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Kmart: A Fix-Up on Fast Forward


The hot seat at Kmart Corp. (KM) is getting even hotter. With the retailer limping through bankruptcy proceedings, CEO James B. Adamson faces increased pressure from creditors to come up with a plan to rescue Kmart by early next year--at least six months before it had counted on emerging from Chapter 11. With sales plummeting, a dismal back-to-school shopping season behind it, and an anemic-looking holiday season ahead, Adamson is hoping a holiday miracle convinces creditors he's still the man to fix Kmart.

To be sure, Adamson has made some progress. He closed 283 of Kmart's 2,100 stores, cut $130 million in annual overhead, and made headway in keeping the shelves fully stocked--a chronic problem at Kmart. But losses have mounted to nearly $2 billion since Jan. 22, when Kmart, with $36 billion in sales last year, became the largest retailer ever to declare bankruptcy.

Moreover, Adamson was a company director before being named chairman and CEO, following the ouster of Charles C. Conaway. While he chaired the audit committee, the board failed to recognize the depth of Kmart's financial deterioration until it was too late. Adamson has also been tarnished by Securities & Exchange Commission and FBI investigations into Kmart's accounting and compensation practices. Directors approved $23 million in loans to 24 senior execs only two months before Kmart went broke. Now Kmart is looking into the role its directors played, and insiders say it may sue to recoup the money. As a result, it's unclear whether Adamson will get the time he needs. "It's make-or-break time for him," says a person close to the company. "People have run out of patience."

Bondholders have another reason to want a speedy reorganization: Kmart bonds have fallen 75% in value, to only 20 cents on the dollar, since January. In bankruptcy, vendors demand stiffer payment terms, day-to-day financing costs are higher, and fees to lawyers and consultants eat up badly needed cash. It's likely the bonds will be converted into common stock once Kmart exits Chapter 11, giving bondholders a chance to sell out and recoup their losses. But their fear is that the longer that takes, the less those shares will be worth. And if Kmart has to liquidate--still considered unlikely--a fire sale probably wouldn't satisfy creditors. In any case, no one has expressed an interest in buying the chain.

This summer, Kmart executives suggested that the Troy (Mich.)-based discounter might not emerge from Chapter 11 until 2004. Adamson is keenly aware that a hasty reorganization could set Kmart up for failure--just look at discount rival Ames Department Stores Inc., which filed for bankruptcy twice before finally liquidating earlier this year.

Adamson would like to decide, for instance, how many more stores need closing or what to do about the disappointing Super Kmarts, which sell groceries as well as hard goods. "You need to emerge with the right capital structure, and with enough capital to fix the business and ensure [vendor] support," he says. "If you don't, then you could end up back in bankruptcy."

But with the two largest bondholder groups breathing down his neck, Adamson may have to take that risk. "They refocused us," Adamson says of Edward S. Lampert's ESL Investments Inc. and Martin J. Whitman's Third Avenue Value Fund, who between them control Kmart debt with a face value of $1 billion--about 25% of the total. Neither investor would comment for this story. But now, Adamson says, "We're feeling that July or earlier is possible. Maybe we can't make it picture-perfect, but we can do enough work to come up with a five-year plan that can be a springboard for an exit." Asked if his job is in jeopardy, Adamson demurs, but adds: "A change in senior leadership will dramatically hurt this company. Even if we have a lousy Christmas, people realize that it would be harmful."

That's because he says Kmart is slowly turning around. The company is making headway with its inventory problems, for instance. In Chicago and Detroit stores, a new system guarantees customers that sale items will always be in stock. If it works, the system will be duplicated nationwide. On the merchandising front, Kmart's hottest asset, Martha Stewart, which totals $1.5 billion annually, has a new line of holiday decorations. Kmart insists that sales of Martha Stewart goods have not been hurt by her involvement in the Imclone stock-trading scandal. And Kmart's new line of Joe Boxer apparel and household goods is on track to sell more than $1 billion a year.

All the same, Adamson has yet to get much traction from his efforts. For the first half of the year, overall same-stores sales fell 11.4% from 2001 levels. Some disruption was expected in the months after the bankruptcy filing as the retailer scrambled to restock its shelves. What's alarming is that sales haven't rebounded since then. In August, the start of the important back-to-school shopping season, same-store sales plummeted 11.9%, compared with a 3.1% increase on average for all discounters, according to research house Sanford C. Bernstein. After Kmart filed for Chapter 11, vendors temporarily stopped shipments. The merchandise eventually returned, but the customers didn't. Says Adamson: "They're just not coming back as fast as we would like."

That bodes ill for the upcoming holiday season. Says one former senior Kmart executive: "If they don't do something unbelievably dramatic, I can't imagine the banks continuing to deal with them after Christmas." The sad truth is that Adamson & Co. would be happy if holiday sales fell only 5% to 6% from last year. Such is the state of affairs at Kmart: Only slightly falling sales end up looking like a gift. By Joann Muller in Detroit


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