Sears 2006 Annual Report Download - page 77

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SEARS HOLDINGS CORPORATION
Notes to Consolidated Financial Statements—(Continued)
settlements and, as hedge accounting was applied to such contracts, an offsetting amount was recorded as a
component of other comprehensive income.
In addition, during fiscal 2006, Sears Canada entered into cross-currency interest rate swaps designated as a
hedge of certain U.S. dollar-denominated floating-rate debt issued by Sears Canada. These swaps were settled
during the third quarter of fiscal 2006 concurrent with the repayment of the hedged debt and, as a result, the
Company recorded the cost of settling these swaps, $8 million, as a component of interest expense in the
Company’s consolidated statements of income for the fiscal year ended February 3, 2007.
Total Return Swaps
The Company, from time to time, invests its surplus cash in various securities and financial instruments,
including total return swaps, which are derivative contracts that synthetically replicate the economic return
characteristics of one or more underlying marketable equity securities. In exchange for receiving the return tied
to the position underlying a total return swap, the Company pays a floating rate of interest tied to LIBOR on the
notional amount of the contract. The fair value of a total return swap is based on the quoted market price of the
underlying position and changes in fair value of the total return swaps are recognized currently in earnings.
During fiscal 2006, the Company entered into total return swaps and recognized $74 million of investment
income, consisting of realized gains of $84 million and unrealized losses of $2 million less $8 million of interest
cost. As of February 3, 2007, the total return swaps had an aggregate notional amount of $375 million and a fair
value of $5 million. The aggregate fair value of the total return swaps has been recorded as a current receivable
on the consolidated balance sheet as of February 3, 2007. These investments are highly concentrated and involve
substantial risks. Accordingly, the Company’s financial position and quarterly and annual results of operations
may be positively or negatively materially affected based on the timing, magnitude and performance of these
investments.
Under the terms of the transactions with the respective counterparties, the Company is required to post cash
collateral of up to 25 percent of the notional amount of the underlying total return swap position, plus the amount
of any unrealized losses on the positions. As of February 3, 2007, the collateral balance held by the Company’s
counterparties based on the Company’s total return swaps’ aggregate notional amount of $375 million was $80
million and was recorded as a current receivable on the Company’s consolidated balance sheet.
Financial Guarantees
The Company issues various types of guarantees in the normal course of business. The Company had the
following guarantees outstanding as of February 3, 2007:
millions
Bank
Issued
SRAC
Issued Other Total
Standby letters of credit ............................................. $888 $119 $— $1,007
Commercial letters of credit .......................................... 71 178 — 249
Secondary lease obligations and performance guarantee .................... — — 90 90
The secondary lease obligations relate to certain store leases of previously divested Sears businesses. The
Company remains secondarily liable if the primary obligor defaults. As of February 3, 2007, the Company had a
$17 million liability recorded in other liabilities, which represents the Company’s current estimate of potential
obligations related to these leases. The performance guarantee relates to certain municipal bonds issued in
connection with the Company’s headquarters building. Payments under this guarantee were $18 million in fiscal
2006. This guarantee expires in 2007.
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