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SEARS HOMETOWN AND OUTLET STORES, INC. REPORTS 2Q FY18 RESULTS
Source: Sears Hometown and Outlet Stores, Inc. news release

Hoffman Estates, Illinois -- Sears Hometown and Outlet Stores, Inc. has reported results for the quarter ended August 4, 2018.

Overview of Unaudited Results

Results for the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017 included:

Net loss decreased $20.1 million to $9.3 million from $29.4 million;

Loss per share decreased $0.89 to $0.41 loss per share from $1.30 loss per share;

Comparable store sales increased 0.9%;

Adjusted EBITDA increased $8.5 million to $11.3 million from $2.8 million.

Will Powell, Chief Executive Officer and President, said, "In the second quarter the positive impact of our business transformation initiatives drove positive comparable store sales in a quarter for the first time in five years and an $8.5 million increase in adjusted EBITDA. The first half of the year represented an improvement of $20.1 million in adjusted EBITDA. In addition to improving our profitability, we reduced our total borrowings by $18.4 million during the second quarter. Transforming a business is a challenging task and we still have much to do to finish the work we have started. However, I am encouraged by the fact that during four of the last five quarters, we have reported positive and increased adjusted EBITDA compared to the prior year. I believe this demonstrates that our initiatives have traction in our business and, in many cases, have reached a scale where they now have a significant impact on our results."

We continue to implement our strategic plan to transform our business. Meaningful progress is evident across many of our initiatives that serve to enable this change.

Examples include:

Changes to our Outlet pricing strategy and improvements to our as-is appliance sourcing led to decreased markdowns and margin improvement of over 500 basis points in our Outlet segment. Additionally, the Outlet segment began to achieve positive comparable store sales in July as we anniversaried the impact of our pricing changes. Due to the ongoing improvement in our Outlet business, we opened one Outlet store in the second quarter, opened an additional Outlet store in the third quarter, and plan to open one or two additional Outlet stores before the end of our 2018 fiscal year.

In the second quarter 2018 lease-to-own comparable sales increased 39.9% and leasing's share of total sales increased to 8.1%, up 233 basis points compared to the second quarter 2017.

We opened one additional Buddy's Home Furnishings store, bringing total openings to six since January 2018. We opened these rent-to-own stores as a franchisee, enabling us to benefit from Buddy's extensive expertise and systems infrastructure in this business in which we own the inventory that we rent to our customers. Buddy's Home Furnishings is the third largest rent-to-own operator in the United States with over 330 locations nationwide. Its principal owner, Vintage Capital Management, LLC, reached an agreement in the second quarter 2018 to acquire Rent-A-Center, Inc. We plan to open three additional Buddy's Home Furnishings locations before the end of our 2018 fiscal year.

SearsHometown.com sales were up 158.0% compared to second quarter 2017.

Commercial sales increased 33.1% compared to second quarter 2017. Our margin on commercial sales increased 48.1% as the margin rate improved by 136 basis points compared to second quarter 2017. Stores participating in this program increased to nearly 55% of our stores from less than 40% last year.

In the second quarter we remodeled and converted 22 Hometown stores to our new Core Store format. We conducted the initial pilot of this format in 2017 in three stores and we were pleased with the results, which included positive comparable store sales and an improved gross margin rate. This expanded pilot will enable us to further assess this new format, which is designed to build on the success of our America's Appliance Experts program through focus on the non-appliance categories in the stores.

As previously disclosed, we recorded a $7.6 million charge in the second quarter associated with commencing the closure of 109 under-performing Hometown stores, which includes $0.8 million of closed-store impairment charges.

As of August 4, 2018, the closure of 98 of these stores was complete, and the remaining eleven stores are expected to be closed in the third quarter. We expect these closings to advance our efforts to improve the profitability of our Hometown segment and strengthen our balance sheet. We had inventory investments in these stores of $31.5 million as of the end of the first quarter 2018 and are using proceeds from the liquidation of this inventory to pay down borrowings under our Amended and Restated Credit Agreement (the "Senior ABL Facility").

Second Quarter Performance Highlights

Consolidated comparable store sales were 0.9% in the second quarter of 2018. This represented a significant improvement from comparable store sales of (10.5)% in the first quarter of 2018 and is the first time since the second quarter of 2013 that we have reported positive consolidated comparable sales. Furthermore, this positive trend continued with positive consolidated comparable sales in August.

Hometown segment comparable store sales increased 2.2% in the second quarter of 2018. Lawn and garden outperformed the comparable store sales average due to strong performance in the month of May resulting from favorable weather conditions. Lawn and garden contributed approximately 50% of Hometown's total comparable store sales dollar increase. Appliances also had positive comparable store sales. Although inventory availability has remained challenging, tools did generate positive comparable store sales for the quarter.

Outlet segment comparable store sales declined 2.3% in the second quarter of 2018. This decline was driven by the continuation of our as-is appliance pricing strategy in Outlet that we launched late in the second quarter of 2017.

The positive gross margin benefit achieved from continuing this new pricing strategy significantly outweighed the sales decline. It is important to note that Outlet achieved positive comparable sales in July 2018, the first month in which the current pricing strategy was comparable to the prior year. In addition, positive comparable store sales continued in August.

Consolidated gross margin was $92.0 million, or 21.3% of net sales, in the second quarter of 2018 compared to $92.3 million, or 18.8% of net sales, in the second quarter of 2017. The gross margin rate improvement of 250 basis points mostly offset the volume-related decrease in gross margin. Closing store costs negatively impacted gross margin by 147 basis points and 228 basis points in the second quarters of 2018 and 2017, respectively.

Hometown gross margin decreased $10.9 million, or 16.2%, to $56.6 million in the second quarter of 2018. Hometown gross margin rate decreased by 70 basis points to 18.7%. The decline was driven by accelerated closing store costs.

Closing store costs negatively impacted gross margin by 218 basis points and 119 basis points in the second quarters of 2018 and 2017, respectively.

Outlet gross margin increased $10.5 million, or 42.3%, to $35.3 million in the second quarter of 2018. Outlet gross margin rate improved by 1,030 basis points to 27.7% driven by higher margins on merchandise sales and lower store closing costs partially offset by an increase in occupancy costs as a percent of sales due to the sales decline and an increase in the number of Company-operated stores. Closing store costs (credits) impacted gross margin by (21) basis points and 495 basis points in the second quarters of 2018 and 2017, respectively.

Consolidated selling and administrative expenses decreased 18.4% to $94.0 million, or 21.8% of net sales, in the second quarter of 2018 from $115.2 million, or 23.5% of net sales, in the comparable quarter last year. The decrease was primarily due to (1) lower commissions paid to dealers and franchisees on lower sales volume, (2) $5.6 million of provisions related to franchisee notes receivable in the second quarter of 2017 (of which provisions there were none in the second quarter of 2018), (3) lower expenses from stores closed (net of new store openings) since the second quarter of 2017, (4) lower IT transformation investments, and (5) lower marketing expense. The reductions were partially offset by higher payroll and benefits due to a higher proportion of Company-operated stores. IT transformation investments were $6.5 million, or 1.5% of sales, in the second quarter of 2018 compared to $8.5 million, or 1.7% of sales, in the second quarter of 2017.
We recorded operating losses of $5.8 million and $27.6 million in the second quarters of 2018 and 2017, respectively. The decrease in operating loss was due to lower selling and administrative expenses, a higher gross margin rate and positive comparable store sales, partially offset by lower volume from closed stores.

We recorded a net loss of $9.3 million for the second quarter of 2018 compared to a net loss of $29.4 million for the prior-year comparable quarter. The decrease in our net loss was primarily attributable to the factors discussed above, partially offset by higher interest expense.

Consolidated adjusted EBITDA improved $8.5 million to $11.3 million in the second quarter of 2018 from $2.8 million in the second quarter of 2017.

Hometown adjusted EBITDA decreased $1.5 million to $0.2 million in the second quarter of 2018 from $1.8 million in the second quarter of 2017. The decrease was driven by lower volume related to closed stores and a lower gross margin rate partially offset by lower selling and administrative expenses and positive comparable store sales.

Outlet adjusted EBITDA increased $10.0 million in the second quarter of 2018 to $11.0 million from $1.0 million in the second quarter of 2017. The improvement was driven by an improved gross margin rate and lower selling and administrative expenses partially offset by lower sales.