Notes to Consolidated Financial Statements

Stock Option Plans
Options to purchase common stock of the Company have been granted to employees under various plans at prices equal to the fair market value of the stock on the dates the options were granted. Generally, options vest over a three- or four-year period and become exercisable either in equal, annual installments over the vesting period, or at the end of the vesting period. Options generally expire in 10 or 12 years.

Additionally, certain options were granted in 1997 with performance-based features that required the Company's share price to reach specified targets at three- and five-year intervals from the grant date to be earned. In February 1999, the Company extended the period of time allowed to meet the specified targets by one year. The Company had 1.2 million and 1.4 million performance-based options outstanding at the end of 1998 and 1997, respectively. Subject to the satisfaction of the performance-based features, these performance-based options vest 50% in year six, 25% in year seven and 25% in year eight from the time of grant. The Company did not recognize compensation expense in 1998 or 1997 related to these options because the exercise price exceeded the Company share price at both year ends.

The Company measures compensation cost under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and no compensation cost has been recognized for its fixed stock option plans. In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used during the respective years to estimate the fair value of options granted:

Had compensation cost for the Company's stock option plans been determined using the fair value method under SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:

Changes in stock options are as follows:

The following table summarizes information about stock options outstanding at January 2, 1999:

Associate Stock Purchase Plan
On May 8, 1997, the shareholders approved the Company's Associate Stock Ownership Plan ("ASOP"). The ASOP allows eligible employees the right to elect to use up to 10% of their eligible compensation to purchase Sears common stock on a quarterly basis at the lower of 85% of the fair market value at the beginning or end of each calendar quarter. The maximum number of shares of Sears common stock available under the ASOP is 10 million. The first purchase period began January 1, 1998, and 0.6 million shares were issued under the ASOP in 1998.


The Company is a multi-line retailer providing a wide array of merchandise and services, and no single product or service accounted for a significant percentage of the Company's consolidated revenue. The Company has four domestic segments, which include the Company's operations in the United States and Puerto Rico, and one international segment. The domestic segments are Retail, Services, Credit and Corporate.

The Retail segment includes the operating results of the Company's Full-line Stores, Home Stores and Auto Stores, and the Services segment includes the operating results of the Company's Home Services and Sears Direct businesses. These businesses have been aggregated into their respective reportable segments based on the management reporting structure and their similar economic characteristics, customers and distribution channels.

A general description of the merchandise and services offered in each segment follows:

Full-lines Stores, which are located principally in shopping malls, sell apparel, home fashions and hardlines merchandise. Home Stores, consisting of Hardware, Dealer and HomeLife furniture Stores, The Great Indoors and Commercial Sales, include sales of hardlines and furniture. The Company's Auto Stores sell and install tires, batteries and related goods and services.

Associates and third-party licensee partners of the Company provide product repair services, extended warranty service contracts and home improvement products. Sears Direct consists of direct-response marketing, which markets insurance (credit protection, life and health), clubs and service memberships, merchandise through specialty catalogs, and impulse and continuity merchandise; and Sears Online, which offers merchandise for sale via the Company's websites.

The Credit business manages the Company's portfolio of receivables arising from purchases of merchandise and services from domestic operations.

The Corporate segment includes activities that are of a holding-company nature, primarily consisting of administrative activities, the costs of which are not allocated to the Company's businesses.

The International segment consists of retail, credit, services and corporate operations similar to the Company's domestic operations. International operations are conducted in Canada through Sears Canada, Inc., a 54.7% owned subsidiary. International operations were also conducted in Mexico through Sears, Roebuck de Mexico, S.A. de C.V. ("Sears Mexico") until March 29, 1997 when the Company sold 60% of the outstanding shares of Sears Mexico. Thereafter, Sears Mexico's results are no longer included in the Company's consolidated results.

The segments do not record intersegment revenues and expenses. External revenues and expenses are allocated between the applicable segments.

The domestic segments participate in a centralized funding program. Interest expense is allocated to the Credit segment based on its funding requirements assuming a 9-to-1 debt to equity ratio. Funding includes debt reflected on the balance sheet and investor certificates related to credit card receivables sold through securitizations. Services is allocated interest income based on the after-tax cash flow it generates through the sale of service contracts. The remainder of net domestic interest expense is reported in the Retail segment.

The Company's segments are evaluated on a pretax basis, and a stand-alone income tax provision is not calculated for the individual segments. The Company includes its deferred income taxes within the Corporate segment. The other accounting policies of the segments are substantially the same as those described in the Company's summary of significant accounting policies footnote.

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