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The Bon-Ton Stores (NASDAQ:BONT)

Q3 2007 Earnings Call

November 29, 2007 10:00 am

Executives

Tim Grumbacher - Executive Chairman of the Board

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

Keith E. Plowman - CFO, Executive VP-Finance, Principal Accounting Officer

Anthony J. Buccina - Vice Chairman, President-Manufacturing

Analysts

Grant Jordan - Wachovia

Kerrie McInerney - Banc of America Securities

David Glick - Buckingham Research

Michael Einstein - Credit Suisse

Paula Kolavia - Broadway Capital

James Food - The Food Corporation

Emily Shanks - Lehman Brothers

Reid Ken - Merrill Lynch

Analyst - Deutsche Bank

Gretchen Haley - J.P. Morgan

Colleen Burns - CIBC World Markets

Robert Wright - Centurion

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to today’s Bon-Ton Stores, Inc. third quarter 2007 earnings conference call. (Operator Instructions) I will now turn the conference over to Mr. Joe Seclich with ICR. Please go ahead, sir.

Joe Seclich

Thanks. Good morning. Welcome to Bon-Ton’s third quarter of fiscal 2007 conference call. Mr. Bud Bergren, President and CEO; Mr. Tony Buccina, Vice Chairman and President-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 from the company’s Web site at www.Bon-Ton.com. You may also obtain a copy of the earnings release by calling 203-682-8200. Before we get started, I would like to remind you of the company’s safe harbor language, the statements contained in this conference calls which are not historical facts may constitute forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995. Actual future results might differ materials from those projected in such statements due to the number of risks and uncertainties, all of which are described in the company’s filings with the SEC. As a reminder, this call is being recorded, Thursday, November 29, 2007. At this time, I’d like to turn the call over to Mr. Bud Bergren, President and CEO.

Byron (Bud) Bergren

Good morning and thank you for joining us this morning. I will begin with my comments on the third quarter and a perspective on where we are year-to-date. I will then comment on the outlook for the fourth quarter of the year. Keith will then provide details of the third quarter financial results and will update financial guidance for 2007. Tony will review the third quarter merchandise results and discuss the merchandising initiatives. I will make closing remarks and then we’ll be available to address your questions.

Our August comparable store sales were positive with good sales results from our semi-annual home sale and back-to-school promotions. We were also getting early indications of favorable customer response to our fall merchandise assortment. Then, September and October began and became more challenging as the deterioration of the macroeconomic environment and the unseasonably warm weather negatively impacted our comparable store sales in both months. Consequently, our third quarter EBITDA and net income results were below our expectations. For the third quarter 2007, we reported a net loss of $19.4 million or $1.17 per diluted share compared to $0.66 loss per share or $10.9 million for the third quarter of 2007, an $8.5 million different. Our gross margin rate in the third quarter of 2007 was 34.8 reflecting increased markdowns and fuel costs during the quarter. EBITDA decreased $12.1 million in the third quarter to $31.4 million.

We are confident we are taking the right steps on the merchandise front. We delivered strong performance in furniture, home, better missy sportswear, cosmetics, and children’s reflecting that our customers are responding to our merchandise offerings. We are confident that, while our customers may be tightening their wallets temporarily, we are providing the merchandise offerings that meets their needs. We will continue to manage our inventories in accordance with the softer retail demand, but still flow fresh merchandise into our assortments where appropriate.

We were also successful in controlling our expenses without sacrificing service levels in our stores. We have strengthened our promotional calendar to attract our customers throughout this important holiday season. As we mentioned in our earnings released, we are pleased with the results so far. At the Bon-Ton Store, specifically, we saw an increase in average price during the third quarter. In addition, the Bon-Ton Stores continued to achieve a penetration rate in excess of 50% to Carson’s sales. The number of credit card loyalty customers for the combined company grew year-to-date. Furthermore, we increased the level of private brand penetration at both Bon-Ton Legacy Stores and Carson’s.

In summary, we cannot control the economy or the weather, but we can position ourselves to operate efficiently in a challenging environment by carefully monitoring our inventory levels and controlling our expenses and continuing to provide our customers with a great merchandise assortment at a value. Tony will provide you with more details on the merchandising, marketing, and store strategies.

We are encouraged by the improvement in our business since the beginning of November when the arrival of seasonable weather had a positive impact on our sales. Our two major promotions in November performed well. Community Day had our largest sales increase to any prior Community Day and the Day After Thanksgiving was a record-breaking day. We believe our reported comparable store sales for November will be in the positive high single to low double digits. We will continue to plan and manage our business prudently to take into account the overall environment.

I would also like to mention that we kicked off our eCommerce Web site on October 15. We are six weeks into this initiative and are very pleased with the results so far. I would like to invite all of you to visit the site under any of our seven nameplates. In fact, buy something while you’re there. We see this as another exciting opportunity to increase top line growth in the future.

Looking ahead to the remainder of the year, we are managing our expenses carefully assuming a continuation of the current retail climate. At the same time, we are also moving forward with our initiatives by refining our merchandise offerings by market and continuing to differentiate our merchandise mix with national and private brands and offering strong marketing and promotional events that appeal to our target customer. We will continue to implement phase III of our systems integration which includes system enhancement in a three-year rollout of our POS systems in the Carson’s stores.

When we bought Carson’s in March of 2006, we had a two-year integration plan. Today, after twenty months, we have the same plan with the same optimism and enthusiasm about the potential of the combined companies. So while there has been a bump in the road during 2007, initial plans and the timing of the integration remains on track.

I would now like to turn the call over to Keith. Keith?

Keith E. Plowman

Thank you, Bud, and good morning everyone. The third quarter started with a positive August sales performance, but then was challenging as a combination of unseasonable weather and a difficult retail environment in September and October fractured our comparable store sales and gross margin rate performance resulting in third quarter EBITDA and net income coming in below our expectations. I will review the income statement components, some key balance sheet numbers, and then discuss the revised full year of fiscal 2007 guidance and the assumptions reflected in our updated guidance.

Before getting into the financial details, I want to emphasize we remain on track to achieve to exceed the incremental cost savings we laid out in the beginning of the year. We believe we have an appropriate debt structure in place. Our excess borrowing capacity was $254 million dollars at the end of the third quarter which was $6 million above the prior year comparable quarter and $179 million dollars above our required covenant of $75 million dollars. And we expect to pay down debt with the cash generated by the business in the fourth quarter.

For the third quarter of fiscal 2007, total sales decreased 2.9% to $780.8 million dollars. Bon-Ton and Carson’s combined comparable store sales for the 13 weeks ended November 3, 2007, decreased 3% compared to the prior year 13-week period. Total year-to-date sales increased 5.4% to $2,227.0 million compared to $2,112.7 million for the same period last year. This year includes 13 weeks of Carson’s in the first quarter of fiscal 2007 compared to 8 weeks of Carson’s operations in the first quarter of fiscal 2006. For informational purposes, combined proforma year-to-date comparable store sales approximated a 3.2% decrease.

Other incomes increased $1.8 million to $24.6 million in the third quarter of fiscal 2007 primarily reflecting increased sales on our proprietary credit card and the program revenue received under the program agreement with HSBC Bank. For the nine-month period ended November 3, 2007, other income increased $11.8 million to $69.4 million.

Gross margin dollars in the third quarter decreased $22.2 million compared to the prior year period. The third quarter gross margin rate decreased 1.8 percentage points to 34.8% of net sales as compared to 36.6 % in the prior year period. The decrease in the gross margin rate primarily reflects increased markdowns and delivery and fuels costs. The increased markdowns reflect some acceleration of markdowns for the last week of October of the third quarter.

Year-to-date gross margin dollars increased $23.0 million compared to the prior year period. The year-to-date gross margin rate decreased 0.8 percentage point to 35.4% of net sales as compared to 36.2% in the prior year period. The year-to-date gross margin rate reflects the negative margin impact of the sales for the first five weeks in the first quarter of fiscal 2007 in Carson’s stores which were not included in the first quarter results of fiscal 2006, increased markdowns, and higher delivery and fuel costs. We have adjusted the carrying costs of the inventory to what we believe is a reliable value at the end of the quarter.

SG&A expenses in the third quarter of 2007 decreased $8.3 million to $265.3 million. The SG&A expense rate of 34% was even with the prior year period. Cost savings in the quarter in approximately $7.0 million. Year-to-date SG&A expenses increased $49.2 million. The increase in SG&A expenses are primarily attributable to the inclusion of the first quarter of fiscal 2007 of 13 weeks of Carson’s operations as compared to only 8 weeks of Carson’s operations in the prior year period. The SG&A expense rate was 35.1% as compared to 34.6% of sales in the prior year period. Year-to-date integration expenses approximated $4.7 million.

EBITDA earnings before interest, taxes, depreciation and amortization for the third quarter of fiscal 2007 decreased $12.1 million to $31.4 million compared to $43.5 million for the prior year period. EBITDA is a non-gap term. For reconciliation of EBITDA to net loss, please refer to our earnings press release. Year-to-date EBITDA decreased $14.4 million to $76.9 million as compared to $91.2 million for the prior year period.

Depreciation and amortization expense, including amortization of lease-related interests, in the third quarter of fiscal 2007 increased $1.8 million to $31.4 million as compared to $29.6 million in the prior year period. Year-to-date depreciation and amortization expense increased $14.5 million to $91.1 million compared to the prior year period. The increase in year-to-date depreciation and amortization expense are primarily attributable to the inclusion in the first quarter of fiscal 2007 of 13 of Carson’s operations as compared to 8 weeks of Carson’s operations in the prior year period and the increased expense associated with prior year capital expenditures.

Interest expense, net, in the third quarter of fiscal 2007 decreased $500,000 to $27.4 million compared to the prior year period. Year-to-date interest expense, net, increased $3.2 million to $82.3 million as compared to the prior year. The increase in year-to-date interest expense is primarily attributable to the inclusion of the 13-week period of Carson’s operation as compared to 8 weeks in the first quarter.

In the first quarter of fiscal 2006, the company recorded a charge of $6.8 million reflecting the write-off of fees associated with a bridge facility and the early payoff of the company’s previous debt.

The net loss in the third quarter of fiscal 2007 was $19.4 million or $1.17 per diluted share as compared to a net loss of $10.9 million or $0.66 per diluted share in the prior year period. For the first nine months ended November 3, 2007, we reported a net loss of $63.6 million or $3.86 per diluted share compared to a net loss of $41.5 million or $2.53 per diluted share for the comparable period last year.

Moving to some key ratios and balance sheet amounts. We have strong balance sheets and we believe we will generate cash flow in the fourth quarter to pay down debt. Our working capital increased to approximately $550.1 million compared to $442.2 million last year, an increase of 24.4% or $107.9 million. The comparison is impacted by the calendar shift between the years.

Merchandise inventories at cost increased $92.4 million or 9.8% compared to the last year primarily reflecting higher plans inventory balances due to the shift in calendar and an increase in the accrual for in-transit and import merchandise reflecting elimination of the transition services agreement and, as previously noted, this proves up by year end.

Retail inventory for comparable stores on a shifted basis increased 0.5%. This would be comparing our third quarter end inventory to the November 2006 week one inventory.

Total debt to total capitalization, including capital leases, was 83% at quarter end compared to 84% in the prior year period. Total debt, including capital leases, was $1,368.6 million at November 3, 2007, compared to $1,334.0 million in the prior year period. We have $100 million of slots and our fixed rate debt to funded debt was 67% at the end of the quarter.

Our outstanding letters of credit were $13 million at quarter end this year versus $21 million at quarter end in 2006. And our excess borrowing capacity was $254 million compared to $229 million at the end of the second quarter 2007 and $247.6 million for the third quarter of fiscal 2006. A covenant in our revolving credit facility carries a $75 million minimum requirement. As of yesterday, our current excess capacity continues to exceed the prior year.

Moving to guidance for fiscal 2007, this is a very difficult retail environment to provide economic guidance for the fourth quarter. Based upon our performance to date through November and what we have experienced, our update to guidance is as follows: We now expect fiscal 2007 earnings per diluted share to be in the range of $1.50 to $1.80 per share and EBITDA to be in the range of $272 million to $280 million.

Assumptions reflected in our revised full year fiscal 2007 guidance include:

– Reduced the total sales growth to an increase of 1.3% to 1.7%;

– Reduced comparable store sales to -1.9% to -2.2%; and

– Reduced the gross margin rate to a range of 36.4% to 36.5%.

Our revised guidance includes the expectation that the retail environment will continue to be promotional through the holidays and we will continue to manage our inventories and expenses accordingly. We believe we have implemented the right strategies and are managing our business to deliver sustainable long-term sales and earnings growth.

Our Form 10-Q for the third quarter of fiscal 2007 will be available by December 13.

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

Anthony J. Buccina

Thanks, Keith. The third quarter started out terrific with both our semi-annual sale and back-to-school promotions performing really well in August. But unseasonably warm weather in September, duplicated in October, slowed down our sales momentum. This is usually when our cold weather categories kick in as they did in the prior year, but this year they did not. Despite the disappointing results, we have the right strategy in place to drive long-term sales growth and profitability for our company. We believe this is evidenced by some of the successes in the third quarter that I’d like to comment about.

Franchise businesses outperformed total store sales and increased as a percent of our total store sales. We’re thrilled with the performance of our key item strategy penetrating at slightly over 22% of our total store and our IVP (Incredible Value Program), our most profitable key item program, penetrating at almost 6% of total store. We continue to advance the ball and growing our unique product penetration, growing over 3 percentage point to total store. That came through growing private brand penetration to 18.7%, an increase of over 2 percentage points over the prior year period and domestic unique brands and product grew to 15.4% of total store from 14.5% in the prior year, an increase of 0.9 of a percent.

Our best performing businesses in the third quarter were furniture, hard home, better missy sportswear, cosmetics, and children’s. Our poor performing categories were missy and men’s outerwear, juniors, accessories, men’s furnishings and moderate sportswear. We advanced the ball on moving Bon-Ton Stores average price closer to that of the Carson’s stores. The average selling price went to 82% versus 76% in the third quarter versus the prior year period. I’m thrilled with our progress in growing the average price in the Bon-Ton Stores in coats, large-sized sportswear, intimate apparel, accessories, shoes, men’s, and home.

Our Northern Lodge strategy which are tailored assortments for those stores with a more casual outdoor lifestyle produced a better sales performance than the non-Northern Lodge Stores and at higher margins. When we looked at our business in sixteen merchandise categories, our Northern Lodge Stores had better sales performance than the non-Northern Lodge Stores in 15 out of 16 of those categories. The customers in our Northern Lodge Stores responded favorably to the way we’re talking to her with our lifestyle merchandise.

Our retail inventory at the end of the third quarter on a shifted basis was up five-tenths over the prior year period. We continue our strong discipline inventory management to trend and maintain an assortment fresher than the prior year going into the fourth quarter.

Here’s what’s happening most recently looking at November sales to date. I would say that the biggest change that we’ve seen is that cold weather merchandise was down double digit in the third quarter. And since the weather got colder at the beginning of November, there was a significant turnaround in cold weather categories and a few examples of that are: missy and men’s coats, missy and men’s cold weather accessories, flannel sheets and home, just to mention a few categories that are improving in sales. You cannot underestimate the impact of weather and the importance of cold weather merchandise on our business.

We had record-breaking days on our two larges days in November: Community Day and our After-Thanksgiving Sale. Our merchandise marketing and store initiatives are firmly in place for the remainder of the fourth quarter. We’re ready to compete and take our share of the holiday business. We’re focusing on what we can control, telling our merchants to get the right goods at the right price and having over 33,000 associates in merchandise, marketing, and stores organization focusing on execution. Our associates are focused on making it happen to execution. People make it happen and that’s what our people are focused on--execution. We have close-knit business relationships with the best of class vendors throughout all merchandise categories that understand our company strategy for the long term and support our strategy. They appreciate the fact that we deal with them fairly and will respect.

The most important season of the year is the fourth quarter and I will say it again. We have the right strategy, the right goods, the right prices, and the entire organization is focused on execution. This is a long-term story not based on one month or one quarter and we’re in the early chapters. We remain committed to executing our merchandise strategy to grow our franchise businesses, strengthen our key item strategy, continue to increase our differentiation in merchandise from our competition by growing our private brands, our exclusive brands, and exclusive merchandise from competitive domestic brands. We grow our market specific strategies, Northern Lodge and City Stores, increase the Bon-Ton Stores average selling price to more close mirror the Carson’s Stores average selling price, and explode or eCommerce business. To date, we’ve had solid results in home, ready-to-wear, children’s, shoes, check items, and our gift cards.

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

Byron (Bud) Bergren

Thanks, Tony. While we recognize we are currently operating in a difficult retail environment, Bon-Ton’s long-term plan is intact and we are confident in the long-term potential of the company. We remain on track to achieve our targets as the relate to the integration of Bon-Ton and Carson’s which we believe will ultimately deliver significant shareholder value. At this time, we will open the floor for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We’ll take our first question from Grant Jordan of Wachovia.

Grant Jordan - Wachovia

Good morning. Thanks for taking the question. I was wondering if you could give us a little more color on the gross margin decline in Q3. I think you said that there was some markdown. I just wanted to know how much that contributed to the decline.

Keith E. Plowman

Let me tell you what happened. The margin in the third quarter really came from two issues. One was that the reduction of the cold weather categories or winter merchandise really didn’t sell the way it did last year in the months of September-October. That was a big one. Those are high margin categories for us. The second was to match the current calendar, we shifted markdowns from week one November to the last week of October this year to match the calendar. Both of those contributed to the decrease in the margin rate. I would tell you that the margin dollars in the drop in October from the prior year, over 80% of that was really due to the drop in cold weather sales.

Grant Jordan - Wachovia

Great. That’s helpful. Looking at your updated guidance, I mean, I want to kind of back into the Q4 numbers. Despite the 13-week versus 14-week comparison, it looks like you’re calling for EBITDA to be up year-over-year. Obviously, you’ve got one month under your belt. Just give us a little more color on why you’re confident you’re going to see the numbers play out that way.

Keith E. Plowman

Based upon what we have on the year-over-year comparisons, we’ve looked at what we’re doing to expenses in the environment that we have sales declining. We feel that the gross margin will hold on a dollar basis fairly close to the prior year, you know, depending on where sales are at it could actually be at a lower rate and, dependent on where sales are at, it could be a slightly higher rate, but close to the same rate. And this references back to what Tony was talking about where there is some shift in the calendar for markdowns taken on the merchandise. Then, as you look down to the expenses in this type environment, the company is continuing to realize what it has it integration reduction in the additional cost savings that we have projected out there and we actually think that we’re going to trend a little bit higher than what we had put out in our original guidance on the cost savings. And then, finally, you go to the expenses that we’re eliminating in the business because it is a difficult retail environment. The combination of all those, as we did in this quarter, will drive the SG&A expenses down below the prior year. As you look at the third quarter, we’re down about $8 million from the prior year in SG&A expenses and that’s after you take into account the inflation which would’ve increased our SG&A on a year-over-year basis by several million dollars.

Grant Jordan - Wachovia

Right. That’s very helpful. And my final question. Maybe you could just give us kind of the dollar magnitude in terms of the shift in markdown dollars?

Keith E. Plowman

We’re really not providing that piece.

Grant Jordan - Wachovia

Okay. All right. Well, thanks for taking the questions.

Keith E. Plowman

Thank you.

Operator

Okay. Next Dana Cohen with Banc of America Securities.

Kerrie McInerney - Banc of America Securities

This is Kerrie McInerney for Dana Cohen. I wanted to asked just a couple of questions. One, on the gross margins, can you give us any sense of how the trends were between the two businesses, the core Bon-Ton and the Carson’s business? And then, on the inventory, I think you had said recently those were planned flat in the quarter, so could you talk about maybe how you got from there to where you ended up? And, if you did mark it down, could you talk about what the increase was in unit setting into Q4?

Keith E. Plowman

Okay. Let me take your first two questions and then I’ll turn it over to someone else to answer. Looking at what happened in the quarter as far as what we did in inventory, essentially, what we have, Kerrie, is we do have a shift in the calendar. When you look at what we ended this year would’ve been the first week of November of the prior year and when you look at that, we do have a shifted inventory impact. We looked at what are purchases were, our receipt of the inventory in that week versus sales, and on a costed basis, that would’ve been in excess of $60 million of increase to our inventory on a shifted basis year-over-year.

Kerrie McInerney - Banc of America Securities

So that guidance is on a shifted basis? The guidance that you had given when you said slide at the end of the quarter, that was on a shifted basis? That incorporated the calendar shift?

Keith E. Plowman

Yes, it did.

Byron (Bud) Bergren

It was comparable. Yes.

Keith E. Plowman

Yes. I needed to look to Bud on that to be sure, but yes, it was.

Byron (Bud) Bergren

It was comparable which is shifted.

Kerrie McInerney - Banc of America Securities

Okay. Okay. And then, on the gross margins, do you have any color by business?

Keith E. Plowman

Yeah. On the gross margins by business, Kerrie, because we collect all our activity into a consolidation now. All purchases are done combined and consolidated, we really can’t track anything but the top line sales and even that’s starting to lose color now because we’re moving companies between the vision. So we’ll report the sales separately through the end of this year then that will be gone and everything will be reported as one company. I really can’t give you color. We deal with vendors for all the businesses on the same basis, so there’s nothing that separates the two.

Kerrie McInerney - Banc of America Securities

Okay. And then one last question. Are you still looking at $106 million for cap ex for the year and can you tell me where you are to date?

Keith E. Plowman

On capital expenditures to date, we’ re sitting at about $82 million and I would expect we’ll be a couple million dollars below that by the end of the year, but we’ll be close to it, a couple million down.

Kerrie McInerney - Banc of America Securities

Great. Thank you.

Keith E. Plowman

You’re welcome.

Operator

Next, we have David Glick from Buckingham Research.

David Glick - Buckingham Research

Yes. Good morning and congratulations on the great start to November. A couple of follow ups. A lot of my questions have been asked already. But in terms of the gross margin, I think you walked through the impact of the calendar shift, I’m wondering if you have any IMU benefit that gives you a little bit of a cushion in your gross margin as your private label penetration goes up and you have more buying power as a bigger company?

Keith E. Plowman

We do, David, but we also have--you know, it’s still a little over 18% of our total, so it does improve a little bit through that amount of mix.

David Glick - Buckingham Research

So just you’re working on a slight IMU benefit versus last year?

Keith E. Plowman

Right. I think in the private brand, David, yes, we did get some benefit on a net basis for the IMU for the private brand.

David Glick - Buckingham Research

Okay. And then, Keith, have you quantified or can you quantify the impact of the 53rd week from an SG&A cost savings? I mean, when looking at the SG&A dollar decrease in the fourth quarter and apply it to about a 10% decrease and I think we’re all just trying to get a comfort level that we can model it that way and to the extent that you can quantify part of it or all of it, obviously, that would be a big benefit.

Keith E. Plowman

We have not quantified that piece out, David. I will tell you what the company is targeting itself for as we’re trying to maintain our SG&A rate on an annual basis to comparable to last year even though we have lower sales. So that’s what we’re trying to push ourselves to and I think that should allow everyone to sort of work back the number.

David Glick - Buckingham Research

Got it. Okay. And can you give us your estimate for interest expense for the year?

Keith E. Plowman

I really don’t have a lot of change. I think on interest, if you wanted to take where you were sitting at through the first three quarters and, essentially, average that out, you’re going to be close. And it would be the same on depreciation. We don’t see a whole lot of change. The purchase accounting now is behind us, you know, the only thing that really impacts those items is the operations within the fourth quarter and I don’t see a whole lot that would change that significantly.

David Glick - Buckingham Research

And can you give us an estimated range of how much debt you (inaudible) down in the fourth quarter?

Keith E. Plowman

We would hope, if you take the low end range of our guidance and run through what would happen. I’m just going to do it just on a real simple, you know, looking at a couple of line items. If you ran down through what we’re giving in guidance at the low end of the range, we would generate somewhat a range I’m going to say of about $26.0 million of net income. You would have depreciation greater than capital expenditures, you know, somewhere in the range of--use the $106.0 million we have and what we have out in appreciation of, say, $15.0 million and then adjust for other small items whether it be in working capital or other depreciation, so forth, you know, we should be looking at a range of about $40.0 million again ready to pay down debt.

David Glick - Buckingham Research

Okay. That’s on an annual basis, not just before…

Keith E. Plowman

Yes. That’s on an annual basis.

David Glick - Buckingham Research

Okay. Because, obviously, you’re paying your debt down as you fund your seasonal working capital and meet your inventory.

Keith E. Plowman

Yeah. There’s no question. Right now, if you look at the end of the quarter, we are pretty close to our peak as far as our borrowings on a revolver sitting around $520.0 million. That’s fairly close to our peak. As we go forward here, because we do not own our credit card facility as this point, anything that we do in sales immediately transfers to cash within a day or two so we get to realize the benefits. And at the end of the third quarter is one of our high borrowing points. Now, as we move forward through November, we’re generating additional cash for the business which is increasing our excess capacity to your point and is reducing the debt levels.

David Glick - Buckingham Research

You could pay down around at least $200.0 million potentially in the fourth quarter?

Keith E. Plowman

We would expect. I mean, that’s where I was trying to go with you, David. If you just take the $40.0 million, we would expect that that $40.0 million is going to be the reduction as compared to the prior year’s year end.

David Glick - Buckingham Research

Got it. Okay. And just one last question in terms of that you’ve quantified your sales outlook. I’m just wondering what you’re seeing. I mean, clearly, it sounds like you had record day, the Day After Thanksgiving, could you give us a sense of the trend line after Thanksgiving. The weather seems favorable for you guys. Are you still maintaining momentum? Can you give us some color on sales?

Byron (Bud) Bergren

Sales, as I said, were strong the first three weeks. It has slowed down a little bit starting Monday but that’s only three days and we feel very strong about the weekend we’re going into.

David Glick - Buckingham Research

Okay. Great. Thanks a lot. Good luck, guys.

Keith E. Plowman

Thank you.

David Glick - Buckingham Research

Thanks.

Operator

We’ll go next to Michael Einstein with Credit Suisse

Michael Einstein - Credit Suisse

Good morning, everyone. A couple of questions for you. Number one, can you still talk about the level of promotions this year versus last year of both yourself and some of your competitors that generated the business in November? Number two, were there any accruals that helped the reported SG&A in the third quarter? And looking forward in terms of SG&A, are there any initiatives that you’d like to share with us in terms of whether there’s another set of reductions that we can look forward to either in advertising or systems or logistics that could be a buffer for the difficult times right now? Thank you.

Byron (Bud) Bergren

I’ll take the sales things first, Michael. First thing is I don’t think--we’re always promotional in the fourth quarter as well as our competitors. I mean, we watch them weekly. We really didn’t add. We’ve got a pretty full calendar right now, so it’s very difficult for us to add event. As I said before, in two of the three weeks, you’ve got two of the weakest volume days. Actually, the two biggest volume days of the year and we had record-breaking results on both of them. I would say that the biggest change that I see in November is really the change in the cold weather categories which are highly profitable for us. As we’ve been running the businesses that are tough, we’ve been pulling back on them. You’ve got the ready-to-wear inventory which was probably one of our more difficult businesses actually running down on a comp store basis and we’re actually trying to reorder men’s and women’s cold weather accessories right now as well as coats in both men’s and women’s.

Keith E. Plowman

Regarding your other question that you had, Michael, on the accruals, you know, helping SG&A, I’m not sure I follow exactly. I mean, we accrue for whatever liabilities we have. I think, overall, what I could say is that we are cutting expenses. We had talked about, obviously, the cost savings and we think we’re tracking better than what we had forecasted originally. But also just general expenses, we are looking in these times to cut out expenses that we can that won’t harm the business as we go forward here long term. So that would all impact us, but that’s all reflected. As we go through each quarter, we reflect whatever expenses we can eliminate. On the initiative side, there’s no question, we do have initiatives. Some are short term, some are long term. We continue to feel confident in where we’re tracking for the cost savings, so we’ll have additional initiatives that will go into effect as we go into next year that will, again, benefit the company. We’re tracking towards the $33.0 million and actually believe that now we might have a little bit of upside potential to the $33.0 million of cost savings, but that’s the easiest way I could answer that.

Michael Einstein - Credit Suisse

Just to clarify, Keith, a couple of people in the segments reversed out some accruals for bonuses, incentive comp, and things like that in the third quarter which helped the reported SG&A and I just wanted to get a sense of whether you did anything like that.

Keith E. Plowman

I think all companies are looking the same way, Michael. As you look through what your expenses are and if it’s a cost that you don’t think you’re going to incur, you certainly pull those costs out.

Michael Einstein - Credit Suisse

Okay. And I can tell you, being in Minneapolis, there is a run on cold weather accessories. There are very few scarves or gloves here.

Keith E. Plowman

Well, we’re happy to hear that.

Byron (Bud) Bergren

You could go to Herberger’s. You’ll find some there.

Michael Einstein - Credit Suisse

Yeah. I’ll be there this afternoon.

Operator

We’ll go next to Paula Kolavia with Broadway Capital.

Paula Kolavia - Broadway Capital

Good morning. Most of my questions have also been answered, but I just wanted to do a housekeeping issue. Can you tell us what you expect the share count for the fourth quarter and the full year? We’ve been using basics for the first three quarters and I think we’ll be using diluted.

Keith E. Plowman

That is correct. Off the top of my head, I don’t know the fourth quarter number, Paula. That’s something we certainly could provide out, but I think you could work through it if you go with about $17.35 million for the full year and I think you can essentially back into the number.

Paula Kolavia - Broadway Capital

Okay. Thanks and good luck this holiday.

Keith E. Plowman

Thank you.

Operator

We’ll go next to James Food with the Food Corporation.

James Food - The Food Corporation

Good morning. You’ve been talking about the strong furniture performance. I see you’ve been slowly expanding the furniture chain. You have 11 or 12. Can you give us a little detail on the average sales per store, what you see as the market’s potential, and could you at some point in time, either sell or merge the furniture business to provide some liquidity?

Byron (Bud) Bergren

Well, let me answer the first couple of that. We see a good opportunity in furniture. It’s been a focus business. It’s actually been a real good business for us in the past. We think there’s an opportunity right now to get some really attractive real estate deals in some of our key markets. The furniture business is significantly higher in sales and gross margin per square foot than the rest of the company in total. We actually made furniture a focus business, particularly the gallery business, not the in-store business, but the furniture gallery business is where we really see moving the business forward.

Keith E. Plowman

Jim, we have no plans to develop and sell the business. Actually, it’s not that expensive to open a furniture store compared to a department store and we plan on opening one or two a year based on, you know, where we get the right location.

James Food - The Food Corporation

And what is the average sales per store?

Byron (Bud) Bergren

The gallery is over three hundred. Yeah, over three hundred dollars per square foot.

James Food - The Food Corporation

Thank you very much.

Operator

We’ll go next to Emily Shanks from Lehman Brothers.

Emily Shanks - Lehman Brothers

Hi. Good morning. You did a very nice job in terms of the cost saves and SG&A. I just want to be crystal clear. I know that you’ve given us a lot of (inaudible) around it. The $7.0 million of cost saves in the third quarter, what exactly is that related to? And am I fair in saying that, from your comments, you expect to meet or exceed that dollar amount in the fourth quarter?

Keith E. Plowman

Yeah. Let me take all your questions. The $7.0 million really goes back to the original $33.0 million over the life of the cost savings that we felt we could realize from the acquisition and integration of the Saks Stores with the Bon-Ton Stores. We are tracking forward to that level and, possibly again, above it. These would be initiatives in I’ll call it elimination of expenses that are not necessary in the business where we find better ways to run it. It deals with manpower operations, everything, within the business. And these are long term, permanent eliminations and cost savings that we will recognize. Based upon where we’re trending and looking at where we were in the fourth quarter, I would expect that we’ll be somewhere close to that $7.0 million or possibly above that number in the fourth quarter.

Emily Shanks - Lehman Brothers

Great. That’s very helpful. One more clarifying question. Cap Ex, you indicated was going to be a couple million less than prior guidance so that we should be using a $106.0 number less a couple million, right?

Keith E. Plowman

That is correct. And, again, I just want to reemphasize that $106.0 is net of the contributions we get from landlords and such. You know, accounting doesn’t really allow you to report that way, but we look at the net cash impact and that number would be down a couple million.

Emily Shanks - Lehman Brothers

Okay. And then the final question I have is a bit of a housekeeping one. Is it possible to give us what the balances are of the revolver mortgage loan facility and then mortgage notes that are outstanding? I know you typically give it only in your case, but we are looking for it at the CNBS.

Keith E. Plowman

Okay. Well, I actually did--a little bit back I believe the question came up from David Glick and I was talking about $520 million in round terms is what we have for the revolver facility. I know the senior notes are sitting at $510 million and the CNBS itself is somewhere around $250 million. Then, we have a couple million dollars sitting out in mortgages and others.

Emily Shanks - Lehman Brothers

Great. Thanks.

Keith E. Plowman

You’re welcome.

Operator

We’ll go next to Reid Ken from Merrill Lynch.

Reid Ken - Merrill Lynch

Thanks. Great year. The November sales are getting off to a great start. I was just wondering given the calendar shift--I know you just gave a rough range--but how much of that increase is from the shift in the week of December into November? If we took that out, what do you think the comp’s going to be?

Keith E. Plowman

I’d have to say, Reid, I’m not sure we’ve look at it that way. You’re saying you want to pull a week out of the sales to see what it looks like on a comparable basis?

Reid Ken - Merrill Lynch

Well, just because of the timing of Thanksgiving this year and so on.

Keith E. Plowman

Oh, okay. I’m sorry. You’re talking just in November. I would say that would put you somewhere in the flat range. Yeah. Flat to off a little bit.

Reid Ken - Merrill Lynch

Okay. And then thanks for the liquidity comments. Just one last one and that front was just as it relates to the STE entity, if EBITDA on the stores were to fluctuate to a level where you might have a cash trap at the end of the year, the parent is not on the hook for writing that balance, right? It only applies to the stores in the entity?

Keith E. Plowman

That is correct, Reid.

Reid Ken - Merrill Lynch

Okay. Great. And then, as you’re looking at you Cap Ex budget for next year, given the cautious consumer out there, are you maybe looking at dialing back on that a little bit, if you could help us understand what your early thoughts are?

Keith E. Plowman

I mean, as we’re looking at 2008, we are certainly looking at the capital project that we think will benefit the company long term, but to your point, we are also looking at what is necessary versus what is not. So, you know, we are ready to I’ll say react to what we see going forward. We want to be careful that we don’t hurt the company’s long term performance and the benefit that we can get for the shareholders over the next several years, but at the same time, we want to make sure that we don’t spend capital that would put us in a different light.

Reid Ken - Merrill Lynch

Okay. Just two more small ones. I was wondering if you think gift card sales are kind of an indicator of the overall health of your consumer and, if so, how are those trending so far this holiday season?

Keith E. Plowman

We’re actually trending up over the prior year. I don’t know that that’s a great indicator for us really because we are company that did not sell a whole lot and we have put new collateral out there. We have some new gift cards that are very attractive to the consumer and we are selling more gift cards through the season. But I don’t know if that’s a good indication.

Reid Ken - Merrill Lynch

Okay. And the last one is just on the competitive landscape. You know, you have one department store competitor especially in the upper Midwest which is trying to create some level with the customers after last year. Is that creating any kind of a competitive headwind this year?

Keith E. Plowman

Our strongest market this year and continues to be Minneapolis and Chicago.

Reid Ken - Merrill Lynch

Great. Thanks a lot.

Keith E. Plowman

Thank you, Reid.

Operator

Okay. Next we’ll go to (Inaudible) from Deutsch Bank

Analyst - Deutsche Bank

Good morning. Not to harp on the SG&A, but are we seeing perhaps a tightening a bonuses in the fourth quarter here that would also contribute to the specific line that you’re talking about.

Keith E. Plowman

The question was asked earlier. You know, essentially, we are looking at all expenses. When you look at the reduction we have in SG&A and I gave how much we estimate is the cost savings for the quarter, you know, what I’ll cost savings being what we felt we could realize from the integration of the company, obviously, we are having a savings above that number. We were able to maintain our SG&A rate as percent of sales comparable to the prior year on a lower sales base. So there’s no question, there are some what I’ll call more temporary type expenses that have been eliminated in the business or have been reduced that are helping us to keep our SG&A down as percent of sales.

Analyst - Deutsche Bank

Okay. And just in terms of the promotional environment, you said it was much harder to insert a new event, but I was wondering about the level of discounts. I mean, do you feel that your customers are focused on a greater discount here as we go forward though the number of events might be the same.

Byron (Bud) Bergren

I would tell you, we’re making it easy for her in that way because when we’re not selling merchandise, we are pricing it aggressively as we always do. And you’ll see, based on the third quarter, the read-to-wear areas--we did not have a good ready-to-wear performance and that’s probably where we have our deepest discounts. On the other hand, you’ve got things like tech that we can’t seem to get enough of it as well as coats and cold weather accessories right now which, let’s put it this way, we’re not giving away our best sellers.

Analyst - Deutsche Bank

Okay. And then just on the year-over-year basis, last year, November, December, the first two weeks of January were very warm months, so we should see positive comps in outerwear on that side of the business, correct?

Byron (Bud) Bergren

Yeah. That’s what we’re seeing actually in November and we expect that to continue in December. Last year in December, it got much warmer and actually those categories slowed down in December.

Analyst - Deutsche Bank

Okay. And then in terms of your loyalty card, have you seen…you said that you were seeing an increase. Has it been more of a steady increase or has there been a shift as the consumer has felt more pressure recently on that?

Keith E. Plowman

I think it’s been a steady shift. We have put some promotions out there to draw new customers into our loyalty program. We are seeing an increase. We’re up about 7% in applications this year on a year-over-year basis through October. And really we’re pretty pleased with what we’re seeing on our loyalty program.

Analyst - Deutsche Bank

Okay. And just lastly, you mentioned getting the vendor support. I was wondering, in terms of the level of allowances there, are they comparable to what you were seeing last year or are you seeing an uptake of that on your vendor base?

Keith E. Plowman

We don’t really comment on that.

Byron (Bud) Bergren

The only thing I would tell you is that our vendors understand our strategy and they support our long term strategy.

Analyst - Deutsche Bank

Thank you very much, guys.

Byron (Bud) Bergren

Thank you.

Operator

We’ll go next to Gretchen Haley with J.P. Morgan.

Gretchen Haley - J.P. Morgan

Good morning. Thanks for taking my call. I just wanted to ask your comment on furniture doing well. Can you talk about just how that’s playing out in the weak housing market?

Anthony J. Buccina

Well, you know, some of the furniture--this came up before when the housing market was tough. Our furniture business was actually good last year also. The same question came up. There is a lot of newness happening in furniture right now. If you look at the mattress business which is a pretty sizable percent of the gallery business, there’s a lot of newness that’s going on there in the way of sleep studio and foam and expensive mattresses and the foam business in there as well as the more luxury sleepwear is really fueling that mattress business which is highly profitable and a big piece of the furniture business.

Gretchen Haley - J.P. Morgan

Okay. Thanks. One more question. Can you comment on just what exclusive implies when you’re talking about private label and exclusive and how the percentage breaks down?

Anthony J. Buccina

As I said, I think the private brand penetrated at $18.7 for the third quarter, that’s up a couple points over the prior year. And what we call exclusive vendors, to us, those are vendors are that not carried by our competitors or it’s domestic product from competitive vendors that is different from our competitors and where we have them make special merchandise for us. And all that penetrates. The penetration on both sides is up for the third quarters and is on track for where we’re saying we want to be.

Gretchen Haley - J.P. Morgan

Okay. Thank you.

Operator

We’ll go next to Colleen Burns from CIBC World Markets

Colleen Burns - CIBC World Markets

Hi. Good morning. On the inventory front, where do you stand on clearance inventory?

Byron (Bud) Bergren

We entered the third quarter up 5% in inventory, on clearance inventory, and we ended up half a point in total on our total comp store inventory.

Colleen Burns - CIBC World Markets

Okay. And then when do you expect your next major inventory reset or full reset and when do those inventories ship in? Is it early December?

Anthony J. Buccina

Yeah. You’re starting to see our transition merchandise come in now. We start having crews and spring setups now.

Colleen Burns - CIBC World Markets

Okay. Did any of that ship in the third quarter or is that really all shipping in the fourth quarter?

Anthony J. Buccina

No. That’s starting to ship in now.

Colleen Burns - CIBC World Markets

That’s starting to ship in now. So the inventory that’s in the third quarter is still just the fall/winter inventory?

Anthony J. Buccina

Yes.

Colleen Burns - CIBC World Markets

Okay. Great. And then with respect to working capital, are you still looking at that to be flat year-over-year?

Anthony J. Buccina

Yes.

Colleen Burns - CIBC World Markets

And then, I know you talked a little bit about Minneapolis and Chicago being some of your stronger market areas, I mean, can you talk about any of your weaker areas that you’ve seen, especially recently?

Anthony J. Buccina

Some of the weaker areas--actually, one thing that did change in the third quarter was where we were involved with the auto industry. In the first half of the year, they were running about--which is Indiana, Ohio, and Michigan--they were running about even with the rest of the company, but in the third quarter, they were off about 1% versus the rest of the company and more so in parts of Ohio and in Michigan. That’s where it’s really slowed down a little bit, even though Detroit, where we have three Parisian stores, our Detroit market has been very good. It’s more outside of Detroit that’s been a little weaker.

Colleen Burns - CIBC World Markets

Okay. Great. That’s very helpful. And then just lastly, on your credit card program, have you heard anything from HSBC on an increase in delinquencies or any changes being made there?

Keith E. Plowman

No. We actually checked with them. That’s very important to us. And we continue to have conversations. We partner with them very strongly. And, actually, they said as of the end of the third quarter they were very comparable to the prior year.

Colleen Burns - CIBC World Markets

Okay. Great. That’s it for me. Thanks a lot.

Keith E. Plowman

Thank you.

Operator

We’ll go back to the lineup. Dana Cohen from Banc of America Securities.

Kerrie McInerney - Banc of America Securities

Hi, guys. It’s Kerrie again for Dana. Just a couple of quick follow up questions. I was wondering if you could give us the impact of the 53rd week in SG&A. And then, also, on the inventories, I don’t mean to beat a dead horse here, but when I take that $60.0 million out, I’m still getting a 3% increase or so, about 3-3.5%, so is there something else in there that you’re taking out to get to the flat comp inventory?

Keith E. Plowman

Again, when Tony talks to the flat inventory, he’s looking at the retail stock ledger of what inventory has come in. He’s not looking at what we accrue for in-transit, Kerrie. And we have the same issue that we had the second quarter, it will be out by year end, where last year we would’ve had in-transit, recorded through or worked through the TSA agreement which means we would not have been recording in exactly the same way in a year-over-year basis. This is something that does correct itself by year end because, at that point, we were recording all inventory ourselves. And we’re not going to a TSA agreement, but we don’t have that comparable year-over-year yet. And that’s around $40.0 million.

Kerrie McInerney - Banc of America Securities

Okay. Thanks.

Operator

Okay. Next is Bill Reuter at Banc of America Securities.

Bill Reuter, Banc of America Securities

Good morning, guys. You guys commented that cold weather merchandise was down double digits, I think that was over September and October. I’m wondering if you comment on how much this category might have been up in November?

Keith E. Plowman

Well, there’s a sizable swing and it’s up by a double digit.

Bill Reuter, Banc of America Securities

Okay. So, I mean, given the fact that November is a bigger month, is it possible that the changes in November would more than offset the decreases in September and October in that category?

Byron (Bud) Bergren

I think in the fourth quarter you will see that. I can’t really say that it will happen in November.

Bill Reuter, Banc of America Securities

Okay. And then with regard to--I mean, you guys do most of your purchasing for the holiday period in the pretty early spring, were you guys able to tweak your orders based upon, you know, expectations from the consumer that might have been a little more negative at that point?

Byron (Bud) Bergren

Yes.

Bill Reuter, Banc of America Securities

Okay. And then my last one is with regard to your private label, do you guys have any sort of a different markdown strategy there in the event that those products aren’t able to sell? And, I guess, do you worry about--I mean, there’s a great margin attached to these products, but do you worry about these inventory levels at all?

Byron (Bud) Bergren

No. We treat the private brand the same way we treat the selling of our domestic products. If it’s selling, the markdowns are taken on a normal basis. If it’s not selling, then it’s a more aggressive basis. We really don’t separate that from the domestic market.

Bill Reuter, Banc of America Securities

So the markdowns don’t get any more aggressive more quickly or anything like that?

Byron (Bud) Bergren

No.

Bill Reuter, Banc of America Securities

Okay. That’s all for me. Thanks.

Operator

Okay. Next to David Glick with Buckingham Research.

David Glick - Buckingham Research

Keith, just a quick follow up. The tax rate we should be using for the fourth quarter and the year, could you help us with this arrangement?

Keith E. Plowman

Yeah. I think overall for the year I would estimate between 36.5 to 37.5. We really can’t finalize it and put it any closer than that at this point, David. I would’ve been down. It reflected a much lower rate in the third quarter because of the lost position and the interest accruals that you have to do under 1040(a), but for the year we’d expect it to be somewhere around 36.5 to 37.5.

David Glick - Buckingham Research

Okay. Thanks a lot.

Keith E. Plowman

Thank you.

Operator

We have time for one more question. We’ll go to Robert Wright with Centurion.

Robert Wright - Centurion

Hi. I had one question in listening to the credit line and so forth. When I think back to the Saks transaction, I think, I’m not sure, with the stock at 11.5 and the bond sitting at 78, that the enterprise value is now less than you paid for the position of Saks? And the bonds , they say about 15.5 yields worst and you talk about using your paying down debt and using excess liquidity. Have you looked into or thought about taking advantage of the market, you know, of having the shareholders and the bonds because the interest rates you’re paying are so much less on your lines than you’re paying in the market, more or less, and I would assume that it would be dramatically additive to earnings? Is that prohibited in some way because of some agreement that you have or covenants? It just would make obvious sense to be buying those bonds if you can?

Keith E. Plowman

Good morning, Robert. This is Keith. We don’t comment on any specific items like that whether it be with stock, bonds, or anything else. But as far as are we prohibited from doing either? No, for the term of our debt agreement.

Robert Wright - Centurion

Okay. Great.

Operator

That is all the time we have for questions. I’d like to turn the conference back over to our speakers for any closing remarks.

Byron (Bud) Bergren

Thank you. In summary, we are encouraged by the improvement we saw in our business since the beginning of November. We have twenty-five more shopping days until Christmas. We’re ready and we know we will continue to do well in our markets. We look forward to speaking with you about the fourth quarter and full-year results at our conference call in March. And thank you for your time in joining us today.

Operator

This concludes today’s conference. We thank everyone for your participation.

You may now disconnect your lines.

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Source: The Bon-Ton Stores Q3 2007 Earnings Call Transcript
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