Sears 2007 Annual Report Download - page 75

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SEARS HOLDINGS CORPORATION
Notes to Consolidated Financial Statements—(Continued)
borrowings and $2 million in outstanding letters of credit. The $17 million in borrowings have been classified
within short-term borrowings on our consolidated balance sheet as of February 2, 2008, as we intend to repay the
entire outstanding amount of this borrowing within the next 12 months.
Convertible Notes
At the time of Kmart’s emergence from bankruptcy, ESL Investments, Inc. (“ESL”), through its affiliates,
was issued $60 million principal of 9% convertible notes (the “Notes”) which were convertible to equity at a
price equal to $10 per share at the option of the holder at any time prior to May 2006. On January 31, 2005, ESL
affiliates converted, in accordance with their terms, the outstanding Notes and six months of accrued interest into
an aggregate of 6.3 million shares of Kmart common stock. In consideration of the conversion of these Notes
prior to maturity, ESL and its affiliates received a $3 million payment from Kmart. The cash payment was
equivalent to the approximate discounted after-tax cost of the future interest payments that would have otherwise
been paid by Kmart to ESL affiliates in the absence of the early conversion. In conjunction with the conversion,
we recognized the remaining related unamortized debt discount of $17 million as interest expense.
Wholly-owned Insurance Subsidiary and Inter-company Notes
As noted in Note 1, we have numerous types of insurable risks, including workers’ compensation, product
and general liability, automobile, warranty, and asbestos and environmental claims. Also, as discussed in Note 1,
we sell extended service contracts to our customers. The associated risks are managed through our wholly-owned
insurance subsidiary. In accordance with applicable insurance regulations, the insurance subsidiary holds
investment grade securities to support the insurance coverage it provides.
We have transferred certain domestic real estate and intellectual property (i.e. trademarks) into separate
wholly-owned, bankruptcy remote subsidiaries. These bankruptcy remote subsidiaries lease the real estate
property to Sears and license the use of the trademarks to Sears and Kmart. Further, the bankruptcy remote
subsidiaries have issued asset-backed notes that are collateralized by the aforementioned real estate rental
streams and intellectual property licensing fee streams. Cash flows received from rental streams and licensing fee
streams paid by Sears, Kmart and, potentially in the future, other affiliates or third parties will be used for the
payment of fees, interest and principal on the asset-backed notes issued. Since the inception of these subsidiaries,
the debt securities have been entirely held by our wholly-owned consolidated subsidiaries in support of our
insurance activities. The net book value of the securitized intellectual property assets was approximately $1.0
billion and $1.0 billion at February 2, 2008 and February 3, 2007, respectively. The net book value of the
securitized real estate assets was approximately $1.0 billion and $1.0 billion at February 2, 2008 and February 3,
2007, respectively.
NOTE 8—DERIVATIVE FINANCIAL INSTRUMENTS AND FINANCIAL GUARANTEES
Foreign Currency Forwards
As of February 2, 2008, we had a series of foreign currency forward contracts outstanding with a total
Canadian notional value of $1.0 billion and with a weighted-average remaining life of 0.3 years. These contracts
have been designated and qualify as hedges of the foreign currency exposure of our net investment in Sears
Canada. Accordingly, the aggregate fair value of the forward contracts as of February 2, 2008, negative
$86 million, has been recorded as a liability on our consolidated balance sheet, with an offsetting amount, net of
tax, recorded as a component of other comprehensive income. Certain of our currency forward contracts require
collateral be posted in the event our liability under such contracts reaches a predetermined threshold. Cash
collateral posted under these contracts is recorded as part of our accounts receivable balance and totaled $33
million as of February 2, 2008.
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