Sears Holdings Corporation(SHLD) today reported net income of $65 million, or $0.50 per diluted share, for the second quarter ended August 2, 2008, compared with net income of $173 million, or $1.15 per diluted share, for the second quarter ended August 4, 2007. Our second quarter 2008 results include the positive impact of the reversal of a $62 million ($37 million after tax or $0.29 per diluted share) reserve because of the overturning of the previously disclosed February 2, 2007 adverse jury verdict relating to the redemption of certain Sears, Roebuck and Co. bonds in 2004. Excluding this item, earnings per diluted share were $0.21 for the second quarter of fiscal 2008. The decline in our second 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.
“Our second quarter results reflect the continued effects of a slowing economy which contributed to the earnings declines we have experienced since the third quarter of 2007,” said W. Bruce Johnson, Sears Holdings’ interim chief executive officer and president. “While it was a difficult quarter, we were successful in reducing our domestic inventory levels by $500 million which should lead to lower markdowns and favorably impact our gross margin rates in the second half of the year.”
Mr. Johnson added, “We expect to generate higher EBITDA in the second half of this year as compared to the corresponding period in 2007 as we benefit from our lower domestic inventory levels and continued vigilant expense management. Given our year-to-date results and the state of the economy, our current full-year EBITDA forecast, which assumes flat to modest comparable store sales declines for the rest of the year, is comparable to, but no longer exceeds, last year’s EBITDA”.
Revenues and Comparable Store Sales
For the quarter, Sears Domestic’s comparable store sales declined 6.7% while Kmart’s comparable store sales declined 5.6%. Total domestic comparable store sales declined 6.2%. The comparable store sales declines at both Kmart and Sears Domestic continue to reflect increasing competition and weakness in the general economy, but are less than the declines reported by Sears Domestic and Kmart during the first quarter of 2008 of 9.8% and 7.1%, respectively. Comparable store sales declined for the quarter across most major categories at both Kmart and Sears Domestic, but continue to be offset by increases in sales of consumer electronics. Comparable store sales declines continue to be driven by categories directly impacted by housing market conditions (including home appliances and, most notably, tools at Sears Domestic), and the increased costs of consumer staples, such as food and gas, which decrease consumers’ discretionary spending.
Bruce Johnson noted that, “Despite the difficult economic environment, we remain focused on long-term value creation and continue to invest in the future of the Company. Since last year we have added 65 net stores, which consist of Home Appliance Showrooms, dealer stores and outlet stores, and we have continued to expand our online and multi-channel capabilities. In May we added a huge selection of books, DVDs, music and software to sears.com, nearly quadrupling the number of products available.”
For the quarter, our total revenues declined $0.5 billion to $11.8 billion in fiscal 2008, as compared to $12.3 billion for the second quarter of fiscal 2007. The decrease in revenue primarily reflects the impact of lower domestic comparable store sales.
Operating Income
For the second quarter 2008, we reported operating income of $187 million, as compared to operating income of $332 million in the second quarter of fiscal 2007. The decrease in operating income was mainly due to lower gross margin generated at both Kmart and Sears Domestic. We generated $3.1 billion in total gross margin in the second quarter as compared to $3.4 billion in the second quarter last year. Our gross margin rate decreased by approximately 120 basis points to 26.5% and reflects rate declines for both Sears Domestic and Kmart due to increased markdown activity as a result of the intense competition for consumer business. Domestic gross margin rate was also reduced as a result of a $36 million increase in inventory reserves over the reserve for the comparable period last year primarily attributable to the reset of the Sears home electronics department and transition to newer products. The decline in Sears Domestic and Kmart gross margin rates was somewhat offset by an increase in the gross margin rate at Sears Canada. Given that we do not expect any significant near-term improvement in the overall retail environment, we believe that our sales and gross margin will likely continue to be pressured by the above-noted unfavorable economic factors for the balance of fiscal 2008.
Declines in sales and gross margin were partially offset by declines in selling and administrative expenses for the quarter. Selling and administrative expenses for the second quarter of 2008 include the above-noted impact of $62 million related to a favorable legal judgment. In addition to the legal judgment, selling and administrative expenses declined $46 million, mainly as a result of our focus on controlling costs. This additional decline was comprised of decreases in domestic operations of $54 million and a slight increase of $8 million at Sears Canada. The decline in domestic selling and administrative expenses is primarily due to lower payroll and advertising expenses. The increase in Sears Canada was primarily due to changes in foreign currency exchange rates.
Financial Position
We had cash and cash equivalents of $1.5 billion at August 2, 2008 (of which $771 million was domestic and $763 million was at Sears Canada) as compared to $2.6 billion at August 4, 2007 and $1.6 billion at February 2, 2008. During the first two quarters of 2008, significant uses of cash included share repurchases of $477 million (as discussed further below), capital expenditures of $277 million and long-term debt repayments of $179 million. These amounts were partially offset by an $812 million increase in short-term borrowings, primarily through borrowing on our $4 billion credit facility.
Merchandise inventories at August 2, 2008 were $9.8 billion, as compared to 10.2 billion at August 4, 2007. Domestic inventory declined from $9.4 billion at August 4, 2007 to $8.9 billion at August 2, 2008, reflecting the effectiveness of our efforts to control inventory levels. Sears Canada’s inventory levels increased approximately $80 million from August 4, 2007 to $880 million at August 2, 2008. The increase in Sears Canada’s inventory is partially due to the change in exchange rates. As we expect difficult economic conditions to persist in the near term, we intend to continue to manage our inventories throughout the remainder of the year with the goal of further reducing our domestic merchandise inventories to better align current levels with expected sales.
Share Repurchase
During the 13- and 26- week periods ended August 2, 2008, we repurchased 5.6 million and 6.0 million of our common shares at a total cost of $437 million and $477 million, respectively, under our share repurchase program. As of August 2, 2008, we had remaining authorization to repurchase $206 million of common shares under the share 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. Since the third quarter of fiscal 2005, when our repurchase plan was first approved, we have repurchased approximately 38.7 million of our common shares at a total cost of $4.8 billion pursuant to the program. As of August 2, 2008, we had approximately 126 million common shares outstanding.
