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 October 28, 2017, The Bon-Ton Stores, Inc. operated, through its subsidiaries, 260 stores, including nine furniture galleries and four clearance centers, in 24 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 28, 2017.
For purposes of the following discussion, references to the third quarter of 2017 and the third quarter of 2016 are to the 13 weeks ended October 28, 2017 and October 29, 2016, respectively. References to fiscal 2018 are to the 52 weeks ending February 2, 2019; references to fiscal 2017 are to the 53 weeks ending February 3, 2018; references to fiscal 2016 are to the 52 weeks ended January 28, 2017.
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.
Recently Adopted Accounting Standards
Effective January 29, 2017, the Company adopted Accounting Standards Update (ASU) No. 2016-09,
Stock Compensation
. The new standard is intended to simplify several aspects of the accounting for share-based payment award transactions. In connection with the adoption of this standard, the Company made a policy election to record the expense associated with forfeitures under its share-based payment plans when they occur (rather than estimating forfeitures and recording over the vesting term of the award). The Company made this election to reduce the complexity of accounting for its awards. The Company used a modified retrospective approach to recording this change and recorded a $500 increase to both additional paid-in capital and accumulated deficit at the time of the adoption to eliminate the forfeiture estimates previously recorded for awards outstanding as of January 29, 2017.
7
THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
Due to the Companys net loss position, weighted average unvested restricted shares (participating securities) of 701,857 and 1,399,101 for the third quarter in each of 2017 and 2016, respectively, and 1,063,304 and 1,333,897 for the 39 weeks ended October 28, 2017 and October 29, 2016, respectively, were not considered in the calculation of net loss available to common shareholders used for both basic and diluted EPS.
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.
The carrying values of the Companys cash and cash equivalents, accounts payable and financial instruments reported within prepaid expenses and other current assets and other long-term assets approximate fair value.
The carrying value and estimated fair value of the Companys debt, excluding capital lease and financing obligations and unamortized second lien senior secured notes deferred financing costs and discount on senior secured credit facility Tranche A-1, as of October 28, 2017 are as follows:
|
|
|
|
|
|
Fair Value Measurements Using
|
|
|
|
Carrying
Value
|
|
Estimated
Fair Value
|
|
Quoted
Prices in
Active
Markets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Second lien senior secured notes
|
|
$
|
350,000
|
|
$
|
130,536
|
|
$
|
130,536
|
|
$
|
|
|
$
|
|
|
Senior secured credit facility
|
|
666,387
|
|
666,387
|
|
|
|
|
|
666,387
|
|
Total
|
|
$
|
1,016,387
|
|
$
|
796,923
|
|
$
|
130,536
|
|
$
|
|
|
$
|
666,387
|
|
The carrying value and estimated fair value of the Companys debt, excluding capital lease and financing obligations and unamortized second lien senior secured notes deferred financing costs and discount on senior secured credit facility Tranche A-1, as of October 29, 2016 are as follows:
|
|
|
|
|
|
Fair Value Measurements Using
|
|
|
|
Carrying
Value
|
|
Estimated
Fair Value
|
|
Quoted
Prices in
Active
Markets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Second lien senior secured notes
|
|
$
|
407,292
|
|
$
|
237,327
|
|
$
|
237,327
|
|
$
|
|
|
$
|
|
|
Senior secured credit facility
|
|
572,131
|
|
572,131
|
|
|
|
|
|
572,131
|
|
Total
|
|
$
|
979,423
|
|
$
|
809,458
|
|
$
|
237,327
|
|
$
|
|
|
$
|
572,131
|
|
The carrying value and estimated fair value of the Companys debt, excluding capital lease and financing obligations and unamortized second lien senior secured notes deferred financing costs and discount on senior secured credit facility Tranche A-1, as of January 28, 2017 are as follows:
9
THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
6.
EXIT OR DISPOSAL ACTIVITIES
The following table summarizes exit or disposal activities during the 39 weeks ended October 28, 2017 related to store closings in fiscal 2017 and 2016 and the Companys expense efficiency initiative:
|
|
Termination
Benefits
|
|
Other
Costs
|
|
Total
|
|
Accrued balance as of January 28, 2017
|
|
$
|
952
|
|
$
|
|
|
$
|
952
|
|
Provisions
|
|
|
|
|
|
|
|
Thirteen weeks ended April 29, 2017
|
|
132
|
|
239
|
|
371
|
|
Thirteen weeks ended July 29, 2017
|
|
421
|
|
34
|
|
455
|
|
Thirteen weeks ended October 28, 2017
|
|
197
|
|
366
|
|
563
|
|
Payments
|
|
|
|
|
|
|
|
Thirteen weeks ended April 29, 2017
|
|
(666
|
)
|
(239
|
)
|
(905
|
)
|
Thirteen weeks ended July 29, 2017
|
|
(313
|
)
|
(34
|
)
|
(347
|
)
|
Thirteen weeks ended October 28, 2017
|
|
(213
|
)
|
(366
|
)
|
(579
|
)
|
Accrued balance as of October 28, 2017
|
|
$
|
510
|
|
$
|
|
|
$
|
510
|
|
The above provisions were included within selling, general and administrative expense.
The Company recorded $1,250 and $9,060 of gains related to various real estate transactions which were included in selling, general and administrative expense during the 13 and 39 weeks ended October 28, 2017, respectively.
7.
EMPLOYEE DEFINED AND POSTRETIREMENT BENEFIT PLANS
The Company provides benefits to certain current and former associates who are eligible under a qualified defined benefit pension plan and various non-qualified supplemental pension plans (collectively, the Pension Plans). Net periodic benefit expense for the Pension Plans includes the following (income) and expense components:
|
|
THIRTEEN
|
|
THIRTY-NINE
|
|
|
|
WEEKS ENDED
|
|
WEEKS ENDED
|
|
|
|
October 28,
|
|
October 29,
|
|
October 28,
|
|
October 29,
|
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Interest cost
|
|
$
|
1,667
|
|
$
|
1,786
|
|
$
|
4,999
|
|
$
|
5,355
|
|
Expected return on plan assets
|
|
(1,934
|
)
|
(2,100
|
)
|
(5,801
|
)
|
(6,300
|
)
|
Recognition of net actuarial loss
|
|
1,406
|
|
1,571
|
|
4,220
|
|
4,714
|
|
Net periodic benefit expense
|
|
$
|
1,139
|
|
$
|
1,257
|
|
$
|
3,418
|
|
$
|
3,769
|
|
During the 39 weeks ended October 28, 2017, contributions of $434 were made to the Pension Plans. The Company anticipates contributing an additional $121 to fund the Pension Plans in fiscal 2017 for an annual total of $555.
The Company also provides medical and life insurance benefits to certain former associates under a postretirement benefit plan (Postretirement Benefit Plan). Net periodic benefit income for the Postretirement Benefit Plan includes the following (income) and expense components:
11
THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
|
|
THIRTEEN
|
|
THIRTY-NINE
|
|
|
|
WEEKS ENDED
|
|
WEEKS ENDED
|
|
|
|
October 28,
|
|
October 29,
|
|
October 28,
|
|
October 29,
|
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Interest cost
|
|
$
|
13
|
|
$
|
16
|
|
$
|
39
|
|
$
|
47
|
|
Recognition of net actuarial gain
|
|
(122
|
)
|
(107
|
)
|
(369
|
)
|
(323
|
)
|
Net periodic benefit income
|
|
$
|
(109
|
)
|
$
|
(91
|
)
|
$
|
(330
|
)
|
$
|
(276
|
)
|
During the 39 weeks ended October 28, 2017, the Company contributed $73 to fund the Postretirement Benefit Plan, and anticipates contributing an additional $194 to fund the Postretirement Benefit Plan in fiscal 2017 for an annual total of $267.
8.
DEBT
On October 24, 2017, The Bon-Ton Department Stores, Inc. and certain subsidiaries as borrowers and certain other subsidiaries as guarantors entered into a Sixth Amendment (the Sixth Amendment) to the Second Amended and Restated Loan and Security Agreement (Second Amended Revolving Credit Facility) with Bank of America, N.A., as Agent, and certain financial institutions as lenders. Among other matters, the Sixth Amendment amends required excess availability from 20% to 15% of the lesser of (a) the aggregate commitments and (b) the aggregate borrowing base through December 2, 2017. After December 2, 2017, the required excess availability will be the greater of (a) 20% of the lesser of (i) the aggregate commitments and (ii) the aggregate borrowing base and (b) $132,500. Through December 2, 2017, the excess availability will be determined on the basis of the Tranche A Borrowing Base, and not the lower of the Tranche A Commitments and the Tranche A Borrowing Base. As a result of the Sixth Amendment, in accordance with accounting principles generally accepted in the United States, the Company is required to reflect the Second Amended Revolving Credit Facility as a short-term borrowing in its balance sheet, although the outstanding balance does not mature until 2021.
On April 28, 2017, The Bon-Ton Department Stores, Inc. and certain subsidiaries as borrowers and certain other subsidiaries as guarantors entered into a Fifth Amendment (the Fifth Amendment) to the Second Amended Revolving Credit Facility. The Fifth Amendment extends the maturity date of the $730,000 Tranche A. Tranche A is now due to mature on April 28, 2022 provided that Tranche A-1 of the Second Amended Revolving Credit Facility (Tranche A-1) is repaid prior to March 15, 2021 or the maturity of Tranche A-1 is extended to at least April 28, 2022. If Tranche A-1 is not so repaid or so extended, or is extended to a date earlier than April 28, 2022, Tranche A will mature on the same date as Tranche A-1. In any event, Tranche A remains subject to a springing maturity date that is sixty days prior to the earliest of the maturity date of (1) any senior note debt (which is currently comprised of the 8.00% Second Lien Senior Secured Notes due June 15, 2021) and (2) if incurred, certain permitted debt secured by junior liens.
In connection with the Fifth Amendment, the Company incurred a loss on extinguishment of debt of $559 due to the write-off of certain deferred fees.
9.
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 2016 and the 39 weeks ended October 28, 2017 on all of the Companys net deferred tax assets. The Companys deferred tax asset valuation
12
THE BON-TON STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
allowance totaled $259,059, $230,298 and $206,089 as of October 28, 2017, October 29, 2016 and January 28, 2017, respectively.
The Company recorded net income tax benefits of $106 and $136 for the 13 and 39 weeks ended October 28, 2017, respectively, which includes $519 and $1,568 non-cash income tax benefits from continuing operations during the 13 and 39 weeks ended October 28, 2017, respectively. The Company recorded net income tax benefits of $158 and $446 for the 13 and 39 weeks ended October 29, 2016, respectively, which includes $591 and $1,784 non-cash income tax benefits from continuing operations during the 13 and 39 weeks ended October 29, 2016, 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 39 weeks ended October 28, 2017 and October 29, 2016, which are exactly offset by income tax expense on other comprehensive income. The net income tax expense and benefit includes $413 and $1,432 recorded in the 13 and 39 weeks ended October 28, 2017, respectively, and $433 and $1,338 recorded in the 13 and 39 weeks ended October 29, 2016, respectively, for recognition of deferred tax liabilities associated with indefinite-lived assets.
10.
CONTINGENCIES
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.
11.
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 $519 and $591 for the third quarter in each of 2017 and 2016, respectively, and $1,568 and $1,784 for the 39 weeks ended on each of October 28, 2017 and October 29, 2016, respectively (see Note 9).
The before-tax amount of amortization of net actuarial loss (gain) (see Note 7) was recorded within selling, general and administrative expense.
12.
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 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 October 28, 2017, October 29, 2016 and January 28, 2017 and for the third quarter in each
13
ITEM 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For purposes of the following discussion, references to the third quarter of 2017 and the third quarter of 2016 are to the 13 weeks ended October 28, 2017 and October 29, 2016, respectively. References to 2017 and 2016 are to the 39 weeks ended October 28, 2017 and October 29, 2016, respectively. References to fiscal 2018 are to the 52-week period ending February 2, 2019; references to fiscal 2017 are to the 53-week period ending February 3, 2018; references to fiscal 2016 are to the 52-week period ended January 28, 2017. 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 260 stores, including nine furniture galleries and four clearance centers, in 24 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 24 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 2017 Guidance
During the third quarter of 2017, we made progress on a number of our strategic initiatives:
·
Experienced strength in key merchandise categories and brands and drove continued double-digit growth in our omnichannel business (reflecting sales via our website, mobile site and our
Let Us Find It
customer service program) as compared to the third quarter of 2017;
·
Continued to effectively execute on a number of profit improvement initiatives, substantially reducing our selling, general and administrative (SG&A) expense for the quarter; and
·
Maintained careful inventory controls, as we reduced inventory by 10% as compared to the third quarter of 2016.
Comparable store sales decreased 6.6% in the third quarter of 2017, largely due to unseasonably warm weather and the continuation of soft mall traffic trends, although we experienced a favorable 3.1% comparable store sales increase for the four weeks ended November 25, 2017, as compared with the same period in fiscal 2016. We are taking more aggressive actions to fuel improved performance. We are working to enhance our merchandise assortment, drive growth in omnichannel and implement a more focused marketing strategy to improve traffic and customer engagement. We have retained consultants to assist us with our strategy to improve our competitive position and our financial performance, and we continue to evaluate ways we can improve our performance, including through the previously announced plan to close at least 40 stores by the end of fiscal 2018.
On October 24, 2017, we amended our Second Amended and Restated Loan and Security Agreement (the Second Amended Revolving Credit Facility) which provides us with immediate flexibility and additional liquidity under the facility. See Liquidity and Capital Resources for further discussion on this amendment.
On November 16, 2017, we revised our fiscal 2017 guidance. We expect loss per share to be in a range of $2.86 to $3.35, inclusive of a $0.05 per share expense from the 53
rd
week.
23
Updated assumptions reflected in our full-year guidance include the following:
·
A comparable store sales decrease ranging from 4.5% to 5.5%, which excludes sales from the 53rd week;
·
A gross margin rate ranging from a 50- to 65-basis-point decrease from the fiscal 2016 rate of 35.5%;
·
SG&A expense between $836 million and $840 million, including approximately $10 million for the 53rd week, compared to SG&A expense of $880.6 million in fiscal 2016;
·
Capital expenditures not to exceed $30 million, net of external contributions; and
·
An estimated 20.3 million weighted average diluted shares outstanding.
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
|
|
THIRTY-NINE
|
|
|
|
WEEKS ENDED
|
|
WEEKS ENDED
|
|
|
|
October 28,
|
|
October 29,
|
|
October 28,
|
|
October 29,
|
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Net sales
|
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
Other income
|
|
3.1
|
|
2.9
|
|
3.5
|
|
3.0
|
|
|
|
103.1
|
|
102.9
|
|
103.5
|
|
103.0
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
Costs of merchandise sold
|
|
66.9
|
|
64.9
|
|
66.5
|
|
64.9
|
|
Selling, general and administrative
|
|
37.2
|
|
36.2
|
|
37.8
|
|
37.3
|
|
Depreciation and amortization
|
|
3.6
|
|
3.8
|
|
4.1
|
|
4.1
|
|
Amortization of lease-related interests
|
|
0.2
|
|
0.2
|
|
0.2
|
|
0.2
|
|
Impairment charges
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
(4.8
|
)
|
(2.2
|
)
|
(5.0
|
)
|
(3.5
|
)
|
Interest expense, net
|
|
3.5
|
|
3.1
|
|
3.5
|
|
2.8
|
|
Loss on extinguishment of debt
|
|
|
|
0.1
|
|
|
|
|
|
Loss before income taxes
|
|
(8.2
|
)
|
(5.4
|
)
|
(8.5
|
)
|
(6.3
|
)
|
Income tax benefit
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
(8.2
|
)%
|
(5.4
|
)%
|
(8.5
|
)%
|
(6.3
|
)%
|
Third Quarter of 2017 Compared with Third Quarter of 2016
Net sales
: Net sales in the third quarter of 2017 were $545.3 million, compared with $589.9 million in the third quarter of 2016, reflecting a decrease of 7.6%. Comparable store sales decreased 6.6% in the period due to unseasonably warm weather and the continuation of soft mall traffic trends.
The best performing merchandise categories in the third quarter of 2017 were Fine Jewelry (included in Accessories) and Hard Home (included in Home). Fine Jewelry benefited from the expansion of merchandise to additional doors and higher omnichannel sales. Hard Home primarily benefited from sales in key items.
Merchandise categories that were challenged in the period included Petites Sportswear and Coats (both included in Womens Apparel). Petites Sportswear was adversely impacted by the strategic reduction of
24
product offerings within certain categories and brands. Coats were adversely impacted by unseasonal weather patterns.
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 $17.1 million in the third quarter of 2017 as compared with $17.3 million in the third quarter of 2016. The decrease was primarily due to lower revenues associated with our proprietary credit card operations. Proprietary credit card sales, as a percentage of total sales, increased 90 basis points to 57.9% in the third quarter of 2017.
Costs and expenses
: Gross margin in the third quarter of 2017 decreased $26.8 million to $180.3 million as compared with $207.1 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 204 basis points to 33.1% in the third quarter of 2017 from 35.1% in the comparable prior year period, primarily due to an increase in the markdown rate driven by a shift in merchandise mix.
SG&A expense in the third quarter of 2017 decreased $11.2 million to $202.6 million as compared with $213.8 million in the third quarter of 2016. This reduction was largely due to savings associated with prior year closed stores and reductions in medical insurance, payroll, taxes and store occupancy costs. The current period expense rate, 37.2% of net sales, increased 91 basis points from that of the prior year period as a result of decreased sales volume.
Depreciation and amortization expense and amortization of lease-related interests decreased $2.5 million to $20.8 million in the third quarter of 2017 from $23.3 million in the third quarter of 2016.
Interest expense, net
: Net interest expense was $18.9 million in the third quarter of 2017 as compared with $18.2 million in the third quarter of 2016. The increase primarily reflects an increased weighted average interest rate and higher debt levels.
Income tax benefit
: The effective income tax rate in the third quarter in each of 2017 and 2016 largely reflects our valuation allowance position against all net deferred tax assets. The $0.1 million income tax benefit in the third quarter of 2017 includes a $0.5 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 third 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.
2017 Compared with 2016
Net sales
: Net sales in 2017 were $1,585.9 million, compared with $1,723.3 million in 2016, reflecting a decrease of 8.0%. Comparable store sales decreased 7.3% in the period due to continued soft mall traffic trends.
The best performing merchandise categories in 2017 were Fine Jewelry (included in Accessories) and Furniture (included in Home). Fine Jewelry benefited from strong promotional events, the expansion of merchandise to additional doors and higher omnichannel sales. Sales in Furniture increased through the expansion of merchandise to additional doors and sales increases in mattresses.
Merchandise categories that were challenged in the period included Petites Sportswear (included in Womens Apparel) and Accessories. Petites Sportswear was adversely impacted by the strategic reduction of product offerings within certain categories and brands. Accessories were adversely affected by lower sales of handbags, specifically within certain key brands.
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 $55.1 million in 2017 as compared with $51.0 million in 2016. The increase primarily reflects income associated with gift card breakage.
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Costs and expenses
: Gross margin in 2017 decreased $73.2 million to $532.1 million as compared with $605.2 million in 2016. Gross margin as a percentage of net sales decreased 157 basis points to 33.6% in 2017 from 35.1% in 2016, due primarily to an increase in the markdown rate.
SG&A expense in 2017 decreased $43.0 million to $598.9 million as compared with $641.9 million in 2016. This reduction was largely driven by expense control measures, specifically in store expenses, reductions in consulting fees, medical insurance, payroll, taxes and rent, as well as gains associated with various real estate transactions. The current period expense rate, 37.8% of net sales, increased 52 basis points from that of the prior year as a result of decreased sales volume in the current period.
Depreciation and amortization expense and amortization of lease-related interests decreased $5.5 million to $68.0 million in 2017 from $73.5 million in 2016.
Interest expense, net
: Net interest expense was $55.0 million in 2017 as compared with $48.4 million in 2016. The increase primarily reflects an increased weighted average interest rate and higher debt levels.
Loss on extinguishment of debt
: In 2017 and 2016, we recorded charges totaling $0.6 million and $0.7 million, respectively, due to the write-off of certain deferred financing fees in connection with amendments to the Second Amended Revolving Credit Facility.
Income tax benefit
: The effective income tax rate in each of 2017 and 2016 largely reflects our valuation allowance position against all net deferred tax assets. The $0.1 million income tax benefit in 2017 includes a $1.6 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 $0.4 million income tax benefit in 2016 includes a $1.8 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 (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 October 28, 2017, we had $7.3 million in cash and cash equivalents and $161.5 million available under our Second Amended Revolving Credit Facility (before taking into account the minimum borrowing availability covenant under such facility, which was $87.5 million at October 28, 2017). Excess availability was $302.7 million as of the comparable prior year period. The reduced excess availability primarily reflects the early payment of senior notes due July 2017 and higher borrowings to fund seasonal operations.
On October 24, 2017, The Bon-Ton Department Stores, Inc. and certain subsidiaries as borrowers and certain other subsidiaries as guarantors entered into a Sixth Amendment (the Sixth Amendment) to the Second Amended Revolving Credit Facility with Bank of America, N.A., as Agent, and certain financial institutions as lenders. Among other matters, the Sixth Amendment amends required excess availability from 20% to 15% of the lesser of (a) the aggregate commitments and (b) the aggregate borrowing base through December 2, 2017. After December 2, 2017, the required excess availability will be the greater of (a) 20% of the lesser of (i) the aggregate commitments and (ii) the aggregate borrowing base and (b) $132.5 million. Through December 2, 2017, the excess availability will be determined on the basis of the Tranche A Borrowing Base, and not the lower of the Tranche A Commitments and the Tranche A Borrowing Base.
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On April 28, 2017, The Bon-Ton Department Stores, Inc. and certain subsidiaries as borrowers and certain other subsidiaries as guarantors entered into a Fifth Amendment (the Fifth Amendment) to the Second Amended Revolving Credit Facility with Bank of America, N.A., as Agent, and certain financial institutions as lenders. The Fifth Amendment extends the maturity date of the $730 million Tranche A of the Second Amended Revolving Credit Facility. Tranche A is now due to mature on April 28, 2022 provided that Tranche A-1 of the Second Amended Revolving Credit Facility is repaid prior to March 15, 2021 or the maturity of Tranche A-1 is extended to at least April 28, 2022. If Tranche A-1 is not so repaid or so extended, or is extended to a date earlier than April 28, 2022, Tranche A will mature on the same date as Tranche A-1. In any event, Tranche A remains subject to a springing maturity date that is sixty days prior to the earliest of the maturity date of (1) any senior note debt (which is currently comprised of our 8.00% Second Lien Senior Secured Notes due June 15, 2021) and (2) if incurred, certain permitted debt secured by junior liens. For more information regarding the Second Amended Revolving Credit Facility, please see Managements Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources in our Annual Report on Form 10-K filed with the SEC on April 12, 2017.
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. In addition, our business and liquidity are dependent to a significant degree on our vendors and their factors. The loss of a key vendor, or material changes in support by them or factors, can have a material impact on our business. Given the Companys recent operating performance and the conditions in the retail industry environment in general, vendors may seek further assurances or take actions to protect against non-payment of amounts due them. Changes in this area could have a material adverse impact on our liquidity. As a consequence, borrowings under the Second Amended Revolving Credit Facility could reach maximum levels, or could result in required minimum excess availability thresholds not being met as defined above. To date, we have successfully managed our vendor relationships to maintain inventory purchases on acceptable payment terms. Based on our current expectations regarding the foregoing factors and our financial performance, 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. Management believes that our current balances of cash, projected cash flow from the holiday period and amounts available under our Second Amended Revolving Credit Facility will be adequate to fund short-term and longer term liquidity needs. However, our ability to fund operations and remain in compliance with the financial covenants under our borrowing arrangements is dependent on a number of factors, including our future operating performance and the factors mentioned above, some of which are beyond our control.
We have begun evaluating potential alternatives for the restructuring of our balance sheet and other strategic alternatives, and have engaged AlixPartners LLP and PJT Partners Inc. as advisors. There can be no assurance that any restructuring or other strategic transaction will occur on terms acceptable to us or at all.
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Cash (used in) provided by our operating, investing and financing activities is summarized as follows:
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THIRTY-NINE
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|
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WEEKS ENDED
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October 28,
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October 29,
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(Dollars in millions)
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|
2017
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2016
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|
|
|
|
|
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Operating activities
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$
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(160.4
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)
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$
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(81.0
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)
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Investing activities
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|
4.7
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|
(43.9
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)
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Financing activities
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|
156.3
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|
125.0
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|
|
|
|
|
|
|
|
|
Net cash used in operating activities was $160.4 million and $81.0 million in 2017 and 2016, respectively. The decrease in cash flow primarily reflects a higher net loss of $27.3 million and a $37.2 million unfavorable change in cash flow from working capital. The decrease in cash flow from working capital was largely due to unfavorable fluctuations of $113.6 million and $21.6 million in cash flows from accounts payable and prepaid expenses, respectively, partially offset by a favorable variance of $107.0 million in cash flows from inventories.
Net cash provided by investing activities was $4.7 million in 2017 compared with net cash used in investing activities of $43.9 million in 2016. In 2017, the inflow of cash includes $39.4 million of proceeds associated with various real estate transactions. Capital expenditures totaled $35.7 million and $43.9 million in 2017 and 2016, 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 $6.8 million and $20.9 million in 2017 and 2016, respectively. We anticipate that our fiscal 2017 capital expenditures will not exceed $44.1 million (excluding external contributions of $14.1 million, reducing anticipated net capital investments to $30.0 million).
Net cash used in financing activities was $156.3 million and $125.0 million in 2017 and 2016, respectively. The increase in cash used in financing activities is primarily a result of increased net borrowings to support current year operations.
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 28, 2017.
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 and in other communications made by the Company, including the Companys fiscal 2017 guidance, 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 such as may, could, will, plan, expect, anticipate, believe, estimate, project, intend, or other similar expressions, involve important risks and uncertainties that could significantly cause
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future results to differ from those expressed in any forward-looking statements. Factors that could cause such differences include, but are not limited to: risks related to retail businesses generally; deterioration of general economic conditions; 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; changes in energy and transportation costs; weather conditions that could negatively impact sales; 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; operational disruptions; unsuccessful marketing initiatives; the ability to improve efficiency through the Companys eCommerce fulfillment center; changes in, or the failure to successfully implement, our key strategies, including the store rationalization program and initiatives to improve our merchandising, marketing and operations; adverse outcomes in litigation; the ability to obtain financing for working capital, capital expenditures and general corporate purposes; the impact of regulatory requirements; the ability of the Company to change its capital structure; and the financial condition of mall operators. Any sales results reported herein do not necessarily predict the Companys performance for the full 2017 holiday season or for the fiscal fourth quarter as a whole. 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 2016 filed with the Securities and Exchange Commission. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.
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