Bon-Ton CEO Discusses Q2 2010 Results - Earnings Call Transcript

Aug.19.10 | About: The Bon-Ton (BONT)

The Bon-Ton Stores, Inc. (NASDAQ:BONT)

Q2 2010 Earnings Call Transcript

August 19, 2010 10:00 am ET

Executives

Joseph Teklit – ICR

Bud Bergren – President and CEO

Keith Plowman – EVP, CFO and Principal Accounting Officer

Tony Buccina – Vice Chairman and President, Merchandising

Analysts

Bill Reuter – Bank of America Merrill Lynch

Leah Hartman – CRT Capital Group

Emily Shanks – Barclays Capital

Grant Jordan – Wells Fargo

Kathleen Brady – Citadel Securities

Chris Beth [ph] – JP Morgan

Chris Spring [ph] – Valley Assets [ph]

Operator

Good day ladies and gentlemen. Thank you for standing by. Welcome to today's Bon-Ton Stores second quarter 2010 earnings conference call. (Operator instructions) And now I would like to turn the conference over to Mr. Joseph Teklit with ICR. Please go ahead, sir.

Joseph Teklit

Thanks. Good morning, everyone. Welcome to Bon-Ton's second quarter 2010 conference call. Today Mr. Bud Bergren, President and CEO; Tony Buccina, Vice Chairman and President of Merchandising; and Keith Plowman, Executive Vice President, Chief Financial Officer and Principal Accounting Officer will host the call. You can access a copy of the company's earnings release on its website at www.bonton.com. You may also obtain a copy of the earnings release by calling 203-682-8200.

As a reminder, the statements contained in this conference call which are not historical facts may constitute forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995 [ph]. Actual results might differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company’s filings with the SEC. And now I will turn the call over to the CEO, Bud Bergren.

Bud Bergren

Thank you Joe. Good morning and thank you for joining us. I'll begin with some general comments on the second quarter of 2010. Keith will then provide details of the financial results and update you on our financial guidance and assumptions for 2010. Tony will discuss merchandize results and trends and offer our thoughts on what we see happening in retail in the upcoming fall season. After that, we will be available to answer your questions.

Let me give some highlights from the second quarter. First, the results for the second quarter met our expectations. We had a 90 basis-point increase in our gross margin rate, and a $4.3 million improvement in operating loss. Our cost strategies were successful as SG&A expenses were well controlled, and EBITDA for the quarter increased by 12%, and excess borrowing capacity under our revolving credit facility was approximately $391 million, up from $174 million a year ago.

For the quarter, our best regional markets were Detroit; Lancaster in York, Pennsylvania; Minneapolis and Buffalo, New York. Our softest regions were Harrisburg in the Lehigh Valley, Central Pennsylvania. Many merchandise initiatives were successful in the second quarter, and we continue to manage our inventory, keep book [ph] clearance low, and deliver fresh goods into our stores, and Tony will discuss this in a little more detail [ph].

Overall, we’re very pleased with our performance in the first-half of fiscal 2010. Customers responded favorably to our merchandise assortments, and e-commerce continues its significant growth. Our value message resonated with our customers through our key item program, including the Incredible Value items. The continued reduction in clearance merchandise combined with disciplined inventory management led to the 180 basis point improvement in our gross margin rate for the spring season.

Our inventory and expense control efforts resulted in our EBITDA dollars more than doubling from the prior year. Although our sales trends slowed during quarter two versus quarter one, we continue to trend positively for the year. Looking ahead, we believe we have positioned ourselves for continued improvement. We will continue to drive towards improved EBITDA, leveraging the same disciplines and tools that we have implemented over the past two years.

We will continue inventory management and fresh flow of goods to our stores based on sales trend, and tight controls on expenses. We will have merchandise assortments that deliver quality and cater to the needs of our customer today with outstanding values by also providing margin opportunities for the company, for use of our merchandise optimization process, private brands and other merchandise initiatives.

In marketing, we plan to target our loyal customers and attract new ones. We will have enhanced our marketing efforts and will present value to ensure we keep our customers excited about shopping at Bon-Ton Stores. In addition, we are emphasizing our commitment to deliver great service through our customer first initiative. Over 24,000 managers and associates are going through training during the month of August. The training was developed based upon feedback from our customers, managers and associates, and emphasizes the customer comes first, and our associates are empowered to satisfy the customer.

We are looking forward to the fall and holiday seasons and we are confident that we have the right strategy and tactics in place to drive sales and to help withstand some renewed softness in overall consumer spending, as evidenced by spending patterns that slowed in the past few months. We continue to enhance our merchandise assortments by accelerating the penetration of exclusive and distinctive merchandise, scaling [ph] our offerings by region and customer preference, and instituting innovative marketing programs. We believe we are on the right track to achieve the fiscal 2010 goals.

At this time, I would like to turn the call over to Keith to review the financials in more detail.

Keith Plowman

Thank you Bud, and good morning everyone. I will review a few of the major accomplishments in the second quarter of 2010, and then I will touch upon certain income statement and balance sheet components, as well as our 2010 guidance. Our comp store sales rose 0.2% in the second quarter, while our gross margin rate increased to 90 basis points to 38% of net sales.

Our EBITDA, defined as earnings before interest, taxes, depreciation and amortization, including amortization of lease-related interests, increased $2 million or 10.5% to $21.3 million. For a reconciliation of EBITDA to net loss please refer to our earnings press release. Our debt levels decreased by approximately $138 million or 12% from prior year levels.

Moving to the details of our second quarter, comparable store sales increased 0.2% compared with the prior-year period, and total sales for the 13 weeks decreased slightly to $608.6 million. Other income in the second quarter decreased to $14 million compared with $16.1 million in the second quarter of 2009. The current year second quarter reflects reduced leased department income, the result of a conversion in 2009 of fine jewelry to an owned department.

Gross margin dollars in the second quarter increased $5.3 million to $231.4 million. The second quarter gross margin rate increased 90 basis points to 38% of net sales compared with 37.1% in the prior-year period, primarily reflecting merchandise mix and increased net markup. SG&A expenses increased $1.2 million to $224.2 million in the second quarter of fiscal 2010 compared with $222.9 million in the second quarter of fiscal 2009, primarily reflecting incentive compensation and retirement accruals in the current year. The SG&A expense rate for the second quarter of fiscal 2010 was 36.8% compared with 36.6% in the prior year period.

Depreciation and amortization expense, including amortization of lease-related interests, decreased $2.3 million to $27.7 million compared with $29.9 million in the second quarter of 2009. Interest expense net increased $5 million to $28.2 million compared with $23.2 million in the second quarter of 2009. The increase reflects higher borrowing rates as a result of our amended and new credit facilities, partially offset by lower net borrowings. We recorded an income tax benefit of $804,000 in the second quarter of fiscal 2010, which compares with an income tax provision of $939,000 in the second quarter of fiscal 2009. And our net loss was $33.7 million, or $1.91 per diluted share for the second quarter of fiscal 2010 compared with a net loss of $34.8 million or $2.04 per diluted share for the second quarter of fiscal 2009.

For the six months ended July 2010, comparable store sales increased 1.6%. Total sales increased 1.3% to $1,270 million, compared with $1,253.8 million for the first six months of the prior year. Our year-to-date gross margin rate improved 180 basis points to 37.7% compared with 35.9% in the prior year period.

SG&A expenses year-to-date decreased $7.7 million compared with the prior year period as a result of our cost control efforts, partially offset by incentive compensation and retirement accruals. Year-to-date operating loss improved $33.5 million to a loss of $769,000 compared with an operating loss of $34.2 million reported in the prior year period.

EBITDA for the first six months of 2010 increased $29.3 million to $54.3 million compared said $25 million in the prior year period, and the year-to-date net loss was $57.3 million or $3.24 per diluted share compared with a net loss of $80.2 million or $4.72 per diluted share in 2009.

Reviewing some key balance sheet amounts, our balance sheet inventory at the end of the second quarter was flat to last year, reflecting higher in transit inventory than the prior year. Our accounts payable increased $41.5 million, reflecting the increase in the in transit inventory as well as increased vendor support.

Total debt including capital leases was $1.4 billion at July 31, 2010, compared with $1.142 billion at August 1, 2009, a reduction of $138.4 million or 12%. Our debt-to-EBITDA ratio looking at EBITDA on a rolling 12 month basis at the end of the second quarter was 4.2 times. Second quarter capital expenditures not reduced by third-party contributions were $13.5 million compared with $6.8 million for the prior-year period.

Year-to-date capital expenditures not reduced by third-party contributions were $20.1 million compared with $13 million for the prior year period. We remain focused on maximizing operating cash flow and controlling our capital expenditures, while balancing that appropriately with addressing our capital requirements and initiatives.

Moving to our full-year fiscal 2010 guidance, as Bud noted in the second quarter we have seen a cautious customer very careful, calculating in what they purchase with value being a constant. With this in mind, our full-year fiscal year 2010 guidance is updated as follows, EBITDA on a range of $235 million to $245 million and income per diluted share to a range of $0.80 to $1.35. Additionally, our estimate for cash flow, which is defined as note 2 in our press release, is a range of $80 million to $90 million, and the assumptions reflected in our full-year guidance include; comparable store sales in a range of 1.0% to 2.0%; gross margin rate of 37.6% to 37.7%; a reduction of SG&A of $15 million to $20 million; an effective tax rate of 0%; capital expenditures not to exceed $50 million, net of external contributions; and an estimated 18.5 million to 19.0 million average shares outstanding.

We are pleased with our performance in the first half of fiscal 2010 and we will maintain and balance our stringent cost and capital controls, and inventory discipline with our sales growth and profitability goals for the second half of 2010. Our Form 10-Q for the second quarter of 2010 will be available around September 9.

And at this time I would like to turn the call over to Tony.

Tony Buccina

Thank you Keith. We were pleased with our second quarter performance that beat plan. Our comparable store sales increased two tenths of a percent for the second quarter, and spring comparable store sales were up 1.6%. Sales in Q2 were not as strong as the first quarter, but continue to comp positive.

Our second-quarter transactions were up 3% to prior-year, showing we’re getting more customers in the store. However, the average retail per transaction decreased from the prior year period. Customers remain focused on value.

We continue to manage our inventory to sales trends, ending the quarter with comparable store retail inventory down 1.6% with clearance inventory down 5.8%. We were especially pleased with our second quarter gross margin performance with gross margin improving 90 basis points in the quarter, and 180 basis points for spring. Gross margin dollars increased 5.3 million for Q2 and 28.2 million for spring. Our gross margin improvement was driven by several merchandising initiatives.

First, our private brand grew faster than the total store. Private brand gross margins were significantly above the company average. We increased penetration in the Incredible Value program also at higher margins than total company. We reduced clearance inventory that helped improve margin. Our merchandise assortment continues to be fresher than the prior year. And we increased sales penetration in the higher margin moderate zones, moderate missy, petites, large size apparel, moderate shoes, and men’s moderate sportswear.

Looking at our sales performance by category, our best performing categories for the quarter were moderate sportswear, petite sportswear, shoes and intimate apparel. The toughest areas were juniors and furniture. Private brand grew faster than the company average. Private brand was 21.1% of sales in Q2 compared with the prior year penetration of 20%.

The best performing brands in the second quarter were Breckenridge, Relativity, Paradise Collection, Intimate Essentials, and Ruff Hewn. Private brand is an important driver of our overall gross margin, delivering margin several hundred basis points above branded merchandise.

Franchise businesses exceeded our sales and gross margin versus the prior year. The best performing franchise businesses in the second quarter were ladies shoes and moderate update sportswear.

Our men’s outdoor apparel business outperformed the company average with significant growth in sales and margin for Q2. The strongest brands were Timberland, and our own private brand, Ruff Hewn. Men’s outdoor apparel is an important category for our stores, and we expect continued growth in the future.

We continue to advance the ball on our store-wide key items initiative. Penetration of total storewide key items grew over 700 basis points in the second quarter. Customers continue to appreciate the value in our Incredible Value program. Penetration in IVP merchandize in Q2 grew to 8.8% of sales versus 7.6% last year. Our overall product differentiation was 35.3% for the second quarter versus 32.1% in the prior year.

Private brand accounted for 60% of our differentiated merchandise. And customers are still responding to our value message. The moderate zone has outperformed the company average in Q2 especially in petites, large sizes and moderate missy sportswear. However, we have started to see improving top line results in some of our better zones, especially missy better sportswear and better shoes, which had increases for the quarter.

Our e-commerce business continues to perform well, up in excess of 60% for the quarter. And finally, we are pleased with the progress of our fine jewelry business. It has been nine months since we took over this business and it continues to improve. Looking ahead to the second half of the year, we expect positive comp sales in the low single digits, our existing merchandise strategies are performing well, and we will continue to enhance them in the fall.

Private brand will continue to lead the company in sales growth. We are expanding existing brands into additional stores. We expect large growth in our Kenneth Roberts line in men’s sportswear. Customers love the updated fashions of Kenneth Roberts in men’s sportswear and men’s furnishings and value they resonate. We are adding new product categories to existing brands, ramped up for boys is adding new size ranges for little boys.

LivingQuarters is growing our selection of home textile merchandise, and Laura Ashley weekend will add casual styling to our popular Laura Ashley career looks. Also, the casual outdoor looks in Ruff Hewn are now being added to infant sizes and to the men’s cold weather accessories. We are also increasing our marketing of private brand to drive the business, especially in direct mail. The additional marketing will support our expanded merchandise offerings, as well as reinforce the lifestyle and value messages to our private brand customers.

We expect private brand margins continue to be higher than the company average by several hundred basis points. Franchise businesses once again are at plan and are expected to grow faster than the company average. We expect ladies shoes to be our fastest-growing franchise business for fall.

Our storewide key item initiative is on track to be over 30% of our total sales in the second half, a significant increase from the prior year period. And the Incredible Value program should be over 9% of total sales, also up from last fall. Unique merchandise will account for about a third of our total sales, and private brand is planned and expected to be about 62% of our differentiated merchandise.

We expect dramatic growth from e-commerce to continue in the back half of 2010 like we got for spring. We are adding more vendors and more items to our site, especially in the areas that are underrepresented such as men’s dresses, ladies accessories, and better missy sportswear. Another initiative for the fall is the integration of our point of sale system in the stores with our website. This integration gives our associates the ability to better serve our customers by offering all that we carry on line, while she is shopping in our store.

Also, we have recently completed the move to the new IBM e-commerce platform for our website. This new platform will increase web sales by making our website faster, enhancing the graphics, an improving the shopping cart process. In addition to the immediate benefits, the platform prepares us for future growth in technology. We have expanded the space in our distribution centers, when we are working to double the number of SKUs that will be available on the web versus fall. And finally on the web, we have integrated the bridal website with our main website.

The bridal customer can now take advantage of all the features of our new site. And in fine jewelry, we were practicing in the spring. We will build upon the solid successes that we learnt during the first half. We are fully prepared for fall with our product assortment, pricing, marketing and people. We believe this will have a significant opportunity in the fall and holiday shopping season as the conversion started at the end of October 2009.

Changes to our marketing programs will help achieve our sales and margin plans. We will retain current customers by increasing targeted marketing to our credit card customers, and we will increase our broadcast [ph] marketing to reach new customers. All marketing will help reinforce our value message.

And in summary, we are confident that we have the right strategy in place to drive top line sales in the fall and do it profitably. We know our customers and what she is looking for value, fashion and quality, and we are well positioned to exceed her expectations.

I will now turn the call back over to Bud.

Bud Bergren

Thank you Tony. As I said before, we are pleased with our performance in the second quarter and the first-half of 2010. We believe our initiatives will provide growth opportunities and continued EBITDA and earnings improvement throughout the year.

At this time, we would like to open the phones up for your questions.

Question-and-Answer Session

Operator

(Operator instructions) We will hear first from Bill Reuter with Bank of America Merrill Lynch. Please go ahead.

Bill Reuter – Bank of America Merrill Lynch

Good morning, guys.

Bud Bergren

Good morning.

Keith Plowman

Good morning.

Bill Reuter – Bank of America Merrill Lynch

With all the talk on sourcing costs going up, I was wondering if you could talk a little bit about in private label what you guys are seeing there, and if you guys are experiencing increases with regard to this holiday season or if you think that maybe it will be more of an impact on 2011?

Tony Buccina

Our private brand team has done a great job on organizing and working well in advance with our vendors, and we see – actually we don’t see really any significant price increases for the fall season. For spring season and 2011, there will be some price increases, but they will be minimal because we do work with our supplier, private brand suppliers, well in advance and is primarily around goods that are cotton based.

And we don’t buy everything that is cotton. Our entire private brand offering and assortment is not just totally based on cotton. There are a lot of other categories that we carry. So, we see small impact at the low single digit for 2011.

Bill Reuter – Bank of America Merrill Lynch

Okay, that's useful. And then in terms of the regional areas that you called out, you called out Harrisburg and Lehigh Valley that were a little more challenged, do you think it was something there in the local economy, or was there something in the competitive environment? I'm wondering what might be causing certain areas to perform better or certain stores to perform better.

Bud Bergren

Both of those areas have been difficult for us for quite a while, and I think it is somewhat of a competitive environment, especially in the Lehigh Valley. There has been some new retail assortment in that market, and we probably need to update our stores, particularly in the Lehigh Valley. In Harrisburg, we have two stores and one has been – had a lot of construction around it. So it is actually a state road construction that has been bothering the traffic to get to our store and that should be cleared up shortly.

Bill Reuter – Bank of America Merrill Lynch

Okay and then just one last one for me. In terms of – people are talking about what if the consumer doesn't show up this holiday season. I am wondering with regard to your operating costs, your SG&A, if – let's assume the consumer didn't show up in the store to the degree that you guys are expecting, whether you guys could cut some costs there or whether at this point pretty much most of those are fixed.

Bud Bergren

Well, we have always had a good track record of being able to flex our expenses based upon what is happening with sales trend, and then some of that would be flexed. Some of the expenses are based on sales, and as sales climb, we get additional expenses because some of our people are based on incentives or commissions and so forth. We don’t think so, but if sales would drop we do have the flexibility to adjust the SG&A.

Bill Reuter – Bank of America Merrill Lynch

Okay, that's it for me. Thanks, guys.

Bud Bergren

Thanks.

Keith Plowman

Thanks Bill.

Operator

We will hear next from Leah Hartman with CRT Capital.

Leah Hartman – CRT Capital Group

Good morning, everyone, and congratulations on that gross margin improvement. It is something we have been keeping our eye on and you even outperformed my positive expectation, so very excited to see that. A few things, Keith, if we could go through the cap structure, just more specifically, the borrowings under the revolver plus the letters of credit outstanding.

Keith Plowman

Sure. I would be happy to do it Leah. Essentially, you have your senior notes which are fixed at 510 million, your asset base facility is 101 million, CMBS facility is 240 million, second line debt is at 75 million, and then I’ll call it capital leases and miscellaneous another 78 million. That makes up your 1.4 billion.

Leah Hartman – CRT Capital Group

Okay.

Keith Plowman

And letters of credit were $5 million, and just for information comparable with last year would have been about $49 million at the end of second quarter.

Leah Hartman – CRT Capital Group

Okay, thank you very much for that detail. It looks like you are forecasting still pulling out SG&A dollars. I was wondering if you could be a little more specific as to where that is coming from in Q3 and Q4.

Keith Plowman

Essentially none of the items to we are pulling out will be customer facing. What we have done is pulled out services that we felt were back office, or not required items that we could pull out of the operations and not have the consumer see any kind of impact, and if you look at where we are year-to-date, we have realized almost $8 million, and that is after we have some increased costs for incentive compensation, as well as the 401 (k) funding, which are not funded at all in 2009 because the company was in a much different position. Our performance was very much below plan and not looking very strong at that point.

So we do believe that we can pull out the $15 million to $20 million that we have noticed there, and additionally that would reflect some increased marketing costs as we look to drive some sales in the second half of the year.

Leah Hartman – CRT Capital Group

Okay. So that sounds like it would be a permanent reduction as we look to '11 as well.

Keith Plowman

That is correct.

Leah Hartman – CRT Capital Group

Could you tell me what the share-based comp was for the second quarter, please?

Keith Plowman

That is not a number that I have of the top of my head. It is a small number for us. But…

Leah Hartman – CRT Capital Group

Yes, it has been running about $1.3 million, $1.5 million or so.

Keith Plowman

It is really going to run somewhere in a couple of million range. It is a small number, and based on where the share prices were with issuance and such, I don’t see any big change in that number.

Leah Hartman – CRT Capital Group

Okay. And you may have said it but I missed it, the net CapEx for the quarter.

Keith Plowman

The net CapEx for the quarter, looking at it from the standpoint of not including any capital expenditures was about $13 million.

Leah Hartman – CRT Capital Group

Okay.

Keith Plowman

And last year would have been around $7 million using around terms, and essentially what you are seeing there Leah is we are investing more money in the capital for the standpoint of POS, as well as touching, the refurbishing stores, the items that there at the locations that have appearance with the customer that we want to get some improvement in what she sees when she comes in.

Leah Hartman – CRT Capital Group

And would you give us an updated maintenance CapEx, because it has been our view that you've really kept things pretty current during these difficult years. I was just wondering if you could give us an idea of – without actually the point of sales upgrades or the e-commerce upgrades, what is the maintenance for your actual physical stores?

Keith Plowman

We have always talked about a number of 40 million, but that does include some maintenance for I will call it, not necessarily the POS, but it would be for things like software upgrades and other items that we need to do in the IT area, which always takes several million dollars per year.

You know, in that number, it depends how you want to find Leah, what you want to look at, touching stores as you roll through from the standpoint of major remodels, or minor remodels, but the number we have put out as a maintenance capital is around $40 million a year.

Leah Hartman – CRT Capital Group

Okay, that is where I thought we were as well. And then the improvement in the private-label penetration, we're really happy to see that. I was wondering if you would be willing to share what the goal is by year-end and if you have it in your mind for calendar '11.

Tony Buccina

We actually have it – if we make our plan in the fall season, it will be about 21% penetrated for this year. And we think that we have already done a lot of our plans for next year and that is probably going to grow by another point next year.

Leah Hartman – CRT Capital Group

Okay.

Tony Buccina

We are not out farther than that right now.

Leah Hartman – CRT Capital Group

Okay, that's okay. We love to see the market on that stuff. And then I have to ask this, Keith. You have the shelf registration statement out there, that I think it is a 155 [ph], the mixed shelf. And we always like to see flexibility. But do you have plans to use it? Could you speak to us about the logic of having that in place at this time?

Keith Plowman

I think you actually answered your question pretty well that it is the flexibility. It is prudent for us to have that in place. We continue to look at our capital structure, opportunities, what is happening in the market. As you know, they are very volatile. I mean, you look at your high yield note market, and it was real hot. It cooled off now. It is getting hot again. You have got your investors out there looking at I would say frustration, and what they are getting in return on what they call safe investments versus more risky investments. We can get a much better return, and I think it is prudent for us to have this in place to address our capital structure as we go forward really based upon what happens in a macro environment.

You know, we have some pretty high cost second-lien debt out there which we are very happy to have in place, but we will continue to evaluate what the opportunities are as we go forward.

Leah Hartman – CRT Capital Group

And that second-lien term loan is callable after November – or in November?

Keith Plowman

That is correct. After November 18, it is a 5% premium. That is for one year, then it goes down to 3% premium and then finally you are at 0% premium.

Leah Hartman – CRT Capital Group

Okay. And I do recall, I believe, that the revolver does permit repurchase of the 10.25% senior notes, in the event you have excess availability above – is it 200?

Keith Plowman

Yes. You are correct in what you are saying.

Leah Hartman – CRT Capital Group

Okay. All right. I've monopolized it. Thank you so much and we really wish you good success with this back-to-school and into holiday.

Keith Plowman

Thank you Leah.

Bud Bergren

Thank you Leah.

Operator

We will take our next question from Emily Shanks with Barclays Capital.

Emily Shanks – Barclays Capital

Good morning everybody.

Bud Bergren

Good morning Emily.

Keith Plowman

Good morning.

Emily Shanks – Barclays Capital

I was hoping you could give us a little color – and apologies if I missed this in the prepared remarks – but just how you are really seeing back-to-school being received by the customers and how August specifically is tracking for you.

Tony Buccina

Well, we don’t really comment on the same month that we’re in. I did say that juniors in the second half of the year, which includes July was one of the poor performing businesses we have. And that is all I can really say right now. We will comment on it at the end of the month.

Emily Shanks – Barclays Capital

Okay, I thought I would try. And then, as you look at this holiday selling season, specifically Christmastime, how are you guys planning your inventories? How should we think about inventory receipts trending?

Tony Buccina

What – they will trend in accordance with sales increases that we have planned. We see our third and fourth quarter planned up in comp stores, low single digits, and that is what we would expect our inventory to be.

Emily Shanks – Barclays Capital

Okay, great. And then just my last one would be a follow-up to an earlier question around product cost inflation. Thank you for your color in terms of up low-single digits this spring. Is your sense that you will try to pass that through to customers, or will it come down to what your peers end up doing? How should we think about that?

Tony Buccina

As you said, I think it is minimal on the impact of our cost of our private brands. And we feel that we can absorb that, and there are certain categories that we feel we probably could get a little more out of. And that is how I would think of private brand. I would tell you the domestic market on the other hand, I was quite pleased with our first market that we experienced on buys in August for the shoe industry. It looks like the big players in shoes are really not looking to a pass on, as much of that to their partners as we thought.

Emily Shanks – Barclays Capital

That's helpful. Best of luck. Thank you.

Bud Bergren

Thank you Emily.

Operator

We will take our next question from Grant Jordan with Wells Fargo.

Grant Jordan – Wells Fargo

Good morning. Thanks for taking the question.

Bud Bergren

Welcome Grant.

Keith Plowman

Good morning.

Grant Jordan – Wells Fargo

Keith, it looks like you guys are continuing to get good leverage on your payables. Is that something that you think there is more room to go on?

Keith Plowman

You know, I think we’re getting back to pretty close to normal terms when you look at where we are as penetration of the payables, the inventory grant, it is starting to get to where it is very normal for us. And we feel good with the support we have got out there. So, I think we have realized a lot of it. If you look at where we are in our debt reduction, over $138 million, and I do call out everyone’s attention that remember last year we received in the second quarter about the $33 million tax refund benefit, which we did not replicate this year.

You know, we continue to bring down that debt level. So, I think you are seeing the support, and those numbers are pretty strong at this point.

Grant Jordan – Wells Fargo

Okay. Definitely, and it looks like in the third quarter last year, they started to normalize somewhat there, so maybe not as much of a year-over-year increase going forward?

Keith Plowman

Right, yes. I think exactly. You will start to see a move down as we go through into the fourth quarter, but certainly you have realized a lot of it now through the first two quarters.

Grant Jordan – Wells Fargo

Okay, great. And then just one follow-up on the previous – one of the previous questions, talking about potential bond buybacks, the second-lien piece restricts you guys from buying back bonds, is that right?

Keith Plowman

The second lien essentially follows the first lien, and we have the same requirements there. So we would have flexibility there. We continue to evaluate all the different alternatives we have Grant, and we’ll just continue to do that taking into account where the economy is and how things are recovering.

Grant Jordan – Wells Fargo

Okay. And then kind of a big-picture question, and that will be it for me, is as we've – it seems like some of those sales numbers we've seen have been fairly inconsistent across the board, particularly the last few months. Do you feel like there has been any share movement in terms of how consumers are shopping, whether it is discount channels, department stores or specialty retail? Or do you think it is just regional differences? Or how do you attribute some of the – kind of those strange numbers we've seen across the board?

Bud Bergren

I will take that Grant. I think most of it is regional differences. I really don’t see that we are losing market share, or somebody is necessarily picking up market share in the regions that we look at. You know, as I said, our strength really has been Minneapolis, Detroit and Buffalo, which are very competitive markets for us. And we have been doing extremely well in those markets, and some of the other ones that are also competitive we have been doing a little less. But I think it is more regional differences than anything else. And plus this summer has been a much – we are, as you know, completely at Northern stores, and this summer has been a lot hotter than last summer, and so we have been affected a little bit on some of the fall product getting early selling on it.

Grant Jordan – Wells Fargo

Okay. Great. That's helpful. Thanks.

Bud Bergren

Thank you Grant.

Operator

We will take our next question from Kathleen Brady with Citadel Securities.

Kathleen Brady – Citadel Securities

Hi, thank you for taking the question. You are forecasting $89 million in free cash flow for the year. How much of that is already realized versus the back half of the year?

Keith Plowman

That is a good question. I have to sit there and think about that one a little bit. As you go through, I would say on a percentage basis as you look at the performance, probably a low percentage. You are going to be down in the certainly less than half and probably down to like a 30% ratio of it, because as you know, we’re a company that generates operating losses in the first three quarters, and we generate our profit in the fourth quarter.

We have realized a small tax refund. We have brought down the inventory levels and realized some benefit there, but the majority of it would come in in the third and fourth quarter, and especially the fourth quarter.

Kathleen Brady – Citadel Securities

So as we think about your debt at the end of the year, do you have a target debt level with that free cash flow, or a target leverage goal?

Keith Plowman

Yes, we essentially have targeted and have gone out in some of our conferences in saying, we would like to be down to about a 4 times debt-to-EBITDA ratio, which obviously reflects both ways on how EBITDA improves or performs as well as the debt levels.

Kathleen Brady – Citadel Securities

Okay, great. And if we could talk a little bit more about the Harrisburg and Lehigh, you've given that a callout has being an underperforming area. Can you talk about the magnitude of the underperformance relative to the rest of the store base?

Tony Buccina

Basically, it is a very small percent of the total. And off the top of my head, I would say it is less than 2% of our total sales.

Kathleen Brady – Citadel Securities

Okay, great. And you've talked about growth in the shoe category. As we think about shoes, is that generally a higher-margin business for you?

Tony Buccina

It is a high – it is company average.

Kathleen Brady – Citadel Securities

Got it. Okay, great. Okay, thank you.

Keith Plowman

Thank you.

Bud Bergren

Thank you.

Operator

We will take our next question from Chris Beth [ph] with JP Morgan.

Chris Beth – JP Morgan

Good morning. I wanted to take a moment and maybe drill down a little bit on your guidance, particularly your gross margin rate. I think if I’m doing my math correctly, it looks like based on your guidance your expectation is that your gross margin rate will decline about 30 basis points in the back half and I am just wondering one, is that accurate, two, why would that be, and then three, would we expect it in the third or fourth quarter? Thank you.

Keith Plowman

You are accurate in what you are saying. If you look over the last year, I would say that in the second half of the year we’re going to be somewhere around 37.6 [ph] as our gross margin rate, and we at 37.9 and that is for 2009 in the back half. So, your 30 basis points is right in target. We think it could be 25 to 40 somewhere in that range depending on whether you go to min or max the guidance we provided. And yes that was intentional, right now what we have stated as we went through the guidance is we did see some softness. We saw a more cautious consumer in the second quarter, and we will utilize dollars as we talked about in the first quarter to continue to try and drive the top line.

I mean, when you look at the performance we had in the first quarter versus the second quarter and the improvement in EBITDA, it is very apparent that driving that top line is very crucial to our company, and we’re going to continue to focus on that.

Chris Beth – JP Morgan

Okay.

Keith Plowman

As far as between the second or the third and the fourth quarter, we really don’t break down between them. What I will tell you is if you look at our margin rate, we were strong both in the third and fourth quarter last year having pretty good improvements over the prior year.

Chris Beth – JP Morgan

Okay. So, it is basically going to cost you more money in order to drive that comp?

Keith Plowman

We think there may be exposure to drive more dollars out there we would have to be more promotional. Yes.

Chris Beth – JP Morgan

Okay. Thank you.

Operator

We will take our next question from Carla Casella with JP Morgan.

Lilly – JP Morgan

Hi, this is Lilly [ph] in for Carla. Most of our questions have been answered, but could you talk about your refi options for the 12.75 basis points [ph] that is callable in November.

Bud Bergren

When you say our refinance option, I mean we have excess capacity, we could pay down that facility after November 18. It would cost us a 5% premium. If we wait another year, it would cost us 3% premium. So, we do have the option to do so. It would not put us in any kind of constraints as far as the requirements under the revolver. I’m not sure if that is what your question is.

Lilly – JP Morgan

That is great. Thank you.

Bud Bergren

You are welcome.

Operator

We will hear next from Chris Spring [ph] with Valley Assets [ph]. Please go ahead.

Chris Spring – Valley Assets

Hi guys. Good morning. One more question on the capital structure, you had mentioned looking at the expenses term loan and the options there, but obviously the magnitude of the senior notes is a lot larger and that has got a hefty coupon as well, given that they are callable, and the high yield market is obviously wide open and receptive to refinancings, any thoughts around potentially refinancing those?

Bud Bergren

You know, the best way I can answer that Chris is we look at everything and we consider all options. It can get any more specific than we have several opportunities, and really it does come down to just as you stated where the markets are, how they stay, and how they perform over the near term, and what the company’s direction is strategically.

Chris Spring – Valley Assets

Thanks.

Bud Bergren

Thank you.

Operator

And we will take our final question from Robert Raiff with Centurion. Your line is open. Please go ahead. And it appears he has disconnected. I will turn the conference back over to our speakers for any additional or closing comments.

Bud Bergren

Thank you very much for your interest in Bon-Ton, and we’ll see you at the end of the third quarter in November for the third quarter results.

Keith Plowman

Thanks again.

Operator

That does conclude today’s conference. Thank you all once again for your participation and have a wonderful day.

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