September 8, 2005
To Our Shareholders:
I know all of our Sears Holdings’ associates join me in
wishing the people of New Orleans and the Gulf Coast and their loved ones as
rapid a recovery as is possible from the incredibly devastating effects of
Hurricane Katrina. The images and words of the suffering are forever seared in
our minds and are a reminder of how quickly and unexpectedly things can change.
I want to especially thank all of the many Sears Holdings associates who have
been working literally around the clock to provide assistance to the impacted
areas and to restore our operations.
Our entire company put forth a heroic effort in response to the
unspeakable destruction left by Hurricane Katrina, and we responded as only
Sears and Kmart can respond. In very short order we formulated a plan of support
for associates, customers and residents ravaged by the disaster. Sears, Lands'
End, and Kmart will make at least $500,000 in merchandise and Kmart and Sears
gift cards available to the American Red Cross. In addition, our company
committed to match customer contributions up to another $500,000. Sears Auto
Centers pitched in with free tire repair for weather-related damage. Kmart and
Sears stores will be accepting American Red Cross vouchers in all stores, and in
partnership with Citigroup, Sears credit customers in hardest hit areas will
have a waiver of late fees and interest on their cards during this time of need.
We continue to assess the effects of Hurricane Katrina on our facilities and
operations and will develop an approach to meeting our customers’ needs in the
We will continue to work through the challenges to our company
arising from Hurricane Katrina – including those directly affecting our stores
and those which are due to its impact on the US economy. The significant
increase in gas prices earlier this year and the increases after Hurricane
Katrina directly affect the purchasing power of our customers. This has
inevitably had an impact on our sales and we expect that our customers will
continue to be impacted by these costs for the foreseeable future.
The merger of Sears and Kmart was completed on March 24, 2005.
Our second quarter report reflects on the roughly four months of progress that
we have made as a combined company since that time. We are working to build a
great company, and one that can withstand the unexpected events of the business
Leadership and Organization:
We announced several important leadership and organizational
Aylwin B. Lewis will
assume the position of Chief Executive Officer and President of Sears
Holdings, with responsibility for the company’s 3,900 stores, as well as
home services, finance, legal, supply chain, information technology, and human
resources. This change reflects the Board’s confidence in Aylwin’s
leadership and is an extension of his previous role as CEO of both the Sears
and Kmart retail businesses.
Alan J. Lacy will
continue to serve as Vice Chairman, a Director and as a member of the Office
of the Chairman and will also continue to serve as the Chairman of the Board
of Directors of Sears Canada. I would like to thank Alan for his leadership
and partnership through the initial phase of the merger integration process.
We will continue to benefit from his leadership and judgment on our merger
integration opportunities and strategic issues.
I will be taking on
additional responsibilities in order to allow me to become more directly
involved in creating the customer-oriented organization Sears Holdings strives
to be and further support our efforts to respond to customer needs.
Alan, Aylwin, and I believe that these changes will achieve
greater clarity in our operating management and will align our corporate
structure with our vision of Sears Holdings.
My decision to become more deeply involved in certain aspects of
Sears Holdings’ business reflects the Board’s and my desire to make the
company more responsive to our customers and to involve me more directly in the
renewal of the company. I intend to serve without compensation, either in cash
or stock options, consistent with my belief that large owners who serve as
Chairman or CEO are best compensated by increasing the value of the company over
time for all shareholders rather than through large compensation packages.
The new leadership structure reflects our determination to go to
market as one company and to bring all of our strengths together to service our
customers. One of our historic weaknesses was our tendency to interact with
customers on a less cohesive basis. We intend to fix this through changes to our
corporate culture, continuing to build the strength and depth of our leadership
team and the energy, hard work, and talent of our associates.
We view leadership as a privilege and a responsibility. We have
asked the leaders of our company to embrace the challenge of making Sears
Holdings a great company once again as we contend with some of the most
ferocious competitors in the business world. To win, we must collectively raise
the bar of our expectations and our standards.
Associates and Culture:
The merger of Sears and Kmart has given us an opportunity to
create a performance-oriented company. We continue to work on steps to make
Sears Holdings more customer-focused and more profitable in order to compete in
the 21st century. Many of our retail competitors have much lower cost
structures that allow them to run different business models that are valued by
both employees and customers alike. The most effective companies, such as GE,
Microsoft, and Procter & Gamble, engage in continuous talent assessment and
have embedded cost management in their everyday business processes. Greatness
requires the ability to change and adapt; we are just beginning.
As our strategy unfolds over the next several years, we hope
that we will be able to demonstrate both financial and operational excellence.
We intend to build on the historic strengths of both companies, while overcoming
some of the more recent weaknesses. This will require the effort of all of our
associates, and we will need to provide them with the direction and the tools to
be successful. We have begun efforts to enhance the communication channels and
feedback mechanisms in the company, and we intend to continue to strengthen them
over time. We understand that change engenders criticism and uncertainty, but we
also understand that we may need to make changes both to our approach and to our
resources to demonstrate with clarity the seriousness of our purpose and the
strength of our vision. We know we cannot please everybody, but we believe that
people generally value clarity and consistency.
We continue to make progress in integrating the two
organizations. Over 400 Kmart associates who were previously based in Troy,
Michigan have relocated to Hoffman Estates. We are very happy with the number of
Kmart associates who have been willing to relocate and we want to thank those
who have chosen not to do so for their service to the company. We expect to
retain a significant presence in Troy, Michigan for the foreseeable future and
will have both permanent as well as transitional associates in that location.
We hope to become widely recognized as a company that attracts
and retains great people and imbues them with an analytic and commercial focus
that will lead them to succeed at Sears Holdings. We intend to create a culture
sufficiently challenging and attractive so that we keep these great people and
become a magnet to the best and brightest.
Customer Focused Company:
Our leadership, organizational, and culture changes are all
designed to make Sears Holdings more customer focused. Sears Holdings touches
our customers in a variety of ways and through our various formats. Our goal is
to make our products, brands, and services more responsive to the needs of our
customers and to build a long term trusting relationship with our customers. Our
leadership team has adopted the following vision statement:
"Sears Holdings is committed to improving the lives of our
customers by providing quality services, products and solutions that earn their
trust and build lifetime relationships."
We understand that we have much work to do to achieve our goal,
but we believe we have the assets, brands, associates, and heritage to make this
Financial Results and Accomplishments:
Sears Holdings has generated over $1 billion of pro forma
adjusted EBITDA in the first six months of 2005 (the pro forma information
includes the results of Sears and Kmart from the beginning of the fiscal year,
while in the reported results Sears’ performance is included since March 25,
2005). In our situation, we believe EBITDA is a more appropriate measure of
performance than GAAP net income, because EBITDA is stated before the impact of
historical depreciation that reflects past capital expenditure policies at Sears
that entailed spending significantly higher amounts than what we believe will be
required going forward, and before purchase price adjustments required by GAAP
that significantly increase non-cash charges which are not reflective of the
underlying business performance. On a GAAP basis, our net income in the first
six months of 2005 was $152 million. Please see our earnings release for a full
reconciliation of pro forma adjusted EBITDA to GAAP net income.
When we assumed control of Kmart, one of our primary goals was
to have the company become consistently profitable, not only year to year, but
within each year. Historically, Sears and Kmart have relied heavily on the
Christmas season and fourth quarter of each year for its annual profitability
and cash flow. While fourth quarter results are expected to continue to be a
disproportionate contributor to annual cash flow and earnings, the performance
of Sears Holdings for the first half of this year is a very positive sign that
we can achieve both significant profitability and consistent profitability
throughout the year.
Specific accomplishments since the closing of the merger have
conversion to almost 50 Sears Essentials stores in 2005
Reduction in our
domestic cost structure as a result of headcount reductions and benefit
changes, as evidenced by the $90 million reduction in domestic selling and
administrative expenses realized in the second quarter compared to last
year, on a pro forma basis
Reduction in domestic
debt by over $200 million in the latest quarter and the increase in domestic
cash to almost $2 billion
Introduction of Sears
appliances and tools, including Kenmore and Craftsman, into Kmart stores
Consolidation of Sears’
advertising with Young & Rubicam, which we believe will bring more
coherence and clarity to our customer messages
excess capital in specific businesses where we can reduce the capital and
improve the operating performance
In my last letter I described our investor relations philosophy:
to clarify, we believe that describing the business issues and performance to
shareholders is crucially important for management; what we believe detracts
from value is having senior management spend an inordinate amount of time on
this activity, to the detriment of a company’s operating performance.
We have chosen to describe in writing, rather than orally or
through presentations, our areas of focus and to incorporate additional pro
forma descriptive analysis to bridge GAAP numbers to numbers that we think more
appropriately describe our business performance. We have tried to provide the
financial information that we would want to see if we were analyzing the company
independently. We believe this approach provides investors with the information
needed to draw their own conclusions.
As we consider our merchandise choices in Sears, Kmart, and
Sears Essentials, we are paying particular attention to development of close
relationships with our vendors. Many of our vendors will see increased sales as
a result of working with us to lower our costs and to improve our customer
presentation and experience. There will be others who do not see their long term
interest aligned with ours, and they may see their business with us reduced or
eliminated. In certain cases, we have attempted to structure long term
relationships with some of our brand partners. We will continue to invest behind
our powerful proprietary brands and to provide the appropriate customer
experience for the national brands that we carry. We are very comfortable with
our long term vision for our brands and our considerable design capabilities. We
look forward to creating long term success that accrues to the benefit of both
Sears Holdings and our vendors.
We now look forward to an improved relationship with Footstar,
which has operated, under a license granted by Kmart, the footwear departments
in Kmart. We recently resolved the dispute between Footstar and Kmart that
resulted from the filing of bankruptcy by Footstar in 2004. As a result, we have
terms for our business relationship that are fair to Kmart and we will assume
control over the Kmart footwear operations beginning January 1, 2009. Over the
next few years we will work closely with Footstar to bring the Kmart footwear
business back to preeminence in the value channel and to ensure a smooth
transition to our full control beginning in 2009.
During the second quarter we also announced that we have
consolidated the Sears advertising relationship with Young & Rubicam. We
felt it was best to organize our advertising under one agency so that we can
make future communications with our customers more organized, unified, and
clear. We are pleased with this outcome and look forward to working closely with
Y&R, and to draw on its parent and other affiliated companies as needed.
On August 31, 2005, Sears Canada announced that it had entered
into an agreement to sell its Credit and Financial Services business to JP
Morgan Chase & Co. From our perspective, this transaction is less a sale,
and more fundamentally the creation of a long term and close business
relationship between Sears Canada and JP Morgan Chase & Co. We believe this
transaction is a significant positive for Sears Canada for three reasons. First,
the upfront and ongoing payments by JP Morgan Chase & Co. recognize the very
significant value represented by the Sears Canada credit card, an institution in
Canada with 10 million total accounts, and approximately US$2 billion of
receivables. Although Sears Canada has not yet made any final determination as
to the use of the anticipated US$1.8 billion in proceeds, it expects to return a
substantial portion of the proceeds to shareholders, including Sears Holdings.
Second, we look forward to working in partnership with JP Morgan Chase &
Co., a leading provider of credit card and financial products, to provide even
better value to our Sears Canada customers. The basis for our confidence in the
prospects for this arrangement comes from the experience that Sears has had with
Citigroup in a similar undertaking. Since November 2003 Sears and Citigroup have
worked closely together to improve our relationships with our customers and we
expect Sears Canada and JP Morgan Chase & Co. to have a similar experience.
Third, we believe the sale of the credit card business will both allow and
require the management of Sears Canada to focus on creating value in the core
retail operations. In this regard, Sears Canada has also announced that it plans
to take actions to reduce its expenses in order to become more competitive.
Thank you for your confidence in Sears Holdings. We look forward
to sharing our progress with you in the future.
Edward S. Lampert