Could Chapter 11 Be in Cards for Kmart?

Amid speculation about discount retailer Kmart's financial future, the company announced today that it has ousted chief operating officer Mark Schwartz.

The embattled retailer also named James B. Adamson, one of its board of directors, to be chairman, replacing Charles Conaway, who will remain as chief executive.

The management changes come in the wake of a string of bad news that has led many analysts to believe that the beleaguered retailer could be filing for Chapter 11 bankruptcy.

Investors nervous about the company's fundamentals have sent Kmart's shares plummeting around 73 percent since the beginning of the year. Standard & Poor's said that it would take Kmart out of its S&P 500 index at the close of trading on Wednesday.

While the recession has made the environment for retailers tough in general, Kmart has had a tougher time of it.

Not only has the company announced that weak December sales would cause it to miss analysts' earnings estimates for the fiscal year ended Jan. 30, 2002, but credit rating agencies Moody's Investors Service and Standard & Poor's have each downgraded their credit ratings on the discount retailer.

The company's board met Tuesday to reportedly discuss various options for the troubled company, including a Chapter 11 bankruptcy filing. A Kmart spokeswoman said she could not disclose what was on the board's agenda.

But the cloud of negativity surrounding the company has made many industry watchers wonder whether or not the company can turn its fortunes around.

Heated Competition

Competition from more nimble discount retailers like Wal-Mart and Target has made it a difficult environment for Kmart to compete in, say analysts.

Chief among Kmart's problems, say industry watchers, are its ability to compete on price, which stems from an inefficient supply-chain infrastructure. While discounter Wal-Mart is renowned for its "just-in-time" inventory system that allows the company to restock products as necessary and keep its costs low, Kmart lacks this efficiency.

"They decided to take Wal-Mart on by way of trying to create what they call price parity," says Kurt Barnard, president of Barnard's Retail Trend Report in Montclair, N.J. "That is impossible. You can't do that with Wal-Mart. That's like having the state of Luxembourg declare war on the United States."

Kmart chairman Chuck Conaway has undertaken strategic initiatives to enhance the company's inventory and information systems since he took the helm in May of 2000. But Standard & Poor's analyst Mary Lou Burde says customers have still been unable to find products on Kmart's shelves.

"Chuck Conaway has achieved some measure of success and started to make improvements in the supply chain, but we're not seeing it in terms of the type of sales they need to get," she says.

Credit Risk

Conaway also brought new marketing initiatives and attractive new merchandise to make the stores' offerings more appealing. The retailer signed a long-term merchandising agreement with Martha Stewart earlier this year to carry the domestic doyenne's Martha Stewart Everyday products until 2008, and also brought back its BlueLight Specials offering savings on brands and products in April.

But none of these initiatives seem to have overcome the company's problems with suppliers. Analysts say the company has been slow in paying its vendors since November.

Further, Kmart's ever-decreasing credit rating is problematic because it makes it more difficult and expensive for the company to borrow money.

And more cash is what Kmart might need in the next couple of months. Along with its earnings warning, the company said it was in discussions with its lenders regarding its "existing and possible supplemental financing facilities."

That statement refers to a $1.5 billion revolving credit facility that the company had been expected to renegotiate in mid-February, according to Standard & Poor's. With the company reviewing its current and prospective liquidity position and business plan for the 2002 and 2003 fiscal years, some analysts expect the company to take on more debt, putting it into an even more precarious financial situation.

Some analysts add that negotiating for more credit is a signal that suppliers are still cutting back.

A Way Out?

Still, Kmart might find a way out of its problems by filing for Chapter 11 bankruptcy, say observers.

"The potential upside is that in either filing for protection or at least in approaching suppliers and requesting aid from them, it might give Kmart the opportunity to come out of this," says Howard Nemiroff, professor of finance at Long Island University in New York .

"The consumer has no idea for the most part that a company may or may not be in bankruptcy," adds Barnard. "So bankruptcy wouldn't make any difference whatsoever so long as the store can show that it has the merchandise the customers came in to buy."

But even if the store does regain the confidence of some suppliers, it will still have a long road ahead of it catching up to its competitors.

"There's a huge gap," between Kmart and its competitors, says Standard & Poor's Burde. "I'm sure it can be narrowed, but there will still be a gap."

ABCNEWS' Ramona Schindelheim and Catherine Valenti contributed to this article