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SHLD > SEC Filings for SHLD > Form 10-K on 18-Mar-2014All Recent SEC Filings

Show all filings for SEARS HOLDINGS CORP



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.
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 1,980 full-line and specialty retail stores in the United States, operating through Kmart and Sears, and 449 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 and banners which offer more than 110 million products and provide the capability for our members and customers to engage in cross-channel transactions such as free store pickup; buy in store/ship to home; and buy online, return in store. We are also the home of Shop Your WaySM, a free member-based social shopping platform that offers rewards, personalized services and a unique experience. Shop Your Way connects all of the ways members shop - in store, at home, online and by phone.
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 in 2013 revolved around continuing our transformation into a member-centric retailer leveraging Shop Your Way and Integrated Retail, which we believe will position us for enhanced growth and profitability to create long-term shareholder value. The investments we made throughout 2013 are enabling us to learn more about how our members want to shop so that we can develop deeper relationships with them and provide them with access to the widest possible assortment of products and services. Looking ahead, we intend to continue to enhance our financial flexibility to support and drive our transformation. While transformations of this size are challenging, we believe that the changes we are making through Shop Your Way and Integrated Retail will benefit us in the changing retail landscape. Our transformation is guided by these five key pillars:
•Create lasting relationships with members by empowering them to manage their lives
•Attain best in class productivity and efficiency
•Build our brands
•Reinvent the Company continuously through technology and innovation
•Reinforce "The SHC Way" by living our values every day

We seek to achieve the execution of the transformation to drive profitability and position ourselves in the changing environment by the following:
•Leveraging Shop Your Way and Integrated Retail as the foundation of our member-centric business model
•Realignment of our of businesses to become a more focused company
•Enhancing our financial flexibility to support and fund our transformation
•Allowing shareholders to participate in value creation actions Leveraging Shop Your Way and Integrated Retail We seek to proactively transform our business to benefit from the changing retail landscape. At the core of our transformation is transitioning to a member-centric integrated retailer leveraging our Shop Your Way platform. Shop Your Way is unique in that it is a program that rewards members, enhances interaction with members and delivers useful information to our Company. As a result, we are able to be more strategic in how we invest in capabilities to enable our members to access the widest possible assortment of products and services.
Realignment Of Our Businesses
We are accelerating our pace of change to position ourselves in the changing environment. We are proactively learning more each day about how our members want to shop and what resonates with them. We are utilizing this feedback as we continue our transition and invest in two primary areas: Our member-based platform Shop Your Way and Integrated Retail. These two key elements represent a different way of doing business at Sears Holdings and are the foundations of our other programs and initiatives. Within these two key areas, we are making substantial investments in engaging members with personalized, relevant content, offering more capabilities to our members, continually enhancing member engagement, and building out our platform technology. To enable this change, we have been strategically realigning our portfolio of businesses to focus on our core strengths, simplify Sears Holdings and become a more focused company that is more efficient to manage and easier to understand - all while seeking to enable us to better optimize our allocation of capital and attract the best talent.
We are investing in capabilities that are intended to enable our members to access the widest possible assortment of products and services. In addition, we are using data and analytics on member trends to make targeted offers and decisions delivered in real-time. We are expanding our reach through Sears Marketplace, our innovative community that allows third-party merchants to advertise or sell their products on the Sears Holdings' family of websites, where we now offer over 100 million items, and multiple delivery options. We are also developing digital and social relationships with our members as we aspire to do more than simply transact. We are working to build valued, trusted relationships with our members by providing differentiated products and services that will be difficult for others to replicate. Enhancing Our Financial Flexibility
As we previously stated, we are reconfiguring our asset base as we accelerate our transformation. In 2012, we separated our Sears Hometown and Outlet Stores business through a rights offering transaction. We consider this transaction to be successful as it:
• generated approximately $450 million of gross proceeds for Sears Holdings;

• did not reduce our overall scale, as our products and services are sold through their locations; and

• allowed existing shareholders the right to participate in value creation generated by Sears Hometown and Outlet Stores.

We recently announced that we intend to separate Lands' End and are exploring strategic alternatives for our Sears Auto Centers business. We believe that these strategic actions are beneficial for a number of reasons:
• First, Sears Holdings becomes a more focused company that is more efficient to manage and easier to understand;

• Second, the management of these separated businesses are better able to pursue their own strategic opportunities, optimize their capital structures, attract talent, and allocate capital in a more focused manner;

• Third, they provide multiple opportunities for our shareholders to participate in the value creation generated by these businesses; and

• Finally, they potentially enhance Sears Holdings' and the separated entities' financial flexibility.

We believe that we can readily generate liquidity from our asset base. In fact, in 2013 we generated $2.0 billion of liquidity consisting of $1.0 billion through real estate transactions in the United States and Canada and another $1.0 billion, as we executed a five-year secured term loan in October 2013. We expect to continue with these types of activities during 2014. We currently anticipate generating about $500 million from an exit dividend in connection with the previously announced separation of Lands' End through a pro rata distribution to our shareholders, with the separation being subject to certain conditions. We currently expect that the combination of (1) the Lands' End transaction, (2) our continuing to work with the board and management of Sears Canada to increase the value of our investment, which has a market value as of March 14, 2014 of about $760 million, and realize significant cash proceeds and
(3) our evaluation of opportunities with respect to a potential separation of our Sears Auto Centers when taken together will result in cash proceeds to the Company in excess of $1.0 billion in 2014, which will help fund our transformation and create value.

Fiscal Year
Our fiscal year end is the Saturday closest to January 31 each year. Fiscal
years 2013 and 2011 consisted of 52 weeks while fiscal year 2012 consisted of 53
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
2013        February 1, 2014    52
2012        February 2, 2013    53
2011        January 28, 2012    52

Holdings' Consolidated Results
Holdings' consolidated results of operations for 2013, 2012 and 2011 are
summarized as follows:
millions, except per share data                       2013          2012          2011
Merchandise sales and services                     $  36,188     $  39,854     $  41,567
Cost of sales, buying and occupancy                   27,433        29,340        30,966
Gross margin dollars                                   8,755        10,514        10,601
Gross margin rate                                       24.2 %        26.4 %        25.5 %
Selling and administrative                             9,384        10,660        10,664
Selling and administrative expense as a
percentage of revenues                                  25.9 %        26.7 %        25.7 %
Depreciation and amortization                            732           830           853
Impairment charges                                       233           330           649
Gain on sales of assets                                 (667 )        (468 )         (64 )
Total costs and expenses                              37,115        40,692        43,068
Operating loss                                          (927 )        (838 )      (1,501 )
Interest expense                                        (254 )        (267 )        (289 )
Interest and investment income                           207            94            41
Other income (loss)                                        2             1            (2 )
Loss from continuing operations before income
taxes                                                   (972 )      (1,010 )      (1,751 )
Income tax expense                                      (144 )         (44 )      (1,369 )
Loss from continuing operations                       (1,116 )      (1,054 )      (3,120 )
Loss from discontinued operations, net of tax              -             -           (27 )
Net loss                                              (1,116 )      (1,054 )      (3,147 )
(Income) loss attributable to noncontrolling
interests                                               (249 )         124             7
NET LOSS ATTRIBUTABLE TO HOLDINGS' SHAREHOLDERS    $  (1,365 )   $    (930 )   $  (3,140 )
Amounts attributable to Holdings' shareholders:
Loss from continuing operations, net of tax        $  (1,365 )   $    (930 )   $  (3,113 )
Loss from discontinued operations, net of tax              -             -           (27 )
Net loss                                           $  (1,365 )   $    (930 )   $  (3,140 )
Diluted loss per share from continuing
operations                                         $  (12.87 )   $   (8.78 )   $  (29.15 )
Diluted loss per share from discontinued
operations                                                 -             -         (0.25 )
                                                   $  (12.87 )   $   (8.78 )   $  (29.40 )
Diluted weighted average common shares
outstanding                                            106.1         105.9         106.8

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. Domestic comparable store sales amounts include sales from and shipped directly to customers. These online sales resulted in a benefit of approximately 60 basis points and 30 basis points, respectively, for 2013 and 2012. In addition, domestic comparable store sales have been adjusted for the change in the unshipped sales reserves recorded at the end of each reporting period, which resulted in a positive impact of approximately 10 basis points for 2013 and no impact in 2012.
As previously noted, fiscal 2013 was comprised of the 52-week period ended February 1, 2014, while fiscal 2012 was comprised of the 53-week period ended February 2, 2013. This one week shift had no impact on the domestic comparable store sales results reported herein due to the fact that for purposes of reporting domestic comparable store sales results for 2013, weeks one through 52 for fiscal 2013 have been compared to weeks two through 53 for fiscal year 2012, thereby eliminating the impact of the one week shift. Domestic 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. 2013 Compared to 2012
Net Loss Attributable to Holdings' Shareholders We recorded a net loss attributable to Holdings' shareholders of $1.4 billion
($12.87 loss per diluted share) and $930 million ($8.78 loss per diluted share)
for 2013 and 2012, respectively. Our results for 2013 and 2012 were affected by a number of significant items. Our net loss as adjusted for these significant items was $700 million ($6.60 loss per diluted share) for 2013 and $266 million ($2.51 loss per diluted share) for 2012. The increase in net loss for the year reflected a decline in gross margin, which resulted from both a decline in revenues as well as a decline in gross margin rate of 220 basis points, partially offset by a decrease in selling and administrative expenses. In addition to our net 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 loss attributable to Sears Holdings Corporation appearing on the Statements of Operations excluding income (loss) attributable to noncontrolling interests, 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 ongoing operating performance, and useful to investors, 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. Adjustments to EBITDA include impairment charges related to fixed assets and intangible assets, pension settlements, closed store and severance charges, domestic pension expense, transaction costs, hurricane losses and the SHO separation. We have adjusted our results for these items to make our statements more comparable and therefore more useful to investors as the items are not representative of our ongoing operations and reflect past investment decisions.

Adjusted EBITDA was determined as follows:

millions                                             2013            2012           2011
Net loss attributable to SHC per statement of
operations                                       $   (1,365 )    $     (930 )   $   (3,140 )
Income (loss) attributable to noncontrolling
interests                                               249            (124 )           (7 )
Loss from discontinued operations, net of tax             -               -             27
Income tax expense                                      144              44          1,369
Interest expense                                        254             267            289
Interest and investment income                         (207 )           (94 )          (41 )
Other (income) loss                                      (2 )            (1 )            2
Operating loss                                         (927 )          (838 )       (1,501 )
Depreciation and amortization                           732             830            853
Gain on sales of assets                                (667 )          (468 )          (64 )
Before excluded items                                  (862 )          (476 )         (712 )

Impairment charges                                      233             330            649
Domestic pension expense                                162             165             74
Closed store reserve, severance and other               130             140            254
Pension settlements                                       -             455              -
Transaction costs                                         -              12              -
Hurricane losses                                          -               -             12
Adjusted EBITDA                                        (337 )           626            277

SHO Separation                                            -             (90 )          (81 )
Adjusted EBITDA as defined                       $     (337 )    $      536     $      196
% to revenues                                          (0.9 )%          1.4 %          0.5 %

Adjusted EBITDA for our segments was as follows:
                                                    2013                                                        2012                                                       2011
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               $ (351 )  $      (940 )    $        364   $      (927 )      $   5   $         (656 ) $      (187 )  $         (838 )   $ (34 ) $      (1,447 )  $        (20 ) $       (1,501 )
Depreciation and
amortization                129            511                92           732          147              578           105               830       149             601             103              853
Gain on sales of assets     (66 )          (63 )            (538 )        (667 )        (37 )           (261 )        (170 )            (468 )     (34 )           (30 )             -              (64 )
Before excluded items      (288 )         (492 )             (82 )        (862 )        115             (339 )        (252 )            (476 )      81            (876 )            83             (712 )

Impairment charges           70            150                13           233           10               25           295               330        15             634               -              649
Domestic pension expense      -            162                 -           162            -              165             -               165         -              74               -               74
Closed store reserve,
severance and other          89            (31 )              72           130           76               44            20               140        76             160              18              254
Pension settlements           -              -                 -             -            -              452             3               455         -               -               -                -
Transaction costs             -              -                 -             -            -                9             3                12         -               -               -                -
Hurricane losses              -              -                 -             -            -                -             -                 -         -              12               -               12
Adjusted EBITDA            (129 )         (211 )               3          (337 )        201              356            69               626       172               4             101              277

SHO Separation                -              -                 -             -            -              (90 )           -               (90 )       -             (81 )             -              (81 )
Adjusted EBITDA as
defined                  $ (129 )  $      (211 )    $          3   $      (337 )      $ 201   $          266   $        69    $          536     $ 172   $         (77 )  $        101   $          196
% to revenues              (1.0 )%        (1.1 )%            0.1 %        (0.9 )%       1.4 %            1.4 %         1.6 %             1.4 %     1.1 %          (0.4 )%          2.2 %            0.5 %

These other significant items included in Adjusted EBITDA are further explained as follows:
• Impairment charges - Accounting standards require the Company to evaluate the carrying value of fixed assets, goodwill and intangible assets for impairment. As a result of the Company's analysis, we have recorded impairment charges related to certain fixed asset and goodwill balances.

• Pension settlements - The Company amended its domestic pension plan and offered a one-time voluntary lump sum payment option in an effort to reduce its long-term pension obligations and ongoing annual pension expense. The pension settlements were funded from existing pension plan assets. In connection with this transaction, the Company incurred a charge to operations as a result of the requirement to expense the unrealized actuarial losses. The charge had no effect on equity because the unrealized actuarial losses are already recognized in accumulated other comprehensive income/(loss). Accordingly, the effect on retained earnings was offset by a corresponding reduction in accumulated other comprehensive loss.

• Closed store reserve and severance - We are transforming our Company to a less asset-intensive business model. Throughout this transformation, we continue to make choices related to our stores, which could result in sales, closures, lease terminations or a variety of other decisions.

• Domestic pension expense - Contributions to our pension plans remain a significant use of our cash on an annual basis. Cash contributions to our pension and postretirement plans are separately disclosed on the cash flow statement. While the Company's 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 associates. The annual pension expense included in our statement of operations 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 $162 million in 2013, $165 million in 2012 and $74 million in 2011. Pension expense is comprised of interest cost, expected return on plan assets and amortization of experience losses. This adjustment eliminates the entire pension expense from the statement of operations to improve comparability. Pension expense is included in the determination of Net Income. The components of the adjustments to EBITDA related to domestic pension expense were as follows:

millions                             2013      2012      2011
Components of net periodic expense:
Interest cost                       $ 219     $ 291     $ 313
Expected return on plan assets       (224 )    (291 )    (302 )
Amortization of experience losses     167       165        63
Net periodic expense                $ 162     $ 165     $  74

In accordance with U.S. GAAP, we recognize on the balance sheet actuarial gains and losses for defined benefit pension plans annually in the fourth quarter of each fiscal year and whenever a plan is determined to qualify for a remeasurement during a fiscal year. For income statement purposes, these actuarial gains and losses are recognized throughout the year through an amortization process. The Company recognizes in its results of operations, as a corridor adjustment, any unrecognized actuarial net gains or losses that exceed 10% of the larger of projected benefit obligations or plan assets. Accumulated gains/losses that are inside the 10% corridor are not recognized, while accumulated actuarial gains/losses that are outside the 10% corridor are amortized over the "average future service" of the population and are included in the amortization of experience losses line item above.
Actuarial gains and losses occur when actual experience differs from the estimates used to allocate the change in value of pension plans to expense throughout the year or when assumptions change, as they may each year. Significant factors that can contribute to the recognition of actuarial gains and losses include changes in discount rates used to remeasure pension obligations on an annual basis or upon a qualifying remeasurement, differences between actual and expected returns on plan assets and other changes in actuarial assumptions. Management believes these actuarial gains and losses are primarily financing activities that are more reflective of changes in current conditions in global financial markets

(and in particular interest rates) that are not directly related to the underlying business and that do not have an immediate, corresponding impact on the benefits provided to eligible retirees. For further information on the actuarial assumptions and plan assets referenced above, see Management's Discussion &Analysis - Application of Critical Accounting Policies and Estimates
- Defined Benefit Pension Plans, and Note 7 of Notes to Consolidated Financial Statements.

• SHO separation - The results of the Sears Hometown and Outlet businesses . . .

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