16 SEARS, ROEBUCK AND CO.
CONSOLIDATED STATEMENTS OF INCOME
millions, except per common share data 1999 1998 1997
- --------------------------------------------------------------------------------------------------------
REVENUES
Merchandise sales and services $36,728 $36,957 $36,649
Credit revenues 4,343 4,618 4,925
------- ------- -------
Total revenues 41,071 41,575 41,574
------- ------- -------
COSTS AND EXPENSES
Cost of sales, buying and occupancy 27,212 27,444 26,985
Selling and administrative 8,418 8,384 8,394
Provision for uncollectible accounts 871 1,287 1,532
Depreciation and amortization 848 830 785
Interest 1,268 1,423 1,409
Reaffirmation charge -- -- 475
Restructuring and impairment costs 41 352 --
------- ------- -------
Total costs and expenses 38,658 39,720 39,580
------- ------- -------
Operating income 2,413 1,855 1,994
Other income, net 6 28 144
------- ------- -------
Income before income taxes, minority interest and extraordinary loss 2,419 1,883 2,138
Income taxes 904 766 912
Minority interest 62 45 38
------- ------- -------
Income before extraordinary loss 1,453 1,072 1,188
Extraordinary loss on early extinguishment of debt, net of tax -- 24 --
------- ------- -------
NET INCOME $ 1,453 $ 1,048 $ 1,188
======= ======= =======
EARNINGS PER COMMON SHARE - BASIC:
Income before extraordinary loss $ 3.83 $ 2.76 $ 3.03
Extraordinary loss -- 0.06 --
------- ------- -------
Net income $ 3.83 $ 2.70 $ 3.03
======= ======= =======
EARNINGS PER COMMON SHARE - DILUTED:
Income before extraordinary loss $ 3.81 $ 2.74 $ 2.99
Extraordinary loss -- 0.06 --
------- ------- -------
Net income $ 3.81 $ 2.68 $ 2.99
======= ======= =======
See accompanying notes.
SEARS, ROEBUCK AND CO. 17
MANAGEMENT'S ANALYSIS OF CONSOLIDATED OPERATIONS
Sears, Roebuck and Co. and its consolidated subsidiaries ("the Company") is a
multiline retailer providing a wide array of merchandise and services in the
United States, Puerto Rico and Canada. Operating results for the Company are
reported for four domestic segments and one international segment. The domestic
segments include the Company's operations in the United States and Puerto Rico.
The Company's segments are defined as follows:
RETAIL - consisting of:
> Full-line Stores - 858 Full-line stores, averaging 88,000 selling square
feet, located primarily in the best malls in the nation and offering:
-- Softlines - A complete selection of fashionable, quality apparel and
accessories for the whole family, plus cosmetics, fine jewelry and home
fashions, at value prices; includes leading national brands as well as
exclusive Sears brands such as Canyon River Blues, Fieldmaster, Crossroads,
TKS Basics and Circle of Beauty.
-- Hardlines - A full assortment of appliances, electronics and home
improvement products and services; includes major national brands as well as
exclusive Sears brands such as Kenmore, Craftsman, WeatherBeater and DieHard.
> Specialty Stores - More than 2,100 specialty stores, located primarily in
freestanding, off-the-mall locations or high-traffic neighborhood shopping
centers.
-- Hardware Stores - 267 neighborhood hardware stores under the Sears
Hardware and Orchard Supply Hardware names, averaging 20,000 to 40,000
selling square feet, that carry Craftsman tools, a wide assortment of
national brands and other home repair products.
-- Dealer Stores - 738 independently-owned stores, averaging 5,000 selling
square feet, that offer appliances, electronics, lawn and garden merchandise,
hardware and automobile batteries in smaller communities and carry exclusive
Sears brands such as Craftsman, Kenmore and DieHard.
-- Contract Sales - Showrooms dedicated to appliance and home improvement
products for commercial customers.
-- The Great Indoors - Two prototype stores for home decorating and
remodeling, averaging 100,000 selling square feet, dedicated to the four main
rooms of the house: kitchen, bedroom, bathroom and great room.
-- Automotive Stores - 798 Sears Auto Centers and 310 NTB National Tire &
Battery stores that offer tires, DieHard and other brands of batteries, and
related services. Auto Stores also included the Parts Group, which sold
automotive parts through Parts America and Western Auto Stores until November
2, 1998, when the Company sold the Parts Group.
-- Homelife Furniture Stores - included in 1997, 1998 and 1999 until January
30, 1999, when the Company sold Homelife.
SERVICES - consisting of:
> Home Services, which provides service contracts, product installation and
repair services, major home improvements and other home services such as pest
control and carpet cleaning.
> Direct Response, consisting of direct-response marketing, which markets
insurance (credit protection, life and health), clubs and services
memberships, merchandise through specialty catalogs, and impulse and
continuity merchandise.
CREDIT - which manages the Company's portfolio of credit card receivables
arising from purchases of merchandise and services from domestic operations. The
domestic credit card receivables portfolio consists primarily of Sears Card and
Sears Premier Card account balances.
CORPORATE - includes activities that are of an overall holding company nature,
primarily consisting of administrative activities and the Sears Online
investment initiatives related to selling merchandise via the Company Web sites,
the costs of which are not allocated to the Company's businesses.
INTERNATIONAL - consisting of retail, services, credit and corporate operations
similar to the Company's domestic operations. International operations are
conducted in Canada through Sears, Canada Inc. ("Sears Canada"), a majority
owned subsidiary. International operations were also conducted through Sears,
Roebuck de Mexico, S.A. de C.V. ("Sears Mexico"), a 75.5% owned subsidiary until
March 1997, when the Company sold 60% of the outstanding shares of Sears Mexico.
Throughout management's analysis of consolidated operations and financial
condition, certain prior year information has been reclassified to conform with
the current year presentation. All references to earnings per share relate to
diluted earnings per common share.
18 SEARS, ROEBUCK AND CO.
MANAGEMENT'S ANALYSIS OF CONSOLIDATED OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS
CONSOLIDATED
Net income in 1999 increased 38.6% to $1.45 billion, or $3.81 per share, from
$1.05 billion, or $2.68 per share for 1998. The results of operations for 1999,
1998, and 1997 were affected by certain noncomparable items. The effects of
these noncomparable items on net income and earnings per share are summarized as
follows:
millions, except per share data 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------
Earnings Earnings Earnings
After-tax per share After-tax per share After-tax per share
- ----------------------------------------------------------------------------------------------------------
Net income excluding noncomparable items $ 1,482 $ 3.89 $ 1,300 $ 3.32 $ 1,303 $ 3.27
Restructuring charge for
NTB and Corporate
staff reductions (29) (0.08) -- -- --
Sale of Homelife -- -- (21) (0.05) -- --
Sale of Western Auto -- -- (243) (0.62) -- --
Extraordinary loss on
debt extinguishment -- -- (24) (0.06) --
SFAS No. 125 accounting -- -- 36 0.09 136 0.35
Reaffirmation charge -- -- -- -- (320) (0.80)
Sale of Advantis -- -- -- -- 91 0.23
Sale of Sears Mexico -- -- -- -- (36) (0.09)
Postretirement life insurance -- -- -- -- 37 0.09
Parts America conversion -- -- -- -- (23) (0.06)
- ----------------------------------------------------------------------------------------------------------
Net income as reported $ 1,453 $ 3.81 $ 1,048 $ 2.68 $ 1,188 $ 2.99
- ----------------------------------------------------------------------------------------------------------
DESCRIPTION OF NONCOMPARABLE ITEMS
In the third quarter of 1999 the Company implemented certain cost reduction
strategies resulting in a $46 million pre-tax charge ($29 million after-tax). Of
the $46 million charge, $25 million related to the closing of 33 automotive
stores and $21 million related to severance costs for headquarters staff
reductions of approximately 450 employees. The Company anticipates annual
savings of approximately $40 million (pretax) related to these cost reduction
efforts.
On November 18, 1998, the Company entered into an agreement to sell its
Homelife furniture business for $100 million in cash, a $10 million note
receivable and a 19% ownership interest in the new Homelife business. The
Company recorded a loss of $33 million ($21 million after-tax) in the fourth
quarter of 1998 related to this transaction. The sale was completed on January
30, 1999.
On November 2, 1998, the Company completed an Agreement and Plan of Merger
of Western Auto, a wholly owned subsidiary, and Advance Auto Parts whereby Sears
exchanged its interest in Western Auto for $175 million in cash and
approximately 40% equity ownership interest in the resulting combined company.
Based upon the terms of the sale, the Company recorded a pretax loss of $319
million ($243 million after-tax) in 1998.
On October 2, 1998, the Company prepaid debt with a face value of $300
million, which was due in May 2000. The transaction generated an extraordinary
loss of $37 million ($24 million after-tax). The loss resulted primarily from
the write-off of the related unamortized discount.
In 1997, the Company implemented Statement of Financial Accounting
Standards ("SFAS") No. 125, which changed the way the Company accounted for
securitizations. SFAS No. 125 accounting provided incremental operating income
of $58 million in 1998 and $222 million in 1997 ($36 million and $136 million,
respectively, after-tax).
The 1997 reaffirmation charge of $475 million ($320 million after-tax)
represents the cost of the settlement of lawsuits and investigations which
alleged that the Company had violated the United States Bankruptcy Code and
consumer protection laws in various states through activities related to certain
debt reaffirmation agreements and other related matters. There are no further
open matters with respect to the reaffirmation charge taken in 1997.
In 1997, the Company sold to IBM its 30% equity interest in Advantis, a
joint venture between IBM and the Company. The sale resulted in a pretax gain of
$150 million ($91 million after-tax) recorded in other income.
In 1997, the Company sold 60% of the outstanding shares of Sears Mexico to
Grupo Carso S.A. de C.V. The sale was recorded in the first quarter of 1997 and
resulted in a pretax loss of $21 million reflected in other income and tax
expense of $15 million, for an after-tax loss of $36 million.
The Company changed its postretirement life insurance benefit plan in 1997
by eliminating retiree life insurance benefits for all active associates not
retired by December 31, 1997. This plan change resulted in a one-time pretax
curtailment gain of $61 million ($37 million after-tax) recorded as a reduction
of selling and administrative expense.
SEARS, ROEBUCK AND CO. 19
MANAGEMENT'S ANALYSIS OF CONSOLIDATED OPERATIONS (CONTINUED)
The majority of the Western Auto stores were converted to the Parts America
format in 1997 and, as a result, the Company recorded a pretax charge of $38
million ($23 million after-tax) for this initiative.
ANALYSIS OF CONSOLIDATED RESULTS EXCLUDING
NONCOMPARABLE ITEMS
Net income in 1999, excluding noncomparable items, was $1.48 billion or $3.89
per share, an increase of 17.2% over comparable 1998 per share earnings of
$3.32. The improvement was the result of better performance in the Retail,
Credit, and International segments and the reduction of shares outstanding,
partially offset by a decline in Services results and higher Corporate expenses
including investments in Sears Online.
In 1998, net income excluding noncomparable items was $1.30 billion or
$3.32 per share, an increase of 1.5% over comparable 1997 per share earnings of
$3.27. The improved profitability of the Credit and Services segments, coupled
with strong International performance, a reduction of shares outstanding, and a
lower effective tax rate was largely offset by a decline in Retail results.
REPORTABLE SEGMENTS
Segment operating income as reported and excluding noncomparable items is as
follows:
millions 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
Excluding Effect of Excluding Effect of Excluding Effect of
non- non- non- non- non- non-
comparable comparable As comparable comparable As comparable comparable As
items items reported items items reported items items reported
- -----------------------------------------------------------------------------------------------------------------------
Retail $ 866 $ (25) $ 841 $ 734 $ (352) $ 382 $ 928 $ 23 $ 951
Services 329 -- 329 375 -- 375 361 -- 361
Credit 1,347 -- 1,347 1,086 58 1,144 1,005 (253) 752
Corporate (301) (21) (322) (211) -- (211) (212) -- (212)
- ------------------------------------------------------------------------------------------------------------------------
Domestic
operating income 2,241 (46) 2,195 1,984 (294) 1,690 2,082 (230) 1,852
- ------------------------------------------------------------------------------------------------------------------------
International 218 -- 218 165 -- 165 142 -- 142
- ------------------------------------------------------------------------------------------------------------------------
Total
operating income $ 2,459 $ (46) $ 2,413 $ 2,149 $ (294) $ 1,855 $ 2,224 $ (230) $ 1,994
- ------------------------------------------------------------------------------------------------------------------------
RETAIL
Retail store revenues as reported, operating income excluding noncomparable
items, and related information are as follows:
millions, except number of
stores and Retail store revenues
per selling square foot 1999 1998 1997
- -----------------------------------------------------------
Full-line Stores revenues $23,798 $23,140 $22,839
Specialty Stores revenues 5,977 7,289 7,247
- -----------------------------------------------------------
Total Retail revenues(1) $29,775 $30,429 $30,086
- -----------------------------------------------------------
Operating income excluding
noncomparable items $ 866 $ 734 $ 928
- -----------------------------------------------------------
Number of Full-line Stores 858 845 833
Number of Specialty Stores 2,153 2,198 2,697
- -----------------------------------------------------------
Total Retail stores 3,011 3,043 3,530
- -----------------------------------------------------------
Retail store revenues per
selling square foot(2) $ 325 $ 317 $ 318
Comparable store sales
percentage increase(3) 1.8% 1.1% 2.3%
- -----------------------------------------------------------
(1) The Company's 1997 fiscal year included 53 weeks, compared to 52 weeks in
1999 and 1998. Excluding the 53rd week in 1997, total retail revenues
increased 3.0% in 1998.
(2) 1997 revenues per square foot calculation excludes the 53rd week.
(3) Includes licensed businesses operating within the Full-line stores.
Retail revenues decreased 2.1% in 1999 to $29.78 billion from $30.43
billion in 1998. Excluding the exited businesses, Western Auto and Homelife,
retail revenues increased 3.2% in 1999. Revenues in 1999 and 1998 included 52
weeks compared to 53 weeks in 1997.
Full-line Stores revenues increased 2.8% in 1999, benefiting from the net
addition of 13 Full-line Stores as 19 stores were opened and 6 were closed. The
Full-line Stores increase was led by solid revenue performance in hardlines
merchandise as comparable store sales increased in 1999. Hardlines revenue
increases in home appliances, electronics and home improvement were partially
offset by a decline in home office merchandise sales. Apparel sales were strong
in women's special sizes, infant's and toddler's, fine jewelry, home fashions,
and cosmetics and fragrances but were offset by results in dresses, footwear,
junior's, boy's, girl's and men's apparel.
Specialty Store revenues decreased to $5.98 billion in 1999 from $7.29
billion in 1998 due primarily to the sale of Western Auto and Homelife.
Excluding the exited businesses, specialty retail revenues increased 4.7% in
1999. The strong revenue performance in Hardware and Dealer Stores was partially
offset by a decline in Auto Stores revenues.
The revenue increase in Hardware and Dealer Stores in 1999 resulted from
the addition of new stores and strong comparable store sales increases. During
1999, the Company opened two net new Hardware Stores and 85 net new Dealer
20 SEARS, ROEBUCK AND CO.
MANAGEMENT'S ANALYSIS OF CONSOLIDATED OPERATIONS (CONTINUED)
Stores. The Contract Sales business and The Great Indoors also produced revenue
gains as the Company continued to expand these businesses.
The Auto Stores 1999 revenues were below management's expectations and
declined from 1998 levels. Comparable store sales decreased and the Company
closed 33 NTB stores in the third quarter of 1999. As of year-end, the Company
operated 798 Sears Auto Centers and 310 NTB stores.
Retail revenues increased 1.1% in 1998 to $30.43 billion from $30.09
billion in 1997. 1998 included 52 weeks of revenue compared to 53 weeks in 1997.
Full-line Stores revenues increased 1.3% in 1998 as the Company added 12
net new Full-line Stores. In 1998, apparel sales gains were led by increases in
women's special sizes, fine jewelry and cosmetics and fragrances, partially
offset by weak sales of dresses, juniors, boy's and men's apparel. Hardlines
merchandise had a solid revenue increase in 1998 led by strong sales growth in
home appliances and electronics merchandise, partially offset by a decline in
home improvement and home office merchandise sales.
Specialty Store revenues increased slightly to $7.29 billion in 1998 from
$7.25 billion in 1997 as strong performance in Hardware and Dealer stores was
offset by a decline in Auto Stores revenue. Auto Stores revenues declined in
1998 from 1997 as comparable store sales decreased from prior year levels,
Western Auto had only 10 months of sales in 1998, and sales were affected by the
relatively mild winter weather.
In addition to revenue performance, gross margin, selling and
administrative expenses, and depreciation and amortization are important
elements in determining Retail operating income. The following discussion of
Retail gross margin, selling and administrative expense, and depreciation and
amortization excludes the effect of noncomparable items to provide a more
meaningful comparison between years. The noncomparable items that affected the
Retail segment operating income were the restructuring costs related to the
closing of 33 NTB stores in 1999, the losses related to the sales of Western
Auto and Homelife in 1998, and the Parts America conversion and the
postretirement life insurance curtailment in 1997.
Retail gross margin as a percentage of Retail revenues was flat in 1999
compared to 1998. While the first three quarters of 1999 reflected unfavorable
gross margin rates compared to 1998, in the fourth quarter, gross margin rates
rebounded in both hardlines and apparel, lifting the retail gross margin rate
for the full year to a level consistent with 1998. In 1998, Retail gross margin
as a percentage of Retail revenues declined 90 basis points from 1997. In 1998,
the decline was due to higher promotional activity driven by a competitive
retail environment.
Retail selling and administrative expense as a percentage of Retail
revenues improved 50 basis points in 1999 from 1998. The improvement was
primarily driven by lower marketing expenses and improvements related to the
exit of the Western Auto and Homelife businesses which had higher cost
structures. In 1998, Retail selling and administrative expense as a percentage
of Retail revenues improved 40 basis points from 1997. In 1998, the improvement
was primarily due to leveraging payroll and other employee-related costs.
Retail depreciation and amortization expense decreased 1.8% in 1999 from
1998 and increased 5.0% in 1998 compared to 1997. The slight decrease in 1999
reflects the absence of depreciation and amortization from the exited businesses
of Homelife and Western Auto. The increase in 1998 reflects the continuation of
the Company's store remodeling program and the growth in the number of Specialty
Stores in operation.
SERVICES
Services revenues and operating income as reported are as follows:
millions 1999 1998 1997
- -------------------------------------------
Revenues $3,078 $3,113 $3,073
- -------------------------------------------
Operating income $ 329 $ 375 $ 361
- -------------------------------------------
Services revenues, generated primarily by the Home Services business,
declined 1.1% in 1999. Home Services revenues were down 1.6% due primarily to a
decline in the home improvement business. Direct Response revenues increased
1.9% in 1999 from 1998 as the clubs and services business improved while
insurance and other merchandise revenues were relatively flat.
In 1998, Services revenues increased 1.3% primarily due to an 8.5% increase
in revenues from Direct Response. All categories of Direct Response products
showed improved revenue results in 1998, including clubs and services, insurance
and specialty catalogs. In 1998 Home Services revenues were flat as an increase
in installation services was offset by a slight decline in the home improvement
business and the 53rd week included in 1997.
Services gross margin as a percentage of Services revenues increased 20
basis points in 1999 from 1998. While gross margin rates were relatively flat in
both the Home Services and Direct Response businesses, a shift in revenue
towards the higher margin Direct Response business caused the overall margin
rate to increase. In addition, included in the improved gross margin are the
costs related to the exit of a Home Services licensed business relationship
which adversely affected the Services gross margin rate by 65 basis points. In
1998, Services gross margin as a percentage of revenues improved 100 basis
points from 1997, primarily due to improved profitability of the service
contracts portfolio within the Home Services business.
Services selling and administrative expense as a percentage of Services
revenues increased 130 basis points in 1999 from 1998. The increase was
primarily due to higher payroll, insurance and marketing costs. In 1998,
Services selling and administrative expense as a percentage of Services revenues
increased 50 basis points from 1997 due to increased infrastructure investments.
Services depreciation and amortization expense increased 16.3% in 1999 from
1998 and 16.7% in 1998 compared to 1997. These increases reflect both
infrastructure investments and recent acquisitions.
SEARS, ROEBUCK AND CO. 21
MANAGEMENT'S ANALYSIS OF CONSOLIDATED OPERATIONS (CONTINUED)
Overall, while operating income for both Home Services and Direct Response
decreased in 1999, the majority of the decrease came from the home improvement
division of the Home Services business. Direct Response continued to provide a
significant portion of the operating income for the Services segment in 1999.
CREDIT
Domestic Credit revenues and operating income are as follows:
millions 1999 1998 1997
- --------------------------------------------------------
Credit revenues $ 4,085 $ 4,369 $ 4,649
- --------------------------------------------------------
Operating income excluding
noncomparable items $ 1,347 $ 1,086 $ 1,005
Noncomparable items:
SFAS No. 125 -- 58 222
Reaffirmation charge -- -- (475)
- --------------------------------------------------------
Operating income
as reported $ 1,347 $ 1,144 $ 752
- --------------------------------------------------------
Operating income as reported was $1.35 billion in 1999, an increase of $203
million over the 1998 level. Although credit revenue decreased during 1999,
operating income favorability resulted from a lower provision for uncollectible
accounts as the quality of the portfolio improved due to improved risk
management techniques and investments made in the collection process. Increases
in SG&A were more than offset by lower interest expense.
In 1998, the primary reason for the $392 million increase in reported
operating income in the Credit segment compared to 1997 was the $475 million
reaffirmation charge which adversely affected 1997 results.
In 1999, Credit revenues decreased 6.5% to $4.09 billion. The decrease in
Credit revenues was attributable to a lower level of average owned credit card
receivables and lower retained interest assets. In 1998, Credit revenues
decreased 6.0% to $4.37 billion, reflecting lower average owned receivable
balances, and the 53rd week of revenues contained in 1997.
A summary of certain Credit information for the managed portfolio is as
follows:
1999 1998 1997
- --------------------------------------------------------------
Sears Card as a % of sales(1) 47.9% 51.6% 55.1%
Average account
balance (dollars) $ 1,121 $ 1,076 $ 1,058
Average managed credit
card receivables (millions) $26,593 $27,922 $27,150
- --------------------------------------------------------------
(1) Sears Card as a % of sales includes Full-line Stores, Specialty Stores,
Home Services, and Retail Outlet Stores.
The percentage of merchandise sales and services transacted with the Sears
Card in 1999 declined to 47.9% compared to 51.6% in 1998, due to a greater
preference for other payment methods, including cash, check and third-party
credit cards.
Credit selling and administrative expense increased 9.0% in 1999 from the
1998 amount. This increase was primarily attributable to increased investment in
credit collection efforts, enhanced risk management systems, the TSYS conversion
costs and the launch of the Sears Premier Card. In 1998, selling and
administrative expense increased 7.7% from the 1997 level primarily due to
increased collection and risk management activities and litigation costs.
Domestic provision for uncollectible accounts and related information is as
follows:
millions 1999 1998 1997
- ---------------------------------------------------------------
Provision for
uncollectible accounts $ 837 $ 1,261 $ 1,493
Net credit charge-offs
to average managed
credit card receivables(1)(2) 6.44% 7.35% 6.48%
Delinquency rates
at year-end(3) 7.58% 6.82% 7.00%
Owned credit
card receivables $17,068 $17,443 $19,386
Allowance for uncollectible
owned accounts $ 725 $ 942 $ 1,077
- ---------------------------------------------------------------
(1)In 1998, the net credit charge-off rate includes the effect of the
conversion of 12% of the accounts to the new credit system ("TSYS") in the
fourth quarter of 1998. The effect on the charge-off rate was not material.
In 1999, 38% of the accounts were converted in March and 50% in April.
Balances are generally charged-off earlier under the TSYS system than under
the previously used proprietary system.
(2)The following table sets forth the quarterly net credit charge-off rates for
the managed portfolio for 1999, 1998 and 1997. Although the 1998 annual
charge-off rate was higher than 1997, 1997 was a year of rapid deterioration
in the charge-off rate while 1998 showed considerable improvement. In 1999,
the charge-off rate continued to improve even though the Company converted
to the TSYS operating system, which generally charges-off accounts earlier
than under the proprietary system previously used. The net charge-off rate is
affected by seasonality, periodic sales of uncollectible accounts to third
parties, bankruptcy trends and other general economic trends.
Q1 Q2 Q3 Q4 ANNUAL RATE
- --------------------------------------------------
1997 4.97% 5.69% 6.87% 7.76% 6.48%
- --------------------------------------------------
1998 8.12% 7.37% 7.20% 6.74% 7.35%
- --------------------------------------------------
1999 7.08% 7.11% 6.39% 5.20% 6.44%
- --------------------------------------------------
(3) Delinquency rates in 1998 and 1997 were calculated based on the company's
proprietary credit system. Under the Company's proprietary credit system,
an account was generally considered delinquent when its cumulative past due
balance was three or more times the scheduled minimum monthly payment. The
1998 delinquency rate was for the 88% of the managed accounts that had not
been converted to TSYS. For the TSYS accounts, which represented 12% of the
managed accounts at year-end 1998, the delinquency rate was 9.28%. For TSYS
accounts, the aging methodology is based on the number of completed billing
cycles during which a customer has failed to make a required payment.
Therefore, under TSYS, accounts are considered delinquent when a customer
has failed to make a payment in each of the last three or more billing
cycles. The 1999 year-end delinquency rate is based on the TSYS
methodology.
22 SEARS, ROEBUCK AND CO.
MANAGEMENT'S ANALYSIS OF CONSOLIDATED OPERATIONS (CONTINUED)
The delinquency rates for accounts that had been converted to TSYS were as
follows on a quarterly basis through 1999:
- -------------------------------------------
January 2, 1999 (12% converted) 9.28%
April 3, 1999 (50% converted) 8.07%
July 3, 1999 (100% converted) 7.29%
October 2, 1999 (100% converted) 7.57%
January 1, 2000 (100% converted) 7.58%
- -------------------------------------------
In 1999, the domestic provision for uncollectible accounts decreased $424
million to $837 million. The decrease is attributable to lower average owned
credit card receivable balances and improvement in portfolio quality during the
year. As shown in the table above, delinquency rates on a TSYS basis declined
from year-end 1998, when delinquencies were at 9.28%, to 7.58% at the end of
1999. In addition, the net charge-off rate for 1999 decreased to 6.44% from
7.35% in 1998. The allowance for doubtful accounts at year-end is $725 million,
or 4.26% of on-book receivables as compared to 5.44% at the prior year-end.
In 1998, the provision for uncollectible accounts decreased 15.5% from
1997. The decrease was primarily attributable to favorable trends in delinquency
rates, charge-off experience and bankruptcy filings, as well as lower owned
credit card receivable balances and one less week of provision expense in 1998
compared to 1997 due to the effect of the 53rd week. As of January 2, 1999, the
allowance was $942 million compared to $1.08 billion at January 3, 1998. The
$135 million decrease in the allowance for uncollectible accounts related to the
improvement in portfolio quality and the reduction in owned credit card
receivable balances. The owned credit card receivables decreased $1.94 billion
during 1998 primarily due to the transfer of credit card receivables from Sears
to a securitization Master Trust to provide receivable balances for future
securitizations. Receivables transferred to the securitization Master Trust in
1998 were classified as retained interest in transferred credit card receivables
in the balance sheet, and were transferred net of the related $106 million
allowance balance.
Interest expense from the domestic segments is included in the Credit
segment discussion because the majority of the Company's domestic interest
expense is allocated to the Credit segment. Generally, the domestic interest
expense that is not allocated to the Credit segment is allocated to the Retail
segment and is not a significant cost relative to costs of sales, buying and
occupancy, selling and administrative expense, and depreciation and amortization
expense in the Retail segment.
Domestic interest expense is combined with the funding cost on receivables
sold through securitizations to represent total funding costs. The Company uses
credit card receivable securitizations as a significant funding source and
therefore, for purposes of this analysis, the interest paid on securitizations
is considered a funding cost. The total domestic funding costs are as follows:
millions 1999 1998 1997
- --------------------------------------------------------
Domestic segments
interest expense(1) $1,168 $1,318 $1,290
Domestic funding cost
of securitized receivables 419 433 437
- --------------------------------------------------------
Total domestic
funding costs $1,587 $1,751 $1,727
- --------------------------------------------------------
(1) Credit segment interest expense was $1,116, $1,244 and $1,259 for 1999,
1998 and 1997, respectively.
Total domestic funding costs decreased 9.4% in 1999 to $1.59 billion. The
decrease in funding costs reflects the lower level of average managed credit
card receivable balances and a lower funding rate environment. In 1998, the
increase in funding costs reflects higher funding requirements due to a higher
average managed credit card receivable portfolio, higher inventory levels and
capital spending and share repurchases partially offset by a lower funding rate.
CORPORATE
Corporate expenses increased $111 million in 1999 compared to 1998. The increase
is primarily attributable to investment spending for the Sears Online initiative
and the $21 million restructuring charge related to staff reductions in the
third quarter of 1999. In addition, increased spending on information systems
and higher performance-based incentive costs drove Corporate expenses higher in
1999. In 1998, Corporate selling and administrative expense decreased $1 million
compared to 1997 due to targeted cost control efforts.
INTERNATIONAL
International revenues and operating income are as follows:
millions 1999 1998 1997
- ---------------------------------------------------
Merchandise sales
and services $3,875 $3,415 $3,490
Credit revenues 258 249 276
- ---------------------------------------------------
Total revenues $4,133 $3,664 $3,766
- ---------------------------------------------------
Operating income $ 218 $ 165 $ 142
- ---------------------------------------------------
International operations include the results of Sears Canada for all
periods presented and the results of Sears Mexico through the first quarter of
1997, when the Company sold its majority interest.
International revenues were $4.13 billion in 1999, a 12.8% increase from
revenues of $3.66 billion in 1998. International revenues increased as Sears
Canada experienced favorable results across all formats including Full-line
stores, dealer stores, furniture stores, catalog, and credit. Comparable store
sales were strong throughout the year. In 1998, revenues decreased 2.7% from
1997 due to the inclusion of $100 million of revenues related to Sears Mexico in
the prior year. Sears Canada had strong retail and catalog sales performance
SEARS, ROEBUCK AND CO. 23
MANAGEMENT'S ANALYSIS OF CONSOLIDATED OPERATIONS (CONTINUED)
in 1998 compared to 1997. However, the favorable performance was partially
offset by the negative effects of a weaker Canadian dollar.
International gross margin as a percentage of International merchandise
sales and services increased 130 basis points in 1999 from 1998 primarily due to
a sharper focus on the management of the cost of goods sold. In 1998, gross
margin as a percentage of merchandise sales and services decreased 30 basis
points from 1997 primarily due to increased buying costs.
International selling and administrative expense as a percentage of total
revenues was relatively flat in 1999 compared to 1998 as payroll, benefits and
other related costs kept pace with the higher sales levels. In 1998,
International selling and administrative expense as a percentage of total
International revenues improved 90 basis points from 1997. The selling and
administrative rate improvement was primarily due to leveraging payroll and
other employee related costs.
International operating income improved $53 million in 1999 compared to
1998. Operating income improved $23 million in 1998 compared to 1997. The
improvement in both years is due to revenue growth resulting from the aggressive
growth strategy in the furniture and dealer store networks and renovations of
Full-line stores.
On December 30, 1999 Sears Canada acquired T. Eaton Company for $66
million. The acquisition included trademarks, leases on 16 stores and certain
tax net operating loss carryforwards.
OTHER INCOME
Consolidated other income consists of:
millions 1999 1998 1997
- --------------------------------------------------------------------
Gain on sale of Advantis $-- $-- $ 150
Loss on sale of Sears Mexico -- -- (21)
Gain on sales of property and investments 10 20 7
Miscellaneous (4) 8 8
- --------------------------------------------------------------------
Total $ 6 $ 28 $ 144
- --------------------------------------------------------------------
INCOME TAX EXPENSE
Consolidated income tax expense as a percentage of pretax income was 37.4% in
1999, 40.7% in 1998 and 42.7% in 1997. The decrease in the effective tax rate in
1999 from 1998 is a result of the unusually high effective rate in 1998 caused
by certain non-tax deductible expenses related to the sale of Western Auto.
Excluding the effect of the Western Auto sale, the Company's consolidated
effective tax rate would have been 38.2% in 1998. The 1997 tax rate was
increased by certain non-tax deductible items related to the reaffirmation
charge and the first quarter sale of Sears Mexico. Excluding these significant
items, the consolidated effective tax rate would have been 39.9% in 1997.
Excluding significant items in both 1998 and 1997, the decrease in 1998 income
tax expense as a percentage of pretax income compared to 1997 was due to
favorable resolution of tax audit issues as well as a reduction in domestic
taxes on international operations.
MARKET RISK
The Company's outstanding debt securities and off-balance sheet derivatives are
subject to repricing risk. The Company's policy is to manage interest rate risk
through the strategic use of fixed and variable rate debt and interest rate
derivatives. All debt securities and off-balance sheet derivatives are
considered non-trading. At year-end 1999 and 1998, 23% and 27%, respectively, of
the funding portfolio was variable rate (including current maturities of
fixed-rate long-term debt that will reprice in the next 12 months and the effect
of off-balance sheet derivative financial instruments, such as interest rate
swaps). Based on the Company's funding portfolio as of year-end 1999 and 1998,
which totaled $24.6 billion and $26.3 billion, respectively, a 100 basis point
change in interest rates would affect annual pretax funding cost by
approximately $56 million and $70 million, respectively. The calculation assumes
the funding portfolio balance at year-end remains constant for an annual period
and that the 100 basis point change occurs at the beginning of the annual
period.
INFLATION
The moderate rate of inflation over the past three years has not had a
significant effect on the Company's sales and profitability.
OUTLOOK
In 2000, the Company expects operating income improvement in its Retail,
Services, Credit and International segments and expects earnings per share to
benefit from a reduction in shares outstanding due to its $1.5 billion share
repurchase program. The Company anticipates low double-digit earnings per share
growth, excluding non-comparable items, for the full year of 2000.
CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING INFORMATION
Certain statements made in this Annual Report including the Chairman's Letter
are forward-looking statements made in reliance on the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. As such, they involve
risks and uncertainties that could cause actual results to differ materially.
The Company's forward-looking statements are based on assumptions about many
important factors, including competitive conditions in the retail industry;
changes in consumer confidence and spending; acceptance of new products; the
ability of the Company to successfully implement its promotional plan and cost
control strategy; success of technological advances; general United States
economic conditions, such as higher interest rates; and normal business
uncertainty. In addition, the Company typically earns a disproportionate share
of its operating income in the fourth quarter due to holiday buying patterns,
which are difficult to forecast with certainty. While the Company believes that
its assumptions are reasonable, it cautions that it is impossible to predict the
impact of such factors which could cause actual results to differ materially
from predicted results. The Company intends the forward-looking statements in
this annual report to speak only at the time of its release and does not
undertake to update or revise these projections as more information becomes
available.
24 SEARS, ROEBUCK AND CO.
CONSOLIDATED BALANCE SHEETS
millions, except per share data 1999 1998
- ------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents $ 729 $ 495
Retained interest in transferred credit card receivables 3,144 4,294
Credit card receivables 18,793 18,946
Less allowance for uncollectible accounts 760 974
-------- --------
Net credit card receivables 18,033 17,972
Other receivables 404 397
Merchandise inventories 5,069 4,816
Prepaid expenses and deferred charges 579 506
Deferred income taxes 709 791
-------- --------
Total current assets 28,667 29,271
Property and equipment
Land 370 395
Buildings and improvements 5,837 5,530
Furniture, fixtures and equipment 5,209 4,871
Capitalized leases 496 530
-------- --------
Gross property and equipment 11,912 11,326
Less accumulated depreciation 5,462 4,946
-------- --------
Total property and equipment, net 6,450 6,380
Deferred income taxes 367 572
Other assets 1,470 1,452
-------- --------
TOTAL ASSETS $ 36,954 $ 37,675
======== ========
LIABILITIES
Current liabilities
Short-term borrowings $ 2,989 $ 4,624
Current portion of long-term debt and capitalized lease obligations 2,165 1,414
Accounts payable and other liabilities 6,992 6,732
Unearned revenues 971 928
Other taxes 584 524
-------- --------
Total current liabilities 13,701 14,222
Long-term debt and capitalized lease obligations 12,884 13,631
Postretirement benefits 2,180 2,346
Minority interest and other liabilities 1,350 1,410
-------- --------
TOTAL LIABILITIES 30,115 31,609
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY
Common shares ($.75 par value per share,
1,000 shares authorized, 369.1 and 383.5 shares outstanding) 323 323
Capital in excess of par value 3,554 3,583
Retained earnings 5,952 4,848
Treasury stock-- at cost (2,569) (2,089)
Deferred ESOP expense (134) (175)
Accumulated other comprehensive income (287) (424)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 6,839 6,066
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 36,954 $ 37,675
======== ========
See accompanying notes.
SEARS, ROEBUCK AND CO. 25
MANAGEMENT'S ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
The Company's significant financial capacity and flexibility are exemplified by
the quality and liquidity of its assets and by its ability to access multiple
sources of capital.
The owned credit card receivables balance of $18.79 billion excludes credit
card receivables transferred to a securitization Master Trust ("Trust"). Through
its subsidiary, SRFG, Inc., the Company sells securities backed by a portion of
the receivables in the Trust to provide funding. In addition to the receivables
in the Trust which back securities sold to third parties, the Company transfers
additional receivables to the Trust in accordance with the terms of the
securitization transactions and to have receivables readily available for future
securitizations.
A summary of these balances at year-end is as follows:
millions 1999 1998 1997
- ----------------------------------------------------------------
Domestic:
Managed credit
card receivables $ 26,785 $ 28,357 $ 28,945
Securitized
balances sold (6,579) (6,626) (6,404)
Retained interest
in transferred
credit card
receivables(1) (3,175) (4,400) (3,316)
Other customer
receivables 37 112 161
- ----------------------------------------------------------------
Domestic owned
credit card receivables 17,068 17,443 19,386
International owned
credit card receivables 1,725 1,503 1,570
- ----------------------------------------------------------------
Consolidated owned
credit card receivables $ 18,793 $ 18,946 $ 20,956
- ----------------------------------------------------------------
(1) The 1999 and 1998 retained interest amounts are shown before reserves of
$31 million and $106 million, respectively, related to the transfer of
credit card receivables into the Master Trust in 1998.
The credit card receivable balances are geographically diversified within
the United States and Canada. The Company grants retail consumer credit based on
the use of proprietary and commercially available credit histories and scoring
models. The Company promptly recognizes uncollectible accounts and maintains an
adequate allowance for uncollectible accounts to reflect losses inherent in the
owned portfolio as of the balance sheet date.
Inventories are primarily valued on the last-in, first-out or LIFO method.
Inventories would have been $595 million higher if valued on the first-in,
first-out or FIFO method at January 1, 2000. Inventories on a FIFO basis totaled
$5.66 billion at January 1, 2000, compared to $5.50 billion at January 2, 1999.
The increase in inventory levels is primarily due to additional inventory needed
to support new Full-line stores, new Specialty Stores, and the growth of Sears
Canada. The sale of Homelife partially offset some of the general increase in
inventory levels.
26 SEARS, ROEBUCK AND CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
millions 1999 1998 1997
- ------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,453 $ 1,048 $ 1,188
Adjustments to reconcile net income to net cash provided by
(used in) operating activities
Depreciation, amortization and other noncash items 908 907 807
Extraordinary loss on early extinguishment of debt -- 37 --
Provision for uncollectible accounts 871 1,287 1,532
Restructuring, impairments and sale of businesses 46 352 (129)
(Gain) loss on sales of property and investments (10) (20) 7
Change in (net of acquisitions):
Deferred income taxes 356 178 273
Retained interest in transferred credit card receivables 1,150 (978) (1,056)
Credit card receivables (873) 423 (2,285)
Merchandise inventories (305) (167) (475)
Other operating assets (150) (65) (160)
Other operating liabilities 251 88 (258)
------- ------- -------
Net cash provided by (used in) operating activities 3,697 3,090 (556)
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of businesses, net of cash acquired (68) (34) (138)
Proceeds from sales of property and investments 118 220 394
Purchases of property and equipment (1,033) (1,212) (1,328)
------- ------- -------
Net cash used in investing activities (983) (1,026) (1,072)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 1,491 2,686 3,920
Repayments of long-term debt (1,516) (3,375) (3,299)
(Decrease) increase in short-term borrowings,
primarily 90 days or less (1,653) (576) 1,834
Termination of interest rate swap agreements -- -- (633)
Repayments of ESOP note receivable 57 23 16
Common shares purchased (570) (528) (170)
Common shares issued for employee stock plans 61 126 103
Dividends paid to shareholders (355) (278) (441)
------- ------- -------
Net cash (used in) provided by financing activities (2,485) (1,922) 1,330
------- ------- -------
Effect of exchange rate changes on cash and cash equivalents 5 (5) (4)
------- ------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 234 137 (302)
------- ------- -------
BALANCE AT BEGINNING OF YEAR 495 358 660
------- ------- -------
BALANCE AT END OF YEAR $ 729 $ 495 $ 358
======= ======= =======
See accompanying notes.
SEARS, ROEBUCK AND CO. 27
CAPITAL RESOURCES
Total net funding for the Company at January 1, 2000, was $24.62 billion
compared with $26.30 billion at January 2, 1999. The decrease in net funding is
primarily due to a decrease in domestic managed credit card receivable balances
at year-end 1999 compared to year-end 1998. Net year-end funding, including
debt reflected on the balance sheet and investor certificates related to credit
card receivables sold through securitizations, is as follows:
millions 1999 % of Total 1998 % of Total 1997 % of Total
- -------------------------------------------------------------------------------------------
Short-term borrowings $ 2,989 12.2% $ 4,624 17.6% $ 5,208 19.1%
Long-term debt and
capitalized lease obligations 15,049 61.1% 15,045 57.2% 15,632 57.4%
Securitized balances sold 6,579 26.7% 6,626 25.2% 6,404 23.5%
- -------------------------------------------------------------------------------------------
Total funding $24,617 100.0% $26,295 100.0% $27,244 100.0%
- -------------------------------------------------------------------------------------------
In 1999, the Company reduced the percentage of short-term borrowings and
increased fixed-rate, longer-term debt and securitization funding in its funding
mix as interest rate conditions were favorable in the term debt markets. The
Company accesses a variety of capital markets to preserve flexibility and
diversify its funding sources. The broad access to capital markets also allows
the Company to effectively manage liquidity and repricing risk. Liquidity risk
is the measure of the Company's ability to fund maturities and provide for the
operating needs of its businesses. Repricing risk is the effect on net income
from changes in interest rates. The Company's cost of funds is affected by a
variety of general economic conditions, including the level and volatility of
interest rates. To aid in the management of repricing risk, the Company uses
off-balance sheet financial instruments, such as interest rate swaps. The
Company has policies that centrally govern the use of such off-balance sheet
financial instruments.
The ratings of the Company's debt securities as of January 1, 2000, appear
in the table below:
MOODY'S DUFF &
INVESTORS PHELPS FITCH
SERVICES, STANDARD CREDIT IBCA,
INC. & POOR'S RATING CO. INC.
- -----------------------------------------------------------
Unsecured
long-term debt A3 A- A A
Unsecured
commercial paper P-2 A-2 D-1 F-1
Term securitization Aaa AAA AAA AAA
- -----------------------------------------------------------
On February 24, 2000, the Duff & Phelps Credit Rating Co. changed its
ratings on the Company's debt securities from A, D-1 and AAA, to A-, D-1- and
AAA, respectively.
The Company utilizes Sears Roebuck Acceptance Corp. ("SRAC"), a wholly
owned subsidiary, to issue commercial paper, to maintain a medium-term note
program, and to issue intermediate and long-term underwritten debt. SRAC issued
term debt securities totaling $1.1 billion in 1999. SRAC commercial paper
outstanding was $2.68 billion and $4.24 billion at January 1, 2000, and January
2, 1999, respectively. SRAC commercial paper is supported by $5.06 billion of
syndicated credit agreements, $875 million of which expires in 2002 and $4.185
billion of which expires in 2003. The weighted average interest rate on SRAC
fixed rate term debt issued in 1999 was 6.44% compared to 6.43% in 1998. The
following securities were issued during 1999:
> $750 million of 6.25%, 10-year underwritten notes, at a yield of 6.43%
> $250 million of variable rate medium term notes, with an average term of
1.8 years; and
> $99 million of fixed rate medium term notes, with an average coupon of
6.51% and an average term of 4.3 years.
The Company, through its subsidiary SRFG, Inc., securitizes domestic credit
card receivables to access intermediate-term funding in a cost-effective manner.
In 1999, the Company issued $1.4 billion of fixed-rate term certificates through
securitizations, compared to $985 million in 1998. As of January 1, 2000, there
were $6.58 billion of investor certificates outstanding that were backed by sold
domestic credit card receivables.
CAPITAL SPENDING
The Company has an ongoing capital expenditure program to renovate and update
its Full-line Stores. In addition, the Company has added more Full-line and
Specialty Stores. Capital expenditures during the past three years are as
follows:
millions 1999 1998 1997
- ------------------------------------------------------
Full-line Stores,
primarily remodeling
and expansion efforts $ 673 $ 672 $ 812
Specialty Stores 114 241 320
Other - distribution /
support 246 299 196
- ------------------------------------------------------
Total capital expenditures $1,033 $1,212 $1,328
- ------------------------------------------------------
The Company plans capital expenditures of $1.2 billion for 2000, which
includes the opening of approximately 10 Full-line Stores, and more than 175
Specialty Stores. The Company may also pursue selective strategic acquisitions.
28 SEARS, ROEBUCK AND CO.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
CAPITAL ACCUMULATED
COMMON IN EXCESS DEFERRED OTHER TOTAL TOTAL
DOLLARS IN MILLIONS SHARES COMMON OF PAR RETAINED TREASURY ESOP COMPREHENSIVE SHAREHOLDERS' COMPREHENSIVE
SHARES IN THOUSANDS OUTSTANDING STOCK VALUE EARNINGS STOCK EXPENSE INCOME EQUITY INCOME
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, beginning
of year 1997 391,394 $323 $3,618 $3,330 $(1,655) $(230) $(441) $4,945
Net income 1,188 1,188 $1,188
Other comprehensive income:
Currency translation (17) (17) (17)
Reclassification
adjustment for
loss included in
net income 87 87 87
Minimum pension
liability, net of
tax of $34 60 60 60
------
Total comprehensive
income $1,318
======
Dividends to shareholders
($0.92 per share) (360) (360)
Stock options exercised
and other changes 2,936 (20) 123 103
Shares repurchased (3,442) (170) (170)
ESOP expense recognized 26 26
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, end of year 1997 390,888 $323 $3,598 $4,158 $(1,702) $(204) $(311) $5,862
- -----------------------------------------------------------------------------------------------------------------------------------
Net income 1,048 1,048 $1,048
Other comprehensive income:
Currency translation (31) (31) (31)
Minimum pension
liability, net of
tax of $45 (82) (82) (82)
------
Total comprehensive
income $ 935
======
Dividends to shareholders
($0.92 per share) (358) (358)
Stock options exercised
and other changes 3,263 (15) 141 126
Shares repurchased (10,643) (528) (528)
ESOP expense recognized 29 29
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, end of year 1998 383,508 $323 $3,583 $4,848 $(2,089) $(175) $(424) $6,066
- -----------------------------------------------------------------------------------------------------------------------------------
Net income 1,453 1,453 $1,453
Other comprehensive income:
Currency translation 14 14 14
Minimum pension
liability, net of
tax of $57 104 104 104
Unrealized gain on
securities held,
net of tax of $11 19 19 19
------
Total comprehensive
income $1,590
======
Dividends to shareholders
($0.92 per share) (349) (349)
Stock options exercised
and other changes 2,041 (29) 90 61
Shares repurchased (16,421) (570) (570)
ESOP expense recognized 41 41
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, end of year 1999 369,128 $323 $3,554 $5,952 $(2,569) $(134) $(287) $6,839
- -----------------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
SEARS, ROEBUCK AND CO. 29
SHARE REPURCHASES
During 1999, the Company repurchased 16.4 million shares of its common stock
for $570 million under its February 1998 share repurchase program related to
employee stock-based incentive plans and its March 1999 $1.5 billion repurchase
plan. As of the end of 1999, the Company has the capacity to repurchase $1.04
billion of shares under the March 1999 $1.5 billion repurchase plan.
LIQUIDITY
Based upon the expected cash flow to be generated from future operations and
the Company's ability to cost-effectively access multiple sources of funding,
the Company believes sufficient resources will be available to maintain its
planned level of operations, capital expenditures, dividends and share
repurchases in the foreseeable future.
YEAR 2000
Year 2000 compliance is the ability of information systems to properly
recognize and process dates and date-sensitive information including the year
2000 and beyond (commonly referred to as Year 2000 or Y2K). Year 2000 compliance
is critical to the Company because the Company and many of its merchandise
vendors and service providers are highly reliant on information systems to
operate their businesses.
The Company used both internal and external resources to complete its Year
2000 compliance initiatives. The Year 2000 efforts of the Company's credit and
bank operations were also subject to regulatory review.
The Company did not experience any significant Y2K problems. All Sears
facilities opened as planned, systems were available on time and data centers,
networks and infrastructure were operational continuously.
As of January 1, 2000, the Company's total costs (including external costs
and the costs of internal personnel) related to its Year 2000 effort are
approximately $62 million, all of which the Company (including Sears Canada) has
incurred. In addition, the Company has accelerated the planned development of
new systems with improved business functionality to replace systems that were
not Year 2000 compliant, including the Company's new payroll processing system.
These systems cost approximately $80 million, all of which the Company has
incurred as of January 1, 2000. The Company funded Year 2000 costs with cash
flows from operations.
30 SEARS, ROEBUCK AND CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE >1 > SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Sears, Roebuck and
Co. and all majority-owned domestic and international companies ("the Company").
Investments in companies in which the Company exercises significant influence,
but not control, are accounted for using the equity method of accounting.
Investments in companies in which the Company has less than a 20% ownership
interest, and does not exercise significant influence, are accounted for at
cost.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Certain reclassifications have been made in the 1998 and 1997 financial
statements to conform with the current year presentation.
FISCAL YEAR
The Company's fiscal year ends on the Saturday nearest December 31. Unless
otherwise stated, references to years in this report relate to fiscal years
rather than to calendar years.
Fiscal year Ended Weeks
- ---------------------------------------------------
1999 January 1, 2000 52
1998 January 2, 1999 52
1997 January 3, 1998 53
- ---------------------------------------------------
MERCHANDISE SALES AND SERVICES
Revenues from merchandise sales and services are net of estimated returns and
allowances and exclude sales tax. Included in merchandise sales and services are
gross revenues of licensees of $1.69, $1.74 and $1.85 billion for 1999, 1998 and
1997, respectively. In December 1999 the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements", which effectively changes previous guidance related to
the recording of licensed business revenues for retail companies. In the year
2000, the Company will change its method of recording licensed business revenue.
This change will reduce reported revenue and reported expenses, but have no
impact on operating income.
SERVICE CONTRACTS
The Company sells extended service contracts with terms of coverage generally
between 12 and 36 months. Revenues and incremental direct acquisition costs from
the sale of these contracts are deferred and amortized over the lives of the
contracts. Costs related to performing the services under the contracts are
expensed as incurred.
STORE PREOPENING EXPENSES
Costs associated with the opening of new stores are expensed as incurred.
EARNINGS PER COMMON SHARE
Basic earnings per common share is computed by dividing net income available to
common shareholders by the weighted average number of common shares outstanding.
Diluted earnings per common share also includes the dilutive effect of potential
common shares (dilutive stock options) outstanding during the period.
CASH AND CASH EQUIVALENTS
Cash equivalents include all highly liquid investments with maturities of three
months or less at the date of purchase.
RETAINED INTEREST IN TRANSFERRED CREDIT CARD RECEIVABLES
As part of its domestic credit card securitizations, the Company transfers
credit card receivables to a Master Trust ("Trust") in exchange for certificates
representing undivided interests in such receivables. Effective January 3, 1998,
the Company reclassified, for all periods presented, its retained interest in
transferred credit card receivables to a separate balance sheet account and
presented the related charge-offs of transferred credit card receivables as a
reduction of credit revenues. Subsequent to January 3, 1998, amounts transferred
from the Company's credit card portfolio to the Trust become securities upon
transfer. Accounts are transferred net of the related allowance for
uncollectible accounts and income is recognized generally on an effective yield
basis over the collection period of the transferred balances. The retained
interest consists of investor certificates held by the Company and the seller's
certificate, which represents both contractually required seller's interest and
excess seller's interest in the credit card receivables in the Trust. The
contractually required seller's interest represents the dollar amount of credit
card receivables that, according to the terms of the Company's securitization
agreements, must be included in the Trust in addition to the amount of
receivables which back the securities sold to third parties. The excess seller's
interest is the dollar amount of receivables that exist in the Trust to provide
for future securitizations, but is not contractually required to be in the
Trust. Retained interests are as follows:
millions 1999 1998 1997
- ---------------------------------------------------------------------------
Investor certificates held by the Company $ 960 $ 920 $ 545
Contractually required seller's interest 760 764 697
Excess seller's interest 1,455 2,716 2,074
- ---------------------------------------------------------------------------
Retained interest in
transferred credit
card receivables $3,175(1) $4,400(1) $3,316
- ---------------------------------------------------------------------------
(1) The 1998 retained interest amount is shown before reserve of $106 million
related to the transfers during 1998, $31 million of which remains at the
1999 year-end.
The Company intends to hold the investor certificates and contractually
required seller's interest to maturity. The excess seller's interest is
considered available for sale. Due to the revolving nature of the underlying
credit card receivables, the carrying value of the Company's retained interest
in transferred credit card receivables approximates fair value and is classified
as a current asset.
SEARS, ROEBUCK AND CO. 31
CREDIT CARD RECEIVABLES
Credit card receivables arise primarily under open-end revolving credit accounts
used to finance purchases of merchandise and services offered by the Company.
These accounts have various billing and payment structures, including varying
minimum payment levels and finance charge rates. Based on historical payment
patterns, the full receivable balance will not be repaid within one year.
Credit card receivables are shown net of an allowance for uncollectible
accounts. The Company provides an allowance for uncollectible accounts based on
impaired accounts, historical charge-off patterns and management judgement.
In 1997 and 1998 under the Company's proprietary credit system,
uncollectible accounts were generally charged off automatically when the
customer's past due balance was eight times the scheduled minimum monthly
payment, except that accounts could be charged off sooner in the event of
customer bankruptcy. However, in the fourth quarter of 1998, the Company
converted 12% of its managed portfolio of credit card receivables to a new
credit processing system. The remaining 88% of accounts on the proprietary
credit system were then converted to the new system in the first and second
quarters of 1999. Under the new system, the Company charges off an account
automatically when a customer has failed to make a required payment in each of
the eight billing cycles following a missed payment. Under both systems, finance
charge revenue is recorded until an account is charged off, at which time
uncollected finance charge revenue is recorded as a reduction of credit
revenues.
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" in 1997. SFAS No. 125 requires that the Company
recognize gains on its credit card securitizations which qualify as sales and
that an allowance for uncollectible accounts not be maintained for receivable
balances which are sold. Prior to adoption of SFAS No. 125, the Company
maintained an allowance for uncollectible sold accounts as a recourse liability
and did not recognize gains on securitizations. Accordingly, the adoption of
SFAS No. 125 increased operating income by $58 million in 1998 and $222 million
in 1997 versus the operating income that would have been recognized under the
previous accounting method. In 1999, the effects of the change in accounting
related to SFAS No. 125, compared to our previous accounting method, were not
material.
MERCHANDISE INVENTORIES
Approximately 87% of merchandise inventories are valued at the lower of cost
(using the last-in, first-out or "LIFO" method) or market using the retail
method. To estimate the effects of inflation on inventories, the Company
utilizes internally developed price indices.
The LIFO adjustment to cost of sales was a credit of $73, $34 and $17
million in 1999, 1998 and 1997, respectively. Partial liquidation of merchandise
inventories valued under the LIFO method resulted in a credit of $2 million in
1997. No layer liquidation occurred in 1999 and 1998. If the first-in, first-out
("FIFO") method of inventory valuation had been used instead of the LIFO method,
merchandise inventories would have been $595 and $679 million higher at January
1, 2000, and January 2, 1999, respectively.
Merchandise inventories of International operations, operations in Puerto
Rico, and certain Sears Automotive Store formats, which in total represent
approximately 13% of merchandise inventories, are recorded at the lower of cost
or market based on the FIFO method.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost less accumulated depreciation.
Depreciation is provided principally by the straight-line method over the
estimated useful lives of the related assets, generally 2 to 10 years for
furniture, fixtures and equipment, and 15 to 50 years for buildings and building
improvements.
LONG-LIVED ASSETS
Long-lived assets, identifiable intangibles and goodwill related to those assets
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of such assets may not be recoverable.
GOODWILL
Included in other assets is the excess of purchase price over net assets of
businesses acquired ("goodwill"), which is amortized using the straight-line
method over periods ranging from 10 to 40 years. The Company periodically
assesses the recoverability of the carrying value and the appropriateness of the
remaining life of goodwill.
ADVERTISING
Costs for newspaper, television, radio and other media advertising are expensed
the first time the advertising occurs. The total cost of advertising charged to
expense was $1.63, $1.67 and $1.59 billion in 1999, 1998 and 1997, respectively.
DIRECT-RESPONSE MARKETING
The Company direct markets insurance (credit protection, life and health), clubs
and services memberships, merchandise through specialty catalogs, and impulse
and continuity merchandise. For insurance and clubs and services, deferred
revenue is recorded when the member is billed (upon expiration of any free trial
period), and revenue is recognized over the insurance or membership period. For
specialty catalog, impulse and continuity merchandise, revenue is recognized
when merchandise is shipped.
Membership acquisition and renewal costs, which primarily relate to
membership solicitations, are capitalized since such direct-response advertising
costs result in future economic benefits. Such costs are amortized over the
shorter of the program's life or five years, primarily in proportion to when
revenues are recognized. For specialty catalogs, costs are amortized over the
life of the catalog, not to exceed one year. The consolidated balance sheets
include deferred direct-response advertising costs of $180 and $131 million at
January 1, 2000, and January 2, 1999, respectively. The current portion is
included in prepaid expenses and deferred charges, the long term portion in
other assets.
32 SEARS, ROEBUCK AND CO.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The Company utilizes various off-balance sheet financial instruments to manage
the interest rate and foreign currency risk associated with its borrowings. The
counterparties to these instruments generally are major financial institutions
with credit ratings of single-A or better.
Interest rate swap agreements modify the interest characteristics of a
portion of the Company's debt. Any differential to be paid or received is
accrued and is recognized as an adjustment to interest expense in the statement
of income. The related accrued receivable or payable is included in other assets
or liabilities. The fair values of the swap agreements are not recognized in the
financial statements.
Gains or losses on terminations of interest rate swaps are deferred and
amortized to interest expense over the remaining life of the original swap
period to the extent the related debt remains outstanding.
Financial instruments used as hedges must be effective at reducing the type
of risk associated with the exposure being hedged and must be designated as
hedges at inception of the hedge contract. Accordingly, changes in market values
of financial instruments must be highly correlated with changes in market values
of the underlying items being hedged. Any financial instrument designated but
ineffective as a hedge would be marked to market and recognized in earnings
immediately.
EFFECT OF NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". In May 1999, the
FASB voted to delay the adoption of SFAS No. 133 by one year. This statement is
now required to be adopted in years beginning after June 15, 2000. The Company
is currently evaluating the effect this statement might have on the consolidated
financial position and results of operations of the Company.
NOTE >2 > DISPOSITION OF BUSINESSES
On November 18, 1998, the Company entered into an agreement to exchange its
interest in the Homelife furniture business for $100 million in cash, a $10
million note receivable and a 19% equity ownership in the new Homelife business.
The Company recorded a pretax charge of $33 million ($21 million after-tax) in
the fourth quarter of 1998 related to this transaction. The sale was completed
on January 30, 1999.
On November 2, 1998, the Company completed an Agreement and Plan of Merger
of Western Auto, a wholly owned subsidiary, and Advance Auto Parts, whereby
Sears exchanged its interest in Western Auto for $175 million in cash and
approximately 40% equity ownership in the resulting combined company. Based on
the terms of the sale, the Company recorded a pretax charge of $319 million
($243 million after-tax) in 1998 related to this transaction. In the fourth
quarter of 1999, certain estimates of remaining liabilities under the terms of
the transaction were revised, resulting in $5 million of pretax income being
recorded in the restructuring and impairment line of the income statement.
NOTE >3 > RESTRUCTURING CHARGES
The Company implemented certain cost-reduction strategies during the third
quarter of 1999 resulting in a $46 million pretax restructuring charge. Of the
$46 million charge, $25 million relates to the closing of 33 automotive stores
in three geographic markets and $21 million relates to severance costs for
headquarters staff reductions of approximately 450 employees. The staff
reductions and the closing of the 33 stores both occurred during the third
quarter of 1999. Of the $25 million charge for the 33 closed stores,
approximately $3 million relates to severance costs, $21 million is to reduce
the carrying value of the closed store assets to their estimated fair value,
less costs to sell, and $1 million is for other related costs. As of January 1,
2000, future cash payments to settle restructuring obligations approximate $16
million, which is expected to be paid primarily in the year 2000. The Company
paid $20 million of the restructuring costs during the fourth quarter of 1999
resulting in a restructuring reserve balance of $26 million as of January 1,
2000.
NOTE >4 > INCOME TAXES
Income before income taxes, minority interest and extraordinary loss is as
follows:
millions 1999 1998 1997
- ----------------------------------------------
Domestic $2,189 $1,704 $2,018
Foreign 230 179 120
- ----------------------------------------------
Total $2,419 $1,883 $2,138
- ----------------------------------------------
Federal, state and foreign taxes are as follows:
millions 1999 1998 1997
- ---------------------------------------------
Current
Federal $ 414 $ 472 $ 468
State 24 41 75
Foreign 110 74 97
- ---------------------------------------------
Total 548 587 640
- ---------------------------------------------
Deferred
Federal 332 159 256
State 40 15 18
Foreign (16) 5 (2)
- ---------------------------------------------
Total 356 179 272
- ---------------------------------------------
Income tax provision $ 904 $ 766 $ 912
- ---------------------------------------------
A reconciliation of the statutory federal income tax rate
to the effective rate is as follows:
1999 1998 1997
- -------------------------------------------------
Statutory federal
income tax rate 35.0% 35.0% 35.0%
State income taxes,
net of federal
income tax benefit 1.7 1.9 2.9
Reaffirmation charge -- -- 1.3
Sale of Sears Mexico -- -- 1.3
Sale of Western Auto -- 2.3 --
Other 0.7 1.5 2.2
- -------------------------------------------------
Effective income tax rate 37.4% 40.7% 42.7%
- -------------------------------------------------
SEARS, ROEBUCK AND CO. 33
Deferred taxes based upon differences between the financial statement and
tax bases of assets and liabilities and available tax carryforwards consists of:
millions 1999 1998
- ---------------------------------------------------------
Deferred tax assets:
Unearned service contract income $ 429 $ 417
Allowance for uncollectible accounts 320 448
State income taxes 149 125
Postretirement benefit liability 933 974
Minimum pension liability 108 165
Loss carryforward acquired 136 --
Other deferred tax assets 478 565
- ---------------------------------------------------------
Total deferred tax assets 2,553 2,694
- ---------------------------------------------------------
Deferred tax liabilities:
Property and equipment 421 399
Prepaid pension 53 78
LIFO 109 123
Deferred gain 279 235
Deferred revenue 137 73
Deferred swap termination loss 173 182
Other deferred tax liabilities 305 241
- ---------------------------------------------------------
Total deferred tax liabilities 1,477 1,331
- ---------------------------------------------------------
Net deferred taxes $1,076 $1,363
- ---------------------------------------------------------
Management believes that the realization of the deferred tax assets is more
likely than not, based on the expectation that the Company will generate the
necessary taxable income in future periods and, accordingly, no valuation
reserve has been provided. Tax benefits from loss carryforwards will expire by
2006.
U.S. income and foreign withholding taxes were not provided on certain
unremitted earnings of international affiliates which the Company considers to
be permanent investments. The cumulative amount of unremitted income for which
income taxes have not been provided totaled $479 million at January 1, 2000. If
these earnings were to be remitted, taxes of $133 million would be due.
Income taxes of $327, $366 and $886 million were paid in 1999, 1998 and
1997, respectively.
NOTE >5 > BENEFIT PLANS
Expenses for retirement and savings-related benefit plans were as follows:
millions 1999 1998 1997
- -------------------------------------------------
Sears 401(k)
Profit Sharing Plan $ 37 $ 31 $ 33
Pension plans 89 88 106
Postretirement benefits (46) (38) (41)
Other plans -- -- 6
- -------------------------------------------------
Total $ 80 $ 81 $ 104
- -------------------------------------------------
SEARS 401(K) PROFIT SHARING PLAN
Most domestic employees are eligible to become members of the Sears 401(k)
Profit Sharing Plan ("the Plan"). Under the terms of the Plan, the Company
matches a portion of the employee contributions. In 1998 and 1997, the Company
matching contribution was based on 6% of consolidated income, as defined, for
the participating companies and was limited to 70% of eligible employee
contributions. In 1999 and future periods, the Plan has been changed and the
Company match is now fixed at 70% of eligible employee contributions. The
Company's matching contributions were $77, $75 and $71 million in 1999, 1998 and
1997, respectively.
The Plan includes an Employee Stock Ownership Plan ("the ESOP") to prefund
a portion of the Company's anticipated contribution. The Company provided the
ESOP with a loan that was used to purchase Sears common shares in 1989. In June
1998, the ESOP refinanced the loan and extended its maturity to 2024. The
purchased shares represent deferred compensation expense, which is presented as
a reduction of shareholders' equity and recognized as expense when the shares
are allocated to employees to fund the Company contribution. The per share cost
of Sears common shares purchased by the ESOP in 1989 was $15.27. The Company
uses the ESOP shares to fund the Company contribution, which thereby reduces
expense.
The ESOP loan bears interest at 6.1% (9.2% prior to refinancing) and is
repaid from dividends on the ESOP shares and additional cash payments provided
by the Company. The Company has contributed cash to the ESOP annually in the
amount equal to the ESOP's required interest and principal payments on the loan,
less dividends received on the ESOP shares. The cash payments amounted to $57,
$24 and $23 million in 1999, 1998 and 1997, respectively. The balance of the
ESOP loan was $210 and $267 million at January 1, 2000 and January 2, 1999,
respectively. Cash on hand in the ESOP at January 1, 2000 was $4 million.
The reported expense is determined as follows:
millions 1999 1998 1997
- -----------------------------------------------
Interest expense
recognized by ESOP $ 13 $ 21 $ 27
Less dividends
on ESOP shares (17) (19) (20)
Cost of shares allocated
to employees and
plan expenses 41 29 26
- -----------------------------------------------
Sears 401(k) Profit
Sharing Plan expense $ 37 $ 31 $ 33
- -----------------------------------------------
At December 31, 1999, total committed to be released, allocated and
remaining unallocated ESOP shares were 2.7, 14.4 and 8.8 million, respectively.
All ESOP shares are considered outstanding in the calculation of earnings per
share.
34 SEARS, ROEBUCK AND CO.
RETIREMENT BENEFIT PLANS
Certain domestic full-time and part-time employees are eligible to participate
in noncontributory defined benefit plans after meeting age and service
requirements. Substantially all Canadian employees are eligible to participate
in contributory defined benefit plans. Pension benefits are based on length of
service, compensation and, in certain plans, Social Security or other benefits.
Funding for the various plans is determined using various actuarial cost
methods. The Company uses October 31 as the measurement date for determining
pension plan assets and obligations.
In addition to providing pension benefits, the Company provides certain
medical and life insurance benefits for retired employees. Employees may become
eligible for medical benefits if they retire in accordance with the Company's
established retirement policy and are continuously insured under the Company's
group medical plans or other approved plans for 10 or more years immediately
prior to retirement. The Company shares the cost of the retiree medical benefits
with retirees based on years of service. Generally, the Company's share of these
benefit costs will be capped at the Company contribution calculated during the
first year of retirement. The Company's postretirement benefit plans are not
funded. The Company has the right to modify or terminate these plans.
The change in benefit obligation, change in plan assets, funded status,
reconciliation to amounts recognized in the consolidated balance sheets and
weighted average assumptions are as follows:
millions Pension Benefits Postretirement Benefits
- -----------------------------------------------------------------------------------------------
1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------
Change in benefit obligation:
Beginning balance $ 2,872 $ 2,824 $ 1,180 $ 1,270
Benefits earned during the period 95 78 5 7
Interest cost 192 184 74 84
Actuarial loss (gain) (16) 104 (205) (22)
Benefits paid (337) (302) (123) (136)
Foreign exchange impact 22 (38) 2 (4)
Plan amendments -- 22 1 --
Disposition of Western Auto -- -- -- (19)
Other 2 -- -- --
- -----------------------------------------------------------------------------------------------
Ending balance $ 2,830 $ 2,872 $ 934 $ 1,180
- -----------------------------------------------------------------------------------------------
Change in plan assets at fair value:
Beginning balance $ 2,560 $ 2,710 $ -- $ --
Actual return on plan assets 368 176 -- --
Company contributions 50 46 123 136
Benefits paid (337) (302) (123) (136)
Foreign exchange impact 28 (54) -- --
Other 2 (16) -- --
- -----------------------------------------------------------------------------------------------
Ending balance $ 2,671 $ 2,560 $ -- $ --
- -----------------------------------------------------------------------------------------------
Funded status of the plan: $ (159) $ (312) $ (934) $(1,180)
Unrecognized net loss (gain) 410 600 (578) (396)
Unrecognized prior service benefit (21) (25) (668) (770)
- -----------------------------------------------------------------------------------------------
Net amount recognized $ 230 $ 263 $(2,180) $(2,346)
- -----------------------------------------------------------------------------------------------
Amounts recognized in the balance sheet consist of:
Prepaid benefit cost $ 171 $ 164 $ -- $ --
Accrued benefit liability (244) (365) (2,180) (2,346)
Accumulated other comprehensive income 303 464 -- --
- -----------------------------------------------------------------------------------------------
Net amount recognized $ 230 $ 263 $(2,180) $(2,346)
- -----------------------------------------------------------------------------------------------
Pension Benefits Postretirement Benefits
1999 1998 1997 1999 1998 1997
- ----------------------------------------------------------------------------------------------------
Weighted average assumptions:
Discount rate 8.00% 7.25% 7.25% 8.00% 7.25% 7.25%
Return on plan assets 9.50% 9.50% 9.50% NA NA NA
Rate of compensation increases 4.00% 4.00% 4.00% NA NA NA
- ----------------------------------------------------------------------------------------------------
SEARS, ROEBUCK AND CO. 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The components of net periodic benefit cost are as follows:
PENSION BENEFITS POSTRETIREMENT BENEFITS
- ------------------------------------------------------------------------------------------------------------------------------
millions 1999 1998 1997 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
Components of net periodic benefit cost:
Benefits earned during the period $ 95 $ 78 $ 74 $ 5 $ 7 $ 13
Interest cost 192 184 190 74 84 105
Expected return on plan assets (228) (220) (208) -- -- --
Amortization of unrecognized
net prior service benefit (3) (8) (6) (102) (103) (68)
Amortization of unrecognized
transitional asset -- (9) (10) -- -- --
Recognized net loss (gain) 34 47 52 (23) (26) (30)
Elimination of postretirement
life insurance for active associates -- -- -- -- -- (61)
Other (1) 16 14 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 89 $ 88 $ 106 $ (46) $ (38) $ (41)
- ------------------------------------------------------------------------------------------------------------------------------
The projected benefit obligation, accumulated benefit obligation and fair
value of plan assets for the pension plans with accumulated benefit obligations
in excess of plan assets were $2,236, $2,110 and $1,866 million, respectively,
at January 1, 2000, and $2,309, $2,210 and $1,845 million, respectively, at
January 2, 1999. The provisions of SFAS No. 87, "Employers' Accounting for
Pensions," require the recognition of a minimum pension liability for each
defined benefit plan for which the accumulated benefit obligation exceeds plan
assets. The minimum pension liability, net of tax, was $195 million at January
1, 2000 and $299 million at January 2, 1999, and is included in accumulated
other comprehensive income as a reduction of shareholders' equity.
In 1997, the Company announced changes to its postretirement life insurance
benefit plan. Retiree life insurance benefits were eliminated for all active
associates not retired by December 31, 1997. This plan change resulted in a
one-time pretax gain of $61 million. In connection with the elimination of
retirement life insurance benefits for all active associates, the Company also
announced the reduction in life insurance over a 10-year period to a maximum
coverage of $5,000 for all post-1977 retirees.
The weighted average health care cost trend rate used in measuring the
postretirement benefit expense in 2000 is 6.0% for pre-65 retirees and 7.5% for
post-65 retirees. For 2001 and beyond, the trend rates are 5.0% for pre-65
retirees and 6.5% for post-65 retirees. A one percentage point change in the
assumed health care cost trend rate would have the following effects:
ONE PERCENTAGE ONE PERCENTAGE
millions POINT INCREASE POINT DECREASE
- ----------------------------------------------------------------------------
Effect on total service
and interest cost components $ 3 $ (2)
Effect on postretirement
benefit obligation $16 $(14)
- ----------------------------------------------------------------------------
NOTE >6 > BORROWINGS
Short-term borrowings consist of:
millions 1999 1998
- ----------------------------------------------------
Commercial paper $2,824 $4,463
Bank loans 95 91
Promissory note 70 70
Other loans -- --
- ----------------------------------------------------
Total short-term borrowings $2,989 $4,624
Weighted average
interest rate at year end 6.0% 5.3%
Weighted average
interest rate at year end,
including effects of swaps 7.1% 6.3%
- ----------------------------------------------------
At January 1, 2000, SRAC's credit facilities totaled $5.06 billion in
syndicated credit agreements. Sears Canada had credit agreements totaling $553
million. These syndicated and other credit agreements provide for loans at
prevailing interest rates and mature at various dates through April 2003. The
Company pays commitment fees in connection with these credit agreements.
The Company had interest rate swap agreements that established fixed rates
on $1.52 billion and $1.50 billion of short-term variable rate debt at January
1, 2000 and January 2, 1999, respectively, resulting in weighted average
interest rates of 6.7% and 6.8%, respectively. The weighted average maturity of
agreements in effect on January 1, 2000, was approximately 14 years.
36 SEARS, ROEBUCK AND CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Long-term debt is as follows:
millions Issue 1999 1998
- ----------------------------------------------------------
SEARS, ROEBUCK AND CO.
6.25% Notes, due through 2004 $ 300 $ 500
8.2% Extendable Notes, due 1999 -- 31
9.375% Debentures, due 2011 300 300
5.57% to 10.0% Medium-Term
Notes, due 2000 to 2021 1,215 1,550
SEARS ROEBUCK ACCEPTANCE CORP.
6.125% to 7.51% Notes,
due 2000 to 2038 5,827 5,084
5.53% to 7.26% Medium-Term
Notes, due 2000 to 2013 5,716 5,976
SEARS DC CORP.
8.54% to 9.26% Medium-Term
Notes, due 2001 to 2012 213 332
SEARS CANADA INC.
6.55% to 11.70% Debentures,
due 2000 to 2007 305 392
SEARS CANADA RECEIVABLES TRUST
5.04% to 9.18% Receivables
Trusts, due 2001 to 2006 735 405
Capitalized Lease Obligations 417 453
Other Notes and Mortgages 21 22
- ----------------------------------------------------------
15,049 15,045
Less current maturities 2,165 1,414
- ----------------------------------------------------------
Total long-term debt $12,884 $13,631
- ----------------------------------------------------------
On October 2, 1998, the Company prepaid its 6% debentures with a face value
of $300 million, which were due in May 2000. The transaction generated an
extraordinary loss of $37 million and a related income tax benefit of $13
million, resulting in an after-tax loss of $24 million. The loss resulted
primarily from the write-off of the related unamortized discount. The debt was
refinanced with the issuance of commercial paper.
As of January 1, 2000, long-term debt maturities for the next five years
are as follows:
millions
- ---------------------------------------------------
2000 $2,165
2001 2,458
2002 1,654
2003 2,540
2004 862
- ---------------------------------------------------
The Company paid interest of $1.2, $1.3 and $1.4 billion in 1999, 1998 and
1997, respectively. Interest capitalized was $5, $5 and $3 million in 1999, 1998
and 1997, respectively.
NOTE >7 > LEASE AND SERVICE AGREEMENTS
The Company leases certain stores, office facilities, warehouses, computers and
transportation equipment.
Operating and capital lease obligations are based upon contractual minimum
rates and, for certain stores, amounts in excess of these minimum rates are
payable based upon specified percentages of sales. Contingent rent is accrued
over the lease term, provided that the achievement of the specified sales level
that triggers the contingent rental is probable. Certain leases include renewal
or purchase options. Operating lease rentals were $399, $431 and $439 million,
including contingent rentals of $52, $55 and $57 million in 1999, 1998 and 1997,
respectively.
Minimum lease obligations, excluding taxes, insurance and other expenses
payable directly by the Company, for leases in effect as of January 1, 2000, are
as follows:
CAPITAL OPERATING
millions LEASES LEASES
- ---------------------------------------------------
2000 $ 66 $ 352
2001 60 303
2002 56 253
2003 56 224
2004 54 195
After 2004 714 1,092
- ---------------------------------------------------
Total minimum payments $1,006 $2,419
Less imputed interest 589
- ---------------------------------------------------
Present value of
minimum lease payments 417
Less current maturities 16
- ---------------------------------------------------
Long-term obligations $ 401
- ---------------------------------------------------
The Company has committed to purchase data and voice networking and
information processing services of at least $216 million annually through 2004
from a third-party provider. Total expenses incurred by the Company for these
services during 1999, 1998 and 1997 were $318, $355 and $361 million,
respectively. The Company may also be responsible for certain stores leases that
have been assigned.
NOTE >8 > FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets, incurs various financial liabilities and enters into agreements
involving off-balance sheet financial instruments. The Company's financial
assets and liabilities are recorded in the consolidated balance sheets at
historical cost, which approximates fair value.
To determine fair value, credit card receivables are valued by discounting
estimated future cash flows. The estimated cash flows reflect the historical
cardholder payment experience and are discounted at market rates. Long-term debt
is valued based on quoted market prices when available or discounted cash flows,
using interest rates currently available to the Company on similar borrowings.
SEARS, ROEBUCK AND CO. 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company is a party to off-balance sheet financial instruments to manage
interest rate and foreign currency risk. These financial instruments involve, to
varying degrees, elements of market, credit, foreign exchange and interest rate
risk in excess of amounts recognized in the balance sheet. In certain
transactions, the Company may require collateral or other security to support
the off-balance sheet financial instruments with credit risk.
DEBT-RELATED
The Company had the following off-balance sheet financial instruments related to
its outstanding borrowings at the end of 1999 and 1998:
1999
- ----------------------------------------------------------------
CONTRACT OR
NOTIONAL FAIR CARRYING
millions AMOUNT VALUE VALUE
- ----------------------------------------------------------------
Interest rate swap agreements:
Pay floating rate,
receive fixed rate $ 83 $ -- $ --
Pay fixed rate,
receive floating rate 1,517 148 --
Foreign currency
hedge agreements 9 (1) --
- ----------------------------------------------------------------
1998
- ----------------------------------------------------------------
CONTRACT OR
NOTIONAL FAIR CARRYING
millions AMOUNT VALUE VALUE
- ----------------------------------------------------------------
Interest rate swap agreements:
Pay floating rate,
receive fixed rate $ 805 $ 9 $ --
Pay fixed rate,
receive floating rate 1,499 (176) --
Foreign currency
hedge agreements 10 (2) --
- ----------------------------------------------------------------
The Company uses interest rate swaps to manage the interest rate risk
associated with its borrowings and to manage the Company's allocation of fixed
and variable-rate debt. For pay floating rate, receive fixed rate swaps, the
Company paid a weighted average rate of 5.21% and received a weighted average
rate of 6.87% in 1999. For pay fixed rate, receive floating rate swaps, the
Company paid a weighted average rate of 6.68% and received a weighted average
rate of 5.21% in 1999. The fair values of interest rate swaps are based on
prices quoted from dealers. If a counterparty fails to meet the terms of a swap
agreement, the Company's exposure is limited to the net amount that would have
been received, if any, over the agreement's remaining life.
Maturity dates of the off-balance sheet financial instruments outstanding
at January 1, 2000 are as follows:
NOTIONAL AMOUNT
- ---------------------------------------------------------
OVER
MILLIONS 1 YEAR 2-5 YEARS 5 YEARS
- ---------------------------------------------------------
Interest rate
swap agreements $ 283 $ 173 $1,144
Foreign currency
hedge agreements 5 4 --
- ---------------------------------------------------------
During 1997, the Company paid $633 million to terminate interest rate
swaps. The deferred loss related to these terminations was $415 million and $441
million at January 1, 2000, and January 2, 1999, respectively, and is being
amortized over the remaining lives of the original swap periods.
CREDIT-RELATED
The Company had outstanding domestic securitized credit card receivables sold of
$6.58 and $6.63 billion at January 1, 2000, and January 2, 1999, respectively,
for which the Company's credit risk exposure is contractually limited to the
investor certificates held by the Company.
OTHER
The Company had a financial guaranty of $89 million at January 1, 2000. This
guaranty represents a commitment by the Company to guarantee the performance of
certain municipal bonds issued in connection with the Company's headquarters
building. No amounts were accrued in the balance sheet for any potential loss
associated with this guaranty at January 1, 2000, and January 2, 1999.
NOTE >9 > SIGNIFICANT GROUP
CONCENTRATIONS OF CREDIT RISK
The Company grants credit to customers throughout North America. The five states
and the respective receivable balances in which the Company had the largest
amount of managed credit card receivables were as follows:
millions 1999 % OF BALANCE 1998 % OF BALANCE
- --------------------------------------------------------------------
California $2,778 10.4% $2,946 10.4%
Texas 2,127 7.9% 2,285 8.1%
Florida 1,943 7.3% 2,069 7.3%
New York 1,592 5.9% 1,689 6.0%
Pennsylvania 1,364 5.1% 1,457 5.1%
- --------------------------------------------------------------------
NOTE >10 > LEGAL PROCEEDINGS
The Company remains a party to two cases arising from the Company's purchase of
garments produced under allegedly illegal labor conditions on the island of
Saipan in the Commonwealth of the Northern Marianas Islands. The two actions
were filed on January 13, 1999, the first on behalf of ten "Doe" plaintiffs in
the United States District Court for the Central District of California against
eighteen domestic
38 SEARS, ROEBUCK AND CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
clothes retailers and eleven foreign clothing suppliers (which case subsequently
was transferred to the United States District Court for the District of Hawaii),
and the second by various interest groups, purportedly on behalf of the general
public of the State of California, in the San Francisco County Superior Courts.
Plaintiffs in the suits seek various injunctive relief, damages (including
punitive and treble damages), restitution and disgorgement of profits, interest,
and attorney fees and costs. On February 23, 2000, the Company entered into a
settlement agreement with the plaintiffs that provides for the dismissal of both
cases with respect to the Company. While continuing to deny plaintiffs' claims
and contentions, the Company agreed to an immaterial one-time cash payment to
the plaintiffs. The Company further agreed that following the effective date of
the agreement, it would only purchase garments produced in Saipan from factories
that adhere to the terms of a monitoring program provided for in the settlement
agreement. The settlement of the cases is subject to the final approval of both
courts. In the event that the settlement is not approved and the cases continue
against the Company, their consequences are not presently determinable, but in
the opinion of the management of the Company, the ultimate liability is not
expected to have a material effect on the results of operations, financial
position, liquidity or capital resources of the Company.
The Company is subject to various other legal and governmental proceedings,
many involving routine litigation incidental to the business. Other matters
contain allegations that are nonroutine and involve compensatory, punitive or
treble damage claims in very large amounts, as well as other types of relief.
The consequences of these matters are not presently determinable but, in the
opinion of management of the Company after consulting with legal counsel, the
ultimate liability in excess of reserves currently recorded is not expected to
have a material effect on annual results of operations, financial position,
liquidity or capital resources of the Company.
NOTE >11 > OTHER INCOME
In 1997, the Company sold its 30% equity interest in Advantis, a joint venture
between IBM and the Company, to IBM. This transaction resulted in a pretax gain
of $150 million and is recorded in other income.
Also in 1997, the Company completed the sale of 60% of the outstanding
shares of Sears, Roebuck de Mexico, S.A. de C.V. to Grupo Carso S.A. de C.V. The
sale resulted in a pretax loss of $21 million and is reflected in other income.
NOTE >12 > EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted earnings
per share:
millions, except per share data 1999 1998 1997
- ----------------------------------------------------------------------
Net income available to
common shareholders(1) $1,453 $1,048 $1,188
Average common
shares outstanding 379.2 388.6 391.6
Earnings per share - basic $ 3.83 $ 2.70 $ 3.03
Dilutive effect
of stock options 1.8 3.1 6.2
Average common and
common equivalent
shares outstanding 381.0 391.7 397.8
Earnings per share - diluted $ 3.81 $ 2.68 $ 2.99
- ----------------------------------------------------------------------
(1) Income available to common shareholders is the same for purposes of
calculating basic and diluted EPS.
In each period, certain options were excluded from the computation of
diluted earnings per share because they would have been antidilutive. At January
1, 2000, January 2, 1999 and January 3, 1998, options to purchase 11.9, 5.2 and
4.7 million shares of stock at prices ranging from $40 to $64, $52 to $64 and
$47 to $64 per share were excluded from the 1999, 1998 and 1997 calculations,
respectively.
NOTE >13 > SHAREHOLDERS' EQUITY
DIVIDEND PAYMENTS
Under terms of indentures entered into in 1981 and thereafter, the Company
cannot take specified actions, including the declaration of cash dividends, that
would cause its unencumbered assets, as defined, to fall below 150% of its
liabilities, as defined. At January 1, 2000, approximately $4.5 billion could be
paid in dividends to shareholders under the most restrictive indentures.
SHARE REPURCHASE PROGRAM
On February 3, 1998, the Board of Directors extended, for an additional two
years, the common share repurchase program which is used to acquire shares for
distribution in connection with the expected exercise of stock options, the
grant of restricted shares and the exchange of deferred shares under the
Company's stock plans. The program authorized the Company to acquire up to 20
million Sears common shares on the open market. By the end of the first quarter
of 1999, all 20 million common shares authorized to be purchased under this
repurchase program had been acquired.
On March 10, 1999, the Board of Directors approved a common share
repurchase program to acquire up to $1.5 billion of the Company's common shares
by December 31, 2001. The shares are to be purchased on the open market or
through privately negotiated transactions. As of January 1, 2000, approximately
14.0 million common shares have been acquired under this repurchase program at a
cost of approximately $464 million.
SEARS, ROEBUCK AND CO. 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE >14 > STOCK-BASED COMPENSATION
STOCK OPTION PLANS
Options to purchase common stock of the Company have been granted to employees
under various plans at prices equal to the fair market value of the stock on the
dates the options were granted. Generally, options vest over a three- or
four-year period and become exercisable either in equal, annual installments
over the vesting period, or at the end of the vesting period. Options generally
expire in 10 or 12 years.
Additionally, certain options were granted in 1997 and 1999 with
performance-based features that required the Company's share price to reach
specified targets at three- and five-year intervals from the grant date to be
earned. In February 1999, the Company extended the period of time allowed to
meet the specified targets for the 1997 grants by one year. The Company had 1.1
million, 1.2 million, and 1.4 million performance-based options outstanding at
the end of 1999, 1998 and 1997, respectively. Subject to the satisfaction of the
performance-based features, these performance-based options vest 50% in year
six, 25% in year seven and 25% in year eight from the time of grant. The Company
did not recognize compensation expense in 1999, 1998 or 1997 related to these
options because the exercise price exceeded the Company share price at each year
end.
The Company measures compensation cost under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and no compensation
cost has been recognized for its fixed stock option plans. In accordance with
SFAS No. 123, "Accounting for Stock-Based Compensation," the fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model. The following assumptions were used during the respective
years to estimate the fair value of options granted:
1999 1998 1997
- ---------------------------------------------------------------------
Dividend yield 2.16% 1.81% 1.59%
Expected volatility 28% 28% 28%
Risk-free interest rate 5.03% 5.82% 6.19%
Expected life of options 6 years 6 years 6 years
- ---------------------------------------------------------------------
Had compensation cost for the Company's stock option plans been determined
using the fair value method under SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
millions, except earnings per share 1999 1998 1997
- ---------------------------------------------------------------------
Net income-- as reported $1,453 $1,048 $1,188
Net income-- pro forma 1,414 1,023 1,174
Earnings per share-- basic
As reported 3.83 2.70 3.03
Pro forma 3.73 2.63 3.00
Earnings per share-- diluted
As reported 3.81 2.68 2.99
Pro forma 3.71 2.61 2.95
- ---------------------------------------------------------------------
Changes in stock options are as follows:
shares in thousands 1999 1998 1997
- --------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
- --------------------------------------------------------------------------------------------------------
Beginning balance 15,251 $39.93 15,155 $34.16 14,389 $25.00
Granted 5,668 40.89 4,171 55.73 4,165 58.23
Exercised (1,084) 22.76 (2,671) 25.00 (2,832) 23.67
Canceled or expired (1,309) 51.11 (1,404) 52.98 (567) 31.17
- --------------------------------------------------------------------------------------------------------
Ending balance 18,526 $40.44 15,251 $39.93 15,155 $34.16
- --------------------------------------------------------------------------------------------------------
Reserved for future
grant at year-end 5,337 9,979 12,840
Exercisable 7,844 $27.92 8,217 $25.43 7,524 $23.89
- --------------------------------------------------------------------------------------------------------
Fair value of options
granted during the year $13.35 $18.61 $17.98
- --------------------------------------------------------------------------------------------------------
40 SEARS, ROEBUCK AND CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information about stock options outstanding
at January 1, 2000:
shares in thousands OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------------------------------------------------------
WEIGHTED AVG.
RANGE OF NUMBER REMAINING WEIGHTED AVG. NUMBER WEIGHTED AVG.
EXERCISE OUTSTANDING CONTRACTUAL LIFE EXERCISE EXERCISABLE EXERCISE
PRICES AT 01/01/00 IN YEARS PRICE AT 01/01/00 PRICE
- -------------------------------------------------------------------------------------------------------------------
$10.00 to $20.00 1,336 4.4 $16.41 1,336 $16.41
20.01 to 30.00 4,229 6.5 24.24 4,224 24.23
30.01 to 40.00 1,103 8.8 31.97 989 31.94
40.01 to 50.00 7,239 8.3 42.94 1,177 48.08
50.01 to 64.00 4,619 8.0 60.31 118 55.81
- -------------------------------------------------------------------------------------------------------------------
$10.00 to $64.00 18,526 7.7 $40.44 7,844 $27.92
- -------------------------------------------------------------------------------------------------------------------
ASSOCIATE STOCK PURCHASE PLAN
On May 8, 1997, the shareholders approved the Company's Associate Stock
Ownership Plan ("ASOP"). The ASOP allows eligible employees the right to elect
to use up to 10% of their eligible compensation to purchase Sears common stock
on a quarterly basis at the lower of 85% of the fair market value at the
beginning or end of each calendar quarter. The maximum number of shares of Sears
common stock available under the ASOP is 10 million. The first purchase period
began January 1, 1998. There were 0.6 million shares issued under the ASOP in
1998 and 0.7 million shares issued in 1999.
NOTE >15 > SUMMARY OF SEGMENT DATA
The Company is a multiline retailer providing a wide array of merchandise and
services, and no single product or service accounted for a significant
percentage of the Company's consolidated revenue. The Company has four domestic
segments, which include the Company's operations in the United States and Puerto
Rico, and one international segment. The domestic segments are Retail, Services,
Credit and Corporate.
The Retail segment includes the operating results of the Company's
Full-line Stores and Specialty Stores; and the Services segment includes the
operating results of the Company's Home Services and Direct Response businesses.
These businesses have been aggregated into their respective reportable segments
based on the management reporting structure and their similar economic
characteristics, customers and distribution channels.
A general description of the merchandise and services offered in each
segment follows:
RETAIL
Full-line Stores, which are located principally in shopping malls, sell apparel,
home fashions and hardlines merchandise. Specialty Stores, consisting of
Hardware, Dealer, The Great Indoors, Auto, Contract Sales, and Homelife
furniture stores sell hardlines, home fashions, auto products and furniture. The
Homelife furniture stores were sold on January 30, 1999.
SERVICES
Associates and third-party licensee partners of the Company provide product
repair services, extended warranty service contracts and home improvement
products. Direct Response consists of direct-response marketing, which markets
insurance (credit protection, life and health), clubs and service memberships,
merchandise through specialty catalogs, and impulse and continuity merchandise.
CREDIT
The Credit business manages the Company's portfolio of credit card receivables
arising from purchases of merchandise and services from domestic operations.
CORPORATE
The Corporate segment includes activities that are of a holding-company nature,
primarily consisting of administrative activities and the Sears Online
investment initiatives related to selling merchandise via the Company Web site,
the costs of which are not allocated to the Company's businesses.
INTERNATIONAL
The International segment consists of retail, credit, services and corporate
operations similar to the Company's domestic operations. International
operations are conducted in Canada through Sears Canada, Inc., a 54.6% owned
subsidiary. International operations were also conducted in Mexico through
Sears, Roebuck de Mexico, S.A. de C.V. ("Sears Mexico") until March 29, 1997,
when the Company sold 60% of the outstanding shares of Sears Mexico. Thereafter,
Sears Mexico's results are no longer included in the Company's consolidated
results.
The segments do not record intersegment revenues and expenses. External
revenues and expenses are allocated between the applicable segments.
The domestic segments participate in a centralized funding program.
Interest expense is allocated to the Credit segment based on its funding
requirements assuming a 9-to-1 debt to equity ratio. Funding includes debt
reflected on the balance sheet and investor certificates related to credit card
receivables sold through securitizations. Services is allocated interest income
based on the after-tax cash flow it generates through the sale of service
contracts. The remainder of net domestic interest expense is reported in the
Retail segment.
The Company's segments are evaluated on a pretax basis, and a stand-alone
income tax provision is not calculated for the individual segments. The Company
includes its deferred income taxes within the Corporate segment. The other
accounting policies of the segments are substantially the same as those
described in the Company's summary of significant accounting policies footnote.
SEARS, ROEBUCK AND CO. 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
millions RETAIL SERVICES CREDIT INTERNATIONAL CORPORATE CONSOLIDATED
- ------------------------------------------------------------------------------------------------------------
1999
Revenue $ 29,775 $ 3,078 $ 4,085 $ 4,133 $ -- $ 41,071
Depreciation and
amortization expense 659 57 14 76 42 848
Interest revenue -- 59 -- -- -- 59
Interest expense 111 -- 1,116 100 -- 1,327
Operating income (expense) 841 329 1,347 218 (322) 2,413
Equity in net income
of investees accounted
for by the equity method (14) -- -- 9 -- (5)
Noncomparable items--
income (expense), pretax (25) -- -- -- (21) (46)
Total assets 10,130 1,087 20,622 3,324 1,791 36,954
Capital expenditures 711 81 39 143 59 1,033
- ------------------------------------------------------------------------------------------------------------
1998
Revenue $ 30,429 $ 3,113 $ 4,369 $ 3,664 $ -- $ 41,575
Depreciation and
amortization expense 671 49 13 64 33 830
Interest revenue -- 59 -- -- -- 59
Interest expense 133 -- 1,244 105 -- 1,482
Operating income (expense) 382 375 1,144 165 (211) 1,855
Equity in net income
of investees accounted
for by the equity method -- -- -- 5 -- 5
Noncomparable items--
income (expense), pretax (352) -- 58 -- (37) (331)
Total assets 10,046 943 21,605 2,816 2,265 37,675
Capital expenditures 934 50 18 91 119 1,212
- ------------------------------------------------------------------------------------------------------------
1997
Revenue $ 30,086 $ 3,073 $ 4,649 $ 3,766 $ -- $ 41,574
Depreciation and
amortization expense 639 42 13 60 31 785
Interest revenue -- 61 -- -- -- 61
Interest expense 92 -- 1,259 119 -- 1,470
Operating income (expense) 951 361 752 142 (212) 1,994
Equity in net income
of investees accounted
for by the equity method -- -- -- 6 -- 6
Noncomparable items--
income (expense), pretax 23 -- (253) (21) 150 (101)
Total assets 10,732 753 22,250 2,801 2,164 38,700
Capital expenditures 1,114 51 9 108 46 1,328
- ------------------------------------------------------------------------------------------------------------
Noncomparable items in 1999 were:
Retail: Restructuring charge for NTB store closings
Corporate: Corporate staff reductions
Noncomparable items in 1998 were:
Retail: Impairment loss related to the sales of Western Auto and
Homelife
Credit: SFAS No. 125 accounting
Corporate: Extraordinary loss on debt extinguishment
Noncomparable items in 1997 were:
Retail: Postretirement life insurance curtailment, partially offset by
the Parts America conversion
Credit: Reaffirmation charge, partially offset by SFAS No. 125
accounting
International: Loss on the sale of Sears Mexico
Corporate: Gain on the sale of Advantis
42 SEARS, ROEBUCK AND CO.
MANAGEMENT'S REPORT
The financial statements, financial analyses and all other information were
prepared by management, which is responsible for their integrity and
objectivity. Management believes the financial statements, which require the use
of certain estimates and judgments, fairly and accurately reflect the financial
position and operating results of Sears, Roebuck and Co. ("the Company") in
accordance with generally accepted accounting principles. All financial
information is consistent with the financial statements.
Management maintains a system of internal controls that it believes
provides reasonable assurance that, in all material respects, assets are
maintained and accounted for in accordance with management's authorizations and
transactions are recorded accurately in the books and records. The concept of
reasonable assurance is based on the premise that the cost of internal controls
should not exceed the benefits derived. To assure the effectiveness of the
internal control system, the organizational structure provides for defined lines
of responsibility and delegation of authority. The Company's formally stated and
communicated policies demand of employees high ethical standards in their
conduct of its business. These policies address, among other things, potential
conflicts of interest; compliance with all domestic and foreign laws, including
those related to financial disclosure; and the confidentiality of proprietary
information. As a further enhancement of the above, the Company's comprehensive
internal audit program is designed for continual evaluation of the adequacy and
effectiveness of its internal controls and measures adherence to established
policies and procedures.
Deloitte & Touche LLP, independent certified public accountants, have
audited the financial statements of the Company, and their report is presented
below. Their audit also includes a study and evaluation of the Company's control
environment, accounting systems and control procedures to the extent necessary
to conclude that the financial statements present fairly the Company's financial
position and results of operations. The independent accountants and internal
auditors advise management of the results of their audits, and make
recommendations to improve the system of internal controls. Management evaluates
the audit recommendations and takes appropriate action.
The Audit Committee of the Board of Directors is comprised entirely of
directors who are not employees of the Company. The committee reviews audit
plans, internal control reports, financial reports and related matters and meets
regularly with the Company's management, internal auditors and independent
accountants. The independent accountants and the internal auditors advise the
committee of any significant matters resulting from their audits and have free
access to the committee without management being present.
/s/ Arthur C. Martinez
Arthur C. Martinez
Chairman, President and Chief Executive Officer
/s/ Julian C. Day
Julian C. Day
Executive Vice President and Chief Operating Officer
/s/ Jeffrey N. Boyer
Jeffrey N. Boyer
Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS
SEARS, ROEBUCK AND CO.
We have audited the accompanying Consolidated Balance Sheets of Sears, Roebuck
and Co. as of January 1, 2000 and January 2, 1999, and the related Consolidated
Statements of Income, Shareholders' Equity, and Cash Flows for each of the three
years in the period ended January 1, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Sears, Roebuck and Co. as of
January 1, 2000 and January 2, 1999, and the results of its operations and its
cash flows for each of the three years in the period ended January 1, 2000 in
conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Chicago, Illinois
February 7, 2000
SEARS, ROEBUCK AND CO. 43
FIVE-YEAR SUMMARY OF CONSOLIDATED FINANCIAL DATA
millions, except per common share and shareholder data 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Revenues $ 41,071 $ 41,575 $ 41,574 $ 38,064 $ 34,835
Costs and expenses 38,658 39,720 39,580 35,981 33,130
Operating income 2,413 1,855 1,994 2,083 1,705
Other income, net 6 28 144 30 27
Income before income taxes, minority
interest and extraordinary loss 2,419 1,883 2,138 2,113 1,732
Income taxes 904 766 912 834 703
Income from continuing operations 1,453 1,072 1,188 1,271 1,025
Income from discontinued operations -- -- -- -- 776
Extraordinary loss -- 24 -- -- --
Net income 1,453 1,048 1,188 1,271 1,801
FINANCIAL POSITION
Retained interest in transferred
credit card receivables $ 3,144 $ 4,294 $ 3,316 $ 2,260 $ 5,579
Credit card receivables, net 18,033 17,972 19,843 19,303 14,527
Merchandise inventories 5,069 4,816 5,044 4,646 4,033
Property and equipment, net 6,450 6,380 6,414 5,878 5,077
Total assets 36,954 37,675 38,700 36,167 33,130
Short-term borrowings 2,989 4,624 5,208 3,533 5,349
Long-term debt 15,049 15,045 15,632 14,907 11,774
Total debt 18,038 19,669 20,840 18,440 17,123
Percent of debt to equity 264% 324% 356% 373% 391%
Shareholders' equity $ 6,839 $ 6,066 $ 5,862 $ 4,945 $ 4,385
SHAREHOLDERS' COMMON SHARE INVESTMENT
Book value per common share $ 18.53 $ 15.82 $ 15.00 $ 12.63 $ 10.40
Shareholders 220,749 233,494 235,336 243,986 256,624
Average common and
equivalent shares outstanding 381 392 398 399 394
Earnings per common share - diluted
Income from continuing operations $ 3.81 $ 2.74 $ 2.99 $ 3.12 $ 2.53
Income from discontinued operations -- -- -- -- 1.97
Extraordinary loss -- .06 -- -- --
Net income $ 3.81 $ 2.68 $ 2.99 $ 3.12 $ 4.50
Cash dividends declared
per common share $ .92 $ .92 $ .92 $ .92 $ 1.26
Cash dividend payout percent 24.1% 34.3% 30.8% 29.5% 28.0%
Market price -
per common share (high-low) 53 3/16 - 26 11/16 65 - 39 1/16 65 1/4 - 38 3/4 53 7/8 - 38 1/4 60 - 30
- ----------------------------------------------------------------------------------------------------------------------------------
Closing market price at December 31 30 3/8 42 1/2 45 1/4 46 39
- ----------------------------------------------------------------------------------------------------------------------------------
Price/earnings ratio (high-low) 14 - 7 24 - 15 22 - 13 17 - 12 16 - 12
- ----------------------------------------------------------------------------------------------------------------------------------
Operating results and financial position reflect the 1995 dispositions of
Allstate and Homart as discontinued operations.
The percent of debt to equity is calculated using equity from continuing
operations.
The 1995 price/earnings ratio was calculated on a continuing operations basis.
Stock prices have not been restated to reflect the Allstate distribution.
Certain prior year information has been reclassified to conform with current
year presentation.
1996 and 1995 have not been restated to reflect the licensed business
reclassification for Sears Canada.
44 SEARS, ROEBUCK AND CO.
QUARTERLY RESULTS (UNAUDITED)
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER YEAR
- ----------------------------------------------------------------------------------------------------------------------------
millions, except per
common share data 1999 1998 1999 1998 1999 1998 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
Revenues $ 9,037 $ 9,233 $ 9,992 $10,314 $ 9,538 $ 9,803 $12,504 $12,225 $41,071 $41,575
- ----------------------------------------------------------------------------------------------------------------------------
Operating income 245 222 564 566 383 173 1,221 894 2,413 1,855
- ----------------------------------------------------------------------------------------------------------------------------
Net income 146 133 331 336 236 44 740 535 1,453 1,048
- ----------------------------------------------------------------------------------------------------------------------------
Earnings per common
share - diluted 0.38 0.34 0.86 0.85 0.62 0.11 1.98 1.39 3.81 2.68
- ----------------------------------------------------------------------------------------------------------------------------
Excluding impact of
noncomparable items
Operating income 245 188 564 537 429 478 1,221 946 2,459 2,149
- ----------------------------------------------------------------------------------------------------------------------------
Net income 146 112 331 318 265 298 740 572 1,482 1,300
- ----------------------------------------------------------------------------------------------------------------------------
Earnings per common
share - diluted $ 0.38 $ 0.28 $ 0.86 $ 0.80 $ 0.69 $ 0.76 $ 1.98 $ 1.48 $ 3.89 $ 3.32
- ----------------------------------------------------------------------------------------------------------------------------
1999 noncomparable items consist of restructuring charges related to the
headquarters staff reduction and the sale of 33 Auto Stores, both of which
occurred in the third quarter.
1998 noncomparable items consist of impairment charges related to the sale of
Western Auto and Homelife, an extraordinary loss on the early extinguishment of
debt and the impact of SFAS No. 125 accounting.
The fourth quarter pretax LIFO adjustments were credits of $103 and $64 million
in 1999 and 1998, compared with charges of $30 million for the first nine months
of the respective Years.
Total of quarterly earnings per common share may not equal the annual amount
because net income per common share is calculated independently for each
quarter.
Certain quarterly information has been reclassified to conform with year-end
presentation.
COMMON STOCK MARKET INFORMATION AND DIVIDEND HIGHLIGHTS (UNAUDITED)
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER YEAR
- -------------------------------------------------------------------------------------------------------------------------------
dollars 1999 1998 1999 1998 1999 1998 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
Stock price range
High 47 1/8 59 7/8 53 3/16 65 47 3/8 63 9/16 35 1/2 50 3/4 53 3/16 65
Low 39 1/16 42 1/2 41 5/8 55 1/16 29 3/8 40 9/16 26 11/16 39 1/16 26 11/16 39 1/16
Close 44 11/16 58 1/4 47 11/16 62 1/16 32 3/4 41 7/8 30 3/8 42 1/2 30 3/8 42 1/2
Cash dividends declared 0.23 0.23 0.23 0.23 0.23 0.23 0.23 0.23 0.92 0.92
- -------------------------------------------------------------------------------------------------------------------------------
Stock price ranges are for the New York Stock Exchange (trading symbol - S),
which is the principal market for the Company's common stock.
The number of registered common shareholders at February 29, 2000 was 219,149.
In addition to the New York Stock Exchange, the Company's common stock is listed
on the following exchanges: Chicago; Pacific, San Francisco; London, England;
Amsterdam, The Netherlands; Swiss, EBS; and Dusseldorf, Germany.
SEARS, ROEBUCK AND CO. 45
EXECUTIVE OFFICERS
ARTHUR C. MARTINEZ 1998-1999. Chairman and chief ALAN J. LACY
60, chairman, president and chief executive officer of Bradlees, Inc., 46, president, Services since September
executive officer since 1995. Chairman 1994-1997. M.B.A., 1971 and B.A. 1999, president of Sears Credit from
and chief executive officer of the Engineering, 1969, Columbia University. 1997 until 1999 (additionally as chief
former Merchandise Group, 1992-1995. financial officer from 1998 to 1999),
M.B.A., 1965, Harvard University; MARY E. CONWAY and chief financial officer, from 1995
B.S., 1960, Polytechnic University. 51, president, Stores since September until 1997. Executive vice president and
1999. President, Full-line Stores chief financial officer 1995-1997;
M. SHAN ATKINS 1999; senior vice president, Northeast senior vice president of Finance of the
42, executive vice president, Strategic Region 1998-1999; region general former Merchandise Group 1994-1995.
Initiatives since September 1999. manager 1993-1998. 1982, Beaver Vice president of Financial Services
Senior vice president-Corporate Strategy, College; 1980, St. Joseph University. and Systems of Philip Morris Companies
April, 1999; vice president/general Inc. and president of Philip Morris
merchandising manager, Lawn & Garden JULIAN C. DAY Capital Corporation, 1993-1994.
1998-1999; vice president-strategy, 47, executive vice president and chief M.B.A., 1977, Emory University; B.S.,
Merchandise Planning Office, Imports operating officer since September 1975, Georgia Institute of Technology,
1996-1998. Vice president and partner 1999. Executive vice president and
of Bain & Company, 1982-1996. chief financial officer, March 1999 GERALD N. MILLER
M.B.A., 1983 Harvard Business to September 1999. Executive vice 52, senior vice president and
School; Bachelor of Commerce, president and chief financial officer chief information officer since 1998.
1979, Queens University. of Safeway, Inc. 1992-1998. M.B.A., Vice president of Logistics Information
1979, London Business School; M.A., Systems 1995-1998; senior systems,
JEFFREY N. BOYER 1975 and B.A., 1974, Oxford University. director 1994-1995. Vice president
41, chief financial officer since of Information Technology of Bergen
September 1999. Vice president and LYLE G. HEIDEMANN Brunswig Corporation, 1987-1994.
controller, 1998-1999; vice president, 54, president, Hardlines since 1999. B.S.-Finance, 1970, Long Beach State.
finance-Full-line Stores, 1996-1998. Senior vice president, Appliances/
Vice president, business development Electronics, 1998-1999; vice president, WILLIAM G. PAGONIS
of The Pillsbury Co., 1995-1996 and Appliances/Electronics, 1997-1998; 58, executive vice president, Logistics
vice president of Finance-general foods vice president, general merchandise since 1994. Senior vice president,
of Kraft General Foods, 1994-1995. manager--Home Appliances, 1996-1997; 1993-1994. Retired Lieutenant General,
B.S., 1980, University of Illinois; divisional vice president, Lawn and U.S. Army. M.B.A., 1970 and B.S.,
C.P.A., 1980, Illinois. Garden/Sporting Goods, 1992-1996. 1964, Pennsylvania State University.
B.S., 1967, Northern Illinois University.
JAMES R. CLIFFORD JOHN T. SLOAN
54, president and chief operating ANASTASIA D. KELLY 48, executive vice president, Human
officer of Full-line Stores since 1998. 50, executive vice president, general Resources since 1999. Senior vice
Sears Canada, Inc.-president and chief counsel since September 1999. president, Human Resources, 1998-1999.
operating officer, 1996-1998; senior vice Executive vice president, general Vice president-Human Resources,
president and chief financial officer, counsel and secretary, March 1999 to Full-line stores, 1996-1998. Senior vice
1993-1996. M.B.A., 1971, Seattle September 1999. Fannie Mae-senior vice president of administration of Tribune
University; B.B.A. 1968, Cleveland State. president, general counsel and secretary, Company, 1993-1996. M.B.A., 1976,
1996-1999; senior vice president and Fordham University; B.S., 1974,
MARK A. COHEN general counsel, 1996 and senior vice Cornell University.
51, president, Softlines, chief marketing president, deputy general 1995-1996.
officer since September 1999. Executive Partner, Wilmer, Cutler & Pickering,
vice president-Marketing from January 1990-1995. J.D., 1981, George
to August 1999. Senior vice president of Washington University National Law
Cosmetics, Accessories, Fine Jewelry, Center; B.A., 1971, Trinity College.
Footwear and Home Fashions,
46 SEARS, ROEBUCK AND CO.
BOARD OF DIRECTORS
a. [PHOTO] ARTHUR C. MARTINEZ 3* a.
ARTHUR C. MARTINEZ
60, chairman, president and chief
executive officer since 1995; chairman
and chief executive officer of the
former Merchandise Group 1992-1995. Vice
chairman and director of Saks Fifth
Avenue 1990-1992. Director, Pepsi Co.,
Inc. Sears director since 1995.
b. [PHOTO] RICHARD C. NOTEBAERT 1,4 b.
RICHARD C. NOTEBAERT
52, chairman, president and chief
executive officer of Ameritech
Corporation from 1994 until his
retirement in December 1999; president
and chief operating officer 1993-1994;
vice chairman 1993. Sears director since
1996.
c. [PHOTO] HALL ADAMS, JR. 1,4 c.
HALL ADAMS
66, chairman and chief executive officer
of Leo Burnett Company, Inc. from 1987
until his retirement in 1992. Director,
The Dun & Bradstreet Corporation and
McDonald's Corporation. Sears director
since 1993.
d.[PHOTO] BRENDA C. BARNES 1,2*,3,4 d.
BRENDA C. BARNES
46, Interim president, chief operating
officer, Starwood Hotels and Resorts
since November 1999; former president
and chief executive officer of
PepsiCola North America 1996-1998;
chief operating officer of PepsiCola
North America 1994-1996. Director, Avon
Products, Inc.; Lucas Digital Ltd. and
Lucas Arts Entertainment Company;
Starwood Hotels & Resorts; and The New
York Times Company. Sears director since
1997.
e.[PHOTO] HUGH B. PRICE 1,4 e.
HUGH B. PRICE
58, president and chief executive
officer of the National Urban League
since 1994; vice president of
Rockefeller Foundation 1988-1994.
Director, Bell Atlantic Corporation, New
England Telephone & Telegraph Co. and
New York Telephone Company. Sears
director since 1997.
f.[PHOTO] WARREN L. BATTS 1*,3,4 f.
WARREN L. BATTS
67, chairman and chief executive officer
of Tupperware Corporation from
1996-1997; chairman of Premark
International, Inc. from 1996-1997;
chairman and chief executive officer of
Premark 1986-1996. Director, The
Allstate Corporation; Cooper Industries,
Inc.; Derby Cycle Corporation and Sprint
Corporation. Sears director since 1986.
g.[PHOTO] PATRICK G. RYAN 2,4 g.
PATRICK G. RYAN
62, chairman and chief executive officer
of Aon Corporation since 1990;
president and chief executive officer
from August 1982 through April 1999.
Director, Tribune Company. Sears
director since 1997.
h.[PHOTO] ALSTON D. CORRELL, JR. 1,2 h.
ALSTON D. CORRELL
58, chairman, chief executive officer
and president of Georgia-Pacific
Corporation since 1993; president and
chief operating officer 1991-1993.
Director, Sun Trust Banks, Inc. and The
Southern Company. Sears director since
1996.
i.[PHOTO] DOROTHY A. TERRELL 1,2 i.
DOROTHY A. TERRELL
54, president, services group and senior
vice president, worldwide sales, Natural
MicroSystems Corporation since 1998;
president of SunExpress, Inc. and
corporate executive officer of Sun
Microsystems, Inc. 1991-1997. Director,
General Mills, Inc.; Herman Miller,
Inc.; and Massachusetts Technology
Development Corporation. Sears director
since 1995.
j.[PHOTO] MICHAEL A. MILES 2,3,4* j.
MICHAEL A. MILES
60, chairman and chief executive officer
of Phillip Morris Companies Inc. from
1991-1994. Director, The Allstate
Corporation; Dell Computer Corporation,
Interpublic Group of Companies, Morgan
Stanley, Dean Witter, Discover & Co. and
Time Warner Inc. Sears director since
1992.
k [PHOTO] W. JAMES FARRELL 1,2 k.
W. JAMES FARRELL
57, chairman and chief executive officer
of Illinois Tool Works Inc. since 1996;
chief executive officer, 1995; executive
vice president 1983-1994. Director, The
Allstate Corporation and The Quaker Oats
Company. Sears director since 1999.
1. Audit Committee
2. Compensation Committee
3. Executive Committee
4. Nominating Committee
* Chairman of Committee
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