Sears' Lampert shows value of annual report as comms tool

This is the time of year when mailboxes get stuffed with company annual reports.

This is the time of year when mailboxes get stuffed with company annual reports.

The reports range in shape, size, and cost. Some companies use it as a sales tool, while others include little more than what the Securities and Exchange Commission requires. Many large companies use it to demonstrate their standing as solid corporate citizens.

For years, Warren Buffett's letter to shareholders in Berkshire Hathaway's report was considered the crown jewel. It was and still is informative, analytical, and folksy, providing Buffett's insight on the current and future state of the economy and stock market. Investors, including many people who will never own a single share of BRK, are quick to read the letter as soon as it hits the company's Web site.

This year, Buffett's letter has competition from Eddie Lampert, who combined Sears and Kmart a year ago and has his eye on building a track record to match that of the Sage of Omaha. Lampert's letter in the company's 2005 report runs nearly 6,000 words and lays out in detail his business philosophy and strategy. It is likely to become required reading at business schools.

Lampert begins his letter by briefly summarizing the financial results, but with a twist. He makes the case that Sears Holdings is essentially a new company with the addition of Kmart, and thus the standard fiscal metrics don't provide an accurate snapshot of the state of the business, so instead he uses pro forma adjusted EBITDA (earnings before interest, taxes, depreciation and amortization). He's quick to point out that this is the metric that the board uses to gauge progress.

The measure shows 23% growth in 2005 over 2004, but Lampert admits he and his senior managers were disappointed and promise to do better.

Lampert also spends a good chunk of the letter talking about profitability and how many retailers mistakenly place too much emphasis on growth at any cost. He assures shareholders that he will only invest capital in stores if he can see that it will increase profitability. Every dollar invested must make money.

He isn't shy about telling the industry and its analysts that they are misguided to view same-store sales as the Holy Grail. He clearly illustrates the inherent flaws in such a metric and how it can mislead investors. A similar criticism, however, can be made about EBITDA and that it doesn't take into account necessary capital expenditures. After making this point, he tells shareholders that he's shifting the company's focus from maintaining sales to growing profit. He has no intention of "giving product away."

Lampert also uses the letter to advocate, telling the three major credit-rating agencies that Sears deserves an investment-grade rating, which would lower his company's borrowing costs.

Lampert knows that any good letter needs a human touch, and he delivers here. He tells the story of a dedicated former staffer who died this year and then notes that the man's son now also works for Sears.

It's too early to tell whether Lampert has Buffett's business prowess, but he obviously understands the value of communications.

Fred Bratman is president of Hyde Park Financial Communications.

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