Sears Holdings Corporation (NASDAQ:SHLD)
Q4 2011 Earnings Call
February 23, 2012 08:00 am ET
Bill Phelan - SVP, Finance
Louis D'Ambrosio - CEO & President
Rob Schriesheim - EVP & CFO
Ron Boire - EVP, Chief Merchandising and President, Sears and Kmart Formats
Gary Balter - Credit Suisse
Paul Linen - Morning Star
Emily Shanks - Barclays Capital
David Gober - Morgan Stanley
Good day ladies and gentlemen and welcome to the Sears Holdings earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the call over to your host Bill Phelan, Senior Vice President of Finance. Please go ahead.
Thank you, operator. Good morning and welcome to Sears Holdings earnings call. I am Bill Phelan, the Senior Vice President of Finance for Sears Holdings. Joining me today are Louis D'Ambrosio, our Chief Executive Officer, Rob Schriesheim, our Chief Financial Officer and Ron Boire, our Chief Merchant and President of the Sears and Kmart Formats.
For our call today, you may follow along with the slides that are shown. Slides will be automatically advanced during the discussion and will be posted to our website after today's call. Before we begin, I would like to remind you that today's discussion will contain forward-looking statements related to future events and expectations.
These statements are based on current expectations and the current economic environment and actual results may differ materially from those expressed or implied in the forward-looking statements. You can find factors that could cause the company's actual results to differ materially listed in today's press release in the presentation for today's call that is posted at the Investor Information section of searsholdings.com and in our most recent SEC filings.
In addition our discussion will include certain non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures can be found in today’s press release. Any reference that our discussion to EBITDA means adjusted EBITDA as defined in the press release and presentation. Finally we assume no obligation to update the information presented on this call except as required by law. Now I would like to turn the call over to Louis.
Thanks Bill and thank you all for joining us today. I know we haven’t typically held earnings call, but we thought it was important to provide you more detail on a number of extraordinary items we are recording this quarter and importantly to make our funding strategy clear. The takeaway is that the company’s significant assets and liquidity as well as the actions we are taking which we will describe today make our result and earnings issue rather than an asset or liquidity one. Today we will discuss our financial performance, our funding strategy and specific actions we are taking to further strengthen the balance sheet and operations.
Additionally I will preview the strategic agenda for Sears Holdings which will guide our actions going forward. We will cover this in more detail at our annual meeting on May 2nd. So let us get right into it. Our fourth quarter earnings were unacceptable. We know that and are taking immediate actions to address it in three areas. First; actions to improve our financial performance including cost reductions, actions to improve inventory productivity, actions to improve margins, honed and targeted marketing and new talent to strengthen our merchandising and leadership team.
Second we are executing actions to unlock the value of our portfolio and assets. We will discuss two such actions today expected to generate approximately $700 million of proceeds and third we are accelerating actions to drive our strategic agenda to lead in integrated retail. So let us first talk about the quarter. Our main challenge in the quarter was margin rate. The largest margin decline was in apparel and related categories particularly Kmart apparel, Lands’ End and footwear.
Several factors contributed to the declines in these categories. We saw a significant increase in commodity costs particularly cotton. High inventory levels led to increased markdowns and clearance. And unseasonably warm weather impacted several categories such as Lands’ End’s typically strong outer wear business. These are explanations of what happened, but they are not excuses. There are actions we could have taken to have mitigated the margin decline. Our buy could have been executed better, both in terms of quantity and assortment. Our promotional cadence should have been more surgical and cost actions could have been taken earlier.
Actions of each of these areas are now well underway. We have reduced inventory by $544 million below last year’s levels. Our promotional design is been refined and targeted. We have implemented cost actions which we believe will yield in the higher end of the $100 to $200 million estimate we have previously provided. We recently announced the hiring of Ron Boire as the Chief Merchant and President of the Sears and Kmart formats to focus on merchandizing, cross category synergies and strengthening our formats around integrated retail.
Ron joins us from Brookstone where he was CEO. Ron joins other recent additions to the team with significant retail experience. Like Sam Solomon, who was CEO of Coleman and now leads our Tools business and Edgar Huber who was CEO of Juicy Couture and now leads Lands’ End.
While we are disappointed in our performance, it is important to distinguish the income statement performance from the balance sheet strength and flexibility, we are an asset rich enterprise with significant liquidity as Rob will describe in detail shortly.
We’re taking actions to unlock the value of our assets and portfolio. We announced today as an example that we plan to transfer direct ownership of Sears Hometown and Outlet businesses and certain hardware stores together as a separate company to our electing shareholders. We expect this transaction to generate $400 million to $500 million of proceeds. Additionally, we announced today a real-estate transaction which we expect to generate proceeds of $270 million within the next 60 days.
We also have a Board with significant ownerships. Our Board owns 65% of the outstanding equity. Accordingly, as equity investors, the Board comes behind all creditors, secured and unsecured. We have a Board focused on creating real, long-term value. I also want to touch briefly on the situation with our trading factor as there has been a lot of press and speculation on this topic. We have had good discussions with our trade partners and factors. And we have presented them with the facts on our financial position. They have been very good, very constructive discussion. They know that when we succeed they succeed.
Now before I turn it over to Rob, I would like to take a few minutes to discuss the strategic framework for our company that will inform and guide our actions moving forward. As we accelerate the transformation of our company we do so with the point of view on how the industry and our world is changing. Rapid advances in technology are transforming the entire retail landscape and where customers work live and shop. Our media and shopping channel are blurring. We no longer choose between shopping online or shopping in the store. We do both and we do it differently at different times. Our customers are using mobile devices to find deals, look up reviews and poll friends even while standing in the aisle. We believe the retailers who best use technology to integrate the customer experience across all channels will be the ones who win. And we are accelerating our actions to bring together a unique set of technology and retail assets to deliver a seamless integrated and rewarding experience for our members and customers at the store, online and in the home.
In short to lead in integrated retail. And at the core of our integrated retail strategy we are building a deeply engaging membership program called SHOP YOUR WAY REWARDS. The program is enabled by technologies and a platform that we expect will allow us to have continuous relationships with our members and customers.
In 2011, we invested several hundred million dollars in our customer experience. We believe that our investments will deliver compelling benefits to our customers and members several of which are already in the market like pick-up, return and exchange of online purchases in five minutes or less. No receipt required, great deals personalized to your interests and online marketplace and being assisted by associates with mobile and iPad applications to help find the right appliance or TV or tractor to fit your need.
So then what the future holds for Sears Holdings is a progressive reshaping and deepening of our relationships with our members through integrated retail. And given the growing size of our membership and the breadth of our assortment this is very compelling for our business model.
As an example, at each of our Shop Your Way Rewards members visited just one more time in a year and purchased an average transaction, we would generate more than $1 billion of additional margin and our assets play particularly well to this strategy. We have an extensive set of customer touch points to further fuel the membership and engagement.
As an example, over this past year, we have had over 1 billion visits to Sears and Kmart across our stores and online. Additionally, we are unique in being invited to our customers’ homes over 15 million times a year through our services business and have over 80 million interactions through our call centers.
Also our members through Shop Your Way Rewards have access to uniquely broad assortment. This assortment enables our members to satisfy many parts of their lives. We also own some of the most important brands in retail such as Kenmore, Craftsman, DieHard, Lands' End.
Kenmore, as an example is in the homes of 100 million American and in the most recent quarter, we gained market share in appliances in both units and dollars while increasing margin rate. And in addition to assortments across owned format members now have access to over 32 million products to our own line marketplace.
So as you can see by combining the technology platforms we are building, with our collection of retail assets, we believe we can deliver an extraordinary integrated customer experience. And in the coming months you’ll see our strategy play-out and innovations connecting our market leading brand, our unique retail assets and our broad range of touch points. We will discuss this in more detail on May 2nd at our Annual Meeting.
So we are prepared to take whatever steps are necessary from cost reductions and operational improvements to active portfolio management, to an acceleration of our strategic initiatives to restore our company to greatness and deliver attractive returns to our shareholders.
Now, let me turn it over to Rob to provide details about our financial. Rob?
Thanks Lou. Good morning and thank you for taking the time to join us on the call. Six months ago I joined as CFO, as I believe we have the opportunity to enhance and unlock value by better leveraging a unique portfolio of assets. My comments today which you can follow beginning on page six of the slide deck which will be automatically forwarded for you will cover the following.
First, our fourth quarter financial results providing detail on the accounting charges and significant items.
Second, structural actions already being executed on around cost reductions, store closures and inventory management.
Third, our financial capacity and funding strategy, which will outline our approach to the management of our capital structure.
Fourth and finally, actions underway to unlock value and our portfolio of assets.
Let me offer some contexts and broad themes that underlie our performance. First, two of our largest categories experienced industry wide declines and those two consumer electronics and appliances represented significant portion of our revenue decline.
Second, we experienced negative effects of an increase in commodity prices notably cotton and fuel coupled with too large of an apparel buy.
Third, unseasonably warm weather across the United States negatively impacted a number of our product categories including, seasonal apparel, snow blowers, snow tires and various other winter related categories. But, as Lou discussed, our execution should have been and needs to be better. We don’t consider these results to be acceptable nor are they indicative of the potential inherent in our portfolio of assets.
With that as background, I will now speak to some of the key elements of the quarter as shown on page eight. On a GAAP basis, we reported a net loss of $2.4 billion or $22.63 per share versus net income of $374 million or $3.43 per share last year. The current quarter includes $2.5 billion of accounting charges and significant items. It’s important to note that only about $95 million of this was cash and I’ll cover this in detail shortly.
On an adjusted basis, EPS from continuing operations for the quarter was $0.54 per share this year compared to $3.67 last year.
On a revenue basis, our consolidated revenues were down 4%. Domestically, we did however see growth of 2.6% in comp store sales since our December 27th announcement.
Overall, we were down 4.1% in comp store sales of Sears due to appliances and consumer electronics. Sears Apparel was up 2.9% across all three categories, including men’s, women’s and kids. This was the second consecutive quarter of growth due to the introduction of new products. We were down 2.7% at Kmart largely due to consumer electronics and lower lay-away. Sears Canada, which reported separately, had a 7.5% decline.
Since GAAP income includes many non-operating items, we use adjusted EBITDA to evaluate our performance. EBITDA declined by $568 million to $351 million this year.
Two quick points; Sears domestic was down $310 million primarily due to weakness in the consumer electronics business, marginal rate declines in seasonal apparel, Lands’ End and footwear and higher expenses in the quarter as we increased our holiday marketing expense. Last year also benefited from favorable adjustments from insurance reserve and property tax rebate. Kmart was down $217 million driven largely by apparel and consumer electronics.
Turning to the full year summary on page nine. On a GAAP basis, we reported a net loss of $3.1 billion or $29.40 per share versus net income of $133 million or $1.19 per share last year. The current year includes $2.7 billion of significant items and accounting adjustments and again I’ll review that shortly.
Adjusted for items, loss per share is $4.52 this year versus earnings per share of a $1.97 in 2010. Adjusted EBITDA for the year was $277 million versus $1.4 billion last year. Sears Domestic experienced a decline of $554 million and Kmart declined $336 million, primarily due to the same drivers of the fourth quarter such as consumers’ electronics and the effect of cost increases.
The quarter was affected by a number of significant items, the most significant of which are itemized on page 10 and the appendix on page 27. Let me speak to the three items which make up $2.4 billion of these charges.
First, we recorded a $1.7 billion non-cash charge to establish a valuation allowance against our domestic deferred tax assets. Accounting rules mandates that valuation reserve be established when income has not been generated over a three year cumulative period to support the deferred tax assets. While an accounting loss was recorded, no economic losses occurred as these NOLs and tax benefits remain available to reduce future taxes as income is generated in subsequent periods.
Second, we recorded a $551 million non-cash charge for the impairment of goodwill balances in our Sears full-line store, automotive and commercial sales format. The goodwill resulted from the Sears Kmart merger in 2005. Given the decline in profitability in these formats coupled with the recently announced store closures we recognized the impairment.
Third, during the quarter we had a $178 million charge for store closings and associated severance. This $178 million includes costs related to inventory markdowns, fixed asset impairments, severance, liquidator fees and lease costs for previously announced closures.
Based on experience with store closures, these closures typically are cash positive because we liquidate the inventory for more than its original cost and we have limited severance exposure as most store associates are part time. More details of the charges are available on page 27 in the appendix and after this call the presentation will be posted on our site.
On page 11, you can see that while the amount of these charges is significant for the three largest components, only $95 million affects cash. Also note that we recorded charge of approximately $75 million in future periods for lease obligations when the stores actually close.
Turning to page 12, as you know appliances is a very important business for us. We are able to increase our average selling price and margin rate in the quarter versus the prior year. However, overall category performance was significantly impacted by the adverse market conditions.
We estimate that industry shipments were down more than we were in the fourth quarter. While we did realize a sales increase in appliances in the quarter, we did pick up significant share on the strength of Kenmore.
Overall, appliance share improved by 220 basis points versus prior year. Our lead increased from 9.6 percentage points last year to 13.6 points this year and Kenmore picked up significant share as well. Kenmore increased share by 220 basis points to 17.8%. Kenmore is the market leader which is highly impressive when you consider that Kenmore is only available at Sears, it speaks to the power of our appliance franchise.
As you can see on page 13, we are taking a number of actions to improve our performance by reducing our cost structure and working capital balances as well as seeking to improve our margins. We are closing marginally performing stores as announced on December 27th including 81 already decided upon with the total likely in the range of about (inaudible) stores.
We are also working to reduce the assets deployed in our operations and are currently planning to reduce our peak inventory as disclosed in our December 27th release by between $500 million and $580 million. And we currently believe it will be in excess of that amount.
As Lou described, we intend to utilize our expense of customer royalty program known as Shop Your Way Rewards to establish digital relationships with our customers. We believe that this will allow us to become more efficient, meaning we can reduce the marketing expense by interacting with customers directly, more effective by providing targeted offers to our customers and more variable by reducing the fixed portion of our cost structure.
Accordingly, the investments we have made and continue to make in our member program we allow us to reduce our core marketing fixed spend by $100 million in 2012 versus prior year. We also currently plan to reengineer our $20 billion of annual merchandise spend over the next two years as part of an overall program to address our margins.
This concludes my comments on our operations. Now, I will move on to our funding strategy. While we continue to be focused on improving our operating performance its important to note that we are an asset rich enterprise with multiple resources at our disposal which we believe provides us with ample financial flexibility. It is important to distinguish between our operating performance and the unrecognized value in our asset portfolio; our substantial liquidity and financial flexibility.
With this in mind, I want to take a few minutes to walk you through our funding strategy and liquidity. Consistent with my comments about the value of our real estate portfolio and the unrecognized value of our asset portfolio, today we announced an agreement for the sale of 11 stores. This will result in net after-tax proceeds of about $270 million expected in the next 60 days.
We believe that this action taken together with the $400 million to $500 million we expect to receive in connection with the transfer of our Sears Hometown and Outlet businesses and certain hardware stores demonstrates the nature of the unrecognized value inherent in our portfolio of assets. As I will show later on these actions add to our already ample liquidity.
Moving to the asset summary on page 15, as of the end of the fourth quarter we had more than $3 billion in liquidity with minimal debt maturities until 2018. Our assets include $8.4 billion of inventory and extensive borrowing base supported by our inventory, owned and leased real estate, market leading proprietary brands such as Kenmore, Craftsman and DieHard, standalone businesses such as Lands’ End and Sears Canada, other businesses and assets with a standalone nature such as Sears Hometown and Outlet businesses and certain hardware stores. This asset portfolio provides us flexibility as we seek to transform our business.
Page 16 contains more detail on our capital structure with the main components of our debt being a $3.275 billion domestic revolving credit facility, until April 2016 that is secured by domestic inventory and receivables. Sears Canada has a similar $800 million Canadian revolver through 2015; $1.24 billion of senior secured notes due in 2018 and about $500 million of remaining Sears, Roebuck and Company debt from the merger.
The first point to make is that our debt is firmly in place for the next several years. Secondly, a few comments about our $3.275 billion domestic revolver. When we initially put a revolver in place back in 2005, the intention was not to use it solely to fund seasonal working capital needs, but forced to be the main portion of our debt.
As such, it does not include typical restrictions on usage. We can use it for almost any purpose including to fund acquisitions, make debt repayments, make pension contribution and other purposes. The owner restrictions relate to dividends and share repurchases.
Also the revolver is a very efficient form of borrowing for two reasons. The borrowing rate is very cost effective. It is LIBOR plus 250 basis points, so we are currently paying about 2.75% interest rate on borrowing. The cost of the revolver feature, we only pay that interest when we draw on the facility.
The revolver has no active financial covenant. There is only a spring covenant which arises if and only if we were to fall below 10% availability. This is something we can manage and for reference, at our peak this past year, our availability was in excess of 25%.
My final point on the revolver has to do with the collateral which supports it. We have significant excess collateral. For that reason, we included in the revolver agreement a $1 billion accordion feature. This means, we have the ability to bring in additional lenders and give them the same first lien on the collateral which the existing lenders have.
We also have the ability to add $760 million of second lien financing. Our excess collateral coupled with the accordion and second lien feature provides us with flexibility to borrow additional funds if desired.
On page 17, is a summary of our debt balances. As you can see, when you compare the current year debt balance to what was reported last year, we actually reduced modestly our debt in 2011, despite the increase in revolver bond. Again, we view the revolver as one of our more efficient funding mechanisms.
As you can see in 2011, we use the revolver to fund $500 million in debt retirement, to invest $350 million in domestic pension and to make a $183 million in share repurchases, obviously which are discretionary item.
On page 18, we have $3.2 billion in liquidity as of year-end 2011 which allows us to use our revolver from more than just working capital.
On page 19, we summarized our future term debt maturities. As I noted, we have retired about a $1.5 billion of debt over the past year and we have additional maturities of the $170 million in 2012. After that, we have minimal repayments until 2018.
Moving to the current assets on page 20, we have $754 million in cash in Sears and Sears Canada as of year end 2011. That merchandize is about $5.5 billion as our $8.4 billion of inventory is partially offset by $2.9 billion of payable. This is an important point. In other words, $5.5 billion of our inventory is already bought and paid for. We have sharpened our focus to manage our inventory and payables closely to improve our productivity and increase our return on invested capital.
We have already made nice progress in reducing our inventory investment as inventory is down $544 million from last year while payables declined $134 million representing about $410 million source of cash. $420 million of the inventory decline was domestic, $123 million of inventory decline was in Sears Canada. Inventory productivity will be a main focus in 2012 and we currently plan to realize further reductions in the October-November peak periods in excess of the $500 million to $580 million previously indicated in the December 27 release.
On page 21, you can see the degree of our excess collateral. The inventory and other collateral are subject to a borrowing base formula which provides an advanced rate of approximately 70% on eligible inventory. This chart summarizes the collateral as valued by the borrowing base formula. As background, the collateral range between $4.9 billion to over $6.6 billion during the fiscal year 2011 depending on our inventory levels. We show two sources of debt on this chart, the $1.24 billion of 2018 senior secured notes and the $3.275 billion revolving credit facility.
Even at our peak borrowing period in October of 2011, we had $2.8 billion of excess collateral as determined by the borrowings base formula. You will also note that at our peak, we had $1.8 billion of excess credit available and as of the year ended January, it was $2.5 billion of availability. So as you can see, there is substantial collateral and credit availability. As indicated on page 22 and as announced separately today, we’ve reached an agreement which has been executed with General Growth Properties, a New York stock exchange listed real-estate investment trust for the sale of 11 of our stores for $270 million on proceeds. We expect to realize those proceeds in the next 60 days.
On page 23, you can note the business of our hometown hardware and outlet stores. In the past, there has been much discussion about the value of the underlying assets at Sears Holdings. We’ve had many conversations internally about the best way to begin to unlock some of that value. The combined business as you can see represent about $2.3 billion to 2.6 billion in revenue between $70 million and $80 million in EBITDA and $350 million to $400 million in assets and $325 million to $375 million in net inventory.
We’ve begun exploring alternatives on locking that value and as Lou indicated we’ve settled on the approach than involves the transfer of direct ownership in these business as a separate company to electing shareholders. As you know, we recently spun off Orchard Supply as part of our plan to unlock value and focus more on our core businesses.
Sears Hometown and Outlet businesses and certain hardware stores reflects a next step in unlocking value in our portfolio of assets and allowing those businesses to pursue a more singular focus of their strategy. We expect to realize approximately $400 million to $500 million in proceeds from this transaction. ESL Investments, our controlling shareholder who owns 61% of Sears Holdings is supportive of the transaction. We issued the press release today announcing this transaction and will keep you apprised as the transaction progresses.
On slide 24, we show an outline of how one might think about our seasonal borrowing needs. At the beginning of 2011, we were undrawn under our revolver facility. In October 2011, which is roughly our peak borrowing season, we disclosed we had $1.65 billion revolver outstanding. Including letters of credit, this was less than 75% utilization meaning we had an excess of 25% availability.
In considering 2012, we need to make some adjustments, absent any changes in EBITDA to illustrate our revolver borrowings. First, in the December 27 release, we indicated that we expected to reduce our peak inventory in 2012 by $500 million to $580 million and to reduce our peak borrowings by $350 million from levels that may have resulted absent such actions. We now currently plan to reduce our peak inventory by an amount in excess of that initial range.
Second, as we discussed we are retiring $300 million less debt this year than last year. Third, we currently expect based on market conditions and other factors that the distribution of rights may generate about $400 million to $500 million. And finally, the announced agreement for the real estate transaction is expected to generate $270 million of proceeds in the next 60 days.
So, in this example, we believe the actions listed here would reduce the borrowing need from the beginning of our fiscal year and our third quarter by about $1.4 billion absent any changes in EBITDA performance for the year. Assuming this had happened in 2011, our increase from January through October would have been approximately $230 million to $330 million.
So, in summary, we have more than ample liquidity. We are focused on improving our operating performance. Today, we have outlined several actions already been executed again in the areas of cost reductions and margin improvement.
In addition, we have begun to execute on inventory management initiative and transactions unlocking the value in the portfolio of our assets, which together are expected to generate over $1 billion in capital.
With that, let me turn the call over to Ron Boire.
Thanks Rob and I am delighted to be here and on this call. I joined Sears because I felt the company had enormous untapped potential in its brands, in its vendor relationships, in its real estate, in its people and in its members. I’ve been impressed on several fronts since joining the company a few weeks ago. I’ll discuss three of these.
First, the level of investment in and focus on creating a differentiated, integrated retail experience for our members is extraordinary. Second, I have been impressed by the commitment of leadership and our owners to the transformation of our company and our brands and third the team here is ready to win.
My focus is on executing our integrated retail strategy envision and creating a culture of excellence in our stores and through our merchandising. To that point I would like to address some of my initial observations. First we must build a customer-focused selling culture in our stores to the integrated retail process.
By leveraging our investments and technology, we can provide customers with better and more timely information and service no matter where or when they choose to shop. Our objective must be to make every member visit an extraordinary event letting them shop their way and be rewarded for it.
For example, our appliance and electronics customers can receive a shopper recap electronically after visiting a store which allows them to review the items they were shopping for at home and purchase them with just a click of the mouse.
Second, from a structural point of view we have the opportunity to leverage our categories and brands in a very different way from our competitors, but breadth and depth of our offering from Hardlines to home and apparel not only is a differentiator for our SHOP YOUR WAY REWARDS program, but also provides many opportunities to improve adjacencies and cross merchandising.
One simple example of this is our strength in tools and work groups where we have market leading positions, yet failed to leverage this in our messaging and merchandising. Our customer should experience a compelling workwear and footwear presentation when he is shopping for tools. Another example is our apparel and electronics businesses. We sell millions of garments each year when mom comes to the store, makes a purchase and exits without ever seeing or experiencing some of our great electronics brands. We have the opportunity to outpost products such as headphones and our apparel and sporting goods departments that appeal to our core customers in those categories. Today headphones are as much a fashion statement as a music accessory. Likewise we brought in new Softline brands and will distort our key brands that offer quality fashions to Kmart and Sears customers.
Our Hardlines business have the reputation for quality and innovation that we need to extend to the whole box. In doing so, we will sell a broader more compelling offering to our customers. These are small but powerful examples of some of the vast merchandising opportunities we have and ways that we can create a differentiated shopping experience for our members in our customers.
We are also focused on continuing our longstanding tradition of great brands and innovative products. This year for example we will introduce new products and technologies in our core brands like Kenmore and Craftsman as well as launch new brands designed to leverage our strength.
In our market leading Kenmore brand, introductions include large capacity and timesaving innovations. In Q1 we are introducing a new large capacity refrigerator line such as our Kenmore 31 cubic foot grab and go, with exclusive indoor design in the industry’s largest front store platform. We are also introducing timesaving frontload washers like the Kenmore Elite frontload with a seller wash, which provides over 35% faster wash cycles to get clothes clear, faster and our successful Craftsman Turn Tight tractors will now feature an industry best six-inch turning radius for faster easier mowing.
In apparel Kmart, we’ll extend our strength in men’s through the launch of our new Legend 1, big men’s casual fashion brand targeted 25 to 35 year old customers. And Heritage Nations an updated men denim brand was launched in Q4. Both of these new brands were developed at our New York design chain.
These are just a few of the many product and brand launches we will execute in 2012 to further enhance our portfolio of brands and continue to bring innovations to market that improve our customer’s lives.
In addition to our focus on selling culture and leveraging our proprietary brands we intend to make our stores easier to navigate and more interactive. With great brand positions and diverse categories from home appliances and fitness to tools and apparel, our customers has many options when entering our stores and we need to do a better job in guiding them through the experience or improving the experience itself.
While I am still relatively new, what I’ve seen in my first two weeks has only confirmed my beliefs the Sears holding is extremely well-positioned to lead the integrated retail revolution in the US. We have world class brands; a solid store base; a strong and growing social, local, mobile and online infrastructure; great people; and most importantly millions of loyal customers who love our brands and are waiting for us to take our integrated experience to the next level.
Now, I would like to hand the call off to Bill Phelan.
Thank you, Ron. Operator we now like to open up the line for questions and answers.
(Operator Instructions) Our first question comes from Gary Balter from Credit Suisse. Your line is open.
Gary Balter - Credit Suisse
Thank you. First of all thank you for doing the call. I very much appreciate it. Just a question on some of the steps that you are taking; you mentioned the inventory going down by let’s say $600 million. You talked about closing some stores. What does that imply for ongoing operations and do you worry about the inventory reduction, the impact it is going to have on sales? Thank you
Hey Gary. It’s Louis. No, not at all, we don’t worry. If you look at the company in the past, we have generated dramatically higher sales and profit with at or lower inventory than we have today. So it’s more of a discussion around inventory productivity and we have many benchmarks from what we have done in recent years to make us feel very comfortable with that level of productivity of what’s achievable. So the intention is not just to cut inventory, it’s to make inventory more productive and if we get to not only industry benchmarks, but benchmarks that we have achieved in the past, we will be able to generate a lot more revenue, a lot more profit with what current or even lower levels of inventory and by the way I would make a similar discussion as it relates to some of the marketing expenses as well. So, that’s the way we think about that, Gary.
And I guess I would just comment that to Louis’ point. The strategy with regard to our inventory is to take actions that increase our returns on invested capital. It’s not so much to cut inventory but to have the right inventory in the right places at the right time. And if you actually look at our payables to inventory ratio, you can see that we’ve begun to optimize our investment of working capital.
Gary Balter - Credit Suisse
And just as part of that (inaudible) and your spin off of 17 million to 18 million of EBITDA and 400 million to 500 million of present value, if you take the EBITDA, less your CapEx, plus pension spending that you project for yourself for 2012, do you expect it to be positive?
Well, Gary, I appreciate the question. We’re obviously consistent with that practice. We’re not going to give guidance on this call. What I would say however to offer you a framework to think about that question is that this past year, we indicated and we feel was a bit of an anomaly. We had the experience of poor execution on our part in terms of buying too much inventory. We experienced higher commodity costs that we were unsuccessful in passing on to some of our customers particularly on the Kmart side that tend to be more price sensitive and we did experience the effects of unseasonably warm weather on our outer wear and some of our other winter items. As a result, if you take that into account and you also take into account that we have executed on $200 million of cost reductions, you would come to the notion that the EBITDA we generated this year is not indicative or a representative of the levels of EBITDA that the asset is, the business is capable of generating going forward.
Gary Balter - Credit Suisse
Last and then I will get off. The spin off, the 17 million to 18 million that’s valued at 400 million to 500 million that’s about if you take (inaudible) that’s about six t times EBITDA ignoring everything else you trade at 30 to 40 times of the pension, who sets the valuation parameters for the spin off?
First of all how Sears trade and valuation of the hometown hardware and outward store is very different exercise as you know. Sears consists of many disparate businesses and the valuation of the Sears in the market place is not necessarily reflect of the value of the independent component and obviously Sears also is valued in the market place based upon perceptions, accurate perceptions in some cases, inaccurate perception in other cases of the value of the portfolio of assets. So the way the evaluation has been set is we had an independent third party look at the value of the businesses as part of ordinary ongoing work that we do during the course of the year, and we are comfortable that the value that we have represented and that our controlling shareholder has indicated that they are interested to invest in, is reflective of fair value.
Our next question comes from Paul Linen from Morning Star your line is open.
Paul Linen - Morning Star
Good morning and thanks for taking our questions. My first question is on appliance sales, obviously that industry continues to be challenged and being the market leader, I am just wondering how you guys are going to fare if the appliance industry stays flat or even down and so my question is really have you done an analysis by store type or region kind of to show that the appliance sales problem is general and not due to a store not being renovated or a regional economy or something like that?
Yeah, as you indicated the appliance industry had seen some challenges. I would point out that in this past quarter from the market data that we've seen in that challenging industry, we gained share from a unit perspective, from a dollar perspective, for the category overall for Kenmore and increased margin in this past quarter margin rates.
What we are doing with specifically with appliances to improve on the convergence and the kind of productivity is really twofold. One is we have a history of very strong innovation. And I think we are going to see this year as Ron spoke about briefly is very interesting products coming out from our appliance team across the spectrum between refrigeration, laundry, dish, which will I think play very well to differentiating strengths of our offerings as well as to the value prop versus our competitors number one.
Number two, is from a go-to-market perspective, we've armed our sales associates with iPad solution selling applications, which they could help guide a customer, a member through the buying process. So you essentially go to the store and you engage, here's what I am looking for, here's you know the size of my family, here's the types of things that we do and then through a series of questions and working with the associates who is armed now with this application you land on the right solutions for you.
So when you talk about which store and whether the investments in store and so forth, one of the important ways we look at our investments in stores is what type of tool have we provided to allow our customer to have a strong experience. And providing our customers the opportunity to work with our associates to have tool which can guide them to the right product, for the right fit is one such an example, that’s another thing we are doing.
We are also spending time looking at as we split the country up by different regions what the appropriate pricing four different region and how do we kind of refine our promotional discount etcetera. So there is a wide openness to looking at, not in the general market but by store but not necessary we just on you know, that this store has two fresh coats of paint and the other stores has three fresh coats profit paint, more in terms of, have we’ve been able to deploy to this store the type of tools to help guide our customers to get them the right solutions for their appliance. That’s the way we think about it.
Paul Linen - Morning Star
It does sound like conversion levers and I guess you would say this is where you deployed those tools you are seeing that are conversion?
We’re not going to comment specifically on what our conversion rates are, but what I can tell you that we’ve been very satisfied with the low lot of those tools and have those tools have also translated into deeper engagement with customers after their store visit.
Paul Linen - Morning Star
Got it. Okay thank you for that. And then question on store closings, first off how many of the store you plan to close? Have you analyzed how many have had recent competitive openings in the last three four years?
And then the second part to that, I thought that most of the store closings were actually all owned. It sounds like they are some leased and may be I just haven’t seen all the numbers in the appendix, but could you break up the economics and cash flows of a store closing when it’s a full line owned versus a full lined leased?
Well, we don’t break out the economics of a store closure whether it’s owned or leased. I guess a couple of comments.
Paul Linen - Morning Star
But are they both positive cash flows, even then the lease stores when you have to pay a kind of stores out?
Yes. And the reason is that was what I was going to address, a couple of issues. One is first of all; we are always able to sell our inventory at levels above cost. Secondly, most of the workers in the stores are part time so severance is limited. Thirdly, we have got minimal go forward lease obligation, many of these stores are in a five-year option period for example and so if you close a store, it might only have 20% or 40% remaining on a go-forward basis. So when we close the stores, the analysis that we always run through is to ensure that it’s a cash flow positive or cash accretive closing.
Our next question comes from [William Ruder] from BOA/Merrill Lynch. Your line is open.
You announced the sale of 11 stores today but you still have a balance sheet with a substantial amount of store value there, I am wondering how you came to the number of eleven and whether you will continue to use this real estate to generate liquidity?
Well, first of all, we do have a substantial real estate portfolio. It obviously has a great deal of value in it that hereto before has been unrecognized.
As far as the specific stores and there is a separate release on this stores and then in the release it specifies the locations etcetera. It was a privately negotiated transaction with General Growth who had a specific interest in these stores. We were leasing these stores, in some cases from General Growth.
So they are purchasing stores as the mall developer and our decision was that at this value, it was a good arrangement for us and a good arrangement for them.
Another thing I wanted to say is, we frequently get offers, whether it’s for a real estate or whether it’s for the use of our brand and we consider that and for those that are compelling that make sense we’re going to execute on, we’re going to do them very deliberately and very thoughtfully. The real value is in the accelerated transformation of our company. The activities we spoke about today are additional ways to unlock unrecognized value and those two steps of activity are very complimentary as we play out our strategy going forward.
Okay. One second once, and my last one. I wonder if you commented on what percentage of your store at this point are forward EBIT negative or anything you could provide in terms of some of the steps in these stores out, how your profitability might improve.
No, we’re not going to provide commentary on that. Thank you for the questions.
Our next question comes from the line of Emily Shanks from Barclays Capital. Your line is open.
Emily Shanks - Barclays Capital
I wanted to echo on you comments. Thank you very much for hosting the call and taking Q&A. My first question is a follow on to sales; specifically you highlighted the unencumbered real estate. Can you give the real estate terms that is unencumbered while it is coming the bank will give you more FCDs, will that hold for some of the (inaudible) real estate
There is 125 stores that are in the bankruptcy remote subsidiary.
Emily Shanks - Barclays Capital
Specific to inventory I was hoping if you give us a little color around what the composition of it is and specifically I am curious to know what the age of the inventory is and perhaps if you could us a little color around categories or package of composition?
No, that level of detail is not something for competitive reason that we would typically disclose. We think we are pretty transparent in all our public filings as far as our balance sheet items and our level of merchandised inventory but asides in the back we did indicate that we had two large of a buy this year and that we are managing our inventory as part of an effort generate higher returns on invested capital and ultimately optimize the performance of the business. That’s far as we are willing to comment.
And the one thing I would say and I inferred in your question we obviously had a very diverse portfolio. So how we look at apparel versus how we look at Sears’s auto and versus how we look at appliances it varies significantly. So the age of one skew for a certain category may be all of the age for that, the same age, different category we would view very differently. So we are as Rob mentioned in his remarks we have sharpened the focus on inventory or dissecting it by category, by skew, by location, by store, by appropriate action and it’s with that sophistication that these reductions and that the actions to improve inventory productivity are taking place. Shortly, not any type of broad levels.
Our final question comes from David Gober from Morgan Stanley. Your line is open.
David Gober - Morgan Stanley
Just had a couple of questions on some of the strategic initiatives that have been at least reported on in the popular press in terms of reallocating some of the assets that you guys have particularly on leasing some space within existing stores to other retailers and brands and also extending some of the brands outside of existing Sears stores, of the Ace Hardware deal and similar deals, any update on how those are going and how you are thinking about both of those initiatives going forward.
Sure. Two or three perspectives. One is fundamentally, our strategy is at the intersection of two important elements. Integrated retail and this deeply engaging membership program we are building, SHOP YOUR WAY REWARDS, so all other strategic elements flow from that. An important part of developing closer relationships with our members through Shop Your Way and reaching them and continuously engaging with them across all channels.
And an important element to that as an example is how we work with our brand. The fundamental purpose of our brand whether it’s Kenmore, Craftsman, DieHard and Lands' End has been and currently is within the current, within our formats. So the vast majority of the focus of let’s say Kenmore is for Sears and Craftsman for Sears and Kmart et cetera.
However, where there are opportunities, where there is another brand to either brand to our format which I’ll talk about in a second or where we could extend the reach to new customers, to a complementary formats, for our brands we are very open to do that as well as. But it’s going to very thoughtful because we want to make sure that the kind of the puts and the takes play out in the way we want them to.
So you mentioned Ace, the Ace rollout I would say is going very well. We’ve expanded the stores by a significant amount versus last year. We now have over 1300 stores where we are selling Craftsman tools through Ace distribution.
By the way, that number will continue to increase in 2012. I would also mention that Costco is also going well. As we look to kind of potentially brought in stores, brought in assortment et cetera. But they are done very thoughtfully. Who are the buyers who are going to Costco, what are they buying, what type of technology, what type of assortment makes sense for Costco versus makes sense for our format. Are there overlaps or are they complementary in terms of customer sets. So these things are done in a very thoughtful way. We are not going to do something in which we are basically shifting profit or revenue from one location to another location. But where there is an opportunity to extend reach, to go deeper in assortment, to extend technology, we are absolutely open to that.
And what I’ll tell you is that we’ll not be, we have received many calls regarding the opportunities of our brand. We are choosing very few of them. None of them will be done unless I am personally involved and none of them with any materiality will be done unless there is a discussion with the entire Board. That’s how important we view our brands.
And the last comment I will make, is that it relates to bringing other brand into our format, I would say there is an openness to that. We have seen, we have done some of that. We are looking to do frankly some additional parts of that which you may see kind of in the future. We have a very attractive set of locations, attractive formats. We have some fantastic brands and products. It did make sense that there is another brand outside of what we own that could generate greater productivity for us in our format. We are wide open to that discussion.
David Gober - Morgan Stanley
And I guess just circling back a little bit on some of the liquidity comments and particularly with the stronger position that you’ve discussed and some of the initiatives, how do you think about uses of capital going forward in terms of CapEx versus either buybacks or potentially dividends or something like that?
Well that’s a pretty, I appreciate the question. It’s a broad question. I guess our Board is very focused on allocating capital where we are going to generate the highest return and where we are going to get the best operating performance.
As far as any specific comment, you know, forward-looking comments about CapEx or share buybacks, that’s not anything that we give guidance on. Obviously, consistent with normal corporate demand, we believe that share repurchases should be based on, if you have no alternative uses of excess capital that we believe would generate higher risk-adjusted returns and if we believe the intrinsic value of the company is greater than the value reflected in the actual share price.
The bulk of our stock repurchases occurred prior to 2008 when the company was generating significant free cash. We did not take on debt to fund those expenditures. In 2020 hindsight, perhaps we would have been better off not buying at those prices, but at the time given the company’s operating performance and what we believe was an improving business and a robust economy we thought the share repurchases were value creating.
Having said that, again we’re not going to provide any guidance on future stock repurchases other than to say, we certainly will not put the company at risk and over extending ourselves by buying back shares. You will notice that even with the lower stock prices, the company has tampered its purchases, repurchase appetite given the more difficult operating performance.
Yeah, and one thing I will add to that is when you look at CapEx, somehow if you look at CapEx as a proxy for what we’re investing to kind of improve the customer experience at the store, given the aforementioned comments about integrated retail and how customers really move seamlessly between different channels, we believe it’s important to look at the overall spend in the customer experience and as I mentioned in my remarks, we’re spending several hundred million dollars in our customer experience and that hits different parts of the financial statements whether it’s the CapEx piece, our investment in stores whether its some our investments in all lines some of which is income statement whether its investment in our membership programs some of which impacts cost of goods sold etcetera. But the complete investment we make in our customer experience is quite significant; it is many ways that is at the core of our strategy going forward. So hopefully those two perspectives provide some insight to your question.
Well, thank you very much. I think that concludes the call. Operator?
Ladies and gentlemen that does conclude today’s conference. You may all disconnect and have a wonderful day.
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