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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 26, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transitional period from ______________ to ________________
Commission File No. 1-777
J. C. PENNEY COMPANY, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-5583779
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6501 Legacy Drive, Plano, Texas 75024 - 3698
(Address of principal executive offices)
(Zip Code)
(972) 431-1000
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
268,302,653 shares of Common Stock of 50 cents par value, as of November 29,
2002.
-1-
PART I - FINANCIAL INFORMATION
Item 1 - Unaudited Financial Statements
J. C. Penney Company, Inc.
Consolidated Statements of Operations
(Unaudited)
($ in millions, except per share data) 13 weeks ended 39 weeks ended
--------------------------- ----------------------------
Oct. 26, Oct. 27, Oct. 26, Oct. 27,
2002 2001 2002 2001
------------- ------------ ------------ --------------
Retail sales, net $ 7,872 $ 7,729 $22,798 $22,462
Costs and expenses
Cost of goods sold 5,470 5,446 15,908 15,908
Selling, general and administrative
expenses 2,153 2,105 6,289 6,140
Other unallocated 4 15 19 9
Net interest expense 97 93 291 285
Acquisition amortization 8 17 25 73
Restructuring and other, net - 2 - 14
------------- ------------ ------------ --------------
Total costs and expenses 7,732 7,678 22,532 22,429
------------- ------------ ------------ --------------
Income from continuing operations
before income taxes 140 51 266 33
Income taxes 51 20 97 14
------------- ------------ ------------ --------------
Income from continuing operations 89 31 169 19
Gain/(loss) on sale of discontinued
operations, net of income tax 34 - 34 (16)
------------- ------------ ------------ --------------
Net income $ 123 $ 31 $ 203 $ 3
Less: preferred stock dividends 6 7 22
20
------------- ------------ ------------ --------------
Net income/(loss) applicable to common
stockholders $ 117 $ 24 $ 183 $ (19)
============= ============ ============ ==============
Earnings/(loss) per share from
continuing operations:
Basic $0.31 $0.09 $ 0.56 $(0.01)
Diluted $0.30 $0.09 $ 0.55 $(0.01)
Earnings/(loss) per share:
Basic $0.44 $0.09 $ 0.68 $(0.07)
Diluted $0.42 $0.09 $ 0.68 $(0.07)
The accompanying notes are an integral part of these Unaudited Interim Consolidated Financial Statements.
-2-
J. C. Penney Company, Inc.
Consolidated Balance Sheets
($ in millions) Oct. 26, Oct. 27, Jan. 26,
2002 2001 2002
-------------- ------------ ---------------
(Unaudited)
Assets
Current assets
Cash and short-term investments
(including restricted balances of $89,
$124 and $115) $ 1,748 $ 1,791 $ 2,840
Receivables (net of bad debt reserves
of $24, $29 and $27) 764 824 698
Merchandise inventory (net of LIFO
reserves of $410, $380 and $377) 5,943 6,273 4,930
Prepaid expenses 202 173 209
-------------- ------------ ---------------
Total current assets 8,657 9,061 8,677
Property and equipment (net of accumulated
depreciation of $3,362, $3,224 and $3,328) 4,866 4,949 4,989
Goodwill 2,302 2,341 2,321
Intangible assets (net of accumulated
amortization of $300, $297 and $304) 506 542 527
Other assets 1,529 1,509 1,534
-------------- ------------ ---------------
Total Assets $ 17,860 $ 18,402 $ 18,048
============== ============ ===============
The accompanying notes are an integral part of these Unaudited Interim Consolidated Financial Statements.
-3-
J. C. Penney Company, Inc.
Consolidated Balance Sheets
($ in millions except per share data) Oct. 26, Oct. 27, Jan. 26,
2002 2001 2002
-------------- ------------ --------------
(Unaudited)
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable and accrued expenses $4,066 $4,005 $3,465
Short-term debt 15 19 15
Current maturities of long-term debt 28 907 920
Deferred taxes 161 129 99
-------------- ------------ --------------
Total current liabilities 4,270 5,060 4,499
Long-term debt 5,169 5,193 5,179
Deferred taxes 1,236 1,132 1,231
Other liabilities 967 954 1,010
-------------- ------------ --------------
Total Liabilities 11,642 12,339 11,919
Stockholders' equity
Capital stock
Preferred stock, no par value and stated value
of $600 per share: authorized, 25 million shares;
issued and outstanding, 0.6, 0.6 and 0.6 million
shares of Series B ESOP convertible preferred 339 371 363
Common stock, par value $0.50 per share:
authorized, 1,250 million shares; issued and
outstanding, 268, 263 and 264 million shares 3,403 3,316 3,324
-------------- ------------ --------------
Total capital stock 3,742 3,687 3,687
-------------- ------------ --------------
Deferred stock compensation 11 5 6
Reinvested earnings at beginning of year 2,573 2,636 2,636
Net income 203 3 98
Common stock dividends declared (100) (99) (128)
Preferred stock dividends (14) (15) (33)
-------------- ------------ --------------
Reinvested earnings at end of period 2,662 2,525 2,573
Accumulated other comprehensive (loss) (197) (154) (137)
-------------- ------------ --------------
Total Stockholders' Equity 6,218 6,063 6,129
-------------- ------------ --------------
Total Liabilities and Stockholders' Equity $17,860 $ 18,402 $ 18,048
============== ============ ==============
The accompanying notes are an integral part of these Unaudited Interim Consolidated Financial Statements.
J. C. Penney Company, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
($ in millions) 39 weeks ended
---------------------------------------
Oct. 26, Oct. 27,
2002 2001
----------------- ----------------
Cash flows from operating activities
Income from continuing operations $ 169 $ 19
Non-cash adjustments to reconcile income from continuing
operations to net cash provided by operating activities:
Restructuring, asset impairments, PVOL and other 33 8
Depreciation and amortization, including intangible assets 486 522
Real estate (gains) - (26)
Pension expense/(income) 8 (47)
Deferred stock compensation 5 -
Deferred taxes 67 17
Change in cash from:
Receivables (66) (131)
Sale of drugstore receivables - 200
Inventory (1,013) (1,004)
Other assets 4 74
Accounts payable 888 448
Current income taxes payable (30) (48)
Other liabilities (159) (280)
----------------- ----------------
Net cash from operating activities 392 (248)
----------------- ----------------
Cash flows from investing activities
Capital expenditures (451) (497)
Proceeds from sale of discontinued operations - 1,306
----------------- ----------------
Net cash from investing activities (451) 809
----------------- ----------------
Cash flows from financing activities
Change in short-term debt - 19
Proceeds from equipment financing 18 -
Proceeds from issuance of long-term debt - 630
Payment of long-term debt, including capital leases (934) (261)
Common stock issued, net 21 27
Preferred stock redeemed (24) (28)
Dividends paid, preferred and common (114) (114)
----------------- ----------------
Net cash from financing activities (1,033) 273
----------------- ----------------
Cash received from discontinued operations - 13
----------------- ----------------
Net (decrease)/increase in cash and short-term investments (1,092) 847
Cash and short-term investments at beginning of year 2,840 944
----------------- ----------------
Cash and short-term investments at end of period $1,748 $1,791
================= ================
The accompanying notes are an integral part of these Unaudited Interim Consolidated Financial Statements.
-5-
Notes to the Unaudited Interim Consolidated Financial Statements
1) Summary of Significant Accounting Policies
------------------------------------------
A description of the Company's significant accounting policies is included in
the Company's Annual Report on Form 10-K for the fiscal year ended January 26,
2002 (the "2001 10-K"). The accompanying unaudited interim consolidated
financial statements should be read in conjunction with the Consolidated
Financial Statements and notes thereto in the 2001 10-K.
The accompanying interim consolidated financial statements are unaudited but, in
the opinion of management, include all material adjustments necessary for a fair
presentation. Because of the seasonal nature of the retail business, operating
results for the three and nine-month periods are not necessarily indicative of
the results that may be expected for the entire year.
Certain reclassifications have been made to prior year amounts to conform to the
current period presentation.
Holding Company
- ---------------
As disclosed in the 2001 10-K, effective January 27, 2002, J. C. Penney Company,
Inc. changed its corporate structure to a holding company format. As part of
this structure, J. C. Penney Company, Inc. changed its name to J. C. Penney
Corporation, Inc. (JCP) and became a wholly owned subsidiary of a newly formed
affiliated holding company (Holding Company). The new holding company assumed
the name J. C. Penney Company, Inc. The Holding Company has no direct
subsidiaries other than JCP, nor does it have any independent assets or
operations. All outstanding shares of common and preferred stock were
automatically converted into the identical number and type of shares in the new
holding company. Stockholders' ownership interests in the business did not
change as a result of the new structure. Shares of the Company remain publicly
traded under the same symbol (JCP) on the New York Stock Exchange. The Holding
Company is a co-obligor (or guarantor, as appropriate) regarding the payment of
principal and interest on JCP's outstanding debt securities. The guarantee by
the Holding Company of certain of JCP's outstanding debt is full and
unconditional. The Holding Company and its consolidated subsidiaries, including
JCP, are collectively referred to in this quarterly report as "Company" or
"JCPenney," unless indicated otherwise.
Recently Issued Accounting Standards
- ------------------------------------
SFAS No. 142
Effective January 27, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets."
Upon adoption, the Company ceased amortization of goodwill and other
indefinite-lived intangible assets, primarily the Eckerd trade name. These
assets are now subject to an impairment test on an annual basis, or when there
is reason to believe that their values have been diminished or impaired.
Additionally, a transitional impairment test is required as of the adoption
date. These impairment tests are performed on each business of the Company where
goodwill is recorded. The net carrying value of goodwill and the Eckerd trade
name was $2,643 million as of January 26, 2002. The Company completed the
transitional impairment test on the Eckerd trade name in the first quarter of
2002 and the transitional goodwill impairment test in the second quarter of 2002
and determined that there was no evidence of impairment. The fair value of the
Company's identified reporting units was estimated using the expected present
value of corresponding future cash flows and market values of comparable
businesses where available. Other intangible assets with estimable useful lives
will continue to be amortized over those lives.
-6-
The following table sets forth the condensed consolidated pro forma results of
operations for the three and nine-month periods ended October 26, 2002 and
October 27, 2001 as if SFAS No. 142 had been in effect for all periods
presented:
($ in millions except EPS) 13 weeks ended 39 weeks ended
--------------------------- --------------------------
Oct. 26, 2002 Oct. 27, 2001 Oct. 26, 2002 Oct. 27, 2001
------------ ------------- ------------- -------------
Reported net income $ 123 $ 31 $ 203 $ 3
Goodwill and trade name amortization - 11 - 44
------------ ------------- ------------ -------------
Adjusted net income $ 123 $ 42 $ 203 $ 47
============ ============= ============ =============
Earnings per share (EPS) - basic:
Reported net income/(loss) $ 0.44 $0.09 $ 0.68 $ (0.07)
Goodwill and trade name amortization - 0.04 - 0.16
------------ ------------- ------------ -------------
Adjusted net income $ 0.44 $0.13 $ 0.68 $0.09
============ ============= ============ =============
Earnings per share (EPS) - diluted:
Reported net income/(loss) $ 0.42 $0.09 $ 0.68 $ (0.07)
Goodwill and trade name amortization - 0.04 - 0.16
------------ ------------- ------------ -------------
Adjusted net income $ 0.42 $0.13 $ 0.68 $0.09
============ ============= ============ =============
Intangible assets consisted of the following:
($ in millions) Oct. 26, Oct. 27, Jan. 26,
2002 2001 2002
---------------- ---------------- ---------------
Amortizing intangible assets:
Prescription files $ 279 $ 246 $ 258
Less accumulated amortization 146 110 121
---------------- ---------------- ---------------
Prescription files, net 133 136 137
---------------- ---------------- ---------------
Favorable lease rights 205 204 204
Less accumulated amortization 154 125 136
---------------- ---------------- ---------------
Favorable lease rights, net 51 79 68
---------------- ---------------- ---------------
Software - 20 -
Less accumulated amortization - 19 -
---------------- ---------------- ---------------
Software, net - 1 -
---------------- ---------------- ---------------
Carrying amount of amortizing
intangible assets 184 216 205
Unamortizing intangible assets
Eckerd trade name(1) 322 326 322
---------------- ---------------- ---------------
Total intangible assets $ 506 $ 542 $ 527
================ ================ ===============
(1) Eckerd trade name is net of accumulated amortization of $43 million and $47
million for the third quarter 2001 and year end 2001.
-7-
The following table provides amortization expense for the periods presented.
Amortization expense related to major business acquisitions is reported as
acquisition amortization on the consolidated statements of operations. The
remaining amount of amortization expense is included in selling, general and
administrative (SG&A) expenses.
($ in millions) 13 weeks ended 39 weeks ended
--------------------------- -----------------------------
Oct. 26, Oct. 27, Oct. 26, Oct. 27,
2002 2001 2002 2001
------------- ------------- ------------- ---------------
Major business acquisitions(1) $ 8 $ 17 $25 $ 73
Other acquisitions 6 5 17 15
------------- ------------- ------------- ---------------
Total for amortizing intangible assets $ 14 $ 22 $42 $ 88
============= ============= ============= ===============
(1) Includes amortization expense of $10 million and $45 million related to
goodwill and trade name for the third quarter and first nine months of 2001,
respectively, before the adoption of SFAS No. 142. Major business acquisitions
include Eckerd Corporation acquired in early 1997, Lojas Renner S.A. acquired in
January 1999 and Genovese Drug Stores, Inc. acquired in March 1999.
Amortization expense for the intangible assets reflected above is expected to be
approximately (in millions) $65, $65, $33, $24 and $16 for fiscal years 2002,
2003, 2004, 2005 and 2006, respectively. Of these amounts, amortization related
to major business acquisitions is expected to be approximately (in millions)
$42, $40, $9, $6 and $1 for fiscal years 2002, 2003, 2004, 2005 and 2006
respectively.
The carrying amount of goodwill was $2,321 million at the beginning of 2002 and
decreased to $2,302 million at October 26, 2002, due to currency translation
adjustments. At October 26, 2002, the total carrying amount of goodwill
consisted of $33 million for the Department Store and Catalog segment and $2,269
million for the Eckerd Drugstore segment.
SFAS No. 144
The Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," on January 27, 2002. The new rules supersede SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." SFAS No. 144 retains many of the fundamental recognition and
measurement provisions, but significantly changes the criteria for classifying
an asset as held-for-sale or as a discontinued operation. Adoption of the new
standard did not have a material impact on the Company's consolidated results of
operations or financial position.
SFAS No. 145
The Company adopted SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and
64, Amendment of FASB Statement No. 13, and Technical Corrections," in the
second quarter of 2002, concurrent with the initial closing of notes tendered in
the Company's debt exchange. Statement No. 145 rescinded Statement No. 4,
"Reporting Gains and Losses from Extinguishment of Debt - an amendment of APB
Opinion No. 30," which required any gain or loss from extinguishment of debt to
be classified as an extraordinary item, net of related income tax effect. As a
result, the criteria set forth by Accounting Principles Board (APB) Opinion No.
30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," will now be used to classify those gains and losses.
Statement No. 145 also amended Statement No. 13, "Accounting for Leases," to
require that certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. In accordance with SFAS No. 145, the net loss on
the debt exchange of approximately $0.4 million was recorded as net interest
expense in income from continuing operations and is more fully discussed in Note
12.
-8-
SFAS No. 146
In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities." This
Statement requires that costs associated with exit or disposal activities be
recorded at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. This
Statement is effective for exit or disposal activities initiated after December
31, 2002, with earlier application encouraged. The Company adopted the
provisions of SFAS No. 146 in the third quarter of 2002. As a result, certain
costs associated with exit or disposal activities will be recorded in later
periods than under the previous rules, but the change did not have a material
impact on the Company's results of operations or financial condition.
2) Discontinued Operations
-----------------------
In the second quarter of 2001, the Company closed on the sale of its Direct
Marketing Services business. Upon completion of the transaction, the loss was
increased by $16 million, from $296 million to $312 million. The additional net
loss of $16 million was reflected in the nine-month period ended October 27,
2001 as a loss on sale of discontinued operations.
During 2002, a change in federal income tax regulations was issued that entitles
the Company to additional tax benefits on the transaction from increased capital
loss deductions. The Internal Revenue Service concurred that the Company was
entitled to an additional deduction and entered into an agreement with the
Company with respect to the reporting of this additional deduction. The $34
million reduction of the tax liability from the original tax provision on the
sale is presented as a gain on sale of discontinued operations in the third
quarter of 2002 in the accompanying consolidated statement of operations.
3) Earnings per Share
------------------
Basic earnings per share (EPS) is computed by dividing income applicable to
common stockholders by the average number of common shares outstanding for the
period. Except when the effect would be anti-dilutive, the diluted EPS
calculation includes the impact of restricted stock awards and shares that could
be issued under outstanding stock options as well as common shares that would
result from the conversion of convertible debentures and convertible preferred
stock. In addition, the related interest on convertible debentures (net of tax)
and preferred stock dividends (net of tax) are added back to income, since these
would not be paid if the debentures or preferred stock were converted to common
stock.
The following potential shares of common stock and their effects on income were
excluded from the diluted EPS calculations because the effect would be
anti-dilutive:
o Certain stock options were excluded from the calculations because their
exercise prices were greater than the average market price. Options to
purchase 14 million and 13 million shares of common stock at exercise
prices ranging from $17 to $71 and $20 to $71, were excluded for the
three-month and nine-month periods ending October 26, 2002, respectively.
Options to purchase 9 million shares of common stock at exercise prices
ranging from $24 to $71 and $22 to $71 were excluded for the three-month
and nine-month periods ending October 27, 2001, respectively.
o The $650 million aggregate principal amount of notes issued in October 2001
and convertible into 22.8 million common shares were excluded for the 2001
calculations and the calculation for the nine months ended October 26,
2002.
o Preferred stock convertible into 11.3 million and 12.4 million common
shares was issued and outstanding at October 26, 2002 and October 27, 2001,
respectively, and was excluded from all EPS calculations shown.
o For the nine months ended October 27, 2001, in addition to the items listed
above, restricted stock units and stock options convertible into 3 million
shares of stock were excluded.
-9-
The computation of basic and diluted earnings per share follows:
(In millions, except per share data) 13 weeks ended 39 weeks ended
------------------------------- ------------------------------
Oct. 26, Oct. 27, Oct. 26, Oct. 27,
2002 2001 2002 2001
-------------- -------------- ------------- -------------
Earnings/(loss):
Income from continuing operations $ 89 $31 $169 $ 19
Less: preferred dividends, net of tax 6 7 20 22
-------------- -------------- ------------- -------------
Income/(loss) from continuing operations
applicable to common stockholders 83 24 149 (3)
Effect of dilutive securities:
Interest on 5% convertible debt, net of tax 5 - - -
-------------- -------------- ------------- -------------
Income/(loss) from continuing operations
used for diluted EPS 88 24 149 (3)
Income/(loss) from continuing operations
applicable to common stockholders 83 24 149 (3)
Gain/(loss) on sale of discontinued operations,
net of tax 34 - 34 (16)
-------------- -------------- ------------- -------------
Earnings/(loss) applicable to common
stockholders 117 24 183 (19)
Effect of dilutive securities:
Interest on 5% convertible debt, net of tax 5 - - -
-------------- -------------- ------------- -------------
Income/(loss) used for diluted EPS $ 122 $24 $ 183 $ (19)
============== ============== ============= =============
Shares:
Average shares outstanding (basic shares) 268 264 267 263
Effect of dilutive securities:
Stock options and restricted stock units 1 4 3 -
Assumed conversion of 5% debentures 23 - - -
-------------- -------------- ------------- -------------
Average shares used for diluted EPS 292 268 270 263
============== ============== ============= =============
Earnings/(loss) per share from
continuing operations:
Basic $0.31 $0.09 $ 0.56 $(0.01)
Diluted $0.30 $0.09 $ 0.55 $(0.01)
Earnings/(loss) per share:
Basic $0.44 $0.09 $ 0.68 $(0.07)
Diluted $0.42 $0.09 $ 0.68 $(0.07)
-10-
4) Cash and Restricted Short-Term Investment Balances
--------------------------------------------------
Restricted short-term investment balances of $89 million, $124 million and $115
million as of October 26, 2002, October 27, 2001 and January 26, 2002,
respectively, were included in the total cash and short-term investment balances
of $1,748 million, $1,791 million and $2,840 million for the same periods.
Restricted balances are pledged as collateral for import letters of credit not
included in the bank credit facility and for a portion of casualty insurance
program liabilities. Cash and short-term investments on the consolidated balance
sheet include $5 million, $5 million and $6 million of cash as of October 26,
2002, October 27, 2001 and January 26, 2002, respectively.
5) Supplemental Cash Flow Information
----------------------------------
($ in millions) 39 weeks ended
-----------------------------------
Oct. 26, Oct. 27,
2002 2001
--------------- --------------
Interest paid $371 $ 371
Interest received 29 35
Income taxes paid 47 27
Non-cash transactions:
- ----------------------
o During the second and third quarters of 2002, the Company exchanged certain
notes and debentures with a net carrying amount of $227 million for new
notes recorded at a fair value of $225 million.
o The Company issued 2.9 million shares of common stock in March 2002 to fund
its fiscal 2001 contribution to the savings plan.
6) Eckerd Managed Care Receivable Securitization
---------------------------------------------
As disclosed in the 2001 10-K, Eckerd sells, on a continuous basis,
substantially all of its managed care receivables to ECR Receivables, Inc., a
subsidiary of Eckerd, which then sells to a third party an undivided interest in
all eligible receivables while retaining a subordinated interest in a portion of
the receivables. A three-year revolving receivables purchase facility agreement
was entered into in May 2001. As of October 26, 2002, securitized managed care
receivables totaled $304 million, of which the subordinated retained interest
was $104 million. Losses and expenses related to receivables sold under this
agreement were approximately $1 million and $3 million in the third quarter and
first nine months of 2002, respectively.
7) Restructuring and Other, Net
----------------------------
During the third quarter of 2002, a $2 million charge for interest associated
with discounting lease obligations was offset by a $2 million reversal of a
contract cancellation reserve that was no longer needed. During the first half
of 2002, the Company recorded a $3 million charge for interest associated with
discounting lease obligations, which was offset by $1 million of downward
adjustments to restructuring reserves and a $2 million gain on the disposal of
assets.
During the third quarter of 2001, the Company recorded a $2 million charge to
increase previously established restructuring reserves. During the first half of
2001, the Company recorded a $12 million charge comprised of JCPenney unit
closings ($15 million), severance benefits paid to certain members of management
($3 million) and Eckerd asset impairments ($1 million), which were offset by
downward adjustments to Eckerd reserves ($7 million).
-11-
8) Restructuring Reserves
----------------------
At October 26, 2002, the consolidated balance sheet included $122 million of
reserves related to restructuring activities compared to $174 million at January
26, 2002. These reserves were initially established in 1996, 1997, 2000 and the
first half of 2001 in connection with store closing programs and other
restructuring activities. The remaining reserves are related primarily to future
lease obligations for both department stores and drugstores that have closed.
Costs are being charged against the reserves as incurred.
Reserves are periodically reviewed for adequacy and are adjusted as appropriate.
During the first nine months of 2002, cash payments related to the reserves were
$54 million ($49 million related to lease payments, $4 million for contract
cancellations and $1 million for severance benefits paid to employees of units
included in the 2001 store closing program). Reserves were increased $5 million
in the first nine months of 2002 for interest on future lease obligations and
adjusted downward $3 million based on favorable experience. Cash payments
related to these reserves are expected to approximate $10 million in the fourth
quarter with most of the remainder to be paid out by the end of 2005.
9) Comprehensive Income/(Loss) and Accumulated Other Comprehensive (Loss)
----------------------------------------------------------------------
Comprehensive Income/(Loss)
($ in millions) 13 weeks ended 39 weeks ended
------------------------------- ------------------------------
Oct. 26, Oct. 27, Oct. 26, Oct. 27,
2002 2001 2002 2001
--------------- --------------- --------------- --------------
Net income $ 123 $ 31 $ 203 $ 3
Other comprehensive (loss)/income
Foreign currency translation adjustments (36) (19) (67) (48)
Non-qualified plan minimum liability adjustment - - - (41)
Net unrealized changes in investment securities 3 (4) 7 5
--------------- --------------- --------------- --------------
(33) (23) (60) (84)
--------------- --------------- --------------- --------------
Total comprehensive income/(loss) $ 90 $ 8 $ 143 $ (81)
=============== =============== =============== ==============
Accumulated Other Comprehensive (Loss)/Income
($ in millions) Oct. 26, Oct. 27, Jan. 26,
2002 2001 2002
---------------- --------------- ---------------
Foreign currency translation adjustments $ (167) $(121) $(100)
Non-qualified plan minimum liability adjustment (51) (41) (51)
Net unrealized changes in investment securities 21 8 14
---------------- --------------- ---------------
Accumulated other comprehensive (loss) $ (197) $(154) $(137)
================ =============== ===============
Net unrealized changes in investment securities are shown net of deferred taxes
of $11 million, $4 million and $8 million as of October 26, 2002, October 27,
2001 and January 26, 2002, respectively. The non-qualified plan minimum
liability is shown net of deferred tax asset of $33 million, $27 million and $33
million as of October 26, 2002, October 27, 2001 and January 26, 2002,
respectively. A deferred tax asset has not been established for foreign currency
translation adjustments.
-12-
10) Bank Credit Agreement
---------------------
As previously disclosed, in May 2002, JCP and J. C. Penney Company, Inc. entered
into a three-year, $1.5 billion revolving bank line of credit (credit facility)
with a syndicate of banks with JPMorgan Chase Bank as administrative agent. This
credit facility replaced a $1.5 billion facility that was scheduled to expire on
November 21, 2002 and a $630 million letter of credit facility. The credit
facility may be used for general corporate purposes, including the issuance of
letters of credit. No borrowings, other than the issuance of trade and stand-by
letters of credit, which totaled $258 million as of the end of the third quarter
of 2002, have been made under this credit facility.
Key terms of this credit facility include a financial performance covenant,
which consists of a maximum ratio of total debt to consolidated EBITDA (as
defined in the credit agreement) as measured on a trailing four quarters basis.
In addition, the amount of outstanding indebtedness under the agreement is
subject to a limitation based on the value of collateral to total indebtedness,
as defined in the credit facility agreement. At October 26, 2002, the Company
was in compliance with all financial covenants of the credit agreement.
Any indebtedness incurred by JCP under the credit facility is collateralized by
all eligible domestic department store and catalog inventory, as defined in the
credit facility agreement, which can be released as performance improvements are
achieved and credit ratings by the rating agencies improve. Pricing is tiered
based on the corporate credit ratings for JCP by Moody's and Standard and
Poor's. Obligations under the credit facility are guaranteed by J. C. Penney
Company, Inc. and JCP Real Estate Holdings, Inc., which is a wholly owned
subsidiary of JCP.
11) Equipment Financing
-------------------
As previously disclosed, in May 2002, JCP entered into a loan agreement with
Lombard US Equipment Finance Corporation to finance the purchase of equipment
for certain store support centers (SSCs). Under the agreement, JCP may borrow up
to a total of $36 million in increments of at least $3 million. Loans made under
the agreement are secured by the equipment being purchased. On June 27, 2002,
JCP borrowed approximately $9 million under this agreement. This note, which
matures July 1, 2007, bears interest at 7.33% per year and is payable in monthly
installments. JCP has the right to prepay the principal balance on the loan
during the loan term, subject to a prepayment penalty of 1% to 5% of the prepaid
amount.
Also as previously disclosed, on August 28, 2002, JCP borrowed an additional $9
million under the agreement. This note, which has similar terms to the first
note, matures September 1, 2007 and bears interest at 6.55% per year.
On November 27, 2002, JCP borrowed an additional $9 million under the agreement.
This note, with similar terms to the notes discussed above, bears interest at
6.35% per year and matures December 1, 2007.
-13-
12) Debt Exchange
-------------
As previously disclosed, on June 26, 2002, JCP offered to exchange in a private
placement:
o For each $1,000 principal amount of outstanding 6.125% Notes Due 2003,
$1,015.15 principal amount of new 9.000% Notes Due 2012 (New Notes);
o For each $1,000 principal amount of 7.375% Notes Due 2004, $1,010.10
principal amount of New Notes; and
o For each $1,000 principal amount of 6.900% Debentures Due 2026, $1,015.15
principal amount of New Notes (collectively, the old notes).
Concurrent with the exchange offer, JCP solicited consents to amend the
indentures governing the old notes from holders of old notes to whom JCP made
the offer. JCP offered consent payments of $10 per $1,000 principal amount
tendered to holders who validly tendered their notes and delivered their
consents within the established timeframe.
Also as previously disclosed, on July 25, 2002, JCP announced the extension of
the exchange offer to August 7, 2002 and the acceptance for settlement of notes
tendered through July 24, 2002. On July 26, 2002, JCP issued New Notes with an
aggregate principal amount of approximately $209 million and a fair value of
approximately $205 million in connection with the approximately $206 million of
old notes tendered through July 24, 2002. On August 9, 2002, the Company
completed the debt exchange offer, resulting in a total amount of new bonds
issued in the exchange of $230.2 million. Approximately $79.4 million principal
amount of 6.125% Notes Due 2003, approximately $67.0 million of 7.375% Notes Due
2004 and approximately $80.8 million of 6.9% Debentures Due 2026 were tendered
in response to the exchange offer. The Company paid total consent fees of
approximately $2.2 million for such tendered notes. In accordance with SFAS No.
145, the net loss of approximately $0.4 million was recorded in interest expense
and was included in income from continuing operations for the nine-month period
ended October 26, 2002. No amendments were made to the indentures governing the
old notes.
On November 18, 2002 the Company filed a registration statement on Form S-4
under the Securities Act with the Securities and Exchange Commission. This
registration statement was filed pursuant to the Registration Rights Agreement,
which was entered into as part of the original exchange offer in June 2002 in
order to offer to exchange notes registered under the Securities Act for the
$230.2 million of notes that were issued in the prior private placement
exchange. Upon effectiveness and closing of this registered exchange offer, such
registered notes as may be issued in the exchange offer will not be subject to
transfer restrictions, and will carry identical terms as the outstanding notes
for which they are being exchanged.
-14-
13) Segment Reporting
-----------------
The Company operates in two business segments: Department Stores and Catalog
(including internet), and Eckerd Drugstores. Other items are shown in the
following table for purposes of reconciling to total Company amounts.
Business Segment Information
($ in millions) Dept.
Stores & Eckerd Other Total
Catalog Drugstores Unallocated Company
- -------------------------------------------------------------------------------------------------------------------------------
3rd Quarter - 2002
Retail sales, net $ 4,310 $ 3,562 $ - $ 7,872
Segment operating profit 170 79 - 249
Net interest expense (97) (97)
Other unallocated (4) (4)
Acquisition amortization (8) (8)
Restructuring and other, net - -
Pre-tax income from continuing operations 140
----------
Depreciation and amortization expense 90 64 8 162
-----------------------------------------------------------------------
3rd Quarter YTD - 2002
Retail sales, net 11,939 10,859 - 22,798
Segment operating profit 349 252 - 601
Net interest expense (291) (291)
Other unallocated (19) (19)
Acquisition amortization (25) (25)
Restructuring and other, net - -
-----------
-----------
Depreciation and amortization expense 276 185 25 486
Total assets $10,894 $6,846 $ 120 $17,860
- ------------------------------------------------------------------------------------------------------------------------------
3rd Quarter - 2001
Retail sales, net $ 4,360 $ 3,369 $ - $ 7,729
Segment operating profit 148 30 - 178
Net interest expense (93) (93)
Other unallocated (15) (15)
Acquisition amortization (17) (17)
Restructuring and other, net (2) (2)
-----------
Pre-tax income from continuing operations 51
-----------
Depreciation and amortization expense 86 57 17 160
----------------------------------------------------------------------
3rd Quarter YTD - 2001
Retail sales, net 12,277 10,185 - 22,462
Segment operating profit 292 122 - 414
Net interest expense (285) (285)
Other unallocated (9) (9)
Acquisition amortization (73) (73)
Restructuring and other, net (14) (14)
-----------
Pre-tax income from continuing operations 33
-----------
Depreciation and amortization expense 282 167 73 522
Total assets $11,395 $ 6,870 $ 137 $ 18,402
- ------------------------------------------------------------------------------------------------------------------------------
-15-
14) Subsequent Event - Pension Plan
-------------------------------
On October 29, 2002, the Company contributed $300 million, or $190 million after
tax, to its pension plan, which represents contributions attributable to both
2002 and 2003. The measurement date for the Company's pension plan is October
31, which was subsequent to the end of the third quarter. As of October 31,
2002, the fair value of the Company's pension assets was approximately $2.9
billion, including the above mentioned $300 million contribution. The Company's
pension assets exceeded the accumulated pension benefit obligation by
approximately $280 million. Accordingly, in 2002, the Company will not record a
minimum liability adjustment, which would be charged to equity under SFAS No.
87, "Employers' Accounting for Pensions."
-16-
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Holding Company
- ---------------
As disclosed in the 2001 10-K, effective January 27, 2002, J. C. Penney Company,
Inc. changed its corporate structure to a holding company format. As part of
this structure, J. C. Penney Company, Inc. changed its name to J. C. Penney
Corporation, Inc. (JCP) and became a wholly owned subsidiary of a newly formed
affiliated holding company (Holding Company). The new holding company assumed
the name J. C. Penney Company, Inc. The Holding Company has no direct
subsidiaries other than JCP, nor does it have any independent assets or
operations. All outstanding shares of common and preferred stock were
automatically converted into the identical number and type of shares in the new
holding company. Stockholders' ownership interests in the business did not
change as a result of the new structure. Shares of the Company remain publicly
traded under the same symbol (JCP) on the New York Stock Exchange. The Holding
Company is a co-obligor (or guarantor, as appropriate) regarding the payment of
principal and interest on JCP's outstanding debt securities. The guarantee by
the Holding Company of certain of JCP's outstanding debt is full and
unconditional. The Holding Company and its consolidated subsidiaries, including
JCP, are collectively referred to in this report as "Company" or "JCPenney,"
unless indicated otherwise.
Critical Accounting Policies
- ----------------------------
Management's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires the
Company to make estimates and judgments that affect reported amounts of assets,
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities. Management bases its estimates on historical experience and on
other assumptions that are believed to be reasonable under the circumstances. On
an ongoing basis, management evaluates estimates used, including those related
to inventory valuation under the retail method, revenue recognition, valuation
of long-lived and intangible assets, including goodwill, and contingencies
related to taxes, litigation and other reserves as well as retiree benefit
plans. Actual results may differ from these estimates under different
assumptions or conditions. Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations, in the 2001 10-K includes
detailed descriptions of certain judgments that management makes in applying its
accounting policies in these areas.
Discontinued Operations
- -----------------------
The Company recorded a $34 million gain in the third quarter of 2002 that is
reported as discontinued operations. This gain relates to additional capital
loss deductions that the Company is entitled to on the 2001 sale of the assets
of J. C. Penney Direct Marketing Services, Inc., as a result of a 2002 tax
regulation change. The final federal tax liability on the transaction was
determined in an agreement between the Company and the Internal Revenue Service.
-17-
Consolidated Results of Operations
($ in millions) 13 weeks ended 39 weeks ended
------------------------------ ------------------------------
Oct. 26, Oct. 27, Oct. 26, Oct. 27,
2002 2001 2002 2001
-------------- --------------- --------------- --------------
Segment operating profit
Department Stores and Catalog $ 170 $148 $ 349 $ 292
Eckerd Drugstores 79 30 252 122
-------------- --------------- --------------- --------------
Total segments 249 178 601 414
Other unallocated (4) (15) (19) (9)
Net interest expense (97) (93) (291) (285)
Acquisition amortization (8) (17) (25) (73)
Restructuring and other, net - (2) - (14)
-------------- --------------- --------------- --------------
Income from continuing operations before
income taxes 140 51 266 33
Income taxes (51) (20) (97) (14)
-------------- --------------- --------------- --------------
Income from continuing operations $ 89 $ 31 $ 169 $ 19
============== =============== =============== ==============
For the third quarter of 2002, the Company reported income from continuing
operations of $89 million, or $0.30 per share, compared to $31 million, or $0.09
per share for the comparable 2001 period. For the nine months ended October 26,
2002, income from continuing operations was $169 million, or $0.55 per share,
compared to $19 million, or a loss of $0.01 per share (due to preferred stock
dividends, net of tax), for the comparable 2001 period. The three and nine
months ended October 26, 2002 did not have any non-comparable items, however
certain non-comparable items affected results for the comparable 2001 periods.
These items are defined and discussed on the following page.
Income from continuing operations for third quarter 2002 was $89 million, or
$0.30 per share, compared to $42 million, or $0.13 per share for the comparable
2001 period, before the effects of non-comparable items in 2001. Income from
continuing operations for the nine months ending October 26, 2002 was $169
million, or $0.55 per share, compared to $32 million, or $0.04 per share, for
the comparable 2001 period before the effects of non-comparable items in 2001.
The improved earnings are a result of sales growth in both department stores and
drugstores, higher gross margins in both operating segments and leveraging of
Eckerd selling, general and administrative (SG&A) expenses. Earnings per share
(EPS) also includes an increase of $0.04 and $0.16 per share for the three and
nine months ended October 26, 2002, respectively, from the elimination of
amortization of goodwill and the Eckerd trade name in compliance with SFAS No.
142, which is discussed in Note 1. This increase to EPS was partially offset by
a decrease of $0.06 and $0.12 per share for the three and nine months ended
October 26, 2002, respectively, from higher non-cash pension expense, as
disclosed in previous Securities and Exchange Commission filings beginning with
the 2001 10-K.
-18-
Non-Comparable Items
- --------------------
The Company considers non-comparable items to be significant charges or credits
that occur infrequently and are not reflective of normal operating performance,
including any subsequent adjustments. Examples of non-comparable items include
significant real estate transactions that are not part of the Company's core
business, start-up and transition costs related to centralizing merchandising
and other processes and costs related to significant acquisitions. The financial
impacts of these transactions complicate comparisons of ongoing operating
results and therefore require discussion to clarify results and trends in the
Company's operations for multiple years.
There were no non-comparable items for the three and nine months ended October
26, 2002. The following table reconciles, for the three and nine months ended
October 27, 2001, income from continuing operations before the effects of
non-comparable items to income from continuing operations as reported in
accordance with generally accepted accounting principles (GAAP). All references
to EPS are on a diluted basis.
($ in millions, except EPS) 13 weeks ended Oct. 27, 2001 39 Weeks ended Oct. 27, 2001
--------------------------------------- ---------------------------------------
Pre- Pre-
Tax Tax Net EPS Tax Tax Net EPS
------- ------ ------- -------- -------- ------ ------- -------
Income from continuing operations
before the effects of non-
comparable items $ 68 $ (26) $42 $0.13 $ 53 $ (21) $ 32 $0.04
------- ------ ------- -------- -------- ------ ------- -------
Restructuring and other, net (2) (14)
Other non-comparable items:
Eckerd pension curtailment gain(1) - 11
Information technology transition
costs(1) - (5)
Centralized merchandising process
costs (ACT)(2) (7) (32)
Real estate gains(2) 28 56
Asset impairments and PVOL(2) (36) (36)
------- ------ ------- -------- -------- ------ ------- -------
Total restructuring and other non-
comparable items (17) 6 11 $(0.04) (20) 7 (13) $(0.05)
------- ------ ------- -------- -------- ------ ------- -------
GAAP income from continuing
operations $ 51 $(20) $ 31 $0.09 $ 33 $(14) $19 $(0.01)
======= ====== ======= ======== ======== ====== ======= =======
(1) Reported as a component of Eckerd Drugstore SG&A expenses.
(2) Reported as a component of other unallocated. PVOL is the present value of
obligations under leases.
The non-comparable net charge of $17 million, or $0.04 per share, in the third
quarter of 2001 included $2 million of restructuring expenses; $7 million of
Accelerating Change Together (ACT) initiative expenses; $36 million for asset
impairments and future lease obligations and $28 million of real estate gains.
The asset impairments and the present value of obligations under leases (PVOL)
were recorded for catalog outlet stores that were scheduled to close in 2002,
five underperforming department stores, third-party fulfillment operations that
have been discontinued and an impairment on an office facility. The real estate
gains were recorded on the sale of certain partnership interests.
For the nine months ended October 27, 2001, non-comparable items totaled $20
million or $0.05 per share, and included a $14 million restructuring charge, $32
million of ACT initiative expenses, real estate gains totaling $56 million and
$36 million of asset impairments and PVOL. Non-comparable items included in
Eckerd (SG&A) expenses were an $11 million gain for pension curtailment and $5
million of information technology transition costs.
-19-
Segment Operating Results
Department Stores and Catalog
- -----------------------------
($ in millions) 13 weeks ended 39 weeks ended
------------------------------- -------------------------------
Oct. 26, Oct. 27, Oct. 26, Oct. 27,
2002 2001 2002 2001
-------------- --------------- -------------- --------------
Retail sales $ 4,310 $ 4,360 $ 11,939 $ 12,277
FIFO/LIFO gross margin 1,579 1,539 4,400 4,279
SG&A expenses (1,409) (1,391) (4,051) (3,987)
-------------- --------------- -------------- --------------
Segment operating profit $ 170 $ 148 $ 349 $ 292
============== =============== ============== ==============
Sales percent increase/(decrease):
Comparable stores(1) 3.9% 5.1% 3.0% 2.9%
Total department stores 3.4% 3.9% 2.0% 1.1%
Catalog (21.2)% (17.7)% (22.6)% (17.5)%
Ratios as a percent of sales:
FIFO/LIFO gross margin 36.6% 35.3% 36.8% 34.9%
SG&A expenses 32.7% 31.9% 33.9% 32.5%
Segment operating profit 3.9% 3.4% 2.9% 2.4%
(1) Comparable store sales include the sales of stores after having been opened
for 12 consecutive months. Stores become comparable on the first day of the
13th month.
Segment operating profit increased 15%, or 50 basis points as a percent of
sales, to $170 million in this year's third quarter from $148 million last year.
Improved gross margin, benefiting from the centralized merchandising process and
Catalog inventory management, contributed to the increase.
Comparable department store sales increased 3.9% over last year's third quarter
while total department store sales for the quarter increased 3.4%. Sales
benefited from a good Back-to-School season and an especially strong October.
Sales gains were led by Apparel, Home and Fine Jewelry. The best performing
apparel categories were misses' sportswear, men's sportswear, juniors' and boys'
apparel, while women's outerwear, infant apparel and furniture experienced some
weakness in sales. Home was led by bedding and bath, window coverings and
housewares, while Fine Jewelry had particularly strong diamond sales.
Catalog sales decreased 21.2% compared to last year primarily as a result of
softer demand, lower circulation quantities and page counts, as well as the
Company's January 2002 policy change to require customer payment at the time of
order shipment. Total internet sales for the third quarter, which are reported
as a component of Catalog sales, increased to $100 million from $81 million last
year.
Gross margin for the quarter increased 130 basis points as a percentage of
sales. Included in gross margin were markdowns of approximately $24 million
related to merchandise delayed in delivery as a result of the West Coast work
stoppage. This quarter marks the fifth consecutive margin ratio increase over
the comparable prior year quarter. Improvement continues to be the result of
better merchandise offerings and benefits from the centralized merchandising
model. Benefits include larger order quantities, which contribute to lower
costs, more timely selection of merchandise, better supplier involvement from
planning stages through sale of the merchandise and more efficient delivery of
merchandise to stores. Also contributing to the improvement in margins were
substantially lower levels of catalog liquidation merchandise.
While SG&A expenses increased 1.3% from last year's third quarter, the increase
relates to planned investments in advertising and the new centralized store
support center (SSC) distribution network. In addition, as previously disclosed,
non-cash pension expenses are higher in the current year periods. Partially
offsetting these expense increases were savings in store labor costs as a result
of the transition to centralized checkouts (also referred to as customer service
centers), progress toward the elimination of in-store receiving and benefits
from centralized
-20-
management of store expenses. The new SSC network for department stores is an
integral part of the Company's centralization efforts. By the end of the third
quarter, seven out of 13 planned SSCs were in operation, providing coverage for
approximately 60% of the department store base. The eighth SSC opened in
mid-November, and a total of ten are expected to be in operation by year end
2002. The majority of efficiencies and cost savings of the new SSC network will
not be fully realized until the implementation of all 13 SSCs. The remaining
three SSCs are scheduled to begin operating in the first half of 2003. It is
anticipated that, when completed, seven of the 13 SSCs will be located in
existing Company facilities.
Segment operating profit for the nine months ended October 26, 2002 improved
19.5% to $349 million from $292 million last year. Sales for comparable
department stores increased 3.0% while catalog sales declined 22.6% compared
with last year's levels. Gross margin for the nine months increased 190 basis
points as a percent of sales, primarily as a result of the benefits from the
centralized buying process and improved inventory management leading to lower
liquidation costs. SG&A expenses increased only 1.6% from last year despite
planned increases in advertising, pension expense and transition costs for the
new distribution network.
The Company is now in the second year of a complex five-year turnaround program
for Department Stores and Catalog. Management has taken steps to maximize
financial flexibility, has implemented a centralized merchandising model, is
well on the way to rolling out a new merchandise logistics network, has made
changes to catalog processes and policies to gain efficiencies and improve
profitability, and has taken steps to improve merchandise offerings and enhance
systems to provide better inventory data and more visibility into merchandise
selling patterns. The profitability of Department Stores and Catalog is impacted
by the customers' response to the merchandise offerings as well as competitive
conditions, the effects of the current economic climate and consumer confidence.
-21-
Eckerd Drugstores
- -----------------
($ in millions)
13 weeks ended 39 weeks ended
-------------------------------- ------------------------------
Oct. 26, Oct. 27, Oct. 26, Oct. 27,
2002 2001 2002 2001
--------------- -------------- -------------- --------------
Retail sales $ 3,562 $ 3,369 $ 10,859 $ 10,185
FIFO gross margin 832 756 2,523 2,316
LIFO (charge) (9) (12) (33) (41)
--------------- -------------- -------------- --------------
LIFO gross margin 823 744 2,490 2,275
SG&A expenses (744) (714) (2,238) (2,153)(1)
--------------- -------------- -------------- --------------
Segment operating profit $ 79 $ 30 $ 252 $ 122
=============== ============== ============== ==============
Sales percent increase:
Comparable stores(2) 4.9% 8.4% 6.2% 8.6%
Total sales 5.7% 7.4% 6.6% 6.1%
Ratios as a percent of sales:
FIFO gross margin 23.3% 22.4% 23.2% 22.7%
LIFO gross margin 23.1% 22.1% 22.9% 22.3%
SG&A expenses 20.9% 21.2% 20.6% 21.1%
Segment operating profit 2.2% 0.9% 2.3% 1.2%
Ratios as a percent of sales, before the
effects of non-comparable items:
FIFO gross margin 23.3% 22.4% 23.2% 22.7%
LIFO gross margin 23.1% 22.1% 22.9% 22.3%
SG&A expenses 20.9% 21.2% 20.6% 21.2%(1)
Segment operating profit 2.2% 0.9% 2.3% 1.1%
(1) A non-comparable net credit of $6 million, primarily a pension curtailment
gain, is recorded in SG&A expenses for the 39 weeks ended October 27, 2001.
(2) Comparable store sales include the sales of stores after having been opened
for at least one full year. Comparable store sales include the sales for
relocated stores.
Eckerd's segment operating profit more than doubled to $79 million in this
year's third quarter from $30 million in the same period last year, and
increased 130 basis points to 2.2% of sales. Sales growth, gross margin
improvement and the leveraging of SG&A expenses all contributed to the increase
in operating profit.
Comparable store sales increased 4.9% for the quarter. Pharmacy sales increased
7.3% and general merchandise sales were flat compared to last year. As a percent
of total drugstore sales, pharmacy sales were 69.8% for the quarter versus 68.4%
for the same period last year, an increase of 140 basis points. Pharmacy sales
growth continues to benefit from certain industry trends such as the increased
use of pharmaceuticals as the first line of defense for healthcare and the aging
population. Sales to customers covered by third party programs such as managed
care organizations, as well as government and private insurance, have continued
to increase as a percent of total pharmacy sales. Third party pharmacy sales for
the third quarter this year were 92.8% of total pharmacy sales, versus 91.7% in
third quarter last year. Continued pharmacy sales growth is dependent on
Eckerd's ability to attract and retain managed care customers. Total pharmacy
sales were negatively impacted by approximately 240 basis points, principally
from a shift from branded drugs to lower priced generic drugs. Although the
shift to more generic drugs negatively affects pharmacy sales, it typically
improves margins. General merchandise sales reflect a continued promotional
selling environment with competitive prices and improved promotional marketing.
General merchandise sales gains were strongest in household products, beverages,
baby and hygiene products, cosmetics and fragrances.
-22-
LIFO gross margin for the quarter increased 100 basis points as a percent of
sales compared to last year, and includes a LIFO charge of $9 million in 2002
compared to $12 million in 2001. The increase in gross margin was primarily from
a shift to more generic drug sales, lower shrinkage rates, as measured by
physical inventories, and improved buying practices. Slightly offsetting this
increase was a higher proportion of lower-margin third party pharmacy sales.
As a percent of sales, SG&A expenses for the quarter improved 30 basis points
over last year. Included in third quarter 2002 is a net $3 million non-recurring
gain for Eckerd's portion of an antitrust settlement for litigation with
manufacturers, of which Eckerd was a co-plaintiff, partially offset by a
non-recurring reserve established for Eckerd's pharmacy benefit management
business. SG&A expenses as a percent of sales continue to improve as a result of
cost saving initiatives, such as efficiencies generated by the reconfigured
store formats, the elimination of redundancies in the back office, more
efficient distribution and the in-sourcing of information technology, as well as
the leverage generated by higher sales. By the end of third quarter 2002, a
total of 1,326 stores, or 50% of the store base, were operating in the new
reconfigured format, approximately 600 of which were completed this year. The
new format stores are more efficient to operate and contribute significantly to
operating results.
The following discussion compares this year's nine months results to 2001
results before the effects of the non-comparable $6 million net credit,
primarily for a pension curtailment gain, that reduced SG&A expenses in the
second quarter of 2001.
Segment operating profit for the nine months ended October 26, 2002 more than
doubled to $252 million from $116 million for the comparable period in 2001.
Comparable store sales increased 6.2%, with pharmacy sales increasing 8.5% and
general merchandise sales increasing 1.7% compared to last year. LIFO gross
margin in the first nine months of 2002 improved 60 basis points as a percent of
sales compared to the same period last year, principally from expanded generic
drug sales. SG&A expenses improved 60 basis points as a percent of sales,
reflecting the results of cost saving initiatives such as the in-sourcing of
information technology, salary savings from streamlining back office and
distribution operations, and efficiencies obtained from the reconfigured
drugstore formats, along with the leverage generated from higher sales.
The Company is in the second year of a three-year turnaround program for the
Eckerd drugstore business. The successful continuation of the Eckerd turnaround
is dependent on Eckerd's ability to successfully attract customers through
various marketing and merchandising programs, secure suitable new drugstore
locations at favorable lease terms, continue the reconfiguration and remodeling
program for drugstores, attract and retain qualified pharmacists and maintain
favorable reimbursement rates from managed care organizations, governmental and
other third party payors.
Other Unallocated
- -----------------
Other unallocated consists of real estate activities, investment transactions,
and other items that are related to corporate initiatives or activities, which
are not allocated to an operating segment but are included in total Company
operating income. Other unallocated for the third quarter of 2002 totaled $4
million, net, and consists primarily of impairment charges for unit closings
offset by real estate income. Third quarter 2001 results substantially included
$7 million of ACT initiative expenses, $36 million of department store and
catalog asset impairments and $28 million of real estate gains.
Net Interest Expense
- --------------------
Net interest expense for the third quarter and first nine months increased $4
million and $6 million, respectively, compared to the same periods last year.
The increase is related to lower returns on short-term investments and fees
related to the credit facility, partially offset by lower interest expense from
reduced borrowing levels.
-23-
Acquisition Amortization
- ------------------------
Acquisition amortization decreased $9 million and $48 million in the third
quarter and first nine months of 2002, respectively, compared to last year. The
decrease was primarily the result of the Company's adoption of SFAS No. 142,
"Goodwill and Other Intangible Assets," which eliminated the amortization
relating to goodwill and the Eckerd trade name.
Income Taxes
- ------------
The Company's effective income tax rate for continuing operations was 36.3% for
the third quarter of 2002 compared with 38.3% for the same period last year. The
decrease is due to recent changes to the tax law related to the deductibility of
dividends paid to the Company's savings plan and the effects of adopting SFAS
No. 142 (amortization of goodwill) discussed above. The effective income tax
rates applicable to continuing operations for nine months ended October 26, 2002
and October 27, 2001 were 36.4% and 40.5%, respectively.
Merchandise Inventories
- -----------------------
On October 26, 2002, consolidated merchandise inventories on the first-in,
first-out (FIFO) basis were $6,353 million compared to $6,653 million at October
27, 2001 and $5,307 million at January 26, 2002. The 4.5% decline compared to
last year's third quarter reflects lower inventories in Department Stores and
Catalog. Inventories for Department Stores and Catalog totaled $3,887 million
and $4,215 million at October 26, 2002 and October 27, 2001, respectively. On a
comparable store basis, department store inventories are on plan and are well
positioned in key gift items and categories for the holiday selling season.
Eckerd Drugstore inventories on a FIFO basis totaled $2,466 million compared
with $2,438 million last year. On a comparable store basis, inventories in
drugstores were approximately 2.9% lower than last year's levels.
The current cost of consolidated inventories exceeded the LIFO basis amount
carried on the balance sheet by approximately $410 million at October 26, 2002,
$377 million at January 26, 2002 and $380 million at October 27, 2001.
Liquidity and Capital Resources
- -------------------------------
After paying $920 million of maturing debt in the first half of the year, which
represents all of the maturities of long-term debt for the year, the Company's
liquidity remains strong with approximately $1.7 billion in cash and short-term
investments as of October 26, 2002. Of the total $1.7 billion in cash and
short-term investments, approximately $89 million of short-term investments were
pledged as collateral for import letters of credit not included in the bank
credit facility and for a portion of casualty program liabilities. Cash flow
generated from operating activities for the first nine months of 2002 was $392
million compared to cash flow used in operating activities of $248 million in
the comparable period of 2001. Improvements in cash flow are principally the
result of better operating performance and inventory management initiatives
under the department stores' new centralized merchandising model, which has
allowed for improvement in the flow of merchandise closer to its selling season.
For 2002, management expects cash uses for capital expenditures and dividends to
exceed cash flow from operating activities by approximately $200 million, which
is a $200 million improvement relative to plan.
The Company has completed two transactions that were part of its long-term
financing strategy to enhance overall liquidity and financial flexibility.
First, in May 2002, JCP and J.C. Penney Company, Inc. executed a $1.5 billion
revolving credit agreement (credit facility), which replaced a $1.5 billion bank
revolving credit facility and $630 million letter of credit facility.
Indebtedness incurred under the credit facility is collateralized by all
eligible domestic department store and catalog inventory, as defined in the
credit facility agreement. This credit facility provides JCP with an additional
source of liquidity for working capital needs and letter of credit support. No
borrowings, other than the issuance of trade and stand-by letters of credit,
which totaled $258 million as of the
-24-
end of the third quarter 2002, have been made under this credit facility. The
Company was in compliance with all financial covenants of the credit facility at
October 26, 2002.
Second, in August 2002, the Company completed a debt exchange in which certain
bondholders tendered a principal amount of $227.2 million of three existing debt
issues in exchange for new 9.000% Notes Due 2012 with a principal amount of
approximately $230.2. Bondholders exchanged $79.4 million of JCP's 6.125% Notes
Due 2003, $67.0 million of its 7.375% Notes Due 2004 and $80.8 million of its
6.9% Debentures Due 2026. This transaction effectively extended the maturity on
amounts represented by the exchanged notes and strengthened the Company's
liquidity as the turnaround of the Department Store and Catalog and Eckerd
drugstore businesses continues to be executed. The debt exchange is discussed
further in Note 12.
For the remainder of 2002, management believes that cash flow generated from
operations, combined with the short-term investment position, will be adequate
to fund cash requirements for capital expenditures, working capital and dividend
payments and, therefore, no external funding will be required. In October 2002,
the Company's strong liquidity position was recognized by Moody's Investors
Service, which assigned the Company its highest liquidity rating (SGL-1).
Additional liquidity strengths include the undrawn $1.5 billion credit facility
discussed above and significant unencumbered assets, primarily Eckerd inventory,
which totaled approximately $2,466 million at October 26, 2002, that could be
used to secure additional short-term funding, if needed. At the present time,
management does not expect to access the capital markets for any external
financing for the remainder of 2002.
Operating cash flows may be impacted by many factors, including the competitive
conditions in the retail industry, and the effects of the current economic
conditions and consumer confidence. Based on the nature of the Company's
businesses, management considers the above factors to be normal business risks.
The Company does not currently foresee any circumstances that would likely
impair the Company's ability to maintain its planned level of operations,
capital expenditures and dividends through the remainder of 2002.
Capital expenditures were $451 million through the first nine months of 2002
compared with $497 million for the comparable 2001 period. These were primarily
for new and relocated Eckerd drugstores and the continued remodeling and
reconfiguration of existing Eckerd drugstores, as well as the rollout of
centralized checkouts in JCPenney department stores, department store support
centers and investments in technology to support the new centralized
merchandising model. Estimated total capital expenditures for the full year are
now estimated to be $700 to $800 million, evenly split between the Department
Stores and Catalog and Eckerd business segments.
A quarterly dividend of $0.125 per share on the Company's outstanding common
stock was paid on November 1, 2002 to stockholders of record on October 10,
2002.
Pension Plan
- ------------
Due to the strong liquidity position and improved 2002 cash flow outlook at the
end of the third quarter, the Company was able to accelerate its strategy to
maintain an adequately funded pension plan. Shortly after the end of the third
quarter, the Company contributed $300 million, or $190 million on an after-tax
basis, to its pension plan. This represents contributions attributable to both
2002 and 2003.
The measurement date for the Company's pension plan is October 31, which was
subsequent to the end of the third quarter. As of October 31, 2002, the fair
value of pension assets was estimated at approximately $2.9 billion, including
the $300 million contribution discussed above. The Company's pension assets
exceeded the accumulated pension benefit obligation by approximately $280
million. Accordingly, in 2002 the Company will not record a minimum liability
adjustment, which would be charged to equity under SFAS No. 87, "Employers'
Accounting for Pensions."
-25-
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 third quarter of 2002, the Audit Committee of the Company's Board of
Directors approved estimated fees for the remainder of 2002, related to the
performance of both audit and allowable non-audit services by the Company's
external auditors, KPMG LLP.
Seasonality
- -----------
The Company's business depends to a great extent on the last quarter of the
year. Historically, sales for that period have averaged approximately one-third
of annual sales and comprise a significant portion of the Company's annual
profits. Accordingly, the results of operations for the three and nine months
ended October 26, 2002 are not necessarily indicative of the results for the
entire year.
-26-
Item 3 - Quantitative and Qualitative Disclosure about Market Risk
The Company is exposed to market risks in the normal course of business due to
changes in interest rates and currency exchange rates. The Company's market
risks related to interest rates at October 26, 2002 are similar to those
disclosed in the Company's 2001 10-K and the Company's Form 10-Qs for the 13
weeks ended April 27, 2002 and July 27, 2002. For the 13 and 39 weeks ended
October 26, 2002 the other comprehensive loss on foreign currency translation
was $36 million and $67 million. Due to the relatively small size of foreign
operations, management believes that its exposure to market risk associated with
foreign currencies would not have a material impact on its financial condition
or results of operations.
Item 4 - Controls and Procedures
Based on their evaluation of the Company's disclosure controls and procedures
(as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act
of 1934) as of a date within 90 days of the filing date of 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 significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their most recent evaluation.
This report may contain forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements, which reflect the Company's current views of future events and
financial performance, involve known and unknown risks and uncertainties that
may cause the Company's actual results to be materially different from planned
or expected results. Those risks and uncertainties include, but are not limited
to, competition, consumer demand, seasonality, economic conditions, and
government activity. Investors should take such risks into account when making
investment decisions.
-27-
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
The Company has no material legal proceedings pending against it.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
The following documents are filed as exhibits to this report:
o 99(i) Certificate of Allen Questrom Pursuant to ss.906 of
the Sarbanes-Oxley Act
o 99(ii) Certificate of Robert B. Cavanaugh Pursuant to ss.906
of the Sarbanes-Oxley Act
(b) Reports on Form 8-K
The Company filed the following reports on Form 8-K during the
period covered in this report:
o Current Report on Form 8-K dated August 9, 2002 (Item 5 -
Other Events and Regulation FD Disclosure; Item 7 -
Financial Statements and Exhibits)
o Current Report on Form 8-K dated August 13, 2002 (Item 9 -
Regulation FD Disclosure)
o Current Report on Form 8-K dated September 6, 2002 (Item 5 -
Other Events and Regulation FD Disclosure; Item 7 -
Financial Statements and Exhibits)
-28-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
J. C. PENNEY COMPANY, INC.
By /s/ W. J. Alcorn
------------------------
W. J. Alcorn
Senior Vice President and Controller
(Principal Accounting Officer)
Date: December 6, 2002
CERTIFICATIONS
- --------------
I, Allen Questrom, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of J. C. Penney Company,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 6, 2002.
/s/ Allen Questrom
--------------------------
Allen Questrom
Chairman and Chief Executive Officer
J. C. Penney Company, Inc.
CERTIFICATIONS
- --------------
I, Robert B. Cavanaugh, Executive Vice President and Chief Financial Officer,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of J. C. Penney Company,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 6, 2002.
/s/ Robert B. Cavanaugh
---------------------------
Robert B. Cavanaugh
Executive Vice President and Chief Financial Officer
J. C. Penney Company, Inc.