NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation and Consolidation
Basis of Presentation
J. C. Penney Company, Inc. is a holding company whose principal operating subsidiary is J. C. Penney Corporation, Inc. (JCP). JCP was incorporated in
Delaware
in
1924
, and J. C. Penney Company, Inc. was incorporated in Delaware in
2002
, when the holding company structure was implemented. The holding company has no independent assets or operations, and no direct subsidiaries other than JCP. The holding company and its consolidated subsidiaries, including JCP, are collectively referred to in this quarterly report as “we,” “us,” “our,” “ourselves” or the “Company,” unless otherwise indicated.
J. C. Penney Company, Inc. is a co-obligor (or guarantor, as appropriate) regarding the payment of principal and interest on JCP’s outstanding debt securities. The guarantee of certain of JCP’s outstanding debt securities by J. C. Penney Company, Inc. is full and unconditional.
These unaudited Interim Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and in accordance with the rules and regulations of the Securities and Exchange Commission (SEC). The accompanying unaudited Interim Consolidated Financial Statements, in our opinion, include all material adjustments necessary for a fair presentation and should be read in conjunction with the audited Consolidated Financial Statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended
February 3, 2018
(
2017
Form 10-K). We follow substantially the same accounting policies to prepare quarterly financial statements as are followed in preparing annual financial statements. A description of such significant accounting policies is included in the
2017
Form 10-K. The
February 3, 2018
financial information was derived from the audited Consolidated Financial Statements, with related footnotes, included in the
2017
Form 10-K. 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.
Fiscal Year
Our fiscal year ends on the Saturday closest to January 31. As used herein, “three months ended
November 3, 2018
” and “
third
quarter of
2018
” refers to the 13-week period ended
November 3, 2018
, and “three months ended
October 28, 2017
” and “
third
quarter of
2017
” refers to the 13-week period ended
October 28, 2017
. "
Nine months ended
November 3, 2018
" and "
nine
months ended
October 28, 2017
" refer to the 39-week periods ended
November 3, 2018
and
October 28, 2017
, respectively. Fiscal year 2018 contains 52 weeks, and fiscal year 2017 contains 53 weeks.
Basis of Consolidation
All significant inter-company transactions and balances have been eliminated in consolidation. Certain reclassifications were made to prior period amounts to conform to the current period presentation.
2. Changes in Accounting for Revenue Recognition and Retirement-Related Benefits
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) Topic 606 (ASC 606),
Revenue from Contracts with Customers, a replacement of Revenue Recognition (Topic 605)
. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We have adopted the new standard using the full retrospective approach on February 4, 2018, and with such adoption our revenue recognition policies related to gift card breakage, customer loyalty programs, credit card income and principal versus agent considerations were changed. Whereas we previously recognized gift card breakage, net of required escheatment,
60
months after the gift card was issued, we now recognize gift card breakage, net of required escheatment, over the redemption pattern of gift cards. Additionally, whereas we utilized the incremental cost method to account for our customer loyalty programs, we now account for our customer loyalty programs as revenue and are required to defer a portion of our sales to loyalty rewards to be earned by reward members for a future discount on a future sale.
We also changed the classification of profit sharing income earned in connection with our private label credit card and co-branded MasterCard® programs owned and serviced by Synchrony Financial (Synchrony). Under our agreement with Synchrony, we receive cash payments from Synchrony based upon the performance of the credit card portfolios. Previously,
the income we earned under our agreement with Synchrony was included as an offset to SG&A expenses. In connection with the adoption of the new standard, we changed our presentation to include such income in a separate line item described as Credit income and other. Further, we adjusted our principal versus agent considerations for certain contracts and where we previously considered ourselves to be the agent (report net sales) under these contracts based on the risk and rewards of the arrangement, we now consider ourselves to be the principal (report gross sales) based on our control of the good or service before it is transferred to the customer. Lastly, we changed our balance sheet presentation of our sales return liability and where we previously reflected the balance as a net liability, we now recognize a gross refund liability for the sales amounts expected to be refunded to customers and an asset for the recoverable cost of the merchandise expected to be returned by customers.
In March 2017, the FASB issued Accounting Standards Update (ASU) 2017-07,
Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
. ASU 2017-07 requires companies to present the service cost component of net periodic pension cost in the same line items in which they report compensation cost. Companies will present all other components of net periodic pension cost outside of operating income, if this subtotal is presented. As required by the standard, we retrospectively adopted ASU 2017-07 on February 4, 2018, and we changed the presentation of our Consolidated Statement of Operations to exclude the Pension line item and to reflect the service cost component of our pension expense/(income) in SG&A and to reflect all other cost components in a new separate line item below operating income/(loss) described as Other components of net periodic pension cost/(income).
These changes have been reported through retrospective application of the new policies to all periods presented. The impacts of all adjustments made to the financial statements are summarized below:
Consolidated Statements of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
October 28, 2017
|
|
October 28, 2017
|
($ in millions, except per share data)
|
Previously Reported
|
|
As Adjusted
|
|
Effect of Change
|
|
Previously Reported
|
|
As Adjusted
|
|
Effect of Change
|
Total net sales
|
$
|
2,807
|
|
|
$
|
2,817
|
|
|
$
|
10
|
|
|
$
|
8,475
|
|
|
$
|
8,503
|
|
|
$
|
28
|
|
Credit income and other
|
—
|
|
|
69
|
|
|
69
|
|
|
—
|
|
|
235
|
|
|
235
|
|
Cost of goods sold (exclusive of depreciation and amortization)
|
1,852
|
|
|
1,859
|
|
|
7
|
|
|
5,498
|
|
|
5,516
|
|
|
18
|
|
Selling, general and administrative (SG&A)
|
840
|
|
|
920
|
|
|
80
|
|
|
2,525
|
|
|
2,793
|
|
|
268
|
|
Pension
|
9
|
|
|
—
|
|
|
(9
|
)
|
|
3
|
|
|
—
|
|
|
(3
|
)
|
Restructuring and management transition
|
52
|
|
|
52
|
|
|
—
|
|
|
295
|
|
|
175
|
|
|
(120
|
)
|
Operating income/(loss)
|
(79
|
)
|
|
(78
|
)
|
|
1
|
|
|
(131
|
)
|
|
(31
|
)
|
|
100
|
|
Other components of net periodic pension cost/(income)
|
—
|
|
|
(2
|
)
|
|
(2
|
)
|
|
—
|
|
|
90
|
|
|
90
|
|
Income/(loss) before income taxes
|
(157
|
)
|
|
(154
|
)
|
|
3
|
|
|
(410
|
)
|
|
(400
|
)
|
|
10
|
|
Net income/(loss)
|
$
|
(128
|
)
|
|
$
|
(125
|
)
|
|
$
|
3
|
|
|
$
|
(370
|
)
|
|
$
|
(360
|
)
|
|
$
|
10
|
|
Basic earnings/(loss) per common share
|
$
|
(0.41
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
0.01
|
|
|
$
|
(1.19
|
)
|
|
$
|
(1.16
|
)
|
|
$
|
0.03
|
|
Diluted earnings/(loss) per common share
|
$
|
(0.41
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
0.01
|
|
|
$
|
(1.19
|
)
|
|
$
|
(1.16
|
)
|
|
$
|
0.03
|
|
Consolidated Statements of Comprehensive Income/(Loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
October 28, 2017
|
|
October 28, 2017
|
($ in millions)
|
Previously Reported
|
|
As Adjusted
|
|
Effect of Change
|
|
Previously Reported
|
|
As Adjusted
|
|
Effect of Change
|
Net income/(loss)
|
$
|
(128
|
)
|
|
$
|
(125
|
)
|
|
$
|
3
|
|
|
$
|
(370
|
)
|
|
$
|
(360
|
)
|
|
$
|
10
|
|
Consolidated Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 28, 2017
|
|
February 3, 2018
|
($ in millions)
|
Previously Reported
|
|
As Adjusted
|
|
Effect of Change
|
|
Previously Reported
|
|
As Adjusted
|
|
Effect of Change
|
Merchandise inventory
|
$
|
3,365
|
|
|
$
|
3,406
|
|
|
$
|
41
|
|
|
$
|
2,762
|
|
|
$
|
2,803
|
|
|
$
|
41
|
|
Other accounts payable and accrued expenses
|
1,056
|
|
|
1,081
|
|
|
25
|
|
|
1,119
|
|
|
1,156
|
|
|
37
|
|
Reinvested earnings/(accumulated deficit)
|
(3,376
|
)
|
|
(3,360
|
)
|
|
16
|
|
|
(3,122
|
)
|
|
(3,118
|
)
|
|
4
|
|
Consolidated Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
October 28, 2017
|
($ in millions)
|
Previously Reported
|
|
As Adjusted
|
|
Effect of Change
|
Cash flows from operating activities:
|
|
|
|
|
|
Net income/(loss)
|
$
|
(370
|
)
|
|
$
|
(360
|
)
|
|
$
|
10
|
|
Inventory
|
(511
|
)
|
|
(510
|
)
|
|
1
|
|
Accrued expenses and other
|
(88
|
)
|
|
(99
|
)
|
|
(11
|
)
|
3
.
Effect of New Accounting Standards
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force)
(ASU 2016-15). ASU 2016-15 clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods therein. Entities should apply the guidance retrospectively, but if it is impracticable to do so for an issue, the amendments related to that issue may be applied prospectively. We have adopted ASU 2016-15 on February 4, 2018 and it did not have a significant impact on our accounting and disclosures.
In February 2016, the FASB issued ASC Topic 842,
Leases (Topic 842), a replacement of Leases (Topic 840) and updated by various targeted improvements
, which will require lessees to recognize most leases on their balance sheets as lease liabilities with corresponding right-of-use assets. While many aspects of lessor accounting would remain the same, the new standard would make some changes, such as eliminating today’s real estate-specific guidance. As a globally converged standard, lessees and lessors would be required to classify most leases using a principle generally consistent with that of International Accounting Standards. The standard also would change what would be considered the initial direct costs of a lease. The standard would be effective for annual periods beginning after December 15, 2018 and interim periods within that year and must be adopted by a modified retrospective method, with elective reliefs, which requires application of the new guidance for all periods presented, or by an optional transition method, which would allow the application of current legacy guidance, including its disclosure requirements, in the comparative periods presented in the year of adoption. The Company plans to use the optional transition method when adopting the new standard.
We have developed a project team to analyze the impacts of the new standard on our current accounting policies and internal controls and the changes required to be made by our leasing software provider. With almost 70% of our store locations involved in an operating lease, the new standard will have a significant impact on our financial statements due to the recognition of lease liabilities and right-of-use assets that are not required by the current accounting requirements for operating leases. Given the magnitude of the project to implement the new standard, we are still evaluating the effect that the new accounting guidance will have on our financial condition, results of operations and cash flows.
4. Revenue
Our contracts with customers primarily consist of sales of merchandise and services at the point of sale, sales of gift cards to a customer for a future purchase, customer loyalty rewards that provide discount rewards to customers based on purchase activity, and certain licensing and profit sharing arrangements involving the use of our intellectual property by others.
Revenue includes Total net sales and Credit income and other. Net sales are categorized by merchandise and service sale groupings as we believe it best depicts the nature, amount, timing and uncertainty of revenue and cash flow.
The following table provides the components of Net sales for the three and
nine
months ended
November 3, 2018
and
October 28, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
($ in millions)
|
November 3, 2018
|
|
October 28, 2017
|
|
November 3, 2018
|
|
October 28, 2017
|
|
|
|
|
|
As Adjusted
|
|
|
|
|
|
As Adjusted
|
Women’s apparel
|
$
|
597
|
|
|
23
|
%
|
|
$
|
610
|
|
|
22
|
%
|
|
$
|
1,905
|
|
|
24
|
%
|
|
$
|
2,036
|
|
|
24
|
%
|
Men’s apparel and accessories
|
552
|
|
|
21
|
%
|
|
571
|
|
|
20
|
%
|
|
1,615
|
|
|
20
|
%
|
|
1,718
|
|
|
20
|
%
|
Home
|
357
|
|
|
13
|
%
|
|
414
|
|
|
15
|
%
|
|
1,073
|
|
|
13
|
%
|
|
1,204
|
|
|
14
|
%
|
Women’s accessories, including Sephora
|
329
|
|
|
12
|
%
|
|
364
|
|
|
13
|
%
|
|
1,029
|
|
|
13
|
%
|
|
1,086
|
|
|
13
|
%
|
Children’s, including toys
|
280
|
|
|
11
|
%
|
|
307
|
|
|
11
|
%
|
|
728
|
|
|
9
|
%
|
|
780
|
|
|
9
|
%
|
Footwear and handbags
|
236
|
|
|
9
|
%
|
|
258
|
|
|
9
|
%
|
|
676
|
|
|
8
|
%
|
|
741
|
|
|
9
|
%
|
Jewelry
|
139
|
|
|
5
|
%
|
|
129
|
|
|
4
|
%
|
|
451
|
|
|
6
|
%
|
|
437
|
|
|
5
|
%
|
Services and other
|
163
|
|
|
6
|
%
|
|
164
|
|
|
6
|
%
|
|
522
|
|
|
7
|
%
|
|
501
|
|
|
6
|
%
|
Total net sales
|
$
|
2,653
|
|
|
100
|
%
|
|
$
|
2,817
|
|
|
100
|
%
|
|
$
|
7,999
|
|
|
100
|
%
|
|
$
|
8,503
|
|
|
100
|
%
|
Credit income and other encompasses the revenue earned from the agreement with Synchrony associated with our private label credit card and co-branded MasterCard® programs.
Merchandise and Service Sales
Total net sales, which exclude sales taxes and are net of estimated returns, are generally recorded when payment is received and the customer takes control of the merchandise. Service revenue is recorded at the time the customer receives the benefit of the service, such as salon, portrait, optical or custom decorating. Shipping and handling fees charged to customers are also included in total net sales with corresponding costs recorded as cost of goods sold. Net sales are not recognized for estimated future returns which are estimated based primarily on historical return rates and sales levels.
Gift Card Revenue
At the time gift cards are sold a performance obligation is created and no revenue is recognized; rather, a contract liability is established for our obligation to provide a merchandise or service sale to the customer for the face value of the card. The contract liability is relieved and a net sale is recognized when gift cards are redeemed for merchandise or services. We recognize gift card breakage, net of required escheatment, over the redemption pattern of gift cards. Breakage is estimated based on historical redemption patterns and the estimates can vary based on changes in the usage patterns of our customers.
Customer Loyalty Rewards
Customers who spend a certain amount with us using our private label card or registered loyalty card receive points that can accumulate towards earning JCPenney Rewards certificates which are redeemable for a discount on future purchases. Points earned by a loyalty customer do not expire but any certificates earned expire two months from the date of issuance. We account for our customer loyalty rewards by deferring a portion of our sales to loyalty points expected to be earned towards a reward certificate, and then recognize the reward certificate as a net sale when used by the customer in connection with a merchandise or service sale. The points earned toward a future reward are valued at their relative standalone selling price by applying fair value based on historical redemption patterns.
The liabilities related to our gift cards and our customer loyalty program are included in Other accounts payable and accrued expenses in the unaudited Interim Consolidated Balance Sheets and constitute our contract liability. The balance of these liabilities were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
November 3, 2018
|
|
October 28, 2017
|
|
February 3, 2018
|
Gift cards
|
$
|
111
|
|
|
$
|
110
|
|
|
$
|
144
|
|
Loyalty rewards
|
60
|
|
|
73
|
|
|
73
|
|
Total contract liability
|
$
|
171
|
|
|
$
|
183
|
|
|
$
|
217
|
|
Contract liability includes consideration received for gift card and loyalty related performance obligations which have not been satisfied as of a given date.
A rollforward of the amounts included in contract liability for the first
nine
months of
2018
and
2017
are as follows:
|
|
|
|
|
|
|
|
|
(in millions)
|
2018
|
|
2017
|
Beginning balance
|
$
|
217
|
|
|
$
|
228
|
|
Current period gift cards sold and loyalty reward points earned
|
232
|
|
|
289
|
|
Net sales from amounts included in contract liability opening balances
|
(75
|
)
|
|
(89
|
)
|
Net sales from current period usage
|
(203
|
)
|
|
(245
|
)
|
Ending balance
|
$
|
171
|
|
|
$
|
183
|
|
Licensing Agreements
Our private label credit card and co-branded MasterCard® programs are owned and serviced by Synchrony. Under our agreement with Synchrony, we receive periodic cash payments from Synchrony based upon the consumer's usage of co-branded card and the performance of the credit card portfolio. We participate in the programs by providing marketing promotions designed to increase the use of each card, including enhanced marketing offers for cardholders. Additionally, we accept payments in our stores from cardholders who prefer to pay in person when they are shopping in our locations. Revenue related to this agreement is recognized over the time we have fulfilled our deliverables and is reflected in Credit income and other.
Principal Versus Agent
We assess principal versus agent considerations depending on our control of the good or service before it is transferred to the customer. When we are the principal and have control of the specified good or service, we include as a net sale the gross amount of consideration to which we expect to be entitled for that specified good or service in revenue. In contrast, when we are the agent and do not have control of the specified good or service, we include as a net sale the fee or commission to which we expect to be entitled for the agency service. In certain instances, the fee or commission might be the net amount retained after paying the supplier.
5. Earnings/(Loss) per Share
Net income/(loss) and shares used to compute basic and diluted earnings/(loss) per share (EPS) are reconciled below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
(in millions, except per share data)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
Earnings/(loss)
|
|
|
|
|
|
|
|
Net income/(loss)
|
$
|
(151
|
)
|
|
$
|
(125
|
)
|
|
$
|
(330
|
)
|
|
$
|
(360
|
)
|
Shares
|
|
|
|
|
|
|
|
Weighted average common shares outstanding (basic shares)
|
316.3
|
|
|
311.6
|
|
|
315.3
|
|
|
310.6
|
|
Adjustment for assumed dilution:
|
|
|
|
|
|
|
|
Stock options, restricted stock awards and warrant
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Weighted average shares assuming dilution (diluted shares)
|
316.3
|
|
|
311.6
|
|
|
315.3
|
|
|
310.6
|
|
EPS
|
|
|
|
|
|
|
|
Basic
|
$
|
(0.48
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
(1.05
|
)
|
|
$
|
(1.16
|
)
|
Diluted
|
$
|
(0.48
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
(1.05
|
)
|
|
$
|
(1.16
|
)
|
The following average potential shares of common stock were excluded from the diluted EPS calculation because their effect would have been anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
(Shares in millions)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
Stock options, restricted stock awards and warrant
|
22.9
|
|
|
32.1
|
|
|
25.8
|
|
|
32.9
|
|
6. Long-Term Debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
November 3, 2018
|
|
October 28, 2017
|
|
February 3, 2018
|
Issue:
|
|
|
|
|
|
|
5.75% Senior Notes Due 2018
(1)
|
|
$
|
—
|
|
|
$
|
190
|
|
|
$
|
190
|
|
8.125% Senior Notes Due 2019
(1)
|
|
50
|
|
|
175
|
|
|
175
|
|
5.65% Senior Notes Due 2020
(1)
|
|
110
|
|
|
400
|
|
|
360
|
|
2017 Credit Facility (Matures in 2022)
|
|
437
|
|
|
211
|
|
|
—
|
|
2016 Term Loan Facility (Matures in 2023)
|
|
1,593
|
|
|
1,635
|
|
|
1,625
|
|
5.875% Senior Secured Notes Due 2023
(1)
|
|
500
|
|
|
500
|
|
|
500
|
|
7.125% Debentures Due 2023
|
|
10
|
|
|
10
|
|
|
10
|
|
8.625% Senior Secured Second Priority Notes Due 2025
(1)
|
|
400
|
|
|
—
|
|
|
—
|
|
6.9% Notes Due 2026
|
|
2
|
|
|
2
|
|
|
2
|
|
6.375% Senior Notes Due 2036
(1)
|
|
388
|
|
|
388
|
|
|
388
|
|
7.4% Debentures Due 2037
|
|
313
|
|
|
313
|
|
|
313
|
|
7.625% Notes Due 2097
|
|
500
|
|
|
500
|
|
|
500
|
|
Total debt
|
|
4,303
|
|
|
4,324
|
|
|
4,063
|
|
Unamortized debt issuance costs
|
|
(50
|
)
|
|
(53
|
)
|
|
(51
|
)
|
Less: current maturities
|
|
(92
|
)
|
|
(232
|
)
|
|
(232
|
)
|
Total long-term debt
|
|
$
|
4,161
|
|
|
$
|
4,039
|
|
|
$
|
3,780
|
|
|
|
(1)
|
These debt issuances contain a change of control provision that would obligate us, at the holders’ option, to repurchase the debt at a price of 101%.
|
On March 12, 2018, JCP issued
$400 million
aggregate principal amount of senior secured second priority notes with a 8.625% interest rate (the "Notes"). The Notes are due in 2025 and are guaranteed, jointly and severally, by the Company and certain domestic subsidiaries of JCP that guarantee the Company's senior secured term loan facility and existing senior secured notes. The net proceeds from the Notes were used for the tender consideration for JCP's contemporaneous cash tender offers for
$125 million
aggregate principal amount of its 8.125% Senior Notes Due 2019 and
$250 million
aggregate principal amount of its 5.65% Senior Notes Due 2020 (collectively, the Securities). In doing so, we recognized a loss on extinguishment of debt of
$23 million
which includes the premium paid over the face value of the accepted Securities of
$20 million
, reacquisition costs of
$1 million
and the write off of unamortized debt issuance costs of
$2 million
.
As of
November 3, 2018
, outstanding borrowings under our $2.35 billion senior secured asset-based revolving credit facility (2017 Credit Facility) were
$437 million
. All borrowings under the 2017 Credit Facility accrue interest at a rate equal to, at the Company’s option, a base rate or an adjusted LIBOR rate plus a spread.
7. Derivative Financial Instruments
We use derivative financial instruments for hedging and non-trading purposes to manage our exposure to changes in interest rates. Use of derivative financial instruments in hedging programs subjects us to certain risks, such as market and credit risks. Market risk represents the possibility that the value of the derivative instrument will change. In a hedging relationship, the change in the value of the derivative is offset to a great extent by the change in the value of the underlying hedged item. Credit risk related to derivatives represents the possibility that the counterparty will not fulfill the terms of the contract. The notional,
or contractual, amount of our derivative financial instruments is used to measure interest to be paid or received and does not represent our exposure due to credit risk. Credit risk is monitored through established approval procedures, including setting concentration limits by counterparty, reviewing credit ratings and requiring collateral (generally cash) from the counterparty when appropriate.
When we use derivative financial instruments for the purpose of hedging our exposure to interest rates, the contract terms of a hedged instrument closely mirror those of the hedged item, providing a high degree of risk reduction and correlation. Contracts that are effective at meeting the risk reduction and correlation criteria are recorded using hedge accounting. If a derivative instrument is a hedge, depending on the nature of the hedge, changes in the fair value of the instrument will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or be recognized in Accumulated other comprehensive income/(loss) until the hedged item is recognized in earnings. The ineffective portion of an instrument’s change in fair value will be immediately recognized in earnings during the period. Instruments that do not meet the criteria for hedge accounting, or contracts for which we have not elected to apply hedge accounting, are valued at fair value with unrealized gains or losses reported in earnings during the period of change.
We have entered into interest rate swap agreements with notional amounts totaling
$1,250 million
to fix a portion of our variable LIBOR-based interest payments. The interest rate swap agreements have a weighted-average fixed rate of
2.04%
, mature on May 7, 2020 and have been designated as cash flow hedges. On September 4, 2018 we entered into additional interest rate swap agreements with notional amounts totaling
$750 million
to fix a portion of our variable LIBOR-based interest payments. The interest rate swap agreements have a weighted-average fixed rate of
3.135%
, have an effective date from May 7, 2020 to May 7, 2025 and have been designated as cash flow hedges.
The fair value of our interest rate swaps are recorded on the unaudited Interim Consolidated Balance Sheets as an asset or a liability (see Note 9). The effective portion of the interest rate swaps' changes in fair values is reported in Accumulated other comprehensive income/(loss) (see Note 10), and the ineffective portion is reported in Net income/(loss). Amounts in Accumulated other comprehensive income/(loss) are reclassified into Net income/(loss) when the related interest payments affect earnings. For the periods presented, all of the interest rate swaps were
100%
effective.
Information regarding the gross amounts of our derivative instruments in the unaudited Interim Consolidated Balance Sheets is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Derivatives at Fair Value
|
|
Liability Derivatives at Fair Value
|
($ in millions)
|
Balance Sheet Location
|
|
November 3, 2018
|
|
October 28, 2017
|
|
February 3, 2018
|
|
Balance Sheet Location
|
|
November 3, 2018
|
|
October 28, 2017
|
|
February 3, 2018
|
Derivatives designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
Prepaid expenses and other
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Other accounts payable and accrued expenses
|
|
$
|
—
|
|
|
$
|
2
|
|
|
$
|
1
|
|
Interest rate swaps
|
Other assets
|
|
23
|
|
|
—
|
|
|
9
|
|
|
Other liabilities
|
|
—
|
|
|
5
|
|
|
—
|
|
Total derivatives designated as hedging instruments
|
|
|
$
|
24
|
|
|
$
|
—
|
|
|
$
|
9
|
|
|
|
|
$
|
—
|
|
|
$
|
7
|
|
|
$
|
1
|
|
8. Restructuring and Management Transition
In the first quarter of 2017, the Company finalized plans to close
138
stores to help align the Company's brick-and-mortar presence with its omnichannel network, thereby redirecting capital resources to invest in locations and initiatives that offer the greatest revenue potential. The store closures resulted in a
$77 million
asset impairment charge for store assets with limited future use and a
$14 million
severance charge for the expected displacement of store associates. During the three months ended October 28, 2017,
$52 million
in store related closing and other costs such as certain lease obligations were recorded as a result of each respective store ceasing operations.
The components of Restructuring and management transition include:
|
|
•
|
Home office and stores
— charges for actions to reduce our store and home office expenses including employee termination benefits, store lease termination and impairment charges;
|
|
|
•
|
Management transition
— charges related to implementing changes within our management leadership team for both incoming and outgoing members of management; and
|
|
|
•
|
Other
— charges related primarily to contract termination costs and costs related to the closure of certain supply chain locations.
|
The composition of Restructuring and management transition charges was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
Cumulative
Amount From Program Inception Through
November 3, 2018
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
|
Home office and stores
|
$
|
2
|
|
|
$
|
52
|
|
|
$
|
11
|
|
|
$
|
173
|
|
|
$
|
484
|
|
Management transition
|
9
|
|
|
—
|
|
|
9
|
|
|
—
|
|
|
9
|
|
Other
|
—
|
|
|
—
|
|
|
—
|
|
|
2
|
|
|
185
|
|
Total
|
$
|
11
|
|
|
$
|
52
|
|
|
$
|
20
|
|
|
$
|
175
|
|
|
$
|
678
|
|
Activity for the Restructuring and management transition liability for the
nine
months ended
November 3, 2018
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
Home Office
and Stores
|
|
Management
Transition
|
|
Other
|
|
Total
|
February 3, 2018
|
$
|
34
|
|
|
$
|
—
|
|
|
$
|
7
|
|
|
$
|
41
|
|
Charges
|
14
|
|
|
9
|
|
|
—
|
|
|
23
|
|
Cash payments
|
(30
|
)
|
|
(2
|
)
|
|
(4
|
)
|
|
(36
|
)
|
November 3, 2018
|
$
|
18
|
|
|
$
|
7
|
|
|
$
|
3
|
|
|
$
|
28
|
|
9. Fair Value Disclosures
In determining fair value, the accounting standards establish a three level hierarchy for inputs used in measuring fair value, as follows:
|
|
•
|
Level 1 — Quoted prices in active markets for identical assets or liabilities.
|
|
|
•
|
Level 2 — Significant observable inputs other than quoted prices in active markets for similar assets and liabilities, such as quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
|
|
|
•
|
Level 3 — Significant unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants.
|
Cash Flow Hedges Measured on a Recurring Basis
As of
November 3, 2018
,
October 28, 2017
and
February 3, 2018
, the
$23 million
,
$(5) million
and
$9 million
fair value of our cash flow hedges, respectively, are valued in the market using discounted cash flow techniques which use quoted market interest rates in discounted cash flow calculations which consider the instrument's term, notional amount, discount rate and credit risk. Significant inputs to the derivative valuation for interest rate swaps are observable in the active markets and are classified as Level 2 in the fair value measurement hierarchy.
Other Non-Financial Assets Measured on a Non-Recurring Basis
In connection with the Company announcing its plan to close underperforming department stores in 2017, long-lived assets held and used with a carrying value of
$86 million
were written down to their fair value of
$9 million
, resulting in asset
impairment charges of
$77 million
in the
nine
months ended
October 28, 2017
. The fair value was determined based on comparable market values of similar properties or on a rental income approach and the significant inputs related to valuing the store related assets are classified as Level 2 in the fair value measurement hierarchy.
In connection with the Company's decision to sell its three airplanes, long-lived assets held and used with a carrying value of
$72 million
were written down to their fair value of
$20 million
, resulting in asset impairment charges of
$52 million
in the
nine
months ended
November 3, 2018
. The fair value was determined based on dealer quotes using a market approach and the significant inputs related to valuing the airplanes are classified as Level 2 in the fair value measurement hierarchy.
Other Financial Instruments
Carrying values and fair values of financial instruments that are not carried at fair value in the unaudited Interim Consolidated Balance Sheets are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 3, 2018
|
|
October 28, 2017
|
|
February 3, 2018
|
($ in millions)
|
Carrying
Amount
|
|
Fair
Value
|
|
Carrying
Amount
|
|
Fair
Value
|
|
Carrying
Amount
|
|
Fair
Value
|
Total debt, excluding unamortized debt issuance costs, capital leases, financing obligation and note payable
|
$
|
4,303
|
|
|
$
|
3,157
|
|
|
$
|
4,324
|
|
|
$
|
3,683
|
|
|
$
|
4,063
|
|
|
$
|
3,607
|
|
The fair value of long-term debt was estimated by obtaining quotes from brokers or was based on current rates offered for similar debt. As of
November 3, 2018
,
October 28, 2017
and
February 3, 2018
, the fair values of cash and cash equivalents and accounts payable approximated their carrying values due to the short-term nature of these instruments.
Concentrations of Credit Risk
We have no significant concentrations of credit risk.
10. Accumulated Other Comprehensive Income/(Loss)
The following tables show the changes in accumulated other comprehensive income/(loss) balances for the
nine
months ended
November 3, 2018
and the
nine
months ended
October 28, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
Net Actuarial
Gain/(Loss)
|
|
Prior Service
Credit/(Cost)
|
|
Foreign Currency Translation
|
|
Gain/(Loss) on Cash Flow Hedges
|
|
Accumulated
Other
Comprehensive
Income/(Loss)
|
February 3, 2018
|
$
|
(330
|
)
|
|
$
|
(26
|
)
|
|
$
|
—
|
|
|
$
|
(4
|
)
|
|
$
|
(360
|
)
|
Other comprehensive income/(loss) before reclassifications
|
—
|
|
|
—
|
|
|
—
|
|
|
10
|
|
|
10
|
|
Amounts reclassified from accumulated other comprehensive income
|
—
|
|
|
3
|
|
|
—
|
|
|
—
|
|
|
3
|
|
November 3, 2018
|
$
|
(330
|
)
|
|
$
|
(23
|
)
|
|
$
|
—
|
|
|
$
|
6
|
|
|
$
|
(347
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
Net Actuarial
Gain/(Loss)
|
|
Prior Service
Credit/(Cost)
|
|
Foreign Currency Translation
|
|
Gain/(Loss) on Cash Flow Hedges
|
|
Accumulated
Other
Comprehensive
Income/(Loss)
|
January 28, 2017
|
$
|
(421
|
)
|
|
$
|
(33
|
)
|
|
$
|
(2
|
)
|
|
$
|
(17
|
)
|
|
$
|
(473
|
)
|
Other comprehensive income/(loss) before reclassifications
|
53
|
|
|
—
|
|
|
—
|
|
|
(2
|
)
|
|
51
|
|
Amounts reclassified from accumulated other comprehensive income
|
8
|
|
|
6
|
|
|
—
|
|
|
5
|
|
|
19
|
|
October 28, 2017
|
$
|
(360
|
)
|
|
$
|
(27
|
)
|
|
$
|
(2
|
)
|
|
$
|
(14
|
)
|
|
$
|
(403
|
)
|
11. Retirement Benefit Plans
The components of net periodic pension expense/(income) for our non-contributory qualified defined benefit pension plan and supplemental pension plans were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
Service cost
|
$
|
9
|
|
|
$
|
11
|
|
|
$
|
28
|
|
|
$
|
32
|
|
|
|
|
|
|
|
|
|
Other components of net periodic pension cost/(income):
|
|
|
|
|
|
|
|
Interest cost
|
34
|
|
|
38
|
|
|
104
|
|
|
114
|
|
Expected return on plan assets
|
(55
|
)
|
|
(53
|
)
|
|
(167
|
)
|
|
(160
|
)
|
Amortization of prior service cost/(credit)
|
2
|
|
|
1
|
|
|
6
|
|
|
5
|
|
Settlement expense
|
—
|
|
|
12
|
|
|
—
|
|
|
12
|
|
Curtailment (gain)/loss recognized
|
—
|
|
|
—
|
|
|
—
|
|
|
7
|
|
Special termination benefit recognized
|
—
|
|
|
—
|
|
|
—
|
|
|
112
|
|
|
(19
|
)
|
|
(2
|
)
|
|
(57
|
)
|
|
90
|
|
Net periodic pension expense/(income)
|
$
|
(10
|
)
|
|
$
|
9
|
|
|
$
|
(29
|
)
|
|
$
|
122
|
|
Service cost is included in SG&A in the unaudited Interim Consolidated Statements of Operations.
In the first quarter of 2017, the Company initiated a Voluntary Early Retirement Program (VERP) for approximately
6,000
eligible associates. Eligibility for the VERP included home office, stores and supply chain personnel who met certain criteria related to age and years of service as of January 31, 2017. Based on the approximately
2,800
associates who elected to accept the VERP, we incurred a total charge of
$112 million
for special retirement benefits. The special retirement benefits increased the projected benefit obligation (PBO) of the qualified defined benefit pension plan (Primary Pension Plan) and the supplemental pension plans by
$88 million
and
$24 million
, respectively. In addition, we incurred curtailment charges of
$7 million
related to our pension plans as a result of the reduction in the expected years of future service related to these plans. As a result of these curtailments, the assets and the liabilities for our Primary Pension Plan and the liabilities of certain supplemental pension plans were remeasured as of March 31, 2017. The discount rate used for the March 31 remeasurements was
4.34%
compared to the year-end 2016 discount rate of
4.40%
. These events resulted in the PBO of our Primary Pension Plan decreasing by
$3 million
and the related assets increasing by
$34 million
and the PBO of our supplemental pension plans increasing by
$3 million
. The funded status of the Primary Pension Plan was
98%
as of the remeasurement date.
During the third quarter of 2017, we recognized settlement expense of
$12 million
due to higher lump-sum payment activity to retirees primarily as a result of the VERP executed earlier in the year. The lump-sum payments reduced our pension obligation by
$195 million
. Following these payments and the completion of a remeasurement of plan assets and liabilities, the plan's funded status was
100%
as of October 28, 2017. The discount rate used for the remeasurement as of October 28, 2017 was
3.94%
compared to the year-end 2016 discount rate of
4.40%
.
12. Real Estate and Other, Net
Real estate and other consists of ongoing operating income from our real estate subsidiaries. Real estate and other also includes net gains from the sale of facilities and equipment that are no longer used in operations, asset impairments, accruals for certain litigation and other non-operating charges and credits. In addition, we entered into a joint venture in 2014 in which we contributed approximately
220
acres of excess property adjacent to our home office facility in Plano, Texas (Home Office Land Joint Venture). The joint venture was formed to develop the contributed property and our proportional share of the joint venture's activities is recorded in Real estate and other, net. During the three months ended November 3, 2018, we sold our interest to the other partner and are no longer a member of the joint venture.
The composition of Real estate and other, net was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
Investment income from Home Office Land Joint Venture
|
$
|
(3
|
)
|
|
$
|
(3
|
)
|
|
$
|
(4
|
)
|
|
$
|
(23
|
)
|
Net gain from sale of operating assets
|
(1
|
)
|
|
(1
|
)
|
|
(58
|
)
|
|
(119
|
)
|
Impairments
|
—
|
|
|
—
|
|
|
52
|
|
|
—
|
|
Other
|
(3
|
)
|
|
6
|
|
|
(3
|
)
|
|
7
|
|
Total expense/(income)
|
$
|
(7
|
)
|
|
$
|
2
|
|
|
$
|
(13
|
)
|
|
$
|
(135
|
)
|
Investment Income from Joint Ventures
During the three and nine months ended November 3, 2018, the Company had income of
$3 million
and
$4 million
, respectively, related to its proportional share of the net income in the Home Office Land Joint Venture and received aggregate cash distributions of
$3 million
and
$4 million
, respectively. During the three and nine months ended October 28, 2017, the Company had income of
$3 million
and
$23 million
, respectively, related to its proportional share of the net income in the Home Office Land Joint Venture and received aggregate cash distributions of
$3 million
and
$31 million
, respectively. Additionally, during the three months ended November 3, 2018, we received
$3 million
in proceeds from the partner to buy out our remaining interest in the joint venture.
Net Gain from Sale of Operating Assets
During the first quarter of 2018, we completed the sale-leaseback of our Milwaukee, Wisconsin distribution facility for a net sale price of
$30 million
and recognized a net gain of
$12 million
. During the second quarter of 2018, we completed the sale of our Manchester, Connecticut distribution facility for a net sale price of
$68 million
and recognized a net gain of
$38 million
. During the first quarter of 2017, we completed the sale of our Buena Park, California distribution facility for a net sale price of
$131 million
and recorded a net gain of
$111 million
.
Impairments
During the second quarter of 2018, we recorded an impairment charge of
$52 million
related to the expected sale of three airplanes. Two of the airplanes were sold during the second quarter of 2018 at their fair value of
$12 million
. During the third quarter of 2018, the third airplane was sold at its fair value of
$8 million
.
13. Income Taxes
The net tax
benefit
of
$8 million
for the three months ended
November 3, 2018
consisted of federal, state and foreign tax benefits of
$2 million
, a
$2 million
benefit relating to other comprehensive income and a
$5 million
benefit due to the release of valuation allowance, offset by
$1 million
of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets.
The net tax
benefit
of
$4 million
for the
nine
months ended
November 3, 2018
consisted of federal, state and foreign tax expenses of
$3 million
,
$3 million
of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets and
$1 million
of net tax expense resulting from enacted state law changes, offset by a
$5 million
benefit relating to other comprehensive income, a
$5 million
benefit due to the release of valuation allowance and a net tax benefit of
$1 million
resulting from state audit settlements.
As of
November 3, 2018
, we have approximately
$2.4 billion
of net operating losses (NOLs) available for U.S. federal income tax purposes, which largely expire in 2032 through 2034 and
$60 million
of tax credit carryforwards that expire at various dates through 2037. A valuation allowance of
$578 million
(restated for the tax effects of revenue recognition) fully offsets the federal deferred tax assets resulting from the NOL and tax credit carryforwards that expire at various dates through 2037. A valuation allowance of
$257 million
fully offsets the deferred tax assets resulting from the state NOL carryforwards that expire at various dates through 2037. In assessing the need for the valuation allowance, we considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets. As a result of our periodic assessment, our estimate of the realization of deferred tax assets is solely based on the future reversals of existing taxable temporary differences and tax planning strategies that we would make use of to accelerate taxable income to utilize expiring NOL and tax credit carryforwards. Accordingly, in the three and
nine
months ended
November 3, 2018
, the valuation allowance was increased by
$35 million
and
$69 million
, respectively, to offset the net deferred tax assets created in the quarter relating primarily to the increase in NOL carryforwards.
14. Litigation and Other Contingencies
Litigation
Shareholder Derivative Litigation
Weitzman/Lipsius.
In October 2013, two purported shareholder derivative actions were filed against certain present and former members of the Company’s Board of Directors and executives by the following parties in the U.S. District Court, Eastern District of Texas, Sherman Division: Weitzman (filed October 2, 2013) and Zauderer (filed October 3, 2013). The Company was named as a nominal defendant in both suits. The lawsuits asserted claims for breaches of fiduciary duties and unjust enrichment based upon alleged false and misleading statements and/or omissions regarding the Company’s financial condition. The lawsuits sought unspecified compensatory damages, restitution, disgorgement by the defendants of all profits, benefits and other compensation, equitable relief to reform the Company’s corporate governance and internal procedures, reasonable costs and expenses, and other relief as the court may deem just and proper. On October 28, 2013, the Court consolidated the two cases into the Weitzman lawsuit. Also, in March 2016, plaintiff Frank Lipsius filed a purported shareholder derivative action against certain present and former members of the Company's Board of Directors and executives in the District Court of Collin County in the State of Texas. The Company was named as a nominal defendant in the suit. The suit generally mirrored the allegations contained in the Weitzman and Zauderer suits and sought similar relief. On May 18, 2017, plaintiff in the Lipsius suit voluntarily dismissed the Collin County action, and on May 19, 2017, refiled the action in the District Court of Dallas County, Texas. The parties have settled the Weitzman and Lipsius derivative litigation and the federal court granted final approval of the settlement on September 12, 2018. The state court litigation was dismissed pursuant to the terms of the settlement shortly thereafter.
Rojas.
On October 19, 2018, a shareholder of the Company, Juan Rojas, filed a shareholder derivative action against certain present and former members of the Company’s Board of Directors in the Delaware Court of Chancery. The Company is named as a nominal defendant. The lawsuit asserts claims for breaches of fiduciary duties based on alleged failures to prevent the Company from engaging in allegedly unlawful promotional pricing practices. While no assurance can be given as to the ultimate outcome of this matter, we believe that the final resolution of this action will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.
Other Legal Proceedings
The District Attorney’s office for the County of San Joaquin, California, joined by District Attorneys for other counties in California, recently concluded an investigation regarding the handling and disposal at JCP’s California stores and distribution centers of certain materials that may be deemed hazardous or universal waste under California law. On February 21, 2018, the District Attorneys provided a settlement demand to JCP that included a proposed civil penalty, reimbursement of investigation costs, enhancements to JCP’s compliance program and certain injunctive relief. JCP and the District Attorneys have reached an agreement to fully resolve this matter by entering into a stipulation for entry of final judgment and permanent injunction, which was approved by a California court on October 16, 2018. JCP did not admit to any issue of law or fact, but agreed to pay a civil penalty and to reimburse the government’s enforcement costs. JCP also agreed to invest in enhancements to its compliance program over the next five years. We do not believe the cost of the settlement and compliance with the final judgment will have a material adverse effect on our results of operations, financial position, liquidity or capital resources.
We are subject to various other legal and governmental proceedings involving routine litigation incidental to our business. Accruals have been established based on our best estimates of our potential liability in certain of these matters, including certain matters discussed above, all of which we believe aggregate to an amount that is not material to the Consolidated Financial Statements. These estimates were developed in consultation with in-house and outside counsel. While no assurance can be given as to the ultimate outcome of these matters, we currently believe that the final resolution of these actions, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.
Contingencies
As of
November 3, 2018
, we have an estimated accrual of
$20 million
related to potential environmental liabilities that is recorded in Other accounts payable and accrued expenses and Other liabilities in the unaudited Interim Consolidated Balance Sheet. This estimate covered potential liabilities primarily related to underground storage tanks, remediation of environmental conditions involving our former drugstore locations and asbestos removal in connection with approved plans to renovate or dispose of our facilities. We continue to assess required remediation and the adequacy of environmental reserves as new
information becomes available and known conditions are further delineated. If we were to incur losses at the estimated amount, we do not believe that such losses would have a material effect on our financial condition, results of operations or liquidity.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
J. C. Penney Company, Inc. is a holding company whose principal operating subsidiary is J. C. Penney Corporation, Inc. (JCP). JCP was incorporated in Delaware in 1924, and J. C. Penney Company, Inc. was incorporated in Delaware in 2002, when the holding company structure was implemented. The holding company has no independent assets or operations and no direct subsidiaries other than JCP. The holding company and its consolidated subsidiaries, including JCP, are collectively referred to in this quarterly report as “we,” “us,” “our,” “ourselves” or the “Company,” unless otherwise indicated.
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 of certain of JCP’s outstanding debt securities by the holding company is full and unconditional.
This discussion is intended to provide information that will assist the reader in understanding our 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 our Company as a whole, as well as how certain accounting principles affect the financial statements. It should be read in conjunction with our consolidated financial statements as of
February 3, 2018
, and for the year then ended, and related Notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), all contained in the Annual Report on Form 10-K for the fiscal year ended
February 3, 2018
(
2017
Form 10-K). Unless otherwise indicated, all references to earnings/(loss) per share (EPS) are on a diluted basis and all references to years relate to fiscal years rather than to calendar years.
Current Initiatives
While current management reassesses our business strategies, we will continue our focus on the following four initiatives:
|
|
•
|
Women's apparel business;
|
First, we will continue to focus on our beauty categories of Sephora, The Salon by InStyle and Fine Jewelry. In 2017, we opened 70 additional Sephora locations, bringing our total number of locations to 642. We added approximately 27 new Sephora locations and intend to continue to roll out and launch new brands in 2018. We are also continuing to rebrand our salons to The Salon by InStyle and plan to modernize and rebrand another 100 salons in 2018. Finally, we intend to continue to enhance our Fine Jewelry offerings to better provide the customer with a total beauty solution. Magnifying the importance of physical stores, we see Sephora, Salon and Fine Jewelry as differentiators to help drive traffic and increase the frequency of visits to our stores.
Second, we will continue to focus on improving our women's apparel offering by strategically adjusting our assortment to better align with customer preferences. Our focus will be in categories that offer the greatest opportunity for growth, particularly special sizes, active wear, dresses, contemporary and casual sportswear. In addition, we are taking steps in women's apparel to simplify the floor, better balance our career and casual offerings and create a stronger value statement with pricing.
Third, we remain committed to becoming a world-class omnichannel retailer. We plan to continue to enhance our site functionality and ship-from-store capabilities and develop additional enhancements to our improved mobile app.
Lastly, we will continue to focus on our home refresh initiative. We have established appliance showrooms in over 600 stores and have increased our mattress offering to approximately 500 in-store showrooms. We see our home refresh initiative as an opportunity for us to increase our revenue per customer.
Third
Quarter Overview
|
|
▪
|
Total net sales were
$2,653 million
with a total net sales
decrease
of
5.8%
compared to the
third
quarter of
2017
and a comparable store sales
decrease
of
5.4%
.
|
|
|
▪
|
Credit income and other was
$80 million
compared to
$69 million
in last year's
third
quarter. The increase was due to increased gain share resulting from improved performance of the credit portfolio.
|
|
|
▪
|
Cost of goods sold, which excludes depreciation and amortization, as a percentage of Total net sales
increased
to
68.1%
compared to
66.0%
in the same period last year. The increase as a rate of sales was primarily attributable to the clearance markdowns related to our decision to liquidate slower-moving, excess inventory, during the period.
|
|
|
▪
|
Selling, general and administrative (SG&A) expenses as a percentage of Total net sales
increased
to
33.3%
for the
third
quarter of
2018
as compared to
32.7%
for the same period last year. The net
increase
in SG&A expenses as a percentage of Total net sales for the quarter was primarily driven by the decrease in net sales and by higher store controllable costs and marketing spend relative to our sales volume, offset by a reduction in lease expense associated with the amortization of gains on the sales of leasehold interests.
|
|
|
▪
|
Our net loss was
$151 million
, or (
$0.48
) per share, compared to a net loss of
$125 million
, or (
$0.40
) per share, for the corresponding prior year quarter. Results for this quarter included the following amounts that are not directly related to our ongoing core business operations:
|
|
|
▪
|
$11 million
, or ($0.03) per share, of restructuring and management transition charges;
|
|
|
▪
|
$19 million
, or $0.06 per share, for other components of net periodic pension income;
|
|
|
▪
|
$3 million
, or $0.01 per share, for our proportional share of net income from our joint venture formed to develop the excess property adjacent to our home office facility in Plano, Texas (Home Office Land Joint Venture); and
|
|
|
▪
|
$2 million
, or $0.01 per share, for the tax benefit resulting from other comprehensive income allocation related to pension and interest rate swap activity.
|
|
|
▪
|
Adjusted net
loss
was
$164 million
, or ($
0.52
) per share, compared to
an adjusted net loss
of
$108 million
, or ($
0.35
) per share, in last year's
third
quarter. See the reconciliation of net income/(loss) and diluted EPS, the most directly comparable generally accepted accounting principles (GAAP) financial measures, to adjusted net income/(loss) and adjusted diluted EPS on page 27.
|
|
|
▪
|
Adjusted earnings before interest expense, income tax (benefit)/expense and depreciation and amortization (Adjusted EBITDA) (non-GAAP) was
$46 million
, a
$56 million
decline
from the same period last year. See the reconciliation of net income/(loss), the most directly comparable GAAP financial measure, to Adjusted EBITDA on page 26.
|
|
|
▪
|
We completed a multi-year extension of our private-label and co-branded credit card agreement with Synchrony Bank. The amended and restated agreement provides for improved alignment with respect to the marketing and servicing alliance of the program.
|
|
|
▪
|
Effective October 15, 2018, the Board of Directors elected Jill Soltau as Chief Executive Officer of the Company.
|
Results of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
($ in millions, except EPS)
|
November 3,
2018
|
|
October 28,
2017
|
(1)
|
November 3,
2018
|
|
October 28,
2017
|
(1)
|
Total net sales
|
$
|
2,653
|
|
|
$
|
2,817
|
|
|
$
|
7,999
|
|
|
$
|
8,503
|
|
|
Credit income and other
|
80
|
|
|
69
|
|
|
234
|
|
|
235
|
|
|
Total revenues
|
2,733
|
|
|
2,886
|
|
|
8,233
|
|
|
8,738
|
|
|
Total net sales increase/(decrease) from prior year
|
(5.8
|
)%
|
|
(1.8
|
)%
|
|
(5.9
|
)%
|
|
(1.3
|
)%
|
|
Comparable store sales increase/(decrease)
(2)
|
(5.4
|
)%
|
|
1.7
|
%
|
|
(1.7
|
)%
|
|
(1.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
Costs and expenses/(income):
|
|
|
|
|
|
|
|
|
Cost of goods sold (exclusive of depreciation and amortization shown separately below)
|
1,808
|
|
|
1,859
|
|
|
5,351
|
|
|
5,516
|
|
|
Selling, general and administrative
|
883
|
|
|
920
|
|
|
2,589
|
|
|
2,793
|
|
|
Depreciation and amortization
|
138
|
|
|
131
|
|
|
419
|
|
|
420
|
|
|
Real estate and other, net
|
(7
|
)
|
|
2
|
|
|
(13
|
)
|
|
(135
|
)
|
|
Restructuring and management transition
|
11
|
|
|
52
|
|
|
20
|
|
|
175
|
|
|
Total costs and expenses
|
2,833
|
|
|
2,964
|
|
|
8,366
|
|
|
8,769
|
|
|
Operating income/(loss)
|
(100
|
)
|
|
(78
|
)
|
|
(133
|
)
|
|
(31
|
)
|
|
Other components of net periodic pension cost/(income)
|
(19
|
)
|
|
(2
|
)
|
|
(57
|
)
|
|
90
|
|
|
(Gain)/loss on extinguishment of debt
|
—
|
|
|
—
|
|
|
23
|
|
|
35
|
|
|
Net interest expense
|
78
|
|
|
78
|
|
|
235
|
|
|
244
|
|
|
Income/(loss) before income taxes
|
(159
|
)
|
|
(154
|
)
|
|
(334
|
)
|
|
(400
|
)
|
|
Income tax expense/(benefit)
|
(8
|
)
|
|
(29
|
)
|
|
(4
|
)
|
|
(40
|
)
|
|
Net income/(loss)
|
$
|
(151
|
)
|
|
$
|
(125
|
)
|
|
$
|
(330
|
)
|
|
$
|
(360
|
)
|
|
Adjusted EBITDA (non-GAAP)
(3)
|
$
|
46
|
|
|
$
|
102
|
|
|
$
|
302
|
|
|
$
|
541
|
|
|
Adjusted net income/(loss) (non-GAAP)
(3)
|
$
|
(164
|
)
|
|
$
|
(108
|
)
|
|
$
|
(353
|
)
|
|
$
|
(129
|
)
|
|
Diluted EPS
|
$
|
(0.48
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
(1.05
|
)
|
|
$
|
(1.16
|
)
|
|
Adjusted diluted EPS (non-GAAP)
(3)
|
$
|
(0.52
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(1.12
|
)
|
|
$
|
(0.42
|
)
|
|
Ratios as a percent of total net sales:
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
68.1
|
%
|
|
66.0
|
%
|
|
66.9
|
%
|
|
64.9
|
%
|
|
SG&A
|
33.3
|
%
|
|
32.7
|
%
|
|
32.4
|
%
|
|
32.8
|
%
|
|
Operating income/(loss)
|
(3.8
|
)%
|
|
(2.8
|
)%
|
|
(1.7
|
)%
|
|
(0.4
|
)%
|
|
|
|
(1)
|
Reflects the retrospective application of the changes in accounting for revenue recognition and retirement-related benefits. See Note 2 of Notes to unaudited Interim Consolidated Financial Statements for a discussion of the changes and related impacts.
|
|
|
(2)
|
Comparable store sales are presented on a 52-week basis and include sales from all stores, including sales from services, that have been open for 12 consecutive full fiscal months and Internet sales. Stores closed for an extended period are not included in comparable store sales calculations, while stores remodeled and minor expansions not requiring store closure remain in the
calculations. Certain items, such as sales return estimates and store liquidation sales, are excluded from the Company’s calculation. Our definition and calculation of comparable store sales may differ from other companies in the retail industry.
|
|
|
(3)
|
See “Non-GAAP Financial Measures” for a discussion of this non-GAAP measure and reconciliation to its most directly comparable GAAP financial measure and further information on its uses and limitations.
|
Total Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
Total net sales
|
$
|
2,653
|
|
|
$
|
2,817
|
|
|
$
|
7,999
|
|
|
$
|
8,503
|
|
Sales percent increase/(decrease):
|
|
|
|
|
|
|
|
Total net sales
|
(5.8
|
)%
|
|
(1.8
|
)%
|
|
(5.9
|
)%
|
|
(1.3
|
)%
|
Comparable store sales
|
(5.4
|
)%
|
|
1.7
|
%
|
|
(1.7
|
)%
|
|
(1.0
|
)%
|
Total net sales
decreased
$164 million
in the
third
quarter of
2018
compared to the
third
quarter of
2017
. For the first
nine
months of 2017, total net sales
decreased
$504 million
from the same period last year.
The following table provides the components of the net sales increase/(decrease):
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
($ in millions)
|
November 3, 2018
|
|
November 3, 2018
|
Comparable store sales increase/(decrease)
|
$
|
(147
|
)
|
|
$
|
(134
|
)
|
Closed stores and other
|
(17
|
)
|
|
(370
|
)
|
Total net sales increase/(decrease)
|
$
|
(164
|
)
|
|
$
|
(504
|
)
|
As our omnichannel strategy continues to mature, it is increasingly difficult to distinguish between a store sale and an Internet sale. Because we no longer have a clear distinction between store sales and Internet sales, we do not separately report Internet sales. Below is a list of some of our omnichannel activities:
|
|
•
|
Stores increase Internet sales by providing customers opportunities to view, touch and/or try on physical merchandise before ordering online.
|
|
|
•
|
Our website increases store sales as in-store customers have often pre-shopped online before shopping in the store, including verification of which stores have online merchandise in stock.
|
|
|
•
|
Most Internet purchases are easily returned in our stores.
|
|
|
•
|
JCPenney Rewards can be earned and redeemed online or in stores.
|
|
|
•
|
In-store customers can order from our website with the assistance of associates in our stores or they can shop our website from the JCPenney app while inside the store.
|
|
|
•
|
Customers who utilize our mobile application can receive mobile coupons to use when they check out both online or in our stores.
|
|
|
•
|
Internet orders can be shipped from a dedicated jcpenney.com fulfillment center, a store, a store merchandise distribution center, a regional warehouse, directly from vendors or any combination of the above.
|
|
|
•
|
Certain categories of store inventory can be accessed and purchased by jcpenney.com customers and shipped directly to the customer's home from the store.
|
|
|
•
|
Internet orders can be shipped to stores for customer pick up.
|
|
|
•
|
"Buy online and pick up in store" is now available in all of our stores.
|
For the
third
quarter of 2018, units per transaction increased, while average unit retail and transaction counts decreased as compared to last year. For the first
nine
months of
2018
, average unit retail and units per transaction increased, while transaction counts decreased as compared to the prior year.
For the
third
quarter of 2018, our top-performing merchandise divisions were Jewelry, Women's Apparel and Men's on a comparable store basis. For the first
nine
months of 2018, our top-performing merchandise divisions were Jewelry, Men's, Women's Apparel and Sephora on a comparable store basis. Geographically, the Northeast and Midwest were the best performing regions of the country during the
third
quarter. The Southeast, Gulf Coast and Northwest were the best performing regions of the country during the first
nine
months of
2018
.
During each of the
third
quarters of
2018
and
2017
, private and exclusive brand merchandise comprised 45% and 7% of total merchandise sales, respectively. For the first
nine
months of
2018
and
2017
, private brand merchandise comprised 45% and 47% of total merchandise sales, respectively, and exclusive brand merchandise comprised 7% and 8% of total merchandise sales, respectively.
Store Count
The following table compares the number of stores for the
three and nine
months ended
November 3, 2018
and
October 28, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
JCPenney department stores
|
|
|
|
|
|
|
|
Beginning of period
|
865
|
|
|
1,011
|
|
|
872
|
|
|
1,013
|
|
Stores opened
|
—
|
|
|
—
|
|
|
1
|
|
|
—
|
|
Closed stores
|
(1
|
)
|
|
(137
|
)
|
|
(9
|
)
|
|
(139
|
)
|
End of period
(1)
|
864
|
|
|
874
|
|
|
864
|
|
|
874
|
|
|
|
(1)
|
Gross selling space, including selling space allocated to services and licensed departments, was 95 million square feet as of
November 3, 2018
and 96 million square feet as of
October 28, 2017
.
|
Credit Income and Other
Our private label credit card and co-branded MasterCard® programs are owned and serviced by Synchrony Financial (Synchrony). Under our agreement with Synchrony, we receive cash payments from Synchrony based upon the performance of the credit card portfolios. We participate in the programs by providing marketing promotions designed to increase the use of each card, including enhanced marketing offers for cardholders. Additionally, we accept payments in our stores from cardholders who prefer to pay in person when they are shopping in our locations. For the
third
quarters of
2018
and
2017
,
we recognized income of
$80 million
and
$69 million
, respectively, pursuant to our agreement with Synchrony. Through the first
nine
months of
2018
and
2017
, we recognized income of
$234 million
and
$235 million
, respectively. The increase for the three month period is due to increased income share resulting from the improved performance of the credit card portfolio.
Cost of Goods Sold
Cost of goods sold, exclusive of depreciation and amortization, for the three months ended
November 3, 2018
was
$1,808 million
, a
decrease
of
$51 million
compared to
$1,859 million
for the three months ended
October 28, 2017
. Cost of goods sold as a percentage of Total net sales was
68.1%
for the three months ended
November 3, 2018
compared to
66.0%
for the three months ended
October 28, 2017
,
an increase
of
210
basis points. Cost of goods sold, exclusive of depreciation and amortization, for the
nine
months ended
November 3, 2018
was
$5,351 million
, a
decrease
of
$165 million
compared to
$5,516 million
for the
nine
months ended
October 28, 2017
. Cost of goods sold as a percentage of Total net sales was
66.9%
for the
nine
months ended
November 3, 2018
compared to
64.9%
for the
nine
months ended
October 28, 2017
,
an increase
of
200
basis points. The increase as a rate of sales for the three month period was primarily attributable to the clearance markdowns to liquidate slower-moving, excess inventory, during the period. The increase as a rate of sales for the
nine
month period was primarily driven by increased Internet clearance selling and continued growth in the mix of the Company's Internet category, and markdown and pricing actions taken in the period to clear slow-moving seasonal inventory.
SG&A Expenses
For the three months ended
November 3, 2018
, SG&A expenses were
$37 million
lower
than the corresponding period of
2017
. SG&A expenses as a percent of Total net sales for the
third
quarter of 2018
increased
to
33.3%
compared to
32.7%
in the
third
quarter of
2017
. For the
nine
months ended
November 3, 2018
, SG&A expenses were
$204 million
lower
than the corresponding period of
2017
. For the first
nine
months of
2018
, SG&A expenses as a percent of Total net sales
decreased
to
32.4%
compared to
32.8%
in the corresponding period of
2017
. The net
increase
in SG&A expenses as a percentage of Total net sales for the three month period was primarily driven by the decrease in net sales and by higher store controllable costs and marketing spend relative to our sales volume, offset by a reduction in lease expense associated with the amortization of gains on the sales of leasehold interests. The net
decrease
in SG&A expenses as a percentage of Total net sales for the
nine
month period was primarily driven by leveraging of our controllable costs and a reduction in lease expense associated with the amortization of gains on the sales of leasehold interests offset by higher marketing spend relative to our sales volume.
Depreciation and Amortization Expense
Depreciation and amortization expense was
$138 million
and
$131 million
for the three months ended
November 3, 2018
and
October 28, 2017
, respectively, and
$419 million
and
$420 million
for the
nine
months ended
November 3, 2018
and
October 28, 2017
, respectively.
Restructuring and Management Transition
The composition of Restructuring and management transition charges was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
Home office and stores
|
$
|
2
|
|
|
$
|
52
|
|
|
$
|
11
|
|
|
$
|
173
|
|
Management transition
|
9
|
|
|
—
|
|
|
9
|
|
|
—
|
|
Other
|
—
|
|
|
—
|
|
|
—
|
|
|
2
|
|
Total
|
$
|
11
|
|
|
$
|
52
|
|
|
$
|
20
|
|
|
$
|
175
|
|
During the
nine
months ended
November 3, 2018
and
October 28, 2017
, we recorded
$11 million
and
$173 million
, respectively, of costs to reduce our store and home office expenses. Costs during the first
nine
months of 2018 include employee termination benefits of $9 million, store related closing costs of $5 million and a $3 million gain on the sale of a closed store. Management transition charges were $9 million for the first nine months of 2018. Costs during the first
nine
months of 2017 include store closing asset impairments of $77 million, employee termination benefits of $21 million and store related closing costs of $75 million.
Real Estate and Other, Net
Real estate and other consists of ongoing operating income from our real estate subsidiaries. Real estate and other also includes net gains from the sale of facilities and equipment that are no longer used in operations, asset impairments, accruals for certain litigation and other non-operating charges and credits. In addition, we entered into the Home Office Land Joint Venture in 2014 in which we contributed approximately
220
acres of excess property adjacent to our home office facility in Plano, Texas. The joint venture was formed to develop the contributed property and our proportional share of the joint venture's activities is recorded in Real estate and other, net. During the three months ended November 3, 2018, we sold our interest to the other partner and are no longer a member of the joint venture.
The composition of Real estate and other, net was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
|
November 3,
2018
|
|
October 28,
2017
|
Investment income from Home Office Land Joint Venture
|
$
|
(3
|
)
|
|
$
|
(3
|
)
|
|
$
|
(4
|
)
|
|
$
|
(23
|
)
|
Net gain from sale of operating assets
|
(1
|
)
|
|
(1
|
)
|
|
(58
|
)
|
|
(119
|
)
|
Impairments
|
—
|
|
|
—
|
|
|
52
|
|
|
—
|
|
Other
|
(3
|
)
|
|
6
|
|
|
(3
|
)
|
|
7
|
|
Total expense/(income)
|
$
|
(7
|
)
|
|
$
|
2
|
|
|
$
|
(13
|
)
|
|
$
|
(135
|
)
|
Investment income from the Home Office Land Joint Venture represents our proportional share of net income from the joint venture.
During the first quarter of 2018, we completed the sale of our Milwaukee, Wisconsin distribution facility for a net sale price of $30 million and recognized a net gain of $12 million. During the second quarter of 2018, we completed the sale of our Manchester, Connecticut distribution facility for a net sale price of $68 million and recognized a net gain of $38 million. During the first nine months of 2017, the net gain from the sale of operating assets includes a $111 million net gain on the sale of our Buena Park, California distribution facility and $8 million in net gains on the sale of excess land.
During the second quarter of 2018, we recorded an impairment charge of $52 million related to the expected sale of three airplanes. Two of the airplanes were sold during the second quarter of 2018 at their fair value of $12 million. During the third quarter of 2018, the third airplane was sold at its fair value of $8 million.
Operating Income/(Loss)
For the
third
quarter of
2018
, we reported
an operating loss
of
$100 million
compared to
an operating loss
of
$78 million
in the
third
quarter of
2017
. For the first
nine
months of
2018
, we reported
an operating loss
of
$133 million
compared to
an operating loss
of
$31 million
in the first
nine
months of
2017
.
Other Components of Net Periodic Pension Cost/(Income)
Other components of net periodic pension cost/(income) was
$(19) million
and
$(2) million
for the three months ended
November 3, 2018
and
October 28, 2017
, respectively, and
$(57) million
and
$90 million
for the
nine
months ended
November 3, 2018
and
October 28, 2017
, respectively.
In February 2017, we announced a Voluntary Early Retirement Program (VERP), which was offered to approximately 6,000 eligible associates. In the first quarter of 2017, we recorded a total charge of approximately $120 million related to the VERP. Charges included $112 million related to special retirement benefits for the approximately 2,800 associates who accepted the VERP and $7 million related to curtailment charges for our pension plans as a result of the reduction in the expected years of future service related to these plans.
(Gain)/Loss on Extinguishment of Debt
During the first quarter of 2018, we settled cash tender offers with respect to portions of our outstanding 8.125% Senior Notes Due 2019 (2019 Notes) and 5.65% Senior Notes Due 2020 (2020 Notes), resulting in a loss on extinguishment of debt of $23 million. During the second quarter of 2017, we settled cash tender offers with respect to portions of our outstanding 5.75% Senior Notes Due 2018 (2018 Notes) and 2019 Notes, resulting in a loss on extinguishment of debt of $34 million, and amended our Revolving Credit Facility, which resulted in a loss on extinguishment of debt of $1 million.
Net Interest Expense
Net interest expense for each of the
third
quarters of 2018 and 2017 was
$78 million
. For the first
nine
months of 2018, net interest expense was
$235 million
, a decrease of $9 million, or 3.7%, from
$244 million
in 2017. The reduction in net interest expense is due to lower debt levels in 2018 compared to 2017.
Income Taxes
The net tax
benefit
of
$8 million
for the three months ended
November 3, 2018
consisted of federal, state and foreign tax benefits of
$2 million
, a
$2 million
benefit relating to other comprehensive income and a
$5 million
benefit due to the release of valuation allowance, offset by
$1 million
of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets.
The net tax
benefit
of
$4 million
for the
nine
months ended
November 3, 2018
consisted of federal, state and foreign tax expenses of
$3 million
,
$3 million
of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets and
$1 million
of net tax expense resulting from enacted state law changes, offset by a
$5 million
benefit relating to other comprehensive income, a
$5 million
benefit due to the release of valuation allowance and a net tax benefit of
$1 million
resulting from state audit settlements.
As of
November 3, 2018
, we have approximately
$2.4 billion
of net operating losses (NOLs) available for U.S. federal income tax purposes, which largely expire in 2032 through 2034 and
$60 million
of tax credit carryforwards that expire at various dates through 2036. A valuation allowance of
$578 million
(restated for the tax effects of revenue recognition) fully offsets the federal deferred tax assets resulting from the NOL and tax credit carryforwards that expire at various dates through 2036. A valuation allowance of
$257 million
fully offsets the deferred tax assets resulting from the state NOL carryforwards that expire at various dates through 2036. In assessing the need for the valuation allowance, we considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets. As a result of our periodic assessment, our estimate of the realization of deferred tax assets is solely based on the future reversals of existing taxable temporary differences and tax planning strategies that we would make use of to accelerate taxable income to utilize expiring NOL and tax credit carryforwards. Accordingly, in the three and
nine
months ended
November 3, 2018
, the valuation allowance was increased by
$35 million
and
$69 million
, respectively, to offset the net deferred tax assets created in the quarter relating primarily to the increase in NOL carryforwards.
Non-GAAP Financial Measures
We report our financial information in accordance with GAAP. However, we present certain financial measures identified as non-GAAP under the rules of the Securities and Exchange Commission (SEC) to assess our results. We believe the presentation of these non-GAAP financial measures is useful in order to better understand our financial performance as well as to facilitate the comparison of our results to the results of our peer companies. In addition, management uses these non-GAAP financial measures to assess the results of our operations. It is important to view non-GAAP financial measures in addition to,
rather than as a substitute for, those measures prepared in accordance with GAAP. We have provided reconciliations of the most directly comparable GAAP measures to our non-GAAP financial measures presented.
The following non-GAAP financial measures are adjusted to exclude restructuring and management transition charges, other components of net periodic pension cost/(income), the (gain)/loss on extinguishment of debt, the proportional share of net income from our Home Office Land Joint Venture and the tax impact for the allocation of income taxes to other comprehensive income items related to our pension plans and interest rate swaps. Unlike other operating expenses, restructuring and management transition charges, other components of net periodic pension cost/(income), the (gain)/loss on extinguishment of debt, the proportional share of net income from our Home Office Land Joint Venture and the tax impact for the allocation of income taxes to other comprehensive income items related to our pension plans and interest rate swaps are not directly related to our ongoing core business operations, which consist of selling merchandise and services to consumers through our department stores and our website at jcpenney.com. Further, our non-GAAP adjustments are for non-operating associated activities such as closed store impairments included in restructuring and management transition charges and such as joint venture earnings from the sale of excess land included in the proportional share of net income from our Home Office Land Joint Venture. Additionally, other components of net periodic pension cost/(income) which is determined using numerous complex assumptions about changes in pension assets and liabilities that are subject to factors beyond our control, such as market volatility. We believe it is useful for investors to understand the impact of restructuring and management transition charges, other components of net periodic pension cost/(income), the (gain)/loss on extinguishment of debt, the proportional share of net income from the Home Office Land Joint Venture and the tax impact for the allocation of income taxes to other comprehensive income items related to our pension plans and interest rate swaps on our financial results and therefore are presenting the following non-GAAP financial measures: (1) adjusted EBITDA; (2) adjusted net income/(loss); and (3) adjusted earnings/(loss) per share-diluted.
Adjusted EBITDA.
The following table reconciles net income/(loss), the most directly comparable GAAP measure, to adjusted EBITDA, which is a non-GAAP financial measure:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
($ in millions)
|
November 3, 2018
|
|
October 28, 2017
|
(1)
|
November 3, 2018
|
|
October 28, 2017
|
(1)
|
Net income/(loss)
|
$
|
(151
|
)
|
|
$
|
(125
|
)
|
|
$
|
(330
|
)
|
|
$
|
(360
|
)
|
|
Add: Net interest expense
|
78
|
|
|
78
|
|
|
235
|
|
|
244
|
|
|
Add: (Gain)/loss on extinguishment of debt
|
—
|
|
|
—
|
|
|
23
|
|
|
35
|
|
|
Add: Income tax expense/(benefit)
|
(8
|
)
|
|
(29
|
)
|
|
(4
|
)
|
|
(40
|
)
|
|
Add: Depreciation and amortization
|
138
|
|
|
131
|
|
|
419
|
|
|
420
|
|
|
Add: Restructuring and management transition charges
|
11
|
|
|
52
|
|
|
20
|
|
|
175
|
|
|
Add: Other components of net periodic pension cost/(income)
|
(19
|
)
|
|
(2
|
)
|
|
(57
|
)
|
|
90
|
|
|
Less: Proportional share of net income from joint venture
|
(3
|
)
|
|
(3
|
)
|
|
(4
|
)
|
|
(23
|
)
|
|
Adjusted EBITDA (non-GAAP)
|
$
|
46
|
|
|
$
|
102
|
|
|
$
|
302
|
|
|
$
|
541
|
|
|
|
|
(1)
|
Reflects the retrospective application of the changes in accounting for revenue recognition and retirement-related benefits. See Note 2 of Notes to unaudited Interim Consolidated Financial Statements for a discussion of the changes and related impacts. For the three months ended
October 28, 2017
, the retrospective application of the changes in accounting for revenue recognition and retirement-related benefits decreased Adjusted EBITDA (non-GAAP) by $6 million. For the
nine
months ended
October 28, 2017
, the retrospective application of the changes in accounting for revenue recognition and retirement-related benefits decreased Adjusted EBITDA (non-GAAP) by $18 million.
|
Adjusted Net Income/(Loss) and Adjusted Diluted EPS.
The following table reconciles net income/(loss) and diluted EPS, the most directly comparable GAAP financial measures, to adjusted net income/(loss) and adjusted diluted EPS, which are non-GAAP financial measures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
($ in millions, except per share data)
|
November 3,
2018
|
|
October 28,
2017
|
(1)
|
November 3,
2018
|
|
October 28,
2017
|
(1)
|
Net income/(loss)
|
$
|
(151
|
)
|
|
$
|
(125
|
)
|
|
$
|
(330
|
)
|
|
$
|
(360
|
)
|
|
Diluted EPS
|
$
|
(0.48
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
(1.05
|
)
|
|
$
|
(1.16
|
)
|
|
Add: Restructuring and management transition charges
(2)
|
11
|
|
|
52
|
|
|
20
|
|
|
175
|
|
|
Add: Other components of net periodic pension cost/(income)
(2)
|
(19
|
)
|
|
(2
|
)
|
|
(57
|
)
|
|
90
|
|
|
Add: (Gain)/loss on extinguishment of debt
(2)
|
—
|
|
|
—
|
|
|
23
|
|
|
35
|
|
|
Less: Proportional share of net income from joint venture
(2)
|
(3
|
)
|
|
(3
|
)
|
|
(4
|
)
|
|
(23
|
)
|
|
Less: Tax impact resulting from other comprehensive income allocation
(3)
|
(2
|
)
|
|
(30
|
)
|
|
(5
|
)
|
|
(46
|
)
|
|
Adjusted net income/(loss) (non-GAAP)
|
$
|
(164
|
)
|
|
$
|
(108
|
)
|
|
$
|
(353
|
)
|
|
$
|
(129
|
)
|
|
Adjusted diluted EPS (non-GAAP)
|
$
|
(0.52
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(1.12
|
)
|
|
$
|
(0.42
|
)
|
|
|
|
(1)
|
Reflects the retrospective application of the changes in accounting for revenue recognition and retirement-related benefits. See Note 2 of Notes to unaudited Interim Consolidated Financial Statements for a discussion of the changes and related impacts. For the three months ended
October 28, 2017
, the retrospective application of the changes in accounting for revenue recognition and retirement-related benefits decreased Adjusted net income/(loss) (non-GAAP) by $6 million. For the
nine
months ended
October 28, 2017
, the retrospective application of the changes in accounting for revenue recognition and retirement-related benefits decreased Adjusted net income/(loss) (non-GAAP) by $18 million.
|
|
|
(2)
|
Adjustments reflect no tax effect due to the impact of the Company's tax valuation allowance.
|
|
|
(3)
|
Represents the net tax benefit that resulted from our other comprehensive income allocation between our Operating loss and Accumulated other comprehensive income.
|
Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash generated from operations, available cash and cash equivalents and access to our revolving credit facility. Our cash flows may be impacted by many factors including the economic environment, consumer confidence, competitive conditions in the retail industry and the success of our strategies. We ended the
third
quarter of
2018
with
$168 million
of cash and cash equivalents. As of the end of the
third
quarter of
2018
, based on our borrowing base, our current borrowings and amounts reserved for outstanding letters of credit, we had
$1,771 million
available for future borrowings under our revolving credit facility, providing total available liquidity of
$1,939 million
.
The following table provides a summary of our key components and ratios of financial condition and liquidity:
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
Cash and cash equivalents
|
$
|
168
|
|
|
$
|
185
|
|
Merchandise inventory
|
3,223
|
|
|
3,406
|
|
Property and equipment, net
|
4,005
|
|
|
4,316
|
|
Total debt and other financing obligations
(1)
|
4,467
|
|
|
4,493
|
|
Stockholders’ equity
|
1,074
|
|
|
1,094
|
|
Total capital
|
5,541
|
|
|
5,587
|
|
Maximum capacity under our Revolving Credit Facility
|
2,350
|
|
|
2,350
|
|
Cash flow from operating activities
|
(311
|
)
|
|
(183
|
)
|
Free cash flow (non-GAAP)
(2)
|
(500
|
)
|
|
(317
|
)
|
Capital expenditures
(3)
|
321
|
|
|
287
|
|
Ratios:
|
|
|
|
Total debt-to-total capital
(4)
|
81
|
%
|
|
80
|
%
|
Cash-to-total debt
(5)
|
4
|
%
|
|
4
|
%
|
|
|
(1)
|
Includes long-term debt, net of unamortized debt issuance costs, including current maturities, capital leases, financing obligation, note payable and any borrowings under our revolving credit facility.
|
|
|
(2)
|
See “Free Cash Flow” below for a reconciliation of this non-GAAP financial measure to its most directly comparable GAAP financial measure and further information on its uses and limitations.
|
|
|
(3)
|
As of the end of the
third
quarters of
2018
and
2017
, we had accrued capital expenditures of
$29 million
and
$35 million
, respectively.
|
|
|
(4)
|
Total debt and other financing obligations divided by total capital.
|
|
|
(5)
|
Cash and cash equivalents divided by total debt and other financing obligations.
|
Free Cash Flow (Non-GAAP)
Free cash flow is a key financial measure of our ability to generate additional cash from operating our business and in evaluating our financial performance. We define free cash flow as cash flow from operating activities, less capital expenditures plus the proceeds from the sale of operating assets. Free cash flow is a relevant indicator of our ability to repay maturing debt, revise our dividend policy or fund other uses of capital that we believe will enhance stockholder value. Free cash flow is considered a non-GAAP financial measure under the rules of the SEC. Free cash flow is limited and does not represent remaining cash flow available for discretionary expenditures due to the fact that the measure does not deduct payments required for debt maturities, payments made for business acquisitions or required pension contributions, if any. Therefore, it is important to view free cash flow in addition to, rather than as a substitute for, our entire statement of cash flows and those measures prepared in accordance with GAAP.
The following table sets forth a reconciliation of net cash provided by/(used in) operating activities, the most directly comparable GAAP financial measure, to free cash flow, a non-GAAP financial measure, as well as information regarding net cash provided by/(used in) investing activities and net cash provided by/(used in) financing activities:
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
($ in millions)
|
November 3,
2018
|
|
October 28,
2017
|
Net cash provided by/(used in) operating activities (GAAP)
|
$
|
(311
|
)
|
|
$
|
(183
|
)
|
Add:
|
|
|
|
Proceeds from sale of operating assets
|
132
|
|
|
153
|
|
Less:
|
|
|
|
Capital expenditures
(1)
|
(321
|
)
|
|
(287
|
)
|
Free cash flow (non-GAAP)
|
$
|
(500
|
)
|
|
$
|
(317
|
)
|
|
|
|
|
Net cash provided by/(used in) investing activities
(2)
|
$
|
(185
|
)
|
|
$
|
(125
|
)
|
Net cash provided by/(used in) financing activities
|
$
|
206
|
|
|
$
|
(394
|
)
|
|
|
(1)
|
As of the end of the
third
quarters of
2018
and
2017
, we had accrued capital expenditures of
$29 million
and
$35 million
, respectively.
|
|
|
(2)
|
Net cash provided by investing activities includes capital expenditures and proceeds from sale of operating assets, which are also included in our computation of free cash flow.
|
Operating Activities
While a significant portion of our sales, profit and operating cash flows have historically been realized in the fourth quarter, our quarterly results of operations may fluctuate significantly as a result of many factors, including seasonal fluctuations in customer demand, product offerings, inventory levels and promotional activity.
Cash flows from operating activities for the
nine
months ended
November 3, 2018
declined
$128 million
to an
outflow
of
$311 million
compared to an
outflow
of
$183 million
for the same period in
2017
. Our net loss of
$330 million
for the
nine
months ended
November 3, 2018
includes significant income and expense items that do not impact operating cash flow including depreciation and amortization, the gain on the sale of assets, restructuring and management transition, (gain)/loss on extinguishment of debt, asset impairments, benefit plans, stock-based compensation and deferred taxes.
Cash flows from operating activities for the first
nine
months of
2018
and
2017
also included construction allowances from landlords of
$12 million
and
$16 million
, respectively, which funded a portion of our capital expenditures in investing activities.
Merchandise inventory
decreased
$183 million
to
$3,223 million
, or
5.4%
, as of the end of the
third
quarter of
2018
compared to
$3,406 million
as of the end of the
third
quarter last year and
increased
$420 million
from year-end
2017
. Based on the identical stores open at
November 3, 2018
and
October 28, 2017
, inventory had decreased by 5.0% primarily due to lower purchasing levels and increased clearance markdowns to liquidate slow-moving inventory. Merchandise accounts payable
decreased
$108 million
as of the end of the
third
quarter of
2018
compared to the corresponding prior year period and
increased
$261 million
from year end.
Investing Activities
Investing activities for the
nine
months ended
November 3, 2018
resulted in cash
outflow
s of
$185 million
compared to
outflow
s of
$125 million
for the same
nine
month period of
2017
.
Cash capital expenditures were
$321 million
for the
nine
months ended
November 3, 2018
and were
$287 million
for the
nine
months ended
October 28, 2017
. In addition, as of the end of the
third
quarters of
2018
and
2017
, we had
$29 million
and
$35 million
, respectively, of accrued capital expenditures. Through the first
nine
months of
2018
, capital expenditures related primarily to investments in our store environment and store facility improvements, including investments in 27 new Sephora inside JCPenney stores and investments in information technology in both our home office and stores. We received construction allowances from landlords of
$12 million
in the first
nine
months of
2018
to fund a portion of the capital expenditures related to store leasehold improvements. These funds are classified as operating activities and have been recorded as deferred rent credits in the Consolidated Balance Sheets and are amortized as an offset to rent expense.
For the
nine
months ended
October 28, 2017
, capital expenditures related primarily to investments in our store environment and store facility improvements, including investments in 70 new and 32 expanded Sephora inside JCPenney stores, the roll out of 100 new appliance showrooms and and investments in information technology in both our home office and stores. We received construction allowances from landlords of
$16 million
in the first
nine
months of
2017
.
Full year
2018
capital expenditures are expected to be approximately
$375 million
net of construction allowances from landlords. Capital expenditures for the remainder of
2018
include accrued expenditures of
$29 million
at the end of the
third
quarter.
Financing Activities
Financing activities for the
nine
months ended
November 3, 2018
resulted in an
inflow
of
$206 million
compared to an
outflow
of
$394 million
for the same period last year. During the first
nine
months of
2018
, we issued $400 million aggregate principal amount of senior secured second priority notes due 2025 and incurred $7 million in related issuance costs, paid $395 million to settle cash tender offers with respect to portions of our outstanding 2019 Notes and 2020 Notes and had net credit facility borrowings of
$437 million
. Additionally, we paid $190 million to retire outstanding debt at maturity and we paid $32 million in required principal payments on outstanding debt and $6 million in required payments on our capital leases, financing obligation and note payable.
Free Cash Flow
Free cash flow for the
nine
months ended
November 3, 2018
decreased
$183 million
to an
outflow
of
$500 million
compared to an
outflow
of
$317 million
in the same period last year. The year-over-year decrease was primarily due to lower operating performance and higher capital expenditures.
Cash Flow Outlook
For the remainder of
2018
, we believe that our existing liquidity will be adequate to fund our capital expenditures and working capital needs; however, in accordance with our long-term financing strategy, we may access the capital markets opportunistically. We believe that our current financial position will provide us the financial flexibility to support our growth initiatives.
Credit Ratings
Our credit ratings and outlook as of
November 23, 2018
from various credit rating agencies were as follows:
|
|
|
|
|
|
Corporate
|
|
Outlook
|
Fitch Ratings
|
B
|
|
Stable
|
Moody’s Investors Service, Inc.
|
B3
|
|
Stable
|
Standard & Poor’s Ratings Services
|
B-
|
|
Negative
|
Credit rating agencies periodically review our capital structure and the quality and stability of our earnings. Rating agencies consider, among other things, changes in operating performance, comparable store sales, the economic environment, conditions in the retail industry, financial leverage and changes in our business strategy in their rating decisions. Downgrades to our long-term credit ratings could result in reduced access to the credit and capital markets and higher interest costs on future financings.
Contractual Obligations and Commitments
Aggregate information about our obligations and commitments to make future payments under contractual or contingent arrangements was disclosed in the
2017
Form 10-K.
Impact of Inflation, Deflation and Changing Prices
We have experienced inflation and deflation related to our purchase of certain commodity products. We do not believe that changing prices for commodities have had a material effect on our Net Sales or results of operations. Although we cannot precisely determine the overall effect of inflation and deflation on operations, we do not believe inflation and deflation have had a material effect on our financial condition or results of operations.
Critical Accounting Policies
Management’s discussion and analysis of our financial condition and results of operations is based upon our unaudited Interim 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 us to make estimates and use judgments
that affect reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances. On an ongoing basis, we evaluate 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. While actual results could differ from these estimates, we do not expect the differences, if any, to have a material effect on the unaudited Interim Consolidated Financial Statements.
Except for the changes in revenue recognition and pension accounting as discussed in Note 2 to the Unaudited Interim Consolidated Financial Statements, there were no changes to our critical accounting policies during the
nine
months ended
November 3, 2018
. For a further discussion of the judgments we make in applying our accounting policies, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our
2017
Form 10-K.
Recently Issued Accounting Pronouncements
Recently issued accounting pronouncements are discussed in Note 3 to the Unaudited Interim Consolidated Financial Statements.
Seasonality
While a significant portion of our sales, profit and operating cash flows have historically been realized in the fiscal fourth quarter, our quarterly results of operations may fluctuate significantly as a result of many factors, including seasonal fluctuations in customer demand, product offerings, inventory levels and our promotional activity. The results of operations and cash flows for the
nine
months ended
November 3, 2018
are not necessarily indicative of the results for future quarters or the entire year.
Cautionary Statement Regarding Forward-Looking Statements
This report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect our current view of future events and financial performance. Words such as "expect" and similar expressions identify forward-looking statements, which include, but are not limited to, statements regarding sales, cost of goods sold, selling, general and administrative expenses, earnings, cash flows and liquidity. Forward-looking statements are based only on the Company's current assumptions and views of future events and financial performance. They are subject to known and unknown risks and uncertainties, many of which are outside of the Company's control, 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, general economic conditions, including inflation, recession, unemployment levels, consumer confidence and spending patterns, credit availability and debt levels, changes in store traffic trends, the cost of goods, more stringent or costly payment terms and/or the decision by a significant number of vendors not to sell us merchandise on a timely basis or at all, trade restrictions, the ability to monetize non-core assets on acceptable terms, the ability to implement our strategic plan including our omnichannel initiatives, customer acceptance of our strategies, our ability to attract, motivate and retain key executives and other associates, the impact of cost reduction initiatives, our ability to generate or maintain liquidity, implementation of new systems and platforms, changes in tariff, freight and shipping rates, changes in the cost of fuel and other energy and transportation costs, disruptions and congestion at ports through which we import goods, increases in wage and benefit costs, competition and retail industry consolidations, interest rate fluctuations, dollar and other currency valuations, the impact of weather conditions, risks associated with war, an act of terrorism or pandemic, the ability of the federal government to fund and conduct its operations, a systems failure and/or security breach that results in the theft, transfer or unauthorized disclosure of customer, employee or Company information, legal and regulatory proceedings and the Company’s ability to access the debt or equity markets on favorable terms or at all. There can be no assurances that the Company will achieve expected results, and actual results may be materially less than expectations. While we believe that our assumptions are reasonable, we caution that it is impossible to predict the degree to which any such factors could cause actual results to differ materially from predicted results. We intend the forward-looking statements in this Quarterly Report on Form 10-Q to speak only as of the date of this report and do not undertake to update or revise projections as more information becomes available.