Chronology of articles (9/29/02-10/18/02) covering saga about Markowski knowing more about Sears deteriorating credit card receivables than its CFO, Paul Liska.

Share price declined by 44% from $41.00 at beginning of saga to $23.15, at end of saga.

Sears sticks to upbeat outlook
Weak sales lead retail experts to doubt promises

By Susan Chandler
Tribune staff reporter
Published September 29, 2002

Business could be better at Sears, Roebuck and Co.

Sales have declined every single month this year. During August, when parents rush to outfit their children for school, Sears' same-store sales plunged 11 percent, a double-digit decline that shocked even retail veterans.

But Sears Chief Executive Alan Lacy is still vowing to deliver a spectacular 22 percent increase in 2002 earnings per share, excluding one-time items. Sears reaffirmed that guidance Sept. 5, counting on cost-cutting and its lucrative credit-card business to save the day.

Now, some Sears watchers are raising doubts the company can deliver on its financial promises.

"They're dreaming," says George Whalin, president of Retail Management Consultants in San Marcos, Calif. "They're going to start reporting some really bad numbers."

On Thursday, Fitch Ratings lowered its outlook on Sears to negative from stable, citing weak sales trends, a difficult retail environment and growing competition from discounters and home-improvement chains. Although it applauded Sears' credit-card growth, Fitch also cited concerns about the quality of its portfolio if economic weakness continues.

Indeed, there is cause for concern, retail experts say.

While Sears' apparel sales have been weak for several years, the Hoffman Estates-based chain has been depending on its credit-card business and sales of big-ticket items like home appliances and consumer electronics.

But appliance sales, where Sears has a commanding 37 percent market share, weakened this summer despite aggressive promotions, including zero-percent financing offers.

Not only is that dragging down the company's top line, it eventually will crimp Sears' high-margin credit card business as well. Fewer big-ticket transactions translates into a smaller portfolio of credit card debt, retail experts point out.

The stakes are high as Lacy approaches his second anniversary at the helm of the nation's third-largest retailer, and his regime's credibility is on the line.

Paul Liska, Sears' new chief financial officer and a Lacy recruit, says he has a firm grip on reality and that Sears will come through with the upbeat numbers it has promised.

Despite sagging sales, Sears has been able to boost its efficiency by downsizing its headquarters staff in Hoffman Estates and de-layering its sprawling field organization, Liska says. Because the layoffs in Hoffman Estates--about 1,300 positions out of 7,000--mostly were over by the end of the first quarter, the company has been able to reap cost savings for almost the entire year.

"We're unique because our profitability is coming from productivity improvements," Liska said. "That's the beauty of productivity. It's totally within your control."

Declining sales expected

All along, Sears has said its 2002 sales would likely decrease. The steeper-than-expected August decline has to be averaged with smaller-than-expected sales declines in the first half, Liska says. "All of this was anticipated."

Overall, Sears is sticking with its prediction that annual sales will be down by about 5 percent, he says.

Sears isn't counting on a fourth-quarter miracle for that to happen. "If it is the same type of selling season as last year, and last year did not feel great, we're fine. We didn't expect the economy to get a lot better."

Anyone who suspects Sears might be too aggressive is off base, Liska adds. "We're a very conservative company on an accounting basis. We do everything according to Hoyle."

Wall Street doesn't seem overly concerned. Of the seven analysts reporting recommendations to Thomson Financial/First Call, none has changed their outlook on Sears' stock this month.

One analyst has Sears rated a "strong buy," and three analysts are recommending Sears as a "buy," according to Tom O'Keefe, equity research analyst with Thomson Financial. Three others have a "hold" rating on the retailer.

Only Merrill Lynch analyst Daniel Barry reacted after the September sales report, slightly trimming his third-quarter and full-year estimates for Sears' stock. And Barry is still expecting Sears to earn $5.31 per share, even more than the 22 percent increase Sears has promised.

But investors, chastened by accounting problems at other companies, don't appear quite as convinced.

Sears' stock price has drifted down from a high of almost $60 a share this summer to about $41, losing almost a third of its value and outpacing the overall market's decline of about 20 percent. Even so, Sears' stock remains well above its 52-week low of $31 per share.

Cash flow questioned

Although mainstream analysts appear comfortable with Sears' earnings story, a small investment firm in Sarasota, Fla., is sounding an alarm. Inc. has a proprietary software system that looks for contradictory indicators in a company's financial reports. And Michael Markowski, the firm's director of research, believes it has found some at Sears.

In the second quarter, when Sears was posting record net income, it also was recording negative cash flow on an operating basis, which means it was paying out more money than it was collecting.

That's a financial anomaly that should be raising red flags for investors, Markowski says.

"They're telling you they're making a lot of money, but they're not generating any cash," he said. "The problem is that, generally, companies generating negative operating cash flow are trying to do whatever they can to maintain Wall Street's projections. They're stretching."

Sears' cash flow has been negative for the past two quarters because of a big increase in receivables, which is money that Sears is owed by shoppers on its credit cards, Securities and Exchange Commission filings show.

Stricter credit controls

While more credit card debt means more interest and fees for Sears, it also sets the stage for trouble if customers can't make their payments. That's exactly what happened to Sears in the mid-1990s when a big push to get more credit cards in the hands of consumers created a flood of bad debt that dragged down earnings several years later.

Since then, Sears has cleaned up its portfolio and tightened collection policies. But there's no doubt that Sears is hitting the accelerator on its credit business again. Since Sears introduced a Sears Gold MasterCard in June 2000, shoppers have racked up an impressive $8.50 billion in balances, a good portion of that outside Sears' stores.

At the end of June, Sears had $29.81 billion in credit card debt outstanding, up 8 percent from a year earlier, most of it on the traditional Sears in-store card.

Liska denies that Sears is stretching. He says the negative operating cash flows are simply a sign that Sears is growing its credit business, which is a "good thing" because "that's how we make a lot of money."'s analysis is flawed, Liska says, because the software program doesn't work with financial companies, and Sears, which earns more than 60 percent of its profit from credit cards, is a finance company.

"If these models really worked, this guy would operate a hedge fund. He wouldn't be running a Web site," Liska said.

Markowski says it's news to him that Sears is a finance company rather than a retailer. And he says he will really be concerned if Sears posts a third consecutive quarter of negative cash flow.

Sears shifts a cost to 2nd quarter
October 3, 2002


Sears, Roebuck and Co. on Wednesday played down its shift of $191 million in costs related to an accounting change to the second quarter from the first after discussions with regulators. But an analyst who tracks Sears' cash flow is warning that the Hoffman Estates-based retailer is still maintaining too low a reserve for uncollectable credit-card accounts even as the company has posted two straight quarters of negative cash flow.

Sears' accounting change increases reported first-quarter results by 59 cents a share to 34 cents, and lowers second-quarter net income to 71 cents, according to amended filings with the U.S. Securities and Exchange Commission.

The move won't affect the earnings estimate for the year, spokeswoman Peggy Palter said. Sears first announced the cost in July, when the company said it changed the way it accounts for the allowance of uncollectible credit-card accounts, to be more conservative.

The decision to record the expense in the second quarter instead of the first came as a result of a "regular review" with the SEC, Palter said.

Sears has boosted its earnings expectations twice this year, and now expects 2002 profit to rise to $5.15 a share from $4.22 last year.

But Michael Markowski, director of research for, said Wednesday that Sears is risking uncollectible credit-card debt as the economy sours.

He noted that Sears reported $1.3 billion in revenue in the most recent quarter from financial products and services, consisting mostly of its Sears and Sears Gold MasterCard credit cards. But the same product line burned up $1.16 billion in operating cash in order to cover the credit-card receivables--the money shoppers owe when they use Sears credit cards, Markowski said. Sears spokeswoman Palter countered that the quality of Sears' credit-card portfolio is excellent, in particular its $8.5 billion in Gold Mastercard receivables.

"We don't think there is any credibility to (Markowski's) assessment," she said.

Also Wednesday, Sears said Cendant Corp.'s Avis Rent A Car System will run Sears' licensed rental-car business, pushing out Budget Rent a Car.

Sears Car Rental locations will be converted to Avis operations, and customers will be able to use their Sears credit card to rent from Avis, Sears said.

As many as 45 Avis locations are expected to open at Sears facilities by the end of January, with at least 100 more to follow over the next three to five years, Sears said.

Sears shares fell $1.16, or 2.89 percent, to $39.01 in New York Stock Exchange composite trading. They have declined 18 percent this year.

Contributing: Bloomberg News

Sears falls on credit woes
October 18, 2002


Sears, Roebuck and Co.'s worsening credit-card problems shot the company's credibility and sent its shares to a 12-year low Thursday.

The retailer--already reeling from a yearlong slump in store sales and struggling to reinvent itself--announced a stunning 26 percent drop in third-quarter profit and a warning of lower full-year 2002 profits because it had uncovered more future uncollectible credit-card debt since firing the head of the credit-card business two weeks ago.

Sears said it must set aside an additional $150 million to cover future uncollectible debts, in addition to the $100 million in extra bad-debt reserves it announced 10 days ago. For the third quarter, Sears increased its allowance for future uncollectible debts by $189 million, and charge-offs for uncollectible accounts increased $33 million.

Financial analysts who gathered for a regularly scheduled meeting at Sears' headquarters in Hoffman Estates on Thursday said they were confused about how CEO Alan Lacy could have missed the growing problem, particularly since Sears' credit business accounts for more than 60 percent of the retailer's operating income.

Analysts remember that Lacy was the man in charge of straightening out Sears' credit-card mess in the 1990s. That's when Sears pleaded guilty to one criminal count of bankruptcy fraud and took a pre-tax charge of $475 million to swallow the costs of a scandal in which the company wrongfully pressured bankrupt credit-card holders to repay debts.

Lacy took pains to explain that today's controversy differs from the earlier scandal, primarily because Sears has been aggressively switching its better customers from the Sears card to the new Sears Gold Mastercard, which has a lower interest rate than its in-store charge card and can also be used at other merchants. That enables the retailer to collect more fees when customers use the cards elsewhere.

Because of the problems, however, Sears will tighten restrictions on who can qualify for the Mastercard and will tighten offers of convenience checks and balance transfers to encourage customers to switch. That's where much of the projected delinquencies came to light, said Sears spokesman Bill Masterson.

Lacy said he fired Kevin Keleghan, former credit and finance group president, because Keleghan "was not being forthcoming" about the problems the credit business faced, and Lacy lost confidence in Keleghan's credibility.

Lacy revealed Thursday that another credit official, whom Sears officials identified as Vish Vishwanath, was fired Wednesday as vice president of risk management and credit analytics because he, too, withheld information.

However, Lacy said his investigation indicated Sears had engaged in no unethical activity and had filed no wrongful financial disclosures or reports with the U.S. Securities and Exchange Commission.

Nevertheless, one analyst Thursday said he saw a parallel with Enron's lack of credibility. Michael Markowski, director of research at, said Sears generated negative operating cash flow for the first half of 2002 and announced record profits for its second quarter, as did Enron in 2001. Also, Markowski suspects Sears' record profits are coming from credit-card holders' late fees. Markowski recommends the SEC institute an accounting policy that would prohibit companies from reporting late fees as profit until cardholders actually pay the fees.

Sears' credit card problem became public Oct. 2, when the SEC forced Sears to restate the timing and manner of its $300 million pre-tax increase in future uncollectible credit-card accounts.

Roman L. Weil, an accounting professor at the University of Chicago Graduate School of Business, said of the SEC's action, "Did Sears break the rules? No. Did Sears know it was skating close to the line? Undoubtedly. Will Sears admit it? Of course not."

Howard Davidowitz, president of retail consulting firm Davidowitz & Associates, told CNN/Money he believed the SEC should look into the matter. An SEC spokeswoman said Thursday the commission would not comment on specific companies.

Just 10 days ago, Lacy said Sears would earn a lower-than-expected 80 to 82 cents a share in the third quarter. On Thursday, he announced the real number--53 cents per share, a surprising 34 percent plunge, and a 26 percent drop from year-earlier earnings.

Sears reduced its full-year forecast for profit excluding some costs to $4.86 a share, from the $5.15 a share estimate it endorsed last week. Third-quarter net income dropped to $189 million, or 59 cents a share, from $262 million, or 80 cents, in the year-earlier period. Revenue fell less than 1 percent to $9.67 billion, the second consecutive quarterly decline.

Sears said it began seeing signs of deteriorating credit quality in September. Its lagged charge-off rate, or the annualized ratio of current losses to credit card loans booked one year ago, was 6.11 percent in the third quarter, up from 5.76 percent in the same period a year earlier, Masterson said. Analysts use lagged rates to normalize losses distorted by rapid growth.

The average number of days of Sears' accounts receivable increased to 242 in the second quarter from 204 in the year-earlier period.

Sears has about 60 million cardholders, including 22 million Gold MasterCard users, as of July. Sears bought Internet and catalog retailer Lands' End, and began selling its new Covington apparel line last month to boost clothing sales. The company will delay the introduction of Lands' End items in its stores for two weeks because of the shutdown of West Coast ports earlier this month, Lacy said.

The retailer expects sales to continue to fall for the rest of the year as it eliminates some other brands and remodels stores, disrupting shoppers. Shares fell $10.80 to close at $23.15 in heavy trading on the New York Stock Exchange--their lowest level since October 1990.

Confronted with the surprise earnings revisions, analysts at the meeting scratched out new estimates on napkins and scrap paper to calculate just how low Sears stock might trade.

The plunge Thursday left the stock at a mere 7.9 times what had been the First Call consensus on Sears' 2003 earnings estimate. It traded as high as $59.90 in June. One analyst reckoned that Sears stock could be halved again, leaving the stock at about 5 times projected earnings.
Contributing: Bloomberg News, AP