NOTE 1—BACKGROUND, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES
Background
Sears Hometown and Outlet Stores, Inc. is a national retailer primarily focused on selling home appliances, hardware, tools and lawn and garden equipment. As of
February 2, 2019
, the Company and our independent dealers and franchisees operated a total of
677
stores across
49
states and in Puerto Rico and Bermuda. In these notes the terms "we," "us," "our," "SHO," and the "Company" refer to Sears Hometown and Outlet Stores, Inc. and its subsidiaries.
The Company separated from Sears Holdings Corporation (“Sears Holdings”) in October 2012 (the “2012 Separation”). The Company has specified rights to use the "Sears" name under a license agreement from Sears Holdings.
Basis of Presentation
These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated.
We operate through
two
segments--our Sears Hometown segment ("Hometown") and our Sears Outlet segment ("Outlet").
Subsequent to the 2012 Separation and until mid-February 2019 we had significant business relationships with Sears Holdings and its subsidiaries, and we relied heavily on them for merchandise and services through various agreements among the Company, Sears Holdings and, in some circumstances, subsidiaries of Sears Holdings (together the “Operative Agreements”). During October 2018 Sears Holdings and many of its subsidiaries (together the “Sears Holdings Companies”) filed voluntary petitions in the United States Bankruptcy Court for the Southern District of New York seeking relief under Chapter 11 of Title 11 of the United States Code. The Company, which is not a subsidiary of Sears Holdings, is not included in the bankruptcy petitions filed by the Sears Holdings Companies, and neither the Company nor its subsidiaries have filed a bankruptcy petition. As part of the Sears Holdings Companies' bankruptcy proceedings Transform Holdco LLC ("Transform Holdco") acquired most of the operating assets (including Sears stores) and related assets of the Sears Holdings Companies (together the “Sears Assets”), and the Operative Agreements were assigned by the Sears Holdings Companies to, and the obligations thereunder were assumed by, Transform Holdco on or about February 11, 2019. According to publicly available information, (1) ESL Investments, Inc. and investment affiliates including Edward S. Lampert (together “ESL”) control Transform Holdco and (2) ESL owns approximately
58.8%
of the Company’s outstanding shares of common stock.
The Company is party to 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
$170 million
(the “Senior ABL Facility”). The Company is also a party to a Term Loan Agreement with Gordon Brothers Finance Company, as agent, lead arranger, and sole bookrunner, and Gordon Brothers Finance Company, LLC, as lender (the “Term Loan”). See Note 8 - Financing Arrangements. The Senior ABL Facility will mature on the earliest of the following dates: (1) February 29, 2020; (2) six months prior to the expiration of specified "Separation Agreements" (which term is defined in the Senior ABL Facility to include specified Operative Agreements) unless the Separation Agreements are extended to a date later than February 29, 2020 or are terminated on a basis reasonably satisfactory to the Senior ABL lenders; and (3) acceleration of the maturity date following an event of default in accordance with the Senior ABL Facility. The Term Loan will mature on the earliest of (1) the maturity date specified in the Senior ABL Facility, (2) February 16, 2023, and (3) acceleration of the maturity date following an event of default in accordance with the Term Loan Agreement. The Senior ABL Facility and the Term Loan Agreement each provides that the termination of "the Separation Agreements" is an event of default thereunder, which could result in all amounts outstanding becoming immediately due and payable. The Company and specified subsidiaries have entered into an Amendments Agreement dated March 12, 2019 with Transform Holdco LLC and its subsidiaries party thereto, as assignees. The Amendments Agreement extends until February 1, 2023 the duration of those Separation Agreements that by their express terms would have expired on February 1, 2020 (October 11, 2022 with respect to the Shop Your Way Rewards Retail Establishment Agreement).
Our consolidated operating loss for our fiscal year 2018 was
$39 million
and included an operating loss of
$58.3 million
from our Hometown segment and
$19.3 million
of operating income from our Outlet segment. The Hometown segment has experienced multiple successive years of operating losses that have continued, and are continuing to worsen. For SHO's 2014 fiscal year the Hometown segment’s operating loss was
$11.9 million
, excluding the impact of goodwill impairment. The segment’s operating
losses have grown each year since then, and the segment suffered an operating loss for our 2018 fiscal year of
$58.3 million
. In part this is due to growing supply-chain cost increases and Craftsman and Kenmore merchandise availability issues. These cost increases and merchandise availability issues have, and will continue to have, a disproportionately adverse impact on the Hometown segment. SHO believes that these cost increases and Kenmore and Craftsman availability issues are unlikely to improve in the near term and perhaps longer. We also believe that we have exhausted all of the means at our disposal to turn the segment’s businesses around. We also believe that, regardless of our commercially reasonable efforts to improve the Hometown segment's operating results (which efforts we intend to continue), the segment likely will continue to experience operating losses.
The Company is seeking to refinance the Senior ABL Facility and Term Loan prior to February 29, 2020, which efforts the Company believes will be augmented by the Company’s improved consolidated operating performance over the last 18 months as well as the value of the Company’s inventory and other assets that would be available as collateral to lenders. While the Company has had discussions with the administrative agent for the Senior ABL Facility about its extension or refinancing, those discussions have not yet resulted in an agreement to extend or refinance. The Company expects to continue such discussions and to engage in discussions with the Term Loan lender, with a goal of completing a replacement credit facility or facilities for the Senior ABL Facility and the Term Loan before the maturity dates of these facilities. We can give no assurance that (1) the discussions will be successful or (2) if the discussions result in an agreement to extend or refinance, that the terms and conditions of the extension or replacement arrangements would not be unfavorable, perhaps significantly unfavorable, compared to the terms and conditions of the Senior ABL Facility and the Term Loan.
The Company is subject to Accounting Standards Update 2014-15, Presentation of Financial Statements - Going Concern, codified as Accounting Standards Codification (ASC) 205-40 (the "Accounting Evaluation Requirements"), which requires management to evaluate an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or, in certain cases, available to be issued). ASC 205-40 states that conditions or events that raise "substantial doubt" about an entity’s ability to continue as a going concern typically relate to the entity’s ability to meet its obligations as they become due, generally within one year after the date that the financial statements are issued. The evaluation of whether substantial doubt is raised does not take into account the potential mitigating effect of management’s plans that have not been fully implemented. If conditions or events indicate that substantial doubt is raised, management is required to evaluate whether its plans that are intended to mitigate those conditions and events will alleviate substantial doubt. ASC 205-40 specifies that management may consider its plans only when it is "probable" that those plans will be effectively implemented and that the plans will mitigate the relevant conditions and events within one year after the financial statements are issued. This probability determination is based on the specific facts and circumstances of the entity and involves significant judgment.
The Senior ABL Facility and the Term Loan Agreement provide that the Company's inability to obtain from the Company's independent registered public accounting firm a report and opinion that "shall not be subject to any 'going concern' or like qualification or exception" constitutes an event of default, which would give the Senior ABL Facility and the Term Loan Agreement lenders the right to accelerate the maturity of all outstanding loans, among other actions. The Senior ABL Facility and the Term Loan Agreement lenders have waived through October 31, 2019 any default resulting from the Going Concern Uncertainty.
While we believe that we should be able to refinance the Senior ABL Facility and the Term Loan, and that the refinancing should satisfy our liquidity needs through the next twelve months from date of issuance, such refinancing has not occurred and cannot be considered "probable" (as defined by the Accounting Evaluation Requirements) as of the date these financial statements are issued. The Company will continue to seek to refinance the Senior ABL Facility and the Term Loan. Because we cannot at this time conclude that any proposed refinancing is "probable" of occurring under the Accounting Evaluation Requirements, and due to the uncertain impact on our business and financial performance associated with ongoing operating losses in our Hometown segment, "substantial doubt" (as defined by the Accounting Evaluation Requirements) is deemed to exist about our ability to continue as a going concern.
The May 3, 2019 report of the Company's independent registered public accounting firm that accompanies these Consolidated Financial Statements incorporates the firm's audit opinion, which expresses "Going Concern Uncertainty" (hereinafter the "Going Concern Uncertainty").
The Senior ABL Facility and the Term Loan Agreement provide that the Company's inability to obtain from the Company's independent registered public accounting firm a report and opinion that "shall not be subject to any 'going concern' or like qualification or exception" constitutes an event of default, which would give the Senior ABL Facility and the Term Loan Agreement lenders the right to accelerate the maturity of all outstanding loans, among other actions. The Senior ABL Facility and the Term Loan Agreement lenders have waived through October 31, 2019 any default resulting from the Going Concern Uncertainty.
Reclassifications
- Certain prior period reclassifications were made to conform with the current period presentation. These reclassifications had no effect on reported operations, cash flows, total assets, or stockholders' equity as previously reported.
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 as well as the methods permitted for determining the primary beneficiary of a variable interest entity. In addition, this guidance requires ongoing reassessments of whether a company is the primary beneficiary of a variable interest entity and disclosures related to a company’s involvement with a variable interest entity.
On an ongoing basis the Company evaluates its business relationships, such as those with its dealers, franchisees, and suppliers, to identify potential variable interest entities. Generally, these businesses 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.
SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
Our fiscal years end on the Saturday closest to January 31. Unless otherwise stated, references to specific years in these notes are to fiscal years. The following fiscal periods are presented herein.
|
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|
|
|
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Fiscal Year
|
Ended
|
Weeks
|
|
2018
|
February 2, 2019
|
52
|
|
2017
|
February 3, 2018
|
53
|
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events. The estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis using historical experience and other factors that management believes to be reasonable under the circumstances. Adjustments to estimates and assumptions are made when facts and circumstances dictate. As future events and their effects cannot be determined with absolute certainty, actual results may differ from the estimates used in preparing the accompanying consolidated financial statements. Significant estimates and assumptions are required as part of determining inventory and accounts and franchisee receivables valuation, estimating depreciation and recoverability of long-lived assets, establishing insurance, warranty, legal and other reserves, performing long-lived asset impairment analysis, and establishing valuation allowances on deferred income tax assets and reserves for tax examination exposures.
Cash and Cash Equivalents
Cash equivalents include (1) all highly liquid investments with original maturities of three months or less at the date of purchase and (2) deposits in-transit from banks for payments related to third-party credit card and debit card transactions.
Allowance for Doubtful Accounts
We provide an allowance for doubtful accounts based on both historical experience and a specific identification basis. Allowances for doubtful accounts on accounts and franchisee receivable balances were
$2.0 million
at
February 2, 2019
and
$5.8 million
at
February 3, 2018
. Our accounts receivable balance is comprised of various vendor-related and customer-related accounts receivable. Our franchisee receivable balance is comprised of promissory notes that relate primarily to the sale of assets for our franchised locations.
The Company provides 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, 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. As of February 2, 2019, all franchisee receivables have been fully reserved.
Merchandise Inventories
Merchandise inventories are valued at the lower of cost or market. Merchandise inventories are valued under the retail inventory method, or "RIM," using primarily a last-in, first-out, or "LIFO," cost-flow assumption.
Inherent in RIM calculations are certain significant management judgments and estimates including, among others, merchandise markons, markups, markdowns, and shrinkage, which significantly impact the ending inventory valuation at cost and resulting gross margins. The methodologies utilized by us in our application of RIM are consistent for all periods presented. Such methodologies include the development of the cost-to-retail ratios, the groupings of homogeneous classes of merchandise, the development of shrinkage and obsolescence reserves, the accounting for price changes, and the computations inherent in the LIFO adjustment (where applicable). Management believes that RIM provides an inventory valuation that reasonably approximates cost and results in carrying inventory at the lower of cost or market.
In connection with our LIFO calculation we estimate the effects of inflation on inventories by utilizing external price indices determined by the U.S. Bureau of Labor Statistics. If we had used the first-in, first-out, or "FIFO" method of inventory valuation instead of the LIFO method, merchandise inventories would have been insignificantly higher at
February 2, 2019
and
February 3, 2018
.
Vendor Rebates and Allowances
We receive rebates and allowances from vendors through a variety of programs and arrangements intended to offset the costs of promoting and selling the vendors' products. In addition, Transform Holdco (Sears Holdings prior to February 11, 2019) allocates a portion of the rebates and allowances it receives from vendors based on shipments to or sales of the related products to the Company. Vendor payments are recognized and recorded as a reduction to the cost of merchandise inventories when earned and, thereafter, as a reduction of cost of sales and occupancy as the merchandise is sold. Up-front consideration received from vendors linked to purchases or other commitments is initially deferred and amortized ratably to cost of sales and occupancy over the life of the contract or as performance of the activities specified by the vendor to earn the fee is completed.
Property and Equipment
Property and equipment are recorded at cost, less accumulated depreciation. Additions and substantial improvements are capitalized and include expenditures that materially extend the useful lives of existing facilities and equipment. Maintenance and repairs that do not materially improve or extend the lives of the respective assets are expensed as incurred.
Property and equipment consists of the following:
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|
|
|
|
|
thousands
|
|
February 2, 2019
|
|
February 3, 2018
|
|
Land
|
|
$
|
1,638
|
|
|
$
|
1,741
|
|
|
Buildings and improvements
|
|
29,735
|
|
|
35,065
|
|
|
Furniture, fixtures and equipment
|
|
35,526
|
|
|
37,303
|
|
|
Capitalized leases
|
|
1,648
|
|
|
1,276
|
|
|
Total property and equipment
|
|
68,547
|
|
|
75,385
|
|
|
Less: accumulated depreciation
|
|
(40,816
|
)
|
|
(39,336
|
)
|
|
Total property and equipment, net
|
|
$
|
27,731
|
|
|
$
|
36,049
|
|
Depreciation expense, which includes depreciation on assets under capital leases, is recorded over the estimated useful lives of the respective assets using the straight-line method for financial statement purposes and accelerated methods for tax purposes. The range of lives are generally
15
to
25
years for buildings,
3
to
10
years for furniture, fixtures, and equipment, and
3
to
5
years for computer systems and equipment. Leasehold improvements are depreciated over the shorter of the associated lease term or the estimated useful life of the asset. Total depreciation expense was
$12.4 million
and
$11.8 million
, for fiscal years
2018
and
2017
, respectively.
As of
February 2, 2019
, management has identified
one
property that is deemed held for sale based on criteria in Accounting Standards Codification ("ASC") 360-10-45-9. This property is reflected in each category of Property and Equipment with the exception of capitalized leases in the table above and had a carrying value of
$1.0 million
as of
February 2, 2019
. As of
February 2, 2019
, the expected fair value less the cost of sale exceeded the carrying value of the Property and Equipment resulting in an impairment charge of
$0.5 million
.
Impairment of Long-Lived Assets and Costs Associated with Exit Activities
In accordance with accounting standards governing the impairment or disposal of long-lived assets, the carrying value of long-lived assets, including property and equipment, is evaluated whenever events or changes in circumstances indicate that a potential impairment has occurred. Factors that could result in an impairment review include, but are not limited to, a current period cash flow loss combined with a history of cash flow losses, current cash flows that may be insufficient to recover the investment in the property over the remaining useful life, or a projection that demonstrates continuing losses associated with the use of a long-lived asset, significant changes in the manner of use of the assets, or significant changes in business strategies. An impairment loss is recognized when the estimated undiscounted cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. When an impairment loss is recognized, the carrying amount of the asset is reduced to its estimated fair value as determined based on quoted market prices or through the use of other valuation techniques. We recorded impairment charges with respect to long-lived assets of
$2.1 million
and
$3.4 million
in fiscal years
2018
and
2017
, respectively, included in Impairment of property and equipment in the accompanying Consolidated Statements of Operations.
We account for costs associated with location closings in accordance with accounting standards pertaining to accounting for costs associated with exit or disposal activities and compensation. When management makes a decision to close a location we record a reserve as of that date for the expected inventory markdowns associated with the closing. We also record a liability for future lease costs (net of estimated sublease income) when we cease to use the location. As of
February 2, 2019
and February 3, 2018, this liability was approximately
$2.6 million
and
$4.7 million
, respectively. See Note 15.
Leases
We lease certain stores, office facilities, computers and transportation equipment. The determination of operating and capital lease obligations is based on the expected durations of the leases and contractual minimum lease payments specified in the lease agreements. For certain stores, amounts in excess of these minimum lease payments are payable based upon a specified percentage of sales. Contingent rent is accrued during the period it becomes probable that a particular store will achieve a specified sales level thereby triggering a contingent rental obligation. Certain leases also include an escalation clause or clauses and renewal option clauses calling for increased rents. Where the lease contains an escalation clause or concession such as a rent holiday, rent expense is recognized using the straight-line method over the term of the lease. We have subleases with Transform Holdco (as assignee) for
23
locations. We had rent expense paid to Sears Holdings (Transform Holdco after February 11, 2019) of
$7.2 million
and
$10.8 million
in
2018
and
2017
, respectively.
We also had rent expense paid to Seritage Growth Properties, a related party, in occupancy charges for of
$0.6 million
and
$1.1 million
in
2018
and
2017
, respectively, for occupancy charges for properties we lease from Seritage.
Rental expense for operating leases was as follows:
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Fiscal Year
|
|
thousands
|
|
2018
|
|
2017
|
|
Minimum rentals
|
|
44,379
|
|
|
59,533
|
|
|
Less-Sublease rentals
|
|
(2,553
|
)
|
|
(7,399
|
)
|
|
Total
|
|
41,826
|
|
|
52,134
|
|
Minimum lease obligations excluding taxes, insurance and other expenses are as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
(thousands)
|
|
Capital Leases
|
|
Operating Leases
|
|
2019
|
|
$
|
259
|
|
|
$
|
39,292
|
|
|
2020
|
|
359
|
|
|
33,666
|
|
|
2021
|
|
21
|
|
|
26,523
|
|
|
2022
|
|
14
|
|
|
19,037
|
|
|
2023
|
|
5
|
|
|
9,486
|
|
|
Thereafter
|
|
—
|
|
|
4,374
|
|
|
Total Minimum Lease Payments
|
|
658
|
|
|
132,378
|
|
|
Less - Sublease Income on Leased Properties
|
|
—
|
|
|
(3,036
|
)
|
|
Net Minimum Lease Payments
|
|
$
|
658
|
|
|
$
|
129,342
|
|
|
|
|
|
|
|
|
Capital lease obligations
|
|
658
|
|
|
|
|
Less Current Portion of Capital Lease Obligations
|
(259
|
)
|
|
|
|
Long-term Capital Lease Obligations
|
|
$
|
399
|
|
|
|
Insurance Programs
We maintain our own insurance arrangements with third-party insurance companies for exposures incurred for a number of risks including worker’s compensation and general liability claims. Insurance expense of
$4.5 million
and
$5.3 million
was recorded during
2018
and
2017
, respectively.
Loss Contingencies
We account for contingent losses in accordance with accounting standards pertaining to loss contingencies. Under accounting standards, loss contingency provisions are recorded for probable losses at management’s best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount is recorded. These estimates are often initially developed substantially earlier than the ultimate loss is known, and the estimates are refined each accounting period, as additional information is known.
Revenue Recognition
Revenues from contracts with customers include sales of merchandise, commissions on merchandise sales made through www.sears.com, Company websites, services and extended-service plans, financing programs, and delivery and handling revenues related to merchandise sold. Revenue is measured based on the amount of fixed consideration that we expect to receive, reduced by estimates for variable consideration such as returns. Revenue also excludes any amounts collected from customers and remitted or payable to governmental authorities. In arrangements where we have multiple performance obligations, the transaction price is allocated to each performance obligation using the relative stand-alone selling price.
We recognize revenues from retail operations upon the transfer of control of goods to the customer. We satisfy our performance obligations at the point of sale for retail store transactions and upon delivery for online transactions. We defer revenue for retail store and online transactions including commissions on extended-service plans, where we have received consideration but have not transferred control of the goods to the customer at the end of the period. The performance obligation is generally satisfied in the following reporting period. The balance of deferred revenue was
$11.9 million
and
$16.4 million
at
February 2, 2019
and
February 3, 2018
, respectively. The change in deferred revenue represents revenue recognized during
2018
.
We recognize revenues from commissions on services, and delivery and handling revenues related to merchandise sold, at the point of sale as we are not the primary obligor with respect to such services and have no future obligations for future performance. Commissions earned on services, and delivery and handling revenues are presented net of related costs because we are acting as an agent in arranging the services for the customer and do not control the services being rendered.
The Company accepts Transform Holdco (Sears Holdings prior to February 11, 2019) gift cards as tender for purchases and is reimbursed weekly by Transform Holdco for gift cards tendered.
Refund Liability and Right of Return Asset
Fiscal 2018 and Subsequent Periods.
Revenues from merchandise sales and services are reported net of estimated returns and allowances and exclude sales taxes. The typical return period is 30 days. The refund liability for returns is calculated as a percentage of sales based on historical return percentages and recognized at the transaction price as a reduction of revenues. The refund liability was
$2.9 million
at February 2, 2019. We also recognize a return asset, and corresponding adjustment to cost of sales, for our right to recover the goods returned by the customer, measured at the former carrying amount of the goods, less any expected recovery cost. The right of return asset was
$1.4 million
at February 2, 2019.
At each financial reporting date, we assess our estimates of expected returns, refund liabilities, and return assets.
Reserve for Sales Returns and Allowances
Fiscal 2017.
Revenues from merchandise sales and services are reported net of estimated returns and allowances and exclude sales taxes. The refund liability for returns and allowances, including the impact to gross profit, is calculated as a percentage of sales based on historical return percentages. Estimated returns are recorded as a reduction of sales and cost of sales. The reserve for returns and allowances was
$1.1 million
at
February 3, 2018
.
Cost of Sales and Occupancy
Cost of sales and occupancy is comprised principally of merchandise costs, warehousing and distribution (including receiving and store delivery) costs, retail store occupancy costs, home services and installation costs, warranty cost, royalties payable to Transform Holdco related to our sale of products branded with one of the KENMORE
®
, CRAFTSMAN
®
, and DIEHARD
®
marks (the "KCD Marks"), customer shipping and handling costs, vendor allowances, markdowns, and physical inventory losses. The KCD Marks are owned by, or licensed to, subsidiaries of Transform Holdco.
Selling and Administrative Expenses
Selling and administrative expenses are comprised principally of dealer and franchisee commissions, payroll and benefits costs for retail and support employees, advertising, pre-opening costs, and other administrative expenses.
Dealer and Franchisee Commissions
In accordance with our agreements with our dealers and franchisees, we pay commissions to our dealers and franchisees on the net sales of merchandise and extended-service plans. In addition, each dealer and franchisee can earn marketing support, home improvement referrals, rent support, and other items. Commission costs are expensed as incurred and reflected within selling and administrative expenses. Commission costs were
$126.8 million
and
$171.7 million
in
2018
and
2017
, respectively. Commission costs vary based on factors including store count, number of dealer and franchise locations, sales mix, sales volume, and commission rates.
Pre-Opening Costs
Pre-opening and start-up activity costs are expensed in the period in which they occur.
Advertising Costs
Advertising costs are expensed as incurred, generally the first time the advertising occurs, and were
$40.0 million
and
$48.2 million
for
2018
and
2017
, respectively. These costs are included within selling and administrative expenses in the accompanying Consolidated Statements of Operations.
Income Taxes
We provide deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax basis of assets and liabilities based on currently enacted tax laws. The tax balances and income tax expense recognized by us are based on management’s interpretation of the tax laws of multiple jurisdictions. Income tax expense also reflects our best estimates and assumptions regarding, among other things, the level of future taxable income, tax planning, and any valuation allowance. For the year-ended
February 2, 2019
, a valuation allowance of
$105.0 million
has been recorded for the full amount of the net deferred tax assets. In the future, we may record additional net deferred tax assets and if future utilization of deferred tax assets is uncertain, we may record additional valuation allowance against such deferred tax assets. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions including the amount of future federal, state and foreign pre-tax operating income (loss), the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income.
Tax benefits are recognized when they are more likely than not to be sustained upon examination. The amount recognized is measured as the largest amount of benefit that is more likely than not of being recognized upon settlement. We will be subject to periodic audits by the Internal Revenue Service and other state local and foreign taxing authorities. Theses audits may challenge certain of the Company’s tax positions such as the timing and amount of income and deductions and the allocation of taxable income to various tax jurisdictions. We evaluate our tax positions and establish liabilities in accordance with the applicable guidance on uncertainty in income taxes. These tax uncertainties are reviewed as facts and circumstances change and are adjusted accordingly. This requires significant management judgment in estimating final outcomes. Actual results could materially differ from these
estimates and could significantly affect the effective tax rate and cash flows in future years. Interest and penalties are classified as income tax expense in the Consolidated Statements of Operations.
Prior to the 2012 Separation, our taxable income was included in the consolidated federal, state and foreign income tax returns of Sears Holdings or its affiliates. Income taxes in these consolidated financial statements have been recognized on a separate return basis. Under a Tax Sharing Agreement between the Company and Transform Holdco (the "Tax Sharing Agreement"), Transform Holdco is responsible for any federal, state or foreign income tax liability relating to tax periods ending on or before the 2012 Separation and the Company is responsible for any federal, state or foreign tax liability relating to tax periods ending after the 2012 Separation.
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:
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 consolidated balance sheets at cost, which approximates fair value due to the short-term nature of these instruments. For short-term borrowings and our Term Loan, the variable interest rates are a significant input in our fair value assessments and are consistent with the interest rates in the market. The carrying value of long-term notes receivable approximates fair value.
We may be required, on a nonrecurring basis, to adjust the carrying value of the Company's long-lived assets. When necessary, these valuations are determined by the Company using Level 3 inputs. These assets are subject to fair value adjustments in certain circumstances as when there is evidence that impairment may exist. As disclosed in Note 1, the Company recorded impairment charges of
$2.1 million
and
$3.4 million
on its property and equipment in
2018
and
2017
, respectively. The Company utilized Level 3 inputs to measure the fair value of property and equipment, and intangible assets.
Recently Issued Accounting Pronouncements
ASU 2016-02
"Leases (Topic 842)"
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02,
Leases
(Topic 842): Amendments to the FASB Accounting Standards Codification® (“ASU 2016-02”), which supersedes the existing guidance for lease accounting, Leases (Topic 840). In order to improve transparency and comparability between companies, ASU 2016-02 requires lessees to recognize leases on their balance sheets, and modifies accounting, presentation and disclosure for both lessors and lessees. Our leases primarily consist of retail space, offices, warehouses, distribution centers and vehicles. We have completed our initial assessment of the standard as well as implementation of our leasing software, including data upload, and are continuing to finalize our calculations, including validation procedures. We continue establishing new processes and internal controls required to comply with the new lease accounting and disclosure requirements set by the new standard.
ASU 2016-02 is effective for annual periods, and interim periods within those years, beginning after December 15, 2018. We are using the package of practical expedients that allows companies to not reassess: (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. We are making accounting policy elections to treat the lease and non-lease components of leases as a single lease component and to exempt leases with an initial term of twelve months or less from balance sheet recognition. Consequently, short-term leases will be expensed over the lease term. We are not electing to adopt the hindsight practical expedient and therefore will maintain the lease terms previously determined under ASC 840.
We will adopt ASU 2016-02 in the first quarter of fiscal year 2019 using the modified retrospective approach. The most significant and material impact of adoption will be the recognition of right-of-use (“ROU”) assets and lease liabilities on our consolidated balance sheets for operating leases, while our accounting for capital leases remains substantially unchanged. In addition, we are currently finalizing our assessment for ROU asset impairment and expect to recognize a cumulative-effect adjustment to the opening balance of retained earnings upon adoption. We do not believe the standard will materially affect our consolidated statements of earnings or cash flows. Our conclusions are preliminary and subject to change as we finalize our analysis. The Company will adopt this standard on February 3, 2019 and prior periods will not be recast in transition.
Recently Adopted Accounting Pronouncements
ASU 2014-09
, "Revenue from Contracts with Customers (Topic 606)"
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)", which supersedes the revenue recognition requirements in Accounting Standards Codification (ASC) 605,
Revenue Recognition
. Several additional ASUs have subsequently been issued amending and clarifying the standard. The core principle of ASU 2014-09 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. The guidance provides a five-step process to achieve that core principle and to determine when and how revenue is recognized. The updates may be applied retrospectively for each period presented or as a cumulative-effect adjustment at the date of adoption.
We adopted this standard on February 4, 2018, using the modified retrospective approach. The impact of the adoption of ASU 2014-09 on our consolidated financial statements is as follows:
|
|
|
|
•
|
Our revenue is primarily generated from the sales of merchandise to customers through the retail, e-commerce or wholesale channels. Our performance obligations underlying such sales, and the timing of revenue recognition related thereto, remain substantially unchanged following the adoption of this ASU.
|
|
|
|
|
•
|
The adoption of ASU No. 2014-09 requires that we recognize our sales return allowance on a gross basis rather than as a net liability. As such, we now recognize (i) a return asset for the right to recover the goods returned by the customer, measured at the former carrying amount of the goods, less any expected recovery costs (recorded as an increase to prepaid expenses and other current assets), (ii) a return liability for the amount of expected returns (recorded as an increase to other current liabilities) and (iii) deferred revenue for commissions earned on extended protection agreements (recorded as an increase to other current liabilities).
|
We have made accounting policy elections to (1) exclude from the measurement of transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by us from a customer (sales tax, value added tax, etc.) and (2) account for shipping and handling activities performed after a customer obtains control of the good as activities to fulfill the promise to transfer the good.
We applied ASU No. 2014-09 only to contracts that were not completed prior to fiscal 2018. The cumulative effect of initially apply ASU No. 2014-09 was a
$2.1 million
increase to the opening balance of accumulated deficit as of February 4, 2018. The comparative prior period information continues to be reported under the accounting standards in effect during those periods.
The effect of the adoption of ASU No. 2014-09 on our consolidated balance sheet as of
February 2, 2019
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thousands
|
|
As Reported
|
|
ASU 2014-09 Effect
|
|
Excluding ASU 2014-09 Effect
|
|
Prepaid expenses and other current assets
|
|
$
|
9,452
|
|
|
$
|
1,226
|
|
|
$
|
8,226
|
|
|
Other current liabilities
|
|
56,009
|
|
|
3,345
|
|
|
52,664
|
|
|
Accumulated deficit
|
|
(435,649
|
)
|
|
(2,119
|
)
|
|
(433,530
|
)
|
NOTE 2—NET SALES
During 2018, approximately
98%
of our revenues were generated in the United States.
Net merchandise and service sales for 2018 were as follows:
|
|
|
|
|
|
|
|
|
Thousands
|
|
52 Weeks Ended February 2, 2019
|
|
Merchandise
|
|
$
|
1,343,459
|
|
|
Services
|
|
79,969
|
|
|
Other
|
|
26,520
|
|
|
Net sales
|
|
$
|
1,449,948
|
|
NOTE 3—ACCOUNTS AND FRANCHISEE RECEIVABLES AND OTHER ASSETS
Accounts and franchisee receivables and other assets consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
thousands
|
|
February 2, 2019
|
|
February 3, 2018
|
|
Short-term franchisee receivables
|
|
$
|
584
|
|
|
$
|
1,205
|
|
|
Miscellaneous receivables
|
|
11,916
|
|
|
14,314
|
|
|
Long-term franchisee receivables
|
|
1,422
|
|
|
7,962
|
|
|
Other assets
|
|
2,277
|
|
|
5,106
|
|
|
Allowance for losses on short-term franchisee receivables (1)
|
|
(584
|
)
|
|
(847
|
)
|
|
Allowance for losses on long-term franchisee receivables (1)
|
|
(1,422
|
)
|
|
(4,928
|
)
|
|
Total Accounts and franchisee receivables and other assets
|
|
$
|
14,193
|
|
|
$
|
22,812
|
|
(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, 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. As of
February 2, 2019
, all franchisee receivables have been fully reserved.
NOTE 4—ALLOWANCE FOR LOSSES ON FRANCHISEE RECEIVABLES
The allowance for losses on Franchisee Receivables consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
thousands
|
|
February 2, 2019
|
|
February 3, 2018
|
|
Allowance for losses on franchisee receivables, beginning of period
|
|
$
|
5,775
|
|
|
$
|
8,242
|
|
|
Provisions during the period
|
|
2,594
|
|
|
7,361
|
|
|
Write off of franchisee receivables
|
|
(6,363
|
)
|
|
(9,828
|
)
|
|
Allowance for losses on franchisee receivables, end of period
|
|
$
|
2,006
|
|
|
$
|
5,775
|
|
On November 2, 2018, the Company and a franchisee entered into a transaction consisting of agreements that terminated all of the franchisee's franchise agreements and sublease arrangements for
21
franchised locations. The agreements provided that the franchisee transferred ownership of all assets, management of stores, and certain rights to property leases. The assets the Company purchased included all store furniture, fixtures, and equipment. As of the transaction date, the franchisee was the obligor on promissory notes to the Company with a total carrying value, net of reserves, of
$2.7 million
. As part of the transaction, the Company waived the remaining unpaid principal on these promissory notes. During
2018
, the Company recognized a loss of
$2.7 million
on the transaction.
On June 7, 2017, the Company and a franchisee entered into a transaction consisting of agreements that terminated all of the franchisee's franchise agreements and sublease arrangements for
14
franchised 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). The agreements provided that the franchisee transferred ownership of all assets, management of stores, and certain rights to property leases (in one instance pursuant to an Occupancy Agreement). The assets the Company purchased included all store furniture, fixtures, and equipment. As of the transaction date, the franchisee was the obligor on promissory notes to the Company with a total carrying value, net of reserves, of
$5.5 million
. As part of the transaction, the Company waived the remaining unpaid principal on these promissory notes and received a new promissory note from the franchisee in the amount of
$1.5 million
, which is payable in installments through December 11, 2022. During
2017
, the Company recognized a loss of
$5.5 million
on the transaction.
NOTE 5—OTHER CURRENT AND LONG-TERM LIABILITIES
Other current and long-term liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
thousands
|
|
February 2, 2019
|
|
February 3, 2018
|
|
Customer deposits
|
|
$
|
12,826
|
|
|
$
|
16,655
|
|
|
Sales and other taxes
|
|
7,165
|
|
|
9,221
|
|
|
Accrued expenses
|
|
23,097
|
|
|
17,755
|
|
|
Payroll and related items
|
|
12,115
|
|
|
7,140
|
|
|
Store closing and severance costs
|
|
2,645
|
|
|
4,655
|
|
|
Total Other current and long-term liabilities
|
|
$
|
57,848
|
|
|
$
|
55,426
|
|
NOTE 6—INCOME TAXES
In connection with the 2012 Separation, SHO and Transform Holdco, as assignee, are parties to a Tax Sharing Agreement that governs the rights and obligations of the parties with respect to pre-2012 Separation and post-2012 Separation tax matters. Under the Tax Sharing Agreement, Transform Holdco is responsible for any federal, state or foreign income tax liability relating to tax periods ending on or before the 2012 Separation. For all periods after the 2012 Separation, the Company 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 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 the 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. Pursuant to the Tax Sharing Agreement, Transform Holdco is responsible for any unrecognized tax liabilities or benefits through the date of the 2012 Separation and the Company is responsible for any uncertain tax positions after the 2012 Separation. For
2018
and
2017
, no unrecognized tax benefits have been identified and reflected in the 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 consolidated financial statements, no interest or penalties related to unrecognized tax benefits are reflected in the consolidated balance sheets or statements of operations.
The provisions for income tax expense for
2018
and
2017
consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
thousands
|
|
February 2, 2019
|
|
February 3, 2018
|
|
(Loss) income before income taxes:
|
|
|
|
|
|
U.S.
|
|
$
|
(54,629
|
)
|
|
$
|
(96,166
|
)
|
|
Foreign
|
|
1,329
|
|
|
1,613
|
|
|
Total
|
|
$
|
(53,300
|
)
|
|
$
|
(94,553
|
)
|
|
Income tax expense (benefit):
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
Federal
|
|
$
|
(2
|
)
|
|
$
|
2
|
|
|
State
|
|
302
|
|
|
215
|
|
|
Foreign
|
|
(136
|
)
|
|
1,046
|
|
|
Total
|
|
164
|
|
|
1,263
|
|
|
Deferred:
|
|
|
|
|
|
Federal
|
|
—
|
|
|
(759
|
)
|
|
Total
|
|
$
|
—
|
|
|
$
|
(759
|
)
|
|
Income tax expense
|
|
$
|
164
|
|
|
$
|
504
|
|
The provisions for income taxes for financial reporting purposes is different from the tax provision computed by applying the statutory federal tax rate. The reconciliation of the tax rate follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
|
February 2, 2019
|
|
February 3, 2018
|
|
Federal tax rate
|
|
21.0
|
%
|
|
33.7
|
%
|
|
State income tax (net of federal benefit)
|
|
(0.4
|
)%
|
|
(0.2
|
)%
|
|
Federal tax rate change
|
|
—
|
%
|
|
(37.2
|
)%
|
|
Valuation allowance
|
|
(21.0
|
)%
|
|
4.4
|
%
|
|
Foreign taxes
|
|
0.2
|
%
|
|
(1.1
|
)%
|
|
Other
|
|
(0.1
|
)%
|
|
(0.1
|
)%
|
|
Effective tax rate
|
|
(0.3
|
)%
|
|
(0.5
|
)%
|
The major components of the deferred tax assets and liabilities as of
February 2, 2019
and
February 3, 2018
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
thousands
|
February 2, 2019
|
|
February 3, 2018
|
|
Deferred tax assets
|
|
|
Bad debts
|
$
|
855
|
|
|
$
|
1,543
|
|
|
Deferred compensation
|
2,181
|
|
|
756
|
|
|
Net operating loss
|
72,192
|
|
|
54,580
|
|
|
Property
|
647
|
|
|
2,598
|
|
|
Royalty-free license
|
23,587
|
|
|
26,451
|
|
|
Other
|
10,538
|
|
|
7,803
|
|
|
Sub-total deferred tax assets
|
$
|
110,000
|
|
|
$
|
93,731
|
|
|
Valuation allowance
|
(104,978
|
)
|
|
(92,362
|
)
|
|
Total deferred tax assets
|
$
|
5,022
|
|
|
$
|
1,369
|
|
|
Deferred tax liabilities
|
|
|
|
|
Inventory
|
(4,394
|
)
|
|
(730
|
)
|
|
Other
|
(628
|
)
|
|
(639
|
)
|
|
Total deferred tax liabilities
|
(5,022
|
)
|
|
(1,369
|
)
|
|
Net deferred tax assets
|
—
|
|
|
—
|
|
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act made broad and complex changes to the U.S. tax code that affected our fiscal year ended February 3, 2018, including, but not limited to, (1) reducing the U.S. federal corporate tax rate, (2) eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized, and (3) various other miscellaneous changes that were effective in fiscal 2017. The Tax Act reduced the federal corporate tax rate to 21% in the fiscal year ended February 3, 2018. Based on Section 15 of the Internal Revenue Code, our fiscal year ended February 3, 2018 had a blended corporate tax rate of
33.7%
, which is based on the applicable tax rates before and after the Tax Act and the number of days in the year.
The Tax Act also established new tax rules that affect fiscal 2018, including, but not limited to, (1) reduction of the U.S. federal corporate tax rate; (2) the elimination of corporate AMT; (3) a new limitation on deductible interest expense; (4) limitations on the deductibility of certain executive compensation; (5) limitations on the use of FTCs to reduce the U.S. income tax liability; and (6) limitations on net operating losses (NOLs) generated in tax years beginning after December 31, 2017, to 80% of taxable income.
The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
In connection with our initial analysis of the impact of the Tax Act, we have recorded a discrete net tax benefit of
$0.8 million
in the period ended February 3, 2018. This net tax benefit consisted of a reduction in the valuation allowance by
$0.8 million
as a result of the elimination of the AMT credit as a deferred tax asset and corresponding establishment of a long-term receivable.
Our accounting for the following elements of the Tax Act is complete.
The Tax Act reduces the corporate rate to 21%, effective January 1, 2018. Our net deferred tax assets ("DTA") and deferred tax liabilities ("DTL") decreased by
$35.2 million
with a corresponding net adjustment to the valuation allowance for the year ended February 3, 2018. A deferred tax benefit of
$0.8 million
was recorded in the period ended February 3, 2018 as a result of a reduction in the valuation allowance due to the elimination of the AMT credit as a deferred tax asset and corresponding establishment of a long-term receivable. During fiscal 2018, the balance of the receivable was increased $0.2 million due to an IRS adjustment and
related payment of additional AMT associated with a recently completed IRS exam and $0.5 million of the receivable was reclassed to a current asset reflecting the portion expected to be received within 12 months.
We account for income taxes in accordance with accounting standards for such taxes, which require that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the financial reporting and tax bases of recorded assets and liabilities. Accounting standards also require that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion of or all of the deferred tax assets will not be realized.
Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. In performing the assessment for 2018, a significant piece of negative evidence evaluated was the cumulative loss incurred over the three-year period ended
February 2, 2019
. The loss was evaluated as book loss adjusted for non-deductible and non-recurring items such as goodwill impairment, sale of property, store closing costs, franchise income/expense and software expenses. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth.
On the basis of this analysis and significant negative objective evidence, management has determined the full valuation allowance is still necessary for the year ended
February 2, 2019
. The valuation allowance increased by
$12.6 million
for the current year which was offset by the increase in net DTAs mainly for the increase in operating loss carryover. As of February 2, 2019, a valuation allowance of
$105.0 million
is recorded for the full amount of the net deferred tax assets. Changes in the valuation allowance are recorded as a non-cash charge to income tax expense. A valuation allowance release resulted in a tax benefit of
$0.8 million
in the year ended February 3, 2018 due to the elimination of the AMT DTA and corresponding establishment of a long term receivable. We will continue to evaluate our valuation allowance in future years for any change in circumstances that causes a change in judgment about the realizability of the deferred tax assets.
At the end of
2018
and
2017
, we had federal net operating loss carryforwards (“NOL”) of
$281.1 million
and
$210.7 million
, respectively, which will expire between 2036 and 2038 though the 2018 NOL has an indefinite life. At the end of
2018
and
2017
, we had state NOL carryforwards of
$16.6 million
and
$13.1 million
, respectively, which will expire between 2019 and 2039 though some of the 2018 state NOLs have an indefinite life. We have credit carryforwards of
$3.3 million
which will expire between 2023 and 2039.
We file federal, state and city income tax returns in the United States and foreign tax returns in Puerto Rico. SHO was also a part of the Sears Holdings combined state returns for the years ended February 2, 2013 and February 1, 2014. The Company has completed its federal audit for the tax return ended January 30, 2016 and all matters have been resolved. Currently, the Company is under audit for two separate state returns for fiscal years 2013 through 2016.
NOTE 7—RELATED-PARTY AGREEMENTS AND TRANSACTIONS
According to publicly available information, ESL Investments, Inc. and its investment affiliates including Edward S. Lampert (together, "ESL") beneficially own
58.8%
of our outstanding shares of common stock and control Transform Holdco and its subsidiaries.
The Operative Agreements, among other things, (1) govern specified aspects of our relationship with Transform Holdco (as assignee of the Operative Agreements), (2) establish terms under which subsidiaries of Transform Holdco are providing services to us, and (3) establish terms pursuant to which subsidiaries of Transform Holdco are obtaining merchandise inventories for us. The terms of the Operative Agreements were agreed to prior to the 2012 Separation (except for amendments entered into after the 2012 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 2012 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 Operative Agreements, the business relationships that are reflected in the Operative Agreements, and the details of these business relationships, many of which details had not been addressed by the terms and conditions of the Operative 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 the Company's best interests. On May 11, 2016, SHO and Sears Holdings entered into amendments to most of the Operative Agreements.
The following is a summary of the nature of the principle related-party transactions between SHO and Transform Holdco (as assignee of the Operative Agreements):
|
|
|
|
•
|
We are party to an agreement with Transform Holdco (as assignee from Sears Holdings) pursuant to which Sears Holdings consummated the 2012 Separation. The agreement, among other things, provided for as part of the 2012 Separation the allocation and transfer, through a series of intercompany transactions, of the assets and the liabilities comprising the Sears Hometown and Hardware and Sears Outlet businesses of Sears Holdings. In the agreement SHO and Transform Holdco agree to release each other from all pre-2012 Separation claims (other than with respect to the agreements executed in connection with the 2012 Separation) and each agrees to defend and indemnify the other with respect to its post-2012 Separation business.
|
|
|
|
|
•
|
We obtain a significant amount of our merchandise inventories from Transform Holdco. This enables us to take advantage of the amount and scope of Transform Holdco's purchasing activities. The Operative Agreements include an Amended and Restated Merchandising Agreement with subsidiaries of Transform Holdco (the "Merchandising Agreement") pursuant to which they (1) sell to us, with respect to certain specified product categories, Sears-branded products including KCD Products and vendor-branded products obtained from Transform Holdco's vendors and suppliers and (2) grant us licenses to use the trademarks owned by subsidiaries of Transform Holdco, or the "Sears marks," including the KCD Marks in connection with the marketing and sale of products sold under the Sears marks. The initial term of the Merchandising Agreement will expire on February 1, 2023, subject to
one
three
-year renewal term with respect to the KCD Products. We pay, on a weekly basis, a royalty determined by multiplying our net sales of the KCD Products by specified fixed royalties rates for each brand’s licensed products, subject to adjustments based on the extent to which we feature Kenmore brand products in certain of our advertising and the extent to which we pay specified minimum commissions to our franchisees and Hometown Store owners. The Operative Agreements also provide for related logistics, handling, warehouse and transportation services, the charges for which are based generally on merchandise inventory units. We also pay fees for participation in Transform Holdco's Shop Your Way program.
|
|
|
|
|
•
|
We obtain our merchandise from Transform Holdco and other vendors. Products which we acquired from Transform Holdco, including KCD Products and other products, accounted for approximately
60%
and
78%
of our total purchases of inventory from all vendors for
2018
and
2017
, respectively. The loss of or a reduction in the amount of merchandise made available to us by Transform Holdco could have a material adverse effect on our business and results of operations.
|
|
|
|
|
•
|
Transform Holdco (as assignee from Sears Holdings) provides the Company with specified corporate services pursuant to the Operative Agreements. These services include tax, accounting, procurement, risk management and insurance, advertising and marketing, loss prevention, environmental, product and human safety, facilities, logistics and distribution, information technology (including the point-of-sale system used by the Company and our dealers and franchisees), online, payment clearing, and other financial, real estate management, merchandise-related and other support services. Transform Holdco charges the Company for these corporate services generally based on actual usage, a pro rata charge based upon sales, head count, or square footage, or a fixed fee or commission as agreed between the parties.
|
|
|
|
|
•
|
Transform Holdco (as assignee from Sears Holdings) has licensed the Company until October 11, 2029, on a royalty-free basis, to use under specified conditions (1) the name "Sears" in our corporate name and to promote our businesses and (2) the www.SearsOutlet.com (our license to use "SearsOutlet.com" on a web platform not operated by Transform Holdco will expire on February 1, 2023), www.searshomeapplianceshowroom.com, www.searshometownstores.com, and www.searshardwarestores.com domain names to promote our businesses. Also, Transform Holdco has licensed the Company until October 11, 2029, on an exclusive, royalty-free basis, under specified conditions to use for the purpose of operating our stores the names "Sears Appliance & Hardware," "Sears Authorized Hometown Stores," "Sears Hometown Store," "Sears Home Appliance Showroom," "Sears Hardware," and "Sears Outlet Store."
|
|
|
|
|
•
|
Transform Holdco (as assignee from Sears Holdings) has assigned to us leases for, or has subleased to us, many of the stores that we operate or that we have, in turn, subleased to franchisees. Generally, the terms of the subleases match the terms, including the payment of rent and expiration date, of the existing leases between Transform Holdco (or one of its subsidiaries) and the landlord. In addition, a small number of our stores are in locations where Transform Holdco currently operates one of its stores or a distribution facility. In such cases we have entered into a lease or sublease with Transform Holdco (or one of its subsidiaries) for the portion of the space in which our store will operate, and we pay rent directly to Transform Holdco on the terms negotiated in connection with the 2012 Separation. We also lease from Transform Holdco office space for our corporate headquarters.
|
|
|
|
|
•
|
SHO receives commissions from Transform Holdco for specified sales of merchandise made through www.sears.com and www.SearsOutlet.com, the sale of extended-service plans, delivery and handling services and relating to the use in our stores of credit cards branded with the Sears name. For certain transactions SHO pays a commission to Transform Holdco.
|
The Operative Agreements may be terminated by either party upon a material breach if the breaching party fails to cure such breach within 30 days following written notice of such breach or, if such breach is not curable, immediately upon delivery of notice of the non-breaching party’s intention to terminate.
The following table summarizes the transactions with Sears Holdings included in the Company’s Consolidated Financial Statements:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
thousands
|
|
February 2, 2019
|
|
February 3, 2018
|
|
Net Commissions from Sears Holdings
|
|
$
|
50,964
|
|
|
$
|
66,557
|
|
|
Purchases related to cost of sales and occupancy
|
|
689,599
|
|
|
958,560
|
|
|
Services included in selling and administrative
|
|
40,027
|
|
|
60,822
|
|
We incur payables to Transform Holdco (and incurred payables to Sears Holdings prior to mid-February 2019) for merchandise inventory purchases and service and occupancy charges (net of commissions) based on the Operative Agreements. Amounts due to or from Transform Holdco 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. In accordance with the Operative Agreements and at the request of Transform Holdco, the Company can pay invoices on
two
or
three
-day terms and receive a deduction on invoices for early–payment discounts of
43
basis points or
37
basis points, respectively. The Company can, in its sole discretion, revert to
ten
–day, no–discount payment terms at any time upon notice to Transform Holdco. The discount received for payments made on accelerated terms, net of incremental interest expense, results in a net financial benefit to the Company. The Company paid invoices on either
two
or
three
–day terms and received discounts of
$2.1 million
and
$4.2 million
in
2018
and
2017
, respectively, which are reflected in the consolidated statements of operations.
We paid Seritage Growth Properties
$0.6 million
and
$1.1 million
in
2018
and
2017
, respectively, for occupancy charges for properties we lease from Seritage. Edward S. Lampert is the Chairman of the Board of Trustees of Seritage.
NOTE 8—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 2012 Separation.
On November 1, 2016, the Company and its primary operating subsidiaries, 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 of specified lenders in an aggregate amount equal to
$170 million
(the “Extended Revolving Credit Commitments”) and non-extended revolving credit commitments of specified lenders 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 the Operative Agreements entered into with Transform Holdco as assignee and its subsidiaries in connection with the 2012 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 were not extended by the Non-Extending Lenders in accordance with the Senior ABL Facility and matured on October 11, 2017. Unamortized debt costs related to the Senior ABL Facility of
$1.3 million
and
$3.5 million
are included in Prepaid and Other current assets on the Consolidated Balance Sheets as of
February 2, 2019
and
February 3, 2018
, respectively, and are being amortized over the remaining term of the Senior ABL Facility.
As of
February 2, 2019
we had
$93.0 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
February 2, 2019
was
$27.7 million
, with
$7.2 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).
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
3.50%
to
4.50%
, (the rate was approximately
6.50%
at February 2, 2019), and in each case based on availability under the Senior ABL Facility, or (2) an alternate base rate plus a borrowing margin, ranging from
2.50%
to
3.50%
(the rate was approximately
8.5%
at February 2, 2019), and in each case based on availability under the Senior ABL Facility.
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). The Senior ABL Facility also imposes various other requirements, which take effect if availability falls below designated thresholds, including a cash dominion requirement with additional borrowing base reporting requirements in addition to a requirement that the fixed charge ratio at the last day of any quarter be not less than
1.0
to
1.0
. The Senior ABL Facility also limits SHO’s ability to declare and pay cash dividends and to repurchase its common stock. The Senior ABL Facility would not have permitted us to pay cash dividends or to repurchase our common stock as of
February 2, 2019
. The Senior ABL Facility also contains affirmative covenants, including financial and other reporting requirements.
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 the Merchandising Agreement and other Operative 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 Transform Holdco terminates the "Separation Agreements" (which include, among other Operative Agreements, the Merchandising Agreement and the Services Agreements).
The Senior ABL Facility provides that the Company's inability to obtain from its independent registered public accounting firm a report and opinion that "shall not be subject to any 'going concern' or like qualification or exception" constitutes an event of default, which would give the Senior ABL Facility lenders the right to accelerate the maturity of all outstanding loans, among other actions. The Senior ABL Facility lenders have waived through October 31, 2019 any default resulting from the Going Concern Uncertainty.
Term Loan Agreement
On February 16, 2018 the Company’s
three
operating subsidiaries, Sears Authorized Hometown Stores, LLC, Sears Home Appliance Showrooms, LLC, and Sears Outlet Stores, LLC, as borrowers, and the Company, as guarantor, entered into a Term Loan Credit Agreement with Gordon Brothers Finance Company, as agent, lead arranger, and sole bookrunner, and Gordon Brothers Finance Company, LLC, as lender (the “Term Loan Agreement”). The Term Loan Agreement provides for a
$40 million
term loan (the “Term Loan”), which amount the Company has borrowed, and is outstanding, in accordance with and subject to the terms and conditions of the Term Loan Agreement. The Company used the proceeds of the Term Loan to pay down borrowings under the Senior ABL Facility. The Term Loan will mature on the earliest of (1) the maturity date specified in the Senior ABL Facility, (2) February 16, 2023, and (3) acceleration of the maturity date following an event of default in accordance with the Term Loan Agreement.
Unamortized debt costs of
$0.9 million
related to the Term Loan are netted against the Term Loan on the Consolidated Balance Sheets as of
February 2, 2019
and are being amortized over the remaining term of the Term Loan.
The principal terms of the Term Loan Agreement are summarized below.
Security and Guarantees
The Term Loan Agreement is secured by a second lien security interest (subordinate only to the liens securing the Senior ABL Facility) on substantially all the assets of the Company and its subsidiaries (the same assets as the assets securing the Senior ABL Facility), including without limitation accounts receivable, inventory, general intangibles, investment property, equipment, cash, cash equivalents, deposit accounts and securities accounts, as well as 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 Term Loan Agreement is guaranteed by the Company and each of its existing and future direct and indirect wholly owned domestic subsidiaries (other than specified immaterial subsidiaries).
Prepayments
The Term Loan is subject to mandatory prepayment in amounts equal to the amount by which the outstanding Term Loan exceeds the borrowing base specified in the Term Loan Agreement plus a reserve to be maintained against the borrowing base for the Senior ABL Facility (the “push-down reserve”), which reserve will be equal to total outstandings under the Term Loan Agreement that exceed the Term Loan Agreement’s borrowing base, if such excess were to arise. If any additional reserves are imposed by the Senior ABL Facility agent against the borrowing base under the Senior ABL Facility or if, under certain circumstances, the agent under the Term Loan imposes reserves against the borrowing base under the Term Loan Agreement, the Company may be required to make additional prepayments under the Term Loan. The Company may not reborrow amounts prepaid.
Interest; Fees
The interest rate applicable to the Term Loan under the Term Loan Agreement is a fluctuating rate of interest (payable and adjusted monthly) equal to the greater of (1) three-month LIBOR (the rate was approximately
2.73%
at
February 2, 2019
) plus
8.50%
per annum and (2) a minimum interest rate of
9.50%
per annum.
Customary fees are payable in respect of the Term Loan Agreement, including a commitment fee and an early prepayment fee.
Covenants
The Term Loan Agreement includes a number of negative covenants that, among other things, limit or restrict the ability of the Company, the Borrowers, and the Company’s other subsidiaries to, subject to exceptions, incur additional indebtedness (including guarantees), grant liens, make investments, make dividends or other distributions with respect to, or repurchase, the Company’s capital stock, make prepayments on other indebtedness, engage in mergers, or change the nature of the business.
In addition, upon excess availability falling below a specified level or the occurrence of an event of default the Company would be subject to a cash dominion requirement.
The Term Loan Agreement also provides that the Borrowers will not permit availability under the Term Loan Agreement and the Senior ABL Facility to be less than
10%
of a combined loan cap.
The Term Loan Agreement also contains affirmative covenants including, among others, financial and other reporting and notification requirements, maintenance of properties, inspection rights, and physical inventories. The Company and the Borrowers also agree that the Company and the Borrowers will cause the push-down reserve to be established and maintained when and if required by the Term Loan Agreement. The Term Loan Agreement borrowing base generally means specified amounts of credit card receivables and inventory (net of reserves), minus the loan cap for the Senior ABL Facility and availability reserves.
The borrowing base under the Term Loan Agreement may be further reduced if the agent under the Senior ABL Facility or, under certain circumstances, the agent under the Term Loan elects in their respective applicable discretion to impose additional reserves against the borrowing base under the Senior ABL Facility or the Term Loan.
Events of Default
The Term Loan Agreement includes customary events of default including non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations or warranties in any material respect, cross default to the Senior ABL Facility and other material indebtedness, bankruptcy and insolvency events, invalidity or impairment of the Term Loan Agreement and the other related loan documents (including the guarantees or security interests provided therein and other Term Loan loan documents (including an agreement with the Company, Transform Holdco, and the agents under the Senior ABL Facility and the Term Loan Agreement)), material judgments, change of control, and failure to perform a “Material Contract” (which includes specified Operative Agreements) to the extent required to maintain it in full force and effect, failure to enforce a Material Contract in accordance with its terms, or termination (including as a result of rejection in an insolvency proceeding) by Transform Holdco of "the Separation Agreements” (which include specified Operative Agreements) and cessation of business activities in the ordinary course.
The Term Loan Agreement provides that the Company's inability to obtain from its independent registered public accounting firm a report and opinion that "shall not be subject to any 'going concern' or like qualification or exception" constitutes an event of default, which would give the Term Loan Agreement lenders the right to accelerate the maturity of all outstanding loans, among other actions. The Term Loan Agreement lenders have waived through October 31, 2019 any default resulting from the Going Concern Uncertainty.
NOTE 9—SUMMARY OF SEGMENT DATA
Our two reportable segments are Hometown and Outlet. The Hometown reportable segment consists of the aggregation of our Hometown Stores, Hardware Stores, Home Appliance Showrooms and Buddy's Home Furnishings Stores business formats. The Outlet business format also represents a reportable segment. 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 other.
Selling and administrative expense includes losses on franchisee notes receivables and IT transformation costs of
$17.7 million
and
$22.6 million
for Hometown in
2018
and
2017
, respectively, and
$10.8 million
and
$19.1 million
for Outlet in
2018
and
2017
, respectively. Costs associated with accelerated store closings totaling
$13.4 million
in 2018 (
$13.7 million
in Hometown;
$(0.3) million
in Outlet) and
$14.8 million
in 2017 (
$7.0 million
in Hometown;
$7.8 million
in Outlet), were included in Cost of sales and occupancy and Selling and administrative expense.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
thousands
|
|
Hometown
|
|
Outlet
|
|
Total
|
|
Net sales
|
|
|
|
|
|
|
|
Appliances
|
|
$
|
659,401
|
|
|
$
|
406,233
|
|
|
$
|
1,065,634
|
|
|
Lawn and garden
|
|
169,012
|
|
|
16,846
|
|
|
185,858
|
|
|
Tools and paint
|
|
79,313
|
|
|
12,989
|
|
|
92,302
|
|
|
Other
|
|
50,792
|
|
|
55,362
|
|
|
106,154
|
|
|
Total
|
|
958,518
|
|
|
491,430
|
|
|
1,449,948
|
|
|
Costs and expenses
|
|
|
|
|
|
|
|
Cost of sales and occupancy
|
|
768,624
|
|
|
358,128
|
|
|
1,126,752
|
|
|
Selling and administrative
|
|
240,955
|
|
|
108,127
|
|
|
349,082
|
|
|
Impairment of property and equipment
|
|
1,007
|
|
|
1,082
|
|
|
2,089
|
|
|
Depreciation and amortization
|
|
6,263
|
|
|
6,111
|
|
|
12,374
|
|
|
Gain on sale of assets
|
|
—
|
|
|
(1,358
|
)
|
|
(1,358
|
)
|
|
Total
|
|
1,016,849
|
|
|
472,090
|
|
|
1,488,939
|
|
|
Operating (loss) income
|
|
$
|
(58,331
|
)
|
|
$
|
19,340
|
|
|
$
|
(38,991
|
)
|
|
Total assets
|
|
$
|
225,919
|
|
|
$
|
117,852
|
|
|
$
|
343,771
|
|
|
Capital expenditures
|
|
$
|
4,812
|
|
|
$
|
1,626
|
|
|
$
|
6,438
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
thousands
|
|
Hometown
|
|
Outlet
|
|
Total
|
|
Net sales
|
|
|
|
|
|
|
|
Appliances
|
|
$
|
805,490
|
|
|
$
|
446,118
|
|
|
$
|
1,251,608
|
|
|
Lawn and garden
|
|
204,371
|
|
|
19,024
|
|
|
223,395
|
|
|
Tools and paint
|
|
103,706
|
|
|
14,289
|
|
|
117,995
|
|
|
Other
|
|
63,655
|
|
|
63,298
|
|
|
126,953
|
|
|
Total
|
|
1,177,222
|
|
|
542,729
|
|
|
1,719,951
|
|
|
Costs and expenses
|
|
|
|
|
|
|
|
Cost of sales and occupancy
|
|
931,078
|
|
|
440,330
|
|
|
1,371,408
|
|
|
Selling and administrative
|
|
283,294
|
|
|
136,273
|
|
|
419,567
|
|
|
Impairment of property and equipment
|
|
2,581
|
|
|
776
|
|
|
3,357
|
|
|
Depreciation and amortization
|
|
5,378
|
|
|
7,661
|
|
|
13,039
|
|
|
Total
|
|
1,222,331
|
|
|
585,040
|
|
|
1,807,371
|
|
|
Operating loss
|
|
$
|
(45,109
|
)
|
|
$
|
(42,311
|
)
|
|
$
|
(87,420
|
)
|
|
Total assets
|
|
$
|
281,805
|
|
|
$
|
130,883
|
|
|
$
|
412,688
|
|
|
Capital expenditures
|
|
$
|
4,156
|
|
|
$
|
5,072
|
|
|
$
|
9,228
|
|
NOTE 10—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 and in the aggregate, in the opinion of management, would not have a material adverse effect on our business, financial position, or results of operations, or cash flows.
NOTE 11—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. Diluted income per common share also includes the dilutive effect of potential common shares. In 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
thousands except income per common share
|
February 2, 2019
|
|
February 3, 2018
|
|
Basic weighted average shares
|
22,702
|
|
|
22,702
|
|
|
Dilutive effect of restricted stock
|
—
|
|
|
—
|
|
|
Diluted weighted average shares
|
22,702
|
|
|
22,702
|
|
|
|
|
|
|
|
Net loss
|
$
|
(53,464
|
)
|
|
$
|
(95,057
|
)
|
|
|
|
|
|
|
Loss per common share:
|
|
|
|
|
Basic
|
$
|
(2.36
|
)
|
|
$
|
(4.19
|
)
|
|
Diluted
|
$
|
(2.36
|
)
|
|
$
|
(4.19
|
)
|
For 2017, unvested shares of restricted stock of
14,000
were excluded from diluted earnings per share through the date of forfeiture. There were
no
unvested shares of restricted stock that were excluded from diluted earnings per share in 2018.
NOTE 12 — EQUITY
Stock-based Compensation
Under our stock-based employee compensation plan, referred to as the Company's Amended and Restated 2012 Stock Plan (the "Plan"), there are
four million
shares of stock reserved for issuance pursuant to the Plan. We are authorized to grant stock options and to make other awards (in addition to restricted stock and stock units) pursuant to the Plan. The Company has made no stock-option awards under the Plan.
A total of
14,000
shares of restricted stock were granted under the Plan to an eligible individual in the second quarter of 2015 and were forfeited in the first quarter of 2017.
During 2015 the Company granted a total of
159,475
stock units under the Plan, which were payable solely in cash based on the Nasdaq stock price on the vesting date. As of
February 2, 2019
,
34,091
of these stock units had been forfeited and the remaining
125,384
stock units vested in accordance with, and subject to the terms and conditions of, governing stock-unit agreements and the Plan.
During 2017 the Company granted a total of
262,788
stock units under the Plan, which were payable solely in cash based on the Nasdaq stock price on the vesting dates. As of
February 2, 2019
,
46,834
of these stock units had been forfeited and
149,748
had vested. The remaining
66,206
stock units will vest, if at all, on January 30, 2020 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 vary based on changes in our Nasdaq stock price at the end of each reporting period.
On January 18, 2018 the Company granted a total of
361,393
stock units under the Plan, which were payable solely in cash based on the Nasdaq stock price on the vesting dates. As of February 2, 2019,
22,514
of these stock units had been forfeited and
116,224
had vested. The remaining
222,655
stock units will vest, if at all, in two substantially equal installments on January 30 in 2020 and 2021 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 vary based on changes in our Nasdaq stock price at the end of each reporting period.
The shares of restricted stock referred to above in this Note 12 constituted outstanding shares of the Company's common stock. The recipients of the restricted stock grants had 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 12, which were, and 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. 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 2018 no stock-based compensation expense was recorded and during 2017 we reversed
$0.1 million
in total stock-based compensation expense related to the forfeiture of unvested restricted stock.
During 2018 and 2017, we recorded
$0.7 million
and
$0.3 million
, respectively, in compensation cost related to the then outstanding stock units, which are included in Selling and administrative expenses in the consolidated statements of operations and Other current liabilities in the consolidated balance sheets. At
February 2, 2019
, we had
$0.3 million
in total estimated unrecognized compensation cost related to the remaining non-vested stock units, which cost we expect to recognize over the next approximately
2.0 years
.
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. Shares that are repurchased by the Company pursuant to the repurchase program would be retired and would resume the status of authorized and unissued shares of common stock.
At
February 2, 2019
, we had
$12.5 million
of remaining authorization under the repurchase program. The Company has not repurchased any shares under the repurchase plan program since late 2013. The Senior ABL Facility and Term Loan Agreement each limits the Company's ability to declare and pay cash dividends and to repurchase its common stock and each would not have permitted the Company to pay cash dividends or to repurchase its common stock as of February 2, 2019.
NOTE 13—DEFINED CONTRIBUTION PLAN
We sponsor a Sears Hometown and Outlet Stores, Inc. 401(k) savings plan for employees meeting service-eligibility requirements. The Company offers a discretionary matching contribution. The expense related to the savings plan has been determined in accordance with U.S. GAAP and the Company accrues the cost of these benefits as incurred during employees' tenure of employment.
Expenses for the retirement savings plan were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
thousands
|
|
2018
|
|
2017
|
|
401(k) Savings Plan
|
|
$
|
1,258
|
|
|
$
|
1,056
|
|
NOTE 14—SALE OF ASSETS
On August 10, 2018, we completed the sale of a property in Newington, Connecticut. The sale price of the property was
$2.8 million
net of closing costs, and we recorded a gain on the sale of approximately
$1.4 million
when the sale was completed in accordance with the terms and conditions of the Purchase and Sale Agreement. We did not sell any owned property in fiscal 2017.
NOTE 15—STORE CLOSING CHARGES
Accelerated Closed Store Charges
In accordance with accounting standards governing costs associated with exit or disposal activities, expenses related to future rent payments for which we no longer expect to receive any economic benefit are accrued as of when we ceased to use the leased space and have been reduced for estimated sublease income. Accelerated store closure costs were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thousands
|
Lease Termination Costs (1)
|
|
Inventory Related (1)
|
|
Accelerated Depreciation (2)
|
|
Other Charges (3)
|
|
Total Store Closing Costs
|
|
Fiscal year ended February 2, 2019
|
$
|
237
|
|
|
$
|
11,730
|
|
|
$
|
1,431
|
|
|
$
|
1,425
|
|
|
$
|
14,823
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thousands
|
Lease Termination Costs (1)
|
|
Inventory Related (1)
|
|
Accelerated Depreciation (2)
|
|
Other Charges (3)
|
|
Total Store Closing Costs
|
|
Fiscal year ended February 3, 2018
|
$
|
9,665
|
|
|
$
|
4,527
|
|
|
$
|
979
|
|
|
$
|
224
|
|
|
$
|
15,395
|
|
|
|
|
|
|
|
(1)
|
Recorded within cost of sales and occupancy in the Condensed Consolidated Statements of Operations. Lease termination costs are net of estimated sublease income, and include the reversal of closed store reserves when a lease agreement is terminated for an amount less than the remaining reserve established for the store.
|
|
(2)
|
Recorded within depreciation and amortization in the Condensed Consolidated Statements of Operations.
|
|
(3)
|
Recorded within selling and administrative in the Condensed Consolidated Statements of Operations.
|
Closed Store Reserves
Store closing reserves of
$2.6 million
and
$4.7 million
are included within other current liabilities in the Consolidated Balance Sheets at
February 2, 2019
and
February 3, 2018
, respectively. Changes in the store closing reserves are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
52 and 53 Weeks Ended
|
|
Thousands
|
|
February 2, 2019
|
|
February 3, 2018
|
|
Store closing and severance costs reserve, beginning of period
|
|
$
|
4,655
|
|
|
$
|
7,659
|
|
|
Store closing costs
|
|
13,392
|
|
|
14,416
|
|
|
Payments/utilization
|
|
(15,414
|
)
|
|
(17,420
|
)
|
|
Store closing and severance costs reserve, end of period
|
|
$
|
2,633
|
|
|
$
|
4,655
|
|
NOTE 16—SUBSEQUENT EVENTS
On March 25, 2019 the Company completed the sale of a property classified as held for sale included in Property and Equipment, Net in the Condensed Consolidated Balance Sheet as of
February 2, 2019
. The sale price of the property was
$0.9 million
net of closing costs, and the carrying value of the asset was
$0.9 million
as of February 2, 2019.
The Company expects
40
to
45
Hometown stores will close or initiate closure in the first quarter of 2019 as a result of decisions by dealers and franchisees and the Company's decision to close a limited number of Company-operated stores. Based on the Company's prior experience, this likely will result in reduced costs, more productive use of capital, and improved profitability for the Company. The closures, if they occur as anticipated, are expected to result in total one-time charges of between
$5.0 million
and
$6.0 million
during the first quarter of 2019 for inventory markdowns and write-offs and other store-closing costs.
On May 3, 2019 the Company entered into (i) a First Amendment to Amended and Restated Credit Agreement (the “ABL Amendment”), among Sears Authorized Hometown Stores, LLC, as the Lead Borrower, Sears Home Appliance Showrooms, LLC and Sears Outlet Stores, L.L.C., as borrowers (collectively, the “Borrowers”), the Company, as parent, Bank of America, N.A., as administrative agent and collateral agent (in such capacities, the “ABL Agent”), and the ABL lenders party thereto, amending the Amended and Restated Credit Agreement dated as of November 1, 2016 among the Borrowers, the Company, the ABL Agent and the ABL lenders party thereto from time to time (the “ABL Credit Agreement”), and (ii) the First Amendment to Term Loan Credit Agreement (the “Term Loan Amendment”), among the Borrowers, the Company, as parent, Gordon Brothers Finance Company, as administrative agent and collateral agent (the "Term Agent"), and the Term lenders party thereto, amending the Term Loan Credit Agreement dated as of February 16, 2018 among the Borrowers, the Company, the Term Agent and the Term Lenders party thereto (the “Term Loan Agreement”).
The ABL Amendment and the Term Loan Amendment generally provide for the following, among other things: (1) the definition of “Change of Control” is amended to provide that a Change of Control occurs if the Permitted Holders (as defined in the ABL Credit Agreement and the Term Loan Agreement) beneficially own more than
75.0%
of the Company’s common stock; (2) under specified conditions cash in excess of
$2.0 million
must be applied to pay amounts outstanding under the ABL Credit Agreement and the Term Loan Agreement under specified circumstances; (3) the ABL lenders and the Term lenders waive until October 31, 2019 any default arising as a result of the Going Concern Uncertainty; and (4) the ABL lenders and the Term lenders consent on a limited basis to the Loan Parties (as defined in the ABL Credit Agreement and the Term Loan Agreement) negotiating and entering into specified acquisitions with Permitted Holders upon compliance with specified conditions, including a requirement that the acquisition agreement must contain a condition precedent to the closing of the acquisition requiring payment in full in cash of all outstanding loans under the ABL Credit Agreement and the Term Loan Agreement. The Term Loan Amendment changes the "February 16, 2023" reference in the definition of "Maturity Date" to February 29, 2020.