Sears Reports: To Buy Back 14% of Stock

It is becoming clear there are two camps with Sears Holdings (SHLD), Lampert is a smart, Lampert is a idiot. The beauty of what is happening is that one camp will eventually be proven correct. There will no middle of the road here. First the results.

Q3 results released.

Company Highlights

– Net loss for the quarter of $1.16 per diluted share ($0.90 per diluted share excluding certain one-time items) as compared to net income of $0.03 per diluted share in the third quarter of 2007

– Total sales of $10.7 billion in the third quarter of fiscal 2008, with a decline in domestic comparable store sales of 9.0% as compared to the third quarter of fiscal 2007

– Adjusted EBITDA of $148 million in the third quarter and $722 million through the first three quarters of 2008

– Managing in a difficult economic environment

– Reduced domestic inventory by $575 million as of third quarter of 2008

– Reduced domestic selling and administrative expenses by $129 million in the third quarter

– Closing select under-performing stores as part of our ongoing review

– Providing differentiated solutions for our customers, including our layaway program

– Maintained strong balance sheet and liquidity position, including a $4 billion revolving credit facility, which matures in March 2010, secured by approximately $10 billion of domestic inventory as of quarter end

– Increased share repurchase authorization of $500 million

HOFFMAN ESTATES, Ill., Dec. 2 /PRNewswire-FirstCall/ — Sears Holdings Corporation (“Holdings,” “we,” “us,” “our” or the “Company”) (Nasdaq: SHLD) today reported a net loss of $146 million, or $1.16 per diluted share compared with net income of $4 million, or $0.03 per diluted share, in the prior year. Our third quarter 2008 results include a charge of $101 million ($61 million after tax or $0.49 per diluted share) related to costs associated with the closure of 14 stores and asset impairments, of which $76 million ($46 million after tax or $0.37 per diluted share) relates to non-cash items. This charge was partially offset by mark-to-market gains on Sears Canada hedge transactions of $67 million ($29 million after tax and minority interest or $0.23 per diluted share). Excluding these items, the net loss per diluted share was $0.90 for the third quarter of fiscal 2008. The decline in our third quarter results from the same quarter last year primarily reflects lower operating results at both Sears Domestic and Kmart, partially offset by improved operating results at Sears Canada.

“We believe we have positioned ourselves well for a difficult holiday shopping season. We have reduced our inventory levels, cut expenses, and announced the closing of select underperforming stores as part of our ongoing review. We are offering differentiated solutions for our customers to help them meet their holiday needs, through programs like our successful layaway program at Kmart, which we have recently expanded to Sears, and our Heroes at Home Military Wish Registry, which enables Americans to help make the wishes of military members and their families come true,” said W. Bruce Johnson, Sears Holdings’ interim chief executive officer and president. “As a result of severe conditions in the economy, our EBITDA forecast mentioned in the August 28, 2008 press release is no longer relevant given its assumption of flat to modest comparable store sales declines in the third and fourth quarters.”

In addition to the 14 store closings noted above, we are closing eight additional underperforming stores. We expect to record a pre-tax charge of up to $21 million related to these closures in the fourth quarter of 2008. We expect that these store closings will be additive to earnings, given that the closure of these stores eliminates negative cash flows incurred from their operations, and will generate cash from the liquidation of inventory and from other proceeds. Mr. Johnson further noted, “Given the current economic and retail environment, we will carefully evaluate alternatives that provide financial flexibility in the near-term, while enhancing shareholder value in the long-term. These actions may include additional store closings or divestitures, remodels or repositioning of existing stores, acquisitions, and repurchases of our debt and common stock.”

Revenues and Comparable Store Sales

For the quarter, our total revenues declined approximately $0.9 billion to $10.7 billion in fiscal 2008, as compared to $11.6 billion for the third quarter of fiscal 2007. The decrease in revenue primarily reflects the impact of lower domestic comparable store sales.

For the quarter, Sears Domestic’s comparable store sales declined 10.6% while Kmart’s comparable store sales declined 7.0%. Total domestic comparable store sales declined 9.0%. The comparable store sales declines at Sears Domestic were more pronounced in the month of October as conditions in the general economy deteriorated further. Comparable store sales declined for the quarter across most major categories at both Kmart and Sears Domestic. Comparable store sales declines continue to be driven by categories directly impacted by housing market conditions (including home appliances at Sears Domestic), a slowdown in consumers’ discretionary spending (including home and household goods and apparel at both Sears Domestic and Kmart and lawn and garden at Sears Domestic), as well as a shift in our promotional strategy for food and consumables at Kmart and tools at Sears Domestic.

November 2008 Comparable Store Sales

Our domestic comparable store sales declined 8.7% during the month of November 2008. This decline includes a decline in comparable store sales of 7.8% at Sears Domestic and 10.0% at Kmart. The month of November 2008 includes two days of the holiday shopping season compared to the month of November 2007 which included nine days due to a one-week shift in the Thanksgiving holiday.

The November Kmart comparable store sales also do not reflect sales made through our layaway program. Initial usage of the program has been encouraging, and these sales are not recognized until after merchandise is both paid for and picked up by customers using the program, which will be predominantly in December 2008.

Comparable store sales declines not attributed to the holiday shift are mainly the result of external economic factors discussed previously. November comparable store sales declines continue to be driven by categories directly impacted by a slowdown in consumers’ discretionary spending (including home and household goods at both Sears Domestic and Kmart and apparel and lawn and garden at Sears Domestic). Declines at Sears Domestic were partially offset by increases in home appliances.

Operating Income

For the third quarter 2008, we reported an operating loss of $202 million, as compared to operating income of $51 million in the third quarter of fiscal 2007. Our operating loss of $202 million was mainly due to the $101 million of above-noted charges, as well as lower gross margin generated at both Kmart and Sears Domestic. We generated $2.9 billion in total gross margin in the third quarter as compared to $3.2 billion in the third quarter last year. The above-noted $101 million charge included a charge to cost of goods sold of $10 million for inventory reserves recorded in connection with store closings. Our gross margin rate decreased by approximately 60 basis points to 26.8% and mainly reflects a rate decline of 150 basis points at Sears Domestic due to increased markdown activity. The decline at Sears Domestic was partially offset by increases of 40 basis points at both Kmart and Sears Canada. If the overall retail environment continues to be impacted by unfavorable economic factors, our sales and gross margin would likely continue to be pressured for the balance of fiscal 2008.

Declines in sales and gross margin were partially offset by a decline of $153 million in selling and administrative expenses for the quarter. The decline includes decreases in domestic expenses of $129 million as compared to the third quarter of fiscal 2007. Depreciation expense increased $71 million and includes a non-cash fixed asset impairment charge of $76 million.

Financial Position

We had cash and cash equivalents of $1.2 billion at November 1, 2008 (of which $502 million was domestic and $670 million was at Sears Canada) as compared to $1.5 billion at November 3, 2007 and $1.6 billion at February 2, 2008. The November 1, 2008 cash balance excludes $94 million on deposit with The Reserve Primary Fund, a money market fund which has temporarily suspended withdrawals while it liquidates its holdings to generate cash to distribute. As a result, we reclassified $94 million from cash to the prepaid expenses and other current assets line within our Condensed Consolidated Balance Sheet at November 1, 2008. We recorded a $3 million loss ($2 million after tax or $0.01 per diluted share) during the third quarter of 2008 in connection with our investment in The Reserve Primary Fund. Subsequently on November 21, 2008, we received notice from The Reserve Primary Fund that it expects to make an additional distribution on or about December 5, 2008 and we estimate our pro rata share to be approximately $54 million.

During the first three quarters of 2008, significant uses of cash included share repurchases of $558 million (as discussed further below), capital expenditures of $395 million, pension contributions of $204 million, net long-term debt repayments of $196 million and payments on commercial paper borrowings of $129 million. These amounts were offset by a $1.9 billion increase in short-term borrowings, primarily through borrowing on our $4 billion credit facility. Had $94 million of our short-term investment in The Reserve Primary Fund been available short-term borrowings would have increased by $1.8 billion.

Merchandise inventories at November 1, 2008 were $11.4 billion, as compared to $12.1 billion at November 3, 2007. Domestic inventory declined $575 million from $11.0 billion at November 3, 2007 to approximately $10.5 billion at November 1, 2008, reflecting the effectiveness of our efforts to control inventory levels. Sears Canada’s inventory levels decreased approximately $189 million from November 3, 2007 to $898 million at November 1, 2008. The decrease in Sears Canada’s inventory is primarily due to the change in exchange rates. As we expect difficult economic conditions to persist in the near term, we intend to tightly manage inventory levels with the goal of reducing domestic inventory levels below last year’s in the fourth quarter.

Resources and Liquidity

Holdings has significant assets, including cash of $1.2 billion, a large number of owned real estate properties, a stable of nationally recognized proprietary brands including Kenmore, Craftsman, Lands’ End and DieHard, our wholly-owned Lands’ End subsidiary and a 72% equity interest in Sears Canada. In addition, on a consolidated basis Holdings has $11.4 billion of inventory, or $7 billion of inventory net of $4.4 billion of accounts payable.

Since the merger of Kmart and Sears created Holdings in 2005, we have consistently generated cash flow from operations. In its first three years (from 2005 to 2007) Holdings generated $5.2 billion of operating cash, and we expect to generate significant cash from operations in fiscal 2008 as well. This strong cash flow has enabled us to reduce our obligations, as we have we paid down approximately $2 billion of the debt assumed in the merger and made contributions of approximately $1 billion to fund the frozen pension plans of our predecessor companies.

Holdings has consistently maintained a strong capital structure with excess liquidity even during the holiday peak. Our revolving credit facility, which matures in March of 2010, is used to issue standby letters of credit to support our insurance programs (currently approximately $1 billion outstanding) and to fund seasonal working capital needs (currently approximately $2 billion in borrowings outstanding excluding our standby letters of credit). As we reach our peak working capital need early in the fourth quarter, we expect to repay the entire $2 billion of borrowings in December (although we do expect to borrow on the revolver again in the month of January 2009). An affiliate of Lehman Brothers has a $207 million total commitment in the $4 billion revolving credit facility, but since September 17, 2008 has not funded its proportionate share of our borrowings under the facility.

Share Repurchase

The Company also announced today that its Board of Directors has approved the repurchase of up to an additional $500 million of the Company’s common shares. This authorization is in addition to the $72 million worth of shares that currently remain available for repurchase under the Company’s existing repurchase program. Share repurchases may be implemented using a variety of methods, which may include open market purchases, privately negotiated transactions, block trades, accelerated share repurchase transactions, the purchase of call options, the sale of put options or otherwise, or by any combination of such methods. Timing of repurchases is dependent on prevailing market conditions, alternative uses of capital and other factors.

Bruce Johnson commented, “After careful consideration and a review of the company’s valuation, prospects, cash flow and liquidity, we believe that our shares represent an attractive investment for our shareholders. Given the difficult retail environment and its effect on our free cash flow, we have reduced our rate of repurchases throughout 2008 as we worked to retain flexibility to pursue opportunities and address contingencies. With significant assets and cash flow, we believe Sears Holdings has the flexibility to continue to invest in our business, repay debt, and consider acquisitions opportunities as well.”

During the 13- and 39- week periods ended November 1, 2008, we repurchased 1.4 million and 7.4 million of our common shares at a total cost of $81 million and $558 million, respectively, under our share repurchase program. During the 4-week period from November 2, 2008 to November 29, 2008 the Company repurchased 1.2 million common shares at a total cost of $53 million. Since the third quarter of fiscal 2005, when our repurchase plan was first approved, we have repurchased approximately 41.4 million of our common shares at a total cost of $4.9 billion pursuant to the program. As of November 28, 2008, we had approximately 123.6 million common shares outstanding.

From the 10-Q also released this morning:

Credit Agreements:
– The Credit Agreement does not contain provisions that would restrict borrowings or letter of credit issuances based on material adverse changes or credit ratings.
– The majority of the letters of credit outstanding under the Credit Agreement are used to provide collateral for our insurance programs.

So, what to think. Poor results, as expected. Do not get too caught up with “analyst expectations” with Sears. They provide them no guidance so results tend to vary from estimates by 20% or more on a regular basis in either direction. It seems that Wall St. even agrees as the stock is up 12% today even though they “missed”.

I have to agree with Bruce Berkowitz. When he commented on the short interest in Sears, he said that “all Lampert has to do is keep buying back stock that will take care of that situation”. Agreed..

I also still believe that down the road something is up with AutoNation (AN), AutoZone (AZO) and Sears Auto. Too much cross ownership and Board representation for Lampert to have 50% or more of all three and for there to be nothing there.

Q4. Will it be lousy also? Yup. I doubt we’ll see a loss again but profits will be lower clearly than last year as they will be across the retail spectrum. What will be of interest in Q4 is how much of the $572 million Lampert has to buy back stock he uses. My guess is most of it. That, at today’s prices comes to about 17.4 million shares and will reduce the number outstanding to 106 million of which Lampert has 65 million.

Squeeze baby squeeze…

Disclosure (“none” means no position):Long SHLD, AN, none
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