Summary of BON TON STORES INC

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
For purposes of the following discussion, references to "first quarter of 2007" are to the thirteen-week period ended May 5, 2007. References to "second quarter of 2007" are to the thirteen-week period ended August 4, 2007. References to "third quarter of 2007" and "third quarter of 2006" are to the thirteen-week periods ended November 3, 2007 and October 28, 2006, respectively. References to "2007" and "2006" are to the thirty-nine weeks ended November 3, 2007 and October 28, 2006, respectively. References to the "Company," "we," "us," and "our" refer to The Bon-Ton Stores, Inc. and its subsidiaries. References to "Carson's" are to the Northern Department Store Group acquired by the Company from Saks Incorporated ("Saks") in March 2006. References to "Bon-Ton" refer to the Company's stores operating under the Bon-Ton and Elder-Beerman nameplates. References to "Parisian" refer to the stores acquired from Belk, Inc. ("Belk") in October 2006.
Overview
We are one of the largest regional department store operators (in terms of sales) 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 operate 280 stores, which includes ten furniture galleries, in 23 states in the Northeast, Midwest and upper Great Plains under the Bon-Ton, Bergner's, Boston Store, Carson Pirie Scott, Elder-Beerman, Herberger's and Younkers nameplates and, under the Parisian nameplate, three stores in the Detroit, Michigan area, encompassing a total of approximately 26 million square feet. Our management believes we hold the #1 or #2 market position among traditional department stores in most of the markets in which we operate.
Effective March 5, 2006, we purchased all of the outstanding securities of two subsidiaries of Saks that were solely related to the business of owning and operating Carson's, which was comprised of 142 retail department stores. The stores were located in 12 states in the Midwest and upper Great Plains regions and operated under the names Carson Pirie Scott, Younkers, Herberger's, Boston Store and Bergner's. Under the terms of the purchase agreement, we paid approximately $1.0 billion in cash for Carson's. Carson's stores encompass a total of approximately 15 million square feet in mid-size and metropolitan markets.
On October 25, 2006, we entered into an asset purchase agreement with Belk pursuant to which we agreed to purchase assets in connection with four department stores, all operated under the Parisian nameplate, and the rights to construct a new Parisian store, which opened October 18, 2007. The purchase price was $22.0 million in cash, subject to certain closing revisions. In addition, we agreed to assume specific liabilities and obligations of Belk and its affiliates with respect to the acquired Parisian stores. The acquisition of Parisian was effective as of October 29, 2006.
We compete in the department store segment of the U.S. retail industry. The department store industry continues to evolve in response to ongoing consolidation among merchandise vendors as well as the evolution of competitive retail formats - mass merchandisers, national chain retailers, specialty retailers and online retailers. Our segment of the retail industry is highly competitive, and we foresee competitive pressures and challenges continuing in the future. As such, we anticipate decreased comparable store sales and a reduction in the gross margin rate in fiscal 2007 (fifty-two weeks ending February 2, 2008) compared to fiscal 2006 (fifty-three weeks ended February 3, 2007).

THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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
                                            November 3,         October 28,         November 3,         October 28,
                                               2007                2006                2007                2006
Net sales                                          100.0 %             100.0 %             100.0 %             100.0 %
Other income                                         3.2                 2.8                 3.1                 2.7

                                                   103.2               102.8               103.1               102.7

Costs and expenses:
Costs of merchandise sold                           65.2                63.4                64.6                63.8
Selling, general and administrative                 34.0                34.0                35.1                34.6
Depreciation and amortization                        3.9                 3.6                 3.9                 3.5
Amortization of lease-related interests              0.2                 0.1                 0.2                 0.1

Income (loss) from operations                          -                 1.7                (0.6 )               0.7
Interest expense, net                                3.5                 3.5                 3.7                 3.7

Loss before income taxes                            (3.5 )              (1.8 )              (4.3 )              (3.1 )
Income tax benefit                                  (1.0 )              (0.4 )              (1.5 )              (1.1 )

Net loss                                            (2.5 )%             (1.4 )%             (2.9 )%             (2.0 )%

Thirteen Weeks Ended November 3, 2007 Compared to Thirteen Weeks Ended October 28, 2006
Net sales: Net sales in the third quarter of 2007 were $780.8 million, compared to $804.1 million in the third quarter of 2006, a decrease of $23.3 million, or 2.9%. Bon-Ton and Carson's combined comparable store sales decreased 3.0%. We believe the comparable store net sales decline reflects the unseasonably warm weather in our geographic regions in September and October, the effect of which offset sales gains achieved during back-to-school and the early fall season. We also believe a challenging macroeconomic environment, the result of a weak housing market, mortgage and credit market concerns and rising energy prices, has pressured consumer spending.
Merchandise categories with sales increases in the period were Home (which includes Furniture), Better Sportswear (included in Women's Apparel) and Cosmetics. The increase in Home was driven by an overall strong performance at Bon-Ton stores and sales of novelty electronic gift items and mattresses throughout the Company. Better Sportswear sales increased as customers responded favorably to expanded offerings from key vendors. Sales in Cosmetics benefited from the introduction of new fragrances as well as the expansion of certain fragrances into additional stores.
The poorest performing categories in the period were Coats, Dresses and Moderate Sportswear (all included in Women's Apparel) and Juniors. Sales in Coats, Dresses and Moderate Sportswear were adversely affected by the unseasonable weather. The performance in Dresses was also affected by an adjusted receipt flow, with increased merchandise receipts planned for the fourth quarter. The sales performance in Juniors reflects what we believe is a general market weakness, with slower denim and sweater sales.

THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other income: Other income, which includes income from revenues received under the Credit Card Program Agreement ("CCPA") with HSBC Bank Nevada, N.A., leased departments and other customer revenues, was $24.6 million, or 3.2% of net sales, in the third quarter of 2007 as compared to $22.9 million, or 2.8% of net sales, in the third quarter of 2006. The increase was primarily due to the program revenue received under the CCPA.
Costs and expenses: Gross margin in the third quarter of 2007 decreased $22.2 million to $272.0 million as compared to $294.3 million in the comparable prior year period, reflecting both decreased sales volume and a decrease in the gross margin rate. Gross margin as a percentage of net sales decreased 1.8 percentage points to 34.8% in the third quarter of 2007 from 36.6% in the same period last year, primarily due to increased net markdowns in the period. Selling, general and administrative ("SG&A") expense in the third quarter of 2007 was $265.3 million as compared to $273.6 million in the third quarter of 2006, a decrease of $8.3 million. The primary factors in the decrease in SG&A expense were reductions in integration expenses and increased efficiencies in operations in the current year, partially offset by increased store pre-opening expenses and increases in those costs affected by normal inflationary adjustments. The current year expense rate, at 34.0% of net sales, was even with the comparable prior year period.
Depreciation and amortization expense and amortization of lease-related interests increased $1.8 million, to $31.4 million, in the third quarter of 2007 from $29.6 million in the third quarter of 2006, primarily reflecting the increased expense associated with asset additions.
Income from operations: Income from operations in the third quarter of 2007 decreased by $13.9 million to $0.0 million, or 0.0% of net sales, as compared to income from operations of $14.0 million, or 1.7% of net sales, in the comparable prior year period.
Interest expense, net: Interest expense, net, decreased slightly to $27.4 million, or 3.5% of net sales, in the third quarter of 2007 as compared to $27.9 million, or 3.5% of net sales, in the third quarter of 2006. Income tax benefit: The income tax benefit reflects an effective tax rate of 29.2% in the third quarter of 2007 as compared to 22.0% in the comparable prior year period. The income tax rates in the third quarter of each of 2007 and 2006 reflect a revision of the respective year-to-date effective tax rates, largely due to a changing mix of taxable income and losses within various subsidiaries of the Company and recognition of the respective third quarter federal and state exposure changes.
Net loss: Net loss in the third quarter of 2007 was $19.4 million, or 2.5% of net sales, as compared to a net loss of $10.9 million, or 1.4% of net sales, in the third quarter of 2006.
Thirty-Nine Weeks Ended November 3, 2007 Compared to Thirty-Nine Weeks Ended October 28, 2006
Net sales: Net sales in 2007 increased 5.4% to $2,227.0 million from $2,112.6 million in 2006. Sales in 2007 include Carson's operations for the thirty-nine-week period; the prior year period included Carson's operations for the thirty-four weeks following the acquisition. The total sales increase reflects the inclusion of the additional five weeks of sales from Carson's as well as sales at the acquired Parisian stores, partially offset by a reduction for closed stores. The balance of sales in 2007 reflects a Bon-Ton comparable store net sales decrease of 7.4% and a Carson's comparable store net sales decrease of 1.0%, which, in total, approximates $71 million.
We believe that the comparable store net sales decrease in 2007 was due to unseasonable weather in our geographic regions in April, September and October, the elimination of the prior year liquidation of non-go-forward merchandise in Bon-Ton stores and, as discussed in more detail above, a challenging macroeconomic environment.

THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The best performing merchandise categories in the period were Children's Apparel and Better Sportswear (included in Women's Apparel). Children's Apparel benefited from increased inventory investment, a promotional event in the first quarter of 2007 and the introduction of new vendors. Better Sportswear sales increased as customers responded favorably to our new and expanded offerings of private brand merchandise and key branded vendors.
The poorest performing categories in the period were Home (which includes furniture) and Coats and Moderate Sportswear (both included in Women's Apparel). A strong third quarter sales performance in the Home area served to partially mitigate the year-to-date decrease; the thirty-nine week decrease is primarily due to the elimination of the prior year liquidation event, the impact of which was particularly significant in the second quarter of 2007. Sales in Coats and Moderate Sportswear were adversely impacted by the unseasonable weather. Moderate Sportswear was also impacted by the elimination of the prior year liquidation of non-go-forward merchandise.
Other income: Other income was $69.4 million, or 3.1% of net sales, in 2007 as compared to $57.6 million, or 2.7% of net sales, in 2006. The increase was primarily due to the inclusion of thirty-nine weeks of Carson's operations in the current year as compared to thirty-four weeks in the prior year and an increase in the program revenue received under the CCPA.
Costs and expenses: Gross margin in 2007 was $788.3 million as compared to $765.3 million in 2006, an increase of $23.0 million. The increase in gross margin dollars is primarily attributable to the inclusion of thirty-nine weeks of Carson's operations in the current year as compared to thirty-four weeks of Carson's operations in the prior year. Gross margin as a percentage of net sales decreased 0.8 percentage point to 35.4% in 2007 from 36.2% in 2006. The decrease in the gross margin rate primarily reflects the inclusion of Carson's sales and markdowns for the first five weeks of the current year, a historically clearance-driven period with reduced margins, and increased net markdowns in the third quarter.
SG&A expense in 2007 was $780.9 million compared to $731.7 million in 2006, an increase of $49.2 million. The primary factors in the increase in SG&A expense were the inclusion of thirty-nine weeks of Carson's operations in the current year as compared to thirty-four weeks of Carson's operations in the prior year period and increases in those costs affected by normal inflationary adjustments. These increases were partially offset by a reduction in integration expenses and increased efficiencies in operations in 2007. The current year expense rate increased 0.5 percentage point to 35.1% of net sales.
Depreciation and amortization expense and amortization of lease-related interests increased $14.5 million, to $91.1 million, in 2007 from $76.7 million in 2006, primarily the result of including thirty-nine weeks of Carson's operations in the current year expense as compared to thirty-four weeks of Carson's operations in the prior year period as well as the increased expense associated with asset additions.
(Loss) income from operations: The loss from operations in 2007 was $14.3 million, or 0.6% of net sales, as compared to income from operations of $14.6 million, or 0.7% of net sales, in 2006. Interest expense, net: Net interest expense was $82.3 million, or 3.7% of net sales, in 2007 as compared to $79.1 million, or 3.7% of net sales, in 2006. The $3.2 million net increase is principally due to thirty-nine weeks of interest expense on debt incurred in connection with the acquisition of Carson's as compared to thirty-four weeks of such interest expense in the prior year, partially offset by a nonrecurrent prior year charge of $6.8 million for the write-off of fees associated with a bridge facility and the early extinguishment of previous debt.

THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Income tax benefit: The income tax benefit reflects an effective tax rate of 34.1% in 2007 as compared to 35.7% in 2006. The current year decrease reflects the effect of the changing mix of taxable income and recognized taxable losses within various subsidiaries of the Company.
Net loss: Net loss in 2007 was $63.6 million, or 2.9% of net sales, compared to a net loss of $41.5 million, or 2.0% of net sales, in 2006. Seasonality and Inflation
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 back-to-school and 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 revolving credit facility.
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. We do not believe inflation had a material effect on operating results during the first thirty-nine weeks of 2007 or 2006. However, there can be no assurance that our business will not be affected by material inflationary adjustments in the future.
Liquidity and Capital Resources
The following table summarizes material measures of the Company's liquidity and capital resources:

                                                    November 3,       October 28,
   (Dollars in millions)                               2007              2006

   Working capital                                 $       550.1     $       442.2
   Current ratio                                          1.86:1            1.72:1
   Debt to total capitalization (1)                       0.83:1            0.84:1
   Unused availability under lines of credit (2)   $       253.6     $       247.8


(1)   Debt includes
      obligations
      under capital
      leases. Total
      capitalization
      includes
      shareholders'
      equity, debt
      and
      obligations
      under capital
      leases.

(2)   Subject to a
      minimum
      borrowing
      availability
      covenant of
      $75 as of
      November 3,
      2007 and
      October 28,
      2006.

Our primary sources of working capital are cash flows from operations and borrowings under our revolving credit facility, which provides for up to $1.0 billion in borrowings.
Increases in working capital and the current ratio are primarily due to increased levels of merchandise inventories as a result of higher planned ending inventory balances reflecting the calendar shift resulting from the 53rd week in fiscal 2006. The increase in unused availability under lines of credit as compared to the prior year primarily reflects a decrease in standby letters of credit to support the importing of merchandise and as collateral for obligations related to general liability and workers' compensation insurance.

THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net cash used in operating activities amounted to $111.8 million and $99.0 million in 2007 and 2006, respectively. The increase in net cash used in the current year primarily reflects the inclusion of Carson's operations for the full thirty-nine weeks of the period; an increased net loss; increased cash outlays for income taxes, bonus and profit sharing and higher merchandise inventories, the effect of which was partially offset by an increase in accounts payable.
Net cash used in investing activities amounted to $79.5 million in 2007, as compared to $1,118.5 million in 2006. The prior year cash outflow reflects the acquisition cost of Carson's.
Net cash provided by financing activities amounted to $190.6 million in 2007, as compared to $1,230.6 million in the prior year. The change primarily reflects prior year borrowings to fund the acquisition of Carson's, partially offset by increased cash requirements for current year operating activities. Aside from planned capital expenditures, our primary cash requirements will be to service debt and finance working capital increases during peak selling seasons.
We paid a quarterly cash dividend of $0.05 per share on shares of Class A Common Stock and Common Stock on May 1, 2007, August 1, 2007 and October 15, 2007 to shareholders of record as of April 16, 2007, July 16, 2007 and October 1, 2007, respectively. Additionally, a quarterly cash dividend of $0.05 per share was declared on December 5, 2007, payable January 15, 2008 to shareholders of record as of January 2, 2008. Our Board of Directors will consider dividends in subsequent periods as it deems appropriate.
Our capital expenditures in 2007 totaled $82.2 million. Capital expenditures for the full fiscal year 2007 (fifty-two weeks ending February 2, 2008), net of landlord contributions, are planned at approximately $106 million. Included in these planned amounts are expenditures relating to the opening of two new stores, expansions of three stores and the renovation and reconfiguration of several existing stores.
We anticipate that our cash flows from operations, supplemented by borrowings under our revolving credit facility, will be sufficient to satisfy our operating cash requirements for at least the next twelve months.
Cash flows from operations are impacted by consumer confidence, weather in the geographic markets served by the Company, and economic and 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.
We have not identified any probable circumstances that would likely impair our ability to meet our cash requirements or trigger a default or acceleration of payment of our debt.
Critical Accounting Policies
Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Preparation of these financial statements required us to make estimates and judgments that affected reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. On an ongoing basis, we evaluate our estimates, including those related to merchandise returns, bad debts, inventories, goodwill, intangible assets, income taxes, financings, contingencies, insurance reserves and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially lead to materially different results under different assumptions and conditions. We believe our critical accounting policies are as described below:
Inventory Valuation
Inventories are stated at the lower of cost or market with cost determined by the retail inventory method. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margin is derived by applying a calculated cost-to-retail ratio to the retail value of inventories. The retail inventory method is an averaging method that is widely used in the retail industry. Use of the retail inventory method will result in valuing inventories at the lower of cost or market if markdowns are taken timely as a reduction of the retail value of inventories.
Inherent in the retail inventory method calculation are certain significant management judgments and estimates including, among others, merchandise markups, markdowns and shrinkage, which significantly impact both the ending inventory valuation at cost and the resulting gross margin. These significant estimates, coupled with the fact that the retail inventory method is an averaging process, can, under certain circumstances, result in individual inventory components with cost above related net realizable value. Factors that can lead to this result include applying the retail inventory method to a group of products that is not fairly uniform in terms of its cost, selling price relationship and turnover; or applying the retail inventory method to transactions over a period of time that include different rates of gross profit, such as those relating to seasonal merchandise. In addition, failure to take timely markdowns can result in an overstatement of inventory under the lower of cost or market principle. We believe that the retail inventory method we use provides an inventory valuation that approximates cost and results in carrying inventory in the aggregate at the lower of cost or market.
We regularly review inventory quantities on-hand and record an adjustment for excess or old inventory based primarily on an estimated forecast of merchandise demand for the selling season. Demand for merchandise can fluctuate greatly. A significant increase in the demand for merchandise could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on-hand. Additionally, estimates of future merchandise demand may prove to be inaccurate, in which case we may have understated or overstated the adjustment required for excess or old inventory. If our inventory is determined to be overvalued in the future, we would be required to recognize such costs in costs of goods sold and reduce operating income at the time of such determination. Likewise, if inventory is later determined to be undervalued, we may have overstated the costs of goods sold in previous periods and would recognize additional operating income when such inventory is sold. Therefore, although every effort is made to ensure the accuracy of forecasts of future merchandise demand, any significant unanticipated changes in demand or in economic conditions within our markets could have a significant impact on the value of our inventory and reported operating results.
Prior to the Carson's acquisition, we utilized the last-in, first-out ("LIFO") cost basis for all of our inventories. In connection with the Carson's acquisition, we evaluated the inventory costing for the acquired inventories and elected the first-in, first-out ("FIFO") cost basis for certain of the acquired Carson's locations. As of February 3, 2007, approximately 30% of our inventories . . .