Form 10-Q SEARS HOMETOWN & OUTLET For: Oct 31

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December 4, 2015 6:06 AM EST

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549 
_______________________________________________
FORM 10-Q
_______________________________________________ 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2015
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-35641 
_______________________________________________
SEARS HOMETOWN AND OUTLET STORES, INC.
(Exact Name of Registrant as Specified in Its Charter)
_______________________________________________
DELAWARE
 
80-0808358
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
 
5500 TRILLIUM BOULEVARD, SUITE 501 HOFFMAN ESTATES, ILLINOIS
 
60192
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (847) 286-7000 
_______________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past
90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
¨ 
  
Accelerated filer
 
ý
 
 
 
 
Non-accelerated filer (Do not check if a smaller reporting company)
 
¨
  
Smaller reporting company
 
¨ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of December 1, 2015, the registrant had 22,721,560 shares of common stock, par value $0.01 per share, outstanding.
 


SEARS HOMETOWN AND OUTLET STORES, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014
 
 
 
 
 
Page
 
 
PART I—FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II—OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 5.
 
 
 
Item 6.



SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
 
 
 
13 Weeks Ended
 
39 Weeks Ended
Thousands, except per share amounts
 
October 31,
2015
 
November 1,
2014
 
October 31,
2015
 
November 1,
2014
NET SALES
 
$
547,143

 
$
565,147

 
$
1,749,522

 
$
1,793,694

COSTS AND EXPENSES
 
 
 
 
 
 
 
 
Cost of sales and occupancy
 
429,361

 
430,085

 
1,350,021

 
1,367,644

Selling and administrative
 
123,030

 
139,766

 
393,755

 
414,271

Impairment of goodwill
 
—

 
167,000

 
—

 
167,000

Depreciation
 
2,221

 
2,035

 
6,246

 
6,390

Gain on the sale of assets
 
—

 
(155
)
 
—

 
(155
)
Total costs and expenses
 
554,612

 
738,731

 
1,750,022

 
1,955,150

Operating loss
 
(7,469
)
 
(173,584
)
 
(500
)
 
(161,456
)
Interest expense
 
(587
)
 
(915
)
 
(1,982
)
 
(2,754
)
Other income
 
721

 
888

 
1,963

 
2,366

Loss before income taxes
 
(7,335
)
 
(173,611
)
 
(519
)
 
(161,844
)
Income tax benefit (expense)
 
3,517

 
2,401

 
361

 
(2,327
)
NET LOSS
 
$
(3,818
)
 
$
(171,210
)
 
$
(158
)
 
$
(164,171
)
 
 
 
 
 
 
 
 
 
NET LOSS PER COMMON SHARE
 
 
 
 
 
 
 
 
ATTRIBUTABLE TO STOCKHOLDERS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic:
 
$
(0.17
)
 
$
(7.55
)
 
$
(0.01
)
 
$
(7.24
)
Diluted:
 
$
(0.17
)
 
$
(7.55
)
 
$
(0.01
)
 
$
(7.24
)
 
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
22,666

 
22,666

 
22,666

 
22,666

Diluted weighted average common shares outstanding
 
22,666

 
22,666

 
22,666

 
22,666

See Notes to Condensed Consolidated Financial Statements.


1

SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
Thousands
 
October 31,
2015
 
November 1,
2014
 
January 31,
2015
ASSETS
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
Cash and cash equivalents
 
$
22,139

 
$
23,189

 
$
19,746

Accounts and franchisee receivables, net
 
18,293

 
20,930

 
15,456

Merchandise inventories
 
448,443

 
462,226

 
442,743

Prepaid expenses and other current assets
 
17,187

 
17,893

 
19,350

Total current assets
 
506,062

 
524,238

 
497,295

PROPERTY AND EQUIPMENT, net
 
59,207

 
50,454

 
50,708

GOODWILL
 
—

 
—

 
—

LONG-TERM DEFERRED TAXES
 
52,652

 
47,359

 
54,273

OTHER ASSETS, net
 
42,337

 
41,185

 
43,446

TOTAL ASSETS
 
$
660,258

 
$
663,236

 
$
645,722

LIABILITIES
 
 
 
 
 
 
CURRENT LIABILITIES
 
 
 
 
 
 
Short-term borrowings
 
$
47,400

 
$
73,200

 
$
84,100

Payable to Sears Holdings Corporation
 
81,422

 
79,940

 
61,089

Accounts payable
 
45,558

 
20,238

 
14,888

Other current liabilities
 
61,554

 
60,079

 
60,938

Current portion of capital lease obligations
 
141

 
75

 
147

Total current liabilities
 
236,075

 
233,532

 
221,162

CAPITAL LEASE OBLIGATIONS
 
182

 
136

 
176

OTHER LONG-TERM LIABILITIES
 
2,109

 
2,908

 
2,098

TOTAL LIABILITIES
 
238,366

 
236,576

 
223,436

COMMITMENTS AND CONTINGENCIES (Note 10)
 

 

 

STOCKHOLDERS' EQUITY
 
 
 
 
 
 
TOTAL STOCKHOLDERS' EQUITY
 
421,892

 
426,660

 
422,286

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
660,258

 
$
663,236

 
$
645,722

See Notes to Condensed Consolidated Financial Statements.


2

SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
 
39 Weeks Ended
Thousands
 
October 31,
2015
 
November 1,
2014
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
Net loss
 
$
(158
)
 
$
(164,171
)
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation
 
6,246

 
6,390

Share-based compensation
 
(236
)
 
606

Gain on the sale of assets
 
—

 
(155
)
Impairment of goodwill
 
—

 
167,000

Provision for losses on franchisee receivables
 
486

 
11,526

Change in operating assets and liabilities:
 
 
 
 
Accounts and franchisee receivables
 
(2,707
)
 
(14,517
)
Merchandise inventories
 
(5,700
)
 
19,881

Payable to Sears Holdings Corporation
 
20,333

 
11,544

Accounts payable
 
30,670

 
(3,891
)
Customer deposits
 
(3,130
)
 
(3,225
)
Deferred income taxes
 
4,150

 
785

Other operating assets
 
(1,191
)
 
2,639

Other operating liabilities
 
3,756

 
1,673

Net cash provided by operating activities
 
52,519

 
36,085

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
Proceeds from sales of property and investments
 
—

 
155

Purchases of property and equipment
 
(13,426
)
 
(10,039
)
Net cash used in investing activities
 
(13,426
)
 
(9,884
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
Payments of capital lease obligations
 
—

 
(587
)
Net short-term borrowings (payments)
 
(36,700
)
 
(25,900
)
Net cash used in financing activities
 
(36,700
)
 
(26,487
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
 
2,393

 
(286
)
CASH AND CASH EQUIVALENTS—Beginning of period
 
19,746

 
23,475

CASH AND CASH EQUIVALENTS—End of period
 
$
22,139

 
$
23,189

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
 
 
 
Cash paid for interest
 
$
2,040

 
$
2,466

Cash paid (refunded) for income taxes
 
$
(2,395
)
 
$
246

See Notes to Condensed Consolidated Financial Statements.


3

SEARS HOMETOWN AND OUTLET STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
 
Thousands
Number of Shares of Common Stock
 
Common Stock/Par Value
 
Capital in Excess of Par Value
 
Retained Earnings (Deficit)
 
Total Stockholders' Equity
Balance at February 1, 2014
22,753

 
$
228

 
$
547,021

 
$
42,976

 
$
590,225

Net loss

 
—

 
—

 
(164,171
)
 
(164,171
)
Share-based compensation
(17
)
 
(1
)
 
607

 
—

 
606

Balance at November 1, 2014
22,736

 
$
227

 
$
547,628

 
$
(121,195
)
 
$
426,660

 
 
 
 
 
 
 
 
 
 
Balance at January 31, 2015
22,736

 
$
227

 
$
547,888

 
$
(125,829
)
 
$
422,286

Net loss

 
—

 
—

 
(158
)
 
(158
)
Share-based compensation
(14
)
 
—

 
(236
)
 
—

 
(236
)
Balance at October 31, 2015
22,722

 
$
227

 
$
547,652

 
$
(125,987
)
 
$
421,892

See Notes to Condensed Consolidated Financial Statements.



4
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 1—BACKGROUND AND BASIS OF PRESENTATION
Background
Sears Hometown and Outlet Stores, Inc. is a national retailer primarily focused on selling home appliances, hardware, tools, and lawn and garden equipment. As of October 31, 2015 the Company or its dealers and franchisees operated a total of 1,172 stores across all 50 states and in Puerto Rico and Bermuda. In these notes and elsewhere in this Quarterly Report on Form 10-Q the terms “we,” “us,” “our,” “SHO,” and the “Company” refer to Sears Hometown and Outlet Stores, Inc. and its subsidiaries.
The Separation
The Company separated from Sears Holdings Corporation (“Sears Holdings”) in October 2012 (the “Separation”). Effective upon the Separation, Sears Holdings ceased to own shares of our common stock, and thereafter our common stock began trading on the NASDAQ Stock Market under the trading symbol “SHOS.”
Basis of Presentation
These unaudited condensed consolidated financial statements include the accounts of Sears Hometown and Outlet Stores, Inc. and its subsidiaries, all of which are wholly owned. These unaudited condensed consolidated financial statements do not include all of the information and footnotes required in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In the opinion of management, all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the first, second and third quarters ended October 31, 2015 are not necessarily indicative of the results that may be expected for the full fiscal year. These financial statements and related notes should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2015.
We operate through two segments--our Sears Hometown and Hardware segment ("Hometown") and our Sears Outlet segment ("Outlet").
Our fiscal-year end is the Saturday closest to January 31 each year. Our third fiscal-quarter end is the Saturday closest to October 31 each year. 
Variable Interest Entities and Consolidation
The Financial Accounting Standards Board ("FASB") has issued guidance on variable interest entities and consolidation for determining whether an entity is a variable interest entity ("VIE") as well as the methods permitted for determining the primary beneficiary of a variable interest entity. In addition, this guidance requires ongoing reassessments as to whether a reporting company is the primary beneficiary of a variable interest entity and disclosures regarding the reporting company’s involvement with a variable interest entity. A variable interest is a contractual, an ownership, or another pecuniary interest in a VIE whereby the reporting company will absorb portions of the VIE’s expected losses or receive portions of the VIE’s expected returns.
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 either qualify for a scope exception under the consolidation guidance or, where a variable interest exists, the Company does not possess the power to direct the activities that most significantly impact the economic performance of these businesses. The Company has not consolidated any of such entities in the periods presented.
Fair Value of Financial Instruments
We determine the fair value of financial instruments in accordance with standards pertaining to fair value measurements. Such standards define fair value and establish a framework for measuring fair value under GAAP. Under fair value measurement accounting standards, fair value is considered to be the exchange price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date. We report the fair value of financial assets and liabilities based on the fair value hierarchy prescribed by accounting standards for fair value measurements, which prioritizes the inputs to valuation techniques used to measure fair value into three levels, as follows:

5
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Level 1 inputs—unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. An active market for the asset or liability is one in which transactions for the asset or liability occurs with sufficient frequency and volume to provide ongoing pricing information.
Level 2 inputs—inputs other than quoted market prices included in Level 1 that are observable, either directly or indirectly, for the asset or liability. Level 2 inputs include, but are not limited to, quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted market prices that are observable for the asset or liability, such as interest-rate curves and yield curves observable at commonly quoted intervals, volatilities, credit risks, and default rates.
Level 3 inputs—unobservable inputs for the asset or liability.
Cash and cash equivalents (level 1), accounts receivable, notes receivable (level 2), short-term debt (level 2), merchandise payables, and accrued expenses are reflected in the Condensed Consolidated Balance Sheets at cost, which approximates fair value due to the short-term nature of these instruments. For short-term debt, the variable interest rates are a significant input in our fair value assessments. The carrying value of long-term notes receivable approximates fair value.
We measure certain non-financial assets and liabilities, including long-lived assets, at fair value on a non-recurring basis.
    
The Company was not required to measure any other significant non-financial asset or liability at fair value as of October 31, 2015.
Recent Accounting Pronouncements
Presentation of Debt Issuance Costs
In April 2015, the Financial Accounting Standards Board ("FASB") issued an accounting standards update which simplifies the presentation of debt issuance costs by requiring that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with discounts or premiums. This update will be effective for the Company in the first quarter of 2016. The adoption of the new standard is not expected to have a material impact on the Company's consolidated financial position, results of operations, cash flows, or disclosures.
Consolidation
In February 2015, the Financial Accounting Standards Board ("FASB") issued an accounting standards update which revises the consolidation model. Specifically, the amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities, eliminate the presumption that a general partner should consolidate a limited partnership, affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships, and provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. This update was effective for the Company in the first quarter of 2015. The adoption of the new standard did not impact the Company’s consolidated financial position, results of operations, cash flows, or disclosures.
Extraordinary and Unusual Items
In January 2015, the FASB issued an accounting standards update which eliminates the concept of an extraordinary item. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Eliminating the extraordinary classification simplifies income statement presentation by altogether removing the concept of extraordinary items from consideration. This update was effective for the Company in the first quarter of 2015. The adoption of the new standard did not impact the Company’s consolidated financial position, results of operations, cash flows, or disclosures.
Presentation of Financial Statements - Going Concern
In August 2014, the FASB issued an accounting standards update which requires management to assess whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued. If substantial doubt exists, additional disclosures are required.

6
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


This update will be effective for the Company in the fourth quarter of 2016. The adoption of the new standard is not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows, or disclosures.

7
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Revenue from Contracts with Customers
In May 2014, the FASB issued an accounting standards update which replaces the current revenue recognition standards. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update will be effective for the Company in the first quarter of 2018 and may be applied retrospectively for each period presented or as a cumulative-effect adjustment at the date of adoption. The Company is evaluating the effect of adopting this new standard and has not yet determined the method by which the standard will be adopted.

Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
    
In April 2014, the FASB issued an accounting standards update which modifies the requirements for disposals to qualify as discontinued operations and expands related disclosure requirements. The update was effective for the Company in the first quarter of 2015. The adoption of the new standard did not impact the Company’s consolidated financial position, results of operations, cash flows or disclosures.

NOTE 2—ACCOUNTS AND FRANCHISEE RECEIVABLES AND OTHER ASSETS
Accounts and franchisee receivables and other assets consist of the following:
 
 
 
October 31,
2015
Thousands
 
Hometown
 
Outlet
 
Total
Short-term franchisee receivables
 
$
1,617

 
$
3,451

 
$
5,068

Miscellaneous receivables
 
5,582

 
8,019

 
13,601

Long-term franchisee receivables
 
16,866

 
27,703

 
44,569

Other assets
 
1,469

 
230

 
1,699

Provision for losses on short-term franchisee receivables (1)
 
(370
)
 
(9
)
 
(379
)
Provision for losses on long-term franchisee receivables (1)
 
(3,838
)
 
(90
)
 
(3,928
)
Total Accounts and franchisee receivables and other assets
 
$
21,326

 
$
39,304

 
$
60,630


 
 
November 1,
2014
Thousands
 
Hometown
 
Outlet
 
Total
Short-term franchisee receivables
 
$
8,129

 
$
4,463

 
$
12,592

Miscellaneous receivables
 
7,609

 
2,112

 
9,721

Long-term franchisee receivables
 
21,246

 
27,688

 
48,934

Other assets
 
2,112

 
282

 
2,394

Provision for losses on short-term franchisee receivables (1)
 
(1,383
)
 
—

 
(1,383
)
Provision for losses on long-term franchisee receivables (1)
 
(10,143
)
 
—

 
(10,143
)
Total Accounts and franchisee receivables and other assets
 
$
27,570

 
$
34,545

 
$
62,115



8
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
 
January 31,
2015
Thousands
 
Hometown
 
Outlet
 
Total
Short-term franchisee receivables
 
$
6,169

 
$
3,652

 
$
9,821

Miscellaneous receivables
 
6,316

 
2,540

 
8,856

Long-term franchisee receivables
 
20,678

 
28,652

 
49,330

Other assets
 
1,973

 
290

 
2,263

Provision for losses on short-term franchisee receivables (1)
 
(3,212
)
 
(9
)
 
(3,221
)
Provision for losses on long-term franchisee receivables (1)
 
(8,068
)
 
(79
)
 
(8,147
)
Total Accounts and franchisee receivables and other assets
 
$
23,856

 
$
35,046

 
$
58,902


(1) The Company recognizes a provision for losses on franchisee receivables (which consist primarily of franchisee promissory notes) in an amount equal to estimated probable losses net of recoveries. The provision 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 provision for losses on franchisee receivables is recognized as selling and administrative expense. Most of our franchisee promissory notes authorize us to deduct debt service from our commissions otherwise due and payable to the franchisees, and we routinely make those deductions to the extent of available commissions payable.

NOTE 3—PROVISION FOR LOSSES ON FRANCHISEE RECEIVABLES
The provision for losses on Franchisee Receivables, which was established in fiscal 2014, consists of the following:
 
Thousands
October 31, 2015
 
November 1, 2014
 
January 31, 2015
Provision for losses on franchisee receivables, beginning of period
$
11,368

 
$
—

 
$
—

Expense accruals during the period
486

 
11,526

 
13,055

Write off of franchisee receivables
(7,547
)
 
—

 
(1,687
)
Provision for losses on franchisee receivables, end of period
$
4,307

 
$
11,526

 
$
11,368


Refer to Note 13 regarding events occurring after October 31, 2015 that may impact Franchisee receivables and provision for losses in the fourth quarter of 2015.

NOTE 4—OTHER CURRENT AND LONG-TERM LIABILITIES
Other current and long-term liabilities consist of the following:
 
Thousands
October 31, 2015
 
November 1, 2014
 
January 31,
2015
Customer deposits
$
27,110

 
$
32,322

 
$
30,241

Sales and other taxes
14,672

 
14,052

 
12,458

Accrued expenses
12,451

 
10,617

 
16,265

Payroll and related items
7,432

 
5,996

 
4,072

Store closing, severance, and executive transition costs
1,998

 
—

 
—

Total Other current and long-term liabilities
$
63,663

 
$
62,987

 
$
63,036


NOTE 5—GOODWILL
We recorded a $167.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2014.
We reviewed the Hometown Stores and Home Appliance Showrooms ("Hometown Reporting Unit") goodwill for impairment annually at the beginning of the fourth fiscal quarter and whenever events or changes in circumstances indicated the

9
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


carrying value of goodwill might not be recoverable. The goodwill impairment test involved a two-step process. In the first step, SHO compared the fair value of the Hometown Reporting Unit to its carrying value. If the fair value of the Hometown Reporting Unit exceeded its carrying value, goodwill was not impaired and no further testing was required. If the fair value of the Hometown Reporting Unit was less than its carrying value, SHO performed the second step of the impairment test to measure the amount of impairment loss. In the second step, the Hometown Reporting Unit's fair value was allocated to all of the assets and liabilities of the Hometown Reporting Unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the Hometown Reporting Unit were being acquired in a business combination. If the implied fair value of the Hometown Reporting Unit's goodwill was less than its carrying value, the difference was recorded as a non-cash impairment loss.
During the third quarter of fiscal 2014 we determined that sufficient indicators of potential impairment existed to require that we conduct an interim impairment analysis of the Hometown Reporting Unit's goodwill. These indicators included a significant and sustained decline in the recent trading values of SHO's stock, coupled with market conditions and business trends affecting the Hometown Reporting Unit. The primary operating factors were declines in revenue and profitability for fiscal 2014. Merchandise revenues in fiscal 2014 were impacted by the highly promotional environment, along with other factors that caused declines in comparable store sales and related profitability below expectations for the Hometown Reporting Unit.
SHO estimated the fair value of the Hometown Reporting Unit using a weighting of fair values derived from the income approach and the market approach. Under the income approach, SHO calculated the fair value of the Hometown Reporting Unit based on the present value of the Hometown Reporting Unit's estimated future cash flows. The cash flow projections were based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. SHO used a discount rate that was based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the Hometown Reporting Unit and its projected cash flows. SHO's market approach used estimated fair values based on market multiples of revenue and earnings derived from comparable publicly traded companies with operating and investment characteristics that were comparable to the operating and investment characteristics of the Hometown Reporting Unit.

Due to the complexity and the effort required to estimate the fair value of the Hometown Reporting Unit for the first step of the impairment test and to estimate the fair values of all assets and liabilities of the Hometown Reporting Unit for the second step of the impairment test, SHO used fair value estimates that were derived based on assumptions and analyses that are subject to change. SHO’s first-step evaluation concluded that the fair value of the Hometown Reporting Unit was substantially below its carrying value. Based on SHO's second-step analyses, the implied fair value of the Hometown Reporting Unit's goodwill was $0. As a result, a full impairment of goodwill was required and we recorded the $167.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2014, which was reflected as "Impairment of goodwill" in the Condensed Consolidated Statements of Operations. The primary factor that contributed to the goodwill impairment loss was the aforementioned 2014 operating issues leading to less-optimistic forecasts for the remainder of fiscal 2014 and fiscal 2015 and the projected corresponding impact beyond those periods.
NOTE 6—INCOME TAXES
SHO and Sears Holdings have entered into a Tax Sharing Agreement that governs the rights and obligations of the parties with respect to pre-Separation and post-Separation tax matters. Under the Tax Sharing Agreement, Sears Holdings generally is responsible for any federal, state, or foreign income tax liability relating to tax periods ending on or before the Separation. For all periods after the Separation, the Company generally is responsible for any federal, state, or foreign tax liability. Current income taxes payable for any federal, state, or foreign income tax returns is reported in the period incurred.
We account for uncertainties in income taxes according to accounting standards for uncertain tax positions. The Company is present in a large number of taxable jurisdictions and, at any point in time, can have tax audits underway at various stages of completion in one or more of these jurisdictions. We evaluate our tax positions and establish liabilities for uncertain tax positions that may be challenged by local authorities and may not be fully sustained, despite our belief that the underlying tax positions are fully supportable. Unrecognized tax benefits are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law, and closings of statutes of limitation. Such adjustments are reflected in the tax provision as appropriate. For the 39 weeks ended October 31, 2015 and November 1, 2014, 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 condensed

10
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


consolidated financial statements, no interest or penalties related to unrecognized tax benefits are reflected in the condensed consolidated balance sheets or statements of operations.

As of October 31, 2015 the Company's net deferred tax asset balance was $61.0 million compared to $57.2 million as of November 1, 2014 and $65.2 million as of January 31, 2015.

NOTE 7—RELATED-PARTY AGREEMENTS AND TRANSACTIONS

According to publicly available information ESL Investments, Inc. and investment affiliates (collectively, "ESL") beneficially own approximately 46% of our outstanding shares of common stock and approximately 57% of Sears Holdings' outstanding shares of common stock.
SHO and Sears Holdings have entered into various agreements (the "SHO-Sears Holdings Agreements") that, among other things, (1) govern specified aspects of our relationship with Sears Holdings, (2) establish terms under which subsidiaries of Sears Holdings provide services to us, and (3) establish terms pursuant to which subsidiaries of Sears Holdings obtain merchandise inventories for us. The terms of the SHO-Sears Holdings Agreements were agreed to prior to the Separation (except for terms changes agreed to after the Separation that have been approved by the Audit Committee of SHO's Board of Directors) in the context of a parent-subsidiary relationship and in the overall context of the Separation. The costs and allocations charged to the Company by Sears Holdings do not necessarily reflect the costs of obtaining the services from unaffiliated third parties or of the Company itself providing the applicable services. The Company engages in frequent discussions, and seeks to resolve disputes, with Sears Holdings about the terms and conditions of the SHO-Sears Holdings Agreements, the business relationships that are reflected in the SHO-Sears Holdings Agreements, and the details of these business relationships, many of which details are not addressed by the terms and conditions of the SHO-Sears Holdings Agreements or, if addressed, are in dispute as to their meaning or application in the context of the existing business relationships. Some of these discussions have resulted in adjustments to the relationships that the Company believes together are in Company's best interests. In many other instances the Company's dispute-resolution efforts, which are continuing, have yet to resolve the underlying disputes.
The following is a summary of the nature of the related-party transactions between SHO and Sears Holdings:

•
SHO receives commissions from Sears Holdings for specified sales of merchandise made through www.sears.com and www.searsoutlet.com, the sale of extended service contracts, delivery and handling services, and relating to the use in our stores of credit cards branded with the Sears name. For specified transactions SHO pays a commission to Sears Holdings.
•
We obtain a significant amount of our merchandise inventories from Sears Holdings. We have a retailer's customary rights to return to Sears Holdings merchandise that is defective (except with respect to agreed-upon amounts of defective apparel that we purchase and then liquidate) or otherwise does not meet contract requirements. In addition, we may determine that an item of Outlet merchandise (usually merchandise that is not new in-box) we have received from Sears Holdings cannot be refurbished or reconditioned or is otherwise not in a physical condition to offer for sale to our customers. We and Sears Holdings (and our Outlet vendors generally) refer to an item of merchandise in this condition as "not saleable" or "non-saleable," and in the normal course we can return the item to Sears Holdings. We generally have comparable return rights with our other Outlet vendors.
•
We pay royalties related to our sale of products branded with the KENMORE®, CRAFTSMAN®, and DIEHARD® marks (which marks are owned by subsidiaries of Sears Holdings, together the "KCD Marks").
•
We pay fees for participation in Sears Holdings' SHOP YOUR WAY REWARDS® program.
•
We have also entered into agreements with Sears Holdings for logistics, handling, warehouse, and transportation services, the charges for which are based generally on merchandise inventory units.
•
Sears Holdings provides the Company with specified corporate services. These services include accounting and finance, human resources, and information technology, among other services. Sears Holdings charges the Company for these corporate services based on actual usage or pro rata charges based upon sales, head count, or other measurements.
•
Sears Holdings leases stores and distribution/repair facilities to the Company, for which the Company pays rent and related occupancy charges to Sears Holdings.
 

11
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following table summarizes the results of the transactions with Sears Holdings reflected in the Company’s Condensed Consolidated Financial Statements:
 
 
 
13 Weeks Ended
 
39 Weeks Ended
 
 
October 31,
2015
 
November 1,
2014
 
October 31,
2015
 
November 1,
2014
Thousands
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Commissions from Sears Holdings
 
$
22,217

 
$
22,069

 
$
70,783

 
$
76,808

Purchases related to cost of sales and occupancy
 
337,228

 
351,935

 
1,072,022

 
1,156,632

Services
 
21,532

 
23,302

 
67,848

 
73,089


We incur payables to Sears Holdings for merchandise inventory purchases and service and occupancy charges (net of commissions) based on the SHO-Sears Holdings Agreements.  Amounts due to or from Sears Holdings are non-interest bearing and are settled on a net basis. We generally pay undisputed amounts within 10 days after the invoice date.

NOTE 8—FINANCING ARRANGEMENT
    
As of October 31, 2015 we had $47.4 million outstanding under our asset-based senior secured revolving credit facility with a group of financial institutions (the "Senior ABL Facility”), which approximated the fair value of these borrowings. The Senior ABL Facility provides (subject to availability under a borrowing base) for maximum borrowings up to the aggregate commitments of all of the lenders, which as of October 31, 2015 totaled $250 million. 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 October 31, 2015 was $196.9 million, with $5.7 million of letters of credit outstanding under the facility.
The principal terms of the Senior ABL Facility are summarized below.
Senior ABL Facility
Maturity; Amortization and Prepayments
The Senior ABL Facility will mature on the earlier of (i) October 11, 2017 or (ii) six months prior to the expiration of our Merchandising Agreement with Sears Holdings (the "Merchandising Agreement"), our Services Agreement with Sears Holdings (the "Services Agreement"), and the other agreements with Sears Holdings or its subsidiaries in connection with the Separation that are specified in the Senior ABL Facility, unless such agreements have been extended to a date later than October 11, 2017 or terminated on a basis reasonably satisfactory to the administrative agent under the Senior ABL Facility.
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.
Guarantees; Security
The obligations under the Senior ABL Facility are guaranteed by us and each of our existing and future direct and indirect wholly owned domestic subsidiaries (subject to certain exceptions). The Senior ABL Facility and the guarantees thereunder are secured by a first priority security interest in assets of the borrowers and guarantors consisting primarily of accounts and notes receivable, inventory, cash, cash equivalents, deposit accounts and securities accounts, as well as certain other assets (other than intellectual property) ancillary to the foregoing and all proceeds of all of the foregoing, including cash proceeds and the proceeds of applicable insurance.
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 our election, either (1) an adjusted London inter-bank offered rate (LIBOR) plus a borrowing margin, which rate was approximately 2.19% at October 31, 2015 or (2) an alternate base rate plus a borrowing margin, with the borrowing margin subject to adjustment based on the average excess availability under the Senior ABL Facility for the preceding fiscal quarter, which rate was approximately 4.25% at October 31, 2015.
Customary fees are payable in respect of the Senior ABL Facility, including letter of credit fees and commitment fees.

12
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Covenants
The Senior ABL Facility includes a number of covenants that, among other things, limit or restrict our ability to, subject to specified exceptions, incur additional indebtedness (including guarantees), grant liens, make investments, make prepayments on other indebtedness, engage in mergers, or change the nature of our business.
The Senior ABL Facility limits SHO's ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends to its stockholders and may repurchase stock if the following conditions are satisfied: either (a) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or as a result of the stock repurchase, (ii) SHO and its subsidiaries that are also borrowers have demonstrated to the reasonable satisfaction of the agent for the lenders that monthly availability (as determined in accordance with the Senior ABL Facility), immediately following the declaration and payment of the cash dividend or the stock repurchase and as projected on a pro forma basis for the twelve months following and after giving effect to the declaration and payment of the cash dividend or the stock repurchase, would be at least equal to the greater of (x) 25% of the Loan Cap (which is the lesser of (A) the aggregate commitments of the lenders and (B) the borrowing base) and (y) $50,000,000, and (iii) after giving pro forma effect to the declaration and payment of the cash dividend or the stock repurchase as if it constituted a specified debt service charge, the specified consolidated fixed charge coverage ratio, as calculated on a trailing twelve months basis, would be equal to or greater than 1.1:1.0, or (b) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or the stock repurchase, (ii) payment of the cash dividend or the stock repurchase is not made with the proceeds of any credit extension under the Senior ABL Facility, (iii) during the 120-day period prior to declaration and payment of the cash dividend or the stock repurchase, no credit extension was outstanding under the Senior ABL Facility, and (iv) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that, on a pro forma and projected basis, no credit extensions would be outstanding under the Senior ABL Facility for the 120-day period following the declaration and payment of the cash dividend or the stock repurchase. No default or event of default presently exists. At October 31, 2015 we did not meet either of the foregoing conditions and as a result the Senior ABL Facility does not permit us to pay cash dividends or repurchase our common stock.
The Senior ABL Facility also contains affirmative covenants, including financial and other reporting requirements.
Events of Default
The Senior ABL Facility includes customary events of default including non-payment of principal, interest, or fees, violation of covenants, inaccuracy of representations or warranties, cross default to certain 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, the Services Agreement, and other SHO-Sears Holdings Agreements) to the extent required to maintain it in full force and effect, the failure to enforce a Material Contract in accordance with its terms, and Sears Holdings' termination of the "Separation Agreements" (which include, among other SHO-Sears Holdings Agreements, the Merchandising Agreement and the Services Agreement).


13
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 9—SUMMARY OF SEGMENT DATA
The Hometown reportable segment consists of the aggregation of our Hometown Stores, Hardware Stores, and Home Appliance Showrooms business formats described in “Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations-Executive Overview" of this Quarterly Report on Form 10-Q. The Outlet reportable segment also represents a business format. These segments are evaluated by our Chief Operating Decision Maker to make decisions about resource allocation and to assess performance. Each of these segments derives its revenues from the sale of merchandise and related services to customers, primarily in the U.S. The net sales categories include appliances, lawn and garden, tools and paint, and other (which includes initial franchise revenue of $0.0 million and $6.5 million for the 13 weeks ended October 31, 2015 and November 1, 2014, respectively). Initial franchise revenue consists of franchise fees paid with respect to new or existing Company-operated stores that we transfer to franchisees plus the net gain or loss on any related transfer of assets to the franchisees. For the 39 weeks ended October 31, 2015, initial franchise revenue was $0.3 million compared to $15.2 million in the 39 weeks ended November 1, 2014.
 
 
13 Weeks Ended October 31, 2015
Thousands
 
Hometown
 
Outlet
 
Total
Net sales
 
 
 
 
 
 
Appliances
 
$
263,853

 
$
136,975

 
$
400,828

Lawn and garden
 
51,907

 
6,085

 
57,992

Tools and paint
 
36,758

 
4,220

 
40,978

Other
 
27,322

 
20,023

 
47,345

Total
 
379,840

 
167,303

 
547,143

Costs and expenses
 
 
 
 
 
 
Cost of sales and occupancy
 
301,966

 
127,395

 
429,361

Selling and administrative
 
85,808

 
37,222

 
123,030

Depreciation
 
901

 
1,320

 
2,221

Total
 
388,675

 
165,937

 
554,612

Operating income (loss)
 
$
(8,835
)
 
$
1,366

 
$
(7,469
)
Total assets
 
$
440,008

 
$
220,250

 
$
660,258

Capital expenditures
 
$
1,902

 
$
5,076

 
$
6,978

 
 
 
13 Weeks Ended November 1, 2014
Thousands
 
Hometown
 
Outlet
 
Total
Net sales
 
 
 
 
 
 
Appliances
 
$
261,645

 
$
139,519

 
$
401,164

Lawn and garden
 
59,447

 
7,065

 
66,512

Tools and paint
 
41,736

 
4,649

 
46,385

Other
 
24,915

 
26,171

 
51,086

Total
 
387,743

 
177,404

 
565,147

Costs and expenses
 
 
 
 
 
 
Cost of sales and occupancy
 
299,013

 
131,072

 
430,085

Selling and administrative
 
103,395

 
36,371

 
139,766

Impairment of goodwill
 
167,000

 
—

 
167,000

Depreciation
 
746

 
1,289

 
2,035

Gain on the sale of assets
 
(155
)
 
—

 
(155
)
Total
 
569,999

 
168,732

 
738,731

Operating income (loss)
 
$
(182,256
)
 
$
8,672

 
$
(173,584
)
Total assets
 
$
455,112

 
$
208,124

 
$
663,236

Capital expenditures
 
$
579

 
$
2,410

 
$
2,989


14
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
 
39 Weeks Ended October 31, 2015
Thousands
 
Hometown
 
Outlet
 
Total
Net sales
 
 
 
 
 
 
Appliances
 
$
805,791

 
$
401,954

 
$
1,207,745

Lawn and garden
 
256,453

 
18,779

 
275,232

Tools and paint
 
118,432

 
12,862

 
131,294

Other
 
70,571

 
64,680

 
135,251

Total
 
1,251,247

 
498,275

 
1,749,522

Costs and expenses
 
 
 
 
 
 
Cost of sales and occupancy
 
970,586

 
379,435

 
1,350,021

Selling and administrative
 
277,745

 
116,010

 
393,755

Depreciation
 
2,437

 
3,809

 
6,246

Total
 
1,250,768

 
499,254

 
1,750,022

Operating income (loss)
 
$
479

 
$
(979
)
 
$
(500
)
Total assets
 
$
440,008

 
$
220,250

 
$
660,258

Capital expenditures
 
$
4,381

 
$
9,045

 
$
13,426



 
 
39 Weeks Ended November 1, 2014
Thousands
 
Hometown
 
Outlet
 
Total
Net sales
 
 
 
 
 
 
Appliances
 
$
795,919

 
$
398,299

 
$
1,194,218

Lawn and garden
 
278,305

 
19,546

 
297,851

Tools and paint
 
132,470

 
13,566

 
146,036

Other
 
79,838

 
75,751

 
155,589

Total
 
1,286,532

 
507,162

 
1,793,694

Costs and expenses
 
 
 
 
 
 
Cost of sales and occupancy
 
983,214

 
384,430

 
1,367,644

Selling and administrative
 
307,747

 
106,524

 
414,271

Impairment of goodwill
 
167,000

 
—

 
167,000

Depreciation
 
2,127

 
4,263

 
6,390

Gain on the sale of assets
 
(155
)
 
—

 
(155
)
Total
 
1,459,933

 
495,217

 
1,955,150

Operating income (loss)
 
$
(173,401
)
 
$
11,945

 
$
(161,456
)
Total assets
 
$
455,112

 
$
208,124

 
$
663,236

Capital expenditures
 
$
2,509

 
$
7,530

 
$
10,039



15
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


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 or in the aggregate, in the opinion of management would not have a material adverse effect on our business, financial position, results of operations, or cash flows.

NOTE 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. There was no dilutive effect of potential common shares.

The following table sets forth the components used to calculate basic and diluted loss per common share attributable to our stockholders.

 
13 Weeks Ended
 
13 Weeks Ended
 
39 Weeks Ended
 
39 Weeks Ended
 
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Thousands except loss per common share
 
 
 
 
 
 
 
Basic and diluted weighted average shares
22,666

 
22,666

 
22,666

 
22,666

 
 
 
 
 
 
 
 
Net loss
$
(3,818
)
 
$
(171,210
)
 
$
(158
)
 
$
(164,171
)
 
 
 
 
 
 
 
 
Loss per common share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Basic and diluted
$
(0.17
)
 
$
(7.55
)
 
$
(0.01
)
 
$
(7.24
)



16
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 12—EQUITY

Stock-based Compensation
Four million shares of the Company's common stock are reserved for issuance under the Company's Amended and Restated 2012 Stock Plan (the "Plan"). A total of 89,221 shares of restricted stock were granted under the Plan in the second quarter of 2013 to a group of eligible individuals (as defined in the Plan) and 14,000 shares of restricted stock were granted under the Plan to an eligible individual in the second quarter of 2015. All of the eligible individuals were employees of the Company at the time of the grants. As of October 31, 2015, 47,263 shares of the original grant of 89,221 shares of restricted stock had been forfeited. During the first quarter of 2015 the Company granted a total of 159,475 stock units under the Plan (all of which stock units are payable solely in cash based on our stock price at the vesting date) to a group of eligible individuals, all of whom were employees of the Company at the time of the grants. As of October 31, 2015, 28,237 stock units had been forfeited. We are authorized to grant stock options and to make other awards (in addition to restricted stock and stock units) to eligible participants pursuant to the Plan. The Company has made no stock-option awards under the Plan. Except for the 103,221 shares of restricted stock and the 159,475 stock units, the Company has made no grants or 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 the first three quarters of 2015 we recorded $(0.2) million in total compensation expense for the remaining 55,958 shares of restricted stock, including the reversal of approximately $0.7 million of compensation expense related to severance and executive transition costs, and $0.1 million in total compensation expense for the remaining 131,238 stock units (none of which had vested as of October 31, 2015). At October 31, 2015 we had $0.4 million in total unrecognized compensation cost related to the remaining non-vested restricted stock, which cost we expect to recognize over approximately the next two years. At October 31, 2015, we had $0.8 million in total unrecognized compensation cost related to the remaining non-vested stock units, which cost we expect to recognize over approximately the next three years.

The remaining 41,958 shares of restricted stock will vest, if at all, on May 16, 2016, and 14,000 shares of restricted stock will vest, if at all, on July 10, 2017, in accordance with and subject to the terms and conditions of restricted-stock agreements (including forfeiture conditions) and the Plan. The fair value of these awards is equal to the market price of our common stock on the date of grant. Changes in restricted-stock awards for 2015 were as follows:
 
 
39 Weeks Ended October 31, 2015
(Shares in Thousands)
 
Shares
 
Weighted-Average Fair Value on Date of Grant
Beginning of year balance
 
70

 
$
44.45

Granted
 
14

 
9.38

Vested
 
—

 
—

Forfeited
 
(28
)
 
44.45

Balance at 10/31/2015
 
56

 
$
35.68

 
 
 
 
 

    The remaining 131,238 stock units will vest, if at all, on April 13, 2018 in accordance with and subject to the terms and conditions of stock unit agreements, including forfeiture conditions, and the Plan. The fair value of these awards will vary based on changes in our stock price at each reporting period.
    
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

17
SEARS HOMETOWN AND OUTLET STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Company may suspend or terminate the repurchase program at any time. At October 31, 2015, the Senior ABL Facility prohibited cash dividends and the repurchase of our common stock.
Shares that are repurchased by the Company pursuant to the repurchase program will be retired and resume the status of authorized and unissued shares of common stock.
No shares were repurchased during the 13 and 39 weeks ended October 31, 2015. At October 31, 2015, we had approximately $12.5 million of remaining authorization under the repurchase program.
NOTE 13—SUBSEQUENT EVENTS

In the fourth quarter of 2015 the Company began discussions and reached oral understandings with two franchisees pursuant to which the Company would repurchase a total of 23 franchised locations. The oral understandings are subject to the negotiation, execution, and delivery by the Company and the franchisees of definitive asset purchase and termination agreements which would terminate the franchise agreements and sublease arrangements for the affected locations. The definitive agreements would provide as part of these transactions that the Company would purchase store furniture, fixtures, and equipment for a total of $0.7 million. As of the end of the third quarter of 2015 the franchisees of the affected locations were obligors on promissory notes payable to the Company with unpaid principal amounts totaling approximately $11.8 million, for which franchisee note receivables the Company carried no reserves.  If the Company and the franchisees were to negotiate, execute, and deliver the necessary definitive agreements (the likelihood of which the Company is unable to predict with certainty), the Company expects that these transactions would be completed in the fourth quarter of 2015 and expects that the Company would write-off the franchisee note receivable balances net of the value of any reacquisition rights and the value of the furniture, fixtures, and equipment that the Company would purchase. The Company currently estimates that the loss associated with the write-off of these franchisee note receivable balances would be between $8.0 and $10.0 million.





Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and notes contained in this Quarterly Report on Form 10-Q and the Consolidated Financial Statements and notes contained in our Annual Report on Form 10-K for the fiscal year ended January 31, 2015 (the "2014 10-K"). This discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements.

18
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

Executive Overview
We are a national retailer primarily focused on selling home appliances, hardware, tools, and lawn and garden equipment. As of October 31, 2015 we or our dealers and franchisees operated a total of 1,172 stores across all 50 states, Puerto Rico, and Bermuda. In the third quarter of 2015, the Company opened ten new stores and closed 53 stores.
In addition to merchandise, we provide our customers with access to a suite of services, including home delivery, installation, and extended service contracts.

Our Hometown and Hardware stores are designed to provide our customers with in-store and online access to a wide selection of national brands of home appliances, tools, lawn and garden equipment, sporting goods, and household goods, depending on the particular format. Our Outlet stores are designed to provide our customers with in-store and online access to purchase, at prices that are significantly lower than manufacturers' list prices, new, one-of-a-kind, out-of-carton, discontinued, obsolete, used, reconditioned, overstocked, and scratched and dented products across a broad assortment of merchandise categories, including home appliances, lawn and garden equipment, apparel, mattresses, sporting goods, and tools.

As of October 31, 2015 Hometown consisted of 1,011 stores as follows:

•
856 Sears Hometown Stores—Primarily independently operated stores, predominantly located in smaller communities and offering appliances, lawn and garden equipment, and hardware. Most of our Sears Hometown Stores carry Kenmore, Craftsman, and DieHard brand products as well as a wide assortment of other national brand products.
•
62 Sears Hardware Stores—Stores that carry Craftsman brand tools and lawn and garden equipment, DieHard brand batteries, and a wide assortment of other national brands and other home improvement products along with a selection of Kenmore and other national brands of home appliances.
•
93 Sears Home Appliance Showrooms—Stores that have a simple, primarily appliance showroom design that are positioned in metropolitan areas.
As of October 31, 2015, Hometown consisted of 850 dealer-operated stores, 107 franchisee-operated stores, and 54 Company-operated stores. The Company requires all dealer and franchisee-operated stores to operate according to the Company’s standards to protect and enhance the quality of its brands. These stores must display the required merchandise, offer all required products and services, and use the Company’s point of sale system. Also, the Company has the right to approve advertising and promotional and marketing materials and imposes certain advertising requirements. The Company owns the merchandise offered for sale by all dealer and franchisee-operated stores, establishes all selling prices for the merchandise, and bears general inventory risk (with specific exceptions) until sale of the merchandise and if the customer returns the merchandise. In addition, because each transaction is recorded in the Company’s point of sale system, the Company bears customer credit risk. The Company establishes a commission structure for stores operated by dealers and franchisees and pays commissions to the dealers and franchisees when they sell the Company's merchandise and provide services.
The Company completed the first Outlet store franchise transactions in the first quarter of 2013. As of October 31, 2015, 67 of the 161 Outlet stores were operated by franchisees.
Dealers and franchisees exercise control over the day-to-day operations of their stores, make capital decisions regarding their stores, and exclusively make all hiring, compensation, benefits, termination, and other decisions regarding the terms and conditions of employment, and exclusively establish all employment policies, procedures, and practices, with respect to employees.
Several of the primary differences between Company-operated stores and dealer or franchisee-operated stores are that (1) the Company is responsible for occupancy and payroll costs associated with Company-operated stores while dealers and franchisees are responsible for these costs for their stores, (2) the Company is responsible for all terms and conditions of employment for the employees in the Company-operated stores and its dealers and franchisees are responsible for all terms and conditions of employment for the employees in their stores, and (3) we pay commissions to our dealers and franchisees.
In the normal course of business, stores can transition from Company-operated to franchisee or dealer-operated, and vice-versa. Potential new stores may be identified by the Company, an existing dealer or franchisee, or a potential dealer or franchisee. If the Company identifies and develops a new store, the Company will generally seek to transfer that store to a dealer or a franchisee. When a dealer or a franchisee ceases to operate a store, the Company may take over its operation, generally on an interim basis, until the Company can transfer the store to another dealer or franchisee. At any given time the Company is generally operating a number of stores that are in transition from one dealer or franchisee to another dealer or

19
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

franchisee. Transition stores are not included in our count of Company-operated stores due to the expected short-term nature of transition operation.
The Company's transfer of a Company-operated store to a franchisee historically has (1) in most instances increased the Company's gross margin primarily due to decreased occupancy costs and (2) increased the Company's selling and administrative expense primarily due to increased commission payments, offset partially by lower payroll and benefits expense.
Initial franchise revenues consist of franchise fees paid by franchisees with respect to new and existing Company-operated stores that we transferred to the franchisees plus the net gain or loss on related transfers of assets to the franchisees. The number of new franchised stores, the number of Company-operated stores transferred, and the net gain or loss per store transferred has been highly variable from quarter to quarter. The variation has resulted from a number of factors, including general economic conditions, which have influenced both the level of new store development and the level of interest of existing or potential franchisees in acquiring store locations, and economic factors specific to our major product categories, such as appliances. Each of these factors has impacted the expected financial returns to the Company from new store development, which in turn has impacted the number of Company-operated stores that the Company has decided from time to time to make available for transfer to franchisees. During the second quarter of 2015 the Company indefinitely suspended its franchising of additional stores except to existing Company franchisees, and the suspension continued in effect during the third quarter of 2015. Initial franchise revenues were less than $0.1 million in the third quarter of 2015 and $6.5 million in the third quarter of 2014.
 
13 Weeks Ended
 
39 Weeks Ended
Thousands
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Hometown
$
—

 
$
336

 
$
(108
)
 
$
313

Outlet
13

 
6,159

 
448

 
14,877

  Total initial franchise revenues
$
13

 
$
6,495

 
$
340

 
$
15,190

 
 
 
 
 
 
 
 
Online
We believe that the results of operations for our businesses have been adversely affected by the continuing growth at other retailers of online sales of merchandise in important product categories, especially home appliances. Our rights to engage in our own online initiatives that would leverage www.sears.com, and our rights to engage on our own terms and conditions in our own online initiatives that would be independent of www.sears.com, are constrained by the SHO-Sears Holdings Agreements and by actions that Sears Holdings has taken that we believe are not in compliance with the Merchandising Agreement and the Services Agreements and as to which we have objected. We believe that these constraints and actions likely will continue to adversely affect our ability to conduct, and grow, our online business and, as a consequence, likely will continue to adversely affect our results of operations. These adverse effects likely will increase over time. We have, for some time, been engaging in discussions with Sears Holdings regarding the elimination of these constraints and the cessation of actions, but we are unable to determine the outcome of these discussions.

Shared Vendor Funds
    
In accordance with the Merchandising Agreement, SHO receives from Sears Holdings specified portions of merchandise subsidies collected by Sears Holdings from its merchandise vendors. During the third quarter of 2015 Sears Holdings' subsidy collections were lower compared to the same period in 2014, and SHO's portion of the collected subsidies during the third quarter declined by approximately $1.6 million compared to the same period in 2014. Also in accordance with the Merchandising Agreement, SHO receives from Sears Holdings specified portions of cash discounts earned by Sears Holdings as a result of its early payment of merchandise-vendor payables. During the third quarter of 2015 Sears Holdings earned higher cash discounts compared to the same period in 2014, and SHO's portion of the earned cash discounts increased during the third quarter by approximately $3.2 million compared to the same period in 2014. Sears Holdings is responsible for the collection of the merchandise subsidies that it has negotiated with its merchandise vendors and the extent to which Sears Holdings will earn cash discounts. As a consequence we cannot provide any assurance that SHO's portion of merchandise subsidies collected by Sears Holdings will stay the same or cease declining and we cannot provide any assurance that SHO's portion of Sears Holdings' earned cash discounts will not decline, stay the same, or continue to increase. If SHO's portion of merchandise

20
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

subsidies collected by Sears Holdings were to continue to decline, and if at the same time SHO's portion of Sears Holdings' earned cash discounts were to decline, SHO's results of operations could be adversely affected to a material extent.
Seasonality

Our business is not concentrated in the holiday season, as the majority of the products we sell are not typically thought of as holiday gifts. Lawn and Garden sales generally peak in our second quarter as customers prepare for and execute outdoor projects during the spring and early summer. See Note 10 to the Consolidated Financial Statements included in the 2014 10-K for our quarterly financial results (unaudited) for our 2013 and 2014 fiscal years.
Results of Operations
The following table sets forth items derived from our consolidated results of operations for the 13 and 39 weeks ended October 31, 2015 and November 1, 2014.
 
 
 
13 Weeks Ended
 
39 Weeks Ended
Thousands
 
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
NET SALES
 
$
547,143

 
$
565,147

 
$
1,749,522

 
$
1,793,694

COSTS AND EXPENSES
 
 
 
 
 
 
 
 
Cost of sales and occupancy
 
429,361

 
430,085

 
1,350,021

 
1,367,644

Gross margin dollars
 
117,782

 
135,062

 
399,501

 
426,050

Margin rate
 
21.5
%
 
23.9
%
 
22.8
%
 
23.8
%
Selling and administrative
 
123,030

 
139,766

 
393,755

 
414,271

Selling and administrative expense as a percentage of net sales
 
22.5
%
 
24.7
%
 
22.5
%
 
23.1
%
Impairment of goodwill
 
—

 
167,000

 
—

 
167,000

Depreciation
 
2,221

 
2,035

 
6,246

 
6,390

Gain on the sale of assets
 
—

 
(155
)
 
—

 
(155
)
Total costs and expenses
 
554,612

 
738,731

 
1,750,022

 
1,955,150

Operating loss
 
(7,469
)
 
(173,584
)
 
(500
)
 
(161,456
)
Interest expense
 
(587
)
 
(915
)
 
(1,982
)
 
(2,754
)
Other income
 
721

 
888

 
1,963

 
2,366

Loss before income taxes
 
(7,335
)
 
(173,611
)
 
(519
)
 
(161,844
)
Income tax benefit (expense)
 
3,517

 
2,401

 
361

 
(2,327
)
NET LOSS
 
$
(3,818
)
 
$
(171,210
)
 
$
(158
)
 
$
(164,171
)
Comparable Store Sales

Comparable store sales amounts include merchandise sales for all stores operating for a period of at least 12 full months, including remodeled and expanded stores but excluding store relocations and stores that have undergone format changes.  Comparable store sales include online transactions fulfilled and recorded by SHO and give effect to the change in the unshipped sales reserves recorded at the end of each reporting period. 
Adjusted Comparable Store Sales

In addition to our net sales determined in accordance with GAAP, for purposes of evaluating our sales performance we also use "Adjusted comparable store sales." This measure includes in net sales, as if fulfilled and recorded by SHO, all in-store sales that were transacted by SHO and its independent dealers and franchisees through www.sears.com and that were fulfilled and recorded by Sears Holdings and for which SHO received an online commission from Sears Holdings ("Commission Sales"). Our management uses Adjusted comparable store sales to evaluate the sales performance of our overall business and individual stores for comparable periods. Adjusted comparable store sales should not be used by investors or other third parties

21
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

as the sole basis for formulating investment decisions as it includes Commission Sales, which were not fulfilled or recorded by SHO or its independent dealers or franchisees and for which sales SHO received only commissions from Sears Holdings. Adjusted comparable store sales should not be considered as a substitute for GAAP measurements.

While Adjusted comparable store sales is a non-GAAP measure, management believes that it is an important indicator of store sales performance because:

•
SHO receives commissions on all Commission Sales.
•
Store sales recorded and fulfilled by SHO and Commission Sales involve essentially the same in-store selling activity. As a consequence, unadjusted comparable store sales, which do not include Commission Sales, understate what SHO believes to be its effective comparable store sales performance.
The following table presents a reconciliation of Adjusted comparable store sales to net sales, the most comparable GAAP measure, for each of the periods indicated: 
 
13 Weeks Ended October 31, 2015
 
39 Weeks Ended October 31, 2015
Thousands
Hometown
 
Outlet
 
Total
 
Hometown
 
Outlet
 
Total
Net sales
$
379,840

 
$
167,303

 
$
547,143

 
$
1,251,247

 
$
498,275

 
$
1,749,522

Less: Non-comparable store sales
(40,037
)
 
(24,346
)
 
(64,383
)
 
(121,325
)
 
(73,969
)
 
(195,294
)
Comparable store sales recorded by SHO
339,803

 
142,957

 
482,760

 
1,129,922

 
424,306

 
1,554,228

Commission Sales (1)
6,922

 
1,753

 
8,675

 
25,447

 
5,629

 
31,076

Adjusted comparable store sales
$
346,725

 
$
144,710

 
$
491,435

 
$
1,155,369

 
$
429,935

 
$
1,585,304

 
 
 
 
 
 
 
 
 
 
 
 
 
13 Weeks Ended November 1, 2014
 
39 Weeks Ended November 1, 2014
Thousands
Hometown
 
Outlet
 
Total
 
Hometown
 
Outlet
 
Total
Net sales
$
387,743

 
$
177,404

 
$
565,147

 
$
1,286,532

 
$
507,162

 
$
1,793,694

Less: Non-comparable store sales
(51,802
)
 
(22,529
)
 
(74,331
)
 
(153,280
)
 
(63,506
)
 
(216,786
)
Comparable store sales recorded by SHO
335,941

 
154,875

 
490,816

 
1,133,252

 
443,656

 
1,576,908

Commission Sales (1)
11,469

 
1,558

 
13,027

 
49,004

 
8,902

 
57,906

Adjusted comparable store sales
$
347,410

 
$
156,433

 
$
503,843

 
$
1,182,256

 
$
452,558

 
$
1,634,814

 
 
 
 
 
 
 
 
 
 
 
 
 
13 Weeks Ended October 31, 2015 vs. 13 Weeks Ended November 1, 2014
 
39 Weeks Ended October 31, 2015 vs. 39 Weeks Ended November 1, 2014
 
Hometown
 
Outlet
 
Total
 
Hometown
 
Outlet
 
Total
Comparable store sales recorded by SHO
1.1
 %
 
(7.7
)%
 
(1.6
)%
 
(0.3
)%
 
(4.4
)%
 
(1.4
)%
Adjusted comparable store sales
(0.2
)%
 
(7.5
)%
 
(2.5
)%
 
(2.3
)%
 
(5.0
)%
 
(3.0
)%
(1) Commission Sales are for comparable stores only. For all comparable and non-comparable stores, Commission Sales for the 13 weeks ended October 31, 2015 and November 1, 2014 were $9.5 million and $14.3 million, respectively, and for the 39 weeks ended October 31, 2015 and November 1, 2014, Commission Sales were $32.4 million and $62.4 million, respectively.

Adjusted EBITDA

In addition to our net income determined in accordance with GAAP, for purposes of evaluating operating performance we also use Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization, or “Adjusted EBITDA,” which excludes

22
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

certain significant items as set forth below. Our management uses Adjusted EBITDA, among other factors, for evaluating the operating performance of our business for comparable periods. Adjusted EBITDA should not be used by investors or other third parties as the sole basis for formulating investment decisions as it excludes a number of important cash and non-cash recurring items. Adjusted EBITDA should not be considered as a substitute for GAAP measurements.

While Adjusted EBITDA is a non-GAAP measurement, management believes that it is an important indicator of operating performance because:

•EBITDA excludes the effects of financing and investing activities by eliminating the effects of interest and depreciation costs; and
•Excludes other significant items that may vary significantly from period to period and may have a disproportionate effect in a given period, which affects comparability of results.

In the second quarter of 2015 the Company began excluding initial franchise revenues from Adjusted EBITDA. This change was based on (1) the Company's decision to indefinitely suspend its franchising of additional stores except to existing Company franchisees and (2) the Company's decision to exclude initial franchise revenues from Adjusted EBITDA for the purposes of fiscal year 2015 annual incentive compensation.

The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated:
 
 
13 Weeks Ended
 
39 Weeks Ended
Thousands
 
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Net loss
 
$
(3,818
)
 
$
(171,210
)
 
$
(158
)
 
$
(164,171
)
Income tax (benefit) expense
 
(3,517
)
 
(2,401
)
 
(361
)
 
2,327

Other income
 
(721
)
 
(888
)
 
(1,963
)
 
(2,366
)
Interest expense
 
587

 
915

 
1,982

 
2,754

Operating loss
 
(7,469
)
 
(173,584
)
 
(500
)
—

(161,456
)
Depreciation
 
2,221

 
2,035

 
6,246

 
6,390

Gain on the sale of assets
 
—

 
(155
)
 
—

 
(155
)
Impairment of goodwill
 
—

 
167,000

 
—

 
167,000

Store closing, severance, and executive transition costs
 
—

 
—

 
1,066

 
—

Initial franchise revenues net of provision for losses
 
110

 
5,031

 
145

 
(3,664
)
Adjusted EBITDA
 
$
(5,138
)
 
$
327

 
$
6,957

 
$
8,115

Store Closings
In the first three quarters of 2015, we closed 116 under-performing stores (113 in Hometown and 3 in Outlet), which were unfavorably impacting Adjusted EBITDA by $2.3 million and $4.3 million for the third quarter and first three quarters of 2015, respectively. As a result of these closures, we should be able to improve future profit performance, reduce expenses, and free up working capital.






13-Week Period Ended October 31, 2015 Compared to the 13-Week Period Ended November 1, 2014
Net Sales


23
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

Net sales in the third quarter of 2015 decreased $18.0 million, or 3.2%, to $547.1 million from the third quarter of 2014. This decrease was driven primarily by (1) a 1.6% decrease in comparable store sales, (2) lower initial franchise revenues, which were less than $0.1 million in the third quarter of 2015 compared to $6.5 million in the third quarter of 2014, (3) the impact of closed stores (net of new store openings), and (4) lower online commissions from Sears Holdings ($2.7 million in the third quarter of 2015 compared to $4.2 million in the third quarter of 2014). These declines were partially offset by the discontinuation of layaway in most of our locations as of August 29, 2015 (resulting in recognition of deferred layaway revenue) and a $2.3 million reduction in third quarter 2014 revenues related to the reconciliation of payments between Sears Holdings and SHO.

Commission Sales during the third quarter of 2015 were $9.5 million compared to $14.3 million in the third quarter of 2014. The decline was primarily due to online promotions offered by Sears Holdings during the third quarter of 2014. Adjusted comparable store sales (which include Commission Sales) for the third quarter of 2015 decreased 2.5%. Comparable store sales in Hometown were up 1.1% while comparable store sales in Outlet were down 7.7%. Adjusted comparable store sales were down 0.2% in Hometown and down 7.5% in Outlet. The Adjusted comparable store sales decrease of 2.5% was primarily due to (1) lower Outlet home appliances sales resulting from a highly promotional environment, which impacted the value proposition of "as-is" home appliances as competitors drove price points lower in new, in-box home appliances, (2) lower lawn and garden sales in both segments due to soft performance in the Hometown yard tractor and snow thrower categories and, in Outlet, due to a large decrease in as-is, out-of-box tractor receipts from Sears Holdings, (3) lower tools sales in Hometown due to declines in core categories such as mechanics tool sets, tool storage and compressors despite aggressive promotional pricing, and (4) a decrease in Outlet apparel sales due to inventory mix and a reduction in allocated space within the selling stores. These decreases were partially offset by higher sales in Hometown home appliances (primarily refrigeration), which was driven by aggressive promotional pricing in the market.
Gross Margin

Gross margin was $117.8 million, or 21.5% of net sales, in the third quarter of 2015 compared to $135.1 million, or 23.9% of net sales, in the third quarter of 2014. The decrease in gross margin rate was primarily driven by (1) lower initial franchise revenues, (2) lower margin on merchandise sales in Hometown partially offset by higher margins in Outlet, (3) higher occupancy costs due to a higher number of Company-operated locations, (4) an unfavorable impact of 31 basis points on the third quarter 2015 gross margin rate due to store closings, and (5) lower online commissions from Sears Holdings. These decreases were partially offset by lower merchandise shrink and a $0.9 million net payment to Sears Holdings in the third quarter of 2014 related to the reconciliation of payments between Sears Holdings and SHO. Excluding the impact of online commissions from Sears Holdings, initial franchise revenues, and closed stores, gross margin declined 98 basis points to 21.6% of net sales in the third quarter of 2015 compared to 22.6% of net sales in the third quarter of 2014.

Selling and Administrative Expenses

Selling and administrative expenses decreased to $123.0 million, or 22.5% of net sales, in the third quarter of 2015 from $139.8 million, or 24.7% of net sales, in the prior-year quarter. The decrease was primarily due to a $11.5 million provision for losses on franchisee receivables recognized in the third quarter of 2014, the impact of closed stores (net of new store openings), and lower commissions paid to dealers and franchisees on lower sales volume. These declines were partially offset by higher payroll and benefits due to more Company-operated stores compared to the prior year.

Impairment of Goodwill

During the three months ended November 1, 2014, we recorded a non-cash goodwill impairment charge of $167.0 million associated with the Hometown Reporting Unit. See Note 5 to the Condensed Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for further discussion of the impairment of goodwill. This charge eliminated all of our recorded goodwill.

Operating Loss
We recorded operating losses of $7.5 million and $173.6 million in the third quarters of 2015 and 2014, respectively. As described above, in the third quarter of 2014 we recorded a non-cash goodwill impairment charge of $167.0 million (which eliminated all of our recorded goodwill) and a $11.5 million provision for losses on franchisee receivables. The improvement in our operating loss in the third quarter of 2015 resulted from lower selling and administrative expenses and a smaller provision for losses on franchisee receivables ($0.1 million) partially offset by lower initial franchise revenues, a lower gross margin rate, and

24
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

lower sales volume. Excluding the $167.0 million goodwill impairment charge from the third quarter of 2014 and the provision for losses on franchisee receivables and the initial franchise revenues from both periods, our third quarter 2015 operating loss would have been $7.4 million compared to $1.6 million operating loss in the third quarter of 2014.
Income Taxes
Income tax benefits of $3.5 million and $2.4 million were recorded in the third quarters of 2015 and 2014, respectively. The effective tax rate (benefits) were 47.9% and 1.4% in the third quarters of 2015 and 2014, respectively.
Net Loss
We recorded net losses of $3.8 million for the third quarter of 2015 compared to $171.2 million for the prior-year quarter. The decrease in our net loss was primarily attributable to the factors discussed above.



25
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

39-Week Period Ended October 31, 2015 Compared to the 39-Week Period Ended November 1, 2014
Net Sales

Net sales in the first three quarters of 2015 decreased $44.2 million, or 2.5%, to $1,749.5 million from the first three quarters of 2014. This decrease was driven primarily by a 1.4% decrease in comparable store sales, lower initial franchise revenues, which were $0.3 million in the first three quarters of 2015 compared to $15.2 million in the first three quarters of 2014, and lower online commissions from Sears Holdings ($9.8 million in the first three quarters of 2015 compared to $18.4 million in the first three quarters of 2014).

Commission Sales during the first three quarters of 2015 were $32.4 million compared to $62.4 million in the first three quarters of 2014. The decline was primarily due to online promotions offered by Sears Holdings during the first three quarters of 2014. Adjusted comparable store sales (which include Commission Sales) for the first three quarters of 2015 decreased 3.0%. Comparable store sales in Hometown were down 0.3% while comparable store sales in Outlet were down 4.4%. Adjusted comparable store sales were down 2.3% in Hometown and down 5.0% in Outlet. The Adjusted comparable store sales decrease of 3.0% was primarily due to (1) lower sales in Outlet resulting from a reduction of as-is, out-of-box products receipts from Sears Holdings, and due to a highly promotional environment, which impacted the value proposition of "as-is" home appliances as competitors drove price points lower in new, in-box home appliances, (2) lower lawn and garden sales in both segments due to poor early season in-stock position of outdoor power equipment and soft performance in the yard tractor category in Hometown, and in Outlet, due to a large decrease in as-is, out-of-box tractor receipts from Sears Holdings and lower winter weather-related product sales in the first quarter of 2015, (3) lower tools sales in core Hometown categories such as mechanics tool sets, tool storage, and compressors despite aggressive promotional pricing, and (4) a decline in Outlet apparel sales due to inventory mix and a reduction in allocated space within the selling stores. For the first three quarters of 2015, Adjusted comparable store sales in Hometown home appliances were flat.
Gross Margin

Gross margin was $399.5 million, or 22.8% of net sales, in the first three quarters of 2015 compared to $426.1 million, or 23.8% of net sales, in the first three quarters of 2014. The decrease in gross margin rate was primarily driven by (1) lower initial franchise revenues, (2) lower online commissions from Sears Holdings, (3) lower delivery income, (4) an unfavorable impact of 30 basis points on the gross margin rate through the first three quarters of 2015 due to store closings, and (5) higher occupancy costs due to a higher number of Company-operated locations. These declines were partially offset by higher margin on Outlet merchandise sales and lower merchandise shrink. Excluding the impact of online commissions from Sears Holdings, initial franchise revenues, and closed stores, gross margin improved 39 basis points to 22.7% of net sales in the first three quarters of 2015 compared to 22.3% of net sales in the first three quarters of 2014.
Selling and Administrative Expenses

Selling and administrative expenses decreased to $393.8 million, or 22.5% of net sales, in the first three quarters of 2015 from $414.3 million, or 23.1% of net sales, in the first three quarters of 2014. The decrease was primarily due to (1) an $11.5 million provision for losses on franchisee receivables recognized in the first three quarters of 2014 compared to $0.5 million recognized in the first three quarters of 2015, (2) the impact of closed stores (net of new stores), (3) lower commissions paid to Sears Holdings for online transactions due to lower Commission Sales, and (4) lower commissions paid to dealers and franchisees on lower sales volume. These decreases were partially offset by $1.1 million of executive transition costs incurred during the first three quarters of 2015.

Impairment of Goodwill

During the three quarters of 2014, we recorded a non-cash goodwill impairment charge of $167.0 million associated with the Hometown Reporting Unit. See Note 5 to the Condensed Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for further discussion of the impairment of goodwill. This charge eliminated all of our recorded goodwill.

Operating Loss
We recorded operating losses of $0.5 million and $161.5 million for the first three quarters of 2015 and 2014, respectively. As described above, in the third quarter of 2014 we recorded a non-cash goodwill impairment charge of $167.0 million (which

26
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

eliminated all of our recorded goodwill) and a $11.5 million provision for losses on franchisee receivables. The improvement in our operating loss for the first three quarters of 2015 resulted from lower selling and administrative expenses and a smaller provision for losses on franchisee receivables ($0.5 million) partially offset by lower initial franchise revenues, a lower gross margin rate, and lower sales volume. Excluding the $167.0 million goodwill impairment charge from the first three quarters of 2014 and the provision for losses on franchisee receivables and the initial franchise revenues from both periods, operating loss for the first three quarters of 2015 would have been $0.4 million compared to operating income of $1.9 million in the first three quarters of 2014.
Income Taxes
We recorded an income tax benefit of $0.4 million in the first three quarters of 2015 compared to income tax expense of $2.3 million in the first three quarters of 2014. The effective tax rate was 69.6% (benefit) and 1.4% in the first three quarters of 2015 and 2014, respectively.
Net loss
We recorded net losses of $0.2 million and $164.2 million for the first three quarters of 2015 and 2014, respectively. The decrease in our net loss was primarily attributable to the factors discussed above.


27
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

Business Segment Results
Hometown
Hometown results and key statistics were as follows:
 
13 Weeks Ended
 
39 Weeks Ended
Thousands, except for number of stores
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Net sales
$
379,840

 
$
387,743

 
$
1,251,247

 
$
1,286,532

Comparable store sales % (1)
1.1
%
 
(6.2
)%
 
(0.3
)%
 
(6.2
)%
Cost of sales and occupancy
301,966

 
299,013

 
970,586

 
983,214

Gross margin dollars
77,874

 
88,730

 
280,661

 
303,318

Margin rate
20.5
%
 
22.9
 %
 
22.4
 %
 
23.6
 %
Selling and administrative
85,808

 
103,395

 
277,745

 
307,747

Selling and administrative expense as a percentage of net sales
22.6
%
 
26.7
 %
 
22.2
 %
 
23.9
 %
Impairment of goodwill
—

 
167,000

 
—

 
167,000

Depreciation
901

 
746

 
2,437

 
2,127

Gain on the sale of assets
—

 
(155
)
 
—

 
(155
)
Total costs and expenses
388,675

 
569,999

 
1,250,768

 
1,459,933

Operating income (loss)
$
(8,835
)
 
$
(182,256
)
 
$
479

 
$
(173,401
)
Total Hometown stores
 
 
 
 
1,011

 
1,108

(1) Adjusted comparable store sales for the 13 and 39 weeks ended October 31, 2015 were (0.2)% and (2.3)%, respectively.
13-Week Period ended October 31, 2015 Compared to the 13-Week Period Ended November 1, 2014
Net Sales
Hometown net sales decreased $7.9 million, or 2.0%, to $379.8 million in the third quarter of 2015 from $387.7 million in the third quarter of 2014. The decrease was primarily due to the impact of closed stores (net of new stores) and lower online commissions from Sears Holdings ($2.1 million in the third quarter of 2015 compared to $3.7 million in the third quarter of 2014). These declines were partially offset by a 1.1% increase in comparable store sales, the discontinuation of layaway in most of our locations as of August 29, 2015 (resulting in recognition of deferred layaway revenue), and a $2.3 million reduction in third quarter 2014 revenues related to the reconciliation of payments between Sears Holdings and SHO.
Adjusted comparable store sales (which includes Commission Sales) for the third quarter of 2015 decreased 0.2% primarily due to lower lawn and garden sales resulting from soft performance in the yard tractor and snow thrower categories, and lower tools sales in core categories such as mechanics tool sets, tool storage and compressors despite aggressive promotional pricing.  Sales in home appliances were higher in the third quarter of 2015 primarily due to refrigeration, which was driven by aggressive promotional pricing in the market.
Gross Margin
Gross margin was $77.9 million, or 20.5% of net sales, in the third quarter of 2015 compared to $88.7 million, or 22.9% of net sales, in the prior-year quarter. The gross-margin rate decline was primarily due to (1) lower margin on merchandise sales, (2) higher occupancy costs due to an increase in the number of Company-operated stores, (3) lower online commissions from Sears Holdings, and (4) an unfavorable impact of 37 basis points on the third quarter 2015 gross margin rate due to store closings partially offset by a $2.3 million net payment to Sears Holdings in the third quarter of 2014 related to the reconciliation of payments between Sears Holdings and SHO. Excluding the impact of online commissions from Sears Holdings, initial franchise revenues, and closed stores, gross margin was 20.6% of net sales in the third quarter of 2015 compared to 22.2% of net sales in the third quarter of 2014.

28
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

Selling and Administrative Expenses
Selling and administrative expenses decreased to $85.8 million, or 22.6% of net sales, in the third quarter of 2015 from $103.4 million, or 26.7% of net sales, in the prior-year quarter. The decrease was primarily due to an $11.5 million provision for losses on franchisee receivables recognized in the third quarter of 2014, the impact of closed stores (net of new store openings), and a reduction in dealer and franchisee commissions on lower sales volume partially offset by higher payroll and benefits associated with a higher Company-operated store count.
Since the Separation we have included an allocation of Home Office overhead expenses in Selling and administrative expenses for Hometown and for Outlet. Home Office overhead expenses are primarily comprised of corporate headquarters payroll, benefits, and other costs and include charges related to our Services Agreement with Sears Holdings. In the first quarter of 2015 we adjusted the allocation of these Home Office overhead expenses between Hometown and Outlet to reflect our expected allocation of resources between Hometown and Outlet during the 2015 fiscal year. If the allocation weighting for the third quarter of 2015 had been similar to the weighting for the prior-year quarter we would have allocated an additional $1.0 million of Home Office overhead expenses to Hometown's Selling and administrative expenses. Beginning with this fiscal year we will reevaluate the allocation of Home Office overhead expenses on an annual basis.

Impairment of Goodwill
During the three months ended November 1, 2014, we recorded a non-cash goodwill impairment charge of $167.0 million associated with the Hometown Reporting Unit. See Note 5 to the Condensed Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for further discussion of the impairment of goodwill. This charge eliminated all of our recorded goodwill.
Operating Loss
We recorded operating losses of $8.8 million in the third quarter of 2015 and $182.3 million in the third quarter of 2014. As described above, in the third quarter of 2014 we recorded a non-cash goodwill impairment charge of $167.0 million (which eliminated all of our recorded goodwill) and a $11.5 million provision for losses on franchisee receivables. The improvement in our operating loss in the third quarter of 2015 resulted from lower selling and administrative expenses and a smaller provision for losses on franchisee receivables ($0.1 million) partially offset by a lower gross margin rate, lower sales volume, and lower initial franchise revenues. Excluding the $167.0 million goodwill impairment charge from the third quarter of 2014 and the provision for losses on franchisee receivables and the initial franchise revenues from both periods, our third quarter 2015 operating loss would have been $8.7 million compared to $4.1 million operating loss in the third quarter of 2014.

39-Week Period Ended October 31, 2015 Compared to the 39-Week Period Ended November 1, 2014
Net Sales

Net sales in the first three quarters of 2015 decreased $35.3 million, or 2.7%, to $1,251.2 million from the first three quarters of 2014. This decrease was driven primarily by the impact of closed stores (net of new store openings), lower online commissions from Sears Holdings ($8.0 million in the first three quarters of 2015 compared to $15.7 million in the first three quarters of 2014), and a 0.3% decrease in comparable store sales.

Adjusted comparable store sales (which includes Commission Sales) for the first three quarters of 2015 decreased 2.3% primarily attributable to lower lawn and garden sales due to poor early season in-stock position of outdoor power equipment and soft performance in the yard tractor category, and lower tools sales in core categories such as mechanics tool sets, tool storage, and compressors despite aggressive promotional pricing. For the first three quarters of 2015, Adjusted comparable store sales in home appliances were flat.
Gross Margin

Gross margin was $280.7 million, or 22.4% of net sales, in the first three quarters of 2015 compared to $303.3 million, or 23.6% of net sales, in the first three quarters of 2014. The decrease in gross margin rate was primarily driven by (1) lower online commissions from Sears Holdings, (2) lower margin on merchandise sales, (3) higher occupancy costs due to an increase in the number of Company-operated stores, (4) an unfavorable impact of 34 basis points on the gross margin rate through the first three quarters of 2015 due to store closings, and (5) lower delivery income, partially offset by lower merchandise shrink.

29
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

Excluding the impact of online commissions from Sears Holdings, initial franchise revenues, and closed stores, gross margin declined 34 basis points to 22.3% of net sales in the first three quarters of 2015 compared to 22.7% in the first three quarters of 2014.
Selling and Administrative Expenses

Selling and administrative expenses decreased to $277.7 million, or 22.2% of net sales, in the first three quarters of 2015 from $307.7 million, or 23.9% of net sales, in the first three quarters of 2014. The decrease was primarily due to (1) lower dealer and franchisee commissions on lower sales volume, (2) an $11.5 million provision for losses on franchisee receivables recognized in the first three quarters of 2014 compared to $0.5 million recognized in the first three quarters of 2015, (3) the impact of closed stores (net of new stores openings), and (4) lower commissions paid to Sears Holdings for online transactions due to lower Commission Sales. These decreases were partially offset by higher payroll and benefits and allocated executive transition costs.
Since the Separation we have included an allocation of Home Office overhead expenses in Selling and administrative expenses for Hometown and for Outlet. Home Office overhead expenses are primarily comprised of corporate headquarters payroll, benefits, and other costs and include charges related to our Services Agreement with Sears Holdings. In the first quarter of 2015 we adjusted the allocation of these Home Office overhead expenses between Hometown and Outlet to reflect our expected allocation of resources between Hometown and Outlet during the 2015 fiscal year. If the allocation weighting for the first three quarters of 2015 had been similar to the weighting for the first three quarters of 2014, we would have allocated an additional $3.3 million of Home Office overhead expenses to Hometown's Selling and administrative expenses. Beginning with this fiscal year we will reevaluate the allocation of Home Office overhead expenses on an annual basis.

Impairment of Goodwill

During the three quarters of 2014, we recorded a non-cash goodwill impairment charge of $167.0 million associated with the Hometown Reporting Unit. See Note 5 to the Condensed Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for further discussion of the impairment of goodwill

Operating Income (Loss)
We recorded operating income of $0.5 million and an operating loss of $173.4 million for the first three quarters of 2015 and 2014, respectively. As described above, in the third quarter of 2014 we recorded a non-cash goodwill impairment charge of $167.0 million (which eliminated all of our recorded goodwill) and a $11.5 million provision for losses on franchisee receivables. The improvement in our operating loss for the first three quarters of 2015 resulted from lower selling and administrative expenses and a smaller provision for losses on franchisee receivables ($0.5 million) partially by a lower gross margin rate, lower sales volume, and lower initial franchise revenues. Excluding the $167.0 million goodwill impairment charge from the first three quarters of 2014 and the provision for losses on franchisee receivables and the initial franchise revenues from both periods, operating income in the first three quarters of 2015 would have been $1.1 million compared to $4.8 million operating income in the first three quarters of 2014.

Outlet
Outlet results and key statistics were as follows:

30
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

 
13 Weeks Ended
 
39 Weeks Ended
Thousands, except for number of stores
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Net sales
$
167,303

 
$
177,404

 
$
498,275

 
$
507,162

Comparable store sales % (1)
(7.7
)%
 
9.3
%
 
(4.4
)%
 
(1.4
)%
Cost of sales and occupancy
127,395

 
131,072

 
379,435

 
384,430

Gross margin dollars
39,908

 
46,332

 
118,840

 
122,732

Margin rate
23.9
 %
 
26.1
%
 
23.9
 %
 
24.2
 %
Selling and administrative
37,222

 
36,371

 
116,010

 
106,524

Selling and administrative expense as a percentage of net sales
22.2
 %
 
20.5
%
 
23.3
 %
 
21.0
 %
Depreciation
1,320

 
1,289

 
3,809

 
4,263

Total costs and expenses
165,937

 
168,732

 
499,254

 
495,217

Operating income (loss)
$
1,366

 
$
8,672

 
$
(979
)
 
$
11,945

Total Outlet stores
 
 

 
161

 
149

(1) Adjusted comparable store sales for the 13 and 39 weeks ended October 31, 2015 were (7.5)% and (5.0)%, respectively.
13-Week Period ended October 31, 2015 Compared to the 13-Week Period Ended November 1, 2014
Net Sales
Outlet net sales decreased $10.1 million, or 5.7%, to $167.3 million in the third quarter of 2015 from $177.4 million in the third quarter of 2014. The decrease was primarily due a 7.7% decrease in comparable store sales and lower initial franchise revenues, which were less than $0.1 million in the third quarter of 2015 compared to $6.2 million in the third quarter of 2014, partially offset by new store sales (net of closures).
Adjusted comparable store sales (which includes Commission Sales) decreased 7.5%. The decrease was driven by (1) lower sales in home appliances primarily due to a highly promotional environment, which impacted the value proposition of "as-is" home appliances as competitors drove price points lower in new, in-box home appliances, (2) a decline in apparel sales due to inventory mix and a reduction in allocated space within the selling stores, (3) lower lawn and garden sales due to a large decrease in as-is, out-of-box tractor receipts from Sears Holdings, and (4) lower mattresses sales resulting from actions taken to improve category profitability through less-aggressive promotions.
Gross Margin
Gross margin was $39.9 million, or 23.9% of net sales, in the third quarter of 2015 compared to $46.3 million, or 26.1% of net sales, in the prior year. The gross margin rate decreased in the third quarter of 2015 compared to the prior-year quarter primarily due to lower initial franchise revenues, a $1.4 million expense reduction in the third quarter of 2014 due to the reconcilement of payments between SHO and Sears Holdings, and higher occupancy costs. These decreases were partially offset by higher margin on merchandise sales and lower merchandise shrink. Excluding the impact of online commissions from Sears Holdings, initial franchise revenues, and closed stores, gross margin improved 51 basis points to 23.8% of net sales in the third quarter of 2015 compared to 23.3% of net sales in the third quarter of 2014.
Selling and Administrative Expenses
Selling and administrative expenses increased to $37.2 million, or 22.2% of net sales, in the third quarter of 2015 from $36.4 million, or 20.5% of net sales, in the prior-year quarter. The increase in selling and administrative expenses was primarily due to higher franchisee commissions for stores that we converted from Company-operated to franchisee-operated and expenses associated with new stores partially offset by lower payroll and benefits costs resulting from the conversion of Company-operated stores.
Since the Separation we have included an allocation of Home Office overhead expenses in Selling and administrative expenses for Outlet and for Hometown. Home Office overhead expenses are primarily comprised of corporate headquarters payroll, benefits, and other costs and include charges related to our Services Agreement with Sears Holdings. In the first quarter of 2015 we adjusted the allocation of these Home Office overhead expenses between Outlet and Hometown to reflect

31
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

our expected allocation of resources between Outlet and Hometown during the 2015 fiscal year. If the allocation weighting for the third quarter of 2015 had been similar to the weighting for prior-year quarter we would have reduced Home Office overhead expenses allocated to Outlet's Selling and administrative expenses by $1.0 million. Beginning with this fiscal year we will reevaluate the allocation of Home Office overhead expenses on an annual basis.

Operating Income
We recorded operating income of $1.4 million and $8.7 million in the third quarters of 2015 and 2014, respectively. The decrease in operating income of $7.3 million was driven primarily by lower initial franchise revenues, lower volume, and higher selling and administrative expenses partially offset by a higher gross margin rate (excluding franchise revenues). Excluding initial franchise revenues from both periods, third quarter 2015 operating income would have been $1.4 million compared to $2.5 million operating income in the third quarter of 2014.


39-Week Period Ended October 31, 2015 Compared to the 39-Week Period Ended November 1, 2014
Net Sales

Net sales in the first three quarters of 2015 decreased $8.9 million, or 1.8%, to $498.3 million from the first three quarters of 2014. This decrease was driven primarily by a 4.4% decrease in comparable store sales and lower initial franchise revenues, which were $0.4 million in the first three quarters of 2015 compared to $14.9 million in the first three quarters of 2014, partially offset by new stores (net of closures).

Adjusted comparable store sales (which includes Commission Sales) for the first three quarters of 2015 decreased 5.0% primarily attributable to (1) lower home appliances sales resulting from a reduction of as-is, out-of-box products receipts from Sears Holdings and a highly promotional environment, which impacted the value proposition of "as-is" home appliances as competitors drove price points lower in new, in-box home appliances, (2) a decline in apparel sales due to inventory mix and a reduction in allocated space within the selling stores, (3) lower lawn and garden sales due to a large decrease in as-is, out-of-box tractor receipts from Sears Holdings, and (4) lower winter weather-related product sales in the first quarter of 2015.
Gross Margin

Gross margin was $118.8 million, or 23.9% of net sales, in the first three quarters of 2015 compared to $122.7 million, or 24.2% of net sales, in the first three quarters of 2014. The decrease in gross margin rate was primarily driven by lower franchise revenues and lower delivery income partially offset by (1) higher margin on merchandise sales, (2) lower occupancy costs associated with the conversion of Company-operated to franchisee-operated stores, (3) lower merchandise shrink, and (4) lower distribution center and product repair costs. Excluding the impact of online commissions from Sears Holdings, initial franchise revenues, and closed stores, gross margin improved 215 basis points to 23.7% of net sales in the first three quarters of 2015 compared to 21.5% of net sales in the first three quarters of 2014.
Selling and Administrative Expenses

Selling and administrative expenses increased to $116.0 million, or 23.3% of net sales, in the first three quarters of 2015 from $106.5 million, or 21.0% of net sales, in the first three quarters of 2014. The increase was primarily due to higher franchisee commissions for stores that we converted from Company-operated to franchisee-operated, the impact of new stores (net of closed stores), and allocated executive transition costs partially offset by lower payroll and benefits costs resulting from the conversion of Company-operated stores.
Since the Separation we have included an allocation of Home Office overhead expenses in Selling and administrative expenses for Outlet and for Hometown. Home Office overhead expenses are primarily comprised of corporate headquarters payroll, benefits, and other costs and include charges related to our Services Agreement with Sears Holdings. In the first quarter of 2015 we adjusted the allocation of these Home Office overhead expenses between Outlet and Hometown to reflect our expected allocation of resources between Outlet and Hometown during the 2015 fiscal year. If the allocation weighting for the first three quarters of 2015 had been similar to the weighting for the first three quarters of 2014, we would have reduced

32
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

Home Office overhead expenses allocated to Outlet's Selling and administrative expenses by $3.3 million. Beginning with this fiscal year we will reevaluate the allocation of Home Office overhead expenses on an annual basis.

Operating Income (Loss)
We recorded an operating loss of $1.0 million and recorded operating income of $11.9 million in the first three quarters of 2015 and 2014, respectively. The $12.9 million decrease in operating income was primarily driven by lower initial franchise revenues and higher selling and administrative expenses, partially offset by a higher gross margin rate (excluding initial franchise revenues). Excluding initial franchise revenues from both periods, operating loss for the first three quarters of 2015 would have been $1.4 million compared to $2.9 million operating loss in the first three quarters of 2014.


33
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

Analysis of Financial Condition
Cash and Cash Equivalents
We had cash and cash equivalents of $22.1 million as of October 31, 2015, $23.2 million as of November 1, 2014, and $19.7 million as of January 31, 2015.
For the first three quarters of 2015 we funded ongoing operations with cash on-hand and cash generated by operating activities. Our primary needs for liquidity are to fund inventory purchases and capital expenditures and for general corporate purposes.

Cash Flows from Operating Activities
For the 39 weeks ended October 31, 2015 cash provided by operating activities was $52.5 million compared to $36.1 million for the 39 weeks ended November 1, 2014. The increase in operating cash flow was due predominately to improvements in merchandise payables and payables to Sears Holdings partially offset by an increase in inventory compared to the first three quarters of 2014.

Total merchandise inventories were $448.4 million at October 31, 2015 and $462.2 million at November 1, 2014. Merchandise inventories decreased $11.5 million in Hometown and $2.3 million in Outlet. The decline in Hometown was primarily due to store closures in our Hardware stores compared to the prior year and a reduction in layaway inventory resulting from the discontinuation of the program in the third quarter of 2015. Outlet's reduction was primarily driven by lower home-appliances inventory due a decrease in the number of units on-hand, partially offset by a shift in the mix of receipts resulting in a higher cost per unit, and in apparel due to tighter management of inventory. These decreases were partially offset by higher lawn and garden and housewares inventory due to seasonal buys and an increase in furniture due to vendor and assortment expansion.

We obtain our merchandise through agreements with subsidiaries of Sears Holdings and with other vendors. Merchandise acquired from subsidiaries of Sears Holdings (including Kenmore, Craftsman, DieHard, and other merchandise) accounted for approximately 78% and 82% of total purchases of all inventory from all vendors for the 13 and 39 weeks ended October 31, 2015, respectively. The loss of, or a material reduction in, the amount of merchandise made available to us by Sears Holdings could have a material adverse effect on our business and results of operations. See also "Risk Factors" in this Quarterly Report on Form 10-Q.

In addition, our merchandise-vendor arrangements generally are not long-term (except for the Merchandising Agreement) and none of them guarantees the availability of merchandise inventory in the future. Our growth strategy depends to a significant extent on the willingness and ability of our vendors to supply us with sufficient merchandise inventory. As a result, our success depends, in part, on maintaining or improving relationships with existing vendors to seek to ensure continuity of merchandise inventory and on developing relationships with new vendors, especially with respect to merchandise inventory to be sold by Outlet. If we fail to maintain or improve our relations with our existing vendors or fail to maintain the quality of merchandise inventory they supply us, or if we cannot maintain or acquire new vendors of favored brand-name merchandise inventory, and if we cannot acquire new vendors of merchandise inventory to be sold by Outlet, our ability to obtain a sufficient amount and variety of merchandise at acceptable prices may be limited, which could have a negative impact on our business and could materially affect our results of operations, financial condition, liquidity, and cash flows. In addition, merchandise inventory acquired from alternative sources, if any, may be of a lesser quality and more expensive than the merchandise inventory that we currently purchase.
Cash Flows from Investing Activities
Cash used in investing activities was $13.4 million for the 39 weeks ended October 31, 2015 compared to $9.9 million for the 39 weeks ended November 1, 2014. Cash used in investing activities in both periods was for purchases of property and equipment.
Cash Flows from Financing Activities
Cash used in financing activities was $36.7 million for the 39 weeks ended October 31, 2015 compared to $26.5 million during the 39 weeks ended November 1, 2014. The increase of $10.2 million in cash used by financing activities was primarily

34
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

due to a reduction of $36.7 million in net borrowings under our Senior ABL Facility in 2015 compared to a $25.9 million reduction in 2014.
Financing Arrangement
As of October 31, 2015 we had $47.4 million outstanding under the Senior ABL Facility, which approximated the fair value of these borrowings. The Senior ABL Facility provides (subject to availability under a borrowing base) for maximum borrowings up to the aggregate commitments of all of the lenders, which as of October 31, 2015 totaled $250 million. 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 October 31, 2015 was $196.9 million with $5.7 million of letters of credit outstanding under the facility.

The principal terms of the Senior ABL Facility are summarized below.
Senior ABL Facility
Maturity; Amortization and Prepayments
The Senior ABL Facility will mature on the earlier of (i) October 11, 2017 or (ii) six months prior to the expiration of the Merchandising Agreement and the other agreements with Sears Holdings or its subsidiaries in connection with the Separation that are specified in the Senior ABL Facility, unless such agreements have been extended to a date later than October 11, 2017 or terminated on a basis reasonably satisfactory to the administrative agent under the Senior ABL Facility.
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.
Guarantees; Security
The obligations under the Senior ABL Facility are guaranteed by us and each of our existing and future direct and indirect wholly owned domestic subsidiaries (subject to certain exceptions). The Senior ABL Facility and the guarantees thereunder are secured by a first priority security interest in assets of the borrowers and guarantors consisting primarily of accounts and notes receivable, inventory, cash, cash equivalents, deposit accounts, and securities accounts, as well as certain other assets (other than intellectual property) ancillary to the foregoing and all proceeds of all of the foregoing, including cash proceeds and the proceeds of applicable insurance.
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 our election, either (1) adjusted LIBOR plus a borrowing margin, approximately 2.19% at October 31, 2015, or (2) an alternate base rate plus a borrowing margin, approximately 4.25% at October 31, 2015, with the borrowing margin subject to adjustment based on the average excess availability under the Senior ABL Facility for the preceding fiscal quarter.
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 covenants that, among other things, limit or restrict our ability to, subject to specified exceptions, incur additional indebtedness (including guarantees), grant liens, make investments, make prepayments on other indebtedness, engage in mergers, or change the nature of our business.

The Senior ABL Facility limits SHO's ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends to its stockholders and may repurchase stock if the following conditions are satisfied: either (a) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or as a result of the stock repurchase, (ii) SHO and its subsidiaries that are also borrowers have demonstrated to the reasonable satisfaction of the agent for the lenders that monthly availability (as determined in accordance with the Senior ABL Facility), immediately following the declaration and payment of the cash dividend or the stock repurchase and as projected on a pro forma basis for the twelve months following and after giving effect to the declaration and payment of the cash dividend or the stock repurchase,

35
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

would be at least equal to the greater of (x) 25% of the Loan Cap (which is the lesser of (A) the aggregate commitments of the lenders and (B) the borrowing base) and (y) $50,000,000, and (iii) after giving pro forma effect to the declaration and payment of the cash dividend or the stock repurchase as if it constituted a specified debt service charge, the specified consolidated fixed charge coverage ratio, as calculated on a trailing twelve months basis, would be equal to or greater than 1.1:1.0, or (b) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or the stock repurchase, (ii) payment of the cash dividend or the stock repurchase is not made with the proceeds of any credit extension under the Senior ABL Facility, (iii) during the 120-day period prior to declaration and payment of the cash dividend or the stock repurchase, no credit extension was outstanding under the Senior ABL Facility, and (iv) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that, on a pro forma and projected basis, no credit extensions would be outstanding under the Senior ABL Facility for the 120-day period following the declaration and payment of the cash dividend or the stock repurchase. No default or event of default presently exists. At October 31, 2015 we did not meet either of the foregoing conditions and as a result the Senior ABL Facility does not permit us to pay cash dividends or repurchase our common stock.
The Senior ABL Facility also contains certain affirmative covenants, including financial and other reporting requirements. As of October 31, 2015 we were in compliance with all of the covenants of the Senior ABL Facility.
Events of Default
The Senior ABL Facility includes customary events of default including non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations or warranties, cross default to certain other material indebtedness, bankruptcy and insolvency events, invalidity or impairment of guarantees or security interests, material judgments, change of control, and other events of default including the failure to perform a "Material Contract" (which includes the Merchandising Agreement and other SHO-Sears Holdings Agreements) to the extent required to maintain it in full force and effect and the failure to enforce a Material Contract in accordance with its terms.

Uses and Sources of Liquidity
We believe that our existing cash and cash equivalents, cash flows from our operating activities, and, to the extent necessary, availability under the Senior ABL Facility will be sufficient to meet our anticipated liquidity needs for at least the next 12 months. As of October 31, 2015, we had cash and cash equivalents of $22.1 million. The adequacy of our available funds will depend on many factors, including the macroeconomic environment and the operating performance of our stores.
Capital lease obligations as of October 31, 2015 and November 1, 2014 were $0.3 million and $0.2 million, respectively.
Off-Balance Sheet Arrangements
As of October 31, 2015, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the Securities and Exchange Commission's Regulation S-K.
Recent Accounting Pronouncements
See Part I, Item 1, “Financial Statements—Notes to Condensed Consolidated Financial Statements— Note 1 — Recent Accounting Pronouncements,” for information regarding new accounting pronouncements.
Business Process Outsourcing and Information Systems
During the first quarter SHO entered into a Master Services Agreement with Capgemini U.S. LLC in which Capgemini agrees to provide business process outsourcing services and services for the migration of the current information technology systems and processes provided by Sears Holdings to new, state-of-art business and technology infrastructure and systems primarily provided by NetSuite Inc. We expect the new infrastructure and systems will provide greater strategic and operational flexibility, provide better control of our systems and processes, reduce our total cost of information-system ownership over the term of the Master Services Agreement, and reduce some of the risks inherent in our services relationship with, and reduce our dependence on, Sears Holdings.   

Our plan and expectation is that the new infrastructure and systems will be fully operational by the end of our 2016 fiscal year, well in advance of the April 2018 termination date of our Services Agreement with Sears Holdings.  The new infrastructure and systems will enable us, and we currently intend, to replace many of the corporate services provided by Sears Holdings with services provided by Capgemini, other third-party providers, and, on a limited-basis, internally by SHO.  The replaced services could include tax, accounting, non-merchandise procurement, risk management and insurance, advertising

36
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

and marketing, human resources, loss prevention, environmental, product and human safety, facilities, information technology, online, payment clearing, and other financial, real estate management, merchandising, and other support services.

We expect to incur increases in capital expenditures and corporate expenses in fiscal 2015 and in fiscal 2016 as a result of the migration to the new infrastructure and systems.  As we report our results, we intend to report on the expenses related to the migration when we believe that disclosure is material or will aid the understanding of our financial condition and results of operations. Selling and administrative expenses related to business process outsourcing ("BPO") were $0.6 million and $1.3 million for the third quarter and first three quarters of 2015, respectively. For the first three quarters of 2015, BPO capital expenditures were $8.3 million.

The migration to the new infrastructure and systems involves significant risks for us, such as with respect to, among other things, the following: conversion and migration of data; availability and customization of solutions; availability of Company personnel and other resources to manage and implement the project; expansion of migration, implementation, and operational scope, cost, and timing; disagreements with Capgemini regarding its contractual rights and obligations and the contractual rights and obligations of its contractors (such as NetSuite Inc.); the amount, quality, and timing of cooperation that we receive from Sears Holdings with respect to the migration; and disruption of our day-to-day business activities. These risks and other risks with respect to the project could have a material adverse effect on our business and results of operations.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements preceded or followed by, or that otherwise include, the words "believes," "expects," "anticipates," "intends," "project," "estimates," "plans," "forecast," "is likely to," and similar expressions or future or conditional verbs such as "will," "may," "would," "should," and "could" are generally forward-looking in nature and not historical facts. The forward-looking statements are subject to significant risks and uncertainties that may cause our actual results, performance, and achievements in the future to be materially different from the future results, future performance, and future achievements expressed or implied by the forward-looking statements. The forward-looking statements include, without limitation, information concerning our future financial performance, business strategies, plans, goals, beliefs, expectations, and objectives. The forward-looking statements are based upon the current beliefs and expectations of our management.
The following factors, among others, could cause our actual results, performance, and achievements to differ materially from those expressed in the forward-looking statements, and one or more of the differences could have a material adverse effect on our ability to operate our business and could have a material adverse effect on our results of operations, financial condition, liquidity, and cash flows: the possible material adverse effects on SHO if Sears Holdings’ financial condition were to significantly deteriorate, including if as a consequence Sears Holdings were to choose to seek the protection of the U.S. bankruptcy laws; our ability to offer merchandise and services that our customers want, including those under the KCD Marks; the Merchandising Agreement provides that (1) if a third party that is not an affiliate of Sears Holdings acquires the rights to one or more (but less than all) of the KCD Marks Sears Holdings may terminate our rights to buy merchandise branded with any of the acquired KCD Marks and (2) if a third party that is not an affiliate of Sears Holdings acquires the rights to all of the KCD Marks Sears Holdings may terminate the Merchandising Agreement in its entirety, over which events we have no control; the sale by Sears Holdings and its subsidiaries to other retailers that compete with us of major home appliances and other products branded with one of the KCD Marks; the willingness and ability of Sears Holdings to fulfill its contractual obligations to us; our ability to successfully manage our inventory levels and implement initiatives to improve inventory management and other capabilities; competitive conditions in the retail industry; worldwide economic conditions and business uncertainty, the availability of consumer and commercial credit, changes in consumer confidence, tastes, preferences and spending, and changes in vendor relationships; the fact that our past performance generally, as reflected on our historical financial statements, may not be indicative of our future performance as a result of, among other things, the consolidation of Hometown and Outlet into a single business entity, the Separation, and operating as a standalone business entity; the impact of increased costs due to a decrease in our purchasing power following the Separation, and other losses of benefits (such as a more effective and productive business relationship with Sears Holdings) that were associated with having been wholly owned by Sears Holdings and its subsidiaries prior to the Separation; our continuing reliance on Sears Holdings for most products and services that are important to the successful operation of our business, and our potential need to rely on Sears Holdings for some products and services beyond the expiration, or earlier termination by Sears Holdings, of our agreements with Sears Holdings; the willingness of Sears Holdings' appliance, lawn and garden, tools, and other vendors to continue to supply to Sears Holdings, on terms (including vendor payment terms for Sears Holdings' merchandise purchases) that are acceptable to it and to us, merchandise that we would need to purchase from Sears Holdings to ensure continuity of merchandise supplies for our

37
SEARS HOMETOWN AND OUTLET STORES, INC.
13 and 39 Weeks Ended October 31, 2015 and November 1, 2014

businesses; the willingness of Sears Holdings’ appliance, lawn and garden, tools, and other vendors to continue to pay to Sears Holdings merchandise-related subsidies and allowances and cash discounts (some of which Sears Holdings is obligated to pay to us); our ability to obtain the resolution, on commercially reasonable terms, of existing disputes and, when they arise, future disputes with Sears Holdings regarding many of the material terms and conditions of our agreements with Sears Holdings; our ability to establish information, merchandising, logistics, and other systems separate from Sears Holdings that would be necessary to ensure continuity of merchandise supplies for our businesses if vendors were to reduce, or cease, their merchandise sales to Sears Holdings or if Sears Holdings were to reduce, or cease, its merchandise sales to us; if Sears Holdings' sales of major appliances and lawn and garden merchandise to its retail customers decline Sears Holdings' sales to us of outlet-value merchandise could decline; our ability to establish a more effective and productive business relationship with Sears Holdings, particularly in light of the existence of pending, and the likelihood of future, disputes with respect to the terms and conditions of our agreements with Sears Holdings; most of our agreements related to the Separation and our continuing relationship with Sears Holdings were negotiated while we were a subsidiary of Sears Holdings, and we may have received different terms from unaffiliated third parties (including with respect to merchandise-vendor and service-provider indemnification and defense for negligence claims and claims arising out of failure to comply with contractual obligations); our reliance on Sears Holdings to provide computer systems to process transactions with our customers (including the point-of-sale system for the stores we operate and the stores that our independent dealers and franchisees operate, which point-of-sale system captures, among other things, credit-card information supplied by our customers) and others, quantify our results of operations, and manage our business ("SHO's SHC-Supplied Systems"); SHO's SHC-Supplied Systems could be subject to disruptions and data/security breaches (Kmart, owned by Sears Holdings, announced in October 2014 that its payment-data systems had been breached), and Sears Holdings could be unwilling or unable to indemnify and defend us against third-party claims and other losses resulting from such disruptions and data/security breaches, which could have one or more material adverse effects on SHO; limitations and restrictions in the Senior ABL Facility and related agreements governing our indebtedness and our ability to service our indebtedness; our ability to obtain additional financing on acceptable terms; our dependence on the ability and willingness of our independent dealers and independent franchisees to operate their stores profitably and in a manner consistent with our concepts and standards; our ability to sell profitably online all of our merchandise and services; our dependence on sources outside the U.S. for significant amounts of our merchandise inventories; fixed-asset impairment for long-lived assets; our ability to attract, motivate, and retain key executives and other employees; our ability to maintain effective internal controls as a publicly held company; our ability to realize the benefits that we expect to achieve from the Separation; litigation and regulatory trends challenging various aspects of the franchisor-franchisee relationship in the fast-food industry could expand to challenge or adversely affect our relationships with our independent dealers and independent franchisees; low trading volume of our common stock due to limited liquidity or a lack of analyst coverage; and the impact on our common stock and our overall performance as a result of our principal stockholders' ability to exert control over us.
The foregoing factors should not be understood as exhaustive and should be read in conjunction with the other cautionary statements, including the "Risk Factors," that are included in this Quarterly Report on Form 10-Q and in the 2014 10-K and in our other filings with the Securities and Exchange Commission and our other public announcements. While we believe that our forecasts and assumptions are reasonable, we caution that actual results may differ materially. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Consequently, actual events and results may vary significantly from those included in or contemplated or implied by our forward-looking statements. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly update or review any forward-looking statement made by us or on our behalf, whether as a result of new information, future developments, subsequent events or circumstances, or otherwise, except as required by law.

38

Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are subject to interest rate risk associated with our Senior ABL Facility, which requires us to pay interest on outstanding borrowings at variable rates. Assuming our Senior ABL Facility were fully drawn in principal amount equal to $250 million, each one percentage point change in interest rates payable with respect to the Senior ABL Facility would result in a $2.5 million change in annual cash interest expense with respect to our Senior ABL Facility.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the 39 weeks ended October 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION

Item 1. Legal Proceedings
As of the date of this Quarterly Report on Form 10-Q we are not party to any litigation that we consider material to our operations.
Notwithstanding the above, from time to time we are, and will continue to be, subject to various legal claims, including those alleging wage and hour violations, payroll violations, employment discrimination, unlawful employment practices, Americans with Disabilities Act claims, Family and Medical Leave Act claims, product liability claims as a result of the sale of merchandise and services, claims with respect to franchise and dealer transactions, relationships, operations, and terminations as well as various legal and governmental proceedings. Some of these claims from time to time include, and will continue to include, class or collective-action allegations, and the proceedings for some of these claims are, and will continue to be, in jurisdictions with reputations for aggressive application of laws and procedures against corporate defendants. Litigation is inherently unpredictable. Each proceeding, claim, and regulatory action against us, whether meritorious or not, could be time consuming, result in significant legal expenses, require significant amounts of management time, result in the diversion of significant operational resources, require changes in our methods of doing business that could be costly to implement, reduce our net sales, increase our expenses, require us to make substantial payments to settle claims or satisfy judgments, require us to cease conducting certain operations or offering certain products in certain areas or generally, and otherwise harm our business, results of operations, financial condition, and cash flows, perhaps materially. See also "Cautionary Statement Regarding Forward-Looking Information" and "Risk Factors" in this Quarterly Report on Form 10-Q.


Item 1A. Risk Factors

There have been no material changes from the risk factors previously disclosed in the 2014 10-K. However, the risks described in “Risk Factors” beginning on page 8 of the 2014 10-K and the risks described in "Risk Factors" in our Quarterly Reports on Form 10-Q for the first and the second quarters of 2015 should be carefully considered. Those risks could materially affect our results of operations, financial condition, liquidity, and cash flows. Those risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Cautionary Statement Regarding Forward-Looking Information,” and the risks to our businesses described elsewhere, in this Quarterly Report on Form 10-Q.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Share Repurchases
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

39

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. At October 31, 2015 the Senior ABL Facility prohibited cash dividends and the repurchase of our common stock.
Shares that are repurchased by the Company pursuant to the repurchase program will be retired and will resume the status of authorized and unissued shares of common stock.
The Company did not repurchase any shares during the 39 weeks ended October 31, 2015. As of October 31, 2015 we had approximately $12.5 million of remaining authorization under the repurchase program.
The Senior ABL Facility limits SHO's ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends to its stockholders and may repurchase stock if the following conditions are satisfied: either (a) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or as a result of the stock repurchase, (ii) SHO and its subsidiaries that are also borrowers have demonstrated to the reasonable satisfaction of the agent for the lenders that monthly availability (as determined in accordance with the Senior ABL Facility), immediately following the declaration and payment of the cash dividend or the stock repurchase and as projected on a pro forma basis for the twelve months following and after giving effect to the declaration and payment of the cash dividend or the stock repurchase, would be at least equal to the greater of (x) 25% of the Loan Cap (which is the lesser of (A) the aggregate commitments of the lenders and (B) the borrowing base) and (y) $50,000,000, and (iii) after giving pro forma effect to the declaration and payment of the cash dividend or the stock repurchase as if it constituted a specified debt service charge, the specified consolidated fixed charge coverage ratio, as calculated on a trailing twelve months basis, would be equal to or greater than 1.1:1.0, or (b) (i) no specified default then exists or would arise as a result of the declaration or payment of the cash dividend or the stock repurchase, (ii) payment of the cash dividend or the stock repurchase is not made with the proceeds of any credit extension under the Senior ABL Facility, (iii) during the 120-day period prior to declaration and payment of the cash dividend or the stock repurchase, no credit extension was outstanding under the Senior ABL Facility, and (iv) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that, on a pro forma and projected basis, no credit extensions would be outstanding under the Senior ABL Facility for the 120-day period following the declaration and payment of the cash dividend or the stock repurchase.
The Senior ABL Facility also imposes various other requirements, such as a cash dominion requirement and a requirement that the fixed charge ratio at the last day of any quarter be not less than 1.0 to 1.0, which take effect if availability falls below designated thresholds and which may limit our ability to make share repurchases.


Item 5. Other Information
    
Subsequent Events

In the fourth quarter of 2015 the Company began discussions and reached oral understandings with two franchisees pursuant to which the Company would repurchase a total of 23 franchised locations. The oral understandings are subject to the negotiation, execution, and delivery by the Company and the franchisees of definitive asset purchase and termination agreements which would terminate the franchise agreements and sublease arrangements for the affected locations. The definitive agreements would provide as part of these transactions that the Company would purchase store furniture, fixtures, and equipment for a total of $0.7 million. As of the end of the third quarter of 2015 the franchisees of the affected locations were obligors on promissory notes payable to the Company with unpaid principal amounts totaling approximately $11.8 million, for which franchisee note receivables the Company carried no reserves.  If the Company and the franchisees were to negotiate, execute, and deliver the necessary definitive agreements (the likelihood of which the Company is unable to predict with certainty), the Company expects that these transactions would be completed in the fourth quarter of 2015 and expects that the Company would write-off the franchisee note receivable balances net of the value of any reaquisition rights and the value of the furniture, fixtures, and equipment that the Company would purchase. The Company currently estimates that the loss associated with the write-off of these franchisee note receivable balances would be between $8.0 and $10.0 million.


Item 6. Exhibits

40

The Exhibits listed in the accompanying “Exhibit Index” have been filed as part of this Quarterly Report on Form 10-Q.


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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
Sears Hometown and Outlet Stores, Inc.
 
 
By:
 
/S/ RYAN D. ROBINSON
Name:
 
Ryan D. Robinson
Title:
 
Senior Vice President and Chief Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
 
Date:
 
December 3, 2015


42
SEARS HOMETOWN AND OUTLET STORES, INC.
EXHIBIT INDEX



Exhibit Number
Document Description
*10.1
Amended and Restated Executive Severance Agreement between the Registrant and David Buckley dated October 1, 2015.
*10.2
Offer letter from the Registrant to Michael McCarthy dated September 3, 2015.
*10.3
Executive Severance Agreement between the Registrant and Michael McCarthy dated September 3, 2015.
*31.1
Certification of Chief Executive Officer Required Under Rule 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of 1934, as amended.
*31.2
Certification of Chief Financial Officer Required Under Rule 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of 1934, as amended.
*32
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished only).
**101
The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2015, formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) the Condensed Consolidated Statements of Operations (Unaudited) for the 13 and 39 Weeks Ended October 31, 2015 and November 1, 2014; (ii) the Condensed Consolidated Balance Sheets (Unaudited) at October 31, 2015, November 1, 2014, and January 31, 2015; (iii) the Condensed Consolidated Statements of Cash Flows (Unaudited) for the 13 and 39 Weeks Ended October 31, 2015 and November 1, 2014; (iv) the Condensed Combined Statements of Stockholders' Equity (Unaudited) for the 13 and 39 Weeks Ended October 31, 2015 and November 1, 2014; and (v) the Notes to the Condensed Consolidated Financial Statements (Unaudited).


* Filed herewith.
** Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.


43


Exhibit 10.1
Amended and Restated Executive Severance Agreement

September 21, 2015

This Amended and Restated Executive Severance Agreement (this “Agreement”) is between Sears Hometown and Outlet Stores, Inc. (together with its subsidiaries “SHO”) and David Buckley (“Executive”).

Preliminary Statement

Executive has been assigned additional job responsibilities, and with respect to this promotion Executive received an increase in annual base salary. This Agreement supersedes and replaces Executive’s Executive Severance Agreement dated June 8, 2012 between Executive and Sears Holdings Corporation (which had been assigned to, and assumed by, SHO).

Terms and Conditions

Executive and SHO, intending to be legally bound and for good and valuable consideration, agree as follows:

1.
Benefits Upon Termination of Employment.

a.Severance Benefits. If Executive’s employment is involuntarily terminated without Cause or Executive voluntarily terminates Executive’s employment for Good Reason (as such terms are defined in Section 2 below), Executive will be entitled to the benefits described in Sections 1(a)(i) and (ii) below (collectively, the “Severance Benefits”). Executive will not be entitled to the Severance Benefits if Executive’s employment terminates for any other reason, including for Cause or due to death or Disability (as defined in Section 2 below). Executive will not be entitled to Severance Benefits if Executive does not meet all of the other requirements of this Agreement, including those of Section 4(g).

i.Continuation of Salary

1.SHO will pay Executive cash severance in an amount equal to six (6) months of Executive’s annual base salary at the rate in effect on the date on which Executive’s employment terminates (the “Date of Termination”). The amount determined in accordance with the preceding sentence (the “Salary Continuation Amount”) will be paid upon the satisfaction of the following conditions: (A) Executive’s Separation from Service (as defined in Section 2 below) has occurred; and (B) the Revocation Period (as defined in Appendix B to this Agreement) has expired. If the foregoing conditions have been satisfied, SHO will pay the Salary Continuation Amount in substantially equal installments on each regular salary payroll date for a period of six (6) months (the “Salary Continuation Period”), except as otherwise provided in this Agreement.

2.Notwithstanding the foregoing, to the extent Executive’s termination is as a result of an event that would trigger payments under a then-current and applicable transition pay or severance plan or program (the “Other Severance Program”) under which Executive would have been eligible for severance pay and benefits for a period longer than the Salary Continuation Period, and provided the severance pay under the Other Severance Program is greater than the Salary Continuation Amount, then the Salary Continuation Amount and the Salary Continuation Period for purposes of this Agreement will be the greater amount and the longer period provided by the Other Severance Program, except as otherwise provided in this Agreement.

3.Further and notwithstanding the foregoing, the SHO obligations that may become due under this Section 1(a)(i) will be reduced on a dollar-for-dollar basis (but not below zero), by the amount, if any, of salary or wages that Executive earns from a subsequent employer (including those arising from self-employment) during the Salary Continuation Period other than all approved external




director fees that Executive earns or is otherwise entitled to receive. Executive will not be obligated to seek affirmatively or accept an employment, contractor, consulting or other arrangement in order to mitigate the Salary Continuation Amount. Further, to the extent Executive does not execute and timely submit the General Release and Waiver (in accordance with Section 4(g) below) by the deadline specified therein, Salary Continuation Amount payments will terminate, and any entitlement to future Salary Continuation Amount payments will be forfeited, and Executive will be required to reimburse SHO for any portion of the Salary Continuation Amount already paid to Executive.

4.Notwithstanding anything in this Section 1(a)(i) to the contrary, if the Salary Continuation Amount payable to Executive in accordance with Section 1(a)(i) during the six (6) months after Executive’s Separation from Service would exceed the Section 409A Threshold and if as of the date of the Separation from Service Executive is a Specified Employee (as such terms are defined in Section 2 below), then payment will be made to Executive on each regular salary payroll date during the first six (6) months of the Salary Continuation Period until the aggregate amount received equals the Section 409A Threshold. Any portion of the Salary Continuation Amount that is in excess of the Section 409A Threshold and that would otherwise be paid during such six (6) months will instead be paid to Executive in a lump sum payment on the date that is six (6) months and one (1) day after the date of Executive’s Separation from Service.

5.All Salary Continuation Amount payments (described under this Section 1(a)(i)) will terminate if Executive is employed by a SHO Competitor or SHO Vendor (as such terms are defined in Sections 4(c)(ii) and 4(d)(ii) herein, respectively) during the Salary Continuation Period (which for purposes of this Section 1(a)(i)(3) will not exceed six (6) months), or in the event of Executive’s breach of this Agreement (in accordance with Section 10 below). In either case, Executive will be required to reimburse SHO for any portion of the Salary Continuation Amount already paid to Executive.

ii.
Continuation of Benefits.

1.During the Salary Continuation Period and subject to the next sentence, Executive will be entitled to participate in all benefit plans and programs (except as specified in this Section 1(a)(ii)) in which Executive was eligible to participate immediately prior to the Date of Termination (subject to the terms and conditions in effect from time to time and the continued availability and applicability of such plans and programs to former employees who are not active employees of SHO). Executive will not be eligible to participate in the long-term disability plan, health care flexible spending account (except on an after-tax basis and only through the earlier of the end of Salary Continuation Period or the calendar year in which the Separation from Service occurs), SHO-paid life insurance, any 40l(k) savings plan maintained by SHO (or any other defined contribution plan sponsored by SHO), or any other plan or benefit that by its terms or in accordance with law is not applicable to former employees who are not active employees of SHO. SHO’s current medical, dental, and vision plans provide COBRA-only coverage for former employees who are not active employees of SHO. If at the Date of Termination COBRA coverage is the only coverage available under SHO’s then-current medical and dental plans, Executive and Executive’s eligible dependents will be eligible during the Salary Continuation Period for COBRA coverage under the then-current plans, with Executive’s percentage share of the cost of COBRA premiums to be the same as the percentage share that Executive paid for medical, dental, and vision plan coverage immediately prior to the Date of Termination.

2.If Executive does not timely execute and submit the General Release and Waiver (in accordance with Section 4(g) herein) by the deadline specified therein, Executive will be required to reimburse SHO for the portion of the cost for the benefits referred to under Section 1(a)(ii)(l) immediately above paid by SHO during the Salary Continuation Period, and Executive will instead be eligible for COBRA coverage under the SHO medical, dental, and vision plans as of the Date of Termination. Executive will be responsible for the full cost of COBRA premiums if this Section 1(a)(ii)(2) is applicable.





3.Subject to Section 1(a)(ii)(4) immediately below, if Executive provides services to another employer and is covered by such employer’s health benefits plan or program, the medical and dental benefits provided by SHO hereunder will be secondary to such employer’s health benefits plan or program in accordance with the terms of the SHO health benefit plans.

4.All of the benefits described in this Section 1(a)(ii) will terminate, and any entitlements to future such payments will be forfeited, if Executive is employed by a SHO Competitor or a SHO Vendor during the Salary Continuation Period (which for purposes of this Section 1(a)(ii)(4) will not exceed six (6) months) or in the event of Executive’s breach of this Agreement (in accordance with Section 10 below). In either case, Executive will be required to reimburse SHO for any portion of the cost for the benefits referred to under Section 1(a)(ii)(1) immediately above paid by SHO during the Salary Continuation Period, and Executive will instead be eligible for COBRA continuation coverage under the SHO medical, dental, and vision plans as of Executive’s Severance from Service date. Executive will be responsible for the full cost of COBRA premiums if this Section 1(a)(ii)(4) is applicable.

iii.Other. In addition to the foregoing Severance Benefits, a lump sum payment will be made to Executive not later than Executive’s next regular salary payroll date following the Date of Termination in an amount equal to the sum of any base salary and any vacation benefits that have accrued through the Date of Termination but only to the extent not already paid. No vacation will accrue during the Salary Continuation Period. No payment will be made with respect to unused “personal” days. Notwithstanding the foregoing and anything herein to the contrary, in the event of Executive’s death during the Salary Continuation Period, any unpaid portion of the Salary Continuation Amount payable in accordance with Section 1(a)(i) above will be paid in a lump sum, within sixty (60) days of death (and no later than amounts would have been paid absent death), to Executive’s estate, and any eligible dependents who are covered dependents as of the date of death will experience a qualifying event under COBRA as a result of such death.

iv.
Impact of Termination on Certain Other Plans/Programs.

1.Annual Incentive Plan. Upon the Date of Termination, Executive’s entitlement to any award under SHO’s Annual Incentive Plan (the “AIP”) or other applicable annual incentive plan sponsored by SHO will be determined in accordance with the terms and conditions of the AIP or other plan document regarding termination of employment.

2.Long-Term Incentive Program. Upon the Date of Termination, Executive’s entitlement to any award granted to Executive under SHO’s Long-Term Incentive Program (the “LTIP) or other applicable long-term incentive program sponsored by SHO will be determined in accordance with the terms and conditions of the applicable award letter and the LTIP or other plan document regarding termination of employment.

3.Stock Plan. Upon the Date of Termination, Executive’s entitlement to any unvested options, restricted stock, or other award granted to Executive under SHO’s 2012 Amended and Restated Stock Plan or other stock plan sponsored by SHO will be determined in accordance with the terms and conditions of the applicable award agreement and the stock plan document regarding termination of employment.

v.Post-Termination Forfeiture of Severance Benefits. If SHO determines after the Date of Termination that Executive engaged in activity during employment with SHO that SHO determines constituted Cause, Executive will immediately cease to be eligible for Severance Benefits and will be required to reimburse SHO for any portion of Severance Benefits received by Executive during the Salary Continuation Period.





2.
Definitions. For purposes of this Agreement, each capitalized term herein is either defined in the section, exhibit, or Appendix in which it first appears or in this Section 2. The following capitalized terms will have the definitions as set forth below:

a.“Cause” means (i) a material breach by Executive (other than a breach resulting from Executive’s incapacity due to a Disability) of Executive’s duties and responsibilities to SHO, including under an offer letter or comparable document (if any, together the “Offer Letter”), which breach is demonstrably willful and deliberate on Executive’s part, is committed in bad faith or without reasonable belief that such breach is in the best interests of SHO, and is not remedied in a reasonable period of time after receipt of written notice from SHO specifying such breach; (ii) Executive’s conviction of a felony involving moral turpitude; or (iii) Executive’s dishonesty or willful misconduct in connection with Executive’s employment.

b.“Disability” means disability as defined under the SHO long-term disability plan in effect as of the date of execution of this Agreement (regardless of whether Executive is a participant under such plan).

c.“Good Reason” means, without Executive’s written consent, (i) a reduction of more than ten percent (10%) in the sum of Executive’s annual base salary and target annual incentive under the AIP from those in effect as of the date of this Agreement; (ii) Executive’s mandatory relocation to an office more than fifty (50) miles from the primary location at which Executive is required to perform Executive’s duties immediately prior to the date of this Agreement; or (iii) any other action or inaction that constitutes a material breach of the terms of Executive’s employment with SHO, including under the Offer Letter, by SHO or its successor, including failure of a successor company to assume or fulfill the obligations under this Agreement. In each case, Executive must provide SHO with written notice of the facts giving rise to a claim that Good Reason exists for purposes of this Agreement within thirty (30) days of the initial existence of such Good Reason event, and SHO will have a right to remedy such event within sixty (60) days after receipt of Executive’s written notice (the “Sixty (60)-Day Period”). If SHO remedies the Good Reason event within the Sixty (60)-Day Period, the Good Reason event (and Executive’s right to receive any benefit under this Agreement on account of termination of employment for Good Reason) will cease to exist. If SHO does not remedy the Good Reason event within the Sixty (60)-Day Period, and Executive does not incur a termination of employment within thirty (30) days following the earlier of: (y) the date SHO notifies Executive that it does not intend to remedy the Good Reason or does not agree that there has been a Good Reason event, or (z) the date on which the Sixty (60)-Day Period expires, the Good Reason event (or any claim of Good Reason) will cease to exist. Notwithstanding the foregoing, if Executive fails to provide written notice to SHO of the facts giving rise to a claim of Good Reason within thirty (30) days of the initial existence of such Good Reason event, the Good Reason event (and Executive’s right to receive any benefit under this Agreement on account of termination of employment for Good Reason) will cease to exist as of the thirty-first (31st) day following the later of its occurrence or Executive’s knowledge thereof. If Executive terminates Executive’s employment under clause (i) of this definition, Executive’s annual base salary rate for purposes of Section 1 hereof will be Executive’s annual base salary rate in effect prior to the reduction that triggered the applicability of such Good Reason event.

d.“SHO Affiliate” means any person with whom SHO is considered to be a single employer under Section 414 (b) of the Internal Revenue Code (the “Code”) and all persons with whom SHO would be considered a single employer under Code Section 414 (c), substituting “50%” for the “80%” standard that would otherwise apply.

e.“Section 409A Threshold” means an amount equal to two (2) times the lesser of (i) Executive’s base salary for services provided to SHO as an employee for the calendar year preceding the calendar year in which Executive has a Separation from Service; or (ii) the maximum amount that may be taken into account under a qualified plan in accordance with Code Section 40l (a)(17) for the calendar year in which Executive has a Separation from Service. In all events, this amount will be limited to the amount specified under Treasury Regulation Section 1.409A-1(b)(9)(iii)(A) or any successor thereto.





f.“Separation from Service” means a “Separation from Service” from SHO within the meaning of Code Section 409A (and regulations issued thereunder). Notwithstanding anything herein to the contrary, the fact that Executive is treated as having incurred a Separation from Service under Code Section 409A and the terms of this Agreement will not be determinative, or in any way affect the analysis, of whether Executive has retired, terminated employment, separated from service, incurred a severance from employment or become entitled to a distribution, under the terms of any retirement plan (including pension plans and 401(k) savings plans) maintained by SHO.

g.“Specified Employee” has the meaning set forth under Code Section 409A (and regulations issued thereunder).

3.
Intellectual Property Rights. Executive acknowledges that Executive’s development work or research on any and all inventions or expressions of ideas that may or may not be eligible for patent, copyright, trademark or trade secret protection, hereafter made or conceived solely or jointly within the scope of employment at SHO, provided such invention or expression of an idea relates to the business of SHO, or relates to actual or demonstrably anticipated research or development of SHO, or results from any work performed by Executive for or on behalf of SHO, are hereby assigned to SHO, including Executive’s entire rights, title and interest. Executive will promptly disclose such invention or expression of an idea to Executive’s management and will, upon request, promptly execute a specific written assignment of title to SHO. If Executive currently holds any inventions or expressions of an idea, regardless of whether they were published or filed with the U.S. Patent and Trademark Office or the U.S. Copyright Office, or is under contract to not so assign, Executive will list them on the last page of this Agreement.

4.
Protective Covenants. Executive acknowledges that this Agreement provides for additional consideration beyond what SHO is otherwise obligated to pay to Executive. In consideration of the opportunity to receive the Severance Benefits, and other good and valuable consideration, Executive agrees to the following:

a.Non-Disclosure of SHO Confidential Information. Executive acknowledges and agrees to be bound by the following, whether or not Executive receives any Severance Benefits under this Agreement:

i.Non-Disclosure. Subject to Section 11, Executive will not, during the term of Executive’s employment with SHO or thereafter, other than in the performance of Executive’s duties and obligations to SHO, including under the Offer Letter, during Executive’s employment with SHO, as required by law or legal process, or as SHO may otherwise consent to or direct in writing, reveal, disclose, sell, use, lecture upon or publish any SHO Confidential Information (as defined in Section 4(a)(iii) below) until such time as the information becomes publicly known other than as a result of its disclosure, directly or indirectly, by Executive.

ii.Proprietary Information. Subject to Section 11, Executive understands that if Executive possesses any proprietary information of another person or company as a result of prior employment or otherwise, SHO expects and requires that Executive will honor any and all legal obligations that Executive has to that person or company with respect to proprietary information, and Executive will refrain from any unauthorized use or disclosure of such information.

iii.SHO Confidential Information. For purposes of this Agreement, “SHO Confidential Information” means trade secrets and non-public information which SHO designates as being confidential or which, under the circumstances, should be treated as confidential, including any information received in confidence from or developed by SHO, its long and short term goals, vendor and supply agreements, databases, methods, programs, techniques, business information, financial information, marketing and business plans, proprietary software, personnel information and files, client information, pricing, and other information relating to the business of SHO that is not known generally




to the public or in the industry.

iv.Return of SHO Property. All documents and other property that relate to the business of SHO are the exclusive property of SHO, even if Executive authored or created them. Executive agrees to return all such documents and tangible property to SHO upon termination of employment or at such earlier time as SHO may request that Executive do so.

v.Conflict of Interest. During Executive’s employment with SHO and during any Salary Continuation Period (which for purposes of this Section 4(a)(v) will not exceed six (6) months), except as may be approved in writing by SHO, neither Executive nor members of Executive’s immediate family (which will refer to Executive, any spouse, and any child) will have financial investments or other interests or relationships with SHO or any customers, suppliers or competitors which might impair Executive’s independence of judgment on behalf of SHO. Also during Executive’s employment with SHO during any Salary Continuation Period, Executive agrees not to engage in any activity in competition with SHO and to avoid any outside activity that could adversely affect the independence and objectivity of Executive’s judgment, interfere with the timely and effective performance of Executive’s duties and responsibilities to SHO, or that could otherwise conflict with the best interests of SHO.

b.Non-Solicitation of Employees. During Executive’s employment with SHO and for twelve (12) months following the Date of Termination, whether or not Executive receives any Severance Benefits under this Agreement, Executive will not, directly or indirectly, solicit or encourage any SHO employee to leave the employee’s employment with SHO, or assist in any way with the hiring of any SHO employee by any future employer or other entity.

c.Non-Competition. Executive acknowledges that as a result of Executive’s position at SHO, Executive has learned or developed, or will learn or develop, SHO Confidential Information and that use or disclosure of SHO Confidential Information is likely to occur if Executive were to render advice or services to any SHO Competitor.

i.Therefore, for twelve (12) months following the Date of Termination, whether or not Executive receives any Severance Benefits under this Agreement, Executive will not, directly or indirectly, aid, assist, participate in, consult with, render services to, accept a position with, become employed by, or otherwise enter into any relationship with (other than having a passive ownership interest in or being a customer of) any SHO Competitor.

ii.For purposes of this Agreement, “SHO Competitor” means those companies listed on Appendix A, each of which Executive acknowledges is a SHO Competitor.

d.Restriction on Post-Employment Affiliation with SHO Vendors. Executive acknowledges that as a result of Executive’s position at SHO, Executive has learned or developed, or will learn or develop, SHO Confidential Information and that use or disclosure of SHO Confidential Information is likely to occur if Executive were to render advice or services to any SHO Vendor (as defined herein).

i.Therefore, for twelve (12) months from the Date of Termination, whether or not Executive receives any Severance Benefits under this Agreement, Executive will not, directly or indirectly, aid, assist, participate in, consult with, render services to, accept a position with, become employed by, or otherwise enter into any relationship with (other than having a passive ownership interest in or being a customer of) any SHO Vendor.

ii. For purposes of this Agreement, “SHO Vendor” means, the vendors, if any, listed in Appendix A as well as any other vendor with combined annual gross sales of services or merchandise to SHO in excess of $200 million.





e.Compliance with Protective Covenants. Executive will provide SHO with such information as SHO may from time to time reasonably request to determine Executive’s compliance with this Section 4. Executive authorizes SHO to contact Executive’s future employers and other entities with which Executive has any business relationship to determine Executive’s compliance with this Agreement or to communicate the contents of this Agreement to such employers and entities. Executive releases SHO, their agents and employees, from all liability for any damage arising from any such contacts or communications.

f.Necessity and Reasonableness. Executive agrees that the restrictions set forth herein are necessary to prevent the use and disclosure of SHO Confidential Information and to otherwise protect the legitimate business interests of SHO. Executive further agrees and acknowledges that the provisions of this Agreement are reasonable.

g.General Release and Waiver. In connection with Executive’s termination of employment with SHO (whether initiated by SHO or Executive in accordance with Section (1)(a) above), Executive will execute a binding general release and waiver of claims in a form to be provided by SHO (the “General Release and Waiver”), which is incorporated by reference in this Agreement. The General Release and Waiver will be in a form substantially similar to the form attached as Appendix B to this Agreement. If the General Release and Waiver is not signed within the time articulated therein, or is signed but subsequently revoked, Executive will cease to be entitled to receive Severance Benefits and will be obligated to reimburse SHO for the portion, if any, of the Severance Benefits already paid to Executive by SHO in its sole discretion prior to the expiration of the Revocation Period.

h.Exception Request. Notwithstanding the foregoing, Executive may request a waiver or a specific exception to the non-competition provisions of this Agreement by written request to the Vice President of Human Resources or Vice President, General Counsel (or the equivalent) of SHO. Such a request will be given reasonable consideration and may be granted, in whole or in part, or denied by SHO in its absolute discretion.

5.
Irreparable Harm. Executive acknowledges that irreparable harm would result from any breach by Executive of the provisions of this Agreement, including Sections 4(a), 4(b), 4(c) and 4(d), and that monetary damages alone would not provide adequate relief for any such breach. Accordingly, if Executive breaches or threatens to breach this Agreement, Executive consents to injunctive relief in favor of SHO without the necessity of SHO posting a bond. Moreover, any award of injunctive relief will not preclude SHO from seeking or recovering any lawful compensatory damages on account of any harm which result from a breach of this Agreement, including a forfeiture of any future payments otherwise due hereunder, and a return of any payments and benefits already received by Executive under this Agreement.

6.
Non-Disparagement. Subject to Section 11, Executive will not take any actions that would reasonably be expected to be detrimental to the interests of SHO nor make derogatory statements, either written or oral to any third party, or otherwise publicly disparage SHO or its products, services, or present or former employees, officers or directors, and will not authorize others to make such derogatory or disparaging statements on Executive’s behalf. This provision does not, and is not intended to, preclude Executive from entering into any relationship with a SHO Competitor or SHO Vendor if such relationship is permissible under Section 4(c) or 4(d) and does not, and is not intended to, preclude Executive from providing truthful testimony in response to legal process or governmental inquiry.

7.
Cooperation. Executive agrees, without receiving additional compensation, to fully and completely cooperate with SHO both during and after the period of employment with SHO (including any Salary Continuation Period), with respect to matters that relate to such period of employment, in all investigations, potential litigation or litigation in which SHO is involved or may become involved other than any such investigations, potential litigation or litigation between SHO and Executive. SHO will reimburse Executive for reasonable travel and out-of-pocket expenses incurred in connection with any such investigations, potential litigation or litigation, except in the case of litigation between SHO and




Executive.

8.
Future Enforcement or Remedy. Any waiver, or failure to seek enforcement or remedy for any breach or suspected breach of any provision of this Agreement by SHO or Executive in any instance will not be deemed a waiver of such provision in the future.

9.
Acting as Witness. Subject to Section 11, Executive agrees that both during and after the period of employment with SHO (including any Salary Continuation Period), Executive will not voluntarily act as a witness, consultant or expert for any person or party in any action against or involving SHO unless subject to judicial enforcement to appear as a fact witness only.

10.
Breach by Executive. In the event of a breach by Executive of any of the provisions of this Agreement, including the non-competition provisions (Section 4) and the non-disparagement provision (Section 6) of this Agreement, the obligation of SHO to pay Salary Continuation Amount or to provide other Severance Benefits under this Agreement will immediately cease and any Salary Continuation Amount payments already received and the value of any other Severance Benefits already received will be returned by Executive to SHO. Further, Executive agrees that SHO will be entitled to recovery of its attorneys’ fees and other associated costs incurred as a result of any attempt to redress a breach by Executive or to enforce its rights and protect its interests under this Agreement.

11.
No Prohibition. Subject to the next sentence, nothing in this Agreement will be construed to prohibit Executive from filing a charge with, reporting possible violations to, or participating or cooperating with any governmental agency or entity, including the Equal Employment Opportunity Commission, the Department of Justice, the Securities and Exchange Commission, Congress, or any agency Inspector General, or making other disclosures that are protected under the whistleblower, anti-discrimination, or anti-retaliation provisions of federal, state, or local law or regulation. Executive may not disclose SHO Confidential Information that is protected by the attorney-client privilege except as expressly authorized by law. Executive does not need the prior authorization of SHO to make any such reports or disclosures, and Executive is not required to notify SHO that Executive has made such reports or disclosures.

12.
Severability. If any provision or provisions of this Agreement is found invalid, illegal, or unenforceable, in whole or in part, then such provision or provisions will be modified or restricted so as to effectuate as nearly as possible in a valid and enforceable way the provisions hereof, or will be deemed excised from this Agreement, as the case may require, and this Agreement will be construed and enforced to the maximum extent permitted by law, as if such provision or provisions had been originally incorporated herein as so modified or restricted or as if such provision or provisions had not been originally incorporated herein, as the case may be.

13.
Employment-at-Will. This Agreement does not constitute a contract of employment, and Executive acknowledges that Executive’s employment with SHO is terminable “at-will” by either party at any time with or without cause and with or without notice.

14.
Other Plans, Programs, Policies and Practices. If any provision of this Agreement conflicts with any other plan, programs, policy, practice or other SHO document, then the provisions of this Agreement will control, except as otherwise precluded by law. Executive will not be eligible for any benefits under any transition or severance plan or program maintained by SHO.

15.
Entire Agreement. This Agreement, including the appendices hereto, contains and comprises the entire understanding and agreement between Executive and SHO and fully supersedes any and all other prior agreements or understandings between Executive and SHO (including Executive’s Executive Severance Agreement dated June 8, 2012 between Executive and Sears Holdings Corporation, which had been assigned to, and assumed by, SHO) in each case with respect to the subject matter contained herein, and may be amended only by a writing signed by (a) one of the Vice President of Human Resources or the Vice President, General Counsel, and Secretary (or equivalent) of SHO and (b) Executive.





16.
Tax Withholding. Any compensation paid or provided to Executive under this Agreement will be subject to any applicable federal, state or local income and employment tax withholding requirements.

17.
Notices. All notices and other communications hereunder will be in writing and will be given by hand delivery to the other parties or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:

If to Executive: At the most recent address on file at SHO.

If to SHO: 5500 Trillium Blvd, Hoffman Estates, Illinois 60192, Attention to both: VP, Human Resources and VP, General Counsel.

18.
Assignment. SHO may assign its rights under this Agreement to any successor in interest, whether by merger, consolidation, sale of assets, or otherwise. This Agreement will be binding whether it is between SHO and Executive or between any successor or assignee of SHO and Executive.

19.
Section 409A Compliance. To the extent that a payment or benefit under this Agreement is subject to Code Section 409A, it is intended that this Agreement as applied to that payment or benefit comply with the requirements of Code Section 409A, and the Agreement will be administered and interpreted consistent with this intent. If the Sixty (60)-Day Period following a Separation from Service begins in one calendar year and ends in a second calendar year (a “Crossover 60-Day Period”) and if there are any payments due Executive under this Agreement that are: (i) conditioned on Executive signing and not revoking a release of claims and (ii) otherwise due to be paid during the portion of the Crossover 60-Day Period that falls within the first year thereof, then such payments will be delayed and paid in a lump sum during the portion of the Crossover 60-Day Period that falls within the second year. Executive’s right to receive installment payments pursuant to this Agreement will be treated as a right to receive a series of separate and distinct payments.

20.
Construction and Interpretation. In this Agreement (1) “includes” and “including” are inclusive and mean, respectively, “includes without limitation” and “including without limitation,” (2) “or” is disjunctive but not necessarily exclusive, (3) “will” expresses an imperative, an obligation, and a requirement, (4) numbered “Section” references refer to sections of this Agreement unless otherwise specified, (5) section headings are for convenience only and will have no interpretive value, and (6) unless otherwise indicated all references to a number of days will mean calendar (and not business) days and all references to months or years will mean calendar months or years.

21.
Counterparts. This Agreement may be executed in one or more counterparts, which together will constitute a valid and binding agreement.

22.
Right to Jury. Executive agrees to waive any right to a jury trial on any claim contending that this Agreement or the General Release and Waiver is illegal or unenforceable in whole or in part, and Executive agrees to try any claims brought in a court or tribunal without use of a jury or advisory jury. Further, should any claim arising out of Executive’s employment, termination of employment or Salary Continuation Period (if any) be found by a court or tribunal of competent jurisdiction to not be released by the General Release and Waiver, Executive agrees to try such claim to the court or tribunal without use of a jury or advisory jury.

23.
Governing Law. This Agreement will be governed under the internal laws of the state of Illinois without regard to principles of conflicts of laws. Executive agrees that the state and federal courts located in the state of Illinois will have exclusive jurisdiction in any action, lawsuit or proceeding based on or arising out of this Agreement, and Executive hereby (a) submits to the personal jurisdiction of such courts, (b) consents to the service of process in connection with any action, suit, or proceeding against Executive, and (c) waives any other requirement (whether imposed by statute, rule of court, or otherwise) with respect to personal jurisdiction, venue or service of process.






EXECUTIVE



/s/ DAVID BUCKLEY
David Buckley
SEARS HOMETOWN AND OUTLET STORES, INC.


By: /s/ BECKY ILIFF
Becky Iliff
Vice President, Human Resources
 
 






Appendix A to Amended and Restated Executive Severance Agreement

SHO Competitors

The following companies (including affiliates and subsidiaries within the same controlled group of corporations) are included within the definition of SHO Competitors as referred to under Section 4(c)(ii)(l) of the Amended and Restated Executive Severance Agreement between SHO and Executive:

Ace Hardware
Lowe’s Home Improvement
The Home Depot
Menard
Whirlpool
ServiceMaster
Rent-A-Center, Inc.
Aaron’s, Inc.
ABT
Amazon
HHGregg
Conn’s, Inc.
Best Buy
Sears Holdings Corporation
Tractor Supply Co.
True Value Company
Wal-Mart
Target
Caterpillar
John Deere


SHO Vendors

The following companies (including affiliates and subsidiaries within the same controlled group of corporations) are included within the definition of SHO Vendors as referred to under Section 4(d) of the Amended and Restated Executive Severance Agreement between SHO and Executive:

Sears Holdings Corporation
Bosch
Electrolux
General Electric
LG
Samsung
Whirlpool
MTD
Techtronic Industries Company Limited
Husqvarna







Appendix B to Amended and Restated Executive Severance Agreement


GENERAL RELEASE AND WAIVER

NOTICE

YOU MAY CONSIDER THIS GENERAL RELEASE AND WAIVER FOR UP TO TWENTY ONE (21) DAYS. IF YOU DECIDE TO SIGN IT, YOU MAY REVOKE THIS GENERAL RELEASE AND WAIVER WITHIN SEVEN (7) DAYS AFTER SIGNING IT (THE “REVOCATION PERIOD”). ANY REVOCATION WITHIN THE REVOCATION PERIOD MUST BE IMMEDIATELY SUBMITTED, IN WRITING, TO PHILIP ETTER, HUMAN RESOURCES, SEARS HOMETOWN AND OUTLETS STORES, INC., 5500 TRILLIUM BOULEVARD, SUITE 501, HOFFMAN ESTATES, IL 60192, AND STATE THAT, “I HEREBY REVOKE MY ACCEPTANCE OF THE GENERAL RELEASE AND WAIVER.” THE EXECUTIVE SEVERANCE AGREEMENT AND GENERAL RELEASE AND WAIVER SHALL NOT BECOME EFFECTIVE OR ENFORCEABLE UNTIL THE REVOCATION PERIOD HAS EXPIRED. YOU SHOULD CONSIDER CONSULTING WITH AN ATTORNEY BEFORE SIGNING THIS GENERAL RELEASE AND WAIVER.

I, David Buckley, acknowledge that there are various state, local, and federal laws that prohibit, among other things, employment discrimination on the basis of age, gender, race, color, national origin, religion, disability, sexual orientation or veteran status and that these laws are enforced through the Equal Employment Opportunity Commission, Department of Labor and state or local human rights agencies. Such laws include, without limitation, the following: Title VII of the Civil Rights Act of 1964; the Americans with Disabilities Act; the Age Discrimination in Employment Act; the Older Workers Benefit Protection Act; the Employee Retirement Income Security Act; 42 U.S.C. Section 1981; and all applicable state and local human and civil rights laws as well as other statutes or laws which regulate employment; and the common law of contracts and torts. I hereby waive and release all rights I may have under these or any other laws with respect to my employment and termination of employment and acknowledge that none of the SHO Parties (as defined below) has (a) discriminated against me, (b) breached any contract with me, (c) committed any civil wrong (tort) against me, or (d) otherwise acted unlawfully against me.
I also waive any right to become, and promise not to consent to become, a member of any class or collective in any case in which claims are asserted against any or all of the SHO Parties that are related in any way to my employment or the termination of my employment with Sears Hometown and Outlet Stores Inc., Sears Holdings Corporation, or any subsidiary of either of them, and that involve claims which have accrued as of the date I sign this General Release and Waiver. If I, with or without my knowledge, become a member of a class in any proceeding, I will opt out of the class at the first opportunity afforded to me to do so. In this regard, I agree that I will execute, without objection or delay, an “opt-out” form presented to me either by the court in which such proceeding is pending or by counsel for any or all of the SHO Parties.
In consideration of the benefits I will receive that are described in the attached Amended and Restated Executive Severance Agreement, I, David Buckley, for myself, my heirs, administrators, representatives, executors, successors and assigns, do hereby release, waive, and forever discharge Sears Hometown and Outlet Stores, Inc., Sears Holdings Corporation, and the current and former agents, parents, subsidiaries, affiliates, related organizations, employees, officers, directors, shareholders, attorneys, successors, and assigns of each of Sears Hometown and Outlet Stores, Inc. and Sears Holdings Corporation (collectively, the “SHO Parties”) from any and all liability, actions, charges, causes of action, demands, damages, or claims for relief or remuneration, sums of money, accounts, or expenses (including attorneys’ fees and costs) of any kind whatsoever, whether known or unknown at this time, arising out of, or connected




with, my employment with Sears Hometown and Outlet Stores Inc., Sears Holdings Corporation, or any subsidiary of either of them and the termination of my employment. The foregoing release, discharge, and waiver includes, but is not limited to, all claims and any obligations or causes of action arising from such claims, including but not limited to, all matters in law, in equity, in contract (oral or written, express or implied), in tort, or pursuant to statute, including claims under any federal, state or local statute or state or federal constitution, including, but not limited to, Title VII of the Civil Rights Act of 1964, the Civil Rights Act of 1866 and 1871 (42 U.S.C. § 1981), the Civil Rights Act of 1991, the Age Discrimination in Employment Act, the Fair Labor Standards Act, the Employee Retirement Income Security Act, the Americans with Disabilities Act, the Rehabilitation Act of 1973, the Worker Adjustment and Retraining Notification Act, the Family and Medical Leave Act, the National Labor Relations Act, the Equal Pay Act, and all other discrimination and employment laws of Illinois and of all other states and municipalities, to the fullest extent permitted under the law. This General Release and Waiver does not apply to any claims or rights that may arise from events occurring after the date of this General Release and Waiver. Also excluded from this General Release and Waiver are any claims which cannot be waived by law, including my right to file a charge with or participate in an investigation conducted by the Equal Employment Opportunity Commission, and my rights specified in paragraph 11 of the Amended and Restated Executive Severance Agreement. I do, however, waive all rights (other than my rights specified in paragraph 11 of the Amended and Restated Executive Severance Agreement) to any monetary or other relief of any kind flowing out of any agency or third-party claims or charges, including any charge I might file with any state, local or federal agency. Subject to my rights specified in paragraph 11 of the Amended and Restated Executive Severance Agreement, I warrant and represent that I have not filed any complaint, charge, or lawsuit against the SHO Parties or any of them with any governmental agency or with any court.
I have read this General Release and Waiver and understand all of its terms.
I have signed this General Release and Waiver voluntarily with full knowledge of its legal significance and consequences.
I have had the opportunity to seek, and I have been advised in writing of my right to seek, legal counsel prior to signing this General Release and Waiver.
I was given at least twenty-one (21) days to consider signing this General Release and Waiver. Any non-material modification of this General Release and Waiver Agreement does not restart the twenty-one (21) day consideration period.

I understand that if I sign this General Release and Waiver, I can change my mind and revoke it within seven (7) days after signing. I understand this General Release and Waiver will not be effective until after the seven (7) day revocation period has expired.
I understand that the delivery of the benefits I will receive that are described in the attached Amended and Restated Executive Severance Agreement does not constitute an admission of liability by the SHO Parties or any of them and that each of the SHO Parties expressly denies any wrongdoing or liability.

THIS IS A RELEASE. READ BEFORE SIGNING.


Signed by: ______________________________
David Buckley

Date: _____________, ____






Exhibit 10.2

September 3, 2015

Mr. Michael McCarthy
36W798 East Ridgewood Drive
Saint Charles, Illinois 60175

Sears Hometown and Outlet Stores, Inc. Offer Letter
    
Dear Michael:

We are pleased to extend to you our offer to join Sears Hometown and Outlet Stores, Inc. (SHO). The following is a description of the terms of our offer.

1.
You will be at-will employee of SHO in the position of Vice President, Merchandising and Inventory, effective September 21, 2015.
2.
You will report to the Chief Executive Officer and President.
3.
Your annualized gross salary will be $300,000.00, payable in semi-monthly installments of $12,500.00, in accordance with SHO’s regular payroll practices, and net of applicable payroll and withholding taxes and other applicable deductions.
4.
You will be eligible to participate in SHO’s Annual Incentive Plan (the “SHO AIP”) in accordance with, and subject to, its terms. Your SHO AIP opportunity will be 50% of your base salary. With respect to each SHO AIP award approved by SHO’s Board of Directors in its sole discretion, any amount payable with respect to the SHO AIP award will be paid by April 15th of the following fiscal year in accordance with the SHO AIP. Your SHO AIP award for SHO’s 2015 fiscal year will be prorated in accordance with the SHO AIP. Further details regarding the SHO AIP will be provided to you.
5.
You will be eligible to participate in SHO’s Long-Term Incentive Program (the “SHO LTIP”) in accordance with, and subject to, its terms. Your SHO LTIP opportunity will be 50% of your base salary. You will not be eligible to participate in the 2015 SHO LTIP awards or awards made prior to SHO’s 2015 fiscal year. If following SHO’s 2015 fiscal year SHO’s Board of Directors in its sole discretion approves awards under the SHO LTIP for a fiscal year, you will become eligible to participate in the awards when approved by the Board of Directors. Further details regarding the SHO LTIP will be provided to you.
6.
You are eligible to receive four (4) weeks paid vacation. You are also eligible for six (6) paid National Holidays each year and up to four (4) personal days per year.
7.
In consideration of your acceptance of our offer of employment in this letter, we will make a $200,000 cash payment to you (net of applicable payroll and withholding taxes and other applicable deductions) on or before the 30th day following the commencement of your employment (the “Commencement Bonus”). If you voluntarily terminate your employment prior to the second anniversary of your employment start date other than for Good Reason (as defined in the Executive Severance Agreement attached to this offer letter) or if prior to that date SHO terminates your employment for Cause (as defined in the Executive Severance Agreement), you will repay to SHO the Commencement Bonus no later than the 30th day following your last day of work. Your repayment obligation will include all taxes withheld for such amounts except to the extent (a) prohibited by law or (b) SHO administratively recovers taxes withheld including via reimbursement, or credit for SHO’s benefit, from the applicable government authority.

8.
You are eligible to participate in all retirement, health, and welfare programs made available or sponsored by SHO on a basis no less favorable than other SHO executives at your level, in accordance with the applicable terms, conditions and availability of those programs.

9.
You represent and warrant to SHO that (a) you are not subject to any obligation, written or oral, containing any non-competition provision or any other restriction (including without limitation, any confidentiality provision) that would result in any restriction on your ability to perform as SHO’s Vice President, Merchandising and Inventory or any other position with SHO or any of its affiliates, and (b) you are not (i)




a member of any board of directors, board of trustees or similar governing body of any for-profit, non-profit, or not-for-profit entity, or (ii) a party to any agreement, written or oral, with any entity under which you would receive remuneration for your services, except as already disclosed to and approved by SHO. You agree that you will not (A) become a member of any board or body described in clause (b)(i) of the preceding sentence or (B) become a party to any agreement described in clause (b)(ii) of the preceding sentence, in each case without the prior written consent of SHO, such consent not to be unreasonably withheld. Further, you continue to agree to refrain from disclosing or using, in violation of any obligation of confidentiality, any information that you acquired as a result of any previous employment or otherwise.

10.
You understand that as a condition of your employment you will be required to sign the attached Executive Severance Agreement, which, among other things, provides for installment severance payments totaling six (6) months of your annual base salary.


This offer is contingent on your successful completion of a criminal background check submitted by SHO. By signing where indicated below, you accept this offer in accordance with and subject to the terms described above. This offer letter is not a contract for employment.

We look forward to you starting in your new position with SHO.

Sincerely,

/s/ BECKY ILIFF
Becky Iliff
Vice President, Human Resources

ACKNOWLEDGE, AGREED, AND ACCEPTED:

I accept the foregoing terms of this offer, as an employee at-will of Sears Hometown and Outlet Stores, Inc.


/s/    MICHAEL MCCARTHY
Michael McCarthy (Signature)






Exhibit 10.3
Executive Severance Agreement

September 3, 2015

This Executive Severance Agreement (this “Agreement”) is between Sears Hometown and Outlet Stores, Inc. (together with its subsidiaries “SHO”) and Michael McCarthy (“Executive”).

Preliminary Statement

In accordance with, and subject to, the terms and conditions of an offer letter dated September 3, 2015, Executive has agreed to serve as SHO’s Vice President, Merchandising and Inventory.

Terms and Conditions

Executive and SHO, intending to be legally bound and for good and valuable consideration, agree as follows:

1.
Benefits Upon Termination of Employment.

a.Severance Benefits. If Executive’s employment is involuntarily terminated without Cause or Executive voluntarily terminates Executive’s employment for Good Reason (as such terms are defined in Section 2 below), Executive will be entitled to the benefits described in Sections 1(a)(i) and (ii) below (collectively, the “Severance Benefits”). Executive will not be entitled to the Severance Benefits if Executive’s employment terminates for any other reason, including for Cause or due to death or Disability (as defined in Section 2 below). Executive will not be entitled to Severance Benefits if Executive does not meet all of the other requirements of this Agreement, including those of Section 4(g).

i.Continuation of Salary

1.SHO will pay Executive cash severance in an amount equal to six (6) months of Executive’s annual base salary at the rate in effect on the date on which Executive’s employment terminates (the “Date of Termination”). The amount determined in accordance with the preceding sentence (the “Salary Continuation Amount”) will be paid upon the satisfaction of the following conditions: (A) Executive’s Separation from Service (as defined in Section 2 below) has occurred; and (B) the Revocation Period (as defined in Appendix B to this Agreement) has expired. If the foregoing conditions have been satisfied, SHO will pay the Salary Continuation Amount in substantially equal installments on each regular salary payroll date for a period of six (6) months (the “Salary Continuation Period”), except as otherwise provided in this Agreement.

2.Notwithstanding the foregoing, to the extent Executive’s termination is as a result of an event that would trigger payments under a then-current and applicable transition pay or severance plan or program (the “Other Severance Program”) under which Executive would have been eligible for severance pay and benefits for a period longer than the Salary Continuation Period, and provided the severance pay under the Other Severance Program is greater than the Salary Continuation Amount, then the Salary Continuation Amount and the Salary Continuation Period for purposes of this Agreement will be the greater amount and the longer period provided by the Other Severance Program, except as otherwise provided in this Agreement.

3.Further and notwithstanding the foregoing, the SHO obligations that may become due under this Section 1(a)(i) will be reduced on a dollar-for-dollar basis (but not below zero), by the amount, if any, of salary or wages that Executive earns from a subsequent employer (including those arising from self-employment) during the Salary Continuation Period other than all approved external director fees that Executive earns or is otherwise entitled to receive. Executive will not be obligated to seek




affirmatively or accept an employment, contractor, consulting or other arrangement in order to mitigate the Salary Continuation Amount. Further, to the extent Executive does not execute and timely submit the General Release and Waiver (in accordance with Section 4(g) below) by the deadline specified therein, Salary Continuation Amount payments will terminate, and any entitlement to future Salary Continuation Amount payments will be forfeited, and Executive will be required to reimburse SHO for any portion of the Salary Continuation Amount already paid to Executive.

4.Notwithstanding anything in this Section 1(a)(i) to the contrary, if the Salary Continuation Amount payable to Executive in accordance with Section 1(a)(i) during the six (6) months after Executive’s Separation from Service would exceed the Section 409A Threshold and if as of the date of the Separation from Service Executive is a Specified Employee (as such terms are defined in Section 2 below), then payment will be made to Executive on each regular salary payroll date during the first six (6) months of the Salary Continuation Period until the aggregate amount received equals the Section 409A Threshold. Any portion of the Salary Continuation Amount that is in excess of the Section 409A Threshold and that would otherwise be paid during such six (6) months will instead be paid to Executive in a lump sum payment on the date that is six (6) months and one (1) day after the date of Executive’s Separation from Service.

5.All Salary Continuation Amount payments (described under this Section 1(a)(i)) will terminate if Executive is employed by a SHO Competitor or SHO Vendor (as such terms are defined in Sections 4(c)(ii) and 4(d)(ii) herein, respectively) during the Salary Continuation Period (which for purposes of this Section 1(a)(i)(3) will not exceed six (6) months), or in the event of Executive’s breach of this Agreement (in accordance with Section 10 below). In either case, Executive will be required to reimburse SHO for any portion of the Salary Continuation Amount already paid to Executive.

ii.
Continuation of Benefits.

1.During the Salary Continuation Period and subject to the next sentence, Executive will be entitled to participate in all benefit plans and programs (except as specified in this Section 1(a)(ii)) in which Executive was eligible to participate immediately prior to the Date of Termination (subject to the terms and conditions in effect from time to time and the continued availability and applicability of such plans and programs to former employees who are not active employees of SHO). Executive will not be eligible to participate in the long-term disability plan, health care flexible spending account (except on an after-tax basis and only through the earlier of the end of Salary Continuation Period or the calendar year in which the Separation from Service occurs), SHO-paid life insurance, any 40l(k) savings plan maintained by SHO (or any other defined contribution plan sponsored by SHO), or any other plan or benefit that by its terms or in accordance with law is not applicable to former employees who are not active employees of SHO. SHO’s current medical, dental, and vision plans provide COBRA-only coverage for former employees who are not active employees of SHO. If at the Date of Termination COBRA coverage is the only coverage available under SHO’s then-current medical and dental plans, Executive and Executive’s eligible dependents will be eligible during the Salary Continuation Period for COBRA coverage under the then-current plans, with Executive’s percentage share of the cost of COBRA premiums to be the same as the percentage share that Executive paid for medical, dental, and vision plan coverage immediately prior to the Date of Termination.

2.If Executive does not timely execute and submit the General Release and Waiver (in accordance with Section 4(g) herein) by the deadline specified therein, Executive will be required to reimburse SHO for the portion of the cost for the benefits referred to under Section 1(a)(ii)(l) immediately above paid by SHO during the Salary Continuation Period, and Executive will instead be eligible for COBRA coverage under the SHO medical, dental, and vision plans as of the Date of Termination. Executive will be responsible for the full cost of COBRA premiums if this Section 1(a)(ii)(2) is applicable.

3.Subject to Section 1(a)(ii)(4) immediately below, if Executive provides




services to another employer and is covered by such employer’s health benefits plan or program, the medical and dental benefits provided by SHO hereunder will be secondary to such employer’s health benefits plan or program in accordance with the terms of the SHO health benefit plans.

4.All of the benefits described in this Section 1(a)(ii) will terminate, and any entitlements to future such payments will be forfeited, if Executive is employed by a SHO Competitor or a SHO Vendor during the Salary Continuation Period (which for purposes of this Section 1(a)(ii)(4) will not exceed six (6) months) or in the event of Executive’s breach of this Agreement (in accordance with Section 10 below). In either case, Executive will be required to reimburse SHO for any portion of the cost for the benefits referred to under Section 1(a)(ii)(1) immediately above paid by SHO during the Salary Continuation Period, and Executive will instead be eligible for COBRA continuation coverage under the SHO medical, dental, and vision plans as of Executive’s Severance from Service date. Executive will be responsible for the full cost of COBRA premiums if this Section 1(a)(ii)(4) is applicable.

iii.Other. In addition to the foregoing Severance Benefits, a lump sum payment will be made to Executive not later than Executive’s next regular salary payroll date following the Date of Termination in an amount equal to the sum of any base salary and any vacation benefits that have accrued through the Date of Termination but only to the extent not already paid. No vacation will accrue during the Salary Continuation Period. No payment will be made with respect to unused “personal” days. Notwithstanding the foregoing and anything herein to the contrary, in the event of Executive’s death during the Salary Continuation Period, any unpaid portion of the Salary Continuation Amount payable in accordance with Section 1(a)(i) above will be paid in a lump sum, within sixty (60) days of death (and no later than amounts would have been paid absent death), to Executive’s estate, and any eligible dependents who are covered dependents as of the date of death will experience a qualifying event under COBRA as a result of such death.

iv.
Impact of Termination on Certain Other Plans/Programs.

1.Annual Incentive Plan. Upon the Date of Termination, Executive’s entitlement to any award under SHO’s Annual Incentive Plan (the “AIP”) or other applicable annual incentive plan sponsored by SHO will be determined in accordance with the terms and conditions of the AIP or other plan document regarding termination of employment.

2.Long-Term Incentive Program. Upon the Date of Termination, Executive’s entitlement to any award granted to Executive under SHO’s Long-Term Incentive Program (the “LTIP) or other applicable long-term incentive program sponsored by SHO will be determined in accordance with the terms and conditions of the applicable award letter and the LTIP or other plan document regarding termination of employment.


3.Stock Plan. Upon the Date of Termination, Executive’s entitlement to any unvested options, restricted stock, or other award granted to Executive under SHO’s 2012 Amended and Restated Stock Plan or other stock plan sponsored by SHO will be determined in accordance with the terms and conditions of the applicable award agreement and the stock plan document regarding termination of employment.

v.Post-Termination Forfeiture of Severance Benefits. If SHO determines after the Date of Termination that Executive engaged in activity during employment with SHO that SHO determines constituted Cause, Executive will immediately cease to be eligible for Severance Benefits and will be required to reimburse SHO for any portion of Severance Benefits received by Executive during the Salary Continuation Period.

2.
Definitions. For purposes of this Agreement, each capitalized term herein is either defined in the section,




exhibit, or Appendix in which it first appears or in this Section 2. The following capitalized terms will have the definitions as set forth below:

a.“Cause” means (i) a material breach by Executive (other than a breach resulting from Executive’s incapacity due to a Disability) of Executive’s duties and responsibilities to SHO, including under an offer letter or comparable document (if any, together the “Offer Letter”), which breach is demonstrably willful and deliberate on Executive’s part, is committed in bad faith or without reasonable belief that such breach is in the best interests of SHO, and is not remedied in a reasonable period of time after receipt of written notice from SHO specifying such breach; (ii) Executive’s conviction of a felony involving moral turpitude; or (iii) Executive’s dishonesty or willful misconduct in connection with Executive’s employment.

b.“Disability” means disability as defined under the SHO long-term disability plan in effect as of the date of execution of this Agreement (regardless of whether Executive is a participant under such plan).

c.“Good Reason” means, without Executive’s written consent, (i) a reduction of more than ten percent (10%) in the sum of Executive’s annual base salary and target annual incentive under the AIP from those in effect as of the date of this Agreement; (ii) Executive’s mandatory relocation to an office more than fifty (50) miles from the primary location at which Executive is required to perform Executive’s duties immediately prior to the date of this Agreement; or (iii) any other action or inaction that constitutes a material breach of the terms of Executive’s employment with SHO, including under the Offer Letter, by SHO or its successor, including failure of a successor company to assume or fulfill the obligations under this Agreement. In each case, Executive must provide SHO with written notice of the facts giving rise to a claim that Good Reason exists for purposes of this Agreement within thirty (30) days of the initial existence of such Good Reason event, and SHO will have a right to remedy such event within sixty (60) days after receipt of Executive’s written notice (the “Sixty (60)-Day Period”). If SHO remedies the Good Reason event within the Sixty (60)-Day Period, the Good Reason event (and Executive’s right to receive any benefit under this Agreement on account of termination of employment for Good Reason) will cease to exist. If SHO does not remedy the Good Reason event within the Sixty (60)-Day Period, and Executive does not incur a termination of employment within thirty (30) days following the earlier of: (y) the date SHO notifies Executive that it does not intend to remedy the Good Reason or does not agree that there has been a Good Reason event, or (z) the date on which the Sixty (60)-Day Period expires, the Good Reason event (or any claim of Good Reason) will cease to exist. Notwithstanding the foregoing, if Executive fails to provide written notice to SHO of the facts giving rise to a claim of Good Reason within thirty (30) days of the initial existence of such Good Reason event, the Good Reason event (and Executive’s right to receive any benefit under this Agreement on account of termination of employment for Good Reason) will cease to exist as of the thirty-first (31st) day following the later of its occurrence or Executive’s knowledge thereof. If Executive terminates Executive’s employment under clause (i) of this definition, Executive’s annual base salary rate for purposes of Section 1 hereof will be Executive’s annual base salary rate in effect prior to the reduction that triggered the applicability of such Good Reason event.

d.“SHO Affiliate” means any person with whom SHO is considered to be a single employer under Section 414 (b) of the Internal Revenue Code (the “Code”) and all persons with whom SHO would be considered a single employer under Code Section 414 (c), substituting “50%” for the “80%” standard that would otherwise apply.

e.“Section 409A Threshold” means an amount equal to two (2) times the lesser of (i) Executive’s base salary for services provided to SHO as an employee for the calendar year preceding the calendar year in which Executive has a Separation from Service; or (ii) the maximum amount that may be taken into account under a qualified plan in accordance with Code Section 40l (a)(17) for the calendar year in which Executive has a Separation from Service. In all events, this amount will be limited to the amount specified under Treasury Regulation Section 1.409A-1(b)(9)(iii)(A) or any successor thereto.





f.“Separation from Service” means a “Separation from Service” from SHO within the meaning of Code Section 409A (and regulations issued thereunder). Notwithstanding anything herein to the contrary, the fact that Executive is treated as having incurred a Separation from Service under Code Section 409A and the terms of this Agreement will not be determinative, or in any way affect the analysis, of whether Executive has retired, terminated employment, separated from service, incurred a severance from employment or become entitled to a distribution, under the terms of any retirement plan (including pension plans and 401(k) savings plans) maintained by SHO.

g.“Specified Employee” has the meaning set forth under Code Section 409A (and regulations issued thereunder).

3.
Intellectual Property Rights. Executive acknowledges that Executive’s development work or research on any and all inventions or expressions of ideas that may or may not be eligible for patent, copyright, trademark or trade secret protection, hereafter made or conceived solely or jointly within the scope of employment at SHO, provided such invention or expression of an idea relates to the business of SHO, or relates to actual or demonstrably anticipated research or development of SHO, or results from any work performed by Executive for or on behalf of SHO, are hereby assigned to SHO, including Executive’s entire rights, title and interest. Executive will promptly disclose such invention or expression of an idea to Executive’s management and will, upon request, promptly execute a specific written assignment of title to SHO. If Executive currently holds any inventions or expressions of an idea, regardless of whether they were published or filed with the U.S. Patent and Trademark Office or the U.S. Copyright Office, or is under contract to not so assign, Executive will list them on the last page of this Agreement.

4.
Protective Covenants. Executive acknowledges that this Agreement provides for additional consideration beyond what SHO is otherwise obligated to pay to Executive. In consideration of the opportunity to receive the Severance Benefits, and other good and valuable consideration, Executive agrees to the following:

a.Non-Disclosure of SHO Confidential Information. Executive acknowledges and agrees to be bound by the following, whether or not Executive receives any Severance Benefits under this Agreement:

i.Non-Disclosure. Subject to Section 11, Executive will not, during the term of Executive’s employment with SHO or thereafter, other than in the performance of Executive’s duties and obligations to SHO, including under the Offer Letter, during Executive’s employment with SHO, as required by law or legal process, or as SHO may otherwise consent to or direct in writing, reveal, disclose, sell, use, lecture upon or publish any SHO Confidential Information (as defined in Section 4(a)(iii) below) until such time as the information becomes publicly known other than as a result of its disclosure, directly or indirectly, by Executive.

ii.Proprietary Information. Subject to Section 11, Executive understands that if Executive possesses any proprietary information of another person or company as a result of prior employment or otherwise, SHO expects and requires that Executive will honor any and all legal obligations that Executive has to that person or company with respect to proprietary information, and Executive will refrain from any unauthorized use or disclosure of such information.

iii.SHO Confidential Information. For purposes of this Agreement, “SHO Confidential Information” means trade secrets and non-public information which SHO designates as being confidential or which, under the circumstances, should be treated as confidential, including, without limitation, any information received in confidence from or developed by SHO, its long and short term goals, vendor and supply agreements, databases, methods, programs, techniques, business information, financial information, marketing and business plans, proprietary software, personnel information and files, client information, pricing, and other information relating to the business of SHO that is not known generally to the public or in the industry.





iv.Return of SHO Property. All documents and other property that relate to the business of SHO are the exclusive property of SHO, even if Executive authored or created them. Executive agrees to return all such documents and tangible property to SHO upon termination of employment or at such earlier time as SHO may request that Executive do so.

v.Conflict of Interest. During Executive’s employment with SHO and during any Salary Continuation Period (which for purposes of this Section 4(a)(v) will not exceed six (6) months), except as may be approved in writing by SHO, neither Executive nor members of Executive’s immediate family (which will refer to Executive, any spouse, and any child) will have financial investments or other interests or relationships with SHO or any customers, suppliers or competitors which might impair Executive’s independence of judgment on behalf of SHO. Also during Executive’s employment with SHO during any Salary Continuation Period, Executive agrees not to engage in any activity in competition with SHO and to avoid any outside activity that could adversely affect the independence and objectivity of Executive’s judgment, interfere with the timely and effective performance of Executive’s duties and responsibilities to SHO, or that could otherwise conflict with the best interests of SHO.

b.Non-Solicitation of Employees. During Executive’s employment with SHO and for twelve (12) months following the Date of Termination, whether or not Executive receives any Severance Benefits under this Agreement, Executive will not, directly or indirectly, solicit or encourage any SHO employee to leave the employee’s employment with SHO, or assist in any way with the hiring of any SHO employee by any future employer or other entity.

c.Non-Competition. Executive acknowledges that as a result of Executive’s position at SHO, Executive has learned or developed, or will learn or develop, SHO Confidential Information and that use or disclosure of SHO Confidential Information is likely to occur if Executive were to render advice or services to any SHO Competitor.

i.Therefore, for twelve (12) months following the Date of Termination, whether or not Executive receives any Severance Benefits under this Agreement, Executive will not, directly or indirectly, aid, assist, participate in, consult with, render services to, accept a position with, become employed by, or otherwise enter into any relationship with (other than having a passive ownership interest in or being a customer of) any SHO Competitor.

ii.For purposes of this Agreement, “SHO Competitor” means those companies listed on Appendix A, each of which Executive acknowledges is a SHO Competitor.

d.Restriction on Post-Employment Affiliation with SHO Vendors. Executive acknowledges that as a result of Executive’s position at SHO, Executive has learned or developed, or will learn or develop, SHO Confidential Information and that use or disclosure of SHO Confidential Information is likely to occur if Executive were to render advice or services to any SHO Vendor (as defined herein).

i.Therefore, for twelve (12) months from the Date of Termination, whether or not Executive receives any Severance Benefits under this Agreement, Executive will not, directly or indirectly, aid, assist, participate in, consult with, render services to, accept a position with, become employed by, or otherwise enter into any relationship with (other than having a passive ownership interest in or being a customer of) any SHO Vendor.

ii. For purposes of this Agreement, “SHO Vendor” means, the vendors, if any, listed in Appendix A as well as any other vendor with combined annual gross sales of services or merchandise to SHO in excess of $200 million.

e.Compliance with Protective Covenants. Executive will provide SHO with such




information as SHO may from time to time reasonably request to determine Executive’s compliance with this Section 4. Executive authorizes SHO to contact Executive’s future employers and other entities with which Executive has any business relationship to determine Executive’s compliance with this Agreement or to communicate the contents of this Agreement to such employers and entities. Executive releases SHO, their agents and employees, from all liability for any damage arising from any such contacts or communications.

f.Necessity and Reasonableness. Executive agrees that the restrictions set forth herein are necessary to prevent the use and disclosure of SHO Confidential Information and to otherwise protect the legitimate business interests of SHO. Executive further agrees and acknowledges that the provisions of this Agreement are reasonable.

g.General Release and Waiver. In connection with Executive’s termination of employment with SHO (whether initiated by SHO or Executive in accordance with Section (1)(a) above), Executive will execute a binding general release and waiver of claims in a form to be provided by SHO (the “General Release and Waiver”), which is incorporated by reference in this Agreement. The General Release and Waiver will be in a form substantially similar to the form attached as Appendix B to this Agreement. If the General Release and Waiver is not signed within the time articulated therein, or is signed but subsequently revoked, Executive will cease to be entitled to receive Severance Benefits and will be obligated to reimburse SHO for the portion, if any, of the Severance Benefits already paid to Executive by SHO in its sole discretion prior to the expiration of the Revocation Period.

h.Exception Request. Notwithstanding the foregoing, Executive may request a waiver or a specific exception to the non-competition provisions of this Agreement by written request to the Vice President of Human Resources or Vice President, General Counsel (or the equivalent) of SHO. Such a request will be given reasonable consideration and may be granted, in whole or in part, or denied by SHO in its absolute discretion.

5.
Irreparable Harm. Executive acknowledges that irreparable harm would result from any breach by Executive of the provisions of this Agreement, including, without limitation, Sections 4(a), 4(b), 4(c) and 4(d), and that monetary damages alone would not provide adequate relief for any such breach. Accordingly, if Executive breaches or threatens to breach this Agreement, Executive consents to injunctive relief in favor of SHO without the necessity of SHO posting a bond. Moreover, any award of injunctive relief will not preclude SHO from seeking or recovering any lawful compensatory damages on account of any harm which result from a breach of this Agreement, including a forfeiture of any future payments otherwise due hereunder, and a return of any payments and benefits already received by Executive under this Agreement.

6.
Non-Disparagement. Subject to Section 11, Executive will not take any actions that would reasonably be expected to be detrimental to the interests of SHO nor make derogatory statements, either written or oral to any third party, or otherwise publicly disparage SHO or its products, services, or present or former employees, officers or directors, and will not authorize others to make such derogatory or disparaging statements on Executive’s behalf. This provision does not, and is not intended to, preclude Executive from entering into any relationship with a SHO Competitor or SHO Vendor if such relationship is permissible under Section 4(c) or 4(d) and does not, and is not intended to, preclude Executive from providing truthful testimony in response to legal process or governmental inquiry.

7.
Cooperation. Executive agrees, without receiving additional compensation, to fully and completely cooperate with SHO both during and after the period of employment with SHO (including any Salary Continuation Period), with respect to matters that relate to such period of employment, in all investigations, potential litigation or litigation in which SHO is involved or may become involved other than any such investigations, potential litigation or litigation between SHO and Executive. SHO will reimburse Executive for reasonable travel and out-of-pocket expenses incurred in connection with any such investigations, potential litigation or litigation, except in the case of litigation between SHO and Executive.





8.
Future Enforcement or Remedy. Any waiver, or failure to seek enforcement or remedy for any breach or suspected breach of any provision of this Agreement by SHO or Executive in any instance will not be deemed a waiver of such provision in the future.

9.
Acting as Witness. Subject to Section 11, Executive agrees that both during and after the period of employment with SHO (including any Salary Continuation Period), Executive will not voluntarily act as a witness, consultant or expert for any person or party in any action against or involving SHO unless subject to judicial enforcement to appear as a fact witness only.

10.
Breach by Executive. In the event of a breach by Executive of any of the provisions of this Agreement, including, without limitation, the non-competition provisions (Section 4) and the non-disparagement provision (Section 6) of this Agreement, the obligation of SHO to pay Salary Continuation Amount or to provide other Severance Benefits under this Agreement will immediately cease and any Salary Continuation Amount payments already received and the value of any other Severance Benefits already received will be returned by Executive to SHO. Further, Executive agrees that SHO will be entitled to recovery of its attorneys’ fees and other associated costs incurred as a result of any attempt to redress a breach by Executive or to enforce its rights and protect its interests under this Agreement.

11.
No Prohibition. Subject to the next sentence, nothing in this Agreement will be construed to prohibit Employee from filing a charge with, reporting possible violations to, or participating or cooperating with any governmental agency or entity, including but not limited to the Equal Employment Opportunity Commission, the Department of Justice, the Securities and Exchange Commission, Congress, or any agency Inspector General, or making other disclosures that are protected under the whistleblower, anti-discrimination, or anti-retaliation provisions of federal, state, or local law or regulation. Employee may not disclose SHO Confidential Information that is protected by the attorney-client privilege except as expressly authorized by law. Employee does not need the prior authorization of SHO to make any such reports or disclosures, and Employee is not required to notify SHO that Employee has made such reports or disclosures.

12.
Severability. If any provision or provisions of this Agreement is found invalid, illegal, or unenforceable, in whole or in part, then such provision or provisions will be modified or restricted so as to effectuate as nearly as possible in a valid and enforceable way the provisions hereof, or will be deemed excised from this Agreement, as the case may require, and this Agreement will be construed and enforced to the maximum extent permitted by law, as if such provision or provisions had been originally incorporated herein as so modified or restricted or as if such provision or provisions had not been originally incorporated herein, as the case may be.

13.
Employment-at-Will. This Agreement does not constitute a contract of employment, and Executive acknowledges that Executive’s employment with SHO is terminable “at-will” by either party at any time with or without cause and with or without notice.

14.
Other Plans, Programs, Policies and Practices. If any provision of this Agreement conflicts with any other plan, programs, policy, practice or other SHO document, then the provisions of this Agreement will control, except as otherwise precluded by law. Executive will not be eligible for any benefits under any transition or severance plan or program maintained by SHO.

15.
Entire Agreement. This Agreement, including the appendices hereto, contains and comprises the entire understanding and agreement between Executive and SHO and fully supersedes any and all other prior agreements or understandings between Executive and SHO, in each case with respect to the subject matter contained herein, and may be amended only by a writing signed by (a) one of the Vice President of Human Resources or the Vice President, General Counsel and Secretary (or equivalent) of SHO and (b) Executive.





16.
Tax Withholding. Any compensation paid or provided to Executive under this Agreement will be subject to any applicable federal, state or local income and employment tax withholding requirements.

17.
Notices. All notices and other communications hereunder will be in writing and will be given by hand delivery to the other parties or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:

If to Executive: At the most recent address on file at SHO.

If to SHO: 5500 Trillium Blvd, Hoffman Estates, Illinois 60192, Attention to both: VP, Human Resources and VP, General Counsel.

18.
Assignment. SHO may assign its rights under this Agreement to any successor in interest, whether by merger, consolidation, sale of assets, or otherwise. This Agreement will be binding whether it is between SHO and Executive or between any successor or assignee of SHO and Executive.

19.
Section 409A Compliance. To the extent that a payment or benefit under this Agreement is subject to Code Section 409A, it is intended that this Agreement as applied to that payment or benefit comply with the requirements of Code Section 409A, and the Agreement will be administered and interpreted consistent with this intent. If the Sixty (60)-Day Period following a Separation from Service begins in one calendar year and ends in a second calendar year (a “Crossover 60-Day Period”) and if there are any payments due Executive under this Agreement that are: (i) conditioned on Executive signing and not revoking a release of claims and (ii) otherwise due to be paid during the portion of the Crossover 60-Day Period that falls within the first year thereof, then such payments will be delayed and paid in a lump sum during the portion of the Crossover 60-Day Period that falls within the second year. Executive’s right to receive installment payments pursuant to this Agreement will be treated as a right to receive a series of separate and distinct payments.

20.
Construction and Interpretation. In this Agreement (1) “includes” and “including” are inclusive and mean, respectively, “includes without limitation” and “including without limitation,” (2) “or” is disjunctive but not necessarily exclusive, (3) “will” expresses an imperative, an obligation, and a requirement, (4) numbered “Section” references refer to sections of this Agreement unless otherwise specified, (5) section headings are for convenience only and will have no interpretive value, and (6) unless otherwise indicated all references to a number of days will mean calendar (and not business) days and all references to months or years will mean calendar months or years.

21.
Counterparts. This Agreement may be executed in one or more counterparts, which together will constitute a valid and binding agreement.

22.
Right to Jury. Executive agrees to waive any right to a jury trial on any claim contending that this Agreement or the General Release and Waiver is illegal or unenforceable in whole or in part, and Executive agrees to try any claims brought in a court or tribunal without use of a jury or advisory jury. Further, should any claim arising out of Executive’s employment, termination of employment or Salary Continuation Period (if any) be found by a court or tribunal of competent jurisdiction to not be released by the General Release and Waiver, Executive agrees to try such claim to the court or tribunal without use of a jury or advisory jury.

23.
Governing Law. This Agreement will be governed under the internal laws of the state of Illinois without regard to principles of conflicts of laws. Executive agrees that the state and federal courts located in the state of Illinois will have exclusive jurisdiction in any action, lawsuit or proceeding based on or arising out of this Agreement, and Executive hereby (a) submits to the personal jurisdiction of such courts, (b) consents to the service of process in connection with any action, suit, or proceeding against Executive, and (c) waives any other requirement (whether imposed by statute, rule of court, or otherwise) with respect to personal jurisdiction, venue or service of process.






EXECUTIVE



/s/ MICHAEL MCCARTHY
Michael McCarthy
SEARS HOMETOWN AND OUTLET STORES, INC.


By: BECKY ILIFF
Becky Iliff
Vice President, Human Resources
 
 








Appendix A to Executive Severance Agreement

SHO Competitors

The following companies (including affiliates and subsidiaries within the same controlled group of corporations) are included within the definition of SHO Competitors as referred to under Section 4(c)(ii)(l) of the Executive Severance Agreement between SHO and Executive:

Ace Hardware
Lowe’s Home Improvement
The Home Depot
Menard
Whirlpool
ServiceMaster
Rent-A-Center, Inc.
Aaron’s, Inc.
ABT
Amazon
HHGregg
Conn’s, Inc.
Best Buy
Sears Holdings Corporation
Tractor Supply Co.
True Value Company
Wal-Mart
Target
Caterpillar
John Deere


SHO Vendors

The following companies (including affiliates and subsidiaries within the same controlled group of corporations) are included within the definition of SHO Vendors as referred to under Section 4(d) of the Executive Severance Agreement between SHO and Executive:

Sears Holdings Corporation
Bosch
Electrolux
General Electric
LG
Samsung
Whirlpool
MTD
Techtronic Industries Company Limited
Husqvarna







Appendix B to Executive Severance Agreement


GENERAL RELEASE AND WAIVER

NOTICE

YOU MAY CONSIDER THIS GENERAL RELEASE AND WAIVER FOR UP TO TWENTY ONE (21) DAYS. IF YOU DECIDE TO SIGN IT, YOU MAY REVOKE THIS GENERAL RELEASE AND WAIVER WITHIN SEVEN (7) DAYS AFTER SIGNING IT (THE “REVOCATION PERIOD”). ANY REVOCATION WITHIN THE REVOCATION PERIOD MUST BE IMMEDIATELY SUBMITTED, IN WRITING, TO PHILIP ETTER, HUMAN RESOURCES, SEARS HOMETOWN AND OUTLETS STORES, INC., 5500 TRILLIUM BOULEVARD, SUITE 501, HOFFMAN ESTATES, IL 60192, AND STATE THAT, “I HEREBY REVOKE MY ACCEPTANCE OF THE GENERAL RELEASE AND WAIVER.” THE EXECUTIVE SEVERANCE AGREEMENT AND GENERAL RELEASE AND WAIVER SHALL NOT BECOME EFFECTIVE OR ENFORCEABLE UNTIL THE REVOCATION PERIOD HAS EXPIRED. YOU SHOULD CONSIDER CONSULTING WITH AN ATTORNEY BEFORE SIGNING THIS GENERAL RELEASE AND WAIVER.

I, Michael McCarthy, acknowledge that there are various state, local, and federal laws that prohibit, among other things, employment discrimination on the basis of age, gender, race, color, national origin, religion, disability, sexual orientation or veteran status and that these laws are enforced through the Equal Employment Opportunity Commission, Department of Labor and state or local human rights agencies. Such laws include, without limitation, the following: Title VII of the Civil Rights Act of 1964; the Americans with Disabilities Act; the Age Discrimination in Employment Act; the Older Workers Benefit Protection Act; the Employee Retirement Income Security Act; 42 U.S.C. Section 1981; and all applicable state and local human and civil rights laws as well as other statutes or laws which regulate employment; and the common law of contracts and torts. I hereby waive and release all rights I may have under these or any other laws with respect to my employment and termination of employment and acknowledge that none of the SHO Parties (as defined below) has (a) discriminated against me, (b) breached any contract with me, (c) committed any civil wrong (tort) against me, or (d) otherwise acted unlawfully against me.
I also waive any right to become, and promise not to consent to become, a member of any class or collective in any case in which claims are asserted against any or all of the SHO Parties that are related in any way to my employment or the termination of my employment with Sears Hometown and Outlet Stores Inc., Sears Holdings Corporation, or any subsidiary of either of them, and that involve claims which have accrued as of the date I sign this General Release and Waiver. If I, with or without my knowledge, become a member of a class in any proceeding, I will opt out of the class at the first opportunity afforded to me to do so. In this regard, I agree that I will execute, without objection or delay, an “opt-out” form presented to me either by the court in which such proceeding is pending or by counsel for any or all of the SHO Parties.
In consideration of the benefits I will receive that are described in the attached Executive Severance Agreement, I, Michael McCarthy, for myself, my heirs, administrators, representatives, executors, successors and assigns, do hereby release, waive, and forever discharge Sears Hometown and Outlet Stores, Inc., Sears Holdings Corporation, and the current and former agents, parents, subsidiaries, affiliates, related organizations, employees, officers, directors, shareholders, attorneys, successors, and assigns of each of Sears Hometown and Outlet Stores, Inc. and Sears Holdings Corporation (collectively, the “SHO Parties”) from any and all liability, actions, charges, causes of action, demands, damages, or claims for relief or remuneration, sums of money, accounts, or expenses (including attorneys’ fees and costs) of any kind whatsoever, whether known or unknown at this time, arising out of, or connected with, my employment




with Sears Hometown and Outlet Stores Inc., Sears Holdings Corporation, or any subsidiary of either of them and the termination of my employment. The foregoing release, discharge, and waiver includes, but is not limited to, all claims and any obligations or causes of action arising from such claims, including but not limited to, all matters in law, in equity, in contract (oral or written, express or implied), in tort, or pursuant to statute, including claims under any federal, state or local statute or state or federal constitution, including, but not limited to, Title VII of the Civil Rights Act of 1964, the Civil Rights Act of 1866 and 1871 (42 U.S.C. § 1981), the Civil Rights Act of 1991, the Age Discrimination in Employment Act, the Fair Labor Standards Act, the Employee Retirement Income Security Act, the Americans with Disabilities Act, the Rehabilitation Act of 1973, the Worker Adjustment and Retraining Notification Act, the Family and Medical Leave Act, the National Labor Relations Act, the Equal Pay Act, and all other discrimination and employment laws of Illinois and of all other states and municipalities, to the fullest extent permitted under the law. This General Release and Waiver does not apply to any claims or rights that may arise from events occurring after the date of this General Release and Waiver. Also excluded from this General Release and Waiver are any claims which cannot be waived by law, including my right to file a charge with or participate in an investigation conducted by the Equal Employment Opportunity Commission, and my rights specified in paragraph 11 of the Executive Severance Agreement. I do, however, waive all rights (other than my rights specified in paragraph 11 of the Executive Severance Agreement) to any monetary or other relief of any kind flowing out of any agency or third-party claims or charges, including any charge I might file with any state, local or federal agency. Subject to my rights specified in paragraph 11 of the Executive Severance Agreement, I warrant and represent that I have not filed any complaint, charge, or lawsuit against the SHO Parties or any of them with any governmental agency or with any court.
I have read this General Release and Waiver and understand all of its terms.
I have signed this General Release and Waiver voluntarily with full knowledge of its legal significance and consequences.
I have had the opportunity to seek, and I have been advised in writing of my right to seek, legal counsel prior to signing this General Release and Waiver.
I was given at least twenty-one (21) days to consider signing this General Release and Waiver. Any non-material modification of this General Release and Waiver Agreement does not restart the twenty-one (21) day consideration period.

I understand that if I sign this General Release and Waiver, I can change my mind and revoke it within seven (7) days after signing. I understand this General Release and Waiver will not be effective until after the seven (7) day revocation period has expired.
I understand that the delivery of the benefits I will receive that are described in the attached Executive Severance Agreement does not constitute an admission of liability by the SHO Parties or any of them and that each of the SHO Parties expressly denies any wrongdoing or liability.





THIS IS A RELEASE. READ BEFORE SIGNING.


Signed by: ______________________________
Michael McCarthy

Date: _____________, ____







CERTIFICATIONS


I, William A. Powell, certify that:

1.
I have reviewed this quarterly report on Form 10-Q of Sears Hometown and Outlet Stores, Inc.

2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
  





Date:
December 4, 2015
 
 
 
 
/s/ William A. Powell
 
William A. Powell
 
 
 
 
Chief Executive Officer and President
 
Sears Hometown and Outlet Stores, Inc.
 






CERTIFICATIONS


I, Ryan D. Robinson, certify that:

1.
I have reviewed this quarterly report on Form 10-Q of Sears Hometown and Outlet Stores, Inc.

2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
  





Date:
December 4, 2015
 
 
 
 
/s/ Ryan D. Robinson
 
Ryan D. Robinson
 
 
 
 
Senior Vice President and Chief Financial Officer
 
Sears Hometown and Outlet Stores, Inc.
 






CERTIFICATION

Pursuant to 18 U.S.C. 1350 as adopted by Section 906 of the Sarbanes-Oxley Act of 2002

Each of the undersigned, William A. Powell, Chief Executive Officer and President of Sears Hometown and Outlet Stores, Inc. (the “Company”) and Ryan D. Robinson, Senior Vice President and Chief Financial Officer of the Company, has executed this certification in connection with the filing with the Securities and Exchange Commission of the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2015 (the “Report”).

Each of the undersigned hereby certifies that:

1.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. 



December 4, 2015
 
 
 
 
 
 
/s/ William A. Powell
 
William A. Powell
 
Chief Executive Officer and President
 
 


/s/ Ryan D. Robinson
Ryan D. Robinson
Senior Vice President and
 
Chief Financial Officer





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