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Bon-Ton Stores (NASDAQ:BONT)

Q4 2011 Earnings Call

March 07, 2012 10:00 am ET

Executives

Jean Fontana - Senior Vice President

Brendan L. Hoffman - Chief Executive Officer, President and Director

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

Anthony J. Buccina - Vice Chairman and President of Merchandising

Analysts

Grant Jordan - Wells Fargo Securities, LLC, Research Division

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

Michael Exstein - Crédit Suisse AG, Research Division

Emily E. Shanks - Barclays Capital, Research Division

William M. Reuter - BofA Merrill Lynch, Research Division

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Karru Martinson - Deutsche Bank AG, Research Division

Carla Casella - JP Morgan Chase & Co, Research Division

Rishi Parekh - Sterne Agee & Leach Inc., Research Division

Todd Harkrider - UBS Investment Bank, Research Division

Colleen Burns

Unknown Analyst

Operator

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

Jean Fontana

Thank you, Augusta. Good morning, and welcome to Bon-Ton's fourth quarter and fiscal 2011 conference call. Mr. Brendan Hoffman, 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 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 might 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. Brendan Hoffman.

Brendan L. Hoffman

Good morning, and thank you for joining us. I'll begin with some opening comments, Keith will provide financial details on fourth quarter and full year 2011 results and outline the financial guidance and assumptions for 2012. Tony will discuss the fourth quarter's merchandise results and the merchandising initiatives for 2012. After that, I will make closing remarks and then we will be available to address your questions.

I will begin by saying how happy I am to be here. I've been on board for only one month and most of my time has been spent in becoming familiar with the company and its people. I've had many one-on-one meetings with the senior leadership group, as well as larger group meetings with the different peer man [ph] heads and their leadership teams. In addition, I've spent a great deal of time visiting stores. I visited over 30 stores in multiple states to try to get a better understanding of the different banner names, store sizes and locations that make up our portfolio of stores. My initial reaction is that I'm more excited about the opportunities that we have in front of us than I had anticipated.

Now for a brief overview of the results from our strategic initiatives that began in mid-September. Sales in our 7 pilot stores significantly outperformed the company. We expanded and updated in better fashion assortments, we reallocated square footage to more productive categories and added new brands, our marketing campaign of Rediscover Bon-Ton resonated with the customers in these markets. Customer feedback from our pilot stores is very positive. They noticed the changes made to their store, the assortment and the improvement in their overall shopping experience. This was evidenced by the results in these stores.

Also shoe expansions in 16 stores, 7 of which were the pilot stores, produced very strong sales results. We significantly increased the square footage of our shoe departments and added new brands for the assortment. We believe this represents a meaningful opportunity going forward.

Based on the success of these pilot stores, we will expand the strategic initiatives to 67 additional stores over the course of this year. We will focus on updated merchandise, we will create visual enhancements and new fixturing, we will renovate and refresh stores, including carpet, lighting, fitting rooms, restrooms, et cetera. In addition to this initiative and based on my early assessment of the company, the other areas of focus for 2012 will include: Reallocating square footage in our stores to increase focus on high-growth categories like ladies shoes. This may include eliminating lower producing categories in smaller stores that are space challenged; increase the attention given to our small stores and niche markets where there is less competition, which provides an opportunity to achieve outside comp store growth increases if we execute more effectively; reengineer our marketing cadence to ensure that our message to the customer is clear and concise, including refreshing some of our events; drive traffic with effective marketing using traditional and new media channels to communicate to the customer her way and reaching younger customers as well; continue to use targeted direct mail to entice our core customer with our value, fashion and quality; Customer First, we have a renewed focus on enhancing our customer shopping experience. We will strive to ensure every customer easily understands our merchandise assortments, promotions, ability to order a size and/or color we don't have in stock for her, either through a well-trained associate or using an online kiosk in a comfortable environment. We will continue to grow our eCommerce business to make sure it's our biggest store in each category and drive sales growth to reach over 5% of our total sales over the next few years.

We will use our multiple markets and banners to test new ideas. We will grow sales by driving increased penetration of our private label credit card business. We expect to increase our focus on the next-generation customer, defined as 31 to 50 years old. We believe this segment represents a big opportunity. And finally, as we put these initiatives in place, we will continue to leverage SG&A investments.

I am optimistic about our future. The knowledge I have gained over the past month has served to reinforce my confidence in the collective strength of the company and our ability to drive profitable sales growth in 2012 and the years ahead. That said, 30 days is a short period and I'm still in the process of my assessment of the business. I will continue to meet with the various teams and visit stores to further evaluate our business and identify future opportunities. I look forward to sharing more of my thoughts and plans with you in the months ahead.

And with that, I would like to turn the call over to Keith to review the financials.

Keith E. Plowman

Thank you, Brendan, and good morning, everyone. I will review our financial results for the fourth quarter and fiscal 2011 and then discuss our full year guidance and assumptions for fiscal 2012.

A few key points in the fourth quarter. EBITDA, defined as earnings before interest, income taxes, depreciation and amortization, including amortization of lease-related interest, impairment charges and the gain on the extinguishment of debt, decreased to $106.4 million as compared to $140.7 million in last year's fourth quarter. Note: For a reconciliation of EBITDA to net income or loss please refer to this morning's earnings press release.

Our net income totaled $78.2 million compared with net income of $85 million in the prior year period. At the end of the fourth quarter, our excess borrowing capacity under revolving credit facility was approximately $438 million. We repurchased in open market transactions $46 million of principal amount, $30 million in November as we previously disclosed and an additional $16 million in January of 2012 of our 10 1/4% Senior Notes that are due March 15, 2014, issued by our subsidiary The Bon-Ton Department Stores Inc. These repurchases were completed at a discount and resulted in a pre-tax gain net of cost of $18.2 million.

Other key points for the year. We reduced our total debt levels by approximately $47 million or 5% compared with the prior year. We decreased debt levels -- or with the decrease debt levels and combined with lower borrowing rate, this allowed us to reduce our interest cost by $5.8 million in the fourth quarter and $22.8 million for the total year.

For our previously announced real estate initiatives, we closed 2 stores in January, one in York, Pennsylvania and one in Dayton, Ohio and 2 at the end of February both in Rochester, New York. We expect a net accretive impact on earnings per diluted share as a result of these closures and we will continue to evaluate our real estate portfolio and we'll close stores that do not meet our profitability thresholds and open new stores as opportunities are identified.

Details of our fourth quarter as follows: Comparable store sales decreased 2.6%, total sales decreased 2.7% to $983.2 million, other income was $26 million compared with $21.7 million in the prior year period. The increase is primarily due to income of $6.5 million related to the cumulative breakage on unused gift and merchandise return cards issued since inception of these programs, partially offset by decreased income from proprietary credit card operations, largely resulting from reduced sales. Gross margin dollars decreased $34.4 million to $339.7 million, reflecting the current year decrease in sales volume and margin rate. Our fourth quarter gross margin rate decreased to 34.6% of net sales compared with 37% in the prior year period. The decline in the gross margin rate in the fourth quarter largely reflects an increased net markdown rate.

Our SG&A expenses increased $4.2 million to $259.4 million compared with $255.2 million in the prior year period. The increase in the SG&A expenses primarily reflects increased store and marketing expenditures partially offset by reduced incentive compensation expenses. The SG&A expense rate for the fourth quarter increased to 26.4% of sales compared with 25.3% of sales in the prior year period.

Depreciation and amortization expense, including amortization of lease-related interest, decreased $3.6 million to $22.4 million compared with $26 million in the fourth quarter of last year primarily due to a reduced asset base.

Non-cash impairment charges totaled about $3.5 million in the fourth quarter of 2011 compared with $1.5 million in the prior year period related to the reduction and the carrying value of certain long-lived and intangible assets. Interest expense decreased $5.8 million to $21.5 million compared with $27.3 million in the prior year period. This decrease primarily 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.

Gain on extinguishment of debt was $18.2 million reflecting our open market repurchase of $46 million of our Senior Notes, and an income tax benefit of $1 million was recorded in the current period compared with an income tax provision of $879,000 in the prior year.

Our net income was $78.2 million or $4 per diluted share compared with net income of $85 million or $4.41 per diluted share in the prior year period. The fourth quarter of fiscal 2011 reflects income of $0.93 per diluted share associated with the gain on extinguishment of debt.

Moving to the full year 2011 results. Comparable store sales decreased 2.8%. Total sales decreased 3.2% to $2,885,000,000. Other income was $68.9 million compared with $66 million in the prior year, impact's the same as noted for the fourth quarter. Gross margin dollars decreased $83 million to $1,037,300,000, reflecting the current year decrease in sales volume and margin rate.

Fiscal 2011 gross margin rate decreased to 36% of net sales compared with 37.6% in the prior year, primarily reflecting an increased net markdown rate. SG&A expenses decreased $6.6 million to $936.1 million compared with $942.7 million in the prior year, primarily due to reduced incentive compensation expense and reduced pension expense, partially offset by increased marketing expenditures and investments in our private brand and eCommerce expenses.

Despite the expense reduction, fiscal 2011 SG&A expense rate increased to 32.4% of sales compared with 31.6% of sales in the prior year period, the result of the decreased sales volume.

Depreciation and amortization expense, including amortization of lease-related interest, decreased $7 million to $99.8 million compared with $106.8 million in the prior year.

Non-cash impairment charges totaled $3.7 million in fiscal 2011 compared with $1.7 million in the prior year and it related to reductions in the carrying value of certain long-lived and intangible assets. Interest expense decreased $22.8 million to $89.5 million compared with $112.3 million in the prior year. 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.

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 agreement.

In the fourth quarter of 2011, we repurchased in open market transactions $46 million of our senior notes. The repurchase was completed at discount that provided a pre-tax gain net of cost of $18.2 million. The combination of these transactions related to debt extinguishment resulted in a gain of $8.7 million in fiscal 2011.

We recorded an income tax benefit of $2 million, which includes a $3.2 million reclassification from shareholders' equity associated with the interest rate swap contract that expired in July of last year. This compares with $1.4 million income tax provision in the prior year. And our net loss was $12.1 million or $0.67 per diluted share compared with net income of $21.5 million or $1.12 per diluted share for fiscal 2010.

Fiscal 2011 results include income of $0.48 per diluted share associated with a net gain on the extinguishment of debt.

Looking at some key ratios and balance sheet amounts. Our total balance sheet inventory at the end of the year increased to 2.5% as compared with the prior year. Our accounts payable support increased to 3.7% as related to inventory.

Total debt, including capital leases, was $883.4 million at January 28, 2012, compared with $930.5 million at January 29, 2011, a reduction of approximately $47 million or 5%. Components of our debt are as follows: Senior Notes, $464 million; revolving credit facility, $119 million; CMBS, mortgage facility, $232 million; mortgage and notes and capital leases, $68 million; and we had letters of credit outstanding of $4 million.

Our fiscal 2011 capital expenditures before netting third-party contributions were $67.2 million compared with $46.3 million for the prior period.

Turning to our fiscal 2011 guidance. It is as follows: EBITDA, in the range of $180 million to $200 million; and income per diluted share in the range of $0.15 to $0.75. Additionally, our estimates for cash flow, as defined in Note 2 of our press release, is expected to be in the range of $60 million to $70 million. Assumptions reflecting our full year guidance are comparable store sales increase in the range of 1% to 2%; gross margin rate in the range of 36.5% to 37.1%; SG&A expense increase of $25 million to $30 million from fiscal 2011 and a reminder that, that does include the 53rd week which is about half of that increase; tax rate of 39%; capital expenditures, not to exceed $70 million net of external contributions; and an estimated $19 million to $20 million average shares outstanding.

Just a note, as we put in last year, the provided guidance does not reflect any potential income tax benefit of reducing or removing the valuation allowance recorded for our deferred tax assets. The amount of adjustment, if any, cannot be determined until our 2012 results are final.

We will continue to look for ways to improve our efficiency and reduce expenses, to manage our capital spending and inventories, maximize our real estate portfolio, reduce debt with cash generated by the business and focus on opportunities to grow top line sales and achieve our profitability goals.

Our Form 10-K for fiscal 2011 will be available on April 12, 2012.

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

Anthony J. Buccina

Our fourth quarter sales and margin performance were below our expectations, partially due to the mild winter, negatively impacting our sales in cold weather merchandise as well as the continued softness in our moderate traditional businesses. In addition, we saw customer resistance to price increases.

We were pleased to see solid performance on our updated categories where we are expanding our offerings. We did miss some opening price point business in moderate, petite, large sizes and managed moderate traditional sportswear, which we are remedying for spring.

Our pilot markets delivered positive comps for the fourth quarter. These stores carry a higher percentage of updated merchandise than the total company average. The pilot stores also received additional marketing, reallocated floor space and capital improvements.

Our best performing businesses were hard home, shoes, cosmetics and Fine Jewelry. Hard home includes the fast-growing category, the fast-growing coffee category, driven by single-serve coffee makers and K-Cups. Shoe sales were driven by updated styles, better brands, EMU boots, and our private brands.

In fall of 2011, we expanded our shoe department in 16 stores and we are pleased with the results. Our cosmetics business was very good in women's and men's fragrance, primarily due to new launches, as well as a strong execution of value sets.

Treatment lines continue their strong performance, driven by new technological advances in skin care. And additionally, we had excellent results with new promotional strategies the last 10 days before Christmas, where cosmetics is a huge percentage of our total company business.

Franchise businesses performed better than the total store for the quarter and generated positive comp sales. The best franchise businesses were cosmetics, ladies shoes and moderate updated Missy sportswear.

Our private brand penetration was slightly down in the fourth quarter compared with the prior year at 18.9% versus 19.2% in the prior year. The margin rate was down several hundred basis points to the prior year period. Private brand was negatively impacted by the downtrend in moderate traditional apparel, lack of cold weather merchandise sell-throughs and the customers' resistance to price increases.

We generated good growth in our eCommerce business, with sales up 16% in the fourth quarter compared with last year and up 35% for the year.

Our storewide key item program penetrated at 30.2%, which was slightly below plan. The IVP, or Incredible Value Program sales, were down for the quarter 10%. Penetration to the total store was slightly down at 7% versus 7.6% in prior year.

Overall, product differentiation for the quarter was 32.4%, a slight increase compared with last year's fourth quarter. Private brand accounted for 58% of the differentiated merchandise.

The poorest performing businesses in the fourth quarter were ladies and men coats, moderate traditional sportswear, intimate apparel and men's moderate traditional sportswear. Our cold weather categories in total were down double digits.

Gross margin rates for the fourth quarter was 34.6% versus 37% in the prior year period. Aggressive promotions were necessary to move the merchandise in the fourth quarter. The lack of cold weather selling also impacted our rate as cold weather product carries a higher gross margin than the total company.

Retail inventory was up 3.3% on a comp store basis versus last year at the end of January. A significant portion of that increase was in cold weather merchandise which we plan to return to our vendors during the first quarter.

We've built inventory on our planned growth areas of cosmetics, shoes and better sportswear, and eCommerce inventory is also up versus last year in order to support our aggressive sales plan for spring.

Our clearance inventory is up in dollars but down in units and is about the same penetration to total company as the last year at the end of January, and the aging of our inventory is in good shape.

Moving on to the first quarter of 2012. The first quarter began with good selling on new spring merchandise even as we cleared out fall inventory. We believe the mild weather could be a positive as we move into the first quarter.

Our eCommerce sales are on track to produce solid increases for spring. We strengthened the advertising calendar by moving a very important promotional event from February to April. Community Day is our charity-driven event that should perform well at the end of April.

We are expanding our growth strategy to 33 additional stores in the spring. Based on the results of the pilot stores in fall, we expect the new set of growth stores to outperform the company and the total company in comp sales.

We will continue to expand the updated merchandise assortment, the penetration of updated categories would be similar to last fall and significantly higher than they were last spring. At the same time, we will plug the holes that we had in our opening price points to recapture those missed sales.

Next, I would like to update you on sourcing and costs. Cost pressures have moderated since their peak levels. However, lower costs will not be fully realized until mid-2012 due to production timing. Fuel so far has not impacted our cost, as the rise in fuel pipe crisis has been recent. 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 production away from China and move into Vietnam, Cambodia, Bangladesh and Sri Lanka. India also remains strong, while duty-free markets in Nicaragua and Jordan remain stable.

Overall, we expect cost up 5% to 7% in spring 2012 versus spring 2011, and we see cost for fall '12 versus fall '11 down 5% to 10% depending on the item.

Our core merchandising strategy is to franchise businesses' key items and differentiation will remain essential to our success in 2012. We have fresh inventories in the right categories and expect to drive positive comp sales in spring.

I will now turn the call back to Brendan.

Brendan L. Hoffman

Thank you, Tony. As we expand the initiatives we have been implementing, we expect to drive profitable sales growth and create the desired level of customer service to achieve our goals.

With that and the reminder that I'm brand new, we will be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question comes from Grant Jordan of Wells Fargo.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

My first question, it looks like for the first time in a while, you're taking SG&A up going into 2012. Can you kind of give us a little bit more detail on where those expenditures are going?

Keith E. Plowman

Yes, sure. Grant, this is Keith. Essentially, what we see is we have some investment in our initiatives that we were put in place. We have the compensation, the incentive compensation, that was pulled out in fiscal 2011 added back and then I mentioned earlier about the 53rd week. All those items together are increasing somewhere in the range of $40 million and then we have initiatives to take that back down in the range of $25 million to $30 million.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. So the $25 million to $30 million is kind of your contingency plan if you need it?

Keith E. Plowman

No, no. That is where we expect ourselves to be at this point, Grant and we we're going to continue to look for ways to be more efficient as we noted in our scripted answers to things. But we think there's some opportunities out there. We think there's some ways to drive more efficiency and our operations and still get the same performance in our stores.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. You talked to someone about focusing more on the smaller sized stores where there's less competition. Out of the 275 stores, how many does that represent?

Brendan L. Hoffman

Well, this is Brendan. I mean, it really represents more than half of our portfolio. It's again what I've been focusing some time on as I get out to get to know the stores. And we'll do -- we'll quantify that more at a later date, but I just intuitively see that there's opportunity there to tweak the stores in terms of the way we're allocating the merchandise assortment and get some outside comps.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. And my last question, Keith, you've mentioned the breakage income in the fourth quarter. Was that from last year's breakage income? Or was that a catch up from a while ago?

Keith E. Plowman

That is a total in the program itself. This is the first time we've recognized it, Grant. Essentially, we continue to track this. We've done it now for multiple years and we are using outside counsel to assist us on this because it's a very technical area. It's an area that is very dependent upon the legal landscape. It is something that -- I couldn't sit here and tell you for sure how that will turn out as we review it again in 2012 just because the legal landscape does change. But this was our first time of recognizing it. It was based upon some recent actions that occurred in the legal markets that gave us clear indication with what we needed from outside counsel that we could recognize this figure.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

How many years does that represent?

Brendan L. Hoffman

It will be since inception, Grant. So I mean, it goes back. We use a low rate model that lets us look at it. We look at breakage and clip drop off based on the number of years. But this is really the first time adjustment and we've been in gift cards and merchandise certificates for years.

Operator

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

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

Congratulations on your new position, Brendan. I know you've identified 67 stores that you're rolling some degree of changes to based on your pilot store tests. Are there any other easy fixes that you can roll across the fleet? And kind of what type of initial results do you hope to get in these new 67 stores?

Brendan L. Hoffman

Yes. Well, I'm happy to be here. I think as I referred to just a moment ago with the small stores, I think there are lots of different things I'm finding and taking notes on where there's opportunities we can move quickly on with some muscle and just quick decisions to drive business and make ourselves more productive. Again, it's only been 30 days, so I'm not ready to fully define that or quantify that yet. But I do think that there is low hanging fruit out there that we can go after and we will go after while we are moving forward on the pilot stores and identifying additional stores for that program as well.

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

Got you. And I know you've indicated and you've given CapEx guidance for the year. I know you've certainly been in a deleveraging mode. Can you talk about how you think about the balance between investing in your store fleet and repaying debt and if we should expect CapEx to tick up over time as you spend more time with the store fleet?

Keith E. Plowman

Yes. This is Keith. What we see -- the $70 million, remember, is net of contributions we get from third parties. So the gross number is always higher than the $70 million as evidenced this year and you'll see in the financial information. What we see is maintenance capital. Again, we've talked about it being in the $35 million to $40 million we think probably $30 million to $35 million as we've looked now on average over the past couple of years based upon the store side, the fleet we have so forth. And I will tell you of 2012 right now, about $30 million of that is designated being maintenance capital the remainder of that on a net basis is going to go to strategic initiatives as well as stores, visual, what we touch her with and how we make her enjoy her shopping experience. When we look at what we have in an asset base, our depreciation and amortization includes amortization of intangible-type assets which some companies have, some don't and it reflects the acquisition. I would tell you, I think somewhere in the $70 million, maybe $80 million to $90 million max, but not even at that level, depending on the investments we're putting out there is a run rate we would go at and again it depends and how much contribution we get from outside, which in 2011 was really north of $50 million of support. So I think we are running pretty close to that investment level. And obviously based upon what we see here as we put more strategic pilot stores out there and we see the results that'll determine how much more we want to determine will put towards capital versus paying down debt which you know we put a lot of attention on paying down debt and deleveraging over the past 4 years. We brought debt down by over $270 million since the end of 2007 and we'll continue to have that focus and the balance between growing and keeping the leverage at a manageable level.

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

Great, and one follow-up, if I may. I think you've cited that you have seen a little bit lower performance on your private label portfolio, but that was a byproduct of lower volumes. I guess, is this a good run rate going forward? And has the economic motto changed demonstrably versus your previous provider?

Brendan L. Hoffman

Are you talking about credit card or was that the...

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

That is the credit card.

Keith E. Plowman

Yes, on the credit card side, we had a penetration this year that really is running in the low 40s again, which is consistent with what you had in the past. It actually grew this year over last year. It's a very important part to us. We don't see anything changing here. I think we've announced just in the last 60 days that we have a new partner here that's going to be joining us in June. We're very excited about the opportunity that we have and partnering with ADS. And we believe there's substantial growth that we can get in the credit card portfolio. Brendan had mentioned about the next gen, the aged 31 to 50 customer, and we believe we have some good opportunities here to really grow the current credit penetration.

Operator

Our next question comes from Michael Exstein of Credit Suisse.

Michael Exstein - Crédit Suisse AG, Research Division

I, too, want to add my congratulations, Brendan, to your new position. Two quick questions. Can you give me an idea on the number of units where the units are at the end of the year versus the dollars of inventory? And can you give us a more precise impact on the 53rd week? How much of that adds to your EBITDA projection for the year?

Brendan L. Hoffman

At the end of the year, our units were slightly down and we said that our comp store inventory was up 3.3%, heavily weighted in the cold weather categories that we will return to our vendor partners in the first quarter.

Keith E. Plowman

And Michael, this is Keith, regarding the 53rd week, it is close to EBITDA neutral. The 53rd week really does not contribute much of the performance.

Operator

We'll go next to Emily Shanks of Barclays Capital.

Emily E. Shanks - Barclays Capital, Research Division

I had just a follow-up on the gross profit margin expansion forecast for fiscal year '12. I was wondering if you could give me a little bit more detail around what the buckets or the specific drivers are, what you think about that?

Brendan L. Hoffman

I mean, from the standpoint of gross margin, what we see is certainly cost Tony talked a little bit about. We will get some benefit as we go in the second half of the year. But really the big driver here besides improving our performance in some categories we have talked about, the traditional and update and so forth, is the cold weather merchandise. We had disclosed previously that cold weather really knocked us to a negative comp as we look at our December and fourth quarter results. And it did the same thing to us on margin. That is a good margin-type product that we sell. And basically we had to be very promotional in moving that product out. We're estimating in round terms that it's increased or that the impact of it was at least 75 basis points to our gross margin rate in 2011 negative. So we would expect that under normal process operations that we would get that benefit back in '12.

Emily E. Shanks - Barclays Capital, Research Division

Okay, great, that's helpful. And then specific to the footprint, do you have any further store closure plans that we should be aware of for fiscal year '12?

Brendan L. Hoffman

There's nothing that we've announced at this point. We do meet monthly. We've disclosed before that we have real estate committee meetings that we look at our portfolio. I will tell you we're still in that range of the 10 to 15 stores that we've been asked before that are not contributing as we think they should. Obviously, that's still based upon preliminary data. We have not reviewed that with the 2011 results. But we'll continue to review this. We think what was done with the Rochester stores and the other locations we closed in 2011 will benefit us going forward and we'll continue to look for more opportunities like that.

Emily E. Shanks - Barclays Capital, Research Division

Okay. And of those 10 to 15 stores, can you remind me, have you disclosed if those are owned or leased?

Brendan L. Hoffman

We have not disclosed. I don't believe that they are owned or leased. But I will tell you the majority would be leased.

Emily E. Shanks - Barclays Capital, Research Division

Okay. And then just my final question, I know you addressed future debt reduction. Just to be clear, are you still open to further open market repurchases, should the economics suffice/be attractive for you?

Brendan L. Hoffman

I'll answer that by saying we certainly have that opportunity. We did 2 what we thought were very good repurchases. In the fourth quarter, we do have funds that are coming and we disclosed about the signing bonus that we'll be getting here in a couple of months and we'll continue to look at all opportunities as we go forward.

Operator

We'll go next to William Reuter of Bank of America Merrill Lynch.

William M. Reuter - BofA Merrill Lynch, Research Division

You talked about returning some of this cold weather inventory in the first quarter. I'm wondering how that works and whether this will negatively impact your first quarter results. And I guess whether this is typical that your agreements with your vendors would allow you to return inventory that essentially you couldn't sell.

Anthony J. Buccina

Well, at first, it is typical that we do have agreements with our vendor partners on returning cold weather seasonal merchandise. We actually -- it wouldn't have a negative effect on margin if you take that out of our inventory. It would -- we don't have to spend markdowns on eliminating that inventory, so it's not a negative to margin. And it is a typical process.

Brendan L. Hoffman

Yes, Tony is right. As you look at it, the return of the merchandise doesn't impact the gross margin rate. Unfortunately, the loss of those sales because of the unseasonable weather is more the negative issue, but we think we've appropriately accounted for the cold weather merchandise that we had on hand at the end of the year.

William M. Reuter - BofA Merrill Lynch, Research Division

Okay. And then to Emily's question about the 75 basis point decline due to the cold weather, was that just due to the mix because those products have higher margins? Or was -- did you take some markdowns there that added to that 75 basis point number?

Brendan L. Hoffman

That would be both. What we did sell-through there was additional mark down pressure and then what we didn't sell, the lost sales and the margin on that product will be the full mix of that.

William M. Reuter - BofA Merrill Lynch, Research Division

Okay. And then my last question, you commented that sales in the pilot stores with some of these new initiatives have been doing better. I'm wondering kind of how much better these are doing, whether it's a couple of percent better or better whether it's 5% better in terms of the same-store sales.

Keith E. Plowman

Well, the way we're looking at it, and you heard Brendan mention about small stores, Bill, as we're looking going forward, we really did 7 pilot stores and I'll group those as to be a 5 of those were smaller, 2 were larger stores. When we look at the smaller stores, they ran about 700 basis points better than the company trend. And when we look at the larger stores, they ran over 400 basis points better than the company trend. Understand that's for the September through January time frame. That's a small timeframe, but when we looked at the performance in those locations compared to the company, we saw a substantial impact.

Operator

We'll go next to Karen Eltrich of Goldman Sachs.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Brendan, I'm wondering, as you look, I know you've been at the company a short time, but how much of the strategy of what you did at Lord & Taylor do you think is transferable to Bon-Ton? And how would you compare the 2 customers?

Brendan L. Hoffman

Well, I think what's interesting about Bon-Ton that differs from Lord & Taylor and maybe a lot of other department stores, is we have -- here, we have such a wide range of stores and locations that really vary from top to bottom very differently. So I think that at the Bon-Ton, it's really not going to be a one-size-fits-all strategy. We're really going to have to look -- we have 7 different banner names. We have a lot -- we play in lots of different states and small cities. And I think there will be a different tweak to the strategy in certain markets versus others, which I really think is exciting because it gives us lots of opportunities to try things and learn. So I think that's a little bit different from Lord & Taylor. I think that how we're positioning ourselves to the customer will be different than what we did at Lord & Taylor, and I don't want to get too much into the Lord & Taylor piece of it. But I just think that the different malls and locations we're in here opens itself up to a different strategy than Lord & Taylor. Now some of the things we get internally at Lord & Taylor to properly structure and position the company I think have merit here and we can talk about that in a later date as well.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

I guess building a little bit into that, do you do you view the localized banners then as an advantage? Or do you view it as a challenge?

Brendan L. Hoffman

Well, I think it's a little bit of both. I mean, I think it might be a slight challenge when you're talking about an eCommerce business. But I think when you're talking about the brick-and-mortar side of it, I think it's a great opportunity to stay in touch with the local customer there. And as I've gotten out to some of these different banners that I have visited before, I'm getting a new appreciation of the importance of a nameplate to that local customers. So I think net-net, it's a positive. So I don't anticipate making any dramatic changes to the different banner names. And we'll just have to continue to work around that to make sure we're maximizing the opportunity online.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Great. And with regards to vendor relationships, that was something that, it seems to me that you brought to Lord & Taylor. As you look at the kind of product offerings at Bon-Ton, do you think there's room for improvement there? Is there an opportunity where you can bring again some of your own historic relationships to expand product offerings?

Brendan L. Hoffman

Well, I've been there, I hope so, to a certain extent in the sense that there's always room for improvement here and that I'm sure that the team that replaced me is looking for ways to improve as well. So I think Tony and his team have done a great job in terms of the relationship with the vendors. I mean, I was really struck when I took the job, all the phone calls I got from the largest vendors pledging their support to the Bon-Ton both past, current and future. So I hope I can only add and strengthen to that. But I think that, that's the foundation here in terms of the relationship with vendors is very strong which I was very pleased to see.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Great. And final question, you guys mentioned that you are open to new stores. I mean, how much opportunity is there in terms of development? Will this be in existing malls? And also maybe you can give us a sense for how much the remodels are costing.

Anthony J. Buccina

All right, I'll try and run through your question there. It was quite a list. We believe there is opportunities but we will tell you that we will vet those out very thoroughly to make sure that they are strong opportunities, and that we invest the capital in the appropriate place. Certainly, doing organic growth is key to us. Brendan has mentioned many opportunities we have here and he's excited about this and the organic growth certainly gives the best growth, gives the best profitability. So we will take that into consideration. But there are many opportunities that come out. It's a matter of determining which one is the optimal one and moving that direction. From this standpoint, let's see what else were your questions here?

Karen Eltrich - Goldman Sachs Group Inc., Research Division

It was only 2. The second question was the cost of the remodel.

Brendan L. Hoffman

Okay. Well, the cost of the remodel depends on what we do. I thought you had 3 there. It depends on what we do there from the standpoint of whether it's just paint and carpet, all the way up to a very strong remodel. So it can be anywhere from $10 to $70 per square foot.

Brendan L. Hoffman

This is Brendan again. Just to add on to what I was talking about before. I do think, as I compare and contrast my previous life, where there's a big opportunity here to learn from what we did previously is on the marketing side. I think some of the new media side in terms of reaching the customer through new channels. I think that can be something that can both drive sales for us and reach out to a new and younger customer.

Operator

Our next question comes from Karru Martinson of Deutsche Bank.

Karru Martinson - Deutsche Bank AG, Research Division

When you guys look at more than half of your portfolio in kind of smaller niche markets, I'm trying to reconcile that with prior company statements that Kohl's and JCPenney's are in somewhere around 80% of your markets. Is it just that there's only one of them that you're going up against? Or how should we look at that competition angle?

Brendan L. Hoffman

When you look at Kohl's and JCPenney, they are in, we've always said closer to 90 plus percent of our market. It's Macy's where we overlap less somewhere in the 50% range. So it is the matter of -- we look to see whether there's one. It doesn't matter if it's both in the markets where they are, but we consider that competition at that point. But you are in the 90% range.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. Then on the cumulative break to gift cards, going forward, we should not expect kind of a $6.5 million, there will be some sort of number, but it will be significantly less.

Brendan L. Hoffman

You definitely should not expect $6.5 million that will be less. And I will tell you that something to become the company can be comfortable and sitting here and telling you that would be income versus expense. Again, as I was trying to articulate earlier, this is really a very technical- it's a legal landscape type issue and question, and things develop and change substantially year-over-year. Again from 2008 to 2011, there was substantial changes that triggered us recognizing this breakage here. Prior to that, we had deemed that we should not recognize anything. So we'll continue to evaluate, we will certainly share as we learn more. But it's something that we all have to see what transpires over 2012.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. Just on that competitive landscape, I mean, how much do you guys overlap with Sears?

Brendan L. Hoffman

To be honest, I don't know. Tony?

Anthony J. Buccina

We don't really look at that. I mean, we don't really look at Sears as overlap. We really look at our overlap with really, JCPenney and Kohl's. As well as Macy's.

Karru Martinson - Deutsche Bank AG, Research Division

And then from a housekeeping's perspective, how should we think about cash taxes for 2012 going forward?

Brendan L. Hoffman

Based on where we are now and with the signing bonus the we had mentioned earlier, we believe that will start entering into a cash tax position as we get through the end of this year. So I would expect that the 39% rate that we threw out there somewhere relative, that should be the correct number.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And just lastly, you guys have a major refinancing coming up in 2014. Are there any early thoughts on how you guys will be approaching that?

Brendan L. Hoffman

I mean, there's nothing specific that we reported at this time. The Senior Notes do have, as you noted there, about 2 plus years to maturity. We continue to investigate the options and timing. Our primary focus right now is on our strategic initiatives and improving our performance and being positioned to launch our refinancing when it's appropriate. So we believe there's time. We have strong excess capacity, our financial position is solid and we believe that will benefit by the 2012 cash flow and we will continue to evaluate what's the right opportunity and time as we go forward.

Operator

We'll go next to Carla Casella of JPMorgan.

Carla Casella - JP Morgan Chase & Co, Research Division

A couple of clarifying questions on your guidance. The free cash flow guidance of -- does that include the $50 million payment you'll get for the new credit card agreement from ADS?

Brendan L. Hoffman

It does include that. It also includes the pension payment contribution. Those are both noted in our press release, Carla.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. Fine with that. And then you mentioned that SG&A should be up for the year, and half of that is related to fourth quarter. Is there a timing issue for the other part of that increase? Is it a first or second because of additional, the community event? Or should it be pretty evenly spread?

Brendan L. Hoffman

The biggest thing will be the 53rd week, which obviously, as you said, is the fourth quarter and comes at the end of the year. The rest of it, we feel we have opportunities that you'll see more. I would say some of the opportunities that we're identifying now will come more in the second quarter forward. But otherwise, timing, they should run consistent through quarters.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. And then on the new stores that you're taking the pilot program and expanding it to, were they as badly underperforming prior as the Lehigh Valley stores? Or now are you going to a tougher store comparison base?

Brendan L. Hoffman

I don't know that I would call it a tougher store comparison base. I think that we're looking at all opportunities and the locations, and we'll continue to assess based on the criteria of the different markets.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. Are they clustered in a certain market or market by market or...

Brendan L. Hoffman

I mean, I think from a standpoint of what we're doing is we're looking at the opportunities and location, certainly looking at the sales trend over the last 4 years since the acquisition. But we're also looking at what we believe we can do with the merchandise mix. We're looking at whether we feel a market is underserved. I mean, think there's multiple criteria that we look at as we try and determine where we should go.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. I guess I was just wondering for the next 30 or so stores, where should we go to see them, assuming that the Lehigh Valley, that's where you got some, where's the next batch?

Brendan L. Hoffman

You're going to be looking at Minneapolis. You're going to be looking at Indiana -- I'm sorry, Indianapolis. You're going to be looking at Minnesota. I mean, is where we're going to really attack the spring season.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. Great. And then you mentioned that you expect to get -- your hope is to get online to be 5% of your sales as the target. What is it today as a percentage of your sales? Is it less than 1% to 2% or...

Brendan L. Hoffman

As we're seeing today, we're in the mid-2% range.

Operator

Our next question comes from Rishi Parekh of Sterne Agee.

Rishi Parekh - Sterne Agee & Leach Inc., Research Division

I'm not sure if it's too early, but are you seeing any customer pushback with your price increases for the first half?

Brendan L. Hoffman

We really are not right now. And we really only have 5 weeks of the season. We were actually quite pleased with the spring selling we had in the February period with a much milder weather pattern. I mean, we found color, was really driving a lot of the apparel as well as the accessory and handbag business and shoe business.

Rishi Parekh - Sterne Agee & Leach Inc., Research Division

Okay. Now with regards to the pilot stories, outside of the incremental increase you've seen in sales, can you maybe quantify what you've seen in terms of margins from a contribution standpoint or, I mean, versus the average store?

Brendan L. Hoffman

I think at this point being that it was a 5 month stay, we're really not ready to share that kind of information. Being it was a pilot, and we're moving more out, we're very pleased with the results we've seen. I'll leave it at that. And as we go forward, we think we'll be able to share more. But 7 stores for 5 months just isn't enough to take out as any kind of absolute evidence.

Rishi Parekh - Sterne Agee & Leach Inc., Research Division

And can you detail what banners you're focused on with these pilot stores?

Brendan L. Hoffman

I don't think banners is part of the focus. Quite frankly, we look at it as where we have better markets that we could address. And banners is not something that we really put into that.

Operator

Our next question comes from Todd Harkrider of UBS.

Todd Harkrider - UBS Investment Bank, Research Division

I just want to extend my congratulations to Brendan on the announcement. But Going back to the competitive theme and switching from the small markets to some of the larger markets, can you talk about more the weakness in Chicago? I know it was weak in late 2009 and again in late 2011. Do you contribute that more to the competitive activity like My Macy's initiative and Ross' entry into Chicago lately? Or do you think it's more execution misses and/or the economy there?

Brendan L. Hoffman

I would say we get a lot of the competitive information that we have from our vendors in that market. And we do not see the drastic market share losses. And we look at that in a bunch of our families of business. And Chicago is our probably our most highly competitive market. And we continuously see new entries and exits out of that.

Todd Harkrider - UBS Investment Bank, Research Division

Okay. And in regards to the same-store sales inventory being up 3.3%. Are you assuming all that back to the vendors? And if you can talk a little bit more in regards to the just the overall inventory and payables level? Now on the 2-year basis, inventories are up 6% and sales are down too and that's obviously boded your payables up for like 26% increase over those 2 years. So any color regards to working capital in '12 would be helpful. And if you think it's achievable to get inventories and payables back in line? Or are you comfortable with where they're at kind of today being above 2009 levels?

Brendan L. Hoffman

Well, first on the inventory being up is that all returnable, no, it's not all returnable merchandise. Some of it is investment that was put in there as we're moving into strategic doors. Some of that would be investment that is put in for eCommerce for the growth we're looking for. Some of it is definitely cold weather. There's a portion there that we're going to sell-through. There's a portion that we'll return which is substantial compared to the prior year. So those would all be factors. As you look out from a standpoint of our AP support inventory, where we believe we are at the end of 2011 is where we were pre the great recession and the acquisition and actually might even have a little bit more room in the accounts payable. But right now, what we see is strong support from our vendor partners and that we think that where we are is AP to inventory support is where we would like to be as we go forward.

Todd Harkrider - UBS Investment Bank, Research Division

Sounds good. And quickly on -- do you pack away items or do you clear it out each year or return the rest of it each year?

Brendan L. Hoffman

We do not pack away any items.

Operator

We'll go next to Colleen Burns of Oppenheimer.

Colleen Burns

On inventory, private brands inventory, was that up on a comp basis heading into the first quarter?

Anthony J. Buccina

Slightly but not up more than the company.

Colleen Burns

And then just on marketing. You talked about marketing being a priority in 2012. Do you plan to have more marketing events? Is it similar to last year? How should we think about that in '12?

Keith E. Plowman

I don't think -- it's not more marketing. We're certainly not -- we're going to try and leverage our expenses throughout the company. But I think it's just -- it's refreshing marketing and recognizing that the world has changed and shifted and customers are getting their information in different ways now, some of which are much more efficient than the old media and trying to make sure we're playing in all channels, freshening up events, taking events that are bigger for other stores like friends and family which have been under penetrated here and making those more important. So I think it's a combination of things that we will test and implement over the course of the balance of the year and beyond.

Colleen Burns

Okay. So you're not actually adding more events this year?

Brendan L. Hoffman

No. I mean, I think we're pretty saturated with the amount of events. I think it's just the way we can re-spin them to make them more effective and meaningful.

Colleen Burns

Okay. And then I guess just on your free cash flow guidance for the year, what are you assuming for working capital this year?

Brendan L. Hoffman

We do not see a lot of change in working capital. Back to the question on AP to inventory, we are at this point saying we will keep inventory levels on a consistent basis year-over-year as well as AP support.

Colleen Burns

Okay. And then just lastly, Brendan, as you look at the opportunities there, what do you see is the biggest challenge for the company this year?

Brendan L. Hoffman

I think it's -- whenever you have declining comps, you just you want to get it pointed in the right direction. And until you do, until you see the customer responding, I think that's always going to be a challenge. We were pleased with our February results. And again as I look outward, I think there's opportunity -- I know there's opportunity here. And I wish I could just -- we'll never move as quickly as I would like to and I think that's a big part of motivate -- not motivating, but getting the organization to move as quickly as I want to, whether it's with the pilot stores or just implementing things elsewhere just to see how the customer responds.

Operator

We'll go next to Jason Jacoboni [ph] with Bank of America Merrill Lynch.

Unknown Analyst

Just to clarify, with the 75 basis point negative impact from cold weather for the full year, or is that just the Q4 impact?

Brendan L. Hoffman

That's the full year impact. As you saw, we were down substantially in the fourth quarter well above that number.

Unknown Analyst

Okay. So it sounds like if you sort of -- you could probably figure it out, but it sounds like it would be the bulk of the margin impact in Q4.

Brendan L. Hoffman

It will be a substantial piece. I don't want to say it's the bulk or not. But it is a big piece.

Unknown Analyst

Okay. And then my other question is you mentioned that you put some additional marketing spend behind the pilot stores. Is that a one-time deal to drive awareness? Or did you continue the higher marketing spend in those locations to help you drive the outperformance that you discussed before?

Brendan L. Hoffman

Well, I mean, I think that whenever you have a new initiative, you got to get behind it and overinvest a little bit. But that would be something that would moderate over time. And as hopefully, it moderates in a percent to the total sales. But as the sales grow, it allows you to keep up the absolute dollar spend.

Operator

Thank you. I'll now turn the conference to Brendan Hoffman for closing remarks.

Brendan L. Hoffman

Thank you all again for your questions and your interest in our company. We look forward to speaking with you about the financial results of our first quarter 2012 on our conference call in May. As a reminder, Keith and I will be presenting at Bank of America Merrill Lynch's 2012 Consumer and Retail Conference tomorrow. Our presentation is at 10:30 a.m. Eastern time and will be webcast at bonton.com. Thank you again for joining us this morning.

Operator

This does conclude today's conference. Thank you all for your participation.

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