FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 26, 2003 Commission file number 1-15274
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transitional period from ______________ to ________________
Commission File No. ______________
J. C. PENNEY COMPANY, INC.
(Exact name of registrant as specified in its charter)
Delaware 26-0037077
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6501 Legacy Drive, Plano, Texas 75024 - 3698
(Address of principal executive offices)
(Zip Code)
(972) 431-1000
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
271,850,210 shares of Common Stock of 50 cents par value, as of September 3,
2003.
INDEX
Page
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Part I Financial Information
Item 1. Financial Statements
Consolidated Statements of Operations 1
Consolidated Balance Sheets 2
Consolidated Statements of Cash Flows 4
Notes to the Unaudited Interim Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
Item 4. Controls and Procedures 25
Part II Other Information
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 27
Signature Page 28
i
PART I - FINANCIAL INFORMATION
Item 1 - Unaudited Financial Statements
J. C. Penney Company, Inc.
Consolidated Statements of Operations
(Unaudited)
($ in millions, except per share data) 13 weeks ended 26 weeks ended
----------------------------- -------------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
-------------- ----------- ------------- ---------------
------------- ---------------
Retail sales, net $ 7,313 $ 7,198 $ 14,806 $ 14,926
Costs and expenses
Cost of goods sold 5,166 5,063 10,333 10,438
Selling, general and administrative expenses 2,042 2,040 4,167 4,136
Other unallocated (11) 5 (18) 15
Net interest expense 108 92 212 194
Acquisition amortization 8 7 18 17
-------------- ----------- ------------- ---------------
-------------- ----------- ------------- ---------------
Total costs and expenses 7,313 7,207 14,712 14,800
-------------- ----------- ------------- ---------------
Income/(loss) before income taxes 0 (9) 94 126
Income taxes 0 3 (33) (46)
-------------- ----------- ------------- ---------------
------------- ---------------
Net income/(loss) $ 0 $ (6) $ 61 $ 80
Less: preferred stock dividends (6) (7) (13) (14)
-------------- ----------- ------------- ---------------
-------------- ----------- ------------- ---------------
Net (loss)/income applicable to common
stockholders $ (6) $ $ 48 $ 66
(13)
============== =========== ============= ===============
(Loss)/earnings per share:
Basic $(0.02) $ (0.05) $0.18 $0.25
Diluted $(0.02) $ (0.05) $0.18 $0.24
The accompanying notes are an integral part of these unaudited Interim Consolidated Financial Statements.
-1-
J. C. Penney Company, Inc.
Consolidated Balance Sheets
(Unaudited)
($ in millions) July 26, July 27, Jan. 25,
2003 2002 2003
-------------- ------------ ---------------
Assets
Current assets
Cash and short-term investments
(including restricted balances of $87,
$121 and $86) $ 2,631 $ 2,004 $ 2,474
Receivables (net of bad debt reserves
of $14, $15 and $14) 713 695 705
Merchandise inventory (net of LIFO
reserves of $421, $401 and $403) 5,175 5,002 4,945
Prepaid expenses 128 118
132
-------------- ------------ ---------------
Total current assets 8,647 7,833 8,242
Property and equipment (net of accumulated
depreciation of $3,336, $3,575 and $3,253) 4,829 4,889 4,901
Goodwill 2,311 2,312 2,304
Intangible assets (net of accumulated
amortization of $352, $285 and $322) 469 513 494
Other assets 1,803 1,532 1,815
-------------- ------------ ---------------
Total Assets $ 18,059 $ 17,079 $ 17,756
============== ============ ===============
The accompanying notes are an integral part of these unaudited Interim Consolidated Financial Statements.
-2-
J. C. Penney Company, Inc.
Consolidated Balance Sheets
(Unaudited)
($ in millions except per share data) July 26, July 27, Jan. 25,
2003 2002 2003
-------------- ------------ --------------
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable and accrued expenses $3,302 $3,370 $3680
Short-term debt 25 17 13
Current maturities of long-term debt 642 14 288
Deferred taxes 112 88 80
-------------- ------------ --------------
Total current liabilities 4,081 3,489 4,061
Long-term debt 5,161 5,172 4,927
Deferred taxes 1,396 1,256 1,391
Other liabilities 979 999 1,007
-------------- ------------ --------------
Total Liabilities 11,617 10,916 11,386
Stockholders' equity
Capital stock
Preferred stock, no par value and stated value
of $600 per share: authorized, 25 million shares;
issued and outstanding, 0.5, 0.6 and 0.6 million
shares of Series B ESOP convertible preferred 317 333
345
Common stock, par value $0.50 per share:
authorized, 1,250 million shares; issued and
outstanding, 272, 268 and 269 million shares 3,486 3,409 3,423
-------------- ------------ --------------
Total capital stock 3,803 3,754 3,756
-------------- ------------ --------------
Reinvested earnings at beginning of year 2,817 2,573 2,573
Net income 61 80 405
Dividends declared (80) (80) (161)
-------------- ------------ --------------
Reinvested earnings at end of period 2,798 2,817
2,573
Accumulated other comprehensive (loss) (159) (164) (203)
-------------- ------------ --------------
Total Stockholders' Equity 6,442 6,163 6,370
-------------- ------------ --------------
Total Liabilities and Stockholders' Equity $18,059 $ 17,079 $ 17,756
============== ============ ==============
The accompanying notes are an integral part of these unaudited Interim Consolidated Financial Statements.
-3-
J. C. Penney Company, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
($ in millions) 26 weeks ended
---------------------------------------
---------------------------------------
July 26, July 27,
2003 2002
----------------- ----------------
Cash flows (used in)/provided by operating activities:
Net income $ 61 $ 80
Adjustments to reconcile net income to net cash
from operating activities:
Asset impairments, PVOL and other unit closing costs 16 28
Depreciation and amortization, including intangible assets 355 324
Net gains on sale of assets (51) (10)
Benefit plans expense 35 4
Vesting of restricted stock awards 3 3
Deferred taxes 37 14
Change in cash from:
Receivables (25) 3
Sale of drugstore receivables 44 -
Inventory (230) (72)
Prepaid expenses and other assets 14 1
Accounts payable 64 302
Current income taxes payable (30) (19)
Other liabilities (334) (228)
----------------- ----------------
Net cash (used in)/provided by operating activities (41) 430
----------------- ----------------
Cash flows (used in)/provided by investing activities:
Capital expenditures (352) (286)
Proceeds from sale of assets 68 18
----------------- ----------------
Net cash (used in) investing activities (284) (268)
----------------- ----------------
Cash flows provided by/(used in) financing activities:
Change in short-term debt 12 2
Proceeds from equipment financing 9 9
Net proceeds from issuance of long-term debt 586 -
Payment of long-term debt, including capital leases (42) (929)
Common stock issued, net 13 18
Preferred stock redeemed (16) (18)
Dividends paid (80) (80)
----------------- ----------------
Net cash provided by/(used in) financing activities 482 (998)
----------------- ----------------
Net increase/(decrease) in cash and short-term investments 157 (836)
Cash and short-term investments at beginning of year 2,474 2,840
----------------- ----------------
Cash and short-term investments at end of period $ 2,631 $ 2,004
================= ================
The accompanying notes are an integral part of these unaudited Interim Consolidated Financial Statements.
-4-
Notes to the Unaudited Interim Consolidated Financial Statements
1) Summary of Significant Accounting Policies
A description of significant accounting policies is included in the Company's
Annual Report on Form 10-K for the fiscal year ended January 25, 2003 (the "2002
10-K"). The accompanying unaudited Interim Consolidated Financial Statements
should be read in conjunction with the Consolidated Financial Statements and
notes thereto in the 2002 10-K.
The accompanying Interim Consolidated Financial Statements are unaudited but, in
the opinion of management, include all material adjustments necessary for a fair
presentation. Because of the seasonal nature of the retail business, operating
results for interim periods are not necessarily indicative of the results that
may be expected for the full year. The January 25, 2003 financial information
has been derived from the audited Consolidated Financial Statements, with
related footnotes, included in the 2002 10-K.
Certain reclassifications have been made to prior year amounts to conform to the
current period presentation.
Holding Company
Effective January 27, 2002, J. C. Penney Company, Inc. changed its corporate
structure to a holding company format. As part of this structure, J. C. Penney
Company, Inc. changed its name to J. C. Penney Corporation, Inc. (JCP) and
became a wholly owned subsidiary of a newly formed affiliated holding company
(Holding Company). The Holding Company assumed the name J. C. Penney Company,
Inc. The Holding Company has no direct subsidiaries other than JCP, nor does it
have any independent assets or operations. All outstanding shares of common and
preferred stock were automatically converted into the identical number and type
of shares in the Holding Company. Stockholders' ownership interests in the
business did not change as a result of the new structure. Shares of the Company
remain publicly traded under the same symbol (JCP) on the New York Stock
Exchange. The Holding Company is a co-obligor (or guarantor, as appropriate)
regarding the payment of principal and interest on JCP's outstanding debt
securities. The guarantee by the Holding Company of certain of JCP's outstanding
debt is full and unconditional. The Holding Company and its consolidated
subsidiaries, including JCP, are collectively referred to in this quarterly
report as "Company" or "JCPenney," unless indicated otherwise.
Stock-Based Compensation
------------------------
The Company has a stock-based compensation plan for associates that provides for
grants of stock awards, stock appreciation rights or options to purchase the
Company's common stock. The Company accounts for the plan under the recognition
and measurement principles of Accounting Principles Board Opinion No. 25 (APB
25), "Accounting for Stock Issued to Employees," and related Interpretations. No
stock-based employee compensation cost is reflected in the consolidated
statement of operations for stock options, as all options granted under the plan
had an exercise price equal to the market value of the underlying common stock
on the date of grant. Compensation expense for fixed stock awards with pro rata
vesting is recorded on a straight-line basis over the vesting period, which
typically ranges from one to five years.
-5-
The following table illustrates the effect on net income and earnings per share
as if the Company had applied the fair value recognition provisions of Statement
of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation," to stock options.
$ in millions, except EPS 13 weeks ended 26 weeks ended
---------------------------- ----------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
------------ ------------ ------------ -------------
Net income/(loss) - as reported $ 0 $ (6) $ 61 $ 80
Add: Stock-based employee compensation
expense included in reported net income, net of
related tax effects 1 1 2 2
Deduct: Total stock-based employee compensation
expense determined under fair value
method(1) for all awards, net of related
tax effects (6) (6) (12) (12)
-------- -------- -------- ---------
Pro forma net (loss)/income $ (5) $ (11) $ 51 $ 70
======== ======== ======== =========
(Loss)/earnings per share:
Basic--as reported $ (0.02) $ (0.05) $ 0.18 $ 0.25
Basic--pro forma $ (0.04) $ (0.07) $ 0.14 $ 0.21
Diluted--as reported $ (0.02) $ (0.05) $ 0.18 $ 0.24
Diluted--pro forma $ (0.04) $ (0.07) $ 0.14 $ 0.21
(1) The fair value of each option grant for the Company's plans is estimated on the date of the
grant using the Black-Scholes option pricing model.
Effect of New Accounting Standards
----------------------------------
The Company adopted Emerging Issues Task Force (EITF) Issue No. 02-16,
"Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor," in the first quarter of 2003. This pronouncement
requires that vendor allowances be treated as a reduction of inventory costs
unless specifically identified as a reimbursement of costs to advertise the
vendor's products or payment for other services. In addition, any vendor
allowances received in excess of costs incurred should be treated as a reduction
of inventory costs. The adoption of this pronouncement did not have a material
impact on Eckerd segment results, but did impact a small portion of vendor
allowances for Department Stores and Catalog and reduced the segment's operating
profit by $1 million and $6 million for the second quarter and first half of
2003, respectively. The adoption resulted in lower net income for the Company of
approximately $1 million for the second quarter and $4 million in the first half
of 2003.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Guarantees of Indebtedness of Others." Disclosures related to this
interpretation were effective for year-end 2002 reporting, and the accounting
requirements are effective for guarantees entered into or modified after
December 31, 2002, and require all guarantees and indemnifications within its
scope to be recorded at fair value as liabilities, and the maximum possible loss
to the Company under these guarantees and indemnifications to be disclosed.
Current period disclosures related to guarantees are included in Note 10.
Adoption of FIN 45 did not have a material impact on the Company's consolidated
financial statements.
-6-
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation Costs - Transition and Disclosure." This statement amended SFAS 123
and provides alternative methods of transition for an entity that voluntarily
changes to the fair value-based method of accounting for stock-based
compensation. It also requires additional disclosures about the effects on
reported net income of an entity's accounting policy with respect to stock-based
employee compensation. As discussed previously, the Company accounts for
stock-based compensation in accordance with APB 25 and adopted the
disclosure-only alternative of SFAS 123. The Company adopted the disclosure
provisions of SFAS 148 effective for fiscal 2002.
On January 17, 2003, FIN 46, "Consolidation of Variable Interest Entities, an
interpretation of ARB 51," was issued. The primary objective of FIN 46 is to
provide guidance on the identification and consolidation of variable interest
entities, or VIEs, which are entities for which control is achieved through
means other than through voting rights. The provisions of FIN 46 are required to
be applied to VIEs created or in which the Company obtains an interest after
January 31, 2003. For VIEs in which the Company holds a variable interest that
it acquired before February 1, 2003, the provisions of FIN 46 are effective for
the third quarter of 2003. The Company does not expect the adoption of FIN 46 in
the third quarter of 2003 to have a material impact on its financial position,
results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
establishes standards that require companies to classify certain financial
instruments as liabilities that were previously classified as equity. SFAS 150
was effective for financial instruments entered into or modified after May 31,
2003, and there was no second quarter impact on the Company's financial
statements. The remaining provisions of SFAS 150 will be effective beginning in
the third quarter of 2003, and the Company does not expect SFAS 150 to have a
material impact on its consolidated financial position or operating results.
Additionally, in May 2003, the EITF reached consensus on Issue 01-8,
"Determining Whether an Arrangement Contains a Lease." This pronouncement
provides guidance in determining whether an arrangement contains a lease that is
within the scope of SFAS 13, "Accounting for Leases." If the delivery of goods
or services is dependent on the use of specified property, plant and equipment
(property) and if the purchaser (lessee) has the right to operate or control the
property while controlling or obtaining more than a minor amount of the output
or other utility of the property, the arrangement may be required to be treated
as a lease. This consensus should be applied to new or modified arrangements
entered into in the first interim period after May 28, 2003, which would be the
third quarter for the Company. The Company does not expect EITF 01-8 to have a
material impact on its consolidated financial position or operating results.
-7-
2) Earnings per Share
------------------
Basic earnings per share (EPS) is computed by dividing income applicable to
common stockholders by the average number of common shares outstanding for the
period. Except when the effect would be anti-dilutive, the diluted EPS
calculation includes the impact of restricted stock awards and shares that could
be issued under outstanding stock options as well as common shares that would
result from the conversion of convertible debentures and convertible preferred
stock. In addition, the related interest on convertible debentures (net of tax)
and preferred stock dividends (net of tax) are added back to income, since these
would not be paid if the debentures or preferred stock were converted to common
stock.
The computation of basic and diluted earnings per share follows:
(In millions, except per share data) 13 weeks ended 26 weeks ended
------------------------- -------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
----------- ------------ ----------- -----------
Earnings:
Net income/(loss) $ 0 $ (6) $ 61 $ 80
Less: preferred dividends, net of tax (6) (7) (13) (14)
----------- ------------ ----------- -----------
(Loss)/income for basic and diluted EPS calculations $ (6) $ (13) $ 48 $ 66
=========== ============ =========== ===========
Shares:
Average shares outstanding (basic shares) 271 268 271 267
Effect of dilutive securities:
Stock options and restricted stock units - - 2 3
----------- ------------ ----------- -----------
Average shares used for diluted EPS 271 268 273 270
=========== ============ =========== ===========
(Loss)/earnings per share:
Basic $ (0.02) $ (0.05) $ 0.18 $ 0.25
Diluted $ (0.02) $ (0.05) $ 0.18 $ 0.24
The following potential shares of common stock and their effects on income were
excluded from the diluted EPS calculations because their effect would be
anti-dilutive:
o Options to purchase 26 million and 23 million shares of common stock at
exercise prices ranging from $9 to $71 were outstanding at July 26, 2003
and July 27, 2002, respectively, and were excluded from the quarter
calculations. Options to purchase 17 million and 9 million shares of common
stock at exercise prices ranging from $19 to $71 and $22 to $71 were
excluded from the calculations for the first half of 2003 and 2002,
respectively, because their exercise prices were higher than the average
stock price.
o The $650 million aggregate principal amount of notes convertible into 22.8
million common shares at a price of $28.50 per share were excluded from all
periods shown.
o Preferred stock convertible into 10.6 million and 11.5 million common
shares was issued and outstanding at July 26, 2003 and July 27, 2002,
respectively, and was excluded from all periods shown.
-8-
3) Cash and Restricted Short-Term Investment Balances
--------------------------------------------------
Restricted short-term investment balances of $87 million, $121 million and $86
million as of July 26, 2003, July 27, 2002 and January 25, 2003, respectively,
were included in the total cash and short-term investment balances of $2,631
million, $2,004 million and $2,474 million for the same periods. Restricted
balances are pledged as collateral for import letters of credit, which are not
included in the bank credit facility, and for a portion of casualty insurance
program liabilities. Cash and short-term investments on the consolidated balance
sheet included $17 million, $5 million and $6 million of cash as of July 26,
2003, July 27, 2002 and January 25, 2003, respectively.
4) Supplemental Cash Flow Information
----------------------------------
($ in millions) 26 weeks ended
-----------------------------------
July 26, 2003 July 27, 2002
----------------- --------------
Interest paid $196 $ 230
Interest received 14 23
Income taxes paid 37 43
Non-cash transactions:
----------------------
o The Company issued 2.4 million shares of common stock in February 2003 and
2.9 million shares of common stock in March 2002 to fund savings plan
contributions of $47 million for 2002 and $58 million for 2001.
o The Company acquired $16 million of drugstore equipment utilizing capital
leases in the first six months of 2003.
o During the second quarter of 2002, the Company exchanged certain notes and
debentures with a net carrying amount of $206 million for new notes
recorded at a fair value of $205 million.
5) Eckerd Managed Care Receivables Securitization
----------------------------------------------
As disclosed in the 2002 10-K, JCP, through Eckerd, has received a total of
approximately $250 million from the securitization of certain Eckerd managed
care receivables. Of the total proceeds, $200 million was received in 2001, when
a revolving receivables purchase facility agreement was entered into with an
unrelated entity. In February 2003, the agreement was amended to add two
additional third party purchasers and additional Eckerd managed care receivables
were securitized with approximately $50 million of cash proceeds received. Under
the agreement Eckerd sells, on a continuous basis, substantially all of its
managed care receivables to ECR Receivables, Inc. (ECR), a subsidiary of Eckerd.
ECR then sells to the third party purchasers an undivided interest in all
eligible receivables while retaining a subordinated interest in a portion of the
receivables.
As of July 26, 2003, securitized managed care receivables totaled $291 million,
of which the subordinated retained interest was $47 million, resulting in net
securitized receivables of $244 million. Losses and expenses related to
receivables sold under this agreement for the second quarter and first half of
2003 were $1 million and $3 million, respectively, and are included in other
unallocated in the accompanying consolidated statements of operations. Losses
and expenses for the second quarter and first half of 2002 were $1 million and
$2 million, respectively.
6) Goodwill and Other Intangible Assets
------------------------------------
Effective January 27, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." Upon adoption, the Company ceased amortization of
goodwill and other indefinite-lived intangible assets,
-9-
primarily the Eckerdtrade name. These assets are now subject to an impairment
test on an annual basis, or when there is reason to believe that their values
have been diminished or impaired. These tests are performed on each business of
the Company where goodwill is recorded. There were no impairment losses related
to goodwill or intangible assets recorded during the first half of 2003 or 2002.
The carrying amounts of goodwill were $2,311 million, $2,312 million and $2,304
million as of July 26, 2003, July 26, 2002 and January 25, 2003, respectively.
The changes in carrying value are related to foreign currency translation
adjustments. At July 26, 2003, the total carrying amount of goodwill consisted
of $42 million for the Department Store and Catalog segment and $2,269 million
for the Eckerd Drugstore segment. Intangible assets, all of which are included
in the Eckerd Drugstore segment, consisted of the following:
($ in millions) July 26, July 27, Jan. 25,
2003 2002 2003
---------------- ---------------- ---------------
Amortizing intangible assets:
Prescription files $ 294 $ 271 $ 289
Less accumulated amortization 174 137 157
---------------- ---------------- ---------------
Prescription files, net 120 134 132
---------------- ---------------- ---------------
Favorable lease rights 205 205 205
Less accumulated amortization 178 148 165
---------------- ---------------- ---------------
Favorable lease rights, net 27 57 40
---------------- ---------------- ---------------
Carrying amount of amortizing
intangible assets 147 191 172
Non-amortizing intangible assets
Eckerd trade name 322 322 322
---------------- ---------------- ---------------
Total intangible assets $ 469 $ 513 $ 494
================ ================ ===============
The net carrying amount of intangible assets decreased $25 million during the
first half of 2003 due to $30 million of amortization of intangible assets
partially offset by $5 million of prescription files acquired.
The following table provides amortization expense for the periods presented.
Amortization expense related to major business acquisitions is reported as
acquisition amortization on the consolidated statements of operations. The
remaining amount of amortization expense is included in selling, general and
administrative (SG&A) expenses.
($ in millions) 13 weeks ended 26 weeks ended
-------------------------- ---------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
---------- ------------ ------------ -----------
------------ -----------
Major business acquisitions(1) $ 8 $ 7 $ 18 $ 17
Other acquisitions 6 5 12 11
---------- ------------ ------------ -----------
Total for amortizing intangible assets $14 $ 12 $ 30 $ 28
========== ============ ============ ===========
(1) Major business acquisitions include Eckerd Corporation acquired in early 1997, Lojas Renner S.A. acquired
in January 1999 and Genovese Drug Stores, Inc. acquired in March 1999.
Amortization expense for the intangible assets reflected above is expected to be
approximately (in millions) $66, $35, $26, $17 and $11 for fiscal years 2003,
2004, 2005, 2006 and 2007, respectively. Of these amounts, amortization related
to major business acquisitions is expected to be approximately (in millions)
$40, $9, $6 and $1 for fiscal years 2003, 2004, 2005 and 2006, respectively.
-10-
7) Restructuring Reserves
----------------------
At July 26, 2003, the consolidated balance sheet included $97 million of
remaining reserves that were established in connection with the Company's
restructuring initiatives compared to $148 million at July 27, 2002 and $113
million at January 25, 2003. The remaining reserves are related to future lease
obligations for both department stores and drugstores that have closed.
Costs are being charged against the reserves as incurred. Reserves are
periodically reviewed for adequacy and are adjusted as appropriate. Imputed
interest expense and any other adjustments to the reserves are included in other
unallocated. During the first half of 2003, cash payments related to the
reserves were $18 million. The reserves were increased by approximately $2
million for imputed interest and other adjustments during the first half of
2003. Cash payments related to these reserves are expected to approximate $11
million for the second half of 2003, with most of the remainder to be paid out
by the end of 2005.
8) Financing Transactions
----------------------
Issuance of $600 Million Debt
On February 28, 2003, JCP issued $600 million principal amount of 8.0% Notes Due
2010 ("Notes") priced at 99.342% of their principal amount to yield 8.125%. J.
C. Penney Company, Inc. is a co-obligor on the Notes. The Notes pay interest on
March 1 and September 1 each year. The Notes are redeemable in whole or in part,
at the Company's option at any time, at a redemption price equal to the greater
of (i) 100% of the principal amount of such Notes or (ii) the sum of the present
values of the remaining scheduled payments, discounted to the redemption date on
a semi-annual basis at the "treasury yield" plus 50 basis points, together in
either case with accrued interest to the date of redemption.
Payments of Sinking Fund Debt
On June 16, 2003, JCP retired $25 million of its 9.75% Debentures Due 2021 at
par through a mandatory sinking fund payment of $12.5 million and an optional
sinking fund payment of $12.5 million. During the quarter, JCP also purchased
$4.1 million principal amount of its 8.25% Debentures Due 2022 for application
to future mandatory sinking fund payments.
-11-
9) Comprehensive Income/(Loss) and Accumulated Other Comprehensive
(Loss)/Income
Comprehensive Income /(Loss)
($ in millions) 13 weeks ended 26 weeks ended
--------------------------- -------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
----------- ------------ ----------- ------------
Net income/(loss) $ 0 $ (6) $ 61 $ 80
Other comprehensive income/(loss):
Foreign currency translation adjustments 18 (29) 26 (31)
Net unrealized gains/(losses) in real estate investment trusts 9 (3) 18 4
----------- ------------ ----------- ------------
27 (32) 44 (27)
----------- ------------ ----------- ------------
Total comprehensive income/(loss) $ 27 $ (38) $ 105 $ 53
=========== ============ =========== ============
Accumulated Other Comprehensive (Loss)/Income
($ in millions) July 26, July 27, Jan. 25,
2003 2002 2003
---------------- --------------- ---------------
Foreign currency translation adjustments $ (138) $(131) $(164)
Non-qualified plan minimum liability adjustment (58) (51) (58)
Net unrealized gains in real estate investment trusts 37 18 19
---------------- --------------- ---------------
Accumulated other comprehensive (loss) $ (159) $(164) $(203)
================ =============== ===============
Net unrealized gains in real estate investment trusts are shown net of deferred
taxes of $20 million, $10 million and $10 million as of July 26, 2003, July 27,
2002 and January 25, 2003, respectively. The non-qualified plan minimum
liability is shown net of deferred tax asset of $39 million, $33 million and $39
million as of July 26, 2003, July 27, 2002 and January 25, 2003, respectively. A
deferred tax asset has not been established for foreign currency translation
adjustments due to the historical reinvestment of earnings in the foreign
subsidiaries.
10) Guarantees
----------
JCP had guarantees, which are described in detail in the 2002 10-K, totaling
$264 million at July 26, 2003. These guarantees include: $172 million potential
remaining obligation for building and equipment leases entered into by third
party operators of certain of the Company's store support centers (SSCs) upon
termination of services for any reason; $43 million related to investments in a
real estate investment trust; $20 million maximum exposure on insurance reserves
established by a former subsidiary included in the sale of the Company's Direct
Marketing Services business; and $29 million of lease guarantees on certain sold
drugstores, $22 million of which is recorded in other liabilities.
-12-
11) Other Unallocated
-----------------
Other unallocated consists of real estate activities, investment transactions
and other items related to corporate initiatives or activities, which are not
allocated to an operating segment but are included in total Company operating
results.
($ in millions) 13 weeks ended 26 weeks ended
----------------------------- ------------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
-------------- ------------- ------------- ----------------
Asset impairments, PVOL and other unit closing costs $ 24 $ 8 $ 39 $ 30
Gains from sale of real estate (30) - (51) (10)
Real estate operations (6) (9) (10) (15)
Third party fulfillment losses and other 1 6 4 10
-------------- ------------- ------------- ----------------
Total $ (11) $ 5 $ (18) $ 15
============== ============= ============= ================
The Company recorded charges of $24 million for the second quarter of 2003 for
asset impairments, the present value of lease obligations (PVOL) and other unit
closing costs. These charges were comprised of $10 million of accelerated
depreciation for catalog facilities closed in second quarter of 2003, $9 million
of asset impairments and $5 million related primarily to remaining lease
obligations for closed units. For the second quarter of 2002 these costs
included $9 million of asset impairments offset by a net credit adjustment of $1
million primarily related to remaining lease obligations for closed units. Asset
impairments, PVOL and other unit closing for the first half of 2003 included $22
million of accelerated depreciation for catalog facilities closed in the second
quarter of 2003, $9 million of asset impairments and $8 million of expenses
related primarily to remaining lease obligations for closed units. Charges for
the first half of 2002 consisted of $17 million of asset impairments and $13
million related to remaining lease obligations and other costs for closed units.
Real estate gains were recorded from the sale of facilities that were no longer
being used in Company operations.
Real estate operations consist primarily of operating income of the Company's
real estate subsidiary.
Third party fulfillment losses and other consists of operating losses related to
third party fulfillment operations that were discontinued in 2002, losses and
expenses related to receivables sold as part of the Eckerd managed care
receivables securitization (see Note 5) and other corporate costs.
-13-
12) Segment Reporting
------------------
Reportable segments are determined based on similar economic characteristics,
the nature of products and services and the method of distribution. Performance
of the segments is evaluated based on segment operating profit. Segment
operating profit is LIFO gross margin less SG&A expenses. Segment assets include
goodwill and intangible assets; however, segment operating profit does not
include the amortization of intangible assets related to major business
acquisitions. The Company operates in two business segments: Department Stores
and Catalog (including internet), and Eckerd Drugstores. Other unallocated is
provided for purposes of reconciling to total Company amounts.
Business Segment Information
($ in millions)
Dept. Stores Eckerd Other Total
& Catalog Drugstores Unallocated Company
-------------------------------------------------------------------------------------------------------------------------------
2nd Quarter - 2003
Retail sales, net $ 3,658 $ 3,655 $ - $ 7,313
-----------------------------------------------------------------------
Segment operating profit 51 54 - 105
Net interest expense (108) (108)
Other unallocated 11 11
Acquisition amortization (8) (8)
------------------
Income before income taxes 0
------------------
Depreciation and amortization expense 88 69 18 175
-------------------------------------------------------------------------------------------------------------------------------
1st Half - 2003
Retail sales, net $ 7,381 $ 7,425 $ 14,806
-----------------------------------------------------------------------
Segment operating profit 134 172 306
Net interest expense (212) (212)
Other unallocated
18 18
Acquisition amortization
(18) (18)
------------------
Income before income taxes 94
------------------
Depreciation and amortization expense 177 138 40 355
Total assets $ 11,072 $ 6,813 $ 174 $ 18,059
===============================================================================================================================
2nd Quarter - 2002
Retail sales, net $ 3,623 $ 3,575 $ - $7,198
-----------------------------------------------------------------------
Segment operating profit 22 73 - 95
Net interest expense (92) (92)
Other unallocated (5)
(5)
Acquisition amortization (7) (7)
------------------
(Loss) before income taxes
(9)
------------------
Depreciation and amortization expense 94 60 7 161
-------------------------------------------------------------------------------------------------------------------------------
1st Half - 2002
Retail sales, net $ 7,629 $ 7,297 $ - $14,926
Segment operating profit 179 173 - 352
Net interest expense (194) (194)
Other unallocated (15) (15)
Acquisition amortization (17) (17)
------------------
Income before income taxes 126
------------------
Depreciation and amortization expense 186 121 17 324
Total assets $ 10,305 $ 6,628 $ 146 $ 17,079
===============================================================================================================================
-14-
13) Subsequent Events
------------------
On August 15, 2003, bondholders exercised their option to redeem approximately
$117 million of $119 million 6.9% Debentures Due 2026. On the same date, JCP
retired $37.5 million of its 8.25% Debentures Due 2022 at par, through the
mandatory sinking fund payment of $12.5 million and available optional sinking
fund payments totaling $25 million. Also in August 2003, JCP purchased
approximately $12.8 million of the 8.25% Sinking Fund Debentures Due 2022. These
purchases, together with the $4.1 million purchases in the second quarter of
2003, will be applied to unspecified future mandatory sinking fund payments.
-15-
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Holding Company
----------------
Effective January 27, 2002, J. C. Penney Company, Inc. changed its corporate
structure to a holding company format. As part of this structure, J. C. Penney
Company, Inc. changed its name to J. C. Penney Corporation, Inc. (JCP) and
became a wholly owned subsidiary of a newly formed affiliated holding company
(Holding Company). The Holding Company assumed the name J. C. Penney Company,
Inc. The Holding Company has no direct subsidiaries other than JCP, nor does it
have any independent assets or operations. All outstanding shares of common and
preferred stock were automatically converted into the identical number and type
of shares in the Holding Company. Stockholders' ownership interests in the
business did not change as a result of the new structure. Shares of the Company
remain publicly traded under the same symbol (JCP) on the New York Stock
Exchange. The Holding Company is a co-obligor (or guarantor, as appropriate)
regarding the payment of principal and interest on JCP's outstanding debt
securities. The guarantee by the Holding Company of certain of JCP's outstanding
debt is full and unconditional. The Holding Company and its consolidated
subsidiaries, including JCP, are collectively referred to in this report as
"Company" or "JCPenney," unless indicated otherwise.
Critical Accounting Policies
----------------------------
Management's discussion and analysis of its financial condition and results of
operations is based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates and judgments that affect reported
amounts of assets, liabilities, revenues and expenses, and related disclosures
of contingent assets and liabilities. Management bases its estimates on
historical experience and on other assumptions that are believed to be
reasonable under the circumstances. On an ongoing basis, management evaluates
estimates used, including those related to inventory valuation under the retail
method; revenue recognition; valuation of long-lived and intangible assets,
including goodwill; estimation of reserves and valuation allowances specifically
related to closed stores, insurance, income taxes, litigation and environmental
contingencies; and pension accounting. Actual results may differ from these
estimates under different assumptions or conditions. Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations, in the
2002 10-K includes detailed descriptions of certain judgments that management
makes in applying its accounting policies in these areas.
-16-
Consolidated Results of Operations
($ in millions except EPS) 13 weeks ended 26 weeks ended
------------------------------ --------------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
-------------- --------------- -------------- -----------------
Department Stores and Catalog $ 51 $ 22 $ 134 $ 179
Eckerd Drugstores 54 73 172 173
-------------- --------------- -------------- -----------------
Total segments 105 95 306 352
Other unallocated 11 (5) 18 (15)
Net interest expense (108) (92) (212) (194)
Acquisition amortization (8) (7) (18) (17)
-------------- --------------- -------------- -----------------
Income before income taxes 0 (9) 94 126
Income taxes 0 3 (33) (46)
-------------- --------------- -------------- -----------------
Net income $ 0 $ (6) $ 61 $ 80
============== =============== ============== =================
Earnings per share, diluted $ (0.02) $ (0.05) $ 0.18 $ 0.24
============== =============== ============== =================
For the second quarter of 2003, the Company reported net income of zero, or a
loss of $0.02 per share (due to preferred stock dividends, net of tax), compared
to a loss of $6 million, or $0.05 per share for the comparable 2002 period.
Results reflect good sales growth and expense control in Department Stores and
Catalog, including internet, which offset the lower sales and profit results for
Eckerd. For the first half of 2003, the Company reported $61 million, or $0.18
per share, compared to $80 million, or $0.24 per share for the comparable 2002
period. The decline in year-to-date earnings was primarily the result of soft
sales in the first quarter for Department Stores and Catalog and higher planned
SG&A expenses, partially offset by gross margin improvement in both operating
segments in the first quarter of 2003. As previously disclosed in the 2002 10-K,
the second quarter and first half of 2003 were negatively impacted as a result
of higher incremental non-cash pension expense.
Also affecting the quarter's results were certain items that are recorded in
other unallocated. These items included $30 million of pre-tax real estate gains
on the sale of closed department store facilities, partially offset by $10
million of accelerated depreciation for catalog facilities closed in second
quarter of 2003, $9 million of asset impairments and $5 million of expenses
related primarily to the present value of lease obligations (PVOL) for closed
units. Results of operations for the second quarter of 2002 included $8 million
of asset impairments, PVOL and other unit closing costs also recorded in other
unallocated.
For the first half of 2003, the results of operations included $51 million of
pre-tax gains on the sale of several closed units, $22 million of accelerated
depreciation for catalog facilities closed in the second quarter of 2003, $9
million of asset impairments and $8 million of expenses related primarily to the
PVOL for closed units. For the first half of 2002, results of operations
included a $10 million pre-tax gain on the sale of a closed unit and $30 million
of asset impairments, PVOL and other unit closing costs in other unallocated.
Items are discussed in other unallocated on page 21 and in Note 11.
-17-
Segment Operating Results
Department Stores and Catalog
($ in millions) 13 weeks ended 26 weeks ended
----------------------------
------------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
------------- -------------- -------------- ------------
Retail sales, net 3,658 $ 3,623 $ 7,381 $ 7,629
------------- -------------- -------------- ------------
FIFO/LIFO gross margin 1,314 1,307 2,774 2,821
SG&A expenses (1,263) (1,285) (2,640) (2,642)
------------- -------------- -------------- ------------
Segment operating profit $ 51 $ 22 $ 134 $ 179
============= ============== ============== ============
Sales percent increase/(decrease):
Comparable stores(1) 2.1% (2.4)% (1.6)% 2.5%
Total department stores 0.5% (2.7)% (3.0)% 1.2%
Catalog 3.9% (21.4)% (4.3)% (23.3)%
Ratios as a percent of sales:
FIFO/LIFO gross margin 35.9% 36.1% 37.6% 37.0%
SG&A expenses 34.5% 35.5% 35.8% 34.6%
Segment operating profit 1.4% 0.6% 1.8% 2.4%
(1) Comparable store sales include sales from stores which have been open for 12 consecutive months. A
store's sales become comparable on the first day of the 13th fiscal month.
Segment operating profit for Department Stores and Catalog in this year's second
quarter more than doubled to $51 million compared to $22 million last year, and
represented an increase of 80 basis points as a percent of sales. Comparable
store sales gains, improved catalog performance and good control of SG&A
expenses led to the improvement.
Comparable department store sales increased 2.1% in the second quarter. Total
department store sales increased 0.5%. All merchandise divisions generated
comparable store sales gains for the quarter, with the best performance in
Children's, Young Men's and Family Footwear. In addition, both fine jewelry and
fashion jewelry performed well compared to last year. The Home division also
continued to have good results, led by window coverings and the expanded
housewares department. During the quarter, the new women's accessory and fashion
jewelry concept was rolled out to about 550 stores and fine jewelry was expanded
in 200 stores. The transition was well executed and customer response has been
better than planned.
Catalog sales increased 3.9% for the quarter compared to last year and
represented the first quarterly increase since the second quarter of 2000. Sales
reflected an improving print business, both in the Big Books and specialty
catalogs, as well as an increase in internet sales. Total internet sales, which
are reported as a component of catalog sales and are an integral part of the
Company's three-channel retailing strategy, increased more than 60% to $112
million.
As discussed in Note 1, the Company adopted EITF Issue 02-16, "Accounting by a
Customer (Including a Reseller) for Certain Consideration Received from a
Vendor," in the first quarter of 2003. This change resulted in a decrease in
segment operating profit of approximately $1 million in the second quarter and
$6 million in the first half.
Gross margin declined 20 basis points as a percent of sales in this year's
second quarter as a result of a more aggressive clearance strategy. This
compared to last year when low inventory levels and light clearance activity
generated a strong 290 basis point improvement in the second quarter.
-18-
SG&A expenses for the quarter improved 100 basis points as a percent of sales
and were $22 million below last year's level. This improvement was primarily the
result of salary savings from centralized checkouts (also referred to as
customer service centers), the elimination of in-store receiving and lower
expenses in Catalog that more than offset transition costs to the new store
distribution network and higher non-cash pension expenses. The new Store Support
Center (SSC) network for department stores, an integral part of the Company's
centralization efforts, was fully operational by the end of the second quarter.
All stores are now being served by one of the 13 SSCs. Once this distribution
network matures, the Company expects to see additional benefits from operational
efficiencies and a consistently better flow of merchandise to individual stores.
The transition to a centralized distribution network has gone according to plan
without any significant issues. The last major piece of the centralized model is
allocation and distribution technology. These systems are expected to be in
place by the end of 2003 and should begin to provide benefits in the latter part
of 2004.
Segment operating profit for the first half of 2003 was $45 million lower than
last year, or 60 basis points as a percent of sales, principally as a result of
a weak first quarter. Comparable store sales declined 1.6% and catalog declined
4.3%. Gross margin improved 60 basis points as a percent of sales, but due to
first quarter sales declines, gross margin dollars were $47 million lower than
last year. The gross margin ratio improved as a result of better merchandise
offerings and benefits from the centralized merchandising model, offset to a
large extent by the Company's aggressive clearance strategies toward the end of
the half. SG&A dollars were well controlled and flat with last year; however, as
a percent of sales, expenses were higher than last year by 120 basis points.
SG&A expenses levels reflect planned increases in advertising, transition costs
for the SSC distribution network and higher non-cash pension expense. Offsetting
these increases were savings in store labor costs as a result of the transition
to centralized checkouts in department stores, catalog expense management and
benefits from centralized management of store expenses.
As the Company continues executing its turnaround strategy for Department Stores
and Catalog, steps have been taken to continue to improve the merchandise
offerings, present a more integrated and powerful marketing message and lower
expenses. For the second half of the year, management is expecting Department
Stores and Catalog to generate improvements in sales and profit. Sales trends in
August 2003, driven by Back-to-School and Fall transition merchandise, have been
positive. The retail environment is showing signs of improvement, including the
positive impact of the tax package and tax rebates on customer spending levels.
Department stores are up against 3.9% comparable store sales gains in last
year's third quarter, with a 13.7% increase in October, as a result of the
Company's successful 100th Anniversary promotion. The catalog sales plan
reflects fewer promotions in the third quarter compared to last year. Department
Stores and Catalog segment operating profit is planned higher than last year in
both the third and fourth quarters, reflecting improvements in merchandise
assortments, marketing, store environment and overall execution. The Company
recently began a cost savings initiative with a goal of reducing the expense
structure for the entire segment by $200 million over the next 18 months to two
years. The successful execution of the turnaround and progress toward improving
the profitability of Department Stores and Catalog is impacted by customers'
response to the merchandise offerings, competitive conditions, the effects of
the current economic climate and the reduction of the Company's expense
structure.
-19-
Eckerd Drugstores
-----------------
($ in millions) 13 weeks ended 26 weeks ended
--------------------------- -------------------------------
July 26, July 27, July 26, July 27,
2003 2002 2003 2002
------------ -------------- ------------- --------------
Retail sales, net 3,655 3,575 $ 7,425 7,297
------------ -------------- ------------- --------------
FIFO gross margin 844 837 1,717 1,691
LIFO charge (11) (9) (18) (24)
------------ -------------- ------------- --------------
LIFO gross margin 833 828 1,699 1,667
SG&A expenses (779) (755) (1,527) (1,494)
------------ -------------- ------------- --------------
Segment operating profit 54 73 $ 172 173
============ ============== ============= ==============
Sales percent (decrease)/increase:
Comparable stores(1) (0.8)% 6.1% (1.0)% 6.9%
Total sales 2.3% 6.5% 1.8% 7.1%
Ratios as a percent of sales:
FIFO gross margin 23.1% 23.4% 23.2% 23.2%
LIFO gross margin 22.8% 23.2% 22.9% 22.9%
SG&A expenses 21.3% 21.1% 20.6% 20.5%
Segment operating profit 1.5% 2.1% 2.3% 2.4%
(1) Comparable store sales include the sales from stores that have been open for at least one full year.
Comparable store sales include the sales for relocated stores.
Eckerd's segment operating profit was $54 million in this year's second quarter
compared to $73 million last year, a decrease of 26%. As a percent of sales,
operating profit declined 60 basis points from 2.1% to 1.5%. The decrease
resulted from a combination of lower gross margin and higher SG&A expense
ratios.
Total sales increased 2.3%, while comparable store sales decreased 0.8% for the
quarter, with pharmacy sales increasing 1.7% and general merchandise (front-end)
sales decreasing 6.0% from last year. As a percent of total drugstore sales,
pharmacy sales were 70.0% for the quarter, an increase of 150 basis points.
Sales to customers covered by third party programs such as managed care
organizations, as well as government and private insurance, have continued to
increase as a percent of total pharmacy sales. Third party pharmacy sales for
the second quarter of 2003 increased 60 basis points to 93.2% of total pharmacy
sales. Total pharmacy sales were negatively impacted by approximately 430 basis
points from a shift from branded drugs to lower priced generic drugs and other
changes in branded drugs, such as Claritin being made available over the
counter. Competitor store openings, particularly in Florida and South Texas,
coupled with execution issues, impacted sales trends. These execution issues are
being addressed through merchandise and marketing changes, as well as a more
competitive store opening program. The best performing front-end categories for
the quarter were seasonal items and over-the-counter medications, while photo
and cigarette sales declined significantly.
LIFO gross margin for the quarter decreased 40 basis points as a percent of
sales compared to last year, while gross margin dollars were basically flat. The
decline was principally from a shift in the mix of sales to lower margin
merchandise.
-20-
SG&A expenses for the quarter increased 3.2% and were 20 basis points higher
than last year as a percent of sales. The increase was related principally to
higher rent and depreciation expense associated with new, relocated and
remodeled stores, increased advertising and higher general liability and
workers' compensation insurance costs. During the quarter, 10 stores were
relocated, 22 new stores opened and 135 stores were remodeled.
Segment operating profit dollars for the first half of 2003 were flat with last
year, and declined 10 basis points as a percent of sales. Comparable store sales
were down 1.0%, while total sales were up 1.8%. Gross margin dollars were up $32
million compared to last year, and as a percent to sales were flat with last
year.
SG&A expenses were up $33 million, principally as a result of higher rent
and depreciation expenses from the new, relocated and remodeled stores,
increased advertising and higher general liability and workers' compensation
insurance costs. As a percent of sales, SG&A expenses were 10 basis points
higher than last year.
Eckerd is in the third year of its turnaround initiative. Operating results in
the second quarter, as well as the first half, were below original expectations,
and the Company expects a difficult second half. For the third quarter, the
Company anticipates a slight increase in comparable store sales, with a low
single digit increase in pharmacy and a decline in front-end sales. Certain
changes are being made to improve operating results, as discussed below.
Management recognizes that it will take time for these changes to impact sales
and profit trends. Consequently, third quarter FIFO operating profit dollars are
expected to be about 30% below last year. Fourth quarter operating profit
dollars are expected to be about equal to last year. This reflects the impact of
this year's fifty-third week as well as some of the early benefits from current
initiatives. Eckerd's full year FIFO operating profit margin is expected to be
in the range of 2.5% to 3.0% of sales.
As communicated in the first quarter of 2003, the FIFO operating profit target
remains at 4% to 4.5% of sales, but is expected to take longer to achieve.
Changes continue to be made to the Eckerd business model to improve the
fundamentals of the business and the long-term competitive position in the
industry. For the year, the Company plans to open or relocate 250 stores,
including about 30 stores that had soft openings in late January 2003. In
addition to a more aggressive store opening and relocation plan, management is
taking a number of steps to improve Eckerd's sales trends, with a focus on
pricing, service and being in stock on merchandise that customers want. These
steps include optimizing pricing through a newly implemented program to better
monitor and adjust pricing across the store to achieve and maintain parity with
drugstore competition, expanding print and radio marketing, the rollout of the
new supply chain management system (Quantum Leap), focusing on speed of service
and the Courtesy Refill program in pharmacy and introducing a new front-end
sales and procurement team to improve overall execution in all areas of the
front end, including assortments, presentation and pricing. The successful
continuation of the Eckerd turnaround is dependent on Eckerd's ability to
attract and retain customers through various marketing and merchandising
programs, to secure suitable new drugstore locations at favorable lease terms,
to attract and retain qualified pharmacists, and to maintain favorable
reimbursement rates from managed care organizations, governmental and other
third-party payors.
Other Unallocated
------------------
Other unallocated consists of real estate activities, investment transactions,
and other items that are related to corporate initiatives or activities, which
are not allocated to an operating segment but are included in total Company
operating results. Other unallocated for the second quarter of 2003 was a net
credit of $11 million, which consisted of $30 million of real estate gains on
the sale of closed department store facilities, $10 million of accelerated
depreciation of catalog facilities closed in second quarter of 2003, $9 million
of asset impairments, $5 million related primarily to remaining lease
obligations for closed units, a $6 million credit for operating income from real
estate activities and $1 million of other costs. Other unallocated for the
second quarter of 2002 was a net expense of $5 million, which included $8
million of asset impairments on certain underperforming department stores,
remaining lease obligations for stores scheduled to close and other unit closing
activities, $9 million of real estate operating activities and a $6 million loss
from third party fulfillment and other corporate activities.
-21-
For the first half of 2003, other unallocated was a net credit of $18 million,
which included $51 million of gains on the sale of closed units, $22 million of
accelerated depreciation primarily related to the closing of certain catalog
facilities, $9 million of asset impairments, $8 million of expenses related
primarily to remaining lease obligations for closed units, a $10 million credit
for real estate operations and $4 million of other expenses. Other unallocated
for the first half of 2002 was a net expense of $15 million and included $30
million of asset impairments on certain underperforming department stores,
remaining lease obligations for stores scheduled to close and other unit closing
activities, a $10 million gain on the sale of a closed store, $15 million of
real estate operating activities and a $10 million loss from third party
fulfillment and other corporate activities.
Net Interest Expense
--------------------
Net interest expense for the second quarter of 2003 was $16 million higher than
the same period last year. This increase was due to higher average long-term
borrowing levels with a higher average interest rate, in particular the $600
million 8% Notes Due 2010 issued in February 2003. Interest was $18 million
higher for the first half of the year compared to the same period last year due
to higher average long-term borrowings at a higher interest rate as well as
lower interest income earned on short-term investments.
Acquisition Amortization
------------------------
The amortization of intangible assets related to major business acquisitions was
$8 million and $7 million for second quarter of 2003 and 2002, respectively.
Acquisition amortization for the first half of 2003 and 2002 was $18 million and
$17 million, respectively. For the full year of 2003, acquisition amortization
is expected to be approximately $40 million.
Income Taxes
-------------
The Company's effective income tax rate was 35.4% for both the second quarter
and first half of 2003 compared with 36.5% for the same periods last year. The
improved rate is primarily due to increased utilization of state tax benefits.
Merchandise Inventories
------------------------
On July 26, 2003, consolidated merchandise inventories on the first-in,
first-out (FIFO) basis were $5,596 million compared to $5,403 million at July
27, 2002 and $5,348 million at January 25, 2003. The 3.6% increase compared to
last year's second quarter reflects higher inventories in both operating
segments.
Inventories on a FIFO basis for the Department Stores and Catalog segment
totaled $3,166 million and $3,100 million at July 26, 2003 and July 27, 2002,
respectively. Inventory levels entering the third quarter are up about 3% in
comparable stores, and are balanced and in line with sales expectations. All
divisions had good sell-through on clearance merchandise during July, and
inventories are focused and well positioned for the Back-to-School and Fall
selling seasons.
Eckerd Drugstore inventories on a FIFO basis totaled $2,430 million at the end
of the quarter compared to $2,303 million at the end of last year's second
quarter. The increase is primarily related to the timing of inventory purchases
and taking advantage of pricing opportunities on certain pharmacy inventory as
well as inventory related to new and relocated stores.
The current cost of consolidated inventories exceeded the LIFO basis amount
carried on the balance sheet by approximately $421 million at July 26, 2003,
$401 million at July 27, 2002 and $403 million at January 25, 2003. The
drugstore segment comprises the majority of the LIFO reserve and is
predominantly the result of inflation on pharmacy inventories.
-22-
Liquidity and Capital Resources
-------------------------------
The Company's financial condition remains strong with approximately $2.6 billion
in cash and short-term investments as of July 26, 2003, which represented
approximately 43% of the $5.8 billion of outstanding long-term debt including
current maturities and proceeds of approximately $250 million from the
securitization of Eckerd managed care receivables. Included in the total cash
and short-term investment balance were restricted short-term investment balances
of $87 million as of July 26, 2003, which are pledged as collateral for import
letters of credit not included in the bank credit facility and for a portion of
casualty program liabilities. Cash flow used in operating activities for the
first half of 2003 was $41 million compared to cash flow generated from
operating activities of $430 million in the comparable period of 2002. The
decrease was due primarily to inventory and related accounts payable.
On June 16, 2003, JCP retired $25 million of its 9.75% Debentures Due 2021 at
par through the mandatory sinking fund payment and an optional sinking fund
payment. During the quarter, JCP also purchased $4.1 million principal amount of
its 8.25% Debentures Due 2022 for application for a future mandatory sinking
fund payment.
On August 15, 2003, bondholders exercised their option to redeem approximately
$117 million of the $119 million 6.9% Debentures Due 2026. On the same date, JCP
retired $37.5 million of its 8.25% Debentures Due 2022 at par, through the
mandatory sinking fund payment of $12.5 million and available optional sinking
fund payments totaling $25 million. Also in August 2003, JCP purchased
approximately $12.8 million of the 8.25% Sinking Fund Debentures Due 2022. These
purchases together with the $4.1 million purchases in the second quarter of
2003, will be applied to unspecified future mandatory sinking fund payments.
During the first quarter, the Company completed two transactions that
strengthened its overall liquidity position. First, on February 3, 2003, the
Company raised approximately $50 million by securitizing additional Eckerd
managed care receivables (See Note 5). Second, on February 28, 2003, JCP issued
$600 million principal amount of unsecured 8% Notes Due 2010 ("Notes") at an
effective rate of 8.125% with the Holding Company as co-obligor (See Note 8).
Additional liquidity strengths include the available $1.5 billion credit
facility discussed in the 2002 10-K and significant unencumbered assets,
primarily Eckerd FIFO inventory, which totaled $2,430 million at July 26, 2003,
that could be used to secure additional short-term funding, if needed. No
borrowings, other than the issuance of trade and stand-by letters of credit,
which totaled $227 million as of the end of the second quarter of 2003, have
been made under this credit facility. The Company was in compliance with all
financial covenants of the credit facility at July 26, 2003.
For the remainder of 2003, management believes that cash flow generated from
operations, combined with the short-term investment position, will be adequate
to fund cash requirements for capital expenditures, working capital and dividend
payments and, therefore, no external funding will be required. The payment of
dividends is subject to approval by the Company's Board of Directors on a
quarterly basis. Management does not currently expect to access the capital
markets for any external financing for the remainder of 2003. However, the
Company manages its financial position on a multi-year basis and may access the
capital markets on an opportunistic basis. On May 29, 2003, Standard & Poor's
(S&P) downgraded the Company and its subsidiaries' corporate credit, senior
unsecured and secured bank loan ratings to BB+ from BBB-. This change brought
the S&P rating more in line with the Moody's and Fitch ratings. This change has
notimpacted the Company's liquidity or financial position as the lower credit
rating had already been incorporated into the long-term financing strategy.
Management believes that the Company's financial position will continue to
provide the financial flexibility to support its turnaround initiatives.
Operating cash flows may be impacted by many factors, including the competitive
conditions in the retail industry and the effects of the current economic
conditions. Based on the nature of the Company's businesses, management
considers the above factors to be normal business risks.
-23-
Capital expenditures were $352 million through the first half of 2003 compared
with $286 million for the comparable 2002 period. This year's investments were
primarily to support the implementation of the SSC distribution network for
department stores, department store modernizations and renewals and technology
improvements, as well as for new and relocated Eckerd drugstores and the
continued remodeling of existing Eckerd drugstores. Management currently expects
total capital expenditures for the full year to be near the lower end of the
original $900 million to $1.1 billion range, about evenly split between
department stores and Eckerd.
A quarterly dividend of $0.125 per share on the Company's outstanding common
stock was paid on May 1, 2003 to stockholders of record on April 10, 2003.
Stock Option Accounting
-----------------------
As discussed in the 2002 10-K, the Company follows Accounting Principles Board
Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," which does not
require expense recognition for stock options when the exercise price of an
option equals, or exceeds, the fair market value of the common stock on the date
of grant. Among other reasons, the Company follows APB 25 accounting because
management believes that the impact of options is already factored into the
earnings calculation through the dilutive effect of option shares.
The Financial Accounting Standards Board (FASB) is currently reviewing the rules
governing stock option accounting and has made a tentative decision to require
expense recognition of stock options in the statement of operations. The FASB
intends to develop revised rules that would be effective for 2004. The Company
will adopt any new rules required by the FASB when they are effective. As
disclosed in the 2002 10-K, the annual impact of expensing stock options for the
Company using current valuation models would be approximately five to seven
cents per share. See Note 1 for the pro forma impact on the second quarters and
first six months of 2003 and 2002.
Recently Issued Accounting Pronouncements
-------------------------------------------
Recently issued accounting pronouncements are discussed in Note 1 to the
unaudited Interim Consolidated Financial Statements.
Pre-Approval of Auditor Services
--------------------------------
During the first quarter of 2003, the Audit Committee of the Company's Board of
Directors approved estimated fees for the remainder of 2003 related to the
performance of both audit and allowable non-audit services by the Company's
external auditors, KPMG LLP.
Seasonality
-----------
The Company's business depends to a great extent on the last quarter of the
year. Historically, sales for that period have averaged approximately one-third
of annual sales and comprise about 45% of the Company's annual profits.
Accordingly, the results of operations for the 13 and 26 weeks ended July 26,
2003 are not necessarily indicative of the results for the entire year.
-24-
Item 3 - Quantitative and Qualitative Disclosure about Market Risk
The Company is exposed to market risks in the normal course of business due to
changes in interest rates and currency exchange rates. The Company's market
risks related to interest rates at July 26, 2003 are similar to those disclosed
in the Company's 2002 10-K. For the 26 weeks ended July 26, 2003 the other
comprehensive income on foreign currency translation was $26 million. Due to the
relatively small size of foreign operations, management believes that its
exposure to market risk associated with foreign currencies would not have a
material impact on its financial condition or results of operations.
Item 4 - Controls and Procedures
Based on their evaluation of the Company's disclosure controls and procedures
(as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act
of 1934) as of the end of the period covered by this Quarterly Report on Form
10-Q, the Company's principal executive officer and principal financial officer
have concluded that the design and operation of the Company's disclosure
controls and procedures are effective for the purpose of ensuring that material
information required to be in this Quarterly Report is made known to them by
others on a timely basis. There have not been any changes in the Company's
internal control over financial reporting that occurred during the Company's
last fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
This report may contain forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements, which reflect the Company's current views of future events and
financial performance, involve known and unknown risks and uncertainties that
may cause the Company's actual results to be materially different from planned
or expected results. Those risks and uncertainties include, but are not limited
to, competition, consumer demand, seasonality, economic conditions, and
government activity. Investors should take such risks into account when making
investment decisions.
-25-
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
The Company has no material legal proceedings pending against it.
Item 4 - Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders of the Company was held on May 16, 2003 at
which the five matters described below were submitted to a vote of stockholders,
with the voting results as indicated.
(1) Election of directors for a three-year term expiring at the Year 2006
Annual Meeting of the Company's stockholders:
AUTHORITY
NOMINEE FOR WITHHELD
V. E. Jordan, Jr. 171,088,508 80,327,793
Burl Osborne 218,955,069 32,461,232
J. C. Pfeiffer 217,400,381 34,015,920
R. G. Turner 218,597,493 32,818,808
(2) The Board of Directors' proposal regarding employment of KPMG LLP as
auditors for the fiscal year ending January 31, 2004:
BROKER
FOR AGAINST ABSTAIN NON-VOTES
237,991,380 10,745,620 2,679,297 903
(3) A stockholder proposal relating to amending JCPenney's written equa1
employment opportunity policy to explicitly prohibit discrimination based
on sexual orientation:
BROKER
FOR AGAINST ABSTAIN NON-VOTES
218,226,637 15,677,855 17,510,906 903
(4) A stockholder proposal relating to expensing the cost of stock option
grants:
BROKER
FOR AGAINST ABSTAIN NON-VOTES
104,904,392 98,178,169 24,562,146 23,771,594
(5) A stockholder proposal relating to eliminating the classification of the
Board:
BROKER
FOR AGAINST ABSTAIN NON-VOTES
144,459,028 77,788,782 5,498,099 23,670,392
-26-
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
-------------------------
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company filed the following report on Form 8-K during the period
covered in this report:
o Current Report on Form 8-K dated May 13, 2003 (Item 7 --
Financial Statements and Exhibits; Item 9 -- Regulation FD
Disclosure)
-27-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
J. C. PENNEY COMPANY, INC.
By /s/ W. J. Alcorn
-------------------------------
W. J. Alcorn
Senior Vice President and Controller
(Principal Accounting Officer)
Date: September 8, 2003
-28-
Exhibit 31.1
CERTIFICATION
I, Allen Questrom, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of J. C. Penney Company,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) [Intentionally omitted]
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: September 8, 2003.
/s/ Allen Questrom
___________________________
Allen Questrom
Chairman and Chief Executive Officer
J. C. Penney Company, Inc.
-29-
Exhibit 31.2
CERTIFICATION
I, Robert B. Cavanaugh, Executive Vice President and Chief Financial Officer,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of J. C. Penney Company,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) [intentionally omitted]
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: September 8, 2003.
/s/ Robert B. Cavanaugh
___________________________
Robert B. Cavanaugh
Executive Vice President and
Chief Financial Officer
J. C. Penney Company, Inc.
-30-
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of J. C. Penney Company, Inc. (the
"Company") on Form 10-Q for the period ending July 26, 2003 (the "Report"), I,
Allen Questrom, Chairman and Chief Executive Officer of the Company, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) the Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
DATED this 8th day of September 2003.
/s/ Allen Questrom
_____________________________
Allen Questrom
Chairman and Chief Executive Officer
-31-
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of J. C. Penney Company, Inc. (the
"Company") on Form 10-Q for the period ending July 26, 2003 (the "Report"), I,
Robert B. Cavanaugh, Executive Vice President and Chief Financial Officer of the
Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) the Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
DATED this 8th day of September 2003.
/s/ Robert B. Cavanuagh
_____________________________
Robert B. Cavanaugh
Executive Vice President and
Chief Financial Officer
-32-