SEARS ROEBUCK & CO - 10-Q Quarterly Report

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 SEPTEMBER 28, 2002

		OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		Commission file number 1-416

SEARS, ROEBUCK AND CO.
(Exact name of registrant as specified in its charter)


New York (State of Incorporation)		36-1750680 (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

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

Yes x No o

As of October 26, 2002, the Registrant had 316,312,198 common shares, $.75 par value, outstanding.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		Condensed Consolidated Statements of Income (Unaudited) 13 Weeks and 39 Weeks Ended September 28, 2002 and September 29, 2001
		Condensed Consolidated Balance Sheets September 28, 2002 (Unaudited), September 29, 2001 (Unaudited) and December 29, 2001
		Condensed Consolidated Statements of Cash Flows (Unaudited) 39 Weeks Ended September 28, 2002 and September 29, 2001
		Notes To Condensed Consolidated Financial Statements (Unaudited)
		Independent Accountants’ Report
	Item 2. Management’s Discussion and Analysis of Operations, Financial Condition and Liquidity
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Disclosure Controls and Procedures
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 6. Exhibits and Reports on Form 8-K
Restated LTPIP and Amendment to 2000 Stock Plan
Computation of Ratio of Income to Fixed Charges
Acknowledgement of Awareness
Certification of Chief Executive Officer
Certification of Chief Financial Officer

SEARS, ROEBUCK AND CO.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
13 and 39 Weeks Ended September 28, 2002


			Page

PART I - FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Condensed Consolidated Statements of Income (Unaudited) 13 Weeks and 39 Weeks Ended September 28, 2002 and September 29, 2001	1

		Condensed Consolidated Balance Sheets September 28, 2002 (Unaudited), September 29, 2001 (Unaudited) and December 29, 2001	2

		Condensed Consolidated Statements of Cash Flows (Unaudited) 39 Weeks Ended September 28, 2002 and September 29, 2001	3

		Notes to Condensed Consolidated Financial Statements (Unaudited)	4

		Independent Accountants’ Report	16

	Item 2.	Management’s Discussion and Analysis of Operations, Financial Condition and Liquidity	17

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31

	Item 4.	Disclosure Controls and Procedures	31

PART II - OTHER INFORMATION

	Item 1.	Legal Proceedings	32

	Item 6.	Exhibits and Reports on Form 8-K	33

SEARS, ROEBUCK AND CO.
Condensed Consolidated Statements of Income
(Unaudited)

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements


				13 Weeks Ended						39 Weeks Ended

millions, except per common share data				Sept. 28,			Sept. 29,			Sept. 28,			Sept. 29,
				2002			2001			2002			2001

REVENUES
Merchandise sales and services				$	8,239		$	8,348		$	24,639		$	24,936
Credit and financial products revenues					1,430			1,382			4,209			3,834

	Total revenues				9,669			9,730			28,848			28,770

COSTS AND EXPENSES
Cost of sales, buying and occupancy					5,934			6,178			17,902			18,453
Selling and administrative					2,340			2,197			6,637			6,484
Provision for uncollectible accounts					603			377			1,685			929
Provision for previously securitized receivables					—			—			—			522
Depreciation and amortization					219			209			650			649
Interest					298			378			866			1,094
Special charges and impairments					—			—			111			287

	Total costs and expenses				9,394			9,339			27,851			28,418

Operating income					275			391			997			352
Other income, net					10			22			98			30

Income before income taxes and minority interest					285			413			1,095			382
Income taxes					(94	)		(150	)		(382	)		(136	)
Minority interest					(2	)		(1	)		23			(5	)

Income before cumulative effect of change in accounting principle					189			262			736			241
Cumulative effect of a change in accounting for goodwill					—			—			(208	)		—

NET INCOME				$	189		$	262		$	528		$	241

EARNINGS PER COMMON SHARE
	BASIC
		Earnings per share before cumulative effect of change in accounting principle		$	0.60		$	0.81		$	2.32		$	0.74
		Cumulative effect of change in accounting principle			—			—			(0.66	)		—

			Earnings per share	$	0.60		$	0.81		$	1.66		$	0.74

	DILUTED
		Earnings per share before cumulative effect of change in accounting principle			0.59		$	0.80		$	2.29		$	0.73
		Cumulative effect of change in accounting principle			—			—			(0.65	)		—

			Earnings per share	$	0.59		$	0.80		$	1.64		$	0.73

Cash dividends declared per common share				$	0.23		$	0.23		$	0.69		$	0.69

Average common and common equivalent shares outstanding					320.1			326.9			321.7			329.5

See accompanying notes.

SEARS, ROEBUCK AND CO.
Condensed Consolidated Balance Sheets


			(Unaudited)

			Sept. 28,			Sept. 29,			December 29,
millions			2002			2001			2001

ASSETS
Current assets
	Cash and cash equivalents		$	637		$	449		$	1,064
	Credit card receivables			30,810			27,841			29,321
		Less allowance for uncollectible accounts		1,676			1,121			1,166

		Net credit card receivables		29,134			26,720			28,155
	Other receivables			452			631			658
	Merchandise inventories			5,961			6,002			4,912
	Prepaid expenses and deferred charges			619			516			458
	Deferred income taxes			992			911			858

	Total current assets			37,795			35,229			36,105
Property and equipment, net				6,748			6,684			6,824
Deferred income taxes				502			256			415
Goodwill				940			291			294
Tradenames and other intangible assets				704			—			—
Other assets				1,314			828			679

	TOTAL ASSETS		$	48,003		$	43,288		$	44,317

LIABILITIES
Current liabilities
	Short-term borrowings		$	4,289		$	3,503		$	3,557
	Current portion of long-term debt and capitalized lease obligations			4,774			3,246			3,157
	Accounts payable and other liabilities			6,867			6,825			7,176
	Unearned revenues			1,189			1,130			1,136
	Other taxes			486			424			558

	Total current liabilities			17,605			15,128			15,584
Long-term debt and capitalized lease obligations				20,781			18,918			18,921
Postretirement benefits				1,592			1,812			1,732
Minority interest and other liabilities				1,811			1,299			1,961

	Total Liabilities			41,789			37,157			38,198

COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS’ EQUITY
Common shares				323			323			323
Capital in excess of par value				3,512			3,519			3,500
Retained earnings				7,723			6,991			7,413
Treasury stock — at cost				(4,489	)		(4,143	)		(4,223	)
Deferred ESOP expense				(42	)		(69	)		(63	)
Accumulated other comprehensive loss				(813	)		(490	)		(831	)

	Total Shareholders’ Equity			6,214			6,131			6,119

	TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	48,003		$	43,288		$	44,317

	Total common shares outstanding			317.4			322.1			320.4

See accompanying notes.

SEARS, ROEBUCK AND CO.
Condensed Consolidated Statements of Cash Flows
(Unaudited)


				39 Weeks Ended

				Sept. 28,			Sept. 29,
millions				2002			2001

CASH FLOWS FROM OPERATING ACTIVITIES
Net income				$	528		$	241
Adjustments to reconcile net income to net cash provided by (used in) operating activities
	Depreciation and amortization				650			649
	Cumulative effect of change in accounting principle				208			—
	Provision for uncollectible accounts				1,685			929
	Provision for previously securitized receivables				—			522
	Special charges and impairments				111			287
	Gain on sales of property and investments				(76	)		1
	Income tax benefit on nonqualified stock options				24			11
	Change in (net of acquisition):
		Deferred income taxes			(214	)		(81	)
		Retained interest in transferred credit card receivables			—			(759	)
		Credit card receivables			(2,640	)		1,065
		Merchandise inventories			(804	)		(420	)
		Other operating assets			126			153
		Other operating liabilities			(715	)		(1,135	)

			Net cash provided by (used in) by operating activities		(1,117	)		1,463

CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of businesses, net of cash acquired					(1,840	)		—
Proceeds from sales of property and investments					140			19
Purchases of property and equipment					(631	)		(859	)
Purchases of long-term investments					(12	)		(16	)

			Net cash used in investing activities		(2,343	)		(856	)

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt					5,055			2,855
Repayments of long-term debt					(2,257	)		(2,471	)
Increase (decrease) in short term borrowings, primarily 90 days or less					729			(761	)
Repayments of ESOP note receivable					8			33
Common shares repurchased					(427	)		(501	)
Common shares issued for employee stock plans					150			53
Dividends paid to shareholders					(220	)		(227	)

			Net cash provided by (used in) financing activities		3,038			(1,019	)

Effect of exchange rate changes on cash and cash equivalents					(5	)		19

NET DECREASE IN CASH AND CASH EQUIVALENTS					(427	)		(393	)

BALANCE AT BEGINNING OF YEAR					1,064			842

BALANCE AT END OF PERIOD				$	637		$	449

See accompanying notes.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

NOTE 1 — CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Condensed Consolidated Balance Sheets as of September 28, 2002 and September 29, 2001, the related Condensed Consolidated Statements of Income for the 13 and 39 weeks ended September 28, 2002 and September 29, 2001, and the Condensed Consolidated Statements of Cash Flows for the 39 weeks ended September 28, 2002 and September 29, 2001, are unaudited. The interim financial statements reflect all adjustments (consisting only of normal recurring accruals) which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Sears, Roebuck and Co. (the “Company” or “Sears”) 2001 Annual Report on Form 10-K. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

Certain reclassifications have been made to the 2001 financial statements to conform with the current year presentation.

NOTE 2 — ACQUISITION

On June 17, 2002, the Company acquired 100 percent of the outstanding common shares of Lands’ End, Inc. (“Lands’ End”). The results of Lands’ End’s operations have been included in the consolidated financial statements since that date. Headquartered in Dodgeville, Wisconsin, Lands’ End is a leading direct merchant of traditionally styled, casual clothing for men, women and children, accessories, footwear, home products, and soft luggage.

The Company acquired Lands’ End for $1.8 billion in cash. The acquisition has been accounted for using the purchase method in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”. Accordingly, the total purchase price has preliminarily been allocated to the assets acquired and liabilities assumed based on their estimated fair values at acquisition as follows (amounts in millions):


Merchandise inventories		$	238
Property and equipment			168
Intangible assets (primarily indefinite lived tradenames)			704
Goodwill			830
Other assets			66
Accounts payable and other liabilities			(166	)

	Total	$	1,840

The amount allocated to goodwill is reflective of the benefit the Company expects to realize from leveraging the Lands’ End brandname across its retail and credit businesses. The Company is in the process of finalizing the valuation of the fair value of assets and liabilities; therefore, the allocation of the purchase price is preliminary. The goodwill related to the Lands’ End acquisition is not deductible for tax purposes.

The following unaudited pro forma information presents the results of operations of the Company as if the Lands’ End acquisition had taken place at the beginning of each respective period. Pro forma adjustments have been made to reflect additional interest expense from the $1.8 billion in debt associated with the acquisition. The pro forma results of operations include $18 million of non-recurring transaction costs incurred by Lands’ End for the 39 weeks ended September 28, 2002.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)


			13 Weeks Ended				39 Weeks Ended

			Sept. 28,		Sept. 29,		Sept. 28,		Sept. 29,
millions, except per share data			2002		2001		2002		2001
					(Pro Forma)		(Pro Forma)		(Pro Forma)

Revenues			$	9,669	$	10,006	$	29,502	$	29,660
Income before cumulative effect of accounting change				189		246		703		202
Net income				189		246		495		202
Earnings per share:
	Basic
		Earnings per share		0.60		0.76		1.51		0.60
	Diluted
		Earnings per share		0.59		0.75		1.49		0.59

The unaudited pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that would have occurred had the Lands’ End acquisition occurred at the beginning of the respective periods.

NOTE 3 — ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS

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


millions		2002				2001

Beginning of year balance		$	1,166			$	686
First quarter activity:
	Provision for uncollectible accounts		381				191		(2)
	Net charge-offs		(385	)			(191	)	(2)
	Transfer to Securitization Master Trust		—				(83	)

First quarter ending balance			1,162				603
Second quarter activity:
	Provision for uncollectible accounts		701		(1)		361
	Provision for previously securitized receivables		—				522		(2)
	Net charge-offs		(378	)			(357	)

Second quarter ending balance			1,485				1,129
Third quarter activity:
	Provision for uncollectible accounts		603		(3)		377
	Net charge-offs		(412	)			(385	)

Third quarter ending balance		$	1,676			$	1,121

(1)		Includes provision of $300 million for a change in accounting estimate as a result of the refinement in method of determining allowance for uncollectible accounts discussed below.

(2)		In the first quarter of 2001, the Company’s securitization transactions were accounted for as sales of receivables as required by SFAS No. 125. As a result of the sale treatment, the provision for uncollectible accounts and net charge-offs were $153 million less in the quarter than they would have been had the receivables been owned. In the second quarter of 2001, the securitized receivables which had previously been considered sold were reconsolidated on to the Company’s balance sheet and a provision of $522 million was recorded to establish an allowance for uncollectible accounts for these receivables. See Note 5 for further discussion.
(3)		Includes provision of $189 million to increase domestic allowance for uncollectible accounts.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

In the second quarter of 2002, the Company refined its method of determining its allowance for uncollectible accounts. The Company periodically reviews its accounting practices to ensure that its adopted policies appropriately reflect changes in its businesses, the industries it operates in, and the regulatory and political environments. During the second quarter, the Company compared its methodology for computing the allowance for uncollectible accounts to the methodologies of participants in the bank card industry. The Company felt that a comparison to bank card issuers was appropriate given the growth of the Sears Gold MasterCard product (approximately $8.5 billion in balances at the end of the second quarter of 2002). The Company determined that practice in the industry was diverse and evolving, particularly in the areas of providing allowances for current accounts, finance charges and credit card fees. Also, during this review the Company became aware of new interpretive guidance that regulators were proposing to narrow the diversity in practice. As a result of its review, the Company refined its methodology for determining the uncollectible portion of current accounts and credit card fee balances, resulting in an increase to the allowance for uncollectible accounts in the amount of $300 million in the second quarter of 2002. In accordance with Accounting Principles Board Opinion No. 20, “Accounting Changes” the effect of this change in accounting was recorded as a change in accounting estimate in the second quarter of 2002.

NOTE 4 — BORROWINGS AND CAPITAL RESOURCES

Total borrowings outstanding at September 28, 2002 and September 29, 2001 were $29.8 billion and $25.7 billion, respectively. The increase compared with last year’s third quarter is due to additional debt issuances to fund the Lands’ End acquisition and credit card receivable growth. Total borrowings are presented on the balance sheet as follows:


		Sept. 28,			Sept. 29,			December 29,
millions		2002			2001			2001

Short-term borrowings		$	4,289		$	3,503		$	3,557

Long-term debt:
	Notes and debentures outstanding	$	13,323		$	13,216		$	12,787
	Securitizations		11,203			8,400			8,952
	Capital lease obligations		444			409			458
	SFAS No. 133 Hedge Accounting Adjustment (See Note 6)		585			139			(119	)
	Less current maturities		(4,774	)		(3,246	)		(3,157	)

Total long-term debt and capitalized lease obligations		$	20,781		$	18,918		$	18,921

The Company’s short-term borrowings consist primarily of unsecured commercial paper. The Company continues to provide support for 100% of its outstanding commercial paper through its investment portfolio and committed credit facilities with various banks. At September 2002, the Company had $4.8 billion in committed credit facilities of which $4.4 billion (for Sears U.S. operations) expires April 2003 and $0.4 billion (for Sears Canada) expires May 2003.

Additionally, in the first quarter 2002, the Company contractually established access to $1.5 billion via a syndicate of multi-seller, asset-backed commercial paper conduit programs sponsored by various banks. These purchase commitments have an original expiration date of March 2003, but are renewable at the mutual consent of the parties. As of September 28, 2002, the Company had utilized $200 million of this program. Subsequently, in October of 2002, the Company utilized an additional $800 million.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

NOTE 5 — SECURITIZATIONS

In September 2000, the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. The guidance in SFAS No. 140 superceded SFAS No. 125. Under SFAS No. 125, the Company’s securitization transactions were accounted for as sales of receivables. SFAS No. 140 established new conditions for a securitization to be accounted for as a sale of receivables. Specifically, SFAS No. 140 changed the requirements for an entity to be a qualifying special purpose entity and modified under what conditions a transferor has retained effective control over transferred assets. The new standard was effective for transfers occurring after March 31, 2001.

The addition of previously uncommitted assets to the securitization trust in April 2001 required the Company to consolidate the securitization structure for financial reporting purposes on a prospective basis. Accordingly, the Company recognized approximately $8.1 billion of previously unconsolidated securitized credit card receivables and related securitization borrowings in the second quarter of 2001. In addition, approximately $3.9 billion of assets were reclassified to credit card receivables from retained interest in transferred credit card receivables. The Company now accounts for securitizations as secured borrowings.

In connection with the consolidation of the securitization structure, the Company recognized a non-cash, pretax charge of $522 million to establish an allowance for uncollectible accounts related to the receivables which were previously considered as sold or accounted for as retained interests in transferred credit card receivables.

At September 28, 2002 and September 29, 2001, $17.3 billion and $11.7 billion, respectively, of domestic credit card receivables were segregated in securitization trusts. In addition, $861 million and $1.1 billion, respectively, of Sears Canada credit card receivables were segregated in securitization trusts.

NOTE 6 — DERIVATIVE FINANCIAL INSTRUMENTS AND FINANCIAL GUARANTEES

The Company utilizes derivative financial instruments as part of an overall risk management program designed to address certain financial exposures faced by the Company. The only significant derivative instruments the Company currently holds are interest rate swaps. As of September 28, 2002, the Company had interest rate swaps with an aggregate fair value of $649 million that have been used to synthetically convert certain of the Company’s domestic fixed rate debt to variable rate. The objective of this conversion is to achieve increased levels of variable rate funding to reflect the growth of variable rate receivable levels within the Company’s credit card receivables portfolio. The Company changed the finance charge on the Sears Card from fixed rate to variable rate in July 2002.

The Company’s interest rate swaps have been recorded on the balance sheet at fair value, classified as $649 million within other assets, which consists of a $585 million hedge adjustment to long-term debt and $64 million of accrued interest receivable. For accounting purposes, the swaps are designated and qualify as fair value hedges of certain of the Company’s fixed rate debt instruments. As the terms of the swaps are designed to match those of the underlying hedged debt, the change in fair value of the swaps is largely offset by changes in fair value recorded on the hedged debt. Consequently, the amount of hedge ineffectiveness recorded during 2002 and 2001 in connection with these hedges was not material and is reflected as a component of interest expense.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

NOTE 7 – SPECIAL CHARGES AND IMPAIRMENTS

Following is a summary of the 2002 activity in the reserves established in connection with the Company’s restructuring initiatives:


		Ending Reserve													Ending Reserve
millions		Balance 12/29/01		2002 Charges		Asset Write-Down			Cash Payments			Other Adjustments			Balance 09/28/02

	Sears Canada
	Employee termination costs	$	—	$	3	$	—		$	(3	)	$	1		$	1
	Contractual obligations and other costs		—		16		—			(13	)		(1	)		2
	Asset impairments		—		92		(92	)		—			—			—

			—		111		(92	)		(16	)		—			3
	Productivity Initiatives
	Employee termination costs		92		—		—			(57	)		—			35
	Contractual obligations and other costs		5		—		—			(1	)		—			4

			97		—		—			(58	)		—			39
	Product Category Exits
	Employee termination costs		7		—		—			(5	)		—			2
	Contractual obligations and other costs		65		—		—			(19	)		—			46

			72		—		—			(24	)		—			48
	2000 Store Closures
	Lease and holding costs		41		—		—			(11	)		—			30

			41		—		—			(11	)		—			30

	Total	$	210	$	111	$	(92	)	$	(109	)	$	—		$	120

Sears Canada

During the first quarter of 2002, Sears Canada announced a plan to convert the existing Eaton’s stores to the Sears Canada banner. In connection therewith, the Company recorded a charge of $111 million, before tax and minority interest, related to employee terminations, asset impairments and other exit costs. Of the $111 million charge, $92 million is to record asset impairments on fixtures and equipment in such facilities. The remaining $19 million is comprised of $16 million for contractual obligations and holding costs and $3 million for employee termination costs.

Productivity Initiatives

During the fourth quarter of 2001, the Company announced a series of strategic initiatives designed to revitalize its Full-line Stores and reduce operating expenses. In connection therewith, the Company recorded a pretax charge of $123 million related to employee termination, facility closing and other exit costs. Of the $123 million charge, $102 million was for employee termination costs associated with the planned elimination of 5,950 associate positions as part of this initiative. The positions to be eliminated included store support positions within the Company’s headquarters as well as positions within store and field operations. The remaining $21 million of productivity related charges was comprised of $13 million for contractual obligations and holding costs associated with certain support facilities to be vacated as a result of the plan, and $8 million to record asset impairments on fixtures and equipment in such facilities. As of December 29, 2001, $10 million and $8 million, respectively, of cash payments had been paid in connection with employee termination costs and contractual obligations, and $8 million of asset impairments were recorded. As of September 28, 2002, approximately 5,300 associates have been terminated as a result of this plan. The reserve balance of $39 million as of September 28, 2002 primarily represents severance costs for terminated associates who are receiving their severance benefits over a period of time and estimated costs for associates to be terminated in the fourth quarter of 2002.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

Product Category Exits

During 2001, the Company announced its decision to exit certain product categories within its Full-line Stores, including its skin care and color cosmetics, installed floor covering and custom window treatments businesses. In connection with these exits, the Company recorded pretax charges totaling $151 million during 2001. Of the $151 million charge, $106 million was recorded for the cost of settling contractual obligations to certain vendors and contractors and for other exit costs associated with the Company’s plan to discontinue these businesses, including incremental customer warranty claims liability to be incurred by the Company in the absence of ongoing relationships with certain product manufacturers. Also included within the $151 million charge were asset impairment charges of $38 million, primarily reflecting the write-down of store fixtures within the exited businesses to their estimated fair value and $7 million of employee termination costs. The reserve balance of $48 million as of September 28, 2002 primarily represents future incremental customer warranty costs.

2000 Store Closures

In December 2000, the Company announced the planned closure of 87 under-performing stores consisting of 53 National Tire and Battery, 30 Hardware and four Full-line Stores (including two Sears Auto Centers). As of September 28, 2002, all 87 stores have been closed. The reserve balance of $30 million as of September 28, 2002 represents estimated future lease obligations and holding costs.

NOTE 8 – SHAREHOLDERS’ EQUITY

Dividend Payments

Under terms of indentures entered into in 1981 and thereafter, the Company cannot take specified actions, including the declaration of cash dividends, that would cause its unencumbered assets, as defined, to fall below 150% of its liabilities, as defined. At September 28, 2002, approximately $7.6 billion could be paid in dividends to shareholders under the most restrictive indentures.

Share Repurchase Program

The Company repurchased common shares during 2002 and 2001 under common share repurchase programs approved by the Board of Directors. A summary of share repurchase activity is as follows (all amounts in millions):


	Shares		Cost

First quarter 2002		8.2	$	427
Second quarter 2002		—		—
Third quarter 2002		—		—

Year to date		8.2	$	427

First quarter 2001		4.3	$	168
Second quarter 2001		6.1		232
Third quarter 2001		3.0		101

Year to date		13.4	$	501

As of September 28, 2002 the Company has remaining authorization to repurchase $1.25 billion of shares by December 31, 2004 under the existing share repurchase program.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

Comprehensive Income (Loss) and Accumulated Other Comprehensive Loss

The following table shows the computation of comprehensive income (loss):


		13 Weeks Ended						39 Weeks Ended

		Sept. 28,			Sept. 29,			Sept. 28,			Sept. 29,
millions		2002			2001			2002			2001

	Net income	$	189		$	262		$	528		$	241
	Other comprehensive income (loss):
	After tax cumulative effect of a change in
	accounting for derivatives		—			—			—			(262	)
	Amounts amortized into interest expense from OCI		4			5			12			13
	Change in fair value of cash flow hedges		2			—			(1	)		34
	Unrealized gain (loss) on investments		—			(1	)		—			4
	Foreign currency translation adjustments		(23	)		(23	)		7			(30	)

	Total other comprehensive income (loss)		(17	)		(19	)		18			(241	)

	Total comprehensive income	$	172		$	243		$	546		$	—

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


	Sept. 28,			Sept. 29,			December 29,
millions	2002			2001			2001

Accumulated derivative loss	$	(200	)	$	(215	)	$	(211	)
Unrealized gain on securities held, net of tax		—			5			—
Currency translation adjustments		(148	)		(148	)		(155	)
Minimum pension liability, net of tax (1)		(465	)		(132	)		(465	)

Accumulated other comprehensive loss	$	(813	)	$	(490	)	$	(831	)

(1)

Minimum pension liability is calculated annually in the fourth quarter. Changes thereto are recorded at that time.

NOTE 9 — OTHER INCOME

Consolidated other income consists of:


	13 Weeks Ended				39 Weeks Ended

millions	Sept. 28,		Sept. 29,		Sept. 28,		Sept. 29,
	2002		2001		2002		2001

Gain on sales of property and investments	$	—	$	—	$	76	$	1
Equity income in unconsolidated companies		10		10		17		17
Sears Mexico dividend		—		12		5		12

Total	$	10	$	22	$	98	$	30

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

NOTE 10 — IMPLEMENTATION OF NEW ACCOUNTING STANDARD

Effective at the beginning of 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets”. Upon adoption of SFAS No. 142, goodwill amortization ceased. Goodwill is now subject to fair-value based impairment tests performed, at a minimum, on an annual basis. In addition, a transitional goodwill impairment test is required as of the adoption date. These impairment tests are conducted on each business of the Company where goodwill is recorded, and may require two steps. The initial step is designed to identify potential goodwill impairment by comparing an estimate of fair value for each applicable business to its respective carrying value. For those businesses where the carrying value exceeds fair value, a second step is performed to measure the amount of goodwill impairment in existence, if any.

The Company had approximately $371 million in positive goodwill and $77 million in negative goodwill recorded in its consolidated balance sheet at the beginning of 2002. The $77 million in negative goodwill was required to be de-recognized upon adoption of the Statement. The Company completed the required transitional goodwill impairment test in the first quarter of 2002 and determined that $261 million of goodwill recorded within the Company’s Retail and Related Services segment, primarily related to NTB and Orchard Supply Hardware, was impaired under the fair value impairment test approach required by SFAS No. 142.

The fair value of these reporting units was estimated using the expected present value of associated future cash flows and market values of comparable businesses where available. Upon adoption of the Statement, a $208 million charge, net of tax and minority interest, was recognized in the first quarter of 2002 to record this impairment as well as the removal of negative goodwill and was classified as a cumulative effect of a change in accounting principle.

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


							13 Weeks Ended											Year Ended

million, except earnings (loss) per
common share				Dec. 29, 2001			Sept. 29, 2001			June 30, 2001			Mar. 31, 2001			Dec. 29, 2001			Dec. 30, 2000			Jan. 1, 2000

Reported net income (loss)				$	494		$	262		$	(197	)	$	176		$	735		$	1,343		$	1,453
Add back:
	Negative goodwill amortization				(3	)		(4	)		(3	)		(4	)		(14	)		(15	)		—
	Positive goodwill amortization				5			5			5			5			20			24			24

Pro forma net income (loss)				$	496		$	263		$	(195	)	$	177		$	741		$	1,352		$	1,477

Earnings per common share
	Basic earnings (loss) per share:
		Reported net income (loss)		$	1.53		$	0.81		$	(0.60	)	$	0.53		$	2.25		$	3.89		$	3.83
			Goodwill amortization		0.01			—			0.01			—			0.02			0.03			0.06

			Pro forma net income (loss)	$	1.54		$	0.81		$	(0.59	)	$	0.53		$	2.27		$	3.92		$	3.89

Diluted earnings (loss) per share:
		Reported net income (loss)		$	1.52		$	0.80		$	(0.60	)	$	0.53		$	2.24		$	3.88		$	3.81
			Goodwill amortization		0.01			—			0.01			—			0.02			0.03			0.06

			Pro forma net income (loss)	$	1.53		$	0.80		$	(0.59	)	$	0.53		$	2.26		$	3.91		$	3.87

Average common shares outstanding					322.6			324.5			326.6			331.8			326.4			345.1			379.2
Average common and common equivalent shares outstanding					325.5			326.9			326.6			333.5			328.5			346.3			381.0

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

The changes in the carrying amount of goodwill as of September 28, 2002, are as follows:


			Retail and Related			Credit and		Corporate and
millions			Services			Financial Products		Other		Sears Canada			Total

Balance as of December 29, 2001			$	291		$	2	$	61	$	(60	)	$	294
	Cumulative effect of adopting SFAS No. 142:
		Impairment loss recognized		(261	)		—		—		—			(261	)
	Elimination of negative goodwill			—			—		—		77			77
	Acquisition of Lands’ End			830			—		—		—			830

Balance as of September 28, 2002			$	860		$	2	$	61	$	17		$	940

NOTE 11 — EARNINGS PER SHARE

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


	13 Weeks Ended				39 Weeks Ended

	Sept. 28,		Sept. 29,		Sept. 28,		Sept. 29,
millions, except per share data	2002		2001		2002		2001

Net income (1)	$	189	$	262	$	528	$	241
Average common shares outstanding		317.1		324.5		317.4		327.6

Earnings per share – basic	$	0.60	$	0.81	$	1.66	$	0.74
Dilutive effect of stock options		3.0		2.4		4.3		1.9
Average common and common equivalent shares outstanding		320.1		326.9		321.7		329.5

Earnings per share – diluted	$	0.59	$	0.80	$	1.64	$	0.73

(1)

Net income is the same for purposes of calculating basic and diluted EPS.

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


	13 Weeks Ended				39 Weeks Ended

	Sept. 28,		Sept. 29,		Sept. 28,		Sept. 29,
millions, except per share data	2002		2001		2002		2001

Income before cumulative effect of accounting change (1)	$	189	$	262	$	736	$	241
Average common shares outstanding		317.1		324.5		317.4		327.6

Earnings per share – basic	$	0.60	$	0.81	$	2.32	$	0.74
Dilutive effect of stock options		3.0		2.4		4.3		1.9
Average common and common equivalent shares outstanding		320.1		326.9		321.7		329.5

Earnings per share – diluted	$	0.59	$	0.80	$	2.29	$	0.73

(1)

Income before cumulative effect of accounting change is the same for purposes of calculating basic and diluted EPS.

In each period, certain options were excluded from the computation of diluted earnings per share because they would have been anti-dilutive. At September 28, 2002, options to purchase 5.9 and 4.4 million common shares at prices ranging from $46 to $64 and $51 to $64 per share were excluded from the 13 and 39 week 2002 calculations, respectively. At September 29, 2001, options to purchase 6.4 and 9.8 million common shares at prices ranging from $43 to $64 and $40 to $64 per share were excluded from the 13 and 39 week 2001 calculations, respectively.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

NOTE 12 — EFFECT OF NEW ACCOUNTING STANDARDS NOT YET ADOPTED

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement changes the timing of recognition for certain exit costs associated with restructuring activities, so that certain exit costs would be recognized over the period in which the restructuring activities occur. Currently exit costs are recognized when the Company commits to a restructuring plan. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002 and could result in the Company recognizing the cost of future restructuring activities over a period of time as opposed to as a single event.

NOTE 13 – LEGAL PROCEEDINGS

On October 18, 2002, a lawsuit was filed in the United States District Court for the Northern District of Illinois against the Company and certain current and former officers alleging that certain public announcements by the Company concerning its credit card business violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Additional lawsuits of the same tenor followed. The plaintiffs purport to represent classes of shareholders who purchased the Company’s common shares between January 17, 2002, and October 17, 2002, a purported derivative suit was filed in the Supreme Court of the State of New York against the Company (as a nominal defendant) and certain current and former directors seeking damages on behalf of the Company. The complaint purports to allege a breach of fiduciary duty by the directors with respect to the Company’s management of its credit business. A like suit was subsequently filed in the Circuit Court of Cook County. Another purported derivative suit, brought against the Company (as a nominal defendant) and certain current and former directors and officers, was subsequently filed in the United States District Court for the North District of Illinois. The Company believes these claims lack merit and intends to defend against them vigorously.

The Company is subject to various other legal and governmental proceedings, many involving litigation incidental to the businesses. Some matters contain class action allegations, 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, the ultimate liability in excess of reserves currently recorded is not expected to have a material effect on annual results of operations, financial position, liquidity or capital resources of the Company.

NOTE 14 — SEGMENT DISCLOSURES

The Company reports its business segments’ results excluding the effects of noncomparable items and securitization income. The Company believes this presentation facilitates the understanding of the results and trends affecting each segment’s core operations. This presentation is consistent with how the Company reports results internally to senior management and the Board of Directors. The Company defines noncomparable items as transactions that are one-time in nature, related to the implementation of special initiatives of the Company (generally special charges and impairments); unusual or infrequent in nature (e.g. significant one-time transactions, significant gains/losses on transactions unrelated to core operations); or related to changes in accounting.

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

The following tables set forth operating results and total assets by segment:

For the 13 weeks ended September 28, 2002


			Retail and Related		Credit and		Corporate and					Consolidated
millions			Services		Financial Products		Other			Sears Canada		GAAP

Merchandise sales and services			$	7,261	$	—	$	91		$	887	$	8,239
Credit and financial products revenues				—		1,363		—			67		1,430

	Total revenues			7,261		1,363		91			954		9,669
Costs and expenses
	Cost of sales, buying and occupancy			5,266		—		33			635		5,934
	Selling and administrative			1,752		233		106			249		2,340
	Provision for uncollectible accounts			—		588		—			15		603
	Depreciation and amortization			180		4		11			24		219
	Interest			21		254		—			23		298

		Total costs and expenses		7,219		1,079		150			946		9,394

Operating income (loss)			$	42	$	284	$	(59	)	$	8	$	275

Total assets			$	12,883	$	29,430	$	2,461		$	3,229	$	48,003

For the 13 weeks ended September 29, 2001


			Retail and Related		Credit and		Corporate and
millions			Services		Financial Products		Other			Sears Canada			Consolidated GAAP

Merchandise sales and services			$	7,310	$	—	$	108		$	930		$	8,348
Credit and financial products revenues				—		1,309		—			73			1,382

	Total revenues			7,310		1,309		108			1,003			9,730
Costs and expenses
	Costs of sales, buying and occupancy			5,432		—		48			698			6,178
	Selling and administrative			1,620		202		125			250			2,197
	Provision for uncollectible accounts			—		366		—			11			377
	Depreciation and amortization			169		5		15			20			209
	Interest			7		343		—			28			378

		Total costs and expenses		7,228		916		188			1,007			9,339

Operating income (loss)				82		393		(80	)		(4	)		391

Goodwill amortization expense				4		—		1			(6	)		(1	)

Operating income (loss) excluding amortization expense			$	86	$	393	$	(79	)	$	(10	)	$	390

Total assets			$	11,676	$	26,245	$	1,990		$	3,377		$	43,288

SEARS, ROEBUCK AND CO.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

For the 39 weeks ended September 28, 2002


			Retail and		Credit and		Corporate							Non-			Consoli-
			Related		Financial		and			Sears				comparable			dated
millions			Services		Products		Other			Canada		Total		items			GAAP

Merchandise sales and services			$	21,728	$	—	$	241		$	2,670	$	24,639	$	—		$	24,639
Credit and financial products revenues				—		4,002		—			207		4,209		—			4,209

	Total revenues			21,728		4,002		241			2,877		28,848		—			28,848
Costs and expenses
	Cost of sales, buying and occupancy			15,873		—		89			1,940		17,902		—			17,902
	Selling and administrative			4,880		725		310			722		6,637		—			6,637
	Provision for uncollectible accounts			—		1,352		—			33		1,385		300			1,685
	Depreciation and amortization			524		14		39			73		650		—			650
	Interest			22		772		—			72		866		—			866
	Special charges and impairments			—		—		—			—		—		111			111

		Total costs and expenses		21,299		2,863		438			2,840		27,440		411			27,851

Operating income (loss)			$	429	$	1,139	$	(197	)	$	37	$	1,408	$	(411	)	$	997

Total assets			$	12,883	$	29,430	$	2,461		$	3,229	$	48,003

For the 39 weeks ended September 29, 2001


			Retail and		Credit and		Corporate												Non-
			Related		Financial		and			Sears						Securitization			comparable			Consolidated
millions			Services		Products		Other			Canada			Total			Impact			Items			GAAP

Merchandise sales and services			$	21,876	$	—	$	304		$	2,756		$	24,936		$	—		$	—		$	24,936
Credit and financial products revenues				—		3,885		—			224			4,109			(275	)		—			3,834

	Total revenues			21,876		3,885		304			2,980			29,045			(275	)		—			28,770
Costs and expenses
	Costs of sales, buying and occupancy			16,259		—		131			2,063			18,453			—			—			18,453
	Selling and administrative			4,827		608		347			741			6,523			(39	)		—			6,484
	Provision for uncollectible accounts			—		1,050		—			32			1,082			(153	)		—			929
	Provision for previously securitized receivables			—		—		—			—			—			—			522			522
	Depreciation and amortization			530		14		44			61			649			—			—			649
	Interest			21		1,110		—			86			1,217			(123	)		—			1,094
	Special charges and impairments			—		—		—			—			—			—			287			287

		Total costs and expenses		21,637		2,782		522			2,983			27,924			(315	)		809			28,418

Operating income (loss)				239		1,103		(218	)		(3	)		1,121			40			(809	)		352

Goodwill amortization expense				13		—		2			(19	)		(4	)		—			—			(4	)

Operating income (loss) excluding amortization expense			$	252	$	1,103	$	(216	)	$	(22	)	$	1,117		$	40		$	(809	)	$	(348	)

Total assets			$	11,676	$	26,245	$	1,990		$	3,377		$	43,288

SEARS, ROEBUCK AND CO.

INDEPENDENT ACCOUNTANTS’ REPORT

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

We have reviewed the accompanying Condensed Consolidated Balance Sheets of Sears, Roebuck and Co. as of September 28, 2002 and September 29, 2001, and the Condensed Consolidated Statements of Income for the 13-week and 39-week periods ended September 28, 2002 and September 29, 2001 and the Condensed Consolidated Statements of Cash Flows for the 39-week periods ended September 28, 2002 and September 29, 2001. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the Consolidated Balance Sheet of Sears, Roebuck and Co. as of December 29, 2001, and the related Consolidated Statements of Income, Shareholders’ Equity, and Cash Flows for the year then ended (not presented herein); and in our report dated February 8, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying Condensed Consolidated Balance Sheet as of December 29, 2001 is fairly stated, in all material respects, in relation to the Consolidated Balance Sheet from which it has been derived.

/s/ DELOITTE & TOUCHE LLP

Deloitte & Touche LLP

Chicago, Illinois
November 5, 2002

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

Item 2. Management’s Discussion and Analysis of Operations, Financial Condition and Liquidity

ANALYSIS OF OPERATIONS

Operating results for the Company are reported for three domestic segments and Sears Canada. The domestic segments include the Company’s operations in the United States and Puerto Rico. The Company’s segments are defined as follows:


•	Retail and Related Services consisting of:

-	Full-line Stores (includes operations of Sears Auto Centers and online revenues of Sears.com).

-	Specialty Stores (Dealer Stores, Hardware Stores, National Tire and Battery, The Great Indoors, Commercial Sales and Outlet stores).

-	Related Services comprised of:

	•	Sears Product Repair Services (a broad range of services including service contracts, product installation and repair services primarily for products sold by the Company).

	•	Direct to Customer (direct marketing of goods and services, clubs and services memberships, merchandise through specialty catalogs and impulse and continuity merchandise). Includes Lands’ End results as of June 17, 2002.


•	Credit and Financial Products includes domestic credit card operations and related financial product offerings (credit protection and insurance products).

•	Corporate and Other includes:

-	Activities that are of an overall holding company nature, primarily consisting of administrative activities, the costs of which are not allocated to the Company’s businesses.

-	Sears Home Improvement Services (including Sears Termite and Pest Control for the 39 weeks ended September 29, 2001).

•	Sears Canada conducts similar retail, credit, and corporate operations in Canada through Sears Canada Inc. (“Sears Canada”), a consolidated, 54.4% owned subsidiary of Sears.

Basis of Presentation

The Company has presented the following discussion of results of operations by business segment. The Company reports its business segments’ results excluding the effects of noncomparable items and securitization income. The Company believes this presentation facilitates the understanding of the results and trends affecting each segment’s core operations. This presentation is consistent with how the Company reports results internally to senior management and the Board of Directors.

All references to earnings per share relate to diluted earnings per common share.

On June 17, 2002 the Company acquired all of the outstanding shares of Lands’ End, Inc. (“Lands’ End”) for approximately $1.8 billion. The results of Lands’ End operations have been reflected in the consolidated financial statements since that date. See Note 2 of the Condensed Consolidated Financial Statements for further discussion.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

Description of Noncomparable Items

For the 13 weeks ended September 28, 2002, the Company reported net income of $189 million, or $0.59 per share, compared to net income of $262 million, or $0.80 per share, in the comparable 2001 period. For the 39 weeks ended September 28, 2002, the Company reported net income of $528 million, or $1.64 per share, compared to net income of $241 million, or $0.73 per share. Results of operations for the 39 week periods ended September 28, 2002 and September 29, 2001 were affected by noncomparable items. The effect of noncomparable items on net income and earnings per share are summarized in the table below.


millions, except earnings per share					13 Weeks Ended									39 Weeks Ended

			Net Income					Earnings Per Share				Net Income						Earnings Per Share

			Sept. 28,			Sept. 29,		Sept. 28,		Sept. 29,		Sept. 28,			Sept. 29,			Sept. 28,			Sept. 29,
			2002			2001		2002		2001		2002			2001			2002			2001

Net income excluding noncomparable items			$	189		$	262	$	0.59	$	0.80	$	909		$	728		$	2.83		$	2.21
Special charges and impairments:
		Sears Canada — Eaton’s conversion costs		—			—		—		—		(40	)		—			(0.13	)		—
		Homelife closure and other		—			—		—		—		—			(129	)		—			(0.39	)
		Exit of cosmetics business		—			—		—		—		—			(53	)		—			(0.16	)
Effect of accounting changes:
		Effect of change in accounting for goodwill		—			—		—		—		(208	)		—			(0.65	)		—
		Effect of change in estimate for the allowance for uncollectible accounts		—			—		—		—		(191	)		—			(0.59	)		—
		Provision for previously securitized receivables		—			—		—		—		—			(331	)		—			(1.01	)
	Securitization income			—			—		—		—		—			26			—			0.08
Unusual/infrequent items:
	Advance Auto Parts gain			—			—		—		—		58			—			0.18			—
Net income as reported			$	189		$	262	$	0.59	$	0.80	$	528		$	241		$	1.64		$	0.73

The Company defines noncomparable items as transactions that are one-time in nature, related to the implementation of special initiatives of the Company (generally special charges and impairments); unusual or infrequent in nature (e.g. significant one-time transactions, significant gains/losses on transactions unrelated to core operations); or related to changes in accounting. Following is a description of the noncomparable items affecting the 39 week periods ended September 28, 2002 and September 29, 2001.

2002 Items:

In February 2002, Sears Canada announced its intention to convert the remaining seven Eaton’s stores to the Sears Canada banner. The conversion of the stores was completed at the end of July 2002. This decision will enable the Company to better leverage its buying and advertising efforts, and take better advantage of the Sears brand’s equity. The Company recorded a one-time, pretax charge of $111 million ($40 million after-tax and minority interest) in the first quarter of 2002 related to the conversions. See Note 7 of the Notes to Condensed Consolidated Financial Statements for further discussion.

In the first quarter of 2002, the Company recorded a non-cash charge of $208 million, net of tax and minority interest due to the adoption of a new accounting standard, SFAS No. 142, “Goodwill and Other Intangible Assets”. This charge was reported as a cumulative effect of an accounting change. See Note 10 of the Notes to Condensed Consolidated Financial Statements for further discussion.

In the second quarter of 2002, the Company refined its method of determining its allowance for uncollectible accounts, resulting in a pretax charge of $300 million ($191 million after-tax). In accordance with Accounting Principles Board Opinion No. 20, “Accounting Changes”, the effect of this change in accounting has been recorded as a change in accounting estimate in the second quarter. See Note 3 of the Notes to Condensed Consolidated Financial Statements for further discussion.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

On March 6, 2002, as part of an Advance Auto Parts (“AAP”) public stock offering, the Company sold approximately 3.1 million of its AAP shares, which reduced the company’s ownership percentage to 24.1%. The Company realized a pretax gain of $71 million ($58 million after-tax) from the sale. This transaction generated after-tax cash proceeds of $110 million. In October 2002, the Company notified AAP that it was exercising its right to demand registration of the remaining 8.4 million AAP shares it owns in order to sell them. The Company’s remaining interest in AAP has a market value of approximately $450 million as of October 28, 2002.

2001 Items:

During the second quarter of 2001, the Company recorded a pretax charge of $205 million ($129 million after-tax) to recognize a loss on its formerly owned Homelife business and write-off a minor investment. Homelife, which was sold to Citicorp Venture Capital, Ltd. in early 1999, filed for bankruptcy on July 16, 2001. As a result of Homelife’s insolvency, the Company recognized certain obligations (primarily related to property leases) which had been previously transferred to Homelife and recorded a reserve for other matters related to Homelife for which Sears incurred losses.

The Company also recorded a pretax charge of $82 million ($53 million after-tax) in the second quarter of 2001 in connection with its exit of the skin care and color cosmetics business. The charge includes asset write-downs and vendor cancellation payments.

During the second quarter of 2001, the Company recorded a non-cash, pretax charge of $522 million ($331 million after-tax) to establish an allowance for uncollectible accounts related to $12 billion of securitized credit card receivables reinstated on the Company’s balance sheet as a result of the Company’s adoption of SFAS No. 140 in April 2001 (see Note 5 of the Notes to Condensed Consolidated Financial Statements). In addition, effective in the second quarter of 2001, the Company’s securitization transactions are accounted for as secured borrowings and the Company ceased recording securitization income. As such, securitization income reported in prior periods is noncomparable subsequent to March 2001. After-tax securitization income of $26 million was recorded in first quarter 2001 net income.

Analysis of Consolidated Results

For the 13 weeks ended September 28, 2002, net income was $189 million, or $0.59 per share, as compared to $262 million, or $0.80 per share, for the comparable 2001 period. For the 39 weeks ended September 28, 2002, net income was $528 million, or $1.64 per share, compared to $241 million, or $0.73 per share, for the comparable 2001 period. Excluding noncomparable items and securitization income, net income for the 39 weeks ended September 28, 2002 was $909 million, or $2.83 per share, compared to $728 million, or $2.21 per share, for the comparable 2001 period.

For the 13 week period, the decrease in earnings per share reflects lower operating income in the Retail and Related Services and Credit and Financial Products segments offset slightly by lower Corporate and Other expenses and by operating income improvements at Sears Canada. For the 39 week period, the increase in earnings per share primarily reflects higher operating income in the Retail and Related Services segment as well as a reduction in shares outstanding due to the Company’s share repurchase program.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

Interest expense is combined with the funding costs on receivables sold through securitizations to represent total funding costs as follows:


millions		13 Weeks Ended				39 Weeks Ended

		Sept. 28,		Sept. 29,		Sept. 28,		Sept. 29,
		2002		2001		2002		2001

Domestic
	Interest expense	$	275	$	350	$	794	$	1,008
	Funding cost on securitized receivables⁽¹⁾		—		—		—		123

Total domestic funding costs			275		350		794		1,131
Sears Canada			23		28		72		86

Total funding costs		$	298	$	378	$	866	$	1,217

⁽¹⁾

Beginning in the second quarter of 2001, funding costs on securitized receivables are included in the domestic segment interest expense.

Total funding costs decreased by $80 million for the 13 week period ended September 28, 2002 as compared to the prior year period primarily due to the Company’s increased use of variable rate financing coupled with the lower interest rate environment offset slightly by the additional debt issued to acquire Lands’ End and fund credit card receivables growth. The shift to more variable rate funding is in response to the growth of variable rate receivables within the credit card portfolio (primarily the Sears Gold MasterCard product) and the Company’s conversion of Sears Card finance charges from fixed rate to variable rate in July 2002. The increase in variable rate funding was achieved primarily by using interest rate swaps to synthetically convert fixed rate debt to variable rate and by issuance of variable rate debt.

Excluding noncomparable items, the Company’s consolidated effective tax rate for the 13 and 39 weeks ended September 28, 2002 was 33.0% and 34.9%, respectively, compared to 36.3% and 35.6% in the comparable prior year period. The decrease in rate for the 13 and 39 weeks ended September 28, 2002 from the comparable prior year period is primarily due to a favorable settlement of a state income tax audit during the third quarter of 2002.

Due to holiday buying patterns, merchandise sales are traditionally higher in the fourth quarter than other quarterly periods and a disproportionate share of operating income is typically earned in the fourth quarter. This business seasonality results in performance for the 13 and 39 weeks ended September 28, 2002 which is not necessarily indicative of performance for the balance of the year.

Retail and Related Services

Retail and Related Services, excluding noncomparable items, results are as follows:


		13 Weeks Ended						39 Weeks Ended

millions		Sept. 28,		Sept. 29,				Sept. 28,		Sept. 29,
		2002		2001				2002		2001

Full-line Stores revenues (includes sears.com)		$	5,095	$	5,550	-8.2	%	$	15,796	$	16,675	-5.3	%
Specialty Stores revenues			1,261		1,176	7.2	%		3,819		3,500	9.1	%
Related Services revenues			905		584	55.0	%		2,113		1,701	24.2	%

	Total Retail and Related Services revenues	$	7,261	$	7,310	-0.7	%	$	21,728	$	21,876	-0.7	%

Cost of sales, buying and occupancy			5,266		5,432				15,873		16,259
Selling and administrative			1,752		1,620				4,880		4,827
Depreciation and amortization			180		169				524		530
Interest expense			21		7				22		21

	Total costs and expenses		7,219		7,228				21,299		21,637

Operating income		$	42	$	82			$	429	$	239

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

Following is a summary of related information:


			Total Number of Stores				2002 Comparable Store Sales

			Sept. 28,		Sept. 29,
			2002		2001		13 Weeks			39 Weeks

Full-line Stores				872		861		-8.2	%		-6.0	%
		Hardlines						-4.3	%		-2.5	%
		Softlines						-16.4	%		-13.5	%
Specialty Stores				1,299		1,310		0.3	%		1.6	%

	Total			2,171		2,171		-6.9	%		-4.8	%

For purposes of determining comparable store sales, a store is considered to be comparable at the beginning of the thirteenth month after the store is opened.

Full-line Store total and comparable revenues for the 13 and 39 weeks ended September 28, 2002 were negatively impacted by the store level disruption caused by the Full-line Store repositioning and remodeling initiatives, which were at their height during the third quarter of 2002. Revenue results in most categories were negatively impacted by the store level disruptions, decreases in advertising expenditures, as well as slower consumer spending due to the softening U.S. economy. In Softlines, all apparel, home fashions and fine jewelry categories experienced revenue declines. In addition, the Company’s exit of the skin care and color cosmetics, installed floor covering and custom window treatments business during the second half of 2001 also contributed to the revenue declines in Softlines. In Hardlines, continued increases in home appliances, home fitness and game room sales were more than offset by declines in home office, home electronics and home improvement revenues.

The Company expects improving comparable store revenue trends in its Full-line Stores in 2003, due to the expected positive impacts of its initiatives to improve its merchandise offerings and enhance the customer shopping experience. The Company is improving its apparel merchandise offerings with the introduction of the Covington brand in 543 stores and the launch of Lands’ End in 184 stores for the holiday selling season. The installation of the center-aisle cash wraps in all Full-line Stores is completed, and progress has been made in implementing uniform merchandise presentation standards and universal fixtures. However, future retail revenues, especially big-ticket items, could be negatively affected by the condition of the U.S. economy.

Specialty Store revenues for the 13 and 39 weeks ended September 28, 2002 benefited from the addition of eight new The Great Indoors stores since the third quarter of last year. The Company plans to open two new stores under this format in 2003. Dealer Store revenues benefited from comparable store sales increases of 4.6% and 5.7%, respectively, for the 13 and 39 weeks ended September 28, 2002. Comparable store sales declined at National Tire and Battery during the third quarter of 2002 as the prior year quarter benefited from the Firestone tire recall.

The revenue increases in the Related Services business during the 13 and 39 weeks ended September 28, 2002 are primarily due to the inclusion of Lands’ End results since June 17, 2002, its date of acquisition. In addition, Sears Product Repair Services revenues increased during both periods due to a recent agreement to provide repair services to an appliance manufacturer and the 39 week period benefited from a vendor product recall.

Retail and Related Services gross margin as a percentage of Retail and Related Services revenues for the third quarter of 2002 improved to 27.5%, an increase of 180 basis points from the third quarter of 2001. The improvement primarily reflects margin improvements within Full-line stores Hardlines, the Specialty Store formats, and the inclusion of Lands’ End results in the third quarter of 2002 as Lands’ End has a higher margin rate than the overall segment. The margin improvements are primarily due to benefits from improved sourcing costs, editing assortments to reduce lower margin products, favorable inventory positions and a decrease in promotional markdown activity. The gross margin rate for Softlines was unfavorable to the prior year quarter as benefits from improved sourcing costs were more than offset by an increase in promotional activity. For the 39 week period, Retail and Related Services gross margin increased 120 basis points.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

Retail and Related Services selling and administrative expenses for the third quarter of 2002 increased 8% from the comparable 2001 period primarily due to the addition of Lands’ End, as well as increased investment in The Great Indoors to support the additional eight stores. Selling and administrative expense as a percentage of Retail and Related Services revenues for the third quarter of 2002 increased to 24.1% from 22.2% in the third quarter of 2001. The increase is reflective of decreased expense leverage in a slower sales environment and the inclusion of Lands’ End which has a higher expense rate than the overall segment. For the 39 week period, Retail and Related Services selling and administrative expense increased only 1% as Lands’ End activity is only included since June 17, 2002.

The increase in interest expense for the third quarter of 2002 is due to the debt issued to fund the acquisition of Lands’ End.

For the 13 week period ended September 28, 2002, operating income declined by $40 million from the comparable prior year period as improvements in margin were more than offset by a decline in revenues and an increase in interest expense. For the 39 week period ended September 28, 2002, operating income improved $190 million from the comparable prior year period as lower revenues and decreased expense leverage were more than offset by margin improvements and cost savings from the Company’s productivity initiatives.

This discussion excludes the impact of noncomparable items related to this segment which would have reduced consolidated operating income by $287 million for the 39 week period ended September 29, 2001. See “Description of Noncomparable Items”.

Credit and Financial Products

Credit and Financial Products results, excluding noncomparable items, are as follows:


		13 Weeks Ended				39 Weeks Ended

millions		Sept. 28,		Sept. 29,		Sept. 28,		Sept. 29,
		2002		2001		2002		2001

Credit and financial products revenues		$	1,363	$	1,309	$	4,002	$	3,885

Selling and administrative			233		202		725		608
Provision for uncollectible accounts			588		366		1,352		1,050
Depreciation and amortization			4		5		14		14
Interest			254		343		772		1,110

	Total costs and expenses		1,079		916		2,863		2,782

Operating income		$	284	$	393	$	1,139	$	1,103

A summary of Credit information is as follows:


		13 Weeks Ended						39 Weeks Ended

		Sept. 28,			Sept. 29,			Sept. 28,			Sept. 29,
		2002			2001			2002			2001

Credit share ⁽¹⁾			46.0	%		48.8	%		44.9	%		47.6	%
Average account balance (as of Sept. 28, 2002 and Sept. 29, 2001) (dollars):
	Sears Card							$	1,240		$	1,156
	Sears Gold MasterCard							$	1,510		$	1,200
	Total							$	1,327		$	1,161
Sears Card portfolio yield			19.75	%		19.91	%		19.68	%		19.56	%
Sears Gold MasterCard portfolio yield			15.26	%		14.31	%		15.05	%		14.25	%
	Total portfolio yield		18.26	%		19.34	%		18.42	%		19.16	%

⁽¹⁾

Credit share is the percentage of retail sales, excluding Lands’ End, Orchard Supply Hardware and National Tire and Battery, paid for with a Sears credit product (Sears Card or MasterCard).

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001


			13 Weeks Ended										39 Weeks Ended

millions	Sept. 28,		% of			Sept. 29,		% of			Sept. 28,		% of			Sept. 29,		% of
	2002		Total			2001		Total			2002		Total			2001		Total

Sears Card average managed credit card receivables	$	19,175		66.8	%	$	23,428		89.8	%	$	20,331		72.8	%	$	24,176		92.5	%
Sears Gold MasterCard average managed credit card receivables		9,541		33.2	%		2,661		10.2	%		7,589		27.2	%		1,962		7.5	%

Total average managed credit card receivables	$	28,716		100.0	%	$	26,089		100.0	%	$	27,920		100.0	%	$	26,138		100.0	%

Sears Card ending credit card receivables											$	18,513		63.2	%	$	23,213		88.4	%
Sears Gold MasterCard ending credit card receivables												10,768		36.8	%		3,051		11.6	%

Total ending credit card receivables											$	29,281		100.0	%	$	26,264		100.0	%

Credit and Financial Products revenues increased 4.1% to $1.4 billion and 3.0% to $4.0 billion, respectively, for the 13 and 39 weeks ended September 28, 2002 from the comparable prior year period. The increase in revenues was primarily attributable to higher average receivable balances as well as an increase in interchange fees generated from the Sears Gold MasterCard. The Sears Gold MasterCard portfolio has continued to grow with balances of approximately $10.8 billion at September 28, 2002. The MasterCard accounts generally have a lower finance charge rate than the Sears Card resulting in a lower overall portfolio yield.

Credit and Financial Products selling and administrative expense as a percentage of Credit and Financial Products revenues was 17.1%, for the 13 weeks ended September 28, 2002 as compared to 15.4% for the comparable prior year period. For the 39 weeks ended September 28, 2002, selling and administrative expense as a percent of revenues was 18.1% as compared to 15.7% last year. The increases were primarily due to higher marketing and fraud loss expenses in both the 13 and 39 week periods, and increased collection expenses in the 39 week period.

The provision for uncollectible accounts increased by $222 million and $302 million, respectively, during the 13 and 39 week periods ended September 28, 2002 as compared to the prior year. The provision increase reflects recent trends experienced in delinquency rates and bankruptcy filings in the third quarter as well as increases in receivable balances in both the 13 and 39 week periods due to the growth of the Sears Gold MasterCard. See “Discussion of Portfolio Quality” below.

Interest expense decreased by $89 million and $338 million, respectively, during the 13 and 39 week periods ended September 28, 2002, respectively, as compared to the comparable prior year periods. The decreases are attributable to lower interest rates on borrowings, offset by the impact of higher borrowing levels to finance receivables growth. The lower interest rate was attributable to the lower interest rate environment coupled with the greater use of variable rate funding by the Company. As of September 28, 2002, approximately 86% of domestic debt was variable versus 60% in the prior year quarter. The Company allocates domestic debt and interest expense to its Credit and Financial Products segment assuming that the segment would be capitalized at a nine to one debt equity ratio.

For the 13 week period ended September 28, 2002, operating income from Credit and Financial Products decreased by $109 million, as favorable funding costs and higher revenues were offset by higher provision and selling and administration expenses. For the 39 week period ended September 28, 2002, operating income increased $36 million as favorable funding costs and higher revenues were partially offset by higher provision and selling and administrative expenses.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

This discussion excludes the effect of noncomparable items. The noncomparable items affecting this segment (the accounting estimate change related to the allowance for uncollectible accounts discussed in Note 3 of the Notes to Condensed Consolidated Financial Statements, the provision for previously securitized receivables and the effect of securitization income discussed in Note 5) would have reduced Credit and Financial Products operating income by $300 million and $482 million, respectively, for the 39 week periods ended September 28, 2002 and September 29, 2001. See “Description of Noncomparable Items.”

Discussion of Portfolio Quality

The Company’s credit portfolio quality at any time reflects, among other factors, the credit worthiness of the individual account holders, the general economic conditions, the success of the Company’s account management and collection activities and the life cycle stage of the portfolio. The Company’s financial results are sensitive to changes in delinquency and net charge-offs related to the Company’s receivables. During periods of economic weakness, delinquencies and net charge-offs are more likely to increase. These trends are considered in establishing the allowance for uncollectible accounts.

Changes in the delinquency and charge-off rates can also result from a change in product mix in the portfolio. The launch of the MasterCard product in mid-2000 was designed to counter the loss of credit share the proprietary Sears Card had been experiencing as alternative payment options became more attractive for certain customer segments. The Sears MasterCard program was designed to primarily target higher quality customers that were Sears customers with little or no activity on their proprietary Sears Card. As of the end of the third quarter of 2002, MasterCard accounts represent 36.8% of the total credit card receivables versus 11.6% at the end of the third quarter of 2001.

Because the MasterCard is a general-purpose credit card, it has different performance characteristics than the Sears Card. For example, because the MasterCard accounts are meant to meet the general financing needs of a customer (as opposed to just their Sears shopping needs) and because MasterCard holders are generally higher credit quality customers, the MasterCard accounts typically have higher average credit limits than Sears Card accounts. In addition, the yield, payment, delinquency and charge-off rates on the MasterCard product are also different from those of the Sears Card. These differences are a result of the higher credit quality of MasterCard accounts, the broader array of services available with the MasterCard product, and the early lifecycle of the MasterCard portfolio. The age of the MasterCard portfolio is an important factor related to the delinquency and loss levels because delinquencies and charge-offs typically increase as young portfolios mature. Consequently, as the MasterCard portfolio matures, the delinquency and charge-off rates are expected to increase and peak, before moving to a stable level. In addition, the migration of higher credit quality customers from the Sears Card portfolio to the MasterCard portfolio has adversely impacted Sears Card statistics.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

The Company’s 60-plus day delinquency rates are summarized below.

Note:

The Company charges off accounts at 240 days where as most bankcard issuers charge off at 180 days. Therefore the Company’s delinquency rate is not directly comparable to participants of the bankcard industry.

During the third quarter of 2002, delinquency rates trended upwards from first and second quarter levels for both the Sears Card and Gold MasterCard portfolios. The 60-plus day delinquency rate for the Sears Card portfolio increased to 9.71% at September 28, 2002, compared to 8.73% at June 29, 2002, and 8.13% at September 30, 2001. The 60-plus day delinquency rate for the MasterCard portfolio increased to 3.00% at September 28, 2002, compared to 2.58% at June 29, 2002, and 1.94% at September 30, 2001. The Sears Card delinquency rate increase reflects the migration of higher credit quality customers to MasterCard and the softening economic environment. The increase in the MasterCard portfolio delinquency rate reflects the maturation of the portfolio as well as the softening economic environment. Because the MasterCard portfolio has a lower delinquency rate than the Sears Card, the growth in the MasterCard portfolio coupled with the decline in the Sears Card portfolio led to an improvement in the total portfolio delinquency rate as compared to the third quarter of 2001. In addition, the amount of bankruptcy filings increased in the third quarter of 2002. Bankruptcy filings, which had increased 1% during the first half of 2002 over comparable 2001 levels, increased by 20% during the third quarter. The trend of increased delinquencies and bankruptcy levels continued in October and is anticipated to continue in the fourth quarter of 2002 and lead to higher charge-offs.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

The Company’s charge-off rate results are summarized below.

Note: The statistics charted above are the monthly charge-off rates and the numerals represent the quarterly average.

The Company’s net charge-offs consist of principal balances charged-off less current period recoveries. The Company’s current credit processing system charges off an account automatically when a customer’s number of missed monthly payments reaches eight, except that accounts can be re-aged once per year when a customer makes two consecutive monthly payments. Also, accounts may be charged off sooner in the event of customer bankruptcy. Finance charge and credit card fee revenue is recorded until an account is charged off at which point the charged off balances are presented as a reduction of revenue. The Company provides for the estimated balance of uncollectible finance charges and credit card fees in its allowance for uncollectible accounts.

The Company maintains an allowance for uncollectible accounts at an amount estimated to be sufficient to absorb losses, net of recoveries, inherent in the existing portfolio. The amount of the allowance necessary is determined primarily based on a migration analysis of current and past due accounts. In evaluating the sufficiency of the allowance, management also considers recent trends in delinquencies, bankruptcies and charge-offs as well as economic conditions and other portfolio data. The provision for uncollectible accounts is the periodic cost of maintaining the allowance. In the third quarter of 2002, the Company increased its allowance for uncollectible accounts in the amount of $189 million, primarily as a result of the portfolio delinquency and bankruptcy trends experienced during the quarter, which reflects the softening economic environment and maturation of the MasterCard portfolio. The following table summarizes the activity in the domestic allowance for uncollectible accounts and related information for the periods indicated:

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001


		13 Weeks Ended						39 Weeks Ended

millions		Sept. 28,			Sept. 29,			Sept. 28,			Sept. 29,
		2002			2001			2002			2001

Balance, beginning of period		$	1,441		$	1,089		$	1,115		$	649
Provision for uncollectible accounts			588			366			1,652			1,050
	Less: securitization adjustment		—			—			—			(153	)

Net domestic provision for uncollectible accounts			588			366			1,652			897
Provision for previously securitized receivables			—			—			—			522
Net charge-offs			(399	)		(366	)		(1,137	)		(896	)
Transfer to Securitization Master Trust			—			—			—			(83	)

Balance, end of period		$	1,630		$	1,089		$	1,630		$	1,089

Bankruptcy filings		$	231		$	193		$	654		$	610
Net credit charge-offs to average managed credit card receivables			5.55	%		5.62	%		5.43	%		5.36	%
Allowance as percent of ending owned credit card receivables									5.57	%		4.15	%
Delinquency rate at period-end ⁽¹⁾									7.24	%		7.41	%

⁽¹⁾

The aging methodology is based on the number of completed billing cycles during which a customer has failed to make a required payment. Accounts are considered delinquent when a customer has failed to make a payment in each of the last three or more billing cycles.

Including noncomparable items, the domestic provision for uncollectible accounts increased by $222 million and $755 million during the 13 and 39 week periods ended September 28, 2002, respectively, from the comparable prior year periods.

• In the first quarter of 2001, the Company’s securitization transactions were accounted for as sales of receivables. As a result of the sale treatment, the provision for uncollectible accounts was $153 million less in the first quarter of 2001 than it would have been had all receivables been owned. See Note 5 of the Condensed Consolidated Financial Statements for further discussion.

• In the second quarter of 2002, the Company refined its method of determining its allowance for uncollectible accounts. The Company periodically reviews its accounting practices to ensure that its adopted policies appropriately reflect changes in its businesses, the industries it operates in, and the regulatory and political environments. During the second quarter, the Company compared its methodology for computing the allowance for uncollectible accounts to the methodologies of participants in the bank card industry. The Company felt that a comparison to bank card issuers was appropriate given the growth of the Sears Gold MasterCard product (approximately $8.5 billion in balances at the end of the second quarter of 2002). The Company determined that practice in the industry was diverse and evolving, particularly in the areas of providing allowances for current accounts, finance charges and credit card fees. Also, during this review the Company became aware of new interpretive guidance that regulators were proposing to narrow the diversity in practice. As a result of its review, the Company refined its methodology for determining the uncollectible portion of current accounts and credit card fee balances, resulting in an increase to the allowance for uncollectible accounts in the amount of $300 million in the second quarter of 2002. In accordance with Accounting Principles Board Opinion No. 20, “Accounting Changes” the effect of this change in accounting was recorded as a change in accounting estimate in the second quarter of 2002.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

Corporate and Other

Revenues from the home improvement services businesses included in the Corporate and Other segment decreased by approximately 15.7% to $91 million and 20.7% to $241 million, respectively, for the 13 and 39 weeks ended September 28, 2002 from the comparable prior year periods. The decrease is due to the disposition of Sears Termite and Pest Control, Inc. on October 1, 2001.

The segment’s operating income improved $21 million for both the 13 and 39 week periods ended September 28, 2002 from the comparable 2001 periods, primarily due to the absence of expenses incurred in the prior year related to the Company’s strategic initiatives.

Sears Canada

Sears Canada revenues decreased 4.9% to $954 million and 3.5% to $2.9 billion, respectively, for the 13 and 39 weeks ended September 28, 2002 from the comparable prior year period. The decrease in revenues for the 13 week period reflects a 1.2% decline in the value of the Canadian dollar relative to the U.S. dollar as well as a 7.3% decrease in comparable store sales. The decrease in revenues for the 39 week period reflects a 2.1% decline in the value of the Canadian dollar relative to the U.S. dollar as well as a 4.1% decrease in comparable store sales.

Sears Canada gross margin as a percentage of Sears Canada merchandise sales and services revenues increased 350 basis points to 28.4% and 220 basis points to 27.3%, respectively, for the 13 and 39 week periods ended September 28, 2002 from the comparable prior year periods. This favorability is primarily due to improved inventory levels which resulted in less clearance activity.

Sears Canada selling and administrative expense as a percentage of total Sears Canada revenues increased 120 basis points to 26.1% and 20 basis points to 25.1%, respectively, for the 13 and 39 week periods ended September 28, 2002 from the comparable prior year periods. Selling and administrative expense as a percent of revenues increased despite operating expense reductions in several areas, such as payroll and benefits, because of higher performance based incentive expense.

Operating income improved by $12 million and $40 million, respectively, for the 13 and 39 week periods ended September 28, 2002 due to margin rate improvements partially offset by decreased revenues.

This discussion excludes the impact of noncomparable items. The noncomparable items affecting this segment were recorded in the special charges and impairment line and would have reduced Sears Canada operating income for the 39 weeks ended September 28, 2002 by $111 million. See “Description of Noncomparable Items.”

ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION

The Company has financial capacity and flexibility due to its access to the capital markets and the quality and liquidity of its assets, principally its credit card receivables. This access to capital markets also allows the Company to effectively manage liquidity and interest rate risk. Liquidity risk is the measure of the Company’s ability to fund maturities and provide for the operating needs of its businesses. Interest rate risk is the effect on net income from changes in interest rates. The Company’s policy is to manage interest rate risk through the strategic use of fixed and variable rate debt and interest rate derivatives. The Company’s cost of funds is affected by a variety of general economic conditions, including the level and volatility of interest rates and the Company’s debt ratings.

In October 2002, Standard and Poors’ and Fitch Ratings placed the Company’s long-term unsecured debt ratings on credit watch with negative implications. Moody’s Investors Service confirmed the Company’s long-term unsecured debt rating but revised its outlook from stable to negative. All three rating agencies reaffirmed the Company’s short-term unsecured debt ratings. The Company’s cost of borrowing long-term unsecured debt may increase if its debt ratings were to be lowered.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

Liquidity

The Company’s principal sources of liquidity are operating cash flows and various sources of capital market borrowings. The Company accesses a variety of capital markets to preserve flexibility and diversify its funding sources. Capital market borrowings are used primarily to support the Company’s Credit business but were also used to finance the Retail and Related Services acquisition of Lands’ End in the second quarter of 2002. Ongoing access to the capital markets is critical to the Credit business. The Company has not identified any reasonably possible circumstances that would trigger any early payment or acceleration provisions in the debt portfolio. Furthermore, the Company believes that it has liquidity necessary to maintain its planned level of operations, capital expenditures and dividends in the foreseeable future.

Operating cash flows from the Company’s retail businesses are impacted by the competitive conditions in the retail industry, the effects of the current economic climate and consumer confidence. Operating cash flows from the Company’s Credit business are directly impacted by changes in interest rates, delinquency and charge-off trends in the credit card receivables portfolio and customer acceptance of the Company’s credit product offerings. Based on the nature of the Company’s businesses, management considers the above factors to be normal business risks.

Significant Assets

A summary of the Company’s credit card receivables at September 28, 2002 and September 29, 2001, respectively, are as follows:


	Sept. 28,		Sept. 29,		December 29,
millions	2002		2001		2001

Domestic:
Credit card receivables	$	29,281	$	26,264	$	27,599
Other customer receivables		33		62		40

Domestic credit card receivables		29,314		26,326		27,639
Sears Canada credit card receivables		1,496		1,515		1,682

Consolidated credit card receivables	$	30,810	$	27,841	$	29,321

Domestic credit card receivables increased $3.0 billion and $1.7 billion from the third quarter of 2001 and 2001 year-end, respectively, as growth from the Sears Gold MasterCard product was partially offset by lower Sears Card receivables. The Sears Gold MasterCard product, which was launched in the second quarter of 2000, had approximately $10.8 billion in outstanding balances at September 28, 2002 compared with $3.1 billion at September 29, 2001.

As of September 28, 2002, consolidated merchandise inventories on the first-in, first-out (FIFO) basis were $6.58 billion, compared with $6.60 billion at September 29, 2001, and $5.50 billion at December 29, 2001. The decrease as compared with last year’s third quarter primarily reflects lower domestic hardlines and softlines inventories, partially offset by the acquired Lands’ End inventory. Sears Canada inventory decreased due to continued focus on managing inventory levels as well as the improved seasonal content of the inventory.

Capital Resources


	Sept. 28,		% of			Sept. 29,		% of			Dec. 29,		% of
millions	2002		Total			2001		Total			2001		Total

Short-term borrowings	$	4,289		14.4	%	$	3,503		13.6	%	$	3,557		13.9	%
Long-term debt ⁽¹⁾		25,555		85.6	%		22,164		86.4	%		22,078		86.1	%

Total borrowings	$	29,844		100.0	%	$	25,667		100.0	%	$	25,635		100.0	%

⁽¹⁾ Includes capitalized lease obligations and current portion of long-term debt.

SEARS, ROEBUCK AND CO.
13 and 39 Weeks Ended September 28, 2002 and September 29, 2001

The Company’s short-term borrowings consist primarily of unsecured commercial paper. The Company continues to provide support for 100% of its outstanding commercial paper through its investment portfolio and committed credit facilities with various banks. At September 2002, the Company had $4.8 billion in committed credit facilities of which $4.4 billion (for Sears U.S. operations) expires in April 2003 and $0.4 billion (for Sears Canada) expires in May 2003.

Additionally, in the first quarter of 2002, the Company contractually established access to $1.5 billion via a syndicate of multi-seller, asset-backed commercial paper conduit programs sponsored by various banks. These purchase commitments have an original expiration date of March 2003, but are renewable at the mutual consent of the parties. As of September 28, 2002, the Company had utilized $200 million of this program. Subsequently, in October of 2002, the Company utilized an additional $800 million.

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 are “forward-looking statements” that are subject to risks and factors that may cause the Company’s actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements include information concerning the Company’s future financial performance, business strategy, plans, goals and objectives. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “estimates,” “plans,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature and not historical facts. These forward-looking statements are based on assumptions about the future that are subject to known and unknown risks and uncertainties and other factors, such as competitive conditions in retail; changes in consumer confidence and spending; changes in interest rates; delinquency and charge-off trends in the credit card receivables portfolio; continued consumer acceptance of the Sears Gold MasterCard Program; the successful execution of and customer reactions to Sears’ Full-line store strategy and other performance improvement initiatives; Sears’ ability to integrate and operate Lands’ End successfully; anticipated cash flow; the resumption of normal shipping on the West Coast following recent labor unrest; the possibility of increased hostilities in the Middle East; general economic conditions and normal business uncertainty. In addition, Sears typically earns a disproportionate share of its operating income in the fourth quarter due to seasonal buying patterns, which are difficult to forecast with certainty. While the Company believes that its forecasts and assumptions are reasonable, it cautions that actual results may differ materially. The Company intends the forward-looking statements to speak only as of the time first made and does not undertake to update or revise them as more information becomes available.

SEARS, ROEBUCK AND CO.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The nature of market risks faced by the Company at September 28, 2002 are disclosed in the Company’s Form 10-K for the year ended December 29, 2001. As of September 28, 2002, 83% of the Company’s funding portfolio was variable rate (including current maturities of fixed-rate long-term debt that will reprice in the next 12 months and fixed-rate debt synthetically converted to variable rate through the use of derivative financial instruments). Based on the size of the Company’s variable rate funding portfolio as of September 28, 2002, which totaled $24.2 billion, a 100 basis point change in interest rates would affect pretax funding cost by approximately $242 million per annum. This estimate assumes that the funding portfolio remains constant for an annual period and the interest rate change occurs at the beginning of the period. This estimate also does not take into account the effect on net interest margin of changes in revenue resulting from either changes in terms of the assets or in the index applicable to the variable rate receivables.

The Company’s level of variable rate funding is in response to the growth of variable rate receivables within the Company’s credit card portfolio (primarily the Sears Gold MasterCard product) and the Company’s conversion of Sears Card finance charges from fixed rate to variable rate in July 2002. The objective of variable rate funding is to reduce net interest margin risk by better aligning the Company’s funding with its credit card assets. However, the Company is exposed to basis risk on any differences in the variable rate on the Company’s debt, primarily LIBOR-based, and the prime-based variable rate finance charge on the Company’s credit card portfolio. Additionally, the Company’s ability to increase the finance charge yield of its variable rate credit card assets may be limited at some point by competitive conditions.

Item 4. Disclosure Controls and Procedures

The Company’s management, including Alan J. Lacy, Chairman of the Board of Directors and Chief Executive Officer (principal executive officer) and Glenn R. Richter, Senior Vice President and Chief Financial Officer (principal financial officer), have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934, as amended, within 90 days of the filing date of this Quarterly Report on Form 10-Q. Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls, since the date the controls were evaluated.

SEARS, ROEBUCK AND CO.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On October 18, 2002, a lawsuit was filed in the United States District Court for the Northern District of Illinois against the Company and certain current and former officers alleging that certain public announcements by the Company concerning its credit card business violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Additional lawsuits of the same tenor followed. The plaintiffs purport to represent classes of shareholders who purchased the Company’s common shares between January 17, 2002, and October 17, 2002. On October 23, 2002, a purported derivative suit was filed in the Supreme Court of the State of New York against the Company (as a nominal defendant) and certain current and former directors seeking damages on behalf of the Company. The complaint purports to allege a breach of fiduciary duty by the directors with respect to the Company’s management of its credit business. A like suit was subsequently filed in the Circuit Court of Cook County. Another purported derivative suit, brought against the Company (as a nominal defendant) and certain current and former directors and officers, was subsequently filed in the United States District Court for the North District of Illinois. The Company believes these claims lack merit and intends to defend against them vigorously.

SEARS, ROEBUCK AND CO.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits.

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

(b) Reports on Form 8-K.

A Current Report on Form 8-K dated July 18, 2002 was filed with the Securities and Exchange Commission on July 18, 2002 to report, under Item 5, that the Registrant issued a press release (attached as Exhibit 99 thereto).

A Current Report on Form 8-K dated August 9, 2002 was furnished to the Securities and Exchange Commission on August 12, 2002 to report, under Item 9, that each of the Principal Executive Officer, Alan J. Lacy, and Principal Financial Officer, Paul J. Liska, of the Registrant submitted to the Securities and Exchange Commission a sworn statement pursuant to the order of the Securities and Exchange Commission dated June 27, 2002.

A Current Report on Form 8-K dated September 5, 2002 was filed with the Securities and Exchange Commission on September 9, 2002 to report, under Item 5, that the Registrant issued a press release (attached as Exhibit 99 thereto).

SEARS, ROEBUCK AND CO.

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, ROEBUCK AND CO. (Registrant)

November 12, 2002	By	/s/ Thomas E. Bergmann

		Thomas E. Bergmann
		Vice President and Controller
		(Principal Accounting Officer and duly
		authorized officer of Registrant)

SEARS, ROEBUCK AND CO.

CERTIFICATIONS

I, Alan J. Lacy, Chairman of the Board of Directors and Chief Executive Officer of Sears, Roebuck and Co., certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sears, Roebuck and Co.

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:


		(a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

		(b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

		(c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):


		(a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

		(b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and;

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002


	By: /s/	Alan J. Lacy

		Alan J. Lacy
		Chairman of the Board of Directors and Chief Executive Officer

SEARS, ROEBUCK AND CO.

I, Glenn R. Richter, Senior Vice President and Chief Financial Officer of Sears, Roebuck and Co., certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sears, Roebuck and Co.

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:


		(a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

		(b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

		(c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;


		(a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

		(b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and;

Date: November 12, 2002


	By: /s/	Glenn R. Richter

		Glenn R. Richter
		Senior Vice President and Chief Financial Officer

SEARS, ROEBUCK AND CO.
E-1
EXHIBIT INDEX


Exhibit No.

3(a)		Restated Certificate of Incorporation as in effect on May 13, 1996 (incorporated by reference to Exhibit 3(a) to Registrant’s Statement No. 333-8141)

3(b)		By-laws, as amended to February 14, 2001 (incorporated by reference to Exhibit 3.(ii) to Registrant’s Annual Report on Form 10-K for the fiscal year ended December 30, 2000)

4.		Registrant hereby agrees to furnish the Commission, upon request, with the instruments defining the rights of holders of each issue of long-term debt of the Registrant and its consolidated subsidiaries.

*10(a)		Conformed Amended and Restated Long-Term Performance Incentive Program (“LTPIP”) Sears, Roebuck and Co., as conformed and restated through August 14, 2002; and Conforming Amendment to the Sears, Roebuck and Co. 2000 Employee Stock Plan for purposes of the LTPIP.

*12.		Computation of ratio of income to fixed charges for Sears and consolidated subsidiaries for each of the five years ended December 30, 2001 and for the nine-month period ended September 29, 2002.

*15.		Acknowledgement of awareness from Deloitte & Touche LLP, dated [November 12, 2002], concerning unaudited interim financial information.

*99(a)		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

*99(b)		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

*Filed herewith.

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents


	2002 Items:

	In February 2002, Sears Canada announced its intention to convert the remaining seven Eaton’s stores to the Sears Canada banner. The conversion of the stores was completed at the end of July 2002. This decision will enable the Company to better leverage its buying and advertising efforts, and take better advantage of the Sears brand’s equity. The Company recorded a one-time, pretax charge of $111 million ($40 million after-tax and minority interest) in the first quarter of 2002 related to the conversions. See Note 7 of the Notes to Condensed Consolidated Financial Statements for further discussion.

	In the first quarter of 2002, the Company recorded a non-cash charge of $208 million, net of tax and minority interest due to the adoption of a new accounting standard, SFAS No. 142, “Goodwill and Other Intangible Assets”. This charge was reported as a cumulative effect of an accounting change. See Note 10 of the Notes to Condensed Consolidated Financial Statements for further discussion.

	In the second quarter of 2002, the Company refined its method of determining its allowance for uncollectible accounts, resulting in a pretax charge of $300 million ($191 million after-tax). In accordance with Accounting Principles Board Opinion No. 20, “Accounting Changes”, the effect of this change in accounting has been recorded as a change in accounting estimate in the second quarter. See Note 3 of the Notes to Condensed Consolidated Financial Statements for further discussion.


	On March 6, 2002, as part of an Advance Auto Parts (“AAP”) public stock offering, the Company sold approximately 3.1 million of its AAP shares, which reduced the company’s ownership percentage to 24.1%. The Company realized a pretax gain of $71 million ($58 million after-tax) from the sale. This transaction generated after-tax cash proceeds of $110 million. In October 2002, the Company notified AAP that it was exercising its right to demand registration of the remaining 8.4 million AAP shares it owns in order to sell them. The Company’s remaining interest in AAP has a market value of approximately $450 million as of October 28, 2002.

	2001 Items:

	During the second quarter of 2001, the Company recorded a pretax charge of $205 million ($129 million after-tax) to recognize a loss on its formerly owned Homelife business and write-off a minor investment. Homelife, which was sold to Citicorp Venture Capital, Ltd. in early 1999, filed for bankruptcy on July 16, 2001. As a result of Homelife’s insolvency, the Company recognized certain obligations (primarily related to property leases) which had been previously transferred to Homelife and recorded a reserve for other matters related to Homelife for which Sears incurred losses.

	The Company also recorded a pretax charge of $82 million ($53 million after-tax) in the second quarter of 2001 in connection with its exit of the skin care and color cosmetics business. The charge includes asset write-downs and vendor cancellation payments.

	During the second quarter of 2001, the Company recorded a non-cash, pretax charge of $522 million ($331 million after-tax) to establish an allowance for uncollectible accounts related to $12 billion of securitized credit card receivables reinstated on the Company’s balance sheet as a result of the Company’s adoption of SFAS No. 140 in April 2001 (see Note 5 of the Notes to Condensed Consolidated Financial Statements). In addition, effective in the second quarter of 2001, the Company’s securitization transactions are accounted for as secured borrowings and the Company ceased recording securitization income. As such, securitization income reported in prior periods is noncomparable subsequent to March 2001. After-tax securitization income of $26 million was recorded in first quarter 2001 net income.

(a)		Exhibits.

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

(b)		Reports on Form 8-K.

		A Current Report on Form 8-K dated July 18, 2002 was filed with the Securities and Exchange Commission on July 18, 2002 to report, under Item 5, that the Registrant issued a press release (attached as Exhibit 99 thereto).

		A Current Report on Form 8-K dated August 9, 2002 was furnished to the Securities and Exchange Commission on August 12, 2002 to report, under Item 9, that each of the Principal Executive Officer, Alan J. Lacy, and Principal Financial Officer, Paul J. Liska, of the Registrant submitted to the Securities and Exchange Commission a sworn statement pursuant to the order of the Securities and Exchange Commission dated June 27, 2002.

		A Current Report on Form 8-K dated September 5, 2002 was filed with the Securities and Exchange Commission on September 9, 2002 to report, under Item 5, that the Registrant issued a press release (attached as Exhibit 99 thereto).

	1.		I have reviewed this quarterly report on Form 10-Q of Sears, Roebuck and Co.

	2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

	3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

	4.		The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: