THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
1.
BASIS OF PRESENTATION
The Bon-Ton Stores, Inc., a Pennsylvania corporation, was incorporated on January 31, 1996 as the successor of a company incorporated on January 31, 1929. As of July 30, 2016, The Bon-Ton Stores, Inc. operated, through its subsidiaries, 267 stores, including nine furniture galleries and four clearance centers, in 26 states in the Northeast, Midwest and upper Great Plains under the Bon-Ton, Bergners, Boston Store, Carsons, Elder-Beerman, Herbergers and Younkers nameplates.
The accompanying unaudited consolidated financial statements include the accounts of The Bon-Ton Stores, Inc. (the Parent) and its subsidiaries (collectively, the Company). All intercompany transactions have been eliminated in consolidation.
The unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and do not include all information and footnotes required in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States. In the opinion of management, all adjustments considered necessary for a fair presentation of interim periods have been included. The Companys business is seasonal in nature and results of operations for the interim periods presented are not necessarily indicative of results for the full fiscal year. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended January 30, 2016.
For purposes of the following discussion, references to the second quarter of 2016 and the second quarter of 2015 are to the 13 weeks ended July 30, 2016 and August 1, 2015, respectively. References to fiscal 2016 are to the 52 weeks ending January 28, 2017; references to fiscal 2015 are to the 52 weeks ended January 30, 2016.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires that management make estimates and assumptions about future events. These estimates and assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and the reported amounts of revenues and expenses. Such estimates include those related to merchandise returns, the valuation of inventories, long-lived assets, intangible assets, insurance reserves, contingencies, litigation and assumptions used in the calculation of income taxes and retirement and other post-employment benefits, among others. These estimates and assumptions are based on managements best estimates and judgments. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. Management adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.
Reclassifications
Certain prior year balances presented in the consolidated financial statements and notes thereto have been reclassified to conform to the current year presentation. These reclassifications did not impact the Companys net loss for the second quarter in each of 2016 and 2015. As a result of adopting Accounting Standards Update (ASU) No. 2015-17,
Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes
(ASU 2015-17) as of January 30, 2016, the Company reclassified the August 1, 2015 consolidated balance sheet resulting in a reduction of $13,239 in long-term deferred income tax assets, a reduction in current deferred income tax liabilities of $22,834 and an increase in other long-term liabilities of $9,595.
7
THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
Recently Adopted Accounting Standards
Effective January 31, 2016, the Company adopted ASU No. 2015-03,
Interest-Imputation of Interest
(ASU 2015-03) and ASU No. 2015-15 (an amendment to ASU 2015-03) and retrospectively applied their provisions. The new standards require that debt issuance costs related to a recognized debt liability, other than those relating to line-of-credit arrangements, be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. As a result of adopting this guidance, as of August 1, 2015 and January 30, 2016, the Company reclassified $7,202 and $6,580, respectively, of the unamortized debt issuance costs for all debt instruments except the senior secured credit facility from other long-term assets to long-term debt and current maturities of long-term debt on the consolidated balance sheets.
Effective January 31, 2016, the Company adopted ASU No. 2015-05,
Intangibles-Goodwill and Other-Internal-Use Software
and prospectively applied its provisions. The new standard provides guidance on the accounting for fees paid by a customer in a cloud computing arrangement. If a cloud computing arrangement includes a software license, then the customer is required to account for the software license consistent with the acquisition of other software licenses. Conversely, if the arrangement does not include a software license, the customer should account for the arrangement as a service contract. The adoption of this guidance did not have a material impact on the Companys consolidated financial statements.
Recently Issued Accounting Standards
In August 2016, the Financial Accounting Standards Board issued ASU No. 2016-15,
Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments
. The new standard provides guidance on eight targeted areas and how they are presented and classified in the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017. The Company is currently reviewing the guidance and assessing the potential impact on its consolidated financial statements.
2.
PER-SHARE AMOUNTS
The following table presents a reconciliation of net loss and weighted average shares outstanding used in basic and diluted earnings (loss) per share (EPS) calculations for each period presented:
8
THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
|
|
THIRTEEN
|
|
TWENTY-SIX
|
|
|
|
WEEKS ENDED
|
|
WEEKS ENDED
|
|
|
|
July 30,
|
|
August 1,
|
|
July 30,
|
|
August 1,
|
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
Basic Loss Per Common Share
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(38,736
|
)
|
$
|
(39,563
|
)
|
$
|
(76,554
|
)
|
$
|
(73,637
|
)
|
Less: Income allocated to participating securities
|
|
|
|
|
|
|
|
|
|
Net loss available to common shareholders
|
|
$
|
(38,736
|
)
|
$
|
(39,563
|
)
|
$
|
(76,554
|
)
|
$
|
(73,637
|
)
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
19,909,198
|
|
19,718,423
|
|
19,834,823
|
|
19,640,016
|
|
|
|
|
|
|
|
|
|
|
|
Basic loss per common share
|
|
$
|
(1.95
|
)
|
$
|
(2.01
|
)
|
$
|
(3.86
|
)
|
$
|
(3.75
|
)
|
|
|
|
|
|
|
|
|
|
|
Diluted Loss Per Common Share
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(38,736
|
)
|
$
|
(39,563
|
)
|
$
|
(76,554
|
)
|
$
|
(73,637
|
)
|
Less: Income allocated to participating securities
|
|
|
|
|
|
|
|
|
|
Net loss available to common shareholders
|
|
$
|
(38,736
|
)
|
$
|
(39,563
|
)
|
(76,554
|
)
|
(73,637
|
)
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
19,909,198
|
|
19,718,423
|
|
19,834,823
|
|
19,640,016
|
|
Common shares issuable - stock options
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding assuming dilution
|
|
19,909,198
|
|
19,718,423
|
|
19,834,823
|
|
19,640,016
|
|
|
|
|
|
|
|
|
|
|
|
Diluted loss per common share
|
|
$
|
(1.95
|
)
|
$
|
(2.01
|
)
|
$
|
(3.86
|
)
|
$
|
(3.75
|
)
|
Due to the Companys net loss position, weighted average unvested restricted shares (participating securities) of 1,382,412 and 890,065 for the second quarter in each of 2016 and 2015, respectively, and 1,301,295 and 799,513 for the 26 weeks ended July 30, 2016 and August 1, 2015, respectively, were not considered in the calculation of net loss available to common shareholders used for both basic and diluted EPS.
In addition, weighted average stock option shares (non-participating securities) totaling 17,555 for the second quarter of 2015 and 63,876 for the 26 weeks ended August 1, 2015, were excluded from the computation of diluted weighted average common shares outstanding, as their effect would have been antidilutive. Certain of these stock option shares were excluded solely due to the Companys net loss position. Had the Company reported net income for the 26 weeks ended August 1, 2015, these shares would have increased diluted weighted average common shares outstanding by 8,395. There were no stock options outstanding during the 26 weeks ended July 30, 2016.
3.
FAIR VALUE MEASUREMENTS
Accounting Standards Codification (ASC) Topic 820,
Fair Value Measurements and Disclosures
(ASC 820), defines fair value and establishes a framework for measuring fair value. ASC 820 establishes fair value hierarchy levels that prioritize the inputs used in valuations determining fair value. Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 inputs are primarily quoted prices for similar assets or liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs based on the Companys own assumptions.
9
|
|
THIRTEEN
|
|
TWENTY-SIX
|
|
|
|
WEEKS ENDED
|
|
WEEKS ENDED
|
|
|
|
July 30,
|
|
August 1,
|
|
July 30,
|
|
August 1,
|
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Interest cost
|
|
$
|
16
|
|
$
|
16
|
|
$
|
31
|
|
$
|
32
|
|
Recognition of net actuarial gain
|
|
(109
|
)
|
(106
|
)
|
(216
|
)
|
(213
|
)
|
Net periodic benefit income
|
|
$
|
(93
|
)
|
$
|
(90
|
)
|
$
|
(185
|
)
|
$
|
(181
|
)
|
During the 26 weeks ended July 30, 2016, the Company contributed $100 to fund the Postretirement Benefit Plan, and anticipates contributing an additional $227 to fund the Postretirement Benefit Plan in fiscal 2016, for an annual total of $327.
8.
INCOME TAXES
The provisions codified within ASC Topic 740,
Income Taxes
(ASC 740), require companies to assess whether valuation allowances should be established against their deferred tax assets based on consideration of all available evidence using a more likely than not standard. In accordance with ASC 740, the Company maintained a full valuation allowance throughout fiscal 2015 and the 26 weeks ended July 30, 2016 on all of the Companys net deferred tax assets. The Companys deferred tax asset valuation allowance totaled $218,177, $192,858 and $186,582 as of July 30, 2016, August 1, 2015 and January 30, 2016, respectively.
The Company recorded net income tax benefits of $144 and $288 for the 13 and 26 weeks ended July 30, 2016, respectively, which includes $596 and $1,193 non-cash income tax benefits from continuing operations during the 13 and 26 weeks ended July 30, 2016, respectively. The Company recorded net income tax benefits of $238 and $397 for the 13 and 26 weeks ended August 1, 2015, respectively, which includes $686 and $1,295 non-cash income tax benefits from continuing operations during the 13 and 26 weeks ended August 1, 2015, respectively. Pursuant to ASC 740, the Company is required to consider all items (including items recorded in other comprehensive income) in determining the amount of tax benefit that results from a loss from continuing operations and that should be allocated to continuing operations. As a result, the Company recorded tax benefits on the losses from continuing operations for the 13 and 26 weeks ended July 30, 2016 and August 1, 2015, respectively, which are exactly offset by income tax expense on other comprehensive income. The net income tax benefits includes $452 and $905 recorded in the 13 and 26 weeks ended July 30, 2016, respectively, and $448 and $898 recorded in the 13 and 26 weeks ended August 1, 2015, respectively, for recognition of deferred tax liabilities associated with indefinite-lived assets.
9.
CONTINGENCIES
In the second quarter of 2015, the Company recognized a gain on insurance recovery of $748 related to a fire at one of the Companys stores, which is shown separately in the accompanying consolidated statements of operations.
The Company is party to legal proceedings and claims that arise during the ordinary course of business. In the opinion of management, the ultimate outcome of any such litigation and claims will not have a material adverse effect on the Companys financial position, results of operations or liquidity.
13
THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
10. COMPREHENSIVE LOSS
Accumulated other comprehensive loss is comprised of the net actuarial loss associated with the Pension Plans and Postretirement Benefit Plan. Other comprehensive income is comprised entirely of the amortization of the net actuarial loss (gain) associated with the Pension Plans and Postretirement Benefit Plan.
The changes recognized within other comprehensive income reflect income tax expense of $596 and $686 for the 13 weeks ended in each of July 30, 2016 and August 1, 2015, respectively, and $1,193 and $1,295 for the 26 weeks ended in each of July 30, 2016 and August 1, 2015, respectively (see Note 8).
The before-tax amount of amortization of net actuarial loss (gain) (see Note 7) was recorded within selling, general and administrative expense.
11. CONDENSED CONSOLIDATING FINANCIAL INFORMATION
Certain debt obligations of the Company, which constitute debt obligations of The Bon-Ton Department Stores, Inc. (the Issuer), are guaranteed by the Parent and by each of its subsidiaries, other than the Issuer, that is an obligor under the Companys Second Amended and Restated Loan and Security Agreement (the Second Amended Revolving Credit Facility). Separate financial statements of the Parent, the Issuer and such subsidiary guarantors are not presented because the guarantees by the Parent and each 100% owned subsidiary guarantor are joint and several, full and unconditional, except for certain customary limitations which are applicable only to a subsidiary guarantor. These customary limitations include releases of a guarantee (1) if the subsidiary guarantor no longer guarantees other indebtedness of the Issuer; (2) if there is a sale or other disposition of the capital stock of a subsidiary guarantor and if such sale complies with the covenant regarding asset sales; and (3) if the subsidiary guarantor is properly designated as an unrestricted subsidiary.
The condensed consolidating financial information for the Parent, the Issuer and the guarantor subsidiaries as of July 30, 2016, August 1, 2015 and January 30, 2016 and for the second quarter in each of 2016 and 2015 and the 26 weeks ended July 30, 2016 and August 1, 2015 as presented below has been prepared from the books and records maintained by the Parent, the Issuer and the guarantor subsidiaries. The condensed financial information may not necessarily be indicative of the results of operations or financial position had the guarantor subsidiaries operated as independent entities. Certain intercompany revenues and expenses included in the subsidiary records are eliminated in consolidation. As a result of this activity, an amount due to/due from affiliates will exist at any time.
On January 15, 2016, the Company and certain other subsidiaries as borrowers or obligors (collectively, the Obligors) entered into a Consent and Third Amendment to the Second Amended Revolving Credit Facility, which among other changes, provided for the joinders of the special purpose entities (SPEs) that had previously participated in the Companys mortgage loan facility as Obligors under the Second Amended Revolving Credit Facility, and as Restricted Subsidiaries and guarantors under the indentures for both the 10
5
/
8
% second lien senior secured notes due 2017 and the 8.00% second lien senior secured notes due 2021. The SPEs and their assets were then added to the second lien security agreement. For comparative purposes, the condensed consolidating financial information as presented below has been retrospectively adjusted as if the activity described above occurred at the beginning of each period presented.
14
ITEM 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For purposes of the following discussion, references to the second quarter of 2016 and the second quarter of 2015 are to the 13 weeks ended July 30, 2016 and August 1, 2015, respectively. References to 2016 and 2015 are to the 26 weeks ended July 30, 2016 and August 1, 2015, respectively. References to fiscal 2016 are to the 52-week period ending January 28, 2017; references to fiscal 2015 are to the 52-week period ended January 30, 2016. References to the Company, we, us, and our refer to The Bon-Ton Stores, Inc. and its subsidiaries.
Overview
General
The Company, a Pennsylvania corporation, is one of the largest regional department store operators in the United States, offering a broad assortment of brand-name fashion apparel and accessories for women, men and children. Our merchandise offerings also include cosmetics, home furnishings and other goods. We currently operate 267 stores, including nine furniture galleries and four clearance centers, in 26 states in the Northeast, Midwest and upper Great Plains under the Bon-Ton, Bergners, Boston Store, Carsons, Elder-Beerman, Herbergers and Younkers nameplates, encompassing a total of approximately 25 million square feet.
We operate in the department store segment of the U.S. retail industry, a highly competitive environment. The department store industry continues to evolve in response to competitive retail formatsmass merchandisers, national chain retailers, specialty retailers and online retailersand the expansion of mobile technology and social media.
Performance Summary and Fiscal 2016 Guidance
During the second quarter of 2016, we made progress on a number of our strategic initiatives:
·
Delivered sales gains in certain key growth categories and brands, and drove accelerated double digit growth in our omnichannel business, with a triple digit increase on our mobile site as compared to the prior year period;
·
Maintained careful inventory controls, as we reduced inventory by 6% as compared to the second quarter of 2015, with fewer markdowns;
·
Realized continued growth in the penetration of proprietary credit card sales to total sales which, at 57.1% in the second quarter of 2016, exceeded that of the comparable prior period by 390 basis points; and
·
Continued to make progress on our cost savings initiatives.
Comparable store sales decreased 2.0% in the second quarter of 2016, reflecting soft mall traffic. However, our omnichannel business, which reflects sales via our website, mobile site, and our
Buy Online Pick Up In-Store
and
Let Us Find It
initiatives, grew significantly, and we expect that it will continue to deliver strong performance. We also believe that the fall assortment will be our best to date. While we are cognizant that the operating environment remains difficult, we believe that we are well positioned for the second half of the fiscal year with a strong merchandising assortment, a compelling marketing program focused on new customer acquisition and continued discipline in inventory management and cost controls.
On August 15, 2016, we completed a closing of a new $150 million revolving commitment that replaces the existing $100 million A-1 Tranche of our Second Amended and Restated Loan and Security Agreement (the Second Amended Revolving Credit Facility) and increases the total commitments under the facility to $880 million (see Liquidity and Capital Resources, for further discussion).
25
On August 18, 2016, we reaffirmed our Fiscal 2016 guidance for the year. We continue to expect loss per diluted share in the range of $0.95 to $1.45.
Results of Operations
The following table summarizes changes in selected operating indicators of the Company, illustrating the relationship of various income and expense items to net sales for the respective periods presented (components may not add or subtract to totals due to rounding):
|
|
THIRTEEN
|
|
TWENTY-SIX
|
|
|
|
WEEKS ENDED
|
|
WEEKS ENDED
|
|
|
|
July 30,
|
|
August 1,
|
|
July 30,
|
|
August 1,
|
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Net sales
|
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
Other income
|
|
3.0
|
|
2.8
|
|
3.0
|
|
2.7
|
|
|
|
103.0
|
|
102.8
|
|
103.0
|
|
102.7
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
Costs of merchandise sold
|
|
63.5
|
|
63.2
|
|
64.9
|
|
64.8
|
|
Selling, general and administrative
|
|
39.1
|
|
38.7
|
|
37.8
|
|
37.2
|
|
Gain on insurance recovery
|
|
|
|
(0.1
|
)
|
|
|
(0.1
|
)
|
Depreciation and amortization
|
|
4.6
|
|
4.4
|
|
4.3
|
|
4.0
|
|
Amortization of lease-related interests
|
|
0.2
|
|
0.2
|
|
0.2
|
|
0.2
|
|
Impairment charges
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
(4.4
|
)
|
(3.6
|
)
|
(4.1
|
)
|
(3.3
|
)
|
Interest expense, net
|
|
2.8
|
|
2.7
|
|
2.7
|
|
2.6
|
|
Loss on extinguishment of debt
|
|
|
|
0.9
|
|
|
|
0.4
|
|
Loss before income taxes
|
|
(7.2
|
)
|
(7.2
|
)
|
(6.8
|
)
|
(6.3
|
)
|
Income tax benefit
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
(7.1
|
)%
|
(7.1
|
)%
|
(6.8
|
)%
|
(6.3
|
)%
|
Second Quarter of 2016 Compared with Second Quarter of 2015
Net sales
: Net sales in the second quarter of 2016 were $542.4 million, compared with $555.4 million in the second quarter of 2015, reflecting a decrease of 2.4%. Comparable store sales decreased 2.0% in the period due to continued soft mall traffic trends.
The best performing merchandise categories in the second quarter of 2016 were Active Sportswear (included in Womens Apparel), Furniture (included in Home) and Mens Sportswear (included in Mens Apparel). Active Sportswear benefited from sales increases in key items and brands. Sales in Furniture increased through the expansion of merchandise to additional doors and sales increases in mattresses. Mens Sportswear primarily benefited from increased inventory investment in key items and growth in our activewear business.
Merchandise categories that were challenged in the period included Better Sportswear and Dresses (both included in Womens Apparel) and Childrens. Better Sportswear was adversely impacted during the second quarter; we have exited poor performing brands and are directing inventory investment to brands that are performing better. Dresses were adversely impacted by unfavorable sales in certain product assortments, including moderate traditional dresses; we are continuing our efforts to align investment with sales trends. Sales in Childrens, particularly denim and sleepwear, have been challenged during the second quarter. We are adjusting our inventory as appropriate, seeking to capitalize on stronger products.
Other income
: Other income, which includes income from revenues received under our credit card program agreement, miscellaneous revenue departments and gift and merchandise return card breakage, was
26
$16.3 million in the second quarter of 2016 as compared with $15.6 million in the second quarter of 2015. The increase primarily reflects increased revenues from our proprietary credit card operations.
Costs and expenses
: Gross margin in the second quarter of 2016 decreased $6.5 million to $198.1 million as compared with $204.6 million in the comparable prior year period, primarily due to the decreased sales volume in the current period. Gross margin as a percentage of net sales decreased 31 basis points to 36.5% in the second quarter of 2016 from 36.8% in the comparable prior year period, primarily due to an unfavorable cumulative markup percentage, partially offset by reduced markdowns.
SG&A expense in the second quarter of 2016 decreased $3.3 million to $211.9 million as compared with $215.2 million in the second quarter of 2015. This reduction was largely due to a benefit from expense control measures, specifically in store expenses, partially offset by higher medical claims as well as severance costs and consulting expenses associated with our cost reduction initiative. The current period expense rate, 39.1% of net sales, increased 32 basis points from that of the prior year period as a result of the decreased sales volume in the period.
Gain on insurance recovery of $0.7 million was due to an insurance settlement in the second quarter of 2015, a residual of claims associated with one store that experienced fire damage in the fourth quarter of fiscal 2014.
Depreciation and amortization expense and amortization of lease-related interests increased $0.8 million to $26.0 million in the second quarter of 2016 from $25.3 million in the second quarter of 2015.
Interest expense, net
: Net interest expense was $15.2 million for the second quarter in each of 2016 and 2015.
Income tax benefit
: The effective income tax rate in the second quarter in each of 2016 and 2015 largely reflects our valuation allowance position against all net deferred tax assets. The $0.1 million income tax benefit in the second quarter of 2016 includes a $0.6 million benefit from the loss on continuing operations which was partially offset by the recognition of deferred tax liabilities associated with indefinite-lived assets. The $0.2 million income tax benefit in the second quarter of 2015 includes a $0.7 million benefit from the loss on continuing operations which was partially offset by the recognition of deferred tax liabilities associated with indefinite-lived assets.
2016 Compared with 2015
Net sales
: Net sales in 2016 were $1,133.4 million, compared with $1,166.4 million in 2015, reflecting a decrease of 2.8%. Comparable store sales decreased 2.4% in the period due to continued soft mall traffic trends.
The best performing merchandise categories in 2016 were Mens Sportswear (included in Mens Apparel), Active Sportswear (included in Womens Apparel) and Hard Home (included in Home). Mens Sportswear benefited from increased inventory investment in key items and growth in our activewear business. Active Sportswear benefited from sales increases in key items and brands. Hard home achieved success from improved performance in luggage and seasonal decor.
Merchandise categories that were challenged in the period included Better Sportswear and Dresses (both included in Womens Apparel) and Childrens. Better Sportswear was adversely impacted during 2016; we have exited poor performing brands and are directing inventory investment to brands that are performing better. Dresses were adversely impacted by unfavorable sales in certain product assortments, including moderate traditional dresses; we are continuing our efforts to align investment with sales trends. Sales in Childrens, particularly denim and sleepwear, have been challenged during 2016. We are adjusting our inventory as appropriate, seeking to capitalize on stronger products.
Other income
: Other income, which includes income from revenues received under our credit card program agreement, miscellaneous revenue departments and gift and merchandise return card breakage, was $33.7 million in 2016 as compared with $31.9 million in 2015. The increase primarily reflects increased revenues from our proprietary credit card operations.
27
Costs and expenses
: Gross margin in 2016 decreased $12.9 million to $398.2 million as compared with $411.1 million in 2015. Gross margin as a percentage of net sales decreased 11 basis points to 35.1% in 2016 from 35.2% in 2015, due primarily to an unfavorable cumulative markup percentage, partially offset by reduced markdowns.
SG&A expense in 2016 decreased $5.8 million to $428.1 million as compared with $433.9 million in 2015. This reduction was largely driven by expense control measures, specifically in store expenses, partially offset by higher medical claims as well as severance costs and consulting expenses associated with our cost reduction initiative. The current period expense rate, 37.8% of net sales, increased 57 basis points from that of the prior year.
Gain on insurance recovery of $0.7 million was due to an insurance settlement in the second quarter of 2015, a residual of claims associated with one store that experienced fire damage in the fourth quarter of fiscal 2014.
Depreciation and amortization expense and amortization of lease-related interests increased $1.8 million to $50.2 million in 2016 from $48.4 million in 2015.
Interest expense, net
: Net interest expense was $30.2 million in 2016 as compared with $30.4 million in 2015. The decrease primarily reflects a reduced weighted average interest rate, partially offset by higher debt levels.
Loss on extinguishment of debt
: In 2015, we recorded charges totaling $4.9 million due to the early termination of one of our mortgage facilities. As a result of the prepayment, we paid an early termination fee of $4.7 million. Additionally, unamortized deferred financing fees were accelerated on the date of termination.
Income tax benefit
: The effective income tax rate in each of 2016 and 2015 largely reflects our valuation allowance position against all net deferred tax assets. The $0.3 million income tax benefit in 2016 includes a $1.2 million benefit from the loss on continuing operations which was partially offset by the recognition of deferred tax liabilities associated with indefinite-lived assets. The $0.4 million income tax benefit in 2015 includes a $1.3 million benefit from the loss on continuing operations which was partially offset by the recognition of deferred tax liabilities associated with indefinite-lived assets.
Seasonality
Our business, like that of most retailers, is subject to seasonal fluctuations, with the major portion of sales and income realized during the second half of each fiscal year, which includes the holiday season. Due to the fixed nature of certain costs, SG&A expense is typically higher as a percentage of net sales during the first half of each fiscal year. We typically finance working capital increases in the second half of each fiscal year through additional borrowings under our $880.0 million Second Amended Revolving Credit Facility that expires on December 12, 2018 (see Liquidity and Capital Resources, below, for further discussion).
Because of the seasonality of our business, results for any quarter are not necessarily indicative of results that may be achieved for a full fiscal year.
Liquidity and Capital Resources
At July 30, 2016, we had $7.0 million in cash and cash equivalents and $224.8 million available under our Second Amended Revolving Credit Facility (before taking into account the minimum borrowing availability covenant under such facility). Excess availability was $265.2 million as of the comparable prior year period. The unfavorable excess availability comparison primarily reflects the repayment of our mortgage facility in January 2016, partially offset by improved cash flows from operating activities.
On August 15, 2016, The Bon-Ton Department Stores, Inc. and certain subsidiaries as borrowers and certain other subsidiaries as obligors entered into a Fourth Amendment (the Fourth Amendment) to the Second Amended Revolving Credit Facility which, among other changes, increased the A-1 Tranche of the
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Second Amended Revolving Credit Facility to a commitment of $150.0 million (from the previous commitment of $100.0 million). This amendment brings total revolving commitments under the Second Amended Revolving Credit Facility to $880.0 million ($730.0 million under Tranche A and $150.0 million under Tranche A-1).
Borrowings under the Second Amended Revolving Credit Facility bear interest at either (1) Adjusted LIBOR (equal to the London Interbank Offered Rate for an interest period selected by the borrowers) plus an applicable margin or (2) a base rate (based on the highest of (a) the Federal Funds Rate plus 0.5%, (b) the Bank of America prime rate, and (c) Adjusted LIBOR based on an interest period of one month plus 1.0%) plus the applicable margin. The applicable margins in respect of the Tranche A-1 facility under the Fourth Amendment will be 9.5% for LIBOR loans and 8.5% for base rate loans. The applicable margins in respect of the Tranche A facility continue to be based upon the excess availability under the Second Amended Revolving Credit Facility.
The financial covenant contained in the Second Amended Revolving Credit Facility requires that the minimum excess availability be an amount greater than or equal to the greater of (1) 10% of the lesser of: (a) the aggregate commitments at such time and (b) the aggregate borrowing base at such time and (2), by virtue of the Fourth Amendment, $75.0 million. In addition, the Fourth Amendment requires that if, at any time on or after January 29, 2017 and for so long as excess availability under the loan agreement is less than 20% of the lesser of (a) the aggregate commitments at such time and (b) the aggregate borrowing base at such time, the fixed charge coverage ratio shall be at least 1.00 to 1.00.
The proceeds of the loans under the Tranche A-1 facility were used to repay existing Tranche A-1 loans and a portion of Tranche A loans and to pay fees and expenses incurred in connection with the Fourth Amendment. We intend to refinance our existing 10
5
/
8
% Second Lien Secured Notes due in July 2017 prior to their maturity.
Typically, cash flows from operations are impacted by the effect on sales of (1) consumer confidence, (2) weather in the geographic markets served by the Company, (3) general economic conditions and (4) competitive conditions existing in the retail industry. A downturn in any single factor or a combination of factors could have a material adverse impact upon our ability to generate sufficient cash flows to operate our business. While the current economic uncertainty affects our assessment of short-term liquidity, we consider our resources (including, but not limited to, cash flows from operations supplemented by borrowings under the Second Amended Revolving Credit Facility) adequate to satisfy our cash needs for at least the next 12 months.
Our primary sources of working capital are cash flows from operations and borrowings under our Second Amended Revolving Credit Facility, which provides for up to $880.0 million in borrowings (limited by amounts available pursuant to a borrowing base calculation). Our business follows a seasonal pattern; working capital fluctuates with seasonal variations, reaching its highest level in October or November to fund the purchase of merchandise inventories prior to the holiday season. The seasonality of our business historically provides greatest cash flow from operations during the holiday season, with fiscal fourth quarter net sales generating the strongest profits of our fiscal year. As holiday sales significantly reduce inventory levels, this reduction, combined with net income, historically provides us with strong cash flow from operations at the end of our fiscal year.
Cash provided by (used in) our operating, investing and financing activities is summarized as follows:
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|
|
TWENTY-SIX
|
|
|
|
WEEKS ENDED
|
|
|
|
July 30,
|
|
August 1,
|
|
(Dollars in millions)
|
|
2016
|
|
2015
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
63.6
|
|
$
|
11.0
|
|
Investing activities
|
|
(25.7
|
)
|
38.2
|
|
Financing activities
|
|
(37.7
|
)
|
(37.0
|
)
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities was $63.6 million and $11.0 million in 2016 and 2015, respectively. The increase in cash flow primarily reflects a $46.9 million favorable change in cash flow from working capital. The improvement in cash flow from working capital was largely due to favorable fluctuations of $21.0 million in cash flows from merchandise inventories, $11.7 million in cash flows from accrued payroll and benefits and accrued expenses and $10.2 million in cash flows from prepaid expenses and other current assets.
Net cash used in investing activities was $25.7 million in 2016 and net cash provided by investing activities was $38.2 million in 2015. In 2015, the inflow of cash includes $84.0 million of proceeds from the sale of assets associated with the sale-leaseback transaction. Capital expenditures totaled $25.7 million and $47.4 million in 2016 and 2015, respectively, reflecting a planned decrease in capital expenditures. These expenditures do not reflect reductions for external contributions (primarily leasehold improvement and fixture allowances received from landlords or vendors) of $14.1 million and $4.5 million in 2016 and 2015, respectively. We anticipate that our fiscal 2016 capital expenditures will not exceed $68.5 million (excluding external contributions of $28.5 million, reducing anticipated net capital investments to $40.0 million).
Net cash used in financing activities was $37.7 million and $37.0 million in 2016 and 2015, respectively.
Aside from planned capital expenditures, the Companys primary cash requirements will be to service debt and finance working capital increases during peak selling seasons.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect reported amounts and disclosure of contingent assets and liabilities. There have been no significant changes in the critical accounting policies and estimates described in our Annual Report on Form 10-K for the year ended January 30, 2016.
Recently Adopted and Issued Accounting Standards
Recently adopted and issued accounting standards are discussed in Note 1 to the Consolidated Financial Statements.
Forward-Looking Statements
Certain information included in this report (as well as other communications made or to be made by the Company) and other materials filed or to be filed by the Company with the Securities and Exchange Commission contain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, which may be identified by words or phrases such as may, could, would, will, plan, expect, believe, anticipate, estimate, project, intend, look forward to or other similar expressions, including the Companys fiscal 2016 guidance and statements regarding enhancements to our online and mobile platforms, anticipated expense savings, future cash flows, inventory management initiatives and projected capital expenditures, involve important risks and uncertainties that could significantly affect results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. Factors that could cause such
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differences include, but are not limited to, risks related to retail businesses generally; a significant and prolonged deterioration of general economic conditions which could negatively impact the Company, including the potential write-down of the current valuation of intangible assets and deferred taxes; risks related to the Companys proprietary credit card program; potential increases in pension obligations; consumer spending patterns, debt levels, and the availability and cost of consumer credit; additional competition from existing and new competitors or changes in the competitive environment; inflation; deflation; changes in the costs of fuel and other energy and transportation costs; weather conditions that could negatively impact sales; uncertainties associated with expanding or remodeling existing stores; the ability to attract and retain qualified management; the dependence upon relationships with vendors and their factors; a data security breach or system failure; the ability to reduce or control SG&A expenses, including initiatives to reduce expenses and improve efficiency; operational disruptions; unsuccessful marketing initiatives; the ability to expand capacity and improve efficiency through the Companys new eCommerce fulfillment center; changes in, or the failure to successfully implement, our key strategies, including initiatives to improve our merchandising, marketing and operations; adverse outcomes in litigation; the incurrence of unplanned capital expenditures; the ability to obtain financing for working capital, capital expenditures and general corporate purposes; the impact of regulatory requirements including the Health Care Reform Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act; the inability or limitations on the Companys ability to favorably adjust the valuation allowance on deferred tax assets; and the financial condition of mall operators. Additional factors that could cause the Companys actual results to differ from those contained in these forward-looking statements are discussed in greater detail under Item 1A of the Companys Annual Report on Form 10-K for fiscal 2015 filed with the Securities and Exchange Commission.
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