SEARS HOMETOWN & OUTLET STORES, INC. (Form: 10-K, Received: 03/31/2017 06:14:57)

Large accelerated filer

Accelerated filer

Non-accelerated filer

(Do not check if a smaller reporting company)

Smaller reporting company

U NITED S TATES

S ECURITIES A ND E XCHANGE C OMMISSION

W ASHINGTON , D.C. 20549

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FORM 10-K

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ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	FOR THE 52 WEEKS ENDED JANUARY 28, 2017



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-35641

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SEARS HOMETOWN AND OUTLET STORES, INC.

(Exact Name of Registrant as Specified in its Charter)

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D ELAWARE		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

Securities registered pursuant to Section 12(b) of the Act:



Title of Each Class		Name of Exchange on Which Registered
Common Stock, par value $0.01 per share		The NASDAQ Stock Market

Securities registered pursuant to Section 12(g) of the Act:

None

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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ¨ No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ¨ No ý

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

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):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No ý

As of March 30, 2017 Sears Hometown and Outlet Stores, Inc. had 22,716,132 shares of common stock, $0.01 par value, outstanding. The aggregate market value (based on the closing price of Sears Hometown and Outlet Stores, Inc.'s common stock quoted on the NASDAQ Stock Market) of Sears Hometown and Outlet Stores, Inc.'s common stock owned by non-affiliates, as of the last business day of Sears Hometown and Outlet Stores, Inc.'s most recently completed second fiscal quarter, was approximately $66,668,000.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Annual Report on Form 10-K incorporates by reference certain information from Sears Hometown and Outlet Stores, Inc.'s definitive 2017 Proxy Statement relating to our Annual Meeting of Stockholders to be held on May 24, 2017, which will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Annual Report on Form 10-K relates.

SEARS HOMETOWN AND OUTLET STORES, INC.

TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K




		Page

PART I

Item 1.	Busines s	0

Item 1A.	Risk Factors	8

Item 1B.	Unresolved Staff Comments	22

Item 2.	Properties	22

Item 3.	Legal Proceedings	25

Item 4.	Mine Safety Disclosure	25

	Executive Officers of the Registrant	26

PART II

Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities	27

Item 6.	Selected Financial Data	30

Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	32

Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	52

Item 8.	Financial Statements and Supplementary Data	53
	Consolidated Statements of Operations for the years ended January 28, 2017, January 30, 2016 and January 31, 2015	54
	Consolidated Balance Sheets at January 28, 2017 and January 30, 2016	55
	Consolidated Statements of Cash Flows for the years ended January 28, 2017, January 30, 2016 and January 31, 2015	56
	Consolidated Statements of Stockholders' Equity for the years ended January 28, 2017, January 30, 2016 and January 31, 2015	57
	Notes to Consolidated Financial Statements	58

Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	86

Item 9A.	Controls and Procedures	86



PART III

Item 10.	Directors, Executive Officers and Corporate Governance	88

Item 11.	Executive Compensation	88

Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	88

Item 13.	Certain Relationships and Related Transactions, and Director Independence	89

Item 14.	Principal Accountant Fees and Services	89

PART IV

Item 15.	Exhibits and Financial Statement Schedules	90

Item 16.	Form 10-K Summary	91

Part I

Item 1. Business

We are a national retailer primarily focused on selling home appliances, lawn and garden equipment, tools, and hardware at our stores and on our websites. We also offer our customers the opportunity to acquire home appliance, lawn and garden, fitness, bedding, and other categories of merchandise and product protection agreements through our lease-to-own program that we operate by agreement with a third party. As of January 28, 2017 our independent dealers and franchisees ("our dealers and franchisees") and we operated a total of 1,020 stores across all 50 states, Puerto Rico, and Bermuda. In addition to merchandise, we provide our customers with access to a full suite of related services, including home delivery, installation, and extended-service plans. In this Annual Report on Form 10-K we refer to ourselves as "SHO," "our company," the "Company," "we," "our," or "us." We became a publicly held company immediately following our October 11, 2012 separation (the "Separation") from Sears Holdings Corporation ("Sears Holdings").

We operate through two segments—the Sears Hometown and Hardware segment ("Hometown") and the Sears Outlet segment ("Outlet"). Our Hometown stores are designed to provide our customers with in-store and online access to a wide selection of national brands of home appliances, lawn and garden equipment, tools, sporting goods, and household goods, depending on the particular store. Our Outlet stores are designed to provide in-store and online access to purchase new, one-of-a-kind, out-of-carton, discontinued, obsolete, used, reconditioned, overstocked, and scratched and dented products, collectively "outlet-value products" across a broad assortment of merchandise categories, including home appliances, mattresses, furniture, and lawn and garden equipment at value-oriented prices. See Note 9 to our Consolidated Financial Statements in this Annual Report on Form 10-K for further information about our segments.

The majority of our Hometown stores are operated by our dealers and franchisees. SHO provides brand and marketing support and inventory on consignment. We initiated efforts to franchise Outlet stores in 2012, with the first stores transferred to franchisees during the 2013 fiscal year. During the second quarter of fiscal 2015 the Company indefinitely suspended its franchising of additional Hometown and Outlet stores except to existing Company franchisees, and the suspension is continuing. We pay our dealers and franchisees commissions based on their net sales of our inventory that we consign to them. We also authorize our dealers and franchisees to sell post-sale services, such as extended-service plans, for which we also pay commissions.

Hometown

As of January 28, 2017 , our dealers and franchisees and we operated a total of 871 Sears Hometown and Hardware stores located across all 50 states, Puerto Rico, and Bermuda.

Our Hometown segment operates through three distinct formats: Sears Hometown Stores ("Hometown Stores"), Sears Hardware Stores ("Hardware Stores"), and Sears Home Appliance Showrooms ("Home Appliance Showrooms"), and related websites.

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Hometown Stores . Our Hometown Stores and website offer products and services across a wide selection of merchandise categories, including home appliances, lawn and garden equipment, tools, sporting goods, and household goods, with the majority of business driven by big-ticket home appliance and lawn and garden sales. Most of our Hometown Stores carry Sears-branded products, including products branded with the KENMORE ^® , CRAFTSMAN ^® , and DIEHARD ^® marks (the "KCD Marks"), and an assortment of other national brands. Primarily independently operated, predominantly located in smaller communities and averaging approximately 8,500 square feet, Hometown Stores are designed to serve trade areas that may not support a full-service big-box retailer. As of January 28, 2017 , there were 795 Hometown Stores in all 50 states, Puerto Rico and Bermuda. Hometown Stores also sell products and services through our website www.searshometownstores.com. Independent dealers operated 789, and we operated six, Hometown Stores.

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Hardware Stores . Our Hardware Stores and website offer products and services across a wide selection of merchandise categories with sales primarily driven by home appliances, lawn and garden equipment, tools, and other home improvement products. In addition, these stores offer certain proprietary in-store services, such as blade sharpening, key cutting, and screen repair, as well as products typically found in local hardware stores, such as fasteners, electrical supplies, and plumbing supplies. Our Hardware Stores have operated as two formats: "traditional" and "neighborhood", with size being the differentiating factor between the two formats. Our "traditional" Hardware Stores average nearly 28,000 square feet in size. Our "neighborhood" Hardware Stores are much smaller in size, averaging 16,000 to 18,000 square feet, and yet, through our multichannel capability, continue to offer the same breadth and depth of inventory as our "traditional" Hardware Stores. Our Hardware Stores, regardless of size, are primarily located in suburban trade areas and are positioned as local stores

designed to appeal to convenience-oriented customers. These stores 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. As of January 28, 2017 , there were 26 Hardware Stores in 11 states, all of which carry a selection of Kenmore and other national brands of home appliances. Hardware Stores also sell products and services through our website www.searshardwarestores.com. Franchisees operated ten, and we operated sixteen, of these stores.

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Home Appliance Showrooms . Our Home Appliance Showrooms and website offer home appliances and related services in stores primarily located in strip malls and lifestyle centers in metropolitan areas. Averaging 5,000 square feet with a simple, primarily appliance-showroom design, our Home Appliance Showrooms offer quality-focused customers a unique store shopping experience. Home Appliance Showroom sales are primarily driven by home appliances as well as, in certain stores, mattresses. These stores carry Kenmore and other national brands of home appliances. As of January 28, 2017 , there were 50 Home Appliance Showrooms in 16 states. Home Appliance Showrooms also sell products and services through our website www.searshomeapplianceshowroom.com. Franchisees operated 34 of these stores, we operated 16 stores.

In 2016 revenue from our Hometown segment was $1.4 billion.

Outlet

Our Sears Outlet stores (the "Outlet Stores") are designed to provide in-store and online access to purchase outlet-value products across a broad assortment of merchandise categories, including home appliances, mattresses, apparel, sporting goods, lawn and garden equipment, tools, and other household goods, including furniture, at prices that are significantly lower than list prices. Outlet Stores serve as a liquidation channel for outlet-value home appliances from major appliance vendors. In 2016 Outlet’s most significant merchandise category was home appliances, which made up over 80% of our Outlet sales revenue. Outlet-value products are generally covered by a warranty. Outlet Stores also offer a full suite of extended-service plans and services. As of January 28, 2017 , Outlet operated 149 locations in 34 states and one in Puerto Rico, of which all offer a wide range of outlet-value products. Outlet also sells products and services through our website www.searsoutlet.com. As of January 28, 2017 , we operated 112 Outlet Stores and franchisees operated 37 Outlet Stores.

In 2016 revenue from our Outlet segment was $630.5 million.

Competition

Hometown

Our Hometown business is subject to highly competitive conditions, with varying levels of competition in each store’s trade area. Hometown Stores and Hardware Stores compete with a wide variety of retailers handling similar lines of merchandise, including department stores, discounters, mass merchandisers, specialty retailers, wholesale clubs, and many other competitors operating on a national, regional, or local level. Hometown Stores and Hardware Stores also compete with online and catalog businesses that have similar merchandise offerings. Home Appliance Showrooms compete with all of the previously listed competitors to the extent that they sell home appliances.

The key national competitors of the Hometown Stores, the Hardware Stores, and the Home Appliance Showrooms are The Home Depot and Lowe’s, as well as Ace Hardware and True Value for the Hardware Stores, and Tractor Supply for the Hometown Stores and the Hardware Stores, all of which offer consumers lines of merchandise that are the same as or similar to lines of merchandise offered by the Hometown Stores, the Hardware Stores, and the Home Appliance Showrooms. Sears Holdings' stores offer consumers lines of merchandise that are similar to the lines of merchandise offered by the Hometown Stores, the Hardware Stores, and the Home Appliance Showrooms. We believe that, historically, the Hometown Stores, the Hardware Stores, and the Home Appliance Showrooms generally did not compete significantly with Sears Holdings' stores. As our stores expand their merchandise offerings (for example, our increased emphasis on mattresses), the level of competition between the Hometown Stores, the Hardware Stores, and the Home Appliance Showrooms and Sears Holdings' stores has increased. In addition to being the principal merchandise vendor for the Hometown business, Sears Holdings also continues to provide some e-commerce services and support to SHO, and Sears Holdings' online sales compete with our business.

We believe that the results of operations for our businesses in fiscal 2016 were, and will continue to be, adversely affected by the continuing growth at other retailers of online sales of merchandise in our 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, were constrained significantly by our agreements with Sears Holdings until those agreements were amended in May 2016, and we are now contractually entitled to use our Hometown websites to make online sales, which began in November 2016. We believe that

these constraints affected our ability to conduct, and grow, our online business during our 2016 fiscal year and, as a consequence, likely adversely affected our results of operations for our 2016 fiscal year.

We believe that the key differentiating factors among competitors operating in this industry include price, product assortment and quality, service and convenience, brand recognition, existence of loyalty programs, online and multichannel capabilities and availability of retail-related services such as access to our lease-to-own and credit-card programs and product delivery, installation, and repair.

Outlet

The Outlet Stores and searsoutlet.com operate in the highly fragmented outlet-value retail industry. In our primary product category, appliances, our Outlet Stores and searsoutlet.com compete at one end of the spectrum with big-box retailers that sell primarily new, in-box product, as new in-box product competes both with new in-box product and out-of-box product sold in the Outlet Stores. To the extent these big-box competitors choose to liquidate their own out-of-box product on their sales floors, this product would compete directly with out-of-box product sold in the Outlet Stores. At the other end of the spectrum are the locally owned appliance retailers that have historically comprised the bulk of the Outlet Stores' direct competition for sales of out-of-box product. These locally owned appliance retailers generally sell both out-of-box and new in-box appliances. Online retailers that sell new or out-of-box appliances are also competitors.

The Outlet Stores' key national competitors with respect to new, in-box appliances are The Home Depot and Lowe’s. In addition, as we continue to expand our product lines into categories such as mattresses and furniture, we expect to face additional competition from other discount retailers that focus on those product categories. While Sears Holdings' stores provide similar lines of merchandise as the Outlet Stores, the Outlet Stores are primarily value-price sellers of distressed, refurbished, and marked-out-of-stock merchandise, which merchandise Sears Holdings' stores generally do not sell in what we believe are significant volumes to consumers. Consequently, we believe that, historically, the Outlet Stores have not competed significantly with Sears Holdings' stores. As our Outlet business expands its merchandise offerings (for example, our recent increased emphasis on mattresses and furniture), the level of competition between the Outlet Stores and Sears Holdings' stores may increase.

We believe that the key differentiating factor between competitors operating in the outlet-value retail industry is price. Other factors include product assortment and quality, service and convenience, brand recognition, existence of loyalty programs, online and multichannel capabilities, and availability of retail-related services such as access to credit and product delivery.

Our Strengths

We believe that our competitive strengths are the following:

Our stores carry a wide variety of well-known, brand-name merchandise.

We offer our customers a broad selection of products, including well-known consumer brand names such as Kenmore, Whirlpool ^® , Samsung, and Craftsman, and we strive to offer high in-stock levels. A typical Hometown Store offers a selection of products similar to department stores, discounters, mass merchandisers, and wholesale clubs and carries more types of products than specialty retailers and smaller independent appliance and hardware stores. This ability to offer a wide variety of well-known, consumer brand-name merchandise enables us to remain competitive in our trade areas and to continue to attract customers.

We operate across the nation through distinctly tailored store formats.

Our different store formats are targeted to the trade areas in which they compete. Our Hometown Stores offer customers in more rural communities a wide variety of merchandise. In those trade areas, we compete against larger national or regional big-box stores on the basis of the convenient shopping experience we provide, and we compete against local independent stores based on our product offerings and competitive pricing.

Our Hardware Stores are located in neighborhood centers in suburban areas where customers can fulfill their hardware, lawn and garden and, in certain stores, home appliance needs. These stores compete against larger warehouse home centers and smaller local hardware stores by offering a broad assortment of products, convenient outlets, and personalized customer assistance.

Our Home Appliance Showrooms include appealing display floors in metropolitan trade areas where we compete with big-box retailers by offering a compelling service model, a wide assortment of brand-name home appliances, significant online and multi-channel capabilities, and convenient locations. We differentiate ourselves from our competitors by providing our customers with a consultative and educational purchase experience. To accommodate the lifestyles of our metropolitan customers, we also provide after-hours showings by appointment.

Our Outlet Stores offer customers a wide range of outlet-value products at locations across the United States and Puerto Rico. Our Outlet Stores differentiate themselves from their competitors by providing a wide range of outlet-value brand-name products, including Kenmore, Whirlpool, GE, LG, and Samsung products, at prices that are significantly lower than list prices.

In addition, SHO has stores located in all 50 states as well as Puerto Rico and Bermuda, without any concentration in one particular region or trade area. The ability to generate revenues with a wide variety of products across a diversified mix of regions and trade areas positions us to be able to take advantage of opportunities as they arise.

The fact that our Hometown Stores are primarily operated by dealers allows us to leverage their knowledge, experience, motivation, and capital.

Our Hometown Stores are primarily owned and operated by individual dealers. Under both our dealer model and our franchise model, SHO provides inventory (on a consignment basis), branding, and marketing to the stores and the dealer or franchisee is responsible for start-up costs, lease payments, and other operating costs including payroll. Our dealer model in particular allows us to leverage the entrepreneurial spirit of our dealers and their local trade-area knowledge to better serve their customers. In addition, our franchise model frees up capital and enables us to focus on strategic planning, marketing, and pricing strategies. We regularly evaluate the performance of franchised and dealer stores and require compliance with established customer service and other operational guidelines.

Our Outlet Stores are the leading liquidation channel of value-priced home appliances.

As the nation’s largest chain retailer of outlet-value home appliances, our Outlet business has become increasingly relevant to major appliance vendors as a liquidation channel for outlet-value appliances.

Our Strategy

We plan to continue to enhance our competitive position, grow our business, and increase our net sales and profitability by implementing the following strategies:

Expand Product Assortment and Optimize Service Offerings . We strive to provide our customers with complete solutions for their home appliance, hardware, and other related home needs. We regularly evaluate other merchandise categories and types of services to enhance our product and service offerings and to create cross-selling opportunities for adjacent products and services. For example, our initiatives to increase product offerings include expanding furniture in our Outlet Stores and adding mattresses in our Home Appliance Showrooms.

Promote Customer Growth through Enhanced Marketing, Improved Customer Experience, and Integrated Multi-Channel Capabilities . We seek to serve our customers’ needs and drive revenue growth through our integrated multi-channel sale capabilities. We have recently launched e-commerce capabilities for our Hometown segment and we continue to seek to enhance our e-commerce operations and our online product selection to improve our customers’ online shopping experiences. We seek to integrate our online business and our brick-and-mortar stores to provide our customers with a seamless shopping experience across channels. On both Company-operated websites and Sears.com we offer our customers the option to purchase items online and pick them up in our local stores as well as order out-of-stock and other items from our in-store kiosks. These capabilities allow us to better serve customers across various channels and improve sales. See, however, "We rely on Sears Holdings for services related to our online business and the processing of online orders " in Item 1A-Risk Factors of this Annual Report on Form 10-K.

We also plan to drive customer growth by refining our marketing initiatives. We believe that we can grow our customer base through advertising in a number of different media, particularly online and email marketing.

We believe that quality customer service contributes to increased store visits and purchases by our customers. We are focused on building long-term relationships with customers and members by improving their in-store and post-sale experiences. We conduct quality control checks of our store managers and sales associates and our dealers and franchisees to improve the quality of customer interaction and product knowledge in the stores we operate and the stores operated by our dealers and franchisees. We continue to improve and augment our post-sale engagement with customers through access to delivery and installation services as well as extended-service plans.

Diversify Our Supply Chain . We intend to continue our efforts to diversify our network of merchandise suppliers and service providers. Such diversification, particularly with respect to merchandise suppliers, is intended to reduce our reliance on Sears Holdings for our inventory.

Provide Industry-Leading Financing Options. We intend to continue to provide to our customers many convenient methods of financing their purchases including extended credit-card offers and lease-to-own alternatives. We believe that our store operating

practices and our relationships with the issuer of the Sears credit card and our lease-to-own provider allow us to offer attractive financing choices for our customers that we believe will lead to higher customer loyalty and profitability for the Company.

Grow Commercial Sales . We are seeking to grow our revenue with business customers who can benefit from our extensive merchandise offerings, broad store network, and delivery and service capabilities. Businesses such as builders, landlords, and apartment operators in the communities we operate represent for us an attractive incremental customer base.

Transform our IT Infrastructure . We are replacing the large majority of our information technology infrastructure, which has been provided by Sears Holdings since the Separation, with new systems and processes. We expect this change will provide much greater strategic and operational flexibility, allow better control of our systems and processes, and reduce some of the risks relating to our relationship with, and dependence on, Sears Holdings. See also "We rely on Sears Holdings and other third parties to provide us with key products and services in connection with the administration of many critical aspects of our business, and we may be required to develop our own systems quickly in order to reduce such dependence" in Part 1A. Risk Factors of this Annual Report on Form 10-K for additional information regarding the conversion and migration of our information technology infrastructure.

Improve Operating Performance . We intend to focus on various initiatives intended to improve our gross margins and our inventory management. Our inventory-procurement operations are focused on developing customized merchandise assortments based on store demographics, sales history, customer preferences and margin by product division. Our inventory management focuses on continually adjusting clearance markdown cadences to reflect changes in inventory turnover and customer preferences. In addition, we intend to focus on controlling costs across our business lines, particularly selling and administrative expenses.

Store Activity. We will continue to take proactive steps to make the best use of capital and reduce costs by closing stores that we determine are not sufficiently profitable. We will also continue to selectively identify trade-area opportunities for new stores over the long term based on market potential, including trade areas where Sears Holdings has closed a full-line department store.

Our Products and Suppliers

Our focus on the preferences of our customers drives our merchandise selection. Our goal is to offer our customers a selection of brands and products within each of our product categories. Our largest revenue-generating category in 2016 was home appliances, representing approximately 72% of net sales.

We are party to an Amended and Restated Merchandising Agreement (as amended, the "Merchandising Agreement") with Sears Holdings, Kmart Corporation, ("Kmart") and Sears, Roebuck and Co. ("SRC") (Kmart and SRC are wholly owned subsidiaries of Sears Holdings) pursuant to which Kmart and SRC (1) sell to us, with respect to certain specified product categories, Sears-branded products (including products branded with the KCD Marks ("KCD Products")) and vendor-branded products obtained from Kmart’s and SRC’s vendors and suppliers and (2) grant us licenses to use the trademarks owned by Kmart, SRC or other subsidiaries of Sears Holdings, including the KCD Marks, in connection with the marketing and sale of products sold under the Sears marks. The initial term of the Merchandising Agreement will expire February 1, 2020 with our right to exercise one three-year extension with respect to KCD Products subject to specified Sears Holdings termination rights and other conditions in the Merchandising Agreement. We expect that our Hometown business will continue to rely on Sears Holdings for a significant majority of its inventory in 2017 .

For the year ended January 28, 2017 , products that we acquired through Sears Holdings accounted for approximately 80% of SHO's merchandise purchases. Most merchandise purchases for Hometown are sourced through Sears Holdings. Our Outlet business relies on suppliers other than Sears Holdings for a significant portion of its inventory. For the year ended January 28, 2017 , products that we acquired through Sears Holdings accounted for approximately 30% of total Outlet purchases.

As described in greater detail in Item 1A. Risk Factors of this Annual Report 1A, we have entered into agreements with Sears Holdings, as well as with third-party service providers, to provide processing and administrative functions over a broad range of areas, and we are likely to continue to do so in the future. We expect to continue to rely to some extent on the infrastructure of Sears Holdings for several services. Our business plans assume that Sears Holdings will continue to meet its contractual obligations to supply us with these services.

Our Dealer and Franchise Models

Dealer Model

As of January 28, 2017 , over 750 of our Hometown Stores were operated by independent authorized dealers who own and operate their stores. The dealer bears responsibility for store operating costs, including all payroll and occupancy costs. SHO

provides the inventory to the dealer on a consignment basis, and the dealer earns a variable commission on sales of merchandise, extended-service plans, and other services. SHO also provides support to dealers for recruiting and training dealer staff, marketing, and other support services.

The dealer relationship is governed by a dealer agreement, which generally has either a three or five-year term (depending on its terms and conditions). If a dealer defaults or fails to renew its dealer agreement, SHO may assume responsibility for the operation of the store until a new dealer is recruited to operate the store.

Franchise Model

As of January 28, 2017 , 34 of our Home Appliance Showrooms, 10 of our Hardware Stores, and 37 of our Outlet Stores were operated by independent franchisees. Under our primary franchise model, the franchisee operates the store and is responsible for its operating costs, including payroll and leasing costs. SHO provides inventory to the franchisee on a consignment basis, and the franchisee earns variable commissions on sales of merchandise, extended-service plans, and other services. SHO also provides brand and marketing services to the franchisee. In certain cases, especially with respect to stores that have been recently sold to franchisees, SHO remains responsible for lease costs in the case of a default by the franchisees until the expiration of the leases, at which time our franchisees generally are required to negotiate new leases to which SHO will not be a party.

The franchise relationship is governed by a franchise agreement with each franchisee that generally has a ten-year term and includes the franchisee's right to extend the term for an additional five years subject to the franchisee's satisfaction of renewal conditions that are specified in the franchise agreement. The franchise agreement also currently obligates the franchisee to pay to SHO specified fees, including an initial franchise fee, training fees, transfer fees, and successor franchise fees.

Beginning in the second quarter of 2015 the Company indefinitely suspended its franchising of additional stores except to existing Company franchisees, and the suspension continues.

Distribution and Systems Infrastructure

The majority of our merchandise comes to our stores directly from vendors or distributors (including Sears Holdings) through our agreements with Sears Holdings. Home delivery is provided by the selling dealers and franchisees, by Sears Holdings, and by other parties.

We rely extensively on computer systems to process transactions, summarize results, and manage our business. Given the number of individual transactions we have each year, it is critical that we maintain uninterrupted operation of our computer and communications hardware and software systems. We currently rely on Sears Holdings to provide us with the computer systems and infrastructure that enable our distribution systems. See "If we do not maintain the security of our customer, associate, and company information, we could damage our reputation, incur substantial additional costs, and become subject to litigation " in Item 1A. Risk Factors of this Annual Report on Form 10-K . For information regarding the migration of the current information technology systems and processes provided to us by Sears Holdings to new, state-of-art business and technology infrastructure and systems see "We rely on Sears Holdings and other third parties to provide us with key products and services in connection with the administration of many critical aspects of our business, and we may be required to develop our own systems quickly in order to reduce such dependence" in Item 1A. Risk Factors of this Annual Report on Form 10-K.

In addition, we also rely on Sears Holdings for warehousing and other logistics services.

We are party to a Services Agreement pursuant to which Sears Holdings Management Corporation, a wholly owned subsidiary of Sears Holdings ("SHMC") provides us with a number of services, including logistics and distribution, information technology (including the point-of-sale system used by the Company and our dealers and franchisees), product repair, ecommerce, and payment clearing and other financial services (as amended, the "Services Agreement"). The term of the Services Agreement will expire on February 1, 2020, subject to specified termination rights. We pay fees and rates for the services received in accordance with the Services Agreement. In addition, we also pay all taxes payable in connection with the services we receive provided under the Services Agreement. See "Certain Relationships and Transactions" in the definitive 2017 Proxy Statement relating to our Annual Meeting of Stockholders to be held on May 24, 2017, which is incorporated by reference into Item 13 of this Annual Report on Form 10-K (the "2017 Proxy Statement), for a general description of the Services Agreement.

Geographic Information

The vast majority of our revenues are generated within the United States. During 2016 , 2015 , and 2014 , a modest percentage of our revenues were generated in Puerto Rico. The vast majority of our long-lived assets are located within the United States.

Employees

As of January 28, 2017 , we had approximately 3,600 employees, approximately 44% of whom were full-time employees. We believe that we have a good working relationship with our employees and we have never experienced a material interruption of business as a result of labor disputes. We offer a broad range of company-paid benefits to our employees. These company-paid benefits include a 401(k) savings plan, medical and dental plans, disability insurance, paid vacation, various employee assistance programs, life insurance, and merchandise discounts.

Intellectual Property

We are party to several Store License Agreements with SRC pursuant to which SRC has granted us, on a royalty-free basis, among other things, (1) an exclusive, non-transferable and terminable license to operate, and to authorize our dealers and franchisees to operate, retail stores and stores-within-a-store using the "Sears Outlet Store," "Sears Authorized Hometown Store," "Sears Hometown Store," "Sears Home Appliance Showroom," "Sears Hardware Store," and "Sears Appliance & Hardware," store names (together, the "store names"), (2) an exclusive, non-transferable and terminable license to use the store names to promote our products, and services related to our products, by all current and future electronic means, channels, processes and methods, including via the Internet, (3) a non-exclusive, nontransferable and terminable license to use, and to authorize our dealers and franchisees to use, certain other trademarks to market and sell services related to our products under those trademarks and (4) an exclusive, non-transferable and terminable license to use certain domain names in connection with the promotion of our stores, the marketing, distribution and sale of our products and the marketing and offering of services related to our products (collectively, the "Store License Agreements"). We are also party to a Trademark License Agreement with SRC pursuant to which SRC has granted us, on a royalty-free basis, a non-exclusive, non-transferable and terminable right to use the "Sears" name in our corporate name and to promote our business (the "Trademark License Agreement"). The Store License Agreements and the Trademark License Agreement will expire in 2029, subject to specified termination rights. For additional information regarding the Store License Agreements and the Trademark License Agreement see "Certain Relationships and Transactions" in the 2017 Proxy Statement.

In the Merchandising Agreement Kmart and SRC agree to (1) sell to us, with respect to certain specified product categories, Sears-branded products (including KCD Products) and vendor-branded products obtained from Kmart’s and SRC’s vendors and suppliers and (2) grant us licenses to use the trademarks owned by Kmart, SRC, or other subsidiaries of Sears Holdings (together, the "Sears marks"), including the KCD Marks, in connection with the marketing and sale of products sold under the Sears marks. We pay, on a weekly basis, a royalty determined by multiplying our net sales of the KCD Products by specified fixed royalties rates for each brand’s licensed products.

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, although this can vary with weather conditions. Quarterly data on the revenue, cost, and net income of the business is available in the Quarterly Financial Data in Note 10 to our Consolidated Financial Statements included herein.

History and Relationship with Sears Holdings

Our Sears Hometown and Hardware and Sears Outlet businesses operated as part of Sears Holdings’ from their inception through the Separation.

In connection with the Separation, we entered into various agreements with Sears Holdings which, among other things, (1) govern certain aspects of our relationship with Sears Holdings following the Separation, (2) establish terms under which subsidiaries of Sears Holdings will provide us with services following the Separation, and (3) establish terms pursuant to which subsidiaries of Sears Holdings will obtain merchandise for us. The terms and conditions of these agreements (as amended, the "SHO-Sears Holdings Agreements") were agreed to in the context of a parent-subsidiary relationship and in the overall context of the Separation (except for amendments that were approved by the Audit Committee of SHO's Board of Directors after the Separation). Accordingly, the terms and conditions of the SHO-Sears Holdings Agreements may be more or less favorable than those we could have negotiated with unaffiliated third parties. See also "Certain Relationships and Transactions" in the 2017 Proxy Statement.

Corporate Information; Our Website; Availability of SEC Reports and Other Information

Our principal executive offices are located at 5500 Trillium Boulevard, Suite 501, Hoffman Estates, Illinois 60192 and our telephone number is (847) 286-7000. Our website address is www.shos.com.

This Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and the amendments, if any, to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 ("Exchange Act") are available, free of charge, through the "Investors-U.S. Securities and Exchange Commission Filings" link at our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission ("SEC").

The Corporate Governance Guidelines of our Board of Directors, the charters of the Audit Committee, the Compensation Committee, and the Nominating and Corporate Governance Committee of the Board of Directors, our Code of Conduct, our Board of Directors Code of Conduct, and our Code of Vendor Conduct are available at the "Corporate Governance " and the "Vendors" links at www.shos.com. References to www.shos.com do not constitute incorporation by reference of the information at www.shos.com, and the information at www.shos.com is not part of this Annual Report on Form 10-K.

Item 1A. Risk Factors

You should carefully consider the risks described below, together with all of the other information included in this Annual Report on Form 10-K (including without limitation "Cautionary Statement Regarding Forward-Looking Information" in this Part I), in evaluating SHO and our common stock. Each of the following risk factors could materially and adversely affect, among other things, our business, results of operations, financial condition, stock price, and prospects.

Risks Relating to Our Relationship with, and Dependence on, Sears Holdings

We depend on Sears Holdings to provide us with most key products and services for our business. Consequently, if Sears Holdings is unwilling, unable, or otherwise fails to provide these key products and services or if Sears Holdings’s brands are impaired, we could be materially and adversely affected.

We rely heavily on the products and services provided by Sears Holdings or its subsidiaries (the "key products and services") including the following:


•	Inventory procurement from third-party vendors, including KCD Products and other products which collectively account for a majority of our revenue;


•	Logistical, supply chain, and inventory support services;


•	Accounting and financial reporting services;


•	Risk management, tax, and insurance services;


•	Online, computer and information technology infrastructure (including the point-of-sale system used by the Company and our dealers and franchisees) and support;


•	Our websites are partially hosted and maintained by a subsidiary of Sears Holdings and purchases made on our websites are processed by a subsidiary of Sears Holdings;


•	Certain of our store leases and the leases for stores that we have subleased, or in the future may sublease, to franchisees or others are leased or subleased to us by subsidiaries of Sears Holdings until their expiration at which time we will be required to renegotiate with the landlords directly;


•	Our stores continue to use the Sears brand name, and other intellectual property owned by Sears Holdings through our license agreements with Sears Holdings;


•	Our stores continue to participate in the SYW program and rely on the customer data and other information provided by the SYW program; and


•	Our stores continue to accept Sears-branded credit cards.

As a result of our dependence on Sears Holdings, we are exposed to the risk that Sears Holdings will become unable or unwilling to fulfill its contractual obligations to us in accordance with their terms. Sears Holdings is subject to various risks and uncertainties, which could in turn adversely affect our business, results of operations, and financial condition. Such risks include (1) risks related to the retail industry, (2) risks related to worldwide economic conditions, (3) risks associated with its computer systems and infrastructure, (4) risks related to Sears Holdings' ability to access capital markets and other financing sources, and (5) risks related to Sears Holdings' financial condition and results of operations. We have been taking action to reduce our dependence on Sears Holdings to enable us to take advantage of what we believe are lower costs, or better terms and conditions, from alternative merchandise and services vendors and to reduce our Sears Holdings-related risks. We will continue to evaluate actions that will enable us to reduce our costs and risks by reducing our dependence on Sears Holdings.

We believe it is necessary for Sears Holdings to continue to provide products and services to us in accordance with the SHO-Sears Holdings Agreements to facilitate the continued successful operation of our business. Sears Holdings has no obligation to provide assistance to us other than to provide the products and services required to be provided pursuant to the SHO-Sears Holdings Agreements. Although Sears Holdings is generally obligated to provide us with these products and services until February 1, 2020, these products and services may not be provided at the same level or at the same prices during the entire duration of the agreements, and we may not be able to obtain the same benefits from these products and services. Generally, we expect to need to rely on Sears Holdings for some products and services for the entire duration of the SHO-Sears Holdings Agreements. In addition, to the extent that our growth depends on expanding the number of stores we operate, we may need to rely on Sears Holdings to supply the same products and services in new regions, trade areas, and store formats. When Sears Holdings is no longer obligated to provide these products and services to us, we may not be able to replace some of these products and services on terms and conditions, including costs, as favorable as those we have with Sears Holdings. See "Certain Relationships and Transactions" in the 2017 Proxy Statement.

The service fees we are obligated to pay to Sears Holdings are not firm and higher service fees could result.

The Services Agreement provides that it will expire on February 1, 2020 unless terminated earlier in accordance with its terms. The Services Agreement also provides that we will pay the service fees specified in the Services Agreement for its duration, subject to (1) fee increases from Sears Holdings' third-party providers providing services and (2) Sears Holdings' right to increase fees for services if a change in legislation, regulation, business conditions, or Sears Holdings’s operations results in an increase in Sears Holdings’s costs associated with one or more of the services.

We depend on Sears Holdings and other vendors to provide our inventory.

Our Hometown and Outlet businesses rely on Sears Holdings (or its subsidiaries) for a significant portion of their inventory, including KCD Products. For the year ended January 28, 2017 , products which we acquired through Sears Holdings accounted for approximately 80% of our merchandise purchases. Hometown merchandise purchases are sourced predominantly through Sears Holdings.

If we are unable to obtain adequate amounts and assortments of merchandise from Sears Holdings, we may be unable on short notice to find alternative sources of supply on terms and conditions that we believe are commercially reasonable, or at all. Sears Holdings is our sole source of supply of new, in-box KCD Products. In addition, the third-party vendors from whom Sears Holdings currently obtains merchandise for us may not be willing to continue to sell merchandise to Sears Holdings on terms and conditions that it believes are commercially reasonable.

In addition, our Outlet business also relies on merchandise vendors other than Sears Holdings ("Other Vendors") for a significant portion of Outlet inventory. For the year ended January 28, 2017 , purchases from Other Vendors accounted for approximately 70% of total Outlet purchases. We intend to increase the portion of our Outlet business's inventory that we purchase from Other Vendors if we believe that action will improve our customer service or profitability. Our agreements with Other Vendors generally do not guarantee the availability of specified amounts of merchandise at any given time, and we have no assurance that any of these agreements will be renewed on commercially reasonable terms, or at all. If the Other Vendors decrease their output of merchandise, raise their prices, or find alternative distribution channels for their products, or all of these, and we are required to find one or more additional Other Vendors, we may not be able to contract with them on a timely basis, on commercially reasonable terms, or at all. This could lead to higher prices, decreased inventory, our inability to maintain an appropriate assortment of merchandise in our stores and could cause us to accelerate store closings, all of which could have a material adverse effect on our business, results of operations, financial condition, and stock price. In addition, if we do not maintain our existing relationships, or build new relationships, with Other Vendors we may not be able to maintain an appropriate assortment of merchandise, and customers may not purchase from our stores.

We rely on Sears Holdings and other third parties to provide us with key products and services in connection with the administration of many critical aspects of our business, and we may be required to develop our own systems quickly in order to reduce such dependence.

We are party to various agreements with Sears Holdings (including without limitation the Services Agreement), as well as with third-party service providers, to provide us with processing and administrative functions over a broad range of areas, and we expect to continue to do so in the future. Key products and services provided by Sears Holdings or other third parties as a part of outsourcing initiatives could be interrupted as a result of many factors, such as acts of God or contract disputes, and any failure by third parties to provide us with these key products and services on a timely basis or within our service level expectations and performance standards could result in a disruption to our business.

We rely heavily on the infrastructure of Sears Holdings for a variety of key products and services. Our various agreements with Sears Holdings (including without limitation the Services Agreement and the Merchandising Agreement), which govern the provision of these key products and services, are not long term, and we may seek to continue to rely on the infrastructure of Sears Holdings after February 1, 2020. Our business plans with respect to approximately the next 18 to 24 months depend to a significant extent on Sears Holdings’ willingness and ability to continue to provide us with these key products (including KCD Products) and services. Any failure to maintain Sears Holdings as a service provider, or any actions by Sears Holdings, during that period when permitted under the applicable agreement, to raise the prices it charges us for these key products and services, could have a material adverse impact on our business and our results of operations.

In addition, disruptions in the computer and communications hardware and software systems provided by Sears Holdings could harm our ability to run our business, result in the compromise of confidential customer data, lead to costly litigation, and damage our reputation with our customers. Any significant interruption in our computer operations may have a material adverse effect on our business and results of operations. As a result of our reliance on the computer and information technology infrastructure

of Sears Holdings, we have limited control over the timing and implementation of upgrades to our computer and information technology systems that we may believe are integral to the successful operation of our business.

We have 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. (collectively, the “BPO”). 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 operational in all material respects by the end of our 2017 fiscal year. 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 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 corporate expenses in fiscal 2017 as a result of the BPO. Selling and administrative expenses related to the BPO were $15.0 million for fiscal 2016 .

Implementation of the BPO 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; future disagreements with Capgemini regarding its and our contractual rights and obligations and the contractual rights and obligations of Capgemini's contractors (such as NetSuite Inc.); the ability and willingness of Capgemini to complete the BPO in accordance with our plans and expectations and on the timetable and at the cost to the Company that we believe we have negotiated with Capgemini as reflected in the Master Services Agreement (several key BPO conversion and migration milestones have not been, or will not be, met and the Company believes that Capgemini is responsible, in all significant respects, for the delays); the amount, quality, and timing of cooperation that we receive from Sears Holdings with respect to the BPO; and disruption of our day-to-day business activities. These risks and other risks with respect to the BPO could have a material adverse effect on our business and results of operations.

If our relationships with our vendors, including Sears Holdings, were to be impaired, it could have a negative impact on our competitive position and our business and financial performance.

We obtain our merchandise from Sears Holdings and Other Vendors. For the year ended January 28, 2017 , products which we acquired from Sears Holdings, including KCD Products and other products, accounted for approximately 80% of our total purchases of inventory from all vendors. The loss of or a 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.

Pursuant to the Merchandising Agreement, subsidiaries of Sears Holdings have agreed to sell non-Sears-branded products to us until February 1, 2020. If we want to continue to purchase non-Sears-branded products from Sears Holdings after February 1, 2020 we will need to seek to extend or renegotiate on comparable terms and conditions the duration of the Merchandising Agreement with respect to non-Sears-branded products. If those efforts were unsuccessful we might not be able to replace the inventory provided under the Merchandising Agreement on commercially reasonable terms, or at all and any such inability could have a material adverse effect on our prospects and results of operations and our ability to operate our business could be significantly impaired, as we would have to find new sources for our inventory. We now purchase and, when in the Company's best interest, intend to accelerate our purchases of non-Sears-branded products from Other Vendors.

Our vendor arrangements with Sears Holdings and Other Vendors generally are not long-term agreements and none of them guarantee the availability of merchandise in the future. Our growth strategy depends to a significant extent on the willingness and ability of our vendors to supply us with sufficient inventory. As a result, our success depends on maintaining good relations with our existing vendors and developing relationships with new vendors. If we fail to maintain our relations with our existing vendors (including without limitation maintaining an effective and productive business relationship with Sears Holdings) or the quality and quantity of merchandise they supply us, or if we cannot acquire new vendors of favored brand-name merchandise, our ability to obtain a sufficient amount and variety of merchandise at acceptable prices may be limited, which would have a negative impact on our competitive position. In addition, to the extent we are able to develop relationships with new vendors and obtain merchandise from alternative sources, the merchandise obtained may be of a lesser quality and more expensive than the merchandise we currently purchase.

We license from Sears Holdings the use of our current store names, specified domain names, and specified trademarks used to brand our products.

We license from Sears Holdings the use of the "Sears" trademark, the KCD Marks, and the "Sears Hometown Store," "Sears Authorized Hometown Store," "Sears Hardware Store," "Sears Home Appliance Showroom," "Sears Appliance & Hardware," and "Sears Outlet" store names (collectively, the "store names") and domain names for websites we operate (the "domain names"). Pursuant to the Merchandising Agreement, our licenses to use the KCD Marks will expire February 1, 2020 or, if renewed for the renewal term, February 1, 2023. Pursuant to the Store License Agreements and Trademark License Agreement, our licenses to use the Sears trademark, the store names, and the domain names (except as provided in the next sentence) will expire in 2029, subject to specified termination rights. In accordance with the Services Agreement our license from Sears Holdings to use the domain name "searsoutlet.com" on a web platform not operated by Sears Holdings will expire on February 1, 2020. For additional information regarding our license rights see "Certain Relationships and Transactions" in the 2017 Proxy Statement.

If the value of the Sears trademark, the KCD Marks, the store names, or the domain names diminishes, if we are unable to extend, renew, or renegotiate the Merchandising Agreement, the Store License Agreements, or the Trademark License Agreement on comparable terms, or at all, or if in connection with an insolvency proceeding with respect to Sears Holdings one or more of these agreements (or other then-available rights to use the KCD Marks, the store names, or the domain names) were rejected or otherwise terminated, our prospects and results of operations could be adversely affected and our ability to operate our business could be impaired, as it would require us to stop using one or more of the aforementioned names in our stores, in our online activities, and in our product advertising.

Several of our agreements with subsidiaries of Sears Holdings contain early termination provisions that are outside of our control and, if triggered, could have a material adverse effect on our ability to operate our business and our financial performance.

Our agreements with subsidiaries of Sears Holdings contain various default and termination provisions, some of which are not within our control. For example, under the Merchandising Agreement, if (i) an unaffiliated third party acquires all rights, title, and interest in and to one or more (but not all) of the KCD Marks, then subsidiaries of Sears Holdings may terminate their obligation to sell to us the products that are branded with the KCD Marks that were subject to such acquisition and (ii) if an unaffiliated third party acquires all rights, title, and interest in and to all of the KCD Marks, then subsidiaries of Sears Holdings may terminate the Merchandising Agreement in its entirety. See "The sale of KCD Products to other retailers, including certain of our competitors, may adversely affect our results of operations" in this Item 1A regarding Sears Holdings' sale on March 9, 2017 of its Craftsman brand to Stanley Black & Decker, Inc. Furthermore, the Merchandising Agreement and our other agreements with subsidiaries of Sears Holdings may also be terminated by either party upon a material breach if breaching party fails to cure such breach within 30 days following written notice of such breach or, if such breach is not curable, immediately upon delivery of notice of the non-breaching party’s intention to terminate. The Merchandising Agreement provides that neither Sears Holdings nor SHO may exercise its express termination rights if it or its affiliates have failed to comply with any of its material obligations in the Merchandising Agreement and the failure is continuing.

In addition, a number of our agreements with subsidiaries of Sears Holdings contain cross-termination provisions such that, if a breach of or default under one of the agreements by one party were to result in the termination of such agreement, the other party may terminate a number of the additional agreements between the parties. If one or more of our agreements with subsidiaries of Sears Holdings were to be terminated earlier than currently anticipated, it could have a material adverse effect on our prospects and results of operations and our ability to operate our business would be significantly impaired. For additional information see "Certain Relationships and Transactions" in the 2017 Proxy Statement. The Company's Amended and Restated Credit Agreement with a syndicate of lenders, including Bank of America, N.A., as administrative agent and collateral agent (the "Senior ABL Facility"), provides that an "Event of Default" would occur with the consequences provided in the Senior ABL Facility if SHC or its subsidiaries terminated each of the Merchandising Agreement, the Services Agreement, the Store License Agreements, the Trademark License Agreement, the Tax Sharing Agreement between the Company and Sears Holdings (the "Tax Sharing Agreement"), and the Employee Transition and Administrative Services Agreement between the Company and SHMC. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Senior ABL Facility" in this Annual Report on Form 10-K.

The sale of KCD Products to other retailers, including certain of our competitors, may adversely affect our results of operations.

KCD Products accounted for approximately 51% of our consolidated revenue during fiscal year 2016 . Sears Holdings has agreed to supply several other retailers, including several of our competitors, with a number of Craftsman- and DieHard-branded products that previously were only sold through affiliates of Sears Holdings. If Sears Holdings continues to supply other retailers, including our competitors, with Craftsman- and DieHard-branded products, or begins to supply other retailers with Kenmore-branded products, our revenue may be adversely affected.

On May 26, 2016 Sears Holdings announced that it would explore alternatives for its Kenmore, Craftsman, and Diehard businesses and further expand the presence of these brands. On August 25, 2016 Sears Holdings announced that it was continuing to explore alternatives for these businesses by evaluating potential partnerships or other transactions. On March 9, 2017 Sears Holdings announced that it had completed its sale to Stanley Black & Decker, Inc. of Sears Holdings' Craftsman business (the "Stanley Purchase"), including the Craftsman brand name and related intellectual property rights. The Stanley Purchase provides Stanley Black & Decker, Inc. with the rights to develop, manufacture, and sell Craftsman-branded products in non-Sears Holdings and non-Company retail, industrial, and online sales channels across the U.S. and in other countries. As part of the agreement, Sears Holdings will continue to offer Craftsman-branded products, sourced from existing suppliers, through its current retail channels, including the Company, via a perpetual license from Stanley Black & Decker, Inc. The Company believes that the Stanley Purchase will enable Stanley Black & Decker, Inc. to significantly increase Craftsman sales through the Company's competitors, such as The Home Depot and Lowe’s.

In connection with the Stanley Purchase Sears Holdings has waived its right in the Merchandising Agreement to terminate, solely as a result of the Stanley Purchase, the Company's rights to buy from Sears Holdings merchandise branded with the Craftsman brand. For additional information see the Company's Current Report on Form 8-K (File No. 001-35641) filed with the Securities and Exchange Commission on March 9, 2017 regarding the Amendment to Amended and Restated Merchandising Agreement dated as of March 8, 2017 among the Company, Sears Holdings, and Stanley Black & Decker. Inc.

Our agreements with Sears Holdings restrict our ability to expand into certain geographic areas.

Currently, Sears full-line stores, Kmart stores, and certain specialty retail stores owned by Sears Holdings sell product lines that are similar to ours. The Merchandising Agreement prohibits us, subject to specified conditions, from opening new Hometown Stores and Hardware Stores in specified areas and from selling new home appliance, patio, and Craftsman lawn and garden merchandise in new Outlet Stores that are located within two miles of an operating Sears Holdings store. These non-competition obligations restrict our ability to open new stores and sell certain types of products in the specified areas that we might otherwise consider as possible targets for expansion and may limit our growth potential.

In connection with the Company’s operation of its websites, the Company has agreed in the Services Agreement to limit its marketing efforts to users located within specified Zip-Code based territories and to pay to Sears Holdings commissions on sales transacted on the Company's websites that result in deliveries outside the specified Zip-Code based territories.

As a publicly traded company separate from Sears Holdings, we may experience increased costs resulting from a decrease in the purchasing power we enjoyed pre-Separation.

Prior to the Separation, we were able to take advantage of Sears Holdings’ size and purchasing power in procuring services, including advertising, shipping and receiving, logistics, store maintenance contracts, employee benefit support, insurance, credit and debit card interchange fees and other services. Following the Separation, we have been a smaller company than Sears Holdings. We do not yet have direct access to all of these services from other vendors on terms that are comparable to the terms of services that were available to us as part of Sears Holdings prior to the Separation. Although Sears Holdings continues to shrink in size and its financial condition continues to worsen, our contractual relationships with Sears Holdings continue to make available to us at least some of these services on favorable terms. As a result we plan to continue to leverage our ongoing relationship with Sears Holdings to seek to obtain the benefits of its purchasing power (which is subject to the risk that Sears Holdings may be unable to continue to purchase for us the merchandise and services we seek on commercially reasonable terms, which risk we believe is growing). We will also continue to seek to expand our direct purchasing relationships with many of our most important vendors. Despite these actions, we may be unable to obtain goods, technology, and services at prices and on terms as favorable as those available to us prior to the Separation, which could increase our costs and reduce our profitability.

We may have been able to receive better terms from unaffiliated third parties than the terms we received in our agreements with Sears Holdings.

The agreements related to the Separation, including the Services Agreement, the Store License Agreements, the Trademark License Agreement, the Merchandising Agreement, and the Retail Establishment Agreement (other than the post-Separation amendments to these agreements, which have been approved by the Audit Committee of the Company's Board of Directors), were agreed to in the context of a parent-subsidiary relationship and in the overall context of the Separation. Accordingly, they may not represent the best terms that could have been available to us from third parties. The terms of the agreements negotiated in the context of the Separation relate to, among other things, the principal actions needed to be taken in connection with the Separation, indemnification, and other obligations among Sears Holdings and us, and the nature of the commercial arrangements between us

and Sears Holdings following the Separation. For additional information see "Certain Relationships and Transactions" in the 2017 Proxy Statement.

We may not be able to resolve successfully future contractual disputes and other conflicts with Sears Holdings.

Several of our agreements with Sears Holdings, such as the Services Agreement, the Store License Agreements, the Trademark License Agreement, and the Merchandising Agreement, were agreed to in the context of a parent-subsidiary relationship and in the overall context of the Separation (other than the post-Separation amendments to these agreements, which have been approved by the Audit Committee of the Company's Board of Directors). We may be unable to obtain expeditious and economical resolution of future disputes that could arise with respect to the following matters, among others, which also could materially and adversely affect our ability to conduct our business: business opportunities that may be attractive to both Sears Holdings and us; the nature, quality and pricing of services Sears Holdings has agreed to provide to us; labor, tax, employee benefit, real estate (including sublease obligations) and other matters arising from the Separation; defense and indemnification arising from losses caused by Sears Holdings; major business combinations involving us; employee retention and recruiting; SHO's intellectual property rights; the extent of SHO's rights to conduct multi-channel retailing; and competition between our stores and websites and Sears Holdings’ stores and websites.

If Sears Holdings' seeks the protection of the U.S. bankruptcy laws, our ability to operate our business and our financial performance could be materially and adversely affected.

If Sears Holdings' seeks the protection of the U.S. bankruptcy laws, the automatic-stay provisions of the United States Bankruptcy Code could prohibit SHO’s attempts to collect (including by set off) amounts due from Sears Holdings that arose prior to its filing of a bankruptcy petition, and Sears Holdings’s unpaid pre-petition obligations to SHO could become general unsecured creditor claims of Sears Holdings that could become relatively valueless. Examples of Sears Holdings' unpaid pre-petition obligations to SHO could include (1) amounts that Sears Holdings collects on behalf of, but does not remit to, SHO, such as vendor subsidies, credit card income, and merchandise credits, (2) amounts that SHO pays to Sears Holdings to pay to others on SHO's behalf but that Sears Holdings does not pay, such as for SHO merchandise purchases from third parties, occupancy costs, and utilities, and (3) accounting adjustments and credits, such as Outlet merchandise cost credits.

We depend on Sears Holdings to provide us with key products and services in the operation of our business. For example, during fiscal year 2016 , merchandise acquired from subsidiaries of Sears Holdings, including Kenmore, Craftsman, DieHard and other products, accounted for approximately 80% of total purchases of all inventory from all vendors. If Sears Holdings seeks the protection of the U.S. bankruptcy laws, a court could, among other things, permit or require Sears Holdings to reject or otherwise terminate one or more of its existing agreements with us, including without limitation the Merchandising Agreement, the Services Agreement, the Store License Agreements, and store leases and subleases (many of which are subleased to our dealers and franchisees). Sears Holdings could also choose, or be required, to sell assets, such as its rights to the Kenmore and Diehard marks and its remaining rights to the Craftsman mark and its rights to the trademarks and service names under which we operate our stores that are used by us in the operation of our business, to satisfy Sears Holdings' obligations to its creditors. If Sears Holdings' contractual obligations to us are terminated or assigned to others or if Sears Holdings sells to third parties rights to assets that we use in the course of our business, we could be materially and adversely affected. A termination of our agreements with Sears Holdings could require us to, among other things, find different service and product providers, possibly on short notice. Even if we are able to find replacement products and services, these products and services may not be of the same type or quality as those which are currently provided by Sears Holdings. If we are forced to enter into new contracts for replacement products and services, the new contracts may have terms and conditions that are less favorable to us than those to which we are currently bound. Different products and services, especially if lower in quality and value, and potential increased costs from less favorable contract terms could materially and adversely affect our ability to do business and our financial performance.

If Sears Holdings seeks the protection of the U.S. bankruptcy laws, the consequences to the Company with respect to its rights under the Senior ABL Facility could be materially adverse. For example, (1) the lenders under the Senior ABL Facility could become uncomfortable lending to the Company due to its close contractual relationships with Sears Holdings, (2) the Senior ABL Facility provides for significant lender discretion, such as the ability to reduce loan advance-rates, which could reduce the amounts that the Company could borrow, (3) the lenders could assert that they have no obligation to extend to the Company additional loans on the basis that the Company has suffered a “Material Adverse Effect,” and (4) Sears Holdings’s rejection or termination of all of the agreements between the Company and Sears Holdings specified in the Senior ABL Facility would be an “Event of Default” under the Senior ABL Facility that would permit the lenders to accelerate and immediately call due all of the Company's outstanding loans.

Risks Relating to Our Business

If we fail to offer merchandise and services that our customers want, our sales may be limited, which would reduce our revenues and profits.

In order for our business to be successful, we must identify, obtain supplies of, and offer to our customers, attractive, innovative and high-quality merchandise on a continuous basis. Our products and services must satisfy the desires of our customers, whose preferences in appliances, hardware and lawn and garden products may change in the future. If we misjudge either the demand for the products we sell or our customers' purchasing habits and tastes, we may be faced with excess inventories of some products and missed opportunities for products we chose not to offer. In addition, our sales may decline or we may be required to sell the merchandise we have obtained at lower prices, increasing our inventory markdowns and promotional expenses. This would have a negative effect on our business and results of operations.

Our business has been and will continue to be affected by worldwide economic conditions; a failure of the economy to sustain its recovery, a renewed decline in consumer-spending levels and other conditions, including inflation, could lead to reduced revenues and gross margins, and negatively impact our results of operations.

Many economic and other factors are outside of our control, including, consumer confidence and spending levels, consumer and commercial credit availability, inflation, employment levels, housing sales and remodels, lower housing turnover, increased mortgage delinquency and foreclosure rates, consumer debt levels, fuel costs and other challenges currently affecting the global economy, the full impact of which on our business, results of operations and financial condition cannot be predicted with certainty. These economic conditions adversely affect the disposable income levels of, and the credit available to, our customers, which could lead to reduced demand for our merchandise. Also affected are our vendors, upon which we depend to provide us with inventory and services. Our vendors could seek to change the terms under which they sell inventory or other services to us which could negatively impact our financial condition. In addition, the inability of vendors to access liquidity, or the insolvency of vendors, could lead to their failure to deliver inventory or other services.

The domestic and international political situation also affects consumer confidence. The threat, outbreak or escalation of terrorism, military conflicts or other hostilities could lead to a decrease in consumer spending. Any of these events and factors could cause us to increase inventory markdowns and promotional expenses, thereby reducing our gross margins and operating results.

If we do not successfully manage our inventory levels, our operating results will be adversely affected.

We must maintain sufficient inventory levels to operate our business successfully. However, we also must avoid accumulating excess inventory as we seek to minimize out-of-stock levels across all product categories and to maintain in-stock levels. We continue to rely on and obtain significant portions of our inventory through Sears Holdings, which obtains a significant portion of inventory from vendors located outside the United States. Some of these vendors often require us to provide, through Sears Holdings, lengthy advance notice of our requirements in order to be able to supply products in the quantities we request. This usually requires us, through Sears Holdings, to order merchandise, and enter into purchase order contracts for the purchase and manufacture of such merchandise, well in advance of the time these products will be offered for sale. As a result, we may experience difficulty in responding to a changing retail environment, which makes us vulnerable to changes in price and consumer preferences. If we do not accurately anticipate the future demand for a particular product or the time it will take to obtain new inventory, our inventory levels will not be appropriate and our results of operations may be negatively impacted.

If we are unable to compete effectively in the highly competitive retail industry, our business and results of operations could be materially adversely affected.

The retail industry is intensely competitive and highly fragmented. In addition, there are few barriers to entry into our current trade areas and new competitors may enter our trade areas at any time. We compete with a wide variety of retailers, including department stores, discounters, mass merchandisers, hardware stores, independent dealers, home improvement stores, home appliance and consumer electronics retailers, auto service providers, specialty retailers, wholesale clubs and many other competitors operating on a national, regional or local level. Some of our competitors are actively engaged in new store expansion. Online and catalog businesses, which handle similar lines of merchandise, also compete with us.

We may not be able to compete successfully against existing and future competitors. Some of our competitors have financial resources that are substantially greater than ours and may be able to purchase inventory at lower costs and better endure the current or future economic downturns. As a result, our sales may decline if we cannot offer competitive prices to our customers or we

may be required to accept lower profit margins. Our competitors may respond more quickly to new or emerging technologies and consumer preferences and may have greater resources to devote to promotion and sale of products and services.

Our existing competitors or new entrants into our industry may use a number of different strategies to compete against us, including the following:


•	Expansion into the suburban and rural trade areas in which many of our stores operate;


•	Lower pricing, particularly with respect to new, in-box appliances;


•	Expanding the offering of free delivery and installation of merchandise and other consumer benefits;


•	Expanding online sales;


•	Extension of credit to customers on terms more favorable than we offer; and


•	Larger store size, which may result in greater operational efficiencies, or innovative store formats, and use of disruptive technology.

Competition from any of these sources could cause us to lose trade area share, sales and customers, increase expenditures or reduce prices, any of which could have a material adverse effect on our business and results of operations.

Our operating results are tied in part to the success of our dealers and franchisees, and the inability of our dealers and franchisees to continue operating their stores profitably could adversely affect our operating results.

As of January 28, 2017 , the significant majority of the stores in our Hometown business were operated by our dealers and franchisees that sell our inventory on a consignment basis. Our dealers’ and franchisees’ ability to continue operating their stores profitably depends on various factors, including their business abilities, financial capabilities (including their access to credit for operating capital), the negotiation of acceptable leases and general economic conditions. Many of the foregoing factors are beyond the control of both SHO and our dealers and franchisees. If our dealers and franchisees are unable or unwilling to operate their stores profitably, this could have a material adverse effect on our business and results of operations including the necessity that we record additional non-cash provisions for losses on franchisee receivables. During our 2016 fiscal year we entered into franchise termination agreements with, or otherwise terminated, franchises in 24 locations.

In addition, if our dealers are unable or unwilling to operate their stores profitably or in a manner consistent with our concepts and standards, we may be required to take over one or more stores from our dealers from time to time. Generally, at any given time, we operate approximately 3-5% of our Sears Hometown Stores as a result of our taking such stores over from our authorized dealers.

Our dealers and franchisees may damage our business or increase our costs by failing to comply with our operating standards or our dealer and franchise agreements.

Our dealers and franchisees operate their stores pursuant to dealer agreements and franchise agreements, respectively, with us. If our dealers and franchisees do not comply with our established operating concepts and standards or the terms in the franchise or dealer agreements, our business may be damaged. We may incur significant additional costs, including time-consuming and expensive litigation, to enforce our rights under the dealer agreements and the franchise agreements. Furthermore, as a franchisor we have obligations to our franchisees. Franchisees may challenge the performance of our obligations under the franchise agreements and subject us to costs in defending these claims and, if the claims are successful, costs in connection with their compliance.

In addition, as a franchisor we are subject to regulation by the Federal Trade Commission and are subject to state laws that govern the offer, sale and termination of franchises and the refusal to renew franchises. The failure to comply with these regulations in any jurisdiction or to obtain required approvals could result in a ban or temporary suspension on future franchise sales, fines or require us to make a rescission offer to franchisees, any of which could adversely affect our business and operating results.

Our sales may fluctuate for a variety of reasons, which could adversely affect our results of operations.

Our business is sensitive to customers' spending patterns, which in turn are subject to prevailing and perceived longer-term economic conditions. Our sales and results of operations have fluctuated in the past and we expect them to continue to fluctuate in the future. A variety of other factors affect our sales and financial performance, including the following:


•	Actions by our competitors, including opening of new stores in our existing trade areas or changes to the way these competitors conduct business online;


•	Increases to the level of discount on promotional pricing of new-in-box appliances in the industry, which could continue to adversely impact our sales of out-of-box appliances and associated margin;


•	The Extent to which we are able to generate profitable sales of merchandise and services on our transactional ecommerce websites in the amounts we have planned to generate;


•	The availability on commercially reasonable terms of the various types of inventory that we need to sell for the profitable operation of our stores;


•	Changes in our merchandise strategy and mix;


•	Real estate and maintenance costs for our existing stores (including disagreements between SHO and Sears Holdings regarding their respective responsibilities for these costs);


•	Changes in population and other demographics;


•	Timing and effectiveness of our promotional events;


•	Weather conditions, including level of rainfall, particularly drought, level of snowfall, average temperature, major storms, and delays in, or advances to, the start of seasonal changes;


•	The availability of locations for new stores that can be operated profitability by the Company and by our dealers and franchisees; and


•	The growth of online shopping in which we may not be able to fully participate

Accordingly, our results for any one quarter or year are not necessarily indicative of the results to be expected for any other quarter or year, and comparable store sales for any particular future period may increase or decrease. For more information on our results of operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Annual Report on Form 10-K.

ESL Investments, Inc. and its investment affiliates, whose interests may be different from the interests of other stockholders, may be able to exert substantial influence over our Company.

According to publicly available information, ESL Investments, Inc. and its investment affiliates including Edward S. Lampert (together, "ESL") owns approximately 57% of our outstanding shares of common stock. Accordingly, ESL could have substantial influence over many, if not all, actions to be taken or approved by our stockholders, and will have a significant voice in the election of directors and any transactions involving a change of control, among other matters affecting the Company.

The interests of ESL, which has investments in other companies (including, according to publicly available information, ownership of approximately 48% of the outstanding common stock of Sears Holdings as of January 28, 2017) may from time to time differ from, or be opposed to, the interests of our other stockholders.

Edward S. Lampert is the Chairman of the Board and the Chief Executive Officer of Sears Holdings.

We may be subject to product liability claims if people or properties are harmed by the products we sell or the services we offer.

Some of the products we sell may expose us to product liability claims relating to personal injury, death, or property damage caused by such products, and may require us to take actions such as product recalls. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on commercially reasonable terms, or at all.

We may be subject to periodic litigation and regulatory proceedings. These proceedings may be affected by changes in laws and government regulations or changes in the enforcement thereof.

From time to time, we may be involved in lawsuits and regulatory actions relating to our business, certain of which may be in jurisdictions with reputations for aggressive application of laws and procedures against corporate defendants. We are impacted by trends in litigation, including class-action allegations brought under various consumer protection and employment laws, including wage and hour laws. We conduct business in all fifty states. Some jurisdictions in which we operate aggressively apply laws and procedures against corporate defendants. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, these proceedings could result in substantial costs and may require that we devote substantial time and resources to defend our Company. Further, changes in governmental regulations in the United States could have adverse effects on our business and subject us to additional regulatory actions. For example, 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 franchisees.

If we do not maintain the security of our customer, associate, and company information, we could damage our reputation, incur substantial additional costs, and become subject to litigation.

In the ordinary course of our business, we collect, process, and store a large amount of customer, associate, and Company information, including financial information and sensitive personal information. Until we complete the implementation of the BPO we will continue to rely heavily on Sears Holdings’ computer and communications hardware and software systems (such as the point-of-sale system used by the Company and our dealers and franchisees) and related security systems (collectively the "Sears Holdings Systems") to collect, process, and store this information. Sears Holdings Systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches, catastrophic events such as fires, tornadoes and hurricanes, and usage errors by Sears Holdings' associates, our associates, and the associates of our dealers and franchisees. The Sears Holdings Systems may be compromised as a result of criminal activity, negligence, or otherwise. Threats may result from human error, fraud, or malice on the part of Sears Holdings' associates, our associates, and the associates of our dealers, franchisees, and other third parties, or may result from accidental technological failure. Any significant compromise or breach of the Sears Holdings Systems could significantly damage our reputation and result in additional costs, lost sales, fines, government investigations, and lawsuits against, or otherwise adversely affecting, SHO. The regulatory environment related to information security and privacy is increasingly rigorous and complex, with new and constantly changing requirements applicable to our business, and compliance with those requirements could result in additional costs. Additionally, several recent, highly publicized data-security breaches and cyber attacks at other large, nationwide retail companies have heightened consumer awareness of this issue and may embolden individuals or groups to target SHO and the Sears Holdings Systems. There is no guarantee that our reliance on the Sears Holdings Systems and related security measures provided by Sears Holdings will protect information against unauthorized access or that the Sears Holdings Systems and related security measures are adequate to safeguard against data-security breaches. If the Sears Holdings Systems experience a significant data-security breach (Kmart, owned by Sears Holdings, announced in October 2014 that its payment-data systems had been breached), or if Sears Holdings or SHO fails to detect and appropriately respond to a significant data-security breach, with respect to our customer, associate, or Company information, we could be exposed to government enforcement actions and private litigation. In addition, our customers could lose confidence in our ability to protect their information, which could cause them to stop shopping with us altogether.

When we complete the implementation of the BPO our systems will be subject to the same information-system risks that are described in the preceding paragraph. See "We rely on Sears Holdings and other third parties to provide us with key products and services in connection with the administration of many critical aspects of our business, and we may be required to develop our own systems quickly in order to reduce such dependence" in this Item 1A for additional information and risks regarding the implementation of the BPO.

If we are unable to renew or enter into new store leases on competitive terms, our revenues or results of operations could be negatively impacted.

A small number of our stores are in locations where Sears Holdings currently operates one of its stores. In such cases we entered into a lease or sublease with Sears Holdings (or one of its subsidiaries) for the portion of the space in which our store will operate and pay rent directly to Sears Holdings (or one of its subsidiaries) on the terms negotiated in connection with the Separation. If we are unable to negotiate leases or subleases with Sears Holdings (or one of its subsidiaries) on commercially reasonable terms, or at all, we may be forced to close the affected stores, which could negatively impact our results of operations.

As of January 28, 2017 , we leased 79 Company-operated Sears Outlet store locations under long-term agreements with landlords that are unaffiliated with Sears Holdings, leased 29 locations with landlords affiliated with Sears Holdings, operated two locations that were co-located with a Sears Appliance and Hardware store which were leased by the Hometown segment, and owned two buildings. Additionally, we are the obligor on 28 leases which are sublet to our franchisees that are unaffiliated with Sears Holdings and five leases are sublet to franchisees with landlords affiliated with Sears Holdings, one location is leased by an independent owner, and three locations are leased by franchisees. If our cost of leasing existing stores increases, we may be unable to maintain our existing store locations as leases expire. Our profitability may decline if we fail to enter into new leases on competitive terms or at all, or we may not be able to locate suitable alternative stores or additional sites for new-store expansion in a timely manner. Furthermore, 87 of our 149 Sears Outlet leases will expire within the next three years and, with respect to 27 of these locations, we do not have lease-renewal rights. A failure to renew or enter into new leases could reduce our revenues and negatively impact our results of operations.

In addition, as of January 28, 2017 , our Sears Hometown business leased 35 Company-operated locations under long-term agreements with landlords that are unaffiliated with Sears Holdings and leased 3 Company-operated locations under long-term agreements with landlords affiliated with Sears Holdings. Additionally, we are the obligor on an additional 15 leases which are sublet to our franchisees. If our franchisees are unable to maintain the payments under either our sublease or assigned lease arrangements, we will be required to make payments under the lease. In addition, upon the expiration of the initial lease term, our

franchisees are responsible for entering into new leases with existing landlords. If our franchisees are unable to negotiate new leases with existing landlords on commercially reasonable terms, or at all, our franchisees may be required to move or close certain of our stores. A failure to maintain payments or to enter into new leases by our franchisees could negatively impact our results of operations.

A number of the leases for both our Outlet and Hometown stores were negotiated by and entered into by a subsidiary of Sears Holdings. Upon the expiration of these leases, we will be required to enter into new leases with the landlords for such properties and we may be unable to enter into new leases as a company independent from Sears Holdings on commercially reasonable terms, or at all. Further, a number of our leases were entered into at a time when the commercial real estate market was depressed. We may be required to enter into negotiations with landlords for new leases in the future at times when the commercial real estate market has rebounded and rental payments are generally higher for commercial real estate. Higher leasing costs could negatively impact our results of operations.

If we fail to timely and effectively obtain shipments of product from our vendors and deliver merchandise to our customers, our operating results will be adversely affected.

We cannot control all of the various factors that might affect our timely and effective procurement of supplies of product from our vendors, including Sears Holdings, and delivery of merchandise to our customers. Our utilization of foreign imports also makes us vulnerable to risks associated with products manufactured abroad, including, among other things, risks of damage, destruction or confiscation of products while in transit to our stores, work stoppages including as a result of events such as strikes, transportation and other delays in shipments including as a result of heightened security screening and inspection processes or other port-of-entry limitations or restrictions in the United States, lack of freight availability and freight cost increases. In addition, if we experience a shortage of a popular item, we may be required to arrange for additional quantities of the item, if available, to be delivered to us through airfreight, which is significantly more expensive than standard shipping by sea. As a result, we may not be able to obtain sufficient freight capacity on a timely basis or at favorable shipping rates and, therefore, we may not be able to timely receive merchandise from our vendors or deliver our products to our customers.

We rely upon Sears Holdings and other third-party land-based carriers for merchandise shipments to our stores and customers. Accordingly, we are subject to the risks, including labor disputes, union organizing activity, inclement weather and increased transportation costs, associated with such carriers' ability to provide delivery services to meet our inbound and outbound shipping needs. In addition, if there was an increase in the cost of fuel above current levels, the cost to deliver merchandise to our stores may rise which could have an adverse impact on our profitability. Failure to procure and deliver merchandise either to us or to our customers in a timely, effective and economically viable manner could damage our reputation and adversely affect our business. In addition, any increase in distribution costs and expenses could adversely affect our future financial performance.

Failure to achieve and maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley could have a material adverse effect on our business and the market price of our common stock.

As a public company, we are required to document and test our internal control over financial reporting in order to satisfy the requirements of Section 404 of Sarbanes-Oxley, which requires annual management assessments of the effectiveness of our internal control over financial reporting along with a report by our independent registered public accounting firm that addresses the effectiveness of internal control over financial reporting. Testing and maintaining internal control can divert our management’s attention from other matters that are also important to the operation of our business. The imposition of these regulations has increased, and may continue to increase, our legal and financial compliance costs and make some activities more difficult, time consuming and costly. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. If we are unable to conclude that we have effective internal control over financial reporting, investors could lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our common stock. In addition, if we do not maintain effective internal controls, we may not be able to accurately report our financial information on a timely basis, which could harm the trading price of our common stock, impair our ability to raise additional capital, or jeopardize our continued listing on the NASDAQ Capital Market or any other stock exchange on which our common stock may be listed.

Risks Relating to our Indebtedness

We and our subsidiaries may incur additional debt, which could substantially reduce our profitability, limit our ability to pursue certain business opportunities, and reduce the value of your investment.

At January 28, 2017 we had approximately $26.8 million of debt outstanding. While the instruments governing our indebtedness include restrictions on our ability to incur additional indebtedness, they do not completely prevent us or our subsidiaries

from incurring additional debt in the future and do not prevent us or our subsidiaries from incurring other obligations that do not constitute indebtedness, which could increase the risks described below and lead to other risks. In addition, we may, subject to certain conditions, increase the borrowing capacity under the Senior ABL Facility without the consent of any person other than the institutions agreeing to provide all or any portion of such increase, by an amount not to exceed $100 million. For additional information regarding the Senior ABL Facility see, "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Senior ABL Facility" in this Annual Report on 10-K. The amount of our debt or such other obligations could have important consequences for holders of our common stock, including, but not limited to:


•	our ability to satisfy obligations to lenders may be impaired, resulting in possible defaults on and acceleration of our indebtedness;


•	our ability to obtain additional financing for refinancing of existing indebtedness, working capital, capital expenditures, product and service development, acquisitions, general corporate purposes and other purposes may be impaired;


•	a substantial portion of our cash flow from operations could be dedicated to the payment of the principal and interest on our debt;


•	we may be increasingly vulnerable to economic downturns and increases in interest rates;


•	our flexibility in planning for and reacting to changes in our business and the retail industry may be limited; and


•	we may be placed at a competitive disadvantage relative to other companies in our industry.

Our Senior ABL Facility contains financial and operating covenants and restrictions that limit our operations and could lead to adverse consequences if we fail to comply with them.

The Senior ABL Facility contains certain financial and operating covenants and other restrictions relating to, among other things, an excess availability requirement and a fixed charge coverage ratio, as well as limitations on indebtedness (including guarantees of additional indebtedness) and liens, mergers, consolidations and dissolutions, sales of assets, investments and acquisitions, dividends and other restricted payments (such as stock repurchases), and certain transactions with affiliates. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Senior ABL Facility" in this Annual Report on Form 10-K.

Failure to comply with these financial and operating covenants could result from, among other things, changes in our results of operations, the incurrence of additional indebtedness, or changes in general economic conditions, which may be beyond our control. The breach of any of these covenants or restrictions could result in a default under the Senior ABL Facility that would permit the lenders to declare all amounts outstanding thereunder to be due and payable, together with accrued and unpaid interest. If we are unable to repay such amounts, lenders having secured obligations, such as the lenders under the Senior ABL Facility, could proceed against the collateral securing the secured obligations. In any such case, we may be unable to borrow under the Senior ABL Facility and may not be able to repay amounts due under such facility. This could have serious consequences to our financial condition and results of operations and could cause us to become bankrupt or insolvent. In addition, these covenants may restrict our ability to engage in transactions (i) that we believe would otherwise be in the best interests of our stockholders or (ii) without which our business and operations could be harmed. As of January 28, 2017 SHO was in compliance with all covenants under the Senior ABL Facility. See also "If Sears Holdings' seeks the protection of the U.S. bankruptcy laws, our ability to operate our business and our financial performance could be materially and adversely affected" in this Item 1A.

Increases in interest rates would increase the cost of servicing our debt and could reduce our profitability.

A significant portion of our outstanding debt, including amounts under the Senior ABL Facility, bears interest at variable rates. As a result, increases in interest rates would increase the cost of servicing our debt and could materially reduce our profitability and cash flows. Assuming our Senior ABL Facility was fully drawn in a principal amount equal to $250 million, each one percentage point change in interest rates would result in a $2.5 million change in annual cash interest expense on our Senior ABL Facility.

We may have future capital needs and may not be able to obtain additional financing on acceptable terms.

Any reductions in our available borrowing capacity under the Senior ABL Facility, or our inability to renew or replace our Senior ABL Facility, when required or when business conditions warrant, could have a material adverse effect on our business, financial condition and results of operations. The economic conditions, credit market conditions and economic climate affecting the retail industry, as well as other factors, may constrain our financing abilities. Our ability to secure additional financing, if available, and to satisfy our financial obligations under indebtedness outstanding from time to time will depend upon our future operating performance, the availability of credit generally, economic conditions and financial, business and other factors, many of which are beyond our control. The market conditions and the macroeconomic conditions that affect the retail industry could have a material adverse effect on our ability to secure financing on favorable terms, if at all. See also "If Sears Holdings' seeks

the protection of the U.S. bankruptcy laws, our ability to operate our business and our financial performance could be materially and adversely affected " in this Item 1A.

We may be unable to secure additional financing or financing on favorable terms or our operating cash flow may be insufficient to satisfy our financial obligations under the indebtedness outstanding from time to time. Furthermore, if financing is not available when needed, or is available on unfavorable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations. If we are unable to secure debt financing and instead raise funds through the issuance of additional equity securities, our stockholders may experience significant dilution.

Risks Relating to Our Common Stock

If our share price fluctuates, you could lose all or a significant part of your investment.

Our common stock trades on the NASDAQ Capital Market under the symbol "SHOS." We neither can provide any assurance that a trading market for our common stock will continue to exist nor can we predict the prices at which our common stock may trade in the future. The market price of our common stock may fluctuate widely, depending on many factors, some of which may be beyond our control, including the following:


•	Our business profile and market capitalization may not continue to fit the investment objectives of some stockholders and, as a result, these stockholders may sell our shares;


•	Actual or anticipated fluctuations in our operating results due to factors related to our business;


•	Our ability to decrease our reliance on products and services provided by Sears Holdings and ability to diversify our supply chain;


•	Success or failure of our business strategy;


•	Sears Holdings' financial performance, condition, and prospects, including the risk of insolvency proceedings;


•	Our relationship with Sears Holdings;


•	Actual or anticipated changes in the U.S. economy or the retailing environment;


•	Our quarterly or annual earnings, or those of other companies in our industry;


•	Our ability to obtain third-party financing as needed;


•	Announcements by us or our competitors of significant acquisitions or dispositions;


•	The failure of securities analysts to cover our common stock;


•	Changes in earnings estimates by securities analysts or our ability to meet those estimates;


•	The operating and stock price performance of other comparable companies;


•	Overall market fluctuations;


•	Changes in laws and regulations affecting our business;


•	Actual or anticipated sales or distributions of our capital stock by our officers, directors or significant stockholders;


•	Terrorist acts or wars; and


•	General economic conditions and other external factors.

In addition, the stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies like us. These broad market and industry factors may materially reduce the market price of our common stock, regardless of our operating performance.

Our common stock may have a low trading volume and limited liquidity, resulting from a continued lack of analyst coverage and institutional interest.

Our common stock may continue to receive limited attention from market analysts. Lack of up-to-date analyst coverage may make it difficult for potential investors to fully understand our operations and business fundamentals, which may limit our trading volume. Low trading volumes and lack of analyst coverage may limit your ability to resell your common stock.

Our common stock price may decline if ESL decides to sell a portion of its holdings of our common stock.

According to publicly available information ESL owns approximately 57% of our outstanding common stock. ESL will, in its sole discretion, determine the timing and terms of any transactions with respect to its shares in us, taking into account business and market conditions and other factors that it deems relevant. ESL is not subject to any contractual obligation to maintain its ownership position in us, although it may be subject to certain transfer restrictions imposed by securities laws. Consequently, we cannot assure you that ESL will maintain its ownership interest in us. Any sale by ESL of our common stock or any announcement by ESL that it has decided to sell shares of our common stock, or the perception by the investment community that ESL has sold or decided to sell shares of our common stock, could have an adverse impact on the price of our common stock.

Your percentage ownership in us may be diluted in the future.

Your percentage ownership in SHO may be diluted in the future because of equity awards that may be granted to our directors, officers and employees in the future. We may in the future decide to make equity-based awards, as well as establish equity incentive plans that may provide for the grant of common stock-based equity awards to our directors, officers and other employees. In addition, we may issue equity in order to raise capital or in connection with future acquisitions and strategic investments, which would dilute your percentage ownership.

We do not expect to pay dividends for the foreseeable future.

We do not expect to pay cash dividends on our common stock for the foreseeable future. As a result, you may not receive any return on an investment in our common stock in the form of cash dividends.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

As of January 28, 2017 , our Hometown business included 871 stores and our Outlet business included 149 stores.

As of January 28, 2017 , 788 of our Hometown Store locations were leased by independent dealers from landlords not affiliated with SHO. Also as of that date (1) franchisees leased a total of 40 Home Appliance Showrooms and Hardware Stores directly from landlords not affiliated with SHO and (2) SHO subleased to franchisees a total of 15 Home Appliance Showrooms and Hardware stores. As part of our sublease arrangements the franchisees agree with SHO to pay rent to SHO and perform the other lease obligations. As of January 28, 2017 SHO operated 32 leased Home Appliance Showrooms and Hardware Stores and operated six leased Hometown Stores. Also as of that date SHO operated 108 leased Outlet Stores, owned and operated two Outlet Stores, subleased 33 Outlet Stores to franchisees, one location was leased by an independent owner, 3 locations were leased directly by franchisees, and 2 locations were in premises leased by the Hardware stores.

As of January 28, 2017 , SHO subleased or leased from Sears Holdings a total of 32 Company-operated locations. In some of these locations Sears Holdings currently operates one of its stores or engages in other or, in some cases, no business activity. In most such circumstances we have entered into a sublease with Sears Holdings (or one of its subsidiaries) for the portion of the space in which our store operates and we pay rent directly to Sears Holdings on the terms negotiated in connection with the Separation. In several locations Sears Holdings owns the premises, which we lease from Sears Holdings. We also lease from Sears Holdings approximately 40,000 square feet of office space for our corporate headquarters in Hoffman Estates, Illinois. We believe that our facilities are adequately maintained and are sufficient to meet our current and projected needs. We review all subleases and leases set to expire in the near-term to determine the appropriate action to take with respect to them, including closing stores, entering into new store subleases or leases, or purchasing properties for new stores.

Generally, the form of sublease from Sears Holdings to us with respect to our subleased premises provides for the following, among other terms and conditions: (1) the duration of the sublease and the rent payable by us to Sears Holdings are the same as the duration and the rent payable by Sears Holdings to its landlord; (2) the premises are subleased to us on an "as is" basis and that Sears Holdings, as sublandlord, makes no representation to us regarding the condition of the subleased premises; (3) we as subtenant (A) are subject to easements, covenants, conditions, and restrictions of Sears Holdings' lease from its landlord and (B) are required to comply with and perform obligations of Sears Holdings as tenant under its lease from its landlord; (4) we are required to indemnify and defend Sears Holdings from and against claims by (A) Sears Holdings' landlord that we have not performed Sears Holdings' obligations as tenant under Sears Holdings' lease from the landlord and (B) any person as a result of our use or occupancy of the subleased premises or our failure to comply with the terms of the sublease or Sears Holdings' lease from its landlord; (5) we may not sublet or assign the sublease without the consent of Sears Holdings; and (6) upon specified defaults by us (including our failure to observe and perform any provision of the sublease to be performed by us) Sears Holdings may, among other remedies, (A) reenter the subleased premises and expel us and (B) recover damages from us.

Logistics

We support the distribution of product sold through our Outlet locations through 18 strategically located distribution locations in 15 states and one in Puerto Rico. The total square footage of all distribution locations is 1,873,055. On occasion, we may lease additional facilities to support additional distribution needs.

Store Openings and Closures

Store opening and closure data for fiscal years 2014 , 2015 , and 2016 is contained in the following table.



Store Openings & Closures

	Fiscal Year
	2014		2015		2016
Beginning Store Count	1,260		1,260		1,160
Store Openings	45		37		20
Store Closures	(45	)	(137	)	(160	)
Ending Store Count	1,260		1,160		1,020

As of January 28, 2017 , we had 1,020 stores in operation, with stores in each state in the U.S., as well as a store in Bermuda and stores in Puerto Rico.

Store Count by State



		Hometown		Outlet
		Company Operated	Dealer/Franchise	Company Operated	Franchise
BR	Bermuda	—	1	—	—
AK	Alaska	—	1	—	—
AL	Alabama	—	28	1	—
AR	Arkansas	—	33	—	—
AZ	Arizona	—	16	—	5
CA	California	2	37	13	6
CO	Colorado	1	16	4	—
CT	Connecticut	1	2	2	—
DE	Delaware	—	3	1	—
FL	Florida	—	20	13	—
GA	Georgia	—	30	4	—
HI	Hawaii	—	1	1	—
IA	Iowa	—	16	—	—
ID	Idaho	—	8	—	1
IL	Illinois	4	24	8	1
IN	Indiana	1	23	2	—
KS	Kansas	—	23	1	1
KY	Kentucky	1	20	1	—
LA	Louisiana	—	21	2	—
MA	Massachusetts	—	4	3	—
MD	Maryland	1	4	3	—
ME	Maine	—	9	—	—
MI	Michigan	—	32	4	1
MN	Minnesota	—	23	2	—
MO	Missouri	3	33	—	3
MS	Mississippi	—	23	—	—
MT	Montana	—	11	—	—
NC	North Carolina	—	26	2	3
ND	North Dakota	—	5	—	—
NE	Nebraska	—	10	—	—
NH	New Hampshire	1	8	—	—
NJ	New Jersey	4	2	6	—
NM	New Mexico	—	8	1	—
NV	Nevada	—	6	3	—
NY	New York	—	19	3	—
OH	Ohio	3	19	8	—
OK	Oklahoma	—	22	—	—
OR	Oregon	—	24	—	2
PA	Pennsylvania	9	13	6	—
PR	Puerto Rico	—	9	1	—
RI	Rhode Island	—	3	—	—
SC	South Carolina	—	14	1	1
SD	South Dakota	—	5	—	—



TN	Tennessee	—	17	4	—
TX	Texas	5	77	5	11
UT	Utah	—	6	—	—
VA	Virginia	—	14	3	—
VT	Vermont	—	8	—	—
WA	Washington	1	17	1	2
WV	West Virginia	—	8	3	—
WI	Wisconsin	1	24	—	—
WY	Wyoming	—	7	—	—
Total		38	833	112	37

Store Ownership Type



	Hometown	Outlet
Company operated stores owned	—	2
Leased	38	110
Total company operated	38	112

Independently owned and operated	833	37

Total store count as of 1/28/2017	871	149

Item 3. Legal Proceedings

As of the date hereof, we are not party to any litigation which we consider material to our operations.

Notwithstanding the above, from time to time we are (or in the future could be), and will continue to be, subject to legal claims, including without limitation those alleging wage and hour violations, employment discrimination, unlawful employment practices, Americans with Disabilities Act claims, breach of contract and other claims by our independent dealers and franchisees, product liability claims as a result of the sale of certain products, as well as various legal and governmental proceedings. Litigation is inherently unpredictable and 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 "Risk Factors-Risks Relating to Our Relationship with, and Dependence on, Sears Holdings" and "Risk Factors-Risks Relating to Our Business" in Item 1A of this Annual Report on Form 10-K.

Item 4. Mine Safety Disclosures

Not Applicable.

EXECUTIVE OFFICERS OF REGISTRANT

The following table sets forth information regarding our executive officers as of the date hereof.



Name	Age		Position
Will Powell		46	Chief Executive Officer and President and a Director
Michael A. Gray		45	Senior Vice President, Store Operations
Ryan D. Robinson		51	Senior Vice President, Chief Administrative Officer, and Chief Financial Officer
David J. Buckley		49	Chief Marketing Officer and Vice President, eCommerce
Philip M. Etter		52	Vice President, Human Resources
Charles J. Hansen		69	Vice President, General Counsel, and Secretary
Michael P. McCarthy		55	Chief Merchandising Officer and Vice President, Merchandising and Inventory

Mr. Powell has been Chief Executive Officer and President and a director since July 2015. From October 2012 until July 2015, he served as Senior Vice President and Chief Operating Officer. Prior to his employment with SHO, he served as Sears Holdings' Senior Vice President and President, Hometown Stores (at that time a division of Sears Holdings), positions he held from November 2008 to October 2012. From November 2007 until November 2008, Mr. Powell served as Sears Holdings' Vice President and General Manager, Outlet Stores (at that time a division of Sears Holdings), and from January 2006 to November 2007, he served as Sears Holdings' Divisional Vice President, Stores/Sales-Dealer Stores. He joined Sears Holdings in August 2003.

Mr. Gray has been Senior Vice President, Store Operations, since February 2016. Prior to that he served as the Company's Vice President and General Manager, Stores, since beginning in 2011. Prior to his employment with the Company he served as Sears Holdings’ Region Vice President and General Manager, Sears Retail Stores, a position he held from March 2009 to June 2011. He joined Sears Holdings in October 2003 and served in various leadership roles. Prior to joining Sears Holdings Mr. Gray served in a variety of leadership positions with other national retail chains including OfficeMax, Petsmart, and Things Remembered.

Mr. Robinson has been Senior Vice President and Chief Financial Officer since June 2014. He previously served as Chief Financial Officer of Urgent Care MSO, LLC (doing business as MedExpress), which operates neighborhood medical centers. Prior to that, he was with Best Buy Co., Inc. for 10 years in roles of increasing responsibility. He began his career with Best Buy in 2002 as Vice President, Finance, Treasurer, with responsibility for tax and business development. He continued his Best Buy service until May 2012 when he was Senior Vice President, Chief Financial Officer, US.

Mr. Buckley has been Chief Marketing Officer and Vice President, e-Commerce since July 2015. He previously served as the Company’s Chief Marketing Officer. Prior to his employment with the Company he served as Divisional Vice President and Chief Marketing Officer, Hometown Stores (at that time a division of Sears Holdings), a position he held from August 2011 to October 2012. He joined Sears Holdings in August 2010 as part of the Senior Leadership Development program, working on several transformational projects during that time. Before joining Sears Holdings, Mr. Buckley was Global Director of Advertising for The Associated Press. Before joining The Associated Press, he served in a variety of leadership positions in advertising at The New York Times Company.

Mr. Etter has been Vice President, Human Resources since February 2016. Prior to that he served as the Company’s Divisional Vice President of Human Resources beginning in 2012. Prior to his employment with the Company he served as Director of Human Resources for Sears Holdings Corporation, Tweeter Home Entertainment Group, Inc., and Macy’s West.

Mr. Hansen has been Vice President, General Counsel, and Secretary since the Separation. From January 2008 until the Separation, he served as Vice President, Chief Counsel of Sears Holdings. Prior to his employment with Sears Holdings, Mr. Hansen was the Executive Vice President and General Counsel of Saks Incorporated, an operator of retail and department stores, a position he held from September 2003 to May 2007.

Mr. McCarthy has been Chief Merchandising Officer and Vice President Merchandising and Inventory since September 2015. Prior to assuming his current role, Mr. McCarthy served as the Vice President of Store Operations for Pep Boys from July 2014 to September 2015. Before joining Pep Boys, Mr. McCarthy served as the Executive Vice President of Macy’s North Region from March 2011 to February 2013 leading a large regional organization with stores located in 10 states. Before joining Macy’s Mr. McCarthy served in various capacities at Sears Holdings culminating in his role as the Senior Vice President and General Manager of Sears Full-Line Stores, a position he held from 2007 to 2011.

Part II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Our common stock is listed and traded on the NASDAQ Stock Market under the ticker symbol SHOS. We had 276 stockholders of record at the close of business on March 17, 2017. The table below sets forth the high and low sales prices on NASDAQ of our common stock for each of the fiscal periods indicated.



2016	High		Low
First Quarter	$	7.04	$	5.30
Second Quarter	7.14		5.38
Third Quarter	6.88		4.75
Fourth Quarter	7.25		3.70

2015	High		Low
First Quarter	$	13.93	$	6.80
Second Quarter	9.92		6.65
Third Quarter	8.95		6.50
Fourth Quarter	9.60		6.78

Dividends

We did not declare any cash dividends on our common stock during fiscal year 2016 . We do not expect to pay cash dividends on our common stock for the foreseeable future. Cash dividends are dependent upon our results of operations, financial condition, cash requirements, the satisfaction of certain conditions (described below in "Share Repurchases") under our Senior ABL Facility, availability of surplus, and such other factors as our Board of Directors may deem relevant. See "We do not expect to pay dividends for the foreseeable future" in Item 1A-Risk Factors of this Annual Report on Form 10-K. At January 28, 2017 the Senior ABL Facility permitted the payment of cash dividends.

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. At January 28, 2017 we had $12.5 million of remaining authorization under the repurchase program. The timing and amount of repurchases depend on various factors, including market conditions, the Company's capital position and internal cash generation, and other factors. The Company's repurchase program does not include specific price targets, may be executed through open-market, privately negotiated, and other transactions that may be available, and may include utilization of Rule 10b5-1 plans. The repurchase program does not obligate the Company to repurchase any dollar amount, or any number of shares, of common stock. The repurchase program does not have a termination date, and the Company may suspend or terminate the repurchase program at any time.

Shares that are repurchased by the Company pursuant to the repurchase program will be retired and will resume the status of authorized and unissued shares of common stock. We did not repurchase any shares of our common stock during our 2016 fiscal year.

The Senior ABL Facility also limits SHO's ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends and may repurchase stock, together not exceeding $37,500,000 in any fiscal year or $75,000,000 in the aggregate, 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 and (ii) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that monthly availability, 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 will be at least equal to the greater of (x) 50% of the Loan Cap and (y) $100,000,000 . No default or event of default presently exists. At January 28, 2017 we met the foregoing conditions and as a result the Senior ABL Facility permits us to pay cash dividends or repurchase our common stock.

The Senior ABL Facility also imposes various other requirements, such as a cash dominion requirement. In addition, upon excess availability falling below a specified level, the Company is required to comply with a minimum fixed charge coverage ratio.

Stock Performance Graph

The following graph compares the cumulative stockholder return on our common stock with the return on the Total Return Index for The S&P 500 Stock Index and The S&P 500 Retailing Industry Group Total Return Index. The graph assumes that $100 was invested on October 12, 2012 in each of our common stock, The S&P 500 Stock Index and The S&P 500 Retailing Industry Group Total Return Index.

Trading in our stock began on October 12, 2012. The table below assumes that $100 was invested on that date in each of our common stock, The S&P 500 Stock Index and The S&P 500 Retailing Industry Group Total Return Index.



	2/1/13		1/31/14		1/30/15		1/29/16		1/27/17
SHOS	$	131.65	$	68.42	$	36.99	$	22.69	$	12.39
S&P 500 INDEX	$	105.92	$	124.78	$	139.65	$	135.82	$	160.63
S&P 500 RETAILING INDEX	$	103.89	$	134.64	$	159.88	$	184.76	$	216.70

Item 6. Selected Financial Data

SELECTED HISTORICAL FINANCIAL AND OTHER DATA

The Consolidated Statement of Operations Data, the Per Common Share Data, the Consolidated Balance Sheet Data, and the Other Financial and Operation Data provided in the table below in this Item 6 with respect to our 2016, 2015, 2014, 2013, and 2012 fiscal years are derived from the audited Consolidated Financial Statements contained in this Annual Report on Form 10-K (for the 2016, 2015, and 2014 fiscal years), the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 2016 (for the 2013 fiscal year), and the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2015 (for the 2012 fiscal year). The information provided in the table below with respect to our 2012 (prior to October 12, 2012) fiscal year (the "Pre-Separation Financial Information") reflects the results of operations and financial position of the consolidated Sears Hometown and Hardware and Sears Outlet businesses operated pre-Separation by Sears Holdings.

All of the information provided in the table below should be read in conjunction with our Consolidated Financial Statements and accompanying notes and "Management’s Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.

The Pre-Separation Financial Information may not reflect (1) what our results of operations, financial position, and cash flows would have been had Sears Holdings operated our businesses as a single combined business entity during these fiscal years or had we operated as a publicly traded company separate from Sears Holdings during these fiscal years or (2) what our results of operations, financial position, and cash flows will be in the future as we continue to operate as a single combined business entity separate from Sears Holdings. This is primarily due to the following:


•	The Pre-Separation Financial Information reflects the results of operations, financial positions, and cash flows of Sears Hometown and Hardware and Sears Outlet prior to their consolidation into SHO, which may not reflect the results of operations, financial positions, and cash flows of SHO had it been a single combined business entity pre-Separation;


•	The Pre-Separation Financial Information does not reflect changes resulting from the Separation and the integration of the Sears Hometown and Hardware and the Sears Outlet businesses into a single combined business entity, including changes in the cost structure, personnel needs, financing, and operation of the businesses; and


•	The Pre-Separation Financial Information reflects assumptions made, and allocations for services and expenses historically provided to the Sears Hometown and Hardware and the Sears Outlet businesses, by Sears Holdings. Those assumptions and allocations may not reflect the costs and expenses we would have incurred as a single combined business entity.

For additional information about our past financial performance and the basis of presentation of our financial statements, see "Selected Historical Financial and Other Data," "Management’s Discussion and Analysis of Financial Condition and Results of Operations," and our financial statements and the notes thereto included in this Annual Report on Form 10-K.




Fiscal years and thousands except for per share amounts and number of stores	2016			2015			2014			2013			2012
Consolidated Statement of Operations Data (1)
Net sales	$	2,070,056		$	2,287,788		$	2,356,033		$	2,421,562		$	2,453,606
Net income (loss)	$	(131,919	)	$	(27,261	)	$	(168,805	)	$	35,550		$	60,080
Per Common Share Data (2)
Basic	$	(5.81	)	$	(1.20	)	$	(7.45	)	$	1.55		$	2.60
Diluted	$	(5.81	)	$	(1.20	)	$	(7.45	)	$	1.55		$	2.60
Consolidated Balance Sheet Data
Total assets	$	468,426		$	633,833		$	645,722		$	847,185		$	785,803
Long-term debt	—			—			—			—			—
Long-term capital lease obligations	$	274		$	382		$	176		$	95		$	769
Other Financial and Operational Data
Adjusted EBITDA (3)	$	(18,521	)	$	9,386		$	2,047		$	45,907		$	98,638
Number of stores	1,020			1,160			1,260			1,260			1,245
Sears Outlet - Comparable Store Sales %	(5.1		)%	(4.1		)%	(1.2		)%	1.2		%	(0.8		)%
Sears Hometown and Hardware - Comparable Store Sales %	(4.2		)%	(0.1		)%	(7.1		)%	(3.2		)%	1.0		%


(1)	Our fiscal year end is the Saturday closest to January 31 each year. Fiscal year 2012 was a 53-week year and fiscal years 2016, 2015, 2014, 2013, were 52-week years.


(2)	23,100,000 shares outstanding effective upon completion of the Separation are used for Fiscal year 2012.

(3)

Adjusted EBITDA —In addition to our net income (loss) determined in accordance with GAAP, for purposes of evaluating operating performance, we use Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization, or "adjusted EBITDA," which is adjusted to exclude certain significant items as set forth below. Our management uses adjusted EBITDA, among other metrics, to evaluate 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, and may not be comparable to similarly titled measures reported by other companies. Adjusted EBITDA should not be considered as a substitute for GAAP measurements.

While adjusted EBITDA is a non-GAAP measurement, we believe it is an important indicator of operating performance for investors because:


•	EBITDA excludes the effects of financing and investing activities by eliminating the effects of interest and depreciation costs; and

•

Other significant items, while periodically affecting our results, may vary significantly from period to period and may have a disproportionate effect in a given period, which affects comparability of results. These items may also include cash charges such as Severance and executive transition costs and IT transformation investments that make it difficult for investors to assess the Company's core operating performance.

Starting with 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) to better align Adjusted EBITDA for purposes of incentive compensation.

In the fourth quarter of 2016, in an effort to improve profitability and make the most productive use of capital, the Company executed an initiative to accelerate the closing of 109 under-performing locations. Under-performing locations are typically closed during the normal course of business at the termination of a lease or expiration of a franchise or dealer agreement and, as a result, do not have significant future lease, severance, or other non-recurring store-closing costs. Due to the number and accelerated nature

of the store closings in the fourth quarter of 2016, the Company has excluded the associated costs of the closings from adjusted EBITDA in the current year.

The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated:



	Fiscal
thousands	2016			2015			2014
Net Loss	$	(131,919	)	$	(27,261	)	$	(168,805	)
Income tax (benefit) expense	81,491			(15,152		)	(3,066		)
Other income	(1,490		)	(2,585		)	(3,149		)
Interest expense	4,263			2,826			3,861
Operating loss	(47,655		)	(42,172		)	(171,159		)
Depreciation and amortization	13,458			10,562			8,935
Gain on the sale of assets	(25,203		)	—			(113		)
Impairment of goodwill, property, and equipment	9,356			3,984			168,237
Severance and executive transition costs	—			1,066			—
Initial franchise revenues net of provision for losses	(552		)	25,086			(3,853		)
IT transformation investments	14,974			10,860			—
Accelerated closure of under-performing stores	17,101			—			—
Adjusted EBITDA	$	(18,521	)	$	9,386		$	2,047

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Consolidated Financial Statements and notes contained elsewhere in this Annual Report on Form 10-K. For pre-Separation periods these financial statements and notes reflect the combined Sears Hometown and Hardware and Sears Outlet businesses of Sears Holdings, which, together with our operation of these businesses following the Separation, are referred to herein as "our" financial condition and results of operations. 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. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Risk Factors" and "Cautionary Statement Regarding Forward-Looking Information."

Overview

We are a national retailer primarily focused on selling home appliances, lawn and garden equipment, tools, and hardware. In addition to merchandise, we provide our customers with access to a full suite of related services, including home delivery, installation, and extended-service plans. As of January 28, 2017 , we and our independent dealers and franchisees operated a total of 1,020 stores across all 50 states, Puerto Rico, and Bermuda. In fiscal year 2016 , the Company opened 20 stores and closed 160 stores.

Our Hometown stores are designed to provide our customers with in-store and online access to a wide selection of national brands of home appliances, lawn and garden equipment, tools, sporting goods, and household goods, depending on the 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 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, apparel, mattresses, lawn and garden equipment, sporting goods and tools.

As of January 28, 2017 , Hometown consisted of 871 stores as follows:


•	795 Hometown Stores—Primarily independently operated stores, predominantly located in smaller communities, and offering home appliances, lawn and garden equipment, tools, sporting goods, and household goods. Most of our Hometown Stores carry proprietary Sears-branded products, such as Kenmore, Craftsman, and DieHard, as well as a wide assortment of other national brands.


•	26 Hardware Stores—Hardware stores that offer primarily home appliances, lawn and garden equipment, tools, and other home improvement products, and featuring Kenmore, Craftsman, and DieHard, as well as a wide assortment of other national brands.


•	50 Home Appliance Showrooms—Stores that have a simple, primarily appliance showroom design that are located in metropolitan areas.

As of January 28, 2017 , our Hometown segment included 789 dealer-operated stores, 44 franchisee-operated stores, and 38 Company-operated stores. The business model and economic structure of the dealer-operated and franchisee-operated stores, which are independently owned, are substantially similar to Company-operated stores in many respects. The Company requires all of the stores to operate under specified circumstances according to the Company’s standards. 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 specified advertising requirements on the owners. The Company owns the merchandise, 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 our dealers and franchisees and pays commissions when our dealers and franchisees sell the merchandise and provide services.

Historically, all of the Company's Outlet stores were operated by the Company. We initiated efforts to franchise Outlet stores in 2012, with the first stores transferred to franchisees during the 2013 fiscal year. During the second quarter of 2015 the Company indefinitely suspended its franchising of additional stores except to existing Company franchisees, and the suspension is continuing. As of January 28, 2017 , 37 of the 149 Sears Outlet stores were operated by franchisees.

Our dealers and franchisees exercise control over the operations of their stores, including complete responsibility for supervising their store managements and their store employees and making capital decisions. 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 our 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 our 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 store locations may be identified by the Company, an existing dealer or franchisee, or a potential dealer or franchisee. If the Company identifies and develops a location, it will generally seek to transfer that store to a dealer. When a dealer or franchisee exits a location, the Company may take over the operation of a store, generally on an interim basis, until the location can be transferred to another dealer. 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 franchisee. Transition stores are not included in our count of Company-operated locations due to the expected short-term nature of transition operation.

The Company's sale of a store to a franchisee generally will increase the Company's gross margin and increase the Company's selling and administrative expense, as the Company's cost of occupancy, which is reflected in cost of sales and occupancy, will be reduced, while the Company's commission payments, which are reflected in selling and administrative expense, will increase. The increase in commission payments will be partially offset by lower payroll and benefits expense.

Initial franchise revenues (shown in the table below) consist of franchise fees paid with respect to new and existing Company-operated stores that we transfer to franchisees plus the net gain or loss on any related transfer 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 are highly variable from quarter to quarter. The variation is driven by a number of factors, including general economic conditions, which influence 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 impacts the expected returns on new store development and the number of Company-operated locations available for sale to franchisees. Initial franchise revenues were $(0.2) million, $0.3 million, and $16.9 million in the 2016, 2015, and 2014 fiscal years, respectively. During the second quarter of fiscal 2015 the Company indefinitely suspended its franchising of additional

stores except to existing Company franchisees, and the suspension is continuing. Initial franchise revenues by quarter for the 2016, 2015, and 2014 fiscal years were:



thousands	First Quarter			Second Quarter			Third Quarter		Fourth Quarter		Fiscal Year Total
	2016
Hometown	$	—		$	—		$	—	$	—	$	—
Outlet	(200		)	—			6		—		(194		)
Total	$	(200	)	$	—		$	6	$	—	$	(194	)


	2015
Hometown	$	(6	)	$	(102	)	$	—	$	—	$	(108	)
Outlet	496			(60		)	13		—		449
Total	$	490		$	(162	)	$	13	$	—	$	341


	2014
Hometown	$	(194	)	$	172		$	336	$	—	$	314
Outlet	3,482			5,236			6,159		1,717		16,594
Total	$	3,288		$	5,408		$	6,495	$	1,717	$	16,908

Franchisee Receivables Charges

The Company had net recoveries related to franchisee receivables of $0.7 million in 2016 compared to an uncollectible expense of $25.4 million in 2015 and $13.1 million in 2014.

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 2016 fiscal year Sears Holdings' subsidy collections were lower compared to the 2015 fiscal year and SHO's portion of the collected subsidies during the 2016 fiscal year were approximately $2.1 million lower than its portion for the 2015 fiscal year. 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 2016 fiscal year Sears Holdings earned higher cash discounts compared to the 2015 fiscal year, and SHO's portion of the earned cash discounts were approximately $13.5 million higher than its portion for the 2015 fiscal year. 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 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.

Fiscal Year

Our fiscal years end on the Saturday closest to January 31. Unless otherwise stated, references to specific years in this Annual Report on Form 10-K are to fiscal years. The following fiscal periods are presented herein:



Fiscal year	Ended	Weeks
2016	January 28, 2017	52
2015	January 30, 2016	52
2014	January 31, 2015	52

Results of Operations

The following table sets forth items derived from our consolidated results of operations for our 2015, 2014 and 2013 fiscal years.



	Fiscal
thousands	2016			2015			2014
NET SALES	$	2,070,056		$	2,287,788		$	2,356,033
COSTS AND EXPENSES
Cost of sales and occupancy	1,661,314			1,769,286			1,803,497
Gross margin	408,742			518,502			552,536
Margin rate	19.7		%	22.7		%	23.5		%
Selling and administrative	458,786			546,128			546,636
Selling and administrative expense as a percentage of net sales	22.2		%	23.9		%	23.2		%
Impairment of goodwill, property, and equipment	9,356			3,984			168,237
Depreciation and amortization	13,458			10,562			8,935
Gain on the sale of assets	(25,203		)	—			(113		)
Total costs and expenses	2,117,711			2,329,960			2,527,192
Operating loss	(47,655		)	(42,172		)	(171,159		)
Interest expense	(4,263		)	(2,826		)	(3,861		)
Other income	1,490			2,585			3,149
Loss before income taxes	(50,428		)	(42,413		)	(171,871		)
Income tax (expense) benefit	(81,491		)	15,152			3,066
NET LOSS	$	(131,919	)	$	(27,261	)	$	(168,805	)

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 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 certain significant items as set forth and discussed 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, we believe it is an important indicator of operating performance for investors because:


•	EBITDA excludes the effects of financing and investing activities by eliminating the effects of interest and depreciation costs; and

•

Starting with the second quarter of 2015 the Company is excluding initial franchise revenues from adjusted EBITDA. This change is based on (1) the Company's decision to indefinitely suspend its franchising of additional stores except to existing Company franchisees and (2) to better align adjusted EBITDA for purposes of incentive compensation.

In the fourth quarter of 2016, in an effort to improve profitability and make the most productive use of capital, the Company executed an initiative to accelerate the closing of 109 under-performing locations. Under-performing locations are typically closed during the normal course of business at the termination of a lease or expiration of a franchise or dealer agreement and, as a result, do not have significant future lease severance or other non-recurring store closing costs. Due to the number and accelerated nature of the store closings in the fourth quarter of 2016, the Company has excluded the associated costs of the closings from adjusted EBITDA in the current year.

The following table presents a reconciliation of adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated:



	Fiscal
thousands	2016			2015			2014
Net Loss	$	(131,919	)	$	(27,261	)	$	(168,805	)
Income tax (benefit) expense	81,491			(15,152		)	(3,066		)
Other income	(1,490		)	(2,585		)	(3,149		)
Interest expense	4,263			2,826			3,861
Operating loss	(47,655		)	(42,172		)	(171,159		)
Depreciation and amortization	13,458			10,562			8,935
Gain on the sale of assets	(25,203		)	—			(113		)
Impairment of goodwill, property, and equipment	9,356			3,984			168,237
Severance and executive transition costs	—			1,066			—
Initial franchise revenues net of provision for losses	(552		)	25,086			(3,853		)
IT transformation investments	14,974			10,860			—
Accelerated closure of under-performing stores	17,101			—			—
Adjusted EBITDA	$	(18,521	)	$	9,386		$	2,047

Accounting for Fees Paid in a Cloud Computing Arrangement

In 2015, the Financial Accounting Standards Board issued ASU 2015-05, "Intangibles -- Goodwill and Other - Internal Use Software, Customer's Accounting For Fees Paid in a Cloud Computing Arrangement," which provided additional guidance on the treatment of IT-related costs for hosted arrangements. Based on an evaluation of this guidance and existing literature, SHO made a correcting adjustment in the fourth quarter of 2015 to move a large majority of these investments from capitalized assets to expense and will expense most of these investments through 2017, when these investments will be substantially complete. IT transformation investments were $15.0 million in 2016 compared to $10.9 million in 2015.

52 Week Period Ended January 28, 2017 Compared to the 52 Week Period Ended January 30, 2016

Net Sales

Net sales for the 2016 fiscal year decreased $217.7 million, or 9.5%, to $2.1 billion from the 2015 fiscal year. This decrease was driven primarily by the impact of closed stores (net of new store openings) and a 4.4% decrease in comparable store sales. Comparable store sales were down 4.2% and 4.9% in Hometown and Outlet, respectively. The home appliances and tools categories both outperformed the average comparable store sales while lawn and garden and mattresses underperformed the average.

Gross Margin

Gross margin was $408.7 million, or 19.7% of net sales, for the full year 2016 compared to $518.5 million, or 22.7% of net sales, for the full year 2015. The decrease in gross margin rate was primarily driven by higher occupancy costs due to more Company-operated locations, lower margin on merchandise sales, $16.1 million of store-closing costs, and $8.5 million higher shrink resulting from $3.7 million physical inventory charges in Outlet in 2016 as compared to $4.6 million of physical inventory gains in Hometown in 2015. The total impact of occupancy costs, store-closing costs, and shrink reduced gross margin 490 basis points for the full year 2016 compared to a reduction of 274 basis points for the full year 2015.

Selling and Administrative Expenses

Selling and administrative expenses decreased to $458.8 million, or 22.2% of net sales, for the full year 2016 from $546.1 million, or 23.9% of net sales, for the full year 2015. The decrease was primarily due to: (1) lower commissions paid to dealers and franchisees on lower sales volume, (2) the conversion of some dealer and franchisee locations to Company-operated stores in 2016, which resulted in some costs previously recorded as selling and administrative expenses to be recorded as a reduction to gross margin, (3) lower expenses being recorded for stores closed (net of new store openings), and (4) a $25.4 million charge in 2015 related to the write-off of, and additional reserves taken on, franchisee notes receivables. The Company recorded $1.0 million of store closing selling and administrative expenses for the full year 2016.

Gain on Sale of Assets

During the second quarter of 2016, we completed the sale of an owned property located in San Leandro, California. Net proceeds from the sale were $26.1 million, and we recorded a gain on the sale of $25.2 million.

Operating Loss

We recorded operating losses of $47.7 million and $42.2 million for the full years 2016 and 2015, respectively. The increase in operating loss was primarily due to lower volume, a lower gross margin rate, impairment charges of $9.4 million in fiscal year 2016 as compared to $4.0 million in fiscal 2015, and higher depreciation and amortization, partially offset by a decrease in selling and administrative expenses and a gain on the sale of assets.

Income Taxes

Income tax expense was $81.5 million in 2016, comprised primarily of a $100.1 million non-cash valuation allowance on our deferred tax assets, and a benefit of $15.2 million in 2015. See Note 6 to our Consolidated Financial Statements in this Annual Report on the Form 10-K for further information.

Net loss

We recorded a net loss of $131.9 million for the full year 2016 compared to a net loss of $27.3 million for the full year 2015. The increase in our net loss was primarily attributable to a higher operating loss, including store-closing costs, and an increase in income tax expense.

52 Week Period Ended January 30, 2016 Compared to the 52 Week Period Ended January 31, 2015

Net Sales

Net sales for the 2015 fiscal year decreased $68.2 million, or 2.9%, to $2.3 billion from the 2014 fiscal year. This decrease in sales was driven by (1) a 1.2% decrease in comparable store sales, (2) the impact of closed stores (net of new store openings), (3) lower initial franchise revenues, which were $0.3 million in 2015 compared to $16.9 million in 2014, and (4) lower online commissions from Sears Holdings ($12.9 million for the 2015 fiscal year compared to $22.6 million for the 2014 fiscal year). Comparable store sales were down 0.1% in Hometown and down 4.1% in Outlet. Home appliances outperformed the average comparable store sales while lawn and garden, tools, and mattresses categories underperformed to the average.

Gross Margin

Gross margin was $518.5 million, or 22.7% of net sales, for the full year 2015 compared to $552.5 million, or 23.5% of net sales, for the full year 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 27 basis points on the gross margin rate 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. Online commissions from Sears Holdings, initial franchise revenues, and closed stores contributed 14 basis points to gross margin in 2015 compared to 127 basis points in 2014.

Selling and Administrative Expenses

Selling and administrative expenses were flat at $546.1 million, or 23.9% of net sales, for the full year 2015 compared to $546.6 million, or 23.2% of net sales, for the full year 2014. Primary drivers included (1) expense decreases resulting from closed stores (net of new stores), (2) lower commissions paid to dealers and franchisees on lower sales volume, (3) lower marketing costs, (4) lower insurance costs, and (5) lower commissions paid to Sears Holdings for online transactions due to lower volume. These decreases were offset by $25.4 million of charges related to franchisee receivables for the full year 2015 compared to $13.1 million recognized for the full year 2014 and our IT transformation investments of $10.9 million. Franchisee receivables charges increased the selling and administrative expenses rate by 111 basis points and 55 basis points in 2015 and 2014, respectively. The IT transformation investments increased the selling and administrative expenses rate by 47 basis points in 2015.

Impairment of Goodwill

During 2014, we recorded a non-cash goodwill impairment charge of $167.0 million associated with the Hometown Reporting Unit. This charge eliminated all of our recorded goodwill.

Operating Loss

We recorded operating losses of $42.2 million and $171.2 million for the full years 2015 and 2014, respectively. The improvement in our operating loss for the full year 2015 resulted primarily from the absence of the 2014 non-cash goodwill impairment charge of $167.0 million (which eliminated all of our recorded goodwill). These improvements were partially offset by (1) lower initial franchise revenues, (2) higher charges related to franchisee receivables, (3) IT transformation investments of $10.9 million, and (4) a lower gross margin rate. The total net impact of franchisee receivables charges, IT transformation investments, goodwill and fixed-asset impairment charges, and initial franchise revenues increased operating losses by $39.9 million and $164.4 million in 2015 and 2014, respectively.

Income Taxes

We recorded an income tax benefit of $15.2 million and $3.1 million in 2015 and 2014, respectively. The effective tax rate (benefit) was 35.7% in 2015 and 1.8% in 2014.

Net loss

We recorded net losses of $27.3 million and $168.8 million in 2015 and 2014, respectively. The decrease in our net loss was primarily attributable to the factors discussed above.

Business Segment Results

Hometown

Hometown results and key statistics were as follows:



	Fiscal Year
thousands, except for number of stores	2016			2015			2014
Net sales	$	1,439,563		$	1,630,276		$	1,692,377
Comparable store sales %	(4.2		)%	(0.1		)%	(7.1		)%
Cost of sales and occupancy	1,145,678			1,262,215			1,297,212
Gross margin	293,885			368,061			395,165
Margin rate	20.4		%	22.6		%	23.3		%
Selling and administrative	318,589			378,141			403,367
Selling and administrative expense as a percentage of net sales	22.1		%	23.2		%	23.8		%
Impairment of goodwill, property, and equipment	4,536			1,983			167,618
Depreciation and amortization	6,032			3,585			3,199
(Gain) Loss on the sale of assets	69			—			(113		)
Total costs and expenses	1,474,904			1,645,924			1,871,283
Operating loss	$	(35,341	)	$	(15,648	)	$	(178,906	)
Total Sears Hometown and Hardware stores	871			1,001			1,109

52 Week Period Ended January 28, 2017 Compared to the 52 Week Period Ended January 30, 2016 -- Hometown

Net Sales

Net sales in 2016 decreased $190.7 million, or 11.7%, to $1.4 billion from 2015. This decrease was driven primarily by the impact of closed stores (net of new store openings) and a 4.2% decrease in comparable store sales. Home appliances, tools, and mattresses outperformed the average comparable store sales while lawn and garden underperformed to the average.

Gross Margin

Gross margin was $293.9 million, or 20.4% of net sales, in 2016 compared to $368.1 million, or 22.6% of net sales, in 2015. The decrease in gross margin rate was primarily driven by (1) $15.1 million of store-closing costs, (2) lower margin on merchandise sales, (3) higher occupancy costs due to an increase in the number of Company-operated stores, and (4) higher shrink due to $4.6 million of physical inventory gains in 2015. The total impact of occupancy, store-closing costs, and shrink reduced gross margin 285 basis points for the full year 2016 compared to a reduction of 124 basis points for the full year 2015.

Selling and Administrative Expenses

Selling and administrative expenses decreased to $318.6 million, or 22.1% of net sales, in 2016 from $378.1 million, or 23.2% of net sales, in 2015. The decrease was primarily due to the impact of (1) lower expenses being recorded for stores closed (net of new store openings), (2) lower dealer and franchisee commissions on lower sales volume, (3) converting some dealer and franchisee locations to Company-operated stores in 2016, which resulted in some costs previously recorded as selling and administrative expenses to be recorded as a reduction to gross margin, and (4) a $12.7 million charge in 2015 related to expenses for uncollectible franchise notes receivable. The Company recorded $0.9 million of store closing selling and administrative expense for the full year 2016.

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 2016 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 2016 fiscal year. If the allocation weighting for 2016 had been similar to the weighting for 2015, we would have allocated an additional $1.3 million of Home Office overhead expenses to Hometown's Selling and administrative expenses. We reevaluate the allocation of Home Office overhead expenses on an annual basis.

Operating Loss

We recorded operating losses of $35.3 million and $15.6 million in 2016 and 2015, respectively. The increase in our operating loss was primarily attributable to lower volume, lower gross margin rate, impairment of long-lived assets of $4.5 million in 2016 compared to $2.0 million in 2015, and higher depreciation and amortization expense partially offset by a decrease in selling and administration expenses.

52 Week Period Ended January 30, 2016 Compared to the 52 Week Period Ended January 31, 2015 -- Hometown

Net Sales

Net sales in 2015 decreased $62.1 million, or 3.7%, to $1.6 billion from 2014. This decrease was driven primarily by the impact of closed stores (net of new store openings), lower online commissions from Sears Holdings ($10.5 million in 2015 compared to $19.5 million in 2014), and a 0.1% decrease in comparable store sales. Home appliances and mattresses outperformed the average comparable store sales while the lawn and garden and tools categories underperformed to the average.

Gross Margin

Gross margin was $368.1 million, or 22.6% of net sales, in 2015 compared to $395.2 million, or 23.3% of net sales, in 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 30 basis points on the gross margin rate in 2015 due to store closings, and (5) lower delivery income, partially offset by lower merchandise shrink. Online commissions from Sears Holdings, initial franchise revenues, and closed stores contributed 14 basis points to gross margin in 2015 compared to 86 basis points in 2014.

Selling and Administrative Expenses

Selling and administrative expenses decreased to $378.1 million, or 23.2% of net sales, in 2015 from $403.4 million, or 23.8% of net sales, in 2014. The decrease was primarily due to lower dealer and franchisee commissions on lower sales volume, the impact of closed stores (net of new stores openings), and lower commissions paid to Sears Holdings for online transactions due to lower volume. These decreases were partially offset by higher payroll and benefits and allocated IT transformation investments. Franchisee receivables charges increased the selling and administrative expenses rate by $12.7 million, or 78 basis points, and $13.0 million, or 77 basis points, in 2015 and 2014, respectively. The $7.4 million of IT transformation investments allocated to Hometown increased the selling and administrative expenses rate by 45 basis points in 2015.

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 2015 had been similar to the weighting for 2014, we would have allocated an additional $4.1 million of Home Office overhead expenses to Hometown's Selling and administrative expenses. We reevaluate the allocation of Home-Office overhead expenses on an annual basis.

Impairment of Goodwill

During 2014 we recorded a non-cash goodwill impairment charge of $167.0 million associated with Hometown.

Operating Loss

We recorded operating losses of $15.6 million and $178.9 million in 2015 and 2014, respectively. The improvement in our operating loss for the full year 2015 resulted from the 2014 non-cash goodwill impairment charge of $167.0 million (which eliminated all of our recorded goodwill), and lower selling and administrative expenses. These improvements were partially offset by (1) a lower gross margin rate, (2) lower volume, (3) IT transformation investments of $7.4 million, (4) higher depreciation and amortization expense, and (5) impairment of long-lived assets of $2.0 million in 2015 compared to $0.6 million in 2014. The net impact of franchisee receivables charges, IT transformation investments, goodwill and fixed asset impairment charges, and initial franchise revenues increased operating losses by $22.2 million and $180.3 million in 2015 and 2014, respectively.

Outlet

Outlet results and key statistics were as follows:



	Fiscal
thousands, except for number of stores	2016			2015			2014
Net sales	$	630,493		$	657,512		$	663,656
Comparable store sales %	(4.9		)%	(4.1		)%	(1.2		)%
Cost of sales and occupancy	515,636			507,071			506,285
Gross margin	114,857			150,441			157,371
Margin rate	18.2		%	22.9		%	23.7		%
Selling and administrative	140,197			167,987			143,269
Selling and administrative expense as a percentage of net sales	22.2		%	25.5		%	21.6		%
Impairment of goodwill, property, and equipment	4,820			2,001			619
Depreciation and amortization	7,426			6,977			5,736
Gain on the sale of assets	(25,272		)	—			—
Total costs and expenses	642,807			684,036			655,909
Operating income (loss)	$	(12,314	)	$	(26,524	)	$	7,747
Total Sears Outlet stores	149			159			151

52 Week Period Ended January 28, 2017 Compared to the 52 Week Period Ended January 30, 2016 -- Outlet

Net Sales

Net sales in 2016 decreased $27.0 million, or 4.1%, to $630.5 million from 2015. This decrease was driven primarily by a 4.9% decrease in comparable store sales, partially offset by the impact of new stores (net of closings). Home appliances, tools, and furniture outperformed the average comparable store sales while the apparel, mattresses and lawn and garden categories underperformed to the average.

Gross Margin

Gross margin was $114.9 million, or 18.2% of net sales, in 2016 compared to $150.4 million, or 22.9% of net sales, in 2015. The decrease in gross margin rate was primarily driven by (1) a lower gross profit rate on merchandise sales primarily driven by price reductions needed to maintain the competitiveness of out–of–box product in a more promotional environment for new, in–box appliances, (2) higher occupancy costs due to more Company-operated locations, (3) higher shrink expenses related to $3.7 million of physical inventory charges taken in 2016, and (4) $1.0 million of store closing costs. The total impact of occupancy, shrink, and store closing costs reduced gross margin 957 basis points for the full year 2016 compared to a reduction of 645 basis points for full year 2015.

Selling and Administrative Expenses

Selling and administrative expenses decreased to $140.2 million, or 22.2% of net sales, for the full year 2016 compared to $168.0 million, or 25.5% of net sales, for the full year 2015. The decrease was primarily due to the impact of lower franchisee commissions on lower sales volumes, converting some franchisee locations to Company-operated stores in 2016 (which resulted in some costs previously recorded as selling and administrative expenses to be recorded as a reduction to gross margin), and $12.7 million of charges related to the write-off of, and additional reserves taken on, franchisee receivables in 2015. These gains were partially offset by higher payroll and benefits costs resulting from a higher number of Company-operated stores. The Company recorded $0.1 million of store-closing selling and administrative expenses for the year 2016.

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 2016 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 2016 fiscal year. If the allocation weighting for 2016 had been similar to the weighting for 2015, we would have reduced the allocation by $1.3 million of Home Office overhead expenses to Outlet’s selling and administrative expenses. We reevaluate the allocation of Home-Office overhead expenses on an annual basis.

Gain on Sale of Asset

Operating Loss

We recorded operating losses of $12.3 million and $26.5 million in 2016 and 2015, respectively. The $14.2 million decrease in operating loss was primarily driven by a lower gross margin rate and lower volume partially offset by lower selling and administrative expenses and a $25.2 million gain on the sale of owned property located in San Leandro, California.

52 Week Period Ended January 30, 2016 Compared to the 52 Week Period Ended January 31, 2015 -- Outlet

Net Sales

Net sales in 2015 decreased $6.1 million, or 0.9%, to $657.5 million from 2014. This decrease was driven primarily by a 4.1% decrease in comparable store sales and lower initial franchise revenues, which were $0.4 million in 2015 compared to $16.6 million in 2014, partially offset by new stores (net of closures). Home appliances outperformed the average comparable store sales while apparel, tools, lawn and garden, mattresses, and furniture underperformed to the average.

Gross Margin

Gross margin was $150.4 million, or 22.9% of net sales, in 2015 compared to $157.4 million, or 23.7% of net sales, in 2014. The decrease in gross margin rate was primarily driven by lower franchise revenues, lower delivery income, and an unfavorable impact of 12 basis points on the gross margin rate in 2015 due to store closings. These decreases were partially offset by higher margin on merchandise sales, lower merchandise shrink, and lower occupancy costs associated with the conversion of Company-operated to franchisee-operated stores. Online commissions from Sears Holdings, initial franchise revenues, and closed stores contributed 15 basis points to gross margin in 2015 compared to 227 basis points in 2014.

Selling and Administrative Expenses

Selling and administrative expenses increased to $168.0 million, or 25.5% of net sales, in 2015 from $143.3 million, or 21.6% of net sales, in 2014. The increase was primarily due to higher franchisee commissions for stores that we converted from Company-operated to franchisee-operated, $12.7 million of charges related to franchise receivables in 2015 compared to $0.1 million in 2014, the impact of new stores (net of closed stores), and allocated IT transformation investments partially offset by lower payroll and benefits costs resulting from the conversion of Company-operated stores, lower insurance costs, and lower marketing costs. Franchisee receivables charges increased the selling and administrative expenses rate by 193 basis points and 1 basis point in 2015 and 2014, respectively. The $3.5 million of IT transformation investments allocated to Outlet increased the selling and administrative expenses rate by 53 basis points in 2015.

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 2015 had been similar to the weighting for 2014, we would have reduced Home Office overhead expenses allocated to Outlet's selling and administrative expenses by $4.1 million. We reevaluate the allocation of Home Office overhead expenses on an annual basis.

Operating Income (Loss)

We recorded an operating loss of $26.5 million and recorded operating income of $7.7 million in 2015 and 2014, respectively. The $34.2 million decrease in operating income was primarily driven by lower initial franchise revenues, higher charges related to franchisee receivables, higher selling and administrative expenses, and $3.5 million of IT transformation investments. These increases were partially offset by a higher gross margin rate (excluding initial franchise revenues). The net impact of franchisee receivables charges, IT transformation investments, higher depreciation expense, impairment of long-lived assets of $2.0 million in 2015 compared to $0.6 million in 2014, and initial franchise revenues increased operating losses by $17.8 million in 2015 and increased operating income by $15.9 million in 2014.

Analysis of Financial Condition

Cash Balances

We had $14.1 million in cash and cash equivalents as of January 28, 2017 and $18.2 million as of January 30, 2016.

During 2016 we financed our operations and investments with cash on hand, proceeds from asset sales, and cash generated from operating activities. Our primary liquidity needs are for funding inventory purchases, our IT transformation and capital expenditures, and general corporate purposes.

Cash Flows from Operating Activities

Cash generated from operating activities in 2016 was $28.8 million compared to $25.5 million in 2015 due predominately to a decrease in inventory, net of payables, and a decline in receivables due to income tax refunds collected, partially offset by lower net income.

Total merchandise inventories were $373.8 million at January 28, 2017 and $434.8 million at January 30, 2016. Merchandise inventories declined $52.9 million and $8.1 million in Hometown and Outlet, respectively. The decrease in Hometown was primarily due to store closures. Outlet's decrease was primarily due to reduced receipts of new, in-box home appliances and store closures.

We obtain our merchandise through agreements with Sears Holdings and with other vendors. For 2016, merchandise acquired from subsidiaries of Sears Holdings (including Kenmore, Craftsman, DieHard, and other products) accounted for approximately 80% of total purchases of all inventory from all vendors. 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.

In addition, our merchandise-vendor arrangements generally are not long-term agreements (except 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 on maintaining good relations with our existing vendors and on developing relationships with new vendors, especially with respect to merchandise inventory to be sold by Outlet. If we fail to maintain our relations with our existing vendors or to maintain the quality of merchandise inventory they supply to 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 sufficient amount and variety of merchandise at acceptable prices may be limited, which would have a negative impact on our competitive position. 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. See "Risk Factors" in this Annual Report on Form 10-K.

Cash Flows from Investing Activities

Cash provided by investing activities was $13.9 million in 2016 compared to cash used of $11.4 million in 2015. In the second quarter of 2016 we received proceeds of $26.1 million from the sale of assets.

Cash Flows from Financing Activities

Cash used in financing activities was $46.9 million for 2016 compared to $15.6 million for 2015. The increase of $31.3 million in cash used in financing activities in 2016 from 2015 was primarily due to greater net payments under our Senior ABL Facility in 2016.

Financing Arrangements

borrowings of $250 million (the "Prior Facility"). Under the Prior Facility the Company initially borrowed $100 million which was used to pay a cash dividend to Sears Holdings prior to the Separation. On November 1, 2016 the Company’s three operating subsidiaries, Sears Authorized Hometown Stores, LLC, Sears Home Appliance Showrooms, LLC, and Sears Outlet Stores, L.L.C., and the Company, entered into the Senior ABL Facility with a syndicate of lenders, including Bank of America, N.A., as administrative agent and collateral agent, which provides (subject to availability under a borrowing base) for aggregate maximum borrowings of $250 million. The Senior ABL Facility provides for extended revolving credit commitments in an aggregate amount equal to $170.0 million (the “Extended Revolving Credit Commitments”) and non-extended revolving credit commitments in an aggregate amount equal to $80.0 million (the “Non-Extended Revolving Credit Commitments”). The Extended Revolving Credit Commitments will mature on the earlier of (1) February 29, 2020 and (2) six months prior to the expiration of agreements entered into with Sears Holdings and its subsidiaries in connection with the Company’s separation from Sears Holdings in October 2012 (the "Subject Agreements") unless they are extended to a date later than February 29, 2020 or terminated on a basis reasonably satisfactory to the administrative agent under the Senior ABL Facility. The Non-Extended Revolving Credit Commitments will mature on the earlier of (1) October 11, 2017 and (2) six months prior to the expiration of the Subject Agreements unless they are extended to a date later than October 11, 2017 or terminated on a basis reasonably satisfactory to the administrative agent under the Amended and Restated Credit Agreement.

As of January 28, 2017 we had $26.8 million outstanding under the Senior ABL Facility, which approximated the fair value of these borrowings. Up to $75 million of the Senior ABL Facility is available for the issuance of letters of credit and up to $25 million is available for swingline loans. The Senior ABL Facility permits us to request commitment increases in an aggregate principal amount of up to $100 million . Availability under the Senior ABL Facility as of January 28, 2017 was $182.5 million, with $6.0 million of letters of credit outstanding under the facility. Costs related to and incurred for the November 1, 2016 refinancing totaled approximately $5.4 million and are included in Prepaid and Other current assets on the Consolidated Balance Sheet.

The principal terms of the Senior ABL Facility are summarized below.

Prepayments

The Senior ABL Facility is subject to mandatory prepayment in amounts equal to the amount by which the outstanding extensions of credit exceed the lesser of the borrowing base and the commitments then in effect.

Security and Guarantees

The Senior ABL Facility is secured by a first lien security interest on substantially all the assets of the Company and its subsidiaries, including, without limitation, accounts receivable, inventory, general intangibles, investment property, equipment, cash, cash equivalents, deposit accounts and securities accounts, as well as certain other assets (other than intellectual property and fee-owned interests in real property) ancillary to any of the foregoing and all proceeds of any of the foregoing, including cash proceeds and the proceeds of applicable insurance. The Senior ABL Facility is guaranteed by the Company and each of its existing and future direct and indirect wholly owned domestic subsidiaries (other than specified immaterial subsidiaries).

Interest; Fees

The interest rates per annum applicable to the loans under the Senior ABL Facility are based on a fluctuating rate of interest measured by reference to, at the Company's election, either (1) an adjusted London inter-bank offered rate (LIBOR) plus a borrowing margin ranging from (x) 3.50% to 4.50%, in the case of the Extended Revolving Credit Commitments or (y) 2.00% to 2.50%, in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 3.94% at January 28, 2017), and in each case based on availability under the Senior ABL Facility, or (2) an alternate base rate plus a borrowing margin, ranging from (x) 2.50% to 3.50%, in the case of the Extended Revolving Credit Commitments or (y) 1.00% to 1.50%, in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 5.94% at January 28, 2017), and in each case based on availability under the Senior ABL Facility.

The interest rates per annum applicable to the loans under the Prior Facility were 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 2.43% at January 30, 2016 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 4.50% at January 30, 2016.

Customary fees are payable in respect of the Senior ABL Facility, including letter of credit fees and commitment fees.

Covenants

The Senior ABL Facility includes a number of negative covenants that, among other things, limit or restrict the ability of the Company and its subsidiaries (including the guarantors) to, subject to certain exceptions, incur additional indebtedness (including guarantees), grant liens, make investments, make prepayments on other indebtedness, and engage in mergers or change the nature of the business of the Company and its subsidiaries (including the guarantors). In addition, upon excess availability falling below a specified level, the Company is required to comply with a minimum fixed charge coverage ratio.

The Senior ABL Facility also limits SHO's ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends and may repurchase stock, together not exceeding $37,500,000 in any fiscal year or $75,000,000 in the aggregate, 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 and (ii) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that monthly availability, 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 will be at least equal to the greater of (x) 50% of the Loan Cap and (y) $100,000,000. No default or event of default presently exists. At January 28, 2017 we met the foregoing conditions and as a result the Senior ABL Facility permits 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 January 28, 2017, SHO was in compliance with all covenants under the Senior ABL Facility.

Events of Default

The Senior ABL Facility includes customary and other events of default including non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations or warranties, cross default to other material indebtedness, bankruptcy and insolvency events, invalidity or impairment of guarantees or security interests, material judgments, change of control, failure to perform a "Material Contract" (which includes the Merchandising Agreement and other 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, or Sears Holdings terminates the "Separation Agreements" (which include, among other SHO-Sears Holdings Agreements, the Merchandising Agreement and the Services Agreements).

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 a result, we expect to fund our ongoing operations through existing cash and cash equivalents, cash generated by operating activities, and with funds available under the Senior ABL Facility. The adequacy of our available funds will depend on many factors, including the macroeconomic environment and the operating performance of our stores. See for example "If Sears Holdings' seeks the protection of the U.S. bankruptcy laws, our ability to operate our business and our financial performance could be materially and adversely affected" in Item 1A of this Annual Report on Form 10-K.

As of January 28, 2017, we had cash and cash equivalents of $14.1 million.

Capital lease obligations as of January 28, 2017 and January 30, 2016 were $0.5 million.

Contractual Obligations and Off-Balance Sheet Arrangements

Information concerning our obligations and commitments to make future payments under contract such as debt and lease agreements and under contingent commitments as of January 28, 2017 is as aggregated in the following table:



thousands	Total		Within 1 Year		1-3 Years		4-5 Years		After 5 Years
Short-term borrowings	$	26,800	$	26,800	$	—	$	—	$	—
Capital leases	543		269		270		4		—
Operating leases	161,400		52,290		63,265		32,341		13,503
Total Contractual Obligations	$	188,743	$	79,359	$	63,535	$	32,345	$	13,503

Application of Critical Accounting Policies and Estimates

In preparing the financial statements, certain accounting policies require considerable judgment to select the appropriate assumptions to calculate financial estimates. These estimates are complex and subject to an inherent degree of uncertainty. We base our estimates on historical experience, terms of existing contracts, evaluation of trends and other assumptions that we believe to be reasonable under the circumstances. We continually evaluate the information used to make these estimates as our business and the economic environment change. Although the use of estimates is pervasive throughout the financial statements, we consider an accounting estimate to be critical if:


•	it requires assumptions to be made about matters that were highly uncertain at the time the estimate was made, and


•	changes in the estimate that are reasonably likely to occur from period to period or different estimates that could have been selected would have a material effect on our financial condition, cash flows or results of operations.

We believe that the current assumptions and other considerations used to estimate amounts reflected in the financial statements are appropriate. However, if actual experience differs from the assumptions and the considerations used in estimating amounts, the resulting changes could have a material adverse effect on our results of operations, and in certain situations, could have a material adverse effect on our financial condition.

The following is a summary of our most critical policies and estimates. See Note 1 of the Notes to the Consolidated Financial Statements for a listing of our other significant accounting policies.

Valuation of Inventory

Our inventory is valued at the lower of cost or market determined primarily using the retail inventory method, or "RIM." To determine inventory cost under RIM, inventory at its retail selling value is segregated into groupings of merchandise having similar characteristics, which are then converted to a cost basis by applying specific average cost factors for each grouping of merchandise. Cost factors represent the average cost-to-retail ratio for each merchandise group based upon the year’s purchasing activity for each store location. Accordingly, a significant assumption under the retail method is that inventory in each group is similar in terms of its cost-to-retail relationship and has similar turnover rates. We monitor the content of merchandise in these groupings to prevent distortions that would have a material effect on inventory valuation.

RIM inherently requires management judgment and certain estimates that may significantly affect the ending inventory valuation, as well as gross margin. The methodologies utilized by SHO in its application of RIM are consistent for all periods presented. Such methodologies include the development of the cost-to-retail ratios, the groupings of homogeneous classes of merchandise, the development of shrinkage and obsolescence reserves, and the accounting for retail price changes. We believe that SHO’s RIM provides an inventory valuation that reasonably approximates cost. Among others, two significant estimates used in inventory valuation are the level and timing of permanent markdowns (clearance markdowns used to clear unproductive or slow-moving inventory) and shrinkage. Amounts are charged to cost of sales at the time the retail value of inventory is reduced through the use of permanent markdowns.

Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise, fashion and design trends and weather conditions. In addition, inventory is also evaluated against corporate pre-determined historical markdown cadences. When a decision is made to permanently mark down merchandise, the resulting gross margin reduction is recognized in the period the markdown is recorded. The timing of the decision, particularly surrounding the balance sheet date, can have a significant effect on the results of operations.

Income Taxes

Our deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial reporting and tax bases of recorded assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or

settled. For the year-ended January 28, 2017, a valuation allowance of $100.1 million has been recorded for the full amount of the net deferred tax assets. In the future, we may record additional net deferred tax assets and if future utilization of deferred tax assets is uncertain, we may record additional valuation allowance against such deferred tax assets. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions including the amount of future state, federal and foreign pre-tax operating income (loss), the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income.

We account for uncertainties in income taxes according to accounting standards for uncertain tax positions. We are present in a large number of taxable jurisdictions, and at any point in time, can have audits underway at various stages of completion in any of these jurisdictions. We evaluate our tax positions and establish liabilities for uncertain tax positions that may be challenged by local authorities and may not be fully sustained, despite the belief that the underlying tax positions are fully supportable. Unrecognized tax benefits are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law, and closing of statutes of limitation. Such adjustments are reflected in the tax provision as appropriate. Pursuant to the Tax Sharing Agreement, which governs the rights and obligations of the parties with respect to pre-Separation and post-Separation tax matters, Sears Holdings is responsible for any unrecognized tax benefits through the date of the Separation.

Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against our net deferred tax assets, if any. As further described above, we consider estimates of the amount and character of future taxable income in assessing the likelihood of realization of deferred tax assets. Our actual effective tax rate and income tax expense could vary from estimated amounts due to the future impacts of various items, including changes in income tax laws, tax planning and our forecasted financial condition and results of operations in future periods. Although we believe current estimates are reasonable, actual results could differ from these estimates.

In accordance with the Tax Sharing Agreement, Sears Holdings is responsible for any federal, state or foreign income tax liability relating to tax periods ending on or before the Separation.

Goodwill Impairment Assessment

We recorded a $167.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2014, which reduced our goodwill balance as of January 28, 2017 to $0. This charge resulted from our evaluation of the carrying value of goodwill for possible impairment under accounting standards governing goodwill and other intangible assets. 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 carrying value of goodwill may 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 is not impaired and no further testing was required. If the fair value of the Hometown Reporting Unit was less than its carrying value, SHO must perform 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 judgment. 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 a $167.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2014, which is reflected as "Impairment of goodwill, property, and equipment" in the 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 corresponding impact beyond those periods.

Reserve for Losses on Franchisee Receivables

The Company recognizes a reserve for losses on franchisee receivables (which consist primarily of franchisee promissory notes) in an amount equal to estimated probable losses net of recoveries. The reserve 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 reserve for losses on franchisee receivables is recognized as selling, general, 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. The reserve for losses on franchisee receivables is evaluated based on our receivable-by-receivable assessment during the year that loan balances would be potentially uncollectible in future periods due to declining results of operations of, or other adverse financial events with respect to, franchise stores that indicated that the franchisees might not be able to meet their debt-service and other obligations to us as they became due. During fiscal 2015 we also forgave balances due on franchisee receivables in accordance with negotiated franchise-termination agreements, and as part of these transactions, the Company purchased store furniture, fixtures, and equipment.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “forward looking statements”). Statements preceded or followed by, or that otherwise include, the words “believes,” “expects,” “anticipates,” “intends,” “project,” “estimates,” “plans,” “forecast,” “is likely to,” "on target," 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, (1) 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 (2) could have a material adverse effect on our results of operations, financial condition, liquidity, and cash flows: if Sears Holdings seeks the protection of the U.S. bankruptcy laws (including the effects of the imposition of the "automatic stay" and the effects if Sears Holdings were to seek to reject one or more of our agreements with Sears Holdings); our ability to offer merchandise and services that our customers want, including those under the KCD Marks; the Merchandising Agreement between us and Sears Holdings provides that (1) if a third party that is not an affiliate of Sears Holdings acquires all rights, title and interest in and to one or more (but less than all) of the KCD Marks Sears Holdings may terminate our rights to buy merchandise branded with the acquired KCD Marks and (2) if a third party that is not an affiliate of Sears Holdings acquires all rights, title and interest in and 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; on May 26, 2016 Sears Holdings announced that it would explore alternatives for its Kenmore, Craftsman, and Diehard businesses and further expand the presence of these brands and on August 25, 2016 Sears Holdings announced that it was continuing to explore alternatives for these businesses by evaluating potential partnerships or other transactions; on March 9, 2017 Sears Holdings announced that it had completed its sale to Stanley Black & Decker, Inc. of Sears Holdings's Craftsman business (the "Stanley Purchase"), including the Craftsman brand name and related intellectual property rights (Sears Holdings has waived its right in the Merchandising Agreement to terminate, as a result of the Stanley Purchase, the Company's rights to buy from Sears Holdings merchandise branded with the Craftsman brand); 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 our Hometown and Outlet businesses 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 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); if Sears Holdings' sales of major appliances and lawn and garden merchandise to its retail customers decline Sears Holdings' sales to us of out-of-box products could decline; our ability to resolve, on commercially reasonable terms, future disputes with Sears Holdings regarding 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; our ability to maintain an effective and productive business relationship with Sears Holdings, particularly if future disputes were to arise 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; our ability to implement our IT transformation initiative in accordance with our plans, expectations, current timetable, and anticipated cost; imitations and restrictions in the Senior ABL Facility and related agreements governing our indebtedness and our ability to service our indebtedness; competitors could continue to reduce their promotional pricing on new-in-box appliances, which could continue to adversely impact our sales of out-of-box appliances and associated margin; our ability to generate profitable sales of merchandise and services on our transactional ecommerce websites in the amounts we have planned to generate; 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 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 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 Annual Report on Form 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 Annual Report on Form 10-K are made only as of the date of this Annual Report on Form 10-K. 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.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We are subject to interest rate risk associated with our Senior ABL Facility, which bears interest at a variable rate. Assuming our Senior ABL Facility were fully drawn in principal amount equal to $250 million, each one percentage point change in interest rates would result in a $2.5 million change in annual cash interest expense on our Senior ABL Facility.

Item 8. Financial Statements and Supplementary Data



	Page

Consolidated Statements of Operations	54

Consolidated Balance Sheets	55

Consolidated Statements of Cash Flows	56

Consolidated Statements of Stockholders' Equity	57

Notes to Consolidated Financial Statements	58

Report of Independent Registered Public Accounting Firm	85

SEARS HOMETOWN AND OUTLET STORES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS



	Fiscal Year Ended
thousands, except per share amounts	January 28, 2017			January 30, 2016			January 31, 2015
NET SALES	$	2,070,056		$	2,287,788		$	2,356,033
COSTS AND EXPENSES
Cost of sales and occupancy	1,661,314			1,769,286			1,803,497
Selling and administrative	458,786			546,128			546,636
Impairment of goodwill, property, and equipment	9,356			3,984			168,237
Depreciation and amortization	13,458			10,562			8,935
Gain on the sale of assets	(25,203		)	—			(113		)
Total costs and expenses	2,117,711			2,329,960			2,527,192
Operating loss	(47,655		)	(42,172		)	(171,159		)
Interest expense	(4,263		)	(2,826		)	(3,861		)
Other income	1,490			2,585			3,149
Loss before income taxes	(50,428		)	(42,413		)	(171,871		)
Income tax (expense) benefit	(81,491		)	15,152			3,066
NET LOSS	$	(131,919	)	$	(27,261	)	$	(168,805	)

NET LOSS PER COMMON SHARE
ATTRIBUTABLE TO STOCKHOLDERS

Basic:	$	(5.81	)	$	(1.20	)	$	(7.45	)
Diluted:	$	(5.81	)	$	(1.20	)	$	(7.45	)

Basic weighted average common shares outstanding	22,691			22,666			22,666
Diluted weighted average common shares outstanding	22,691			22,666			22,666

See Notes to Consolidated Financial Statements.

SEARS HOMETOWN AND OUTLET STORES, INC.

CONSOLIDATED BALANCE SHEETS



thousands	January 28, 2017			January 30, 2016
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	14,104		$	18,244
Accounts and franchisee receivables, net	11,448			11,753
Merchandise inventories	373,815			434,846
Prepaid expenses and other current assets	9,370			22,176
Total current assets	408,737			487,019
PROPERTY AND EQUIPMENT, net	40,935			49,315
INTANGIBLE ASSETS, net	1,527			4,377
LONG-TERM DEFERRED TAXES	—			79,141
OTHER ASSETS, net	17,227			13,981
TOTAL ASSETS	$	468,426		$	633,833
LIABILITIES
CURRENT LIABILITIES
Short-term borrowings	$	26,800		$	68,300
Payable to Sears Holdings Corporation	80,724			54,126
Accounts payable	17,853			39,762
Other current liabilities	70,377			66,466
Total current liabilities	195,754			228,654
OTHER LONG-TERM LIABILITIES	1,973			2,670
TOTAL LIABILITIES	197,727			231,324
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS' EQUITY
Common stock: $.01 par value;	227			227
Authorized shares: 400,000
Issued and outstanding shares: 22,716 and 22,722, respectively
Capital in excess of par value	555,481			555,372
Accumulated deficit	(285,009		)	(153,090		)
TOTAL STOCKHOLDERS' EQUITY	270,699			402,509
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	468,426		$	633,833

See Notes to Consolidated Financial Statements.

SEARS HOMETOWN AND OUTLET STORES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS



	Fiscal Year Ended
thousands	January 28, 2017			January 30, 2016			January 31, 2015

CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss	$	(131,919	)	$	(27,261	)	$	(168,805	)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation and amortization	13,458			10,562			8,935
Share-based compensation	109			(70		)	866
Gain on the sale of assets	(25,203		)	—			(113		)
Impairment of goodwill, property, and equipment	9,356			3,984			168,237
Provision (recoveries) for losses on franchisee receivables	(791		)	25,426			13,055
Change in operating assets and liabilities:
Accounts and franchisee receivables	2,255			1,056			(12,988		)
Merchandise inventories	61,031			7,897			39,364
Payable to Sears Holdings Corporation	26,598			(6,963		)	(7,307		)
Accounts payable	(21,909		)	24,874			(9,241		)
Store closing accrual	7,659			—			—
Customer deposits	(4,316		)	(5,982		)	(5,306		)
Deferred income taxes	79,141			(6,431		)	(7,129		)
Other operating assets	13,580			(13,123		)	1,069
Other operating liabilities	(167		)	11,576			3,763
Net cash provided by operating activities	28,882			25,545			24,400
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of property and investments	26,073			—			154
Purchases of property and equipment	(12,198		)	(11,430		)	(12,849		)
Net cash provided by (used in) investing activities	13,875			(11,430		)	(12,695		)
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings (payments) of capital lease obligations	37			183			(434		)
Net payments on short-term borrowings	(41,500		)	(15,800		)	(15,000		)
Payments for refinancing fees	(5,434		)	—			—
Net cash used in financing activities	(46,897		)	(15,617		)	(15,434		)
NET CHANGE IN CASH AND CASH EQUIVALENTS	(4,140		)	(1,502		)	(3,729		)
CASH AND CASH EQUIVALENTS—Beginning of period	18,244			19,746			23,475
CASH AND CASH EQUIVALENTS—End of period	$	14,104		$	18,244		$	19,746
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest	$	4,168		$	2,945		$	3,622
Cash (received) paid for income taxes	$	(9,788	)	$	(5,764	)	$	824
SUPPLEMENTAL NON CASH INFORMATION
Tax adjustment related to separation	$	—		$	7,554		$	—
Reacquisition rights in exchange for notes receivable	$	—		$	6,100		$	—

See Notes to Consolidated Financial Statements.

SEARS HOMETOWN AND OUTLET STORES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY



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	—		—			—			(168,805		)	(168,805		)

Share-based compensation	(17	)	(1		)	867			—			866

Balance at January 31, 2015	22,736		227			547,888			(125,829		)	422,286

Net loss	—		—			—			(27,261		)	(27,261		)

Share-based compensation	(14	)	—			(70		)	—			(70		)

Tax adjustment related to the separation	—		—			7,554			—			7,554

Balance at January 30, 2016	22,722		227			555,372			(153,090		)	402,509

Net loss	—		—			—			(131,919		)	(131,919		)

Share-based compensation	(6	)	—			109			—			109

Balance at January 28, 2017	22,716		$	227		$	555,481		$	(285,009	)	$	270,699

See Notes to Consolidated Financial Statements.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—BACKGROUND, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES

Background

Sears Hometown and Outlet Stores, Inc. is a national retailer primarily focused on selling home appliances, hardware, tools and lawn and garden equipment. As of January 28, 2017, the Company and our independent dealers and franchisees operated a total of 1,020 stores across all 50 states and in Puerto Rico and Bermuda. In these notes the terms "we," "us," "our," "SHO," and the "Company" refer to Sears Hometown and Outlet Stores, Inc. and its subsidiaries.

The Separation

The Company separated from Sears Holdings Corporation (“Sears Holdings”) in October 2012 (the “Separation”). To our knowledge Sears Holdings does not own any shares of our common stock. As part of the Separation, Sears Holdings contributed to SHO equity intercompany balances due to/from Sears Holdings, which included amounts arising from pre-Separation purchases of merchandise inventories. After the Separation, the Company continues to purchase most of its merchandise from Sears Holdings and amounts payable to Sears Holdings are reflected separately on the consolidated balance sheet. The Company has specified rights to use the "Sears" name under a license agreement from Sears Holdings.

Basis of Presentation

These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated.

We operate through two segments--our Sears Hometown and Hardware segment ("Hometown") and our Sears Outlet segment ("Outlet").

Reclassifications - Certain prior year amounts have been reclassified in order to conform to the current year presentation. For the years ended January 30, 2016 and January 31, 2015, the Company reclassified $4.0 million and $1.2 million of store impairment charges previously recorded in “Depreciation and amortization” to “Impairment of goodwill, property, and equipment.” The Company does not consider this adjustment to be significant to the consolidated financial statements.

Variable Interest Entities and Consolidation

The Financial Accounting Standards Board ("FASB") has issued guidance on variable interest entities and consolidation for determining whether an entity is a variable interest entity as well as the methods permitted for determining the primary beneficiary of a variable interest entity. In addition, this guidance requires ongoing reassessments of whether a company is the primary beneficiary of a variable interest entity and disclosures related to a company’s involvement with a variable interest entity.

On an ongoing basis the Company evaluates its business relationships, such as those with its dealers, franchisees, and suppliers, to identify potential variable interest entities. Generally, these businesses qualify for a scope exception under the consolidation guidance, or, where a variable interest exists, the Company does not possess the power to direct the activities that most significantly impact the economic performance of these businesses. The Company has not consolidated any of such entities in the periods presented.

SIGNIFICANT ACCOUNTING POLICIES

Fiscal Year

Our fiscal years end on the Saturday closest to January 31. Unless otherwise stated, references to specific years in these notes are to fiscal years. The following fiscal periods are presented herein.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Fiscal Year	Ended	Weeks
2016	January 28, 2017	52
2015	January 30, 2016	52
2014	January 31, 2015	52

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events. The estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis using historical experience and other factors that management believes to be reasonable under the circumstances. Adjustments to estimates and assumptions are made when facts and circumstances dictate. As future events and their effects cannot be determined with absolute certainty, actual results may differ from the estimates used in preparing the accompanying consolidated financial statements. Significant estimates and assumptions are required as part of determining inventory and accounts and franchisee receivables valuation, estimating depreciation and recoverability of long-lived assets, establishing insurance, warranty, legal and other reserves, performing goodwill and long-lived asset impairment analysis, and establishing valuation allowances on deferred income tax assets and reserves for tax examination exposures.

Cash and Cash Equivalents

Cash equivalents include (1) all highly liquid investments with original maturities of three months or less at the date of purchase and (2) deposits in-transit from banks for payments related to third-party credit card and debit card transactions.

Allowance for Doubtful Accounts

We provide an allowance for doubtful accounts based on both historical experience and a specific identification basis. Allowances for doubtful accounts on accounts and notes receivable balances were $8.2 million at January 28, 2017 and $12.1 million at January 30, 2016. Our accounts receivable balance is comprised of various vendor-related and customer-related accounts receivable. Our notes receivable balance is comprised of promissory notes that relate primarily to the sale of assets for our franchised locations.

The Company provides an allowance for losses on franchisee receivables (which consist primarily of franchisee promissory notes) in an amount equal to estimated probable losses net of recoveries. The allowance is based on an analysis of expected future write-offs, existing economic conditions, and an assessment of specific identifiable franchisee promissory notes and other franchisee receivables considered at risk or uncollectible. The expense associated with the allowance for losses on franchisee receivables is recognized as selling, and administrative expense.

Merchandise Inventories

Merchandise inventories are valued at the lower of cost or market. Merchandise inventories are valued under the retail inventory method, or "RIM," using primarily a last-in, first-out, or "LIFO," cost-flow assumption.

Inherent in RIM calculations are certain significant management judgments and estimates including, among others, merchandise markons, markups, markdowns, and shrinkage, which significantly impact the ending inventory valuation at cost and resulting gross margins. The methodologies utilized by us in our application of RIM are consistent for all periods presented. Such methodologies include the development of the cost-to-retail ratios, the groupings of homogeneous classes of merchandise, the development of shrinkage and obsolescence reserves, the accounting for price changes, and the computations inherent in the LIFO adjustment (where applicable). Management believes that RIM provides an inventory valuation that reasonably approximates cost and results in carrying inventory at the lower of cost or market.

In connection with our LIFO calculation we estimate the effects of inflation on inventories by utilizing external price indices determined by the U.S. Bureau of Labor Statistics. If we had used the first-in, first-out, or "FIFO" method of inventory valuation instead of the LIFO method, merchandise inventories would have been $0.3 million higher at January 28, 2017 and $0.6 million higher at January 30, 2016.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Vendor Rebates and Allowances

Sears Holdings receives rebates and allowances from vendors through a variety of programs and arrangements intended to offset the costs of promoting and selling the vendors' products. Sears Holdings allocates a portion of the rebates and allowances to us based on shipments to or sales of the related products to the Company. These vendor payments are recognized and recorded as a reduction to the cost of merchandise inventories when earned and, thereafter, as a reduction of cost of sales and occupancy as the merchandise is sold. Up-front consideration received from vendors linked to purchases or other commitments is initially deferred and amortized ratably to cost of sales and occupancy over the life of the contract or as performance of the activities specified by the vendor to earn the fee is completed.

Property and Equipment

Property and equipment are recorded at cost, less accumulated depreciation. Additions and substantial improvements are capitalized and include expenditures that materially extend the useful lives of existing facilities and equipment. Maintenance and repairs that do not materially improve or extend the lives of the respective assets are expensed as incurred.

Property and equipment consists of the following:



thousands	January 28, 2017			January 30, 2016
Land	$	1,741		$	2,123
Buildings and improvements	41,071			49,680
Furniture, fixtures and equipment	37,174			37,681
Capitalized leases	1,175			1,005
Total property and equipment	81,161			90,489
Less: accumulated depreciation	(40,226		)	(41,174		)
Total property and equipment, net	$	40,935		$	49,315

Depreciation expense, which includes depreciation on assets under capital leases, is recorded over the estimated useful lives of the respective assets using the straight-line method for financial statement purposes and accelerated methods for tax purposes. The range of lives are generally 15 to 25 years for buildings, 3 to 10 years for furniture, fixtures, and equipment, and 3 to 5 years for computer systems and equipment. Leasehold improvements are depreciated over the shorter of the associated lease term or the estimated useful life of the asset. Total depreciation expense was $10.6 million , $8.8 million , and $9.0 million for fiscal years 2016 and 2015 and 2014, respectively.

As of January 28, 2017, management has identified one property that is deemed held for sale based on criteria in Accounting Standards Codification ("ASC") 360-10-45-9. This property is reflected in each category of Property and Equipment with the exception of capitalized leases in the table above and had a carrying value of $2.6 million as of January 28, 2017. This property is currently listed on the open market and is expected to be sold to a third party in the first half of fiscal year 2017. As of January 28, 2017, the expected fair value less the cost of sale exceeded the carrying value of the Property and Equipment.

Impairment of Long-Lived Assets and Costs Associated with Exit Activities

In accordance with accounting standards governing the impairment or disposal of long-lived assets, the carrying value of long-lived assets, including property and equipment, is evaluated whenever events or changes in circumstances indicate that a potential impairment has occurred. Factors that could result in an impairment review include, but are not limited to, a current period cash flow loss combined with a history of cash flow losses, current cash flows that may be insufficient to recover the investment in the property over the remaining useful life, or a projection that demonstrates continuing losses associated with the use of a long-lived asset, significant changes in the manner of use of the assets, or significant changes in business strategies. An impairment loss is recognized when the estimated undiscounted cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. When an impairment loss is recognized, the carrying amount of the asset is reduced to its estimated fair value as determined based on quoted market prices or through the use of other valuation techniques. We recorded impairment charges with respect to long-lived assets of $9.4 million , $4.0 million and $1.2 million in fiscal years 2016, 2015 and 2014, respectively, included in Impairment of Goodwill, Property, and Equipment in the accompanying Consolidated Statement of Operations. See Note 5 regarding the $167.0 million non-cash goodwill impairment charge we recorded in the third quarter of our 2014 fiscal year.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

We account for costs associated with location closings in accordance with accounting standards pertaining to accounting for costs associated with exit or disposal activities and compensation. When management makes a decision to close a location we record a reserve as of that date for the inventory markdowns associated with the closing. We record a liability for future lease costs (net of estimated sublease income) when we cease to use the location. At fiscal year end, this liability was approximately $7.7 million . See note 16.

Leases

We lease certain stores, office facilities, computers and transportation equipment. The determination of operating and capital lease obligations is based on the expected durations of the leases and contractual minimum lease payments specified in the lease agreements. For certain stores, amounts in excess of these minimum lease payments are payable based upon a specified percentage of sales. Contingent rent is accrued during the period it becomes probable that a particular store will achieve a specified sales level thereby triggering a contingent rental obligation. Certain leases also include an escalation clause or clauses and renewal option clauses calling for increased rents. Where the lease contains an escalation clause or concession such as a rent holiday, rent expense is recognized using the straight-line method over the term of the lease. We have subleases with Sears Holdings for 45 locations. We had rent expense paid to Sears Holdings of $17.0 million , $19.3 million and $27.8 million in 2016, 2015 and 2014, respectively. We also had rent expenses paid to Seritage Growth Properties of $1.0 million and $0.5 million in 2016 and 2015, respectively, for occupancy charges for three properties we lease from Seritage. No rent expenses were paid to Seritage Growth Properties in fiscal 2014.

Rental expense for operating leases was as follows:



	Fiscal Year
thousands	2016			2015			2014
Minimum rentals	$	69,111		$	63,336		$	63,115
Less-Sublease rentals	(13,181		)	(25,505		)	(28,457		)
Total	$	55,930		$	37,831		$	34,658

Minimum lease obligations excluding taxes, insurance and other expenses are as follows:

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Fiscal Year	Capital Leases			Operating Leases
thousands
2017	$	269		$	52,290
2018	164			37,801
2019	106			25,464
2020	4			19,851
2021	—			12,490
Thereafter	—			13,504
Total Minimum Lease Payments	543			161,400
Less - Sublease Income on Leased Properties	—			(31,751		)
Net Minimum Lease Payments	$	543		$	129,649

Less:
Implicit Interest	—
Capital Lease Obligations	543
Less Current Portion of Capital Lease Obligations	(269		)
Long-term Capital Lease Obligations	$	274

Insurance Programs

We maintain with third-party insurance companies our own insurance arrangements for exposures incurred for a number of risks including worker’s compensation and general liability claims. Insurance expense of $5.4 million , $4.1 million and $5.7 million was recorded during 2016, 2015 and 2014, respectively.

Loss Contingencies

We account for contingent losses in accordance with accounting standards pertaining to loss contingencies. Under accounting standards, loss contingency provisions are recorded for probable losses at management’s best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount is recorded. These estimates are often initially developed substantially earlier than the ultimate loss is known, and the estimates are refined each accounting period, as additional information is known.

Revenue Recognition

Revenues 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. We recognize revenues from retail operations at the later of the point of sale or the delivery of goods to the end user. Net sales are presented net of any taxes collected from customers and remitted or payable to governmental authorities. We recognize revenues from commissions on services and extended-service plans, 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.

The Company accepts Sears Holdings gift cards as tender for purchases and is reimbursed by Sears Holdings for gift cards tendered.

Reserve for Sales Returns and Allowances

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Revenues from merchandise sales and services are reported net of estimated returns and allowances and exclude sales taxes. The reserve for returns and allowances is calculated as a percentage of sales based on historical return percentages. Estimated returns are recorded as a reduction of sales and cost of sales. The reserve for returns and allowances was $1.1 million at January 28, 2017 and $1.4 million at January 30, 2016.

Cost of Sales and Occupancy

Cost of sales and occupancy are 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 Sears Holdings related to our sale products branded with one of the KENMORE®, CRAFTSMAN®, and DIEHARD® marks (the "KCD Marks," and products branded with one of the KCD Marks are referred to as the "KCD Products"), customer shipping and handling costs, vendor allowances, markdowns, and physical inventory losses. The KCD Marks are owned by subsidiaries of Sears Holdings.

Selling and Administrative Expenses

Selling and administrative expenses are comprised principally of dealer and franchisee commissions, payroll and benefits costs for retail and support employees, advertising, pre-opening costs, and other administrative expenses.

Dealer and Franchisee Commissions

In accordance with our agreements with our dealers and franchisees, we pay commissions to our dealers and franchisees on the net sales of merchandise and extended-service plans. In addition, each dealer and franchisee can earn commissions for third-party gift cards sold and can earn marketing support, home improvement referrals, rent support, and other items. Commission costs are expensed as incurred and reflected within selling and administrative expenses. Commission costs were $209.5 million , $278.1 million , and $297.1 million in 2016, 2015 and 2014, respectively. Commission costs vary based on factors including store count, number of dealer and franchise locations, sales mix, sales volume, and commission rates.

Pre-Opening Costs

Pre-opening and start-up activity costs are expensed in the period in which they occur.

Advertising Costs

Advertising costs are expensed as incurred, generally the first time the advertising occurs, and were $65.2 million , $70.5 million and $73.9 million for 2016, 2015 and 2014, respectively. These costs are included within selling and administrative expenses in the accompanying consolidated statements of operations.

Income Taxes

We provide deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax basis of assets and liabilities based on currently enacted tax laws. The tax balances and income tax expense recognized by us are based on management’s interpretation of the tax laws of multiple jurisdictions. Income tax expense also reflects our best estimates and assumptions regarding, among other things, the level of future taxable income, tax planning, and any valuation allowance. For the year-ended January 28, 2017, a valuation allowance of $100.1 million has been recorded for the full amount of the net deferred tax assets. In the future, we may record additional net deferred tax assets and if future utilization of deferred tax assets is uncertain, we may record additional valuation allowance against such deferred tax assets. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions including the amount of future state, federal and foreign pre-tax operating income (loss), the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income.

Tax positions are recognized when they are more likely than not to be sustained upon examination. The amount recognized is measured as the largest amount of benefit that is more likely than not of being recognized upon settlement. We will be subject to periodic audits by the Internal Revenue Service and other state and local taxing authorities. Theses audits may challenge certain of the Company’s tax positions such as the timing and amount of income and deductions and the allocation of taxable income to

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

various tax jurisdictions. We evaluate our tax positions and establish liabilities in accordance with the applicable guidance on uncertainty in income taxes. These tax uncertainties are reviewed as facts and circumstances change and are adjusted accordingly. This requires significant management judgment in estimating final outcomes. Actual results could materially differ from these estimates and could significantly affect the effective tax rate and cash flows in future years. Interest and penalties are classified as income tax expense in the Consolidated Statements of Operations.

Prior to the Separation, our taxable income was included in the consolidated federal, state and foreign income tax returns of Sears Holdings or its affiliates. Income taxes in these consolidated financial statements have been recognized on a separate return basis. Under a Tax Sharing Agreement between the Company and Sears Holdings entered into prior to the Separation (the "Tax Sharing Agreement"), Sears Holdings is responsible for any federal, state or foreign income tax liability relating to tax periods ending on or before the Separation and the Company is responsible for any federal, state or foreign tax liability relating to tax periods ending after the Separation.

Fair Value of Financial Instruments

We determine the fair value of financial instruments in accordance with standards pertaining to fair value measurements. Such standards define fair value and establish a framework for measuring fair value in Generally Accepted Accounting Principles ("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 risk and default rates.

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

Cash and cash equivalents, merchandise payables to Sears Holdings, accrued expenses (level 1), accounts and notes receivable, and short-term debt (level 2) are reflected in the Consolidated Balance Sheets at cost, which approximates fair value due to the short-term nature of these instruments. For short-term 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. As disclosed in Note 5, the Company recorded a goodwill impairment charge during the third quarter of fiscal 2014 and recorded certain intangible assets during fiscal 2015. As disclosed in Note 1, the Company recorded impairment charges on its property and equipment in fiscal years 2016, 2015, and 2014, respectively. The Company utilized Level 3 inputs to measure the fair value of goodwill, property and equipment, and the intangible assets.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

New Accounting Pronouncements -

Technical Corrections and Improvements

In December 2016, the FASB issued an accounting standards update (ASU 2016-19) which made minor changes to certain aspects of the FASB Accounting Standards Codification. The types of changes made by the ASU can be categorized as follows: 1) changes to resolve differences between current and pre-Codification guidance (e.g., FASB Statements, EITF Issues), 2) updates to wording and references to avoid misapplication, 3) textual simplifications to increase the Codification's utility and understandability, and 4) minor amendments to guidance that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Most changes are effective upon issuance of the ASU; certain changes, however, are effective for interim and annual reporting periods beginning after December 15, 2016. We are currently evaluating the effect the update will have on our consolidated financial statements and related disclosures.

Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers

In December 2016, the FASB issued Accounting Standards Update ("ASU") 2016-20, Technical Corrections and Improvements to Topic 606, Revenue From Contracts with Customers. The update makes minor changes to the Board's new revenue guidance, ASU 2014-09, Revenue from Contracts with Customers (Topic 606) which was issued in February 2014. The technical corrections affect narrow aspects of the new revenue standard, including: loan guarantee fees, contract costs-impairment testing, contract costs - interaction of impairment testing with guidance in other topics, provisions for losses on construction-type and production-type contracts, scope of the new revenue standard, disclosure of remaining performance obligations, disclosure of prior-period performance obligations, a contract modification example, refund liability, advertising costs, fixed-odds wagering contracts in the casino industry, and cost capitalization for advisers to private and public funds. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements for Topic 606 (and any other Topic amended by ASU 2014-09). We have formed a committee to evaluate the effect the update will have on our consolidated financial statements and related disclosures, which evaluation is in the initial stages.

Accounting Changes and Error Corrections

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments-Equity Method and Joint Ventures (topic 323). Guidance in the Codification was amended in response to SEC staff announcements made at the September 22, 2016 and November 17, 2016 EITF meetings. The announcements addressed addressed the following topics:

- The "additional qualitative disclosures" that a registrant is expected to provide when it "cannot reasonably estimate the impact" that ASUs 2014-09, 2016-02, and 2016-03 will have in applying the guidance in SAB Topic 11.M .

-Guidance in ASC 323 related to the amendments made by ASU 2014-01 regarding use of the proportional amortization method in accounting for investments in qualified affordable housing projects.

We are currently evaluating the effect the update will have on our consolidated financial statements and related disclosures.

Classification of Certain Cash Flows Receipts and Cash Payments

In August 2016, the FASB issued an accounting standards update (ASU 2016-15, Topic 230) which amended ASC 230. The update adds and clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows. The ASU is a result of consensus reached by the FASB's Emerging Issues Task Force (EITF) on issues related to eight types of cash flows, including: 1) debt prepayment or debt extinguishment costs, 2) settlement of zero coupon bonds, 3) contingent consideration payments made after a business combination, 4) proceeds from the settlement of insurance claims, 5) proceeds from the settlement of corporate-owned life insurance policies, 6) distributions received from equity-method investees, 7) beneficial interests in securitization transactions, and 8) separately identifiable cash flows and application of the predominance principle. The pronouncement becomes effective for fiscal years beginning after December 15, 2017 (which will be the Company's 2018 fiscal year) and interim periods within those fiscal years. We are currently evaluating the effect the update will have on our consolidated financial statements and related disclosures.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Stock-based Compensation

In March 2016, the FASB issued ASU 2016-09, Compensation–Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which makes several modifications to the accounting for employee share-based payment transactions, including the requirement to recognize the income tax effects of awards that vest or settle as income tax expense. This guidance also clarifies the presentation of certain components of share-based awards in the statement of cash flows. This guidance is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods, and early adoption is permitted. We are currently evaluating the effect the update will have on our consolidated financial statements and related disclosures.

Leases

In February 2016, the FASB issued an accounting standards update (ASU 2016-02, Topic 746) which replaces the current lease accounting standard. The update will require, among other items, lessees to recognize a right-of-use ("ROU") asset and a lease liability for most leases. Extensive quantitative and qualitative disclosures, including significant judgments made by management, will be required to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing contracts. The update is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The new standard must be adopted using a modified retrospective transition, and provides for certain practical expedients. Transition will require application of the new guidance at the beginning of the earliest comparative period presented. We are currently evaluating the effect the update will have on our consolidated financial statements. Upon adoption, the Company expects that the ROU asset and the lease liability will be recognized in the balance sheets in amounts that will be material.

Revenue from Contracts with Customers

In May 2014, the FASB issued an accounting standards update (ASU 2014-09, Topic 606) 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. After the FASB's August 2015 update to defer the effective date one year, 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. Thereafter, in May 2016, FASB issued another accounting standards update (ASU 2016-12, Topic 606) which amends certain aspects of the Board's revenue standard, ASU 2014-09, "Revenue From Contracts With Customers." We have formed a committee to evaluate the effect of adopting these new standards, and the committee has not yet determined the method by which the standards will be adopted.

Presentation of Financial Statements

In August 2014, the FASB issued an accounting standards update (ASU 2014-15, Subtopic 205-40), which became effective for the Company beginning in the fourth quarter of our fiscal year ending January 28, 2017 ("2016"). The new accounting standards update requires the management of an entity to assess with respect to each of the entity's quarterly and annual reporting periods 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 the year after the entity issues financial statements. Depending on the assessment conducted by the entity's management, additional disclosures in the notes to the financial statements may be required. The adoption of the new standard did not have a material impact on the Company’s consolidated financial position, results of operations, cash flows, or disclosures. The new accounting standards do not require us to make any additional disclosure with respect to the fourth quarter of our 2016 fiscal year or for the entire 2016 fiscal year.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2—ACCOUNTS AND FRANCHISEE RECEIVABLES AND OTHER ASSETS

Accounts and franchisee receivables and other assets consist of the following:



thousands	January 28 2017			January 30, 2016
Short-term franchisee receivables	$	1,920		$	2,376
Miscellaneous receivables	10,475			10,754
Long-term franchisee receivables	18,406			23,068
Other assets	6,116			1,677
Allowance for losses on short-term franchisee receivables (1)	(947		)	(1,377		)
Allowance for losses on long-term franchisee receivables (1)	(7,295		)	(10,764		)
Total Accounts and franchisee receivables and other assets	$	28,675		$	25,734

(1) The Company recognizes an allowance for losses on franchisee receivables (which consist primarily of franchisee promissory notes) in an amount equal to estimated probable losses net of recoveries. The allowance is based on an analysis of expected future write-offs, existing economic conditions, and an assessment of specific identifiable franchisee promissory notes and other franchisee receivables considered at risk or uncollectible. The expense associated with the allowance for losses on franchisee receivables is recognized as selling and administrative expense. Most of our franchisee promissory notes authorize us to deduct debt service from our commissions otherwise due and payable to the franchisees, and we routinely make those deductions to the extent of available commissions payable. We established an allowance for losses on franchisee receivables beginning in fiscal 2014 based on our receivable-by-receivable assessment during the year that some of the franchisee receivables were potentially uncollectible in future periods due to declining results of operations of, or other adverse financial events with respect to, franchise stores that indicated that the franchisees might not be able, or were unable or unwilling, to meet their debt-service and other obligations to us as they became due.

NOTE 3—ALLOWANCE FOR LOSSES ON FRANCHISEE RECEIVABLES

The allowance for losses on Franchisee Receivables consists of the following:



thousands	January 28, 2017			January 30, 2016
Allowance for losses on franchisee receivables, beginning of period	$	12,141		$	11,368
Expense (benefit) during the period	(791		)	25,426
Write off of franchisee receivables	(3,383		)	(24,653		)
Other	275			—
Allowance for losses on franchisee receivables, end of period	$	8,242		$	12,141

NOTE 4—OTHER CURRENT AND LONG-TERM LIABILITIES

Other current and long-term liabilities consist of the following:



thousands	January 28, 2017		January 30, 2016
Customer deposits	$	19,943	$	24,259
Sales and other taxes	11,380		12,880
Accrued expenses	27,602		23,865
Payroll and related items	5,766		6,563
Store closing, severance and executive transition costs	7,659		1,569
Total Other current and long-term liabilities	$	72,350	$	69,136

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5—GOODWILL AND INTANGIBLE ASSETS

Goodwill

We had a goodwill balance of $167.0 million which was assigned to our Sears Hometown reporting unit upon separation. 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 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.

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 a $167.0 million non-cash goodwill impairment charge in fiscal 2014, which is reflected as "Impairment of goodwill, property and equipment" in the 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.

Intangible assets

Intangible assets consist of the following:



thousands	January 28, 2017			January 30, 2016
Reacquisition rights	$	6,100		$	6,100
Less: accumulated amortization expense	(4,573		)	(1,723		)
Total intangible assets, net	$	1,527		$	4,377

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In fiscal 2016, the Company repurchased a total of 24 franchised locations of which there was no reacquisition rights value associated with the transactions as several of the reacquired stores were closed and the remaining had negative cash flows and minimal time remaining on the lease. The fiscal 2015 repurchase transactions included the execution of definitive asset purchase and termination agreements which terminated the franchise agreements and sublease arrangements for those locations. These definitive agreements also required the Company to purchase store furniture, fixtures, and equipment. The franchisees of the affected locations were obligors on promissory notes payable to the Company and as part of the definitive agreements, the Company wrote-off the franchisee note receivable balances net of the value of the reacquisition rights and the value of the furniture, fixtures, and equipment that the Company purchased. Reacquisition rights were recorded at estimated fair value using the income approach.

Reacquisition rights are definite-life assets, and as such, we record amortization expense based on a method that most appropriately reflects our expected cash flows from these assets with a weighted-average amortization period of 2.3 years. Amortization expense for reacquisition rights were $2.8 million and $1.7 for the years ended January 28, 2017 and January 30, 2016, respectively. Amortization expense is estimated to be $1.2 million in 2017, $0.2 million in 2018, and $0.1 million in 2019.

NOTE 6—INCOME TAXES

In connection with the Separation, SHO and Sears Holdings entered into a Tax Sharing Agreement with Sears Holdings 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 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 is responsible for any federal, state or foreign tax liability. Current income taxes payable for any federal, state or foreign income tax returns is reported in the period incurred.

We account for uncertainties in income taxes according to accounting standards for uncertain tax positions. The Company is present in a large number of taxable jurisdictions and, at any point in time, can have audits underway at various stages of completion in one or more of these jurisdictions. We evaluate our tax positions and establish liabilities for uncertain tax positions that may be challenged by local authorities and may not be fully sustained, despite the belief that the underlying tax positions are fully supportable. Unrecognized tax benefits are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law, and closings of statutes of limitation. Such adjustments are reflected in the tax provision as appropriate. Pursuant to the Tax Sharing Agreement, Sears Holdings is responsible for any unrecognized tax liabilities or benefits through the date of the Separation and the Company is responsible for any uncertain tax positions after the Separation. For 2016, 2015 and 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 consolidated financial statements, no interest or penalties related to unrecognized tax benefits are reflected in the consolidated balance sheets or statements of operations.

As of January 28, 2012 the assets and liabilities of the Sears Hometown and Hardware and Sears Outlet businesses were owned by subsidiaries of Sears Holdings. On August 31, 2012, through a series of intercompany transactions Sears Holdings and several of its subsidiaries transferred the assets and liabilities comprising the Sears Hometown and Hardware and Sears Outlet businesses to SHO. In connection with the intercompany transactions, for tax purposes the transferred assets and liabilities were stepped up to their estimated fair market values as of August 31, 2012, but for financial statement purposes the book value of the assets and liabilities remained unchanged at their historical cost bases. This tax adjustment related to the Separation was accounted for as an equity contribution that increased net deferred tax assets by $80.4 million reflecting the stepped-up tax basis in excess of the book basis that occurred in connection with the intercompany transactions described above, primarily for merchandise inventories, favorable leases, fixed assets, and royalty-free licenses to use the "Sears" name. In 2015, a property that was not included in the 2012 valuation was revalued to its estimated 2012 fair market value. The increase in tax basis related to this property was recorded in 2015 as an increase to deferred tax assets of $7.6 million with the offset reflected as an equity contribution. Because this non-cash adjustment only impacts the balance sheet in each of the years it was unrecorded and its impact is not material to the consolidated financial statements based on management’s assessment of SEC Staff Accounting Bulletin No. 99, this correction was recorded in 2015 and no prior periods were adjusted.

The provisions for income tax expense for 2016, 2015 and 2014 consist of the following:

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



			Fiscal Year Ended
thousands			2016			2015			2014
Income (loss) before income taxes:
	U.S.		$	(51,588	)	$	(41,643	)	$	(172,829	)
	Foreign		1,160			(770		)	958
		Total	$	(50,428	)	$	(42,413	)	$	(171,871	)
Income tax expense (benefit):
Current:
	Federal		$	(155	)	$	(9,758	)	$	2,872
	State		1,001			605			608
	Foreign		542			432			584
		Total	1,388			(8,721		)	4,064
Deferred:
	Federal		67,463			(4,666		)	(6,037		)
	State		12,640			(1,765		)	(1,093		)
	Foreign		—			—			—
		Total	$	80,103		$	(6,431	)	$	(7,130	)

Income tax expense (benefit)			$	81,491		$	(15,152	)	$	(3,066	)

The provisions for income taxes for financial reporting purposes is different from the tax provision computed by applying the statutory federal tax rate. The reconciliation of the tax rate follows:



	Fiscal Year Ended
	2016		2015		2014
Federal tax rate	35.0	%	35.0	%	35.0	%
State income tax (net of federal benefit)	1.7	%	1.8	%	0.2	%
Goodwill	—	%	—	%	(34.0	)%
Valuation allowance	(198.5	)%	(1.6	)%	0.1	%
Other	0.2	%	0.5	%	0.5	%
Effective tax rate	(161.6	)%	35.7	%	1.8	%

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The major components of the deferred tax assets and liabilities as of January 28, 2017 and January 30, 2016 are as follows:



			Fiscal Year Ended
thousands			January 28, 2017			January 30, 2016
Deferred tax assets
	Bad Debts		$	3,487		$	4,735
	Deferred Compensation		468			1,454
	Inventory		3,159			4,100
	Net Operating Loss		39,169			9,873
	Property		296			4,986
	Royalty-free License		44,280			48,513
	Other		11,230			7,063
		Sub-total deferred tax assets	$	102,089		$	80,724
		Valuation allowance	(100,906		)	(830		)
		Total deferred tax assets	$	1,183		$	79,894
Deferred tax liabilities
	Property		—			—
	Other		(1,183		)	(753		)
		Total deferred tax liabilities	(1,183		)	(753		)
Net deferred tax assets			—			$	79,141

We account for income taxes in accordance with accounting standards for such taxes, which require that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the financial reporting and tax bases of recorded assets and liabilities. Accounting standards also require that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion of or all of the deferred tax assets will not be realized.

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. In performing the assessment for 2016, a significant piece of negative evidence evaluated was the cumulative loss incurred over the three-year period ended January 28, 2017. The loss was evaluated as book income/loss adjusted for non-deductible and non-recurring items such as goodwill impairment, sale of property, store closing costs, franchise income/expense and software expenses. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth.

On the basis of this analysis and significant negative objective evidence, for the year ended January 28, 2017, a valuation allowance of $100.1 million has been recorded for the full amount of the net deferred tax assets. The valuation allowance was recorded as a non-cash charge to income tax expense. A valuation allowance of $0.7 million and $0.1 million was recognized through tax expense for the years ended January 30, 2016 and January 31, 2015, respectively due to the estimated future foreign taxable income available to use the foreign tax credit and the Puerto Rico AMT credit carryforwards. We will continue to evaluate our valuation allowance in future years for any change in circumstances that causes a change in judgment about the realizability of the deferred tax assets.

At the end of 2016 and 2015, we had a federal net operating losses (“NOL”) of $99.4 million and $22.7 million , respectively, which will expire between 2036 and 2037. At the end of 2016 and 2015, we had state NOLs of $6.8 million and $2.9 million , respectively, which will expire between 2019 and 2037. We have credit carryforwards of $3.1 million which will expire between 2023 and 2037.

We file federal, state and city income tax returns in the United States and foreign tax returns in Puerto Rico. SHO was also a part of the Sears Holdings' combined state returns for the years ended February 2, 2013 and February 1, 2014. Currently,

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the Company is under audit for the years ended February 2, 2013 and February 1, 2014 as part of the Sears Holdings' combined return audits, as well as the Company's federal tax return for the year ended January 30, 2016.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7—RELATED-PARTY AGREEMENTS AND TRANSACTIONS

According to publicly available information, ESL Investments, Inc. and its investment affiliates including Edward S. Lampert (together, "ESL") beneficially own approximately 57% of our outstanding shares of common stock and, as of January 28, 2017, approximately 48% of Sears Holdings' outstanding shares of common stock.

We are party to various agreements with Sears Holdings (the "SHO-Sears Holdings Agreements") which, among other things, (1) govern specified aspects of our relationship with Sears Holdings, (2) establish terms under which subsidiaries of Sears Holdings are providing services to us, and (3) establish terms pursuant to which subsidiaries of Sears Holdings are obtaining merchandise inventories for us. The terms of the SHO-Sears Holdings Agreements were agreed to prior to the Separation (except for amendments entered into after the Separation that were approved by the Audit Committee of SHO's Board of Directors) in the context of a parent-subsidiary relationship and in the overall context of the Separation. The costs and allocations charged to the Company by Sears Holdings do not necessarily reflect the costs of obtaining the services from unaffiliated third parties or of the Company itself providing the applicable services. The Company has engaged in frequent discussions, and has resolved disputes, with Sears Holdings about the terms and conditions of the 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 had not been addressed by the terms and conditions of the SHO-Sears Holdings Agreements or, if addressed, in the past were, and in the future could be, in dispute as to their meaning or application in the context of the existing business relationships. Many of these discussions have resulted in adjustments to the relationships that the Company believes together are in Company's best interests. On May 11, 2016, SHO and Sears Holdings entered into amendments to most of the SHO-Sears Holdings Agreements. These amendments are referred to in our Current Report on Form 8-K (File No. 001-35641) filed with the Securities and Exchange Commission on May 17, 2016. We also filed a Current Report on Form 8-K (File No. 001-35641) with the Securities and Exchange Commission on March 9, 2017 regarding the Amendment to Amended and Restated Merchandising Agreement dated as of March 8, 2017 among the Company, Sears Holdings, and Stanley Black & Decker. Inc.

The following is a summary of the nature of the related-party transactions between SHO and Sears Holdings:

•

We are party to a Separation Agreement with Sears Holdings pursuant to which Sears Holdings consummated the Separation. The Separation Agreement, among other things, provided for the allocation and transfer, through a series of intercompany transactions, of the assets and the liabilities comprising the Sears Hometown and Hardware and Sears Outlet businesses of Sears Holdings. In the Separation Agreement SHO and Sears Holdings agree to release each other from all pre-separation claims (other than with respect to the agreements executed in connection with the Separation) and each agrees to defend and indemnify the other with respect to its post-separation business.

•

We obtain a significant amount of our merchandise inventories from Sears Holdings. This enables us to take advantage of the amount and scope of Sears Holdings' purchasing activities. The SHO-Sears Holdings Agreements include an Amended and Restated Merchandising Agreement with Sears Holdings, Kmart and SRC (the "Merchandising Agreement") pursuant to which Kmart and SRC (1) sell to us, with respect to certain specified product categories, Sears-branded products including KCD Products and vendor-branded products obtained from Kmart’s and SRC’s vendors and suppliers and (2) grant us licenses to use the trademarks owned by Kmart, SRC or other subsidiaries of Sears Holdings, or the "Sears marks," including the KCD Marks in connection with the marketing and sale of products sold under the Sears marks. The initial term of the Merchandising Agreement will expire on February 1, 2020, subject to one three-year renewal term with respect to the KCD Products. We pay, on a weekly basis, a royalty determined by multiplying our net sales of the KCD Products by specified fixed royalties rates for each brand’s licensed products, subject to adjustments based on the extent to which we feature Kenmore brand products in certain of our advertising and the extent to which we pay specified minimum commissions to our franchisees and Hometown Store owners. The SHO-Sears Holdings Agreements also provide for related logistics, handling, warehouse and transportation services, the charges for which are based generally on merchandise inventory units. We also pay fees for participation in Sears Holdings' SYW program.

•

We obtain our merchandise from Sears Holdings and other vendors. For the year ended January 28, 2017, products which we acquired from Sears Holdings, including KCD Products and other products, accounted for approximately 80% , 82% , and 84% of our total purchases of inventory from all vendors for 2016, 2015, and 2014, respectively. The loss of or a 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.


•	Sears Holdings provides the Company with specified corporate services pursuant to the SHO-Sears Holdings Agreements. These services include tax, accounting, procurement, risk management and insurance, advertising and marketing, loss

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

prevention, environmental, product and human safety, facilities, logistics and distribution, information technology (including the point-of-sale system used by the Company and our dealers and franchisees), online, payment clearing, and other financial, real estate management, merchandise-related and other support services. Sears Holdings charges the Company for these corporate services generally based on actual usage, a pro rata charge based upon sales, head count, or square footage, or a fixed fee or commission as agreed between the parties.

•

Sears Holdings has licensed the Company until October 11, 2029, on a royalty-free basis, to use under specified conditions (1) the name "Sears" in our corporate name and to promote our businesses and (2) the www.searsoutlet.com, www.searshomeapplianceshowroom.com, www.searshometownstores.com, and www.searshardwarestores.com domain names to promote our businesses. Also, Sears Holdings has licensed the Company until October 11, 2029, on an exclusive, royalty-free basis, under specified conditions to use for the purpose of operating our stores the names "Sears Appliance & Hardware," "Sears Authorized Hometown Stores," "Sears Hometown Store," "Sears Home Appliance Showroom," "Sears Hardware," and "Sears Outlet Store."

•

Sears Holdings has assigned to us leases for, or has subleased to us, many of the stores that we operate or that we have, in turn, subleased to franchisees. Generally, the terms of the subleases match the terms, including the payment of rent and expiration date, of the existing leases between Sears Holdings (or one of its subsidiaries) and the landlord. In addition, a small number of our stores are in locations where Sears Holdings currently operates one of its stores or a distribution facility. In such cases we have entered into a lease or sublease with Sears Holdings (or one of its subsidiaries) for the portion of the space in which our store will operate, and we pay rent directly to Sears Holdings on the terms negotiated in connection with the Separation. We also lease from Sears Holdings office space for our corporate headquarters.


•	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 plans, delivery and handling services and relating to the use in our stores of credit cards branded with the Sears name. For certain transactions SHO pays a commission to Sears Holdings.

The SHO-Sears Holdings Agreements may be terminated by either party upon a material breach if the breaching party fails to cure such breach within 30 days following written notice of such breach or, if such breach is not curable, immediately upon delivery of notice of the non-breaching party’s intention to terminate.

The following table summarizes the transactions with Sears Holdings included in the Company’s Consolidated Financial Statements:



	Fiscal Year Ended
	January 28, 2017		January 30, 2016		January 31, 2015
thousands

Net Commissions from Sears Holdings	$	82,447	$	91,291	$	99,054
Purchases related to cost of sales and occupancy	1,153,739		1,386,414		1,499,231
Services included in selling and administrative	77,189		88,486		96,027

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. During most of fiscal 2016 the Company, with Sears Holdings agreement, paid invoices on three-day terms and deducted from each invoice an early-payment discount of 37 basis points. In addition, at the request of Sears Holdings (1) the Company advanced $20 million to Sears Holdings on October 14, 2016 for merchandise received by SHO before an invoice was received from Sears Holdings for the merchandise, (2) with Sears Holdings' agreement the Company deducted $0.1 million from each weekly invoice received by the Company after October 14, 2016 from Sears Holdings as a 37 -basis-point fee with respect to the $20 million advance, and (3) Sears Holdings repaid to the Company the $20 million advance on November 28, 2016. The total of (1) the discounts we received for the payments we made on three -day terms and (2) the fees we received for the $20 million advance, less incremental interest expense, resulted in a net financial benefit to the Company in 2016 of approximately $4.4 million . We are continuing to pay invoices on three -day terms with the 37 basis-point discount, which we expect will increase the Senior ABL Facility borrowings by approximately $30 - 40 million but will result in a net financial benefit for us in 2017. Sears Holdings and we each are able to

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

revert to ten -day, no-discount payment terms at any time by notice to the other, and Sears Holdings has advised us that they intend to revert to ten -day, no-discount payment terms beginning in the near future.

We paid Seritage Growth Properties $1.0 million and $0.5 million in 2016 and 2015, respectively, for occupancy charges for three properties we lease from Seritage. Edward S. Lampert is the Chairman of the Board of Trustees of Seritage.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8—FINANCING ARRANGEMENT

In October 2012 the Company entered into a Credit Agreement with a syndicate of lenders, including Bank of America, N.A., as administrative agent, which provides (subject to availability under a borrowing base) for aggregate maximum borrowings of $250 million (the "Prior Facility"). Under the Prior Facility the Company initially borrowed $100 million which was used to pay a cash dividend to Sears Holdings prior to the Separation. On November 1, 2016 the Company’s three operating subsidiaries, Sears Authorized Hometown Stores, LLC, Sears Home Appliance Showrooms, LLC, and Sears Outlet Stores, L.L.C., and the Company, entered into an Amended and Restated Credit Agreement with a syndicate of lenders, including Bank of America, N.A., as administrative agent and collateral agent, which provides (subject to availability under a borrowing base) for aggregate maximum borrowings of $250 million (the "Senior ABL Facility"). The Senior ABL Facility provides for extended revolving credit commitments in an aggregate amount equal to $170 million (the “Extended Revolving Credit Commitments”) and non-extended revolving credit commitments in an aggregate amount equal to $80 million (the “Non-Extended Revolving Credit Commitments”). The Extended Revolving Credit Commitments will mature on the earlier of (1) February 29, 2020 and (2) six months prior to the expiration of agreements entered into with Sears Holdings and its subsidiaries in connection with the Company’s separation from Sears Holdings in October 2012 (the "Subject Agreements") unless they are extended to a date later than February 29, 2020 or terminated on a basis reasonably satisfactory to the administrative agent under the Senior ABL Facility. The Non-Extended Revolving Credit Commitments will mature on the earlier of (1) October 11, 2017 and (2) six months prior to the expiration of the Subject Agreements unless they are extended to a date later than October 11, 2017 or terminated on a basis reasonably satisfactory to the administrative agent under the Amended and Restated Credit Agreement. Costs related to and incurred for the November 1, 2016 refinancing totaled approximately $5.4 million and are included in Prepaid and Other current assets on the Consolidated Balance Sheet.

As of January 28, 2017 we had $26.8 million outstanding under the Senior ABL Facility, which approximated the fair value of these borrowings. Up to $75 million of the Senior ABL Facility is available for the issuance of letters of credit and up to $25 million is available for swingline loans. The Senior ABL Facility permits us to request commitment increases in an aggregate principal amount of up to $100 million . Availability under the Senior ABL Facility as of January 28, 2017 was $182.5 million , with $6.0 million of letters of credit outstanding under the facility.

The principal terms of the Senior ABL Facility are summarized below.

Prepayments

Security and Guarantees

Interest; Fees

The interest rates per annum applicable to the loans under the Senior ABL Facility are based on a fluctuating rate of interest measured by reference to, at the Company's election, either (1) an adjusted London inter-bank offered rate (LIBOR) plus a borrowing margin ranging from (x) 3.50% to 4.50% , in the case of the Extended Revolving Credit Commitments or (y) 2.00% to 2.50% , in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 3.94% at January 28, 2017), and in each case based on availability under the Senior ABL Facility, or (2) an alternate base rate plus a borrowing margin, ranging from (x) 2.50% to 3.50% , in the case of the Extended Revolving Credit Commitments or (y) 1.00% to 1.50% , in the case of the Non-Extended Revolving Credit Commitments (which the blended rate was approximately 5.94% at January 28, 2017), and in each case based on availability under the Senior ABL Facility.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Customary fees are payable in respect of the Senior ABL Facility, including letter of credit fees and commitment fees.

Covenants

The Senior ABL Facility also limits SHO's ability to declare and pay cash dividends and repurchase its common stock. SHO may declare and pay cash dividends and may repurchase stock, together not exceeding $37,500,000 in any fiscal year or $75,000,000 in the aggregate, 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 and (ii) SHO demonstrates to the reasonable satisfaction of the agent for the lenders that monthly availability, 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 will be at least equal to the greater of (x) 50% of the Loan Cap and (y) $100,000,000 . No default or event of default presently exists. At January 28, 2017, we met the foregoing conditions and as a result the Senior ABL Facility permits us to pay cash dividends or repurchase our common stock.

Events of Default

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9—SUMMARY OF SEGMENT DATA

The Hometown reportable segment consists of the aggregation of our Hometown Stores, Hardware Stores and Home Appliance Showroom formats. 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 United States. The Net Sales categories include appliances, lawn and garden, tools and paint and other. The other category includes initial franchise revenue of $0 , $(0.1) million and $0.3 million from Hometown in 2016, 2015 and 2014, respectively, and $(0.2) million , $0.4 million and $16.6 million from Outlet in 2016, 2015 and 2014, respectively. Initial franchise revenues consist of franchise fees paid with respect to new and existing Company-operated stores that we transfer to franchisees plus the net gain or loss on any related transfer of assets to the franchisees. Selling and administrative expense includes losses on franchisee notes receivables and IT transformation costs of $9.2 million , $20.1 million and $13.0 million million for Hometown in 2016, 2015 and 2014, respectively, and $5.0 million , $16.2 million and $0.1 million for Outlet in 2016, 2015 and 2014, respectively.



	2016
thousands	Hometown			Outlet			Total
Net sales
Appliances	$	963,391		$	517,625		$	1,481,016
Lawn and garden	247,157			20,454			267,611
Tools and paint	150,520			17,856			168,376
Other	78,495			74,558			153,053
Total	1,439,563			630,493			2,070,056
Costs and expenses
Cost of sales and occupancy	1,145,678			515,636			1,661,314
Selling and administrative	318,589			140,197			458,786
Impairment of goodwill, property, and equipment	4,536			4,820			9,356
Depreciation and amortization	6,032			7,426			13,458
Loss (Gain) on the sale of assets	69			(25,272		)	(25,203		)
Total Costs and expenses	1,474,904			642,807			2,117,711
Operating loss	$	(35,341	)	$	(12,314	)	$	(47,655	)
Total assets	$	303,166		$	165,260		$	468,426
Capital expenditures	$	7,377		$	4,821		$	12,198

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



	2015
thousands	Hometown			Outlet			Total
Net sales
Appliances	$	1,056,175		$	529,083		$	1,585,258
Lawn and garden	286,222			22,166			308,388
Tools and paint	183,591			17,850			201,441
Other	104,288			88,413			192,701
Total	1,630,276			657,512			2,287,788
Costs and expenses
Cost of sales and occupancy	1,262,215			507,071			1,769,286
Selling and administrative	378,141			167,987			546,128
Impairment of goodwill, property, and equipment	1,983			2,001			3,984
Depreciation and amortization	3,585			6,977			10,562
Total	1,645,924			684,036			2,329,960
Operating loss	$	(15,648	)	$	(26,524	)	$	(42,172	)
Total assets	$	421,615		$	212,218		$	633,833
Capital expenditures	$	4,563		$	6,867		$	11,430



	2014
thousands	Hometown			Outlet		Total
Net sales
Appliances	$	1,056,114		$	522,247	$	1,578,361
Lawn and garden	316,725			22,297		339,022
Tools and paint	204,117			18,471		222,588
Other	115,421			100,641		216,062
Total	1,692,377			663,656		2,356,033
Costs and expenses
Cost of sales and occupancy	1,297,212			506,285		1,803,497
Selling and administrative	403,367			143,269		546,636
Impairment of goodwill, property, and equipment	167,618			619		168,237
Depreciation and amortization	3,199			5,736		8,935
Gain on the sale of assets	(113		)	—		(113		)
Total Costs and expenses	1,871,283			655,909		2,527,192
Operating income (loss)	$	(178,906	)	$	7,747	$	(171,159	)
Total assets	$	430,128		$	215,594	$	645,722
Capital expenditures	$	3,046		$	9,803	$	12,849

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10 —QUARTERLY FINANCIAL DATA (UNAUDITED)

The following tables reflect the unaudited quarterly consolidated statements of operations for the periods indicated.




	Fiscal Year Ended January 28, 2017
thousands, except per share amounts	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
NET SALES	$536,981			$556,388			$487,795			$488,892
COSTS AND EXPENSES
Cost of sales and occupancy	420,790			441,508			392,562			406,454
Selling and administrative	117,992			118,808			109,158			112,828
Impairment of goodwill, property, and equipment	—			—			—			9,356
Depreciation and amortization	3,257			3,293			3,188			3,720
Loss (gain) on the sale of assets	—			(25,269		)	—			66
Total costs and expenses	542,039			538,340			504,908			532,424
Operating income (loss)	(5,058		)	18,048			(17,113		)	(43,532		)
Interest expense	(766		)	(886		)	(840		)	(1,771		)
Other income	397			378			373			342
Income (loss) before income taxes	(5,427		)	17,540			(17,580		)	(44,961		)
Income tax benefit (expense)	1,857			(6,898		)	(75,617		)	(833		)
NET INCOME (LOSS)	$	(3,570	)	$	10,642		$	(93,197	)	$	(45,794	)

NET INCOME (LOSS) PER COMMON SHARE
ATTRIBUTABLE TO STOCKHOLDERS

Basic:	$	(0.16	)	$	0.47		$	(4.11	)	$	(2.02	)
Diluted:	$	(0.16	)	$	0.47		$	(4.11	)	$	(2.02	)

Basic weighted average common shares outstanding	22,666			22,696			22,702			22,691
Diluted weighted average common shares outstanding	22,666			22,696			22,702			22,691

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




	Fiscal Year Ended January 30 ,2016
thousands, except per share amounts	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
NET SALES	$582,769			$619,610			$547,143			$538,266
COSTS AND EXPENSES
Cost of sales and occupancy	442,410			478,250			429,361			419,265
Selling and administrative	135,710			138,920			125,409			146,089
Impairment of goodwill, property, and equipment	—			—			—			3,984
Depreciation and amortization	1,861			2,164			2,271			4,266
Total costs and expenses	579,981			619,334			557,041			573,604
Operating income (loss)	2,788			276			(9,898		)	(35,338		)
Interest expense	(781		)	(614		)	(587		)	(844		)
Other income	682			560			721			622
Income (loss) before income taxes	2,689			222			(9,764		)	(35,560		)
Income tax (expense) benefit	(1,397		)	(627		)	4,221			12,955
NET INCOME (LOSS)	$	1,292		$	(405	)	$	(5,543	)	$	(22,605	)

NET INCOME (LOSS) PER COMMON SHARE
ATTRIBUTABLE TO STOCKHOLDERS

Basic:	$	0.06		$	(0.02	)	$	(0.24	)	$	(1.00	)
Diluted:	$	0.06		$	(0.02	)	$	(0.24	)	$	(1.00	)

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

NOTE 11—COMMITMENTS AND CONTINGENCIES

We are subject to various legal and governmental proceedings arising out of the ordinary course of business, the outcome of which, individually and in the aggregate, in the opinion of management, would not have a material adverse effect on our business, financial position, or results of operations, or cash flows.

NOTE 12—INCOME (LOSS) PER COMMON SHARE

Basic income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for each period. Diluted income (loss) per common share also includes the dilutive effect of potential common shares.

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

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



	Fiscal Year Ended
	January 28, 2017			January 30, 2016			January 31, 2015
thousands except income per common share
Basic weighted average shares	22,691			22,666			22,666
Dilutive effect of restricted stock	—			—			—
Diluted weighted average shares	22,691			22,666			22,666

Net loss	$	(131,919	)	$	(27,261	)	$	(168,805	)

Loss per common share:

Basic	$	(5.81	)	$	(1.20	)	$	(7.45	)
Diluted	$	(5.81	)	$	(1.20	)	$	(7.45	)

For the years ended January 28, 2017, January 30, 2016, and January 31, 2015, unvested shares of restricted stock of 14,000 , 55,958 , and 70,247 , respectively, were excluded from the computation of diluted earnings per share due to them having an anti-dilutive effect.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13 — EQUITY

Stock-based Compensation

Four million shares of 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 was granted under the Plan in the second quarter of 2013 (the "2013 Grants") 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 (the "2015 Grant"). All of the eligible individuals were employees of the Company at the time of the grants.

As of May 16, 2016, 52,691 shares of the 2013 Grants had been forfeited. On that date the remaining 36,530 shares of restricted stock comprising the 2013 Grants vested in accordance with the terms and conditions of the governing restricted-stock agreements and the Plan. The 14,000 shares of restricted stock comprising the 2015 Grant will vest, if at all, on July 10, 2017 in accordance with and subject to the terms and conditions of the governing restricted-stock agreement (including forfeiture conditions) and the Plan. The fair value of this award will vary based on changes in our stock price at each reporting period.

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 January 28, 2017, 34,091 stock units had been forfeited. The remaining 125,384 stock units will vest, if at all, on April 13, 2018 in accordance with and subject to the terms and conditions of governing stock-unit agreements, including forfeiture conditions, and the Plan. The fair value of these awards will vary based on changes in our stock price at each reporting period.

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 2013 Grants, the 2015 Grant, and the grants of the 159,475 stock units, the Company has not made any grant or award 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 fiscal year we recorded $0.1 million in total stock-based compensation expense for the remaining 50,530 shares of restricted stock (of which 36,530 shares had vested as of May 16, 2016), including the reversal of approximately $0.1 million of stock-based compensation expense related to unvested forfeited restricted stock, and $0.3 million in total compensation expense for the remaining 125,384 stock units (none of which had vested as of January 28, 2017). At January 28, 2017 we had $0.1 million in total unrecognized compensation cost related to the 2015 Grant, which cost we expect to recognize in the second quarter of fiscal 2017. At January 28, 2017, we had $0.2 million in total unrecognized compensation cost related to the remaining non-vested stock units, which cost we expect to recognize over the next year.

The fair value of the 2013 Grants and the 2015 Grant is equal to the market price of our common stock on the date of grant. Changes in these grants for 2016 were as follows:



	52 Weeks Ended January 28, 2017
(Shares in thousands)	Shares		Weighted-Average Fair Value on Date of Grant
Beginning of year balance	56		$	35.68
Granted	—		—
Vested	(36	)	44.45
Forfeited	(6	)	44.45
Balance at 1/28/2017, unvested	14		$	9.38

Share Repurchase Program

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On August 28, 2013 the Company's Board of Directors authorized a $25 million repurchase program for the Company's outstanding shares of common stock. The timing and amount of repurchases depend on various factors, including market conditions, the Company's capital position and internal cash generation, and other factors. The Company's repurchase program does not include specific price targets, may be executed through open-market, privately negotiated, and other transactions that may be available, and may include utilization of Rule 10b5-1 plans. The repurchase program does not obligate the Company to repurchase any dollar amount, or any number of shares, of common stock. The repurchase program does not have a termination date, and the Company may suspend or terminate the repurchase program at any time. Shares that are repurchased by the Company pursuant to the repurchase program are retired and resume the status of authorized and unissued shares of common stock. At January 28, 2017 the Senior ABL Facility permits us to repurchase our common stock.

No shares were repurchased during fiscal years 2016, 2015 or 2014. At January 28, 2017, we had $12.5 million of remaining authorization under the repurchase program.

NOTE 14—DEFINED CONTRIBUTION PLAN

We sponsor a Sears Hometown and Outlet Stores, Inc. 401(k) savings plan for employees meeting service-eligibility requirements. The Company offers a discretionary match contribution. The expense related to the savings plan has been determined in accordance with U.S. GAAP and the Company accrues the cost of these benefits during the years that employees render service.

Expenses for the retirement savings plan were as follows:



thousands	2016		2015		2014
401(k) Savings Plan	$	957	$	905	$	1,137

NOTE 15—SALE OF ASSETS

On July 27, 2016, we completed the sale of an owned property located in San Leandro, California. Net proceeds from the sale were $26.1 million , and we recorded a gain on the sale of $25.2 million when the sale was completed in accordance with the terms and conditions of the Purchase and Sale Agreement.

NOTE 16—STORE CLOSING CHARGES

We continue to take proactive steps to make the best use of capital and reduce costs. In the fourth quarter of 2016, we closed 109 locations ( 98 Hometown; 11 Outlet). The closings resulted in one-time charges of $16.2 million and $17.7 million for the fourth quarter and full year 2016, respectively. The $17.7 million full year 2016 charges include $8.5 million for lease terminations and future rent obligations, $7.2 million for inventory markdowns and write-offs, $0.6 million for writeoffs and impairment of fixed assets, and $1.4 million for other store-closing costs. As of January 28, 2017 we had $7.7 million in reserves remaining for future rent obligations, included in Other current liabilities on our Consolidated Balance Sheets.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

Sears Hometown and Outlet Stores, Inc.

Hoffman Estates, Illinois

We have audited the accompanying consolidated balance sheets of Sears Hometown and Outlet Stores, Inc. (the "Company") as of January 28, 2017 and January 30, 2016 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended January 28, 2017. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at January 28, 2017 and January 30, 2016, and the results of its operations and its cash flows for each of the three years in the period ended January 28, 2017 , in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of January 28, 2017 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 30, 2017 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP

BDO USA, LLP

Chicago, Illinois

March 30, 2017

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and 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 Exchange Act. 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 Annual Report on Form 10-K.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the Company's fourth fiscal quarter ended January 28, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management's Report on Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the reliability of financial reporting and the preparation and fair presentation of published financial statements.

All control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to the reliability of financial reporting and financial statement preparation and presentation.

Management assessed the effectiveness of the Company's internal control over financial reporting as of January 28, 2017, with the participation of our principal executive and principal financial officers. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on management's assessment, management believes that as of January 28, 2017, the Company’s internal controls over financial reporting were effective based on those criteria.

The effectiveness of the Company's internal control over financial reporting as of January 28, 2017 has been audited by BDO USA, LLP as stated in the following Report of Independent Registered Public Accounting Firm:

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

Sears Hometown and Outlet Stores, Inc.

Hoffman Estates, Illinois

We have audited the internal control over financial reporting of Sears Hometown and Outlet Stores, Inc. (the "Company") as of January 28, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, "Management’s Report on Internal Control over Financial Reporting". Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the COSO criteria .

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of January 28, 2017 and January 30, 2016 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended January 28, 2017 and our report dated March 30, 2017 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP

BDO USA, LLP

Chicago, Illinois

March 30, 2017

Part III

Item 10. Directors, Executive Officers and Corporate Governance.

Information required by this Item 10 with respect to directors, the Audit Committee, audit committee financial experts, and Section 16(a) beneficial ownership reporting compliance is included under the headings "Item 1. Election of Directors," "Corporate Governance-Director Independence," "Audit Committee Financial Experts," and "Other Information-Section 16(a) Beneficial Ownership Reporting Compliance" of the 2017 Proxy Statement and is incorporated herein by reference.

The information required by this Item 10 regarding the Company's executive officers is included under the heading "Executive Officers of Registrant" in Part I of this Annual Report on Form 10-K and is incorporated herein by reference.

SHO has adopted a Code of Conduct, which applies to all employees, including our principal executive officer and our principal financial officer and principal accounting officer, and a Code of Conduct for our Board of Directors. Directors who are also officers of SHO are subject to both codes of conduct. Each code of conduct is a code of ethics as defined in Item 406 of SEC Regulation S-K. The codes of conduct are available on the Governance section of our website, www.shos.com . Any amendment to, or waiver from, a provision of either code of conduct will be posted to the above-referenced website.

During the Company's 2016 fiscal year there were no changes to the process by which stockholders may recommend nominees to the Board of Directors.



Item 11.	Executive Compensation

Information regarding executive and director compensation is incorporated herein by reference to information under the headings "Item 1-Election of Directors-Executive Compensation," "Item 1-Election of Directors-Compensation of Directors," and "Item 1-Election of Directors-Executive Compensation-Compensation Committee Report" of the 2017 Proxy Statement. The material incorporated herein by reference to the information set forth under the heading "Item 1-Election of Directors-Compensation Committee Report" of the 2017 Proxy Statement shall be deemed furnished, and not filed, in this Annual Report on Form 10-K and shall not be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Exchange Act as a result of this furnishing except to the extent that it is specifically incorporated by reference by the Company.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information regarding security ownership of specified beneficial owners and management is incorporated herein by reference to the material under the heading "Item 1. Election of Directors-Amount and Nature of Beneficial Ownership" of the 2017 Proxy Statement.

Equity Compensation Plan Information

The below table reflects information, as of January 28, 2017, about securities authorized for issuance under our equity compensation plans.



Plan Category	(a) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (1)	(b) Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights (1)	(c) Number of Securities Remaining Available for Future Issuances Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
Equity Compensation Plans Approved by Security Holders	--	--	3,826,754 (2)
Equity Compensation Plans Not Approved by Security Holders	--	--	--
Total	--	--	3,826,754 (2)

(1) We have not issued any options, warrants, or other rights under the Sears Hometown and Outlet Stores, Inc. Amended and Restated 2012 Stock Plan that are exercisable for the purchase of shares of our common stock.

(2) A total of 4,000,000 shares of stock are reserved for issuance under the Company's Amended and Restated 2012 Stock Plan, consisting of restricted stock, stock units representing rights to receive cash or shares of our common stock, stock options, and stock appreciation rights. As of January 28, 2017 a total of 173,246 stock units and shares of restricted stock were outstanding.

Item 13. Certain Relationships and Related Transactions, and Director Independence

Information regarding certain relationships and related transactions with Sears Holdings, director independence, and independence of members of the Audit Committee of the Company's Board of Directors is incorporated herein by reference to information under the headings "Certain Relationships and Transactions" and "Corporate Governance" in the 2017 Proxy Statement.

Item 14. Principal Accountant Fees and Services

Information regarding principal accountant fees and services is incorporated herein by reference to the material under the heading "Item 3-Ratification of Appointment of Independent Registered Public Accounting Firm — Independent Registered Public Accounting Firm Fees" of the 2017 Proxy Statement.

Part IV

Item 15. Exhibits, Financial Statement Schedules.

Documents filed as part of this report:


(1)	Financial Statements

Financial Statements filed in Part II, Item 8 of this Annual Report on Form 10-K.

(2) Schedules to Financial Statements:

All financial statement schedules have been omitted because they are either inapplicable or the information required is provided in the Company's Consolidated Financial Statements and Notes thereto or included in Part II, Item 8 of this Annual Report on Form 10-K.

(3) List of Exhibits

Incorporated herein by reference is a list of the Exhibits contained in the Exhibit Index.

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SEARS HOMETOWN AND OUTLET STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Item 16. Form 10-K Summary

Not Applicable

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, Chief Administrative Officer, and Chief Financial Officer (principal financial officer and principal accounting officer)

Date:		March 30, 2017

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities stated and on the dates indicated.




* Will Powell Will Powell	Director, Chief Executive Officer and President (principal executive officer)	March 30, 2017
* Will Powell Will Powell

* E.J. Bird E.J. Bird	Chairman of the Board of Directors	March 30, 2017
* E.J. Bird E.J. Bird

* William K. Phelan William K. Phelan	Director	March 30, 2017
* William K. Phelan William K. Phelan

* James F. Gooch James F. Gooch	Director	March 30, 2017
* James F. Gooch James F. Gooch

* David Robbins David Robbins	Director	March 30, 2017
* David Robbins David Robbins

* Josephine Linden Josephine Linden	Director	March 30, 2017
* Josephine Linden Josephine Linden

* Kevin Longino Kevin Longino	Director	March 30, 2017

/ S /Ryan D. Robinson * By Ryan D. Robinson, Attorney in Fact		March 30, 2017

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EXHIBIT INDEX



Exhibit Number		Document Description
3.1		Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
3.2		Certificate of Amendment of Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.2 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
3.3		Amended and Restated Bylaws of Registrant (incorporated by reference to Exhibit 3.1 to Registrant's Current Report on Form 8-K filed December 9, 2013 (File No. 001-35641)).
4.1		Form of common stock certificate (incorporated by reference to Exhibit 4.1 to Registrant's Form S-1/A filed on August 31, 2012 (File No. 333-181051)).
10.1		Separation Agreement between Sears Holdings Corporation and Registrant dated as of August 8, 2012 (incorporated by reference to Exhibit 10.1 to Registrant's Form S-1/A filed on August 31, 2012 (File No. 333-181051)).
10.2		Amendment No. 1 to Separation Agreement between Registrant and Sears Holdings Corporation dated December 9, 2013 (incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended November 2, 2013 (File No. 001-35641)).
10.3		Store License Agreement between Sears, Roebuck and Co. and Sears Authorized Hometown Stores, LLC dated August 8, 2012 (incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.4		Store License Agreement between Sears, Roebuck and Co. and Sears Home Appliance Showrooms, LLC dated August 8, 2012 (incorporated by reference to Exhibit 10.3 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.5		Store License Agreement between Sears, Roebuck and Co. and Sears Outlet Stores, L.L.C. dated August 8, 2012 (incorporated by reference to Exhibit 10.4 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.6		Amendment No. 1 to Store License Agreement (Outlet) between Sears, Roebuck and Co. and Sears Outlet Stores, L.L.C. dated December 9, 2013 (incorporated by reference to Exhibit 10.6 to Registrant's Annual Report on Form 10-K for the fiscal year ended February 1, 2014 (File No. 001-35641)).
10.7		Amendment No. 2 to Store License Agreement (Outlet) between Sears, Roebuck and Co. and Sears Outlet Stores, L.L.C. dated May 11, 2016 (incorporated by reference to Exhibit 10.6 to Registrant's Current Report on Form 8-K filed May 17, 2016 (File No. 001-35641)).
10.8		Trademark License Agreement between Sears, Roebuck and Co. and Registrant dated August 8, 2012 (incorporated by reference to Exhibit 10.5 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.9(1)		Amendment No. 4 to Merchandising Agreement between (1) Sears, Roebuck and Co., Kmart Corporation and Sears Holdings Corporation and (2) Registrant, Sears Authorized Hometown Stores, LLC and Sears Outlet Stores, L.L.C. dated May 11, 2016 (incorporated by reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K filed May 17, 2016 (File No. 001-35641)).
10.10(1)(4)		Amended and Restated Merchandising Agreement between (1) Sears, Roebuck and Co., Kmart Corporation and Sears Holdings Corporation and (2) Registrant, Sears Authorized Hometown Stores, LLC, and Sears Outlet Stores, L.L.C. dated May 11, 2016.
10.11		Amendment to Amended and Restated Merchandising Agreement between (1) Sears, Roebuck and Co. and Kmart Corporation and (2) Registrant, Sears Authorized Hometown Stores, LLC, and Sears Outlet Stores, L.L.C. dated March 8, 2017 (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed March 9, 2017 (File No. 001-35641)).
10.12		Services Agreement between Sears Holdings Management Corporation and Registrant dated August 8, 2012 (incorporated by reference to Exhibit 10.7 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.13		Amendment No. 1 to Services Agreement between Registrant and Sears Holdings Management Corporation dated December 9, 2013 (incorporated by reference to Exhibit 10.3 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended November 2, 2013 (File No. 001-35641)).
10.14		Amendment No. 2 to Services Agreement between Registrant and Sears Holdings Management Corporation dated April 23, 2014 (incorporated by reference to Exhibit 10 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended May 3, 2014 (File No. 001-35641)).

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EXHIBIT INDEX



10.15		Amendment No. 3 to Services Agreement between Registrant and Sears Holdings Management Corporation dated March 11, 2015 (incorporated by reference to Exhibit 10.14 to Registrant's Annual Report on Form 10-K for the fiscal year ended January 31, 2015 (File No. 001-35641)).
10.16(1)		Amendment No. 4 to Services Agreement between Registrant and Sears Holdings Management Corporation dated May11, 2016 (incorporated by reference to Exhibit 10.3 to Registrant's Current Report on Form 8-K filed May 17, 2016 (File No. 001-35641)). .
10.17(1)		Retail Establishment Agreement between Sears Holdings Management Corporation and Registrant (incorporated by reference to Exhibit 10.8 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.18		Amendment No. 1 to Shop Your Way Retail Establishment Agreement between Sears Holdings Management Corporation and Registrant dated May 11, 2016 (incorporated by reference to Exhibit 10.7 to Registrant's Current Report on Form 8-K filed May 17, 2016 (File No. 001-35641)).
10.19(2)(4)		Amendment No. 2 to the Shop Your Way Retail Establishment Agreement between Sears Holdings Management Corporation and Registrant dated February 2, 2017.
10.20		Tax Sharing Agreement between Sears Holdings and Registrant dated as of August 8, 2012 (incorporated by reference to Exhibit 10.9 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.21		Employee Transition and Administrative Services Agreement between Sears, Roebuck and Co., Registrant, Sears Authorized Hometown Stores, LLC and Sears Outlet Stores, L.L.C. dated as of August 31, 2012 (incorporated by reference to Exhibit 10.10 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended July 28, 2012 (File No. 001-35641)).
10.22		Statement of Work #1 to Employee Transition and Administrative Services Agreement between (i) Registrant, Sears Authorized Hometown Stores, LLC, and Sears Outlet Stores, L.L.C. and (ii) Sears Holdings Management Corporation dated December 9, 2013 (incorporated by reference to Exhibit 10.5 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended November 2, 2013 (File No. 001-35641)).
10.23		Amendment No. 1 to Employee Transition and Administrative Services Agreement between Sears, Roebuck and Co., Registrant, Sears Authorized Hometown Stores, LLC and Sears Outlet Stores, L.L.C. dated May 11, 2016 (incorporated by reference to Exhibit 10.5 to Registrant's Current Report on Form 8-K filed May 17, 2016 (File No. 001-35641)).
10.24		Supplemental Agreement between Registrant and Sears Holdings Corporation dated December 9, 2013 (incorporated by reference to Exhibit 10.4 to Registrant's Quarterly Report on Form 10-Q for the quarterly period ended November 2, 2013 (File No. 001-35641)).
10.25		Amendment No. 1 to Supplemental Agreement between Registrant and Sears Holdings Corporation dated May 11, 2016 (incorporated by reference to Exhibit 10.4 to Registrant's Current Report on Form 8-K filed May 17, 2016 (File No. 001-35641)). .
10.26(3)		Sears Hometown and Outlet Stores, Inc. Umbrella Incentive Program (incorporated by reference to Exhibit 10.11 to the Registrant's Form S-1/A filed on August 31, 2012 (File No. 333-181051)).
10.27(3)		Sears Hometown and Outlet Stores, Inc. Annual Incentive Plan (incorporated by reference to Exhibit 10.12 to Registrant's Form S-1/A filed on August 31, 2012 (File No. 333-181051)).
10.28(3)		Sears Hometown and Outlet Stores, Inc. Long-Term Incentive Program (incorporated by reference to Exhibit 10.13 to Registrant's Form S-1/A filed on August 31, 2012 (File No. 333-181051)).
10.29(3)		Sears Hometown and Outlet Stores, Inc. Amended and Restated 2012 Stock Plan (incorporated by reference to Exhibit 10.14 to Registrant's Annual Report on Form 10-K for the fiscal year ended January 31, 2015 (File No. 001-35641)).
10.30(3)		Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.1 to Registrant's Form S-8 filed on May 16, 2013 (File No. 333-188645)).
10.31(3)		Form of Amended and Restated Executive Severance Agreement (incorporated by reference to Exhibit 10.27 to Registrant's Annual Report on Form 10-K for the fiscal year ended January 30, 2016 (File No. 001-35641)). .
10.32(3)		Form of Cash Retention Agreement (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed April 21, 2015 (File No. 001-35641)).
10.33(3)		Form of Stock Units Agreement (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed February 3, 2017 (File No. 001-35641)).

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EXHIBIT INDEX



10.34(3)		Amended and Restated Executive Severance Agreement dated July 1, 2015 between Registrant and Will Powell (incorporated by reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K filed July 1, 2015 (File No. 001-35641)).
10.35(3)		Letter agreement between Registrant and Will Powell dated July 1, 2015 (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed July 1, 2015 (File No. 001-35641).
10.36(3)		Retention Agreement between Registrant and Will Powell dated September 14, 2016 (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed September 16, 2016 (File No. 001-35641)).
10.37(3)		Executive Severance Agreement dated June 10, 2014 between Registrant and Ryan D. Robinson (incorporated by reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K filed June 12, 2014 (File No. 001-35641)).
10.38(3)		Letter agreement between Registrant and Ryan D. Robinson, dated June 10, 2014 (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed June 12, 2014 (File No. 001-35641)).
10.39(3)		Letter agreement between Registrant and Charles J. Hansen, dated August 28, 2012 (incorporated by reference to Exhibit 10.21 to Registrant's Form S-1/A filed on August 31, 2012 (File No. 333-181051)).
10.40(3)		Letter agreement between Registrant and David J. Buckley dated July 1, 2015 (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed July 1, 2015 (File No. 001-35641).
10.41(3)		Letter agreement between Registrant and Michael A. Gray dated October 10, 2012 (incorporated by reference to Exhibit 10.37 to Sears Holdings Corporation's Annual Report on Form 10-K for the fiscal year ended January 30, 2016 (File No. 000-51217)).
10.42		Amended and Restated Credit Agreement, dated November 1, 2016, among Sears Authorized Hometown Stores, LLC and the other borrowers named therein, Registrant, and Bank of America, N.A., as Administrative Agent and Collateral Agent, and other lenders party thereto, as lenders (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed November 7, 2016 (File No. 001-35641)).
10.43		Amended and Restated Guaranty and Security Agreement, dated November 1, 2016, by Sears Authorized Hometown Stores, LLC, and other borrowers and guarantors party thereto and Bank of America, N.A., as Agent (incorporated by reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K filed November 7, 2016 (File No. 001-35641)).
21(4)		Subsidiaries of Registrant.
23(4)		Consent of BDO USA, LLP.
24(4)		Powers of Attorney.
31.1(4)		Certification of Chief Executive Officer Required Under Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.
31.2(4)		Certification of Chief Financial Officer Required Under Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.
32.1(4)		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.
101(5)		The following financial information from the Annual Report on Form 10-K for the fiscal year ended January 28, 2017, formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Statements of Operations for the fiscal years ended January 28, 2017, January 30, 2016, and January 31, 2015; (ii) the Consolidated Balance Sheets at January 28, 2017 and January 30, 2016; (iii) the Consolidated Statements of Cash Flows for the fiscal years ended January 28, 2016, January 30, 2016, and January 31, 2015; (iv) the Consolidated Statements of Stockholders' Equity for the fiscal years ended January 28, 2017, January 30, 2016, and January 31, 2015; and (v) the Notes to the Consolidated Financial Statements.


(1)	The Securities and Exchange Commission granted the Company's request for confidential treatment for the omitted portions of this Exhibit. The Company has separately filed the omitted portions with the Securities and Exchange Commission.


(2)	Specified provisions of this Exhibit have been omitted and separately filed by the Company with the Securities and Exchange Commission pursuant to the Company's request for confidential treatment.


(3)	A management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 15(b) of Form 10-K.


(4)	Filed herewith.


(5)	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

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SEARS HOMETOWN AND OUTLET STORES, INC.

EXHIBIT INDEX

purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

The use of “[***]” in this Exhibit indicates that confidential numbers have been omitted pursuant to a grant of confidential treatment by the Securities and Exchange Commission. The omitted numbers have been filed separately with the Securities and Exchange Commission. The use of “#” in this Exhibit indicates that the omitted numbers are in a range of numbers none of which exceeds 6.

Exhibit 10.10

AMENDED AND RESTATED MERCHANDISING AGREEMENT

BETWEEN

SEARS, ROEBUCK AND CO.,

KMART CORPORATION, AND

SEARS HOLDINGS CORPORATION

AND

SEARS HOMETOWN AND OUTLET STORES, INC.,

SEARS AUTHORIZED HOMETOWN STORES, LLC,

AND SEARS OUTLET STORES, L.L.C.,

TABLE OF CONTENTS

1. ADDITIONAL TERMS AND CONDITIONS . 1

2. TERM AND TERMINATION . 1

(a) Initial Term. 1

(b) The Term; Renewal Rights. 1

(d) Seller’s Right to Terminate Its Section 3 Obligations. 3

(e) Seller’s Termination Rights on Appendix 5(a). 4

(f) Seller’s Termination of an Individual Market. 4

(g) Buyer’s Transition and Sell-Off Rights. 4

3. HTS PRODUCTS . 4

(a) Seller’s Obligation to Sell. 4

(b) Invoice Prices for HTS Products. 5

(d) Retail Pricing. 5

(e) HTS Product Quality, Availability, and Packaging. 6

(f) Location-Specific Products. 6

(g) Buyer-Unique Products. 7

(h) Buyer-Direct Merchandise. 8

4. OUTLET PRODUCTS . 8

(a) Section 4 Definitions 8

(b) DRM.. 9

(d) Land’s End. 9

(e) Right of First Offer for Additional Categories. 9

(f) Seller’s Compliance with Rights of First Offer; Termination. 9

(g) Retail Pricing. 10

(h) Invoice Prices for Outlet Products. 10

(i) Non-Saleable DRM Products. 10

(j) Delivery of Outlet Products. 10

(k) Outlet Product Restrictions. 10

(l) Sale of Additional Outlet Products. 11

(m) Sale of Additional LG DRM Product. 13

5. ROYALTIES . 13

(a) Quarterly Royalty Reports; Royalties Payable. 13

(b) Commercial Sales 14

(d) Featuring Kenmore-Branded Product. 15

(e) Minimum Commission. 15

(f) Record Retention; Audit Rights. 15

6. INVENTORY MANAGEMENT POLICES AND PROCESSES; DELIVERY TERMS . 16

7. PAYMENT TERMS FOR INVOICE PRICES AND ROYALTIES . 16

(a) Invoice Prices for Products. 16

(b) Royalties. 16

8. SUBSIDIES AND MARKETING/MERCHANDISING SUPPORT . 16

(a) Vendor Subsidies. 16

(b) Product Information Support. 18

9. CUSTOMERS AND TRADE AREAS . 18

(a) General. 18

(b) Buyer. 19

(d) Growth. 21

(e) New HTS Stores and Renewals-Exclusivity. 21

10. PRODUCT WARRANTIES AND RETURNS . 21

(a) Product Warranties. 21

(b) Product Returns. 22

(d) Product Recalls and Similar Product Issues. 23

(e) Disclaimer. 24

11. PRODUCT SERVICING . 24

12. INTELLECTUAL PROPERTY . 24

(a) Seller 24

(b) Buyer 28

13. CONFIDENTIALITY . 29

(a) Confidential Information. 29

(b) Treatment of Confidential Information. 29

14. INDEMNIFICATION . 30

(a) Seller Indemnities 30

(b) Buyer Indemnities. 30

(d) Exclusions from Claims; Tender and Cooperation. 31

15. INSURANCE . 31

(a) Required Coverage. 31

(b) Proof of Insurance. 32

16. LIMITATION ON LIABILITY . 32

17. MINIMUM QUANTITIES . 32

18. DISPUTE RESOLUTION . 32

(a) Committees. 32

(b) Dispute Resolution. 33

19. SELLER’S CLOSING LOCATIONS . 34

20. GLOSSARY . 34

21. SHC’S SOLE OBLIGATION . 39

22. GENERAL . 39

(a) Good Faith. 39

(b) Assignment. 39

(d) Promotional Calendars. 40

(e) Negotiating Event. 40

(f) Consideration. 40

(g) Construction and Interpretation. 40

(h) Counterparts; Facsimile. 41

(i) Entire Agreement; Severability. 41

(j) Injunctive Relief. 41

(k) Notices. 42

(l) No Waiver. 43

(m) Publicity. 43

(n) Relationship of the Parties. 43

(o) Reporting. 43

(p) Representations and Warranties. 43

(q) Recalculation of Charges, Fees and Expenses. 43

(r) Survival. 43

(s) Condition Precedent to the Effectiveness of this Agreement. 43

(t) Governing Law; Jurisdiction; Waiver of Jury Trial. 44

Appendices

Appendix 1 Additional Terms and Conditions 42

Appendix 3(a) HTS Product Categories 45

Appendix 3(b) HTS Invoice Prices 46

Appendix 4(b) Invoice Prices for DRM 47

Appendix 4(c) MOS Categories and Initial MOS Invoice Prices 49

Appendix 4(m) Additional LG DRM Product Sort Process 51

Appendix 5(a) Royalty Rates; Kenmore Royalty Credits 52

Appendix 5(e) Average Aggregate Minimum Commission 58

Appendix 6 Inventory Management Policies and Processes 59

Appendix 7(a) Payment Due Date 67

Appendix 9(a)(ii) Kmart Locations 68

Appendix 12(a)(iii) Seller Marks 69

Appendix 18(a)(i) Merchandising Operating Committee 70

AMENDED AND RESTATED MERCHANDISING AGREEMENT

This Amended and Restated Merchandising Agreement (this “ Agreement ”) is, except as expressly stated herein, retroactive to May 1, 2016 (the “ Effective Date ”) and is between (1) SEARS, ROEBUCK AND CO., a New York corporation (“ SRC ”), KMART CORPORATION, a Michigan corporation (“ Kmart ” and together with SRC, “ Seller ”), and SEARS HOLDINGS CORPORATION, a Delaware corporation (“ SHC ”), and (2) SEARS HOMETOWN AND OUTLET STORES, INC., a Delaware corporation (“ SHO ”), SEARS AUTHORIZED HOMETOWN STORES, LLC, a Delaware limited liability company ( SAHS ”), and SEARS OUTLET STORES, L.L.C., a Delaware limited liability company (“ Outlet Co. ” and together with SHO and SAHS, “ Buyer ”) and is signed on the dates set forth below. Other capitalized terms used but not defined in this Agreement are defined in Section 20 , which begins on page 35.

TERMS AND CONDITIONS

For good and valuable consideration, the receipt of which Seller and Buyer acknowledge, Seller and Buyer agree as follows:

ADDITIONAL TERMS AND CONDITIONS . The Additional Terms and Conditions that are attached to this Agreement as Appendix 1 are incorporated into this Agreement by reference and are binding on Seller and Buyer as if expressly included below. To the extent any provision on Appendix 1 is inconsistent with the body of this Agreement, the body of this Agreement controls.

TERM AND TERMINATION .

Initial Term . The initial term of this Agreement begins on the Effective Date and will end, unless terminated earlier or extended in accordance with Section 2(c) or Section 2(d) , at 5:00 p.m. (Central Time) on February 1, 2020 (the “ Initial Term ”). A “ Contract Year ” begins on the first day of a Seller’s fiscal year and ends on the last day of the Seller’s fiscal year, except that the first Contract Year begins on the Effective Date and ends on January 28, 2017.

The Term; Renewal Rights . Subject to Section 2(c) , Section 2(d) , and the next sentences of this Section 2(b) , Buyer may elect to extend for one three-year period Seller’s obligations in Section 3 to sell KCD-Branded Products to Buyer. Buyer may not exercise its rights in the preceding sentence if Buyer or any of its Affiliates has failed to comply with any of its material obligations in this Agreement and the failure is continuing. The renewal period is referred to as the “ Renewal Period ” and references to the “Second Renewal Period” in the other agreements between the Parties and/or their Affiliates shall be deemed to refer to such Renewal Period. Buyer will deliver written notice to Seller not later than six months prior to the end of the Initial Term if Buyer elects to extend the Term for the Renewal Period. The Initial Term and the Renewal Period (if elected) are together referred to as the “ Term ” and the last day of the Term is referred to as the “ Expiration Date .” This Agreement applies to all Products shipped on or after the Effective Date and before the Expiration Date, regardless of when Buyer placed the order for the Products.

Termination of the Agreement . Neither Party may exercise its rights in this Section 2(c) if the Party or any of its Affiliates has failed to comply with any of its material obligations in this Agreement and the failure is continuing.

Termination for Material Breach . Subject to the next sentence and to Section 18 , (A) Seller or Buyer may terminate this Agreement in the event of a material breach of this Agreement by the other Party, including Seller’s right to terminate this Agreement if Buyer purports to assign any of its rights or delegate any of its obligations under this Agreement in contravention of Section 22(b) , if the breach is curable by the breaching Party and the breaching Party fails to cure the breach within 30 days following its receipt of written notice of the breach from the non-breaching Party. If the breach is not curable by the breaching Party, the non-breaching Party may immediately terminate this Agreement following the non-breaching Party’s delivery of notice to the breaching Party.

Seller’s Right to Terminate upon a KCD Change in Control .

Subject to the following sentences of this Section 2(c)(ii)(A) , if a KCD Change in Control occurs during the Initial Term Seller may, by written notice delivered to Buyer on or before the 60 ^th day following the effectiveness of the KCD Change in Control, terminate this Agreement. The termination will take effect on the date that is the first anniversary (the “ Section 2(c)(ii)(A) End Date ”) of the date that Seller delivered the written notice to Buyer in accordance with the preceding sentence. If the Section 2(c)(ii)(A) End Date is a date that is later than December 31, 2020, the Initial Term will be extended for all purposes of this Agreement to include the period ending on the Section 2(c)(ii)(A) End Date unless Buyer notifies Seller in writing on or before the 15 ^th day following Buyer’s receipt of the notice referred to in the first sentence of this Section 2(c)(ii)(A) that the extension will not occur.

Subject to the following sentence of this Section 2(c)(ii)(B) , if a KCD Change in Control occurs during the Renewal Period Seller may, by written notice delivered to Buyer on or before the 60 ^th day following the effectiveness of the KCD Change in Control, terminate this Agreement. The termination will take effect on the date that is the earlier of (1) the end of the Renewal Period and (2) the first anniversary of the date that Seller delivered the written notice to Buyer in accordance with the preceding sentence.

Upon Seller’s exercise of its right to terminate this Agreement in accordance with Section 2(c)(ii)(A) or Section 2(c)(ii)(B) Buyer’s right to extend the Term of this Agreement in accordance with Section 2(b) will immediately terminate.

Seller’s Rights to Immediate Termination . Seller may terminate this Agreement effective immediately upon written notice to Buyer in the event that (A) Buyer purports to assign any of its rights or delegate any of its obligations under this Agreement in contravention of Section 22(b), (B) Buyer is unable to pay its debts as they mature or enters into a voluntary suspension of payments or voluntary or involuntary bankruptcy, makes an assignment for the benefit of creditors, has a receiver or trustee appointed for it or for any of its property, or adopts a resolution for winding-up, (C) a SHO Stockholding Change occurs, or (D) Buyer fails to comply with Section 12(a)(iii)(F) (New Name Request).

Termination in Response to Termination of Another Agreement. Seller or Buyer may terminate this Agreement (whichever Party is entitled to terminate, the “ Terminating Party ”) effective immediately upon 30-days’ advance written notice to the other Party if (A) the Terminating Party or any of its Affiliates terminates the Separation Agreement in accordance with its terms as a result of a material breach of, or a material default by, the other Party or its Affiliates of their obligations in the Separation Agreement, (B) the Terminating Party or any of its Affiliates terminates the Services Agreement in accordance with its terms as a result of a material breach of, or a material default by, the other Party or its Affiliates of their obligations in the Services Agreement, (C) the Terminating Party or any of its Affiliates terminates a License Agreement in accordance with its terms as a result of a material breach of, or a material default by, the other Party or its Affiliates of their obligations in the License Agreement, or (D) the Terminating Party or any of its Affiliates terminates the SYW Agreement in accordance with its terms as a result of a material breach of, or a material default by, the other Party or its Affiliates of their obligations in the SYW Agreement. “ License Agreement ” means each of the following, each dated August 8, 2012: the Store License Agreement between SAHS and SRC; the Store License Agreement between Outlet Co. and SRC; the Store License Agreement between Sears Home Appliance Showrooms, LLC and SRC; and the Trademark License Agreement between SHO and SRC. “ Services Agreement ” means the Services Agreement dated August 8, 2012 between SHMC and SHO, as amended. “ SYW Agreement ” means the Shop Your Way Rewards Retail Establishment Agreement dated August 8, 2012 between SHMC and SHO.

Cross Default . A Party’s breach of the Services Agreement constitutes a breach by the breaching Party of this Agreement (which breach may only be cured, if at all, in accordance with the express provisions of the Services Agreement). The non-breaching Party’s remedies under this Section 2(c)(v) are in addition to and not in lieu of any and all other legal and equitable remedies available to the non-breaching Party under this Agreement and under the Services Agreement.

Seller’s Right to Terminate Its Section 3 Obligations . Seller may not exercise its rights in this Section 2(d) if Seller or any of its Affiliates has failed to comply with any of its material obligations in this Agreement and the failure is continuing.

Subject to the following sentences of this Section 2(d)(i) , if a KCD Mark Acquisition occurs during the Initial Term Seller may, by written notice delivered to Buyer on or before the 60 ^th day following the effectiveness of the KCD Mark Acquisition, terminate Seller’s obligations in Section 3 to sell all KCD-Branded Products that are branded with a KCD Mark that is the subject of the KCD Mark Acquisition. The termination will take effect on the date that is the first anniversary (the “ Section 2(d)(i) End Date ”) of the date that Seller delivered the written notice to Buyer in accordance with the preceding sentence. If the Section 2(d)(i) End Date is a date that is later than December 31, 2020, the Initial Term will be extended for all purposes of this Agreement to include the period ending on the Section 2(d)(i) End Date unless Buyer notifies Seller in writing on or before the 15 ^th day following Buyer’s receipt of the notice referred to in the first sentence of this Section 2(d)(i) that the extension will not occur.

Subject to the following sentence of this Section 2(d)(ii) , if a KCD Mark Acquisition occurs during the Renewal Period, Seller may, by written notice delivered to Buyer on or before the 60 ^th day following the effectiveness of the KCD Mark Acquisition, terminate Seller’s obligations in Section 3 to sell all KCD-Branded Products that are branded with a KCD Mark that is the subject of the KCD Mark Acquisition. The termination will take effect on the date that is the earlier of (A) the end of the Renewal Period and (B) the first anniversary of the date that Seller delivered the written notice to Buyer in accordance with the preceding sentence.

When a termination in accordance with this Section 2(d) takes effect Buyer’s renewal rights in Section 2(b) will immediately terminate with respect to all KCD-Branded Products that are branded with the KCD Mark or KCD Marks that are the subject of the KCD Mark Acquisition.

Seller’s Termination Rights on Appendix 5(a) . Seller has termination rights that are specified on Appendix 5(a) .

Seller’s Termination of an Individual Market . If Seller or its Affiliates decides to initiate a Market Exit, Seller may, upon 60-days’ advance written notice delivered to Buyer, terminate Seller’s obligations in this Agreement with regard to the Geographic Market specified in the written notice. A Market Exit does not prohibit Buyer from transporting Products to and selling Products, including Products bearing a Seller Mark, within the affected Geographic Market; subject to SHO’s obligation to comply with all Applicable Laws. For purposes of this Agreement, a “ Market Exit ” means that Seller and its Affiliates close all physical stores operated by Seller or its Affiliates in such Geographic Market (but expressly excluding online sales) and close all of Seller’s and its Affiliates warehousing, distribution, logistics, and other support activities for its and its Affiliates’ physical stores in the Geographic Market. A “ Geographic Market ” means a state, territory or other similarly sized region (e.g., Rhode Island, Puerto Rico or Guam). In the event of a Market Exit, Buyer may request that Seller continue to perform some or all of its obligations under this Agreement; Seller has no obligation to agree to such request, and may condition its acceptance on new or modified terms and conditions (including changes in pricing); any such agreement must be documented in writing and signed by both Parties (after receipt of necessary internal approvals), to be effective.

Buyer’s Transition and Sell-Off Rights . Subject to the next sentence, upon termination of this Agreement for any reason or upon expiration of this Agreement Seller will provide Buyer with all reasonable transition services (“ Transition Assistance ”) for a period beginning on the date of termination or expiration and ending on or before the 180 ^th day after thereafter (the “ Transition Period ”). This Section 2(g) is not applicable if a termination of this Agreement occurs in accordance with Section 2(c)(i) , Section 2(c)(ii) , Section 2(c)(iii) , or Section 2(d) . The Transition Assistance will include enabling Buyer to transition from the Products to the products of another provider and will include Seller’s continued sale of Products, and continued provision of services that are necessary to implement the continued sale of Products (including all services to be provided by Seller that are described on Appendix 6 ), to Buyer in accordance with the terms and conditions of this Agreement to the extent necessary for an orderly transition. During the Transition Period (i) the HTS Invoice Prices, the Outlet Invoice Prices, and Royalties will be the HTS Invoice Prices, the Outlet Invoice Prices, and the Royalties, respectively, in effect immediately prior to the termination or expiration of this Agreement and (ii) the prices for services provided by Seller to Buyer in accordance with this Agreement will be the prices for the services in effect immediately prior to the termination or expiration of this Agreement. For all other Transition Assistance, Seller will not charge Buyer fees that exceed Seller’s then-standard rates (taking into account the average discount Seller provides to comparable wholesale or licensee customers). During the Transition Period Seller and Buyer will perform all of the terms and conditions of this Agreement to be performed and observed by each of them as if this Agreement were in full force and effect during the Transition Period. During the Transition Period and thereafter Buyer will use commercially reasonable efforts to sell off all of the Products in Buyer’s inventory in accordance with the terms of this Agreement.

HTS PRODUCTS .

Seller’s Obligation to Sell . Subject to the other sentences of this Section 3(a) , subject to Sections 2(c) , 2(d) , and 2(e) , and in accordance with Section 6 , Buyer may purchase from Seller, and Seller will sell to Buyer, all of the products that Seller from time to time purchases from Vendors that are included in the product categories listed on Appendix 3(a) (the product categories together the “ HTS Product Categories ” and the products together the ” HTS Products ”) other than Customer-Specific Products and Non-Retail Products. Buyer acknowledges that Seller’s obligations to sell the HTS Products to Buyer in accordance with this Agreement is subject to Seller’s Vendors agreeing to sell the HTS Products to Seller for resale to Buyer on commercially reasonable terms and conditions, over which Seller may have little or no control. Subject to Section 3(b) , Seller will take commercially reasonable actions necessary to acquire HTS Products for sale to Buyer at the best prices to Seller or its Affiliates available from Vendors. Seller will (i) not refuse or otherwise cease to sell to Buyer any HTS Product that is available for purchase on commercially reasonable terms from a Vendor except on 12-months’ prior written notice to Buyer, and (ii) promptly notify Buyer if a Vendor discontinues an HTS Product.

“ Customer-Specific Product ” is a product that Seller sells to a customer that is a reseller (other than Buyer and Seller’s Retail Businesses) and the product includes branding, trade dress, or significant features that are unique to the customer.

“ Non-Retail Product ” is a product that Seller does not sell to end-user consumers.

“ Seller’s Retail Businesses ” means all retail businesses operated by Seller and its Affiliates including Sears stores and Kmart stores and including Sears.com, Kmart.com, and all other retail businesses operated by Digital Methods.

Invoice Prices for HTS Products . The invoice prices for the HTS Products that Seller will sell to Buyer are described on Appendix 3(b) (the “ HTS Invoice Prices ”). The HTS Invoice Price of each HTS Product will include (and will not be charged additionally to Buyer) all costs of manufacturing and delivering the Products to the FOB Point, including (i) all duties and taxes (including excise and withholding taxes) payable in any country where production or delivery takes place, (ii) all commissions to selling agents, and (iii) other incidental charges. Seller’s invoices will itemize for Buyer each 3(b) Amount described on Appendix 3(b) to the extent Seller’s systems permits itemization. If a value-added tax is imposed in the Territory that is applicable to Seller’s sale of HTS Products to Buyer then Seller and Buyer will negotiate in Good Faith an amendment to this Agreement, the terms of which would adjust the HTS Invoice Prices or make other changes to this Agreement (to make Seller whole on the Sale of HTS Products to Buyer and its Affiliates) given the imposition of the tax. For clarity, the parties note that, Seller is, where required by applicable law, entitled to charge Buyer under this Agreement for all value-added and sales taxes. For clarity, the parties note the term “HTS Invoice Price” in the Agreement includes amounts that were previously included in Seller’s invoice costs for HTS Products but which amounts Seller agrees with the vendor of the HTS Products to pay separately to the vendor (“ Added Costs ”). Buyer shall pay its share of all Added Costs; regardless of when they are incurred. Seller has provided, and shall provide, Buyer prompt notice of all Added Costs and changes to Added Costs after they are agreed to by Seller and its vendors, after which notice Buyer may as soon as reasonably practicable revise its forecasts for HTS Products for which Seller has not yet entered a purchase order into its purchase order system and that are affected by the noticed Added Costs or changes thereto.

Vendor Charges . With respect to HTS Products sold to Buyer in accordance with this Agreement, Seller may charge back to Buyer all price adjustments, charges, and penalties that Seller is obligated to pay to its Vendors that occur to the extent due to the direct result of Buyer’s act or omission, including failure to comply with Vendor policies.

Retail Pricing . Buyer will determine advertised prices, promotional prices, and retail prices for all HTS Products in Buyer’s sole discretion. Any agreement or understanding to the contrary is unauthorized, in conflict with Buyer’s and Seller’s policies, and a violation of the terms and conditions of this Agreement. Buyer is aware that Seller’s Vendors from time to time adopt minimum advertised price policies (“ MAP ”) and unilateral pricing policies (“ UPP ”) that may apply to Seller and its sale of HTS Products to Buyer in accordance with the terms and conditions of this Agreement. Buyer is also aware that the failure to comply with a Vendor’s MAP or UPP could result in the Vendor’s imposition of financial penalties on Seller and the Vendor’s refusal to sell one or more HTS Products to Seller, which ultimately could result in Seller’s inability to sell one or more HTS Products to Buyer in accordance with the terms and conditions of this Agreement. Buyer is also aware that Seller could seek to implement its own MAP and UPP with respect to HTS Products.

HTS Product Quality, Availability, and Packaging . Subject to Section 3(a) , all HTS Products that are sold by Seller or its Affiliates to other customers (including Seller’s Retail Businesses) will be identical in all respects, to the HTS Products sold by Seller or its Affiliates to Buyer except for required changes to packaging and labeling that are required by Applicable Law or for which Buyer bears the entire cost. Seller will use commercially reasonable efforts to include in HTS Products available to Buyer all new products and product innovations that Seller purchases from Vendors so that Buyer will have the opportunity to offer HTS Products that are as compelling to Buyer’s end-user consumers as Seller’s comparable product offerings in its full line stores. Seller will obtain Buyer’s prior written approval for all initial KCD-Unique Product packaging specifications and graphic designs and for all changes to them.

Location-Specific Products . Buyer may sell each Location-Specific Product only in accordance with Seller’s requirements as to where the Location-Specific Product may be sold. A “ Location-Specific Product ” is an HTS Product, other than a Customer-Specific Product and a Non-Retail Product, that Seller sells to resellers (including Seller’s Retail Businesses) and as to which Seller requires all of the resellers to resell only at “bricks and mortar” physical locations or by Digital Methods.

Buyer-Unique Products . Subject to Sections 2(c) , 2(d) , and 2(e) , and in accordance with Section 6 , Buyer may purchase from Seller, and Seller will sell to Buyer, Buyer-Unique Products (subject to the terms, conditions and exceptions set forth below). Buyer acknowledges that Seller’s obligations to sell Buyer-Unique Products to Buyer in accordance with this Agreement is subject to vendors agreeing to sell the Buyer-Unique Products to Seller for resale by Buyer on commercially reasonable terms and conditions, over which Seller may have little or no control. Subject to the provisions of this Section 3(g) and Sections 3(b) and 3(h) , Seller will take commercially reasonable actions necessary to acquire Buyer-Unique Products for sale to Buyer at the best prices to Seller or its Affiliates available from vendors; provided that Seller is not obligated to acquire any products which: (x) would harm Seller’s relationship with another Seller vendor,(y) would impose unique risks or obligations on Seller (e.g., products not covered by Seller which have unique storage, shipping, or compliance requirements). Subject to the foregoing sentence, Seller will (x) not refuse to sell to Buyer any Buyer-Unique Product that is available for purchase on commercially reasonable terms from a Vendor, and (y) promptly notify Buyer if a Vendor discontinues a Buyer-Unique Product . During Seller’s 2016 fiscal year, Seller has agreed to hold up to $13 million of Buyer-Unique Products inventory based upon a forecast of needs that Buyer has provided. On or before September 30 ^th of each year during the Term, Buyer may request in writing that Seller sell Buyer-Unique Products up to a specified dollar amount during Seller’s next fiscal year. Seller will consider such request in Good Faith, and Seller will establish a limit on the amount of Buyer-Unique Products it is willing to buy for Buyer based upon its own inventory needs, finances and other relevant factors. The amounts established under the immediately preceding two sentences will be used in establishing the BUP Cap for each Contract Year pursuant to Appendix 6 ( Inventory Management Policies and Processes ).

“ Buyer-Unique Products ” are new in-box products in the HTS Product Categories that Buyer seeks to purchase from Seller and that Seller sells to Buyer but are not offered for sale contemporaneously by Seller at Seller’s FLS Stores. Buyer-Unique Products include vendor branded products (the “ Vendor-Unique Products ”) and KCD-Unique Products (as defined below). Buyer-Unique Products includes all Vendor-Unique Products which Seller is selling to Buyer on the Effective Date. Seller may, at any time, elect to begin selling any or all Buyer-Unique Product(s) at Seller’s FLS Stores or on Sears.com and Buyer shall not object to, or take any action to prevent, Seller from selling Buyer-Unique Products at Seller’s FLS Stores. If Seller intends to begin selling Buyer-Unique Products at Seller’s FLS Stores (vs Sears.com), Seller shall forecast its needs to its Vendors and Seller will not floor Buyer-Unique Products until Seller has sufficient supply so as to not interfere with Buyer’s reasonably anticipated needs (based on Buyer’s forecasts and sales). Once Seller begins selling Buyer-Unique Products either in store or online, then such Products shall become HTS Products. If Seller stops selling an HTS Product at its FLS Stores, such Product shall become a Buyer-Unique Product if: (A) Buyer indicates it wishes to continue to sell such Product, (B) Seller is able to continue to purchase such Product on commercially reasonable terms, and (C) in the case of a Products branded with a KCD Mark, SBMC (as defined below) authorizes the sale of such product to Buyer as set described in Section 3(g)(ii) . Buyer may request that Seller add additional Buyer-Unique Products from time to time and Seller will not unreasonably withhold or delay its approval of such items. Grounds for Seller denying such a request include issues such as: (x) Seller would not be fully reimbursed for its costs associated with such Product under this Agreement, (y) the new Buyer-Unique Product is outside of the specifications of Products handled at that time by Seller’s supply chain organization (e.g., too big, too fragile), and (z) environmental or other regulatory concerns.

Seller shall use commercially reasonable efforts to purchase Vendor-Unique Products for resale to Buyer until such time as Buyer has established its own PO System (as defined in the Services Agreement). Upon completion of Buyer’s PO System, Buyer shall purchase all Vendor-Unique Products as Buyer-Direct Merchandise.

“ KCD-Unique Products” are new in-box products in the HTS Product Categories branded with a KCD Mark that Seller is not presently buying and that Seller’s Affiliate, Sears Brands Management Corporation (“ SBMC ”), agrees in advance and in writing, that Seller may sell to Buyer. SBMC has no obligation to agree to sell any KCD-Unique Products to Seller and may decline to do so in its sole and absolute discretion. KCD-Unique Products are Buyer-Unique Products under this Agreement for all purposes.

Buyer-Unique Products are HTS Products under this Agreement for all purposes and will be priced as if they were HTS Products under Section 3(b) . The sale by Seller of a Buyer-Unique Product through Seller’s Digital Methods does not result in that Product converting into an HTS Product and does not relieve Buyer of its obligations to purchase any Buyer-Unique Products consistent with its forecasting obligations detailed in Appendices 1 and 6 .

Beginning on the first day of the third Contract Year, the HTS Invoice Price for purchases by Buyer of Vendor-Unique Products will be subject to an additional charge of 5.0% of Core Cost.

Buyer-Direct Merchandise . As more fully described in the Services Agreement, Seller will facilitate Buyer’s purchase of “Buyer-Direct Merchandise” (defined in the Services Agreement), including EMP purchase orders (as more fully described in the Services Agreement) and products covered by Buyer purchase orders issued through Seller’s systems to Vendors for the direct shipment of those products to Buyer’s facilities or customers (as more fully described in the Services Agreement). For the avoidance of doubt, Seller’s or its Affiliates’ obligations with respect to Buyer-Direct Merchandise are described fully in the Services Agreement and are referenced in this Agreement for context only. No rights or obligations with respect to Buyer-Direct Merchandise are created by this Agreement. Buyer-Direct Merchandise is not a Product for purposes of this Agreement. Seller will be entitled to invoice Buyer for all Buyer-Direct Merchandise under the Merchandise Agreement in the week after delivery to Buyer, its Affiliates and/or a SHO Authorized Seller (as that term is defined in the Services Agreement), as applicable.

OUTLET PRODUCTS .

Section 4 Definitions

“ DRM ” means all distressed and refurbished merchandise that from time to time comes into the possession of Seller or one or more of its Affiliates (including Home Appliance merchandise at Seller’s Sears Delivery Operations (“ SDO ”) and that is included in a DRM Merchandise Category.

“ DRM Merchandise Category ” means each of the consumer electronics, furniture, home appliances, lawn and garden, mattresses, sporting goods, and tools Product categories.

“ MOS ” means marked-out-of stock merchandise described on Appendix 4(c) regardless of brand that from time to time comes into the possession of Seller or one or more of its Affiliates.

“ Right of First Offer ” means the obligation of Seller to negotiate in Good Faith with Buyer for 20 business days from Buyer’s written request regarding the price and other material terms and conditions on which Seller would be willing to sell DRM or MOS to Buyer.

“ Additional LG DRM Product ” means lawn and garden products which has been returned to Seller and which are located at its customer return centers. Additional LG DRM Product has historically not been sold to Buyer and do not constitute DRM for purposes of this Agreement.

“ Additional Outlet Products ” means Major Home Appliances located in the 48 contiguous States of the United States that Seller has placed in Clearance Status and that Seller elects to sell to Buyer and Buyer elects to purchase (as provided for in Section 4(i)(A) (Sale of Additional Outlet Product) below). Additional Outlet Products do not include Major Home Appliances that are not owned by Seller or its Affiliates, or that Seller or its Affiliates have leased or rented to consumers.

“ Major Home Appliances ” means clothes washers, clothes dryers, dishwashers, ranges, ovens, cooktops, micro-hood combinations, refrigerators and freezers and other home appliances considered to be a “Major Home Appliance” by American Home Appliance Manufacturers Association.

“ Clearance Status ” means those products for which Seller’s personnel have either: (I) placed the unit in either “D” (discontinued), “F” (final), “X” (clearance) status or (II) placed such unit on the “991 table”.

DRM . Subject to Section 6 , during the Initial Term Seller will sell, and Buyer will purchase, all DRM at the prices listed on Appendix 4(b) . Merchandise that is deemed to be DRM for purposes of this Agreement will be determined consistent with the mutual understandings of Seller and Buyer in effect immediately prior to the Effective Date. For DRM at Seller’s SDOs, Seller will, at Buyer’s sole cost and expense, deliver such Products to Buyer’s nearest facility on a weekly basis.

MOS . Subject to Section 6 , during the Initial Term Seller will sell, and Buyer will purchase, all MOS at the prices listed on Appendix 4(c) . Merchandise that is deemed to be MOS for purposes of this Agreement will be determined consistent with the mutual understandings of Seller and Buyer in effect immediately prior to the Effective Date.

Land’s End . Subject to the next sentence, Seller’s obligations to sell, and Buyer’s obligations to purchase, MOS in the Land’s End category terminates on April 11, 2018. If at any time thereafter Seller acquires from Land’s End MOS in the Land’s End category, and Buyer chooses to liquidate such goods (rather than selling them in its stores), Seller will give Buyer 30 days to match any bona fide third party offer it receives for the purchase of such goods.

Right of First Offer for Additional Categories . Buyer will have a continuing Right of First Offer to purchase all of Seller’s (i) discontinued and obsolete products, (ii) overstock products and home goods and furniture that were new and still in original packaging, (iii) distressed, refurbished, discontinued, and obsolete home goods and furniture, and (iv) marked-out-of-stock footwear, except that Buyer’s rights in this Section 4(e) do not apply to Non-Retail Products.

Seller’s Compliance with Rights of First Offer; Termination . Seller may comply with its obligations with respect to each Right of First Offer provided in this Section 3(g) by notifying Buyer once during each calendar quarter as to the DRM or MOS, as the case may be, that is subject to the Right of First Offer. If with respect to a Right of First Offer Buyer fails during any 12-month period to engage in Good Faith negotiations for 50% or more of Seller’s notifications in the preceding sentence for the Right of First Offer, Seller’s obligations, and Buyer’s rights, with respect to the Right of First Offer will terminate.

Retail Pricing . Buyer will determine advertised prices, promotional prices, and retail prices for DRM, MOS, and all other Products acquired from Seller in accordance with this Section 3(g) (together, “ Outlet Products ”) in Buyer’s sole discretion. Any agreement or understanding to the contrary is unauthorized, in conflict with Buyer’s and Seller’s policies, and a violation of the terms and conditions of this Agreement.

Invoice Prices for Outlet Products . The invoice prices for the Outlet Products that Seller will sell to Buyer in accordance with this Section 3(g) (the “ Outlet Invoice Prices ”) will include (and will not be charged additionally to Buyer) all costs of manufacturing and delivering the Outlet Products to the FOB Point, including (i) all duties and taxes (including excise and withholding taxes) payable in any country where production or delivery takes place, (ii) all commissions to selling agents, and (iii) other incidental charges. If a value-added tax is imposed in the Territory that is applicable to Seller’s sale of Outlet Products to Buyer then Seller and Buyer will negotiate in Good Faith an amendment to this Agreement, the terms of which would adjust the Outlet Invoice Prices or make other changes to this Agreement (to make Seller whole on the Sale of Outlet Products to Buyer and its Affiliates) given the imposition of the tax. For clarity, the parties note that, Seller is, where required by applicable law, entitled to charge Buyer under this Agreement for all value-added and sales taxes.

Non-Saleable DRM Products . The Parties acknowledge that a certain amount of the DRM sent to Buyer by Seller from time to time may be “Non-Saleable DRM Products”. “ Non-Saleable DRM Products ” are DRM that in accordance with the Non-Saleable DRM Products Criteria provided in Appendix 4(g)(1) are non-saleable. The “ Non-Saleable Outlet Products Process ” means the processes, procedures, and related accounting practices reflected on Appendix 4(g)(2) . In addition to the credits for Non-Saleable DRM Products which Buyer is entitled to under Appendix 4(g)(2) ; Buyer will be separately entitled to a credit (the “ Non-Repairable Credit ”) for KCD-Branded Products which Seller’s Affiliate declines to repair because they are either not repairable or too costly to repair under Appendix 1.01-C (Product Services) to the Services Agreement; unless (i) Buyer claimed such DRM product was “Non-Saleable” under this Section 4(i) ; (ii) the repair of such DRM KCD-Branded Product would not have been covered under the Seller Warranty (had a consumer being seeking repair of such product) (e.g., the products damage was due to mistreatment; not due to defective part), or (iii) Buyer fails to submit such DRM product for repair (through the use of Seller’s Affiliate’s online tool) within 30 days of Seller’s delivery of such DRM Product to Buyer. The Non-Repairable Credit shall equal: (A) from the Effective Date through April 29, 2017 - twenty-five percent (25%), and (B) from April 30, 2017 through the Term - fifty percent (50%); in each case of the Outlet Invoice Price actually paid by Buyer to Seller.

Delivery of Outlet Products . Buyer agrees to timely take delivery of/pick-up all MOS. Buyer will pay a $10 charge, per month for any pallet of MOS, which Buyer does not take delivery of/pick-up within 60 days of Seller notifying Buyer that it is available.

Outlet Product Restrictions . Buyer acknowledges that Seller’s obligations to sell the Outlet Products to Buyer in accordance with this Agreement may be subject to Seller’s Vendors agreeing to permit Seller to sell the Outlet Products to Buyer for resale in accordance with this Section 3(g) , over which Seller may have little or no control. Seller will take commercially reasonable actions necessary to be able to sell the Outlet Products to Buyer in accordance with this Section 3(g) . If Seller has entered into an agreement with a Vendor in effect immediately prior to the Effective Date and the agreement requires Seller to return Outlet Products to the Vendor (a “ Return-Requirement Agreement ”), or a Return-Requirement Agreement is extended or renewed on or after the Effective Date on substantially the same terms and conditions as its predecessor agreement, the provisions of the extended or renewed agreement will prevail over the provisions of this Section 4(k) . Subject to the next sentence, if on or after the Effective Date Seller in Good Faith enters into an agreement with a Vendor that would require Seller to return an Outlet Product to the Vendor and the price that the Vendor of the Outlet Product would be obligated to pay to Seller would be greater than the Outlet Invoice Price that Buyer would be obligated to pay to Seller for the Outlet Product (the “ Vendor’s RTV Payment ”), Seller may return the Outlet Product to the Vendor (in exchange for the Vendor’s RTV Payment) rather than selling the Outlet Product to Seller in accordance with Section 3(g)(b) . Seller will not give the Vendor a financial or other benefit (including agreeing to pay the Vendor a higher purchase price for Seller’s purchase of the Outlet Product from the Vendor), or give the Vendor Seller’s commitment or obligation, directly or indirectly in exchange for, or as an inducement to the Vendor to pay, the Vendor’s RTV Payment.

Sale of Additional Outlet Products .

AOP Notice . Seller may elect, in its sole discretion, to notify Buyer in writing (via an email to Marty.Burks@shos.com), of Additional Outlet Product (and their location) that Seller would like to sell to Buyer. Buyer will then have 2 business days to notify Seller in writing (via an email to Steven.Stafford@searshc.com) of whether or not Buyer accepts, in Buyer’s sole discretion, Seller’s offer to sell any or all of the offered Additional Outlet Products (each Buyer notification an “ AOP Notice ”).

Outlet Invoice Prices . For all Additional Outlet Products that are new in-box, the Outlet Invoice Price will equal 23% off Seller’s Core Cost for such Additional Outlet Product,. For all other Additional Outlet Products, the Outlet Invoice Price will equal 42% off Seller’s Core Cost for such Additional Outlet Product. Buyer will pay the Outlet Seller Warranty Charge on each Additional Outlet Product subject to a Seller Warranty.

Delivery, F.O.B. Point and Risk of Loss .

Products Not at a DC . For Additional Outlet Products not located at a Seller distribution facility: (1) within two days of receiving an AOP Notice accepting Seller’s offer, Seller will segregate each such Product listed in such notice, and (2) after receiving such notice, Buyer must promptly schedule with Seller’s representative pick-up of such Product during the normal operating hours of Seller’s facility. Seller will attach corner posts and shrink each such Additional Outlet Product that is out of box. Buyer will be solely responsible for promptly picking-up each such product from Seller’s facility; at Buyer’s sole cost and expense. Risk of loss for such products will transfer to Buyer upon the earlier of: (x) Buyer’s pick-up, and (y) ten days after the AOP notice accepting Seller’s offer.

Products at a DC . Additional Outlet Products located at a Seller distribution facility will be shipped by Seller to Buyer in the same manner as other Outlet Products. Buyer will be solely responsible for all shipping costs. Risk of loss for such Product will transfer upon shipment.

Co-Ordination with Services Agreement . If a unit of Additional Outlet Product is sold on SearsOutlet.com prior to receipt of an AOP Notice pursuant to Appendix 1.01-D (eCommerce Services) to the Services Agreement (the “ eCommerce Appendix ”), then the eCommerce Appendix will control over this Agreement for such unit.

Sale of Additional LG DRM Product .

Notice of Additional LG DRM Product . Seller may elect, in its sole discretion, to notify Buyer, of Additional LG DRM Product (and their location) that Seller would like to sell to Buyer. Buyer will then have 2 business days to notify Seller in writing whether or not Buyer accepts, in Buyer’s sole discretion, Seller’s offer to sell any or all of the offered Additional LG DRM Product (each Buyer notification an “ ALG Notice ”).

Additional LG DRM Product Invoice Prices. For all Additional LG DRM Product, the Invoice Price will be specified by Seller as a percentage off Seller’s DOS Cost in Seller’s ALG Notice for such Additional LG DRM Product. In addition, Buyer will pay the Sort Charge set forth in Appendix 4(m) based upon the level of service performed by Seller’s affiliates prior to sale to Buyer. Buyer will also pay the Outlet Seller Warranty Charge on each Additional LG DRM Product subject to a Seller Warranty.

Delivery, F.O.B. Point and Risk of Loss . For Additional LG DRM Products: (1) within two days of receiving an ALG Notice accepting Seller’s offer, Seller will segregate each such Product listed in such notice, and (2) after receiving such notice, arrange to deliver the Product to Buyer at Buyer’s sole cost and expense. Risk of loss for such products will transfer to Buyer upon shipment (and Seller will assist Buyer will filing any claims against the carrier). ALL ADDITIONAL LG DRM PRODUCTS WILL BE SOLD TO BUYER AS-IS, WHERE-IS, WITH NO RETURN RIGHTS. Notwithstanding the foregoing, Buyer may include Seller’s standard warranty for KCD-Branded Products provided that Buyer pays the Outlet Seller Warranty Charge for such Product.

ROYALTIES .

Quarterly Royalty Reports; Royalties Payable . Within 15 days following the end of each of Buyer’s fiscal quarters during the Term and during any sell-off period in accordance with Section 2(g) , Buyer will submit to Seller a true and correct report for the fiscal quarter of Gross Sales, Net Sales, and Royalties for each KCD-Branded Product sold by Buyer to a customer during the fiscal quarter (each a “ Royalty Report ”). “ Gross Sales ” means the total amount of specified merchandise sold, other than among a Party and its Affiliates, without deduction of any kind (including deductions for separately invoiced freight and insurance, bad debts, and uncollectible accounts). “ Net Sales ” means Gross Sales less all returns of the specified merchandise and all adjustments to resolve customer complaints and without any other deduction (including deductions for cash discounts, freight discounts, advertising discounts, and uncollectable amounts). “ Royalties ” for a Buyer fiscal quarter means the royalties payable by Buyer with respect to its Net Sales of each category of KCD-Branded Products at the Royalty Rates specified on Appendix 5(a) , less the Kenmore Royalty Credit for the fiscal quarter determined as specified on Appendix 5(a) but subject to Section 5(d) and Section 5(e) . Buyer will pay Royalties at the times specified in Section 7(b) . Buyer will include with each Royalty Report a certificate from a Senior Vice President of Buyer certifying, to the Senior Vice President’s best knowledge after due inquiry, (i) that the contents of the Royalty Report are true and correct in all material respects and (ii) whether during the fiscal quarter Buyer complied with Section 5(d) and Section 5(e) .

Commercial Sales . In addition to the limited license granted to SHO’s Affiliates under the License Agreements to sell Seller-Branded Products in SHO’s Affiliates retail stores, Seller grants SHO’s Affiliates in connection with their operation (in accordance with the various agreements between the Parties /or their Affiliates), of a stores using the “Store Names” (as defined in the Licensee Agreements) a personal, limited, non-transferable, and terminable right and license to use the licensed Store Names to sell HTS Products and Outlet Products to Commercial Customers subject to following conditions:

Non-Sub-licensable . The license granted under this subsection (f) will be non-sub-licensable, except that SHO’s Affiliates may grant sub-licenses to dealers and franchises of stores using the Store Names in connection with the operation of such stores the same extent they are authorized to grant sub-licenses to the Store Names under the License Agreement;

Commission . In addition to all other amounts due Seller and its Affiliates, Buyer shall pay Seller a commission equal to one percent (1%) of all products Net Sales made by SHO, its Affiliates and SHO Authorized Sellers (the “ CS Royalty ”) to Commercial Customers. Within 15 days following the end of each of Buyer’s fiscal quarters during the Term and during any sell-off period in accordance with Section 2(g) , Buyer will submit to Seller a true and correct report (the “ CS Royalty Report ”) for the fiscal quarter of Gross Sales, Net Sales, and CS Royalties for each sale to a Commercial Customer. Buyer will include with each CS Royalty Report a certificate from a Senior Vice President of Buyer certifying, to the Senior Vice President’s best knowledge after due inquiry that the contents of the CS Royalty Report are true and correct in all material respects.

“ Commercial Customers ” means purchasers who are not end users (e.g., contractors, home builders, multi-unit property owners); but does not include purchasers of multiple copies of the same SKU (even by contractors, home builders, etc.) that are sold in store operated by Buyer, its Affiliates and/or the SHO Authorized Sellers and picked up by the purchaser at such store (or picked up at such store by a third party arranged by the purchaser without assistance from Buyer, Affiliates or the SHO Authorized Sellers).

Existing Sears Commercial Customers . Buyer agrees that it, it’s Affiliates and the SHO Authorized Sellers and will not solicit or sell to “Existing Commercial Customers” of Seller and its Affiliates. “ Existing Commercial Customers ” is defined as a Commercial Customer who, at the applicable time, has made a purchase of products for a commercial project through Seller and its Affiliates in the immediately preceding twelve (12) months. In the event Buyer, its Affiliates, or a SHO Authorized Seller makes a sale to an Existing Commercial Customer, SHO will remit all net margin from the sale to Seller and discontinue further sales to and discussions with the Existing Commercial Customer for a period of 24 months.

Deliveries to Commercial Customers . All deliveries to Commercial Customers made by Buyer, its Affiliates and SHO Authorized Sellers must be made by Seller’s Affiliates pursuant to the Section entitled “Commercial Customer Deliveries” in Appendix 1.01-C (Supply Chain Services) to the Services Agreement; except for Products which are delivered to such stores and which are then delivered by a SHO Authorized Seller using its own self-delivery capabilities.

Adjustments . If Buyer or Seller discovers any inconsistencies or mistakes in a Royalty Report or CS Royalty Report, Buyer will deliver an updated Royalty Report or CS Royalty Report, as applicable, within 30 days of such discovery rectifying the inconsistencies or mistakes and, if Royalties or CS Royalties have been under-reported, Buyer will, with delivery of the updated report, simultaneously tender the under-paid Royalties or CS Royalties, as applicable to Seller. If Buyer has over paid Royalties or CS Royalties, Buyer will identify the amount of the overpayment in its updated report and Seller will credit the amount of the overpayment against amounts due in subsequent payment periods after Seller has confirmed that a credit is due.

Featuring Kenmore-Branded Product . Subject to the next sentence, to be eligible for the Kenmore Royalty Credit for a Buyer fiscal quarter Buyer will during the fiscal quarter (i) use commercially reasonable efforts to feature Products sold under the Kenmore Mark (“ Kenmore-Branded Products ”) in all pre-prints and free-standing inserts created by Buyer for the Sears Hometown Store, Sears Home Appliance Showroom, and Sears Hardware Store formats, and (ii) use commercially reasonable efforts to feature Kenmore-Branded Products on the cover of all preprints created by Buyer in the Sears Hometown Store and Sears Home Appliance Showroom formats. In no event during the Buyer fiscal quarter will Buyer feature Kenmore-Branded Products (x) in less than 95% of all pre-prints and free-standing inserts created by Buyer for the Sears Hometown Store, Sears Home Appliance Showroom, and Sears Hardware Store formats, (y) on the cover of less than 95% of all preprints created by Buyer for the Sears Hometown Store and Sears Home Appliance Showroom formats, and (z) on the cover of less than 50% of the preprints created by Buyer for the Sears Hardware Store formats.

Minimum Commission . To be eligible for the Kenmore Royalty Credit for a Buyer fiscal quarter Buyer will during the fiscal quarter pay the Franchisees and the owners of the Sears Hometown Stores the Average Aggregate Minimum Commission Rate specified on Appendix 5(e) on sales of Kenmore-Branded Products.

Record Retention; Audit Rights . Buyer will keep and preserve accurate records of each transaction relating to Buyer’s calculations of CS Royalties, Royalties, Kenmore Royalty Credit, Average Aggregate Minimum Commission and Buyer’s sales for the longer of (i) the minimum period required by Applicable Law, and (ii) two years following the applicable transaction. Upon Seller’s reasonable request Buyer will provide Seller with information that will enable Seller to confirm Buyer’s calculations of CS Royalties, Royalties, Kenmore Royalty Credit, Average Aggregate Minimum Commission and Buyer’s sales. Seller, with reasonable notice to Buyer, may during normal business hours conduct audits of the books and records of Buyer to confirm Buyer’s calculations of CS Royalties, Royalties, Kenmore Royalty Credit, Average Aggregate Minimum Commission and Buyer’s sales (each an “ Audit ”). Subject to the next sentence, Audits may occur no more than twice per calendar year and may be conducted by Seller’s employees, by Seller’s authorized agents, or by a combination of the two, in each case only if each person participating in an Audit agrees to treat all information with respect to the Audit as confidential in accordance with Section 13(b) . If an Audit or other information demonstrates that Buyer under-reported a Royalty or over-reported a CS Royalties, Royalties, Kenmore Royalty Credit, Average Aggregate Minimum Commission or Buyer’s sales by more than 5% with respect to two or more Buyer fiscal months, or Buyer fiscal quarters, as the case may be, Seller has the right to conduct Audits on a quarterly basis until such time as Buyer has properly reported Buyer’s sales, CS Royalties, Royalties, and Average Aggregate Minimum Commission and Kenmore Royalty Credits for three consecutive Audits, after which time Seller’s rights in accordance with this Section 5(f) will revert to conducting Audits no more than twice per calendar year. Seller will pay for all Audits but if an Audit shows a 5% or greater discrepancy in the amount of the Buyer’s Sales, CS Royalties, Royalty, and Average Aggregate Minimum Commission or Kenmore Royalty Credit calculated by Buyer for a Buyer fiscal month or Buyer fiscal quarter, as the case may be, then Buyer will pay for that Audit and all subsequent Audits for a period of one year.

INVENTORY MANAGEMENT POLICES AND PROCESSES; DELIVERY TERMS . With respect to Seller’s obligations in Section 3(a) and Section 3(g) , Buyer and Seller will comply with the Inventory Management Policies and Processes specified on Appendix 6 (the “ Inventory Policies and Processes ”). Seller will deliver all Products to the applicable FOB Point in accordance with the Inventory Policies and Processes. With respect to each Product, Seller will have title to, and risk of loss for, the Product until Seller delivers the Product to the FOB Point in accordance with this Section 6 , at which time Seller’s title and risk of loss will terminate.

PAYMENT TERMS FOR INVOICE PRICES AND ROYALTIES .

Invoice Prices for Products . Seller will invoice Buyer for Products sold to Buyer no earlier than the date the invoiced Products are delivered to the FOB Point. “ FOB Point ” means a Sears Hometown Store, a Sears Hardware Store, a Sears Outlet Store, including such a store operated by a Franchisee, the residence of a customer of any of these stores, or a distribution facility to which a Product is delivered in accordance with Buyer’s instructions. Not later than the Payment Due Date specified on Appendix 7(a) , Buyer will pay for the undisputed portion of each invoice and notify Seller of any disputed amount and the reason for the dispute.

Royalties . During the period that Buyer’s Stores use Seller’s point-of-sale system (the “ POS ”) to record all sales of Products, Buyer will pay to Seller the Royalty and CS Royalty due, as determined by the POS, for each of Buyer’s fiscal weeks not later than the Payment Due Date specified on Appendix 7(a) . If Buyer’s Stores cease to use the POS, Buyer will pay to Seller the Royalty and CS Royalty due, as determined from the Royalty Reports and CS Royalty in accordance with Section 5 , for each Buyer fiscal quarter not later than the Payment Due Date specified on Appendix 7(a) .

SUBSIDIES AND MARKETING/MERCHANDISING SUPPORT .

Vendor Subsidies .

Subject to the provisions of this Section 8(a), Seller will pay to Buyer the Subsidy Pro Rata Share of each Vendor Subsidy that Seller collects (by actual payment or as a credit against a Seller obligation) with respect to the Product categories sold by Seller to Buyer except to the extent that Seller is prohibited by the terms of a Vendor contract from paying a Subsidy Pro Rata Share to Buyer and except to the extent that a Vendor refuses to pay to Seller a Vendor Subsidy with respect to Seller’s sales of Products to Buyer. Vendor Subsidies received for the following will not be allocated between Seller and Buyer on a Subsidy Pro Rata Share basis:

“HotBuys/Door Buster” items will be allocated on an actual specific units sold basis;

training events (such as Home Appliance Roadshow, SHO Celebration, Powerama) will be allocated to Buyer to the extent it is incurring the related expense;

new store locations will be allocated to Buyer with respect to Buyer’s store locations for which the Vendor Subsidy is applicable and to Seller with respect to Seller’s store locations for which the Vendor Subsidy is applicable;

Buyer-specific transition and Vendor-Unique Product merchandise subsidies will be allocated to Buyer only;

Seller-specific transition merchandise subsidies will be allocated to Seller only;

Buyer-specific fixture subsidies will be allocated to Buyer only;

Seller-specific fixture subsidies will be allocated to Seller only,

Defective and return subsidies based upon actual units returned will be allocated to Buyer and Seller on an actual cost-incurred basis; however, all defective/return credits which are paid on a percentage of cost basis will be allocated based upon the Subsidy Pro Rata Share; provided further , that for Products which Buyer stops returning to Seller SHO shall no longer be entitled to share in the liquidation proceeds for such products; nor in the defective and returned subsidy for such Products (unless the Vendor has expressly agreed to provide such subsidies on defective Products which Seller (or Buyer) are repairing and reselling) ;

Subsidies collected by Sears de Puerto Rico directly (and not by SRC) will be allocated to Buyer and Seller based on balance of Product sales in Puerto Rico (excluding Buyer’s Outlet sales in Puerto Rico);

Vendor-specified subsidies for the promotion of on-line sales on Seller’s and its Affiliates’ websites and mobile applications (e.g., Sears.com and Kmart.com) and subsidies for the placement of banner advertisements on such websites and applications, will be allocated to Seller only; and

Vendor-specified subsidies for the promotion of on-line sales on the SHO Web Platforms, and subsidies for the placement of banner advertisements on such websites, will be allocated to Buyer only.

Seller will in Good Faith use commercially reasonable efforts to maximize the Vendor Subsidies and to obtain Vendors’ permission to share all Vendor Subsidies with Buyer in accordance with this Section 8(a).

Seller will calculate Subsidy Pro Rata Share on a fiscal monthly basis and pay the Subsidy Pro Rata Share to Buyer by the 15th day of the next fiscal month.

“ Subsidy Pro Rata Share ” of a Vendor Subsidy paid by the Vendor with respect to, or in connection with, a Product category means a fraction the numerator of which is Buyer’s total fiscal year-to-date sales in the Product category (excluding Buyer-Unique Products, Buyer-Direct Merchandise, and Outlet Products) and the denominator of which is the sum of (A) Buyer’s total fiscal year-to-date sales in the Product category (excluding Buyer-Unique Products, Buyer-Direct Merchandise, Outlet Products), and (B) SRC’s total fiscal year-to-date sales in the Product category. Seller’s sales figures for calculation of Subsidy Pro Rata Share will not include sales by Seller’s Kmart stores. If Seller begins selling a Buyer-Unique Product (the date that selling begins, the “ Selling Date ”), all of Buyer and Seller’s sales of such Product shall thereafter no long be considered sales of Buyer-Unique Products and any Vendor Subsidy collected by Seller or Buyer shall be considered Vendor Subsidy and shall be shared under this Section. Buyer shall provide to Seller Buyer’s sales figures to the extent necessary for Seller to calculate the applicable Subsidy Pro Rata Shares; Buyer shall mark such information as “Highly Confidential – Limited Distribution Internally” and Seller will use reasonable efforts to ensure that such information is only used for the purposes described herein.

“ Vendor Subsidy ” means support or assistance payments from Vendors relating to merchandise sold or the Vendor-customer relationship and include (regardless as to how they are entitled) advertising and marketing allowances, brand-building subsidies, display subsidies, electronic efforts subsidies, fixed-percentage subsidies, fixture subsidies, markdown support, new-outlet subsidies, product-return assistance, quality-assurance subsidies, reset subsidies, signage subsidies, transition-support subsidies, volume incentive discounts, and similar Vendor support and assistance provided on products sold by SRC. Vendor Subsidy will not include Vendor support or any other amounts paid by Vendors on Products sold in Seller’s Kmart stores or on Kmart.com.

Upon written request of the other Party, a Party will promptly provide to the requesting Party, reasonable detail to support the Vendor Subsidies shared and not shared under this Agreement, including, online only subsidies, and the information used to calculate the Subsidy Pro-Rata Share paid, and to the extent permitted under the applicable agreement with the Vendor, copies of the underlying promotional agreements.

Product Information Support . Seller agrees to provide to Buyer the following Product promotional and information support:

Marketing and Promotional Materials . Seller will provide to Buyer a reasonable supply of customer literature and other marketing and promotional items for the Products, consistent with past practices and conditioned on the provision of marketing materials to Seller by its Vendors.

Electronic Efforts . Seller will support Buyer’s electronic marketing, distribution, logistic, accounting and sales efforts by providing to Buyer in electronic format (or other format reasonably requested by Buyer) such Product descriptions, text, high-resolution Product images (including supplemental feature shots), audio, video and other web content that Seller has prepared for its own use as Buyer reasonably requests from time to time for any website that is owned or controlled by Buyer (including any product specific site or Micro site) or any other Internet-based application relating to the Products. Seller and Buyer will negotiate in Good Faith the appropriate pro rata charges that Buyer would pay for these services.

Other Support . Periodically during the Term, Buyer and Seller will negotiate to determine the level of Seller’s support required to successfully implement Product launches and other promotional initiatives as mutually agreed upon by the Parties to support the sale of the Products. Such support will be determined on a case by case basis in view of competitive conditions in the marketplace and will be documented through a promotional agreement, consistent with past practices and conditioned on the further support of Seller’s Vendors.

CUSTOMERS AND TRADE AREAS .

General . Nothing in this Section 9 or elsewhere in this Agreement limits or restricts in any way whatsoever the unrestricted rights of each of Seller and its Affiliates to market or sell Products, other merchandise, or services by Digital Methods or the unrestricted rights of Buyer and its Affiliates to market or sell Products other than Seller-Branded Products, other merchandise, or services by Digital Methods. The rights of Buyer and its Affiliates to sell Seller-Branded Products by Digital Methods are subject to Section 12(a)(iii)(B) .

In this Section 9 all references to “ stores ,” “ Stores ,” and “ Showrooms ” refer only to “brick and mortar” physical locations and all references to “ new ” and “ New ” stores, Stores, or Showrooms refer to stores, Stores or Showrooms that first open for business on or after the October 11, 2012;

“ FLS Stores ” mean the Seller-owned or operated stores branded with the name ‘Sears’ or other name used by Seller for any or all of its stores but excluding stores branded with the name “Kmart” and successor names for Seller’s Kmart stores. “ Sears Stores ” means the FLS Stores and the Kmart locations set forth on Appendix 9(a)(ii) (Kmart Locations).

Buyer .

HTS Stores . Buyer and its Affiliates may continue to, and may authorize others to continue to, own, license, franchise, and otherwise operate at all times after the Effective Date the Sears Hometown Stores, Sears Home Appliance Showrooms, and Sears Hardware Stores owned, licensed, franchised, or otherwise operated on or before the Effective Date. Buyer and its Affiliates may open, own, license, franchise, and otherwise operate, and may authorize others (except Seller Competitors), to own, license, franchise, and otherwise operate, at all times after the Effective Date new Sears Hometown Stores, new Sears Home Appliance Showrooms, and new Sears Hardware Stores (“ New HTS Stores ”) without restriction, except that none of Buyer and its Affiliates will, directly or indirectly, open, own, license, franchise, or otherwise operate, or authorize others to operate, a New HTS Store or any other new store in any Metropolitan Statistical Area (as defined by the United States Office of Management and Budget) unless one of the following applies to the New HTS Store or the other new store:

Intentionally Omitted.

The New HTS Store or other new store (other than a No-EBITDA Store) is at least eight miles (using the most logical driving route) from all existing FLS Stores and the New HTS Store or other new store is at least two miles (using the most logical driving route) from the Kmart locations set forth on Appendix 9(a)(ii) (Kmart Locations);

The New HTS Store or other new store (other than a No-EBITDA Stores) is between five miles and eight miles (using the most logical driving route) from all existing Sears Stores (each an “ EBITDA Store ”) and Buyer has requested (in advance of committing to such location), and received Seller’s prior written approval (which approval will not be unreasonably withheld or delayed). For each EBITDA Store, Buyer will pay Seller annually 30% of the new EBITDA Store’s annual EBITDA, if any, for the first five of Buyer’s fiscal years that the new EBITDA Store is open for business, or

The New HTS Store or other new store distributes products primarily on a rent-to-own basis.

Sears Outlet Stores . Buyer and its Affiliates may continue to own and operate all Sears Outlet Stores owned and operated on the Effective Date without restriction. Buyer may open, own, and operate after the Effective Date new Sears Outlet Stores without restriction, except that on and after the Effective Date Buyer and its Affiliates will not sell and Buyer and its Affiliates will not authorize third parties (e.g., dealers, franchisees) to sell “New Products” at any Sears Outlet Store that is/was: (a) acquired by Buyer or its Affiliates, or their authorized third party sellers (e.g., dealers, franchisees) after October 31, 2013 or subject to a lease executed after October 31, 2013 (other than the renewal or extension of a lease if the lease was executed on or before October 31, 2013 and other than a lease or sublease by Buyer to a Buyer dealer or franchisee); and (b) within two miles (using the most logical driving route) of an operating Sears Store. “ New Products ” means home appliance products, patio products and Craftsman lawn and garden products that are, in each case, new and in box and are a current model (not obsolete); however a model designated in writing as discontinued by the manufacturer (or in the case of Kenmore, by SHMC or its Affiliates), shall not be a New Product.

New SHO Location Notice . Buyer will, within five (5) Business Days of the beginning of each month, notify Seller in writing of any new locations Buyer intends to open during the month. In addition, Buyer will notify Seller in writing (at least 5 days prior to signing a lease for such location) of any: (i) New HTS Store locations that are within 9 miles (using the most logical driving distance) of a Sears Store, and (ii) new Sears Outlet Store locations that are that are within 3 miles of a Sears Store (using the most logical driving distance). Seller has no objections to the operation of the following four Buyer Stores (collectively the “ No-EBITDA Stores ”): Austin, TX, Plano, TX, Los Angeles (Hawthorn)), CA, and Murray, UT stores (and Buyer will not be obligated to pay any of its EBITDA on these locations under this Section 9(b)(iii) ). Seller also has no objections to the following 5 Stores: Westlake, OH, Overland Park, KS, Southfield, MI, Grand Prairie, TX and Louisville, KY locations, and for each of the five Stores mentioned in this sentence, Buyer shall pay Seller annually 30% of the store’s annual EBITDA, if any, for the first five of Buyer’s fiscal years that the Store is open for business.

Relocation of Existing Store . Buyer may relocate HTS and Sears Outlet Stores, but Buyer will not relocate (a) an HTS Store that is within eight miles of a Sears Store to a new physical location that is closer to a Sears Store than the original physical location, (b) an HTS Store that is eight miles or more from a Sears Store to a new physical location that is within eight miles of a Sears Store, (c) an Outlet Store that is selling New Products and that is within two miles of a Sears Store to a new physical location that is closer to a Sears Store than the original physical location, or (d) an Outlet Store that is selling New Products and that is two miles or more from a Sears Store to a new physical location that is closer to a Sears Store than the original physical location. For purposes of this Section 9 , distance between Stores is measured by using the most logical driving route.

Seller .

Existing Stores and New Stores . Seller and its Affiliates may continue to, and may authorize others to continue to, own and operate after the Effective Date all stores owned and operated by them on the Effective Date. Subject to the next sentence, after the Effective Date Seller and its Affiliates may open new stores, and authorize Authorized Stores, using store names used by Seller and its Affiliates on the Effective Date without restriction. After the Effective Date none of Seller and its Affiliates will, directly or indirectly, do any of the following:

(A) in any MicroSA open, own, or operate any new store, or authorize in any MicroSA any new Authorized Store, that is (1) branded with any Mark that includes “Kenmore” or “Craftsman” or (2) a Sears Store;

(B) open, own, or operate any new store, or sell Prohibited Products to any new Authorized Store, that is substantially similar to one or more of the Sears Hometown Stores, Sears Home Appliance Showrooms, or Sears Outlet Stores formats existing on the Effective Date; or

(C) open, own, or operate any new store, or authorize any new Authorized Store, that markets or sells, or authorizes (via a license agreement, operating agreement, or otherwise) any natural person, business entity, or non-entity business enterprise to market or sell, any item of Exclusive Merchandise at a store physically located in any Zip Code area with respect to which, and to the extent, Buyer or any Affiliate of Seller has agreed with the owner of an HTS Store to refrain from selling Exclusive Merchandise in the Zip Code area.

Defined Terms . “ Authorized Store ” means a store (A) that is authorized by Seller or its Affiliates pursuant to a license agreement, an operating agreement, or otherwise to market or sell one or more Prohibited Products, or (B) to which Seller or its Affiliates sell products. “ Exclusive Merchandise ” means the following merchandise identified by the “Kenmore” name: clothes washers; clothes dryers; dishwashers; ranges; and full-size refrigerators. “ MicroSA ” means a Micropolitan Statistical Area (as defined by the United States Office of Management and Budget). “ Prohibited Products ” means Exclusive Merchandise, freezers, built-in cooking, lawn mowers and tractors, and the Products in the following KCD-Branded Product Categories: Hand tools & Mechanics Tools; Power Tools; and Garage & Storage.

Growth . Buyer and Seller will negotiate in Good Faith with respect to each request by Buyer to sell Seller-Branded Products to Buyer’s Affiliates, Franchisees, or licensees at “brick and mortar” physical locations outside the Territory.

New HTS Stores and Renewals-Exclusivity . After the Effective Date Buyer will not enter into an Authorizing Agreement for a New HTS Store that includes, or amend an Authorizing Agreement to add, product-exclusivity rights. If after the Effective Date Buyer in its discretion elects to renew, or permits the assignment of, an Authorizing Agreement for a Sears Hometown Store that includes product-exclusivity rights, Buyer will use commercially reasonable efforts to seek to renew, or permit the assignment of, the Authorizing Agreement on terms and conditions that eliminate the product-exclusivity rights effective upon the renewal or the assignment. “ Authorizing Agreement ” means an agreement authorizing an unrelated third-party owner or Franchisee to operate an HTS Store and includes Buyer’s franchise agreements and dealer agreements.

PRODUCT WARRANTIES AND RETURNS .

Product Warranties .

No-Vendor-Warranty Products . With each KCD-Branded Product that Seller purchases from a Vendor without the Vendor’s customer warranty and resells to Buyer in accordance with the terms and conditions of this Agreement (a “ No-Vendor-Warranty Product ”) Seller will include Seller’s customer warranty (the “ Seller Warranty ”). If Seller also sells the No-Vendor-Warranty Product through Seller’s Retail Businesses, the duration and coverage of the Seller Warranty will be no less favorable to Buyer’s customers than the duration and coverage of the most-favorable-to-customer warranty provided by Seller for the No-Vendor-Warranty Product when sold by Seller’s Retail Businesses. If Seller does not sell the No-Vendor-Warranty Product through Seller’s Retail Businesses, the duration and coverage of the Seller Warranty will be no less favorable to Buyer’s customers than the duration and coverage of the most-favorable-to-customer warranty provided by Seller for a product that is comparable to the No-Vendor-Warranty Product when sold by Seller’s Retail Businesses. All Products that Seller purchases from a Vendor without the Vendor’s Warranty, other than No-Vendor-Warranty Products, and resells to Buyer in accordance with the terms and conditions of this Agreement are referred to as “ Excluded No-Warranty Products .” Promptly after the Effective Date, Buyer shall reverse (and pay Seller for), all credits Buyer took against the Seller Warranty charges (for “KCD Charges”), since the start of Seller’s 2016 fiscal year.

Vendor-Warranty Products . With each Product that Seller purchases from a Vendor with the Vendor’s customer warranty and resells to Buyer in accordance with the terms and conditions of this Agreement (a “ Vendor-Warranty Product ”) Seller will pass-through the Vendor’s customer warranty(the “ Vendor Warranty ”). Seller will perform its obligations in this Section 10(a)(ii) without any additional compensation payable by Buyer to Seller. The Seller Warranty and the Vendor Warranty are together referred to as the “ Warranty .”

Seller’s Compensation for Seller Warranty . As Seller’s sole compensation for the Seller Warranty for a No-Vendor-Warranty Product (including a “stock product”) that is an HTS Product, the HTS Invoice Price described on Appendix 3(b) includes a charge for the Seller Warranty, and as Seller’s sole compensation for the Seller Warranty for a No-Vendor-Warranty Product that is an Outlet Product, Seller’s charge for the Seller Warranty is set forth on Appendix 4(b) (collectively, “ Seller’s Compensation ”). Seller’s Warranty does not cover Outlet Product while in Buyer’s possession prior to sale by Buyer to a consumer and charges for repair of such products (“ Outlet Store Stock ”) are set forth in Appendix 1.01-B (Product Services) to the Services Agreement (the “ Product Services Appendix ”).

Product Returns .

Repairable Products Covered by a Warranty . For each Product that a customer returns to Buyer for the reason that the Product is defective and the returned Product is covered by a Warranty, Buyer will accept the return of the Product and deliver it to Seller in accordance with and subject to the Product Services Appendix. Seller will determine whether the Product is repairable and, subject to the Product Services Appendix, Seller at its sole expense will repair, and return to the customer, each repairable returned Product in accordance with Section 11 . Notwithstanding the foregoing, for Craftsman ratchets that are covered by the Craftsman Hand Tool Lifetime warranty (“ LW Ratchets ”), Buyer will be responsible for repairing such LW Ratchets (at its cost) using ratchet repair kits provided by Seller. Seller will reimburse Buyer for the cost of the ratchet repair kits purchased from Seller and used by Buyer or its dealers or franchisees in the repair of the LW Ratchets.

Non-Repairable Products Covered by a Warranty . For each Product that (A) a customer returns to Buyer for the reason that the Product is defective, (B) the returned Product is covered by a Warranty, and (C) Buyer, in Good Faith, determines is not repairable, Buyer, at its sole expense and using commercially reasonable arrangements determined by Seller, will replace the Product (each a “ Non-Repairable Product ”) for the customer and dispose of the Non-Repairable Product at Buyer’s sold cost and expense in accordance with all applicable laws.

Product Returns .

For each Non-Repairable Product that is an HTS Product that Seller replaces in Good Faith pursuant to and in accordance with Seller’s “Craftsman Hand Tool Lifetime warranty exchange” (or any successor lifetime program Seller offers on Craftsman products, each a “ CLW Replacement Product ”) Buyer will be entitled to a credit equal to the HTS Invoice Price paid by Buyer to Seller for the CLW Replacement Product Buyer provided to its customer. Except for as noted above, the CLW Replacement Product credit does not apply to any Products that is not a CLW Replacement Product; regardless of whether such Product is warranted by Seller or not. In addition to all other amounts due under the Agreement, for each Non-Repairable Product that is an HTS Product subject to Seller’s “Craftsman lifetime warranty exchange” (or any successor lifetime program Seller offers on Craftsman products) Buyer will separately pay Seller, via a separate payment at the time of its purchase, an additional three percent (3%) on top of the invoice price charged to Buyer for such products (the “ Lifetime Warranty Charge ”). For example, if a particular socket set (which was subject to the Seller’s “Craftsman lifetime warranty exchange,”) was bought by Buyer at an invoice price of $10, then Buyer will pay Seller an additional $0.30 for such product. Seller will, once per month, rebate to Buyer the Lifetime Warranty Charge paid by Buyer to Seller on the CLW Replacement Product provided by Buyer to its customers during the previous month. Buyer shall dispose of all CLW Replacement Product in accordance the Seller’s defective tool barrel program.

Non-Defective Products . Seller will have no obligation to Buyer or any of its customers with respect to Products the customers return to Buyer that are not defective, which Products Buyer may dispose at Buyer’s discretion (subject to applicable laws) and solely for its account, including selling the Products at Buyer’s Stores and, subject to Section 12(a)(iii)(B)(6) , selling the Products to liquidators.

Returned Products Not Covered by a Warranty . Subject to Section 10(d) , Seller will have no obligation to Buyer or any of its customers with respect to Products the customers return to Buyer that are not covered by a Warranty except to the extent that Buyer requests that Seller repair the Product, in which event Seller will repair the Product in accordance with the Services Agreement. With respect to Products described in the preceding sentence that are not repairable, Buyer may dispose of the Products at Buyer’s discretion (subject to applicable laws) and solely for its account, including selling the Products at Buyer’s Stores and, subject to Section 12(a)(iii)(B)(6) , selling the Products to liquidators. Seller may dispose of any non-repairable Products returned to it by Buyer at Seller’s discretion and solely for Seller’s account.

Warranty Claims for KCD-Branded Merchandise . If Buyer receives a warranty claim for merchandise that is branded with a KCD Mark but was not purchased from Buyer, Buyer will handle the merchandise in accordance with this Section 10(b) as if the merchandise were a KCD-Branded Product.

Product Recalls and Similar Product Issues . If Seller learns that a Product has been recalled by the U.S. Consumer Product Safety Commission, Seller or a Vendor voluntarily conducts a Product recall, or Seller or a Vendor takes other action with respect to Products that may be defective, Seller will (i) notify Buyer, (ii) provide Buyer with available Seller transaction detail with respect to Buyer’s purchases of the recalled Product, and (iii) provide Buyer, at Seller’s sole expense, sufficient replacement Product, correction kits, or other items to enable Buyer to meet the requirements of the recall or other action. All other costs incurred by Buyer in connection with the recall or other action, including all labor, parts, travel, customer notification, reporting, and legal costs, will be the sole responsibility of Buyer. Seller will have no obligation to Buyer or any other person for claims, costs, obligations, damages, or expenses arising in connection with the recall or other action, including any extraordinary expenses, lost profits, or opportunity costs incurred by Buyer or any customer of Buyer with respect to the recall or other action. Seller and Buyer each will cooperate with the other to assert against, and collect from, the Vendor of the affected Product all claims, costs, obligations, damages, and expenses incurred by each of Seller and Buyer arising in connection with the recall or other action.

Disclaimer . Except as otherwise provided in this Agreement each Party disclaims all other express or implied representations, warranties, and covenants (including warranties of non-infringement and title). Seller and Buyer each acknowledges that reliance on any representation, warranty, or covenant not contained in this Agreement is not what Seller and Buyer intend and would not be reasonable.

PRODUCT SERVICING .

Services for the Product sold under this Agreement are set forth in the Product Services Appendix of the Services Agreement. The Parties agree that this Agreement and such Product Services Appendix are integrally related and that neither party would have entered into this Agreement or such Product Services Appendix individually.

INTELLECTUAL PROPERTY .

Seller

Work Product . All marketing materials, advertising materials, promotional materials, point of sale displays, packaging, customer information and material, warranty card information, software, data, service training materials, parts lists, owner’s manuals, service manuals, web content, performance claims and evaluations, testing protocols and data used to evaluate performance claims, database formats, methods used to assemble and maintain electronic Seller-Branded Product catalogs, and programming related to Seller or its Affiliates’ web sites and user applications (e.g., mobile applications) and all files, data, notes, copies, abstracts, copyrights, summaries, and other materials relating to Seller-Branded Products and all copyrights therein, that are prepared, developed or created by or on behalf of Seller or its Affiliates or Buyer or its Affiliates or any of their respective Personnel (together, “ Seller Work Product ”), will be owned worldwide by Seller or its Affiliates. All Seller Work Product will be deemed “work made for hire” as that term may be defined from time to time in Section 101 of the Copyright Act, 17 U.S.C. Section 101 (or any successor). Seller or its Affiliates will be deemed the author of the Seller Work Product, and Seller or its Affiliates will be the owner of all right, title and interest, including all copyrights, in and to the Seller Work Product. If for any reason the Seller Work Product is found not to have been created as work made for hire, Buyer hereby assigns to Seller or its Affiliates without limitation and without additional compensation to Buyer, all right, title and interest, including the copyrights and any other intellectual property rights embodied in the Seller Work Product. Buyer will (and will cause its Affiliates to) execute and deliver to Seller all further documents deemed by Seller to be useful in documenting, effectuating or recording the foregoing assignment. Buyer will not, and will not permit its Affiliates or any third party to, disclose or provide any of the Seller Work Product to any person or entity other than Seller or its Affiliates.

Ownership of Innovations . Buyer acknowledges (on behalf of itself and its Affiliates) that Seller or its Affiliates will exclusively own all right, title and interest in and to all cosmetic designs, ornamental appearance and trade dress embodied in Seller-Branded Products (including design patents and pending applications) regardless of whether the cosmetic design, ornamental appearance or trade dress originated solely with Seller or its Affiliates, solely with Buyer or its Affiliates or jointly with Seller, Buyer, their respective Affiliates and others. All such cosmetic design, ornamental appearance and trade dress rights and design patents and pending applications will be deemed the intellectual property of Seller or its Affiliates.

Licenses to Use Seller Marks .

Subject to the next sentence and to Section (B) , Seller hereby grants to Buyer during the Term and during any sell-off period contemplated under Section 2(g) the following: (1) a nonexclusive, nontransferable, and revocable right and license to use, in connection with the marketing and selling of the Seller-Branded Products but in no event to alter, the KCD Marks (the Royalties for which are provided in Section 5(a) ); and (2) a nonexclusive, nontransferable, royalty-free, and revocable right and license to use in connection with the marketing and selling of the Seller-Branded Products, but in no event to alter, all Seller Marks other than the KCD Marks, in each case described in clauses (1) and (2) with respect to the Marks that are affixed to Seller-Branded Products. Buyer may grant sublicenses to Franchisees and the owners of the Sears Hometown Stores to use, in connection with the marketing and selling by them of the Seller-Branded Products, but in no event to alter, the Seller Marks.

Subject to the other sentences of this Section (B) , the licenses granted in Section 12(a)(iii)(A) are limited to the following:

Buyer may market all Seller-Branded Products by all current and future means, methods, and channels (including by Seller Digital Methods) in the Territory. The term “Seller Digital Methods includes, upon its implementation in accordance with the eCommerce Appendix, the “New SearsOutlet.com” (as that term is defined therein); subject to the restrictions on the sales of “New Products” as set forth therein. Further, Seller agrees that if Seller and Buyer, each in their sole discretion, agree to extend past the Initial Term the purchase by Buyer of DRM or MOS Products; then Seller will cause its Affiliates to agree to extend for that same period SHO’s rights to use the New Sears Outlet.com to sell such DRM or MOS product subject to the terms of the eCommerce Appendix and such other terms as may be agreed to by the parties to such Appendix;

Buyer may market all Seller-Branded Products on the “SHO Web Platforms” as permitted under and subject to the terms and conditions set forth in in the eCommerce Appendix (including the restrictions on the sale of “New Products” to the Services Agreement (as those terms are defined therein);

Buyer may market all Seller-Branded Products by all current and future means, methods, and channels (including by Seller Digital Methods) outside of the Territory if such marketing would not violate any Existing Contractual Obligation;

Buyer may sell all Seller-Branded Products at “brick and mortar” physical locations in the Territory subject to Section 9(b) ;

Buyer may sell all Seller-Branded Products in the Territory and outside the Territory in each case by Seller Digital Methods including delivering Seller-Branded Products outside the Territory to end-user consumers who used one or more Seller Digital Methods to purchase the Seller-Branded Products; and

Buyer may sell Outlet Products to liquidators but only after using commercially reasonable efforts to obtain the agreement of the liquidators to remove or obliterate (where removal is not possible) all Seller Marks from the Seller-Branded Products and all related labels, tags, and packaging.

“ Existing Contractual Obligation ” means a contractual obligation that (y) has been entered into in Good Faith by, and is binding on, Seller or one or more of its Affiliates, and (z) if it first becomes binding on Seller or one or more of its Affiliates on or after the October 11, 2012, all terms and conditions in the contractual obligation that limit Seller’s right to grant a license to, or otherwise authorize, Buyer to market or sell one or more Seller-Branded Products also to the same extent limit the right of Seller and its Affiliates to grant a license to, or otherwise authorize, each of Seller’s Retail Businesses to market and sell the same Seller-Branded Products. “ Seller Digital Methods ” means Digital Methods owned or operated by Seller or its Affiliates and includes the Outlet Stores website operated by Seller’s Affiliates immediately prior to the Effective Date and its successors owned or operated by Seller’s Affiliates.

Subject to the next sentence, Seller may terminate Buyer’s rights in Section 12(a)(iii)(B)(5) to sell by Seller Digital Methods upon 24-months’ prior written notice. Upon termination in accordance with the preceding sentence of Buyer’s rights to sell by Seller Digital Methods, Seller will grant Buyer a license to allow Buyer to (1) market all Seller-Branded Products by all then-current and future means, methods, and channels outside of the Territory if such marketing would not violate any Existing Contractual Obligation in effect immediately prior to the date of such license, and (2) sell all Products by all Digital Methods in the Territory and all Product outside of the Territory if the sale would not violate any Existing Contractual Obligation in effect immediately prior to the date of such license. The license described in the preceding sentence will include terms that are usual and customary for licenses of this type for comparable circumstances and a duration that is the same as the remaining duration of the last of the License Agreements to terminate in accordance with its terms.

Buyer will use Seller Marks in full compliance with the terms and conditions of this Agreement and with all commercially reasonable standards, specifications, and operating procedures prescribed by Seller from time to time, including all logo and trademark-usage guidelines.

Subject to the following sentences of this subsection, Buyer will submit to Seller for its review and approval, prior to publication, all Non-Guideline Advertising created by Buyer for Seller-Branded Products that incorporate one or more Seller Marks, including newspaper, magazine and website advertising, television and radio tapes, store signage, display billboards and any and all other materials on which a Seller Mark appears. Buyer will submit all Non-Guideline Advertising to Seller’s designated marketing associate by email or overnight courier so that the designated marketing associate receives the materials at least seven business days before Buyer intends to use them. If Seller does not notify Buyer of Seller’s disapproval of these materials within five business days after Seller’s designated marketing associate actually received them, the materials will be deemed approved. Seller’s approval of Non-Guideline Advertising is limited to the use of Seller Marks in connection with the advertising and will not be deemed to constitute approval of the appropriateness or compliance with Applicable Laws. “ Non-Guideline Advertising ” means all advertising that deviates in any material respect from Seller’s logo and trademark-usage guidelines in effect from time to time and delivered to Buyer, but no change that is applicable to Buyer will take effect upon less than 60-days’ advance written notice to Buyer.

Buyer may from time to time make a written request to Seller (each a “ New Name Request ”, for authorization to sell Products under this Agreement and/or Services provided under the Services Agreement in formats owned , licensed, authorized or operated by Buyer or its Affiliates which do not use one of the “Sears” names licensed by SHO and its Affiliates under the License Agreement (each a “ Non-Sears Business ,” e.g., “Hometown Stores, instead of ‘Sears Hometown Stores”). In each New Name Request, Buyer will identify the specific Product(s) and/or Service(s) that Buyer and its Affiliates desire to continue to purchase from Seller in accordance wit h this Agreement and the specific formats and locations of the stores for which SHO desires to use the non “Sears” name, and the Services they desire to continue having sold at the Non-Sears Business. Seller shall not unreasonably withhold or delay its approval/rejection of any such requ est; however Seller may condition its approval upon Buyer and its Affiliates accepting changes, negotiated in Good Faith, to this Agreement and the other Ancillary Agreements (including the financial terms thereo f). Absent written approval by Seller, signed by a Vice President or above of Seller, Buyer and its Affiliates are not authorized (1) to sell at a Non-Sears Business: (i) Products purchased under this Agreement, or (ii) Services provided for resale under the Services Agreement (e.g., protection agreements, and (2) to use Services provided for Buyer and its Affiliates benefit under the Services Agreement in connection with a Non-Sears Business. For clarity, the parties note that Seller may approve certain Products/Services while rejecting others. All Services are subject to the terms and conditions of the Services Agreement (including Section 1.11 (SHO New Name)).

Ownership; Display and Notices; Goodwill . Buyer acknowledges that (A) Seller or its Affiliates own all the proprietary rights to Seller Marks and (B) Buyer gains no ownership rights to Seller Marks licensed under this Agreement and gains only the limited right to use Seller Marks subject to the terms of this Agreement. Seller and its Affiliates reserve the unrestricted right to use, and to grant others the right to use, Seller Marks. Buyer will display the trademark and service mark notices for Seller Marks that Seller requests. Buyer’s use of Seller Marks and any goodwill generated from their use inures only to the benefit of Seller or its Affiliates. Buyer will not directly or indirectly contest or challenge the validity of Seller Marks or the rights of Seller and its Affiliates in Seller Marks. Buyer will not register or attempt to register any Mark that is confusingly similar to the Seller Marks or which dilutes any of the Seller Marks, including any domain name or URL containing or otherwise identifying any Seller Mark. Any content displayed on any website containing any Seller Mark must be pre-approved by Seller.

Other Obligations . Buyer will not use, advertise, promote or register any trademark, service mark, design mark or logo that is similar to any Seller Mark. Buyer will not engage in any act which would disparage or dilute the distinctiveness of any Seller Mark, and Buyer will use its best efforts to support the premium nature of the brands represented by Seller Marks. Buyer acknowledges that Buyer will not have any right, title or interest in or to any intellectual-property right in any Seller-Branded Product. Buyer will not have any right to alter any Seller-Branded Product or Seller-Branded Product packaging or repair, duplicate, translate, decompile, reverse engineer or adapt any Seller-Branded Product without Seller’s prior written consent. Buyer will not use any trademark, trade name, brand name or identifying mark of its own or any third party, alone or in combination with Seller Marks in connection with the sale of the Seller-Branded Products, if such use would create a combination mark.

Notice of Infringement or Claim . Buyer will promptly notify Seller if Buyer learns of any challenge to its use, or any apparent infringement, of any Seller Mark or any claim by any person to rights in any Seller Mark that are inconsistent with Seller’s rights to Seller Marks as described in this Section 12(a) . Seller and its Affiliates retain the right to control exclusively all settlements, litigation, and Patent and Trademark Office proceedings and other proceedings arising out of each such infringement or claim. Buyer will execute all documents and provide, at Seller’s expense, all assistance that Seller reasonably requests to protect Seller’s interests in Seller Marks and to protect Seller’s interests in all litigation and proceedings concerning Seller Marks.

Retention of Rights . Nothing in this Agreement limits in any way the rights of Seller and its Affiliates in and to Seller Marks, including without limitation (A) all rights of ownership in and to Seller Marks, including the right to license or transfer the same, and, (B) the unimpaired right to use and to license others to use Seller Marks in connection with manufacturing, marketing, distribution, sale, service, maintenance, repair, or provision of any products or services whether within or without the Territory.

Buyer

License to Use Buyer Marks .

Buyer hereby grants to Seller, during the Term and during any sell-off period contemplated under Section 2(g) , a nonexclusive, nontransferable, revocable, royalty-free right to use, but in no event to alter, Buyer Marks that are necessary for Seller to use to perform its obligations in accordance with the terms and conditions of this Agreement.

Seller will use Buyer Marks in full compliance with the terms and conditions of this Agreement and with all standards, specifications, and operating procedures prescribed by Buyer from time to time, including any logo and trademark usage guidelines.

Ownership; Display and Notices; Goodwill . Seller acknowledges that (A) Buyer or its Affiliates own all the proprietary rights to Buyer Marks and (B) Seller gains no ownership rights to Buyer Marks licensed under this Agreement and gains only the limited right to use Buyer Marks subject to the terms of this Agreement. Buyer and its Affiliates reserve the unrestricted right to use, and to grant others the right to use, Buyer Marks. Seller will display the trademark and service mark notices for Buyer Marks that Buyer requests. Seller’s use of Buyer Marks and any goodwill generated from their use inures only to the benefit of Buyer or its Affiliates. Seller will not directly or indirectly contest or challenge the validity of Buyer Marks or the rights of Buyer and its Affiliates in Buyer Marks. Seller will not register or attempt to register any Mark that is confusingly similar to the Buyer Marks or which dilutes any of the Buyer Marks, including any domain name or URL containing or otherwise identifying any Buyer Mark. Any content displayed on any website containing any Buyer Mark must be pre-approved by Buyer.

Other Obligations . Seller will not use, advertise, promote or register any trademark, service mark, design mark or logo that is similar to any Buyer Mark. Seller will not engage any act which would disparage or dilute the distinctiveness of any Buyer Mark, and Seller will use its best efforts to support the premium nature of the brands represented by Buyer Marks.

Notice of Infringement or Claim . Seller will promptly notify Buyer if Seller learns of any challenge to its use, or any apparent infringement, of any Buyer Mark or any claim by any person to rights in any Buyer Mark that are inconsistent with Buyer’s rights to Buyer Marks as described in this Section 12(b) . Buyer and its Affiliates retain the right to control exclusively all settlements, litigation, and Patent and Trademark Office proceedings and other proceedings arising out of each such infringement or claim. Seller will execute all documents and provide, at Buyer’s expense, all assistance that Buyer reasonably requests to protect Buyer’s interests in Buyer Marks and to protect Buyer’s interests in all litigation and proceedings concerning Buyer Marks.

Retention of Rights . Nothing in this Agreement limits in any way the rights of Buyer and its Affiliates in and to Buyer Marks, including without limitation (A) all rights of ownership in and to Buyer Marks, including the right to license or transfer the same, and, (B) the unimpaired right to use and to license others to use Buyer Marks in connection with manufacturing, marketing, distribution, sale, service, maintenance, repair, or provision of any products or services whether within or without the Territory.

CONFIDENTIALITY .

Confidential Information . “ Confidential Information ” means all information, whether disclosed in oral, written, visual, electronic or other form, that (i) one Party (the “ Disclosing Party ”) discloses to the other Party (the “Receiving Party ”), (ii) relates to or is disclosed in connection with this Agreement or a Party’s business, and (iii) if not designated as “confidential” (in which event the information is deemed to be Confidential Information), is or reasonably should be understood by the Receiving Party to be confidential or proprietary to the Disclosing Party. The Disclosing Party’s sales, pricing, costs, inventory, operations, employees, current and potential customers, financial performance and forecasts, and business plans, strategies, forecasts and analyses, as well as information as to which the Securities and Exchange Commission has granted confidential treatment pursuant to its Rule 406 of Regulation C (the “ CTR Information ”) , are Confidential Information.

Treatment of Confidential Information . The Receiving Party will use Confidential Information only in accordance with this Agreement and, except as expressly permitted by this Agreement and subject to the next sentence, will not disclose any Confidential Information for three years from the date of receipt of the Confidential Information. Neither Party will disclose the CTR Information during the period ending December 31, 2022.

Limitations . The Receiving Party will (A) restrict disclosure of the Confidential Information to its and its Affiliates’ Personnel (“ Representatives ”) with a need to know the Confidential Information for purposes of performing the Receiving Party’s responsibilities or exercising the Receiving Party’s rights under this Agreement, (B) advise those Representatives of the obligation not to disclose the Confidential Information, (C) copy the Confidential Information only as necessary for those Representatives who need it for performing the Receiving Party’s responsibilities under this Agreement, and ensure that confidentiality is maintained in the copying process; and (D) protect the Confidential Information, and require those Representatives to protect it, using the same degree of care as the Receiving Party uses with its own Confidential Information, but no less than reasonable care.

Permitted Disclosure . Either Party may disclose the Confidential Information to any of its Affiliates but only if the Affiliate’s use of such Confidential Information will be subject to the terms and conditions of this Agreement and the Disclosing Party will remain responsible for disclosures by its Affiliates and their Personnel in violation of this Agreement. Buyer may disclose (A) the existence and contents of this Agreement in connection with Buyer’s filings with the Securities and Exchange Commission and with federal and state franchise regulatory authorities (including filing this Agreement as an exhibit to Buyer’s filings), and (B) Seller’s Confidential Information related to Products to Franchisees and their Personnel in connection with the sale of Products but the use of the Confidential Information in accordance with this clause (B) will be subject to the terms and conditions of this Agreement and Buyer will remain responsible for disclosures made by Franchisees and their Personnel in violation of this Agreement.

Liability for Unauthorized Use . The Receiving Party will be liable to the Disclosing Party for any unauthorized disclosure or use of Confidential Information by any of its and its Affiliates or current or former Personnel.

Destruction . Within ten days after receiving the Disclosing Party’s written request, the Receiving Party will destroy or return (as instructed by the Disclosing Party) any materials containing Confidential Information, and certify to the Disclosing Party that it has satisfied its obligations under this Section 13(b) .

Exceptions to Confidential Treatment .

Exceptions . The obligations under this Section 13 do not apply to any Confidential Information that the Receiving Party can demonstrate (A) was previously known to the Receiving Party without any obligation to hold it in confidence, (B) is disclosed to third parties by the Disclosing Party without an obligation of confidentiality to the Disclosing Party, (C) is or becomes available to any member of the public other than by unauthorized disclosure, (D) was or is independently developed by the Receiving Party without use of the Confidential Information, (E) legal counsel’s advice is that the Confidential Information is required to be disclosed by Applicable Law or the rules and regulations of any applicable regulatory authority, or (F) legal counsel’s advice is that the Confidential Information is required to be disclosed in response to a valid subpoena or order of a court or other governmental body of competent jurisdiction or other valid legal process.

Notification . In the case of any disclosure under Section 13(c)(i)(E) or Section 13(c)(i)(F) the Receiving Party must notify the Disclosing Party prior to disclosure and use reasonable efforts to cooperate with the Disclosing Party so that the Disclosing Party may take legally available steps to resist or narrow the requested disclosure and obtain an appropriate protective order or other assurance that confidential treatment will be accorded the Confidential Information.

INDEMNIFICATION .

Seller Indemnities . To the fullest extent permitted by Applicable Law and subject to Section 14(d) and Section 16 , Seller will defend, indemnify, and hold harmless Buyer, its Affiliates, and their respective present, former, and future directors, officers, other employees, agents, each of their successors, and assigns, and the heirs, executors, administrators of each of the foregoing that are natural persons (together, the “ Buyer Indemnified Persons ”), against all damages, losses, costs, expenses (including attorneys’ fees, costs and expenses), and other liabilities arising out of or in connection with all Seller Claims. “ Seller Claims ” means all claims, demands, suits, and causes of action by third parties (other than Buyer and its Affiliates) arising out of or in connection with this Agreement (including claims of negligence by Personnel of Seller or its Affiliates) that result, or are claimed to result, in whole or in part, from (i) the violation by Seller, its Affiliates, or any of their Personnel of any intellectual property right of another, (ii) the failure by Seller or its Affiliates to perform their obligations in this Agreement in accordance with their terms, or (iii) any other act or omission of Seller or its Affiliates.

Buyer Indemnities . To the fullest extent permitted by Applicable Law and subject to Section 14(d) and Section 16 , Buyer will defend, indemnify and hold harmless Seller, its Affiliates, and their respective present, former, and future directors, officers, other employees, agents, each of their successors, and assigns, and the heirs, executors, administrators of each of the foregoing that are natural persons (together, the “ Seller Indemnified Persons ”), against all damages, losses, costs, expenses (including attorneys’ fees, costs and expenses) and other liabilities arising out of or in connection with all Buyer Claims. “ Buyer Claims ” means all claims, demands, suits, and causes of action by third parties (other than Seller and its Affiliates) arising out of or in connection with this Agreement (including claims of negligence by the Personnel of Buyer or its Affiliates) that result, or are claimed to result, from (i) the use of any Seller Mark by Buyer, its Affiliates, or its Franchisees that is not accordance with the terms of this Agreement or the violation by Buyer, its Affiliates, or any of their Personnel of any intellectual property right of another, (ii) Buyer’s display, sale, assembly, installation, service, or repair, or installation of any Product (excluding claims, demands, suits, and causes of action arising out of or in connection with services to be performed by Seller for Buyer in accordance with the terms and conditions of the Services Agreement and all other services that are performed for Buyer by Seller or its Affiliates), (iii) the failure by Buyer or its Affiliates to perform their obligations in this Agreement in accordance with their terms, (iv) Seller’s purchase, sale, distribution and other acts or omissions in connection with any Buyer-Unique Product (but excluding the gross negligence or intentional misconduct of Seller and its Affiliates, or (iv) any other act or omission of Buyer or its Affiliates. “ Claims ” means the Seller Claims and the Buyer Claims together.

Defense . The Party that is obligated to provide defense and indemnity to the other Party with respect to a Claim in accordance with this Section 14 (the “ Indemnifying Party ”) has the right to control the defense of the Claim, but the other Party (the “ Indemnified Party ”) has the right to participate in the defense. Upon the Indemnifying Party’s request, the Indemnified Party will reasonably cooperate in the defense, and the Indemnifying Party must reimburse the Indemnified Party for its reasonable out-of-pocket expenses in providing the requested cooperation. The Indemnified Party will provide prompt notification to the Indemnifying Party of each Claim to which it is entitled to be indemnified, but any delay by the Indemnified Party in giving notice will not relieve the Indemnifying Party of its obligations pursuant to this Section 14 except to the extent that the Indemnifying Party demonstrates actual damage caused by such delay. The obligations of Seller and Buyer to defend, indemnify and hold harmless, respectively, the Buyer Indemnified Parties and the Seller Indemnified Parties under this Section 14 are independent of each other and any other obligation of the Parties under this Agreement.

Exclusions from Claims; Tender and Cooperation . Excluded from Claims are claims, actions, liabilities, proceedings, losses, and expenses (including attorneys’ fees) arising out of or with respect to the death of or injury to any person or damage to any property, by whomsoever suffered, to the extent resulting or claimed to result from a latent or patent defect in a Product (each a “ Product Liability Claim ”). Buyer and Seller each will take all commercially reasonable actions, and cooperate with the other Party, as may be necessary to (i) tender each Product Liability Claim to the Vendor or manufacturer of the applicable Product and (ii) cause the Vendor or manufacturer to assume and bear financial responsibility for, and hold Buyer and Seller harmless from, the Product Liability Claim to the fullest extent permitted by Applicable Law, including the legal defense of the Product Liability Claim.

INSURANCE .

Required Coverage . Buyer will obtain and maintain at its own cost occurrence‑based Commercial General Liability Insurance, including but not limited to products, completed operations and contractual liability, in amounts not less than $5,000,000.00 per occurrence, naming the Seller and Buyer (together the “ Insured Parties ”) as additional insureds. This insurance must be primary to any of Seller’s coverage. Buyer will furnish certificate(s) of insurance upon execution of this Agreement, and within 15 days of any insurance renewals. All of the insurance policies specified in this Section 15(a) must contain a provision that such policies may not be cancelled or materially altered without 30 days prior written notice to Seller. All insurance carriers for the insurance coverage referred to in this Section 15(a) must be listed in the current Best’s Insurance Guide as possessing a minimum policyholders rating of “A” and a financial category of “VI” ($25,000,000 to $50,000,000).

Proof of Insurance . Buyer will once each year, and, upon request by Seller, promptly furnish or cause to be furnished to Seller, a copy of the insurance certificate and premium receipt for the most recent payment.

LIMITATION ON LIABILITY . Neither Party will be liable to the other Party or its Affiliates, directors, officers, customers or employees for any indirect, special, consequential, incidental, or punitive damages, losses, or expenses (including, without limitation, lost or anticipated revenues, profits, or savings relating to the same) arising in connection with any Claim or the failure to perform, or the termination of, this Agreement regardless of the nature of the Claim or the failure to perform, or the termination of this Agreement even if a Party has been advised of the likelihood or possibility of such damages, losses, or expenses.

MINIMUM QUANTITIES . Buyer will purchase at least $100 of Products during the Term. If at the expiration of the Term Buyer has ordered less than $100 of Products, Buyer will pay Seller (upon request) the difference between the amount ordered and $100. Seller acknowledges that except as set forth in this Section 17 , Buyer is not obligated or committed to purchase any quantities of Products except as expressly ordered by Buyer according to the Inventory Policies and Processes.

DISPUTE RESOLUTION .

Committees .

Merchandising Operating Committee . Buyer and Seller will form a committee (the “ Merchandising Operating Committee ”) that will address all day-to-day operational, financial, and other issues that may arise with respect to this Agreement, including its interpretation, the Parties intent reflected in this Agreement, and the policies and practices between Seller and its Affiliates and the businesses comprising Buyer’s businesses in effect immediately prior to the Effective Date. The Merchandising Operating Committee will discuss all of these issues and will attempt to resolve informally all Disputes in accordance with Section 18(b)(i) . The Merchandising Operating Committee will consist of three employees of each Party or of an Affiliate of the Party, in all cases as designated by the Party. The initial employee designees are listed on Appendix 18(a)(i) . Each Party may replace one or more of its designees at any time upon notice to the other Party. Each Party will promptly fill all of its Merchandising Operating Committee vacancies as they arise by notice to the other Party. Unless the members of the Merchandising Operating Committee unanimously agree otherwise, the Merchandising Operating Committee will meet at least once every calendar month during the Term on the dates determined by the members of the Merchandising Operating Committee. If the members of the Merchandising Operating Committee cannot agree on a date or a time for a particular monthly meeting the meeting will occur at 1:00 p.m. Central Time on the second Thursday of the month at the offices of SHC, 3333 Beverly Road, Hoffman Estates, IL 60179 B6-D. At all times one of the members of the Merchandising Operating Committee will serve as the Merchandising Operating Committee’s Chairperson. The initial Chairperson is listed on Appendix 18(a)(i) and the other Merchandising Operating Committee members each will serve thereafter as Chairperson, on a monthly basis, rotating between Seller’s designees and Buyer’s designees. The Chairperson (A) will request that Merchandising Operating Committee members provide meeting agenda items and (B) will distribute to members, at least two business days in advance of each Merchandising Operating Committee meeting, an agenda for the meeting.

Executive Committee . Buyer and Seller will form a committee (the “ Executive Committee ”) that will attempt to resolve all Disputes that the Merchandising Operating Committee has been unable to resolve in accordance with Section 18(b) and that the Merchandising Operating Committee has referred to the Executive Committee. The Executive Committee will consist of the Chief Financial Officer, the General Counsel (or other chief legal officer), and the chief merchandising officer of each Party.

Dispute Resolution .

Merchandising Operating Committee’s Attempt to Resolve Dispute . If a Dispute arises, neither Party may cease to perform any of its obligations in this Agreement in accordance with their terms or take any formal legal action (such as seeking to terminate this Agreement, seeking mediation in accordance with Section 18(b)(iv) , or instituting or seeking any judicial or other legal action, relief, or remedy with respect to or arising out of this Agreement) unless the Party has first (1) delivered a notice of dispute (the “ Dispute Notice ”) to all of the members of the Merchandising Operating Committee and (2) complied with the other terms and conditions of this Section 18 . At the first monthly meeting of the Merchandising Operating Committee following the delivery of the Dispute Notice the Merchandising Operating Committee will attempt to resolve all of the Disputes that are the subject of the Dispute Notice. Each Party will cause its designees on the Merchandising Operating Committee to negotiate in Good Faith to resolve all Disputes in a timely manner.

Executive Committee’s Attempt to Resolve Dispute . If the Merchandising Operating Committee is unable to resolve all of the Disputes included in the Dispute Notice by the end of the first Merchandising Operating Committee meeting following the delivery of the Dispute Notice, the Chairperson for the next Merchandising Operating Committee meeting will notify each member of the Executive Committee in writing of each unresolved Dispute. The Executive Committee will meet not later than the 10 ^th day following delivery of the notification by the Merchandising Operating Committee’s Chairperson (the “ Dispute Meeting ”) and attempt to resolve each Dispute that is listed on the notification. Each Party will cause its designees on the Executive Committee to negotiate in Good Faith to resolve all Disputes in a timely manner. If by the 10 ^th day following the Dispute Meeting the Executive Committee has not resolved all of the Disputes (the “ Resolution Failure Date ”) the Parties will proceed to mediate the unresolved Disputes (“ Unresolved Disputes ”) in accordance with Section 18(b)(iv) .

Dispute Defined . Subject to the next sentence, “ Dispute ” means each claim, controversy, dispute, and disagreement between (A) on the one hand, Buyer or any of its Affiliates, or any of their respective shareholders, officers, directors, agents, employees, legal representatives (including attorneys in their representative capacity), successors and assigns, and (B) on the other hand, Seller or any of its Affiliates, employees, legal representatives (including attorneys in their representative capacity), successors and assigns, in each case arising out of or relating to a Party’s performance, or failure to perform, one or more of its obligations in this Agreement. Disputes do not include claims, controversies, disputes, or disagreements with respect to compliance with Section 13 or payment obligations with respect to amounts due in accordance with the terms and conditions of this Agreement that are not reasonably in dispute. Furthermore, no party may provide a Dispute Notice for any Dispute, or otherwise assert and/or claim a Dispute to the extent the Dispute relates to any act or omission of a Party, its Affiliates or its/their Representatives (other than clerical or accounting errors which the asserting Party was not aware of) in connection with, or related to, its rights, or the other Party, its Affiliates or its/their Representatives performance or non-performance under this Agreement that occurred more than 120 days prior to the time such claims, controversy, dispute, and/or disagreement is first asserted (together, “ Stale Claims ”) and each Party waives on its behalf (and on behalf of its Affiliates and its/their Representatives) any rights to a Stale Claim. Notwithstanding the foregoing, the term “Stale Claims” does not include claims, controversies, disputes, and disagreements brought by either Party in regards to: (X) the other Party’s rights and obligations under Section 14 (Indemnification); (Y) claims by a Party for reimbursement from the other Party for fees, expenses (including attorneys’ fees), charges, costs, damages penalties and other amounts paid by a Party or its Affiliates to a third party, including such amounts arising from non-indemnified third party claims, controversies and disagreements; provided that the Party brings such claim within 120 days after the Party makes such a payment; and (Z) an act or omission of the other Party, its Affiliates and/or its/their Representatives which the other Party demonstrates was intentionally done (or not done) with actual knowledge that it was in violation of this Agreement (including such Party’s duty of Good Faith). With respect to Stale Claims, for example: (I) a “clerical or accounting error” shall not include a claim by a Party that it should not be charged for activities for which it regularly received charges which instead will be deemed to be a Stale Claim to the extent that such claim is for acts/omissions that are more than 120 days old; (II) a claim relating to charges which were incorrectly calculated due to a “clerical or accounting error” of which the claiming party was unaware would not be a Stale Claim to the extent based solely on such “clerical or accounting error”, (III) an intentional overcharge by a Party which it knew it was making in violation of this Agreement, will not be deemed to be a Stale Claim even if raised more than 120 days after such overcharge; provided that the claiming Party can prove such violation was intentional and made with actual knowledge that such overcharge was a violation of this Agreement.

Mediation of Unresolved Disputes . Seller and Buyer will in Good Faith attempt to resolve all Unresolved Disputes by non-binding mediation. Buyer and Seller will negotiate in Good Faith to determine the mediator, the mediator’s compensation and related costs, and the applicable rules for the mediation. If by the 15 ^th day following the Resolution Failure Date Seller and Buyer have been unable to settle an Unresolved Dispute the obligations of Seller and Buyer in this Section will terminate with respect to the Unresolved Dispute.

SELLER’S CLOSING LOCATIONS . Seller will notify Buyer of each Sears Store location that Seller or its Affiliates intend to close. Seller will notify Buyer of the store-closing decision not later than the 10 ^th day following the decision or the day before public disclosure of the decision, whichever occurs first. If Seller notifies Buyer of the decision before Seller publicly discloses the decision it will constitute Confidential Information until the decision is publicly disclosed. Seller will notify Buyer, not later than the 30 ^th day following the decision, as to whether Seller intends to continue its retail presence in the trade area that included the closing store. If Seller does not (a) notify Buyer in accordance with the preceding sentence that Seller intends to continue its retail presence in the trade area, or (b) does not open a new Sears Store in the trade area within 18 months of the notification, Buyer may open one or more New HTS Stores or other new stores in the trade area when the store location closes free of the restrictions, if any, in Section 9(b)(i) with respect to the closed store.

GLOSSARY .

The following terms have the meanings given below and include the singular and the plural forms of the terms:

“ 3(b) Amount ” is defined on Appendix 3(b) .

“ Affiliates ” means (solely for purposes of this Agreement and for no other purpose) (i) with respect to Buyer, its subsidiaries including Outlet Co and SAHS, (ii) with respect to Seller, SHC and its subsidiaries including Sears Holdings Management Corporation (“ SHMC ”), and (iii) with respect to SHC, its subsidiaries.

“ Applicable Laws ” means all applicable laws, ordinances, regulations, rules, and court and administrative orders and decrees of all national, regional, state, local and other governmental units that have jurisdiction in the given circumstances.

“ Average Aggregate Minimum Commission ” is defined on Appendix 5(e) .

“ Buyer ” is defined in the introductory paragraph of this Agreement.

“ Buyer Marks ” means Marks owned by Buyer or its Affiliates.

“ Buyer Stores ” means, together, the Sears Hardware Stores, the Sears Hometown Stores, and the Sears Outlet Stores.

“ Confidential Information ” is defined in Section 13(a) .

“ Core Cost ” is defined on Appendix 3(b) .

“ Digital Methods ” means promoting and selling by all current and future electronic means, channels, processes, and methods, including via the Internet.

“ Disclosing Party ” is defined in Section 13(a) .

“ Dispute ” is defined in Section 18(b)(ii) .

“ Dispute Resolution Meeting ” is defined in Section 18(b)(i) .

“ DRM ” is defined in Section 4(a)(i) .

“ Effective Date ” is defined in Section 2(a) .

“ Excluded No-Warranty Product ” is defined in Section (a)(i) .

“ FOB Point ” is defined in Section 7(a) .

“ Franchisee ” means a natural person or entity that has purchased (i) a franchise as described in the Franchise Disclosure Document of Sears Home Appliance Showrooms, LLC dated May 11, 2012 (with respect to Sears Home Appliance Showrooms), (ii) a franchise as described in the Franchise Disclosure Document of Sears Home Appliance Showrooms, LLC dated May 11, 2012 (with respect to Sears Hardware Stores), and (ii) a franchise pursuant to which Buyer or its Affiliates grant a third party the right to use a “Sears” tradename in compliance with the License Agreements.

“ Inventory Policies and Processes ” is defined in Section 6 .

“ Good Faith ” means honesty in fact and the observance of reasonable commercial standards of fair dealing in accordance with Applicable Law.

“ Group ” means a “group” as that term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended.

“ Home Appliance Category ” is defined on Appendix 5(a) .

“ HTS Invoice Prices ” is defined in Section 3(b) .

“ HTS Produc ts” is defined in Section 3(a) .

“ Initial Term ” is defined in Section 2(a) .

“ KCD-Branded Product Category ” is defined on Appendix 5(a) .

“ KCD-Branded Products ” means all Seller-Branded Products sold under a KCD Mark.

“ KCD Change in Control ” means the occurrence of any transaction or event or series of transactions or events, whether voluntary or involuntary, that results in an Unaffiliated Person or a Group acquiring directly, or as a consequence of which an Unaffiliated Person or a Group acquires directly, at any time after the date of this Agreement and by whatever means (including by license), all rights, title and interest in and to all of the KCD Marks. “ Unaffiliated Person ” means a natural person, entity, or other enterprise other than Seller or Seller’s Affiliate. “ Seller’s Affiliate ” means each natural person, entity, and other enterprise that directly or indirectly, and by whatever means, controls, is under common control with, or is controlled by, Seller.

“ KCD Marks ” means Kenmore®, Craftsman®, DieHard®, and t h e sub-brand Marks associated with, and the trade dress related to, the Kenmore, the Craftsman, and the DieHard Marks.

“ KCD Mark Acquisition ” means the occurrence of any transaction or event or series of transactions or events (other than a KCD Change in Control), whether voluntary or involuntary, that results in an Unaffiliated Person or a Group acquiring directly, or as a consequence of which an Unaffiliated Person or a Group acquires directly, at any time after the date of this Agreement and by whatever means (including by license), all rights, title and interest in and to one or more but less than all of the KCD Marks.

“ Kenmore-Branded Product ” is defined in Section 5(d) .

“ Kenmore Royalty Credit ” is defined on Appendix 5(a) .

“ License Agreements ” is defined in Section 2(c)(iv) .

“ Mark ” means any name, brand, mark, trademark, service mark, sound mark, trade dress, trade name, business name, slogan, or other indicia of origin and includes all common law or statutory property rights related to such Mark.

“ MOS ” is defined in Section 4(a)(iii) .

“ Net Sales ” is defined in Section 5(a) .

“ No-Vendor-Warranty Product ” is defined in Section 10(a)(i)

“ Non-Retail Products ” is defined in Section 3(a) .

“ Outlet Invoice Prices ” is defined in Section 4(h) .

“ Outlet Products ” is defined in Section 4(g) .

“ Party ” means (1) SRC and Kmart together, on the one hand, and (2) SHO, SAHS, and Outlet Co. together, on the other hand. Although SHC is a party to this Agreement SHC is not a Party.

“ Personnel ” means the officers, directors, employees, agents, suppliers, licensors, licensees, contractors, subcontractors, advisors, including attorneys, accountants, technical consultants or investment bankers and other representatives, from time to time, of (i) the applicable entity, (ii) as to Seller, its Affiliates, and (iii) as to Buyer, its Affiliates.

“ Products ” means, together, HTS Products and Outlet Products.

“ Receiving Party ” is defined in Section 13(a) .

“ Renewal Period ” is defined in Section 2(b) .

“ Representatives ” is defined in Section 13(b)(i) .

“ Right of First Offer ” is defined in Section 4(a)(iv) .

“ Royalties ” is defined in Section 5(a) .

“ Sears Hardware Stores ” means all stores that are operated, or authorized to operate, by Buyer or Franchisees and that are branded with the name “Sears Hardware Stores” or “Sears Appliance & Hardware Stores.”

“ Sears Hometown Stores ” means all stores that are operated, or authorized to operate, by Buyer and that are branded with the name “Sears Hometown Store” or “Sears Authorized Hometown Store.”

“ Sears Outlet Stores ” means all stores that are operated, or authorized to operate, by Buyer and that are branded with the name “Sears Outlet Store.”

“ Seller ” is defined in the introductory paragraph of this Agreement.

“ Seller-Branded Product ” means Products sold under a Seller Mark and includes KCD-Branded Products.

“ Seller Competitor ” means, solely for purposes of this Agreement and for no other purpose, Amazon.com, Inc., Best Buy Co., Inc., hhgregg, Inc., The Home Depot, Inc., Lowe’s Companies, Inc., Target Corporation, Tractor Supply Co., Wal-Mart Stores, Inc., each other retailer that competes in any material respect with Seller’s major home appliance business or Seller’s power lawn and garden business, and the Seller Competitor Affiliates of each of them. “ Seller Competitor Affiliates ” means each individual or entity that directly or indirectly, and by whatever means, controls, is under common control with, or is controlled by, a Seller Competitor.

“ Seller Marks ” means Marks owned by Seller or its Affiliates and includes the KCD Marks.

“ Seller Warranty ” is defined in Section 10(a)(i) .

“ Seller’s Retail Businesses ” is defined in Section 3(a) .

“ Separation Agreement ” means that certain Separation Agreement dated August 8, 2012 between SHC and SHO.

“ Services Agreement ” is defined in Section 2(c)(iv) .

“ SHC ” is defined in the introductory paragraph of this Agreement.

“ SHO ” is defined in the introductory paragraph of this Agreement.

“ SHO Authorized Seller(s) ” is defined in the Services Agreement.

“ SHO Stockholding Change ” means the occurrence of any transaction or event, whether voluntary or involuntary, that results in a Seller Competitor becoming, or as a consequence of which a Seller Competitor becomes, directly or indirectly, at any time after the date of this Agreement and by whatever means, the beneficial owner of more than 50% of the total voting power of outstanding securities entitled to vote in, or carrying the right to direct the voting with respect to, directly or indirectly and by whatever means the election of the board of directors of SHO or any of its subsidiaries.

“ Specification ” means the detailed description of Products agreed upon by Seller and Buyer as contained in any Vendor Agreement.

“ SYW Agreement ” is defined in Section 2(c)(iv) .

“ Term ” is defined in Section 2(a) .

“ Territory ” means the United States of America (including its unincorporated territories Guam, Puerto Rico, and the United States Virgin Islands) and Bermuda.

“ Vendor ” means any source (other than Seller’s Affiliates) from whom Seller purchases Products; and for purposes of the Section 8(a) (Vendor Subsidies) only, any source (other than Sellers and its Affiliates) from whom Buyer purchases products.

Vendor-Warranty Product ” is defined in Section 10(a)(ii).

“ Vendor Agreement ” means any Purchase Order or other agreement in writing and executed by Buyer and Seller relating to Products, including this Agreement, advertising, point of sale, promotional service, promotional funding or other selling assistance agreements, buying or supply agreements, exclusivity agreements, letters of agreement, and any written amendments, waivers and consents relating to any of the foregoing.

“ Vendor Warranty ” is defined in Section 10(a)(ii) .

“ Warranty ” is defined in Section 10(a)(ii) .

SHC’S SOLE OBLIGATION . As its sole obligation in this Agreement and unless Buyer has failed to comply with one or more of its material obligations in this Agreement and the failure is continuing, SHC will cause SRC, Kmart, and the Affiliates of each of them to take all actions that will enable Seller to perform, and not take any action that would disable to any extent Seller from performing, its obligations in this Agreement in accordance with their terms. For clarity, the parties note that this clause does not affect SBMC’s right to approve or reject a proposed KCD-Unique Product, in SBMC’s sole discretion.

GENERAL .

Good Faith . SHC and the Parties each will exercise Good Faith in the performance of its obligations in this Agreement.

Assignment . Seller may at any time assign, delegate or subcontract its rights, or obligations or both, in whole or in part, under this Agreement except to a Seller Competitor, without the consent of Buyer. Subject to the next sentence, Buyer may not assign or otherwise transfer any of its rights or obligations under this Agreement (except to a wholly owned subsidiary of Buyer), by operation of law or otherwise, without the express prior written consent of Seller, and any attempt to assign or assignment without the express prior written consent of Seller is void. Buyer may exercise all of its rights, and perform all of its obligations, under this Agreement through its wholly owned subsidiaries.

Computer Access . If either Party is given access, whether on-site or through remote facilities, to any communications, computer, or electronic data storage systems of the other Party or its Affiliates (each an “ Electronic Resource ”), in connection with this Agreement, then the Party given access will use such access solely to perform, and will not attempt to access any Electronic Resource other than those specifically required to perform, its obligations under this Agreement. The Party given access will limit such access to those of its Personnel who need to have such access in connection with this Agreement, will advise the other Party in writing of the name of each of its Personnel who will be granted such access, and will strictly follow all security rules and procedures for use of such Electronic Resources. All user identification numbers and passwords disclosed to a Party given access and any information obtained by the Party given access as a result of its access to, and use of such Electronic Resources will be deemed to be, and will be treated as, Confidential Information of the other Party. Each Party will cooperate with the other Party in the investigation of any apparent unauthorized access by the other Party, its Affiliates, or its Personnel to any Electronic Resources or unauthorized release of Confidential Information. Each Party will promptly notify the other Party of any actual or suspected unauthorized access or disclosure of any Electronic Resource.

Promotional Calendars . To the extent permitted by Applicable Law and consistent with practices in effect prior to the Effective Date, Seller will deliver to Buyer Seller’s promotional calendars with respect to Products (including for Home Appliances, Tools, Lawn and Garden, Sporting Goods, Mattresses, and Consumer Electronics) as soon as they have been approved, including all amendments. Also consistent with practices prior to the Effect Date, the promotional calendars will include Seller’s “master price files” (and substitute information) describing Seller’s retail and promotional pricing, as to which the Parties acknowledge that Section 3(d) and Section 4(g) are and will be applicable.

Negotiating Event . If a Negotiating Event occurs and thereafter a Party (the “ Delivering Party ”) delivers to the other Party (the “ Receiving Party ”) an Opinion of Counsel that states that, as a consequence of the Negotiating Event the Delivering Party is unable, due to Applicable Law, to continue to perform any of the obligations to be performed by it in accordance with the terms and conditions of this Agreement (an “ Impediment ”), Seller and Buyer will negotiate in Good Faith an amendment to this Agreement that would eliminate the Impediment. “ Opinion of Counsel ” means a written opinion (which may be reasoned) of a reputable law firm of national stature. The form and substance of the written opinion, and the law firm, will be subject to the approval of the Receiving Party. “ Negotiating Event ” means the occurrence of any transaction or event, whether voluntary or involuntary, as a result of which a single stockholder or a Group ceases to be the “beneficial owner” (as defined in Securities and Exchange Commission Rules 13d-3 and 13d-5 under the Securities Exchange Act of 1934, as amended) of a majority of the total voting power of the then-outstanding voting capital stock of SHC or SHO.

Consideration . Buyer has given, and Seller has received and accepted, adequate, good, sufficient, and valuable consideration for this Agreement, and for all purposes of this Agreement this Agreement is fully supported by adequate, good, sufficient, and valuable consideration provided by Buyer and received and accepted by Seller. Buyer’s adequate, good, sufficient, and valuable consideration includes, without limitation, the mutual covenants, obligations, and promises herein and the following (which separately and together have enabled Seller to execute and deliver this Agreement and have assisted and will assist Seller’s performance of its obligations under this Agreement): (i) Buyer has at great length discussed and upon reasonable request during the Term will discuss its business needs with Seller for the purpose of enabling Seller to make compelling business proposals to Buyer; (ii) Buyer has entered into negotiations with Seller that culminated in the execution and delivery of this Agreement, which Agreement gives Seller many advantages over other vendors; (iii) Buyer has provided and upon reasonable request during the Term will provide information to Seller about Buyer’s operations; (iv) Seller has bargained for and, pursuant to this Agreement will receive, material benefits, interests, rights, and value from Buyer through such consideration and that Seller is not entitled to, and would not have received, such benefits, interests, rights, and value absent this Agreement; and (v) Buyer is obligated to purchase Products in accordance with, and subject to the terms and conditions of Sections 4(b) and 4(a)(iii). This Agreement is legally binding; and Seller will not, directly or indirectly, plead or otherwise assert in any manner in any litigation, arbitration, mediation, or other dispute-resolution proceeding that this Agreement is invalid, void, voidable, revocable, terminable, or otherwise unenforceable for lack, inadequacy, or insufficiency of consideration; and by this Agreement Seller irrevocably waives and will be estopped from pleading or asserting, directly or indirectly, any cause of action, claim, defense, right, or prayer for relief to such effect. Each of Seller’s waivers in this Section 22(f) is reasonable and made with Seller’s full knowledge of its significance and consequences.

Construction and Interpretation . In this Agreement (1) “ include ,” “ includes ,” and “ including ” are inclusive and mean, respectively, “include without limitation,” “includes without limitation,” and “including without limitation,” (2) “ or ” is disjunctive but not necessarily exclusive, (3) “ will ” and “ shall ” each 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, (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, (7) references to $ or Dollars will mean U.S. Dollars, and (8) references to a Party’s approval or consent right include the Party’s obligation not to unreasonably delay or withhold its approval or consent. Seller and Buyer intend that this Agreement be construed without any rule requiring construction or interpretation against Seller, whose representatives drafted this Agreement. To the extent the Parties intend that a term or condition of this Agreement reflect policies and practices in effect immediately prior to the Effective Date, the Parties will negotiate in Good Faith to determine the policies and practices.

Counterparts; Facsimile . This Agreement may be executed in any number of separate counterparts, all of which, when taken together, will constitute one and the same instrument, notwithstanding the fact that all Parties did not sign the same counterpart. A signature transmitted to the other Party or its counsel by email or facsimile transmission will be effective to bind the Party whose signature was transmitted, as a duly executed and delivered original. Each Party will promptly deliver its original signature pages to this Agreement to counsel for the other Party promptly following execution, but any failure to do so will not affect the binding effect of such signature.

Entire Agreement; Severability . This Agreement together with the Services Agreement, which includes each of the Exhibits, Appendices and other documents attached to this Agreement and the Services Agreement, are a single integrated agreement which sets forth the entire agreement and understanding between the Parties with respect to the Products described herein and the Services described in the Services Agreement; except for those matters set forth in the Separation Agreement and the other “Ancillary Agreements” (as that term is defined in the Separation Agreement) and supersedes all prior agreements and understandings, oral and written, between the Parties hereto with respect to the subject matter hereof. This Agreement will not be supplemented, modified, or amended except by a written instrument signed by a duly authorized representative of each of Buyer and Seller. In the event of any conflict or inconsistency between this Agreement and the terms and condition of any forecast, purchase order, or other order document, including any inconsistency as to any Product invoice price, the terms and conditions of this Agreement will control unless such other document constitutes an Amendment and expressly references and supersedes this Agreement. This Agreement will be binding upon and inure to the benefit of the successors, representatives and permitted assigns of the Parties. The terms and conditions of this Agreement supersede and replace those of any prior negotiations and any documents that the Parties have exchanged in connection therewith (together, “ Negotiation Documents ”). Buyer and Seller represent and warrant that they are entering into this Agreement based solely on the provisions set forth herein and not in reliance, in whole or in part, on any claim or representation contained in any Negotiation Document. If any provision of this Agreement is held invalid or unenforceable by a court of competent jurisdiction, such invalidity shall not affect the validity or operation of any other provision and such invalid provision shall be deemed to be severed from the Agreement.

Injunctive Relief . Each Party acknowledges that any breach by a Party of Section 12 or Section 13 of this Agreement may cause the non-breaching Party and its Affiliates irreparable harm for which the non-breaching Party and its Affiliates have no adequate remedies at law. Accordingly, each Party and its Affiliates are entitled to seek injunctive relief, without complying with Section 18(b) and regardless of Buyer’s cure rights, if any, for any such breach in any state or federal court in Chicago, Illinois, USA, and each Party consents to the exclusive jurisdiction and venue in the state and federal courts in Chicago, Illinois, USA for injunctive relief purposes. Each Party waives all claims for damages by reason of the wrongful issuance of an injunction and acknowledges that its only remedy in that case is the dissolution of that injunction.

Notices . Notices under this Agreement are sufficient if given by nationally recognized overnight courier service, certified mail (return receipt requested), or email or facsimile with electronic confirmation or personal delivery to the other Party at the address below:

If to either Seller: Sears, Roebuck and Co.

3333 Beverly Road

Hoffman Estates, IL 60179

Attn: EVP, Chief Merchandising Officer, & President-Sears Full Line Store & Kmart Formats

Facsimile: (847) 286-0204

With a copy to: Sears Holdings Management Corporation

3333 Beverly Road

Hoffman Estates, IL 60179

Attn: General Counsel

Facsimile: (847) 286-2471

If to any Buyer : Sears Hometown and Outlet Stores, Inc.

3333 Beverly Road

Hoffman Estates, IL 60179

Attn.: Senior Vice President and Chief Operating Officer

Facsimile: (847) 286-7838

With a copy to: Sears Hometown and Outlet Stores, Inc.

3333 Beverly Road

Hoffman Estates, IL 60179

Attn: General Counsel

If to SHC : Sears, Roebuck and Co.

3333 Beverly Road

Hoffman Estates, IL 60179

Attn: EVP, Chief Merchandising Officer, & President-Sears Full Line Store & Kmart Formats

Facsimile: (847) 286-0204

With a copy to: Sears Holdings Management Corporation

3333 Beverly Road

Hoffman Estates, IL 60179

Attn: General Counsel

Facsimile: (847) 286-2471

Notice is effective: (i) when delivered personally, (ii) three business days after sent by certified mail, (iii) on the business day after sent by a nationally recognized courier service, or (iv) on the business day after sent by email or facsimile with electronic confirmation to the sender. A Party may change its notice address by giving notice in accordance with this Section 21(k) .

No Waiver . The terms, covenants and conditions of this Agreement may be waived only by a written instrument signed by the Party waiving compliance. Any Party’s failure at any time to require performance of any provision will not affect that Party’s right to enforce that or any other provision at a later date. No waiver of any condition or breach of any provision, term or covenant contained in this Agreement, whether by conduct or otherwise, in any one or more instances will be deemed to be or construed as a further or continuing waiver of that or any other condition or of the breach of that or another provision, term or covenant of this Agreement.

Publicity. Each Party will refrain from making any reference to this Agreement or to the other Party in the solicitation of business, unless the other Party gives its prior written consent to such action and approves any press release or other publicity materials prior to their dissemination.

Relationship of the Parties . The relationship of Seller and Buyer to each other is that of independent contractors, and neither Party will not represent that the other Party is its partner in any manner. Buyer has no authority to enter into any contract or incur any expense or obligation of any kind in Seller’s name.

Reporting . For purpose of this Agreement, unless otherwise indicated herein, all calculations and measurements with respect to Buyer’s purchases and sales of Products and similar information will be measured in units or dollars, as the context requires, and determined by reference to Seller’s information reporting systems.

Representations and Warranties . Each Party represents that it has the right, power and authority to grant to the other Party the rights provided under this Agreement and to perform its obligations under this Agreement, and that such Party’s execution, delivery, and performance of this Agreement have been duly authorized and will not violate any other agreement, restriction, or Applicable Law to which such Party is a party or by which such Party is bound.

Recalculation of Charges, Fees and Expenses . If there is after the Effective Date, a change in legislation, regulation, business conditions, or Seller’s operations that result in an increase in Seller’s costs, fees, and expenses associated with one or more Product(s), upon Seller’s demonstration of such facts, there will be an equitable adjustment to the amounts charged to Buyer hereunder to make Seller whole. Seller will use commercially reasonable efforts to mitigate the impact of any such change.

Survival . Each term of this Agreement that would, by its nature, survive the termination or expiration of this Agreement will so survive, including the obligation of either Party to pay all amounts accrued hereunder and including Section 7 (PAYMENT TERMS), Section 12 (INTELLECTUAL PROPERTY.), Section 13 (CONFIDENTIALITY.), Section 14 (INDEMNIFICATION.), Section 21 (SHC’S SOLE OBLIGATION.), and this Section 22 (GENERAL.).

Condition Precedent to the Effectiveness of this Agreement . This Agreement will not become effective until it has been approved by the Audit Committee of the Board of Directors of SHC and by the Audit Committee of the Board of Directors of Buyer. Further, this Agreement will not become effective until the parties (or their Affiliates, as applicable) also execute (collectively the “Related Amendments”): (a) Amendment No. 4 to Services Agreement, (b) Amendment No. 1 to Employee Transition and Administrative Services Agreement, (c) Amendment No. 1 to Shop Your Way Rewards Retail Establishment Agreement, (d) Amendment No. 1 to Trademark License Agreement, and (e) Amendment No. 1 to Supplemental Agreement, (f) Amendment No. 4 to the prior Merchandising Agreement between the Parties, and (g) Amendment No. 2 to Store License Agreement (Outlet).

Governing Law; Jurisdiction; Waiver of Jury Trial .

Governing Law . This Agreement will be construed in accordance with, and governed by, the federal laws of the United States, including the Lanham Act, and the internal laws of the State of Illinois, other than its conflict of laws principles and the Illinois Franchise Disclosure Act. This Agreement will not be subject to any of the provisions of the United Nations Convention on Contracts for the International Sale of Goods.

Jurisdiction . Each of the Parties submits, for itself and its property, to the exclusive jurisdiction of all Illinois state courts and federal courts of the United States of America sitting in Cook County, Illinois, and all appellate courts to each thereof, in all actions and proceedings arising out of or relating to this Agreement or the transactions contemplated hereby or for recognition or enforcement of all judgments relating thereto, and each of the Parties (A) will commence all such actions and proceedings only in such courts, (B) will cause all claims in respect of all such actions and proceedings to be heard and determined in such Illinois state court or, to the extent permitted by law, in such federal court, (C) waives, to the fullest extent it may legally and effectively do so, all objections that it may now or hereafter have to the laying of venue of all such actions and proceedings in any such Illinois state or federal court, and (D) waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such actions and proceedings in all such Illinois state and federal courts. A final judgment in any such action or proceeding will be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Each Party irrevocably consents to service of process in the manner provided for notices in Section 22(k) . Nothing in this Agreement will affect the right of any Party to serve process in any other manner permitted by Applicable Law.

Waiver of Jury Trial . Each Party acknowledges that each controversy that may arise under this Agreement is likely to involve complicated and difficult issues and, therefore, it irrevocably and unconditionally waives all rights it may have to a trial by jury in respect of any litigation directly or indirectly arising out of or relating to this Agreement or the transactions contemplated hereby. Each Party certifies and acknowledges that (A) it understands and has considered the implications of such waivers, (B) it makes such waivers voluntarily, and (C) it has been induced to enter into this Agreement by, among other things, the mutual waivers and certifications in this Section 22(t) .

(SIGNATURE PAGE FOLLOWS)



SEARS, ROEBUCK AND CO. KMART CORPORATION By: Sears Holdings Management Corporation, their agent By: /s/ ROBERT A. RIECKER Robert A. Riecker VP, Controller & Chief Accounting Officer	SEARS HOMETOWN AND OUTLET STORES, INC. By: /s/ WILL POWELL William Powell Chief Executive Officer and President
SEARS HOLDINGS CORPORATION By: /s/ ROBERT A. RIECKER Robert A. Riecker VP, Controller & Chief Accounting Officer	SEARS AUTHORIZED HOMETOWN STORES, LLC By: /s/ WILL POWELL William Powell President
	SEARS OUTLET STORES, L.L.C. By: /s/ WILL POWELL William Powell President

Appendix 1

Additional Terms and Conditions

1. PURCHASING MECHANICS . The execution of the Merchandising Agreement to which this Appendix 1 is attached (the “ Merchandising Agreement ”) does not give rise to any commitment on the part of Buyer to purchase any HTS Product. A commitment to purchase HTS Product arises only at such time as: (a) for HTS Products that are not Buyer-Unique Products, Buyer requests (via Seller’s systems or any other method approved of by Seller) such Products to be shipped to Buyer’s stores or Buyer’s customers, and (b) for Buyer-Unique Products, Buyer has sent Seller Buyer’s forecast for such Products. Except as provided above, all estimates or forecasts of Buyer’s future needs for Products which may be provided to Seller by Buyer are for planning purposes only and do not in any way represent a commitment by Buyer nor give rise to any obligation or liability of Buyer. Except as stated in this paragraph and as outlined in Section 2(iii)(B)(iii) and Section 2(viii) of Appendix 6 , Buyer has no responsibility for any actions taken by Seller based on such estimates or forecasts.

2. CODES OF CONDUCT. Buyer acknowledges that it has been furnished a copy of the Sears Holdings Corporation Code of Conduct (the “ Code of Conduct ”) and that Seller employees are required to follow the Code of Conduct. Buyer will support the Code of Conduct and will not directly or indirectly take any action that may cause a Seller employee to violate any law or the Code of Conduct. Without limiting the foregoing, Buyer will not directly or indirectly offer or give any personal benefit (other than infrequent, non-cash gifts of nominal value consistent with the Code of Conduct), including commissions, kickbacks, payments, loans, gratuities (including travel and entertainment), bribes, gifts, samples, services, promises of future employment or personal considerations (each a “ Benefit ”) to any Personnel of Seller and Seller’s Affiliates or to any person that Buyer knows is a member of such Personnel’s family, or to any entity in which Buyer knows such Personnel or a member of such Personnel’s family owns a direct or indirect interest. Buyer will notify the Sears Holdings Corporation Office of Compliance within five business days after it has knowledge of any violation or attempted violation of the Code of Conduct or this Section 2 . Any such notice is deemed to have been given when delivered by certified mail, return receipt requested, by email at compliance@searshc.com or to such other email address as may be provided in the Code of Conduct. Buyer will cooperate with any request by Seller to provide information and documentation regarding any communication or transaction with Seller or its Personnel. If Buyer adopts a code of conduct with respect to its Personnel and delivers that code of conduct to Seller, Seller will support that code of conduct and will not directly or indirectly take any action that may cause any of Buyer’s Personnel to violate the code of conduct or any Applicable Law.

3. PACKAGING, LABELING, SHIPPING AND BILLING. Seller will be responsible for providing adequate packaging, tagging, labeling, packing, shipping and billing. Seller will comply with all packaging, tagging, labeling, packing, shipping and billing requirements reasonably requested by Buyer as well as any and all requirements established by applicable laws, regulations, carrier tariffs and product classifications. For Products to be shipped to Buyer from a point of origin within the United States, Seller will deliver Products to the designated carrier on or before the ship date specified in the applicable Vendor Agreement. For Products to be shipped to Buyer or a Buyer-branded outlet from a point of origin outside the United States. Seller will deliver Products in accordance with the delivery terms specified in the applicable Vendor Agreement and such delivery will be made on or before the ready date specified in such Vendor Agreement. Delivery dates specified will be of the essence of the Vendor Agreement. Seller will ship all Products in full packs and full shipments in accordance with Buyer’s requirements as set forth in the Vendor Guide or any Vendor Agreement.

4. REPRESENTATIONS AND WARRANTIES.

(a) KCD-Branded Products . Without in any way disclaiming implied remedies or limiting remedies for breach thereof, Seller represents and warrants that all KCD-Branded Products will: (a) conform to the Specification for such Products; (b) be fit and sufficient for the ordinary purpose for which Products is used; (c) be free from defects in workmanship, materials and packaging; (d) be free from defects in construction and design; (e) be fit and sufficient for the purpose stated on any packaging, labeling or advertising; and (f) be equivalent in materials, quality, fit, finish, workmanship, performance and design to any samples submitted to and approved by Buyer.

(b) Advertising. Seller represents and warrants that all claims made by Seller in any packaging, labeling, advertising, or other consumer material in connection with any KCD-Branded Products or Seller brand relating to Products will be true and will have been substantiated and at the time such claims are made.

(c) Intellectual Property . Seller represents and warrants that: (a) all patents, trademarks, trade names, trade dress, copyrights, trade secrets, rights of publicity and other intellectual property rights (other than those intellectual property rights owned by or licensed to Buyer) used by Seller in connection with KCD-Branded Products or in the development or manufacture of KCD-Branded Products are either owned by Seller or Seller has been and is properly authorized by the owner of such rights to use such intellectual property rights in connection with such KCD-Branded Products and to sell such KCD-Branded Products incorporating such intellectual property rights to Buyer for use or further resale and (b) KCD-Branded Products will not, at the time that it is delivered, offered for sale or sold by Buyer, infringe any patent, trademark, service mark, trade name, trade dress, copyright, trade secret, domain name, right of publicity or other intellectual property right of any person, corporation or other entity. Seller will notify Buyer’s chief legal officer in writing by certified mail, return receipt requested, within five business days after it has knowledge of any claim or allegation of infringement, misuse, dilution, misappropriation or other violation of any patent, trademark, service mark, trade name, trade dress, copyright, trade secret, domain name, right of publicity or other intellectual property right in any way related to or affecting KCD-Branded Products.

(d) Compliance with Law . Seller represents and warrants that: (a) all KCD-Branded Products have been or will be produced, assembled packaged, tagged, labeled, packed, shipped and invoiced (“ Products Production ”) in compliance with the applicable requirements of federal, state and local laws, regulations, ordinances and administrative orders and rules of the United States and its territories and those of all other countries in which such Products Production or delivery of KCD-Branded Products takes place; (b) Seller, its affiliates, and the Personnel of each of them who are involved in the Products Production or delivery of KCD-Branded Products each will during the term of each Vendor Agreement strictly comply with all applicable federal, state and local laws, regulations, and prohibitions of the United States and its territories, and the laws, regulations, and prohibitions of all countries in which any Products Production or delivery of KCD-Branded Products occurs including all laws, regulations and prohibitions governing the working conditions, wages, hours and minimum age of the work force; and (c) Products Production has not and will not involve at any time, in whole or in part, any use of child, convict or forced labor. Seller will provide Buyer with any guaranty of compliance with the foregoing in such form as Buyer may designate with respect to any Products.

(e) Antidumping. Seller represents and warrants that all sales of KCD-Branded Products to Buyer will be made at no less than fair value under the United States antidumping law and that no government has provided a countervailable subsidy for KCD-Branded Products actionable under U.S. law. Seller will indemnify Buyer for (i) all antidumping and countervailing duties imposed on all KCD-Branded Products that is sold prior to the date of publication of the International Trade Administration’s preliminary determination of sales at less than fair value or prior to the date of publication of the existence of countervailable subsidies and exported before the date of publication of the International Trade Administration’s final determination of sales at less than fair value or the existence of countervailable subsidies and (ii) any expenses (including reasonable attorneys’ fees) and administrative costs incurred by Buyer, its Authorized Resellers, and Buyer-Branded Outlets in their participation in any United States antidumping or countervailable duty proceeding involving any warranted KCD-Branded Products.

(f) Non-KCD-Branded Products . Seller hereby assigns to Buyer all assignable warranties, representations, covenants and indemnities granted to Buyer by third parties in Vendor-Unique Products and all remedies for breach of such warranties, representations, covenants and indemnities. For all Products that are not KCD-Branded Products, including Vendor-Unique Products, to the extent that Seller is not permitted to assign any of such protections to Buyer, Seller will enforce such protections on behalf of Buyer to the extent Seller is permitted to do so under the terms of the applicable third party agreements.

5. FUNDS PROCESSING. All electronic fund transfers and wire transactions will be in accordance with National Automated Clearing House Association (NACHA) rules and in accordance with any instructions and procedures which Buyer may from time to time supply. Neither Party will be liable to the other Party for any indirect, special, incidental, exemplary or consequential damages arising from or as a result of any delay, omission or error in the electronic transmission or receipt of any documents, even if the other Party has been advised of the possibility of such damages.

End of Appendix

Appendix 3(a)

HTS Product Categories

Division Description and Number

1. FURNITURE-IN STORE—1

2. HOME OFFICE—3

3. SPORTING GOODS—6

4. HOUSEWARES—8

5. TOOLS—9

6. NURSERY—12

7. HEALTH AND BEAUTY—13

8. LUGGAGE—14

9. FLOORCARE/SEWING—20

10. COOKING & CLEANUP—22

11. WINDOW SHOP—24

12. HOME BIG TICKET—025

13. LAUNDRY—26

14. SCAN BASED TRADING—27

15. AUTOMOTIVE—28

16. PAINT—30

17. HOME ENVIRONMENT—32

18. ELECTRICAL—34

19. FLOOR COVERING—37

20. MENS SPORTSWEAR—41

21. AIR & WATER APPLIANCES—42

22. FOOD STORAGE—46

23. CHILDREN’S HARDLINES—49)

24. GENERAL MERCHANDISE—50

25. TOYS—52

26. HOME ELECTRONICS—57

27. ENTERTAINMENT SOFTWARE—58

28. MENS SHOES—67

29. LAWN, GARDEN, PATIO—71

30. OUTLET BUDGET SHOP—80

31. BEDDING—82

32. BATHROOM FIXTURES/PLUMBING—83

33. PANTRY AND HOUSEHOLD—87

34. BED AND BATH—96

35. PARTS OTHER-COUNTER—98

End of Appendix

Appendix 3(b)

HTS Invoice Prices

The HTS Invoice Prices will be the sum of (1) Seller’s invoice costs from Vendors for HTS Products, plus (2) the net amount of the following charges and credits without duplication (each a “ 3(b) Amount ”):


1.	Audit recoveries


2.	Carriage costs from the Vendor’s delivery point to the FOB Point;


3.	Cash discounts;


4.	Distribution-center markdowns;


5.	Distribution-center shrink;


6.	Other logistics expense;


7.	Charge for Seller Warranty for No-Vendor-Warranty Products that are HTS Products: [***]% of Core Cost (“ Core Cost ” means costs reflected in the Sears Corporate Repository of Referential Information or successor system);


8.	Source penalties;


9.	Packaging costs requested by Buyer;


10.	Vendor-compliance income; and


11.	All other charges and expenses consistent with practices in effect for Buyer and Seller immediately prior to the Effective Date.

End of Appendix

Appendix 4(b)

Invoice Prices for DRM

The Outlet Invoice Prices for DRM are described on the following table; provided that for all DRM that are No-Vendor Warranty Products, in addition to the amount set forth below, Buyer shall pay Seller (as part of the Invoice Price) an additional four and one-half percent ([***]%) of such DRM’s DOS Cost (the “ Outlet Seller Warranty Charge ”). For example, if a particular lawn mower that was a No-Vendor Warranty Product was purchased by Buyer on November 1 ^st , 2016 and that product had a $100 DOS Cost, then Buyer would pay Seller $[***] for such product, plus $[***] (for a total Invoice Price of $[***]). Buyer is responsible for carriage only from Seller’s MDOs to the Sears Outlet Stores. As used herein, “ DOS Cost ” means the cost shown in Seller’s Distribution Operations System, or such replacement system as Seller may utilize from time to time.

Table A—For All Outlet Products



Description and Seller Division	Percentage Off Seller’s DOS Cost

Furniture-In Store (Div 001, 008 and 025)	[***]%
Sporting Goods (Div 006)	[***]%
Housewares (Div 008)	[***]%
Tools (Div 009)	[***]%
Floor care, Sewing (Div 020)	[***]%
Cooking And Cleanup (Div 022)	[***]%
Laundry (Div 026)	[***]%
Plumbing & Heating (Div 042)	[***]%
Food Storage (Div 046)	[***]%
Baby Furniture – Children’s Hardlines	[***]%
Audio/Visual (Div 057)	[***]%
Lawn, Garden, Patio (Div 071)	[***]%
Mattresses* (Div 082)	[***]%

*Note: Buyer currently receives DRM premium mattresses under this Agreement and the Vendors of such mattresses have not, to date, enforced any marketing limitations that would make it impracticable for Buyer to sell such Products at its Sears Outlet stores or on SearsOutlet.com (including any authorized successor thereto). If the Vendors of such DRM premium mattresses do in the future enforce any such restrictions (other than those that Buyer has previously been complying with), and Buyer notifies Seller within writing within 60 days of such restriction being implemented that such restrictions are in fact significantly impacting Buyer’s sales of such DRM premium mattresses at Sears Outlet stores (each a “ PM Impairment Notice ”); Seller will work in good faith to encourage such Vendors to agree to reasonable terms to permit such DRM premium mattresses continued sale at Sears Outlet stores. Buyer must in each PM Impairment Notice specify: (i) the specific restriction which is impacting Buyer’s sales of DRM premium mattresses, (ii) certify that Buyer was not previously complying with such restriction, and (iii) Buyer must estimate the amount of the impact (based upon actual sales data) on Buyer’s future sales (which information Buyer will mark “Highly Confidential – Limited Distribution Internally). If the Vendors do not agree to reasonable terms to permit continue sales of DRM premium mattresses by Sears Outlets stores within 60 days of Buyer’s notice, Buyer may cease purchasing all DRM premium mattresses under this Agreement; in which case Seller shall be free to dispose of its premium mattresses in any manner, including by sale to a third party, with no ongoing obligation to Buyer.

End of Appendix

Appendix 4(c)

MOS Categories and Initial MOS Invoice Prices

The categories of MOS that Seller will sell, and Buyer will purchase, in accordance with, and subject to, Section 4(b) of the Merchandising Agreement to which this Appendix 4(c)(ii) is attached and forms a part are described in the table below in the column labeled “Source and Merchandise Description.” The invoice prices for MOS during the Initial Term will be the sum of (1) the applicable amounts listed in the following table in the column labeled “Base Price” plus (2) at the end of each fiscal year during the Term, an additional amount equal to 10% of Buyer’s annual EBITDA, if any, with respect to MOS sold by Buyer, which amount (if any) Buyer will pay on or before the 45th day after the end of Buyer’s fiscal year. Buyer is responsible for carriage only from Seller’s CRC’s to the Sears Outlet Stores.



Source and Merchandise Description	Base Price
Kmart —all items in all categories of MOS, including all product sold by Kmart.com that is returned to Kmart stores.	Per pallet $ [***]
Lands’ End —all items in all categories of MOS (Apparel) and all items in all categories of MOS shoes, including all product sold by LandsEnd.com that is returned to Sears stores but only through April 11, 2018 subject to Section 4(d) .	Per item $ [*] Per item $ [*]
Sears, Roebuck and Co. (including Sears.com) —all items in all categories of MOS (Apparel), including all product sold by Sears.com that is returned to Sears stores. *	Per item $ [***]

*In the event in a particular month’s deliveries of MOS (Apparel) from Sears, Roebuck and Co. (including Sears.com) (collectively, “ Sears MOS ”), the amount of damaged/defective (Blue Label) product exceeds 15% of the items delivered in such month (the “ Sears MOS Cap ”), then Buyer will not be charged anything for each damaged/defective (Blue Label) item in excess of the Sears MOS Cap. Buyer shall be liable for payment for the $[***] per item charge for each item of damaged/defective (Blue Label) product at or below the monthly Sears MOS Cap threshold. If Buyer identifies that an item is damaged/defective Buyer will use commercially reasonable efforts to ensure that such items are only scraped or recycled; Buyer will use commercially reasonable efforts to ensure that all damaged/defective it identifies are not sold by Buyer (directly or indirectly) to consumers; provided that Buyer may sell such MOS Products to liquidators as long as Buyer complies with Section 12(a)(iii)(B)(5). Seller will include on each invoice for Sears MOS the total number of items in each shipment and the total number of damaged/defective (Blue Label) items. If Buyer disputes the amount of damaged/defective (Blue Label) product, Buyer must promptly notify Seller in writing, and hold the damaged/defective products that Buyer has identified at its location for a minimum of fourteen (14) days after Buyer presents its claims for rejected units to Seller (so that Seller may review such products/claims); after which time the damaged/defective Products shall be scrapped or recycled by Buyer (including selling to liquidators), and Buyer will use commercially reasonable efforts to ensure that none of such damaged/defective (Blue Label) product is sold by Buyer (directly or indirectly) to consumers; provided that Buyer may sell such MOS Products to liquidators as long as Buyer complies with Section 12(a)(iii)(B)(5) . Seller will promptly notify Buyer of any change to which items Seller classifies as damaged/defective (Blue Label) product that Seller is selling to Buyer and Buyer is free to contest any such change which Buyer in Good Faith believes will significantly decrease Buyer’s return on Sears MOS.

End of Appendix

Appendix 4(g)(2)

Non-Saleable DRM Products Process

This process is applicable to all DRM Products received by Buyer’s Outlet Repair and Distribution Centers (ORDCs) from Seller’s MDO/DOS units that are determined to be Non-Saleable DRM Products in accordance with Appendix 4(g)(1) of the Amended and Restated Merchandising Agreement to which this Appendix is attached.



ORDC Responsibility	• Buyer will inspect all DRM Products within three (3) business days starting the first business day after physical receipt of the product by Buyer at Buyer’s ORDC facility (but no later than 5 business days after delivery by Seller, e.g., the product is made available at co-located facilities and for other facilities, arrival of the trailer) (the “Inspection Period”) and make an initial determination as to “Non-Saleable” status during that initial inspection. The Inspection Period will be extended on a day for day basis for SHO holidays and for Products received within three (3) business days of the start of a SHO inventory audit freeze period. • The Non-Saleable DRM Product will be logged by Buyer on the Non-Saleable Products Log Form on the date of inspection and tagged with a Non-Saleable Products Form • All DRM Products initially determined to be Non-Saleable DRM Product will be moved by Buyer to a staging area immediately following initial non-saleable designation. • ORDC General Manager (GM) must approve all Non-Saleable DRM Products daily o Non-saleable claim cannot be made until GM or ASM Ops (Ops Lead) approves o If the ORDC GM approves Non-Saleable designation, the DRM Product Quality Inventory Control associate (PQIC) Inventory Control Lead (ICL) f ills out the on-line Non-Saleable DRM Product Form via Seller’s Non-Saleable Products Request Tool (or Seller’s replacement therefor), and checks off the log that it was entered • All entries must be entered as a positive number (meaning no minus sign in front of the sell/cost values) • The non-saleable notification will automatically be routed to the MDO DOS Unit manager via email. The requestor (PQIC or ICL) will also receive a copy of the email which must be printed and filed in the BIRP 1-31 folder • ORDC must claim a DRM item as non-saleable no later than 1 business day after the end of the Inspection Period. If a Product is missing Seller’s paperwork (e.g., bill of lading or MDO DOS tag), Buyer will immediately notify Seller and segregate such Products the timelines set forth herein will be delayed until Seller provides such paperwork. o Upon Seller’s written request in email made to Buyer’s assigned Director of the applicable ORDCs, MDOs are to be provided weekly access to the ORDCs to verify load quality of items shipped to the ORDC by the MDO(s). o MDOs will send a request to verify load quality 48 hours in advance of the desired verification date. MDO load quality verification will occur on an agreed upon date between the ORDC and MDO. o All tags such as MDO DOS tags, 991 clearance tags (SDO, Full-Line) must remain on the DRM until expiration of Seller’s review period (and any resulting dispute resolution period; failure to do will invalidate Buyer’s right to seek reimbursement on that DRM item.
MDO/DOS Unit / ORDC Responsibility	• The MDO/DOS unit manager has 3 business days from the time the Non–Saleable DRM Product Request Tool email was sent to request visual inspection, beginning the first business day after the ORDC completes the online non-saleable submission o To request visual inspection, the MDO/DOS Unit manager must email the ORDC GM at the generic email ID SGXXXX@shos.com (where XXXX is the ORDC unit number) o If the MDO/DOS unit does not make a request within the allotted time, the merchandise can be transferred to the salvage area. o ORDC will not return non-saleable products to the MDO/DOS unit • If a request is made by the MDO/DOS unit manager for visual inspection, within the required time, the ORDC must hold the product for 6 business days, beginning the first business day after the MDO requests a visual inspection o Product will be held in the HOLD for MDO inspection staging area within the ORDC while waiting for visual inspection § If no inspection is made within the allotted time, the ORDC may transfer the non-saleable DRM Product to the salvage area • Co-located MDOs are those that are physically attached to an ORDC. For those instances where a co-located MDO exists, the GM of that MDO will act as inspector for all remote MDOs that ship into that particular ORDC. This means that the remote MDOs will not request pictures from the receiving ORDC and that the co-located MDO GM will inspect product on their behalf if requested to do so by the remote MDO GM. All inspections, discussions, and dispute resolutions will take place between the co-located ORDC GM and co-located MDO GM. o For non-co-located facilities, then the ORDC GM will, upon email request from the MDO/DOS unit manager, arrange for the delivery of photographic evidence of the non-salable condition to the MDO/DOS unit manager for remote inspection. If such a request is made, the timeline for the MDO/DOS manager will not start until such photographic evidence is sent. The MDO/DOS manager may, at his/her option, also inspect the non-saleable DRM at Buyer’s facility. If the non-co-located MDO GM does not reply back within the defined non-saleable process period (as described in the ORDC Responsibility and MDO/DOS Unit / ORDC Responsibility sections) then the item will be deemed non-salable and will be disposed of in accordance with the previously defined process. • Should an inspection occur, the ORDC GM or ASM-Ops must complete the inspection with the MDO/DOS unit Manager or designee o If both parties agree that the item is non-saleable, the process continues consistent with this process. o If both parties agree that the item does not meet the non-saleable criteria, the ORDC PQIC or ICL will reverse the claim using the On-line Non-Saleable DRM Products Chargeback Form via Non-Saleable Outlet Products Request Tool § All credits to the MDO/DOS Unit number must be entered as a negative number (meaning a minus sign is entered in front of the sell/cost values) § The credit must be entered by the ORDC no later than 2 business days after inspection deeming the product saleable § Merchandise will be moved to appropriate stage for processing o If both parties do not agree on the condition of the item, the parties will follow the Dispute Resolution portion of this process. • After any in person or remote inspection of the non-salable product confirms its status, the ORDC will transfer the merchandise to the salvage area o ORDC will remove all merchandise nomenclature and follow merchandise salvage process o ORDC will not return the non-saleable products to the MDO/DOS unit
Disputes	• If there is a disagreement between parties, the MDO/DOS unit District Manager and Director of Outlet Distribution Centers should be engaged to resolve dispute. For all DRM items for which the parties do not agree upon its designation as non-saleable, Buyer shall retain the product until resolution of the dispute. • Escalate to MDO/DOS unit region level or ORDC Vice President if the issue is not able to be resolved
Financial Entry Responsibilities	At the end of the fiscal month a spreadsheet of all the Non-Saleable Charges/Credits to the Seller Business Units (MDO/DOS unit) will be extracted from the on-line tool and Buyer will process a journal entry charging the depreciation to the CDC High Level Ledger Business and crediting the ORDC at Sell/Cost in Account 12135
ORDC Responsibility Reconciling with SR02	• ORDC ICL should total all the requests made through the end of the fiscal month from the Log attaching the emails in the BIRP 1-31 folder • Compare to the Non-Saleable entry on the final week of month’s BIRP report • If the sell values match, no further research is required and the emails from the 1-31 can be attached to the log and filed as documentation with the BIRP report
Placing a Claim for a Front Load Washer – ORDC Responsibility	• Upon receipt of merchandise shipped from the MDO, determine if the required minimum of 2 shipping pins (bolts) are installed. § If 2 or more shipping pins (bolts) ARE installed, the merchandise should: o Move to disposition per the inspection and move document o During testing process, PINS (BOLTS) will be removed o After the testing process, PINS (BOLTS) will be re-installed and Customer Shipping Bolt Removal Form attached to the back of the merchandise (make copies on colored paper) § If the minimum 2 shipping pins (bolts) were not installed by the shipping MDO, then the Outlet facility takes the following action: o Log product on the non-saleable log as a “PENDING” credit o Send product to testing immediately to determine if there is drum damage § Testing must be complete within 60 business days o If drum damage exists, the merchandise is moved to the non-saleable staging area § Non-saleable process documented above is followed § ORDC PQIC or ICL files a claim Non-Saleable Products Chargeback Form via Non-Saleable Products Request Tool § Must use “No Shipping Bolts” reason when completing claim § Request Tool Claim must be filed within 60 business days o If no drum damage exists and the product is deemed saleable, the merchandise can be moved to the next appropriate phase on the move document and crossed off the non-saleable pending claim log o Shipping pins (bolts) MUST be re-installed after the merchandise has completed ORS testing and the Customer Shipping Bolt Removal Form needs to be attached to the back of the merchandise
Installation Guide For Shipping Bolts	§ All front load washers must have (AT THE MINIMUM), 2 shipping pins (bolts) installed before the item can be moved to the selling floor or shipped to another Outlet selling unit § Make sure the ORS team has a small supply of shipping pins (bolts) on hand to be able to install as needed; These can be ordered through the On-line part system based make and model § Installation guide for shipping pins (bolts) is at the link below: Installation of HE3_HE3t_HE4t Transportation Bolts IMPORTANT – DO NOT SHIP ANY FRONT LOAD WASHERS TO ANY OUTLET SELLING UNITS WITHOUT SHIPPING PINS/BOLTS
Placing a claim for fitness equipment	• ORDCs have up to 30 business days to file a non-saleable claim on fitness equipment. This is due to the need for assembly to properly assess the product • Send product to the testing area for assembly and assessment o Assembly and assessment must be complete within 30 business days o If the product doesn’t pass the non-saleable criteria then it is moved to the non-saleable staging area § Non-saleable process documented above is followed § ORDC PQIC or ICL files a claim Non-Saleable Products Chargeback Form via Non-Saleable Products Request Tool § Use the proper reason when completing claim § Request Tool Claim must be filed within 30 business days o If the merchandise is deemed saleable, the merchandise can be moved to the next appropriate phase on the move document and crossed off the non-saleable pending claim log
Puerto Rico – Mattresses and box springs	• Seller will not ship mattresses and box springs to Buyer on the island of Puerto Rico • If in error, mattresses and box springs are shipped to Buyer then they will be immediately deemed non-saleable

End of Appendix

Appendix 4(m)

Additional LG DRM Product Sort Process

Prior to offering Additional LG DRM Product to Buyer, Seller will perform one of the following 3 sort processes on the product and will notify Buyer of the “ Sort Charge ” that will apply to each Additional LG DRM Product offered to Buyer.

Sort 1 (Full Service)


•	Scan item


•	Visually inspect


•	Add gas if visual test is good


•	Startup trimmer


•	Test


•	No issues or small repair


•	Remove gas


•	Clean/ power wash unit


•	Pack

Sort Charge = $6.45

Sort 2 (Salvage units that don’t appear to need repair or clean up):


•	Scan item


•	Visually inspect


•	Add gas if visual test is good (no parts added)


•	Startup trimmer


•	Test


•	Remove gas


•	Pack

Sort Charge= $4.45

Sort 3 (Visual only inspection) :


•	Visual inspection (looks good 90+% all parts)


•	Separate


•	Scan products


•	Pack into Gaylords


•	Ship

Sort Charge = $2.45 a Unit

End of Appendix

Appendix 5(a)

Royalty Rates; Kenmore Royalty Credits

I. ROYALTY RATES

Royalty Rates during the Initial Term:




KCD-Branded Product		Royalty Rate before Deduction of the Kenmore Royalty Credit
Kenmore-branded		[***]#%
Craftsman-branded—Lawn & Garden		[***]#%
Craftsman-branded—all other		[***]#%
DieHard-branded		[***]#%

Royalty Rates during the Renewal Period:

The Royalty Rates for KCD-Branded Product that are major home appliances (divisions 022, 026, and 046 as described on Appendix 3(a) ), lawn mowers, and tractors will be the rates specified above in the column labeled “Royalty Rate before Deduction of the Kenmore Royalty Credit” (the “ Initial-Term Rate ”).

The Royalty Rates for all other KCD-Branded Products will be determined in accordance with the following:

1. Renewal Period .

(a) Delivery of Comparable Market Royalty Rate . On or before the 270 ^th day immediately preceding the last day of the Initial Term Seller will deliver to Buyer a written schedule that indicates (i) the Comparable Market Royalty Rate for the Renewal Period for each KCD-Branded Product Category and (ii) a description of the calculations from which Seller determined the Comparable Market Royalty Rates. At the same time Seller will deliver to Buyer a certificate from a Senior Vice President of SHC certifying, to the Senior Vice President’s best knowledge after due inquiry, that the Comparable Market Royalty Rates were calculated in accordance with the terms and conditions of the Merchandising Agreement to which this Appendix 5(a) is attached and forms a part (the “ Agreement ”) and that the Comparable Market Royalty Rates described on the certificate are true and correct. The date on which Seller makes the deliveries required by the preceding sentences of this paragraph 1.a) is the “ FRP Delivery Date .”

(b) Royalty Rate . If for a KCD-Branded Product Category the Initial-Term Rate is greater than the Comparable Market Royalty Rate for the Renewal Period, then the Initial-Term Rate will be the Royalty Rate for the KCD-Branded Product Category for the Renewal Period. Subject to paragraph 1.c) of this Appendix 5(a) , if for the KCD-Branded Product Category the Initial-Term Rate is less than the Comparable Market Royalty Rate for the Renewal Period, then the Comparable Market Royalty Rate for the Renewal Period will become the Royalty Rate for the KCD-Branded Product Category during the Renewal Period (the “ FRP Adjusted Royalty Rate ”).

(c) Buyer’s Rejection of the FRP Adjusted Royalty Rate; Seller’s Termination Right . Buyer may reject the FRP Adjusted Royalty Rate for each KCD-Branded Product Category or any of them (each an “ FRP Rejected Category ”) by written notice delivered to Seller on or before the 30 ^th day following the FRP Delivery Date (a “ FRP Rejection Notice ”). Subject to the last sentence of this paragraph 1.c) , if Seller receives an FRP Rejection Notice then, on or before the 15 ^th day following Seller’s receipt of the FRP Rejection Notice, Seller may either (i) terminate Seller’s obligations in Section 3 of the Agreement to sell to Buyer all KCD-Branded Products in the FRP Rejected Category, or (ii) terminate this Agreement, which termination referred to in clause (i) or clause (ii) will take effect on the last day of the Initial Term. If Seller receives an FRP Rejection Notice and does not exercise either of its termination rights described in, and in accordance with, the terms of the preceding sentence, then the Initial-Term Rate and not the Comparable Market Royalty Rate will become the Royalty Rate for the FRP Rejected Category during the Renewal Period. Seller may not exercise its termination rights in this paragraph 1.c) if Seller or any of its Affiliates has failed to comply with any of its material obligations in the Agreement and the failure is continuing.

(d) KCD Change in Control . If (i) a KCD Change in Control occurs during the Renewal Period, (ii) Seller does not exercise its rights in Section 2(c)(ii) of the Agreement, and (iii) after the effective date of the KCD Change in Control the bona fide royalty rate paid by the Sears Full-Line stores to the acquiror of all of the KCD Marks in the KCD Change in Control (including all entities resulting from the KCD Change in Control and all successors, the “ KCD Acquiror ”) for an Equivalent Product Category is greater the Royalty Rate then in effect for the equivalent KCD-Branded Product Category (a “ FRP Greater Rate ”), then on the first anniversary of the effective date of the KCD Change in Control the FRP Greater Rate will become the Royalty Rate during that portion of the remaining Term that the Sears Full-Line stores are obligated to pay to the KCD Acquiror the FRP Greater Rate for the Equivalent Product Category, subject to adjustment in accordance with paragraph 2 of this Appendix 5(a) with respect to the Renewal Period. If and when the FRP Greater Rate ceases to be payable by the Sears Full-Line stores the Royalty Rate will revert, for the remainder of the Renewal Period, to the Royalty Rate in effect immediately prior to the KCD Change in Control.

(e) KCD Mark Acquisition . If (i) a KCD Mark Acquisition occurs, (ii) after the effective date of KCD Mark Acquisition Seller does not exercise its rights in Section 2(d) of the Agreement, and (iii) at any time after the effective date of the KCD Mark Acquisition the royalty rate paid by the Sears Full-Line stores to the acquiror of the KCD Marks that comprised the KCD Mark Acquisition (including all entities resulting from the KCD-Mark Acquisition and all successors, the “ KCD-Mark Acquiror ”) for an Equivalent Product Category is greater the Royalty Rate then in effect for the equivalent KCD-Branded Product Category (a “ FRP MA Rate ”), then on the first anniversary of the KCD-Mark Acquisition the FRP MA Rate will become the Royalty Rate for the KCD-Branded Product Category during the period that the Sears Full-Line stores are obligated to pay to the KCD-Mark Acquiror the FRP MA Rates for the Equivalent Product Category. When the Sears Full-Line stores cease to be obligated to pay the FRP MA Rate the Royalty Rate will revert to the Royalty Rate in effect immediately prior to the KCD Mark Acquisition.

2. Terms Defined for the Purposes of this Appendix 5(a) .

“ Comparable Customer ” means either (a) a wholesaler that purchases KCD-Branded Products from Seller for resale to end-user consumers in the Territory, or (b) Seller’s licensee that Seller has licensed to arrange for the manufacture of KCD-Branded Products and their resale to end-user consumers in the Territory.

“ Comparable Market Royalty Rate ” for a KCD-Branded Product Category means the Initial-Term Rate for the KCD-Branded Product Category plus the mathematical product of (a) and (b), where (a) is the difference between (1) the Equivalent Economic Rate for the KCD-Branded Product Category earned by Seller from Comparable Customers during the twelve-month Seller fiscal period immediately preceding the FRP Delivery Date or the SRP Delivery Date, as the case may be, and (2) the Initial-Term Rate for the KCD-Branded Product Category, and (b) is the Volume Factor.

“ Equivalent Economic Rate ” for a KCD-Branded Product Category means the effective net product contribution profit earned by Seller with respect to the KCD-Branded Product Category as a percent of Seller’s Retail-Equivalent Sales to all Comparable Customers for the KCD-Branded Product Category. For purposes of calculation, if with respect to any Comparable Customer the net product contribution profit is a royalty or a wholesale margin, then the royalty or wholesale margin will be adjusted to reflect the differences, if any, between (a) the allowances, credits, deductions, offsets, rebates, reimbursements, and other monetary benefits (such as payment terms) offered to the Comparable Customer and (b) the allowances, credits, deductions, offsets, rebates, reimbursements, and other monetary benefits (such as payment terms) offered to Buyer. If the net product contribution profit is a wholesale margin, then the net product contribution profit will be additionally adjusted to reflect costs of freight, duty, logistics, and distribution to achieve relative equivalency in comparing rates. “ Seller’s Retail Equivalent Sales ” for the KCD-Branded Product Category will be calculated by grossing up non-retail sales based on Buyer’s weighted average first-cost margin for the KCD-Branded Product Category or using such other basis on which Seller and Buyer mutually agree. For the purposes of calculating the Equivalent Economic Rate for a KCD-Branded Product Category, Seller will include only those products sold by Comparable Customers that are reasonably similar to KCD-Branded Products sold by Buyer that comprise the KCD-Branded Product Category.

“ Equivalent Product Category ” means a product category that includes products that are (i) sold by Seller to the Sears Full-Line stores and (ii) substantially similar with respect to features, benefits, quality, fit, finish, and ergonomics to the KCD-Branded Products in a KCD-Branded Product Category.

“ KCD-Branded Product Category ” means each of the following categories:

Kenmore :

Home Environment (includes Floor care, Air & Water, among others)

Small Kitchen Appliances & Housewares

Other Kenmore

Craftsman

Hand tools & Mechanics Tools

Power Tools

Garage & Storage

Tool Accessories

Spec & Other Powered Equipment

Non-Powered & Watering Equipment

L&G Accessories & Attachments

Other Craftsman (includes Apparel, Toys, Grilling Accessories, among others)

DieHard

Batteries (includes Automotive, Sport & Marine, Alkaline)

Power Accessories

Apparel

Other DieHard

“ Volume Factor ” with respect to a KCD-Branded Product Category means the lesser of (i) one, and (ii) a fraction the numerator of which is Buyer’s total sales of KCD-Branded Products comprising the KCD-Branded Product Category and the denominator of which is the Comparable Customers’ total sales of KCD Branded Products comprising the KCD-Branded Product Category. For the purposes of the preceding sentence all sales to other than end-user consumers ( i.e ., wholesale sales) will be converted to retail-equivalent sales by grossing up the wholesale sales based on Buyer’s weighted average first cost margin for the KCD Category or using such other basis on which Seller and Buyer mutually agree.

II. KENMORE ROYALTY CREDIT

1. Select Definitions

“ Buyer’s Balance of Sales in the Home Appliance Category ” means a fraction, expressed as a decimal, (i) the numerator of which is Buyer’s Net Sales during a Buyer fiscal quarter of HTS Products at Sears Hometown Stores and Sears Home Appliance Showrooms formats in the Home Appliance Category that are Kenmore-Branded Products, and (ii) the denominator of which is Buyer’s Net Sales during the fiscal quarter of HTS Products sold at Sears Hometown Stores and Sears Home Appliance Showrooms formats in the Home Appliance Category (regardless of brand). Buyer’s Net Sales at Sears Hardware Stores and Sears Outlet stores do not factor into the calculation of Buyer’s Balance of Sales in the Home Appliance Category and such sales are not subject to the Kenmore Royalty Credit.

The “ Home Appliance Category ” means the following product categories:

Cooking & Cleanup—Division 22

Laundry—Division 26

Air & Water Appliances—Division 42

Food Storage—Division 46

Floor care/Sewing—Division 20

Home Environment—Division 32

2. Calculation of Kenmore Royalty Credit

The “ Kenmore Royalty Credit ” will be determined by Seller by reducing the Royalties on the incremental sales that result in a change to Buyer’s Balance of Sales in the Home Appliance Category in accordance with the following:




Buyer’s Balance of Sales in the Home Appliance Category Royalty Rates	63.2% and below	63.2% to 64.99%	65.0% to 69.99%	70.0& to 74.99%	75.0% and over
Royalty on Step Incremental Sales	[***]# %	[***]# %	[***]# %	[***]# %	[***]# %

(No Reduction)

For clarity, the parties note that each tier of HTS Product sales is subject to its own reduced royalty rate.

Example 1 . Buyer’s Net Sales during the quarter of HTS Products at Sears Hometown Stores and Sears Appliance Showroom formats in the Home Appliance Category is equal to $250,000,000. Buyer’s Net Sales during the quarter of HTS Products that were branded Kenmore Branded Products at Sears Hometown Stores and Sears Home Appliance Showroom formats in the Home Appliance Category is equal to $200,000,000, for a total Buyer’s Balance of Sales in the Home Appliance Category of 80.0%.

$ millions

Total applicable Sales

Kenmore BOS

Kenmore Sales

$250.00
63.2% and
below
$158.00

63.2% to
65.00%
$4.50

65.0% to
70.00%
$12.50

70.0& to
75.00%
$12.50

Over
75.0%
$12.50

Total
$200.00

Kenmore Base Royalty

(% Kenmore Sales)

[***]#

[***]

Kenmore Base Royalty $

[***]

Kenmore Royalty Credit %

[***]#

[***]

[***]#

Kenmore Royalty Credit $

[***]

Kenmore Net Royalty %

[***]#

[***]

[***]#

Kenmore Net Royalty $

[***]

Example 2 . Buyer’s Net Sales during the quarter of HTS Products at Sears Hometown Stores and Sears Appliance Showroom formats in the Home Appliance Category is equal to $300,000,000. Buyer’s Net Sales during the quarter of HTS Products that are Kenmore Branded Products at Sears Hometown Stores and Sears Appliance Showroom formats in the Home Appliance Category is equal to $200,000,000, for a total Buyer’s Balance of Sales in the Home Appliance Category of 66.7%.

$ millions

Total HST Sales

Kenmore BOS

Kenmore Sales

$300.00
63.2% and
below
$189.60

63.2% to
64.99%
$5.40

65.0% to
69.99%
$5.10

70.0& to
74.99%
$0.00

75.0%
and over
$0.00

Total
$200.00

Kenmore Base Royalty

(% Kenmore Sales)

[***]#

Kenmore Base Royalty $

[***]

Kenmore Royalty Credit %

[***]#

Kenmore Royalty Credit $

[***]

Kenmore Net Royalty %

[***]#

Kenmore Net Royalty $

[***]

3. Balance of Floor Requirement . In addition to the other requirements set forth in the Agreement, in order for Buyer to be eligible for the Kenmore Royalty Credit, in a particular fiscal quarter no less than 45% of all floor space dedicated to products in the Home Appliance Category must be dedicated to Kenmore Branded Products.”

End of Appendix

Appendix 5(e)

Average Aggregate Minimum Commission

The “ Aggregate Average Minimum Commission Rate ” on Kenmore-Branded Products in the Home Appliance Category means a commission rate that is not less than 200 basis points higher than the average aggregate merchandise commission rate paid by Buyer to owners of Sears Hometown Stores and Franchisees with respect to sales of non-Kenmore-Branded Products in the Home Appliance Category calculated based on Buyer’s customary methods of calculating commission rates payable to owners of Sears Hometown Stores and to Franchisees.”

End of Appendix

Appendix 6

Inventory Management Policies and Processes

This Appendix 6 only applies to HTS Products bought under this Agreement. It does not apply to Outlet Products or to merchandise bought directly by SHO, including merchandise bought by SHO under the Services Agreement.

Definitions used in this Appendix 6

“ Buyer IM Team ” means Seller’s IM employees who are identified by Seller (subject to the approval of Buyer) to provide the IM services described in this Appendix 6 .

“ DC ” means one of Seller’s distribution facilities.

“ DOS ” means Seller’s “Distribution Operation System”.

“ Format ” means a Party.

“ IDRP ” means Seller’s demand planning system.

“ IM ” means Inventory Management.

“ Inventory ” means Product, including Buyer-Unique Products.

“ Pack Away ” means Seller storing Products in its DC until the next selling season.

“ RIM ” means Seller’s store replenishment system.

“ Seller IM ” means Seller’s inventory management function.

Charges and Fees

Charges and fees for Seller’s services described in this Appendix 6 are reflected on Appendix 1.01-C (Supply Chain Services) to the Services Agreement.


1.	Separation of Inventory . The following applies to Product and, unless otherwise indicated below, Buyer Unique Products:


(a)	Regarding the Logical Separation of DC inventory for Seller and Buyer


(i)	Logical Separation is an operational separation, not a physical separation of inventory.

(A)

Either Seller or Buyer may at any time request a logical separation of DC inventory, which if approved by Seller IM team, will be implemented. Absent such a request by either Party, the Inventory pool for all Products will not be logically separated. Once the Inventory for a particular SKU has been logically separated, it will not be logically combined again absent approval of the Party who requested such separation.


(B)	Regardless of whether the Inventory pool is logically separated or not, Seller is not obligated to physically separate the SHO Inventory.


(ii)	Calculating logical separation of DC inventory for each Party to draw from is a function of relative demand forecasts entered into IDRP based upon


•	Using relative demand forecasts to determine IDRP stocking targets in accordance with Seller’s order feasibility logic for each Party


•	Entering relative demand forecasts by item, by week and by DC by each Party


•	Establishing how much time is required to fulfill demand is a function of order feasibility logic parameters within IDRP:


o	Varies by Vendor production point of origin


o	Determined by Vendor production planning cycle and total lead-times


•	Calculating demand forecasts is a function within IDRP generated by:


o	Establishing each store reorder points by users


o	Downloading store on hand and store on order counts from RIM


o	Entering sales forecasts by users


o	Entering floor set quantities by users


•	Allocating DC on hand inventory and inbound PO’s is performed between IDRP and DOS for the following functions:


o	Store replenishment


o	Customer orders


o	Flooring of newly assorted items


(iii)	Supplying and/or reviewing all demand forecast data is the responsibility of Buyer


(A)	IDRP will continue to provide baseline sales forecast for Buyer. Buyer IM team will review and modify forecasts where appropriate in collaboration with Buyer.


(B)	Entering forecasts into IDRP will be performed by the IDRP certified Buyer IM Team under order feasibility parameters based upon IDRP forecasting logic


(C)	Collaborating on forecasts will be performed between Buyer IM Teams and Buyer


(D)	Altering forecasts to change prevailing logic of similar item history as the default for IDRP demand forecasts in DC logical separation of inventory calculations will be completed by Buyer IM Team.


(1)	Submitting store demand and sales forecasts via IDRP is the responsibility of Buyer


(2)	Communicating demand/sales changes where the Buyer default demand forecast is deemed too high/low is the responsibility of Buyer


(E)	Forecasting store reorder point increases and decreases must occur within IDRP along with all other demand factors such as resets, seasonal buys, and promotions by Buyer IM Team


(F)	Planning demand where IDRP is not used within Seller, must be communicated to Seller IM teams based on order feasibility by Buyer


(G)	Execution of inbound DC PO’s is a function of the Seller IM teams


(H)	Supplying plans for Buyer demand that exceeds prior Buyer forecasts where typical order feasibility logic does not supply Vendors ample time to produce larger than normal volumes of product is also required


(I)	Forecasting the demand impacts of new store openings and store closings must be completed within order feasibility parameters by Buyer or prior demand forecast will dictate logical separation of inventory for Buyer


(iv)	Party ordering logic applicable to either Party at the item level:


(A)	Customer Order Parameters


(1)	Filling orders from the DC for customer orders will default to orders being filled from either Party’s specific separation of inventory.


(2)	Filling orders from the DC for customer orders will have an exception process to allow orders from each Party to only draw from a Party-specific logically separated DC inventory


(i)	Exception process to be agreed-upon between both Buyer IM Team and Seller IM team


(B)	Store Replenishment Parameters


(1)	Filling orders from the DC for store replenishment orders will default to orders being filled from either Party’s specific separation of inventory


(2)	Filling orders from the DC for store replenishment will have an exception process to allow orders from each Party to only draw from a Party-specific logically separated DC inventory.


(i)	Exception process to be agreed-upon between both Buyer IM Team and Seller IM team


(C)	Alteration of default Party ordering logic will be performed by Seller IM teams


(1)	Exception process to be agreed-upon between both Buyer IM Team and Seller IM team


(D)	Communication of adjustments by either Party to default format ordering logic will be performed by Seller IM team where:


(1)	Occurrences where Vendor supply interruptions are uncovered


(2)	Availability of items at any Vendor becomes constrained


(3)	Requirements by law for minimum availability per marketing of promotions where the demand was planned according to order feasibility logic


(4)	Overselling forecasts by either Party where the other Party’s ability to fulfill demand forecasts are at risk


(E)	Branch Transfer

(1)

Shared Inventory. The Seller IM team may, from time to time, propose the branch transfer of shared Inventory to Buyer. If Buyer doesn’t wish to participate in such transfer (and pay the related costs), Buyer must elect to have a logical separation of the Inventory for the affected SKUs; which election will be irrevocable until the current inventory is sold through. If Buyer does not elect to separate the Inventory, then Buyer shall be deemed to approve the branch transfer and will be liable for its share of the related costs.


(2)	Logically Separated and Buyer-Unique Products. Buyer may request, from time to time, branch transfers for Inventory for its portion of logically separated Inventory and for Buyer-Unique Products. Seller shall provide a quote for such moves, and if Buyer approves such quote, Seller shall perform such move and charge Buyer the agreed upon rates.


2.	Transition and Assortment Inventory Planning


(i)	Supplying annual calendars with estimated due dates to Buyer is the responsibility of Seller IM teams


(ii)	Establishing forecasts for ROIC, Seasonal and/or Annual demand according to Vendor Production Planning Lead-times including Vendor/manufacturer preseason part procurement planning according to planning calendars will be performed by Buyer, including for Buyer-Unique Products. Seller will provide Buyer with at least 10 days’ notice of the due date for Buyer’s forecast.


(A)	Determination of specific timelines and due dates for calendars will be performed by each BU Seller IM Team and communicated to the Buyer IM Team as additional information of Vendor requirements for production planning becomes available, impacting future order feasibility.


(1)	Each Seller IM team will ensure that the calendar incorporates lead times for above mentioned forecasts allow Buyer to review assortments, complete modeling and submit a forecast.


(B)	Common seasonal areas to note but not exclusive to:


(1)	Annual power lawn and garden estimates due in early fall prior to next spring season


(2)	Initial birding set up quantity due late spring prior to next spring season


(3)	Air conditioners due early fall prior to next spring season –


(4)	Outdoor Living annual estimates and floor set quantities due mid-summer prior to next spring season


(5)	Seasonal Christmas estimates early spring (trees, lights, etc.).


(6)	Planning for all products is due at the same time as Seller plans for Buyer inclusion in buy plans with Vendors and according to predetermined planning calendars with store flooring needs, replenishment points and sales forecasts established.


(iii)	Documentation of items and programs requiring CAPCON or ROIC approval where Buyer provides requests will be included in total Seller buy review are to be supplied by Buyer –


(A)	Requesting product where Buyer forecasts are not within +/- 10% tolerance of 3 year average historical Buyer sales


(1)	Negotiation of separate exit strategies is required of Buyer prior to confirmation of approvals to minimize negative impact to DC inventory levels including but not limited to:


(i)	Absorbing excess quantities into Buyer store locations determined by item by DC Logical Separation of Inventory


(B)	Exercising one of the following options is required of Buyer where requested product based on Buyer forecasts are within +/- 10% tolerance and where excess inventory remains in DC’s logically separated for Buyer


(1)	Receiving all excess quantities at store level


(2)	Complying with Seller merchandise control policies and submit appropriate “Pack Away” forms for approval. Seller shall have the right to approve or reject Pack Away requests in its reasonable discretion, which will not be unreasonably withheld or delayed.


(i)	Upon approval, Pack Away items will be held in DCs until the next season (handling, storage, etc. will be billed to Buyer).


(ii)	Upon denial, excess quantities will be receipted at Buyer store level and executed by the Buyer IM Team


(3)	Absent the Parties agreeing to a Pack-Away for specific seasonal product forecasted by Buyer, Buyer will be obligated to purchase 100% of its forecasted amount. Seller will age Inventory using generally accepted inventory-aging practices in a manner consistent with Seller’s practices. Buyer must promptly take shipment of all aged inventory of such Buyer forecasted seasonal product.


(iv)	New Product Assortment/Floor Sets


(A)	Adherence to the same lead-times as Seller IM teams is required of Buyer regarding initial flooring inventory demand, as this demand has order feasibility requirements


(v)	Following the Seller new Vendor and new item processes is required of Buyer for Buyer-Unique Products by Buyer Merchant and Buyer IM teams


(A)	All aforementioned demand forecast parameters apply to Buyer-Unique Products


(vi)	Performance of record creation activities for Buyer -unique items will be completed by Buyer‘s IM Team that has been certified in RIM. Seller will continue to use existing record Creation processes for shared items.


(vii)	Seller, in its sole discretion, will determine the flow path for all Products that are not Buyer-Unique Products . Flow paths for Buyer-Unique Products will be subject to mutual agreement of the Parties.


(viii)	Buyer will be obligated to Seller with respect to these forecasts. Buyer must promptly offer Seller the right to retain any Buyer-Unique Product for resale by Seller to any party (whether at wholesale or retail) other than Buyer; however, Seller’s refusal of that offer does not relieve Buyer of its obligation to purchase any forecasted Buyer-Unique Product.


3.	Emergency/Disaster Orders:


(i)	Unpredictable catastrophic event impacting localized emergency demand


•	Forecasting is the responsibility of both Seller and Buyer and includes:


o	establishing Emergency/Disaster quantities based on a 4 year average; said forecast is the basis for allocation to each Party.


o	Committing to Vendor held stock is the responsibility of the Seller IM team inclusive of aforementioned forecasting for demand for each Party.


o	Where availability is constrained, allocation will be based upon collaboration between selected delegates from Seller IM team and Buyer.


•	Forecasting when and where an Emergency/Disaster will occur is not feasible; therefore, demand will vary based upon where emergency/disasters occur


•	Planning and executing Emergency/Disaster Response is the responsibility of Seller according to the Disaster Program; this includes:


o	Disaster Program Procedures:


§	Notification of district managers responsible for each district to the disaster program coordinator is the responsibility of the field leadership team for each Party


§	Notifications of changes to district managers responsible is the responsibility of the field leadership team for each Party


§	Notification of local demand for emergency/disasters is the responsibility of the Party field district managers via the disaster hotline


§	Handling inbound disaster hotline calls is the responsibility of Seller IM team


§	Allocation of disaster merchandise both in DC’s and Vendor held stock is the responsibility of the Seller IM team based on requests from a Party’s district managers


•	Where availability is constrained, allocation will be based upon collaboration between selected delegates from Seller IM team and Buyer


§	Event examples:


•	Hurricane


•	Tornado


•	Flooding


•	Excessive snowfall


•	Infrastructure disruption


§	Items Included:


•	Wet/dry vacuums


•	Sump pumps


•	Snow throwers


•	Ice melt


•	Gas cans


•	Generators


•	Chainsaws


•	AA, AAA, C and D cell batteries


•	Flashlights


4.	Puerto Rico: Seller’s Affiliates will provide IM services for Buyer Stores in Puerto Rico that are substantially the same in all material respects as the IM services provided by Seller’s Affiliates for Buyer Stores in Puerto Rico and Guam as of the Effective Date.


5.	Buyer-Unique Products . The following provisions apply to Buyer-Unique Products. To the extent that the following provisions conflict with the above or other provisions of the Agreement, the following provisions shall control.


(a)	Dedicated Inventory for Buyer-Unique Products.

(i)

Buyer has prior to the Effective Date provided a list of Buyer-Unique Product with an Inventory cost of approximately $17 million. Buyer represent that the foregoing list is accurate and correct. The Parties have agreed that for 2016, Buyer may have up to $13 million in Buyer-Unique Products in Seller’s Inventory at any one time (each “ BUP Cap ”). For each Contract Year thereafter, the BUP Cap and a SKU count plan (each a “ SKU Count Plan ”) will be established based upon the amount of overall Buyer-Unique Product SHMC has agreed to purchase for a particular Contract Year and SHO’s historical inventory terms for such Products (or similar products for new Products).

(ii)

Buyer will provide weekly reports to Seller IM team listing all Buyer-Unique Products, by SKU, which Buyer desires Seller to buy for Buyer over the next 90 days, as well as all other “SHO Provided Products” (as that term is defined in Attachment 1.01-C (Supply Chain Services) for the HTS Product Categories to the Services Agreement that SHO intends to buy on its own, for each SKU Buyer will list the proposed vendor and whether such SKU has been purchased by Seller from such vendor previously or not. SHO will mark such information “Highly Confidential – Limited Distribution Internally.” For new vendors, Seller shall have the option of having such vendor agree to a contract with such vendor or requiring Buyer to enter into its own agreement with such vendor.


(iii)	Seller IM and Buyer IM Teams, including respective merchant teams and company designees, will meet 2 times each month to review the Buyer provided weekly reports and discuss Buyer-Unique Product purchases that Buyer desires Seller to purchase under this Agreement. Buyer will identify the Inventory to be purchased, vendor of that product, and Buyer’s desired flow path for such Inventory.


(iv)	Seller is not obligated to purchase any Buyer-Unique Product which: (I) in Seller IM teams view would cause the amount of Buyer-Unique Product to in the future exceed the BUP Cap, or (II) would violate any other restriction in this Agreement, including causing Seller to violate any applicable law in the purchase, storage, distribution or sale of such Buyer-Unique Product.


(v)	If Seller does not have the warehouse space to accommodate Buyer’s forecasted purchasing needs for Buyer-Unique Product, Seller will notify Buyer and if requested by Buyer pursuant to Section 1.01E. (SHO’s Requests for Services/System Changes) of the Services Agreement, Seller’s Affiliates will provide a proposal for additional warehousing space for such Products.


(vi)	New Buyer-Unique Product onboarding process


(A)	Buyer will submit new unique items that require DC stocking to Seller IM team following established flow path process:


(1)	Items must be approved under this process before the items are entered in IMA.


(2)	Buyer must provide 90 day advance notice regarding SKU additions of more than 5% over SKU Count Plan.


(3)	Buyer must provide volume forecast of new SKUs at time of submittal (inbound, outbound, storage as described under forecasting requirements

(4)

If Buyer’s change in SKU or flow paths resulting from additions or subtractions of Buyer-Unique Products and corresponding changes to needs for shared Products has a significant impact on Seller’s productivity costs and/or storage capacity, the parties will need to agree to an adjustment to the costs hereunder and the costs under the Services Agreement (each via an written amendment, subject to the necessary approvals) before Seller will be required to purchase, distribute, store and/or sell such Buyer-Unique Product.


(5)	Buyer is responsible for tracking all Buyer-Unique Product SKUs and Buyer shall designate all Buyer-Unique Products in Seller’s Inventory systems using a flag (or flags) designated by Seller from time to time.


(B)	Buyer will appoint a contact manager of supply chain operations (single point of contact) to work with Seller IM teams for planning assistance with new product launches seasonal sets, new or closing stores, flow path decisions and operational issues.


(C)	Buyer will provide feedback via digital load quality surveys


(D)	Buyer will provide complete and proper build of online items with all necessary artifacts, including using designated flags for Buyer-Unique Product.


(E)	Buyer will provide competent inventory management to drive inventory productivity and space utilization


(vii)	Tracking of Buyer-Unique Products


(A)	Seller will track all Buyer-Unique Products (using the flags set by Buyer) throughout its DC


(B)	Logical separation will not apply to Buyer-Unique Products. Buyer-Unique Products will be treated as solely owned by Buyer for purposes of any charges under this Appendix 6.6


(C)	Buyer will adhere to the non-productive inventory targets agreed to with respect to the Inventory of Buyer-Unique Products. If a Buyer-Unique Product becomes non-productive in accordance with GAAP , Buyer shall work through that Inventory within 30 days.


(D)	Any Buyer-Unique Product inventory that has not been worked through after 30 days from becoming GT80 it shall be disposed of at Buyer’s cost. Outlet products will not be managed at Seller’s DC facilities and Buyer will take all DC discontinued Product each month as requested


(E)	Buyer may request Pack-Away of Buyer-Unique Product per Section 2(iii)(B) above, in which event Seller will include an additional charge for the inventory carrying cost in its proposal to SHO. If Buyer does not agree to such cost, then Pack-Away will not performed for such Buyer-Unique Product.


(viii)	For KCD-Branded Products, Seller is not obligated to purchase such products until they have been approved by the Seller’s Affiliates that manage KCD- Branded Products (the “ KCD Team ”). Before approaching the Seller IM Teams regarding KCD-Branded Product, Buyer will first work with the KCD Team; which KCD Team will determine whether to source such products and from which vendors.


(b)	Accommodation of Buyer-Unique Product

(i)

Seller is under no obligation to accommodate any purchase of Buyer-Unique Products if that purchase would negatively impact the business relationship Seller has with the Vendor of that Buyer-Unique Product. Buyer is responsible for any costs associated with modification of IM process to accommodate acceptance of Buyer-Unique Products, including reimbursement for any cash in advance payments or alternative payment plans required for acquisition of Buyer-Unique Product desired by Buyer.

(ii)

Buyer is not authorized to commit Seller to purchase any products, and Buyer will not claim that it is so authorized. Seller shall have no obligation to purchase any Buyer-Unique Product until Seller issues a purchase order for such Products. Seller will use commercially reasonable efforts to timely issue purchase orders for Buyer Unique Product which Seller has agreed to purchase hereunder; provided Buyer is fully in compliance with Buyer’s obligations under this Agreement.


(iii)	Buyer is not authorized to negotiate the purchase of KCD-Unique Products and Buyer will not claim that it is. The purchase of such products will be solely handled by Seller and its Affiliates without the involvement of Buyer.


(iv)	For Vendor—Unique Products, Buyer and Seller shall jointly discuss with the Vendor any proposed purchases and Buyer must fully disclosed to Seller all terms and conditions regarding such purchases.

(v)

Buyer’s estimates for Buyer-Unique Products will be deemed forecasted for purposes of this Appendix 6 . Absent the Parties agreeing to a Pack-Away for specific Buyer-Unique Products, Buyer will be obligated to purchase 100% of its forecasted amount. Buyer and Seller will age Inventory using generally accepted inventory-aging practices in a manner consistent with Seller’s practices. Buyer must promptly take shipment of all aged inventory of Buyer-Unique Products. Buyer must promptly offer Seller the right to retain any such aged Buyer-Unique Product for resale by Seller to any party (whether at wholesale or retail) other than Buyer; however, Seller’s refusal of that offer does not relieve Buyer of its obligation to purchase any forecasted Buyer-Unique Product.


(c)	Transition of Product from shared Product to Buyer-Unique Product


(i)	If Buyer requests Seller to continue to purchase a Product which Seller has stated it will no longer purchase under Section 3(a) (Seller’s Obligation to Sell) of the Agreement, such Product shall become a Buyer-Unique Product and it shall be subject to all the same terms and restrictions as other Buyer-Unique Products.

End of Appendix

Appendix 7(a)

Payment Due Date


1.	Invoices . Except as is otherwise agreed to, in advance, and in writing by the parties:

a. Seller will generally deliver invoices to Buyer for all payments due hereunder from Buyer to Seller on the Tuesday of each week.

b. From the Effective Date through July 31, 2016, the Payment Due Date is three days after Buyer’s receipt of the invoice (e.g., Friday if the invoice is delivered on Tuesday). If Buyer pays such invoice in full by such date, Buyer may deduct from each such invoice an early payment discount equal to 37 basis points (i.e., to 0.37%) of the total amount of the invoice (the “ Early Payment Discount ”). If Buyer does not pay such invoice in full by such date, no Early Payment Discount is earned on such invoice.

c. For all invoices delivered after July 31, 2016 (each a “ Post-July 2016 Invoice ”), the “ Payment Due Date ” is the 10 ^th day following Buyer’s receipt of the invoice. No Early Payment Discount is earned on such invoices. If with respect to a Post- July 2016 Invoice Seller requests in writing that the Early Payment Discount apply to the invoice, Buyer in its sole discretion may, but will have no obligation to, agree to pay the invoice on the payment terms set forth in the immediately preceding Section 1b .


2.	Royalties . If after January 28, 2017 Buyer ceases using the POS, then the Payment Due Date for Royalties and CS Royalties will be the 10 ^th day following the end of Buyer’s fiscal quarter in accordance with Section 7(b) of this Agreement.


3.	Holidays . If the applicable payment date (i.e., the 3 ^rd or 10 ^th day) is a Saturday, Sunday, or bank holiday, Buyer will pay on the next banking day, which will become the Payment Due Date. Electronic fund transfers initiated on the Payment Due Date will be timely made for purposes of this Agreement.


4.	For the remainder of the Term . Seller and Buyer will negotiate in Good Faith to determine the Payment Due Dates, which negotiations will take into account, among other things, then-current market conditions.

End of Appendix

Appendix 9(a)(ii)

Kmart Locations



Store No.	Location	Address	City	State	Country
1992	TAMUNING - D	404 N MARINE CORPS DR	TAMUNING	GU	Guam
2151	ST CROIX – D	93A ESTATE DIAMOND	ST CROIX	VI	US Virgin Islands
2270	HOMEWOOD – D	17550 HALSTEAD	HOMEWOOD	IL	USA
9016	ST THOMAS – D	CHARLOTTE AMALIE	ST THOMAS	VI	US Virgin Islands
2725	LIHUE – D	4303 NAWILIWILI RD	LIHUE	HI	USA
1420	BIG BEAR LAKE – D	42126 BIG BEAR LAKE	BIG BEAR LAKE	CA	USA
5205	BRIDGEHAMPTON – D	2044 MONTAUK HWY	BRIDGEHAMPTON	NY	USA
5078	KEARNY – D	200 PASSAIC AVE	KEARNY	NJ	USA
5170	LAS VEGAS - D	5051 E BONANZA RD	LAS VEGAS	NV	USA
2573	PASSAIC - D	24 34 BARBOUR AVENUE	PASSAIC	NJ	USA

End of Appendix

Appendix 12(a)(iii)

Seller Marks


1.	The KCD Marks


2.	The feature Marks and sub-brand Marks associated with the Seller-Branded Products


3.	The trade dress related to the above Marks

End of Appendix

Appendix 18(a)(i)

Merchandising Operating Committee

Designated by Buyer : Michael Gray; Susan Hilsenbeck; Mike McCarthy

Designated by Seller : James Coyle; Dean Schwartz; Carson Anderson

Initial Chairperson : James Coyle

End of Appendix

The use of “[***]” in this Exhibit indicates that a confidential portion has been omitted pursuant to a request for confidential treatment a nd the omitted material has been filed separately with the Securities and Exchange Commission.

Exhibit 10.19

AMENDMENT #2 TO THE SHOP YOUR WAY REWARDS ESTABLISHMENT AGREEMENT

Dated: February 2, 2017

THIS AMENDMENT #2 , is made as of the date listed above (“ Amendment Effective Date ”), by and between Sears Hometown and Outlet Stores, Inc., on behalf of itself and its subsidiaries (collectively “ SHO ”), and Sears Holdings Management Corporation, on behalf of itself and for the benefit of its Affiliates (collectively “ SHMC ”) and amends that certain Shop Your Way Rewards Establishment Agreement, dated August 8, 2012, by and between SHO and SHMC (“ Agreement ”). All terms capitalized herein, but not defined herein, shall have the meanings ascribed to them in the Agreement.

WHEREAS , the Parties wish to amend certain terms in the Agreement;

NOW, THEREFORE , for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, SHO and SHMC (individually or collectively referred to as the “ Party ” or “ Parties ”) agree as follows:

1. Amendments . As of the Amendment Effective Date, the Agreement shall be modified as follows:

(a) Section VI.C of the Agreement is hereby amended by deleting the language of the section and substituting the following language.

Appendix VI.C describes the Points Fee that SHO will pay to SHMC in accordance with this Agreement with respect to the issuance and redemption of Points, all of which fees are non-refundable regardless of the extent to which Points are redeemed.

(b) Section VII of the Agreement is hereby by amended by inserting the following, new subsection VII.D, which shall immediately follow subsection VII.C:


VII.D .	SHO’s Other Obligations .


1.	SHO at each of its store locations shall display and promote, at the point of sale, marketing collateral for the SYW branded CITI credit card (“CITI Card”). SHMC at its expense will provide each SHO location with such marketing collateral to be displayed.


2.	For transactions occurring in store, SHO will maintain a process that requires inquiring of each customer whether or not the customer is a Member and if the answer is affirmative asking for the customer’s Member Number. Such process will be executed prior to transaction completion.


3.	SHO will maintain a process in its POS System 1) that requires inquiring of each customer that does not self-identify as Member if the customer would like to

- 1 -

enroll into the Program, and 2) to enroll into the Program those of SHO’s customers that request to enroll.


4.	SHO will maintain a process in its POS System for SHO’s customers to apply for the CITI Card.

SHO will allow for the earning, awarding, and redeeming of Points at the SHO Sites (defined below). In order to accomplish this, SHO will connect the SHO Sites (or, as applicable, the shopping cart at such sites) to the appropriate SHMC API’s allowing for the earning, awarding, and redeeming of Points online. “SHO Sites” means the websites, apps, and similar digital properties that SHO owns or operates where customers purchase products.

SHMC will share with SHO (1) the email addresses of all Members who had enrolled in the Program at a SHO POS on or before February 2, 2017 and (2) the email addresses of all Members who enroll in the Program at a SHO POS after February 2, 2017 (the email addresses described in (1) and (2), the “SHO email addresses”); provided, however that the email addresses of Members who have opted out of receiving email communications will not be shared with SHO. Use of the SHO email addresses provided by SHMC will be subject to Section VII(C) of this Agreement. Furthermore, SHO may use the SHO email addresses to communicate with its customers (including Members who are customers) and for the purpose of conducting its business, each in accordance with its privacy policy and applicable law, and for no other purpose of any kind whatsoever, including, without limitation, the sale or renting of such email addresses to third parties.

(d) Appendix VI.C is hereby deleted in its entirety and replaced with the Appendix VI.C attached hereto.

2. Governing Law . Section XXXVI of the Agreement is specifically restated herein by reference.

3. No Other Amendments . Except as expressly amended herein, the Agreement shall continue in full force and effect, in accordance with its terms, without any waiver, amendment or other modification of any provision thereof.

Signature Page Follows

- 2 -

IN WITNESS WHEREOF , the Parties hereto have executed this Amendment #2 as of the Amendment Effective Date.



Sears Holdings Management Corporation By: /s/ ERIC JAFFE Eric Jaffee Senior Vice President, Shop Your Way	Sears Hometown and Outlet Stores, Inc. By: /s/ CHARLES J. HANSEN Charles J. Hansen Vice President, General Counsel, and Secretary

Signature Page

Amendment #2

Appendix VI.C

[***] A total of three pages were omitted and filed separately with the Securities and Exchange Commission

- 3 -

Exhibit 21

Subsidiaries of Sears Hometown and Outlet Stores, Inc.

As of January 28, 2017



	Jurisdiction of Formation
Sears Authorized Hometown Stores, LLC	Delaware
Sears Home Appliance Showrooms, LLC	Delaware
Sears Outlet Stores, L.L.C.	Delaware
Troy Coolidge No. 6, LLC*	Michigan
Outlet Merchandise, LLC	Delaware

*Dissolved February 16, 2017

Exhibit 23

Consent of Independent Registered Public Accounting Firm

Sears Hometown and Outlet Stores, Inc.

Hoffman Estates, Illinois 60192

We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (File No. 333-188645) of Sears Hometown and Outlet Stores, Inc. of our reports dated March 30, 2017 relating to the consolidated financial statements and the effectiveness of internal control over financial reporting of Sears Hometown and Outlet Stores, Inc. appearing in this Annual Report on Form 10-K.

/s/ BDO USA, LLP

BDO USA, LLP

Chicago, Illinois

March 30, 2017

Exhibit 24

POWER OF ATTORNEY

The undersigned, being a director and an officer of SEARS HOMETOWN AND OUTLET STORES, INC., a Delaware corporation (the “Company”), does hereby constitute and appoint MICHAEL A. GRAY, CHARLES J. HANSEN, and RYAN D. ROBINSON, with full power to each of them to act alone, as the true and lawful attorneys and agents of the undersigned, with full power of substitution and resubstitution to each of the attorneys and agents, to execute, file, and deliver all instruments and to do all acts and things that the attorneys and agents, or any of them, deem advisable to enable the Company to comply with the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission with respect thereto, relating to the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2017, including specifically, but without limitation of the general authority hereby granted, the power and authority to sign his name in the name and on behalf of the Company or as a director or officer, or both, of the Company, as indicated below opposite his signature, to the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2017 and all amendments and papers supplemental thereto; and the undersigned does hereby fully ratify and confirm all that the attorneys and agents or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof.

Dated March 29, 2017



Signature: /s/ WILL POWELL Will Powell	Title: Director and Chief Executive Officer and President

POWER OF ATTORNEY

The undersigned, being a director of SEARS HOMETOWN AND OUTLET STORES, INC., a Delaware corporation (the “Company”), does hereby constitute and appoint MICHAEL A. GRAY, CHARLES J. HANSEN, and RYAN D. ROBINSON, with full power to each of them to act alone, as the true and lawful attorneys and agents of the undersigned, with full power of substitution and resubstitution to each of the attorneys and agents, to execute, file, and deliver all instruments and to do all acts and things that the attorneys and agents, or any of them, deem advisable to enable the Company to comply with the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission with respect thereto, relating to the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2017, including specifically, but without limitation of the general authority hereby granted, the power and authority to sign his name as a director of the Company, as indicated below opposite his signature, to the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2017 and all amendments and papers supplemental thereto; and the undersigned does hereby fully ratify and confirm all that the attorneys and agents or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof.

Dated March 29, 2017



Signature: /s/ E. J. BIRD E.J. Bird	Title: Chairman of the Board

Exhibit 24

POWER OF ATTORNEY

Dated March 29, 2017



Signature: /s/ JAMES F. GOOCH James F. Gooch	Title: Director

POWER OF ATTORNEY

The undersigned, being a director of SEARS HOMETOWN AND OUTLET STORES, INC., a Delaware corporation (the “Company”), does hereby constitute and appoint MICHAEL A. GRAY, CHARLES J. HANSEN, and RYAN D. ROBINSON, with full power to each of them to act alone, as the true and lawful attorneys and agents of the undersigned, with full power of substitution and resubstitution to each of the attorneys and agents, to execute, file, and deliver all instruments and to do all acts and things that the attorneys and agents, or any of them, deem advisable to enable the Company to comply with the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission with respect thereto, relating to the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2017, including specifically, but without limitation of the general authority hereby granted, the power and authority to sign her name as a director of the Company, as indicated below opposite her signature, to the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2017 and all amendments and papers supplemental thereto; and the undersigned does hereby fully ratify and confirm all that the attorneys and agents or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof.

Dated March 29, 2017



Signature: /s/ JOSEPHINE LINDEN Josephine Linden	Title: Director

Exhibit 24

POWER OF ATTORNEY

Dated March 29, 2017



Signature: /s/ KEVIN LONGINO Kevin Longino	Title: Director

POWER OF ATTORNEY

Dated March 29, 2017



Signature: /s/ WILLIAM K. PHELAN William K. Phelan	Title: Director

Exhibit 24

POWER OF ATTORNEY

Dated March 29, 2017



Signature: /s/ DAVID ROBBINS David Robbins	Title: Director

Exhibit 31.1

CERTIFICATIONS

I, Will Powell, certify that:


1.	I have reviewed this Annual Report on Form 10-K 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 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 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:	March 30, 2017

/s/ WILL POWELL
Will Powell

Chief Executive Officer and President
Sears Hometown and Outlet Stores, Inc.

Exhibit 31.2

CERTIFICATIONS

I, Ryan D. Robinson, certify that:


1.	I have reviewed this Annual Report on Form 10-K 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 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 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:	March 30, 2017

/s/ RYAN D. ROBINSON
Ryan D. Robinson

Senior Vice President, Chief Administrative Officer, and Chief Financial Officer
Sears Hometown and Outlet Stores, Inc.

Exhibit 32.1

CERTIFICATION

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

Each of the undersigned, Will Powell, Chief Executive Officer and President of Sears Hometown and Outlet Stores, Inc. (the “Company”) and Ryan D. Robinson, Senior Vice President, Chief Administrative Officer, 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 Annual Report on Form 10-K for the 52 weeks ended January 28, 2017 (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.



March 30, 2017

/s/ WILL POWELL
Will Powell
Chief Executive Officer and President



/s/ RYAN D. ROBINSON
Ryan D. Robinson
Senior Vice President, Chief Administrative Officer, and Chief Financial Officer