UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
_______________________________________________
FORM 10-Q
_______________________________________________
| ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| FOR THE QUARTERLY PERIOD ENDED APRIL 29, 2017 | |
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 001-35641
_______________________________________________
SEARS HOMETOWN AND OUTLET STORES, INC.
(Exact Name of Registrant as Specified in Its Charter)
_______________________________________________
| DELAWARE | 80-0808358 | |
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
| 5500 TRILLIUM BOULEVARD, SUITE 501 HOFFMAN ESTATES, ILLINOIS | 60192 | |
| (Address of Principal Executive Offices) | (Zip Code) | |
Registrant’s Telephone Number, Including Area Code: (847) 286-7000
_______________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past
90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer | ¨ | Accelerated filer | ý | |||
| Non-accelerated filer (Do not check if a smaller reporting company) | ¨ | Smaller reporting company | ¨ | |||
| Emerging growth company | ¨ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of April 29, 2017 the registrant had 22,702,132 shares of common stock, par value $0.01 per share, outstanding.
SEARS HOMETOWN AND OUTLET STORES, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
13 Weeks Ended April 29, 2017 and April 30, 2016
| Page | ||
| PART I—FINANCIAL INFORMATION | ||
| Item 1. | ||
| Item 2. | ||
| Item 3. | ||
| Item 4. | ||
| PART II—OTHER INFORMATION | ||
| Item 1. | ||
| Item 1A. | ||
| Item 2. | ||
| Item 6. | ||
SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
| 13 Weeks Ended | ||||||||
| Thousands, except per share amounts | April 29, 2017 | April 30, 2016 | ||||||
| NET SALES | $ | 448,233 | $ | 536,981 | ||||
| COSTS AND EXPENSES | ||||||||
| Cost of sales and occupancy | 354,478 | 420,790 | ||||||
| Selling and administrative | 110,881 | 117,992 | ||||||
| Depreciation and amortization | 2,204 | 3,257 | ||||||
| Total costs and expenses | 467,563 | 542,039 | ||||||
| Operating loss | (19,330 | ) | (5,058 | ) | ||||
| Interest expense | (1,591 | ) | (766 | ) | ||||
| Other income | 319 | 397 | ||||||
| Loss before income taxes | (20,602 | ) | (5,427 | ) | ||||
| Income tax benefit (expense) | (832 | ) | 1,857 | |||||
| NET LOSS | $ | (21,434 | ) | $ | (3,570 | ) | ||
| NET LOSS PER COMMON SHARE | ||||||||
| ATTRIBUTABLE TO STOCKHOLDERS | ||||||||
| Basic: | $ | (0.94 | ) | $ | (0.16 | ) | ||
| Diluted: | $ | (0.94 | ) | $ | (0.16 | ) | ||
| Basic weighted average common shares outstanding | 22,702 | 22,666 | ||||||
| Diluted weighted average common shares outstanding | 22,702 | 22,666 | ||||||
See Notes to Condensed Consolidated Financial Statements.
1
SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
| Thousands | April 29, 2017 | April 30, 2016 | January 28, 2017 | |||||||||
| ASSETS | ||||||||||||
| CURRENT ASSETS | ||||||||||||
| Cash and cash equivalents | $ | 22,360 | $ | 22,703 | $ | 14,104 | ||||||
| Accounts and franchisee receivables, net | 10,915 | 10,961 | 11,448 | |||||||||
| Merchandise inventories | 372,487 | 430,416 | 373,815 | |||||||||
| Prepaid expenses and other current assets | 8,883 | 23,119 | 9,370 | |||||||||
| Total current assets | 414,645 | 487,199 | 408,737 | |||||||||
| PROPERTY AND EQUIPMENT, net | 41,021 | 50,450 | 40,935 | |||||||||
| LONG-TERM DEFERRED TAXES | — | 76,666 | — | |||||||||
| OTHER ASSETS, net | 17,259 | 16,731 | 18,754 | |||||||||
| TOTAL ASSETS | $ | 472,925 | $ | 631,046 | $ | 468,426 | ||||||
| LIABILITIES | ||||||||||||
| CURRENT LIABILITIES | ||||||||||||
| Short-term borrowings | $ | 93,700 | $ | 32,000 | $ | 26,800 | ||||||
| Payable to Sears Holdings Corporation | 36,023 | 103,150 | 80,724 | |||||||||
| Accounts payable | 27,671 | 31,214 | 17,853 | |||||||||
| Other current liabilities | 64,252 | 62,985 | 70,377 | |||||||||
| Total current liabilities | 221,646 | 229,349 | 195,754 | |||||||||
| OTHER LONG-TERM LIABILITIES | 2,117 | 2,708 | 1,973 | |||||||||
| TOTAL LIABILITIES | 223,763 | 232,057 | 197,727 | |||||||||
| COMMITMENTS AND CONTINGENCIES (Note 9) | ||||||||||||
| STOCKHOLDERS' EQUITY | ||||||||||||
| TOTAL STOCKHOLDERS' EQUITY | 249,162 | 398,989 | 270,699 | |||||||||
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 472,925 | $ | 631,046 | $ | 468,426 | ||||||
See Notes to Condensed Consolidated Financial Statements.
2
SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| 13 Weeks Ended | ||||||||
| Thousands | April 29, 2017 | April 30, 2016 | ||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net loss | $ | (21,434 | ) | $ | (3,570 | ) | ||
| Adjustments to reconcile net loss to net cash (used) provided by operating activities: | ||||||||
| Depreciation and amortization | 2,204 | 3,257 | ||||||
| Share-based compensation | (103 | ) | 50 | |||||
| Deferred income taxes | — | 2,475 | ||||||
| Provision for (recoveries of) losses on franchisee receivables | 116 | (232 | ) | |||||
| Change in operating assets and liabilities: | ||||||||
| Accounts and franchisee receivables | 970 | 1,437 | ||||||
| Merchandise inventories | 1,328 | 4,430 | ||||||
| Payable to Sears Holdings Corporation | (44,701 | ) | 49,024 | |||||
| Accounts payable | 9,818 | (8,548 | ) | |||||
| Closing store accrual | (3,440 | ) | — | |||||
| Other operating assets and liabilities, net | (1,248 | ) | (5,358 | ) | ||||
| Net cash (used) provided by operating activities | (56,490 | ) | 42,965 | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Purchases of property and equipment | (2,076 | ) | (2,290 | ) | ||||
| Net cash used in investing activities | (2,076 | ) | (2,290 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Net borrowings (payments) of capital lease obligations | (78 | ) | 84 | |||||
| Net short-term borrowings (payments) | 66,900 | (36,300 | ) | |||||
| Net cash provided (used) in financing activities | 66,822 | (36,216 | ) | |||||
| NET CHANGE IN CASH AND CASH EQUIVALENTS | 8,256 | 4,459 | ||||||
| CASH AND CASH EQUIVALENTS—Beginning of period | 14,104 | 18,244 | ||||||
| CASH AND CASH EQUIVALENTS—End of period | $ | 22,360 | $ | 22,703 | ||||
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | ||||||||
| Cash paid for interest | $ | 1,594 | $ | 782 | ||||
| Cash paid (refunded) for income taxes | $ | 616 | $ | (2,291 | ) | |||
See Notes to Condensed Consolidated Financial Statements.
3
SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
| Thousands | Number of Shares of Common Stock | Common Stock/Par Value | Capital in Excess of Par Value | Accumulated Deficit | Total Stockholders' Equity | |||||||||||||
| Balance at January 30, 2016 | 22,722 | $ | 227 | $ | 555,372 | $ | (153,090 | ) | $ | 402,509 | ||||||||
| Net loss | — | — | — | (3,570 | ) | (3,570 | ) | |||||||||||
| Share-based compensation | (3 | ) | — | 50 | — | 50 | ||||||||||||
| Balance at April 30, 2016 | 22,719 | $ | 227 | $ | 555,422 | $ | (156,660 | ) | $ | 398,989 | ||||||||
| Balance at January 28, 2017 | 22,716 | $ | 227 | $ | 555,481 | $ | (285,009 | ) | $ | 270,699 | ||||||||
| Net loss | — | — | — | (21,434 | ) | (21,434 | ) | |||||||||||
| Share-based compensation | (14 | ) | — | (103 | ) | — | (103 | ) | ||||||||||
| Balance at April 29, 2017 | 22,702 | $ | 227 | $ | 555,378 | $ | (306,443 | ) | $ | 249,162 | ||||||||
See Notes to Condensed Consolidated Financial Statements.
4
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1—BACKGROUND AND BASIS OF PRESENTATION
Background
Sears Hometown and Outlet Stores, Inc. is a national retailer primarily focused on selling home appliances, lawn and garden equipment, and tools. As of April 29, 2017 the Company or its dealers and franchisees operated a total of 1,012 stores across all 50 states and in Puerto Rico and Bermuda. In these notes and elsewhere in this Quarterly Report on Form 10-Q the terms “we,” “us,” “our,” “SHO,” and the “Company” refer to Sears Hometown and Outlet Stores, Inc. and its subsidiaries.
Our common stock trades on the NASDAQ Stock Market under the trading symbol “SHOS.”
The Separation
The Company separated from Sears Holdings Corporation (“Sears Holdings”) in October 2012 (the “Separation”). To our knowledge Sears Holdings does not own any shares of our common stock. The Company has specified rights to use the "Sears" name under a license agreement from Sears Holdings.
Basis of Presentation
These unaudited Condensed Consolidated Financial Statements include the accounts of Sears Hometown and Outlet Stores, Inc. and its subsidiaries, all of which are wholly owned. These unaudited Condensed Consolidated Financial Statements do not include all of the information and footnotes required in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In the opinion of management, all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the first quarter ended April 29, 2017 are not necessarily indicative of the results that may be expected for the full fiscal year. These financial statements and related notes should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017 (the "2016 10-K").
We operate through two segments--our Sears Hometown and Hardware segment ("Hometown") and our Sears Outlet segment ("Outlet").
Our first fiscal-quarter end is the Saturday closest to April 30 each year. Our fiscal-year end is the Saturday closest to January 31 each year.
Reclassifications- certain amounts have been reclassified in order to conform to the current period presentation.
Variable Interest Entities and Consolidation
The Financial Accounting Standards Board ("FASB") has issued guidance on variable interest entities and consolidation for determining whether an entity is a variable interest entity ("VIE") as well as the methods permitted for determining the primary beneficiary of a variable interest entity. In addition, this guidance requires ongoing reassessments as to whether a reporting company is the primary beneficiary of a variable interest entity and disclosures regarding the reporting company’s involvement with a variable interest entity.
On an ongoing basis the Company evaluates its business relationships, such as those with its independent dealers, independent franchisees, and suppliers, to identify potential variable interest entities. Generally, these businesses either qualify for a scope exception under the consolidation guidance or, where a variable interest exists, the Company does not possess the power to direct the activities that most significantly impact the economic performance of these businesses. The Company has not consolidated any of such entities in the periods presented.
Fair Value of Financial Instruments
We determine the fair value of financial instruments in accordance with standards pertaining to fair value measurements. Such standards define fair value and establish a framework for measuring fair value under GAAP. Under fair value measurement accounting standards, fair value is considered to be the exchange price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date. We report the fair value of financial assets and liabilities based on the fair value hierarchy prescribed by accounting standards for fair value measurements, which prioritizes the inputs to valuation techniques used to measure fair value into three levels, as follows:
5
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Level 1 inputs—unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. An active market for the asset or liability is one in which transactions for the asset or liability occurs with sufficient frequency and volume to provide ongoing pricing information.
Level 2 inputs—inputs other than quoted market prices included in Level 1 that are observable, either directly or indirectly, for the asset or liability. Level 2 inputs include, but are not limited to, quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted market prices that are observable for the asset or liability, such as interest-rate curves and yield curves observable at commonly quoted intervals, volatilities, credit risks, and default rates.
Level 3 inputs—unobservable inputs for the asset or liability.
Cash and cash equivalents, merchandise payables, accrued expenses (level 1), accounts and franchisee notes receivable, and short-term debt (level 2) are reflected in the Condensed Consolidated Balance Sheets at cost, which approximates fair value due to the short-term nature of these instruments. For short-term debt, the variable interest rates are a significant input in our fair value assessments. The carrying value of long-term notes receivable approximates fair value.
We measure certain non-financial assets and liabilities, including long-lived assets, at fair value on a nonrecurring basis.
The Company was not required to measure any other significant non-financial asset or liability at fair value as of April 29, 2017.
Recent Accounting Pronouncements
Stock-based Compensation
In March 2016, the FASB issued an accounting standards update (ASU) 2016-09, Topic 718 which makes several modifications to the accounting for employee share-based payment transactions, including the requirement to recognize the income tax effects of awards that vest or settle as income tax expense. This guidance also clarifies the presentation of certain components of share-based awards in the statement of cash flows. This guidance is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods, and early adoption is permitted. The Company has adopted this pronouncement in the first quarter 2017, and the impact was not significant to the Condensed Consolidated Financial Statements.
Leases
In February 2016, the FASB issued ASU 2016-02, Topic 842 which replaces the current lease accounting standard. The update will require, among other items, lessees to recognize a right-of-use ("ROU") asset and a lease liability for most leases. Extensive quantitative and qualitative disclosures, including significant judgments made by management, will be required to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing contracts. The update is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The new standard must be adopted using a modified retrospective transition, and provides for certain practical expedients. Transition will require application of the new guidance at the beginning of the earliest comparative period presented. We are currently evaluating the effect the update will have on our Condensed Consolidated Financial Statements. Upon adoption, the Company expects that the ROU asset and the lease liability will be recognized in the balance sheets in amounts that will be material.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Topic 606, which replaces the current revenue recognition standards. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update will be effective for the Company in the first quarter of 2018 and may be applied retrospectively for each period presented or as a cumulative-effect adjustment at the date of adoption. In May 2016, FASB issued another accounting standards update (ASU 2016-12, Topic 606), which amends certain aspects of the Board's revenue standard ASU 2014-09, "Revenue From Contracts With Customers".
6
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue From Contracts with Customers. The update makes minor changes to the Board's new revenue guidance, ASU 2014-09, Revenue from Contracts with Customers (Topic 606) which was issued in May 2014. The technical corrections affect narrow aspects of the new revenue standard, including: loan guarantee fees, contract costs-impairment testing, contract costs - interaction of impairment testing with guidance in other topics, provisions for losses on construction-type and production-type contracts, scope of the new revenue standard, disclosure of remaining performance obligations, disclosure of prior-period performance obligations, a contract modification example, refund liability, advertising costs, fixed-odds wagering contracts in the casino industry, and cost capitalization for advisers to private and public funds. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements for Topic 606 (and any other Topic amended by ASU 2014-09).
The Company is evaluating the effect of adopting these new standards and has not yet determined the method by which the standards will be adopted. We have formed a committee to evaluate the effect of adopting these new standards, of which evaluation is in the initial stages.
Classification of Certain Cash Flows Receipts and Cash Payments
In August 2016, the FASB issued ASU 2016-15, Topic 230, which amended ASC 230. The update adds and clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows. The ASU is a result of consensus reached by the FASB's Emerging Issues Task Force (EITF) on issues related to eight types of cash flows, including: 1) debt prepayment or debt extinguishment costs, 2) settlement of zero coupon bonds, 3) contingent consideration payments made after a business combination, 4) proceeds from the settlement of insurance claims, 5) proceeds from the settlement of corporate-owned life insurance policies, 6) distributions received from equity-method investees, 7) beneficial interests in securitization transactions, and 8) separately identifiable cash flows and application of the predominance principle. The pronouncement becomes effective for fiscal years beginning after December 15, 2017 (which will be the Company's 2018 fiscal year) and interim periods within those fiscal years. We are currently evaluating the effect the update will have on our Condensed Consolidated Financial Statements and related disclosures.
Business Combinations-Clarifying the Definition of a Business
In January 2017, the FASB issued ASU 2017-01, Topic 805. The amendments in the update affect all reporting entities that must determine whether they have acquired or sold a business. The goal of the amendments was to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including: acquisitions, disposals, goodwill, and consolidation. The pronouncement is effective with respect to annual periods beginning after December 15, 2017, including interim periods within those periods. We are currently evaluating the effect the update will have on our Condensed Consolidated Financial Statements and related disclosures.
Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets
In February 2017, the FASB issued ASU 2017-05, Subtopic 610-20. The pronouncement clarifies the scope of Subtopic 610-20 and adds guidance for partial sales of nonfinancial assets. The scope of Subtopic 610-20 (as originally issued in update 2014-09) included the derecognition of an in substance nonfinancial asset. Interpretation of the original update was uncertain since the term "in substance nonfinancial asset" was not well defined. Furthermore, under the original promulgation, there was a lack of clarity with respect to the accounting with partial sales of nonfinancial assets- whereby, for example, a seller retains an equity interest in the entity that owns the assets or has an equity interest in the buyer. The issuance of ASU 2017-05 clarified terminology and provided greater instruction with respect to accounting treatment associated with partial sales of nonfinancial assets. The ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. We have evaluated the pronouncement with respect to first quarter 2017 business activity, and have determined the ASU is not applicable. While not relevant to the current period, the update will be reevaluated with respect to future business activity, which may trigger the ASU's guidance.
7
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2—ACCOUNTS AND FRANCHISEE RECEIVABLES AND OTHER ASSETS
Accounts and franchisee receivables and other assets consist of the following:
| Thousands | April 29, 2017 | April 30, 2016 | January 28, 2017 | |||||||||
| Short-term franchisee receivables | $ | 1,838 | $ | 2,197 | $ | 1,920 | ||||||
| Miscellaneous receivables | 9,943 | 9,985 | 10,475 | |||||||||
| Long-term franchisee receivables | 17,129 | 21,302 | 18,406 | |||||||||
| Other assets | 6,702 | 4,842 | 7,643 | |||||||||
| Allowance for losses on short-term franchisee receivables (1) | (866 | ) | (1,221 | ) | (947 | ) | ||||||
| Allowance for losses on long-term franchisee receivables (1) | (6,572 | ) | (9,413 | ) | (7,295 | ) | ||||||
| Total Accounts and franchisee receivables and other assets | $ | 28,174 | $ | 27,692 | $ | 30,202 | ||||||
(1) The Company recognizes an allowance for losses on franchisee receivables (which consist primarily of franchisee promissory notes) in an amount equal to estimated probable losses net of recoveries. The allowance is based on an analysis of expected future write-offs and existing economic conditions and an assessment of specific identifiable franchisee promissory notes and other franchisee receivables considered at risk or uncollectible. The expense associated with the allowance for losses on franchisee receivables is recognized as selling and administrative expense. Most of our franchisee promissory notes authorize us to deduct debt service from our commissions otherwise due and payable to the franchisees, and we routinely make those deductions to the extent of available commissions payable.
NOTE 3—ALLOWANCE FOR LOSSES ON FRANCHISEE RECEIVABLES
The allowance for losses on franchisee receivables consists of the following:
| 13 Weeks Ended | 13 Weeks Ended | 52 Weeks Ended | |||||||||
| Thousands | April 29, 2017 | April 30, 2016 | January 28, 2017 | ||||||||
| Allowance for losses on franchisee receivables, beginning of period | $ | 8,242 | $ | 12,141 | $ | 12,141 | |||||
| Provisions (recoveries) during the period | 116 | (232 | ) | (791 | ) | ||||||
| Write off of franchisee receivables against the allowance | (920 | ) | (1,275 | ) | (3,383 | ) | |||||
| Other | — | — | 275 | ||||||||
| Allowance for losses on franchisee receivables, end of period | $ | 7,438 | $ | 10,634 | $ | 8,242 | |||||
NOTE 4—OTHER CURRENT AND LONG-TERM LIABILITIES
Other current and long-term liabilities consist of the following:
| Thousands | April 29, 2017 | April 30, 2016 | January 28, 2017 | ||||||||
| Customer deposits | $ | 20,417 | $ | 24,090 | $ | 19,943 | |||||
| Sales and other taxes | 12,841 | 13,254 | 11,380 | ||||||||
| Accrued expenses | 21,939 | 22,114 | 27,602 | ||||||||
| Payroll and related items | 6,953 | 5,079 | 5,766 | ||||||||
| Severance and executive transition costs | 4,219 | 1,156 | 7,659 | ||||||||
| Total Other current and long-term liabilities | $ | 66,369 | $ | 65,693 | $ | 72,350 | |||||
8
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 5—INCOME TAXES
SHO and Sears Holdings entered into a Tax Sharing Agreement that governs the rights and obligations of the parties with respect to pre-Separation and post-Separation tax matters. Under the Tax Sharing Agreement, Sears Holdings generally is responsible for any federal, state, or foreign income tax liability relating to tax periods ending on or before the Separation. For all periods after the Separation, the Company generally is responsible for any federal, state, or foreign tax liability. Current income taxes payable for any federal, state, or foreign income tax returns is reported in the period incurred.
We account for uncertainties in income taxes according to accounting standards for uncertain tax positions. The Company is present in a large number of taxable jurisdictions and, at any point in time, can have tax audits underway at various stages of completion in one or more of these jurisdictions. We evaluate our tax positions and establish liabilities for uncertain tax positions that may be challenged by local authorities and may not be fully sustained, despite our belief that the underlying tax positions are fully supportable. Unrecognized tax benefits are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law, and closings of statutes of limitation. Such adjustments are reflected in the tax provision as appropriate. For the 13 Weeks ended April 29, 2017 and April 30, 2016, no unrecognized tax benefits have been identified and reflected in the Condensed Consolidated Financial Statements.
We classify interest expense and penalties related to unrecognized tax benefits and interest income on tax overpayments as components of income tax expense. As no unrecognized tax benefits have been identified and reflected in the Condensed Consolidated Financial Statements, no interest or penalties related to unrecognized tax benefits are reflected in the Condensed Consolidated Balance Sheets or Statements of Operations.
Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to realize the benefit of the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss for the three years ended January 28, 2017. Such objective evidence limits the ability to consider other subjective evidence such as our projections for the future. On the basis of this analysis, management has established a full valuation allowance to offset the net deferred tax assets that are not expected to be realized. Management will continue to evaluate objective and subjective evidence for changes in circumstances that cause a change in judgment about the realizability of the deferred tax assets.
We file federal, state, and city income tax returns in the United States and foreign tax returns in Puerto Rico. The U.S. Internal Revenue Service has commenced an audit of the Company's federal income tax return for the year ended January 30, 2016. SHO was also a part of the Sears Holdings' combined state returns for the years ended February 2, 2013 and February 1, 2014. Currently, the Company is under audit in two states for the years ended February 2, 2013 and February 1, 2014 as part of the Sears Holdings' combined return audits.
NOTE 6—RELATED-PARTY AGREEMENTS AND TRANSACTIONS
According to publicly available information ESL Investments, Inc. and investment affiliates including Edward S. Lampert (collectively, "ESL") beneficially own approximately 57% of our outstanding shares of common stock and approximately 59% of Sears Holdings' outstanding shares of common stock (the latter percentage amount includes shares that may be acquired within 60 days upon the exercise of warrants to purchase shares). Mr. Lampert is the Chairman of the Board and Chief Executive Officer of Sears Holdings.
SHO and Sears Holdings have entered into various agreements (as amended, the "SHO-Sears Holdings Agreements") that, among other things, (1) govern specified aspects of our relationship with Sears Holdings, (2) establish terms under which subsidiaries of Sears Holdings provide services to us, and (3) establish terms pursuant to which subsidiaries of Sears Holdings obtain merchandise inventories for us. The terms of the SHO-Sears Holdings Agreements were agreed to prior to the Separation (except for amendments entered into after the Separation that were approved by the Audit Committee of SHO's Board of Directors) in the context of a parent-subsidiary relationship and in the overall context of the Separation. The costs and allocations charged to the Company by Sears Holdings do not necessarily reflect the costs of obtaining the services from unaffiliated third parties or of the Company itself providing the applicable services. The Company has engaged in frequent discussions, and has resolved disputes, with Sears Holdings about the terms and conditions of the SHO-Sears Holdings Agreements, the business relationships that are reflected in the SHO-Sears Holdings Agreements, and the details of these business relationships, many of which details had not been addressed by the terms and conditions of the SHO-Sears Holdings
9
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Agreements or, if addressed, in the past were, and in the future could be, in dispute as to their meaning or application in the context of the existing business relationships. Many of these discussions have resulted in adjustments to the relationships that the Company believes together are in Company's best interests. On May 11, 2016, SHO and Sears Holdings entered into amendments to most of the SHO-Sears Holdings Agreements. The amendments are referred to in our Current Report on Form 8-K (File No. 001-35641) filed with the Securities and Exchange Commission on May 17, 2016. We also filed a Current Report on Form 8-K (File No. 001-35641) with the Securities and Exchange Commission on March 9, 2017 regarding the Amendment to Amended and Restated Merchandising Agreement dated as of March 8, 2017 among the Company, Sears Holdings, and Stanley Black & Decker. Inc.
The following is a summary of the nature of the related-party transactions between SHO and Sears Holdings:
| • | SHO receives commissions from Sears Holdings for specified online sales, sales of extended service contracts, and sales of delivery and handling services, and commissions relating to the use in our stores of credit cards branded with the Sears name. For specified transactions SHO pays commissions to Sears Holdings. |
| • | We obtain a significant amount of our merchandise inventories from Sears Holdings. We have a retailer's customary rights to return to Sears Holdings merchandise that is defective (except with respect to agreed-upon amounts of defective apparel that we purchase and then liquidate) or otherwise does not meet contract requirements. In addition, we may determine that an item of Outlet merchandise (usually merchandise that is not new in-box) we have received from Sears Holdings cannot be refurbished or reconditioned or is otherwise not in a physical condition to offer for sale to our customers. We and Sears Holdings (and our Outlet vendors generally) refer to an item of merchandise in this condition as "not saleable" or "non-saleable," and in the normal course we can return the item to Sears Holdings. We generally have comparable return rights with our other Outlet vendors. |
| • | We pay royalties related to our sale of products branded with the KENMORE®, CRAFTSMAN®, and DIEHARD® marks (which marks are owned by, or licensed to, subsidiaries of Sears Holdings, together the "KCD Marks"). The royalty rates vary but none exceeds 6%. |
| • | We pay fees for participation in Sears Holdings' SHOP YOUR WAY REWARDS® program. |
| • | We pay fees to Sears Holdings for logistics, handling, warehouse, and transportation services, which fees are based generally on merchandise inventory units. |
| • | Sears Holdings provides the Company with specified corporate services. These services include accounting and finance, and information technology, among other services. Sears Holdings charges the Company for these corporate services based on actual usage or pro rata charges based upon sales, head count, or other measurements. |
| • | Sears Holdings leases stores and distribution/repair facilities to the Company, for which the Company pays rent and related occupancy charges to Sears Holdings. |
The following table summarizes the results of the transactions with Sears Holdings reflected in the Company’s Condensed Consolidated Financial Statements:
| 13 Weeks Ended | |||||||||
| April 29, 2017 | April 30, 2016 | ||||||||
| Thousands | |||||||||
| Net Commissions from Sears Holdings | $ | 17,397 | $ | 21,574 | |||||
| Purchases related to cost of sales and occupancy | 264,530 | 313,534 | |||||||
| Services included in selling and administrative expense | 16,533 | 21,448 | |||||||
We incur payables to Sears Holdings for merchandise inventory purchases and service and occupancy charges (net of commissions) based on the SHO-Sears Holdings Agreements. Amounts due to or from Sears Holdings are non-interest bearing and, except as provided in the following sentences of this paragraph, are settled on a net basis and have payment terms of 10 days after the invoice date. From time to time, in accordance with the SHO–Sears Holdings Agreements and at the request of Sears Holdings, the Company pays invoices on three–day terms and deducts from the invoices an early–payment discount of 37 basis points. The Company can, in its sole discretion, revert to ten–day, no–discount payment terms at any time upon notice to Sears Holdings. The discount received for payments made on three–day terms, net of incremental interest expense, results in a net financial benefit to the Company. During the 13 weeks ended April 29, 2017, the Company paid most
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SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
invoices on three–day terms and realized a financial benefit of $0.6 million. During the 13 weeks ended April 30, 2016, the Company did not pay any invoice on three–day terms and, accordingly, did not realize any financial benefit.
We recorded real estate occupancy payments of $0.3 million and $0.2 million for the first quarters of 2017 and 2016, respectively, to Seritage Growth Properties, a real estate investment trust. Edward S. Lampert is the Chairman of the Board of Trustees of Seritage.
NOTE 7—FINANCING ARRANGEMENTS
In October 2012 the Company entered into a Credit Agreement with a syndicate of lenders, including Bank of America, N.A., as administrative agent, which provided (subject to availability under a borrowing base) for aggregate maximum borrowings of $250 million (the “Prior Facility”). Under the Prior Facility the Company initially borrowed $100 million which was used to pay a cash dividend to Sears Holdings prior to the Separation.
On November 1, 2016 the Company’s three operating subsidiaries, Sears Authorized Hometown Stores, LLC, Sears Home Appliance Showrooms, LLC, and Sears Outlet Stores, L.L.C., and the Company, entered into an Amended and Restated Credit Agreement with a syndicate of lenders, including Bank of America, N.A., as administrative agent and collateral agent, which provides (subject to availability under a borrowing base) for aggregate maximum borrowings of $250 million (the “Senior ABL Facility”). The Senior ABL Facility, which amended and restated the Prior Facility in its entirety, provides for extended revolving credit commitments in an aggregate amount equal to $170 million (the “Extended Revolving Credit Commitments”) and non-extended revolving credit commitments in an aggregate amount equal to $80 million (the “Non-Extended Revolving Credit Commitments”). The Extended Revolving Credit Commitments will mature on the earlier of (1) February 29, 2020 and (2) six months prior to the expiration of specified agreements entered into with Sears Holdings and its subsidiaries in connection with the Separation (the “Subject Agreements”) unless they are extended to a date later than February 29, 2020 or terminated on a basis reasonably satisfactory to the administrative agent under the Senior ABL Facility. The Non-Extended Revolving Credit Commitments will mature on the earlier of (1) October 11, 2017 and (2) six months prior to the expiration of the Subject Agreements unless they are extended to a date later than October 11, 2017 or terminated on a basis reasonably satisfactory to the administrative agent under the Amended and Restated Credit Agreement. Costs related to and incurred for the November 1, 2016 refinancing totaled approximately $5.4 million, of which $4.9 million is remaining and is included in Prepaid and Other current assets on the Consolidated Balance Sheet as of April 29, 2017 and is being amortized over the remaining term of the Senior ABL Facility.
As of April 29, 2017 we had $93.7 million outstanding under the Senior ABL Facility, which approximated the fair value of these borrowings. Up to $75 million of the Senior ABL Facility is available for the issuance of letters of credit and up to $25 million is available for swingline loans. The Senior ABL Facility permits us to request commitment increases in an aggregate principal amount of up to $100 million. Availability under the Senior ABL Facility as of April 29, 2017 was $115.2 million, with $6.1 million of letters of credit outstanding under the facility.
In the first quarter of 2017, we resumed our agreement with Sears Holdings whereby SHO paid Sears Holdings's invoices for merchandise and services on accelerated terms in exchange for a 37-basis point cash discount. The discounts we received for the accelerated payments, less incremental interest expense, resulted in a net financial benefit to the Company. Our Senior ABL Facility borrowings increased by approximately $30 million as a result of the agreement. We can, in our sole discretion, revert to ten-day, no-discount payment terms at any time.
The principal terms of the Senior ABL Facility are summarized below.
Prepayments
The Senior ABL Facility is subject to mandatory prepayment in amounts equal to the amount by which the outstanding extensions of credit exceed the lesser of the borrowing base and the commitments then in effect.
Security and Guarantees
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SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Senior ABL Facility is secured by a first lien security interest on substantially all the assets of the Company and its subsidiaries, including, without limitation, accounts receivable, inventory, general intangibles, investment property, equipment,
cash, cash equivalents, deposit accounts and securities accounts, as well as certain other assets (other than intellectual property and fee-owned interests in real property) ancillary to any of the foregoing and all proceeds of any of the foregoing, including cash proceeds and the proceeds of applicable insurance. The Senior ABL Facility is guaranteed by the Company and each of its existing and future direct and indirect wholly owned domestic subsidiaries (other than specified immaterial subsidiaries).
Interest; Fees
The interest rates per annum applicable to the loans under the Senior ABL Facility are based on a fluctuating rate of interest measured by reference to, at the Company’s election, either (1) an adjusted London inter-bank offered rate (LIBOR) plus a borrowing margin ranging from (x) 3.50% to 4.50%, in the case of the Extended Revolving Credit Commitments or (y) 2.00% to 2.50%, in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 4.19% at April 29, 2017), and in each case based on availability under the Senior ABL Facility, or (2) an alternate base rate plus a borrowing margin, ranging from (x) 2.50% to 3.50%, in the case of the Extended Revolving Credit Commitments or (y) 1.00% to 1.50%, in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 6.19% at April 29, 2017), and in each case based on availability under the Senior ABL Facility.
The interest rates per annum applicable to the loans under the Prior Facility were based on a fluctuating rate of interest measured by reference to, at our election, either (1) an adjusted London inter-bank offered rate (LIBOR) plus a borrowing margin, which rate was approximately 2.44% at April 30, 2016 or (2) an alternate base rate plus a borrowing margin, with the borrowing margin subject to adjustment based on the average excess availability under the Prior Facility for the preceding fiscal quarter, which rate was approximately 4.50% at April 30, 2016.
Customary fees are payable in respect of the Senior ABL Facility, including letter of credit fees and commitment fees.
Covenants
The Senior ABL Facility includes a number of negative covenants that, among other things, limit or restrict the ability of the Company and its subsidiaries (including the guarantors) to, subject to certain exceptions, incur additional indebtedness (including guarantees), grant liens, make investments, make prepayments on other indebtedness, and engage in mergers or change the nature of the business of the Company and its subsidiaries (including the guarantors). In addition, upon excess availability falling below a specified level, the Company is required to comply with a minimum fixed charge coverage ratio.
The Senior ABL Facility also limits SHO’s ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends and may repurchase stock, together not exceeding $37.5 million in any fiscal year or $75 million in the aggregate, if the following conditions are satisfied: either (a) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or as a result of the stock repurchase, (ii) SHO and its subsidiaries that are also borrowers have demonstrated to the reasonable satisfaction of the agent for the lenders that monthly availability (as determined in accordance with the Senior ABL Facility), immediately following the declaration and payment of the cash dividend or the stock repurchase and as projected on a pro forma basis for the twelve months following and after giving effect to the declaration and payment of the cash dividend or the stock repurchase, would be at least equal to the greater of (x) 25% of the Loan Cap (which is the lesser of (A) the aggregate commitments of the lenders and (B) the borrowing base) and (y) $50 million, and (iii) after giving pro forma effect to the declaration and payment of the cash dividend or the stock repurchase as if it constituted a specified debt service charge, the specified consolidated fixed charge coverage ratio, as calculated on a trailing twelve months basis, would be equal to or greater than 1.1:1.0, or (b) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or the stock repurchase and (ii) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that monthly availability, immediately following the declaration and payment of the cash dividend or the stock repurchase and as projected on a pro forma basis for the twelve months following and after giving effect to the declaration and payment of the cash dividend or the stock repurchase will be at least equal to the greater of (x) 50% of the Loan Cap and (y) $100 million. No default or event of default presently exists. SHO believes that it would have met the foregoing conditions at April 29, 2017 and that the Senior ABL Facility as of that date would have permitted us to pay cash dividends and repurchase our common stock subject to the limits described above in this paragraph.
The Senior ABL Facility also contains affirmative covenants, including financial and other reporting requirements. As of April 29, 2017, SHO was in compliance with all covenants under the Senior ABL Facility.
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SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Events of Default
The Senior ABL Facility includes customary and other events of default including non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations or warranties, cross default to other material indebtedness, bankruptcy and insolvency events, invalidity or impairment of guarantees or security interests, material judgments, change of control, failure to perform a “Material Contract” (which includes specified SHO-Sears Holdings Agreements) to the extent required to maintain it in full force and effect, the failure to enforce a Material Contract in accordance with its terms, or Sears Holdings terminates specified “Separation Agreements” (which include specified SHO-Sears Holdings Agreements).
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SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 8—SUMMARY OF SEGMENT DATA
The Hometown reportable segment consists of the aggregation of our Hometown Stores, Hardware Stores, and Home Appliance Showrooms business formats described in “Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations-Executive Overview" of this Quarterly Report on Form 10-Q. The Outlet reportable segment also represents a business format. These segments are evaluated by our Chief Operating Decision Maker to make decisions about resource allocation and to assess performance. Each of these segments derives its revenues from the sale of merchandise and related services to customers, primarily in the U.S. Sales categories include appliances, lawn and garden, tools and paint, and other (which includes initial franchise revenue).
| 13 Weeks Ended April 29, 2017 | ||||||||||||
| Thousands | Hometown | Outlet | Total | |||||||||
| Net sales | ||||||||||||
| Appliances | $ | 197,726 | $ | 125,865 | $ | 323,591 | ||||||
| Lawn and garden | 63,563 | 5,595 | 69,158 | |||||||||
| Tools and paint | 25,287 | 3,880 | 29,167 | |||||||||
| Other | 10,638 | 15,679 | 26,317 | |||||||||
| Total | 297,214 | 151,019 | 448,233 | |||||||||
| Costs and expenses | ||||||||||||
| Cost of sales and occupancy | 229,874 | 124,604 | 354,478 | |||||||||
| Selling and administrative | 74,417 | 36,464 | 110,881 | |||||||||
| Depreciation and amortization | 855 | 1,349 | 2,204 | |||||||||
| Total | 305,146 | 162,417 | 467,563 | |||||||||
| Operating loss | $ | (7,932 | ) | $ | (11,398 | ) | $ | (19,330 | ) | |||
| Total assets | $ | 320,074 | $ | 152,851 | $ | 472,925 | ||||||
| Capital expenditures | $ | 1,255 | $ | 821 | $ | 2,076 | ||||||
| 13 Weeks Ended April 30, 2016 | ||||||||||||
| Thousands | Hometown | Outlet | Total | |||||||||
| Net sales | ||||||||||||
| Appliances | $ | 230,934 | $ | 142,048 | $ | 372,982 | ||||||
| Lawn and garden | 78,417 | 4,688 | 83,105 | |||||||||
| Tools and paint | 36,117 | 4,614 | 40,731 | |||||||||
| Other | 21,111 | 19,052 | 40,163 | |||||||||
| Total | 366,579 | 170,402 | 536,981 | |||||||||
| Costs and expenses | ||||||||||||
| Cost of sales and occupancy | 284,138 | 136,652 | 420,790 | |||||||||
| Selling and administrative | 80,853 | 37,139 | 117,992 | |||||||||
| Depreciation and amortization | 1,569 | 1,688 | 3,257 | |||||||||
| Total | 366,560 | 175,479 | 542,039 | |||||||||
| Operating income (loss) | $ | 19 | $ | (5,077 | ) | $ | (5,058 | ) | ||||
| Total assets | $ | 421,801 | $ | 209,245 | $ | 631,046 | ||||||
| Capital expenditures | $ | 1,306 | $ | 984 | $ | 2,290 | ||||||
14
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 9—COMMITMENTS AND CONTINGENCIES
We are subject to various legal and governmental proceedings arising out of the ordinary course of business, the outcome of which, individually or in the aggregate, in the opinion of management would not have a material adverse effect on our business, financial position, results of operations, or cash flows.
NOTE 10— LOSS PER COMMON SHARE
Basic loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding for each period. In the periods where the Company records a net loss the diluted per share amount is equal to the basic per share amount.
The following table sets forth the components used to calculate basic and diluted loss per common share attributable to our stockholders.
| 13 Weeks Ended | 13 Weeks Ended | ||||||
| April 29, 2017 | April 30, 2016 | ||||||
| Thousands except income per common share | |||||||
| Basic weighted average shares | 22,702 | 22,666 | |||||
| Diluted weighted average shares | 22,702 | 22,666 | |||||
| Net loss | $ | (21,434 | ) | $ | (3,570 | ) | |
| Loss per common share: | |||||||
| Basic | $ | (0.94 | ) | $ | (0.16 | ) | |
| Diluted | $ | (0.94 | ) | $ | (0.16 | ) | |
15
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 11—EQUITY
Stock-Based Compensation
Four million shares of the Company's common stock are reserved for issuance under the Company's Amended and Restated 2012 Stock Plan (the "Plan").
A total of 89,221 shares of restricted stock were granted under the Plan in 2013 (the "2013 Grants") to a group of eligible individuals (as defined in the Plan) and 14,000 shares of restricted stock were granted under the Plan to an eligible individual in 2015 (the "2015 Grant"). As of May 16, 2016, 52,691 shares of restricted stock comprising the 2013 Grants had been forfeited. On that date the remaining 36,530 shares of restricted stock comprising the 2013 Grants vested in accordance with the terms and conditions of the governing restricted-stock agreements and the Plan. The 14,000 shares of restricted stock comprising the 2015 Grant were forfeited in the first quarter of 2017.
In 2015 the Company granted a total of 159,475 stock units under the Plan to a group of eligible individuals, all of whom were employees of the Company at the time of the grants. As of April 29, 2017, 34,091 stock units had been forfeited. The remaining 125,384 stock units will vest, if at all, on April 13, 2018 in accordance with and subject to the terms and conditions of governing stock-unit agreements, including forfeiture conditions, and the Plan. The fair value of these awards will vary based on changes in our stock price at each reporting period.
During the first quarter of 2017 the Company granted a total of 222,788 stock units under the Plan to a group of eligible individuals, all of whom were employees of the Company at the time of the grants. As of April 29, 2017, 33,333 of these stock units had been forfeited. The remaining 189,455 stock units will vest, if at all, in three substantially equal installments on January 30 in 2018, 2019, and 2020 in accordance with and subject to the terms and conditions of governing stock unit agreements, including forfeiture conditions, and the Plan.
The shares of restricted stock referred to above in this Note 11 constituted outstanding shares of the Company's common stock. The recipients of the restricted stock grants had, with respect to their restricted stock, full voting and dividend rights with respect to, but were unable to transfer or pledge, their shares of restricted stock prior to the applicable vesting dates. The stock units referred to above in this Note 11, which are payable solely in cash based on the Nasdaq closing price of our common stock at the applicable vesting dates, do not constitute outstanding shares of the Company's common stock. The recipients of the stock unit grants have, with respect to their stock units, no rights to receive the Company's common stock or other securities of the Company, no rights as a stockholder of the Company, no dividend rights, and no voting rights.
We are authorized to grant stock options and to make other awards (in addition to restricted stock and stock units) to eligible participants pursuant to the Plan. The Company has made no stock-option awards under the Plan. Except for the grants of restricted stock and stock units referred to above in this Note 11, the Company has not made any grant or award under the Plan. We do not currently have a broad-based program that provides for awards under the Plan on an annual basis.
We account for stock-based compensation using the fair value method in accordance with accounting standards regarding share-based payment transactions. During the first quarter of 2017 we recorded $0.1 million in total compensation expense for 314,839 stock units. At April 29, 2017 we had $0.8 million in total unrecognized compensation cost related to the remaining non-vested stock units, which we expect to recognize over the next approximately 2.5 years.
Changes during the first quarter of 2017 with respect to the 2015 Grant are noted below.
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SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 13 Weeks Ended April 29, 2017 | |||||||
| (Shares in Thousands) | Shares | Weighted-Average Fair Value Per Share on Date of Grant | |||||
| Beginning of year balance | 14 | $ | 9.38 | ||||
| Granted | — | — | |||||
| Vested | — | — | |||||
| Forfeited | (14 | ) | 9.38 | ||||
| Balance at April 29, 2017 | — | $ | — | ||||
Share Repurchase Program
On August 28, 2013 the Company's Board of Directors authorized a $25 million repurchase program for the Company's outstanding shares of common stock. The timing and amount of repurchases depend on various factors, including market conditions, the Company's capital position and internal cash generation, and other factors. The Company's repurchase program does not include specific price targets, may be executed through open-market, privately negotiated, and other transactions that may be available, and may include utilization of Rule 10b5-1 plans. The repurchase program does not obligate the Company to repurchase any dollar amount, or any number of shares, of common stock. The repurchase program does not have a termination date, and the Company may suspend or terminate the repurchase program at any time. See Note 7 to these Condensed Consolidated Financial Statements regarding the Senior ABL Facility's limits on SHO’s ability to repurchase its common stock. Shares that are repurchased by the Company pursuant to the repurchase program will be retired and resume the status of authorized and unissued shares of common stock.
No shares were repurchased during the 13 weeks ended April 29, 2017. At April 29, 2017, we had approximately $12.5 million of remaining authorization under the repurchase program.
NOTE 12—ACCELERATED CLOSURE OF UNDERPERFORMING STORES
We continue to take proactive steps to make the best use of capital and to reduce costs. In the first quarter of 2017 we recognized a benefit of $0.9 million resulting from lease-termination costs for stores that we closed in the fourth quarter of 2016, which costs were less than our previous accruals. As of January 28, 2017, we had $7.7 million in reserves remaining for future rent obligations, included in Other current liabilities on our Condensed Consolidated Balance Sheets. As of April 29, 2017, we had $4.2 million in reserves remaining after reducing the reserve by $3.5 million for rent payments and lease-termination costs during the first quarter of 2017.
NOTE 13—SUBSEQUENT EVENTS
Franchise Reacquisitions
In the second quarter of 2017 the Company began discussions and reached an agreement in principle with a franchisee pursuant to which the Company would reacquire a total of 14 franchised locations. The agreement in principle is subject to the negotiation, execution, and delivery by the Company and the franchisee of definitive agreements that would terminate the franchise agreements and sublease arrangements for the affected locations (except with respect to one location as to which the Company would either assume the lease or enter into a lease directly with the landlord). As of the end of the first quarter of 2017 the franchisee of the affected locations was the obligor on promissory notes payable to the Company with a carrying value, net of reserves, of $5.5 million. If the Company and the franchisee were to negotiate, execute, and deliver the necessary definitive agreements (the likelihood of which the Company is unable to predict with certainty), the Company expects that these transactions would be completed in the second quarter of 2017. If the transactions were completed, the Company expects that it would settle the carrying value of the promissory notes payable to the Company based on the terms and conditions of the definitive agreements. The Company could incur an additional loss with respect to the transactions to the extent that any negotiated cash payment or payments on the promissory notes payable plus the value of any reacquisition rights and the value of the furniture, fixtures, and equipment that the Company would acquire were less than $5.5 million.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Store Closings
In May 2017 the Company determined that it planned to close 22 stores (12 Hometown; 10 Outlet) prior to their lease terminations to continue in the Company's efforts to make the best use of capital and reduce costs. The closings are expected to result in a one-time charge of between $7.0 million and $9.0 million between the second and third quarters of 2017 for lease terminations and future rent obligations, inventory markdowns and write-offs, impairment of fixed assets, and other store-closing costs.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and notes contained in this Quarterly Report on Form 10-Q and the Consolidated Financial Statements and notes contained in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017 (the "2016 10-K"). This discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements.
Executive Overview
We are a national retailer primarily focused on selling home appliances, lawn and garden equipment, and tools. As of April 29, 2017, we or our dealers and franchisees operated a total of 1,012 stores across all 50 states, Puerto Rico, and Bermuda. In the first quarter of 2017, the Company opened 2 stores and closed 10 stores.
In addition to merchandise, we provide our customers with access to a suite of services, including home delivery, installation, and extended service contracts as well as access to financing through credit card and leasing programs.
Our Hometown stores are designed to provide our customers with in-store and online access to a wide selection of national brands of home appliances, tools, lawn and garden equipment, sporting goods, and household goods, depending on the particular format. Our Outlet stores are designed to provide our customers with in-store and online access to purchase, at prices that are significantly lower than list prices, new, one-of-a-kind, out-of-carton, discontinued, obsolete, used, reconditioned, overstocked, and scratched and dented products across a broad assortment of merchandise categories, including home appliances, lawn and garden equipment, apparel, mattresses, sporting goods, and tools.
As of April 29, 2017 Hometown consisted of 864 stores as follows:
| • | 789 Sears Hometown Stores—Primarily independently operated stores, predominantly located in smaller communities and offering appliances, lawn and garden equipment, and hardware. Most of our Sears Hometown Stores carry Kenmore, Craftsman, and DieHard brand products as well as a wide assortment of other national brand products. |
| • | 26 Sears Hardware Stores—Stores that carry Craftsman brand tools and lawn and garden equipment, DieHard brand batteries, and a wide assortment of other national brands and other home improvement products along with a selection of Kenmore and other national brands of home appliances. |
| • | 49 Sears Home Appliance Showrooms—Stores that have a simple, primarily appliance showroom design that are positioned in metropolitan areas. |
As of April 29, 2017, Hometown consisted of 783 dealer-operated stores, 37 franchisee-operated stores, and 44 Company-operated stores. The Company requires all dealer and franchisee-operated stores to operate according to the Company’s standards to protect and enhance the quality of its brands. These stores must display the required merchandise, offer all required products and services, and use the Company’s point-of-sale system. Also, the Company has the right to approve advertising and promotional and marketing materials and imposes certain advertising requirements. The Company owns the merchandise offered for sale by all dealer and franchisee-operated stores, establishes all selling prices for the merchandise, and bears general inventory risk (with specific exceptions) until sale of the merchandise and if the customer returns the merchandise. In addition, because each transaction is recorded in the Company’s point-of-sale system, the Company bears customer credit risk. The Company establishes a commission structure for stores operated by our dealers and franchisees and pays commissions to them when they sell the Company's merchandise and provide services.
As of April 29, 2017, 37 of the Company's 148 Outlet stores were operated by franchisees.
Dealers and franchisees exercise control over the day-to-day operations of their stores, make capital decisions regarding their stores, and exclusively make all hiring, compensation, benefits, termination, and other decisions regarding the terms and
18
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
conditions of employment, and exclusively establish all employment policies, procedures, and practices with respect to employees.
Several of the primary differences between Company-operated stores and dealer or franchisee-operated stores are that (1) the Company is responsible for occupancy and payroll costs associated with Company-operated stores while dealers and franchisees are responsible for these costs for their stores, (2) the Company is responsible for all terms and conditions of employment for the employees in the Company-operated stores and its dealers and franchisees are responsible for all terms and conditions of employment for the employees in their stores, and (3) we pay commissions to our dealers and franchisees.
In the normal course of business, stores can transition from Company operated to franchisee or dealer operated, and vice-versa. Potential new stores may be identified by the Company, an existing dealer or franchisee, or a potential dealer or franchisee. If the Company identifies and develops a new store, the Company will generally seek to transfer that store to a dealer or a franchisee. When a dealer or a franchisee ceases to operate a store, the Company may take over its operation, generally on an interim basis, until the Company can transfer the store to another dealer or franchisee. At any given time the Company is generally operating a number of stores that are in transition from one dealer or franchisee to another dealer or franchisee. Transition stores are not included in our count of Company-operated stores due to the expected short-term nature of transition operation.
The Company's transfer of a Company-operated store to a franchisee historically has (1) in most instances increased the Company's gross margin primarily due to decreased occupancy costs and (2) increased the Company's selling and administrative expense primarily due to increased commission payments, offset partially by lower payroll and benefits expense.
Initial franchise revenues consist of franchise fees paid by franchisees with respect to new and existing Company-operated stores that we transferred to the franchisees plus the net gain or loss on related transfers of assets to the franchisees. The number of new franchised stores, the number of Company-operated stores transferred, and the net gain or loss per store transferred has been highly variable from quarter to quarter. The variation has resulted from a number of factors, including general economic conditions, which have influenced both the level of new store development and the level of interest of existing or potential franchisees in acquiring store locations, and economic factors specific to our major product categories, such as appliances. Each of these factors has impacted the expected financial returns to the Company from new store development, which in turn has impacted the number of Company-operated stores that the Company has decided from time to time to make available for transfer to franchisees. Beginning in the second quarter of 2015 the Company indefinitely suspended its franchising of additional stores except to existing Company franchisees, and the suspension continued through the first quarter of 2017. There were no initial franchise revenues, which include the net gain or loss on related transfers of assets to franchisees in the first quarter of 2017 and $0.2 million loss in the first quarter of 2016.
Amendments to Agreements with Sears Holdings
On May 11, 2016 the Company and Sears Holdings executed and delivered to each other amendments to most of the SHO-Sears Holdings Agreements including an amendment to our Merchandising Agreement with Sears Holdings (the "Merchandising Amendment"). The Merchandising Amendment provided that (a) SHO would pay Sears Holdings $0.6 million and SHO waived claims against Sears Holdings relating to product repair claims and (b) Sears Holdings waived claims against SHO relating to alleged KCD warranty fee underpayments and other IT and service-order transfer related claims. The net benefit to SHO of the Merchandising Amendment was $2.8 million, which amount (the "Merchandising Net Benefit") we recorded in the first quarter of 2016 as a reduction to cost of sales and occupancy expenses. For additional information regarding the amendments to the SHO-Sears Holdings Agreements see the Company's Current Reports on Form 8-K filed with the Securities and Exchange Commission on May 17, 2016 and March 9, 2017 (File No. 001-35641).
Shared Vendor Funds
In accordance with our Amended and Restated Merchandising Agreement with Sears Holdings, SHO receives from Sears Holdings specified portions of merchandise subsidies collected by Sears Holdings from its merchandise vendors and specified portions of cash discounts earned by Sears Holdings as a result of its early payment of merchandise-vendor payables ("Vendor Funds"). During the first quarter of 2017 Sears Holdings' Vendor Funds were higher compared to the first quarter of 2016 and SHO's portion of the collected Vendor Funds during the first quarter of 2017 year were approximately $2.6 million higher than its portion for the first quarter of 2016. We cannot provide any assurance that SHO's portion of Vendor Funds collected by Sears Holdings will not decline, stay the same, or continue to increase, and if SHO's portion of Vendor Funds collected by Sears Holdings were to decline, SHO's results of operations could be adversely affected to a material extent.
19
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
Home Office Overhead Allocation
Since the Separation we have included an allocation of Home Office overhead expenses in selling and administrative expenses for Hometown and Outlet. Home Office overhead expenses are primarily comprised of corporate headquarters payroll, benefits, and other costs and include charges related to our Services Agreement with Sears Holdings.
Seasonality
Our business is not concentrated in the holiday season, as the majority of the products we sell are not typically thought of as holiday gifts. Lawn and Garden sales generally peak in our second quarter as customers prepare for and execute outdoor projects during the spring and early summer. See Note 10 to the Consolidated Financial Statements included in the 2016 10-K for our quarterly financial results (unaudited) for 2016.
Results of Operations
The following table sets forth items derived from our consolidated results of operations for the 13 weeks ended April 29, 2017 and April 30, 2016.
| 13 Weeks Ended | ||||||||
| Thousands | April 29, 2017 | April 30, 2016 | ||||||
| NET SALES | $ | 448,233 | $ | 536,981 | ||||
| COSTS AND EXPENSES | ||||||||
| Cost of sales and occupancy | 354,478 | 420,790 | ||||||
| Selling and administrative | 110,881 | 117,992 | ||||||
| Selling and administrative expense as a percentage of net sales | 24.7 | % | 22.0 | % | ||||
| Depreciation and amortization | 2,204 | 3,257 | ||||||
| Total costs and expenses | 467,563 | 542,039 | ||||||
| Operating loss | (19,330 | ) | (5,058 | ) | ||||
| Interest expense | (1,591 | ) | (766 | ) | ||||
| Other income | 319 | 397 | ||||||
| Loss before income taxes | (20,602 | ) | (5,427 | ) | ||||
| Income tax (expense) benefit | (832 | ) | 1,857 | |||||
| NET LOSS | $ | (21,434 | ) | $ | (3,570 | ) | ||
| Gross Margin | $ | 93,755 | $ | 116,191 | ||||
| Margin rate | 20.9 | % | 21.6 | % | ||||
Comparable Store Sales
Comparable store sales include merchandise sales for all stores operating for a period of at least 12 full months, including remodeled and expanded stores but excluding store relocations and stores that have undergone format changes. Comparable store sales include online transactions fulfilled and recorded by SHO and give effect to the change in the unshipped sales reserves recorded at the end of each reporting period.
20
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
Net Loss
We recorded a net loss of $21.4 million for the first quarter of 2017 compared to a net loss of $3.6 million for the prior-year comparable quarter. The increase in our net loss was primarily attributable to the factors discussed below in this Item 2 in addition to higher income tax expense. Income tax expense of $0.8 million and income tax benefit of $1.9 million were recorded in the first quarters of 2017 and 2016, respectively. The effective tax expense (benefit) rate was 4.0% in the first quarter of 2017 and (34.2)% in the first quarter of 2016.
Adjusted EBITDA
In addition to our net loss determined in accordance with GAAP, for purposes of evaluating operating performance we also use adjusted earnings before interest, taxes, depreciation and amortization, or “adjusted EBITDA,” which excludes certain significant items as set forth and discussed below. Our management uses adjusted EBITDA, among other factors, for evaluating the operating performance of our business for comparable periods. Adjusted EBITDA should not be used by investors or other third parties as the sole basis for formulating investment decisions as it excludes a number of important cash and non-cash recurring items. Adjusted EBITDA should not be considered as a substitute for GAAP measurements.
While adjusted EBITDA is a non-GAAP measurement, we believe it is an important indicator of operating performance for investors because:
| • | EBITDA excludes the effects of financing and investing activities by eliminating the effects of interest and depreciation costs; and |
| • | Other significant items, while periodically affecting our results, may vary significantly from period to period and may have a disproportionate effect in a given period, which affects comparability of results. These items may also include cash charges such as severance and executive transition costs and IT transformation investments that make it difficult for investors to assess the Company's core operating performance. |
In the fourth quarter of 2016 the Company executed an initiative to accelerate the closing of 109 under-performing locations in an effort to improve profitability and make the most productive use of capital. In the normal course of business we typically close under-performing locations at the termination of a lease or the expiration of a franchise or dealer agreement. As a result, we do not ordinarily incur significant future lease, severance, or other non-recurring store-closing costs. Due to the number and accelerated nature of the store closings in the fourth quarter of 2016, the Company excluded the associated costs of the closings from adjusted EBITDA for the fourth quarter of 2016. In the first quarter of 2017, we recognized, and included in adjusted EBITDA, a benefit of $0.9 million relating to stores closed in the fourth quarter of 2016 because of lease buyouts for less than amounts previously accrued.
The following table presents a reconciliation of adjusted EBITDA to net loss, the most comparable GAAP measure, for each of the periods indicated:
| 13 Weeks Ended | ||||||||
| Thousands | April 29, 2017 | April 30, 2016 | ||||||
| Net loss | $ | (21,434 | ) | $ | (3,570 | ) | ||
| Income tax expense (benefit) | 832 | (1,857 | ) | |||||
| Other income | (319 | ) | (397 | ) | ||||
| Interest expense | 1,591 | 766 | ||||||
| Operating loss | (19,330 | ) | (5,058 | ) | ||||
| Depreciation and amortization | 2,204 | 3,257 | ||||||
| Initial franchise revenues, net of provision for losses | 116 | (32 | ) | |||||
| IT transformation investments | 9,255 | 3,150 | ||||||
| Accelerated closure of under-performing stores | $ | (950 | ) | $ | — | |||
| Adjusted EBITDA | $ | (8,705 | ) | $ | 1,317 | |||
21
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
13-Week Period Ended April 29, 2017 Compared to the 13-Week Period Ended April 30, 2016
Net Sales
Net sales in the first quarter of 2017 decreased $88.7 million to $448.2 million, or 16.5%, from the first quarter of 2016. This decrease was driven primarily by the impact of closed stores (net of new store openings) and a 7.3% decrease in comparable store sales. Comparable store sales were down 6.8% and 8.3% in Hometown and Outlet, respectively. The home appliances category outperformed the average comparable store sales while lawn and garden, tools, and mattresses underperformed the average.
Gross Margin
Gross margin was $93.8 million, or 20.9% of net sales, in the first quarter of 2017 compared to $116.2 million, or 21.6% of net sales, in the first quarter of 2016. The decrease in gross margin rate was primarily driven by lower margin on merchandise sales and a $2.8 million benefit in the first quarter of 2016 ("Merchandising Net Benefit") related to the amendment and restatement of our Merchandising Agreement with Sears Holdings. The impact of this benefit was an increase in the gross margin rate of 52 basis points in the first quarter of 2016. The decrease in the first quarter 2017 gross margin rate was partially offset by higher commissions on sales of protection agreements and lower shrink due to a $3.4 million Outlet physical inventory charge in the first quarter of 2016.
Selling and Administrative Expenses
Selling and administrative expenses decreased to $110.9 million, or 24.7% of net sales, in the first quarter of 2017 from $118.0 million, or 22.0% of net sales, in the prior-year comparable quarter. The decrease was primarily due to lower expenses from closed stores (net of new store openings) since the second quarter of 2016 and lower commissions paid to dealers and franchisees on lower sales volume partially offset by higher IT transformation investments. IT transformation expense was $9.3 million, or 2.1% of sales, in the first quarter of 2017 compared to $3.2 million, or 0.6% of sales, in the first quarter of 2016.
Operating Loss
We recorded operating losses of $19.3 million and $5.1 million in the first quarters of 2017 and 2016, respectively. The increase in operating loss was primarily due to lower volume and a lower gross margin rate partially offset by a decrease in selling and administrative expenses.
Income Taxes
Income tax expense of $0.8 million and income tax benefit of $1.9 million were recorded in the first quarters of 2017 and 2016, respectively. The effective tax expense (benefit) rate was 4.0% in the first quarter of 2017 and (34.2)% in the first quarter of 2016.
Net Loss
We recorded a net loss of $21.4 million for the first quarter of 2017 compared to a net loss of $3.6 million for the prior-year comparable quarter. The increase in our net loss was primarily attributable to the factors discussed above.
22
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
Business Segment Results
Hometown
Hometown results and key statistics were as follows:
| 13 Weeks Ended | |||||||
| Thousands, except for number of stores | April 29, 2017 | April 30, 2016 | |||||
| NET SALES | $ | 297,214 | $ | 366,579 | |||
| Comparable store sales % | (6.8 | )% | (2.6 | )% | |||
| COSTS AND EXPENSES | |||||||
| Cost of sales and occupancy | 229,874 | 284,138 | |||||
| Selling and administrative | 74,417 | 80,853 | |||||
| Selling and administrative expense as a percentage of net sales | 25.0 | % | 22.1 | % | |||
| Depreciation and amortization | 855 | 1,569 | |||||
| Total costs and expenses | 305,146 | 366,560 | |||||
| Operating (loss) income | $ | (7,932 | ) | $ | 19 | ||
| Gross margin dollars | 67,340 | 82,441 | |||||
| Margin rate | 22.7 | % | 22.5 | % | |||
| Total Hometown stores | 864 | 986 | |||||
13-Week Period ended April 29, 2017 Compared to the 13-Week Period Ended April 30, 2016.
Net Sales
Hometown net sales in the first quarter of 2017 decreased $69.4 million to $297.2 million, or 18.9%, from the first quarter of 2016. This decrease was driven primarily by the impact of closed stores (net of new store openings) and a 6.8% decrease in comparable store sales. The home appliances category outperformed the average comparable store sales while lawn and garden, tools, and mattresses underperformed the average.
Gross Margin
Gross margin was $67.3 million, or 22.7% of net sales, in the first quarter of 2017 compared to $82.4 million, or 22.5% of net sales, in the first quarter of 2016. The increase in gross margin rate was primarily driven by lower occupancy costs and higher commissions on sales of protection agreements partially offset by lower margin on merchandise sales and higher costs for supply chain services provided by Sears Holdings. Occupancy costs reduced the gross margin rate 121 basis points in the first quarter of 2017 compared to a reduction of 182 basis points in the first quarter of 2016.
Selling and Administrative Expenses
Selling and administrative expenses decreased to $74.4 million, or 25.0% of net sales, in the first quarter of 2017 from $80.9 million, or 22.1% of net sales, in the prior-year comparable quarter. The decrease was primarily due to lower expenses from closed stores (net of new store openings) since the second quarter of 2016 and lower commissions paid to dealers and franchisees on lower sales volume partially offset by higher IT transformation investments. IT transformation expense was $6.2 million, or 2.1% of sales, in the first quarter of 2017 compared to $2.1 million, or 0.6% of sales, in the first quarter of 2016.
23
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
Operating (Loss) Income
We recorded an operating loss of $7.9 million and operating income of $19,000 in the first quarters of 2017 and 2016, respectively. The increase in operating loss was primarily due to lower volume partially offset by a decrease in selling and administrative expenses.
Outlet
Outlet results and key statistics were as follows:
| 13 Weeks Ended | |||||||
| Thousands, except for number of stores | April 29, 2017 | April 30, 2016 | |||||
| NET SALES | $ | 151,019 | $ | 170,402 | |||
| Comparable store sales % | (8.3 | )% | (3.1 | )% | |||
| COSTS AND EXPENSES | |||||||
| Cost of sales and occupancy | 124,604 | 136,652 | |||||
| Selling and administrative | 36,464 | 37,139 | |||||
| Selling and administrative expense as a percentage of net sales | 24.1 | % | 21.8 | % | |||
| Depreciation and amortization | 1,349 | 1,688 | |||||
| Total costs and expenses | 162,417 | 175,479 | |||||
| Operating loss | $ | (11,398 | ) | $ | (5,077 | ) | |
| Gross margin dollars | 26,415 | 33,750 | |||||
| Margin rate | 17.5 | % | 19.8 | % | |||
| Total Outlet stores | 148 | 159 | |||||
13-Week Period ended April 29, 2017 Compared to the 13-Week Period Ended April 30, 2016.
Net Sales
Outlet net sales in the first quarter of 2017 decreased $19.4 million to $151.0 million, or 11.4%, from the first quarter of 2016. This decrease was driven primarily by an 8.3% decrease in comparable store sales and the impact of closed stores (net of new store openings). The mattresses and lawn and garden categories outperformed the average comparable store sales while home appliances, tools, furniture, and apparel underperformed the average.
Gross Margin
Gross margin was $26.4 million, or 17.5% of net sales, in the first quarter of 2017 compared to $33.7 million, or 19.8% of net sales, in the first quarter of 2016. The decrease in gross margin rate was primarily due to lower margin on merchandise sales, $2.4 million from the Merchandising Net Benefit in the first quarter of 2016, and flat occupancy costs on lower volume. These declines were partially offset by lower shrink due to a $3.4 million physical inventory charge in the first quarter of 2016, lower distribution center and product repair charges, and higher commissions on sales of protection agreements. The combined impact of occupancy costs, shrink, and the Merchandising Net Benefit reduced the gross margin rate 929 basis points in the first quarter of 2017 compared to a reduction of 874 basis points in the first quarter of 2016.
Selling and Administrative Expenses
Selling and administrative expenses decreased to $36.5 million, or 24.1% of net sales, in the first quarter of 2017 from $37.1 million, or 21.8% of net sales, in the prior-year comparable quarter. The decrease was primarily due to lower expenses
24
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
from closed stores (net of new store openings) and lower commissions paid to dealers and franchisees on lower sales volume partially offset by higher IT transformation investments. IT transformation expense was $3.1 million, or 2.1% of sales, in the first quarter of 2017 compared to $1.1 million, or 0.6% of sales in the first quarter of 2016.
Operating Loss
We recorded operating losses of $11.4 million and $5.1 million in the first quarters of 2017 and 2016, respectively. The increase in operating loss was primarily due to lower volume and a lower gross margin rate partially offset by a decrease in selling and administrative expenses.
Analysis of Financial Condition
Cash and Cash Equivalents
We had cash and cash equivalents of $22.4 million as of April 29, 2017 and $22.7 million as of April 30, 2016.
For the first quarter of 2017 we funded ongoing operations with cash on-hand and cash provided by financing activities. Our primary needs for liquidity are to fund inventory purchases, IT transformation investments, and capital expenditures and for general corporate purposes.
Cash Flows from Operating Activities
For the 13 weeks ended April 29, 2017 cash used in operating activities was $56.5 million compared to $43.0 million cash provided for the 13 weeks ended April 30, 2016. The decrease in operating cash flow was due predominately to lower net income and a decrease in payables to Sears Holdings (approximately $30 million resulting from accelerated payment terms in exchange for early-payment discounts) partially offset by an increase in Merchandise payables.
Total merchandise inventories were $372.5 million at April 29, 2017 and $430.4 million at April 30, 2016. Merchandise inventories declined $51.4 and $6.5 million in Hometown and Outlet, respectively. The decrease in Hometown was primarily due to store closures. Outlet's decrease was primarily driven by lower home appliances receipts, store closures, and a furniture assortment transition partially offset by higher lawn and garden inventory due to opportunistic buys in 2017.
We obtain our merchandise through agreements with subsidiaries of Sears Holdings and with other vendors. Merchandise acquired from subsidiaries of Sears Holdings (including Kenmore, Craftsman, DieHard, and other merchandise) accounted for approximately 80% of total purchases of all inventory from all vendors for both the 13 weeks ended April 29, 2017 and April 30, 2016. The loss of, or a material reduction in the amount of, merchandise made available to us by Sears Holdings could have a material adverse effect on our business and results of operations. See also "Cautionary Statement Regarding Forward-Looking Information" in this Quarterly Report on Form 10-Q.
In addition, our merchandise-vendor arrangements generally are not long-term (except for the Merchandising Agreement) and none of them guarantees the availability of merchandise inventory in the future. Our growth strategy depends to a significant extent on the willingness and ability of our vendors to supply us with sufficient merchandise inventory. As a result, our success depends, in part, on maintaining or improving relationships with existing vendors to seek to ensure continuity of merchandise inventory and on developing relationships with new vendors, especially with respect to merchandise inventory to be sold by Outlet. If we fail to maintain or improve our relations with our existing vendors or fail to maintain the quality of merchandise inventory they supply us, or if we cannot maintain or acquire new vendors of favored brand-name merchandise inventory, and if we cannot acquire new vendors of merchandise inventory to be sold by Outlet, our ability to obtain a sufficient amount and variety of merchandise at acceptable prices may be limited, which could have a negative impact on our business and could materially affect our results of operations, financial condition, liquidity, and cash flows. In addition, merchandise inventory acquired from alternative sources, if any, may be of a lesser quality and more expensive than the merchandise inventory that we currently purchase.
Cash Flows from Investing Activities
Cash used in investing activities was $2.1 million for the 13 weeks ended April 30, 2017 compared to $2.3 million for the 13 weeks ended April 30, 2016. Both periods included purchases of property and equipment.
25
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
Cash Flows from Financing Activities
Cash provided by financing activities was $66.8 million for the 13 weeks ended April 29, 2017 compared to $36.2 million used during the 13 weeks ended April 30, 2016. The increase of $103.0 million in cash provided by financing activities was primarily due to an increase of $66.9 million in net borrowings under our Senior ABL Facility in 2017 compared to a $36.3 million paid in 2016. The increase in short-term borrowings includes the impact of accelerated payment terms on payables to Sears Holdings in exchange for early-payment discounts.
Financing Arrangements
In October 2012 the Company entered into a Credit Agreement with a syndicate of lenders, including Bank of America, N.A., as administrative agent, which provided (subject to availability under a borrowing base) for aggregate maximum borrowings of $250 million (the “Prior Facility”). Under the Prior Facility the Company initially borrowed $100 million which was used to pay a cash dividend to Sears Holdings prior to the Separation.
On November 1, 2016 the Company’s three operating subsidiaries, Sears Authorized Hometown Stores, LLC, Sears Home Appliance Showrooms, LLC, and Sears Outlet Stores, L.L.C., and the Company, entered into an Amended and Restated Credit Agreement with a syndicate of lenders, including Bank of America, N.A., as administrative agent and collateral agent, which provides (subject to availability under a borrowing base) for aggregate maximum borrowings of $250 million (the “Senior ABL Facility”). The Senior ABL Facility, which amended and restated the Prior Facility in its entirety, provides for extended revolving credit commitments in an aggregate amount equal to $170 million (the “Extended Revolving Credit Commitments”) and non-extended revolving credit commitments in an aggregate amount equal to $80 million (the “Non-Extended Revolving Credit Commitments”). The Extended Revolving Credit Commitments will mature on the earlier of (1) February 29, 2020 and (2) six months prior to the expiration of specified agreements entered into with Sears Holdings and its subsidiaries in connection with the Company’s separation from Sears Holdings in October 2012 (the “Subject Agreements”) unless they are extended to a date later than February 29, 2020 or terminated on a basis reasonably satisfactory to the administrative agent under the Senior ABL Facility. The Non-Extended Revolving Credit Commitments will mature on the earlier of (1) October 11, 2017 and (2) six months prior to the expiration of the Subject Agreements unless they are extended to a date later than October 11, 2017 or terminated on a basis reasonably satisfactory to the administrative agent under the Amended and Restated Credit Agreement. Costs related to, and incurred for, the November 1, 2016 refinancing totaled approximately $5.4 million, of which $4.9 million is remaining, is included in Prepaid and Other current assets on the Consolidated Balance Sheet as of April 29, 2017, and is being amortized over the remaining term of the Senior ABL Facility.
As of April 29, 2017 we had $93.7 million outstanding under the Senior ABL Facility, which approximated the fair value of these borrowings. Up to $75 million of the Senior ABL Facility is available for the issuance of letters of credit and up to $25 million is available for swingline loans. The Senior ABL Facility permits us to request commitment increases in an aggregate principal amount of up to $100 million. Availability under the Senior ABL Facility as of April 29, 2017 was $115.2 million, with $6.1 million of letters of credit outstanding under the facility.
The principal terms of the Senior ABL Facility are summarized below.
Prepayments
The Senior ABL Facility is subject to mandatory prepayment in amounts equal to the amount by which the outstanding extensions of credit exceed the lesser of the borrowing base and the commitments then in effect.
Security and Guarantees
The Senior ABL Facility is secured by a first lien security interest on substantially all the assets of the Company and its subsidiaries, including, without limitation, accounts receivable, inventory, general intangibles, investment property, equipment, cash, cash equivalents, deposit accounts and securities accounts, as well as certain other assets (other than intellectual property and fee-owned interests in real property) ancillary to any of the foregoing and all proceeds of any of the foregoing, including cash proceeds and the proceeds of applicable insurance. The Senior ABL Facility is guaranteed by the Company and each of its existing and future direct and indirect wholly owned domestic subsidiaries (other than specified immaterial subsidiaries).
26
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
Interest; Fees
The interest rates per annum applicable to the loans under the Senior ABL Facility are based on a fluctuating rate of interest measured by reference to, at the Company’s election, either (1) an adjusted London inter-bank offered rate (LIBOR) plus a borrowing margin ranging from (x) 3.50% to 4.50%, in the case of the Extended Revolving Credit Commitments or (y) 2.00% to 2.50%, in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 4.19% at April 29, 2017), and in each case based on availability under the Senior ABL Facility, or (2) an alternate base rate plus a borrowing margin, ranging from (x) 2.50% to 3.50%, in the case of the Extended Revolving Credit Commitments or (y) 1.00% to 1.50%, in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 6.19% at April 29, 2017), and in each case based on availability under the Senior ABL Facility.
The interest rates per annum applicable to the loans under the Prior Facility were based on a fluctuating rate of interest measured by reference to, at our election, either (1) an adjusted London inter-bank offered rate (LIBOR) plus a borrowing margin, which rate was approximately 2.44% at April 30, 2016 or (2) an alternate base rate plus a borrowing margin, with the borrowing margin subject to adjustment based on the average excess availability under the Prior Facility for the preceding fiscal quarter, which rate was approximately 4.50% at April 30, 2016.
Customary fees are payable in respect of the Senior ABL Facility, including letter of credit fees and commitment fees.
Covenants
The Senior ABL Facility includes a number of negative covenants that, among other things, limit or restrict the ability of the Company and its subsidiaries (including the guarantors) to, subject to certain exceptions, incur additional indebtedness (including guarantees), grant liens, make investments, make prepayments on other indebtedness, and engage in mergers or change the nature of the business of the Company and its subsidiaries (including the guarantors). In addition, upon excess availability falling below a specified level, the Company is required to comply with a minimum fixed charge coverage ratio.
The Senior ABL Facility also limits SHO’s ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends and may repurchase stock, together not exceeding $37.5 million in any fiscal year or $75 million in the aggregate, if the following conditions are satisfied: either (a) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or as a result of the stock repurchase, (ii) SHO and its subsidiaries that are also borrowers have demonstrated to the reasonable satisfaction of the agent for the lenders that monthly availability (as determined in accordance with the Senior ABL Facility), immediately following the declaration and payment of the cash dividend or the stock repurchase and as projected on a pro forma basis for the twelve months following and after giving effect to the declaration and payment of the cash dividend or the stock repurchase, would be at least equal to the greater of (x) 25% of the Loan Cap (which is the lesser of (A) the aggregate commitments of the lenders and (B) the borrowing base) and (y) $50 million, and (iii) after giving pro forma effect to the declaration and payment of the cash dividend or the stock repurchase as if it constituted a specified debt service charge, the specified consolidated fixed charge coverage ratio, as calculated on a trailing twelve months basis, would be equal to or greater than 1.1:1.0, or (b) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or the stock repurchase and (ii) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that monthly availability, immediately following the declaration and payment of the cash dividend or the stock repurchase and as projected on a pro forma basis for the twelve months following and after giving effect to the declaration and payment of the cash dividend or the stock repurchase will be at least equal to the greater of (x) 50% of the Loan Cap and (y) $100 million. No default or event of default presently exists. SHO believes that it would have met the foregoing conditions at April 29, 2017 and that the Senior ABL Facility as of that date would have permitted us to pay cash dividends and repurchase our common stock subject to the limits described above in this paragraph.
The Senior ABL Facility also contains affirmative covenants, including financial and other reporting requirements. As of April 29, 2017, SHO was in compliance with all covenants under the Senior ABL Facility.
Events of Default
The Senior ABL Facility includes customary and other events of default including non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations or warranties, cross default to other material indebtedness, bankruptcy and insolvency events, invalidity or impairment of guarantees or security interests, material judgments, change of control, failure to perform a “Material Contract” (which includes specified SHO-Sears Holdings Agreements) to the extent required to maintain it
27
SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
in full force and effect, the failure to enforce a Material Contract in accordance with its terms, or Sears Holdings terminates the “Separation Agreements” (which include specified SHO-Sears Holdings Agreements).
Uses and Sources of Liquidity
As of April 29, 2017, we had cash and cash equivalents of $22.4 million. The adequacy of our available funds will depend on many factors, including the macroeconomic environment and the operating performance of our stores. We believe that our existing cash and cash equivalents, cash flows from our operating activities, and, to the extent necessary, availability under the Senior ABL Facility will be sufficient to meet our anticipated liquidity needs for at least the next 12 months.
Capital lease obligations as of April 29, 2017 and April 30, 2016 were $0.5 million and $0.6 million, respectively.
Off-Balance Sheet Arrangements
As of April 29, 2017, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the Securities and Exchange Commission's Regulation S-K.
Recent Accounting Pronouncements
See Part I, Item 1, “Financial Statements—Notes to Condensed Consolidated Financial Statements— Note 1 — Recent Accounting Pronouncements,” for information regarding new accounting pronouncements.
Business Process Outsourcing and Information Systems
We have entered into a Master Services Agreement with Capgemini U.S. LLC in which Capgemini agrees to provide business process outsourcing services and services for the migration of the current information technology systems and processes provided by Sears Holdings to new, state-of-art business and technology infrastructure and systems primarily provided by NetSuite Inc. (collectively, the “BPO”). We expect the new infrastructure and systems will provide greater strategic and operational flexibility, provide better control of our systems and processes, reduce our total cost of information-system ownership over the term of the Master Services Agreement, and reduce some of the risks inherent in our services relationship with, and reduce our dependence on, Sears Holdings.
Our plan and expectation is that the new infrastructure and systems will be operational in all material respects by the end of 2017. The new infrastructure and systems will enable us, and we currently intend, to replace many of the corporate services provided by Sears Holdings with services provided by Capgemini, other third-party providers, and, on a limited basis, internally by SHO. The replaced services could include tax, accounting, non-merchandise procurement, risk management and insurance, advertising and marketing, human resources, loss prevention, environmental, product and human safety, facilities, information technology, online, payment clearing, and other financial, real estate management, merchandising, and other support services.
We continue to incur additional corporate expenses in 2017 as a result of the BPO. Selling and administrative expenses related to the BPO were $9.3 million and $3.2 million in the first quarters of 2017 and 2016, respectively.
The migration to the new infrastructure and systems involves significant risks for us, which we have summarized in Item 1A, "Risk Factors," in the 2016 10-K. These risks could have a material adverse effect on our business and results of operations.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "forward-looking statements"). Statements preceded or followed by, or that otherwise include, the words "believes," "expects," "anticipates," "intends," "project," "estimates," "plans," "forecast," "is likely to," and similar expressions or future or conditional verbs such as "will," "may," "would," "should," and "could" are generally forward-looking in nature and not historical facts. The forward-looking statements are subject to significant risks and uncertainties that may cause our actual results, performance, and achievements in the future to be materially different from the future results, future performance, and future achievements expressed or implied by the forward-looking statements. The forward-looking statements include, without limitation, information concerning our future financial performance, business strategies, plans, goals, beliefs, expectations, and objectives. The forward-looking statements are based upon the current beliefs and expectations of our management.
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SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
The following factors, among others, (1) could cause our actual results, performance, and achievements to differ materially from those expressed in the forward-looking statements, and one or more of the differences could have a material adverse effect on our ability to operate our business and (2) could have a material adverse effect on our results of operations, financial condition, liquidity, and cash flows: if Sears Holdings seeks the protection of the U.S. bankruptcy laws (including the effects of the imposition of the "automatic stay" and the effects if Sears Holdings were to seek to reject one or more of the SHO-Sears Holdings Agreements); our ability to offer merchandise and services that our customers want, including those under the KCD Marks; our Amended and Restated Merchandising Agreement with Sears Holdings provides that (1) if a third party that is not an affiliate of Sears Holdings acquires the rights to one or more (but less than all) of the KCD Marks Sears Holdings may terminate our rights to buy merchandise branded with any of the acquired KCD Marks and (2) if a third party that is not an affiliate of Sears Holdings acquires the rights to all of the KCD Marks Sears Holdings may terminate the Amended and Restated Merchandising Agreement in its entirety, over which events we have no control; the sale by Sears Holdings and its subsidiaries to other retailers that compete with us of major home appliances and other products branded with one of the KCD Marks; on May 26, 2016 Sears Holdings announced that it would explore alternatives for its Kenmore, Craftsman, and Diehard businesses and further expand the presence of these brands and on August 25, 2016 Sears Holdings announced that it was continuing to explore alternatives for these businesses by evaluating potential partnerships or other transactions; on March 9, 2017 Sears Holdings announced that it had completed its sale to Stanley Black & Decker, Inc. of Sears Holdings's Craftsman business (the "Stanley Purchase"), including the Craftsman brand name and related intellectual property rights (Sears Holdings has waived its right in the Amended and Restated Merchandising Agreement to terminate, as a result of the Stanley Purchase, the Company's rights to buy from Sears Holdings merchandise branded with the Craftsman brand); the willingness and ability of Sears Holdings to fulfill its contractual obligations to us; our ability to successfully manage our inventory levels and implement initiatives to improve inventory management and other capabilities; competitive conditions in the retail industry; worldwide economic conditions and business uncertainty, the availability of consumer and commercial credit, changes in consumer confidence, tastes, preferences and spending, and changes in vendor relationships; the fact that our past performance generally, as reflected on our historical financial statements, may not be indicative of our future performance as a result of, among other things, the consolidation of Hometown and Outlet into a single business entity, the Separation, and operating as a standalone business entity; the impact of increased costs due to a decrease in our purchasing power following the Separation, and other losses of benefits associated with having been wholly owned by Sears Holdings and its subsidiaries prior to the Separation; our continuing reliance on Sears Holdings for most products and services that are important to the successful operation of our business, and our potential need to rely on Sears Holdings for some products and services beyond the expiration, or earlier termination by Sears Holdings, of our agreements with Sears Holdings; the willingness of Sears Holdings' appliance, lawn and garden, tools, and other vendors to continue to supply to Sears Holdings, on terms (including vendor payment terms for Sears Holdings' merchandise purchases) that are acceptable to it and to us, merchandise that we would need to purchase from Sears Holdings to ensure continuity of merchandise supplies for our businesses; the willingness of Sears Holdings’ appliance, lawn and garden, tools, and other vendors to continue to pay to Sears Holdings merchandise-related subsidies and allowances and cash discounts (some of which Sears Holdings is obligated to pay to us); our ability to resolve, on commercially reasonable terms, future disputes with Sears Holdings regarding the material terms and conditions of our agreements with Sears Holdings; our ability to establish information, merchandising, logistics, and other systems separate from Sears Holdings that would be necessary to ensure continuity of merchandise supplies for our businesses if vendors were to reduce, or cease, their merchandise sales to Sears Holdings or if Sears Holdings were to reduce, or cease, its merchandise sales to us; if Sears Holdings' sales of major appliances and lawn and garden merchandise to its retail customers decline Sears Holdings' sales to us of outlet-value merchandise could decline; our ability to maintain an effective and productive business relationship with Sears Holdings, particularly if future disputes were to arise with respect to the terms and conditions of our agreements with Sears Holdings; most of our agreements related to the Separation and our continuing relationship with Sears Holdings were negotiated while we were a subsidiary of Sears Holdings (except for amendments agreed to after the Separation), and we may have received different terms from unaffiliated third parties (including with respect to merchandise-vendor and service-provider indemnification and defense for negligence claims and claims arising out of failure to comply with contractual obligations); our reliance on Sears Holdings to provide computer systems to process transactions with our customers (including the point-of-sale system for the stores we operate and the stores that our independent dealers and independent franchisees operate, which point-of-sale system captures, among other things, credit-card information supplied by our customers) and others, quantify our results of operations, and manage our business ("SHO's SHC-Supplied Systems"); SHO's SHC-Supplied Systems could be subject to disruptions and data/security breaches (Sears Holdings announced on May 31, 2017 that its Kmart store payment-data systems had been infected with a malicious code and that the code had been removed and the event contained), and Sears Holdings could be unwilling or unable to indemnify and defend us against third-party claims and other losses resulting from such disruptions and data/security breaches, which could have one or more material adverse effects on SHO; our ability to implement the BPO in accordance with our plans, expectations, current timetable, and anticipated cost; limitations and restrictions in the Senior ABL Facility and related agreements governing our indebtedness and
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SEARS HOMETOWN AND OUTLET STORES, INC.
13 Weeks Ended April 29, 2017 and April 30, 2016
our ability to service our indebtedness; competitors could continue to reduce their promotional pricing on new-in-box appliances, which could continue to adversely impact our sales of out-of-box appliances and associated margin; our ability to generate profitable sales of merchandise and services on our transactional ecommerce websites in the amounts we have planned to generate; our ability to obtain additional financing on acceptable terms; our dependence on the ability and willingness of our independent dealers and independent franchisees to operate their stores profitably and in a manner consistent with our concepts and standards; our ability to sell profitably online all of our merchandise and services; our dependence on sources outside the U.S. for significant amounts of our merchandise inventories; fixed-asset impairment for long-lived assets; our ability to attract, motivate, and retain key executives and other employees; our ability to maintain effective internal controls as a publicly held company; our ability to realize the benefits that we expect to achieve from the Separation; litigation and regulatory trends challenging various aspects of the franchisor-franchisee relationship could expand to challenge or adversely affect our relationships with our independent dealers and independent franchisees; low trading volume of our common stock due to limited liquidity or a lack of analyst coverage; and the impact on our common stock and our overall performance as a result of our principal stockholder's ability to exert control over us.
The foregoing factors should not be understood as exhaustive and should be read in conjunction with the other cautionary statements, including the "Risk Factors," that are included in this Quarterly Report on Form 10-Q and in the 2016 10-K and in our other filings with the Securities and Exchange Commission and our other public announcements. While we believe that our forecasts and assumptions are reasonable, we caution that actual results may differ materially. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Consequently, actual events and results may vary significantly from those included in or contemplated or implied by our forward-looking statements. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly update or review any forward-looking statement made by us or on our behalf, whether as a result of new information, future developments, subsequent events or circumstances, or otherwise, except as required by law.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are subject to interest rate risk associated with our Senior ABL Facility, which requires us to pay interest on outstanding borrowings at variable rates. Assuming our Senior ABL Facility were fully drawn in principal amount equal to $250 million, each one percentage point change in interest rates payable with respect to the Senior ABL Facility would result in a $2.5 million change in annual cash interest expense with respect to our Senior ABL Facility.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the 13 weeks ended April 29, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As of the date of this Quarterly Report on Form 10-Q we are not party to any litigation that we consider material to our operations.
Notwithstanding the above, from time to time we are, and will continue to be, subject to various legal claims, including those alleging wage and hour violations, payroll violations, employment discrimination, unlawful employment practices, Americans with Disabilities Act claims, Family and Medical Leave Act claims, product liability claims as a result of the sale of merchandise and services, claims with respect to franchise and dealer transactions, relationships, operations, and terminations as well as various legal and governmental proceedings. Some of these claims from time to time include, and will continue to include, class or collective-action allegations, and the proceedings for some of these claims are, and will continue to be, in jurisdictions with reputations for aggressive application of laws and procedures against corporate defendants. Litigation is inherently unpredictable. Each proceeding, claim, and regulatory action against us, whether meritorious or not, could be time consuming, result in significant legal expenses, require significant amounts of management time, result in the diversion of significant operational resources, require changes in our methods of doing business that could be costly to implement, reduce our net sales, increase our expenses, require us to make substantial payments to settle claims or satisfy judgments, require us to cease conducting certain operations or offering certain products in certain areas or generally, and otherwise harm our business, results of operations, financial condition, and cash flows, perhaps materially. See also "Cautionary Statement Regarding Forward-Looking Information" and "Risk Factors" in this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed in the 2016 10-K, which risks should be carefully considered. Those risks could materially affect our results of operations, financial condition, liquidity, and cash flows. Those risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Cautionary Statement Regarding Forward-Looking Information,” and the risks to our businesses described elsewhere, in this Quarterly Report on Form 10-Q.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On August 28, 2013 the Company's Board of Directors authorized a $25 million repurchase program for the Company's outstanding shares of common stock. The timing and amount of repurchases depend on various factors, including market conditions, the Company's capital position and internal cash generation, and other factors. The Company's repurchase program does not include specific price targets, may be executed through open-market, privately negotiated, and other transactions that may be available, and may include utilization of Rule 10b5-1 plans. The repurchase program does not obligate the Company to repurchase any dollar amount, or any number of shares, of common stock. The repurchase program does not have a termination date, and the Company may suspend or terminate the repurchase program at any time.
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Shares that are repurchased by the Company pursuant to the repurchase program will be retired and will resume the status of authorized and unissued shares of common stock.
The Company did not repurchase any shares during the 13 weeks ended April 29, 2017. As of April 29, 2017 we had approximately $12.5 million of remaining authorization under the repurchase program. The Senior ABL Facility limits SHO’s ability to repurchase its common stock. See "Management's Discussion and Analysis-Analysis of Financial Condition-Financing Arrangements" in this Quarterly Report on Form 10-Q.
Item 6. Exhibits
The Exhibits listed in the accompanying “Exhibit Index” have been filed as part of this Quarterly Report on Form 10-Q.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Sears Hometown and Outlet Stores, Inc. | ||
| By: | /S/ E.J. BIRD | |
| Name: | E. J. Bird | |
| Title: | Interim Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | |
| Date: | June 1, 2017 | |
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| Exhibit Number | Exhibit Description |
| 3.1 | Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)). |
| 3.2 | Certificate of Amendment of Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.2 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)). |
| 3.3 | Amended and Restated Bylaws of Registrant (incorporated by reference to Exhibit 3.1 to Registrant's Current Report on Form 8-K filed December 9, 2013 (File No. 001-35641)). |
| *10.1 | Amendment 7 to Services Agreement between Registrant and Sears Holdings Management Corporation dated April 7, 2017. |
| 10.2 | Amendment to Amended and Restated Merchandising Agreement dated as of March 8, 2017 among (1) Registrant, Sears Authorized Hometown Stores, LLC, and Sears Outlet Stores, L.L.C., (2) Sears Holdings Corporation, Sears, Roebuck and Co., and Kmart Corporation, and (3) Stanley Black & Decker, Inc. (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed March 9, 2017 (File No. 001-35641)). |
| *31.1 | Certification of Chief Executive Officer Required Under Rule 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of 1934, as amended. |
| *31.2 | Certification of Interim Chief Financial Officer Required Under Rule 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of 1934, as amended. |
| *32 | Certification of Chief Executive Officer and Interim Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished only). |
| **101 | The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter ended April 29, 2017, formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) the Condensed Consolidated Statements of Operations (Unaudited) for the 13 Weeks Ended April 29, 2017; (ii) the Condensed Consolidated Balance Sheets (Unaudited) at April 29, 2017, April 30, 2016, and January 28, 2017; (iii) the Condensed Consolidated Statements of Cash Flows (Unaudited) for the 13 Weeks Ended April 29, 2017; (iv) the Condensed Combined Statements of Stockholders' Equity (Unaudited) for the 13 Weeks Ended April 29, 2017; and (v) the Notes to the Condensed Consolidated Financial Statements (Unaudited). |
* Filed herewith.
** Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
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