to our shareholders

Opportunity in home services, direct response and electronic commerce
We continue to see a major growth opportunity in home services through Sears HomeCentral, where we are the market leader in every major category we serve. Even though Sears is five times the size of the next largest player, our $3 billion business represents a small share of the $175 billion home services market and offers a tremendous opportunity for us.

Within home services, we did well in 1998 in product repair and service contracts. In home improvement services, we continue to make selective acquisitions - last year they were in remodeling and carpet cleaning - that increase the scale and scope of our service offerings. Integration of these companies, coupled with slower acquisition of new customers, affected home improvement services performance, which did not meet our aggressive goals.

In 1998 we also established Sears Direct, which includes our existing, highly successful direct response business as well as our new electronic commerce initiatives. Sears Direct utilizes Sears extensive customer information database to offer products and services targeted to individual customer needs. Through our Sears, Craftsman and Wish Book websites and future Internet-based offerings, we are creating virtual stores that are always open and responsive to our customers.

Continued improvement in Canadian operations
For the second consecutive year, Sears Canada produced outstanding operating results. Canada's aggressive growth strategy included refurbishing full-line stores and expanding its dealer and furniture store networks. We expect continued growth in 1999 as Sears Canada further implements the strategic initiatives that produced its dramatic turnaround. The unfavorable change in the Canadian dollar exchange rate makes the reported increase less robust than it actually was.

Modified specialty store portfolio
We modified our specialty store business portfolio in 1998 to focus more closely on our core operations and to free up capital that can be redirected to produce higher returns. For example, we merged our Western Auto and Parts America stores with Advance Holdings, Inc., one of the nation's leading parts and accessories retailers. This partnering provided us with $175 million in proceeds and will allow us to participate in the market leadership and upside potential of the combined company through our 40 percent ownership stake.

Our remaining automotive business, which is comprised of NTB National Tire & Battery stores and Sears Auto Centers, was affected by our focus on putting a solid infrastructure in place to support future growth. NTB is now well positioned to gain market share as its name gains consumer recognition.

We also sold our HomeLife furniture business in January 1999. The transaction generated $110 million in proceeds and offers growth potential through Sears 19 percent equity stake in the new company.

Priorities for 1999
Our challenges are clear. Our sense of urgency in dealing with them is high. Sears management and associates are united in the effort to resume the company's revenue growth and convert it into profits. We must solve basic business issues within our existing channels while at the same time investing in new channels that serve customers in new ways. In line with this outlook, our key priorities for 1999 are to:
  • Revitalize our full-line store revenue and profit growth through more focused assortments, extension of our private brands and more creative merchandising and marketing.

  • Continue to improve credit performance and growth prospects by leveraging the opportunities provided through operational changes.

  • Manage our specialty businesses aggressively to create complementary channels for our key merchandise categories.

  • Accelerate new growth through home services, direct response and electronic commerce.

  • Aggressively manage our costs and cash flow.

Our associates and management team are hard at work making the necessary adjustments. Thanks to their dedicated efforts, we expect improved performance in 1999, with earnings per share growth in the low double-digit percentage range.

We want to provide our customers with the products and services they want - anytime, anywhere, anyway they want them. The following pages show how Sears can deliver this value to customers through retail, services and credit offerings that, in turn, can create enhanced value for you, our shareholders.

As part of our continuing dialogue with shareholders, we included an extensive question and answer section on pages 14 through 17 to address key issues in our businesses. If you would like to share your comments, I encourage you to visit our website.

Arthur C. Martinez
Chairman and Chief Executive Officer
March 12, 1999

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