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J.C. Penney 10-K 2007 Documents found in this filing:
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
(Mark One)
þ ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
For the fiscal year ended
February 3, 2007
or
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
For the transition period
from to
Commission file
number 001-15274
(Exact name of registrant as
specified in its charter)
6501 Legacy Drive, Plano, Texas 75024 –
3698
(Address of principal executive
offices)
(Zip Code)
(972) 431-1000
(Registrant’s telephone
number, including area code)
Securities registered pursuant to
Section 12(b) of the Act:
Securities registered pursuant to
Section 12(g) of the Act:
None
(Title of class)
Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities
Act. Yes þ No o
Indicate by check mark if the
registrant is not required to file reports pursuant to
Section 13 or 15(d) of the
Act. Yes o No þ
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for
the past
90 days. Yes þ No o
Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K
(§ 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant’s
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
Indicate by check mark whether the
registrant is a shell company (as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
State the aggregate market value of
the voting and non-voting common equity held by non-affiliates
computed by reference to the price at which the common equity
was last sold, or the average bid and asked price of such common
equity, as of the last business day of the registrant’s
most recently completed second fiscal quarter (July 29,
2006). $14,241,614,688
Indicate the number of shares
outstanding of each of the registrant’s classes of common
stock, as of the latest practicable date.
225,793,408 shares of Common
Stock of 50 cents par value, as of March 19, 2007.
DOCUMENTS INCORPORATED BY
REFERENCE
Table of Contents
Business
Overview
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 new holding
company assumed the name J. C. Penney Company, Inc. (Company).
The holding company has no independent assets or operations, and
no direct subsidiaries other than JCP. Common stock of the
Company is publicly traded under the symbol “JCP” on
the New York Stock Exchange. The Company is a co-obligor (or
guarantor, as appropriate) regarding the payment of principal
and interest on JCP’s outstanding debt securities. The
guarantee by the Company of certain of JCP’s outstanding
debt securities is full and unconditional. The holding company
and its consolidated subsidiaries, including JCP, are
collectively referred to in this Annual Report on
Form 10-K
as “Company” or “JCPenney,” unless otherwise
indicated.
Since JCP’s founding by James Cash Penney in 1902, the
Company has grown to be a major retailer, operating 1,033
JCPenney department stores in 49 states and Puerto Rico as
of February 3, 2007. The Company’s business consists
of selling merchandise and services to consumers through its
department stores and Direct (Internet/catalog) channels.
Department stores and Direct generally serve the same type of
customers and provide virtually the same mix of merchandise, and
department stores accept returns from sales made in stores, via
the Internet and through catalogs. The Company markets family
apparel, jewelry, shoes, accessories and home furnishings. In
addition, the department stores provide customers with services
such as salon, optical, portrait photography and custom
decorating. See Retail Sales Mix on page 17 for sales by
category.
A five-year summary of certain financial and operational
information regarding the Company’s continuing operations
can be found in Part II, Item 6, Selected Financial
Data, of this Annual Report on
Form 10-K.
For a discussion of the Company’s ongoing merchandise
initiatives, see Part II, Item 7, Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
For purposes of this Annual Report on Form 10-K, all references
to Notes are to the Notes to the Consolidated Financial
Statements beginning on page F-7.
Discontinued
Operations
On July 5, 2005, the Company’s indirect wholly owned
subsidiary, J. C. Penney Brazil, Inc., closed on the sale of its
shares of Lojas Renner S.A. (Renner), a Brazilian department
store chain, through a public stock offering registered in
Brazil. The net after-tax cash proceeds from the sale of
approximately $260 million were used for common stock
repurchases, which are more fully discussed in Note 3.
Including a favorable tax adjustment in 2006, the sale resulted
in a cumulative pre-tax gain of $26 million and a gain of
$1 million on an after-tax basis.
On July 31, 2004, the Company and certain of its
subsidiaries closed on the sale of its Eckerd drugstore
operations (Eckerd) to the Jean Coutu Group (PJC) Inc. (Coutu)
and CVS Corporation and CVS Pharmacy, Inc. The net
after-tax cash proceeds from the sale of approximately
$3.5 billion were used for common stock repurchases and
debt reduction, which are more fully discussed in Notes 3
and 11. Through 2006, the cumulative loss on the sale was
$715 million pre-tax, or $1,326 million on an
after-tax basis.
For all periods presented, the results of operations and
financial position for Renner and Eckerd are reflected as
discontinued operations.
Competition
and Seasonality
The business of marketing merchandise and services is highly
competitive. The Company is one of the largest department store,
catalog and
e-commerce
retailers in the United States, and it has numerous competitors,
as further
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described on page 4 in Item 1A, Risk Factors. Many
factors enter into the competition for the consumer’s
patronage, including price, quality, style, service, product
mix, convenience and credit availability. The Company’s
annual earnings depend to a great extent on the results of
operations for the last quarter of its fiscal year, which
includes the holiday season, when a significant portion of the
Company’s sales and profits are recorded.
Trademarks
The JCPenney, Every Day Matters, Okie Dokie, Worthington,
east5th, a.n.a, St.John’s Bay, The Original Arizona Jean
Company, Ambrielle, Stafford, J. Ferrar, JCPenney Home
Collection and Studio by JCPenney Home Collection trademarks, as
well as certain other trademarks, have been registered, or are
the subject of pending trademark applications with the United
States Patent and Trademark Office and with the registries of
many foreign countries
and/or are
protected by common law. The Company considers its marks and the
accompanying name recognition to be valuable to its business.
For further discussion of the Company’s private brands, see
Part II, Item 7, Management’s Discussion and
Analysis of Financial Condition and Results of Operations,
beginning on page 12 herein.
Web
Site Availability
The Company maintains an Internet Web site at
www.jcpenney.net and makes available free of charge
through this Web site its annual report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K
and all related amendments to those reports, as soon as
reasonably practicable after the materials are electronically
filed with or furnished to the Securities and Exchange
Commission. In addition, the Web site also provides press
releases, an investor update package, access to Web casts of
management presentations and other materials useful in
evaluating the Company.
Suppliers
The Company purchases its merchandise from approximately 2,900
domestic and foreign suppliers, many of which have done business
with the Company for many years. In addition to its Plano, Texas
home office, the Company, through its international purchasing
subsidiary, maintained buying and quality assurance inspection
offices in 18 foreign countries as of February 3, 2007.
Employment
The Company and its consolidated subsidiaries employed
approximately 155,000 full-time and part-time associates as
of February 3, 2007.
Environmental
Matters
Environmental protection requirements did not have a material
effect upon the Company’s operations during fiscal 2006.
While management believes it would be unlikely, it is possible
that compliance with such requirements would lengthen lead time
in expansion plans and increase construction costs and
therefore, operating costs due in part to the expense and time
required to conduct environmental and ecological studies and any
required remediation.
In 2006, management engaged an independent engineering firm to
update a previous evaluation of the Company’s established
reserves for potential environmental liability associated with
facilities, some of which the Company no longer owns or
operates. Based on this analysis, the Company increased its
reserves to an amount that it believes is adequate to cover the
estimated potential liabilities, which primarily relate to
underground storage tanks. Funds spent to remedy these sites are
charged against the established reserves. In addition, the
Company also has recorded reserves for the estimated cost of
asbestos removal where renovations or a sale of the facility are
planned.
As part of the sale agreements for the 2004 disposition of
Eckerd, the Company retained responsibility to remediate
environmental conditions that existed at the time of the sale.
Certain properties, principally distribution centers, were
identified as having such conditions at the time of sale.
Reserves were established by management, after consultation with
an environmental engineering firm, for specifically identified
properties, as well as a certain percentage of the remaining
properties, considering such factors as age, location and prior
use of the properties.
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Executive
Officers of the Registrant
The following is a list, as of March 19, 2007, of the names
and ages of the executive officers of J. C. Penney Company, Inc.
and of the offices and other positions held by each such person
with the Company. These officers hold identical positions with
JCP, other than Mr. Alcorn, whose title with JCP is Senior
Vice President, Controller and Chief Purchasing Officer.
References to JCPenney positions held during fiscal years 2001
and earlier (prior to the creation of the holding company) are
for JCP. There is no family relationship between any of the
named persons.
Mr. Ullman has served as Chairman of the Board of Directors
and Chief Executive Officer of the Company since December 2004.
He was Directeur General, Group Managing Director, LVMH
Moët Hennessy Louis Vuitton (luxury goods
manufacturer/retailer) from 1999 to 2002. He was President of
LVMH Selective Retail Group from 1998 to 1999. From 1995 to
1998, he was Chairman of the Board and Chief Executive Officer
of DFS Group Ltd. From 1992 to 1995, he was Chairman of the
Board and Chief Executive Officer of R. H. Macy &
Company, Inc. He has served as a director of the Company, and a
director of JCP, since December 2004.
Mr. Alcorn has served as Controller of the Company since
1996 and was elected as a Senior Vice President of the Company
in 2001. He has served in various positions of increasing
importance with the Company since 1971.
Ms. Bober has served as Executive Vice President, General
Counsel and Secretary of the Company since September 2005. From
February 2005 to September 2005, she served as Senior Vice
President, General Counsel and Secretary of the Company. She
served as Senior Vice President and General Counsel of The Chubb
Corporation from 1999 to 2005.
Mr. Cavanaugh has served as Executive Vice President and
Chief Financial Officer of the Company since 2001. He served as
Senior Vice President and Chief Financial Officer of Eckerd
Corporation, a former subsidiary of the Company, from 1999 to
2001. From 1996 to 1999, he served as Vice President and
Treasurer of the Company. He has served as a director of JCP
since 2002.
Mr. Hicks has served as President and Chief Merchandising
Officer of the Company since January 2005. He served as
President and Chief Operating Officer of Stores and Merchandise
Operations from July through December 2004. He has served as a
director, and President and Chief Merchandising Officer of JCP
since January 2005. He served as President and Chief Operating
Officer of Stores and Merchandise Operations of JCP from July
2002 to December 2004. From 1999 to 2002, he served as President
of Payless ShoeSource, Inc.
Mr. Nealon was elected Executive Vice President and Chief
Information Officer effective October 2, 2006. From 2002 to
2006, he was employed by Electronic Data Systems Corporation
(global technology services), where he served on assignment as
the Senior Vice President and Chief Information Officer of
Southwest Airlines Co. From 2000 to 2002, he was a partner with
the Feld Group (information technology consulting).
Mr. Theilmann has served as Executive Vice President, Chief
Human Resources and Administration Officer of the Company since
June 2005. From 2002 to 2005, he served as Senior Vice
President, Human Resources and Chief People Officer of the
International business of Yum! Brands Inc. (restaurants). From
2000 to 2002, he served as Vice President of Human Resources for
European operations at Yum! Brands Inc.
Table of Contents
The following risk factors should be read carefully, along with
the cautionary statement regarding forward-looking information
on page 39, in connection with evaluating the
Company’s business and the forward-looking information
contained in this Annual Report on
Form 10-K.
Any of the following risks could materially adversely affect the
Company’s business, operating results, financial condition
and the actual outcome of matters as to which forward-looking
statements are made in this Annual Report on
Form 10-K.
While the Company believes it has identified and discussed below
the key risk factors affecting its business, there may be
additional risks and uncertainties that are not presently known
or that are not currently believed to be significant that may
adversely affect the Company’s business, performance or
financial condition in the future.
The retail industry is highly competitive, with few barriers to
entry. The Company competes with many other local, regional and
national retailers for customers, associates, locations,
merchandise, services and other important aspects of the
Company’s business. Those competitors include other
department stores, discounters, home furnishing stores,
specialty retailers, wholesale clubs,
direct-to-consumer
businesses and other forms of retail commerce. Some competitors
are larger than JCPenney, have greater financial resources
available to them, and, as a result, may be able to devote
greater resources to sourcing, promoting and selling their
products. Competition is characterized by many factors,
including merchandise assortment, advertising, price, quality,
service, location, reputation and credit availability. The
performance of competitors as well as changes in their pricing
and promotional policies, marketing activities, new store
openings, brand launches and other merchandise and operational
strategies could cause the Company to have lower sales, lower
gross margin
and/or
higher operating expenses such as marketing costs and other
selling, general and administrative expenses, which in turn
could have an adverse impact on the Company’s profitability.
The Company’s sales and operating results depend in part on
its ability to predict or respond to changes in fashion trends
and customer preferences in a timely manner by consistently
offering stylish quality merchandise assortments at competitive
prices. The Company continuously assesses emerging styles and
trends and focuses on developing a merchandise assortment to
meet customer preferences. Even with these efforts, the Company
cannot be certain that it will be able to successfully meet
constantly changing customer demands. To the extent the
Company’s predictions differ from its customers’
preferences, the Company may be faced with excess inventories
for some products
and/or
missed opportunities for others. Excess inventories can result
in lower gross margins due to greater than anticipated discounts
and markdowns that might be necessary to reduce inventory
levels. Low inventory levels can adversely affect the timing of
shipments to customers and diminish sales and brand loyalty.
Consequently, any sustained failure to identify and respond to
emerging trends in lifestyle and customer preferences and buying
trends could have an adverse impact on the Company’s
business and any significant misjudgments regarding inventory
levels could adversely impact the Company’s results of
operations.
The Company’s results of operations are sensitive to
changes in overall economic and political conditions that impact
consumer spending, including discretionary spending. Many
economic factors outside of the Company’s control,
including the housing market, interest rates, recession,
inflation and deflation, energy costs and availability, consumer
credit availability and terms, consumer debt levels, tax rates
and policy, and unemployment trends influence consumer
confidence and spending. The domestic and international
political situation also affects consumer confidence and
spending. Additional events that could impact the Company’s
performance include pandemics, terrorist threats and activities,
worldwide military and domestic disturbances and conflicts, and
political instability. A general reduction in the level of
consumer spending could adversely affect the Company’s
growth and profitability.
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The Company’s merchandise is sourced from a wide variety of
suppliers, and its business depends on being able to find
qualified suppliers and access products in a timely and
efficient manner. A substantial portion of the Company’s
merchandise is sourced outside of the United States. All of the
Company’s suppliers must comply with the Company’s
supplier legal compliance program and applicable laws. Although
the Company diversifies its sourcing and production by country,
the failure of a supplier to produce and deliver the
Company’s goods on time, to meet the Company’s quality
standards or to meet the requirements of the Company’s
supplier compliance program or applicable laws, or the
Company’s inability to flow merchandise to its stores or
through Direct in the right quantities at the right time could
adversely affect the Company’s profitability. Similarly,
political or financial instability, changes in U.S. and
foreign laws and regulations affecting the importation and
taxation of goods, including duties, tariffs and quotas, or
changes in the enforcement of those laws and regulations, as
well as currency exchange rates, transport capacity and costs
and other factors relating to foreign trade and the inability to
access suitable merchandise on acceptable terms could adversely
impact the Company’s results of operations.
The Company’s annual earnings and cash flows depend to a
great extent on the results of operations for the last quarter
of its fiscal year, which includes the holiday season. The
Company’s fiscal fourth-quarter results may fluctuate
significantly, based on many factors, including holiday spending
patterns and weather conditions. This seasonality causes the
Company’s operating results to vary considerably from
quarter to quarter.
The Company’s plans to accelerate the growth of new stores,
primarily in the off-mall format, depend in part on the
availability of store sites or existing retail stores on
acceptable terms. The Company competes with other retailers and
businesses for suitable locations for its stores. Local land use
and other regulations may impact the Company’s ability to
find suitable locations. In addition, increases in real estate,
construction and development costs could limit the
Company’s growth opportunities and adversely impact its
return on investment. Furthermore, although the Company has
conducted strategic market research, including reviewing
demographic and regional economic trends, prior to making a
decision to enter into a particular market, the Company cannot
be certain that its entry into a particular market will prove
successful. The inability to execute the Company’s new
store growth strategy in a manner that generates appropriate
returns on investment could have an adverse impact on its future
growth and profitability.
The Company’s results depend on the contributions of its
associates, including its senior management team and other key
associates. Since 2000, the Company has hired seasoned
individuals, including executive level associates and others
with a breadth of experience in merchandising, marketing, and
buying and allocation under a centralized model. The
Company’s performance depends to a great extent on its
ability to attract, retain and motivate quality associates
throughout the organization, many of whom, particularly in the
department stores, are in entry level or part-time positions
with historically high rates of turnover. The Company’s
ability to meet its labor needs while controlling its costs is
subject to external factors such as unemployment levels,
prevailing wage rates, minimum wage legislation and changing
demographics. If the Company is unable to attract, retain and
motivate quality associates at all levels, its results of
operations could be adversely impacted.
The Company’s operations are dependent upon the integrity,
security and consistent operation of various systems and data
centers, including the
point-of-sale
systems in the stores, data centers that process transactions,
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communication systems and various software applications used
throughout the Company to track inventory flow, process
transactions and generate performance and financial reports. The
Company could encounter difficulties in developing new systems
or maintaining and upgrading existing systems. Such difficulties
could lead to significant expenses or to losses due to
disruption in business operations. In addition, despite the
Company’s considerable efforts and technology to secure its
computer network, security could be compromised, confidential
information could be misappropriated or system disruptions could
occur. This could lead to loss of sales or profits or cause the
Company to incur significant costs to reimburse third parties
for damages. In addition, the continued realization of the
benefits of the Company’s centralized buying and allocation
processes and systems is a key element of the Company’s
ability to meet its long-term customer and financial goals. The
effectiveness of these processes and systems is an important
component of the Company’s ability to have the right
inventory at the right place, time and price.
None.
At February 3, 2007, the Company operated 1,033 JCPenney
department stores throughout the continental United States,
including Alaska, and Puerto Rico, of which 314 were owned. The
Company also owned and operated four Direct (Internet/catalog)
fulfillment centers and three regional warehouses. The Company
owned seven of its 13 store merchandise distribution centers,
each of which was located in either the Company’s owned
fulfillment centers or regional warehouses. The Company owned
its home office facility in Plano, Texas, as well as
approximately 240 acres of property adjacent to the
facility. Information relating to certain of the Company’s
facilities is included in Part II, Item 6, Selected
Financial Data, of this Annual Report on
Form 10-K.
Gayle G. Pitts, et al v. J. C. Penney Direct Marketing
Services, Inc. (DMS), AEGON Direct Marketing Services, Inc., and
J. C. Penney Life Insurance Company n/k/a Stonebridge Insurance
Company,
No. 01-03395-F,
in the 214th Judicial District Court of Nueces County,
Texas; and Appellant(s): Stonebridge Life Insurance Company
f/k/a J. C. Penney Life Insurance Company (JCPenney Life), J. C.
Penney Direct Marketing Services, Inc., and AEGON Direct
Marketing Services, Inc. v. Gayle G. Pitts, et al,
No. 13-05-131-CV,
in the Court of Appeals for the Thirteenth District of Texas.
This is a class action lawsuit (the Texas DMS Lawsuit) filed
against the above named defendants. It involves the sale of J.
C. Penney Life Insurance accidental death and dismemberment
insurance over the telephone. The named plaintiffs allege that
they did not give permission to defendants to charge their
credit cards for such insurance premiums. They allege that the
scripted questions asked during the telephone sales presentation
are inadequate to obtain permission to charge the
customer’s credit card, primarily because the customer is
not told that the insurance company already has his or her
credit card number.
The Texas DMS Lawsuit originally also included as defendants J.
C. Penney Company, Inc., and J. C. Penney International
Insurance Group, Inc. The plaintiffs have since dismissed these
parties.
The Texas DMS Lawsuit originally also included named plaintiffs
who did not deny giving permission to charge their credit cards
for premiums, but who alleged that they had submitted claims
that were wrongfully denied. Those former named plaintiffs and
their claims were severed into a separate lawsuit captioned
York, et al v. J. C. Penney Company, Inc., J. C.
Penney Direct Marketing Services, Inc., J. C. Penney Life
Insurance Company, J. C. Penney International Group, Inc., AEGON
Direct Marketing Services, Inc., AEGON USA, Inc., and
Commonwealth General Corporation,
No. 02-2651-F,
in the 214th District Court of Nueces County, Texas (the
Severed Lawsuit). The Severed Lawsuit was originally pled as a
class action, but the plaintiffs amended their petition and now
assert only individual claims.
The assets of DMS, including the stock of JCPenney Life, were
sold to Commonwealth General Corporation (Commonwealth), a
domestic subsidiary of AEGON, N. V., pursuant to a Stock
Purchase Agreement (the
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Agreement) dated as of March 7, 2001, among Commonwealth as
Purchaser, DMS as Seller, and JCP as Parent corporation of DMS.
Thus, as a matter of law, all of the liabilities of JCPenney
Life stayed with that company after the sale. Commonwealth is
currently providing defense to DMS.
Under the Agreement, JCP and DMS agreed to indemnify
Commonwealth for any liability of JCPenney Life, but only to the
extent that such liability arises out of or relates to a breach
of a representation and warranty in the Agreement. Commonwealth
may claim entitlement to indemnification from JCP and DMS if a
final determination in the Texas DMS Lawsuit is adverse to
JCPenney Life, and Commonwealth successfully contends that the
liability arose out of a breach of a representation or warranty
in the Agreement. JCP’s and DMS’s liability for
breaches of representations and warranties is subject to both a
deductible and a cap.
In September 2002, the trial court certified the Texas DMS
Lawsuit as a national class action. On July 15, 2004, the
Court of Appeals for the Thirteenth District of Texas reversed
the certification order and remanded the case to the trial
court. Plaintiffs filed a second supplemental motion for class
certification, this time seeking a Texas class only. On
January 31, 2005, the trial court granted the motion,
certifying a Texas class. Following appeal of the trial court
order by the defendants, on May 18, 2006, the Court of
Appeals for the Thirteenth District of Texas upheld the trial
court’s certification of a class of Texas consumers who
purchased the accidental death and dismemberment insurance
products between 1996 and the certification date. The defendants
have appealed the decision of the Court of Appeals to the
Supreme Court of Texas.
On February 3, 2005, Vicente Balderaz filed a complaint in
the First Judicial District, State of New Mexico, County of
Santa Fe
(No. D-0101-CV2005-00249)
(the New Mexico Lawsuit) against the same defendants as the
Texas DMS Lawsuit, including DMS, and asserting essentially the
same claims. DMS has since been dismissed. The New Mexico
Lawsuit seeks certification of a nation-wide class. On November
9 and 10, 2005, the trial court held a hearing on the
plaintiff’s motion for class certification.
The Company denies the allegations against its current and
former subsidiaries in the Texas DMS Lawsuit, the Severed
Lawsuit, and the New Mexico Lawsuit and, along with the other
defendants, is vigorously defending the cases and opposing class
certification. Although it is too early to predict the outcome
of the Texas DMS Lawsuit, the Severed Lawsuit, and the New
Mexico Lawsuit, management is of the opinion that they should
not have a material adverse effect on the Company’s
consolidated financial position or results of operations.
No matters were submitted to a vote of stockholders during the
fourth quarter of fiscal 2006.
Market
for Registrant’s Common Equity
The Company’s common stock is traded principally on the New
York Stock Exchange (NYSE) under the symbol “JCP.” The
number of stockholders of record at March 19, 2007 was
37,388. In addition to common stock, the Company has authorized
25 million shares of preferred stock, of which no shares
were issued and outstanding at February 3, 2007.
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The table below sets forth the quoted high and low market prices
of the Company’s common stock on the NYSE for each
quarterly period indicated, the quarter-end closing market price
of the Company’s common stock, as well as the quarterly
cash dividends declared per share of common stock:
The Company’s Board of Directors (Board) reviews the
dividend policy and rate on a quarterly basis, taking into
consideration the overall financial and strategic outlook for
the Company, earnings, liquidity and cash flow projections, as
well as competitive factors. In February 2007, the Board
authorized a plan to increase the quarterly dividend on its
common stock to $0.20 per share beginning with the
May 1, 2007 dividend. On March 29, 2007, the Board
declared a quarterly dividend of $0.20 per share to be paid
on May 1, 2007.
Additional information relating to the common stock and
preferred stock, including the Series B ESOP Convertible
Preferred Stock (which was redeemed in 2004), of the Company is
included under the captions “Consolidated Statements of
Stockholders’ Equity”
(page F-5),
“Capital Stock”
(page F-24)
and “Equity and Debt Restructuring”
(pages F-18
to F-19), which appear in this Annual Report on
Form 10-K
on the pages indicated.
Issuer
Purchases of Securities
During the 2004 to 2006 period, the Company repurchased shares
of its common stock under its common stock repurchase programs
totaling $4.9 billion in the aggregate as authorized by the
Board. Share repurchases were made in open-market transactions,
subject to market conditions, legal requirements and other
factors. The Company repurchased and retired 11.3 million,
44.2 million and 50.1 million shares of common stock
during 2006, 2005 and 2004, respectively, at a cost of
approximately $750 million, $2.2 billion and
$1.95 billion, respectively. No repurchases of common stock
were made during the fourth quarter of 2006, and no amounts
remained authorized for share repurchase as of February 3,
2007. On March 29, 2007, the Board authorized a new program
of common stock repurchases of up to $400 million, which is
expected to be completed by the end of fiscal 2007.
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Five-Year
Total Stockholder Return Comparison
The following presentation compares JCPenney’s cumulative
five-year stockholder returns on an indexed basis with the
S&P 500 Stock Index and the S&P 500 Retail Index for
Department Stores. A list of these companies follows the graph
below. The following graph and related information shall not be
deemed “soliciting material” or “filed” with
the Securities and Exchange Commission, nor shall such
information be incorporated by reference into any future filing
under the Securities Act of 1933 or Securities Exchange Act of
1934, each as amended, except to the extent that the Company
specifically incorporates it by reference into such filing.
The stockholder returns shown are neither determinative nor
indicative of future performance.
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FIVE-YEAR
FINANCIAL SUMMARY (UNAUDITED)
(1) Includes the effect of
the 53rd week in 2006 and 2003. Excluding sales of
$204 million for the 53rd week in 2006, total
department store sales increased 5.0%. Excluding sales of
$152 million for the 53rd week in 2003, total
department store sales increased 4.7% and decreased 0.7% for
2004 and 2003, respectively.
(2) Comparable department
store sales are presented on a
52-week
basis. Comparable department store sales include sales of new
and relocated stores, and stores reopened after being closed for
an extended period (e.g., stores closed due to 2005 hurricanes),
after such stores have been open for 12 full consecutive fiscal
months. Stores remodeled and minor expansions not requiring
store closure remain in the comparable department store sales
calculation.
(3) Includes the effect of
the 53rd week in 2006 and 2003. Excluding sales of
$50 million for the 53rd week in 2006, total Direct
sales increased 2.4%. Excluding sales of $46 million for
the 53rd week in 2003, total Direct sales increased 3.3%
and 1.5% for 2004 and 2003, respectively.
(4) In 2006, costs
associated with the Company’s store merchandise
distribution centers were reclassified from SG&A Expenses
into Cost of Goods Sold, Depreciation and Amortization and
Pre-Opening Expenses were reclassified from SG&A Expenses to
be presented as separate line items and Real Estate and Other
was included as a component of Operating Income. All prior
periods presented have been reclassified to reflect these new
classifications.
(5) Represents income from
continuing operations plus after-tax interest expense on
long-term debt divided by the sum of beginning of year
stockholders’ equity and long-term debt, including current
maturities.
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FIVE-YEAR
OPERATIONS SUMMARY (UNAUDITED)
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The following discussion, which presents the results of
JCPenney, should be read in conjunction with the accompanying
consolidated financial statements and notes thereto beginning on
page F-3,
along with the unaudited Five-Year Financial and Operations
Summaries on pages 10 and 11, the risk factors
beginning on page 4 and the cautionary statement regarding
forward-looking information on page 39. Unless otherwise
indicated, this Management’s Discussion and Analysis
(MD&A) relates only to results from continuing operations,
all references to earnings per share (EPS) are on a diluted
basis and all references to years relate to fiscal years rather
than to calendar years. Fiscal 2006 contained 53 weeks,
while both 2005 and 2004 contained 52 weeks.
Corporate
Governance and Financial Reporting
The Company remains committed to both maintaining the highest
standard of corporate governance and continuously improving the
transparency of its financial reporting, by providing
stockholders with informative financial disclosures and
presenting an accurate view of the Company’s financial
position and operating results. Management continues to employ a
reporting matrix that requires written certifications on a
quarterly basis from a cross-discipline team of approximately 20
members of management who have responsibility for verifying and
reporting corporate results.
For this Annual Report on
Form 10-K,
the Company made further enhancements to its financial reporting
with expanded disclosures in several areas, such as:
Consistent with the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act), the Company is
required again to report on the effectiveness of its internal
control over financial reporting. In relation to these
requirements, the Company’s external auditors expressed an
unqualified opinion on management’s assessment of, and the
effective operation of, the Company’s internal control over
financial reporting.
Executive
Overview
2006 marked the completion of the second year of the
Company’s
2005-2009
Long Range Plan and reflected an acceleration of progress
towards attaining the Company’s stated financial objectives
set in 2005. This progress has resulted in the evolution of the
Long Range Plan’s fundamental strategies into updated
initiatives and new financial performance goals for the
five-year period ending in 2011 that will be publicly announced
at the Company’s Analyst Meeting on April
17-18, 2007.
2006
Accomplishments
Comparable department store sales increased 3.7% in 2006, on top
of a 2.9% increase in 2005, representing the sixth consecutive
year of comparable department store sales increases, averaging
more than a 3% increase per year. The Company also experienced
productivity improvements in its store portfolio with sales per
gross square foot increasing 4.5% to $164 in 2006 from $157 in
2005. The Company’s off-mall stores opened in the 2003 to
2005 timeframe experienced a higher level of productivity than
the Company average with 2006 sales per gross square foot of
approximately $200.
In Direct (Internet/catalog), the Company continues to
experience a transformation into an Internet portal that
functions as the customers’ gateway to the Company and a
shopping channel supported by print media. Internet sales in
2006 were $1.3 billion, an increase of approximately 24%
(22% on a
52-week
basis), on top of a nearly 28% increase in 2005. Print sales and
Internet sales each represented approximately 45% of total
Direct sales, with the remainder from catalog outlet stores.
Total Direct sales increased 4.1% (2.4% on a
52-week
basis) in 2006, the fourth consecutive year of sales gains.
Direct sales were approximately 15% of total net retail sales in
each of the last three years.
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Further
Strengthened Operating Performance
For 2006, operating income increased 100 basis points to
9.7% of sales, driven by substantially higher gross margin.
Operating
Income
(1) Operating Income
excludes Net Interest Expense as well as Bond Premiums and
Unamortized Costs. Beginning in 2006, Real Estate and Other was
included as a component of Operating Income; all prior periods
shown have been reclassified to reflect this presentation.
Operating Income is the key measurement on which management
evaluates the financial performance of the retail
operations.
Income from continuing operations for 2006 increased
approximately 16% to $1,134 million compared to
$977 million in 2005. Diluted EPS from continuing
operations of $4.88 for 2006 improved 27% compared to $3.83 in
2005. The 2006 results reflected a credit of $32 million,
or $0.14 per share, due primarily to the release of federal
income tax reserves resulting from the favorable resolution of
prior year tax matters, while the 2005 results included a
one-time credit to income of $49 million, or $0.20 per
share, which was principally attributable to eliminating the
remaining state tax net operating loss valuation allowances as a
result of the significantly improved operating performance.
Excluding these tax credits, 2006 income from continuing
operations and EPS increased 19% and 31%, respectively.
Operating performance has improved year over year for each of
the past six years, with operating income margin increasing
860 basis points since 2000 and diluted EPS from continuing
operations increasing to $4.88 for 2006 from $(0.78) in 2000.
Operating
Results from Continuing Operations
(1) Comparable department
store sales are presented on a
52-week
basis. Comparable department store sales include sales of new
and relocated stores, and stores reopened after being closed for
an extended period (e.g., stores closed due to 2005 hurricanes),
after such stores have been open for 12 full consecutive fiscal
months. Stores remodeled and minor expansions not requiring
store closure remain in the comparable department store sales
calculation.
(2) Includes the effect of
the 53rd week in 2006 and 2003. Excluding sales of
$50 million for the 53rd week in 2006, total Direct
sales increased 2.4% for 2006. Excluding sales of
$46 million for the 53rd week in 2003, total Direct
sales increased 3.3% for 2004.
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During 2006, JCPenney announced that it expects to open
approximately 50 new stores per year from 2007 through 2009,
representing annual square footage growth of approximately 3%.
Signaling the launch of the Company’s accelerated growth
strategy, during 2006, the Company opened 28 new stores, 23 of
which are in what management believes is the successful off-mall
format. For the year, square footage grew 1.7%.
The Company introduced
a.n.atm,
a new private brand in women’s casual sportswear, in early
2006. It continues to exceed management’s expectations,
with first year sales of more than $300 million.
In late 2006, the Company launched a joint initiative with
Sephora U.S.A., Inc. (Sephora). Sephora began exclusively
servicing JCPenney customers’ online beauty needs through a
link to www.sephora.com from www.jcp.com, and in
early October 2006, the first five Sephora inside JCPenney
locations opened. Sephora inside JCPenney locations are expected
to be added to approximately 19 more JCPenney stores in the
first half of 2007, with additional locations planned for the
second half of the year and an accelerated rollout starting in
2008.
The Company’s capital structure and credit profile
continued to improve during 2006, principally as a result of
improved operating performance and the completion of a
$750 million common stock repurchase program. Combined with
the 2005 and 2004 capital structure repositioning programs,
which were initiated on July 31, 2004 in conjunction with
the sale of Eckerd, the programs represent an aggregate
$4.9 billion of common stock repurchases and an aggregate
$2.14 billion of debt reductions. To fund the programs, the
Company used the $3.5 billion in net cash proceeds from the
sale of the Eckerd drugstore operations, $260 million in
net cash proceeds from the sale of Lojas Renner S.A. (Renner)
shares, cash proceeds from the exercise of employee stock
options and existing cash and short-term investment balances.
Based on improvements in the Company’s capital structure
and related liquidity and coverage metrics, as well as the
Company’s improved operating performance and operating cash
flow generation, several positive credit rating actions occurred
in 2006. Moody’s Investors Service, Inc. (Moody’s)
raised its senior unsecured credit rating for the Company from
Ba1 to Baa3 in February 2006. Standard & Poor’s
Ratings Services (Standard & Poor’s) raised its
senior unsecured credit rating for the Company from BB+ to
BBB-in March 2006. Fitch Ratings (Fitch) raised its credit
rating on the Company’s senior unsecured notes and
debentures and its $1.2 billion revolving credit facility
from BBB- to BBB in October 2006. The Company now has investment
grade credit ratings from all three major credit rating agencies.
From 2000 to 2006, the Company has transitioned from a
turnaround to a growth mode. During this timeframe, the
Company’s stock price has increased from $12.81 to $83.70
and total stockholder return, which includes both stock price
appreciation and the reinvestment of dividends, grew at a
compound annual growth rate of 39%. Over this same period, the
Company had a 53% compound earnings per share growth rate. With
the stock price closing at $83.70 at the end of 2006, compared
to $56.21 at the end of 2005, the Company’s market
capitalization rose $5.8 billion during 2006 to reach
$18.9 billion at the end of 2006.
Current
Developments
In March 2007, the Company’s Board of Directors (Board)
authorized a new program of common stock repurchases of up to
$400 million, which will be funded with cash and short-term
investment balances. The new program, which is in addition to
the $750 million program completed in 2006, is expected to
be completed by the end of 2007. In addition, in February 2007,
the Board approved a plan to increase the quarterly dividend
rate from $0.18 to $0.20 per share beginning with the
May 1 quarterly dividend, bringing the expected annual
dividend rate from $0.72 per share to $0.80 per share,
an 11% increase. This comes on top of the 44% dividend increase
in 2006. On March 29, 2007, the Board declared a quarterly
dividend of $0.20 per share to be paid on May 1, 2007.
The Company pays dividends if, when and as declared by the Board.
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In February 2007, the Company launched
Ambrielletm,
a new private label lingerie brand. In response to feedback from
customers and research of direct competitors,
Ambrielletm
was created to fill a void in the marketplace for a sensual
lingerie brand targeted to the modern customer at a smart price.
Also in February 2007, the Company launched two new exclusive
brands by Liz Claiborne, Inc., Liz &
Co.®,
a traditional casual women’s apparel and accessories line,
and CONCEPTS by
Claibornetm,
featuring casual sportswear as well as suits and accessories for
the modern male customer.
On February 1, 2007, the Company announced its plans to
launch American
Livingtm,
a new lifestyle brand created exclusively for the JCPenney
customer by Polo Ralph Lauren’s Global Brand Concepts. The
launch is expected to be the largest in the Company’s
history and will include a full range of merchandise for women,
men and children, as well as intimate apparel, accessories and
home goods. Polo Ralph Lauren’s Global Brand Concepts will
be responsible for the design, production, marketing and
advertising of American
Livingtm,
which is expected to be available in JCPenney’s stores,
catalog and on jcp.com beginning in spring 2008.
In February 2007, JCPenney launched its new brand positioning:
Every Day
Matterstm.
This new branding is expected to position JCPenney as a
lifestyle solution for its target customers and will be evident
in every aspect of the Company’s business, from its
approach to merchandising to its marketing and advertising, to
most importantly, its enhanced customer service, with associates
focused on moving from a “transactional” relationship
to an “emotional” relationship with customers. This
new positioning of the JCPenney brand was unveiled to the public
with a new television advertising campaign, launched during
JCPenney’s sixth annual exclusive retail sponsorship of the
Academy Awards on February 25, 2007.
In March 2007, JCPenney scored highest in the Broadlines and
Department Store sector in Institutional Investor
magazine’s second annual ranking of “America’s
Most Shareholder-Friendly Companies.” Rankings were
determined by survey results from more than 750 portfolio
managers, buy-side and sell-side analysts asked to name the
companies in their areas of expertise that are the most
responsive to shareholders. This was in addition to JCPenney
being one of four award winners named in the same survey last
year.
Additional awards include JCPenney being listed in Fortune
Magazine’s 2007 list of America’s Most Admired
Companies, and ranking third in the General Merchandisers
category. Also in March 2007, the U.S. Environmental
Protection Agency named J. C. Penney Company, Inc. as the 2007
ENERGY STAR Retail Partner of the Year for outstanding
energy management and reductions in greenhouse gas emissions.
The award winners are selected from thousands of organizations
that participate in the ENERGY STAR program. JCPenney’s
accomplishments were recognized at an awards ceremony in
Washington, D.C., on March 21.
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Results
of Operations
The following discussion and analysis, consistent with all other
financial data throughout this Annual Report on
Form 10-K,
focuses on the results of operations and financial condition
from the Company’s continuing operations.
In 2006, the Company achieved its sixth consecutive year of
earnings improvement. Income from continuing operations was
$1,134 million, $977 million and $657 million in
2006, 2005 and 2004, respectively. Earnings increased as a
result of continued strong sales growth and further gross margin
improvement, combined with lower interest expense and bond
premiums. EPS from continuing operations increased 27% in 2006
to $4.88, compared to $3.83 in 2005 and $2.20 in 2004. EPS also
benefited from the Company’s common stock repurchase
programs.
(1) Includes the effect of
the 53rd week in 2006 and 2003. Excluding sales of
$204 million for the 53rd week in 2006, total
department store sales increased 5.0%. Excluding sales of
$152 million for the 53rd week in 2003, total
department store sales increased 4.7% for 2004.
(2) Comparable department
store sales are presented on a
52-week
basis. Comparable department store sales include sales of new
and relocated stores, and stores reopened after being closed for
an extended period (e.g., stores closed due to 2005 hurricanes),
after such stores have been open for 12 full consecutive fiscal
months. Stores remodeled and minor expansions not requiring
store closure remain in the comparable department store sales
calculation.
Comparable department store sales increased for the sixth
consecutive year, driven primarily by an increase in sales
transactions, coupled with positive trends in both units per
transaction and average unit retail. Department store sales
increased in all merchandise divisions and across all geographic
regions in 2006, reflecting positive customer response to the
style, quality, selection and smart pricing offered in the
Company’s merchandise assortments, compelling marketing
programs and continued improvement in the store shopping
experience. Management was pleased with the performance of all
apparel areas, especially women’s. Private brand sales,
including exclusive brands found only at JCPenney, totaled
approximately 48%, 46% and 42% of total department store
merchandise sales for 2006, 2005 and 2004, respectively, and
contributed significantly to the overall 2006 sales gains. Sales
for the 28 stores opened in 2006 were approximately
$216 million, including $72 million for the 10 stores
that were relocated.
The Direct channel represented approximately 15% of total net
retail sales in each of the last three years. Direct sales
continue to reflect a transformation into an Internet dominated
shopping channel supported by targeted specialty print media,
with sales increasing 4.1%, 3.6% and 1.5% for 2006, 2005 and
2004, respectively. Internet sales increased approximately 24%
in 2006 to $1,292 million, compared to $1,038 million
in 2005 and $812 million in 2004. On a
52-week
basis, Internet sales increased approximately 22%. Internet
sales represented approximately 44% of total Direct sales for
2006, compared to 37% in 2005 and 30% in 2004. Consistent with
customer shopping patterns, the Company continually reviews its
catalog page counts and circulation to ensure that print
catalogs remain productive.
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The following percentages represent the mix of consolidated net
retail sales:
Central to the Company’s merchandising initiatives is the
objective to become the leading retailer in offering style and
quality at smart prices with merchandise that inspires and
reflects the lifestyles of the Company’s target customer,
to continue building key JCPenney private and exclusive brands
and to be a leader in offering the most desired national
destination brands. Recent brand launches, which are discussed
below, support these merchandising initiatives.
The Company introduced
a.n.atm,
a private brand in women’s casual sportswear and
accessories, in early 2006. In September 2006, the Company
launched
east5thtm,
a new private brand in women’s traditional career wear.
During the 2006
Back-To-School
season, the Company launched X-Games boys’ apparel as an
exclusive line in over 600 JCPenney department stores and
Stevies by Steve
Maddentm
in girls’ apparel. This followed other recent launches such
as
Vans®
for the young surf and skate customer,
Solitude®
by Shaun Tomson, a California lifestyle-inspired men’s
apparel brand, and an expanded assortment of bedding and
accessories for student dorm rooms. The Company continues to
experience strength in the Miss
Bisou®
clothing collection for juniors, an extension of the Bisou
Bisou®
women’s sportswear line, and Studio by the JCPenney Home
Collectiontm,
a modern furniture collection, which were launched in early
2006. Also in early 2006, the Company added the Chris
Madden®
Hotel Collection, which features silk-blend comforters and 600
thread count sheets. Management is pleased with customer
response and sales results for all of the Company’s new and
expanded merchandise launches.
In April 2006, the Company announced a joint initiative with
Sephora U.S.A., Inc. (Sephora), under which JCPenney has begun
to sell beauty and fragrance products in its stores through
Sephora inside JCPenney locations and through the Internet. In
early October 2006, the first five Sephora inside JCPenney
locations opened. Management is pleased with initial results and
favorable customer reaction to the broad assortment of beauty
brands available in these locations. Sephora inside JCPenney
locations are expected to be added to approximately 19 more
JCPenney stores in the first half of 2007, with additional
locations planned for the second half of the year and an
accelerated rollout starting in 2008.
Store
Shopping Experience
Based on ongoing customer feedback, the Company has taken
several actions to improve the customer shopping experience
across all channels, including more closely aligning stores and
Direct promotions to improve effectiveness while maintaining the
capability to address unique customer needs in each channel. To
enhance customers’ in-store experience, the Company has
invested in renovating existing stores, and enhancing and
standardizing store layout and in-store visual displays,
accelerated the investment in new stores, particularly the
off-mall format, as well as reconfigured the store staffing
model to better serve customers while providing cost
efficiencies. The Company opened 28 new stores in 2006, 23 of
which were off-mall, bringing the total new off-mall stores
concept to more than 40 locations. Performance of new stores
(both mall and off-mall) continues to exceed the Company’s
expectations. During 2006, the Company completed its rollout of
a new
point-of-sale
(POS) system to all stores. The
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POS system reduces transaction time and will provide Internet
connectivity to all 35,000 in-store POS devices to enhance the
customer shopping experience.
In support of making the stores an easy and exciting place to
shop, during 2006, the Company began utilizing an online survey
to accumulate customer feedback on the store shopping
experience. Information has been obtained in such areas as
associate interactions with customers, availability of
associates, attractiveness of displays and fixtures, overall
store cleanliness and pricing and signing accuracy. The results
are used by stores to focus efforts on improvements that will
better meet their customers’ needs.
Costs associated with the Company’s 13 store merchandise
distribution centers were reclassified from SG&A expenses
into cost of goods sold in the fourth quarter of 2006 and are
reflected as such for all periods presented to better reflect
logistics costs associated with the Company’s high
percentage of private brand merchandise.
As a percent of sales, gross margin improved 100 basis
points in 2006, on top of an 80 basis-point improvement in 2005.
The continued improvement in gross margin reflects continued
strength in the performance of the Company’s private
brands, ongoing improvement in inventory management, including
better flow of seasonal goods resulting in lower markdowns, and
a larger contribution to sales from higher margin merchandise
divisions. The higher LIFO credit in 2006 was the result of
favorable costing, coupled with higher inventory levels.
In order to provide more clarity on the impact of growth
initiatives, depreciation and amortization, as well as
pre-opening expenses, have been presented as separate components
of operating expenses. Accordingly, these expenses are not
included in the table above, but are discussed under separate
headings below.
SG&A expenses improved by 10 basis points in 2006 to
27.7% of sales, on top of a 60 basis-point improvement in 2005.
As a percentage of sales, advertising costs increased
30 basis points, while total retirement-related benefit
plan expenses decreased 30 basis points. Increased
advertising expenses included costs related to the March 2006
virtual store at One Times Square in New York City, which
showcased an exclusive assortment of the Company’s private
and exclusive brands, as well as marketing costs related to the
Company’s fifth annual exclusive retail sponsorship of the
Academy Awards and retail sponsorships of the Teen Choice Awards
and the MTV Video Music Awards. The decrease in
retirement-related benefit plan expenses was driven by the
$60 million decrease in qualified pension plan expense,
which resulted from strong investment returns on the plan’s
assets. See a further discussion of the pension expense
beginning on page 34. SG&A expenses for 2006 included
$26 million related to expensing stock options in
accordance with Statement of Financial Accounting Standards
No. 123 (revised), “Share-Based Payment”
(SFAS No. 123R). Total SG&A expense dollars
increased 5.6% in 2006, driven by marketing and store staffing
expenditures made to support a successful holiday season,
operating costs for the 28 new stores added during the year, as
well as incremental operating expenses related to the
53rd week of 2006, which were approximately
$65 million.
SG&A expenses improved by 60 basis points in 2005, with
savings driven by efficiencies from changes in the department
store staffing model and efficiencies in the Direct channel.
While expenditures for advertising were virtually flat with
2004, the Company shifted a portion of the marketing dollars
spent in 2005 from promotional
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advertising to elevating the branding message of both JCPenney
and the Company’s private brands. SG&A expenses for
2005 included $32 million, or about $0.08 per share,
related to expensing employee stock options, which started in
the first quarter of 2005 upon the early adoption of
SFAS No. 123R. 2005 SG&A expenses also reflected a
previously disclosed one-time credit of $13 million
recorded in the third quarter related to the Company’s
share of expected proceeds from the Visa Check/MasterMoney
Antitrust Litigation settlement, which was essentially offset by
hurricane-related costs, net of probable insurance recoveries.
As expected with the accelerated store growth and investments in
improving existing stores, depreciation and amortization
expenses increased to $389 million in 2006, compared to
$372 million in 2005 and $359 million in 2004. As a
percentage of sales, depreciation and amortization expenses were
consistent from year to year at approximately 2%.
Pre-opening expense includes costs such as advertising, hiring
and training costs for new associates, processing and stocking
initial merchandise inventory and rental costs. With the launch
of the Company’s accelerated store growth strategy in 2006,
pre-opening expense increased to $27 million in 2006,
compared to $15 million and $11 million in 2005 and
2004, respectively. The Company opened 28, 18 and 14 new
stores, in 2006, 2005 and 2004, respectively.
Real estate and other consists primarily of ongoing operating
income from the Company’s real estate subsidiaries. In
addition, net gains were recorded from the sale of facilities
and real estate that are no longer used in Company operations
and investments in real estate partnerships. For 2005,
approximately half of the gain from the sale of real estate was
from the sale of a vacant merchandise processing facility that
was made obsolete by the centralized network of store
distribution centers put in place by mid-2003. Impairments
relate primarily to department stores and are the result of the
Company’s ongoing process of evaluating the productivity of
its asset base, as described under Valuation of Long-Lived
Assets on page 33. PVOL represents the present value of
operating lease obligations on closed units. In addition, in
2006 and 2004, the Company recorded charges of $7 million
and $29 million, respectively, associated with senior
management transition.
Operating income improved for the sixth straight year in 2006,
increasing 17.8%, or 100 basis points as a percent of
sales, driven by sales gains and continued improvement in gross
margin. This reflects the ongoing significant improvements the
Company has made in merchandise assortments, as well as further
refinements to the Company’s planning and allocation
systems to ensure that the merchandise is in the right place at
the right time. Operating
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income is the key measurement on which management evaluates the
financial performance of the Company’s retail operations.
Net interest expense totaled $130 million,
$169 million and $223 million in 2006, 2005 and 2004,
respectively. Net interest expense consists primarily of
interest expense on long-term debt, net of interest income
earned on cash and short-term investments. Net interest expense
in 2006 primarily benefited from higher short-term interest
rates on cash and short-term investment balances. The
weighted-average interest rate on long-term debt has remained
relatively constant at 7.8%, 7.8% and 7.7% in 2006, 2005 and
2004, respectively. Interest income earned on short-term
investments increased in 2006 to an average annual interest rate
of 5.0%, compared to 3.2% in 2005 and 1.5% in 2004. Total debt
was reduced by $2.14 billion as part of the Company’s
debt reduction programs initiated in 2004 and completed by the
end of the second quarter of 2005. For 2004, net interest
expense of $95 million was allocated to the operating
results of Eckerd and recorded as discontinued operations.
During 2005 and 2004, the Company incurred $18 million and
$47 million, respectively, of premiums, commissions and
unamortized costs related to the purchase of debt in the open
market and redemption of securities under the 2005 and 2004 debt
reduction programs, which are discussed on
pages 28-29.
These costs are reflected in Bond Premiums and Unamortized Costs
in the Consolidated Statements of Operations. No such costs were
incurred by the Company in 2006.
The overall effective tax rates for continuing operations were
36.7%, 32.3% and 34.6% for 2006, 2005 and 2004, respectively.
The 2006 rate was favorably impacted by the release of
$32 million, or $0.14 per share, of federal income tax
reserves resulting from the favorable resolution of prior year
tax matters. The 2005 rate reflected a credit of
$49 million, or $0.20 per share, which was principally
attributable to reversing the remaining state tax net operating
loss valuation allowance. Also benefiting 2005 was a one-time
credit of $5 million related to changes in state income tax
laws. The 2007 effective income tax rate is expected to increase
to approximately 38.6%.
Discontinued
Operations
Discontinued operations added $0.08 per share to net income
in 2006, principally related to positive variances on tax
reserves that had been provided for in connection with the sale
of previously owned businesses. For 2005, discontinued
operations added $0.43 per share to net income, while in
2004, discontinued operations resulted in a charge of
$0.44 per share. The 2005 credit was principally related to
favorable resolution of certain tax matters associated with the
Company’s former Eckerd drugstore operations, and the 2004
charge resulted primarily from the loss on the sale of Eckerd
combined with Eckerd operating losses to the date of sale.
On July 5, 2005, the Company’s indirect wholly owned
subsidiary, J. C. Penney Brazil, Inc., closed on the sale of its
shares of Lojas Renner S. A. (Renner), a Brazilian department
store chain, through a public stock offering registered in
Brazil. The Company generated cash proceeds of $283 million
from the sale of its interest in Renner. After taxes and
transaction costs, net proceeds approximated $260 million.
Proceeds from the sale were used for common stock repurchases,
which are more fully discussed under Equity and Debt
Restructuring on
pages 28-29.
Including an $8 million credit related to taxes that was
recorded in 2006, the sale resulted in a cumulative pre-tax gain
of $26 million and an after-tax gain of $1 million.
The relatively high tax cost is largely due to the tax basis of
the Company’s investment in Renner being lower than its
book basis as a result of accounting for the investment under
the cost method for tax purposes. Included in the pre-tax gain
on the sale was $83 million of foreign currency translation
losses that had accumulated since the Company acquired its
controlling interest in Renner.
On July 31, 2004, the Company and certain of its
subsidiaries closed on the sale of its Eckerd drugstore
operations to the Jean Coutu Group (PJC) Inc. (Coutu) and
CVS Corporation and CVS Pharmacy, Inc. and received net
cash
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proceeds of approximately $3.5 billion. Proceeds from the
sale were used for common stock repurchases and debt reduction,
which are more fully discussed under Equity and Debt
Restructuring on
pages 28-29.
During 2006, the Company recorded an after-tax credit of
$4 million related to the Eckerd discontinued operations,
which was primarily related to taxes. Through 2006, the
cumulative loss on the sale was $715 million pre-tax, or
$1,326 million on an after-tax basis. The relatively high
tax cost is a result of the tax basis of Eckerd being lower than
its book basis because the Company’s previous drugstore
acquisitions were largely tax-free transactions. Of the total
after-tax loss on the sale, $108 million was recorded in
2004 to reflect revised estimates of certain post-closing
adjustments and resulting sales proceeds, and
$1,325 million was recorded in 2003 to reflect Eckerd at
its estimated fair value less costs to sell. These charges were
partially offset by an after-tax credit of $103 million
recorded in 2005, which was primarily related to the favorable
resolution of certain tax matters, as well as a reduction of the
taxes payable on the sale of Eckerd due to adjustments in
Eckerd’s tax basis.
Upon closing on the sale of Eckerd on July 31, 2004, the
Company established reserves for estimated transaction costs and
post-closing adjustments. Certain of these reserves involved
significant judgment and actual costs incurred over time could
vary from these estimates. The more significant remaining
estimates relate to the costs to exit the Colorado and New
Mexico markets and environmental indemnifications. Management
continues to review and update the remaining reserves on a
quarterly basis and believes that the overall reserves, as
adjusted, are adequate as of February 3, 2007 and
consistent with original estimates. Cash payments for the
Eckerd-related reserves are included in the Company’s
Consolidated Statements of Cash Flows as Cash Paid for
Discontinued Operations, with tax payments included in operating
cash flows and all other payments included in investing cash
flows.
In November 2003, the Company closed on the sale of its six
Mexico department stores and recorded a loss of
$14 million, net of a $27 million tax benefit. In 2005
and 2004, the Company recognized after-tax gains of
$5 million and $4 million, respectively, related to
reserve adjustments and additional tax benefits realized.
In 2006, 2005 and 2004, after-tax gains of $7 million,
$3 million and $1 million, respectively, were recorded
related to the sale of J. C. Penney Direct Marketing Services,
Inc.’s assets due to favorable resolution of certain past
tax issues, tax regulation changes and tax audits.
The Company’s financial statements, accompanying notes and
other information provided in this Annual Report on
Form 10-K
reflect these businesses as discontinued operations for all
periods presented.
Financial
Condition
The strength of the Company’s financial condition is
primarily dependent on the competitiveness of its customer value
proposition and the level of operating performance relative to
the capital resources invested in the business. Therefore,
management’s successful execution of the Long Range Plan
will continue to be the key driver of the Company’s
consistent operating performance improvement, earnings per share
growth, market valuation and overall financial condition.
The Company’s financial strategy will continue to focus on
opportunities to deliver value to stockholders, strengthen the
financial position and improve the credit rating profile. Long
range planning targets have been established related to
operating financial goals, key financial metrics, cash flow,
credit ratings, dividends and earnings per share growth, which
are discussed below.
At the April 2006 Analyst Meeting, management provided updated
profitability targets to the original 2005 to 2009 Long Range
Plan. Specific long-range operating financial objectives
include generating annual low single-digit comparable
department store sales increases and mid single-digit Direct
sales increases, with total sales increasing mid-single digits,
continued improvement in annual gross margin and leveraging of
SG&A expenses, with the objective of reaching an operating
income target of 10.0% to 10.5% of sales in 2009, and achieving
16% annual
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EPS growth through 2009. With the 2006 operating income
margin at 9.7%, the Company’s 2006 operating performance
came close to achieving in just two years the planned
performance levels in its original
2005-2009
Long Range Plan. Management will communicate operating
performance targets for a new 2007 to 2011 Long Range Plan at
its April 2007 Analyst Meeting. Going forward, the growth
drivers for operating income will continue to be new store
growth, sales productivity improvements, continued improvements
in the gross margin rate and SG&A leverage. The
Company’s progress toward achieving its operating financial
goals could be impacted by various risks, which are discussed in
Item 1A, Risk Factors, beginning on page 4, and the
cautionary statement regarding forward-looking information on
page 39.
The Company expects cash flow from operating activities
(operating cash flow) to increase each year, resulting
principally from higher net income. Operating cash flow is
targeted to exceed planned capital spending levels, in order to
provide financial flexibility and ongoing support for the Long
Range Plan.
Continued strong operating performance, increasing operating
cash flows and a strengthening capital structure should enable
the Company to achieve competitive investment grade credit
ratings, allowing access to the commercial paper market,
thereby enhancing the Company’s financial flexibility.
The goal of the Company’s dividend policy is to
deliver competitive value to stockholders. The Company’s
Board of Directors (Board) increased the cash dividends to
stockholders by 44% in 2006 and a plan to increase the cash
dividend by 11% was approved by the Board for 2007.
The Company’s 2006 performance represented further progress
toward industry leadership, resulting from continued improvement
in operating results and the completion of a $750 million
stock repurchase program. Over the past several years, the
Company’s returns on capital have significantly improved,
and its financial leverage has been dramatically reduced. The
Company’s operating performance in 2006 was well ahead of
schedule in achieving the objectives established in the original
2005-2009
Long Range Plan.
Management and the investment community utilize these financial
metrics to assess the Company’s financial health and
benchmark against planned targets as well as peers in the retail
industry. The Company’s calculations of these metrics are
based on components of the GAAP financial statements and may
vary from those of other companies, potentially limiting
comparability. These measures are not considered GAAP measures,
but management believes they provide the most comprehensive
perspective of the Company’s capital productivity and
financial leverage.
In 2006, the Company’s return on stockholders’ equity
(ROE) and return on invested capital (ROIC) improved
significantly. In 2006, the Company achieved a 28.3% ROE,
representing a 31% improvement since 2000. The Company
calculates ROE as income from continuing operations divided by
beginning of year stockholders’ equity. The Company uses an
11% ROIC as its target, or “hurdle”, rate for new
capital investments, which represents the Company’s blended
(debt and equity) long-term cost of capital estimate. In 2006,
the Company exceeded this level with a ROIC of 17.4%. The
Company calculates ROIC as income from continuing operations
plus after-tax interest expense on long-term debt divided by the
sum of beginning of year stockholders’ equity and long-term
debt, including current maturities. Beginning in 2007, return
metrics will reflect the 2006 reduction to equity resulting from
a change in pension accounting rules (discussed in Note 1
on pages F-12 and F-13). Notwithstanding the equity adjustment,
further improvements in both ROE and ROIC are expected in future
years with continued earnings growth.
After significant improvement during the 2001 to 2005 turnaround
period, the Company’s capital structure as of year-end 2006
remains competitive. As of year-end 2006, the Company’s
debt percent to total capital improved to a level of
44.5%, compared to 46.4% and 44.7% in 2005 and 2004,
respectively. The improvement in 2006 was primarily a result of
higher net income. No material changes in long-term debt
occurred during 2006.
Under the Company’s 2005 Credit Agreement, discussed on
page 27, the Company is required to satisfy a leverage
ratio covenant and a fixed charge coverage ratio covenant, which
are discussed in Note 10. The leverage ratio
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continued to improve during 2006 to a level of 1.5 to 1.0, and
remained in compliance with the 2005 Credit Agreement covenant
requirement of no more than 3.0 to 1.0. The fixed charge
coverage ratio also improved during 2006 to a level of 6.9 to
1.0, and remained in compliance with the 2005 Credit Agreement
covenant requirement of at least 3.2 to 1.0.
Over the 2000 to 2006 period, the Company’s liquidity and
capital resources have strengthened significantly and created an
increased level of financial flexibility to support the
Company’s Long Range Plan. The Company manages its capital
structure to ensure financial flexibility and access to capital,
at a competitive cost, necessary to support the Long Range Plan.
Management considers all on- and off-balance sheet debt in
evaluating the Company’s overall liquidity position and
capital structure. See the discussion of off-balance sheet
arrangements on pages 27-28 and the detailed disclosure
regarding operating leases and their off-balance sheet present
value in Note 16.
At year-end 2006, the Company had approximately
$2.7 billion of cash and short-term investments, which
represented nearly 80% of its $3.4 billion of outstanding
long-term debt, including current maturities. Cash and
short-term investments included restricted short-term investment
balances of $58 million as of February 3, 2007,
pledged as collateral for a portion of casualty insurance
program liabilities. In 2006, the cash and short-term investment
balance was reduced by the completion of a $750 million
common stock repurchase program. In addition to cash and
short-term investments, the Company’s liquidity position
includes a five-year $1.2 billion revolving credit facility
that was put in place in April 2005 (2005 Credit Agreement). The
2005 Credit Agreement is unsecured, and all collateral securing
the previously existing $1.5 billion credit facility has
been released. The dollar amount of the credit facility was
reduced due to the sale of Eckerd. For further discussion of the
credit facility, see page 27. The Company’s liquidity
is enhanced by the fact that the current debt portfolio and
material lease agreements contain no provisions that could
trigger acceleration of payments or collateral support in the
event of adverse changes in the Company’s financial
condition.
Cash
Flows
The following is a summary of the Company’s cash flows from
operating, investing and financing activities for both
continuing and discontinued operations:
(1) Includes $300 million discretionary cash
contributions to the Company’s qualified pension plan in
both 2006 and 2004. The approximately $110 million tax
benefit related to the 2006 contribution will not be realized
until fiscal 2007; the 2004 contribution was $190 million
after tax. No contribution to the Company’s qualified
pension plan was made in 2005 due to the plan’s well-funded
status and Internal Revenue Service limitations on tax
deductible contributions.
(2) Includes $822 million of income taxes paid
related to the sale of Eckerd.
Significantly improved operating performance over the past few
years has provided the financial flexibility to increase capital
expenditures for new store growth, store renewals and updates,
with additional liquidity allowing the Company to increase
funding to its qualified pension plan.
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Cash
Flow from Operating Activities – Continuing
Operations
The Company’s operations are seasonal in nature, with the
business depending to a great extent on the last quarter of the
year when a significant portion of the sales, profits and
positive operating cash flows are realized. Cash requirements
are highest in the third quarter as the Company builds inventory
levels in preparation for the holiday season.
In both 2006 and 2004, the Company made $300 million
discretionary contributions to its qualified pension plan. Based
on market conditions, the resulting well-funded status of the
pension plan and Internal Revenue Service rules limiting tax
deductible contributions, the Company did not make a
discretionary pension contribution to its qualified pension plan
in 2005. Additionally, due to the adoption of
SFAS No. 123R in 2005, $39 million and
$43 million, respectively, of excess tax benefits from
stock options exercised are reflected in cash flows from
financing activities for 2006 and 2005, whereas for 2004,
$76 million of excess tax benefits from stock options
exercised were reflected in cash flows from operating activities.
Cash
Flow from Investing Activities – Continuing
Operations
Capital expenditures, including capitalized software costs, were
$772 million, $535 million and $398 million in
2006, 2005 and 2004, respectively. The increase was principally
for new off-mall stores, store renewals and modernizations and
costs related to new
point-of-sale
technology at each of the Company’s 35,000 registers.
During 2006, the Company opened 28 new stores, 10 of which were
store relocations, and closed four stores. The following
provides a breakdown of capital expenditures:
Consistent with the Long Range Plan, new store growth is planned
to further accelerate in 2007. Management expects 2007 capital
expenditures to be approximately $1.2 billion.
Approximately 55% of the capital spending will relate to new or
relocated stores, 30% to store renewals and updates, 10% to
technology, and 5% to other routine projects. The Company
currently plans to open 50 new and relocated stores in 2007, of
which over 80% are expected to be off-mall. Incorporating
relocations and store closures, net square footage growth is
expected to increase approximately 3%.
Proceeds from the sale of real estate assets were
$20 million for 2006, compared to $31 million and
$34 million in 2005 and 2004, respectively.
Cash
Flow from Financing Activities – Continuing
Operations
For 2006, cash payments for long-term debt, including capital
leases, totaled $21 million. During 2005, such payments
totaled $474 million and are discussed further under Equity
and Debt Restructuring on
pages 28-29.
During 2006, the Company returned approximately
$900 million to stockholders through common stock
repurchases and dividend payments. The Company repurchased
11.3 million shares of common stock for $750 million
during 2006. Common stock was retired on the same day it was
repurchased, and the related cash settlements were completed on
the third business day following the repurchase.
JCPenney raised the quarterly dividend on its common stock to
$0.18 per share beginning with the May 1, 2006
dividend. The Company paid quarterly dividends of
$0.125 per share in 2005 and 2004. The Board reviews the
dividend policy and rate on a quarterly basis, taking into
consideration the overall financial and strategic outlook for
the Company, earnings, liquidity and cash flow projections, as
well as competitive factors. Based on the current outlook for
earnings, cash flow and liquidity, in February 2007, the Board
approved a plan to increase the quarterly dividend by 11%, from
$0.18 per share to $0.20 per share, to be effective
with the dividend to be paid on May 1, 2007. Prior to
August 26, 2004, the Company also paid semi-annual
dividends on its Series B ESOP Convertible
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Preferred Stock at an annual rate of $2.37 per common share
equivalent. All outstanding shares of Series B ESOP
Convertible Preferred Stock were converted to common shares on
August 26, 2004.
Net proceeds from the exercise of stock options were
$135 million in 2006, compared to $162 million in 2005
and $248 million in 2004.
Due to the adoption of SFAS No. 123R in 2005,
$39 million and $43 million, respectively, of excess
tax benefits from stock options exercised are reflected in cash
flows from financing activities for 2006 and 2005, whereas for
2004, $76 million of excess tax benefits from stock options
exercised were reflected in cash flows from operating activities.
In 2007, the Company’s financing strategy will continue to
focus on opportunities to deliver value to stockholders,
strengthen the financial position and improve the credit
profile. The Company’s strengthened financial position
provides an increased level of financial flexibility to support
the strategic growth objectives of the Long Range Plan.
Consistent with the Company’s goal of delivering value to
stockholders, in February 2007, the Board approved a plan to
increase the quarterly dividend by 11%, from $0.18 per
share to $0.20 per share, to be effective with the dividend
to be paid on May 1, 2007. On March 29, 2007, the
Board declared a quarterly dividend of $0.20 per share to
be paid on May 1, 2007. In addition, the Board authorized a
new $400 million common stock repurchase program, which is
expected to be completed by the end of 2007 and will be funded
by a portion of the cash proceeds and tax benefits from
associate stock option exercises and cash and short-term
investment balances.
In accordance with its financing strategy, the Company expects
to maintain its strong liquidity position in 2007. The Company
expects operating cash flow to increase each year, resulting
principally from higher net income. Operating cash flow is
targeted to exceed planned capital spending levels, which should
provide financial flexibility and ongoing support for the Long
Range Plan. Until all of the Company’s credit ratings
improve to competitive investment-grade levels, access to the
capital markets for cash needs will retain an element of
uncertainty. As such, management intends to maintain sufficient
cash investment levels to ensure support for operational
business needs, strategic initiatives, long-term debt
maturities, dividends and contingency items, such as the
opportunistic purchase of selected real estate properties
attributable to consolidation within the retail industry. The
Company does not expect to borrow under its credit facility
except to support ongoing letters of credit. The Company has
$425 million of notes scheduled to mature in 2007, and an
additional $200 million scheduled to mature in fiscal 2008.
In accordance with its long-term financing strategy, the Company
manages its financial position on a multi-year basis and may
access the capital markets opportunistically.
The Company’s cash flows may be impacted by many factors,
including the competitive conditions in the retail industry, the
effects of the economic environment and consumer confidence
levels. Based on the nature of the Company’s business,
management considers the above factors to be normal business
risks.
Total LIFO inventory was $3,400 million at the end of 2006
compared with $3,210 million at the end of 2005. FIFO
inventory was $3,408 million at the end of 2006, which
increased 5.4% when compared to last year’s
$3,234 million, primarily as a result of new store openings
in 2006 and new stores planned for the first quarter of 2007.
After an effective transition from fall and holiday assortments,
the Company was well positioned at the end of 2006 with fresh
merchandise for the spring season and less clearance merchandise
than the prior year. Inventory also reflected a good balance
between fashion and basic merchandise.
With new systems and its network of store distribution centers,
the Company has continued to enhance its ability to allocate and
flow merchandise to stores in-season by recognizing sales trends
earlier and accelerating receipts, replenishing individual
stores based on rates of sale and consistently providing high
in-stock levels in basics and advertised items. This continued
improvement of inventory management has helped to drive more
profitable sales and improvements in inventory turnover, which
for 2006, 2005 and 2004 was 3.33, 3.28 and 3.21, respectively.
With the elimination of global trade quotas on apparel and
textiles, the Company expects to concentrate production of
private brand merchandise in fewer countries and with fewer
manufacturers. On an ongoing basis, the Company develops
contingency plans to provide for alternate sources for product
in order to ensure uninterrupted access to
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merchandise. Cost reductions will allow the Company to invest in
higher quality merchandise and thereby improve the value
proposition to the Company’s target customer.
Aggregated information about the Company’s obligations and
commitments to make future contractual payments, such as debt
and lease agreements, and contingent commitments as of
February 3, 2007 is presented in the following table.
(1) Represents expected payments through 2016. Based on
the accounting rules for retirement and postretirement benefit
plans, the liabilities reflected in the Company’s
Consolidated Balance Sheets differ from these estimated future
payments. See Note 17.
(2) The 2007 interest payments include $84 million
that is reflected in Accrued Expenses and Other Current
Liabilities in the Company’s Consolidated Balance Sheet at
February 3, 2007. See Note 7.
(3) Represents future minimum lease payments for
non-cancelable operating leases, including renewals determined
to be reasonably assured.
(4) Standby letters of credit ($116 million) are
issued as collateral to a third-party administrator for
self-insured workers’ compensation and general liability
claims. The remaining $6 million are outstanding import
letters of credit.
(5) Surety bonds are primarily for previously incurred
and expensed obligations related to workers’ compensation
and general liability claims.
(6) Consists primarily of (a) minimum purchase
requirements for exclusive merchandise and fixtures;
(b) royalty obligations and (c) minimum obligations
for professional services, energy services, software maintenance
and network services.
(7) Includes (a) $11 million for certain
personal property leases assumed by the purchasers of Eckerd;
(b) $11 million on loans related to a real estate
investment trust and (c) $20 million related to a
third-party reinsurance guarantee.
The Company is predominantly engaged in the retailing business
of buying and selling apparel, accessories and home merchandise.
In the normal course of business, the Company issues purchase
orders to vendors/suppliers for merchandise inventory to meet
customer demand for fashion, seasonal and basic merchandise. The
Company’s purchase orders are not unconditional
commitments, but rather represent executory contracts requiring
performance by vendors/suppliers, including delivery of the
merchandise prior to a specified cancellation date and meeting
product specifications and other requirements. Failure to meet
agreed-upon
terms and conditions may result in the
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cancellation of the order. Accordingly, the table above excludes
outstanding purchase orders for merchandise inventory that has
not been shipped. Under the terms of the purchase orders,
merchandise is purchased on a Free on Board (F.O.B.) shipping
point basis, which means ownership of the merchandise passes to
the Company upon shipment. As a result, the cost of merchandise
shipped but not received by the Company as of year end
(in-transit merchandise) is recorded on the Consolidated Balance
Sheets in Merchandise Inventory with a corresponding offset in
Trade Payables. As of February 3, 2007, the Company had
approximately $392 million of domestic and foreign
in-transit merchandise, which together with trade payables for
merchandise already received, is reflected in the table above.
Additionally, the Company issues letters of credit for selected
merchandise inventory sourced overseas, which are also included
in the previous table.
The Company, JCP and J. C. Penney Purchasing Corporation are
parties to a five-year $1.2 billion unsecured revolving
credit facility (2005 Credit Agreement) with a syndicate of
lenders with JPMorgan Chase Bank, N.A., as administrative agent.
The 2005 Credit Agreement is available for general corporate
purposes, including the issuance of letters of credit. Pricing
is tiered based on JCP’s senior unsecured long-term debt
ratings by Moody’s and Standard & Poor’s.
JCP’s obligations under the 2005 Credit Agreement are
guaranteed by the Company. No borrowings, other than the
issuance of trade and standby letters of credit, which totaled
$122 million as of the end of 2006, have been made under
this facility. The 2005 Credit Agreement includes two financial
leverage metric covenants, which are discussed in Note 10.
Improvements in the Company’s operating performance and
financial metrics led to its long-term debt credit rating being
raised to investment grade level by Fitch in 2005 and by
Moody’s and Standard & Poor’s in early 2006.
Restoring competitive investment grade credit ratings,
consistent with retail industry leaders, continues to be a
financial goal for the Company.
As of March 19, 2007, the Company’s credit ratings and
outlook were as follows:
During the first quarter of 2006, both Moody’s and
Standard & Poor’s raised the Company’s credit
ratings to investment grade. In February 2006, Moody’s
raised its senior unsecured credit rating for the Company from
Ba1 to an investment grade rating of Baa3. In April 2006,
Standard & Poor’s raised its credit rating on the
Company’s long-term corporate credit and senior unsecured
debt from BB+ to an investment grade rating of BBB-. In October
2006, Fitch raised its credit rating on the Company’s
senior unsecured notes and debentures and its $1.2 billion
2005 Credit Agreement from BBB- to BBB, both investment grade
credit ratings. In December 2006, Moody’s raised its
outlook on the Company’s long-term debt rating from
“Stable” to “Positive.” Going forward, the
Company expects that the rating agencies will continue to focus
on operating performance consistency, earnings growth and
financial leverage as key factors in any ratings decisions.
The Company has an indenture covering approximately
$255 million of long-term debt that contains a financial
covenant requiring the Company to have a minimum of 200% net
tangible assets to senior funded indebtedness (as defined in the
indenture). This indenture permits the Company to issue
additional long-term debt if it is in compliance with the
covenant. As of year-end 2006, the Company’s percent of net
tangible assets to senior funded indebtedness was 292%.
Other than operating leases, which are included in the
Contractual Obligations and Commitments table on page 26,
the Company does not have any off-balance sheet financing. The
Company has not created, and is not party to, any
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special-purpose or off-balance sheet entities for the purpose of
raising capital, incurring debt or operating its business.
As of February 3, 2007, the Company had guarantees of
approximately $11 million for certain personal property
leases assumed by the purchasers of Eckerd, which were
previously reported as operating leases. Currently, management
does not believe that any potential financial exposure related
to these guarantees would have a material impact on the
Company’s financial position or results of operations.
JCP, through JCP Realty, Inc., a wholly owned subsidiary, has
investments in 14 partnerships that own regional mall
properties, six as general partner and eight as limited partner.
JCP’s potential exposure to risk is greater in partnerships
in which it is a general partner. Mortgages on the six general
partnerships total approximately $353 million; however, the
estimated market value of the underlying properties is
approximately $842 million. These mortgages are
non-recourse to JCP, so any financial exposure is minimal. In
addition, JCP Realty, Inc. has guaranteed loans totaling
approximately $11 million related to an investment in a
real estate investment trust. The estimated market value of the
underlying properties significantly exceeds the outstanding
mortgage loans, and the loan guarantee to market value ratio is
less than 3% as of February 3, 2007. In the event of
possible default, the creditors would recover first from the
proceeds of the sale of the properties, next from the general
partner, then from other guarantors before JCP’s guarantee
would be invoked. As a result, management does not believe that
any potential financial exposure related to this guarantee would
have a material impact on the Company’s financial position
or results of operations.
As part of the 2001 sale of the assets of the Company’s
Direct Marketing Services subsidiary, JCP signed a guarantee
agreement with a maximum exposure of $20 million. Any
potential claims or losses are first recovered from established
reserves, then from the purchaser and finally from any state
insurance guarantee fund before JCP’s guarantee would be
invoked. As a result, management does not believe that any
potential exposure would have a material effect on the
Company’s consolidated financial statements.
The Company does not have any additional arrangements or
relationships with entities that are not consolidated into the
financial statements.
In order to enhance stockholder value, strengthen the
Company’s capital structure and improve its credit rating
profile, since 2004, the Company has implemented programs to
repurchase common stock, reduce debt and redeem all outstanding
shares of Series B ESOP Convertible Preferred Stock
(Preferred Stock). In order to fund these programs, the Company
used the $3.5 billion in net cash proceeds from the sale of
the Eckerd drugstore operations, $260 million in net cash
proceeds from the sale of Renner stock, cash proceeds and tax
benefits from the exercise of employee stock options and
existing cash and short-term investment balances.
Stock
Repurchases
During the 2004 to 2006 period, the Company purchased a combined
$4.9 billion of its common stock through open-market
transactions as follows:
(1) Excludes commissions.
Of the total repurchases, the Company’s Board authorized
$3.0 billion in 2004, $1.15 billion in 2005 and
$750 million in 2006.
Debt
Reduction
The Company’s debt reduction programs, which were completed
by the end of the second quarter of 2005, consisted of
approximately $2.14 billion of debt reductions.
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The Company’s debt retirements included $250 million
of open-market debt repurchases in the first half of 2005, the
payment of $193 million of long-term debt at the scheduled
maturity date in May 2005 and 2004 transactions that consisted
of $650 million of debt converted to common stock,
$822 million of cash payments and the termination of the
$221 million Eckerd securitized receivables program. The
Company incurred pre-tax charges of $18 million and
$47 million in 2005 and 2004, respectively, related to
these early debt retirements.
Series B
Convertible Preferred Stock Redemption
On August 26, 2004, the Company redeemed, through
conversion to common stock, all of its outstanding shares of
Preferred Stock. All of these shares were held by the
Company’s Savings, Profit-Sharing and Stock Ownership Plan,
a 401(k) savings plan. Each holder of Preferred Stock received
20 equivalent shares of JCPenney common stock for each share of
Preferred Stock in their Savings Plan account in accordance with
the original terms of the Preferred Stock. Preferred Stock
shares, which were included in the diluted earnings per share
calculation as appropriate, were converted into approximately
nine million common stock shares. Annual dividend savings
approximated $11 million after tax.
Risk
Management
Management is committed to proactively managing enterprise risks
as the strategies and initiatives of the Long Range Plan are
executed in order to maximize enterprise value (defined as the
combined capital markets’ value of the Company’s debt
and equity) to investors. The success to date in implementing
the
2005-2009
Long Range Plan has resulted in strategic and operational
initiatives that have associated and ever-changing performance
opportunities, both upside and downside. Over the past six
years, the Company’s enterprise value increased
significantly as its portfolio of risks was managed effectively.
Management defines risk as the potential deviation from planned
operating results that may have a negative impact on investor
enterprise value in the short or long term. The deviation can
arise from inadequate or ineffective internal processes or
systems, external events or Company personnel. The Company is
subject to risks inherent in operating a multi-channel retailing
organization. For a detailed discussion on risks and
uncertainties, see Item 1A, Risk Factors, beginning on
page 4 and the cautionary statement regarding
forward-looking information on page 39.
The key driver in managing strategic and operating risks in
order to maximize enterprise value is consistent execution of
the Long Range Plan strategies and initiatives. Managing
strategic and operating risks provides opportunities, both to
capitalize on positive events and mitigate negative
circumstances.
The Company conducts extensive customer research. During 2006,
the Company began utilizing an online survey to accumulate
customer feedback on the store shopping experience. Information
has been obtained in such areas as associate interactions with
customers, availability of associates, attractiveness of
displays and fixtures, overall store cleanliness and pricing and
signing accuracy. The results are used by stores to focus
efforts on improvements that will better meet their
customers’ needs. The Company also regularly measures
customer satisfaction through a customer scorecard, which
benchmarks customer perceptions against key competitors. Exit
surveys are regularly conducted to better understand customer
shopping habits and whether they are finding what they want at
JCPenney. In addition, management continues to focus on
measuring marketing productivity by utilizing post-event
analyses and other measurement tools.
The Company has resources dedicated to monitoring the external
environment, which includes retail competitors, retail industry
and consumer trends, as well as the current economic outlook.
The deeper the Company’s understanding is of
competitors’ strategies, performance, and strengths and
weaknesses, the better it can develop appropriate responses to
compete more effectively, enhance the Company’s competitive
position, and achieve and sustain top quartile performance.
Management conducts ongoing strategic geographic market
research, including demographic and regional economic trends,
prior to making a decision to enter or relocate into a
particular geographic area. The Company conducts ongoing
benchmarking of key metrics for all geographic markets,
including market share, sales growth, sales per square foot, and
competitor and population trends.
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Product development and sourcing are critical to the success of
the private brand business. Another key Company initiative is
reducing private brand “cycle time” – the
time it takes from concept until the merchandise hits the
selling floor. With the Company’s most recent private brand
launches, management has been able to demonstrate that it can
significantly reduce the cycle time. The Company’s
substantial sourcing abilities should enable it to continue to
reduce the product lead times and offer customers more relevant
and timely merchandise. Management has established processes to
optimize order flow by country and to reduce the cycle time from
the design stage to having the merchandise available for sale to
customers.
The Company has a diversified supplier base, both domestic and
foreign, and is not dependent to any significant degree on any
single supplier. Additionally, the Company has business
continuity plans in place for all merchandise distribution
centers that would provide rerouting of merchandise allocations
to have uninterrupted flow of merchandise to both stores and
direct to customers.
In order to ensure that associates have the tools and skills
needed to support the Company’s strategies and initiatives,
senior management has been developing new training programs and
has been involved in delivering these programs to associates.
This includes “Retail Academy,” a week-long program
for high-potential associates focused on retail strategy and
team building, and “WINNING TOGETHER Leading
Together,” a course led by the Company’s Chief
Executive Officer focused on improving leadership skills for the
Company’s most senior 500 managers.
The Company seeks to minimize operational risk associated with
communication and information systems through the development of
back-up
systems and emergency plans. The Company has disaster prevention
and recovery plans in place should events occur that could
interrupt operations. Ongoing assessment and testing is being
conducted to minimize current and future risk. There is a
process in place to provide regular associate training,
operating instructions and site visits to help limit operational
defects or mistakes.
The Company has a number of integrated programs in place to
mitigate the financial impact from property losses or
third-party liability claims. Each year, management reviews the
level of risk that will be retained by the Company and the
portion of risk that will be supported by conventional insurance
contracts. The Company’s strong financial profile, business
continuity plans, and third-party insurance where appropriate,
mitigate the risk that any single risk event would have a
material impact on the Company’s financial position or
operations.
As part of its ongoing planning process, management measures key
risks in terms of the potential impact on enterprise market
value, operating performance, key financial metrics, and the
Company’s overall financial condition. This process
utilizes scenario analysis and “stress testing” of
risks that can cause variation from planned operating results
and impact the Company’s enterprise value. Until such time
as the Company has steady and reliable access to commercial
paper, it plans to maintain sufficient cash investment levels to
cover peak seasonal inventory needs and contingencies.
The Company also recognizes that to achieve its strategies, it
must maintain its reputation among many constituents –
customers, suppliers, investors and regulators, as well as the
general public – for business practices of the highest
ethical quality. Attention to integrity and reputation has
always been a key aspect of the Company’s practices and
maintenance of reputation is the responsibility of everyone in
the organization. The Company supports this individual
responsibility in many ways, including a code of ethics,
training, policies, reporting mechanisms and oversight through
the Company’s Legal Compliance and Business Ethics
Committee, which is discussed below.
The Company has an enterprise-wide risk management framework in
place to identify, measure and manage risks. The Company’s
organizational structure, both at the Board and management
levels, plays a critical role in maintaining an effective
overall risk management process, as highlighted by the risk
management and monitoring processes described below.
Independent Oversight – Several Board
committees oversee the risk governance activities of the senior
management committees. The Audit Committee is responsible for
discussion of guidelines and policies governing the process by
which risk assessment and management is undertaken. In addition,
the Audit Committee reviews with management the systems of
internal control over financial reporting that are relied upon
to provide reasonable assurance of compliance with the
Company’s operational risk management processes. The
Finance Committee
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reviews the Company’s overall financial plans, policies,
strategies and capital structure. The Human Resources and
Compensation Committee oversees senior management committees
responsible for retirement and welfare plans, equity and other
compensation plans. The Corporate Governance Committee monitors
developments in the governance area and recommends policies and
practices to the Board of Directors.
Executive Board – The Executive Board,
comprised of the top members of senior management, meets monthly
and is involved in the development of corporate strategy,
monthly review of operational and financial results, progress on
planned initiatives and other matters that relate to the
leadership and management of the Company. The Executive Board
also provides direction for managing the portfolio of risks
throughout the enterprise.
Legal Compliance and Business Ethics Committee (Ethics
Committee) – This Committee provides assistance to
the Chief Ethics Officer in ensuring that the Company’s
legal compliance and ethics program is effective under
applicable laws and regulations. The Ethics Committee’s
responsibilities include assessing the risks of non-compliance
with applicable laws or regulations and of unethical conduct by
associates or agents of the Company; determining how best to
mitigate such risks through the promulgation
and/or
revision of written compliance and ethics standards, including
the Company’s Statement of Business Ethics; and the
communication of such standards through training, auditing,
monitoring and other forms of checking; encouraging associates
to report possible violations of Company compliance- and
ethics-related standards. The Ethics Committee also oversees
internal investigations into possible violations of law or
Company policy and the discipline imposed for any violations of
Company policy. The Ethics Committee also assists the Chief
Ethics Officer in reporting, no less than annually, to the Board
and the Audit Committee of the Board on the operation, content
and effectiveness of the Company’s legal compliance and
ethics programs.
Human Resources Committee (HRC) – The
HRC, which is made up of senior executives of the Company,
ensures appropriate management and fiduciary responsibilities
are carried out with respect to retirement and welfare plans,
and manages and provides direction for equity and compensation
plan strategies.
Capital Appropriations Committee (CAC) – The
CAC, which is made up of senior executives of the Company,
reviews and approves individual capital and systems projects,
and ensures proper capital allocation consistent with the
overall capital expenditure plan approved by the Board of
Directors.
Disclosure and Controls Review Committee (DCRC) and
Sarbanes-Oxley Compliance and Monitoring Group –
The DCRC is made up of senior executives of the Company,
including the Chief Executive Officer (CEO) and the Chief
Financial Officer (CFO). The DCRC ensures that the
Company’s established disclosure controls and procedures
and certification process are adhered to. The Company has a
Sarbanes-Oxley Compliance and Monitoring Group, which consists
of associates dedicated full-time to managing the ongoing
process of monitoring and self-testing key controls throughout
the organization, documenting and testing significant changes to
internal control over financial reporting and meeting the
related reporting requirements.
Independent Support Functions – Internal Audit,
Legal and Finance support the Company’s risk management
function. They operate independently of the operating divisions
of the Company. As an important component of the Company’s
control structure, the Internal Audit department reports
functionally to the Audit Committee of the Board of Directors.
Internal Audit performs reviews and completes test work to
ensure that: (a) risks are appropriately identified and
managed; (b) interaction with various internal governance
groups, such as the legal compliance coordinators, occurs as
needed; (c) significant financial, managerial and operating
information is reliable and timely; (d) associates’
actions are in compliance with policies, standards, procedures
and applicable laws and regulations; (e) resources are
acquired economically, used efficiently and adequately
protected; (f) quality and continuous improvement are
fostered in the organization’s control process; and
(g) significant legislative or regulatory issues impacting
the organization are recognized and addressed appropriately.
Legal compliance coordinators, working with Internal Audit, are
responsible for ensuring that all areas of the Company maintain
effective compliance procedures.
During 2006, the Company continued to focus on further
tightening its overall internal control structure by having
ongoing discussions between management and the Company’s
Audit Committee in their oversight role and discussing
management’s actions and programs to control and monitor
the Company’s major fraud risks. In
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addition, Internal Audit completed a review of the
Company’s different whistleblower hotlines to identify ways
to improve the effectiveness for associates and external
stakeholders to report suspected wrongdoings and other concerns
related to ethics, legal compliance, accounting complaints, loss
prevention and human resources issues.
The Company is responsible for maintaining effective internal
control over financial reporting in order to provide reasonable
assurance regarding the reliability of financial reporting and
the timely and accurate preparation of financial statements for
external purposes. Since 2004, under Section 404 of the
Sarbanes-Oxley Act, management has reported publicly on the
effectiveness of the Company’s internal control over
financial reporting and has included Management’s Report on
Internal Control over Financial Reporting for 2006 on
page 40. Additionally, the Company’s external auditors
are required to express an opinion on management’s
assessment as well as on the effectiveness of the Company’s
internal control over financial reporting. KPMG LLP’s
report as of year-end 2006 is included on page 41.
Critical
Accounting Policies
The application of accounting policies necessarily involves
judgment and, in certain instances, the use of estimates and
assumptions. Different amounts could be reported under different
conditions or using different assumptions. Management believes
that the accounting policies used to develop estimates that are
the most critical to understanding and evaluating the
Company’s reported results relate to: inventory valuation
under the retail method of accounting; 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. Historically, actual results have not been
materially different than the estimates that are discussed
below. Although the Company also has other policies considered
key accounting policies, such as revenue recognition, these
policies do not require management to make estimates or
judgments that are difficult or subjective.
The Company’s management has discussed the development and
selection of the critical accounting policies with the Audit
Committee of the Board and its independent auditors. The Audit
Committee has reviewed the Company’s disclosures relating
to these policies in this MD&A. For a complete list of the
Company’s significant accounting policies, see Note 1,
which begins on
page F-7.
Inventories are valued primarily at the lower of cost (using the
last-in,
first-out or “LIFO” method) or market, determined by
the retail method for department stores and store distribution
centers, and standard cost, representing average vendor cost,
for Direct and regional warehouses. Under the retail method,
inventory is segregated into groupings of merchandise having
similar characteristics and is stated at its current retail
selling value. Inventory retail values are converted to a cost
basis by applying specific average cost factors to each grouping
of merchandise. Cost factors represent the average
cost-to-retail
ratio for each merchandise group based on the beginning of
period inventory plus the current period’s purchase
activity, as calculated on a monthly basis, for each store
location. Accordingly, a significant assumption under retail
method accounting is that the inventory in each group of
merchandise is similar in terms of its
cost-to-retail
relationship and has similar gross margin and turnover rates.
Management monitors the content of merchandise in these
groupings to ensure distortions that would have a material
effect on inventory valuation do not occur. The retail method
inherently requires management judgment and certain estimates
that may significantly impact the ending inventory valuation at
cost, as well as gross margin. Among others, two of the most
significant estimates are permanent reductions to retail prices
(markdowns) used to clear unproductive or slow-moving inventory
and inventory shortages (shrinkage).
Permanent markdowns designated for clearance activity are
recorded at the point of decision, when the utility of inventory
has diminished, versus the point of sale. Factors considered in
the determination of permanent markdowns include current and
anticipated demand, customer preferences, age of the merchandise
and style trends. The corresponding reduction to gross margin is
also recorded in the period the decision is made.
Shrinkage is estimated as a percentage of sales for the period
from the last inventory date to the end of the fiscal year.
Physical inventories are taken at least annually for all
department stores, store distribution centers, warehouses and
Direct fulfillment centers on a staggered basis throughout the
year, and inventory records are adjusted accordingly. The
shrinkage rate from the most recent physical inventory, in
combination with current events and historical experience, is
used as the standard for the shrinkage accrual rate for the next
inventory cycle.
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To estimate the effects of inflation/deflation on ending
inventory, an internal index measuring price changes from the
beginning to the end of the year is calculated using merchandise
cost data at the item level.
Management evaluates recoverability of long-lived assets
whenever events or changes in circumstances indicate that the
carrying value may not be recoverable, for example, when a
store’s performance falls below minimum Company standards.
In the fourth quarter of each fiscal year, management reviews
the performance of individual stores. Underperforming stores are
selected for further evaluation of the recoverability of the
carrying amounts. If the evaluation, done on an undiscounted
cash flow basis, indicates that the carrying amount of the asset
may not be recoverable, the potential impairment is measured as
the excess of carrying value over the fair value of the impaired
asset. Management estimates fair value based on a projected
discounted cash flow method using a discount rate that is
considered to be commensurate with the risk inherent in the
Company’s current business model.
Additional factors are taken into consideration, such as local
market conditions, operating environment, mall performance and
other trends.
Impairment losses totaling $2 million, $7 million and
$12 million in 2006, 2005 and 2004, respectively, were
recorded for underperforming department stores and underutilized
Direct and other facilities. If different assumptions were made
or different market conditions were present, any estimated
potential impairment amounts could vary from recorded amounts.
Based on an overall analysis of store performance and expected
trends, management periodically evaluates the need to close
underperforming stores. Reserves are established at the point of
closure for the present value of any remaining operating lease
obligations (PVOL), net of estimated sublease income, and at the
point of decision for severance and other exit costs, as
prescribed by SFAS No. 146, “Accounting for Costs
Associated with Exit or Disposal Activities.” See further
discussion in Note 1 on
page F-13.
Two key assumptions in calculating the reserve include the
timeframe expected to terminate lease agreements and estimation
of other related exit costs. If different assumptions were used
regarding the timing and potential termination costs, the
resulting reserves could vary from recorded amounts. Reserves
are reviewed periodically and adjusted, when necessary.
The Company records a provision for workers’ compensation
and general liability risk based on historical experience,
current claims data and independent actuarial best estimates,
including incurred but not reported claims. The Company targets
this provision above the midpoint of the actuarial range, and
total estimated claim liability amounts are discounted using a
risk-free rate.
Income taxes are estimated for each jurisdiction in which the
Company operates. This involves assessing the current tax
exposure together with temporary differences, which result from
differing treatment of items for tax and book purposes. Deferred
tax assets and liabilities are provided for based on these
assessments. Deferred tax assets are evaluated for
recoverability based on estimated future taxable income. To the
extent that recovery is deemed unlikely, a valuation allowance
is recorded. During 2005, management determined that the Company
will more likely than not generate sufficient income over the
next several years to utilize state tax net operating losses for
which a valuation allowance had been recorded. This valuation
allowance was appropriately reversed. Tax reserves are provided
for when the Company considers that it is probable that taxes
will be due. Such reserves are evaluated and adjusted as
appropriate, while taking into account the progress of audits of
various taxing jurisdictions. Management does not expect the
outcome of tax audits to have a material adverse effect on the
Company’s financial condition, results of operations or
cash flow. Many years of data have been incorporated into the
determination of tax reserves, and the Company’s estimates
have historically been reasonable.
The Company is involved in legal proceedings and governmental
inquiries associated with employment and other matters. Reserves
have been established based on management’s best estimates
of the Company’s potential liability in these matters.
These estimates have been developed in consultation with
in-house and outside counsel. Management does not believe that
these proceedings and inquiries, either individually or in the
aggregate, will have a material adverse effect on the
Company’s consolidated financial position, results of
operations or cash flow. See further discussion in Note 20.
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Reserves for potential environmental liabilities related to
facilities, some of which the Company no longer operates, are
adjusted based on the Company’s experience, as well as
consultations with independent engineering firms and in-house
legal counsel, as appropriate. Management believes the
established reserves, as adjusted, are adequate to cover
estimated potential liabilities.
Pension
JCP sponsors a non-contributory qualified defined benefit
pension plan (the primary pension plan), supplemental retirement
plans for certain management associates and other postretirement
benefit plans. Refer to Note 17 for further discussion of
these plans. Effective January 1, 2007, the Company
implemented certain changes to its retirement benefits, which
are discussed on pages 37-38. As of February 3, 2007,
the Company adopted the recognition provisions of
SFAS No. 158, “Employers’ Accounting for
Defined Benefit Pension and Other Postretirement
Plans – an amendment of FASB Statements No. 87,
88, 106, and 132(R).” Refer to Note 1 for a discussion
of the impact of adopting SFAS No. 158.
Major assumptions used in accounting for retirement plans
include the expected long-term rate of return on plan assets and
the discount rate. Assumptions are determined based on Company
information and market indicators and are evaluated at each
annual measurement date (October 31). A change in any of
these assumptions could have a significant effect on the
Company’s pension and other postretirement benefit plan
costs. These assumptions require significant judgment, and the
calculation of pension costs is relatively complex. The Company
utilizes third parties, including actuarial and investment
advisory firms, to help evaluate the appropriateness of the
expected rate of return, the discount rate and other pension
plan assumptions annually. The following discussion relates to
the primary pension plan only, since it represents the majority
of the Company’s recorded pension expense and related
asset/liability amounts in its consolidated financial statements.
For purposes of estimating demographic mortality in the
measurement of the Company’s pension obligation, as of
October 31, 2004, the Company began using the Retirement
Plans 2000 Table of Combined Healthy Lives (RP 2000 Table),
projected to 2005, using Scale AA to forecast mortality
improvements five years into the future to 2005. Previously, the
Company had utilized the 1983 Group Annuity Mortality Table,
which it continued to use for calculating funding requirements
through 2006 based on Internal Revenue Service regulations. This
change did not have a material impact on the projected benefit
obligation. Beginning in 2007, for funding purposes, the Company
will begin using a projected version of the RP 2000 Table.
In accounting for pension costs, the Company uses fair value,
which is the market value of plan assets as of the annual
measurement date, to calculate the expected return on assets and
gain/loss amortization components of net periodic pension
expense.
As a result of strong asset performance over the past few years,
combined with voluntary Company contributions of
$300 million in 2006, 2004, 2003 and 2002 totaling
$1.2 billion, pension expense has decreased each year since
2003.
Since the inception of the Company’s primary pension plan
in 1966 through the October 31, 2006 measurement date, the
average annual return has been 9.7%. After three years of
decline in the fair value of pension assets during the
2000-2002
bear market, pension assets experienced significant increases
due to consecutive annual gains in global equity markets during
the last four years. Because the fair value of plan assets is
measured as of a point in time, the change in fair value between
measurement dates affects the subsequent year’s net pension
expense. Since
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inception, the Company’s primary pension plan has incurred
cumulative pre-tax expense of approximately $192 million.
This is the result of cumulative pension expense during the
1966-1984
period of $366 million, cumulative pension income during
the
1985-2001
period of $488 million and pension expense in the
2002-2006
period totaling $314 million. The Company has maintained an
expected rate of return of 8.9% over the last three years,
consistent with historical returns and management’s
long-term view of expected returns. Pension expense, which is a
non-cash item, will decline in 2007 by approximately
$100 million primarily as a result of 2006 positive return
on plan assets.
To develop its expected return on plan assets, the Company
considers its long-term asset allocation policy, historical
returns on plan assets and overall capital market returns,
taking into account current and expected market conditions. The
Company’s primary pension plan is well diversified with an
asset allocation policy that provides for a targeted 70%, 20%
and 10% mix of equities (U.S.,
non-U.S. and
private), fixed income (investment-grade and high-yield) and
real estate (private and public), respectively. This allocation
provides the pension plan with the appropriate balance of
investment return and volatility risk, given the funded nature
of the plan, its present and future liability characteristics
and its long-term investment horizon. See Note 17 for a
further discussion of the asset allocation strategy for plan
assets.
The Company increased the discount rate used to measure the
pension obligation from 5.80% to 5.85% in 2006. In the previous
two years, the Company lowered the discount rate. The discount
rate is based on the yield to maturity of a representative
portfolio of AA-rated corporate bonds as of the October 31
measurement date each year, with an average cash flow duration
similar to the pension liability. This methodology is consistent
with guidance in SFAS No. 87, “Employers’
Accounting for Pensions,” to use the rate currently
available on high-quality bonds and the subsequent guidance
issued by the Securities and Exchange Commission that
high-quality bonds should be those with at least a AA rating by
a recognized rating agency.
The sensitivity of the pension expense to a plus or minus
one-half of one percent of expected return on assets is a
decrease or increase in expense of approximately $0.06 per
share. Increasing the discount rate by one-half of one percent
would decrease expense by approximately $0.03 per share,
while decreasing the discount rate by one-half of one percent
would increase the expense by approximately $0.11 per
share. The variability of the impact on pension expense of a
change in the discount rate is due to the resulting level of net
gains or losses that are amortized only to the extent they
exceed 10 percent of the greater of the projected benefit
obligation or the market-related value of plan assets (the
10 percent corridor under SFAS No. 87).
Funding
Policy
The Company’s funding policy is to maintain a well-funded
pension plan throughout all business and economic cycles.
Maintaining a well-funded plan over time provides additional
financial flexibility to the Company, including lower pension
expense and reduced cash contributions, especially in the event
of a decline in the capital markets. In addition, a well-funded
plan assures associates of the plan’s and the
Company’s financial ability to continue to provide
competitive retirement benefits, while at the same time being
cost effective. The Company targets to maintain a funded ratio,
which is the plan’s assets as a percent of the actuarial
funding liability under the Employee Retirement Income Security
Act of 1974 (ERISA), in the range of 120% to 150%. The Pension
Protection Act (PPA), a 2006 amendment to ERISA, increases the
limit on maximum deductible contributions from 100% of the
actuarial funding liability to 150%. Increasing the funding
limit provides the Company enhanced flexibility to make
discretionary pension contributions and to maintain the
plan’s funded ratio within the funding policy target range.
The PPA enabled the Company to make a discretionary
$300 million pre-tax contribution to the plan in the fourth
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quarter of 2006. In 2005, the Company did not make a
discretionary contribution to the pension plan due to the
plan’s well-funded position and Internal Revenue Service
rules limiting tax deductible contributions.
Funding
History
The Company made cash contributions to its primary pension plan
annually during the
1966-1983
period in order to provide an asset base to support the
accelerating liability growth in the early years of the plan.
Over the
1984-2006
period, the Company made cash contributions to the plan in eight
years
(1993-1996,
2002-2004,
2006) and no contributions in the other 15 years due
to maintaining a well-funded plan and the actual investment
return on plan assets.
Since the plan’s inception, the Company has contributed
$2.0 billion, or approximately $1.2 billion on an
after-tax basis, to its primary pension plan, including the
contribution made in the fourth quarter of 2006. Over this
timeframe, the actual investment return on plan assets has
generated a significant portion of the $8.3 billion in
pension plan total value, defined as $3.0 billion in
cumulative benefit payments to retired associates plus
$5.3 billion in plan assets as of fiscal year-end 2006. In
effect, the Company’s cumulative after-tax cash
contributions over this timeframe represent approximately 14% of
the plan’s total value (i.e., $1.2 billion as a
percent of $8.3 billion). The remainder of the plan’s
total value has been generated by the actual investment returns
since inception.
ERISA
Funded Status
The Company’s primary pension plan remains in a well-funded
position. Although no additional funding was required under
ERISA, the Company made discretionary pre-tax contributions of
$300 million to its primary pension plan in the fourth
quarter of 2006 and in the third quarter of 2004. The Company
did not make a discretionary contribution to the pension plan in
2005 due to the plan’s well-funded position and Internal
Revenue Service rules limiting tax deductible contributions. At
October 31, 2006, plan assets of $4.8 billion were
124% of the $3.9 billion ERISA funding liability.
Reflecting the fourth quarter 2006 contribution to the plan, the
funded status as of year-end 2006 was 137%.
Expected
Contributions
Future contributions to the pension plan will be dependent on
asset returns and future discount rates impacting the
plan’s actuarial funding liability. The Company does not
anticipate mandatory funding requirements in 2007 under ERISA.
It plans to make a discretionary contribution, however, if
market conditions and the funded position of the pension plan
allow such a contribution to be tax deductible. See Note 17
for further discussion.
Accounting
for Stock-Based Compensation
The Company has a stock-based compensation plan for
approximately 1,700 executives and senior management that
provides for grants to associates of stock awards (stock or
units, restricted or unrestricted), stock appreciation rights or
options to purchase the Company’s common stock.
Over the past three years, the Company’s annual stock
option grants have averaged about 1.4% of outstanding shares,
including the common stock equivalent of preferred shares. As of
February 3, 2007, options to purchase 8.3 million
shares of common stock, representing 3.7% of total shares, were
outstanding, of which 4.3 million were exercisable. Of the
exercisable options, 100% were
“in-the-money,”
or had an exercise price below the closing
end-of-year
stock price of $83.70.
Prior to 2005, the Company followed Accounting Principles Board
(APB) Opinion No. 25, “Accounting for Stock Issued to
Employees,” which did not require expense recognition for
stock options when the exercise price of an option equaled, or
exceeded, the quoted market value of the common stock on the
date of grant. Effective January 30, 2005, the Company
early-adopted SFAS No. 123R, which requires the use of
the fair value method for accounting for all stock-based
compensation, including stock options. The statement was adopted
using the modified prospective method of application. Under this
method, in addition to reflecting compensation expense for new
share-based awards, expense is also recognized to reflect the
remaining vesting period of awards that had been included in
pro-forma disclosures in prior periods. The Company did not
adjust prior year financial statements under the optional
modified retrospective method of application, but has disclosed
the pro-forma impact of expensing stock options on 2004 in
Note 1.
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(1) See Note 1 for the effect on net income and
earnings per share as if the fair value method had been applied
to all outstanding awards in 2004.
(2) Of the total, $10 million and $12 million
in 2006 and 2005, respectively, related to stock options.
Prior to 2005, the Company used the Black-Scholes option pricing
model to estimate the grant date fair value of its stock option
awards. For grants subsequent to the adoption of
SFAS No. 123R, the Company estimates the fair value of
stock option awards on the date of grant using a binomial
lattice model developed by outside consultants who worked with
the Company in the implementation of SFAS No. 123R.
The Company believes that the binomial lattice model is a more
accurate model for valuing employee stock options since it
better reflects the impact of stock price changes on option
exercise behavior.
The expected volatility used in the binomial lattice model is
based on an analysis of historical prices of JCPenney’s
stock and open market exchanged options, and was developed in
consultation with an outside valuation specialist and the
Company’s financial advisors. The expected volatility
reflects the volatility implied from a price quoted for a
hypothetical call option with a duration consistent with the
expected life of the options and the volatility implied by the
trading of options to purchase the Company’s stock on
open-market exchanges. As a result of the Company’s
recently completed turnaround that began in 2001 and the
disposition of the Eckerd drugstore operations, a significant
portion of historical volatility is not considered to be a good
indicator of future volatility. The expected term of options
granted is derived from the output of the binomial lattice
model, and represents the period of time that the options are
expected to be outstanding. This model incorporates an early
exercise assumption in the event of a significant increase in
stock price. The risk-free rate is based on zero-coupon
U.S. Treasury yields in effect at the date of grant with
the same period as the expected option life. The dividend yield
is assumed to increase ratably to the Company’s expected
dividend yield level based on targeted payout ratios over the
expected life of the options.
As of February 3, 2007, there was $25 million and
$33 million of compensation cost not yet recognized or
earned related to stock options and associate restricted stock
(share and unit) awards, respectively, which is expected to be
recognized as earned over weighted-average periods of 1.0 and
1.2 years, respectively.
See Notes 1 and 15 for more details about the
Company’s stock-based compensation.
Retirement
and Medical Benefit Plan Changes
In April 2006, the Company’s Board of Directors approved
several benefit plan changes in recognition of the declining
prevalence of defined benefit pension plans in the retail
industry and the increasing value that associates place on
portability of retirement benefits. The overarching goal was to
provide competitive benefits that are cost effective for both
the Company and its associates.
These changes include replacing the current Company matching
contribution of 4.5% of available profits with a fixed Company
matching contribution of 50 cents on each dollar contributed up
to 6% of pay to the Company’s 401(k) defined contribution
plan. The Company will retain the flexibility to make additional
discretionary matching contributions. The pension plan was
closed to associates hired or rehired on or after
January 1, 2007. A replacement benefit is being provided to
those associates in the form of a retirement account, a
component of the defined contribution 401(k) plan, whereby the
Company will contribute an amount equal to 2% of
participants’ annual pay after one year of service.
Participating associates will be fully vested after three years.
Associates hired or rehired on or prior to December 31,
2006 will remain in the Company’s pension plan and continue
to earn credited service.
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Finally, medical benefits for active associates were modified to
increase the percentage of costs borne by the Company.
These benefit plan changes were communicated to associates in
May 2006 and became effective January 1, 2007. The changes
did not have a significant impact on fiscal year 2006 retirement
benefit and medical plan expenses, and going forward, the
aggregate impact is not expected to have a material effect on
the Company’s financial condition, liquidity or results of
operations. For a further discussion of these changes, see
Note 17.
New
Accounting Pronouncements
In July 2006, the FASB issued two standards that address
accounting for income taxes: FASB Staff Position (FSP)
FAS 13-2,
“Accounting for a Change in the Timing of Cash Flows
Relating to Income Taxes Generated by a Leveraged Lease
Transaction,” and FASB Interpretation No. (FIN) 48,
“Accounting for Uncertainty in Income Taxes.” FSP
FAS 13-2
requires a recalculation of returns on leveraged leases if there
is a change or projected change in the timing of cash flows
relating to income taxes generated by the leveraged lease. The
adoption of FSP
FAS 13-2
effective at the beginning of 2007 is not expected to have a
material impact on the Company’s consolidated financial
statements.
FIN 48 prescribes a comprehensive model for recognizing,
measuring, presenting and disclosing in the financial statements
uncertain tax positions that a company has taken or expects to
take in its tax returns. It applies to all tax positions
accounted for in accordance with SFAS No. 109 and is
effective for fiscal years beginning after December 15,
2006. The Company will apply the provisions of this
interpretation beginning in the first quarter of 2007, and
currently expects that its adoption will not have a material
impact on the Company’s consolidated results of operations
or financial position. The Company does, however, expect to make
certain balance sheet reclassifications upon the adoption of
this interpretation.
In September 2006, the Financial Accounting Standards Board
(FASB) issued SFAS No. 157, “Fair Value
Measurements,” which defines fair value, establishes a
framework for measuring fair value and expands disclosures about
fair value measurements. This Statement applies under other
accounting pronouncements that require or permit fair value
measurements. Accordingly, this Statement does not require any
new fair value measurements. The provisions of
SFAS No. 157 will be effective as of the beginning of
the Company’s fiscal 2008. The Company does not expect that
the adoption of SFAS No. 157 will have a material
impact on its consolidated financial statements.
In September 2006, the SEC issued Staff Accounting
Bulletin No. 108 (SAB 108), “Considering the
Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements.”
SAB 108 addresses how the effect of prior year uncorrected
misstatements should be evaluated when quantifying misstatements
in current year financial statements. SAB 108 requires
companies to quantify misstatements using a balance sheet and
income statement approach and to evaluate whether either
approach results in quantified error that is material in light
of the relevant quantitative and qualitative factors. The
provisions of SAB 108 became effective during the fourth
quarter of 2006 but had no impact on the financial position or
operating results of the Company.
In February 2007, the FASB issued SFAS No. 159,
“The Fair Value Option for Financial Assets and
Liabilities.” This statement permits entities to choose to
measure many financial instruments and certain other items at
fair value. If the fair value option is elected, unrealized
gains and losses will be recognized in earnings at each
subsequent reporting date. SFAS No. 159 is effective
for fiscal years beginning after November 15, 2007. The
Company is currently evaluating the impact of this adoption on
its consolidated financial statements.
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Fiscal
Year 2007 Guidance
On February 22, 2007, management communicated the following
initial guidance for 2007 in the Company’s
fourth quarter and full-year 2006 earnings release:
Cautionary
Statement Regarding Forward-Looking Information
This Annual Report on
Form 10-K
contains forward-looking statements made within the meaning of
the Private Securities Litigation Reform Act of 1995, which
reflect the Company’s current view of future events and
financial performance. The words expect, plan, anticipate,
believe, intent, should, will and similar expressions identify
forward-looking statements. Any such forward-looking statements
are subject to risks and uncertainties that may cause the
Company’s actual results to be materially different from
planned or expected results. Those risks and uncertainties
include, but are not limited to, competition, consumer demand,
seasonality, economic conditions, including the price and
availability of oil and natural gas, impact of changes in
consumer credit payment terms, changes in management, retail
industry consolidations, a pandemic, acts of terrorism or war
and government activity. Furthermore, the Company typically
earns a disproportionate share of its operating income in the
fourth quarter due to holiday buying patterns, and such buying
patterns are difficult to forecast with certainty. While the
Company believes that its assumptions are reasonable, it
cautions that it is impossible to predict the degree to which
any such factors could cause actual results to differ materially
from predicted results. For additional discussion on risks and
uncertainties, see Item 1A, Risk Factors, beginning on
page 4. The Company intends the forward-looking statements
in this Annual Report on
Form 10-K
to speak only as of the date of this report and does not
undertake to update or revise these projections as more
information becomes available.
The Company maintains a majority of its cash and short-term
investments in financial instruments with original maturities of
three months or less. Such investments are subject to interest
rate risk and may have a small decline in value if interest
rates increase. Since the financial instruments are of short
duration, a change of 100 basis points in interest rates
would not have a material effect on the Company’s financial
condition.
All of the Company’s outstanding long-term debt as of
February 3, 2007 is at fixed interest rates and would not
be affected by interest rate changes. Future borrowings under
the Company’s multi-year revolving credit facility, to the
extent that fluctuating rate loans were used, would be affected
by interest rate changes. As of February 3, 2007, no cash
borrowings were outstanding under the facility, and
approximately $122 million in letters of credit were
supported by this facility. The Company does not believe that a
change of 100 basis points in interest rates would have a
material effect on the Company’s financial condition.
The fair value of long-term debt is estimated by obtaining
quotes from brokers or is based on current rates offered for
similar debt. At February 3, 2007, long-term debt,
excluding equipment financing, capital leases and other, had a
carrying value of $3.4 billion and a fair value of
$3.6 billion. At January 28, 2006, long-term debt,
excluding equipment financing, capital leases and other, had a
carrying value of $3.4 billion and a fair value of
$3.7 billion.
The effects of changes in the U.S. equity and bond markets
serve to increase or decrease the value of assets in the
Company’s qualified pension plan, which is well funded. At
the October 31, 2006 measurement date, plan assets of
$4.8 billion were approximately 124% of the
$3.9 billion actuarial funding liability under the Employee
Retirement Income Security Act of 1974 (ERISA). The Company
seeks to manage exposure to adverse equity and bond returns by
maintaining diversified investment portfolios and utilizing
professional investment managers.
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See the Index to Consolidated Financial Statements on
Page F-1.
None.
Based on their evaluation of the Company’s disclosure
controls and procedures (as defined in
Rules 13a-15
and 15d-15
under the Securities Exchange Act of 1934 (the Exchange Act)) as
of the end of the period covered by this Annual Report on
Form 10-K,
the Company’s principal executive officer and principal
financial officer concluded that the Company’s disclosure
controls and procedures are effective to ensure that information
required to be disclosed, by the Company in the reports that it
files or submits under the Exchange Act, is recorded, processed,
summarized and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms and is
accumulated and communicated to management, including the
Company’s principal executive officer and principal
financial officer, as appropriate, to allow timely decisions
regarding required disclosure.
Management’s
Report on Internal Control Over Financial
Reporting
The management of the Company is responsible for establishing
and maintaining adequate internal control over financial
reporting.
The management of the Company has assessed the effectiveness of
the Company’s internal control over financial reporting as
of February 3, 2007. In making this assessment, management
used criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal
Control – Integrated Framework. Based
on its assessment, the management of the Company believes that,
as of February 3, 2007, the Company’s internal control
over financial reporting is effective based on those criteria.
KPMG LLP, the registered public accounting firm that audited the
financial statements included in this Annual Report on
Form 10-K,
has issued an attestation report on management’s assessment
of the Company’s internal control over financial reporting.
This attestation report appears on page 41 herein.
There were no changes in the Company’s internal control
over financial reporting during the Company’s fourth
quarter ended February 3, 2007, that have materially
affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
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Report
of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
J. C. Penney Company, Inc.:
We have audited management’s assessment, included in the
accompanying “Management’s Report on Internal Control
Over Financial Reporting,” that J. C. Penney Company, Inc.
maintained effective internal control over financial reporting
as of February 3, 2007, based on criteria established in
Internal Control – Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). J. C. Penney Company, Inc.’s management
is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an
opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that J. C. Penney
Company, Inc. maintained effective internal control over
financial reporting as of February 3, 2007, is fairly
stated, in all material respects, based on criteria established
in Internal Control – Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Also, in our opinion, J. C. Penney
Company, Inc. maintained, in all material respects, effective
internal control over financial reporting as of February 3,
2007, based on criteria established in Internal
Control – Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of J. C. Penney Company, Inc. and
subsidiaries as of February 3, 2007 and January 28,
2006, and the related consolidated statements of operations,
stockholders’ equity and cash flows for each of the years
in the three-year period ended February 3, 2007, and our
report dated April 2, 2007 expressed an unqualified opinion
on those consolidated financial statements.
Dallas, Texas
April 2, 2007
None.
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The information required by Item 10 with respect to
executive officers is included within Item 1 in Part I
of this Annual Report on
Form 10-K
under the caption “Executive Officers of the
Registrant.”
The information required by Item 10 with respect to
directors, audit committee, audit committee financial experts
and Section 16(a) beneficial ownership reporting compliance
is included under the captions “Election of
Directors,” “Audit Committee” and
“Section 16(a) Beneficial Ownership Reporting
Compliance” in the Company’s definitive proxy
statement for 2007, which will be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, and is
incorporated herein by reference.
Code
of Ethics, Corporate Governance Guidelines and Committee
Charters
The Company has adopted a code of ethics for officers and
employees, which applies to, among others, the Company’s
principal executive officer, principal financial officer, and
controller, and which is known as the “Statement of
Business Ethics.” The Company has also adopted certain
ethical principles and policies for its directors, which are set
forth in Article V of the Company’s Corporate
Governance Guidelines. The Statement of Business Ethics and
Corporate Governance Guidelines are available on the
Company’s Web site at www.jcpenney.net.
Additionally, the Company will provide copies of these documents
without charge upon request made to:
J. C. Penney Company, Inc.
Office of Investor Relations
P.O. Box 10001
Dallas, TX
75301-4301
(Telephone
972-431-3436)
The Company intends to satisfy the disclosure requirement under
Item 5.05 of
Form 8-K
regarding an amendment to or waiver of any provision of the
Statement of Business Ethics that applies to any officer of the
Company by posting such information on the Company’s Web
site at www.jcpenney.net.
Copies of the Company’s Audit Committee, Human Resources
and Compensation Committee, the Committee of the Whole and
Corporate Governance Committee Charters are also available on
the Company’s Web site at www.jcpenney.net. Copies
of these documents will likewise be provided without charge upon
request made to the address or telephone number provided above.
The information required by Item 11 is included under the
captions “Compensation Committee Interlocks and Insider
Participation,” “Compensation Discussion and
Analysis,” “Report of the Human Resources and
Compensation Committee,” “Summary Compensation
Table,” “Grants of Plan-Based Awards for Fiscal
2006,” “Outstanding Equity Awards At Fiscal Year-End
2006,” “Option Exercises and Stock Vested for Fiscal
2006,” “Pension Benefits,” “Nonqualified
Deferred Compensation for Fiscal 2006,” “Potential
Payments and Benefits on Termination of Employment” and
“Director Compensation for Fiscal 2006” in the
Company’s definitive proxy statement for 2007, which will
be filed with the Securities and Exchange Commission pursuant to
Regulation 14A, and is incorporated herein by reference.
The information required by Item 12 with respect to
beneficial ownership of the Company’s common stock is
included under the caption “Beneficial Ownership of Common
Stock” in the Company’s definitive proxy statement for
2007, which will be filed with the Securities and Exchange
Commission pursuant to Regulation 14A, and is incorporated
herein by reference.
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Equity
Compensation Plan(s) Information
The following table shows the number of options and other awards
outstanding as of February 3, 2007 under the
J. C. Penney Company, Inc. 2005 Equity Compensation
Plan (2005 Plan) and prior plans, as well as the number of
shares remaining available for grant under the 2005 Plan.
(1) On May 20, 2005, the Company’s
stockholders approved the 2005 Plan, which reserved an aggregate
of 17.2 million shares of common stock for issuance to
associates and non-employee directors. No shares remain
available for future issuance from prior plans.
(2) As of March 14, 2007, the Company granted stock
options, performance unit awards and restricted stock unit
awards covering 1,847,318 shares of common stock under the
2005 Plan. It is expected that the number of shares remaining
available for future issuance under the 2005 Plan will be
decreased further by the number of restricted stock units to be
awarded to the Company’s non-associate directors as part of
their annual fees following the Annual Meeting of
Stockholders.
The information required by Item 13 is included under the
captions “Board Independence” and “Policies and
Procedures with Respect to Related Person Transactions” in
the Company’s definitive proxy statement for 2007, which
will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A, and is incorporated herein by
reference.
The information required by Item 14 is included under the
captions “Audit and Other Fees” and “Audit
Committee’s Pre-Approval Policies and Procedures” in
the Company’s definitive proxy statement for 2007, which
will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A, and is incorporated herein by
reference.
(a) Documents filed as part of this report:
1. Consolidated Financial Statements:
The consolidated financial statements of J. C. Penney Company,
Inc. and subsidiaries are listed in the accompanying “Index
to Consolidated Financial Statements” on
page F-1.
2. Financial Statement Schedules:
Schedules have been omitted as they are inapplicable or not
required under the rules, or the information has been submitted
in the consolidated financial statements and related financial
information contained otherwise in this Annual Report on
Form 10-K.
3. Exhibits:
See separate Exhibit Index beginning on
page E-1.
(b) Each management contract or compensatory plan or
arrangement required to be filed as an exhibit to this Annual
Report on
Form 10-K
is specifically identified in the separate Exhibit Index
beginning on
page E-1
and filed with or incorporated by reference in this report.
(c) Other Financial Statement Schedules. None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
J. C. PENNEY COMPANY, INC.
(Registrant)
R. B. Cavanaugh
Executive Vice President
and Chief Financial Officer
Dated: April 4, 2007
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
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The Board of Directors and Stockholders
J. C. Penney Company, Inc.:
We have audited the accompanying consolidated balance sheets of
J. C. Penney Company, Inc. and subsidiaries as of
February 3, 2007 and January 28, 2006, and the related
consolidated statements of operations, stockholders’ equity
and cash flows for each of the years in the three-year period
ended February 3, 2007. These consolidated financial
statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of J. C. Penney Company, Inc. and subsidiaries as of
February 3, 2007 and January 28, 2006, and the results
of their operations and their cash flows for each of the years
in the three-year period ended February 3, 2007, in
conformity with U.S. generally accepted accounting
principles.
As discussed in Note 1 to the Consolidated Financial
Statements, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123 (revised 2004),
“Share-Based Payment” in fiscal year 2005 and
Statement of Financial Accounting Standards No. 158,
“Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans” on February 3, 2007.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of J. C. Penney Company, Inc.’s internal
control over financial reporting as of February 3, 2007,
based on criteria established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report
dated April 2, 2007 expressed an unqualified opinion on
management’s assessment of, and the effective operation of,
internal control over financial reporting.
Dallas, Texas
April 2, 2007
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CONSOLIDATED
STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these
Consolidated Financial Statements.
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CONSOLIDATED
BALANCE SHEETS
(1) Common stock has a par value of $0.50 per
share; 1,250 million shares are authorized. At
February 3, 2007, 226 million shares were issued and
outstanding. At January 28, 2006, 233 million shares
were issued and outstanding.
The accompanying notes are an integral part of these
Consolidated Financial Statements.
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CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
(1) A deferred tax asset
was not established for the currency translation adjustments of
Mexico or Renner discontinued operations due to the historical
reinvestment of earnings in these subsidiaries.
(3) Reflects the adoption
of the recognition provisions of Statement of Financial
Accounting Standards No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement
Plans – an amendment of FASB Statements No. 87,
88, 106, and 132(R).” See Note 1.
The accompanying notes are an integral part of these
Consolidated Financial Statements.
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CONSOLIDATED
STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these
Consolidated Financial Statements.
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NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
1) Nature
of Operations and Summary of Significant Accounting
Policies
JCPenney was founded by James Cash Penney in 1902 and has grown
to be a major retailer, operating 1,033 JCPenney department
stores throughout the continental United States, including
Alaska, and Puerto Rico. The Company sells family apparel,
jewelry, shoes, accessories and home furnishings to customers
through department stores and Direct (Internet/catalog). In
addition, the department stores provide services, such as
styling salon, optical, portrait photography and custom
decorating, to customers.
The consolidated financial statements present the results of J.
C. Penney Company, Inc. and its subsidiaries (the Company or
JCPenney). All significant intercompany transactions and
balances have been eliminated in consolidation.
The Company is a holding company whose principal operating
subsidiary is J. C. Penney Corporation, Inc. (JCP). JCP was
incorporated in Delaware in 1924, and the Company was
incorporated in Delaware in 2002, when the holding company
structure was implemented. The holding company has no direct
subsidiaries other than JCP, and has no independent assets or
operations.
The Company is a co-obligor (or guarantor, as appropriate)
regarding the payment of principal and interest on JCP’s
outstanding debt securities. The guarantee by the Company of
certain of JCP’s outstanding debt securities is full and
unconditional.
Fiscal
Year
Effective January 29, 2005, the Company changed its fiscal
year end to the Saturday closest to January 31, to be in
alignment with the fiscal calendar prevalently used in the
retail industry. Historically, the Company’s fiscal year
has ended on the last Saturday in January. This change had no
impact on fiscal 2004 or 2005 reported results. Fiscal 2006
contained 53 weeks. Unless otherwise stated, references to
years in this report relate to fiscal years rather than to
calendar years.
The accounts of Lojas Renner S.A. (Renner), which are now
included in Income/(Loss) from Discontinued Operations for all
periods presented, were on a calendar-year basis.
The preparation of financial statements, in conformity with
generally accepted accounting principles (GAAP), requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the
reporting period. While actual results could differ from these
estimates, management does not expect the differences, if any,
to have a material effect on the financial statements.
The most significant estimates relate to inventory valuation
under the retail method, specifically permanent reductions to
retail prices (markdowns) and adjustments for shortages
(shrinkage); valuation of long-lived assets; valuation
allowances and reserves for workers’ compensation and
general liability, environmental contingencies, income taxes and
litigation; reserves related to the Eckerd discontinued
operations; and pension accounting. Workers’ compensation
and general liability reserves are based on historical
experience, current claims data and independent actuarial best
estimates, including incurred but not reported claims.
Environmental remediation reserves are estimated using a range
of potential liability, based on the Company’s experience
and consultation with independent engineering firms and in-house
legal counsel, as appropriate. Income taxes are estimated for
each jurisdiction in which the Company operates. Deferred tax
assets are evaluated for recoverability, and a valuation
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allowance is recorded if it is deemed more likely than not that
the asset will not be realized. During 2005, the valuation
allowance previously established for state net operating losses
was reversed based on management’s assessment that the
Company will more likely than not generate sufficient income
over the next several years to utilize the losses. Litigation
reserves are based on management’s best estimate of
potential liability, with consultation of in-house and outside
counsel. Related to pension accounting, the selection of
assumptions, including the estimated rate of return on plan
assets and the discount rate, impact the actuarially determined
amounts reflected in the Company’s consolidated financial
statements.
Certain reclassifications have been made to prior year amounts
to conform to the current year presentation. The most
significant reclassifications relate to store merchandise
distribution center expenses and depreciation and amortization
and pre-opening expenses. Store merchandise distribution center
expenses are now included in Cost of Goods Sold for all periods
presented, and depreciation and amortization and pre-opening
expenses are now presented as separate line items on the
Consolidated Statements of Operations. Previously, store
merchandise distribution center expenses, depreciation and
amortization and pre-opening expenses were included in Selling,
General and Administrative Expenses. None of the
reclassifications impacted the Company’s net income in any
period.
Retail sales, net of estimated returns, and excluding sales
taxes, are recorded at the point of sale when payment is made
and customers take possession of the merchandise in department
stores, at the point of shipment of merchandise ordered through
Direct (Internet/catalog) or, in the case of services, the
customer has received the benefit of the service, such as salon,
portrait, optical or custom decorating. Commissions earned on
sales generated by licensed departments are included as a
component of retail sales. Shipping and handling fees charged to
customers are also recorded as retail sales with related costs
recorded as cost of goods sold. The Company provides for
estimated future returns based on historical return rates and
sales levels. Sales taxes are not included in retail sales as
the Company acts as a conduit for collecting and remitting sales
taxes to the appropriate governmental authorities.
At the time gift cards are sold, no revenue is recognized;
rather, a liability is established for the face amount of the
card. The liability is relieved and revenue is recognized when
gift cards are redeemed for merchandise. The liability remains
recorded until the earlier of redemption, escheatment or
60 months. After 60 months, any remaining liability is
relieved and recognized as a reduction of Selling, General and
Administrative (SG&A) Expenses. It is the Company’s
historical experience that the likelihood of redemption after
60 months is remote. The liability for gift cards is
recorded in Accrued Expenses and Other Current Liabilities on
the Consolidated Balance Sheets and was $231 million at
February 3, 2007 and $219 million at January 28,
2006.
Cost of Goods Sold includes all costs directly related to
bringing merchandise to its final selling destination. These
costs include the cost of the merchandise (net of discounts or
allowances earned), freight costs, warehouse operating expenses,
sourcing and procurement costs, buying and brand development
costs, including buyers’ salaries and related expenses,
merchandise examination, inspection and testing, store
merchandise distribution center expenses and shipping and
handling costs incurred related to Direct sales to customers.
SG&A expenses include salaries and related expenses other
than those pertaining to buying, sourcing, warehousing
merchandise and store merchandise distribution centers. SG&A
expenses also include advertising costs, occupancy and rent
expense, utilities and maintenance, personal property taxes,
administration costs related to the Company’s home office
and district operations, costs related to information
technology, credit card fees and taxes other than income taxes.
Advertising costs, which include newspaper, television, radio
and other media advertising, are expensed either as incurred or
the first time the advertising occurs. Total advertising costs,
net of cooperative advertising agreements, were
$1,324 million, $1,202 million and $1,223 million
for 2006, 2005 and 2004, respectively. These totals include
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direct-to-consumer
advertising, consisting of catalog book costs and Internet
advertising, of $357 million, $351 million and
$351 million for 2006, 2005 and 2004, respectively. Catalog
book preparation and printing costs, which are considered direct
response advertising, are charged to expense over the productive
life of the catalog, not to exceed eight months. Deferred
catalog book costs of $56 million as of February 3,
2007 and $51 million as of January 28, 2006 were
included in Prepaid Expenses on the Consolidated Balance Sheets.
The Company receives vendor support in the form of cash payments
or allowances through a variety of programs, including
cooperative advertising, markdown reimbursements, vendor
compliance and defective merchandise. The Company has agreements
in place with each vendor setting forth the specific conditions
for each allowance or payment. In accordance with Emerging
Issues Task Force
02-16,
“Accounting by a Customer (Including a Reseller) for
Certain Consideration Received from a Vendor,” depending on
the arrangement, the Company either recognizes the allowance as
a reduction of current costs or defers the payment over the
period the related merchandise is sold. If the payment is a
reimbursement for costs incurred, it is offset against those
related costs; otherwise, it is treated as a reduction to the
cost of merchandise.
For cooperative advertising programs offered by national brands,
the Company generally offsets the allowances against the related
advertising expense. Many of these programs require
proof-of-advertising
to be provided to the vendor to support the reimbursement of the
incurred cost. Programs that do not require
proof-of-advertising
are monitored to ensure that the allowance provided by each
vendor is a reimbursement of costs incurred to advertise for
that particular vendor’s label. If the allowance exceeds
the advertising costs incurred on a vendor-specific basis, then
the excess allowance for the vendor is recorded as a reduction
of merchandise cost.
Markdown reimbursements related to merchandise that has been
sold are negotiated by the Company’s buying teams and are
credited directly to Cost of Goods Sold in the period received.
If vendor allowances are received prior to merchandise being
sold, they are recorded as a reduction of merchandise cost.
Vendor compliance charges reimburse the Company for incremental
merchandise handling expenses incurred due to a vendor’s
failure to comply with the Company’s established shipping
or merchandise preparation requirements. Vendor compliance
arrangements entered into after December 31, 2002 are
recorded as a reduction of the cost of the merchandise.
Allowances or cash from vendor compliance arrangements entered
into prior to December 31, 2002 are recorded as a reduction
of merchandise handling costs.
Subsequent to the construction/buildout period of store
facilities, costs associated with the pre-opening phase,
including advertising, hiring and training costs for new
associates, processing and stocking initial merchandise
inventory and rental costs, if applicable, are expensed in the
period incurred. Due to the adoption of Financial Accounting
Standards Board (FASB) Staff Position
13-1,
“Accounting for Rental Costs Incurred during a Construction
Period,” beginning in fiscal 2006, rental costs incurred
during the construction/buildout period are also included in
pre-opening expense. Previously, such costs were capitalized as
part of the building or leasehold improvement. In total,
pre-opening expense was $27 million, $15 million and
$11 million, respectively, for 2006, 2005 and 2004.
Income taxes are accounted for under the asset and liability
method prescribed by Statement of Financial Accounting Standards
(SFAS) No. 109, “Accounting for Income Taxes.”
Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss
and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the
enactment date. A valuation allowance is recorded to reduce the
carrying amounts of deferred tax assets unless it is more likely
than not such assets will be realized. During 2005, the
valuation allowance previously established for state net
operating losses was reversed based on management’s
assessment that the Company will more likely than
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not generate sufficient income over the next several years in
order to utilize the remaining state net operating loss tax
assets.
Basic earnings per share (EPS) is computed by dividing net
income and prior to 2005, less dividend requirements on the
Series B ESOP Convertible Preferred Stock, net of tax, by
the weighted-average number of common shares outstanding for the
period. Except when the effect would be anti-dilutive at the
continuing operations level, the diluted EPS calculation
includes the impact of restricted stock units and shares that,
during the period, could have been issued under outstanding
stock options, as well as common shares that would have resulted
from the conversion of convertible debentures and convertible
preferred stock. If the applicable shares are included in the
calculation, the related interest on convertible debentures (net
of tax) and preferred stock dividends (net of tax) are added
back to income, since these would not be paid if the debentures
or preferred stock were converted to common stock. Both the
convertible debentures and preferred stock were converted to
common stock in the second half of 2004. See Notes 3 and 11
for further discussion.
Comprehensive income consists of two components: net income and
other comprehensive income/(loss). Other comprehensive
income/(loss) is the sum of unrealized gains/(losses) on
investments and non-qualified plan minimum liability
adjustments, net of tax. However, the February 3, 2007
balance of accumulated other comprehensive (loss)/income was
adjusted to reflect the recognition provisions of
SFAS No. 158, “Employers’ Accounting for
Defined Benefit Pension and Other Postretirement
Plans – an amendment of FASB Statements No. 87,
88, 106, and 132(R),” which resulted in the reversal of the
additional minimum liability and the recognition of net
actuarial losses and prior service costs not yet included in
periodic pension/postretirement cost, net of tax. Beginning in
2007, other comprehensive income/(loss) will reflect gain or
loss and prior service cost arising during the period and
reclassification adjustments for amounts being recognized as
components of net periodic pension/postretirement cost during
the period, all net of tax. See the Retirement-Related Benefits
accounting policy below and Notes 14 and 17 for further
discussion.
All highly-liquid investments with original maturities of three
months or less are considered to be short-term investments. The
short-term investments consist primarily of eurodollar time
deposits and money market funds and are stated at cost, which
approximates fair market value.
Total Cash and Short-Term Investments for 2006 and 2005 included
restricted short-term investment balances of $58 million
and $65 million, respectively. Restricted balances are
pledged as collateral for a portion of casualty insurance
program liabilities.
Inventories are valued primarily at the lower of cost (using the
last-in,
first-out or “LIFO” method) or market, determined by
the retail method for department stores and store distribution
centers, and standard cost, representing average vendor cost,
for Direct and regional warehouses. The lower of cost or market
is determined on an aggregate basis for similar types of
merchandise. To estimate the effects of inflation/deflation on
ending inventory, an internal index measuring price changes from
the beginning to the end of the year is calculated using
merchandise cost data at the item level.
Total Company LIFO (credits) included in Cost of Goods Sold were
$(16) million, $(1) million and $(18) million in
2006, 2005 and 2004, respectively. If the
first-in,
first-out or “FIFO” method of inventory valuation had
been used instead of the LIFO method, inventories would have
been $8 million and $24 million higher at
February 3, 2007 and January 28, 2006, respectively.
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Property and equipment is stated at cost less accumulated
depreciation. Depreciation is computed primarily by using the
straight-line method over the estimated useful lives of the
related assets. Leasehold improvements are depreciated over the
shorter of the estimated useful lives of the improvements or the
term of the lease, including renewals determined to be
reasonably assured.
Routine maintenance and repairs are expensed when incurred.
Major replacements and improvements are capitalized. The cost of
assets sold or retired and the related accumulated depreciation
or amortization are removed from the accounts with any resulting
gain or loss included in net income.
The Company accounts for its conditional asset retirement
obligations, which are primarily related to asbestos removal,
based on the guidance of FASB Interpretation (FIN) No. 47,
“Accounting for Conditional Asset Retirement
Obligations – an Interpretation of FASB Statement
No. 143.” FIN No. 47 requires the Company to
recognize a liability for the fair value of the conditional
asset retirement obligation when incurred if the
liability’s fair value can be reasonably estimated.
Costs associated with the acquisition or development of software
for internal use are capitalized in Other Assets in the
Company’s Consolidated Balance Sheets and are amortized
over the expected useful life of the software, generally between
three and seven years. Subsequent additions, modifications or
upgrades to internal-use software are capitalized only to the
extent that they allow the software to perform a task it
previously did not perform. Software maintenance and training
costs are expensed in the period incurred.
In accordance with SFAS No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets,” the
Company evaluates long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying
amount of those assets may not be recoverable. Factors
considered important that could trigger an impairment review
include, but are not limited to, significant underperformance
relative to historical or projected future operating results and
significant changes in the manner of use of the assets or the
Company’s overall business strategies. Potential impairment
exists if the estimated undiscounted cash flows expected to
result from the use of the asset plus any net proceeds expected
from disposition of the asset are less than the carrying value
of the asset. The amount of the impairment loss represents the
excess of the carrying value of the asset over its fair value.
Management estimates fair value based on a projected discounted
cash flow method using a discount rate that is considered to be
commensurate with the risk inherent in the Company’s
current business model. Additional factors are taken into
consideration, such as local market conditions, operating
environment, mall performance and other trends.
Based on management’s ongoing review of the performance of
its portfolio of stores and other facilities, impairment losses
totaling $2 million, $7 million and $12 million
in 2006, 2005 and 2004, respectively, were recorded for
underperforming department stores and underutilized catalog and
other facilities. These charges are reflected in Real Estate and
Other (Income)/Expense, which is a component of Income from
Continuing Operations in the accompanying Consolidated
Statements of Operations. See further discussion in Note 18.
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The Company uses a consistent lease term when calculating
depreciation of leasehold improvements, determining
straight-line rent expense and determining classification of
leases as either operating or capital. For purposes of
recognizing incentives, premiums, rent holidays and minimum
rental expenses on a straight-line basis over the terms of the
leases, the Company uses the date of initial possession to begin
amortization, which is generally when the Company enters the
property and begins to make improvements in preparation of its
intended use. Renewal options determined to be reasonably
assured are also included in the lease term. Some leases require
additional payments based on sales and are recorded in rent
expense when the contingent rent is probable.
Some of the Company’s lease agreements contain
developer/tenant allowances. Upon receipt of such allowances,
the Company records a deferred rent liability in Other
Liabilities on the Consolidated Balance Sheets. The allowances
are then amortized on a straight-line basis over the terms of
the leases as a reduction of rent expense.
The Company accounts for its defined benefit pension plans and
its non-pension postretirement benefit plans using actuarial
models required by SFAS No. 87, “Employers’
Accounting for Pensions,” and SFAS No. 106,
“Employers’ Accounting for Postretirement Benefits
Other Than Pensions.” These models effectively spread
changes in asset values, the pension obligation and assumption
changes systematically and gradually over the remaining service
periods of the active employees. One of the principal components
of the net periodic pension calculation is the expected
long-term rate of return on plan assets. The required use of the
expected long-term rate of return on plan assets may result in
recognized pension income that is greater or less than the
actual returns on those plan assets in any given year. Over
time, however, the expected long-term returns are designed to
approximate the actual long-term returns and, therefore result
in a pattern of income and expense that more closely matches the
pattern of services provided by employees. Differences between
actual and expected returns are recognized gradually in net
periodic pension expense or are offset by future gains or losses.
The Company uses long-term historical actual return data, the
mix of investments that comprise plan assets and future
estimates of long-term investment returns by reference to
external sources to develop its expected return on plan assets.
The discount rate assumptions used for pension and non-pension
postretirement benefit plan accounting reflect the rates
available on AA-rated corporate bonds on the October 31
measurement date of each year. The rate of compensation increase
is another significant assumption used in the actuarial model
for pension accounting and is determined based upon the
Company’s historical experience and future expectations.
For retiree medical plan accounting, the health care cost trend
rates do not have a material impact since defined dollar limits
have been placed on Company contributions.
For purposes of estimating demographic mortality in the
measurement of the Company’s pension obligation, as of
October 31, 2004, the Company began using the Retirement
Plans 2000 Table of Combined Healthy Lives (RP 2000 Table),
projected to 2005, using Scale AA to forecast mortality
improvements into the future to 2005. Previously, the Company
had utilized the 1983 Group Annuity Mortality Table, which it
continued to use for calculating funding requirements through
2006 based on Internal Revenue Service regulations. Beginning in
2007, for funding purposes, the Company will begin using a
projected version of the RP 2000 Table.
The Company adopted the recognition and disclosure provisions of
SFAS No. 158, “Employers’ Accounting for
Defined Benefit Pension and Other Postretirement
Plans – an amendment of FASB Statements No. 87,
88, 106, and 132(R)” as of February 3, 2007.
SFAS No. 158 requires the Company to recognize the
funded status – the difference between the fair value
of plan assets and the plan’s benefit
obligation – of its defined benefit pension and
postretirement plans directly on the balance sheet. Each
overfunded plan is recognized as an asset and each underfunded
plan is recognized as a liability. The initial adoption was
reflected as a decrease to the February 3, 2007 balance of
accumulated other comprehensive (loss)/income, a component of
stockholders’ equity, and included the elimination of the
additional minimum liability, which is no longer required. In
periods subsequent to adoption, adjustments to other
comprehensive income will reflect prior service cost or credits
and actuarial gain or loss amounts arising during the period and
reclassification adjustments for amounts being recognized as
components of net periodic pension/postretirement cost, net of
tax, in accordance with current pension accounting rules.
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SFAS No. 158 will also require the Company to measure
the funded status of its pension and postretirement plans as of
the year-end balance sheet date by fiscal year-end 2008.
Currently, the Company’s measurement date for its plans is
October 31.
The following table summarizes the effect of required changes in
the additional minimum liability as of February 3, 2007
prior to the adoption of SFAS No. 158 as well as the
impact of the initial adoption of SFAS No. 158 on the
Company’s Consolidated Balance Sheet:
In accordance with SFAS No. 146, “Accounting for
Costs Associated with Exit or Disposal Activities,” costs
associated with exit or disposal activities are recorded at
their fair values when a liability has been incurred. Reserves
are established at the time of closure for the present value of
any remaining operating lease obligations (PVOL), net of
estimated sublease income, and at the point of decision for
severance and other exit costs. Since the Company has an
established program for termination benefits upon a reduction in
force or the closing of a facility, termination benefits paid
under the existing program are considered part of an ongoing
benefit arrangement, accounted for under SFAS No. 112,
“Employers’ Accounting for Postemployment
Benefits,” and recorded when payment of the benefits is
considered probable and reasonably estimable.
The Company has a stock-based compensation plan that provides
for grants to associates of restricted and non-restricted stock
awards (shares and units), stock appreciation rights or options
to purchase the Company’s common stock. Prior to 2005, the
Company accounted for the plan under the recognition and
measurement principles of Accounting Principles Board Opinion
No. 25, “Accounting for Stock Issued to
Employees” (APB No. 25), and related Interpretations.
No compensation cost was reflected in the Consolidated
Statements of Operations for stock options prior to 2005, since
all options granted under the plan had an exercise price equal
to the quoted market value of the underlying common stock on the
date of grant.
Effective January 30, 2005, the Company early-adopted
SFAS No. 123 (revised), “Share-Based
Payment” (SFAS No. 123R), which requires the use
of the fair value method of accounting for all stock-based
compensation, including stock options. The statement was adopted
using the modified prospective method of application. Under this
method, in addition to reflecting compensation expense for new
share-based awards, expense is also recognized to reflect the
remaining vesting period of awards that had been included in
pro-forma disclosures in prior periods. The Company did not
adjust prior year financial statements under the optional
modified retrospective method of adoption.
Under APB No. 25, pro-forma expense for stock options was
calculated on a straight-line basis over the stated vesting
period, which typically ranges from one to three years. Upon the
adoption of SFAS No. 123R, the Company records compensation
expense on a straight-line basis over the associate service
period, which is to the earlier of the retirement eligibility
date, if the grant contains provisions such that the award
becomes fully vested upon retirement, or the stated vesting
period (the non-substantive vesting period approach).
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The cost charged against income for all stock-based
compensation, including stock options for 2006 and 2005, was
$60 million, $38 million and $23 million for
2006, 2005 and 2004, respectively, or $37 million,
$23 million and $14 million after tax.
The following table illustrates the effect on net income and
earnings per share as if the fair value method had been applied
to all outstanding awards in 2004. The 2006 and 2005 information
is provided in the table for purposes of comparability.
(1) If the pro-forma expense had been attributed such
that all expense was recognized by retirement eligibility, total
stock-based employee compensation expense for 2004 would have
been $29 million, net of tax, pro-forma net income would
have been $509 million and basic and diluted pro-forma
earnings per share would have been $1.78 and $1.72,
respectively.
Prior to 2005, the Company used the Black-Scholes option pricing
model to estimate the grant date fair value of stock option
awards. For grants subsequent to the adoption of
SFAS No. 123R, the Company estimates the fair value of
stock option awards on the date of grant using a binomial
lattice model developed by outside consultants who worked with
the Company in the implementation of SFAS No. 123R.
The Company believes that the binomial lattice model is a more
accurate model for valuing employee stock options since it
better reflects the impact of stock price changes on option
exercise behavior.
The expected volatility used in the binomial lattice model is
based on an analysis of historical prices of JCPenney’s
stock and open market exchanged options, and was developed in
consultation with an outside valuation specialist and the
Company’s financial advisors. The expected volatility
reflects the volatility implied from a price quoted for a
hypothetical call option with a duration consistent with the
expected life of the options and the volatility implied by the
trading of options to purchase the Company’s stock on
open-market exchanges. As a result of the Company’s
recently completed turnaround that began in 2001 and the
disposition of the Eckerd drugstore operations, a significant
portion of historical volatility is not considered to be a good
indicator of future volatility. The expected term of options
granted is derived from the output of the binomial lattice
model, and represents the period of time that the options are
expected to be outstanding. This model incorporates an early
exercise assumption in the event of a significant increase in
stock price. The risk-free rate is based on zero-coupon
U.S. Treasury yields in effect at the date of grant with
the same period as the expected option life. The dividend yield
is assumed to increase ratably to the Company’s expected
dividend yield level based on targeted payout ratios over the
expected life of the options.
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The following table presents the assumptions utilized to
estimate the grant date fair value of stock options:
SFAS No. 123R also requires that excess tax benefits
related to stock option exercises be reflected as financing cash
inflows instead of operating cash inflows.
The Company has elected to adopt the shortcut method provided in
the Financial Accounting Standards Board’s (FASB’s)
Staff Position No. FAS 123(R)-3, “Transition
Election Related to Accounting for the Tax Effects of
Share-Based Payment Awards,” for determining the initial
pool of excess tax benefits available to absorb tax deficiencies
related to stock-based compensation subsequent to the adoption
of SFAS No. 123R. The shortcut method includes
simplified procedures for establishing the beginning balance of
the pool of excess tax benefits (the APIC Tax Pool) and for
determining the subsequent effect on the APIC Tax Pool and the
Company’s Consolidated Statements of Cash Flows of the tax
effects of share-based compensation awards.
See Note 15 for additional discussion of the Company’s
stock-based compensation.
The Company’s Consolidated Statements of Cash Flows are
prepared using the indirect method, which reconciles net income
to cash flow from operating activities. These adjustments
include the removal of timing differences between the occurrence
of operating receipts and payments and their recognition in net
income. The adjustments also remove from operating activities
cash flows arising from investing and financing activities,
which are presented separately from operating activities.
Supplemental cash flow information, including interest and
income taxes paid and received, as well as any non-cash
investing and financing activities, is presented in Note 5.
In July 2006, the FASB issued two standards that address
accounting for income taxes: FASB Staff Position (FSP)
FAS 13-2,
“Accounting for a Change in the Timing of Cash Flows
Relating to Income Taxes Generated by a Leveraged Lease
Transaction,” and FASB Interpretation No. (FIN) 48,
“Accounting for Uncertainty in Income Taxes.” FSP
FAS 13-2
requires a recalculation of returns on leveraged leases if there
is a change or projected change in the timing of cash flows
relating to income taxes generated by the leveraged lease. The
adoption of FSP
FAS 13-2
effective at the beginning of 2007 is not expected to have a
material impact on the Company’s consolidated financial
statements.
FIN 48 prescribes a comprehensive model for recognizing,
measuring, presenting and disclosing in the financial statements
uncertain tax positions that a company has taken or expects to
take in its tax returns. It applies to all tax positions
accounted for in accordance with SFAS No. 109 and is
effective for fiscal years beginning after December 15,
2006. The Company will apply the provisions of this
interpretation beginning in the first quarter of 2007, and
currently expects that its adoption will not have a material
impact on the Company’s consolidated results of operations
or financial position. The Company does, however, expect to make
certain balance sheet reclassifications upon the adoption of
this interpretation.
In September 2006, the FASB issued SFAS No. 157,
“Fair Value Measurements,” which defines fair value,
establishes a framework for measuring fair value and expands
disclosures about fair value measurements. This Statement
applies under other accounting pronouncements that require or
permit fair value measurements. Accordingly, this Statement does
not require any new fair value measurements. The provisions of
SFAS No. 157 will be effective as of the beginning of
the Company’s fiscal 2008. The Company does not expect that
the adoption of SFAS No. 157 will have a material
impact on its consolidated financial statements.
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In September 2006, the SEC issued Staff Accounting
Bulletin No. 108 (SAB 108), “Considering the
Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements.”
SAB 108 addresses how the effect of prior year uncorrected
misstatements should be evaluated when quantifying misstatements
in current year financial statements. SAB 108 requires
companies to quantify misstatements using a balance sheet and
income statement approach and to evaluate whether either
approach results in quantified error that is material in light
of the relevant quantitative and qualitative factors. The
provisions of SAB 108 became effective during the fourth
quarter of 2006 but had no impact on the financial position or
operating results of the Company.
In February 2007, the FASB issued SFAS No. 159,
“The Fair Value Option for Financial Assets and
Liabilities.” This statement permits entities to choose to
measure many financial instruments and certain other items at
fair value. If the fair value option is elected, unrealized
gains and losses will be recognized in earnings at each
subsequent reporting date. SFAS No. 159 is effective
for fiscal years beginning after November 15, 2007. The
Company is currently evaluating the impact of this adoption on
its consolidated financial statements.
2) Discontinued
Operations
On July 5, 2005, the Company’s indirect wholly owned
subsidiary, J. C. Penney Brazil, Inc., closed on the sale of its
shares of Renner, a Brazilian department store chain, through a
public stock offering registered in Brazil. The Company
generated cash proceeds of $283 million from the sale of
its interest in Renner. After taxes and transaction costs, net
proceeds approximated $260 million. Proceeds from the sale
were used for common stock repurchases, which are more fully
discussed in Note 3.
Including an $8 million credit related to taxes that was
recorded in 2006, the sale resulted in a cumulative pre-tax gain
of $26 million and an after-tax gain of $1 million.
The relatively high tax cost is largely due to the tax basis of
the Company’s investment in Renner being lower than its
book basis as a result of accounting for the investment under
the cost method for tax purposes. Included in the pre-tax gain
on the sale was $83 million of foreign currency translation
losses that had accumulated since the Company acquired its
controlling interest in Renner. For all periods presented,
Renner’s results of operations and financial position have
been reclassified and reflected as a discontinued operation.
On July 31, 2004, the Company and certain of its
subsidiaries closed on the sale of its Eckerd drugstore
operations to the Jean Coutu Group (PJC) Inc. (Coutu) and
CVS Corporation and CVS Pharmacy, Inc. (together, CVS) for
a total of approximately $4.7 billion in cash proceeds.
After taxes, fees and other transaction costs and estimated
post-closing adjustments, the ultimate net cash proceeds from
the sale totaled approximately $3.5 billion. Proceeds from
the sale were used for common stock repurchases and debt
reduction, which are more fully discussed in Notes 3 and 11.
During 2006, the Company recorded an after-tax credit of
$4 million related to the Eckerd discontinued operations,
which was primarily related to taxes. Through 2006, the
cumulative loss on the sale was $715 million pre-tax, or
$1,326 million on an after-tax basis. The relatively high
tax cost is a result of the tax basis of Eckerd being lower than
its book basis because the Company’s previous drugstore
acquisitions were largely tax-free transactions. Of the total
after-tax loss on the sale, $108 million was recorded in
2004 to reflect revised estimates of certain post-closing
adjustments and resulting sales proceeds, and
$1,325 million was recorded in 2003 to reflect Eckerd at
its estimated fair value less costs to sell. These charges were
partially offset by an after-tax credit of $103 million
recorded in 2005, which was primarily related to the favorable
resolution of certain tax matters, as well as a reduction of the
taxes payable on the sale of Eckerd due to adjustments in
Eckerd’s tax basis.
Upon closing on the sale of Eckerd on July 31, 2004, the
Company established reserves for estimated transaction costs and
post-closing adjustments. Certain of these reserves involved
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