 25,
1995 and January 26, 1994, respectively.
Cash: For the purpose of reporting cash flows, cash includes cash on hand
in stores, deposits in banks, certificates of deposit and short-term marketable
securities with maturities of 90 days or less.
Inventories: Inventories are stated at the lower of cost or market,
primarily using the retail method. As of year end 1995, 1994 and 1993, the
last-in, first-out (LIFO) method, utilizing internal inflation indices, was used
to determine cost for $6,131, $6,518 and $5,874 of inventory, respectively.
Inventories valued on LIFO at year end 1995, 1994 and 1993 were $751, $804 and
$861 lower than amounts that would have been reported using the first-in,
first-out (FIFO) method. The FIFO method was used to determine cost at year end
1995 and 1994 for $504 and $335 of inventory, respectively.
Property and Equipment: Property and equipment are recorded at cost, less
any impairment losses relating to FAS 121, including a provision for capitalized
interest. Capitalized amounts include expenditures which materially extend the
useful lives of existing facilities and equipment. Expenditures for repairs and
maintenance which do not materially extend the useful lives of the related asset
are charged to expense as incurred.
Expenditures for owned properties, primarily self-developed locations,
which Kmart intends to sell and lease-back within one year are included in other
current assets, and those extending beyond one year are included in other assets
and deferred charges.
Depreciation and Amortization: Depreciation and amortization, which
includes amortization of property held under capital leases over the respective
lease terms, are computed based upon the estimated useful lives of the
respective assets using the straight-line method for financial statement
purposes and accelerated methods for tax purposes. The general range of lives is
twenty-five to fifty years for buildings, five to twenty-five years for
leasehold improvements and three to seventeen years for furniture and fixtures.
20
<PAGE> 21
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Financial Instruments: With the exception of long-term debt, shareholders'
equity and equity investments, Kmart records all financial instruments,
including accounts receivable, accounts payable and marketable securities at
cost, which approximates market value.
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.
Licensee Sales: Kmart'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 which operate the
footwear departments in domestic Kmart stores.
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 provides for the future net lease
obligation and nonrecoverable investment in fixed assets directly related to
discontinuance of operations and, prior to 1994, other expenses and estimated
operating losses through the expected closing dates.
Advertising Costs: Advertising costs are expensed the first time the
advertising takes place. Included in selling, general and administrative
expenses for fiscal 1995, 1994 and 1993 are $515, $459, and $449, respectively,
of advertising expenses.
Income Taxes: Deferred income taxes are provided on temporary differences
between financial statement and taxable income. Kmart accrues appropriate U.S.
and foreign taxes payable on all of the earnings of subsidiaries, except with
respect to earnings that are intended to be permanently reinvested, or are
expected to be distributed free of additional tax by operation of relevant
statutes currently in effect and by utilization of available tax credits and
deductions.
Earnings (Loss) Per Common Share: Kmart computes earnings (loss) per common
share by dividing net income (loss) less dividends paid on Series C convertible
preferred stock by the weighted average number of shares of common stock and
dilutive common stock equivalents outstanding ("weighted average common shares")
during each year. As of January 31, 1996, all the outstanding shares of Series C
convertible preferred stock were exchanged for the same number of shares of
Series D convertible preferred stock and all the Series D shares were then
redeemed for shares of Kmart common stock. The redemption of the remaining
outstanding shares of Series D convertible preferred stock had no effect on the
weighted average common shares. In determining the weighted average number of
fully diluted common shares outstanding, the Series A conversion preferred
stock, prior to its conversion into common stock in September 1994, was treated
as common stock.
Use of Estimates: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Reclassifications: Certain reclassifications of prior year amounts have
been made to conform to the 1995 presentation.
2) SUBSEQUENT EVENTS
In April 1996, the Company received $62 from the sale of approximately 30%
of its investment in the common stock of TPH. In conjunction with the sale,
which netted proceeds below the Company's carrying value of the investment, the
Company revalued its remaining investment and recorded a $61 loss in
21
<PAGE> 22
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
discontinued operations, net of income taxes. Subsequent to the first quarter,
the Company sold approximately 3% of its original investment in TPH and received
$8 in net proceeds. As a result of management's intent to dispose of its
remaining interest within a one-year time frame, the Company has accounted for
its investment in TPH and PayLess Drug Stores Northwest, Inc. ("PayLess"), which
was sold to TPH in the first quarter of 1994, as a discontinued operation and
has restated its prior period consolidated financial statements and accompanying
notes.
In March 1996, Kmart entered into an agreement with Tesco PLC ("Tesco") for
the purchase of Kmart's businesses in the Czech and Slovak Republics. Under the
terms of the agreement, Tesco will purchase two companies which operate six
Kmart stores in the Czech Republic and seven stores in the Slovak Republic for
approximately $118, which approximates net book value. The final transaction may
be subject to certain regulatory approvals and is expected to be concluded by
the end of the second quarter of 1996.
3) DISCONTINUED OPERATIONS AND DISPOSITIONS
Discontinued operations include Borders Group, Inc. ("Borders Group"),
OfficeMax, Inc. ("OfficeMax"), The Sports Authority, Inc. ("The Sports
Authority"), Coles Myer, Ltd. ("Coles Myer"), PACE Membership Warehouse, Inc.
("PACE"), TPH, PayLess and Furr's/Bishop ("Furr's") cafeteria chains.
1995 ACTIVITY
Discontinued operations for 1995 include the Borders Group, whose initial
public offering ("IPO") was completed in June 1995. In this IPO, Kmart sold 87%
of its equity interest for net proceeds of approximately $493. Additionally, in
July 1995, the Borders Group agreed to purchase all of Kmart's remaining 13%
interest which resulted in net proceeds of approximately $73. As a result of
these transactions, the Company recorded an aftertax loss of $185.
Also in July 1995, OfficeMax completed the public offering of Kmart's
remaining equity interest in OfficeMax. Kmart received net proceeds of
approximately $360 and recorded an after tax gain of $107.
In October 1995, The Sports Authority completed the public offering of
Kmart's remaining equity interest in The Sports Authority. Kmart received
approximately $151 in net proceeds and recorded an aftertax gain of $48.
As the Company no longer owns any interest in the aforementioned entities,
they are accounted for as discontinued operations in the accompanying financial
statements.
In November 1995, Kmart disposed of the assets of its automotive service
centers at a book value of approximately $84 receiving approximately $50 in cash
and the balance in a five-year interest-bearing note. Under the terms of the
agreement, the centers will continue to operate at Kmart locations in exchange
for various rents and fees for services provided by Kmart. The Company also
disposed of certain Senior Notes of TPH acquired in 1993 in connection with the
sale of PayLess for approximately $102.
1994 ACTIVITY
Discontinued operations for 1994 include OfficeMax, whose IPO was completed
in November 1994. This IPO reduced Kmart's interest in OfficeMax from over 90%
to approximately 25% and resulted in net proceeds of approximately $642. Also,
in November 1994, the IPO of The Sports Authority was completed reducing Kmart's
interest from 100% to approximately 30% and resulted in net proceeds of
approximately $254. These transactions resulted in an after-tax gain of $101.
22
<PAGE> 23
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Additionally, in November 1994, Kmart completed the sale of its 21.5%
equity interest in Coles Myer, an Australian retailer which operates department
and general merchandise stores including certain stores using the "Kmart" name.
Net cash proceeds of $928 were realized from the sale resulting in an after-tax
gain of $48. As part of the transaction, Kmart extended a long-term license
agreement that allows Coles Myer to use the "Kmart" name in Australia and New
Zealand.
In January 1995, Kmart charged $32 to loss on disposal of discontinued
operations for sublease exposure related to lease guarantees on properties
sublet to Furr's, which was sold by Kmart in 1986.
Due to the 1995 completion of the divestitures of the Borders Group,
OfficeMax and The Sports Authority, results of these operations for 1994 and
1993 have been restated and accounted for as discontinued operations. The
results of Coles Myer and the charge for Furr's have also been included as
discontinued operations. Kmart's interest in the results of these operations was
an after-tax gain of $75 during 1994.
1993 ACTIVITY
In January 1994, PACE sold the assets and lease obligations of 93 of its
warehouses and virtually all of the inventory and membership files in the 34
warehouses not included in the transaction to Sam's Club, a division of
Wal-Mart, for approximately $774 in cash. Operations of the 34 remaining PACE
sites not included in the transaction were discontinued, and PACE was
subsequently divested in August 1995. Included in this loss were the write-off
of unamortized goodwill of $395, a provision for the expected remaining lease
obligations in the warehouses not sold, other PACE liabilities and a provision
for additional costs anticipated during the wind-down of PACE operations.
The loss on disposal of discontinued operations in 1993 of $521 includes
the losses on disposal of PACE assets and the divestiture of PayLess. The
operations of these businesses were reclassified to discontinued operations to
reflect their respective plans for disposition. The sale of PayLess was
completed in April 1994 to TPH and its subsidiary Thrifty PayLess, Inc. for
approximately $595 in cash, $100 in Senior Notes of TPH and approximately 46% of
the common equity of TPH.
4) STORE RESTRUCTURING AND OTHER CHARGES
On January 5, 1994 the Kmart Board of Directors approved a restructuring
plan involving domestic and Canadian Kmart stores, Builders Square and the
Walden division of the Borders Group. As a result, in the fourth quarter of
1993, Kmart recorded a pretax charge (Store Restructuring and Other Charges) of
$1,348, $862 after tax. The portion of the charge associated with the Borders
Group, $218 pretax and $139 after tax, has subsequently been restated as
discontinued operations. The remaining restructuring provision included
anticipated costs of $1,130 associated with Kmart stores which were to be closed
and relocated, enlarged or refurbished in the U.S. and Canada and the closing
and relocation of certain Builders Square stores. These costs included lease
obligations for store closings as well as fixed asset write-downs, primarily
furniture and fixtures, and inventory dispositions and related operating losses
for all affected stores. The restructuring provision also included $20 to
increase the reserve for lease obligations for stores closed as part of Kmart's
1989 restructuring plan. Other charges included the estimated costs of $76 for
re-engineering programs (principally severance) and other nonrecurring charges
and an accrual of $12 for a nonroutine legal judgment resulting from the
insolvency of an insurer.
23
<PAGE> 24
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
The following table sets forth the 1993 restructuring plan and related
activity through January 31, 1996:
<TABLE>
<CAPTION>
ACTIVITY TO DATE
---------------------------------------
NONCASH COSTS RESERVE AT
PROVISION CASH COSTS AND ASSET CHANGES IN JANUARY 31,
RECORDED INCURRED WRITE-DOWNS ESTIMATE 1996
-------- ---------- ------------- ---------- -----------
<S> <C> <C> <C> <C> <C>
1993 Restructuring Plan:
Lease obligation costs................... $ 577 $166 $(75)(a) $(57) $429
Asset write-downs........................ 181 -- 201 49 29
Inventory disposition costs and related
operating losses...................... 264 35 159 13 83
Re-engineering and other nonrecurring
charges............................... 76 54 25 12 9
Nonroutine legal accrual................. 12 7 -- (5) --
------ ---- ---- ---- ----
$1,110 $262 $310 $ 12 $550
====== ==== ==== ==== ====
</TABLE>
- -------------------------
(a) Represents $35 and $40 for interest expense accreted during 1995 and 1994 on
discounted lease obligations.
Cash costs incurred for the 1993 restructuring plan of $262, include $177,
$80 and $5 for 1995, 1994 and 1993, respectively. Noncash charges of $310
include $159, $146 and $5 for the same periods, respectively.
Changes in estimate are representative of management's assessment in the
fourth quarter of 1995 and 1994 that, based on actual experiences to date,
certain charges will be higher than originally planned while others will be less
than planned.
Builders Square and Kmart Canada substantially completed their
restructuring plans during 1995. Actual results were in line with the original
reserve of $226 and $39 for Builders Square and Canada, respectively.
The 1989 restructuring plan, with the $20 addition in 1993, included $526
for stores which were closed and relocated, enlarged or refurbished, and through
January 31, 1996, $509 was charged against this reserve. Cash costs relating to
the 1989 restructuring plan were $54, $53 and $82 for 1995, 1994 and 1993,
respectively. There were no noncash charges for 1995 compared to $29 and $137
for 1994 and 1993, respectively.
The restructuring obligation is included primarily in "Other long-term
liabilities" in the Consolidated Balance Sheets.
5) ASSET IMPAIRMENT CHARGES
Kmart adopted Financial Accounting Standard No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("FAS 121") in the fourth quarter of 1995. This statement requires companies to
record impairments of long-lived assets, certain identifiable intangibles, and
associated goodwill on an exception basis, when there is evidence that events or
changes in circumstances have made recovery of an asset's carrying value
unlikely. In conducting its review, management considered, among other things,
its current and expected operating cash flows together with a judgment as to the
fair value the Company could receive upon sale of its investment. Based on this
review, Kmart recorded a $532 pretax charge, $390 after tax, relating to
Builders Square and certain international operations.
6) EXTRAORDINARY ITEMS
The Company entered into agreements whereby holders of approximately $550
of certain real estate related debt agreed to eliminate put features which would
have required Kmart to purchase the debt from the
24
<PAGE> 25
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
holders if Kmart's long-term debt rating was lowered to non-investment grade or
the lowest level of investment grade rating in certain cases. As a result, Kmart
recorded an extraordinary noncash charge of $51, net of income taxes, primarily
relating to make-whole premiums payable under such agreements.
In August 1993, Kmart 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 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, was reported as an extraordinary item.
7) PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
<TABLE>
<CAPTION>
JANUARY 31, JANUARY 25,
1996 1995
----------- -----------
<S> <C> <C>
Property owned:
Land................................................................. $ 153 $ 153
Buildings............................................................ 440 446
Leasehold improvements............................................... 1,438 1,619
Furniture and fixtures............................................... 5,132 5,540
Construction in progress............................................. 78 132
Property under capital leases.......................................... 2,811 3,055
------- -------
10,052 10,945
Less-accumulated depreciation and amortization:
Property owned....................................................... (3,262) (3,426)
Property under capital leases........................................ (1,489) (1,508)
------- -------
Total........................................................... $ 5,301 $ 6,011
======= =======
</TABLE>
Accumulated depreciation for owned property includes $29 and $122 of the
store restructuring provision as of January 31, 1996 and January 25, 1995,
respectively. Interest costs capitalized were $7, $17 and $11 in 1995, 1994 and
1993, respectively.
8) INVESTMENTS IN AFFILIATED RETAIL COMPANIES
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. Fees and income earned
under the license agreements in 1995, 1994 and 1993 of $182, $204 and $195,
respectively, are included in licensee fees and other income. Kmart's equity in
the income of footwear departments in Kmart stores and dividends received were
as follows:
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
Equity in income............................................ $38 $52 $52
=== === ===
Dividends................................................... $52 $38 $55
=== === ===
</TABLE>
25
<PAGE> 26
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Meldisco's summarized financial information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1994 1993
------ ------ ------
<S> <C> <C> <C>
Net sales............................................. $1,141 $1,235 $1,175
====== ====== ======
Gross profit.......................................... $ 487 $ 548 $ 525
====== ====== ======
Net income............................................ $ 79 $ 107 $ 97
====== ====== ======
Inventory............................................. $ 135 $ 148 $ 137
Other current assets.................................. 74 117 85
Non-current assets.................................... 1 2 2
------ ------ ------
Total assets.......................................... 210 267 224
Current liabilities................................... 15 42 30
------ ------ ------
Net assets............................................ $ 195 $ 225 $ 194
====== ====== ======
Equity of Kmart....................................... $ 94 $ 108 $ 94
====== ====== ======
</TABLE>
Unremitted earnings included in consolidated retained earnings were $72,
$86 and $64 at year end 1995, 1994 and 1993, respectively.
9) NOTES PAYABLE, LINES OF CREDIT AND OTHER COMMITMENTS AND CONTINGENCIES
The following table is a summary of annual short-term borrowings:
<TABLE>
<CAPTION>
JANUARY 31, JANUARY 25,
1996 1995
----------- -----------
<S> <C> <C>
Maximum amount outstanding............................... $ 2,660 $ 3,784
Average amount outstanding............................... 1,043 1,915
Amount outstanding at year end........................... -- 748
Weighted average interest rate at year end............... -- 6.1%
Weighted average annual interest rate.................... 6.4% 4.6%
</TABLE>
At January 31, 1996, Kmart had guaranteed lines of credit of which $199 had
been borrowed against to fund certain of Kmart's real estate development joint
ventures. These lines of credit mature February 1997. In addition, Kmart had
guaranteed a line of credit of which $385 had been borrowed against to fund
certain of Kmart's real estate development projects. This line of credit had a
weighted average interest rate at January 31, 1996 of 7.6%. Additional
borrowings in excess of repayments will be conditioned upon the approval of the
banks.
Kmart has outstanding guarantees for leases of certain previously sold
subsidiaries including Furr's, the Borders Group, OfficeMax and The Sports
Authority. Also, Kmart has entered into certain real estate arrangements whereby
Kmart is obligated to purchase completed projects. The aggregate amount
guaranteed was $1,542 at January 31, 1996.
Kmart and Coles Myer have guaranteed indebtedness related to certain
properties in Australia on a joint and several basis. Coles Myer subsequently
indemnified Kmart from any liability incurred pursuant to the Kmart guarantees.
As of January 31, 1996, the amount guaranteed was approximately $18.
Kmart has guaranteed indebtedness of other parties related to certain of
its leased properties financed by industrial revenue bonds. At January 31, 1996,
the total amount of such guaranteed indebtedness was $218, of which $81 was
included in capital lease obligations. The agreements will expire during fiscal
years 2004 to
26
<PAGE> 27
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
2009. Kmart's exposure to credit loss, in the event of nonperformance by the
other parties to the agreements, was $137 at January 31, 1996. However, no
concentration of credit risk exists and Kmart does not anticipate nonperformance
by the other parties.
There are various claims, lawsuits and pending actions against Kmart
incident to its operations. It is the opinion of management that the ultimate
resolution of these matters will not have a material effect on Kmart's
liquidity, financial position or results of operations.
10) LONG-TERM DEBT AND NOTES PAYABLE
Long-term debt and notes payable, net of unamortized discount, is comprised
of the following:
<TABLE>
<CAPTION>
JANUARY 31, JANUARY 25,
1996 1995
----------- -----------
<S> <C> <C>
Notes payable due 1997 (7.76% weighted average interest rate).......... $1,998 $ --
12 1/8% notes due 1995................................................. -- 150
8 1/8% notes due 2006.................................................. 199 199
8 1/4% notes due 2022.................................................. 99 99
12 1/2% debentures due 2005............................................ 100 100
8 3/8% debentures due 2022............................................. 100 100
7 3/4% debentures due 2012............................................. 198 198
7.95% debentures due 2023.............................................. 299 299
Medium-term notes due 1997 through 2020 (8.22% weighted average
interest rate)....................................................... 605 680
Mortgages.............................................................. 301 306
Other.................................................................. 43 107
------ ------
Total............................................................. 3,942 2,238
Portion due within one year............................................ (7) (235)
------ ------
Long-term debt and notes payable....................................... $3,935 $2,003
====== ======
</TABLE>
As of March 7, 1996, Kmart had $1,988 borrowed under its credit facilities.
Additional borrowings in excess of repayments will be conditioned upon the
approval of the banks.
In early 1996, Kmart's long-term senior unsecured debt rating was
downgraded to non-investment grade (BB by Standard and Poor's Corporation and
Ba2 by Moody's Investors Services, Inc.). As a result of the ratings downgrade,
higher interest rates became effective on Kmart's bank debt. Prior to the
downgrade, Kmart had entered into agreements in principle (a) with a group of
debt holders to eliminate put features from approximately $550 of real estate
related debt in exchange for repayment of such debt, including make-whole
premiums on certain debt, in October 1997 or such earlier date as the debt
matures or is refinanced and (b) with its bankers, to modify the terms of
certain of Kmart's credit facilities. The maturities of Kmart's seasonal bank
credit facility and certain of the bank real estate debt were extended to
February 1997, and the maturity of all other bank credit facilities remained at
October 1997. Under the agreements, Kmart is required to maintain $400 in
balances in its cash management system with its credit facility banks. The
current credit agreements contain certain restrictive provisions regarding the
maintenance of net worth and a fixed charge coverage ratio. At January 31, 1996,
Kmart was in compliance with all covenants under these agreements. In addition,
included in the agreements is a prohibition against declaration or payment of
dividends.
Real estate debt in the principal amount of approximately $90 was not
subject to the agreements described in the preceding paragraph and relates to
real estate debt of certain of the Company's former subsidiaries. Of the $90
outstanding, subsequent to year end, $20 was put to the Company and repaid,
along
27
<PAGE> 28
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
with a $3 make-whole premium. Kmart expects to sell and/or remarket such debt to
the former subsidiaries or other third parties. Kmart does not expect that any
losses incurred by it as a result of such repayment will exceed $15, which is
the threshold absent a waiver for an event of default under the agreements
described in the preceding paragraph.
During the first half of 1996, Kmart expects to explore the renegotiation
and/or restructuring of its bank credit facilities to enhance its credit,
liquidity and financial flexibility and to enable Kmart, under its current
forecast, to meet its committed and other capital needs and scheduled debt
repayments throughout 1996 and later years. In that connection, Kmart also
intends to explore other alternatives, including the possible divestiture of
additional non-core assets, sale-leaseback of certain real estate and the sale
of debt or equity securities. There can be no assurance, however, as to Kmart's
ability to effect such modifications in its capital structure or as to the terms
of any such modification.
Kmart's liquidity is presently sufficient, and it remains generally current
with trade vendors, continues to receive and honor usual and customary trade
terms and remains in compliance with all bank covenants. However, should Kmart's
operating performance deteriorate or should providers of goods and services to
Kmart tighten credit terms, Kmart may need to consider alternative sources of
funds, a reduction in capital expenditures or additional restructuring of its
capital structure.
In June 1994, Kmart called for early redemption of all $300 of its 8 3/8%
debentures due January 15, 2017. The resulting redemption premium and associated
cost of $18, net of applicable taxes, has been reported as part of the loss on
disposal of PayLess included in discontinued operations in 1993.
Based on the quoted market prices for the same, or similar issues, or on
the current rates offered to Kmart for debt of the same remaining maturities,
the fair value of long-term debt was $3,462 and $2,106 at January 31, 1996 and
January 25, 1995, respectively.
The principal maturities of long-term debt for years subsequent to 1995
are: 1996-$7, 1997-$2,167, 1998-$94, 1999-$70, 2000-$65 and 2001 and
later-$1,539.
Cash paid for interest, net of amounts capitalized, was $460, $521 and $465
in 1995, 1994 and 1993, respectively.
11) LEASES
Kmart 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 Company the option to extend the life of the lease up to
50 years beyond the initial noncancelable term. Substantially all Builders
Square retail units are leased, generally for terms 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's
leased facilities.
28
<PAGE> 29
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Lease Commitments: Future minimum annual lease payments with respect to
noncancellable capital and operating leases as of January 31, 1996 are
summarized below for the years indicated:
<TABLE>
<CAPTION>
MINIMUM LEASE
PAYMENTS
--------------------
CAPITAL OPERATING
------- ---------
<S> <C> <C>
Fiscal Year:
1996.................................................................... $ 385 $ 591
1997.................................................................... 376 569
1998.................................................................... 361 557
1999.................................................................... 345 540
2000.................................................................... 326 530
Later years............................................................. 2,933 7,261
------- -------
Total minimum lease payments......................................... 4,726 10,048
Less -- minimum sublease rental income.................................... -- (777)
------- -------
Net minimum lease payments................................................ 4,726 $ 9,271
=======
Less:
Estimated executory costs............................................... (1,290)
Amount representing interest............................................ (1,688)
-------
1,748
Portion due within one year............................................... (119)
-------
Long-term lease obligations............................................... $ 1,629
=======
</TABLE>
A summary of operating lease rental expense and short-term rentals is as
follows:
<TABLE>
<CAPTION>
1995 1994 1993
----- ----- ----
<S> <C> <C> <C>
Minimum rentals...................................................... $ 680 $ 691 $602
Percentage rentals................................................... 36 33 40
Less -- sublease rentals............................................. (111) (120) (92)
----- ----- -----
Total................................................................ $ 605 $ 604 $550
===== ===== =====
</TABLE>
Kmart incurred capital lease obligations to obtain store facilities and
equipment of $7, $189 and $177 in 1995, 1994 and 1993, respectively. These
noncash transactions have been excluded from the Consolidated Statements of Cash
Flows.
12) INCOME TAXES
Components of income (loss) from continuing retail operations and equity in
net income of unconsolidated companies before income taxes are as follows:
<TABLE>
<CAPTION>
1995 1994 1993
----- ---- -----
<S> <C> <C> <C>
U.S.................................................................. $(513) $ 89 $(492)
Foreign.............................................................. (199) 26 12
----- ---- -----
Total................................................................ $(712) $115 $(480)
===== ==== =====
</TABLE>
29
<PAGE> 30
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
The provision (credit) for income taxes consists of the following:
<TABLE>
<CAPTION>
1995 1994 1993
----- ---- -----
<S> <C> <C> <C>
Current:
Federal............................................................ $(211) $(48) $ 25
State and local.................................................... 1 6 (5)
Foreign............................................................ (3) 8 26
Deferred:
Store restructuring and other charges.............................. 122 38 (334)
Excess of tax over book depreciation............................... -- 58 81
LIFO inventory..................................................... (13) 14 68
Property taxes..................................................... 17 13 (16)
Pension funding.................................................... 29 (22) (3)
Inventory reserve.................................................. -- (34) --
Fixed asset impairment............................................. (199) -- --
Valuation allowance................................................ 57 -- --
Tax credits........................................................ (29) -- --
Other.............................................................. 7 (22) (34)
----- ---- -----
Total income taxes................................................... $(222) $ 11 $(192)
===== ==== =====
</TABLE>
A reconciliation between the federal statutory income tax rate to Kmart's
effective tax rate is shown below stated as a percent of income (loss) from
continuing retail operations and equity in net income of unconsolidated
companies:
<TABLE>
<CAPTION>
1995 1994 1993
----- ----- -----
<S> <C> <C> <C>
Provision (credit) at federal statutory rate %........................ (35.0) 35.0 (35.0)
State and local taxes, net of federal tax benefit..................... 0.1 3.7 (2.1)
Tax credits........................................................... (1.1) (9.5) (1.5)
Equity in net income of affiliated retail companies subject to lower
tax rates........................................................... (1.5) (12.7) (2.8)
Enacted federal tax rate change....................................... -- -- 3.3
Valuation allowance................................................... 8.1 -- --
Tax rate differential in international................................ (2.1) 1.2 (0.2)
ESOP dividend......................................................... (0.5) (4.4) (1.0)
Other................................................................. 0.8 (3.7) (0.7)
----- ----- -----
Effective tax rate %.................................................. (31.2) 9.6 (40.0)
===== ===== =====
</TABLE>
30
<PAGE> 31
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Deferred tax assets and liabilities which are included in the accompanying
consolidated balance sheets are comprised of the following:
<TABLE>
<CAPTION>
JANUARY 31, JANUARY 25,
1996 1995
----------- -----------
<S> <C> <C>
Deferred tax assets:
Federal benefit for state and foreign deferred....................... $ 32 $ 35
Discontinued operations.............................................. 93 199
Accruals and other liabilities....................................... 202 200
Capital leases....................................................... 140 145
Store restructuring obligations...................................... 238 396
Other................................................................ 122 56
---- ------
Total deferred tax assets....................................... 827 1,031
---- ------
Deferred tax liabilities:
Inventory............................................................ 236 283
Property and equipment............................................... 370 542
Valuation allowance.................................................. 57 --
Other................................................................ 86 58
---- ------
Total deferred tax liabilities.................................. 749 883
---- ------
Net deferred tax assets......................................... $ 78 $ 148
==== ======
</TABLE>
Kmart has not recorded deferred income taxes applicable to undistributed
earnings of foreign subsidiaries that are indefinitely reinvested in foreign
operations. Undistributed earnings totaled $7, $181 and $189 at year end 1995,
1994, and 1993, respectively.
The Company has available alternative minimum tax credit carryforwards of
approximately $54 which may be carried forward indefinitely.
Cash paid for income taxes was $80, $83 and $270 in 1995, 1994 and 1993,
respectively.
Effective in the first quarter of 1993, Kmart adopted Financial Accounting
Standard No. 109 "Accounting for Income Taxes" ("FAS 109"). FAS 109 is an asset
and liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in a company's financial statements or tax returns. In estimating
future tax consequences, FAS 109 generally considers all expected future events
other than enactment of changes in the tax law or rates. The adoption of FAS 109
resulted in the recording of a one-time credit, as the cumulative effect of an
accounting change, of $49 in the first quarter of 1993.
13) SHAREHOLDERS' EQUITY
In August 1991, Kmart 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. In September 1994, each of the outstanding Depositary
Shares automatically converted into two shares of Kmart common stock.
In October 1992, Kmart issued 784,938 shares of Series B convertible
preferred stock in exchange for all the outstanding stock of Borders, Inc. In
July 1994, all outstanding shares of Series B convertible preferred stock were
exchanged for the same number of shares of Series C convertible preferred stock.
As of January 31, 1996, all of the outstanding shares of Series C convertible
preferred stock were exchanged for the same number of shares of Series D
convertible preferred stock and all the Series D shares were then redeemed for
shares of Kmart common stock.
31
<PAGE> 32
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Common and treasury shares outstanding and related changes for year end
1995, 1994 and 1993, are as follows:
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Common Shares:
Beginning of the year............................... 464,549,561 416,546,780 415,640,206
Sold under stock option plans....................... 292,715 237,230 791,425
Issued under performance restricted stock plan...... 504,635 95,162 192,526
Issued under directors stock plan................... 9,472 2,518 1,950
Common issued from conversion of Series A conversion
preferred........................................ -- 46,000,000 --
Common issued from redemption of Series C and D
convertible preferred............................ 21,313,503 1,874,799 --
Forfeited or withheld under performance restricted
stock plan....................................... (36,565) (178,255) (28,955)
Retirement of shares, at cost....................... (122,137) (28,673) (50,372)
----------- ----------- -----------
End of the year..................................... 486,511,184 464,549,561 416,546,780
=========== =========== ===========
Treasury Shares:
Beginning of the year............................... 5,882,487 7,468,564 8,756,822
Reacquisition of shares............................. 219 -- --
Reissue of shares for the retirement savings plan... -- (1,586,077) (1,288,258)
----------- ----------- -----------
End of the year..................................... 5,882,706 5,882,487 7,468,564
=========== =========== ===========
</TABLE>
14) PENSION PLANS
Prior to 1996, U.S. Kmart and Builders Square had defined benefit pension
plans covering eligible associates who meet certain requirements of age, length
of service and hours worked per year. Effective January 31, 1996, the pension
plans were frozen and associates no longer earn additional benefits under the
plans. Benefits paid to retirees are based upon age at retirement and years of
credited service and earnings as of January 31, 1996. Kmart Canada Limited
associates are covered by a defined contribution plan. Kmart'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
contributed $6 and $64 to its principal pension plan during fiscal 1995 and
1994, respectively, but was not required to contribute to its principal pension
plan in fiscal 1993. The total consolidated pension expense was $44, $81 and $66
in 1995, 1994 and 1993, respectively.
As a result of freezing the plans, the Company recorded a pretax net
pension curtailment gain of $124 in the first quarter of 1995.
32
<PAGE> 33
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
For Kmart's pension plans, the following tables summarize the funded
status, components of pension cost and actuarial assumptions:
<TABLE>
<CAPTION>
JANUARY 31, 1996 JANUARY 25, 1995
----------------------------- -----------------------------
EMPLOYEE NON-QUALIFIED EMPLOYEE NON-QUALIFIED
PENSION PLAN PLANS PENSION PLAN PLANS
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Actuarial value of benefit obligations:
Estimated present value of vested
benefits............................... $ (1,742) $ (36) $ (1,379) $ (29)
Estimated present value of non-vested
benefits............................... (127) (1) (140) (1)
--------- ------ --------- ------
Accumulated benefit obligation............ (1,869) (37) (1,519) (30)
Value of future pay increases............. -- -- (189) (4)
--------- ------ --------- ------
Projected benefit obligation.............. (1,869) (37) (1,708) (34)
Estimated market value of plan assets....... 1,778 -- 1,462 --
--------- ------ --------- ------
Plan assets under projected benefit
obligation................................ (91) (37) (246) (34)
Unrecognized net asset...................... (89) -- (97) 3
Unrecognized prior service cost............. -- -- 38 4
Unrecognized net loss and other............. 85 10 112 7
Adjustment required to recognize minimum
liability................................. -- (9) -- (10)
--------- ------ --------- ------
Accrued pension costs....................... $ (95) $ (36) $ (193) $ (30)
========= ====== ========= ======
</TABLE>
<TABLE>
<CAPTION>
1995 1994 1993
----- ----- -----
<S> <C> <C> <C>
Components of pension cost:
Normal service cost................................................ $ 51 $ 77 $ 65
Interest cost on projected benefit obligation...................... 136 140 132
Return on plan assets.............................................. (378) 30 (159)
Net amortization and deferral of other components.................. 233 (167) 27
----- ----- -----
Total................................................................ $ 42 $ 80 $ 65
===== ===== =====
Actuarial assumptions at end of year:
Discount rates..................................................... 7.25% 8.25% 7.25%
Expected return on plan assets..................................... 9.50% 9.50% 9.50%
Salary increases................................................... 4.50% 4.50% 4.50%
</TABLE>
Under the provisions of Financial Accounting Standard No. 87 ("FAS 87"),
"Employers' Accounting for Pensions," Kmart is required to record an unfunded
pension liability when the accumulated benefit obligation exceeds plan assets.
This liability is partially offset by an intangible pension asset, with the
intangible asset being limited to the amount of unrecognized prior service cost,
including unamortized transition obligation. At January 31, 1996, the unfunded
pension liability exceeded the intangible pension asset by $9. FAS 87 requires
this excess to be recorded as a reduction in shareholders' equity.
15) OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS
Kmart adopted Financial Accounting Standard No. 106 "Employers' Accounting
for Postretirement Benefits Other Than Pensions" ("FAS 106") at the beginning of
1993. This statement requires Kmart to accrue for future postretirement medical
benefits. In prior years, these claims were expensed when paid. As a result of
adopting FAS 106, Kmart recorded an after tax charge of $78, as the cumulative
effect of an accounting change, in 1993.
33
<PAGE> 34
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Kmart sponsors a health care plan that offers postretirement continuation
of medical benefits to full-time associates who have worked 10 years and who
have retired after age 55, with the option of participation in Kmart's medical
plan, until age 65. The plan is contributory, with retiree contributions
adjusted annually.
The accounting for the plan anticipates future cost-sharing changes to the
written plan that are consistent with Kmart's expressed intent to increase the
retiree contribution rate annually for the expected inflation rate for that
year. The accrued postretirement benefit costs under FAS 106 were $104 and $107
at January 31, 1996 and January 25, 1995, respectively.
16) RETIREMENT SAVINGS PLAN
The Retirement Savings Plan provides that associates of Kmart and certain
subsidiaries who have completed one year of service can invest from 1% to 16% of
their earnings in the associate's choice of a growth equity fund, an
international equity fund, a core equity fund, a balanced equity fund, a managed
income fund, a Kmart common stock fund or a choice of three pre-mixed portfolio
funds. For each dollar the participant contributes, up to 6% of earnings, Kmart
will contribute an additional 50 cents which is invested in the Employee Stock
Ownership Plan (ESOP). Effective January 1, 1995, a new profit sharing program
was introduced as part of the Retirement Savings Plan. The Company makes all
contributions based on profits, with minimum yearly contributions required of
$32. Kmart's expense related to the Retirement Savings Plan was $73 for 1995 and
$46 for 1994 and 1993.
17) PERFORMANCE RESTRICTED STOCK PLAN
Under the Performance Restricted Stock Plan, the Compensation and
Incentives Committee of the Board of Directors may grant awards of common stock
to officers and other key employees of Kmart and its subsidiaries. As of January
31, 1996, there were awards for 3,000,000 shares outstanding and shares
available for grant of 442,100. Kmart recorded $(1), $1 and $3 of compensation
expense related to the Performance Restricted Stock Plan in 1995, 1994 and 1993,
respectively.
18) 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 and its subsidiaries at no less than 100% of the fair market
value of the common stock on the date of grant. Such options may be either
incentive stock options (ISO's) 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 ten years and two days (NQSO's). 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.
Twenty million shares of common stock were authorized for issuance under
the 1992 Stock Option Plan. Payment upon exercise of an option may be made in
cash, already owned shares or a combination of both according to the terms of
the Plan.
34
<PAGE> 35
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Pertinent information covering the Plans follows:
<TABLE>
<CAPTION>
1995 1994
--------------------------- --------------------------
NUMBER OPTION PRICE NUMBER OPTION PRICE
OF SHARES PER SHARE OF SHARES PER SHARE
---------- ------------- ---------- ------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year......... 23,210,037 $ 9.90-$26.03 22,095,167 $9.90-$26.03
Granted.................................. 4,961,900 $ 6.31-$15.44 3,325,500 $18.88
Exercised................................ (292,715) $10.94 (237,230) $9.90-$20.66
Canceled................................. (1,412,932) $10.94-$26.03 (1,973,400) $9.90-$26.03
---------- ----------
Outstanding at end of year............... 26,466,290 $ 6.31-$26.03 23,210,037 $9.90-$26.03
========== ==========
Exercisable at end of year............... 16,151,681 $17.16-$26.03 15,357,537 $9.90-$23.03
========== ==========
Available for grant at end of year....... 11,436,791 12,072,800
========== ==========
</TABLE>
In October 1995, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("FAS
123") which is effective for fiscal years beginning after December 15, 1995. As
permitted by FAS 123, the Company has elected to continue to account for its
stock-based plans under APB No. 25, "Accounting for Stock Issued to Employees".
19) BUSINESS GROUP INFORMATION
Kmart's consolidated operations consist primarily of the operation of
general merchandise, discount retail stores under the Kmart name in the United
States. Operations also include a chain of home improvement stores operated
under the name Builders Square. The results of operations for PayLess, which was
sold to TPH in the first quarter of 1994, are included as continuing retail
operations in the consolidated financial statements, on a fully consolidated
basis, for 1993. The results of operations for the Borders Group, OfficeMax and
The Sports Authority, for which public offerings were completed in 1995, are
included as discontinued operations. Business group information follows:
<TABLE>
<CAPTION>
INCOME (LOSS)
EQUITY IN NET FROM CONTINUING CAPITAL
OPERATING INCOME OF NET RETAIL OPERATIONS DEPRECIATION EXPENDITURES
INCOME UNCONSOLIDATED INTEREST BEFORE INCOME AND -- OWNED AND
YEAR SALES (LOSS)(a) COMPANIES EXPENSE TAXES(B) AMORTIZATION LEASED(C)
---- ------- --------- -------------- ------- ----------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
General
Merchandise:........ 1995 $31,713 $ 83 $ 38 $(434) $(313) $689 $ 547
1994 29,563 528 52 (478) 102 641 1,182
1993 28,038 110 52 (467) (305) 591 936
Builders Square:...... 1995 2,676 (387) -- (12) (399) 40 38
1994 2,951 28 -- (15) 13 39 132
1993 2,719 (166) -- (9) (175) 35 112
Total Kmart:.......... 1995 34,389 (304) 38 (446) (712) 729 585
1994 32,514 556 52 (493) 115 680 1,314
1993 30,757 (56) 52 (476) (480) 626 1,048
</TABLE>
- -------------------------
(a) Operating income (loss) for 1995 includes charges of $162, $370 and $532
related to the adoption of FAS 121 regarding the accounting for impairment
of long-lived assets for General Merchandise, Builders Square and Kmart,
respectively. Operating income (loss) for 1993 includes store restructuring
and other charges of $904, $226 and $1,130 for General Merchandise, Builders
Square and Kmart, respectively. Operating income also includes corporate
expense of $40 and $41 for 1994 and 1993, respectively. Corporate expenses
were not significant in 1995.
(b) Including equity in net income of unconsolidated companies.
(c) Leased asset additions for Kmart were $7, $189 and $177 for 1995, 1994 and
1993, respectively.
35
<PAGE> 36
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
INVESTMENTS IN
AFFILIATED
IDENTIFIABLE RETAIL DISCONTINUED TOTAL
YEAR ASSETS COMPANIES OPERATIONS ASSETS
---- ------------ -------------- ------------ -------
<S> <C> <C> <C> <C> <C>
General Merchandise:........................ 1995 $ 13,969 $ 94 $ 7 $14,070
1994 13,717 108 76 13,901
Builders Square:............................ 1995 1,013 -- -- 1,013
1994 1,211 -- -- 1,211
Divested/Discontinued Specialty
Retail Businesses:........................ 1995 -- -- 314 314
1994 -- -- 1,530 1,530
Total Kmart:................................ 1995 14,982 94 321 15,397
1994 14,928 108 1,606 16,642
</TABLE>
36
<PAGE> 37
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
20) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Each of the quarters includes 13 weeks, except for the fourth quarter of
1995 which includes 14 weeks. Earnings per share amounts for each quarter are
required to be computed independently and may not equal the amount computed for
the total year.
<TABLE>
<CAPTION>
QUARTER
-------------------------------------
FIRST SECOND THIRD FOURTH
------ ------ ------ -------
<S> <C> <C> <C> <C>
1995
Gross revenue from continuing retail operations.......... $7,443 $8,440 $7,975 $10,531
Cost of merchandise sold................................. $5,788 $6,544 $6,286 $ 8,378
Net income (loss) from continuing retail operations
before extraordinary item............................. $ (25) $ 22 $ (118) $ (369)
Discontinued operations, net of income taxes............. (3) 1 1 1
Gain (loss) on disposal of discontinued operations, net
of income taxes....................................... -- (77) 48 (1)
Extraordinary item, net of income taxes.................. -- -- -- (51)
------ ------ ------ -------
Net loss................................................. $ (28) $ (54) $ (69) $ (420)
====== ====== ====== =======
Earnings (loss) per common share:
Continuing retail operations.......................... $ (.06) $ .05 $ (.26) $ (.80)
Gain (loss) on disposal of discontinued operations.... -- (.17) .11 --
Extraordinary item.................................... -- -- -- (.11)
------ ------ ------ -------
Net loss................................................. $ (.06) $ (.12) $ (.15) $ (.91)
====== ====== ====== =======
Common stock price range (calendar quarters):
High.................................................. $14 3/8 $15 3/8 $16 1/4 $14 1/2
Low................................................... 12 12 5/8 13 5/8 6
Dividends paid per common share (calendar quarters)...... .24 .12 .12 .12
1994
Gross revenue from continuing retail operations.......... $6,913 $7,942 $7,783 $ 9,876
Cost of merchandise sold................................. $5,153 $5,963 $5,883 $ 7,869
Net income (loss) from continuing retail operations...... $ 14 $ 85 $ 21 $ (16)
Discontinued operations, net of income taxes............. 4 9 18 44
Gain on disposal of discontinued operations, net of
income taxes.......................................... -- -- -- 117
------ ------ ------ -------
Net income............................................... $ 18 $ 94 $ 39 $ 145
====== ====== ====== =======
Earnings (loss) per common share:
Continuing retail operations.......................... $ .03 $ .18 $ .04 $ (.04)
Discontinued operations............................... .01 .02 .04 .09
Gain on disposal of discontinued operations........... -- -- -- .26
------ ------ ------ -------
Net income............................................... $ .04 $ .20 $ .08 $ .31
====== ====== ====== =======
Common stock price range (calendar quarters):
High.................................................. $21 1/2 $18 5/8 $18 5/8 $17 3/4
Low................................................... 17 7/8 15 15 3/4 12 3/4
Dividends paid per common share (calendar quarters)...... .24 .24 .24 .24
</TABLE>
37
<PAGE> 38
KMART CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Kmart implemented a new inventory accounting system in 1995 which provides
more precise, detailed departmental information by store. This system results in
a more accurate valuation of inventories and the recording of gross profit
margins during interim periods in a manner consistent with that used to value
inventory at year end. The use of this more precise interim information had no
effect on annual results. However, gross profits reported during each of the
first three quarters of fiscal 1995 were lower than those that would have been
reported using the prior method, with an equivalent positive effect in the
fourth quarter. The new inventory accounting system contributed to approximately
1.3%, 0.2% and 0.5%, as a percentage of sales, of the U.S. Kmart gross margin
decline in the first, second and third quarters of 1995, respectively, and 1.5%,
as a percentage of sales, of the U.S. Kmart gross margin increase in the fourth
quarter of 1995.
The first quarter of 1995 included a $124 pretax net pension curtailment
gain resulting from the decision to replace the defined benefit pension plans
with a profit sharing program. The fourth quarter of 1995 included a pretax
provision of $532 related to the adoption of FAS 121.
The fourth quarters of 1995 and 1994 included LIFO credits of $43 and $57,
respectively. Also, the fourth quarter of 1994 included provisions for inventory
markdowns and shrinkage aggregating $188 and charges totaling $61 for closings
of regional offices and the Kmart Fashions division headquarters, the
cancellation of certain real estate projects and the sale of corporate aircraft.
Previously published quarterly financial data have been restated for
discontinued operations.
In December 1995, the common stock dividend was eliminated.
As of January 31, 1996, there were 94,656 Kmart shareholders of record.
Kmart common stock is listed on the New York, Pacific and Chicago stock
exchanges (trading symbol KM).
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