KMART CORP - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JANUARY 30, 2002

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. 1-327

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KMART CORPORATION
(Exact name of registrant as specified in its charter)

MICHIGAN 38-0729500
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

3100 WEST BIG BEAVER ROAD 48084
TROY, MICHIGAN (zip code)
(Address of principal executive offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
(248) 463-1000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE SECURITIES EXCHANGE ACT
OF 1934:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE SECURITIES EXCHANGE ACT
OF 1934:
NONE

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

The aggregate market value of voting stock including Common Stock held by
non-affiliates of the Registrant on May 1, 2002 was $628,361,591. The market
value of the Common Stock is based on the closing price on the New York Stock
Exchange on such date.

As of May 1, 2002, 502,689,273 shares of Common Stock of the Registrant
were outstanding.
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PART I

ITEM 1. BUSINESS

HISTORY

Kmart Corporation and subsidiaries ("Kmart," "we" or "our") is the nation's
second largest discount retailer and the fourth largest general merchandise
retailer. Kmart was incorporated under the laws of the State of Michigan on
March 9, 1916, as the successor to the business developed by its founder, S. S.
Kresge, who opened his first store in 1899. After operating Kresge department
stores for over 45 years, our store program commenced with the opening of the
first Kmart store in March 1962. Our principal executive offices are located at
3100 West Big Beaver Road, Troy, Michigan 48084.

PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

On January 22, 2002 ("Petition Date"), Kmart and 37 of its U.S.
subsidiaries (collectively, the "Debtors") filed voluntary petitions for
reorganization under Chapter 11 of the federal bankruptcy laws ("Bankruptcy
Code" or "Chapter 11") in the United States Bankruptcy Court for the Northern
District of Illinois ("Court") under case numbers 02 B 02462 through 02 B 02499.
The reorganization is being jointly administered under the caption "In re Kmart
Corporation, et al. Case No. 02 B 02474." The Debtors are currently operating
their business as debtors-in-possession pursuant to the Bankruptcy Code.

We decided to seek judicial reorganization based upon a rapid decline in
our liquidity resulting from our below-plan sales and earnings performance in
the fourth quarter, the evaporation of the surety bond market and erosion of
supplier confidence. Other factors included intense competition in the discount
retailing industry, unsuccessful sales and marketing initiatives, the continuing
recession, and recent capital market volatility. As a debtor-in-possession,
Kmart is authorized to continue to operate as an ongoing business, but may not
engage in transactions outside the ordinary course of business without the
approval of the Court, after notice and an opportunity for a hearing.

At first day hearings held on January 22 and 25, 2002, the Court entered
orders granting authority to Kmart to, among other things, pay pre-petition and
post-petition employee wages, salaries, benefits and other employee obligations,
to pay vendors and other providers in the ordinary course for goods and services
received from January 22, 2002, and to honor customer service programs,
including warranty returns, layaways and gift certificates. On January 25, 2002,
the Court also gave interim approval for $1.15 billion of a $2 billion senior
secured 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 March 6, 2002, the Court
approved the entire $2 billion DIP Credit Facility underwritten by JP Morgan
Chase Bank, Fleet Retail Finance, Inc., General Electric Capital Corporation and
Credit Suisse First Boston to supplement our cash flow from operations during
the reorganization process. A description of the DIP Credit Facility appears in
Item 7. Management's Discussion and Analysis -- Analysis of Financial Condition.

Under the Bankruptcy Code, actions to collect pre-petition indebtedness, as
well as most other pending litigation, are stayed and other contractual
obligations against Kmart generally may not be enforced. Absent an order of the
Court, substantially all pre-petition liabilities are subject to settlement
under a plan of reorganization to be voted upon by creditors and equity holders
and approved by the Court. Although the Debtors expect to file a reorganization
plan or plans that provide for emergence from bankruptcy in 2003 or 2004, there
can be no assurance that a reorganization plan or plans will be proposed by the
Debtors or confirmed by the Court, or that any such plan(s) will be consummated.
As provided by the Bankruptcy Code, the Debtors initially have the exclusive
right to solicit a plan of reorganization for 120 days. On April 23, 2002, the
Court extended to August 7, 2002, the period in which Kmart has the exclusive
right to file a plan of reorganization and extended to October 4, 2002, the
period in which Kmart has the exclusive right to submit acceptances of its plan.
A hearing to extend further these exclusive periods is scheduled for July 24,
2002. Further extensions may be granted or rejected by the Court. If the Debtors
fail to file a plan of reorganization during such period or if such plan is not
accepted by the required number of creditors and equity holders, any party in
interest may subsequently file its own plan of reorganization for the Debtors. A
plan of reorganization

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must be confirmed by the Court, upon certain findings being made by the Court
which are required by the Bankruptcy Code. The Court may confirm a plan
notwithstanding the non-acceptance of the plan by an impaired class of creditors
or equity security holders if certain requirements of the Bankruptcy Code are
met.

Under the Bankruptcy Code, we may assume or reject executory contracts,
including lease obligations, subject to the approval of the Court and certain
other conditions. Parties affected by these rejections may file claims with the
Court in accordance with the reorganization process. Unless otherwise agreed,
the assumption of an executory contract will require Kmart to cure all prior
defaults under the related executory contract, including all pre-petition
liabilities. In this regard, we expect that liabilities subject to the
proceedings will arise in the future as a result of the rejection of additional
executory contracts, including leases, and from the determination of the Court
(or agreement by parties in interest) of allowed claims for contingencies and
other disputed amounts. Conversely, we would expect that the assumption of
additional executory contracts and unexpired leases may convert liabilities
shown on our financial statements as subject to compromise to post-petition
liabilities. Due to the uncertain nature of many of the potential claims, we are
unable to project the magnitude of such claims with any degree of certainty.
Kmart has incurred, and will continue to incur, significant costs associated
with the reorganization.

On April 15, 2002, we filed with the Court schedules and statements of
financial affairs setting forth, among other things, the assets and liabilities
of the Debtors as shown by our books and records, subject to the assumptions
contained in certain notes filed in connection therewith. All of the schedules
are subject to further amendment or modification. We have mailed notices to all
known creditors that the deadline for filing proofs of claim with the Court is
July 31, 2002. Differences between amounts scheduled by Kmart and claims by
creditors will be investigated and resolved in connection with our claims
resolution process. That process will not commence until after the July 31, 2002
bar date and, in light of the number of creditors of the Debtors, may take
considerable time to complete. Accordingly, the ultimate number and amount of
allowed claims is not presently known and, because the settlement terms of such
allowed claims are subject to a confirmed plan of reorganization, the ultimate
distribution with respect to allowed claims is not presently ascertainable.

The United States Trustee has appointed an unsecured creditors committee
and a financial institutions committee. A request has also been made for the
establishment of an equity holders committee. The official committees and their
legal representatives have a right to be heard on all matters that come before
the Court, and are the primary entities with which Kmart will negotiate the
terms of a plan of reorganization. There can be no assurance that these
committees will support Kmart's positions in the bankruptcy proceedings or the
plan of reorganization once proposed, and disagreements between Kmart and these
committees could protract the bankruptcy proceedings, could negatively impact
Kmart's ability to operate during bankruptcy and could delay Kmart's emergence
from bankruptcy.

We have filed over 100 motions in the Chapter 11 case whereby we were
granted authority or approval with respect to various items required by the
Bankruptcy Code and/or necessary for our reorganization efforts. In addition to
motions pertaining to real estate disposition matters, we have obtained orders
providing for, among other things, (i) implementation of a key employee
retention and incentive program, (ii) authorization of a second lien for vendors
in connection with our secured inventory trade credit program, (iii)
authorization of a settlement agreement with our sureties who support our
self-insurance program and state licensing requirements, and (iv) the extension
of time to assume or reject leases.

At this time, it is not possible to predict the effect of the Chapter 11
reorganization on our business, various creditors and security holders or when
we will be able to exit Chapter 11. Our future results are dependent upon our
confirming and implementing, on a timely basis, a plan of reorganization.

Under the priority scheme established by the Bankruptcy Code, certain
post-petition liabilities and pre-petition liabilities need to be satisfied
before shareholders are entitled to receive any distribution. The ultimate
recovery to creditors, trust convertible preferred securities holders and/or
common shareholders, if any, will not be determined until confirmation of a plan
or plans of reorganization. No assurance can be given as to what values, if any,
will be ascribed in the bankruptcy proceedings to each of these constituencies.
A plan of reorganization could also result in holders of Kmart common stock
receiving no value for their interests. Because of such possibilities, the value
of the common stock is highly speculative. Accordingly, Kmart urges
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that appropriate caution be exercised with respect to existing and future
investments in any of these liabilities and/or securities.

The Consolidated Financial Statements contained herein have been prepared
on a going concern basis, which assumes continuity of operations and realization
of assets and satisfaction of liabilities in the ordinary course of business,
and in accordance with Statement of Position 90-7 ("SOP 90-7"), "Financial
Reporting by Entities in Reorganization under the Bankruptcy Code." The ability
of Kmart to continue as a going concern is predicated upon, among other things,
the confirmation of a reorganization plan, compliance with the provisions of the
DIP Credit Facility and the ability to generate cash flows from operations and
obtain financing sources sufficient to satisfy our future obligations. Please
refer to Item 7. Management's Discussion and Analysis of Results of Operations
and Financial Condition, and Note 1 of the Notes to Consolidated Financial
Statements in Item 8. Financial Statements and Supplementary Data, for
additional information.

RESTATEMENT OF FISCAL 2001 UNAUDITED QUARTERLY FINANCIAL DATA

Given our recent bankruptcy filing and the increased uncertainty relating
to vendor rebates and allowances ("allowances") and the corresponding difficulty
in reliably estimating such amounts in the future, we concluded that it would be
preferable to change our accounting method for interim recognition of such cost
recoveries from vendors. Under the new methodology, Kmart will recognize a cost
recovery from vendors only when a formal agreement for such amount has been
obtained and the underlying activity for which the amount was provided has been
performed. This change in methodology does not affect the results that otherwise
would have been reported for the full fiscal year, but rather affects the
interim recognition of allowances during the year. We believe our new method is
preferable because it provides higher precision, better verifiability, reduced
reliance on estimates and is consistent with an analogous application of Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements."
While this change in method was adopted in the fourth quarter of fiscal 2001,
generally accepted accounting principles require the restatement of the first
three quarters of fiscal 2001 to reflect this change.

Additionally, in January 2002, Kmart announced that we had received an
anonymous letter sent to the Securities and Exchange Commission ("SEC"), our
auditors and directors expressing concern with respect to various matters.
Accordingly, the Board of Directors instructed that an internal investigation be
undertaken under the supervision of the Audit Committee by outside legal
counsel, with the assistance of independent accounting advisors. We delayed
filing our Form 10-K for the fiscal year ended January 30, 2002 to provide,
among other things, additional time to review the results, based on information
available to date, of the investigation.

Based on the results of the investigation to date, as well as the results
of our new management team's review of Kmart's accounting policies and methods,
we concluded that (1) an adjustment should be made with respect to the
accounting for up-front consideration in a transaction from a vendor which more
appropriately should have been deferred and recognized over the life of the
contract and (2) the recording of additional general liability reserves in the
fourth quarter was more appropriately designated as a second quarter event.
Accordingly, adjustments were made for such transactions, including restatements
of previously reported quarterly financial statements for fiscal 2001. Our
financial statements for prior fiscal years were not affected.

We will be filing amendments to our quarterly reports on Form 10-Q for the
first three quarters of fiscal 2001 as soon as is practicable, in order to
restate the Consolidated Financial Statements therein. The summarized quarterly
financial information included in this Form 10-K has been restated. For
information regarding the restatement, see Notes 2 and 22 of the Notes to
Consolidated Financial Statements in Item 8. Financial Statements and
Supplementary Data, of this Form 10-K.

OPERATIONS

We operate in the general merchandise retailing industry through 2,114
Kmart discount stores with locations in each of the 50 United States, Puerto
Rico, the U.S. Virgin Islands and Guam, and through our e-commerce shopping
site, www.bluelight.com. Our general merchandise retail operations are located
in 324 of the 331 Metropolitan Statistical Areas in the United States. Kmart
stores are generally one-floor, free-standing units ranging in size from 40,000
to 194,000 square feet. On March 20, 2002, the Court approved
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the closure of 283 stores located in 40 states and in Puerto Rico, or
approximately 13% of our 2,114 stores. We anticipate closing these locations in
the second quarter of fiscal 2002, following liquidation sales.

We currently have 124 Kmart Supercenters that combine a full grocery, deli,
bakery, video rental and 24 hour/seven-days-a-week availability along with the
general merchandise selection of a Kmart discount store. Kmart Supercenters
represent the third largest super center operation in the United States. The
store closings noted above include 12 Kmart Supercenters.

A key component of our developing strategy is to invest in merchandising
and marketing initiatives to enhance our strategic positioning by offering
exclusive brands that will differentiate us from our competitors, including
Martha Stewart Everyday home, garden, colors, baby, kitchen, keeping and
decorating products, along with candles and accessories; Jaclyn Smith women's
apparel, jewelry and accessories; Kathy Ireland women's apparel, accessories and
exercise equipment; Disney apparel for infants and children; Sesame Street
apparel for infants and children; Route 66 men's and women's apparel and
accessories; and JOE BOXER apparel, accessories and home furnishings. We are
seeking or have received Court approval to continue our relationships with most
of these key brand partners.

We will optimize our supply chain to maximize efficiencies and service
capabilities. We are continuing to evaluate the performance of every store and
terms of every lease. We are pursuing opportunities to reduce annual expenses
through reengineering the organization, staff reductions, office consolidations
and other actions.

Based upon our results under the BlueLight Always campaign during 2001, we
have scaled back the strategy under which we lowered prices from a peak of over
30,000 items to approximately 18,000 items through the end of January 2002.
During fiscal 2002, we plan to rely more heavily on promotional activities.

Information regarding our discontinued operations and dispositions appears
in Note 9 of the Notes to Consolidated Financial Statements in Item 8. Financial
Statements and Supplementary Data, of this Form 10-K.

Information regarding our analysis of operations and financial condition
appears in Item 7. Management's Discussion and Analysis of Results of Operations
and Financial Condition, of this Form 10-K.

COMPETITION

We have several major competitors on a national level, including Wal-Mart,
Target, Sears, Kohl's, and J.C. Penney, and many competitors on a local and
regional level which compete with our individual stores. Success in this
competitive market is based on factors such as price, quality, service, product
assortment and convenience.

SEASONALITY

Due to the seasonal nature of the retail industry, where merchandise sales
and cash flows from operations are historically higher in the fourth quarter
than any other period, a disproportionate amount of operating cash flows are
generated in the fourth quarter. In preparation for the fourth quarter holiday
season, we significantly increase our merchandise inventories, which
traditionally have been financed by cash flows from operations, bank lines of
credit, trade credit and terms from vendors. Our profitability and cash flows
are primarily dependent upon the large sales volume generated during the fourth
quarter of our fiscal year. Fourth quarter sales represented over 30% of total
net sales in fiscal 2001.

CREDIT SALES

Kmart and Capital One Financial Corporation ("Capital One") launched a
Kmart MasterCard on September 25, 2000. The Kmart MasterCard combines the
exclusivity of private label card benefits along with MasterCard's global
acceptance at more than 18 million locations. Capital One is the exclusive
issuer and creditor of the Kmart MasterCard and is responsible for the
evaluation and approval of credit applications for

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the Kmart MasterCard. As of January 30, 2002, there were 4,285,000 cardholders.
Kmart bears no credit risk or risk of loss with respect to any Kmart MasterCard
account. The former private label Kmart Credit Card through Household Bank (SB),
N.A., a unit of Household International, Inc. was discontinued in October 2000.
In addition to the Kmart MasterCard program, which is owned and operated by
Capital One, all of our stores accept major bank credit cards as payment for
merchandise.

EMPLOYEES

We employed approximately 234,000 persons as of January 30, 2002.
Approximately 22,000 employees will be affected by the store closures expected
to be completed in the second quarter of fiscal 2002.

FOOD AND CONSUMABLES DISTRIBUTION AGREEMENT

In February 2001, we entered into a strategic alliance with Fleming
Companies, Inc. ("Fleming"). During the ten-year term of the agreement, Fleming
will supply substantially all food and consumables products in all current and
future Kmart stores and Kmart Supercenters. Under terms of the agreement,
Fleming provides procurement, storage, and logistics functions. Fees paid to
Fleming under the agreement for such services vary based on volume and other
factors. We continue to be responsible for in-store product pricing, promotional
planning, assortment planning and in-store display. This agreement created a
strategic alliance between Fleming and Kmart to merchandise, procure and
distribute pantry and supermarket products in the most cost efficient manner and
to provide for the joint exploration, evaluation, and implementation of
practices and procedures to reduce total supply chain costs. Fleming began
supplying merchandise under the new agreement in early fiscal 2001.

EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS

Compliance with federal, state and local provisions which have been enacted
or adopted regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had, and is not
expected to have, a material adverse effect on capital expenditures, earnings or
the competitive position of Kmart and its subsidiaries.

ITEM 2. PROPERTIES

At January 30, 2002, we operated a total of 2,114 general merchandise
stores which are located in the United States, Puerto Rico, the U.S. Virgin
Islands and Guam. We lease our store facilities, with the exception of 133
stores that we own. Our store leases are generally for terms of 25 years with
multiple five-year renewal options that allow us the option to extend the life
of the lease up to 50 years beyond the initial non-cancelable term. On March 20,
2002, the Court approved the closure of 283 stores in 40 states and in Puerto
Rico.

We own our headquarters and one administrative building in Troy, Michigan
and lease an administrative building in Royal Oak, Michigan. We own one
distribution center and lease 17 other distribution centers in the United States
for initial terms of 10 to 30 years with options to renew for additional terms.
In addition, we own or lease 169 parcels not currently used for store
operations, the majority of which are rented to others.

A description of our leasing arrangements appears in Note 14 of the Notes
to Consolidated Financial Statements in Item 8. Financial Statements and
Supplementary Data, of this Form 10-K.

ITEM 3. LEGAL PROCEEDINGS

On the Petition Date, Kmart and 37 of its U.S. subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the Bankruptcy Code in the
Court. The reorganization is being jointly administered under the caption "In re
Kmart Corporation, et al., case No. 02 B 02474." Included in the Consolidated
Financial Statements are subsidiaries operating outside of the United States,
which have not commenced Chapter 11 cases or other similar proceedings
elsewhere, and are not debtors. The assets and liabilities and results of
operations of such non-filing subsidiaries are not considered material to the
Consolidated Financial

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Statements. We retain control of our assets and are authorized to operate the
business as a debtor-in-possession while being subject to the jurisdiction of
the Court. As of the Petition Date, all pending litigation is stayed, and absent
further order of the Court, no party may take any action to recover on
pre-petition claims against Kmart and 37 of its U.S. subsidiaries. At this time,
it is not possible to predict the outcome of the Chapter 11 cases or their
effect on our business. If it is determined that the liabilities subject to
compromise in the Chapter 11 cases exceed the fair value of the assets,
unsecured claims may be satisfied at less than 100% of their fair value and the
equity interests of our shareholders may have no value. See Item 1. Business
Proceedings Under Chapter 11 of the Bankruptcy Code.

Kmart has been provided with copies of anonymous letters sent to the SEC,
our auditors, directors and legal counsel expressing concern with respect to
various matters. The letters purport to be sent by certain of our employees. The
letters have been referred to the Audit Committee, which has engaged outside
counsel to review and investigate the matters set forth in the letters. We are
cooperating with the SEC and the U.S. Attorney's office for the Eastern District
of Michigan with respect to their investigations of these matters.

Since February 21, 2002, five separate purported class actions have been
filed on behalf of purchasers of Kmart common stock between May 17, 2001 and
January 22, 2002, inclusive, naming Charles Conaway as CEO and Chairman of the
Board of Kmart as the sole defendant. The complaints filed in the United States
District Court for the Eastern District of Michigan, allege that Mr. Conaway
made material misstatements or omissions during the alleged class period that
inflated the trading prices of Kmart's common stock and seek, among other
things, damages under Section 10b-5 of the Securities and Exchange Act of 1934.
Kmart is not a defendant.

Kmart is involved in discussions with the United States Attorney for the
District of Puerto Rico regarding a criminal investigation arising out of the
alleged actions of certain of our employees following the 1998 Hurricane
Georges.

On March 18, 2002, a purported class action was filed in the United States
District Court for the Eastern District of Michigan on behalf of participants or
beneficiaries of the Kmart Corporation Retirement Savings Plan against various
officers and directors of Kmart alleging breach of fiduciary duty under ERISA
for excessive investment in company stock; failure to provide complete and
accurate information about Kmart common stock and failure to provide accurate
information regarding our financial condition. Class action allegations are also
made for current and former employees who participate in the Kmart Corporation
Retirement Savings Plan. Kmart is not a defendant.

Kmart is a defendant in six putative class actions and one multi-plaintiff
case pending in California, all relating to our classification of assistant
managers and various other employees as "exempt" employees under the federal
Fair Labor Standards Act and the California Labor Code and our alleged failure
to pay overtime wages as required by these laws. These seven wage-and-hour cases
were all filed during 2001 and are currently pending in the U.S. District Court
for the Eastern District of California (Henderson v. Kmart), the U.S. District
Court for the Central District of California (Gulley v. Kmart, the
multi-plaintiff case, which was originally brought in state court) and the
Superior Courts of the State of California for the Counties of Alameda, Los
Angeles and Riverside (Panossian v. Kmart, Wallace v. Kmart, Pierce v. Kmart,
Hancock v. Kmart, Pryor v. Kmart). If all of these cases were determined
adversely to Kmart, the resulting damages would have a material adverse impact
on our results of operations and financial condition. However, there have been
no class certifications, all of the cases are stayed as a result of the
Company's bankruptcy and, based on our initial investigations, we believe that
the Company has numerous defenses to each of these claims. As a result, we are
currently unable to quantify the financial exposure of these cases.

We are a party to a substantial number of other claims, lawsuits, and
pending actions, most of which are routine and all of which are incidental to
our business. Some matters involve claims for large amounts of damages as well
as other relief. The Company assesses the likelihood of potential losses on an
ongoing basis and when they are considered probable and reasonably estimable,
records an estimate of the ultimate

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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. Although the final consequences of these proceedings are
not presently determinable, in the opinion of management, they are not expected
to have a material adverse affect on our liquidity, financial position or
results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

PART II

ITEM 5. MARKET FOR KMART'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is listed on the New York, Pacific and Chicago Stock
Exchanges. There were approximately 75,997 shareholders of record of Kmart
common stock as of May 1, 2002.

The quarterly high and low sales prices for our common stock for the two
most recent fiscal years are set forth in Note 22 of the Notes to Consolidated
Financial Statements in Item 8. Financial Statements and Supplemental Data, of
this Form 10-K.

ITEM 6. SELECTED FINANCIAL DATA

The table below summarizes our recent financial information. For further
information, refer to our Consolidated Financial Statements and Notes to
Consolidated Financial Statements in Item 8. Financial Statements and
Supplemental Data, of this Form 10-K.

8

CONSOLIDATED SELECTED FINANCIAL DATA
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
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(1) Our fiscal year ends on the last Wednesday in January. Fiscal 2000 consisted
of 53 weeks.

(2) Comparable store sales for 2000 are based on the 52 week period ended
January 24, 2001.

(3) Net income (loss) from continuing operations includes not only the items in
Restructuring, impairment and other charges of $23 for VERP/Severance, $97
for BlueLight.com, and $979 for asset impairments in 2001, $19 ($13 net of
tax) related to Voluntary Early Retirement Programs in 1998 and $114 ($81
net of tax) related to Voluntary Early Retirement Programs in 1997, but also
includes in 2001, 2000 and 1999 non-comparable charges of $163 related to
our supply chain restructuring, $728 ($463 net of tax) for strategic
initiatives and $11 ($7 net of tax) to reflect the cumulative effect of a
change in accounting method for layaway sales, respectively.

(4) Consistent with the requirements of Statement of Financial Accounting
Standards No. 128, "Earnings per Share," preferred securities were not
included in the calculation of diluted earnings per share for 2001, 2000 and
1997 due to their anti-dilutive effect.

(5) For fiscal year 2001, working capital, long-term debt and current ratio do
not include liabilities classified as subject to compromise.

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MANAGEMENT'S DISCUSSION AND ANALYSIS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This Form 10-K, as well as other statements or reports made by or on behalf
of Kmart, may contain or may incorporate by reference material which includes
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 that reflect, when made, Kmart's current views
with respect to current events and financial performance. Statements, other than
those based on historical facts, which address activities, events or
developments that we expect or anticipate may occur in the future are forward-
looking statements, which are based upon a number of assumptions concerning
future conditions that may ultimately prove to be inaccurate. Such
forward-looking statements are and will be, as the case may be, subject to many
risks, uncertainties and factors relating to Kmart operations and business
environment which may cause the actual results of Kmart to be materially
different from any 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, the following:

GENERAL FACTORS

- general economic conditions,

- weather conditions, including those which affect buying patterns of our
customers,

- changes in consumer spending and our ability to anticipate buying
patterns and implement appropriate inventory strategies,

- competitive pressures and other third party actions,

- ability to timely acquire desired goods and/or fulfill labor needs at
planned costs,

- our ability to successfully implement business strategies and otherwise
execute planned changes in various aspects of the business,

- regulatory and legal developments,

- our ability to attract, motivate and/or retain key executives and
associates,

- our ability to attract and retain customers,

- other factors affecting business beyond our control,

BANKRUPTCY RELATED FACTORS

- our ability to continue as a going concern,

- our ability to operate pursuant to the terms of the DIP Credit Facility,

- our ability to obtain Court approval with respect to motions in the
Chapter 11 proceeding prosecuted by it from time to time,

- our ability to develop, prosecute, confirm and consummate one or more
plans of reorganization with respect to the Chapter 11 cases,

- risks associated with third parties seeking and obtaining court approval
to terminate or shorten the exclusivity period that we have to propose
and confirm one or more plans of reorganization, for the appointment of a
Chapter 11 trustee or to convert the cases to Chapter 7 cases,

- our ability to obtain and maintain normal terms with vendors and service
providers,

- our ability to maintain contracts that are critical to our operations,

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MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

- the potential adverse impact of the Chapter 11 cases on our liquidity or
results of operations, and

- our ability to fund and execute our business plan.

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.

Similarly, these and other factors, including the terms of any
reorganization plan ultimately confirmed, can affect the value of our various
pre-petition liabilities, common stock and/or other equity securities. No
assurance can be given as to what values, if any, will be ascribed in the
bankruptcy proceedings to each of these constituencies. A plan of reorganization
could result in holders of Kmart common stock receiving no value for their
interests. Because of such possibilities, the value of the common stock is
highly speculative. Accordingly, we urge that appropriate caution be exercised
with respect to existing and future investments in any of these liabilities
and/or securities.

The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements and Notes to Consolidated Financial
Statements, in Item 8. Financial Statements and Supplementary Data, of this Form
10-K.

OVERVIEW

As a result of a rapid decline in our liquidity resulting from our
below-plan sales and earnings performance in the fourth quarter, the evaporation
of the surety bond market, an erosion of supplier confidence, intense
competition, unsuccessful sales and marketing initiatives, the continuing
recession, and recent capital market volatility, Kmart and 37 of its U.S.
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the Bankruptcy Code in the Court, on January 22, 2002.

Under Chapter 11 we are operating our business as a debtor-in-possession.
As of the Petition Date, actions to collect pre-petition indebtedness are stayed
and other contractual obligations against Kmart may not be enforced. In
addition, under the Bankruptcy Code we may assume or reject executory contracts,
including lease obligations. Parties affected by these rejections may file
claims with the Court in accordance with the reorganization process.
Substantially all pre-petition liabilities are subject to settlement under a
plan of reorganization to be voted upon by creditors and equity holders and
approved by the Court.

Information regarding the Chapter 11 case appears in Item 1.
Business -- Proceedings Under Chapter 11 of the Bankruptcy Code, of this Form
10-K.

On January 25, 2002, the Court gave interim approval for $1.15 billion of a
$2 billion senior secured DIP Credit Facility for payment of permitted
pre-petition claims, working capital needs, letters of credit and other general
corporate purposes. On March 6, 2002, the Court approved the entire $2 billion
DIP Credit Facility. The DIP Credit Facility requires that we maintain certain
financial covenants and restricts future liens, indebtedness, capital
expenditures, dividend payments and sale of assets. A description of the DIP
Credit Facility appears in Item 7. Management's Discussion and
Analysis -- Analysis of Financial Condition.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires that we make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and revenues and expenses during the period. We
base our estimates on historical experience and other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about carrying values of assets and liabilities that
are not readily apparent from other sources. We continually evaluate the

12

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

information used to make these estimates as our business and the economic
environment change. The use of estimates is pervasive throughout our financial
statements, but the accounting policies and estimates we consider most critical
are as follows:

INVENTORY VALUATION

Our inventories are valued at the lower of cost or market value, primarily
using the retail inventory method. The last-in, first-out method, utilizing
internal inflation indices is used to determine cost. Inventory valuation
requires significant judgments and estimates, including merchandise markdowns
and provisions for shrinkage. We evaluate all of our inventory units to
determine excess or slow-moving units based on current quantities and
projections of future demand and market conditions. For those units in inventory
that are so identified, as well as prior season fashion merchandise, we estimate
market value or net sales value based upon current realization trends. If the
projected net sales value is less than cost on a unit basis, we provide a
markdown allowance to reflect the lower value of that inventory. If actual
market or weather conditions are more or less favorable than those projected by
management, adjustments may result.

RESTRUCTURING CHARGES

We have provided restructuring charges in both fiscal 2000 and 2001 to
close stores, liquidate inventory, and optimize our information systems, supply
chain and BlueLight.com. These charges required judgments about exit costs to be
incurred for employee severance, contract and lease terminations, the future net
realizable value of long-lived assets and inventory to be disposed of, and other
liabilities. As a result of the bankruptcy proceedings, certain estimates for
store closings are now calculated based on statutory formulas, however,
significant judgment is involved in estimating the claims of lessors for items
other than rent, including cure costs, taxes, utilities, etc. The ability to
obtain agreements with lessors to terminate leases or with other parties to
assign leases can also affect the accuracy of current estimates.

IMPAIRMENT OF LONG-LIVED ASSETS

It is our policy to review our long-lived assets for possible impairment
whenever events or circumstances indicate that the carrying amount of an asset
may not be recoverable. We recognize losses relating to the impairment of
long-lived assets when future undiscounted cash flows are less than an asset's
carrying value. Assumptions and estimates used in the evaluation of impairment,
including current and future economic trends for stores in many geographic
regions, are subject to a high degree of judgment and complexity and changes in
the assumptions and estimates may affect the carrying value of long-lived
assets, and could result in additional impairment charges in future periods.

SELF-INSURANCE RESERVES

We self-insure or retain a portion of the exposure for losses related to
workers compensation and general liability costs. General liability costs relate
primarily to litigation that arises from store operations. It is our policy to
record our self-insurance reserves, as determined actuarially, based upon claims
filed and an estimate of claims incurred but not yet reported. Any actuarial
projection of losses concerning workers compensation and general liability is
subject to a high degree of variability. Among the causes of this variability
are unpredictable external factors affecting future inflation rates, litigation
trends, legal interpretations, benefit level changes and claims settlement
patterns, including the effect of the bankruptcy proceedings.

For a detailed discussion of our accounting policies and related estimates
and judgments, see Note 3 of the Notes to Consolidated Financial Statements, in
Item 8. Financial Statements and Supplementary Data, of this Form 10-K. While we
believe that the historical experience and other factors considered provide a
meaningful basis for the accounting policies applied in the preparation of the
Consolidated Financial Statements, we cannot guarantee that our estimates and
assumptions will be accurate, which could require us to make adjustments to
these estimates in future periods.
13

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

ANALYSIS OF OPERATIONS EXCLUDING NON-COMPARABLE ITEMS DESCRIBED BELOW

The following table segregates non-comparable items from operating income
as reported in the Consolidated Statements of Operations:

FISCAL 2001 COMPARED TO FISCAL 2000

Management uses operating income before non-comparable items, among other
metrics, to measure operating performance. It supplements and is not intended to
represent a measure of performance in accordance with disclosures required by
accounting principles generally accepted in the United States. The following
discussion excludes non-comparable items. See the table above for a
reconciliation to reported amounts and the section titled Description of
Non-comparable Items described below.

Fiscal 2001, which ended on January 30, 2002, included 52 weeks. Fiscal
2000, which ended on January 31, 2001, included 53 weeks. Same-store sales for
fiscal 2001 compare the 52 week period ended January 30, 2002, to the 52 week
period ended January 31, 2001, and therefore exclude the first week of fiscal
year 2000. Same-store sales include sales of all stores that have been open for
greater than 13 full months.

Same-store sales and total sales for 2001 decreased (0.1%) and (2.4%),
respectively. The decrease in same-store sales is due primarily to fewer sales
transactions due to reduced promotional activity and increased competition in
the discount retail industry, the deflationary effect of our BlueLight Always
program under which we lowered prices on over 30,000 high-frequency items and
the effect of prior year clearance sales of discontinued merchandise. In
addition, total sales decreased due to an additional week of sales in 2000 due
to the 53 week fiscal year and the net effect of store openings and closings.

Gross Margin decreased by ($1,445) from fiscal 2000 and was, as a
percentage of sales, 17.4% in 2001 and 20.9% in 2000. The decline in gross
margin rate is driven by a 13.5% rate in the fourth quarter, attributable to the
pricing effects of our BlueLight Always program, and to higher markdowns of
seasonal apparel due to unseasonably warm weather. Additionally, in fiscal 2001
we experienced a decrease in vendor allowances of approximately $150, primarily
due to the erosion in supplier confidence brought on by the events leading up to
our bankruptcy filing; an increase in sales of food and consumables, which on a
percent of sales basis, carry

14

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

lower margins; and an adjustment to inventory for LIFO, due to lower inventory
levels, partially offset by a decrease in clearance sales in 2001 as compared to
2000 and lower distribution costs under our arrangement with Fleming.

Selling, general and administrative expenses ("SG&A"), which includes
advertising costs (net of co-op recoveries of $434 in 2001 and $633 in 2000),
was 20.7% of sales in 2001 versus 19.0% in 2000. The increase of $461 over the
prior year is due primarily to increased expenses for general liability and
workers compensation claims as reserves were increased by approximately $210 in
2001 following significant analysis and actuarial studies, a decrease in co-op
recoveries caused by erosion in supplier confidence as a result of the events
leading up to our bankruptcy filing under Chapter 11, employee compensation and
utility rate increases, partially offset by a reduction in advertising expense.

Operating loss was ($1,210), or (3.3)% of sales, for 2001 compared to
operating income of $683 million, or 1.8% of sales, for 2000. The decrease in
operating income is attributable to lower sales, a lower gross margin rate and
an increase in SG&A expenses as discussed above.

Net interest expense was $344 and $287 in 2001 and 2000, respectively.
Included in net interest expense is interest income of $4 and $17 for 2001 and
2000, respectively. Net interest expense increased by $57 as a result of the
issuance in January 2001 of $400 million of 9.375% Notes due January 2006, the
issuance in June 2001 of $430 million of 9 7/8% Notes due June 2008, increased
borrowings under our Revolving Credit Agreement and lower investment income. As
of the Petition Date, we stopped accruing interest on debt classified as
Liabilities subject to compromise in our Consolidated Balance Sheets in
accordance with SOP 90-7.

Effective income tax rate was (4.4%) and (40.4%) in 2001 and 2000,
respectively. The decrease in the effective income tax benefit rate is due to a
valuation allowance established for deferred tax assets which we may not be able
to utilize in future years. See Note 17 of the Notes to Consolidated Financial
Statements, in Item 8. Financial Statements and Supplementary Data, of this form
10-K.

FISCAL 2000 COMPARED TO FISCAL 1999

The following discussion excludes non-comparable items. See the table above
for a reconciliation to reported amounts and the section titled Description of
Non-comparable Items described below.

Fiscal 2000, which ended on January 31, 2001, included 53 weeks. Fiscal
1999, which ended on January 26, 2000 included 52 weeks. Same-store sales for
fiscal 2000 compare the 52 week period ended January 24, 2001 to the 52 week
period ended January 26, 2000, and therefore exclude the last week of fiscal
year 2000. Same-store sales include sales of all stores that have been open for
greater than 13 full months.

Same-store sales and total sales for 2000 increased 1.1% and 3.1%,
respectively. The increase in same-store sales primarily reflected the
completion of our discount store conversion initiative in 2000. In addition,
total sales increased due to the net effect of store openings and closings, and
to an additional week of sales in 2000 due to the 53 week fiscal year.

Gross margin decreased ($79) to $7,735 in fiscal 2000, and was, as a
percentage of sales, 20.9% in 2000 and 21.8% in 1999. The decline in the gross
margin rate was due to a shift to clearance sales and promotional sales from
regular sales, growth in lower margin food and consumables sales categories, and
to incremental expenses for the distribution of these grocery and consumable
goods.

SG&A, which includes advertising costs (net of co-op recoveries of $633 in
2000 and $610 in 1999), was 19.0% of sales in 2000 versus 18.3% in 1999. The
increase of $481 over the prior year was primarily attributable to normal wage
increases, an investment in store labor and employee severance costs.

Operating income was $683, or 1.8% of sales, for 2000 compared to operating
income of $1,300, or 3.6% of sales, for 1999.
15

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Net interest expense was $287 and $280 in 2000 and 1999, respectively.
Included in net interest expense is interest income of $17 and $23 for 2000 and
1999, respectively. The increase of $7 primarily relates to additional
borrowings under our credit facilities and lower investment income.

Effective income tax rate was (40.4%) and 33.0% in 2000 and 1999,
respectively. See Note 17 of the Notes to Consolidated Financial Statements, in
Item 8. Financial Statements and Supplementary Data, of this form 10-K.

ANALYSIS OF FINANCIAL CONDITION

Following the Petition Date, we have utilized cash flows from operations
and the DIP Credit Facility as our primary sources of working capital. Shortly
after the Petition Date, in conjunction with our filing under Chapter 11, we
entered into a $2 billion DIP Credit Facility and the Court gave interim
approval to borrow up to $1.15 billion. On March 6, 2002, the Court approved the
entire $2 billion DIP Credit Facility. The DIP Credit Facility is a revolving
credit facility under which Kmart is the borrower and the rest of the Debtors
are guarantors. The DIP Credit Facility has been afforded superpriority claim
status in the Chapter 11 case and is collateralized by first liens on
substantially all of the Debtors' assets (subject to valid and unavoidable
prepetition liens and certain other permitted liens) and provides that proceeds
be used for working capital needs and other general corporate purposes. This
superpriority claim and lien position is shared on an equal and ratable basis
with up to $200 million of claims of our principal cash management banks
relating to overdrafts, fees and certain other liabilities arising from the
provision of treasury, depository and cash management services to the Debtors.

Borrowings under the DIP Credit Facility bear interest at the Prime Rate
plus 2.5% per annum or, at Kmart's option, at the LIBOR rate plus 3.5% per
annum. The DIP Credit Facility stipulates that borrowings thereunder may not
exceed the lesser of 95% of our borrowing base (which is tied to our eligible
inventory levels) or 95% of the commitment (currently $2 billion). Kmart is
obligated to pay an unused commitment fee to the DIP Credit Facility lenders
equal to (i) 1% per annum on the total unused commitment to the extent that the
average total commitment usage is less than or equal to 33 1/3% of the total
commitment, (ii) 3/4% per annum on the total unused commitment to the extent
that the average total commitment usage is greater than 33 1/3% but less than or
equal to 66 2/3% of the total commitment and (iii) 1/2% per annum on the total
unused commitment to the extent that the average total commitment usage is
greater than 66 2/3% of the total commitment.

To the extent that the cumulative net cash proceeds from the sale of
certain leasehold interests and fixed assets exceeds $150 from and after the
Petition Date, the DIP Credit Facility requires us to prepay loans and reduce
commitments thereunder in an amount equal to 50% of such excess.

Under the DIP Credit Facility, capital expenditures are restricted to $650
during fiscal 2002, $800 during fiscal 2003 and $212 during fiscal 2004 up to
April 22, 2004, the maturity date, providing that no more than 55% of the
capital expenditures permitted in any fiscal year may be made in the first two
fiscal quarters and 20% of the unused portion of permitted capital expenditures
in any fiscal year may be carried forward to and used in the following year. We
are also required to maintain specified levels of cumulative earnings before
interest, taxes, depreciation, amortization and special charges for periods
ending as early as June 2002 and thereafter. The DIP 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 dividend payments, sell or dispose of assets, change the nature
of our business and enter into affiliate transactions, mergers and
consolidations. Failure to satisfy these covenants would (in some cases, after
the expiration of a grace period) result in an event of default that could
cause, absent the receipt of appropriate waivers, the funds necessary to
maintain our operations to become unavailable. The DIP Credit Facility contains
other customary events of default, including (i) certain ERISA events, (ii) a
change of control and (iii) the occurrence of certain specified events in the
Chapter 11 cases.

16

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

There were $400, $664 and $330 of borrowings outstanding under our $400
credit facility, $1.1 billion credit facility and DIP Credit Facility,
respectively, at the end of fiscal year 2001.

Net cash provided by operating activities was $997 in 2001 as compared to
net cash provided by operating activities of $1,114 in 2000. The decrease in net
cash provided by operating activities was primarily the result of lower net
earnings, excluding non-comparable items, partially offset by a decrease in
inventory and an increase in accounts payable. Inventory decreased $596 due to
the erosion of supplier confidence brought on by events leading up to the
bankruptcy filing, resulting in the interruption of our supply chain. The
increase in accounts payable is attributable to the bankruptcy filing because
pre-petition indebtedness was stayed. Substantially all liabilities as of the
Petition Date are subject to settlement under a plan of reorganization to be
voted upon by creditors and equity holders and approved by the Court.

Net cash used for investing activities was $1,501 in 2001 compared to
$1,144 in 2000. The increase in cash used for investing activities was primarily
due to higher capital expenditures for the conversion and expansion of Kmart
stores to Kmart Supercenters, expansion of aisles to increase visibility of
promotional items and an investment in point-of-sale equipment.

Net cash provided by financing activities was $1,354 in 2001 compared to
$87 in 2000. The increase in cash provided by financing activities was primarily
the result of the issuance of $430 of 9 7/8% Notes due June 2008, increased
borrowings under the Credit Facility and the 364-day Facility and borrowings of
$330 under our DIP Credit Facility, partially offset by the redemption of $262
of Collateralized Mortgage Backed Securities.

Due to the seasonal nature of the retail industry, where merchandise sales
and cash flows from operations are historically higher in the fourth quarter
than any other period, a disproportionate amount of operating income and cash
flows from operations is earned in the fourth quarter. In preparation for the
Christmas season, we significantly increase our merchandise inventories, which
traditionally have been financed by cash flow from operations, bank lines of
credit, trade credit and terms from vendors. Our profitability and cash flows
are primarily dependent upon the large sales volume generated during the fourth
quarter of our fiscal year. Fourth quarter sales represented over 30% of total
net sales in fiscal 2001.

In July 2001, we terminated the common stock repurchase program that was
initiated in April 1999. Under the program we repurchased approximately 22
million shares of common stock at a cost of approximately $55 and $200 in fiscal
years 2000 and 1999, respectively. We also terminated the trust convertible
preferred securities repurchase program that was initiated in February 2000.
Under the program we repurchased approximately 2 million shares of trust
convertible securities during fiscal year 2000 at a cost of approximately $84.

Inflation has not had a significant impact on our business over the past
three years and we do not expect it to have a significant impact on operations
in the foreseeable future, unless global or geo-political situations
substantially affect the world economy.

17

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

Information concerning our obligations and commitments to make future
payments under contracts, such as debt and lease agreements, and under
contingent commitments is aggregated in the following tables.

Under the Bankruptcy Code, actions to collect pre-petition indebtedness, as
well as most other pending litigation, are stayed and other contractual
obligations against Kmart may not be enforced. In addition, we may assume or
reject executory contracts, including lease obligations, such as the 283 stores
we were authorized to close by the Court on March 6, 2002. Therefore, the
commitments shown in the above table and discussed above may not reflect actual
cash outlays in the future periods.

GUARANTEES

We have guaranteed leases for properties operated by certain former
subsidiaries including Borders Group, Inc., OfficeMax, Inc. and The Sports
Authority, Inc. The present value of the lease obligations we have guaranteed is
approximately $339. Our rights and obligations with respect to our guarantee of
The Sports Authority, Inc., OfficeMax, Inc., and Borders Group, Inc. leases are
governed by Lease Guaranty, Indemnification and Reimbursement Agreements dated
as of November 23, 1994, November 9, 1994, and May 24, 1995, respectively, as
may be amended from time to time. In addition, as of January 30, 2002, we had
guaranteed $82 of indebtedness of other parties related to certain of our leased
properties financed by industrial revenue bonds. These agreements expire from
2004 through 2009. Kmart's contingent obligation is dependent on the future
operating results of the guarantees and is subject to settlement under a plan of
reorganization to be voted upon creditors and equity holders and approved by the
Court.

DESCRIPTION OF NON-COMPARABLE ITEMS

During fiscal years 2001 and 2000, we instituted certain restructuring
actions to improve our operations. Also, in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," we recorded an impairment charge in fiscal
2001. These actions are summarized below.

18

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

LONG-LIVED ASSET IMPAIRMENT

Due to below-plan sales and earnings performance in the fourth quarter, our
filing under Chapter 11 and planned actions under such filings, we performed a
recoverability test on our long-lived assets. In accordance with SFAS No. 144,
we recorded a non-cash charge of $979 in the fourth quarter of fiscal 2001. This
charge is included in the Restructuring, impairment and other charges line in
the Consolidated Statements of Operations.

Of the $979 charge, $929 relates to long-lived assets in our stores. We
reviewed assets on a store level basis, which is the lowest level of assets for
which there are identifiable cash flows. The carrying amount of the store asset
groups were compared to the related expected undiscounted future cash flows to
be generated by those assets over the estimated remaining useful life of the
primary asset. Cash flows were projected for each store based upon historical
results and expectations. In cases where the expected future cash flows were
less than the carrying amount of the assets, those stores were considered
impaired and the asset group was written down to fair value. Fair value was
based on appraised value or estimated sales values of similar assets in recent
transactions.

We performed an additional assessment of assets that were not included in
the above store analysis. We recorded charges totaling $50 for capital projects
that were cancelled due to capital expenditure restrictions in our DIP Credit
Facility.

SUPPLY CHAIN OPERATIONS

On September 6, 2001, we announced that we would restructure certain
aspects of our supply chain operations. This restructuring program focused on
the supply chain infrastructure, including the reconfiguration of our
distribution center ("DC") network and implementation of new operating software
across our supply chain. As a result of these actions, we recorded a $163 charge
during the third quarter of fiscal year 2001.

Reconfiguration of the distribution center network entailed replacing two
aging distribution centers with two state-of-the-art facilities. The existing
distribution centers were not properly fitted for softline DC operations and
required significant investment to upgrade. Replacing the facilities is expected
to enable increased throughput and quicker inventory turns and improve
efficiency across all other centers. In addition, the distribution of
slower-moving goods is being centralized at one newly designated center.
Included in the charge was $37 for a reserve for future lease obligations
related to the closing of the two aging distribution centers, both of which we
have exited, and a $10 charge to provide for contractual employee obligations in
accordance with EITF 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." These charges are included in Cost of
sales, buying and occupancy in the Consolidated Statements of Operations. During
the fourth quarter of fiscal 2001, $6 was paid and charged to the reserves.
Additionally, we reversed through Reorganization items $30 of this charge to
reduce the reserves for future lease obligations to the amount of allowed claims
under the Bankruptcy Code.

We recorded an $88 charge for the disposal of computer equipment and
software, leasehold improvements and other assets that will no longer be
utilized. These charges are included in Selling, general and administrative
expenses in the Consolidated Statements of Operations. In addition, we recorded
a $5 charge for other supply chain assets. These charges were recorded in
accordance with SFAS No. 144 and are included in Cost of sales, buying and
occupancy in the Consolidated Statements of Operations. New real-time
distribution software will be implemented across our supply chain improving
product flow and efficiency while enabling a world class distribution network.
The current warehouse management software system does not provide adequate
performance reporting and is not cost effective to upgrade. Due to increased
efficiency associated with the new software we will be able to increase
productivity through improved cube management while reducing labor costs.
Completion of the implementation is expected by the end of the third quarter of
19

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

fiscal 2003. The existing supply chain software will continue to be utilized
until replaced in 2003. Depreciation has been accelerated to reflect the revised
remaining useful lives. We recorded a charge of $23 related to the accelerated
depreciation for these assets in 2001. These charges are included in Cost of
sales, buying and occupancy in the Consolidated Statements of Operations.

As a result of these actions we expect results from operations before
income taxes to improve by approximately $5 per year. These savings will be
achieved through reductions in labor costs, depreciation expense and maintenance
costs, and increased productivity.

The following table summarizes the significant components and presentation,
in the Consolidated Statements of Operations, of the charge for the
restructuring of our supply chain operations during 2001.

BLUELIGHT.COM

As a result of the changed environment for internet businesses, in which
their ability to raise capital became restricted, management's revised future
cash flow projections and the potential need for significant additional cash
advances, we adopted a multi-step plan to substantially restructure the
operations of BlueLight.com.

At the end of the second quarter, we acquired the remaining 40% interest in
BlueLight.com, giving us control of the entity. To acquire the 40% interest, we
issued $69 in shares of Kmart common stock and paid $16 in cash for a total
purchase price of $85. In connection with the acquisition, the return of capital
put rights were terminated, the related $62.5 liability was relieved, and the
4.4 million warrants for Kmart common stock issued to SOFTBANK Venture Capital
(currently, Mobius Venture Capital) and other investors were cancelled.

As a result of these activities, we recorded a $92 charge during the second
quarter of fiscal year 2001. Of the charge, $41 related to the impairment of our
investment in BlueLight.com, which was written down to fair value. This charge
was recorded based upon our revised cash flow projections for the business in
accordance with SFAS No. 144. The remaining $51 of the charge related to the
restructuring of our e-commerce business.

Of the $51 restructuring charge, $29 related to assets impaired as a result
of the restructuring. These assets represent furniture and fixtures, leasehold
improvements, and computer software and hardware, the majority of which were
located in the headquarters of BlueLight.com, and have not been utilized in the
restructured operations. This charge was recorded in accordance with SFAS No.
144. Liabilities for lease terminations, contract terminations and other costs
totaling $22 were established in accordance with EITF 94-3 as a result of the
decision to exit the BlueLight.com headquarters building and outsource certain
aspects of our overall e-commerce business, including fulfillment, technology
and customer service. During the year, $5 has been paid and charged against the
liability.

During the remainder of 2001, we continued executing our restructuring
plan, including formally communicating severance benefits to 114 employees at
the BlueLight.com headquarters and terminating ninety-eight of those employees.
We recorded an additional $5 charge in the third quarter of fiscal 2001 to
provide for these costs, $4 of which has been paid and charged against the
liability.

20

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

We also outsourced the hosting of our site, fulfillment of e-commerce
orders and all related customer service. The restructuring has reduced the
operating costs of BlueLight.com by over 75%, from a first half of fiscal 2001
loss of $55 to a second half loss of $12. We are pursuing additional cost
savings, which we expect to reduce our e-commerce loss by over $45 in 2002 from
2001 levels.

All charges for the restructuring and impairment of the investment are
included in the line Restructuring, impairment and other charges in the
Consolidated Statements of Operations. The results of BlueLight.com's operations
are fully consolidated in our financial statements commencing July 31, 2001.

EMPLOYEE SEVERANCE AND VERP

During the first quarter of 2001, we realigned our organization and reduced
our workforce by 350 employees through a voluntary early retirement program
("VERP") and other employee separations. The total cost of the realignment
aggregated $23, which is included in our Consolidated Statements of Operations
in the line Restructuring, impairment and other charges. The charge relates, in
part, to 130 employees that accepted the VERP offer, with costs aggregating $6.
The remaining 220 employees were severed and given post-employment benefits
including severance, outplacement services, continuation of healthcare benefits
and other benefits totaling $17. All payments associated with the severance and
VERP charge have been made as of January 30, 2002.

2000 STRATEGIC ACTIONS

In the second quarter of fiscal year 2000, we announced a series of
strategic actions aimed at strengthening financial performance by achieving
improvements in return on invested capital. These actions included deciding to
close certain Kmart and Kmart Supercenters, accelerating certain inventory
reductions and redefining our information technology strategy. As a result of
these initiatives, we recorded a pre-tax charge of $740 ($471 net of tax) during
the second quarter of 2000. During the third quarter of fiscal year 2000, we
reduced this charge by $12 ($8 net of tax) due to changing the number of
scheduled store closings from 72 to 69, thus reducing the reserve for closed
stores from $300 to $288 million. During fiscal year 2001, $42 was paid and
charged to the reserve. In connection with the bankruptcy filing, we recorded to
the reserve a non-cash adjustment of $37 for the rejection of certain leases
associated with the 2000 strategic actions charge to reduce the reserve to the
allowed claim amount under the Bankruptcy Code.

The following table summarizes the significant components of the charge for
strategic actions taken during fiscal year 2000 and the presentation in our
Consolidated Statements of Operations:

21

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

REORGANIZATION ITEMS

Reorganization items represent amounts we incurred as a result of the
Chapter 11 proceedings in accordance with SOP 90-7. The amounts for
Reorganization items in the Consolidated Statements of Operations include a
charge of $8 for professional services, a credit of $18 for the reduction of
lease obligations due to the rejection of closed store leases not classified as
discontinued operations and a credit of $174 for the reduction of our estimated
obligation for general liability claims.

RECORDING OF TAX VALUATION ALLOWANCE

Following the Petition Date, we recorded a non-cash charge of $958 to
provide a valuation allowance on net deferred tax assets in accordance with SFAS
No. 109 "Accounting for Income Taxes," as realization of such assets in future
years is uncertain.

DISCONTINUED OPERATIONS

In connection with Kmart's bankruptcy filing, we recorded a non-cash credit
of $169 for the reduction of our obligation due to the rejection of leases for
our discontinued operations to reduce the reserves to the amount of the allowed
claim under the Bankruptcy Code.

OTHER ITEMS NOT RELATED TO FISCAL YEAR 2001 OPERATING RESULTS

Included in 2001 operating results are adjustments to our asset and
liability accounts that reduced operating results reported in 2001 by $15 in the
first quarter, $21 in the second quarter, $2 in the third quarter and $23 in the
fourth quarter. Substantially all of the adjustments related to prior years.

FISCAL YEAR 2002

Our BlueLight Always campaign significantly impacted the gross margin
decline that occurred in the fourth quarter of fiscal 2001 and we do not expect
that to continue in fiscal 2002. In that regard, we have scaled back the
BlueLight Always campaign under which we lowered prices from a peak of over
30,000 items to approximately 18,000 items through the end of January 2002. In
addition, significant allowances, which have historically been collected in the
fourth quarter, were severely impacted in 2001 by the events leading up to the
bankruptcy. These two factors alone accounted for the majority of our gross
margin rate erosion.

The DIP Credit Facility restricts us to $650 for capital expenditures for
fiscal year 2002. Projects identified in the fiscal year 2002 capital budget
include $213 for store operations and maintenance, $84 for supply chain
operations, $55 for store expansions, $43 for information technology and $22 for
merchandising.

STORE ACTIVITY

We ended the year with an increase in our number of stores from 2,105 in
2000 compared to 2,114 in 2001. We opened 20 stores (14 Kmart stores and six
Kmart Supercenters) and closed 11 Kmart stores. We expect to open three Kmart
Supercenters during 2002. Capital expenditures relating to these projects will
be funded through operating cash flows.

On March 20, 2002, the Court approved the closure of 283 stores, or
approximately 13% of our 2,114 stores. The closures include 270 Kmart discount
stores and 12 Kmart Supercenters in 40 states, and one Kmart store in Puerto
Rico. Stores were selected by evaluating the market and financial performance of
every store and the terms of every lease. Candidates for closure were stores
that did not meet our financial requirements for ongoing operations.
Renegotiating lease terms was also explored to improve store profitability and
avoid the need for closure.

22

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Shortly after receiving Court approval we commenced store-closing sales,
which are expected to continue for approximately two to three months.
Approximately 22,000 associates will be impacted by the closures. Associates
have been notified and received information about the benefits and other
resources available to them.

On April 4, 2002, we announced that we had contracted with firms to assist
in the disposition of leases for these stores. Under the agreement, the firms
will assist our internal real estate staff in identifying retailers and
investors interested in an assignment and landlords interested in a termination
of the leases for the closing stores. Leases that are not marketed will be
rejected shortly after the completion of the related store-closing sales.

The closure of these stores is expected to significantly enhance our
operational and financial performance. We anticipate the sales generated from
store closings and related cost savings will enhance our cash flow by
approximately $550 in 2002 and approximately $45 annually thereafter. These
stores represented approximately $3,500 in sales in 2001. As a result of these
anticipated store closings, we recorded a charge of approximately $500 in the
fourth quarter of 2001, which is included in the long-lived asset impairment
charge described above. In the first quarter of fiscal 2002, we will record an
additional $600 to $800 charge relating primarily to exit costs to be incurred
for lease rejections and severance, and markdowns taken on inventory in
connection with liquidation sales. In conjunction with the store-closing sales,
we will also accelerate certain inventory reductions for which we expect a
charge in the first quarter of fiscal 2002 for approximately $250.

PENSKE

On April 9, 2002 we reached an agreement with Penske Corporation, Penske
Auto Centers, Inc., and Penske Auto Centers, LLC (collectively "Penske") whereby
Penske and Kmart will work together to achieve an orderly wind-down of
operations at auto service centers at more than 563 Kmart stores in 44 states
following Penske's unilateral decision to close the business as of April 6,
2002. We account for our investment in Penske Auto Centers LLC under the equity
method and our investment at January 30, 2002 had no carrying value. We do not
expect this matter to have a material adverse effect on our liquidity, financial
position or results of operations.

NEW ACCOUNTING PRONOUNCEMENTS

The provisions of Statement of Financial Accounting Standards ("SFAS") No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
by SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities -- Deferral of the Effective Date of FASB Statement No. 133," and
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," (collectively, "SFAS No. 133") became effective for Kmart on
February 1, 2001. SFAS No. 133 requires all derivatives to be recorded on the
balance sheet at fair value and establishes accounting treatment for various
types of hedges. We currently do not engage in these types of transactions, and
there was no impact to our financial statements from the adoption of SFAS No.
133.

In June 2001, the FASB issued SFAS No. 141, "Business Combinations,"
effective for all business combinations initiated after June 30, 2001. This
statement also applies to all business combinations accounted for using the
purchase method for which the date of acquisition is July 1, 2001 or thereafter.
Also, in June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," and SFAS No. 143, "Accounting for Asset Retirement Obligations,"
effective for fiscal years beginning after December 15, 2001. The adoption SFAS
No. 141 and SFAS No. 142 are not expected to have a material impact on our
earnings or financial position. We are currently assessing the impact that SFAS
No. 143 will have on our earnings and financial position.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," effective for fiscal years
beginning after December 15, 2001. We have elected early adoption of
23

MANAGEMENT'S DISCUSSION AND ANALYSIS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

SFAS No. 144 for the fiscal year 2001. See Note 6 of the Notes to Consolidated
Financial Statements, in Item 8. Financial Statements and Supplementary Data, of
this form 10-K for a discussion of the impairment charges recorded in accordance
with SFAS No. 144.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At January 30, 2002, 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 DIP
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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following information is submitted pursuant to the requirements of Item
8:

24

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying Notes to Consolidated Financial Statements
25

CONSOLIDATED BALANCE SHEETS

See accompanying Notes to Consolidated Financial Statements
26

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying Notes to Consolidated Financial Statements
27

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

See accompanying Notes to Consolidated Financial Statements
28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

1) PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

On January 22, 2002 ("Petition Date"), Kmart Corporation and 37 of its U.S.
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the federal bankruptcy laws ("Bankruptcy Code" or "Chapter 11") in the United
States Bankruptcy Court for the Northern District of Illinois ("Court"). The
reorganization is being jointly administered under the caption "In re Kmart
Corporation, et al. case No. 02 B 02474." Included in the Consolidated Financial
Statements are subsidiaries operating outside of the United States, which have
not commenced Chapter 11 cases or other similar proceedings elsewhere, and are
not debtors. The assets and liabilities of such non-filing subsidiaries are not
considered material to the Consolidated Financial Statements. Kmart Corporation
and all of its consolidated subsidiaries are collectively referred to herein as
"Kmart," "we" or "our." We decided to seek judicial reorganization based upon a
rapid decline in liquidity resulting from below-plan sales and earnings
performance in the fourth quarter, the evaporation of the surety bond market, an
erosion in supplier confidence, intense competition in the discount retail
industry, unsuccessful sales and marketing initiatives, the continuing recession
and recent capital market volatility.

As a debtor-in-possession, Kmart is authorized to continue to operate as an
ongoing business, but may not engage in transactions outside the ordinary course
of business without the approval of the Court, after notice and an opportunity
for a hearing. Under the Bankruptcy Code, actions to collect pre-petition
indebtedness, as well as most other pending litigation, are stayed and other
contractual obligations against Kmart may not be enforced. In addition, under
the Bankruptcy Code we may assume or reject executory contracts, including lease
obligations. Parties affected by these rejections may file claims with the Court
in accordance with the reorganization process. Absent an order of the Court,
substantially all pre-petition liabilities are subject to settlement under a
plan of reorganization to be voted upon by creditors and equity holders and
approved by the Court.

On January 25, 2002, the Court gave interim approval for $1.15 billion of a
$2 billion senior secured debtor-in-possession financing facility ("DIP Credit
Facility") for payment of permitted pre-petition claims, working capital needs,
letters of credit and other general corporate purposes. On March 6, 2002, the
Court approved the entire $2 billion DIP Credit Facility to supplement our cash
flow from operations during the reorganization process. The DIP Credit Facility
requires that we maintain certain financial covenants and restrict future liens,
indebtedness, capital expenditures, dividend payments and sale of assets.

The accompanying Consolidated Financial Statements have been prepared on a
going concern basis, which assumes continuity of operations and realization of
assets and satisfaction of liabilities in the ordinary course of business, and
in accordance with Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting
by Entities in Reorganization under the Bankruptcy Code." Accordingly, all
pre-petition liabilities subject to compromise have been segregated in the
Consolidated Balance Sheets and classified as Liabilities subject to compromise,
at the estimated amount of allowable claims. Liabilities not subject to
compromise are separately classified as current and non-current. Revenues,
expenses, realized gains and losses, and provisions for losses resulting from
the reorganization are reported separately as Reorganization items. Cash used
for reorganization items is disclosed separately in the Consolidated Statements
of Cash Flows.

The ability of Kmart to continue as a going concern is predicated upon,
among other things, the confirmation of a reorganization plan, compliance with
the provisions of the DIP Credit Facility and the ability to generate cash from
operations and obtain financing sources sufficient to satisfy our future
obligations.

2) RESTATEMENT OF FISCAL 2001 UNAUDITED QUARTERLY FINANCIAL DATA

Given our recent bankruptcy filing and the increased uncertainty relating
to vendor rebates and allowances ("allowances") and the corresponding difficulty
in reliably estimating such amounts in the future, we concluded that it would be
preferable to change our accounting method for interim recognition of cost
recoveries from vendors. Under the new methodology, Kmart will recognized a cost
recovery from vendors
29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

only when a formal agreement for such amount has been obtained and the
underlying activity for which the amount was provided has been performed. This
change in methodology does not affect the results that otherwise would have been
reported for the full fiscal year, but rather affects the interim recognition of
allowances during the year. While this change in method was adopted in the
fourth quarter of fiscal 2001, generally accepted accounting principles require
the restatement of the first three quarters of fiscal 2001 to reflect this
change.

Additionally, in January 2002, Kmart announced that we had received an
anonymous letter sent to the Securities and Exchange Commission ("SEC"), our
auditors and directors expressing concern with respect to various matters.
Accordingly, the Board of Directors instructed that an internal investigation be
undertaken under the supervision of the Audit Committee by outside legal
counsel, with the assistance of independent accounting advisors.

Based on the results of the investigation to date, as well as the results
of our new management team's review of Kmart's accounting policies and methods,
adjustments were made, to restate previously reported quarterly financial
statements. Our financial statements for prior fiscal years were not affected.

For information regarding the restatements, see Note 22.

3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations: Kmart operates discount department stores located in
all 50 states, Puerto Rico, the U.S. Virgin Islands, and Guam. Kmart has two
equity investments including our 49% interest in substantially all of the
Meldisco subsidiaries of Footstar, Inc. ("FTS"), which operate the footwear
department in Kmart stores and our 36% interest in Penske Auto Centers LLC. See
Note 23 regarding the wind down of Penske Auto Centers LLC operations. We have
one operating segment that comprises our retail business.

Basis of Consolidation: The Consolidated Financial Statements include all
majority-owned subsidiaries in which we exercise control. Investments in which
we exercise significant influence, but which we do not control (generally 20% to
50% ownership interest), are accounted for under the equity method of
accounting. All material intercompany transactions and balances have been
eliminated.

Fiscal Year: Our fiscal year ends on the last Wednesday in January. Fiscal
year 2001 consisted of 52 weeks and ended on January 30, 2002. Fiscal year 2000
consisted of 53 weeks and ended on January 31, 2001. Fiscal year 1999 consisted
of 52 weeks and ended on January 26, 2000.

Bankruptcy Accounting: Since the Chapter 11 bankruptcy filing, we have
applied the provisions of SOP 90-7, which does not significantly change the
application of accounting principles generally accepted in the United States;
however, it does require that the financial statements for periods including and
subsequent to filing the Chapter 11 petition distinguish transactions and events
that are directly associated with the reorganization from the ongoing operations
of the business.

Cash: Cash and cash equivalents include all highly liquid investments with
maturities of three months or less. Included are temporary investments of $0 and
$71, at year end 2001 and 2000, respectively, and receivables for credit card
sales transactions of $79 and $69 at year end 2001 and 2000, respectively. Also
included in cash and cash equivalents at January 30, 2002 is $29 million of
restricted cash.

Merchandise Inventories: Inventories are stated at the lower of cost or
market, primarily using the retail method. The last-in, first-out ("LIFO")
method, utilizing internal inflation indices, was used to determine the cost for
$5,537, $6,104 and $6,690 of inventory as of fiscal year end 2001, 2000 and
1999, respectively. Inventories valued on LIFO were $269, $194 and $202 lower
than amounts that would have been reported using the first in, first out
("FIFO") method at fiscal year end 2001, 2000 and 1999, respectively. We
recorded a LIFO charge of $75 in 2001 and credits of $8 and $47 in 2000 and
1999, respectively.

30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Property and Equipment: Property and equipment are recorded at cost.
Additions and betterments are capitalized and include expenditures that
materially extend the useful lives of existing facilities and equipment.
Maintenance and repairs that do not materially improve or extend the lives of
the respective assets are expensed as incurred.

Long-lived Assets: Long-lived assets consist primarily of land, buildings,
furniture and equipment and leasehold improvements. The recoverability of the
carrying value of long-lived assets to be held and used is evaluated at the
store level based on an analysis of operating results and consideration of other
significant events or changes in the business environment. If a store asset
group has indications of impairment, we will evaluate whether impairment exists
on the basis of undiscounted expected future cash flows from operations before
interest over the remaining useful life of the primary asset. If impairment
exists, the carrying amount of the long-lived assets is reduced to its estimated
fair value. Assets to be disposed of are reported at the lower of carrying
amount or fair value less the cost to sell.

Capitalized Software Costs: Costs associated with the acquisition or
development of software for internal use are capitalized and amortized using the
straight-line method over the expected useful life of the software, which ranges
from 3 to 7 years.

Depreciation and Amortization: Depreciation and amortization, including
depreciation of property held under capital leases, are computed based upon the
estimated useful lives of the respective assets using the straight-line method
for financial statement purposes and accelerated methods for tax purposes. The
general range of lives are 25 to 50 years for buildings, 5 to 25 years for
leasehold improvements, 3 to 17 years for furniture and fixtures and 3 to 5
years for computer systems and equipment.

Financial Instruments: Cash and cash equivalents, trade accounts payable
and accrued liabilities are reflected in our financial statements at cost, which
approximates fair value. The fair value of our debt and other financial
instruments is discussed in Note 8.

Derivative Instruments and Hedging Activities: The provisions of Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities -- Deferral of the effective date
FASB Statement No. 133," and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," (collectively "SFAS No. 133")
became effective for Kmart on February 1, 2001. We do not engage in hedging
transactions or invest in derivative instruments. Accordingly, the provisions of
SFAS No. 133 do not have a material impact on our Consolidated Financial
Statements.

Self-insurance: We self-insure or retain a portion of the exposure for
losses related to workers compensation and general liability costs. It is our
policy to record our self-insurance reserves, as determined actuarially, based
upon claims filed and an estimate of claims incurred but not yet reported.

Revenue Recognition: We recognize revenue from the sale of merchandise at
the time the merchandise is sold, net of anticipated returns. We defer the
recognition of layaway sales and profit until the period the merchandise is
delivered to the customer. Our deferred revenue is recorded in Accrued payroll
and other liabilities in the Consolidated Balance Sheets. As a result of
adopting Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"), we recorded a one-time, after-tax earnings reduction of
$7, or $0.01 per share, in the fourth quarter of 1999 to reflect the cumulative
effect of the accounting change related to the modification of accounting for
layaway sales. Prior to the adoption of SAB 101, layaway sales and profits were
recognized at the time the merchandise was placed in layaway.

Vendor Rebates and Allowances: Periodic payments from vendors in the form
of buydowns, volume or other purchase discounts that are evidenced by signed
agreements are reflected in the carrying value of the inventory when earned and
as a component of Cost of sales, buying and occupancy as the merchandise is
sold. Up-front consideration received from vendors linked to purchases or other
commitments is initially deferred and amortized ratably over the life of the
contract or as performance of the activities specified by the vendor to
31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

earn the fee is completed. Allowances are included as a component of Cost of
sales, buying and occupancy and as reductions in advertising expense in Selling,
general and administrative expenses. See Note 22 for a discussion of the change
in accounting method for interim recognition of cost recoveries from vendors
adopted in fiscal 2001.

Pre-Opening Costs: The costs of start-up activities are expensed in the
period in which they occur.

Advertising Costs: Advertising costs, net of co-op recoveries from vendors
of $434, $633 and $610 for fiscal years 2001, 2000 and 1999, respectively, are
expensed as incurred and amounted to $616, $508 and $453 in 2001, 2000 and 1999,
respectively. These costs are included in Selling, general and administrative
expenses in the Consolidated Statements of Operations.

Income Taxes: Deferred income taxes are provided for temporary differences
between financial statement and taxable income. We accrue U.S. and foreign taxes
payable on our pro rata share of the earnings of subsidiaries, except with
respect to earnings that are intended to be permanently reinvested, or expected
to be distributed free of additional tax by operation of relevant statutes
currently in effect, and by utilization of available tax credits and deductions.
In accordance with SFAS No. 109 "Accounting for Income Taxes," we have recorded
a full valuation allowance on net deferred tax assets as realization of such
assets in future years is uncertain. See Note 17.

Stock Option Plans: Kmart accounts for its stock option plans in
accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations. See Note 21.

Use of Estimates: The preparation of the Consolidated Financial Statements
in conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results,
particularly with respect to matters impacted by the proceedings under Chapter
11, could differ from those estimates.

Reclassifications: Certain reclassifications of prior year amounts have
been made to conform to the current presentation.

New Accounting Pronouncements: In June 2001, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 141, "Business Combinations," and SFAS
No. 142, "Goodwill and Other Intangible Assets," effective for all business
combinations initiated after June 30, 2001 and for fiscal years beginning after
December 15, 2001, respectively. SFAS No. 141 eliminates the pooling of
interests method of accounting for business combinations, with limited
exceptions, for transactions initiated prior to July 1, 2001, and broadens the
criteria for recording intangible assets separate from goodwill. We do not
expect that the application of the provisions of SFAS No. 141 will have a
material impact to our Consolidated Financial Statements. Under the provisions
of SFAS No. 142, the nonamortization provisions and annual impairment tests of
goodwill will have no impact on Kmart. Also, in June 2001, the FASB issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses
the accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. SFAS No.
143 will be effective for Kmart on January 30, 2003. We are currently assessing
the impact that the application of the provisions of SFAS No. 143 will have on
our Consolidated Financial Statements. In August 2001, the FASB issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This
Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," and establishes a single
accounting approach for measuring impairment of long-lived assets, including a
segment of a business accounted for as a discontinued operation whether sold or
disposed of by other means. We adopted the provisions of SFAS No. 144 as of the
beginning of fiscal 2001. See Note 6 for a discussion of impairment charges
recorded in accordance with SFAS No. 144.

32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

4) INTEREST ON PRE-PETITION DEBT

Included in the line Interest expense, net in the Consolidated Statements
of Operations is interest income of $4, $17 and $23 for fiscal years 2001, 2000
and 1999, respectively. On the Petition Date we stopped accruing interest on all
unsecured pre-petition debt in accordance with SOP 90-7. Contractual interest
expense not accrued or recorded on certain pre-petition debt totaled $8 in
fiscal 2001.

5) REORGANIZATION ITEMS

Reorganization items represent amounts we incurred as a result of the
Chapter 11 proceedings in accordance with SOP 90-7. The amounts for
Reorganization items in the Consolidated Statements of Operations include a
charge of $8 for professional services, a credit of $18 for the reduction of
lease obligations due to the rejection of closed store leases not classified as
discontinued operations and a credit of $174 for the reduction of our estimated
obligation for general liability claims.

6) RESTRUCTURING, IMPAIRMENT AND OTHER CHARGES

LONG LIVED ASSET IMPAIRMENT

Due to below-plan sales and earnings performance in the fourth quarter, our
filing under Chapter 11 and planned actions under such filings, we performed a
recoverability test on our long-lived assets. In conjunction with this analysis
we recorded a non-cash charge of $979 in accordance with SFAS No. 144. This
charge is included in the Restructuring, impairment and other charges line in
the Consolidated Statements of Operations.

Of the $979 charge, $929 relates to long-lived assets in our store
locations. We reviewed assets on a store-level basis, which is the lowest level
of assets for which there are identifiable cash flows. The carrying amount of
the store asset groups were compared to the related expected undiscounted future
cash flows to be generated by those assets over the estimated remaining useful
life of the primary asset. Cash flows were projected for each store based upon
historical results and estimates of future performance. In cases where the
expected future cash flows were less than the carrying amounts of the assets,
those stores were considered impaired and the asset group was written down to
fair value. Fair value represents appraised value or is estimated based on sales
values of similar assets sold in recent transactions.

We performed an additional assessment of assets that were not included in
the above store analysis. We recorded charges totaling $50 for capital projects
that were cancelled, due to capital expenditure restrictions in our DIP Credit
Facility.

SUPPLY CHAIN OPERATIONS

On September 6, 2001, we announced that we would restructure certain
aspects of our supply chain infrastructure, including the reconfiguration of our
distribution center network and implementation of new operating software across
our supply chain. Completion of these actions is expected by the end of the
third quarter of 2003. In conjunction with these actions, we recorded special
charges totaling $163 during 2001.

We recorded a $93 charge related to the planned disposal of supply chain
software and hardware and other assets that will no longer be utilized, in
accordance with SFAS No. 144. As certain other components of our supply chain
software will continue to be utilized until replaced, depreciation will be
accelerated to reflect the revised useful lives and these assets will be fully
amortized by the end of the third quarter in 2003. We recorded a charge of $23
related to the accelerated depreciation on these assets during fiscal 2001. The
expected incremental depreciation aggregates $13 in fiscal 2002 and $5 in fiscal
2003. A $47 charge was provided for lease terminations and contractual
employment obligations for staff reductions of 956 employees at our distribution
centers in accordance with EITF 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a
33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Restructuring)" ("EITF 94-3"). The majority of the employees were severed in the
fourth quarter of fiscal year 2001, with the remaining employees to be severed
in the first quarter of fiscal year 2002. During the fourth quarter $6 was paid
and charged to reserves for lease terminations and contractual employment
obligations. Additionally, we reversed through Reorganization items $30 of this
charge to reduce the lease termination reserve to the amount of the allowed
claim amount under the Bankruptcy Code.

The following table summarizes the significant components and presentation
in the Consolidated Statements of Operations of the charge for restructuring our
supply chain operations during 2001.

BLUELIGHT.COM

We recorded a $92 charge related to our e-commerce site, BlueLight.com, in
the second quarter comprised of $41 for the impairment of our investment in
BlueLight.com and $51 for the restructuring of our e-commerce business. These
charges are included in the line Restructuring, impairment and other charges in
the Consolidated Statements of Operations.

As a result of the changed environment for internet businesses, in which
their ability to raise capital became restricted, management's revised future
cash flow projections and the potential need for significant additional cash
advances, we adopted a multi-step plan to substantially restructure the
operations of BlueLight.com. The initial step was executed by acquiring the
remaining 40% interest in BlueLight.com, LLC through the purchase of all
outstanding common and preferred stock of BlueLight.com, Inc., a holding
company, and certain limited liability company interests not then owned by us.
BlueLight.com, Inc. and BlueLight.com, LLC (hereinafter together or
individually, "BlueLight.com") then became wholly owned subsidiaries of Kmart,
which allowed us to execute the subsequent steps of our plan. The purchase price
of the additional interest was $85, with $69 being satisfied through the
issuance of 6.1 million unregistered shares of Kmart common stock and $16 paid
in cash. Based upon the revised cash flow projections for the business, we
recorded a $41 charge to write-down our investment in BlueLight.com to estimated
fair value in accordance with SFAS No. 144. Fair value was estimated using the
present value of estimated future cash flows.

In conjunction with the transaction, the return of capital puts for $62.5
and the 4.4 million warrants for Kmart stock originally granted to SOFTBANK
Venture Capital (currently Mobius Venture Capital) and other investors,
previously disclosed, were terminated. The $62.5 liability for the return of
capital puts, recorded due to the uncertainties surrounding a start-up operation
in the highly competitive e-commerce industry, was relieved.

Of the $51 restructuring charge, $29 related to assets impaired as a result
of the restructuring. These assets represent furniture and fixtures, leasehold
improvements, and computer software and hardware, the majority of which were
located in the headquarters of BlueLight.com, and have not been utilized in the
restructured operations. These assets were reduced to the lower of carrying
amount or fair value less cost to sell in accordance with SFAS No. 144. Fair
value was determined using the present value of estimated future cash flows.
Liabilities for lease terminations, contract terminations and other costs
totaling $22 were established in accordance with EITF 94-3 as a result of the
decision to exit the BlueLight.com headquarters building and outsource certain
aspects of our overall e-commerce business, including fulfillment, technology

34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

and customer service. During fiscal 2001, $5 was paid and charged against the
reserves. After the application of the provisions of SFAS No. 144, as described
above, we had remaining long-lived assets with an estimated fair value of $2.5,
which are being depreciated over their remaining estimated useful life of 2.5
years.

During the remainder of 2001, we continued executing our restructuring
plan, including formally communicating to 114 employees at the BlueLight.com
headquarters expected severance dates and the severance benefit amount they
would receive upon termination. In conjunction with this communication, we
recorded an additional $5 charge to provide for these costs, $4 of which has
been paid and charged against the reserve. These charges are included in the
line Restructuring, impairment and other charges in the Consolidated Statements
of Operations. Ninety-eight employees were terminated during the second half of
fiscal 2001. We also outsourced the hosting of our site, fulfillment of
e-commerce orders and all related customer service.

EMPLOYEE SEVERANCE AND VERP

During the first quarter of 2001, we realigned our organization and reduced
our workforce by 350 employees through a voluntary early retirement program
("VERP") and other employee separations. The total cost of the realignment
aggregated $23, which is included in our Consolidated Statements of Operations
in the line Restructuring, impairment and other charges. The charge relates, in
part, to 130 employees that accepted the VERP offer with costs aggregating $6.
The remaining 220 employees were severed and given post-employment benefits
including severance, outplacement services, continuation of healthcare benefits
and other benefits totaling $17. All benefits associated with the employee
severance and VERP charge have been made as of January 30, 2002.

2000 STRATEGIC ACTIONS

During the second quarter of fiscal year 2000, we announced a series of
strategic actions aimed at strengthening financial performance by achieving
improvements in return on invested capital. These actions included deciding to
close certain Kmart stores and Kmart Supercenters, accelerating certain
inventory reductions and redefining our information technology strategy.

As a result of these initiatives, we recorded charges totaling $728 ($463
after-tax). During fiscal year 2001, $42 was paid and charged to the reserve. In
connection with the bankruptcy filing we reduced the reserve, recording a
non-cash adjustment of $37 for the rejection of certain leases associated with
the 2000 strategic actions charge to reduce the reserve to the allowed claim
amount under the Bankruptcy Code. The following table summarizes the significant
components of the charge for strategic actions taken during fiscal year 2000 and
the presentation in our Statements of Operations:

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

RESERVE ACTIVITY

The following table provides information regarding liabilities established,
with respect to the fiscal year 2000 strategic actions charge, the fiscal year
2001 employee severance and VERP charge, the fiscal 2001 BlueLight.com
restructuring charge and the fiscal year 2001 supply chain charge. The
liabilities aggregated $127 and $177 at January 30, 2002 and January 31, 2001,
respectively.

7) LIABILITIES SUBJECT TO COMPROMISE

Under bankruptcy law, actions by creditors to collect indebtedness we owe
prior to the Petition Date are stayed and certain other pre-petition contractual
obligations may not be enforced against Kmart and 37 of its U.S. subsidiaries.
We have received approval from the Court to pay certain pre-petition liabilities
including employee salaries and wages, benefits and other employee obligations.
Except for secured debt, employee payroll and benefits, sales and use taxes and
capital lease obligations, all pre-petition liabilities have been classified as
Liabilities subject to compromise, in the fiscal year 2001 Consolidated Balance
Sheet. Adjustments to the claims may result from negotiations, payments
authorized by Court order, additional rejection of executory contracts including
leases, or other events.

Pursuant to an order of the Court we mailed notices to all known creditors
that the deadline for filing proofs of claim with the Court is July 31, 2002.
Amounts that we have recorded may be different than amounts filed by our
creditors. The number and amount of allowed claims cannot be presently
ascertained.

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

The following table summarizes the components of the liabilities included
in the line Liabilities subject to compromise in our Consolidated Balance Sheet
as of January 30, 2002.

8) LONG-TERM DEBT AND NOTES PAYABLE

On January 25, 2002, the Court authorized borrowings up to $1.15 billion of
the DIP Credit Facility for the payment of permitted pre-petition claims,
working capital needs, letters of credit and other general corporate purposes.
On March 6, 2002, the Court approved the entire $2 billion DIP Credit Facility.
Debt issuance costs associated with the DIP Credit Facility totaled $71 and are
being amortized through its maturity in April 2004. The DIP Credit Facility is a
revolving credit facility in which Kmart is the borrower and the rest of the
debtors are guarantors. The DIP Credit Facility is collateralized by first liens
on substantially all of our assets (subject to valid and unavoidable
pre-petition liens and certain other permitted liens). Borrowings under the DIP
Credit Facility can be denominated in U.S. dollars bearing interest at the Prime
Rate plus 2.5% per annum, or at Kmart's option, in Eurodollars bearing interest
at the LIBOR rate plus 3.5% per annum. The DIP Credit Facility requires that we
maintain certain financial covenants and restricts future liens, indebtedness,
capital expenditures, dividend payments and sale of assets.

Prior to the Petition Date, our primary sources of working capital had been
cash flows from operations and borrowings under our $1.1 billion credit facility
("Credit Facility") and $400 credit facility ("364-day Facility"). On June 15,
2001, we sold in an underwritten offering $430 of 9 7/8% Notes due June 2008.
Interest was payable semiannually on June 15 and December 15. On January 30,
2001, we sold in an underwritten offering $400 of 9.375% Notes due February 1,
2006 ("Notes"). Interest was payable semi-annually on February 1 and August 1.
We used the proceeds from the notes for the paydown of certain collateralized
mortgage backed securities and other general corporate purposes. The various
facilities contain certain

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

affirmative and negative covenants customary to these types of agreements. Due
to the proceedings under Chapter 11, we are in default on our debt agreements,
with the exception of the DIP Credit Facility. While operating under Chapter 11,
we are prohibited from paying interest on unsecured pre-petition debts. We
ceased accruing interest on all unsecured long-term debt subject to compromise
in accordance with SOP 90-7. The estimated fair market value of debentures
included in long-term debt classified in Liabilities subject to compromise, was
approximately $817 at the end of fiscal year 2001. Fair market value for medium
term notes classified in Liabilities subject to compromise cannot be reasonably
estimated at year end 2001. The estimated fair market value of long-term debt
was $2,016 at fiscal year end 2000. The estimated fair market value was based on
the quoted market prices for the same or similar issues or on the current rates
offered to Kmart for debt of the same remaining maturities. There were $400,
$664 and $330 of borrowings outstanding under our 364-day Credit Facility,
Credit Facility and DIP Credit Facility, respectively, at the end of fiscal year
2001.

The contractual principal maturities of long-term debt for the five years
subsequent to 2001 are: 2002 -- $1,151; 2003 -- $53; 2004 -- $661; 2005 -- $113;
2006 -- $615 and 2007 and later -- $1,083. Cash paid for interest was $205, $285
and $262 in 2001, 2000 and 1999, respectively.

9) DISCONTINUED OPERATIONS AND DISPOSITIONS

Discontinued operations primarily relate to Builder's Square, Inc.
("Builder's Square"). On June 11, 1999, Hechinger Company ("Hechinger"), which
had previously acquired substantially all of the operating assets of Builder's
Square, filed for Chapter 11 bankruptcy protection. In the second quarter of
1999, we recorded a charge of $354 ($230 after tax) which reflected our best
estimate of the impact of Hechinger's default on lease obligations for up to 117
former Builder's Square locations, which are guaranteed by Kmart. The charge did
not reflect an amount, if any, which we may ultimately recover on account of any
claims previously filed by Kmart or an amount, if any, which may be sought by
others against Kmart. In connection with Kmart's bankruptcy filing, we recorded
a non-cash credit of $169 for the reduction of our obligation due to the
rejection of leases for the Builder's Square, Hechinger, Pace and Furr's
locations to reduce the reserves to the amount of the allowed claim under the
Bankruptcy Code.

10) PROPERTY AND EQUIPMENT

38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

The following table provides a breakdown of the number of stores leased
compared to owned:

11) INVESTMENTS IN AFFILIATED RETAIL COMPANIES

MELDISCO

All Kmart footwear departments are operated under a license agreement with
the Meldisco subsidiaries of FTS, substantially all of which are 49% owned by
Kmart and 51% owned by FTS. Income earned under various agreements was $255,
$270 and $245 in 2001, 2000 and 1999, respectively. We received dividends from
Meldisco in 2001, 2000 and 1999 of $51, $44 and $38, respectively. Unremitted
earnings included in consolidated retained earnings were $46, $51 and $44 at
year end 2001, 2000 and 1999, respectively.

BLUELIGHT.COM

On July 31, 2001, we acquired the remaining 40% interest in BlueLight.com
through the purchase of all outstanding common and preferred stock of
BlueLight.com, Inc., a holding company, and certain limited liability company
interests not owned by Kmart, at which time BlueLight.com became a wholly-owned
subsidiary of Kmart. The results of BlueLight.com's operations are fully
consolidated in our financial

39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

statements commencing July 31, 2001. For the period from February 1, 2001 to
July 31, 2001, BlueLight.com had net sales of $8 million, gross profit of $1
million and a net loss of $55 million.

PENSKE

In November 1995, we sold our auto service center business to Penske Auto
Centers, Inc., a corporation controlled by Penske Corporation ("Penske"). In
connection with the sale, Kmart and Penske entered into a multi-year master
sublease agreement for the auto service center locations that are operated by
Penske and Penske Auto Centers. We entered an agreement effective January 1,
2000 with Penske under which we acquired a 22 percent interest in Penske LLC, an
entity formed to own and operate the Penske Auto Centers. In January 2001, Kmart
and Penske entered into an agreement to increase our interest in Penske LLC from
22 percent to 36 percent. Our investment in Penske LLC is accounted for under
the equity method and has no carrying value at January 30, 2002. See Note 23
regarding the wind-down of Penske Auto Centers operations.

12) OTHER COMMITMENTS AND CONTINGENCIES

Guarantees:

We have outstanding guarantees for property leased by certain former
subsidiaries as follows:

Our rights and obligations with respect to our guarantee of The Sports
Authority, Inc., OfficeMax, Inc. and Borders Group, Inc. leases are governed by
Lease Guaranty, Indemnification and Reimbursement Agreements dated as of
November 23, 1994, November 9, 1994, and May 24, 1995, respectively, as may be
amended from time to time. In addition, as of January 30, 2002, we had
guaranteed $82 of indebtedness of other parties related to certain of our leased
properties financed by industrial revenue bonds. These agreements expire from
2004 through 2009. Kmart's contingent obligation is dependent on the future
operating results of the guarantees and is subject to settlement under a plan of
reorganization to be voted upon by creditors and equity holders and approved by
the Court.

40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Legal Proceedings:

Kmart has been provided with copies of anonymous letters sent to the
Securities and Exchange Commission ("SEC"), our auditors, directors and legal
counsel expressing concern with respect to various matters. The letters purport
to be sent by certain of our employees. The letters have been referred to the
Audit Committee, which has engaged outside counsel to review and investigate the
matters set forth in the letters. We are cooperating with the SEC and the U. S.
Attorney's office for the Eastern District of Michigan with respect to their
investigations of these matters.

Since February 21, 2002, five separate purported class actions have been
filed on behalf of purchasers of Kmart common stock between May 17, 2001 and
January 22, 2002, inclusive, naming Charles Conaway as CEO and Chairman of the
Board of Kmart as the sole defendant. The complaints filed in the United States
District Court for the Eastern District of Michigan, allege that Mr. Conaway
made material misstatements or omissions during the alleged class period that
inflated the trading prices of Kmart's common stock and seek, among other
things, damages under Section 10b-5 of the Securities and Exchange Act of 1934.
Kmart is not a defendant.

Kmart is involved in discussions with the United States Attorney for the
District of Puerto Rico regarding a criminal investigation arising out of the
alleged actions of certain of our employees following the 1998 Hurricane
Georges.

On March 18, 2002, a purported class action was filed in the United States
District Court for the Eastern District of Michigan on behalf of participants or
beneficiaries of the Kmart Corporation Retirement Savings Plan against various
officers and directors of Kmart alleging breach of fiduciary duty under ERISA
for excessive investment in company stock; failure to provide complete and
accurate information about Kmart common stock and failure to provide accurate
information regarding our financial condition. Class action allegations are also
made for current and former employees who participate in the Kmart Corporation
Retirement Savings Plan. Kmart is not a defendant.

Kmart is a defendant in six putative class actions and one multi-plaintiff
case pending in California, all relating to our classification of assistant
managers and various other employees as "exempt" employees under the federal
Fair Labor Standards Act and the California Labor Code and our alleged failure
to pay overtime wages as required by these laws. These seven wage-and-hour cases
were all filed during 2001 and are currently pending in the U.S. District Court
for the Eastern District of California (Henderson v. Kmart), the U.S. District
Court for the Central District of California (Gulley v. Kmart, the
multi-plaintiff case, which was originally brought in state court) and the
Superior Courts of the State of California for the Counties of Alameda, Los
Angeles and Riverside (Panossian v. Kmart, Wallace v. Kmart, Pierce v. Kmart,
Hancock v. Kmart, Pryor v. Kmart). If all of these cases were determined
adversely to Kmart, the resulting damages would have a material adverse impact
on our results of operations and financial condition. However, there have been
no class certifications, all of the cases are stayed as a result of the
Company's bankruptcy and, based on our initial investigations, we believe that
the Company has numerous defenses to each of these claims. As a result, we are
currently unable to quantify the financial exposure of these cases.

We are a party to a substantial number of other claims, lawsuits, and
pending actions, most of which are routine and all of which are incidental to
our business. Some matters involve claims for large amounts of damages as well
as other relief. The Company assesses the likelihood of potential losses on an
ongoing basis and when they are considered probable and reasonably estimable,
records 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. Although
the final consequences of these proceedings are not presently determinable, in
the opinion of management, they are not expected to have a material adverse
affect on our liquidity, financial position or results of operations.

41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Other:

Minimum royalty payments in certain vendor contracts for the five years
subsequent to 2001 are: 2002 -- $65; 2003 -- $87; 2004 -- $84; 2005 -- $81;
2006 -- $84 and 2007 and later -- $90.

13) LIABILITIES

Accrued payroll and other liabilities and Other long-term liabilities
included in the Consolidated Balance Sheets consist of the following:

As discussed in Note 7, all pre-petition liabilities except for secured
debt, employee payroll and benefits, sales and use taxes and capital lease
obligations, have been classified as Liabilities subject to compromise.

14) LEASES

We conduct operations primarily in leased facilities. Kmart store leases
are generally for terms of 25 years with multiple five-year renewal options that
allow us the option to extend the life of the lease up to 50 years beyond the
initial noncancelable term. In certain Kmart leased facilities, selling space
has been sublet to other retailers, including Olan Mills, Inc., Penske LLC, and
the Meldisco subsidiaries of FTS.

42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Under the Bankruptcy Code we may assume or reject executory contracts,
including lease obligations. Therefore, the commitments shown below may not
reflect actual cash outlays in the future periods. See Note 23, Subsequent
Events.

15) SHARE REPURCHASE PROGRAMS

In July 2001, we terminated the common stock repurchase program that was
initiated in April 1999. Under the program we repurchased approximately 22
million shares of common stock at a cost of approximately $55 and $200 in fiscal
years 2000 and 1999, respectively. We also terminated the trust convertible
preferred securities repurchase program that was initiated in February 2000.
Under the program we repurchased approximately 2 million shares of trust
convertible securities during fiscal year 2000 at a cost of approximately $84.

16) CONVERTIBLE PREFERRED SECURITIES

In June 1996, a trust sponsored and wholly owned by Kmart issued to the
public 20,000,000 trust convertible preferred securities ("Preferred
Securities"). The proceeds from the sale of the Preferred Securities, together
with the proceeds of a sale of common trust securities to Kmart, were used to
purchase from Kmart 7 3/4% subordinated convertible debentures due June 15,
2016. The debentures are the sole asset of the trust.

43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

The Preferred Securities accrue and pay cash distributions quarterly at a
rate of 7 3/4% per annum. We have guaranteed, on a subordinated basis,
distributions and other payments due on the Preferred Securities. We have
stopped accruing distributions on the Preferred Securities in accordance with
SOP 90-7. Contractual distributions for fiscal year 2001 on the Preferred
Securities were $72.

The Preferred Securities are convertible at the option of the holder at any
time at the rate of 3.3333 shares of Kmart common stock for each Preferred
Security, and are mandatorily redeemable upon repayment of the debentures,
either at maturity on June 15, 2016, or upon their earlier redemption. The
debentures became callable at our option beginning June 15, 1999.

During fiscal year 2000 we repurchased approximately 2 million shares of
Preferred Securities at a cost of approximately $84. For purposes of computing
earnings per share ("EPS"), the discount on the repurchase, net of tax, was
added to net income to arrive at income available to common shareholders.

Based on the quoted market prices, fair value of the Preferred Securities
was approximately $130 and $714 as of fiscal year end 2001 and 2000,
respectively.

17) INCOME TAXES

44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

We have recorded a full valuation allowance on net deferred tax assets, in
accordance with SFAS No. 109, "Accounting for Income Taxes," as realization of
such assets in future years is uncertain. At January 30, 2002, we have unused
net operating loss ("NOL") carryforwards of approximately $1,003. The federal
tax benefits of these NOL carryforwards will expire in 2021 and the state tax
benefits will predominantly expire between 2016 and 2021. Additionally, we have
available foreign tax credit carryforwards of approximately $66 which would
expire in 2002 ($9), 2003 ($19), 2005 ($20) and 2006 ($18); general business tax
credit carryforwards of approximately $26 which would expire in 2020 ($15) and
2021 ($11) and alternative minimum tax ("AMT") credit carryforwards of
approximately $109 which may be carried forward indefinitely.

In 2001, the Internal Revenue Service completed its examination of Kmart's
federal income tax returns through 1998. We believe that adequate tax accruals
have been provided for all years.

On March 9, 2002, the Job Creation and Worker Assistance Act of 2002 was
enacted. This law allows NOL carrybacks arising in taxable years ending 2001 and
2002 to offset 100% of a taxpayer's alternative minimum taxable income. As such,
Kmart anticipates filing amended carryback claims, which will result in
additional AMT refunds of $13.

Cash (received) paid for income taxes was $(79), $50 and $59 in 2001, 2000
and 1999, respectively.

45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

18) EARNINGS PER SHARE

In fiscal years 2001 and 2000, all outstanding stock options were excluded
from the computation of diluted earnings per share because they would have been
anti-dilutive. For fiscal year 2001, options to purchase 60.0 million shares of
common stock at prices ranging from $4.86 to $26.03 were excluded from the
calculations. For fiscal year 2000, options to purchase 46.3 million shares of
common stock at prices ranging from $5.34 to $26.03 were excluded from the
calculations. The calculations also exclude the effect of Preferred Securities.
For fiscal years 2001 and 2000, diluted shares outstanding exclude approximately
59.9 million common shares from potential conversion of certain Preferred
Securities due to their anti-dilutive effect. For fiscal year 2000 diluted
shares outstanding exclude approximately 0.2 million shares from the potential
conversion of written put options due to their anti-dilutive effect.

19) PENSION PLANS AND OTHER POST-RETIREMENT BENEFITS

In the first quarter of 2001, we announced a Voluntary Early Retirement
Program ("VERP") for certain Kmart associates at the Kmart Resource Center over
the age of 49 with at least 10 years of service as of May 7, 2001. Of the 539
Kmart associates eligible for the program, 130 accepted the early retirement
offer, and we recorded a pre-tax charge of $6. Payouts under this program were
funded from the Kmart Employee Pension Plan except for certain payments to
highly compensated employees, which were paid directly. Prior to 1996, Kmart had
defined benefit pension plans covering eligible associates who met certain
requirements of

46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

age, length of service, and hours worked per year. Effective January 31, 1996,
the pension plans were frozen, and associates no longer earn additional benefits
under the plans.

The plan's assets consist primarily of equity and fixed income securities.
Contributions to the plans were not required for fiscal years 2001, 2000 and
1999. Total consolidated pension income was $72, $71 and $68 in 2001, 2000 and
1999, respectively.

The $195 liability reported in the fiscal year 2001 Consolidated Balance
Sheet has been included as a component of Liabilities subject to compromise
pending final resolution of an allowed claim that may be filed by the Pension
Benefit Guaranty Corporation.

The following tables summarize the change in benefit obligation, change in
plan assets, funded status, amounts recognized and actuarial assumptions for our
employee pension plans. We have non-qualified plans for directors and officers
which were partially funded as of years ended 2001 and 2000. Benefits under the
plans totaled $36 and $32 at the end of 2001 and 2000, respectively, which have
been accrued in the Consolidated Balance Sheets. Plan assets totaled $16 and $15
as of year end 2001 and 2000, respectively.

47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Full time associates who have worked 10 years and who have retired after
age 55 have the option of participation in Kmart's medical plan until age 65.
The plan is contributory, with retiree contributions adjusted annually. The
accounting for the plan anticipates future cost-sharing changes that are
consistent with our expressed intent to increase the retiree contribution rate
annually. The accrued post-retirement benefit costs were $43 and $49 at the end
of 2001 and 2000, respectively.

20) RETIREMENT SAVINGS PLAN

The Retirement Savings Plan provides that associates of Kmart who have
completed 1,000 hours of service within a twelve month period can invest from 1%
to 16% of their earnings in their choice of various investments. For each dollar
the participant contributed up to 6% of earnings, we contributed an additional
50 cents which was invested in the Employee Stock Ownership Plan. In February
2002, the Employee Stock Ownership Plan provision was removed and the Employer
Match Contribution could be directed at the discretion of the participant.

The Retirement Savings Plan also had a profit sharing feature whereby we
would make contributions based on profits, with minimum yearly contributions
required of $30. The profit sharing feature was discontinued in 2001. Our total
expense related to the Retirement Savings Plan was $41, $73 and $94 in 2001,
2000 and 1999, respectively.

21) STOCK OPTION PLANS

We use the intrinsic value method of accounting for our stock option and
restricted stock plans in accordance with APB No. 25. Since stock options were
granted at exercise prices equal to the market prices on the grant date, no
compensation cost has been recognized for stock options granted under our stock
based compensation plans.

Had the compensation cost for our stock-based compensation plans been
determined based on the fair value at the grant dates consistent with the method
of FAS No. 123 "Accounting for Stock-Based Compensation," net (loss) income and
net (loss) income per share would have been the pro forma amounts shown below.

48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

To determine these amounts, the fair value of each stock option has been
estimated on the date of the grant using a Black-Scholes option-pricing model
with a dividend yield of 0%. Options generally vest over 3 years on a
straight-line basis with a term of 10 years.

The following table summarizes information about stock options outstanding
as of January 30, 2002:

22) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

As discussed in Note 2, Kmart determined that we would restate our
previously reported quarterly financial statements based upon the results of the
internal investigation. We concluded that (1) an adjustment should be made with
respect to the accounting for up-front consideration in a transaction from a
vendor which more appropriately should have been deferred and recognized over
the life of the contract and (2) the recording of additional general liability
reserves in the fourth quarter was more appropriately designated as a second
quarter event. Accordingly, adjustments were made for such transactions,
including restatements of previously reported quarterly financial statements.
The first item resulted in a net reduction to operating results in the second
quarter of $42 ($28 after-tax), or $.06 per share, and an increase in third
quarter

49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

operating results of $15 ($10 after-tax), or $.02 per share, resulting in a net
reduction to results of operations for fiscal year 2001 of $27 or $.04 per
share. The second item increased general liability reserves in the second
quarter, rather than the fourth quarter, by approximately $167 ($112 after-tax),
or $.23 per share, through a charge to Selling, general and administrative
(S,G&A) expenses.

Given our recent bankruptcy filing and the increased uncertainty relating
to allowances and the corresponding difficulty in reliably estimating such
amounts in the future, we concluded that it would be preferable to change our
accounting method for interim recognition of such cost recoveries from vendors.

For interim reporting periods in fiscal 2000 and prior, our policy was to
record allowances not yet subject to a written agreement during the first three
quarters of a fiscal year based upon our estimate of annual allowances ("our
plan") as determined by historical experience and current understandings with
our vendors. These amounts were supplemented by allowances obtained that were
not contemplated in such plan. While many agreements are finalized throughout
the year, significant activity occurs in the fourth quarter to finalize
outstanding agreements and collect allowances.

During the fourth quarter of fiscal 2001 we adopted a new accounting policy
effective as of February 1, 2001, for interim financial reporting only,
requiring that cost recoveries from vendors be recognized only when a formal
agreement for such amount has been obtained and the underlying activity for
which the amount was provided has been performed. This change in methodology
does not affect the results that otherwise would have been reported for the full
fiscal year, but rather affects the interim recognition of allowances during the
year. We believe our new method is preferable because it provides higher
precision, better verifiability, reduced reliance on estimates and is consistent
with an analogous application of Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements."

Embedded in the accounting change that gives effect to the change in
interim financial reporting for allowances is an adjustment for an indeterminate
amount of supplemental or "incremental" allowances that were initially recorded
in the first three quarters prior to having been documented, or otherwise deemed
appropriate, pursuant to our historical policy. Kmart has concluded that it is
not practicable to determine the impact on prior quarters. It should be noted
however, that the restated interim information reflects such allowances only to
the extent they are supported by formal agreements or otherwise deemed
appropriate in the quarter recognized.

50

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Following is a summary of the effects of the restatements discussed above,
including the change in accounting method, and the pro forma effect of the
change in accounting method on the comparable quarters in the prior year:

51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

Earnings per share amounts for each quarter are required to be computed
independently and may not equal the amount computed for the total year. In the
fourth quarter of fiscal year 2001, we recorded charges for impairments of $979
in accordance with SFAS No. 144, a valuation allowance on deferred tax assets of
$958 in accordance with SFAS No. 109, an increase in the LIFO reserve of $75, a
credit of $184 for reorganization items for amounts directly resulting from the
Chapter 11 proceedings and a credit of $169 for reversals of rejected lease
reserves of discontinued operations.

Included in 2001 operating results are adjustments to our asset and
liability accounts that reduced operating results reported in 2001 by $15 in the
first quarter, $21 in the second quarter, $2 in the third quarter and $23 in the
fourth quarter. Substantially all of the adjustments related to prior years.

23) SUBSEQUENT EVENTS

STORE CLOSINGS

On March 20, 2002, the Court approved the closure of 283 stores, or
approximately 13% of our 2,114 stores. The closures include 270 Kmart discount
stores and 12 Kmart Supercenters in 40 states, and 1 Kmart store in Puerto Rico.
Stores were selected by evaluating the market and financial performance of every
store and the terms of every lease. Candidates for closure were stores, which
did not meet our financial requirements for ongoing operations. Renegotiating
lease terms was also explored to improve store profitability and avoid the need
for closure.

Shortly after receiving Court approval, we commenced store-closing sales,
which are expected to continue for approximately two to three months.
Approximately 22,000 associates will be impacted by the closures. Associates
have been notified and received information about the benefits and other
resources available to them.

52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)

On April 4, 2002, we announced that we had contracted with firms to assist
in the disposition of leases for these stores. Under the agreement, the firms
will assist our internal real estate staff in identifying retailers and
investors interested in an assignment and landlords interested in terminations
of the leases for the closing stores. Leases which are not marketed will be
rejected shortly after the completion of the related store-closing sales. As a
result of these store closings, Kmart expects to record a total charge in the
range of $1.1 billion to $1.3 billion. Of this amount, approximately $500 was
included in the long-lived asset impairment charge recorded in the fourth
quarter of 2001, and $600 to $800 related primarily to exit costs to be incurred
for lease rejections and severance, and markdowns taken on inventory in
connection with liquidation sales, will be recorded in the first quarter of
2002. In conjunction with the store closing sales, we will also transfer and
liquidate additional inventory from the remaining stores, for which we expect a
charge in the first quarter of 2002 for approximately $250.

KEY BRAND PARTNERS

On March 20, 2002, the Court authorized our business relationships with
several key brand partners. Motions were approved allowing Kmart to assume our
license agreements with Martha Stewart Living Omnimedia, Inc. for Martha Stewart
Everyday home, garden, colors, baby, kitchen, keeping and decorating products,
along with candles and accessories; Jaclyn Smith G.H. Production, Inc. for
Jaclyn Smith women's apparel, jewelry and accessories; Kathy Ireland World Wide,
Inc. for Kathy Ireland women's apparel, accessories and exercise equipment;
Disney Enterprises, Inc. for Disney apparel for infants and children; and Joe
Boxer Licensing, LLC. for JOE BOXER apparel, accessories and home furnishings.

PENSKE

On April 9, 2002, we reached an agreement with Penske Corporation, Penske
Auto Centers, Inc., and Penske Auto Centers, LLC (collectively "Penske") whereby
Penske and Kmart will work together to achieve an orderly wind-down of
operations at auto service centers at more than 563 Kmart stores in 44 states
following Penske's unilateral decision to close the business as of April 6,
2002. We do not expect this matter to have a material adverse affect on our
liquidity, financial position or results of operations.

KEY EXECUTIVE RETENTION PLAN

In March 2002, we received court approval to implement our Key Employee
Retention Plan ("KERP") which provides cash incentives and certain benefits to
key members of our salaried management team. The KERP is expected to encourage
employees to continue their employment with Kmart through the reorganization
process.

There are three components to the KERP; the annual performance plan, stay
bonus and severance plan. The annual performance plan provides a cash bonus
based on achieving corporate-wide financial goals. The stay bonus provides
periodic cash incentives to stay with Kmart during the entire reorganization
process. The severance plan provides cash and benefits in case of involuntary
termination due to restructuring or job elimination.

53

KMART CORPORATION

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FISCAL YEARS 2001, 2000 AND 1999
(DOLLARS IN MILLIONS)

54

MANAGEMENT'S RESPONSIBILITY
FOR FINANCIAL STATEMENTS

Management is responsible for the preparation of our Consolidated Financial
Statements and related information appearing in this report. These financial
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America on a consistent basis applying certain
estimates and judgments based upon currently available information and
management's view of current conditions and circumstances. On this basis, we
believe that these financial statements reasonably present our financial
position and results of operations.

To fulfill our responsibility, we maintain comprehensive systems of
internal controls designed to provide reasonable assurance that assets are
safeguarded and transactions are executed in accordance with established
procedures. The concept of reasonable assurance is based upon recognition that
the cost of the controls should not exceed the benefit derived. We believe our
system of internal controls provide this reasonable assurance.

We have adopted a code of conduct to guide our management in the continued
observance of high ethical standards of honesty, integrity, and fairness in the
conduct of business and in accordance with the law. Compliance with the
guidelines and standards is periodically reviewed and is acknowledged by all
management associates.

Our Board of Directors has an Audit Committee consisting solely of outside
directors. The duties of the Audit Committee include keeping informed of the
financial condition of Kmart and reviewing our financial policies and
procedures, our internal accounting controls, and the objectivity of our
financial reporting. Both our independent accountants and the internal auditors
have free access to the Audit Committee and meet with the Audit Committee
periodically, with and without management present.

JAMES B. ADAMSON
Chief Executive Officer

A.A. KOCH
Chief Financial Officer

55

REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and
Board of Directors of
Kmart Corporation

In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Kmart
Corporation and its subsidiaries at January 30, 2002 and January 31, 2001, and
the results of their operations and their cash flows for each of the three years
in the period ended January 30, 2002, in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the accompanying index presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of Kmart's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

The accompanying consolidated financial statements have been prepared assuming
that Kmart Corporation will continue as a going concern, which contemplates
continuity of Kmart's operations and realization of its assets and payments of
its liabilities in the ordinary course of business. As more fully described in
the notes to the consolidated financial statements, on January 22, 2002, Kmart
Corporation filed a voluntary petition for reorganization under Chapter 11 of
the United States Bankruptcy Code. The uncertainties inherent in the bankruptcy
process and Kmart's recurring losses from operations raise substantial doubt
about Kmart Corporation's ability to continue as a going concern. Kmart
Corporation is currently operating its business as a Debtor-in-Possession under
the jurisdiction of the Bankruptcy Court, and continuation of Kmart as a going
concern is contingent upon, among other things, the confirmation of a Plan of
Reorganization, Kmart's ability to comply with all debt covenants under the
existing debtor-in-possession financing agreement, and Kmart Corporation's
ability to generate sufficient cash from operations and obtain financing sources
to meet its future obligations. If no reorganization plan is approved, it is
possible that Kmart's assets may be liquidated. The consolidated financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of these
uncertainties.

/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP

Detroit, Michigan
May 15, 2002

56

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS OF THE REGISTRANT

JAMES B. ADAMSON, 54

Chairman of the Board and Chief Executive Officer of Kmart. Former Chairman,
Advantica Restaurant Group (formerly Flagstar Corporation) (food services and
restaurant franchises). Previously served as Chief Executive Officer and
President, Denny's Inc. and as Chief Executive Officer, Chief Operating Officer
and Retail President of Burger King Corporation. Has served as a director of
Kmart Corporation since 1996.

LILYAN H. AFFINITO, 70

Former Vice Chairman of the Board of Maxxam Group Inc. (forest products
operations, real estate management and development and aluminum production).
Director of Caterpillar, Inc. Has served as a director of Kmart since 1990.

RICHARD G. CLINE, 67

Chairman, Hawthorne Investors, Inc. (management advisory services and private
investments). Previously served as Chairman and Chief Executive Officer and as
Chairman, President and Chief Executive Officer of Nicor, Inc. (natural gas
distribution and containerized shipping) and as Chairman, Hussmann
International, Inc. (refrigerated merchandising equipment). Director of Ryerson
Tull, Inc. and PepsiAmericas, Inc. Chairman and Trustee of Northern Funds and
Northern Institutional Funds. Has served as a director of Kmart since 1995.

WILLIE D. DAVIS, 67

President of All Pro Broadcasting, Inc. (radio stations). Director of Alliance
Bank, Bassett Furniture Industries, Incorporated, Checkers, Inc., The Dow
Chemical Company, Johnson Controls, Inc., MGM Mirage, Inc., MGM, Inc., Sara Lee
Corporation, Strong Funds and Wisconsin Energy Corporation. Has served as a
director of Kmart since 1986.

JOSEPH P. FLANNERY, 70

Chairman of the Board, President and Chief Executive Officer of Uniroyal
Holding, Inc. (investment management company). Director of ArvinMeritor, Inc.,
Ingersoll Rand Company, Newmont Mining Corporation and The Scotts Company. Has
served as a director of Kmart since 1985.

ROBERT D. KENNEDY, 69

Former Chairman and Chief Executive Officer of Union Carbide Corporation
(chemicals and plastics manufacturer). Director of Chase Industries, Inc.,
Hercules, Inc., International Paper, Inc. and Sunoco, Inc. Has served as a
director of Kmart since 1996.

ROBIN B. SMITH, 62

Chairman and Chief Executive Officer of Publishers ClearingHouse (distribution
of publications). Previously served as President and Chief Executive Officer of
Publishers ClearingHouse. Director of BellSouth Corp. and of Prudential
Investments mutual funds. Has served as a director of Kmart since 1996.

THOMAS T. STALLKAMP, 55

Vice Chairman and Chief Executive Officer, MSX International (provider of
technology based business systems and services). Previously served as Vice
Chairman and as President of DaimlerChrysler Corporation

57

and as President of Chrysler Corporation. Director of Baxter International, Inc.
Has served as a director of Kmart since 1999.

RICHARD J. STATUTO, 44

President and Chief Executive Officer of St. Joseph Health Systems (provider of
hospital, physician, homecare, wellness and insurance services). Previously
served as Chief Operating Officer and Vice President of Marketing and Planning
of St. Joseph Health Systems. Also Vice-Chairman of Christus Health. Has served
as a director of Kmart since 2001.

EXECUTIVE OFFICERS OF THE REGISTRANT

JAMES B. ADAMSON, 54

See above.

RANDY L. ALLEN, 54

Executive Vice President, Strategic Initiatives and Chief Diversity Officer. Ms.
Allen assumed her current position in 2001. Prior thereto she was the Executive
Vice President, Chief Planning and Information Officer for Kmart from 2000 to
2001; a partner at Deloitte & Touche from 1996 to 2000; Chief Administrative and
Information Officer at Phillips Van Heusen Corporation from 1993 to 1996.

JULIAN C. DAY, 49

President and Chief Operating Officer. Mr. Day joined Kmart under his current
title on March 11, 2002. Prior thereto he was the Executive Vice President and
Chief Operating Officer at Sears Roebuck, Inc. from 1999 to 2002; Executive Vice
President and Chief Financial Officer at Safeway, Inc. from 1993 to 1998; and
President and Chief Executive Officer of Bradley Printing Company from 1991 to
1992.

RONALD B. HUTCHISON, 52

Executive Vice President, Chief Restructuring Officer. Mr. Hutchison joined
Kmart under his current title on January 17, 2002. Prior thereto he was the
Executive Vice President, Chief Financial Officer at Advantica Restaurant Group
from 1995 to 2002; and Vice President, Treasurer/Taxes at Leaseway Corporation
from 1980 to 1995.

CECIL B. KEARSE, 49

Executive Vice President, Merchandising. Mr. Kearse assumed his current position
in 2000. Prior thereto he held the following positions at Kmart: Senior Vice
President and General Merchandise Manager, Home from 1997 to 2000; Vice
President, Merchandise Presentation and Communication from 1996 to 1997.

JANET G. KELLEY, 49

Executive Vice President and General Counsel. Ms. Kelley assumed her current
position in 2002. She joined Kmart in 2001 as Senior Vice President and General
Counsel. Ms. Kelley previously served as Vice President and Senior Counsel at
the Limited, Inc. from 1999 to 2001. Ms. Kelley held the following positions at
Sunbeam Corporation: General Counsel from 1998 to 1999; Vice President from 1996
to 1998; and Associate General Counsel from 1995 to 1996.

ALBERT A. KOCH, 59

Chief Financial Officer. Mr. Koch joined Kmart under his current title on March
11, 2002 pursuant to an agreement between Kmart and JA&A Services LLC, an
affiliate of Jay Alix & Associates. Prior thereto he held the following
positions at Jay Alix and Associates: Chairman from 2001 to the present and
Managing Principal from 1995 to 2001.

58

MICHAEL T. MACIK, 55

Executive Vice President, Human Resources. Mr. Macik joined Kmart under his
current title on April 9, 2002. Prior thereto he was the Executive Vice
President, Chief Operating Officer at Right Management Associates from 2001 to
2002 and the Vice President, Human Resources at Kmart from 1992 to 2001.

RICHARD J. NOECHEL, 33

Vice President, Controller. Mr. Noechel assumed his current position in 2001.
Prior thereto he was the Divisional Vice President, Financial Reporting at Kmart
in 2001; Senior Manager International Accounting at DaimlerChrysler Corporation
from 2000 to 2001; Forecast Team Leader at DaimlerChrysler Corporation from 1998
to 2000; Accounting Research Specialist at Chrysler Corporation from 1997 to
1998; and a manager at Price Waterhouse LLP from 1996 to 1997.

EDWARD J. STENGER, 44

Treasurer. Mr. Stenger joined Kmart under his current title on March 11, 2002
pursuant to an agreement between Kmart and JA&A Services, LLC, an affiliate of
Jay Alix & Associates. Prior thereto he held the following positions at Jay Alix
& Associates: Co-Managing Director from 2000 to 2002 and a Principal from 1992
to 2000.

As of January 30, 2002, the following individuals served as executive officers.
The employment of these individuals was terminated after fiscal 2001.

CHARLES C. CONAWAY, Chief Executive Officer.

ANTHONY D'ONOFRIO, Executive Vice President, Global Systems Capability and Chief
Supply Chain Officer.

JOHN T. MCDONALD, JR., Executive Vice President, Chief Financial Officer.

DAVID ROTS, Executive Vice President, Chief Administrative Officer.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth information concerning total compensation
paid to Kmart's Chief Executive Officer during fiscal 2001 and the four other
most highly compensated executive officers of Kmart who served in such
capacities as of January 30, 2002 (the "named executive officers") for services
rendered to Kmart during each of the last three fiscal years, if applicable.
Pursuant to the SEC rules, the table also sets forth information concerning the
compensation of former executive officers of Kmart who are also deemed by SEC
rules to be named executive officers for fiscal 2001.

- ---------------

(1) Employment terminated -- Mr. Conaway -- 3/11/02; Mr. Rots -- 3/25/02; Mr.
D'Onofrio -- 3/25/02; Mr. Schwartz -- 1/15/02; Mr. Boyer -- 11/9/01.

(2) Only one of the officers was employed for the full 3-year period.

(3) At the election of the officers, up to 100% of salary may be deferred
pursuant to Kmart's Management Deferred Compensation and Restoration Plan.

(4) Ms. Allen's 2001 bonus consists of a $150,000 signing bonus which was the
second installment of her original $300,000 signing bonus; Mr. Boyer's 2001
bonus consists of a $100,000 signing bonus, payable when employment
commenced on May 7, 2001, and a $200,000 guaranteed bonus.

(5) The dollar amounts under "Other Annual Compensation" include: Reimbursement
of Housing and Temporary Living Costs plus associated tax gross-up -- Mr.
Conaway -- $109,197 (2001), $414,076 (2000); Mr. Rots -- $1,288 (2001),
$313,924 (2000); Mr. D'Onofrio -- $70,098 (2001), $15,682 (2000); Mr.
Schwartz -- $1,202,347 (2001), $232,459 (2000); Mr. Boyer -- $161,548
(2001); Non-Business Use of Company Plane plus associated tax
gross-up -- Mr. Conaway -- $97,838 (2001), $24,337 (2000); Mr.
Rots -- $38,278 (2001), $23,501 (2000); Ms. Allen -- $1,933 (2001); Mr.
D'Onofrio -- $3,897 (2000); Mr. Schwartz -- $69,096 (2001), $39,899 (2000);
Other amounts reimbursed for the payment of taxes -- Mr. Conaway -$13,888
(2001); Mr. Rots -- $422,185 (2001), $28,631 (2000); Ms. Allen -- $4,804
(2001); Mr. Kearse -- $6,078 (2001); Mr. D'Onofrio -- $505,722 (2001); Mr.
Schwartz -- $2,434,616 (2001); Mr. Boyer -- $18,934 (2001).

(6) The stock options (other than options for 3,000,000 shares granted to Mr.
Conaway) were granted under the 1997 Long-Term Equity Compensation Plan or
the 1992 Stock Option Plan.

(7) As of January 30, 2002, the number of shares and value of all restricted
stock held by the named executive officers were as follows: Mr.
Conaway -- 615,000/$854,850; Mr. Rots -- 127,147/$176,734; Ms.
Allen -- 240,745/$334,636; Mr. Kearse -- 20,000/$27,800; Mr. Schwartz's and
Mr. Boyer's shares were canceled in connection with their terminations. The
shares granted in fiscal 2001 to Messrs. Rots, Kearse, D'Onofrio and
Schwartz were canceled in December, 2001 in connection with their entering
into new employment agreements.

60

(8) The dollar amounts for fiscal year 2001 set forth under "All Other
Compensation" include: Value of Life Insurance Premiums -- Mr.
Conaway -- $1,205; Mr. Rots -- $424; Ms. Allen -- $1,439; Mr. Kearse --
$1,175; Mr. D'Onofrio -- $639; Mr. Schwartz -- $542; Mr. Boyer -- $287;
Company Contributions to Retirement Savings Plan and/or Management Deferred
Compensation and Restoration Plan -- Mr. Conaway -- $40,995; Mr.
Rots -- $25,728; Ms. Allen -- $11,050; Mr. Kearse -- $26,947; Mr.
D'Onofrio -- $24,885; Mr. Schwartz -- $16,875; Other Compensation -- Mr.
Conaway -- $2,000,000 amount paid pursuant to employment contract
attributable to amounts foregone from previous employment; Mr.
Schwartz -- $3,014,031 amount of loan forgiveness; Mr. Boyer -- $500,000
payment in connection with execution of his Confidentiality, Non-competition
and Non-solicitation Agreement and severance of $83,333.

OPTION GRANTS IN FISCAL YEAR 2001

- ---------------

(1) All options were granted at a price equal to 100% of the market value of the
Kmart common stock on the applicable date of grant. The exercise price may
be paid in cash, previously owned shares or a combination of both.

(2) Options have a term of ten years and one day and will become exercisable in
three equal annual installments commencing one year from date of grant,
other than the January 7, 2002 options granted to Messrs. Rots, Kearse,
D'Onofrio and Schwartz with an exercise price of $4.86, which will begin
vesting by January 31, 2004 upon achievement of performance goals.

(3) Any value of Kmart common stock underlying the options will depend on the
value, if any, ascribed to Kmart common stock in any plan of reorganization
which may be confirmed. As described earlier, Kmart believes that, in light
of the bankruptcy, the value of Kmart common stock is highly speculative.
Accordingly, Kmart is not presently ascribing to any value to the above
options. Nevertheless, in order to comply with SEC rules, this column sets
forth the estimated present value of the options granted during fiscal year
2001 on the date of grant using the Black-Scholes option pricing model based
upon the following assumptions: an estimated time until exercise of 5 years;
a 5-year stock price volatility rate of .4273098 for options granted on
February 6, 2001, .4204622 for options granted on May 7, 2001 and May 15,
2001, and .5722765 for options granted on January 7, 2002, respectively; a
dividend yield of 0.00%; and no adjustment for non-transferability or
forfeiture.

61

OPTION EXERCISES AND VALUES FOR FISCAL YEAR 2001

The table below shows the value at January 30, 2002 of options held by each
of the named executive officers. None of the named executive officers exercised
stock options during fiscal year 2001.

- ---------------

(1) Option value based on a per share value of $1.39.

(2) Options were canceled in connection with an execution of a Separation and
General Release.

PENSION PLANS

The accrual of benefits under Kmart's tax-qualified Employee Pension Plan
and Supplemental Pension Benefit Plan was frozen as of January 31, 1996.
Therefore, service after January 31, 1996 is not recognized for benefit
accumulation purposes, but is recognized for vesting purposes. Kmart's
Supplemental Pension Benefit Plan provides benefits to the extent that ERISA
limits the pension to which an employee would otherwise be entitled under the
Employee Pension Plan absent such limitation. Of the named executive officers,
only Mr. Kearse is eligible to receive benefits under Kmart's frozen Employee
Pension and Supplemental Pension Benefit Plans. Mr. Kearse has 27 years of
service under the Plans after age 21. His estimated accrued benefit under the
combined Plans and under the "final average compensation formula" is $3,001.78
per month at age 65. This amount is based on the pension being paid during his
lifetime and would be reduced on an actuarial equivalent basis in the event of a
survivor benefit or optional form of payment. The "final average compensation
formula" is 1.50% of the average of the officer's best five compensation years
prior to January 31, 1996 multiplied by years of service after age 21 and prior
to January 31, 1996 up to 35 years minus 2% of the applicable Social Security
benefit for each year of services up to 30 years.

Kmart has also adopted a Supplemental Executive Retirement Plan for the
purpose of providing income to executive officers of Kmart who retire prior to
age 65 or who are hired by Kmart later in their careers, whom the Board of
Directors approves as eligible to receive benefits under the Plan. Benefits are
determined by the Board based on the position, responsibilities and rate of
compensation of the employee, benefit payable or which would have been payable
under other plans and such other factors as the Board may deem relevant.

Kmart has also adopted a Special Supplemental Executive Retirement Plan to
provide supplemental retirement income to certain senior officers and other key
executives designated by the Compensation & Incentives Committee of the Board.
Participants who retire at or after age 60 are entitled to receive an annual
benefit equal to 5 percent of "Final Average Compensation" multiplied by the
number of years of participation in the plan (up to a maximum of 10). Benefits
become vested at the rate of 50% (after 3 years of participation), 75% (after 4
years of participation) and 100% (after 5 or more years of participation).
Participants who retire between ages 55 and 60 can begin receiving their vested
benefits, but the benefits will be reduced at the rate of 6 percent per year to
reflect commencement prior to age 60. Final Average Compensation means the
average of the participant's highest base pay plus bonus for any three years (or
lesser period of employment). Messrs. Conaway, Rots, Boyer and Schwartz are the
only individuals to have been designated as participants in this plan. Since
none of these executives had accrued any vested benefits at the time of their
termination of employment, their accrued benefits have been forfeited.

62

DIRECTOR COMPENSATION

Generally, for fiscal year 2001, directors who were not employees of Kmart
or its subsidiaries received an annual retainer of $50,000, with no additional
amount payable for attending meetings. Fifty percent (and at the election of the
director, up to 100%) of the annual retainer was paid in Common Stock in lieu of
cash payments to the Directors Stock Plan. In addition, under the Directors
Stock Plan, restricted stock units, which are distributed as shares of Common
Stock upon termination of Board service, are accrued for a period of time equal
to the director's Board service, but no more than ten years, in an amount equal
to 50% of the annual retainer plus, for Committee chairpersons, an amount equal
to 10% of the annual retainer. Commencing January 23, 2002, the stock portion of
the annual retainer was eliminated (i.e. the annual retainer will be $25,000 in
cash); non-employee directors will be entitled to $2,000 for each Board or
Committee meeting attended; no further awards will be made under the Director
Stock Plan; and Committee chairpersons will receive an additional cash retainer
of $10,000 per year.

Under Kmart's Deferred Compensation Plan for Non-Employee Directors and the
Directors Stock Plan, a director may elect to defer all or any portion of his or
her compensation for services as a director which is payable in cash or Common
Stock. Under these Plans, deferred cash amounts earn interest at a rate
equivalent to the ten-year U.S. Treasury Note rate plus 5%, and deferred shares
of Common Stock are credited with an amount equal to any dividends payable on
such shares, which are converted on a quarterly basis to additional shares.

In addition, on February 6, 2001, each of Kmart's non-employee directors
received an option grant pursuant to the Directors Stock Plan, which entitles
them to purchase 12,700 shares of Common Stock. This option vests in three equal
installments on each of the first three anniversaries of the date of grant and
has a per share exercise price of $8.55.

Effective January 1, 1996, benefits under Kmart's Directors Retirement Plan
were terminated with respect to new directors and the accrual of future benefits
for existing directors was terminated. Non-employee directors who served on the
Board prior to December 31, 1995 and who served at least five years are entitled
to benefits under the Plan. Upon retirement from the Board, such directors will
receive an annual benefit equal to the annual retainer at the time of retirement
for a period equal to the director's accrual years under the frozen Plan, not to
exceed ten years. Mrs. Affinito and Messrs. Davis and Flannery have vested
benefits under the frozen Directors Retirement Plan.

Directors who are employees of Kmart or its subsidiaries do not receive the
above compensation or benefits.

Mr. Adamson was appointed Chairman of the Board of Directors as of January
17, 2002 and entered into a services agreement with Kmart effective as of that
date that provides for fees and other compensatory items, pursuant to which Mr.
Adamson agreed to forego any other compensation described above that he may
otherwise have been entitled to receive as a non-employee director. This
agreement is more fully described at "Chairman and Executive Officers Services
and Employment Arrangements." This service agreement has been superseded by the
employment agreement between Kmart and Mr. Adamson, described at "Chairman and
Executive Officer Services and Employment Arrangements -- Post Fiscal Year End
Developments."

CHAIRMAN AND EXECUTIVE OFFICER SERVICES AND EMPLOYMENT ARRANGEMENTS

JAMES ADAMSON SERVICES AGREEMENT

Mr. Adamson was appointed to the position of Chairman of the Board of Kmart
effective as of January 17, 2002. In connection with his appointment, Kmart
entered into a services agreement with Mr. Adamson as of that date, subject to
Court approval, which provided for annual fees of $1 million and has a term
ending on the earlier of the date on which Kmart emerged from bankruptcy as an
ongoing business (which may be referred to herein as the "emergence date") or
April 30, 2004. This agreement provided that Mr. Adamson would provide services
to Kmart as its Chairman of the Board, with overall responsibility for managing
and implementing Kmart's restructuring initiatives and assisting Mr. Conaway in
connection with Kmart's merchandising and marketing functions. Under this
agreement, and, with Court approval,
63

Mr. Adamson was paid an inducement payment equal to $2.5 million, grossed up for
income and other taxes, which amount was subject to repayment on a pro-rata
basis if his services were terminated prior to January 31, 2003 either by Kmart
for cause or because of Mr. Adamson's voluntary resignation (other than by
reason of a breach by Kmart of a material provision of the services agreement).
Mr. Adamson's services agreement provides for a "success payment" of a maximum
of $4 million relating to Kmart's emergence from bankruptcy as an on-going
business; the maximum success payment would be made if the emergence date
occurred on or prior to July 31, 2003 and would be reduced on a daily basis
until no success payment would be made if the emergence date occurred following
April 30, 2004. The services agreement also provided for certain benefits, such
as reimbursement for travel expenses and the provision by Kmart of suitable
housing for Mr. Adamson and his spouse in the Detroit metropolitan area. These
benefits would be "grossed-up" by Kmart to compensate for the imposition of any
taxes on Mr. Adamson with respect to these benefits. Under the services
agreement, Kmart established a $10 million letter of credit for the purpose of
satisfying Kmart's obligations.

Effective March 11, 2002, Mr. Adamson was appointed to the position of
Chairman of the Board and Chief Executive Officer of Kmart. In connection with
his appointment, he entered into an employment agreement with Kmart, described
below at "Post Fiscal Year End Developments". The employment agreement was
subject to Court approval, which was received on April 23, 2002, and supersedes
the services agreement.

EXECUTIVE OFFICER EMPLOYMENT ARRANGEMENTS

The following employment agreements and other arrangements with respect to
Kmart's named executive officers are described as in effect as of January 30,
2002, subject, where applicable, to acceptance or rejection by Kmart in
accordance with federal bankruptcy laws.

Mr. Conaway. Kmart entered into an employment agreement with Mr. Conaway
as of May 30, 2000, which was amended during May 2001 and during November 2001.
This agreement has a term ending on May 30, 2005, subject to automatic annual
one-year extensions, commencing on May 20, 2004, and provides for an annual
salary of at least $1.4 million and an annual target bonus opportunity of at
least 125% of his then-current annual salary based on the attainment of
performance goals. Mr. Conaway is also eligible under this agreement for annual
option grants during the term of his employment with a target value equal to
400% of his base salary, such grants to be made based upon the achievement of
performance goals established by the Compensation Committee. In connection with
the May 2001 amendment to his employment agreement, Kmart made a retention loan
to Mr. Conaway in the principal amount of $5 million, the terms of which are set
forth at "Transactions with Executive Officers". Mr. Conaway's agreement also
provides for payment over time of approximately $5 million in cash and $10
million in shares of restricted stock to compensate Mr. Conaway for amounts that
he was required to forego from his prior employer in order to accept employment
with Kmart in 2000.

Mr. Conaway's employment agreement provides that if his employment is
terminated by Kmart during the term of the agreement other than for cause or
disability or if he terminates under a constructive termination, he will be
entitled to receive monthly severance payments equal to his monthly base salary
at the time of termination, plus 1/12th of the annual on-plan bonus for the year
in which termination occurs, which payments will be made during a severance
period of 36 months, but may be paid in a lump sum at Kmart's discretion (such
payments, the "severance payments"). If his employment is terminated under these
circumstances within two years of a change in control of Kmart, he will be
entitled to receive a lump sum payment equal to the severance payments. Payments
to Mr. Conaway will be "grossed-up" to compensate for the imposition of any
golden parachute excise taxes. Under this agreement, Mr. Conaway is subject to
18-month post-termination non-competition and non-solicitation covenants.

Kmart amended and restated Mr. Conaway's employment agreement as of January
21, 2002, subject to Court approval. The terms of the restated agreement remain
substantially similar to those in effect prior to such restatement, except as
follows: (i) the definition of "constructive termination" was narrowed to take
into account the appointment of Mr. Adamson as the Chairman of the Board; (ii)
the maturity date of his loan was revised (as set forth below, at "Transactions
with Executive Officers") and (iii) the remaining installments of

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the payments to be made in respect of foregone compensation, totaling
approximately $6.5 million, would be paid to Mr. Conaway in a cash lump sum if
he was still employed by Kmart on July 31, 2003, provided that this amount would
be paid earlier if Mr. Conaway's employment was terminated prior to July 31,
2003 either by Kmart without cause, because of Mr. Conaway's death or
disability, or if Mr. Conaway terminated his employment for one of the following
reasons: his salary was reduced or was not paid; Kmart's principal office was
relocated; someone was appointed to a position at Kmart that was equal with Mr.
Conaway's position; or if Mr. Conaway was not elected to, or was removed from,
the position of Kmart's Chief Executive Officer.

Mr. Conaway's employment with Kmart was terminated effective March 11,
2002. The terms of his separation agreement from Kmart are set forth below,
under "Post Fiscal Year End Developments". In connection with his termination of
employment, Mr. Conaway's employment agreement, as amended and restated as of
January 21, 2002, was withdrawn from the Court approval process.

Messrs, Kearse, D'Onofrio and Rots. Kmart entered into an employment
agreement with each of Messrs. Kearse, D'Onofrio and Rots effective December 3,
2001, which agreements superseded and replaced Kmart's earlier Confidentiality,
Non-competition and Non-solicitation Agreements with each of these executives.
Each of the employment agreements has a term ending on January 31, 2006, subject
to automatic annual one-year extensions, commencing on December 3, 2002. In
addition to providing for salary and participation in Kmart's annual incentive
plan and option programs, each of the agreements provides for a retention loan
by Kmart of $2.5 million, the terms of which loans are set forth at
"Transactions with Executive Officers". In addition to eligibility to be granted
options during the term of employment, each of the agreements also provides for
the grant of an initial option to the executive to purchase 525,000 shares of
Kmart common stock, the vesting of which is subject to the attainment of
performance goals. Mr. Kearse's and Mr. Rots's agreements each provide for the
continued deferral of cash awards ($1,000,000 with respect to Mr. Kearse and
$750,000 with respect to Mr. Rots), which amounts were originally granted
pursuant to the terms of the Confidentiality, Non-competition and
Non-solicitation Agreements. When made, the distribution of the deferred amounts
will include a gross-up for income and other taxes incurred by the executive at
the time of distribution. Mr. D'Onofrio's agreement provides that a payment of
$750,000 previously made to Mr. D'Onofrio in connection with the execution of
his Confidentiality, Non-competition and Non-solicitation Agreement will be
subject to repayment if his employment is terminated prior to January 31, 2004;
if, however, he is employed on that date, he is entitled to be grossed-up with
respect to income and other taxes with respect to the payment of such amount. In
connection with entering into their December 2001 employment agreements, grants
of restricted stock made to each of Messrs. Kearse, D'Onofrio and Rots pursuant
to their Confidentiality, Non-competition and Non-solicitation Agreements were
cancelled and forfeited.

If Messrs. Kearse's, D'Onofrio's or Rots's employment is terminated by
Kmart during the term of their respective employment agreements (other than for
cause or disability) or if the executive terminates under a constructive
termination, the executive will be entitled to receive monthly severance
payments equal to his monthly base salary at the time of termination, plus
1/12th of the annual target bonus for the year in which such termination occurs,
which payments will be made during a severance period of 36 months, but may be
paid in a lump sum at Kmart's discretion (such payments, the "severance
payments"). If the executive's employment is terminated without cause and within
two years of a change in control of Kmart, he would be entitled to receive a
lump sum payment equal to the severance payments. Payments to the executives
will be "grossed-up" to compensate for the imposition of any golden parachute
excise taxes. Under their respective employment agreements, each of Messrs.
Kearse, D'Onofrio, and Rots is subject to a 12-month post-termination
non-competition covenant and a 24-month post-termination non-solicitation
covenant.

The employment agreements with Messrs. Kearse, D'Onofrio and Rots were
amended and restated as of January 21, 2002. The terms of each of these restated
agreements remain substantially similar to those in effect prior to such
restatement, except as follows: (i) the definition of "constructive termination"
was generally narrowed to take into account the appointment of Ronald Hutchison
as the Chief Restructuring Officer of Kmart and (ii) the maturity date of the
loans was revised (as set forth below, at "Transactions with Executive
Officers"). Mr. Rots's restated agreement further provides that he would be
entitled to terminate his employment under a constructive termination if, after
July 31, 2003, Mr. Conaway's employment was
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terminated by Kmart without cause or by Mr. Conaway under a constructive
termination. Pursuant to Mr. Rots' restated employment agreement, the $750,000
deferred cash amount (which, together with a gross-up for income and other
taxes, had previously been distributed to Mr. Rots) would be subject to
repayment by Mr. Rots if his employment was terminated prior to January 31,
2004, unless his employment was terminated prior to that date either by Kmart
without cause, because of Mr. Rots's death or disability, if Mr. Rots terminated
his employment because his salary had been reduced or had not been paid or if he
terminated his employment following the termination, after July 31, 2003, of Mr.
Conaway's employment, as described above. Mr. Kearse's deferred amount generally
will be forfeited or, if previously distributed, will be subject to repayment by
Mr. Kearse if his employment is terminated prior to January 31, 2004, unless his
employment is terminated prior to that date either by Kmart without cause,
because of Mr. Kearse's death or disability, or if Mr. Kearse terminates his
employment because his salary has been reduced or has not been paid. In
addition, the post-termination non-competition period for each of these
agreements was lengthened to 18 months.

Both Mr. D'Onofrio's and Mr. Rots's employment with Kmart terminated
effective March 25, 2002. The terms of their respective separations from Kmart
are set forth below, under "Post Fiscal Year End Developments". The employment
agreements of Messrs. D'Onofrio and Rots, as amended and restated as of January
21, 2002, have been withdrawn from the Court approval process.

Mr. Schwartz. Kmart entered into an employment agreement with Mr. Schwartz
effective as of December 3, 2001. This agreement generally contains terms and
provisions substantially similar to those with respect to the December 3, 2001
employment agreements of Messrs. Kearse, D'Onofrio and Rots (including with
respect to the continued deferral of a $1 million cash award and the calculation
and payment of severance), except that Mr. Schwartz's retention loan from Kmart
was in the principal amount of $3 million.

Mr. Schwartz's employment with Kmart terminated effective January 15, 2002,
pursuant to the terms of a Separation Agreement and General Release dated as of
such date. This agreement provides for, among other things, Mr. Schwartz's
release of Kmart with respect to all claims; his continuing obligation to comply
with the confidentiality, non-competition and non-solicitation covenants
contained in his employment agreement; the forgiveness of the $3 million
retention loan to Mr. Schwartz (described at "Transactions with Executive
Officers"); and associated tax gross-up payments. Mr. Schwartz received no
severance or other benefits in connection with the termination of his employment
with Kmart.

Ms. Allen. Ms. Allen was appointed to the position of Chief Information
Officer effective September 15, 2000, and, in connection with her appointment,
Kmart entered into a letter agreement effective as of September 14, 2000 (for
purposes of this paragraph, her "offer letter"), and a Confidentiality, Non-
competition and Non-solicitation Agreement effective as of December 4, 2000 and
a letter agreement describing certain severance benefits (for purposes of this
paragraph, her "non-competition agreement"). Ms. Allen's offer letter provides
for the payment of base salary and benefits, the opportunity to earn an annual
performance bonus, the amount of which is to be based on performance relative to
pre-established performance objectives, and the grant of stock options during
her employment. Ms. Allen's offer letter also provides for a cash hiring
incentive of $300,000, which amount is repayable to Kmart if Ms. Allen
voluntarily terminates her employment within 2 years of her hiring date. As
special consideration for foregone income from her previous employer, Kmart
granted to Ms. Allen in September 2000, pursuant to the terms of her offer
letter, shares of restricted stock grant which are scheduled to vest on
September 30 of each of 2002 and 2003, provided that certain conditions are met
with respect to her replacement at her previous employer, and an option grant of
100,000 shares, which will become vested on September 30, 2003, provided she is
employed by Kmart at that time. Ms. Allen's non-competition agreement provides
for perpetual covenants with respect to confidentiality, cooperation with regard
to Company litigation and non-disparagement of Kmart, and for post-employment
non-competition and non-solicitation covenants lasting for 18 months following
the termination of her employment for any reason, provided that the
non-competition covenant will terminate earlier upon a change in control of
Kmart (as defined in her non-competition agreement). As consideration for her
entering into this non-competition agreement, Kmart granted to Ms. Allen
restricted stock valued at $1,500,000 on the date of grant, which shares will
vest subject to the attainment of certain performance goals, and paid to Ms.
Allen a lump sum cash payment of $500,000, which is repayable to Kmart if her
employment is terminated prior to January 31, 2004 unless the termination of her
employment is (i) by reason of her death,
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(ii) by Kmart without cause, (iii) by Ms. Allen for good reason or (iv) within
three years following a change in control of Kmart (each term as defined in her
non-competition agreement) for one of the three reasons listed above. In
addition, if the performance goals relating to the restricted stock grant are
met during her employment and at any time prior to January 31, 2005, she is
entitled to additional restricted stock grants per applicable goal. Ms. Allen's
severance agreement provides for cash severance benefits in the form of salary
continuation for a period of 24 months following the termination of her
employment with Kmart, if such termination is by Kmart other than for cause or
disability or if she terminates her employment for good reason (each term as
defined in her severance agreement). These severance payments will be reduced by
any compensation received by a subsequent employer, and will cease if Ms. Allen
violates the non-competition covenant in her severance agreement during the
one-year period following such a termination of employment.

Mr. Boyer. Mr. Boyer was appointed to the position of Chief Financial
Officer effective May 7, 2001 and, in connection with his appointment, entered
into a letter agreement as of such date (for purposes of this paragraph, his
"offer letter"), a Confidentiality, Non-competition and Non-solicitation
Agreement effective as of May 21, 2001 (for purposes of this paragraph, his
"non-competition letter") and a letter agreement describing certain severance
benefits (for purposes of this paragraph, his "severance agreement"). The terms
of Mr. Boyer's offer letter are substantially similar to Ms. Allen's offer
letter, except that his inducement payment under the offer letter is $100,000;
his guaranteed bonus for the year 2001 was $200,000; he was designated as a
participant in Kmart's Special Supplemental Executive Retirement Plan; and his
initial option grant was for 120,000 shares. The terms on his non-competition
agreement and severance agreement are substantially similar to Ms. Allen's
non-competition agreement and severance agreement, respectively, including the
lump sum payment of $500,000 under the non-competition agreement.

Mr. Boyer's employment with Kmart terminated effective November 9, 2001,
pursuant to the terms of a full and complete release of liability and severance
agreement, entered into between Kmart and Mr. Boyer as of November 23, 2001 (for
purposes of this paragraph, his "separation agreement"). Mr. Boyer's separation
agreement provides for his release of Kmart and its affiliates with respect to
all claims and his obligation to abide by covenants relating to confidentiality,
non-disparagement, cooperation with respect to Kmart litigation and, for one
year following termination, non-solicitation. As consideration for the release,
Kmart, among other things, agreed to (i) continue his base salary until December
31, 2003, (ii) pay an amount equal to $200,000 in respect of his guaranteed
bonus with respect to fiscal year 2001, (iii) allow Mr. Boyer to keep the
$500,000 payment made at the time he entered into his non-competition agreement,
(iv) cancel his obligation to repay the $100,000 that was paid to Mr. Boyer as
an inducement to commence employment with Kmart and (v) fully vest his stock
option on 120,000 shares. Pursuant to his separation agreement, the restricted
shares granted to Mr. Boyer in connection with entering into his non-competition
agreement were cancelled.

POST FISCAL YEAR END DEVELOPMENTS

The following discussion relates to (i) new appointments occurring before
or after the end of fiscal year 2001 with respect to executive officers
currently expected to be named executive officers with respect to fiscal year
2002 and (ii) the termination of employment, following the end of fiscal year
2001, of executive officers who are named executive officers with respect to
fiscal year 2001.

Mr. Adamson's Appointment as Chief Executive Officer. Mr. Adamson was
appointed by the Board of Directors to the position of the Chairman of the Board
and Chief Executive Officer as of March 11, 2002. In connection with his
appointment, Kmart entered into an employment agreement with Mr. Adamson,
effective as of March 11, 2002, subject to Court approval. Upon receipt of such
approval, which occurred on April 23, 2002, the employment agreement superseded
Mr. Adamson's services agreement with Kmart, described above under "James
Adamson Services Agreement". The employment agreement with Mr. Adamson provides
for a term of employment ending on April 30, 2004, provided that the term will
automatically extend for an additional year on each anniversary of the effective
date, unless earlier terminated as provided in the agreement. Mr. Adamson's
employment agreement provides for an annual base salary of $1.5 million and
participation in Kmart's annual bonus plan at a target bonus level equal to 125%
of his annual salary. During Kmart's chapter 11 case, Mr. Adamson's annual bonus
will be paid under Kmart's Key Employee Retention Program. Under the terms of
the employment agreement, Mr. Adamson will no longer be required to repay
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any portion of the inducement payment paid pursuant to his services agreement.
Mr. Adamson's employment agreement provides for the payment of an emergence
bonus, the amount and other terms and conditions of which will be determined
during the process during which Kmart's plan of reorganization is developed and
finalized. Mr. Adamson's employment agreement provides for the continuation of
certain reasonable travel and housing benefits as were originally provided under
his services agreement, and for participation in Kmart's welfare and other
benefit plans made available to Kmart's senior executives in general.

In the event of a termination of Mr. Adamson's employment either by Kmart
(other than for disability or cause) or by Mr. Adamson for good reason, Mr.
Adamson's employment agreement provides for the payment of cash severance as
follows:

- if such termination occurs on or prior to April 30, 2003 and prior to the
date on which a confirmed plan of reorganization (other than a plan of
liquidation) is approved by the bankruptcy court (referred to as the
"plan confirmation date"), a cash lump sum equal to the sum of 300% of
Mr. Adamson's base salary and 100% of his target bonus in effect for the
year of termination, minus the amount of the entire inducement payment
paid pursuant to his services agreement;

- if such termination occurs following April 30, 2003 but prior to the plan
confirmation date, then an initial payment equal to Mr. Adamson's base
salary and target bonus as in effect immediately prior to the time of
termination would be made at the time of termination, and an additional
payment equal to 200% of Mr. Adamson's base salary as in effect
immediately prior to the time of termination would be made if and when
the plan confirmation date occurred; or

- if such termination occurs following the plan confirmation date (or in
contemplation of the plan confirmation date in order to reduce the
amounts payable under the employment agreement), a payment equal to 300%
of his base salary as in effect immediately prior to the time of
termination and 100% of his target bonus as in effect for the year in
which termination occurs would be made at the time of termination.

Following such a termination of employment, Mr. Adamson will also be
entitled to continued health and life insurance benefits for two years following
such a termination of employment, and full vesting and/or exercisability of
equity awards, deferred compensation and pension benefits. Payments to Mr.
Adamson will be "grossed-up" to compensate for the imposition of any golden
parachute excise taxes thereon. Following approval of the employment agreement
by the Court, the $10 million letter of credit that Kmart established for the
purpose of satisfying its obligations to Mr. Adamson was terminated. Mr.
Adamson's employment agreement provides for 12-month post-termination
non-competition and non-solicitation covenants.

Appointment of Julian Day and Michael Macik. Kmart appointed Julian Day to
the office of President and Chief Operating Officer effective April 9, 2002, and
appointed Michael Macik to the office of Executive Vice President, Human
Resources effective April 8, 2002. In connection with their appointments, Kmart
entered into employment agreements with each of Mr. Day and Mr. Macik. (Mr.
Day's agreement was subject to and has received Court approval). Each of the
employment agreements provides for an initial term commencing on the effective
date of employment and ending April 30, 2004, provided that the term will be
automatically extended for an additional year on each anniversary of the
effective date of the executive's employment with Kmart, unless earlier
terminated as provided in the agreements. Each of the employment agreements
provides for a lump sum inducement payment of, in Mr. Day's case, $775,000 and
in Mr. Macik's case, $425,000 and, in addition to base salary and other
benefits, provides for an annual target cash bonus equal to, in Mr. Day's case,
100% of base salary and, in Mr. Macik's case, 60% of base salary. Each of Mr.
Day and Mr. Macik is entitled to receive a bonus in connection with Kmart's
emergence from bankruptcy. The amount of the emergence bonus and the form in
which it will be paid are to be determined in the process of developing Kmart's
plan of reorganization. Mr. Day's employment agreement provides for
reimbursement by Kmart with respect to temporary housing and relocation expenses
and for payment of certain amounts by Kmart (up to a maximum of $1.5 million) in
the event Mr. Day does not receive certain compensation payments from his prior
employer. Each of the executives will be entitled to participate in the
long-term cash and equity-based compensation programs that Kmart may provide
following its emergence from bankruptcy.

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The calculation of cash severance payments and the timing of the payment of such
amounts are substantially similar to those described above with respect to Mr.
Adamson's employment agreement.

Appointment of Ronald Hutchison. The Board of Directors appointed Ronald
Hutchison to the office of Chief Restructuring Officer effective January 21,
2002. In connection with his appointment, Kmart entered into an employment
agreement with Mr. Hutchison, which has been approved by the Court. Mr.
Hutchison's agreement provides for a term commencing on the effective date of
employment and ending on the earlier of January 31, 2003, or the date on which
Kmart emerges from Chapter 11 as an ongoing business (for purposes of this
paragraph, the "emergence date"), provided that the term will be automatically
extended for an additional year unless Kmart delivers a written notice of
non-extension to Mr. Hutchison prior to December 31, 2002. The agreement
provides for a lump sum inducement payment of $250,000 and, in addition to base
salary and other benefits, provides for a lump sum emergence bonus of $1
million. In the event that Mr. Hutchison's employment is terminated by Kmart
other than for disability or cause or by Mr. Hutchison following a constructive
termination (each term as defined in the agreement), he is entitled to receive,
in addition to accrued but unpaid salary and benefits under Company benefit
plans, (i) a lump sum cash payment equal to his base salary as in effect on the
date of termination, (ii) if the emergence date occurs within 12 months
following such termination, a lump sum cash payment of $525,000 and (iii)
continued participation in welfare benefit plans for 12 months following such
termination. Payments to Mr. Hutchison will be "grossed-up" to compensate for
the imposition of any golden parachute excise taxes thereon. Mr. Hutchison's
agreement provides for customary confidentiality, non-disparagement and
cooperation covenants.

Appointment of Albert Koch and Ted Stenger. Mr. Koch was appointed to the
position of Chief Financial Officer, and Mr. Stenger was appointed to the
position of Treasurer, reporting to Mr. Koch, pursuant to the terms of a letter
agreement, effective March 10, 2002 (the "JAS Agreement"), entered into between
Kmart and JA&A Services, LLC ("JAS"), which is the employer of Messrs. Koch and
Stenger. Under this arrangement, Kmart will compensate JAS for Messrs. Koch and
Stenger's services at an hourly rate of $640 and $620, respectively. JAS is
entitled to review its billing rates effective January 1 of each year. The JAS
Agreement provides that Mr. Koch and Mr. Stenger will be entitled to the benefit
of indemnities provided by Kmart to its officers and directors. During the term
of the JAS Agreement, in addition to hourly fees and expenses, Kmart is
obligated to pay JAS an annual performance fee based on Kmart's EBITDA for each
year. If at any time prior to the earlier of (i) the second anniversary of the
effective date of the JAS Agreement or (ii) confirmation of a plan of
reorganization, new chief executive officers are employed and there is a
material change in the responsibilities or duties of Mr. Koch and Mr. Stenger
without JAS's consent, the JAS Agreement will terminate and JAS will be entitled
to a $2 million fee.

Termination of Mr. Conaway's Employment. Mr. Conaway's employment and
services as a director with Kmart terminated effective March 11, 2002, pursuant
to the terms of a separation agreement dated as of such date. This agreement
provides for, among other things, receipt by Mr. Conaway of a cash severance
payment equal to approximately $4 million and the waiver by Mr. Conaway of (i)
approximately $4.5 million in additional severance and (ii) a $6.5 million lump
sum payment attributable to foregone compensation from his previous employer. In
connection with the cash severance payment, which was made in accordance with a
Court order authorizing Kmart to continue to make severance payments in
connection with employment termination generally, Mr. Conaway executed a release
in favor of Kmart. This agreement also acknowledges that, in accordance with the
terms of the May 2001 promissory note evidencing the $5 million retention loan
to Mr. Conaway (described at "Transactions with Executive Officers"), the
principal amount of and accrued interest on such a loan were to be forgiven. The
agreement also provides for the following payments and benefits, which are
subject to (and will not be made without) Court approval and for which Mr.
Conaway must execute an additional release in favor of Kmart: tax gross-up
payments associated with the loan forgiveness provided for in the May 2001
promissory note; the continuation until March 11, 2003 of certain health
benefits, and the continuation until September 11, 2002 of certain other
benefits, such as residential security and outplacement benefits. Pursuant to
his separation agreement, Mr. Conaway will be subject to non-competition and
non-solicitation covenants for a period of 12 months following his termination.
Upon execution of the separation agreement, Mr. Conaway's employment agreement
with Kmart, as amended and

69

restated as of January 21, 2002, described above at "Chairman and Executive
Officer Services and Employment Arrangements", was rescinded and revoked and
such agreement was withdrawn from the Court approval.

Termination of Messrs. D'Onofrio and Rots. The employment of Messrs.
D'Onofrio and Rots terminated effective March 25, 2002. Kmart entered into
letter agreements with each of Messrs. D'Onofrio and Rots pursuant to which
Kmart agreed, on an interim basis, to continue to pay to these executives an
amount equal to their monthly salary and reserved the right to determine its
rights and obligations under their respective employment agreements. Kmart has
since determined to cease making monthly payments to Messrs. D'Onofrio and Rots.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

OWNERSHIP OF KMART COMMON STOCK

The following table sets forth certain information concerning persons
which, to the knowledge of Kmart, own more than 5% of the outstanding Kmart
common stock.

- ---------------

(1) Information obtained from Schedule 13G as of March 4, 2002 filed with the
SEC by Appaloosa Management L.P. and David A. Tepper. Mr. Tepper is the sole
stockholder and president of Appaloosa Partners Inc. Appaloosa Partners Inc.
is the general partner of, and Mr. Tepper owns a majority of the limited
partnership interests of, Appaloosa Management L.P. Includes 28,447,666
shares of Kmart common stock that can be acquired by conversion of 8,534,300
7 3/4% Trust Convertible Preferred Securities.

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OWNERSHIP OF KMART COMMON STOCK BY DIRECTORS AND EXECUTIVE OFFICERS

The following table shows the Kmart common stock ownership of Kmart's
directors, the named executive officers and all of the directors and executive
officers of Kmart as a group, in each case as of January 30, 2002.

- ---------------

* Directors and executive officers as a group owned less than 1% of the
outstanding shares of Kmart common stock.

(1) Includes restricted Kmart common stock units accrued under the Directors
Stock Plan as follows: Mr. Adamson -- 16,300 units; Ms. Affinito -- 15,194
units; Mr. Cline -- 16,566 units; Mr. Flannery -- 1,515 units; Mr.
Kennedy -- 16,300 units; Ms. Smith -- 14,686 units; and Mr.
Stallkamp -- 7,816 units.

(2) Includes shares of Kmart common stock that can be acquired by exercise of
stock options within 60 days of January 30, 2002, as follows: Mr.
Adamson -- 13,634 shares; Ms. Affinito -- 13,634 shares; Ms. Allen -- 56,667
shares; Mr. Cline -- 18,634 shares; Mr. Davis -- 13,634 shares; Mr.
D'Onofrio -- 63,334 shares; Mr. Flannery -- 18,634 shares; Mr.
Kearse -- 384,993 shares; Mr. Kennedy -- 13,634 shares; Mr. Rots -- 156,001
shares; Ms. Smith -- 13,634 shares; Mr. Stallkamp -- 8,634 shares; and all
directors and executive officers as a group -- 839,067 shares.

(3) Includes shares of Kmart common stock that can be acquired by conversion of
Kmart Financing I Trust Convertible Preferred Stock as follows: Mr.
Kennedy -- 1,000 shares; and all directors and executive officers as a
group -- 1,000 shares.

(4) Mr. Statuto may be deemed to share voting and investment power as to 6,400
shares of Kmart common stock owned by CHRISTUS Health of which he is Vice
Chairman. If such additional shares were included, executive officers and
directors as a group would be considered to beneficially own 3,836,272
shares of Kmart common stock, or 0.8% of the Kmart common stock outstanding
as of January 30, 2002. Mr. Statuto disclaims beneficial ownership of such
shares.

71

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

TRANSACTIONS WITH EXECUTIVE OFFICERS

Pursuant to an amendment to his original May 2000 employment agreement,
Kmart made a full recourse retention loan to Mr. Conaway in the principal amount
of $5 million in May 2001. Pursuant to the employment agreements entered into in
December, 2001, Kmart made full recourse retention loans to each of Messrs.
D'Onofrio, Kearse, Rots and Schwartz, as well as to John T. McDonald, Jr.
(former Chief Financial Officer), in December 2001 in the aggregate principal
amount of $2.5 million each (except for Mr. Schwartz's loan, which was in the
principal amount of $3 million). Mr. McDonald's aggregate $2.5 million loan was
to be made in two installments, one in December 2001 and one in December, 2002.
The loan originally to be made in December 2002 was subsequently made in January
2002. These loans are hereinafter referred to as the "Executive Loans." Each of
the Executive Loans originally had a term of approximately five years, accruing
interest at 3.97% per year, payment of which is deferred until the maturity
date. When the executives' employment agreements (other than Mr. Schwartz's
agreement) were amended and restated in January 2002, the maturity dates of each
of the Executive Loans (other than Mr. Schwartz's loan) were amended to January
31, 2004. Each of the Executive Loans provides that it is to be forgiven in full
on the maturity date if the executive is employed by Kmart on that date, with
earlier forgiveness in the event that the executive is terminated (i) by Kmart
without cause, (ii) because of death or disability or (iii) voluntarily by the
executive under a constructive termination (in connection with the revision of
the maturity date, a constructive termination is limited in this instance to a
reduction in base salary or due to a failure by Kmart to pay the executive's
base salary). Each Executive Loan also provides that Kmart is obligated to
"gross-up" the executive with respect to income and other taxes incurred by the
executive with respect to loan forgiveness.

In December 2001, Kmart also made full recourse retention loans to Messrs.
David Montoya (former SVP, Specialty Operations) and Gregg Treadway (former EVP,
Store Operations), each in the amount of $750,000, and to Ms. Janet Kelley (EVP,
General Counsel) in the amount of $500,000. The terms of these loans are
substantially similar to the Executive Loans described above, except that the
maturity date is January 31, 2005 and there is no tax "gross-up" obligation on
the part of Kmart in connection with any loan forgiveness. The employment of
Messrs. Montoya and Treadway terminated, effective March 22, 2002 and May 6,
2002, respectively.

The loans to executive officers described above formed part of a broader
retention program pursuant to which Kmart made loans aggregating approximately
$30 million, as publically disclosed on Exhibit 99.2 to Kmart's Form 8-K dated
May 9, 2002. Kmart has not taken any corporate action since the commencement of
the Chapter 11 case to forgive any of these loans.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

a) The following documents are filed as part of this report

1. Financial Statements

Financial statements filed as part of this Form 10-K are listed
under Part II, Item 8.

2. Financial Statement Schedules

Financial statement schedules filed as part of this Form 10-K are
listed under Part II, Item 8.

The separate financial statements and summarized financial
information of majority-owned subsidiaries not consolidated and of 50%
or less owned persons have been omitted because they are not required
pursuant to conditions set forth in Rules 3-09 and 1-02(w) of Regulation
S-X.

All other schedules have been omitted because they are not required
under the instructions contained in Regulation S-X because the
information called for is contained in the financial statements and
notes thereto.

72

3. Exhibits

See Exhibit Index included in this report.

b) Reports on Form 8-K:

We filed a Current Report on Form 8-K dated January 22, 2002
to report that Kmart Corporation and 37 of its U.S. subsidiaries
filed voluntary petitions for relief under Chapter 11 of the
United States Bankruptcy Code in the United States Court for the
Northern District of Illinois Case No. 02-B02474, that James B.
Adamson had been appointed Chairman of the Board, Mark Schwartz's
employment as President and Chief Operating Officer had been
terminated and Ron Hutchison had been appointed Chief
Restructuring Officer and Executive Vice President and to file a
copy of the press release.

73

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on May 15, 2002.

Each signatory hereby acknowledges and adopts the typed form of his or her
name in the electronic filing of this document with the Securities and Exchange
Commission.

KMART CORPORATION

By: /s/ JAMES B. ADAMSON
-----------------------------------
James B. Adamson
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)

By: /s/ A.A. KOCH
-----------------------------------
A.A. Koch
Chief Financial Officer
(Principal Financial Officer)

By: /s/ RICHARD J. NOECHEL
-----------------------------------
Richard J. Noechel
Vice President and Controller
(Principal Accounting Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons, on behalf of the
Registrant and in the capacities indicated, on May 15, 2002.

Each signatory hereby acknowledges and adopts the typed form of his or her
name in the electronic filing of this document with the Securities and Exchange
Commission.

/s/ JAMES B. ADAMSON /s/ ROBERT D. KENNEDY
- --------------------------------------------- ---------------------------------------------
James B. Adamson, Director Robert D. Kennedy, Director

/s/ LILYAN H. AFFINITO /s/ ROBIN B. SMITH
- --------------------------------------------- ---------------------------------------------
Lilyan H. Affinito, Director Robin B. Smith, Director

/s/ RICHARD G. CLINE /s/ THOMAS T. STALLKAMP
- --------------------------------------------- ---------------------------------------------
Richard G. Cline, Director Thomas T. Stallkamp, Director

/s/ WILLIE D. DAVIS /s/ RICHARD J. STATUTO
- --------------------------------------------- ---------------------------------------------
Willie D. Davis, Director Richard J. Statuto, Director

/s/ JOSEPH P. FLANNERY
- ---------------------------------------------
Joseph P. Flannery, Director

74

EXHIBIT INDEX

- ---------------

Notes:

* Filed as Exhibits to the Form 10-K Report of the Registrant for
the fiscal year ended January 27, 1993 (file number 1-327) and are
incorporated herein by reference.

** Filed as Exhibits to the Form 10-K Report of the Registrant for
the fiscal year ended January 26, 1994 (file number 1-327) and are
incorporated herein by reference.

*** Filed as Exhibits to the Form 10-K Report of the Registrant for
the fiscal year ended January 25, 1995 (file number 1-327) and are
incorporated herein by reference.

**** Filed as Exhibits to the Form 10-K Report of the Registrant for the
fiscal year ended January 31, 1996 (file number 1-327) and are
incorporated herein by reference.

***** Filed as Exhibits to the Form 10-K Report of the Registrant for the
fiscal year ended January 27, 1999 (file number 1-327) and are
incorporated herein by reference.

****** Filed as part of the 1997 Proxy Statement and is incorporated
herein by reference.

******* Filed as Form 8-K dated June 4, 1995 and is incorporated herein by
reference.

******** Filed as an Exhibit to the Form 10-Q Report of the Registrant for
the fiscal quarter ended October 28, 1998 (file number 1-327) and is
incorporated herein by reference.

********* Filed as an Exhibit to the Form 10-Q Report of the Registrant for
the fiscal quarter ended May 2, 2001 (file number 1-327) and is
incorporated herein by reference.

********** Filed as an Exhibit to the Form 10-Q Report of the Registrant for
the fiscal quarter ended August 1, 2001 (file number 1-327) and is
incorporated herein by reference.

*********** Filed as Exhibits to the Form 10-Q Report of the Registrant for the
fiscal quarter ended October 31, 2001 (file number 1-327) and is
incorporated herein by reference.

FH Filed herewith.

(#) Exhibit numbers in the Form 10-K or 10-Q Reports for the periods
indicated.

(A) This document is a management contract or compensatory plan.

76

In reliance upon Item 601(b)(4)(iii)(A) of Regulation S-K, various
instruments defining the rights of holders of long-term debt of the Registrant
are not being filed herewith because the total amount of securities authorized
under each such instrument does not exceed 10% of the total assets of the
Registrant.

The Registrant agrees to furnish a copy to the Commission upon request of
the following instruments defining the rights of holders of long-term debt:

Indenture dated as of February 1, 1985, between Kmart Corporation and The
Bank of New York, Trustee, as supplemented by the First Supplemental Indenture
dated as of March 1, 1991

12 1/2% Debentures Due 2005

8 3/8% Notes Due 2004

8 1/8% Notes Due 2006

7 3/4% Debentures Due 2012

8 1/4% Notes Due 2022

8 3/8% Debentures Due 2022

7.95% Debentures Due 2023

Fixed-Rate Medium-Term Notes (Series A, B, C, D)

7 3/4% Trust Convertible Preferred Securities

77