##### Table of Contents



United StatesSecurities And Exchange CommissionWashington, D.C. 20549 FORM 10-K For Annual and Transition Reports pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934 þ
    
    Annual Report
            Pursuant To Section 13 Or 15(D) Of The Securities
 Exchange Act Of 1934
 For
The Fiscal Year Ended January 1, 2005 Or
 o
    
        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)
           3333 Beverly
          Road, Hoffman Estates, Illinois
    
        (I.R.S.
          Employer Identification No.) 
          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 RegisteredCommon Shares, par value $0.75 per share
    
    New York Stock Exchange
Chicago Stock Exchange
Pacific Stock Exchange
 Securities registered pursuant to Section 12(g) of the Act:                    None On January 31, 2005, the Registrant had 217,638,851 common shares outstanding. The aggregate market value (based on the closing price of the Registrants common shares as reported in a summary of composite transactions
in The Wall Street Journalfor stocks listed on the New York Stock Exchange) 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 the Registrants common shares), as of July 2, 2004 was approximately $5.2 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          þ                    No          o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes          þ                    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.þ Documents Incorporated By ReferenceNone.




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TABLE OF CONTENTS  PART IItem 1. BusinessItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission of Matters to a Vote of Security HoldersPART IIItem 5. Market for Registrants Common Equity and Related Stockholder MattersItem 6. Selected Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7a. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataItem 9. Changes in and Disagreements with Independent Auditors on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPART IIIItem 10. Directors and Executive Officers of the RegistrantItem 11. Executive CompensationItem 12. Security Ownership of Certain Beneficial Owners and ManagementItem 13. Certain Relationships and Related TransactionsItem 14. Principal Accounting Fees and ServicesSIGNATURESSEARS, ROEBUCK AND CO. Notes to Consolidated Financial Statements2005 Performance CriteriaLetter from the RegistrantRegistrant's 2005 Long-Term Incentive PlanComputation of Ratio of Income to Fixed ChargesSubsidiariesConsent of Deloitte & Touche LLPPower of AttorneyCertification CEOCertification of CFOCertification of CEO    Table of Contents  
 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 had offered its customers various credit, financial and related
insurance products. On November 3, 2003, the Company sold its domestic Credit and Financial Products business,
including its clubs and services business, to Citigroup, 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 Citigroup and its affiliates. With the sale, the Company became a more focused
retailer and used the proceeds generated from the sale to strengthen its balance sheet and return
value to its shareholders. As a result of the sale, the Companys financial reporting segments for
fiscal 2004 were changed to reflect two operating segments  a Domestic segment and a Sears Canada
segment. On November 17, 2004, Sears and Kmart Holding Corporation (Kmart) announced that they had signed
a definitive merger agreement (the Merger Agreement) that will combine Sears and Kmart into a
major new retail company named Sears Holdings Corporation
(Holdings). Holdings is expected to be the
nations third largest retailer, initially with approximately $55 billion in annual revenues and
2,350 full-line and off-mall stores, and 1,100 specialty retail stores in the United States. Sears
and Kmart will become wholly owned subsidiaries of Holdings. Under the terms of the Merger Agreement, Kmart shareholders will receive one share of Holdings
common stock for each Kmart share and Sears shareholders have the right to elect $50 in cash or 0.5
of a share of Holdings for each share of Sears common stock. Sears shareholder elections will be
prorated to ensure that, in the aggregate and with certain limited exceptions, 55% of Sears shares
are converted into Holdings shares and 45% of Sears shares are converted to cash. As a result of
the merger, the former shareholders of Kmart are expected to have an approximate 63% interest in
Holdings and the former shareholders of Sears are expected to have an approximate 37% interest in
Holdings. The merger, which is expected to close in March 2005, has received regulatory approval and is
subject to approval by Kmart and Sears stockholders and the satisfaction or waiver of other
customary closing conditions. Special meetings of stockholders of Sears and Kmart to consider
adoption of the Merger Agreement are scheduled to be held on March 24, 2005. The merger will be treated as a purchase business combination for accounting purposes, with Sears
being acquired by Kmart. Sears assets acquired and liabilities assumed will be recorded at their
fair value on the balance sheet of Holdings. This report discusses Sears business and its results
of operations and financial condition without taking into consideration the pending business
combination with Kmart. For more information pertaining to the pending transaction with Kmart, please refer to Holdings
Registration Statement on Form S-4 (Registration No. 333-120954), which is available at
http://www.sec.gov. The information contained in that Registration Statement is not part of this
document. 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 amendments to such reports are
available, free of charge, on the Corporate Governance section of the Investor Relations portion of
the Companys internet website, www.sears.com. These reports are available as soon as reasonably
practicable after they are electronically filed with or furnished to the Securities and Exchange
Commission. 2




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The Corporate Governance Guidelines of the Companys Board of Directors, the charters of the Audit,
Compensation and Nominating and Governance Committees of the Board of Directors and the Companys
Core Values and Code of Conduct are also available on the Corporate Governance Section of 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: Domestic- consisting of: Full-line Stores- 873 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, consumer electronics, home fashion and home
improvement products, such as tools, fitness and lawn and garden
equipment; products range from leading national brands to
proprietary Company brands including Kenmore and Craftsman.
    Apparel/Accessories- A complete selection of fashionable, quality
apparel, footwear and accessories for the whole family and fine
jewelry at accessible prices; includes leading national brands,
exclusive products from leading suppliers, as well as proprietary
Company brands such as Lands End, Covington, Canyon River Blues,
Apostrophe, Structure and TKS Basics.
    Sears Auto Centers- A leading retailer of tires, car batteries,
and certain automotive services, including the sale of major
national brands of tires and batteries, as well as the Companys
proprietary DieHard branded products.
    sears.com Sears extension of its product selection through
internet channels offering a more limited assortment of home,
apparel, and accessory merchandise and providing customers the
option of buying through the internet and picking up their
merchandise in Full-line Stores.
    Store Acquisitions- In September 2004, the Company completed the
acquisition of ownership or leasehold interest of 50 stores from
Kmart for $576 million plus the assumption of existing real estate
leases. Thirty percent of the purchase price has been paid and
the balance will be paid upon taking possession of the stores in
2005. The Company expects to take possession of the stores in
spring 2005, and a majority of the stores are expected to be
converted to Sears nameplates by the fourth quarter of 2005. This
acquisition represents another step in the Companys strategic
goal to grow its store base and the Sears brand off-mall.In February 2005, primarily as a result of the Kmart store
acquisition, the Company announced the launch of a new, mid-sized
off-mall format  Sears Essentials  to offer the Companys
products that are integral to home and family life, such as
appliances, lawn and garden, tools, home electronics, apparel and
home fashions along with convenience items such as health and
beauty, pantry, household and paper products, pet supplies and
toys. The first 25 Sears Essentials stores, all of which are
being acquired from Kmart, are scheduled to open in spring 2005.
The stores are primarily located in large, densely populated
markets with demographics that are attractive to the Company.
They will be on one level, utilize an open racetrack design with
exit cashiering and a centralized customer service center  a
common off-mall layout similar to that of the Sears Grand stores.The Company also agreed during 2004 to sublease six off-mall
locations from Wal-Mart. The Company has already taken possession
of two of those locations and expects to take possession of two
additional locations in each of 2005 and 2006, respectively. 3




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Specialty Stores- Approximately 1,100 Specialty Stores, located primarily in free-standing,
off-the-mall locations or high-traffic neighborhood shopping centers.  
    Dealer Stores 818 primarily independently-owned stores,
predominately located in smaller communities and averaging 5,700
net selling square feet, offering home goods, including
appliances, consumer 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 90
Sears Hardware Stores, doing business under the Sears Hardware &
Appliance name, and six Orchard Supply Hardware stores also offer
a limited selection of home appliances.
    The Great Indoors (TGI) 17 stores specializing in home
decorating and remodeling, averaging 98,000 net selling square
feet, dedicated to the four main rooms of the house: kitchen,
bedroom, bathroom and great room.
    Sears Outlet Stores- 51 stores, averaging 26,000 net selling
square feet, offering overstock and/or distressed appliances,
consumer electronics and lawn and garden merchandise at a
discount.
    Commercial Sales- This business primarily targets home builders,
remodelers and property managers for appliance purchases.
    National Tire & Battery (NTB) These stores offer major
national brands of tires, batteries and related services. This
business was sold to TBC Corporation (TBC) on November 29, 2003.
The results of operations for this business are included in the
Companys financial statements through November 28, 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 products and soft luggage. These products are offered through
multiple selling channels consisting of regular monthly mailings of its catalogs as well as through
the internet, international businesses and 17 retail stores. These retail stores, averaging 6,100
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. Home 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, consumer 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 protection agreements, product installation services and Kenmore and
Carrier residential heating and cooling systems. This business also includes home improvement
services (primarily siding, windows, cabinet refacing, kitchen remodeling and carpet cleaning
provided through Sears Home Improvement Services). Credit and Financial Products- The Credit and Financial Products business included the domestic
credit card receivables portfolio, consisting 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 4




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##### Table of Contents



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 business also sold related financial products such as credit protection
and insurance products. This business was sold on November 3, 2003. The results of operations for
this business 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. Under the long-term marketing and
servicing alliance, Citibank (USA) N.A. provides credit and customer service benefits to the
Companys proprietary and Gold MasterCard holders. In addition, Citibank (USA) N.A. supports the
Companys current zero-percent financing program. 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. Sears Canada The Company conducts similar retail, credit and corporate operations in Canada through Sears
Canada, Inc. (Sears Canada), a consolidated, 54.3% owned subsidiary of Sears. As of January 1,
2005, Sears Canada conducted retail operations through 121 department stores, 49 furniture and
appliance stores, 153 dealer stores operated under independent local ownership, 13 outlet stores,
50 floor covering centers, 6 specialty off-mall stores, approximately 2,300 catalog pick-up
locations, 112 travel offices and over the internet through sears.ca. The 2003 and 2002 segment information has been presented on the 2004 basis  Domestic and Sears
Canada. In addition, the Company has provided, for 2003 and 2002, information on the operating
segments comprising the Domestic segment in 2003 and 2002.   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 1, 2005, January
3, 2004 and December 28, 2002 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 of Financial Condition and Results of Operations. 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 Trade Names The SEARS trade name and service mark is used by the Company. SEARS is the subject of numerous
United States and foreign service mark registrations and is material to the Companys retail
operations and other related businesses. The Company sells proprietary branded merchandise under a number of brand names which are important
to its domestic operations. The Companys LANDS END®, KENMORE® ,
CRAFTSMAN® and DIEHARD® brands are among the most recognized proprietary brands
in retailing. These marks are the subject of numerous United States 5




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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®, COVINGTON®, STRUCTURE®,
A&E FACTORY SERVICE®, WISHBOOK® and SEARS. GOOD LIFE. GREAT PRICE.TM The Companys right to use its trade name and marks continues so long as it uses
them. 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,
automotive retailers, home improvement retailers and national and local product and auto 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 203,000 people in the United States and Puerto Rico, and 44,000
people in Canada, including part-time employees. 6




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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 Domestic
segment. Full-line
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    LandsStores
    
    
    Specialty Stores
    
    
    End
    
    TotalNTB(1)
    
    
    Hardware
    
    
    Dealer
    
    
    Other(2)Stores as of January 1, 2005:Owned
    
    
    519
    
    
    
    
    
    
    
    18
    
    
    
    1
    
    
    
    23
    
    
    
    
    
    
    
    561Leased(3)
    
    
    354
    
    
    
    
    
    
    
    227
    
    
    
    18
    
    
    
    50
    
    
    
    17
    
    
    
    666Independently-owned and operated stores
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    799
    
    
    
    
    
    
    
    
    
    
    
    799Total
    
    
    873
    (4)
    
    
    
    
    
    
    245
    
    
    
    818
    
    
    
    73
    
    
    
    17
    
    
    
    2,026Total stores as of fiscal year-end: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
    )2003
    
    
    871
    
    
    
    
    
    
    
    245
    
    
    
    792
    
    
    
    68
    
    
    
    16
    
    
    
    1,992Stores opened during fiscal 2004
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    36
    
    
    
    7
    
    
    
    1
    
    
    
    50Stores closed during fiscal 2004
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    (2
    )
    
    
    
    
    
    
    (16
    )Stores as of January 1, 2005
    
    
    873
    
    
    
    
    
    
    
    245
    
    
    
    818
    
    
    
    73
    
    
    
    17
    
    
    
    2,026Gross retail area as of fiscal year-endsquare feet in millions2004
    
    
    128.4
    
    
    
    
    
    
    
    8.7
    
    
    
    7.2
    
    
    
    4.6
    
    
    
    0.1
    
    
    
    149.02003
    
    
    127.4
    
    
    
    
    
    
    
    9.2
    
    
    
    6.7
    
    
    
    4.4
    
    
    
    0.1
    
    
    
    147.82002
    
    
    127.6
    
    
    
    2.6
    
    
    
    9.3
    
    
    
    6.4
    
    
    
    4.4
    
    
    
    0.1
    
    
    
    150.4Retail selling area as of fiscal year-endsquare feet in millions2004
    
    
    79.4
    
    
    
    
    
    
    
    6.7
    
    
    
    4.6
    
    
    
    3.1
    
    
    
    0.1
    
    
    
    93.92003
    
    
    79.4
    
    
    
    
    
    
    
    6.7
    
    
    
    4.4
    
    
    
    3.2
    
    
    
    0.1
    
    
    
    93.82002
    
    
    79.1
    
    
    
    0.3
    
    
    
    6.8
    
    
    
    4.1
    
    
    
    3.3
    
    
    
    0.1
    
    
    
    93.7Retail store revenues
            per net selling square
foot(5)2004
    
    $
    2912003
    
    $
    3022002
    
    $
    303
   (1)
    
    Sold in November 2003.(2)
    
    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.(3)
    
    Many of the leases contain renewal options and contingent rentals (for additional
(3) information, see Note 7 of the Notes to Consolidated Financial Statements).(4)
    
    Includes Sears Auto Centers.(5)
    
    Includes net commissions earned from licensed businesses operating within the Retail stores.  7




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In addition, at January 1, 2005, there were 735 supply chain distribution facilities, store
warehouses, customer call centers, and sales and service facilities most of which are leased for
terms ranging from one to 10 years or are part of other Sears facilities included in the table
above. As of January 1, 2005, Sears Canada operated 121 department stores, 49 furniture and appliance
stores, 153 dealer stores operated under independent local ownership, 13 outlet stores, 50 floor
covering centers, 6 specialty off-mall stores, approximately 2,300 catalog pick-up locations and
112 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 certified the consolidated action as a class action.
Discovery is underway. The trial is scheduled to begin in April
2006.  
    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. Discovery is underway. No trial date has been
set.  
    On October 23, 2002, a purported derivative suit was filed in the
Supreme Court of the State of New York (the New York Court)
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 its credit
business. Two similar suits were subsequently filed in the
Circuit Court of Cook County, Illinois (the Illinois State
Court), and a third was filed in the United States District Court
for the Northern District of Illinois. The New York Court
derivative suit was dismissed on June 21, 2004 and the plaintiff
has filed a notice of appeal. The two Illinois State Court
derivative suits were dismissed on September 30, 2004. The order
of dismissal became final on December 1, 2004, and the time to
appeal has expired. The Illinois federal court suit has been
stayed pending resolution of the New York Court derivative action.  
    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 the Companys
domestic wholly-owned financing subsidiary, 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 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 8




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##### Table of Contents



SRAC between October 24, 2001 and October 17, 2002, inclusive. The defendants filed motions to
dismiss the action. On September 24, 2004, the court granted these motions in part, and denied
them in part. The court dismissed the claims related to the March 18 and May 21, 2002 note
offerings because the plaintiff did not purchase notes in those offerings. The court dismissed
the Section 10(b) and Rule 10b-5 claims against several of the individual defendants because the
plaintiff failed to adequately plead such claims. The court sustained the remaining claims. By
leave of court, the plaintiffs filed a second amended complaint on November 15, 2004.
Defendants (other than one of the underwriter defendants) filed motions to partially dismiss the
second amended complaint on January 10, 2005. The defendant that did not move to partially
dismiss filed an answer to the second amended complaint on January 28, 2005, denying all
liability. Following the announcement on November 17, 2004 of the pending business combination transaction
with Kmart, several actions have been filed purporting to challenge the transaction. These
lawsuits are in their preliminary stages, and defendants have not yet been required to respond to
certain of the complaints. The Company believes that all of these claims lack merit and intends to
defend against them vigorously.  
    Three actions have been filed in the Circuit Court of Cook County,
Illinois. These actions assert claims on behalf of a purported
class of the Companys stockholders against the Company and
certain of its officers and directors, together with Kmart, Edward
S. Lampert and other affiliated entities, alleging breach of
fiduciary duty in connection with the mergers. The plaintiffs
allege that the mergers favor interested defendants by awarding
them disproportionate benefits, and that the defendants failed to
take appropriate steps to maximize the value of a merger
transaction for the Companys stockholders. The actions have been
consolidated, and an amended complaint was filed in early January
2005. The amended complaint asserts similar breach-of-fiduciary
duty claims, as well as alleging that defendants have made
insufficient and misleading disclosures in connection with the
mergers, and seeks injunctive relief. The plaintiffs have moved
for expedited discovery. On February 1, 2005, the court granted
the defendants motion to stay or dismiss these actions in favor
of the pending New York actions discussed below. Accordingly,
these actions are stayed pending resolution of the New York
actions. Plaintiffs have filed a notice of appeal of the stay
order to the Appellate Court of Illinois-First District.  
    Two actions have been filed in the Supreme Court of the State of
New York, New York County, asserting substantially similar claims
against the Company and certain of its officers and directors.
The parties have agreed to consolidate these two actions. Pending
consolidation, the defendants moved to dismiss the complaint
in both actions for lack of standing and failure to state a cause
of action. On February 15, 2005, the Court ordered that the two cases
be consolidated as a single action. On February 16, 2005, the plaintiffs
filed a superceding consolidated amended class action complaint. The amended
complaint asserts claims on behalf of a purported class of the Company's stockholders
against the Company and certain of its officers and directors for breach of fiduciary
duty in connection with the mergers on the grounds that defendants allegedly failed
to take proper steps to maximize the value of a merger transaction for the Company's
stockholders. Additionally, the plaintiffs claim that the defendants made insufficient
and misleading disclosures in connection with the mergers. The amended complaint also
names Kmart, Edward S. Lampert, and ESL, Inc. as defendants on the grounds that they
aided and abetted the alleged breaches of fiduciary duty. The amended complaint seeks
provisional and permanent injunctive relief, as well as damages. Also on February 16, 2005,
the plaintiffs filed an order to show cause seeking expedited discovery about the appraisal
of the Company's real estate. A briefing schedule on the motion has not been set.  
    One action has been filed in the United States District Court for
the Northern District of Illinois. This action asserts claims
under the federal securities laws on behalf of a purported class
of the Companys stockholders against the Company and Alan J.
Lacy, for allegedly failing to make timely disclosure of merger
discussions with Kmart during the period November 8 through 16,
2004, and seeks damages. The court has appointed a lead plaintiff
and lead counsel, and an amended complaint is due to be filed by
March 11, 2005. 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 9




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##### Table of Contents



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 10




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##### Table of Contents



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 the Certificate of Incorporation,
which is incorporated in this Annual Report on Form 10-K as to Exhibit 3.1 and incorporated in
this Item 5 by reference. 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 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 preemptive, 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 restrictions
imposed by the Merger Agreement. Those restrictions limit repurchases to open market transactions
to satisfy obligations under the Sears 401(k) Savings Plan, the Lands End Retirement Plan and the
Sears Puerto Rico Savings Plan and prohibit redemptions. The Company has suspended its share
repurchase program as a result of the pending business combination with Kmart. The Merger
Agreement permits payment of cash dividends consistent with past practices. 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
    
    
    Year2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Stock price rangeHigh
    
    $
    48.35
    
    
    $
    28.54
    
    
    $
    43.71
    
    
    $
    34.80
    
    
    $
    41.36
    
    
    $
    46.35
    
    
    $
    54.30
    
    
    $
    55.94
    
    
    $
    54.30
    
    
    $
    55.94Low
    
    
    42.01
    
    
    
    18.50
    
    
    
    36.64
    
    
    
    24.15
    
    
    
    33.34
    
    
    
    32.91
    
    
    
    31.65
    
    
    
    43.59
    
    
    
    31.65
    
    
    
    18.50Close
    
    
    43.06
    
    
    
    23.75
    
    
    
    36.64
    
    
    
    33.36
    
    
    
    40.02
    
    
    
    44.83
    
    
    
    51.03
    
    
    
    44.87
    
    
    
    51.03
    
    
    
    44.87Cash 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 11




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##### Table of Contents



on the following exchanges: Chicago; Pacific, San Francisco; London, England; Amsterdam, the
Netherlands; Swiss EBS; and Düsseldorf, Germany. The number of registered common shareholders as of January 31, 2005 was 141,216. Equity Compensation Plan Information 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 1, 2005. Number of securities to
    
    
    Weighted-average exercise
    
    
    Number of securities remainingbe issued upon exercise
    
    
    price of outstanding
    
    
    available for future issuanceof outstanding options,
    
    
    options, warrants
    
    
    under equity compensation plansPlan Category
    
    warrants and rights
    
    
    and rights
    
    
    (2)Equity compensation plans
approved by security holders
    
    
    13,584,690
    
    
    $
    42.62
    
    
    
    4,659,710Equity compensation plans not
approved by security holders
    
    
    9,227,277
    (1)
    
    $
    31.78
    
    
    
    2,275,057Total
    
    
    22,811,967
    
    
    $
    38.24
    
    
    
    6,934,767
   (1)
    
    The sole equity compensation plan not previously submitted to the Companys shareholders for
approval is the 2001 Broad Based Stock Option Plan. The Company adopted this plan in 2001 to
further enable Sears to align the interests of shareholders with employees by motivating
participants to achieve long-range goals while simultaneously providing a program to attract
and retain eligible associates. The plan provides for the grant of stock options to eligible
associates of Sears with the exception of senior management, which is excluded from
participation. Stock options granted under the plan are nonqualified stock options for tax
purposes, expire 10 years from the date of grant and may contain conditions requiring
participants to satisfy employment, performance or certain other criteria. The exercise price
of the options granted is equal to 100% of the fair market value of Sears stock on the date of
the grant.(2)
    
    Excludes the securities to be issued upon exercise of outstanding options, warrants and rights.  Issuer Purchases of Equity Securities(1) Total Number ofmillions (except average price paid
        
        
        
        
        
        
        
        
        Shares
        
        
        Dollar Value ofper share)
        
        Total
        
        
        
        
        
        
        Purchased as
        
        
        Shares that MayNumber of
        
        
        Average
        
        
        Part of Publicly
        
        
        Yet Be PurchasedShares
        
        
        Price Paid
        
        
        Announced Plan
        
        
        Under the Plan orPurchased
        
        
        per
          Share
        
        
        or
          Programs
        
        
        ProgramsOctober 3, 2004
            to October 30, 2004
        
        
        0.6
        
        
        $
        32.35
        
        
        
        0.6
        
        
        $
        481October 31,
            2004 to November 27, 2004
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        481November 28,
            2004 to January 1, 2005
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        481As of January 1,
            2005
        
        
        0.6
        
        
        $
        32.35
        
        
        
        0.6
        
        
        $
        481
   (1)
    
    On October 8, 2003, the Board of Directors approved a share repurchase program giving the Company authorization to
acquire up to $3.0 billion of the Companys common shares by December 31, 2006.  12




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##### Table of Contents



Item 6. Selected Financial Data Five-Year Summary of Consolidated Financial Data millions, except per common share and shareholders
        
        2004
        
        
        2003(1)
        
        
        2002(2)
        
        
        2001
        
        
        2000OPERATING RESULTSRevenues (3)
        
        $
        36,099
        
        
        $
        41,124
        
        
        $
        41,366
        
        
        $
        40,990
        
        
        $
        40,848Costs and expenses
            (3)
        
        
        35,612
        
        
        
        39,926
        
        
        
        39,285
        
        
        
        39,812
        
        
        
        38,661Operating income
        
        
        487
        
        
        
        1,198
        
        
        
        2,081
        
        
        
        1,178
        
        
        
        2,187Gain on sale of businesses
            (3)
        
        
        
        
        
        
        4,224
        
        
        
        
        
        
        
        
        
        
        
        Other income, net
        
        
        60
        
        
        
        27
        
        
        
        372
        
        
        
        45
        
        
        
        36Income before income
            taxes, minority interest and cumulative effect of change in accounting
            principle
        
        
        547
        
        
        
        5,449
        
        
        
        2,453
        
        
        
        1,223
        
        
        
        2,223Income taxes
        
        
        170
        
        
        
        2,007
        
        
        
        858
        
        
        
        467
        
        
        
        831Income before cumulative
            effect of change in accounting principle
        
        
        332
        
        
        
        3,397
        
        
        
        1,584
        
        
        
        735
        
        
        
        1,343Cumulative effect
            of change in accounting principle (4)
        
        
        (839
        )
        
        
        
        
        
        
        (208
        )
        
        
        
        
        
        
        Net (loss) income
        
        $
        (507
        )
        
        $
        3,397
        
        
        $
        1,376
        
        
        $
        735
        
        
        $
        1,343FINANCIAL POSITIONCredit card receivables,
            net (3)
        
        $
        1,239
        
        
        $
        1,956
        
        
        $
        30,731
        
        
        $
        28,155
        
        
        $
        17,317Retained interest
            in transferred credit card receivables
        
        
        32
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        3,105Merchandise inventories,
            net
        
        
        5,549
        
        
        
        5,335
        
        
        
        5,115
        
        
        
        4,912
        
        
        
        5,618Property and equipment,
            net
        
        
        6,749
        
        
        
        6,788
        
        
        
        6,910
        
        
        
        6,824
        
        
        
        6,653Total assets (3)
        
        
        22,474
        
        
        
        27,723
        
        
        
        50,409
        
        
        
        44,317
        
        
        
        36,899Short-term borrowings
            (5)
        
        
        685
        
        
        
        1,033
        
        
        
        4,525
        
        
        
        3,557
        
        
        
        4,280Long-term debt, including
            current portion (3)(5)
        
        
        3,803
        
        
        
        7,168
        
        
        
        26,112
        
        
        
        22,078
        
        
        
        13,580Total debt (3)(5)
        
        
        4,488
        
        
        
        8,201
        
        
        
        30,637
        
        
        
        25,635
        
        
        
        17,860Shareholders
            equity
        
        $
        6,092
        
        
        $
        6,401
        
        
        $
        6,753
        
        
        $
        6,119
        
        
        $
        6,769SHAREHOLDERS AND
            PER SHARE DATAShareholders
        
        
        141,942
        
        
        
        150,759
        
        
        
        157,378
        
        
        
        164,354
        
        
        
        209,101Average common and
            equivalent shares outstanding
        
        
        217
        
        
        
        286
        
        
        
        321
        
        
        
        329
        
        
        
        346Earnings per common
            share  dilutedIncome before cumulative
            effect of change in accounting principle
        
        $
        1.53
        
        
        $
        11.86
        
        
        $
        4.94
        
        
        $
        2.24
        
        
        $
        3.88Cumulative effect
            of change in accounting principle
        
        
        (3.87
        )
        
        
        
        
        
        
        (0.65
        )
        
        
        
        
        
        
        Net (loss)/income
        
        $
        (2.34
        )
        
        $
        11.86
        
        
        $
        4.29
        
        
        $
        2.24
        
        
        $
        3.88Cash dividends declared
            per common share
        
        $
        0.92
        
        
        $
        0.92
        
        
        $
        0.92
        
        
        $
        0.92
        
        
        $
        0.92Market price 
            per common share (high-low)
        
        
        54.30-
        
        
        
        55.94-
        
        
        
        59.90-
        
        
        
        48.93-
        
        
        
        43.50-31.65
        
        
        
        18.50
        
        
        
        19.71
        
        
        
        29.90
        
        
        
        25.25Closing market price
            at December 31
        
        $
        51.03
        
        
        $
        45.49
        
        
        $
        23.15
        
        
        $
        47.64
        
        
        $
        34.75
  (1)
    Includes the results of operations for domestic 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 Citigroup. (See Note 2 of the Notes
to Consolidated Financial Statements).(4)
    The Company changed its method of accounting for domestic retirement plans in 2004 and goodwill in 2002. (See Notes 9 and 1, respectively, of the Notes to Consolidated
Financial Statements).(5)
    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).  13




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Managements Discussion and Analysis of Financial Condition and Results of Operations 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 four
sections: Overview and Consolidated Operations, Segment Operations, Analysis of Consolidated
Financial Condition and Critical Accounting Estimates. 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, 2004 and 2002 results reflect a 52-week period while 2003 results reflect a
53-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
119-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 200,000 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 its customers homes and family
life. The Company 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 only retailer where consumers
can find each of the Kenmore, Craftsman, DieHard and Lands End 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
2,400 Sears-brand and affiliated stores in the United States and Canada, a product repair and home
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 a compelling customer value proposition
through the combination of high quality products and services at competitive prices. The Company
seeks to deliver a high level of profitability and cash flow by:  §
    maximizing the effectiveness of its retail product pricing through a combination
of everyday low pricing and promotional activity;  §
    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 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. 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 its 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




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##### 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:  §
    strengthening product assortments by:  Ø
    introducing a number of innovative products within home appliances
and home improvement that offer both high-performance and
high-efficiency, andØ
    increasing the fashion content within its apparel offering,
including the introduction of two new proprietary brands 
Structure and A|Line;  §
    focusing on improved gross margin performance by:  Ø
    better leveraging its preferred vendor relationships,Ø
    increasing the amount of product that is sourced directly,Ø
    introducing Profit Logic, a system that provides
innovative pricing analytics, to certain parts of the apparel
business, andØ
    over time, transitioning to an allocation process
allowing us to better assort product to store-specific
demographics as well as more effectively replenish product
during the selling season based upon rate of sale; and  §
    identifying ways to reduce the level of capital invested in store remodels to improve
overall efficiency of the Companys capital expenditures . Another important component of improving the Companys long-term performance is to provide
better access to its products. The Company has aggressively focused on increasing its presence
outside of the traditional mall-based formats. In 2004, the Company expanded its off-mall presence
by:  §
    acquiring ownership or leasehold interest in 50 off-mall stores in key Sears
markets from Kmart for $576 million. Sears expects to take possession of the stores in the
Spring of 2005 and is targeting to open the stores under Sears nameplates by the end of
2005;  §
    subleasing six stores from Wal-Mart Stores, Inc. Sears opened two stores in 2004 and is
targeting to take possession of two stores in 2005 and two stores in 2006; and  §
    developing the new Sears Grand format which had four locations at the end of 2004. The acquired stores are a unique opportunity to rapidly enter attractive markets for the
Company. The newly acquired stores will offer a relevant subset of traditional categories,
including apparel, home appliances, consumer electronics, home improvement and home fashions, plus
consumables and transactional items. Where possible, the floor design of the new stores will be on
one level, utilizing a common layout similar to the open-racetrack design of existing Sears Grand
stores, with exit cashiering near the front entrance/exit. These strategic initiatives are necessary as the Companys 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. Sears combination with
Kmart, which will result in the formation of a new holding company called Sears Holdings Corporation, is
anticipated to
dramatically accelerate the Companys off-mall growth strategy.
The merger, if approved, is expected to create the third largest U.S. retailer, with initially approximately $55 billion in annual revenues
and 2,350 full-line and off-mall stores, and 1,100 specialty retail stores in the United States.
The advantages and efficiencies that are expected to come from increased scale should allow the
combined company to grow at a pace that exceeds what could be accomplished by Sears on its own. 15




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##### Table of Contents



The following discussion addresses Sears results of operations and financial condition without
taking into consideration the pending merger. Overall, the Companys operating results for 2004 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 data2004
    
    
    2003
    
    
    2002Merchandise sales and services revenues
    
    $
    35,718
    
    
    $
    36,372
    
    
    $
    35,698Domestic comparable store sales
    
    
    -1.4
    %
    
    
    -2.7
    %
    
    
    -5.6
    %Credit and financial products revenues
    
    
    381
    
    
    
    4,752
    
    
    
    5,668Total revenues
    
    $
    36,099
    
    
    $
    41,124
    
    
    $
    41,366Gross margin rate
    
    
    27.2
    %
    
    
    27.9
    %
    
    
    28.2
    %Selling and administrative expense as a percentage
of total revenues
    
    
    22.8
    %
    
    
    22.2
    %
    
    
    22.4
    %Operating income
    
    $
    487
    
    
    $
    1,198
    
    
    $
    2,081Gain on sale of businesses
    
    $
    
    
    
    $
    4,224
    
    
    $
    Cumulative effect of change in accounting principle
    
    $
    (839
    )
    
    $
    
    
    
    $
    (208
    )Net (loss)/income
    
    $
    (507
    )
    
    $
    3,397
    
    
    $
    1,376(Loss)/earnings per share  diluted
    
    $
    (2.34
    )
    
    $
    11.86
    
    
    $
    4.29
 Effective January 4, 2004, the Company changed its method for recognizing gains and losses for
both its domestic pension and postretirement benefit plans. The Company began recognizing
experience gains and losses on a more current basis, while under its previous methods, the Company
amortized experience gains and losses over future service periods. As a result of this accounting
change, the Company recorded an after-tax charge of $839 million, or $3.81 per share, in the first
quarter of 2004 for the cumulative effect of change in accounting principle. The charge represents
the recognition of unamortized experience gains and losses at the beginning of 2004 in accordance
with the new accounting methods. The results of operations for the 53-week period ended January 3, 2004 include the results of
operations for the divested businesses, Credit and Financial Products and NTB. The Company believes that an understanding of its reported results and its ongoing financial
performance is not complete without considering the impact the following items had on the results
of operations for the fiscal years 2004, 2003 and 2002, respectively. These items relate to the
change in accounting related to construction allowances on certain Sears Canada properties, the
deconsolidation of Sears Canadas securitized receivables, costs associated with the pending merger
with Kmart, the Companys refinement of its business strategy, and the results of operations of
divested businesses. Items like these affect the Companys results from time to time. However,
the amounts of these types of items may vary significantly from period to period and have a
disproportionate effect on the periods presented, which affects the comparability of the Companys
financial performance. Management considers the total impact of these items, along with reported
results, when they review and evaluate the Companys financial performance. 16




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##### Table of Contents



millions
    
    2004
    
    
    2003
    
    
    2002Merger related costs
    
    $
    13
    
    
    $
    
    
    
    $
    Sears Canada securitization of receivables
    
    
    (32
    )
    
    
    
    
    
    
    Sears Canada construction allowances
    
    
    51
    
    
    
    
    
    
    
    Negative carry related to Credit legacy debt and related
debt retirement costs
    
    
    84
    
    
    
    18
    
    
    
    Curtailment gain on post-retirement medical plans
    
    
    (30
    )
    
    
    
    
    
    
    Employment termination costs
    
    
    41
    
    
    
    28
    
    
    
    Charges associated with the refinement of TGI business strategy
    
    
    
    
    
    
    141
    
    
    
    Charges associated with conversion of Sears Canada Eatons stores
    
    
    
    
    
    
    
    
    
    
    111Accelerated depreciation resulting from CSC purchased services
transaction
    
    
    39
    
    
    
    
    
    
    
    Gain on sale of domestic Credit and Financial Products Business
    
    
    
    
    
    
    (4,143
    )
    
    
    Gain on sale of NTB
    
    
    
    
    
    
    (81
    )
    
    
    Loss on early retirement of debt
    
    
    
    
    
    
    791
    
    
    
    Pro forma effects on the prior year:Divested businesses:Operating income
    
    
    
    
    
    
    (1,299
    )
    
    
    (1,224
    )Zero-percent financing costs
    
    
    
    
    
    
    211
    
    
    
    216Pro forma revenues earned under Citigroup alliance
    
    
    
    
    
    
    125
    
    
    
    167Total divested businesses
    
    
    
    
    
    
    (963
    )
    
    
    (841
    )Total
    
    $
    166
    
    
    $
    (4,209
    )
    
    $
    (730
    )
  §
    Total revenues decreased 12.2% from 2003, which in turn were 0.6% lower than 2002.
The decrease in 2004 reflects the decline in credit and financial products revenues, of $4,752
million, as a result of the sale of the domestic Credit and Financial Products business, the
sale of NTB, which had revenues of $400 million in 2003, domestic comparable store sales
declines and the additional fiscal week in 2003. The 53rd week favorably impacted
2003 merchandise sales and services revenues by approximately $560 million.  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
$560 million.  §
    The decline in 2004 gross margin rate compared with 2003 results from higher levels of
clearance activity coupled with the need to take deeper markdowns in order to clear seasonal
and slower moving inventory as a result of weak sales trends.  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.  §
    Overall, selling and administrative expenses as a percentage of total revenues increased in
2004 primarily due to a reduction in expense leverage resulting from the divestiture of the
domestic Credit and Financial Products and NTB businesses coupled with lower overall sales.  The decrease in selling and administrative expenses in 2003 compared to 2002 is primarily due
to lower expenses for the domestic Credit and Financial Products business. Savings realized
from productivity improvements were more than offset by higher expenses in Sears Canada due to
the stronger Canadian dollar 17




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##### Table of Contents



and the inclusion of Lands End for the full year of fiscal 2003.  §
    The increase in depreciation and amortization in 2004 compared to
2003 is due to $39 million of additional depreciation expense
related to shortening the estimated remaining useful life for
assets sold to Computer Sciences Corporation and $51 million of
additional depreciation expense recorded as a result of a revision
in the Companys accounting for construction allowances.
Previously landlord construction allowances were amortized as a
reduction of depreciation expense over the estimated useful life
of the property. The Company will now record construction
allowances as deferred credits, which will be amortized as a
reduction of rent expense over the lease term. The cumulative
effect of this correction resulted in the Company recording $51
million of additional depreciation expense in the fourth quarter
of 2004.  §
    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 $41 million in 2004, $140 million in 2003 and $111
million in 2002. The actions taken over the past three years are
as follows:  Ø
    During 2004, the Company completed a review of its headquarters
and field support structure to identify opportunities to streamline its
operations to improve profitability and allow the Company to focus its
efforts on retail operations. As a result, the Company recorded a pretax
charge of $41 million related to employee termination costs.  Ø
    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. In addition, the Company recorded a $28
million pretax charge for severance costs associated with the Companys
productivity improvement initiatives.  Ø
    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
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.  §
    In 2003, the 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.  §
    In 2003, 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.  §
    The decrease in the 2004 effective income tax rate to 31.1% from
36.8% in 2003 is primarily due to increased levels of tax exempt
interest income and tax credits awarded to Sears under a U.S.
federal program designed to encourage companies to make commercial
investments in low-income communities across the United States. 18




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##### Table of Contents



§
    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 2003.
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. 19




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##### Table of Contents



SEGMENT OPERATIONS During fiscal 2004, the Company was organized into two principal business segments  Domestic
and Sears Canada. Following is a discussion of results of operations by business segment. Domestic Domestic results and key statistics were as follows: millions, except number of stores and Retail storerevenues per net selling square foot2004
    
    
    2003
    
    
    2002Full-line Stores
    
    $
    22,287
    
    
    $
    22,863
    
    
    $
    23,028Specialty Stores
    
    
    4,748
    
    
    
    5,072
    
    
    
    5,106Direct to Customer
    
    
    1,614
    
    
    
    1,752
    
    
    
    1,175Home Services
    
    
    2,581
    
    
    
    2,527
    
    
    
    2,476Merchandise sales and services revenues
    
    
    31,230
    
    
    
    32,214
    
    
    
    31,785Credit and Financial Products revenues
    
    
    
    
    
    
    4,429
    
    
    
    5,392Total domestic revenues
    
    
    31,230
    
    
    
    36,643
    
    
    
    37,177Cost of sales, buying and occupancy
    
    
    22,800
    
    
    
    23,313
    
    
    
    22,864Gross margin as a percentage of revenues
    
    
    27.0
    %
    
    
    27.6
    %
    
    
    28.1
    %Selling and administrative
    
    
    7,038
    
    
    
    7,956
    
    
    
    8,213Selling and administrative as a percentage of revenues
    
    
    22.5
    %
    
    
    21.7
    %
    
    
    22.1
    %Provision for uncollectible accounts
    
    
    
    
    
    
    1,695
    
    
    
    2,203Depreciation and amortization
    
    
    815
    
    
    
    797
    
    
    
    783Interest, net
    
    
    168
    
    
    
    915
    
    
    
    1,049Loss on early retirement of debt
    
    
    
    
    
    
    791
    
    
    
    Special charges and impairments
    
    
    41
    
    
    
    140
    
    
    
    Total costs and expenses
    
    
    30,862
    
    
    
    35,607
    
    
    
    35,112Operating income
    
    $
    368
    
    
    $
    1,036
    
    
    $
    2,0652004
    
    
    2003
    
    
    2002Number of:Full-line Stores
    
    
    873
    
    
    
    871
    
    
    
    872Specialty Stores
    
    
    1,136
    
    
    
    1,105
    
    
    
    1,305Lands End Retail Stores
    
    
    17
    
    
    
    16
    
    
    
    15Total Retail Stores
    
    
    2,026
    
    
    
    1,992
    
    
    
    2,192Retail store revenues per net selling square foot
    
    $
    291
    
    
    $
    302
    
    
    $
    303Comparable store sales percentage decrease(-)/increase(+) (1) (2)Home Group
    
    
    -0.3
    %
    
    
    -1.6
    %
    
    
    -5.7
    %Apparel/accessories
    
    
    -5.2
    %
    
    
    -4.2
    %
    
    
    -10.2
    %Full-line Stores
    
    
    -1.9
    %
    
    
    -2.7
    %
    
    
    -6.7
    %Specialty Stores
    
    
    +1.8
    %
    
    
    -2.7
    %
    
    
    +0.9
    %Total
    
    
    -1.4
    %
    
    
    -2.7
    %
    
    
    -5.6
    %
  (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.  20




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##### Table of Contents



2004 Compared with 2003 Merchandise sales and services revenues decreased 3.1% from the prior year primarily due to the
53rd week in fiscal 2003 and a reduction in revenues due to the divestiture of NTB in
the fourth quarter of 2003. In addition, domestic comparable store sales declined 1.4%, excluding
the 53rd week in 2003. Sales increases in many of the Full-Line Store hardlines businesses in a challenging competitive
environment were insufficient to overcome weak apparel trends. Comparable store sales in consumer
electronics increased 1.1% primarily due to positive customer response to the reset of the
electronics department and a shift in focus to three core product categories: video, digital
imaging, and family entertainment. Home appliance sales increased slightly in 2004 primarily due
to increases in cooking and laundry. Apparel comparable sales decreased 5.2% compared to the
previous year, with decreases across all categories primarily due to slow seasonal transitions,
insufficient levels of fashion-oriented product and the overall decline in apparel inventory during
the first half of the year as the Company overcorrected its inventory level overages faced in
fiscal 2003. Specialty Stores revenues in 2004 decreased 6.4% compared to the prior year, due to the loss of
revenues from the divested NTB business and the impact of the 53rd week in fiscal 2003.
A 1.8% increase in comparable store sales was driven by growth across all business formats, led by
The Great Indoors and hardware stores. Direct to Customer revenues in 2004 declined 7.9%, primarily due to a decrease in revenues from the
Lands End direct to customer business and the impact of the 53rd week in fiscal 2003. Home Services revenues in 2004 increased 2.1% compared to the prior year despite the
53rd week reported in 2003. Revenues increased primarily due to strong growth in the
Home Improvement Services business, including window installation, vinyl siding and kitchen
remodeling services. Gross margin as a percentage of merchandise sales and services revenues in 2004 decreased 60 basis
points compared to 2003 due to increased markdowns taken in consumer electronics, home appliances
and apparel. Within consumer electronics and home appliances, aggressive markdowns were taken in
anticipation of business resets and the introduction of new products. Within apparel, a higher
level of promotional markdowns coupled with a higher rate of clearance markdowns taken on slower
moving inventory negatively impacted the gross margin rate. Domestic selling and administrative expense as a percentage of domestic total revenues increased 80
basis points primarily due to a reduction in expense leverage resulting from lower comparable store
sales in 2004 and the impact of the 53rd week in 2003, as well as the effect of the sale
of the domestic Credit and Financial Products business, which had a lower expense structure than
the retail businesses. Also included in 2004 selling and administrative expenses was a $30 million post-retirement medical curtailment gain and $13 million
of direct costs associated with the pending merger with Kmart. Interest expense decreased in 2004 compared to the prior year, which included interest expense
related to the domestic Credit and Financial Products business that was sold in November 2003.
Also included in the 2003 interest expense was $791 million due to the loss on the early retirement
of debt. Special charges and impairments in 2004 included a pretax charge for severance costs of $41 million
associated with the restructuring of the Companys home office operations. In 2003, the Company
recorded a $141 million charge related to the its refinement of the TGI business strategy. Of the
$141 million, $112 million was recorded in special charges and impairments and $29 million was
recorded in cost of sales, buying and occupancy. In addition, a $28 million pretax charge was
recorded in special charges and impairments for employee termination costs associated with the
Companys productivity improvement initiatives. The decrease in operating income in 2004 as compared to the prior year was primarily due to the
loss of operating income of the divested domestic Credit and Financial Products and NTB businesses. 21




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##### Table of Contents



2003 Compared with 2002 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 Citigroup.
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 the early
retirement of debt. 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 and $465 million in 2003 and 2002,
respectively. Merchandise sales and services revenues increased 1.3% over the prior year primarily due to
the 53rd week in fiscal 2003, which impacted revenues by approximately $560 million, and
a full year of revenues from the Lands End direct to customer business, which was acquired in June
2002. These increases were partially offset by comparable store sales declines in the Full-line
Stores. 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
consumer electronics, which continued 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 compared 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
hardware stores, outlet stores, TGI and NTB. Direct to Customer revenues increased to $1.8 billion in 2003 compared to $1.2 billion in 2002,
primarily due to 2003 benefiting from a full year of revenues from the Lands End direct to
customer business versus six months in 2002. Lands End contributed approximately $1.6 billion in
direct to customer revenues in 2003 compared with $1.0 billion in 2002. Home Services revenues of $2.5 billion in 2003 were up slightly from the prior year. Increased
revenues generated from service contracts and from various home improvement businesses, such as cabinet refacing and kitchen remodeling, were partially 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. 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 decline in gross margin as a percentage of merchandise sales and services revenues in 2003
as compared to 2002 occurred as a result of a significant increase in promotional markdowns and
clearance activities, primarily in apparel categories. This decline was partially offset by
continued improvements in vendor sourcing and the inclusion of Lands End, which has a higher gross
margin rate. 22




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##### Table of Contents



Selling and administrative expense savings recognized in 2003 from productivity initiatives were
partially offset by the inclusion of a full year of operating expenses of the Lands End direct to
customer business. The decrease in the provision for uncollectible accounts was primarily attributable to reduced
adjustments to the allowance for uncollectible accounts in 2003 as compared to 2002. The 2003
provision included a $110 million increase to the allowance for uncollectible accounts due to the
increase in delinquencies and charge-off rates, attributable to the seasoning of the MasterCard
portfolio. This provision was partially offset by a $93 million pretax gain related to the sale of
approximately $2.5 billion of previously charged-off credit card receivable accounts. 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 expense decreased in 2003 compared to the prior year due 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. In addition, 2003 interest expense was favorably impacted by lower
levels of outstanding debt due to the early retirement of debt previously discussed. Special charges and impairments in 2003 included costs related to asset impairment, contractual
obligations and employee terminations incurred in connection with the Companys refinement of its
TGI business strategy in the third quarter of 2003. The total pretax charge associated with the
refinement was $141 million. Of the $141 million, $112 million was recorded in special charges and
impairments and $29 million of this charge was related to inventory clearance costs and was
recorded in cost of sales, buying and occupancy. During the second quarter of 2003, the Company
also recorded a $28 million pretax charge for employee termination costs associated with the
Companys productivity improvement initiatives. In connection with the debt retirement activities related to the sale of the domestic Credit and
Financial Products business, the Company recorded a pretax loss of $791 million, representing premiums paid on the 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. The decrease in operating income in 2003 as compared to the prior year was primarily due to the
$791 million loss on early retirement of debt and the $140 million pretax charge related to the
refinement of the TGI business strategy and the Companys ongoing productivity initiatives. 23




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##### Table of Contents



Sears Canada Sears Canada results were as follows: millions, except foreign exchange rate
    
    2004
    
    
    2003
    
    
    2002Merchandise sales and services
    
    $
    4,488
    
    
    $
    4,158
    
    
    $
    3,913Credit revenues
    
    
    381
    
    
    
    323
    
    
    
    276Total revenues
    
    
    4,869
    
    
    
    4,481
    
    
    
    4,189Cost of sales, buying and occupancy
    
    
    3,197
    
    
    
    2,918
    
    
    
    2,782Gross margin as a percentage of revenues
    
    
    28.8
    %
    
    
    29.8
    %
    
    
    28.9
    %Selling and administrative
    
    
    1,207
    
    
    
    1,127
    
    
    
    1,036Selling and administrative as a percentage of revenues
    
    
    24.8
    %
    
    
    25.2
    %
    
    
    24.7
    %Provision for uncollectible accounts
    
    
    64
    
    
    
    52
    
    
    
    58Depreciation and amortization
    
    
    174
    
    
    
    112
    
    
    
    92Interest, net
    
    
    108
    
    
    
    110
    
    
    
    94Special charges and impairments
    
    
    
    
    
    
    
    
    
    
    111Total costs and expenses
    
    
    4,750
    
    
    
    4,319
    
    
    
    4,173Operating income
    
    $
    119
    
    
    $
    162
    
    
    $
    16Comparable store sales percentage
increase(+)/decrease(-) (C$)
    
    
    +1.6
    %
    
    
    -4.9
    %
    
    
    -4.3
    %Foreign currency exchange rate (annual average)
    
    
    0.7701
    
    
    
    0.7122
    
    
    
    0.6359
 2004 Compared with 2003 Merchandise sales and services revenues increased 7.9% for the 52-week period in 2004 as
compared to the 53-week period in 2003 due to a favorable foreign currency exchange rate. The
increase in the foreign currency exchange rate accounted for approximately $340 million of the year
over year increase. Comparable store sales, on a Canadian dollar (C$) basis, excluding the
53rd week in 2003, increased 1.6% over the prior year. Increases in major appliances,
home furnishings, footwear and menswear, were partially offset by declines in childrens apparel
and housewares. Credit revenues increased 18.0% compared to the prior year primarily due to the effects of foreign
currency exchange rates and a fourth quarter 2004 amendment to the provisions of its credit card
securitization program which resulted in the Company no longer consolidating the securitization
trusts to which the receivables are sold. Previously, the receivables and corresponding debt
related to its securitzation trusts were consolidated. The Company recognized $32 million of
credit revenues as a result of these amendments in 2004. Within Sears Canadas credit operations,
the net charge-off rate decreased to 5.0% in 2004 from 5.7% in 2003. The decline in the gross margin rate in 2004 as compared to 2003 is due to a higher mix of
promotional sales, a balance of sales shift to lower margin products such as major appliances and
home furnishings and aggressive markdown actions taken throughout the year to clear seasonal inventory. Inventory levels were well controlled throughout the year and
remained consistent with 2003 levels. Selling and administrative expense as a percentage of total revenues decreased in 2004 primarily
due to a decrease in advertising expense, as well as a decrease in payroll and benefits expense
resulting from lower headcount and reduced employee related costs. These decreases were partially
offset by expenses recorded in the first quarter of 2004 related to Sears Canadas decision to
license Sears Canada Auto Centers to three auto service providers. 24




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##### Table of Contents



The increase in depreciation and amortization in 2004 compared to 2003 is due to $51 million
of additional depreciation expense recorded as a result of a revision in Sears Canadas accounting
for construction allowances. Previously landlord construction allowances were amortized as a
reduction of depreciation expense over the estimated useful life of the property. Overall, operating income for 2004 improved slightly over the prior year, with the benefits of
foreign currency exchange and improved selling and administrative expense leverage being offset by
the decline in gross margin rate. 2003 Compared with 2002 Merchandise sales and services revenues increased 6.3% in 2003 due to the benefit of exchange
rates, partially offset by a decrease in comparable store sales. Comparable store sales, on a C$
basis, excluding the 53rd week in 2003, decreased 4.9% in 2003. Sales in most
merchandise categories declined from the previous year, including furniture, hardware, sporting
goods, toys and consumer electronics. Sales in major appliances were positive compared to 2002,
which is consistent with industry growth brought about by strong housing starts. Credit revenues increased 17.0% compared to the prior year due to an increase in balances,
specifically for Sears Canada MasterCard, and the effect of foreign currency exchange rates.
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% 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 $16 million compared to the prior year as C$ based interest expense from reduced funding requirements was more than 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. ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION The Company ended the year with approximately $4.2 billion of cash and investments, a decrease of
$4.9 billion from the prior year. During 2004, the Company utilized cash and investments for
working capital needs as well as to retire $2.6 billion of domestic term debt and repurchase $1.1
billion of common shares. The Company also expended cash to pay approximately $1.3 billion of
taxes associated with the sale of its Credit and Financial Products business. The Company expects
to retire an additional $297 million of domestic term debt in 2005. 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: 25




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millions
    
    2004
    
    
    2003
    
    
    2002Full-line Stores, primarily remodeling and expansion efforts
    
    $
    628
    
    
    $
    653
    
    
    $
    636Specialty Stores
    
    
    20
    
    
    
    29
    
    
    
    113Other domestic  distribution/support
    
    
    97
    
    
    
    111
    
    
    
    169Sears Canada
    
    
    137
    
    
    
    132
    
    
    
    117Total capital expenditures
    
    $
    882
    
    
    $
    925
    
    
    $
    1,035
 The Company plans capital expenditures of approximately $600 million for 2005. The 2005
domestic capital plan contemplates the relocation of one Full-Line Store, opening of five Sears
Grand stores, opening and relocation of five Hardware stores and the conversion of approximately 50
off-mall stores acquired from Kmart and two Wal-Mart 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, off-balance sheet debt related to
the securitization of credit card receivables, dividend payments and share issuances and
repurchases. The Companys total funding balances as of year-end were as follows: January 1, 2005
    
    
    January 3, 2004millions
    
    Domestic
    
    
    Sears Canada
    
    
    Domestic
    
    
    Sears CanadaShort-term borrowings
    
    $
    685
    
    
    $
    
    
    
    $
    719
    
    
    $
    314Long-term debt (including current portion):Long-term borrowings
    
    
    2,720
    
    
    
    528
    
    
    
    5,336
    
    
    
    1,245Capitalized lease obligations
    
    
    340
    
    
    
    146
    
    
    
    355
    
    
    
    142Securitized borrowing
    
    
    
    
    
    
    1,039
    
    
    
    
    
    
    
    SFAS No. 133 hedge accounting adjustment
    
    
    69
    
    
    
    
    
    
    
    90
    
    
    
    Total funding
    
    $
    3,814
    
    
    $
    1,713
    
    
    $
    6,500
    
    
    $
    1,701
 The decrease in total funding from January 3, 2004 is primarily due to the retirement of $2.6
billion of domestic term debt. Effective December 31, 2004, amendments made to the Sears Canada
securitization trusts classified the trusts as qualified special purpose entities and as such, they
are no longer required to be consolidated within Sears. As a result, as of January 1, 2005, the
securitized funding is no longer reported within the consolidated balance sheet. 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 The Companys primary need for liquidity is to fund capital expenditures and the seasonal working
capital requirements of its retail business. These needs generally will be funded by the Companys
liquid investment portfolio and operating cash flows. 26




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##### Table of Contents



The Companys total cash and available-for-sale investment portfolio as of January 1, 2005 and
January 3, 2004 were as follows: January 1, 2005
    
    
    January 3, 2004Sears
    
    
    
    
    
    
    Searsmillions
    
    Domestic
    
    
    Canada
    
    
    Domestic
    
    
    CanadaCash and cash equivalents
    
    $
    4,102
    
    
    $
    63
    
    
    $
    8,959
    
    
    $
    98Available-for-sale securities
    
    
    52
    
    
    
    
    
    
    
    
    
    
    
    Total cash and available-for-sale investments
    
    $
    4,154
    
    
    $
    63
    
    
    $
    8,959
    
    
    $
    98
 In order to ensure liquidity and provide additional capacity, the Company intends to maintain
access to capital markets. The Companys domestic wholly-owned financing subsidiary, SRAC, has an
unsecured, three-year revolving credit facility in the amount of $2.0 billion. No borrowings were
outstanding under this committed credit facility in 2004. This facility and other debt agreements
require SRAC to maintain specified fixed charge coverage ratios, and the credit facility requires
the Companys domestic segment to maintain a minimum level of tangible net worth and a minimum
interest coverage ratio. SRAC and the Company were in compliance with these covenants at January
1, 2005. This credit facility does not contain provisions that would restrict borrowings based on
material adverse changes or credit ratings. In connection with the pending merger with Kmart, SRAC and Kmart are in the process of obtaining a
$4.0 billion, five-year senior secured revolving credit facility. The new facility would be
guaranteed by Holdings, Sears, Kmart and certain of their respective subsidiaries, and would be
secured by the inventory and credit card receivables of Sears and Kmart Corporation and certain of
their respective subsidiaries. The facility is expected to be effective upon the closure of the
merger and is not expected to contain provisions that would restrict borrowings based on material
adverse changes or credit ratings. This credit facility would replace the $2.0 billion credit
facility described above. The ratings of the Companys domestic debt securities as of January 1, 2005, appear in the table
below: Moodys
    
    
    Standard &Investors
    
    
    Poors Ratings
    
    
    FitchService
    
    
    Services
    
    
    RatingsUnsecured long-term debt
    
    Baa2
    
    BBB
    
    BBB-Unsecured commercial paper
    
    
    P-2
    
    
    
    A-2
    
    
    
    F3
 On November 17, 2004, Moodys Investors Services (Moodys) lowered the Companys domestic
unsecured long-term debt rating from Baa1 to Baa2, keeping this rating on review for possible
downgrade, and placed the Companys domestic unsecured short-term rating on review for possible
downgrade. Fitch Ratings placed the Companys domestic unsecured debt ratings on Ratings Watch
negative. These actions are primarily a result of the announcement of the Companys proposed merger
with Kmart. Standard & Poors Rating Services (Standard & Poors) also announced on this date
that the Companys domestic unsecured short-term and long-term debt ratings will remain on
CreditWatch with negative implications where they were initially placed October 21, 2004. A downgrade of the Companys short-term rating by either Standard & Poors or Moodys would reduce
its flexibility to issue commercial paper, affecting the cost, placement term and, potentially, the
amount of short-term debt available. However, the Company believes that it has cash and
investments necessary to refund all commercial paper outstanding as well as to meet near-term
working capital needs. The Company does not expect that a one notch downgrade of its long-term debt by either Standard &
Poors or Moodys would substantially affect its ability to access the term debt capital markets.
However, depending upon market conditions, the amount, timing, and pricing of new borrowings could
be adversely affected. If two or more 27




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of the Companys domestic long-term debt ratings are
downgraded to below BBB-/Baa3, the Companys flexibility to access the term debt capital markets
would be reduced. In the event of a downgrade of the Companys long-term debt, the cost of borrowing and fees payable under SRACs current credit facility could increase. None of the Companys borrowing arrangements have provisions that would require repayment of
principal prior to maturity due to a ratings downgrade. The Company has been advised
that, upon completion of the pending merger with Kmart,
Holdings unsecured long-term debt will be rated Ba1, BB+, and BB by Moodys, Standard & Poors, and Fitch,
respectively. These ratings are below these rating agencies investment grade ratings.
In addition, the Company has been advised that its domestic long-term
debt securities will be rated BB+ and BB by Standard & Poors and Fitch,
respectively, and continues to be reviewed for possible downgrade by
Moodys. Such rating actions will reduce Holdings flexibility to access the term debt capital markets
and increase the cost of such borrowings. In addition, the Company
expects Holdings commercial paper
ratings will no longer be investment grade, and as such, the Company
would not expect Holdings to be able to
access the commercial paper market following the merger. 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: Contractual Obligations
    
    
    
    
    
    Payments Due by PeriodWithin
    
    
    
    
    
    
    
    
    
    
    Aftermillions
    
    Total
    
    
    1 Year
    
    
    2-3 Years
    
    
    4-5 Years
    
    
    5 YearsLong-term debt (1)
    
    $
    3,257
    
    
    $
    297
    
    
    $
    1,063
    
    
    $
    523
    
    
    $
    1,374Short-term debt
    
    
    685
    
    
    
    685
    
    
    
    
    
    
    
    
    
    
    
    Capital lease obligations
    
    
    486
    
    
    
    33
    
    
    
    61
    
    
    
    52
    
    
    
    340Kmart leasehold interest
    
    
    404
    
    
    
    404
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    
    2,580
    
    
    
    369
    
    
    
    600
    
    
    
    436
    
    
    
    1,175Total contractual obligations
    
    $
    7,412
    
    
    $
    1,788
    
    
    $
    1,724
    
    
    $
    1,011
    
    
    $
    2,889
  (1) Excludes $9 million of discount on long-term debt and does not include an estimate of future interest payments.  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 indicated in Note 9 of the Notes to Consolidated Financial Statements, the projected benefit
obligation of the Companys defined benefit plans exceeded plan assets by $0.9 billion at the end
of 2004 as compared to $0.7 billion at the end of 2003. This increase in net obligation was
primarily due to the growth in plan obligations resulting from lower discount rates. The Company
expects to contribute approximately $100 million to the domestic pension plan in 2005. 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. 28




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Off-Balance Sheet Arrangements:
    
    
    
    
    
    Amount of Expiration Per PeriodTotalAmount
    
    
    Within
    
    
    
    
    
    
    
    
    
    
    Aftermillions
    
    Committed
    
    
    1 Year
    
    
    2-3 Years
    
    
    4-5 Years
    
    
    5 YearsSecuritized borrowings
    
    $
    1,039
    
    
    $
    460
    
    
    $
    267
    
    
    $
    
    
    
    $
    312Import letters of credit
    
    
    198
    
    
    
    198
    
    
    
    
    
    
    
    
    
    
    
    Secondary lease obligations
    
    
    100
    
    
    
    17
    
    
    
    27
    
    
    
    20
    
    
    
    36Standby letters of credit
    
    
    151
    
    
    
    145
    
    
    
    1
    
    
    
    
    
    
    
    5Guarantee
    
    
    57
    
    
    
    17
    
    
    
    40
    
    
    
    
    
    
    
    
 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. Inventory valuation Approximately 86% 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 and obsolescence 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, asbestos and environmental, 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 29




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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 historically 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 changed its
method of accounting for its domestic defined benefit plans in the first quarter of 2004 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 recorded an after-tax charge of $839 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 is at the 10% corridor limit at the beginning of 2005,
additional pension expense will be recognized in 2005 for the full amount of any experience losses
realized in 2005. 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 2004, the Company
lowered the discount rate used to determine the pension obligation from 6.00% to 5.75% based on the
lower interest rate environment. A further 25 basis point change in the discount rate would
generate an experience gain or loss of approximately $100 million. 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. 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. 30




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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. Domestic and foreign tax authorities periodically audit the Companys income tax returns. These
audits include questions regarding its tax filing positions, including the timing and amount of
deductions and the allocation of income among various tax jurisdictions. In evaluating the
exposures associated with its various tax filing positions, the Company records reserves for
probable exposures. A number of years may elapse before a particular matter, for which the Company
has established a reserve, is audited and fully resolved. Annual tax examinations of Sears are
performed by the United States Internal Revenue Service and various state and local tax
authorities. Similarly, Sears Canada is examined each tax year by the Canada Revenue Agency and
various provincial tax authorities. Generally, the tax years for Sears prior to 1998 and for Sears
Canada prior to 1999 are closed to examination. 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 of Financial
Condition and Results of Operations. 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 contain forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. Such statements include, but are not limited to, statements about the expected benefits of the business combination transaction with
Kmart, and future financial and operating results. Such statements are based upon the current
beliefs and expectations of Kmarts and Sears management and are subject to significant risks and
uncertainties. Actual results may differ from those set forth in the forward-looking statements. The following factors, among others, could cause actual results to differ from those set forth in
the forward-looking statements: the timing of receipt of regulatory approvals in connection with
the transaction; the failure of Kmart and Sears stockholders to approve the transaction; the risk
that the businesses will not be integrated successfully; failure to quickly realize synergies and
cost-savings from the transaction as a result of technical, logistical, competitive and other
factors; disruption from the transaction making it more difficult to maintain relationships with
clients, employees or suppliers; competitive conditions in retail and related services industries;
changes in consumer confidence, tastes, preferences and spending; the availability and level of
consumer debt; the successful execution of, and customer response to, strategic initiatives,
including the full-line store strategy and the conversion and integration of the Kmart stores and
other new store locations; the pace of growth in store locations, which may be higher or lower than
anticipated; the possibility that new business and strategic options for one or more business
segments will be identified, potentially including selective acquisitions, dispositions,
restructurings, joint ventures and partnerships; trade restrictions, tariffs, and other factors
potentially affecting the ability to find qualified vendors and access products in an efficient
manner; the ability to successfully implement initiatives to improve inventory management
capabilities; anticipated cash flow; changes in interest rates; the outcome of pending legal
proceedings and bankruptcy claims; social and political conditions such as war, political unrest
and terrorism or natural disasters; the possibility of negative investment returns in any pension
plans; volatility in financial markets; the terms and availability of debt financing; changes in
debt ratings, credit spreads and cost of funds; the possibility of interruptions in systematically
accessing the public debt markets; the impact of seasonal buying patterns, which are difficult to
forecast with certainty; and general economic conditions and normal business uncertainty. These
forward-looking statements speak only as of the time first made, and no undertaking has been made
to update or revise them as more information becomes available. 31




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##### Table of Contents



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 funding obligations and derivative financial instruments. The Companys policy is to
manage interest rate risk through the use of fixed and variable rate funding and interest rate
derivatives. All debt securities and derivative instruments are considered non-trading. At year-end 2004 and 2003, 47% and 53%, respectively, of the Companys funding portfolio was
variable rate (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 2004 and 2003, which totaled $2.5 billion and $4.3
billion, respectively, an immediate 100 basis point change in interest rates would have affected
pretax funding costs by approximately $25 million and $43 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. 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: Notional
    
    Fair
    
    Weighted-AverageAmount
    
    Value
    
    Remaining Life(millions)
    
    (millions)
    
    (years)$1,337
    
    $82
    
    4.1
 
 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, Executive 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 32




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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 1, 2005 that has materially affected, or
is reasonably likely to materially affect, the Companys internal control over financial
reporting. 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 the
Company in accordance with accounting principles generally accepted in the United States of
America. Managements report on internal control over financial reporting and the attestation report of
Deloitte & Touche LLP, the Companys independent registered public accounting firm, on
managements assessment of internal control over financial reporting is included on pages F-2 and
F-3 of this report and are incorporated in this Item 9A by reference. Mr. Lacy, the Companys chief executive officer, has certified to the New York Stock Exchange that
he is not aware of any violations by the Company of the exchanges corporate governance listing
standards. The Audit Committee of the Board of Directors is comprised entirely of independent directors. 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 registered public
accountants, and performs other duties as outlined in the Audit Committee Charter. The independent
registered public accountants, the internal auditors and the Companys chief compliance officer
advise the committee of any significant matters resulting from their audits or reviews and have
free access to the committee without management being present. 
 Item 9B. Other Information The Company entered into a
letter agreement with Glenn R. Richter on February 17, 2005. The Company has disclosed the material terms of the agreement with Mr. Richter in
Item 11 of this Annual Report on Form 10-K. Mr. Richter intends
to resign from the Company as of March 28, 2005. 33




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##### Table of Contents



PART III 
 Item 10. Directors and Executive Officers of the Registrant Directors The Companys Board of Directors has three classes of as nearly equal size as possible. Directors
hold office for staggered terms of three years. One of the three classes is elected each year to
succeed the directors whose terms are expiring. The following are the current directors of the
Company and their principal employment during the past five years. Hall Adams, Jr.  Chairman of the Board and Chief Executive Officer of Leo Burnett Company, Inc.
(advertising) until his retirement in 1992. Mr. Adams is a director of McDonalds Corporation.Director since 1993. Age 71. Term expires at the 2006 annual meeting of shareholders. William L. Bax  Managing Partner of PricewaterhouseCoopers Chicago area practice (international
public accounting firm) until his retirement in 2003. Mr. Bax is a director of Big Shoulders Fund
and Childrens Memorial Hospital. He is also a member of the DePaul University Board of Trustees.Director since 2003. Age 61. Term expires at the 2007 annual meeting of shareholders. Donald J. Carty  Chairman of the Board and Chief Executive Officer of AMR Corporation and American
Airlines, Inc. (air transportation) until his retirement in 2003. He is a director of Dell, Inc.,
Hawaiian Holdings, CHC Helicopter Corp. and Solutions Inc.Director since 2001. Age 58. Term expires at the 2007 annual meeting of shareholders. W. James Farrell  Chairman of the Board and Chief Executive Officer of Illinois Tool Works Inc.
(manufacturing and marketing of engineered components). Mr. Farrell is a director of Illinois Tool
Works Inc., Kraft Foods, Inc., The Allstate Corporation, and UAL Corp. He is also Chairman of The
Federal Reserve Bank of Chicago.Director since 1999. Age 62. Term expires at the 2006 annual meeting of shareholders. Alan J. Lacy  Chairman of the Board of Sears, Roebuck and Co. since December 2000 and President
and Chief Executive Officer since October 2000. Mr. Lacy was President, Services, prior thereto.Director since 2000. Age 51. Term expires at the 2007 annual meeting of shareholders. Michael A. Miles  Chairman of the Board and Chief Executive Officer of Philip Morris Companies
Inc. (consumer products) until his retirement in 1994. Mr. Miles is a Special Limited Partner of
Forstmann Little & Co. (investment firm) and a member of its Advisory Board. He is a director of
AMR Corp., Citadel Broadcasting, Dell, Inc., Morgan Stanley and Time Warner Inc.Director since 1992. Age 65. Term expires at the 2005 annual meeting of shareholders. Dorothy A. Terrell  Venture Partner with First Light Capital (venture capital company) since April
2003. Ms. Terrell served as President, Platforms and Services Group, and Senior Vice President,
Worldwide Sales, of NMS Communications (telecommunications) until her retirement in 2002. She is a
director of General Mills, Inc., Herman Miller, Inc. and Lightbridge, Inc.Director since 1995. Age 59.Term expires at the 2005 annual meeting of shareholders. Raul H. Yzaguirre  President and Chief Executive Officer of the National Council of LaRaza (social
services) until his retirement effective as of January 1, 2005. He is a director of AARP Services,
Inc., the Council of Better Business Bureaus, and Educate, Inc.Director since 2001. Age 65. Term expires at the 2005 annual meeting of shareholders. 34




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##### Table of Contents



Executive Officers The following table and information 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, their current ages, and, with the exception of Mr. Lacy for whom such
information appears above, their principal employment during the past five years. Date FirstBecamean ExecutiveName
    
    Position
    
    Officer
    
    AgeAlan J. Lacy
    
    Chairman of the Board of Directors,
    
    1995
    
    51President and Chief Executive OfficerJanine M. Bousquette
    
    Executive Vice President, Chief Customer
    
    2002
    
    44and Marketing OfficerBeryl J. Buley
    
    Executive Vice President and General
    
    2005
    
    44Manager, Retail Store OperationsKristine K. Crow
    
    Senior Vice President, Financial Services
    
    2004
    
    45Mark C. Good
    
    Executive Vice President and General
    
    2002
    
    48Manager, Home ServicesGerald F. Kelly
    
    Senior Vice President, Procurement and
    
    2002
    
    57Continuous Improvement and ChiefInformation OfficerSara A. LaPorta
    
    Senior Vice President, Strategy
    
    2002
    
    44Greg A. Lee
    
    Senior Vice President, Human Resources
    
    2001
    
    55Gwendolyn K. Manto
    
    Executive Vice President and General
    
    2004
    
    50Manager - ApparelMindy C. Meads
    
    Executive Vice President, Sears Roebuck
    
    2003
    
    53and Co. and President and ChiefExecutive Officer, Lands End, Inc.Robert J. OLeary
    
    Senior Vice President, Public Relations
    
    2003
    
    54and Government AffairsLuis A. Padilla
    
    President, Merchandising
    
    2004
    
    50Glenn R. Richter
    
    Executive Vice President and Chief
    
    2001
    
    43Financial OfficerWilliam C. White
    
    Executive Vice President, Retail Store
    
    2003
    
    57Operations Integration and PlanningAndrea L. Zopp
    
    Senior Vice President and General Counsel
    
    2003
    
    48
  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. 35




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##### Table of Contents



Mr. Buley joined Sears as Senior Vice President and General Manager, Home Stores in September 2003.
He was elected Executive Vice President and General Manager, Retail Store Operations in January
2005. Prior to joining Sears, he was Executive Vice President of Kohls Corporation, a department
store retailer. Ms. Crow became Senior Vice President, Financial Services in May 2004. Prior thereto, she was Vice
President, Customer Relationship Management for Sears. Mr. Good has been Executive Vice President and General Manager, Home Services (formerly Product
Repair Services) since August 1999. Mr. Kelly joined Sears as Senior Vice President and Chief Information Officer in October 2002. He
assumed his current position in June 2004. Prior to joining Sears, he was Senior Vice President -
Logistics, Information Systems and Technology at Payless Shoesource, Inc., a footwear retailer. 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. 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. 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. 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. Mr. OLeary joined Sears as Senior Vice President, Public Relations 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. Mr. Padilla joined Sears as President, Merchandising in September 2004. Prior to joining Sears,
Mr. Padilla was Executive Vice President, Merchandising and Chief Merchant for Marshall Fields, a
department store retailer, from 2001 to 2004. He was Senior Vice President and General
Merchandise Manager, Softlines for Target Corporation, a discount store retailer, prior thereto. Mr. Richter joined Sears as Vice President and Controller in February 2000. He was named Senior
Vice President, Finance in July 2001 and became Senior Vice President and Chief Financial Officer
in October 2002. He became Executive Vice President and Chief Financial Officer in April 2004. Mr. White became Executive Vice President, Retail Store Operations Integration and Planning in
January 2005. He was appointed Executive Vice President and General Manager, Store
Operations-Sears Retail in April 2003 and served as Senior Vice President  Sears Automotive prior
thereto. 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. 36




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##### Table of Contents



The Companys Core Values and Code of Ethics applies to the Companys principal executive officer,
principal financial officer and principal accounting officer. The Company intends to disclose on
the Investor Relations portion of www.sears.com any amendment to, or waiver from, a provision of
its Core Values and Code of Conduct that applies to any of those three officers of the Company. Board and Committee Information The Board of Directors and four committees of the Board govern Sears. Directors discharge their
responsibilities throughout the year at Board and committee meetings and also through considerable
telephone contact and other communications with the Chairman and other key executives, as well as
with outside auditors and external advisors such as legal counsel and investment bankers. Other
than Alan J. Lacy, the Chairman, President and Chief Executive Officer of the Company, the Board
has determined that each Director is independent. Director independence was determined in
accordance with the applicable corporate governance listing standards of the New York Stock
Exchange and the Companys independence standards set forth in the Corporate Governance Guidelines
of the Companys Board of Directors posted on the Investor Relations section of the Companys
website, www.sears.com. The following table identifies the current membership of Board committees. Nominating andDirector
        
        Audit
        
        Compensation
        
        Executive
        
        GovernanceHall Adams, Jr.
        
        ü
        
        
        
        
        
        
        üWilliam L. Bax
        
        ü*
        
        
        
        üDonald J. Carty
        
        ü
        
        ü
        
        
        
        
        ü*W. James Farrell
        
        ü
        
        üAlan J. Lacy
        
        
        
        
        
        ü*Michael A. Miles
        
        
        
        ü*
        
        ü
        
        
        üDorothy A. Terrell
        
        ü
        
        üRaul H. Yzaguirre
        
        ü
  
  
 Mr. Bax, the Chairman of the Audit Committee, is an Audit Committee financial expert as defined by
the Securities and Exchange Commission. The Board of Directors has not designated a Lead Director.
Pursuant to the Corporate Governance Guidelines of the Companys Board of Directors, when
non-employee Directors meet in executive session the leader of the meeting is the Chair of the
Committee having jurisdiction over the subject matter of the meeting. The Guidelines require the
non-employee Directors to meet in executive session at least once each year. Executive sessions are generally held at each
regularly scheduled Board meeting. You may contact any Board member, the non-employee Directors or the entire Board at any time. Your
communication should be sent to the Sears, Roebuck and Co. Board of Directors  Non-employee
Directors, c/o Corporate Secretary, Sears, Roebuck and Co., Law Department, 3333 Beverly Road,
Hoffman Estates, IL 60179. Additional information regarding the Companys policies on
communicating with the Board of Directors can be found in the Investor Relations section of the
Companys website, www.sears.com. 37




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##### Table of Contents



Section 16(a) Beneficial Ownership Reporting Compliance Securities and Exchange Commission rules require the Company to disclose certain late filings
of stock transaction reports by its directors and executive officers. Based solely on a review of
reports filed by the Company on these individuals behalf and written representations from them
that no other reports were required, the Company believes nothing is required to be disclosed
herein with respect to Section 16(a) filing requirements during fiscal 2004. 
 Item 11. Executive Compensation Executive Compensation The following Summary Compensation Table shows compensation information for Sears Chairman,
President and Chief Executive Officer, Mr. Lacy, and the four other executive officers who were
most highly compensated for 2004 (the Named Officers). Amounts reflect fiscal years ending
January 1, 2005, January 3, 2004, and December 28, 2002. Annual Compensation
    
    
    Long-Term CompensationAwards
    
    
    PayoutsOther
    
    
    
    
    
    
    SecuritiesAnnual
    
    
    Restricted
    
    
    Underlying
    
    
    LTIP
    
    
    AllName and
    
    
    
    
    
    
    
    
    
    
    
    
    
    Compen-
    
    
    Share
    
    
    Options
    
    
    Payouts
    
    
    OtherPrincipal Position
    
    Year
    
    
    Salary(a)
    
    
    Bonus(b)
    
    
    sation(c)
    
    
    Awards(d)
    
    
    (#)
    
    
    
    
    
    Comp.(e)Alan J. LacyChairman, President & CEO
    
    
    2004
    
    
    $
    1,023,708
    
    
    $
    768,731
    
    
    $
    5,166
    
    
    $
    1,003,500
    
    
    
    262,204
    
    
    $
    
    
    
    $
    39,849
    (f)2003
    
    
    
    1,016,146
    
    
    
    897,813
    
    
    
    76,215
    
    
    
    
    
    
    
    264,146
    
    
    
    
    
    
    
    44,313
    (f)2002
    
    
    
    996,875
    
    
    
    1,797,917
    
    
    
    64,965
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,700Luis A. Padilla
    
    
    2004
    
    
    $
    220,729
    
    
    $
    750,000
    
    
    $
    12,594
    
    
    $
    2,017,500
    
    
    
    100,000
    
    
    
    
    
    
    $
    157,226
    (g)President, MerchandisingGwendolyn K. Manto
    
    
    2004
    
    
    $
    482,708
    
    
    $
    467,500
    
    
    $
    125,298
    
    
    $
    822,500
    
    
    
    40,000
    
    
    
    
    
    
    $
    EVP/GM, ApparelGlenn R. Richter
    
    
    2004
    
    
    $
    538,805
    
    
    $
    338,219
    
    
    $
    
    
    
    $
    54,528
    
    
    
    50,000
    
    
    
    
    
    
    $
    9,100EVP
& Chief Financial Officer
    
    
    2003
    
    
    
    486,982
    
    
    
    380,150
    
    
    
    
    
    
    
    1,228,500
    
    
    
    40,000
    
    
    
    
    
    
    
    8,4002002
    
    
    
    405,964
    
    
    
    456,667
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,700Mindy C. Meads
    
    
    2004
    
    
    $
    594,231
    
    
    $
    222,400
    
    
    $
    8,233
    
    
    $
    430,000
    
    
    
    50,000
    
    
    
    
    
    
    $
    24,651Lands End, Inc., EVP of
    
    
    2003
    
    
    
    507,624
    
    
    
    260,928
    
    
    
    2,149
    
    
    
    541,000
    
    
    
    35,000
    
    
    
    
    
    
    
    470,111
    (h)President & CEO of
   
    
    2002
    
    
    
    227,679
    
    
    
    440,192
    
    
    
    
    
    
    
    485,350
    
    
    
    33,000
    
    
    
    
    
    
    
    7,085Sears, Roebuck and Co.
   (a)
    The amounts in this column are
actual amounts earned in the fiscal
year stated. The amounts shown are
more or less than the annual rate
for each executive as Sears 2004
fiscal year was the 364 days ended
January 1, 2005, its 2003 fiscal
year was the 371 days ended January
3, 2004 and its 2002 fiscal year
was the 364 days ended December 28,
2002.Mr. Padilla became an executive
officer of the Company on September
20, 2004 and Ms. Manto became an
executive officer of the Company on
January 31, 2004.For Ms. Meads, except for bonus,
2002 amounts are for the period
subsequent to the Companys
acquisition of Lands End, Inc. on
June 17, 2002, only.(b)
    The amounts in this column were
awarded under the Companys Annual
Incentive Compensation Plan, except
for $100,000 sign-on 38




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##### Table of Contents



bonuses paid
to Mr. Padilla and Ms. Manto and
guaranteed minimum bonuses of
$650,000 and $367,500,
respectively, payable to Mr.
Padilla and Ms. Manto under their
employment offer letters.Pursuant to a deferred equity
exchange feature available to
participants in the Companys
Deferred Compensation Plan, Mr.
Lacy elected to exchange and defer
20% of his 2004 bonus ($153,746 of
the $768,731 reflected in the
table) at the closing market price
per share on March 15, 2005. As a
result of his election to exchange
and defer, Mr. Lacy received a 20%
premium ($30,749) on the portion of
the bonus he elected to exchange
and defer. He received the premium
in restricted common share
equivalents, which will vest on
March 15, 2008. The premium is
included in the table under All
Other Compensation.Mr. Lacy also elected to exchange
and defer 20% of his 2003 bonus
($179,563 of the $897,813 reflected
in the table) at the closing market
price of $44.36 per share on March
15, 2004. As a result of his
election to exchange and defer, Mr.
Lacy received a 20% premium
($35,913) on the portion of the
bonus he elected to exchange and
defer. He received the premium in
restricted common share
equivalents, which will vest on
March 15, 2007. The premium is
included in the table under All
Other Compensation.Mr. Lacy elected to defer 20% of
his 2002 bonus ($359,583 of the
$1,797,917 reflected in the table).
This amount was deposited in his
accounts under the Companys
Deferred Compensation Plan.(c)
    For Mr. Lacy, the figures
include use of corporate aircraft
in the amount of $49,812 in 2003
and $36,482 in 2002, as well as
ground transportation and financial
planning.For Ms. Manto, the figure includes
relocation program expenses in the
amount of $74,607, personal use of
corporate aircraft and travel
expenses for her spouse in
connection with a business meeting.The figures also include tax
reimbursement payments associated
with the foregoing personal
benefits for Mr. Lacy and Ms. Manto
and tax reimbursement payments for
relocation program expenses and
personal use of corporate aircraft
for Mr. Padilla and Ms. Meads.Perquisites and other personal
benefits not exceeding in the
aggregate the lesser of $50,000 or
10% of the total of salary and
bonus during any reported year are
not included.(d)
    Restricted shares are Sears
common shares that cannot be sold
or otherwise transferred by the
Named Officer until such
restrictions lapse. Restricted
share awards are valued at the
closing price of Sears common
 shares on the date of grant. The
Company pays dividends on
restricted shares at the same rate
paid on all other Sears common
 shares. All restricted shares may
be forfeited if employment is
terminated prior to the vesting
date. Upon retirement or Company
approved early retirement, death,
permanent disability or a change in
control of the Company prior to the
scheduled vesting date, a prorated
number of shares will vest. If any
of these events occur less than six
months from the date of grant, all
shares will be forfeited, except
that upon effectiveness of the
pending business combination
between the Company and Kmart the
portion of the restricted shares
that does not vest will be
converted into restricted shares of
Sears Holdings Corporation.On January 1, 2005, the Named Officers owned the numbers of restricted shares set forth
in the table below. The market value is based on the closing price of a Sears common share
of $51.03 on December 31, 2004, the last trading day prior to the end of the 2004 fiscal
year. Mr. Lacy
    
    
    Mr. Padilla
    
    
    Ms. Manto
    
    
    Mr. Richter
    
    
    Ms. MeadsNumber of Shares
    
    
    22,500
    
    
    
    50,000
    
    
    
    20,000
    
    
    
    26,200
    
    
    
    30,000Market Value
    
    $
    1,148,175
    
    
    $
    2,551,500
    
    
    $
    1,020,600
    
    
    $
    1,336,986
    
    
    $
    1,530,900
 The following restricted stock grants reflected in the table vested or will vest, in whole or
in part, in under three years from the date of grant:  On March 10, 2004, Mr. Richter was granted 1,200 restricted shares that will vest on March
10, 2006 in consideration for a reduction in his annual incentive target percentage;On April 5, 2004, Ms. Meads was granted 10,000 restricted shares that will vest on February
1, 2007 in connection with a promotion;On April 25, 2003, Ms. Meads was granted 20,000 restricted shares that will vest on April
25, 2005 in connection with a promotion; andOn June 17, 2002, Ms. Meads was granted 8,500 restricted shares that vested on June 17,
2004 in connection with the Companys acquisition of Lands End, Inc.All such grants will vest pro rata upon effectiveness of the merger with Kmart. 39




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##### Table of Contents



(e)
    These amounts represent the
Companys matching contributions
under the Sears 401(k) Savings
Plan and under the Companys
nonqualified Supplemental 401(k)
Savings Plan and, in the case of
Ms. Meads, the Lands End
Retirement Plan, in addition to
amounts specified in footnotes
(f), (g), and (h).(f)
    These amounts include the
premiums received by Mr. Lacy as a
result of the equity exchanges of
portions of his annual bonus
payments, as disclosed in footnote
(b).(g)
    This amount was paid to Mr.
Padilla in consideration of his
forfeiting a retention award he
was scheduled to receive had he
remained employed by his previous
employer.(h)
    This amount includes a
$425,000 retention payment made to
Ms. Meads pursuant to her
agreement in connection with the
acquisition of Lands End, Inc.  Stock Options The following table summarizes all stock options granted to the Named Officers during 2004.
Individual grants are listed separately for each Named Officer. The table also shows the potential
realizable value of each grant given two potential performance scenarios. Individual Grants(a)Number of
    
    
    % of Total
    
    
    
    
    
    
    
    
    
    
    Potential realizable value atSecurities
    
    
    Options
    
    
    Exercise
    
    
    
    
    
    
    assumed annual rates of stockUnderlying
    
    
    Granted to
    
    
    or Base
    
    
    
    
    
    
    price appreciation for 10-yearOptions
    
    
    Employees
    
    
    Price
    
    
    Expiration
    
    
    option term(b)Name
    
    Granted
    
    
    in 2004
    
    
    ($)
    
    
    Date
    
    
    5% ($)
    
    
    10% ($)Alan J. Lacy
    
    
    230,000
    
    
    
    2.63
    
    
    
    44.53
    
    
    
    02/04/2014
    
    
    
    6,441,076
    
    
    
    16,322,95132,204
    (c)
    
    
    0.36
    
    
    
    38.22
    
    
    
    02/13/2013
    
    
    
    774,067
    
    
    
    1,961,637Luis A. Padilla
    
    
    100,000
    
    
    
    1.14
    
    
    
    40.02
    
    
    
    09/20/2014
    
    
    
    2,516,836
    
    
    
    6,378,157Gwendolyn K. Manto
    
    
    40,000
    
    
    
    0.45
    
    
    
    44.53
    
    
    
    02/04/2014
    
    
    
    1,120,187
    
    
    
    2,838,774Glenn R. Richter
    
    
    50,000
    
    
    
    0.57
    
    
    
    44.53
    
    
    
    02/04/2014
    
    
    
    1,400,234
    
    
    
    3,548,468Mindy C. Meads
    
    
    50,000
    
    
    
    0.57
    
    
    
    44.53
    
    
    
    02/04/2014
    
    
    
    1,400,234
    
    
    
    3,548,468
  (a)
    All options have the following
material terms. Options become
exercisable in three equal annual
installments beginning one year from the
date of the grant, and remain exercisable
until the 10th anniversary of
the grant except for reload grants (see
footnote (c)), unless cancelled earlier
as a result of termination of employment.
Upon retirement or Company approved
early retirement, death or permanent
disability, a prorated number of shares
will vest. The shares will vest 100%
upon a change in control of the Company,
as defined in the Sears Employee Stock
Plans. The option exercise price equals
the average market price of a common
share on the date of grant. The options
include rights permitting the option
holder to elect to have shares withheld
to satisfy withholding tax requirements.
The option holder can pay the option
exercise price by tendering Sears common
 shares, which in turn gives the option
holder the right to purchase the same
number of shares tendered at a price
equal to the average market price on the
exercise date. The Company can terminate all outstanding
stock options, vested and unvested, if it
merges with another entity or enters into
certain other extraordinary transactions.
In the event of such a transaction, the
Company must make one of three equitable
adjustments to the outstanding options:
1) replace the options with equivalent
options for shares in the new entity; 2)
accelerate the vesting of options so that
they are exercisable prior to the
transaction, or 3) pay in cash the
difference between the exercise price and
the market price of the options, whether
vested or unvested, on the date of the
transaction. Upon closing of the pending
business combination transaction with
Kmart Holding Corporation, all
outstanding options will be converted
into the right to receive a cash payment
equal to the excess, if any, of the
blended merger price over the exercise
price of the options. The blended
merger price is designed to mirror the
value of the 45%/55% cash/stock
consideration that Sears stockholders
will receive in the merger. It is
calculated as follows: 45% x $50, plus
55% of one-half of the Kmart common stock
closing price on the last trading day
prior to closing of the business
combination transaction. 40




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(b)
    These amounts represent assumed rates
of appreciation only. There can be no
assurance that the amounts reflected in
these columns will be achieved or, if
achieved, will be realizable at the time
of any option exercise. The actual value
realized may vary significantly from
these potential values and will
ultimately depend upon the excess of the
stock price over the exercise price on
the date the option is exercised, and
upon any applicable taxes and fees.(c)
    These options were granted pursuant
to the reload feature available to key
executives of the Company. Reload grants
expire on the same date as the underlying
options that were originally granted.  The following table shows the aggregate option exercises by the Named Officers during 2004 and
the number of shares and the value of grants held by each outstanding as of the end of the fiscal
year. Value of Unexercised,Number of Securities Underlying
    
    
    In-The-Money OptionsUnexercised Options at 01/01/05
    
    
    at 01/01/05(a)Shares
    
    
    ValueAcquired on
    
    
    Realized
    
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableName
    
    Exercise(#)
    
    
    ($)
    
    
    (# of Shares)
    
    
    (# of Shares)
    
    
    ($ Value)
    
    
    ($ Value)Alan J. Lacy
    
    
    56,878
    
    
    
    943,037
    
    
    
    1,113,295
    
    
    
    485,803
    
    
    
    14,629,255
    
    
    
    9,883,495Luis A. Padilla
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100,000
    
    
    
    
    
    
    
    1,101,000Gwendolyn K. Manto
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,000
    
    
    
    
    
    
    
    260,000Glenn R. Richter
    
    
    110,533
    
    
    
    1,613,632
    
    
    
    
    
    
    
    26,667
    
    
    
    
    
    
    
    783,743Mindy C. Meads
    
    
    36,666
    
    
    
    578,708
    
    
    
    47,000
    
    
    
    34,334
    
    
    
    162,500
    
    
    
    685,786
  (a) The value of unexercised, in-the-money options is based on the closing market price of a Sears common share of
$51.03 as of December 31, 2004, the last trading day of the Companys fiscal year.  2005 Long-Term Incentive Program Plan The Sears Long-Term Incentive Plan (LTIP) was adopted by the Board of Directors in December 2004.
The LTIP provides for performance-based awards made under the Sears 2000 Employees Stock Plan and
the Sears Long Term Incentive Compensation Plan that are consistent with the performance measures
provided in those Plans. The LTIP provides for the award of performance units and/or stock options to eligible employees.
The performance units represent the right to receive either shares of Sears common stock or cash,
as determined by the Compensation Committee, based on Sears total shareholder return (share price
appreciation plus dividends, assuming reinvestment) in relation to the total shareholder return of
all of the companies in the S&P 500 Index for the three-year period January 1, 2005 through
December 31, 2007. Payouts will range from 50% of the targeted number of shares or cash amount at
a threshold 25th percentile total shareholder return level to 150% of the targeted number of shares
or cash amount at the 75th percentile total shareholder return level and above. Minimum payouts of
30% of the target award will be made based on Sears total shareholder return in relation to that
of all S&P 500 Index companies for each of the one-year periods ended December 31, 2005 and
December 31, 2006. Payments in respect of performance units will be made as soon as practicable in
2008 after the Compensation Committee has certified Sears total shareholder return results and the
amounts to be paid, except for earlier payout in the event of a participants death. Stock options granted under the LTIP will have an exercise price per share that is not less than
100% of the fair market value of a share of Sears common stock on the date of grant and will vest
one-third when the fair market value of a share of Sears common
stock for the 41




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##### Table of Contents



previous 20 trading days has increased by 10% or more above the exercise price of the
option, one-third when the fair market value of a share of Sears common stock for the previous 10
trading days has increased by 10% or more above the options exercise price and one-third when the
fair market value of a share of Sears common stock for the previous 20 trading days has increased
by 30% or more above the options exercise price. The LTIP is administered by the Compensation Committee, which will determine which eligible
employees are to receive awards under the LTIP. The eligible employees are Sears Chief Executive
Officer, its President of Merchandising, all employees who report directly to the Chief Executive
Officer and other key employees recommended by the Chief Executive Officer. The number of options and performance units that may be awarded under the LTIP are limited by the
terms of the LTIP. No awards under the LTIP were made in 2004. The LTIP and all awards under it will be automatically cancelled without consideration immediately
prior to the effective date of the business combination transaction with Kmart. Furthermore, no
award under the LTIP may be paid or settled while the agreement providing for that transaction
remains in effect or if the transaction closes. Pension Plan The Company maintains basic and supplemental pension plans that, subject to vesting conditions,
provide retirement benefits for certain full-time and part-time United States associates of the
Company and its subsidiaries. Through December 31, 1999, annual retirement benefits under the pension plans were based upon
credited years of service and the average annual cash compensation of the associates highest five
successive calendar years of earnings out of the ten years immediately preceding termination of
employment (final average annual compensation). Benefits earned through December 31, 1988 are
reduced by a portion of the participants estimated social security benefits. Effective January 1, 2000, retirement benefits are based on the individuals cash compensation each
year instead of his or her final average annual compensation. Cash compensation for pension plan
purposes generally consists of salary and annual bonus. In the case of the Named Officers, it
generally consists of amounts paid as shown in the salary and bonus columns in the Summary
Compensation Table on page 35, excluding:  §
    Amounts earned before the Named Officer became eligible under the plan; and  §
    Sign-on bonuses, as described in footnote (b) to the Summary Compensation Table. Effective January 1, 2005, associates hired in 2004 or later and those under the age of 40 as
of December 31, 2004 will no longer earn additional retirement benefits under the pension plans.
Retirement benefits under the Pension Plans continue to accrue for
associates age 40 and older as of December 31, 2004, unless they elected to receive the enhanced
match available under the Sears 401(k) Savings Plan. As of December 31, 2004, and rounded to the nearest whole number, credited years of service under
the pension plans for the Named Officers were as follows: Alan J. Lacy, 9; Glenn Richter, 4; Gwen
Manto, 0; Mindy Meads, 0; and Luis Padilla, 0. Ms. Meads, Ms. Manto and Mr. Padilla are not
participants under the pension plans. The Pension Plan Table below shows annual retirement benefits that would be payable based upon
various assumptions as to annual cash compensation and years of service. It assumes retirement on
December 31, 2005 at age 65. The table also assumes that benefits will be payable over the
participants lifetime with no survivor benefits. 42




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##### Table of Contents



Years of ServiceRemuneration
    
    5
    
    10
    
    15
    
    25
    
    35$1,000,000
1,650,000
2,300,000
2,950,000
3,600,000
4,250,000
    
    $66,619
110,942
155,265
199,588
243,911
288,234
    
    $118,541
197,593
276,644
355,695
434,746
513,798
    
    $166,956
278,453
389,950
501,446
612,943
724,439
    
    $273,892
456,828
639,764
822,700
1,005,637
1,188,573
    
    $376,457
627,527
878,596
1,129,665
1,380,734
1,631,804
 Officers Agreements The Named Officers have entered into agreements with the Company that require the Named Officers to
maintain the confidentiality of information concerning the Companys business. The agreements also
prohibit the Named Officers from working for a competitor of the Company or hiring any Sears
employees for one year after their employment with the Company ends. Under the agreements, if the
Company terminates a Named Officers employment without cause, the Named Officer will receive the
following benefits:  §
    Severance equal to a pro-rated bonus in the year termination occurs, plus
two years of salary continuation, which includes annual base pay and annual
target bonus calculated for the year the Named Officers employment with the
Company ends;  §
    Most Company benefits during the salary continuation period; and  §
    Continued vesting of stock options and restricted shares during the
salary continuation period. All of the above payments will lapse if the Named Officer is employed by a competitor of the
Company within one year of termination of active employment. If the Named Officers employment is terminated in connection with a change in control of Sears,
the Named Officer will receive the following benefits:  §
    Pro-rated salary, including base pay and target bonus, as of the
change in control termination;  §
    A lump sum equal to two years of annual base pay plus the annual
target bonus, determined by the year of the change in control
termination;  §
    Most Company benefits for two years following the change in control
termination; and  §
    Immediate vesting of any unvested stock options and restricted shares. Generally, a change in control occurs if:  §
    Anyone acquires beneficial ownership of 20% or more of the
outstanding Sears common shares or the combined voting power of all
voting securities;  §
    The current Board and all future nominees of the current Board cease
to constitute a majority of the Board; or  §
    A fundamental corporate change occurs, such as a reorganization,
merger, consolidation, liquidation, or dissolution or a sale of
substantially all of Sears assets, unless Sears shareholders and
directors maintain control of the resulting entity. Named Officers agreements may also provide for supplemental plan benefits as described in the
compensation tables. 43




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Lacy Employment Agreement.Kmart and Sears have entered into an employment agreement, dated as of
November 16, 2004, with Mr. Lacy. The employment agreement provides for a term of employment
commencing upon completion of the pending business combination with Kmart and ending on the fifth
anniversary thereof. If that transaction is completed, the employment agreement will supersede the
Executive Non-Disclosure and Non-Solicitation of Employees Agreement and the Executive
Severance/Non-Compete Agreement, which Mr. Lacy executed with Sears as of November 26, 2001, the
terms of which are substantially similar to those described above. During the term, Mr. Lacy will
serve as the Vice Chairman and Chief Executive Officer of Holdings and a member of its board of
directors. During the term, Mr. Lacy will receive an annual base salary of no less than $1,500,000
(which represents an increase of $465,000 over his current base salary of $1,035,000) and a target
bonus of 150% of his annual base salary (which represents an increase of 25 percentage points over
his current target bonus of 125% of his annual base salary) and will be eligible for, and receive
benefits under, employee benefit and perquisite arrangements no less favorable than those generally
applicable or made available to senior executives of Holdings. Upon completion of the transaction, Mr. Lacy will be granted 75,000 restricted shares of Holdings
common stock, which will vest in full on June 30, 2006, subject to Mr. Lacys continued employment
with Holdings through such date. In addition, upon completion of the transaction, Mr. Lacy will be
granted a stock option to purchase 200,000 shares of Holdings common stock with a per share
exercise price equal to the fair market value of Holdings common stock on the date of grant. The
stock option will vest with respect to one-quarter of the shares subject to the stock option on
each of the first four anniversaries of completion of the mergers, subject to Mr. Lacys continued
employment with Holdings through each applicable vesting date. If Mr. Lacys employment is terminated by Holdings without cause (as defined in the employment
agreement) or Mr. Lacy resigns with good reason (as defined in the employment agreement), Mr. Lacy
will be entitled, subject to execution of a release in favor of Holdings, to receive severance
benefits, including:  §
    a pro rata bonus based on the performance of Holdings for the year in
which the termination occurs;  §
    two times the sum of Mr. Lacys then current annual base salary and target
bonus;  §
    two additional years of age and service credit under all welfare benefit
plans, programs, agreements and arrangements of Holdings;  §
    accelerated vesting of equity-based awards and three years to exercise any
vested options; and  §
    continued welfare benefits for two years. If Mr. Lacys employment is terminated due to his death or disability (as defined in the
employment agreement), Mr. Lacy (or his estate) will be entitled to receive a pro-rata bonus for
the year of termination, accelerated vesting of equity-based awards and three years to exercise
vested options and continued welfare benefits for two years. Under the employment agreement, Mr. Lacy is restricted from revealing confidential information of
Holdings and, for one year following Mr. Lacys termination of
employment during the term for any reason, Mr. Lacy may not solicit for employment any employees of
Holdings and may not compete with Holdings. In the event that any payments to Mr. Lacy are subject
to an excise tax under Section 4999 of the Internal Revenue Code, Mr. Lacy will be entitled to an
additional gross-up payment so that he remains in the same after-tax position he would have been in
had the excise tax not been imposed. Padilla Termination Rights.If Mr. Padilla is terminated other than for cause (as defined in
his agreement with the Company) before the first anniversary of his service with Sears, the 50,000
shares of restricted stock granted to him in connection with his joining the Company will fully
vest at the end of his two-year salary continuation period and he will receive a cash payment
within 30 days after the end of that salary continuation period equivalent in value to the product
of the 33,334 (the number of options granted to him in connection with his joining the Company that
do not vest until three years after his start date with the Company) and the positive difference
between the fair market value of a share of Sears common stock on the last day of the salary
continuation period and the exercise price of the options). 44




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Richter Employment Agreement.The Company entered into a letter agreement, dated as of
February 17, 2005, to amend Mr. Richters executive severance/non-compete agreement. The letter
agreement provides that if the merger is not consummated, the letter agreement will be of no force
and effect. In addition, the letter agreement provides that so long as Mr. Richter remains employed with the Company through the
completion of the merger, (i) upon the completion of the merger, Mr. Richter will resign from all
positions with the Company that he currently holds, (ii) upon completion of the merger, he will
receive a payment equal to $641,000 in lieu of receiving any severance payments or benefits to
which he might otherwise be entitled under his severance/non-compete agreement, and any unvested
restricted shares of Sears common stock that does not otherwise become vested pursuant to the merger agreement will
nevertheless also become vested, (iii) Mr. Richter will cease to be subject to the covenant not to
compete to which he would otherwise be bound under his executive severance/non-compete agreement
and (iv) Mr. Richters no solicitation of the Company's employees covenant will be extended for two years instead
of one year following termination of his employment. In all other material respects, as modified by the
letter agreement, his executive severance/non-compete agreement, the terms of which are
substantially similar to those described above, will remain in full force and effect. Certain Restricted Share Provisions In 1999, the Company granted Mr. Lacy 25,000 performance-based restricted shares. These shares
were to vest (the share-price condition) when the daily average price per Sears common share was
at least $100.00 for 20 consecutive trading days prior to March 12, 2003. If the share price
condition was not met, 50% of the shares would vest on March 12, 2003 and 50% would vest on March
12, 2004. Because the share-price condition was not met, 12,500 restricted shares vested on March
12, 2003 and the remaining 12,500 restricted shares vested on March 12, 2004. Directors Compensation and Benefits In order to align directors interests with shareholders interests, compensation is paid to
directors who are not employees of the Company in the form of deferred shares, stock options and
cash.  §
    Each year, the Company grants to each non-employee director deferred shares
in an amount equal to the directors total cash retainer. The deferred shares
vest over the twelve-month period following the grant date. The directors
receive their vested deferred shares as shares of Sears common stock when they
leave the Board.  §
    The Company annually grants each non-employee director an option to
purchase Sears common shares that vests at the next annual meeting or upon a
change in control. The number of shares subject to the option equals the
amount of the directors total cash retainer divided by one-third of the
average market price of a share of stock of the Company on the date of grant
of the option. The option exercise price equals the average market price of
the underlying shares on the grant date.  §
    The Company pays each non-employee director an annual cash retainer of
$40,000 in quarterly installments. Further, the Company pays the chairs of
the Audit, Compensation and Nominating and Governance Committees additional
annual cash retainers of $7,500. The actual number of deferred shares and option shares granted each year depends on the price of
Sears common shares on the grant date. On May 13, 2004, the Company granted each non-employee
director who was not a Committee Chairman 1,053 deferred shares and an option to buy 3,159 shares
at an exercise price of $37.98 per share. Each Committee Chairman received 1,250 deferred shares
and an option to buy 3,751 shares at an exercise price of $37.98 per share. Each non-employee director has the right to elect to receive some or all of his or her annual cash
retainer in the form of stock options. The number of shares underlying the options granted in lieu
of the annual cash retainer will 45




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equal the total dollar amount of the cash retainer with respect to
which the director has made the election, divided by one-third of the average of the closing market prices of a share of stock of the Company on each of the trading days in the calendar year
preceding May 31. The options will be granted to the director quarterly, each grant covering 25%
of the shares calculated as described in the preceding sentence. The exercise price will equal the
average of the high and low trading prices of the underlying shares on the date of each quarterly
grant. The vesting schedule for new awards is determined by the Board of Directors at the time of
award. Non-employee directors who were first elected to the Board prior to December 31, 1995 will receive
$30,000 annually after they retire from the Board pursuant to the Non-Employee Director Retirement
Plan. The Non-Employee Director Retirement Plan was terminated in 1995. Compensation Committee Interlocks and Insider Participation During 2004, the following directors (none of whom was or had been an officer or employee of the
Company or any of its subsidiaries) served on the Companys Compensation Committee: Donald J.
Carty, W. James Farrell, Michael A. Miles, and Dorothy A. Terrell. There were no interlocks during
2004 with other companies within the meaning of the Securities and Exchange Commissions rules. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management Beneficial Ownership of Directors and Executive Officers Sears common share ownership of directors and executive officers as of January 1, 2005
was as follows: Sum of CommonSears Common
    
    
    Shares PlusSears Common
    
    
    Share
    
    
    Common ShareName
    
    Shares(a)
    
    
    Equivalents(b)
    
    
    EquivalentsHall Adams, Jr.
    
    
    24,954
    (c)
    
    
    --
    
    
    
    24,954William L. Bax
    
    
    6,448
    (d)
    
    
    --
    
    
    
    6,448Donald J. Carty
    
    
    62,841
    (e)
    
    
    --
    
    
    
    62,841W. James Farrell
    
    
    15,469
    (f)
    
    
    --
    
    
    
    15,469Alan J. Lacy
    
    
    1,288,992
    (g)
    
    
    91,494
    
    
    
    1,380,486Michael A. Miles
    
    
    34,794
    (h)
    
    
    12,267
    
    
    
    47,061Dorothy A. Terrell
    
    
    25,004
    (c)
    
    
    --
    
    
    
    25,004Raul H. Yzaguirre
    
    
    9,735
    (i)
    
    
    1,811
    
    
    
    11,546Gwendolyn K. Manto
    
    
    33,333
    (j)
    
    
    --
    
    
    
    33,333Mindy C. Meads
    
    
    88,666
    (k)
    
    
    --
    
    
    
    88,666Luis A. Padilla
    
    
    50,000
    
    
    
    --
    
    
    
    50,000Glenn R. Richter
    
    
    40,327
    (l)
    
    
    131
    
    
    
    40,458All directors and executive officers as a group
    
    
    2,179,500
    (m)
    
    
    156,530
    
    
    
    2,336,030
   (a)
    Ownership is as of January 1, 2005 and includes:  §
    Shares in which the director or executive officer may be deemed to have a beneficial interest (including options
vesting by March 2, 2005); and  §
    For Executive Officers, shares held as nontransferable restricted shares, which are subject to forfeiture under
certain circumstances. 46




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(b)
    These common share equivalents represent fees deferred by directors and salary, bonuses and other compensation deferred
by executive officers at the request of the individual director or officer. They do not represent beneficially owned shares. Deferred amounts are converted into common share equivalents, the value of which mirrors the value of Sears common
            shares. Common share equivalents are credited with amounts equal to the dividends paid on shares of common stock and are
paid out in cash (or in some cases shares of Sears common stock) when the director or officer ceases to serve as a director
or officer. Accordingly, the amounts ultimately realized by the directors and officers will reflect changes in the market
value of Sears common shares from the date of deferral until the date of payout.(c)
    Includes 7,041 vested deferred shares and 16,813 shares subject to exercisable options.(d)
    Includes 1,492 vested deferred shares and 2,256 shares subject to exercisable options.(e)
    Includes 3,193 vested deferred shares and 9,648 shares subject to exercisable options.(f)
    Includes 4,556 vested deferred shares and 10,913 shares subject to exercisable options.(g)
    Includes 1,113,295 shares subject to exercisable options and 4,175 shares credited to Mr. Lacys 401(k) Plan account.(h)
    Includes 7,477 vested deferred shares and 23,936 shares subject to exercisable options.(i)
    Includes 3,117 vested deferred shares and 6,618 shares subject to exercisable options.(j)
    Includes 13,333 shares subject to exercisable options.(k)
    Includes 58,666 shares subject to exercisable options.(l)
    Includes 13,333 shares subject to exercisable options and 794 shares credited to Mr. Richters 401(k) Plan account.(m)
    Includes 33,917 directors vested deferred shares, 1,634,419 shares subject to exercisable options and 15,711 shares
credited to executive officers 401(k) Plan accounts.  To the knowledge of the Company, as of January 1, 2005 no director or executive officer
(including each person listed in the table) beneficially owned 1% or more of Sears outstanding
common shares, and all directors and executive officers together beneficially owned an aggregate of
approximately 1% of Sears outstanding common shares, including shares subject to exercisable
options. Beneficial Ownership of 5% Shareholders Amount and Nature of Beneficial
    
    Percent ofName and Address
    
    Ownership: Sears Common Shares (a)
    
    ClassESL Investments, Inc. and related entities, as a group
200 Greenwich Avenue
Greenwich, CT 06830
    
    31,100,000(b)
    
    14.4% (c)State Street Bank and Trust Company
225 Franklin Street
Boston, Massachusetts 02110
    
    20,672,409(d)
    
    
    10.0
    %Hotchkis and Wiley Capital Management, LLC(e)
725 South Figueroa Street
Los Angeles, CA 90017
    
    
    17,093,848
    
    
    
    8.3
    %
  (a)
    Except as otherwise indicated, (1) beneficial
ownership is based on the latest Schedule 13D or 13G
filed by the shareholder and (2) the shareholders
listed in the table have sole voting and dispositive
power with respect to the common shares indicated
next to their respective names. Information is
provided for reporting purposes only and should not
be construed as an admission of actual beneficial
ownership.(b)
    ESL Investments, Inc. disclosed sole voting and
dispositive power as to 31,049,166 shares; Edward S.
Lampert disclosed sole voting and dispositive power
as to 31,100,000 shares; RBS Partners, L.P. disclosed
sole voting and dispositive power as to 30,883,800
shares; ESL Partners, L.P. disclosed sole voting and
dispositive power as to 22,810,436 shares; RBS
Investment Management, L.L.C. disclosed sole voting
and dispositive power as to 165,366 shares; ESL
Institutional Partners, L.P. disclosed 47




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sole voting
and dispositive power as to 165,366 shares; ESL
Investors, L.L.C. disclosed sole voting and
dispositive power as to 8,073,364 shares; and ESL
Investment Management, L.L.C. disclosed sole voting
and dispositive power as to 50,834 shares.  (c)
    The Company had 215,689,744 common shares
outstanding as of January 1, 2005. The Percent of
Class was calculated by using the disclosed number
of beneficially owned shares by ESL Investments, L.P.
and related entities, as a group, as the numerator
and the number of the Companys outstanding common
shares as of January 1, 2005 as the denominator.  (d)
    State Street Bank and Trust Company, as trustee,
has advised the Company that as of December 31, 2004
it held 15,071,926 shares on behalf of participants
in the Sears 401(k) Savings Plan. In its Schedule
13G, State Street disclosed sole voting power as to
5,600,483 shares, shared voting power as to
15,071,926 shares and shared dispositive power as to
20,672,409 shares.  (e)
    Hotchkis and Wiley Capital Management, LLC is a
registered investment adviser under the Investment
Company Act of 1940. It disclosed sole dispositive
power as to 17,093,848 shares and sole voting power
as to 12,467,748 shares. The Percent of Class was
calculated by using the 17,093,848 shares as to which
sole dispositive power is disclosed. Hotchkis and
Wiley Capital Management, LLC disclaims beneficial
ownership of these shares.   
 Item 13. Certain Relationships and Related Transactions Certain Transactions As described in Item 12, State Street Bank and Trust Company (State Street) beneficially
owns 10% of Sears outstanding common shares. State Street provides credit lines to the Company,
provides investment management services to the Sears Pension Plan and serves as trustee for the
Sears 401(k) Savings Plan and the Sears Puerto Rico Savings Plan. In addition, State Street also
provides, through a joint venture with Citigroup formed on April 1, 2000, administrative services
to the Sears 401(k) Savings Plan and the Sears Pension Plan. In 2004, the Company, the Sears
401(k) Savings Plan and the Sears Pension Plan together paid State Street approximately $15.7
million for these and related services. In September 2004, the Company acquired ownership or leasehold interest in 50 off-mall stores from
Kmart for $576 million plus the assumption of existing real estate leases. The acquisitions
include real estate and store fixtures, but exclude inventory and liabilities not related to
leases. ESL Investments, Inc. and certain affiliated entities, all of which are controlled by
Edward S. Lampert, are the beneficial owners of approximately 14.4% of the outstanding shares of
the Companys common stock and approximately 53% of the outstanding shares of Kmart common stock.
See Note 2 of Notes to Consolidated Financial Statements for more information about this
acquisition. 
 Item 14. Principal Accounting Fees and Services The following table shows the fees paid or accrued by the Company and its subsidiaries for the
audit and other services provided by Deloitte & Touche (including Deloitte & Touche LLP, the member
firms of Deloitte Touche Tohmatsu and their respective affiliates (Deloitte)) for the past two
fiscal years: thousands
    
    2004
    
    
    2003Audit fees (1)
    
    $
    5,094
    
    
    $
    4,601Audit-related fees (2)
    
    $
    1,154
    
    
    
    2,475Tax fees (3)
    
    $
    1,719
    
    
    
    2,498All other fees (4)
    
    
    
    
    
    
    53$
    7,967
    
    
    $
    9,627
   (1)
    Includes fees for professional services provided in
conjunction with the audit of the Companys financial
statements, review of the Companys quarterly financial
statements, comfort letters and attestation services
normally provided in connection with statutory and
regulatory filings and engagements; 48




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(2)
    Includes fees for assurance and related professional
services primarily related to audit of employee benefit
plans, consultation on accounting standards or
transactions, services related to business acquisitions
or divestitures, and other attestation services;(3)
    Includes fees for professional services provided
related to tax compliance (preparation of international
and other returns), tax planning (consultation on
matters related to tax accounting methods and use of
tax credits), and tax advice (consultation on matters
related to audit issues, and sales and use taxes); and(4)
    All other fees consist of permissible work performed by
Deloitte that is not within the above categories. For
2003, this consisted of software licensing for a
non-financial systems upgrade.   The Audit Committee must pre-approve all engagements of our independent registered public
accountants as required by its charter and the rules of the Securities and Exchange Commission.
Prior to the beginning of each fiscal year, the Audit Committee will approve an annual estimate of
fees for engagements, taking into account whether the services are permissible under applicable law
and the possible impact of each non-audit service on the independent registered public accountants
independence from management. In addition, the Audit Committee will evaluate known potential
engagements of the independent registered public accountants, including the scope of the proposed
work to be performed and the proposed fees, and approve or reject each service. Management may
present additional services for approval at subsequent committee meetings. The Audit Committee has
delegated to the Audit Committee Chairman the authority to evaluate and approve engagements on
behalf of the Audit Committee in the event a need arises for pre-approval between Committee
meetings and in the event the engagement for services was within the annual estimate but not
specifically approved. If the Chairman so approves any such engagements, he will report that
approval to the full Committee at the next Committee meeting. Since the effective date of the Securities and Exchange Commissions rules regarding strengthening
auditor independence, all of the audit, audit-related, and tax services provided by Deloitte were
pre-approved in accordance with the Audit Committees policies and procedures. Item 15. Exhibits and Financial Statement Schedules (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 and is incorporated
in this Item 15 by reference. (a)3  Exhibits: An Exhibit Index has been filed as a part of this Report beginning on
page E-1 and is incorporated herein by reference. 49




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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)By:
    

*Michael J. Graham
Michael J. GrahamVice President and ControllerFebruary 23, 2005
 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
        
        Chairman of the Board of Directors,
        
        
        )Alan J. Lacy
        
        President and Chief Executive Officer
        
        
        ))*Glenn R. Richter
        
        Executive Vice President and Chief
        
        
        )Glenn R. Richter
        
        Financial Officer (Principal Financial
        
        
        )Officer)
        
        
        ))*Michael
J. Graham
        
        Vice President and Controller (Principal
        
        
        )Michael J. Graham
        
        Accounting Officer)
        
        
        ))
        
        
        February 23, 2005)*Hall Adams, Jr.
        
        Director
        
        
        )Hall Adams, Jr.
        
        
        
        
        ))*William L. Bax
        
        Director
        
        
        )William L Bax
        
        
        
        
        ))
 50




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Signature
    
        Title
    
    
    
    
    
        Date*Donald J.
            Carty
    
    Director
    
    
    )Donald J. Carty
    
    
    
    
    )))*W. James
            Farrell
    
    Director
    
    
    )W. James Farrell
    
    
    
    
    )
    
    
    February 23, 2005)*Michael A.
            Miles
    
    Director
    
    
    )Michael A. Miles
    
    
    
    
    )))*Dorothy A.
            Terrell
    
    Director
    
    
    )Dorothy A. Terrell
    
    
    
    
    )))*Raul H. Yzaguirre
    
    Director
    
    
    )Raul H. Yzaguirre
    
    
    
    
    )))
 *By: /s/ Michael J.
Graham
Individually and as Attorney-in-fact
          Michael J. Graham 51




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SEARS, ROEBUCK AND CO.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Year Ended January 1, 2005 PageManagements
            Report
        
        
        F-2Report of Independent
            Registered Public Accounting Firm
        
        
        F-3Consolidated Statements
            of Operations
        
        
        F-5Consolidated Balance
            Sheets
        
        
        F-6Consolidated Statements
            of Cash Flows
        
        
        F-7Consolidated Statements
            of Shareholders Equity
        
        
        F-8Notes to Consolidated
            Financial Statements
        
        
        F-9Schedule II
             Valuation and Qualifying Accounts
        
        
        F-43
 F-1




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Managements Report The financial statements, financial analyses and all other information included in this Annual
Report on Form 10-K were prepared by management, which is responsible for their integrity and
objectivity and for establishing and maintaining adequate internal controls over financial
reporting. The Companys internal control over financial reporting is designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. The Companys
internal control over financial reporting includes those policies and procedures that:  i.
    pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company;ii.
    provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company; andiii.
    provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Companys assets that could have a material effect
on the financial statements. There are inherent limitations in the effectiveness of any internal control, including the
possibility of human error and the circumvention or overriding of controls. Accordingly, even
effective internal controls can provide only reasonable assurances with respect to financial
statement preparation. Further, because of changes in conditions, the effectiveness of internal
controls may vary over time. Management assessed the design and effectiveness of the Companys internal control over financial
reporting as of January 1, 2005. In making this assessment, management used the criteria set forth
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control  Integrated Framework. Based on managements assessment using those criteria, it believes
that, as of January 1, 2005, the Companys internal controls over financial reporting are
effective. Deloitte & Touche LLP, independent registered public accounting firm, have audited the financial
statements of the Company for the fiscal years ended January 1, 2005, January 3, 2004 and December
28, 2002 and have attested to managements assertion regarding the effectiveness of the Companys
internal control over financial reporting as of January 1, 2005. Their report is presented on the
following page. The independent registered public 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. F-2




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Report of Independent Registered Public Accounting Firm 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. (the
Company) as of January 1, 2005 and January 3, 2004, and the related consolidated statements of
operations, shareholders equity, and cash flows for each of the three years in the period ended
January 1, 2005. Our audits also included the financial statement schedule listed in the Index at
Item 15. We also have audited managements assessment, included in the accompanying Managements
Report, that the Company maintained effective internal control over financial reporting as of
January 1, 2005, based on criteria established in Internal ControlIntegrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission. The Companys management is
responsible for these financial statements and financial statement schedule, for maintaining
effective internal control over financial reporting, and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an opinion on these
financial statements and financial statement schedule, an opinion on managements assessment, and
an opinion on the effectiveness of the Companys internal control over financial reporting based on
our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement and
whether effective internal control over financial reporting was maintained in all material
respects. Our audit of financial statements included examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. Our audit of internal control over financial reporting included obtaining
an understanding of internal control over financial reporting, evaluating managements assessment,
testing and evaluating the design and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles and
that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the companys
assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of January 1, 2005 and January 3, 2004,
and the results of its operations and its cash flows for each of the three years in the period ended January 1, 2005, in conformity with
accounting F-3




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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. Also, in our opinion, managements assessment that the Company maintained effective
internal control over financial reporting as of January 1, 2005, is fairly stated, in all material
respects, based on the criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal control over financial reporting
as of January 1, 2005, based on the criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. As discussed in Notes 1 and 9 to the consolidated financial statements, the Company changed its
method of accounting for goodwill in 2002 and domestic pension and postretirement plans in 2004. /s/ DELOITTE & TOUCHE LLP
            
            Deloitte & Touche LLPChicago,
            Illinois February 23, 2005
 F-4




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SEARS, ROEBUCK AND CO.
Consolidated Statements of Operations millions,
          except per common share data
        
        2004
        
        
        2003
        
        
        2002REVENUESMerchandise sales
            and services
        
        $
        35,718
        
        
        $
        36,372
        
        
        $
        35,698Credit and financial
            products revenues
        
        
        381
        
        
        
        4,752
        
        
        
        5,668Total revenues
        
        
        36,099
        
        
        
        41,124
        
        
        
        41,366COSTS AND EXPENSESCost of sales, buying
            and occupancy
        
        
        25,997
        
        
        
        26,231
        
        
        
        25,646Selling and administrative
        
        
        8,245
        
        
        
        9,083
        
        
        
        9,249Provision for uncollectible
            accounts
        
        
        64
        
        
        
        1,747
        
        
        
        2,261Depreciation and
            amortization
        
        
        989
        
        
        
        909
        
        
        
        875Interest, net
        
        
        276
        
        
        
        1,025
        
        
        
        1,143Loss on early retirement
            of debt, net
        
        
        
        
        
        
        791
        
        
        
        Special charges and
            impairments
        
        
        41
        
        
        
        140
        
        
        
        111Total costs and expenses
        
        
        35,612
        
        
        
        39,926
        
        
        
        39,285Operating income
        
        
        487
        
        
        
        1,198
        
        
        
        2,081Gain on sale of businesses
        
        
        
        
        
        
        4,224
        
        
        
        Other income, net
        
        
        60
        
        
        
        27
        
        
        
        372Income before income
            taxes, minority interest and cumulative effect of change in accounting
            principle
        
        
        547
        
        
        
        5,449
        
        
        
        2,453Income taxes
        
        
        170
        
        
        
        2,007
        
        
        
        858Minority interest
        
        
        45
        
        
        
        45
        
        
        
        11Income before cumulative
            effect of change in accounting principle
        
        
        332
        
        
        
        3,397
        
        
        
        1,584Cumulative effect
            of change in accounting principle
        
        
        (839
        )
        
        
        
        
        
        
        (208
        )NET (LOSS)/INCOME
        
        $
        (507
        )
        
        $
        3,397
        
        
        $
        1,376(LOSS)/EARNINGS
            PER COMMON SHARE:BASICEarnings per share
            before cumulative effect of change in accounting principle
        
        $
        1.55
        
        
        $
        11.95
        
        
        $
        4.99Cumulative effect
            of change in accounting principle
        
        
        (3.92
        )
        
        
        
        
        
        
        (0.65
        )(Loss)/earnings per
            share
        
        $
        (2.37
        )
        
        $
        11.95
        
        
        $
        4.34DILUTEDEarnings per share
            before cumulative effect of change in accounting principle
        
        $
        1.53
        
        
        $
        11.86
        
        
        $
        4.94Cumulative effect
            of change in accounting principle
        
        
        (3.87
        )
        
        
        
        
        
        
        (0.65
        )(Loss)/earnings per
            share
        
        $
        (2.34
        )
        
        $
        11.86
        
        
        $
        4.29
 See accompanying notes. F-5




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SEARS, ROEBUCK AND CO.
Consolidated Balance Sheets millions, except per share data
    
    2004
    
    
    2003ASSETSCurrent assetsCash and cash equivalents
    
    $
    4,165
    
    
    $
    9,057Credit card receivables, net of allowance for
    
    
    1,239
    
    
    
    1,956uncollectible accounts of $36 and $42, respectivelyOther receivables
    
    
    642
    
    
    
    733Merchandise inventories, net
    
    
    5,549
    
    
    
    5,335Prepaid expenses, deferred charges and other current assets
    
    
    493
    
    
    
    407Deferred income taxes
    
    
    475
    
    
    
    708Total current assets
    
    
    12,563
    
    
    
    18,196Property and equipmentLand
    
    
    402
    
    
    
    392Buildings and improvements
    
    
    7,542
    
    
    
    7,151Furniture, fixtures and equipment
    
    
    4,979
    
    
    
    4,972Capitalized leases
    
    
    618
    
    
    
    609Gross property and equipment
    
    
    13,541
    
    
    
    13,124Less accumulated depreciation
    
    
    6,792
    
    
    
    6,336Total property and equipment, net
    
    
    6,749
    
    
    
    6,788Deferred income taxes
    
    
    271
    
    
    
    378Goodwill
    
    
    963
    
    
    
    943Tradenames and other intangible assets
    
    
    1,285
    
    
    
    710Other assets
    
    
    643
    
    
    
    708TOTAL ASSETS
    
    $
    22,474
    
    
    $
    27,723LIABILITIESCurrent liabilitiesShort-term borrowings
    
    $
    685
    
    
    $
    1,033Current portion of long-term debt and capitalized lease obligations
    
    
    330
    
    
    
    2,950Merchandise payables
    
    
    2,962
    
    
    
    3,106Income taxes payable
    
    
    412
    
    
    
    1,867Other liabilities
    
    
    3,146
    
    
    
    2,950Unearned revenues
    
    
    1,081
    
    
    
    1,244Other taxes
    
    
    581
    
    
    
    609Total current liabilities
    
    
    9,197
    
    
    
    13,759Long-term debt and capitalized lease obligations
    
    
    3,473
    
    
    
    4,218Pension and postretirement benefits
    
    
    1,685
    
    
    
    1,956Minority interest and other liabilities
    
    
    2,027
    
    
    
    1,389Total Liabilities
    
    
    16,382
    
    
    
    21,322SHAREHOLDERS EQUITYCommon shares issued ($.75 par value per share, 1,000 shares authorized,
215.7 and 230.4 shares outstanding, respectively)
    
    
    323
    
    
    
    323Capital in excess of par value
    
    
    3,534
    
    
    
    3,519Retained earnings
    
    
    10,934
    
    
    
    11,636Treasury stock  at cost
    
    
    (8,612
    )
    
    
    (7,945
    )Deferred ESOP expense
    
    
    (2
    )
    
    
    (26
    )Accumulated other comprehensive loss
    
    
    (85
    )
    
    
    (1,106
    )Total Shareholders Equity
    
    
    6,092
    
    
    
    6,401TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    22,474
    
    
    $
    27,723
 See accompanying notes. F-6




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SEARS, ROEBUCK AND CO.
Consolidated Statements of Cash Flows millions
        
        2004
        
        
        2003
        
        
        2002CASH FLOWS FROM OPERATING
            ACTIVITIESNet (loss)/income
        
        $
        (507
        )
        
        $
        3,397
        
        
        $
        1,376Adjustments to reconcile
            net income to net cash provided by (used in) operating activitiesDepreciation and amortization
        
        
        989
        
        
        
        909
        
        
        
        875Cumulative effect
            of a change in accounting principle
        
        
        839
        
        
        
        
        
        
        
        208Provision for uncollectible
            accounts
        
        
        64
        
        
        
        1,747
        
        
        
        2,261Gain on sales of
            property and investments
        
        
        (37
        )
        
        
        (12
        )
        
        
        (347
        )Income tax benefit
            on nonqualified stock options
        
        
        45
        
        
        
        25
        
        
        
        24Loss on early retirement
            of debt
        
        
        
        
        
        
        791
        
        
        
        Gain on sale of businesses
        
        
        
        
        
        
        (4,224
        )
        
        
        Special charges and
            impairments
        
        
        
        
        
        
        112
        
        
        
        111Change in (net of
            dispositions and acquisitions):Deferred income taxes
        
        
        (198
        )
        
        
        648
        
        
        
        (203
        )Sears credit card
            receivables
        
        
        14
        
        
        
        1,779
        
        
        
        2,554Merchandise inventories
        
        
        (141
        )
        
        
        (158
        )
        
        
        45Other operating assets
        
        
        264
        
        
        
        (496
        )
        
        
        (56
        )Other operating liabilities
        
        
        (1,278
        )
        
        
        (739
        )
        
        
        34Net cash provided
            by operating activities
        
        
        54
        
        
        
        3,779
        
        
        
        6,882CASH FLOWS FROM INVESTING
            ACTIVITIESAcquisition of businesses,
            net of cash acquired
        
        
        (29
        )
        
        
        
        
        
        
        (1,840
        )Acquisition of leasehold
            interest
        
        
        (172
        )
        
        
        
        
        
        
        Change in Sears MasterCard
            credit card receivables
        
        
        
        
        
        
        (1,255
        )
        
        
        (7,387
        )Proceeds from sale
            of businesses
        
        
        
        
        
        
        21,651
        
        
        
        Proceeds from sales
            of property and investments
        
        
        1,337
        
        
        
        53
        
        
        
        568Purchases of property
            and equipment
        
        
        (882
        )
        
        
        (925
        )
        
        
        (1,035
        )Purchases of long-term
            investments
        
        
        (1,371
        )
        
        
        (21
        )
        
        
        (15
        )Net cash (used in)
            provided by investing activities
        
        
        (1,117
        )
        
        
        19,503
        
        
        
        (9,709
        )CASH FLOWS FROM FINANCING
            ACTIVITIESProceeds from long-term
            debt
        
        
        312
        
        
        
        3,757
        
        
        
        6,565Repayments of long-term
            debt
        
        
        (2,928
        )
        
        
        (12,643
        )
        
        
        (3,256
        )(Decrease) increase
            in short-term borrowings, primarily 90 days or less
        
        
        (373
        )
        
        
        (3,519
        )
        
        
        964Repayments of ESOP
            note receivable
        
        
        
        
        
        
        2
        
        
        
        11Common shares repurchased
        
        
        (1,097
        )
        
        
        (3,673
        )
        
        
        (427
        )Common shares issued
            for employee stock plans
        
        
        400
        
        
        
        191
        
        
        
        157Dividends paid to
            shareholders
        
        
        (151
        )
        
        
        (327
        )
        
        
        (293
        )Net cash (used in)
            provided by financing activities
        
        
        (3,837
        )
        
        
        (16,212
        )
        
        
        3,721Effect of exchange
            rate changes on cash and cash equivalents
        
        
        8
        
        
        
        25
        
        
        
        4NET (DECREASE) INCREASE
            IN CASH AND CASH EQUIVALENTS
        
        
        (4,892
        )
        
        
        7,095
        
        
        
        898BALANCE AT BEGINNING
            OF YEAR
        
        
        9,057
        
        
        
        1,962
        
        
        
        1,064BALANCE AT END
            OF YEAR
        
        $
        4,165
        
        
        $
        9,057
        
        
        $
        1,962
  See accompanying notes. F-7




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SEARS, ROEBUCK AND CO.
Consolidated Statements of Shareholders Equity dollars in millions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    Totalshares in thousands
    
    Common
    
    
    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 2002
    
    
    320,446
    
    
    $
    323
    
    
    $
    3,500
    
    
    $
    7,413
    
    
    $
    (4,223
    )
    
    $
    (63
    )
    
    $
    (831
    )
    
    $
    6,119Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,376
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,376Total other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (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
    )
    
    $
    6,401Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (507
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (507
    )Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,021
    
    
    
    1,021Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    514Dividends declared to shareholders
($0.92 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (195
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (195
    )Stock options exercised and other
changes
    
    
    10,726
    
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    430
    
    
    
    
    
    
    
    
    
    
    
    445Shares repurchased
    
    
    (25,412
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,097
    )
    
    
    
    
    
    
    
    
    
    
    (1,097
    )ESOP expense recognized
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    24Balance, end of year 2004
    
    
    215,690
    
    
    $
    323
    
    
    $
    3,534
    
    
    $
    10,934
    
    
    $
    (8,612
    )
    
    $
    (2
    )
    
    $
    (85
    )
    
    $
    6,092
 See accompanying notes. F-8




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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. On November 17, 2004, Sears and Kmart Holding Corporation (Kmart) announced that they had signed
a definitive merger agreement (the Merger) that will combine Sears and Kmart into a major new
retail company named Sears Holdings Corporation
(Holdings). Holdings is expected to be the nations third
largest retailer, initially with approximately $55 billion in annual revenues and 2,350 full-line
and off-mall stores, and 1,100 specialty retail stores in the United States. Under the terms of the agreement, Kmart shareholders will receive one share of Holdings common
stock for each Kmart share and Sears shareholders have the right to elect $50 in cash or 0.5 shares
of Holdings for each share of Sears common stock. Sears shareholder elections will be prorated to
ensure that in the aggregate 55% of Sears shares are converted into Holdings shares and 45% of
Sears shares are converted to cash. The merger will be treated as a purchase business combination for accounting purposes, with Sears
being acquired by Kmart. Sears assets acquired and liabilities assumed will be recorded at their
fair value. The merger is subject to approval by Sears and Kmart stockholders, and the
satisfaction or waiver of other customary closing conditions. Basis of Consolidation The consolidated financial statements include the accounts of Sears, Roebuck and Co. and all
majority-owned subsidiaries, including Sears Canada, Inc. (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
        
        Weeks2004
        
        January 1, 2005
        
        
        522003
        
        January 3, 2004
        
        
        532002
        
        December 28, 2002
        
        
        52
 F-9




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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, self-insurance, warranty, tax 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 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.
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 1, 2005
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
Canada 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. In 2003, the Company either repaid or transferred to Citigroup all of its domestic debt securitized
by credit card receivables. F-10




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements On December 31, 2004, the Company modified certain provisions within the legal structure of the
Canadian related trusts, which resulted in the trusts meeting the definition of a qualified special
purpose entity. Previously, the receivables and related borrowings recorded within the
securitization trusts were consolidated. In accordance with FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities, qualifying special purpose entities are not
consolidated. As a result, the Sears Canada securitized receivables and related borrowings are no
longer presented in the consolidated balance sheet. Merchandise Inventories Approximately 86% 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 the effects of inflation on inventories, the Company utilizes
internally developed price indices. The LIFO adjustment to cost of sales was a credit of $42 million in 2004, a credit of $22 million
in 2003 and a charge of $11 million in 2002. If the first-in, first-out (FIFO) method of
inventory valuation had been used instead of the LIFO method, merchandise inventories would have
been $538 and $580 million higher at January 1, 2005 and January 3, 2004, 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 and obsolescence 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. 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 F-11




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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. Goodwill Under the provisions of Statement of Financial Accounting Standards (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 $963 million of goodwill as of January 1, 2005
resulting in no impairment being recorded. The changes in the carrying amount of goodwill as of January 1, 2005 are as follows: Searsmillions
        
        Domestic
        
        
        Canada
        
        
        TotalBalance, beginning
            of year 2003
        
        $
        927
        
        
        $
        17
        
        
        $
        944Acquisition of Lands
            End
        
        
        1
        
        
        
        
        
        
        
        1Sale of Credit and
            Financial Products business
        
        
        (2
        )
        
        
        
        
        
        
        (2
        )Balance, end of year
            2003
        
        $
        926
        
        
        $
        17
        
        
        $
        943Acquisition of:Standards of Excellence
        
        $
        13
        
        
        $
        
        
        
        $
        13Westar
        
        
        7
        
        
        
        
        
        
        
        7Balance, end of year
            2004
        
        $
        946
        
        
        $
        17
        
        
        $
        963
 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. F-12




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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 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: millions
        
        2004
        
        
        2003Balance, beginning
            of year
        
        $
        131
        
        
        $
        131Warranty expense
        
        
        198
        
        
        
        204Warranty claims
        
        
        (198
        )
        
        
        (204
        )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 Home Services businesses, and all
shipping, handling and delivery costs associated with its 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 Costs for newspaper, television, radio and other media advertising are expensed the first time the
advertising occurs. The total net cost of advertising charged to selling, general and
administrative expense was $1.7 billion, $1.8 billion and $1.8 billion in 2004, 2003 and 2002,
respectively. Certain costs related to catalogs are capitalized. Costs are amortized over the life of the
catalog, not to exceed one year. When the carrying amount of such deferred costs exceed the
estimated future net revenues realized from such catalogs, any excess is recorded as advertising
expense of the current period. The consolidated balance sheets include deferred costs of $49
million and $24 million at January 1, 2005 and January 3, 2004, respectively. The current portion
is included in prepaid expenses and deferred charges, while the long-term portion is included in
other assets. F-13




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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, prior to 2004, the Company recognized changes in plan obligations and
assets systematically over time. This systematic recognition of changes was accomplished by
amortizing experience gains/losses in excess of the 10% corridor into expense over the estimated
associate service period. For 2004, the Company changed its method of accounting for its domestic
defined benefit plans to accelerate recognition of experience gains and losses. 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 15 years for
identifiable intangible assets with a definitive estimated useful life. Leasehold improvements are
depreciated over the shorter of the lease term or estimated useful life of the improvement. 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 1, 2005, 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 (loss)/income and (loss)/earnings per share if
the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation. F-14




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements millions, except earnings per share
      
      2004
      
      
      2003
      
      
      2002Net (loss)/income 
          as reported
      
      $
      (507
      )
      
      $
      3,397
      
      
      $
      1,376Less: Total stock-based
          employee compensation expense determined under fair value based method
          for all awards, net of related taxes
      
      
      (123
      )
      
      
      (44
      )
      
      
      (49
      )Net (loss)/income 
          pro forma
      
      $
      (630
      )
      
      $
      3,353
      
      
      $
      1,327(Loss)/earnings per
          share  basicAs reported
      
      $
      (2.37
      )
      
      $
      11.95
      
      
      $
      4.34Pro forma
      
      
      (2.94
      )
      
      
      11.79
      
      
      
      4.18(Loss)/earnings per
          share  dilutedAs reported
      
      $
      (2.34
      )
      
      $
      11.86
      
      
      $
      4.29Pro forma
      
      
      (2.91
      )
      
      
      11.71
      
      
      
      4.14
 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 November 2004, the FASB issued SFAS No. 151, Inventory Costs  An Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to
clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). SFAS No. 151 is effective for fiscal years beginning after June 15,
2005 and is required to be adopted by the Company in the first quarter of fiscal 2006. The Company
does not expect SFAS No. 151 to have a material impact on the Company. F-15




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets  An Amendment of
APB Opinion No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 eliminates the
exception from fair value measurement for nonmonetary exchanges of similar productive assets in
paragraph 21(b) of APB Opinion No. 29, and replaces it with an exception for exchanges that do not
have commercial substance. SFAS No. 153 is effective for fiscal periods beginning after June 15,
2005. The Company does not expect SFAS No. 153 to have a material impact on the Company. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. This
statement revised SFAS No. 123, Accounting for Stock-Based compensation, and requires companies
to expense the value of employee stock options and similar awards. The effective date of this
standard is interim and annual periods beginning after June 15, 2005. Historically, the Company has elected to follow the intrinsic value method in accounting for its
employee stock options and employee stock purchase plans. No stock-based compensation costs were
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. Upon the adoption of SFAS No. 123R, the Company will be required to expense stock options over the
vesting period in its statement of operations. In addition, the Company will need to recognize
expense over the remaining vesting period associated with unvested options outstanding as of June
15, 2005. For the years ended January 1, 2005, January 3, 2004 and December 28, 2002, total
stock-based employee compensation expense, net of related tax effects, determined under this new
standard would have been $123 million, $44 million and $49 million, respectively. NOTE 2  ACQUISITIONS/DISPOSITIONS On September 29, 2004, the Company closed the acquisition of ownership or leasehold interest in 50
off-mall stores from Kmart for $576 million plus the assumption of existing real estate leases.
ESL Partners, L.P., and certain affiliated entities combined own greater than ten percent of both
the Company and Kmart Holding Corporation. As of January 1, 2005, the Company has paid 30 percent
($172 million) of the purchase price and will pay the remaining 70 percent ($404 million) upon
taking possession of the stores in 2005. A liability for the remaining 70 percent is reported
within other liabilities on the balance sheet. The acquisitions include real estate and store
fixtures, but exclude inventory and liabilities not related to leases. The purchase price of $576
million is recorded within trade names and other intangible assets on the balance sheet. The
Company will take possession of the stores in the spring of 2005 and expects to convert the stores
to Sears nameplates by the fourth quarter of 2005 In addition, the Company agreed to sublease six
stores from Wal-Mart Stores, Inc. Sears has taken possession of two stores in 2004. On November 5, 2004, the Company acquired Westar, a premier supplier of major kitchen appliances
and architectural plumbing fixtures. The Company paid $12 million in cash. The acquisition has
been accounted for using the purchase method in accordance with SFAS No. 141, Business
Combinations. Accordingly, the total purchase price has been allocated to the assets acquired and
liabilities assumed based on their estimated fair value at acquisition. On July 10, 2004, the Company acquired Standards of Excellence, a San Diego-based supplier of
premium appliances, designer fixtures and decorative hardware. The Company paid $17 million in
cash. The acquisition has been accounted for using the purchase method in accordance with SFAS No.
141, Business Combinations. Accordingly, the total purchase price has been allocated to the
assets acquired and liabilities assumed based on their estimated fair values at acquisition. F-16




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements On November 3, 2003, the Company completed the sale of its domestic Credit and Financial Products
business, including its clubs and services business, to Citigroup. The sale generated total
proceeds of $32 billion, consisting of the assumption of $10 billion of securitized debt by
Citigroup 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. 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 and $465 million in 2003 and 2002, 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  SECURITIZED ASSETS The Company securitizes certain of its Canadian credit card receivables through trusts. Under the
Sears Canada securitization program, trusts purchased undivided interests in the receivable
balances totaling $1,039 million and $1,093 million for 2004 and 2003, respectively, funded by
issuing short-term and long-term debt, primarily commercial paper and senior and subordinated
receivables-backed notes. These certificates entitled the holder to a series of scheduled cash
flows under preset terms and conditions, the receipt of which was dependent upon cash flows
generated by the related trusts assets. Prior to December 31, 2004, the Company accounted for
credit card securitizations as secured borrowings. On December 31, 2004, the Company modified certain provisions within the legal structure of the
trusts, which resulted in the trusts meeting the definition of a qualified special purpose entity.
Previously, the receivables and related borrowings recorded within the securitization trusts were
consolidated. In accordance with FIN No. 46, Consolidation of Variable Interest Entities,
qualifying special purpose entities are not consolidated. As a result, the Sears Canada
securitized receivables and related borrowings are no longer presented in the consolidated balance
sheet. The Company also recognized $32 million of credit revenue related to the sale of
receivables. F-17




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements The undivided co-ownership interest is sold on a fully serviced basis and the Company receives no
fee for ongoing servicing responsibilities. The Company receives proceeds equal to fair value for
the assets sold and retained rights to future cash flows arising after the investors in the
securitization trusts have received the return for which they contracted. The co-owners have no
recourse to the Companys retained interest in the receivables sold other than in respect of
amounts in the cash reserve account and the interest-only strip receivable. Retained interests at year-end were as follows: millions
        
        2004
        
        
        2003Interest-only strip
        
        $
        47
        
        
        $
        Allowance for uncollectible
            accounts Score Trusts
        
        
        (11
        )
        
        
        Trust servicing liability
        
        
        (4
        )
        
        
        $
        32
        
        
        $
        
 At January 1, 2005, the retained interest is recorded within other receivables on the
consolidated balance sheet. The fair value of the retained interests in securitized receivables
was $32 million, with a weighted-average life of less than one year. The following table shows the key economic assumptions used in measuring the interest-only strip
and securitization gains. The table also displays the sensitivity of the current fair value of
residual cash flows to immediate 100 and 200 basis point adverse changes in yield, payment rate,
net charge-off rate and discount rate assumptions. millions
        
        
        
        
        
        Effects
          of Adverse ChangesAssumptions
        
        100
          bp
        
        
        200
          bpYield (annual rate)
        
        
        24.43
        %
        
        $
        4
        
        
        $
        9Principal payment
            rate (monthly)
        
        
        24.56
        %
        
        $
        3
        
        
        $
        6Net charge-off rate
            (annual rate)
        
        
        5.30
        %
        
        $
        1
        
        
        $
        2Discount rate (annual
            rate)
        
        
        12.00
        %
        
        $
        
        
        
        $
        
 Managed Portfolio Data The following table summarizes the Sears Canada credit card receivables: millions
        
        2004
        
        
        2003Managed accounts
        
        $
        2,399
        
        
        $
        2,235Less: co-ownership
            interest held by third parties
        
        
        (1,039
        )
        
        
        Co-ownership retained
            by the Company
        
        
        1,360
        
        
        
        2,235Less: long-term portion
            of deferred customer accounts receivable
        
        
        (85
        )
        
        
        (237
        )Total
        
        $
        1,275
        
        
        $
        1,998Percentage of
            managed accounts delinquent over 90 days
        
        
        0.6
        %
        
        
        0.6
        %
 Under the securitization program, there is a daily distribution of collections from credit
card receivables and a reinvestment of those amounts by the trusts to purchase additional charge
account receivables in order to maintain existing outstanding debt levels. F-18




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements In addition to Canadian credit card securitizations, certain real estate assets were transferred to
a wholly-owned consolidated subsidiary of Sears and segregated into a trust owned by the
consolidated subsidiary. As of January 1, 2005 and January 3, 2004, the net book value of the
securitized real estate was $476 million and $500 million, respectively. These assets are related
to an inter-company loan agreement. NOTE 4  BORROWINGS Total borrowings outstanding as of January 1, 2005 and January 3, 2004 were $4.4 billion and $8.1
billion, respectively. Short-term borrowings consist of unsecured commercial paper of $685 million and $1,033 million at
January 1, 2005 and January 3, 2004, respectively. The weighted-average annual interest rate paid
on short-term debt was 1.5% and 2.2% in 2004 and 2003, respectively. The Company maintains committed credit facilities to support its unsecured commercial paper
borrowings. The Companys domestic wholly-owned financing subsidiary, Sears Roebuck Acceptance
Corp. (SRAC), has an unsecured, three-year revolving credit facility in the amount of $2.0
billion. This facility and other debt agreements require SRAC to maintain specified fixed charge
coverage ratios, and the credit facility requires the Companys domestic segment to maintain a
minimum level of tangible net worth and a minimum interest coverage ratio. SRAC and the Company
were in compliance with these covenants at January 1, 2005. As of January 1, 2005, there were no
outstanding borrowings related to this credit facility. The Company had interest rate swap agreements that established floating rates on $1.3 billion and
$2.0 billion of long-term fixed rate debt at January 1, 2005 and January 3, 2004, respectively.
The weighted-average maturity of these agreements was 4.1 and 3.5 years as of both January 1, 2005
and January 3, 2004, respectively. The weighted-average interest rate received by the Company
related to the agreements was 5.2% and 4.9% at January 1, 2005 and January 3, 2004, respectively. F-19




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements Long-term debt is as follows: ISSUE
        
        2004
        
        
        2003millionsSEARS, ROEBUCK
            AND CO.6.25% Notes, due
            in 2005
        
        $
        
        
        
        $
        2369.375% Debentures,
            due 2011
        
        
        
        
        
        
        2518.23% to 10.0% Medium-Term
            Notes, due 2005 to 2012
        
        
        
        
        
        
        367SEARS ROEBUCK ACCEPTANCE
            CORP.6.125% to 7.50% Notes,
            due 2005 to 2043
        
        
        1,839
        
        
        
        1,8384.95% to 7.75% Medium-Term
            Notes, due 2005 to 2013
        
        
        852
        
        
        
        1,267LIBOR + 1.18%
            to 2.95% Floating Rate Medium-Term Notes,due 2004
        
        
        
        
        
        
        1,346SEARS DC CORP.9.07% to 9.20% Medium-Term
            Notes, due 2012
        
        
        23
        
        
        
        23SEARS CANADA INC.6.55% to 7.45% Debentures
            and Medium-Term Notes, due 2006 to 2010
        
        
        520
        
        
        
        481SEARS CANADA RECEIVABLES
            TRUST4.72% to 9.18% Receivables
            Trusts, due 2005 to 2006
        
        
        
        
        
        
        756CAPITALIZED LEASE
            OBLIGATIONS
        
        
        486
        
        
        
        497OTHER NOTES AND MORTGAGES
        
        
        14
        
        
        
        16Total long-term borrowings
        
        
        3,734
        
        
        
        7,078SFAS No. 133
            Hedge Accounting Adjustment (see Note 5)
        
        
        69
        
        
        
        90Current maturities
        
        
        (330
        )
        
        
        (2,950
        )Long-term debt and
            capital lease obligations
        
        $
        3,473
        
        
        $
        4,218Weighted-average
            annual interest rate on long-term debt
        
        
        5.9
        %
        
        
        4.2
        %
 The fair value of long-term debt was $3.9 billion and $7.3 billion at January 1, 2005 and
January 3, 2004, respectively. Included in current maturities of long-term debt are securities with provisions that permit
optional early redemptions in 2005. As of January 1, 2005, long-term debt maturities for the next five years and thereafter are as
follows: millions2005
        
        $
        3302006
        
        
        6552007
        
        
        4692008
        
        
        2572009 and thereafter
        
        
        2,023$
        3,734
 The Company paid interest of $0.4 billion, $0.7 billion and $1.1 billion in 2004, 2003 and
2002, respectively. Interest capitalized was $0.2 million, $1.6 million and $3.9 million in 2004,
2003 and 2002, respectively. F-20




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements NOTE 5  DERIVATIVE FINANCIAL INSTRUMENTS AND FINANCIAL GUARANTEES 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 1, 2005,
the Company had interest rate swaps with an aggregate fair value of $82 million that have been used
to synthetically convert certain of the Companys domestic fixed rate debt to variable rate. The Companys interest rate swaps have been recorded on the balance sheet at fair value, classified
as $13 million of other receivables and $69 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 is largely offset by changes in fair value
recorded on the hedged debt. Consequently, the amount of hedge ineffectiveness recorded during
2004 in connection with these hedges was not material and is reflected as a component of interest
expense. 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. In addition, the
Company recognized a non-cash pretax loss of $316 million attributable to a deferred loss on an
interest rate swap which was previously classified as a component of other comprehensive income.
The recognition of this loss was triggered by retirement of borrowings to which the interest rate
swap was designated. The pretax loss is also presented as a component of the loss on early
retirement of debt. The following sets forth the notional amounts and fair values of interest rate swaps outstanding at
the end of 2004 and 2003: 2004
    
    
    2003millions
    
    Contract or
    
    
    
    
    
    
    Contract orNotional
    
    
    
    
    
    
    NotionalAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueInterest rate swap agreements:Pay floating rate, receive fixed rate
    
    $
    1,337
    
    
    $
    82
    
    
    $
    1,970
    
    
    $
    112
 The Company paid a weighted-average rate of 1.6% and received a weighted-average rate of 5.2%
in 2004. 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 1,
2005, the Company had the following guarantees outstanding: millionsParent guarantee
            of SRAC debt
        
        $
        3,385Import letters of
            credit
        
        
        198Standby letters of
            credit
        
        
        151Secondary lease obligations
        
        
        100Performance guarantee
        
        
        57
 F-21




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements The debt obligations of SRAC are reflected in the Companys consolidated balance sheets. As a
result of the Companys sale of Credit, 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. Sears also guarantees any
outstanding borrowings under SRACs three-year, unsecured credit facility. As of January 1, 2005,
no borrowings were outstanding under this facility. These guarantees would require Sears to repay
such debt should SRAC default in payment. The secondary lease obligations relate to certain store leases of Sears. The Company remains
secondarily liable if the primary obligor defaults. As of January 1, 2005, the Company had a $17
million liability recorded in other liabilities which represents the Companys current estimate of
potential obligation related to these leases. The performance guarantee relates to certain municipal bonds issued in connection with the
Companys headquarters building. Payments under this guarantee were $10 million in both 2004 and
2003 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 2007. NOTE 6  SPECIAL CHARGES AND IMPAIRMENTS Special charges and impairments included the following: millions
        
        2004
        
        
        2003
        
        
        2002Restructuring
            initiativesEmployee termination
            costs
        
        $
        41
        
        
        $
        28
        
        
        $
        TGI strategic review
        
        
        
        
        
        
        112
        
        
        
        Sears Canada 
            Eatons conversion
        
        
        
        
        
        
        
        
        
        
        111$
        41
        
        
        $
        140
        
        
        $
        111
 Employee Termination Costs During the second quarter of 2004, the Company recorded a severance charge of $41 million
associated with the termination of 3,300 associates resulting from the Companys extensive review
of its headquarters and field operations following the sale of the domestic Credit and Financial
Products business. During the second quarter of 2003, the Company recorded a $28 million pretax
charge for severance costs associated with the Companys productivity improvement initiatives. 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 F-22




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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 million for
employee termination costs. All actions identified under this plan had been executed by December
28, 2002. Following is a summary of the activity in the 2004 reserve established for special charges and
impairments: Balance,beginning
        
        
        
        
        
        
        Cash
        
        
        Balance,millions
        
        of
          year
        
        
        2004
          Charge
        
        
        Payments
        
        
        end
          of year2004 employee termination
            costs
        
        $
        
        
        
        $
        41
        
        
        $
        (22
        )
        
        $
        19
 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 $425 million, $499 million and $474
million, including contingent rentals of $44 million, $44 million and $56 million in 2004, 2003 and
2002, respectively. F-23




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements Minimum lease obligations, excluding taxes, insurance and other expenses payable directly by the
Company, for leases in effect as of January 1, 2005, are as follows: Capital
    
    
    Operatingmillions
    
    Leases
    
    
    Leases2005
    
    $
    83
    
    
    $
    3692006
    
    
    82
    
    
    
    3242007
    
    
    74
    
    
    
    2762008
    
    
    70
    
    
    
    2382009
    
    
    64
    
    
    
    198After 2009
    
    
    617
    
    
    
    1,175Total minimum payments (1)
    
    
    990
    
    
    $
    2,580Less imputed interest
    
    
    504Present value of minimum lease payments (1)
    
    
    486Less current maturities
    
    
    32Long-term obligations
    
    $
    454
   (1)
Sears Canada: Total operating minimum lease payments of
$588 million; capital lease present value of minimum lease
payments of $146 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 was prohibited from taking 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 1, 2005, approximately $4.1
billion in dividends could be paid to shareholders under this restriction. This prohibition was
removed by mutual consent in January 2005. Share Repurchase Program The Company repurchased 25.4 million, 91.7 million and 8.2 million common shares in 2004, 2003 and
2002, respectively, under share repurchase programs approved by the Board of Directors. As of
January 1, 2005, the Company had remaining authorization to repurchase $481 million of shares by
December 31, 2006 under a $3.0 billion share repurchase plan approved by the Board of Directors on
October 8, 2003. Due to the pending merger with Kmart, the Company has suspended its share
repurchase program. F-24




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements Comprehensive Income and Accumulated Other Comprehensive Income (Loss) The following table shows the computation of comprehensive income: January 1,
    
    
    January 3,
    
    
    December 28,millions
    2005
    
    
    2004
    
    
    2002Net (loss) income
    
    $
    (507
    )
    
    $
    3,397
    
    
    $
    1,376Other comprehensive income (loss):Minimum pension liability (1)
    
    
    954
    
    
    
    (367
    )
    
    
    (246
    )Recognition of deferred swap loss, net of tax of $134
    
    
    
    
    
    
    182
    
    
    
    Amounts amortized into interest expense from OCI (2)
    
    
    
    
    
    
    14
    
    
    
    16Change in fair value of cash flow hedges (3)
    
    
    3
    
    
    
    (4
    )
    
    
    (6
    )Foreign currency translation adjustments
    
    
    64
    
    
    
    125
    
    
    
    11Total accumulated other comprehensive income (loss)
    
    
    1,021
    
    
    
    (50
    )
    
    
    (225
    )Total comprehensive income
    
    $
    514
    
    
    $
    3,347
    
    
    $
    1,151
    (1)
    Net of tax (benefit) of $550 million, $(211) million and $(153) million for 2004, 2003 and 2002, respectively. 2004
amount reflects the effect of the change in accounting for domestic retirement benefits discussed in Note 9.(2)
    Net of tax of $8 million and $10 million for 2003 and 2002, respectively.(3)
    Net of tax (benefit) of $2 million, $(3) million and $(2) million for 2004, 2003 and 2002, respectively.   The following table displays the components of accumulated other comprehensive loss: millions
    2004
    
    
    2003
    
    
    2002Accumulated derivative loss
    
    $
    (6
    )
    
    $
    (9
    )
    
    $
    (201
    )Currency translation adjustments
    
    
    45
    
    
    
    (19
    )
    
    
    (144
    )Minimum pension liability, net of tax (1)
    
    
    (124
    )
    
    
    (1,078
    )
    
    
    (711
    )Accumulated other comprehensive loss
    
    $
    (85
    )
    
    $
    (1,106
    )
    
    $
    (1,056
    )
    (1)
    2004 Minimum pension liability reflects the effect of the change in accounting for domestic retirement benefits
discussed in Note 9.   NOTE 9  BENEFIT PLANS Expenses for retirement and savings-related benefit plans were as follows: millions
    
    
    2004
    
    
    2003
    
    
    2002Sears 401(k) Savings Plan
    
    $
    19
    
    
    $
    45
    
    
    $
    26Pension plans
    
    
    109
    
    
    
    148
    
    
    
    70Postretirement benefits
    
    
    (50
    )
    
    
    (65
    )
    
    
    (60
    )Total
    
    $
    78
    
    
    $
    128
    
    
    $
    36
 F-25




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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. In January 2004, the Company match on eligible employee contributions was
increased from 70% to 110% for associates hired on or after January 1, 2004, associates under age
40 as of December 31, 2004 and associates age 40 and over as of December 31, 2004 who choose the
new retirement program. The Companys matching contributions were $65 million, $65 million and $72
million in 2004, 2003 and 2002, 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 $65 million, $33 million and $56 million in
2004, 2003 and 2002, 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. In 2004, no Company cash contribution was required. The cash
payments amounted to $2 million and $11 million in 2003 and 2002, respectively. The balance of the
ESOP loan was $1 million and $7 million at January 1, 2005 and January 3, 2004, respectively. Cash
on hand in the ESOP at January 1, 2005 was $1 million. In 2004, the ESOP allocated 1.6 million shares to employees. At January 1, 2005, 25.8 million ESOP
shares had been allocated and 0.1 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 domestic and Canadian employees
certain medical benefits. Certain domestic retirees are also provided life insurance benefits.
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-26




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements Accounting Change 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, 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 elected to participate in the
enhanced 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. A curtailment gain of $30 million is included in
selling and administrative costs as a result of the change in the domestic retiree medical benefit. In connection with the domestic pension and postretirement plan changes discussed above, the
Company believed it was preferable to change its accounting methods, which under SFAS No. 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 recorded an after-tax charge of $839 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. 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: F-27




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements Pension Benefitsmillions
    
    Domestic
    
    
    Sears Canada
    
    
    Total2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Change in projected benefit obligationBeginning balance
    
    $
    3,252
    
    
    $
    2,500
    
    
    $
    849
    
    
    $
    642
    
    
    $
    4,101
    
    
    $
    3,142Benefits earned during the period
    
    
    85
    
    
    
    71
    
    
    
    26
    
    
    
    19
    
    
    
    111
    
    
    
    90Interest cost
    
    
    189
    
    
    
    147
    
    
    
    59
    
    
    
    48
    
    
    
    248
    
    
    
    195Actuarial loss
    
    
    107
    
    
    
    846
    
    
    
    84
    
    
    
    49
    
    
    
    191
    
    
    
    895Benefits paid
    
    
    (325
    )
    
    
    (302
    )
    
    
    (60
    )
    
    
    (51
    )
    
    
    (385
    )
    
    
    (353
    )Foreign currency exchange impact
    
    
    
    
    
    
    
    
    
    
    84
    
    
    
    127
    
    
    
    84
    
    
    
    127Other
    
    
    (9
    )
    
    
    (10
    )
    
    
    15
    
    
    
    15
    
    
    
    6
    
    
    
    5Balance as of the measurement date
    
    $
    3,299
    
    
    $
    3,252
    
    
    $
    1,057
    
    
    $
    849
    
    
    $
    4,356
    
    
    $
    4,101Change in assets at fair value:Beginning balance
    
    $
    1,842
    
    
    $
    1,381
    
    
    $
    915
    
    
    $
    719
    
    
    $
    2,757
    
    
    $
    2,100Actual return on plan assets
    
    
    263
    
    
    
    297
    
    
    
    91
    
    
    
    90
    
    
    
    354
    
    
    
    387Company contributions
    
    
    644
    
    
    
    476
    
    
    
    2
    
    
    
    1
    
    
    
    646
    
    
    
    477Benefits paid
    
    
    (325
    )
    
    
    (302
    )
    
    
    (60
    )
    
    
    (51
    )
    
    
    (385
    )
    
    
    (353
    )Foreign currency exchange impact
    
    
    
    
    
    
    
    
    
    
    91
    
    
    
    136
    
    
    
    91
    
    
    
    136Other
    
    
    (9
    )
    
    
    (10
    )
    
    
    21
    
    
    
    20
    
    
    
    12
    
    
    
    10Balance as of the measurement date
    
    $
    2,415
    
    
    $
    1,842
    
    
    $
    1,060
    
    
    $
    915
    
    
    $
    3,475
    
    
    $
    2,757Funded status of the plans
    
    $
    (884
    )
    
    $
    (1,410
    )
    
    $
    3
    
    
    $
    66
    
    
    $
    (881
    )
    
    $
    (1,344
    )Unrecognized net loss
    
    
    329
    
    
    
    1,899
    
    
    
    203
    
    
    
    118
    
    
    
    532
    
    
    
    2,017Unrecognized prior service (benefit) cost
    
    
    (7
    )
    
    
    (19
    )
    
    
    11
    
    
    
    16
    
    
    
    4
    
    
    
    (3
    )Net amount recognized at measurement date
    
    $
    (562
    )
    
    $
    470
    
    
    $
    217
    
    
    $
    200
    
    
    $
    (345
    )
    
    $
    670Amounts recognized in the balance sheet
consist of:Prepaid benefit cost
    
    $
    
    
    
    $
    
    
    
    $
    217
    
    
    $
    200
    
    
    $
    217
    
    
    $
    200Accrued benefit liability
    
    
    (756
    )
    
    
    (1,228
    )
    
    
    
    
    
    
    
    
    
    
    (756
    )
    
    
    (1,228
    )Accumulated other comprehensive income
(1)
    
    
    194
    
    
    
    1,698
    
    
    
    
    
    
    
    
    
    
    
    194
    
    
    
    1,698Net amount recognized
    
    $
    (562
    )
    
    $
    470
    
    
    $
    217
    
    
    $
    200
    
    
    $
    (345
    )
    
    $
    670Contributions from 11/04  12/04
    
    
    1
    
    
    
    634
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    634Net amount recognized as of fiscal
year-end
    
    $
    (561
    )
    
    $
    1,104
    
    
    $
    217
    
    
    $
    200
    
    
    $
    (344
    )
    
    $
    1,304Accumulated benefit obligation
    
    $
    3,166
    
    
    $
    3,070
    
    
    $
    924
    
    
    $
    751
    
    
    $
    4,090
    
    
    $
    3,821
   (1) The minimum pension liability, net of tax, was $124 million and $1,078 million as of January 1, 2005 and
January 3, 2004,     respectively.
 
 F-28




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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. Plan assets were invested in the following classes of securities (none of which were securities of
the Company): Plan Assets as of October 312004
    
    
    2003Equity
    
    67%
    
    
    68%Fixed income
    
    27%
    
    
    25%Real estate
    
    4%
    
    
    5%Other
    
    2%
    
    
    2%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, 2004, the plans target asset allocation was 73% equity (which included
investments classified as real estate and other in the table above) and 27% 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 used in 2003 and 2002. 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 reviewed the plans asset allocation and concluded to increase the
relative fixed-income allocation over time from 25% to 30% to 35%. The change in asset allocation
is expected to be completed in 2005. As such, the long-term return rate has been adjusted from
9.0% to 8.0% for purpose of determining future expense. The Company expects to contribute $100
million to the domestic pension plan in 2005. F-29




---



##### Table of Contents



Postretirement Benefitsmillions
    
    Domestic
    
    
    Sears Canada
    
    
    Total2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Change in projected benefit obligation:Beginning of year balance
    
    $
    754
    
    
    $
    802
    
    
    $
    155
    
    
    $
    102
    
    
    $
    909
    
    
    $
    904Benefits earned during the period
    
    
    2
    
    
    
    3
    
    
    
    5
    
    
    
    3
    
    
    
    7
    
    
    
    6Interest cost
    
    
    41
    
    
    
    39
    
    
    
    15
    
    
    
    8
    
    
    
    56
    
    
    
    47Plan amendments
    
    
    (19
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19
    )
    
    
    Actuarial loss
    
    
    8
    
    
    
    18
    
    
    
    21
    
    
    
    33
    
    
    
    29
    
    
    
    51Benefits paid
    
    
    (122
    )
    
    
    (108
    )
    
    
    (12
    )
    
    
    (10
    )
    
    
    (134
    )
    
    
    (118
    )Foreign currency exchange impact
    
    
    
    
    
    
    
    
    
    
    17
    
    
    
    19
    
    
    
    17
    
    
    
    19Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance as of the measurement date
    
    $
    664
    
    
    $
    754
    
    
    $
    201
    
    
    $
    155
    
    
    $
    865
    
    
    $
    909Change in plan assets at fair value:Beginning of year balance
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Company contributions
    
    
    122
    
    
    
    108
    
    
    
    12
    
    
    
    10
    
    
    
    134
    
    
    
    118Benefits paid
    
    
    (122
    )
    
    
    (108
    )
    
    
    (12
    )
    
    
    (10
    )
    
    
    (134
    )
    
    
    (118
    )Balance as of the measurement date
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Funded status of the plans
    
    $
    (664
    )
    
    $
    (754
    )
    
    $
    (201
    )
    
    $
    (155
    )
    
    $
    (865
    )
    
    $
    (909
    )Unrecognized net (gain) loss
    
    
    (16
    )
    
    
    (283
    )
    
    
    101
    
    
    
    69
    
    
    
    85
    
    
    
    (214
    )Unrecognized prior service benefit
    
    
    (149
    )
    
    
    (237
    )
    
    
    
    
    
    
    
    
    
    
    (149
    )
    
    
    (237
    )Net amount recognized
    
    $
    (829
    )
    
    $
    (1,274
    )
    
    $
    (100
    )
    
    $
    (86
    )
    
    $
    (929
    )
    
    $
    (1,360
    )Amounts recognized in the balance
sheet consist of:Accrued benefit liability
    
    $
    (829
    )
    
    $
    (1,274
    )
    
    $
    (100
    )
    
    $
    (86
    )
    
    $
    (929
    )
    
    $
    (1,360
    )
 Weighted-average assumptions used to determine plan obligations are as follows: Pension BenefitsDomestic
    
    
    Canada2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Discount Rate
    
    
    5.75
    %
    
    
    6.00
    %
    
    
    7.00
    %
    
    
    6.00
    %
    
    
    6.50
    %
    
    
    7.00
    %Rate of compensation increases
    
    
    4.25
    %
    
    
    4.25
    %
    
    
    4.25
    %
    
    
    4.25
    %
    
    
    4.00
    %
    
    
    4.00
    %
 Postretirement BenefitsDomestic
    
    
    Canada2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Discount Rate
    
    
    5.75
    %
    
    
    6.00
    %
    
    
    7.00
    %
    
    
    6.25
    %
    
    
    6.50
    %
    
    
    7.00
    %Rate of compensation increases
    
    NA
    
    NA
    
    NA
    
    
    4.25
    %
    
    
    4.00
    %
    
    
    4.00
    %
 F-30




---



##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements Weighted-average assumptions used to determine net cost for years ended are as follows: Pension BenefitsDomestic
    
    
    Canada2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Discount Rate
    
    
    6.00
    %
    
    
    7.00
    %
    
    
    7.25
    %
    
    
    6.50
    %
    
    
    7.00
    %
    
    
    6.30
    %Return of plan assets
    
    
    8.00
    %
    
    
    9.00
    %
    
    
    9.00
    %
    
    
    7.00
    %
    
    
    7.00
    %
    
    
    7.00
    %Rate of compensation increases
    
    
    4.25
    %
    
    
    4.25
    %
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.00
    %
 Postretirement BenefitsDomestic
    
    
    Canada2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Discount Rate
    
    
    6.00
    %
    
    
    7.00
    %
    
    
    7.25
    %
    
    
    6.50
    %
    
    
    7.00
    %
    
    
    6.50
    %Return of plan assets
    
    NA
    
    NA
    
    NA
    
    
    7.00
    %
    
    
    7.00
    %
    
    
    7.00
    %Rate of compensation increases
    
    NA
    
    NA
    
    NA
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.00
    %
 The components of net periodic benefit cost are as follows: Pension Benefitsmillions
    
    Domestic
    
    
    Canada
    
    
    Total2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Components of net periodic
benefit cost:Benefits earned during the
period
    
    $
    85
    
    
    $
    71
    
    
    $
    69
    
    
    $
    26
    
    
    $
    19
    
    
    $
    20
    
    
    $
    111
    
    
    $
    90
    
    
    $
    89Interest cost
    
    
    189
    
    
    
    147
    
    
    
    154
    
    
    
    59
    
    
    
    48
    
    
    
    42
    
    
    
    248
    
    
    
    195
    
    
    
    196Expected return on plan
assets
    
    
    (186
    )
    
    
    (143
    )
    
    
    (177
    )
    
    
    (80
    )
    
    
    (70
    )
    
    
    (59
    )
    
    
    (266
    )
    
    
    (213
    )
    
    
    (236
    )Amortization of
unrecognized net prior
service benefit
    
    
    (12
    )
    
    
    (9
    )
    
    
    (9
    )
    
    
    6
    
    
    
    6
    
    
    
    5
    
    
    
    (6
    )
    
    
    (3
    )
    
    
    (4
    )Recognized net loss (gain)
    
    
    28
    
    
    
    87
    
    
    
    29
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    28
    
    
    
    84
    
    
    
    29Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    (5
    )
    
    
    (4
    )
    
    
    (6
    )
    
    
    (5
    )
    
    
    (4
    )Net periodic benefit cost
(benefit)
    
    $
    104
    
    
    $
    153
    
    
    $
    66
    
    
    $
    5
    
    
    $
    (5
    )
    
    $
    4
    
    
    $
    109
    
    
    $
    148
    
    
    $
    70
 Postretirement Benefitsmillions
    
    Domestic
    
    
    Canada
    
    
    Total2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Components of net periodic
benefit cost:Benefits earned during the
period
    
    $
    2
    
    
    $
    3
    
    
    $
    4
    
    
    $
    5
    
    
    $
    3
    
    
    $
    3
    
    
    $
    7
    
    
    $
    6
    
    
    $
    7Interest cost
    
    
    41
    
    
    
    39
    
    
    
    45
    
    
    
    11
    
    
    
    8
    
    
    
    12
    
    
    
    52
    
    
    
    47
    
    
    
    57Expected return on plan
assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of
unrecognized net prior
service benefit
    
    
    (79
    )
    
    
    (97
    )
    
    
    (97
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (79
    )
    
    
    (97
    )
    
    
    (97
    )Recognized net loss (gain)
    
    
    (4
    )
    
    
    (21
    )
    
    
    (22
    )
    
    
    4
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (21
    )
    
    
    (27
    )Other
    
    
    (30
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (30
    )
    
    
    
    
    
    
    Net periodic benefit cost
(benefit)
    
    $
    (70
    )
    
    $
    (76
    )
    
    $
    (70
    )
    
    $
    20
    
    
    $
    11
    
    
    $
    10
    
    
    $
    (50
    )
    
    $
    (65
    )
    
    $
    (60
    )
 F-31




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements For 2005 and beyond, the weighted-average health care cost trend rates used in measuring the
postretirement benefit expense are a 7.0% trend rate in 2005 to an ultimate trend rate of 5.0% in
2009 for pre-65 retirees, and a 10.5% trend rate in 2005 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
    
    $
    29
    
    
    $
    (28
    )
 The cumulative effect of the accounting changes related to fiscal 2004 is presented in the
following table: millions, except per share data
    2004Pretax
    
    
    After-taxDomestic Pension
    
    $
    1,574
    
    
    $
    999Domestic Postretirement
    
    
    (253
    )
    
    
    (160
    )Total
    
    $
    1,321
    
    
    $
    839Diluted loss per share
    
    
    
    
    
    $
    (3.87
    )
 Presented below is pro forma net income and earnings per share for the year ended January 3,
2004 and December 28, 2002 showing the estimated effects as if the accounting change were applied
retroactively: millions, except per share data
    
    2003
    
    
    2002Net income  as reported
    
    $
    3,397
    
    
    $
    1,376Income before cumulative effect of change in accounting principle
    
    
    
    
    
    
    1,584Impact of change in accounting for domestic
retirement plans, net of taxes
    
    
    (341
    )
    
    
    (409
    )Net income   pro forma
    
    $
    3,056
    
    
    $
    967Income before cumulative effect of change in accounting
principle 
pro forma
    
    $
    3,056
    
    
    $
    1,175Earnings per share  basic:As reported
    
    $
    11.95
    
    
    $
    4.34Pro forma
    
    
    10.75
    
    
    
    3.05Earnings per share  diluted:As reported
    
    $
    11.86
    
    
    $
    4.29Pro forma
    
    
    10.67
    
    
    
    3.02Earnings per share before cumulative effect of change in
accounting principle basic:As reported
    
    $
    11.95
    
    
    $
    4.99Pro forma
    
    
    10.75
    
    
    
    3.70Earnings per share before cumulative effect of change in
accounting principle diluted:As reported
    
    $
    11.86
    
    
    $
    4.94Pro forma
    
    
    10.67
    
    
    
    3.02
 The Company uses October 31 as the measurement date for determining retirement plan assets,
obligations and experience gains or losses. Under the new accounting method for domestic plans,
the Company will recognize the portion of experience gain or loss in excess of the 10% corridor at
the measurement date, which falls in the fourth quarter of the fiscal year. F-32




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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. The 2004 option
grant vested over a ten-month 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: 2004
    
    
    2003
    
    
    2002Dividend yield
    
    
    2.01
    %
    
    
    4.01
    %
    
    
    1.92
    %Expected volatility
    
    
    42
    %
    
    
    42
    %
    
    
    41
    %Risk-free interest rate
    
    
    4.06
    %
    
    
    3.90
    %
    
    
    4.75
    %Expected life of options
    
    8 years
    
    8 years
    
    8 years
 Changes in employee stock options are as follows (shares in thousands): 2004
    
    
    2003
    
    
    2002Weighted-
    
    
    
    
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceBeginning of year balance
    
    
    27,268
    
    
    $
    35.79
    
    
    
    26,878
    
    
    $
    40.32
    
    
    
    32,578
    
    
    $
    39.04Granted
    
    
    8,747
    
    
    
    44.21
    
    
    
    8,945
    
    
    
    22.31
    
    
    
    1,081
    
    
    
    51.41Exercised
    
    
    (10,086
    )
    
    
    38.36
    
    
    
    (4,451
    )
    
    
    32.52
    
    
    
    (3,414
    )
    
    
    32.96Canceled or expired
    
    
    (3,272
    )
    
    
    33.66
    
    
    
    (4,104
    )
    
    
    39.68
    
    
    
    (3,367
    )
    
    
    38.97End of year balance
    
    
    22,657
    
    
    $
    38.20
    
    
    
    27,268
    
    
    $
    35.79
    
    
    
    26,878
    
    
    $
    40.32Reserved for future grant at year-end
    
    
    6,286
    
    
    
    
    
    
    
    12,319
    
    
    
    
    
    
    
    17,381Exercisable
    
    
    15,108
    
    
    $
    44.01
    
    
    
    9,343
    
    
    $
    43.75
    
    
    
    9,855
    
    
    $
    43.33Fair value of options granted during
the year
    
    
    
    
    
    $
    19.29
    
    
    
    
    
    
    $
    7.56
    
    
    
    
    
    
    $
    23.05
 The following table summarizes information about stock options outstanding at January 1, 2005
(shares in thousands): Options Outstanding
    
    
    Options ExercisableWeighted-Average
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Range of
    
    Number
    
    
    Remaining
    
    
    Average
    
    
    Number
    
    
    AverageExercise
    
    Outstanding
    
    
    Contractual
    
    
    Exercise
    
    
    Exercisable
    
    
    ExercisePrices
    
    at 01/01/05
    
    
    Life in Years
    
    
    Price
    
    
    at 01/01/05
    
    
    Price$20.00 to $30.00
    
    
    6,221
    
    
    
    8.9
    
    
    $
    21.78
    
    
    
    245
    
    
    $
    23.2430.01 to 40.00
    
    
    5,673
    
    
    
    6.8
    
    
    
    36.54
    
    
    
    5,072
    
    
    
    36.7340.01 to 50.00
    
    
    7,820
    
    
    
    8.5
    
    
    
    44.24
    
    
    
    7,489
    
    
    
    44.3350.01 to 64.00
    
    
    2,943
    
    
    
    4.8
    
    
    
    60.08
    
    
    
    2,302
    
    
    
    61.23$20.00 to $64.00
    
    
    22,657
    
    
    
    7.7
    
    
    $
    38.20
    
    
    
    15,108
    
    
    $
    44.01
 F-33




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SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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 1, 2005, 5.0 million shares had been issued under the ASPP and 5.0 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 was contingent
upon the attainment of specific performance targets over a three-year period. As of January 1, 2005, the performance targets were not met. As such, no payments will be made
under this plan. NOTE 11  OTHER INCOME Other income consists of: millions
    
    2004
    
    
    2003
    
    
    2002Gain on sales of property and investments
    
    $
    37
    
    
    $
    12
    
    
    $
    347Equity income in unconsolidated companies
    
    
    8
    
    
    
    8
    
    
    
    20Sears Mexico dividend
    
    
    8
    
    
    
    7
    
    
    
    5Other
    
    
    7
    
    
    
    
    
    
    
    Total
    
    $
    60
    
    
    $
    27
    
    
    $
    372
 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
    
    2004
    
    
    2003
    
    
    2002Domestic
    
    $
    406
    
    
    $
    5,279
    
    
    $
    2,424Foreign
    
    
    141
    
    
    
    170
    
    
    
    29Total
    
    $
    547
    
    
    $
    5,449
    
    
    $
    2,453
 F-34




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements Federal, state and foreign taxes are as follows: millions
    
    2004
    
    
    2003
    
    
    2002CurrentFederal
    
    $
    320
    
    
    $
    1,270
    
    
    $
    988State
    
    
    25
    
    
    
    92
    
    
    
    2Foreign
    
    
    20
    
    
    
    28
    
    
    
    39Total
    
    
    365
    
    
    
    1,390
    
    
    
    1,029DeferredFederal
    
    
    (203
    )
    
    
    544
    
    
    
    (167
    )State
    
    
    (16
    )
    
    
    29
    
    
    
    32Foreign
    
    
    24
    
    
    
    44
    
    
    
    (36
    )Total
    
    
    (195
    )
    
    
    617
    
    
    
    (171
    )Income taxes
    
    $
    170
    
    
    $
    2,007
    
    
    $
    858
 A reconciliation of the statutory federal income tax rate to the effective income tax rate is
as follows: 2004
    
    
    2003
    
    
    2002Statutory federal rate
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %State income taxes, net of federal tax benefit
    
    
    1.1
    
    
    
    1.5
    
    
    
    0.9Tax exempt interest income
    
    
    (1.8
    )
    
    
    
    
    
    
    Federal income tax credits
    
    
    (3.2
    )
    
    
    (0.1
    )
    
    
    (0.2
    )Other
    
    
    
    
    
    
    0.4
    
    
    
    (0.7
    )Effective income tax rate
    
    
    31.1
    %
    
    
    36.8
    %
    
    
    35.0
    %
 Deferred taxes based upon differences between the financial statement and tax bases of assets
and liabilities and available tax carryforwards consist of: millions
    
    2004
    
    
    2003Deferred tax assets:Unearned service contract income
    
    $
    170
    
    
    $
    316Pension reserves
    
    
    98
    
    
    
    Postretirement benefit liability
    
    
    351
    
    
    
    519Minimum pension liability
    
    
    73
    
    
    
    625Special charges and impairments
    
    
    100
    
    
    
    129Insurance reserves
    
    
    73
    
    
    
    58State income taxes
    
    
    101
    
    
    
    88Other deferred tax assets
    
    
    379
    
    
    
    520Gross deferred tax assets
    
    
    1,345
    
    
    
    2,255Deferred tax liabilities:Property and equipment
    
    
    (335
    )
    
    
    (374
    )Prepaid pension
    
    
    
    
    
    
    (495
    )Inventory reserves
    
    
    (57
    )
    
    
    (82
    )Other deferred tax liabilities
    
    
    (207
    )
    
    
    (218
    )Gross deferred tax liabilities
    
    
    (599
    )
    
    
    (1,169
    )Net deferred tax asset
    
    $
    746
    
    
    $
    1,086
 F-35




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 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 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 $1,041 million at
January 1, 2005. If these earnings were to be remitted, taxes of $262 million would be due. Income taxes of $1,316 million, $348 million and $918 million were paid in 2004, 2003 and 2002,
respectively. Domestic and foreign tax authorities periodically audit the Companys income tax returns. These
audits include questions regarding its tax filing positions, including the timing and amount of
deductions and the allocation of income among various tax jurisdictions. In evaluating the
exposures associated with its various tax filing positions, the Company records reserves for
probable exposures. A number of years may elapse before a particular matter, for which the Company
has established a reserve, is audited and fully resolved. Annual tax examinations of Sears are
performed by the United States Internal Revenue Service and various state and local tax
authorities. Similarly, Sears Canada is examined each tax year by the Canada Revenue Agency and
various provincial tax authorities. Generally, the tax years for Sears prior to 1998 and for Sears
Canada prior to 1999 are closed to examination. NOTE 13  EARNINGS PER SHARE The following table sets forth the computations of basic and diluted earnings per share: millions, except per share data
    
    2004
    
    
    2003
    
    
    2002Net (loss)/income (1)
    
    $
    (507
    )
    
    $
    3,397
    
    
    $
    1,376Average common shares outstanding
    
    
    214.0
    
    
    
    284.3
    
    
    
    317.4Dilutive effect of stock options
    
    
    2.7
    
    
    
    2.0
    
    
    
    3.3Average common and common equivalent shares outstanding
    
    
    216.7
    
    
    
    286.3
    
    
    
    320.7(Loss)/earnings per shareBasic
    
    $
    (2.37
    )
    
    $
    11.95
    
    
    $
    4.34Diluted
    
    $
    (2.34
    )
    
    $
    11.86
    
    
    $
    4.29
   (1)
    Net income is the same for purposes of calculating basic and diluted earnings per share.
 
 F-36




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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
    
    2004
    
    
    2003
    
    
    2002Income before cumulative effect of change in accounting principle (1)
    
    $
    332
    
    
    $
    3,397
    
    
    $
    1,584Average common shares outstanding
    
    
    214.0
    
    
    
    284.3
    
    
    
    317.4Dilutive effect of stock options
    
    
    2.7
    
    
    
    2.0
    
    
    
    3.3Average common and common equivalent shares outstanding
    
    
    216.7
    
    
    
    286.3
    
    
    
    320.7Earnings per shareBasic
    
    $
    1.55
    
    
    $
    11.95
    
    
    $
    4.99Diluted
    
    $
    1.53
    
    
    $
    11.86
    
    
    $
    4.94
   (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 1, 2005, January 3, 2004 and December
29, 2002, options to purchase 9.2 million, 16.4 million and 5.8 million common shares at prices
ranging from $42 to $64, $37 to $64 and $45 to $64 per share were excluded from the 2004, 2003 and
2002 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 certified the consolidated action as a class action.
Discovery is underway. The trial is scheduled to begin in April
2006.
    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. Discovery is underway. No trial date has been
set.
    On October 23, 2002, a purported derivative suit was filed in the
Supreme Court of the State of New York (the New York Court)
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 its credit
business. Two similar suits were F-37




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements  subsequently filed in the Circuit Court of Cook County, Illinois (the Illinois State Court),
and a third was filed in the United States District Court for the Northern District of Illinois.
The New York Court derivative suit was dismissed on June 21, 2004 and the plaintiff has filed a
notice of appeal. The two Illinois State Court derivative suits were dismissed on September 30,
2004 and the order of dismissal became final on December 1, 2004, and the time to appeal has
expired. The Illinois federal court derivative suit has been stayed pending resolution of the
New York Court derivative action.
    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 the Companys domestic
wholly-owned financing subsidiary, 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. The
defendants filed motions to dismiss the action. On September 24, 2004, the court granted
these motions in part, and denied them in part. The court dismissed the claims related to the
March 18 and May 21, 2002 note offerings because the plaintiff did not purchase notes in those
offerings. The court dismissed the Section 10(b) and Rule 10b-5 claims against several of the
individual defendants because the plaintiff failed to adequately plead such claims. The court
sustained the remaining claims. By leave of court, the plaintiffs filed a second amended
complaint on November 15, 2004. Defendants (other than one of the underwriter defendants)
filed motions to partially dismiss the second amended complaint on January 10, 2005. The
defendant that did not move to partially dismiss filed an answer to the second amended
complaint on January 28, 2005, denying all liability. Following the announcement on November 17, 2004 of the pending business combination transaction
with Kmart, several actions have been filed purporting to challenge the transaction. These
lawsuits are in their preliminary stages, and defendants have not yet been required to respond to
certain of the complaints. The Company believes that all of these claims lack merit and intends to
defend against them vigorously.  
    Three actions have been filed in the Circuit Court of Cook County,
Illinois. These actions assert claims on behalf of a purported
class of the Companys stockholders against the Company and
certain of its officers and directors, together with Kmart, Edward
S. Lampert and other affiliated entities, alleging breach of
fiduciary duty in connection with the mergers. The plaintiffs
allege that the mergers favor interested defendants by awarding
them disproportionate benefits, and that the defendants failed to
take appropriate steps to maximize the value of a merger
transaction for the Companys stockholders. The actions have been
consolidated, and an amended complaint was filed in early January
2005. The amended complaint asserts similar breach-of-fiduciary
duty claims, as well as alleging that defendants have made
insufficient and misleading disclosures in connection with the
mergers, and seeks injunctive relief. The plaintiffs have moved
for expedited discovery. On February 1, 2005, the court granted
the defendants motion to stay or dismiss these actions in favor
of the pending New York actions. Accordingly, these actions are
stayed pending resolution of the New York actions discussed below.
Plaintiffs have filed a notice of appeal of the stay order to the
Appellate Court of Illinois-First District.
    Two actions have been filed in the Supreme Court of the State of
New York, New York County, asserting substantially similar claims
against the Company and certain of its officers and directors.
The parties have agreed to consolidate these two actions. Pending
consolidation, the defendants moved to dismiss the complaint
in both actions for lack of standing and failure to state a cause
of action. On February 15, 2005, the Court ordered that the two cases
be consolidated as a single action. On February 16, 2005, the plaintiffs
filed a F-38




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements  superceding consolidated amended class action complaint. The amended
complaint asserts claims on behalf of a purported class of the Company's stockholders
against the Company and certain of its officers and directors for breach of fiduciary
duty in connection with the mergers on the grounds that defendants allegedly failed
to take proper steps to maximize the value of a merger transaction for the Company's
stockholders. Additionally, the plaintiffs claim that the defendants made insufficient
and misleading disclosures in connection with the mergers. The amended complaint also
names Kmart, Edward S. Lampert, and ESL, Inc. as defendants on the grounds that they
aided and abetted the alleged breaches of fiduciary duty. The amended complaint seeks
provisional and permanent injunctive relief, as well as damages. Also on February 16, 2005,
the plaintiffs filed an order to show cause seeking expedited discovery about the appraisal
of the Company's real estate. A briefing schedule on the motion has not been set.
    One action has been filed in the United States District Court for the Northern District of
Illinois. This action asserts claims under the federal securities laws on behalf of a purported
class of the Companys stockholders against the Company and Alan J. Lacy, for allegedly failing
to make timely disclosure of merger discussions with Kmart during the period November 8 through
16, 2004, and seeks damages. The court has appointed a lead plaintiff and lead counsel, and an
amended complaint is due to be filed by March 11, 2005. 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 With the sale of the domestic Credit and Financial Products business, the Companys financial
reporting segments for fiscal 2004 have been changed to reflect two operating segments  a Domestic
segment and a Sears Canada segment. The Domestic segment comprise the former Retail and Related
Services segment, including the revenues earned from the Citibank relationship, and the former
Corporate and Other segment. The Sears Canada segment continues to represent the results of
operations of Sears Canada. The Domestic segment consists of merchandise sales and related services, including product
protection agreements, delivery and product installation and repair services. It includes all
Sears selling channels, Specialty and Full-line Stores as well as Direct to Customer operations
encompassing online, catalogs, and the Lands End online and catalog business. The results of
operations for the divested businesses, Credit and Financial Products and NTB, are included within
the Domestic segment for 2003. The Sears Canada segment includes similar retail, credit and corporate operations conducted by
Sears Canada, a 54.3% 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. The 2003 and 2002 segment information have been presented on the 2004 basis  Domestic and Sears
Canada. In addition, the Company has provided, for 2002 and 2003, information on the operating
segments comprising the Domestic segment in 2003 and 2002. F-39




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 2004 Searsmillions
    
    Domestic
    
    
    Canada
    
    
    ConsolidatedRevenuesMerchandise sales and services
    
    $
    31,230
    
    
    $
    4,488
    
    
    $
    35,718Credit and financial products revenues
    
    
    
    
    
    
    381
    
    
    
    381Total revenues
    
    
    31,230
    
    
    
    4,869
    
    
    
    36,099Costs and expensesCost of sales, buying and occupancy
    
    
    22,800
    
    
    
    3,197
    
    
    
    25,997Selling and administrative
    
    
    7,038
    
    
    
    1,207
    
    
    
    8,245Provision for uncollectible accounts
    
    
    
    
    
    
    64
    
    
    
    64Depreciation and amortization
    
    
    815
    
    
    
    174
    
    
    
    989Interest, net
    
    
    168
    
    
    
    108
    
    
    
    276Special charges and impairments
    
    
    41
    
    
    
    
    
    
    
    41Total costs and expenses
    
    
    30,862
    
    
    
    4,750
    
    
    
    35,612Operating income
    
    $
    368
    
    
    $
    119
    
    
    $
    487Total assets
    
    $
    18,930
    
    
    $
    3,544
    
    
    $
    22,474Capital expenditures
    
    $
    745
    
    
    $
    137
    
    
    $
    882
 2003 Retail and
    
    
    Credit and
    
    
    CorporateRelated
    
    
    Financial
    
    
    and
    
    
    Total
    
    
    Searsmillions
    
    Services
    
    
    Products
    
    
    Other
    
    
    Domestic
    
    
    Canada
    
    
    ConsolidatedRevenuesMerchandise sales and services
    
    $
    31,842
    
    
    $
    
    
    
    $
    372
    
    
    $
    32,214
    
    
    $
    4,158
    
    
    $
    36,372Credit and financial products revenues
    
    
    
    
    
    
    4,429
    
    
    
    
    
    
    
    4,429
    
    
    
    323
    
    
    
    4,752Total revenues
    
    
    31,842
    
    
    
    4,429
    
    
    
    372
    
    
    
    36,643
    
    
    
    4,481
    
    
    
    41,124Costs and expensesCost of sales, buying and occupancy
    
    
    23,164
    
    
    
    
    
    
    
    149
    
    
    
    23,313
    
    
    
    2,918
    
    
    
    26,231Selling and administrative
    
    
    6,898
    
    
    
    645
    
    
    
    413
    
    
    
    7,956
    
    
    
    1,127
    
    
    
    9,083Provision for uncollectible accounts
    
    
    
    
    
    
    1,695
    
    
    
    
    
    
    
    1,695
    
    
    
    52
    
    
    
    1,747Depreciation and amortization
    
    
    740
    
    
    
    14
    
    
    
    43
    
    
    
    797
    
    
    
    112
    
    
    
    909Interest, net
    
    
    84
    
    
    
    813
    
    
    
    18
    
    
    
    915
    
    
    
    110
    
    
    
    1,025Loss on early retirement of debt
    
    
    
    
    
    
    791
    
    
    
    
    
    
    
    791
    
    
    
    
    
    
    
    791Special charges and impairments
    
    
    128
    
    
    
    
    
    
    
    12
    
    
    
    140
    
    
    
    
    
    
    
    140Total costs and expenses
    
    
    31,014
    
    
    
    3,958
    
    
    
    635
    
    
    
    35,607
    
    
    
    4,319
    
    
    
    39,926Operating income (loss)
    
    $
    828
    
    
    $
    471
    
    
    $
    (263
    )
    
    $
    1,036
    
    
    $
    162
    
    
    $
    1,198Total assets
    
    $
    20,138
    
    
    $
    218
    
    
    $
    3,164
    
    
    $
    23,520
    
    
    $
    4,203
    
    
    $
    27,723Capital expenditures
    
    $
    750
    
    
    $
    3
    
    
    $
    40
    
    
    $
    793
    
    
    $
    132
    
    
    $
    925
 F-40




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements 2002 Retail and
    
    
    Credit and
    
    
    CorporateRelated
    
    
    Financial
    
    
    and
    
    
    Total
    
    
    Searsmillions
    
    Services
    
    
    Products
    
    
    Other
    
    
    Domestic
    
    
    Canada
    
    
    ConsolidatedRevenuesMerchandise sales and services
    
    $
    31,459
    
    
    $
    
    
    
    $
    326
    
    
    $
    31,785
    
    
    $
    3,913
    
    
    $
    35,698Credit and financial products revenues
    
    
    
    
    
    
    5,392
    
    
    
    
    
    
    
    5,392
    
    
    
    276
    
    
    
    5,668Total revenues
    
    
    31,459
    
    
    
    5,392
    
    
    
    326
    
    
    
    37,177
    
    
    
    4,189
    
    
    
    41,366Costs and expensesCost of sales, buying and occupancy
    
    
    22,743
    
    
    
    
    
    
    
    121
    
    
    
    22,864
    
    
    
    2,782
    
    
    
    25,646Selling and administrative
    
    
    6,816
    
    
    
    955
    
    
    
    442
    
    
    
    8,213
    
    
    
    1,036
    
    
    
    9,249Provision for uncollectible accounts
    
    
    
    
    
    
    2,203
    
    
    
    
    
    
    
    2,203
    
    
    
    58
    
    
    
    2,261Depreciation and amortization
    
    
    710
    
    
    
    18
    
    
    
    55
    
    
    
    783
    
    
    
    92
    
    
    
    875Interest, net
    
    
    35
    
    
    
    1,014
    
    
    
    
    
    
    
    1,049
    
    
    
    94
    
    
    
    1,143Special charges and impairments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111
    
    
    
    111Total costs and expenses
    
    
    30,304
    
    
    
    4,190
    
    
    
    618
    
    
    
    35,112
    
    
    
    4,173
    
    
    
    39,285Operating income (loss)
    
    $
    1,155
    
    
    $
    1,202
    
    
    $
    (292
    )
    
    
    2,065
    
    
    $
    16
    
    
    $
    2,081Total assets
    
    $
    12,469
    
    
    $
    32,207
    
    
    $
    2,252
    
    
    $
    46,928
    
    
    $
    3,481
    
    
    $
    50,409Capital expenditures
    
    $
    894
    
    
    $
    6
    
    
    $
    18
    
    
    $
    918
    
    
    $
    117
    
    
    $
    1,035
 NOTE 16  QUARTERLY RESULTS (Unaudited) millions, except per common share data First Quarter
    
    
    Second Quarter
    
    
    Third Quarter
    
    
    Fourth Quarter
    
    
    Year2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Revenues
    
    $
    7,794
    
    
    $
    8,880
    
    
    $
    8,781
    
    
    $
    10,196
    
    
    $
    8,295
    
    
    $
    9,794
    
    
    $
    11,229
    
    
    $
    12,254
    
    
    $
    36,099
    
    
    $
    41,124Operating (loss)/income
    
    
    (41
    )
    
    
    309
    
    
    
    53
    
    
    
    489
    
    
    
    (85
    )
    
    
    242
    
    
    
    560
    
    
    
    158
    
    
    
    487
    
    
    
    1,198Net (loss)/income
before accounting
change
    
    
    (20
    )
    
    
    192
    
    
    
    53
    
    
    
    309
    
    
    
    (61
    )
    
    
    147
    
    
    
    360
    
    
    
    2,749
    
    
    
    332
    
    
    
    3,397Net (loss)/income
    
    
    (859
    )
    
    
    192
    
    
    
    53
    
    
    
    309
    
    
    
    (61
    )
    
    
    147
    
    
    
    360
    
    
    
    2,749
    
    
    
    (507
    )
    
    
    3,397(Loss)/earnings per
share before
accounting change -
diluted
    
    
    (0.09
    )
    
    
    0.60
    
    
    
    0.24
    
    
    
    1.04
    
    
    
    (0.29
    )
    
    
    0.52
    
    
    
    1.68
    
    
    
    10.84
    
    
    
    1.53
    
    
    
    11.86(Loss)/earnings per
common share - diluted
    
    $
    (3.90
    )
    
    $
    0.60
    
    
    $
    0.24
    
    
    $
    1.04
    
    
    $
    (0.29
    )
    
    $
    0.52
    
    
    $
    1.68
    
    
    $
    10.84
    
    
    $
    (2.34
    )
    
    $
    11.86
 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. F-41




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##### Table of Contents



SEARS, ROEBUCK AND CO.
Notes to Consolidated Financial Statements The first quarter 2004 included an after-tax charge of $839 million, or $3.81 per share, for the
cumulative effect of a change in accounting principle related to the Companys pension and
post-retirement medical benefit plans and a curtailment gain of $30 million, or $0.09 per share,
related to the Companys retiree medical benefits offered to employees under the age of forty. The second quarter 2004 included a pretax charge of $41 million, or $0.12 per share, for severance
costs associated with the restructuring of the Companys home office organization and a pretax
charge of $39 million, or $0.12 per share, related to additional expense due to shortening the
estimated remaining useful lives for the assets sold to Computer Sciences Corporation. The fourth quarter 2004 included a pretax gain of $32 million, or $0.05 per share, related to the
sale of receivables due to changes in Sears Canada credit card receivables securitization program,
a pretax charge of $51 million, or $0.08 per share, related to the cumulative change in accounting
for construction allowances and a pretax charge of $13 million, or $0.04 per share, related to the
costs associated with the pending merger with Kmart. In addition, pretax LIFO credits of $42
million and $52 million were recorded in the fourth quarter of 2004 and 2003, respectively,
compared with charges of $0 and $12 million, $0 and $12 million and $0 and $6 million for the
first, second and third quarters of fiscal 2004 and 2003, 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-42




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##### Table of Contents



SEARS, ROEBUCK AND CO.
SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS AdditionsBalance at
    
    
    Charged tobeginning of
    
    
    costs and
    
    
    
    
    
    
    
    
    
    
    Balance atperiod
    
    
    expenses
    
    
    Deductions
    
    
    Other(1)
    
    
    end of periodYear Ended January 1, 2005Allowance for uncollectible accounts
    
    $
    42
    
    
    $
    64
    
    
    $
    (70
    )
    
    $
    
    
    
    $
    36Year 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
    )
    
    $
    
    
    
    $
    1,832
   (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-43




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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 1, 2005 2.1
    
    Asset Purchase Agreement dated as of June 29,
2004 by and between Sears, Roebuck and Co. and
Kmart Corporation (incorporated by reference to
Exhibit 2 to Registrants Quarterly Report on
Form 10-Q for the fiscal quarter ended July 3,
2004).**2.2
    
    Agreement and Plan of Merger, dated as of
November 16, 2004, between Kmart Holding
Corporation and Sears, Roebuck and Co.
(incorporated by reference to Exhibit 2.1 to
Registrants Current Report on Form 8-K dated
November 18, 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
(incorporated by reference to Exhibit 3.2 to
Registrants Annual Report on Form 10-K for the
fiscal year ended January 3, 2004).**4.1
    
    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).** ****4.2
    
    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).** ****4.3
    
    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).** ****4.4
    
    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 Registrants Annual Report on Form 10-K for the
fiscal year ended December 28, 2002).** ****
 E-1




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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 1, 2005 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 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 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).****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
    
    2005 Performance Criteria under Registrants Annual Incentive Compensation Plans. ****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 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).** ****
 E-2




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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 1, 2005 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).** ****10.25
    
    Letter from Registrant to Gerald F. Kelly relating to employment
dated September 27, 2002 (incorporated by reference to Exhibit
10.35 to 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 Registrants Annual Report on Form 10-K for the
fiscal year ended December 28, 2002).** ****10.27
    
    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 Registrants Quarterly Report on Form 10-Q for the fiscal
quarter ended June 28, 2003).10.28
    
    Letter from Registrant to Luis Padilla relating to employment dated
August 16, 2004 (incorporated by reference to Exhibit 10 to
Registrants Quarterly Report on Form 10-Q for the fiscal quarter
ended October 2, 2004).** ****10.29
    
    Employment Agreement, dated as of November 16, 2004, among Alan J.
Lacy, Kmart Holding Corporation and Registrant (incorporated by
reference to Exhibit 10.1 to Registrants Current Report on Form
8-K dated November 18, 2004).** *****10.30
    
    Letter from Registrant to Glenn R. Richter relating to employment
dated as of February 17, 2005. ****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
    
    Three-Year Credit Agreement dated as of May 17, 2004 among Sears
Roebuck Acceptance Corp. (SRAC), the banks, financial
institutions and other institutional lenders (the Lenders) listed
on the signature pages thereof, Barclays Bank PLC, as syndication
agent, Bank of America, N.A., Bank One, NA and Wachovia Bank
National Association, as documentation agents, Citigroup Global
Markets Inc. and Barclays Capital, the Investment Banking Division
of Barclays Bank PLC, as joint lead arrangers and joint
bookrunners, and Citibank, N.A., as administrative agent for the
Lenders (incorporated by reference to Exhibit 10(a) to SRACs
Current Report on Form 8-K dated May 17, 2004).****
 E-3




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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 1, 2005 10.34
    
    Guarantee, dated as of May 17, 2004, by Registrant in favor of the
Benefited Parties (incorporated by reference to Exhibit 10(b) to
SRACs Current Report on Form 8-K dated May 17, 2004).*****10.35
    
    Guarantee executed by Registrant under the Indenture, dated as of May 15, 1995, between SRAC 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).*****10.36
    
    Guarantee executed by Registrant under the Indenture, dated as of October 1, 2002, SRAC 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).*****10.37
    
    Guarantee dated as of November 3, 2003 by Registrant of the commercial paper master notes of SRAC
(incorporated by reference to Exhibit 10.38 to Registrants Annual Report on Form 10-K for the
fiscal year ended January 3, 2004).10.38
    
    Purchase, Sale and Servicing Transfer Agreement, dated as of July 15, 2003, by and among
Registrant, certain subsidiaries of Registrant and Citigroup (incorporated by reference to Exhibit
10.1 to SRACs Current Report on Form 8-K dated July 15, 2003).*****10.39
    
    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 Citigroup (incorporated
by reference to Exhibit 2(b) to Registrants Quarterly Report on Form 10-Q for the fiscal quarter
ended September 27, 2003).**10.40
    
    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 Registrants Quarterly Report
on Form 10-Q for the fiscal quarter ended September 27, 2003).**10.41
    
    Amendment, as of August 13, 2003, to Registrants 2002 Non-employee Director Stock Plan
(incorporated by reference to Exhibit 10(b) to Registrants Quarterly Report on Form 10-Q for the
fiscal quarter ended September 27, 2003).**10.42
    
    Master Services Agreement between Sears, Roebuck and Co. and Computer Sciences Corporation dated
as of June 1, 2004 (incorporated by reference to Exhibit 10(c) to Registrants Quarterly Report on
Form 10-Q/A (Amendment No. 2) for the quarter ended July 3, 2004).**10.43
    
    Support Agreement and Irrevocable Proxy, dated as of November 16, 2004, among certain affiliates
of ESL Investments, Inc., Kmart Holding Corporation and Registrant (incorporated by reference to
Exhibit 99.1 to Registrants current report on Form 8-K dated November 18, 2004).***10.44
    
    Registrants 2005 Long-Term Incentive LTIP. *****12.
    
    Computation of ratio of income to fixed charges for Registrant and consolidated subsidiaries.18.
    
    Letter regarding change in accounting principle (incorporated by reference to Exhibit 18 to
Registrants Quarterly Report on Form 10-Q for the fiscal quarter ended April 3, 2004).***21.
    
    Subsidiaries of Registrant.
 E-4




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##### Table of Contents



EXHIBIT INDEX
Sears, Roebuck and Co. Form 10-K
For the Year Ended January 1, 2005 *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.*32.1
    
    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*****
    
    SEC File No. 1-4040
 E-5