Ch. 11 shakes up vendor relation: Payment concerns suspend some product shipments - Statistical Data Included

DSN Retailing Today, Feb 11, 2002 by Mike Duff

TROY, MICH. -- Exactly one week after Kmart filed for Chapter 11 protection, a U.S. Bankruptcy Court for the Northern District of Illinois approved a $2 billion debtor-in-possession credit facility that provides for payment to many of the retailer's key vendor partners. The court's decision did not come as a surprise. However, it still represented a positive turning point in Kmart's vendor relations, which had taken on a decidedly negative mood when a handful of large-scale suppliers announced on Jan. 21 they were halting shipments for lack of payment.

With vendor shipments having been restored and a Chapter 11 emergence date of July 2003 identified by Kmart, it is unlikely the retailer will lose any key vendors during its bankruptcy reorganization process--provided things go as scripted.

Nonetheless, events of last month have done nothing to improve Kmart's relations with its vendors, many of which are watching developments carefully and have demonstrated a willingness to act when their interests are threatened by cutting off shipments.

Cognizant of the fragility of its vendor relationships, Kmart is doing what it can to reassure the most important ones by designating them "critical vendors" that will be able to recoup their accounts receivable. These include two of its largest trade creditors, Fleming and Handleman.

Despite any sense of trepidation, many vendors have rallied around Kmart since its Chapter 11 bankruptcy filing. But industry observers continue to monitor each supplier carefully as they look for breaks in solidarity

Critically, those who control key brands sold on a proprietary basis by Kmart in the discount store channel, including Martha Stewart Everyday and Kathy Ireland, are sticking with the company and considering, at least for now, how to press the opportunities that a Chapter 11 filing presents.

Proprietary brand operators aren't qualified for status as critical vendors, according to one source, because the deals between them and the retailer are structured differently than traditional vendor/retailer arrangements. Therefore, these deals require independent negotiations.

Analysts also have roundly criticized Kmart for its deemphasizing of private labels and proprietary brands as it revisited its marketing strategy last year. Moving from an emphasis on exclusive brands to one featuring everyday low prices was a mistake that undermined what differentiation the retailer enjoyed from its competition, they contend.

"With Kmart, exclusives are probably their best bet, a la Martha Stewart," said Emme Kozloff, a Bernstein Research analyst. Wal-Mart, she noted, is not as aggressive on this front as Kmart, and Target tends to develop proprietary labels on a different basis, taking department store or little-know designers and spinning product lines that are consistent with its cheap-chic marketing approach.

Kmart's proprietary labels, developed with several well-known personalities who have essentially branded their names, have a unique cachet that has helped keep consumers interested. "Brand exclusives are the only way to jump-start traffic," Kozloff said.

Martha Stewart Omnimedia sought to squelch rumors that it was shopping its mass-market line around almost as soon as Kmart declared bankruptcy.

Yet rumblings in the media world, where Martha has the bulk of her interests, had Stewart looking for a new retail partner in the mass market.

Gossip in the New York magazine world must be taken with a grain of salt, though, or perhaps more than a grain. MSO has a contract with Kmart, and any moves on the vendor's part could spark damaging litigation. Additionally, MSO analysts caution. the company is unlikely to get better terms from Kmart's competition than it currently receives, and certainly the leverage Stewart's company would enjoy with Target, Wal-Mart, Sears or JCPenney would be less.

Kmart royalties represent by far the bulk of what MSO refers to as the merchandising segment of its income, the others being publishing, television and direct commerce. But merchandising is a relatively small proportion of MSO revenues, representing less than 15% of revenues in the first three quarters of the current fiscal year. However, merchandising made a disproportionately large contribution to income from operations, about 42%, in part due to continuing losses in the direct commerce segment.

That being said, the contribution from the merchandising segment is important. Indeed, almost all of the merchandising revenue falls straight down to the income from operations line. MSO might well find it impossible to generate a deal that is so lucrative from another retailer.

MSO merchandising revenues increased $6 million, or 31.7%, to $24.9 million for the nine months ended Sept. 30, from $18.9 million for the year-earlier period, according to filings with the Securities and Exchange Commission. The gain primarily reflected two factors. One was increased sales of Martha Stewart Everyday products sold at Kmart. Better results derived from the launch of its new kitchen keeping and decorating product lines and a sales increase in the established garden product line. The other factor was a boost in royalty rate commencing in August that derived from a new and extended agreement inked by MSO and Kmart last year.