K-Mart & Chapter 11

A Chapter 11 bankruptcy allows a business, Kmart in this case, to attempt to stay in business while a bankruptcy court supervises the reorganization of the company’s obligations. With chapter 11, the court can grant either partial or complete relief from the company’s current debts and contracts allowing the company to attempt to make a fresh start. What happens often if the company’s debts exceed their assets, the company’s owners or stockholders will receive nothing. The company’s creditors would then end up with ownership of the company once it reorganizes (U.S., 2007).

Kmart had been struggling for awhile with sluggish sales and competition with Wal-Mart and Target. Kmart was hoping the holiday season of 2001 would improve their financial situation and held off filing for Chapter 11 bankruptcy to see how much financial improvement they would see after the holidays. However, they were to have a disappointing end-of-year holiday season which didn’t help their situation. Kmart failed to pay its top food provider, Fleming Companies Inc. $78 million (Kmart, 2002). Therefore Fleming Companies only left the perishable items it was delivering to Kmart and didn’t unload the rest of K-Marts shipment.

Kmart then began closing its weakest stores. Kmart Corporation filed for Chapter 11 bankruptcy on January 22, 2002 in the United States Bankruptcy Court, Northern District of Illinois, Eastern pision, Docket No. 02-02474 (Kmart, 2002). Its stock plunged nearly 60% on this day and their stocks closed at 70 cents. Kmart chose the Chapter 11 bankruptcy route hoping it would buy the company enough time to get the company reorganized and hopefully “on the road to visibility” by 2003 (Buy, 2002).

Kmart listed its assets when filing for bankruptcy to be $16.3 billion, with $10.3 billion in total debts (CNN, 2002). This figure makes Kmart the largest the largest retailer to declare bankruptcy. This filing wasn’t at all surprising to analysts at the time who had been predicting Kmart would file for bankruptcy. Kmart has been making almost $40 billion a year in sales. As of the end of 2001 Kmart had approximately 275,000 employees in its 2,105 stores. The restructuring affected over 60,000 employees and about 1,000 management personnel (Iwata, 2002).

Kmart had announced that it will fund its turnaround with the $2 billion “senior secured debtor-in-possession (DIP)” financing it secured in financing from J.P. Morgan Chase Bank, General Electric Capital Corp., Credit Suisse First Boston and Fleet Retail Finance Inc (Kmart, 2002). Although the financing was subject to bankruptcy court approval, it helped Kmart’s cash flow while Kmart went through the process of restructuring (Kmart, 2002).

By mid-January 2002, ratings agencies downgraded Kmart’s credit, Kmart’s stock plunged and its stock was removed from Standard & Poor’s benchmark index of 500 leading stocks. Kmart is the largest retailer in history to seek court protection from creditors (Kmart, 2002).

The U.S. Trustee which represents the “bankruptcy arm” of the Justice Department, appointed committees to represent the interests of Kmart’s creditors and stockholders to work with Kmart in developing a reorganization plan that would allow them to get out of debt (World, 2002). They had to create a plan that would be acceptable to Kmart’s creditors, bondholders, stockholders while at the same time confirmed by the court. However, the court has the power to disregard the vote of Kmart’s creditors and stockholders and confirm Kmart’s plan if the court finds that the plan treats creditors and stockholders fairly.

Once Kmart’s reorganization plan is confirmed, another more detailed report which must contain a summary of the reorganization plan must be filed with the U.S. Securities and Exchange Commission on Form 8-K. Sometimes a company attaches a copy of its complete reorganization plan (U.S., 2007.)

Not surprising, stock of companies in Chapter 11 is considered to be extremely risky and can lead to financial loss. In the U.S. Securities and Exchange Commission webpage, it states, “although a company may emerge from bankruptcy as a viable entity, generally, the creditors and the bondholders become the new owners of the shares” (U.S., 2007).

Wall Street analysts felt the Chapter 11 filing was a good move for Kmart since it ended weeks of speculation of the company’s future and allowed Kmart to “repair its relationships with vendors, making itself more competitive” (CNN, 2002).

Chapter 11 bankruptcy allows the filer, or in this case Kmart to re-organize its business while attempting to become profitable. Although Kmart continues to run its day-to-day business operations, the bankruptcy court must approve all of the company’s significant business decisions. Kmart’s securities can continue to be traded even after it files for bankruptcy under Chapter 11. There currently is no federal law that prohibits trading of securities of companies in bankruptcy.

Kmart continued to honor all credit cards, gift certificates and store credits. Because Kmart’s pension and savings plans are independent of Kmart, the company said they would continue to be administered as usual (CNN, 2002). Kmart’s vendors, suppliers and business partners will be paid under normal terms for all goods and services they provide to Kmart during its reorganization.

According to Hoover’s Handbook of American Business, “Kmart has been difficult to turn around” (Hoover’s 2007). Kmart has since had numerous reorganization efforts, new store concepts, expanded selections of merchandise while adjusting its pricing strategies. However, it is still struggling to remain competitive with Wal-Mart and Target and a rather weak economy. Since finally for bankruptcy, Kmart closed over 283 stores resulting in over 22,000 job losses (Hoover’s, 2007). Kmart is currently a wholly owned subsidiary of Sears Holdings Corporation (Nasdaq: SHLD) (K-mart, 2007). Looking at statistics on a Hoover’s Business website, Kmart’s annual income statements from 2004-2006 reflects a company that isn’t seeing any substantial growth or losses.

Some of the latest news on Kmart is that they have a agreed to a “gift-card fee refund program” (Kmart, 2007) as part of its settlement with the Federal Trade Agency. The FTC had earlier charged Kmart with deceptively engaging in deceptive practices in marketing and selling its gift cards. Apparently when customers attempted to use the cards after 24 months, a charge of $50.40 was deducted from the amount on the card (K-Mart, 2007).

A report put out on financial performance of Sears holdings stated that their net income and sales for the fourth quarter of 2006 and their fiscal year ending February 3rd, 2007 stated both their net income and sales were up. Sears holdings net income $820 million while their fiscal year net income was $1.5 billion. The company attributes the rise in net income and sales to improvements in the operating incomes of Kmart and Sears domestic. They also reported that slowdown in the housing market and competition in the U.S. market affected sales of both Kmart and Sears.

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References

• Hoover’s Handbook of American Business 2007. Austin, Tex: Hoover’s Business Press, 2006
• “Kmart files Chapter 11.” CNNMoney. 22Jan2002. CNN. 3 Apr 2007. <http://money.cnn.com/2002/01/22/companies/kmart>.
• “K-Mart files Chapter 11.” The Daily Texan Online. 23Jan2002. World & Nation. 5 Apr 2007 .
• “Kmart files for Chapter 11 bankruptcy.” Michigan Daily. 23 Jan 2002.
• “Kmart to refund gift-card fees.” CNNMoney. 15 Mar 2007
• “Reorganization Under the Bankruptcy Code.” U.S. Courts. 2007. U.S. Courts. 2 Apr 2007 .
• Russell, Nancy. World Socialist. 26Jan2002. Accessed 4Apr2007
• “U.S. Securities and Exchange Commission.” Security and Exchange Commission. 2007. 3 Apr 2007 http://www.sec.gov/investor/pubs/bankrupt.htm.