Kmart in court, Part III - Reporter's Notebook

DSN Retailing Today, May 6, 2002 by Laura Heller

CHICAGO -- Something unusual occurred at Kmart's April 24 Omnibus hearing: Participants in the Chapter 11 bankruptcy proceedings turned the discussion from legal matters to retailing for the first time since the hearings began in mid-February.

Until now, the Chapter 11 process, and all that goes with it, has been so far removed from the realities of retailing that the lawyers and executives may as well be speaking gibberish. But legalese finally gave way to retail-speak last month when the issue of future store closings came before the court.

Kmart had requested a deadline of March 31, 2003, to determine any future store closings related to the restructuring after already announcing 283 closures on March 8. That deadline was fine with the landlords of the more than 2,000 remaining locations, but four objected and demanded their day in court.

Kmart attorney Jack Butler argued the retailer needed to get through the critical holiday selling season before it could determine any future store closings, and that the first round of cuts was based strictly on financial reasons.

Butler proffered a voluntary agreement that Kmart would not allow a lease to go dark or otherwise be rejected between Oct. 1,2002 and Jan. 15, 2003, but "if we're going to have to fight about this in court, we're not going to make this promise," he said.

One party accepted these terms and attorneys representing the remaining three--with single stores in Cicero, Ill., Key West, Fla., and Stockton, Calif.--all insisted on questioning company executives as to the future of these locations. They requested a Sept. 15 deadline, arguing that Kmart should have a "much better" idea of whether these particular stores will be viable going forward.

Future store closings have been the subject of much conjecture in retail and financial circles, with many believing 283 are too few and a significant number of additional locations will be shuttered in the future. Chairman and ceo Jim Adamson has done little to clarify this issue. However, he has consistently implied that once a more detailed analysis of Kmart stores is completed, more units may be closed and merchandising initiatives abandoned.

Given the many components to a retail strategy, store analysis is hardly as straightforward as examining a bottom line. Distribution and logistics figure heavily and new marketing and merchandising initiatives need to be assessed relative to Kmart's target demographic. And just who exactly that target demographic is needs to be clearly defined, thus further determining the present and future profitability of existing Kmart stores.

That's a lot of moving parts, and the very nuts and bolts of retailing, something lawyers clearly have a difficult time understanding. Michael P. Deighan, a consultant with Rockwood/Gemini Advisors, a real estate advisory firm contracted to help Kmart evaluate locations, testified that 340 stores initially were under the microscope with "significant cash flow problems and were evaluated on purely financial metrics," he said. "Now it's a much more difficult analysis that will deal with market competition across all 50 states and will have to be overlaid not just with holiday sales but operational and strategic plans developed by [Adamson]. . We will need at least until March 31, 2003 to evaluate."

And they'll get it, as presiding judge Susan Sonderby ruled the deadline request to be valid. Attorneys were clearly stumped by Kmart's reasoning, seemingly unable to comprehend why executives were not intimately familiar with the specifics of the three stores in question. With more than 2,000 units still in operation and all that goes with the daily operations of one of the country's largest retailers, let alone one in Chapter 11, the assumption that they should be aware seems almost laughable.

That these attorneys--albeit a minute percentage compared to the legions involved in the proceedings-are so baffled by the realities of retailing speaks volumes as to the complexity of the Chapter 11 process. Enormous amounts of money are spent discussing, disputing and defining all the legal points, while newly appointed executives are minding and redefining the stores.

On April 23, the judge approved, or rather informed, the legal teams that her approval was unnecessary for the compensation package established for Adamson. He will receive a $2.5 million signing bonus, a $1.5 million annual salary and a bonus of 120% of that base salary. The new contract also calls for bonuses to be credited against severance should Adamson leave before April 2003.

That's a far cry from the original package when he signed on as chairman on Jan. 17, prior to the departure of then-ceo Chuck Conaway. That $8.5 million package included a $4 million bonus should Kmart emerge from bankruptcy by the July 2003 target date and a $10 million letter of credit, which has been eliminated. Conaway's severance and exit settlement will not be reviewed until Labor Day.

Adamson made "substantial concessions," according to Butler, and apparently the other parties agreed. Attorney's for financial institutions, creditors and the U.S. Trustees all signed off on the package. But the judge confounded all present--sending a rather large group of attorneys into a quick huddle--by saying her approval of all prepetition, uncontested executive packages was unnecessary.