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Quality breakdown of Kmart, from the New York Times:
January 22, 2002

Kmart Files for Bankruptcy

By STEPHANIE STROM and LESLIE KAUFMAN

he Kmart Corporation (news/quote), the nation's third-largest discount retailer, filed for bankruptcy protection today after weak holiday sales and tough competition from Wal-Mart (news/quote) and other rivals depleted the company's cash.

The move ranks as the largest-ever retail bankruptcy proceeding, a record previously held by Federated Department Stores (news/quote) and a sister company, Allied Stores, which filed in 1990.

The bankruptcy filing comes a day after the Fleming Companies (news/quote), a major food distributor and grocery wholesaler, halted shipments to Kmart after the company failed to make its weekly payment. But Kmart's troubles had been mounting for some time, with holiday sales coming in at the low end of what the company had expected and with a longer-term strategy of low pricing that hurt revenue.

The company acknowledged those difficulties today, saying that its decision to seek Chapter 11 bankruptcy reorganization was based on a combination of factors, including a rapid decline in its available cash after its weak fourth-quarter sales and "an erosion of supplier confidence." It also cited the intense competition among discount retailers and the continuing recession.

Kmart, which is based in Troy, Mich., said that its 2,100 stores would continue to operate as it restructured its business and that it had secured $2 billion in debtor-in-possession financing from Credit Suisse First Boston, Fleet Retail Finance, General Electric (news/quote) Capital and J.P. Morgan Chase (news/quote).

The company projected that it would emerge from bankruptcy protection in 2003. It filed for Chapter 11 protection in federal bankruptcy court in Chicago.

"We are committed and determined to complete our reorganization as quickly and as smoothly as possible, while taking full advantage of this chance to make a fresh start and reposition Kmart for the future," said Charles C. Conaway, the company's chief executive

"We deeply regret any adverse effect today's action will have on our associates, vendors and business partners," he said in a statement. "I also regret the impact of our filing on all Kmart shareholders, including many of our associates. But after considering a wide range of alternatives, it became clear that this course of action was the only way to truly resolve the company's most challenging problems."

Mr. Conaway added, "I am confident that, with our tremendous resources and dedicated supplier and associate communities, Kmart will emerge from this process as a stronger, more dynamic, more profitable enterprise with a well-defined position in the discount retail sector."

Shares of Kmart plunged more than 60 percent, or $1.05, to close at 69 cents on the New York Stock Exchange today. In contrast, the company's stock traded at a 52-week high of $13.55 in August.

A critical question for the retailer is whether Martha Stewart, its most important and visible supplier, will continue to supply the stores with her line of housewares.

Oddly, the spectacular failure of the Enron Corporation (news/quote), already the largest corporate bankruptcy ever, may have had as much to do with Kmart's failure as skittish suppliers and hard-nosed bankers.

Kmart relies on surety bonds, essentially agreements by insurance companies to continue financing in case of a default, to back its workers' compensation program and to cover liabilities arising from its sales of guns and liquor, advisers and executives close to the company said.

Enron depended on such bonds, too, and after it went bankrupt, leaving insurance companies to cover its liabilities, insurers drastically raised prices for surety bonds. In Kmart's case, insurers were requiring cash collateral for the securities.

That placed a large, unanticipated drain on Kmart's cash flow that, coupled with supplier demands for payment on delivery and the company's weak performance during the crucial holiday period, drove it to seek court protection.

"Their cash-flow model for post-Christmas would have been fine — until Enron scared every last living person in finance out of their wits," one adviser said.

Even though Kmart drew down a $1.5 billion credit line just after the holidays, the demands on its cash were too great.

Kmart's inability to pay Fleming, one of its biggest and most loyal suppliers, $78 million to cover its bill shows how desperate its position has become, said Walter F. Loeb, a long-time retail consultant. "They're now starved for food, so to speak, and that can't go on for more than two or three days," he said. "They have no money, and it's hard to see what other choice they have."

Fleming's demand for payment also demonstrates how worried one critical Kmart distributor has become. Kmart represents 27 percent of Fleming's sales, and Fleming had committed to building three warehouses to service Kmart. Suppliers hate to alienate such a major customer. "Fleming probably shipped to Kmart longer than most," said one executive close to the company.

The two companies are also related through Ronald W. Burkle, an investor who holds big stakes in both Kmart and Fleming and brokered their relationship.

Fleming is regarded as a smart operator in the investment community, but its shares have plummeted as speculation about Kmart's problems have mounted. "Fleming is working with Kmart as they navigate through their current financial problems, and we intend to resume delivery of food and other consumable products to Kmart upon receiving satisfactory assurance of Kmart's performance," Neal Rider, Fleming's chief financial officer, said in a statement. "We are also taking the appropriate steps to protect Fleming's interest."

Kmart has been on the ropes on and off for more than a decade, partly crushed by ferociously efficient competitors like Wal-Mart and Target, and partly a victim of its own missteps, like stocking dowdy fashions and being slow to invest in computer technologies that others, especially Wal-Mart, have exploited.

In fact, Kmart was near filing for bankruptcy in the mid-1990's, when it was losing money because its stores were outdated and because acquisitions of unrelated businesses like Office Max and Borders books had stretched its resources. Under shareholder pressure, Kmart saved itself then by spinning off several units, including Borders, the Sports Authority and other specialty retail units, and replacing its long-time chief executive, Joseph Antonini.

But to no avail — competitors kept coming. Wal-Mart, which was dwarfed by Kmart in its 1970's heyday, is now nearly five times larger. And Target, regarded as having the most fashionable merchandise among the discounters, just replaced Kmart as the nation's second-largest discounter.

Kmart's board fought hard to avoid a bankruptcy filing in recent weeks. The company's directors pressed management and its advisers last week to come up with alternatives to keep Kmart out of the courts, even though Mr. Conaway had argued that bankruptcy was the company's best option.

Credit rating agencies had been downgrading the retailer's debt. Banks including J. P. Morgan Chase and FleetBoston (news/quote), as well as lenders like the General Electric Capital Corporation, were negotiating with the company in the last week about various types of financing.

Kmart has secured the services of Henry S. Miller, the head of Dresdner Kleinwort Wasserstein's restructuring practice, as its bankruptcy adviser. Jack Butler, a partner at Skadden, Arps, Slate, Meagher & Flom, who has represented the company for the last several years, will act as the company's lawyer.

Investors became increasingly worried about Kmart after the company's board held a marathon 36-hour meeting spanning Jan. 7 and 8, only to issue no public statements about the outcome of the meeting for 48 more hours. When Kmart finally did talk last Thursday, it merely announced a series of high-level executive changes and said it would review its liquidity and continue discussions about financing.

James B. Adamson, an outside director with firsthand experience in managing distressed companies, became Kmart's chairman. And Mark S. Schwartz, who had been brought in with much fanfare from Wal-Mart to resuscitate Kmart's fortunes even though he was credited with the failure of two other retailers, Big V Supermarkets and Hechingers-Builders Square II, was dismissed as president.

That did little, however, to calm the fears of the company's suppliers and financiers. Mr. Adamson, who is chairman of the Advantica Restaurant Group (news/quote), which operates Denny's and other restaurant franchises, joined Kmart's board in 1996, and although he worked wonders to bring Revco out of bankruptcy, critics complain that he has not helped Kmart avoid it.

Mr. Adamson is expected to bring in a colleague who has worked with him at Advantica as Kmart's chief restructuring officer to work alongside Mr. Conaway, an adviser said.

While the board shuffled management last week, banks led by J. P. Morgan Chase worked feverishly to cobble together $2 billion to $3 billion in asset-backed financing for Kmart.

One investor was told that the bank had offered Kmart two choices. It could file for court protection to secure that money, or it could stay out of bankruptcy and take a smaller loan of $750 million to $1.2 billion.

The terms of that loan would have placed J. P. Morgan first in line to recover not only that money but also the $1.5 billion it was owed after Kmart drew down its credit line after the holidays. In bankruptcy, however, J. P. Morgan will have the same standing as bondholders, who are owed some $4.5 billion, and trade creditors, who are owed $2 billion to $3 billion.

An executive close to the talks said Kmart had hoped to arrange financing that would keep it out of bankruptcy. "But in a situation like this, you need to file as quickly as possible so that suppliers start shipping again," he said.

Kmart's problems have mounted over the last three decades, and a quick fix is not likely — nor is a strategy for a turnaround clear. Several regional discounters have either gone out of business or sought court protection at least twice.