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Consolidations: Kmart Leads Off

NEW YORK — The year is still young, but already consolidation and restructuring could be the buzzwords for 2003.<br><br>Kmart Corp., which became the biggest retail bankruptcy in history when it filed Chapter 11 nearly one year ago, is expected...

NEW YORK — The year is still young, but already consolidation and restructuring could be the buzzwords for 2003.

This story first appeared in the January 13, 2003 issue of WWD.  Subscribe Today.

Kmart Corp., which became the biggest retail bankruptcy in history when it filed Chapter 11 nearly one year ago, is expected to disclose this week the list of sites it will shutter in its latest round of store closings. A real estate source close to the company said at least 250 stores will be closed, and that the final number is likely to be closer to 325.

On the potential list of store closures is the Astor Place showcase in Manhattan. Kmart will seek court approval of the closings at a hearing on Jan. 28, said Jack Ferry, spokesman for Kmart, who declined to comment on the number of units involved.

Kmart, of course, is in the final stages of fine-tuning its plan of reorganization, which is expected to be filed by the end of February in a Chicago bankruptcy court. Meanwhile, the retail chain’s board is also trying to wrap up its investigation of what went wrong under the discounter’s former management.

Kmart chairman and chief executive officer James Adamson told WWD last year that the retailer won’t rule out the possibility of suing its former executives. Former ceo Charles Conaway and former president and chief operating officer Mark Schwartz are reportedly key figures in both internal investigations by Kmart and, with the aid of the Federal Bureau of Investigation, those conducted by the U.S. attorney’s office in Michigan. The latter investigation is said to be concentrating on accounting and corporate stewardship issues.

Kmart’s query began last January and has focused largely on compensation and loan deals inked by the two and 26 other former executives, which aggregated to $28 million in loans. The discount chain filed Chapter 11 on Jan. 22 of last year.

The Securities and Exchange Commission is also conducting a separate probe on Kmart. Sources said all parties are sharing information gleaned from the different probes.

According to sources, both Schwartz and Conaway have been questioned by Kmart’s lawyers, with Schwartz’s deposition held last week and Conaway’s last year. Conaway reportedly will be asked more questions later this month. Erin Kelley of Sidley Austin Brown & Wood, Conaway’s attorney, could not be reached for comment.

Ferry said that the “stewardship review is ongoing. We expect the depositions of the ex-employees to be completed [by the end of] this month.” He did not know whether the rest of the internal probe would be completed at that time, or whether there would be a need to delve into other issues.

Coming out of the holiday season, it is too early to tell which retailers might be forced to consider a Chapter 11 filing. However, experts said that several factors are in place to push retailers into a consolidation-and-restructuring mode.

Retailers just reported their worst same-store numbers for the holiday season in 30 years. Moreover, tightly managed inventory controls left little room for the usual pop in retail sales during the postholiday clearance period. In addition, retailers, in their attempts to liberate some cash, are likely to deal with recurring complaints that there are simply too many stores with too much merchandise vying for too few consumers as they attempt to curtail the flow of red ink from their bottom lines.

According to Jay McIntosh, who heads up the retail and consumer products group at Ernst & Young: “There are two things that concern us for the year — high levels of consumer debt and deflation.”

McIntosh sees 2003 as a year where there will be “significant store closings” and reductions in new store openings as firms work on improving their free cash flow.

McIntosh observed that retailers have done a really good job of taking costs out of 2002. Their ability to do so again in 2003, and how much they can wring out of their supply chains, will have an impact on this year’s balance sheets.

McIntosh’s group is projecting a 2 to 4 percent rise in 2003 retail results. Full-year results for 2002, not yet in, will be slightly higher, predicted McIntosh.

As for consumers’ personal income statements, McIntosh observed: “We’ve already had a lot of refinancing, with a great wave of cash inflows in 2001 and 2002. How much more cash can that provide? People were charging less in the last holiday season. All of the issues that existed this year will probably exist next holiday season.”

At the end of 2002, those issues included high levels of consumer debt, a so-so stock market performance and 6 percent unemployment. While the unemployment rate remained unchanged, the Labor Department’s data showed that payrolls tumbled in December, shedding 101,000 jobs. The largest drop before last month’s was in February, when 165,000 jobs were lost.

The year is only 13 days old, and already AT&T said it will slash 3,500 jobs, Cigna Corp. will lose 3,000-plus and Alcoa Inc. will add 8,000 to the jobs-lost column. On Friday, J.C. Penney Co. said it will cut 2,000 jobs from its catalog division. Kmart, which last year contributed 22,000 to the lost-job category when it closed 283 stores, will likely shed just as many jobs when it announces which sites will be shuttered this week.

On a net basis, the economy last year sacrificed 181,000 jobs. It’s the perception of continuing job losses, however, that could have an impact on the psyche of consumers and their willingness to keep their purse strings open.

McIntosh said that he thinks consumers are holding back on their spending because of concerns over personal finances, whether related to job security, the status of 401k plans or the value of their stock portfolios.

Of course, there is also competition from life’s basic necessities for a chunk of the consumer’s monthly cash outlay. Even many of those with a strong sense of job security are facing higher utility and gas bills and tax hikes at the local and state levels. The Energy Department said Thursday that gasoline prices nationwide are expected to be in the $1.54-a-gallon range by mid-spring. That price-per-gallon estimate follows a 30 percent spike in December from year-ago levels.

Shari Schwartzman Eberts, equity analyst at J.P. Morgan Securities Inc., in a research note last month noted a “strong negative correlation between same-store sales results and retail gasoline prices,” particularly among the customers of discounters, for whom gasoline costs make up a greater share of disposable income.

As 2003 starts off with Frederick’s of Hollywood exiting bankruptcy proceedings and The Warnaco Group expecting to have its plan of reorganization confirmed by a Manhattan bankruptcy court on Thursday, there are already a few firms that are on the radar screens of credit analysts.

Many are wondering what will happen with Speigel Group, which operates catalog operations and Eddie Bauer stores. Speigel’s last annual report was filed in 2001, and there have been several delays over the filings of its quarterly reports with the SEC. One analyst expects that Sears’ purchase of Lands’ End and the now availability of the catalog’s merchandise in select stores will have an impact on sales at Eddie Bauer.

Another firm already struggling, but so far avoiding bankruptcy speculation, is San Diego-based Factory 2-U Stores, and it may face further competitive pressure in the current economic environment.

Richard Jaffe, equity analyst at UBS Warburg, in a research update on Factory 2-U last month, wrote in his statement of risk on the company: “Promotional pricing by the mass merchants and discounters could develop into further competitive pressure for Factory 2-U. Factory 2-U management faces the challenge of dealing with the logistics required for a low average-price, high unit-count, fast-turning business.”