Leaner meaner cleaner: nearly $1 billion in cost cutting has goosed earnings and improved efficiencies - Kmart, includes related article on Wall Street perceptions of Kmart - It's Now or Never Supplement - Company Profile

Discount Store News, Dec 9, 1996 by Richard Halverson

A looming financial disaster about 12 months ago was about to send the company into a downward spiral of bankruptcy and virtually cripple its fledgling turnaround efforts, but Kmart miraculously rebounded, cleaned up its balance sheet and made itself more fiscally credible than perhaps it has ever been.

The top-to-bottom monetary repair work also sent a clear message that Kmart is dead serious about becoming a fierce competitor.

Financially, the company has travelled leagues. 9Kmart has tackled the most critical problems with its bottom line, cutting costs by $900 million in `95 and `96 and logging its third modest quarterly net profit in a row following severe losses in `95.

Now it must address top-line problems - anemic sales, in particular - as well as restore investment-grade ratings to its debt, currently rated as junk bonds.

Although a new $3.7 billion credit line and a successful preferred stock offering swept aside last year's talk of bankruptcy, the chain still faces a huge challenge: how to bolster sales that run about half the per-square-foot sales that Wal-Mart stores generate.

That job runs beyond the purview of the financial division, which to a certain extent has to stand aside and hope it works.

"The culture's changed. The people have changed," said Marv Rich, executive vice president of strategic planning and financial administration, who joined the company two years ago when Kmart's looming financial crisis could no longer be ignored.

Even long-term employees "have caught fire and no longer are in denial," he said. "Now it's a question of execution, and this company has a hard time executing," Rich said.

Kmart's third quarter report underscores the problem: Total corporate sales declined 1.6% in the three months ended Oct. 30, and comp store sales were essentially flat at 0.1%. For the year to date, total revenues dipped 0.5%, while comp sales rose 1.8%. In contrast, total sales for the third period rose 12% at Wal-Mart and 14% at Target.

This year's earnings growth has been largely the result of Kmart's cost-cutting efforts, more of which are on the way. * Payroll functions, which are currently handled by two companies, are likely to be consolidated next year. * Another potential target: store-level computer systems. Right now, Kmart has seven different platforms operating in stores across the country. * Workers compensation, public liability and health care programs are under scrutiny for cost savings. Collectively, they cost the company more than $500 million. "We need to do a better job of managing these programs from a delivery-of-value standpoint back to our associates, and at the same time use our buying power more effectively to get better deals," said cfo Marty Welch, who joined Kmart one year ago from Federal-Mogul Corp., a Detroit auto parts manufacturer, where he was finance chief. * Further opportunities for cost-cutting exist in property management, where the company spends about $500 million, and in energy costs, which also run about $500 million. With the deregulation of the energy industry, in particular, Kmart's financial team sees an opportunity to cut deals and slash costs.

Certainly, most of the largest expense reductions have already taken place.

Over the past year, Kmart sold off its stores in the Czech and Slovak Republics and its Singapore operations. And if the Rite Aid acquisition of Thrifty PayLess goes through, Kmart will finally get the rest of its cash out of the sale of its PayLess Drugs sale in the form of about $200 million in Rite Aid stock it can readily sell. It also sold its money-losing auto service centers to Penske, ending a $20 million-per-year drain.

The poorly performing Builders Square home center chain remains a millstone around Kmart's neck. A Kmart guarantee of Builders Square leases means it can't afford even to give it away in a home center market dominated by The Home Depot.

Kmart contends that Builders Square is profitable at the even line, before EBIDA. The division showed a third quarter operating profit of $23 million, compared to a $5 million loss in the same period a year ago.

Kmart does not plan to open additional Builders Square units, nor has it earmarked capital expenditures beyond those that will cover standard maintenance requirements.

Because Kmart guarantees Builders Square leases, it is reluctant to sell the chain to a highly leveraged operator that might fall victim to The Home Depot's dominance.

"We intend to not be in this business, but we intend to do that in a prudent way," Welch said.

Another major priority is to restore investment-grade ratings to Kmart debt, allowing it to regain access to public debt markets and getting freer bank terms, Welch said. He conceded that such a project could take as long as two to three years.

With the $3.7 billion credit line and term loan agreement signed in June, Kmart has no significant debt coming due for the next three years. What little is due, $143 million spread throughout 1997, is "fully and readily financeable," Welch said.