As is typical in the retail industry, Sears Holdings’ operating cash flows mainly consist of net income, changes in net inventory (inventory less payables) and capital expenditures. This, along with uses of cash to repay our debt obligations (including interest) and to honor our legacy pension commitments, constitute the vast majority of total cash flows. While our recent operating results have generated negative cash flows, we want to clarify the facts around our sources and uses of cash, as well as how the term “Cash Burn” is used.
“Cash Burn” typically compares the inflows of cash to a company with its uses of cash. Given the seasonal nature of our business, our operating cash flows (i.e. cash flows excluding amounts needed to fund debt and pension obligations) should be viewed in the context of two cycles: February through October (the beginning of our first quarter through the end of our third quarter), and November through January (our fourth quarter). We build inventory through Q3 in order to serve our members during the holiday season in Q4. Given the typical payment terms with our vendors, we finance a portion of this inventory build by using our credit facility, thereby resulting in higher levels of borrowing at the end of Q3. We sell this inventory in Q4, and pay down the associated credit facility borrowings.
One might calculate our domestic operating cash flows through Q3 using public information as ($1.1) billion as the sum of:
- Third quarter year-to-date EBITDA of ($772) million;
- Change in net inventory of ($148) million; and
- Third quarter year-to-date capital expenditures of $170 million.
If we use the average Q4 operating cash flows of the prior two years of approximately positive $750 million1, full year operating cash flows would be approximately $(350) million. One could then add to that figure the full year estimated non-operating cash flows of $(713)2 million, to arrive at full year total cash flows of $(1.06) billion3. As a result, and purely as a function of historical facts, it is difficult to understand any third party estimates of “cash burn” well in excess of this figure. Once the performance of our fourth quarter is known (not only EBITDA but our working capital changes and overall cash flow), any conclusions relying on such erroneous assumptions can be corrected.
One issue to note is that we distinguish between operating cash flows and non-operating cash flows. Our largest non-operating cash requirement is the funding of our pension obligation which will be about $417 million this year, declining to about $250 million next year. Our cumulative contributions have been about $1.6 billion for the four year period 2011 through 2014. In funding our pension obligation, we have used one form of debt, our revolving credit facility, to fund another form of debt, our pension. As we disclosed as of the end of our third quarter, our revolver borrowings would have been about $392 million instead of the reported $1.6 billion when excluding the past 33 months’ worth of pension contributions.
We believe that it is important to distinguish between a company’s short-term profit performance and its access to capital and asset base to fund its operations and obligations. Whether it was financial services companies (or a company like Ford) that reported significant losses during the financial crisis or technology companies in stages of hyper-growth that constantly raise new rounds of capital, either a strong asset base or access to capital distinguishes those companies which emerge stronger from those that do not. Fortunately, we have both a strong asset base and access to capital, which allows us to pursue our transformation in the face of challenging profit performance.
Sears Holdings has demonstrated a consistent ability to generate liquidity from a variety of sources. In addition, the high-level analysis for 2014 provided above does not include any proceeds from liquidity actions. Year-to-date, we have raised approximately $2.2 billion (resulting in a year-over-year reduction in debt including retirement obligations), and over the past three years we have generated about $5 billion of enhanced liquidity.
As we continue to transform our Company, we have the resource base needed to enable us to invest in our Shop Your Way and Integrated Retail initiatives while fulfilling all of our obligations.
Robert Schriesheim is EVP, Chief Financial Officer for Sears Holdings.
1 Q4 operating cash flows include domestic EBITDA, net inventory changes, and capital expenditures and exclude pension contributions. This is not intended to provide any guidance, nor foreshadowing about future performance, about which no assurances may be given.
2 Non-operating cash flows primarily include pension contributions of $417 million per our third quarter earnings deck posted on our website, plus last twelve months interest expense paid in cash through the third quarter of this year of approximately $226 million, and capital lease payments of approximately $70 million as disclosed in our 2013 10-K.
3 This is not intended to provide any guidance, nor foreshadowing about future performance, about which no assurances may be given.