Overview

General

We compete in the department store segment of the U.S. retail industry. Founded in 1898, the Company is one of the largest regional department store operators, offering a broad assortment of brand-name fashion apparel and accessories for women, men and children as well as cosmetics, home furnishings and other goods. We currently operate 280 stores 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, stores in the Detroit, Michigan area, encompassing a total of approximately 26 million square feet. The Company had net sales of $3.1 billion in 2008.

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 142 retail department stores. The stores are located in 12 states in the Midwest and upper Great Plains regions and operate 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.

To finance the acquisition and the payoff of our previous revolving credit facility, we entered into a new revolving credit facility which provides for up to $1.0 billion in borrowings, issued $510.0 million in senior unsecured notes, and entered into a new mortgage loan facility in the aggregate principal amount of $260.0 million.

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 in October 2007. The purchase price was $25.7 million in cash. 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 these Parisian stores was effective as of October 29, 2006.

Economic Factors and Company Performance

Our performance in 2008 reflects the declining U.S. economy and record low consumer confidence that have greatly impacted the retail industry, including the department store sector. A wide range of factors contributed to the difficult economic environment: a poor housing market, high energy costs, mortgage and credit market concerns, rising unemployment and a loss of wealth due to the decline in the stock market. We believe that, for these reasons, consumers were less willing to spend their discretionary income.

While we prudently managed variables within our control - inventory investment, operating expenses and capital expenditures - in response to the deteriorating economic situation, we were unable to counteract the severe external pressures. As a result, we reported a decline in sales and gross margin, as well as considerable asset impairments and an income tax valuation allowance adjustment, resulting in a significant loss for the year. Given the outlook of continued recessionary factors, we anticipate another difficult year in 2009. Assumptions in our 2009 projections include:

• a comparable store sales decrease in the range of 6.5% to 9.0%;

• a reduction in other income;

• a gross margin rate of 35.5% to 36.0%;

• a reduction of $70.0 million in our SG&A expenses; and

• an effective tax rate of 0%.

In response to the deepening economic crisis, we have implemented a cost savings plan in 2009 which builds upon the expense control efforts initiated in 2008; actions taken include the reduction of corporate and store personnel, the elimination of bonus payments for senior executives and merit-based wage increases for all associates, the suspension of employer contributions to our 401(k) plan, and the reduction of capital spending and inventory levels. The impact of these actions is estimated to be an annualized increase in income from operations of $70.0 million. Our cash flow in 2009 will benefit from these savings as well as the lower capital spending.

Summary of Charges

In 2008, we recognized material non-cash charges which we believe are primarily a result of the downturn in our business and the expectation that current economic challenges will impede near-term recovery in the retail sector. Our assessment of the recoverability of these assets considered Company-specific projections, assumptions about market rates and transactions and, in the case of goodwill, our market capitalization at the time of testing. As a result of the reviews, the following charges were recorded:

 (Dollars in millions, except per share data)                           Earnings per
 Category                                        Charge                Diluted Share


 Goodwill impairment                            $  (17.8 ) pre-tax     $        (0.71 )
 Long-lived assets impairment                      (17.9 ) pre-tax              (0.65 )
 Intangible assets impairment                       (8.1 ) pre-tax              (0.29 )
 Deferred tax valuation allowance adjustment      (108.5 ) after-tax            (6.46 )

The charges noted above compare unfavorably with a per share impact for asset impairment charges of $(0.16) in 2007.

Results of Operations

The following table summarizes changes in our selected operating indicators, illustrating the relationship of various income and expense items to net sales for each year presented (components may not add or subtract to totals because of rounding):

                                                        Percent of Net Sales
                                                   2008         2007        2006


        Net sales                                   100.0 %      100.0 %     100.0 %

        Other income                                  3.0          3.0         2.8

                                                    103.0        103.0       102.8

        Costs and expenses:
        Costs of merchandise sold                    65.0         63.9        63.0
        Selling, general and administrative          33.0         31.7        31.4
        Depreciation and amortization                 3.8          3.5         3.0
        Amortization of lease-related interests       0.2          0.1         0.1
        Goodwill impairment                           0.6            -           -
        Other impairment charges                      0.8          0.1         0.1

        (Loss) income from operations                (0.3 )        3.7         5.2
        Interest expense, net                         3.1          3.2         3.2

        (Loss) income before income taxes            (3.4 )        0.5         2.0
        Income tax provision                          2.0          0.2         0.6

        Net (loss) income                            (5.4 )%       0.3 %       1.4 %

2008 Compared with 2007

Net sales: Net sales in 2008 decreased 7.0% to $3,130.0 million from $3,365.9 million in 2007. Comparable store sales decreased 7.4% from the prior year. We believe the comparable store sales decline reflects a confluence of factors that created an adverse economic environment throughout the year, particularly the last quarter of 2008, which weakened consumer sentiment and pressured spending.

The best performing merchandise category in the period was Children's Apparel. Sales increases in this category primarily reflect expanded and improved product selection in branded playwear and outerwear. The poorest performing categories in the period were Furniture (included in Home) and Moderate Sportswear and Dresses (both included in Women's Apparel). Furniture sales were impacted by the difficult housing market in new construction and existing home sales, and continued deterioration in consumer spending for more expensive items. Moderate Sportswear and Dresses have been impacted by the challenging economic environment, which has resulted in reduced consumer spending on discretionary items. Sales in Moderate Sportswear were also affected by the decision made in 2007 by certain of our key vendors to exit the moderate sportswear business. It was not until the fall of 2008 that we began receiving merchandise from new, replacement vendors.

Other income: Other income, which includes income from revenues received under our credit card program agreement with HSBC, leased departments and other customer revenues, was $95.5 million, or 3.0% of net sales, in 2008 as compared with $102.7 million, or 3.0% of net sales, in 2007. The decrease primarily reflects reduced sales volume in the current year.

Costs and expenses: Gross margin dollars in 2008 were $1,095.0 million as compared with $1,215.8 million in 2007, a decrease of $120.8 million. The decrease in gross margin dollars reflects the reduced sales volume and a decrease in the gross margin rate. Gross margin as a percentage of sales decreased 1.1 percentage points to 35.0% in the current year from 36.1% in the prior year. The decrease in the gross margin rate primarily reflects an increased net markdown rate in response to the challenging economic environment.

SG&A expense in 2008 was $1,033.5 million as compared with $1,066.7 million in 2007, a decrease of $33.1 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 33.0% of net sales, compared with 31.7% in 2007, due to the reduced sales volume.

In 2008, depreciation and amortization expense and amortization of lease-related interests increased $0.2 million, to $122.2 million, from $122.0 million in 2007.

We 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 Other Intangible Assets" ("SFAS No. 142"). Based upon our review, the fair value of our 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. There was no such charge in 2007. See Notes 1 and 3 in the Notes to Consolidated Financial Statements.

In the fourth quarter of 2008, in accordance with the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), we recorded $17.9 million of non-cash asset impairment charges which resulted in a reduction in the carrying amount of certain store properties. We recorded charges of $2.7 million for asset impairments in 2007. See Notes 1 and 2 in the Notes to Consolidated Financial Statements.

In the fourth quarter of 2008, a review was completed of the carrying value of certain intangible assets in accordance with SFAS No. 142. As a result of our assessment, we recorded non-cash asset impairment charges of $8.1 million related to the reduction in the value of four indefinite-lived trade names and two indefinite-lived private label brand names. In 2007, we recorded impairment charges of $1.3 million related to the reduction in the value of two indefinite-lived private label brand names. See Notes 1 and 3 in the Notes to Consolidated Financial Statements.

(Loss) income from operations: The loss from operations in 2008 was $(9.0) million, or (0.3)% of net sales, as compared with income from operations of $125.7 million, or 3.7% of net sales, in 2007.

Interest expense, net: Net interest expense in 2008 was $97.8 million, or 3.1% of net sales, as compared with $108.2 million, or 3.2% of net sales, in 2007. The $10.3 million decrease primarily reflects decreased borrowing levels and reduced interest rates in the current year and $1.0 million of prior year expense incurred for the early extinguishment of debt.

Income tax provision: The income tax provision reflects an effective tax rate of
(59.1)% in 2008, compared with 34.0% in 2007. The 2008 income tax provision includes an unfavorable $108.5 million tax expense adjustment in the fourth quarter of 2008 pursuant to establishment of an additional valuation allowance against our deferred tax assets and a favorable $7.0 million tax benefit adjustment in the third quarter of 2008 related to expiration of certain exposures pursuant to the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN No. 48").

Net (loss) income: Net loss in 2008 was $(169.9) million, or (5.4)% of net sales, as compared with net income of $11.6 million, or 0.3% of net sales, in 2007.

2007 Compared with 2006

2007 consisted of 52 weeks, while 2006 consisted of 53 weeks. Comparability between the periods is also affected by the inclusion of five additional weeks of Carson's operations in the first quarter of 2007; the prior year period includes Carson's operations following the March 5, 2006 acquisition.

Net sales: Net sales in 2007 increased 0.1% to $3,365.9 million from $3,362.3 million in 2006. The total sales increase reflects the inclusion of the five additional weeks of sales from Carson's in the first quarter of 2007 as well as sales at the acquired Parisian stores, partially offset by a reduction for closed stores and the inclusion of an additional week of sales in the prior year, reflective of the fifty-three week fiscal period. The balance of sales in 2007 reflects a Bon-Ton comparable store net sales decrease of 6.5% and, for informational purposes only, a full-year Carson's comparable store net sales decrease of 1.6%, which, in total, approximates $112 million.

We believe that the comparable store net sales decline was the result of several factors including, among others:

• A challenging economic environment, the result of a weak housing market, mortgage and credit market concerns and rising energy prices, which pressured consumer spending.

• Unseasonable weather in our geographic regions in April, September, October and December, which negatively impacted apparel sales.

• The elimination of the prior year liquidation of non-go-forward merchandise in Bon-Ton stores. The quantifiable impact of the liquidation sales in the prior year was approximately $17.5 million in the Home area alone. We believe there were incremental sales generated in the prior year from increased customer traffic as a result of the liquidation event, the effect of which cannot be discretely quantified.

The best performing merchandise categories in the period were Children's Apparel, Footwear and Better Sportswear (included in Women's Apparel). Children's Apparel benefited from increased inventory investment and the introduction of new vendors and licensed product. Sales increases in Footwear were primarily the result of increased inventory investment and the expansion of certain vendors into additional stores. 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), Moderate Sportswear and Coats (both included in Women's Apparel). The sales decrease in Home was primarily due to the elimination of the prior year liquidation event, the impact of which was particularly significant in the second quarter of 2007, and the concerns in the housing market. Sales in Coats and Moderate Sportswear were adversely impacted by the unseasonable weather. Moderate Sportswear was also affected by the decision made by certain of our key vendors to exit the moderate sportswear business; the Company was unable to develop sufficient new merchandise resources to mitigate the sales volume erosion in 2007.

Other income: Other income, which includes income from revenues received under our credit card program agreement with HSBC, leased departments and other customer revenues, was $102.7 million, or 3.0% of net sales, in 2007 as compared with $93.5 million, or 2.8% of net sales, in 2006. The increase in dollars was primarily due to the inclusion of thirteen weeks of Carson's operations in the first quarter of 2007 as compared with eight weeks of Carson's post-acquisition operations in the first quarter of 2006 and increased revenues received under the credit card program agreement, partially offset by the inclusion of an additional week of operations in the prior year.

Costs and expenses: Gross margin dollars in 2007 were $1,215.8 million as compared with $1,243.5 million in 2006, a decrease of $27.7 million. The decrease in gross margin dollars primarily reflects the reduced sales volume attributable to the comparable store sales decrease and a

decrease in the gross margin rate. Gross margin as a percentage of sales decreased 0.9 percentage point to 36.1% in the current year from 37.0% in the prior year. The decrease in the gross margin rate reflects the inclusion of Carson's sales and markdowns for the first five weeks of the current year; this historically clearance-driven period with reduced margins was not included in the prior year period. Additionally, the gross margin rate was impacted by increased net markdowns in the third and fourth quarters of 2007, the result of increased promotional activity in response to unseasonable weather conditions and the challenging economic environment.

SG&A expense in 2007 was $1,066.7 million as compared with $1,056.5 million in 2006, an increase of $10.2 million. The principal factors in the increase in SG&A expense were the inclusion of five incremental weeks of Carson's operations in the first quarter of 2007 as compared with the first quarter of 2006 and increases in those costs affected by normal inflationary adjustments. These increases were partially offset by a reduction in integration expenses, increased efficiencies in operations in 2007 and the inclusion of an additional week of operations in the prior year. The 2007 expense rate increased 0.2 percentage point to 31.7%.

Depreciation and amortization expense and amortization of lease-related interests increased $18.0 million, to $122.0 million, in 2007 from $104.0 million in 2006, primarily the result of including thirteen weeks of Carson's operations in the first quarter of 2007 as compared with eight weeks of Carson's operations in the first quarter of 2006 as well as the increased expense associated with asset additions.

In 2007 we recorded $2.7 million of asset impairment charges which resulted in a reduction in the carrying amount of certain store properties, as compared with $2.9 million of charges in 2006 for an impaired store property and a reduction in the value of duplicate information systems software. Additionally, in 2007 we recorded an impairment charge of $1.3 million related to a reduction in the value of two indefinite-lived private label brand names. There was no such charge in 2006.

Income from operations: Income from operations in 2007 was $125.7 million, or 3.7% of net sales, as compared with $173.7 million, or 5.2% of net sales, in 2006.

Interest expense, net: Net interest expense in 2007 was $108.2 million, or 3.2% of net sales, as compared with $107.1 million, or 3.2% of net sales, in 2006. The $1.0 million increase is principally due to the net additional weeks of interest expense on debt incurred in connection with the acquisition of Carson's compared with such interest expense in the prior year, partially offset by a 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.

Income tax provision: The income tax provision reflects an effective tax rate of 34.0% in 2007 as compared with 29.5% in 2006. Included in the prior year provision is an income tax benefit adjustment of $4.1 million principally associated with a net reduction in income tax valuation allowances.

Net income: Net income in 2007 was $11.6 million, or 0.3% of net sales, as compared with $46.9 million, or 1.4% of net sales, in 2006.

Liquidity and Capital Resources

At January 31, 2009, we had $19.7 million in cash and cash equivalents and $268.7 million available under our asset-based revolving credit facility (before taking into account the minimum borrowing availability of $75.0 million). The borrowing base calculation under our revolving credit facility contains an inventory advance rate subject to periodic review at the lender's discretion. Based upon the most recent inventory appraisal in February 2009, we realized a decrease in our advance rate, the effect of which would have reduced borrowing availability by $31.4 million had the new advance rate been applied to our calculation at January 31, 2009.

While much of the reported loss in 2008 resulted from material non-cash charges for asset impairments and deferred tax valuation allowances, our operating performance decreased as well. In anticipation of continued recessionary pressures in 2009, we have heightened our focus on maximizing operating cash flow and have significantly curtailed our planned capital expenditures. Additionally, we will continue to control inventory levels in order to benefit our working capital needs. We anticipate that these actions, together with projected cash benefits from our cost savings initiatives, will positively impact our 2009 cash flow.

Our business is dependent to a significant degree upon close relationships with our vendors and their factors. The loss of key vendor or factor support could have a material adverse effect on our business. Given the weak global markets, vendors and factors may seek assurances to protect against non-payment of amounts due them. If we continue to experience declining operating performance, and if we experience severe liquidity challenges, vendors and factors may demand that we accelerate our payment for their products. These demands could have a significant adverse impact on our operating cash flow and result in a severe diminishment of our liquidity. Under such circumstances, borrowings under our existing credit facility could reach maximum levels, in which case we would take actions to obtain additional liquidity. However, there can be no assurance that we would be successful obtaining such additional liquidity. As a result, we may not be able to meet our obligations as they become due. In addition, if our vendors are unable to access liquidity or become insolvent, they could be unable to supply us with product or continue with their support of our advertising and promotional programs. Any such disruptions could negatively impact our ability to acquire merchandise or obtain vendor allowances in support of our advertising and promotional programs, which in turn could have an adverse impact on our business, operating results, financial condition or cash flow.

Historically, we have generated cash flow from operating activities and used supplemental borrowings under our credit facility to provide the liquidity we need to operate our business. The downturn in the global economy and the recent distress in the financial markets have resulted in extreme volatility in the capital markets and diminished liquidity and credit availability. The tightening of credit markets could make it more difficult for us to access funds, to refinance our existing indebtedness, to enter into agreements for new indebtedness or to obtain funding through the issuance of securities and could potentially increase our borrowing costs. If such conditions were to persist, we would seek alternative sources of liquidity, but there can be no assurance that we would be successful obtaining such additional liquidity. As a result, we may be unable to meet our obligations as they become due.

Typically, 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. Currently, our business model is adversely impacted by additional economic drivers reflective of the global recession. While the current and anticipated future difficult economic conditions affect our assessment of short-term liquidity, we consider our resources (cash flows from operations supplemented by borrowings under the credit facility) adequate to satisfy our 2009 cash needs. While there can be no assurances, management believes there should be sufficient liquidity to cover our short-term funding needs.

The following table summarizes material measures of our liquidity and capital resources:

                                                   January 31,          February 2,        February 3,
(Dollars in millions)                                 2009                 2008               2007


Working capital                                   $       424.4        $       426.5      $       402.4
Current ratio                                            2.13:1               1.96:1             1.79:1
Debt to total capitalization(1)                          0.90:1               0.76:1             0.78:1
Unused availability under lines of credit(2)      $       268.7 (3)    $       351.0      $       341.3

(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.

(3) Based upon the most recent inventory appraisal in February 2009, unused availability under lines of credit would have been reduced by $31.4 had the new advance rate been applied to our calculation at January 31, 2009.

Our primary sources of working capital are cash flows from operations and borrowings under our revolving credit facility. 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.

Working capital levels decreased minimally between 2008 and 2007. The increase in the current ratio in 2008, as compared with 2007, primarily reflects proportionately larger decreases in current liabilities as compared with current assets, principally due to reduced accrued liabilities relating to benefits. The increase in debt to total capitalization is largely due to the significant decrease in shareholders' equity in 2008, the result of the net loss for the period as well as a decline in the funded status of the Company's defined benefit pension plans. The decrease in unused availability under lines of credit as compared with the prior year reflects decreased availability primarily due to reduced inventory levels as well as increased documentary letters of credit to support the purchasing of inventory.

Increases in working capital and the current ratio in 2007, as compared with 2006, largely reflect reductions in accrued liabilities and income taxes payable. The decrease in debt to total capitalization reflects cash flow . . .