Byline: Jennifer Weitzman

NEW YORK — Surpassing Wall Street estimates, Sears, Roebuck & Co. posted a 17 percent increase in earnings in its second quarter ended July 1, but warned that the second half would be tough.
The nation’s second-largest retailer, next to Wal-Mart Stores Inc., earned $388 million, compared with $331 million a year ago. On a per-share basis, Sears rose 29 percent to $1.11 from 86 cents. Sears earnings were 6 cents ahead of Wall Street’s consensus estimate of $1.05, partly reflecting an aggressive share repurchase program.
Weakness in apparel was offset by strength in hard lines, lower expenses and strong credit card earnings.
For Sears chairman and chief executive Arthur C. Martinez, who led a turnaround of Sears in the Nineties and plans to retire by the end of the year, it may have been his final upbeat earnings report. Though there was some decline in the late Nineties, and concerns that the turnaround would be short-lived, Sears’ most recent quarters have been strong. However, during a conference call Friday, Martinez said Sears, like other retailers, is in for a rough second half, with the biggest challenge being seasonal apparel.
Martinez said the process of finding a successor “is moving smoothly and the time line is still on track.” He declined to specify the time frame.
“Department comp and nondepartment comps have had a tough season and there will be pressure on margins via promotions and liquidations, and we can’t remain above that fray,” Martinez said. In addition, Sears is facing increased expenses with the release of its Sears Gold Card credit card.
He said Sears expects to maintain strength in hard lines, though with intensified promotional pressure in the second half.
When asked by an analyst if he was still comfortable with projections for the full year, Martinez said he hasn’t changed his mind about earlier guidance.
In the quarter, revenues increased 4.6 percent to $10.1 billion from $9.64 billion as a result of improvements in full-line, dealer stores, Sears Canada and credit divisions. Domestic full-line stores comparable-store sales increased 2.7 percent.
“In our retail business, we posted solid sales growth and lower selling and administrative expenses, while our credit business saw further improvement in portfolio quality and lower operating costs. Our strong cash flow allowed us to repurchase over 10 million shares of Sears stock during the quarter and our return on equity over the last 12 months has expanded to 25.1 percent,” Martinez said.
For its soft-line business, full-line comps were flat. Although apparel was below expectations, Sears officials on the call noted the category’s performance was consistent with other retailers. Most of the industry has felt the impact of cool and wet weather, and weak apparel offerings from vendors. However, Sears said it experienced “meaningful sales increases” with its private brands, but performed poorly in highly seasonal categories, which hurt gross margins. Sears was helped by strong results in jewelry, home fashion and shoes. Martinez said this year’s Nike launch exceeded expectations and has been a catalyst for footwear sales.
Sears said its full-line operation was helped by robust hard-line sales and decreased selling and administrative expenses, which increased full-line operating earnings by 9.8 percent. Hard-line comps were up in the mid-single digits, driven by core appliances and electronics.
Credit operating income increased by 26.3 percent due to higher revenues, improved portfolio quality, securitization activity and reductions in selling and administrative expenses.
Martinez also said Sears doesn’t expect its credit operation to show the kind of problems experienced at the Fingerhut division of Federated Department Stores Inc., which as previously reported cited difficulties last week.
“This is absolutely a different and unrelated situation,” Martinez said.
Sears Canada revenues increased 9.9 percent to $1.02 billion, due to a 10 percent increase in comparable sales growth in its full-line retail stores.
Mark Picard, with Lazard Freres, said Sears strong position in hard lines is offsetting softness in apparel, and that although Sears had flat comps in the quarter, several other department store chains are reporting negative comps.
“Sears is holding its own well against what we believe is a competitive retail environment,” Picard said. He said Sears’s private brands are exceeding plan and the company is also getting solid traction in nonapparel lines like home fashion, jewelry and shoes, though “aggressive promotions to drive traffic,” does put a drag on results, according to Picard.
Looking ahead, Picard said Sears will be in a defense mode for business. He said they will align inventory to be appropriate with sales trends and try to enhance operating margins and profitability and not focus as much on exceeding sales plans. “You must make the most of the macroenvironment you are in.”
Martinez added that Sears has found success with children’s merchandise and will continue to launch new lines, including Frankie the Turtle this summer. Despite the economic and consumer spending slowdown, “Sears will continue to forecast conservatively given sales and industry performances, particularly in the soft-line offerings,” he said.
With Sears aggressive online strategy, Martinez said the company will continue to invest, as Web-site traffic is building. “We are seeing an impact on the site on the core retail customer, where 10 percent are making purchases after getting information” from the Web site.
For the half, net income was $623 million or $1.76 per share, compared with $477 million, or $1.24 a share, an increase of 42 percent. Revenues for the half climbed 4.1 percent to $19 billion from $18.3 billion.

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