10-Q/A 1 k91997a1e10vqza.txt AMENDMENT TO QUARTERLY REPORT, DATED 10/27/04 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A AMENDMENT NO. 1 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 27, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File No. 000-50278 KMART HOLDING CORPORATION (Exact name of registrant as specified in its charter) Delaware 32-0073116 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)

~~3100 West Big Beaver Road - Troy, Michigan 48084 (Address of principal executive offices) (Zip Code)~~

Registrant's telephone number, including area code (248) 463-1000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed, by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ----- ----- Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No ----- ----- As of November 5, 2004, 89,178,003 shares of Common Stock of the Registrant were outstanding. 1 EXPLANATORY NOTE The purpose of this Amendment No. 1 to Quarterly Report on Form 10-Q/A is to restate the unaudited financial statements of Kmart Holding Corporation and its subsidiaries (the "Company," "we" or "our") filed with the Securities and Exchange Commission ("SEC") on Form 10-Q on November 17, 2004. In conjunction with their review of Sears Holdings Corporation's registration statement on Form S-4 in connection with the pending merger between Kmart and Sears, Roebuck and Company ("Sears"), the SEC reviewed Kmart's Form 10-K for the year ended January 28, 2004. Upon shareholder approvals of the merger transaction, Sears Holdings Corporation will be a new retail company resulting from the merger of Kmart and Sears. As a result of this review, it has been determined that the Company did not reflect an embedded beneficial conversion feature of the convertible note issued upon emergence from bankruptcy. The accounting treatment of the note is based on the determination of a commitment date as defined by Emerging Issues Task Force No. 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" ("EITF 00-27"). A commitment date occurs when, amongst other things, an agreement is binding on both parties and the agreement specifies all significant terms, including the quantity to be exchanged. The Company believed that it had met these qualifications as of the initial agreement date and accounted for the note accordingly. The SEC believes that at the time of the agreement these conditions had not been met, and therefore a commitment date did not occur until issuance of the note. After discussions with the SEC, the Company has agreed to restate its financial statements. This amendment reflects a May 6, 2003 commitment date, resulting in a portion of the note being allocated to stockholders' equity, as required by EITF 00-27. The restatement resulted in a non-cash charge to interest expense of $2 million, $8 million, $6 million and $13 million due to the amortization of the discount for the 13-weeks ended October 27, 2004 and October 29, 2003, the 39-weeks ended October 27, 2004 and the 26-weeks ended October 29, 2003, respectively. See Note 3 to the unaudited Condensed Consolidated Financial Statements for further explanation and a discussion of the impact to the Company's net income and earnings per share. The Items of our Quarterly Report on Form 10-Q for the quarterly period ended October 27, 2004 which are amended and restated herein are: 1. Part 1, Item 1 - Financial Statements 2. Part 1, Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 3. Part 1, Item 4 - Controls and Procedures Except as otherwise expressly noted herein, this Amendment No. 1 to Quarterly Report on Form 10-Q/A does not reflect events occurring after the November 17, 2004 filing of our Quarterly Report on Form 10-Q in any way, except as those required to reflect the effects of this restatement of our financial statements for the periods presented or as deemed necessary in connection with the completion of restated financial statements. The remaining Items contained within this Amendment No. 1 to our Quarterly Report on Form 10-Q/A consist of all other Items originally contained in our Quarterly Report on Form 10-Q for the quarterly period ended October 27, 2004 in the form filed with the SEC on November 17, 2004. These remaining Items are not amended hereby, but are included for the convenience of the reader. In order to preserve the nature and character of the disclosures set forth in such Items as originally filed, except as expressly noted herein, this report continues to speak as of the date of the original filing, and we have not updated the disclosures in this report to speak as of a later date. While this report primarily relates to the historical periods covered, events may have taken place since the original filing that might have been reflected in this report if they had taken place prior to the original filing. 2 INDEX

3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 4 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 5 CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS, EXCEPT SHARE DATA) (UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 6 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 7 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION Kmart Holding Corporation ("Kmart," "we," "us," "our," the "Company" or the "Successor Company") is the nation's third largest discount retailer. We operate in the general merchandise retailing industry through 1,484 Kmart discount stores and Supercenters with locations in 49 states, Puerto Rico, the U.S. Virgin Islands, Guam and through our e-commerce shopping site, www.kmart.com. These interim Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation have been included. All significant intercompany accounts and transactions have been eliminated. Operating results for the interim period are not necessarily indicative of the results that may be expected for the full year. Readers of these interim period statements should refer to the audited consolidated financial statements and notes thereto which are included in our Annual Report on Form 10-K/A for the year ended January 28, 2004. Certain prior period amounts have been reclassified to conform to the current interim period presentation. The American Institute of Certified Public Accountants Statement of Position 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" ("SOP 90-7") requires that the financial statements for the period following filing for Chapter 11 bankruptcy protection through the date a plan of reorganization is confirmed distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Accordingly, revenues, expenses, realized gains and losses and provisions for losses directly associated with reorganization and restructuring of the business during the Predecessor Company's (defined below) bankruptcy proceedings have been reported separately as Reorganization items, net in the Unaudited Condensed Consolidated Statements of Operations. See below for a more detailed discussion of the Company's Chapter 11 proceedings. 2. EMERGENCE FROM CHAPTER 11 BANKRUPTCY PROTECTION AND FRESH-START ACCOUNTING Confirmation of Plan of Reorganization On May 6, 2003 (the "Effective Date"), Kmart Corporation (the "Predecessor Company") emerged from reorganization proceedings under Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or "Chapter 11") pursuant to the terms of the Plan of Reorganization (defined below). The Predecessor Company became a wholly-owned subsidiary of Kmart Management Corporation, which is a wholly-owned subsidiary of Kmart Holding Corporation. On January 22, 2002 (the "Petition Date"), the Predecessor Company and 37 of its U.S. Subsidiaries (collectively the "Debtors") filed voluntary petitions for reorganization under Chapter 11 in the United States Bankruptcy Court for the Northern District of Illinois (the "Court"). During the reorganization proceedings, the Debtors continued to operate their business as debtors-in-possession under the jurisdiction of the Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Court. On January 24, 2003, the Debtors filed a Plan of Reorganization and related Disclosure Statement and on February 25, 2003, filed an Amended Joint Plan of Reorganization (the "Plan of Reorganization") and related amended Disclosure Statement with the Court. The Plan of Reorganization received the formal endorsement of the statutory creditors' committees and, as modified, was confirmed by the Court by order docketed on April 23, 2003. 8 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED) Plan Investors At the time of emergence, ESL Investments, Inc. ("ESL") and Third Avenue Trust, on behalf of certain of its investment series ("Third Avenue," and together with ESL, the "Plan Investors") made a substantial investment in the Successor Company in furtherance of our financial and operational restructuring plan. The Plan Investors and their affiliates received approximately 32 million shares of our newly issued common stock ("Common Stock") in satisfaction of pre-petition claims they held, and we issued 14 million shares of Common Stock to affiliates of ESL and to Third Avenue, in exchange for $127 million, net of commitment fees and Plan Investor expenses of $13 million. In addition, we issued a 9 percent, $60 million principal convertible note (the "Note") to affiliates of ESL. With respect to the Note, the principal is convertible at any time prior to its maturity in May 2006, at the option of the holder, into 6 million shares of Common Stock at a conversion price equal to $10 per share. ESL was also granted the option to purchase, prior to May 6, 2005, approximately 6.6 million shares of Common Stock at a price of $13 per share. A portion of the option was assigned to Third Avenue. The investment was made pursuant to an Investment Agreement dated January 24, 2003, as amended (the "Investment Agreement"). See Note 3 - Restatement, for further discussion of the Note and the related embedded beneficial conversion feature. Discharge of Liabilities Under Chapter 11, actions by creditors to collect indebtedness owed prior to the Petition Date were stayed and certain other pre-petition contractual obligations were not enforced against the Debtors. The Predecessor Company received approval from the Court to pay certain pre-petition liabilities including employee salaries and wages, benefits and other employee obligations. On the Effective Date, all then-outstanding equity securities of the Predecessor Company, as well as substantially all of its pre-petition liabilities, were cancelled. Common Stock was issued in satisfaction of certain of those claims. On the Effective Date, 89,677,509 shares of Common Stock and 8,173,145 options to purchase shares of Common Stock were issued pursuant to the Plan of Reorganization. All of the shares of Common Stock issued on May 6, 2003 were or will be distributed pursuant to the Plan of Reorganization in satisfaction of pre-petition claims, except that 14 million shares were issued to affiliates of ESL and to Third Avenue pursuant to the Investment Agreement described above. The options to purchase shares of Common Stock were issued to the Plan Investors and our former Chief Executive Officer. All shares were issued without registration under the Securities Act of 1933, as amended (the "Securities Act") in reliance on the provisions of Section 1145 of the Bankruptcy Code and Section 4(2) of the Securities Act. In addition, as part of the Plan of Reorganization, an independent creditor litigation trust was established for the benefit of the Predecessor Company's pre-petition creditors and equity holders, and to pursue claims which arose from the Predecessor Company's prior accounting and stewardship investigations. Fresh-Start Adjustments In connection with our emergence from Chapter 11, we reflected the terms of the Plan of Reorganization in our consolidated financial statements, applying the terms of SOP 90-7 with respect to financial reporting. Upon applying Fresh-Start accounting, a new reporting entity (the Successor Company) is deemed to be created and the recorded amounts of assets and liabilities are adjusted to reflect their estimated fair values. The reported historical financial statements of the Predecessor Company for periods ended prior to May 1, 2003 generally are not comparable to those of the Successor Company. In this Quarterly Report on Form 10-Q/A, references to the 13-weeks ended April 30, 2003 and prior periods refer to the Predecessor Company. References to the Successor Company refer to the Company on and after April 30, 2003 after giving effect to the provisions of the Plan of Reorganization and the application of Fresh-Start accounting. 9 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED) To facilitate the calculation of the enterprise value of the Successor Company, we developed a set of financial projections. Based on these financial projections and with the assistance of a financial advisor, we determined the enterprise value using various valuation methods, including (i) a comparison of the Company and its projected performance to the market values of comparable companies, (ii) a review and analysis of several recent transactions of companies in similar industries to the Company, and (iii) a calculation of the present value of the future cash flows under the projections. The estimated enterprise value was highly dependent upon achieving the future financial results set forth in the projections as well as the realization of certain other assumptions which are not guaranteed. The estimated enterprise value of the Company was calculated to be approximately $2.3 billion to $3.0 billion. We selected the midpoint of the range, $2.6 billion, as the estimated enterprise value. In applying Fresh-Start accounting, adjustments to reflect the fair value of assets and liabilities, on a net basis, and the write-off of the Predecessor Company's equity accounts resulted in a charge of $5.6 billion. The fair value adjustments included the recognition of approximately $2.2 billion of intangible assets that were previously not recorded in the Predecessor Company's financial statements, such as favorable leasehold interests, Kmart brand rights, pharmacy customer relationships and other lease and license agreements. The restructuring of the Predecessor Company's capital structure and resulting discharge of pre-petition debt resulted in a gain of $5.6 billion. The charge for the revaluation of the assets and liabilities and the gain on the discharge of pre-petition debt are recorded in Reorganization items, net in the Unaudited Condensed Consolidated Statements of Operations. In addition, the excess of fair value of net assets over reorganization value (i.e., "negative goodwill") of approximately $5.6 billion was allocated on a pro-rata basis reducing our non-current, non-financial instrument assets, including the previously unrecorded intangible assets, to $10 million as of April 30, 2003. Refer to our Annual Report on Form 10-K/A for the year ended January 28, 2004 for a more detailed discussion. Claims Resolution We continue to make progress in the reconciliation and settlement of the various classes of claims associated with the discharge of the Predecessor Company's liabilities subject to compromise pursuant to the Plan of Reorganization. Since June 30, 2003, the first distribution date established in the Plan of Reorganization, approximately 21.3 million shares of the 31.9 million shares previously issued to us as disbursing agent with respect to such claims have been distributed to holders of Class 5 claims and approximately $4.1 million in cash has been distributed to holders of Class 7 claims. Due to the significant volume of claims filed to-date, it is premature to estimate with any degree of accuracy the ultimate allowed amount of such claims for each class of claims under the Plan of Reorganization. Accordingly, our current distribution reserve for claim settlements is 20 percent of shares issued. Differences between amounts filed and our estimates are being investigated and will be resolved in connection with our claims resolution process. In this regard, it should be noted that the claims reconciliation process may result in material adjustments to current estimates of allowable claims. During the second quarter of fiscal 2004, we reduced the distribution reserve from 30 percent to 20 percent, resulting in the distribution of approximately an additional 2.2 million shares to claimants who had previously received shares for allowed claims. The remaining shares in the distribution reserve will be issued to claimants on a pro-rata basis if, upon settlement of all claims, the ultimate amount allowed for Class 5 claims is consistent with the Plan of Reorganization. The next scheduled distribution under the Plan of Reorganization is expected to commence on or about January 1, 2005. On August 31, 2004, we entered into a settlement agreement with a past provider of our surety bonds, Fireman's Fund Insurance Company ("Fireman's Fund") to resolve all issues in connection with its pre-petition claims. In accordance with the terms of the settlement agreement, Kmart assumed responsibility for Fireman's Fund future obligations under the bonds issued with respect to the Predecessor Company's workers' compensation insurance program and Fireman's Fund assigned its Class 5 claim to the Company. We received 494,481 shares of the Company's Common Stock relating to the settlement between the parties on August 31, 2004, which represents 80% of the shares Fireman's Fund would have received for an allowed claim. The remaining 20% will be received upon the final settlement of all Class 5 claims, as noted above. The Company recorded a liability for the obligations under the bonds of approximately $33 million. 10 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED) Bankruptcy-Related Recoveries For the 13-weeks and 39-weeks ended October 27, 2004, we recognized recoveries of $1 million and $13 million, respectively, from vendors who had received cash payments for pre-petition obligations (critical vendor claims) or preference payments. See Note 20 - Commitments and Contingencies for a more detailed discussion of the critical vendor claims lawsuit. We entered into two settlement agreements in the second quarter of fiscal 2004 with respect to certain other bankruptcy-related recoveries. These agreements resulted in the receipt of $1.4 million in cash and the assignment of a Class 5 claim to the Company. We received 8,217 shares of Common Stock relating to this assignment in July 2004, which represents 80% of the total claim. The remaining 20% will be received upon the final settlement of all Class 5 claims, as noted above. 3. RESTATEMENT The accompanying unaudited condensed consolidated financial statements for the 13-weeks ended October 27, 2004 and October 29, 2003, the 39-weeks ended October 27, 2004, and the 26-weeks ended October 29, 2003, and as of October 27, 2004, January 28, 2004 and October 29, 2003 have been restated. The restatement reflects the recognition of an embedded beneficial conversion feature of the Company's Note with the Plan Investors. Accounting for the embedded beneficial conversion feature and the resulting recognition of additional interest expense is in accordance with Emerging Issues Task Force Issue No. 00-27, "Application of Issue No. 98-5 to Certain Convertible Instruments" ("EITF 00-27"). As discussed in Note 2, the Note with the Plan Investors is convertible into shares of Common stock at a conversion price equal to $10 per share. The accounting treatment of the Note is based on the determination of a commitment date as defined by EITF 00-27. A commitment date occurs when, amongst other things, an agreement is binding on both parties and the agreement specifies all significant terms, including the quantity to be exchanged. For purposes of calculating the intrinsic value of the embedded beneficial conversion feature, the Company initially determined that the commitment date was January, 24, 2003, the date the Investment Agreement with the Plan Investors was signed. It was subsequently determined that the commitment date was May 6, 2003, the date the Note was issued and when the quoted market price of the Company's Common stock was $15. Upon applying the criteria of EITF 00-27, the Company first allocated the proceeds received from the Plan Investors, net of expenses, of $187 million to the Note, Common stock and stock options issued pursuant to the Investment Agreement and based on their relative fair values. The Company used a Black-Scholes model to value the stock options with the following assumptions: no dividend yield, option life of two years, volatility of 45 percent and an interest rate of 2.76 percent. The fair value of the options was $32 million as of May 6. 2003. The fair value of the convertible debt was based on the market price of our Common stock of $15 on the issuance date, and was $90 million as of May 6. 2003. An effective conversion price was then calculated and used to measure the intrinsic value of the embedded beneficial conversion feature. The resulting discount of $49 million reduced the initial carrying amount of the Note to $11 million, with a corresponding increase in Capital in excess of par value. In addition, the Company recognized a related deferred tax liability of $18 million due to the difference between the book and tax basis of the Note, with a corresponding decrease in Capital in excess of par value. The debt discount was amortized to interest expense over one year using the effective interest method through December 2003, at which time the Plan Investors elected to extend the term of the Note an additional two years through May 6, 2006. The remaining debt discount as of December 2003 will be recognized over the additional two year term. We recognized an additional $2 million, $8 million, $6 million and $13 million of interest expense due to the amortization of the discount for the 13-weeks ended October 27, 2004 and October 29, 2003, the 39-weeks ended October 27, 2004 and the 26-weeks ended October 29, 2003, respectively. Following is the effect of our restatement on our unaudited condensed consolidated financial statements. 11 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) EFFECT OF THE RESTATEMENTS ON THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED)

12 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The restatement had no effect on the Predecessor Company's unaudited Condensed Consolidated Statement of Operations for the 13-weeks ended April 30, 2003. EFFECT OF THE RESTATEMENTS ON THE CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED)

13 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The deferred tax liability was offset with the Company's other deferred tax liabilities and assets for each period and presented as a single amount in the Consolidated Balance Sheets. The Company had a net deferred tax liability as of October 27, 2004 which was classified in Other long-term liabilities. The Company had a net deferred tax asset as of January 28, 2004 which was classified in Other assets and deferred charges. The Company had a net deferred tax liability as of October 29, 2003 which was classified in Accrued expenses and other liabilities. 14 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) 4. REAL ESTATE AND PROPERTY TRANSACTIONS Home Depot U.S.A., Inc. On June 3, 2004, the Company entered into multiple agreements with Home Depot U.S.A., Inc. (a subsidiary of The Home Depot, Inc.) ("Home Depot") to sell owned properties and assign leased properties for a maximum purchase price of $365 million in cash. These agreements were later amended to reflect that the Company would sell four properties and assign 14 properties for an aggregate purchase price of $271 million. Pursuant to these agreements, on June 15, 2004, the Company completed the sale of four owned properties to Home Depot for $59 million in cash, resulting in a net gain of $43 million. The Company completed the assignment of 13 of the remaining properties in the third quarter of fiscal 2004, resulting in proceeds to the Company of $200 million in cash, and a net gain of $198 million. We anticipate closing on the final property during the fourth quarter, resulting in additional proceeds of $12 million. Sears, Roebuck and Co. On June 29, 2004, the Company entered into an agreement with Sears, Roebuck and Co. ("Sears") to sell owned properties and assign leased properties for a maximum purchase price of $621 million in cash. On September 29, 2004, the Company agreed to sell four owned properties, assign 45 leased properties and lease one owned store to Sears for a total purchase price of approximately $576 million. The Company received 30% of the purchase price in September 2004 upon closing, and recognized a gain on the transaction of $599 million. The remaining 70% of the purchase price will be received when Sears occupies the properties, which shall take place no later than April 15, 2005. The receivable for the remaining purchase price of $403 million is included in Accounts receivable, net in our Unaudited Condensed Consolidated Balance Sheet as of October 27, 2004. ESL and its affiliates own over 10 percent of both Sears and the Company. Other The Company also sold certain other assets, resulting in net gains of $10 million and $71 million for the 13-weeks and 39-weeks ended October 27, 2004, respectively. Included within this gain for the 39-week period was $18 million related to the sale of the Company's Trinidad subsidiary and its associated property, $12 million related to the sale of the Company's corporate airplanes and $41 million from sales of other real and personal property. During the 39-weeks ended October 27, 2004 and the 26-weeks ended October 26, 2003, we purchased 28 and eight previously-leased operating properties for $103 million and $61 million, respectively. 5. PENSION PLAN The following table summarizes the net periodic expense recognized for our qualified employee pension plan.

During the 39-weeks ended October 27, 2004 contributions to the plan were approximately $10 million. Contributions to the plan were not required during fiscal 2003. The minimum required contribution for fiscal 2004 and fiscal 2005 is approximately $11 million and $4 million, respectively. 6. EARNINGS PER SHARE Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during each period. Diluted earnings per share assumes the exercise of stock options, the conversion of convertible debt and the impact of restricted stock when dilutive. 15 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) A reconciliation of basic weighted average common shares outstanding to diluted weighted average common shares outstanding is as follows:

A reconciliation of net income available to common shareholders to net income available to common shareholders with assumed conversions is as follows:

Certain common stock equivalents were excluded from the calculation of diluted earnings per share for the 13-weeks and 39-weeks ended October 27, 2004 as they were anti-dilutive. All common stock equivalents were excluded from the calculation of diluted earnings per share for the 13-weeks ended October 29, 2003 and April 30, 2003 and the 26-weeks ended October 29, 2003 as they were anti-dilutive. Upon our emergence from bankruptcy, all common stock equivalents of the Predecessor Company were cancelled. 7. DEBT Credit Facility Our credit agreement (the "Credit Facility") is an $800 million revolving credit facility with an equivalent letter of credit sub-limit under which Kmart Corporation is the borrower. Availability under the Credit Facility is subject to an inventory borrowing base formula. Since its issuance, we have only used the Credit Facility to support outstanding letters of credit. To reduce the overall cost of the facility, we voluntarily reduced the size of the Credit Facility from $1.5 billion to $1.0 billion in July 2004 and we amended and restated the Credit Facility in October 2004 to eliminate the synthetic term loan provisions, which reduced the size of the Credit Facility from $1.0 billion to $800 million. In conjunction with these reductions to our Credit Facility, the accelerated amortization of the associated debt issuance costs totaled $3 million for the 13-week period and $12 million for the 39-weeks ended October 27, 2004, respectively. The Credit Facility is guaranteed by the Successor Company, Kmart Management Corporation, Kmart Services Corporation (a subsidiary of Kmart Management Corporation) and Kmart Corporation's direct and indirect domestic subsidiaries. The Credit Facility is secured primarily by first liens on inventory, the proceeds thereof and certain related assets of Kmart Corporation and the guarantors. Borrowings under the Credit Facility are subject to a sliding pricing scale based on our earnings before interest, taxes, depreciation, amortization and other charges ("EBITDA") levels and such adjustments are implemented quarterly. Utilization of the Credit Facility in support of trade and standby letters of credit currently bears interest at 1.25% and 2.00% per annum, respectively. In addition, we are required to pay a fee based on the unutilized commitment under the Credit Facility equal to 0.375% per annum. The Credit Facility gives the Company the ability to repurchase up to $500 million of the Company's Common Stock, depending on our EBITDA levels and subject to the approval of the Company's Board of Directors. 16 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) As of October 27, 2004, we had utilized $22 million of the Credit Facility for letters of credit issued for ongoing import purchasing operations, and contractual and regulatory purposes, including letters of credit utilized as collateral to support our self-insurance programs. During fiscal 2004, we have replaced letters of credit used as collateral for certain programs with cash collateral which reduces fees paid by the Company with respect to the letters of credit. We continue to classify the cash collateral as Cash and cash equivalents due to our ability to convert the cash to letters of credit at any time at our discretion. As of October 27, 2004, $221 million of cash was posted as collateral. Total availability under the Credit Facility as of October 27, 2004 was approximately $750 million. The Credit Facility financial covenants include a requirement that we maintain certain availability minimums, and failure to do so triggers additional required minimum levels of EBITDA. The Credit Facility also contains other customary covenants, including certain reporting requirements and covenants that restrict our ability to incur or create liens, indebtedness and guarantees, make investments, pay dividends or make other equity distributions, sell or dispose of stock or assets, change the nature of our business and enter into affiliate transactions, mergers and consolidations. Failure to satisfy these covenants would result in an event of default that could result in our inability to access the funds. As of October 27, 2004, and in all periods since our emergence from Chapter 11, we have been in compliance with all Credit Facility covenants. Letter of Credit Agreement On August 13, 2004, the Company entered into a letter of credit agreement (the "LC Agreement") with a commitment amount of up to $200 million through January 7, 2005, and increasing to $600 million thereafter. Standby letters of credit issued under the LC Agreement bear interest at 0.20% per annum. No interest is charged for trade letters of credit issued under the LC Agreement; however, we are required to pay a fee based on the unutilized commitment, as defined in the LC Agreement, equal to 0.125% per annum. We amended the LC Agreement on October 4, 2004, primarily to provide Kmart with an election to post either cash or inventory as collateral. Electing inventory would result in incremental costs under the LC Agreement. The LC Agreement is subject to a pledge and security agreement pursuant to which, after January 7, 2005, the Company must post as collateral cash in an amount equal to 100.5% of the face value of letters of credit outstanding under the LC Agreement or elect to post inventory as collateral, subject to certain conditions. Prior to January 7, 2005, the collateral posted by the Company is a leasehold mortgage on certain properties leased by the Company. The LC Agreement contains customary covenants, including covenants that restrict our ability to incur or create liens on collateralized assets, and sell, transfer, assign or otherwise dispose of any collateralized assets. Failure to satisfy these covenants would result in an event of default that could result in our inability to issue new letters of credit. Subject to these covenants the Company is required to maintain in a deposit account $250 million of cash invested with the issuing bank until such time that the cash collateral is equal to the 100.5% of the face value of the letters of credit outstanding, as discussed above. This cash is classified as Cash and cash equivalents as of October 27, 2004. As of October 27, 2004, and in all periods since inception of the LC Agreement, we have been in compliance with all covenants of the LC Agreement. As of October 27, 2004, we had utilized $197 million of the LC Agreement. Predecessor Company Debt Borrowings of the Predecessor Company during Chapter 11 proceedings were available through the Court-approved $2 billion debtor-in-possession financing facility ("DIP Credit Facility") for the payment of permitted pre-petition claims, working capital needs, letters of credit and other general corporate purposes. On May 6, 2003, in connection with the Debtors' emergence from Chapter 11, the DIP Credit Facility was terminated. Due to its filing for Chapter 11, the Predecessor Company was in default on all of its debt agreements entered into prior to January 22, 2002. While operating under Chapter 11, the Predecessor Company was prohibited under the Bankruptcy Code from paying interest on unsecured pre-petition debts. On the Petition Date, the Predecessor Company stopped accruing interest on all unsecured pre-petition debt until it emerged from bankruptcy in accordance with SOP 90-7. Contractual interest expense not accrued or recorded by the Predecessor Company on certain pre-petition debt totaled $67 million for the 13-weeks ended April 30, 2003. 17 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) Interest Expense, Net

Cash paid for interest was $42 million, $37 million, and $19 million for the 39-weeks ended October 27, 2004, the 26-weeks ended October 29, 2003 and the 13-weeks ended April 30, 2003, respectively. 8. INCOME TAXES We recorded a tax provision of $334 million and $483 million during the 13-weeks and 39-weeks ended October 27, 2004, respectively, based on the estimated effective tax rate for fiscal 2004 of 37.7%. We recorded a $14 million and $20 million tax benefit from our losses during the 13-weeks and 26-weeks ended October 29, 2003, respectively, based upon the estimated effective tax rate for the 39-weeks ended January 28, 2004 (successor period). The $6 million tax benefit recorded during the first quarter of fiscal 2003 relates to an Internal Revenue Code provision allowing for the 10-year carryback of certain losses. The Predecessor Company recorded a full valuation allowance against its net deferred tax assets in accordance with SFAS No. 109, "Accounting for Income Taxes," as realization of such assets in future years was uncertain. Accordingly, no tax benefit was realized from the Predecessor Company's losses in the first quarter of fiscal 2003. Given the Company's actual and forecasted levels of profitability in fiscal 2004, management believes that a portion of the pre-emergence net deferred tax assets will more likely than not be realized. As such, the Company reduced the valuation allowance on its pre-emergence net deferred tax assets by $92 million in the second quarter of fiscal 2004 to reflect its estimated utilization through the end of fiscal 2004. The Company will continue to assess the likelihood of realization of its pre-emergence net deferred tax assets and would reduce the valuation allowance on such assets in the future if it becomes more likely than not that the net deferred tax assets will be utilized. In accordance with SOP 90-7, subsequent to emergence from Chapter 11, the benefit from the reduction of the valuation allowance on pre-emergence deferred tax assets is recorded as a direct credit to Capital in excess of par value with no impact on the Company's earnings or cash flows. During the second quarter of fiscal 2004 and the third quarter of fiscal 2003, we reduced our reserves for Predecessor Company income tax liabilities by $5 million and $24 million, respectively, primarily due to favorable claims settlements. We recorded these adjustments to Capital in excess of par value in our Unaudited Condensed Consolidated Balance Sheets. Cash paid for income taxes was $4 million for the 39-weeks ended October 27, 2004. Cash received for tax refunds and credits was $6 million and $2 million for the 26-weeks ended October 29, 2003 and the 13-weeks ended April 30, 2003, respectively. 9. TREASURY STOCK The Company has a share repurchase program with authorization to repurchase $100 million of Common Stock. Since the inception of the share repurchase program in fiscal 2003, we have repurchased 128,400 shares of Common Stock for grants of stock based compensation (weighted-average price of $28.87 per share) at a cost of approximately $4 million. During fiscal 2004, we were assigned 507,974 shares of common stock (weighted average price of $76.14 per share) with an approximate value of $39 million. These assignments were the result of settlement agreements resolving claims arising from our Chapter 11 reorganization; see Note 2 - Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting. 18 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) There were 499,506, 43,749 and 48,953 shares in treasury as of October 27, 2004, January 28, 2004 and October 29, 2003, respectively. 10. STOCK-BASED COMPENSATION The Company accounts for stock-based compensation using the fair value method. Upon the departure of our former President and Chief Executive Officer, Julian C. Day, in October 2004, the vesting period for 778,880 stock options was accelerated and 389,439 stock options were cancelled effective immediately, as required by the terms of his nonqualified stock option agreement, as amended, with the Company. The accelerated vesting resulted in $2 million of compensation cost to be recognized during the 13-weeks ended October 27, 2004. On October 18, 2004, the Company's new President and Chief Executive Officer, Aylwin B. Lewis, was granted 150,000 options to purchase shares of Common Stock with a grant price of $88.62 per share and 50,781 shares of restricted stock at a grant price of $88.62 per share. These grants vest in installments over 4.25 years from the grant date and we will recognize compensation expense of approximately $10 million during this same period. The options expire 10 years from the date of grant. The Predecessor Company accounted for stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations, which did not require the recognition of expense for the fair value of stock-based compensation. In accordance with the disclosure requirements of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123" the pro forma effects of recognizing the fair value of stock-based compensation on net loss and loss per share had the Predecessor Company applied the fair value method to stock options granted by the Predecessor Company would have resulted in a pro forma adjustment of $38 million for stock-based employee compensation income, a pro forma net loss of $824 million and a pro forma basic/diluted loss per share of $1.58 for the 13-weeks ended April 30, 2003. Pro forma stock-based employee compensation income of $38 million for the 13-weeks ended April 30, 2003 is due to the reversal of expense for options that were not vested upon cancellation of the outstanding stock awards of the Predecessor Company. Upon our emergence from Chapter 11, all outstanding stock options of the Predecessor Company were cancelled in accordance with the Plan of Reorganization. We account for restricted stock grants as fixed awards, and record deferred employee compensation to Capital in excess of par value. During the 39-weeks ended October 27, 2004, we granted 82,842 shares of restricted stock at a weighted average price of $66.39 per share. During the 26-weeks ended October 29, 2003 we granted 68,436 shares of restricted stock at a weighted average price of $29.22 per share. As of October 27, 2004, deferred employee compensation on all outstanding restricted stock grants is $7 million and is being amortized to compensation expense on a straight-line basis over the vesting period of three to four years. 11. PROPERTY HELD FOR SALE Property held for sale was $30 million, $56 million and $70 million as of October 27, 2004, January 28, 2004 and October 29, 2003, respectively, and is included within Other current assets in our Unaudited Condensed Consolidated Balance Sheets. During the 13-weeks and 39-weeks ended October 27, 2004, we sold $5 million and $22 million of these assets for a gain of $1 million and $1 million, respectively. During the second and third quarters of fiscal 2003, we sold $90 million of assets classified as property held for sale for a net gain of $2 million. See Note 4 - Real Estate and Property Transactions for further discussion of these transactions. 12. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) represents net income or loss, adjusted for the effect of other items that are recorded directly to shareholders' equity. During the 39-weeks ended October 27, 2004, we sold available-for-sale equity securities and in conjunction with these sales, reduced accumulated other comprehensive income by $1 million. Comprehensive income and net income are equivalent for the 13-weeks ended October 27, 2004. For the 13-weeks ended April 30, 2003, comprehensive loss included a minimum pension liability adjustment of $94 million. No adjustments were made to comprehensive income (loss) for the 13-weeks and 26-weeks ended October 29, 2003. 19 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 13. INVESTMENTS IN AFFILIATED RETAIL COMPANIES Kmart footwear departments are operated under a master agreement with Footstar, Inc. ("FTS") and related license agreements with certain Meldisco subsidiaries of FTS, most of which are 49% owned by Kmart and 51% owned by FTS. On March 2, 2004, FTS and its direct and indirect subsidiaries, including all Meldisco subsidiaries, filed for Chapter 11 protection in the United States Bankruptcy Court for the Southern District of New York. FTS continues to operate its businesses and manage its properties as debtors-in-possession. Given the likelihood of future receipts of the amounts due from the Meldisco subsidiaries with which we do business, no valuation reserve has been established for $24 million due to us from FTS as of October 27, 2004. On August 12, 2004, FTS filed a motion with the bankruptcy court to assume the master agreement and the license agreements. On September 30, 2004, the Company objected to that motion, and also filed a separate motion to terminate the master agreement and the license agreements because of various defaults by FTS under the agreements. Should the bankruptcy court overrule the Company's objection and permit FTS to assume the master agreement and the license agreements, FTS must cure all past defaults under those agreements. On July 26, 2004, the Company filed a proof of claim in the FTS bankruptcy case for an amount in excess of our recorded receivable of $24 million; however, at this time, we are not able to accurately determine the ultimate amount to be realized as we have not received all information from FTS necessary for us to complete our claim. The Company believes the cure amount may be substantially in excess of $24 million. FTS asserts that the amount required to cure past defaults is $18 million, and that such amount should be reduced by overpayments FTS alleges it made to the Company for certain fees. If no resolution is achieved consensually with FTS with respect to the assumption of the master agreement, the license agreements and the cure amount, and the bankruptcy court permits FTS to assume the master agreement and the license agreements, the cure amount will be determined by the bankruptcy court. In September 2004, FTS restated six years of its consolidated financial statements for fiscal years 1997 through 2002. These restatements have not had a significant effect on our previously reported equity income derived from our investment in the Meldisco subsidiaries. FTS has yet to file audited financial statements and periodic reports for fiscal years 2003 and periodic reports for the first three quarters of fiscal 2004. We have received preliminary financial results from FTS for fiscal 2003 and for the first two quarters of fiscal 2004 as of the filing of this quarterly report on our Form 10-Q. These statements provide the basis of our estimate of equity income as presented in our Unaudited Condensed Consolidated Statements of Operations for the Meldisco subsidiaries with which we do business. We have not received preliminary financial statements for the third quarter of fiscal 2004. The Company has reviewed FTS' monthly operating reports for periods following its Chapter 11 filing, and noted that FTS has allocated certain of its reorganization and other costs to the Meldisco business. These charges have adversely impacted our estimated earnings recorded in fiscal 2004. We disagree with FTS' approach and have notified FTS of our position. The table below lists the net sales at our footwear departments for those Meldisco subsidiaries and our equity income earned from those Meldisco subsidiaries for the 13-weeks ended October 27, 2004, October 29, 2003 and April 30, 2003, the 39-weeks ended October 27, 2004 and the 26-weeks ended October 29, 2003.

14. BARTER TRANSACTIONS In fiscal 2004, we entered into barter transactions for advertising services with The WB Television Network ("The WB") and E! Entertainment Television, Inc. ("E!"). We promoted The WB in a significant number of our television, newspaper and other advertising expenditures during the third quarter of fiscal 2004. In return, we received advertising on certain television shows of The WB. We are promoting E! in our print advertising from August 2004 through November 2004, and we are receiving apparel promotions on the E! News Live show for a comparable period. 20 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) We recognize barter revenue in accordance with Emerging Issues Task Force No. 99-17 ("EITF 99-17"), "Accounting for Advertising Barter Transactions." In accordance with EITF 99-17, the fair value of these barter arrangements was not determinable and therefore the revenue and expenses were not recognized in our Unaudited Condensed Consolidated Statements of Operations. 15. RELATED PARTY TRANSACTIONS As further discussed in the Company's MD&A, the Company is considering various uses of its cash, including investments in various forms of securities. The Board of Directors of the Company has delegated authority to invest the Company's surplus cash, to Edward Lampert, subject to various limitations including those in the Company's existing Credit Facility as well as additional limitations that have been or may be from time to time adopted by the Board of Directors and/or the Finance Committee of the Board of Directors. Mr. Lampert is Chairman of the Company's Board of Directors and is the Chairman and Chief Executive Officer of ESL. Neither Mr. Lampert nor ESL will receive compensation for any such investment activities undertaken on behalf of the Company. Further, to clarify the expectations that the Board of Directors has with respect to the investment of our surplus cash, the Board has renounced, in accordance with Delaware law, any interest or expectancy of the Company associated with any investment opportunities in securities that may come to the attention of Mr. Lampert or any employee, officer, director or adviser to ESL and its affiliated investment entities who also serves as an officer or director of the Company (each, a "Covered Party") other than (a) investment opportunities that come to such Covered Party's attention directly and exclusively in such Covered Party's capacity as a director of, officer or employee of the Company, (b) control investments in companies in the mass merchandise or discount retailing industry and (c) investment opportunities in companies or assets with a significant role in the Company's retailing business, including investment in real estate currently leased by the Company or in suppliers for which the Company is a substantial customer representing over 10% of such companies' revenues, unless in any such instance ESL has a pre-existing investment. During the second quarter of fiscal 2004, ESL hired an employee of the Company. This employee has assumed the role of Vice President of ESL, and will continue to serve Kmart as Vice President - In-Store Business Development. 16. CORPORATE COST REDUCTION AND ASSOCIATE TERMINATION BENEFITS We initiated a corporate cost reduction program in August 2004, and in connection with this program, eliminated approximately 250 positions at our corporate headquarters in Troy, Michigan. Severance benefits, outplacement services and continuing health insurance benefits, which amounts were based on employees' years of service and job grade, aggregating $6 million will be paid to affected employees primarily through the end of the year. The anticipated annual savings of this action is $18 million on a pre-tax basis. We are also continuing efforts to reduce other corporate non-payroll expenses. Upon the resignation of our former President and Chief Executive Officer, he received a $2 million severance payment, pro-rata portions of his annual and Long Term Incentive Plan bonuses and accelerated vesting of 778,880 stock options, all as required by various agreements with the Company. In conjunction with these actions, we incurred compensation expense of $5 million in the third quarter of fiscal 2004, which is recorded in SG&A in our Unaudited Condensed Consolidated Statement of Operations for the 13-weeks and 39-weeks ended October 27, 2004. 17. DISCONTINUED OPERATIONS During the first quarter of fiscal 2003, the Predecessor Company closed 316 stores, of which 66 stores met the criteria to be accounted for as discontinued operations. The Company applied the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," ("SFAS No. 144") which requires closed stores to be classified as discontinued operations when the operations and cash flows of the stores have been (or will be) eliminated from ongoing operations and the company no longer has any significant continuing involvement in the operations associated with the stores after closure. The table below sets forth the components of the net loss associated with the discontinued operations for the 13-weeks ended April 30, 2003. 21 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The Company applied the provisions of SFAS No. 144 to the stores sold to Home Depot and Sears and determined that none of the stores met the criteria to be accounted for as discontinued operations. 18. SPECIAL CHARGES Special charges are transactions which, in management's judgment, may make meaningful comparisons of operating results between reporting periods difficult. In determining what amounts constitute a special charge, management considers the nature, magnitude and frequency of their occurrence. During fiscal 2002, the Predecessor Company instituted certain restructuring actions to improve operations and executed significant inventory liquidations as a result of the stores closed under Chapter 11 proceedings. The effects of these actions on the 13-weeks ended April 30, 2003 are summarized below. Corporate Cost Reduction Initiatives During fiscal 2002 and the 13-weeks ended April 30, 2003, the Predecessor Company eliminated approximately 950 positions with an initial charge of $50 million recorded in fiscal 2002. The Predecessor Company reduced its reserve for such corporate cost reductions by $10 million in the 13-weeks ended April 30, 2003, as a result of a change in the estimated expenses. This reduction is included in Restructuring, impairment and other charges in the Unaudited Condensed Consolidated Statements of Operations. Accelerated Depreciation The Predecessor Company recorded charges of $52 million during the 13-weeks ended April 30, 2003 for accelerated depreciation on unimpaired assets to be disposed of following the 316 store closings. Of the $52 million recorded, $47 million is included in Restructurings, impairments and other charges and $5 million is included in Discontinued operations in the Unaudited Condensed Consolidated Statements of Operations. Reserve Activity As part of Fresh-Start accounting, reserves established in connection with certain restructurings were discharged as of April 30, 2003 in accordance with the Plan of Reorganization. See Note 2 - Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting for a detailed discussion of the discharge of Liabilities subject to compromise under the Plan of Reorganization. 19. REORGANIZATION ITEMS, NET Reorganization items represent amounts the Predecessor Company incurred as a result of its Chapter 11 reorganization, and are presented separately in the Unaudited Condensed Consolidated Statements of Operations. For the 13-weeks ended April 30, 2003, the following were recorded: 22 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The following paragraphs provide additional information relating to costs that were recorded in Reorganization items, net in the Unaudited Condensed Consolidated Statement of Operations for the 13-weeks ended April 30, 2003. Gain on extinguishment of debt/Revaluation of assets and liabilities See Note 2 - Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting for a discussion on the extinguishment of debt and the revaluation of assets and liabilities. Fleming settlement On February 3, 2003, the Predecessor Company announced the termination of the supply relationship with Fleming Companies, Inc. ("Fleming") by means of a rejection of the 2001 contract through the Debtor's Chapter 11 reorganization. As part of the bankruptcy proceedings, Fleming filed a claim of $1.5 billion on March 11, 2003. The Predecessor Company and Fleming came to an agreement on a settlement of Fleming's claims, and on March 27, 2003, the Court approved the settlement of all claims asserted by Fleming. Under the settlement, the Predecessor Company paid Fleming $15 million of Fleming's net post-petition administrative claim, which exceeded $30 million. Additionally, Fleming's general unsecured claim was reduced from approximately $1.5 billion to $385 million, which was recorded in the first quarter of fiscal 2003. Estimated claims for rejected executory contracts For the 13-weeks ended April 30, 2003, the Predecessor Company recorded expense of $200 million for estimated allowable claims for rejected executory contracts, primarily equipment leases and service contracts. The estimate was based on a review of each class of contract. On April 30, 2003, upon adoption of Fresh-Start accounting, these liabilities were discharged in accordance with the Plan of Reorganization; see Note 2 - Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting. 2003 store closings As a result of the decision to close the 316 stores, the Predecessor Company recorded a charge of $214 million in the first quarter of fiscal 2003 for lease terminations and other costs, of which $56 million is included in Discontinued operations and the remaining $158 million is included in Reorganization items, net in the Unaudited Condensed Consolidated Statements of Operations. Other reorganization items For the 13-weeks ended April 30, 2003, the Predecessor Company recorded professional fees of $43 million, employee costs of $66 million relating to the Key Executive Retention Program, a gain of $17 million for the sale of pharmacy customer lists, income of $65 million for lease auction proceeds related to the 2003 and 2002 closed stores, a gain of $15 million for the settlement of pre-petition liabilities and net expenses of $14 million for other miscellaneous reorganization items. 23 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 20. COMMITMENTS AND CONTINGENCIES Other and Routine Actions On November 7, 2003, the Company filed suit in the United States District Court for the Eastern District of Michigan, which was later dismissed and refiled in the Oakland County Circuit Court (State of Michigan), against Capital One Bank, Capital One, F.S.B., and Capital One Services, Inc. (collectively, "Capital One"). The complaint, as amended, alleges breach of contract, tortious interference with business relationships, misappropriation of a trade secret, trademark infringement, and a violation of the Michigan Consumer Protection Act, which claims arise out of Capital One's alleged failure to market and support a co-branded credit card under an agreement the parties had with respect to a Kmart MasterCard. Kmart is seeking monetary damages. Capital One has filed a motion to dismiss; a hearing on that motion has not been scheduled. Trial is currently set for June, 2005. Discovery is proceeding. On September 24, 2004, the Company filed suit against i2 Technologies, Inc. ("i2") and two of its senior executives in the District Court for Dallas County, Texas. The suit alleges fraud, breach of contract and rescission arising out of the September 29, 2000 contract between Kmart and i2 for software licenses, software development and consulting work (the "Contract"). After entering into the Contract, Kmart experienced difficulty in integrating the new software. Kmart also discovered that several of the software component packages it had purchased did not exist. Kmart is seeking monetary damages. There are no court dates set yet. In Capital Factors v. Kmart Corporation, the United States District Court for the Northern District of Illinois ruled that the Court did not have the authority to authorize the payment of pre-petition claims of certain trade vendors by the Company. That ruling was appealed by the Company to the Seventh Circuit Court of Appeals. The Seventh Circuit upheld the decision of the District Court. Critical vendors sought a rehearing by the Seventh Circuit, which was denied, and filed petitions for Writ of Certiorari to the Supreme Court, which were also denied. In order to satisfy our fiduciary responsibility to pursue claims against the critical vendors, on January 26, 2004 we filed 45 lawsuits against a total of 1,189 vendors that received these payments. Subsequently, many of the cases were severed into lawsuits against individual defendants although all cases are proceeding on a common pretrial procedural track. The lawsuits seek to recover critical vendor payments in excess of $174 million. The Company notified affected vendors that we are willing to settle these claims for a percentage of the money they received, based on the amount of the claim. The ultimate amount of recovery can not be determined at this time. As of October 27, 2004, Kmart has settled 215 critical vendor claims. We are a party to a substantial number of other claims, lawsuits and pending actions which are routine and incidental to our business. To the extent that any such claim relates to a contract which was assumed by us when we emerged from Chapter 11 or relates to a time period occurring after the Petition Date, the Company shall be responsible for any damages which may result. In addition, certain contracts allow for damage provisions or other repayments as a result of our termination of the contracts. We assess the likelihood of potential losses on an ongoing basis, and when they are considered probable and reasonably estimable, we record an estimate of the ultimate outcome. If there is no single point estimate of loss that is considered more likely than others, an amount representing the low end of the range of possible outcomes is recorded. Our Unaudited Condensed Consolidated Balance Sheet as of October 27, 2004 only reflects potential losses for which the Company may have ultimate responsibility. 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS Part I, Item 2 of this report should be read in conjunction with Part II, Item 7 of our Annual Report on Form 10-K/A for the year ended January 28, 2004. The information contained herein is not a comprehensive discussion and analysis of the financial condition and results of operations of the Company, but rather an update of the previous disclosures. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Form 10-Q/A, as well as other statements or reports made by or on behalf of Kmart, which address activities, events or developments that we expect or anticipate may occur in the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, that reflect, when made, Kmart's current views with respect to current events and financial performance. The words "believe," "expect," "anticipate," "project," and similar expressions, among others, generally identify "forward-looking statements," which speak only as of the date the statement was made. Such forward-looking statements are based upon assumptions concerning future conditions that may ultimately prove to be inaccurate and involve risks, uncertainties and factors that could cause actual results to differ materially from any anticipated future results, express or implied by such forward-looking statements. Factors that could cause actual results to differ materially from these forward-looking statements include, but are not limited to, factors relating to Kmart's internal operations and the external environment in which it operates; Kmart's ability to successfully implement business strategies and otherwise fund and execute planned changes in various aspects of the business; marketplace demand for the products of Kmart's key brand partners, as well as the engagement of appropriate new brand partners; changes in consumer spending and Kmart's ability to anticipate buying patterns and implement appropriate inventory strategies; Kmart's ability to reverse its negative same-store sales trend; competitive pressures and other third party actions, including pressures from pricing and other promotional activities of competitors, as well as new competitive store openings; Kmart's ability to properly monitor its inventory needs in order to timely acquire desired goods in appropriate quantities and/or fulfill labor needs at planned costs; Kmart's ability to attract and retain customers; Kmart's ability to maintain normal terms with vendors and service providers; Kmart's ability to maintain contracts, including leases, that are critical to its operations; Kmart's ability to develop a market niche; regulatory and legal developments; general economic conditions; weather conditions, including those which affect buying patterns of Kmart's customers; other factors affecting business beyond Kmart's control; and Kmart's ability to attract, motivate and/or retain key executives and associates. Kmart undertakes no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances after the date such statements were made. Consequently, all of the forward-looking statements are qualified by these cautionary statements and there can be no assurance that the results or developments anticipated will be realized or that they will have the expected effects on our business or operations. The forward-looking statements contained herein or otherwise that we make or are made on our behalf speak only as of the date of this report, or if not contained herein, as of the date when made, and we do not undertake to update these risk factors or such forward-looking statements. 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) RESULTS OF OPERATIONS The results of operations presented below reflect certain restatements to our previously reported results of operations for the 13-weeks ended October 27, 2004 and October 29, 2003, the 39-weeks ended October 27, 2004, and the 26-weeks ended October 29, 2003. See Note 3 - Restatement for a discussion of the restatement. The following table is presented solely to complement management's discussion and analysis.

13-WEEKS ENDED OCTOBER 27, 2004 COMPARED TO 13-WEEKS ENDED OCTOBER 29, 2003 Same-store sales and total sales decreased 12.8% and 13.7%, respectively, for the 13-weeks ended October 27, 2004 as compared to the 13-weeks ended October 29, 2003. Same-store sales include sales of all open stores that have been open for more than 13 full months. The decline in same-store and total sales has been affected by soft customer demand during the back-to-school season, less promotional advertising in our circulars and increased competition at certain store locations. Favorable markon, improvements in shrink, and reductions in markdowns on promotional and clearance items were the primary factors improving our gross margin rate this quarter. This improvement in the current quarter was partially offset by the effect of the decline in sales on certain fixed operating costs. As a result, gross margin as a percentage of sales increased to 26.1% for the 13-weeks ended October 27, 2004, from 22.9% in the prior year comparable quarter. Gross margin decreased $22 million to $1.15 billion, for the 13-weeks ended October 27, 2004, from $1.17 billion for the 13-weeks ended October 29, 2003. Selling, general and administrative expenses ("SG&A") decreased $136 million to $1.04 billion for the 13-weeks ended October 27, 2004, from $1.18 billion for the 13-weeks ended October 29, 2003. SG&A, as a percentage of sales, increased to 23.7% for the 13-weeks ended October 27, 2004, from 23.2% in the prior year comparable quarter. The decline in SG&A resulted from a reduction in store payroll and related expenditures due to increased operating efficiencies and reduced sales volume at our stores, and to reductions in newspaper advertising. Included in SG&A for the period is compensation expense of $5 million related to the departure of our former President and Chief Executive Officer. 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) Operating income for the 13-weeks ended October 27, 2004 was $909 million, or 20.7% of sales, as compared to a loss of $11 million, or (0.2%) of sales, for the same period in the prior year. Adjusted operating income for the 13-weeks ended October 27, 2004 was $102 million, or 2.3% of sales, as compared to a loss of $(12) million, or (0.2%) of sales, for the same period in the prior year. Adjusted operating income for the 13-weeks ended October 27, 2004 and October 29, 2003 exclude $807 million and $1 million of gains on sales of assets, respectively, primarily related the previously announced transactions with Home Depot and Sears; see Note 4 - Real Estate and Property Transactions. See below for a discussion of adjusted operating income as a non-GAAP measure. Operating income increased in the current quarter due to the decrease in SG&A as compared to the prior quarter in fiscal 2003, as discussed above. Interest expense, net for the 13-weeks ended October 27, 2004 and October 29, 2003 was $24 million and $32 million, respectively. During the 13-weeks ended October 27, 2004, $13 million of interest expense was recorded for the accretion of obligations recorded at net present value. To reduce the overall cost of our Credit Facility, we restated and amended it in October 2004, reducing the facility from $1.0 billion to $800 million. We recognized $6 million of debt issuance costs in Interest expense, net for the 13-weeks ended October 27, 2004, $3 million of which we accelerated in conjunction with the reduction to our Credit Facility. Interest expense is net of interest income of $9 million and $2 million for the 13-weeks ended October 27, 2004 and October 29, 2003, respectively. The effective income tax rate was 37.7% and (33.3%) for the 13-weeks ended October 27, 2004 and October 29, 2003, respectively; see Note 8 - Income Taxes for a more detailed discussion. The following table is presented solely to complement management's discussion and analysis.

27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) 26-WEEKS ENDED OCTOBER 27, 2004 COMPARED TO 26-WEEKS ENDED OCTOBER 29, 2003 Same-store sales and total sales decreased 13.9% and 14.6%, respectively, for the 26-weeks ended October 27, 2004 as compared to the 26-weeks ended October 29, 2003. Factors contributing to the decline in same store and total sales included reductions in promotional events and promotional advertising in our circulars, soft customer demand during the back-to-school season and increased competition at certain store locations. Favorable markon, improvements in shrink, and reductions in markdowns on promotional and clearance items were the primary factors improving our gross margin rate this period. The margin rate improvement in the current period was partially offset by the effect of the decline in sales on certain fixed operating costs. As a result, gross margin as a percentage of sales increased to 26.0% for the 26-weeks ended October 27, 2004, from 22.3% for the 26-weeks ended October 29, 2003. Gross margin decreased $13 million to $2.39 billion, for the 26-weeks ended October 27, 2004, from $2.40 billion for the 26-weeks ended October 29, 2003. SG&A decreased $322 million for the 26-weeks ended October 27, 2004 to $2.08 billion, or 22.7% of sales, from $2.40 billion, or 22.4% of sales, for the 26-weeks ended October 29, 2003. The decline resulted from a reduction in store payroll and related expenditures due to increased operating efficiencies and reduced sales volume at our stores, and to reductions in newspaper advertising. The remaining net reduction in SG&A is due primarily to continued efforts to reduce our operating costs. Operating income for the 26-weeks ended October 27, 2004 was $1.18 billion as compared to a loss of $1 million for the same period of the prior year. Adjusted operating income for the 26-weeks ended October 27, 2004 was $305 million as compared to a loss of $4 million, for the same period in the prior year. Adjusted operating income for the 26-weeks ended October 27, 2004 and October 29, 2003 exclude $879 million and $3 million of gains on sales of assets, respectively, primarily related to the previously announced transactions with Home Depot and Sears; see Note 4 - Real Estate and Property Transactions. See below for a discussion of adjusted operating income as a non-GAAP measure. Operating income also increased in the current period due to the decrease in SG&A as compared to the prior period in fiscal 2003, as discussed above. Interest expense, net for the 26-weeks ended October 27, 2004 and October 29, 2003 was $57 million and $58 million, respectively. To reduce the overall cost of the facility, we voluntarily reduced the size of the Credit Facility from $1.5 billion to $1.0 billion in July 2004 and we amended and restated the Credit Facility in October 2004 to eliminate the synthetic term loan provisions, which reduced the size of the Credit Facility from $1.0 billion to $800 million. We recognized $18 million of debt issuance costs in Interest expense, net for the 26-weeks ended October 27, 2004, $12 million of which we accelerated in conjunction with the reduction to our Credit Facility. During the 26-weeks ended October 27, 2004, $26 million of interest expense was recorded for the accretion of obligations recorded at net present value. Interest expense is net of interest income of $16 million and $4 million for the 26-weeks ended October 27, 2004 and October 29, 2003, respectively. Effective income tax rate was 37.7% and (35.7%) for the 26-weeks ended October 27, 2004 and October 29, 2003, respectively. 13-WEEKS ENDED APRIL 28, 2004 COMPARED TO 13-WEEKS ENDED APRIL 30, 2003 Same-store sales and total sales decreased 12.9% and 25.3%, respectively, for the 13-weeks ended April 28, 2004 as compared to the 13-weeks ended April 30, 2003. The decrease in same-store sales is due primarily to several Company-wide promotional events occurring in the first quarter of fiscal 2003 along with a reduction in advertising, including the frequency of mid-week circulars in the current year. The decrease in total sales is attributable to the decrease in same-store sales and the closure of 316 stores in the first quarter of fiscal 2003. Gross margin decreased $282 million to $1.14 billion, for the 13-weeks ended April 28, 2004, from $1.42 billion for the 13-weeks ended April 30, 2003. Gross margin, as a percentage of sales, increased to 24.6% for the 13-weeks ended April 28, 2004, from 23.0% for the 13-weeks ended April 30, 2003. Favorably affecting the gross margin rate were fewer clearance markdowns and reduced depreciation as a result of the write-off of long-lived assets in conjunction with the application of Fresh-Start accounting. 28 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) SG&A decreased $417 million to $1.0 billion, or 21.8% of sales for the 13-weeks ended April 28, 2004, from $1.42 billion, or 23.0% of sales, for the 13-weeks ended April 30, 2003. The decrease in SG&A resulted from reduced payroll and related expenses in our stores during the first quarter of the current year, as well as the effect of store closings and corporate cost reduction initiatives implemented in the first quarter of fiscal 2003. Also affecting the decline was a reduction in advertising expenses and lower depreciation as a result of the write-off of long-lived assets in conjunction with the application of Fresh-Start accounting. Operating income for the 13-weeks ended April 28, 2004 was $165 million, or 3.6% of sales, as compared to a loss of $39 million, or (0.6%) of sales, for the same period in the prior year. The improvement was primarily due to the decrease in SG&A and the improvement in our gross margin rate, as discussed above, partially offset by an overall decline in gross margin dollars due to our reduced store base. Operating income was also affected by net gains on sales of assets of $32 million in the first quarter of the current year and Restructuring, impairment and other charges of $37 million in the first quarter of fiscal 2003. Interest expense, net for the 13-weeks ended April 28, 2004 and April 30, 2003 was $28 million and $57 million, respectively. During the 13-weeks ended April 28, 2004, $12 million of interest expense was recorded for the accretion of obligations recorded at net present value. Included in interest expense for the 13-weeks ended April 30, 2003 was $37 million of amortization of debt issuance costs associated with the Predecessor Company's Court-approved $2 billion debtor-in-possession financing facility. Interest at the stated contractual amount on unsecured debt that was not charged to earnings for the 13-weeks ended April 30, 2003 was $67 million. Interest expense is net of interest income of $5 million and $1 million for the 13-weeks ended April 28, 2004 and April 30, 2003, respectively. The effective income tax rate was 38.1% and (0.7%) for the 13-weeks ended April 28, 2004 and April 30, 2003, respectively; see Note 8 - Income Taxes for a more detailed discussion. 39-WEEKS ENDED OCTOBER 27, 2004 (SUCCESSOR COMPANY) Due to the application of Fresh-Start accounting upon our emergence from bankruptcy, the reported historical financial statements of the Predecessor Company for periods prior to May 1, 2003 generally are not comparable to those of the Successor Company. Total sales were $13.79 billion for the 39-weeks ended October 27, 2004. Same-store sales decreased 13.6%. Reductions in promotions and advertising, including the frequency of mid-week circulars in the current year, have affected same-store sales and total sales. Gross margin for the 39-weeks ended October 27, 2004 was $3.52 billion or 25.6% of sales. A reduction in clearance markdowns and improvements in shrink favorably affected gross margin in the current period. Included in gross margin was a $22 million charge in conjunction with store closings inventory liquidations. SG&A was $3.09 billion or 22.4% of sales for the period. Reduced payroll and related expenses at our stores, as well as a reduction in advertising expenses favorably affected SG&A for the period. Operating income for the 39-weeks ended October 27, 2004 was $1.35 billion, or 9.8% of sales. Operating income was favorably affected by the improvements in gross margin and reductions in SG&A, as discussed above. Adjusted operating income for the 39-weeks ended October 27, 2004 was $438 million, which excludes gains on sales of assets of $911 million, primarily related to the previously announced transactions with Home Depot and Sears - see Note 4 - Real Estate and Property Transactions. See below for a discussion of adjusted operating income as a non-GAAP measure. Interest expense, net for the 39-weeks ended October 27, 2004 was $85 million. To reduce the overall cost of the facility, we voluntarily reduced the size of the Credit Facility from $1.5 billion to $1.0 billion in July 2004 and we amended and restated the Credit Facility in October 2004 to eliminate the synthetic term loan provisions, which reduced the size of the Credit Facility from $1.0 billion to $800 million. We recognized $22 million of debt issuance costs in Interest expense, net for the 39-weeks ended October 27, 2004, $12 million of which we accelerated in conjunction with the reduction to our Credit Facility. During the 39-weeks ended October 27, 2004, $38 million of interest expense was recorded for the accretion of obligations recorded at net present value. Interest expense is net of interest income of $21 million. 29 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) The effective income tax rate was 37.7% for the 39-weeks ended October 27, 2004; see Note 8 - Income Taxes for a more detailed discussion. NON-GAAP MEASURES Adjusted operating income is a non-GAAP measure. The Company has provided this non-GAAP measure as we believe the significant gains on sales of assets realized in the current period do not reflect the results from our core business, and they distort the ability to assess the quality of our earnings. The non-GAAP measure provides a more meaningful comparison of our ongoing results and helps facilitate an analysis of the Company's operating performance. In addition, management ignores the impact of these gains when assessing the Company's results for the period. This non-GAAP financial measure should be evaluated in conjunction with, and is not a substitute for, GAAP financial measures. Following is a reconciliation of adjusted results to GAAP results:

LIQUIDITY AND FINANCIAL CONDITION Kmart continued to maintain strong liquidity for the 39-weeks ended October 27, 2004 with cash flow from operations of $171 million and $524 million in proceeds from asset sales. Our principal cash needs are for our operations and capital expenditures, which have been satisfied through our net earnings and our existing $2.6 billion balance in cash and cash equivalents as of October 27, 2004. Working capital required for our business is significantly affected by our level of sales, seasonality and the credit extended by our vendors. In addition, we have funds available under our Credit Facility. From its inception, we have only used the Credit Facility to support issuances of letters of credit. However, should we experience significant negative sales trends, a significant disruption of terms with our vendors, the Credit Facility for any reason becomes unavailable and/or actual results differ materially from those projected, our compliance with financial covenants and our cash resources could be adversely affected. The Company continues to explore various alternatives to reduce the cost and improve the terms of our Credit Facility to reflect the improvement in the Company's financial condition. In the normal course of business, the Company considers opportunities to purchase leased operating properties, as well as offers to sell owned or if leased, assign operating and non-operating properties. These transactions may, individually or in the aggregate, result in material proceeds or outlays of cash. In addition, the Company reviews leases that will expire in the short-term in order to determine the appropriate action to take with respect to the lease. CREDIT FACILITY Our credit agreement (the "Credit Facility") is an $800 million revolving credit facility with an equivalent letter of credit sub-limit under which Kmart Corporation is the borrower. Availability under the Credit Facility is subject to an inventory borrowing base formula. Since its issuance, we have only used the Credit Facility to support outstanding letters of credit. To reduce the overall cost of the facility, we voluntarily reduced the size of the Credit Facility from $1.5 billion to $1.0 billion in July 2004 and we amended and restated the Credit Facility in October 2004 to eliminate the synthetic term loan provisions, which reduced the size of the Credit Facility from $1.0 billion to $800 million. In conjunction with these reductions to our Credit Facility, the accelerated amortization of the associated debt issuance costs totaled $3 million for the 13-week period and $12 million for the 39-weeks ended October 27, 2004, respectively. The Credit Facility is guaranteed by the Successor Company, Kmart Management Corporation, Kmart Services Corporation (a subsidiary of Kmart Management Corporation) and Kmart Corporation's direct and indirect domestic subsidiaries. The Credit Facility is secured primarily by first liens on inventory, the proceeds thereof and certain related assets of Kmart Corporation and the guarantors. 30 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) Borrowings under the Credit Facility are subject to a sliding pricing scale based on our earnings before interest, taxes, depreciation, amortization and other charges ("EBITDA") levels and such adjustments are implemented quarterly. Utilization of the Credit Facility in support of trade and standby letters of credit currently bears interest at 1.25% and 2.00% per annum, respectively. In addition, we are required to pay a fee based on the unutilized commitment under the Credit Facility equal to 0.375% per annum. The Credit Facility gives the Company the ability to repurchase up to $500 million of the Company's Common Stock, depending on our EBITDA levels and subject to the approval of the Company's Board of Directors. As of October 27, 2004, we had utilized $22 million of the Credit Facility for letters of credit issued for ongoing import purchasing operations, and contractual and regulatory purposes, including letters of credit utilized as collateral to support our self-insurance programs. During fiscal 2004, we have replaced letters of credit used as collateral for certain programs with cash collateral which reduces fees paid by the Company with respect to the letters of credit. We continue to classify the cash collateral as Cash and cash equivalents due to our ability to convert the cash to letters of credit at any time at our discretion. As of October 27, 2004, $221 million of cash was posted as collateral. Total availability under the Credit Facility as of October 27, 2004 was approximately $750 million. The Credit Facility financial covenants include a requirement that we maintain certain availability minimums, and failure to do so triggers additional required minimum levels of EBITDA. The Credit Facility also contains other customary covenants, including certain reporting requirements and covenants that restrict our ability to incur or create liens, indebtedness and guarantees, make investments, pay dividends or make other equity distributions, sell or dispose of stock or assets, change the nature of our business and enter into affiliate transactions, mergers and consolidations. Failure to satisfy these covenants would result in an event of default that could result in our inability to access the funds. As of October 27, 2004, and in all periods since our emergence from Chapter 11, we have been in compliance with all Credit Facility covenants. Letter of Credit Agreement On August 13, 2004, the Company entered into a letter of credit agreement (the "LC Agreement") with a commitment amount of up to $200 million through January 7, 2005 and increasing to $600 million thereafter. Standby letters of credit issued under the LC Agreement bear interest at 0.20% per annum. No interest is charged for trade letters of credit issued under the LC Agreement; however, we are required to pay a fee based on the unutilized commitment, as defined in the LC Agreement, equal to 0.125% per annum. We amended the LC Agreement on October 4, 2004, primarily to provide Kmart with an election to post either cash or inventory as collateral. Electing inventory would result in incremental costs under the LC Agreement. As of October 27, 2004, Kmart has posted cash collateral of $250 million to support the LC Agreement. We classify the cash collateral as Cash and cash equivalents due to our ability to post inventory as collateral at any time at our discretion. The LC Agreement is subject to a pledge and security agreement pursuant to which, after January 7, 2005, the Company must post as collateral cash in an amount equal to 100.5% of the face value of letters of credit outstanding under the LC Agreement or elect to post inventory as collateral, subject to certain conditions. Prior to January 7, 2005, the collateral posted by the Company is a leasehold mortgage on certain properties leased by the Company. The LC Agreement contains customary covenants, including covenants that restrict our ability to incur or create liens on collateralized assets, and sell, transfer, assign or otherwise dispose of any collateralized assets. Failure to satisfy these covenants would result in an event of default that could result in our inability to issue new letters of credit. Subject to these covenants the Company is required to maintain in a deposit account $250 million of cash invested with the issuing bank until such time that the cash collateral is equal to the 100.5% of the face value of the letters of credit outstanding, as discussed above. This cash is classified as Cash and cash equivalents as of October 27, 2004. As of October 27, 2004, and in all periods since inception of the LC Agreement, we have been in compliance with all covenants of the LC Agreement. As of October 27, 2004, we had utilized $197 million of the LC Agreement. 31 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) CASH FLOWS Operating activities provided net cash of $171 million and $576 million for the 39-weeks ended October 27, 2004 and the 13-weeks ended April 30, 2003, respectively. During the 26-weeks ended October 29, 2003, operating activities used $396 million of net cash. Cash flow for the current 39-week period was favorably affected by our strong net earnings which was partially offset by the increase in our inventories, net of associated accounts payable for the upcoming holiday season and by funding $77 million for future associate medical and dental expenses. For the 26-weeks ended October 29, 2003, the use of cash was primarily due to payments of $470 million for exit costs and reorganization items. For the 13-weeks ended April 30, 2003, a decrease in inventory due to liquidation sales in conjunction with store closings and improved inventory management, partially offset by a decrease in accounts payable, had a favorable affect on operating cash flow. Investing activities generated $345 million, $32 million and $60 million for the 39-weeks ended October 27, 2004, the 26-weeks ended October 29, 2003 and the 13-weeks ended April 30, 2003, respectively. During the current year, we received proceeds of $524 million from sales of real and personal property, including $432 million from the sale of owned and assignment of leased properties to Sears and Home Depot. See Note 4 - Real Estate and Property Transactions and Note 12 - Property Held for Sale for a more detailed discussion of these transactions. During the 39-weeks ended October 27, 2004 and the 26-weeks ended October 26, 2003, we purchased 28 and eight previously-leased operating properties for $103 million and $61 million, respectively. Additionally, we received proceeds of $92 million from the sale of property held for sale during the 26-weeks ended October 29, 2003. Proceeds of $64 million were received during the 13-weeks ended April 30, 2003, from the sale of four owned Kmart store locations and the sale of furniture and fixtures from closed store locations. Payments on capital lease obligations and mortgages of $40 million and $17 million were the uses of cash for financing activities during the 39-weeks ended October 27, 2004 and the 13-weeks ended April 30, 2003, respectively. Financing activities provided $73 million in cash for the 26-weeks ended October 29, 2003. Upon emergence from bankruptcy in May, 2003, the Company received net proceeds of $127 million from the issuance of Common Stock to the Plan Investors and proceeds of $60 million from the issuance of the convertible note to affiliates of ESL. The positive effect of these items was partially offset by payments made for other financing arrangements. See Note 2 - Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting for a more detailed discussion. The Company has a share repurchase program with authorization to repurchase $100 million in Common Stock. As of October 27, 2004, we had repurchased approximately $4 million of Common Stock. FUTURE LIQUIDITY ITEMS PENSION PLAN Prior to 1996, the Predecessor Company maintained defined benefit pension plans covering eligible associates. Effective January 31, 1996, the pension plans were frozen, and associates no longer earn additional benefits under the plans (except for purposes of the subsidized early retirement program provided by the plan). The plans' assets consist primarily of equity and fixed income securities. Prior to 2004, no contributions had been made to the plans for the past eight years. During the 39-weeks ended October 27, 2004 contributions to the plans were approximately $10 million. The minimum required contribution for fiscal 2004 and fiscal 2005 is approximately $11 million and $4 million, respectively. 32 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) REAL ESTATE TRANSACTIONS Home Depot U.S.A., Inc. On June 3, 2004, the Company entered into multiple agreements with Home Depot U.S.A., Inc. (a subsidiary of The Home Depot, Inc.) ("Home Depot") to sell owned properties and assign leased properties for a maximum purchase price of $365 million in cash. These agreements were later amended to reflect that the Company would sell four properties and assign 14 properties for an aggregate purchase price of $271 million. Pursuant to these agreements, on June 15, 2004, the Company completed the sale of four owned properties to Home Depot for $59 million in cash, resulting in a net gain of $43 million. The Company completed the assignment of 13 of the remaining properties in the third quarter of fiscal 2004, resulting in proceeds to the Company of $200 million in cash, and a net gain of $198 million. We anticipate closing on the final property during the fourth quarter, resulting in additional proceeds of $12 million. Sears, Roebuck and Co. On June 29, 2004, the Company entered into an agreement with Sears, Roebuck and Co. ("Sears") to sell owned properties and assign leased properties for a maximum purchase price of $621 million in cash. On September 29, 2004, the Company agreed to sell four owned properties, assign 45 leased properties and lease one owned store to Sears for a total purchase price of approximately $576 million. The Company received 30% of the purchase price in September, 2004 upon closing, and recognized a gain on the transaction of $599 million. The remaining 70% of the purchase price will be received when Sears occupies the properties, which shall take place no later than April 15, 2005. The receivable for the remaining purchase price of $403 million is included in Accounts receivable, net in our Unaudited Condensed Consolidated Balance Sheet as of October 27, 2004. ESL and its affiliates own over 10 percent of both Sears and the Company. OTHER In light of the Company's liquidity position and subject to compliance with our Credit Facility, we may consider various uses of cash and other resources in the future which could include investments in various forms of securities, share repurchases, the acquisition of related or unrelated businesses, and the payment of dividends. STORE ACTIVITY During the 39-weeks ended October 27, 2004, the Company purchased 28 previously leased store locations; sold 17 stores; closed four stores; and allowed leases to expire on four stores. As of October 27, 2004, we operated 1,486 stores. In the second and third quarters of fiscal 2003, we closed one store and purchased seven previously leased store locations and one previously leased distribution center. In the first quarter of fiscal 2003, the Predecessor Company closed 316 stores. CRITICAL ACCOUNTING POLICIES AND ESTIMATES In preparing our financial statements, certain of our accounting policies require considerable judgment to select the appropriate assumptions to calculate financial estimates. By their nature, these estimates are complex and subject to an inherent degree of uncertainty. We base our estimates on historical experience, terms of existing contracts, our evaluation of trends and other assumptions that we believe to be reasonable under the circumstances. We continually evaluate the information used to make these estimates as our business and the economic environment change. Management believes the current assumptions and other considerations used to estimate amounts reflected in our financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts, the resulting changes could have a material adverse effect on our consolidated results of operations, and in certain situations, could have a material adverse effect on our financial condition. We have disclosed our critical accounting policies and estimates, which include inventory valuation, self-insurance reserves, pension accounting and deferred taxes, in our Annual Report on Form 10-K/A for the year ended January 28, 2004. 33 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED) DISCONTINUED OPERATIONS During the 39-weeks ended October 27, 2004, the Company applied the provisions of SFAS No. 144 to the stores sold to Home Depot and Sears and determined that none of the stores met the criteria to be accounted for as discontinued operations. During the first quarter of fiscal 2003, the Predecessor Company closed 316 stores. Of the total stores closed, 66 met the criteria for discontinued operations. For a comprehensive discussion, see Note 17 - Discontinued Operations. For the 13-weeks ended April 30, 2003, 250 of the 316 stores closed were accounted for in continuing operations as they did not meet the criteria for discontinued operations. Total sales, gross margin and SG&A for these 250 stores were $854 million, $301 million and $146 million, respectively. SPECIAL CHARGES Special charges are transactions which, in management's judgment, may make meaningful comparisons of operating results between reporting periods difficult. In determining what amounts constitute a special charge, management considers the nature, magnitude and frequency of their occurrence. For the 13-weeks ended April 30, 2003, the Predecessor Company recorded special charges of $42 million. For a comprehensive discussion, see Note 18 - Special Charges. REORGANIZATION ITEMS, NET Reorganization items represent amounts the Predecessor Company incurred as a result of Chapter 11, and are presented separately in the Unaudited Condensed Consolidated Statements of Operations as required by SOP 90-7. The Predecessor Company recorded $813 million for the 13-weeks ended April 30, 2003 for reorganization items. For a comprehensive discussion, see Note 19 - Reorganization Items, net. OTHER MATTERS The Martha Stewart Everyday brand is considered a distinctive brand for Kmart and we currently sell Martha Stewart Everyday home, garden, colors, baby, kitchen, keeping and decorating product lines, along with candles and accessories. To date, we have not experienced any significant adverse impact from Ms. Stewart's recent conviction and incarceration on the sales of Martha Stewart Everyday brand products. Although product sales have not been significantly affected by past events, the Company is not able to determine the potential effects that these events may have on the future sales of its Martha Stewart Everyday brand products. 34 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At October 27, 2004, we did not have any derivative instruments that increased our exposure to market risks for interest rates, foreign currency rates, commodity prices or other market price risks. We do not use derivatives for speculative purposes. Currently, our exposure to market risks results primarily from changes in interest rates, principally with respect to the Credit Facility, which is a variable rate financing agreement. We do not use swaps or other interest rate protection agreements to hedge this risk. ITEM 4. CONTROLS AND PROCEDURES Under the supervision of, and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this report (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic filings under the Exchange Act. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will uncover or detect failures within the Company to disclose material information otherwise required to be set forth in the Company's periodic reports. As a result of the Securities and Exchange Commission's ("SEC") review of our Form 10-K for the year ended January 28, 2004, it was determined that the Company did not reflect an embedded beneficial conversion feature of the convertible note issued upon the Company's emergence from bankruptcy as required by Emerging Issues Task Force No. 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" ("EITF 00-27"). This review was performed in conjunction with the SEC's review of Sears Holdings Corporation's registration statement on Form S-4 in connection with the pending merger between Kmart and Sears, Roebuck and Company ("Sears"). Upon shareholder approvals of the merger transaction, Sears Holdings Corporation will be a new retail company resulting from the merger of Kmart and Sears. According to EITF 00-27, the accounting treatment of the note is based on the determination of a commitment date. A commitment date occurs when, amongst other things, an agreement is binding on both parties and the agreement specifies all significant terms, including the quantity to be exchanged. The Company believed that it had met these qualifications as of the initial agreement date and accounted for the note accordingly. The SEC believes that at the time of the agreement, these conditions had not been met, and therefore the commitment date did not occur until the issuance of the note. After discussions with the SEC, the Company has agreed to restate its financial statements. The determination that the commitment date was at the issuance of the note rather than when the agreement was signed effected the valuation of the beneficial conversion feature as a result of a change in the fair value of the Company's common stock between these two periods. The restatement is further discussed in "Explanatory Note" in the forepart of this Form 10-Q/A, and in Note 3, "Restatement" in the Notes to the Unaudited Condensed Consolidated Financial Statements in Item 1. In management's opinion, given the interpretive nature of the restatement, such restatement did not change its conclusion that the Company's controls and procedures are effective. No changes in the Company's internal controls over financial reporting have come to management's attention that occurred during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 35 PART II. OTHER INFORMATION ITEM 1.LEGAL PROCEEDINGS See Note 20 of the Notes to Unaudited Condensed Consolidated Financial Statements for information concerning legal proceedings. ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES The Company has a share repurchase program with authorization to repurchase $100 million of Common Stock. As of October 27, 2004, we had repurchased approximately $4 million of Common Stock.

(1) The Company was assigned 494,481 shares (weighted-average price of $76.06 per share) of Common Stock as part of a settlement agreement reached with a Class 5 claimholder; in addition the Company was assigned 1,730 shares (weighted-average price of $83.37 per share) of Common Stock for payment of withholding taxes related to the vesting of restricted stock. (2) The Company was assigned 5,276 shares of Common Stock as part of a settlement agreement reached with a critical vendor. ITEM 6. EXHIBITS Exhibit 10.1 Employment Agreement, dated as of October 18, 2004, between Kmart Holding Corporation and Aylwin B. Lewis (previously filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q, for the period ended October 27, 2004, and incorporated herein by reference) Exhibit 10.2 Julian C. Day Separation Agreement, dated as of October 18, 2004 (previously filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q, for the period ended October 27, 2004, and incorporated herein by reference) Exhibit 10.3 First Amendment to Letter of Credit Agreement, dated as of August 13, 2004 among Kmart Corporation, Bank of America, National Association and Fleet National Bank as issuing banks (previously filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q, for the period ended October 27, 2004, and incorporated herein by reference) Exhibit 10.4 Credit Agreement, dated as of May 6, 2003, as amended and restated as of October 7, 2004, among Kmart Corporation as Borrower, the other Credit Parties signatory thereto, as Credit Parties, the Lenders signatory thereto, from time to time, as Lenders, and General Electric Capital Corporation, as Administrative Agent, Co-Collateral Agent and Lender, GECC Capital Markets Group, Inc., as Co-Lead Arranger and Co-Book Runner, Fleet Retail Finance Inc., as Syndication Agent, Co-Collateral Agent and Lender, Fleet Securities, Inc., as Co-Lead Arranger and Co-Book Runner, GMAC Commercial Finance LLC, as Co-Documentation Agent and Wells Fargo Foothill Inc. as Co-Documentation Agent (previously filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q, for the period ended October 27, 2004, and incorporated herein by reference) Exhibit 31.1 Chief Executive Officer Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as Amended 36 Exhibit 31.2 Chief Financial Officer Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as Amended Exhibit 32.1 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 37 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signatory hereby acknowledges and adopts the typed form of his/her name in the electronic filing of this document with the Securities and Exchange Commission. Date: FEBRUARY 11, 2005 Kmart Holding Corporation ---------------------------------------------- (Registrant) By: /s/ Aylwin B. Lewis ---------------------------------------------- Aylwin B. Lewis President and Chief Executive Officer (Principal Executive Officer) /s/ James D. Donlon, III ---------------------------------------------- James D. Donlon, III Senior Vice President, Chief Financial Officer (Principal Financial Officer) /s/ James F. Gooch ---------------------------------------------- James F. Gooch Vice President, Controller (Principal Accounting Officer) 38 EXHIBIT INDEX

KMART HOLDING CORP 10-Q/A