Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Anthony J. Buccina - Vice Chairman and President of Merchandising

Jean Fontana - Senior Vice President

Keith E. Plowman - Chief Financial Officer, Executive Vice President of Finance and Principal Accounting Officer

Byron L. Bergren - Chief Executive Officer, President and Director

Analysts

Jonathan Feldman - Nomura Securities Co. Ltd., Research Division

Michael Exstein - Crédit Suisse AG, Research Division

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Karen Eltrich - Goldman Sachs Group Inc., Research Division

William M. Reuter - BofA Merrill Lynch, Research Division

Kristina M. Westura - Telsey Advisory Group LLC

Kevin Boler

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Colleen Burns - Oppenheimer

Unknown Analyst -

Bon-Ton Stores (BONT) Q3 2011 Earnings Call November 17, 2011 10:00 AM ET

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to today's Bon-Ton Stores Inc. Third Quarter 2011 Financial Results Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. And now, I'd like to turn the conference over to Ms. Jean Fontana from ICR. Please go ahead, ma'am.

Jean Fontana

Thank you. Good morning, and welcome to Bon-Ton's Third Quarter Fiscal 2011 Conference Call. Mr. Bud Bergren, President and CEO; Mr. Tony Buccina, Vice Chairman and President of Merchandising; and Mr. Keith Plowman, Executive Vice President and Chief Financial Officer, will host today's call.

You may access a copy of the earnings release on the company's website at www.bonton.com. You may also obtain a copy of the earnings release by calling (203) 682-8200.

The statements contained in this conference call, which are not historical facts, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected in such statements due to a number of risks and uncertainties, including those set forth in the cautionary note in the earnings release and all of which are described in the company's filings with the SEC.

I would now like to turn the call over to Mr. Bud Bergren.

Byron L. Bergren

Good morning, and thank you for joining us. I'll begin with some general comments on the third quarter and then touch upon our objectives for the fourth quarter. Keith will provide details on the third quarter and our guidance and assumptions for 2011. Tony will discuss the quarter's merchandise results and the merchandising initiatives for the holiday selling season. After that, I'll make some closing remarks, and then we will be available to address your questions.

Our third quarter performance did not meet our expectations. As noted in our October sales release, we broadly identified the issues behind the weak sales performance, including lackluster sales of traditional merchandise apparel or moderate apparel, price resistance, changes in advertising and our core customer being affected by the economy.

We have taken significant action to drive sales in the fourth quarter. We believe our merchandise assortment is now better aligned with our customer preference, as we have significantly expanded our stronger selling updated categories, and we are planning more aggressive promotional events to drive traffic and transactions.

Additionally, the strategic initiatives introduced in September, such as our pilot stores, expanded shoe departments and assortments, our customer-first program and the increased offerings of updated ladies merchandise, have all yield solid results. We believe our inventory is now priced appropriately and is well positioned heading into the holiday season. And that, the changes we have instituted in merchandising and marketing, will yield improved results in the fourth quarter. Tony will get into more detail.

Our third quarter results included the following: comparable store sales decreased 5.9%; the best-performing markets during the quarter were Detroit, Des Moines, Dayton, Lehigh Valley and Omaha; softest markets were Chicago, Buffalo, Harrisburg, Minneapolis and Milwaukee. We generated strong growth at our eCommerce business. Sales were up 28% in the third quarter compared with the prior period.

Following a strategic review of our real estate portfolio, we announced our plans to close 2 stores, West Manchester in York, Pennsylvania and Northwest in Dayton, Ohio; and sell and close 3 stores at Rochester, New York. We will close 4 of our -- of the 5 stores in 2012 and the fifth one, Marketplace in Rochester, by early 2014. We expect an accretive net impact to the earnings per diluted share as a result of these closures.

We continue to look to close underperforming stores and announce new stores in the future as we improve our portfolio. Our 2 new stores received an enthusiastic reception from our customers when we opened them on November 9, our Herberger's in Edina, Minnesota and our Carson's store, which is a relocation, in our Kokomo, Indiana store.

Next, I would like to discuss our plans for the holiday shopping season. We've taken significant steps we believe will benefit sales. Our first customer -- our customer-first program, which is focused on customer shopping experience, has been very well received, and our customers have told us so.

Next, we believe the cosmetics, cold-weather merchandise, ladies updated sportswear and shoe categories will all generate solid sales results. We have a strong portfolio of distinctive private brand products, such as Ruff Hewn, Laura Ashley and Kenneth Roberts, complemented by the latest introductions of John Bartlett and Mambo. With our updated merchandise brands, we believe we can attract and develop a younger attitude customer.

eCommerce remained strong. We are on track this year with our eCommerce, a goal -- a growth by at least 1% of total company sales. Year-to-date, eCommerce sales have increased 58%.

We also see growth opportunities in the renovated 17 locations, of which 7 are pilot stores and 13 have expanded shoe departments. We've expanded and emphasized our growth businesses, both with assortment and visual enhancements, and will continue the strategy into more locations because it's working.

Digital and social media is very exciting, and it's just in the infancy stage. But we have made solid progress in reaching this customer her way. And we installed kiosks in 12 stores, and we are pleased with the online orders being placed through this technology. We will add kiosks to more locations in the spring. We've also announced that we'll be opening at midnight on the day after Thanksgiving, with over 400 or 500 bonus buys.

Next, I'd like to update you on our sourcing cost. Cost pressures have moderated since their peak levels. However, lower cost will not be fully realized until mid-2012 due to production timing. The cost of cotton still remains well above the early 2010 levels. Pressures on Chinese wages and currency valuations remain drivers of the cost increases. Globally elsewhere, costs have moderated, and we will continue to diversify our product away from China. We are currently renegotiating spring production where possible.

Overall, we expect total cost up 5% to 7% in the spring of '12 versus 2011. Heading into fall of 2012, we see cost flat to down 5% to 10%, depending on the item with cotton-based products falling in cost the most.

Next, I would like to make -- take a moment to address the announcement on Monday about my transition from CEO to Chairman of the Board. First of all, I'm very excited about taking on the new role and working with the board for the long-term benefit of the shareholders. The search for a new CEO will start soon, and candidates will be considered both internally and externally. Time is not the driving force but placing the right person in -- is the top priority.

I want to assure everyone that until we appoint the new CEO, we have gone through an orderly -- and have gone through an orderly transition, I'll be focused on and actively engaged in the continued rollout of our strategic initiatives and strengthening of the operation of our company to deliver improved profitability.

And with that, I'd like to turn the call over to Keith to review the financials. Keith?

Keith E. Plowman

Thank you, Bud, and good morning, everyone. I will review the financial results for the third quarter and then discuss our full year guidance and assumptions for 2011.

In the third quarter, EBITDA, defined as earnings before interest, taxes, depreciation and amortization, including amortization of lease related interest, decreased to $25 million as compared with $48.7 million in last year's third quarter. A reminder that for a reconciliation of EBITDA to net loss, please refer to our earnings press release put out this morning. Our net loss totaled $22 million compared with a net loss of $6.3 million in the prior year period.

At the end of the third quarter, our excess borrowing capacity under our revolving credit facility was approximately $380 million. As a reminder, in early 2011, we reduced our revolving credit facility by $50 million, which impacts only October-November borrowing capacity, and we paid off our second lien term loan of $75 million, both resulting in a planned reduction to our availability of $125 million versus the $82 million we experienced through the third quarter. And our debt levels were approximately $55 million or 5% lower compared with the prior year period. Lower borrowing rates and debt levels have allowed us to reduce our interest expense as compared with the prior year period by approximately $6.4 million in the third quarter.

Details of our third quarter are as follows. Comparable store sales decreased 5.9%. Total sales decreased 6.3% to $656.1 million. Other income was $14.5 million compared with $16.4 million in the third quarter of 2010. The decrease in other income in the third quarter primarily reflects the current year decrease in sales volume. Gross margin dollars decreased $22.3 million to $245.4 million, reflecting the current year decrease in sales volume and margin rates. Our third quarter gross margin rate decreased to 37.4% of net sales compared with 38.2% in the prior year period. The decrease in the gross margin rate in the third quarter largely reflects an increased net markdown rate.

SG&A expenses decreased $566,000 to $234.9 million compared with $235.4 million in the third quarter of fiscal 2010. The improvement in the SG&A dollars reflects cost-control efforts and reduced incentive compensation accruals, partially offset by increased marketing expenditures. The SG&A expense rate for the third quarter increased to 35.8% of sales compared with 33.6% of sales in the prior year period.

Depreciation and amortization expense, including amortization of lease-related interest, decreased $1.5 million to $24.5 million compared with $25.9 million in the third quarter of fiscal 2010. Net interest expense decreased $6.4 million to $21.9 million compared with $28.3 million in the third quarter of fiscal 2010. An income tax provision of $640,000 was recorded in the third quarter of 2011 compared with a provision of $651,000 in the prior year period. And our net loss was $22 million or $1.21 per diluted share compared with the net loss of $6.3 million or $0.36 per diluted share for the third quarter of fiscal 2010.

Moving to our year-to-date results. Comparable store sales decreased 3%, and total sales decreased 3.5% to $1,901,400,000. Other income was $42.9 million compared with $44.3 million in the prior year period. Gross margin dollars decreased $48.6 million to $697.5 million, reflecting the current year decrease in sales volume and margin rate. Our year-to-date gross margin rate decreased to 36.7% of sales compared with 37.9% in the prior year period, largely reflecting increased net markdown.

SG&A expenses decreased $10.8 million to $676.7 million compared with $687.5 million in the prior year period, the result of effective cost controls and reduced incentive compensation accruals partially offset by increased expenditures for marketing, private brand and eCommerce. Additionally, the year-to-date period includes a favorable insurance receipt recorded in the second quarter of fiscal 2011. Despite the expense reductions, the year-to-date SG&A expense rate increased to 35.6% of sales compared with 34.9% of sales in the prior year period, reflecting the decreased sales volume.

Depreciation and amortization expense, including amortization of lease-related interest, decreased $3.4 million to $77.6 million compared with $81 million in the prior year period. Net interest expense decreased $72 million -- $68 million compared with $85 million in the prior year period. The decrease reflects reduced borrowing levels and lower interest rates as a result of our prepayment of the second lien term loan and the amendment of our revolving credit facility. As a reminder, in the first quarter of fiscal 2011, we recorded a $9.5 million loss on the extinguishment of debt for fees and accelerated amortization of deferred fees associated with the voluntary prepayment of our second lien term loan and the amendment and restatement of our revolving credit facility.

An income tax benefit of $971,000 was recorded in the year-to-date period. This compares with the $474,000 income tax provision in the prior year period. And our net loss was $90.3 million or $5 per diluted share compared with the net loss of $63.5 million or $3.60 per diluted share for the prior year period. The first quarter of fiscal 2011 included a charge of $0.52 per diluted share associated with the loss on the extinguishment of the debt.

The following are some key ratios and balance sheet amounts. Our total balance sheet inventory at the end of the third quarter increased to 3.9% as compared with the prior year, including increased in-transit merchandise. Our on-hand inventories remained fresh. The increase in the in-transit merchandise also drove our accounts payable to increase by 11.7%.

Total debt including capital leases was $1,055,000,000 at October 29, 2011, compared with $1,110,000,000 at October 30, 2010, a reduction of $55 million or approximately 5%. Our year-to-date 2011 capital expenditures before netting third-party budget contributions were approximately $51 million compared with $36 million for the prior year period. And components of our debt structure at the end of the third quarter were: senior notes, $510 million; revolving credit facility, $242 million; CMBS facility, $233 million; mortgage notes and other debt, $70 million; and our LCs, outstanding letters of credit, were just shy of $4 million.

Moving to the details of our quarter -- of our third quarter 2011 guidance for 2011. Our fiscal 2011 full year guidance is as follows: EBITDA on the range of $190 million to $210 million; income per diluted share in the range of a loss of $0.65 per share to income of $0.25 per share; and cash flow in the range of $25 million to $40 million.

Assumptions reflected in the full year guidance are as follows: comparable store sales in the range of 3.3% decrease to 1.6% decrease, and mathematically, that means the fourth quarter would be down 4% to up 1%; gross margin rate down 80 basis points compared to the prior year. For the fourth quarter, that means we would be down 0 to 10 basis points; SG&A expense down approximately $10 million to $12 million for the year. It means we'd be about flat on SG&A for the fourth quarter; tax expense or impact is expected to be immaterial; capital expenditures, not to exceed $70 million net of external contributions; and the range of shares, average shares outstanding, are approximately 18 million to 20 million shares.

We want to call out that the provided guidance does not reflect any potential income tax benefit of reducing the valuation allowance recorded for deferred tax assets. The amount of any adjustment will be determined when we have our final 2011 results.

We will continue to control expenses, capital spending and inventories while focusing on opportunities to grow our top line sales and benefit gross margin dollars. Our Form 10-Q for the third quarter 2011 will be available around December 8.

At this time, I would like to turn the call over to Tony.

Anthony J. Buccina

Thank you, Keith. We were disappointed with our third quarter sales performance. We attributed the weak performance to several factors. First, the moderate traditional merchandise is underperforming. As we transition the merchandise mix to more updated offerings, we are pleased with the updated sales trend, which is above the company average. We expect the sales growth to accelerate as we continue to build our updated assortments. Second, marketing changes around several events in October did not drive sales that we anticipated. Third, we believe customers have been resistant to price increases, particularly in cotton products and, especially, in basic merchandise.

Before I outline actions that have been taken to drive sales in the fourth quarter, I will discuss the third quarter results. While our average unit retail sale was up 4.1%, the number of units sold was well below our plan. The average unit retail sale was not up as much as our average unit retail inventory. Transactions in the third quarter were down 10.6% compared with the same period last year. The average retail sale per transaction was up 4.9%.

On a positive note, the results in our pilot markets we tested that complete rollout of our growth strategy achieved positive comp sales for the test period of September, October. We increased the penetration of updated merchandise faster in the pilot markets than the total company. The pilot stores also benefited from additional marketing, reallocated floorspace and capital improvements.

In addition, the 13 stores where we expanded selling space for shoes are doing well. In these stores, the shoe category was up double digits, and the 13 locations perform better than the total company. Where we invested capital, we got the return.

Our best-performing businesses categories were hard home, cosmetics, shoes and fine jewelry. Fashion watches and luggage also continue to do well. The hard home business was driven by small electrics in the coffee category. Cosmetics continued their strong performance in the new items in the treatment lines, and customers are responding very favorably to our new shoe assortments, especially in the stores where we expanded the square footage allocated to the shoe department.

Updated merchandise continues to outperform traditional merchandise in men's and women's apparel, accessories and shoes. eCommerce sales were up double digits again, as our investments in infrastructure and digital marketing continue to drive growth online. The IVP, Incredible Value Program sales were slightly down for the third quarter, but the penetration to total sales increased.

The weakest areas for third quarter were moderate traditional apparel in Missy, women's, petites and men's sportswear. Other tough areas were ladies' outerwear and mens' outerwear and furniture. Cold-weather merchandise in total was significantly worse than the total store for third quarter. Almost 1/3 of our sales dropped for the quarter was in cold-weather items.

Gross margin rates for the third quarter was 37.4% versus 38.2% in the prior year. We have become more aggressive in our pricing, especially in the areas where we saw customer resistance to price increases. Retail inventory on a comp store basis was up 2.7% to last year at the end of October. We have significantly more inventory in the areas that are performing well, such as cosmetics, shoes and hard home. We have cut back inventory in the moderate traditional apparel zones. We continue to fund growth in eCommerce and in private brand.

We were also more aggressive in moving slow-selling merchandise into the clearance category this year, which resulted in year-over-year increase in clearance inventory. Clearance is still about 7% of our total inventory. Our raising of inventory is in good shape. All of our inventory increase is in the 0- to 90-day category, and we have less inventory than last year in categories older than 90 days.

Private brand sales in the third quarter were slower than the total store. Penetration was 20%, slightly below last year of 20.7%. Private brand is heavily affected by the downtrend in moderate traditional apparel. The gross margin rate remains higher in private brand than the company average.

Our franchise businesses performed much better than the total store. Cosmetics, moderate updated ladies' sportswear and ladies shoes were the best performers. Our storewide key item penetrated at 31.4% of total sales. This is slightly down from last year, but within our target range. Our product differentiation was 33%, which is our target penetration, and private brand accounted for over 60% of the differentiated merchandise.

Moving to the fourth quarter. We have strength in our promotional plans for November and December. Many of our marketing events will be more aggressive. We are spending more media dollars in the holiday period than last year, especially in broadcast and digital. We believe our offers will be compelling to our customers and will drive traffic into the stores and online.

We will continue to shift receipts into updated merchandise versus traditional styles. We have reduced inventories in the moderate traditional merchandise and expanded our updated offerings. We are executing our planned strategy for long-term growth by offering a more updated assortment that is better aligned with our core customers' preferences while building upon the assortment to attract the younger customer.

The mix of inventory as we move into the fourth quarter is where we plan to be with the penetration of updated merchandise. The biggest moves are in the test group of stores, but we are also significantly changing the rest of our stores, too. We expect the test stores to outperform the rest of the stores in the fourth quarter, as they are getting all components of our growth strategy.

In private brand, the new labels of John Bartlett and Mambo achieved good results in the third quarter. We expect private brand sales to improve in the fourth quarter for the same reason as total store, improvements and updated merchandise, aggressive marketing, lower prices and a great gift strategy.

We remain confident in our core merchandise strategies as a franchise businesses, key items and differentiation. We've added inventory to drive sales in the areas with positive trends, like cosmetics, shoes and hard home. We also expect cold-weather merchandise to improve in the fourth quarter with the arrival of more seasonal weather.

And finally, we continue to monitor our pricing as we maintain price increases that our customer accepted and adjust prices down where there was resistance in order to achieve our planned rates of sale. We have seen improved sell-throughs when we advertise the lower prices on these items. Overall, we believe we are better positioned to drive sales in the fourth quarter, with improved selling and updated merchandise and more aggressive marketing plan and merchandise that is priced to move.

I will now turn the call back over to Bud.

Byron L. Bergren

Thank you, Tony. We have taken significant action to drive sales and profit in the fourth quarter. We have instituted appropriate pricing adjustments to help drive sales. And additionally, all components of our holiday marketing media will feature more aggressive promotions to attract customers during this critical selling season.

With that, we'll be glad to open up the phone for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Grant Jordan with Wells Fargo.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

My first question, I guess -- just trying to get a little more information and understand some of the changes you made in marketing in the third quarter that did not work.

Anthony J. Buccina

Really, in October was, really, we made the biggest changes. And what we did in the first week and really in the last week of October, we combined 2 short-term events into a longer event. Our intent was to really pick up business. But we got just the opposite, where we really didn't get the kind of business that we anticipated. But that was basically it, Grant. We combined in weeks 2 -- in weeks 1 and in weeks 4, we really combined 2 shorter-term, what I would call, harder hitting events into a longer event in both weeks.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. And so the combination of that was a reduction in sales relative to the 2 shorter events?

Anthony J. Buccina

Yes.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

And you believe that consumers viewed that negatively and did not respond. I guess -- I'm trying to parse out the effect of that versus just general decline in sales.

Byron L. Bergren

Grant, the -- it's -- we've learned the hard way maybe that events don't carry that long. Consumer really wants to respond when they see the value for the day. And carrying an event for a long period of time isn't something that works anymore. And so I don't know if I can give you a percent what effect that had on it, but that was part of -- part of the issue in pricing and moderate traditional sportswear are the other parts of it.

Anthony J. Buccina

The other big thing that we did in week 4 was we also converted -- we tried to execute a lowest price of the season with really without any coupons. And I guess we learned that the hard way. We were successful with it at the end of June, and we thought that would continue to finish the quarter. So we felt that, that would really drive a lot of business, and we found the out the hard way that our customer shops with coupons and not without coupons.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. Yes, that makes sense. On the SG&A line, on an absolute dollars, you guys were flat from the quarter relative to last year. Do you see opportunities to reduce SG&A if the sales plan doesn't perform as you expect?

Byron L. Bergren

Well, we'll adjust the SG&A based on sales plan but usually going into the fourth quarter, that's so key to us. We're not looking at cutting selling staff on the floor at all. We think it's -- that's important right now. But if for some reason sales didn't materialize, we would adjust accordingly. But right now, we feel that we want to invest in the selling associates.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. And my last question on the gross margin. You talked about for the fourth quarter, your guidance assumes flat to down 10 basis points. And just trying to make sure I understand all the levers there. Certainly, what we've heard is that the environment has become more promotional. You talked earlier about private brands getting less traction, which typically adds to your margin. Are you comping against anything last year that would help your gross margin this year on a comparable basis?

Keith E. Plowman

Grant, when you take a look at the fourth quarter of last year versus our full year trend rate, we are comping against the best quarter for 2010. I mean, we were down last year in the fourth quarter, about 120 basis points compared to 2009. And when you look at the rest of the year, we were up 50 basis points for the year. So we really took quite a hit. We did some things that I think we've gotten smarter on. We talked about some of that in the first quarter of this year. If you remember, we were about 190 basis points negative gross margin comparable year-over-year. That has declined down to 80 basis points for the next 2 quarters, and we had much tougher quarters to compare to for the first 3. So we think we have some opportunities here, which certainly we know are going to have to offset cost increases and promotional and so forth. But from what we've analyzed and the way we've put it together, we believe that that's the exposure we would have in the fourth quarter.

Operator

Our next question comes from William Reuter with Bank of America Merrill Lynch.

William M. Reuter - BofA Merrill Lynch, Research Division

On your second quarter call, you guys talked about some of these same issues with the traditional merchandise underperforming, and you guys had kind of thought at that point that you had it fixed for fall. I guess I'm wondering if you can talk a little bit about -- and I guess it's expanding upon some of the things you already talked about. But talk about maybe what you maybe misinterpreted in terms of having things fixed, whether it was -- you're talking about more advertising or more promotions or whether it was the inventory. If you can talk a little more about that.

Anthony J. Buccina

Well, I would say that we really saw that happen to us in the fourth quarter, and that's when we begin to make changes to address to a more -- to more updated merchandise in our mix. Well, we were able to achieve some of that in the second quarter and we actually -- we're targeted to move to a bigger percent of our inventory and sales in the updated categories in third and fourth quarter. I would tell you, if you look at the third quarter, we actually made a big move on our inventories from -- we penetrated at the end of October about 7% of our inventory in percentage points moved to updated, and our sales in the updated, the penetration moved 5 points. Now that's going to improve in the fourth quarter to hit the plan that we said we were going to hit. And if you look at it right now, our updated merchandise, that's only going to continue to increase into the fourth quarter. To answer your question, the timing on it from private brands, as well as domestic market, started in the second quarter and got bigger in the third quarter, okay. And that all didn't start on August 1. It really -- you started to receive those goods August through the end of October and we are where we want to be right now at the end of October.

William M. Reuter - BofA Merrill Lynch, Research Division

And then you -- I know that weather was really warm in October. Can you talk about how this might have impacted your same-store sales? I know it's probably hard to do a real calculation there, but whatever you can help us to provide.

Anthony J. Buccina

Let me tell you what we did. We penetrated in the third quarter about 14% last year, and the -- and this year, we penetrated about 11% for the quarter. Now that jumped for the -- in cold-weather merchandise, okay. And in the fourth quarter, that jumps up to about 21% to 22% of our total company. All cold weather really wasn't bad in the third quarter. Actually, cold-weather gloves, hats, scarves, accessories were really terrific and had big comps in both ladies, men's and kids. The tougher areas for us were really in cold-weather boots, coats and sweaters. Now we do feel that -- no, sooner or later, in our area, it does get colder, and we feel that we're positioned right with the right manufactures.

William M. Reuter - BofA Merrill Lynch, Research Division

Okay. And then one last one. I was wondering if you have provided the information in the past upon how many of your stores are EBITDA negative. And I guess kind of a related question, you talked about markets that were doing good and ones that were doing bad. If you can talk about how the performance of -- why you think some markets are doing better than others.

Keith E. Plowman

So I'll take the first part of the question. And essentially, yes, we've disclosed that in the past. We said between 10 and 15. With some of the actions that we've taken, that number will come down. Obviously, that is a moving target. We need to drive more top line performance. And as we do that, those will grow or will decrease also. We need to keep focused both on the top line as well as the assets themselves. So some of the moves we made is going to help that over the next year or so, but that's the range we're in, 10 to 15.

Byron L. Bergren

And I'll fill the one on markets. The markets that did well for us during the quarter are ones that have been consistently doing well: Detroit, Des Moines, Dayton. Ones that turned around is -- because they had a better quarter than in the past and -- in Omaha, which has consistently been good. Lehigh Valley was our pilot market and it ran over the company. So we're very happy with the results of all the strategic initiatives we did in Lehigh Valley. The softer markets were somewhat of a surprise. The Chicago, Buffalo and Minneapolis and Milwaukee have been fairly good, and we think there was a lot more weather-related into those markets because they are very cold-weather related. Now Harrisburg, which has been a problem all along, that's been a market that's been struggling for us as the -- there's high unemployment in that area. And I think that's the reason there, and -- so I don't know if that -- hopefully, that answers your question.

Operator

Our next question comes from Edward Yruma with KeyBanc Capital Markets.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Can you please talk about the performance of some of your stores were you retooled the operating model? I know that you've seen some better performance there earlier. Has that continued?

Byron L. Bergren

Ed, are you referring to our pilot stores where we did those -- the tests?

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Yes.

Byron L. Bergren

What we did in those stores is we respaced them, first of all, giving more space to higher productivity areas, like shoes and accessories and updated sportswear. We did a minor remodels in those stores with carpet and paint. We redid the bathrooms. We did totally new visual in those markets. And as Tony said, he changed the assortment, and we did added marketing under an umbrella called Rediscover Bon-Ton. And we're very happy with the results and -- I'm sorry, we also did customer first, which is a training of our associates. We put them -- we changed the dress code, which has been very positive, did retraining and looking at productivity and actually added hours into those stores for staffing also. And we're very happy with the results we got out of those stores, and we'll be rolling that out to more stores over the next few years.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Great. And a follow-up to the question on gross margins. So I'm just trying to understand, from a year-over-year perspective, what level of promotional increase have you baked into your gross margin guidance?

Byron L. Bergren

I don't know if we can answer that for you, Ed. We've -- we adjust prices quite a bit, and I don't know how much I could tie it specifically what is driven by marketing.

Operator

Our next question comes from Karen Eltrich with Goldman Sachs.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Getting back to pricing, is -- particularly for private label, what magnitude of price increases were you trying to take? And I guess how much are you bringing that down?

Anthony J. Buccina

Well, here's what, our average price -- our average unit retail selling price was 4.1% in the third quarter. We owned our average unit retail inventory, up about almost 11%. So if you wanted to say how much we passed on, we passed on about 1/3 of the price increase. That was consistent between private brands and domestic brands.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

But you saw more resistance in the private.

Anthony J. Buccina

Yes. What we've -- no. No. It was -- that was basically the same. I mean, yes, yes.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Private label penetration was lower this quarter?

Anthony J. Buccina

Right. As far as the average price -- as far as to answer your question on the average price in private brand was almost -- the increase was almost identical to the total company increase, as well as the increase in the average unit retail ownership where we have it versus the private.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

So as we go to the fourth quarter then, I guess -- what is the increase in the cost? And again, how much then will you be passing through?

Anthony J. Buccina

I believe that we will pass through the same kind of increase in the fourth quarter as we've did -- done in the third quarter. I think we will be looking at an average price that's probably up in that 4% to 5% range.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

But with more promotional activity.

Anthony J. Buccina

Yes.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Kind of on that, you mentioned digital. With your now online capabilities, what kind of distribution list have you built? And how effective are you finding that to drive traffic into your stores?

Byron L. Bergren

This year we're going into e-mails with 3x the number of e-mails we had last year. So we use it sparingly because we don't want -- we do -- we don't want to get complaints from the customers about over burdening them with it. But we do use it to drive traffic and have been successful with it. And that's a major goal of growing our e-mail portfolio.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Great. And final question, if you may give us a sense for how much Lehigh Valley outcomp the system.

Byron L. Bergren

We haven't given that out, and we prefer not to.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Okay, fair enough. Actually -- I'm sorry, one last question. As you talk about that -- those 10 to 15 underperforming stores. How many of those would you view kind of as on the bubble for closure? And do you look at the underperformers? Do you think it's driven by unfavorable leases, or is it driven by bad location?

Byron L. Bergren

It's driven -- a lot of things drive it. Most of it is bad location, and -- most of it is that or bad lease conditions. Now if it's bad lease conditions, we've been able to renegotiate with our developers to help along those lines. But if it's the location, and then obviously, we would -- we want to move on to something else and improve our portfolio.

Keith E. Plowman

And just to add a comment to that. You asked the question about how many are on the bubble. Some of the locations are in a bubble. The recent years, the recession, the macro impact have pushed locations in there that did not exist in that group before, and we still think there's some opportunity to take those out of there as we move forward.

Operator

Our next question comes from Rishi Parekh with Sterne Agee.

Rishi Parekh

Just going back on your promotions. Can you give us an idea what the impact of those promotions had on same-store sales in Q3?

Keith E. Plowman

We really haven't looked at -- we really haven't looked on it, but it was -- both weeks that we talked about, we're down in the double-digit range.

Rishi Parekh

Okay. And I assume you acquired a lot of this inventory for these promotions 5 to 6 months ago. So was the ineffectiveness of this promotions due to product? Was it mostly due to price resistance? And can you just give us an idea what merchandise segments you -- that were tied to these promotions? Was it cold-weather, basics, children's apparel?

Anthony J. Buccina

I'd have to say all of the above. I mean they were storewide promotions. It's not geared towards any one family of business. And I would say the change in the event was really the issue that we did -- really the issue that affected it the most.

Rishi Parekh

Okay. Just going back on your assortments. I think you stated in the past that, at least in our conversations, that your assortments are 60-40 traditional and updated. When do you think it will switch to that 40-60 goal that you are looking for? How long do you think it'll take to get to that level? [indiscernible]

Anthony J. Buccina

We have a 3-year plan to do that, okay? We were trying to move our -- our plan this year was to move our company in fall '11 in those same categories. We were planning to move them up 12%, 12 percentage points. What I told you for the -- what I said earlier was that we moved the inventory into the third quarter and to more updated by 7%, and we moved our sales in that category 5 points in penetration to total company. So we moved the penetration and inventory 7 points, and we moved the penetration of sales 5 points, okay. And the traditional -- the updated merchandise in the third quarter was up 6%. So we're still -- we're hitting in the right direction. And we feel that well beyond our plan, our plan by the end of the fourth quarter.

Rishi Parekh

Okay. You stated you're renegotiating your spring merchandise. Does that mean you're canceling spring orders? And can you give us an idea in terms of your unit plans for spring inventories? Are you looking for it to be down 5%, down 10%?

Byron L. Bergren

No. What -- we're not canceling orders on spring. What we're going back to our manufacturers, and with prices coming down, renegotiating some of the prices where the opportunity exists, and that's part of it. In the way of units versus dollars, we still are buying dollars versus units.

Rishi Parekh

Okay. And one last question, I'll get back into the queue. But can you repurchase your bonds with your revolver? And can you just give us an idea what your capacity is? And is this something that you are currently evaluating?

Keith E. Plowman

We do have the capability to do that within revolver. There's certain requirements we need to meet as far as the calculation. That's not anything I can share, but it is something that is out there. It's been asked before. And we look at all options.

Operator

We move on to our next question, from Michael Exstein with Credit Suisse.

Michael Exstein - Crédit Suisse AG, Research Division

I really have 2 questions. Number 1, you've been very introspective about things that you have done you think not done particularly well. But how much of the issues that you're dealing with may be competitive, as the promotional environment around you has become much more intense? How much do you think that has weighed in on your performance, number 1? And number 2, did you actually give us the units versus dollar value of your unit -- of your inventories at the end of the quarter? How much they are down, the units were down?

Byron L. Bergren

I'll try the first side of that, then let Tony have the second side. It's -- it is a very promotional environment out there, and it can -- it always has been promotional. And obviously, by our sales versus our competition, we are giving up market share. We're losing it to somebody. I can't tell you who. But I don't know if I can tell you exactly how much is because of the promotional environment. I haven't seen a lot of changes necessarily from our competitors. It's very competitive. And obviously, we lost on the deal. We're giving market share to somebody. I'll let Tony get the second.

Anthony J. Buccina

Mike, on the average unit inventory, we were operating with about 7% less units in our company, okay. And our average retail is up 11%.

Operator

Our next question comes from Colleen Burns with Oppenheimer.

Colleen Burns - Oppenheimer

I guess just first on these -- on the updated merchandise. Is that just more fashion younger? Is that what you're targeting? I just want to make sure I understand exactly what that updated offering's are.

Anthony J. Buccina

It's really -- what really did is we re-categorized all of our vendors, any vendor that we did over $50,000 annually with, into a -- what we call a traditional or an updated bucket, okay. And that's how we're really measuring the updated versus the traditional merchandise. We hadn't done that in a while, since merger, and we went back and we did that. And we're actually looking at that now on a weekly basis. But it's not only to attract the younger customers. It's also to just attract our -- to our core customer, a more youthful styling.

Colleen Burns - Oppenheimer

Okay, that makes sense. And then just on the inventory. How much of the inventory increase was private brand? What was your private brand inventory up at the end of the third quarter?

Anthony J. Buccina

Our private brand inventory was up about $10 million. I want to tell you one thing about private brands though. The big thing that -- I mean, I should've answered it on a question before. But the private brand really is affected by the price increases. The same way that domestic market is. The big deal with private brand is it's very heavy penetrated in traditional moderate apparel that we're moving aggressively in there into the more updated category. I mean, that's more -- that's really where the slowdown was in the private brand. The updated merchandise in private brand is doing very well. It's more of the traditional mix that's really holding us down in the moderate zones.

Colleen Burns - Oppenheimer

Got you. And then just for spring. Can you say just how you're buying dollars? Are you buying that up low single digits, down, flat?

Anthony J. Buccina

Yes, we're buying it up low single digits.

Colleen Burns - Oppenheimer

Okay. And then lastly, just on your $25 million to $40 million cash flow guidance for the year. What's your working capital expectation?

Keith E. Plowman

As we see it right now, working capital being somewhat flat. That really, the 25% to 40%, does not take into account certain amortization costs, like stock comp and things like that. It doesn't take into account dividends or working capital changes, which we've held pretty flat year-over-year. So as we would see it right now, we don't expect a lot of impact there.

Operator

And our next question comes from Jonathan Feldman with Nomura Securities.

Jonathan Feldman - Nomura Securities Co. Ltd., Research Division

I was wondering if you could just talk to what you think is driving the weakness in the moderate fashion [ph] traditional categories. Do you think there's been some change in consumer behavior? Do you think it's macro related? Anything -- thoughts on that subject?

Anthony J. Buccina

I think it's all of the above that you said. I think they are being affected. That older traditional customer is being infected by the macro environment. I also feel that the merchant -- that's where we hit -- where we're getting price increases there is where we had the biggest price resistance, okay. And I've -- I'll try to give an example of that. In the moderate denim areas, last year, we were promoting denim at about a $25 average price, $24.99. The price increases in denim for the third quarter were up in that moderate area by $35 to $40, okay. And ever since we got it back down to promoting it to last year with working with our suppliers, now, our denim business is up. So they're not paying more. They're not paying more for the prices where there's really no fashion or where they don't see the value.

Operator

And our next question comes from Leah Hartman with Sky Harbor Capital.

Leah A. Hartman

Could you walk us through and break down the $70 million of CapEx, how that's being spent this year?

Keith E. Plowman

In round terms, half -- about half of it is on maintenance and, what we call, IT investments and initiatives that we have. That's more or less that maintenance capital we talk about in the $35 million to $40 million range. A portion of it went for the strategic initiatives that we put in place. There's a portion going to visual and basically trying to get the appearance and the attitude for the customer where we want it to be. So right now, we're pretty much on track. We had some expansion, as you know, on locations that Bud talked about earlier, and we believe we'll be fairly close to that $70 million.

Leah A. Hartman

And where -- now that we have, what did you say, $51 million to date, where are the dollars going in this quarter? [indiscernible] and the same, all of those initiatives or targeted?

Keith E. Plowman

I'd say the remainder of the dollars more will be on the maintenance-type areas, because as we get into the fourth quarter, we won't do a lot of big initiatives or projects. We don't want to do anything that could impact the stores.

Leah A. Hartman

How much does it cost to do or changeover a regular store to the pilot format?

Byron L. Bergren

It depends on the current condition of the store. You can spend anywhere from $10 a square foot up to $50 a square foot. So it depends on the condition of the store and where we see the store has an opportunity to grow.

Leah A. Hartman

And could you talk about the total debt level expected at year-end, so year-over-year? And I believe you did pay that term loan, but it was first quarter. Is that correct?

Keith E. Plowman

That's correct. And when we paid down the term loan, essentially, that would've been out of cash flow generated by the company. So simple way of looking at it, last year, we were just a little over $930 million in debt. If you take our cash flow that we put out, which is a simple cash flow but we think is representative, that would be the reduction, somewhere between $25 million and $40 million, to that debt level at year-end.

Leah A. Hartman

Okay. And as you're looking forward into the fourth quarter, some big moves about opening much earlier, again, are you now going to be using your e-mails to drive the coupons out? Is that mass mailing? You're saying it so important to your customer to have those coupons. Can you talk anything about your you know?

Byron L. Bergren

Yes. We definitely will be using coupons under e-mail blast, that we also be spending more money on prospecting and with Google search and things along those lines also.

Leah A. Hartman

Okay. And just a final question on the bank line. It's a no-covenant loan as long as you maintain. What's the dollar level of liquidity?

Keith E. Plowman

Well, it does vary. It, essentially, is a percentage. It's set up in the agreements that we filed out there. But in round terms, if you use $50 million to $60 million, you're in the relative range of what it would be on a monthly basis.

Leah A. Hartman

Great. And you ended the third quarter with $380 million.

Keith E. Plowman

That is correct.

Operator

And our next question comes from Kevin Boler with Morgan Stanley.

Kevin Boler

Yes. I had a follow-up quarter on the revolver. I was under the impression that, that revolver would spring to 60 days prior to the March maturity of the bonds if the bonds are not refinanced. Do you have a different interpretation on that?

Keith E. Plowman

No. That is correct, and we disclosed that in our documents.

Kevin Boler

Because someone had asked if you could retire the bonds into the revolver, and I thought you said that you could do that?

Keith E. Plowman

No. They asked if we could use proceeds, as I understood it, of the revolver to buy back bonds, and we do have the availability. We have to meet certain covenant tests to make sure that we perform to those levels. And if we do that, we would have the option of utilizing funds to buy back senior notes in the market.

Operator

And at this time, we'll take a follow-up from William Reuter.

William M. Reuter - BofA Merrill Lynch, Research Division

Just one quick question. I think you know that your transactions were down 10.6%. I'm wondering if you measure traffic in your stores. Just in terms of how many people were in your stores during the quarter, and how that changed year-over-year.

Byron L. Bergren

No, we don't. We don't measure traffic in the stores at all. We do measure traffic on our eCommerce site, which is up dramatically, but we don't in the stores.

Operator

We'll take our follow-up this time from Rishi Parekh with Sterne Agee.

Rishi Parekh

Just want to confirm, and I assume you do, but do you still have the capacity to issue more second lien debt?

Keith E. Plowman

Do we have the capacity -- to issue? I'm certain that if we went out in the market and showed that we felt that was the appropriate thing to do, we keep relationships and communications, so we would have that availability if we thought that was appropriate.

Rishi Parekh

Okay. And what areas are you seeing customer resistance to price increases? Can you give us an idea what -- is it women's apparel, children's clothing?

Anthony J. Buccina

It's really -- the biggest has been really in the moderate traditional zones, whether it's men's, ladies, large sizes or petites, sportswear. It's where we have the biggest price increases on the cotton, basically, the cotton-based products, and that's where we've had our biggest price resistance.

Rishi Parekh

Okay. And can you just remind me of your margin discrepancy between branded and private and your shrink as a percentage of revenue?

Anthony J. Buccina

Well, I could tell you the private brand is still -- we've always said it's a couple of hundred basis points higher than the domestic brands, and that's where it fell for the quarter. And that's probably where -- that's about where we are at year-to-date.

Keith E. Plowman

And as far as the shrink percent, we're more focused what the shrink is by store and what type of product and things like that, the product-type line versus whether it is private brand or domestic.

Rishi Parekh

Okay. And if you were to exclude the underperforming stores, can you give us an idea what the net benefit to EBITDA would be? Is it $5 million, $10 million? Just trying to get an understanding of the scope of how negative these stores are.

Keith E. Plowman

It's a number that moves around quite a bit. I don't think it's anything we'd want to disclose at this point for those locations. It does change, again depending on our sales volume and where we are as far as the macro environment and impacts. So at this point, I would say that it's not anything we disclosed.

Rishi Parekh

And lastly, what percentage of those underperforming stores are tied to the 23 facilities encumbered by the mortgage facility?

Keith E. Plowman

None of them.

Operator

And our final question today will come from Jason Yakovan [ph] with Bank of America Merrill Lynch.

Unknown Analyst -

You mentioned last year that the average remodel age was something like 14 years. Are you comfortable with that? And if not, what would be the ideal number for the average remodel age?

Byron L. Bergren

No, I'm not comfortable with 14 years. That's one of the reasons we're putting this effort into updating our stores and I -- where we can get a return on it. The -- I would prefer that we are under 10 years or less. It would be my preference.

Unknown Analyst -

Okay. And then just a quick follow-up to that. I think you mentioned on a previous question that a remodel could be anywhere from $10 to $50 a square foot. So if you spent, say, $10 a square foot for some relatively minor remodel, would you consider that a remodeled store when you're saying that your average remodel age is 14 years? Or does that really just consider stores where there's been a more significant remodel?

Byron L. Bergren

I would consider that a store that we've updated if we spent at least $10. If we go under that, I wouldn't. But $10 basically gets you a paint and carpet and some lighting and fixturing without doing any demolition or anything, but it does update the store.

Operator

And our final question today will come from Kristina Westura with Telsey Advisory Group.

Kristina M. Westura - Telsey Advisory Group LLC

I just had a question on the inventory of 3.9% at the end of the quarter. I was just wondering how much of that increase is due to in-transit inventory.

Keith E. Plowman

I would say, at round terms, about 1/3 of that number is in-transit.

Kristina M. Westura - Telsey Advisory Group LLC

Okay. And then where would you expect the inventory to be at the end of the fourth quarter?

Anthony J. Buccina

We would expect it relatively where it's at -- similar to where it's at right now for the third quarter.

Kristina M. Westura - Telsey Advisory Group LLC

Okay. And then just on China. You had mentioned trying to diversify away from -- sourcing away from China. Can you just remind us how much of product is sourced through China, and where you expect it to go down the road?

Anthony J. Buccina

Yes. We -- currently we use a source about 55% of our business is in the China. It's looking like it's about 40% now. That's where we're moving towards it. Low-cost producing countries, like Vietnam and Bangladesh, will be about 42%, and duty free, we're going to be about 18%.

Kristina M. Westura - Telsey Advisory Group LLC

And then lastly, just in terms of free shipping online. Just wondering if that's having any material -- or sort of any impact on the gross margin, and how we should think about it for the fourth quarter.

Anthony J. Buccina

It's -- in the third quarter, it was about -- of our margin, it was about -- I guess about 10 basis points or 13 basis points. And I think that, that will be around where we expect in the fourth quarter.

Byron L. Bergren

Let me just clarify one thing that Tony said on the inventory. He's not referring to it at the same dollar level, but coming down and be -- maybe as a percent over the year before, not the same dollar level at the end of the year.

Operator

And that concludes today's question-and-answer session. Mr. Bergren, at this time, I'll turn the conference back over to you for any additional or closing remarks.

Byron L. Bergren

Thank you. Thank you for your questions and your interest in Bon-Ton. We look forward to speaking with you about our financial results of our fourth quarter and full year of 2011 on our conference call in March. Thank you very much.

Operator

And that does conclude our conference for today. We thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Bon-Ton Stores' CEO Discusses Q3 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts