UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 29, 2006
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ________________
Commission File Number: 1-15274
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)
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer X Accelerated filer Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. 224,207,781 shares of Common
Stock of 50 cents par value, as of September 5, 2006.
INDEX
Page
----------
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 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 31
Part II Other Information
Item 1A. Risk Factors 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 6. Exhibits 34
Signature Page 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 26 weeks ended
------------------------------- ------------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
--------------- ------------- ------------- ---------------
Retail sales, net $ 4,238 $ 3,981 $ 8,458 $ 8,099
Cost of goods sold 2,610 2,465 5,061 4,889
--------------- ------------- ------------- ---------------
Gross margin 1,628 1,516 3,397 3,210
Selling, general and administrative expenses 1,357 1,303 2,757 2,689
Net interest expense 32 40 66 89
Bond premiums and unamortized costs - 5 - 18
Real estate and other (income) (9) (14) (22) (36)
--------------- ------------- ------------- ---------------
Income from continuing operations
before income taxes 248 182 596 450
Income tax expense 70 60 205 157
--------------- ------------- ------------- ---------------
Income from continuing operations $ 178 $ 122 $ 391 $ 293
Income/(loss) from discontinued operations,
net of income tax expense/(benefit) of $1,
$28, ($1) and $28 1 9 (2) 10
--------------- ------------- ------------- ---------------
Net income $ 179 $ 131 $ 389 $ 303
=============== ============= ============= ===============
Basic earnings/(loss) per share:
--------------------------------
Continuing operations $ 0.76 $ 0.46 $ 1.68 $ 1.10
Discontinued operations 0.01 0.04 (0.01) 0.04
--------------- ------------- ------------- ---------------
Net income $ 0.77 $ 0.50 $ 1.67 $ 1.14
=============== ============= ============= ===============
Diluted earnings/(loss) per share:
----------------------------------
Continuing operations $ 0.75 $ 0.46 $ 1.66 $ 1.09
Discontinued operations 0.01 0.04 (0.01) 0.04
--------------- ------------- ------------- ---------------
Net income $ 0.76 $ 0.50 $ 1.65 $ 1.13
=============== ============= ============= ===============
The accompanying notes are an integral part of these unaudited Interim
Consolidated Financial Statements.
-1-
J. C. Penney Company, Inc.
Consolidated Balance Sheets
(Unaudited)
($ in millions) July 29, July 30, Jan. 28,
2006 2005 2006
--------------- ------------ --------------
Assets
Current assets
Cash and short-term investments
(including restricted balances of $56,
$64 and $65) $ 2,374 $ 3,385 $ 3,016
Receivables 330 212 270
Merchandise inventory (net of LIFO
reserves of $24, $25 and $24) 3,461 3,445 3,210
Prepaid expenses 191 194 206
--------------- ------------ --------------
Total current assets 6,356 7,236 6,702
Property and equipment (net of accumulated
depreciation of $2,217, $2,169 and $2,097) 3,897 3,625 3,748
Prepaid pension 1,464 1,515 1,469
Other assets 546 536 542
--------------- ------------ --------------
Total Assets $12,263 $ 12,912 $ 12,461
=============== ============ ==============
The accompanying notes are an integral part of these unaudited Interim
Consolidated Financial Statements.
-2-
J. C. Penney Company, Inc.
Consolidated Balance Sheets
(Unaudited)
($ in millions, except per share data) July 29, July 30, Jan. 28,
2006 2005 2006
-------------- ------------- -------------
Liabilities and Stockholders' Equity
Current liabilities
Trade payables $ 1,410 $ 1,362 $ 1,171
Accrued expenses and other 1,262 1,297 1,562
Current maturities of long-term debt 343 15 21
Income taxes payable - 36 8
-------------- ------------- -------------
Total current liabilities 3,015 2,710 2,762
Long-term debt 3,114 3,457 3,444
Deferred taxes 1,260 1,320 1,287
Other liabilities 969 1,031 961
-------------- ------------- -------------
Total Liabilities 8,358 8,518 8,454
Stockholders' Equity
Common stock and additional paid-in capital(1) 3,481 4,090 3,479
Reinvested earnings at beginning of year 512 812 812
Net income 389 303 1,088
Retirement of common stock (408) (759) (1,263)
Dividends declared (84) (66) (125)
-------------- ------------- -------------
Reinvested earnings at end of period 409 290 512
Accumulated other comprehensive income 15 14 16
-------------- ------------- -------------
Total Stockholders' Equity 3,905 4,394 4,007
-------------- ------------- -------------
Total Liabilities and Stockholders' Equity $12,263 $12,912 $12,461
============== ============= =============
(1) Common stock has a par value of $0.50 per share; 1,250 million shares are
authorized. As of July 29, 2006, July 30, 2005 and January 28, 2006, 227 million
shares, 256 million shares and 233 million shares were issued and outstanding,
respectively.
The accompanying notes are an integral part of these unaudited Interim
Consolidated Financial Statements.
-3-
J. C. Penney Company, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
---------------------------------------
26 weeks ended
---------------------------------------
July 29, July 30,
($ in millions) 2006 2005
------------------ -----------------
(Revised)
Cash flows from operating activities:
Net income $ 389 $ 303
Loss/(income) from discontinued operations 2 (10)
Adjustments to reconcile net income to net cash provided by operating
activities:
Asset impairments, PVOL and other unit closing costs 2 3
Depreciation and amortization 176 175
Net gains on sale of assets (5) (22)
Benefit plans expense 15 31
Stock-based compensation 22 27
Deferred taxes 15 78
Change in cash from:
Receivables 17 (15)
Inventory (252) (303)
Prepaid expenses and other assets (17) 12
Trade payables 239 219
Current income taxes payable (110) (32)
Accrued expenses and other liabilities (314) (253)
------------------ -----------------
Net cash provided by operating activities 179 213
------------------ -----------------
Cash flows from investing activities:
Capital expenditures (323) (233)
Proceeds from the sale of discontinued operations - 283
Proceeds from sale of assets 11 27
------------------ -----------------
Net cash (used in)/provided by investing activities (312) 77
------------------ -----------------
Cash flows from financing activities:
Payments of long-term debt, including capital leases and bond premiums (7) (466)
Common stock repurchased (516) (1,018)
Common stock dividends paid (71) (69)
Proceeds from stock options exercised 78 118
Excess tax benefits on stock options exercised 33 40
------------------ -----------------
Net cash (used in) financing activities (483) (1,395)
------------------ -----------------
Cash flows from discontinued operations:
Operating cash flows 8 14
Investing cash flows (34) (181)
Financing cash flows - 8
------------------ -----------------
Total cash (paid for) discontinued operations (26) (159)
------------------ -----------------
Net (decrease) in cash and short-term investments (642) (1,264)
Cash and short-term investments at beginning of year 3,016 4,649
------------------ -----------------
Cash and short-term investments at end of period $ 2,374 $ 3,385
================== =================
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 28, 2006 (the 2005
10-K). The accompanying unaudited Interim Consolidated Financial Statements
present the results of J. C. Penney Company, Inc. and its subsidiaries (the
Company or JCPenney) and should be read in conjunction with the Consolidated
Financial Statements and notes thereto in the 2005 10-K. All significant
intercompany transactions and balances have been eliminated in consolidation.
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 28, 2006 financial information
was derived from the audited Consolidated Financial Statements, with related
footnotes, included in the 2005 10-K.
Certain reclassifications were made to prior year amounts to conform to the
current period presentation, including the reclassification of the results of
operations of Lojas Renner S.A. (Renner) to discontinued operations for all
periods presented (see Note 2).
Certain debt securities were issued by J. C. Penney Corporation, Inc. (JCP), the
wholly owned operating subsidiary of the Company. The 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 Company of certain of
JCP's outstanding debt securities is full and unconditional.
Stock-Based Compensation
The Company has a stock-based compensation plan that provides for grants of
restricted and non-restricted stock awards (shares and units), stock
appreciation rights or options to purchase the Company's common stock to its
associates and non-employee directors . Effective January 30, 2005, the Company
adopted Statement of Financial Accounting Standards No. 123 (revised),
"Share-Based Payment" (SFAS No. 123R), which requires the use of the fair value
method of accounting for all stock-based compensation, including stock options.
The statement was adopted using the modified prospective method of application.
Under this method, in addition to reflecting compensation expense for new
share-based awards, expense is also recognized to reflect the remaining vesting
period of awards that had been included in pro-forma disclosures in prior
periods. The Company did not adjust prior year financial statements under the
optional modified retrospective method of application.
Prior to 2005, the Company used the Black-Scholes option pricing model to
estimate the grant date fair value of stock option awards. For grants subsequent
to the adoption of SFAS No. 123R, the Company estimates the fair value of stock
option awards on the date of grant using a binomial lattice model developed by
outside consultants who worked with the Company in the implementation of SFAS
No. 123R. The Company believes that the binomial lattice model is a more
accurate model for valuing employee stock options since it better reflects the
impact of stock price changes on option exercise behavior.
See Note 10 for additional discussion of the Company's stock-based compensation.
-5-
Cash Flow Presentation
Beginning with the 2005 10-K, the Company has separately disclosed the
operating, investing and financing portions of the cash flows attributable to
its discontinued operations. In prior periods, these were reported on a combined
basis as a single amount.
Effect of New Accounting Standards
In July 2006, the Financial Accounting Standards Board (FASB) issued two related
standards that address accounting for income taxes: FASB Interpretation No.
(FIN) 48, "Accounting for Uncertainty in Income Taxes," and FASB Staff Position
(FSP) FAS 13-2, "Accounting for a Change in the Timing of Cash Flows Relating to
Income Taxes Generated by a Leveraged Lease Transaction." Among other things,
FIN 48 requires applying a "more likely than not" threshold to the recognition
and derecognition of tax positions, while FSP FAS 13-2 requires a recalculation
of returns on leveraged leases if there is a change or projected change in the
timing of cash flows relating to income taxes generated by the leveraged lease.
The new guidance will be effective for the Company as of the beginning of 2007.
The Company is currently evaluating the impact, if any, of adopting FIN 48 on
its financial position, results of operations and cash flows. FSP FAS 13-2 is
not expected to have a material impact on the Company's consolidated financial
statements.
In October 2005, the FASB issued Staff Position (FSP) FAS 13-1, "Accounting for
Rental Costs Incurred during a Construction Period." FSP FAS 13-1 requires
rental costs associated with ground or building operating leases that are
incurred during a construction period to be treated as rental expense, as
opposed to capitalizing them as a part of the building or leasehold improvement.
The provisions of this FSP must be applied to the first reporting period
beginning after December 15, 2005, and therefore, beginning in the first quarter
of 2006, the Company no longer capitalizes rental costs incurred during the
construction period. Retrospective application is permitted but not required.
The Company adopted FSP No. FAS 13-1 on a prospective basis in the first quarter
of fiscal 2006. The adoption of FSP No. FAS 13-1 did not have a significant
effect on the Company's consolidated financial statements.
2) Discontinued Operations
-----------------------
Lojas Renner S.A.
On July 5, 2005, the Company's indirect wholly owned subsidiary, J. C. Penney
Brazil, Inc., closed on the sale of its shares of Renner, a Brazilian department
store chain, through a public stock offering registered in Brazil. The Company
generated cash proceeds of $283 million from the sale of its interest in Renner.
After taxes and transaction costs, net proceeds approximated $260 million.
Proceeds from the sale were used for common stock repurchases, which are more
fully discussed in Note 4.
The sale resulted in a cumulative pre-tax gain of $26 million and a loss of $7
million on an after-tax basis. The relatively high tax cost is largely due to
the tax basis of the Company's investment in Renner being lower than its book
basis as a result of accounting for the investment under the cost method for tax
purposes. Included in the pre-tax gain on the sale was $83 million of foreign
currency translation losses that had accumulated since the Company acquired its
controlling interest in Renner.
Eckerd Drugstores
On July 31, 2004, the Company and certain of its subsidiaries closed on the sale
of its Eckerd drugstore operations to the Jean Coutu Group (PJC) Inc. and CVS
Corporation and CVS Pharmacy, Inc. (together, CVS). During the first half of
2006, the Company recorded a $2 million after-tax charge relating to the Eckerd
sale, primarily related to taxes payable resulting from a state sales tax audit.
Through the second quarter of 2006, the cumulative loss on the Eckerd sale was
$717 million pre-tax, or $1,332 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.
-6-
The net cash proceeds of approximately $3.5 billion from the Eckerd sale, which
closed in the second quarter of 2004, were used for common stock repurchases and
debt reduction, which are more fully discussed in Note 4.
Upon closing on the sale of Eckerd, the Company established reserves 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 remaining estimates relate
to the costs to exit the Colorado and New Mexico markets and environmental
indemnifications. Management continues to review and update the remaining
reserves on a quarterly basis and believes that the overall reserves, as
adjusted, are adequate at the end of the second quarter of 2006 and consistent
with original estimates. Cash payments for the Eckerd-related reserves are
included in the Company's Consolidated Statements of Cash Flows as Cash Paid for
Discontinued Operations, with tax payments included in operating cash flows and
all other payments, if applicable, included in investing cash flows.
The Company engaged a third-party real estate firm to assist it in disposing of
the Colorado and New Mexico properties. As of July 29, 2006, most of the
properties had been disposed of, and the Company is working through disposition
plans for the remaining properties.
JCP assumed sponsorship of the Pension Plan for Former Drugstore Associates and
various other nonqualified retirement plans and programs. JCP further assumed
all severance obligations and post-employment health and welfare benefit
obligations under various Eckerd plans and employment and other specific
agreements. JCP has either settled the obligations in accordance with the
provisions of the applicable plan or program or determined in most other cases
to terminate the agreements, plans or programs and settle the underlying benefit
obligations. On June 20, 2005, the Board of Directors of JCP approved the
termination of JCP's Pension Plan for Former Drugstore Associates. Plan assets
were distributed by the purchase of an annuity contract with a third party
insurance company effective as of June 13, 2006.
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. Reserves were established by management, after
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.
-7-
The Company's financial statements reflect Renner and Eckerd as discontinued
operations for all periods presented. Results of the discontinued operations are
summarized below:
Discontinued Operations
($ in millions) 13 weeks ended 26 weeks ended
----------------------------- ------------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
----------------------------- ------------------------------
Gain/(loss) on sale of Eckerd, net of income tax
expense/(benefit) of $1, $(13), $(1) and $(13) $ 1 $ 5 $ (2) $ 5
Renner income from operations, net of
income tax expense of $-, $4, $- and $4 - 6 - 7
(Loss) on sale of Renner, net of income tax
expense of $-, $34, $- and $34 - (8) - (8)
Other discontinued operations, net of income
tax expense of $-, $3, $- and $3 - 6 - 6
----------------------------- ------------------------------
Total income/(loss) from discontinued
operations $ 1 $ 9 $ (2) $ 10
============================= ==============================
Included in the Renner income from operations amounts provided above were net
sales of $113 million and $187 million for the second quarter and first half of
2005, respectively.
3) 2006 Common Stock Repurchase Program
------------------------------------
In February 2006, the Company's Board of Directors (Board) authorized a $750
million common stock repurchase program, which is being funded with 2005 free
cash flow and cash proceeds from employee stock option exercises. During the
second quarter of 2006, the Company repurchased 8.0 million shares of common
stock for $530 million. The current repurchase program was completed on
September 5, 2006.
Common stock is retired on the same day it is repurchased, with the excess of
the purchase price over the par value being allocated between Reinvested
Earnings and Additional Paid-In Capital.
Common Stock Outstanding
During the first half of 2006, the number of outstanding shares of common stock
changed as follows:
Outstanding
(in millions) Common Shares
------------------------
Balance as of January 28, 2006 233
Exercise of stock options 2
Common stock repurchased and retired (8)
------------------------
Balance as of July 29, 2006 227
========================
4) 2005 and 2004 Equity and Debt Reduction Programs
------------------------------------------------
By the end of 2005, the Company had completed its 2005 and 2004 equity and debt
reduction programs. The Company used the approximate $3.5 billion in net cash
proceeds from the sale of the Eckerd
-8-
drugstore operations, $260 million in net cash proceeds from the sale of its
shares of Renner, cash proceeds from the exercise of employee stock options and
existing cash and short-term investment balances, including free cash flow
generated in 2004, to fund the programs, which consisted of common stock
repurchases, debt reduction and redemption, through conversion to common stock,
of all outstanding shares of the Company's Series B ESOP Convertible Preferred
Stock.
Common Stock Repurchases
The Company repurchased 12.5 million shares of common stock at a cost of $666
million during the second quarter of 2005 and 20.2 million shares of common at a
cost of $1,026 million during the first half of 2005.
The Company's 2005 and 2004 common stock repurchase programs totaled $4.15
billion and were completed in the fourth quarter of 2005. In total, 94.3 million
shares were repurchased under these programs.
Debt Reduction
The Company's 2005 and 2004 debt reduction programs, which were completed by the
end of the second quarter of 2005, consisted of approximately $2.14 billion of
debt retirements. The 2005 debt retirements included $194 million and $56
million of open-market debt repurchases in the first and second quarters of
2005, respectively, and the payment of $193 million of long-term debt at the
scheduled maturity date in May 2005.
The Company incurred pre-tax charges of $18 million in 2005 related to these
early debt retirements ($13 million and $5 million, respectively, in the first
and second quarters).
5) Earnings per Share
------------------
Basic earnings per share (EPS) is computed by dividing net income by the
weighted-average number of shares of common stock outstanding for the period.
Except when 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.
Income from continuing operations and shares used to compute EPS from continuing
operations, basic and diluted, are reconciled below:
(in millions, except EPS) 13 weeks ended 26 weeks ended
-------------------------- --------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
------------ ----------- ----------- ------------
Earnings:
---------
Income from continuing operations, basic and
diluted $ 178 $ 122 $ 391 $ 293
============ =========== =========== ============
Shares:
-------
Average common shares outstanding (basic shares) 233 262 233 267
Adjustment for assumed dilution:
Stock options and restricted stock units 2 3 3 2
------------ ----------- ----------- ------------
Average shares assuming dilution (diluted shares) 235 265 236 269
============ =========== =========== ============
EPS from continuing operations:
-------------------------------
Basic $ 0.76 $0.46 $1.68 $ 1.10
Diluted $ 0.75 $0.46 $1.66 $ 1.09
-9-
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 26 weeks ended
--------------------------- ---------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
------------- ------------ ------------ -------------
Stock options 1 4 1 4
============= ============ ============ =============
6) Cash and Short-Term Investments
-------------------------------
($ in millions) July 29, July 30, Jan. 28,
2006 2005 2006
------------------- ----------------- ---------------
Cash $ 133 $ 136 $ 109
Short-term investments 2,241 3,249 2,907
------------------- ----------------- ---------------
Total cash and short-term investments $ 2,374 $3,385 $3,016
=================== ================= ===============
Restricted Short-Term Investment Balances
Short-term investments include restricted balances of $56 million, $64 million
and $65 million as of July 29, 2006, July 30, 2005 and January 28, 2006,
respectively. Restricted balances are pledged as collateral for a portion of
casualty insurance program liabilities.
7) Supplemental Cash Flow Information
----------------------------------
($ in millions) 26 weeks ended
----------------------------------------
July 29, 2006 July 30, 2005
----------------- -----------------
Total interest paid $ 136 $ 177
Less: interest paid attributable to discontinued operations - 6
----------------- -----------------
Interest paid by continuing operations $ 136 $ 171(1)
================= =================
Interest received by continuing operations $ 73 $ 58
================= =================
Total income taxes paid $ 291 $ 126
Less: income taxes (received) attributable to discontinued
operations (9) (26)
----------------- -----------------
Income taxes paid by continuing operations $ 300 $ 152
================= =================
(1) Includes cash paid for bond premiums and commissions of $15 million.
-10-
8) Credit Agreement
----------------
On April 7, 2005, the Company, JCP and J. C. Penney Purchasing Corporation
entered into a five-year $1.2 billion unsecured revolving credit facility (2005
Credit Facility) with a syndicate of lenders with JPMorgan Chase Bank, N.A., as
administrative agent.
The 2005 Credit Facility includes a requirement that the Company maintain, as of
the last day of each fiscal quarter, a maximum ratio of Funded Indebtedness to
Consolidated EBITDA (Leverage Ratio, as defined in the 2005 Credit Facility), as
measured on a trailing four-quarters basis, of no more than 3.0 to 1.0.
Additionally, the 2005 Credit Facility requires that the Company maintain, for
each period of four consecutive fiscal quarters, a minimum ratio of Consolidated
EBITDA plus Consolidated Rent Expense to Consolidated Interest Expense plus
Consolidated Rent Expense (Fixed Charge Coverage Ratio, as defined in the 2005
Credit Facility) of at least 3.2 to 1.0. As of July 29, 2006, the Company was in
compliance with the requirements of both the Leverage Ratio at 1.7 to 1.0 and
the Fixed Charge Coverage Ratio at 6.1 to 1.0.
No borrowings, other than the issuance of standby and import letters of credit,
which totaled $138 million as of the end of the second quarter of 2006, have
been made under the 2005 Credit Facility.
9) Comprehensive Income and Accumulated Other Comprehensive Income
---------------------------------------------------------------
Comprehensive Income
($ in millions) 13 weeks ended 26 weeks ended
------------------------------- -------------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
-------------- -------------- --------------- --------------
Net income $ 179 $ 131 $ 389 $ 303
Other comprehensive income/(loss):
Net unrealized gains/(losses) in
real estate investment trusts 5 30 (1) 42
Reclassification adjustment for currency
translation loss included in discontinued
operations - 83 - 83
Other comprehensive income from
discontinued operations - 22 - 21
-------------- -------------- --------------- --------------
5 135 (1) 146
-------------- -------------- --------------- --------------
Total comprehensive income $ 184 $ 266 $ 388 $ 449
============== ============== =============== ==============
Accumulated Other Comprehensive Income
($ in millions) July 29, July 30, Jan. 28,
2006 2005 2006
----------------- ----------------- ---------------
Net unrealized gains in real estate investment trusts(1) $ 117 $ 116 $ 118
Nonqualified retirement plan minimum liability
adjustment(2) (102) (102) (102)
----------------- ----------------- ---------------
Accumulated other comprehensive income $ 15 $ 14 $ 16
================= ================= ===============
(1) Shown net of a deferred tax liability of $63 million, $63 million and $64
million as of July 29, 2006, July 30, 2005 and January 28, 2006, respectively.
(2) Shown net of a deferred tax asset of $65 million, $66 million and $65
million as of July 29, 2006, July 30, 2005 and January 28, 2006, respectively.
-11-
10) Stock-Based Compensation
------------------------
In May 2005, the Company's stockholders approved the J. C. Penney Company, Inc.
2005 Equity Compensation Plan (2005 Plan), which reserved an aggregate of 17.2
million shares of common stock for issuance to associates and non-employee
directors. The 2005 Plan replaced the Company's 2001 Equity Compensation Plan
(2001 Plan), and since June 1, 2005, all grants have been made under the 2005
Plan. The 2005 Plan provides for grants to associates of options to purchase the
Company's common stock, restricted and non-restricted stock awards (shares and
units) and stock appreciation rights. The 2005 Plan also provides for grants of
restricted and non-restricted stock awards (shares and units) and stock options
to non-employee members of the Board. As of July 29, 2006, 15.1 million shares
of stock were available for future grants.
Annual awards of stock options and restricted stock awards are granted according
to a pre-established calendar and typically vest over periods ranging from one
to three years. The number of option shares and awards is fixed at the grant
date, and the exercise price of stock options is set at the opening market price
of the Company's common stock on the date of grant. The 2005 Plan does not
permit awarding stock options below grant-date market value nor does it allow
any re-pricing subsequent to the date of grant. Options have a maximum term of
10 years. Over the past three years, the Company's annual stock option and
restricted stock award grants have averaged about 1.3% of total outstanding
stock. The Company issues new shares upon the exercise of stock options,
granting of restricted shares and vesting of restricted stock units.
Stock-Based Compensation Cost
($ in millions) 13 weeks ended 26 weeks ended
--------------------------- ----------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
------------ ------------- -------------- ------------
Stock awards (units and stock) (1) $ 10 $ - $ 12 $ 3
Stock options (2) 5 5 10 24
------------ ------------- -------------- ------------
Total stock-based compensation cost $ 15 $ 5 $ 22 $ 27
============ ============= ============== ============
Total income tax benefit recognized in the
Consolidated Statement of Operations for
stock-based compensation arrangements $ 6 $ 3 $ 8 $ 11
------------ ------------- -------------- ------------
(1) Stock award cost for 2006 reflects recognition of the March 2006
performance-based restricted stock awards over the service periods during
which each tranche of shares is earned.
(2) Stock option cost for the first half of 2005 reflected the early adoption
of SFAS No. 123R.
-12-
Stock Options
During the first half of 2006, the Company granted approximately 1.5 million
stock options to associates at an average option price of $60.51. As of July 29,
2006, options to purchase 9.5 million shares of common stock were outstanding.
If all options were exercised, common stock outstanding would increase by 4.2%.
Additional information regarding options outstanding as of July 29, 2006
follows:
(Shares in thousands; price is weighted-average exercise price)
Exercisable Unexercisable Total Outstanding
Shares % Price Shares % Price Shares % Price
------------------------------ ----------------------------- ---------------------------
In-the-money 4,522 84% $ 32 4,174 100% $ 48 8,696 91% $ 39
Out-of-the-money(1) 843 16% 71 6 0% 63 849 9% 71
------------------- --------------------- ------------------
Total options outstanding 5,365 100% $ 38 4,180 100% $ 48 9,545 100% $ 42
============================== ============================= ===========================
(1) Out- of- the-money options are those with an exercise price equal to or
above the closing price of $62.75 as of July 29, 2006.
As of July 29, 2006, unrecognized or unearned compensation expense for stock
options, net of estimated forfeitures, was $36 million, which will be recognized
as expense over the remaining vesting period, which has a weighted-average
period of approximately 1.2 years.
Stock Awards
The 2005 Plan also provides for grants of restricted and non-restricted stock
awards (shares and units) to associates and non-employee directors.
Associate Stock Awards
The following is a summary of the status of the Company's associate restricted
stock awards as of July 29, 2006 and activity during the six months then ended:
(shares in thousands) Weighted-Average
Stock Awards Grant Date Fair Value
-------------------- ----------------------
Nonvested at January 29, 2006 452 $ 39
Granted 415 61
Vested (51) 25
Forfeited (3) 34
--------------------
Nonvested at July 29, 2006 813 $ 51
====================
On March 22, 2006, the Company granted approximately 400,000 performance-based
restricted stock unit awards to associates. The performance unit grant is a
target award with a payout matrix ranging from 0% to 200% based on 2006 earnings
per share (defined as per common share income from continuing operations,
excluding any unusual and/or extraordinary items as determined by the Human
Resources and Compensation Committee of the Board). A payment of 100% of the
target award is achieved at planned earnings per share of $4.26. In addition to
the performance requirement, the award includes a time-based vesting
requirement, under which one-third of the earned performance unit award vests on
each of the first three anniversaries of the grant date provided that the
associate remains continuously employed with the Company during that time. Upon
vesting, the performance units are paid out in shares of JCPenney common stock.
-13-
As of July 29, 2006, there was $42 million of compensation cost not yet
recognized or earned. That cost is expected to be recognized over the remaining
vesting period, which has a weighted-average term of approximately 1.2 years.
Non-Employee Director Stock Awards
Restricted stock units granted to non-employee directors are expensed when
granted since the recipients have the right to receive the shares upon a
qualifying termination of service in accordance with the grant. During the
second quarters of 2006 and 2005, the Company granted 17,710 and 13,000 of such
restricted stock units, respectively. No such awards were granted in the first
quarters of 2006 or 2005.
11) Retirement Benefit Plans
------------------------
Net Periodic Benefit Cost/(Credit)
The components of net periodic benefit cost/(credit) for the qualified and
nonqualified pension plans and the postretirement plans for the 13 weeks ended
July 29, 2006 and July 30, 2005 are as follows:
Pension Plans
-------------------------------------------------------
Qualified Supplemental Postretirement
(Nonqualified) Plans
($ in millions) ------------------------------ --------------------------- -----------------------
13 weeks ended 13 weeks ended 13 weeks ended
------------------------------ --------------------------- -----------------------
July 29, July 30, July 29, July 30, July 29, July 30,
2006 2005 2006 2005 2006 2005
------------------------------ --------------------------- -----------------------
Service cost $ 23 $ 13 $ 1 $ - $ 1 $ -
Interest cost 53 28 5 2 - -
Expected return on plan assets (94) (46) - - - -
Net amortization 19 14 4 2 (8) (4)
------------------------------ --------------------------- -----------------------
Net periodic benefit cost/(credit) $ 1 $ 9 $ 10 $ 4 $ (7) $ (4)
============================== =========================== =======================
The components of net periodic benefit cost/(credit) for the qualified and
nonqualified pension plans and the postretirement plans for the 26 weeks ended
July 29, 2006 and July 30, 2005 are as follows:
Pension Plans
-------------------------------------------------------
Qualified Supplemental Postretirement
(Nonqualified) Plans
($ in millions) ------------------------------ --------------------------- -----------------------
26 weeks ended 26 weeks ended 26 weeks ended
------------------------------ --------------------------- -----------------------
July 29, July 30, July 29, July 30, July 29, July 30,
2006 2005 2006 2005 2006 2005
------------------------------ --------------------------- -----------------------
Service cost $ 47 $ 33 $ 1 $ 1 $ 1 $ 1
Interest cost 106 73 11 7 1 2
Expected return on plan assets (186) (119) - - - -
Net amortization 38 37 9 5 (15) (9)
------------------------------ --------------------------- -----------------------
Net periodic benefit cost/(credit) $ 5 $ 24 $ 21 $ 13 $ (13) $ (6)
============================== =========================== =======================
-14-
Employer Pension Contributions
The Company did not make a discretionary contribution to its qualified pension
plan in 2005 due to the plan's well-funded status and Internal Revenue Service
rules limiting tax deductible contributions. In 2006, the Company does not
expect to be required to make a contribution to its qualified pension plan. New
pension legislation was enacted in August 2006 that would allow the Company to
make additional discretionary contributions to the plan if so desired. Although
no discretionary contributions have been made to the qualified pension plan
during the first six months of 2006, the Company has factored into its plan a
discretionary contribution later in 2006. The actual decision to make a
contribution and the amount of any contribution in 2006 will consider factors
such as market conditions, the funded status of the plan, the level of free cash
flow and general economic trends.
Postretirement Medical Benefits
Effective June 7, 2005, the Company amended its medical plan to reduce the
Company-provided subsidy to post-age 65 retirees by 45% beginning January 1,
2006, and then fully eliminate the subsidy after December 31, 2006. This change
resulted in an incremental credit of approximately $6.5 million in fiscal 2005
and is expected to result in an additional $8 million incremental credit in
fiscal 2006 to postretirement medical plan expense, which is a component of
selling, general and administrative expenses.
Retirement Benefit Plan Changes
The Company provides retirement and other postretirement benefits to
substantially all employees (associates). Retirement benefits are an important
part of the Company's total compensation and benefits program designed to
attract and retain qualified and talented associates. The Company's retirement
benefit plans consist of a non-contributory qualified defined benefit pension
plan (pension plan), non-contributory supplemental retirement and deferred
compensation plans for certain management associates, a 1997 voluntary early
retirement program, a contributory medical and dental plan and a 401(k) and
employee stock ownership plan. These plans are discussed in more detail in the
Company's 2005 10-K. Associates hired or rehired on or after January 1, 2002 are
not eligible for retiree medical or dental coverage.
Effective January 1, 2007, the Company is implementing certain changes to its
retirement benefits. With respect to the 401(k) plan, all associates who have
attained age 21 will be immediately eligible to participate in the plan. All
eligible associates who have completed one year, and at least 1,000 hours, of
service will be offered a fixed Company matching contribution of 50 cents on
each dollar contributed up to 6% of pay. The Company may make an additional
discretionary matching contribution each fiscal year end. This fixed plus
discretionary match will replace the current Company contribution of an amount
equal to 4.5% of available profits plus discretionary contributions. The vesting
period for Company matching contributions under the 401(k) plan will be changed
to full vesting after three years from the current five-year pro rata vesting.
New associates hired on or after January 1, 2007 will not participate in the
Company's pension plan but will be eligible for a new retirement account. This
account will be a component of the defined contribution 401(k) plan that will
receive a Company contribution equal to 2% of participants' annual pay after one
year of service and will be fully vested after three years. Associates hired on
or prior to December 31, 2006 will remain in the Company's pension plan.
-15-
12) Real Estate and Other (Income)/Expense
--------------------------------------
($ in millions) 13 weeks ended 26 weeks ended
----------------------------- -----------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
-------------- ------------- -------------- ------------
Real estate operations $ (9) $ (8) $ (17) $ (17)
Net gains from sale of real estate (2) (8) (5) (22)
Asset impairments, PVOL and other unit
closing costs 2 2 2 3
Other - - (2) -
-------------- ------------- -------------- ------------
Total $ (9) $ (14) $ (22) $ (36)
============== ============= ============== ============
Real estate operations consist primarily of ongoing income from the Company's
real estate subsidiaries. In addition, net gains were recorded from the sale of
facilities and real estate that are no longer used in Company operations. Net
gains from the sale of real estate for 2006 were $2 million and $5 million for
the second quarter and first half, respectively and were primarily from the sale
of closed store locations. For the second quarter of 2005, net gains consisted
of $8 million related primarily to closed store locations, while gains for the
first half of 2005 also included the sale of a vacant merchandise processing
facility that became obsolete when the centralized network of store distribution
centers was put into place by mid-2003.
13) Guarantees
----------
As of July 29, 2006, JCP had guarantees totaling $43 million, which are
described in detail in the 2005 10-K. These guarantees consist of: $11 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 $12 million for
certain personal property leases assumed by the purchasers of Eckerd, which were
previously reported as operating leases.
14) Subsequent Event
----------------
Common Stock Repurchases
From July 30, 2006 through September 5, 2006, the Company repurchased an
additional 3.3 million shares of common stock at a cost of $220 million to
complete the $750 million common stock repurchase program. A total of 11.3
million shares were repurchased under the program.
-16-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion, which presents the results of J. C. Penney Company,
Inc. and its subsidiaries (the Company or JCPenney), should be read in
conjunction with the Company's consolidated financial statements as of January
28, 2006, and for the year then ended, and related Notes and Management's
Discussion and Analysis of Financial Condition and Results of Operations, all
contained in the Company's Annual Report on Form 10-K for the year ended January
28, 2006 (the 2005 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. Unless otherwise indicated, all references to earnings per share
(EPS) are on a diluted basis, and all references to years relate to fiscal years
rather than to calendar years.
Certain debt securities were issued by J. C. Penney Corporation, Inc. (JCP), the
wholly owned operating subsidiary of the Company. The 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 Company of certain of
JCP's outstanding debt securities is full and unconditional.
Key Items
---------
o EPS from continuing operations increased 63% to $0.75 in the second quarter
of 2006 from $0.46 in last year's second quarter. Income from continuing
operations on a dollar basis increased 46% to $178 million in the second
quarter of 2006, compared to $122 million last year. For the first half of
2006, income from continuing operations increased to $391 million, or $1.66
per share, compared to $293 million, or $1.09 per share, for the first half
of 2005. The results for the second quarter and first half included credits
related to income taxes of $26 million, or $0.11 per share, in 2006 and $5
million, or $0.02 per share, in 2005. In addition, EPS benefited from the
reduction in average shares outstanding as a result of the Company's
current common stock repurchase program.
o Net income per share increased to $0.76 in the second quarter of 2006,
compared to $0.50 in the comparable 2005 period. For the first half of
2006, net income per share increased to $1.65, compared to $1.13 in the
first half of 2005. Net income in the second quarter of 2006 reflected an
after-tax credit of $1 million, and the first half of 2006 reflected an
after-tax charge of $2 million, or $0.01 on a per share basis, related to
discontinued operations. Discontinued operations added $9 million and $10
million to net income for the second quarter and first half of 2005,
respectively, or $0.04 on a per share basis for each period.
-17-
o Operating profit increased 27.2% to $271 million, or 6.4% of sales, for the
second quarter of 2006, compared with $213 million, or 5.4% of sales, in
the same quarter last year, an improvement of 100 basis points as a percent
of sales. For the first half of 2006, operating profit was $640 million, or
7.6% of sales, compared with $521 million, or 6.4% of sales, in the first
half of 2005.
13 weeks ended 26 weeks ended
---------------------------- -----------------------------
($ in millions) July 29, July 30, July 29, July 30,
2006 2005 2006 2005
-------------- ------------ -------------- ------------
Gross margin $ 1,628 $1,516 $ 3,397 $3,210
Selling, general and administrative
(SG&A) expenses 1,357 1,303 2,757 2,689
-------------- ------------ -------------- ------------
Operating profit(1) $ 271 $ 213 $ 640 $ 521
============== ============ ============== ============
As a percent of sales 6.4% 5.4% 7.6% 6.4%
(1) See definition of operating profit on page 20.
o Comparable department store sales increased 6.6% for the second quarter of
2006, on top of a 4.2% increase in last year's second quarter. This
represented the thirteenth consecutive quarter of comparable department
store sales gains. Direct (Internet/catalog) sales increased 2.7% for the
second quarter of 2006, with the Internet channel increasing approximately
25%. In last year's second quarter, Direct sales increased 7.1%, with the
Internet channel increasing approximately 35%. For the first half of 2006,
comparable department store sales increased by 3.9% and Direct sales
increased 3.4%, with the Internet channel sales increasing approximately
23%.
o During the second quarter of 2006, the Company repurchased 8.0 million
shares of common stock for $530 million under the current $750 million
repurchase program authorized by the Board of Directors in February 2006.
The current program was completed on September 5, 2006.
o During the second quarter of 2006, the Company completed the rollout of its
new point-of-sale system. This new system reduces transaction time and
provides connectivity to jcp.com for each of the approximately 35,000
point-of-sale registers located in its department stores.
o During the second quarter of 2006, the Company announced the appointment of
Catherine G. West as Chief Operating Officer. On joining the Company on
July 31, Ms. West became a member of the Executive Board, reporting to
Myron E.Ullman, III, Chairman and Chief Executive Officer. Ms. West's
responsibilities include Stores, Supply Chain and Property Development.
Discontinued Operations
-----------------------
Discontinued operations reflected a credit of $0.01 per share in the second
quarter of 2006 and a charge of $0.01 per share in the first half of 2006
related to management's ongoing review and true-up of Eckerd reserves. During
the second quarter and first half of 2005, discontinued operations added $0.04
per share to net income, principally related to adjustments associated with the
2004 sale of Eckerd and international operations, including operating income for
Lojas Renner S.A., the Company's Brazilian department store chain, to the date
of sale offset by the transaction loss. These are discussed in more detail on
the following page.
-18-
Lojas Renner S.A.
In July 2005, the Company's indirect wholly owned subsidiary, J. C. Penney
Brazil, Inc., closed on the sale of its shares of Renner, a Brazilian department
store chain, through a public stock offering registered in Brazil. The Company
received net cash proceeds of approximately $260 million from the sale of its
interest in Renner. Proceeds from the sale were used for common stock
repurchases, which are more fully discussed under 2005 and 2004 Equity and Debt
Reduction Programs on page 28. The sale resulted in a cumulative pre-tax gain of
$26 million and a loss of $7 million on an after-tax basis. For all periods
presented, Renner's results of operations and financial position have been
reclassified and reflected as a discontinued operation.
Eckerd Drugstores
Related to the sale of its Eckerd drugstore operations, the Company recorded a
$1 million after-tax credit during the second quarter of 2006 and a $2 million
after-tax charge during the first half of 2006. The activity was primarily
related to taxes payable resulting from a state sales tax audit. Through the
first half of 2006, the cumulative loss on the Eckerd sale was $717 million
pre-tax, or $1,332 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.
The net cash proceeds of approximately $3.5 billion from the Eckerd sale, which
closed in the second quarter of 2004, were used for common stock repurchases and
debt reduction, which are more fully discussed under 2005 and 2004 Equity and
Debt Reduction Programs on page 28.
Upon closing of the Eckerd sale, the Company established reserves for estimated
transaction costs and post-closing adjustments. Certain of these reserves
involved significant judgment, and actual costs incurred over time could vary
from these estimates. The more significant remaining estimates relate to the
costs to exit the Colorado and New Mexico markets and environmental
indemnifications. Management continues to review and update the remaining
reserves on a quarterly basis and believes that the overall reserves, as
adjusted, are adequate as of July 29, 2006 and consistent with original
estimates. Cash payments for the Eckerd-related reserves are included in the
Company's Consolidated Statements of Cash Flows as Cash Paid for Discontinued
Operations, with tax payments included in operating cash flows and all other
payments, if applicable, included in investing cash flows.
-19-
Results of Operations
---------------------
The following discussion and analysis, consistent with all other financial data
throughout this report, focuses on the results of operations and financial
condition from the Company's continuing operations.
($ in millions, except EPS) 13 weeks ended 26 weeks ended
------------------------------- ------------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
-------------- --------------- --------------- --------------
Retail sales, net $ 4,238 $ 3,981 $ 8,458 $ 8,099
-------------- --------------- --------------- --------------
Gross margin 1,628 1,516 3,397 3,210
SG&A expenses 1,357 1,303 2,757 2,689
-------------- --------------- --------------- --------------
Operating profit(1) 271 213 640 521
Net interest expense 32 40 66 89
Bond premiums and unamortized costs - 5 - 18
Real estate and other (income) (9) (14) (22) (36)
-------------- --------------- --------------- --------------
Income from continuing operations
before income taxes 248 182 596 450
Income tax expense 70 60 205 157
-------------- --------------- --------------- --------------
Income from continuing operations $ 178 $ 122 $ 391 $ 293
============== =============== =============== ==============
Diluted EPS from continuing operations $ 0.75 $ 0.46 $ 1.66 $ 1.09
Ratios as a percent of sales:
Gross margin 38.4% 38.1% 40.2% 39.6%
SG&A expenses 32.0% 32.7% 32.6% 33.2%
Operating profit(1) 6.4% 5.4% 7.6% 6.4%
Depreciation and amortization included
in operating profit $ 88 $ 88 $ 176 $ 175
(1) ) Operating profit (gross margin less SG&A expenses), is a non-GAAP
(Generally Accepted Accounting Principles) measure, which is the key measurement
used by management to evaluate the financial performance of retail operations.
Operating profit excludes Net Interest Expense, Bond Premiums and Unamortized
Costs and Real Estate and Other. Real estate operations, gains and losses on the
sale of real estate properties, asset impairments and other unit closing costs
and other corporate charges are evaluated separately from operations and are
recorded in Real Estate and Other in the Consolidated Statements of Operations.
The Company delivered a record performance during the second quarter of 2006
with income from continuing operations of $178 million, or $0.75 per share,
compared to $122 million, or $0.46 per share, for the comparable 2005 period.
Income from continuing operations for the first half of 2006 increased to $391
million, or $1.66 per share, compared to $293 million, or $1.09 per share, for
the first half of 2005. The increase over 2005 reflects improved operating
profit, driven by strong sales performance, improved gross margin and leverage
of selling, general and administrative expenses, combined with lower net
interest expense. The results for the second quarter and first half included a
credit related to income taxes of $26 million in 2006 and $5 million in 2005.
Earnings per share for the second quarter and first half of 2006 also benefited
from the reduction in average shares outstanding compared to the prior year as
the result of the Company's current common stock repurchase program. The Company
currently expects 2006 third quarter, fourth quarter and full year EPS from
continuing operations to be approximately $1.07, $1.84 and $4.55, respectively.
-20-
Retail Sales, Net
($ in millions)
13 weeks ended 26 weeks ended
------------------------------------ ---------------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
------------------- -------------- --------------- ----------------
Retail sales, net $ 4,238 $ 3,981 $ 8,458 $ 8,099
------------------- -------------- --------------- ----------------
Sales percent increase:
Comparable department stores(1) 6.6% 4.2% 3.9% 3.5%
Total department stores 7.1% 5.1% 4.6% 4.2%
Direct (Internet/catalog) 2.7% 7.1% 3.4% 6.2%
(1) Comparable department store sales include sales of stores after having been
open for 12 full consecutive fiscal months. New and relocated stores, and the
reopened stores impacted by the 2005 hurricanes, become comparable on the first
day of the 13th full fiscal month of operation.
Comparable department store sales increased 6.6% for the second quarter of 2006,
and total department store sales increased 7.1%. These increases were on top of
second quarter 2005 increases of 4.2% for comparable department store sales and
5.1% for total department store sales. For the first half of 2006, comparable
store sales increased 3.9%, while total department store sales increased 4.6%.
For the second quarter and year-to-date 2006, both fashion and basic merchandise
have experienced sales gains, and the Company's key private brands continue to
perform well. Department store sales have continued to benefit from positive
customer response to the style, quality, selection and value offered in the
Company's merchandise assortments, compelling marketing programs and continued
improvement in the store shopping experience. Second quarter and year-to-date
sales reflect improvements in all merchandise divisions, led by fine jewelry,
children's apparel, family footwear and women's accessories. In addition, all
apparel lines, particularly women's, improved throughout the quarter with
positive response to new product offerings, such as a.n.a(TM), a modern casual
women's apparel line. From a regional perspective, for the second quarter of
2006, sales increased in all regions of the country, with the strongest
performance in the west and southeast.
Direct sales, which offer customers multi-channel convenience and a broader
merchandise selection complementing that carried in the Company's department
stores, increased 2.7% in the second quarter of 2006, on top of a 7.1% increase
in last year's second quarter. Direct sales continue to reflect a focus on
targeted specialty media and the expanded assortments and convenience of the
Internet. The Direct channel represented approximately 14% and 15% of total net
retail sales in the second quarters of 2006 and 2005, respectively. Consistent
with customer shopping patterns, the Company continually reviews its catalog
page counts and circulation to ensure that print catalogs remain productive,
while planning for a gradual shift toward a higher level of shopping via the
Internet. The Internet channel continues to experience strong sales growth,
increasing approximately 25% in the current quarter, on top of an approximately
35% increase in last year's second quarter. Internet sales represented
approximately 41% of total Direct sales for the second quarter of 2006, up from
approximately 34% in last year's second quarter. For the first half of 2006,
Direct sales increased 3.4%, with the Internet component increasing
approximately 23%.
The Company has implemented lifestyle merchandising that reflects its customers'
style preferences - conservative, traditional, modern and trendy - making
JCPenney more relevant to an expanded customer base. The Company will continue
to enhance its strong private, exclusive and national brands that develop
customer loyalty by focusing its merchandise more closely on each of the
customer lifestyles. Additional resources are being focused on the Company's
branding efforts to ensure consistency in product design, packaging, in-store
presentation, lifestyle marketing and point-of-sale support. The brands launched
in early 2006 and in 2005 support these merchandising initiatives.
-21-
The Company continues to emphasize the introduction of new brands that fit
within the lifestyle matrix. During the 2006 Back-To-School season, the Company
is launching X-Games boys' apparel as an exclusive line in over 600 JCPenney
department stores and Stevies by Steve Madden(TM) in girls' apparel. This
follows other recent launches such as Vans for the young surf and skate
customer, Solitude(R) by Shaun Tomson, a California lifestyle-inspired men's
apparel brand, Rule by Steve Madden(TM) in family footwear, and an expanded
assortment of bedding and accessories for student dorm rooms. The Company has
seen continued strength in the Miss Bisou(R) clothing collection for juniors, an
extension of the Bisou Bisou(R) women's sportswear line, and Studio by the
JCPenney Home Collection(TM), a modern furniture collection. Also in 2006, the
Company added the Chris Madden(R) Hotel Collection, which features silk-blend
comforters and 600 thread count sheets. Management is pleased with customer
response and sales results for the Company's new and expanded merchandise
launches.
Complementing the new product offerings, the Company launched an integrated
marketing campaign during the 2006 Back-To-School season to strengthen the
branding and messaging efforts with its target customers. In August 2006,
JCPenney was the exclusive retail sponsor of both the Teen Choice Awards and the
MTV Video Music Awards. Also in August, "JCPenney JAM - The Concert for
America's Kids," which benefited the JCPenney Afterschool Fund, aired in
primetime on CBS.
The Company continues to make progress on its joint initiative with Sephora
U.S.A., Inc. (Sephora), under which JCPenney will sell Sephora products in its
stores and through the Internet. Sephora products will be the exclusive beauty
offering at JCPenney, beginning in a limited number of stores in fall 2006. The
Sephora departments in JCPenney stores will feature top brands from makeup,
skincare, fragrance and accessory products carried in Sephora's stores across
the United States. Beginning August 3, 2006, Sephora began exclusively servicing
JCPenney customers' online beauty needs through a link to www.sephora.com from
www.jcp.com. ---------------
------------
For the third and fourth quarters of 2006 (excluding the 53rd week), comparable
store sales are expected to increase low single digits. Direct sales are
expected to increase low single digits in the third quarter and mid single
digits in the fourth quarter due to the 53rd week in 2006.
Gross Margin
Gross margin improved 30 basis points as a percent of sales in this year's
second quarter to $1,628 million, compared to $1,516 million in the comparable
2005 period. Through the first half of 2006, gross margin was $3,397 million,
compared to $3,210 million in the prior year first half, an increase of 60 basis
points as a percent of sales. The continued improvement in gross margin reflects
strength in the performance of the Company's private brands, the increased
effectiveness of planning and allocation technology resulting in better product
flow and a larger contribution to sales from higher margin merchandise
divisions.
SG&A Expenses
SG&A expenses were $1,357 million in the second quarter of 2006 compared to
$1,303 million in the second quarter of 2005, and continue to be well leveraged,
improving by 70 basis points in the second quarter of 2006 to 32.0% of sales.
Improvements in the expense ratios reflected leverage of salary and marketing
costs against higher sales. On a year-to-date basis, SG&A expenses were $2,757
million in 2006 compared to $2,689 million in 2005, an improvement of 60 basis
points as a percent of sales. These year-to-date improvements reflect leverage
of salary and logistics costs, which were partially offset by higher marketing
costs, including costs related to the launch of the Company's new branding
campaign in March.
Operating Profit
Operating profit improved 27.2% or 100 basis points as a percent of sales, for
the second quarter of 2006 to $271 million, or 6.4% of sales, compared to $213
million, or 5.4% of sales, for the comparable period last year. On a
year-to-date basis, operating profit increased approximately 23% to $640
million, or 7.6% of
-22-
sales, compared to $521 million, or 6.4% of sales, for the comparable period
last year. Operating profit improvements were driven by sales gains, as well as
continued improvements in gross margin and expense leverage. Operating profit
(gross margin less SG&A expenses), a non-GAAP measure, is the key measurement on
which management evaluates the financial performance of the retail operations.
For the third and fourth quarter of 2006, the Company expects moderate
improvements in operating profit over last year, primarily as a result of SG&A
expense leverage.
Net Interest Expense
Net interest expense was $32 million and $40 million for the second quarters of
2006 and 2005, respectively. On a year-to-date basis, net interest expense was
$66 million in 2006, compared to $89 million in 2005. Net interest expense
consists primarily of interest expense on long-term debt, net of interest income
earned on cash and short-term investments. Net interest expense in the second
quarter and first half of 2006 benefited from higher short-term interest rates
on cash and short-term investment balances, as well as the reduction in average
long-term debt. The Company expects net interest expense to be approximately $40
million in both the third and fourth quarters of 2006 reflecting both seasonal
needs and completion of the current share repurchase program.
Bond Premiums and Unamortized Costs
No bond premiums, commissions or unamortized costs were incurred during the
first half of 2006. During the second quarter of 2005, the Company incurred $5
million of bond premiums, commissions and unamortized costs related to the
purchase of debt in the open market under its debt reduction program, which is
discussed on page 28. For the first half of 2005, such costs totaled $18
million.
Real Estate and Other (Income)
Real Estate and Other (Income) consists of ongoing real estate operations, gains
and losses on the sale of real estate properties, asset impairments, charges
associated with unit closings and catalog facilities and other non-operating
items. Real Estate and Other for the second quarter of 2006 consisted primarily
of $9 million of income from ongoing real estate operations with $2 million of
gains on the sale of closed units, which were offset by $2 million of costs
related to asset impairments, the present value of operating lease obligations
(PVOL) and other unit closing costs. On a year-to-date basis, Real Estate and
Other was a credit of $22 million, which consisted of $17 million of income for
ongoing real estate operations, a $2 million credit related to other corporate
items and $5 million of gains on the sale of closed units, which were partially
offset by $2 million of costs related to asset impairments, PVOL and other unit
closing costs.
Real Estate and Other for the second quarter of 2005 was a credit of $14
million, which consisted of $8 million of income from ongoing real estate
operations and $8 million of gains on the sale of closed units, which were
partially offset by $2 million of costs related to asset impairments, PVOL and
other unit closing costs. For the first half of 2005, Real Estate and Other was
a credit of $36 million, which consisted of $17 million of income from ongoing
real estate operations, $22 million of gains on the sale of closed units,
primarily a vacant merchandise processing facility and $3 million of costs
related to asset impairments, PVOL and other unit closing costs.
Income Taxes
The Company's effective income tax rate for continuing operations was 28.2% for
the second quarter of 2006, compared with 33% for the second quarter of 2005.
For the first half of 2006, the Company's effective income tax rate for
continuing operations was 34.4%, compared with 34.9% for the first half of 2005.
The effective tax rate decreased due to the release of $26 million of federal
income tax reserves due primarily to the expiration of the statute of
limitations on prior years. Management expects a more normalized tax rate of
approximately 38.5% in the third and fourth quarters, resulting in an effective
tax rate for the full year 2006 of approximately 37%.
-23-
Merchandise Inventory
---------------------
Merchandise inventory was relatively flat at $3,461 million as of July 29, 2006,
compared to $3,445 million at July 30, 2005. Merchandise inventory was $3,210
million at January 28, 2006. Inventory at the end of the second quarter of 2006
was in line with plan, reflecting a good balance between fashion and basic
merchandise, with less seasonal clearance than last year. A modest increase in
inventory is planned in the third quarter 2006 to correlate with the planned
openings of 25 new stores. With new systems and its network of store
distribution centers, the Company has continued to enhance its ability to
allocate and flow merchandise to stores in-season by recognizing sales trends
earlier and adjusting receipts, replenishing individual stores based on rates of
sale and consistently providing high in-stock levels in basics and advertised
items. This continued improvement of inventory management has helped to drive
more profitable sales. With the elimination of global trade quotas on apparel
and textiles, the Company expects to concentrate production of private brand
merchandise in fewer countries and with fewer manufacturers. On an ongoing
basis, the Company develops contingency plans to provide for alternate sources
for product in order to ensure uninterrupted access to merchandise. Cost
reductions will allow the Company to invest in higher quality merchandise and
thereby improve the value proposition to the Company's target customer.
Financial Goals
---------------
The Company's financial strategy will continue to focus on opportunities to
deliver value to stockholders, strengthen the Company's financial position and
improve its credit profile. In order for the Company to achieve its objective of
becoming a leader in performance and execution, long-range planning targets have
been established related to operating financial goals, key financial metrics,
cash flow, credit ratings, dividends and earnings per share growth. As announced
at the April 2006 Analyst Meeting, the Company's long range plan includes
certain financial targets, strategic store growth and private brand initiatives
and programs such as the $750 million common stock repurchase program for 2006
and a competitive dividend, including the recent increase in quarterly dividends
from $0.125 per share to $0.18 per share, beginning with the May 1, 2006
quarterly dividend. Financial targets include comparable department store sales
increases in the low single digits, Direct sales increases in the low to mid
single digits, gross margin approximating 40% of sales, SG&A expenses under 30%
of sales, an operating profit margin of 10% to 10.5% of sales by 2009 and annual
EPS growth of approximately 16% over the 2006 to 2009 period. The Company's
progress toward achieving its operating financial goals could be impacted by
various risks, which are discussed in the Company's 2005 10-K.
Liquidity and Capital Resources
-------------------------------
The Company ended the second quarter with approximately $2.4 billion in cash and
short-term investments, which represented approximately 69% of the $3.5 billion
of outstanding long-term debt, including current maturities. Cash and short-term
investments included restricted short-term investment balances of $56 million as
of July 29, 2006, which are pledged as collateral for a portion of the casualty
insurance program liabilities. From July 30, 2006 to September 5, 2006, the
Company used $220 million of cash and short-term investments to complete the
current $750 million common stock repurchase program. The Company's next
scheduled long-term debt maturity is in April 2007 and approximates $325
million.
The Company, JCP and J. C. Penney Purchasing Corporation are parties to a
five-year $1.2 billion unsecured revolving credit facility (2005 Credit
Facility) with a syndicate of lenders with JPMorgan Chase Bank, N.A., as
administrative agent. The 2005 Credit Facility includes a requirement that the
Company maintain, as of the last day of each fiscal quarter, a maximum ratio of
Funded Indebtedness to
-24-
Consolidated EBITDA (Leverage Ratio, as defined in the 2005 Credit Facility), as
measured on a trailing four-quarters basis, of no more than 3.0 to 1.0.
Additionally, the 2005 Credit Facility requires that the Company maintain, for
each period of four consecutive fiscal quarters, a minimum ratio of Consolidated
EBITDA plus Consolidated Rent Expense to Consolidated Interest Expense plus
Consolidated Rent Expense (Fixed Charge Coverage Ratio, as defined in the 2005
Credit Facility) of at least 3.2 to 1.0. As of July 29, 2006, the Company's
Leverage Ratio was 1.7 to 1.0, and its Fixed Charge Coverage Ratio was 6.1 to
1.0, both in compliance with the requirements.
Cash Flows
The following is a summary of the Company's cash flows from operating, investing
and financing activities:
($ in millions)
26 weeks ended
------------------------------
July 29, July 30,
2006 2005
------------ -------------
Net cash provided by/ (used in):
Operating activities $ 179 $ 213
Investing activities (312) 77
Financing activities (483) (1,395)
Cash (paid) for discontinued operations(1) (26) (159)
------------ -------------
Net (decrease) in cash and short-term investments $ (642) $ (1,264)
============ =============
(1) See the Company's Consolidated Statements of Cash Flows on page 4 for a
breakdown of cash (paid) for discontinued operations among operating, investing
and financing activities.
Cash Flow from Operating Activities
While cash flows from operating activities were positively impacted in the first
half of 2006 by improved operating performance and timing differences related to
inventory purchases, operating cash flows were reduced by higher income tax
payments and higher cash contributions to the Company's 401(k) savings plan.
Cash Flow from Investing Activities
Capital expenditures were $323 million for the first half of 2006, compared with
$233 million for the first half of 2005. Capital spending was principally for
new stores, store renewals and modernizations and new point-of-sale technology.
The Company completed the implementation of the new point-of-sale technology in
all of its stores during the second quarter of 2006. Management continues to
expect total capital expenditures for the full year to be in the area of $800
million.
In the first half of 2006, the Company opened three new stores, including one
relocation. Twenty-five new store openings, including 9 relocations, are planned
for the third quarter of 2006. As announced in April, the Company expects to
accelerate its store growth with plans to open 50 stores annually during 2007 to
2009, representing annual square footage growth of approximately 3%. New stores
will be primarily in the off-mall format. Combined with planned new store
openings for 2006, this would result in over 175 new stores by 2009.
Proceeds from the sale of closed units were $11 million for the first half of
2006, compared with $27 million for the first half of 2005.
In the second quarter of 2005, cash proceeds of $283 million were received from
the sale of the Company's interest in Renner, a Brazilian department store
chain.
-25-
Cash Flow from Financing Activities
For the first half of 2006, cash payments for long-term debt, including capital
leases, totaled $7 million. During the first half of 2005, such payments totaled
$466 million and also included premiums and commissions paid by the Company
related to its debt reduction program, which is discussed on page 28.
During the first half of 2006, the Company repurchased 8.0 million shares of
common stock for $530 million, $14 million of which was settled subsequent to
the end of the second quarter. During the first half of 2005, the Company
repurchased 20.2 million shares of common stock for $1,026 million, $59 million
of which was settled subsequent to the end of the second quarter. In addition,
$51 million of cash was paid during the first quarter of 2005 for settlement of
2004 share repurchases. Common stock is retired on the same day it is
repurchased, and the related cash settlements are completed on the third
business day following the repurchase.
Proceeds from the exercise of stock options were $78 million and $118 million
for the first half of 2006 and 2005, respectively.
Excess tax benefits from stock options exercised were $33 million and $40
million for the first half of 2006 and 2005, respectively.
As authorized by the Board of Directors (Board), the Company paid quarterly
dividends of $0.18 per share of common stock, or $42 million in total, on May 1,
2006 and $0.125 per share of common stock, or $29 million in total, on February
1, 2006. For the first half of 2005, the Company paid quarterly dividends of
$0.125 per share of common stock on May 2, 2005 and February 1, 2005, or $34
million and $35 million in total, respectively. Dividends are paid to
stockholders of record as of the 10th day of the month preceding the dividend
payment date, or the immediately preceding business day if the 10th falls on a
Saturday or Sunday. Dividends are paid when, as and if declared by the Board.
For the remainder of 2006, management believes that cash flow generated from
operations, combined with existing cash and short-term investments will be
adequate to execute the remainder of the $750 million common stock repurchase
program and fund capital expenditures, working capital and dividend payments,
and, therefore, no external funding will be required. While at the present time,
management does not expect to access the capital markets for any external
financing for the remainder of 2006, it may 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.
Based on improvements in the capital structure, the Company's related liquidity
and coverage metrics, the Company's improved operating performance and
generation of free cash flow, both Standard & Poor's Ratings Services and
Moody's Investors Service, Inc. raised the Company's credit ratings to
investment grade during the first quarter of 2006. In April 2006, Standard &
Poor's raised its credit rating on the Company's long-term corporate credit and
senior unsecured debt from BB+ to an investment grade rating of BBB-, and in
February 2006, Moody's raised its corporate family debt rating, as well as its
senior unsecured credit rating for the Company, from Ba1 to an investment grade
rating of Baa3. In October 2005, Fitch Ratings raised its credit rating on the
Company's senior unsecured notes and debentures and its $1.2 billion 2005 Credit
Facility from BB+ to BBB-, an investment grade credit rating. As of the end of
the second quarter of 2006, all three credit rating agencies have an outlook of
"Stable" on the Company's credit ratings.
Additional liquidity strengths include the 2005 Credit Facility discussed
previously. No borrowings, other than the issuance of trade and standby letters
of credit, which totaled $138 million as of the end of the second quarter of
2006, have been, or are expected to be, made under this facility.
-26-
Free Cash Flow from Continuing Operations
($ in millions) 26 weeks ended
-------------------------------------
July 29, July 30,
2006 2005
---------------- -----------------
Net cash provided by operating activities (GAAP) $ 179 $ 213
Less:
Capital expenditures (323) (233)
Dividends paid (71) (69)
Plus:
Proceeds from sale of assets 11 27
---------------- -----------------
Free cash flow from continuing operations (non-GAAP measure) $ (204) $ (62)
================ =================
In addition to cash flow from operating activities, management evaluates free
cash flow from continuing operations, an important financial measure that is
widely used by investors, the rating agencies and banks. Free cash flow from
continuing operations is defined as cash provided by operating activities less
dividends and capital expenditures, net of proceeds from the sale of assets. The
Company's calculation of free cash flow may differ from that used by other
companies, and therefore, comparability may be limited. While free cash flow is
a non-GAAP financial measure, it is derived from components of the Company's
consolidated GAAP cash flow statement.
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. Positive free
cash flow generated by a company indicates the amount of cash available for
reinvestment in the business or cash that can be returned to investors through
increased dividends, stock repurchase programs, debt retirements or a
combination of these. Conversely, negative free cash flow indicates the amount
of cash that must be raised from investors through new debt or equity issues,
reduction in available cash balances or a combination of these. Based on the
seasonality of the Company's business, cumulative free cash flow is generally
negative the first three quarters of the year and becomes positive in the fourth
quarter.
For the first half of 2006, free cash flow from continuing operations was in
line with management's expectations, reflecting a deficit of $204 million,
compared to a deficit of $62 million for the comparable 2005 period. The
decrease in free cash flow was due to higher payments related to income taxes,
higher cash contributions to the Company's 401(k) savings plan and the planned
increase in capital expenditures. The Company continues to track toward its plan
to generate approximately $200 million of positive free cash flow for the full
year of 2006. Such plan takes into account a potential $300 million pre-tax
voluntary qualified pension plan contribution. The actual decision to make a
contribution and amount of any such contribution in 2006 is subject to market
conditions, the funded status of the plan, the level of free cash flow and
general economic trends. New pension legislation was enacted in August 2006 that
provides the Company enhanced flexibility to consider additional discretionary
pension contributions in 2006 and beyond.
-27-
2006 Common Stock Repurchase Program
------------------------------------
In February 2006, the Board authorized a common stock repurchase program of $750
million, which is being funded with 2005 free cash flow and cash proceeds from
the exercise of employee stock options. During the second quarter of 2006, the
Company repurchased 8.0 million shares of common stock for $530 million. The
current repurchase program was completed on September 5, 2006.
Common Stock Outstanding
During the first half of 2006, the number of outstanding shares of common stock
changed as follows:
Outstanding
(in millions) Common Shares
------------------------
Balance as of January 28, 2006 233
Exercise of stock options 2
Common stock repurchased and retired (8)
------------------------
Balance as of July 29, 2006 227
========================
2005 and 2004 Equity and Debt Reduction Programs
------------------------------------------------
Common Stock Repurchases
The Company repurchased 12.5 million shares of common stock at a cost of $666
million during the second quarter of 2005 and 20.2 million shares of common
stock at a cost of $1,026 million during the first half of 2005.
Under the Company's 2005 and 2004 common stock repurchase programs, which were
completed in the fourth quarter of 2005, a total of 94.3 million shares were
repurchased at a cost of $4.15 billion. Common stock was retired on the same day
it was repurchased, with the excess of the purchase price over the par value
being allocated between Reinvested Earnings and Additional Paid-In Capital.
Debt Reduction
The Company's 2005 and 2004 debt reduction programs, which were completed by the
end of the second quarter of 2005, consisted of approximately $2.14 billion of
debt retirements. The 2005 debt retirements included $194 million and $56
million of open-market debt repurchases in the first and second quarters of
2005, respectively and the payment of $193 million of long-term debt at the
scheduled maturity date in May 2005. The Company incurred pre-tax charges of $18
million in 2005 related to early debt retirements ($13 million and $5 million
respectively, in the first and second quarters).
Accounting for Stock-Based Compensation
---------------------------------------
The Company has a stock-based compensation plan that provides for grants to
associates and non-employee directors of the Company of stock awards (restricted
or unrestricted stock or units), stock appreciation rights or options to
purchase the Company's common stock. Annual stock options and restricted stock
awards are granted according to a pre-established calendar. The number of
options and awards is fixed at the grant date, and the exercise price of stock
options is set at the opening market price of the Company's common stock on the
date of grant. Effective January 30, 2005, the Company adopted Statement of
Financial Accounting Standards No. 123 (revised), "Share-Based Payment" (SFAS
No. 123R), which requires the use of the fair value method of accounting for all
stock-based compensation, including stock options. The statement was adopted
using the modified prospective method of application. Under this method, in
addition to reflecting compensation expense for new share-based awards, expense
is also recognized to reflect the remaining vesting period of awards that had
been included in pro-forma disclosures in prior periods. The Company
-28-
did not adjust prior year financial statements under the optional modified
retrospective method of application.
Prior to fiscal year 2005, the Company used the Black-Scholes option pricing
model to estimate the grant date fair value of stock option awards. For grants
subsequent to the adoption of SFAS No. 123R, the Company estimates the fair
value of stock option awards on the date of grant using a binomial lattice model
developed by outside consultants who worked with the Company in the
implementation of SFAS No. 123R. The Company believes that the binomial lattice
model is a more accurate model for valuing employee stock options since it
better reflects the impact of stock price changes on option exercise behavior.
Stock-Based Compensation Cost
($ in millions) 13 weeks ended 26 weeks ended
--------------------------- ----------------------------
July 29, July 30, July 29, July 30,
2006 2005 2006 2005
------------ ------------- -------------- ------------
Stock awards (units and stock) (1) $ 10 $ - $ 12 $ 3
Stock options (2) 5 5 10 24
------------ ------------- -------------- ------------
Total stock-based compensation cost $ 15 $ 5 $ 22 $ 27
============ ============= ============== ============
Total income tax benefit recognized in the
Consolidated Statement of Operations for
stock-based compensation arrangements $ 6 $ 3 $ 8 $ 11
------------ ------------- -------------- ------------
(1) Stock award cost for 2006 reflects recognition of the March 2006
performance-based restricted stock awards over the service periods during which
each tranche of shares is earned.
(2) Stock option cost for the first half of 2005 reflected the early adoption of
SFAS No. 123R.
As of July 29, 2006, there was $36 million and $42 million of compensation cost
not yet recognized or earned related to stock options and associate restricted
stock (share and unit) awards, respectively. These expenses related to stock
options and associate restricted stock (share and unit) awards are expected to
be recognized as earned over a weighted-average period of 1.2 years.
Retirement and Medical Benefit Plans
------------------------------------
As part of the Company's long range plan, a project was initiated to review the
Company's employee benefit programs, including the pension, savings and medical
plans. The overarching goal was to provide competitive benefits that are cost
effective for both the Company and its associates, while achieving one of the
key strategies of making JCPenney a great place to work. As a result of this
review, in April 2006, the Company's Board of Directors approved several benefit
plan changes. These changes include replacing the current Company matching
contribution of 4.5% of available profits with a fixed Company matching
contribution of 50 cents on each dollar contributed up to 6% of pay to the
Company's 401(k) defined contribution plan. The Company will retain the
flexibility to make an additional discretionary matching contribution each
fiscal year end. In addition, the Company will establish a new retirement
account, within the savings plan, for new associates in lieu of participation in
the Company's existing defined benefit pension plan (pension plan), which will
remain in place for associates hired on or prior to December 31, 2006. Finally,
medical benefits for active associates will be modified to increase the
percentage of costs borne by the Company. These benefit plan changes were
communicated to associates in May 2006 and will be effective beginning in 2007.
See further discussion in Note 11.
-29-
These benefit plan changes will not have an impact on fiscal year 2006
retirement benefit and medical plan expenses. Going forward, the aggregate
impact is not expected to have a material impact on the Company's financial
condition, liquidity, or results of operations.
As reported in the Company's 2005 10-K, the Company's existing pension plan
remains well funded with the fair value of assets exceeding the projected
benefit obligation by $518 million as of year-end 2005. While well funded, the
Company's pension plan is subject to the impact of market and interest rate
volatility.
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 assets; 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. For a further
discussion of the judgments management makes in applying its accounting
policies, see Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, in the 2005 10-K.
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 2006, the Audit Committee of the Board approved
estimated fees for the remainder of 2006 related to the performance of both
audit, including Sarbanes-Oxley Section 404 attestation work, as well as
allowable non-audit services by the Company's external auditors, KPMG LLP.
Seasonality
-------------
The results of operations and cash flows for the 13 and 26 weeks ended July 29,
2006 are not necessarily indicative of the results for the entire year. The
Company's annual earnings depend to a great extent on the results of operations
for the last quarter of its fiscal year when a significant portion of the
Company's sales and profits are recorded.
-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. The Company's market risks related to interest rates
at July 29, 2006 are similar to those disclosed in the 2005 10-K.
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 were
no changes in the Company's internal control over financial reporting during the
Company's second quarter ended July 29, 2006 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, which reflect the Company's
current view of future events and financial performance. The words expect, plan,
anticipate, believe, intent, should, will and similar expressions identify
forward-looking statements. Any such forward-looking statements are subject to
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, including the price and availability of oil
and natural gas, changes in interest rates, changes in management, retail
industry consolidations, government activity and acts of terrorism or war.
Please refer to the Company's 2005 Annual Report on Form 10-K and subsequent
filings for a further discussion of risks and uncertainties. The Company intends
the forward-looking statements in this Quarterly Report on Form 10-Q to speak
only at the time of its filing and does not undertake to update or revise these
forward-looking statements as more information becomes available.
-31-
PART II - OTHER INFORMATION
Item 1A. Risk Factors.
There have been no material changes to the risk factors set forth under Part I,
Item 1A of the 2005 Form 10-K and Part II, Item 1A of the Company's Quarterly
Report on Form 10-Q for the period ended April 29, 2006.
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 July 29, 2006:
Total Number of Maximum Approximate
Shares Dollar Value of
Purchased as Shares that May Yet
Total Number Part of Be Purchased Under
of Shares Average Publicly the Plans or
Purchased Price Paid Announced Plans Programs (in
Period During Period Per Share or Programs millions)
----------------------------- -------------- ------------- ----------------- ---------------------
April 30, 2006 through
June 3, 2006 - $ - - $ 750
June 4, 2006 through
July 1, 2006 3,134,400 $ 66.85 3,134,400 $ 540
July 2, 2006 through
July 29, 2006 4,884,600 $ 65.54 4,884,600 $ 220
-------------- -----------------
Total 8,019,000 8,019,000
============== =================
In February 2006, the Board of Directors approved a new common stock repurchase
program of up to $750 million. This program, which the Company announced on
February 16, 2006, was completed on September 5, 2006.
-32-
Item 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of the Company was held on May 19, 2006,
at which the four matters described below were submitted to a vote of
stockholders, with the voting results as indicated.
1. Election of directors for a three-year term expiring at the Company's 2009
Annual Meeting of Stockholders:
Nominee For Authority
Withheld
----------------------- ------------- -----------------
V. E. Jordan, Jr. 167,878,968 34,261,347
Burl Osborne 190,584,740 11,555,575
R. G. Turner 187,521,945 14,618,370
M. B. West 190,370,322 11,769,993
The following persons continue to serve as directors until the terms
indicated.
Term expiring at the 2007 Annual Meeting of Stockholders:
Colleen C. Barrett
M. Anthony Burns
Maxine K. Clark
Ann Marie Tallman
Term expiring at the 2008 Annual Meeting of Stockholders:
Thomas J. Engibous
Kent B. Foster
Leonard H. Roberts
Myron E. Ullman, III
2. The Board of Directors' proposal regarding employment of KPMG LLP as
auditors for the fiscal year ending February 3, 2007:
Broker
For Against Abstain Non-Votes
---------------- ------------ ------------ --------------
194,575,833 5,590,628 1,973,854 1
3. The Board of Directors' proposal to amend the Company's Restated
Certificate of Incorporation and Bylaws to declassify the Board of
Directors:
Broker
For Against Abstain Non-Votes
---------------- ------------ ------------ --------------
195,255,283 4,604,307 2,280,724 2
4. A stockholder proposal regarding executive compensation:
Broker
For Against Abstain Non-Votes
---------------- ------------ ------------ --------------
26,779,005 155,542,573 3,469,235 16,349,503
-33-
Item 6. Exhibits.
Exhibit Nos.
------------
3.1 Bylaws of the Company, as amended to July 21, 2006
10.1 Form of Election to Receive Stock in Lieu of Cash Retainer(s)
(incorporated by reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K dated May 19, 2006)
10.2 Form of Notice of Election to Defer under the J. C. Penney Company,
Inc. Deferred Compensation Plan for Directors (incorporated by
reference to Exhibit 10.2 of the Company's Current Report on Form 8-K
dated May 19, 2006)
10.3 Form of Notice of Change in the Amount of Fees deferred under the J.
C. Penney Company, Inc. Deferred Compensation Plan for Directors
(incorporated by reference to Exhibit 10.3 of the Company's Current
Report on Form 8-K dated May 19, 2006)
10.4 Form of Notice of Termination of Election to Defer under the J. C.
Penney Company, Inc. Deferred Compensation Plan for Directors
(incorporated by reference to Exhibit 10.4 of the Company's Current
Report on Form 8-K dated May 19, 2006)
10.5 Letter Agreement between J. C. Penney Company, Inc. and Catherine West
(incorporated by reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K dated June 7, 2006)
10.6 Summary of Non-Employee Director Compensation for 2006-2007
(incorporated by reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K dated July 25, 2006)
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
-34-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
J. C. PENNEY COMPANY, INC.
By /s/ W. J. Alcorn
-----------------
W. J. Alcorn
Senior Vice President and Controller
(Principal Accounting Officer)
Date: September 6, 2006
-35-