Does Sears Holdings (SHLDQ) Chairman and CEO Eddie Lampert really believe his once-venerable retailing empire is on the verge of collapse, or is the company's "going-concern" declaration merely some boilerplate to comply with SEC regulations?
In a March 21 filing with the SEC, Sears Holdings wrote: "Our historical operating results indicate substantial doubt exists related to the Company's ability to continue as a going concern."
Certainly, for a business to get to the point that it needs to include such language in its filings shows there is risk of failure. However, "substantial doubt" doesn't mean certainty and management can mitigate those risks. Lampert believes his plans more than override those fears.
In fact, in the filing, Sears Holdings follows up the going concern language by noting that, "We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements." That's encouraging, but the next sentence notes that "... we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional debt financing, or whether such actions would generate the expected liquidity as currently planned."
A warning shot
A "going concern" notice is language companies use to let investors know there are some serious, potentially fatal, risks facing it. All companies operate on the assumption they will remain a going concern, or a viable business, well into the future. That is the presumption everyone goes by and it's the basis for how companies file their financial statements.
However, when significant problems arise that could create not only turmoil, but actually undermine the company's ability to keep functioning, businesses have a duty to warn people that risk exists. The Financial Accounting Standards Board says, "When relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued," management should disclose the risk [emphasis added].
The board goes on to say that even if there are conditions that can mitigate or even alleviate the substantial doubts raised, companies must still warn of the existence of the risks.
A deeply dug hole
This is what seems to be going on with Sears. In its annual 10-K report, the retailer pointed to its historical operating results for causing the "substantial doubt" about its future existence. One look at Sears quarterly filings shows that deepening losses can only go on for so long before a company gives up the ghost.
In the fourth quarter, Sears' losses expanded to $607 million from $580 million the previous year, though both periods included non-cash charges for Sears' deteriorating trade name, understandably, though, it was a much larger amount this year than last. Revenues were also on the decline, falling to $6.1 billion from $7.3 billion, and though a lot has to do with the large number of stores Sears Holdings has closed, it's also because fewer people are shopping at its Sears and Kmart stores.
Yet following the filing of the annual report, Sears CFO Jason Hollar took to the company's blog to further explain that this was indeed boilerplate to the extent Sears is required to disclose the risks by regulation, but the retail company has a plan in place to turn things around. He also pointed to Sears' independent auditors giving the retailer an "unqualified audit opinion," meaning they believe Sears remains a going concern "that can meet its financial and other obligations for the foreseeable future."
Plenty of wiggle room
One can argue that Hollar's outlook is just feel-good language intended to get investors to whistle past the graveyard. That's what teen retailer Aeropostale appeared to do as it careened toward bankruptcy. Despite consistently touting its plans to return to profitability, it still went under, and it never warned investors about its ability to survive as a going concern.
In none of its filings did Aeropostale mention there was any "substantial doubt." Not when its stock plunged into penny stock territory, nor when it was delisted from the NYSE, nor even when it filed notices saying it couldn't file its financial statements in a timely manner. In fact, the only time Aeropostale warned about its viability was after it declared bankruptcy. The Wall Street Journal reported that Sears' disclosure about its concerns and its optimism were required by a new accounting rule.
Sears and Lampert do finally have a plan for fixing the retailer, and it's rather innovative, even if it's a long shot to succeed after more than a decade of neglect. But maybe the saying "better late than never" will hold true for the retailer.
The domino effect
Plan or not, though, there are real-world implications that stem from Sears raising these doubts in its filings, even if everyone already knew they existed. Vendors that were already jittery about delivering merchandise to the retailer may become even more so now that Sears has publicly acknowledged the jeopardy it faces. Vendors are already unable to get insurance to cover their shipments to the retailer, and continuing to supply Sears means they are gambling they'll still be paid if the music stops.
Sears' stock also plunged 12% on the disclosure, though it has rallied sharply since, and that could be because investors realize Sears was merely following the rules and Lampert has a game plan, even if it is late in coming. Recently reported insider buying also pushed the stock up. That doesn't mean I'd be buying Sears stock, though, because the retailer faces some exceptionally strong headwinds that even better-financed companies are having trouble getting through.
The going concern notice by Sears is important and there is a lot to be worried about with the retailer, but this particular disclosure isn't the final piece of this puzzle, and Lampert may make a surprise return from the brink.