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SEARS HOMETOWN AND OUTLET STORES, INC. REPORTS 1Q 2016 RESULTS
Source: Sears press release

Hoffman Estates, Illinois -- Sears Hometown and Outlet Stores, Inc. has reported results for its fiscal quarter ended April 30, 2016.

Overview of Preliminary, Unaudited Results

Results for the first fiscal quarter of 2016 compared to the first fiscal quarter of 2015 included:

•Comparable store sales decreased 2.8%
•Adjusted EBITDA decreased $6.1 million to $1.3 million from $7.4 million
•Expenses for IT transformation investments were $3.2 million
•Operating loss increased $7.8 million to $(5.1) million from $2.8 million operating income
•Loss per share increased $0.22 to $(0.16) from $0.06 income per share

Will Powell, Chief Executive Officer and President, said, "In the first quarter, we continued to make progress on the rollout of our America's Appliance Experts program and the transformation of our IT platform, which will better position the Company for long-term success. We experienced a challenging sales quarter, but saw improvements in several strategic growth categories and took steps in Outlet to be more competitive in the current highly promotional environment. In addition, actions taken in 2015 resulted in lower year-over-year expenses."

"Hometown posted an overall comparable store sales decline of 2.6% in the first quarter of 2016, which was driven by a decline in home appliances and a decline in lawn and garden due to unfavorable weather conditions in key trade areas. We did achieve positive comparable sales increases in mattresses and tools, which were the third and second consecutive quarterly increases in these key categories, respectively."

"Outlet comparable store sales declined 3.1% in the first quarter of 2016 primarily driven by lower sales of home appliances due to continued competitive pricing pressure on new, in-box products, which made out-of-box product price comparisons less compelling. During the quarter, we initiated a highly competitive pricing test in a group of Outlet stores that resulted in a 640 basis points improvement in comparable store sales compared to stores on the existing promotional plan. Due to the success of the test, we plan to roll out our highly competitive pricing nationally in the second quarter of 2016."

"Mattress sales in Outlet were negatively impacted by a decline in mattress inventory received from Sears Holdings Corporation compared to the prior year. Through a relationship with another key vendor we are adding more mattress inventory to fill the gap, which has resulted in improved results as new product arrives. The furniture category delivered a 23.3% comparable store sales increase, the second consecutive quarterly increase for this strategic growth category. Also, we achieved comparable store sales increases in the lawn and garden and tools categories as a result of better inventory positions compared to the prior year. We have also continued to improve our inventory position in out-of-box home appliances since the first quarter of 2015 as a result of new supply agreements with key vendors."

"In the first quarter of 2016 we converted another 78 Hometown stores to our America's Appliance Experts program ("AAE"), which we believe improves our home appliances shopping experience. The AAE store locations outperformed non-AAE locations in total and home appliance comparable store sales by 224 basis points and 572 basis points, respectively. Also, the gross margin in our AAE stores was slightly higher than in our non-AAE stores. At the end of the first quarter of 2016, we had 255 AAE locations and plan to convert over 200 additional locations in 2016."

"In the first quarter of 2016 in our Hometown Segment we opened 2 new stores and closed 17 under-performing stores. The first quarter 2016 impact of these closed locations was a reduction of $0.5 million in EBITDA and a reduction of 13 basis points of gross margin rate. These closures should enable us to reduce expenses, improve future profit performance, and free up net working capital of over $9 million."

"Results for the first quarter of 2016 were also unfavorably impacted by merchandise inventory shrink compared to last year primarily due to a $2.5 million physical inventory gain recorded in Hometown in the first quarter of 2015 and a $3.4 million physical inventory charge incurred in Outlet in the first quarter of 2016. The year-over-year change in our shrink results unfavorably impacted the gross margin rate by 105 basis points in the first quarter of 2016 with reductions of 45 basis points and 231 basis points in Hometown and Outlet, respectively. The physical inventory gain in 2015 was historically unusual and we did not expect those results to repeat."

"In the first quarter of 2016 Selling and administrative expense was down $17.7 million (131 basis points) compared to the first quarter of 2015. Our Selling and administrative expense favorably reflected the closure of 137 unproductive stores along with actions taken in 2015 to reduce overall payroll and benefits costs at our support center and in our field organization. We continued to make progress with our IT transformation initiative, which will provide greater strategic and operating flexibility including improvements in our ability to assort and price merchandise , as well as the ability to source products directly from vendors. Selling and administrative expenses include $3.2 million and $1.5 million of IT transformation costs for the first quarters of 2016 and 2015, respectively. To make these expenses more transparent to investors, we have broken them out in our Adjusted EBITDA calculation."

"At the end of the first quarter of 2016 outstanding borrowings on our senior ABL facility were $32.0 million, which was at a similar level compared to the prior year, and we had $212.3 million of unused borrowing capacity. In May 2016 we and Sears Holdings amended most of our agreements (see "Subsequent Events" below), and among the amendments is our agreement to pay Sears Holdings for merchandise and services on accelerated terms during the second quarter of 2016 in return for a 37 basis-point discount. This will result in additional borrowings during the second quarter, but the early payment discount less incremental interest expense will result in a net financial benefit to SHO."

First Quarter Results

Net sales in the first quarter of 2016 decreased $45.8 million, or 7.9%, to $537.0 million from the first quarter of 2015. This decrease was driven primarily by the impact of closed stores (net of new store openings) and a 2.8% decrease in comparable store sales.

Comparable store sale were down 2.6% and 3.1% in Hometown and Outlet, respectively. The consolidated comparable store sales decrease of 2.8% was primarily due to (1) lower Hometown home appliances sales resulting from a change in promotional pricing strategy to improve our gross margin in an aggressive promotional pricing environment and softness in the sales of the dishwasher and food storage categories, (2) lower sales in Outlet's home appliance due to higher industry-wide promotional activity, which impacted the value proposition of out-of-box home appliances as competitors reduced prices on new, in-box home appliances, (3) lower Hometown lawn and garden sales due, in part, to unusually cool and wet weather, and (4) lower Outlet apparel and mattress sales due to a decrease in product supply from Sears Holdings. These decreases were partially offset by (1) a lower quarter-end deferral of unshipped sales, (2) sales increases in Hometown tools, which responded favorably to changes in marketing and pricing strategies, and (3) higher sales in Outlet's home furnishings due to an expansion in furniture categories.

Gross margin was $116.2 million, or 21.6% of net sales, in the first quarter of 2016 compared to $140.4 million, or 24.1% of net sales, in the first quarter of 2015. The decrease in gross margin rate was primarily driven by (1) higher shrink driven by a $3.4 million physical inventory charge to Outlet in the first quarter of 2016 and a $2.5 million physical inventory gain in Hometown in the first quarter of 2015, (2) higher occupancy costs due to a higher number of Company-operated locations, (3) lower margin on merchandise sales, (4) lower online commissions from Sears Holdings, and (5) higher distribution center and product repair costs in Outlet. These declines were partially offset by a $2.8 million net benefit from the May 2016 amendment to our Merchandising Agreement with Sears Holdings (the "Merchandising Net Benefit"), all of which was included in first quarter 2016 gross margin. Stores closed in the first quarter of 2016 reduced the gross margin rate 13 basis points. The total impact of occupancy costs, online commissions from Sears Holdings, initial franchise revenues, shrink, the Merchandising Net Benefit, and closed stores reduced gross margin 373 basis points in the first quarter of 2016 compared to a reduction of 192 basis points in the first quarter of 2015.

Selling and administrative expenses decreased to $118.0 million, or 22.0% of net sales, in the first quarter of 2016 from $135.7 million, or 23.3% of net sales, in the prior-year comparable quarter. The decrease was primarily due to lower commissions paid to dealers and franchisees on lower sales volume from operating a higher number of company operated stores in 2016, lower expenses due to stores closed (net of new store openings) since the second quarter of 2015, and $1.4 million of executive transition costs incurred in the first quarter of 2015. These declines were partially offset by $3.2 million of IT transformation investments, a $1.7 million increase over the first quarter of 2015, and higher payroll and benefits due to a higher number of Company-operated stores.

We recorded an operating loss of $5.1 million and operating income of $2.8 million in the first quarters of 2016 and 2015, respectively. The reduction in operating income was primarily due to lower gross margin (including the impact of lower volume, a lower gross margin rate, and higher shrink partially offset by the Merchandising Net Benefit), $1.7 million of higher IT transformation investments, and higher depreciation and amortization expense. The gross margin reduction was partially offset by favorability in selling and administrative expenses in the first quarter of 2016.