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 "second quarter of 2008" are to the thirteen-week period ended August 2, 2008. References to "third quarter of 2008" and "third quarter of 2007" are to the thirteen-weeks ended November 1, 2008 and November 3, 2007, respectively. References to "2008" and "2007" are to the thirty-nine weeks ended November 1, 2008 and November 3, 2007, respectively. References to "fiscal 2008" and "fiscal 2007" are to the fifty-two weeks ending January 31, 2009 and the fifty-two weeks ended February 2, 2008, respectively. References to "the Company," "we," "us," and "our" refer to The Bon-Ton Stores, Inc. and its subsidiaries. Overview
We are 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. Due primarily to the acquisition of The Elder-Beerman Stores Corp. in October 2003 and the acquisition of the Northern Department Store Group ("Carson's") from Saks Incorporated in March 2006, we have grown dramatically in recent years. Sales increased from $713 million in fiscal 2002 to $3.4 billion in fiscal 2007, and the number of stores increased from 72 stores operating in nine states in the Northeast to our current 281 stores in 23 states in the Northeast, Midwest and upper Great Plains. These stores, which include 12 furniture galleries and encompass a total of approximately 26 million square feet, are operated under the Bon-Ton, Bergner's, Boston Store, Carson Pirie Scott, Elder-Beerman, Herberger's and Younkers nameplates and, in the Detroit, Michigan area, under the Parisian nameplate.
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 continuing in the future. In addition, the economic environment has been challenging in 2008 and we expect it to remain so in the near-term. As such, in fiscal 2008 we expect a comparable store sales decrease of 6.5 to 7.5 percent, a reduced gross margin rate and reduced selling, general and administrative ("SG&A") expense as compared with fiscal 2007 results. Further deterioration of general economic conditions could negatively impact our expected operating results.

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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 1, November 3, November 1, November 3, 2008 2007 2008 2007 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Other income 3.1 3.2 3.2 3.1 103.1 103.2 103.2 103.1 Costs and expenses: Costs of merchandise sold 64.4 65.2 64.9 64.6 Selling, general and administrative 36.1 34.0 36.4 35.1 Depreciation and amortization 4.1 3.9 4.2 3.9 Amortization of lease-related interests 0.2 0.2 0.2 0.2 Goodwill impairment - - 0.8 - (Loss) income from operations (1.7 ) - (3.3 ) (0.6 ) Interest expense, net 3.4 3.5 3.5 3.7 Loss before income taxes (5.1 ) (3.5 ) (6.8 ) (4.3 ) Income tax benefit (3.1 ) (1.0 ) (2.9 ) (1.5 ) Net loss (2.0 )% (2.5 )% (3.9 )% (2.9 )%

Third Quarter of 2008 Compared with Third Quarter of 2007 Net sales: Net sales in the third quarter of 2008 were $724.9 million, compared with $780.8 million in the third quarter of 2007, reflecting a decrease of $55.9 million, or 7.2%. The Company's comparable store sales decreased 8.3% in the third quarter of 2008. We believe the comparable store sales decline was due to recent events in the financial markets and their impact on the wider economy, resulting in further weakened consumer confidence which has pressured consumer spending.
The best performing merchandise categories in the third quarter of 2008 were Coats (included in Women's Apparel) and Children's Apparel. Sales in Coats were driven by the arrival of seasonal weather and promotional activity in the period. Children's Apparel sales benefited from expanded and improved product selection in outerwear and branded playwear. The poorest performing categories in the period were Furniture (included in Home) and Petites, Better Sportswear and Dresses (all of which are included in Women's Apparel). Furniture sales were impacted by the continued deterioration in consumer spending for more expensive items. Apparel sales in Petites, Better Sportswear and Dresses remain difficult as economic concerns have resulted in reduced discretionary spending by our customer.
Other income: Other income, which includes income from revenues received under a credit card program agreement with HSBC Bank Nevada, N.A., leased departments and other customer revenues, was $22.7 million, or 3.1% of net sales, in the third quarter of 2008 as compared with $24.8 million, or 3.2% of net sales, in the third quarter of 2007. The decrease was primarily due to reduced sales volume in the period.
Costs and expenses: Gross margin in the third quarter of 2008 decreased $13.9 million to $258.1 million, as compared with $272.0 million in the comparable prior year period. The decrease in gross margin dollars is attributable to decreased sales volume. Gross margin as a percentage of net sales increased 0.8 percentage point to 35.6% in the third quarter of 2008 from 34.8% in the same period last year, primarily due to a decreased net markdown rate on reduced levels of inventory, improved aging of inventory and reduced distribution costs.
SG&A expense in the third quarter of 2008 was $261.9 million as compared with $265.4 million in the third quarter of 2007, reflecting a decrease of $3.5 million. The decrease primarily resulted from expense reductions in payroll and benefits in response to our sales trend, partially offset by incremental advertising expenditures in the period. The current year expense rate increased 2.1 percentage points to 36.1% of net sales, compared with 34.0% for the same period last year, as we were unable to leverage our expense savings due to the shortfall in sales.

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THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Depreciation and amortization expense and amortization of lease-related interests decreased $0.4 million, to $31.0 million in the third quarter of 2008 from $31.4 million in the third quarter of 2007.
(Loss) income from operations: The loss from operations in the third quarter of 2008 was ($12.0) million, or 1.7% of net sales, as compared with minimal income from operations in the comparable prior year period. Interest expense, net: Net interest expense was $24.7 million, or 3.4% of net sales, in the third quarter of 2008 as compared with $27.4 million, or 3.5% of net sales, in the third quarter of 2007. The $2.7 million decrease primarily reflects decreased borrowing levels and reduced interest rates. Income tax benefit: The income tax benefit reflects an effective tax rate of 61.0% in the third quarter of 2008, as compared with 29.2% in the third quarter of 2007. The current year increase resulted primarily from a favorable adjustment, pursuant to the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN No. 48"), of $7.0 million resulting from a statute-of-limitations expiration and, to a lesser extent, the impact on state income taxes from changes to the mix of taxable income and losses within various subsidiaries of the Company. Net loss: Net loss in the third quarter of 2008 was $14.3 million, or 2.0% of net sales, compared with a net loss of $19.4 million, or 2.5% of net sales, in the third quarter of 2007. 2008 Compared with 2007 Net sales: Net sales in 2008 were $2,098.6 million, compared with $2,227.0 million in 2007, reflecting a decrease of $128.5 million, or 5.8%. Comparable store sales decreased 6.3% in 2008. We believe the comparable store sales decline reflects the challenging economic environment throughout the thirty-nine week period - largely the result of mortgage and credit market concerns, a weak housing market and rising energy prices - which has pressured consumer spending. The best performing categories in 2008 were Coats (included in Women's Apparel) and Children's Apparel. Sales in Coats benefited from a strong third quarter performance, primarily due to seasonal weather and promotional activity. Sales increases in Children's Apparel primarily reflect growth within our private brand labels as well as expanded and improved product selection in key categories. The poorest performing categories in the period were Moderate Sportswear and Dresses (both included in Women's Apparel) and Furniture (included in Home). Sales in Moderate Sportswear and Dresses have been impacted by the challenging economic environment, which has resulted in reduced consumer spending on discretionary items. Moderate Sportswear was also affected by the decision made in fiscal 2007 by certain of our key vendors to exit the moderate sportswear business. We began receiving merchandise from new, replacement vendors in the third quarter of 2008, including some brands that are exclusive to Bon-Ton in our markets. Furniture sales were impacted by the continued deterioration in consumer spending for big-ticket purchases. Other income: Other income was $67.0 million, or 3.2% of net sales, in 2008 as compared with $69.9 million, or 3.1% of net sales, in 2007. The decrease primarily reflects reduced sales volume.

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THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Costs and expenses: Gross margin in 2008 was $737.3 million as compared with $788.3 million in 2007, reflecting a decrease of $51.0 million. The decrease in gross margin dollars is due to the decreased sales volume in the period and the reduction in the gross margin rate. Gross margin as a percentage of net sales decreased 0.3 percentage point to 35.1% in the current year from 35.4% last year, primarily due to an increased net markdown rate.
SG&A expense in 2008 was $764.1 million compared with $781.4 million in 2007, reflecting a decrease of $17.3 million. The decrease primarily resulted from expense reductions in payroll, benefits and advertising in response to our sales trend. Other expense reductions were due to increased efficiencies in operations and prior year store closing expenses. Despite the expense savings, the expense rate in 2008 increased 1.3 percentage points to 36.4% of net sales, compared with 35.1% in 2007, due to the reduced sales volume.
Depreciation and amortization expense and amortization of lease-related interests increased $1.2 million, to $92.3 million in 2008 from $91.1 million in 2007, primarily the result of increased expense associated with prior year asset additions.
The Company recorded a non-cash goodwill impairment charge of $17.8 million in the second quarter of 2008 in accordance with Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Intangible Assets" ("SFAS No. 142") as, based upon our review, the fair value of the Company's single reporting unit, estimated using a combination of our common stock trading value as of the end of the second quarter of 2008, a discounted cash flow analysis and other generally accepted valuation methodologies, was less than the carrying amount. See Note 3 in Notes to Consolidated Financial Statements.
Loss from operations: The loss from operations in 2008 was $69.8 million, or 3.3% of net sales, as compared with $14.3 million, or 0.6% of net sales, in 2007.
Interest expense, net: Net interest expense was $73.4 million, or 3.5% of net sales, in 2008 as compared with $82.3 million, or 3.7% of net sales, in 2007. The $8.9 million decrease principally reflects decreased borrowing levels and reduced interest rates in 2008, as well as $1.0 million of prior year expense incurred for the early extinguishment of debt.
Income tax benefit: The income tax benefit reflects an effective tax rate of 42.6% in 2008, as compared with 34.1% in 2007. The current year increase resulted primarily from a favorable adjustment, pursuant to the provisions of FIN No. 48, of $7.0 million resulting from a statute-of-limitations expiration and, to a lesser extent, the impact on state income taxes from changes to the mix of taxable income and losses within various subsidiaries of the Company. Net loss: Net loss in 2008 was $82.2 million, or 3.9% of net sales, compared with a net loss of $63.6 million, or 2.9% of net sales, in 2007. 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 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.

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THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources The following table summarizes material measures of the Company's liquidity and capital resources: November 1, November 3, (Dollars in millions) 2008 2007 Working capital $ 555.0 $ 550.1 Current ratio 1.96:1 1.86:1 Debt to total capitalization (1) 0.82:1 0.83:1 Unused availability under lines of credit (2) $ 213.7 $ 253.6

(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 1, 2008 and November 3, 2007.

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.
The decrease in unused availability under lines of credit as compared with the prior year primarily reflects our ability to utilize our liquidity position to support certain vendors, primarily those smaller in size, while taking advantage of discount terms that have been offered on short-term accelerated payments to benefit gross margin in subsequent periods. These short-term accelerated payments are expected to continue through the holiday season. We expect our excess borrowing capacity to increase in the fourth quarter, consistent with the prior year pattern, which will support the working capital and operational needs of our business.
Net cash used in operating activities was $98.1 million and $104.9 million in 2008 and 2007, respectively. The decrease primarily reflects reduced working capital requirements, most notably in income taxes payable and accrued expenses. Net cash used in investing activities was $76.3 million in 2008, as compared with $86.4 million in 2007, primarily the result of reduced capital expenditures in the current year.
Net cash provided by financing activities was $170.0 million in 2008, as compared with $190.6 million in the prior year. The change primarily reflects reduced net borrowings due to decreased cash requirements for current year operating activities and reduced capital expenditures.
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, 2008, August 1, 2008 and November 3, 2008 to shareholders of record as of April 15, 2008, July 15, 2008 and October 15, 2008, respectively. Additionally, a quarterly cash dividend of $0.05 per share was declared on November 18, 2008, payable February 2, 2009 to shareholders of record as of January 15, 2009. Our Board of Directors will consider dividends in subsequent periods as it deems appropriate.
Capital expenditures for 2008, which do not reflect landlord contributions of approximately $14.7 million, totaled $76.6 million. Capital expenditures for fiscal 2008, reduced by landlord contributions, are planned at approximately $70.0 million. Included in these planned amounts are expenditures relating to the opening of two new stores, expansions of two stores and renovation of an existing store as well as expenditures relating to information systems.

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THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 requires us to make estimates and judgments that affect 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, inventories, goodwill, intangible assets, income taxes, financings, contingencies, insurance reserves, litigation and pension and supplementary retirement plans. 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.
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. Our critical accounting policies are 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 has been 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 or 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.

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THE BON-TON STORES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We regularly review inventory on-hand and record an adjustment for excess or old inventory based primarily on a 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 on-hand. Additionally, estimates of 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 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 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 the majority of the acquired Carson's locations. As of February 2, 2008, approximately 32% of our inventories were valued using a FIFO cost basis and approximately 68% of our inventories were valued using a LIFO cost basis. As is currently the case with many companies in the retail industry, our LIFO calculations yielded inventory increases in recent prior years due to deflation reflected in price indices used. The LIFO method values merchandise sold at the cost of more recent inventory purchases (which the deflationary indices indicated to be lower), resulting in the general inventory on-hand being carried at the older, higher costs. Given these higher values and the promotional retail environment, we have reduced the carrying value of our LIFO inventories to an estimated realizable value. These reductions totaled $37.0 million as of November 1, 2008 and February 2, 2008. Inherent in the valuation of inventories are significant management judgments and estimates regarding future merchandise selling costs and pricing. Should these estimates prove to be inaccurate, we may have overstated or understated our inventory carrying value. In such cases, operating results would ultimately be impacted.
Vendor Allowances
As is standard industry practice, allowances from merchandise vendors are received as reimbursement for charges incurred on marked-down merchandise. Vendor allowances are generally credited to costs of goods sold, provided the allowance is: (1) collectable, (2) for merchandise either permanently marked down or sold, (3) not predicated on a future purchase, (4) not predicated on a future increase in the purchase price from the vendor, and (5) authorized by internal management. If the aforementioned criteria are not met, the allowances are reflected as an adjustment to the cost of merchandise capitalized in inventory.
Additionally, allowances are received from vendors in connection with cooperative advertising programs and for reimbursement of certain payroll expenses. These allowances received from each vendor are reviewed to ensure reimbursements are for specific, incremental and identifiable advertising or payroll costs incurred to sell the vendor's products. If a vendor reimbursement exceeds the costs incurred, the excess reimbursement is recorded as a reduction of cost purchases from the vendor and reflected as a reduction of costs of merchandise sold when the related merchandise is sold. All other amounts are recognized as a reduction of the related advertising or payroll costs that have been incurred and reflected in SG&A expense.

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