NEW YORK — Kmart Corp.’s blue light just turned red.

The beleaguered retailer Thursday revealed it is in the middle of talks with lenders regarding its financing. The Troy, Mich.-based company also is planning to close up to 250 of its underperforming stores and a Chapter 11 filing isn’t out of the question to help it reject the leases, industry sources said.

But even if many financial experts believe bankruptcy fears surrounding Kmart might be overblown for now, they said the retailer only has about six months to turn itself around before it has to take drastic action. That time frame also raises questions over the long-term future of Kmart chief executive officer Chuck Conaway, who joined the company in June 2000.

An announcement on the store closures and other turnaround moves is expected next week, sources said. Financial professionals tracking Kmart’s negotiations with its lenders said the discounter is likely to include a statement that it has a letter of commitment from its banks. J.P. Morgan Chase and possibly Fleet Bank are likely to provide the financing, but they declined comment.

Both moves would be considered positive signs for vendors and factors. Vendors, some of whom complained of late or no payments on invoices for goods shipped, have been increasingly skittish since the beginning of the year following the lackluster holiday season.

Shares of Kmart on Thursday tanked in trading on the New York Stock Exchange, following the company’s warning that it would not meet Wall Street consensus estimates for 2002. The stock reached a new 52-week low, with intraday trading hitting $4.07 before climbing back up to $4.20, down 60 cents, or 12.5 percent, from Wednesday’s closing price.

A spokesman for Kmart would only say that the retailer is “reviewing liquidity needs and business plans. We’re looking at what our needs are for the 2002 and 2003 fiscal years.” He declined comment on store closures.

Those closures could be what spurred a Chapter 11 filing, observers said. Concern over Kmart’s financial situation has increased rapidly since a report issued last week by Prudential Securities retail analyst Wayne Hood, which claimed that, if its cash flow deteriorated, a bankruptcy filing would be the only way for the retailer to meet its challenges. Although other analysts disagreed, one source familiar with the situation said: “The consideration of a Chapter 11 filing is real. There has been a slowness in payment of vendors in some areas and there are definitely store closings on the block.”

Retailers in the past have been known to file for Chapter 11 and then use the process to reject scores of leases at underperforming locations. Jay Indyke, bankruptcy counsel at Kronish Lieb Weiner & Hellman, observed: “The question is how much does the retailer tenant have to pay the landlords to get out of those leases. If the rent is at market value or below, it might be more beneficial for both sides to negotiate a lease termination outside of a bankruptcy.”

He explained that, generally, a looming bankruptcy might be enough incentive for some landlords to approve a deal or even buy back the lease interest so they don’t have to be part of the bankruptcy proceeding. Such a move gives landlords more control over their property. Tenants who terminate leases while in bankruptcy leave landlords holding unsecured prepetition trade claims, with the possibility of getting back very little of the rent claim owed.

Financial sources told WWD that Kmart was getting ready to put in place a new bank line in February, up from the expected May 1 refinancing time period. “A bank line in place by the time vendors ship for spring,” a credit analyst said, “would give them some measure of comfort.”

A retail credit analyst for an investment firm focusing on distressed securities, said: “Kmart has been trying to fix its liquidity issue. It is okay for now, and are likely to get the bank financing they need.”

He expects the refinancing facility to be in the range of $2 billion, up from the current $1.1 billion credit facility that expires in December. The analyst also said that the new facility is likely to be collateralized by inventory, as well as by real estate holdings.

Even though Kmart told WWD that it doesn’t have a cash crunch, liquidity concerns are bound to arise since the proposed refinancing facility that’s been the talk of the Street represents a $900 million increase. Moreover, retailers surely want more availability than they need for their own comfort zone, and at least one analyst said that “Kmart needs $3 billion to insure smooth sailing through 2002.”

Rumors began circulating in the marketplace about store closures in August. At the time, only about 100 sites were supposedly targeted. With the deteriorating economy and poor sales results, that number has reached as high as 250 locations in recent weeks. Some vendors, analysts, factors and credit specialists are expecting at least 200 stores shuttered initially, with a second round of sites going dark possibly later this year. Kmart currently operates more than 2100 stores.

However, the closure of even 250 stores may not be enough. Restructuring experts, as well as vulture fund analysts, said Thursday that Kmart would need to close at least 400 to 500 stores in order to implement a successful turnaround that fits its capital structure and leaves it with a manageable store base.

Richard D. Hastings, a credit economist at Cyber Business Credit, observed: “Retailers are having more difficulties finding their own niche on a national scale because the retailing industry has matured. This means that the business model that works is duplicated by most competitors, leaving success to only those that are the best executors of that model. As for Kmart, there is still a demand for that chain. However, if Kmart doesn’t act on store closings and address efficiency issues during the next three to four months, it may be much more difficult for them to achieve their turnaround.”

Meanwhile, vendors and factors are growing increasingly anxious about the retailer’s financial situation. Some said an additional financial danger is that, if vendors become truly concerned, they might begin demanding delivery only with cash on delivery, placing further pressure on Kmart’s cash flow. However, vendors said that is extremely unlikely for now. A source at one major Kmart private label apparel supplier said the retailer had been paying its bills regularly and had given no indications that it was planning to do otherwise. “They obviously are going through their moment, but they’re OK in that sense,” he said.

Other smaller vendors said they probably have no choice but to take the risk and ship since Kmart is their largest customer. More importantly, they don’t know where they can make up the business if they elect not to accept the orders.

One concern, said some, involves Kmart’s request that they hold shipments on new orders for more than four months versus shipping when completed and ready to go. The issue, said one self-financing vendor, is paying costs for production up front knowing that payment might not be made until possibly six months down the road. That’s because the vendor will have to store inventory for several months and won’t be able to invoice Kmart for the goods until they are shipped. If the discounter then pushes out the terms of payment from 30 to 60 or 90 days, but files bankruptcy before payment, the vendor is out-of-pocket and becomes an unsecured creditor near the bottom of the financial food chain.

Meanwhile, some factors reacted by pulling back on lines of credit, as well as their approvals on certain orders. Others continued to support Kmart. Ben Solo of Solo Credit said: “We are encouraging people to do business with them at the present time. We are not holding back.”

A credit manager from a company on Kmart’s vendor list said: “I think Kmart’s liquidity is OK for the near term. Our concern is more with their position in the long term. It makes us nervous. They are also in a good position to close stores right now. They can take the charges on the chin. I think Wall Street would prefer that. There is also concerns that they’ll file [for bankruptcy protection], which leaves us in a miserable position. They’re not going away. I just don’t know what will happen to them.” – Vicki M. Young with contributions by Valerie Seckler, Scott Malone and Arthur Zaczkiewicz.

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