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Sears Outshines Kmart in 3Q

Home Fashions Product Categories Slump at Both Chains

Getting a big $140 million boost from money it put in the bank, and further buoyed by strong improvement in its Sears U.S. stores which offset weakness at Kmart, Sears Holdings Corp. more than tripled third-quarter profits, which shot up by 237.9% to $196 million $58 million a year ago.

But even without that extra kick from its invested cash, operating profits improved by more than 60.8%, to $550 million from $342 million last year, helped by stronger margins, lower costs and improved operating metrics, if not sales, in the core Sears business unit.

Lifting operating results, average gross margin widened by 70 basis points, or seven-tenths of a percentage point, to 28.3% of sales from 27.4% during the same period a year ago. At the same time, operating costs, when measured as a percentage of sales, were whittled down a corresponding 70 basis points, or seven-tenths of a percentage point, to 23.7% from 24.4% the preceding year.

But that's where the good news stopped and some investors jumped ship. Wall Street knocked the share price of the nation's third-largest retailer down by 5.4% or $9.58 a share, to a still pricey $169.57, the day the results came out, concerned that the jump in earnings came from outside investments rather than merchandising savvy.

Indeed, sales from its merchandising operations, excluding credit-card results, dipped by 1.5% to $11.9 billion from $12.1 billion last year. And the crucial gauge of same-store sales fell even further, by 3.0%. Comps slid down by 4.8% at Sears nameplates, but almost held their own at Kmart units, slipping by 0.7%.

Despite its persistent big declines in same-store sales, U.S. Sears stores — the biggest of the parent's business units — boosted operating profits by 35.5%, to $382 million from $282 million, excluding one-time items like restructuring costs. But Kmart stumbled, its operating profits dipping by almost a third, or 32.9%, to $57 million from $85 million a year ago.

The improved operating profit, the retailer said, was helped by lower costs across the board, and bulked up margins at both Sears U.S. and Sears Canada. Lower sales and margins at Kmart acted as a drag.

In broad strokes, the retailer said, the drop in same-store sales reflected "the impact of increased competition and lower transaction volumes." More specifically, it said, Kmart comps declined across a broad number of merchandise categories, including home goods, hardlines, food and consumables, and general merchandise. Acting as an offset were improving same-store sales in apparel and pharmacy. At Sears, same-store sales declined across most product lines — home fashions, lawn and garden were the hardest hit. Sears' apparel comps showed "pronounced" increases, the retailer said, reflecting a return to more basic looks following the failure of last year's "fashion-forward" thrust.

Despite the 1.3% drop in overall sales, stockpiles swelled by 7.1% during the third quarter, to $11.5 billion from $10.8 billion, stemming from the earlier shipment of product, expanded assortments and a decision to support the growing apparel business at both Sears and Kmart units.

The rising stockpiles took a bite out of cash reserves, which fell to $2.1 billion from $3.7 billion at the end of the second quarter. That further disquieted investors, since it reduced the war-chest of funds available to make an acquisition that might propel earnings even higher in the future.

SEARS HOLDINGS CORP.

Qtr. 10/26 (x000) 2006 2005 % change
a. Sales in the prior-year third quarter include credit card and financial products revenues of $84,000. Merchandise sales and services of $11.9 billion declined by 1.5% from $12.1 billion. Nine-month sales include $171 million in credit revenues. Nine-month merchandising sales declined by 3.1% to $36.7 billion from $37.9 billion a year ago.
b.Third-quarter net income includes an $8 million gain on the sale of assets, compared with a $15 million gain a year ago; $3 million in restructuring costs, down from $59 million last year; $140 million in interest and investment income, up from $40 million last year; a $12 million loss on the company's share of a subsidiary, compared with a prior-year profit of $14 million. Nine-month net income includes a $32 million gain on the sales of assets, compared with $26 million a year ago; $27 million in restructuring costs, down from $104 million; $241 million in investment income, compared with $118 million; and $17 million in income from its share of a subsidiary, compared with a year-before loss of $1 million.
Sales $11,941,000 $12,202,000a -2.1
Oper. income (EBIT) 550,000 342,000 60.8
Net income 196,000b 58,000b 237.9
Per share(diluted) 1.27 0.35 262.9
Average gross margin 28.3% 27.4% 11
SG&A expenses 23.7% 24.4%
Nine months
Sales 36,724 38,175a -3.8
Oper. income (EBIT) 1,962,000 1,190,000 64.9
Net income 670,000b 141,000b 375.2
Per share(diluted) 4.29 0.87 393.1
Average gross margin 28.2% 27.0%
SG&A expenses 22.8% 23.7%


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