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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-K



x
    
    ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the fiscal year ended January 3, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934


Commission file number 1-416

SEARS, ROEBUCK AND CO.



New York
    
    36-1750680(State of Incorporation)
    
    (I.R.S. Employer Identification No.)3333 Beverly Road, Hoffman Estates,Illinois
    
    60179(Address of principal executive offices)
    
    (Zip Code)


Registrants telephone number, including area code: (847) 286-2500

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
    
    Name of Each Exchange on Which RegisteredNew York Stock ExchangeCommon Shares, par value $0.75 per share
    
    Chicago Stock ExchangePacific Stock Exchange


Securities registered pursuant to Section 12(g) of the Act:             None

On January 31, 2004, the Registrant had 222,926,291 common shares outstanding. The aggregate market value (based on the closing price of the Registrants common share as reported in a summary of
composite transactions in The Wall Street Journalfor stocks listed on the New York Stock Exchange on June 27, 2003) of the Registrants common shares owned by non-affiliates (which are assumed to be
shareholders other than (i) directors and executive officers of the Registrant and (ii) any person known by the Registrant to beneficially own five percent or more of Registrants common shares), as of
June 27, 2003 was approximately $6.0 billion.

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been
subject to such filing requirements for the past 90 days.

Yes            x            No           o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes           x            No           o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of the Registrants knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K.  x

Documents Incorporated By Reference

Part III of this Form 10-K incorporates by reference certain information from the Registrants proxy statement relating to its Annual Meeting of Shareholders to be held on May 13, 2004 (the 2004 Proxy
Statement).

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TABLE OF CONTENTS



|                                                                                       |                                                                                                       |  |  |  |  |  |  | 
|-------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                                                                
|                                                                                       | Item 1. Business                                                                                     
|                                                                                       | Item 1A. Executive Officers of the Registrant                                                        
|                                                                                       | Item 2. Properties                                                                                   
|                                                                                       | Item 3. Legal Proceedings                                                                            
|                                                                                       | Item 4. Submission of Matters to a Vote of Security Holders                                          
|PART II                                                                               
|                                                                                       | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                        
|                                                                                       | Item 6. Selected Financial Data                                                                      
|                                                                                       | Item 7. Managements Discussion and Analysis                                                         
|                                                                                       | Item 7a. Quantitative and Qualitative Disclosures About Market Risk                                  
|                                                                                       | Item 8. Financial Statements and Supplementary Data                                                  
|                                                                                       | Item 9. Changes in and Disagreements with Independent Auditors on Accounting and Financial Disclosure
|                                                                                       | Item 9A. Controls and Procedures                                                                     
|PART III                                                                              
|                                                                                       | Item 10. Directors and Executive Officers of the Registrant                                          
|                                                                                       | Item 11. Executive Compensation                                                                      
|                                                                                       | Item 12. Security Ownership of Certain Beneficial Owners and Management                              
|                                                                                       | Item 13. Certain Relationships and Related Transactions                                              
|                                                                                       | Item 14. Principal Accounting Fees and Services                                                      
|                                                                                       | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                             
|SIGNATURES                                                                            
|SEARS, ROEBUCK AND CO. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
|                                                                                       | Managements Report                                                                                  
|                                                                                       | Independent Auditors Report                                                                         
|                                                                                       | SEARS, ROEBUCK AND CO. Consolidated Statements of Income                                             
|                                                                                       | SEARS, ROEBUCK AND CO. Consolidated Balance Sheets                                                   
|                                                                                       | SEARS, ROEBUCK AND CO. Consolidated Statements of Cash Flows                                         
|                                                                                       | SEARS, ROEBUCK AND CO. Consolidated Statements of Shareholders Equity                               
|                                                                                       | SEARS, ROEBUCK AND CO. Notes to Consolidated Financial Statements                                    
|EXHIBIT INDEX                                                                         
|By-Laws                                                                               
|Amendment                                                                             
|Guarantee                                                                             
|Computation                                                                           
|Subsidiaries                                                                          
|Consent                                                                               
|Power of Attorney                                                                     
|Certification of CEO                                                                  
|Certification of CFO                                                                  
|Certification of CEO and CFO                                                          



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PART I




Item 1. Business

Sears, Roebuck and Co. (Sears, and together with its consolidated
subsidiaries, the Company) originated from an enterprise established in 1886
and incorporated under the laws of New York in 1906. Its principal executive
offices are located at 3333 Beverly Road, Hoffman Estates, Illinois. The
Company is a multi-line retailer that offers a wide array of merchandise and
related services and is among the largest retailers in North America. In
addition, through its Credit and Financial Products businesses, the Company has
offered its customers various credit, financial and related insurance products.
For the year ended January 3, 2004, the Company was organized into four
principal business segments - Retail and Related Services, Credit and Financial
Products, Corporate and Other, and Sears Canada.

On November 3, 2003, the Company sold its domestic Credit and Financial
Products business, including its clubs and services business, to Citicorp, a
global financial services holding company. The sale resulted in the transfer
of responsibility and control of all credit underwriting and funding risk, as
well as processing and customer support activities for the products, to
Citicorp and its affiliates. With the sale, the Company has become more
focused as a retailer and has used the proceeds generated from the sale to
strengthen its balance sheet and return value to its shareholders.

The Companys Annual Reports on Form 10-K, including this Form 10-K, as well as
the Companys Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
any amendments to such reports are available, free of charge, on the Investor
Relations portion of the Companys internet website, www.sears.com. These
reports are available as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange
Commission.

The Corporate Governance Guidelines of the Companys Board of Directors, the
charters of the Audit, Compensation and Nominating Committees of the Board of
Directors and the Companys Core Values and Code of Conduct are also available
on the Investor Relations portion of www.sears.com, and will be provided, free
of charge, to any shareholder who requests a copy by calling 1-800-SEARS80.
References to the Companys website address do not constitute incorporation by
reference of the information contained on the website, and the information
contained on the website is not part of this document.

The Companys business segments are defined as follows:

Retail and Related Services- consisting of:

Full-line Stores- 871 Full-line Stores, averaging 91,000 net selling square
feet, located primarily in shopping malls across the nation and offering:



| |  |  | Home Group- A full assortment of products for the home including
appliances, electronics, home fashions and home improvement products,
such as tools, fitness and lawn and garden equipment; products range
from leading national brands to proprietary Company brands such as
Kenmore, Craftsman and WeatherBeater.     
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Apparel/Accessories- A complete selection of fashionable, quality
apparel, footwear and accessories for the whole family and fine
jewelry at value prices; includes leading national brands as well as
exclusive proprietary Company brands such as Lands End, Covington,
Canyon River Blues, Apostrophe and TKS Basics.
|
| |  |  | Sears Auto Centers- A full selection of automotive services including
the sale of major national brands of tires and batteries including the
Companys proprietary DieHard branded products.                                                                                                                             
|
| |  |  | sears.com Sears extension of its product selection through internet
channels offering a limited assortment                                                                                                                                                                                                             

2



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| |  |  | of home and accessories
merchandise and providing customers the option of buying through the
internet and picking up their merchandise in Full-line Stores.
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

Specialty Stores- Approximately 1,100 Specialty Stores, located primarily in
free-standing, off-the-mall locations or high-traffic neighborhood shopping
centers.



| |  |  | Dealer Stores- 792 primarily independently-owned stores,
predominately located in smaller communities and averaging 5,600 net
selling square feet, offering home goods including appliances,
electronics, lawn and garden merchandise, hardware and automotive
batteries. Dealer Stores carry proprietary Company brands such as
Craftsman, Kenmore and DieHard as well as a wide assortment of
national brands.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Hardware Stores -245 neighborhood Hardware Stores under the Sears
Hardware and Orchard Supply Hardware brands averaging 21,000 and
41,000 net selling square feet, respectively, that carry Craftsman
tools and lawn and garden equipment, a wide assortment of national
brands and other home improvement products. Approximately 60 Sears
Hardware Stores also offer a limited selection of home appliances.  
|
| |  |  | The Great Indoors (TGI) -18 stores specializing in home decorating
and remodeling, averaging 104,000 net selling square feet, dedicated
to the four main rooms of the house: kitchen, bedroom, bathroom and
great room.                                                                                                                                                                                       
|
| |  |  | Sears Outlet Stores- 45 stores averaging 27,000 net selling square
feet offering overstock and/or distressed appliances, electronics and
lawn and garden merchandise at a discount.                                                                                                                                                                                                                             
|
| |  |  | Commercial Sales- This business primarily targets home builders,
remodelers and property managers for appliance purchases as well as
vocational schools, factory maintenance and service companies for
industrial tool purchases.                                                                                                                                                                               
|
| |  |  | National Tire & Battery (NTB) -These stores offer major national
brands of tires, DieHard and other brands of batteries and related
services. This business was sold to TBC Corporation (TBC) on
November 29, 2003.                                                                                                                                                                                         

Direct to Customer- The Direct to Customer business includes the direct
merchant business of Lands End, Inc. (Lands End), which was acquired by the
Company in June 2002. Lands End is a leading direct merchant of traditionally
styled, casual clothing, accessories and footwear for men, women and children,
as well as home fashion products and soft luggage. These products are offered
through multiple selling channels consisting of regular monthly mailings of its
primary, prospecting and specialty catalogs as well as through the internet,
international businesses and 16 retail stores. These retail stores, averaging
6,400 net selling square feet, also offer traditionally-styled casual clothing
for men, women and children primarily from overstocks of the catalog and
internet channels. Direct to Customer also includes direct marketing of Sears
goods through specialty catalogs as well as other impulse and continuity
merchandise.

Product Repair Services- Product Repair Services, the nations largest product
repair service provider, is a key element in the Companys active relationship
with more than 48 million households. With over 10,000 service technicians
making over 14 million service calls annually, this business delivers a broad
range of retail related residential and commercial services in all 50 states of
the United States and Puerto Rico under the Sears Parts & Repair Services and
A&E Factory Service brand names. Commercial and residential customers can
obtain parts and repair services for all major brands of products such as home
appliances, lawn and garden equipment, home electronics, floorcare products,
and heating and cooling systems. Smaller items for repair can be brought into
Sears Parts & Repair Centers located throughout the United States or to any
Sears Full-line Store. Customers can also purchase service contracts, product
protection agreements, product installation services and Kenmore and Carrier
residential heating and cooling systems.

3



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##### Table of Contents



Credit and Financial Products

This segment formerly managed the Companys domestic portfolio of credit card
receivables, which was sold on November 3, 2003. The domestic credit card
receivables portfolio consisted primarily of the proprietary Sears Card and
Sears ChargePlus (collectively, Sears Card) and Sears Gold MasterCard and The
Great Indoors Gold MasterCard (collectively, MasterCard) account balances.
Sears Card receivables were generated primarily from purchases of merchandise
and services from the Companys domestic operations. The MasterCard credit
card receivables were generated from purchases from the Company and other
merchants, balance transfers and the use of convenience checks and cash
advances. The MasterCard products are widely accepted by merchants outside the
Company. This segment also sold related financial products such as credit
protection and insurance products. The results of operations for this segment
are included in the Companys financial statements through November 2, 2003.

The Company and Citibank (USA) N.A. have entered into a long-term marketing and
servicing alliance with an initial term of 10 years, with an option to renew.
Revenues earned under this alliance are being reported within the Retail and
Related Services segment.

Corporate and Other

Corporate and Other operations include activities that are of an overall
holding company nature, primarily consisting of administrative activities, the
costs of which are not allocated to the Companys domestic businesses. This
segment also includes home improvement services (primarily siding and windows
through Sears Home Improvement Services).

Sears Canada

The Company conducts similar retail, credit and corporate operations in Canada
through Sears Canada, Inc. (Sears Canada), a consolidated, 54.4% owned
subsidiary of Sears. As of January 3, 2004, Sears Canada conducted retail
operations through 122 department stores, 47 furniture and appliance stores,
144 dealer stores, operated under independent local ownership, 14 outlet
stores, 53 floor covering centers, 49 automotive centers, approximately 2,200
catalog pick-up locations, 110 travel offices and over the internet through
sears.ca.



---

Information regarding revenues, operating income, total assets and capital
expenditures of the Companys business segments for each of the three fiscal
years ended January 3, 2004, December 28, 2002 and December 29, 2001 is
contained in Note 15 of the Notes to Consolidated Financial Statements.
Information on the components of revenue is included in Item 7,
Managements Discussion and Analysis.

Seasonality and Inflation

Due to consumer holiday buying patterns, merchandise sales traditionally are
higher in the fourth quarter than in the other quarterly periods, and the
Company typically earns a disproportionate share of its annual operating income
in the fourth quarter.

The moderate rate of inflation over the past three years has not had a
significant effect on the Companys revenues and profitability.

Trademarks and Tradenames

The name SEARS trade name and mark is used by the Company. The name is the
subject of numerous United States and foreign trademark and service mark
registrations. This trademark is material to the Companys domestic operations
and other related businesses.

Sears sells proprietary branded merchandise under a number of brand names which
are important to its domestic

4



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operations. The Companys LANDS END®, KENMORE®, CRAFTSMAN® and DIEHARD®
brands are among the most recognized proprietary brands in retailing. These
names are the subject of numerous United States and foreign trademark
registrations. Other important and well-recognized Company trademarks and
service marks include THE GREAT INDOORS®, OSH®, CANYON RIVER BLUES®,
APOSTROPHE®, TKS BASICS®, COVINGTONTM, STRUCTURE®, A&E FACTORY
SERVICE®, WISHBOOK® and SEARS. GOOD LIFE. GREAT PRICE.TM. The
Companys right to use all of its trade names continues so long as it uses the
names.

Competition

The domestic retail business is highly competitive. The Company competes with
other national and local department stores, specialty stores, discount stores,
consumer electronics retailers, home improvement retailers and national and
local product repair specialists. The Company also competes with other
internet and catalog businesses which carry similar merchandise offerings.

The principal factors that differentiate retail competitors include convenience
of shopping facilities, quality of merchandise, competitive prices, brand names
and availability of retail related services such as access to credit, product
delivery, repair and installation. The Company believes its business model and
the strength of its proprietary brands enables it to compete effectively
despite strong competitive pressures in recent years.

Employees

The Company employs approximately 201,000 people in the United States and
Puerto Rico, and 48,000 people in Canada, including part-time employees.

5



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Item 1A. Executive Officers of the Registrant

The following table sets forth the names of the executive officers of the
Company, their current positions and offices with the Company, the date they
first became executive officers of the Company and their current ages:

Date First Becamean ExecutiveName
    
    Position
    
    Officer
    
    AgeAlan J. Lacy
    
    Chairman of the Board of Directors, President and
Chief Executive Officer
    
    
    1995
    
    
    
    50Lucinda M. Baier
    
    Senior Vice President and General Manager, Credit and
Financial Products
    
    
    2003
    
    
    
    39Janine M. Bousquette
    
    Executive Vice President, Chief Customer and
Marketing Officer
    
    
    2002
    
    
    
    43Mark S. Cosby
    
    Executive Vice President, Sears, Roebuck and Co. and
President, Full-line Stores - Sears Retail
    
    
    2002
    
    
    
    45Mark C. Good
    
    Executive Vice President and General Manager, Product
Repair Services
    
    
    2002
    
    
    
    47Gerald F. Kelly
    
    Senior Vice President and Chief Information Officer
    
    
    2002
    
    
    
    56Sara A. LaPorta
    
    Senior Vice President, Strategy
    
    
    2002
    
    
    
    43Greg A. Lee
    
    Senior Vice President, Human Resources
    
    
    2001
    
    
    
    54Gwendolyn K. Manto
    
    Executive Vice President and General Manager - Apparel
    
    
    2004
    
    
    
    49Mindy C. Meads
    
    Executive Vice President, Sears Roebuck and Co. and
President and Chief Executive Officer, Lands End
    
    
    2003
    
    
    
    52Robert J. OLeary
    
    Senior Vice President, Public
Relations, Communications
and Government Affairs
    
    
    2003
    
    
    
    53William G. Pagonis
    
    Senior Vice President, Supply Chain Management
    
    
    1995
    
    
    
    62Glenn R. Richter
    
    Senior Vice President and Chief Financial Officer
    
    
    2001
    
    
    
    42William C. White
    
    Executive Vice President and General Manager,
Full-line Store Operations - Sears Retail
    
    
    2003
    
    
    
    56Andrea L. Zopp
    
    Senior Vice President and General Counsel
    
    
    2003
    
    
    
    47


Messrs. Lacy, Good, Pagonis and White have held the positions set forth in the
above tables for at least the last five years or have served the Company in
various executive or administrative capacities for at least that length of
time. The remaining executive officers have held the following positions for
such five-year period:

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Ms. Baier joined Sears
as Vice President - Tax in December 2000. She was named
Vice President, Finance - Credit and Financial Products in November 2001 and
held that position until 2003. She became Senior Vice President and General
Manager - Sears Credit in March 2003. Ms. Baier has served as Senior Vice
President and General Manager - Credit and Financial Products since August
2003. Prior to joining Sears, Ms. Baier was Senior Vice President,
Merchandising for US Office Products, a distributor of wholesale office
products, from 1999 to 2000.

Ms. Bousquette joined Sears as Executive Vice President, Chief Customer and
Marketing Officer, in October 2002. Prior to joining Sears, she was Chief
Marketing Officer and Executive Vice President of eToys Inc., a Web-based
retailer, from 1999 to 2001. From 1995 to 1999, she was Vice President,
Marketing with Pepsi-Cola Division of PepsiCo, Inc., a snack and beverage
manufacturer and distributor, serving as Vice President of Marketing for
Trademark Pepsi Brands from 1997 to 1999.

Mr. Cosby joined Sears as Executive Vice President, Sears, Roebuck and Co. and
President, Full-line Stores in November 2002. Prior to joining Sears, he was
Chief Operating Officer, KFC of TRICON Global Restaurants, Inc. (now Yum!
Brands, Inc.), a restaurant operating company, from 2001 to 2002 and
Chief Development Officer from 1997 to 2001.

Mr. Kelly joined Sears as Senior Vice President and Chief Information Officer
in October 2002. Prior to joining Sears, he was Senior Vice President -
Logistics, Information Systems and Technology at Payless Shoesource, Inc., a
footwear retailer, from 1996 to 2001.

Ms. LaPorta joined Sears as Senior Vice President, Strategy in December 2002.
Prior to joining Sears, she was Vice President of The Boston Consulting Group,
an international strategy and general management consulting firm, from 1986 to
2002.

Mr. Lee joined Sears as Senior Vice President, Human Resources in January 2001.
Prior to joining Sears, he was Senior Vice President, Human Resources of
Whirlpool Corporation, a manufacturer of major home appliances, since June
1998. Prior to joining Whirlpool, Mr. Lee served in the same capacity for The
St. Paul Companies, a property and casualty insurance company.

Ms. Manto joined Sears as Executive Vice President and General Manager, Apparel
in February 2004. Prior to joining Sears, she was Vice Chairman/Chief
Merchandising Officer of Stein Mart, an off-price specialty retailer from 2000
to 2003. From 1998 to 2000, Ms. Manto served as President of Kids Foot Locker,
a specialty retailer of childrens athletic footwear and apparel.

Ms. Meads joined Sears as Executive Vice President and General Manager,
Softlines in April 2003. Ms. Meads was named Executive Vice President, Sears,
Roebuck and Co. and President and Chief Executive Officer, Lands End in
February 2004. Prior to joining Sears, she was Executive Vice President of
Merchandising and Design for Lands End, Inc., a catalog and online retailer of
clothing, accessories and home fashions, from 1998 to 2003.

Mr. OLeary joined Sears as Senior Vice President, Public Relations, Communications
and Government Affairs in July 2003. Prior to joining Sears, he was Senior
Vice President, Global Communications for The Goodyear Tire and Rubber Company,
a manufacturer and distributor of engineered rubber products and chemicals,
from 2002 to 2003. From 2000 to 2002, Mr. OLeary was a seed investor and board
member of several startup business groups, primarily responsible for marketing,
branding and communications strategy. He also served as General Manager of
Global Public Affairs for Mobil Corporation, a global energy and petrochemical
company, from 1995 to 1999.

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Mr. Richter joined Sears as Vice President and Controller in February 2000. He
was named Senior Vice President, Finance in July 2001 and held that position
until October 2002. Mr. Richter has served as Senior Vice President and Chief
Financial Officer since October 2002. Prior to joining Sears, Mr. Richter was
Senior Vice President and Chief Financial Officer of Dade Behring
International, a manufacturer of medical testing systems, from 1998 to 2000,
and Senior Vice President and Corporate Controller from 1997 to 1998.

Ms. Zopp joined Sears as Senior Vice President and General Counsel in July
2003. Prior to joining Sears, she was Vice President and Deputy General
Counsel of Sara Lee Corporation, a global manufacturer and marketer of
consumer products, from 2000 to 2003, and Partner at Sonnenschein Nath &
Rosenthal from 1997 to 2000.

8



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Item 2. Properties

The Companys principal executive offices are located on a 200-acre site owned
by the Company at the Prairie Stone office park, in Hoffman Estates, Illinois.
The complex consists of six interconnected office buildings totaling
approximately two million gross square feet of office space.

The following table sets forth information concerning stores operated by the
Companys Retail and Related Services segment.

Full-line Stores
    
    
    Specialty Stores
    
    Lands' End
    
    
        TotalNTB
    
    
    Hardware
    
    
    Dealer
    
    
    Other(1)Stores as of January 3, 2004:Owned
    
    
    516
    
    
    
    
    
    
    
    18
    
    
    
    1
    
    
    
    23
    
    
    
    
    
    
    
    558Leased(2)
    
    
    355
    
    
    
    
    
    
    
    227
    
    
    
    15
    
    
    
    45
    
    
    
    16
    
    
    
    658Independently-owned and operated stores
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    776
    
    
    
    
    
    
    
    
    
    
    
    776Total
    
    
    871
    (3)
    
    
    
    
    
    
    245
    
    
    
    792
    
    
    
    68
    
    
    
    16
    
    
    
    1,992Total stores as of fiscal year-end:2000
    
    
    863
    
    
    
    229
    
    
    
    274
    
    
    
    790
    
    
    
    43
    
    
    
    
    
    
    
    2,199Stores opened during fiscal 2001
    
    
    13
    
    
    
    1
    
    
    
    4
    
    
    
    33
    
    
    
    14
    
    
    
    
    
    
    
    65Stores closed during fiscal 2001
    
    
    (9
    )
    
    
    (7
    )
    
    
    (30
    )
    
    
    (30
    )
    
    
    (3
    )
    
    
    
    
    
    
    (79
    )2001
    
    
    867
    
    
    
    223
    
    
    
    248
    
    
    
    793
    
    
    
    54
    
    
    
    
    
    
    
    2,185Stores opened during fiscal 2002
    
    
    15
    
    
    
    2
    
    
    
    3
    
    
    
    13
    
    
    
    10
    
    
    
    
    
    
    
    43Stores acquired through acquisition
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    15Stores closed during fiscal 2002
    
    
    (10
    )
    
    
    
    
    
    
    (2
    )
    
    
    (39
    )
    
    
    
    
    
    
    
    
    
    
    (51
    )2002
    
    
    872
    
    
    
    225
    
    
    
    249
    
    
    
    767
    
    
    
    64
    
    
    
    15
    
    
    
    2,192Stores opened during fiscal 2003
    
    
    4
    
    
    
    2
    
    
    
    
    
    
    
    31
    
    
    
    9
    
    
    
    1
    
    
    
    47Stores closed during fiscal 2003
    
    
    (5
    )
    
    
    (2
    )
    
    
    (4
    )
    
    
    (6
    )
    
    
    (5
    )
    
    
    
    
    
    
    (22
    )Stores disposed through divestiture
    
    
    
    
    
    
    (225
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (225
    )Stores as of January 3, 2004
    
    
    871
    
    
    
    
    
    
    
    245
    
    
    
    792
    
    
    
    68
    
    
    
    16
    
    
    
    1,992Gross retail
area as of fiscal year-endsquare feet in millions2003
    
    
    127.4
    
    
    
    
    
    
    
    9.2
    
    
    
    6.7
    
    
    
    4.4
    
    
    
    0.1
    
    
    
    147.82002
    
    
    127.6
    
    
    
    2.6
    
    
    
    9.3
    
    
    
    6.4
    
    
    
    4.4
    
    
    
    0.1
    
    
    
    150.42001
    
    
    127.3
    
    
    
    2.5
    
    
    
    9.1
    
    
    
    6.6
    
    
    
    3.4
    
    
    
    
    
    
    
    148.9Retail
selling area as of fiscal year-endsquare feet in millions2003
    
    
    79.4
    
    
    
    
    
    
    
    6.7
    
    
    
    4.4
    
    
    
    3.2
    
    
    
    0.1
    
    
    
    93.82002
    
    
    79.1
    
    
    
    0.3
    
    
    
    6.8
    
    
    
    4.1
    
    
    
    3.3
    
    
    
    0.1
    
    
    
    93.72001
    
    
    79.2
    
    
    
    0.3
    
    
    
    6.7
    
    
    
    4.3
    
    
    
    2.4
    
    
    
    
    
    
    
    92.9Retail store revenues per net selling square foot (4)2003
    
    $
    3022002
    
    $
    3032001
    
    $
    318




---

|(1) |  | Consists of specialty appliance and electronic stores, retail outlet stores and TGI stores. Excludes Other facilities owned or leased as part of Full-line Store
properties.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) |  | Many of the leases contain renewal options and contingent rentals (for additional information, see Note 7 of the Notes to Consolidated Financial Statements).                 
|(3) |  | Includes Sears Auto Centers.                                                                                                                                                  
|(4) |  | Includes net commissions earned from licensed businesses operating within the Retail stores.                                                                                  



---

9



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##### Table of Contents



In addition, at January 3, 2004, there were 888 other sales offices and
service facilities, most of which are occupied under short-term leases or are
a part of other Sears facilities included in the above table. There were also
137 distribution facilities, most of which are leased for terms ranging from
one to 10 years.

As of January 3, 2004, Sears Canada operated 122 department stores, 47
furniture and appliance stores, 144 dealer stores, operated under independent
local ownership, 14 outlet stores, 53 floor covering centers, 49 automotive
centers, approximately 2,200 catalog pick-up locations and 110 travel offices.




Item 3. Legal Proceedings

Pending against the Company and certain of its officers and directors are a
number of lawsuits, described below, that relate to the credit card business
and public statements about it. The Company believes that all of these claims
lack merit and is defending against them vigorously.



|§ |  | On and after October 18, 2002, several actions were filed in the
United States District Court for the Northern District of Illinois
against the Company and certain current and former officers alleging
that certain public announcements by the Company concerning its credit
card business violated Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The Court
has consolidated the actions and appointed the Department of the
Treasury of the State of New Jersey and its Division of Investments as
lead plaintiff. The Court has more recently denied defendants
motions to dismiss the complaint and certified the consolidated action
as a class action on behalf of a class of all persons who purchased
securities of the Company between October 24, 2001 and October 17,
2002, inclusive. The Court has scheduled trial to begin on April 4,
2005. A similar case filed in the United States District Court for
the Northern District of California was transferred to the Northern
District of Illinois and subsequently voluntarily dismissed by the
plaintiffs in that action.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|§ |  | On and after November 15, 2002, several actions were filed in the
United States District Court for the Northern District of Illinois
against the Company, certain officers and directors, and alleged
fiduciaries of Sears 401(k) Savings Plan (the Plan), seeking damages
and equitable relief under the Employee Retirement Income Security Act
of 1974 (ERISA). The plaintiffs purport to represent participants
in the Plan, and allege breaches of fiduciary duties under ERISA in
connection with the Plans investment in the Companys common shares
and alleged communications made to Plan participants regarding the
Companys financial condition. These actions have been consolidated
into a single action. A motion to dismiss the consolidated complaint
is pending. A motion for certification of the action as a class
action was ordered withdrawn pending the courts decision on the
motion to dismiss.                                                                                                                                                                                                                     
| 
|§ |  | On October 23, 2002, a purported derivative action was filed in the
Supreme Court of the State of New York against the Company (as a
nominal defendant) and certain current and former directors seeking
damages on behalf of the Company. The complaint purports to allege a
breach of fiduciary duty by the directors with respect to the
Companys management of the credit card business. A motion to dismiss
is pending. Two similar actions were subsequently filed in the
Circuit Court of Cook County, Illinois, and a third was filed in the
United States District Court for the Northern District of Illinois.
These actions have been stayed pending disposition of the action in
New York. The plaintiffs in the Northern District of Illinois action
have appealed the stay order to the United States Court of Appeals for
the Seventh Circuit.                                                                                                                                                                                                                                                                                       
| 
|§ |  | On June 17, 2003, an action was filed in the Northern District of
Illinois against the Company and certain officers, purportedly on
behalf of a class of all persons who, between June 21, 2002 and
October 17, 2002, purchased the 7% notes that Sears, Roebuck
Acceptance Corp. (SRAC) issued on June 21, 2002. An amended
complaint has been filed, naming as additional defendants certain
former officers, SRAC and several investment banking firms who acted
as underwriters for SRACs March 18, May 21 and June 21, 2002 notes
offerings. The amended complaint alleges that the defendants made
misrepresentations or omissions concerning its credit business during
the class period and in the registration statements and prospectuses                                                                                                                                                                                                                                                                                                                                                                                               

10



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##### Table of Contents





| |  | relating to the offerings. The amended complaint alleges that these
misrepresentations and omissions violated Sections 10(b) and 20(a) of the
Securities Exchange Act and Rule 10b-5 promulgated thereunder, and Sections
11, 12 and 15 of the Securities Act of 1933 and purports to be brought on
behalf of a class of all persons who purchased any security of SRAC between
October 24, 2001 and October 17, 2002, inclusive. Motions to dismiss the
amended complaint are pending.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Company is subject to various other legal and governmental proceedings,
many involving litigation incidental to the businesses. Some matters contain
class action allegations, environmental and asbestos exposure allegations and
other consumer-based claims that involve compensatory, punitive or treble
damage claims in very large amounts as well as other types of relief. The
consequences of these matters are not presently determinable but, in the
opinion of management of the Company after consulting with legal counsel, and
taking into account insurance and reserves, the ultimate liability is not
expected to have a material adverse effect on annual results of operations,
financial position, liquidity or capital resources of the Company.




Item 4. Submission of Matters to a Vote of Security Holders

None




PART II




Item 5. Market for Registrants Common Equity and Related Stockholder Matters

Description of Sears Common Shares

The summary contained herein of certain provisions of the Restated Certificate
of Incorporation, as amended (the Certificate of Incorporation), of Sears
does not purport to be complete and is qualified in its entirety by reference
to the provisions of such Certificate of Incorporation incorporated as Exhibit
3.1 hereto and incorporated by reference herein.

The Certificate of Incorporation authorizes the issuance of 1,000,000,000
common shares, par value $0.75 per share, and 50,000,000 preferred shares, par
value $1.00 per share. As of the date hereof, there are no preferred shares
outstanding. Preferred shares may be issued in series with rights and
privileges as authorized by the Board of Directors.

Subject to the restrictions on dividends mentioned below and the rights of the
holders of any preferred shares which may hereafter be issued, each holder of
common shares is entitled to one vote per share, to vote cumulatively for the
election of directors, to dividends declared by the Board of Directors and,
upon liquidation, to share in the assets of Sears pro rata in accordance with
his, her or its holdings after payment of all liabilities and obligations.
The holders of common shares have no preemption, redemption, subscription or
conversion rights.

Sears Board of Directors is divided into three classes serving staggered
three-year terms. Because the Board is classified, shareholders wishing to
exercise cumulative voting rights to assure the election of one or more
directors must own approximately two to three times as many shares (depending
on the number of directors in the class and on the Board as a whole) as would
be required if the Board were not classified. Directors may be removed only
for cause upon the affirmative vote of at least 75% of the shares entitled to
vote. Such a vote is also required to alter, amend or repeal, or to adopt any
provision inconsistent with, Article 5 of the Certificate of Incorporation
concerning directors, or to fix the number of directors by shareholder vote.

There are no restrictions on repurchases or redemption of shares by Sears
except for an agreement pursuant to which Sears has provided a credit facility
in support of certain tax increment revenue bonds issued by the Village of
Hoffman

11



---



##### Table of Contents



Estates, Illinois, in connection with the construction of its headquarters
facility. This agreement provides that Sears will not take certain actions,
including the declaration of cash dividends and the repurchase of shares,
which would cause Unencumbered Assets plus certain Capitalized Rentals to drop
below 150% of Liabilities plus such Capitalized Rentals (as such terms are
defined in the agreement). The amount by which such Unencumbered Assets plus
Capitalized Rentals exceeds 150% of such Liabilities plus Capitalized Rentals,
as computed under certain of the agreement provisions, is set forth in Note 8
of the Notes to Consolidated Financial Statements.

Information regarding the principal market for Sears common shares, the number
of shareholders and the prices of, and dividends paid on, Sears common shares
is included below.

Common Stock Market Information and Dividend Highlights

dollars
    
    First Quarter
    
    Second Quarter
    
    Third Quarter
    
    Fourth Quarter
    
    Year2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002Stock price rangeHigh
    
    
    28.54
    
    
    $
    54.29
    
    
    
    34.80
    
    
    
    59.90
    
    
    
    46.35
    
    
    
    54.87
    
    
    
    55.94
    
    
    
    40.69
    
    
    
    55.94
    
    
    
    59.90Low
    
    
    18.50
    
    
    
    46.55
    
    
    
    24.15
    
    
    
    47.79
    
    
    
    32.91
    
    
    
    39.75
    
    
    
    43.59
    
    
    
    19.71
    
    
    
    18.50
    
    
    
    19.71Close
    
    
    23.75
    
    
    
    51.27
    
    
    
    33.36
    
    
    
    54.30
    
    
    
    44.83
    
    
    
    40.62
    
    
    
    44.87
    
    
    
    23.15
    
    
    
    44.87
    
    
    
    23.15Cash dividends declared
    
    
    0.23
    
    
    
    0.23
    
    
    
    0.23
    
    
    
    0.23
    
    
    
    0.23
    
    
    
    0.23
    
    
    
    0.23
    
    
    
    0.23
    
    
    
    0.92
    
    
    
    0.92


Stock price ranges are for
the New York Stock Exchange (trading symbol - S),
which is the principal market for the Companys common stock. In addition to
the New York Stock Exchange, the Companys common stock is listed on the
following exchanges: Chicago; Pacific, San Francisco; London, England;
Amsterdam, the Netherlands; Swiss EBS; and Dusseldorf, Germany.

The number of registered common shareholders as of February 27, 2004 was
149,591.

Options to purchase common shares of the Company have been granted to employees
and non-employee directors under various stock-based compensation plans. The
following table summarizes the number of stock options issued, the
weighted-average exercise price and the number of securities remaining to be
issued under all outstanding equity compensation plans as of January 3, 2004.

Number of securities to be
    
    Weighted-average exercise
    
    Number of securities remainingissued upon exercise of
    
    price of outstanding
    
    available for future issuanceoutstanding options,
warrants
    
    options, warrants
    
    under equity compensationPlan Category
    
    and rights
    
    and rights
    
    plans (2)Equity compensation
plans approved by
security holders
    
    
    16,961,216
    
    
    $
    40.01
    
    
    
    8,567,753Equity compensation
plans not approved
by
security holders
    
    
    10,452,718
    (1)
    
    $
    29.01
    
    
    
    4,326,745Total
    
    
    27,413,934
    
    
    $
    35.82
    
    
    
    12,894,498




---

|   
|---
|(1)
|   
|(2)



---

12



---



##### Table of Contents






Item 6. Selected Financial Data

Five-Year Summary of Consolidated Financial Data

millions, except per common share and shareholders
    
    2003(1)
    
    
    2002(2)
    
    
    2001
    
    
    2000
    
    
    1999OPERATING RESULTSRevenues (3)
    
    $
    41,124
    
    
    $
    41,366
    
    
    $
    40,990
    
    
    $
    40,848
    
    
    $
    39,430Costs and expenses (3)
    
    
    39,926
    
    
    
    39,285
    
    
    
    39,812
    
    
    
    38,661
    
    
    
    37,017Operating income
    
    
    1,198
    
    
    
    2,081
    
    
    
    1,178
    
    
    
    2,187
    
    
    
    2,413Gain on sale of businesses (3)
    
    
    4,224
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income, net
    
    
    27
    
    
    
    372
    
    
    
    45
    
    
    
    36
    
    
    
    6Income
before income taxes, minority interest and
cumulative effect of change in accounting principle
    
    
    5,449
    
    
    
    2,453
    
    
    
    1,223
    
    
    
    2,223
    
    
    
    2,419Income taxes
    
    
    2,007
    
    
    
    858
    
    
    
    467
    
    
    
    831
    
    
    
    904Income before cumulative effect of change in accounting
principle
    
    
    3,397
    
    
    
    1,584
    
    
    
    735
    
    
    
    1,343
    
    
    
    1,453Cumulative effect of change in accounting principle
    
    
    
    
    
    
    (208
    )
    
    
    
    
    
    
    
    
    
    
    Net income
    
    $
    3,397
    
    
    $
    1,376
    
    
    $
    735
    
    
    $
    1,343
    
    
    $
    1,453FINANCIAL POSITIONCredit card receivables, net (3)
    
    $
    1,956
    
    
    $
    30,731
    
    
    $
    28,155
    
    
    $
    17,317
    
    
    $
    18,033Retained interest in transferred credit card receivables
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,105
    
    
    
    3,211Merchandise inventories
    
    
    5,335
    
    
    
    5,115
    
    
    
    4,912
    
    
    
    5,618
    
    
    
    5,069Property and equipment, net
    
    
    6,788
    
    
    
    6,910
    
    
    
    6,824
    
    
    
    6,653
    
    
    
    6,450Total assets
    
    
    27,723
    
    
    
    50,409
    
    
    
    44,317
    
    
    
    36,899
    
    
    
    36,954Short-term borrowings (4)
    
    
    1,033
    
    
    
    4,525
    
    
    
    3,557
    
    
    
    4,280
    
    
    
    2,989Long-term debt, including current portion (3)(4)
    
    
    7,168
    
    
    
    26,112
    
    
    
    22,078
    
    
    
    13,580
    
    
    
    15,049Total debt (3)(4)
    
    
    8,201
    
    
    
    30,637
    
    
    
    25,635
    
    
    
    17,860
    
    
    
    18,038Shareholders equity
    
    $
    6,401
    
    
    $
    6,753
    
    
    $
    6,119
    
    
    $
    6,769
    
    
    $
    6,839SHAREHOLDERS AND PER SHARE DATAShareholders
    
    
    150,759
    
    
    
    157,378
    
    
    
    164,354
    
    
    
    209,101
    
    
    
    220,749Average common and equivalent shares outstanding
    
    
    286
    
    
    
    321
    
    
    
    329
    
    
    
    346
    
    
    
    381Earnings per common share - diluted
    
    $
    11.86
    
    
    $
    4.94
    
    
    $
    2.24
    
    
    $
    3.88
    
    
    $
    3.81Income before cumulative effect of change in
accounting principle
    
    $
    11.86
    
    
    $
    4.94
    
    
    $
    2.24
    
    
    $
    3.88
    
    
    $
    3.81Cumulative effect of change in accounting principle
    
    
    
    
    
    
    (0.65
    )
    
    
    
    
    
    
    
    
    
    
    Net income
    
    $
    11.86
    
    
    $
    4.29
    
    
    $
    2.24
    
    
    $
    3.88
    
    
    $
    3.81Cash dividends declared per common share
    
    $
    0.92
    
    
    $
    0.92
    
    
    $
    0.92
    
    
    $
    0.92
    
    
    $
    0.92Market price
- per common share (high-low)
    
    
    55.94-
    
    
    
    59.90-
    
    
    
    48.93-
    
    
    
    43.50-
    
    
    
    53.19-18.50
    
    
    
    19.71
    
    
    
    29.90
    
    
    
    25.25
    
    
    
    26.69Closing market price at December 31
    
    $
    45.49
    
    
    $
    23.15
    
    
    $
    47.64
    
    
    $
    34.75
    
    
    $
    30.38




---

|(1) |  | Includes the results of operations for Credit and Financial Products through November 2, 2003 and the results of operations for NTB
through November 29, 2003, the respective dates of divestiture, and fifty-three weeks.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) |  | Includes results of operations for Lands End effective June 17, 2002, the date of acquisition.                                                                                                                           
|(3) |  | On November 3, 2003, the Company sold its domestic Credit and Financial Products business to Citicorp. (See Note 2 of the Notes to Consolidated Financial Statements).                                                    
|(4) |  | On November 17, 2003 the Company completed cash tender offers to purchase unsecured public term debt securities maturing after 2003 (See Note 4 of the Notes to
Consolidated Financial Statements).                       

---

Certain prior year information has been reclassified to conform with current
year presentation.

13



---



##### Table of Contents






Item 7.   Managements Discussion and Analysis

Managements Discussion and Analysis is designed to provide the reader of the
financial statements with a narrative on the Companys results of operations,
financial position and liquidity, risk management activities, significant
accounting policies and critical estimates, and the future impact of accounting
standards that have been issued but are not yet effective. Managements
Discussion and Analysis is presented in five sections: Overview and
Consolidated Operations, Segment Operations, Analysis of Consolidated Financial
Condition, Critical Accounting Estimates and Outlook. It is useful to read
Managements Discussion and Analysis in conjunction with the Consolidated
Financial Statements and related notes thereto contained elsewhere in this
document.

Unless otherwise noted, 2003 results reflect a 53-week period while 2002 and
2001 results reflect a 52-week period. All references to earnings per share
relate to diluted earnings per common share.

OVERVIEW AND CONSOLIDATED OPERATIONS

Sears, Roebuck and Co. is one of the largest retailers in the United States and
Canada with a 118 year history of providing high quality merchandise and
related services to a broad array of customers. The Company was founded on the
concept of satisfaction guaranteed or your money back. This fundamental
concept, executed daily by over 240,000 associates, has contributed to the
Companys significant brand recognition and equity. The Companys vision is to
be the preferred and most trusted resource for products and services that
enhance our customers homes and family life. We will be differentiated from
most competitors by offering customers high quality national brands similar to
other retailers, as well as the Companys proprietary brands which enjoy high
levels of consumer awareness, trust and integrity. Sears is the primary
retailer where consumers can find each of the Kenmore, Craftsman, DieHard,
Lands End and Covington brands. The Company also offers customers an
extensive level of retail related services such as delivery, installation,
product repair, product warranty and protection services. These products and
services are provided to the customer through a wide network reaching the
consumer through multiple channels, including over 2,300 Sears-brand and
affiliated stores in the United States and Canada, a product repair services
system with over 10,000 technicians, leading internet channels of sears.com,
sears.ca and landsend.com, and direct to customer catalog programs.

Fundamentally, the Companys business model is to offer the customer a
compelling price/value relationship through the combination of high quality
products and services at a competitive price. The Company seeks to deliver a
high level of profitability and cash flow by:



| |  |  | maximizing the effectiveness of its retail product pricing through
promotional activity and advertising programs enhancing brand
awareness;                                                             
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | minimizing its product and service costs through economies of scale
as one of the nations largest retailers and related services providers
while leveraging its centralized overhead expense structure;
|
| |  |  | reinvesting operating cash flows into necessary capital projects
that create future revenues, realize cost savings or improve product
quality in its proprietary brands; and                            
|
| |  |  | returning profits to shareholders through dividends, share
repurchases and increased share price.                                                                                                       

The retail industry is highly competitive and has been in each year of the
Companys 118 year life. The industry continuously faces market driven
challenges as new and existing competitors seek areas of growth to expand their
businesses. The Company has succeeded in the retail industry due to its
proprietary brands and the importance of its related product and service
offerings to customers. An important challenge for the Company is to identify
new growth vehicles to extend the reach of its product and service offerings.
Historically, the Company has shown innovation in new products and services and
new distribution channels to reach our customers. In the recent past, the
Companys efforts to grow have become more challenging as its primary retail
stores are within a mall-based format, which has seen a reduced preference to
the consumer versus other formats. The Company is further challenged by
competitors that specialize in certain types of consumer goods and are focused
on being the lowest cost provider in those categories.

14



---



##### Table of Contents



The Company has responded to these challenges by launching several strategic
initiatives which are expected to return the Company to a more profitable
growth path, including:



| |  |  | improving its merchandise offerings through the acquisition of Lands End and the launch of
Covington in 2002;                                                                                                                                                                                                                                                           
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | enhancing the customers experience in the stores through various actions such as the
standardization and simplification of merchandise presentation, store signage, fixturing and
store layouts, and the installation of centralized checkouts;                                                                                                                         
|
| |  |  | investing in alternative channels of distribution including direct to customer through the
internet and direct mail, dealer stores, and other off-mall formats;                                                                                                                                                                                                          
|
| |  |  | launching Sears Grand in 2003, an off-mall pilot format combining the Companys traditional
branded and proprietary goods with expanded offerings such as convenience goods and other
new services, which seeks to assess the viability of an off-mall Sears store, much larger in
square footage, and with a higher level of consumer convenience and
accessibility; and
|
| |  |  | focusing the Company as a retailer through the sale of its domestic Credit and Financial
Products business in 2003 while continuing to offer access to credit
services and financial
products to its customers through its strategic alliance with Citibank
(USA) N.A.                                                                                                   

These strategic initiatives are necessary as our most successful competitors
enjoy lower operating cost structures outside of the mall, or higher gross
margins within the mall from a more specialized merchandise mix. The Company
believes it can succeed by further differentiating its products and services,
lowering its operating and sourcing costs and investing in new growth vehicles.

Fiscal 2003 was a defining year for the Company. On November 3, 2003, the
Company completed the sale of its domestic Credit and Financial Products
business, including its clubs and services business, to Citicorp and entered
into a long-term marketing and servicing alliance with Citibank (USA) N.A.
Under the long-term marketing and servicing alliance, Citibank (USA) N.A. will
provide credit and customer service benefits to the Companys proprietary and
Gold MasterCard holders. In addition, Citibank (USA) N.A. will support the
Companys current zero-percent financing program.

The sale generated total proceeds of $32 billion, consisting of the assumption
by Citicorp of $10 billion of securitized debt and cash proceeds received by
the Company of $22 billion. The Company recorded a pretax gain on the sale of
$4 billion. Using proceeds from the sale of the Credit and Financial Products
business, the Company repaid $5.5 billion of outstanding short-term borrowings
and allocated $10.5 billion for the retirement of unsecured term debt (of which
$6.4 billion was retired during the fourth quarter of 2003 through a tender
offer for such debt). In connection with the debt retirement activities, the
Company recorded a pretax loss of $791 million, representing premiums paid on
early retirement of debt, gains on the termination of associated derivative
instruments to hedge interest rate risk, the write-off of unamortized debt
discount and debt issuance costs and the loss on a previously terminated
derivative contract. Of the total debt retirement loss of $791 million, $420
million represented a non-cash charge. After taxes and transaction costs of
$1.5 billion, and an additional after-tax contribution of $500 million to the
domestic pension plan, the Company expects net cash proceeds from the sale of
approximately $4 billion.

The divestiture of its domestic Credit and Financial Products business
significantly strengthened the Companys financial position and liquidity. At
January 3, 2004, the Company had domestic term debt outstanding of $5.3
billion. The Company plans to repay $2.6 billion of domestic term debt in
2004, through either scheduled maturities or optional early retirements. In
addition, the Company expects to return approximately $4 billion of the cash
proceeds received from the sale of the Credit and Financial Products business
to its shareholders. Through January 3, 2004, the Company had returned $2.7
billion through the repurchase of the Companys common shares.

This divestiture, along with the beginning of a new strategic relationship with
Citibank (USA) N.A., has created a Company with a pure retail focus. The
Companys financial position has been significantly strengthened through the
reduction of over $21 billion of debt. These steps place the Company in a more
sound financial position to

15



---



##### Table of Contents



invest in important growth opportunities.

Overall, the Companys operating results for 2003 reflect the challenging
retail environment and a restrained level of consumer spending early in the
year. A summary of consolidated results of operations is as follows:

millions, except per share data

2003
    
    
    2002
    
    
    2001Merchandise sales and services revenues
    
    $
    36,372
    
    
    $
    35,698
    
    
    $
    35,755Domestic comparable store sales
    
    
    -2.7%
    
    
    
    -5.6%
    
    
    
    -2.3%Credit and financial products revenues
    
    
    4,752
    
    
    
    5,668
    
    
    
    5,235Total revenues
    
    $
    41,124
    
    
    $
    41,366
    
    
    $
    40,990Gross margin rate
    
    
    27.9%
    
    
    
    28.2%
    
    
    
    26.6%Selling and administrative expense as a percentage
of total revenues
    
    
    22.2%
    
    
    
    22.4%
    
    
    
    21.7%Operating income
    
    $
    1,198
    
    
    $
    2,081
    
    
    $
    1,178Gain on sale of businesses
    
    $
    4,224
    
    
    $
    
    
    
    $
    Other income, net
    
    $
    27
    
    
    $
    372
    
    
    $
    45Net income
    
    $
    3,397
    
    
    $
    1,376
    
    
    $
    735Earnings per share  diluted
    
    $
    11.86
    
    
    $
    4.29
    
    
    $
    2.24




|§ |  | Total revenues decreased 0.6% from 2002, which in turn were 0.9% higher
than 2001. The decrease in 2003 reflects the decline in credit and
financial products revenues as a result of the sale of the domestic Credit
and Financial Products business, partially offset by an increase in
merchandise sales and services due to the inclusion of Lands End for the
full year of 2003 as well as the additional fiscal week in 2003. The
53rd week favorably impacted merchandise sales and services
revenues by approximately two percent. The Company noted an improvement
in domestic comparable store sales trends in certain key categories,
particularly in the second half of 2003. This improvement is attributed
to the previously mentioned key strategic initiatives taken by the Company
as well as improvements in various economic indicators such as increasing
consumer confidence levels and declining unemployment rates.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|  |  | The increase in 2002 total revenues compared to 2001 reflected an increase
in revenues generated by the domestic Credit and Financial Products business
due to growth in the MasterCard portfolio and the revenues generated
from the Lands End direct to customer business, which was acquired in June
2002. This increase was partially offset by a decline in merchandise sales
and services in both the Retail and Related Services and Sears Canada
segments, attributable to disruptions caused by the Full-line Store
repositioning efforts, a highly competitive and promotional retail
environment and the effects of a softening economy which included declining
consumer confidence and increasing unemployment.                                                                                                                                                                                                              
| 
|§ |  | The decline in 2003 gross margin rate compared with 2002 is reflective
of inventory clearance activities and a highly competitive retail
environment, which resulted in a significant increase in promotional
activity. The improvement in gross margin rate in 2002 from 2001
resulted from the exit of certain, lower margin and unprofitable
merchandise categories, improved inventory management and sourcing and
the inclusion of Lands Ends results in 2002, whose business has a
higher gross margin rate.                                                                                                                                                                                                                                                                                                                                                                                                                       
| 
|§ |  | Overall, selling and administrative expenses decreased $138 million in
2003 primarily due to lower expenses for the domestic Credit and
Financial Products business. The savings realized from the Companys
productivity improvements were more than offset by higher expenses in
Sears Canada due to the stronger Canadian dollar and the inclusion of
Lands End for the full year of fiscal 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| 
|§ |  | Special charges and impairments reflect costs incurred from strategic
actions implemented by the Company to restructure its operations and
charges for asset impairments. Such charges amounted to $112 million
in 2003,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

16



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##### Table of Contents





| |  | $111 million in 2002 and $542 million in 2001. The actions taken over the
past three years are as follows:
| |  | ----------------------------------------------------------------------------------------------------------



| | 4 |  | During 2003, the Company announced a refinement of the
business strategy for TGI, which included its decision to close
three TGI stores and cease development of four future locations. In
addition, the carrying value of the long-lived assets for the
remaining eighteen locations were reviewed for recoverability. As a
result, the Company recorded a pretax charge of $141 million. Of
the $141 million charge, $112 million was recorded in special
charges and impairments and $29 million in cost of sales, buying and
occupancy.                                                                                                                                                                                                                                               
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 4 |  | During 2002, Sears Canada converted its seven stores
operating under the Eatons banner to Sears Canada stores, resulting
in a restructuring charge of $111 million for severance, asset
impairment and other exit costs. Financial performance of the
Eatons stores had not met expectations, and the customer base was
smaller than anticipated. The conversion of these stores to the
Sears banner has allowed Sears Canada to focus on managing its
business. The restructuring was principally designed to improve the
Sears Canada brand equity and improve sales results in these stores.
While the Company anticipated better leverage of its existing
buying and marketing activities, the expected cost savings to Sears
from this conversion were not expected to be material.
|
| | 4 |  | During 2001, special charges and impairments amounted to $542
million. Such costs consisted of the following:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             



| |  |  | $151 million restructuring charge for the exit of
unprofitable and non-strategic Full-line Store business
categories (including cosmetics, installed floor coverings and
custom window treatments) and a restructuring charge of $123
million for productivity initiatives primarily related to
employee termination costs for staff reductions at the
Companys headquarters and in its Full-line Stores. These two
restructurings, which were part of a series of initiatives
designed to improve profitability, generated approximately $350
million in cost reductions in 2002 and an additional $100
million in 2003 largely as a result of the elimination of
approximately 5,950 positions;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $205 million for impairment and other losses
primarily resulting from the insolvency of Homelife, a former
operating division of Sears which was sold in 1998; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  |  | $63 million for the cost of a civil legal
settlement relating to selling practices in 1994 and 1995 of
certain automotive batteries manufactured by Exide
Technologies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           



|§ |  | Gain on the sale of businesses consisted of a $4 billion pretax gain
on the sale of the Companys domestic Credit and Financial Products
business and an $81 million pretax gain on the sale of the Companys
NTB business. See Note 2 of the Notes to Consolidated Financial
Statements for further discussion.                                                                                                                                                                                                           
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|§ |  | Other income in 2002 included a $336 million pretax gain on the sale
of the Companys holdings in Advance Auto Parts, Inc.                                                                                                                                                                                                                                                                                                                                                                                                 
| 
|§ |  | During 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142 Goodwill and Other Intangible Assets,
resulting in a charge of $208 million (net of income taxes and
minority interest), representing the cumulative effect of the change
in accounting for goodwill as of the beginning of 2002. The charge
reflected goodwill impairment primarily related to NTB and Orchard
Supply Hardware, offset by the reversal of negative goodwill related
to Sears Canadas purchase of Eatons.
| 
|§ |  | The Companys net income and earnings per share results for fiscal
years 2003, 2002 and 2001 were impacted by significant items, which
include costs incurred from strategic actions implemented by the
Company to restructure its operations, changes in accounting and costs
due to asset impairments.                                                                                                                                                                                                                   

17



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##### Table of Contents





| | 4 |  | Results of operations for fiscal year 2003 included a gain on
the sale of the Companys domestic Credit and Financial Products,
whose 2003 results included a gain from the sale of previously
charged-off receivable accounts, the gain on the sale of its NTB
business, a loss on early retirement of debt and a charge related to
the refinement of the business strategy for TGI. In aggregate,
these items increased net income for fiscal year 2003 by $2.2
billion, or $7.50 per share.                                                                                                                                                                                                                                                          
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 4 |  | The Companys fiscal year 2002 results were also affected by
significant items including the adoption of new accounting standards
for goodwill, a charge for the conversion of Eatons stores to Sears
Canada stores, a gain on the sale of investments and a change in
accounting estimate related to the refinement of the Companys
method for determining its domestic allowance for uncollectible
accounts. In aggregate, these items reduced net income for fiscal
year 2002 by $202 million, or $0.63 per share.                                                                                                                                                                                                                                 
|
| | 4 |  | The Companys fiscal year 2001 results were affected by
business category exits, productivity initiatives, impairment and
other losses related to Homelife, and costs related to the
settlement of a civil legal case. In addition, the Company recorded
a $522 million provision for uncollectible accounts for previously
securitized receivables to establish an allowance for uncollectible
accounts related to $12 billion of securitized receivables
reinstated on the Companys balance sheet as a result of the
adoption of SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities. In aggregate,
these items reduced net income for fiscal year 2001 by $650 million,
or $1.98 per share.

These items had a significant impact on continuing operations in the periods
reported. The Company believes that an understanding of its reported results
and its ongoing financial performance is not complete without considering the
impact these items and other transactions, as described within Managements
Discussion and Analysis, had on the Companys overall performance.

SEGMENT OPERATIONS

During fiscal 2003, the Company was organized into four principal business
segments - Retail and Related Services, Credit and Financial Products,
Corporate and Other, and Sears Canada. Following is a discussion of results of
operations by business segment.

18



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##### Table of Contents



Retail and Related Services

Retail and Related Services results and key statistics were as follows:

millions, except number of stores and Retail store   revenues
per net selling square foot

2003
    
    
    2002
    
    
    2001Full-line Stores
    
    $
    22,863
    
    
    $
    23,028
    
    
    $
    24,314Specialty Stores
    
    
    5,072
    
    
    
    5,106
    
    
    
    4,747Direct to Customer
    
    
    1,752
    
    
    
    1,175
    
    
    
    223Product Repair Services
    
    
    2,155
    
    
    
    2,150
    
    
    
    2,062Total Retail and Related Services revenues
    
    
    31,842
    
    
    
    31,459
    
    
    
    31,346Cost of sales, buying and occupancy
    
    
    23,164
    
    
    
    22,743
    
    
    
    23,081Gross margin as a percentage of revenues
    
    
    27.3%
    
    
    
    27.7%
    
    
    
    26.4%Selling and administrative
    
    
    6,914
    
    
    
    6,816
    
    
    
    6,628Selling and administrative as a percentage of revenues
    
    
    21.7%
    
    
    
    21.7%
    
    
    
    21.1%Depreciation and amortization
    
    
    740
    
    
    
    710
    
    
    
    704Interest, net
    
    
    84
    
    
    
    35
    
    
    
    32Special charges and impairments
    
    
    112
    
    
    
    
    
    
    
    484Total costs and expenses
    
    
    31,014
    
    
    
    30,304
    
    
    
    30,929Operating income
    
    $
    828
    
    
    $
    1,155
    
    
    $
    417


2003
    
    
    2002
    
    
    2001Number of:Full-line Stores
    
    
    871
    
    
    
    872
    
    
    
    867Specialty Stores
    
    
    1,105
    
    
    
    1,305
    
    
    
    1,318Lands End Retail Stores
    
    
    16
    
    
    
    15
    
    
    
    Total Retail Stores
    
    
    1,992
    
    
    
    2,192
    
    
    
    2,185Retail store revenues per net selling square foot
    
    $
    302
    
    
    $
    303
    
    
    $
    318Comparable store sales percentage (decrease)
increase(1) (2)Home Group
    
    
    -1.6%
    
    
    
    -5.7%
    
    
    
    -1.3%Apparel/accessories
    
    
    -4.2%
    
    
    
    -10.2%
    
    
    
    -6.8%Full-line Stores
    
    
    -2.7%
    
    
    
    -6.7%
    
    
    
    -3.0%Specialty Stores
    
    
    -2.7%
    
    
    
    0.9%
    
    
    
    2.5%Total
    
    
    -2.7%
    
    
    
    -5.6%
    
    
    
    -2.3%


---

(1)
    
    For purposes of determining comparable store sales, a store is considered to be
comparable at the beginning of the 13th month after the store is opened.(2)
    
    2003 comparable store sales results were calculated for the 52 weeks ended December
27, 2003 compared with the 52 weeks ended December 28, 2002.


---

STRATEGIC ACTIONS

On August 28, 2003, the Company announced a refinement to the business strategy
for TGI, which included its decision to close three TGI stores and cease
development of four future locations. In addition, the carrying value of the
long-lived assets for the remaining eighteen TGI stores were reviewed for
recoverability. As a result, the Company recorded a pretax charge of $141
million. The $141 million pretax charge consisted of $99 million related to
asset impairments, $29 million related to inventory clearance costs, $11
million related to other contractual obligations and $2 million related to
employee termination costs. Of the $141 million charge, $112 million was
recorded in special charges and impairments and $29 million was recorded in
cost of sales, buying and occupancy both within the Retail and Related Services
segment. The three stores were closed and all related employees terminated by
the end of fiscal 2003. The strategy was undertaken in an effort to increase
the profitability of TGI. The Company does not anticipate that these actions
will result in a material impact on the consolidated results of operations.

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On November 3, 2003, the Company completed the sale of its domestic Credit and
Financial Products business, to Citicorp and entered into a long-term marketing
and servicing alliance with Citibank (USA) N.A. In connection with the
long-term alliance, the Retail and Related Services segment will earn revenues
by generating credit sales and new accounts for Citicorp and selling other
Citicorp products. In 2003, the Company earned approximately $30 million under
the long-term alliance, which is reflected within Full-line Store revenue. The
Company estimates that it will earn approximately $150 million in 2004 from
Citibank for these services. In addition, historical level zero-percent
receivable balances will be supported by Citibank at no cost to the Company.
Zero-percent expense reported within the Retail and Related Services segment
was $211 million, $212 million and $191 million in 2003, 2002 and 2001,
respectively.

On November 29, 2003, the Company sold its NTB business and related inventory
to TBC for total cash consideration of $264 million. The Company recognized a
pretax gain of $81 million. Upon completion of the transaction, substantially
all of the approximately 3,900 employees of NTB became employees of TBC.
Revenues for NTB were $400 million, $465 million and $494 million in 2003, 2002
and 2001, respectively.

RESULTS OF OPERATIONS

2003 Compared with 2002

During 2003, the Company continued to focus on improving its merchandise
offerings, particularly its apparel offerings, as well as enhancing the
customers shopping experience. Lands End was rolled out to an additional 218
Full-line Stores in the Spring of 2003 and to the remaining Full-line Stores in
September 2003, with Lands End merchandise now available in all Full-line
Stores. The Companys exclusive Covington brand was well received in 2003 with
sales reaching over $500 million. In the fall, the Company launched an
exclusive Lucy Pereda apparel collection in a select number of stores, and
announced the purchase of the Structure brand, a trendier mens apparel brand,
to broaden the depth of its current apparel offerings. In relation to its Home
Group business, the Company initiated a relaunch initiative for the home
appliance business in June 2003, which focused on defending market share and
accelerating growth of this business. The impact of these initiatives, as well
as improvements in various economic indicators such as increasing consumer
confidence and declining unemployment rates, resulted in improvements in
comparable store sales trends in certain key categories in the second half of
2003.

Total Retail and Related Services revenues increased 1.2% over the prior year.
The additional fiscal week in 2003 favorably impacted revenues by approximately
two percent. In addition, revenues from the Lands End direct to customer
business, which was acquired in June 2002, contributed approximately $600
million of incremental revenues over 2002 as the revenues from this business
were included in the Companys results of operations for the full year of 2003.

While the retail environment remained highly competitive and promotionally
intense throughout 2003, improvements in Full-line Store sales were seen across
several key businesses. The lawn and garden business had an exceptional year,
posting double-digit comparable store sales increases over the prior year.
These increases were offset by declines in other Home Group categories
including home electronics, which continues to be impacted by price deflation
and competition, and home fashions. Home appliance sales showed a modest
increase in 2003 with trend improvements seen in the second half of the year as
a result of the Companys home appliance relaunch initiative. Finally, notable
improvements were seen in key womens ready-to-wear categories as a result of
the Companys actions to improve its merchandise offering. These improvements
were offset by weak sales in fine jewelry, mens and intimate apparel.

Specialty Stores revenues in 2003 were relatively flat to the prior year,
despite the benefit received from the 53rd week and the net increase
of 25 Dealer stores in 2003. A comparable store sales increase of 2.2% in
Dealer Stores, which was driven by double-digit increases in lawn and garden
sales and a low-single digit increase in appliance sales, was more than offset
by comparable store sales declines within all other off-mall retail formats
including

20



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##### Table of Contents



Hardware stores, outlet stores, TGI and NTB.

Direct to Customer revenues increased to $1.8 billion in 2003 from $1.2 billion
in 2002, primarily due to the revenues from the Lands End direct to customer
business. Lands End contributed approximately $1.6 billion in direct to
customer revenues in 2003 compared with $1.0 billion in 2002.

Product Repair Services revenues of $2.2 billion in 2003 were relatively flat
to the prior year as increased revenues generated from service contracts, were
offset by decreased revenues from the cooling and heating business. The
cooling and heating business was adversely affected by unseasonable
temperatures in both the summer and winter of 2003.

The decline in gross margin as a percentage of revenues in 2003 occurred as a
result of a significant increase in promotional markdowns and clearance
activities, primarily in apparel categories, partially offset by continued
improvements in vendor sourcing and the inclusion of Lands End, which has a
higher gross margin rate.

Selling and administrative expense savings recognized in 2003 from the
Companys ongoing productivity initiatives were offset by the inclusion of a
full year of operating expenses of the Lands End direct to customer business.

The overall decrease in operating income was primarily the result of reduced
gross margins due to a significant increase in promotional activity in the
highly competitive retail environment, as well as the charge related to the TGI
strategic refinement.

2002 Compared with 2001

In order to enhance the customer experience and improve operating performance,
the Company undertook a repositioning of Full-line Stores in 2002 to improve
merchandise presentation and provide easier, more convenient shopping. The
repositioning effort included installation of centralized checkouts, simplified
store signage, and standardization of fixturing and store layouts. The Company
also improved its merchandise offerings by reducing the number of brands and
labels it carried after reviewing every brand to determine customer relevancy
and profitability. To improve the quality of apparel offerings, Lands End was
acquired in June 2002, which added a nationally recognized apparel brand to the
Companys merchandise assortment, and the Covington brand was rolled out in
2002. The Company exited unprofitable businesses, including cosmetics,
installed carpet and custom window treatments. The repositioning led to a
disruptive sales environment, contributing to comparable store sales declines.
However, significant progress was made towards the repositioning plan,
resulting in an increase in the overall profitability of the segment.

Retail and Related Services revenues increased 0.4% in 2002, primarily due to
the acquisition of Lands End and the opening of seven new TGI stores, offset
by a decline of 5.6% in comparable store sales. Full-line Store revenues
decreased 5.3%, as a result of store-level disruptions caused by the
repositioning effort, a highly competitive and promotional retail environment
and a weak U.S. economy. In the Home Group, sales of home appliances,
electronics and other big-ticket items slowed in the second half of 2002. Home
Group sales were also negatively impacted by the exit of certain lines
including bicycles and the editing of product offerings, such as home
computers. As discussed above, the Company reduced the number of brands it
carried which negatively impacted 2002 total revenues and apparel/accessories
comparable store sales.

Specialty Stores revenues increased 7.6% in 2002 due to the addition of seven
TGI stores (bringing the total to 20) and a comparable store sales increase of
0.9%. Comparable store sales increases of 4.2% in Dealer Stores were partially
offset by comparable store sales declines of 4.1% in NTB and 0.3% in Hardware
stores. Direct to Customer revenues increased over the prior year primarily
due to the acquisition of Lands End, which contributed approximately $1.0
billion in revenues in 2002. Product Repair Services revenues increased to
$2.2 billion in 2002 due to increased product repair revenues resulting from a
vendor product recall and an agreement to provide repair services for an
appliance manufacturer.

21



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##### Table of Contents



Gross margin as a percentage of revenues improved 130 basis points in 2002.
The improvement occurred as a result of the exit of unprofitable merchandise
categories in Full-line Stores, improved inventory management and strategic
sourcing initiatives across all formats and the inclusion of Lands End, which
has a higher margin rate.

Selling and administrative expense as a percentage of revenues increased 60
basis points in 2002 from 2001. While the Company continued to recognize
expense savings from its productivity initiatives in 2002, selling and
administrative expense leverage was unfavorably affected by decreases in
Full-line Store revenues, the rollout of the additional TGI stores and the
inclusion of Lands End, which has a higher expense rate.

Operating income was $1.2 billion in 2002, $738 million higher than 2001, due
to the benefits of the Full-line Store repositioning, strategic sourcing
initiatives, margin rate improvements and the inclusion of Lands End. In
addition, results for fiscal year 2001 included special charges and impairments
of $484 million related to various Company restructuring initiatives.

Credit and Financial Products

On November 3, 2003, the Company sold substantially all the assets and
liabilities of its domestic Credit and Financial Products business, including
its clubs and services business, to Citicorp. The 2003 segment results include
the results of operations of the Credit and Financial Products business through
November 2, 2003, as well as a $791 million pretax loss related to retirement
of debt. The Company concluded its debt tender offers to purchase unsecured
domestic term debt securities on November 17, 2003.

Credit and Financial Products results were as follows:

millions
    
    2003
    
    
    2002
    
    
    2001Credit and financial products revenues
    
    $
    4,429
    
    
    $
    5,392
    
    
    $
    4,941Selling and administrative
    
    
    645
    
    
    
    955
    
    
    
    794Provision for uncollectible accounts
    
    
    1,695
    
    
    
    2,203
    
    
    
    1,810Depreciation and amortization
    
    
    14
    
    
    
    18
    
    
    
    18Interest, net
    
    
    813
    
    
    
    1,014
    
    
    
    1,272Loss on early retirement of debt
    
    
    791
    
    
    
    
    
    
    
    Total costs and expenses
    
    
    3,958
    
    
    
    4,190
    
    
    
    3,894Operating income
    
    $
    471
    
    
    $
    1,202
    
    
    $
    1,047


A summary of credit information is as follows:

2003
    
    
    2002
    
    
    2001Credit share(1)
    
    
    42.2%
    
    
    
    44.0%
    
    
    
    47.0%Average account balance for the period (dollars):Sears Card
    
    $
    1,194
    
    
    $
    1,196
    
    
    $
    1,142MasterCard
    
    $
    1,718
    
    
    $
    1,562
    
    
    $
    1,112Total portfolio
    
    $
    1,384
    
    
    $
    1,321
    
    
    $
    1,136Portfolio yield:Sears Card
    
    
    18.56%
    
    
    
    19.48%
    
    
    
    19.56%MasterCard
    
    
    15.04%
    
    
    
    15.53%
    
    
    
    15.16%Total portfolio
    
    
    17.04%
    
    
    
    18.29%
    
    
    
    19.14%


---

(1)
    
    Credit share is the percentage of retail sales, excluding Direct to Customer,
Orchard Supply Hardware and NTB, paid for with a Sears credit product (Sears Card or MasterCard).





22



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##### Table of Contents



millions
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of2003
    
    
    Total
    
    
    2002
    
    
    Total
    
    
    2001
    
    
    TotalAverage managed credit card receivables:Sears Card
    
    $
    16,750
    
    
    
    56.9%
    
    
    $
    19,836
    
    
    
    69.9%
    
    
    $
    23,819
    
    
    
    90.5%MasterCard
    
    
    12,689
    
    
    
    43.1%
    
    
    
    8,536
    
    
    
    30.1%
    
    
    
    2,499
    
    
    
    9.5%Total
    
    $
    29,439
    
    
    
    100.0%
    
    
    $
    28,372
    
    
    
    100.0%
    
    
    $
    26,318
    
    
    
    100.0%Ending managed credit card receivables:Sears Card
    
    $
    
    
    
    
    
    
    
    $
    18,391
    
    
    
    59.8%
    
    
    $
    22,321
    
    
    
    80.9%MasterCard
    
    
    
    
    
    
    
    
    
    
    12,375
    
    
    
    40.2%
    
    
    
    5,278
    
    
    
    19.1%Total
    
    $
    
    
    
    
    
    
    
    $
    30,766
    
    
    
    100.0%
    
    
    $
    27,599
    
    
    
    100.0%


Below is a summary of 60-plus day delinquency rates, net charge-off rates and
bankruptcy filings for each respective fiscal period.

2003
    
    
    2002
    
    
    200160-plus day delinquencies as % of ending receivables:Sears Card
    
    
    
    
    
    
    10.34%
    
    
    
    8.91%MasterCard
    
    
    
    
    
    
    3.76%
    
    
    
    1.97%Total
    
    
    
    
    
    
    7.69%
    
    
    
    7.58%Bankruptcy filings (in millions)
    
    $
    922
    
    
    $
    900
    
    
    $
    805Net charge-offs as a % of average receivables:Sears Card
    
    
    6.20%
    
    
    
    6.29%
    
    
    
    5.71%MasterCard
    
    
    6.39%
    
    
    
    3.40%
    
    
    
    1.64%Total
    
    
    6.28%
    
    
    
    5.42%
    
    
    
    5.32%


2003 Compared with 2002

In 2003, Credit and Financial Products revenues decreased 17.9% from the prior
year primarily due to the sale of the Credit and Financial Products business.
The portfolio yield declined in 2003 compared to 2002 as the portfolio
composition shifted from an average of approximately 30% MasterCard balances in
2002 to an average of approximately 43% in 2003. The MasterCard product
generally carried a risk-based variable finance charge rate that was typically
lower than the finance charge rate on the Sears Card. In addition, MasterCard
account holders typically repaid their accounts more quickly, which reduced the
yield generated on the portfolio. The average per card balance continued to
increase in 2003 primarily due to the MasterCard, which carried a higher
average credit line and outstanding balances, and had greater utility due to
its global acceptance and cash access features.

Selling and administrative expenses were 14.6% of credit and financial products
revenues in 2003 compared to 17.7% in 2002. The decrease was primarily due to
decreased operating costs reflective of ongoing productivity efforts, lower
marketing costs related to the MasterCard product, and increased reimbursement
from the Retail and Related Services segment for zero-percent financing.

The provision for uncollectible accounts was 38.3% of revenues in 2003 compared
to 40.9% in 2002. The decrease was primarily attributable to reduced
adjustments to the allowance for uncollectible accounts in 2003 as compared to
2002 as well as the recoveries attributable to the sale of previously
charged-off receivable accounts in the second quarter of 2003. During 2003,
the Company increased its allowance for uncollectible accounts by $110 million
to reflect increased delinquencies and higher charge-off rates due to the
seasoning of the MasterCard portfolio and an increase in the domestic credit
card receivable balances. During 2003, the Company sold approximately $2.5
billion of previously charged-off credit card receivable accounts, and
recognized a pretax gain of $93 million. During 2002, the Company increased
its allowance for uncollectible accounts by $665 million to reflect higher
delinquency and charge-off patterns, and a refinement to its allowance
methodology.

Interest costs were 18.4% of revenues in 2003 compared to 18.8% in 2002. The
decrease was attributable to the Companys use of variable rate funding in a
lower interest rate environment, partially offset by higher funding

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##### Table of Contents



levels to support receivables growth as well as a widening of Company credit
spreads over applicable reference rates.

The decline in operating income in 2003 was primarily due to the inclusion of
ten months results in 2003, as compared to a full year in 2002 as well as the
loss on early retirement of debt of $791 million in 2003.

2002 Compared with 2001

In 2002, Credit and Financial Products revenues increased 9.1% from the prior
year. The increase in revenues was primarily due to a 7.8% increase in average
balances, partially offset by an 85 basis point decline in portfolio yield. The
decline in portfolio yield was primarily the result of the shift of the
portfolio composition from an average of 9.5% MasterCard balances in 2001 to
30.1% in 2002. The increase in average per card balances was primarily
attributable to the growth of the MasterCard portfolio, which carried a higher
average credit line and outstanding balances, and had greater utility due to
its global acceptance and cash access features.

Selling and administrative expense increased 20.3% in 2002 from 2001 levels.
The increase was primarily due to increases in costs associated with the
continued roll-out of the MasterCard product, marketing, payroll and benefits
expense and consumer fraud costs. These increases were partially offset by
increased reimbursement from Retail and Related Services for zero-percent
financing.

The provision for uncollectible accounts increased by $393 million in 2002
compared to 2001. The Company increased its allowance for uncollectible
accounts by $365 million to reflect increased delinquencies and higher expected
charge-offs resulting from a difficult economy, the seasoning of the MasterCard
portfolio and an increase in the domestic credit card receivable balances. In
addition, the Company recorded an increase of $300 million in the domestic
allowance for uncollectible accounts as a result of refining the allowance
methodology to include current accounts and credit card fees. The provision
for uncollectible accounts in 2001 included a non-cash, pretax charge of $522
million to establish an allowance for uncollectible accounts related to
previously securitized credit card receivables reinstated on the Companys
balance sheet as a result of the Companys adoption of SFAS No. 140 in the
second quarter of 2001.

Interest expense decreased by $258 million in 2002 compared to the prior year.
The decrease was attributable to the Companys use of variable rate funding in
a lower interest rate environment, partially offset by higher funding levels to
support receivables growth as well as a widening of Company credit spreads over
applicable reference rates.

Operating income increased by $155 million in 2002 from 2001 as increased
revenues and lower funding costs were partially offset by increases in the
provision for uncollectible accounts and selling and administrative costs.

Corporate and Other

Corporate and Other segment results were as follows:

millions
    
    2003
    
    
    2002
    
    
    2001Home improvement services revenues
    
    $
    372
    
    
    $
    326
    
    
    $
    378Cost of sales, buying and occupancy
    
    
    149
    
    
    
    121
    
    
    
    159Selling and administrative
    
    
    425
    
    
    
    442
    
    
    
    473Depreciation and amortization
    
    
    43
    
    
    
    55
    
    
    
    58Interest, net
    
    
    18
    
    
    
    
    
    
    
    Special charges and impairments
    
    
    
    
    
    
    
    
    
    
    58Total costs and expenses
    
    
    635
    
    
    
    618
    
    
    
    748Operating loss
    
    $
    (263
    )
    
    $
    (292
    )
    
    $
    (370
    )


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##### Table of Contents



Revenues from the home improvement services businesses included in the
Corporate and Other segment increased by 14.1% to $372 million in 2003
primarily due to increased revenues generated from cabinet refacing and kitchen
remodeling. Interest expense in 2003 represents the portion of interest
expense incurred after November 2, 2003 on the remaining domestic term debt
that was related to the Credit and Financial Products segment (credit legacy
debt). Segment operating loss improved by $29 million, or 9.9%, primarily
reflecting the benefits of productivity initiatives.

Revenues from the home improvement services businesses decreased by 13.8% in
2002 to $326 million primarily due to the sale of Sears Termite and Pest
Control, Inc. on October 1, 2001 to the ServiceMaster Company. Segment
operating loss improved $78 million reflecting the benefits of productivity
initiatives and the absence of the 2001 $58 million pretax charge related to
productivity initiatives, which included eliminating store support positions at
the Companys headquarters.

Sears Canada

Sears Canada results were as follows:

millions, except foreign exchange rate
    
    2003
    
    
    2002
    
    
    2001Merchandise sales and services
    
    $
    4,158
    
    
    $
    3,913
    
    
    $
    4,031Credit revenues
    
    
    323
    
    
    
    276
    
    
    
    294Total revenues
    
    
    4,481
    
    
    
    4,189
    
    
    
    4,325Cost of sales, buying and occupancy
    
    
    2,918
    
    
    
    2,782
    
    
    
    2,994Selling and administrative
    
    
    1,127
    
    
    
    1,036
    
    
    
    997Provision for uncollectible accounts
    
    
    52
    
    
    
    58
    
    
    
    56Depreciation and amortization
    
    
    112
    
    
    
    92
    
    
    
    83Interest, net
    
    
    110
    
    
    
    94
    
    
    
    111Special charges and impairments
    
    
    
    
    
    
    111
    
    
    
    Total costs and expenses
    
    
    4,319
    
    
    
    4,173
    
    
    
    4,241Operating income
    
    $
    162
    
    
    $
    16
    
    
    $
    84Comparable store sales percentage decrease (C$)
    
    
    -4.6%
    
    
    
    -4.3%
    
    
    
    -0.4%Foreign exchange rate (annual average)
    
    
    0.7122
    
    
    
    0.6359
    
    
    
    0.6451


2003 Compared with 2002

Merchandise sales and services revenues increased 6.3% in 2003 due to the
benefit of exchange rates, partially offset by a decrease in
comparable store sales. Comparable store sales, on a Canadian dollar (C$) basis, decreased 4.6%
in 2003. Full-line Stores revenues decreased 6.2%, and comparable store sales
declined 5.2%. Sales in most merchandise categories declined from the previous
year, including furniture, hardware, sporting goods, toys and electronics.
Sales in major appliances were positive compared to 2002, which is consistent
with industry growth brought about by strong housing starts.

Specialty Stores revenues increased 1.0% in 2003, due to exchange rate
benefits. Comparable store sales, on a C$ basis, for Specialty Stores
decreased 2.0% in 2003 with a comparable store sales increase of 4.4% in Dealer
Stores and decreases of 2.9% in Sears Home stores and 6.1% in Outlet stores.

Credit revenues increased 17.0% compared to the prior year due to an increase
in balances, specifically for Sears Canada MasterCard, and the effects of
foreign exchange. Within Sears Canada credit operations, the net charge-off
rate increased to 5.3% in 2003 from 4.5% in 2002, however, improvements in
delinquency trends resulted in a reduction in the provision for uncollectible
accounts in 2003.

Gross margin as a percentage of merchandise sales and services revenues was
29.8% in 2003 compared to 28.9%

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##### Table of Contents



in 2002. The increase occurred as a result of a decline in promotional
markdowns and improvements in vendor sourcing.

Selling and administrative expense as a percentage of total revenues increased
50 basis points in 2003. While Sears Canada continued to recognize expense
savings from its productivity initiatives in 2003, selling and administrative
expense leverage was unfavorably affected by the decline in C$ revenues.

Depreciation and amortization increased by $20 million due to the change in the
exchange rate. Interest expense increased $16 million compared to the prior
year as Canadian dollar based interest expense from reduced funding
requirements was offset by the variance in the exchange rate.

Operating income for 2003 improved by $146 million over the prior year, due to
an increase in revenues, as well as an improved margin rate. In addition,
segment results for 2002 included a pretax charge of $111 million associated
with the conversion of seven stores operating under the Eatons banner to Sears
Canada stores.

2002 Compared with 2001

Similar to the domestic segments, Sears Canada focused on improving its
business model in 2002 in order to increase profitability in a challenging
environment. During 2002, the Company completed its conversion of the
remaining Eatons stores to Sears Canada Stores.

Merchandise sales and services revenues decreased 2.9% in 2002 while comparable
store sales on a C$ basis declined 4.3%. Full-line Stores revenues decreased
5.4%, while comparable store sales declined 5.2%. The decline in revenue
reflected reduced promotional activity as well as disruption caused by store
renovations. Sales in most merchandise categories declined from the previous
year, with the decline in electronics sales being most significant. Sales in
major appliances, however, were positive compared to 2001 due to the growth
brought about by strong housing starts.

Specialty Stores revenues increased 5.3% in 2002 due to exchange rate benefits.
Comparable store sales for Specialty Stores decreased 0.6% in 2002 with
comparable store sales increases of 5.6% in Dealer Stores, offset by declines
of 1.0% in Sears Home stores and 5.0% in Outlet stores.

Credit revenues were down 6.1% compared to the prior year primarily due to
customers carrying lower charge account receivable balances. Within Sears
Canada credit operations, the net charge-off rate increased to 4.5% in 2002
from 4.1% in 2001. Canada experienced similar economic conditions as the U.S.,
and as a result, charge-offs increased.

Gross margin as a percentage of merchandise sales and services revenues
improved by 320 basis points in 2002 reflecting improved inventory levels,
leading to lower liquidation losses and a reduction in the level of
unprofitable promotional activity.

Selling and administrative expense as a percentage of total revenues increased
160 basis points in 2002, despite operating expense reductions in several areas
such as payroll and benefits. The increase resulted from higher performance
based incentive expense as a result of its improved profitability.

Depreciation and amortization increased by $9 million, or 10.8%, due to the
absence of the amortization of negative goodwill, which was written off upon
adoption of SFAS No. 142. Interest expense declined $17 million or 15.3%
compared to the prior year due to lower funding needs.

Operating income in 2002 declined $68 million from the prior year primarily due
to the pretax charge of $111 million related to the conversion of the seven
stores operating under the Eatons banner to Sears Canada stores. The negative
impact of this charge was partially offset by an improvement in the margin rate
during 2002.

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##### Table of Contents



ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION

The Company ended the year with approximately $9.1 billion of cash and cash
equivalents, an increase of $7.1 billion from the prior year, primarily due to
proceeds from the sale of the Companys domestic Credit and Financial Products
business less cash used to retire debt, repurchase shares and contribute to the
Companys domestic pension plan. As a result of the sale and related liability
management actions, the Companys domestic long-term debt position has been
reduced to $5.3 billion as of the end of the current fiscal year, down from
$23.9 billion last year-end. The Company expects to retire an additional $2.6
billion of domestic term debt by year-end 2004, $2.4 billion of which is
expected in the first half of 2004, and pay $1.5 billion for taxes and other
expenses associated with the sale of the domestic Credit and Financial Products
business. The Company plans to target, exclusive of seasonal working capital
requirements, domestic funded term debt, less cash and investments, of
approximately $1.5 billion.

The cash provided by 2003 operating activities resulted from the decline in
outstanding balances within the credit card receivables portfolio, partially
offset by cash used to fund inventory increases and operating liabilities. The
cash used in 2002 resulted from the growth of the domestic credit card
receivables portfolio. Investments in credit card receivables are reported as
reductions of operating cash flows in the Companys financial statements.

The increase in cash provided by investing activities during 2003 was due to
the sale of the domestic Credit and Financial Products and NTB businesses. The
increase in cash used for investing activities in 2002 compared with the prior
year is the result of the $1.8 billion acquisition of Lands End, partially
offset by proceeds from the disposition of holdings in Advance Auto Parts.

The Company has an ongoing capital expenditure program to renovate and update
its long-term assets, primarily focused on Full-line Stores. In addition, the
Company has opened new Full-line and Specialty Stores. Total capital
expenditures for property, plant and equipment for the past three years were as
follows:

millions
    
    2003
    
    
    2002
    
    
    2001Full-line Stores, primarily remodeling and expansion efforts
    
    $
    653
    
    
    $
    636
    
    
    $
    530Specialty Stores
    
    
    29
    
    
    
    113
    
    
    
    318Other
domestic - distribution/support
    
    
    111
    
    
    
    169
    
    
    
    191Sears Canada
    
    
    132
    
    
    
    117
    
    
    
    87Total capital expenditures
    
    $
    925
    
    
    $
    1,035
    
    
    $
    1,126


The Company plans capital expenditures of approximately $1.1 billion for 2004.
The 2004 domestic capital plan contemplates the opening of two Full-line Stores
and three Sears Grand stores as well as the remodeling of approximately 110
Full-line Stores. The Company may also from time to time consider selective
transactions to create value and improve performance, which may include
acquisitions, dispositions, restructurings, joint ventures and partnerships.

Financing Activities

The Companys financing activities include net borrowings, dividend payments
and share issuances and repurchases. The Companys total debt balances as of
year-end were as follows:

January 3, 2004
    
    December 28, 2002millions
    
    Domestic
    
    
    Sears Canada
    
    
    Domestic
    
    
    Sears CanadaShort-term borrowings
    
    $
    719
    
    
    $
    314
    
    
    $
    4,397
    
    
    $
    128Long-term debt (including current portion):Long-term borrowings
    
    
    5,336
    
    
    
    1,245
    
    
    
    23,883
    
    
    
    1,162Capitalized lease obligations
    
    
    355
    
    
    
    142
    
    
    
    331
    
    
    
    127SFAS No. 133 hedge accounting adjustment
    
    
    90
    
    
    
    
    
    
    
    609
    
    
    
    Total debt
    
    $
    6,500
    
    
    $
    1,701
    
    
    $
    29,220
    
    
    $
    1,417


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The decrease in total domestic debt is primarily due to the sale of the
domestic Credit and Financial Products business to Citicorp. Citicorp assumed
$10 billion of the Companys securitized debt as part of the sale. In
addition, on November 17, 2003, the Company and its wholly-owned subsidiaries,
SRAC and Sears DC Corp., concluded cash tender offers to purchase unsecured
term debt securities maturing after 2003, resulting in the retirement of $6.4
billion of outstanding unsecured term debt. Finally, concurrent with the sale
of the domestic Credit and Financial Products business, short-term borrowings
were reduced from $4.5 billion at the end of 2002 to $1.0 billion at the end of
2003, as the Company repaid amounts outstanding associated with, and in some
cases terminated, its short-term borrowings programs.

As a result of the early retirement of debt, the Company recorded a pretax
charge of $791 million, representing premiums paid on early retirement of debt,
gains on the termination of associated derivative instruments to hedge interest
rate risk, the write-off of unamortized debt discount and debt issuances costs
and the loss on a previously terminated derivative contract.

The Company continues to use interest rate derivatives to synthetically convert
fixed rate debt to variable rate debt. The interest rate derivatives qualify as
fair value hedges in accordance with SFAS No. 133 Accounting for Derivative
Instruments and Hedging Activities, and as such are recorded on the balance
sheet at market value with an offsetting entry to the underlying hedged item,
which is debt.

Liquidity

Historically, the Company has been an active borrower in various capital
markets due to the funding needs of its domestic credit card receivables
portfolio. As a result of the sale of its domestic Credit and Financial
Products business, the Companys need to access capital markets for borrowings
has been greatly reduced. The Companys primary need for liquidity will be to
fund capital expenditures and the seasonal working capital requirements of its
retail business. These needs will primarily be funded through the Companys
liquid investment portfolio and operating cash flows.

In order to ensure liquidity and provide additional capacity, the Company
intends to maintain access to capital markets. Effective November 3, 2003, the
Company, through its domestic wholly-owned financial subsidiary, SRAC, amended
its $3.5 billion unsecured, 364-day revolving credit facility by extending the
termination date to May 2004 for consenting lenders and modifying the option to
extend the repayment of any borrowings to November 2004. The amendment also
provided for the commitment amount under this facility to be reduced to $2.5
billion as of December 3, 2003. This facility provides support for the
Companys domestic direct-issue commercial paper program. No borrowings were
outstanding under this committed credit facility in 2003. The Company is
beginning the renewal process of its domestic credit facility and is targeting
a new facility in the range of $1.0 billion to $2.0 billion. In addition,
Sears Canada has a $0.5 billion committed credit facility.

The ratings of the Companys domestic debt securities as of January 3, 2004,
appear in the table below:

Moody's
    
    
    
    Standard &Investors
    
    Fitch
    
    Poor's RatingsService
    
    Ratings
    
    ServicesUnsecured long-term debt
    
    Baa1
    
    BBB+
    
    BBBUnsecured commercial paper
    
    P-2
    
    F2
    
    A-2


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##### Table of Contents



Contractual Obligations and Off-Balance Sheet Arrangements

To facilitate an understanding of the Companys contractual obligations and
off-balance sheet arrangements, the following data is provided:

millions
    
    
    
    
    
    Payments Due by PeriodWithin
    
    
    
    
    
    
    
    
    
    
    AfterTotal
    
    
    1 Year
    
    
    2-3 Years
    
    
    4-5 Years
    
    
    5 YearsContractual obligationsLong-term debt (1)
    
    $
    6,592
    
    
    $
    2,921
    
    
    $
    1,305
    
    
    $
    662
    
    
    $
    1,704Short-term debt
    
    
    1,033
    
    
    
    1,033
    
    
    
    
    
    
    
    
    
    
    
    Capital lease obligations
    
    
    497
    
    
    
    29
    
    
    
    56
    
    
    
    49
    
    
    
    363Operating leases
    
    
    2,152
    
    
    
    322
    
    
    
    526
    
    
    
    362
    
    
    
    942Total other contractual cash obligations
    
    $
    10,274
    
    
    $
    4,305
    
    
    $
    1,887
    
    
    $
    1,073
    
    
    $
    3,009




---

| | (1)   Excludes $11 million of premium/discount on long-term debt.
| | -----------------------------------------------------------------

---

The Company has no material unconditional purchase obligations as defined by
SFAS No. 47, Disclosure of Long-Term Purchase Obligations.

Defined benefit retirement plans

As is indicated in Note 9 of the Notes to Consolidated Financial Statements,
the projected benefit obligation of the defined benefit plans exceeded plan
assets by $0.7 billion at the end of 2003 as compared to $1.0 billion at the
end of 2002. This decrease in net obligation was attributable to the fact that
plan assets increased in value, primarily due to the increased level of
contributions in 2003 which more than offset the growth in plan obligations
resulting from lower discount rate and benefits accrued during the period. The
Company does not expect to contribute to the domestic pension plan in 2004.
The Critical Accounting Estimates section and Note 9 of the Notes to
Consolidated Financial Statements provide a more complete description of the
status of the Companys defined benefit plans.

Amount of Expiration Per Periodmillions
    
    TotalAmounts
    
    
    Within
    
    
    
    
    
    
    
    
    AfterCommitted
    
    
    1 Year
    
    
    2-3 Years
    
    
    4-5 Years
    
    
    5 YearsOff-balance sheet arrangementsImport letters of credit
    
    $
    155
    
    
    $
    155
    
    
    $
    
    
    
    $
    
    
    
    $
    Secondary lease obligations
    
    
    93
    
    
    
    12
    
    
    
    21
    
    
    
    16
    
    
    
    44Standby letters of credit
    
    
    89
    
    
    
    57
    
    
    
    2
    
    
    
    
    
    
    
    30Guarantees
    
    
    72
    
    
    
    18
    
    
    
    37
    
    
    
    17
    
    
    
    


CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements requires the Company to estimate the
effect of various matters that are inherently uncertain as of the date of the
financial statements. Each of these required estimates varies in regard to the
level of judgment involved and its potential impact on the Companys reported
financial results. Estimates are deemed critical when a different estimate
could have reasonably been used or where changes in the estimate are reasonably
likely to occur from period to period, and would materially impact the
Companys financial condition, changes in financial condition or results of
operations. The Companys significant accounting policies are discussed in
Note 1 of the Notes to Consolidated Financial Statements; critical estimates
inherent in these accounting policies are discussed in the following
paragraphs.

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Inventory valuation

Approximately 88% of merchandise inventories are valued at the lower of cost or
market, with cost determined using the retail inventory method (RIM) under
the last-in, first-out (LIFO) cost flow assumption. Inherent in the RIM
calculation are certain significant management judgments and estimates
including, among others, merchandise markon, markups, markdowns, shrinkage and
vendor allowances, which significantly impact the ending inventory valuation at
cost as well as resulting gross margins. The methodologies used to value
merchandise inventories include the development of the cost-to-retail ratios,
the groupings of homogenous classes of merchandise, the development of
shrinkage reserves, the accounting for price changes and the computations
inherent in the LIFO adjustment.

Self-insurance reserves

The Company uses a combination of third-party insurance and/or self-insurance
for a number of risks including workers compensation, automobile, product and
general liability claims. The Companys liability reflected on the
consolidated balance sheet represents an estimate of the ultimate cost of
uninsured claims incurred as of the balance sheet date. In estimating this
liability, the Company utilizes loss development factors prepared by
independent third-party actuaries. These development factors utilize
historical data to project the future development of incurred losses. Loss
estimates are adjusted based upon actual claims settlements and reported
claims. Although the Company does not expect the amounts ultimately paid to
differ significantly from its estimates, self-insurance reserves could be
affected if future claim experience differs significantly from the historical
trends and the actuarial assumptions.

Defined benefit retirement plans

The fundamental components of accounting for defined benefit retirement plans
consist of the compensation cost of the benefits earned, the interest cost from
deferring payment of those benefits into the future and the results of
investing any assets set aside to fund the obligation. Such retirement
benefits are earned by associates ratably over their service careers; therefore
the amounts reported in the income statement for these retirement plans have
historically followed the same pattern. Accordingly, changes in the
obligations or the value of assets to fund it have been recognized
systematically and gradually over the associates estimated period of service.
This systematic and gradual recognition of changes has been accomplished by
amortizing experience gains/losses in excess of the 10% corridor into expense
over the associate service period and by recognizing the difference between
actual and expected asset returns over a five-year period.

As discussed in Note 9 of the Notes to Consolidated Financial Statements, the
Company will change its method of accounting for its domestic defined benefit
plans to immediately recognize any experience gains or loss in excess of the
10% corridor and to value plan assets at fair value. The Company believes that
the new method is preferable in light of changes made to its domestic benefit
plans to discontinue providing pension and retiree medical benefits to
associates under the age of 40 as the new policy accelerates recognition of
events which have already occurred. As a result of this accounting method
change, the Company expects to record an after-tax charge of $840 million in
the first quarter of 2004 for the cumulative effect of the change in accounting
principle.

Under its new accounting method, the Companys pension expense in future
periods may be more volatile as this method accelerates recognition of actual
experience. Furthermore, because the domestic pension plans unrecognized loss
will be at the 10% corridor limit at the beginning of 2004, additional pension
expense will be recognized in 2004 for the full amount of any experience losses
realized in 2004. The largest drivers of experience losses in recent years
have been the discount rate used to determine the present value of the
obligation and the actual return on pension assets.

The discount rate used to determine the present value of the obligation is
adjusted annually based on prevailing interest rates as of the measurement
date, which is October 31. In 2003, the Company lowered the discount rate used
to determine the pension obligation from 7.00% to 6.00% based on the lower
interest rate environment. A further 25 basis point decline in the discount
rate would generate an experience loss of approximately $100 million.

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##### Table of Contents



Future pension expense may also be affected by the actual return on plan assets
achieved. The current assumption is that pension assets will earn an average
annual 8% return. Every one percentage point variance from the actual return
to the assumed rate of 8% will generate an experience gain or loss of $25
million.

Allowance for uncollectible accounts

The Company records an allowance for uncollectible accounts to reflect
managements best estimate of losses inherent in its portfolio of credit card
receivables as of the balance sheet date. This allowance is established
through a charge to the provision for uncollectible accounts and represents
amounts of current and past due credit card receivable balances (principal,
finance charge and credit card fee balances) which management estimates will
not be collected. The Company calculates the allowance for uncollectible
accounts using a model that considers the current condition of the portfolio
and factors such as bankruptcy filings, historical charge-off patterns and
other portfolio data. The Companys calculation is then reviewed by management
to assess whether, based on economic events, additional analyses are required
to appropriately estimate losses inherent in the portfolio. Management
believes that the allowance for uncollectible accounts is adequate to cover
anticipated losses in the reported credit card receivable portfolio under
current conditions; however, significant deterioration in any of the
above-noted factors, or in the overall health of the economy, could materially
change these expectations.

Valuation of long-lived assets

The Company evaluates the carrying value of long-lived assets whenever events
or changes in circumstances indicate that a potential impairment has occurred.
A potential impairment has occurred if the projected future undiscounted cash
flows are less than the carrying value of the assets. The estimate of cash
flows includes managements assumptions of cash inflows and outflows directly
resulting from the use of that asset in operations. When a potential
impairment has occurred, an impairment write-down is recorded if the carrying
value of the long lived asset exceeds its fair value. Fair value is measured
based on a projected discounted cash flow model using a discount rate the
Company feels is commensurate with the risk inherent in the Companys business.
The Companys impairment analyses contain estimates due to the inherently
judgmental nature of forecasting long-term estimated cash flows and determining
the ultimate useful lives of assets. Actual results will differ, which could
materially impact the Companys impairment assessment.

Income taxes

The Company provides deferred income tax assets and liabilities based on the
estimated future tax effects of differences between the financial and tax bases
of assets and liabilities based on currently enacted tax laws. The tax
balances and income tax expense recognized by the Company are based on
managements interpretation of the tax laws of multiple jurisdictions. Income
tax expense also reflects the Companys best estimates and assumptions
regarding, among other things, the level of future taxable income,
interpretation of the tax laws, and tax planning. Future changes in tax laws,
changes in projected levels of taxable income, and tax planning could affect
the effective tax rate and tax balances recorded by the Company.

Managements estimates as of the date of the financial statements reflect its
best judgment giving consideration to all currently available facts and
circumstances. As such, these estimates may require adjustment in the future,
as additional facts become known or as circumstances change.

The Companys management has discussed the development and selection of these
critical accounting policies with the Audit Committee of the Companys Board of
Directors and the Audit Committee has reviewed the Companys disclosures in
this Managements Discussion and Analysis.

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Adoption of New Accounting Standards

In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in
issuing the guarantee. The recognition and measurement provisions of FIN 45
were applicable to guarantees issued or modified after December 31, 2002. The
disclosure requirements were effective for financial statements ending after
December 15, 2002. The Company has adopted FIN 45 and provided disclosures
regarding its guarantees in Note 5 of the Notes to Consolidated Financial
Statements.

In January 2003, the Emerging Issues Task Force (EITF) issued EITF 02-16,
Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor, which states that cash consideration received from a
vendor is presumed to be a reduction of the prices of the vendors products or
services and should, therefore, be characterized as a reduction of Cost of
Merchandise Sold when recognized in the Consolidated Statements of Earnings.
That presumption is overcome when the consideration is either a reimbursement
of specific, incremental and identifiable costs incurred to sell the vendors
products, or a payment for assets or services delivered to the vendor. The
Company receives allowances from its vendors through a variety of programs and
arrangements, including co-operative advertising and markdown reimbursement
programs. Given the promotional nature of the Companys business, the
allowances are generally intended to offset the Companys cost of promoting,
advertising and selling expense when the purpose for which the vendor funds
were intended to be used has been fulfilled. Co-operative advertising
allowances are reported as a reduction of advertising expense in the period in
which the advertising occurs. Markdown reimbursements are credited to cost of
sales, buying and occupancy during the period in which the related promotional
markdown is taken. EITF 02-16 was effective for contracts entered into after
December 31, 2002. The adoption of EITF 02-16 did not have a material impact
on the Companys financial position or results of operations in 2003.

In December 2003, the FASB revised SFAS No. 132, Employers Disclosures about
Pensions and Other Postretirement benefits - an amendment of FASB Statements
No. 87, 88 and 106. The Company has adopted the disclosure only provisions of
the revised statement for fiscal year 2004.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133. The statement was effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of SFAS No. 149 did
not have a material impact on the Companys financial position or results of
operations in 2003.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards that require companies to classify certain financial
instruments as liabilities that were previously classified as equity. The
Company did not reclassify any financial instruments as a result of adopting
SFAS No. 150.

OUTLOOK

The Companys preliminary outlook for fiscal year 2004 is for earnings per
share before the cumulative effect of a change in accounting principle, as
discussed in the Critical Accounting Policies section of this Managements
Discussion and Analysis, to range from $3.60 to $3.80. This includes the
negative carrying cost of approximately $0.20 to $0.25 per share on the
Companys remaining credit legacy debt related to its Credit and Financial
Products business. The preliminary outlook encompasses several important
factors, including: a 52-week fiscal year in 2004, versus the 53-week fiscal
year in 2003; pension costs reflected under the new accounting method; the

32



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amount of outstanding debt; and the number of shares outstanding due to the
ongoing share repurchase program. The Company expects domestic comparable
store sales to grow in the low-single digit range for the year.

With the sale of the domestic Credit and Financial Products business, the
Company will be more focused as a retailer, and thus the Companys reporting
segments will be changed to reflect two operating segments - a
domestic segment
and an international segment. The Domestic segment will comprise the former
Retail and Related Services segment, including the revenues earned from the
Citicorp relationship, and the former Corporate and Other segment. The
International segment will continue to represent the results of operations of
Sears Canada.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Certain statements made in this Annual Report on Form 10-K and in other public
announcements by the Company, including in the Chairmans letter accompanying
the report, are forward-looking statements that are subject to risks and
uncertainties that may cause the Companys actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by these forward-looking statements.
Forward-looking statements include information concerning the Companys future
financial performance, business strategy, plans, goals and objectives.
Statements preceded by, followed by or that otherwise include the words
believes, expects, anticipates, intends, estimates, plans,
forecasts, is likely to, projected and similar expressions or future or
conditional verbs such as will, should, would, may and could are
generally forward-looking in nature and not historical facts.

Following are some of the risks and uncertainties that could affect our
financial condition or results of operations, and could cause actual results,
performance or achievements to differ from the future results, performance or
achievements expressed or implied by these forward-looking statements:
competitive conditions in the retail and related services industries; changes
in consumer confidence and spending; the success of the Full-line Store
strategy and other strategies; the possibility that the Company will identify
new business and strategic options for one or more of its business segments,
potentially including selective acquisitions, dispositions, restructurings,
joint ventures and partnerships; the Companys ability to integrate and operate
Lands End successfully; the successful integration of Sears retail business
with Citicorps operation of the Credit and Financial Products business, which
involves significant training and the integration of complex system and
processes; the outcome of pending legal proceedings; anticipated cash flow;
social and political conditions such as war, political unrest and terrorism or
natural disasters; the possibility of negative investment returns in the
Companys pension plans; changes in interest rates; the volatility in financial
markets; changes in the Companys debt ratings, credit spreads and cost of
funds; the possibility of interruptions in systematically accessing the public
debt markets; general economic conditions and normal business uncertainty. In
addition, Sears typically earns a disproportionate share of its operating
income in the fourth quarter due to seasonal buying patterns, which are
difficult to forecast with certainty. Additional discussion of these and other
risks and uncertainties is contained elsewhere under Managements Discussion
and Analysis and Quantitative and Qualitative Disclosures About Market Risk.

While the Company believes that its forecasts and assumptions are reasonable,
it cautions that actual results may differ materially. The Company intends
the forward-looking statements to speak only as of the time first made and
does not undertake to update or revise them as more information becomes
available.




Item 7a. Quantitative and Qualitative Disclosures About Market Risk

The primary market risk exposure faced by the Company is interest rate risk,
which arises from the Companys debt obligations and derivative financial
instruments. The Companys policy is to manage interest rate risk through the
use of fixed and variable rate debt and interest rate derivatives. All debt
securities and derivative instruments are considered non-trading. The overall
reduction in debt significantly reduced the Companys exposure to market risk.

At year-end 2003 and 2002, 53% and 80%, respectively, of the Companys funding
portfolio was variable rate

33



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(including fixed rate debt synthetically converted
to variable rate through the use of derivative financial instruments). Based
on the size of the Companys variable rate funding portfolio at year-end 2003
and 2002, which totaled $4.3 billion and $24.2 billion, respectively, an
immediate 100 basis point change in interest rates would have affected pretax
funding costs by approximately $43 million and $242 million, respectively.
These estimates do not take into account the effect on revenue resulting from
invested cash or the returns on assets being funded. These
estimates also
assume that the variable rate funding portfolio remains constant for an annual
period and that the interest rate change occurs at the beginning of the period.
As a result of the sale of the Companys Credit and Financial Products
business to Citicorp on November 3, 2003, the Companys domestic funding
requirements have declined such that it is unlikely that current maturities of
domestic term debt will be refinanced and therefore are not considered variable
rate in the calculation above. Prior to the sale, it was assumed that these
current maturities
of fixed rate term debt would be refinanced and were considered variable rate
due to the interest rate risk upon refinancing. Under the methodology used
prior to the sale, at year-end 2002, approximately 83% of the Companys funding
portfolio was variable rate debt.

The Company actively manages the risk of nonpayment by its derivative
counterparties by limiting its exposure to individual counterparties based on
credit ratings, value at risk and maturities. The counterparties to these
instruments are major financial institutions with credit ratings of single-A
or better. In certain cases, counterparty risk is also managed through the
use of collateral in the form of cash or U.S. government securities. The
following table summarizes notional amounts, fair values and weighted-average
remaining life of the Companys domestic derivative instruments:

Weighted-AverageNotional Amount
    
    Fair Value
    
    Remaining Life(millions)
    
    (millions)
    
    (years)$1,970
    
    $112
    
    3.5





Item 8. Financial Statements and Supplementary Data

The consolidated financial statements of the Company, including the notes to
all such statements, and other information are included in this report
beginning on page F-1.




Item 9. Changes in and Disagreements with Independent Auditors on Accounting and Financial Disclosure

None




Item 9A. Controls and Procedures

The Companys management, including Alan J. Lacy, Chairman of the Board of
Directors, President and Chief Executive Officer (principal executive officer)
and Glenn R. Richter, Senior Vice President and Chief Financial Officer
(principal financial officer), have evaluated the effectiveness of the
Companys disclosure controls and procedures, as such term is defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended, (the Exchange Act). Based upon their evaluation, the principal
executive officer and principal financial officer concluded that, as of the
end of the period covered by this report, the Companys disclosure controls
and procedures were effective for the purpose of ensuring that the information
required to be disclosed in the reports that the Company files or submits
under the Exchange Act with the Securities and Exchange Commission (the SEC)
(1) is recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms, and (2) is accumulated and
communicated to the Companys management, including its principal executive
and principal financial officers, as appropriate to allow timely decisions
regarding required disclosure. In addition, based on that evaluation, no
change in the Companys internal control over financial reporting occurred
during the fiscal year ended January 3, 2004 that has materially affected, or
is reasonably likely to materially affect, the Companys internal control over
financial reporting.

34



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##### Table of Contents






PART III




Item 10. Directors and Executive Officers of the Registrant

Information regarding directors and executive officers of Sears is
incorporated herein by reference to the descriptions under Item 1: Election
of Directors and Section 16(a) Beneficial Ownership Reporting Compliance of
the 2004 Proxy Statement and to Item 1A of this Report under the caption
Executive Officers of the Registrant.




Item 11. Executive Compensation

Information regarding executive compensation is incorporated by reference to
the material under the captions Item 1: Election of Directors, Directors
Compensation and Benefits, Executive Compensation, Stock Options,
Long-Term Performance Incentive Program, Pension Plan, Officers
Agreements and Compensation Committee Interlocks and Insider Participation
of the 2004 Proxy Statement.




Item 12. Security Ownership of Certain Beneficial Owners and Management

Information regarding security ownership of certain beneficial owners and
management is incorporated herein by reference to the material under the
heading Beneficial Ownership of the 2004 Proxy Statement.

See also Part II, Item 5 for a discussion of securities authorized for
issuance under equity compensation plans.




Item 13. Certain Relationships and Related Transactions

Information regarding certain relationships and related transactions is
incorporated herein by reference to the material under the heading Certain
Transactions of the 2004 Proxy Statement.




Item 14. Principal Accounting Fees and Services

Information regarding principal accounting fees and services is incorporated
herein by reference to the material under the heading Principal Accounting
Fees and Services of the 2004 Proxy Statement.




Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)1 and 2 - An Index to Financial Statements and Financial
Statement Schedules has been filed as a part of this Report
beginning on page F-1 hereof.

(a)3 - Exhibits:



| |  | An Exhibit Index has been filed as a part of this Report
beginning on page E-1 hereof and is incorporated herein by
reference.
| |  | --------------------------------------------------------------------------------------------------------------------------------

(b) - Reports on Form 8-K:



| |  | A Current Report on Form 8-K dated October 16, 2003 was filed with the
Securities and Exchange Commission on October 16, 2003 to report, the
release of third quarter earnings of the Registrant.                                                     
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | A Current Report on Form 8-K dated November 3, 2003 as filed with the
Securities and Exchange Commission on December 19, 2003 to provide pro forma
financial information relating to the sale of the Companys Credit and
Financial Products business.

35



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##### Table of Contents










SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, as amended (the Exchange Act) the Registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.

SEARS, ROEBUCK AND CO.  (Registrant)*Michael J. GrahamBy:
    
    Michael J. GrahamVice President and ControllerMarch 10, 2004


Pursuant to the requirements of the Exchange Act, this report has been signed
below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

Signature
    
    
    
    Title
    
    
    
    Date*Alan J. Lacy

Alan J. Lacy
    
    
    
    Chairman of the Board of
Directors, President
and Chief Executive Officer
    
    )
)
)*Glenn R. Richter

Glenn R. Richter
    
    
    
    Senior Vice President and
Chief Financial Officer
(Principal Financial
Officer)
    
    )
)
)
)*Michael J. Graham

Michael J. Graham
    
    
    
    Vice President and
Controller (Principal 
Accounting Officer)
    
    )
)
)
)
    
    March 10, 2004*Hall Adams, Jr.

Hall Adams, Jr.
    
    
    
    Director
    
    )
)
)
)*Brenda C. Barnes

Brenda C. Barnes
    
    
    
    Director
    
    )
)
)
)*William L. Bax

William L Bax
    
    
    
    Director
    
    )
)
)
)


36



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##### Table of Contents



Signature
    
    
    
    Title
    
    
    
    Date*James R. Cantalupo

James R. Cantalupo
    
    
    
    Director
    
    )
)
)
)*Donald J. Carty

Donald J. Carty
    
    
    
    Director
    
    )
)
)
)
    
    March 10, 2004*W. James Farrell

W. James Farrell
    
    
    
    Director
    
    )
)
)
)*Michael A. Miles

Michael A. Miles
    
    
    
    Director
    
    )
)
)
)*Hugh B. Price

Hugh B. Price
    
    
    
    Director
    
    )
)
)
)*Dorothy A. Terrell

Dorothy A. Terrell
    
    
    
    Director
    
    )
)
)
)*Raul H. Yzaguirre

Raul H. Yzaguirre
    
    
    
    Director
    
    )
)
)
)


*By:
    
    /s/Michael J. Graham
    
    Individually and as Attorney-in-factMichael J. Graham


37



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##### Table of Contents






SEARS, ROEBUCK AND CO.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Year Ended January 3, 2004

PageManagements Report
    
    
    
    F-2Independent Auditors Report
    
    
    
    F-3Consolidated Statements of Income
    
    
    
    F-4Consolidated Balance Sheets
    
    
    
    F-5Consolidated Statements of Cash Flows
    
    
    
    F-6Consolidated Statements of Shareholders Equity
    
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    
    F-8Schedule II  Valuation and Qualifying Accounts
    
    
    
    F-40


F - 1



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##### Table of Contents






Managements Report

The financial statements, financial analyses and all other information were
prepared by management, which is responsible for their integrity and
objectivity. Management believes the financial statements, which require the
use of certain estimates and judgments, fairly and accurately reflect the
financial position and operating results of Sears, Roebuck and Co. (the
Company) in accordance with accounting principles generally accepted in the
United States of America. All financial information is consistent with the
financial statements.

Management maintains a system of internal controls that it believes provides
reasonable assurance that, in all material respects, assets are maintained and
accounted for in accordance with managements authorizations, transactions are
recorded accurately in the books and records, and are appropriately reported
and disclosed in the Companys financial statements. The concept of reasonable
assurance is based on the premise that the cost of internal controls should not
exceed the benefits derived. To assure the effectiveness of the internal
control system, the organizational structure provides for defined lines of
responsibility and delegation of authority. The Companys formally stated and
communicated policies demand of employees high ethical standards in their
conduct of its business. These policies address, among other things, potential
conflicts of interest; compliance with all domestic and foreign laws, including
those related to financial disclosure; and the confidentiality of proprietary
information. As a further enhancement of the above, the Companys
comprehensive internal audit program is designed for continual evaluation of
the adequacy and effectiveness of its internal controls and measures adherence
to established policies and procedures.

Deloitte & Touche LLP, independent certified public accountants, have audited
the financial statements of the Company, and their report is presented on the
following page. Their audit also includes gaining an understanding of the
Companys control environment, accounting systems and control procedures to the
extent necessary to plan and execute the audit. The independent accountants
and internal auditors advise management of the results of their audits, and
make recommendations to improve the system of internal controls. Management
evaluates the audit recommendations and takes appropriate action.

The Audit Committee of the Board of Directors is comprised entirely of
directors who are not employees of the Company. The committee reviews audit
plans, internal control reports, financial reports and related matters and
meets regularly with the Companys management, internal auditors and
independent accountants, and performs other duties as outlined in the Audit
Committee Charter. The independent accountants and the internal auditors
advise the committee of any significant matters resulting from their audits and
have free access to the committee without management being present.

/s/ Alan J. Lacy
Alan J. LacyChairman of the Board of Directors, President and
Chief Executive Officer

/s/ Glenn R. Richter
Glenn R. RichterSenior Vice President and Chief Financial Officer

/s/ Michael J. Graham
Michael J. GrahamVice President and Controller

F - 2



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##### Table of Contents






Independent Auditors Report

To the Board of Directors and Shareholders of
Sears, Roebuck and Co.

We have audited the accompanying Consolidated Balance Sheets of Sears, Roebuck
and Co. as of January 3, 2004 and December 28, 2002, and the related
Consolidated Statements of Income, Shareholders Equity, and Cash Flows for
each of the three years in the period ended January 3, 2004. Our audits also
included the financial statement schedule of Sears, Roebuck and Co., listed on
page F-1. These financial statements and financial statement schedule are the
responsibility of the Companys management. Our responsibility is to express
an opinion on the financial statements and financial statement schedule based
on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Sears, Roebuck and Co. as of
January 3, 2004 and December 28, 2002, and the results of its operations and
its cash flows for each of the three years in the period ended January 3,
2004, in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

As discussed in Notes 1, 5 and 16 to the consolidated financial statements, the
Company changed its method of accounting for goodwill in 2002 and its methods
of accounting for credit card securitizations, derivative instruments and
hedging activities in 2001, as required by new accounting standards.

/s/    DELOITTE & TOUCHE LLP
Deloitte & Touche LLP

Chicago, Illinois
March 9, 2004

F - 3



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##### Table of Contents






SEARS, ROEBUCK AND CO.
Consolidated Statements of Income

millions, except per common share data
    
    2003
    
    
    2002
    
    
    2001REVENUESMerchandise sales and services
    
    $
    36,372
    
    
    $
    35,698
    
    
    $
    35,755Credit and financial products revenues
    
    
    4,752
    
    
    
    5,668
    
    
    
    5,235Total revenues
    
    
    41,124
    
    
    
    41,366
    
    
    
    40,990COSTS AND EXPENSESCost of sales, buying and occupancy
    
    
    26,231
    
    
    
    25,646
    
    
    
    26,234Selling and administrative
    
    
    9,111
    
    
    
    9,249
    
    
    
    8,892Provision for uncollectible accounts
    
    
    1,747
    
    
    
    2,261
    
    
    
    1,866Depreciation and amortization
    
    
    909
    
    
    
    875
    
    
    
    863Interest, net
    
    
    1,025
    
    
    
    1,143
    
    
    
    1,415Loss on early retirement of debt, net
    
    
    791
    
    
    
    
    
    
    
    Special charges and impairments
    
    
    112
    
    
    
    111
    
    
    
    542Total costs and expenses
    
    
    39,926
    
    
    
    39,285
    
    
    
    39,812Operating income
    
    
    1,198
    
    
    
    2,081
    
    
    
    1,178Gain on sale of businesses
    
    
    4,224
    
    
    
    
    
    
    
    Other income, net
    
    
    27
    
    
    
    372
    
    
    
    45Income before income taxes, minority interest and cumulative
effect of change in accounting principle
    
    
    5,449
    
    
    
    2,453
    
    
    
    1,223Income taxes
    
    
    2,007
    
    
    
    858
    
    
    
    467Minority interest
    
    
    45
    
    
    
    11
    
    
    
    21Income before cumulative effect of change in accounting principle
    
    
    3,397
    
    
    
    1,584
    
    
    
    735Cumulative effect of change in accounting for goodwill
    
    
    
    
    
    
    (208
    )
    
    
    NET INCOME
    
    $
    3,397
    
    
    $
    1,376
    
    
    $
    735EARNINGS PER COMMON SHARE:BASICEarnings per share before cumulative effect of change in
accounting principle
    
    $
    11.95
    
    
    $
    4.99
    
    
    $
    2.25Cumulative effect of change in accounting principle
    
    
    
    
    
    
    (0.65
    )
    
    
    Earnings per share
    
    $
    11.95
    
    
    $
    4.34
    
    
    $
    2.25DILUTEDEarnings per share before cumulative effect of change in
accounting principle
    
    $
    11.86
    
    
    $
    4.94
    
    
    $
    2.24Cumulative effect of change in accounting principle
    
    
    
    
    
    
    (0.65
    )
    
    
    Earnings per share
    
    $
    11.86
    
    
    $
    4.29
    
    
    $
    2.24


See accompanying notes.

F - 4



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SEARS, ROEBUCK AND CO.
Consolidated Balance Sheets

millions, except per share data
    
    2003
    
    
    2002ASSETSCurrent assetsCash and cash equivalents
    
    $
    9,057
    
    
    $
    1,962Credit card receivables
    
    
    1,998
    
    
    
    32,563Less allowance for uncollectible accounts
    
    
    42
    
    
    
    1,832Net credit card receivables
    
    
    1,956
    
    
    
    30,731Other receivables
    
    
    733
    
    
    
    891Merchandise inventories, net
    
    
    5,335
    
    
    
    5,115Prepaid expenses and deferred charges
    
    
    407
    
    
    
    535Deferred income taxes
    
    
    708
    
    
    
    749Total current assets
    
    
    18,196
    
    
    
    39,983Property and equipmentLand
    
    
    392
    
    
    
    442Buildings and improvements
    
    
    7,151
    
    
    
    6,930Furniture, fixtures and equipment
    
    
    4,972
    
    
    
    5,050Capitalized leases
    
    
    609
    
    
    
    557Gross property and equipment
    
    
    13,124
    
    
    
    12,979Less accumulated depreciation
    
    
    6,336
    
    
    
    6,069Total property and equipment, net
    
    
    6,788
    
    
    
    6,910Deferred income taxes
    
    
    378
    
    
    
    734Goodwill
    
    
    943
    
    
    
    944Tradenames and other intangible assets
    
    
    710
    
    
    
    704Other assets
    
    
    708
    
    
    
    1,134TOTAL ASSETS
    
    $
    27,723
    
    
    $
    50,409LIABILITIESCurrent liabilitiesShort-term borrowings
    
    $
    1,033
    
    
    $
    4,525Current portion of long-term debt and capitalized lease obligations
    
    
    2,950
    
    
    
    4,808Merchandise payables
    
    
    3,106
    
    
    
    2,945Income taxes payable
    
    
    1,867
    
    
    
    787Other liabilities
    
    
    2,950
    
    
    
    3,753Unearned revenues
    
    
    1,244
    
    
    
    1,199Other taxes
    
    
    609
    
    
    
    580Total current liabilities
    
    
    13,759
    
    
    
    18,597Long-term debt and capitalized lease obligations
    
    
    4,218
    
    
    
    21,304Pension and postretirement benefits
    
    
    1,956
    
    
    
    2,491Minority interest and other liabilities
    
    
    1,389
    
    
    
    1,264Total Liabilities
    
    
    21,322
    
    
    
    43,656COMMITMENTS AND CONTINGENT LIABILITIESSHAREHOLDERS EQUITYCommon shares issued ($.75 par value per share, 1,000 shares authorized,
230.4 and 316.7 shares outstanding, respectively)
    
    
    323
    
    
    
    323Capital in excess of par value
    
    
    3,519
    
    
    
    3,505Retained earnings
    
    
    11,636
    
    
    
    8,497Treasury
stock - at cost
    
    
    (7,945
    )
    
    
    (4,474
    )Deferred ESOP expense
    
    
    (26
    )
    
    
    (42
    )Accumulated other comprehensive loss
    
    
    (1,106
    )
    
    
    (1,056
    )Total Shareholders Equity
    
    
    6,401
    
    
    
    6,753TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    27,723
    
    
    $
    50,409


See accompanying notes.

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##### Table of Contents






SEARS, ROEBUCK AND CO.
Consolidated Statements of Cash Flows

millions
    
    2003
    
    
    2002
    
    
    2001CASH FLOWS FROM OPERATING ACTIVITIESNet income
    
    $
    3,397
    
    
    $
    1,376
    
    
    $
    735Adjustments to reconcile net income to net cash provided by
(used in) operating activities
Depreciation and amortization
    
    
    909
    
    
    
    875
    
    
    
    863Loss on early retirement of debt
    
    
    791
    
    
    
    
    
    
    
    Cumulative effect of a change in accounting for goodwill
    
    
    
    
    
    
    208
    
    
    
    Provision for uncollectible accounts
    
    
    1,747
    
    
    
    2,261
    
    
    
    1,866Special charges and impairments
    
    
    112
    
    
    
    111
    
    
    
    542Gain on sale of businesses
    
    
    (4,224
    )
    
    
    
    
    
    
    Gain on sales of property and investments
    
    
    (12
    )
    
    
    (347
    )
    
    
    (21
    )Income tax benefit on nonqualified stock options
    
    
    25
    
    
    
    24
    
    
    
    14Change in (net of dispositions and acquisitions):Deferred income taxes
    
    
    648
    
    
    
    (203
    )
    
    
    (190
    )Retained interest in transferred credit card receivables
    
    
    
    
    
    
    
    
    
    
    (759
    )Credit card receivables
    
    
    524
    
    
    
    (4,833
    )
    
    
    (810
    )Merchandise inventories
    
    
    (158
    )
    
    
    45
    
    
    
    610Other operating assets
    
    
    (496
    )
    
    
    (56
    )
    
    
    61Other operating liabilities
    
    
    (739
    )
    
    
    34
    
    
    
    (596
    )Net cash provided by (used in) operating activities
    
    
    2,524
    
    
    
    (505
    )
    
    
    2,315CASH FLOWS FROM INVESTING ACTIVITIESAcquisition of businesses, net of cash acquired
    
    
    
    
    
    
    (1,840
    )
    
    
    Proceeds from sale of businesses
    
    
    21,651
    
    
    
    
    
    
    
    Proceeds from sales of property and investments
    
    
    53
    
    
    
    568
    
    
    
    59Purchases of property and equipment
    
    
    (925
    )
    
    
    (1,035
    )
    
    
    (1,126
    )Purchases of long-term investments
    
    
    (21
    )
    
    
    (15
    )
    
    
    (21
    )Net provided by cash (used in) investing activities
    
    
    20,758
    
    
    
    (2,322
    )
    
    
    (1,088
    )CASH FLOWS FROM FINANCING ACTIVITIESProceeds from long-term debt
    
    
    3,757
    
    
    
    6,565
    
    
    
    4,051Repayments of long-term debt
    
    
    (12,643
    )
    
    
    (3,256
    )
    
    
    (3,532
    )(Decrease) increase in short-term borrowings, primarily 90 days
or less
    
    
    (3,519
    )
    
    
    964
    
    
    
    (708
    )Repayments of ESOP note receivable
    
    
    2
    
    
    
    11
    
    
    
    33Common shares repurchased
    
    
    (3,673
    )
    
    
    (427
    )
    
    
    (625
    )Common shares issued for employee stock plans
    
    
    191
    
    
    
    157
    
    
    
    75Dividends paid to shareholders
    
    
    (327
    )
    
    
    (293
    )
    
    
    (302
    )Net cash (used in) provided by financing activities
    
    
    (16,212
    )
    
    
    3,721
    
    
    
    (1,008
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    25
    
    
    
    4
    
    
    
    3NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    7,095
    
    
    
    898
    
    
    
    222BALANCE AT BEGINNING OF YEAR
    
    
    1,962
    
    
    
    1,064
    
    
    
    842BALANCE AT END OF YEAR
    
    $
    9,057
    
    
    $
    1,962
    
    
    $
    1,064


See accompanying notes.

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##### Table of Contents






SEARS, ROEBUCK AND CO.
Consolidated Statements of Shareholders Equity

dollars in millionsshares in thousands
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    TotalCommon
    
    
    Common
    
    
    Capital in
    
    
    
    
    
    
    
    
    
    
    Deferred
    
    
    Other
    
    
    Share-Shares
    
    
    Shares
    
    
    Excess of
    
    
    Retained
    
    
    Treasury
    
    
    ESOP
    
    
    Comprehen-
    
    
    holders'Outstanding
    
    
    Issued
    
    
    Par Value
    
    
    Earnings
    
    
    Stock
    
    
    Expense
    
    
    sive Loss
    
    
    EquityBalance, beginning of year 2001
    
    
    333,203
    
    
    $
    323
    
    
    $
    3,538
    
    
    $
    6,979
    
    
    $
    (3,726
    )
    
    $
    (96
    )
    
    $
    (249
    )
    
    $
    6,769Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    735
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    735Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (582
    )
    
    
    (582
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    153Dividends declared to shareholders
($0.92 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (301
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (301
    )Stock options exercised and other
changes
    
    
    3,349
    
    
    
    
    
    
    
    (38
    )
    
    
    
    
    
    
    128
    
    
    
    
    
    
    
    
    
    
    
    90Shares repurchased
    
    
    (16,106
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (625
    )
    
    
    
    
    
    
    
    
    
    
    (625
    )ESOP expense recognized
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33
    
    
    
    
    
    
    
    33Balance, end of year 2001
    
    
    320,446
    
    
    
    323
    
    
    
    3,500
    
    
    
    7,413
    
    
    
    (4,223
    )
    
    
    (63
    )
    
    
    (831
    )
    
    
    6,119Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,376
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,376Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (225
    )
    
    
    (225
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,151Dividends declared to shareholders
($0.92 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (292
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (292
    )Stock options exercised and other
changes
    
    
    4,517
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    176
    
    
    
    
    
    
    
    
    
    
    
    181Shares repurchased
    
    
    (8,229
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (427
    )
    
    
    
    
    
    
    
    
    
    
    (427
    )ESOP expense recognized
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21
    
    
    
    
    
    
    
    21Balance, end of year 2002
    
    
    316,734
    
    
    $
    323
    
    
    $
    3,505
    
    
    $
    8,497
    
    
    $
    (4,474
    )
    
    $
    (42
    )
    
    $
    (1,056
    )
    
    $
    6,753Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,397
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,397Total other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50
    )
    
    
    (50
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,347Dividends declared to shareholders
($0.92 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (258
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (258
    )Stock options exercised and other
changes
    
    
    5,295
    
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    202
    
    
    
    
    
    
    
    
    
    
    
    216Shares repurchased
    
    
    (91,653
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,673
    )
    
    
    
    
    
    
    
    
    
    
    (3,673
    )ESOP expense recognized
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    16Balance, end of year 2003
    
    
    230,376
    
    
    $
    323
    
    
    $
    3,519
    
    
    $
    11,636
    
    
    $
    (7,945
    )
    
    $
    (26
    )
    
    $
    (1,106
    )
    
    $
    6,401


See accompanying notes.

F - 7



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##### Table of Contents






SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Sears, Roebuck and Co. (together with its consolidated subsidiaries, the
Company) is a multi-line retailer that offers a wide array of merchandise and
related services. The Company operates principally in the United States,
Puerto Rico and Canada.

On November 3, 2003, the Company sold substantially all the assets and
liabilities of its domestic Credit and Financial Products business, including
its clubs and services business. The Companys results of operations include
the results of the domestic Credit and Financial Products business through
November 2, 2003. In addition, the Company sold its National Tire & Battery
(NTB) business on November 29, 2003. The Companys results of operations
included the results of its NTB business through the date of the sale.

Basis of Consolidation

The consolidated financial statements include the accounts of Sears, Roebuck
and Co. and all majority-owned subsidiaries, including Sears Canada.
Investments in companies in which the Company exercises significant influence,
but not control, are accounted for using the equity method of accounting.
Investments in companies in which the Company has less than a 20% ownership
interest, and does not exercise significant influence, are accounted for at
cost. All intercompany accounts and transactions have been eliminated during
consolidation.

Fiscal Year

The Companys fiscal year ends on the Saturday nearest December 31. Unless
otherwise stated, references to years in this report relate to fiscal years
rather than to calendar years.

Fiscal year
    
    Ended
    
    Weeks2003
    
    January 3, 2004
    
    532002
    
    December 28, 2002
    
    522001
    
    December 29, 2001
    
    52


Reclassifications

Certain reclassifications have been made to prior year financial statements and
the notes to conform with the current year presentation.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Significant estimates are required as
part of inventory valuation; determining the allowance for uncollectible
accounts; depreciation; amortization and recoverability of long-lived assets;
establishing restructuring, warranty, and other reserves; and calculating
retirement benefits. Actual results may differ from these estimates.

Cash and Cash Equivalents

Cash equivalents include all highly liquid investments with original maturities
of three months or less at the date of purchase. Such investments may include,
but are not limited to, commercial paper, United States federal, state and

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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

municipal government securities, floating rate notes, repurchase agreements
using the previously mentioned securities as collateral, and money market
funds.

Credit Card Receivables

Credit card receivables arise under revolving credit accounts used primarily to
finance purchases. Sears Card products are typically available only on
purchases of merchandise and services offered by the Company, whereas
MasterCard is widely accepted by merchants outside the Company. Additional
MasterCard product receivables are generated from balance transfers and cash
advances. These accounts have various billing and payment structures,
including varying minimum payment levels and finance charge rates and fees.
Based on historical payment patterns, the full receivable balance will not be
repaid within one year. With the sale of the Companys domestic Credit and
Financial Products business, all credit card receivables as of January 3, 2004
originated from the Companys Sears Canada subsidiary.

Credit card receivables are shown net of an allowance for uncollectible
accounts. The allowance is an estimate of losses inherent in the portfolio
(including current accounts, finance charges and credit card fee balances) as
of the balance sheet date. The Company calculates the allowance using a model
that analyzes factors such as bankruptcy filings, delinquency rates, historical
charge-off patterns, recovery rates and other portfolio data. The Companys
calculation is then reviewed by management to assess whether, based on economic
events, additional analyses are required to appropriately estimate losses
inherent in the portfolio.

Accounting for Credit Card Securitizations

Credit card securitizations are utilized as part of the Companys overall
funding strategy. Sears sells certain of its credit card receivable balances
to various subsidiaries that in turn transfer those balances to master trusts
(trusts). The trusts then securitize the receivable balances by issuing
certificates representing undivided interests in the trusts receivables to
both outside investors and to the Company (as a retained interest). These
certificates entitle the holder to a series of scheduled cash flows under
preset terms and conditions, the receipt of which is dependent upon cash flows
generated by the related trusts assets. In each securitization transaction, a
Sears subsidiary has retained certain subordinated interests which serve as a
credit enhancement to the certificates held by the outside investors. As a
result, the credit quality of certificates held by outside investors is
enhanced. However, the investors and the trusts have no recourse against the
Company beyond the trust assets.

On March 31, 2001, the Company adopted the requirements of Statement of
Financial Accounting Standards (SFAS) No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, which
superceded SFAS No. 125. Under SFAS No. 125, the Companys securitization
transactions were accounted for as sales of receivables. SFAS No. 140
established new conditions for a securitization to be accounted for as a sale
of receivables. Accordingly, the Company recorded on the balance sheet
approximately $8.1 billion of previously unconsolidated securitized credit card
receivables and related securitization borrowings in the second quarter of
2001. In addition, approximately $3.9 billion of assets were reclassified to
credit card receivables from retained interest in transferred credit card
receivables. In connection with the consolidation of the securitization
structure, the Company recognized a non-cash, pretax charge of $522 million in
2001 to establish an allowance for uncollectible accounts related to the
receivables which were previously considered as sold or accounted for as
retained interests in transferred credit card receivables.

In 2003, the Company either repaid or transferred to Citicorp all of its
domestic debt securitized by credit card receivables.

Merchandise Inventories

Approximately 88% of merchandise inventories are valued at the lower of cost or
market, with cost determined using the retail inventory method (RIM) under
the last-in, first-out (LIFO) cost flow assumption. To estimate

F - 9



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

the effects of inflation on inventories, the Company utilizes internally
developed price indices.

The LIFO adjustment to cost of sales was a credit of $22 million in 2003, a
charge of $11 million in 2002 and a charge of $25 million in 2001. If the
first-in, first-out (FIFO) method of inventory valuation had been used
instead of the LIFO method, merchandise inventories would have been $580 and
$602 million higher at January 3, 2004 and December 28, 2002, respectively.

Inherent in the RIM calculation are certain significant management judgments
and estimates including, among others, merchandise markons, markups, markdowns
and shrinkage, which significantly impact the ending inventory valuation at
cost as well as resulting gross margins. The methodologies utilized by the
Company in its application of the RIM are consistent for all periods presented.
Such methodologies include the development of the cost-to-retail ratios, the
groupings of homogenous classes of merchandise, the development of shrinkage
reserves, the accounting for price changes and the computations inherent in the
LIFO adjustment. Management believes that the Companys RIM and application of
LIFO provides an inventory valuation which reasonably approximates cost using a
last-in, first-out assumption and results in carrying inventory at the lower of
cost or market.

Vendor Allowances

The Company receives allowances from its vendors through a variety of programs
and arrangements, including co-operative advertising and markdown reimbursement
programs. Given the promotional nature of the Companys business, the
allowances are generally intended to offset the Companys costs of promoting,
advertising and selling the vendors products in its stores. Vendor allowances
are recognized as a reduction of cost of goods sold or related selling expense
when the purpose for which the vendor funds were intended to be used has been
fulfilled. Co-operative advertising allowances are reported as a reduction of
advertising expense in the period in which the advertising expenditures are
incurred. Markdown reimbursements are credited to cost of goods sold during
the period in which the related promotional markdown was taken. Accordingly, a
reduction or increase in vendor allowances has an inverse impact on cost of
sales and/or selling and administrative expenses.

Deferred Policy Acquisition Costs

For certain insurance products, policy acquisition costs were amortized for 5
to 15 years in proportion to income produced. The consolidated balance sheets
include deferred policy acquisition costs of $219 million at December 28, 2002.
The current portion is included in prepaid expenses and deferred charges,
while the long-term portion is included in other assets. In connection with
the sale of the domestic Credit and Financial Products business, all
outstanding insurance products were transferred to the buyer and deferred
policy acquisition costs were written-off in 2003.

Tradenames and Other Identifiable Intangible Assets

The identifiable intangible assets of the Company are primarily
indefinite-lived tradenames acquired in business combinations. Identifiable
intangibles with finite lives are amortized and those with indefinite lives are
not amortized. The estimated useful life of an identifiable intangible asset
to the Company is based upon a number of factors including the effects of
demand, competition and the level of maintenance expenditures required to
obtain future cash flows.

The Company tests identifiable intangible assets with an indefinite life for
impairment, at a minimum on an annual basis, relying on a number of factors
including operating results, business plans and projected future cash flows.
The impairment test for identifiable intangible assets not subject to
amortization consists of a comparison of the fair value of the intangible asset
with its carrying amount. Identifiable intangible assets that are subject to
amortization are evaluated for impairment using a process similar to that used
to evaluate other long-lived assets. An impairment loss is recognized for the
amount by which the carrying value exceeds the fair value of the asset.

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

Goodwill

Under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets,
goodwill is no longer amortized. Prior to the start of 2002, the Company
followed the provisions of Accounting Principles Board Opinion (APB) No. 17,
which required that goodwill be amortized by systematic charges to income over
the period expected to be benefited. That period ranged from 5 to 40 years.

The Companys policy is to test the realizability of goodwill as of the end of
the fiscal year. The Company tested the realizability of the $943 million of
goodwill as of January 3, 2004 resulting in no impairment being recorded.

The changes in the carrying amount of goodwill as of January 3, 2004 are as
follows:

Retail and
    
    
    Credit and
    
    
    Corporatemillions
    
    Related
    
    
    Financial
    
    
    and
    
    
    SearsServices
    
    
    Products
    
    
    Other
    
    
    Canada
    
    
    TotalBalance, beginning of year 2002
    
    $
    291
    
    
    $
    2
    
    
    $
    61
    
    
    $
    (60
    )
    
    $
    294Cumulative effect of adopting SFAS No. 142:Impairment loss recognized
    
    
    (261
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (261
    )Elimination of negative goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    77
    
    
    
    77Acquisition of Lands End
    
    
    834
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    834Balance, end of year 2002
    
    $
    864
    
    
    $
    2
    
    
    $
    61
    
    
    $
    17
    
    
    $
    944Acquisition of Lands End
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Sale of Credit and Financial Products business
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Balance, end of year 2003
    
    $
    865
    
    
    $
    
    
    
    $
    61
    
    
    $
    17
    
    
    $
    943


Long-Lived Asset Recoverability

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-lived Assets, the carrying value of long-lived assets, primarily property
and equipment, is evaluated whenever events or changes in circumstances
indicate that a potential impairment has occurred. A potential impairment has
occurred if projected undiscounted cash flows are less than the carrying value
of the assets. The estimated cash flows include managements assumptions of
cash inflows and outflows directly resulting from the use of that asset in
operations. The SFAS No. 144 impairment test is a two-step process. If the
carrying value of the asset exceeds the expected future cash flows from the
asset, impairment is indicated. The impairment loss recognized is the excess
of the carrying value of the asset over its fair value.

Revenue Recognition

In-store revenues from merchandise sales and services, including delivery fees,
are reported net of estimated returns and allowances and customer rebates, and
are recognized when the related goods are shipped and all significant
obligations of the Company have been satisfied. The reserve for returns and
allowances is calculated as a percentage of sales based on historical return
percentages. Commissions earned on sales made by licensed businesses are also
included as a component of merchandise sales and services. Beginning November
3, 2003, revenues earned under the long-term alliance entered into with
Citibank N.A. are included as a component of merchandise sales and services.
Incentive payments are earned for the generation of new accounts, new financial
products sales and credit card sales.

Revenues from product installation and repair services are recognized as the
services are provided. Additionally, the Company sells extended service
contracts with terms of coverage between 12 and 60 months. Revenues from the
sale of these contracts are deferred and amortized over the lives of the
contracts while the service costs are expensed as incurred. Incremental costs
directly related to the acquisition of such contracts are deferred and

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

charged to expense in proportion to the revenue recognized.

The Company directly markets merchandise through catalogs and online via
websites. Revenue is recognized for these items when the merchandise is
delivered to a customer unless the terms of the sale are FOB shipping point, in
which case the revenue is recognized upon shipment.

The Company is responsible for providing warranty coverage on certain products.
Based on historical warranty claims, the Company accrues the estimated costs
of the warranty coverage at the time of sale. A rollforward of the warranty
reserve is as follows:

millions2003
    
    
    2002Balance, beginning of year
    
    $
    131
    
    
    $
    114Warranty expense
    
    
    204
    
    
    
    233Warranty claims
    
    
    (204
    )
    
    
    (216
    )Balance, end of year
    
    $
    131
    
    
    $
    131


The Company recognizes finance charges and fee income on credit card
receivables according to the contractual provisions of the credit agreements,
and such charges and income are recorded until an account is charged off, at
which time uncollected finance charge and fee revenue are recorded as a
reduction of credit revenues. The Company provides an allowance for
estimated uncollectible finance charge and fee revenues in the provision for
uncollectible accounts.

Cost of Sales, Buying and Occupancy Expenses

Cost of sales, buying and occupancy includes the cost of merchandise, buying,
warehousing, distribution and delivery and store occupancy costs related to the
Companys retail store operations, service and installation costs associated
with product repair services businesses, and all shipping, handling and
delivery costs associated with our online and direct-to-customer businesses.

Selling and Administrative Expenses

Selling and administrative expenses primarily include payroll and related
benefits, advertising and data processing expenses.

Advertising and Direct Response Marketing

Costs for newspaper, television, radio and other media advertising are expensed
the first time the advertising occurs. The total cost of advertising charged
to selling, general and administrative expense was $1.8 billion, $1.8 billion
and $1.6 billion in 2003, 2002 and 2001, respectively.

Certain direct response advertising and solicitation costs are capitalized.
Membership acquisition and renewal costs, which primarily relate to membership
solicitations, are capitalized since such direct response advertising costs
result in future economic benefits. Generally, such costs are amortized over
the shorter of the programs life or five years, primarily in proportion to
when revenues are recognized. For specialty catalogs, costs are amortized over
the life of the catalog, not to exceed one year. When the carrying amount of
such deferred direct advertising costs exceed the estimated future net revenues
realized from such advertising, any excess is recorded as advertising expense
of the current period. The consolidated balance sheets include deferred direct
response advertising costs of $24 million and $58 million at January 3, 2004
and December 28, 2002, respectively. The current portion is included in
prepaid expenses and deferred charges, while the long-term portion is included
in other assets.

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

Income Taxes

The Company provides deferred income tax assets and liabilities based on the
estimated future tax effects of differences between the financial and tax bases
of assets and liabilities based on currently enacted tax laws. The tax
balances and income tax expense recognized by the Company are based on
managements interpretation of the tax laws of multiple jurisdictions. Income
tax expense also reflects the Companys best estimates and assumptions
regarding, among other things, the level of future taxable income,
interpretation of the tax laws, and tax planning. Future changes in tax laws,
changes in projected levels of taxable income, and tax planning could affect
the effective tax rate and tax balances recorded by the Company.

Defined Benefit Plans

For defined benefit plans, the Company recognizes changes in plan obligations
and assets systematically over time. This systematic recognition of changes is
accomplished by amortizing experience gains/losses in excess of the 10%
corridor into expense over the estimated associate service period and by
recognizing the difference between actual and expected asset returns over a
five-year period. See Note 9 for a discussion of the fiscal year 2004
accounting change.

Depreciation and Amortization

Depreciation and amortization is provided principally by the straight-line
method over the estimated useful lives of the related assets, generally 2 to 10
years for furniture, fixtures and equipment, 15 to 50 years for buildings and
building improvements and 3 to 5 years for identifiable intangible assets with
a definitive estimated useful life.

Earnings Per Common Share

Basic earnings per common share is computed by dividing net income available to
common shareholders by the weighted-average number of common shares outstanding
for the periods presented. Diluted earnings per common share also includes the
dilutive effect of potential common shares (primarily dilutive stock options)
outstanding during the period for the periods presented.

Stock-Based Compensation

At January 3, 2004, the Company had various stock-based employee compensation
plans which are described more fully in Note 10. The Company accounts for
those plans in accordance with APB No. 25, Accounting For Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost was reflected in net income, as no options granted under those plans had
an exercise price less than the market value of the underlying common stock on
the date of grant. The following table illustrates the effect on net income
and earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, Accounting for Stock-Based Compensation.

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

millions, except earnings per share2003
    
    
    2002
    
    
    2001Net income - as reported
    
    $
    3,397
    
    
    $
    1,376
    
    
    $
    735Less: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of related
taxes
    
    
    (44
    )
    
    
    (49
    )
    
    
    (51
    )Net income - pro forma
    
    $
    3,353
    
    
    $
    1,327
    
    
    $
    684Earnings per
share - basicAs reported
    
    $
    11.95
    
    
    $
    4.34
    
    
    $
    2.25Pro forma
    
    
    11.79
    
    
    
    4.18
    
    
    
    2.10Earnings per
share - dilutedAs reported
    
    $
    11.86
    
    
    $
    4.29
    
    
    $
    2.24Pro forma
    
    
    11.71
    
    
    
    4.14
    
    
    
    2.08


Financial Instruments

The Company uses financial instruments primarily to manage its exposures to
movements in interest rates. The use of interest rate derivatives lessens the
exposure to this risk with the intent to reduce the risk or cost to the
Company. The Company does not use derivatives for trading purposes.

The Company formally documents its hedge relationships, including
identification of the hedging instruments and the hedged items, as well as its
risk management objectives and strategies for undertaking the hedge
transaction. The Company also formally assesses, both at inception and at
least quarterly thereafter, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in the fair value of
the hedged item. If it is determined that a derivative ceases to be a highly
effective hedge, the Company discontinues hedge accounting.

The Companys interest rate derivatives are designated as fair value hedges of
fixed rate borrowings on the date the derivative is entered. A fair value
hedge is a hedge of a recognized asset or liability or an unrecognized firm
commitment. For fair value hedges, both the effective and ineffective portions
of the changes in the fair value of the derivative, along with the offsetting
gain or loss on the hedged item that is attributable to the hedged risk, are
recorded in earnings and reported in the consolidated statements of income in
the same account as the hedged item.

Fair Value of Financial Instruments

Due to their short-term nature, the carrying value of the Companys cash and
cash equivalents, investments, credit card and other receivables and short-term
borrowings approximate fair value. The fair value of long-term debt is
disclosed in Note 4. The Companys derivative financial instruments are
recorded on the balance sheet within other assets and other long-term
liabilities at fair value. Fair value estimates for the Companys derivative
and debt instruments are based on market prices when available or are derived
from financial valuation methodologies such as discounted cash flow analyses.

Effect of Accounting Standards Not Yet Adopted

In January 2004, the Financial Accounting Standards Board (FASB) staff issued
FASB Staff Position (FSP) 106-1, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003 (the Act). The Act was signed into law in December 2003. In
accordance with this FSP, any measures of the accumulated projected benefit
obligation or net periodic postretirement benefit cost in the financial
statements or accompanying notes do not reflect the effects of the Act on the
plan. While the impact of the Medicare legislation will not be known until
detailed regulations are developed, the Company does not expect the impact to
be material to the Companys consolidated financial statements.

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

NOTE 2 - ACQUISITIONS/DISPOSITIONS

On November 3, 2003, the Company completed the sale of its domestic Credit and
Financial Products business, including its clubs and services business, to
Citicorp. The sale generated total proceeds of $32 billion, consisting of the
assumption of $10 billion of securitized debt by Citicorp and cash proceeds
received by the Company of $22 billion. The Company recorded a pretax gain of
$4.1 billion as a result of the sale. The results of operations for this sold
business are reflected in the Credit and Financial Products segment as further
illustrated in Note 15.

Additionally, the Company and Citibank (USA) N.A. entered into a long-term
marketing and servicing alliance with an initial term of 10 years, with an
option to renew. Under the long-term marketing and servicing alliance,
Citibank (USA) N.A. will provide credit and customer service benefits to the
Companys proprietary and Gold MasterCard holders. In addition, Citibank (USA)
N.A. will support the Companys current zero-percent financing program.

On November 29, 2003, the Company sold NTB to TBC Corporation (TBC). The
sale generated total cash proceeds of $264 million. The Company recognized a
pretax gain of $81 million as a result of the sale. Revenues for NTB were $400
million, $465 million and $494 million in 2003, 2002 and 2001, respectively.

The gain on sale for each transaction are as follows:

Credit andmillions
    
    FinancialProducts
    
    
    NTBTotal proceeds
    
    $
    31,621
    
    
    $
    264Net assets disposed
    
    
    27,353
    
    
    
    163Initial gain
    
    
    4,268
    
    
    
    101Transaction costs
    
    
    125
    
    
    
    20Pretax gain
    
    $
    4,143
    
    
    $
    81


On June 17, 2002, the Company acquired 100 percent of the outstanding common
shares of Lands End, Inc. (Lands End) for $1.8 billion in cash. The
allocation of the purchase price assigned $834 million to goodwill and $704
million to intangible assets. The results of Lands Ends operations have been
included in the consolidated financial statements since that date. Lands End
is a leading direct merchant of traditionally styled,
casual clothing, accessories and footwear for men, women and children, as well
as home products and soft luggage.

NOTE 3 - CREDIT CARD RECEIVABLES

A summary of the Companys credit card receivables at year-end is as follows:

millions2003
    
    
    2002Credit card receivables (1)Domestic
    
    $
    
    
    
    $
    30,766Sears Canada
    
    
    1,998
    
    
    
    1,797Total credit card receivables
    
    
    1,998
    
    
    
    32,563Allowance for uncollectible accounts
    
    
    (42
    )
    
    
    (1,832
    )Net credit card receivables
    
    $
    1,956
    
    
    $
    30,731




---

|(1) |  | At January 3, 2004 and December 28, 2002, $1.1 billion and $23.8 billion, respectively, of credit card receivables were
segregated in securitization trusts.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

A summary of the activity in the allowance for uncollectible accounts is as follows:

millions2003
    
    
    2002Balance, beginning of year
    
    $
    1,832
    
    
    $
    1,158Provision for uncollectible accounts(1)
    
    
    1,747
    
    
    
    2,261Net charge-offs
    
    
    (1,634
    )
    
    
    (1,587
    )Sale of the domestic Credit and Financial Products business(2)
    
    
    (1,903
    )
    
    
    Balance, end of year
    
    $
    42
    
    
    $
    1,832




---

|(1) |  | In the second quarter of 2002, the Company refined its method of
determining the uncollectible portion of current accounts and
credit card fee balances, resulting in an increase to the
allowance for uncollectible accounts in the amount of $300
million. In accordance with APB No. 20, Accounting Changes, the
effect of this change in accounting was recorded as a change in
accounting estimate in the second quarter of 2002.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | In connection with the sale of the domestic Credit and Financial
Products business, the domestic allowance for uncollectible
accounts of $1.9 billion was written-off.                                                                                                                                                                                                                                                                  

---

NOTE 4 - BORROWINGS

Total borrowings outstanding as of January 3, 2004 and December 28, 2002 were
$8.1 billion and $30.0 billion, respectively.

Short-term borrowings consist of:

millions2003
    
    
    2002Unsecured commercial paper
    
    $
    1,033
    
    
    $
    2,950Asset-backed commercial paper
    
    
    
    
    
    
    1,500Bank loans
    
    
    
    
    
    
    75Total short-term borrowings
    
    $
    1,033
    
    
    $
    4,525Weighted-average annual interest rate on short-term debt
    
    
    2.2%
    
    
    
    2.8%


The Company maintains committed credit facilities to support its unsecured
commercial paper borrowings. In February 2003, the Companys domestic
wholly-owned financing subsidiary, Sears Roebuck Acceptance Corp. (SRAC),
through a syndicate of banks, obtained an unsecured, 364-day revolving credit
facility in the amount of $3.5 billion. Effective November 3, 2003, SRAC
amended the facility extending the termination date to May 2004 for consenting
lenders and modifying the option to extend the repayment of any borrowings to
November 2004. The amendment also provided for the commitment amount under
this facility to be reduced to $2.5 billion as of December 3, 2003. As of
January 3, 2004, there were no outstanding borrowings related to this credit
facility.

The Company maintained asset-backed commercial paper programs. The programs
were terminated and amounts outstanding were repaid concurrent with the sale of
the Credit and Financial Products business on November 3, 2003.

In March 2003, the Company negotiated a $2.0 billion private asset-backed
facility. Borrowings under the facility were scheduled to enter an
amortization period in January 2004 and bore interest at a variable rate based
on LIBOR. On November 3, 2003, this facility was terminated and amounts
outstanding were repaid concurrent with the sale of the Credit and Financial
Products business.

The Company had interest rate swap agreements that established floating rates
on $2.0 billion and $10.7 billion of

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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

long-term fixed rate debt at January 3,
2004 and December 28, 2002, respectively. The weighted-average maturity of
these agreements was approximately 3.5 years as of both January 3, 2004 and
December 28, 2002. The weighted-average interest rate received by the Company
related to the agreements was 4.9% and 4.5% at
January 3, 2004 and December 28, 2002, respectively.

Long-term debt is as follows:

ISSUE
    
    2003
    
    
    2002millionsSEARS, ROEBUCK AND CO.6.25% Notes, due in 2004
    
    $
    236
    
    
    $
    3009.375% Debentures, due 2011
    
    
    251
    
    
    
    3008.23% to 10.0% Medium-Term Notes, due 2004 to 2012
    
    
    367
    
    
    
    610SEARS ROEBUCK ACCEPTANCE CORP.6.125% to 7.50% Notes, due 2004 to 2043
    
    
    1,838
    
    
    
    8,5422.70%% to 7.75% Medium-Term Notes, due 2004 to 2013
    
    
    1,267
    
    
    
    1,678LIBOR + 1.18% to 2.95% Floating Rate Medium-Term Notes,
due 2004
    
    
    1,346
    
    
    
    440SRFG, INC.5.25% to 7.50% Asset-backed certificates, due 2003 to 2005
    
    
    
    
    
    
    3,671LIBOR + 0.10% to 1.25% Floating Rate Asset-backed certificates,
due 2004 to 2012
    
    
    
    
    
    
    8,280SEARS DC CORP.9.07% to 9.20% Medium-Term Notes, due 2012
    
    
    23
    
    
    
    53SEARS CANADA INC.6.55% to 7.45% Debentures and Medium-Term Notes, due 2006 to 2010
    
    
    481
    
    
    
    398SEARS CANADA RECEIVABLES TRUST4.72% to 9.18% Receivables Trusts, due 2004 to 2006
    
    
    756
    
    
    
    757CAPITALIZED LEASE OBLIGATIONS
    
    
    497
    
    
    
    458OTHER NOTES AND MORTGAGES
    
    
    16
    
    
    
    16Total long-term debt
    
    
    7,078
    
    
    
    25,503SFAS No. 133 Hedge Accounting Adjustment (see Note 5)
    
    
    90
    
    
    
    609Current maturities
    
    
    (2,950
    )
    
    
    (4,808
    )Long-term debt
    
    $
    4,218
    
    
    $
    21,304Weighted-average annual interest rate on long-term debt
    
    
    4.2%
    
    
    
    4.4%


The fair value of long-term debt was $7.3 billion and $25.1 billion at January
3, 2004 and December 28, 2002, respectively.

Included in current maturities of long-term debt are securities with provisions
that permit optional early redemptions in 2004. On February 2, 2004, Sears,
Roebuck and Co. redeemed its outstanding term debt of $618 million. Through
the end of February 2004, an additional $48 million of SRAC debt has been
called.

On September 1, 2003, SRAC redeemed the entire outstanding principal amount of
its $250 million 7% notes due March 1, 2038. On October 23, 2003, SRAC also
redeemed the entire principal amount of its $250 million 6.95% notes due
October 23, 2038.

On November 17, 2003, the Company and its wholly-owned subsidiaries, SRAC and
Sears DC Corp., completed cash tender offers to purchase their respective
unsecured public term debt securities maturing after 2003, which included 214
series of securities with an aggregate principal amount of approximately $11.8
billion. Approximately $6.4 billion of debt was tendered.

A loss on early retirement of debt of $791 million was recorded during the
fourth quarter of 2003 related to the significant amount of debt retirement
activities that occurred following the sale of the domestic Credit and
Financial Products business. This loss consisted of a $752 million loss
representing premium costs, the write-off

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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

of unamortized issuance costs, the
write-off of unamortized discounts and fees associated with the retirement of
debt, and a $316 million loss related to the write-off of the unamortized loss
on a previously terminated interest rate swap, partially offset by a $277
million gain related to the unwind of interest rate swaps designated as fair
value hedges of the debt which was retired. Of the total debt retirement loss
of $791 million, $420 million was non-cash.

As of January 3, 2004, long-term debt maturities for the next five years and
thereafter are as follows:

millions2004
    
    $
    2,9502005
    
    
    4702006
    
    
    8912007
    
    
    4582008 and thereafter
    
    
    2,309$
    7,078


The Company paid interest of $0.7 billion, $1.1 billion and $1.3 billion in
2003, 2002 and 2001, respectively. Interest capitalized was $2 million, $4
million and $11 million in 2003, 2002 and 2001, respectively.

NOTE 5 - DERIVATIVE FINANCIAL INSTRUMENTS AND FINANCIAL GUARANTEES

Effective in the first quarter of 2001, the Company adopted SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended by
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities. The adoption of SFAS No. 133 did not affect net income.
In 2001, the cumulative effect of the change in accounting principle reduced
other comprehensive income (OCI) by $262 million, including the
reclassification to OCI of a $228 million ($389 million pretax) deferred loss
on an interest rate swap that was terminated in 1997 and the recognition in OCI
of $34 million ($56 million pretax) related to a cash flow hedge. The Company
terminated the cash flow hedge during the second quarter of 2001. The
termination had no impact on earnings. The deferred swap loss was being
amortized into earnings at the rate of approximately $17 million ($26 million
pretax) a year over the original life of the interest rate swap. As a result
of the sale of the Credit and Financial Products business and the resulting
retirement of borrowings to which the
interest rate swap was designated, the Company recognized a non-cash pretax
loss of $316 million. The pretax loss is presented as a component of the loss
on early retirement of debt.

Also, during the fourth quarter of 2003, the Company terminated a number of
outstanding interest rate swaps as a result of the Companys retirement of the
underlying related debt. The Company recognized a pretax gain of $277 million
related to the termination of these interest rate swaps, which is presented as
a component of the loss on early retirement of debt.

The Company utilizes derivative financial instruments as part of an overall
risk management program designed to address certain financial exposures faced
by the Company. The only significant derivative instruments the Company
currently holds are interest rate swaps. As of January 3, 2004, the Company
had interest rate swaps with an aggregate fair value of $112 million that have
been used to synthetically convert certain of the Companys domestic fixed rate
debt to variable rate.

The Companys remaining interest rate swaps have been recorded on the balance
sheet at fair value, classified as $22 million of other receivables and $90
million of other assets. For accounting purposes, the swaps are designated and
qualify as fair value hedges of certain of the Companys fixed rate debt
instruments. As the critical terms of the swaps are designed to match those of
the underlying hedged debt, the change in fair value of the swaps

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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

is largely
offset by changes in fair value recorded on the hedged debt. Consequently, the
amount of hedge ineffectiveness recorded during 2003 in connection with these
hedges was not material and is reflected as a component of interest expense.

The following sets forth the notional amounts and fair values of interest rate
swaps outstanding at the end of 2003 and 2002:

2003
    
    2002Contract or
    
    
    
    
    
    
    Contract ormillions
    
    Notional
    
    
    
    
    
    
    NotionalAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueInterest rate swap agreements:Pay floating rate, receive fixed rate
    
    $
    1,970
    
    
    $
    112
    
    
    $
    10,742
    
    
    $
    690


The Company paid a weighted-average rate of 1.3% and received a
weighted-average rate of 4.6% in 2003. The fair values of interest rate swaps
are based on prices quoted from derivative dealers. If a counterparty fails to
meet the terms of a swap agreement, the Companys exposure is limited to the
net amount that would have been received, if any, over the agreements
remaining life, net of any collateral posted.

Financial Guarantees

The Company issues various types of guarantees in the normal course of
business. As of January 3, 2004, the Company had the following guarantees
outstanding:

millionsGuarantee of SRAC debt
    
    $
    5,181Import letters of credit
    
    
    155Secondary lease obligations
    
    
    93Standby letters of credit
    
    
    89Performance guarantee
    
    
    72


The debt obligations of SRAC are reflected in the Companys consolidated
balance sheets. As a result of the Companys sale of its domestic Credit and
Financial Products Business, Sears was required to issue a guarantee of SRACs
outstanding public debt in order to maintain SRACs exemption from being deemed
an investment company under the Investment Company Act of 1940, as amended.
This guarantee would require the Company to
repay such debt should SRAC default.

The secondary lease obligations relate to certain store leases of Homelife and
NTB assigned to Homelife and an affiliate of TBC, respectively. The Company
remains secondarily liable if the primary obligor defaults. As of January 3,
2004, the Company had a $21 million liability recorded in other liabilities
which represents the Companys current estimate of potential exposure related
to these guarantees.

The performance guarantee relates to certain municipal bonds issued in
connection with the Companys headquarters building. Payments under this
guarantee were $10 million and $6 million for 2003 and 2002, respectively, and
have been recorded as long-term receivables since they are expected to be
recovered from future cash flows generated by the property. This guarantee
expires in 2012.

On November 24, 2003, approximately $500 million of certain real estate assets
were transferred to a wholly-owned consolidated subsidiary of Sears, Roebuck
and Co. and segregated into a trust owned by the consolidated subsidiary.
These assets are related to an inter-company loan arrangement.

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

NOTE 6 - SPECIAL CHARGES AND IMPAIRMENTS

Special charges and impairments included the following:

millions2003
    
    
    2002
    
    
    2001Restructuring initiativesTGI strategic review
    
    $
    112
    
    
    $
    
    
    
    $
    Sears Canada
 Eatons conversion
    
    
    
    
    
    
    111
    
    
    
    Productivity initiatives
    
    
    
    
    
    
    
    
    
    
    123Product category exits
    
    
    
    
    
    
    
    
    
    
    151Other
special chargesHomelife closure
    
    
    
    
    
    
    
    
    
    
    185Exide battery litigation settlement
    
    
    
    
    
    
    
    
    
    
    63Other
    
    
    
    
    
    
    
    
    
    
    20$
    112
    
    
    $
    111
    
    
    $
    542


The Great Indoors Strategic Review

On August 28, 2003, the Company announced a refinement of the business strategy
for TGI which included its decision to close three TGI stores and cease
development of four future locations. In addition, the carrying value of the
long-lived assets for the remaining eighteen TGI stores were reviewed for
recoverability. As a result, the Company recorded a pretax charge of $141
million. The $141 million pretax charge consisted of $99 million related to
asset impairments, $29 million related to inventory clearance costs, $11
million related to other contractual obligations and $2 million related to
employee terminations costs. Of the $141 million charge, $112 million was
recorded in special charges and impairments and $29 million was recorded in
cost of sales, buying and occupancy both within the Retail and Related Services
segment.

The asset impairment charge of $99 million includes $60 million related to the
write-down of property and equipment to be held and used, and $39 million
related to the write-down of property and equipment to fair value (less costs
to sell and net of estimated salvage value) for three stores which were closed
and four locations for which development ceased. The review process which led
to the Companys conclusion to close three under-performing stores also
included revising the cash flow projections for all stores. For certain TGI
stores, the sum of the undiscounted cash flows expected to result from the use
and eventual disposition of the assets did not exceed the carrying amount of
their assets. Consequently, the Company obtained external assessments of fair
market value
for those stores. The impairment charge of $60 million represents the excess
carrying value of the long-lived assets over the estimated fair value of the
related properties.

The pretax charge also provided a reserve of $11 million for incremental costs
and contractual obligations for items such as reimbursement to licensed
businesses for facility closures, lease termination costs and other exit costs
incurred as a direct result of the store closures. As a result of the store
closures, along with the decision to modify the TGI merchandise assortment,
certain inventory was written down to its net realizable value. This resulted
in a charge to cost of sales, buying and occupancy of $29 million. As of
January 3, 2004, the three stores have been closed and all related employees
terminated.

Sears Canada - Eatons Conversion

In February 2002, Sears Canada announced its intention to convert the remaining
seven Eatons stores to the Sears Canada banner. The conversion of the stores
was completed at the end of July 2002. This decision enabled the Company to
better leverage its buying and advertising efforts, and take better advantage
of the Sears brands equity. The Company recorded a one-time, pretax charge of
$111 million in 2002 related to the conversions. Of the $111 million charge,
$92 million was to record asset impairments on fixtures and equipment in such
facilities. The remaining $19 million was comprised of $16 million for
contractual obligations and holding costs and $3

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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

million for employee
termination costs. All actions identified under this plan had been executed by
December 28, 2002.

Productivity Initiatives

During the fourth quarter of 2001, the Company announced a series of strategic
initiatives designed to revitalize its Full-line Stores and reduce operating
expenses. In connection therewith, the Company recorded a pretax charge of
$123 million related to employee termination, facility closing and other exit
costs. Of the $123 million charge, $102 million is for employee termination
costs associated with the planned elimination of approximately 5,950 associate
positions. The positions eliminated include store support positions within the
Companys headquarters as well as positions within store and field operations.
The remaining $21 million of productivity-related charges was comprised of $13
million for contractual obligations and holding costs associated with certain
support facilities to be vacated as a result of the plan, and $8 million to
record asset impairments on fixtures and equipment in such facilities. All
actions identified under this plan had been executed by December 28, 2002.

Product Category Exits

During 2001, the Company announced its decision to exit certain product
categories within its Full-line Stores, including its skin care and color
cosmetics, installed floor covering and custom window treatments businesses.
In connection with these exits, the Company recorded pretax charges totaling
$151 million during 2001. Of the $151 million charge, $106 million was
recorded for the cost of settling contractual obligations to certain vendors
and contractors and for other exit costs associated with the Companys plan to
discontinue these businesses, including incremental customer warranty claims
liability to be incurred by the Company in the absence of ongoing relationships
with certain product manufacturers. Also included within the $151 million
charge were asset impairment charges of $38 million, primarily reflecting the
write-down of store fixtures within the exited businesses to their estimated
fair value. The remaining $7 million of product category exit charges was for
employee termination costs associated with managements decision to eliminate
1,980 associate positions connected to the exited businesses, primarily store
sales positions. All positions had been eliminated as of December 28, 2002.

Homelife Closure

The Company sold its Homelife furniture division to Citicorp Venture Capital,
Ltd. in early 1999. As part of the sale, Sears received a 19% equity interest
in the new Homelife Corporation. Additionally, the Company assigned
certain store leases to Homelife in connection with the sale. Subsequently,
the Company guaranteed certain indebtedness related to the new Homelife
Corporation, and also obtained secured interests in certain Homelife assets.
Homelife ceased operations and subsequently filed for Chapter 11 bankruptcy
protection on July 16, 2001. The Company recorded a pretax charge of $185
million in the second quarter of 2001 to reflect the Companys estimated
obligations and asset impairments relative to Homelife. The pretax charge
included an accrual for net future lease obligations of $150 million reduced by
estimated sublease income, early terminations and lease mitigation costs of $50
million; indebtedness guarantees, obligations to Homelife customers related to
unshipped product billed on the Sears card, and other costs of $69 million; and
write-offs of $16 million for logistics services previously provided to
Homelife. As of January 3, 2004, the Company has paid approximately $119
million relative to its Homelife obligations. While the timing of any
additional cash outlays related to these charges is uncertain, management does
not expect that such payments will have a material impact on the liquidity or
financial condition of the Company.

Exide Battery Litigation Settlement

The Company reached a civil settlement agreement in December 2001 with the U.S.
Attorney for the Southern District of Illinois concluding an investigation into
the advertising of certain Company automotive batteries in 1994 and 1995 that
were manufactured by Exide Technologies. A pretax charge of $63 million was
recorded to reflect

F  -  21



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

the Companys payment obligation to the government under
the terms of the settlement agreement.

Other

During 1999 and 2000, the Company made investments totaling $20 million in a
privately-held retail company specializing in home decorating products and
services. In 2001, the Company recorded a pretax charge of $20 million to
write-off its investment in this entity as it had ceased operations.

Following is a summary of the 2003 activity in the reserves established in
connection with the Companys restructuring initiatives:

Balance,millions
    
    beginning
    
    
    2003
    
    
    Asset
    
    
    Cash
    
    
    Balance,of year
    
    
    Additions
    
    
    Write-Down
    
    
    Payments
    
    
    end of yearProductivity initiativesEmployee termination costs
    
    $
    23
    
    
    $
    28
    (1)
    
    $
    
    
    
    $
    (42
    )
    
    $
    9The Great IndoorsEmployee termination costs
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    2Asset impairments
    
    
    
    
    
    
    99
    
    
    
    (99
    )
    
    
    
    
    
    
    Contractual obligations and other costs
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    112
    
    
    
    (99
    )
    
    
    
    
    
    
    13Total
    
    $
    23
    
    
    $
    140
    
    
    $
    (99
    )
    
    $
    (42
    )
    
    $
    22




---

|(1) |  | In the second quarter of 2003, the Company recorded a pretax charge of $28 million for the estimated cost of severance
for approximately 650 associates. Of the $28 million pretax charge, $16 million was recorded as selling and
administrative expense in the Retail and Related Services segment and $12 million was recorded in the Corporate and
Other segment.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

NOTE 7 - LEASES

The Company leases certain stores, office facilities, warehouses, computers and
transportation equipment.

Operating and capital lease obligations are based upon contractual minimum
rates and, for certain stores, amounts
in excess of these minimum rates are payable based upon specified percentages
of sales. Contingent rent is accrued over the lease term, provided that the
achievement of the specified sales level that triggers the contingent rental is
probable. Certain leases include renewal or purchase options. Operating lease
rentals were $499 million, $474 million and $483 million, including contingent
rentals of $44 million, $56 million and $59 million in 2003, 2002 and 2001,
respectively.

Minimum lease obligations, excluding taxes, insurance and other expenses
payable directly by the Company, for leases in effect as of January 3, 2004,
are as follows:

F  -  22



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

millions
    
    Capital
    
    
    OperatingLeases
    
    
    Leases2004
    
    $
    80
    
    
    $
    3252005
    
    
    80
    
    
    
    2862006
    
    
    78
    
    
    
    2432007
    
    
    70
    
    
    
    1982008
    
    
    67
    
    
    
    165After 2008
    
    
    665
    
    
    
    942Total minimum payments (1)
    
    
    1,040
    
    
    $
    2,159Less imputed interest
    
    
    543Present
value of minimum lease payments (1)
    
    
    497Less current maturities
    
    
    29Long-term obligations
    
    $
    468




---

|(1) |  | Sears Canada: Total operating minimum lease payments of
$590 million; capital lease present value of minimum
lease payments of $133 million
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------

---

NOTE 8 - SHAREHOLDERS EQUITY

Dividend Payments

Under an agreement pursuant to which Sears has provided a credit facility in
support of certain tax increment revenue bonds issued by the Village of Hoffman
Estates, Illinois, in connection with the construction of its headquarters
facility, the Company cannot take specified actions, including the declaration
of cash dividends, that would cause its unencumbered assets, as defined, to
fall below 150% of its liabilities, as defined. At January 3, 2004,
approximately $3.8 billion could be paid in dividends to shareholders under the
most restrictive indentures.

Share Repurchase Program

The Company repurchased 91.7 million, 8.2 million and 16.1 million common
shares in 2003, 2002 and 2001, respectively, under share repurchase programs
approved by the Board of Directors. As of January 3, 2004, the Company had
remaining authorization to repurchase $1.6 billion of shares by December 31,
2006 under a $3.0 billion share repurchase plan approved by the Board of
Directors on October 8, 2003.

F  -  23



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

Comprehensive Income and Accumulated Other Comprehensive Loss

The following table shows the computation of comprehensive income:

millions
    
    January 3,
    
    
    December 28,
    
    
    December 29,2004
    
    
    2002
    
    
    2001Net income
    
    $
    3,397
    
    
    $
    1,376
    
    
    $
    735Other comprehensive income (loss):Minimum pension liability (1)
    
    
    (367
    )
    
    
    (246
    )
    
    
    (333
    )Cumulative effect of a change in
accounting for derivatives, net of tax of $183
    
    
    
    
    
    
    
    
    
    
    (262
    )Early retirement of debt, net of tax of $134
    
    
    182
    
    
    
    
    
    
    
    Amounts amortized into interest expense from OCI (2)
    
    
    14
    
    
    
    16
    
    
    
    17Change in fair value of cash flow hedges (3)
    
    
    (4
    )
    
    
    (6
    )
    
    
    34Unrealized loss on investments, net of tax of $1
    
    
    
    
    
    
    
    
    
    
    (1
    )Foreign currency translation adjustments
    
    
    125
    
    
    
    11
    
    
    
    (37
    )Total accumulated other comprehensive loss
    
    
    (50
    )
    
    
    (225
    )
    
    
    (582
    )Total comprehensive income
    
    $
    3,347
    
    
    $
    1,151
    
    
    $
    153


(1)
    
    Net of tax of $211 million, $153 million and $184 million for 2003, 2002 and 2001, respectively.(2)
    
    Net of tax of $8 million, $10 million and $9 million for 2003 2002 and 2001, respectively.(3)
    
    Net of tax of $3 million, $2 million and $22 million for 2003, 2002 and 2001, respectively.


The following table displays the components of accumulated other comprehensive loss:

millions
    
    2003
    
    
    2002
    
    
    2001Accumulated derivative loss
    
    $
    (9
    )
    
    $
    (201
    )
    
    $
    (211
    )Currency translation adjustments
    
    
    (19
    )
    
    
    (144
    )
    
    
    (155
    )Minimum pension liability, net of tax
    
    
    (1,078
    )
    
    
    (711
    )
    
    
    (465
    )Accumulated other comprehensive loss
    
    $
    (1,106
    )
    
    $
    (1,056
    )
    
    $
    (831
    )


NOTE 9  BENEFIT PLANS

Expenses for retirement and savings-related benefit plans were as follows:

millions
    
    2003
    
    
    2002
    
    
    2001Sears 401(k) Savings Plan
    
    $
    45
    
    
    $
    26
    
    
    $
    23Pension plans
    
    
    148
    
    
    
    70
    
    
    
    68Postretirement benefits
    
    
    (65
    )
    
    
    (60
    )
    
    
    (65
    )Total
    
    $
    128
    
    
    $
    36
    
    
    $
    26


Sears 401(k) Savings Plan

Most domestic employees are eligible to become members of the Sears 401(k)
Savings Plan (the Plan). Under the terms of the Plan, the Company matches a
portion of employee contributions with Sears common shares. Per the Plan, the
Company match is 70% of eligible employee contributions. The Companys
matching contributions

F - 24



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

were $65 million, $72 million and $76 million in 2003, 2002 and 2001,
respectively. Matching contributions were made at the end of each calendar
quarter, based on the quarter-end stock price.

The Plan includes an Employee Stock Ownership Plan (the ESOP) to prefund a
portion of the Companys anticipated contribution. The Company provided the
ESOP with a loan that was used to purchase Sears common shares in 1989. The
purchased shares represent deferred compensation expense, which is presented as
a reduction of shareholders equity and recognized as expense when the shares
are allocated to employees to fund the Company contribution. The per share
cost of Sears common shares purchased by the ESOP in 1989 was $15.27. To the
extent the Company uses the ESOP shares to fund the Company contribution, the
expense recognized by the Company is reduced. The Company contribution funded
with ESOP shares was $33 million, $56 million and $76 million in 2003, 2002 and
2001, respectively, and the Company contribution funded with cash was $32
million and $16 million in 2003 and 2002, respectively.

The ESOP loan bears interest at 6.1% and is repaid from dividends on the ESOP
shares and additional cash payments provided by the Company. The Company has
contributed cash to the ESOP annually in the amount equal to the ESOPs
required interest and principal payments on the loan, less dividends received
on the ESOP shares. The cash payments amounted to $2, $11 and $33 million in
2003, 2002 and 2001, respectively. The balance of the ESOP loan was $7 and $16
million at January 3, 2004 and December 28, 2002, respectively. Cash on hand
in the ESOP at January 3, 2004 was $2 million.

In 2003, the ESOP allocated 1.0 million shares to employees. At January 3,
2004, 24.2 million ESOP shares had been allocated and 1.7 million are available
for future allocation. All ESOP shares are considered outstanding in the
calculation of earnings per share.

Retirement Benefit Plans

Certain domestic full-time and part-time employees are eligible to participate
in noncontributory defined benefit plans after meeting age and service
requirements. Substantially all Canadian employees are eligible to participate
in contributory defined benefit plans. Pension benefits are based on length of
service, compensation and, in certain plans, social security or other benefits.
Funding for the various plans is determined using various actuarial cost
methods.

In addition to providing pension benefits, the Company provides certain medical
and life insurance benefits for retired employees. Employees may become
eligible for medical benefits if they retire in accordance with the Companys
established retirement policy and are continuously insured under the Companys
group medical plans or other approved plans for 10 or more years immediately
prior to retirement. The Company shares the cost of the retiree medical
benefits with retirees based on years of service. Generally, the Companys
share of these benefit costs will be capped at the Company contribution
calculated during the year of retirement. The Companys postretirement benefit
plans are not funded. The Company has the right to modify or terminate these
plans.

F - 25



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

The Company uses October 31 as the measurement date for determining pension
plan assets and obligations. The change in benefit obligation, change in plan
assets, funded status and reconciliation to amounts recognized in the
consolidated balance sheets are as follows:

Pension BenefitsDomestic
    
    
    Sears Canada
    
    
    Totalmillions
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002Change in projected benefit obligationBeginning balance
    
    $
    2,500
    
    
    $
    2,421
    
    
    $
    642
    
    
    $
    670
    
    
    $
    3,142
    
    
    $
    3,091Benefits earned during the period
    
    
    71
    
    
    
    69
    
    
    
    19
    
    
    
    20
    
    
    
    90
    
    
    
    89Interest cost
    
    
    147
    
    
    
    154
    
    
    
    48
    
    
    
    42
    
    
    
    195
    
    
    
    196Actuarial loss (gain)
    
    
    846
    
    
    
    141
    
    
    
    49
    
    
    
    (78
    )
    
    
    895
    
    
    
    63Benefits paid
    
    
    (302
    )
    
    
    (280
    )
    
    
    (51
    )
    
    
    (36
    )
    
    
    (353
    )
    
    
    (316
    )Foreign exchange impact
    
    
    
    
    
    
    
    
    
    
    127
    
    
    
    13
    
    
    
    127
    
    
    
    13Other
    
    
    (10
    )
    
    
    (5
    )
    
    
    15
    
    
    
    11
    
    
    
    5
    
    
    
    6Balance as of the measurement date
    
    $
    3,252
    
    
    $
    2,500
    
    
    $
    849
    
    
    $
    642
    
    
    $
    4,101
    
    
    $
    3,142Change in assets at fair value:Beginning balance
    
    $
    1,381
    
    
    $
    1,586
    
    
    $
    719
    
    
    $
    763
    
    
    $
    2,100
    
    
    $
    2,349Actual return on plan assets
    
    
    297
    
    
    
    (107
    )
    
    
    90
    
    
    
    (40
    )
    
    
    387
    
    
    
    (147
    )Company contributions
    
    
    476
    
    
    
    187
    
    
    
    1
    
    
    
    1
    
    
    
    477
    
    
    
    188Benefits paid
    
    
    (302
    )
    
    
    (280
    )
    
    
    (51
    )
    
    
    (36
    )
    
    
    (353
    )
    
    
    (316
    )Foreign exchange impact
    
    
    
    
    
    
    
    
    
    
    136
    
    
    
    15
    
    
    
    136
    
    
    
    15Other
    
    
    (10
    )
    
    
    (5
    )
    
    
    20
    
    
    
    16
    
    
    
    10
    
    
    
    11Balance as of the measurement date
    
    $
    1,842
    
    
    $
    1,381
    
    
    $
    915
    
    
    $
    719
    
    
    $
    2,757
    
    
    $
    2,100Funded status of the plans
    
    $
    (1,410
    )
    
    $
    (1,119
    )
    
    $
    66
    
    
    $
    77
    
    
    $
    (1,344
    )
    
    $
    (1,042
    )Unrecognized net loss
    
    
    1,899
    
    
    
    1,303
    
    
    
    118
    
    
    
    66
    
    
    
    2,017
    
    
    
    1,369Unrecognized prior service (benefit) cost
    
    
    (19
    )
    
    
    (29
    )
    
    
    16
    
    
    
    19
    
    
    
    (3
    )
    
    
    (10
    )Net amount recognized at measurement date
    
    $
    470
    
    
    $
    155
    
    
    $
    200
    
    
    $
    162
    
    
    $
    670
    
    
    $
    317Amounts recognized in the balance sheet consist of:Prepaid benefit cost
    
    $
    
    
    
    $
    
    
    
    $
    200
    
    
    $
    162
    
    
    $
    200
    
    
    $
    162Accrued benefit liability
    
    
    (1,228
    )
    
    
    (965
    )
    
    
    
    
    
    
    
    
    
    
    (1,228
    )
    
    
    (965
    )Accumulated other comprehensive
income (1)
    
    
    1,698
    
    
    
    1,120
    
    
    
    
    
    
    
    
    
    
    
    1,698
    
    
    
    1,120Net amount recognized
    
    $
    470
    
    
    $
    155
    
    
    $
    200
    
    
    $
    162
    
    
    $
    670
    
    
    $
    317Contributions from 11/03  12/03
    
    
    634
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    634
    
    
    
    Net amount recognized as of
fiscal year-end
    
    $
    1,104
    
    
    $
    155
    
    
    $
    200
    
    
    $
    162
    
    
    $
    1,304
    
    
    $
    317Accumulated benefit obligation
    
    $
    3,070
    
    
    $
    2,346
    
    
    $
    751
    
    
    $
    575
    
    
    $
    3,821
    
    
    $
    2,921


(1)
    
    The minimum pension liability, net of tax, was $1,078 million and $711 million as of January 3, 2004 and December 28, 2002, respectively.


The Company has appointed a non-affiliated third party professional investment
advisor to manage the domestic pension plan assets. The plans overall
investment objective is to provide a long-term return that, along with Company
contributions, is expected to meet future benefit payment requirements. A
long-term horizon has been adopted in establishing investment policy such that
the likelihood and duration of investment losses are carefully weighed against
the long-term potential for appreciation of assets. The plans investment
policy requires investments to be diversified across individual securities,
industries, market capitalization and valuation characteristics. In addition,
various techniques are utilized to monitor, measure and manage risk.

F - 26



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

Plan assets were invested in the following classes of securities (none of which
were securities of the Company):

Plan Assets as of October 312003
    
    
    2002Equity
    
    
    68
    %
    
    
    62
    %Fixed income
    
    
    25
    %
    
    
    27
    %Real estate
    
    
    5
    %
    
    
    5
    %Other
    
    
    2
    %
    
    
    6
    %100
    %
    
    
    100
    %


The plans target allocation is determined taking into consideration the
amounts and timing of projected liabilities, the Companys funding policies and
expected returns on various asset classes. At October 31, 2003 and October 31,
2002, the plans target asset allocation was 75% equity (which included
investments classified as real estate and other in the table above) and 25%
fixed income.

To develop the expected long-term rate of return on assets assumption, the
Company considered the historical returns and the future expectations for
returns for each asset class, as well as the target asset allocation of the
pension portfolio. This resulted in the selection of the 9.0% long-term rate
of return on assets assumption used in 2002 and 2001. However, subsequent to
the measurement date of October 31, 2003, the Company contributed an additional
$634 million to the pension plan, which significantly increased the plan
assets. As a result of the significant change in the funded status of the
plan, the Company is currently reviewing the plans asset allocation and may
increase the relative fixed-income allocation in the future. As such, the
long-term return rate has been adjusted from 9.0% to 8.0% for purpose of
determining future expense. The Company does not expect to contribute to the
domestic pension plan in 2004.

Postretirement BenefitsDomestic
    
    
    Sears Canada
    
    
    Totalmillions
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002Change in projected benefit obligation:Beginning of year balance
    
    $
    802
    
    
    $
    814
    
    
    $
    102
    
    
    $
    91
    
    
    $
    904
    
    
    $
    905Benefits earned during the period
    
    
    3
    
    
    
    4
    
    
    
    3
    
    
    
    3
    
    
    
    6
    
    
    
    7Interest cost
    
    
    39
    
    
    
    45
    
    
    
    8
    
    
    
    12
    
    
    
    47
    
    
    
    57Actuarial loss
    
    
    18
    
    
    
    47
    
    
    
    33
    
    
    
    2
    
    
    
    51
    
    
    
    49Benefits paid
    
    
    (108
    )
    
    
    (139
    )
    
    
    (10
    )
    
    
    (8
    )
    
    
    (118
    )
    
    
    (147
    )Foreign exchange impact
    
    
    
    
    
    
    
    
    
    
    19
    
    
    
    2
    
    
    
    19
    
    
    
    2Other
    
    
    
    
    
    
    31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31Balance as of the measurement date
    
    $
    754
    
    
    $
    802
    
    
    $
    155
    
    
    $
    102
    
    
    $
    909
    
    
    $
    904Change in plan assets at fair value:Beginning of year balance
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Company contributions
    
    
    108
    
    
    
    139
    
    
    
    10
    
    
    
    8
    
    
    
    118
    
    
    
    147Benefits paid
    
    
    (108
    )
    
    
    (139
    )
    
    
    (10
    )
    
    
    (8
    )
    
    
    (118
    )
    
    
    (147
    )Balance as of the measurement date
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Funded status of the plans
    
    $
    (754
    )
    
    $
    (802
    )
    
    $
    (155
    )
    
    $
    (102
    )
    
    $
    (909
    )
    
    $
    (904
    )Unrecognized net (gain) loss
    
    
    (283
    )
    
    
    (322
    )
    
    
    69
    
    
    
    34
    
    
    
    (214
    )
    
    
    (288
    )Unrecognized prior service benefit
    
    
    (237
    )
    
    
    (334
    )
    
    
    
    
    
    
    
    
    
    
    (237
    )
    
    
    (334
    )Net amount recognized
    
    $
    (1,274
    )
    
    $
    (1,458
    )
    
    $
    (86
    )
    
    $
    (68
    )
    
    $
    (1,360
    )
    
    $
    (1,526
    )Amounts recognized in the balance
sheet consist of:Accrued benefit liability
    
    $
    (1,274
    )
    
    $
    (1,458
    )
    
    $
    (86
    )
    
    $
    (68
    )
    
    $
    (1,360
    )
    
    $
    (1,526
    )


F - 27



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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

Weighted-average assumptions used to determine plan obligations are as follows:

Pension Benefits
    
    
    Postretirement Benefits2003
    
    
    2002
    
    
    2001
    
    
    2003
    
    
    2002
    
    
    2001Discount rate
    
    
    6.00%
    
    
    
    7.00%
    
    
    
    7.25%
    
    
    
    6.00%
    
    
    
    7.00%
    
    
    
    7.25%Rate of compensation increases
    
    
    4.25%
    
    
    
    4.25%
    
    
    
    4.00%
    
    
    NA
    
    
    NA
    
    
    NA


Weighted-average assumptions used to determine net cost for years ended are as
follows:

Pension Benefits
    
    
    Postretirement Benefits2003
    
    
    2002
    
    
    2001
    
    
    2003
    
    
    2002
    
    
    2001Discount rate
    
    
    7.00%
    
    
    
    7.25%
    
    
    
    8.25%
    
    
    
    7.00%
    
    
    
    7.25%
    
    
    
    8.25%Return on plan assets
    
    
    9.00%
    
    
    
    9.00%
    
    
    
    9.50%
    
    
    NA
    
    
    NA
    
    
    NARate of compensation increases
    
    
    4.25%
    
    
    
    4.00%
    
    
    
    4.00%
    
    
    NA
    
    
    NA
    
    
    NA


The components of net periodic benefit cost are as follows:

Pension Benefits
    
    
    Postretirement Benefitsmillions
    
    2003
    
    
    2002
    
    
    2001
    
    
    2003
    
    
    2002
    
    
    2001Components of net periodic benefit cost:Benefits earned during the period
    
    $
    90
    
    
    $
    89
    
    
    $
    68
    
    
    $
    6
    
    
    $
    7
    
    
    $
    4Interest cost
    
    
    195
    
    
    
    196
    
    
    
    211
    
    
    
    47
    
    
    
    57
    
    
    
    68Expected return on plan assets
    
    
    (213
    )
    
    
    (236
    )
    
    
    (221
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of unrecognized net prior service
benefit
    
    
    (3
    )
    
    
    (4
    )
    
    
    (4
    )
    
    
    (97
    )
    
    
    (97
    )
    
    
    (102
    )Recognized net loss (gain)
    
    
    84
    
    
    
    29
    
    
    
    18
    
    
    
    (21
    )
    
    
    (27
    )
    
    
    (35
    )Other
    
    
    (5
    )
    
    
    (4
    )
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    Net periodic benefit cost (benefit)
    
    $
    148
    
    
    $
    70
    
    
    $
    68
    
    
    $
    (65
    )
    
    $
    (60
    )
    
    $
    (65
    )


For 2004 and beyond, the weighted-average health care cost trend rates used in
measuring the postretirement benefit expense are a 8.0% trend rate in 2004 to
an ultimate trend rate of 5.0% in 2009 for pre-65 retirees, and a 11.5% trend
rate in 2004 to an ultimate trend rate of 6.5% in 2009 for post-65 retirees. A
100 basis point change in the assumed health care cost trend rate would have
the following effects on the postretirement liability:

100 Basis
    
    
    100 Basismillions
    
    Point Increase
    
    
    Point DecreaseEffect on total service and interest cost components
    
    $
    3
    
    
    $
    (2
    )Effect on postretirement benefit obligation
    
    $
    30
    
    
    $
    (28
    )


Subsequent Event

Subsequent to the sale of its domestic Credit and Financial Products business,
the Company initiated a project to review its domestic employee retirement
benefits cost structure and programs. The Company assessed its retirement
benefits programs in the context of comparable programs in the retail industry.
As a result of this review, the Company concluded that its current retirement
benefit package is not comparable with its retail peers nor is it consistent
with the needs of the typical associate. As such, in January 2004, the Company
announced a series of benefit plan changes which included the enhancement of
the Companys 401(k) defined contribution plan and the phasing out of
participation in its domestic pension plan. Associates hired in 2004 and those
under the age of 40 as of December 31, 2004, will receive an increased Company-matching
contribution to the 401(k) plan of 110%, but will no longer earn additional
pension benefits effective January 1, 2005. Pension benefits continue to
accrue for associates age 40 and older as of December 31, 2004, unless they
elect to participate in the enhanced

F - 28



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

401(k) defined contribution plan. In addition, the Company eliminated its
retiree medical insurance contribution for associates hired in 2004 and those
under the age of 40 as of December 31, 2004, and capped the contribution at the
2004 level for associates age 40 and older.

In connection with the domestic pension and postretirement plan changes
discussed above, the Company believes that it would be preferable to change its
accounting methods which under SFAS Nos. 87 and 106 delay recognition of past
events. Therefore, in the first quarter of 2004 the Company changed its method
for determining the market-related value of plan assets used in determining the
expected return-on-assets component of annual net pension costs and its method
for recognizing gains and losses for both its domestic pension and
postretirement benefit plans. Under the previous accounting method, the
market-related value of the domestic pension plan assets was determined by
averaging the value of equity assets over a five-year period. The new method
recognizes equity assets at fair value. Further, under its previous accounting
method, all unrecognized gains and losses in excess of the 10 percent corridor
were amortized over the expected working lifetime of active employees
(approximately 10 years). Under the new methodology, the portion of the total
gain or loss outside the 10 percent corridor will be immediately recognized.
As a result of this accounting change, the Company will record an after-tax
charge of approximately $840 million in the first quarter of 2004 for the
cumulative effect of the change in accounting. The charge represents the
recognition of unamortized experience losses at the beginning of 2004 in
accordance with the new methods.

NOTE 10  STOCK-BASED COMPENSATION

Stock Option Plans

Options to purchase common shares of the Company have been granted to employees
under various plans at prices not less than the fair market value of the shares
on the dates the options were granted. Generally, options vest over a three-
or four-year period and become exercisable either in equal, annual installments
over the vesting period, or at the end of the vesting period. Options
generally expire in 10 years.

In accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the
fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the assumptions listed below:

2003
    
    
    2002
    
    
    2001Dividend yield
    
    
    4.01%
    
    
    
    1.92%
    
    
    
    1.60%Expected volatility
    
    
    42%
    
    
    
    41%
    
    
    
    31%Risk-free interest rate
    
    
    3.90%
    
    
    
    4.75%
    
    
    
    4.86%Expected life of options
    
    8 years
    
    
    8 years
    
    
    8 years


The Company had 0.9 million performance-based options outstanding at the end of
both 2002 and 2001. These options contained vesting provisions that required
the Companys share price to reach specified targets at specified intervals.
These options were cancelled in March 2003 as the vesting provisions were not
met. The Company did not recognize compensation expense in 2003, 2002 or 2001
related to these options because the exercise price exceeded the Company share
price at each year-end.

F - 29



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

Changes in stock options are as follows (shares in thousands):

2003
    
    2002
    
    2001Weighted-
    
    
    
    
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceBeginning of year balance
    
    
    26,878
    
    
    $
    40.32
    
    
    
    32,578
    
    
    $
    39.04
    
    
    
    21,950
    
    
    $
    38.42Granted
    
    
    8,945
    
    
    
    22.31
    
    
    
    1,081
    
    
    
    51.41
    
    
    
    14,942
    
    
    
    38.27Exercised
    
    
    (4,451
    )
    
    
    32.52
    
    
    
    (3,414
    )
    
    
    32.96
    
    
    
    (2,052
    )
    
    
    22.74Canceled or expired
    
    
    (4,104
    )
    
    
    39.68
    
    
    
    (3,367
    )
    
    
    38.97
    
    
    
    (2,262
    )
    
    
    42.32End of year balance
    
    
    27,268
    
    
    $
    35.81
    
    
    
    26,878
    
    
    $
    40.32
    
    
    
    32,578
    
    
    $
    39.04Reserved for future grant at year-end
    
    
    12,319
    
    
    
    
    
    
    
    17,381
    
    
    
    
    
    
    
    15,755Exercisable
    
    
    9,343
    
    
    $
    43.75
    
    
    
    9,855
    
    
    $
    43.33
    
    
    
    9,399
    
    
    $
    41.90Fair value of options granted during
the year
    
    
    
    
    
    $
    7.56
    
    
    
    
    
    
    $
    23.05
    
    
    
    
    
    
    $
    14.47


The following table summarizes information about stock options outstanding at
January 3, 2004 (shares in thousands):

Options Outstanding
    
    
    Options OutstandingWeighted-Average
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Range of
    
    Number
    
    
    Remaining
    
    
    Average
    
    
    Number
    
    
    AverageExercise
    
    Outstanding
    
    
    Contractual
    
    
    Exercise
    
    
    Exercisable
    
    
    ExercisePrices
    
    at 01/03/04
    
    
    Life in Years
    
    
    Price
    
    
    at 01/03/04
    
    
    Price$20.00 to $30.00
    
    
    8,586
    
    
    
    8.7
    
    
    $
    21.94
    
    
    
    669
    
    
    $
    24.5430.01 to 40.00
    
    
    12,134
    
    
    
    7.8
    
    
    
    37.01
    
    
    
    3,111
    
    
    
    34.2240.01 to 50.00
    
    
    3,298
    
    
    
    5.6
    
    
    
    43.59
    
    
    
    3,119
    
    
    
    43.5550.01 to 64.00
    
    
    3,250
    
    
    
    5.7
    
    
    
    60.02
    
    
    
    2,444
    
    
    
    61.42$10.00 to $64.00
    
    
    27,268
    
    
    
    7.6
    
    
    $
    35.81
    
    
    
    9,343
    
    
    $
    43.75


Associate Stock Purchase Plan

The Companys Associate Stock Purchase Plan (ASPP) allows eligible employees
the right to elect to use up to 15% of their eligible compensation to purchase
the Companys common shares on a quarterly basis at the lower of 85% of the
fair market value at the beginning or end of each calendar quarter. The
maximum number of shares available under the ASPP is 10 million. As of January
3, 2004, 4.4 million shares had been issued under the ASPP and 5.6 million
shares remain available.

Performance Share Plan

In 2001, the Companys Board of Directors approved the initiation of a
performance share plan for a limited number of key executives. The level of
awards to be earned under the plan is contingent upon the attainment of
specific performance targets over a three-year period. Subject to the
satisfaction of the performance-based features, the awards vest 50% in 2004 and
50% in 2005. Performance award expense of approximately $10 million and $5
million was recorded in 2003 and 2002, respectively.

F - 30



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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

NOTE 11 - OTHER INCOME

Other income consists of:

millions
    
    2003
    
    
    2002
    
    
    2001Gain on sales of property and investments
    
    $
    12
    
    
    $
    347
    
    
    $
    21Equity income in unconsolidated companies
    
    
    8
    
    
    
    20
    
    
    
    12Sears Mexico dividend
    
    
    7
    
    
    
    5
    
    
    
    12Total
    
    $
    27
    
    
    $
    372
    
    
    $
    45


The gain on sales of property and investments for 2002 includes a gain of $336
million related to the sale of the Companys holdings of common stock in
Advance Auto Parts, Inc.

NOTE 12 - INCOME TAXES

Income before income taxes, minority interests and cumulative effect of change
in accounting principle was as follows:

millions
    
    2003
    
    
    2002
    
    
    2001Domestic
    
    $
    5,279
    
    
    $
    2,424
    
    
    $
    1,125Foreign
    
    
    170
    
    
    
    29
    
    
    
    98Total
    
    $
    5,449
    
    
    $
    2,453
    
    
    $
    1,223


Federal, state and foreign taxes are as follows:

millions
    
    2003
    
    
    2002
    
    
    2001CurrentFederal
    
    $
    1,270
    
    
    $
    988
    
    
    $
    300State
    
    
    92
    
    
    
    2
    
    
    
    (4
    )Foreign
    
    
    28
    
    
    
    39
    
    
    
    25Total
    
    
    1,390
    
    
    
    1,029
    
    
    
    321DeferredFederal
    
    
    544
    
    
    
    (167
    )
    
    
    88State
    
    
    29
    
    
    
    32
    
    
    
    32Foreign
    
    
    44
    
    
    
    (36
    )
    
    
    26Total
    
    
    617
    
    
    
    (171
    )
    
    
    146Income taxes
    
    $
    2,007
    
    
    $
    858
    
    
    $
    467


A reconciliation of the statutory federal income tax rate to the effective
income tax rate is as follows:

2003
    
    
    2002
    
    
    2001Statutory federal rate
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %State income taxes, net of federal tax benefit
    
    
    1.5
    
    
    
    0.9
    
    
    
    1.5Sears Canada deferred tax asset revaluation
    
    
    0.1
    
    
    
    (0.8
    )
    
    
    1.9Other
    
    
    0.2
    
    
    

    (0.1
    )
    

    
    (0.2
    )Effective income tax rate
    
    
    36.8
    %
    
    
    35.0
    %
    
    
    38.2
    %


F - 31



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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

Deferred taxes based upon differences between the financial statement and tax
bases of assets and liabilities and available tax carryforwards consist of:

millions
    
    2003
    
    
    2002Assets/(liabilities)Deferred tax assets:Unearned service contract income
    
    $
    316
    
    
    $
    414Allowance for uncollectible accounts
    
    
    7
    
    
    
    646State income taxes
    
    
    88
    
    
    
    61Postretirement benefit liability
    
    
    519
    
    
    
    599Minimum pension liability
    
    
    625
    
    
    
    417Net operating loss carryforward
    
    
    39
    
    
    
    93Special charges and impairments
    
    
    129
    
    
    
    90Other deferred tax assets
    
    
    532
    
    
    
    544Gross deferred tax assets
    
    
    2,255
    
    
    
    2,864Deferred tax liabilities:Property and equipment
    
    
    (374
    )
    
    
    (293
    )Prepaid pension
    
    
    (495
    )
    
    
    (172
    )LIFO
    
    
    (82
    )
    
    
    (67
    )Deferred restructuring
    
    
    
    
    
    
    (236
    )Deferred revenue
    
    
    
    
    
    
    (356
    )Other deferred tax liabilities
    
    
    (218
    )
    
    
    (257
    )Gross deferred tax liabilities
    
    
    (1,169
    )
    
    
    (1,381
    )Net deferred tax asset
    
    $
    1,086
    
    
    $
    1,483


Management believes that the realization of the deferred tax assets is more
likely than not, based on the expectation that the Company will generate the
necessary taxable income in future periods and, accordingly, no valuation
reserve has been provided. Tax benefits from loss carryforwards will expire by
year-end 2009.

U.S. income and foreign withholding taxes were not provided on certain
unremitted earnings of international affiliates which the Company considers to
be permanent investments. The cumulative amount of unremitted income for which
income taxes have not been provided totaled $482 million at January 3, 2004.
If these earnings were to be remitted, taxes of $64 million would be due.

Income taxes of $348 million, $918 million and $341 million were paid in 2003,
2002 and 2001, respectively.

NOTE 13 - EARNINGS PER SHARE

The following table sets forth the computations of basic and diluted earnings
per share:

millions, except per share data
    
    2003
    
    
    2002
    
    
    2001Net income (1)
    
    $
    3,397
    
    
    $
    1,376
    
    
    $
    735Average common shares outstanding
    
    
    284.3
    
    
    
    317.4
    
    
    
    326.4Dilutive effect of stock options
    
    
    2.0
    
    
    
    3.3
    
    
    
    2.1Average common and common equivalent shares outstanding
    
    
    286.3
    
    
    
    320.7
    
    
    
    328.5Earnings per shareBasic
    
    $
    11.95
    
    
    $
    4.34
    
    
    $
    2.25Diluted
    
    $
    11.86
    
    
    $
    4.29
    
    
    $
    2.24


(1)
    
    Net income is the same for purposes of calculating basic and diluted earnings per share.


F - 32



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

The following table sets forth the computations of basic and diluted earnings
per share before cumulative effect of change in accounting principle:

millions, except per share data
    
    2003
    
    
    2002
    
    
    2002Income before cumulative effect of change in accounting principle (1)
    
    $
    3,397
    
    
    $
    1,584
    
    
    $
    735Average common shares outstanding
    
    
    284.3
    
    
    
    317.4
    
    
    
    326.4Dilutive effect of stock options
    
    
    2.0
    
    
    
    3.3
    
    
    
    2.1Average common and common equivalent shares outstanding
    
    
    286.3
    
    
    
    320.7
    
    
    
    328.5Earnings per shareBasic
    
    $
    11.95
    
    
    $
    4.99
    
    
    $
    2.25Diluted
    
    $
    11.86
    
    
    $
    4.94
    
    
    $
    2.24


(1)
    
    Income before cumulative effect of change in accounting principle is the same for purposes of calculating basic and diluted earnings per share.


In each period, certain options were excluded from the computation of diluted
earnings per share because they would have been anti-dilutive. At January 3,
2004, December 28, 2002 and December 29, 2001, options to purchase 16.4
million, 5.8 million and 6.5 million common shares at prices ranging from $37
to $64, $45 to $64 and $40 to $64 per share were excluded from the 2003, 2002
and 2001 calculations, respectively.

NOTE 14 - LEGAL PROCEEDINGS

Pending against the Company and certain of its officers and directors are a
number of lawsuits, described below, that relate to the credit card business
and public statements about it. The Company believes that all of these claims
lack merit and is defending against them vigorously.



|§ |  | On and after October 18, 2002, several actions were filed in the
United States District Court for the Northern District of Illinois
against the Company and certain current and former officers alleging
that certain public announcements by the Company concerning its credit
card business violated Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The Court
has consolidated the actions and appointed the Department of the
Treasury of the State of New Jersey and its Division of Investments as
lead plaintiff. The Court has more recently denied defendants
motions to dismiss the complaint and certified the consolidated action
as a class action on behalf of a class of all persons who purchased
securities of the Company between October 24, 2001 and October 17,
2002, inclusive. The Court has scheduled trial to begin on April 4,
2005. A similar case filed in the United States District Court for
the Northern District of California was transferred to the Northern
District of Illinois and subsequently voluntarily dismissed by the
plaintiffs in that action.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|§ |  | On and after November 15, 2002, several actions were filed in the
United States District Court for the Northern District of Illinois
against the Company, certain officers and directors, and alleged
fiduciaries of Sears 401(k) Savings Plan (the Plan), seeking damages
and equitable relief under the Employee Retirement Income Security Act
of 1974 (ERISA). The plaintiffs purport to represent participants
in the Plan, and allege breaches of fiduciary duties under ERISA in
connection with the Plans investment in the Companys common shares
and alleged communications made to Plan participants regarding the
Companys financial condition. These actions have been consolidated
into a single action. A motion to dismiss the consolidated
complaint is pending. A motion for certification of the action as a class
action was ordered withdrawn pending the courts decision on the motion to dismiss.                                                                                                                                                                                                                     

F - 33



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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements



|§ |  | On October 23, 2002, a purported derivative action was filed in
the Supreme Court of the State of New York against the Company (as
a nominal defendant) and certain current and former directors
seeking damages on behalf of the Company. The complaint purports
to allege a breach of fiduciary duty by the directors with respect
to the Companys management of the credit card business. A motion
to dismiss is pending. Two similar actions were subsequently
filed in the Circuit Court of Cook County, Illinois, and a third
was filed in the United States District Court for the Northern
District of Illinois. These actions have been stayed pending
disposition of the action in New York. The plaintiffs in the
Northern District of Illinois action have appealed the stay order
to the United States Court of Appeals for the Seventh Circuit.                                                                                                                                                                                                                                                                                                                                            
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|§ |  | On June 17, 2003, an action was filed in the Northern District of
Illinois against the Company and certain officers, purportedly on
behalf of a class of all persons who, between June 21, 2002 and
October 17, 2002, purchased the 7% notes that SRAC issued on June
21, 2002. An amended complaint has been filed, naming as
additional defendants certain former officers, SRAC and several
investment banking firms who acted as underwriters for SRACs
March 18, May 21 and June 21, 2002 notes offerings. The amended
complaint alleges that the defendants made misrepresentations or
omissions concerning its credit business during the class period
and in the registration statements and prospectuses relating to
the offerings. The amended complaint alleges that these
misrepresentations and omissions violated Sections 10(b) and 20(a)
of the Securities Exchange Act and Rule 10b-5 promulgated
thereunder, and Sections 11, 12 and 15 of the Securities Act of
1933 and purports to be brought on behalf of a class of all
persons who purchased any security of SRAC between October 24,
2001 and October 17, 2002, inclusive. Motions to dismiss the
amended complaint are pending.

The Company is subject to various other legal and governmental proceedings,
many involving litigation incidental to the businesses. Some matters contain
class action allegations, environmental and asbestos exposure allegations and
other consumer-based claims that involve compensatory, punitive or treble
damage claims in very large amounts as well as other types of relief. The
consequences of these matters are not presently determinable but, in the
opinion of management of the Company after consulting with legal counsel, and
taking into account insurance and reserves, the ultimate liability is not
expected to have a material adverse effect on annual results of operations,
financial position, liquidity or capital resources of the Company.

NOTE 15  SUMMARY OF SEGMENT DATA

For each of the three fiscal years presented, the Company organized its
business into three domestic segments: Retail and Related Services, Credit and
Financial Products and Corporate and Other; and one international segment:
Sears Canada.

The Retail and Related Services segment consists of merchandise sales and
related services, including service contracts, delivery and product
installation and repair services. It includes all Sears selling channels,
including Specialty and Full-line Stores as well as Direct to Customer
operations which includes online, catalogs, and Lands End online and catalog
business. Beginning November 3, 2003, this segment also includes the revenues
earned under the long-term marketing and servicing alliance with Citibank (USA)
N.A.

The Credit and Financial Products segment managed the Companys domestic
portfolio of Sears Card and MasterCard receivables. Sears Card receivables
arise primarily from purchases of merchandise and services from domestic
operations, whereas MasterCard is widely accepted by merchants outside the
Company. This segment also included related financial products, such as credit
protection and insurance products. The domestic Credit and Financial products
business was sold on November 3, 2003, and thus the segment results include the
results of operations through November 2, 2003.

F - 34



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

The Corporate and Other segment includes activities that are of an overall
holding company nature primarily consisting of administrative activities. This
segment also includes Home Improvement Services such as siding and windows.

The Sears Canada segment includes similar retail, credit and corporate
operations conducted by Sears Canada, a 54.4% owned subsidiary.

These businesses have been aggregated into their respective reportable segments
based on the management reporting structure and their similar economic
characteristics, customers and distribution channels. No single product or
service accounts for a significant percentage of the Companys consolidated
revenue.

External revenues and expenses are allocated between the applicable segments.
For zero-percent financing promotions in which customers receive free
financing, Retail and Related Services reimbursed Credit and Financial Products
over the life of the financing period at a 10% annual rate. The cost was
reported as selling expense by Retail and Related Services and an offsetting
benefit was recognized by Credit and Financial Products. With the sale of the
domestic Credit and Financial Products business, the allocation of these costs
are included in the results of operation through November 2, 2003. Under the
terms of the long-term marketing and servicing alliance with Citibank (USA)
N.A., Citibank will support the Companys historical level zero-percent
receivable balances at no cost to the Company.

The domestic segments participate in a centralized funding program. Interest
expense was allocated to the Credit and Financial Products segment based on its
funding requirements. Funding included unsecured debt reflected on the balance
sheet and investor certificates related to credit card receivables transferred
to trusts through securitizations. The remainder of net domestic interest
expense was reported in the Retail and Related Services segment through
November 3, 2003. Subsequent to the sale of the Credit and Financial Products
business, the allocation of interest expense was changed such that net interest
expense associated with approximately $3.8 billion of outstanding domestic term
debt remaining from the Credit and Financial Products segment (credit legacy
debt) is allocated to the Corporate and Other Segment. The Company expects to
retire $2.6 billion of the domestic term debt in 2004, which will reduce the
amount of credit legacy debt.

The Companys segments are evaluated on a pretax basis, and a stand-alone
income tax provision is not calculated for the individual segments. The
Company includes its deferred income taxes within the Corporate and Other
segment. The other accounting policies of the segments are substantially the
same as those described in the Companys summary of significant accounting
policies footnote.

With the sale of the domestic Credit and Financial Products business, the
Companys financial reporting segments for fiscal 2004 will be changed to
reflect two operating segments - a Domestic segment and an International
segment. The Domestic segment will comprise the former Retail and Related
Services segment, including the revenues earned from the Citibank relationship,
and the former Corporate and Other segment. The International segment will
continue to represent the results of operations of Sears Canada.

F - 35



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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

2003

Retail and
    
    
    Credit and
    
    
    Corporatemillions
    
    Related
    
    
    Financial
    
    
    and
    
    
    Sears
    
    
    ConsolidatedServices
    
    
    Products
    
    
    Other
    
    
    Canada
    
    
    GAAPRevenuesMerchandise sales and services
    
    $
    31,842
    
    
    $
    
    
    
    $
    372
    
    
    $
    4,158
    
    
    $
    36,372Credit and financial products revenues
    
    
    
    
    
    
    4,429
    
    
    
    
    
    
    
    323
    
    
    
    4,752Total revenues
    
    
    31,842
    
    
    
    4,429
    
    
    
    372
    
    
    
    4,481
    
    
    
    41,124Costs and expensesCost of sales, buying and occupancy
    
    
    23,164
    
    
    
    
    
    
    
    149
    
    
    
    2,918
    
    
    
    26,231Selling and administrative
    
    
    6,914
    
    
    
    645
    
    
    
    425
    
    
    
    1,127
    
    
    
    9,111Provision for uncollectible accounts
    
    
    
    
    
    
    1,695
    
    
    
    
    
    
    
    52
    
    
    
    1,747Depreciation and amortization
    
    
    740
    
    
    
    14
    
    
    
    43
    
    
    
    112
    
    
    
    909Interest, net
    
    
    84
    
    
    
    813
    
    
    
    18
    
    
    
    110
    
    
    
    1,025Loss on early retirement of debt
    
    
    
    
    
    
    791
    
    
    
    
    
    
    
    
    
    
    
    791Special charges and impairments
    
    
    112
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    112Total costs and expenses
    
    
    31,014
    
    
    
    3,958
    
    
    
    635
    
    
    
    4,319
    
    
    
    39,926Operating income (loss)
    
    $
    828
    
    
    $
    471
    
    
    $
    (263
    )
    
    $
    162
    
    
    $
    1,198Total assets
    
    $
    20,138
    
    
    $
    218
    
    
    $
    3,164
    
    
    $
    4,203
    
    
    $
    27,723Capital expenditures
    
    $
    750
    
    
    $
    3
    
    
    $
    40
    
    
    $
    132
    
    
    $
    925


2002

Retail and
    
    
    Credit and
    
    
    Corporatemillions
    
    Related
    
    
    Financial
    
    
    and
    
    
    Sears
    
    
    ConsolidatedServices
    
    
    Products
    
    
    Other
    
    
    Canada
    
    
    GAAPRevenuesMerchandise sales and services
    
    $
    31,459
    
    
    $
    
    
    
    $
    326
    
    
    $
    3,913
    
    
    $
    35,698Credit and financial products revenues
    
    
    
    
    
    
    5,392
    
    
    
    
    
    
    
    276
    
    
    
    5,668Total revenues
    
    
    31,459
    
    
    
    5,392
    
    
    
    326
    
    
    
    4,189
    
    
    
    41,366Costs and expensesCost of sales, buying and occupancy
    
    
    22,743
    
    
    
    
    
    
    
    121
    
    
    
    2,782
    
    
    
    25,646Selling and administrative
    
    
    6,816
    
    
    
    955
    
    
    
    442
    
    
    
    1,036
    
    
    
    9,249Provision for uncollectible accounts
    
    
    
    
    
    
    2,203
    
    
    
    
    
    
    
    58
    
    
    
    2,261Depreciation and amortization
    
    
    710
    
    
    
    18
    
    
    
    55
    
    
    
    92
    
    
    
    875Interest, net
    
    
    35
    
    
    
    1,014
    
    
    
    
    
    
    
    94
    
    
    
    1,143Special charges and impairments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111
    
    
    
    111Total costs and expenses
    
    
    30,304
    
    
    
    4,190
    
    
    
    618
    
    
    
    4,173
    
    
    
    39,285Operating income (loss)
    
    $
    1,155
    
    
    $
    1,202
    
    
    $
    (292
    )
    
    $
    16
    
    
    $
    2,081Total assets
    
    $
    12,469
    
    
    $
    32,207
    
    
    $
    2,252
    
    
    $
    3,481
    
    
    $
    50,409Capital expenditures
    
    $
    894
    
    
    $
    6
    
    
    $
    18
    
    
    $
    117
    
    
    $
    1,035


F - 36



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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

2001

Retail and
    
    
    Credit and
    
    
    Corporatemillions
    
    Related
    
    
    Financial
    
    
    and
    
    
    Sears
    
    
    ConsolidatedServices
    
    
    Products
    
    
    Other
    
    
    Canada
    
    
    GAAPRevenuesMerchandise sales and services
    
    $
    31,346
    
    
    $
    
    
    
    $
    378
    
    
    $
    4,031
    
    
    $
    35,755Credit and financial products revenues
    
    
    
    
    
    
    4,941
    
    
    
    
    
    
    
    294
    
    
    
    5,235Total revenues
    
    
    31,346
    
    
    
    4,941
    
    
    
    378
    
    
    
    4,325
    
    
    
    40,990Costs and expensesCost of sales, buying and occupancy
    
    
    23,081
    
    
    
    
    
    
    
    159
    
    
    
    2,994
    
    
    
    26,234Selling and administrative
    
    
    6,628
    
    
    
    794
    
    
    
    473
    
    
    
    997
    
    
    
    8,892Provision for uncollectible accounts
    
    
    
    
    
    
    1,810
    
    
    
    
    
    
    
    56
    
    
    
    1,866Depreciation and amortization
    
    
    704
    
    
    
    18
    
    
    
    58
    
    
    
    83
    
    
    
    863Interest, net
    
    
    32
    
    
    
    1,272
    
    
    
    
    
    
    
    111
    
    
    
    1,415Special charges and impairments
    
    
    484
    
    
    
    
    
    
    
    58
    
    
    
    
    
    
    
    542Total costs and expenses
    
    
    30,929
    
    
    
    3,894
    
    
    
    748
    
    
    
    4,241
    
    
    
    39,812Operating income (loss)
    
    $
    417
    
    
    $
    1,047
    
    
    $
    (370
    )
    
    $
    84
    
    
    $
    1,178Total assets
    
    $
    10,674
    
    
    $
    27,900
    
    
    $
    2,264
    
    
    $
    3,479
    
    
    $
    44,317Capital expenditures
    
    $
    829
    
    
    $
    25
    
    
    $
    185
    
    
    $
    87
    
    
    $
    1,126


NOTE 16  IMPLEMENTATION OF NEW ACCOUNTING STANDARDS

In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The recognition and
measurement provisions of FIN 45 were applicable to guarantees issued or
modified after December 31, 2002. The disclosure requirements were effective
for financial statements ending after December 15, 2002. The Company has
adopted FIN 45 and provided disclosures regarding its guarantees in Note 5.

In January 2003, the Emerging Issues Task Force (EITF) issued EITF 02-16,
Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor, which states that cash consideration received from a
vendor is presumed to be a reduction of the prices of the vendors products or
services and should, therefore, be characterized as a reduction of Cost of
Merchandise Sold when recognized in the Consolidated Statements of Earnings.
That presumption is overcome when the consideration is either a reimbursement
of specific, incremental and identifiable costs incurred to sell the vendors
products, or a payment for assets or services delivered to the vendor. The
Company receives allowances from its vendors through a variety of programs and
arrangements, including co-operative advertising and markdown reimbursement
programs. Given the promotional nature of the Companys business, the
allowances are generally intended to offset the Companys cost of promoting,
advertising and selling expense when the purpose for which the vendor funds
were intended to be used has been fulfilled. Co-operative advertising
allowances are reported as a reduction of advertising expense in the period in
which the advertising occurs. Markdown reimbursements are credited to cost of
sales, buying and occupancy during the period in which the related promotional
markdown is taken. EITF 02-16 was effective for contracts entered into after
December 31, 2002. The adoption of EITF 02-16 did not have a material impact
on the Companys financial position or results of operations in 2003.

In December 2003, the FASB revised SFAS No. 132, Employers Disclosures about
Pensions and Other Postretirement benefits  an amendment of FASB Statements
No. 87, 88 and 106. The Company has adopted the

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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

disclosure only provisions of the revised statement for fiscal year 2003.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracted and for
hedging activities under SFAS No. 133. The statement was effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of SFAS No. 149 did
not have a material impact on the Companys financial position or results of
operations in 2003.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards that require companies to classify certain financial
instruments as liabilities that were previously classified as equity. The
Company did not reclassify any financial instruments as a result of adopting
SFAS No. 150.

Effective at the beginning of 2002, the Company adopted SFAS No. 142. Upon
adoption of SFAS No. 142, goodwill amortization ceased. The Company completed
the required transitional goodwill impairment test in the first quarter of 2002
and determined that $261 million of goodwill recorded within the Companys
Retail and Related Services segment, primarily related to NTB and Orchard
Supply Hardware, was impaired under the fair value impairment test approach
required by SFAS No. 142.

The fair value of these reporting units was estimated using the expected
present value of associated future cash flows and market values of comparable
businesses where available. Upon adoption of the SFAS No. 142, a $208 million
charge, net of tax and minority interest, was recognized in the first quarter
of 2002 to record this impairment as well as the recognition of negative
goodwill and was classified as a cumulative effect of a change in accounting
principle.

The following table presents the pro forma effect of the adoption of SFAS No.
142 on periods prior to adoption as if the change was applied at the beginning
of the respective fiscal year:

millions, except earnings per common share
    
    2001Reported net income
    
    $
    735Add back:Negative goodwill amortization
    
    
    (14
    )Positive goodwill amortization
    
    
    20Pro forma net income
    
    $
    741Earnings per common shareBasic earnings per share:Reported net income
    
    $
    2.25Goodwill amortization
    
    
    0.02Pro forma net income
    
    $
    2.27Diluted earnings per share:Reported net income
    
    $
    2.24Goodwill amortization
    
    
    0.02Pro forma net income
    
    $
    2.26Average common shares outstanding
    
    
    326.4Average common and common equivalent shares outstanding
    
    
    328.5


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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements

NOTE 17  QUARTERLY RESULTS (Unaudited)

millions, except per common share data

First Quarter
    
    Second Quarter
    
    Third Quarter
    
    Fourth Quarter
    
    Year2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002Revenues
    
    $
    8,880
    
    
    $
    9,037
    
    
    $
    10,196
    
    
    $
    10,142
    
    
    $
    9,794
    
    
    $
    9,669
    
    
    $
    12,254
    
    
    $
    12,518
    
    
    $
    41,124
    
    
    $
    41,366Operating income
    
    
    309
    
    
    
    356
    
    
    
    489
    
    
    
    366
    
    
    
    242
    
    
    
    275
    
    
    
    158
    
    
    
    1,084
    
    
    
    1,198
    
    
    
    2,081Net income before
accounting change
    
    
    192
    
    
    
    318
    
    
    
    309
    
    
    
    229
    
    
    
    147
    
    
    
    189
    
    
    
    2,749
    
    
    
    848
    
    
    
    3,397
    
    
    
    1,584Net income
    
    
    192
    
    
    
    110
    
    
    
    309
    
    
    
    229
    
    
    
    147
    
    
    
    189
    
    
    
    2,749
    
    
    
    848
    
    
    
    3,397
    
    
    
    1,376Earnings per share
before accounting
change - diluted
    
    
    0.60
    
    
    
    0.98
    
    
    
    1.04
    
    
    
    0.71
    
    
    
    0.52
    
    
    
    0.59
    
    
    
    10.84
    
    
    
    2.67
    
    
    
    11.86
    
    
    
    4.94Earnings per common
share - diluted
    
    $
    0.60
    
    
    $
    0.34
    
    
    $
    1.04
    
    
    $
    0.71
    
    
    $
    0.52
    
    
    $
    0.59
    
    
    $
    10.84
    
    
    $
    2.67
    
    
    $
    11.86
    
    
    $
    4.29


The first quarter 2002 results included a pretax charge of $111 million, or
$0.13 per share, related to the conversion of Eatons stores to Sears Canada, a
pretax gain of $71 million, or $0.18 per share, related to the sale of a
portion of the Companys investment in Advance Auto Parts, Inc, and an
after-tax charge of $208 million, or $0.64 per share, related to the adoption
of SFAS No. 142.

The second quarter 2002 results included a pretax charge of $300 million, or
$0.60 per share, which reflected a change in estimate related to the Companys
decision to refine its methodology for determining its domestic allowance for
uncollectible accounts.

The fourth quarter 2002 results included a pretax gain of $265 million, or
$0.56 per share, related to the sale of the Companys remaining investment in
the common stock of Advance Auto Parts, Inc.

The third quarter 2003 results included a pretax charge of $141 million, or
$0.32 per share, related to the Companys refinement of its business strategy
for TGI.

The fourth quarter 2003 results included three significant items: a pretax gain
of $4.1 billion, or $10.38 per share, related to the sale of the Companys
domestic Credit and Financial Products business, a pretax gain of $81 million,
or $0.20 per share, related to the sale of NTB and a pretax charge of $791
million, or $1.98 per share, related to the Companys domestic debt retirement
activities. In addition, pretax LIFO credits of $52 and $19 million were
recorded in the fourth quarter of 2003 and 2002, respectively, compared with
charges of $12 million, $12 million and $6 million for the first, second and
third quarters of fiscal 2003 and 2002, respectively.

The sum of quarterly earnings per common share may not equal the annual amount
as net income per common share is independently calculated for each quarter.

F - 39



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##### Table of Contents



SEARS, ROEBUCK AND CO.
SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS



AdditionsBalance at
    
    
    Charged to
    
    
    
    
    
    
    
    
    
    
    Balance atbeginning
    
    
    and costs
    
    
    
    
    
    
    
    
    
    
    end ofof period
    
    
    expenses
    
    
    Deductions
    
    
    Other(1)
    
    
    periodYear Ended January 3, 2004Allowance for uncollectible accounts
    
    $
    1,832
    
    
    $
    1,747
    
    
    $
    (1,634
    )
    
    $
    (1,903
    )
    
        $
    42Year Ended December 28, 2002Allowance for uncollectible accounts
    
    $
    1,158
    
    
    $
    2,261
    
    
    $
    (1,587
    )
    
    $
    
    
    
    $
    1,832Year Ended December 29, 2001Allowance for uncollectible accounts
    
    $
    686
    
    
    $
    1,866
    
    
    $
    (1,394
    )
    
    $
    
    
    
    $
    1,158


(1)
    
    On November 3, 2003, the Company sold its domestic Credit and Financial Products business. As a result, the domestic allowance for uncollectible
accounts of approximately $1.9 billion was written-off.


F - 40



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##### Table of Contents






EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 3, 2004



3.1
    
    Restated Certificate of Incorporation, as
amended to May 13, 1996 (incorporated by
reference to Exhibit 3(a) to Registration
Statement No. 333-8141 of Registrant).*3.2
    
    By-Laws as amended to October 8, 2003.4.1
    
    Forms of restricted stock grants under
Registrants 1990 Employees Stock Plan
(incorporated by reference to Exhibit 4.(i)
to Registrants Annual Report on Form 10-K
for the fiscal year ended December 31,
1993).** ****4.2
    
    Form of restricted stock grants under
Registrants 1994 Employees Stock Plan
(incorporated by reference to Exhibit 4.(ii)
to Registrants Annual Report on Form 10-K
for the fiscal year ended December 31,
1994).** ****4.3
    
    Forms of stock options granted under
Registrants 1994 Employees Stock Plan
(incorporated by reference to Exhibit 4(v) to
Registrants Annual Report on Form 10-K for
the fiscal year ended January 2, 1999).**
****4.4
    
    Forms of stock options granted under
Registrants 2000 Employees Stock Plan
(incorporated by reference to Exhibit 4(vi)
to Registrants Annual Report on Form 10-K
for the fiscal year ended December 29,
2001).** ****4.5
    
    Registrant hereby agrees to furnish to the
Commission, upon request, with the
instruments defining the rights of holders of
each issue of long-term debt of Registrant
and its consolidated subsidiaries.10.1
    
    Registrants 1986 Employees Stock Plan, amended as of May 12,
1994 (incorporated by reference to Exhibit 10.19 to The Allstate
Corporations Annual Report on Form 10-K for the fiscal year
ended December 31, 1994).*** ****10.2
    
    Registrants 1990 Employees Stock Plan, amended as of May 12,
1994 (incorporated by reference to Exhibit 10.20 to The Allstate
Corporations Annual Report on Form 10-K for the fiscal year
ended December 31, 1994).*** ****10.3
    
    Registrants 1994 Employees Stock Plan (incorporated by reference
to Appendix A to Registrants Proxy Statement dated March 23,
1994).** ****10.4
    
    Registrants 2000 Employees Stock Plan (incorporated by reference
to Appendix A to Registrants Proxy Statement dated March 17,
2000).** ****10.5
    
    Registrants Associate Stock Ownership Plan (incorporated by
reference to Exhibit 10.(iii)(21) to Registrants Annual Report
on Form 10-K for the fiscal year ended January 3, 1998).** ****10.6
    
    First Amendment to Registrants Associate Stock Ownership Plan,
effective as of January 1, 2001 (incorporated by reference to
Exhibit 10.10 to the Registrants Annual Report on Form 10-K for
the fiscal year ended December 28, 2002).****10.7
    
    Second Amendment to Registrants Associate Stock Ownership Plan,
changing the name of the Plan to the Associate Stock Purchase
Plan, effective as of April 1, 2001 (incorporated by reference
to Exhibit 10.11 to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 28, 2002).****10.8
    
    Third Amendment to Registrants Associate Stock Purchase Plan,
effective as of June 29, 2002 (incorporated by reference to
Exhibit 10.12 to the Registrants Annual Report on Form 10-K for
the fiscal year ended December 28, 2002).****10.9
    
    Registrants 2001 Broad-Based Stock Option Plan (incorporated by
reference to Exhibit 4 to Registration Statement No. 333-72514
of Registrant).****


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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 3, 2004



10.10
    
    Registrants Annual Incentive Compensation Plan, amended and
restated as of January 1, 1994 (incorporated by reference to
Appendix B to Registrants Proxy Statement dated March 23,
1994).** ****10.11
    
    Registrants Conformed Amended and Restated Long-Term
Performance Incentive Program (LTPIP), as conformed and
restated through August 14, 2002 and Conforming Amendment to
Registrants 2000 Employee Stock Plan for purposes of the LTPIP
(incorporated by reference to Exhibit 10(a) to Registrants
Quarterly Report on Form 10-Q for the fiscal quarter ended
September 28, 2002).** ****10.12
    
    Description of Registrants Supplemental Life Insurance Plan,
amended as of December 31, 1986 (incorporated by reference to
the second and third full paragraphs on page 10 of Registrants
Proxy Statement dated March 26, 1987).** ****10.13
    
    Registrants Supplemental Retirement Income Plan, as amended and
restated effective March 25, 1997 (incorporated by reference to
Exhibit 10.(ii)(11) to Registrants Annual Report on Form 10-K
for the fiscal year ended January 1, 2000).** ****10.14
    
    Registrants Supplemental Long-Term Disability Plan
(incorporated by reference to Exhibit 10(d) to Registrants
Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 1995).** ****10.15
    
    Registrants Deferred Compensation Plan, as
amended and restated to December 13, 2000
(incorporated by reference to Exhibit 10.
(ii)(15) to Registrants Annual Report on
Form 10-K for the fiscal year ended December
30, 2000). ** ****10.16
    
    Registrants Supplemental 401(k) Savings
Plan, as amended and restated as of January
1, 2001 (incorporated by reference to
Exhibit 10.21 to the Registrants Annual
Report on Form 10-K for the fiscal year
ended December 28, 2002).****10.17
    
    Registrants Transferred Executives Pension
Supplement (incorporated by reference to
Exhibit 10.(iii)(16) to Registrants Annual
Report on Form 10-K for the fiscal year
ended December 31, 1988).** ****10.18
    
    Amendment to Registrants Transferred
Executives Pension Supplement adopted on
March 13, 1996 (incorporated by reference to
Exhibit 10.(iii)(14) to Registrants Annual
Report on Form 10-K for the fiscal year
ended December 30, 1995).** ****10.19
    
    Amendment to Registrants Executive
Retirement Plan Arrangements, effective as
of March 24, 1997 (incorporated by reference
to Exhibit 10.2 to Registrants Quarterly
Report on Form 10-Q for the fiscal quarter
ended June 28, 1997).** ****10.20
    
    Registrants Non-Employee Directors
Retirement Plan, as amended and restated to
March 13, 1996 (incorporated by reference to
Exhibit 10.(iii)(8) to Registrants Annual
Report on Form 10-K for the fiscal year
ended December 30, 1995).** ****10.21
    
    Description of Registrants Non-Employee
Director Life Insurance Plan (incorporated
by reference to the first paragraph on page
10 of Registrants Proxy Statement dated
March 26, 1998).** ****10.22
    
    Registrants Non-Employee Director Stock
Plan (incorporated by reference to Appendix
B of Registrants Proxy Statement dated
March 20, 1996).** ****10.23
    
    Registrants 2002 Non-Employee Director
Stock Plan (incorporated by reference to
Appendix B to Registrants Proxy Statement
dated March 27, 2002).** ****10.24
    
    Term Sheet from Registrant to Greg A. Lee dated December 8, 2000
relating to employment (incorporated by reference to Exhibit 10
to Registrants Quarterly Report on Form 10-Q for the fiscal
quarter ended March 31, 2001).** ****


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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 3, 2004



10.25
    
    Letter from Registrant to Gerald F. Kelly relating to
employment dated September 27, 2002 (incorporated by reference
to Exhibit 10.35 to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 28, 2002).****10.26
    
    Letter from Registrant to Janine M. Bousquette relating to
employment dated October 4, 2002 (incorporated by reference to
Exhibit 10.36 to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 28, 2002).****10.27
    
    Letter from Registrant to Mark S. Cosby relating to employment
dated November 13, 2002 (incorporated by reference to Exhibit
10.37 to the Registrants Annual Report on Form 10-K for the
fiscal year ended December 28, 2002).****10.28
    
    Memorandum from Greg A. Lee to William G. Pagonis relating to
employment dated April 9, 2002 (incorporated by reference to
Exhibit 10.38 to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 28, 2002).****10.29
    
    Letter from Registrant to Robert J. OLeary relating to
employment dated as of June 2, 2003 (incorporated by reference
to Exhibit 10(b) to the Registrants Quarterly Report on Form
10-Q for the fiscal quarter ended June 28, 2003).*10.30
    
    Amendment, dated as of November 6, 2003, to Executive Severance
Non-Compete Agreement between Lyle Heidemann and Sears, Roebuck
and Co. dated November 13, 2001.10.31
    
    Form of Non-Compete/Change of Control Agreement for Executive
Officers of Registrant (incorporated by reference to Exhibit 10
to Registrants Quarterly Report on Form 10-Q for the fiscal
quarter ended July 3, 1999).** ****10.32
    
    Form of Executive Non-Disclosure and Non-Solicitation of
Employees Agreement and form of Executive Severance/Non-Compete
Agreement for Executive Officers of Registrant (incorporated by
reference to Exhibit 10.(ii)(26) to Registrants Annual Report
on Form 10-K for the fiscal year ended December 29, 2001).**
****10.33
    
    $3,500,000,000 364-day Credit Agreement dated as of February
24, 2003 among Sears Roebuck Acceptance Corp. (SRAC), the
banks, financial institutions and other institutional lenders
listed on the signature pages thereof, Bank One, NA, as
syndication agent, Barclays Bank PLC and Bank of America, N.A.,
as documentation agents, Salomon Smith Barney Inc. and Banc One
Capital Markets, Inc. as joint lead arrangers and joint
bookrunners, and Citibank, N.A., as agent for the Lenders
(incorporated by reference to Exhibit 10(a) to SRACs Current
Report on Form 8-K dated February 24, 2003).10.34
    
    Credit Agreement Support Letter dated as of February 24, 2003
between Registrant and Sears Roebuck Acceptance Corp.
(incorporated by reference to Exhibit 10(b) to SRACs Current
Report on Form 8-K dated February 24, 2003).10.35
    
    Acknowledgement and Extension Agreement, dated as of August 19,
2003, among Sears Roebuck Acceptance Corp. (SRAC),
Registrant, and Certain Lenders that are parties to the 364-day
Credit Agreement dated as of February 24, 2003 (which is set
forth as Exhibit 10(c) to SRACs Current Report on Form 8-K
dated February 24, 2003) (incorporated by reference to Exhibit
10(c) to the Registrants Quarterly Report on Form 10-Q for the
fiscal quarter ended September 27, 2003).10.36
    
    Guarantee executed by the Registrant under the Indenture, dated
as of May 15, 1995, between Sears Roebuck Acceptance Corp. and
JP Morgan Chase Bank (successor to The Chase Manhattan Bank,
N.A.), as supplemented by the First Supplemental Indenture,
dated as of November 3, 2003. (incorporated by reference to
Exhibit 4(g) to SRACs Quarterly Report on Form 10-Q for the
fiscal quarter ended September 27, 2003).


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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 3, 2004



10.37
    
    Guarantee executed by the Registrant under the Indenture, dated as of October 1, 2002,
between Sears Roebuck Acceptance Corp. and BNY Midwest Trust Company, as supplemented by the
First Supplemental Indenture, dated as of November 3, 2003 (incorporated by reference to
Exhibit 4(h) to SRACs Quarterly Report on Form 10-Q for the fiscal quarter ended September
27, 2003).*10.38
    
    Guarantee dated as of November 3, 2003 of the commercial paper master notes, executed
between the Registrant and Sears Roebuck Acceptance Corp.10.39
    
    Purchase, Sale and Servicing Transfer Agreement, dated as of July 15, 2003, by an among
Registrant, certain subsidiaries of Registrant and Citicorp (incorporated by reference to
Exhibit 10.1 to SRACs Current Report on Form 8-K dated July 15, 2003).10.40
    
    Amendment No. 1, dated as of November 3, 2003, to the Purchase, Sale and Servicing Transfer
Agreement, by and among Registrant, certain subsidiaries of Registrant and Citicorp
(incorporated by reference to Exhibit 2(b) to the Registrants Quarterly Report on Form 10-Q
for the fiscal quarter ended September 27, 2003).10.41
    
    Amended and Restated Program Agreement, dated as of July 15, 2003, amended and restated as
of November 3, 2003, by and between Registrant, Sears Intellectual Property Management
Company, and Citibank (USA) N.A. (incorporated by reference to Exhibit 10(a) to the
Registrants Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2003).10.42
    
    Amendment, as of August 13, 2003, to Registrants 2002 Non-employee Director Stock Plan (as
set forth in Appendix B of Registrants Proxy Statement dated March 27, 2003) (incorporated
by reference to Exhibit 10(a) to the Registrants Quarterly Report on Form 10-Q for the
fiscal quarter ended September 27, 2003).*12.
    
    Computation of ratio of income to fixed charges for Registrant and consolidated subsidiaries.*21.
    
    Subsidiaries of Registrant.*23.
    
    Consent of Deloitte & Touche LLP.*24.
    
    Power of Attorney of certain officers and directors of Registrant.*31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*32.
    
    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.




|*    |  | Filed herewith                                                                                                                                 
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|    
|**   |  | SEC File No. 1-416                                                                                                                             
|    
|***  |  | SEC File No. 1-11840                                                                                                                           
|    
|**** |  | A management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 15(c) of Form 10-K

E - 4