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 October 30, 2004 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 number _______________________
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.
285,603,643 shares of Common Stock of 50 cents par value, as of December 3,
2004.
INDEX
Page
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Part I Financial Information
Item 1. Unaudited 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 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 31
Part II Other Information
Item 1. Legal Proceedings 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 6. Exhibits 33
Signature Page 34
Certifications 35
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 39 weeks ended
------------------------------ ----------------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003
-------------- ------------ ------------ --------------
Retail sales, net $4,461 $4,332 $ 12,351 $ 11,688
Cost of goods sold 2,640 2,666 7,472 7,256
-------------- ------------ ------------ --------------
Gross margin 1,821 1,666 4,879 4,432
Selling, general and administrative expenses 1,475 1,458 4,148 4,087
Net interest expense 71 64 177 199
Bond premiums and unamortized costs 47 - 47 -
Real estate and other expense/(income) - 4 (13) (17)
-------------- ------------ ------------ --------------
Income from continuing operations
before income taxes 228 140 520 163
Income tax expense 79 46 181 52
-------------- ------------ ------------ --------------
Income from continuing operations $ 149 $ 94 $ 339 $ 111
Discontinued operations, net of income tax
(benefit)/expense of $-, $(5), $(178) and $22 - (14) (148) 30
-------------- ------------ ------------ --------------
Net income $ 149 $ 80 $ 191 $ 141
Less: preferred stock dividends - 6 12 19
-------------- ------------ ------------ --------------
Net income applicable to common
stockholders $ 149 $ 74 $ 179 $ 122
============== ============ ============ ==============
Basic earnings/(loss) per share:
--------------------------------
Continuing operations $ 0.53 $ 0.32 $ 1.17 $ 0.34
Discontinued operations - (0.05) (0.53) 0.11
-------------- ------------ ------------ --------------
Net income $ 0.53 $ 0.27 $ 0.64 $ 0.45
============== ============ ============ ==============
Diluted earnings/(loss) per share:
-----------------------------------
Continuing operations $ 0.50 $ 0.31 $ 1.12 $ 0.34
Discontinued operations - (0.04) (0.48) 0.11
-------------- ------------ ------------ --------------
Net income $ 0.50 $ 0.27 $ 0.64 $ 0.45
============== ============ ============ ==============
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) Oct. 30, Oct. 25, Jan. 31,
2004 2003 2004
--------------- ------------ --------------
Assets
Current assets
Cash and short-term investments
(including restricted balances of $64,
$87 and $87) $ 4,577 $ 1,921 $ 2,994
Receivables (net of bad debt reserves
of $6, $4 and $5) 225 417 233
Merchandise inventory (net of LIFO
reserves of $43, $49 and $43) 4,237 4,194 3,156
Prepaid expenses 161 140 130
--------------- ------------ --------------
Total current assets 9,200 6,672 6,513
Property and equipment (net of accumulated
depreciation of $2,317, $2,278 and $2,122) 3,496 3,490 3,515
Prepaid pension 1,570 1,381 1,320
Goodwill 40 41 42
Other assets 583 519 556
Assets of discontinued operations (net of fair value
adjustment of $-, $- and $450) - 6,973 6,354
--------------- ------------ --------------
Total Assets $14,889 $ 19,076 $ 18,300
=============== ============ ==============
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) Oct. 30, Oct. 25, Jan. 31,
2004 2003 2004
-------------- ------------ -------------
Liabilities and Stockholders' Equity
Current liabilities
Trade payables $ 1,773 $ 1,556 $ 1,167
Accrued expenses and other 1,396 1,099 1,384
Short-term debt 23 29 18
Current maturities of long-term debt 603 485 242
Current income taxes, payable and deferred 110 106 943
-------------- ------------ -------------
Total current liabilities 3,905 3,275 3,754
Long-term debt 3,955 5,103 5,114
Deferred taxes 1,289 1,330 1,217
Other liabilities 997 779 804
Liabilities of discontinued operations - 2,086 1,986
-------------- ------------ -------------
Total Liabilities 10,146 12,573 12,875
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 and 0.5 million
shares of Series B ESOP convertible preferred - 310 304
Common stock, par value $0.50 per share:
authorized, 1,250 million shares; issued and
outstanding, 267, 273 and 274 million shares 3,741 3,505 3,531
-------------- ------------ -------------
Total capital stock 3,741 3,815 3,835
-------------- ------------ -------------
Reinvested earnings at beginning of year 1,728 2,817 2,817
Net income/(loss) 191 141 (928)
Retirement of common stock (674) - -
Dividends declared (116) (114) (161)
-------------- ------------ -------------
Reinvested earnings at end of period 1,129 2,844 1,728
Accumulated other comprehensive (loss) (127) (156) (138)
-------------- ------------ -------------
Total Stockholders' Equity 4,743 6,503 5,425
-------------- ------------ -------------
Total Liabilities and Stockholders' Equity $14,889 $ 19,076 $18,300
============== ============ =============
The accompanying notes are an integral part of these unaudited Interim
Consolidated Financial Statements.
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J. C. Penney Company, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
($ in millions) 39 weeks ended
----------------------------------------
Oct. 30, Oct. 25,
2004 2003
------------------ -----------------
Cash flows from operating activities:
Income from continuing operations $ 339 $ 111
Adjustments to reconcile income from continuing operations
to net cash (used in) operating activities:
Depreciation and amortization 264 291
Asset impairments, PVOL and other unit closing costs 10 27
Net gains on sale of assets (3) (51)
Benefit plans expense 45 66
Pension contribution (300) (300)
Deferred taxes 70 288
Change in cash from:
Receivables (18) (3)
Inventory (1,081) (1,224)
Prepaid expenses and other assets (15) (23)
Trade payables 606 563
Current income taxes payable 34 (201)
Accrued expenses and other liabilities (90) (119)
------------------ -----------------
Net cash (used in) operating activities (139) (575)
------------------ -----------------
Cash flows from investing activities:
Capital expenditures (317) (243)
Proceeds from the sale of Eckerd drugstores 4,666 -
Proceeds from sale of assets 28 89
------------------ -----------------
Net cash provided by/(used in) investing activities 4,377 (154)
------------------ -----------------
Cash flows from financing activities:
Change in short-term debt 5 16
Net proceeds from issuance of long-term debt - 595
Payment of long-term debt, including capital
leases and bond premiums (850) (202)
Common stock issued, net 191 6
Common stock repurchased (1,040) -
Dividends paid, preferred and common (116) (114)
------------------ -----------------
Net cash (used in)/provided by financing activities (1,810) 301
------------------ -----------------
Cash (paid to) discontinued operations (845) (125)
------------------ -----------------
Net increase/(decrease) in cash and short-term investments 1,583 (553)
Cash and short-term investments at beginning of year 2,994 2,474
------------------ -----------------
Cash and short-term investments at end of period $ 4,577 $ 1,921
================== =================
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 31, 2004 (the "2003
10-K"). The accompanying unaudited Interim Consolidated Financial Statements
should be read in conjunction with the Consolidated Financial Statements and
notes thereto in the 2003 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 31, 2004 financial information
has been derived from the audited Consolidated Financial Statements, with
related footnotes, included in the 2003 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 that provides for grants to
associates of stock awards, stock appreciation rights or options to purchase the
Company's common stock. 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. The Company accounts for stock
options under the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related Interpretations. No stock-based employee compensation cost is reflected
in the consolidated statements of operations for stock options, since all
options granted under the plan have an exercise price equal to the market value
of the underlying common stock on the date of grant.
-5-
The following table illustrates the effect on net income and earnings per share
(EPS) as if the Company had applied the fair value recognition provisions of
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," to stock options.
($ in millions, except EPS) 13 weeks ended 39 weeks ended
-------------------------- ------------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003
------------ ------------ ------------- -----------
Net income, as reported $ 149 $ 80 $ 191 $ 141
Add: Stock-based employee compensation
expense included in reported net income, net of
related tax effects 1 1 5 3
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (1) (6) (13) (18)
------------ ------------ ------------- -----------
Pro forma net income $ 149 $ 75 $ 183 $ 126
============ ============ ============= ===========
Earnings per share:
Basic--as reported $ 0.53 $ 0.27 $ 0.64 $ 0.45
Basic--pro forma $ 0.53 $ 0.25 $ 0.61 $ 0.39
Diluted--as reported $ 0.50 $ 0.27 $ 0.64 $ 0.45
Diluted--pro forma $ 0.50 $ 0.25 $ 0.61 $ 0.39
Effect of New Accounting Standards
In December 2003, the Financial Accounting Standards Board (FASB) issued SFAS
No. 132 (Revised 2003), "Employers' Disclosures about Pensions and Other
Postretirement Benefits." This Statement amends the disclosure requirements of
SFAS No. 87, "Employers' Accounting for Pensions," No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits," and No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions." The Statement requires interim
disclosure that is addressed in Note 12 but did not change the recognition and
measurement requirements of the amended Statements.
On May 19, 2004, the FASB issued FASB Staff Position (FSP) SFAS 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." The referenced legislation
(the Act) was passed in December 2003, and provides for a federal subsidy to
employers that offer retiree prescription drug benefits that are at least
actuarially equivalent to those offered under the government sponsored Medicare
Part D. While the provisions of FSP SFAS 106-2 were effective in the Company's
third quarter of 2004, final regulations that would define actuarial equivalency
have not yet been issued. As a result, the expense amounts shown in Note 12 do
not reflect the potential effects of the Act, which, due largely to the cap on
Company contributions, are not expected to have a material effect on the
Company's consolidated financial statements.
The provisions of FASB Interpretation No. 46R (FIN 46R), "Consolidation of
Variable Interest Entities," became effective in the first quarter of 2004. FIN
46R replaced the same titled FIN 46 that was issued in January 2003. FIN 46R
identifies when entities must be consolidated with the financial statements of a
company where the investors in an entity do not have the characteristics of a
controlling financial interest or the entity does not have sufficient equity at
risk for the entity to finance its activities without additional subordinated
financial support. The adoption of FIN 46R did not have a material impact on the
Company's consolidated financial statements.
-6-
2) Discontinued Operations
---------------------------
Eckerd Drugstores
On July 31, 2004, the Company closed on the sale of its Eckerd drugstore
operations for a total of approximately $4.7 billion in cash proceeds that
included a $209 million adjustment for the estimated increase in Eckerd's
working capital from January 31, 2004 to July 31, 2004. After deducting taxes,
fees and other transaction costs, and estimated post-closing adjustments, the
ultimate net cash proceeds from the sale are expected to total approximately
$3.5 billion. As previously reported, The Jean Coutu Group (PJC) Inc. (Coutu)
acquired Eckerd drugstores and support facilities located in 13 Northeast and
Mid-Atlantic states, as well as the Eckerd Home Office located in Florida. CVS
Corporation and CVS Pharmacy, Inc. (collectively, CVS) acquired Eckerd
drugstores and support facilities located in the remaining southern states,
principally Florida and Texas, as well as Eckerd's pharmacy benefits management,
mail order and specialty pharmacy businesses. Proceeds from the sale will be
used for common stock repurchases and debt reduction, as announced on August 2,
2004 and more fully discussed in Note 3.
The loss on the sale was $713 million pre-tax, or $1,433 million on an after-tax
basis. The relatively high tax cost is a result of the tax basis of Eckerd being
lower than its book basis because the Company's previous drugstore acquisitions
were largely tax-free transactions. Of the total after-tax loss on the sale,
$1,402 million had been recorded through the first quarter of 2004 to reflect
Eckerd at its estimated fair value less costs to sell, and the remaining $31
million was recorded during the second quarter of 2004, to reflect estimates of
certain post-closing adjustments and resulting sales proceeds. During the third
quarter of 2004, the Company paid $624 million for the first installment of
taxes due on the sale of Eckerd. The remaining balance will be paid in January
2005.
Additionally, $3.4 billion of the present value of lease obligations (PVOL),
which was an off-balance sheet obligation under generally accepted accounting
principles (GAAP), was eliminated with the transfer of these leases to the
purchasers of the Eckerd drugstore operations upon the closing of the sale.
The Company established reserves at July 31, 2004 for estimated transaction
costs and post-closing adjustments. Certain of these reserves involved
significant judgment and actual costs incurred over time could vary from these
estimates. The more significant estimates relate to the estimated working
capital adjustment, the costs to exit the Colorado and New Mexico markets,
severance payments to former Eckerd associates, assumption of the Eckerd Pension
Plan and various post-employment benefit obligations and environmental
indemnifications, which are discussed below. No reserve adjustments were
recorded during the third quarter as no additional information became available
that would indicate the reserves recorded as of the second quarter in total
required adjustment. Cash payments for the Eckerd related reserves are
separately presented in the Company's consolidated statements of cash flows as
cash used in discontinued operations.
In late October, in accordance with the terms of the respective sale agreements
with Coutu and CVS, the purchasers submitted to the Company their proposed
adjustments to the pre-closing working capital estimates. A review of the
requested adjustments is currently underway. The respective sale agreements
provide for a review period which can potentially take several months to
finalize.
As part of the Asset Purchase Agreement with CVS, it was agreed that, with
respect to the Colorado and New Mexico locations (CN real estate interests), at
closing any of these properties that were not disposed of would be transferred
to CVS. On August 25, 2004, the Company and CVS entered into the CN Rescission
Agreement, whereby the Company received a one-time payment from CVS of $21.4
million, which represented the agreed-upon limit of CVS's liability regarding
the CN real estate interests plus net proceeds from dispositions as of August 25
minus expenses borne and paid by CVS as of August 25 relating to the CN real
estate interests. Effective August 25, CVS transferred to the Company all CN
real
-7-
estate interests not disposed of, corresponding third party agreements and
liabilities. The Company has engaged a third party real estate firm and is
working through disposition plans on an individual property basis.
At the closing of the sale of Eckerd on July 31, 2004, the Company assumed
sponsorship of the Eckerd Pension Plan, the Eckerd Contingent Separation Pay
Programs and various other terminated non-qualified retirement plans and
programs. The Company further assumed all severance and post-employment health
and welfare benefit obligations under various Eckerd plans, employment and other
specific agreements. The Company is evaluating its options with respect to these
assumed liabilities, including, but not limited to, termination of the
agreements, plans or programs and/or settlement of the underlying benefit
obligations. During the third quarter of 2004, the Company made payments of
approximately $35 million related primarily to severance and post-employment
benefit obligations.
As part of the Eckerd sale agreements, the Company retained responsibility to
remediate environmental conditions that existed at the time of the sale. Certain
properties, principally distribution centers, were identified as having such
conditions at the time of sale. Preliminary cost estimates have been established
by management, in consultation with an environmental engineering firm, for
specifically identified properties, as well as a certain percentage of the
remaining properties, considering such factors as age, location and prior use of
the properties. Further studies are underway to develop remediation plans and
refine cost estimates, which could vary from preliminary estimates.
Both CVS and Coutu entered into agreements with the Company and the Company's
insurance provider in order to assume the obligations for general liability and
workers' compensation claims that had been transferred to the purchasers at
closing. The agreement with CVS was entered into concurrent with the closing,
while the agreement with Coutu was finalized in the third quarter. At closing,
the Company had approximately $64 million in letters of credit pledged as
collateral to its insurance provider in support of general liability and
workers' compensation claims that were transferred to Coutu as part of the
Eckerd sale. Upon the finalization of the insurance assumption agreements, this
amount was reduced to approximately $8.5 million. Based on a separate agreement
between Coutu and the Company, Coutu will provide replacement letters of credit
to the insurance company no later than September 17, 2006, which will release
the Company from any further potential obligation.
The Company is providing to the purchasers certain information systems,
accounting, banking, vendor contracting, tax and other transition services as
set forth in the Company's Transition Services Agreements (Transition
Agreements) with CVS and Coutu for a period of 12 months from the closing date,
unless terminated earlier by the purchasers. One Transition Agreement with
Pharmacare Management Services, Inc., a subsidiary of CVS, involves the
provision of information and data management services for a period of up to 15
months from the closing date. Under the Transition Agreements, the Company will
receive monthly service fees, which are designed to recover the estimated costs
of providing the specified services. If actual costs to provide such services
exceed the estimates, any additional costs incurred would be reflected in
discontinued operations.
Discontinued operations in the consolidated statements of operations reflect
Eckerd's operating results for all periods presented, including allocated
interest expense. Interest expense was allocated to the discontinued operation
based on Eckerd's outstanding balance on its intercompany loan payable to
JCPenney, which accrued interest at JCPenney's weighted average interest rate on
its net debt (long-term debt net of short-term investments) calculated on a
monthly basis.
Mexico Department Stores
Effective November 30, 2003, the Company closed on the sale of its six Mexico
department stores to Grupo Sanborns S.A. de C.V. of Mexico City. The stock sale
transaction, which included the Mexico holding company and operating companies
comprising JCPenney's Mexico department store operation,
-8-
resulted in a loss of $14 million, net of a $27 million tax benefit. The loss
was principally related to currency translation losses of $25 million
accumulated since operations began in 1995 that were previously reflected as
reductions to stockholders' equity. Additional components of the loss included
potential liability on certain real estate and merchandise and transaction
costs.
Results of the discontinued operations as reflected in the consolidated
statements of operations are summarized below:
($ in millions) 13 weeks ended 39 weeks ended
------------------------------- -------------------------------
Oct. 30, Oct. 25, Oct.30, Oct. 25,
2004 2003 2004 2003
------------------------------- -------------------------------
Eckerd
Net sales $ - $3,642 $7,254 $ 11,067
------------------------------- -------------------------------
Gross margin - 832 1,676 2,531
Selling, general and administrative expenses - 798 1,635 2,325
Interest expense - 42 97 119
Acquisition amortization - 7 5 25
Other - 2 2 5
------------------------------- -------------------------------
(Loss)/income before income taxes - (17) (63) 57
Income tax (benefit)/expense - (6) (23) 22
------------------------------- -------------------------------
Eckerd (loss)/income from operations - (11) (40) 35
(Loss) on sale of Eckerd, net of income tax
(benefit) of $-, $-, $(155) and $- - - (108) -
Mexico (loss) from operations, net of income
tax expense of $-, $1, $- and $- - (3) - (5)
------------------------------- -------------------------------
Total discontinued operations, net $ - $ (14) $(148) $ 30
=============================== ===============================
With the closings of the Eckerd sale on July 31, 2004 and the Mexico stores on
November 30, 2003, there were no assets or liabilities of discontinued
operations as of October 30, 2004. Assets and liabilities of discontinued
operations as of October 25, 2003 and January 31, 2004 were as follows:
($ in millions) Oct. 25, Jan. 31,
2003(1) 2004
----------------- -----------------
Current assets $ 2,706 $ 2,467
Other assets 4,267 4,337
----------------- -----------------
Total Assets $ 6,973 $ 6,804
----------------- -----------------
Current liabilities $ 1,630 $ 1,509
Other liabilities 456 477
----------------- -----------------
Total Liabilities $ 2,086 $ 1,986
----------------- -----------------
JCPenney's net investment $ 4,887 $ 4,818
Fair value adjustment - (450)
----------------- -----------------
$ 4,887 $ 4,368
================= =================
(1) Includes $22 million of current assets and $4 million of other assets for
Mexico department stores.
Effective May 20, 2004, the Company terminated Eckerd's managed care receivables
securitization program. Upon termination and final payment of $221 million, the
receivables under the program were conveyed back to Eckerd. This transaction was
considered in the determination of the fair value of the Company's investment in
Eckerd at January 31, 2004.
-9-
3) Capital Structure Repositioning
--------------------------------
On August 2, 2004, the Company announced its intention to use the approximately
$3.5 billion in net cash proceeds from the sale of the Eckerd drugstore
operations and $1.1 billion of existing cash balances to implement a major
repositioning of its capital structure. This repositioning program includes the
following:
Debt Reduction
The Company's debt reduction program consists of the retirement of $2.3 billion
of debt in 2004 and 2005.
Debt reductions totaling approximately $1 billion for the second and third
quarters of 2004 consisted of the following:
o In May 2004, Eckerd's managed care receivables securitization program,
which had been an off-balance sheet obligation, was terminated and the
related debt paid off in the amount of $221 million.
o In June 2004, JCP's 7.375% Notes in the amount of $208 million matured and
were paid.
o In June 2004, JCP retired $25 million of its 9.75% Debentures Due 2021 at
par, through the mandatory sinking fund payment of $12.5 million and an
additional $12.5 million optional sinking fund payment. On September 1,
2004, JCP redeemed the remaining principal balance of $92.2 million for
this issue, at a redemption price of 103.2% plus accrued interest.
o On August 15, 2004, 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 an optional sinking fund payment for an additional $25 million. On
September 1, 2004, JCP redeemed the remaining principal balance of $158.2
million for this issue, at a redemption price of 103.096% plus accrued
interest.
o On September 1, 2004, JCP redeemed its $200 million face amount 6.0%
Original Issue Discount Debentures Due 2006. At the date of redemption,
these debentures had a recorded balance of $175 million, due to an
unamortized discount of $25 million.
o During the third quarter of 2004, the Company purchased approximately $100
million of JCP's long-term debt on the open market. While the Board of
Directors has authorized up to $200 million aggregate principal amount of
open market purchases of JCP's long-term debt, the Company currently does
not expect to purchase additional open market debt under this authorization
within the next 12 months.
Additionally, on October 26, 2004, the Company called all of JCP's outstanding
$650 million 5.0% Convertible Subordinated Notes Due 2008. Holders of the Notes
had the option to convert the Notes into shares of the Company's common stock at
a conversion price of $28.50 until the close of business on November 16, 2004.
Substantially all of the Notes were converted into approximately 22.8 million
shares of common stock, and the remainder redeemed on November 17, 2004.
No additional debt payments are anticipated for the remainder of 2004. For the
first half of 2005, debt payments are expected to include the following:
o Holders of JCP's 7.4% Debentures Due 2037, with a principal amount of $400
million, have the right to elect to redeem the debentures in April 2005.
o In May 2005, the Company expects to pay the $193 million of JCP's 7.05%
Notes Due 2005, at the scheduled maturity date.
The pre-tax cost to redeem the securities included in the capital structure
repositioning, including call premiums and unamortized costs, is expected to
total approximately $50 million. During the third
-10-
quarter of 2004, the Company incurred $47 million of this amount, which is
reflected in bond premiums and unamortized costs in the consolidated statements
of operations.
Series B Convertible Preferred Stock Redemption
On August 26, 2004, the Company redeemed all of its outstanding shares of Series
B ESOP Convertible Preferred Stock (Preferred Stock), all of which were held by
the Company's Savings, Profit-Sharing and Stock Ownership Plan, a 401(k) savings
plan. Each preferred stockholder received 20 equivalent shares of JCPenney
common stock for each one share of Preferred Stock in their Savings Plan
account. Preferred Stock shares, which are included in the diluted earnings per
share calculation as appropriate, were converted into approximately nine million
common stock shares.
Common Stock Repurchases
Based on approval from the Company's Board of Directors, the Company has
implemented a common stock repurchase program of up to $3.0 billion (not to
exceed 133 million shares), including the repurchase of up to $650 million of
common stock that had been contingent upon the conversion of JCP's outstanding
5.0% Convertible Subordinated Notes Due 2008, which occurred from October 26,
2004 through November 16, 2004. Share repurchases have been and will continue to
be made periodically in open-market transactions, subject to market conditions,
legal requirements and other factors. The Company repurchased 27.6 million
common shares during the quarter ended October 30, 2004 at a cost of
approximately $1,040 million. The shares repurchased were immediately retired.
As of October 30, 2004, approximately $1,960 million remained authorized for
share repurchases.
During the first nine months of 2004, common stock outstanding decreased seven
million shares to 267 million shares from 274 million shares at the beginning of
the year. The decline in outstanding shares is attributable to approximately 28
million shares repurchased and retired offset by nine million shares issued for
redeeming the convertible preferred stock on August 26, 2004 and 12 million
shares issued substantially from the exercise of stock options.
4) Earnings per Share
-------------------
Basic earnings per share (EPS) is computed by dividing net income less dividend
requirements on the Series B ESOP Convertible Preferred Stock, net of tax as
applicable, by the weighted average number of common shares outstanding for the
period. Except where the effect would be anti-dilutive at the continuing
operations level, the diluted EPS calculation includes the impact of restricted
stock units and shares that during the period could have been issued under
outstanding stock options as well as common shares that would have resulted from
the conversion of convertible debentures and convertible preferred stock. If the
applicable shares are included in the calculation, 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.
-11-
Income from continuing operations and shares used to compute EPS from continuing
operations, basic and diluted, are reconciled below:
(in millions, except per share data) 13 weeks ended 39 weeks ended
--------------------------- --------------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003
------------ ----------- ----------- ------------
Earnings:
Income from continuing operations $ 149 $ 94 $ 339 $ 111
Less: preferred stock dividends, net of tax - 6 12 19
------------ ----------- ----------- ------------
Income from continuing operations, basic 149 88 327 92
Adjustment for assumed dilution:
Interest on 5% convertible debt, net of tax 5 6 16 -
------------ ----------- ----------- ------------
Income from continuing operations,
diluted $ 154 $ 94 $ 343 $ 92
============ =========== =========== ============
Shares:
Average common shares outstanding (basic
shares) 279 272 280 271
Adjustments for assumed dilution:
Stock options and restricted stock units 5 3 5 3
Shares from convertible preferred stock 2 - - -
Shares from convertible debt 23 23 23 -
------------ ----------- ----------- ------------
Average shares assuming dilution (diluted
shares) 309 298 308 274
============ =========== =========== ============
EPS from continuing operations:
Basic $ 0.53 $0.32 $1.17 $ 0.34
Diluted $ 0.50 $0.31 $1.12 $ 0.34
The following potential shares of common stock were excluded from the EPS
calculation because their effect would be anti-dilutive:
(shares in millions)
13 weeks ended 39 weeks ended
--------------------------- -----------------------------
Oct. 30, Oct. 25, Oct.30, Oct. 25,
2004 2003 2004 2003
------------- ------------ ------------- -------------
Stock options (1) 3 8 6 17
$650 million notes convertible at $28.50
per share - - - 23
Preferred stock - 10 7 11
(1) Exercise prices per share for the excluded stock
options for the respective periods ranged from: $41 to $71 $21 to $71 $36 to $71 $19 to $71
-12-
5) Cash and Short-Term Investments
--------------------------------
($ in millions) Oct. 30, Oct. 25, Jan. 31,
2004 2003 2004
------------------- ----------------- ---------------
Cash $ 90 $ 5 $ 8
Short-term investments 4,487 1,916 2,986
------------------- ----------------- ---------------
Total cash and short-term investments $4,577 $1,921 $2,994
=================== ================= ===============
Restricted Short-term Investment Balances
Short-term investments include restricted balances of $64 million, $87 million
and $87 million as of October 30, 2004, October 25, 2003 and January 31, 2004,
respectively. Restricted balances are pledged as collateral for import letters
of credit not included in the Company's bank credit facility and/or for a
portion of casualty insurance program liabilities.
6) Supplemental Cash Flow Information
-----------------------------------
($ in millions) 39 weeks ended
-----------------------------
Oct. 30, Oct. 25,
2004 2003
------------ ------------
Total interest paid $ 385 $ 374
Less: interest paid attributable to discontinued operations 95 116
------------ ------------
Interest paid by continuing operations $ 290 $ 258
============ ============
Interest received $ 38 $ 23
============ ============
Income taxes paid $ 720 $ 41
Less: income taxes paid attributable to discontinued operations 624 4
------------ ------------
Income taxes paid by continuing operations $ 96 $ 37
============ ============
Non-cash Transactions
o During the third quarter of 2004, the Company redeemed all outstanding
shares of its Preferred Stock. Each preferred stockholder received 20
equivalent shares of JCPenney common stock for each one share of Preferred
Stock. The Preferred Stock shares were converted into approximately nine
million common stock shares.
o The Company issued 2.4 million shares of common stock in the first quarter
of 2003 to fund savings plan contributions of $47 million for 2002.
7) Goodwill
----------
The carrying amount of goodwill for Renner Department Stores in Brazil was $40
million, $41 million and $42 million as of October 30, 2004, October 25, 2003
and January 31, 2004, respectively. The changes in carrying value are related to
foreign currency translation adjustments. There were no impairment losses
related to goodwill recorded during the first nine months of 2004 or 2003.
-13-
8) Credit Agreement
----------------
The Company's Credit Agreement dated as of May 31, 2002 with JPMorgan Chase Bank
as administrative agent was amended effective as of June 2, 2004. The amendments
permitted the sale of Eckerd Corporation and its affiliates and assets, permit a
broader range of cash investments, and permit issuing banks to extend maturities
of certain letters of credit past the expiration of the Credit Agreement as long
as they are collateralized with cash at that time. No borrowings, other than the
issuance of trade and standby letters of credit, which totaled $159 million as
of the end of the third quarter of 2004, have been, or are expected to be, made
under this facility.
9) Comprehensive Income and Accumulated Other Comprehensive (Loss)
-----------------------------------------------------------------
Comprehensive Income/(Loss)
($ in millions) 13 weeks ended 39 weeks ended
------------------------------- -------------------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003
-------------- -------------- --------------- --------------
Net income $ 149 $ 80 $ 191 $ 141
Other comprehensive income/(loss):
Foreign currency translation adjustments 9 (2) (1) 23
Net unrealized gains in real estate
investment trusts 16 7 12 25
Non-qualified retirement plan minimum
liability adjustment - - (1) -
Other comprehensive (loss)/income - (2) 1 (1)
from discontinued operations -------------- -------------- --------------- --------------
25 3 11 47
-------------- -------------- --------------- --------------
Total comprehensive income $ 174 $ 83 $ 202 $ 188
============== ============== =============== ==============
Accumulated Other Comprehensive (Loss)/Income
($ in millions) Oct. 30, Oct. 25, Jan. 31,
2004 2003 2004
---------------- ------------- ---------------
Foreign currency translation adjustments (1) $ (116) $ (117) $ (115)
Net unrealized gains in real estate investment trusts (2) 72 44 60
Non-qualified retirement plan minimum liability adjustment (3) (83) (58) (82)
Other comprehensive (loss) from discontinued operations (4) - (25) (1)
---------------- ------------- ---------------
Accumulated other comprehensive (loss) $ (127) $ (156) $ (138)
================ ============= ===============
(1) A deferred tax asset has not been established due to the historical
reinvestment of earnings in the Company's Brazilian subsidiary.
(2) Shown net of a deferred tax liability of $39 million, $24 million and $32
million as of October 30, 2004, October 25, 2003 and January 31, 2004,
respectively.
(3) Shown net of a deferred tax asset of $53 million, $39 million and $52
million as of October 30, 2004, October 25, 2003 and January 31, 2004,
respectively.
(4) Shown net of a deferred tax asset of $- million, $- million and $1 million
as of October 30, 2004, October 25, 2003 and January 31, 2004,
respectively.
-14-
10) Contractual Obligations and Guarantees
---------------------------------------
Contractual Obligations
In December 2003, JCP notified the third-party service providers of the six
outsourced store support centers (SSCs) of its intent to terminate contracted
services. In accordance with the related service contracts, JCP assumed
approximately $95 million of building and equipment leases during the first half
of 2004. The remaining equipment leases totaling approximately $20 million were
assumed during the third quarter of 2004. Additional contractual obligations are
disclosed in the 2003 10-K.
Guarantees
As of October 30, 2004, JCP had guarantees totaling $80 million. Guarantees of
$48 million are described in detail in the 2003 10-K and include: $18 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 $10 million
related to certain leases for stores that were sold in 2003, which is recorded
in accrued expenses and other. In addition, JCP had guarantees of approximately
$32 million for certain personal property leases assumed by the purchasers of
Eckerd, which were previously reported as operating leases.
11) Real Estate and Other Expense/(Income)
---------------------------------------
($ in millions) 13 weeks ended 39 weeks ended
----------------------------- -----------------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003
-------------- ------------- -------------- ------------
Real estate activities $ (6) $ (8) $ (20) $(18)
Net gains from sale of real estate - - (3) (51)
Asset impairments, PVOL and other unit
closing costs 6 11 10 50
Other - 1 - 2
-------------- ------------- -------------- ------------
Total $ - $ 4 $ (13) $(17)
============== ============= ============== ============
Real estate activities consisted primarily of income from the Company's real
estate subsidiaries. Net real estate gains were recorded from the sale of
facilities that are no longer used in Company operations.
Asset impairments, PVOL and other unit closing costs totaled $6 million for the
third quarter of 2004 and consisted of $3 million of asset impairments and $3
million of charges related to the PVOL for closed stores. For the first nine
months of 2004, these costs totaled $10 million and consisted of $5 million of
asset impairments and $5 million of expenses related to PVOL and other costs for
closed units. For the third quarter of 2003, asset impairments, PVOL and other
unit closing costs totaled $11 million, and consisted of $8 million of asset
impairments and $3 million of charges related to the PVOL and other costs for
closed units. These costs totaled $50 million for the first nine months of 2003
and consisted of $22 million of accelerated depreciation for closed catalog
facilities, $17 million of asset impairments and $11 million of expenses related
to PVOL and other costs for closed units.
-15-
12) Retirement Benefit Plans
Net Periodic Benefit Cost/(Credit)
The components of net periodic benefit cost/(credit) for the qualified and
non-qualified pension plans and the postretirement plans for the 13 weeks ended
October 30, 2004 and October 25, 2003 follow:
Pension Plans
-------------------------------------------------
Qualified Supplemental Postretirement
(Non-Qualified) Plans
--------------------- ---------------------- ----------------------
($ in millions) 13 weeks ended 13 weeks ended 13 weeks ended
--------------------- ---------------------- ----------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003 2004 2003
--------------------- ---------------------- ----------------------
Service cost $ 29 $ 17 $ - $ 1 $ 1 $ 1
Interest cost 67 45 5 5 3 3
Expected return on plan assets (101) (57) - - - -
Net amortization 32 25 2 2 (6) (5)
--------------------- ---------------------- ----------------------
Net periodic benefit cost/(credit) $ 27 $ 30 $ 7 $ 8 $ (2) $ (1)
====================== ====================== =======================
The components of net periodic benefit cost/(credit) for the qualified and
non-qualified pension plans and the postretirement plans for the 39 weeks ended
October 30, 2004 and October 25, 2003 follow:
Pension Plans
-------------------------------------------------
Qualified Supplemental Postretirement
(Non-Qualified) Plans
--------------------- ---------------------- ----------------------
($ in millions) 39 weeks ended 39 weeks ended 39 weeks ended
--------------------- ---------------------- ----------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003 2004 2003
--------------------- ---------------------- ----------------------
Service cost $ 52 $ 39 $ 1 $ 2 $ 3 $ 2
Interest cost 122 101 11 12 8 9
Expected return on plan assets (183) (129) - - - -
Net amortization 58 57 6 4 (17) (14)
--------------------- ---------------------- ----------------------
Net periodic benefit cost/(credit) $ 49 $ 68 $ 18 $ 18 $ (6) $ (3)
====================== ====================== =======================
Employer Contributions
As previously disclosed in the 2003 10-K, the Company was not required to make a
contribution to its qualified plan in 2004 under the Employee Retirement Income
Security Act of 1974. However, during the third quarter of 2004, the Company
made a $300 million discretionary contribution to its qualified plan ($190
million after income taxes). The Company also made a $300 million discretionary
contribution during the third quarter of 2003.
-16-
13) Subsequent Events
-----------------
Common Stock Repurchases
From October 31, 2004 through December 3, 2004, the Company repurchased an
additional 5.7 million shares of common stock at a cost of approximately $230
million under the common stock repurchase program, bringing the total
repurchases to date up to 33 million shares at a cost of approximately $1.3
billion. This represents more than 40 percent of the total planned common stock
repurchase program, which is more fully described in Note 3.
Conversion of Subordinated Notes
From October 26, 2004 through November 16, 2004, substantially all of JCP's
outstanding $650 million 5.0% Convertible Subordinated Notes Due 2008 were
converted into approximately 22.8 million shares of common stock. The conversion
of subordinated notes is discussed more fully in Note 3 on page 10.
-17-
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion relates to J.C. Penney Company, Inc. and its
consolidated subsidiaries and should be read in conjunction with the Company's
consolidated financial statements as of January 31, 2004, and the year then
ended, and Management's Discussion and Analysis of Financial Condition and
Results of Operations, both contained in the Company's Annual Report on Form
10-K for the year ended January 31, 2004 (the "2003 10-K").
This discussion is intended to provide the reader with information that will
assist in understanding the Company's financial statements, the changes in
certain key items in those financial statements from period to period, and the
primary factors that accounted for those changes, how operating results affect
the financial condition and results of operations of the Company as a whole, as
well as how certain accounting principles affect the Company's financial
statements.
Key Items
o Income from continuing operations increased to $149 million, or $0.50 per
share, compared to $94 million, or $0.31 per share, for the comparable 2003
period. For the first nine months of 2004, income from continuing
operations was $339 million, or $1.12 per share, compared to $111 million,
or $0.34 per share, for the comparable 2003 period. All references to
earnings per share (EPS) are on a diluted basis.
o Third quarter 2004 operating profit, defined on page 22, increased 66% to
$346 million compared with $208 million last year, driven by sales gains
and continued improvement in gross margin and expense leverage.
o Comparable department store sales increased by 2.7% and 6.2% for the third
quarter and first nine months of 2004, respectively, when compared to the
same periods in fiscal 2003. Catalog/Internet sales increased 3.6% and 2.9%
for the third quarter and first nine months of 2004, respectively, with the
Internet channel increasing nearly 30% for the third quarter and about 35%
on a year-to-date basis.
o Net income per share increased to $0.50 in the third quarter of 2004,
compared to $0.27 in the 2003 third quarter. On a year-to-date basis, net
income per share was $0.64 in 2004, an increase when compared to $0.45 per
share in the comparable 2003 period.
o On July 31, 2004, the last day of the Company's second quarter, the Company
closed on the sale of its Eckerd drugstore operations and received
approximately $4.7 billion in cash proceeds that included a $209 million
working capital adjustment. Cash proceeds after income taxes, fees and
transaction costs are expected to be approximately $3.5 billion.
o The Company ended the third quarter of 2004 with $4.6 billion of cash and
short-term investments. The Company is progressing on its capital structure
repositioning program and has completed the following:
o The repurchase of 27.6 million shares of common stock for
approximately $1.04 billion, completing about one-third of the planned
repurchase program through the third quarter with an additional 5.7
million shares for approximately $0.23 billion repurchased from
October 31st through December 3rd;
o The conversion of all of the Company's outstanding shares of Series B
ESOP Convertible Preferred Stock into approximately nine million
common stock shares;
-18-
o $1 billion reduction of outstanding debt through the third quarter,
including payments of approximately $800 million and the termination
of the $221 million Eckerd securitized receivables program, resulting
in $4.6 billion in long-term debt, including current maturities, at
the end of the third quarter; and
o The conversion of substantially all of JCP's $650 million 5.0%
Convertible Subordinated Notes Due 2008 into approximately 22.8
million shares of common stock from October 26, 2004 through November
16, 2004. As of November 17, 2004, total debt reductions under the
capital structure repositioning program were approximately $1.7
billion.
o On October 27, 2004, Myron (Mike) E. Ullman, III was named to succeed Allen
Questrom as Chairman and Chief Executive Officer of the Company, effective
December 1, 2004. On November 12, 2004, the Company announced that Vanessa
Castagna, Executive Vice President, Chairman and Chief Executive Officer of
JCPenney Stores, Catalog and Internet, had elected to resign as an officer
of the Company, effective November 14, 2004. Ken Hicks, President and Chief
Operating Officer of JCPenney Stores and Merchandise Operations, will take
on the added responsibility of leading JCPenney's stores, catalog and
Internet teams as a transitional step.
o On October 22, 2004, Moody's raised its senior implied credit rating for
the Company from Ba2 to Ba1, the highest non-investment grade rating, and
its senior unsecured debt rating from Ba3 to Ba2.
Discontinued Operations
-----------------------
On July 31, 2004, the Company closed on the sale of its Eckerd drugstore
operations for a total of approximately $4.7 billion in cash proceeds that
included a $209 million adjustment for the estimated increase in Eckerd's
working capital from January 31, 2004 to July 31, 2004. After deducting taxes,
fees and other transaction costs, and estimated post-closing adjustments, the
ultimate net cash proceeds from the sale are expected to total approximately
$3.5 billion. As previously reported, The Jean Coutu Group (PJC) Inc. (Coutu)
acquired Eckerd drugstores and support facilities located in 13 Northeast and
Mid-Atlantic states, as well as the Eckerd Home Office located in Florida. CVS
Corporation and CVS Pharmacy, Inc. (collectively, CVS) acquired Eckerd
drugstores and support facilities located in the remaining southern states,
principally Florida and Texas, as well as Eckerd's pharmacy benefits management,
mail order and specialty pharmacy businesses. Proceeds from the sale will be
used for common stock repurchases and debt reduction, as announced on August 2,
2004 and more fully discussed under Capital Structure Repositioning on pages
28-29.
The loss on the sale was $713 million pre-tax, or $1,433 million on an after-tax
basis. The relatively high tax cost is a result of the tax basis of Eckerd being
lower than its book basis because the Company's previous drugstore acquisitions
were largely tax-free transactions. Of the total after-tax loss on the sale,
$1,402 million had been recorded through the first quarter of 2004 to reflect
Eckerd at its estimated fair value less costs to sell, and during the second
quarter of 2004, the remaining $31 million was recorded to reflect revised
estimates of certain post-closing adjustments and resulting sales proceeds.
Additionally, $3.4 billion of the present value of lease obligations (PVOL),
which was an off-balance sheet obligation under generally accepted accounting
principles (GAAP), was eliminated with the transfer of these leases to Coutu and
CVS upon the closing of the sale.
The Company established reserves at July 31, 2004 for estimated transaction
costs and post-closing adjustments. Certain of these reserves involved
significant judgment and actual costs incurred over time could vary from these
estimates. The more significant estimates relate to the estimated working
capital adjustment, the costs to exit the Colorado and New Mexico markets,
severance payments to former
-19-
Eckerd associates, assumption of the Eckerd Pension Plan and various
post-employment benefit obligations and environmental indemnifications. No
reserve adjustments were recorded during the third quarter as no additional
information became available that would indicate the reserves recorded as of the
second quarter in total required adjustment. Cash payments for the Eckerd
related reserves are separately presented in the Company's consolidated
statements of cash flows as cash used in discontinued operations.
In late October, in accordance with terms of the respective sale agreements with
Coutu and CVS, the purchasers submitted to the Company their proposed
adjustments to the pre-closing working capital estimates. A review of the
requested adjustments is currently underway. The respective sale agreements
provide for a review period which can potentially take several months to
finalize.
At the closing of the sale of Eckerd on July 31, 2004, the Company assumed
sponsorship of the Eckerd Pension Plan, the Eckerd Contingent Separation Pay
Programs and various other terminated non-qualified retirement plans and
programs. The Company further assumed all severance and post-employment health
and welfare benefit obligations under various Eckerd plans, employment and other
specific agreements. The Company is evaluating its options with respect to these
assumed liabilities, including, but not limited to, termination of the
agreements, plans or programs and/or settlement of the underlying benefit
obligations. During the third quarter of 2004, the Company made payments of
approximately $35 million related primarily to severance and post-employment
benefit obligations.
The Company is providing to the purchasers certain information systems,
accounting, banking, vendor contracting, tax and other transition services as
set forth in the Company's Transition Services Agreements (Transition
Agreements) with CVS and Coutu for a period of 12 months from the closing date,
unless terminated earlier by the purchasers. One Transition Agreement with
Pharmacare Management Services, Inc., a subsidiary of CVS, involves the
provision of information and data management services for a period of up to 15
months from the closing date. Under the Transition Agreements, the Company will
receive monthly service fees, which are designed to recover the estimated costs
of providing the specified services. If actual costs to provide such services
exceed the estimates, any additional costs incurred would be reflected in
discontinued operations.
Discontinued operations in the consolidated financial statements presented for
2003 also included Mexico department stores, which were sold in November 2003.
-20-
Results of Operations
The following discussion and analysis, consistent with all other financial data
throughout this report, focuses on the results of operations and financial
condition from the Company's continuing operations.
($ in millions, except EPS) 13 weeks ended 39 weeks ended
------------------------------- ------------------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003
-------------- --------------- --------------- --------------
Retail sales, net $ 4,461 $ 4,332 $ 12,351 $11,688
-------------- --------------- --------------- --------------
Gross margin 1,821 1,666 4,879 4,432
SG&A expenses 1,475 1,458 4,148 4,087
-------------- --------------- --------------- --------------
Operating profit 346 208 731 345
Net interest expense 71 64 177 199
Bond premiums and unamortized costs 47 - 47 -
Real estate and other expense/(income) - 4 (13) (17)
-------------- --------------- --------------- --------------
Income from continuing operations
before income taxes 228 140 520 163
Income tax expense 79 46 181 52
-------------- --------------- --------------- --------------
Income from continuing operations $ 149 $ 94 $ 339 $ 111
============== =============== =============== ==============
Diluted EPS from continuing operations $ 0.50 $ 0.31 $ 1.12 $ 0.34
Ratios as a percent of sales:
Gross margin 40.8% 38.5% 39.5% 37.9%
SG&A expenses 33.1% 33.7% 33.6% 35.0%
Operating profit 7.7% 4.8% 5.9% 2.9%
Depreciation and amortization included
in operating profit $ 91 $ 92 $ 264 $ 269
The Company continued to improve its profitability during the third quarter of
2004 as reflected in income from continuing operations of $149 million, or $0.50
per share, compared to $94 million, or $0.31 per share, for the comparable 2003
period. For the first nine months of 2004, income from continuing operations was
$339 million, or $1.12 per share, compared to $111 million, or $0.34 per share
for the comparable 2003 period. The significant increase over 2003 reflects
improved operating profit, resulting from strong sales growth, continued gross
margin improvement and leveraging of selling, general and administrative (SG&A)
expenses. The Company expects fourth quarter earnings per share from continuing
operations to range from $0.95 to $1.05, including the impact of an estimated
$0.05 to $0.10 per share from charges related to the recently announced senior
management transition and potential asset impairments.
Operating Profit
-----------------
Operating profit for the third quarter of 2004 increased 66% to $346 million, or
7.7% of sales, compared to $208 million, or 4.8% of sales, for the comparable
period last year. For the first nine months of 2004, operating profit more than
doubled, reaching $731 million, or 5.9% of sales, compared to $345 million, or
2.9% of sales, for the comparable 2003 period.
-21-
Operating profit and its components (sales, gross margin and SG&A) are the key
measurements on which management evaluates the financial performance of the
retail operations. Real estate activities, gains and losses on the sale of real
estate properties, asset impairments and other charges associated with closing
store and catalog facilities are evaluated separately from operations, and are
recorded in real estate and other in the consolidated statements of operations.
Retail Sales, Net
($ in millions)
13 weeks ended 39 weeks ended
------------------------------------ ---------------------------------
Oct. 30, Oct. 25, Oct. 30, Oct. 25,
2004 2003 2004 2003
------------------- -------------- ---------------------------------
Retail sales, net $ 4,461 $ 4,332 $12,351 $11,688
------------------- -------------- ---------------------------------
Sales percent increase/(decrease):
Comparable stores (1) 2.7% 1.8% 6.2% (0.3)%
Total department stores 2.9% 0.3% 6.2% (1.8)%
Catalog/Internet 3.6% 4.1% 2.9% (1.4)%
(1) Comparable store sales include sales from stores that have been open for 12
consecutive months. A store's sales become comparable on the first day of
the 13th fiscal month.
Comparable department store sales increased 2.7% for the quarter, while total
department store sales increased 2.9%. Third quarter sales reflected good
customer response to back-to-school merchandise assortments combined with
improvements in all merchandise divisions. Florida and the Gulf Coast areas
started seeing a recovery from the major storm activity earlier in the third
quarter, although those markets did not fully recover by quarter-end. Department
store sales have continued to benefit from good customer response to both
fashion and basic merchandise, planned marketing events, improved store
environment, particularly visual presentation, and added convenience. The
fashionable merchandise and focus on maintaining fresh seasonal assortments
contributed to the improvement in sales. These factors also drove increases for
the first nine months of 2004, where both comparable department store sales and
total department store sales increased 6.2%.
Catalog/Internet sales increased 3.6% and 2.9% for the third quarter and first
nine months of 2004, respectively, compared to last year. Sales reflect a focus
on targeted specialty media and the expanded assortments and convenience of the
Internet. Total Internet sales, which are an integral part of the Company's
multi-channel retailing strategy, increased nearly 30% for the third quarter and
about 35% on a year-to-date basis.
In May, the Company launched the Chris Madden home furnishings collection,
reflecting the Company's continuing strategy to deliver affordable, quality,
trend-right fashion to its customers. Chris Madden's "Turning Home Into Haven"
collection is JCPenney's largest home furnishings launch ever and was introduced
with a comprehensive national advertising campaign. Sales results from the
collection were strong throughout the second and third quarters, particularly in
bedding and furniture. In addition, the Company has partnered with Colin Cowie,
a nationally recognized wedding planner, and launched an innovative
technology-based wedding registry as well as a new line of tableware and
giftware in the third quarter of 2004. While still early in its rollout, initial
sales from the program have exceeded expectations, with glassware and bridal
gifts showing the best performance.
-22-
Gross Margin
Gross margin improved 230 basis points as a percent of sales in this year's
third quarter to $1,821 million compared to $1,666 million in the comparable
2003 period. For the first nine months of 2004, gross margin improved 160 basis
points as a percent of sales, to $4,879 million from $4,432 million in the
comparable 2003 period. The improvement reflects better inventory management,
good sell-through of seasonal merchandise, less clearance, more consistent
execution and continuing benefits from the centralized merchandising model.
Benefits of the centralized model have included enhanced merchandise offerings,
an integrated marketing plan, leverage in the buying and merchandising process
and more efficient selection and allocation of merchandise to individual
department stores.
SG&A Expenses
SG&A expenses in this year's third quarter were $1,475 million compared to
$1,458 million in last year's third quarter. Expenses continued to be well
leveraged, improving by 60 basis points as a percent of sales. For the first
nine months of 2004, SG&A expenses were $4,148 million compared to $4,087
million in the comparable period of 2003, which represented a 140 basis point
improvement as a percent of sales. Both the quarter and year-to-date
improvements reflect savings in labor costs, centralized store expense
management, a decline in non-cash pension costs and planned savings from the
Company's previously announced cost savings initiatives.
With the sale of Eckerd completed, management is focused on its Department Store
and Catalog/Internet business as well as the execution of its capital
repositioning program, which was announced on August 2, 2004. The performance
target for Department Stores and Catalog/Internet continues to be to generate an
operating profit of 6% to 8% of sales in 2005. The successful execution of the
turnaround, growth of the business and progress toward improving profitability
is impacted by customers' response to the Company's merchandise offerings, the
competitive environment, the effects of current economic conditions, continued
improvement in gross margin and the reduction of the expense structure. The
Company's strategic plan, financing strategy and risk management are detailed in
its 2003 Annual Report.
Net Interest Expense
---------------------
Net interest expense was $71 million and $64 million for the third quarters of
2004 and 2003. On a year-to-date basis, net interest expense was $177 million in
2004 compared to $199 million in the first nine months of 2003. The increase for
the quarter is due to interest that had been attributed to Eckerd that is now
reflected in continuing operations as a result of the sale of Eckerd in the
second quarter of 2004. While the Company has reduced debt significantly through
the third quarter, the reduction in interest expense will be gradual as the
Company continues to execute its planned debt reduction program over the next
several months. The decrease in interest expense on a year-to-date basis is
primarily related to lower average borrowing levels for continuing operations,
as well as an increase in interest income due to higher average balances of
short-term investments.
For the third quarter of 2004, no net interest expense was allocated to Eckerd
discontinued operations, compared to $41 million for the same period last year.
For the first nine months of 2004, this amounted to $95 million compared to $116
million for the first three quarters of 2003. The lower interest expense is the
result of the sale of the Eckerd drugstore operations on July 31, 2004, offset
to some extent by increases in both the Company's weighted average interest rate
and the intercompany loan balance between Eckerd and a subsidiary of the Company
through the first six months of 2004.
-23-
Bond Premiums and Unamortized Costs
------------------------------------
Call premiums and unamortized costs to redeem the securities included in the
capital structure repositioning, which is discussed on pages 28-29, are expected
to total approximately $50 million. During the third quarter and first nine
months of 2004, the Company incurred $47 million of this amount, which is
reflected in bond premiums and unamortized costs in the consolidated statements
of operations.
Real Estate and Other Expense/(Income)
----------------------------------------
Real estate and other consists of real estate activities, gains and losses on
the sale of real estate properties, asset impairments and other charges
associated with closing store and catalog facilities. Real estate and other for
the third quarter of 2004 resulted in a near-zero balance, which consisted of a
$6 million credit for real estate operations and $6 million of costs related to
asset impairments, PVOL and other costs of closed stores. For the first nine
months of 2004, real estate and other was a net credit of $13 million, which
consisted of a $20 million credit for real estate operations, $3 million of net
gains on the sale of closed units and $10 million of charges related to asset
impairments, PVOL and other costs of closed stores.
For the third quarter of 2003, real estate and other was a net expense of $4
million, which consisted of an $8 million credit for real estate operations, $8
million of asset impairments and $4 million of charges related to PVOL and other
expenses. For the first nine months of 2003, real estate and other was a net
credit of $17 million, which consisted of an $18 million credit for real estate
operations, $51 million of gains on the sale of closed units, $22 million of
accelerated depreciation for closed catalog facilities, $17 million of asset
impairments and $13 million of charges related to PVOL and other expenses.
Income Taxes
--------------
The Company's effective income tax rate for continuing operations was 34.9% for
the third quarter and first nine months of 2004 compared with 33.6% and 32.3%
for the third quarter and first nine months of 2003, respectively. The rate
increase for the third quarter and first nine months of 2004 is primarily due to
improved earnings, which decreased the favorable impact of permanent
adjustments, principally the deduction for dividends paid to the employee stock
ownership plan. For the fourth quarter of 2004, the Company anticipates an
effective income tax rate for continuing operations of 35.0%.
Merchandise Inventory
-----------------------
Merchandise inventory was $4,237 million at October 30, 2004 compared to $4,194
million at October 25, 2003 and $3,156 million at January 31, 2004. With an
increase of 1.0% compared to last year, inventory at the end of the third
quarter of 2004 was in line with plan, was well managed, and reflected a good
balance of seasonal and basic merchandise with less clearance. The Company has
enhanced its ability to allocate and flow merchandise to stores in-season by
recognizing sales trends earlier and accelerating receipts, replenishing
individual stores based on rates of sale, and consistently providing high
in-stock levels in basics and advertised items.
-24-
Liquidity and Capital Resources
---------------------------------
The Company ended the third quarter with approximately $4.6 billion in cash and
short-term investments. Of the $4.7 billion of gross proceeds received from the
closing of the Eckerd sale on July 31, 2004, expected net cash proceeds of
approximately $3.5 billion are being used to repurchase common stock and reduce
debt as part of a major repositioning of the Company's capital structure. During
the third quarter, approximately $1.6 billion of the proceeds was used for such
purposes. See pages 28-29 for additional information related to the progress of
the Company's capital structure repositioning program.
Cash and short-term investments included restricted short-term investment
balances of $64 million and $87 million as of October 30, 2004 and October 25,
2003, respectively, which are pledged as collateral for import letters of credit
not included in the bank credit facility and/or for a portion of casualty
program liabilities.
The following is a summary of the Company's cash flows from operating, financing
and investing activities:
($ in millions)
39 weeks ended
-------------------------------
Oct. 30, Oct. 25,
2004 2003
------------- -------------
Net cash (used in)/provided by:
Operating activities $ (139) $ (575)
Investing activities 4,377 (154)
Financing activities (1,810) 301
Cash (paid to) discontinued operations (845) (1) (125)
------------- -------------
Net increase/(decrease) in cash and cash equivalents $ 1,583 $ (553)
============= =============
(1) Includes $624 million paid for the first installment of income taxes due on
the sale of Eckerd.
Cash Flow from Operating Activities
The improvement in net cash (used in) operating activities in the first nine
months of 2004 compared with the same period in 2003 was primarily attributable
to improved operating performance and better inventory management. In each of
the 39-week periods ended October 30, 2004 and October 25, 2003, the Company
made a $300 million discretionary contribution to the Company's qualified
pension plan.
Cash Flow from Investing Activities
Gross cash proceeds of $4,666 million were received from the sale of Eckerd,
which closed on July 31, 2004. After deducting taxes, fees and other transaction
costs, and estimated post-closing adjustments, the ultimate net cash proceeds
from the sale of Eckerd are expected to total approximately $3.5 billion.
Capital expenditures were $317 million for the first three quarters of 2004
compared with $243 million for the comparable 2003 period. Capital spending was
for new stores, store renewals and modernizations and technology, including gift
registry. Through the third quarter of 2004, the Company opened 13 new or
relocated stores, with one additional store opening by the end of fiscal year
2004. Management continues to expect total capital expenditures for the full
year to be in the area of $500 million.
Proceeds from the sale of closed units were $28 million for the first nine
months of 2004 compared with $89 million for the comparable 2003 period, and
were reflected in investing activities in the Company's consolidated statements
of cash flows.
-25-
Cash Flow from Financing Activities
As a part of the Company's planned $2.3 billion debt reduction program,
approximately $1.0 billion of on- and off-balance sheet obligations were paid
off in the second and third quarters of 2004 as follows:
o As reflected in cash paid to discontinued operations on the consolidated
statement of cash flows, Eckerd's managed care receivables securitization
program was paid off in May 2004 for a total of $221 million and the
program was terminated.
o In June 2004, JCP's 7.375% Notes in the amount of $208 million matured and
were paid.
o Also in June 2004, $25 million of JCP's 9.75% Debentures Due 2021 were
retired at par, through the mandatory sinking fund payment of $12.5 million
and an optional sinking fund payment of an additional $12.5 million. JCP
redeemed the remaining principal balance of this issue of $92.2 million on
September 1, 2004, at a redemption price of 103.2% plus accrued interest.
o During the third quarter, JCP retired the entire $195.7 million balance of
its 8.25% Debentures Due 2022. $37.5 million of the balance was retired at
par, with the remaining $158.2 being redeemed at a redemption price of
103.096% plus accrued interest.
o On September 1, JCP redeemed its $200 million face amount 6.0% Original
Issue Discount Debentures Due 2006. At the date of redemption, these
debentures had a recorded balance of $175 million, due to the unamortized
discount of $25 million.
o During the third quarter, the Company purchased approximately $100 million
of JCP's long-term debt on the open market. While the Board of Directors
has authorized up to $200 million aggregate principal amount of open market
purchases of JCP's long-term debt, the Company currently does not expect to
purchase additional open market debt under this authorization within the
next 12 months.
The Company repurchased 27.6 million shares of common stock for approximately $1
billion during the third quarter of 2004. No common stock repurchases were made
during the first two quarters of 2004 or the first three quarters of 2003. Net
proceeds from the exercise of stock options were approximately $191 million for
the first nine months of 2004 and were insignificant for 2003.
Quarterly dividends of $0.125 per share, or approximately $35 million per
quarter, were paid on the Company's outstanding common stock on February 1,
2004, May 1, 2004 and August 1, 2004 to stockholders of record on January 10,
2004, April 10, 2004 and July 9, 2004, respectively. The payment of common stock
dividends is subject to approval by the Company's Board of Directors on a
quarterly basis.
On October 26, 2004, the Company announced that it was calling all of JCP's
outstanding $650 million 5.0% Convertible Subordinated Notes Due 2008. Holders
of the Notes had the option to convert the Notes into shares of the Company's
common stock at a conversion price of $28.50 until the close of business on
November 16, 2004. All but $0.7 million of the Notes were converted into
approximately 22.8 million shares from October 26, 2004 through November 16,
2004. The remaining Notes were redeemed on November 17, 2004 at 102.5% plus
accrued interest.
For the remainder of 2004, management believes that cash flow generated from
operations, combined with the proceeds from the Eckerd sale and the balance of
remaining short-term investments, will be adequate to execute the common stock
repurchase and debt reduction programs and fund capital expenditures, working
capital and dividend payments and, therefore, no external funding will be
required. At the present time, management does not expect to access the capital
markets for any external financing for the remainder of 2004. However, the
Company may access the capital markets on an opportunistic basis. Management
believes that the Company's financial position will continue to provide the
financial flexibility to support its strategic plan. The Company's cash flows
may be impacted by many factors, including the competitive conditions in the
retail industry, and the effects of the current economic environment and
consumer confidence. Based on the nature of the Company's business, management
considers the above factors to be normal business risks.
-26-
On August 2, 2004, Fitch Ratings upgraded its credit ratings on the Company's
$1.5 billion secured bank facility to BBB- from BB+, its senior unsecured notes
to BB+ from BB and its convertible subordinated notes to BB from B+. Standard &
Poor's revised its outlook to "Stable" from "Negative." On October 22, 2004,
Moody's raised its senior implied credit rating for the Company from Ba2 to Ba1,
the highest non-investment grade rating, and its senior unsecured debt rating
from Ba3 to Ba2.
Additional liquidity strengths include the available $1.5 billion credit
facility discussed in the 2003 10-K and in Note 8. This revolving credit
facility was amended effective June 2, 2004 to permit the sale of the Eckerd
drugstore operations and its affiliates and assets, allow a broader range of
cash investments, and permit issuing banks to extend maturities of certain
letters of credit past the expiration of the Credit Agreement as long as they
are collateralized with cash at that time. No borrowings, other than the
issuance of trade and standby letters of credit, which totaled $159 million as
of the end of the third quarter of 2004, have been, or are expected to be, made
under this facility. The Company was in compliance with all financial covenants
of the credit facility as of October 30, 2004.
Free Cash Flow
In addition to cash flow from operating activities, management also evaluates
free cash flow from continuing operations, which is a non-GAAP financial
measure. Management believes free cash flow from continuing operations is
important in evaluating the Company's financial performance and measuring the
ability to generate cash without incurring additional external financing.
Through the first nine months of 2004, free cash flow from continuing operations
was a deficit of $544 million, a significant improvement compared to a deficit
of $843 million for the comparable 2003 period. Better earnings and inventory
leverage contributed to the improvement, offset slightly by an increase in
capital expenditures. The Company anticipates free cash flow for the full year
2004 to be positive.
The following table reconciles net cash (used in) operating activities (GAAP) to
free cash flow from continuing operations (a non-GAAP measure) for the 39 weeks
ended October 30, 2004 and October 25, 2003:
($ in millions) 39 weeks ended
------------------------------------
Oct. 30, Oct. 25,
2004 2003
---------------- ----------------
Net cash (used in) operating activities - (GAAP) $ (139) $ (575)
Less:
Capital expenditures (317) (243)
Dividends paid (116) (114)
Plus:
Proceeds from sale of assets 28 89
---------------- ----------------
Free cash flow from continuing operations $ (544) $ (843)
================ ================
-27-
Capital Structure Repositioning
-------------------------------
On August 2, 2004, the Company announced that it intends to use the expected
$3.5 billion in net cash proceeds from the sale of the Eckerd drugstore
operations and $1.1 billion of existing cash balances to implement a major
repositioning of its capital structure. This repositioning program is
progressing as planned and includes the following:
Debt Reduction
The Company's debt reduction program consists of the planned retirement of $2.3
billion of debt in 2004 and 2005. Through the third quarter of 2004, the Company
reduced debt by approximately $1 billion, including payments of approximately
$800 million and the termination of the $221 million Eckerd securitized
receivables program. From October 26, 2004 through November 16, 2004,
substantially all of JCP's $650 million 5.0% Convertible Subordinated Notes Due
2008 were converted into approximately 22.8 million shares of common stock,
resulting in total debt reduction of approximately $1.7 billion.
No additional debt payments are anticipated for the remainder of 2004. For the
first half of 2005, debt payments are expected to include the following:
o Holders of JCP's 7.4% Debentures Due 2037, with a principal amount of $400
million, have the right to elect to redeem the debentures in April 2005.
o In May 2005, the Company expects to pay the $193 million of JCP's 7.05%
Notes Due 2005, at the scheduled maturity date.
Series B Convertible Preferred Stock Redemption
On August 26, 2004, the Company redeemed all of its outstanding shares of Series
B ESOP Convertible Preferred Stock (Preferred Stock), all of which were held by
the Company's Savings, Profit-Sharing and Stock Ownership Plan, a 401(k) savings
plan. Each preferred stockholder received 20 equivalent shares of JCPenney
common stock for each one share of Preferred Stock in their Savings Plan
account. Preferred Stock shares, which are included in the diluted earnings per
share calculation as appropriate, were converted into approximately nine million
common stock shares. Annual dividend savings will approximate $11 million after
tax.
Common Stock Repurchases
The Company has implemented a common stock repurchase program of up to $3.0
billion (not to exceed 133 million shares), including the repurchase of up to
$650 million of common stock that had been contingent upon the conversion of
JCP's outstanding 5.0% Convertible Subordinated Notes Due 2008, which has been
completed. Share repurchases have been and will continue to be made periodically
in open-market transactions, subject to market conditions, legal requirements
and other factors. The Company repurchased 27.6 million common shares during the
quarter ended October 30, 2004 at a cost of approximately $1,040 million. The
shares repurchased were immediately retired. As of October 30, 2004,
approximately $1,960 million remained authorized for share repurchases. From
October 31, 2004 through December 3, 2004, the Company repurchased an additional
5.7 million shares of common stock at a cost of approximately $230 million under
the common stock repurchase program, bringing the total repurchases to date up
to 33 million shares at a cost of approximately $1.3 billion. This represents
more than 40 percent of the total planned common stock repurchase program. The
program is expected to be completed within the next six to nine months.
During the first nine months of 2004, common stock outstanding decreased seven
million shares to 267 million shares from 274 million shares at the beginning of
the year. The decline in outstanding shares is attributable to approximately 28
million shares repurchased and retired offset by nine million shares
-28-
issued for redeeming the convertible preferred stock on August 26, 2004 and 12
million shares issued substantially from the exercise of stock options.
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; 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 2003 10-K
includes detailed descriptions of certain judgments that management makes in
applying its accounting policies in these areas.
Stock Option Accounting
-------------------------
As discussed in the 2003 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. The Financial Accounting Standards Board (FASB) proposed a new rule
that would require expense recognition of stock options in the statement of
operations beginning in the third quarter of 2005. The Company will adopt any
new rules required by the FASB when they are effective. As required by Statement
of Financial Accounting Standards (SFAS) No. 123 for companies retaining APB 25
accounting, the Company discloses the estimated impact of fair value accounting
for stock options granted. See Note 1 to the Unaudited Interim Consolidated
Financial Statements for the pro forma impact on the third quarters and first
nine months of 2004 and 2003.
-29-
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 2004, the Audit Committee of the Company's Board of
Directors approved estimated fees for the remainder of 2004 related to the
performance of both audit and allowable non-audit services by the Company's
external auditors, KPMG LLP. On November 15, 2004, the Audit Committee approved
additional estimated fees related to KPMG LLP's audit of the Company's internal
control over financial reporting, which is required for the first time in 2004
by Section 404 of the Sarbanes-Oxley Act of 2002, due to revised estimates of
the total anticipated audit effort.
Seasonality
------------
The results of operations and cash flows for the 13 and 39 weeks ended October
30, 2004 are not necessarily indicative of the results for the entire year. The
Company's business depends to a great extent on the last quarter of the year.
Historically for the fourth quarter, Department Stores and Catalog/Internet
sales have averaged approximately one-third of annual sales and income from
continuing operations has averaged about 60% of the full year total.
-30-
Item 3 - Quantitative and Qualitative Disclosures 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 October 30, 2004 are similar to those
disclosed in the Company's 2003 10-K. For the 39 weeks ended October 30, 2004,
the other comprehensive loss on foreign currency translation was $1 million. Due
to the limited nature 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-15 and 15d-15 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 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 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.
-31-
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
The Company has no material legal proceedings pending against it.
In the matter of Gayle G. Pitts, et al. v. J. C. Penney Company, Inc., J. C.
Penney Direct Marketing Services, Inc., ("DMS") et al. reported in the Company's
Annual Report on Form 10-K for the fiscal year ended January 31, 2004, J. C.
Penney Company, Inc., J.C. Penney International Insurance Group, Inc. and AEGON
U.S.A. have been dismissed as defendants. The remaining defendants are J. C.
Penney Life Insurance Company N/K/A Stonebridge Life Insurance Company, JCPenney
Direct Marketing Services, Inc., and AEGON DMS. The class certification has been
reversed but plaintiffs have filed another motion for class certification, which
is pending.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Purchases of Securities
The table below sets forth the information with respect to purchases made
by or on behalf of the Company of the Company's common stock during the
quarter ended October 30, 2004:
Period Total Average Total Number of Maximum Dollar
Number of Price Paid Shares Purchased Value of
Shares Per Share as Part of Shares that
Purchased Publicly May Yet Be
Announced Plans Purchased
or Programs (1) Under the
Plans or
Programs (in
millions)
----------------------------- ------------- ------------ ------------------- ----------------
August 1, 2004 through
September 4, 2004 6,451,800 $ 39.40 6,451,800 $2,746
September 5, 2004 through
October 2, 2004 12,724,100 $ 37.01 19,175,900 $2,275
October 3, 2004 through
October 30, 2004 8,441,000 $ 37.24 27,616,900 $1,960
------------- -------------------
Total 27,616,900 27,616,900
============= ===================
(1) The Company's Board of Directors approved a common stock repurchase
program of up to $3.0 billion for common stock repurchases (not to
exceed 133 million shares), including up to $650 million that had been
contingent upon the conversion of the Company's 5.0% Convertible
Subordinated Notes Due 2008, which occurred from October 26, 2004
through November 16, 2004. The repurchase program, which the Company
announced on August 2, 2004, has no expiration date, but is expected
to be completed within the next six to nine months.
On August 26, 2004, the Company redeemed all of its outstanding shares of
Series B ESOP Convertible Preferred Stock (Preferred Stock), all of which
were held by the Company's Savings, Profit-Sharing and Stock Ownership
Plan, a 401(k) savings plan. Each preferred stockholder received 20
equivalent shares of JCPenney common stock for each one share of Preferred
Stock in their Savings Plan account. The Preferred Stock shares were
converted into approximately nine million common stock shares.
-32-
Item 6 - Exhibits
Exhibit Nos.
10.1 Term Sheet dated as of October 27, 2004 between the Company and Myron
E. Ullman, III
10.2 Notice of Restricted Stock Award to Myron E. Ullman, III, dated as of
December 1, 2004
10.3 Notice of Restricted Stock Unit Award to Myron E. Ullman, III, dated
as of December 1, 2004
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
-33-
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: December 7, 2004
-34-
Exhibit 10.1
Myron E. (Mike) Ullman, III
Position: Chairman and Chief Executive Officer
Starting Date: December 1, 2004
Base Salary: $1,500,000, reviewed annually
Short-Term Incentive*
100% at Target
200% at Max
Profit cliff at 95% of plan
Incentive guaranteed at target from 12/1/ 2004 to 1/31/2005.
Signing Bonus
$3,000,000 issued at stating date in vested restricted stock units (based on
average market price of JCPenney stock on date of signing). The units are
payable six months after separation from service, but if termination is
voluntary or for retirement no earlier than January 1, 2008. Otherwise subject
to the terms of the Company's plan.
2005 Long-Term Incentive Award
$6,000,000 of restricted stock awarded at starting date (based on average market
price of JCPenney stock on date of signing), vesting 20% per year beginning on
December 1, 2005, subject to employment on each vesting date and otherwise
subject to the terms and conditions of the Company plan.
Subsequent Long-Term Incentive Awards
Long-term incentive awards will commence with the fiscal year beginning February
1, 2006. The value of each award is up to $6,000,000 as determined in the
discretion of the Board as recommended by the Human Resources and Compensation
Committee annually. The Company is currently revising its long-term incentive
strategy. Criteria, performance measures, and clawback provisions are currently
being reviewed and will be submitted for approval by the Board on the
recommendation of the Human Resources and Compensation Committee no later than
the March 2005 Board meeting. Performance measures will be approved by the Board
on the recommendation of the Human Resources and Compensation Committee annually
thereafter.
*Subject to the terms and conditions of the applicable Company plan.
/s/ Myron E. Ullman, III 10/27/2004
------------------------------------------
Myron E. Ullman, III
/s/ Burl Osborne
------------------------------------------
Burl Osborne
/s/ Thomas Engibous
------------------------------------------
Thomas Engibous
-35-
Exhibit 10.2
JCPENNEY COMPANY, INC. 2001 EQUITY COMPENSATION PLAN
NOTICE OF RESTRICTED STOCK AWARD
Name: MYRON E. ULLMAN, III
Equity Plan
-------------
The Company maintains the J. C. Penney Company, Inc. 2001 Equity Compensation
Plan ("Plan"), under which the Human Resources and Compensation Committee of the
Board of Directors ("Committee") may, among other things, grant stock awards
covering shares of the Company's Common Stock of 50(cent) par value of J. C.
Penney Company, Inc. to associates of the Company as the Committee may determine
subject to terms, conditions, or restrictions relating to such awards as it may
deem appropriate.
Stock Award
-------------
Under the terms of the Plan, a restricted stock award for 160,599 shares was
granted to you on December 1, 2004. The shares covered by the stock award shall
vest in accordance with the following schedule provided you are still actively
employed on the vesting dates with no interruption of employment with the
Company:
Amount of Total Restricted Stock
Scheduled Vesting Date Award Vesting
December 1, 2005 32,120
December 1, 2006 32,120
December 1, 2007 32,120
December 1, 2008 32,120
December 1, 2009 32,119
You will be eligible to receive dividends and have voting rights on the
restricted shares during the vesting period. Dividends received by you pursuant
to the restricted shares will not themselves be subject to restrictions. Once
the restricted stock award vests, there is no further retention period
associated with the vested shares under the Plan (although other restrictions
may apply - you should check with the Company's General Counsel or his/her
designee prior to disposing of the vested shares).
Employment Termination
-----------------------
If your employment terminates for any reason, other than death or disability (as
defined in the supplement attached hereto), prior to December 1, 2009, all
unvested portions of this restricted stock award will be forfeited. If your
employment terminates due to death or disability prior to December 1, 2009, the
restricted stock award will immediately vest with no further restrictions under
the Plan. The beneficiary listed on your J. C. Penney Company, Inc.,
Company-Paid Life Insurance Beneficiary Designation Form will receive the vested
shares covered by the stock award in the case of termination of employment due
to death.
Taxes and Withholding
-----------------------
At the time the granted shares vest, the fair market value of the shares (the
average of the high and low JCPenney stock price on the NYSE multiplied by the
number of vested shares) will be included in your W-2 form and the Company will
be required to withhold applicable taxes on such shares. The Company may collect
any withholding taxes due by requesting you send the withholding amount, by
deducting the required amount from your paycheck or other payment or by
retaining and canceling the number of vested shares equal to the value of the
required tax withholding. Alternatively, you may choose to be taxed currently
with respect to the restricted shares by making an election under Section 83(b)
of the Internal Revenue Code within 30 days following the grant of restricted
stock. You should consult with your personal tax advisor regarding the
advisability of making such an election.
Effect on Other Benefits
-------------------------
The value of the shares covered by the stock award will not be included as
compensation or earnings for purposes of any other compensation, retirement, or
benefit plan offered to Company associates.
Administration
-------------------
The Committee has full authority and discretion, subject only to the terms of
the Plan, to decide all matters relating to the administration and
interpretation of the Plan and this award and all such Committee determinations
shall be final, conclusive, and binding.
-36-
Supplement
Definitions:
Disability
A termination of employment with the Company or a subsidiary by reason of
disability mans the inability of an Associate Participant to engage in any
substantial gainful activity by reason of any medically determinable physical or
mental impairment which can be expected to result in death or which has lasted
or can be expected to last for a continuous period of not less than 12 months.
An Associate Participant shall be deemed to have terminated employment with the
Company or a subsidiary by reason of disability if it shall be determined that
such termination resulted from such Associate Participant having suffered a
disability, as defined in the United States Social Security Laws (Title 42
United States Code, Section 423, or any amendment or successor statutory
provision thereto).
-37-
Exhibit 10.3
NOTICE OF RESTRICTED STOCK UNIT AWARD
Name: MYRON E. ULLMAN, III
Restricted Stock Unit Grant
------------------------------
A restricted stock unit award for 80,299 units was granted to you on December 1,
2004. Each restricted stock unit shall at all times be deemed to have a value
equal to the then-current fair market value of J. C. Penney Company, Inc. Common
Stock of 50(cent) par value ("Common Stock"). The restricted stock unit grant is
100% vested as of December 1, 2004. This grant is subject to all the terms,
rules, and conditions of the J. C. Penney Company, Inc. 2001 Equity Compensation
Plan ("Plan").
You will be eligible to be credited with a quarterly distribution of an amount
equivalent to the dividend declared on Common Stock on the restricted stock
units until such time as the units are converted to shares of Common Stock. Any
such dividends shall be converted into a number of additional restricted stock
units equal to the aggregate dividend which would have been paid with respect to
the number of restricted stock units then credited to you under this grant
divided by the closing price of the Company Stock on the New York Stock Exchange
on the day on which such dividends are paid. Any such additional restricted
stock units shall vest immediately and be treated in the same manner as the
original restricted stock units.
Payment Date
----------------
Upon your employment termination, the Company will issue to you shares of Common
Stock in cancellation of the restricted stock units. If your employment
termination is for any reason other than voluntary separation or retirement, the
restricted stock units will be payable six months from date of separation. If
your employment termination is voluntary or for retirement, the restricted stock
units will be payable six months after separation from service or January 1,
2008, whichever is later. The beneficiary listed on your J. C. Penney Company,
Inc., Company-Paid Life Insurance Beneficiary Designation Form will receive the
vested shares covered by the stock award in the case of termination of
employment due to death.
Taxes and Withholding
--------------------------
At the time the Company issues to you, in cancellation of the restricted stock
units, shares of Common Stock, the fair market value of the shares (the average
of the high and low JCPenney stock price on the NYSE multiplied by the number of
vested shares) will be included in your W-2 form and the Company will be
required to withhold applicable taxes on such shares. The Company may collect
any withholding taxes due by requesting you send the withholding amount, by
deducting the required amount from your paycheck or other payment or by
retaining and canceling the number of vested shares equal to the value of the
required tax withholding.
Effect on Other Benefits
---------------------------
The value of the shares covered by the restricted stock unit grant will not be
included as compensation or earnings for purposes of any other compensation,
retirement, or benefit plan offered to Company associates.
Administration
---------------
The Human Resources and Compensation Committee of the Company's Board of
Directors has full authority and discretion to decide all matters relating to
the administration and interpretation of the Plan and this award and all such
Committee determinations shall be final, conclusive, and binding.
-38-
Exhibit 31.1
CERTIFICATION
--------------
I, Myron E. Ullman, III, 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: December 7, 2004.
/s/ Myron E. Ullman, III
---------------------------
Myron E. Ullman, III
Chairman and Chief Executive Officer
J. C. Penney Company, Inc.
-39-
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: December 7, 2004.
/s/ Robert B. Cavanaugh
---------------------------
Robert B. Cavanaugh
Executive Vice President and
Chief Financial Officer
J. C. Penney Company, Inc.
-40-
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 October 30, 2004 (the "Report"),
I, Myron E. Ullman, III, 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 7th day of December 2004.
/s/ Myron E. Ullman, III
-----------------------------
Myron E. Ullman, III
Chairman and Chief Executive Officer
-41-
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 October 30, 2004 (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 7th day of December 2004.
/s/ Robert B. Cavanaugh
-----------------------------
Robert B. Cavanaugh
Executive Vice President and
Chief Financial Officer
-42-