Background and Basis of Presentation (Policies)

6 Months Ended

Aug. 03, 2019

Organization, Consolidation and Presentation of Financial Statements [Abstract]

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 13 and 26 weeks ended August 3, 2019 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 February 2, 2019 (the "2018 10-K").

Segment Reporting

During the second quarter of 2019, we began to separately report the results of our Sears Outlet and Buddy’s Home Furnishing Stores businesses (together, the “Outlet Segment” or "Outlet"), including substantially all of the assets and liabilities comprising the Outlet Segment as discontinued operations. The Company is reporting the operating results and cash flows of the Outlet Segment as discontinued operations, and thus they have been excluded from continuing operations and segment results for all periods presented. Consequently, we now report our results of operations as a single segment that includes all of our continuing operations (the "Hometown segment" or "Hometown"). The assets and liabilities of the Outlet Segment are presented as current assets and liabilities of businesses held for sale in the Condensed Consolidated Balance Sheets. See Note 2 for additional information regarding the Company's discontinued operations.

Fiscal Period

Our second fiscal-quarter end is the Saturday closest to July 31. For 2019 and 2018, our second fiscal quarters ended as follows:



Fiscal Year	First Quarter Ended	Weeks
2019	August 3, 2019	13
2018	August 4, 2018	13

Our fiscal year end is the Saturday closest to January 31. Our 2019 fiscal year will end February 1, 2020. Unless otherwise stated, references to specific years and quarters in these notes are to fiscal years and fiscal quarters, respectively.

Reclassifications

Certain amounts have been reclassified in order to conform to the current-period presentation.

Revenue Recognition, Refund Liability and Right of Return Asset, and Cost of Sales and Occupancy

Revenue Recognition

Revenues from contracts with customers include sales of merchandise, commissions on merchandise sales made through www.sears.com, Company websites, services and extended-service plans, financing programs, and delivery and handling revenues related to merchandise sold. Revenue is measured based on the amount of fixed consideration that we expect to receive, reduced by estimates for variable consideration such as returns. Revenue also excludes any amounts collected from customers and remitted or payable to governmental authorities. In arrangements where we have multiple performance obligations, the transaction price is allocated to each performance obligation using the relative stand-alone selling price.

We recognize revenues from retail operations upon the transfer of control of goods to the customer. We satisfy our performance obligations at the point of sale for retail store transactions and upon delivery for online transactions. We defer revenue for retail store and online transactions including commissions on extended-service plans, where we have received consideration but have not transferred control of the goods to the customer at the end of the period. The performance obligation is generally satisfied in the following reporting period. The balance of deferred revenue was $11.5 million and $10.6 million at August 3, 2019 and February 2, 2019, respectively. The change in deferred revenue represents additional revenue deferred during the first and second quarter of 2019. We recognize revenues from commissions on services, and delivery and handling revenues related to merchandise sold, at the point of sale as we are not the primary obligor with respect to such services and have no future obligations for future performance. Commissions earned on services, and delivery and handling revenues are presented net of related costs because we are acting as an agent in arranging the services for the customer and do not control the services being rendered.

The Company accepts Transform's Sears gift cards as tender for purchases and is reimbursed weekly by Transform for gift cards tendered.

Refund Liability and Right of Return Asset

Revenues from merchandise sales and services are reported net of estimated returns and allowances and exclude sales taxes. The typical return period is 30 days. The refund liability for returns is calculated as a percentage of sales based on historical return percentages. Estimated returns are recorded as a reduction of revenues. The refund liability was $1.5 million and $1.4 million at August 3, 2019 and February 2, 2019, respectively. We also recognize a return asset, and corresponding adjustment to cost of sales, for our right to recover the goods returned by the customer, measured at the former carrying amount of the goods, less any expected recovery cost. The right of return asset was $0.6 million and $0.7 million at August 3, 2019 and February 2, 2019, respectively. At each financial reporting date, we assess our estimates of expected returns, refund liabilities, and return assets.

Cost of Sales and Occupancy

Cost of sales and occupancy is comprised principally of merchandise costs, warehousing and distribution (including receiving and store delivery) costs, retail store occupancy costs, home services and installation costs, warranty cost, royalties payable to Transform (as assignee from Sears Holdings) related to our sale of products branded with one of the KENMORE^®, CRAFTSMAN^®, and DIEHARD^® marks (the "KCD Marks"), customer shipping and handling costs, vendor allowances, markdowns, and physical inventory losses. The KCD Marks are owned by, or licensed to, subsidiaries of Transform (as assignee from Sears Holdings).

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 VIE. In addition, this guidance requires ongoing reassessments as to whether a reporting company is the primary beneficiary of a VIE and disclosures regarding the reporting company’s involvement with a VIE.

On an ongoing basis the Company evaluates its business relationships, such as those with its independent dealers, independent franchisees, and suppliers, to identify potential VIE's. 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:

Level 1 inputs—unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. An active market for the asset or liability is one in which transactions for the asset or liability occurs with sufficient frequency and volume to provide ongoing pricing information.

Level 2 inputs—inputs other than quoted market prices included in Level 1 that are observable, either directly or indirectly, for the asset or liability. Level 2 inputs include, but are not limited to, quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted market prices that are observable for the asset or liability, such as interest-rate curves and yield curves observable at commonly quoted intervals, volatilities, credit risks, and default rates.

Level 3 inputs—unobservable inputs for the asset or liability.

Cash and cash equivalents, merchandise payables, accrued expenses (Level 1), accounts and franchisee notes receivable, and short-term debt (Level 2) are reflected in the Condensed Consolidated Balance Sheets at cost, which approximates fair value due to the short-term nature of these instruments. For short-term borrowings and our Term Loan, the variable interest rates are a significant input in our fair value assessments and are consistent with the interest rates in the market. The carrying value of long-term notes receivable approximates fair value.

We may be required, on a nonrecurring basis, to adjust the carrying value of the Company's long-lived assets. When necessary, these valuations are determined by the Company using Level 3 inputs. These assets are subject to fair value adjustments in certain circumstances as when there is evidence that impairment may exist. The Company was not required to measure any other significant non-financial asset or liability at fair value as of August 3, 2019.

Recently Issued and Adopted Accounting Pronouncements

Recently Issued Accounting Pronouncements

Recently issued accounting pronouncements that are not yet effective and that we have not discussed in the 2018 10-K or below are either inapplicable to us or, if applicable, we do not expect that they will have a material impact on our consolidated results of operations, consolidated financial condition, or consolidated cash flows.

Recently Adopted Accounting Pronouncements

ASU 2016-02 "Leases (Topic 842)"

In February 2016, the FASB issued Accounting Standards Update ("ASU") 2016-02, "Leases (Topic 842)", which establishes a right-of-use model and requires an entity that is a lessee to recognize the right-of-use assets and liabilities arising from leases on the balance sheet. ASU No. 2016-02 also requires disclosures about the amount, timing, and uncertainty of cash flows arising from leases. Leases will be classified as finance or operating, with classification affecting both the pattern and classification of expense recognition in the statements of earnings. This guidance was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842; and ASU No. 2018-11, Targeted Improvements. ASU No. 2016-02 and subsequent updates require a modified retrospective transition, with the cumulative effect of transition, including initial recognition of lease assets and liabilities for existing operating leases, as of (i) the effective date or (ii) the beginning of the earliest comparative period presented. These updates also provide a number of practical expedients for implementation which we are applying, as discussed below.

On February 3, 2019 (the "effective date"), we adopted ASU No. 2016-02 and subsequent updates, collectively referred to as Topic 842, using the modified retrospective transition method. In addition, we adopted the package of practical expedients in transition, which permits us to not reassess our prior conclusions pertaining to lease identification, lease classification and initial direct costs on leases that commenced prior to our adoption of the new standard. We also elected to treat the lease and non-lease components of leases as a single lease component and to exempt leases with an initial term of twelve months or less from balance sheet recognition.

As a result of adopting Topic 842, we recognized net operating right-of-use assets of $3.0 million and operating lease liabilities of $5.4 million on the effective date. Existing prepaid rent, accrued rent, and deferred rent were recorded as an offset to our gross operating lease right-of-use assets. The cumulative effect of the adoption resulted in a $2.4 million adjustment to the opening balance of retained earnings as of February 3, 2019. The standard did not have a material impact on our results of operations or cash flows.

SEARS HOMETOWN & OUTLET STORES, INC. 10-Q