<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934
For the quarterly period ended October 29, 2003

                                       OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934
For the transition period from ______________ to _____________

Commission File No. 000-50278

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

                    Delaware                                     32-0073116
   ------------------------------------------                -------------------
        (State or other jurisdiction of                       (I.R.S. Employer
         incorporation or organization)                      Identification No.)

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

Registrant's telephone number, including area code             (248) 463-1000

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed, by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                           Yes [X]     No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

                           Yes [X]     No [ ]

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.

                           Yes [X]     No [ ]

As of November 30, 2003, 89,628,556 shares of Common Stock of Kmart Holding
Corporation were outstanding.

                                        1
<PAGE>

                                      INDEX

<TABLE>
<CAPTION>
                                                                                                         PAGE
                                                                                                         -----
<S>                                                                                                      <C>
PART I     FINANCIAL INFORMATION

Item 1.    Financial Statements

           Condensed Consolidated Statements of Operations (Unaudited) --
           Successor Company - for the 13-weeks ended October 29, 2003
           Predecessor Company - for the 13-weeks ended October 30, 2002                                   3

           Condensed Consolidated Statements of Operations (Unaudited) --
           Successor Company - for the 26-weeks ended October 29, 2003
           Predecessor Company - for the 13-weeks ended April 30, 2003 and the
                39-weeks ended October 30, 2002                                                            4

           Condensed Consolidated Balance Sheets (Unaudited) --
           Successor Company - as of October 29, 2003
           Predecessor Company - as of  January 29, 2003 and October 30, 2002                              5

           Condensed Consolidated Statements of Cash Flows (Unaudited) --
           Successor Company - for the 26-weeks ended October 29, 2003
           Predecessor Company - for the 13-weeks ended April 30, 2003 and the
                39-weeks ended October 30, 2002                                                            6

           Notes to Unaudited Condensed Consolidated Financial Statements                                7-24

Item 2.    Management's Discussion and Analysis of Results of Operations and Financial Condition         25-35

Item 3.    Quantitative and Qualitative Disclosures about Market Risk                                     36

Item 4.    Controls and Procedures                                                                        36

PART II    OTHER INFORMATION

Item 1.    Legal Proceedings                                                                              37

Item 5.    Other Information                                                                              37

Item 6.    Exhibits and Reports on Form 8-K                                                              37-38

           Signatures                                                                                     39
</TABLE>

                                        2
<PAGE>

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                  (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                 13-WEEKS ENDED
                                                                     ----------------------------------------
                                                                        SUCCESSOR              PREDECESSOR
                                                                         COMPANY                 COMPANY
                                                                     OCTOBER 29, 2003        OCTOBER 30, 2002
                                                                     ----------------        ----------------
<S>                                                                  <C>                     <C>
Sales                                                                    $ 5,092                 $ 6,459
Cost of sales, buying and occupancy                                        3,925                   5,353
                                                                         -------                 -------
Gross margin                                                               1,167                   1,106

Selling, general and administrative expenses                               1,178                   1,448
Restructuring, impairment and other charges                                    -                      (6)
Equity income in unconsolidated subsidiaries                                  (1)                     (8)
                                                                         -------                 -------
Loss before interest, reorganization items, income
   taxes and discontinued operations                                         (10)                   (328)
Interest expense, net (contractual interest for the 13-weeks
   ended October 30, 2002 was $104)                                           24                      37
Reorganization items, net                                                      -                       4
Benefit from income taxes                                                    (11)                     (7)
                                                                         -------                 -------
Loss before discontinued operations                                          (23)                   (362)
Discontinued operations (net of income taxes of $0)                            -                     (21)
                                                                         -------                 -------
Net loss                                                                 $   (23)                $  (383)
                                                                         =======                 =======

Basic/diluted loss before discontinued operations                        $ (0.26)                $ (0.72)
Discontinued operations                                                        -                   (0.04)
                                                                         -------                 -------
Basic/diluted net loss per common share                                  $ (0.26)                $ (0.76)
                                                                         =======                 =======

Basic/diluted weighted average shares (millions)                            89.6                   502.5
</TABLE>

See accompanying Notes to unaudited Condensed Consolidated Financial Statements.

                                        3
<PAGE>

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                  (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                       SUCCESSOR COMPANY                PREDECESSOR COMPANY
                                                                       -----------------       -------------------------------------
                                                                        26-WEEKS ENDED         13-WEEKS ENDED        39-WEEKS ENDED
                                                                       OCTOBER 29, 2003        APRIL 30, 2003       OCTOBER 30, 2002
                                                                       -----------------       --------------       ----------------
<S>                                                                    <C>                     <C>                  <C>
Sales                                                                   $     10,744           $      6,181          $     20,823
Cost of sales, buying and occupancy                                            8,344                  4,762                17,784
                                                                        ------------           ------------          ------------
Gross margin                                                                   2,400                  1,419                 3,039

Selling, general and administrative expenses                                   2,401                  1,421                 4,653
Restructuring, impairment and other charges                                        -                     37                     8
Equity income in unconsolidated subsidiaries                                      (3)                    (7)                  (27)
                                                                        ------------           ------------          ------------
Income (loss) before interest expense, reorganization items, income
   taxes and discontinued operations                                               2                    (32)               (1,595)
Interest expense, net (contractual interest for the 13-weeks ended
   April 30, 2003 and the 39-weeks ended October 30, 2002
   was $124 and $306, respectively)                                               45                     57                   102
Reorganization items, net                                                          -                    769                   259
Benefit from income taxes                                                        (15)                    (6)                  (19)
                                                                        ------------           ------------          ------------

Loss before discontinued operations                                              (28)                  (852)               (1,937)

Discontinued operations (net of income taxes of $0 and $0)                         -                    (10)                 (181)
                                                                        ------------           ------------          ------------
Net loss                                                                $        (28)          $       (862)         $     (2,118)
                                                                        ============           ============          ============

Basic/diluted loss before discontinued operations                       $      (0.32)          $      (1.63)         $      (3.85)
Discontinued operations                                                            -                  (0.02)                (0.36)
                                                                        ------------           ------------          ------------
Basic/diluted net loss per common share                                 $      (0.32)          $      (1.65)         $      (4.21)
                                                                        ============           ============          ============

Basic/diluted weighted average shares (millions)                                89.6                  522.7                 502.7
</TABLE>

See accompanying Notes to unaudited Condensed Consolidated Financial Statements.

                                        4
<PAGE>

                      CONDENSED CONSOLIDATED BALANCE SHEETS
                    (DOLLARS IN MILLIONS, EXCEPT SHARE DATA)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                 SUCCESSOR
                                                                                  COMPANY        PREDECESSOR COMPANY
                                                                                 -----------   -------------------------
                                                                                 OCTOBER 29,   JANUARY 29,   OCTOBER 30,
                                                                                    2003          2003          2002
                                                                                 -----------   -----------   -----------
<S>                                                                              <C>           <C>           <C>
ASSETS
CURRENT ASSETS
 Cash and cash equivalents                                                        $    941      $    613      $    381
 Merchandise inventories                                                             4,404         4,825         6,330
 Other current assets                                                                  552           664           687
                                                                                  --------      --------      --------
TOTAL CURRENT ASSETS                                                                 5,897         6,102         7,398

Property and equipment, net                                                            115         4,892         5,764
Other assets and deferred charges                                                      105           244           230
                                                                                  --------      --------      --------
TOTAL ASSETS                                                                      $  6,117      $ 11,238      $ 13,392
                                                                                  ========      ========      ========

LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES

 Long-term debt due within one year                                               $     61      $      -      $      -
 Accounts payable                                                                    1,203         1,248         1,825
 Accrued payroll and other liabilities                                                 733           710           691
 Taxes other than income taxes                                                         295           162           306
                                                                                  --------      --------      --------
TOTAL CURRENT LIABILITIES                                                            2,292         2,120         2,822
                                                                                  --------      --------      --------

LONG-TERM LIABILITIES

 Long-term debt and mortgages payable                                                   24             -           575
 Capital lease obligations                                                             419           623           660
 Pension obligation                                                                    867             -             -
 Unfavorable operating leases                                                          322             -             -
 Other long-term liabilities                                                           486           181           209
                                                                                  --------      --------      --------
TOTAL LONG-TERM LIABILITIES                                                          2,118           804         1,444

TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE                                          4,410         2,924         4,266
LIABILITIES SUBJECT TO COMPROMISE                                                        -         7,969         7,128
Predecessor Company obligated mandatorily redeemable convertible
 preferred securities of a subsidiary trust holding solely 7 3/4 % convertible
 junior subordinated debentures (redemption value $648 and $883, respectively)           -           646           874

SHAREHOLDERS' EQUITY (DEFICIT)
 Successor Company preferred stock 20,000,000 shares authorized;
  no shares outstanding                                                                  -             -             -
 Predecessor Company common stock $1 par value, 1,500,000,000 shares
  authorized; 519,123,988 and 503,458,279 shares outstanding, respectively               -           519           503
 Successor Company common stock $0.01 par value, 500,000,000 shares
  authorized; 89,655,445 shares outstanding                                              1             -             -
 Capital in excess of par value                                                      1,735         1,922         1,709
 Treasury stock, at cost                                                                (1)            -             -
 Accumulated deficit                                                                   (28)       (2,742)       (1,088)
                                                                                  --------      --------      --------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT)                                                 1,707          (301)        1,124
                                                                                  --------      --------      --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)                              $  6,117      $ 11,238      $ 13,392
                                                                                  ========      ========      ========
</TABLE>

See accompanying Notes to unaudited Condensed Consolidated Financial Statements.

                                        5
<PAGE>

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                              (DOLLARS IN MILLIONS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                    SUCCESSOR
                                                                     COMPANY                PREDECESSOR COMPANY
                                                                ----------------    ------------------------------------
                                                                    26-WEEKS           13-WEEKS             39-WEEKS
                                                                      ENDED             ENDED                ENDED
                                                                OCTOBER 29, 2003    APRIL 30, 2003      OCTOBER 30, 2002
                                                                ----------------    --------------      ----------------
<S>                                                             <C>                 <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Net loss                                                       $        (28)      $       (862)      $     (2,118)
   Adjustments to reconcile net loss to net cash
     (used for) provided by operating activities:
       Restructuring, impairments and other charges                          -                 44                788
       Reorganization items, net                                             -                769                278
       Depreciation and amortization                                        10                177                558
       Equity income in unconsolidated subsidiaries                         (3)                (7)               (27)
   Dividends received from Meldisco                                          -                 36                 45
   Cash used for store closings and other charges                          (11)               (64)              (147)
   Cash used for payments of exit costs and other
     reorganization items                                                 (470)               (19)              (113)
   Change in:
       Inventories                                                          27                480             (1,202)
       Accounts payable                                                     43               (117)               859
       Deferred income taxes and taxes payable                              (4)               (16)               (23)
       Other assets                                                        (10)               123                 49
       Other liabilities                                                    50                 32                252
                                                                  ------------       ------------       ------------
NET CASH (USED FOR) PROVIDED BY OPERATING ACTIVITIES                      (396)               576               (801)
                                                                  ------------       ------------       ------------

CASH FLOWS FROM INVESTING ACTIVITIES
   Proceeds from sale of property and equipment                             93                 64                 13
   Capital expenditures                                                    (61)                (4)              (206)
                                                                  ------------       ------------       ------------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES                        32                 60               (193)
                                                                  ------------       ------------       ------------

CASH FLOWS FROM FINANCING ACTIVITIES
   Proceeds from issuance of debt                                           60                  -                  -
   Proceeds from DIP Credit Facility                                         -                  -                245
   Payments on debt                                                        (36)                (1)               (22)
   Purchase of treasury stock                                               (3)                 -                  -
   Debt issuance costs                                                     (46)                 -                (36)
   Payments on capital lease obligations                                   (29)               (16)               (57)
   Fees paid to Plan Investors                                             (13)                 -                  -
   Issuance of common shares                                               140                  -                  -
                                                                  ------------       ------------       ------------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES                        73                (17)               130
                                                                  ------------       ------------       ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS                                   (291)               619               (864)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                           1,232                613              1,245
                                                                  ------------       ------------       ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD                          $        941       $      1,232       $        381
                                                                  ============       ============       ============
</TABLE>

See accompanying Notes to unaudited Condensed Consolidated Financial Statements.

                                        6
<PAGE>
     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   EMERGENCE FROM CHAPTER 11 BANKRUPTCY PROTECTION

     Confirmation of Plan of Reorganization

              On May 6, 2003 ("Effective Date") Kmart Corporation (the
     "Predecessor Company") emerged from reorganization proceedings under
     Chapter 11 of the federal bankruptcy laws ("Bankruptcy Code" or "Chapter
     11") pursuant to the terms of the "Plan of Reorganization" (as hereinafter
     defined). The Predecessor Company became a wholly-owned subsidiary of Kmart
     Management Corporation, which is a newly-formed, wholly-owned subsidiary of
     a newly-created holding company, Kmart Holding Corporation ("Kmart," "we,"
     "us," "our," the "Company" or "Successor Company"). Kmart is the nation's
     third largest discount retailer and the sixth largest general merchandise
     retailer.

              On January 22, 2002 ("Petition Date"), the Predecessor Company and
     37 of its U.S. subsidiaries (collectively, the "Debtors") filed voluntary
     petitions for reorganization under Chapter 11 in the United States
     Bankruptcy Court for the Northern District of Illinois ("Court"). During
     the reorganization proceedings, the Debtors continued to operate its
     business as debtors-in-possession under the jurisdiction of the Court and
     in accordance with the applicable provisions of the Bankruptcy Code and
     orders of the Court. On January 24, 2003, the Debtors filed a Plan of
     Reorganization and related Disclosure Statement and on February 25, 2003,
     filed an Amended Joint Plan of Reorganization (the "Plan of
     Reorganization") and related amended Disclosure Statement with the Court.
     The Plan of Reorganization received the formal endorsement of the statutory
     creditors' committees and, as modified, was confirmed by the Court by order
     docketed on April 23, 2003 ("Confirmation Date").

              In connection with our emergence from bankruptcy, we reflected the
     terms of the Plan of Reorganization in our consolidated financial
     statements applying the terms of the American Institute of Certified Public
     Accountants Statement of Position 90-7, "Financial Reporting by Entities in
     Reorganization Under the Bankruptcy Code" ("SOP 90-7") with respect to
     financial reporting upon emergence from Chapter 11 ("Fresh-Start
     accounting"). Upon applying Fresh-Start accounting, a new reporting entity
     (the Successor Company) is deemed to be created and the recorded amounts of
     assets and liabilities are adjusted to reflect their estimated fair values
     (see Note 3 - Fresh-Start Accounting). The reported historical financial
     statements of the Predecessor Company for periods ended prior to May 1,
     2003 generally are not comparable to those of the Successor Company. In
     this Quarterly Report on Form 10-Q, references to the 13-weeks ended April
     30, 2003 and periods ended in fiscal 2002 refer to the Predecessor Company.

     Plan Investors

              At the time of emergence, ESL Investments, Inc. ("ESL") and Third
     Avenue Trust, on behalf of certain of its investment series ("Third
     Avenue," and together with ESL, the "Plan Investors"), made a substantial
     investment in the Successor Company in furtherance of our financial and
     operational restructuring plan. The Plan Investors and their affiliates
     received approximately 32 million shares of Kmart Holding Corporation's new
     common stock in satisfaction of pre-petition claims they held, and we
     issued 14 million shares of new common stock to affiliates of ESL and to
     Third Avenue, in exchange for $127 million, net of commitment fees and Plan
     Investor expenses of $13 million. In addition, we issued a 9%, $60 million
     principal amount convertible note, due in May 2004, to affiliates of ESL.
     The terms of the agreement allow the affiliates of ESL the right to extend
     the maturity of the convertible note for an additional two years with
     notice prior to March 2004. With respect to the 9% convertible note, the
     principal is convertible at any time, at the option of the holder, into new
     shares of common stock at a conversion price equal to $10 per share.
     ESL was also granted the option, exercisable at its own discretion prior to
     May 6, 2005, to purchase from the Successor Company approximately 6.6
     million new shares of common stock at a price of $13 per share. A portion
     of the option was assigned to Third Avenue. The investment was made
     pursuant to the Investment Agreement dated January 24, 2003, as amended
     (the "Investment Agreement").

              ESL and its affiliates beneficially own over 50% of the common
     stock of the Successor Company, including shares received in exchange for
     pre-petition obligations, as well as shares obtainable upon exercise of
     options and conversion of the $60 million convertible note issued to
     affiliates of ESL. Each of the Plan Investors is represented on our Board
     of Directors.

                                        7
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     Discharge of Liabilities

              On the Effective Date, all then-outstanding equity securities of
     the Predecessor Company, as well as substantially all of its pre-petition
     liabilities, were cancelled. New common stock of the Successor Company was
     issued in satisfaction of certain of those claims. The new securities of
     the Successor Company issued on the Effective Date pursuant to the Plan of
     Reorganization and related transactions, consisted of 89,677,509 shares of
     new common stock and options to purchase 8,324,883 shares of new common
     stock of which, 151,738 options to purchase shares of new common stock were
     cancelled, during the third quarter of fiscal 2003. All of the shares of
     new common stock issued on May 6, 2003 were or will be distributed pursuant
     to the Plan of Reorganization in satisfaction of pre-petition claims,
     except for 14 million shares issued to affiliates of ESL and to Third
     Avenue in exchange for $127 million, net of $13 million of commitment fees
     and Plan Investor expenses. All such shares were issued without
     registration under the Securities Act of 1933 in reliance on the provisions
     of Section 1145 of the Bankruptcy Code and Section 4(2) of the Securities
     Act of 1933. In addition, as part of the Plan of Reorganization, an
     independent creditor litigation trust ("Creditor Trust") was established
     for the benefit of the Predecessor Company's pre-petition creditors and
     equity holders, and to pursue claims which arose from the Predecessor
     Company's prior accounting and stewardship investigations. The following
     table outlines the discharge of the Predecessor Company's Liabilities
     subject to compromise pursuant to the Plan of Reorganization:

<TABLE>
<CAPTION>
           TYPE OF CLAIM/SECURITY                                       TREATMENT UNDER THE PLAN OF REORGANIZATION
           ----------------------                                       ------------------------------------------
<S>                                                    <C>
Class 1 - Secured Claims                               100% cash recovery.

Class 3 - Pre-petition Lender Claims                   Issued 18,723,775 shares of new common stock of the Successor Company and
                                                       cash recovery of $243 million.

Class 4 - Pre-petition Note Claims                     Issued 25,008,573 shares of new common stock of the Successor Company.
                                                       Holders may also receive, as described below, recoveries under the Creditor
                                                       Trust.

Class 5 - Trade Vendor and Lease Rejection             Issued 31,945,161 shares of new common stock of the Successor Company.
Claims over $30,000                                    Holders may also receive, as described below, recoveries under the Creditor
                                                       Trust.

Class 6 - Other Unsecured Claims over $30,000          Claim holders will receive their pro-rata share of the "Other Unsecured
                                                       Claims Cash Payment" on the third anniversary of the effective date of the
                                                       Plan of Reorganization. In addition, the holder of any Other Unsecured
                                                       claim may elect to be treated, in lieu of payment, as a Trade Vendor/Lease
                                                       Rejection claim holder. Holders may also receive, as described below,
                                                       recoveries under the Creditor Trust.

Class 7 - General Unsecured Convenience Claims         Recovery to be paid in cash equal to 6.25% of allowed claims or $1,875 if
less than or equal to $30,000                          the amount of such allowed claims is greater than $30,000 and the holder of
                                                       such claim has made the convenience claim election. In addition, the holder
                                                       of any General Unsecured Convenience Claim that would otherwise constitute
                                                       a Trade Vendor/Lease Rejection claim may elect to be treated, in lieu of
                                                       payment, as a Trade Vendor/Lease Rejection claim holder.

Class 8 - Trust Preferred Obligations                  These obligations were cancelled upon emergence. Holders may receive, as
                                                       described below, recoveries under the Creditor Trust.

Class 10 - Subordinated Security Claims                Those who held common stock of the Predecessor Company may receive their
                                                       pro-rata share of up to 2.5% of the recoveries under the Creditor Trust.
</TABLE>

                                       8
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

<TABLE>
<S>                                                    <C>
Class 11 - Existing Common Stock                       The Predecessor Company's stock was cancelled upon emergence. Holders,
                                                       together with those who hold Subordinated Security Claims, may receive
                                                       their pro-rata share of up to 2.5 % of the recoveries under the Creditor
                                                       Trust.

Class 12 - Other Interests                             Cancelled - no recovery.
</TABLE>

              Holders of Pre-petition Note Claims, Trade Vendor and Lease
     Rejection Claims over $30,000, Other Unsecured Claims over $30,000 and
     Trust Preferred Obligations will receive their pro-rata share of recoveries
     in the Creditor Trust (excluding up to 2.5% of such recoveries, which may
     be payable to holders of Subordinated Securities Claims and Predecessor
     Company's Common Stock).

              In addition to the classes described above, the Plan of
     Reorganization allows for two additional classes of claims, Class 2 - Other
     Priority Claims and Class 9 - Intercompany Claims. The Class 2 claims are
     primarily claims held by current and former employees for unpaid wages,
     salaries, bonuses, severance pay, vacation pay and other unpaid employee
     benefits. We believe we have paid all such valid and otherwise allowable
     amounts, and therefore, there should be no significant amount of such
     claims, if any, that remain unpaid. The Class 9 claims are claims by one or
     more of Kmart and its affiliates against other Kmart affiliates on account
     of various matters. Kmart, at its option, may either reinstate or eliminate
     intercompany claims.

              There are also other unclassified claims, including administrative
     claims, priority tax claims, Pension Benefit Guarantee Corporation claims,
     workers' compensation programs and consignment claims. Administrative
     claims will receive a 100% cash recovery; priority tax claims will receive
     a 100% cash recovery paid over a six-year period beginning on their
     assessment date; and the Pension Benefit Guarantee Corporation claims,
     workers' compensation programs and consignment claims were assumed by the
     Successor Company.

     Claims Resolution

              We continue to make progress in the reconciliation and settlement
     of the various classes of claims. On May 30, 2003, the Bankruptcy Court
     confirmed and established May 6, 2003 as the record date for purposes of
     establishing the persons that are claimholders of record to receive
     distributions in accordance with the terms of the Plan of Reorganization.
     Since June 30, 2003, the first distribution date established in the Plan,
     approximately 7.9 million shares of the 31.9 million shares previously
     issued to us as disbursing agent with respect to such claims have been
     distributed to holders of Class 5 claims and approximately $2.2 million in
     cash has been distributed to holders of Class 7 claims. Due to the
     significant volume of claims filed to-date it is premature to estimate with
     any degree of accuracy the ultimate allowed amount of such claims for each
     class of claims under the Plan of Reorganization. Differences between
     amounts filed and our estimates are being investigated and will be resolved
     in connection with our claims resolution process. In this regard, it should
     be noted that the claims reconciliation process may result in material
     adjustments to current estimates of allowable claims.

              The amount of each quarterly distribution will depend on the
     amount of the claims allowed and the reserve established for disputed
     claims, in either instance as of the respective distribution date. The next
     scheduled distribution under the Plan of Reorganization is expected to
     commence on or about January 2, 2004. We have filed a notice with the Court
     to reduce the distribution reserve. If approved, approximately 3 million
     additional shares will be issued to those claimants who have already
     received shares for allowed claims.

2.   BASIS OF PRESENTATION

              These interim unaudited Condensed Consolidated Financial
     Statements have been prepared in accordance with the rules and regulations
     of the Securities and Exchange Commission ("SEC"). Accordingly, they do not
     include all of the information and footnotes required by accounting
     principles generally accepted in the United States of America for complete
     financial statements. In the opinion of management, all adjustments (which
     include normal recurring adjustments) considered necessary for a fair
     presentation have been included. All significant inter-company accounts and
     transactions have been eliminated. Operating results for the interim period
     are not necessarily indicative of the results that may be expected for the
     full year. Readers of these statements should refer to the audited
     consolidated financial statements and notes thereto which are included in
     our Current Report on Form 8-K, filed with the SEC on August 8, 2003, for
     the 13-weeks ended April 30, 2003 and the Predecessor Company's Annual
     Report on Form 10-K for the year

                                        9
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     ended January 29, 2003. Certain reclassifications of prior period financial
     statements have been made to conform to the current interim period
     presentation.

              SOP 90-7 requires that the financial statements for the period
     following the Chapter 11 filing through the Confirmation Date distinguish
     transactions and events that are directly associated with the
     reorganization from the ongoing operations of the business. Accordingly,
     revenues, expenses, realized gains and losses and provisions for losses
     directly associated with the reorganization and restructuring of the
     business are reported separately as Reorganization items, net in the
     Predecessor Company's unaudited Condensed Consolidated Statement of
     Operations. The unaudited Condensed Consolidated Balance Sheet for periods
     prior to the emergence date distinguishes pre-petition liabilities subject
     to compromise from both those pre-petition liabilities that are not subject
     to compromise and from post-petition liabilities. Liabilities subject to
     compromise are reported at the amounts expected to be allowed, even if they
     may be settled for lesser or greater amounts.

              In accordance with SOP 90-7, we adopted Fresh-Start accounting as
     of the Confirmation Date. However, in light of the proximity of such date
     to our April 30, 2003 quarter-end, for accounting purposes the effects of
     Fresh-Start accounting and the Plan of Reorganization, including the
     cancellation of the existing common stock and the issuance of the new
     common stock were reported "as if" they occurred on April 30, 2003.
     References to the Successor Company in the unaudited Condensed Consolidated
     Financial Statements and the Notes thereto refer to the Company on and
     after April 30, 2003 after giving effect to the provisions of the Plan of
     Reorganization and the application of Fresh-Start accounting.

3.   FRESH-START ACCOUNTING

     Fresh-Start Adjustments

              In accordance with Fresh-Start accounting, all assets and
     liabilities were recorded at their respective fair market values. Such fair
     values represented our best estimates based on independent appraisals and
     valuations. Immaterial differences between estimated pre-petition
     liabilities assumed by Kmart and the final settlement amounts are
     recognized as they occur.

              To facilitate the calculation of the enterprise value of the
     Successor Company, we developed a set of financial projections. Based on
     these financial projections and with the assistance of a financial advisor,
     the enterprise value was determined by the Company, using various valuation
     methods, including (i) a comparison of the Company and its projected
     performance to the market values of comparable companies, (ii) a review and
     analysis of several recent transactions of companies in similar industries
     to the Company, and (iii) a calculation of the present value of the future
     cash flows under the projections. The estimated enterprise value is highly
     dependent upon achieving the future financial results set forth in the
     projections as well as the realization of certain other assumptions which
     are not guaranteed. The estimated enterprise value of Kmart was calculated
     to be approximately $2.3 billion to $3.0 billion. We selected the midpoint
     of the range, $2.6 billion, as the estimated enterprise value. In applying
     Fresh-Start accounting, adjustments to reflect the fair value of assets and
     liabilities, on a net basis, and the write-off of the Predecessor Company's
     equity accounts resulted in a charge of $5.6 billion. The restructuring of
     Kmart's capital structure and resulting discharge of pre-petition debt
     resulted in a gain of $5.6 billion. The charge for the revaluation of the
     assets and liabilities and the gain on the discharge of pre-petition debt
     are recorded in Reorganization items, net in the unaudited Condensed
     Consolidated Statement of Operations. In addition, the excess of fair value
     of net assets over reorganization value ("negative goodwill") of
     approximately $5.6 billion was allocated on a pro-rata basis reducing our
     non-current, non-financial instrument assets to $10 million as of April 30,
     2003.

              As part of the provisions of SOP 90-7, we were required to adopt
     on April 30, 2003 all accounting guidance that was going to be effective
     within a twelve-month period. See Note 21 - Recently Adopted Accounting
     Pronouncements for a discussion of the impact on our financial statements
     of the accounting guidance we were required to adopt.

     Changes to Significant Accounting Policies

              Fresh-Start accounting requires the selection of appropriate
     accounting policies for the Successor Company. The significant accounting
     policies disclosed in our Current Report on Form 8-K, filed with the SEC on
     August 8, 2003, for the 13-weeks ended April 30, 2003 will continue to be
     used by the Company except for the policy related to merchandise
     inventories. We elected to change the method of accounting for our
     merchandise inventories from the last-in, first-out ("LIFO") method to the
     first-in, first out ("FIFO") method. We believe that this change is
     preferable to

                                       10
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     provide a better matching of expenses and revenues given falling product
     costs that have resulted in the value of inventories under the LIFO method
     to be approximately equal to their replacement cost on a FIFO basis.

              The following table reflects the reorganization adjustments to
     Kmart's Consolidated Balance Sheet as of April 30, 2003:

<TABLE>
<CAPTION>
                                                      PREDECESSOR                                                  SUCCESSOR
                                                        COMPANY                                                     COMPANY
                                                    APRIL 30, 2003      ADJUSTMENTS       RECAPITALIZATION      APRIL 30, 2003
                                                    --------------      -----------       ----------------      --------------
<S>                                                 <C>                 <C>               <C>                   <C>
ASSETS

CURRENT ASSETS
  Cash and cash equivalents                           $    1,232        $         -         $          -          $     1,232
  Merchandise inventories                                  4,446                (15)  1                -                4,431
  Other current assets                                       528                168   1              195   2              891
                                                      ----------        -----------         ------------          -----------
    TOTAL CURRENT ASSETS                                   6,206                153                  195                6,554

  Property and equipment, net                              4,623             (4,613)  1                -                   10
  Other assets and deferred charges                          212               (154)  1               38   2               96
                                                      ----------        -----------         ------------          -----------

TOTAL ASSETS                                          $   11,041        $    (4,614)        $        233          $     6,660
                                                      ==========        ===========         ============          ===========

LIABILITIES AND SHAREHOLDERS'
  EQUITY (DEFICIT)

CURRENT LIABILITIES
  Long-term debt due within one year                  $        -        $         -         $          8   2      $         8
  Accounts payable                                         1,151                  -                    9   2            1,160
  Other current liabilities                                  915                117   1              563   2            1,595
                                                      ----------        -----------         ------------          -----------
    TOTAL CURRENT LIABILITIES                              2,066                117                  580                2,763

LONG-TERM LIABILITIES
  Long-term debt                                               -                  -                  108   2              108
  Capital lease obligations                                  415                  -                    -                  415
  Other long-term liabilities                                174                279   1            1,208   2            1,661
                                                      ----------        -----------         ------------          -----------
    TOTAL LONG-TERM LIABILITIES                              589                279                1,316                2,184

    TOTAL LIABILITIES NOT
      SUBJECT TO COMPROMOSE                                2,655                396                1,896                4,947

LIABILITIES SUBJECT TO COMPROMISE                          8,896                114   1           (9,010)  2                -

  Trust convertible securities                               387               (387)  1                -                    -
SHAREHOLDERS' EQUITY (DEFICIT)
  Accumulated other comprehensive income                    (907)               907   1                -                    -
  Common stock                                               537               (537)  1                1   3                1
  Other equity                                              (527)            (5,107)  1            7,346   4            1,712
                                                      ----------        -----------         ------------          -----------
    TOTAL SHAREHOLDERS' EQUITY (DEFICIT)                    (897)            (4,737)               7,347                1,713
TOTAL LIABILITIES AND
  SHAREHOLDERS' EQUITY (DEFICIT)                      $   11,041        $    (4,614)        $        233          $     6,660
                                                      ==========        ===========         ============          ===========
</TABLE>

     1.   To adjust assets and liabilities to fair market value ("FMV"), and
          reflect the write-off of the Predecessor Company's equity and the
          application of negative goodwill to long-lived assets.

     2.   To record assumption or discharge of Liabilities subject to compromise
          and cash received from the Plan Investors.

     3.   To record par value of new common stock of the Successor Company.

     4.   To record gain on discharge of liabilities subject to compromise and
          additional paid-in-capital of new common stock of the Successor
          Company.

                                       11
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

4.   DISCONTINUED OPERATIONS

              During the first quarter of fiscal 2003 and the second quarter of
     fiscal 2002, the Predecessor Company closed 316 and 283 stores,
     respectively. SFAS No. 144, "Accounting for the Impairment or Disposal of
     Long-Lived Assets," ("SFAS No. 144") requires closed stores to be
     classified as discontinued operations when the operations and cash flows of
     the stores have been (or will be) eliminated from ongoing operations and
     the company no longer has any significant continuing involvement in the
     operations associated with the stores after closure. The Predecessor
     Company determined that it met the second criteria, as upon closure of the
     stores, operations ceased and there was no continuing involvement. To
     determine if cash flows had been or would be eliminated from ongoing
     operations, a number of qualitative and quantitative factors were
     evaluated, including: proximity to a remaining open store, physical
     location within a metropolitan or non-metropolitan statistical area and
     transferability of sales between open and closed trade areas. Based on
     these criteria, a small number of stores closed in fiscal 2002 met the
     criteria for discontinued operations; however, in management's opinion they
     were not considered material to the consolidated results of operations and
     were not separately presented. Upon closure of the 316 stores in 2003,
     which included a substantial exit of the state of Texas, we re-evaluated
     the 283 stores that were closed in 2002 and the 316 stores closed in 2003
     to identify stores that should be accounted for as discontinued operations.
     This analysis resulted in a total of 121 stores identified as meeting the
     criteria for discontinued operations treatment for all periods presented in
     the unaudited Condensed Consolidated Statements of Operations. The table
     below sets forth the components of the net loss associated with the
     discontinued operations for the 13-weeks ended April 30, 2003 and October
     30, 2002 and the 39-weeks ended October 30, 2002.

<TABLE>
<CAPTION>
                                                                                   Predecessor Company
                                                                  -----------------------------------------------------
                                                                    13-Weeks           13-Weeks            39-Weeks
                                                                      Ended              Ended              Ended
                                                                  April 30, 2003    October 30, 2002   October 30, 2002
                                                                  --------------    ----------------   ----------------
<S>                                                               <C>               <C>                <C>
Sales                                                              $       232        $       270         $   1,064
Cost of sales, buying and occupancy                                        150                233             1,027
                                                                   -----------        -----------         ---------
Gross margin                                                                82                 37                37
Selling, general and administrative expenses                                43                 63               235
Restructuring, impairments and other charges                                 5                  -                 1
Reorganization items, net                                                   44                 (4)               19
                                                                   -----------        -----------         ---------
Discontinued operations from 2002 and 2003 store closings                  (10)               (22)             (218)
Previous discontinued operations                                             -                  1                37
                                                                   -----------        -----------         ---------
Discontinued operations                                            $       (10)       $       (21)        $    (181)
                                                                   ===========        ===========         =========
</TABLE>

              In connection with its bankruptcy filing, the Predecessor Company
     recorded primarily non-cash credits in the 13-weeks and 39-weeks ended
     October 30, 2002 of $1 million and $37 million, respectively. The credits
     related to the reduction of existing lease obligations of
     previously-reported discontinued operations. The 39-weeks ended October 30,
     2002 also included a credit of $7 million related to the recovery of claims
     through the bankruptcy of Hechinger Company.

5.   TREASURY STOCK

              On August 28, 2003, the Company's Board of Directors approved the
     repurchase of up to $10 million of the Company's outstanding stock for the
     purpose of providing restricted stock grants to certain employees. During
     the third quarter of fiscal 2003, we repurchased a total of 90,500 shares
     (weighted-average price of $29.91 per share) of common stock at a cost of
     approximately $3 million. We subsequently issued 68,436 restricted shares
     to employees; see Note 6 - Stock Based Compensation.

              In addition, on October 2, 2003 we repurchased a total of 26,889
     shares (at a price of $25.68 per share) of common stock for the purpose of
     paying withholding taxes for certain former associates that were part of
     the Class 5 claimholders distribution, see Note 1 - Emergence from Chapter
     11 Bankruptcy Protection. There are 48,953 shares in treasury as of October
     29, 2003.

6.   STOCK-BASED COMPENSATION

              In December 2002, the Financial Accounting Standards Board
     ("FASB") issued SFAS No. 148, "Accounting for Stock-Based Compensation -
     Transition and Disclosure, an Amendment of FASB Statement No. 123" ("SFAS
     No. 148"), which provides three alternative methods of transition to the
     fair value method of accounting for stock options. SFAS No. 148 also amends
     the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based
     Compensation."

                                       12
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

              In the second quarter of fiscal 2003, the Company voluntarily
     elected to account for stock-based compensation using the fair value method
     on a prospective basis as permitted by SFAS 148. During the second quarter
     of fiscal 2003, approximately 1.7 million options to purchase shares of
     common stock of the Successor Company were granted, of which 151,738
     options were cancelled during the third quarter of fiscal 2003. The impact
     of the election was not material to the results of operations for any
     period presented.

              The Predecessor Company accounted for stock options using the
     intrinsic value method in accordance with Accounting Principles Board
     Opinion No. 25, "Accounting for Stock Issued to Employees (APB No. 25)" and
     related interpretations, which did not require the recognition of expense
     for the fair value of stock-based compensation. All outstanding stock
     options of the Predecessor Company were cancelled in accordance with the
     Plan of Reorganization.

              In accordance with the disclosure requirements of SFAS No. 148,
     the pro forma effects of recognizing compensation income (expense) on net
     loss and loss per share, had the Predecessor Company applied the fair value
     method to stock options granted by the Predecessor Company, is as follows:

<TABLE>
<CAPTION>
                                                                                  Predecessor Company
                                                                  -----------------------------------------------------
                                                                    13-Weeks            13-Weeks          39-Weeks
                                                                     Ended               Ended              Ended
                                                                  April 30, 2003   October 30, 2002    October 30, 2002
                                                                  --------------   ----------------    ----------------
<S>                                                               <C>              <C>                 <C>
Net loss, as reported                                              $      (862)       $      (383)        $  (2,118)

Deduct: Total stock-based employee
    compensation income (expense) determined
    under the fair value-based method for all
    awards, net of related tax effects                                      38                 (1)              (12)
                                                                   -----------        -----------         ---------
Pro forma net loss                                                 $      (824)       $      (384)        $  (2,130)
                                                                   ===========        ===========         =========
Basic/diluted loss per share:
As reported                                                        $     (1.65)       $     (0.76)        $   (4.21)
                                                                   ===========        ===========         =========
Pro forma                                                          $     (1.58)       $     (0.76)        $   (4.24)
                                                                   ===========        ===========         =========
</TABLE>

              Pro forma stock-based employee compensation income of $38 million
     for the 13-weeks ended April 30, 2003 is due to the reversal of expense for
     options that were not vested upon cancellation of the outstanding stock
     awards of the Predecessor Company.

              In September of fiscal 2003 we granted 68,436 shares of restricted
     stock to certain members of management at a grant price of $29.07. The
     shares were issued from Treasury stock, at no cost to the individuals. We
     accounted for these restricted stock grants as fixed awards, and recorded
     deferred employee compensation (a component of capital in excess of par
     value) of approximately $2 million as of the grant date. The $2 million of
     deferred employee compensation is being amortized to compensation expense
     on a straight-line basis over the vesting period of three years.

7.   DEBT RESTRUCTURING

     Credit Facility

              On May 6, 2003, our $2 billion credit agreement (the "Credit
     Facility"), which was an integral part of the Plan of Reorganization,
     syndicated by General Electric Capital Corporation, Fleet Retail Finance
     Inc. and Bank of America, N.A., became effective. Debt issuance costs
     associated with the Credit Facility totaled $58 million of which $46
     million was paid during the 39-weeks ended October 29, 2003 and all of
     which will be amortized through May 2006. The Credit Facility is a
     revolving credit facility under which Kmart Corporation is the borrower and
     contains an $800 million letter of credit sub-limit. Availability under the
     Credit Facility is also subject to an inventory borrowing base formula. The
     Credit Facility is guaranteed by the Successor Company, Kmart Management
     Corporation, Kmart Services Corporation (a subsidiary of Kmart Management
     Corporation) and Kmart's direct and indirect domestic subsidiaries. The
     Credit Facility is secured primarily by first liens on inventory, the
     proceeds thereof and certain related assets of Kmart and the guarantors.
     Borrowings under the Credit Facility currently bear interest at either (i)
     the Prime rate plus 2.5% per annum

                                       13
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     or (ii) the LIBOR rate plus 3.5% per annum, at our discretion, which
     interest rate margin may be reduced after the first anniversary of the
     effective date of the Credit Facility if Kmart meets certain earnings
     before interest, taxes, depreciation, amortization and other charges
     ("EBITDA") levels. In addition, we are required to pay a fee based on the
     unutilized commitment under the Credit Facility equal to 0.75% per annum.
     Effective December 1, the Company voluntarily reduced the size of the
     facility to $1.5 billion to reduce the overall cost of the facility.

              The Credit Facility financial covenants include a requirement that
     Kmart maintain certain specified excess availability minimums, and failure
     to do so triggers additional required minimum levels of EBITDA. The Credit
     Facility also contains other customary covenants, including certain
     reporting requirements and covenants that restrict our ability to incur or
     create liens, indebtedness and guarantees, make investments, pay dividends
     or make other equity distributions, sell or dispose of stock or assets,
     change the nature of our business and enter into affiliate transactions,
     mergers and consolidations. Failure to satisfy these covenants would (in
     some cases, after the receipt of notice and/or the expiration of a grace
     period) result in an event of default that could result in our inability to
     access the funds necessary to maintain our operations.

     Predecessor Company Debt

              Borrowings of the Predecessor Company were available through the
     Court-approved $2 billion debtor-in-possession financing facility ("DIP
     Credit Facility") for the payment of permitted pre-petition claims, working
     capital needs, letters of credit and other general corporate purposes. Debt
     issuance costs of $71 million were amortized through April 30, 2003. The
     DIP Credit Facility was a revolving credit facility under which the
     Predecessor Company was the borrower and the rest of the Debtors were
     guarantors, and was collateralized by first liens on substantially all of
     the Debtors assets (subject to valid and unavoidable pre-petition liens and
     certain other permitted liens). Borrowings under the DIP Credit Facility
     were denominated in U.S. dollars bearing interest at the Prime Rate plus
     2.5% per annum, or at the Predecessor Company's option, in Eurodollars
     bearing interest at the LIBOR rate plus 3.5% per annum. On May 6, 2003, in
     connection with the Debtors' emergence from Chapter 11, the DIP Credit
     Facility was terminated.

              Due to its filing for Chapter 11, the Predecessor Company was in
     default on all of its debt agreements entered into prior to January 22,
     2002. While operating under Chapter 11, the Predecessor Company was
     prohibited under the Bankruptcy Code from paying interest on unsecured
     pre-petition debts.

              Included in Interest expense, net in the unaudited Condensed
     Consolidated Statement of Operations is interest income of $2 million, $1
     million, $1 million, $4 million and $3 million for the 13 weeks ended
     October 29, 2003, April 30, 2003 and October 30, 2002, the 26 weeks ended
     October 29, 2003 and the 39 weeks ended October 30, 2002, respectively. On
     the Petition Date, the Predecessor Company stopped accruing interest on all
     unsecured pre-petition debt until it emerged from bankruptcy in accordance
     with SOP 90-7. Contractual interest expense not accrued or recorded by the
     Predecessor Company on certain pre-petition debt totaled $67 million for
     the 13-weeks ended April 30, 2003 and October 30, 2002. Contractual
     interest expense not accrued or recorded on certain pre-petition debt
     totaled $204 million for the 39-weeks ended October 30, 2002.

8.   SPECIAL CHARGES

              Special charges are transactions which, in management's judgment,
     may make meaningful comparisons of operating results between reporting
     periods difficult. In determining what amounts constitute a special charge,
     management considers the nature, magnitude and frequency of their
     occurrence. During fiscal 2002, the Predecessor Company instituted certain
     restructuring actions to improve operations and executed significant
     inventory liquidations as a result of the stores closed under Chapter 11
     proceedings. Their effect on the 13-weeks ended April 30, 2003 and October
     30, 2002 and the 39-weeks ended October 30, 2002 are summarized below.

     Accelerated Depreciation

              During the fourth quarter of fiscal 2002, the Predecessor Company
     analyzed stores based on profitability, lease terms and geographic areas.
     As a result of the analysis, the Predecessor Company decided to close 316
     stores, and in light of the shortened recoverability period in the stores
     to be closed, recorded charges of $52 million during the 13-weeks ended
     April 30, 2003 for accelerated depreciation on unimpaired assets to be
     disposed of following the store closings. Of the charge, $47 million is
     included in Restructurings, impairments and other charges and $5 million is
     included in Discontinued operations in the unaudited Condensed Consolidated
     Statements of Operations.

              On September 6, 2001, the Predecessor Company announced it would
     restructure certain aspects of the supply chain operations. Depreciation
     was accelerated on certain existing supply chain assets to reflect the
     revised remaining

                                       14
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     useful life. The Predecessor Company recorded a charge of $9 million for
     accelerated depreciation in the 39-weeks ended October 30, 2002 of which $7
     million and $2 million was included in Cost of sales, buying and occupancy
     and Selling, General and Administrative ("SG&A") expenses, respectively, in
     the unaudited Condensed Consolidated Statements of Operations.

              In the fourth quarter of fiscal 2001 the Predecessor Company
     recorded a non-cash charge for the impairment of long-lived assets in
     accordance with SFAS No. 144. Included in the charge was the write-down to
     fair value of long-lived assets at 283 stores for which the Predecessor
     Company received Court approval to close. Depreciation on the remaining
     asset values was accelerated to reflect the revised useful lives and the
     assets were fully-depreciated by the end of the second quarter of fiscal
     2002. The Predecessor Company recorded charges of $0 and $18 million for
     the 13-weeks and 39-weeks ended October 30, 2002, respectively, related to
     the accelerated depreciation of these assets. The charges are included in
     Cost of sales, buying and occupancy in the unaudited Condensed Consolidated
     Statements of Operations.

     Corporate Cost Reduction Initiatives

              During the fourth quarter of fiscal 2002, the Predecessor Company
     announced its intention to eliminate in the first quarter of fiscal 2003
     approximately 500 corporate support positions. As a result of the expected
     job eliminations, the Predecessor Company recorded a charge of $36 million
     during the fourth quarter of fiscal 2002. For the 13-weeks ended April 30,
     2003 the Predecessor Company recorded a credit of $10 million as a result
     of a change in the estimated expense. This credit is included in
     Restructurings, impairments and other charges in the accompanying unaudited
     Condensed Consolidated Statements of Operations.

              As a result of the closing of 283 stores during the second quarter
     of fiscal 2002, the Predecessor Company eliminated approximately 400
     positions at corporate headquarters and approximately 50 national positions
     that provided corporate support. As a result of the job eliminations the
     Predecessor Company recorded a charge of $15 million during the second
     quarter of fiscal 2002. This charge is included in Restructuring,
     impairment and other charges for the 39-weeks ended October 30, 2002, in
     the accompanying unaudited Condensed Consolidated Statements of Operations.

     Markdowns for Inventory Liquidation

              For the 39-weeks ended October 30, 2002, the Predecessor Company
     recorded charges of $785 million to write-down inventory liquidated at the
     283 closing stores to net realizable value. Of the charge, $652 million is
     included in Cost of sales, buying and occupancy for the period and $133
     million is included in Discontinued operations in the accompanying
     unaudited Condensed Consolidated Statements of Operations.

              Of the $785 million charge, $348 million relates to the write-down
     of inventory to estimated selling value in connection with liquidation
     sales in the 283 stores for which the Predecessor Company received Court
     approval to close on March 20, 2002. The liquidation sales and store
     closings were completed on June 2, 2002. During the liquidation sales, the
     actual markdowns required to liquidate the inventory were lower than
     expected. As a result, in the second quarter, the Predecessor Company
     recorded a credit of $36 million to adjust the original estimate. In
     addition, a charge of $320 million was recorded related to the acceleration
     of markdowns on approximately 107,000 stock keeping units (SKUs) of
     inventory items that were transferred from the remaining open stores to the
     283 closing stores and included in the liquidation sales. The SKUs were no
     longer carried as part of the product assortment in the remaining open
     stores and were reduced to estimated selling value. The liquidation of
     these SKUs required higher markdowns than anticipated; accordingly, an
     adjustment of $54 million was recorded in the second quarter of 2002. The
     remaining $117 million of the charge related to liquidation fees and
     expenses associated with the disposition of inventory through the
     liquidation sales at the 283 closing stores, of which $9 million was
     recorded in the second quarter.

                                       15
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

            The following table summarizes the components of the charge for
     markdowns for inventory liquidation during the 39-weeks ended October 30,
     2002:

<TABLE>
<CAPTION>
                                                                                          Predecessor Company
                                                                                   39-weeks ended October 30, 2002
                                                                   --------------------------------------------------------------
                                                                                                        Accelerated
                                                                                                         Markdown of
                                                                    Write-down      Liquidator Fees     Discontinued
                                                                   of Inventory      and Expenses           SKUs          Total
                                                                   ------------     ---------------     -------------   ---------
<S>                                                                <C>              <C>                 <C>             <C>
First Quarter                                                      $       384        $       108         $     266     $     758

Second Quarter:
  Adjustments for actual selling values                                    (36)                 -                54            18
  Additional fees and expenses                                               -                  9                 -             9
                                                                   -----------        -----------         ---------     ---------
Total                                                              $       348        $       117         $     320     $     785
                                                                   ===========        ===========         =========     =========
</TABLE>

              As part of Fresh-Start accounting, reserves established in
     connection with certain restructurings were discharged as of April 30, 2003
     in accordance with the Plan of Reorganization. See Note 1 - Emergence from
     Chapter 11 Bankruptcy Protection for a detailed discussion of the discharge
     of Liabilities subject to compromise under the Plan of Reorganization.
     Restructuring reserves related to the 2002 employee severance program of
     $36 million were assumed by the Successor Company. Payments made against
     this reserve were $26 million during the second and third quarters of
     fiscal 2003. In addition, we recorded non-cash reductions of $2 million to
     the reserve during the third quarter of fiscal 2003.

     Restructuring of BlueLight.com

              In the third quarter of fiscal 2002, the Predecessor Company
     reduced the reserves established for BlueLight.com contract terminations by
     $6 million based on revised estimates for the remaining obligations. The $6
     million credit is included in the line Restructuring, impairment and other
     charges in the unaudited Condensed Consolidated Statements of Operations.

9.   REORGANIZATION ITEMS, NET

              Reorganization items represent amounts the Predecessor Company
     incurred as a result of its Chapter 11 reorganization, and are presented
     separately in the unaudited Condensed Consolidated Statements of
     Operations.

              The following paragraphs provide additional information relating
     to costs that were recorded in the line Reorganization items, net in the
     unaudited Condensed Consolidated Statement of Operations for the 13-weeks
     ended April 30, 2003 and October 30, 2002, and the 39-weeks ended October
     30, 2002:

<TABLE>
<CAPTION>
                                                                                  Predecessor Company
                                                                  ----------------------------------------------------
                                                                    13-Weeks            13-Weeks          39-Weeks
                                                                      Ended              Ended             Ended
                                                                  April 30, 2003    October 30, 2002  October 30, 2002
                                                                  --------------    ----------------  ----------------
<S>                                                               <C>               <C>               <C>
Gain on extinguishment of debt                                     $    (5,642)            $    -         $       -
Revaluation of assets and liabilities                                    5,642                  -                 -
Fleming settlement                                                         385                  -                 -
Estimated claims for rejected executory contracts                          200                  -                 -
2003 store closings                                                        158                  -                 -
2002 store closings                                                          -                  4               197
Other                                                                       26                  -                62
                                                                   -----------        -----------         ---------
Reorganization items, net                                          $       769        $         4         $     259
                                                                   ===========        ===========         =========
</TABLE>

                                       16
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     Gain on extinguishment of debt/Revaluation of assets and liabilities

              See Note 3 - Fresh-Start Accounting for a discussion on the
     extinguishment of debt and the revaluation of assets and liabilities.

     Fleming settlement

              On February 3, 2003, the Predecessor Company announced the
     termination of the supply relationship with Fleming Companies, Inc.
     ("Fleming") by means of a rejection of the 2001 contract through the
     Debtor's Chapter 11 reorganization. As part of the bankruptcy proceedings,
     Fleming filed a claim of $1.5 billion on March 11, 2003. The Predecessor
     Company and Fleming came to an agreement on a settlement of Fleming's
     claims, and on March 27, 2003, the Court approved the settlement of all
     claims asserted by Fleming. Under the settlement, the Predecessor Company
     paid Fleming $15 million of Fleming's net post-petition administrative
     claim, which exceeded $30 million. Additionally, Fleming's general
     unsecured claim was reduced from approximately $1.5 billion to $385
     million, which was recorded in the first quarter of fiscal 2003.

     2003 store closings

              On January 28, 2003, the Court approved the closure of 326 stores
     located in 40 states, which number was later reduced to 316. Stores were
     selected by evaluating the market and financial performance of every store
     and the terms of every lease. Several factors were considered in the store
     closing analysis, including historical and projected operating results; the
     anticipated impact of current and future competition; future lease
     liability and real estate value; store age, size, and capital spending
     requirements; the expected impact of store closings on Kmart's competitive
     position; the estimated potential savings from exiting markets and regions;
     the potential impact of store closings on purchasing power and allowances;
     and the potential impact of store closings on market coverage. Shortly
     after receiving Court approval, the Predecessor Company commenced store
     closing sales which were completed by April 13, 2003. In accordance with
     SFAS No. 144, 66 of the 316 closed stores were considered discontinued
     operations (see Note 4 - Discontinued Operations). As a result of the
     decision to close the 316 stores, the Predecessor Company determined that
     $395 million was the estimated allowed claim amount for lease terminations
     and other costs. During the first quarter of fiscal 2003, the Predecessor
     Company reclassified $181 million of capital lease obligations to the
     closed store reserve and recorded a charge of $214 million for lease
     terminations and other costs, of which $56 million is included in
     Discontinued operations and the remaining $158 million is included in
     Reorganization items, net in the unaudited Condensed Consolidated
     Statements of Operations. The liability for estimated allowed claims was
     recorded in accordance with SFAS No. 146, "Accounting for Costs Associated
     with Exit or Disposal Activities." On April 30, 2003, upon adoption of
     Fresh-Start accounting, this liability was discharged in accordance with
     the Plan of Reorganization; see Note 1 - Emergence from Chapter 11
     Bankruptcy Protection.

     2002 store closings

              On March 20, 2002, the Court approved the closure of 283 stores.
     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.
     In accordance with SFAS No. 144, 55 of the 283 closed stores were
     considered discontinued operations (see Note 4 - Discontinued Operations).
     As a result of the decision to close the 283 stores, the Predecessor
     Company determined that $372 million was the estimated allowed claim amount
     for lease terminations and other costs. During the first quarter of fiscal
     2002 the Predecessor Company reclassified $144 million of capital lease
     obligations to the closed store reserve and recorded a charge of $228
     million for lease terminations and other costs, of which $25 million is
     included in Discontinued operations and the remaining $203 million is
     included in Reorganization items, net in the unaudited Condensed
     Consolidated Statements of Operations. During the second and third quarters
     fiscal 2002, the Predecessor Company recorded a credit of $10 million and a
     charge of $4 million, respectively, to adjust the reserve for estimated
     allowable claims. The closed store reserve is included in the line
     Liabilities subject to compromise in the unaudited Condensed Consolidated
     Balance Sheet as of January 29, 2003. The liability for estimated allowed
     claims was recorded in accordance with Emerging Issues Task Force 94-3,
     "Liability Recognition for Certain Employee Termination Benefits and Other
     Costs to Exit an Activity (including Certain Costs Incurred in a
     Restructuring)." On April 30, 2003, upon adoption of Fresh-Start
     accounting, this liability was discharged in accordance with the Plan of
     Reorganization; see Note 1 - Emergence from Chapter 11 Bankruptcy
     Protection.

              As a result of both store closing actions, the existing store base
     was reduced from 2,114 stores prior to the announcement of the 2002 store
     closings to 1,513 upon completion of the 2003 store closings. As of October
     29, 2003, Kmart's existing store base was 1,512 stores.

                                       17
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     Estimated claims for rejected executory contracts

              For the 13-weeks ended April 30, 2003, the Predecessor Company
     recorded expense of $200 million for estimated allowable claims for
     rejected executory contracts, primarily equipment leases and service
     contracts. The estimate was based on a review of each class of contracts.
     Estimates of claims may be different from actual amounts alleged to be
     owing and filed by our creditors. Differences between amounts filed and our
     estimate will be investigated and resolved in connection with our claims
     resolution process. In this regard, it should be noted that the claims
     reconciliation process may result in material adjustments to current
     estimates of allowable claims. On April 30, 2003, upon adoption of
     Fresh-Start accounting, these liabilities were discharged in accordance
     with the Plan of Reorganization; see Note 1 - Emergence from Chapter 11
     Bankruptcy Protection.

     Other reorganization items

              For the 13-weeks ended April 30, 2003, the Predecessor Company
     recorded professional fees of $43 million, employee costs of $66 million
     relating to the Key Executive Retention Plan ("KERP"), a gain of $17
     million for the sale of pharmacy lists, income of $65 million for lease
     auction proceeds related to the 2003 and 2002 closed stores, a gain of $15
     million for the settlement of pre-petition liabilities and net expenses of
     $14 million for other miscellaneous reorganization items. For the 13-weeks
     ended October 30, 2002, the Predecessor Company recorded professional fees
     of $14 million, employee costs of $20 million, a gain of $22 million for
     the settlement of pre-petition liabilities and net income of $12 million
     for other miscellaneous reorganization items. For the 39-weeks ended
     October 30, 2002, the Predecessor Company recorded professional fees of $81
     million, employee costs of $83 million, a gain of $15 million for the sale
     of pharmacy lists, a gain of $56 million for the settlement of pre-petition
     liabilities and net income of $31 million for other miscellaneous
     reorganization items.

10.  TRADE VENDORS LIEN PROGRAM

              On May 6, 2003, the post-emergence Trade Vendors' Lien Program
     became effective. Under this program, certain vendors who provide retail
     merchandise to us on credit after May 6, 2003, or who had provided
     merchandise to us on credit after the Petition Date and before May 6, 2003
     which was not paid for as of May 6, 2003, were granted mortgages on certain
     unencumbered owned and operated real properties (the "Trade Vendor Lien").
     The Trade Vendor Lien expires by its terms on May 6, 2005, and may be
     terminated, with proper notice, at the sole discretion of Kmart on or after
     May 6, 2004.

              In addition, under the Plan of Reorganization, any person or
     entity acquiring property under the Plan of Reorganization, and any
     creditor and/or equity security holder of the Debtors or the reorganized
     Kmart entities is deemed to have contractually subordinated any existing or
     future claim, right or interest they may have in and to any proceeds
     received from the disposition, release or liquidation of any of Kmart's and
     Kmart's subsidiaries' leasehold interests in any open and operating stores
     as of May 6, 2003 to the claims of the trade vendors participating in the
     Trade Vendors' Lien Program. The lenders under the Exit Financing Facility
     and certain other parties are not subordinated in this regard. As long as
     the Trade Vendors' Lien is still effective (i) we may not encumber, sell,
     lease, transfer or otherwise dispose of or take other action to impair the
     subordination granted under the program with respect to more than 20% of
     the fair market value of the leases subject to the program, and (ii) any
     loan or investment under a certain amount by ESL or Third Avenue is subject
     to the subordination set forth in the provision. This claims subordination
     terminates upon termination or expiration of the Trade Vendors' Lien.

11.  PROPERTY HELD FOR SALE

              Included in Other current assets in our unaudited Condensed
     Consolidated Balance Sheet for the period ended October 29, 2003, is $70
     million of property held for sale. During the first quarter of fiscal 2003,
     the Predecessor Company classified $160 million of property held for sale
     in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal
     of Long-Lived Assets." During the second and third quarters of fiscal 2003,
     we sold $90 million of these assets, for a gain of $2 million which is
     recorded in SG&A in our unaudited Condensed Consolidated Statements of
     Operations. Property held for sale consists primarily of closed store
     locations and undeveloped property that we are actively marketing and
     expect to sell within one year.

                                       18
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

12.  WORKERS' COMPENSATION

              In March 2002, the Court issued an order providing for the
     continuation of our existing surety bond coverage, which permits us to
     self-insure our workers' compensation programs in various states.
     Discussions have been ongoing with the issuers of pre-petition surety bonds
     regarding the further continuation of the bonds. To date, we have reached
     agreement with Liberty Mutual, historically our largest provider of surety
     bonds, on the terms and conditions of a 2 to 2-1/2 year continuation of
     their bonds. Our discussions with the remaining issuers of pre-petition
     surety bonds are continuing. If those discussions prove unsuccessful and
     the applicable surety bonds were to be cancelled, we could lose our
     self-insured status in the states covered by those surety bonds and be
     required to pursue alternative workers' compensation insurance programs in
     the affected states. These alternative programs include (i) retaining
     self-insurance privileges in certain states using alternative forms of
     security, (ii) purchasing insurance policies to cover our workers'
     compensation liabilities in certain states, and (iii) participating in
     state-assigned risk and/or state fund insurance programs. We do not expect
     that any such alternative programs would result in additional costs having
     a material adverse effect on our financial position or results of
     operations.

13.  INCOME TAXES

              The Predecessor Company recorded a full valuation allowance
     against net deferred tax assets in accordance with SFAS No. 109,
     "Accounting for Income Taxes,", as realization of such assets in future
     years is uncertain. Accordingly, no tax benefit was realized from the
     Predecessor Company's losses in the first quarter of fiscal 2003 or the
     39-weeks ended October 30, 2002. The Successor Company recorded tax
     benefits of $11 million and $15 million from our losses during the 13-weeks
     and 26-weeks ended October 29, 2003, respectively, based upon the estimated
     effective tax rate for the nine month period ending January 28, 2004
     (Successor period).

              Tax benefits recorded during the 13-weeks ended April 30, 2003 and
     39-weeks ended October 30, 2002 related primarily to an Internal Revenue
     Code provision allowing for the 10-year carryback of certain losses, and
     refunds resulting from the Job Creation and Worker Assistance Act of 2002.
     The benefit recognized in fiscal 2002 was partially offset by expense paid
     to foreign jurisdictions.

              During the third quarter of fiscal 2003, we reduced our reserves
     for Predecessor Company tax liabilities by $24 million, primarily due to
     favorable claims settlements. In accordance with SOP 90-7, subsequent to
     emergence from bankruptcy, any benefit realized from an adjustment to
     pre-confirmation income tax liabilities shall be recorded as an addition to
     paid-in-capital, not as income to the company. We recorded this adjustment
     to Capital in excess of par in our unaudited Condensed Consolidated Balance
     Sheet as of October 29, 2003.

14.  LOSS PER SHARE

              The Successor Company calculates loss per share in accordance with
     SFAS No. 128, "Earnings Per Share." Basic and diluted earnings per share
     information is presented in the unaudited Condensed Consolidated Statements
     of Operations. In all periods presented, net losses were incurred;
     therefore common stock equivalents were not used in the calculation of
     diluted earnings per share as they would have an anti-dilutive effect. For
     the 13-weeks and 26-weeks ended October 29, 2003, dilutive common stock
     equivalents include options to purchase approximately 8.2 million shares of
     the Successor Company's common stock at a price ranging from $10 to $20 per
     share, the potential conversion of up to 6.3 million shares related to the
     $60 million principal amount convertible notes issued to the Plan Investors
     and approximately 68 thousand shares of restricted stock.

              Periods prior to April 30, 2003 include common stock equivalents
     of the Predecessor Company. All outstanding stock options and trust
     convertible securities of the Predecessor Company were cancelled in
     accordance with the Plan of Reorganization. For the 13-weeks ended April
     30, 2003, common stock equivalents include options to purchase 43.3 million
     shares of common stock at prices ranging from $4.86 to $24.03 per share and
     potential conversion of certain trust preferred securities into 25.5
     million shares of common stock. For the 13-weeks and 39-weeks ended October
     30, 2002, common stock equivalents include options to purchase 50.5 million
     shares of common stock at prices ranging from $4.86 to $26.03 per share and
     potential conversion of certain trust convertible preferred securities into
     58.9 million shares of common stock.

15.  COMPREHENSIVE LOSS

              Comprehensive loss represents net loss, adjusted for the effect of
     other items that are recorded directly to shareholders' equity. For the
     13-weeks ended April 30, 2003, comprehensive loss included a minimum
     pension liability

                                       19
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     adjustment of $94 million which was subsequently eliminated through the
     application of Fresh-Start accounting. For the 39-weeks ended October 30,
     2002, the Predecessor Company recorded an adjustment to shareholders'
     equity in accordance with SFAS No. 115, "Accounting for Certain Investments
     in Debt and Equity Securities," of $2 million to reduce the value of its
     investment in certain available-for-sale equity securities to current
     market value. Comprehensive loss and net loss are equivalent for all other
     periods presented.

16.  RELATED PARTY TRANSACTIONS

              During the second and third quarters of fiscal 2003, the Company
     hired certain employees of ESL. William C. Crowley assumed the position of
     Senior Vice President, Finance at the Company to assist primarily with
     financial matters while continuing in his current role as President and
     Chief Operating Officer of ESL and as a Director of Kmart Holding
     Corporation. ESL's Vice President - Research, assumed the role of Vice
     President - Real Estate for the Company and a former independent contractor
     of ESL was hired to assist with our operational strategy and business
     development.

17.  INVENTORIES AND COST OF MERCHANDISE SOLD

              For the periods ended January 29, 2003 and October 30, 2002,
     inventory is accounted for using the LIFO method. Inventories valued on
     LIFO at January 29, 2003 and October 30, 2002 were $190 million and $269
     million lower, respectively than the amounts that would have been reported
     under the FIFO method. As previously discussed, we elected to change our
     method of accounting for merchandise inventories from LIFO to FIFO; see
     Note 3 - Fresh Start Accounting.

18.  INVESTMENTS IN AFFILIATED RETAIL COMPANIES

              Kmart footwear departments are operated under a license agreement
     with the Meldisco subsidiaries of Footstar, Inc. ("FTS"), substantially all
     of which are 49% owned by Kmart and 51% owned by FTS. We have been advised
     that FTS will be restating its financial statements for prior periods. As a
     result, we have not received final financial statements for fiscal 2002 or
     the first three quarters of fiscal 2003 for Meldisco at the time of our
     filing of this Quarterly Report on Form 10-Q. We received preliminary
     financial statements from FTS which we believe provided a reliable basis to
     estimate equity income as recognized in all periods presented in our
     unaudited Condensed Consolidated Statements of Operations. For the 13-weeks
     ended October 29, 2003, April 30, 2003 and October 30, 2002, the 26-weeks
     ended October 29, 2003, and the 39-weeks ended October 30, 2002 Meldisco
     had net sales of $201 million, $246 million, $261 million, $423 million and
     $859 million, respectively. Although there can be no assurance until
     Meldisco restates its financial statements, at this time, we do not expect
     the restatement to have a material effect on our equity income from
     Meldisco.

19.  LIABILITIES SUBJECT TO COMPROMISE

              Under Chapter 11 and in general, actions by creditors to collect
     indebtedness owed prior to the Petition Date were stayed and certain other
     pre-petition contractual obligations were not enforced against the Debtors.
     The Predecessor Company received approval from the Court to pay certain
     pre-petition liabilities including employee salaries and wages, benefits
     and other employee obligations. Except for secured debt and capital lease
     obligations, all pre-petition liabilities have been classified as
     Liabilities subject to compromise in the unaudited Condensed Consolidated
     Balance Sheets as of January 29, 2003 and October 30, 2002. On the
     Effective Date, substantially all of the pre-petition liabilities were
     cancelled. See Note 1 - Emergence from Chapter 11 Bankruptcy Protection for
     a discussion of the discharge of pre-petition liabilities.

              The following table summarizes the components of Liabilities
     subject to compromise in our unaudited Condensed Consolidated Balance
     Sheets as of January 29, 2003 and October 30, 2002:

                                       20
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

<TABLE>
<CAPTION>
                                                                         PREDECESSOR COMPANY
                                                                   ------------------------------
                                                                   JANUARY 29,        OCTOBER 30,
                                                                      2003               2002
                                                                   -----------        -----------
<S>                                                                <C>                <C>
Debt and notes payable                                             $     3,348        $     3,324
Accounts payable                                                         2,343              2,262
Pension Obligation                                                         741                180
Closed store reserves                                                      722                705
General liability and workers compensation                                 320                261
Taxes payable                                                              285                162
Other liabilities                                                          210                234
                                                                   -----------        -----------
  Total liabilities subject to compromise                          $     7,969        $     7,128
                                                                   -----------        -----------
</TABLE>

20.  OTHER COMMITMENTS AND CONTINGENCIES

     Contingent Liabilities

              The Predecessor Company had (i) guaranteed obligations for real
     property leases of certain Debtors and certain of its former subsidiaries,
     including, but not limited to, The Sports Authority, Inc., OfficeMax, Inc.
     and Borders Group, Inc., some of which leases were assigned pre-petition;
     (ii) contingent liabilities under real property leases assigned by the
     Predecessor Company pre-petition; and (iii) guaranteed indebtedness of
     other parties related to certain leased properties financed by industrial
     revenue bonds. To the extent not expressly assumed or reinstated under the
     Plan of Reorganization, these guarantees were discharged subject to
     pre-petition claims administration, and to the extent expressly assumed or
     reinstated, such guarantees are not considered to have a material adverse
     effect on the Successor Company's financial position or results of
     operations.

     Legal Proceedings

              Fair Labor Standards Litigation

              Kmart Corporation is a defendant in five putative class actions
     pending in California, all relating to the classification of assistant
     managers and various other employees as "exempt" employees under the
     federal Fair Labor Standards Act ("FLSA") and the California Labor Code,
     and its alleged failure to pay overtime wages as required by these laws.
     These wage-and-hour cases were all filed during 2001 and are currently
     pending in the United States District Court for the Eastern District of
     California (Henderson v. Kmart), and the Superior Courts of the State of
     California for the Counties of Alameda, Los Angeles and Riverside
     (Panossian v. Kmart, Wallace v. Kmart, Hancock v. Kmart, Pryor v. Kmart).
     Wallace v. Kmart, and a multi-plaintiff case, Gulley v. Kmart, have been
     dismissed. If these cases were determined adversely to Kmart, the resulting
     damages could 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 and enjoined as a result of the Predecessor
     Company's Chapter 11 proceedings and confirmation of the Plan of
     Reorganization and, based on our initial investigations, we believe that we
     have meritorious defenses to each of these claims. We presently do not
     expect to have any material financial exposure as a result of these cases.

              Kmart is a defendant in a putative class action pending in
     Oklahoma relating to the proper payment of overtime to hourly associates
     under the FLSA. The plaintiff claims he represents a class of all current
     and former employees who have been improperly denied overtime pay. This
     case was filed on March 4, 2003 and is currently pending in the U.S.
     District Court for the Northern District of Oklahoma. The parties have
     reached a tentative agreement for settlement.

              There is an increasing trend of high profile class action
     litigation, particularly in the retail industry, against employers of large
     numbers of people which allege violations of the FLSA. Other companies
     against which these cases have been filed have paid significant settlements
     and/or had significant judgments entered against them. Kmart has a large
     employee base; however, no FLSA class actions against Kmart have yet been
     certified. The actions described above are the only FLSA related matters
     that are currently pending against Kmart.

                                       21
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

              To the extent that any awards are granted to the respective
     plaintiffs, the Successor Company will be responsible only for the portion
     of any such award relating to a post-petition period. Any portion of any
     such award that is a monetary claim relating to a pre-petition period will
     be addressed in accordance with the Plan of Reorganization.

     Securities Action Litigation

              Since February 21, 2002, five separate purported class actions
     have been filed on behalf of purchasers of the Predecessor Company's common
     stock. The initial complaints were filed on behalf of purchasers of common
     stock between May 17, 2001 and January 22, 2002, inclusive, and named
     Charles C. Conaway, former Chief Executive Officer and Chairman of the
     Board of the Predecessor Company as the sole defendant. The complaints
     filed in the United States District Court for the Eastern District of
     Michigan, allege, among other things, that Mr. Conaway made material
     misstatements or omissions during the alleged class period that inflated
     the trading prices of the Predecessor Company's common stock and seek,
     among other things, damages under Section 10(b) of the Securities Exchange
     Act of 1934 and Rule 10b-5 promulgated thereunder. On October 15, 2002, an
     amended consolidated complaint was filed that enlarged the class of persons
     on whose behalf the action was brought to include purchasers of the
     Predecessor Company's securities between March 13, 2001 and May 15, 2002,
     and added former officers and PricewaterhouseCoopers LLP as defendants.
     Kmart is not a defendant in this litigation. On September 19, 2003, the
     complaints filed in the United States District Court for the Eastern
     District of Michigan were dismissed with prejudice.

              On July 31, 2002, attorneys for plaintiffs in the then pending
     class action lawsuits filed a class proof of claim in the Court (the "Class
     Proof of Claim") on behalf of the plaintiffs and all purchasers of the
     Predecessor Company's common stock between May 17, 2001 and January 22,
     2002, inclusive. The Class Proof of Claim, which is asserted against the
     Debtors, reserved the right to identify additional claimants or members of
     the class group in the future. In support of the Class Proof of Claim, the
     claimants rely on the above-referenced class actions filed against the
     parties. The claimants state that the grounds for liability are alleged
     damages for violations of federal securities laws, including the Securities
     Exchange Act of 1934, in connection with the purchase or acquisition of the
     Predecessor Company's common stock by the claimants during the class
     period. The Class Proof of Claim alleges that the Debtors are liable to the
     claimants for damages in a sum not presently determinable but believed to
     be not less than $700 million in the aggregate, plus interest, costs and
     allowed attorneys' fees.

              On April 26, 2002, a lawsuit was filed in the United States
     District Court for the Eastern District of Michigan ("District Court") on
     behalf of three limited partnerships (the "Softbank Funds") that purchased
     stock of Bluelight.com, a subsidiary of the Predecessor Company, naming
     Charles C. Conaway, as former CEO and Chairman of the Board of the
     Predecessor Company, as the sole defendant. The Predecessor Company was not
     a defendant in this litigation. The complaint alleges that Mr. Conaway
     breached his fiduciary duty, took certain actions and made certain
     misrepresentations that induced plaintiffs to exchange their Bluelight.com
     stock for the Predecessor Company's stock and prevented plaintiffs from
     realizing the market value of their stock. The complaint also alleges
     violations of Section 10(b) of the Securities Exchange Act of 1934, Rule
     10b-5 promulgated thereunder and Section 410 of the Michigan Uniform
     Securities Act. On January 16, 2003, the District Court dismissed the
     complaint. On February 14, 2003, a lawsuit was filed by the Softbank Funds
     against Mr. Conaway in the Circuit Court of Cook County, Illinois ("Circuit
     Court"). This lawsuit seeks $33 million from the defendant for alleged
     breach of fiduciary duty in connection with the failure of the Predecessor
     Company to cause the registration of the plaintiffs' shares of the
     Predecessor Company's common stock to become effective. This claim is
     essentially the same as count I of the District Court lawsuit that was
     dismissed on January 16, 2003. On June 26, 2003, the Circuit Court
     dismissed the complaint without prejudice. The Softbank Funds filed a First
     Amended Complaint seeking $33 million from Mr. Conaway and a motion for
     Voluntary Dismissal of the Complaint on July 25, 2003. On August 4, 2003,
     the Circuit Court dismissed the First Amended Complaint without prejudice.
     On July 31, 2003, the Softbank Funds filed a Petition for Discovery Before
     Suit to Identify Responsible Persons (the "Petition") against Conaway and
     other parties (but not Kmart) involved in the Bluelight.com transaction. In
     response to the Petition, the Circuit Court entered an order allowing
     limited discovery by the Softbank Funds pursuant to an agreement as to the
     scope of the pre-suit discovery agreed to by the parties served with the
     Petition.

              On May 2, 2002, the Softbank Funds filed proofs of claim with the
     Court in an aggregate amount equal to $56 million.

              The foregoing actions, which were brought by or on behalf of
     holders of common stock of the Predecessor Company and are referred to as
     "Securities Actions" under the Plan of Reorganization, were brought against
     persons other than the Company and, therefore, were not extinguished upon
     emergence from Chapter 11. Accordingly, to the extent that any awards are
     granted to the respective plaintiffs under these actions and a claim is
     allowed against the Predecessor Company under the proofs of claim
     previously filed with the Court, the allowed claim, to the extent not

                                       22
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

     covered by insurance, will be addressed and treated solely in accordance
     with the Plan of Reorganization. Except as noted above, the foregoing
     actions relate to periods occurring prior to the Petition Date. Any
     obligations which we may have with respect to a claim for indemnification
     by any of the defendants will be governed by the terms of the Plan of
     Reorganization.

              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 current and former employees and directors of
     Kmart Corporation alleging breach of fiduciary duty under the Employee
     Retirement Income Security Act for excessive investment in the Predecessor
     Company's stock; failure to provide complete and accurate information about
     the Predecessor Company's common stock; and failure to provide accurate
     information regarding the Predecessor Company's financial condition.
     Subsequently, amended complaints were filed that added additional current
     and former employees and directors of the Predecessor Company as
     defendants. Kmart is not a defendant in this litigation. On July 29, 2002,
     the plaintiffs filed proofs of claim with the Court in an aggregate amount
     equal to $180 million. On August 20, 2003, the defendants' motion to
     dismiss the purported class action in the United States District Court for
     the Eastern District of Michigan was denied.

     Other and Routine Actions

              Kmart is a defendant in a pre-petition putative nationwide class
     action pending in Colorado and a post-petition putative class action
     involving eight stores in New York relating to proper access to facilities
     for the disabled under the Americans with Disabilities Act ("ADA"). The
     Colorado class action is pending in the United States District Court in
     Denver, Colorado. The parties are awaiting the court's decision on class
     certification and responsibility for attorney fees. At this time, the
     likelihood of a material unfavorable outcome is not considered probable. We
     have experienced an increase in ADA public accommodation lawsuits filed
     against Kmart stores since emergence from bankruptcy.

              On November 7, 2003 Kmart filed suit in the United States District
     Court for the Eastern District of Michigan against Capital One Bank,
     Capital One, F.S.B., and Capital One Services, Inc. (collectively, "Capital
     One"). The complaint alleges breach of contract, breach of the covenant of
     good faith and fair dealing, unjust enrichment, promissory estoppel and
     tortious interference with business relationships and prospective economic
     advantage arising out of Capital One's alleged failure to market and
     support a co-branded credit card under an agreement the parties had with
     respect to a Kmart MasterCard. We are seeking monetary damages.

              On November 18, 2003, the Creditor Trust filed suit in the Oakland
     County (Michigan) Circuit Court against six former executives of the
     Predecessor Company (the "Officer Defendants") and PricewaterhouseCoopers
     LLP, the Predecessor Company's independent auditor. The allegations against
     the Officer Defendants include, among other things, violations of their
     fiduciary duty, their duty of good faith and loyalty, and their duty of
     care, and breach of contract related to the Officer Defendants' employment
     agreements with the Predecessor Company. Allegations against
     PricewaterhouseCoopers LLP include, among other things, breach of duty of
     care owed to the Predecessor Company and breach of contract arising out of
     consulting agreements between PricewaterhouseCoopers LLP and the
     Predecessor Company. Kmart is not a defendant in this litigation.

              In Capital Factors v. Kmart Corporation, the United States
     District Court for the Northern District of Illinois ruled that the Court
     did not have the authority to authorize the payment of pre-petition claims
     of certain trade vendors by the Predecessor Company. We appealed that
     ruling and the case is pending in the Seventh Circuit Court of Appeals. As
     a result of the District Court's ruling, the Company has been contacting
     vendors that received trade vendor payments and have requested that they
     return the money they received to the Company. The Company is currently in
     active settlement negotiations with numerous vendors pursuant to which the
     vendors would repay a percentage of the money they received in return for
     the Company's agreement not to seek a greater amount in the event the
     District Court's ruling is affirmed on appeal.

              We are a party to a substantial number of other claims, lawsuits
     and pending actions which are routine and incidental to our business. To
     the extent that any claim relates to a contract which was assumed by us
     when we emerged or relates to a time period occurring after the Petition
     Date, the Successor Company shall be responsible for any damages which may
     result. In addition, certain contracts allow for damage provisions or other
     repayments as a result of our termination of the contracts.

                                       23
<PAGE>

     NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
     (CONTINUED)

              We assess the likelihood of potential losses on an ongoing basis,
     and when they are considered probable and reasonably estimable, we record
     an estimate of the ultimate outcome. If there is no single point estimate
     of loss that is considered more likely than others, an amount representing
     the low end of the range of possible outcomes is recorded. Our balance
     sheet as of October 29, 2003 only reflects potential losses for which the
     Successor Company may have ultimate responsibility.

     Investigative Matters

              Prior to emergence, the Predecessor Company had been provided with
     copies of anonymous letters that were sent to the SEC, the Predecessor
     Company's independent auditors, directors, legal counsel and others,
     expressing concern with respect to various matters. The letters purported
     to be sent by certain of our employees. The letters were referred to the
     Predecessor Company's Audit Committee of the Board of Directors, which
     engaged outside counsel to review and investigate the matters set forth in
     the letters. We are cooperating with the SEC and the United States
     Attorney's office for the Eastern District of Michigan with respect to the
     investigations of these matters. The staff of the SEC has expressed
     concerns about and is investigating the manner in which we recorded vendor
     allowances before the change in accounting principles at the end of fiscal
     2001 and about the disclosure of certain events bearing on the Predecessor
     Company's liquidity in the fall of 2001. The U.S. Attorney for the Eastern
     District of Michigan also is undertaking an inquiry into these matters. A
     detailed discussion of the investigation and stewardship review, as well as
     the results of such investigation and review, is contained in the
     Disclosure Statement, which we filed as Exhibit 2.2 to our Current Report
     on Form 8-K dated March 7, 2003.

              After consultation with the statutory committees in the Chapter 11
     proceedings, the Predecessor Company determined that the Creditor Trust was
     the preferred available mechanism for resolving any legal claims that the
     Company might have based on information from these investigations. As part
     of the Plan of Reorganization, the trustee of the Creditor Trust is charged
     with responsibility for determining which claims to pursue and, thereafter,
     litigating such claims. As discussed above, the Creditor Trust has begun
     litigation against former officers based on information from these
     investigations.

21.  RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

              In November 2002, the EITF reached a final consensus on EITF Issue
     No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain
     Consideration Received from a Vendor" ("EITF Issue No. 02-16"). This issue
     addressed the income statement classification of cash consideration
     received from a vendor and the recognition criteria for performance-driven
     vendor rebates or refunds. This consensus, which was effective for all
     arrangements entered into after December 31, 2002, resulted in certain
     co-op advertising recoveries, which would previously have been recorded as
     a reduction of SG&A, being recorded as a reduction of Cost of sales, buying
     and occupancy. We adopted EITF Issue No. 02-16 at the beginning of fourth
     quarter 2002.

              In April 2003, the FASB issued SFAS No. 149, "Amendment of
     Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS No.
     149"). This statement amends and clarifies the accounting for derivative
     instruments and hedging activities under SFAS No. 133, "Accounting for
     Derivative Instruments and Hedging Activities." As required by SOP 90-7,
     the Company had to adopt, upon emergence from bankruptcy, all accounting
     guidance that would otherwise become effective within the next twelve
     months. We adopted SFAS No. 149 effective April 30, 2003. There was no
     impact to the Company upon the adoption of SFAS No. 149.

              In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
     Financial Instruments with Characteristics of both Liabilities and Equity"
     ("SFAS No. 150"). SFAS No. 150 requires certain financial instruments with
     characteristics of both liabilities and equity to be classified as
     liabilities. As required by SOP 90-7, the Company had to adopt, upon
     emergence from bankruptcy, all accounting guidance that would otherwise
     become effective within the next twelve months. We adopted SFAS No. 150
     effective April 30, 2003. We did not have any financial instruments that
     were classified as equity prior to the adoption of SFAS No. 150 that were
     required to be reclassified to liabilities.

22.  SUBSEQUENT EVENTS

               In December 2003, we notified employees of our decision to close
     one of our distribution centers, in order to improve productivity and
     efficiency through our logistics network. The closing of this distribution
     center will not have a material impact to the Company's financial condition
     or results of operations.

                                       24
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION

     CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

              This Form 10-Q, 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's 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 economic conditions,

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

     -    marketplace demand for the products of our key brand partners, as well
          as the engagement of appropriate new brand partners,

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

     -    competitive pressures and other third party actions, including
          pressures from pricing and other promotional activities of
          competitors, as well as new competitive store openings,

     -    the resolution of allowed claims for which we are obligated to pay
          cash under the Plan of Reorganization,

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

     -    our ability to properly monitor our inventory needs and remain
          in-stock,

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

     -    our ability to operate pursuant to our Credit Facility,

     -    outcome of negotiations on collective bargaining agreements and other
          labor issues with unions representing employees in our distribution
          centers,

     -    regulatory and legal developments,

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

     -    our ability to attract and retain customers,

     -    our ability to offset the negative effects that filing for
          reorganization under Chapter 11 had on our business, including the
          loss in customer traffic and the impairment of vendor relations,

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

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

     -    our ability to implement our long-term strategy and/or develop a
          market niche,

     -    our ability to fund and execute our business plan, and

     -    other factors affecting business beyond our control.

              Consequently, all of the forward-looking statements are qualified
     by these cautionary statements and there can be no assurance that the
     results or developments anticipated will be realized or that they will have
     the expected effects on our business or operations. The forward-looking
     statements contained herein or otherwise that we make or are made on our
     behalf speak only as of the date of this report, or if not contained
     herein, as of the date when made, and we do not undertake to update these
     risk factors or such forward-looking statements.

                                       25
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     OVERVIEW

              On the Effective Date, the Predecessor Company emerged from
     reorganization proceedings under Chapter 11 of the federal bankruptcy laws
     pursuant to the terms of the Debtors' Plan of Reorganization. The
     Predecessor Company became a wholly-owned subsidiary of Kmart Management
     Corporation, which is a newly-formed, wholly-owned subsidiary of a
     newly-created holding company, Kmart Holding Corporation. Kmart is the
     nation's third largest discount retailer and the sixth largest general
     merchandise retailer.

              On the Petition Date, the Predecessor Company and 37 of its U.S.
     subsidiaries filed voluntary petitions for reorganization under Chapter 11.
     On January 24, 2003, the Debtors filed a Plan of Reorganization and related
     Disclosure Statement and on February 25, 2003, filed the Plan of
     Reorganization and a related amended Disclosure Statement with the Court.
     The Plan of Reorganization received the formal endorsement of the statutory
     creditors committees and, as modified, was confirmed by the Court by order
     docketed on April 23, 2003.

              In accordance with SOP 90-7, we adopted Fresh-Start accounting as
     of the Confirmation Date. However, in light of the proximity of such date
     to our fiscal quarter end, we applied, for accounting purposes, the effects
     of Fresh-Start accounting and the Plan of Reorganization, including the
     cancellation of the existing common stock and the issuance of the new
     common stock, "as if" they occurred on April 30, 2003. Upon applying
     Fresh-Start accounting, a new reporting entity, the Successor Company, is
     deemed to be created and the recorded amounts of assets and liabilities are
     adjusted to reflect their estimated fair values (see Note 3 - Fresh-Start
     Accounting). The reported historical financial statements of the
     Predecessor Company for periods ended prior to May 1, 2003 generally are
     not comparable to those of the Successor Company. In this Quarterly Report
     on Form 10-Q, references to our results of operations for the 13-weeks
     ended April 30, 2003 and periods ended in fiscal 2002 refer to the
     Predecessor Company.

              At the time of emergence, the Plan Investors made a substantial
     investment in the Successor Company in furtherance of our financial and
     operational restructuring plan. The Plan Investors and their affiliates
     received approximately 32 million shares of Kmart Holding Corporation's new
     common stock in satisfaction of pre-petition claims they held, and we
     issued 14 million shares of new common stock to affiliates of ESL and to
     Third Avenue, in exchange for $127 million, net of commitment fees and Plan
     Investor expenses of $13 million. In addition, we issued a 9%, $60 million
     principal amount convertible note, due in May 2004, to the affiliates of
     ESL. The terms of the agreement allow the affiliates of ESL the right to
     extend the maturity of the convertible note for an additional two years
     with notice prior to March 2004. With respect to the 9% convertible note,
     the principal is convertible at any time, at the option of the holder, into
     new shares of common stock at a conversion price equal to $10 per share.
     ESL also was granted the option, exercisable in its own discretion prior to
     May 6, 2005, to purchase from the Successor Company approximately 6.6
     million new shares of common stock at a price of $13 per share. A portion
     of the option was assigned to Third Avenue. The investment was made
     pursuant to the Investment Agreement.

              ESL and its affiliates beneficially own over 50% of the common
     stock of the Successor Company, including shares received in exchange for
     pre-petition obligations, as well as shares obtainable upon exercise of
     options and conversion of the $60 million convertible note issued to
     affiliates of ESL. Each of the Plan Investors is represented on our Board
     of Directors.

              The Plan of Reorganization became effective on May 6, 2003, at
     which time all then-outstanding equity securities of the Predecessor
     Company, as well as substantially all of its pre-petition liabilities, were
     cancelled. Holders of the Predecessor Company's stock may receive up to
     2.5% of the recoveries under the Creditor Trust; see Note 1 - Emergence
     from Chapter 11 Bankruptcy Protection. New common stock of the Successor
     Company was issued in satisfaction of certain of those pre-petition
     liability claims; see Note 1 - Emergence from Chapter 11 Bankruptcy
     Protection. The new securities of the Successor Company issued on the
     Effective Date pursuant to the Plan of Reorganization and related
     transactions, consisted of 89,677,509 shares of new common stock and
     options to purchase 8,324,883 shares of new common stock. During the third
     quarter of fiscal 2003, 151,738 of the options to purchase shares of new
     common stock were cancelled. All of the shares of new common stock issued
     on May 6, 2003 were or will be distributed pursuant to the Plan of
     Reorganization in satisfaction of pre-petition claims, except for 14
     million shares of new common stock of the Successor Company issued to
     affiliates of ESL and Third Avenue for $127 million, net of commitment fees
     and Plan Investor expenses of $13 million. All such shares were issued
     without registration under the Securities Act of 1933 in reliance on the
     provisions of Section 1145 of the Bankruptcy Code and Section 4(2) of the
     Securities Act of 1933. In addition, as part of the Plan of Reorganization,
     the Creditor Trust was established for the

                                       26
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     benefit of the Predecessor Company's pre-petition creditors and equity
     holders, to pursue claims which arose from the Predecessor Company's prior
     accounting and stewardship investigations.

              The ability of Kmart to continue as a going concern is predicated
     upon numerous issues, including our ability to achieve the following:

        -    implementing our business plan and returning Kmart to
             profitability;

        -    taking appropriate action to offset the negative effects that the
             Chapter 11 filing had on our business, including the loss in
             customer traffic and the impairment of vendor relations;

        -    operating within the framework of our Credit Facility, including
             its limitations on capital expenditures, its financial covenants,
             our ability to generate cash flows from operations or seek other
             sources of financing and the availability of projected vendor
             terms; and

        -    attracting, motivating and/or retaining key executives and
             associates.

              These challenges are in addition to those operational and
     competitive challenges faced by Kmart in connection with our business as a
     discount retailer. Refer to the "Cautionary Statement Regarding
     Forward-Looking Information" above.

     CRITICAL ACCOUNTING POLICIES AND ESTIMATES

              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 information used
     to make these estimates as our business and the economic environment
     change. We have disclosed our critical accounting policies and estimates in
     our Current Report on Form 8-K, filed with the SEC on August 8, 2003. See
     Note 3 - Fresh Start Accounting for a discussion of our change from the
     LIFO method of inventory valuation to the FIFO method for our accounting
     for merchandise inventories.

     RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

              For a comprehensive discussion see Note 21 - Recently Adopted
     Accounting Pronouncements.

                                       27
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

              As previously discussed, due to the application of Fresh-Start
     accounting, the reported historical financial statements of the Predecessor
     Company for periods prior to May 1, 2003 generally are not comparable to
     those of the Successor Company. Therefore, the Results of Operations and
     the Liquidity and Financial Condition of the Successor Company have not
     been combined with those of the Predecessor Company in this Management's
     Discussion and Analysis.

     RESULTS OF OPERATIONS

              The following tables are presented solely to complement
     management's discussion and analysis of results of operations.

<TABLE>
<CAPTION>
                                                                           SUCCESSOR            PREDECESSOR
                                                                            COMPANY              COMPANY
                                                                        ----------------     ----------------
                                                                         13-WEEKS ENDED       13-WEEKS ENDED
                                                                        OCTOBER 29, 2003     OCTOBER 30, 2002
                                                                        ----------------     ----------------
<S>                                                                     <C>                  <C>
Sales                                                                   $          5,092     $          6,459
Cost of sales, buying and occupancy                                                3,925                5,353
                                                                        ----------------     ----------------
Gross margin                                                                       1,167                1,106
Selling, general and administrative expenses                                       1,178                1,448
Restructuring, impairment and other charges                                            -                   (6)
Equity income in unconsolidated subsidiaries                                          (1)                  (8)
                                                                        ----------------     ----------------
Loss before interest, reorganization items, income
   taxes and discontinued operations                                                 (10)                (328)
Interest expense, net                                                                 24                   37
Reorganization items, net                                                              -                    4
Benefit from income taxes                                                            (11)                  (7)
                                                                        ----------------     ----------------
Loss before discontinued operations                                                  (23)                (362)
Discontinued operations                                                                -                  (21)
                                                                        ----------------     ----------------
Net loss                                                                $            (23)    $           (383)
                                                                        ================     ================
</TABLE>

     13-WEEKS ENDED OCTOBER 29, 2003 COMPARED TO 13-WEEKS ENDED OCTOBER 30, 2002

              Same-store sales and total sales decreased 8.6% and 21.2%,
     respectively, for the 13-weeks ended October 29, 2003, as compared to the
     13-weeks ended October 30, 2002. Same-store sales include sales of all open
     stores that have been open for greater than 13 full months. The decrease in
     same-store sales is due primarily to the year-over-year comparison with
     several Company-wide promotional events that were taking place a year ago,
     and the reduction in the frequency of mid-week advertising circulars in the
     current year. The decrease in total sales is attributable to the decrease
     in same-store sales and the closure of 316 stores during the first quarter
     of fiscal 2003.

              Gross margin increased $61 million to $1,167 million for the
     13-weeks ended October 29, 2003, from $1,106 million for the 13-weeks ended
     October 30, 2002. Gross margin, as a percentage of sales, increased to
     22.9% for the 13-weeks ended October 29, 2003, from 17.1% for the
     comparable period in the prior year. The overall improvement in gross
     margin rate is primarily attributable to lower distribution costs as a
     result of the Company's in-sourcing of the distribution of pantry, food and
     consumable products, lower depreciation expense resulting from impairment
     charges taken while operating in bankruptcy and as a result of the
     write-off of long-lived assets in conjunction with the application of
     Fresh-Start accounting, lower shrinkage, supplier cost reductions and an
     improved sales mix as a result of a

                                       28
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     decrease in promotional activity as referenced in the sales summary above.
     Gross margin also benefited from the reclassification of co-op advertising
     recoveries recorded in Cost of sales, buying and occupancy in 2003, as
     required under generally accepted accounting principles. These improvements
     in the gross margin rate were partially offset by the impact of clearance
     markdowns.

              Selling, general and administrative expenses (SG&A), which
     includes advertising costs (net of co-op recoveries of $108 million in
     2002), decreased $270 million to $1,178 million for the 13-weeks ended
     October 29, 2003 from $1,448 million for the 13-weeks ended October 30,
     2002. The decrease in SG&A is primarily due to the reduction of our store
     base after closing 316 stores during the first quarter of fiscal 2003, as
     well as a decrease in payroll and other related expenses from corporate
     headquarters' cost reduction initiatives. In addition, lower depreciation
     expense resulting from impairment charges taken while operating in
     bankruptcy and the write-off of long-lived assets in conjunction with
     Fresh-Start accounting combined with a decrease in advertising expense
     contributed to the improvement in SG&A expenses. Collectively, these
     reductions were partially offset by the impact of the reclassification of
     co-op advertising recoveries, as discussed above. SG&A, as a percentage of
     sales, increased to 23.1% for the 13-weeks ended October 29, 2003, from
     22.4% for the comparable period in the prior year. As a percent of sales,
     the increase is due primarily to the reclassification of co-op recoveries
     as discussed above.

              Loss before interest, reorganization items, income taxes and
     discontinued operations for the 13-weeks ended October 29, 2003 was $10
     million, or (0.2%) of sales, as compared to a loss of $328 million, or
     (5.1%) of sales, for the 13-weeks ended October 30, 2002. The decrease in
     operating loss from the comparable period in the prior year was due to the
     decrease in SG&A and the increase in gross margin, as discussed above.

              Interest expense, net for the 13-weeks ended October 29, 2003 and
     October 30, 2002 was $24 million and $37 million, respectively. The
     decrease in net interest expense is primarily attributable to the decrease
     in our capital lease interest expense as a result of the store closings.
     While operating under Chapter 11, the Predecessor Company was prohibited
     from paying interest on unsecured pre-petition debt. Interest at the stated
     contractual amount on unsecured debt that was not charged to earnings for
     the 13-weeks ended October 30, 2002 was $104 million.

              Effective income tax rate was (32.4%) and (1.9%) for the 13-weeks
     ended October 29, 2003 and October 30, 2002, respectively. See Note 13 -
     Income Taxes.

              Significant changes were made to the April 30, 2003 unaudited
     Condensed Consolidated Balance Sheet to reflect the application of
     Fresh-Start accounting. See Note 3 - Fresh Start Accounting for further
     details of the adjustments.

<TABLE>
<CAPTION>
                                                                  SUCCESSOR
                                                                   COMPANY                        PREDECESSOR COMPANY
                                                               ----------------  -------------------------------------------------
                                                                26-WEEKS ENDED    26-WEEKS ENDED   13-WEEKS ENDED   13-WEEKS ENDED
                                                               OCTOBER 29, 2003  OCTOBER 30, 2002  APRIL 30, 2003    MAY 1, 2002
                                                               ----------------  ----------------  --------------   --------------
<S>                                                            <C>               <C>               <C>              <C>
Sales                                                            $    10,744        $   13,642       $    6,181        $   7,181
Cost of sales, buying and occupancy                                    8,344            11,265            4,762            6,519
                                                                 -----------        ----------       ----------        ---------

Gross margin                                                           2,400             2,377            1,419              662
Selling, general and administrative expenses                           2,401             2,983            1,421            1,670
Restructuring, impairment and other charges                                -                 8               37                -
Equity income in unconsolidated subsidiaries                              (3)              (22)              (7)              (5)
                                                                 -----------        ----------       ----------        ---------
Income (loss) before interest, reorganization items, income
   taxes and discontinued operations                                       2              (592)             (32)          (1,003)
Interest expense, net                                                     45                69               57               33
Reorganization items, net                                                  -                 8              769              251
Benefit from income taxes                                                (15)               (7)              (6)             (12)
                                                                 -----------        ----------       ----------        ---------
Loss before discontinued operations                                      (28)             (662)            (852)          (1,275)

Discontinued operations                                                    -               (14)             (10)            (167)
                                                                 -----------        ----------       ----------        ---------
Net loss                                                         $       (28)       $     (676)      $     (862)       $  (1,442)
                                                                 -----------        ----------       ----------        ---------
</TABLE>

                                       29
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     26-WEEKS ENDED OCTOBER 29, 2003 COMPARED TO 26-WEEKS ENDED OCTOBER 30, 2002

              Same-store sales and total sales decreased 6.9% and 21.2%,
     respectively, for the 26-weeks ended October 29, 2003 as compared to the
     26-weeks ended October 30, 2002. Same-store sales include sales of all open
     stores that have been open for greater than 13 full months. The decrease in
     same-store sales is due primarily to the year-over-year comparison with
     several Company-wide promotional events that were taking place a year ago.
     The decrease in total sales is attributable to the decrease in same-store
     sales and the closure of 316 stores during the first quarter of fiscal
     2003.

              Gross margin increased $23 million to $2,400 million, for the
     26-weeks ended October 29, 2003, from $2,377 million for the 26-weeks ended
     October 30, 2002. Gross margin, as a percentage of sales, increased to
     22.3% for the 26-weeks ended October 29, 2003, from 17.4% for the 26-weeks
     ended October 30, 2002. The overall improvement in gross margin rate is
     primarily attributable to lower distribution costs as a result of the
     Company's in-sourcing of the pantry, food and consumable products, lower
     depreciation expense resulting from impairment charges taken while
     operating in bankruptcy and as a result of the write-off of long-lived
     assets in conjunction with the application of Fresh-Start accounting, lower
     shrinkage, supplier cost reductions and an improved sales mix as a result
     of a decrease in promotional activity as referenced in the sales summary
     above. Gross margin also benefited from the reclassification of co-op
     advertising recoveries recorded in Cost of sales, buying and occupancy in
     2003, as required under generally accepted accounting principles. These
     improvements in the gross margin rate were partially offset by the impact
     of clearance markdowns.

              SG&A, which includes advertising costs (net of co-op recoveries of
     $199 million in fiscal 2002) decreased $582 million for the 26-weeks ended
     October 29, 2003 to $2,401 million, or 22.3% of sales, from $2,983 million,
     or 21.9% of sales, for the 26-weeks ended October 30, 2002. The decrease in
     SG&A is primarily due to the reduction of our store base after closing 316
     stores during the first quarter of fiscal 2003, as well as a decrease in
     payroll and other related expenses from corporate headquarters' cost
     reduction initiatives. In addition, lower depreciation expense resulting
     from impairment charges taken while operating in bankruptcy and the
     write-off of long-lived assets in conjunction with Fresh-Start accounting
     combined with a decrease in advertising expense contributed to the
     improvement in SG&A expenses. Collectively, these reductions were partially
     offset by the impact of the reclassification of co-op advertising
     recoveries, as discussed above.

              Income (Loss) before interest, reorganization items, income taxes
     and discontinued operations for the 26-weeks ended October 29, 2003 was $2
     million as compared to a loss of ($592) million for the same period of the
     prior year. The decrease in operating loss from the comparable period in
     the prior year was primarily due to the decrease in SG&A and the increase
     in gross margin, as discussed above.

              Interest expense, net for the 26-weeks ended October 29, 2003 and
     October 30, 2002 was $45 million and $69 million, respectively. The
     decrease in interest expense is primarily attributable to the decrease in
     our capital lease interest expense as a result of store closings.

              Effective income tax rate was (34.9%) and (1.0%) for the 26-weeks
     ended October 29, 2003 and October 30, 2002, respectively.

     13-WEEKS ENDED APRIL 30, 2003 COMPARED TO 13-WEEKS ENDED MAY 1, 2002

              Same-store sales and total sales decreased 3.2% and 13.9%,
     respectively, for the 13-weeks ended April 30, 2003 as compared to the
     13-weeks ended May 1, 2002. The decrease in same-store sales was primarily
     due to sluggish retail sales as a result of consumer concerns over the war
     with Iraq, general economic factors and unseasonable weather conditions.
     Same-store sales include sales of all open stores that have been open for
     greater than 13 full months. The decrease in total sales was attributable
     to the decrease in same-store sales and the closure of 283 stores during
     the second quarter of fiscal 2002.

              Gross margin increased $757 million to $1,419 million, for the
     13-weeks ended April 30, 2003, from $662 million for the 13-weeks ended May
     1, 2002. Gross margin, as a percentage of sales, increased to 23.0% for the
     13-weeks ended April 30, 2003, from 9.2% for the 13-weeks ended May 1,
     2002. The increase in gross margin was primarily related to the charge of
     $625 million recorded in the first quarter of 2002 in conjunction with the
     store closing

                                       30
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     liquidation sales. In addition, our gross margin rate was positively
     affected by a favorable gross margin rate realized from closing store
     liquidation sales, a decrease in sales of food and consumables, which carry
     lower margins, and a decrease in promotional markdowns, partially offset by
     the impact of clearance markdowns.

              SG&A, which includes advertising costs (net of co-op recoveries of
     $69 million in fiscal 2002) decreased $249 million for the 13-weeks ended
     April 30, 2003 to $1,421 million, or 23.0% of sales, from $1,670 million,
     or 23.3% of sales, for the 13-weeks ended May 1, 2002. The decrease in SG&A
     was primarily the result of the closure of 283 stores in the second quarter
     of 2002 and lower payroll and other related expenses in the first quarter
     of 2003 stemming from corporate headquarters cost reduction initiatives. In
     addition, SG&A was favorably impacted by a decrease in utility expenses and
     electronic media advertising, and lower depreciation expense as a result of
     the impairment charge recorded in the fourth quarter of fiscal 2002.
     Offsetting the positive impact of these items was an increase in pension
     and workers' compensation expense and the impact of the previously
     discussed reclassification of co-op advertising recoveries in accordance
     with EITF 02-16.

              Loss before interest, reorganization items, income taxes and
     discontinued operations for the 13-weeks ended April 30, 2003 was $32
     million, or (0.5%) of sales, as compared to a loss of $1,003 million, or
     (14.0%) of sales, for the same period of the prior year. The decrease in
     operating loss was primarily due to the 2002 charge for accelerated
     inventory markdowns of $625 million and the decrease in SG&A as previously
     discussed.

              Interest expense, net for the 13-weeks ended April 30, 2003 and
     May 1, 2002 was $57 million and $33 million, respectively. The increase in
     interest expense was due to accelerated amortization on debt issuance costs
     related to our DIP Credit Facility in conjunction with our emergence from
     Chapter 11. Interest at the stated contractual amount on unsecured debt
     that was not charged to earnings for the 13-weeks ended April 30, 2003 and
     May 1, 2002 was $67 million and $69 million, respectively.

              Effective income tax rate was (0.7%) and (0.9%) for the 13-weeks
     ended April 30, 2003 and May 1, 2002, respectively, see Note 13 - Income
     Taxes.

     39-WEEKS ENDED OCTOBER 30, 2002 (PREDECESSOR COMPANY)

              Total sales were $20,823 million for the 39-weeks ended October
     30, 2002. Same-store sales decreased (7.6%). Same-store sales include sales
     of all open stores that have been open for greater than 13 full months.

              Gross margin for the 39-weeks ended October 30, 2002 was $3,039
     million, or 14.6% of sales.

              SG&A, which includes advertising costs, was $4,653 million, or
     22.4% of sales for the period. The Predecessor Company recorded $268
     million of co-op advertising recoveries in SG&A prior to the adoption of
     EITF No. 02-16, as discussed above.

              Operating loss before interest, reorganization items, income taxes
     and discontinued operations for the 39-weeks ended October 30, 2002 was
     ($1,595) million, or (7.7%) of sales.

              Interest expense, net was $102 million for the 39-weeks ended
     October 30, 2002.

              Effective income tax rate was (1.0%) for the 39-weeks ended
     October 30, 2002. See Note 13 - Income Taxes.

     LIQUIDITY AND FINANCIAL CONDITION

     26-WEEKS ENDED OCTOBER 29, 2003 (SUCCESSOR COMPANY)

              Our cash needs are satisfied through working capital generated by
     our business and availability under our Credit Facility. The level of cash
     generated by our business is dependent, in significant part, on our level
     of sales and the credit extended by our vendors. Since the Predecessor
     Company's filing for reorganization under Chapter 11, most of our vendors
     continue to support us and have resumed normal trade terms. We continue to
     focus on our vendor relationships and do not expect to experience any
     significant disruption of terms with our vendors. Should we experience a
     significant disruption of terms with our vendors, sales fail to improve,
     the Credit Facility for any reason becomes unavailable and/or

                                       31
<PAGE>
     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     actual results differ materially from those projected, our compliance with
     financial covenants and our cash resources could be adversely affected.

              On May 6, 2003, our $2 billion Credit Facility financed by General
     Electric Capital Corporation, Fleet Retail Finance, Inc. and Bank of
     America, N.A. became effective. Debt issuance costs associated with the
     Credit Facility totaled $58 million and will be amortized through May 2006.
     The Credit Facility is a revolving facility under which Kmart Corporation
     is the debtor and its parent entities and most direct and indirect
     subsidiaries are guarantors. The Credit Facility is collateralized by first
     liens on inventory, the proceeds thereof, and certain intellectual property
     necessary to realize the value of the inventory. Borrowings under the
     Credit Facility currently bear interest at either the Prime rate plus 2.5%
     per annum or the LIBOR rate plus 3.5% per annum, at our discretion, which
     interest rate margin may be reduced after the first anniversary of the
     effective date of the Credit Facility if we achieve certain EBITDA levels.
     In addition, we are required to pay a fee of 0.75% per annum on the
     unutilized commitment under the Credit Facility. The Credit Facility
     financial covenants include a requirement that we maintain certain
     availability minimums, and failure to do so triggers additional required
     minimum levels of EBITDA. The Credit Facility also contains other customary
     covenants, including certain reporting requirements and covenants that
     restrict our ability to incur or create liens, indebtedness and guarantees,
     make investments, pay dividends or make other equity distributions, sell or
     dispose of stock or assets, change the nature of our business and enter
     into affiliate transactions , mergers and consolidations. Failure to
     satisfy these covenants would (in some cases, after the receipt of notice
     and/or the expiration of a grace period) result in an event of default that
     could result in our inability to access the funds necessary to maintain our
     operations. As of October 29, 2003 we had utilized $392 million of the
     Credit Facility for letters of credit issued for ongoing import purchasing
     operations, contractual and regulatory purposes. We have experienced
     incremental collateral requirements to support our self-insurance programs
     in the form of letters of credit. Total availability under the Credit
     Facility at October 29, 2003 is approximately $1.6 billion. We do not
     currently expect to borrow from the Credit Facility in fiscal 2003.
     Effective December 1, 2003, we voluntarily reduced the size of our Credit
     Facility to $1.5 billion to reduce the overall cost of the facility to
     reflect the improvement in the Company's financial condition. The Company
     continues to explore various alternatives to reduce the cost and improve
     the terms of our Credit Facility.

              Net cash used for operating activities was $396 million for the
     26-weeks ended October 29, 2003. Net cash used for operating activities was
     primarily driven by payments of $470 million during the second and third
     quarters of fiscal 2003 for exit costs and reorganization items. The
     payments for exit costs and reorganization items include $243 million to
     pre-petition lenders, $89 million for reclamation claims settlements, $81
     million to retain bankruptcy advisors and $69 million under the KERP.

              Net cash provided by investing activities was $32 million for the
     26-weeks ended October 29, 2003 and was primarily the result of proceeds of
     $92 million from the sale of property classified as held for sale (see Note
     11 - Property Held for Sale), partially offset by $61 million for capital
     expenditures primarily related to the purchase of seven stores and one
     distribution center that were previously leased. In the normal course of
     business, the Company considers opportunities to purchase leased operating
     properties, as well as offers to sell owned, or assign leased, operating
     and non-operating properties. In addition, the Company reviews leases that
     will expire in the short-term in order to determine the appropriate action
     to take in respect with the lease. We consider the merits of each action
     and execute transactions considered to be favorable to the Company only
     after appropriate due diligence.

              Net cash provided by financing activities was $73 million for the
     26-weeks ended October 29, 2003. Upon emergence from bankruptcy, the
     Company received proceeds of $140 million from the issuance of common stock
     to the Plan Investors and proceeds of $60 million from the issuance of the
     convertible note to affiliates of ESL. The positive impact of these items
     was offset by payments made for other financing arrangements.

              On August 28, 2003, the Company's Board of Directors approved the
     repurchase of up to $10 million of the Company's outstanding stock for the
     purpose of providing restricted stock grants to certain employees. The
     repurchase was subject to the approval of the parties to the Credit
     Facility, which was obtained. Certain of such grants are subject to
     shareholder approval. During the third quarter of fiscal 2003 we
     repurchased a total of 90,500 shares of common stock at a cost of
     approximately $3 million.

                                       32
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     13-WEEKS ENDED APRIL 30, 2003 (PREDECESSOR COMPANY)

              Net cash provided by operating activities was $576 million for the
     13-weeks ended April 30, 2003. Net cash provided by operating activities
     was primarily driven by a decrease in inventory of $480 million due to
     store liquidation sales and improved inventory management, partially offset
     by a decrease in accounts payable.

              Net cash provided by investing activities was $60 million for the
     13-weeks ended April 30, 2003. Net cash provided by investing activities
     was the result of first quarter fiscal 2003 proceeds of $64 million from
     the sale of four owned Kmart store locations and the sale of furniture and
     fixtures from closed store locations, partially offset by $4 million for
     capital expenditures.

              Net cash used for financing activities was $17 million for the
     13-weeks ended April 30, 2003 primarily due to payments on debt and capital
     lease obligations.

     39-WEEKS ENDED OCTOBER 30, 2002 (PREDECESSOR COMPANY)

              Net cash used for operating activities for the 39-weeks ended
     October 30, 2002 was $801 million. Cash used for operating activities was
     primarily due to the increase in inventories, net of accounts payable, the
     liquidation of inventory in our closed store locations and cash used for
     reorganization items.

              Net cash used for investing activities was $193 million for the
     39-weeks ended October 30, 2002. The Predecessor Company had capital
     expenditures of $206 million during the period, partially offset by sale of
     furniture and fixtures from our closed stores of $13 million.

              Net cash provided by financing activities for the 39-weeks ended
     October 30, 2002 was $130 million. Cash provided by financing activities
     was primarily due to net borrowings under the DIP Credit Facility,
     partially offset by payments for other financing arrangements.

              Following the Petition Date and prior to emergence, the
     Predecessor Company utilized cash flows from operations and the DIP Credit
     Facility as its primary sources of working capital. The DIP Credit Facility
     was a revolving credit facility under which the Predecessor Company was the
     borrower and the rest of the Debtors were guarantors.

     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 income and cash flows from operations are earned in the fourth
     quarter. Our results of operations and cash flows are primarily dependent
     upon the large sales volume generated during the fourth quarter of our
     fiscal year. Fourth quarter fiscal 2002 sales represented over 29% of total
     net sales in fiscal 2002. As a result, operating performance for the
     interim periods is not necessarily indicative of operating performance for
     the entire year. To support the higher seasonal sales volume, we experience
     a seasonal inventory build in October and November and, as a result, our
     usage of credit lines has historically been higher for this period of the
     year.

     Inflation

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

     Pension Plan

              Prior to 1996, the Predecessor Company maintained defined benefit
     pension plans covering eligible associates. Effective January 31, 1996, the
     pension plans were frozen, and associates no longer earn additional
     benefits under the plans (except for purposes of the subsidized early
     retirement program provided by the plan). The plans' assets consist
     primarily of equity and fixed income securities. For the past nine years,
     the Predecessor Company has not been required to make contributions to the
     plans.

                                       33
<PAGE>
     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

              In light of losses in the equity markets in 2002 and prior years,
     and the effect of such returns on the value of the plans' assets, we
     presently expect that we will be required to commence making significant
     contributions to the plans in 2005 or 2006, although it is possible that
     contributions could be required earlier. Given that the plans are frozen,
     the timing for the commencement of our future funding requirements will
     depend, in large part, on the future investment performance of the plans'
     assets. Once funding obligations commence, we presently anticipate that
     such obligations could continue for a period of five or six years at an
     average rate of between $100 million and $200 million a year, or between
     $700 million and $1 billion in the aggregate. The actual level of
     contributions will depend upon a number of factors, including legislative
     charges, actual demographic experience, pension fund returns and other
     changes affecting valuations.

              In addition to the funding described above, as a result of the
     returns over the most recent years, decreases in our annual discount rate
     and expected rate of return on assets, we recorded pension expense of $11
     million and $23 million in the 13-weeks and 26-weeks ended October 29, 2003
     (Successor Company), respectively, and $20 million for the 13-weeks ended
     April 30, 2003 (Predecessor Company), as opposed to income as has been
     recorded in the most recent years.

     FRESH-START ADJUSTMENTS

              In accordance with Fresh-Start accounting, all assets and
     liabilities are recorded at their respective fair market values. Fair
     values used represent our best estimates based on independent appraisals
     and valuations.

              To facilitate the calculation of the enterprise value of the
     Successor Company, we developed a set of financial projections. Based on
     these financial projections and with the assistance of a financial
     advisor, the enterprise value was determined by the Company, using various
     valuation methods, including (i) a comparison of the Company and its
     projected performance to the market values of comparable companies, (ii) a
     review and analysis of several recent transactions of companies in similar
     industries to the Company, and (iii) a calculation of the present value of
     the future cash flows under the projections. The estimated enterprise value
     is highly dependent upon achieving the future financial results set forth
     in the projections as well as the realization of certain other assumptions
     which are not guaranteed. The estimated enterprise value of Kmart was
     calculated to be approximately $2.3 billion to $3.0 billion. We selected
     the midpoint of the range, $2.6 billion, as the estimated enterprise value.
     In applying Fresh-Start accounting, adjustments to reflect the fair value
     of assets and liabilities, on a net basis, and the write-off of the
     Predecessor Company's equity accounts resulted in a charge of $5.6 billion.
     The restructuring of Kmart's capital structure and resulting discharge of
     pre-petition debt resulted in gain of $5.6 billion. The charge for the
     revaluation of the assets and liabilities and the gain on the discharge of
     pre-petition debt are recorded in Reorganization items, net in the
     unaudited Condensed Consolidated Statement of Operations. For a
     comprehensive discussion see Note 3 - Fresh-Start Accounting.

     DISCONTINUED OPERATIONS

              During the first quarter of fiscal 2003 and the second quarter of
     fiscal 2002, the Predecessor Company closed 316 and 283 stores,
     respectively. Of the total store closings 121 met the criteria for
     discontinued operations. For a comprehensive discussion see Note 4 -
     Discontinued Operations.

              Of the 599 stores that were closed in 2003 and 2002, 478 are
     included in continuing operations, as they did not meet the criteria for
     discontinued operations. For the 13-weeks ended April 30, 2003, 250 of the
     316 stores closed were accounted for in continuing operations. Total sales,
     gross margin and SG&A for these 250 stores were $854 million, $301 million
     and $146 million, respectively. For the 13-weeks ended October 30, 2002,
     total sales, gross margin and SG&A for the 478 stores that were reported in
     continuing operations were $898 million, $129 million and $204 million,
     respectively. For the 39-weeks ended October 30, 2002, total sales, gross
     margin and SG&A for the 478 stores that were reported in continuing
     operations were $3,782 million, $661 million and $797 million,
     respectively.

     SPECIAL CHARGES

              Special charges are transactions which, in management's judgment,
     may make meaningful comparisons of operating results between reporting
     periods difficult. In determining what amounts constitute a special charge,
     management considers the nature, magnitude and frequency of their
     occurrence. During fiscal 2002, the Predecessor Company instituted certain
     restructuring actions to improve operations and executed significant
     inventory liquidations as a result of the stores closed under Kmart's
     Chapter 11 proceedings. For the 13-weeks ended April 30, 2003, and the
     13-weeks and 39-weeks ended October 30, 2002, the Predecessor Company
     recorded special charges of $42 million, $(6) million and $821 million,
     respectively. For a comprehensive discussion see Note 8 - Special Charges.

                                       34
<PAGE>

     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION - (CONTINUED)

     REORGANIZATION ITEMS, NET

              Reorganization items represent amounts the Predecessor Company
     incurred as a result of Chapter 11, and are presented separately in the
     unaudited Condensed Consolidated Statements of Operations. The Predecessor
     Company recorded $4 million, $769 million and $259 million for the 13-weeks
     ended October 30, 2002, the 13-weeks ended April 30, 2003 and the 39-weeks
     ended October 30, 2002, respectively, for reorganization items. The net
     increase in Reorganization items for the 13-weeks ended April 30, 2003 as
     compared to the 39-weeks ended October 30, 2002, is primarily due to the
     Fleming settlement of $385 million and expense of $200 million for
     estimated claims for rejected executory contracts, partially offset by the
     2002 store closings charge of $203 million. For a comprehensive discussion
     see Note 9 - Reorganization Items, net.

     OTHER MATTERS

              Lawsuits, Investigations and Other Contingent Liabilities

              During the third quarter of fiscal 2003 tentative contract
     agreements between Kmart and the local memberships of the United Auto
     Workers at two of our distribution centers were ratified by Kmart
     associates. The two distribution centers supply approximately 15 percent of
     our stores.

              We are a party to a substantial number of other claims, lawsuits
     and pending actions which are routine and incidental to our business. To
     the extent that any claim relates to a contract which was assumed by us
     when we emerged or relates to a time period occurring after the Petition
     Date, the Successor Company shall be responsible for any damages which may
     result. In addition, certain contracts allow for damage provisions or other
     repayments as a result of our termination of the contracts. For a
     comprehensive discussion see Note 20 - Other Commitments and Contingencies.

              Other

              On August 6, 2003, we announced the launch of the Thalia Sodi
     Collection. The Collection captures the personal style and attitude of the
     Hispanic actress and singer, Thalia Sodi, and her culture. It includes
     branded apparel for women and girls, as well as footwear, accessories,
     jewelry, intimates, hosiery and bed and bath products. The Thalia Sodi
     Collection is available in 335 Kmart stores including those in the New York
     City, Los Angeles, San Francisco, Miami, Denver, Las Vegas, Phoenix, San
     Diego, Chicago and Puerto Rico areas.

              On June 4, 2003, Martha Stewart was indicted in the United States
     District Court of the Southern District of New York. The Martha Stewart
     brand is considered a distinctive brand for Kmart and we currently sell
     Martha Stewart home, garden, colors, baby, kitchen, keeping and decorating
     product lines, along with candles and accessories. Martha Stewart resigned
     her position as Chairman and Chief Executive Officer of Martha Stewart
     Omnimedia, Inc; however, she serves as the Chief Creative Officer and
     remains on the Board of Directors. To date, we have not experienced any
     significant adverse impact from this matter on the sales of Martha Stewart
     brand products. Although product sales have not been significantly affected
     by past events, the Company is not able to determine the potential effects
     that these events may have on the future sales of its Martha Stewart brand
     products.

                                       35
<PAGE>

     ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

              At October 29, 2003, we did not have any derivative instruments
     that increased our exposure to market risks for interest rates, foreign
     currency rates, commodity prices or other market price risks. We do not use
     derivatives for speculative purposes. Currently, our exposure to market
     risks results primarily from changes in interest rates, principally with
     respect to the Credit Facility, which is a variable rate financing
     agreement. We do not use swaps or other interest rate protection agreements
     to hedge this risk.

     ITEM 4. CONTROLS AND PROCEDURES

              We carried out an evaluation, under the supervision of our
     management Disclosure Committee (which includes the Chief Executive Officer
     and Co-Principal Financial Officers), of the effectiveness of our
     disclosure controls and procedures pursuant to Securities and Exchange Act
     of 1934 Rules 13a-15(e) and 15d-15(e). Based upon this evaluation, the
     Chief Executive Officer and Co-Principal Financial Officers concluded that
     as of the end of the period covered by this quarterly report, our
     disclosure controls and procedures are effective to ensure that information
     required to be disclosed in our periodic SEC reports is recorded,
     processed, summarized, and reported as and when required. No change in our
     internal control over financial reporting occurred during our most recent
     fiscal quarter that has materially affected, or is reasonably likely to
     materially affect, our internal control over financial reporting.

                                       36
<PAGE>

     PART II. OTHER INFORMATION

     ITEM 1. LEGAL PROCEEDINGS

             See Note 20 of the Notes to unaudited Condensed Consolidated
             Financial Statements for information concerning legal proceedings.

     ITEM 5. OTHER INFORMATION

             Effective September 1, 2003, William C. Crowley was hired as Senior
             Vice President, Finance. Mr. Crowley will continue to serve on our
             Board of Directors.

             Effective September 3, 2003, Janet L. Kelly was hired as Senior
             Vice President and Chief Administrative Officer.

             Effective September 3, 2003, Lisa Schultz was hired as Senior Vice
             President and Chief Creative Officer.

             Effective September 15, 2003, Bruce Johnson was hired as Senior
             Vice President, Supply Chain and Operations.

             The date of receipt of shareholder proposals for the Company's
             Annual Meeting to be held in 2004 is January 5, 2004.

     ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

     (a)     The following exhibits are filed as a part of this report:

             Exhibit 10.1-Employment Agreement, dated as of September 15, 2003,
             between Kmart Management Corporation and Bruce Johnson

             Exhibit 10.2- Employment Agreement dated as of September 3, 2003,
             between Kmart Management Corporation and Janet L. Kelly

             Exhibit 10.3- Employment Agreement dated as of September 3, 2003,
             between Kmart Management Corporation and Lisa Schultz

             Exhibit 10.4-Kmart Management Corporation Restricted Stock
             Agreement with Bruce Johnson

             Exhibit 10.5- Kmart Management Corporation Restricted Stock
             Agreement with Janet L. Kelly

             Exhibit 10.6- Kmart Management Corporation Restricted Stock
             Agreement with Lisa Schultz

             Exhibit 10.7- Kmart Management Corporation Restricted Stock
             Agreement with Harold Lueken

             Exhibit 10.8-Amendment No. 1 to the May 6, 2003 Nonqualified Stock
             Option Agreement between Kmart Holding Corporation and Julian C.
             Day

             Exhibit 10.9 - Form of Kmart Holding Corporation Long Term
             Incentive Award Agreement

             Exhibit 31.1 -Chief Executive Officer Certification pursuant to
             Section 302 of the Sarbanes-Oxley Act of 2002

             Exhibit 31.2 -Co-Principal Financial Officer Certification pursuant
             to Section 302 of the Sarbanes-Oxley Act of 2002

             Exhibit 31.3 - Co-Principal Financial Officer Certification
             pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

     (b)     The following exhibit is furnished as a part of this report:

             Exhibit 32 -Certifications pursuant to Section 906 of the
             Sarbanes-Oxley Act of 2002

                                       37
<PAGE>

     (c)    Reports on Form 8-K: We filed and furnished the following Current
            Reports on Form 8-K and with the SEC:

             1.    On August 29, 2003, Kmart Holding Corporation furnished a
                   Current Report on Form 8-K to report the second quarter 2003
                   operating results and the approval by the Board of Directors
                   of a $10 million share repurchase.

             2.    On September 2, 2003, Kmart Holding Corporation furnished a
                   Current Report on Form 8-K to announce the hiring of three
                   Senior Vice Presidents.

             3.    On October 16, 2003, Kmart Holding Corporation filed a
                   Current Report on Form 8-K to announce the dismissal of
                   PricewaterhouseCoopers LLP as our certifying accountant and
                   the hiring of BDO Seidman, LLP as our certifying accountant,
                   effective October 8, 2003.

                                       38
<PAGE>

                                   SIGNATURES

Pursuant to the requirements 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.

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

                              Date:          DECEMBER 5, 2003

                                            Kmart Holding Corporation
                                     -----------------------------------
                                                  (Registrant)

                              By:            /s/ Julian C. Day
                                     -----------------------------------
                                               Julian C. Day
                                            PRESIDENT AND CHIEF
                                             EXECUTIVE OFFICER
                                       (Principal Executive Officer)

                                          /s/ Richard J. Noechel
                                     -----------------------------------
                                            Richard J. Noechel
                                            VICE PRESIDENT AND
                                                CONTROLLER

                                     (Principal Accounting Officer and
                                       Co-Principal Financial Officer)

                                       39
<PAGE>

                                  EXHIBIT INDEX

EXHIBIT NUMBER                           DESCRIPTION

Exhibit 10.1-    Employment Agreement, dated as of September 15, 2003,
                 between Kmart Management Corporation and Bruce Johnson

Exhibit 10.2-    Employment Agreement dated as of September 3, 2003,
                 between Kmart Management Corporation and Janet L. Kelly

Exhibit 10.3-    Employment Agreement dated as of September 3, 2003,
                 between Kmart Management Corporation and Lisa Schultz

Exhibit 10.4-    Kmart Management Corporation Restricted Stock
                 Agreement with Bruce Johnson

Exhibit 10.5-    Kmart Management Corporation Restricted Stock
                 Agreement with Janet L. Kelly

Exhibit 10.6-    Kmart Management Corporation Restricted Stock
                 Agreement with Lisa Schultz

Exhibit 10.7-    Kmart Management Corporation Restricted Stock
                 Agreement with Harold Lueken

Exhibit 10.8-    Amendment No. 1 to the May 6, 2003 Nonqualified Stock
                 Option Agreement between Kmart Holding Corporation and Julian
                 C. Day

Exhibit 10.9 -   Form of Kmart Holding Corporation Long Term
                 Incentive Award Agreement

Exhibit 31.1 -   Chief Executive Officer Certification pursuant to
                 Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 -   Co-Principal Financial Officer Certification pursuant
                 to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.3 -   Co-Principal Financial Officer Certification
                 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32 -     Sarbanes Oxley Act Section 906 Certification