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SHLD > SEC Filings for SHLD > Form 10-K on 20-Mar-2013All Recent SEC Filings

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Form 10-K for SEARS HOLDINGS CORP


20-Mar-2013

Annual Report


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, the parent company of Kmart and Sears, was formed in connection with the March 24, 2005 Merger of these two companies. We are an integrated retailer with significant physical and intangible assets, as well as virtual capabilities enabled through technology. We currently operate a national network of stores with 2,019 full-line and 54 specialty retail stores in the United States, operating through Kmart and Sears, and 475 full-line and specialty retail stores in Canada operating through Sears Canada Inc. ("Sears Canada"), a 51%-owned subsidiary. Further, we operate a number of websites under the Sears.com and Kmart.com banners which offer more than 60 million products and provide the capability for our customers to engage in cross-channel transactions such as buy online/pick-up in store; buy in store/ship to home; and buy online, return in store. We are also the home of SHOP YOUR WAY™, a social shopping experience where members have the ability to earn points, receive additional benefits and interact/shop with each other through shopyourway.com. The Company is the leading home appliance retailer as well as a leader in tools, lawn and garden, fitness equipment and automotive repair and maintenance. Key proprietary brands include Kenmore®, Craftsman®and DieHard®. We also maintain a broad apparel offering including such well-known labels as Lands' End®, the Kardashian Kollection, Jaclyn Smith, Joe Boxer, Sandra Lee and Levi's, as well as Sofia by Sofia Vergara and the Country Living Home Collection. We are the nation's largest provider of home services, with more than 14 million service calls made annually.
We currently conduct our operations in three 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.
Our focus continues to be on our core customers, our Members, and finding ways to provide them value and convenience through Integrated Retail and our SHOP YOUR WAY Membership platform. We have invested significantly in our online ecommerce platforms, our Membership rewards program and the technology needed to support these initiatives. Our actions in 2012 were guided by the following strategic priorities:
Innovation Around Our Customers and Members We continue to focus on building and growing a deeply engaging membership program, called SHOP YOUR WAY. SHOP YOUR WAY is more than just a typical loyalty program. It is a comprehensive platform that transforms customer transactions into relationships and allows us to know our Members better and to serve them better as well. It includes the rewards program, our shopyourway.com social shopping platform, our SHOP YOUR WAY Max free


shipping platform and a variety of other applications and components. Collectively, these elements change the way we do business both inside and outside the Company.
We are also focused on providing integrated retail solutions for our Members and customers. We rolled out tablets and mobile devices to Sears Domestic stores across the country. The tablets are equipped to help our store associates provide a better overall shopping experience. Our associates can use tablets to look at product specifications, compare products side-by-side and search for inventory if it is not readily available at the store. More information about products, inventory, pricing and reviews is now available at their fingertips, which means Members can have more confidence in their product selection. We have designed other experiences that provide seamless and convenient integrated experiences for our Members. Building on our Buy Online Pick Up In Store and Ready in 5 promise, we developed a Return/Exchange in 5 capability that allows Members to fill out the product return information online. Members simply drop off or exchange the item they want to return at our Merchandise Pick Up area within five minutes or less.
Core Retail Excellence
We are also focused on providing great merchandise value to our customers and Members. In 2012, we launched several innovative brand offerings such as Outdoor Life, Alphaline electronics accessories, and RoadHandler tires. In January 2013, we announced that we would be developing two new apparel lines in a collaborative effort between SHOP YOUR WAY and our Kmart format. We have a long heritage of building celebrity brands, both at Sears and Kmart. We chose to partner with Nicki Minaj and Adam Levine for this collaboration because of their creativity, their global appeal and their strong interest in developing their clothing brands in a unique and innovative manner.
We are focused on providing flexibility and convenience for our Members through such things as buy online/pick-up in store, buy in store/ship to home, digital receipts and returns and exchanges in five minutes or less. We enhanced our layaway program and added the capability for our Members to make layaway payments online and have the items from their layaway shipped directly to their homes when their contract has been completed. We also provide our customers with easy access to a broad and diverse range of products and categories through marketplace on sears.com.
Financial and Operational Discipline
In 2012, we also demonstrated our financial flexibility by positively impacting our liquidity by $1.8 billion, while unlocking the value in our asset portfolio, as part of our on-going asset re-configuration where we are re-deploying our capital in support of our member-centric, integrated retail strategy. Actions taken included:
• the separation of our Sears Hometown and Outlet businesses through a rights offering transaction, which generated gross proceeds of approximately $447 million;

• the partial spin-off of 45% of Sears Canada;

• the execution of various real estate transactions which generated cash proceeds of approximately $440 million;

• Reducing inventory by nearly $1.0 billion below last year's level and adjusting our promotional cadence to be more targeted;

• Reducing our fixed cost structure by over $500 million; and

• Capitalizing on an opportunity to reduce risk related to our legacy pension obligation by making a voluntary offer to former employees to pay a lump sum.

We are an asset-rich enterprise with substantial liquidity, unencumbered real estate and well-established stand-alone businesses, including Lands' End and Sears Canada. We expect to generate at least $500 million of additional liquidity through monetization of assets over the next 12 months. In addition to our asset monetizations, we currently expect to reduce 2013 peak domestic inventory by $500 million from the 2012 level of $8.6 billion at the end of the third quarter as a result of stores already or expected to be closed, initiatives underway to reduce slow-moving inventory and modest productivity improvement. This action is expected to generate $300 million of cash after consideration of related payables. We also expect to further reduce our fixed cost base by another $200 million in 2013.


RESULTS OF OPERATIONS

Fiscal Year
Our fiscal year end is the Saturday closest to January 31 each year. Fiscal year
2012 consisted of 53 weeks while fiscal years 2011 and 2010 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
2012        February 2, 2013    53
2011        January 28, 2012    52
2010        January 29, 2011    52


Holdings' Consolidated Results
Holdings' consolidated results of operations for 2012, 2011 and 2010 are
summarized as follows:
millions, except per share data                       2012          2011          2010
REVENUES
Merchandise sales and services                     $  39,854     $  41,567     $  42,664
COSTS AND EXPENSES
Cost of sales, buying and occupancy                   29,340        30,966        31,000
Gross margin dollars                                  10,514        10,601        11,664
Gross margin rate                                       26.4 %        25.5 %        27.3 %
Selling and administrative                            10,660        10,664        10,425
Selling and administrative expense as a
percentage of revenues                                  26.7 %        25.7 %        24.4 %
Depreciation and amortization                            830           853           869
Impairment charges                                       330           649             -
Gain on sales of assets                                 (468 )         (64 )         (67 )
Total costs and expenses                              40,692        43,068        42,227
Operating income (loss)                                 (838 )      (1,501 )         437
Interest expense                                        (267 )        (289 )        (293 )
Interest and investment income                            94            41            36
Other income (loss)                                        1            (2 )         (14 )
Income (loss) from continuing operations before
income taxes                                          (1,010 )      (1,751 )         166
Income tax expense                                       (44 )      (1,369 )         (27 )
Income (loss) from continuing operations              (1,054 )      (3,120 )         139
Income (loss) from discontinued operations, net
of tax                                                     -           (27 )          11
Net income (loss)                                     (1,054 )      (3,147 )         150
(Income) loss attributable to noncontrolling
interests                                                124             7           (17 )
NET INCOME (LOSS) ATTRIBUTABLE TO HOLDINGS'
SHAREHOLDERS                                       $    (930 )   $  (3,140 )   $     133
Amounts attributable to Holdings' shareholders:
Income (loss) from continuing operations, net of
tax                                                $    (930 )   $  (3,113 )   $     122
Income (loss) from discontinued operations, net
of tax                                                     -           (27 )          11
Net income (loss)                                  $    (930 )   $  (3,140 )   $     133

NET INCOME (LOSS) PER COMMON SHARE ATTRIBUTABLE
TO HOLDINGS' SHAREHOLDERS
Diluted income (loss) per share from continuing
operations                                         $   (8.78 )   $  (29.15 )   $    1.09
Diluted income (loss) per share from
discontinued operations                                    -         (0.25 )        0.10
                                                   $   (8.78 )   $  (29.40 )   $    1.19
Diluted weighted average common shares
outstanding                                            105.9         106.8         111.7

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. In addition, comparable store sales amounts include sales from sears.com and kmart.com shipped directly to customers and have been adjusted for the change in the unshipped sales reserves recorded at the end of each reporting period. Comparable store sales results for 2012 were calculated based on the 52-week period ended January 26, 2013 as compared to the comparable 52-week period in the prior year.


2012 Compared to 2011
Net Loss from Continuing Operations Attributable to Holdings' Shareholders We recorded a net loss from continuing operations attributable to Holdings' shareholders of $930 million ($8.78 loss per diluted share from continuing operations) and $3.1 billion ($29.15 loss per diluted share from continuing operations) for 2012 and 2011, respectively. Our results for 2012 and 2011 were affected by a number of significant items, including non-cash charges related to pension settlements and the impairment of goodwill balances and a $1.8 billion non-cash charge to establish a valuation allowance against our domestic deferred tax assets in 2011. Our net loss from continuing operations as adjusted for these significant items was $215 million ($2.03 loss per diluted share from continuing operations) for 2012 and $482 million ($4.52 loss per diluted share from continuing operations) for 2011. The improvement in net loss for the year reflected an improvement in gross margin rate of 90 basis points and a decrease in selling and administrative expenses, which were partially offset by a decline in gross margin dollars, given lower sales.
In addition to our net income (loss) from continuing operations determined in accordance with GAAP, for purposes of evaluating operating performance, we use an Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") measurement as well as Adjusted Earnings per Share ("Adjusted EPS").
Adjusted EBITDA is computed as net income (loss) attributable to Sears Holdings Corporation appearing on the Statements of Operations excluding income (loss) attributable to noncontrolling interest, income tax expense, interest expense, interest and investment income, other income (loss), depreciation and amortization and gain on sales of assets. In addition, it is adjusted to exclude certain significant items as set forth below. Our management uses Adjusted EBITDA to evaluate the operating performance of our businesses, as well as executive compensation metrics, for comparable periods. Adjusted EBITDA should not be used by investors or other third parties as the sole basis for formulating investment decisions as it excludes a number of important cash and non-cash recurring items.
While Adjusted EBITDA is a non-GAAP measurement, management believes that it is an important indicator of operating performance because:
• EBITDA excludes the effects of financings and investing activities by eliminating the effects of interest and depreciation costs;

• Management considers gains/(losses) on the sale of assets to result from investing decisions rather than ongoing operations; and

• Other significant items, while periodically affecting our results, may vary significantly from period to period and have a disproportionate effect in a given period, which affects comparability of results.


Adjusted EBITDA was determined as follows:

millions                                             2012           2011           2010
Net income (loss) attributable to SHC per
statement of operations                          $     (930 )   $   (3,140 )   $      133
Income (loss) attributable to noncontrolling
interest                                               (124 )           (7 )           17
(Income) loss from discontinued operations, net
of tax                                                    -             27            (11 )
Income tax expense                                       44          1,369             27
Interest expense                                        267            289            293
Interest and investment income                          (94 )          (41 )          (36 )
Other income (loss)                                      (1 )            2             14
Operating income (loss)                                (838 )       (1,501 )          437
Depreciation and amortization                           830            853            869
Gain on sales of assets                                (468 )          (64 )          (67 )
Before excluded items                                  (476 )         (712 )        1,239
Impairment charges                                      330            649              -
Pension settlements                                     455              -              -
Closed store reserve and severance                      140            254             26
Domestic pension expense                                165             74            120
Transaction costs                                        12              -              -
Hurricane losses                                          -             12              -
Adjusted EBITDA as defined                       $      626     $      277     $    1,385
% to revenues                                           1.6 %          0.7 %          3.2 %


Adjusted EBITDA for our segments was as follows:
                                                    2012                                                             2011                                                             2010
millions                Kmart     Sears Domestic     Sears Canada     Sears Holdings     Kmart     Sears Domestic     Sears Canada     Sears Holdings     Kmart     Sears Domestic     Sears Canada     Sears Holdings
Operating income
(loss) per statement
of operations          $   5     $         (656 )   $      (187 )    $         (838 )   $ (34 )   $       (1,447 )   $        (20 )   $       (1,501 )   $ 353     $         (149 )   $        233     $         437
Depreciation and
amortization             147                578             105                 830       149                601              103                853       149                620              100               869
Gain on sales of
assets                   (37 )             (261 )          (170 )              (468 )     (34 )              (30 )              -                (64 )      (7 )              (46 )            (14 )             (67 )
Before excluded
items                    115               (339 )          (252 )              (476 )      81               (876 )             83               (712 )     495                425              319             1,239

Closed store reserve
and severance             76                 44              20                 140        76                160               18                254        13                 13                -                26
Impairment charges        10                 25             295                 330        15                634                -                649         -                  -                -                 -
Pension settlements        -                452               3                 455         -                  -                -                  -         -                  -                -                 -
Domestic pension
expense                    -                165               -                 165         -                 74                -                 74         -                120                -               120
Transaction costs          -                  9               3                  12         -                  -                -                  -         -                  -                -                 -
Hurricane losses           -                  -               -                   -         -                 12                -                 12     $   -     $            -     $          -     $           -
Adjusted EBITDA as
defined                $ 201     $          356     $        69      $          626     $ 172     $            4     $        101     $          277     $ 508     $          558     $        319     $       1,385
% to revenues            1.4 %              1.7 %           1.6 %               1.6 %     1.1 %               -%              2.2 %              0.7 %     3.3 %              2.5 %            6.7 %             3.2 %


We also believe that use of Adjusted EPS improves the comparability of year-to-year results and is representative of our underlying performance. We have chosen to provide this supplemental information to illustrate the results of operations giving effect to the non-GAAP adjustments shown in the reconciliations below, and to provide an additional measure of performance. The following tables set forth results of operations on a GAAP and "As Adjusted" basis, as well as the impact each significant item used in calculating Adjusted EBITDA had on specific income and expense amounts reported in our Consolidated Statements of Operations during the years 2012, 2011 and 2010.

                                                                                                            Year Ended February 2, 2013
                                             Closed Store
                                            Reserve, Store                                                                                              Domestic       Gain on Sale of
millions, except per                       Impairments and       Gain on Sales                               Goodwill                                    Pension       Canadian Joint                            As
share data                     GAAP           Severance            of Assets       Transaction Costs        Impairment         Pension Settlements       Expense           Venture           Tax Matters      Adjusted
Cost of sales, buying and
occupancy impact            $ 29,340     $          (35 )       $        -        $              -       $          -        $                -        $       -     $          -          $           -     $ 29,305
Selling and
administrative impact         10,660               (105 )                -                     (12 )                -                      (455 )           (165 )              -                      -        9,923
Depreciation and
amortization impact              830                (22 )                -                       -                  -                         -                -                -                      -          808
Impairment charges impact        330                (35 )                -                       -               (295 )                       -                -                -                      -            -
Gain on sales of assets
impact                          (468 )                -                419                       -                  -                         -                -                -                      -          (49 )
Operating loss impact           (838 )              197               (419 )                    12                295                       455              165                -                      -         (133 )
Interest and investment
income impact                     94                  -                  -                       -                  -                         -                -              (25 )                    -           69
Income tax expense impact        (44 )              (74 )              157                      (5 )                -                         -              (62 )              9                    143          124
Loss attributable to
noncontrolling interest
impact                           124                 (7 )                8                       -               (145 )                      (1 )              -               12                      -           (9 )
After tax and
noncontrolling interest
impact                          (930 )              116               (254 )                     7                150                       454              103               (4 )                  143         (215 )
Diluted loss per share
impact                      $  (8.78 )   $         1.09         $    (2.40 )      $           0.07       $       1.42        $             4.29        $    0.97     $      (0.04 )        $        1.35     $  (2.03 )


                                                                                                                Year Ended January 28, 2012
                                                              Closed Store
                                            Domestic         Reserve, Store
millions, except per share                   Pension        Impairments and                                   Gain on Sales                              Goodwill                             Discontinued
data                             GAAP        Expense           Severance           Mark-to-Market Losses        of Assets       Hurricane Losses        Impairment         Tax Matters         Operations        As Adjusted
Cost of sales, buying and
occupancy impact              $ 30,966     $       -     $           (130 )       $                 -        $        -        $             -       $          -        $           -     $              -     $     30,836
Selling and administrative
impact                          10,664           (74 )               (124 )                         -                 -                    (12 )                -                    -                    -           10,454
Depreciation and
amortization impact                853             -                   (8 )                         -                 -                      -                  -                    -                    -              845
Impairment charges impact          649             -                  (98 )                         -                 -                      -               (551 )                  -                    -                -
Gain on sales of assets
impact                             (64 )           -                    -                           -                33                      -                  -                    -                    -              (31 )
Operating loss impact           (1,501 )          74                  360                           -               (33 )                   12                551                    -                    -             (537 )
Other loss impact                   (2 )           -                    -                           6                 -                      -                  -                    -                    -                4
Income tax expense impact       (1,369 )         (28 )               (134 )                        (2 )              13                     (5 )                -                1,819                    -              294
Loss from discontinued
operations, net of tax
impact                             (27 )           -                    -                           -                 -                      -                  -                    -                   27                -
Loss attributable to
noncontrolling interest
impact                               7             -                   (1 )                        (1 )               -                      -                  -                    -                    -                5
After tax and
. . .
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