Managerial Accounting Homework Case Bon Ton Caught In The Rain of US Retail Bankruptcies BON TON CAUGHT IN THE RAIN OF US RETAIL BANKRUPTCIES 1 On Monday June 11, 2018, intern Jane Smith sat at her desk at a prestigious investment firm, looking at the file for the US retail store chain Bon Ton Holdings, Inc (Bon Ton) She tried to recall her first year financial accounting class Her mentor at the firm had asked her to analyze Bon Ton's financial condition as the investment company was managing some client portfolios where Bon Ton stocks were present Smith did some initial investigation and discovered that the store was not doing very well Moreover, the US retail industry had been experiencing a systemic meltdown since 2017 More than 15 US retailers had filed for bankruptcy in 2017, the most in the last six years The 100 year old company, Bon Ton, was no exception In 2017, it had announced store closures in five states, and on January 16, 2018, it had entered into forbearance agreements with some of its lenders after the grace period of a US$14 million 2 debt payment expired 3 On January 31, 2018, it announced store closures at 42 locations as part of its rationalization program 4 The company ultimately filed a voluntary petition for protection against bankruptcy and for reorganization on February 4, 2018, under chapter 11 in the United States Bankruptcy Court for the District of Delaware 5 Thinking about the risk of retaining Bon Ton stocks in the client portfolios, Smith wondered whether it would be feasible for Bon Ton to stay afloat and revive its business How were its competitors faring Could Bon Ton survive, and if so, how While researching retail companies that had gone bankrupt, Smith came across a tool to predict bankruptcy, Altman's Z score She planned to complement her analysis with the bankruptcy prediction findings to arrive at a comprehensive analysis of Bon Ton and recommend a course of action for her firm ABOUT THE COMPANY Bon Ton Stores Inc was a department store chain in the United States founded in 1898 The company's stores offered fashion apparel and accessories for women, men, and children Its products also included cosmetics, home furnishings, and other goods 6 As of 2017, the company operated through more than 250 stores in 24 states, and the majority of its stores were leased The company was headquartered in York, Pennsylvania, which was its administrative and sales support hub The merchandising and marketing divisions were based in Milwaukee, Wisconsin The company owned and leased distribution centers in Illinois, Pennsylvania, and Ohio operated a furniture warehouse in Naperville, Illinois and leased an omnichannel fulfillment center in West Jefferson, Ohio The company operated under seven retail nameplates across the United States Bon Ton, Carson's, Younkers, Herberger's, Elder Beerman, Boston Store, and Bergner's 7 BON TON'S BUSINESS MODEL Value Proposition Bon Ton promoted itself as a store that offered better brands, better savings, and it carried a broad collection of quality goods at favorable prices Bon Ton stores provided an assortment of nationally distributed brands of apparel, accessories, footwear, cosmetics, and home furnishings for example, Anne Klein, Calvin Klein, Jessica Simpson, Kenneth Cole, and Under Armor It also offered exclusive private brands like Laura Ashley, Ruff Hewn, Relativity, and Studio Works Bon Ton's private brands made unique and exclusive fashion products available at compelling price points, contributing to competitive differentiation and customer loyalty The costs associated with in house, private brands enabled Bon Ton to realize a favorable profit margin 8 Customer Relationship The primary target consumers of Bon Ton were women between the ages of 25 and 60 with average annual household income of $55,000 to $125,000 The company also targeted a broader audience that included men and children 9 Bon Ton focused on excellent customer service in order to develop long standing relationships with its customers It provided training programs to build an efficient sales force for customers, and in addition to phone and online support, Bon Ton had sales associates dedicated to customer sales assistance in selected stores Many departments had self service centres for customer convenience Bon Ton also implemented a Let Us Find It program to assist customers in finding preferred items at other store locations or through the company's omnichannel assortment, which enabled customers to order merchandise for delivery directly to their addresses Bon Ton also expanded its order fulfillment locations to serve omnichannel orders that were directed to store locations In 2016, Bon Ton introduced mobile capabilities and provided customers with a Buy Online Pick Up In Store convenience program To gain customer loyalty, it also had a private label credit card program, which offered cardholders rewards, including advanced sales notices, discounts, and event invitations 10 Vendor Management Bon Ton served as a distribution channel that helped merchandise vendors reach their target customers The company created relationships with vendors by evaluating their sales and profitability and making purchasing decisions based on these analyses As was prevalent in the industry, Bon Ton received allowances from some of its vendors when sales did not meet specified margins It also received support from some vendors in the form of allowances and reimbursements for costs incurred to promote and sell on behalf of the vendors 11 Marketing Bon Ton engaged customers through a multichannel marketing program that included traditional print media, broadcasting, and digital media Bon Ton used localization and personalization strategies in its email and direct marketing to individual customers Besides advertising and sales promotions, it offered purchase incentives and in store events such as designer appearances and fashion shows to build a solid customer base Bon Ton also tried to connect with people by participating in charitable causes and events 12 Inventory Management Bon Ton had a centralized planning and allocation team for all its stores this team included staff who supported regional and local planning and allocation The company operated a pre distribution model, through which we allocate ed merchandise on our initial purchase orders to each store This merchandise wa s shipped from our vendors to our distribution facilities for delivery to designated stores 13 Bon Ton had a reactive distribution technique for stores with high customer demand The technique leveraged electronic data interchange inventory management technology to effectively move and deliver prelabelled merchandise to individual stores, and it used high speed automated conveyor systems and hand held radio frequency devices to track merchandise Bon Ton's third party carriers distributed merchandise to the stores, where most of the merchandise was held Bon Ton monitored inventory levels following a seasonal pattern and maintained inventories to support both offline and online sales 14 ABOUT THE FOUNDER AND CHIEF EXECUTIVE OFFICER Max and Samuel Grumbacher started Bon Ton in 1898 as S Grumbacher and Son, a one room store on Market Street in York, Pennsylvania, founded by Max and Samuel Grumbacher It had come a long way, and now operated in approximately 2 2 million square metres (24 million square feet) in around 260 stores in 24 US states under the different nameplates 15 Tim Grumbacher had been involved in the company's management since 1977 and had been the chairman of the board of directors and strategic initiatives officer since June 2013 Kathryn Bufano held positions as president, chief executive officer (CEO), and director After August 25, 2017, William Tracy, the former chief operating officer, took over the CEO role after Bufano stepped down when her contract ended 16 Although the firm had posted annual losses under Bufano's tenure, Bon Ton's press release announcing this change gave no specific reason for Bufano's resignation Bufano supported Tracy as he moved into the new role, and Tracy stated that he appreciated the board's confidence and support during his transition 17 PAST PERFORMANCE Beginning in 2014, Bon Ton's downturn was prominent, and this was reflected in the company's share price (see Exhibit 1) Its sales and margin performance were below expectations that year, resulting in a greater net loss than that of the prior year However, according to Bufano, It was a year of both challenges and accomplishments She felt confident in the long term potential of the company, saying that, while the performance was disappointing, we believe the progress we made on our strategic initiatives will contribute meaningfully to future profitability and growth 18 In the fall of 2014, the company started a Voice of the Customer brand positioning program, supported by the tagline Your Store Your Style According to Bufano, this served as the embodiment of our customer focus and commitment to delivering localized and relevant fashion across our many channels our brick and mortar stores, website and app Even after executing customer centric strategies, Bufano felt that the company had failed to reflect its accomplishments in the financials (see Exhibits 2 4) 19 In 2016, Bon Ton realized a net cost savings of $31 million, which was $7 million above the high end of the company's target According to the CEO's statement in the annual report, 2016 was a year of progress for BonTon, despite the ongoing challenges that we faced from the retail environment The company paid off a $150 million asset based term loan and $57 million in outstanding principal on its 2017 senior secured notes, which slightly improved its liquidity and overall capital structure However, the company still ended up with a net loss of $63 million as of January 2017 around $6 million more than that of the previous year (see Exhibit 2) 20 In 2017, the company continued to meet losses Sales decreased, and the bottom line plunged (see Exhibits 2 7) In the company's Form 8 K for the first quarter (Q1) of 2017, Bufano stated, Our first quarter results did not meet our expectations due primarily to weak mall traffic trends, unfavorable weather and marketing challenges associated with the Easter calendar shift That said, our omnichannel business once again generated double digit growth and we continued to expand our merchandise offering with highly recognized brands as well as exclusive and private brands that resonate with our customer 21 Bon Ton planned to focus on its omnichannel strategy and expand its merchandise portfolio to appeal to customers Internally, Bon Ton was looking to roll out a profit improvement initiative to achieve additional cost reductions in fiscal 2017 22 In Q2 2017, as per Bon Ton's earnings call, the company was optimistic about sales in several categories, such as fine jewellery, young men's denim, and brands such as Under Armour, Tommy Hilfiger, and Vera Bradley 23 According to Tracy, the new president and CEO, Our cosmetic business performed ahead of our expectations driven by the strength in the fragrance category We are also pleased with the continued momentum in our e commerce business, which saw a double digit increase during the quarter We made great progress on our cost reduction plan as we reduce SG A selling, general, and administrative expenses by $20 7 million in the quarter Adjusted EBITDA earnings before interest, taxes, depreciation, and amortization was $9 1 million, an increase of $6 6 million compared to last year's second quarter Second quarter 2017 adjusted EBITDA includes $12 1 million in benefit from gift card breakage and gains in our real estate transactions 24 Bon Ton planned to expand its merchandise offerings, focusing on five core areas of gifting, cold weather merchandise, activewear, denim and private and exclusive brands Bon Ton planned to launch FAO Schwarz and expand its Discovery Kids product, and its previous success with pantry offerings influenced the company to consider expanding its specialty food business, with national and key local brands 25 RESULTS AND OUTLOOK FOR THE YEAR Bon Ton's third quarter report of 2017 indicated that there had been progress on a number of strategic initiatives The report showed that Bon Ton did the following x Experienced strength in key merchandise categories and brands and drove continued doubledigit 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 x 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 x Maintained careful inventory controls, as we reduced inventory by 10 as compared to the third quarter of 2016 26 At the same time, the company faced continuing challenges Sales at stores decreased 6 6 per cent because of warm weather and subdued footfall at malls Revenue realization was less from proprietary credit card operations, miscellaneous revenue departments, and gift and merchandise return card breakage 27 Shifts in the mix of merchandise led to a markdown rate that affected gross margins and was in turn intensified by a decrease in the gross margin Net interest expense increased from the previous year due to a spike in weighted average interest rate and expanded debt 28 The company's cash flow from operations and up to $880 million in borrowings provided a source of working capital The company had planned capital expenditures beyond these, its main cash expenses would be for servicing debt and financing during peak selling seasons 29 Bon Ton's quarter wise financial performance in 2017 reflected the challenging situation (see Exhibits 5 7) The company indicated that it had started evaluating potential strategic alternatives and engaging consultants for financial restructuring 30 CHALLENGES In 2017, many retail players closed their stores and planned for more closures in 2018 Many retailers in the United States filed for bankruptcy in 2017 due to overburdening debt, a decline in footfall, and pressure from competitors Some of the troubled retailers were Sears, Payless ShoeSource Inc , Abercrombie Fitch, Toys R Us, and Gymboree Group Inc 31 Amazon com Inc (Amazon), Walmart Inc , and Home Depot Inc were expected to acquire a large amount of the industry's gains 32 Amazon had been the chief competitor to all the other retail players 33 Some other department store industry leaders, such as Dillard's Inc , Kohl's Corporation, Nordstrom Inc , Macy's Inc , and J C Penney Company Inc were also facing challenges in the current market condition (see Exhibit 8) A Forbes report on retail sales for June 2017 provided a sobering look at the current state of American retail Although year on year total sales were up for the first half of 2017, the estimated figures for May June 2017 were lower With some exceptions (electronics appliance stores sporting goods and hobby, book, and music stores) most reporting categories showed monthly declines Even non store retailers reported a 2 8 dip Overall June retail and food services sales dropped 3 2 compared to the previous month 34 Department store and retail companies were affected by consumers' shifting shopping patterns from shopping in brick and mortar stores to buying through online retail channels and using smart phones and social media Certainly, Internet shopping had been replacing the hassles of in store shopping Online shopping not only gave consumers access to more products, often at a cheaper price, but it also saved huge amounts of time when people need a specific item Forbes also reported that men were spending more on clothes This is an interesting trend, especially now that Walmart has acquired men's clothing retailer Bonobos Men are paying serious attention to their presentation, both at work to advance their careers and in their personal lives when casual attire is called for 35 The US retail industry, which included mass merchandisers, national chain retailers, and specialty retailers, became highly competitive as online retailers emerged and mobile technology and social media expanded Competition in the industry revolved around price, quality and selection of merchandise, reputation, store location, advertising and customer service While Bon Ton competed with similar department stores and many other retailers including store based, mail order, and internet retailers, 36 many of its competitors were in better shape (see Exhibit 8) Moreover, prevailing economic conditions and various economic factors affected consumers' spending habits, especially with respect to the merchandise that Bon Ton stores sold Reduced consumer traffic in traditional shopping malls, where most of the Bon Ton stores were located, had caused a decline in the company's financial condition and operating results 37 Customer traffic and conversion, both in stores and online, had important effects on sales, and in store sales were highly dependent on the geographical locations of stores As demographic patterns changed, many of Bon Ton's current locations had lost appeal Financial conditions that affected the operators of some shopping malls where Bon Ton stores were located had also affected the company's sales 38 Declining operating performance and a severe liquidity crisis meant that vendors might demand accelerated payments, resulting in a significant adverse impact on Bon Ton's operating cash flow and liquidity As of January 28, 2017, the company had a total debt of $989 3 million, which included capital lease and financing obligations 39 This indebtedness curbed Bon Ton's ability to replenish inventory at competitive prices and terms, generate sales, and maintain stores, and price increases for merchandise, raw materials, fuel and labor or their reduced availability threatened to increase the company's cost of goods, further damaging its financial results 40 To create an online presence, Bon Ton invested in technology and made operational changes, which increased customer traffic but did not significantly affect the company's bottom line The cost to ship merchandise to customers and the competitive pressures to offer free or reduced shipping, as well as the significant cost to provide and maintain the infrastructure and systems necessary to operate an omnichannel business, all led to lower margins 41 The turnover rate in the retail industry was very high Bon Ton faced significant costs for example, for wages and benefits such as health care to attract and retain key employees 42 Bon Ton's real estate exposure was significant The company owned or leased approximately 260 stores Its store lease agreements included both a fixed rent portion and a variable portion based on the sales percentage at each location These agreements also prevented stores from closing before the contracts terminated, although some stores that were in economic distress were allowed to close However, leases and other obligations restricted Bon Ton's ability to close unprofitable owned or leased stores and forced the company to operate some locations at a loss Moreover, a decline in real estate values posed a risk to Bon Ton's borrowing 43 ANALYSTS' OPINIONS ABOUT THE COMPANY Smith also went through some analyst reports Neil Saunders, a retail analyst of GlobalData (data and insights solution providers), noted that Bon Ton's offerings were undifferentiated and unclear, and had become increasingly irrelevant to consumers Many of Bon Ton's stores were in areas where the availability of branded fashions and home wares was traditionally poor, Saunders said However, while this once made them a focal point and a destination for local shoppers, the internet has done much to change this dynamic and has made the stores less relevant 44 Another analyst made a similar comment Bon Ton is kind of a microcosm of the department store industry, said Philip Emma, senior analyst for restructuring intelligence firm Debtwire Their business model is selling brand name merchandise that consumers recognize in a mall based setting and that's the segment of retail that's had the biggest struggle 45 ALTMAN'S Z SCORE One of the most popular bankruptcy prediction models was developed by Edward I Altman in 1968 Altman applied a statistical technique called multivariate analysis to a mix of financial variables to detect the likelihood of solvency in times of distress Each company was given a score (Z score) calculated through a discriminant function of the five variables, weighted by coefficients The model had been revised several times for different contexts (e g , for private firms) The Z score model for non manufacturing firms and for companies in emerging markets outside the United States was introduced in 1995 (see Exhibit 9) The Z score model excluded industry sensitive asset turnover variables from the last revised model, to minimize the industry effect 46 CONCLUSION On February 6, 2018, Bon Ton announced that the United States Bankruptcy Court for the District of Delaware had approved its voluntary petitions for financial restructuring 47 With existing losses and significant loans, what actions might put Bon Ton back on track What measures could the company take to fight bankruptcy Smith prepared to analyze these questions from the perspectives of both Bon Ton and an investor in order to present her findings to the investment company EXHIBIT 2 BON TON CONSOLIDATED ANNUAL INCOME STATEMENT (IN US$ MILLIONS) 2013 2014 20 15 2016 2017 Period End Date 02 Feb2013 01 Feb2014 31 Jan2015 30 Jan2016 28 Jan2017 Net Sales 2,919 4 2,770 1 2,756 2 2,717 7 2,600 6 Other Income 90 4 61 0 66 7 71 8 73 8 Total Revenue 2,978 8 2,834 1 2,822 9 2,789 5 2,674 4 Costs of Merchandise Sold 1,873 9 1,768 7 1,773 0 1,775 7 1,677 7 Gross Profit 1,104 9 1,065 4 1,049 9 1,013 8 906 7 Selling, General, and Administrative 806 8 771 1 771 4 764 2 737 3 Advertising 129 3 128 3 135 6 137 3 141 5 Depreciation and Amortization 68 3 5 9 90 1 91 8 92 2 Amortization of LeaRe Jaelated Interests 47 4 5 4 5 4 2 Termination Benefits and 4 2 Other Closing Cost D 0 0 0 D 0 4 1 1 9 Gain on Insurance Recovery D C 110 8 11 4 0 0 Impairment Charges 5 8 6 2 2 5 3 6 17 0 Total Operating Expense 1,034 9 996 0 993 3 1,003 8 904 1 Operating Income 70 0 69 4 56 6 10 0 2 6 Interest Expense, Net 83 0) (68 8) 62 0) 63 0) (67 1) Loss on ExtingTishment of Debt B 5 1 4 0 2 5 2 0 8 Capitalized Interest 0 2 0 2 0 3 D 5 0 2 Net Income before Taxes 121 3 13 6 15 4 158 9 165 0 Provision for Income Taxes 0 2 10 1 1 6 11 9 11 6 Net Income after Taxes Loss 121 6 13 6 17 0 157 1 163 4 Basic EPS 11 16 10 19 10 36 12 90 13 18 Diluted EPS 11 16 10 19 10 36 12 90 13 18EXHIBIT 6 BON TON CONSOLIDATED QUARTERLY BALANCE SHEET (IN US$ MILLIONS) Fiscal year ends in January 2017 04 2017 07 2017 10 Current Assets Cash Cash and Cash Equivalents 7 Total Cash 6 7 6 Receivables Inventories 59 714 658 Prepaid Expenses 852 Total Current Assets 83 604 747 461 Non Current Assets Properly, Plant, and Equipment Land Fixtures and Equipment Other Properties 1,616 1 596 Property and Equipment, at Cost 1,585 1,616 1 596 Accumulated Depreciation 1,585 11,046 Property, Plant, and Equipment, Net il,049 11,056 571 547 Intangible Assets 72 70 Other WORK WHAT Assets 59 22 Total Non Current Asset 28 665 Total Assets 1,468 Liabilities and Stockholders' Equity 1,387 1,587 Liabilities Current Liabilities Shareda Debt Capital Leases 665 Accounts Payable 7 161 Taxes Payable 178 248 Accrued Liabilities 179 Other Current Liabilities 137 149 26 Total Current Liabilities 22 346 Man Current Liabilities 348 1,091 LOOKED Debt 895 Capital Leases 849 345 132 Other Long Texan Liabilities 130 129 174 Total Non Current Liabilities 170 177 1,201 Total Liabilities 1,150 551 1,547 Stockholders Equity 1 498 1,743 Common Stock Additional Paid In Capital 168 Retained Earnings i173 257 Treasury Stock il il il Accumulated Other Comprehensive Income 172 Total Stockholders' Equity 171 79 Total Liabilities and Stockholders' Equity 156 1,468 1 387 1 587EXHIBIT 5 BON TON CONSOLIDATED QUARTERLY INCOME STATEMENT (IN US$ MILLIONS, EXCEPT PER SHARE DATA) Fiscal year ends in January 2017 04 2017 07 2017 10 Revenue 553 525 562 Cost of Revenue 364 325 365 Gross Profit 189 200 197 Operating Expenses Sales, General, and Administrative 205 191 203 Other Operating Expenses 23 24 21 Total Operating Expenses 228 215 223 Operating Income 139 115 126 Other Income (Expense) 19 118 119 Income before Income Taxes 157 133 145 Provision for Income Taxes 0 Net Income from Continuing Operations 157 133 145 Net Income 157 133 145 Net Income Available to Common 157 133 145 ShareholdersEXHIBIT 7 BON TON CONSOLIDATED QUARTERLY CASH FLOW STATEMENT (IN US$ MILLIONS) Fiscal year ends in January 2017 04 2017 07 2017 10 Cash Flows from Operating Activities Depreciation and Amortization 22 23 20 Amortization Of Debt Discount Premium and Issuance Costs 3 2 2 Investment Asset Impairment Charges Deferred Income Taxes 0 Stock Based Compensation 1 Inventory 11 56 193 Prepaid Expenses 16 i19 Accounts Payable 29 22 54 Accrued Liabilities A i16 Other Working Capital 17 Other Clon Cash Items 155 137 144 Net Cash Provided by Operating Activities 131 42 i172 Cash Flows from Investing Activities Investments in Property, Plant, and Equipment i10 i1 1 14 Properly, Plant, and Equipment Reductions 0 21 19 Net Cash Used for Investing Activities 10 10 Cash Flows from Financing Activities Long Ten Debt Issued 170 106 287 Long Jeu Debt Repayment i122 1157 106 Other Financing Activities i7 12 5 Net Cash Provided by (Used for) Financing Activities 41 153 168 Net Change in Cash Cash at Beginning of Period 7 7 Cash at End of Period 7 Free Cash Flow Operating Cash Flow 131 42 1172 Capital Expenditure 110 i1 1 i14 Free Cash Flow 149 31 i186

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Managerial Accounting Homework Case Bon-Ton: Caught In The Rain of US Retail Bankruptcies BON-TON: CAUGHT IN THE RAIN OF US RETAIL BANKRUPTCIES 1 On Monday

Managerial Accounting Homework Case "Bon-Ton: Caught In The Rain of US Retail Bankruptcies"

BON-TON: CAUGHT IN THE RAIN OF US RETAIL BANKRUPTCIES¹

On Monday June 11, 2018, intern Jane Smith sat at her desk at a prestigious investment firm, looking at the file for the US retail store chain Bon-Ton Holdings, Inc. (Bon-Ton). She tried to recall her first-year financial accounting class. Her mentor at the firm had asked her to analyze Bon-Ton's financial condition as the investment company was managing some client portfolios where Bon-Ton stocks were present. Smith did some initial investigation and discovered that the store was not doing very well. Moreover, the US retail industry had been experiencing a systemic meltdown since 2017. More than 15 US retailers had filed for bankruptcy in 2017, the most in the last six years. The 100-year-old company, Bon-Ton, was no exception. In 2017, it had announced store closures in five states, and on January 16, 2018, it had entered into forbearance agreements with some of its lenders after the grace period of a US$14 million² debt payment expired.³ On January 31, 2018, it announced store closures at 42 locations as part of its rationalization program.⁴ The company ultimately filed a voluntary petition for protection against bankruptcy and for reorganization on February 4, 2018, under chapter 11 in the United States Bankruptcy Court for the District of Delaware.⁵ Thinking about the risk of retaining Bon-Ton stocks in the client portfolios, Smith wondered whether it would be feasible for Bon-Ton to stay afloat and revive its business. How were its competitors faring? Could Bon-Ton survive, and if so, how? While researching retail companies that had gone bankrupt, Smith came across a tool to predict bankruptcy, Altman's Z-score. She planned to complement her analysis with the bankruptcy prediction findings to arrive at a comprehensive analysis of Bon-Ton and recommend a course of action for her firm.

ABOUT THE COMPANY

Bon-Ton Stores Inc. was a department store chain in the United States founded in 1898. The company's stores offered "fashion apparel and accessories for women, men, and children." Its products also included "cosmetics, home furnishings, and other goods."⁶ As of 2017, the company operated through more than 250 stores in 24 states, and the majority of its stores were leased. The company was headquartered in York, Pennsylvania, which was its administrative and sales support hub. The merchandising and marketing divisions were based in Milwaukee, Wisconsin. The company owned and leased distribution centers in Illinois, Pennsylvania, and Ohio; operated a furniture warehouse in Naperville, Illinois; and leased an omnichannel fulfillment center in West Jefferson, Ohio. The company operated under seven retail nameplates across the United States: Bon-Ton, Carson's, Younkers, Herberger's, Elder-Beerman, Boston Store, and Bergner's.⁷

BON-TON'S BUSINESS MODEL

Value Proposition

Bon-Ton promoted itself as a store that offered "better brands, better savings," and it carried a broad collection of quality goods at favorable prices. Bon-Ton stores provided an assortment of nationally distributed brands of apparel, accessories, footwear, cosmetics, and home furnishings?for example, Anne Klein, Calvin Klein, Jessica Simpson, Kenneth Cole, and Under Armor. It also offered exclusive private brands like Laura Ashley, Ruff Hewn, Relativity, and Studio Works. Bon-Ton's private brands made unique and exclusive fashion products available at compelling price points, contributing to competitive differentiation and customer loyalty. The costs associated with in-house, private brands enabled Bon-Ton to realize a favorable profit margin.⁸

Customer Relationship

The primary target consumers of Bon-Ton were "women between the ages of 25 and 60 with average annual household income of $55,000 to $125,000." The company also targeted a "broader audience" that included men and children.⁹

Bon-Ton focused on excellent customer service in order to develop long-standing relationships with its customers. It provided training programs to build an efficient sales force for customers, and in addition to phone and online support, Bon-Ton had sales associates dedicated to customer sales assistance in selected stores. Many departments had self-service centres for customer convenience. Bon-Ton also implemented a "Let Us Find It" program to assist customers in finding preferred items at other store locations or through the company's omnichannel assortment, which enabled customers to order merchandise for delivery directly to their addresses. Bon-Ton also expanded its order-fulfillment locations to serve omnichannel orders that were directed to store locations. In 2016, Bon-Ton introduced mobile capabilities and provided customers with a "Buy Online Pick Up In-Store" convenience program. To gain customer loyalty, it also had a private-label credit card program, which offered cardholders rewards, including advanced sales notices, discounts, and event invitations.¹⁰

Vendor Management

Bon-Ton served as a distribution channel that helped merchandise vendors reach their target customers. The company created relationships with vendors by evaluating their sales and profitability and making purchasing decisions based on these analyses. As was prevalent in the industry, Bon-Ton received allowances from some of its vendors when sales did not meet specified margins. It also received support from some vendors in the form of allowances and reimbursements for costs incurred to promote and sell on behalf of the vendors.¹¹

Marketing

Bon-Ton engaged customers through a multichannel marketing program that included traditional print media, broadcasting, and digital media. Bon-Ton used localization and personalization strategies in its email and direct marketing to individual customers. Besides advertising and sales promotions, it offered purchase incentives and in-store events such as designer appearances and fashion shows to build a solid customer base. Bon-Ton also tried to connect with people by participating in charitable causes and events.¹²

Inventory Management

Bon-Ton had a centralized planning and allocation team for all its stores; this team included staff who supported regional and local planning and allocation. The company operated a pre-distribution model, "through which we allocate[ed] merchandise on our initial purchase orders to each store. This merchandise [wa]s shipped from our vendors to our distribution facilities for delivery to designated stores."¹³ Bon-Ton had a "reactive distribution technique" for stores with high customer demand. The technique leveraged electronic data interchange inventory management technology to effectively move and deliver prelabelled merchandise to individual stores, and it used high-speed automated conveyor systems and hand-held radio frequency devices to track merchandise. Bon-Ton's third-party carriers distributed merchandise to the stores, where most of the merchandise was held. Bon-Ton monitored inventory levels following a seasonal pattern and maintained inventories to support both offline and online sales.¹⁴

ABOUT THE FOUNDER AND CHIEF EXECUTIVE OFFICER

Max and Samuel Grumbacher started Bon-Ton in 1898 as S.Grumbacher and Son, a one-room store on Market Street in York, Pennsylvania, founded by Max and Samuel Grumbacher. It had come a long way, and now operated in approximately 2.2 million square metres (24 million square feet) in around 260 stores in 24 US states under the different nameplates.¹⁵

Tim Grumbacher had been involved in the company's management since 1977 and had been the chairman of the board of directors and strategic initiatives officer since June 2013. Kathryn Bufano held positions as president, chief executive officer (CEO), and director. After August 25, 2017, William Tracy, the former chief operating officer, took over the CEO role after Bufano stepped down when her contract ended.¹⁶Although the firm had posted annual losses under Bufano's tenure, Bon-Ton's press release announcing this change gave no specific reason for Bufano's resignation. Bufano supported Tracy as he moved into the new role, and Tracy stated that he appreciated the board's confidence and support during his transition.¹⁷

PAST PERFORMANCE

Beginning in 2014, Bon-Ton's downturn was prominent, and this was reflected in the company's share price (see Exhibit 1). Its sales and margin performance were below expectations that year, resulting in a greater net loss than that of the prior year. However, according to Bufano, "It was a year of both challenges and accomplishments." She felt confident in the long-term potential of the company, saying that, while the performance was "disappointing, we believe the progress we made on our strategic initiatives will contribute meaningfully to future profitability and growth."¹⁸

In the fall of 2014, the company started a "Voice of the Customer" brand positioning program, supported by the tagline "Your Store. Your Style." According to Bufano, this served "as the embodiment of our customer focus and commitment to delivering localized and relevant fashion across our many channels? our brick-and-mortar stores, website and app." Even after executing customer-centric strategies, Bufano felt that the company had failed to reflect its accomplishments in the financials (see Exhibits 2-4).¹⁹

In 2016, Bon-Ton realized a "net cost savings of $31 million, which was $7 million above the high end" of the company's target. According to the CEO's statement in the annual report, "2016 was a year of progress for BonTon, despite the ongoing challenges that we faced from the retail environment." The company paid off a $150 million asset-based term loan and $57 million in outstanding principal on its 2017 senior secured notes, which slightly improved its liquidity and overall capital structure. However, the company still ended up with a net loss of $63 million as of January 2017?around $6 million more than that of the previous year (see Exhibit 2).²⁰

In 2017, the company continued to meet losses. Sales decreased, and the bottom line plunged (see Exhibits 2-7). In the company's Form 8-K for the first quarter (Q1) of 2017, Bufano stated,

Our first quarter results did not meet our expectations due primarily to weak mall traffic trends, unfavorable weather and marketing challenges associated with the Easter calendar shift. That said, our omnichannel business once again generated double digit growth and we continued to expand our merchandise offering with highly recognized brands as well as exclusive and private brands that resonate with our customer.²¹

Bon-Ton planned to focus on its omnichannel strategy and expand its merchandise portfolio to appeal to customers. Internally, Bon-Ton was looking to roll out a profit improvement initiative to achieve additional cost reductions in fiscal 2017.²²

In Q2 2017, as per Bon-Ton's earnings call, the company was optimistic about sales in several categories, such as fine jewellery, young men's denim, and brands such as Under Armour, Tommy Hilfiger, and Vera Bradley.²³ According to Tracy, the new president and CEO,

Our cosmetic business performed ahead of our expectations driven by the strength in the fragrance category. We are also pleased with the continued momentum in our e-commerce business, which saw a double-digit increase during the quarter...

We made great progress on our cost reduction plan as we reduce SG&A [selling, general, and administrative expenses] by $20.7 million in the quarter. Adjusted EBITDA [earnings before interest, taxes, depreciation, and amortization] was $9.1 million, an increase of $6.6 million compared to last year's second quarter. Second quarter 2017 adjusted EBITDA includes $12.1 million in benefit from gift card breakage and gains in our real estate transactions.²⁴

Bon-Ton planned to expand its merchandise offerings, "focusing on five core areas" of "gifting, cold weather merchandise, activewear, denim and private and exclusive brands." Bon-Ton planned to launch FAO Schwarz and expand its Discovery Kids product, and its previous success with pantry offerings influenced the company to consider expanding its specialty food business, with national and key local brands.²⁵

RESULTS AND OUTLOOK FOR THE YEAR

Bon-Ton's third-quarter report of 2017 indicated that there had been progress on a number of strategic initiatives. The report showed that Bon-Ton did the following:

x Experienced strength in key merchandise categories and brands and drove continued doubledigit 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; x 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 x Maintained careful inventory controls, as we reduced inventory by 10% as compared to the third quarter of 2016.²⁶

At the same time, the company faced continuing challenges. Sales at stores decreased 6.6 per cent because of warm weather and subdued footfall at malls. Revenue realization was less from proprietary credit card operations, miscellaneous revenue departments, and gift-and-merchandise return card breakage.²⁷ Shifts in the mix of merchandise led to a markdown rate that affected gross margins and was in turn intensified by a decrease in the gross margin. Net interest expense increased from the previous year due to a spike in weighted average interest rate and expanded debt.²⁸

The company's cash flow from operations and up to $880 million in borrowings provided a source of working capital. The company had planned capital expenditures; beyond these, its main cash expenses would be for servicing debt and financing during peak selling seasons.²⁹

Bon-Ton's quarter-wise financial performance in 2017 reflected the challenging situation (see Exhibits 5- 7). The company indicated that it had started evaluating potential strategic alternatives and engaging consultants for financial restructuring.³⁰

CHALLENGES

In 2017, many retail players closed their stores and planned for more closures in 2018. Many retailers in the United States filed for bankruptcy in 2017 due to overburdening debt, a decline in footfall, and pressure from competitors. Some of the troubled retailers were Sears, Payless ShoeSource Inc., Abercrombie & Fitch, Toys "R" Us, and Gymboree Group Inc.³¹ Amazon.com Inc. (Amazon), Walmart Inc., and Home Depot Inc. were expected to acquire a large amount of the industry's gains.³² Amazon had been the chief competitor to all the other retail players.³³ Some other department store industry leaders, such as Dillard's Inc., Kohl's Corporation, Nordstrom Inc., Macy's Inc., and J.C. Penney Company Inc. were also facing challenges in the current market condition (see Exhibit 8).

A Forbes report on retail sales for June 2017 provided "a sobering look at the current state of American retail." Although year-on-year total sales were up for the first half of 2017, the estimated figures for May-June 2017 were lower. With some exceptions (electronics; appliance stores; sporting goods; and hobby, book, and music stores) most reporting categories showed monthly declines: "Even non-store retailers . . . reported a 2.8% dip. Overall June retail and food services sales dropped 3.2%" compared to the previous month.³⁴

Department store and retail companies were affected by consumers' shifting shopping patterns: from shopping in brick-and-mortar stores to buying through online retail channels and using smart phones and social media. Certainly, Internet shopping had been "replacing the hassles of in-store shopping." Online shopping not only gave consumers "access to more products, often at a cheaper price," but it also saved "huge amounts of time when people need a specific item."

Forbes also reported that men were "spending more on clothes. This is an interesting trend, especially now that Walmart has acquired men's clothing retailer Bonobos. Men are paying serious attention to their presentation, both at work to advance their careers and in their personal lives when casual attire is called for."³⁵

The US retail industry, which included mass merchandisers, national chain retailers, and specialty retailers, became highly competitive as online retailers emerged and mobile technology and social media expanded. Competition in the industry revolved around "price, quality and selection of merchandise, reputation, store location, advertising and customer service." While Bon-Ton competed with similar department stores and many other retailers "including store-based, mail-order, and internet retailers,"³⁶ many of its competitors were in better shape (see Exhibit 8).

Moreover, prevailing economic conditions and various economic factors affected consumers' spending habits, especially with respect to the merchandise that Bon-Ton stores sold. "Reduced consumer traffic in traditional shopping malls," where most of the Bon-Ton stores were located, had caused a decline in the company's financial condition and operating results.³⁷

Customer traffic and conversion, both in stores and online, had important effects on sales, and in-store sales were highly dependent on the geographical locations of stores. As demographic patterns changed, many of Bon-Ton's current locations had lost appeal. Financial conditions that affected the operators of some shopping malls where Bon-Ton stores were located had also affected the company's sales.³⁸

Declining operating performance and a severe liquidity crisis meant that vendors might demand accelerated payments, resulting in "a significant adverse impact" on Bon-Ton's operating cash flow and liquidity. As of January 28, 2017, the company had a total debt of $989.3 million, which included capital lease and financing obligations.³⁹

This indebtedness curbed Bon-Ton's ability to "replenish inventory at competitive prices and terms, generate sales, and maintain . . . stores," and price increases for "merchandise, raw materials, fuel and labor or their reduced availability" threatened to increase the company's cost of goods, further damaging its financial results.⁴⁰ To create an online presence, Bon-Ton invested in technology and made operational changes, which increased customer traffic but did not significantly affect the company's bottom line. The "cost to ship merchandise to customers and the competitive pressures to offer free or reduced shipping," as well as the "significant cost to provide and maintain the infrastructure and systems necessary to operate [an] omnichannel business," all led to lower margins.⁴¹

The turnover rate in the retail industry was very high. Bon-Ton faced significant costs?for example, for wages and benefits such as health care?to attract and retain key employees.⁴²

Bon-Ton's real estate exposure was significant. The company owned or leased approximately 260 stores. Its store lease agreements included both a fixed rent portion and a variable portion based on the sales percentage at each location. These agreements also prevented stores from closing before the contracts terminated, although some stores that were in economic distress were allowed to close. However, leases and other obligations restricted Bon-Ton's ability to close unprofitable owned or leased stores and forced the company to operate some locations at a loss. Moreover, a decline in real estate values posed a risk to Bon-Ton's borrowing.⁴³

ANALYSTS' OPINIONS ABOUT THE COMPANY

Smith also went through some analyst reports. Neil Saunders, a retail analyst of GlobalData (data and insights solution providers), noted that Bon-Ton's offerings were undifferentiated and unclear, and had become increasingly irrelevant to consumers. "Many of Bon-Ton's stores were in areas where the availability of branded fashions and home wares was traditionally poor," Saunders said. "However, while this once made them a focal point and a destination for local shoppers, the internet has done much to change this dynamic and has made the stores less relevant."⁴⁴

Another analyst made a similar comment. "Bon-Ton is kind of a microcosm of the department store industry," said Philip Emma, senior analyst for restructuring intelligence firm Debtwire. "Their business model is selling brand-name merchandise that consumers recognize in a mall-based setting?and that's the segment of retail that's had the biggest struggle."⁴⁵

ALTMAN'S Z-SCORE

One of the most popular bankruptcy prediction models was developed by Edward I. Altman in 1968. Altman applied a statistical technique called multivariate analysis to a mix of financial variables to detect the likelihood of solvency in times of distress. Each company was given a score (Z-score) calculated through a discriminant function of the five variables, weighted by coefficients. The model had been revised several times for different contexts (e.g., for private firms). The Z-score model for non-manufacturing firms and for companies in emerging markets outside the United States was introduced in 1995 (see Exhibit 9). The Z-score model excluded industry-sensitive asset-turnover variables from the last revised model, to minimize the industry effect.⁴⁶

CONCLUSION

On February 6, 2018, Bon-Ton announced that the United States Bankruptcy Court for the District of Delaware had approved its voluntary petitions for financial restructuring.⁴⁷ With existing losses and significant loans, what actions might put Bon-Ton back on track? What measures could the company take to fight bankruptcy? Smith prepared to analyze these questions from the perspectives of both Bon-Ton and an investor in order to present her findings to the investment company.

EXHIBIT 2: BON-TON-CONSOLIDATED ANNUAL INCOME STATEMENT (IN US$ MILLIONS) 2013 2014 20 15 2016 2017 Period End Date 02-Feb2013 01-Feb2014 31-Jan2015 30-Jan2016 28-Jan2017 Net Sales 2,919.4 2,770.1 2,756.2 2,717.7 2,600.6 Other Income 90.4 61.0 66.7 71.8 73.8 Total Revenue 2,978.8 2,834.1 2,822.9 2,789.5 2,674.4 Costs of Merchandise Sold 1,873.9 1,768.7 1,773.0 1,775.7 1,677.7 Gross Profit 1,104.9 1,065.4 1,049.9 1,013.8 906.7 Selling, General, and Administrative 806.8 771.1 771.4 764.2 737.3 Advertising 129.3 128.3 135.6 137.3 141.5 Depreciation and Amortization 68.3 :5.9 90.1 91.8 92.2 Amortization of LeaRe-Jaelated Interests 47 4.5 4.5 4.2 Termination Benefits and 4.2 Other Closing Cost D.0 0.0 D.0 4.1 1.9 Gain on Insurance Recovery D.C 110.8 11.4 0.0 Impairment Charges 5.8 6.2 2.5 3.6 17.0 Total Operating Expense 1,034.9 996.0 993.3 1,003.8 904.1 Operating Income 70.0 69.4 56.6 10.0 2.6 Interest Expense, Net 83.0) (68.8) 62.0) 63.0) (67.1) Loss on ExtingTishment of Debt B.5 1.4 0.2 5.2 0.8 Capitalized Interest 0.2 0.2 0.3 D.5 0.2 Net Income before Taxes 121.3 13.6 15.4 158.9 165.0 Provision for Income Taxes 0.2 10.1 1.6 11.9 11.6 Net Income after Taxes/Loss 121.6 13.6 17.0 157.1 163.4 Basic EPS 11.16 10.19 10.36 12.90 13.18 Diluted EPS 11.16 10.19 10.36 12.90 13.18EXHIBIT 6: BON-TON-CONSOLIDATED QUARTERLY BALANCE SHEET (IN US$ MILLIONS) Fiscal year ends in January. 2017-04 2017-07 2017-10 Current Assets Cash Cash and Cash Equivalents 7 Total Cash 6 7 6 Receivables Inventories 59 714 658 Prepaid Expenses 852 Total Current Assets 83 604 747 461 Non Current Assets Properly, Plant, and Equipment Land Fixtures and Equipment Other Properties 1,616 1.596 Property and Equipment, at Cost 1,585 1,616 1.596 Accumulated Depreciation 1,585 11,046 Property, Plant, and Equipment, Net il,049 11,056 571 547 Intangible Assets 72 70 Other WORK WHAT Assets 59 22 Total Non-Current Asset 28 665 Total Assets 1,468 Liabilities and Stockholders' Equity 1,387 1,587 Liabilities Current Liabilities Shareda Debt Capital Leases 665 Accounts Payable 7 161 Taxes Payable 178 248 Accrued Liabilities 179 Other Current Liabilities 137 149 26 Total Current Liabilities 22 346 Man Current Liabilities 348 1,091 LOOKED Debt 895 Capital Leases 849 345 132 Other Long Texan Liabilities 130 129 174 Total Non-Current Liabilities 170 177 1,201 Total Liabilities 1,150 551 1,547 Stockholders Equity 1.498 1,743 Common Stock Additional Paid In Capital 168 Retained Earnings i173 257 Treasury Stock il il il Accumulated Other Comprehensive Income 172 Total Stockholders' Equity 171 79 Total Liabilities and Stockholders' Equity 156 1,468 1.387 1.587EXHIBIT 5: BON-TON-CONSOLIDATED QUARTERLY INCOME STATEMENT (IN US$ MILLIONS, EXCEPT PER-SHARE DATA) Fiscal year ends in January. 2017-04 2017-07 2017-10 Revenue 553 525 562 Cost of Revenue 364 325 365 Gross Profit 189 200 197 Operating Expenses Sales, General, and Administrative 205 191 203 Other Operating Expenses 23 24 21 Total Operating Expenses 228 215 223 Operating Income 139 115 126 Other Income (Expense) [19 118 119 Income before Income Taxes 157 133 145 Provision for Income Taxes 0 Net Income from Continuing Operations 157 133 145 Net Income 157 133 145 Net Income Available to Common 157 133 145 ShareholdersEXHIBIT 7: BON-TON-CONSOLIDATED QUARTERLY CASH FLOW STATEMENT (IN US$ MILLIONS) Fiscal year ends in January. 2017-04 2017-07 2017-10 Cash Flows from Operating Activities Depreciation and Amortization 22 23 20 Amortization Of Debt Discount/Premium and Issuance Costs 3 2 2 Investment/Asset Impairment Charges Deferred Income Taxes 0 Stock Based Compensation 1 Inventory 11 56 193 Prepaid Expenses 16 i19 Accounts Payable 29 22 54 Accrued Liabilities A i16 Other Working Capital 17 Other Clon Cash Items 155 137 144 Net Cash Provided by Operating Activities 131 42 i172 Cash Flows from Investing Activities Investments in Property, Plant, and Equipment i10 i1 1 14 Properly, Plant, and Equipment Reductions 0 21 19 Net Cash Used for Investing Activities 10 10 Cash Flows from Financing Activities Long-Ten Debt Issued 170 106 287 Long-Jeu Debt Repayment i122 1157 106 Other Financing Activities i7 12 5 Net Cash Provided by (Used for) Financing Activities 41 153 168 Net Change in Cash Cash at Beginning of Period 7 7 Cash at End of Period 7 Free Cash Flow Operating Cash Flow 131 42 1172 Capital Expenditure 110 i1 1 i14 Free Cash Flow 149 31 i186