United States
Securities And Exchange Commission
Washington, D.C. 20549

FORM 10-K/A
(Amendment No. 1)

For Annual and Transition Reports pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 000-51217

SEARS HOLDINGS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

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

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

Securities registered pursuant to Section 12(g) of the Act:
Common Shares, par value $0.01 per share

        Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý    No o

        Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

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

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

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

Large accelerated filer ý        Accelerated filer o        Non-accelerated filer o

        Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý

        On February 25, 2006, the Registrant had 158,997,881 common shares outstanding. The aggregate market value (based on the closing price of the Registrant's common shares as reported in a summary of composite transactions in The Wall Street Journal for stocks quoted on the NASDAQ National Market) of the Registrant's common shares owned by non-affiliates (which are assumed, solely for the purpose of this calculation, to be stockholders other than (i) directors and executive officers of the Registrant and (ii) any person known by the Registrant to beneficially own five percent or more of the Registrant's common shares), as of July 30, 2005 was approximately $15 billion.

Documents Incorporated By Reference

        Part III of this Form 10-K/A incorporates by reference certain information from the Registrant's proxy statement relating to its Annual Meeting of Stockholders to be held on April 12, 2006 (the "2006 Proxy Statement"), which will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Form 10-K/A relates.

Explanatory Note

        This Form 10-K/A (Amendment No. 1) is being filed to correct an error in the disclosure of rental expense for the 2005 fiscal year contained in Note 17 of the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the fiscal year ended January 28, 2006. For ease of reference, this Amendment restates the Form 10-K in its entirety.

        The correction is reflected in the following table:

Rental Expense for Operating Leases—

PART I

Item 1.    Business

General

        Sears Holdings Corporation ("Holdings" or the "Company") is the parent company of Kmart Holding Corporation ("Kmart") and Sears, Roebuck and Co. ("Sears"). Holdings was formed as a Delaware corporation in 2004 in connection with the merger of Kmart and Sears (the "Merger"). The Merger, completed on March 24, 2005, combined two of America's oldest existing retail entities, both with origins dating to the late 1800s. The Company is a broadline retailer with approximately 2,300 full-line and 1,100 specialty retail stores in the United States operating through Kmart and Sears and approximately 370 full-line and specialty retail stores in Canada operating through Sears Canada Inc. ("Sears Canada"), a 54%-owned subsidiary.

The Merger

        The Merger has provided Holdings with an opportunity to significantly improve the earnings and cash flow performance of both Kmart and Sears given the scale of the combined entity. The Merger has also provided a means for leveraging the historical strengths of Kmart and Sears with the goal of making the Company's products, brands and service offerings more responsive to the needs of customers, thereby building long-term, value-added customer relationships.

        Sears has a long-standing reputation for offering customers a wide variety of merchandise and related services, with a particular emphasis on a number of strong proprietary brands such as Kenmore, Craftsman, Diehard and Lands' End. Historically, Sears conducted its business primarily using a mall-based format. At the time of the Merger, Sears operated 874 domestic full-line stores mainly located in such on-mall locations. In response to off-mall competitor growth, Sears commenced a strategy prior to the Merger to increase the number of its off-mall stores in order to expand distribution points for its brands, merchandise and services. Kmart, on the other hand, historically used large format, off-mall locations in selling a selection of general merchandise goods. At the time of the Merger, Kmart operated approximately 1,400 off-mall stores and sought to further improve its operational performance by pursuing opportunities to offer customers a differentiated high-quality product selection to distinguish itself from competitors.

        With Kmart's approximately 1,400 off-mall locations, Holdings is in a position to offer a greater number of customers an opportunity to purchase Sears products and services outside of Sears' traditional mall-based stores. This increase in distribution points brought about by the Merger provides a more rapid and lower-cost store base growth than Sears would have been able to accomplish on its own. At the same time, the addition of Sears-owned brands and services, including Sears' credit products, to Kmart stores enhances the selection and value proposition offered to Kmart customers and helps to differentiate Kmart from its general merchandise competitors. Furthermore, its combined store base of approximately 2,300 full-line stores places Holdings in a position to compete on a scale larger than that of many of its national competitors.

        The scale of the combined enterprise has also generated significant opportunities for realizing cost synergies across a number of areas, including merchandise and non-merchandise purchasing, delivery and distribution and within other selling, general and administrative expense areas. While the Company will continue to operate both the Sears and Kmart store formats in the foreseeable future, many of the functions supporting these formats have been integrated. This integration will continue.

        From an accounting perspective, the Merger has been treated as a purchase business combination, with Kmart acquiring Sears. In identifying Kmart as the acquiring entity, the companies took into account the relative share ownership of the Company after the Merger, the composition of the governing body of the combined entity and the designation of certain senior management positions.

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Accordingly, the historical financial statements of Kmart serve as the historical financial statements of Holdings, the registrant.

        In connection with the Merger, Kmart shareholders received one share of Holdings common stock for each Kmart share owned. In all, approximately 94.9 million shares of Holdings common stock were issued in exchange for all outstanding common stock of Kmart. Sears shareholders were issued an aggregate of 62.2 million shares of Holdings common stock at a total value of approximately $6.5 billion (based on the average closing price of $104.33 of Kmart's common stock during the period from November 15, 2004 through November 19, 2004, two business days before and after the date the Merger was announced). In addition, approximately $5.4 billion in cash was paid in consideration for (i) all outstanding shares of common stock of Sears, based upon the proration provisions of the agreement pursuant to which the Merger was effected, and (ii) all outstanding stock options of Sears. Including transaction costs of approximately $18 million, the total consideration paid was approximately $11.9 billion.

        Additional information concerning the Merger is contained in Note 2 of Notes to Consolidated Financial Statements.

Bankruptcy of Kmart Corporation

        Kmart Corporation (the "Predecessor Company") is a predecessor operating company of Kmart (the "Successor Company"). In January 2002, the Predecessor Company and 37 of its U.S. subsidiaries (collectively, the "Debtors") filed voluntary petitions for reorganization under Chapter 11 of the federal bankruptcy laws ("Chapter 11"). The Debtors decided to seek bankruptcy reorganization based upon a rapid decline in their liquidity resulting from below-plan sales and earnings performance in the fourth quarter of fiscal 2001, the evaporation of the surety bond market, an erosion of supplier confidence, intense competition and unsuccessful sales and marketing initiatives, as well as the continued recession and capital market volatility in existence at that time. The Predecessor Company utilized Chapter 11 to strengthen its balance sheet and reduce debt, focus its store portfolio on the most productive locations and terminate leases for closed stores, develop a more efficient organization and lower overall operating costs.

        On May 6, 2003 (the "Effective Date"), the Predecessor Company emerged from reorganization proceedings under Chapter 11 pursuant to the terms of an Amended Joint Plan of Reorganization (the "Plan of Reorganization") and related amended Disclosure Statement. This Plan received formal endorsement of the statutory creditors' committee and, as modified, was confirmed by the U.S. Bankruptcy Court in April 2003. The Predecessor Company is presently an indirect wholly-owned subsidiary of Holdings.

Sale of Sears Canada's Credit and Financial Services Business

        On November 15, 2005, Sears Canada completed the sale of substantially all of the assets and liabilities of its Credit and Financial Services operations to JPMorgan Chase & Co. ("JPMorgan Chase") for approximately $2.0 billion in cash proceeds net of securitized receivables and other related costs and taxes. In addition, Sears Canada and JPMorgan Chase concurrently entered into a long-term marketing and servicing alliance with an initial term of ten years. Sears Canada used a substantial portion of the proceeds generated from this sale to fund an extraordinary cash dividend and a tax-free return of stated capital to shareholders of record on December 16, 2005. Holdings, as beneficial owner of approximately 54% of the outstanding common stock of Sears Canada, received $877 million in after-tax proceeds from this distribution. Additional information concerning the sale is contained in Note 4 of Notes to Consolidated Financial Statements.

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Sears Canada Take-Over Bid

        In December 2005, Holdings announced its intention to acquire the remaining 46% interest in Sears Canada that it does not already own. The Company commenced a take-over bid for the remaining interest in Sears Canada on February 9, 2006. The Company has offered C$16.86 (Canadian dollars) per share, or approximately C$835 million ($720 million U.S. dollars), for the minority interest. The take-over bid is open for acceptance until March 17, 2006. The Company believes that 100% ownership of Sears Canada would allow Sears Canada to be able to compete with the other Canadian retailers and the Canadian operations of major U.S. retailers.

        In December 2005, the Company entered into a lock-up agreement with Natcan Investment Management, Inc. ("Natcan"), pursuant to which Natcan agreed to tender all Sears Canada common shares (representing approximately 9% of the outstanding common shares of Sears Canada) that it owns or controls in response to the Company's take-over bid, at a price of C$16.86 per share. This agreement obligates the Company to spend approximately $141 million to purchase the Natcan shares.

Real Estate Transactions

        In the normal course of business, the Company considers opportunities to purchase leased operating properties, as well as offers to sell owned, or assign leased, operating and non-operating properties. These transactions may, individually or in the aggregate, result in material proceeds or outlays of cash. In addition, the Company reviews leases that will expire in the short term in order to determine the appropriate action to take with respect to them.

        Further information concerning the Company's real estate transactions is contained in Note 16 of Notes to Consolidated Financial Statements.

Business Segments

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

        Financial information, including revenues, operating income and total assets for each of these business segments is contained in Note 21 of Notes to Consolidated Financial Statements. Information regarding the components of revenue for Holdings is included in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."

Kmart

        As of January 28, 2006, Holdings operated a total of 1,416 Kmart stores across 49 states, Guam, Puerto Rico, and the U.S. Virgin Islands. This store count included 1,361 discount stores, averaging 92,000 square feet, and 55 Super Centers, averaging 165,000 square feet. Most Kmart stores are one-floor, free-standing units that carry a wide assortment of general merchandise, including products sold under such well-known labels as Jaclyn Smith, Joe Boxer, and Martha Stewart Everyday. Subsequent to the Merger, the Company began selling certain Sears brand products and services within certain Kmart stores. As of January 28, 2006, approximately 100 Kmart stores were selling an assortment of Sears brand products, mainly within home appliances and tools. Approximately 1,100 Kmart stores also contain in-store pharmacies. The Super Centers generally operate 24-hours a day and combine a full-service grocery along with the general merchandise selection of a discount store. Kmart also sells its products through its kmart.com website.

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Sears Domestic

        As of January 28, 2006, Sears Domestic operations consisted of the following:

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Full-line Stores—866 Full-line stores located across all 50 states and Puerto Rico, primarily mall-based locations averaging 132,000 square feet. Full-line stores offer a wide array of products across many merchandise categories, including home appliances, consumer electronics, tools, fitness and lawn and garden equipment, certain automotive services and products such as tires and batteries, home fashion products, as well as apparel, footwear and accessories for the whole family, including Lands' End merchandise. Also, as of January 28, 2006, the Company operated a total of 58 Sears Essentials and Sears Grand stores located in 22 states, primarily free-standing units averaging 122,000 square feet and offering health and beauty, pantry, household products and toys in addition to the offerings of the typical mall-based store. In February 2006, management decided that, on a go-forward basis, Sears Essentials and Sears Grand stores will all be operated under the Sears Grand name. Management expects to begin the conversion to the Sears Grand nameplate in the first half of fiscal 2006. Sears also extends the availability of its product selection through the use of its sears.com website, which offers a more limited assortment of home, apparel and accessory merchandise and provides customers the option of buying through the internet and picking up their merchandise in Sears Full-line stores.



•

Specialty Stores—1,128 specialty stores located across all 50 states and Puerto Rico, located primarily in free-standing, off-mall locations or high-traffic neighborhood shopping centers, and including the operations of:



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809 Dealer Stores—Primarily independently-owned stores, predominantly located in smaller communities and averaging 8,900 square feet offering appliances, consumer electronics, lawn and garden equipment, hardware and automotive batteries. Dealer stores carry proprietary Sears brands, such as Craftsman, Kenmore and DieHard, as well as a wide assortment of national brands.



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147 Sears Hardware Stores and 84 Orchard Supply Hardware Stores—Neighborhood hardware stores averaging 37,000 square feet that carry Craftsman tools and lawn and garden equipment, a wide assortment of national brands and other home improvement products. Approximately 120 locations also offer a limited selection of home appliances.



•

16 The Great Indoors Stores—Home decorating and remodeling superstores, averaging 143,000 square feet, dedicated to the four main rooms of the house: kitchen, bedroom, bathroom and great room.



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50 Outlet Stores—Locations offering overstock and/or distressed appliances, consumer electronics and lawn and garden equipment at a discount.



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Commercial Sales—This business primarily targets home builders, remodelers and property managers for appliance purchases.



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Direct to Customer—The Direct to Customer business includes the direct merchant business of Lands' End, Inc. ("Lands' End"). Lands' End is a leading direct merchant of traditionally-styled casual clothing, accessories and footwear for men, women and children, as well as home products and soft luggage. These products are offered through multiple selling channels including Landsend.com, one of the leading apparel websites, as well as catalog mailings, international businesses and 17 Lands' End retail stores. These retail stores, averaging 7,700 square feet, offer Lands' End merchandise primarily from catalog and internet channel overstocks. Direct to Customer also includes direct marketing of Sears goods through specialty catalogs.

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Home Services—Product Repair Services, the nation's largest product repair service provider, is a key element in the Company's active relationship with more than 46 million households. With over 10,000 service technicians making over 13 million service calls annually, this business delivers a broad range of retail-related residential and commercial services across all 50 states and Puerto Rico under the Sears Parts & Repair Services and A&E Factory Service brand names. Commercial and residential customers can obtain parts and repair services for all major brands of products within the home appliances, lawn and garden equipment, consumer electronics, floorcare products, and heating and cooling systems categories. Smaller items for repair can be brought into Sears Parts & Repair Centers located throughout the United States or to any Sears Full-line store. This business also offers protection agreements, product installation services and Kenmore and Carrier residential heating and cooling systems. Home Services also includes home improvement services (primarily siding, windows, cabinet refacing, kitchen remodeling, HVAC and carpet cleaning) provided through Sears Home Improvement Services.

Sears Canada

        Sears Canada, a consolidated, 54%-owned subsidiary of Sears, conducts retail operations in Canada similar to those conducted by Sears Domestic, with a greater emphasis on apparel and other softlines than in the U.S. stores. In addition, Sears Canada conducted credit operations prior to the November 15, 2005 sale of its Credit and Financial Services operations to JPMorgan Chase.

        As of January 28, 2006, Sears Canada operated a total of 123 full-line stores, 252 specialty stores (49 furniture and appliance stores, 159 dealer stores operated under independent local ownership, five appliances and mattresses stores, 28 Corbeil stores and 11 outlet stores), 50 floor covering stores, approximately 2,116 catalog pick-up locations and 112 travel offices. Sears Canada also conducts business over the internet through its website, sears.ca.

Trademarks, Trade Names and Licenses

        The "KMART®" and "SEARS®" trade names, service marks and trademarks, used by the Company both in the United States and internationally, are material to the Company's retail and other related businesses.

        The Company sells proprietary branded merchandise under a number of brand names that are important to its operations. The Company's KENMORE®, CRAFTSMAN®, DIEHARD® and LANDS' END® brands are among the most recognized proprietary brands in retailing. These marks are the subject of numerous United States and foreign trademark registrations. Other well-recognized Company trademarks and service marks include THE GREAT INDOORS®, OSH®, CANYON RIVER BLUES®, COVINGTON®, and ATHLETECH®. The Company also has the right to sell an exclusive line of Martha Stewart Everyday® products in its Kmart locations over the next four years, as well as within Sears Canada stores through August 2008.

Seasonality

        The retail business is seasonal in nature, and the Company generates a high proportion of its revenues and operating cash flows during the fourth quarter of its fiscal year, which includes the holiday season. As a result, the Company's overall profitability is heavily impacted by its fourth quarter operating results. Additionally, in preparation for the fourth quarter holiday season, the Company significantly increases its merchandise inventory levels, which have traditionally been financed from operating cash flows and credit terms received from vendors. Fourth quarter reported revenues accounted for 33% of total reported revenues in fiscal 2005.

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Competition

        The Company's business is subject to highly competitive conditions. The Company competes with a wide variety of retailers, including other department stores, discounters, home improvement stores, consumer electronics dealers, auto parts and auto service providers, specialty retailers, wholesale clubs and many other competitors operating on a national, regional or local level along with internet and catalog businesses, which handle similar lines of merchandise. Wal-Mart, Target, Kohl's, JC Penney, Home Depot, Lowe's and Best Buy are some of the major competitors with which the Company competes. Home Depot, Lowe's and Best Buy are major competitors in relation to the Company's home appliance business, which accounted for approximately 15% of the Company's fiscal 2005 reported revenues. Sears Canada competes in Canada with Hudson's Bay Company and U.S.-based competitors, including those mentioned above, that are expanding into Canada. Success in this competitive marketplace is based on factors such as price, convenience, product assortment and quality, and service, including availability of retail-related services such as access to credit, product delivery, repair and installation.

Employees

        As of January 28, 2006, the Company had approximately 317,000 employees in the United States and U.S. territories, and approximately 38,000 employees in Canada through Sears Canada including, in each case, part-time employees.

Our Website; Availability of SEC Reports and Other Information

        The Company's corporate website is located at www.searsholdings.com. The Company's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports are available, free of charge, through the SEC filings portion of the Investor Information section of the Company's website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission.

        The Corporate Governance Guidelines of the Company's Board of Directors, the charters of the Audit, Compensation, Finance and Nominating and Governance Committees of the Board of Directors, the Company's Code of Conduct and the Board of Directors Code of Conduct are available on the Corporate Governance section of www.searsholdings.com. References to the Company's website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.

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Item 1A.    Risk Factors

        References to "us", "we" and "our" refer to the Company. The following risk factors could adversely affect our business, results of operations and financial condition. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us may also negatively impact us.

If we fail to offer merchandise and services that our customers want, our sales may be limited, which would reduce our revenues and profits.

        In order for our business to be successful, we must identify, obtain supplies of, and offer to our customers attractive, innovative and high-quality merchandise on a continuous basis. Our products and services must satisfy the desires of our customers, whose preferences may change in the future. If we misjudge either the demand for products and services we sell or our customers' purchasing habits and tastes, we may be faced with excess inventories of some products and missed opportunities for products and services we chose not to offer. In addition, our sales may decline or we may be required to sell the merchandise we have obtained at lower prices. This would have a negative effect on our business and results of operations.

If we do not successfully manage our inventory levels, our operating results will be adversely affected.

        We must maintain sufficient inventory levels to operate our business successfully. However, we also must guard against accumulating excess inventory as we seek to minimize out-of-stock levels across all product categories and to maintain in-stock levels. We obtain a significant portion of our inventory from vendors located outside the United States. These vendors often require lengthy advance notice of our requirements in order to be able to supply products in the quantities we request. This usually requires us to order merchandise, and enter into purchase order contracts for the purchase and manufacture of such merchandise, well in advance of the time these products will be offered for sale. As a result, we may experience difficulty in responding to a changing retail environment, which makes us vulnerable to changes in price. If we do not accurately anticipate the future demand for a particular product or the time it will take to obtain new inventory, our inventory levels will not be appropriate and our results of operations may be negatively impacted.

If we are unable to compete effectively in the highly competitive retail industry, our business and results of operations could be materially adversely affected.

        The retail industry is highly competitive with few barriers to entry. We compete with a wide variety of retailers including other department stores, discounters, home improvement stores, consumer electronics dealers, auto parts and auto service providers, specialty retailers, wholesale clubs and many other competitors operating on a national, regional or local level. Internet and catalog businesses which handle similar lines of merchandise also compete with us. In this competitive marketplace, success is based on factors such as price, product assortment and quality, service, and convenience.

        Our success depends on our ability to differentiate ourselves from our competitors with respect to shopping convenience, a quality assortment of available merchandise and superior customer service. We must also successfully respond to our customers' changing tastes. The performance of our competitors, as well as changes in their pricing policies, marketing activities, new store openings and other business strategies, could have a material adverse effect on our business, financial condition and results of operations.

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Our failure to successfully integrate Kmart and Sears may cause us to fail to realize cost savings and other benefits, which could adversely affect our future results.

        We may fail to successfully complete the integration of Kmart and Sears and, as a result, may fail to realize synergies, cost savings and other benefits expected from the Merger. The eventual success of the Merger depends, in part, on our ability to realize the anticipated growth opportunities and cost savings from combining the businesses of Kmart and Sears. In particular, expanding the offering and distribution of proprietary brands may impact the value of those brands and lead to cannibalization of sales from either Sears or Kmart. In addition, we may be unable to successfully differentiate product offerings at our various locations. If we do not achieve these benefits, our results of operations could be materially adversely affected.

        Also, we may fail to achieve sufficient cost savings through the integration of purchasing functions, supply chain, administrative and other operational activities. Furthermore, we must achieve these savings without adversely affecting our revenues. If we are not able to successfully achieve these objectives, the anticipated benefits of the Merger may not be realized fully or at all, or it may take longer to realize them than expected, and our results of operations could be materially adversely affected.

Due to the seasonality of our business, our annual operating results would be adversely affected if our fourth quarter results fail to meet our expectations.

        Our business is seasonal, with a high proportion of revenues and operating cash flows being generated during the fourth quarter of our fiscal year, which includes the holiday season. As a result, our fourth quarter operating results significantly impact our annual operating results. Our fourth quarter operating results may fluctuate significantly, based on many factors, including holiday spending patterns and weather conditions.

Our comparable store sales may fluctuate for a variety of reasons, which could adversely affect our results of operations.

        Our business is sensitive to customers' spending patterns, which in turn are subject to prevailing economic conditions. Our comparable store sales and results of operations have fluctuated in the past, and we expect them to continue to fluctuate in the future. A variety of other factors affect our comparable store sales and financial performance, including:

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actions by our competitors, including opening of new stores in our existing markets,



•

seasonal fluctuations due to weather conditions,



•

changes in our merchandise strategy and mix,



•

changes in population and other demographics, and



•

timing of our promotional events.

Accordingly, our results for any one fiscal quarter are not necessarily indicative of the results to be expected for any other quarter, and comparable store sales for any particular future period may decrease. For more information on our results of operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of this Form 10-K.

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We rely on foreign sources for significant amounts of our merchandise, and our business may therefore be negatively affected by the risks associated with international trade.

        We depend on a large number of products produced in foreign markets. We face risks associated with the delivery of merchandise originating outside the United States, including:

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potential economic and political instability in countries where our suppliers are located,



•

increases in shipping costs,



•

transportation delays and interruptions,



•

adverse fluctuations in currency exchange rates, and



•

changes in U.S. and foreign laws affecting the importation and taxation of goods, including duties, tariffs and quotas, or changes in the enforcement of those laws.

A decline in general economic conditions, consumer spending levels and other conditions could lead to reduced consumer demand for our merchandise thereby reducing our revenues and gross margins.

        Many economic and other factors outside our control, including consumer confidence, consumer spending levels, employment levels, prevailing interest rates, housing starts and remodels, and consumer debt levels, as well as fuel costs and the availability of consumer credit, affect consumer spending habits. In addition, disposable income levels may influence consumer purchasing patterns. A general slowdown in the United States economy or an uncertain economic outlook could adversely affect consumer spending habits and our operating results.

        The domestic and international political situation also affects consumer confidence. The threat, outbreak or escalation of terrorism, military conflicts or other hostilities could lead to a decrease in consumer spending. Any of these events and factors could cause us to increase inventory markdowns and promotional expenses, thereby reducing our gross margins and operating results.

We rely extensively on computer systems to process transactions, summarize results and manage our business. Disruptions in these systems could harm our ability to run our business.

        Given the number of individual transactions we have each year, it is critical that we maintain uninterrupted operation of our computer and communications hardware and software systems. Our primary computer systems and operations are located at our corporate headquarters in Hoffman Estates, Illinois and our facilities in Troy, Michigan. In addition, each of our stores is connected to our computerized inventory management and other systems. Our systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches, catastrophic events such as fires, tornadoes and hurricanes, and usage errors by our employees. If our systems are damaged or cease to function properly, we may have to make a significant investment to fix or replace them, and we may suffer interruptions in our operations in the interim. Any material interruption in our computer operations may have a material adverse effect on our business or results of operations.

The loss of key personnel may disrupt our business and adversely affect our financial results.

        We depend on the contributions of our senior management team, including Aylwin B. Lewis (Chief Executive Officer and President) and other key employees, for our future success. Although certain executives, including Mr. Lewis, have employment agreements with us, changes in our senior management and any future departures of key employees may disrupt our business and materially adversely affect our results of operations.

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Affiliates of our Chairman, whose interests may be different than your interests, exert substantial influence over our company.

        Affiliates of Edward S. Lampert, the Chairman of our Board of Directors, beneficially own approximately 41% of the outstanding shares of our common stock. These affiliates are controlled, directly or indirectly, by Mr. Lampert. Accordingly, these affiliates, and thus Mr. Lampert, have substantial influence over many if not all actions to be taken or approved by our stockholders, including the election of directors and any transactions involving a change of control.

        The interests of these affiliates, which have investments in other companies, may from time to time diverge from the interests of our other stockholders, particularly with regard to new investment opportunities. This substantial influence may have the effect of discouraging offers to acquire our company because the consummation of any such acquisition would likely require the consent of these affiliates.

We may be subject to product liability claims if people or property are harmed by the products we sell.

        Some of the products we sell may expose us to product liability claims relating to personal injury, death, or property damage caused by such products, and may require us to take actions such as product recalls. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all.

We may be subject to periodic litigation and other regulatory proceedings. These proceedings may be affected by changes in laws and government regulations or changes in the enforcement thereof.

        From time to time we may be involved in lawsuits and regulatory actions relating to our business. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, these proceedings could result in substantial costs and may require that we devote substantial resources to defend our company. Further, changes in governmental regulations both in the United States and in the other countries where we operate could have adverse effects on our business and subject us to additional regulatory actions. For a description of current legal proceedings, see Item 3, "Legal Proceedings" in this Form 10-K.

Item 1B.    Unresolved Staff Comments

        None.

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Item 2.    Properties

        The following table summarizes the locations of the Company's Kmart and Sears Domestic stores as of January 28, 2006:

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        In addition, as of January 28, 2006, the Company had 42 domestic supply chain distribution centers, of which 14 are owned and 28 are leased for terms ranging from one to 15 years. Of the total, 15 primarily support Kmart locations and the remaining 27 primarily support Sears stores. In addition, the Company had 651 domestic store warehouses, customer call centers and service facilities, most of which are leased for terms ranging from one to 10 years or are part of other facilities included in the above table.

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

        In December 2005, the Company sold the former Kmart headquarters building in Troy, Michigan. The Company still owns an 86,000 square foot office building in Troy, Michigan which houses the Company's data center.

        As of January 28, 2006, Sears Canada operated a total of 123 full-line stores, 252 specialty stores (49 furniture and appliance stores, 159 dealer stores operated under independent local ownership, five appliances and mattresses stores, 28 Corbeil stores and 11 outlet stores), 50 floor covering stores, approximately 2,116 catalog pick-up locations and 112 travel offices.

        A description of the Company's leasing arrangements appears in Note 17 of Notes to Consolidated Financial Statements.

Item 3.    Legal Proceedings

        See Part II, Item 8, "Financial Statements and Supplementary Data"—"Notes to Consolidated Financial Statements", Note 11—"Emergence from Chapter 11 Bankruptcy Protection and Fresh-Start Accounting," and Note 22—"Legal Proceedings", for information regarding legal proceedings, which information is incorporated herein by this reference.

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

        None.

13

Item 4A.    Executive Officers of the Registrant

        The following table and information sets forth the names of the executive officers of the Company, their current positions and offices with the Company, the date they first became executive officers of the Company, their current ages, and their principal employment during the past five years.

*

Became an executive officer of Holdings upon the completion of the Merger on March 24, 2005.

        Mr. Lewis became Chief Executive Officer and President in October 2005, after serving as the Chief Executive Officer and President of Kmart and Sears Retail as well as President of Holdings from March 2005 until September 2005. He was previously a director and the Chief Executive Officer and President of Kmart from October 2004 to March 2005. Prior to joining Kmart in October 2004, Mr. Lewis was President, Chief Multi-Branding and Operating Officer of YUM! Brands, Inc. (franchisor and licensor of quick-service restaurants) from 2000 until October 2004.

        Mr. Lacy was previously Chief Executive Officer and Vice Chairman of the Company from March 2005 to September 2005. He served as Chairman of the Board, Chief Executive Officer and President of Sears from December 2000 until March 2005.

        Ms. Austin became Executive Vice President, Chief Information Officer in February 2006 and was Senior Vice President and Chief Information Officer prior thereto. She was Senior Vice President,

14

Chief Information Officer of Kmart from April 2002 to March 2005. She previously served as its Vice President, IT Applications from 2001 to 2002.

        Ms. Crow became Senior Vice President, Financial Services of Sears in May 2004. From December 2000 to April 2004, she was Vice President, Customer Relationship Management for Sears.

        Mr. Crowley was previously Senior Vice President, Finance of Kmart, and had served as an officer of Kmart since 2003. Mr. Crowley is also the President and Chief Operating Officer of ESL Investments, Inc., a private investment firm, and has served in that capacity since 1999.

        Mr. Good was previously Executive Vice President and General Manager, Home Services (formerly Product Repair Services) of Sears from August 1999 to March 2005, when he assumed the same role with Sears Holdings.

        Mr. Harker joined the Company as Vice President and Chief Counsel in September 2005. He became Acting General Counsel and Corporate Secretary in January 2006. Prior to joining Sears Holdings, he practiced corporate law with the law firm of Wachtell, Lipton, Rosen and Katz from September 2000 to August 2005.

        Mr. Johnson was previously Kmart's Senior Vice President, Supply Chain and Operations. He joined Kmart in October 2003, after serving as Director, Organization and Systems for Carrefour S.A. from March 1998 to October 2003.

        Mr. Laughlin was elected Senior Vice President, Merchandising in December 2005. Previously, he served as Sears' Senior Vice President/General Merchandise Manager, Sears Home, from October 2003 to December 2005, Senior Vice President/General Manager, Home Stores from May 2003 to September 2003, and Vice President/General Merchandise Manager, Tools and Paint prior thereto.

        Mr. Luse joined Sears as Vice President, HR Retail and Related Services in 2001.

        Ms. McGuire joined the Company as Executive Vice President and Chief Marketing Officer in October 2005. Prior to joining Sears Holdings, she spent over 30 years at International Business Machines Corporation, most recently as Vice President, Worldwide Strategy and Marketing, IBM Systems and Technology Group from January 2005 to September 2005. Previously she served as IBM's Vice President, Worldwide Marketing and Strategy, IBM Global Services from August 2003 to January 2005 and Vice President, Worldwide Market Management and Integrated Marketing Communications from 1995 to August 2003.

        Mr. Phelan was elected Vice President and Controller of Sears Holdings effective March 2005. From December 2000 to March 2005 he served as Assistant Controller of Sears.

        Mr. Whitsett was elected Senior Vice President, Kmart Merchandising Officer in July 2005. He joined Kmart in 1999 as Director, Merchandise Planning & Replenishment and has served in a variety of positions, including Divisional Vice President, Merchandise Planning from 2000 to 2003, Divisional Vice President, Merchandising Consumables in 2003, Vice President/General Merchandise Manager, Drug Store and Food from 2003 to 2004, and Vice President/General Merchandise Manager from 2004 to 2005.

        Mr. Yulinsky joined the Company as Executive Vice President, Strategy and Customer Insight in October 2005. Previously, he was a leader of the Financial Institutions and Marketing/CRM practice at McKinsey and Co., a consulting firm, from August 1999 to October 2005.

        The Company's Code of Conduct applies to all employees, including the Company's principal executive officer, principal financial officer and principal accounting officer. The Code of Conduct is available on the "Corporate Governance" portion of the Company's corporate website at searsholdings.com. The Company intends to disclose on this website any amendment to, or waiver of, a provision of its Code of Conduct that applies to any of those three officers of the Company.

15

PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

        Holdings common stock is quoted on The NASDAQ Stock Market under the ticker symbol SHLD. There were approximately 25,000 registered stockholders of Holdings common stock as of January 28, 2006.

        The common stock of Holdings began trading on March 28, 2005, the first trading day after the consummation of the Merger. Prior to that date, Kmart's common stock was quoted on The NASDAQ Stock Market, under the ticker symbol KMRT. The quarterly high and low sales prices for Holdings' common stock (for the 2005 fiscal year) and for Kmart's common stock (for the 2004 fiscal year) are set forth below.

⁽¹⁾

During the first quarter of 2005, Kmart's common stock traded from January 27, 2005 until March 23, 2005, during which its high price was $133.85 and its low price was $89.37.

        Neither Holdings nor Kmart paid dividends on common stock in the last two fiscal years.

16

Equity Compensation Plan Information

        The following table reflects information about securities authorized for issuance under the Company's equity compensation plans as of January 28, 2006.

⁽¹⁾

Includes a grant to Aylwin B. Lewis of options to purchase 150,000 shares of Holdings' common stock and a grant to Alan J. Lacy of options to purchase 200,000 shares of Holdings' common stock. On October 18, 2004, Kmart granted Mr. Lewis options to purchase 150,000 shares of Kmart's common stock, subject to approval by Kmart's stockholders. Kmart's stockholders approved the option grant on March 24, 2005, and these options were converted into options to purchase an equal number of shares of Holdings' common stock upon effectiveness of the Merger. The grant to Mr. Lacy was approved by Kmart, the sole stockholder of Holdings on November 16, 2004 in connection with the approval of Mr. Lacy's employment agreement pursuant to which the options were granted.

Purchase of Equity Securities

        The following table provides information about shares of common stock the Company acquired during the fourth quarter of fiscal 2005, including shares assigned to the Company as part of settlement agreements resolving claims arising from the Chapter 11 reorganization of the Predecessor Company. During the 13 weeks ended January 28, 2006, the Company repurchased 1.3 million of its common shares at a total cost of $155 million under a common share repurchase program. This program, approved by the Board of Directors during the third quarter of fiscal 2005, authorized the repurchase

17

of up to an aggregate of $1.0 billion of the Company's common shares. As of January 28, 2006, the Company had approximately $0.4 billion of remaining authorization under this program.

⁽¹⁾

Includes the following numbers of shares acquired as payment of withholding taxes in connection with the vesting of restricted stock and as Bankruptcy-related settlements:

⁽²⁾

Excluding shares acquired pursuant to Bankruptcy-related settlements, the average price paid per share was $117.63.

18

Item 6.    Selected Financial Data

        The table below summarizes the Company's recent financial information. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 and the Company's consolidated financial statements and notes thereto in Item 8.

⁽¹⁾

Fiscal 2005 includes the results of Sears subsequent to the Merger date. As a result, fiscal 2005 results include approximately 44 weeks of Sears' results and 52 weeks of Kmart's results.

⁽²⁾

Fiscal 2005 ended on the last Saturday in January 2006. Fiscal 2001, fiscal 2002, the 39 weeks ended January 28, 2004, and fiscal 2004 ended on the last Wednesday in January. The reported results for fiscal 2003 have been divided into two parts as a result of Kmart's emergence from Chapter 11 bankruptcy in fiscal 2003. As further discussed in Note 11 of Notes to Consolidated Financial Statements, due to the application of Fresh-Start Accounting (defined below) upon emergence from Chapter 11 bankruptcy, the reported historical financial statements of the Predecessor Company for the periods prior to May 1, 2003 generally are not

19

comparable to those of the Successor Company. Thus, the results of operations of the Successor Company were not combined with those of the Predecessor Company.

⁽³⁾

Results include the following items of the type that periodically affect results, but the amounts of which may vary significantly from period to period and have a disproportionate effect on the periods presented: in fiscal 2005, a $90 million charge, net of taxes, due to the cumulative effect of a change in accounting principle pertaining to a change in accounting for certain indirect buying, warehousing and distribution costs, a $39 million gain on the sale of assets, a $111 million charge for restructuring costs; in fiscal 2004, a $946 million net gain on sales of assets; in the 39 weeks ended January 28, 2004, an $89 million net gain on sales of assets; in the 13 weeks ended April 30, 2003, a $47 million charge for accelerated depreciation on unimpaired assets to be disposed of following store closings, and a $10 million credit as a result of a change in the estimated expenses for 2002 cost reduction initiatives; in fiscal 2002, $1,019 million for inventory write-downs in conjunction with accelerated mark-downs due to store closings, $533 million for asset impairments, $50 million for cost reduction initiatives, and $33 million for other items; in fiscal 2001, $827 million for asset impairments, $163 million for supply chain restructuring, $97 million for the restructuring/impairment of BlueLight.com, and $23 million for a voluntary early retirement program/severance.

⁽⁴⁾

For fiscal years 2002 and 2001, long-term debt does not include liabilities classified as subject to compromise.

20

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        In order to facilitate an understanding of Holdings, the reporting periods presented, and the basis for this presentation, the Company has divided its "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A") into the following seven sections:

•

Overview of Holdings



•

Merger and Change in Fiscal Year



•

Fiscal 2005 Initiatives and Accomplishments



•

Results of Operations:

Fiscal 2005 Summary

Holdings Results:

•

Fiscal 2005 Compared to Fiscal 2004 (as reported and pro forma)



•

Fiscal 2004 Compared to Fiscal 2003 (as reported)



•

39-Week Period Ended January 26, 2005 Compared to the 39 Week Period Ended January 28, 2004



•

13-Week Period Ended April 28, 2004 Compared to the 13 Week Period Ended April 30, 2003 (Predecessor Company)

Business Segment Results:

•

Kmart Fiscal 2005 (as reported) Compared to Fiscal 2004 (as reported)



•

Sears Domestic Fiscal 2005 (pro forma) Compared to Fiscal 2004 (pro forma)



•

Sears Canada Fiscal 2005 (pro forma) Compared to Fiscal 2004 (pro forma)

Pro Forma Reconciliation

•

Analysis of Consolidated Financial Condition



•

Contractual Obligations and Off-Balance-Sheet Arrangements



•

Application of Critical Accounting Policies

Overview of Holdings

        Holdings, the parent company of Kmart and Sears, was formed in connection with the March 24, 2005 Merger of these two companies. The Company is a broadline retailer and, at the end of fiscal 2005, had approximately 2,300 full-line and 1,100 specialty retail stores in the United States operating through Kmart and Sears and approximately 370 full-line and specialty retail stores in Canada operating through Sears Canada, a 54%-owned subsidiary.

        The Company currently conducts its operations in three business segments: Kmart, Sears Domestic and Sears Canada. Prior to the Merger, the Company operated a single business segment, Kmart. The nature of operations conducted within each of these segments is discussed within the "Business Segments" section of Item 1 in this Form 10-K.

Merger and Change in Fiscal Year

        The Merger has been accounted for as a purchase business combination, with Kmart acquiring Sears. Accordingly, the historical financial statements of Kmart serve as the historical financial statements of Holdings, the registrant. The consolidated statements of operations and cash flows for

21

fiscal 2005 include the results of operations of Sears subsequent to the Merger date, or from March 25, 2005 forward. Therefore, Holdings' operating results for fiscal 2005 include approximately 44 weeks of Sears' results and 52 weeks of Kmart's results.

        Kmart shareholders received one share of Holdings common stock for each Kmart share owned. In all, approximately 94.9 million shares of Holdings common stock were issued in exchange for all outstanding common stock of Kmart. In aggregate, approximately 62.2 million shares of Holdings common stock were issued to Sears shareholders at a value of approximately $6.5 billion (based on the average closing price of $104.33 of Kmart's common stock during the period from November 15, 2004 through November 19, 2004, two business days before and after the date the Merger was announced). In addition, approximately $5.4 billion in cash was paid in consideration for (i) all outstanding shares of common stock of Sears, based upon the proration provisions of the agreement pursuant to which the Merger was effected, and (ii) all outstanding stock options of Sears. Including transaction costs of approximately $18 million, the total consideration paid for the acquisition of Sears was approximately $11.9 billion.

        Effective March 23, 2005, the Company changed its fiscal year end from the last Wednesday in January to the Saturday closest to January 31st. As the change in fiscal year end reflects a change of only three days, the historical financial statements have not been recast to reflect this change. Sears Canada's fiscal year end is the Saturday closest to December 31st. The results of operations for Sears Canada are reported to Holdings on a one-month lag. Therefore, the consolidated statements of operations and cash flows for fiscal 2005 include operating results for Sears Canada from March 25, 2005 through December 31, 2005.

Fiscal 2005 Initiatives and Accomplishments

        This Annual Report on Form 10-K reports on the ten months of progress Holdings has made as a combined company since the Merger. Management has made significant progress in integrating Sears and Kmart and in focusing the combined organization on certain key initiatives. Rather than pursuing the development of a single strategy for Holdings, the Company's management team has instead established certain key principles to guide Holdings' activities.

        The Company strives to create a culture of continuous learning. Management analyzes, tests and adapts both its competitive strategies and everyday practices on an on-going basis in an effort to better serve customer needs and attract new customers to the Company's stores and services. Rather than focusing on building market share through non-value added promotions and sales events, the Company aims to consistently exceed customer expectations by providing quality services, products and solutions that earn customers' trust so as to build long-term customer relationships.

        The Company is also focused on running its business for the long-term benefit of its stockholders. The Company is committed to applying the same continuous learning processes used to build customer relationships in identifying and implementing ways to improve the efficiency and effectiveness of Company operations. The objective is to improve overall profitability and capture market opportunities when and where they exist.

        Though constant progress is always a priority, the Company believes it has taken significant steps in fiscal 2005 consistent with achieving its two main initiatives:

Building long-term customer relationships

        To make its products, brands and service offerings more responsive to the needs of its customers and to build long-term relationships with them, the Company has made and plans to continue making a number of changes to its store formats and associated product offerings. The Company closely monitors customer response to these changes. The Company's strategies and plans will continue to evolve as it

22

incorporates learnings from customer response to these changes. Specific initiatives and accomplishments in fiscal 2005 included:

•

launching a new off-mall store format under the Sears nameplate. This mid-size store format offers customers the "best of both", meeting the everyday needs of customers as well as offering more destination-focused purchase categories. This new format was operated under the Sears Essentials nameplate during fiscal 2005. In February 2006, management decided that, on a go-forward basis, Sears Essentials and Sears Grand, the Company's other off-mall Sears format, will both operate under the Sears Grand name. As of January 28, 2006, Holdings had opened 50 Sears Essentials stores, mostly by way of converting former Kmart store locations. Management expects to begin the conversion to the Sears Grand nameplate in the first half of fiscal 2006. The Sears Essentials stores have achieved varying degrees of success. While the Company continues to believe that the format offers an attractive means for providing customers with Sears brands and appliances in off-mall locations, the Company has also achieved success selling such products in Kmart stores. As a result, the Company has reduced the number of stores planned for conversion to the Sears Grand format in fiscal 2006. In addition, the Company will continue to assess the pace of conversion to, and planned location of Sears Grand stores and the offering of Sears products in existing or remodeled Kmart stores based on customer response and the capital required;



•

introducing select Sears private label branded products, including Kenmore, Craftsman and Diehard products, into certain Kmart stores, enabling Kmart to better differentiate itself from other mass market retailers;



•

remodeling approximately 90 Kmart stores, where the expected financial returns justified the required capital outlay, to include Sears-brand products. The Company intends to continue its roll-out of home appliances, including Sears Kenmore products, into both Sears Grand and Kmart locations over the next several years as a means of expanding its points of distribution in response to competitor store growth. As of January 28, 2006, approximately 90 Kmart stores, including, certain of the remodeled locations, offered broad assortments of home appliances;



•

completing a national roll-out of Sears credit card acceptance to all Kmart locations, and offering Kmart customers the opportunity to apply for Sears credit cards and related financial services at Kmart locations; and



•

testing multiple new initiatives at select locations, including the addition of certain Sears customer services, including Sears Auto Centers, licensed businesses such as hearing and optical centers, and auto and truck rental services, to Kmart stores.

Improving Profitability

        Actions taken in fiscal 2005 consistent with the Company's commitment to improving its profitability through increasing the efficiency and effectiveness of its operations included:

•

initiating and continuing efforts to improve gross margins by reducing reliance on certain promotional events, particularly at Sears;



•

improving efficiencies and cost effectiveness of the supply chain, including transportation synergies, the consolidation of international buying offices and a greater emphasis on direct import merchandise procurement;



•

optimizing Kmart and Sears relationships with vendors and suppliers by sourcing goods on a combined basis, where possible, to obtain better costs, vendor support and terms;

23

•

integrating the home office functions of Kmart and Sears to reduce the overall cost structure of Holdings. As of January 28, 2006, Holdings had eliminated approximately 1,500 positions between Sears' and Kmart's combined home office functions;



•

lowering fixed costs associated with marketing expenditures by reducing the number of creative agencies utilized by Sears; and



•

implementing a rigorous process to ensure that the Company's capital is expended only on those efforts that improve the experience for customers and provide the opportunity for attractive returns on investment.

        The financial impact of these profitability initiatives is described below in the "Results of Operations" section.

RESULTS OF OPERATIONS

        Within this "Results of Operations" section, the Company discloses results of operations on both an "as reported" and a "pro forma" basis. The reported results are not necessarily representative of the Company's ongoing operations because Sears results are included only for the period of time after the March 24, 2005 Merger. Prior to that date, the reported results reflect only Kmart's results. Therefore, to facilitate an understanding of the Company's trends and on-going performance, the Company has presented pro forma results in addition to the reported results. The pro forma results adjust the reported amounts to give effect to the Merger as if it had occurred at the beginning of fiscal 2004. Thus, the pro forma results include both Kmart and Sears for both fiscal 2004 and fiscal 2005. A reconciliation of pro forma amounts to reported amounts has been included under the heading "Pro Forma Reconciliation".

        The discussion of reported results for fiscal 2004 as compared to fiscal 2003 has been divided into two parts as a result of Kmart's emergence from Chapter 11 bankruptcy in fiscal 2003. As further discussed in Note 11 of Notes to Consolidated Financial Statements, due to the application of Fresh-Start Accounting (defined below) upon emergence from Chapter 11 bankruptcy, the reported historical financial statements of the Predecessor Company for the periods prior to May 1, 2003 generally are not comparable to those of the Successor Company. Thus, the results of operations of the Successor Company were not combined with those of the Predecessor Company for purposes of this MD&A.

        References to comparable store sales amounts within the following discussion include sales for all stores operating for a period of at least 12 full months, including remodeled and expanded stores, but excluding store relocations and stores that have undergone format changes.

        Finally, the Company notes that the discussion that follows should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8.

24

Fiscal 2005 Summary

        Holdings' consolidated results of operations for fiscal 2005 and fiscal 2004, presented on both a reported and a pro forma basis, are summarized below.

        The following discussion is designed to provide the reader with an overview of fiscal 2005 operating results as compared to fiscal 2004, with particular emphasis on significant events and transactions that had a disproportionate effect on the Company's results for the periods presented. Further discussion regarding the Company's operating performance follows this overview section.

25

Earnings per Diluted Share

        The following table summarizes Holdings' diluted earnings per share on both a reported and pro forma basis for fiscal 2005 and fiscal 2004.

⁽¹⁾

Effective January 27, 2005, Kmart changed its method of accounting for certain indirect buying, warehousing and distribution costs and, as a result, the Company recorded the cumulative effect of this change in accounting principle in fiscal 2005. Further information regarding this change in accounting is set forth in Note 3 of Notes to Consolidated Financial Statements.

        Significant asset sales and restructuring charges greatly impacted the Company's fiscal 2005 and fiscal 2004 diluted earnings per share on both a reported and pro forma basis. Items of these types periodically affect the Company's results, but may vary significantly in amount from period to period and have a disproportionate effect on the Company's results for the periods presented. The impact of these items on diluted earnings per share is shown in the following table:

⁽²⁾

Gain on Sale of Assets: In fiscal 2004, Kmart completed multiple sale and lease assignment transactions, including significant transactions with The Home Depot, Inc. ("Home Depot") and Sears. These transactions resulted in aggregate gains of $946 million, or $5.78 per diluted share, being recorded as part of fiscal 2004 reported earnings as compared to $39 million, or $0.16 per diluted share, for fiscal 2005, a difference of $5.62 per diluted share. The fiscal 2004 pro forma gain on sale of assets impact of $1.35 per diluted share excludes the impact of gains recognized in fiscal 2004 for sales of properties to Sears. Further information regarding these transactions is set forth in Note 16 of Notes to Consolidated Financial Statements.

⁽³⁾

Restructuring Charges: During fiscal 2005, the Company recorded $111 million in restructuring charges, or $0.35 per diluted share, in connection with the Merger and integration of Sears' and Kmart's headquarters support functions, as well as in connection with productivity initiatives at Sears Canada. The fiscal 2004 pro forma restructuring charges included a $41 million, or $0.16 per diluted share, charge recorded by Sears in connection with certain productivity initiatives at that entity. Further information regarding these restructuring charges is set forth in Note 5 of Notes to Consolidated Financial Statements.

        In aggregate, the items set forth above lowered fiscal 2005 earnings per diluted share, on a reported and pro forma basis, by $0.19 and $0.18 per share, respectively, while increasing fiscal 2004 reported and pro forma earnings per diluted share by $5.78 and $1.19, respectively. Accordingly, from

26

fiscal 2004 to fiscal 2005, these items represent a difference of $5.97 and $1.37 per diluted share on a reported and pro forma basis, respectively. In assessing the Company's operating performance, management segregates these items from other operating results for the affected periods.

Revenues and Comparable Store Sales

        On a reported basis, revenues increased $29.3 billion, or 148%, to $49.1 billion in fiscal 2005 versus fiscal 2004. The increase in reported revenues was due to the inclusion of Sears in fiscal 2005. On a pro forma basis, revenues declined $1.7 billion, or 3.0%, to $54.3 billion in fiscal 2005 as compared to fiscal 2004. Domestic comparable store sales were down 5.3% in the aggregate, with Sears Domestic comparable store sales declining 8.4% and Kmart comparable store sales declining 1.2%.

        Kmart's comparable store sales decline in fiscal 2005 was primarily due to lower transaction volumes across most businesses. Apparel sales at Kmart increased for the year on a comparable store basis, but this improvement was more than offset by sales declines in both home goods and the food and drug business. Kmart recorded a 0.9% comparable store sales increase during the fourth quarter of fiscal 2005 as a result of a 1.0% increase in comparable store sales during the holiday period (the nine-weeks ended December 31, 2005). However, the impact of the fourth-quarter sales increase was more than offset by lower sales recorded for the balance of the year.

        The sharper decline in Sears Domestic comparable store sales relative to Kmart was due mainly to efforts initiated at Sears in fiscal 2005 to improve gross margin by reducing reliance on certain promotional events. Kmart conducted similar efforts to shed unprofitable sales promotions and improve overall profitability during fiscal 2004. The Company expects the degree of comparable store sales declines at Sears to moderate in fiscal 2006 as the Company passes through the anniversary of fiscal 2005 gross margin improvement initiatives at Sears.

        The disappointing performance of Sears' apparel business was also a factor in the decline of Sears' comparable store sales during fiscal 2005. Comparable store sales in Sears' overall apparel business were down 13.8% for the year. In fiscal 2005, Sears attempted a more "fashion forward" apparel offering, relying on the introduction of several new proprietary brands. Customer response to these offerings and brands did not meet management's expectations. The Company continues to adjust its apparel strategy to better meet customer demand.

        The Company continues to face market share pressure as competitors open additional locations and engage in heavy promotional activity. The Company expects these trends to continue in the foreseeable future, and these trends may negatively affect the Company's future sales performance and results of operations.

Gross Margin Rate

        Gross margin as a percentage of merchandise sales and services revenue ("gross margin rate") on a reported basis was 27.4% in fiscal 2005 as compared to 24.7% in fiscal 2004. This increase was primarily attributable to the fiscal 2005 addition of Sears, which had a higher overall gross margin rate than Kmart. On a pro forma basis, gross margin rate improved to 27.4% in fiscal 2005 as compared to 26.4% in fiscal 2004. The fiscal 2005 increase in pro forma gross margin rate was primarily attributable to improvement in the Sears Domestic gross margin rate, mainly as a result of improved inventory management and the utilization of more targeted clearance and promotional markdowns versus historical reliance on storewide events. This improvement in Sears Domestic gross margin rate, however, was less in the third and fourth quarters of fiscal 2005 than during the first two fiscal quarters of the year as poor customer response to full line apparel offerings resulted in additional markdowns being taken to clear fashion apparel in the second half of the year. The Company's ability to generate future improvement in overall gross margins depends on its ability to realize projected purchasing

27

synergies and cost savings, as well as improve the profitability of clearance goods and Sears' apparel business.

Selling and Administrative Expense Rate

        On a reported basis, selling and administrative expenses as a percentage of total revenues was 21.9% for fiscal 2005, as compared to 20.2% for fiscal 2004. The increase in the reported selling and administrative expense rate was primarily attributable to the fiscal 2005 addition of Sears, which had a higher cost structure than Kmart. On a pro forma basis, selling and administrative expenses as a percentage of total revenues was 22.3% for both fiscal 2005 and fiscal 2004. While selling and administrative expenses decreased by $399 million primarily as a function of reduced payroll expenditures and cost-saving initiatives, selling and administrative expenses as a percentage of total revenues was unchanged as the impact of these reductions was offset by lower expense leverage given lower overall sales, as well as increases at Sears Canada in both associate stock-based compensation expense and marketing expense. The Company's fiscal 2005 domestic selling and administrative expense rate improved by approximately 10 basis points compared to fiscal 2004.

Reduction in Debt Assumed as Part of the Merger

        Subsequent to the Merger, the Company reduced domestic debt levels by $0.8 billion. This debt was primarily Sears debt included in Holdings' consolidated balance sheet subsequent to the Merger. The repayments were funded primarily from operating cash flows.

Share Repurchases

        Subsequent to the Merger, through January 28, 2006, the Company repurchased approximately 5.0 million of its common shares at a total cost of approximately $0.6 billion under the Company's $1.0 billion common share repurchase program described under "Financing" below. The stock repurchases were funded from operating cash flows.

Significant Transactions

Sears Canada Credit Sale

        Sears Canada completed the sale of substantially all of the assets and liabilities of its Credit and Financial Services operations to JPMorgan Chase in November 2005, and concurrently, the two parties entered into a long-term marketing and servicing alliance with an initial term of ten years. Sears Canada used a substantial portion of the proceeds generated from this sale to fund an extraordinary cash dividend and a tax-free return of stated capital to its shareholders. Holdings, as beneficial owner of approximately 54% of the outstanding common stock of Sears Canada, received $877 million in after-tax proceeds from this distribution. Additional information concerning the sale is contained in Note 4 of Notes to Consolidated Financial Statements.

Orchard Supply Hardware

        In November 2005, the Company completed a transaction resulting in the private equity fund of Ares Management LLC ("Ares") investing cash for 19.9% of the voting stock of Orchard Supply Hardware Stores Corporation ("OSH"). Prior to the Ares investment, OSH was a wholly-owned subsidiary of the Company. The private equity fund invested $59 million in cash for the 19.9% equity interest and a three-year option to purchase, for $127 million, additional shares of OSH that currently represent 30.2% of OSH's outstanding voting stock. This structure allowed the Company to realize immediate value for OSH, a chain of hardware stores based in California that is not central to the Company's core business, while continuing to participate in the additional value the Company believes the OSH management team and Ares can create.

28

Sears Canada Take-Over Bid

        In December 2005, Holdings announced its intention to acquire the remaining 46% interest in Sears Canada that it does not already own. The Company commenced a take-over bid for the remaining interest in Sears Canada on February 9, 2006. The Company has offered C$16.86 (Canadian dollars) per share, or approximately C$835 million ($720 million U.S. dollars), for the minority interest. The take-over bid is open for acceptance until March 17, 2006. The Company believes that 100% ownership of Sears Canada would allow Sears Canada to be able to compete with the other Canadian retailers and the Canadian operations of major U.S. retailers.

Holdings Results

Fiscal 2005 Compared to Fiscal 2004

        The consolidated statement of operations for fiscal 2005 is not comparable to that for fiscal 2004 because the prior year does not include Sears' results. Additionally, the consolidated statement of operations for fiscal 2005 is not representative of the Company's operations as it only includes Sears' results of operations after the Merger, or from March 25, 2005 forward. For these reasons, the Company believes that an understanding of its reported results, trends and on-going performance is not complete without presenting results on a pro forma basis. Accordingly, the Company has provided an analysis of operating results for fiscal 2005 as compared to fiscal 2004 on both a reported and a pro forma basis.

Holdings Reported Results

Fiscal 2005 Compared to Fiscal 2004

        Total revenues increased $29.3 billion, or 148%, to $49.1 billion for fiscal 2005, as compared to total revenues of $19.8 billion for fiscal 2004. The increase was attributable to the addition of Sears revenues of $30.0 billion in fiscal 2005, partially offset by a decline in Kmart's revenues of $0.7 billion, or 3.8%, due to a reduction in the total number of Kmart stores in operation, including 48 converted to a Sears format, and the comparable store sales decline of 1.2% discussed above. Total fiscal 2005 revenues benefited from $153 million of sales being recorded during the first quarter of fiscal 2005 as a result of three additional days being included in the fiscal 2005 period due to the Company's change from a Wednesday to a Saturday month end.

        Gross margin as a percentage of merchandise sales and services revenue was 27.4% for fiscal 2005, as compared to 24.7% for fiscal 2004. The increase was primarily attributable to the addition of Sears, which had a higher overall gross margin rate than Kmart, in fiscal 2005.

        Selling and administrative expenses as a percentage of total revenues was 21.9% for fiscal 2005, as compared to 20.2% for fiscal 2004. The increase was primarily attributable to the addition of Sears, which had a higher cost structure than Kmart, in fiscal 2005.

        Depreciation and amortization was $932 million for fiscal 2005, as compared to $27 million for fiscal 2004. The increase was primarily attributable to the addition of Sears, which accounted for $885 million of the combined expense in the current year.

        Restructuring charges were $111 million for fiscal 2005. These charges included a $57 million charge for employee-related termination costs associated with Sears Canada restructuring initiatives implemented during fiscal 2005, including a workforce reduction of approximately 1,200 associates, as well as $54 million at Kmart for relocation assistance and employee termination-related costs associated with Holdings' home office integration efforts.

        Included in operating income were gains on sales of assets of $39 million and $946 million for fiscal 2005 and fiscal 2004, respectively. During fiscal 2004, the Company entered into multiple

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agreements with Home Depot to sell four properties and assign 14 leased properties for an aggregate purchase price of $271 million, resulting in a total gain on sale of $253 million. Also during fiscal 2004, Kmart sold four owned properties, assigned 45 leased properties and leased one owned store to Sears for a total purchase price of approximately $576 million, resulting in a gain of $599 million. Additionally, the Company sold certain other real and personal property, resulting in net gains of $39 million and $94 million for fiscal 2005 and fiscal 2004, respectively. Included within the fiscal 2004 gains were $22 million related to the sale of owned, or assignment of leased, properties, $18 million related to the sale of the Company's Trinidad subsidiary and its associated property, $12 million related to the sale of corporate airplanes and $42 million from sales of other real and personal property.

        Operating income was $2.1 billion for fiscal 2005 as compared to $1.8 billion for fiscal 2004. Fiscal 2005 included the addition of $1.4 billion in Sears operating income generated subsequent to the Merger, which was offset by the collective impact of $906 million less in gains on the sale of assets realized by Kmart in the current year and, to a lesser degree, a $148 million decline in Kmart operating income, excluding gains on asset sales. Holdings' operating income for fiscal 2005 also included a $317 million gain on sale of business, reflecting a minority interest gain on the sale of Sears Canada's Credit and Financial Services business in November 2005. This gain had no impact on Holdings' net income as its entire impact was offset by increased minority interest expense. See Note 4 of Notes to Consolidated Financial Statements for further detail.

        Interest expense increased $129 million in fiscal 2005 as a result of the inclusion of Sears debt in the current year, as well as additional interest expense incurred upon the conversion of Kmart's 9% subordinated convertible notes. Bankruptcy-related recoveries declined $19 million in the current year period and represent amounts recognized from vendors who had received cash payment for pre-petition obligations. Other income increased by $35 million in the current year period primarily due to a gain of $21 million recognized in connection with the settlement pertaining to Kmart's license agreement with Footstar, Inc. ("FTS") for the operation of Kmart's footwear departments. The effective tax rate decreased to 36.4% in fiscal 2005 from 37.7% in fiscal 2004, with the decrease primarily attributable to the November 2005 sale of Sears Canada's Credit and Financial Service business being taxed at a capital gains rate, lowering the effective tax rate for fiscal 2005.

        Effective January 27, 2005, the Company determined that it would be preferable to conform one of the accounting practices utilized by Kmart to that of Sears. The Company changed its method of accounting for certain indirect overhead costs from inventoriable costs to period expenses. In accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes", a change in accounting policy to conform the acquirer's policy to that of the acquired entity is treated as a change in accounting principle. As a result of the accounting change, the Company recorded a charge of $90 million, net of taxes, in the first quarter of fiscal 2005 for the cumulative effect of this change in accounting principle. The charge represents the amount of indirect costs reflected within inventory at the beginning of fiscal 2005. See Note 3 of Notes to Consolidated Financial Statements for further detail.

Holdings Pro Forma Results

Pro Forma Fiscal 2005 Compared To Pro Forma Fiscal 2004

        Total revenues declined $1.7 billion, or 3.0%, to $54.3 billion for fiscal 2005, as compared to total revenues of $56.0 billion for fiscal 2004. The decline was primarily attributable to total revenue declines of 3.9% and 3.8% at Sears Domestic and Kmart, respectively, partially offset by a 5.3% revenue increase at Sears Canada, primarily due to favorable exchange rates. Domestic comparable store sales were down 5.3% in the aggregate, with Sears Domestic comparable store sales declining 8.4% and Kmart comparable store sales declining 1.2%. The Sears Domestic comparable store sales decrease was primarily attributable to efforts initiated in fiscal 2005 to improve gross margin rates by reducing

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reliance on certain promotional events and, to a lesser degree, poor customer response to full line store apparel offerings, as discussed above. Kmart's comparable store sales declined primarily as a result of lower transaction volumes.

        Gross margin as a percentage of merchandise sales and services revenue was 27.4% for fiscal 2005, as compared to 26.4% for fiscal 2004. The increase was primarily attributable to improvement in the Sears Domestic gross margin rate, mainly as a result of improved inventory management and the utilization of more targeted clearance and promotional markdowns as discussed above. Sears Domestic's gross margin rate as a percentage of merchandise sales and services revenue was 29.3% for fiscal 2005, as compared to 27.4% for fiscal 2004.

        Selling and administrative expenses as a percentage of total revenues was 22.3% for both fiscal 2005 and fiscal 2004. As discussed above, the Company reduced overall selling and administrative expense by $399 million in fiscal 2005; however, the impact of these reductions was mitigated by lower leverage of these expenses given lower overall sales in fiscal 2005, as well as increases at Sears Canada in both associate stock-based compensation and marketing expense.

        Restructuring charges for fiscal 2005 totaled $111 million as compared to $41 million for fiscal 2004. The fiscal 2005 charges included a $57 million charge for employee-related termination costs associated with Sears Canada restructuring initiatives, including a workforce reduction of approximately 1,200 associates, as well as $54 million recorded at Kmart for relocation assistance and employee termination- related costs associated with Holdings' home office integration efforts. The $41 million charge recorded in fiscal 2004 reflected a charge recorded by Sears in the second quarter of fiscal 2004 as part of a productivity initiative.

        Operating income was $2.1 billion for fiscal 2005, as compared to $1.6 billion for fiscal 2004. The increase was primarily attributable to increased operating income at Sears Domestic, which had $646 million in additional operating income during fiscal 2005. This increase was partially offset by $307 million less in gains on the sale of assets realized by Kmart in the current year and, to a lesser degree, a $148 million decline in Kmart operating income, excluding gains on asset sales, and a $78 million decline in Sears Canada's operating income, excluding the gain on sale of business in fiscal 2005. Holdings' operating income for fiscal 2005 also included a $317 million gain on sale of business, reflecting a minority interest gain on the sale of Sears Canada's Credit and Financial Services business in November 2005. This gain had no impact on Holdings' net income as its entire impact was offset by increased minority interest expense. See Note 4 of Notes to Consolidated Financial Statements for further detail.

        Interest expense declined $80 million in fiscal 2005, as compared to fiscal 2004 due primarily to lower average borrowings. Bankruptcy-related recoveries decreased $19 million in the current year and represent amounts recognized from vendors who had received cash payment for pre-petition obligations. The effective tax rate increased to 37.3% in fiscal 2005 from 34.6% in fiscal 2004, with the lower fiscal 2004 effective rate attributable to the inclusion of Sears.

Holdings Reported Results

Fiscal 2004 Compared to Fiscal 2003

        The discussion of reported results for fiscal 2004 as compared to fiscal 2003 has been divided into two parts as a result of Kmart Corporation's emergence from Chapter 11 bankruptcy in fiscal 2003. As further discussed in Note 11 of Notes to Consolidated Financial Statements, due to the application of Fresh-Start Accounting (defined in Note 11 of Notes to Consolidated Financial Statements) upon emergence from bankruptcy, the reported historical financial statements of the Predecessor Company

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for periods prior to May 1, 2003 generally are not comparable to those of the Successor Company. Thus, fiscal 2004 results have been set forth in two parts as shown in the below table.

39 Weeks Ended January 26, 2005 Compared to 39 Weeks Ended January 28, 2004

        Comparable store sales and total sales decreased 10.4% and 11.6%, respectively, for the 39 weeks ended January 26, 2005 as compared to the 39 weeks ended January 28, 2004. Factors contributing to the decline in same store and total sales included reductions in promotional events and promotional advertising in the Company's circulars, soft customer demand for apparel and increased competition at certain store locations.

        Gross margin decreased $0.1 billion to $3.8 billion for the 39 weeks ended January 26, 2005, from $3.9 billion for the 39 weeks ended January 28, 2004. Gross margin rate increased to 24.7% for the 39 weeks ended January 26, 2005 from 22.5% for the 39 weeks ended January 28, 2004. Improvements in product margin contributed 270 basis points to the increase in gross margin rate during the 39 weeks ended January 26, 2005, primarily due to favorable markon, reductions in markdowns on clearance items and improvement in store inventory shrinkage. Improvements in inventory shrinkage at distribution centers as a result of improved inventory management and supply chain operations contributed 63 basis points to the increase in gross margin rate for the 39 weeks ended January 26, 2005.

        Selling, general and administrative expenses decreased $0.4 billion for the 39 weeks ended January 26, 2005 to $3.0 billion, or 19.8% of sales, from $3.5 billion, or 20.2% of sales, for the 39 weeks ended January 28, 2004. The decline in SG&A was primarily due to reductions of $263 million

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in store payroll and related benefits as a result of increased operating efficiencies and reduced sales volume at the Company's stores. Reductions in expenses for weekly and mid-week circular advertising, partially offset by an increase in our electronic media advertising, contributed $69 million to the decrease in SG&A. In addition, improved workers compensation costs generated a reduction of $54 million to SG&A for the 39 weeks ended January 26, 2005.

        Operating income for the 39 weeks ended January 26, 2005 was $1.7 billion, or 10.9% of sales, as compared to $0.5 billion, or 2.9% of sales, for the same period of the prior year. For the 39 weeks ended January 26, 2005 and January 28, 2004, the Company recognized $914 million and $89 million of gain on sales of assets, respectively, primarily related to sales transactions with Home Depot and Sears as further discussed in Note 16 of Notes to Consolidated Financial Statements. The increase in operating income, excluding these gains, was due to the decrease in SG&A, net of the decrease in gross margin, as noted above.

        Interest expense, net for the 39 weeks ended January 26, 2005 and January 28, 2004 was $80 million and $127 million, respectively. The reduction in interest expense was mainly due to an increase of $23 million in interest income for the 39 weeks ended January 26, 2005 compared to the 39 weeks ended January 28, 2004. Interest income increased due to an increase in the Company's average cash and cash equivalents balance and an improvement on the rate of return due to improved interest rates. During the 39 weeks ended January 26, 2005 the Company also experienced a decline in debt discount accretion and interest on capital leases of $15 million and $8 million, respectively.

        The effective income tax rate was 37.7% for the 39 weeks ended January 26, 2005 and 38.1% for the 39 weeks ended January 28, 2004.

13 Weeks Ended April 28, 2004 Compared to 13 Weeks Ended April 30, 2003

        Comparable store and total sales for the 13 weeks ended April 28, 2004 as compared to the 13 weeks ended April 30, 2003 decreased $0.7 billion or 12.9% and $1.6 billion or 25.3%, respectively. The decrease in comparable store sales was due primarily to several Company-wide promotional events occurring in the first quarter of fiscal 2003 along with a reduction in advertising, including the frequency of mid-week circulars in fiscal 2004. Approximately $0.9 billion of the decrease in total sales was due to the closure of 316 stores in the first quarter of fiscal 2003, of which 250 stores were included in continuing operations. The remaining decrease in total sales is primarily attributable to the decrease in comparable store sales.

        Gross margin decreased $0.3 billion to $1.1 billion, for the 13 weeks ended April 28, 2004, from $1.4 billion for the 13 weeks ended April 30, 2003. Gross margin rate increased to 24.6% for the 13 weeks ended April 28, 2004, from 23.0% for the 13 weeks ended April 30, 2003. Reduced depreciation, as a result of the write-off of long-lived assets in conjunction with the application of Fresh-Start Accounting favorably affected the gross margin rate 54 basis points in the fiscal 2004 period.

        SG&A decreased $0.4 billion to $1.0 billion, or 21.8% of sales for the 13 weeks ended April 28, 2004, from $1.4 billion, or 23.0% of sales, for the 13 weeks ended April 30, 2003. Contributing to the decline was a reduction in advertising expenses in the fiscal 2004 period of $93 million, reduced payroll and related expenses in the Company's open stores of $62 million and reduced depreciation as a result of the write-off of long-lived assets in conjunction with the application of Fresh-Start Accounting of $86 million. SG&A included $146 million related to store closures during the 13 weeks ended April 30, 2003, as discussed above.

        Operating income for the 13 weeks ended April 28, 2004 was $165 million, or 3.6% of sales, as compared to a loss of $39 million, or (0.6%) of sales, for the same period in fiscal 2003. The improvement was primarily due to the decrease in SG&A and the improvement in the Company's gross margin rate, as discussed above, partially offset by an overall decline in gross margin dollars due to the

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reduced store base. Operating income was also affected by net gain on sales of assets of $32 million in the first quarter of fiscal 2004 and restructuring charges of $37 million in the first quarter of fiscal 2003.

        Interest expense, net for the 13 weeks ended April 28, 2004 and April 30, 2003 was $28 million and $57 million, respectively. During the 13 weeks ended April 28, 2004, $12 million of interest expense was recorded for the accretion of obligations recorded at net present value. Included in interest expense for the 13 weeks ended April 30, 2003 was $37 million of amortization of debt issuance costs associated with the Predecessor Company's Court-approved $2 billion debtor-in-possession financing facility. Interest at the stated contractual amount on unsecured debt that was not charged to earnings for the 13 weeks ended April 30, 2003 was $67 million. Interest expense is net of interest income of $5 million and $1 million for the 13 weeks ended April 28, 2004 and April 30, 2003, respectively.

        The effective income tax rate was 38.1% and (0.7%) for the 13 weeks ended April 28, 2004 and April 30, 2003, respectively.

Business Segment Results

        Holdings is continuing the process of integrating Kmart and Sears. To date, for purposes of reviewing results of operations and making asset-allocation decisions, senior management has continued to utilize principally the reporting structures that existed independently for Sears and Kmart prior to the Merger. As a result, the following discussion of segment operations is organized into three principal business segments: Kmart, Sears Domestic and Sears Canada.

Kmart

        Kmart results and key statistics were as follows:

Fiscal 2005 Compared To Fiscal 2004

        Comparable store sales and total sales decreased 1.2% and 3.8%, respectively, during fiscal 2005, primarily as a result of lower transaction volumes across most businesses. Apparel sales increased for the year on a comparable store basis, but this improvement was more than offset by sales declines in both home goods and the food and drug business. Total sales benefited from $153 million of additional sales recorded during the first quarter of fiscal 2005 as a result of three additional days being included in the fiscal 2005 period due to the Company's change from a Wednesday to a Saturday month end. However, this favorable impact was more than offset by a reduction in the total number of Kmart stores in operation. A total of 60 Kmart stores were closed in fiscal 2005, including 48 Kmart stores

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converted to the Sears Essentials format. These store closures and conversions accounted for a 2.2% decline in total Kmart sales for fiscal 2005. The remaining balance of the decline in total sales was due to the decline in comparable store sales and the fact that fiscal 2004 total sales benefited from partial-year sales recorded in stores closed during fiscal 2004.

        Gross margin as a percentage of merchandise sales and services revenue was 24.3% in fiscal 2005, as compared to 24.7% for fiscal 2004. The decline in gross margin rate was primarily attributable to the impact of increased occupancy and distribution costs during fiscal 2005, due in part to lower expense leverage given lower sales levels in fiscal 2005, as well as increased utilities and transportation expense stemming from higher energy price levels prevalent during fiscal 2005. These items collectively reduced Kmart's gross margin rate in fiscal 2005 by approximately 50 basis points. Excluding the impact of distribution and occupancy costs, Kmart's gross margin rate increased by approximately 10 basis points over fiscal 2004 levels. This improvement reflected overall improved margin management in a number of businesses, most notably within the hardlines and food and drug businesses, partially offset by the impact of higher markdown levels and clearance activity in those Kmart stores preparing for conversion to the Sears Essentials format. Within the hardlines business, comparable store sales, gross margin rate and gross margin dollars all increased relative to fiscal 2004 levels; however, the better than expected gross margin rate improvement within food and drug for fiscal 2005 came at the expense of lower sales and total gross margin dollars versus fiscal 2004. The Company's fiscal 2006 plans include efforts to increase food and drug sales and, thereby, the total gross margin dollars generated by that business, which may negatively impact its gross margin rate.

        Selling and administrative expenses as a percentage of total revenues was 19.9% for fiscal 2005, as compared to 20.2% for fiscal 2004. The improvement in rate is primarily a function of reductions in payroll and benefits costs, which were approximately $150 million lower in fiscal 2005, as compared to fiscal 2004, primarily due to reduced performance-based incentive expense. The reduction in payroll and benefits expense accounted for a 20 basis point improvement in Kmart's overall selling and administrative expense rate. Selling and administrative expenses declined approximately $44 million for fiscal 2005 as compared to fiscal 2004 at those store locations that were either closed or converted to the Sears Essentials format during fiscal 2005.

        Restructuring charges related to Holdings' home office integration efforts were $54 million during fiscal 2005, including $36 million for relocation assistance and $18 million for employee termination-related costs.

        Operating income for fiscal 2005 decreased compared to fiscal 2004 primarily due to $906 million less in gains on the sale of assets realized in the current year and, to a lesser degree, a decline in sales and gross margin, and the restructuring charges of $54 million recorded in the current year period, offset by lower selling and administrative expense.

Sears Domestic

        The consolidated statement of operations for Holdings for fiscal 2005 includes Sears Domestic results from March 25, 2005 forward. It does not reflect a full year for Sears Domestic or any prior year operating results for comparison. The Company believes that an understanding of its reported results and its ongoing financial performance is not complete without presenting the Sears Domestic results of operations on a pro forma basis. The presentation below provides the results of operations on a reported and pro forma basis.

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        Sears Domestic results and key statistics were as follows: