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Sears Holdings 10-K 2011
Form 10-K

 

 

United States

Securities and Exchange Commission

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended January 29, 2011

or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 000-51217

 

 

SEARS HOLDINGS CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   20-1920798
(State of Incorporation)   (I.R.S. Employer Identification No.)

 

3333 Beverly Road, Hoffman Estates, Illinois   60179
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (847) 286-2500

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Name of Each Exchange on Which Registered
Common Shares, par value $0.01 per share   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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 and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

On February 26, 2011, the Registrant had 108,742,366 common shares outstanding. The aggregate market value (based on the closing price of the Registrant’s common shares for stocks quoted on the NASDAQ Global Select Market) of the Registrant’s common shares owned by non-affiliates (which are assumed, solely for the purpose of this calculation, to be stockholders other than (i) directors and executive officers of the Registrant and (ii) any person known by the Registrant to beneficially own five percent or more of the Registrant’s common shares), as of the last business day of the Registrant’s most recently completed second fiscal quarter, was approximately $1.9 billion.

Documents Incorporated By Reference

Part III of this Form 10-K incorporates by reference certain information from the Registrant’s definitive proxy statement relating to our Annual Meeting of Stockholders to be held on May 3, 2011 (the “2011 Proxy Statement”), which will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Form 10-K relates.

 

 

 


PART I

 

Item 1. Business

General

Sears Holdings Corporation (“Holdings,” “we,” “us,” “our,” or the “Company”) is the parent company of Kmart Holding Corporation (“Kmart”) and Sears, Roebuck and Co. (“Sears”). Holdings was formed as a Delaware corporation in 2004 in connection with the merger of Kmart and Sears (the “Merger”) on March 24, 2005. We are a broadline retailer with 2,201 full-line and 1,354 specialty retail stores in the United States operating through Kmart and Sears and 483 full-line and specialty retail stores in Canada operating through Sears Canada Inc. (“Sears Canada”), a 92%-owned subsidiary.

Business Segments

During 2010, we operated three reportable segments: Kmart, Sears Domestic and Sears Canada. Financial information, including revenues, operating income, total assets and capital expenditures for each of these business segments is contained in Note 18 of Notes to Consolidated Financial Statements. Information regarding the components of revenue for Holdings is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Kmart

At January 29, 2011, Holdings operated a total of 1,307 Kmart stores across 49 states, Guam, Puerto Rico, and the U.S. Virgin Islands. This store count consists of 1,278 discount stores, averaging 93,000 square feet, and 29 Super Centers, averaging 169,000 square feet, and includes 6 Kmart stores that we have announced plans to close in early 2011. Most Kmart stores are one-floor, free-standing units that carry a wide array of products across many merchandise categories, including consumer electronics, seasonal merchandise, outdoor living, toys, lawn and garden equipment, food and consumables and apparel, including products sold under such well-known labels as Jaclyn Smith and Joe Boxer, and certain proprietary Sears brand products (such as Kenmore, Craftsman, and DieHard) and services. At January 29, 2011, 268 Kmart stores were selling an assortment of major home appliances, including Kenmore-branded products. Kmart began operating its own footwear business, which had previously been operated by a third party, in January 2009. There are 981 Kmart stores that also operate in-store pharmacies. The Super Centers generally operate 24 hours a day and combine a full-service grocery along with the merchandise selection of a discount store. There are also 20 Sears Auto Centers operating in Kmart stores. Sears Auto Centers offer a variety of professional automotive repair and maintenance services, as well as a full assortment of automotive accessories. Kmart has continued to expand its layaway program, which allows customers to cost-effectively finance their purchases. In addition, we have expanded the ways our customers can receive their purchases, allowing our customers to buy online and pick up in store. This service, powered by MyGofer, is now available in over 600 Kmart stores via either MyGofer.com or Kmart.com. Kmart also sells its products through its kmart.com website.

Sears Domestic

At January 29, 2011, Sears Domestic operations consisted of the following:

 

   

Full-line Stores—894 broadline stores, of which 842 are full-line stores located across all 50 states and Puerto Rico. These stores are primarily mall-based locations averaging 133,000 square feet. Full-line stores offer a wide array of products and service offerings across many merchandise categories, including home appliances, consumer electronics, tools, sporting goods, outdoor living, lawn and garden equipment, certain automotive services and products, such as tires and batteries, home fashion products, as well as apparel, footwear, jewelry and accessories for the whole family. Our product offerings include our proprietary Kenmore, Craftsman, DieHard, Lands’ End, Covington, Apostrophe, and Canyon River Blues brand merchandise. In addition, at January 29, 2011, we operated 52 Sears

 

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Essentials/Grand stores located in 24 states. These stores are primarily free-standing units averaging 117,000 square feet, offering health and beauty products, pantry goods, household products and toys in addition to the offerings of the typical mall-based store. There are 22 Sears Essentials/Grand stores that operate in-store pharmacies. We also have 768 Sears Auto Centers operating in association with full-line stores and 19 Sears Auto Centers operating out of Sears Essentials/Grand stores. In addition, there are 30 free standing Sears Auto Centers that operate independently of full-line stores. Sears also extends the availability of its product selection through the use of its sears.com website, which offers an assortment of home, apparel and accessory merchandise and provides customers the option of buying through a mobile app or online and picking up their merchandise in one of our full-line and specialty stores. We have announced plans to close 6 broadline stores in the first part of 2011.

 

   

Specialty Stores—1,354 specialty stores (including the 30 free standing Sears Auto Centers noted above) located across all 50 states, Puerto Rico and Guam, in free-standing, off-mall locations or high-traffic neighborhood shopping centers. Specialty store operations primarily consist of:

 

   

938 Sears Hometown Stores—Primarily independently-owned stores, predominantly located in smaller communities and averaging 7,700 square feet offering appliances, consumer electronics, lawn and garden equipment, and hardware. Most of our hometown stores carry proprietary Sears brand products, such as Kenmore, Craftsman, and DieHard, as well as a wide assortment of national brands.

 

   

59 Sears Home Appliance Showrooms—Innovative stores averaging 5,100 square feet that have a simple, appliance only showroom design that are strategically positioned in high-growth suburban areas. Sears Home Appliance Showrooms offer the best advantages of our Sears Full-Line Stores combined with the Hometown Store customer service standard.

 

   

106 Sears Hardware Stores and 89 Orchard Supply Hardware Stores—Neighborhood hardware stores averaging 42,000 square feet that carry Craftsman brand tools and lawn and garden equipment, DieHard brand batteries and a wide assortment of national brands and other home improvement products. 134 of these locations also offer a limited selection of Kenmore brand home appliances.

 

   

12 The Great Indoors Stores—Home decorating and remodeling superstores, averaging 143,000 square feet, dedicated to the four main rooms of the house: kitchen, bedroom, bathroom and great room.

 

   

102 Outlet Stores—Locations offering overstock and/or distressed appliances, consumer electronics, lawn and garden equipment and other merchandise at a discount.

 

   

Lands’ End—Lands’ End, Inc. (“Lands’ End”) is a leading direct merchant of traditionally styled casual clothing, accessories and footwear for men, women and children, as well as home products and soft luggage. These products are offered through multiple selling channels including Landsend.com, one of the leading apparel websites, as well as catalog mailings, and international businesses. Lands’ End has 14 retail stores, averaging 8,600 square feet, which offer Lands’ End merchandise primarily from catalog and Internet channel overstocks. In addition, Lands’ End has 292 “store within a store” departments inside Sears Domestic broadline locations. The retail sales in those full-line store locations are included in the results of our full-line stores.

 

   

Commercial Sales—We sell Sears merchandise, parts, and services to commercial customers through our business-to-business Sears Commercial Sales and Appliance Builder/Distributor businesses.

 

   

Sears Commercial Sales provides appliances and services to commercial customers in the single-family residential construction/remodel, property management, multi-family new construction, and government/military sectors.

 

   

Our Appliance Builder/Distributor business offers premium appliance and plumbing fixtures to architects, designers, and new construction or remodeling customers, and is currently operating in seven markets with 26 facilities.

 

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Home Services—Product Repair Services, the nation’s largest product repair service provider, is a key element in our active relationship with more than 44 million households. With over 8,600 service technicians making over 11 million service calls annually, this business delivers a broad range of retail-related residential and commercial services across all 50 states, Puerto Rico, Guam and the Virgin Islands under the Sears Parts & Repair Services and A&E Factory Service brand names. Commercial and residential customers can obtain parts and repair services for all major brands of products within the home appliances, lawn and garden equipment, consumer electronics, floor care products, and heating and cooling systems categories. We also provide repair parts with supporting instructions for “do-it-yourself” customers through our PartsDirect.com website. Smaller items for repair can be brought into Sears Parts & Repair Centers located throughout the United States or into many Sears full-line, hometown and hardware stores. This business also offers protection agreements, product installation services and Kenmore and Carrier brand residential heating and cooling systems. Home Services also includes home improvement services (primarily siding, windows, cabinet refacing, kitchen remodeling, roofing, carpet and upholstery cleaning, air duct cleaning, and garage door installation and repair) provided through Sears Home Improvement Services.

Sears Canada

Sears Canada, a consolidated, 92%-owned subsidiary of Sears, conducts retail operations in Canada similar to those conducted by Sears Domestic, with a greater emphasis on apparel and other softlines than in the U.S. stores.

At January 29, 2011, Sears Canada operated a total of 122 full-line stores, 361 specialty stores (including 48 furniture and appliance stores, 268 dealer stores operated under independent local ownership, 4 appliance and mattress stores, 30 Corbeil stores, and 11 outlet stores), 20 floor covering stores, 1,822 catalog pick-up locations and 108 travel offices. Sears Canada also sells its products through its sears.ca website.

Acquisition of Noncontrolling Interest in Sears Canada

During 2010 and 2009, we acquired approximately 19 million and 0.5 million, respectively, of Sears Canada’s common shares in open market transactions. We paid a total of $560 million and $7 million, respectively, for the additional shares and accounted for the acquisition of additional interest in Sears Canada as an equity transaction in accordance with accounting standards on noncontrolling interests. Accordingly, we reclassified an accumulated other comprehensive loss from noncontrolling interest to controlling interest in the Consolidated Statement of Equity.

During 2008, we acquired approximately 2.6 million of Sears Canada’s common shares in open market transactions. We paid a total of $37 million for the additional shares and accounted for the acquisition of additional interest in Sears Canada as a purchase business combination under accounting rules in place at that time.

At January 29, 2011, January 30, 2010, and January 31, 2009, Sears Holdings was the beneficial holder of approximately 97 million, or 92%, 79 million or 73% and 78 million or 73%, respectively, of the common shares of Sears Canada.

Real Estate Transactions

In the normal course of business, we consider opportunities to purchase leased operating properties, as well as offers to sell owned, or assign leased, operating and non-operating properties. These transactions may, individually or in the aggregate, result in material proceeds or outlays of cash. In addition, we review leases that will expire in the short term in order to determine the appropriate action to take with respect to them.

Further information concerning our real estate transactions is contained in Note 12 of Notes to Consolidated Financial Statements.

 

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Trademarks, Trade Names and Licenses

The KMART® and SEARS® trade names, service marks and trademarks, used by us both in the United States and internationally, are material to our retail and other related businesses.

We sell proprietary branded merchandise under a number of brand names that are important to our operations. Our KENMORE®, CRAFTSMAN®, DIEHARD® and LANDS’ END® brands are among the most recognized proprietary brands in retailing. These marks are the subject of numerous United States and foreign trademark registrations. Other well recognized Company trademarks and service marks include APOSTROPHE®, CANYON RIVER BLUES®, COVINGTON®, BASIC EDITIONS®, OSH®, SHOPYOURWAY®, SMART SENSE™ and THE GREAT INDOORS®, which also are registered or are the subject of pending registration applications in the United States. We have the right to sell an exclusive line of Jaclyn Smith® products through July 2011 (with an option to extend for up to two additional three-year terms, subject to certain conditions). We also have the right to sell an exclusive line of Joe Boxer® products through December 2015 (with an option to extend for up to two additional five-year terms, subject to certain conditions). Generally, our right to use our trade names and marks continues so long as we use them.

Seasonality

The retail business is seasonal in nature, and we generate a high proportion of our revenues, operating income and operating cash flows during the fourth quarter of our year, which includes the holiday season. As a result, our overall profitability is heavily impacted by our fourth quarter operating results. Additionally, in preparation for the fourth quarter holiday season, we significantly increase our merchandise inventory levels, which are financed from operating cash flows, credit terms received from vendors and borrowings under our amended credit agreement (described in the “Uses and Sources of Liquidity” section below). Fourth quarter reported revenues accounted for 30%, 30% and 28% of total reported revenues in years 2010, 2009 and 2008, respectively. See Note 20 to our Consolidated Financial Statements for further information on revenues earned by quarter in 2010 and 2009.

Competition

Our business is subject to highly competitive conditions. We compete with a wide variety of retailers, including other department stores, discounters, home improvement stores, consumer electronics dealers, auto service providers, specialty retailers, wholesale clubs, as well as many other retailers operating on a national, regional or local level. Online and catalog businesses, which handle similar lines of merchandise, also compete with us. Walmart, Target, Kohl’s, JC Penney, Macy’s, Home Depot, Lowe’s and Best Buy are some of the national retailers with which we compete. Home Depot and Lowe’s are major competitors in relation to our home appliance business, which accounted for approximately 16% of our 2010 and 15% of our 2009 and 2008 reported revenues. Sears Canada competes in Canada with Hudson’s Bay Company and certain U.S.-based competitors, including those mentioned above, that may be expanding into Canada. Success in these competitive marketplaces is based on factors such as price, product assortment and quality, service and convenience, including availability of retail-related services such as access to credit, product delivery, repair and installation. Additionally, we are influenced by a number of factors including, but not limited to, the cost of goods, consumer debt availability and buying patterns, economic conditions, customer preferences, inflation, currency exchange fluctuations, weather patterns, and catastrophic events. Item 1A in this report on Form 10-K contains further information regarding risks to our business.

Employees

At January 29, 2011, we had approximately 280,000 employees in the United States and U.S. territories, and approximately 32,000 employees in Canada through Sears Canada. These employee counts include part-time employees.

 

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Our Website; Availability of SEC Reports and Other Information

Our corporate website is located at searsholdings.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports are available, free of charge, through the “SEC Filings” portion of the Investor Information section of our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).

The Corporate Governance Guidelines of our Board of Directors, the charters of the Audit, Compensation, Finance and Nominating and Corporate Governance Committees of the Board of Directors, our Code of Conduct and the Board of Directors Code of Conduct are available in the Corporate Governance section of searsholdings.com. References to our website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.

 

Item 1A. Risk Factors

The following risk factors could adversely affect our business, results of operations and financial condition. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us may also negatively impact our business.

If we fail to offer merchandise and services that our customers want, our sales may be limited, which would reduce our revenues and profits.

In order for our business to be successful, we must identify, obtain supplies of, and offer to our customers, attractive, innovative and high-quality merchandise on a continuous basis. Our products and services must satisfy the desires of our customers, whose preferences may change in the future. If we misjudge either the demand for products and services we sell or our customers’ purchasing habits and tastes, we may be faced with excess inventories of some products and missed opportunities for products and services we chose not to offer. In addition, our sales may decline or we may be required to sell the merchandise we have obtained at lower prices. This would have a negative effect on our business and results of operations.

If we do not successfully manage our inventory levels, our operating results will be adversely affected.

We must maintain sufficient inventory levels to operate our business successfully. However, we also must guard against accumulating excess inventory as we seek to minimize out-of-stock levels across all product categories and to maintain in-stock levels. We obtain a significant portion of our inventory from vendors located outside the United States. Some of these vendors often require lengthy advance notice of our requirements in order to be able to supply products in the quantities we request. This usually requires us to order merchandise, and enter into purchase order contracts for the purchase and manufacture of such merchandise, well in advance of the time these products will be offered for sale. As a result, we may experience difficulty in responding to a changing retail environment, which makes us vulnerable to changes in price. If we do not accurately anticipate the future demand for a particular product or the time it will take to obtain new inventory, our inventory levels will not be appropriate and our results of operations may be negatively impacted.

If we are unable to compete effectively in the highly competitive retail industry, our business and results of operations could be materially adversely affected.

The retail industry is highly competitive with few barriers to entry. We compete with a wide variety of retailers, including other department stores, discounters, home improvement stores, home appliances and consumer electronics retailers, auto service providers, specialty retailers, wholesale clubs and many other competitors operating on a national, regional or local level. Some of our competitors are actively engaged in new store expansion. Online and catalog businesses, which handle similar lines of merchandise, also compete with us. In this competitive marketplace, success is based on factors such as price, product assortment and quality, service and convenience.

 

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Our success depends on our ability to differentiate ourselves from our competitors with respect to shopping convenience, a quality assortment of available merchandise and superior customer service. We must also successfully respond to our customers’ changing tastes. The performance of our competitors, as well as changes in their pricing policies, marketing activities, new store openings and other business strategies, could have a material adverse effect on our business, financial condition and results of operations.

Our business has been and will continue to be affected by worldwide economic conditions; a failure of the economy to sustain its recovery, a renewed decline in consumer-spending levels and other conditions, including inflation, could lead to reduced revenues and gross margins, and negatively impact our liquidity.

Many economic and other factors are outside of our control, including consumer and commercial credit availability, consumer confidence and spending levels, inflation, employment levels, housing sales and remodels, consumer debt levels, fuel costs and other challenges currently affecting the global economy, the full impact of which on our business, results of operations and financial condition cannot be predicted with certainty. These economic conditions adversely affect the disposable income levels of, and the credit available to, our customers, which could lead to reduced demand for our merchandise. Also affected are our vendors, upon which we depend to provide us with financing on our purchases of inventory and services. Our vendors could seek to change either the availability of vendor credit to us or other terms under which they sell to us, or both, which could negatively impact our liquidity. In addition, the inability of vendors to access liquidity, or the insolvency of vendors, could lead to their failure to deliver inventory or other services. Certain of our vendors also are experiencing increases in the cost of various raw materials, such as cotton, oil-related materials, steel and rubber, which could result in increases in the prices that we pay for merchandise, particularly apparel, appliances and tires.

In addition to credit terms from vendors, our liquidity needs are funded by our operating cash flows and, to the extent necessary, borrowings under our credit agreements and commercial paper program. The availability of financing depends on numerous factors, including economic and market conditions, our credit ratings, and lenders’ assessments of our prospects and the prospects of the retail industry in general. The lenders under our credit facilities may not be able to meet their commitments if they experience shortages of capital and liquidity and there can be no assurance that our ability to otherwise access the credit markets, will not be adversely affected by changes in the financial markets and the global economy.

The domestic and international political situation also affects consumer confidence. The threat, outbreak or escalation of terrorism, military conflicts or other hostilities could lead to a decrease in consumer spending. Any of these events and factors could cause us to increase inventory markdowns and promotional expenses, thereby reducing our gross margins and operating results.

Due to the seasonality of our business, our annual operating results would be adversely affected if our business performs poorly in the fourth quarter.

Our business is seasonal, with a high proportion of revenues, operating income and operating cash flows being generated during the fourth quarter of our year, which includes the holiday season. As a result, our fourth quarter operating results significantly impact our annual operating results. Our fourth quarter operating results may fluctuate significantly, based on many factors, including holiday spending patterns and weather conditions.

Our sales may fluctuate for a variety of reasons, which could adversely affect our results of operations.

Our business is sensitive to customers’ spending patterns, which in turn are subject to prevailing economic conditions. Our sales and results of operations have fluctuated in the past, and we expect them to continue to fluctuate in the future. A variety of other factors affect our sales and financial performance, including:

 

   

actions by our competitors, including opening of new stores in our existing markets or changes to the way these competitors go to market online,

 

   

seasonal fluctuations due to weather conditions,

 

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changes in our merchandise strategy and mix,

 

   

changes in population and other demographics, and

 

   

timing of our promotional events.

Accordingly, our results for any one quarter are not necessarily indicative of the results to be expected for any other quarter, and comparable store sales for any particular future period may increase or decrease. For more information on our results of operations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this report on Form 10-K.

We rely on foreign sources for significant amounts of our merchandise, and our business may therefore be negatively affected by the risks associated with international trade.

We depend on a large number of products produced in foreign markets. We face risks associated with the delivery of merchandise originating outside the United States, including:

 

   

potential economic and political instability in countries where our suppliers are located,

 

   

increases in shipping costs,

 

   

transportation delays and interruptions,

 

   

adverse fluctuations in currency exchange rates, and

 

   

changes in U.S. and foreign laws affecting the importation and taxation of goods, including duties, tariffs and quotas, or changes in the enforcement of those laws.

We rely extensively on computer systems to process transactions, summarize results and manage our business. Disruptions in these systems could harm our ability to run our business.

Given the number of individual transactions we have each year, it is critical that we maintain uninterrupted operation of our computer and communications hardware and software systems. Our systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches, including breaches of our transaction processing or other systems that result in the compromise of confidential customer data, catastrophic events such as fires, tornadoes and hurricanes, and usage errors by our employees. If our systems are breached, damaged or cease to function properly, we may have to make a significant investment to fix or replace them, we may suffer interruptions in our operations in the interim, we may face costly litigation, and our reputation with our customers may be harmed. Any material interruption in our computer operations may have a material adverse effect on our business or results of operations. In addition, we are pursuing complex initiatives to transform our information technology processes and systems. The risk of disruption is increased in periods where such complex and significant systems changes are undertaken.

We rely on third parties to provide us with services in connection with the administration of certain aspects of our business.

We have entered into agreements with third-party service providers (both domestic and overseas) to provide processing and administrative functions over a broad range of areas, and we may continue to do so in the future. These areas include finance and accounting, information technology, call center, human resources and procurement functions. Services provided by third parties as a part of outsourcing initiatives could be interrupted as a result of many factors, such as acts of God or contract disputes, and any failure by third parties to provide us with these services on a timely basis or within our service level expectations and performance standards could result in a disruption of our business. In addition, to the extent we are unable to maintain our outsourcing arrangements, we would incur substantial costs, including costs associated with hiring new employees, in order to return these services in-house.

 

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We could incur charges due to impairment of goodwill, intangible and long-lived assets.

At January 29, 2011, we had goodwill and intangible asset balances of $4.5 billion, which are subject to periodic testing for impairment. Our long-lived assets, primarily stores, also are subject to periodic testing for impairment. A significant amount of judgment is involved in the periodic testing. Failure to achieve sufficient levels of cash flow within each of our reporting units, for sales of our branded products or at individual store locations could result in impairment charges for goodwill and intangible assets or fixed asset impairment for long-lived assets, which could have a material adverse effect on our reported results of operations. Impairment charges, if any, resulting from the periodic testing are non-cash. Our goodwill impairment analysis also includes a comparison of the aggregate estimated fair value of all reporting units to our total market capitalization. Therefore, a significant and sustained decline in our stock price could result in goodwill impairment charges. During times of financial market volatility, significant judgment is used to determine the underlying cause of the decline and whether stock price declines are short-term in nature or indicative of an event or change in circumstances. See Note 13 to our Consolidated Financial Statements for further information.

The loss of key personnel may disrupt our business and adversely affect our financial results.

We depend on the contributions of key personnel, including Edward S. Lampert (chairman) and other key employees, for our future success. Although certain executives have employment agreements with us, changes in our senior management and any future departures of key employees may disrupt our business and materially adversely affect our results of operations.

Affiliates of our Chairman, whose interests may be different than your interests, exert substantial influence over our Company.

Affiliates of Edward S. Lampert, the Chairman of our Board of Directors, beneficially own approximately 60% of the outstanding shares of our common stock. These affiliates are controlled, directly or indirectly, by Mr. Lampert. Accordingly, these affiliates, and thus Mr. Lampert, have substantial influence over many, if not all, actions to be taken or approved by our shareholders, including the election of directors and any transactions involving a change of control.

The interests of these affiliates, which have investments in other companies, may from time to time diverge from the interests of our other shareholders, particularly with regard to new investment opportunities. This substantial influence may have the effect of discouraging offers to acquire our Company because the consummation of any such acquisition would likely require the consent of these affiliates.

We may be subject to product liability claims if people or properties are harmed by the products we sell or the services we offer.

Some of the products we sell may expose us to product liability claims relating to personal injury, death, or property damage caused by such products, and may require us to take actions such as product recalls. We also provide various services, which could also give rise to such claims. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all.

We may be subject to periodic litigation and other regulatory proceedings. These proceedings may be affected by changes in laws and government regulations or changes in the enforcement thereof.

From time to time, we may be involved in lawsuits and regulatory actions relating to our business, certain of which may be in jurisdictions with reputations for aggressive application of laws and procedures against corporate defendants. We are impacted by trends in litigation, including class-action allegations brought under various consumer protection and employment laws, including wage and hour laws. Due to the inherent

 

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uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, these proceedings could result in substantial costs and may require that we devote substantial resources to defend our Company. Further, changes in governmental regulations both in the United States and in the other countries where we operate could have adverse effects on our business and subject us to additional regulatory actions. For a description of current legal proceedings, see Item 3, “Legal Proceedings,” as well as Note 19 to the Consolidated Financial Statements in this report on Form 10-K.

Our pension and postretirement benefit plan obligations are currently underfunded, and we may have to make significant cash payments to some or all of these plans, which would reduce the cash available for our businesses.

We have unfunded obligations under our domestic and foreign pension and postretirement benefit plans. The funded status of our pension plans is dependent upon many factors, including returns on invested assets, the level of certain market interest rates and the discount rate used to determine pension obligations. Unfavorable returns on the plan assets or unfavorable changes in applicable laws or regulations could materially change the timing and amount of required plan funding, which would reduce the cash available for our businesses. In addition, a decrease in the discount rate used to determine pension obligations could result in an increase in the valuation of pension obligations, which could affect the reported funding status of our pension plans and future contributions, as well as the periodic pension cost in subsequent years.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

The following table summarizes the locations of our Kmart and Sears Domestic stores at January 29, 2011:

 

     Kmart      Sears Domestic  

State/Territory

   Discount
Stores
     Super
Centers
     Full-line
Mall Stores
     Sears
Essentials/
Grand Stores
     Specialty
Stores
 

Alabama

     25         —           11         2         30   

Alaska

     —           —           3         —           3   

Arizona

     17         —           14         1         20   

Arkansas

     5         —           7         —           36   

California

     100         —           80         8         146   

Colorado

     17         —           13         2         24   

Connecticut

     7         —           8         1         13   

Delaware

     6         —           4         —           5   

District of Columbia

     —           —           —           —           1   

Florida

     88         —           54         5         44   

Georgia

     36         —           21         1         50   

Hawaii

     7         —           6         —           1   

Idaho

     8         —           6         —           6   

Illinois

     55         4         37         6         60   

Indiana

     33         4         20         —           42   

Iowa

     24         —           11         —           23   

Kansas

     11         —           9         1         24   

Kentucky

     29         —           11         1         26   

 

10


     Kmart      Sears Domestic  

State/Territory

   Discount
Stores
     Super
Centers
     Full-line
Mall Stores
     Sears
Essentials/
Grand Stores
     Specialty
Stores
 

Louisiana

     11         —           13         —           23   

Maine

     6         —           6         —           12   

Maryland

     21         —           19         2         12   

Massachusetts

     18         —           21         1         12   

Michigan

     72         6         26         2         39   

Minnesota

     28         —           12         —           41   

Mississippi

     6         —           8         —           25   

Missouri

     25         —           11         4         51   

Montana

     10         —           3         —           7   

Nebraska

     8         —           4         —           11   

Nevada

     10         —           4         1         10   

New Hampshire

     6         —           6         2         8   

New Jersey

     36         —           20         2         20   

New Mexico

     15         —           7         —           10   

New York

     55         1         45         —           35   

North Carolina

     47         —           25         —           40   

North Dakota

     7         —           4         —           5   

Ohio

     58         9         41         2         59   

Oklahoma

     9         —           11         —           20   

Oregon

     14         —           9         —           26   

Pennsylvania

     95         2         45         2         38   

Rhode Island

     1         —           2         —           2   

South Carolina

     27         —           14         1         18   

South Dakota

     9         —           2         —           5   

Tennessee

     34         —           23         —           26   

Texas

     20         —           59         1         109   

Utah

     15         —           5         2         11   

Vermont

     3         —           2         —           10   

Virginia

     41         2         23         1         29   

Washington

     18         —           23         —           18   

West Virginia

     16         1         8         —           9   

Wisconsin

     32         —           15         1         40   

Wyoming

     9         —           2         —           7   

Puerto Rico

     23         —           9         —           11   

U.S. Virgin Islands

     4         —           —           —           —     

Guam

     1         —           —           —           1   
                                            

Totals

     1,278         29         842         52         1,354   
                                            

 

11


 

     Kmart      Sears Domestic      Sears Canada      Total  
     Discount
Stores
     Super
Centers
     Full-line
Mall Stores
     Sears
Essentials/
Grand Stores
     Specialty
Stores
     Full-line
Stores
     Specialty
Stores
    

Owned

     177         20         514         17         90         14         2         834   

Leased

     1,101         9         328         35         324         108         72         1,977   

Independently-owned and operated stores

     —           —           —           —           940         —           287         1,227   
                                                                       

Stores at January 29, 2011

     1,278         29         842         52         1,354         122         361         4,038   
                                                                       

In addition, at January 29, 2011, we had 38 domestic supply chain distribution centers, of which 12 were owned and 26 were leased for terms ranging from 3 to 5 years. Of the total, 11 primarily support Kmart store locations, 23 primarily support Sears stores and 4 support both Sears and Kmart stores. We also had 480 domestic store warehouses, customer call centers and service facilities (including 26 facilities related to our appliance builder/distributor business), most of which are leased for terms ranging generally from 3 to 5 years or are part of other facilities included in the above table.

Our principal executive offices are located on a 200-acre site owned by us at the Prairie Stone office park in Hoffman Estates, Illinois. The complex consists of six interconnected office buildings totaling approximately two million gross square feet of office space. In addition, we have a campus in Dodgeville, Wisconsin supporting the corporate headquarters, distribution center and customer sales/service operations for Land’s End. We also own an 86,000 square foot office building in Troy, Michigan. We operate numerous buying offices throughout the world that procure product internationally, as well as an information technology center in Pune, India.

At January 29, 2011, Sears Canada operated a total of 122 full-line stores, 361 specialty stores (including 48 furniture and appliance stores, 268 dealer stores operated under independent local ownership, 4 appliance and mattress stores, 30 Corbeil stores, and 11 outlet stores), 20 floor covering stores, 1,822 catalog pick-up locations and 108 travel offices.

In August 2007, Sears Canada sold its headquarters office building and adjacent land in Toronto, Ontario. Sears Canada leased back the property under a leaseback agreement through March 2009, at which time it finished its relocation of all head office operations to previously underutilized space in the Toronto Eaton Centre, Ontario. See Note 12 to our Consolidated Financial Statements for further information on this transaction.

A description of our leasing arrangements and commitments appears in Note 15 of Notes to Consolidated Financial Statements.

 

Item 3. Legal Proceedings

Item 103 of SEC Regulation S-K requires that we disclose legal proceedings to which the Company and a governmental authority is a party and that arise under laws dealing with the discharge of materials into the environment or the protection of the environment, if the proceeding reasonably involves potential monetary sanctions of $100,000 or more. Disclosure also is required as to any such proceedings known by us to be contemplated by governmental authorities. In that connection, we note that our Orchard Supply Hardware subsidiary (“OSH”) has received a notice of violation from the California South Coast Air Quality Management District (“SCAQMD”) alleging that OSH stores that are located in the SCAQMD jurisdiction sold architectural coating products that exceed the current SCAQMD limitations on volatile organic compounds. The parties are currently negotiating toward a resolution of this matter.

See Part II, Item 8, “Financial Statements—Notes to Consolidated Financial Statements,” Note 19—“Legal Proceedings,” for additional information regarding legal proceedings, which information is incorporated herein by this reference.

 

12


EXECUTIVE OFFICERS OF THE REGISTRANT

The following table and information sets forth the names of our executive officers, their current positions and offices with the Company, the date they first became executive officers of the Company, their current ages, and their principal employment during the past five years.

 

Name

 

Position

  Date First
Became
an
Executive
Officer
    Age  

Louis J. D’Ambrosio

  Chief Executive Officer and President     2011        46   

Scott J. Freidheim

  Executive Vice President and President – Kenmore, Craftsman & DieHard     2009        45   

John D. Goodman

  Executive Vice President, Apparel and Home     2009        46   

W. Bruce Johnson

  Executive Vice President – Off-Mall Businesses and Supply Chain     2005     59   

Michael D. Collins

  Senior Vice President and Chief Financial Officer     2008        47   

Dane A. Drobny

  Senior Vice President, General Counsel and Corporate Secretary     2010        43   

William R. Harker

  Senior Vice President     2006        38   

William K. Phelan

  Senior Vice President, Controller and Chief Accounting Officer     2005     48   

 

* Became an executive officer of Holdings upon the completion of the Merger on March 24, 2005.

Mr. D’Ambrosio joined the Company as our Chief Executive Officer and President in February 2011. He served as the President and Chief Executive Officer of Avaya Inc. from July 2006 to June 2008. He also served as a director of Avaya from November 2006 to June 2008. Mr. D’Ambrosio was previously Avaya’s Senior Vice President and President, Global Sales and Marketing from November 2005 until July 2006. From January 2004 until November 2005, Mr. D’Ambrosio served as Avaya’s Group Vice President, Global Sales, Channels and Marketing. From December 2002 until December 2003, Mr. D’Ambrosio was Avaya’s Group Vice President, Avaya Global Services. Before joining Avaya, Mr. D’Ambrosio spent 16 years at International Business Machines Corporation, where he held several executive posts and was a member of the worldwide management committee. His roles included leading strategy for global services, sales and marketing for software, and industry operations for Asia Pacific. Mr. D’Ambrosio currently serves as the Non-Executive Chairman of the Board of Directors of Sensus (Bermuda 2) Ltd. and Sensus USA Inc., a clean technology company.

Mr. Freidheim joined the Company as Executive Vice President, Operating and Support Businesses in January 2009. In February 2011, Mr. Freidheim was elected Executive Vice President, President-Kenmore, Craftsman & DieHard. Prior to joining the Company, Mr. Freidheim served as an Executive Vice President and Chief Administrative Officer from September 2008 to December 2008 and Executive Vice President and Co-Chief Administrative Officer of Lehman Brothers Holdings Inc. (“Lehman Brothers”) from October 2006 to September 2008. Mr. Freidheim also served as Managing Director—Office of the Chairman from 1996 to 2007. Mr. Freidheim served as Global Head of Strategy of Lehman Brothers from 2005 to 2007 and Global Head of Corporate Communications, Advertising, Marketing and Brand of Lehman Brothers from 2003 to 2007. In September 2008, Lehman Brothers filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court for the Southern District of New York.

Mr. Goodman joined the Company as Executive Vice President, Apparel and Home in November 2009. Mr. Goodman also served as our President, Kmart Apparel from November 2009 until February 2010. Mr. Goodman, who served as Chief Apparel and Home Officer from January 2004 until May 2005 for Kmart, was the Chief Executive Officer for apparel retailer Charlotte Russe Holding Inc. from November 2008 to October 2009. He served as the President and Chief Executive Officer of Mervyn’s LLC, a department store chain, from April 2008 to October 2008 and as President of the Dockers® brand at Levi Strauss and Co., an apparel company, from May 2005 to April 2008. In July 2008, Mervyn’s LLC filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court for the District of Delaware. In October 2008, Mervyn’s LLC announced that it would liquidate its assets through Chapter 7 of the United States Bankruptcy Code.

 

13


Mr. Johnson was elected as the Company’s Executive Vice President—Off-Mall Businesses and Supply Chain in February 2011. He served as the Company’s interim Chief Executive Officer and President from February 2008 to February 2011. He previously served as the Company’s Executive Vice President, Supply Chain and Operations since the Merger. He joined Kmart in October 2003 as Senior Vice President, Supply Chain and Operations.

Mr. Collins joined the Company in October 2008 as Senior Vice President, Financial Planning and Analysis. In December 2008, he was elected Senior Vice President and Chief Financial Officer. Prior to joining the Company, Mr. Collins served as Senior Vice President, Planning and Analysis, at General Electric Company’s NBC Universal Division from March 2004 to October 2008. Mr. Collins worked in a variety of finance positions in his 18-year career at General Electric Company.

Mr. Drobny joined us as Senior Vice President, General Counsel and Corporate Secretary in May 2010. Prior to joining Holdings, he practiced law with the law firm of Winston & Strawn LLP, most recently as Capital Partner, from September 1993 until May 2010.

Mr. Harker joined the Company as Vice President and Chief Counsel in September 2005. He became Vice President, Acting General Counsel and Corporate Secretary in January 2006. In April 2006, Mr. Harker was elected Senior Vice President, Acting General Counsel and Corporate Secretary. He served as the Company’s General Counsel and Corporate Secretary from December 2006 to May 2010 and also served as our Senior Vice President, Human Resources, from February 2008 to August 2009. Prior to joining Holdings, he practiced corporate law with the law firm of Wachtell, Lipton, Rosen and Katz. Mr. Harker is also the Executive Vice President and General Counsel of ESL Investments, Inc., a private investment firm, and has served in that capacity since February 2011. Mr. Harker has served as a director of Sears Canada since November 2008.

Mr. Phelan was elected Senior Vice President and Controller of the Company in September 2007. From December 2007 until December 2008, Mr. Phelan also served as the Company’s Treasurer. From the consummation of the Merger until September 2007, Mr. Phelan served as Vice President and Controller. Prior to the consummation of the Merger, he served as Assistant Controller of Sears.

 

14


PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Holdings’ common stock is quoted on The NASDAQ Stock Market under the ticker symbol SHLD. There were 16,320 shareholders of record at February 28, 2011. The quarterly high and low sales prices for Holdings’ common stock are set forth below.

 

     Fiscal Year 2010  
     Sears Holdings  
     First
Quarter
     Second
Quarter
     Third
Quarter
     Fourth
Quarter
 

Common stock price

           

High

   $ 124.96       $ 125.42       $ 78.92       $ 79.97   

Low

   $ 88.36       $ 59.21       $ 60.12       $ 62.02  
     Fiscal Year 2009  
     Sears Holdings  
     First
Quarter
     Second
Quarter
     Third
Quarter
     Fourth
Quarter
 

Common stock price

           

High

   $ 63.57       $ 71.99       $ 79.35       $ 106.06   

Low

   $ 34.27       $ 49.80       $ 60.30       $ 65.71   

Holdings has not paid and does not expect to pay dividends in the foreseeable future.

Equity Compensation Plan Information

The following table reflects information about securities authorized for issuance under our equity compensation plans at January 29, 2011.

 

Plan Category

   (a)
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and
rights
     (b)
Weighted-average
exercise price of
outstanding
options,
warrants and
rights
     (c)
Number of securities
remaining available for
future issuance
under equity
compensation plans*
 

Equity compensation plans approved by security holders

     —           —           529,586   

Equity compensation plans not approved by security holders

     —           —           —     

Total

     —           —           529,586   

 

* Represents shares of common stock that may be issued pursuant our 2006 Stock Plan. Excludes shares covered by an outstanding plan award that, subsequent to January 29, 2011, ultimately are not delivered on an unrestricted basis (for example, because the award is forfeited, canceled, settled in cash or used to satisfy tax withholding obligations). Awards under the 2006 Stock Plan may be restricted stock awards, a grant of shares of our common stock in connection with an award made under a long-term incentive plan, or certain other awards.

 

15


Stock Performance Graph

Comparison of Five-Year Cumulative Stockholder Return

The following graph compares the cumulative total return to stockholders on Holdings’ common stock from January 27, 2006 through January 28, 2011, the last trading day before the end of our 2010 year, with the return on the S&P 500 Stock Index, the S&P 500 Retailing Index and the S&P 500 Department Stores Index for the same period. The graph assumes an initial investment of $100 on January 27, 2006 in each of our common stock, the S&P 500 Stock Index, the S&P Retailing Index and the S&P 500 Department Stores Index.

The S&P 500 Retailing Index consists of companies included in the S&P 500 Stock Index in the broadly defined retail sector, which includes competing retailers of softlines (apparel and domestics) and hardlines (appliances, electronics and home improvement products), as well as food and drug retailers. The S&P 500 Department Stores Index consists primarily of department stores that compete with our full-line stores.

LOGO

 

     Jan. 27,
2006
     Feb. 2,
2007
     Feb. 1,
2008
     Jan. 30,
2009
     Jan. 29,
2010
     Jan. 28,
2011
 

Sears Holdings

   $ 100.00       $ 143.79       $ 87.92       $ 33.22       $ 75.72       $ 61.76   

S&P 500 Stock Index

   $ 100.00       $ 115.03       $ 112.92       $ 68.46       $ 91.15       $ 110.53   

S&P 500 Retailing Index

   $ 100.00       $ 115.11       $ 93.95       $ 58.51       $ 91.01       $ 115.96   

S&P 500 Department Stores Index

   $ 100.00       $ 143.82       $ 91.83       $ 43.37       $ 72.51       $ 83.16   

 

16


Purchase of Equity Securities

The following table provides information about shares of common stock we acquired during the fourth quarter of 2010. During the quarter ended January 29, 2011, we repurchased 1.2 million of our common shares at a total cost of $77 million under our common share repurchase program. At January 29, 2011, we had $187 million of remaining authorization under the program.

 

     Total
Number of
Shares
Purchased(1)
     Average
Price Paid
per Share
     Total Number of
Shares
Purchased
as Part of
Publicly
Announced
Program(2)
     Average Price
Paid per Share
for Publicly
Announced
Program
     Approximate
Dollar Value of
Shares that
May Yet Be
Purchased
Under the
Program
 

October 31, 2010 to November 27, 2010

     281,657       $ 63.75         278,638       $ 63.72      

November 28, 2010 to January 1, 2011

     886,733         67.18         882,448         67.18      

January 2, 2011 to January 29, 2011

     1,913         75.68         —           —        
                                            

Total

     1,170,303       $ 66.37         1,161,086       $ 71.76       $ 187,000,000   
                                            

 

(1)

Includes 9,217 shares acquired from associates to meet withholding tax requirements from the vesting of restricted stock. These shares were acquired during the quarter as follows:

 

October 31, 2010 to November 27, 2010

     3,019   

November 28, 2010 to January 1, 2011

     4,285   

January 2, 2011 to January 29, 2011

     1,913   
        

Total

     9,217   
        

 

(2)

Our common share repurchase program was initially announced on September 14, 2005 and has a total authorization since inception of the program of $6.0 billion. The program has no stated expiration date.

 

17


Item 6. Selected Financial Data

The table below summarizes our recent financial information. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and our Consolidated Financial Statements and notes thereto in Item 8.

 

     Fiscal  
dollars in millions, except per share and store data    2010     2009     2008     2007     2006(1)  

Summary of Operations

          

Total revenues(2)

   $ 43,326      $ 44,043      $ 46,770      $ 50,703      $ 53,016   

Domestic comparable sales %

     (1.6 )%      (5.1 )%      (8.0 )%      (4.3 )%      (3.7 )% 

Net income attributable to Holdings’ shareholders(3)

     133        235        53        826        1,492   

Per Common Share

          

Basic:

          

Net income attributable to Holdings’ shareholders

   $ 1.19      $ 1.99      $ 0.42      $ 5.71      $ 9.59   

Diluted:

          

Net income attributable to Holdings’ shareholders

   $ 1.19      $ 1.99      $ 0.42      $ 5.70      $ 9.58   

Holdings’ book value per common share

   $ 78.19      $ 79.21      $ 76.91      $ 80.59      $ 82.60   

Financial Data

          

Total assets

   $ 24,268      $ 24,808      $ 25,342      $ 27,397      $ 29,906   

Long-term debt

     2,130        1,123        1,527        1,922        2,109   

Long-term capital lease obligations

     533        575        605        684        734   

Capital expenditures

     441        361        497        570        508   

Number of stores

     4,038        3,950        3,948        3,876        3,820   

 

(1)

During the fourth quarter of 2007, Sears Canada changed its year end from the Saturday nearest December 31st to the Saturday nearest January 31st. This change was retrospectively applied to prior year amounts reported in the 2006 column as required by accounting standards for reporting changes in accounting.

 

(2)

We follow a retail-based financial reporting calendar. Accordingly, our 2006 results reflect the 53-week period ended February 3, 2007 whereas years 2010, 2009, 2008, and 2007 contained 52-weeks.

 

(3)

The periods presented were impacted by certain significant items, which affected the comparability of amounts reflected in the above selected financial data. For 2010, 2009, and 2008, these significant items are discussed within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 2007 results include the impact of a $14 million loss derived from our investments in total return swaps, a $27 million curtailment gain recorded in connection with changes made to Sears Canada’s benefit plans and a $19 million gain related to insurance recoveries for certain Sears Domestic properties damaged by hurricanes during 2005. 2006 results include the impact of a $74 million gain derived from our investments in total return swaps, $36 million related to the June 2006 settlement of Visa/MasterCard antitrust litigation, a tax benefit of $31 million related to the resolution of certain income tax matters, restructuring charges of $28 million, a $41 million gain on the sale of Kmart’s former headquarters building, and a charge of $74 million related to an unfavorable verdict in connection with a legal settlement.

 

18


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

We have divided our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” into the following six sections:

 

   

Overview of Holdings

 

   

Results of Operations:

Fiscal Year

Holdings’ Consolidated Results

Business Segment Results

 

   

Analysis of Consolidated Financial Condition

 

   

Contractual Obligations and Off-Balance Sheet Arrangements

 

   

Application of Critical Accounting Policies and Estimates

 

   

Cautionary Statement Regarding Forward-Looking Information

The discussion that follows should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8.

OVERVIEW OF HOLDINGS

Holdings is the parent company of Kmart and Sears. We are a broadline retailer and, at the end of 2010, had 2,201 Kmart and domestic full-line stores and 1,354 specialty retail stores in the United States operating through Kmart and Sears and 483 full-line and specialty retail stores in Canada operating through Sears Canada, a 92%-owned subsidiary.

We currently conduct our operations in three reportable business segments: Kmart, Sears Domestic and Sears Canada. The nature of operations conducted within each of these segments is discussed within the “Business Segments” section of Item 1 in this report on Form 10-K. Our business segments have been determined in accordance with accounting standards regarding the determination, and reporting, of business segments.

The retail industry is highly competitive and as such, Holdings faces significant challenges, including the current macroeconomic environment, as many of our product categories are impacted by the housing market and availability of credit to our customers. The retail industry is also rapidly evolving as retail is increasingly impacted by new technologies and social media. We believe that this evolution provides us with significant growth opportunities, if we are able to transform our portfolio of businesses by leveraging our existing store network with emerging technologies to develop lasting relationships with our customers. Over the past 12 months, we have worked hard to improve our stores, while also taking steps to reposition ourselves for retail in the 21st century.

Our existing store base is a significant asset, as our 4,000 stores provide us with a physical presence in almost all major communities in the United States and Canada. We have been working to improve our existing stores in a number of ways. First and foremost, we are using technology to transform our store experiences and we continue to innovate as an integrated retailer, offering our customers a seamless experience across channels under the Shop Your Way banner. Shop Your Way represents our commitment to providing our customers the opportunity to buy whatever they want, wherever they want and whenever they want. Second, we have developed a framework for experimentation across business units in some of our most important markets and have identified several initiatives to be rolled out based on test results and customer feedback. Third, our efforts to improve basic store execution produced nearly double-digit increases in our customer service scores year-over-year at both Sears and Kmart.

 

19


Improving our store experience is just one part of becoming the preferred destination for our customers. We have focused much of our efforts in emerging areas of retail, like our rewards program and our online platforms.

We launched our Shop Your Way Rewards program late in 2009 and continued to grow membership and capabilities in 2010. The Shop Your Way Rewards program is intended to transition Sears Holdings from serving customers to building relationships with members. We believe that Shop Your Way Rewards will allow us to learn more about our individual customers and therefore position us to better meet their needs. The Shop Your Way Rewards program will also enhance our ability to communicate with customers digitally. Such digital communication tools present a new opportunity to personalize our messages and make them more individually relevant.

We also made a great deal of progress in 2010 on our online and mobile properties. We greatly expanded our assortment, improved our website performance and multichannel capabilities, created innovative mobile apps, and developed social capabilities. Several industry sources recognized us for the speed and performance of our website during the holidays. Other specific examples include:

 

   

We grew our Marketplace assortment to more than 17 million items. The Sears.com Marketplace provides sellers with access to millions of customers through a variety of fulfillment options.

 

   

MyGofer expanded its fulfillment options in a variety of ways, as well as serving as the engine behind additional integrated retail efforts. MyGofer.com provides features and benefits designed to create a one-stop shopping experience, offering a range of quality products including groceries, prescriptions, health and beauty products, and electronics. MyGofer was created to provide our customers with speed and convenience – the same day a customer places an order, it is ready within hours, with pickup now available in over 600 stores.

 

   

With regards to social media, we deployed a variety of campaigns and applications to make our experiences more engaging and “sticky,” both on sites like Facebook and Twitter, as well as on sears.com. Social shopping platforms empower customers to get real-time feedback and recommendations from personal, extended and local networks, thus allowing them to make more informed, smarter shopping decisions. A variety of different experiences are currently available on the web and on mobile phones that allow customers to take advantage of social tools including liking, sharing, rating and reviewing products. We intend to build on our early learnings to make social shopping more central to our overall experiences.

We will continue to invest in our online properties. By integrating our vast store network with our online properties, we believe that Sears Holdings will succeed in the rapidly evolving retail environment. The web and mobile platforms integrate shopping and marketing in a very different way than stores and traditional media have in the past.

RESULTS OF OPERATIONS

Fiscal Year

Our fiscal year end is the Saturday closest to January 31st each year. Fiscal years 2010, 2009 and 2008 all consisted of 52 weeks. Unless otherwise stated, references to years in this report relate to fiscal years rather than to calendar years. The following fiscal periods are presented in this report.

 

Fiscal year

   Ended      Weeks  

2010

     January 29, 2011         52   

2009

     January 30, 2010         52   

2008

     January 31, 2009         52   

 

20


Holdings’ Consolidated Results

Holdings’ consolidated results of operations for 2010, 2009, and 2008 are summarized as follows:

 

millions, except per share data    2010     2009     2008  

REVENUES

      

Merchandise sales and services

   $ 43,326      $ 44,043      $ 46,770   
                        

COSTS AND EXPENSES

      

Cost of sales, buying and occupancy

     31,448        31,824        34,118   

Gross margin dollars

     11,878        12,219        12,652   

Margin rate

     27.4     27.7     27.1

Selling and administrative

     10,571        10,654        11,060   

Selling and administrative expense as a percentage of revenues

     24.4     24.2     23.6

Depreciation and amortization

     900        926        981   

Impairment charges

     —          —          360   

Gain on sales of assets

     (67     (74     (51
                        

Total costs and expenses

     42,852        43,330        46,468   
                        

Operating income

     474        713        302   

Interest expense

     (310     (265     (272

Interest and investment income

     36        33        46   

Other income (loss)

     (14     (61     108   
                        

Income before income taxes

     186        420        184   

Income taxes

     (36     (123     (85
                        

Net income

     150        297        99   

Income attributable to noncontrolling interests

     (17     (62     (46
                        

NET INCOME ATTRIBUTABLE TO HOLDINGS’ SHAREHOLDERS

   $ 133      $ 235      $ 53   
                        

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO HOLDINGS’ SHAREHOLDERS

      

Diluted earnings per share

   $ 1.19      $ 1.99      $ 0.42   

Diluted weighted average common shares outstanding

     111.7        117.9        127.0   

References to comparable store sales amounts within the following discussion include sales for all stores operating for a period of at least 12 full months, including remodeled and expanded stores, but excluding store relocations and stores that have undergone format changes. Comparable store sales results for 2010 were calculated based on the 52-week period ended January 29, 2011.

2010 Compared to 2009

Net Income Attributable to Holdings’ Shareholders

We recorded net income attributable to Holdings’ shareholders of $133 million ($1.19 per diluted share) for 2010 and $235 million ($1.99 per diluted share) in 2009. Our results for 2010 and 2009 were affected by a number of significant items. Our net income, as adjusted for these significant items was $231 million ($2.07 per diluted share) for 2010 and $376 million ($3.19 per diluted share) for 2009. The decrease in net income for the year reflects a decrease in operating income of $239 million, primarily due to a decline in gross margin, due to lower overall revenues, partially offset by a decline in selling and administrative expenses.

In addition to net income determined in accordance with GAAP, we use certain non-GAAP measures in assessing our operating performance. We believe GAAP measures “As Adjusted” serve as appropriate measures to be used in evaluating the performance of our business and we adjust incentive compensation metrics for our

 

21


executive management team for these same items. Furthermore, we believe our use of GAAP measures “As Adjusted,” including Diluted Income per Share “As Adjusted,” provides an appropriate measure to use in assessing our performance across periods, given that this measure provides an adjustment for certain significant items, the magnitude of which may vary significantly from period to period and, thereby, have a disproportionate effect on the earnings we report for a given period. Accordingly, we consider the aggregate impact of these items, along with reported results, in reviewing and evaluating our financial performance. However, we do not, and do not recommend that you solely use GAAP measures “As Adjusted” to assess our financial performance or to formulate investment decisions, as the measures may exclude a number of important cash and non-cash recurring items. The following tables set forth results of operations on a GAAP and “As Adjusted” basis, as well as the impact each significant item had on specific income and expense amounts reported in our Consolidated Statements of Income during years 2010, 2009 and 2008.

 

    Fiscal 2010 (Year ended January 29, 2011)  
millions, except per share data   GAAP     Domestic
Pension
Expense
    Mark-to-
Market
Losses
    Closed Store
Reserve and
Severance
    Gain on Sale
of Real
Estate
    Canadian
Dividend Tax
Impact
    Tax
Matters
    As
Adjusted
 

Cost of sales, buying and occupancy impact

  $ 31,448      $ —        $ —        $ (12   $ —        $ —        $ —        $ 31,436   

Selling and administrative impact

    10,571        (120     —          (14     —          —          —          10,437   

Depreciation and amortization impact

    900        —          —          (10     —          —          —          890   

Gain on sales of assets impact

    (67     —          —          —          35        —          —          (32

Operating income impact

    474        120        —          36        (35     —          —          595   

Other loss impact

    (14     —          6        —          —          —          —          (8

Income tax expense impact

    (36     (24     (1     (6     7        9        (13     (64

Noncontrolling interest impact

    (17     —          (1     —          —          —          —          (18

After tax and noncontrolling interest impact

    133        96        4        30        (28     9        (13     231   

Diluted income per share impact

  $ 1.19      $ 0.86      $ 0.04      $ 0.27      $ (0.25   $ 0.08      $ (0.12   $ 2.07   

 

    Fiscal 2009 (Year ended January 30, 2010)  
millions, except per share data   GAAP     Domestic
Pension
Expense
    Mark-to-
Market
Gains
    Closed Store
Reserve and
Severance
    Gain on Sale
of Sears
Canada
Headquarters
    Visa /
MasterCard
Settlement
    Tax
Matters
    As
Adjusted
 

Cost of sales, buying and occupancy impact

  $ 31,824      $ —        $ —        $ (37   $ —        $ —        $ —        $ 31,787   

Selling and administrative impact

    10,654        (170     —          (82     —          32        —          10,434   

Depreciation and amortization impact

    926        —          —          (12     —          —          —          914   

Gain on sales of assets impact

    (74     —          —          —          44        —          —          (30

Operating income impact

    713        170        —          131        (44     (32     —          938   

Other loss impact

    (61     —          33        —          —          —          —          (28

Income tax expense impact

    (123     (50     (8     (38     10        10        (41     (240

Noncontrolling interest impact

    (62     —          (9     (3     12        —          —          (62

After tax and noncontrolling interest impact

    235        120        16        90        (22     (22     (41     376   

Diluted income per share impact

  $ 1.99      $ 1.02      $ 0.14      $ 0.77      $ (0.19   $ (0.19   $ (0.35   $ 3.19   

 

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    Fiscal 2008 (Year ended January 31, 2009)  
millions, except per share data   GAAP     Impairments     Mark-to-
Market
Gains
    Closed Store
Reserve and
Severance
    Legal
Settlement
    Repurchase
of Debt
Securities
    Tax
Matters
    As
Adjusted
 

Cost of sales, buying and occupancy impact

  $ 34,118      $ —        $ —        $ (36   $ —        $ —        $ —        $ 34,082   

Selling and administrative impact

    11,060        —          —          (41     62        —          —          11,081   

Impairment charges impact

    360        (360     —          —          —          —          —          —     

Operating income impact

    302        360        —          77        (62     —          —          677   

Interest expense impact

    (272     —          —          —          —          (13     —          (285

Other income impact

    108        —          (81     —          —          —          —          27   

Income tax expense impact

    (85     (107     26        (30     25        5        (8     (174

Noncontrolling interest impact

    (46     (52     22        —          —          —          —          (76

After tax and noncontrolling interest impact

    53        201        (33     47        (37     (8     (8     215   

Diluted income per share impact

  $ 0.42      $ 1.57      $ (0.26   $ 0.37      $ (0.29   $ (0.06   $ (0.06   $ 1.69   

Contributions to our pension plans remain a significant use of our cash on an annual basis. While Sears Holdings’ pension plan is frozen, and thus associates do not currently earn pension benefits, we have a legacy pension obligation for past service performed by Kmart and Sears, Roebuck and Co. associates. The annual pension expense included in our financial statements related to these legacy domestic pension plans was relatively minimal in years prior to 2009. However, due to the severe decline in the capital markets that occurred in the latter part of 2008, our domestic pension expense was $120 million in 2010 and $170 million in 2009.

During 2010, Sears Canada paid $754 million in dividends of which Holdings received $639 million. As Sears Canada is a consolidated subsidiary of Holdings, no income was recognized on the receipt of the dividend. However, Holdings did record $9 million of income tax expense related to the dividend.

Revenues and Comparable Store Sales

Revenues declined $717 million, or 1.6%, to $43 billion, in 2010 from $44 billion in 2009. The decrease was primarily due to lower comparable store sales and the impact of having fewer Kmart and Sears full-line stores in operation during 2010. Revenues included a $433 million increase due to foreign currency exchange rates.

Domestic comparable store sales declined 1.6% in the aggregate, with an increase at Kmart of 0.7% and a decline at Sears Domestic of 3.6% in 2010. The Kmart improvement was driven by increases in most categories, with higher increases in the apparel, footwear, jewelry, sporting goods and toys categories, partially offset by declines in the food and consumables and pharmacy categories. Declines in sales at Sears Domestic were primarily driven by the hardlines categories, as well as apparel. Over half of the total decline occurred in the consumer electronics category. In contrast, Sears’ footwear, jewelry and automotive categories generated comparable store sales growth during the period.

Gross Margin

We generated $11.9 billion in gross margin in 2010 and $12.2 billion in 2009. Current year gross margin dollars include an increase of $142 million related to the impact of foreign currency exchange rates and charges of $12 million for markdowns recorded in connection with store closings announced during 2010. Gross margin for 2009 included a $37 million charge for markdowns recorded in connection with store closings. Gross margin declined $341 million as compared to the prior year, primarily due to declines in sales and margin rate at Sears Domestic and Sears Canada, partially offset by an increase in gross margin and margin rate at Kmart.

 

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Sears Domestic’s gross margin as a percentage of merchandise sales and services revenue (“margin rate”) decreased 100 basis points mainly due to reduced margin rates in home services and appliances. Sears Canada’s margin rate declined 180 basis points due to price compression in the appliance and electronics categories, as well as an increase in promotional and clearance markdowns related to a challenging economic environment. These declines were partially offset by an increase in margin rate of 110 basis points at Kmart, in part as a result of an increase in sales of higher margin categories such as apparel and sporting goods.

The cost of our merchandise sales and services is impacted by commodity prices for various raw materials, such as cotton, oil-related materials, steel and rubber, which could result in increases in prices that we pay for merchandise. This may adversely affect our results in 2011.

Selling and Administrative Expenses

Our selling and administrative expenses decreased $83 million in 2010 to $10.6 billion and included incremental expenses of $135 million related to our continued investment in our multi-channel capabilities and launch of our Shop Your Way Rewards program and an increase of $97 million related to the impact of foreign currency exchange rates. The decrease includes a $100 million reduction in payroll and benefits expense, a $31 million reduction in advertising expense and a $41 million reduction in insurance expense, as well as reductions in various other expense categories. Selling and administrative expenses for 2010 were impacted by domestic pension plan expense of $120 million and store closing costs and severance of $14 million. Selling and administrative expenses for 2009 were impacted by domestic pension plan expense of $170 million and store closing costs and severance of $82 million, partially offset by a gain of $32 million recorded in connection with the settlement of Visa/MasterCard antitrust litigation.

Selling and administrative expenses as a percentage of total revenues (“selling and administrative expense rate”) were 24.4% for 2010 and 24.2% for 2009. The increase in our selling and administrative expense rate is primarily the result of lower expense leverage given lower overall sales.

Depreciation and Amortization

Depreciation and amortization expense decreased by $26 million during 2010 to $900 million. The decrease is primarily attributable to having fewer assets available for depreciation.

Gain on Sales of Assets

We recorded a gain on the sales of assets of $67 million during 2010 and $74 million in 2009. Gain on sales of assets for 2010 and 2009 were impacted by the recognition of previously deferred gains on sales of assets.

We sold a Sears Auto Center in October 2006, at which time we leased back the property for a period of time. Given the terms of the contract, for accounting purposes, the excess of proceeds received over the carrying value of the associated property was deferred. We closed our operations at this location during the first quarter of 2010 and, as a result, recognized a gain of $35 million on this sale at that time.

Sears Canada sold its headquarters office building and adjacent land in Toronto, Ontario in August 2007. Sears Canada leased back the property under a leaseback agreement through March 2009, at which time it finished its relocation of all head office operations to previously underutilized space in the Toronto Eaton Centre, Ontario. Given the terms of the leaseback, for accounting purposes, the excess of proceeds received over the carrying value of the associated property was deferred, and the resulting $44 million gain was recognized when Sears Canada no longer occupied the associated property in 2009.

 

24


Operating Income

Operating income was $474 million for 2010 and $713 million for 2009. Operating income decreased $239 million and was the result of reductions in gross margin, partially offset by lower selling and administrative expenses. Operating income for 2010 includes expenses of $156 million related to domestic pension plans, store closings and severance and a $35 million gain recognized on the sale of a Sears Auto Center. Operating income for 2009 includes expenses of $301 million related to domestic pension plans, store closings and severance, a $44 million gain recognized by Sears Canada on the sale of its former headquarters, and a $32 million gain recorded in connection with the settlement of Visa/MasterCard antitrust litigation.

Interest Expense

We incurred $310 million in interest expense during 2010 and $265 million in 2009. Our interest expense increased primarily due to an increase in average total debt balances throughout 2010.

Other Income (Loss)

Other income (loss) is primarily comprised of mark-to-market and settlement gains and losses on Sears Canada hedge transactions. Total net mark-to-market and settlement losses of $15 million were recorded on these transactions in 2010. Total net mark-to-market and settlement losses of $67 million were recorded on these transactions in 2009. See Notes 4 and 5 to the Consolidated Financial Statements for further information regarding these transactions.

Income Taxes

Our effective tax rate was 19.4% in 2010 and 29.3% in 2009. The decrease in our tax rate is primarily due to lower taxable income and the resolution of certain federal and state income tax matters during 2010, which resulted in a $13 million tax benefit.

2009 Compared to 2008

Net Income Attributable to Holdings’ Shareholders

We recorded net income attributable to Holdings’ shareholders of $235 million ($1.99 per diluted share) for 2009 and $53 million ($0.42 per diluted share) in 2008. Our results for 2009 and 2008 were affected by a number of significant items. Our net income, as adjusted for these significant items was $376 million ($3.19 per diluted share) for 2009 and $215 million ($1.69 per diluted share) for 2008. The increase in net income for the year reflects an increase in operating income of $411 million, primarily due to a decline in selling and administrative expenses and the below noted significant items, partially offset by a decline in gross margin dollars.

Revenues and Comparable Store Sales

Revenues declined $2.8 billion, or 5.8%, to $44 billion, in 2009 from $46.8 billion in 2008. The decrease was primarily due to lower comparable store sales and the impact of having 62 fewer Kmart and Sears full-line stores in operation during 2009, and includes a $142 million decline due to foreign currency exchange rates.

Domestic comparable store sales declined 5.1% in the aggregate, and included a modest decline at Kmart of 0.8% and a decline at Sears Domestic of 8.7% in 2009. The decline in comparable store sales at Kmart was primarily driven by lower sales in the apparel and food and consumables categories, partially offset by increases in the toys category, as well as the benefit of assuming the operations of its footwear business from a third party effective January 2009. Declines in sales at Sears Domestic reflect decreases in the home appliance, lawn & garden, and home electronics categories.

 

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Gross Margin

We generated $12.2 billion in gross margin in 2009 and $12.7 billion in 2008. The total decline of $433 million primarily reflects the impact of lower overall sales on our gross margin and includes a $50 million decline related to the impact of foreign currency exchange rates on gross margin at Sears Canada. Our gross margin was also impacted by charges of $37 million and $36 million recorded in cost of sales for margin related expenses taken in connection with store closings announced during 2009 and 2008, respectively.

While gross margin dollars declined, our margin rate increased 60 basis points to 27.7% in 2009 from 27.1% for 2008. The increase was a result of improvements in margin rate of 110 basis points at Sears Domestic, 20 basis points at Kmart, and 90 basis points at Sears Canada. Increases in our margin rate stem from improvements in merchandise cost and reduced clearance markdowns as a result of better inventory management.

Selling and Administrative Expenses

Our selling and administrative expenses decreased $406 million in 2009 to $10.7 billion, with the decrease mainly reflecting our focus on controlling costs given the economic environment. The decrease includes a $187 million reduction in payroll and benefits expense, a $180 million reduction in advertising expense, a $53 million reduction in insurance expense, and a decrease of $27 million related to the impact of foreign currency exchange rates. Selling and administrative expenses for 2009 were impacted by domestic pension plan expense of $170 million and store closing costs and severance of $82 million, partially offset by a gain of $32 million recorded in connection with the settlement of Visa/MasterCard antitrust litigation. Selling and administrative expenses for 2008 were impacted by a $41 million charge related to store closing and severance, as well as the positive impact of the reversal of a $62 million reserve because of a favorable verdict in connection with a legal settlement.

Selling and administrative expenses as a percentage of total revenues (“selling and administrative expense rate”) were 24.2% for 2009 and 23.6% for 2008. The increase in our selling and administrative expense rate is primarily the result of the above noted significant items, as well as lower expense leverage given lower overall sales.

Depreciation and Amortization

Depreciation and amortization expense decreased by $55 million during 2009 to $926 million. The decrease is primarily attributable to having fewer assets available for depreciation.

Impairment Charges

We recorded impairment charges of $360 million during 2008 related to impairment of goodwill and long-lived assets. We did not record any such impairments in 2009. Impairment charges recorded during 2008 are further described in Note 14 in Notes to Consolidated Financial Statements.

Gain on Sales of Assets

We recorded a total gain on the sales of assets of $74 million during 2009 and $51 million in 2008. The increase in gains on sales of assets was due to a $44 million gain recognized by Sears Canada on the sale of its former headquarters, as well as $13 million related to the sale of pharmacy lists for Kmart stores closed during the year. Gains on sales of assets in 2008 included a $32 million gain on the sale of Sears Canada’s Calgary downtown full-line store.

Sears Canada sold its headquarters office building and adjacent land in Toronto, Ontario in August 2007. Sears Canada leased back the property under a leaseback agreement through March 2009, at which time it finished its relocation of all head office operations to previously underutilized space in the Toronto Eaton Centre, Ontario. Given the terms of the leaseback, for accounting purposes, the excess of proceeds received over the carrying value of the associated property was deferred, and the resulting gain was recognized when Sears Canada no longer occupied the associated property.

 

26


Operating Income

Operating income was $713 million for 2009 and $302 million for 2008. Operating income increased $411 million and was the result of reductions in selling and administrative expenses, partially offset by lower gross margin dollars given lower overall sales. Operating income for 2009 includes expenses of $301 million related to domestic pension plans, store closings and severance, a $44 million gain recognized by Sears Canada on the sale of its former headquarters, and a $32 million gain recorded in connection with the settlement of Visa/MasterCard antitrust litigation. Operating income for 2008 included a charge of $437 million related to costs associated with asset impairments and store closings and severance, as well as the positive impact of the reversal of a $62 million reserve because of a favorable verdict in connection with a legal settlement.

Interest Expense

We incurred $265 million in interest expense during 2009 and $272 million in 2008. While our total debt balances declined throughout the year, our interest expense was flat to 2008 primarily due to an increase in amortization expense related to capitalized debt issuance costs related to our amended revolving credit facility.

Interest and Investment Income

We earned $33 million in interest and investment income in 2009 and $46 million for 2008. Interest and investment income includes dividends of $9 million and $10 million in 2009 and 2008, respectively, from our cost method investment in Sears Mexico, and interest income of $5 million and $25 million in 2009 and 2008, respectively. The decrease in interest income in 2009 was primarily due to lower yields received on short-term investments during the year, as well as lower average cash balances throughout the year.

Other Income (Loss)

Other income (loss) is primarily comprised of mark-to-market and settlement gains and losses on Sears Canada hedge transactions. Total net mark-to-market and settlement losses of $67 million were recorded on these transactions in 2009. Total net gains of $81 million were recorded on these transactions in 2008. See Notes 4 and 5 to the Consolidated Financial Statements for further information regarding these transactions.

Income Taxes

Our effective tax rate was 29.3% in 2009 and 46.2% in 2008. The decrease in our tax rate is primarily due to the resolution of certain federal and state income tax matters during 2009, which resulted in the recording of a $41 million tax benefit. Income tax expense in 2008 included a benefit of $8 million related to the resolution of certain tax matters, but was higher mainly due to a portion of our impairment charge for goodwill in 2008 not being deductible for tax purposes.

 

27


Business Segment Results

Kmart

Kmart results and key statistics were as follows:

 

millions, except for number of stores    2010     2009     2008  

Merchandise sales and services

   $ 15,593      $ 15,743      $ 16,219   

Cost of sales, buying and occupancy

     11,757        12,038        12,442   

Gross margin dollars

     3,836        3,705        3,777   

Margin rate

     24.6     23.5     23.3

Selling and administrative

     3,341        3,386        3,456   

Selling and administrative expense as a percentage of revenues

     21.4     21.5     21.3

Depreciation and amortization

     149        152        138   

Impairment charges

     —          —          21   

Gain on sales of assets

     (7     (23     (10
                        

Total costs and expenses

     15,240        15,553        16,047   
                        

Operating income

   $ 353      $ 190      $ 172   
                        

Total Kmart stores

     1,307        1,327        1,368   

2010 Compared to 2009

Revenues and Comparable Store Sales

Kmart’s comparable store sales increased 0.7% while total sales declined 1.0% in 2010. The decline in total revenues primarily reflects the impact of having fewer stores in operation. The comparable store sales increase was primarily driven by increases in most categories, with higher increases in the apparel, footwear, jewelry, sporting goods and toys categories, partially offset by declines in the food and consumable and pharmacy categories.

Gross Margin

Kmart generated $3.8 billion in gross margin in 2010 and $3.7 billion in 2009. The $131 million increase is mainly a result of a 110 basis point increase in margin rate and includes a $6 million charge recorded in cost of sales for margin related expenses taken in connection with store closings in 2010. Gross margin for 2009 included a $27 million charge recorded in cost of sales for margin related expenses taken in connection with store closings in 2009. Kmart’s margin rate increased to 24.6%, from 23.5% in 2009, in part as a result of an increase in sales of higher margin categories such as apparel and sporting goods.

Selling and Administrative Expenses

Kmart’s selling and administrative expenses decreased $45 million to $3.3 billion in 2010 and included incremental expenses of $24 million related to our continued investment in our multi-channel capabilities and the launch of our Shop Your Way Rewards program. The decline in selling and administrative expenses primarily reflects a reduction in payroll expenses of $16 million, a reduction in advertising expenses of $11 million, as well as reductions in various other expense categories. Selling and administrative expenses include charges related to store closings and severance of $7 million and $35 million, for 2010 and 2009, respectively, as well as a $17 million gain related to settlement of Visa/MasterCard antitrust litigation in 2009. Our selling and administrative expense rate was 21.4% for 2010 and 21.5% in 2009, and decreased primarily as a result of the above noted significant items.

 

28


Depreciation and Amortization

Depreciation and amortization expense decreased $3 million in 2010 to $149 million. The decrease is primarily attributable to having fewer assets available for depreciation.

Operating Income

Kmart recorded operating income of $353 million in 2010 and $190 million in 2009. Operating income increased due to the improved margin rate and decreased selling and administrative expenses noted above. Kmart’s operating income for 2010 includes expenses of $13 million related to store closings and severance. Kmart’s operating income for 2009 includes expenses of $65 million related to store closings and severance, partially offset by a $17 million gain related to settlement of Visa/MasterCard antitrust litigation.

2009 Compared to 2008

Revenues and Comparable Store Sales

Kmart’s comparable store sales and total sales declined 0.8% and 2.9%, respectively, in 2009. The decline in total revenues primarily reflects the impact of having 41 fewer stores in operation. The 0.8% decline in Kmart comparable store sales during 2009 was primarily driven by declines in the apparel and food and consumables categories. This decline was partially offset by the benefit of assuming the operations of its footwear business from a third party effective January 2009, as well as an increase in the toys category.

Gross Margin

Kmart generated $3.7 billion in gross margin in 2009 and $3.8 billion in 2008. The $72 million decline is mainly a result of the impact of lower overall sales on Kmart’s gross margin and includes a $27 million charge recorded in cost of sales for margin related expenses taken in connection with store closings in 2009. Gross margin for 2008 included a charge of $15 million recorded in cost of sales for margin related expenses taken in connection with store closings announced during that year. Kmart’s margin rate increased 20 basis points to 23.5%, from 23.3% in 2008, mainly as a result of improvements in merchandise cost and reduced clearance markdowns as a result of better inventory management.

Selling and Administrative Expenses

Kmart’s selling and administrative expenses decreased $70 million to $3.4 billion in 2009. The decline in selling and administrative expenses primarily reflects a reduction in payroll expenses of $38 million, a reduction in advertising expenses of $20 million, as well as reductions in various other expense categories. Selling and administrative expenses for 2009 include charges related to store closings and severance of $35 million, as well as a $17 million gain related to settlement of Visa/MasterCard antitrust litigation. Selling and administrative expenses for 2008 include charges of $12 million related to store closings and severance. Our selling and administrative expense rate was 21.5% for 2009 and 21.3% in 2008, and increased primarily as a result of the above noted significant items, as well as lower expense leverage given lower overall sales.

Depreciation and Amortization

Depreciation and amortization expense increased by $14 million in 2009 to $152 million. The increase is primarily due to the addition of property and equipment in the Kmart segment during the year.

Impairment Charges

We recorded impairment charges of $21 million during 2008 related to impairment of goodwill and long-lived assets. We did not record any such impairments in 2009. Impairment charges recorded during 2008 are further described in Note 14 in Notes to Consolidated Financial Statements.

 

29


Operating Income

Kmart recorded operating income of $190 million in 2009 and $172 million in 2008. Kmart’s operating income for 2009 includes expenses of $65 million related to store closings and severance, partially offset by a $17 million gain related to settlement of Visa/MasterCard antitrust litigation. Kmart’s operating income for 2008 includes expenses of $48 million related to impairment charges and store closings and severance.

Sears Domestic

Sears Domestic results and key statistics were as follows:

 

millions, except for number of stores    2010     2009     2008  

Merchandise sales and services

   $ 22,937      $ 23,672      $ 25,315   

Cost of sales, buying and occupancy

     16,358        16,653        18,084   

Gross margin dollars

     6,579        7,019        7,231   

Margin rate

     28.7     29.7     28.6

Selling and administrative

     6,086        6,220        6,415   

Selling and administrative expense as a percentage of revenues

     26.5     26.3     25.3

Depreciation and amortization

     651        672        724   

Impairment charges

     —          —          339   

Gain on sales of assets

     (46     (6     (10
                        

Total costs and expenses

     23,049        23,539        25,552   
                        

Operating income (loss)

   $ (112   $ 133      $ (237
                        

Number of:

      

Full-line stores(1)

     894        908        929   

Specialty stores

     1,354        1,284        1,233   
                        

Total Domestic Sears stores

     2,248        2,192        2,162   
                        

 

(1)

2010 includes 842 full-line stores and 52 Sears Essentials/Grand stores; 2009 includes 848 full-line stores and 60 Sears Essentials/Grand stores; 2008 includes 856 full-line stores and 73 Sears Essentials/Grand stores

2010 Compared to 2009

Revenues and Comparable Store Sales

Sears Domestic’s comparable store sales and total sales declined 3.6% and 3.1%, respectively, during 2010. The decline in total revenues primarily reflects the impact of lower comparable store sales. Comparable store sales declines were driven by the hardlines categories, as well as apparel. Over half of the total decline occurred in consumer electronics. In contrast, Sears’ footwear, jewelry, and automotive categories generated comparable store sales growth during the period.

Gross Margin

Sears Domestic’s gross margin dollars declined $440 million to $6.6 billion in 2010. Current year gross margin included a $6 million charge recorded in cost of sales for margin related expenses taken in connection with store closings. Sears Domestic’s gross margin for 2009 included a $10 million charge for markdowns recorded in connection with store closings. The decline was mainly a result of the impact of lower overall sales on Sears Domestic’s gross margin and a decline in margin rate. Sears Domestic’s gross margin rate was 28.7% in 2010 and 29.7% in 2009, a decrease of 100 basis points. The decline was mainly due to reduced margin rates in home services and appliances.

 

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Selling and Administrative Expenses

Sears Domestic’s selling and administrative expenses decreased $134 million to $6.1 billion in 2010 and included incremental expenses of $111 million related to our continued investment in our multi-channel capabilities and the continued launch of our Shop Your Way Rewards program. The decrease includes a reduction in payroll and benefits expense of $86 million, a reduction in advertising expenses of $35 million, and a $42 million reduction in insurance expense, as well as reductions in various other expense categories. Selling and administrative expenses for 2010 were impacted by domestic pension plan expense of $120 million and store closing costs and severance of $7 million. Selling and administrative expenses for 2009 were impacted by domestic pension plan expense of $170 million, store closing costs and severance of $39 million, and a $15 million gain related to settlement of Visa/MasterCard antitrust litigation.

Our selling and administrative expense rate was 26.5% for 2010 and 26.3% for 2009. The increase in our selling and administrative expense rate is primarily the result lower expense leverage given lower overall sales.

Depreciation and Amortization

Depreciation and amortization expense decreased by $21 million to $651 million during 2010, and includes a $10 million charge taken in connection with store closings. The decrease is primarily attributable to having fewer assets available for depreciation.

Gain on Sales of Assets

We recorded a gain on the sales of assets of $46 million during 2010 and $6 million in 2009. We sold a Sears Auto Center in October 2006, at which time we leased back the property for a period of time. Given the terms of the contract, for accounting purposes, the excess of proceeds received over the carrying value of the associated property was deferred. We closed our operations at this location during the first quarter of 2010 and, as a result, recognized a gain of $35 million on this sale at that time.

Operating Income

Sears Domestic reported an operating loss of $112 million in 2010 and operating income of $133 million in 2009. The decrease in Sears Domestic’s operating results was primarily the result of lower gross margin dollars given lower overall sales and lower margin rate, partially offset by reductions in selling and administrative expenses and the above noted significant items. Operating income in 2010 includes expenses of $143 million related to domestic pension plans and store closings and severance. Operating income in 2009 includes expenses of $228 million related to domestic pension plans and store closings and severance, as well as a $15 million gain related to settlement of Visa/MasterCard antitrust litigation.

2009 Compared to 2008

Revenues and Comparable Store Sales

Sears Domestic’s comparable store sales and total sales declined 8.7% and 6.5%, respectively, during 2009. The decline in total revenues primarily reflects the impact of lower comparable store sales and includes the impact of having 21 fewer full-line stores in operation. Comparable store sales declines were driven by decreases in the home appliance, lawn & garden, and home electronics categories.

Gross Margin

Sears Domestic’s gross margin dollars declined $212 million to $7 billion in 2009. The decline was mainly a result of the impact of lower overall sales on Sears Domestic’s gross margin and included a $10 million charge recorded in cost of sales for margin related expenses taken in connection with store closings. Sears Domestic’s

 

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gross margin for 2008 included a $21 million charge for markdowns recorded in connection with store closings. Sears Domestic’s margin rate was 29.7% in 2009 and 28.6% in 2008, an increase of 110 basis points. The increase in margin rate was mainly the result of improvements in merchandise cost and reduced clearance markdowns as a result of better inventory management.

Selling and Administrative Expenses

Sears Domestic’s selling and administrative expenses decreased $195 million to $6.2 billion in 2009, with the decrease mainly reflecting a focus on controlling costs. The decrease includes a reduction in payroll and benefits expense of $148 million, a reduction in advertising expenses of $82 million, and was offset by slight increases in various other expense categories. Selling and administrative expenses for 2009 were impacted by domestic pension plan expense of $170 million, store closing costs and severance of $39 million, and a $15 million gain related to settlement of Visa/MasterCard antitrust litigation. Selling and administrative expenses for 2008 were impacted by the positive impact of the reversal of a $62 million reserve because of a favorable verdict in connection with a legal settlement and a $29 million charge related to store closing and severance.

Our selling and administrative expense rate was 26.3% for 2009 and 25.3% for 2008. The increase in our selling and administrative expense rate is primarily the result of the significant items noted above.

Depreciation and Amortization

Depreciation and amortization expense decreased by $52 million to $672 million during 2009. The decrease is primarily attributable to having fewer assets available for depreciation.

Impairment Charges

We recorded impairment charges of $339 million during 2008 related to impairment of goodwill and long-lived assets. We did not record any such impairments in 2009. Impairment charges recorded during 2008 are further described in Note 14 in Notes to Consolidated Financial Statements.

Operating Income

Sears Domestic reported operating income of $133 million in 2009 and an operating loss of $237 million in 2008. The increase in Sears Domestic’s operating results was primarily the result of the above noted significant items and reductions in selling and administrative expenses, partially offset by lower gross margin dollars given lower overall sales. Operating income in 2009 includes expenses of $228 million related to domestic pension plans and store closings and severance, as well as a $15 million gain related to settlement of Visa/MasterCard antitrust litigation. The operating loss for 2008 includes the above-noted impairment and store closing charges of $389 million and the positive impact of the reversal of a $62 million reserve because of a favorable verdict in connection with a pre-merger legal matter.

 

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Sears Canada

Sears Canada, a consolidated, 92%-owned subsidiary of Sears, conducts similar retail operations as Sears Domestic. Sears Canada results and key statistics were as follows:

 

millions, except for number of stores    2010     2009     2008  

Merchandise sales and services

   $ 4,796      $ 4,628      $ 5,236   

Cost of sales, buying and occupancy

     3,333        3,133        3,592   

Gross margin dollars

     1,463        1,495        1,644   

Margin rate

     30.5     32.3     31.4

Selling and administrative

     1,144        1,048        1,189   

Selling and administrative expense as a percentage of revenues

     23.9     22.6     22.7

Depreciation and amortization

     100        102        119   

Gain on sales of assets

     (14     (45     (31
                        

Total costs and expenses

     4,563        4,238        4,869   
                        

Operating income

   $ 233      $ 390      $ 367   
                        

Number of:

      

Full-line stores

     122        122        122   

Specialty stores

     361        280        266   
                        

Total Sears Canada stores

     483        402        388   
                        

2010 Compared to 2009

Revenues

Sears Canada’s revenues increased 3.6% in 2010. The increase in total revenues of $168 million includes a $433 million increase due to the impact of exchange rates. On a Canadian dollar basis, revenues decreased by $265 million, primarily reflecting a comparable store sales decrease of 4.0%. Comparable store sales decreases were more pronounced in the appliances and apparel categories. We believe the decline in comparable store sales is mainly the result of a continued tightening in consumer discretionary spending resulting from falling consumer confidence levels, as well as increased cross-border shopping due to the effect of a strong Canadian dollar relative to the U.S. dollar.

Gross Margin

Gross margin dollars decreased $32 million to $1.5 billion for 2010 and include a $142 million increase due to the impact of exchange rates. Gross margin decreased $174 million on a Canadian dollar basis as a result of lower overall sales and a decline in margin rate. Sears Canada’s margin rate decreased to 30.5% in 2010 from 32.3% in 2009 due to price compression in the appliance and electronics categories, as well as an increase in promotional and clearance markdowns related to a challenging economic environment.

Selling and Administrative Expenses

Sears Canada’s selling and administrative expenses increased $96 million to $1.1 billion in 2010 and includes a $97 million increase due to the impact of exchange rates. On a Canadian dollar basis, selling and administrative expenses were flat. Sears Canada’s selling and administrative expense rate was 23.9% in 2010 and 22.6% in 2009, and increased primarily as a result of lower expense leverage given lower overall sales on a Canadian dollar basis.

 

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Gain on Sales of Assets

Sears Canada recorded total gains on sales of assets of $14 million during 2010 and $45 million in 2009. During 2009, Sears Canada recognized a previously deferred $44 million gain related to the August 2007 sale of its former headquarters.

Operating Income

Sears Canada’s operating income decreased $157 million to $233 million in 2010 and includes a $42 million increase due to the impact of foreign currency exchange rates. The decrease of $199 million on a Canadian dollar basis reflects the above noted decreases in gross margin dollars given lower overall sales on a Canadian dollar basis and reduced margin rate and decrease in gains on sales of assets.

2009 Compared to 2008

Revenues

Sears Canada’s revenues decreased 11.6% in 2009. The decrease in total revenues of $608 million includes a $142 million decline due to the impact of exchange rates. On a Canadian dollar basis, revenues decreased by $466 million, reflecting lower comparable stores sales across all major categories. The decline in comparable store sales is mainly the result of lower sales in Sears Canada’s Full-line, Direct, Home, Dealer and Outlet channels, partially offset by higher sales in Corbeil stores.

Gross Margin

Gross margin dollars decreased $149 million to $1.5 billion for 2009 and include a $50 million decline due to the impact of exchange rates. Gross margin decreased $99 million on a Canadian dollar basis as a result of lower overall sales. Sears Canada’s margin rate increased to 32.3% in 2009 from 31.4% in 2008 primarily as a result of improved inventory management.

Selling and Administrative Expenses

Sears Canada’s selling and administrative expenses declined $141 million to $1 billion in 2009 and include severance expenses of $8 million recorded during the year. The decrease in expenses primarily reflects a reduction in advertising expenses during 2009, as well as a decline of $27 million due to the impact of exchange rates. Sears Canada’s selling and administrative expense rate was 22.6% in 2009 and 22.7% in 2008, and decreased primarily as a result of the noted decline in selling and administrative expenses.

Gain on Sales of Assets

Sears Canada recorded total gains on sales of assets of $45 million during 2009 and $31 million in 2008. During 2009, Sears Canada recognized a previously deferred $44 million gain related to the August 2007 sale of its former headquarters. During 2008, Sears Canada benefited from a $32 million gain from the sale of its Calgary downtown full-line store.

Operating Income

Sears Canada’s operating income increased $23 million to $390 million in 2009. The increase in operating income includes an $18 million decline due to the impact of foreign currency exchange rates. The increase of $41 million on a Canadian dollar basis reflects the above noted decreases in selling and administrative expenses and increase in gains on sales of assets, which were partially offset by a decrease in gross margin dollars given lower overall sales.

 

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ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION

Cash Balances

Cash and cash equivalents include all highly liquid investments with original maturities of three months or less at the date of purchase. Our cash and cash equivalents balances at the years ended January 29, 2011 and January 30, 2010 are detailed in the following table.

 

millions    January 29,
2011
     January 30,
2010
 

Domestic

     

Cash and equivalents

   $ 465       $ 221   

Cash posted as collateral

     325         9   

Credit card deposits in transit

     169         168   
                 

Total domestic cash and cash equivalents

     959         398   

Sears Canada

     416         1,291   
                 

Total cash and cash equivalents

     1,375         1,689   

Restricted cash

     15         11   
                 

Total cash balances

   $ 1,390       $ 1,700   
                 

We had total cash balances of $1.4 billion at January 29, 2011 and $1.7 billion at January 30, 2010. The decrease in cash balances from January 30, 2010 primarily reflects a decrease in net operating cash flows generated during 2010 due to decreased income, higher pension and post retirement contributions and higher working capital balances (inventory less merchandise payables). Primary uses of cash for 2010 included $603 million for the purchase of Sears Canada shares, repayments of long-term debt of $486 million, capital expenditures of $441 million, $394 million for share repurchases, and contributions to our pension and post-retirement benefit plans of $316 million. These uses of cash were funded in part from $1.25 billion of proceeds from our senior secured notes offering in October 2010.

Our invested cash may include, from time to time, investments in, but not limited to, commercial paper, U.S. federal, state and municipal government securities, floating-rate notes, repurchase agreements and money market funds. Cash amounts held in these short-term investments are readily available to us.

Credit card deposits in transit include deposits in-transit from banks for payments related to third-party credit card and debit card transactions.

Restricted cash consists of cash related to Sears Canada’s cash balances, which have been pledged as collateral for letters of credit obligations issued under its offshore merchandise purchasing program and with counterparties related to outstanding derivative contracts, as well as funds held in trust in accordance with regulatory requirements governing advance ticket sales related to Sears Canada’s travel business.

We classify outstanding checks in excess of funds on deposit within other current liabilities and reduce cash balances when these checks clear the bank on which they were drawn. Outstanding checks in excess of funds on deposit were $122 million and $116 million for the year ended 2010 and 2009, respectively.

Investment of Available Capital

Since the Merger, we have generated significant operating cash flows, and management expects that our cash flows will continue to exceed our annual operating cash needs for the foreseeable future. We have and will continue to invest in our businesses to improve the customer experience and provide the opportunity for attractive returns. Further, at January 29, 2011, we have repurchased approximately $5.8 billion of our common shares since the Merger and may continue to repurchase shares subject to market conditions and board

 

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authorization. In addition, we may pursue investments in the form of acquisitions, joint ventures and partnerships where we believe appropriate returns can be obtained. Further, we may determine under certain market conditions that available capital is best utilized to fund investments that we believe offer us attractive return opportunities, whether or not related to our ongoing business activities.

Our Board of Directors has delegated authority to direct investment of our surplus cash to our Chairman, Edward S. Lampert, subject to various limitations that have been or may be from time to time adopted by the Board of Directors and/or Finance Committee of the Board of Directors.

Operating Activities and Cash Flows

Holdings generated $130 million in operating cash flows during 2010 and $1.5 billion in 2009. As a retailer, Holdings’ primary source of operating cash flows is the sales of goods and services to customers, while the primary use of cash in operations is to fund the purchase of merchandise inventories. The decrease in operating cash flows in 2010 is mainly the result of higher working capital balances, increased pension and postretirement contributions, as well as decreased net income.

Holdings generated $1.5 billion in operating cash flows during 2009 and $992 million in 2008. The increase in net operating cash flows generated during 2009 primarily reflects increases in cash from working capital, as well as increased net income.

Merchandise inventories increased $418 million to $9.1 billion at January 29, 2011 from $8.7 billion at January 30, 2010. The increase was primarily in the Kmart apparel, electronics, toys, footwear and sporting goods categories. Inventory levels at Sears Canada increased approximately $150 million primarily due to the change in exchange rates, lower sales and the timing of merchandise receipts. Merchandise payables were $3.1 billion at January 29, 2011 and $3.3 billion at January 30, 2010. The decrease in merchandise payables is reflective of reduced inventory receipts at the end of 2010 due to lower sales at Sears Domestic.

Investing Activities and Cash Flows

Net cash flows used in investing activities totaled $406 million in 2010, $172 million in 2009, and $637 million in 2008. Cash used in investing activities in all three years was primarily used for purchases of property and equipment.

We spent $441 million on capital expenditures during 2010, $361 million during 2009 and $497 million during 2008. Capital expenditures during 2010 included investments in online initiatives, information technology and infrastructure for stores and distribution centers. Capital expenditures during 2009 included investments in information technology and infrastructure for the stores and distribution centers. Capital expenditures during 2008 included ongoing investments in the maintenance of the company’s facilities (including a significant investment in lighting retrofit projects to reduce energy consumption in Holdings’ facilities) and in information technology.

We anticipate 2011 capital expenditure levels to increase as compared to 2010 levels, due to investment in information technology upgrades and ongoing investment in the infrastructure of our facilities. It should be noted that in the normal course of business, we consider opportunities to purchase leased operating properties, as well as offers to sell owned, or assign leased, operating and non-operating properties. These transactions may, individually or in the aggregate, result in material proceeds or outlays of cash and cause our capital expenditure levels to vary from period to period. In addition, we review leases that will expire in the short term in order to determine the appropriate action to take with respect to them. During 2008, we purchased 9 previously leased operating properties for $22 million. We did not make any such purchases in 2010 or 2009.

 

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During 2009, we received $166 million in cash from changes in investments and restricted cash. This reflects cash received from The Reserve Primary Fund of $38 million, as well as changes in restricted cash requirements at Sears Canada.

During 2008, we purchased an additional 2.6 million of Sears Canada’s common shares in open market transactions. We paid a total of $37 million for the additional shares acquired. This transaction is further described in Note 2 to the Consolidated Financial Statements.

We purchased 5.3 million shares of common stock of Restoration Hardware, Inc. (“Restoration”), a specialty retailer of hardware, bathware, furniture, lighting, textiles, accessories and gifts during 2007. Our investment of $30 million represented an ownership interest of 13.67% of Restoration’s total outstanding shares. We sold our investment in Restoration during the second quarter of 2008.

Financing Activities and Cash Flows

Net cash used in financing activities was $95 million in 2010, $951 million in 2009 and $643 million in 2008. The financing activities in 2010 reflect purchases of Sears Canada shares, debt repayments and common share repurchase activity, which were funded in part from $1.25 billion of proceeds from our senior secured notes offering in October 2010. Financing activities in 2009 and 2008 primarily reflect common share repurchase activity and debt repayments.

During 2010, we acquired approximately 19 million additional Sears Canada common shares. We paid a total of $560 million for the additional shares. In addition, Sears Canada purchased and cancelled approximately 2.2 million common shares during 2010 under their Normal Course Issuer Bid, at a cost of $43 million. Sears Canada declared and paid cash dividends of $7.00 Canadian per common share, or approximately $754 million Canadian ($708 million U.S.). Accordingly, Sears Canada paid $69 million to minority shareholders in connection with these dividends. For further information, see Note 2 of Notes to Consolidated Financial Statements.

Repayments of debt during 2010 were $486 million. Total short-term borrowings at January 29, 2011 of $360 million were $35 million higher than our level of borrowings at January 30, 2010. The increase in outstanding long-term debt includes an increase in domestic long-term debt and capital lease obligations of $1.2 billion. Of this amount, $425 million is due in 2011, of which $295 million was paid in February 2011. Repayments of debt during 2009 were $335 million and $262 million in 2008. In 2010, we took the following steps to enhance our liquidity position and reduce reliance on our domestic revolving credit facility during the peak holiday borrowing period:

 

   

On September 10, 2010, our Sears Canada subsidiary entered into a five-year $800 million Canadian credit facility. The facility is secured by a first lien on Sears Canada’s inventory and receivable balances. At January 29, 2011, Sears Canada had drawn approximately $107 million ($108 million Canadian) on the facility and including letters of credit, had a remaining capacity of approximately $510 million ($511 million Canadian).

 

   

On September 15, 2010, Sears Holdings and Sears Canada executed an inter-company loan whereby Sears Holdings borrowed $389 million from Sears Canada. Sears Holdings used the loan proceeds to fund its seasonal working capital build for the holiday selling season, thereby reducing borrowings on its credit facility. The inter-company loan was repaid in full to Sears Canada on November 12, 2010.

 

   

On October 12, 2010, Sears Holdings issued $1.25 billion of 6 5/8% senior secured notes due 2018. These notes are secured by domestic inventory and credit card accounts receivable.

All of these steps taken during 2010 extend the duration of our capital structure, while at the same time allowing us to fund operations, continue to invest in our businesses, repurchase our stock, make payments on our term debt and complete our acquisition of additional noncontrolling interest in Sears Canada.

 

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We repurchased $394 million, $424 million and $678 million of our common stock pursuant to our common share repurchase program in 2010, 2009 and 2008, respectively. The common share repurchase program was initially announced in 2005 and has a total authorization since inception of the program of $6.0 billion. At January 29, 2011, we had approximately $187 million of remaining authorization under the program. The share repurchase program has no stated expiration date and share repurchases may be implemented using a variety of methods, which may include open market purchases, privately negotiated transactions, block trades, accelerated share repurchase transactions, the purchase of call options, the sale of put options or otherwise, or by any combination of such methods.

Uses and Sources of Liquidity

Our primary need for liquidity is to fund working capital requirements of our retail businesses, capital expenditures and for general corporate purposes, including debt repayment, pension plan contributions and common share repurchases. We believe that these needs will be adequately funded by our operating cash flows, credit terms received from vendors and borrowings under our credit agreements (described below). At January 29, 2011, $2.2 billion was available under our domestic credit facility and $510 million under Sears Canada’s credit facility.

Our year end 2010 and 2009 outstanding borrowings were as follows:

 

millions    January 29,
2011
     January 30,
2010
 

Short-term borrowings:

     

Unsecured commercial paper

   $ 360       $ 206   

Secured borrowings

     —           119   

Long-term debt, including current portion:

     

Notes and debentures outstanding

     2,575         1,545   

Capitalized lease obligations

     597         635   
                 

Total borrowings

   $ 3,532       $ 2,505   
                 

In 2005, the Finance Committee of our Board of Directors authorized the repurchase, subject to market conditions and other factors, of up to $500 million of our outstanding indebtedness in open market or privately negotiated transactions. The source of funds for the purchases is our cash from operations or borrowings under the Credit Agreement. Our wholly owned finance subsidiary, Sears Roebuck Acceptance Corp. (“SRAC”), has repurchased $215 million of its outstanding notes, including $6 million repurchased during 2009 and $49 million repurchased during 2008, thereby reducing the unused balance of this authorization to $285 million. We recognized a gain of $13 million on the repurchases made during 2008.

Certain of our debt is variable rate and we therefore manage interest rate risk through the use of fixed and variable-rate funding and interest rate derivatives. At both January 30, 2010 and January 31, 2009, we had interest rate derivatives with notional amounts of $120 million and nominal fair values.

Debt Ratings

Our corporate family debt rating at January 29, 2011 appear in the table below:

 

Moody’s
Investors
Service

  

Standard &
Poor’s
Ratings
Services

  

Fitch
Ratings

Ba2

   BB-    B+

 

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Domestic Credit Agreement

We have a $2.4 billion domestic credit agreement (the “Domestic Credit Agreement”) in place as a funding source for general corporate purposes. The Domestic Credit Agreement includes a $1.5 billion letter of credit sub-limit and an accordion feature that gives us the flexibility, subject to certain terms and conditions, to increase the size of the credit facility, or add a term loan tranche to the Domestic Credit Agreement, in an aggregate amount of up to $1.0 billion. The Domestic Credit Agreement, which has an expiration date of June 2012, is an asset based revolving credit facility under which SRAC and Kmart Corporation are the borrowers. The Domestic Credit Agreement is secured by a first lien on most of our domestic inventory and credit card and pharmacy receivables, and determines availability pursuant to a borrowing base formula. We are currently discussing with our advisors alternatives to extend or replace our domestic credit facility.

The Domestic Credit Agreement limits our ability to make restricted payments, including dividends and share repurchases, if availability under the credit facility, as defined, is less than 25% (15% during the holiday period, which is defined as October 15 to December 15). It also imposes various other requirements which take effect if availability falls below designated thresholds, including a cash dominion requirement and a requirement that the fixed charge ratio at the last day of any quarter be not less than 1.0 to 1.0. We have also agreed to limit the amount of cash accumulated when borrowings are outstanding under the Domestic Credit Agreement.

At January 29, 2011, we had no borrowings outstanding under the Domestic Credit Agreement. We had $235 million of letters of credit outstanding under the Domestic Credit Agreement. As a result, our availability under the agreement was $2.2 billion at January 29, 2011. The majority of the letters of credit outstanding are used to provide collateral for our insurance programs.

Senior Secured Notes

In October 2010, we sold $1 billion aggregate principal amount of senior secured notes (the “Notes”), which bear interest at 6 5/8% per annum and mature on October 15, 2018. Concurrent with the closing of the sale of the Notes, the Company sold $250 million aggregate principal amount of Notes to the Company’s domestic pension plan in a private placement. The Notes are guaranteed by certain subsidiaries of the Company and are secured by a security interest in certain assets consisting primarily of domestic inventory and credit card receivables (the “Collateral”). The lien that secures the Notes is junior in priority to the lien on such assets that secures obligations under the Domestic Credit Agreement, as well as certain other first priority lien obligations. The Company used the net proceeds of this offering to repay borrowings outstanding under the Domestic Credit Agreement on the settlement date and to fund the working capital requirements of our retail businesses, capital expenditures and for general corporate purposes. The indenture under which the Notes were issued contains restrictive covenants that, among other things, (1) limit the ability of the Company and certain of its domestic subsidiaries to create liens and enter into sale and leaseback transactions and (2) limit the ability of the Company to consolidate with or merge into, or sell other than for cash or lease all or substantially all of its assets to, another person. The indenture also provides for certain events of default, which, if any occur, would permit or require the principal and accrued and unpaid interest on all the then outstanding notes to be due and payable immediately. Generally, the Company is required to offer to repurchase all outstanding Notes at a purchase price equal to 101% of the principal amount if the borrowing base (as calculated pursuant to the indenture) falls below the principal value of the notes plus any other indebtedness for borrowed money that is secured by liens on the Collateral for two consecutive quarters or upon the occurrence of certain change of control triggering events. The Company may call the Notes at a premium based on the “Treasury Rate” as defined in the indenture, plus 50 basis points. We have agreed to offer to exchange the Notes held by nonaffiliates for a new issue of substantially identical notes registered under the Securities Act of 1933, as amended.

Sears Canada Credit Agreement

In September 2010, Sears Canada entered into a five-year, $800 million Canadian senior secured revolving credit facility (the “Sears Canada Facility”). The Sears Canada Facility is available for Sears Canada’s general corporate purposes and is secured by a first lien on substantially all of Sears Canada’s non-real estate assets. Availability under the Sears Canada Facility is determined pursuant to a borrowing base formula based on inventory and account and credit card receivables, subject to certain limitations.

 

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At January 29, 2011, we had approximately $107 million ($108 million Canadian) of borrowings outstanding under the Sears Canada Facility and classified these borrowings as long-term debt as we do not intend to repay outstanding amounts within the next twelve months. Availability under this agreement, given total outstanding borrowings and letters of credit, was approximately $510 million ($511 million Canadian) at January 29, 2011.

Orchard Supply Hardware LLC (“OSH LLC”) Credit Agreement

In November 2005, OSH LLC entered into a five-year, $130 million senior secured revolving credit facility (the “OSH LLC Facility”), which includes a $25 million letter of credit sublimit. The OSH LLC Facility was amended and extended in January 2010 and, as a result, available capacity was bifurcated into a $100 million tranche maturing December 2013 and a $20 million tranche maturing December 2011. The OSH LLC Facility continues to have a $25 million letter of credit sublimit. The OSH LLC Facility is available for OSH LLC’s general corporate purposes and is secured by a first lien on substantially all of OSH LLC’s non-real estate assets. Availability under the OSH LLC Facility is determined pursuant to a borrowing base formula based on inventory and account and credit card receivables, subject to certain limitations. At January 29, 2011, there were $48 million borrowings outstanding under the OSH LLC Facility and $7 million in outstanding letters of credit.

OSH LLC Real Estate Secured Term Loan

During the third quarter of 2010, OSH LLC repaid the $120 million CMBS Loan in its entirety through a combination of available cash, borrowing on the OSH LLC Facility and entering into a new $50 million real estate secured term loan with a variable interest rate above LIBOR and a due date of 2013.

Letters of Credit Facility

On January 20, 2011, we and certain of our subsidiaries entered into a letter of credit facility (the “LC Facility”) with Wells Fargo Bank, National Association (“Wells Fargo”), pursuant to which Wells Fargo may, on a discretionary basis and with no commitment, agree to issue standby letters of credit upon our request in an aggregate amount not to exceed $500 million for general corporate purposes. The letters of credit issued under the LC Facility are secured by a first priority lien on cash placed on deposit at Wells Fargo pursuant to a pledge and security agreement in an amount equal to 103% of the face value of all issued and outstanding letters of credit. The LC Facility has a term ending on January 20, 2014, unless terminated sooner pursuant to its terms. Wells Fargo may, in it sole discretion, terminate the LC Facility at any time.

The LC Facility enables us to more cost-effectively obtain letters of credit when surplus cash is available to collateralize the letters of credit. On January 29, 2011, $150 million of letters of credit were outstanding from the facility. We may replace our letters of credit issued under our LC Facility with letters of credit issued under the Domestic Credit Facility in the future and as such, cash collateral is considered unrestricted cash.

Benefit and Pension Plan Obligations

Contributions to our pension plans remain a significant use of our cash on an annual basis. While Sears Holdings’ pension plan is frozen, and thus associates do not currently earn pension benefits, the company has a legacy pension obligation for past service performed by Kmart and Sears, Roebuck and Co. associates. During 2010, we contributed $277 million to our domestic pension plan. We estimate that the domestic pension contribution will be approximately $340 million in 2011 and $320 million in 2012, though the ultimate amount of pension contributions could be affected by further changes in the applicable regulation and financial market and investment performance.

Wholly owned Insurance Subsidiary and Inter-company Notes

As noted in Note 1 of Notes to Consolidated Financial Statements, we have numerous types of insurable risks, including workers’ compensation, product and general liability, automobile, warranty, and asbestos and environmental claims. In addition, as discussed in Note 1, we sell extended service contracts to our customers.

 

40


The associated risks are managed through our wholly owned insurance subsidiary. In accordance with applicable insurance regulations, the insurance subsidiary holds investment grade securities to support the insurance coverage it provides.

We have transferred certain domestic real estate and intellectual property (i.e. trademarks) into separate wholly owned, bankruptcy remote subsidiaries. These bankruptcy remote subsidiaries lease the real estate property to Sears and license the use of the trademarks to Sears and Kmart. Further, the bankruptcy remote subsidiaries have issued asset-backed notes that are collateralized by the aforementioned real estate rental streams and intellectual property licensing fee streams. Cash flows received from rental streams and licensing fee streams paid by Sears, Kmart and, potentially in the future, other affiliates or third parties, will be used for the payment of fees, interest and principal on the asset-backed notes issued. Since the inception of these subsidiaries, the debt securities have been entirely held by our wholly owned consolidated subsidiaries in support of our insurance activities. At January 29, 2011 and January 30, 2010, the net book value of the securitized intellectual property assets was approximately $1.0 billion. The net book value of the securitized real estate assets was approximately $0.8 billion at January 29, 2011 and $0.9 billion at January 30, 2010.

Contractual Obligations and Off-Balance Sheet Arrangements

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

 

     Total      Payments Due by Period  

Contractual Obligations

      Within 1 Year      1-3 Years      4-5 Years      After 5 Years      Other  
millions                                          

Operating leases

   $ 5,342       $ 801       $ 1,307       $ 909       $ 2,325       $ —     

Short-term debt

     360         360         —           —           —           —     

Capital lease obligations

     986         130         247         212         397         —     

Royalty license fees(1)

     130         63         47         20         —           —     

Purchase obligations

     32         16         16         —           —           —     

Pension funding obligations

     2,493         352         1,040         815         286         —     

Long-term debt including current portion and interest

     3,808         592         683         333         2,200         —     

Liability and interest related to uncertain tax positions(2)

     246         —           —           —           —           246   
                                                     

Total contractual obligations

   $ 13,397       $ 2,314       $ 3,340       $ 2,289       $ 5,208       $ 246   
                                                     

 

(1)

We pay royalties under various merchandise license agreements, which are generally based on sales of products covered under these agreements. We currently have license agreements for which we pay royalties, including those to use American Greetings and Joe Boxer. Royalty license fees represent the minimum Holdings is obligated to pay, regardless of sales, as guaranteed royalties under these license agreements.

 

(2)

At January 29, 2011, our uncertain tax position liability and gross interest payable were $192 million and $54 million, respectively. We are unable to reasonably estimate the timing of liabilities and interest payments arising from uncertain tax positions in individual years due to the uncertainties in the timing of the effective settlement of tax positions.

Other Commercial Commitments

We issue various types of guarantees in the normal course of business. We had the following guarantees outstanding at January 29, 2011:

 

millions    Bank
Issued
     SRAC
Issued
     Other      Total  

Standby letters of credit

   $ 405       $ 66       $ —         $ 471   

Commercial letters of credit

     9         118         —           127   

Secondary lease obligations and performance guarantee

     —           —           20         20   

 

41


The secondary lease obligations relate to certain store leases of previously divested Sears businesses. We remain secondarily liable if the primary obligor defaults.

Application of Critical Accounting Policies and Estimates

In preparing the financial statements, certain accounting policies require considerable judgment to select the appropriate assumptions to calculate financial estimates. These estimates are complex and subject to an inherent degree of uncertainty. We base our estimates on historical experience, terms of existing contracts, evaluation of trends and other assumptions that we believe to be reasonable under the circumstances. We continually evaluate the information used to make these estimates as our business and the economic environment change. Although the use of estimates is pervasive throughout the financial statements, we consider an accounting estimate to be critical if:

 

   

it requires assumptions to be made about matters that were highly uncertain at the time the estimate was made, and

 

   

changes in the estimate that are reasonably likely to occur from period to period or different estimates that could have been selected would have a material effect on our financial condition, cash flows or results of operations.

Management believes the current assumptions and other considerations used to estimate amounts reflected in the financial statements are appropriate. However, if actual experience differs from the assumptions and the considerations used in estimating amounts, the resulting changes could have a material adverse effect on our consolidated results of operations, and in certain situations, could have a material adverse effect on our financial condition.

Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and the Audit Committee has reviewed the disclosure presented below relating to the selection of these estimates.

The following is a summary of our most critical policies and estimates. See Note 1 of Notes to Consolidated Financial Statements for a listing of our other significant accounting policies.

Valuation of Inventory

Our inventory is valued at the lower of cost or market determined primarily using the retail inventory method (“RIM”). RIM is an averaging method that is commonly used in the retail industry. To determine inventory cost under RIM, inventory at its retail selling value is segregated into groupings of merchandise having similar characteristics, which are then converted to a cost basis by applying specific average cost factors for each grouping of merchandise. Cost factors represent the average cost-to-retail ratio for each merchandise group based upon the year purchasing activity for each store location. Accordingly, a significant assumption under the retail method is that inventory in each group is similar in terms of its cost-to-retail relationship and has similar turnover rates. Management monitors the content of merchandise in these groupings to prevent distortions that would have a material effect on inventory valuation.

RIM inherently requires management judgment and certain estimates that may significantly affect the ending inventory valuation, as well as gross margin. Among others, two significant estimates used in inventory valuation are the level and timing of permanent markdowns (clearance markdowns used to clear unproductive or slow-moving inventory) and shrinkage. Amounts are charged to cost of sales, buying and occupancy at the time the retail value of inventory is reduced through the use of permanent markdowns.

Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise, fashion trends and weather conditions. In addition, inventory is also evaluated against corporate pre-determined historical markdown cadences. When a decision is made to permanently markdown merchandise, the resulting gross margin reduction is recognized in the period the markdown is recorded. The timing of the decision, particularly surrounding the balance sheet date, can have a significant effect on the results of operations.

 

42


Shrinkage is estimated as a percentage of sales for the period from the date of the last physical inventory to the end of the year. Physical inventories are taken annually for all stores and inventory records are adjusted accordingly. The shrinkage rate from the most recent physical inventory, in combination with historical experience, is used as the basis for the shrinkage accrual following the physical inventory.

Self Insurance Reserves

We use a combination of third-party insurance and/or self-insurance for a number of risks including workers’ compensation, asbestos and environmental, automobile, warranty, product and general liability claims. General liability costs relate primarily to litigation that arises from store operations. Self-insurance reserves include actuarial estimates of both claims filed and carried at their expected ultimate settlement value and claims incurred but not yet reported. Our estimated claim amounts are discounted using a rate with a duration that approximates the duration of our self-insurance reserve portfolio. Our liability reflected on the consolidated balance sheets represents an estimate of the ultimate cost of claims incurred at the balance sheet date. In estimating this liability, we utilize loss development factors based on Company-specific data to project the future development of incurred losses. Loss estimates are adjusted based upon actual claims settlements and reported claims. These projections are subject to a high degree of variability based upon future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns. Although we do not expect the amounts ultimately paid to differ significantly from our estimates, self-insurance reserves could be affected if future claim experience differs significantly from the historical trends and the actuarial assumptions.

Defined Benefit Retirement Plans

The fundamental components of accounting for defined benefit retirement plans consist of the compensation cost of the benefits earned, the interest cost from deferring payment of those benefits into the future and the results of investing any assets set aside to fund the obligation. Such retirement benefits were earned by associates ratably over their service careers. Therefore, the amounts reported in the income statement for these retirement plans have historically followed the same pattern. Accordingly, changes in the obligations or the value of assets to fund them have been recognized systematically and gradually over the associate’s estimated period of service. The largest drivers of losses in recent years have been the discount rate used to determine the present value of the obligation and the actual return on pension assets. We recognize the changes by amortizing experience gains/losses in excess of the 10% corridor into expense over the associate service period and by recognizing the difference between actual and expected asset returns over a five-year period.

Holdings’ actuarial valuations utilize key assumptions including discount rates and expected returns on plan assets. We are required to consider current market conditions, including changes in interest rates and plan asset investment returns, in determining these assumptions. Actuarial assumptions may differ materially from actual results due to changing market and economic conditions, changes in investment strategies, higher or lower withdrawal rates, and longer or shorter life spans of participants.

Income Taxes

We account for income taxes according to accounting standards for such taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the book basis and tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If future utilization of deferred tax assets is uncertain, the Company may record a valuation allowance against certain deferred tax assets.

In accordance with accounting standards for uncertain tax positions, we record unrecognized tax benefits for positions taken or expected to be taken on tax returns, including the decision to exclude certain income or transactions from a return, when a more-likely-than-not threshold is met for a tax position and management

 

43


believes that the position will be sustained upon examination by the taxing authorities. Further, we record the largest amount of the unrecognized tax benefit that is greater than 50% likely of being realized upon settlement. Management evaluates each position based solely on the technical merits and facts and circumstances of the position, assuming the position will be examined by a taxing authority having full knowledge of all relevant information. Significant management judgment is required to determine whether the recognition threshold has been met and, if so, the appropriate amount of unrecognized tax benefits to be recorded in the Consolidated Financial Statements. Management reevaluates tax positions each period in which new information about recognition or measurement becomes available.

Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against our net deferred tax assets, if any. In assessing the likelihood of realization of deferred tax assets, management considers estimates of the amount and character of future taxable income. Our actual effective tax rate and income tax expense could vary from estimated amounts due to the future impacts of various items, including changes in income tax laws, tax planning and the Company’s forecasted financial condition and results of operations in future periods. Although management believes current estimates are reasonable, actual results could differ from these estimates.

Domestic and foreign tax authorities periodically audit our income tax returns. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposures associated with our various tax filing positions, we record reserves in accordance with accounting standards for uncertain tax positions. A number of years may elapse before a particular matter, for which we have established a reserve, is audited and fully resolved. Management’s estimates at the date of the financial statements reflect our best judgment, giving consideration to all currently available facts and circumstances. As such, these estimates may require adjustment in the future, as additional facts become known or as circumstances change. For further information, see Note 11 of Notes to Consolidated Financial Statements.

Goodwill and Intangible Asset Impairment Assessments

At January 29, 2011 and January 30, 2010, we had goodwill and intangible asset balances of $4.5 billion and $4.6 billion, respectively. Holdings evaluates the carrying value of goodwill and intangible assets for possible impairment under accounting standards governing goodwill and other intangible assets. The majority of our goodwill and intangible assets relate to Kmart’s acquisition of Sears, Roebuck and Co. in March 2005. We allocated goodwill, which is defined as the total purchase price less the fair value of all assets and liabilities acquired, to reporting units at the acquisition date. As required by accounting standards, we perform annual goodwill and intangible impairment tests in the fourth quarter and update the tests between annual tests if events or circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; and the testing for recoverability of a significant asset group within a reporting unit. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements.

Goodwill Impairment Assessments

Our goodwill resides in multiple reporting units. The goodwill impairment test involves a two-step process. The first step is a comparison of each reporting unit’s fair value to its carrying value. We estimate fair value using the best information available, using both a market participant approach, as well as a discounted cash flow model, commonly referred to as the income approach. The market participant approach determines the value of a

 

44


reporting unit by deriving market multiples for reporting units based on assumptions potential market participants would use in establishing a bid price for the unit. This approach therefore assumes strategic initiatives will result in improvements in operational performance in the event of purchase, and includes the application of a discount rate based on market participant assumptions with respect to capital structure and access to capital markets. The income approach uses a reporting unit’s projection of estimated operating results and cash flows that is discounted using a weighted-average cost of capital that reflects current market conditions. The projection uses management’s best estimates of economic and market conditions over the projected period, including growth rates in sales, costs, estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. Our final estimate of fair value of reporting units is developed by equally weighting the fair values determined through both the market participant and income approaches.

If the carrying value of the reporting unit is higher than its fair value, there is an indication that impairment may exist and the second step must be performed to measure the amount of impairment loss. The amount of impairment is determined by comparing the implied fair value of reporting unit goodwill to the carrying value of the goodwill in the same manner as if the reporting unit was being acquired in a business combination. Specifically, we would allocate the fair value to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that would calculate the implied fair value of goodwill. If the implied fair value of goodwill is less than the recorded goodwill, we would record an impairment charge for the difference. We did not record any goodwill impairment charges in 2010 or 2009. See Notes 13 and 14 to the Consolidated Financial Statements for further information regarding goodwill and related impairment charges recorded during 2008.

The use of different assumptions, estimates or judgments in either step of the goodwill impairment testing process, such as the estimated future cash flows of our reporting units, the discount rate used to discount such cash flows, or the estimated fair value of the reporting units’ tangible and intangible assets and liabilities, could significantly increase or decrease the estimated fair value of a reporting unit or its net assets, and therefore, impact the related impairment charge. At the 2010 annual impairment test date, the above-noted conclusion that no indication of goodwill impairment existed at the test date would not have changed had the test been conducted assuming: 1) a 100 basis point increase in the discount rate used to discount the aggregate estimated cash flows of our reporting units to their net present value in determining their estimated fair values (without any change in the aggregate estimated cash flows of our reporting units), or 2) a 100 basis point decrease in the estimated sales growth rate or terminal period growth rate without a change in the discount rate of each reporting unit.

Based on our sensitivity analysis, we do not believe that the recorded goodwill balance is at risk of impairment at any reporting unit at the end of the year because the fair value is substantially in excess of the carrying value and not at risk of failing step one. However, goodwill impairment charges may be recognized in future periods in one or more of the reporting units to the extent changes in factors or circumstances occur, including deterioration in the macroeconomic environment, retail industry or in the equity markets, which includes the market value of our common shares, deterioration in our performance or our future projections, or changes in our plans for one or more reporting units.

Intangible Asset Impairment Assessments

We review definite and indefinite-lived intangible assets for impairment by comparing the carrying amount of each asset to the sum of undiscounted cash flows expected to be generated by the asset. We consider both the market approach and income approach when testing intangible assets with indefinite lives for impairment on an annual basis. We determined that the income approach, specifically the Relief from Royalty Method, was most appropriate for analyzing our indefinite-lived assets. This method is based on the assumption that, in lieu of ownership, a firm would be willing to pay a royalty in order to exploit the related benefits of this asset class. The Relief from Royalty Method involves two steps: (i) estimation of reasonable royalty rates for the assets and

 

45


(ii) the application of these royalty rates to a net sales stream and discounting the resulting cash flows to determine a value. We multiplied the selected royalty rate by the forecasted net sales stream to calculate the cost savings (relief from royalty payment) associated with the assets. The cash flows are then discounted to present value by the selected discount rate and compared to the carrying value of the assets. We did not record any intangible asset impairment charges in 2010 or 2009.

The use of different assumptions, estimates or judgments in our intangible asset impairment testing process, such as the estimated future cash flows of assets and the discount rate used to discount such cash flows, could significantly increase or decrease the estimated fair value of an asset, and therefore, impact the related impairment charge. At the 2010 annual impairment test date, the above-noted conclusion that no indication of intangible asset impairment existed at the test date would not have changed had the test been conducted assuming: 1) a 100 basis point increase in the discount rate used to discount the aggregate estimated cash flows of our assets to their net present value in determining their estimated fair values (without any change in the aggregate estimated cash flows of our reporting units), 2) a 100 basis point decrease in the terminal period growth rate without a change in the discount rate of each reporting unit, or 3) a 10 basis point decrease in the royalty rate applied to the forecasted net sales stream of our assets.

New Accounting Pronouncements

See Note 1 of Notes to Consolidated Financial Statements for information regarding new accounting pronouncements.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Certain statements made in this Annual Report on Form 10-K and in other public announcements by us contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements include information concerning our future financial performance, business strategy, plans, goals and objectives. Statements preceded or followed by, or that otherwise include, the words “believes,” “expects,” “anticipates,” “intends,” “estimates,” “plans,” “forecast,” “is likely to” and similar expressions or future or conditional verbs such as “will,” “may” and “could” are generally forward-looking in nature and not historical facts. Such statements are based upon the current beliefs and expectations of Holdings’ management and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements.

The following factors, among others, could cause actual results to differ from those set forth in the forward-looking statements: our ability to offer merchandise and services that our customers want, including our proprietary brand products; our ability to successfully implement initiatives to improve inventory management and other capabilities; competitive conditions in the retail and related services industries; worldwide economic conditions and business uncertainty, the availability of consumer and commercial credit, changes in consumer confidence, tastes, preferences and spending, and changes in vendor relationships; the impact of seasonal buying patterns, including seasonal fluctuations due to weather conditions, which are difficult to forecast with certainty; our dependence on sources outside the United States for significant amounts of our merchandise; our extensive reliance on computer systems to process transactions, summarize results and manage our business; our reliance on third parties to provide us with services in connection with the administration of certain aspects of our business; impairment charges for goodwill and intangible assets or fixed-asset impairment for long-lived assets; our ability to properly implement and realize the expected benefits from our organizational structure and operating model; our ability to attract, motivate and retain key executives and other associates; the outcome of pending and/or future legal proceedings, including product liability claims and bankruptcy claims, including proceedings with respect to which the parties have reached a preliminary settlement; and the timing and amount of required pension plan funding.

 

46


Certain of these and other factors are discussed in more detail in Item 1A of this Annual Report on Form 10-K. While we believe that our forecasts and assumptions are reasonable, we caution that actual results may differ materially. We intend the forward-looking statements to speak only at the time made and do not undertake to update or revise them as more information becomes available.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We face market risk exposure in the form of interest rate risk and foreign currency risk. These market risks arise from our derivative financial instruments and debt obligations.

Interest Rate Risk

We manage interest rate risk through the use of fixed and variable-rate funding and interest rate derivatives. All debt securities and interest-rate derivative instruments are considered non-trading. At January 29, 2011, 21% of our debt portfolio was variable rate. Based on the size of this variable rate debt portfolio at January 29, 2011, which totaled approximately $740 million, an immediate 100 basis point change in interest rates would have affected annual pretax funding costs by $7 million. These estimates do not take into account the effect on income resulting from invested cash or the returns on assets being funded. These estimates also assume that the variable rate funding portfolio remains constant for an annual period and that the interest rate change occurs at the beginning of the period.

Foreign Currency Risk

At January 29, 2011, we had a series of foreign currency forward contracts outstanding, totaling $629 million Canadian notional value and with a weighted average remaining life of 0.5 years, designed to hedge our net investment in Sears Canada against adverse changes in exchange rates. The aggregate fair value of the forward contracts at January 29, 2011 was $1 million. A hypothetical 1% adverse movement in the level of the Canadian exchange rate relative to the U.S. dollar at January 29, 2011, with all other variables held constant, would have resulted in a loss in the fair value of our foreign currency forward contracts of approximately $6 million at January 29, 2011. Certain of our currency forward contracts require collateral be posted in the event our liability under such contracts reaches a predetermined threshold. Cash collateral posted under these contracts is recorded as part of our accounts receivable balance. We had $3 million of cash collateral posted under these contracts at January 29, 2011.

Sears Canada mitigates the risk of currency fluctuations on offshore merchandise purchases denominated in U.S. currency by purchasing U.S. dollar denominated collar contracts for a portion of its expected requirements. At January 29, 2011, these contracts had a notional value of approximately $372 million and a weighted average remaining life of 0.5 years. The aggregate fair value of the collar contracts at January 29, 2011 was negative $3 million. A hypothetical 1% adverse movement in the level of the Canadian exchange rate relative to the U.S. dollar at January 29, 2011, with all other variables held constant, would have resulted in a fair value for these contracts of approximately negative $7 million at January 29, 2011, a decrease of $4 million.

Counterparties

We actively manage the risk of nonpayment by our derivative counterparties by limiting our exposure to individual counterparties based on credit ratings, value at risk and maturities. The counterparties to these instruments are major financial institutions with credit ratings of single-A or better. In certain cases, counterparty risk is also managed through the use of collateral in the form of cash or U.S. government securities.

 

47


Item 8. Financial Statements and Supplementary Data

 

     Page  

Consolidated Statements of Income for the years ended January 29, 2011, January  30, 2010 and January 31, 2009

     49   

Consolidated Balance Sheets at January 29, 2011 and January 30, 2010

     50   

Consolidated Statements of Cash Flows for the years ended January 29, 2011, January  30, 2010 and January 31, 2009

     51   

Consolidated Statements of Equity for the years ended January 29, 2011, January  30, 2010 and January 31, 2009

     52   

Notes to Consolidated Financial Statements

     53   

Schedule II—Valuation and Qualifying Accounts

     101   

Management’s Annual Report on Internal Control over Financial Reporting

     102   

Report of Independent Registered Public Accounting Firm

     103   

 

48


SEARS HOLDINGS CORPORATION

Consolidated Statements of Income

 

millions, except per share data    2010     2009     2008  

REVENUES

      

Merchandise sales and services

   $ 43,326      $ 44,043      $ 46,770   
                        

COSTS AND EXPENSES

      

Cost of sales, buying and occupancy

     31,448        31,824        34,118   

Selling and administrative

     10,571        10,654        11,060   

Depreciation and amortization

     900        926        981   

Impairment charges

     —          —          360   

Gain on sales of assets

     (67     (74     (51
                        

Total costs and expenses

     42,852        43,330        46,468   
                        

Operating income

     474        713        302   

Interest expense

     (310     (265     (272

Interest and investment income

     36        33        46   

Other income (loss)

     (14     (61     108   
                        

Income before income taxes

     186        420        184   

Income taxes

     (36     (123     (85
                        

Net income

     150        297        99   

Income attributable to noncontrolling interests

     (17     (62     (46
                        

NET INCOME ATTRIBUTABLE TO HOLDINGS’ SHAREHOLDERS

   $ 133      $ 235      $ 53   
                        

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO HOLDINGS’ SHAREHOLDERS

      

Basic earnings per share

   $ 1.19      $ 1.99      $ 0.42   

Diluted earnings per share

   $ 1.19      $ 1.99      $ 0.42   

Basic weighted average common shares outstanding

     111.5        117.8        127.0   

Diluted weighted average common shares outstanding

     111.7        117.9        127.0   

See accompanying Notes to Consolidated Financial Statements.

 

49


SEARS HOLDINGS CORPORATION

Consolidated Balance Sheets

 

millions, except per share data    January 29,
2011
    January 30,
2010
 

ASSETS

    

Current assets

    

Cash and cash equivalents

   $ 1,375      $ 1,689   

Restricted cash

     15        11   

Accounts receivable

     683        652   

Merchandise inventories

     9,123        8,705   

Prepaid expenses and other current assets

     312        351   

Deferred income taxes

     27        30   
                

Total current assets

     11,535        11,438   
                

Property and equipment

    

Land

     2,055        2,059   

Buildings and improvements

     6,343        6,193   

Furniture, fixtures and equipment

     2,918        2,766   

Capital leases

     399        374   
                

Gross property and equipment

     11,715        11,392   

Less accumulated depreciation

     (4,350     (3,683
                

Total property and equipment, net

     7,365        7,709   

Goodwill

     1,392        1,392   

Trade names and other intangible assets

     3,139        3,208   

Other assets

     837        1,061   
                

TOTAL ASSETS

   $ 24,268      $ 24,808   
                

LIABILITIES

    

Current liabilities

    

Short-term borrowings

   $ 360      $ 325   

Current portion of long-term debt and capitalized lease obligations

     509        482   

Merchandise payables

     3,101        3,335   

Other current liabilities

     3,115        3,098   

Unearned revenues

     976        1,012   

Other taxes

     557        534   
                

Total current liabilities

     8,618        8,786   

Long-term debt and capitalized lease obligations

     2,663        1,698   

Pension and postretirement benefits

     2,151        2,271   

Other long-term liabilities

     2,222        2,618   
                

Total Liabilities

     15,654        15,373   
                

EQUITY

    

Sears Holdings Corporation equity

    

Preferred stock, 20 shares authorized; no shares outstanding

     —          —     

Common stock $0.01 par value; 500 shares authorized; 109 and 115 shares outstanding, respectively

     1        1   

Treasury stock – at cost

     (5,826     (5,446

Capital in excess of par value

     10,185        10,465   

Retained earnings

     4,930        4,797   

Accumulated other comprehensive loss

     (779     (721
                

Total Sears Holdings Corporation equity

     8,511        9,096   

Noncontrolling interest

     103        339   
                

Total Equity

     8,614        9,435   
                

TOTAL LIABILITIES AND EQUITY

   $ 24,268      $ 24,808   
                

See accompanying Notes to Consolidated Financial Statements.

 

50


SEARS HOLDINGS CORPORATION

Consolidated Statements of Cash Flows

 

millions    2010     2009     2008  

CASH FLOWS FROM OPERATING ACTIVITIES

      

Net income

   $ 150      $ 297      $ 99   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     900        926        981   

Impairment charges

     —          —          360   

Gain on sales of assets

     (67     (74     (51

Pension and post-retirement plan contributions

     (316     (209     (286

Settlement of Canadian dollar hedges

     (3     —          (64

Change in operating assets and liabilities (net of acquisitions and dispositions):

      

Deferred income taxes

     (20     90        (385

Merchandise inventories

     (366     188        1,003   

Merchandise payables

     (264     272        (389

Income and other taxes

     (35     101        (173

Mark-to-market asset on Sears Canada U.S. dollar collar contracts

     7        65        (74

Other operating assets

     4        48        207   

Other operating liabilities

     140        (197     (236
                        

Net cash provided by operating activities

     130        1,507        992   
                        

CASH FLOWS FROM INVESTING ACTIVITIES

      

Acquisitions of businesses, net of cash acquired

     —          —          (37

Proceeds from sales of property and investments

     35        23        86   

Net decrease (increase) in investments and restricted cash

     —          166        (189

Purchases of property and equipment

     (441     (361     (497
                        

Net cash used in investing activities

     (406     (172     (637
                        

CASH FLOWS FROM FINANCING ACTIVITIES

      

Stock issued under executive compensation plans

     —          13        —     

Proceeds from debt issuances

     1,452        —          17   

Repayments of long-term debt

     (486     (335     (262

Increase (decrease) in short-term borrowings, primarily 90 days or less

     35        (117     280   

Debt issuance costs

     (30     (81     —     

Purchase of Sears Canada shares

     (603     (7     —     

Sears Canada dividends paid to minority shareholders

     (69     —          —     

Purchase of treasury stock

     (394     (424     (678
                        

Net cash used in financing activities

     (95     (951     (643
                        

Effect of exchange rate changes on cash and cash equivalents

     57        132        (161
                        

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (314     516        (449

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     1,689        1,173        1,622   
                        

CASH AND CASH EQUIVALENTS, END OF YEAR

   $ 1,375      $ 1,689      $ 1,173   
                        

SUPPLEMENTAL DISCLOSURE ABOUT NON-CASH INVESTING AND FINANCING ACTIVITIES:

      

Bankruptcy related settlements resulting in the receipt of treasury stock

   $ —        $ —        $ 12   

Capital lease obligation incurred

     17        7        12   

Supplemental Cash Flow Data:

      

Income taxes paid (refunds received)

     59        (70     107   

Cash interest paid

     180        185        207   

See accompanying Notes to Consolidated Financial Statements.

 

51


SEARS HOLDINGS CORPORATION

Consolidated Statements of Equity

 

    Equity Attributable to Holdings’ Shareholders              
dollars and shares in millions   Number of
Shares
    Common
Stock
    Treasury
Stock
    Capital in
Excess of
Par Value
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Noncontrolling
Interests
    Total  

Balance at February 2, 2008

    132      $ 1      $ (4,331   $ 10,419      $ 4,509      $ 69      $ 313      $ 10,980   

Comprehensive income (loss)

               

Net income

    —          —          —          —          53        —          46        99   

Pension and postretirement adjustments, net of tax

    —          —          —          —          —          (604     59        (545

Cumulative translation adjustment, net of tax

    —          —          —          —          —          (77     (95     (172
                     

Total Comprehensive Loss

                  (618

Stock awards

    —          —          2        (8     —          —          —          (6

Pre-petition tax settlements

    —          —          —          23        —          —          —          23   

Bankruptcy related settlement agreements

    —          —          (12     7        —          —          —          (5

Shares repurchased