##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



|x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended July 29, 2006
|- | ------------------------------------------------------------------------------------------------------------------------------------

Or



| ̈ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------

Commission file number 000-51217

SEARS HOLDINGS CORPORATION

(Exact name of registrant as specified in its charter)



|                                                                                      |  |                                               
|------------------------------------------------------------------------------------- |  | ----------------------------------------------
|Delaware (State of Incorporation)                                                     |  | 20-1920798(I.R.S. Employer Identification No.)
|                                                                                      | 
|3333 Beverly Road, Hoffman Estates, Illinois (Address of principal executive offices) |  | 60179(Zip Code)                               

Registrants Telephone Number, Including Area Code: (847) 286-2500

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

Yes     x            No ̈

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

Large accelerated filer    x    Accelerated
filer ̈Non-accelerated filer ̈

Indicate by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).

Yes ̈No    x

As of August 29, 2006, the Registrant had 154,039,407 common shares, $0.01 par value, outstanding.



---



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



|                               |  |                                                                                                                       |  |    
|------------------------------ |  | --------------------------------------------------------------------------------------------------------------------- |  | ---
|                               |  | Page                                                                                                                 
|PART I  FINANCIAL INFORMATION |  |                                                                                                                      
|                               |  |                                                                                                                      
|Item 1.                        |  | Financial Statements                                                                                                  |  |    
|                               |  |                                                                                                                      
|                               |  | Condensed Consolidated Statements of Income (Unaudited) for the 13 and 26 Weeks Ended July 29, 2006 and July 30, 2005 |  | 1  
|                               |  |                                                                                                                      
|                               |  | Condensed Consolidated Balance Sheets (Unaudited) as of July 29, 2006, July 30, 2005 and January 28, 2006             |  | 2  
|                               |  |                                                                                                                      
|                               |  | Condensed Consolidated Statements of Cash Flows (Unaudited) for the 26 Weeks Ended July 29, 2006 and July 30, 2005    |  | 3  
|                               |  |                                                                                                                      
|                               |  | Notes to Condensed Consolidated Financial Statements (Unaudited)                                                      |  | 4  
|                               |  |                                                                                                                      
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                 |  | 21 
|                               |  |                                                                                                                      
|Item 3.                        |  | Quantitative and Qualitative Disclosures about Market Risk                                                            |  | 40 
|                               |  |                                                                                                                      
|Item 4.                        |  | Controls and Procedures                                                                                               |  | 40 
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                                                      
|                               |  |                                                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                                                     |  | 41 
|                               |  |                                                                                                                      
|Item 1A.                       |  | Risk Factors                                                                                                          |  | 41 
|                               |  |                                                                                                                      
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                           |  | 41 
|                               |  |                                                                                                                      
|Item 6.                        |  | Exhibits                                                                                                              |  | E-1



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Condensed Consolidated Statements of Income

(Unaudited)

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements



|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|----------------------------------------------------------------------------------------------------- |  | -------------- | ------ | - | -------------- | - | ------ | ------------ |  | - | ------------ | - |  | - | ------ | -
|                                                                                                      |  | 13 Weeks Ended |        |   | 26 Weeks Ended |  
|millions, except per share data                                                                       |  | July 29,2006   |        |   | July 30,2005   |   |        | July 29,2006 |  |   | July 30,2005 |  
|REVENUES                                                                                              |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Merchandise sales and services                                                                        |  | $              | 12,785 |   |                | $ | 13,114 |              |  | $ | 24,783       |   |  | $ | 20,749 |  
|Credit and financial products revenues                                                                |  |                |       |   |                |   | 78     |              |  |   |             |   |  |   | 87     |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Total revenues                                                                                        |  |                | 12,785 |   |                |   | 13,192 |              |  |   | 24,783       |   |  |   | 20,836 |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|COSTS AND EXPENSES                                                                                    |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Cost of sales, buying and occupancy                                                                   |  |                | 9,158  |   |                |   | 9,541  |              |  |   | 17,823       |   |  |   | 15,202 |  
|Selling and administrative                                                                            |  |                | 2,827  |   |                |   | 3,009  |              |  |   | 5,548        |   |  |   | 4,737  |  
|Depreciation and amortization                                                                         |  |                | 276    |   |                |   | 280    |              |  |   | 565          |   |  |   | 387    |  
|Gain on sales of assets                                                                               |  |                | (7     | ) |                |   | (4     | )            |  |   | (24          | ) |  |   | (10    | )
|Restructuring charges                                                                                 |  |                | 14     |   |                |   | 42     |              |  |   | 23           |   |  |   | 45     |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Total costs and expenses                                                                              |  |                | 12,268 |   |                |   | 12,868 |              |  |   | 23,935       |   |  |   | 20,361 |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Operating income                                                                                      |  |                | 517    |   |                |   | 324    |              |  |   | 848          |   |  |   | 475    |  
|Interest expense, net                                                                                 |  |                | 42     |   |                |   | 72     |              |  |   | 89           |   |  |   | 114    |  
|Bankruptcy-related recoveries                                                                         |  |                | (11    | ) |                |   | (15    | )            |  |   | (12          | ) |  |   | (32    | )
|Other income                                                                                          |  |                | (16    | ) |                |   | (2     | )            |  |   | (27          | ) |  |   | (11    | )
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Income before income taxes, minority interest and cumulative effect of change in accounting principle |  |                | 502    |   |                |   | 269    |              |  |   | 798          |   |  |   | 404    |  
|Income taxes                                                                                          |  |                | 201    |   |                |   | 103    |              |  |   | 319          |   |  |   | 155    |  
|Minority interest                                                                                     |  |                | 7      |   |                |   | 5      |              |  |   | 5            |   |  |   | 7      |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Income before cumulative effect of change in accounting principle                                     |  |                | 294    |   |                |   | 161    |              |  |   | 474          |   |  |   | 242    |  
|Cumulative effect of change in accounting principle, net of tax                                       |  |                |       |   |                |   |       |              |  |   |             |   |  |   | (90    | )
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|NET INCOME                                                                                            |  | $              | 294    |   |                | $ | 161    |              |  | $ | 474          |   |  | $ | 152    |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|EARNINGS PER COMMON SHARE                                                                             |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|BASIC                                                                                                 |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Earnings per share before cumulative effect of change in accounting principle                         |  | $              | 1.88   |   |                | $ | 0.98   |              |  | $ | 3.02         |   |  | $ | 1.69   |  
|Cumulative effect of change in accounting principle                                                   |  |                |       |   |                |   |       |              |  |   |             |   |  |   | (0.63  | )
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Earnings per share                                                                                    |  | $              | 1.88   |   |                | $ | 0.98   |              |  | $ | 3.02         |   |  | $ | 1.06   |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|DILUTED                                                                                               |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Earnings per share before cumulative effect of change in accounting principle                         |  | $              | 1.88   |   |                | $ | 0.98   |              |  | $ | 3.01         |   |  | $ | 1.66   |  
|Cumulative effect of change in accounting principle                                                   |  |                |       |   |                |   |       |              |  |   |             |   |  |   | (0.61  | )
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Earnings per share                                                                                    |  | $              | 1.88   |   |                | $ | 0.98   |              |  | $ | 3.01         |   |  | $ | 1.05   |  
|                                                                                                      |  |                |        |   |                |   |        |              |  |   |              |   |  |   |        |  
|Basic weighted average common shares outstanding                                                      |  |                | 156.4  |   |                |   | 164.9  |              |  |   | 157.2        |   |  |   | 143.1  |  
|Diluted weighted average common shares outstanding                                                    |  |                | 156.5  |   |                |   | 165.1  |              |  |   | 157.3        |   |  |   | 145.4  |  

See accompanying notes.



1



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Condensed Consolidated Balance Sheets



|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | - | ------------ | - | ------ | --------------- |  | - | ------ | -
|                                                                                                        |  | (Unaudited)  |        |   |              |  
|millions, except per share data                                                                         |  | July 29,2006 |        |   | July 30,2005 |   |        | January 28,2006 | 
|ASSETS                                                                                                  |  |              |        |   |              |   |        |                 |  |   |        |  
|Current assets                                                                                          |  |              |        |   |              |   |        |                 |  |   |        |  
|Cash and cash equivalents                                                                               |  | $            | 3,690  |   |              | $ | 2,138  |                 |  | $ | 4,440  |  
|Credit card receivables                                                                                 |  |              |       |   |              |   | 1,159  |                 |  |   |       |  
|Accounts receivable                                                                                     |  |              | 803    |   |              |   | 663    |                 |  |   | 811    |  
|Merchandise inventories                                                                                 |  |              | 9,455  |   |              |   | 8,953  |                 |  |   | 9,068  |  
|Prepaid expenses and other current assets                                                               |  |              | 370    |   |              |   | 461    |                 |  |   | 372    |  
|Deferred income taxes                                                                                   |  |              | 547    |   |              |   | 625    |                 |  |   | 516    |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|Total current assets                                                                                    |  |              | 14,865 |   |              |   | 13,999 |                 |  |   | 15,207 |  
|                                                                                                        |  |              |       
|Property and equipment, net                                                                             |  |              | 9,395  |   |              |   | 10,084 |                 |  |   | 9,823  |  
|Goodwill                                                                                                |  |              | 1,885  |   |              |   | 1,911  |                 |  |   | 1,684  |  
|Tradenames and other intangible assets                                                                  |  |              | 3,454  |   |              |   | 4,039  |                 |  |   | 3,448  |  
|Other assets                                                                                            |  |              | 462    |   |              |   | 485    |                 |  |   | 411    |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|TOTAL ASSETS                                                                                            |  | $            | 30,061 |   |              | $ | 30,518 |                 |  | $ | 30,573 |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|LIABILITIES                                                                                             |  |              |        |   |              |   |        |                 |  |   |        |  
|Current liabilities                                                                                     |  |              |        |   |              |   |        |                 |  |   |        |  
|Short-term borrowings                                                                                   |  | $            | 82     |   |              | $ | 78     |                 |  | $ | 178    |  
|Current portion of long-term debt and capitalized lease obligations                                     |  |              | 213    |   |              |   | 744    |                 |  |   | 570    |  
|Merchandise payables                                                                                    |  |              | 3,274  |   |              |   | 3,460  |                 |  |   | 3,458  |  
|Income taxes payable                                                                                    |  |              | 486    |   |              |   | 449    |                 |  |   | 449    |  
|Other current liabilities                                                                               |  |              | 4,031  |   |              |   | 3,120  |                 |  |   | 3,917  |  
|Unearned revenues                                                                                       |  |              | 1,082  |   |              |   | 1,019  |                 |  |   | 1,047  |  
|Other taxes                                                                                             |  |              | 727    |   |              |   | 687    |                 |  |   | 731    |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|Total current liabilities                                                                               |  |              | 9,895  |   |              |   | 9,557  |                 |  |   | 10,350 |  
|                                                                                                        |  |              |       
|Long-term debt and capitalized lease obligations                                                        |  |              | 3,475  |   |              |   | 3,333  |                 |  |   | 3,268  |  
|Pension and postretirement benefits                                                                     |  |              | 2,361  |   |              |   | 2,614  |                 |  |   | 2,421  |  
|Minority interest and other liabilities                                                                 |  |              | 2,719  |   |              |   | 3,713  |                 |  |   | 2,923  |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|Total Liabilities                                                                                       |  |              | 18,450 |   |              |   | 19,217 |                 |  |   | 18,962 |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|SHAREHOLDERS EQUITY                                                                                    |  |              |        |   |              |   |        |                 |  |   |        |  
|Preferred stock, 20 shares authorized; no shares outstanding                                            |  |              |       |   |              |   |       |                 |  |   |       |  
|Common stock $0.01 par value; 500 shares authorized; 156, 165, and 160 shares outstanding, respectively |  |              | 2      |   |              |   | 2      |                 |  |   | 2      |  
|Capital in excess of par value                                                                          |  |              | 10,256 |   |              |   | 9,923  |                 |  |   | 10,258 |  
|Retained earnings                                                                                       |  |              | 2,672  |   |              |   | 1,492  |                 |  |   | 2,198  |  
|Treasury stock  at cost                                                                                |  |              | (1,138 | ) |              |   | (26    | )               |  |   | (642   | )
|Accumulated other comprehensive loss                                                                    |  |              | (181   | ) |              |   | (90    | )               |  |   | (205   | )
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|Total Shareholders Equity                                                                              |  |              | 11,611 |   |              |   | 11,301 |                 |  |   | 11,611 |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                              |  | $            | 30,061 |   |              | $ | 30,518 |                 |  | $ | 30,573 |  
|                                                                                                        |  |              |        |   |              |   |        |                 |  |   |        |  

See accompanying notes.



2



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)



|                                                                                   |  |                |       |   |              |   |        |  
|---------------------------------------------------------------------------------- |  | -------------- | ----- | - | ------------ | - | ------ | -
|                                                                                   |  | 26 Weeks Ended |      
|millions                                                                           |  | July 29,2006   |       |   | July 30,2005 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                               |  |                |       |   |              |   |        |  
|Net income                                                                         |  | $              | 474   |   |              | $ | 152    |  
|Adjustments to reconcile net income to net cash provided by operating activities:  |  |                |       |   |              |   |        |  
|Depreciation and amortization                                                      |  |                | 565   |   |              |   | 387    |  
|Cumulative effect of change in accounting principle, net of tax                    |  |                |      |   |              |   | 90     |  
|Provision for uncollectible credit card accounts                                   |  |                |      |   |              |   | 17     |  
|Gain on sales of assets                                                            |  |                | (24   | ) |              |   | (10    | )
|Gain on sale of investments                                                        |  |                | (18   | ) |              |   |       |  
|Change in operating assets and liabilities (net of acquisitions and dispositions): |  |                |       |   |              |   |        |  
|Deferred income taxes                                                              |  |                | 62    |   |              |   | (193   | )
|Credit card receivables                                                            |  |                |      |   |              |   | (171   | )
|Merchandise inventories                                                            |  |                | (358  | ) |              |   | 278    |  
|Merchandise payables                                                               |  |                | (183  | ) |              |   | (69    | )
|Income and other taxes                                                             |  |                | 15    |   |              |   | 176    |  
|Other operating assets                                                             |  |                | (55   | ) |              |   | 109    |  
|Other operating liabilities(1) (2)                                                 |  |                | (88   | ) |              |   | (398   | )
|                                                                                   |  |                |       |   |              |   |        |  
|Net cash provided by operating activities                                          |  |                | 390   |   |              |   | 368    |  
|                                                                                   |  |                |       |   |              |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                               |  |                |       |   |              |   |        |  
|Acquisitions of businesses, net of cash acquired                                   |  |                | (278  | ) |              |   | (1,019 | )
|Proceeds from sales of property and investments                                    |  |                | 57    |   |              |   | 19     |  
|Purchases of property and equipment                                                |  |                | (173  | ) |              |   | (180   | )
|                                                                                   |  |                |       |   |              |   |        |  
|Net cash used in investing activities                                              |  |                | (394  | ) |              |   | (1,180 | )
|                                                                                   |  |                |       |   |              |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                               |  |                |       |   |              |   |        |  
|Proceeds from debt issuances                                                       |  |                | 260   |   |              |   |       |  
|Proceeds from termination of interest rate swaps                                   |  |                |      |   |              |   | 60     |  
|Repayments of long-term debt                                                       |  |                | (426  | ) |              |   | (152   | )
|Decrease in short-term borrowings, primarily 90 days or less                       |  |                | (95   | ) |              |   | (514   | )
|Purchase of treasury stock                                                         |  |                | (509  | ) |              |   |       |  
|Income tax benefit on nonqualified stock options                                   |  |                |      |   |              |   | 47     |  
|Proceeds from the exercise of stock options                                        |  |                |      |   |              |   | 98     |  
|Debt issue costs paid                                                              |  |                |      |   |              |   | (19    | )
|                                                                                   |  |                |       |   |              |   |        |  
|Net cash used in financing activities                                              |  |                | (770  | ) |              |   | (480   | )
|                                                                                   |  |                |       |   |              |   |        |  
|Effect of exchange rate changes on cash and cash equivalents                       |  |                | 24    |   |              |   | (5     | )
|                                                                                   |  |                |       |   |              |   |        |  
|NET DECREASE IN CASH AND CASH EQUIVALENTS                                          |  |                | (750  | ) |              |   | (1,297 | )
|                                                                                   |  |                |       |   |              |   |        |  
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                       |  |                | 4,440 |   |              |   | 3,435  |  
|                                                                                   |  |                |       |   |              |   |        |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                           |  | $              | 3,690 |   |              | $ | 2,138  |  
|                                                                                   |  |                |       |   |              |   |        |  
|SUPPLEMENTAL DISCLOSURE ABOUT NON-CASH INVESTING AND FINANCING ACTIVITIES:         |  |                |       |   |              |   |        |  
|Bankruptcy related settlements resulting in the receipt of treasury stock          |  | $              | 1     |   |              | $ | 12     |  
|Conversion of 9% convertible note                                                  |  |                |      |   |              |   | 63     |  
|Supplemental Cash Flow Data:                                                       |  |                |       |   |              |   |        |  
|(1)Income
taxes paid                                                               |  |                | 265   |   |              |   | 84     |  
|(2)Cash
interest paid                                                              |  |                | 141   |   |              |   | 87     |  

See accompanying notes.



3



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1  BASIS OF PRESENTATION

Sears Holdings Corporation
(Holdings or the Company) is the parent company of Kmart Holding Corporation (Kmart) and Sears, Roebuck and Co. (Sears). Holdings was formed as a Delaware corporation in 2004 in connection with the
merger of Kmart and Sears (the Merger), which was completed on March 24, 2005. The Company is a broadline retailer with approximately 2,300 full-line and 1,100 specialty retail stores in the United States operating through Kmart and
Sears and approximately 380 full-line and specialty retail stores in Canada operating through Sears Canada Inc. (Sears Canada), a 70%-owned subsidiary.

For accounting purposes, the Merger has been treated as a purchase business combination, with Kmart acquiring Sears. Accordingly, the historical financial statements of Kmart serve as the historical financial statements of Holdings, the
registrant. The results of Sears are included in the condensed consolidated financial statements subsequent to the Merger date. Thus, the accompanying condensed consolidated statements of income and cash flows for the 26-week period ended
July 30, 2005 include approximately 18 weeks of Sears results and 26 weeks of Kmarts results. See Note 2 for summary unaudited pro forma information and details on the purchase accounting applied to the Merger.

Effective March 23, 2005, the Company changed its fiscal year end from the last Wednesday in January to the Saturday closest to January 31st. As the change in
fiscal year end reflected a change of only three days, the historical financial statements have not been recast to reflect this change. Sears Canadas fiscal year end is the Saturday closest to December 31st. The results of operations for
Sears Canada are reported to Holdings on a one-month lag. Accordingly, the statements of income for the 13-week periods ended July 29, 2006 and July 30, 2005 include operating results for Sears Canada for the periods from April 1,
2006 to July 1, 2006 and April 3, 2005 to July 2, 2005, respectively. For the 26-week periods ended July 29, 2006 and July 30, 2005, the statements of income and cash flows include operating results for Sears Canada from
January 1, 2006 to July 1, 2006 and March 25, 2005 to July 2, 2005, respectively.

These interim unaudited condensed consolidated
financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation have been included. All
significant intercompany accounts and transactions have been eliminated. Operating results for the interim period are not necessarily indicative of the results that may be expected for the full year. The retail business is seasonal in nature, and
the Company generates a high proportion of its revenues and operating cash flows during the fourth quarter of its fiscal year, which includes the holiday season.

Readers of these interim period statements should refer to the audited consolidated financial statements and notes thereto, which are included in Sears Holdings Annual Report on Form 10-K/A for its fiscal year ended January 28,
2006.

As a result of conforming financial statement classifications in connection with the Merger, certain prior period amounts have been reclassified to
conform to the current interim period presentation.

NOTE 2  THE MERGER

On March 24, 2005, Kmart and Sears completed the Merger pursuant to the Agreement and Plan of Merger, dated as of November 16, 2004 (the Merger Agreement). Upon consummation of the Merger, Kmart
and Sears became wholly-owned subsidiaries of Holdings.



4



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



Under the terms of the Merger Agreement, Kmart shareholders received one share of Holdings common stock for each
Kmart share owned. Approximately 94.9 million shares of Holdings common stock were issued in exchange for all outstanding common stock of Kmart based on the one-for-one ratio. Sears shareholders had the right to elect to receive $50 in cash or
0.5 of a share of Holdings common stock for each Sears share owned. Sears shareholder elections were prorated to ensure that, in the aggregate, 55 percent of Sears shares were converted into Holdings shares and 45 percent of Sears shares were
converted to cash. Shares of Sears restricted common stock were converted into Holdings common stock on a 0.5 for 1 basis. In aggregate, 62.2 million shares of Holdings common stock were issued to Sears shareholders at a value of approximately
$6.5 billion (based on the average closing price of $104.33 of Kmarts common stock during the period from November 15, 2004 through November 19, 2004, two business days before and after the date the Merger was announced). In
addition, approximately $5.4 billion in cash was paid in consideration for (i) all outstanding shares of common stock of Sears, based upon the proration provisions of the Merger Agreement, and (ii) all outstanding stock options of Sears.
Including transaction costs of $18 million, the total consideration paid was approximately $11.9 billion.

In accordance with Statement of Financial
Accounting Standards (SFAS) No. 141, Business Combinations, the Merger has been treated as a purchase business combination for accounting purposes, with Kmart designated as the acquirer. In identifying Kmart as
the acquiring entity, the companies took into account the relative share ownership of the Company after the Merger, the composition of the governing body of the combined entity and the designation of certain senior management positions. Accordingly,
the historical financial statements of Kmart serve as the historical financial statements of Holdings. The Company completed the purchase price allocation for the Merger during the first quarter of fiscal 2006. As a result, goodwill attributable to
the Merger increased by approximately $37 million during the first quarter of fiscal 2006, primarily based on the receipt of additional information regarding the fair values of certain properties and certain pre-acquisition legal contingencies. The
following summarizes the assets acquired and liabilities assumed as of the March 24, 2005 Merger date, based on the final purchase price allocation.



|                                                   |  |   |       
|-------------------------------------------------- |  | - | ------
|millions                                           |  |  
|Cash and cash equivalents                          |  | $ | 4,351 
|Merchandise inventories                            |  |   | 6,134 
|Other current assets                               |  |   | 1,977 
|Property and equipment                             |  |   | 9,731 
|Goodwill                                           |  |   | 1,721 
|Tradenames and other intangible assets             |  |   | 3,914 
|Other assets                                       |  |   | 475   
|                                                   |  |   |       
|Total assets acquired                              |  | $ | 28,303
|                                                   | 
|Merchandise payables and other current liabilities |  | $ | 6,784 
|Unearned revenues (including non-current portion)  |  |   | 1,896 
|Total debt and capitalized lease obligations       |  |   | 4,421 
|Deferred income taxes                              |  |   | 658   
|Pension and postretirement benefits                |  |   | 1,647 
|Minority interest and other liabilities            |  |   | 1,035 
|                                                   |  |   |       
|Total liabilities assumed                          |  | $ | 16,441
|                                                   |  |   |       
|Net assets acquired                                |  | $ | 11,862
|                                                   |  |   |       



5



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



The Company has allocated approximately $3.9 billion to identifiable intangible assets, of which approximately
$2.8 billion relates to the indefinite-lived tradenames of Sears, Kenmore, Craftsman, Lands End and DieHard. These indefinite-lived tradenames are not subject to amortization as management expects these tradenames to generate cash flows
indefinitely. The remaining intangible assets of $1.1 billion include finite-lived tradenames, favorable leases, contractual arrangements and customer lists, and will be amortized over their estimated useful lives, with a weighted-average life
of nine years. The Company recorded $48 million of amortization expense for the 26-week period ended July 29, 2006 related to its amortizable intangible assets. Annual amortization expense for each of the next five fiscal years is estimated to
be $102 million per year.

Selected Unaudited Pro Forma Combined Financial Information

The unaudited pro forma financial information in the table below summarizes the combined results of operations of Kmart and Sears for the 26-week period ended
July 30, 2005 as though the Merger had occurred as of the beginning of fiscal 2004. The unaudited pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have
been achieved if the Merger had taken place at the beginning of the period presented, or that may result in the future. In addition, Holdings is realizing operating synergies as a result of the Merger. The following unaudited pro forma financial
information has not been adjusted to reflect operating efficiencies realized as a result of the Merger.



|                                                                                      |  |                                |       
|------------------------------------------------------------------------------------- |  | ------------------------------ | ------
|millions, except per share data                                                       |  | 26 weeks endedJuly 30, 2005(1)
|                                                                                      |  | Pro forma                     
|Revenues                                                                              |  | $                              | 25,973
|Operating income                                                                      |  | $                              | 424   
|Income before cumulative effect of change in accounting principle                     |  | $                              | 173   
|Net income                                                                            |  | $                              | 83    
|Diluted earnings per share before cumulative effect of change in accounting principle |  | $                              | 1.06  
|Diluted earnings per share                                                            |  | $                              | 0.51  

---

|(1) | Includes $34 million of transaction costs and $45 million of integration costs related to the
Merger.
|--- | -----------------------------------------------------------------------------------------------------

NOTE 3  ACQUISITION OF MINORITY INTEREST IN SEARS CANADA

During the first half of fiscal 2006, the Company increased its majority interest in Sears Canada from 54% to 70% by acquiring 17.8 million common shares of Sears Canada pursuant to its take-over bid for Sears
Canada, first announced in December 2005. The Company paid a total of $278 million for the additional 17.8 million common shares acquired and has accounted for the acquisition of additional interests in Sears Canada as a purchase business
combination for accounting purposes. The total amount paid for shares acquired has been allocated to the assets acquired and liabilities assumed based on their estimated fair values as of the respective acquisition dates. Total consideration for the
additional interest acquired exceeded the associated proportionate pre-acquisition carrying value for Sears Canada by approximately $185 million. The Company estimates that this excess is allocable to real property ($5 million), trademarks and other
identifiable intangible assets ($56 million), goodwill ($165 million) and other assets and liabilities ($-41 million). This purchase price allocation is preliminary and further refinements may be necessary. The acquisition of the additional interest
in Sears Canada was not material to the Companys operations or financial position.



6



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



On August 8, 2006, the Ontario Securities Commission (OSC) issued an order in respect of
Holdings offer for the outstanding shares of Sears Canada. The effect of the OSCs order is that no shares may trade pursuant to Holdings offer until certain conditions are satisfied. Satisfaction of the conditions of the order
would require Holdings to, among other things, exclude the votes of over 30% of the shares held by shareholders of Sears Canada other than Holdings at the commencement of the offer from the calculation of the majority of the minority approval
requirement for the contemplated second step subsequent acquisition transaction. On August 9, 2006, the Company commenced an appeal from the OSCs order to the Ontario Superior Court (Divisional Court). The Divisional Court is
scheduled to hear argument on this appeal on September 18, 2006.

The Company has extended its offer to September 29, 2006, and may further extend
the offer, to preserve the Companys rights under the offer pending the outcome of the appellate process in relation to the OSCs order.

NOTE
4CHANGE IN ACCOUNTING PRINCIPLE

Effective January 27, 2005, the Company changed its method of accounting for certain indirect
buying, warehousing and distribution costs. Prior to this change, the Company had included indirect buying, warehousing and distribution costs as inventoriable costs. Beginning in fiscal 2005, such costs have been expensed as incurred, which is the
method of accounting previously followed by Sears. The Company believes that this change provides a better measurement of operating results in light of changes to the Companys supply chain to realize cost savings from the Merger, the closure
of certain facilities and the combined capacity of the existing distribution and headquarters facilities. In accordance with Accounting Principles Board Opinion (APB) No. 20, Accounting Changes, changes in
accounting policy to conform the acquirers policy to that of the acquired entity are treated as a change in accounting principle. The indirect buying, warehousing and distribution costs that were capitalized to inventory as of January 26,
2005 have been reflected in the condensed consolidated statement of income for the 26-week period ended July 30, 2005 as a cumulative effect of a change in accounting principle in the amount of $90 million net of income taxes of
$58 million.

NOTE 5  RESTRUCTURING ACTIVITIES

During fiscal 2005, the Company initiated a number of restructuring activities including actions to integrate the home office functions of Kmart and Sears Domestic and align its workforce accordingly. Approximately 1,435 Kmart associates
were notified that their positions had been relocated, were under review, or had been eliminated, and approximately 780 former Sears employees were notified of the decision to eliminate their positions in connection with the home office integration
efforts. Also during the third quarter of fiscal 2005, Sears Canada implemented a series of productivity improvement initiatives, which included a workforce reduction of approximately 1,200 associates. These initiatives resulted in the recognition
of $14 million and $23 million of restructuring costs for the 13- and 26-week periods ended July 29, 2006, respectively.

As of July 29, 2006,
all actions related to these activities have been substantially completed. The remaining costs to be incurred will be recognized over the associates remaining service periods in accordance with SFAS No. 146, Accounting for Costs
Associated with Disposal and Exit Activities. The remaining reserve balance of $22 million at July 29, 2006 represents payments to be made in the remainder of fiscal 2006 in accordance with the Companys severance and
relocation plans.



7



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



Following is a summary of the fiscal 2006 activity in the reserves established for these integration and productivity
initiatives:



|               |  |                                             |     |                                                |   |                                      |  |                      |    |                         |   |                                     |  |   |    |  |   |   
|-------------- |  | ------------------------------------------- | --- | ---------------------------------------------- | - | ------------------------------------ |  | -------------------- | -- | ----------------------- | - | ----------------------------------- |  | - | -- |  | - | --
|millions       |  | EstimatedTotalCumulativeCosts to beIncurred |     | CumulativeCosts recognizedthrough July 29,2006 |   | Ending ReserveBalanceJanuary 28,2006 |  | Fiscal 2006Additions |    | Fiscal 2006CashPayments |   | Ending ReserveBalance July 29, 2006
|Kmart          |  | $                                           | 61  |                                                | $ | 58                                   |  | $                    | 21 |                         | $ | 4                                   |  | $ | 15 |  | $ | 10
|Sears Domestic |  |                                             | 59  |                                                |   | 59                                   |  |                      | 2  |                         |   |                                    |  |   | 2  |  |   |  
|Sears Canada   |  |                                             | 76  |                                                |   | 76                                   |  |                      | 13 |                         |   | 19                                  |  |   | 20 |  |   | 12
|               |  |                                             |     |                                                |   |                                      |  |                      |    |                         |   |                                     |  |   |    |  |   |   
|Total          |  | $                                           | 196 |                                                | $ | 193                                  |  | $                    | 36 |                         | $ | 23                                  |  | $ | 37 |  | $ | 22
|               |  |                                             |     |                                                |   |                                      |  |                      |    |                         |   |                                     |  |   |    |  |   |   

NOTE 6 SALE OF SEARS CANADA CREDIT AND FINANCIAL SERVICES OPERATIONS

On November 15, 2005, Sears Canada completed the sale of substantially all of the assets (principally net credit card receivables of $1.3 billion and customer
relationship intangibles of $0.4 billion) and liabilities of its Credit and Financial Services operations to JPMorgan Chase & Co. (JPMorgan Chase) for approximately $2.0 billion in cash proceeds, net of securitized
receivables and other related costs and taxes.

Prior to the sale of Sears Canadas Credit and Financial Services operations, Sears Canada had
securitized certain of its credit card receivables through trusts. Sears Canada sold undivided co-ownership interests in its portfolio of current and deferred charge accounts receivable to two separate trusts and retained the right to receive the
income generated by the undivided co-ownership interests sold to the trusts in excess of the trusts stipulated share of service charge revenues. The securitization trusts were transferred to JPMorgan Chase in connection with the sale of this
business. During fiscal 2005, the amounts recognized as income from the sale of the credit card receivables to the trusts were not material.

The
Companys condensed consolidated statements of income and cash flows for the 26-week period ended July 30, 2005 includes the results of Sears Canadas Credit and Financial Services operations from March 25, 2005 through
July 2, 2005.

NOTE 7  DERIVATIVE FINANCIAL INSTRUMENTS

During the first quarter of fiscal 2006, the Company settled $800 million in Canadian notional value of foreign currency forward contracts that were used to hedge the Companys net investment in Sears Canada
against adverse changes in exchange rates. The Company paid $43 million to settle these contracts, representing the aggregate fair value of the settled forwards as of the respective settlement dates. For those contracts for which hedge accounting
had been applied, the Company recorded an offsetting amount of $48 million as a component of accumulated other comprehensive loss in the Companys condensed consolidated balance sheet. The Company recorded a gain of $5 million during the first
quarter of fiscal 2006 for the remaining contracts, for which hedge accounting was not applied. This gain has been classified as part of Other income within the Companys condensed consolidated statement of income for the 26-week period ended
July 29, 2006. During the 26-week period ended July 29, 2006, the Company entered into foreign currency forward contracts totaling $535 million Canadian notional value designed to hedge the Companys net investment in Sears Canada
against adverse changes in exchange rates. These contracts had an aggregate fair value of $6 million as of July 29, 2006. A total of $400 million in Canadian notional value of these outstanding forward contracts are hedges which qualify for
hedge accounting and, as such, an unrealized gain of $8 million was recorded as a component of accumulated



8



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



other comprehensive loss in the Companys consolidated balance sheet as of July 29, 2006. The remaining $135 million in Canadian notional value are
contracts for which hedge accounting has not been applied. Accordingly, a gain of $1 million and a loss of $2 million have been reflected as components of Other income in the Companys condensed consolidated statements of income for the 13-and
26-week periods ended July 29, 2006, respectively. In addition, during the first quarter of fiscal 2006, Sears Canada entered into cross-currency interest rate swaps designated as a hedge of certain U.S. dollar-denominated floating-rate debt
issued by Sears Canada. These swaps mature in December 2012 and, as of July 29, 2006, had a notional principal amount of $259 million and a fair value of negative $6 million.

NOTE 8BORROWINGS

Total borrowings were as follows:



|                                           |  |              |       |              |   |                 |  |   |      
|------------------------------------------ |  | ------------ | ----- | ------------ | - | --------------- |  | - | -----
|millions                                   |  | July 29,2006 |       | July 30,2005 |   | January 28,2006
|Short-term borrowings:                     |  |              |       |              |   |                 |  |   |      
|Unsecured commercial paper                 |  | $            | 82    |              | $ | 78              |  | $ | 178  
|Long-term debt, including current portion: |  |              |       |              |   |                 |  |   |      
|Notes and debentures outstanding           |  |              | 2,843 |              |   | 3,189           |  |   | 2,974
|Capitalized lease obligations              |  |              | 845   |              |   | 888             |  |   | 864  
|                                           |  |              |       |              |   |                 |  |   |      
|Total debt                                 |  | $            | 3,770 |              | $ | 4,155           |  | $ | 4,016
|                                           |  |              |       |              |   |                 |  |   |      

Credit Agreement

The Companys $4.0 billion, five-year credit agreement (the Credit Agreement) has an expiration date of March 2010 and is available for general corporate purposes and includes a $1.5 billion letter of credit
sublimit. The Credit Agreement is a revolving credit facility under which Sears Roebuck Acceptance Corp. (SRAC) and Kmart Corporation are the borrowers. The Credit Agreement is guaranteed by Holdings and certain of its direct and
indirect subsidiaries and is secured by a first lien on domestic inventory, credit card accounts receivable and the proceeds thereof. Availability under the Credit Agreement is determined pursuant to a borrowing base formula, based on domestic
inventory and credit card accounts receivable, subject to certain limitations. As of July 29, 2006, the Company had $457 million of letters of credit outstanding under the Credit Agreement with $3.5 billion of availability remaining under the
Credit Agreement. There were no direct borrowings under the facility during the first half of fiscal 2006. The Credit Agreement does not contain provisions that would restrict borrowings or letter of credit issuances based on material adverse
changes or credit ratings

Letter of Credit Agreement

The Company has an additional letter of credit agreement (the LC Agreement) with a commitment amount of up to $1 billion. The LC Agreement expires in August 2007. As of July 29, 2006, there were $433 million of
letters of credit outstanding under the LC Agreement.

Under the terms of the LC Agreement, the Company has the ability to post cash, inventory or other
letters of credit, including letters of credit issued under the Credit Agreement, as collateral. However, the Credit Agreement prohibits the Company from using inventory as collateral under the LC Agreement. The cash collateral account is subject to
a pledge and security agreement pursuant to which if the Company elects to post cash collateral, it must maintain cash in an amount equal to 100.5% of the face value of letters of credit



9



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



outstanding. The Company had $435 million of cash posted as collateral under the LC Agreement as of July 29, 2006. The Company continues to classify the
cash collateral as cash and cash equivalents due to its ability to substitute these letters of credit with letters of credit under the Credit Agreement, which does not require cash collateral, and its ability to provide letters of credit under the
Credit Agreement as collateral. There are no provisions in the LC Agreement that would restrict issuances based on credit ratings, but issuances could be restricted under certain circumstances based on a material adverse change.

Cash Collateral

The Company posts cash collateral for certain
self-insurance programs. The Company continues to classify the cash collateral as cash and cash equivalents due to the Companys ability to substitute letters of credit for the cash at any time at its discretion. As of July 29, 2006, $98
million of cash was posted as collateral for self-insurance programs.

OSH Supply Hardware LLC (LLC) Credit Agreement

In fiscal 2005, LLC entered into a five-year, $130 million senior secured revolving credit facility (the LLC Facility), which includes a
$25 million letter of credit sublimit. The LLC Facility is available for LLCs general corporate purposes and is secured by a first lien on substantially all of LLCs non-real estate assets. Availability under the LLC Facility is
determined pursuant to a borrowing base formula based on inventory and accounts and credit card accounts receivable, subject to certain limitations. As of July 29, 2006, $2 million was outstanding under the LLC Facility  there were
no borrowings and $2 million in outstanding letters of credit.

Inter-company Loan

The Company has also transferred certain domestic real estate and intellectual property into separate bankruptcy remote Special Purpose Vehicles (SPVs). The SPV holding the real estate assets leases such
property to Sears, Roebuck and Co. and Kmart Corporation. The SPV holding the intellectual property licenses these trademarks to Sears, Roebuck and Co. and Kmart Corporation. Each SPV has issued asset-backed notes that are collateralized by the real
estate and intellectual property, respectively. Cash flows received by the SPVs from rents and licensing fees paid by Sears, Roebuck and Co., Kmart Corporation and, potentially in the future, other affiliates or third parties will be used for the
payment of fees, interest and principal on notes issued by the SPVs. As of July 29, 2006, these debt securities were entirely held by wholly-owned consolidated subsidiaries of the Company and the net book value of the securitized intellectual
property assets was approximately $1.0 billion, and the net book value of the securitized real estate assets was approximately $1.1 billion.



10



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



NOTE 9  BASIC AND DILUTED WEIGHTED AVERAGE COMMON SHARES

The following reconciles basic weighted average common shares outstanding to diluted weighted average shares outstanding.



|                                                   |  |                |  |                |  |              |  |                
|-------------------------------------------------- |  | -------------- |  | -------------- |  | ------------ |  | ---------------
|                                                   |  | 13 Weeks Ended |  | 26 Weeks Ended
|millions                                           |  | July 29,2006   |  | July 30,2005   |  | July 29,2006 |  | July 30,2005(1)
|Basic weighted average common shares outstanding   |  | 156.4          |  | 164.9          |  | 157.2        |  | 143.1          
|Dilutive effect of stock options                   |  | 0.1            |  | 0.2            |  | 0.1          |  | 2.3            
|                                                   |  |                |  |                |  |              |  |                
|Diluted weighted average common shares outstanding |  | 156.5          |  | 165.1          |  | 157.3        |  | 145.4          
|                                                   |  |                |  |                |  |              |  |                

---

|(1) | The weighted average common shares outstanding amounts for the 26-week period ended July 30, 2005 utilize Kmart outstanding common shares for the period prior
to the March 24, 2005 Merger.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

NOTE 10  CLAIMS RESOLUTION AND BANKRUPTCY-RELATED SETTLEMENTS

Claims Resolution

On May 6, 2003, Kmart Corporation (the
Predecessor Company), a predecessor operating company of Kmart, emerged from reorganization proceedings under Chapter 11 of the federal bankruptcy laws pursuant to the terms of a plan of reorganization (the Plan of
Reorganization). The Predecessor Company is now an indirect, wholly-owned subsidiary of Holdings.

The Company continues to make progress in the
reconciliation and settlement of various classes of claims associated with the discharge of the Predecessor Companys liabilities subject to compromise pursuant to the Plan of Reorganization. Since June 30, 2003, the first distribution
date established in the Plan of Reorganization, approximately 28 million shares of the 32 million shares set aside for distribution have been distributed to holders of Class 5 claims and approximately $4 million in cash has been
distributed to holders of Class 7 claims. Due to the significant volume of claims filed to-date, it is premature to estimate with any degree of accuracy the ultimate allowed amount of such claims for each class of claims under the Plan of
Reorganization. Accordingly, the Companys current distribution reserve for Class 5 claim settlements is 5 percent of the total shares expected to be distributed. The remaining shares in the distribution reserve will be issued to
claimants if, upon settlement of all claims, the ultimate amount allowed for Class 5 claims is consistent with the Plan of Reorganization. Differences between amounts filed and the Companys estimates are being investigated and will be
resolved in connection with its claims resolution process. The claims reconciliation process may result in material adjustments to current estimates of allowable claims and the distribution to claimants. The next scheduled distribution under the
Plan of Reorganization is expected to commence on or about October 1, 2006.

Bankruptcy-Related Settlements

The Company recognized recoveries of $11 million and $12 million for the 13- and 26-week periods ended July 29, 2006, respectively, related to vendors who had
received cash payments for pre-petition obligations (critical vendor claims) or preference payments. In conjunction with these recoveries, for the 13- and 26-week periods ended July 29, 2006, the Company was assigned 6,796 and 7,334 shares of
common stock (weighted average price of $136.88 and $135.68 per share), respectively, and with an approximate value of $1 million.



11



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



NOTE 11  SHAREHOLDERS EQUITY

Share Repurchase Program

During the 13- and 26-week periods ended July 29, 2006, the Company repurchased
0.7 million and 4.0 million common shares pursuant to its common share repurchase program at a total cost of $91 million and $504 million, or an average price of $137.67 and $127.66 per share, respectively. As of July 29, 2006, the
Company had remaining authorization to repurchase $406 million of common shares under its common share repurchase program. The repurchase program has no stated expiration date and the remaining shares may be purchased in the open market, through
self-tender offers or through privately negotiated transactions.

Comprehensive Income and Accumulated Other Comprehensive Loss

The following table shows the computation of comprehensive income:



|                                                    |  |                |     |               |                |     |              |  |              |     |  |   |     |  
|--------------------------------------------------- |  | -------------- | --- | ------------- | -------------- | --- | ------------ |  | ------------ | --- |  | - | --- | -
|                                                    |  | 13 Weeks Ended |     |               | 26 Weeks Ended |    
|millions                                            |  | July 29,2006   |     | July 30, 2005 |                |     | July 29,2006 |  | July 30,2005 |    
|Net income                                          |  | $              | 294 |               | $              | 161 |              |  | $            | 474 |  | $ | 152 |  
|Other comprehensive income (loss):                  |  |                |     |               |                |     |              |  |              |     |  |   |     |  
|Change in fair value of interest rate swaps         |  |                |    |               |                | 1   |              |  |              |    |  |   | 1   |  
|Unrealized gain (loss) on foreign currency forwards |  |                | 14  |               |                | (10 | )            |  |              | 3   |  |   | (10 | )
|Foreign currency translation adjustments            |  |                | 18  |               |                | (8  | )            |  |              | 21  |  |   | (4  | )
|                                                    |  |                |     |               |                |     |              |  |              |     |  |   |     |  
|Total other comprehensive income (loss)             |  |                | 32  |               |                | (17 | )            |  |              | 24  |  |   | (13 | )
|                                                    |  |                |     |               |                |     |              |  |              |     |  |   |     |  
|Total comprehensive income                          |  | $              | 326 |               | $              | 144 |              |  | $            | 498 |  | $ | 139 |  
|                                                    |  |                |     |               |                |     |              |  |              |     |  |   |     |  



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



|                                        |  |              |      |   |              |   |     |                 |  |   |      |  
|--------------------------------------- |  | ------------ | ---- | - | ------------ | - | --- | --------------- |  | - | ---- | -
|millions                                |  | July 29,2006 |      |   | July 30,2005 |   |     | January 28,2006 | 
|Cumulative unrealized derivative losses |  | $            |     |   |              | $ | (9  | )               |  | $ |     |  
|Currency translation adjustments        |  |              | 6    |   |              |   | (4  | )               |  |   | (18  | )
|Minimum pension liability, net of tax   |  |              | (187 | ) |              |   | (77 | )               |  |   | (187 | )
|                                        |  |              |      |   |              |   |     |                 |  |   |      |  
|Accumulated other comprehensive loss    |  | $            | (181 | ) |              | $ | (90 | )               |  | $ | (205 | )
|                                        |  |              |      |   |              |   |     |                 |  |   |      |  



12



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



NOTE 12  BENEFIT PLANS

Benefit Plans

The Company provides benefits to certain associates who are eligible under various defined benefit
pension plans, contributory defined benefit pension plans and other postretirement plans, primarily retiree medical benefits. The following table summarizes the components of total net periodic benefit expense for the Companys retirement
plans:



|                                    |  |                |      |   |                |   |     |              |  |   |              |   |  |   |      |  
|----------------------------------- |  | -------------- | ---- | - | -------------- | - | --- | ------------ |  | - | ------------ | - |  | - | ---- | -
|                                    |  | 13 Weeks Ended |      |   | 26 Weeks Ended |  
|millions                            |  | July 29,2006   |      |   | July 30, 2005  |   |     | July 29,2006 |  |   | July 30,2005 |  
|Components of net periodic expense: |  |                |      |   |                |   |     |              |  |   |              |   |  |   |      |  
|Benefits earned during the period   |  | $              | 10   |   |                | $ | 21  |              |  | $ | 21           |   |  | $ | 29   |  
|Interest costs                      |  |                | 107  |   |                |   | 92  |              |  |   | 215          |   |  |   | 152  |  
|Expected return on plan assets      |  |                | (105 | ) |                |   | (82 | )            |  |   | (212         | ) |  |   | (135 | )
|                                    |  |                |      |   |                |   |     |              |  |   |              |   |  |   |      |  
|Net periodic expense                |  | $              | 12   |   |                | $ | 31  |              |  | $ | 24           |   |  | $ | 46   |  
|                                    |  |                |      |   |                |   |     |              |  |   |              |   |  |   |      |  

Contributions

During the 13-week period ended July 29, 2006, the Company made contributions of $23 million and $15 million to the Kmart and Sears domestic pension plans, respectively. The Company expects to make contributions of $92 million and $141
million over the remainder of fiscal 2006 to the Kmart and Sears domestic pension plans, respectively.

NOTE 13  INCOME TAXES

The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes which requires that deferred tax assets and
liabilities be recognized using enacted tax rates for the effect of temporary differences between the financial reporting and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a
valuation allowance if it is more likely than not that some portion of or all of the deferred tax asset will not be realized.

During the first quarter of
fiscal 2005, the Company recognized a reversal of approximately $1.1 billion of its pre-Merger deferred income tax valuation allowance as a result of the Merger and the combined tax attributes resulting from it. SFAS No. 109 requires that this
reversal be included in the Companys purchase accounting adjustments as a reduction to goodwill attributable to the Merger. Given the Companys current and forecasted levels of profitability, as well as its ability to realize the deferred
tax assets through tax strategies if necessary, management believes that a significant portion of the deferred tax asset will more likely than not be realized.

In connection with the Merger, deferred tax assets of $350 million were recorded related to state net operating losses (NOLs) of Sears. A valuation allowance of $330 million was recorded with respect to this deferred
tax asset. As a result, the Company recognized a net deferred tax asset of $20 million in conjunction with the purchase price allocation related to the Merger. The Company will continue to assess the likelihood of realization of these state
deferred tax assets and will reduce the valuation allowance on such assets in the future if it becomes more likely than not that the net deferred tax assets will be utilized. To the extent that these valuation allowances are reversed in the future,
such effects would be recorded as a decrease to goodwill.



13



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxesan Interpretation of FASB Statement No. 109 (FIN 48). This Interpretation prescribes a recognition threshold and measurement process for recording within the financial statements uncertain tax positions taken
or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure related to uncertain tax positions. The provisions of FIN 48 are
effective as of the beginning of the Companys 2007 fiscal year. The Company is currently evaluating the impact, if any, of adopting FIN 48 on its financial statements.

NOTE 14  SUMMARY OF SEGMENT DATA

Holdings has integrated many Kmart and Sears store-support functions to more
efficiently serve both formats; however, for purposes of reviewing operating performance and making asset-allocation decisions, senior management has continued to utilize principally the reporting structures that existed independently for Kmart and
Sears prior to the Merger. As a result, the Company has three reportable segments: Kmart, Sears Domestic and Sears Canada. The accompanying summary of segment data for the 26-week period ended July 30, 2005 includes the results of operations of
Sears subsequent to March 24, 2005, the date of the Merger. Sears Canadas results are reported to Holdings on a one-month lag. Therefore, the results of operations for the 13-week periods ended July 29, 2006 and July 30, 2005
include operating results for Sears Canada for the periods from April 2, 2006 to July 2, 2006 and April 3, 2005 to July 2, 2005, respectively. For the 26-week period ended July 30, 2005, the results of operations include
operating results for Sears Canada from March 25, 2005 to July 2, 2005.



|                                    |  |                                      |       |          |   |               |        |  |   |       |  |   |        |  
|----------------------------------- |  | ------------------------------------ | ----- | -------- | - | ------------- | ------ |  | - | ----- |  | - | ------ | -
|                                    |  | For the 13 Weeks Ended July 29, 2006 |      
|millions                            |  | Kmart                                |       | Sears    |   | SearsHoldings |       
|                                    |  |                                      |       | Domestic |   |               | Canada |  |   |      
|Merchandise sales and services      |  | $                                    | 4,472 |          | $ | 7,051         |        |  | $ | 1,262 |  | $ | 12,785 |  
|Costs and expenses                  |  |                                      |       |          |   |               |        |  |   |       |  |   |        |  
|Cost of sales, buying and occupancy |  |                                      | 3,389 |          |   | 4,884         |        |  |   | 885   |  |   | 9,158  |  
|Selling and administrative          |  |                                      | 874   |          |   | 1,669         |        |  |   | 284   |  |   | 2,827  |  
|Depreciation and amortization       |  |                                      | 18    |          |   | 224           |        |  |   | 34    |  |   | 276    |  
|Gain on sales of assets             |  |                                      |      |          |   | (7            | )      |  |   |      |  |   | (7     | )
|Restructuring charges               |  |                                      |      |          |   |              |        |  |   | 14    |  |   | 14     |  
|                                    |  |                                      |       |          |   |               |        |  |   |       |  |   |        |  
|Total costs and expenses            |  |                                      | 4,281 |          |   | 6,770         |        |  |   | 1,217 |  |   | 12,268 |  
|                                    |  |                                      |       |          |   |               |        |  |   |       |  |   |        |  
|Operating income                    |  | $                                    | 191   |          | $ | 281           |        |  | $ | 45    |  | $ | 517    |  
|                                    |  |                                      |       |          |   |               |        |  |   |       |  |   |        |  
|Total assets                        |  | $                                    | 7,335 |          | $ | 19,571        |        |  | $ | 3,155 |  | $ | 30,061 |  
|                                    |  |                                      |       |          |   |               |        |  |   |       |  |   |        |  



14



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|-------------------------------------- |  | ------------------------------------ | ----- | - | -------- | - | ------ | ------------- | - | ----- | - |  | - | ------ | -
|                                       |  | For the 13 Weeks Ended July 30, 2005 |      
|millions                               |  | Kmart                                |       |   | Sears    |   |        | SearsHoldings |  
|                                       |  |                                      |       |   | Domestic |   | Canada |               |   |       |  
|Merchandise sales and services         |  | $                                    | 4,642 |   |          | $ | 7,337  |               | $ | 1,135 |   |  | $ | 13,114 |  
|Credit and financial products revenues |  |                                      |      |   |          |   |       |               |   | 78    |   |  |   | 78     |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Total revenues                         |  |                                      | 4,642 |   |          |   | 7,337  |               |   | 1,213 |   |  |   | 13,192 |  
|Costs and expenses                     |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Cost of sales, buying and occupancy    |  |                                      | 3,529 |   |          |   | 5,180  |               |   | 832   |   |  |   | 9,541  |  
|Selling and administrative             |  |                                      | 964   |   |          |   | 1,718  |               |   | 327   |   |  |   | 3,009  |  
|Depreciation and amortization          |  |                                      | 10    |   |          |   | 235    |               |   | 35    |   |  |   | 280    |  
|Gain on sales of assets                |  |                                      | (2    | ) |          |   |       |               |   | (2    | ) |  |   | (4     | )
|Restructuring charges                  |  |                                      | 42    |   |          |   |       |               |   |      |   |  |   | 42     |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Total costs and expenses               |  |                                      | 4,543 |   |          |   | 7,133  |               |   | 1,192 |   |  |   | 12,868 |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Operating income                       |  | $                                    | 99    |   |          | $ | 204    |               | $ | 21    |   |  | $ | 324    |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Total assets                           |  | $                                    | 7,533 |   |          | $ | 18,706 |               | $ | 4,279 |   |  | $ | 30,518 |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  



|                                    |  |                                      |       |   |          |   |               |        |  |   |       |  |   |        |  
|----------------------------------- |  | ------------------------------------ | ----- | - | -------- | - | ------------- | ------ |  | - | ----- |  | - | ------ | -
|                                    |  | For the 26 Weeks Ended July 29, 2006 |      
|millions                            |  | Kmart                                |       |   | Sears    |   | SearsHoldings |       
|                                    |  |                                      |       |   | Domestic |   |               | Canada |  |   |      
|Merchandise sales and services      |  | $                                    | 8,726 |   |          | $ | 13,748        |        |  | $ | 2,309 |  | $ | 24,783 |  
|Costs and expenses                  |  |                                      |       |   |          |   |               |        |  |   |       |  |   |        |  
|Cost of sales, buying and occupancy |  |                                      | 6,630 |   |          |   | 9,545         |        |  |   | 1,648 |  |   | 17,823 |  
|Selling and administrative          |  |                                      | 1,729 |   |          |   | 3,289         |        |  |   | 530   |  |   | 5,548  |  
|Depreciation and amortization       |  |                                      | 33    |   |          |   | 464           |        |  |   | 68    |  |   | 565    |  
|Gain on sales of assets             |  |                                      | (17   | ) |          |   | (7            | )      |  |   |      |  |   | (24    | )
|Restructuring charges               |  |                                      | 4     |   |          |   |              |        |  |   | 19    |  |   | 23     |  
|                                    |  |                                      |       |   |          |   |               |        |  |   |       |  |   |        |  
|Total costs and expenses            |  |                                      | 8,379 |   |          |   | 13,291        |        |  |   | 2,265 |  |   | 23,935 |  
|                                    |  |                                      |       |   |          |   |               |        |  |   |       |  |   |        |  
|Operating income                    |  | $                                    | 347   |   |          | $ | 457           |        |  | $ | 44    |  | $ | 848    |  
|                                    |  |                                      |       |   |          |   |               |        |  |   |       |  |   |        |  
|Total assets                        |  | $                                    | 7,335 |   |          | $ | 19,571        |        |  | $ | 3,155 |  | $ | 30,061 |  
|                                    |  |                                      |       |   |          |   |               |        |  |   |       |  |   |        |  



15



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|-------------------------------------- |  | ------------------------------------ | ----- | - | -------- | - | ------ | ------------- | - | ----- | - |  | - | ------ | -
|                                       |  | For the 26 Weeks Ended July 30, 2005 |      
|millions                               |  | Kmart                                |       |   | Sears    |   |        | SearsHoldings |  
|                                       |  |                                      |       |   | Domestic |   | Canada |               |   |       |  
|Merchandise sales and services         |  | $                                    | 9,182 |   |          | $ | 10,338 |               | $ | 1,229 |   |  | $ | 20,749 |  
|Credit and financial products revenues |  |                                      |      |   |          |   |       |               |   | 87    |   |  |   | 87     |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Total revenues                         |  |                                      | 9,182 |   |          |   | 10,338 |               |   | 1,316 |   |  |   | 20,836 |  
|Costs and expenses                     |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Cost of sales, buying and occupancy    |  |                                      | 6,997 |   |          |   | 7,304  |               |   | 901   |   |  |   | 15,202 |  
|Selling and administrative             |  |                                      | 1,920 |   |          |   | 2,462  |               |   | 355   |   |  |   | 4,737  |  
|Depreciation and amortization          |  |                                      | 20    |   |          |   | 327    |               |   | 40    |   |  |   | 387    |  
|Gain on sales of assets                |  |                                      | (8    | ) |          |   |       |               |   | (2    | ) |  |   | (10    | )
|Restructuring charges                  |  |                                      | 45    |   |          |   |       |               |   |      |   |  |   | 45     |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Total costs and expenses               |  |                                      | 8,974 |   |          |   | 10,093 |               |   | 1,294 |   |  |   | 20,361 |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Operating income                       |  | $                                    | 208   |   |          | $ | 245    |               | $ | 22    |   |  | $ | 475    |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  
|Total assets                           |  | $                                    | 7,533 |   |          | $ | 18,706 |               | $ | 4,279 |   |  | $ | 30,518 |  
|                                       |  |                                      |       |   |          |   |        |               |   |       |   |  |   |        |  

NOTE 15  LEGAL PROCEEDINGS

Pending against Sears and certain of its officers and directors are a number of lawsuits, described below, that relate to Sears former credit card business and public statements about it. The Company believes
that all of these claims lack merit and, except as noted below, 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 Sears and certain former officers
alleging that certain public announcements by Sears 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. On May 17, 2006, defendants entered into a memorandum of understanding with the lead plaintiff, providing for settlement of the action. Under the settlement, Sears is required to make a
payment of $215 million. Sears has made claims under relevant insurance policies, and expects that, after giving effect to anticipated insurance proceeds, the cash payment for settlement by Sears will be approximately $85 million on a pre-tax basis.
The settlement is subject to judicial approval. In agreeing to the settlement, defendants did not admit any wrongdoing and deny committing any violation of law. Defendants agreed to the settlement solely to eliminate the uncertainties, burden and
expense of further protracted litigation.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On and after November 15, 2002, several actions were filed in the United States District Court for the Northern District of Illinois against Sears, 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 Sears common shares and alleged communications made to Plan participants regarding Sears financial
condition. The Court has consolidated these actions and certified the consolidated action as a class action. On August 28, 2006, the parties agreed to settle the action. The settlement is subject to judicial approval. Pending entry into a
memorandum of understanding reflecting the settlement, the parties have agreed to suspend all discovery and other proceedings. Defendants do not admit any wrongdoing and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



16



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



| | deny any committing any violation of law. Defendants agreed to the settlement solely to eliminate the uncertainties, burden and expense of further protracted
litigation. The settlement is not expected to have a material adverse effect on annual results of operations, financial position, liquidity or capital resources of the Company.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 Sears (as a nominal defendant)
and certain current and former directors seeking damages on behalf of Sears. The complaint purports to allege a breach of fiduciary duty by the directors with respect to Sears 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. A New York appellate court affirmed the dismissal on December 6, 2005, and the time for further appeal has expired. 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 had been stayed pending resolution of the New York Court derivative action. The defendant directors filed a motion to
dismiss the Illinois federal court action on May 22, 2006.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On June 17, 2003, an action was filed in the United States District Court for the Northern District of Illinois against Sears and certain officers, purportedly
on behalf of a class of all persons who, between June 21, 2002 and October 17, 2002, purchased the 7% notes that SRAC issued on June 21, 2002. An amended complaint was 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. On September 14,
2005, the court granted the pending motions to dismiss in part, and denied them in part. The court dismissed the Section 11 claim with respect to SRACs May 21, 2002 notes on the ground that the plaintiffs lacked standing, and the
Section 12 claims with respect to SRACs March 18, 2002 notes and May 21, 2002 notes on the ground that the plaintiffs could not allege damages. The court dismissed the Section 15 claim on the ground that the plaintiffs had
failed to allege a predicate violation of the Securities Act of 1933 on the part of SRAC. The court dismissed the Section 10(b) and Rule 10b-5 claims as to some, but not all, of the individual defendants. The court sustained the remaining
claims. By leave of court, the plaintiffs filed a third amended complaint on October 28, 2005. The non-underwriter defendants filed a motion to partially dismiss the third amended
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



17



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



| | complaint on November 15, 2005. Plaintiffs have requested discovery from third parties with respect to plaintiffs remaining claims under the
Securities Act.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

Following the announcement of the Merger on November 17, 2004, several actions have been filed relating to 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 were filed and then consolidated in the Circuit Court of Cook County, Illinois. These actions assert claims on behalf of a purported class of Sears stockholders
against Sears and certain of its officers and directors, together with Kmart, Edward S. Lampert, William C. Crowley and other affiliated entities, alleging breach of fiduciary duty in connection with the Merger. The plaintiffs allege that the Merger
favors 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 Sears stockholders. On August 8, 2006, the court granted
defendants renewed motions to dismiss plaintiffs amended complaint.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 Sears stockholders against Sears 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 appointed a
lead plaintiff and lead counsel, and an amended complaint was filed on March 11, 2005. The amended complaint names Edward S. Lampert and ESL Partners, L.P. as additional defendants, and purports to assert claims on behalf of sellers of Sears
stock during the period September 9 through November 16, 2004. All defendants moved to dismiss, and briefing on the motions was completed in early July 2005. On March 22, 2006, the district court denied the defendants
motions to dismiss and subsequently denied a motion for reconsideration by Sears and Alan J. Lacy and a motion for permission to file an interlocutory appeal by Edward S. Lampert and ESL. On August 30, 2006, the court set a briefing schedule
for plaintiffs motion for class certification and indicated that the parties should commence discovery.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Effective May 11, 2005,
Sears terminated for cause its Master Services Agreement (the Agreement) with Computer Sciences Corporation (CSC). CSC had been providing information technology infrastructure support services, including desktops, servers,
and systems to support Sears-related websites, voice and data networks and decision support technology to Sears and its subsidiaries under the 10-year Agreement entered into in June 2004. CSC is obligated to continue providing these services
for an extended period following termination of the Agreement. CSC disputes Sears assertion that grounds for termination for cause existed and claims that, as a result of terminating this Agreement, Sears is liable to CSC for damages.

CSC filed a lawsuit in the United States District Court for the Northern District of Illinois (the District Court) on March 18, 2005
seeking a declaratory judgment that CSC was not in material breach of the Agreement and an injunction to prevent Sears from terminating the Agreement for cause. On April 14, 2005, the District Court denied CSCs motion for a preliminary
injunction and granted Sears motion to compel arbitration. On April 22, 2005 the District Court denied CSCs motion for reconsideration of the District Courts April 14th ruling, and CSC appealed the District Courts
ruling to the United States Court of Appeals for the Seventh Circuit. That appeal remains pending. On April 14, 2005, CSC filed an emergency claim with the American Arbitration Association (AAA), seeking to enjoin Sears from
terminating the Agreement for cause. The AAA denied CSCs request for emergency relief on April 18, 2005. In compliance with the District Courts order compelling



18



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



arbitration, the parties began selecting an arbitration panel. While arbitrator selection was in progress, the parties agreed to suspend arbitration and the
appeal while they voluntarily mediate their disputes. The arbitration was recently dismissed by the AAA for lack of action. Settlement discussions continue.

In Capital Factors v. Kmart Corporation, the United States District Court for the Northern District of Illinois ruled that the Bankruptcy Court did not have the authority to authorize the payment of pre-petition claims of certain trade
vendors by the Company. An appeal of the ruling and subsequent motions for rehearing were denied. In order to satisfy its fiduciary responsibility to pursue claims against the critical vendors during the pendency of the appeal, in January 2004
the Company filed suit against a total of 1,189 vendors that received these payments seeking to recover in excess of $174 million paid to the critical vendors. To date, Kmart has settled approximately 920 critical vendor claims for a total
recovery the Company values at approximately $80 million.

Kmart is a defendant in a pending pre-petition nationwide class action relating to proper
access to facilities for the disabled under the Americans with Disabilities Act. The class action is pending in the United States District Court in Denver, Colorado. On July 13, 2005, the court certified a nationwide class of individuals who
use wheelchairs or scooters for mobility and who shop at Kmart. On February 9, 2006, Kmart entered into a settlement agreement with the plaintiffs in this action. Pursuant to the settlement agreement, which was approved by the Court on
July 22, 2006, Kmart will: (1) make certain renovations to Kmart stores over a seven and a half year period to improve accessibility for individuals who use wheelchairs or scooters for mobility; (2) revise certain policies,
procedures, and training that relate to or affect individuals who use wheelchairs or scooters for mobility; and (3) pay approximately $13 million in damagesapproximately $8 million in cash and $5 million in gift cardsto a
sub-class of the class certified by the court to resolve claims for statutory minimum damages under disability statutes in seven states.

As previously
reported in Kmarts Annual Report on Form 10-K for its fiscal year ended January 26, 2005, the staff of the Securities and Exchange Commission has been investigating, and the U.S. Attorney for the Eastern District of Michigan has
undertaken an inquiry into, the manner in which Kmart recorded vendor allowances before a change in accounting principles at the end of fiscal 2001 and the disclosure of certain events bearing on the Predecessor Companys liquidity in the fall
of 2001. Kmart has cooperated with the SEC and the U.S. Attorneys office with respect to these matters, which are ongoing.

On August 23, 2005,
the SEC filed a complaint in the United States District Court for the Eastern District of Michigan against the Predecessor Companys former chief executive officer and its former chief financial officer alleging that they misled investors about
the Predecessor Companys liquidity and related matters in the months preceding its bankruptcy in violation of federal securities law. The complaint seeks permanent injunctions, disgorgement with interest, civil penalties and officer and
director bars. Kmart is not named as a defendant in the action. In its press release announcing the filing of the complaint, the SEC stated that its Kmart investigation is continuing.

In May and July 2006, two putative class action lawsuits, which each name as defendants Sears Holdings Corporation and Edward Lampert, were filed in United States District Court for the Southern District of New York,
purportedly on behalf of a class of persons that sold shares of Kmart Holding Corp stock on or after May 6, 2003 through June 4, 2004. These complaints allege that Kmarts Plan of Reorganization and Disclosure Statement filed on
January 24, 2003 and amended on February 25, 2003 misrepresented Kmarts assets, particularly its real estate holdings, as evidenced, according to the complaints, by the prices at which Kmart subsequently sold certain of its stores in
June 2004 to Home Depot and Sears. Plaintiffs in both actions, as well



19



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

Notes to Condensed Consolidated Financial Statements(Continued)

(Unaudited)



as one of the members of the putative class, have each filed a motion for consolidation, appointment as lead plaintiff and approval of selection of lead
counsel. The motions are currently pending before the district court.

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. Additional information regarding legal proceedings may be found in Sears
Holdings Annual Report on Form 10-K/A for its fiscal year ended January 28, 2006.

During the second quarter of fiscal 2006, the Company
recorded a gain of $36 million for the aggregate amount received by Holdings in June 2006 as part of the settlement of Visa/MasterCard litigation concerning alleged unlawful inflation of interchange fees. The Company has recorded the $36
million gain as a reduction to Selling and administrative expense in the condensed consolidated statements of income for the 13- and 26-week periods ended July 29, 2006.



20



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with Part II, Item 7 of the Companys Annual Report on Form 10-K/A for the year ended
January 28, 2006.

OVERVIEW AND CONSOLIDATED OPERATIONS

Overview

Holdings, the parent company of Kmart and Sears, was formed in connection with the March 24, 2005
Merger of these two companies. The Company is a broadline retailer with approximately 2,300 full-line and 1,100 specialty retail stores in the United States operating through Kmart and Sears and approximately 380 full-line and specialty retail
stores in Canada operating through Sears Canada, a 70% -owned subsidiary. The Company currently conducts its operations in three business segments: Kmart, Sears Domestic and Sears Canada. The nature of operations conducted within each of these
segments is discussed within the Business Segments section of Part I, Item 1 of the Companys Annual Report on Form 10-K/A for the year ended January 28, 2006.

Merger and Change in Fiscal Year

For accounting purposes, the Merger
has been treated as a purchase business combination, with Kmart acquiring Sears. As such, the historical financial statements of Kmart serve as the historical financial statements of Holdings. The results of Sears are included in the condensed
consolidated financial statements subsequent to the Merger date. Thus, the accompanying condensed consolidated statements of income and cash flows for the 26-week period ended July 30, 2005 include approximately 18 weeks of Sears results
and 26 weeks of Kmarts results.

The Company believes that an understanding of its reported results, trends and on-going performance is not complete
without presenting the results for the 26-week period ended July 30, 2005 on a pro forma basis. Accordingly, the Company has prepared unaudited pro forma financial information to summarize the combined results of operations of Kmart and Sears
for the 26-week period ended July 30, 2005 as though the Merger had occurred as of the beginning of fiscal 2004. The unaudited pro forma financial information is presented herein for informational purposes only and is not indicative of the
results of operations that would have been achieved if the Merger had taken place at the beginning of the period presented, or that may result in the future. In addition, Holdings is realizing operating synergies as a result of the Merger. The
unaudited pro forma financial information for the 26-week period ended July 30, 2005 has not been adjusted to reflect operating efficiencies realized as a result of the Merger.

Effective March 23, 2005, the Company changed its fiscal year end from the last Wednesday in January to the Saturday closest to January 31st. As the change in fiscal year end reflected a change of only three
days, the historical financial statements have not been recast to reflect this change. Sears Canadas fiscal year end is the Saturday closest to December 31st, and the results of operations for Sears Canada are reported to Holdings on a
one-month lag. Accordingly, the condensed consolidated financial statements for the 13- and 26-week periods ended July 29, 2006 include the results of operations for Sears Canada for the 13- and 26-week periods ended July 1, 2006, and for
the 13- and 26-weeks ended July 30, 2005, the condensed consolidated financial statements include the results of Sears Canada for the 13- and approximately 14-weeks ended July 2, 2005.

Second Quarter and First Half 2006 Initiatives and Accomplishments

The Company continues to focus efforts on its two main initiatives: building long-term customer relationships and improving the profitability of the Companys business by increasing the efficiency and effectiveness of its



21



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



operations. The details of these initiatives have been set forth in Part II, Item 7 of the Companys Annual Report on Form 10-K/A for the year
ended January 28, 2006. The following provides an overview of results and activities for the second quarter and first half of fiscal 2006 in pursuit of the Companys initiatives.



| |  |  | For the second quarter of fiscal 2006, net income increased to $294 million, or $1.88 per diluted share, as compared to net income of $161 million, or $0.98 per diluted share, for
the second quarter of last year. First half net income increased to $474 million, or $3.01 per diluted share, as compared to net income of $152 million, or $1.05 per diluted share, for the first half of last year. Prior year first half results
included a $90 million charge due to the cumulative effect of a change in accounting for certain indirect overhead costs included in inventory. Excluding the change in accounting, prior year first half net income was $242 million, or $1.66 per
diluted share. The improvement in the earnings reflects improved profitability at both Kmart and Sears, largely due to reduced expenses.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Domestic comparable stores sales declined 3.8% for the second quarter of fiscal 2006, with Sears Domestic comparable store sales declining 6.3% and Kmart comparable store sales
declining 0.6%. For the first half of fiscal 2006, domestic comparable store sales declined 4.3%, with Sears Domestic comparable store sales declining 7.3% and Kmart comparable store sales declining 0.4%. The profit impact of these comparable store
sales declines, however, was largely offset by an improvement in gross margin rate (defined below). For the quarter, Holdings gross margin rate reached 28.4%, an increase of 120 basis points, as compared with a gross margin rate of 27.2% for
the second quarter of fiscal 2005. The first half gross margin was 28.1% for fiscal 2006, an increase of 130 basis points, as compared with a pro forma gross margin rate of 26.8% for the first half of fiscal 2005. The increased margin rate primarily
reflects improved inventory management and control, with the largest improvement in rate occurring at Sears Domestic and Sears Canada.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Operating income increased $193 million to $517 million for the second quarter of fiscal 2006, as compared with $324 million for the second quarter of fiscal 2005. For the first
half of fiscal 2006, operating income increased $373 million to $848 million, as compared with $475 million for the first half of fiscal 2005. Operating income doubled during the first half of fiscal 2006 when compared to pro forma operating income
of $424 million for the first half of 2005. These increases were primarily attributable to the realization of Merger synergies and improved expense management, as well as lower fiscal 2006 restructuring costs and a gain of $36 million related to the
settlement of the Visa/Mastercard antitrust litigation recorded in the second quarter of fiscal 2006.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During the first half of fiscal 2006, the Company repurchased four million shares of its common stock at a total cost of $504 million, or an average price of $127.66 per share. As
of July 29, 2006, the Company had remaining authorization to repurchase $406 million of common shares under its common share repurchase program. The remaining shares may be purchased in the open market, through self-tender offers or through
privately negotiated transactions. Timing will depend on prevailing market conditions, alternative uses of capital and other factors.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Results of Operations

As noted above, the condensed consolidated statement of income for the 26-week period ended July 30, 2005 is not
representative of the Companys operations as it only includes Sears results of operations from March 25, 2005 forward. Accordingly, the Companys condensed consolidated results of operations for the 26-week period ended
July 30, 2005 have been summarized below on both a reported and pro forma basis. The unaudited pro forma financial information in the tables below summarizes the combined results of operations of Kmart and Sears for the 26-week period ended
July 30, 2005 as though the Merger had occurred as of the beginning of fiscal 2004. The unaudited pro forma financial information is presented herein for informational purposes only and is not indicative of the results of operations that would
have been achieved if the Merger had taken place at the



22



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



beginning of the period presented, or that may result in the future. In addition, Holdings is realizing operating synergies as a result of the Merger. The
unaudited pro forma financial information for the 26-week period ended July 30, 2005 has not been adjusted to reflect operating efficiencies realized as a result of the Merger.

The pro forma adjustments are described on page 33. References to comparable store sales amounts within the following discussion include sales for all stores operating for a period of at least 12 full months,
including remodeled and expanded stores, but excluding store relocations and format changes.



|                                                                                                      |  |                |        |   |              |   |        |  
|----------------------------------------------------------------------------------------------------- |  | -------------- | ------ | - | ------------ | - | ------ | -
|                                                                                                      |  | 13 Weeks Ended |       
|                                                                                                      |  | Reported       |       
|millions, except per share data                                                                       |  | July 29,2006   |        |   | July 30,2005 |  
|Merchandise sales and services                                                                        |  | $              | 12,785 |   |              | $ | 13,114 |  
|Credit and financial products revenues                                                                |  |                |       |   |              |   | 78     |  
|                                                                                                      |  |                |        |   |              |   |        |  
|Total revenues                                                                                        |  |                | 12,785 |   |              |   | 13,192 |  
|                                                                                                      |  |                |        |   |              |   |        |  
|Cost of sales, buying and occupancy                                                                   |  |                | 9,158  |   |              |   | 9,541  |  
|Gross margin dollars                                                                                  |  |                | 3,627  |   |              |   | 3,573  |  
|Gross margin rate                                                                                     |  |                | 28.4   | % |              |   | 27.2   | %
|                                                                                                      |  |               
|Selling and administrative                                                                            |  |                | 2,827  |   |              |   | 3,009  |  
|Selling and administrative expense as a percentage of total revenues                                  |  |                | 22.1   | % |              |   | 22.8   | %
|                                                                                                      |  |               
|Depreciation and amortization                                                                         |  |                | 276    |   |              |   | 280    |  
|Gain on sales of assets                                                                               |  |                | (7     | ) |              |   | (4     | )
|Restructuring charges                                                                                 |  |                | 14     |   |              |   | 42     |  
|                                                                                                      |  |                |        |   |              |   |        |  
|Total costs and expenses                                                                              |  |                | 12,268 |   |              |   | 12,868 |  
|                                                                                                      |  |                |        |   |              |   |        |  
|Operating income                                                                                      |  |                | 517    |   |              |   | 324    |  
|Interest expense, net                                                                                 |  |                | 42     |   |              |   | 72     |  
|Bankruptcy-related recoveries                                                                         |  |                | (11    | ) |              |   | (15    | )
|Other income                                                                                          |  |                | (16    | ) |              |   | (2     | )
|                                                                                                      |  |                |        |   |              |   |        |  
|Income before income taxes, minority interest and cumulative effect of change in accounting principle |  |                | 502    |   |              |   | 269    |  
|Income taxes                                                                                          |  |                | 201    |   |              |   | 103    |  
|Minority interest                                                                                     |  |                | 7      |   |              |   | 5      |  
|                                                                                                      |  |                |        |   |              |   |        |  
|Income before cumulative effect of change in accounting principle                                     |  |                | 294    |   |              |   | 161    |  
|Cumulative effect of change in accounting principle, net of tax                                       |  |                |       |   |              |   |       |  
|                                                                                                      |  |                |        |   |              |   |        |  
|NET INCOME                                                                                            |  | $              | 294    |   |              | $ | 161    |  
|                                                                                                      |  |                |        |   |              |   |        |  
|Diluted earnings per share before cumulative effect of change in accounting principle                 |  | $              | 1.88   |   |              | $ | 0.98   |  
|Diluted earnings per share                                                                            |  | $              | 1.88   |   |              | $ | 0.98   |  



23



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|----------------------------------------------------------------------------------------------------- |  | -------------- | ------ | - | ------------ | - | ------ | ------------ |  | - | ------ | -
|                                                                                                      |  | 26 Weeks Ended |       
|                                                                                                      |  | Reported       |        |   | Proforma     |  
|millions, except per share data                                                                       |  | July 29,2006   |        |   | July 30,2005 |   |        | July 30,2005 | 
|Merchandise sales and services                                                                        |  | $              | 24,783 |   |              | $ | 20,749 |              |  | $ | 25,800 |  
|Credit and financial products revenues                                                                |  |                |       |   |              |   | 87     |              |  |   | 173    |  
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|Total revenues                                                                                        |  |                | 24,783 |   |              |   | 20,836 |              |  |   | 25,973 |  
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|Cost of sales, buying and occupancy                                                                   |  |                | 17,823 |   |              |   | 15,202 |              |  |   | 18,874 |  
|Gross margin dollars                                                                                  |  |                | 6,960  |   |              |   | 5,547  |              |  |   | 6,926  |  
|Gross margin rate                                                                                     |  |                | 28.1   | % |              |   | 26.7   | %            |  |   | 26.8   | %
|                                                                                                      |  |                |       
|Selling and administrative                                                                            |  |                | 5,548  |   |              |   | 4,737  |              |  |   | 6,078  |  
|Selling and administrative expense as a percentage of total revenues                                  |  |                | 22.4   | % |              |   | 22.7   | %            |  |   | 23.4   | %
|                                                                                                      |  |                |       
|Depreciation and amortization                                                                         |  |                | 565    |   |              |   | 387    |              |  |   | 563    |  
|Gain on sales of assets                                                                               |  |                | (24    | ) |              |   | (10    | )            |  |   | (11    | )
|Restructuring charges                                                                                 |  |                | 23     |   |              |   | 45     |              |  |   | 45     |  
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|Total costs and expenses                                                                              |  |                | 23,935 |   |              |   | 20,361 |              |  |   | 25,549 |  
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|Operating income                                                                                      |  |                | 848    |   |              |   | 475    |              |  |   | 424    |  
|Interest expense, net                                                                                 |  |                | 89     |   |              |   | 114    |              |  |   | 147    |  
|Bankruptcy-related recoveries                                                                         |  |                | (12    | ) |              |   | (32    | )            |  |   | (32    | )
|Other income                                                                                          |  |                | (27    | ) |              |   | (11    | )            |  |   | (21    | )
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|Income before income taxes, minority interest and cumulative effect of change in accounting principle |  |                | 798    |   |              |   | 404    |              |  |   | 330    |  
|Income taxes                                                                                          |  |                | 319    |   |              |   | 155    |              |  |   | 144    |  
|Minority interest                                                                                     |  |                | 5      |   |              |   | 7      |              |  |   | 13     |  
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|Income before cumulative effect of change in accounting principle                                     |  |                | 474    |   |              |   | 242    |              |  |   | 173    |  
|Cumulative effect of change in accounting principle, net of tax                                       |  |                |       |   |              |   | (90    | )            |  |   | (90    | )
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|NET INCOME                                                                                            |  | $              | 474    |   |              | $ | 152    |              |  | $ | 83     |  
|                                                                                                      |  |                |        |   |              |   |        |              |  |   |        |  
|Diluted earnings per share before cumulative effect of change in accounting principle                 |  | $              | 3.01   |   |              | $ | 1.66   |              |  | $ | 1.06   |  
|Diluted earnings per share                                                                            |  | $              | 3.01   |   |              | $ | 1.05   |              |  | $ | 0.51   |  

Holdings Consolidated Results

Revenues

Domestic comparable store sales declined 3.8% and 4.3% for the second quarter and first half of fiscal
2006, respectively. Sears Domestic comparable store sales declined 6.3% and 7.3% for the quarter and first half, respectively, while Kmart comparable store sales declined 0.6% for the quarter and 0.4% for the first half. Both the current quarter and
year-to-date comparable store sales declines reflect the impact of increased competition and lower transaction volumes.

For both the second quarter and
first half of fiscal 2006, Kmart experienced lower transaction volumes within home goods partially offset by increased sales within a number of merchandise categories, including apparel, general merchandise, pharmacy and food and other consumable
goods. Sears Domestic recorded comparable store sales declines during both the second quarter and first half of fiscal 2006 across most categories and



24



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



formats, with more pronounced sales declines within both the home fashion and lawn and garden categories.

The overall comparable store sales declines at Sears Domestic reflect lower transaction volumes, as well as the unfavorable sales impact stemming from continuing efforts
to improve gross margin at Sears Domestic by reducing reliance on certain promotional events, particularly in relation to promotional and clearance activity in apparel.

Total revenues for the second quarter of fiscal 2006 declined $0.4 billion, or 3.1%, to $12.8 billion, as compared to $13.2 billion for the second quarter last year. Sears revenues were $8.3 billion in the second
quarter of fiscal 2006 as compared to $8.6 billion for the second quarter last year, reflecting the impact of comparable store sales declines, partially offset by an increase in the total number of Sears Full-line stores in operation, resulting
mainly due to conversions from the Kmart format. In addition, Sears revenues for the quarter were positively impacted by favorable foreign exchange rates relative to revenues recorded at Sears Canada, as the Canadian dollar strengthened relative to
last year. Total revenues at Kmart declined $0.1 billion for the second quarter of fiscal 2006, primarily due to a reduction in the total number of Kmart stores in operation.

For the first half of fiscal 2006, total revenues increased $3.9 billion, or 18.9%, to $24.8 billion, as compared to $20.8 billion for the first half last year. This increase primarily reflects the inclusion of Sears
for the full year-to-date period in fiscal 2006. Sears revenues were $16.1 billion for the first half of fiscal 2006, as compared to $11.7 billion for the first half of fiscal 2005, as the fiscal 2005 first half period only included the results of
Sears subsequent to March 24, 2005, the date of its acquisition by Kmart. Total first half revenues in fiscal 2006 declined $1.2 billion, or 4.6%, when compared to pro forma revenues of $26.0 billion for the first half of 2005, as pro forma
revenues for 2005 include Sears revenues for the entire 26-week period ended July 30, 2005. The decline in fiscal 2006 first half revenues versus pro forma revenues for the first half of 2005 was due primarily to the above-noted comparable
store sales declines. In addition, revenues for the first half of fiscal 2006 declined as a result of the elimination of credit revenues given the sale of the Sears Canada Credit and Financial Services operations in November 2005, as well as the
first half of fiscal 2005 having benefited from $153 million of additional sales recorded during the first quarter, as three additional days were included in the first quarter period given the Companys change from a Wednesday to a Saturday
month end. The negative revenue impact resulting from these factors was partially offset by the impact of favorable exchange rates relative to revenues recorded at Sears Canada as previously noted.

Gross Margin

For the quarter, gross margin as a percentage of
merchandise sales and services revenue (gross margin rate) was 28.4% in fiscal 2006, as compared to 27.2% in fiscal 2005. For the first half of fiscal 2006, the gross margin rate was 28.1%, as compared to 26.7% (as reported) and 26.8%
(pro forma) for the first half of last year. Gross margin rates improved across all segments with more pronounced improvements at both Sears Domestic and Sears Canada. The Companys improved gross margin rate primarily reflects better inventory
management and control. Sears Domestic gross margin rates improved across most full-line store merchandise categories, with the most notable improvement occurring within apparel, where the Company has benefited from enhancing the profitability of
its promotional and clearance activity. The overall improvement in gross margin rates helped largely offset the unfavorable profit impact of revenue declines.

Selling and Administrative Expenses

Selling and administrative expenses as a percentage of total revenues (selling and administrative
expense rate) was 22.1% for the second quarter of fiscal 2006, as compared to 22.8% for the second quarter of fiscal 2005. For



25



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



the first half of fiscal 2006, the selling and administrative expense rate was 22.4%, as compared to 22.7% (as reported) and 23.4% (pro forma) for the first
half of last year. Total selling and administrative expenses in the second quarter of fiscal 2006 included a $36 million gain recorded by the Company for the aggregate amount received by Holdings in June 2006 as part of the settlement of
Visa/MasterCard antitrust litigation. Excluding this $36 million settlement gain, the selling and administrative expense rate was 22.4% and 22.5% for the second quarter and first half of fiscal 2006, respectively. The current year rate improvement
primarily reflects the realization of Merger synergies, improved expense management, particularly within payroll and benefits, as well as within corporate and store support expense centers.

Restructuring Charges

Restructuring charges of $14 million and $42
million were recorded in the second quarters of fiscal 2006 and fiscal 2005, respectively. On a year-to-date basis, restructuring charges were $23 million in fiscal 2006, as compared to $45 million in fiscal 2005. The current year charges include
$19 million recorded at Sears Canada ($14 million in the second quarter) for workforce reductions and ongoing restructuring efforts initiated during the second half of fiscal 2005, and $4 million recorded at Kmart for relocation assistance and
employee termination-related costs associated with Holdings home office integration efforts, also initiated in fiscal 2005. The prior year charges of $45 million ($42 million recorded in the second quarter of fiscal 2005) were recognized at
Kmart in connection with the same home office integration effort.

Depreciation and Amortization

For the quarter, depreciation and amortization was $276 million in fiscal 2006, as compared with $280 million for the second quarter of fiscal 2005. For the first half,
depreciation and amortization was $565 million in fiscal 2006, as compared to $387 million (as reported) for the first half of fiscal 2005. The increase was primarily attributable to the addition of Sears, which accounted for $532 million of the
combined expense in the current year-to-date period, as compared to $367 million (as reported) in the prior year year-to-date period.

Operating Income

For the quarter, operating income increased $193 million to $517 million in fiscal 2006, as compared with $324 million in the second quarter of fiscal
2005. First half operating income was $848 million in fiscal 2006, as compared to $475 million (as reported) and $424 million (pro forma) for the first half of last year. The improvement in operating income for both the second quarter and
year-to-date period was mainly a result of realizing Merger synergies and improved expense management, as well as lower fiscal 2006 restructuring costs and a gain of $36 million related to the settlement of the Visa/Mastercard antitrust litigation
recorded in the second quarter of fiscal 2006, as noted above.

Interest Expense, Bankruptcy-related Recoveries and Other Income

For the quarter, interest expense declined $30 million due lower overall average borrowings. For the same reason, interest expense for the first half of fiscal 2006
declined $25 million and $58 million, as compared with the prior year first half as reported and pro forma amounts, respectively. In addition, the first half of fiscal 2005 included $17 million of interest expense, representing the recognition of
the remaining unamortized debt discount on convertible subordinated notes of Kmart converted into shares of Kmart by ESL affiliates in January of fiscal 2005. For the first half of fiscal 2006, Bankruptcy-related recoveries declined $20 million
versus in the first half of fiscal 2005 and represent amounts recognized from vendors who had received cash payment for pre-petition obligations. Other income increased $14 million for the second quarter of fiscal 2006 primarily due to a gain
recognized in connection with the Companys sale of its entire equity interest in a land-development joint venture unrelated to its ongoing operations.



26



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



Income Taxes

For
the quarter, the effective tax rate was 40.0%, as compared to 38.3% in the second quarter of fiscal 2005, with the increase primarily attributable to Canadian and state income taxes. For the same reason, the effective tax rate was 40.0% for the
first half of fiscal 2006, as compared to 38.4% for the same period last year.

SEGMENT OPERATIONS

Holdings has integrated many Kmart and Sears store-support functions to more efficiently serve both formats; however, for purposes of reviewing operating performance and
making asset-allocation decisions, senior management has continued to utilize principally the reporting structures that existed independently for Kmart and Sears prior to the Merger. As a result, the following discussion of the Companys
business segments is organized into three segments: Kmart, Sears Domestic and Sears Canada.

Kmart

Kmart results and key statistics were as follows:



|                                                                     |  |                |       |   |                |   |       |              |  |   |              |   |  |   |       |  
|-------------------------------------------------------------------- |  | -------------- | ----- | - | -------------- | - | ----- | ------------ |  | - | ------------ | - |  | - | ----- | -
|Kmart                                                                |  | 13 Weeks Ended |       |   | 26 Weeks Ended |  
|millions, except number of stores                                    |  | July 29,2006   |       |   | July 30,2005   |   |       | July 29,2006 |  |   | July 30,2005 |  
|Merchandise sales and services                                       |  | $              | 4,472 |   |                | $ | 4,642 |              |  | $ | 8,726        |   |  | $ | 9,182 |  
|Cost of sales, buying and occupancy                                  |  |                | 3,389 |   |                |   | 3,529 |              |  |   | 6,630        |   |  |   | 6,997 |  
|Gross margin dollars                                                 |  |                | 1,083 |   |                |   | 1,113 |              |  |   | 2,096        |   |  |   | 2,185 |  
|Gross margin rate                                                    |  |                | 24.2  | % |                |   | 24.0  | %            |  |   | 24.0         | % |  |   | 23.8  | %
|Selling and administrative                                           |  |                | 874   |   |                |   | 964   |              |  |   | 1,729        |   |  |   | 1,920 |  
|Selling and administrative expense as a percentage of total revenues |  |                | 19.5  | % |                |   | 20.8  | %            |  |   | 19.8         | % |  |   | 20.9  | %
|Depreciation and amortization                                        |  |                | 18    |   |                |   | 10    |              |  |   | 33           |   |  |   | 20    |  
|Gain on sales of assets                                              |  |                |      |   |                |   | (2    | )            |  |   | (17          | ) |  |   | (8    | )
|Restructuring charges                                                |  |                |      |   |                |   | 42    |              |  |   | 4            |   |  |   | 45    |  
|                                                                     |  |                |       |   |                |   |       |              |  |   |              |   |  |   |       |  
|Total costs and expenses                                             |  |                | 4,281 |   |                |   | 4,543 |              |  |   | 8,379        |   |  |   | 8,974 |  
|                                                                     |  |                |       |   |                |   |       |              |  |   |              |   |  |   |       |  
|Operating income                                                     |  | $              | 191   |   |                | $ | 99    |              |  | $ | 347          |   |  | $ | 208   |  
|                                                                     |  |                |       |   |                |   |       |              |  |   |              |   |  |   |       |  
|Number of stores                                                     |  |                |       |   |                |   |       |              |  |   | 1,398        |   |  |   | 1,445 |  

Revenues

For
the quarter, comparable store sales and total sales declined 0.6% and 3.7%, respectively. For the first half of fiscal 2006, comparable store sales and total sales declined 0.4% and 5.0%, respectively, as compared to the first half of last year. The
decline in Kmart comparable store sales for both the quarter and year-to-date periods reflects the impact of increased competition and was primarily due to lower transaction volumes within home goods partially offset by increased sales within a
number of merchandise categories, including apparel, general merchandise, pharmacy and within food and other consumable goods.

Total sales were also
negatively impacted by a reduction in the total number of Kmart stores in operation, which accounted for an approximate 3.0% decline in total Kmart sales for both the second quarter and first half of fiscal 2006, as compared to the same periods last
year. In addition, year-to-date sales in the prior year period benefited from $153 million of additional sales recorded during the first quarter of 2005, as three additional days were included in the fiscal 2005 period given the Companys
change from a Wednesday to a Saturday month end.



27



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



Gross Margin

Kmarts gross margin rate for the second quarter of the fiscal 2006 was 24.2%, as compared with 24.0% for the second quarter of fiscal 2005. For the first half of fiscal 2006, the gross margin rate was 24.0%, as compared with 23.8% for
the same period last year. The increase in gross margin rate reflects improved gross margin management across a number of businesses, most notably within apparel. The improved gross margin performance within Kmarts apparel business primarily
reflects improved profitability of promotional and clearance activity. For the quarter, Kmarts overall gross margin rate improvement was partially offset by lower margin rates within certain hardlines businesses, most notably hardware, where a
number of merchandise lines were liquidated during the second quarter of fiscal 2006 in preparation for replacement by Craftsman-branded hardware products. Additionally, both the quarter and first half gross margin rates for fiscal 2006 were
negatively impacted by reduced expense leverage relative to buying and occupancy costs, given lower overall sales levels in fiscal 2006. Lower expense leverage relative to such costs reduced the overall gross margin rate for the second quarter and
first half of fiscal 2006 by approximately 30 basis points and 20 basis points, respectively.

Selling and Administrative Expenses

The selling and administrative expense rate was 19.5% for the second quarter of fiscal 2006, as compared with 20.8% for the second quarter of fiscal 2005. For the first
half of fiscal 2006, the selling and administrative expense rate was 19.8%, as compared with 20.9% for the same period last year. Fiscal 2006 selling and administrative expenses included a $19 million gain recorded in the second quarter,
representing Kmarts portion of the settlement in the Visa/MasterCard antitrust litigation. This gain accounted for approximately 40 basis points and 20 basis points of the overall improvement in selling and administrative expense rates for the
second quarter and first half of fiscal 2006, respectively. The remaining 90 basis point improvement in the second quarter and year-to-date rates reflects lower costs across a number of expense categories, most notably store payroll and benefit
costs, which accounted for approximately 40 basis points and 50 basis points of the overall rate improvement for the quarter and year-to-date periods, respectively.

Restructuring Charges

On a year-to-date basis, Kmart recorded restructuring charges of $4 million and $45 million in
fiscal 2006 and fiscal 2005, respectively. These charges were for relocation assistance and employee termination-related costs incurred in connection with Holdings home office integration efforts initiated in Fiscal 2005. These restructuring
charges included $0 million and $42 million recorded during the second quarter of fiscal 2006 and fiscal 2005, respectively.

Operating Income

For the quarter, Kmarts operating income increased $92 million to $191 million in fiscal 2006, as compared with $99 million in the second quarter
of fiscal 2005. First half operating income was $347 million in fiscal 2006, as compared with $208 million for the first half of last year. The improvement in operating income for both the second quarter and year-to-date periods was mainly a result
of realizing Merger synergies and improved expense management as noted above. In addition, the prior year second quarter and year-to-date periods included $42 million and $45 million, respectively, in merger-related restructuring charges as noted
above. The favorable impact derived from these factors, as well as the $19 million gain recorded on the settlement of the Visa/Mastercard antitrust litigation, was partially offset by a decline in gross margin dollars generated during the current
year second quarter and year-to-date periods as a result of lower overall sales levels.



28



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



Sears Domestic

Holdings condensed consolidated statement of operations for the 26-week period ended July 30, 2005 only includes the results of Sears subsequent to March 24, 2005, the date of its acquisition by Kmart. The Company believes
that an understanding of its reported results and its ongoing financial performance is not complete without presenting the Sears results of operations on a pro forma basis. The presentation below provides the results of operations on a reported and
pro forma basis.



|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |        |   |  |   |        |  
|-------------------------------------------------------------------- |  | -------------- | ----- | - | -------------- | - | ----- | -------------- |  | - | ------------ | - |  | ------------ | ------ | - |  | - | ------ | -
|Sears Domestic                                                       |  | Reported       |       |   | Reported       |   |       | Pro Forma      | 
|                                                                     |  | 13 Weeks Ended |       |   | 26 Weeks Ended |   |       | 26 Weeks Ended | 
|millions, except number of stores                                    |  | July 29,2006   |       |   | July 30,2005   |   |       | July 29,2006   |  |   | July 30,2005 |   |  | July 30,2005 |       
|Merchandise sales and services                                       |  | $              | 7,051 |   |                | $ | 7,337 |                |  | $ | 13,748       |   |  | $            | 10,338 |   |  | $ | 14,508 |  
|Cost of sales, buying and occupancy                                  |  |                | 4,884 |   |                |   | 5,180 |                |  |   | 9,545        |   |  |              | 7,304  |   |  |   | 10,322 |  
|Gross margin dollars                                                 |  |                | 2,167 |   |                |   | 2,157 |                |  |   | 4,203        |   |  |              | 3,034  |   |  |   | 4,186  |  
|Gross margin rate                                                    |  |                | 30.7  | % |                |   | 29.4  | %              |  |   | 30.6         | % |  |              | 29.3   | % |  |   | 28.9   | %
|Selling and administrative                                           |  |                | 1,669 |   |                |   | 1,718 |                |  |   | 3,289        |   |  |              | 2,462  |   |  |   | 3,533  |  
|Selling and administrative expense as a percentage of total revenues |  |                | 23.7  | % |                |   | 23.4  | %              |  |   | 23.9         | % |  |              | 23.8   | % |  |   | 24.4   | %
|Depreciation and amortization                                        |  |                | 224   |   |                |   | 235   |                |  |   | 464          |   |  |              | 327    |   |  |   | 469    |  
|Gain on sales of assets                                              |  |                | (7    | ) |                |   |      |                |  |   | (7           | ) |  |              |       |   |  |   | (1     | )
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |        |   |  |   |        |  
|Total costs and expenses                                             |  |                | 6,770 |   |                |   | 7,133 |                |  |   | 13,291       |   |  |              | 10,093 |   |  |   | 14,323 |  
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |        |   |  |   |        |  
|Operating income                                                     |  | $              | 281   |   |                | $ | 204   |                |  | $ | 457          |   |  | $            | 245    |   |  | $ | 185    |  
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |        |   |  |   |        |  
|                                                                     |  |                |       |   |               
|Number of :                                                          |  |                |       |   |                |   |       |                |  |   |              |   |  |              |        |   |  |   |        |  
|Full-line Stores(1)                                                  |  |                |       |   |                |   |       |                |  |   | 934          |   |  |              | 906    |   |  |   | 906    |  
|Specialty Stores                                                     |  |                |       |   |                |   |       |                |  |   | 1,091        |   |  |              | 1,150  |   |  |   | 1,150  |  
|Total Domestic Sears Stores                                          |  |                |       |   |                |   |       |                |  |   | 2,025        |   |  |              | 2,056  |   |  |   | 2,056  |  

---

|(1) | The period ended July 29, 2006 includes 863 Full-line stores and 71 Sears Essentials/Grand stores;
|--- | --------------------------------------------------------------------------------------------------

| | The period ended July 30, 2005 includes 868 Full-line stores and 38 Sears Essentials/Grand stores
| | -------------------------------------------------------------------------------------------------

In discussing Sears Domestics year-to-date results, the discussion below pertains to pro forma information contained within the table above which compares Sears Domestics results for the 26-week period
ended July 29, 2006 with Sears Domestics results for the comparable 26-week period ended July 30, 2005. These pro forma results have been prepared assuming the Merger occurred at the beginning of fiscal 2004.

Revenues

For the quarter, merchandise sales and services revenue
declined $0.3 billion, or 3.9%, to $7.1 billion in fiscal 2006, as compared with total revenues of $7.3 billion for the second quarter of fiscal 2005. The decline was due to a 6.3% decrease in comparable store sales, primarily reflecting the impact
of increased competition and lower transaction volumes, as well as continued efforts to improve gross margin by reducing reliance on certain promotional events, most notably within apparel. Comparable store sales declined across most categories and
formats, with more pronounced sales declines within both the home fashion and lawn and garden categories. The Company believes the more pronounced sales declines within lawn and garden reflect, in part, overall poor weather conditions prevalent
during the majority of the summer selling season, as well as the unfavorable impact of certain economic conditions, such as higher energy costs, on consumer demand for higher-ticket discretionary purchases within this category. Additionally, the
sales declines reflect the impact of reducing the floor space and



29



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



number of floor models related to tractors and mowers, as well as reduced advertising of such products relative to prior year. In regards to home fashions,
the sales declines primarily reflect issues related to new product lines launched during the second quarter of fiscal 2006, including inventory receipt delays which, in turn, resulted in lower than planned in-stock levels of new products, and
marketing assets not timed to coincide with the launch. The impact of comparable store sales declines was partially offset by an increase in the total number of Sears Domestic full-line stores in operation, including those Kmart locations which have
been converted to the Sears Grand format.

For the first half of fiscal 2006, total merchandise sales and services revenue declined $0.8 billion, or 5.2%,
to $13.7 billion, as compared with total revenues of $14.5 billion for the comparable prior year period. The year-to-date decline was due to a 7.3% decrease in comparable store sales, with declines across most categories and formats, partially
offset by an increase in the total number of Sears stores in operation, most notably the number of full-line stores, as a number of Kmart locations have been converted to the Sears Grand format during the past 12 months. The first half decline in
comparable store sales generally reflects the same factors as described above relative to the second quarter of fiscal 2006.

Gross Margin

For the quarter, the gross margin rate was 30.7% in fiscal 2006 as compared to 29.4% in the second quarter of fiscal 2005. Gross margin rates improved
across the majority of full-line store merchandise categories, with the most notable improvement occurring within apparel. The increase in gross margin rate was primarily attributable to improved inventory management, including less inventory
shrinkage, and the utilization of more targeted clearance and promotional markdowns versus historical reliance on storewide events, particularly within apparel. The margin benefit derived from better overall inventory management was partially offset
by lower expense leverage relative to buying and occupancy costs due to lower sales levels during the second quarter of fiscal 2006 as compared with the second quarter of fiscal 2005. Lower expense leverage relative to such costs reduced the second
quarter fiscal 2006 gross margin rate by approximately 30 basis points.

For the first half of fiscal 2006, the gross margin rate was 30.6%, as compared
with 28.9% in the same period last year. The increased gross margin rate was attributable primarily to the same factors as described above relative to the second quarter of fiscal 2006. For the first half of fiscal 2006, gross margin rates improved
across all full-line store merchandise categories with the exception of home appliances. The apparel business had the most notable gross margin rate improvement, while the decline in the home appliances gross margin rate reflected increased
promotional activity, primarily during the first quarter of fiscal 2006, as compared with the same period last year. The higher level of promotional activity within home appliances was designed to increase the value of customer transactions within
this business, including per customer unit sales, higher utilization of Sears Card products, as well as increased sales of service contracts.

Selling
and Administrative Expenses

For the quarter, selling and administrative expenses were 23.7% of total revenues in fiscal 2006, as compared with 23.4% in
the second quarter of fiscal 2005. A $17 million gain, representing Sears Domestics portion of settlement proceeds received in connection with settlement of Visa/MasterCard antitrust litigation, was recorded as a reduction to total selling and
administrative expenses during the second quarter of fiscal 2006. This gain accounted for an approximate 20 basis point improvement in the selling and administrative expense rate during the second quarter of fiscal 2006. Excluding this gain, total
selling and administrative expenses declined $32 million, with the majority of the reductions stemming from reduced payroll and benefits costs, as well as reduced marketing. The impact of these spending reductions, however, was mitigated by lower
expense leverage given lower sales levels during the second quarter of fiscal 2006 as compared with the second quarter of fiscal 2005. Lower expense leverage accounted for approximately 50 basis points of the net increase in the overall rate.



30



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



For the first half of fiscal 2006, selling and administrative expenses as a percentage of total revenues was 23.9% in
fiscal 2006, as compared to 24.4% for the same period last year. The improvement in rate primarily reflects lower marketing expense, which accounted for approximately 60 basis points of improvement in the overall rate, partially mitigated by lower
expense leverage given lower sales levels during the current year period as compared to the prior year period.

Operating Income

Operating income increased $77 million and $272 million for the second quarter and first half of fiscal 2006, respectively, as compared with the comparable prior year
periods, primarily reflecting lower selling and administrative expenses, as well as the $17 million gain recorded in relation to the settlement of Visa/MasterCard antitrust litigation as noted above.

Sears Canada

Sears Canada, a consolidated, 70%-owned subsidiary of
Sears, conducts similar retail operations as Sears Domestic. In November 2005, Sears Canada completed the sale of its Credit and Financial Services operations.

The results of operations for Sears Canada are reported to Holdings on a one-month lag. Accordingly, the condensed consolidated statement of income for the 13-week period ended July 29, 2006 includes operating results for Sears Canada
from April 2, 2006 through July 1, 2006, while the 13-week period ended July 30, 2005 includes operating results for Sears Canada from April 3, 2005 to July 2, 2005. The Company believes that an understanding of its reported
results and its ongoing financial performance is not complete without presenting Sears Canadas results of operations on a pro forma basis. The presentation below provides the results of operations on a reported and pro forma basis.



|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |       |   |  |   |       |  
|-------------------------------------------------------------------- |  | -------------- | ----- | - | -------------- | - | ----- | -------------- |  | - | ------------ | - |  | ------------ | ----- | - |  | - | ----- | -
|                                                                     |  | Reported       |       |   | Reported       |   |       | Pro Forma      | 
|                                                                     |  | 13 Weeks Ended |       |   | 26 Weeks Ended |   |       | 26 Weeks Ended | 
|millions, except number of stores                                    |  | July 29,2006   |       |   | July 30,2005   |   |       | July 29,2006   |  |   | July 30,2005 |   |  | July 30,2005 |      
|Merchandise sales and services                                       |  | $              | 1,262 |   |                | $ | 1,135 |                |  | $ | 2,309        |   |  | $            | 1,229 |   |  | $ | 2,110 |  
|Credit and financial products revenues                               |  |                |      |   |                |   | 78    |                |  |   |             |   |  |              | 87    |   |  |   | 173   |  
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |       |   |  |   |       |  
|Total revenues                                                       |  |                | 1,262 |   |                |   | 1,213 |                |  |   | 2,309        |   |  |              | 1,316 |   |  |   | 2,283 |  
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |       |   |  |   |       |  
|Cost of sales, buying and occupancy                                  |  |                | 885   |   |                |   | 832   |                |  |   | 1,648        |   |  |              | 901   |   |  |   | 1,555 |  
|Gross margin dollars                                                 |  |                | 377   |   |                |   | 303   |                |  |   | 661          |   |  |              | 328   |   |  |   | 555   |  
|Gross margin rate                                                    |  |                | 29.9  | % |                |   | 26.7  | %              |  |   | 28.6         | % |  |              | 26.7  | % |  |   | 26.3  | %
|Selling and administrative                                           |  |                | 284   |   |                |   | 327   |                |  |   | 530          |   |  |              | 355   |   |  |   | 625   |  
|Selling and administrative expense as a percentage of total revenues |  |                | 22.5  | % |                |   | 27.0  | %              |  |   | 23.0         | % |  |              | 27.0  | % |  |   | 27.4  | %
|Depreciation and amortization                                        |  |                | 34    |   |                |   | 35    |                |  |   | 68           |   |  |              | 40    |   |  |   | 74    |  
|Gain on sales of assets                                              |  |                |      |   |                |   | (2    | )              |  |   |             |   |  |              | (2    | ) |  |   | (2    | )
|Restructuring charges                                                |  |                | 14    |   |                |   |      |                |  |   | 19           |   |  |              |      |   |  |   |      |  
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |       |   |  |   |       |  
|Total costs and expenses                                             |  |                | 1,217 |   |                |   | 1,192 |                |  |   | 2,265        |   |  |              | 1,294 |   |  |   | 2,252 |  
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |       |   |  |   |       |  
|Operating income                                                     |  | $              | 45    |   |                | $ | 21    |                |  | $ | 44           |   |  | $            | 22    |   |  | $ | 31    |  
|                                                                     |  |                |       |   |                |   |       |                |  |   |              |   |  |              |       |   |  |   |       |  
|                                                                     |  |                |       |   |               
|Number of :                                                          |  |                |       |   |                |   |       |                |  |   |              |   |  |              |       |   |  |   |       |  
|Full-line Stores                                                     |  |                |       |   |                |   |       |                |  |   | 123          |   |  |              | 122   |   |  |   | 122   |  
|Specialty Stores                                                     |  |                |       |   |                |   |       |                |  |   | 254          |   |  |              | 246   |   |  |   | 246   |  
|Total Sears Canada Stores                                            |  |                |       |   |                |   |       |                |  |   | 377          |   |  |              | 368   |   |  |   | 368   |  



31



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



In discussing Sears Canadas year-to-date results, the discussion below pertains to the pro forma information
contained within the table above for the comparable 26-week period ended July 30, 2005. These pro forma results have been prepared assuming the Merger occurred at the beginning of fiscal 2004.

Revenues

Total revenues increased 4.0% and 1.1% for the second
quarter and the first half of fiscal 2006, respectively, as compared to the comparable periods last year. The increases reflect the impact of favorable foreign exchange rates, as the Canadian dollar has strengthened relative to the comparable prior
year periods. Excluding the impact of exchange rate changes, second quarter and first half total revenue for fiscal 2006 declined approximately 6.2% and 7.0%, respectively, as compared to the comparable periods last year. These declines primarily
reflect the impact of the sale of Sears Canadas Credit and Financial Services operations in November 2005 and, to a lesser degree, lower comparable store sales. The revenue stream from Sears Canadas Credit and Financial Services
operations was replaced in part by performance payments received pursuant to the strategic alliance with JPMorgan Chase, a significant portion of which is based upon a percentage of sales charged to the Canadian Sears Card and Canadian Sears
MasterCard. These performance payments are affected by seasonal consumer spending which, historically, is lower in the first half of the year. Conversely, revenues from Sears Canadas Credit and Financial Services operations in the first half
of fiscal 2005 were generated from finance charges which, historically, were higher in the first half of the year due to larger receivable balances on the Canadian Sears Card and Canadian Sears MasterCard following the 2004 holiday season. The
performance payments noted above are classified within Merchandise sales and services and, along with the impact of favorable exchange rates, largely account for the increase in Merchandise sales and services as compared to the prior year period.
Sears Canada comparable store sales declined 3.0% and 2.8% for the second quarter and the first half of fiscal 2006, respectively. The declines in comparable store sales reflect increased sales in cosmetics, footwear, major appliances and seasonal
merchandise which were more than offset by declines in all other categories.

Gross Margin

The gross margin rates for the second quarter and first half of fiscal 2006 increased, as compared with the comparable periods last year, reflecting lower promotional
discount activity, a favorable shift in sales mix to higher margin categories and channels, improved inventory management and less inventory shrinkage, and the favorable impact of a stronger Canadian dollar on the cost of imported merchandise.

Selling and Administrative Expenses

The selling and
administrative expense rate for the second quarter and first half of fiscal 2006 declined, as compared with the comparable periods last year, primarily due to the sale of Sears Canadas Credit and Financial services operation, as well as the
positive impact of productivity initiatives initiated at Sears Canada in the third quarter of fiscal 2005, including a workforce reduction of approximately 1,200 associates.

Restructuring Charges

Restructuring charges of $14 million and $19 million were recognized for the second quarter
and the first half of fiscal 2006, respectively, in relation to costs incurred for productivity initiatives initiated in fiscal 2005 as previously noted.

Operating Income

Operating income increased $24 million and $13 million for the second quarter and the first half of fiscal 2006,
respectively, as compared with the comparable periods last year, reflecting lower selling and administrative



32



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



expenses and increased gross margin, partially offset by lower Credit and Financial Services revenues and the above-noted restructuring charges recorded in
fiscal 2006.

PRO FORMA RECONCILIATION

The following
tables provide a reconciliation from the as reported results to the pro forma results presented above for Sears Holdings, Sears Domestic and Sears Canada for the 26-week period ended July 30, 2005.

Sears Holdings



|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|----------------------------------------------------------------------------------------------------- |  | ---------------------------------- | ------ | - | --------------------- | - | ----- | -------------- |  | - | -------- | ---- |  | - | ------ | -
|                                                                                                      |  | 26-week period ended July 30, 2005 |       
|millions, except per common share data                                                                |  | As reported                        |        |   | Pre-mergerActivity(1) |   |       | PurchaseAcctng |  |   | ProForma |     
|Merchandise sales and services                                                                        |  | $                                  | 20,749 |   |                       | $ | 5,051 |                |  | $ |         |      |  | $ | 25,800 |  
|Credit and financial products revenues                                                                |  |                                    | 87     |   |                       |   | 86    |                |  |   |         |      |  |   | 173    |  
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|Total revenue                                                                                         |  |                                    | 20,836 |   |                       |   | 5,137 |                |  |   |         |      |  |   | 25,973 |  
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|Cost of sales, buying and occupancy                                                                   |  |                                    | 15,202 |   |                       |   | 3,672 |                |  |   |         |      |  |   | 18,874 |  
|Gross margin dollars                                                                                  |  |                                    | 5,547  |   |                       |   | 1,379 |                |  |   |         |      |  |   | 6,926  |  
|Gross margin rate                                                                                     |  |                                    | 26.7   | % |                       |   | 27.3  | %              |  |   |         | %    |  |   | 26.8   | %
|Selling and administrative                                                                            |  |                                    | 4,737  |   |                       |   | 1,330 |                |  |   | 11       | (2)  |  |   | 6,078  |  
|Selling and administrative as % of total revenues                                                     |  |                                    | 22.7   | % |                       |   | 25.9  | %              |  |   |         | %    |  |   | 23.4   | %
|Depreciation and amortization                                                                         |  |                                    | 387    |   |                       |   | 147   |                |  |   | 29       | (3)  |  |   | 563    |  
|Gain on sales of assets                                                                               |  |                                    | (10    | ) |                       |   | (1    | )              |  |   |         |      |  |   | (11    | )
|Restructuring charges                                                                                 |  |                                    | 45     |   |                       |   |      |                |  |   |         |      |  |   | 45     |  
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|Total costs and expenses                                                                              |  |                                    | 20,361 |   |                       |   | 5,148 |                |  |   | 40       |      |  |   | 25,549 |  
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|Operating income (loss)                                                                               |  |                                    | 475    |   |                       |   | (11   | )              |  |   | (40      | )    |  |   | 424    |  
|Interest expense (income), net                                                                        |  |                                    | 114    |   |                       |   | 35    |                |  |   | (2       | )(4) |  |   | 147    |  
|Bankruptcy-related recoveries                                                                         |  |                                    | (32    | ) |                       |   |      |                |  |   |         |      |  |   | (32    | )
|Other income                                                                                          |  |                                    | (11    | ) |                       |   | (10   | )              |  |   |         |      |  |   | (21    | )
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|Income before income taxes, minority interest and cumulative effect of change in accounting principle |  |                                    | 404    |   |                       |   | (36   | )              |  |   | (38      | )    |  |   | 330    |  
|Income tax expense (benefit)                                                                          |  |                                    | 155    |   |                       |   | 4     |                |  |   | (15      | )(5) |  |   | 144    |  
|Minority interest                                                                                     |  |                                    | 7      |   |                       |   | 6     |                |  |   |         |      |  |   | 13     |  
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|Income before cumulative effect of change in accounting principle                                     |  |                                    | 242    |   |                       |   | (46   | )              |  |   | (23      | )    |  |   | 173    |  
|Cumulative effect of change in accounting principle, net of tax                                       |  |                                    | (90    | ) |                       |   |      |                |  |   |         |      |  |   | (90    | )
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|NET INCOME (LOSS)                                                                                     |  | $                                  | 152    |   |                       | $ | (46   | )              |  | $ | (23      | )    |  | $ | 83     |  
|                                                                                                      |  |                                    |        |   |                       |   |       |                |  |   |          |      |  |   |        |  
|Diluted earnings per share before cumulative effect of change in accounting principle                 |  | $                                  | 1.66   |   |                       |   |       |                |  |   |          |      |  | $ | 1.06   |  
|Diluted earnings per share                                                                            |  | $                                  | 1.05   |   |                       |   |       |                |  |   |          |      |  | $ | 0.51   |  

---

|(1) | Represents the 2005 results of operations for the period January 30, 2005 through March 24, 2005 for Sears Domestic and the period January 2, 2005
through March 24, 2005 for Sears Canada.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Represents an increase to selling and administrative expense resulting from the adjustment to Sears pension and postretirement plans based on the adjustment of
such liabilities to fair value.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Represents an increase in depreciation and amortization expense resulting from the adjustment to Sears property and equipment and identifiable intangible
assets based on the adjustment of such assets to fair value.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



33



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



|(4) | Represents a decrease to interest expense resulting from the adjustment to Sears debt based
on the adjustments of such liabilities to fair value.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Represents the aggregate pro forma effective income tax effect (38.4%) of notes
(2) through (4) above.
|--- | ------------------------------------------------------------------------------------------------------

Sears Domestic



|                                                  |  |                                    |        |   |                       |   |       |                |  |   |          |     |  |   |        |  
|------------------------------------------------- |  | ---------------------------------- | ------ | - | --------------------- | - | ----- | -------------- |  | - | -------- | --- |  | - | ------ | -
|                                                  |  | 26-week period ended July 30, 2005 |       
|millions                                          |  | As reported                        |        |   | Pre-mergerActivity(1) |   |       | PurchaseAcctng |  |   | Proforma |    
|Merchandise sales and services                    |  | $                                  | 10,338 |   |                       | $ | 4,170 |                |  | $ |         |     |  | $ | 14,508 |  
|Cost of sales, buying and occupancy               |  |                                    | 7,304  |   |                       |   | 3,018 |                |  |   |         |     |  |   | 10,322 |  
|Gross margin dollars                              |  |                                    | 3,034  |   |                       |   | 1,152 |                |  |   |         |     |  |   | 4,186  |  
|Gross margin rate                                 |  |                                    | 29.3   | % |                       |   | 27.6  | %              |  |   |         | %   |  |   | 28.9   | %
|Selling and administrative                        |  |                                    | 2,462  |   |                       |   | 1,060 |                |  |   | 11       | (2) |  |   | 3,533  |  
|Selling and administrative as % of total revenues |  |                                    | 23.8   | % |                       |   | 25.4  | %              |  |   |         | %   |  |   | 24.4   | %
|Depreciation and amortization                     |  |                                    | 327    |   |                       |   | 116   |                |  |   | 26       | (3) |  |   | 469    |  
|Gain on sales of assets                           |  |                                    |       |   |                       |   | (1    | )              |  |   |         |     |  |   | (1     | )
|                                                  |  |                                    |        |   |                       |   |       |                |  |   |          |     |  |   |        |  
|Total costs and expenses                          |  |                                    | 10,093 |   |                       |   | 4,193 |                |  |   | 37       |     |  |   | 14,323 |  
|                                                  |  |                                    |        |   |                       |   |       |                |  |   |          |     |  |   |        |  
|Operating income (loss)                           |  | $                                  | 245    |   |                       | $ | (23   | )              |  | $ | (37      | )   |  | $ | 185    |  
|                                                  |  |                                    |        |   |                       |   |       |                |  |   |          |     |  |   |        |  

Sears Canada



|                                                  |  |                                    |       |   |                       |   |      |                |  |   |          |     |  |   |       |  
|------------------------------------------------- |  | ---------------------------------- | ----- | - | --------------------- | - | ---- | -------------- |  | - | -------- | --- |  | - | ----- | -
|                                                  |  | 26-week period ended July 30, 2005 |      
|millions                                          |  | As reported                        |       |   | Pre-mergerActivity(1) |   |      | PurchaseAcctng |  |   | Proforma |    
|Merchandise sales and services                    |  | $                                  | 1,229 |   |                       | $ | 881  |                |  | $ |         |     |  | $ | 2,110 |  
|Credit and financial product revenues             |  |                                    | 87    |   |                       |   | 86   |                |  |   |         |     |  |   | 173   |  
|                                                  |  |                                    |       |   |                       |   |      |                |  |   |          |     |  |   |       |  
|Total revenues                                    |  |                                    | 1,316 |   |                       |   | 967  |                |  |   |         |     |  |   | 2,283 |  
|                                                  |  |                                    |       |   |                       |   |      |                |  |   |          |     |  |   |       |  
|Cost of sales, buying and occupancy               |  |                                    | 901   |   |                       |   | 654  |                |  |   |         |     |  |   | 1,555 |  
|Gross margin dollars                              |  |                                    | 328   |   |                       |   | 227  |                |  |   |         |     |  |   | 555   |  
|Gross margin rate                                 |  |                                    | 26.7  | % |                       |   | 25.8 | %              |  |   |         | %   |  |   | 26.3  | %
|Selling and administrative                        |  |                                    | 355   |   |                       |   | 270  |                |  |   |         |     |  |   | 625   |  
|Selling and administrative as % of total revenues |  |                                    | 27.0  | % |                       |   | 27.9 | %              |  |   |         | %   |  |   | 27.4  | %
|Depreciation and amortization                     |  |                                    | 40    |   |                       |   | 31   |                |  |   | 3        | (3) |  |   | 74    |  
|Gain on sales of assets                           |  |                                    | (2    | ) |                       |   |     |                |  |   |         |     |  |   | (2    | )
|Restructuring charges                             |  |                                    |      |   |                       |   |     |                |  |   |         |     |  |   |      |  
|                                                  |  |                                    |       |   |                       |   |      |                |  |   |          |     |  |   |       |  
|Total costs and expenses                          |  |                                    | 1,294 |   |                       |   | 955  |                |  |   | 3        |     |  |   | 2,252 |  
|                                                  |  |                                    |       |   |                       |   |      |                |  |   |          |     |  |   |       |  
|Operating income (loss)                           |  | $                                  | 22    |   |                       | $ | 12   |                |  | $ | (3       | )   |  | $ | 31    |  
|                                                  |  |                                    |       |   |                       |   |      |                |  |   |          |     |  |   |       |  

---

|(1) | Represents the 2005 results of operations for the period January 30, 2005 through March 24, 2005 for Sears Domestic and the period January 2, 2005
through March 24, 2005 for Sears Canada.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Represents an increase to selling and administrative expense resulting from the adjustment to Sears pension and postretirement plans based on the adjustment of
such liabilities to fair value.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Represents an increase in depreciation and amortization expense resulting from the adjustment to Sears property and equipment and identifiable intangible
assets based on the adjustment of such assets to fair value.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



34



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION

Cash and Cash Equivalents

The Companys cash and cash equivalents include all highly liquid investments with
original maturities of three months or less at the date of purchase. The Companys cash and cash equivalents balances as of July 29, 2006 and January 28, 2006 are detailed in the following table.



|                                         |  |              |       |                 |   |      
|---------------------------------------- |  | ------------ | ----- | --------------- | - | -----
|millions                                 |  | July 29,2006 |       | January 28,2006
|Domestic cash                            |  |              |       |                 |   |      
|Cash and equivalents                     |  | $            | 2,493 |                 | $ | 3,208
|Cash posted as collateral                |  |              | 533   |                 |   | 466  
|Credit card deposits in transit          |  |              | 161   |                 |   | 102  
|                                         |  |              |       |                 |   |      
|Total domestic cash and cash equivalents |  |              | 3,187 |                 |   | 3,776
|Sears Canada                             |  |              | 503   |                 |   | 664  
|                                         |  |              |       |                 |   |      
|Total cash and cash equivalents          |  | $            | 3,690 |                 | $ | 4,440
|                                         |  |              |       |                 |   |      

As of July 29, 2006, the Company had $3.7 billion of cash and cash equivalents as compared to $2.1 billion at
July 30, 2005 and $4.4 billion at January 28, 2006. The decline in cash and cash equivalents from January 28, 2006 is attributable to share repurchases ($509 million), cash used in the acquisition of additional interests in Sears
Canada ($278 million), capital expenditures ($173 million) and net debt repayments ($166 million), partially offset by cash generated from operations ($390 million).

The Company has posted cash collateral for certain outstanding letters of credit and self-insurance programs. Such cash collateral is classified within cash and cash equivalents given its ready availability to the
Company as the Company has the ability to substitute letters of credit at any time for this cash collateral.

Credit card deposits in transit include
deposits in-transit from banks for payments related to third-party credit card and debit card transactions, including those generated on the Sears Card and Sears MasterCard products.

The Company classifies outstanding checks in excess of funds on deposit within Other current liabilities and reduces cash and cash equivalents when these checks clear the bank on which they were drawn. Outstanding
checks in excess of funds on deposit were $441 million and $444 million as of July 29, 2006 and January 28, 2006, respectively.

Investment of Available Capital

Since the Merger, the Companys cash flows have exceeded its working capital, financing and capital
investment needs, and management expects that the Companys cash flows will continue to exceed its operating cash needs for the foreseeable future. The Company regularly evaluates how best to use available capital to increase shareholder value.
The Company has and will continue to invest in its businesses to improve the customer experience and provide the opportunity for attractive returns. Through July 29, 2006, the Company has also repurchased $1.1 billion of its common shares since the
Merger and expects to continue to repurchase shares subject to market conditions and board authorization. In addition, the Company may pursue investments in the form of acquisitions, joint ventures and partnerships where the Company believes
attractive returns can be obtained. Further, the Company may determine under certain market conditions that available capital is best utilized to fund investments that it believes offer the Company attractive return opportunities, whether or not
related to its ongoing business activities.



35



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



As previously disclosed in the Companys Annual Report on Form 10-K/A for its fiscal year ended January 28,
2006, the Companys Board of Directors has delegated authority to direct investment of the Companys surplus cash to its Chairman, Edward S. Lampert, subject to various limitations that have been or may be from time to time adopted by the
Board of Directors and/or Finance Committee of the Board of Directors. As of July 29, 2006, the Companys surplus cash was primarily invested in short-term, highly liquid investments, including commercial paper, U.S. federal, state and
municipal government securities, floating-rate notes, repurchase agreements and money market funds. Subsequent to July 29, 2006, the Company is using, and may in the future use, a portion of its available capital to invest in other securities
and financial instruments, including derivatives. These investments may include significant and highly concentrated direct investments and/or related derivative positions with respect to the equity securities of public companies. Derivative
contracts would be recorded on the Companys balance sheet at fair value and, for non-hedge contracts, changes in fair value would be recognized currently in earnings as unrealized gains or losses. Any such investments will involve risks, and
shareholders should recognize that Holdings balance sheet may change depending on the extent of excess funds and the timing, magnitude and performance of investments which the Company may make. Furthermore, such investments would be subject to
volatility that may affect both the recorded value of the investments as well as the Companys periodic earnings.

See supplement to risk factors
contained in Part II, Item 1A.

Operating Activities and Cash Flows

Holdings generated approximately $0.4 billion in operating cash flows for both the first half of fiscal 2006 and the first half of fiscal 2005. The Companys primary source of operating cash flows is the sale of
goods and services to customers, while the primary use of cash in operations is to fund the purchase of merchandise inventories.

The Company had total
merchandise inventories of approximately $9.5 billion as of July 29, 2006, as compared to $9.0 billion as of July 30, 2005, with increases across a number of businesses, including both Kmart and Sears Domestic apparel and within Sears
Domestic hardlines businesses. The increase primarily reflects planned increases due to earlier receipt of product this year, primarily apparel receipts at both Kmart and Sears Domestic for the back-to-school period, and increases in categories
where the Company believes business trends support higher inventory levels, as well as, to a lesser degree, to support new product lines. Merchandise payables were $3.3 billion at July 29, 2006, as compared to $3.5 billion as of July 30,
2005.

Investing Activities

During the 26-week period
ended July 29, 2006, the Company spent $173 million on capital expenditures compared to $180 million spent during the equivalent 26-week period in the prior year. The prior year spending of $180 million excludes approximately $40 million of
capital expenditures made by Sears during the period January 30, 2005 through March 24, 2005 (pre-Merger period).

Financing Activities

During the first quarter of fiscal 2006, the Board of Directors authorized the repurchase of up to an aggregate of $500 million of the Companys
common shares in addition to the $1.0 billion repurchase authorization previously approved by the Board of Directors. During the 26-week period ended July 29, 2006, the Company repurchased 4.0 million of its common shares at a total cost
of $504 million under the program. As of July 29, 2006, the Company had $406 million of remaining authorization under the Companys common share repurchase program.



36



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



The Companys outstanding borrowings as of July 29, 2006, July 30, 2005 and January 28, 2006
were as follows:



|                                           |  |              |       |              |   |                 |  |   |      
|------------------------------------------ |  | ------------ | ----- | ------------ | - | --------------- |  | - | -----
|millions                                   |  | July 29,2006 |       | July 30,2005 |   | January 28,2006
|Short-term borrowings:                     |  |              |       |              |   |                 |  |   |      
|Unsecured commercial paper                 |  | $            | 82    |              | $ | 78              |  | $ | 178  
|Long-term debt, including current portion: |  |              |       |              |   |                 |  |   |      
|Notes and debentures outstanding           |  |              | 2,843 |              |   | 3,189           |  |   | 2,974
|Capitalized lease obligations              |  |              | 845   |              |   | 888             |  |   | 864  
|                                           |  |              |       |              |   |                 |  |   |      
|Total debt                                 |  | $            | 3,770 |              | $ | 4,155           |  | $ | 4,016
|                                           |  |              |       |              |   |                 |  |   |      
|Memo: Sears Canada debt                    |  | $            | 826   |              | $ | 716             |  | $ | 716  

Liquidity

The
Companys primary need for liquidity is to fund seasonal working capital requirements of its retail businesses, capital expenditures and for general corporate purposes. The Company believes that these needs will be adequately funded by the
Companys operating cash flows, credit terms from vendors, current balances in cash and cash equivalents and, to the extent necessary, borrowings under the Companys various revolving credit facilities. At July 29, 2006, $3.5 billion
was available under such facilities. While the Company expects to use these facilities as its primary funding source, it may also access the public debt markets on an opportunistic basis. Additionally, the Company may from time to time consider
selective strategic transactions to create value and improve performance, which may include acquisitions, dispositions, restructurings, joint ventures and partnerships. Transactions of these types may result in material proceeds or cash outlays. See
the Companys Annual Report on Form 10-K/A for the fiscal year ended January 28, 2006 for additional information regarding the Companys sources of liquidity.

Debt Ratings

The ratings of the Companys domestic debt securities as of
July 29, 2006 appear in the table below:



|                           |  |                         |  |                                  |  |             
|-------------------------- |  | ----------------------- |  | -------------------------------- |  | ------------
|                           |  | MoodysInvestorsService |  | Standard &Poors RatingsServices |  | FitchRatings
|Unsecured long-term debt   |  | Ba1                     |  | BB+                              |  | BB          
|Unsecured commercial paper |  | NP                      |  | B-1                              |  | B           

Credit Agreement

The Companys $4.0 billion, five-year credit agreement (the Credit Agreement) has an expiration date of March 2010 and is available for general corporate purposes and includes a $1.5 billion letter of credit
sublimit. The Credit Agreement is a revolving credit facility under which SRAC and Kmart Corporation are the borrowers. The Credit Agreement is guaranteed by Holdings and certain of its direct and indirect subsidiaries and is secured by a first lien
on domestic inventory, credit card accounts receivable and the proceeds thereof. Availability under the Credit Agreement is determined pursuant to a borrowing base formula, based on domestic inventory and credit card accounts receivable, subject to
certain limitations. As of July 29, 2006, the Company had $457 million of letters of credit outstanding under the Credit Agreement with $3.5 billion of availability remaining under the Credit Agreement. There were no direct borrowings under the
facility during the first half of fiscal 2006. The Credit Agreement does not contain provisions that would restrict borrowings or letter of credit issuances based on material adverse changes or credit ratings.



37



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



Letter of Credit Agreement

The Company has an additional letter of credit agreement (the LC Agreement) with a commitment amount of up to $1 billion. The LC Agreement expires in August 2007. As of July 29, 2006, there
were $433 million of letters of credit outstanding under the LC Agreement.

Under the terms of the LC Agreement, the Company has the ability to post cash,
inventory or other letters of credit, including letters of credit issued under the Credit Agreement, as collateral. However, the Credit Agreement prohibits the Company from using inventory as collateral under the LC Agreement. The cash collateral
account is subject to a pledge and security agreement pursuant to which if the Company elects to post cash collateral, it must maintain cash in an amount equal to 100.5% of the face value of letters of credit outstanding. The Company had $435
million of cash posted as collateral under the LC Agreement as of July 29, 2006. The Company continues to classify the cash collateral as cash and cash equivalents due to its ability to substitute these letters of credit with letters of credit
under the Credit Agreement, which does not require cash collateral, and its ability to provide letters of credit under the Credit Agreement as collateral. There are no provisions in the LC Agreement that would restrict issuances based on credit
ratings, but issuances could be restricted under certain circumstances based on a material adverse change.

Cash Collateral

The Company posts cash collateral for certain self-insurance programs. The Company continues to classify the cash collateral as cash and cash equivalents in the
accompanying condensed consolidated balance sheets due to the Companys ability to substitute letters of credit for the cash at any time at its discretion. As of July 29, 2006, $98 million of cash was posted as collateral for
self-insurance programs.

OSH Supply Hardware LLC (LLC) Credit Agreement

In fiscal 2005, LLC entered into a five-year, $130 million senior secured revolving credit facility (the LLC Facility), which includes a $25 million letter of credit sublimit. The LLC
Facility is available for LLCs general corporate purposes and is secured by a first lien on substantially all of LLCs non-real estate assets. Availability under the LLC Facility is determined pursuant to a borrowing base formula based on
inventory and accounts and credit card accounts receivable, subject to certain limitations. As of July 29, 2006, $2 million was outstanding under the LLC Facility  there were no borrowings and $2 million in outstanding letters of
credit.

Inter-company Loan

The Company has also
transferred certain domestic real estate and intellectual property into separate bankruptcy remote Special Purpose Vehicles (SPVs). The SPV holding the real estate assets leases such property to Sears, Roebuck and Co. and Kmart
Corporation. The SPV holding the intellectual property licenses these trademarks to Sears, Roebuck and Co. and Kmart Corporation. Each SPV has issued asset-backed notes that are collateralized by the real estate and intellectual property,
respectively. Cash flows received by the SPVs from rents and licensing fees paid by Sears, Roebuck and Co., Kmart Corporation and, potentially in the future, other affiliates or third parties will be used for the payment of fees, interest and
principal on notes issued by the SPVs. As of July 29, 2006, these debt securities were entirely held by wholly-owned consolidated subsidiaries of the Company and the net book value of the securitized intellectual property assets was
approximately $1.0 billion, and the net book value of the securitized real estate assets was approximately $1.1 billion.

Recent Accounting
Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) ratified the consensus reached on Emerging Issues Task Force
(EITF) Issue No. 06-03, How Sales Taxes Collected from Customers and Remitted to



38



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



Governmental Authorities Should Be Presented in the Income Statement (That is, Gross Versus Net Presentation). The EITFs reached a consensus that
the presentation of taxes on either a gross or net basis is an accounting policy decision that requires disclosure. EITF 06-3 is effective for the first interim or annual reporting period beginning after December 15, 2006. The adoption of
EITF 06-3 will not have any effect on the Companys financial position or results of operations.

In July 2006, the FASB issued FASB Interpretation
No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109 (FIN 48). This Interpretation prescribes a recognition threshold and measurement process for recording within
the financial statements uncertain tax positions taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure related to
uncertain tax positions. The provisions of FIN 48 are effective as of the beginning of the Companys 2007 fiscal year. The Company is currently evaluating the impact, if any, of adopting FIN 48 on its financial statements.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Certain statements made in this Quarterly Report on Form 10-Q and in other public announcements by the Company contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are subject to risks and uncertainties that may cause the Companys actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by
these forward-looking statements. Forward-looking statements include information concerning the Companys future financial performance, business strategy, plans, goals and objectives. Statements preceded or followed by, or that otherwise
include, the words believes, expects, anticipates, intends, estimates, plans, forecast, is likely to and similar expressions or future or conditional
verbs such as will, may and could are generally forward-looking in nature and not historical facts. Such statements include, but are not limited to, statements about the expected benefits of the business
combination of Sears and Kmart and future financial and operating results. Such statements are based upon the current beliefs and expectations of Holdings management and are subject to significant risks and uncertainties. Actual results may
differ materially 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 risk that the Company fails to offer merchandise and services that its customers want; the risk that the Company does not successfully manage its inventory levels; the ability of the Company to
compete effectively in the highly competitive retail industry; the Companys failure to successfully invest available capital could negatively affect the Companys performance; failure to successfully integrate Kmart and Sears, which may
cause a failure to realize cost savings and other benefits; the impact of seasonal buying patterns, which are difficult to forecast with certainty; comparable store sales may fluctuate for a variety of reasons; the Company may rely on foreign
sources for significant amounts of merchandise, and its business may therefore be negatively affected by the risks associated with international trade; the possibility of disruptions in computer systems to process transactions, summarize results and
manage the Companys business; the loss of key personnel; the Company may be subject to product liability claims if people or property are harmed by the products it sells; the Company may be subject to periodic litigation and other regulatory
proceedings, which may be affected by changes in laws and government regulations or changes in the enforcement thereof; and a decline in general economic conditions, consumer spending levels and other conditions could lead to reduced consumer demand
for the Companys merchandise.

Certain of these and other factors are discussed in more detail in the Companys filings with the Securities and
Exchange Commission and the Annual Report on Form 10-K/A of Sears Holdings Corporation for the fiscal year ended January 28, 2006, which may be accessed through the Commissions website at www.sec.gov.



39



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

13 and 26 Weeks Ended July 29, 2006 and July 30, 2005



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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The nature of market risks faced by the Company at July 29, 2006 is the same as disclosed in the Companys Annual Report on Form 10-K/A for the year ended January 28, 2006. As of July 29, 2006, 9% of the Companys
debt portfolio was variable rate. Based on the size of this variable rate debt portfolio at July 29, 2006, which totaled approximately $322 million, an immediate 100 basis point change in interest rates would have affected annual pretax funding
costs by $3.2 million. These estimates do not take into account the effect on income resulting from invested cash or the returns on assets being funded. These estimates also assume that the variable rate funding portfolio remains constant for an
annual period and that the interest rate change occurs at the beginning of the period.

As of July 29, 2006, the Company had a series of foreign
currency forward contracts outstanding, totaling $535 million Canadian notional value and with a weighted average remaining life of 0.8 years, designed to hedge the Companys net investment in Sears Canada against adverse changes in
exchange rates. The aggregate fair value of the forward contracts as of July 29, 2006 was $6 million. A hypothetical 10% adverse movement in the level of the Canadian exchange rate relative to the U.S. dollar as of July 29, 2006, with
all other variables held constant, would have resulted in a loss in the fair value of the Companys foreign currency forward contracts of $53 million as of July 29, 2006.

Item 4. Controls and Procedures

The Companys management, including Aylwin B. Lewis, Chief Executive
Officer and President (principal executive officer), and William C. Crowley, Executive Vice President and Chief Financial and Administrative 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), as of the end of the period covered by this report. Based
upon their evaluation, the principal executive officer and the principal financial officer concluded that, as of the end of the period covered by this report, the Companys disclosure controls and procedures were effective for the purpose of
ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms, and (2) is accumulated and communicated to the Companys management, including its principal executive and principal financial officers, as appropriate to allow timely
decisions regarding required disclosure.

In addition, as required by Rule 13a-15(d) under the Exchange Act, the Companys management, including the
Companys principal executive officer and principal financial officer, have evaluated the Companys internal control over financial reporting to determine whether any changes occurred during the quarter covered by this report that have
materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



40



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

PART II. OTHER INFORMATION

Item 1.
Legal Proceedings

See Part I, Item 1, Financial StatementsNotes to Condensed Consolidated Financial Statements,
Note 10Claims Resolution and Bankruptcy-Related Settlements, and Note 15Legal Proceedings, for information regarding legal proceedings, which information is incorporated herein by this reference.

Item 1A. Risk Factors

The Companys Annual
Report on Form 10-K/A for its fiscal year ended January 28, 2006 includes a detailed discussion of risk factors that could adversely affect the Companys business, results of operations and financial condition. The information
presented below supplements those risk factors.

The Companys failure to successfully invest available capital could negatively affect the
Companys performance

The Companys performance with respect to the investment of surplus cash is substantially dependent on the performance
of Edward S. Lampert, to whom the Companys Board of Directors has delegated authority to direct such investments, subject to certain limitations.

There can be no assurance that the Company will be successful in its efforts to identify investment opportunities that meet its requirements. Any such investments may include significant and highly concentrated direct investments, related
derivative positions, or both, with respect to the equity securities of public companies. In addition, any such investments will involve risks, and Holdings balance sheet may fluctuate, depending on the extent of excess funds and the timing,
magnitude and performance of the Companys investments. Furthermore, such investments would be subject to volatility due to market conditions and other conditions over which the Company may not have control, which may affect both the recorded
value of the investments as well as the Companys periodic earnings. Accordingly, the poor performance by a significant investment of the Company could have a material adverse effect on the results of operations and financial condition of the
Company.

Item 2. Unregistered Sales of Equity Securities and Uses of Proceeds

The following table provides information about shares of common stock the Company acquired during the second quarter of fiscal 2006, including shares assigned to the Company as part of settlement agreements resolving
claims arising from the Chapter 11 reorganization of Kmart Corporation. During the 13 weeks ended July 29, 2006, the Company repurchased 0.7 million of its common shares at a total cost of $91 million under its common share repurchase
program. The program was initially announced on September 14, 2005 with a total authorization by the Companys Board of Directors of up to $1.0 billion. During the first quarter of 2006, the Board of Directors authorized the repurchase of
up to an additional $500 million of common stock (announced April 5, 2006), for a total authorization of $1.5 billion. The program has no stated expiration date. As of July 29, 2006, the Company had $406 million of remaining authorization
under the program.



41



---

##### Table of Contents

SEARS HOLDINGS CORPORATION



|                               |  |                                  |  |                           |        |                                                                     |         |                                                        |   |                                                                            |  |   |            
|------------------------------ |  | -------------------------------- |  | ------------------------- | ------ | ------------------------------------------------------------------- | ------- | ------------------------------------------------------ | - | -------------------------------------------------------------------------- |  | - | -----------
|                               |  | TotalNumber ofSharesPurchased(1) |  | AveragePrice PaidperShare |        | Total Number ofShares Purchasedas Part of PubliclyAnnounced Program |         | Average Price Paidper ShareforPubliclyAnnouncedProgram |   | ApproximateDollar Value
ofShares that MayYet Be PurchasedUnder the Program
|April 30, 2006 to May 27, 2006 |  | 190,841                          |  | $                         | 137.98 |                                                                     | 190,000 |                                                        | $ | 137.95                                                                     |  |   |            
|May 28, 2006 to July 1, 2006   |  | 33,608                           |  |                           | 154.79 |                                                                     |        |                                                        |   |                                                                           |  |   |            
|July 2, 2006 to July 29, 2006  |  | 473,140                          |  |                           | 137.59 |                                                                     | 469,000 |                                                        |   | 137.56                                                                     |  |   |            
|                               |  |                                  |  |                           |        |                                                                     |         |                                                        |   |                                                                            |  |   |            
|Total                          |  | 697,589                          |  | $                         | 138.52 |                                                                     | 659,000 |                                                        | $ | 137.67                                                                     |  | $ | 406,000,000
|                               |  |                                  |  |                           |        |                                                                     |         |                                                        |   |                                                                            |  |   |            

---

|(1) | Includes 31,793 shares acquired from associates to meet withholding tax requirements from the
vesting of restricted stock. In addition, the Company recognized recoveries of $11 million in the quarter ended July 29, 2006 related to vendors who had received cash payments for pre-petition obligations (critical vendor claims) or preference
payments. In conjunction with these recoveries, the Company was assigned 6,796 shares of common stock with a weighted average price of $136.88. These shares were acquired during the quarter as follows:
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                               |  |       
|------------------------------ |  | ------
|April 30, 2006 to May 27, 2006 |  | 841   
|May 28, 2006 to July 1, 2006   |  | 33,608
|July 2, 2006 to July 29, 2006  |  | 4,140 

Item 6. Exhibits



|(a) | Exhibits.
|--- | ---------

An Exhibit Index has been filed as part of this Report on Page
E-1.



42



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.



| |  |                 |  |                                        |  |     |  |                                                                                                                        
| |  | --------------- |  | -------------------------------------- |  | --- |  | -----------------------------------------------------------------------------------------------------------------------
| |  |                 |  | SEARS HOLDINGS CORPORATION(Registrant)
| |  |                 |  |                                       
| |  | August 31, 2006 |  |                                        |  | By: |  | /S/    WILLIAM K.
PHELAN                                                                                               
| |  |                 |  |                                        |  |     |  | William K. PhelanVice President and Controller (Principal Accounting Officer and duly authorized officer of
Registrant)



43



---

##### Table of Contents

SEARS HOLDINGS CORPORATION

EXHIBIT INDEX



|      |  |                                                                                                                                                                                                                                                  
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | 
|3.1   |  | Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to Registrants Current Report on Form 8-K, dated March 24, 2005, filed on March 24, 2005 (File
No. 000-51217)).                                                 
|      | 
|3.2   |  | Restated By-Laws (incorporated by reference to Exhibit 3.2 to Registrants Current Report on Form8-K, dated March 24, 2005, filed on March 24, 2005 (File No.
000-51217)).                                                                       
|      | 
|10.1  |  | Letter from Registrant to Craig T. Monaghan relating to employment dated July 26, 2006 (incorporated by reference to Exhibit 10.1 to Registrants Current Report on Form 8-K, dated July
26, 2006, filed on August 1, 2006 (File No. 000-51217)).
|      | 
|*10.2 |  | Third Amendment to Letter of Credit Agreement, dated as of July 21, 2006, among Kmart Corporation, Sears, Roebuck and Co, and Bank of America, National Association as issuing
bank.                                                             
|      | 
|*31.1 |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                              
|      | 
|*31.2 |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                              
|      | 
|*32   |  | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                   

---

|* | Filed herewith
|- | --------------



E-1