Edgar Filing: J C PENNEY CO INC

JCP-08.02.2014-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 2, 2014



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 1-15274

J. C. PENNEY COMPANY, INC.

(Exact name of registrant as specified in its charter)



Delaware		26-0037077
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

6501 Legacy Drive, Plano, Texas		75024 - 3698
(Address of principal executive offices)		(Zip Code)

(Registrant’s telephone number, including area code)

(972) 431-1000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer x	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 304,836,982 shares of Common Stock of 50 cents par value, as of September 5, 2014.

J. C. PENNEY COMPANY, INC.

FORM 10-Q

For the Quarterly Period Ended August 2, 2014

INDEX




	Page
Part I. Financial Information
Item 1. Unaudited Interim Consolidated Financial Statements
Consolidated Statements of Operations	2
Consolidated Statements of Comprehensive Income/(Loss)	3
Consolidated Balance Sheets	4
Consolidated Statements of Cash Flows	5
Notes to Unaudited Interim Consolidated Financial Statements
1. Basis of Presentation and Consolidation	6
2. Earnings/(Loss) per Share	7
3. Credit Facility	7
4. Fair Value Disclosures	8
5. Stockholders’ Equity	9
6. Stock-Based Compensation	10
7. Retirement Benefit Plans	12
8. Restructuring and Management Transition	13
9. Real Estate and Other, Net	14
10. Income Taxes	14
11. Litigation, Other Contingencies and Guarantees	15
12. Effect of New Accounting Standards	16
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3. Quantitative and Qualitative Disclosures About Market Risk	31
Item 4. Controls and Procedures	31
Part II. Other Information
Item 1. Legal Proceedings	32
Item 1A. Risk Factors	33
Item 6. Exhibits	43
SIGNATURES	45

Table of Contents

Part I. Financial Information

Item 1. Unaudited Interim Consolidated Financial Statements

J. C. PENNEY COMPANY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



	Three Months Ended						Six Months Ended
(In millions, except per share data)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Total net sales	$	2,799		$	2,663		$	5,600		$	5,298
Cost of goods sold	1,791			1,876			3,666			3,699
Gross margin	1,008			787			1,934			1,599
Operating expenses/(income):
Selling, general and administrative (SG&A)	964			1,026			1,973			2,104
Pension	2			34			3			68
Depreciation and amortization	160			143			318			279
Real estate and other, net	(53		)	(68		)	(70		)	(90		)
Restructuring and management transition	5			47			27			119
Total operating expenses	1,078			1,182			2,251			2,480
Operating income/(loss)	(70		)	(395		)	(317		)	(881		)
Loss on extinguishment of debt	—			114			—			114
Net interest expense	106			95			203			156
Income/(loss) before income taxes	(176		)	(604		)	(520		)	(1,151		)
Income tax expense/(benefit)	(4		)	(18		)	4			(217		)
Net income/(loss)	$	(172	)	$	(586	)	$	(524	)	$	(934	)
Earnings/(loss) per share:
Basic	$	(0.56	)	$	(2.66	)	$	(1.72	)	$	(4.24	)
Diluted	$	(0.56	)	$	(2.66	)	$	(1.72	)	$	(4.24	)
Weighted average shares – basic	305.2			220.6			305.1			220.2
Weighted average shares – diluted	305.2			220.6			305.1			220.2

See the accompanying notes to the unaudited Interim Consolidated Financial Statements.

Table of Contents

J. C. PENNEY COMPANY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)

(Unaudited)



	Three Months Ended						Six Months Ended
($ in millions)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Net income/(loss)	$	(172	)	$	(586	)	$	(524	)	$	(934	)
Other comprehensive income/(loss), net of tax:
Real estate investment trusts (REITs)
Unrealized gain/(loss)	—			(3		)	—			—
Retirement benefit plans
Reclassification for amortization of net actuarial (gain)/loss	9			27			20			55
Reclassification for amortization of prior service (credit)/cost	1			—			—			(1		)
Total other comprehensive income/(loss), net of tax	10			24			20			54
Total comprehensive income/(loss), net of tax	$	(162	)	$	(562	)	$	(504	)	$	(880	)

See the accompanying notes to the unaudited Interim Consolidated Financial Statements.

Table of Contents

J. C. PENNEY COMPANY, INC.

CONSOLIDATED BALANCE SHEETS



	August 2, 2014			August 3, 2013			February 1, 2014
(In millions, except per share data)	(Unaudited)			(Unaudited)
Assets
Current assets:
Cash in banks and in transit	$	189		$	198		$	113
Cash short-term investments	847			1,337			1,402
Cash and cash equivalents	1,036			1,535			1,515
Merchandise inventory	2,848			3,155			2,935
Deferred taxes	182			115			193
Prepaid expenses and other	207			209			190
Total current assets	4,273			5,014			4,833
Property and equipment (net of accumulated depreciation of $3,485, $3,067 and $3,315)	5,415			5,820			5,619
Prepaid pension	701			22			663
Other assets	723			798			686
Total Assets	$	11,112		$	11,654		$	11,801
Liabilities and Stockholders’ Equity
Current liabilities:
Merchandise accounts payable	$	984		$	1,276		$	948
Other accounts payable and accrued expenses	1,176			1,350			1,198
Short-term borrowings	—			850			650
Current portion of capital leases and note payable	30			27			27
Current maturities of long-term debt	28			23			23
Total current liabilities	2,218			3,526			2,846
Long-term capital leases and note payable	44			71			62
Long-term debt	5,323			4,850			4,839
Deferred taxes	364			242			335
Other liabilities	563			645			632
Total Liabilities	8,512			9,334			8,714
Stockholders’ Equity
Common stock⁽¹⁾	152			110			152
Additional paid-in capital	4,588			3,828			4,571
Reinvested earnings/(accumulated deficit)	(1,532		)	(554		)	(1,008		)
Accumulated other comprehensive income/(loss)	(608		)	(1,064		)	(628		)
Total Stockholders’ Equity	2,600			2,320			3,087
Total Liabilities and Stockholders’ Equity	$	11,112		$	11,654		$	11,801


(1)	1,250 million shares of common stock are authorized with a par value of $0.50 per share. The total shares issued and outstanding were 304.8 million, 220.4 million and 304.6 million as of August 2, 2014, August 3, 2013 and February 1, 2014, respectively.

See the accompanying notes to the unaudited Interim Consolidated Financial Statements.

Table of Contents

J. C. PENNEY COMPANY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	Three Months Ended						Six Months Ended
($ in millions)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Cash flows from operating activities
Net income/(loss)	$	(172	)	$	(586	)	$	(524	)	$	(934	)
Adjustments to reconcile net income/(loss) to net cash provided by/(used in) operating activities:
Restructuring and management transition	1			24			3			61
Asset impairments and other charges	2			7			4			9
Net gain on sale of non-operating assets	(9		)	(62		)	(21		)	(62		)
Net gain on sale of operating assets	—			(2		)	(1		)	(18		)
Loss on extinguishment of debt	—			114			—			114
Depreciation and amortization	160			143			318			279
Benefit plans	(4		)	24			(13		)	41
Stock-based compensation	9			11			16			16
Deferred taxes	(14		)	(25		)	(19		)	(189		)
Change in cash from:
Inventory	(13		)	(357		)	87			(814		)
Prepaid expenses and other assets	8			(9		)	(19		)	41
Merchandise accounts payable	143			29			36			114
Current income taxes	(6		)	5			4			60
Accrued expenses and other	32			(24		)	(5		)	(178		)
Net cash provided by/(used in) operating activities	137			(708		)	(134		)	(1,460		)
Cash flows from investing activities
Capital expenditures	(61		)	(439		)	(141		)	(653		)
Net proceeds from sale of non-operating assets	11			55			26			55
Net proceeds from sale of operating assets	—			1			2			19
Joint venture return of investment	8			—			8			—
Net cash provided by/(used in) investing activities	(42		)	(383		)	(105		)	(579		)
Cash flows from financing activities
Proceeds from short-term borrowings	—			—			—			850
Payment on short-term borrowings	(650		)	—			(650		)	—
Net proceeds from issuance of long-term debt	500			2,180			500			2,180
Premium on early retirement of debt	—			(110		)	—			(110		)
Payments of capital leases and note payable	(13		)	(14		)	(18		)	(19		)
Payments of long-term debt	(6		)	(245		)	(11		)	(245		)
Financing costs	(60		)	(4		)	(60		)	(12		)
Proceeds from stock options exercised	—			2			—			7
Tax withholding payments for vested restricted stock	—			(4		)	(1		)	(7		)
Net cash provided by/(used in) financing activities	(229		)	1,805			(240		)	2,644
Net increase/(decrease) in cash and cash equivalents	(134		)	714			(479		)	605
Cash and cash equivalents at beginning of period	1,170			821			1,515			930
Cash and cash equivalents at end of period	$	1,036		$	1,535		$	1,036		$	1,535
Supplemental cash flow information
Income taxes received/(paid), net	(16		)	(2		)	(19		)	88
Interest received/(paid), net	(57		)	(152		)	(183		)	(236		)
Supplemental non-cash investing and financing activity
Property contributed to joint venture	—			—			30			—
Increase/(decrease) in other accounts payable related to purchases of property and equipment	(6		)	(178		)	(5		)	102
Financing costs withheld from proceeds of long-term debt	—			70			—			70

See the accompanying notes to the unaudited Interim Consolidated Financial Statements.

Table of Contents

J. C. PENNEY COMPANY, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation and Consolidation

Basis of Presentation

J. C. Penney Company, Inc. is a holding company whose principal operating subsidiary is J. C. Penney Corporation, Inc. (JCP). JCP was incorporated in Delaware in 1924, and J. C. Penney Company, Inc. was incorporated in Delaware in 2002, when the holding company structure was implemented. The holding company has no independent assets or operations, and no direct subsidiaries other than JCP. The holding company and its consolidated subsidiaries, including JCP, are collectively referred to in this quarterly report as “we,” “us,” “our,” “ourselves” or the “Company,” unless otherwise indicated.

J. C. Penney Company, Inc. is a co-obligor (or guarantor, as appropriate) regarding the payment of principal and interest on JCP’s outstanding debt securities. The guarantee of certain of JCP’s outstanding debt securities by J. C. Penney Company, Inc. is full and unconditional.

These unaudited Interim Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and in accordance with the rules and regulations of the Securities and Exchange Commission (SEC). The accompanying unaudited Interim Consolidated Financial Statements, in our opinion, include all material adjustments necessary for a fair presentation and should be read in conjunction with the audited Consolidated Financial Statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 (2013 Form 10-K). We follow substantially the same accounting policies to prepare quarterly financial statements as are followed in preparing annual financial statements. A description of such significant accounting policies is included in the 2013 Form 10-K. The February 1, 2014 financial information was derived from the audited Consolidated Financial Statements, with related footnotes, included in the 2013 Form 10-K. Because of the seasonal nature of the retail business, operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.

Fiscal Year

Our fiscal year ends on the Saturday closest to January 31. As used herein, “three months ended August 2, 2014” and “three months ended August 3, 2013” refer to the 13-week periods ended August 2, 2014 and August 3, 2013, respectively. “Six months ended August 2, 2014” or “2014 first half,” and “six months ended August 3, 2013,” or “2013 first half,” refer to the 26-week periods ended August 2, 2014 and August 3, 2013, respectively. Fiscal years 2014 and 2013 contain 52 weeks.

Basis of Consolidation

All significant intercompany transactions and balances have been eliminated in consolidation. Certain reclassifications were made to prior period amounts to conform to the current period presentation. None of the reclassifications affected our net income/(loss) in any period.

Use of Estimates and Assumptions

The preparation of unaudited Interim Consolidated Financial Statements, in conformity with GAAP, requires us to make assumptions and use estimates 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. The most significant estimates relate to: inventory valuation under the retail method, specifically permanent reductions to retail prices (markdowns), permanent devaluation of inventory (markdown accruals) and adjustments for shortages (shrinkage); valuation of long-lived assets and indefinite-lived intangible assets for impairments; reserves for closed stores, workers’ compensation and general liability (insurance), environmental contingencies, income taxes and litigation; and pension and other postretirement benefits accounting. Such estimates and assumptions are subject to inherent uncertainties, which may result in actual amounts differing from reported amounts.

Table of Contents

2. Earnings/(Loss) per Share

Net income/(loss) and shares used to compute basic and diluted earnings/(loss) per share (EPS) are reconciled below:



	Three Months Ended						Six Months Ended
(in millions, except per share data)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Earnings/(loss)
Net income/(loss)	$	(172	)	$	(586	)	$	(524	)	$	(934	)
Shares
Weighted average common shares outstanding (basic shares)	305.2			220.6			305.1			220.2
Adjustment for assumed dilution:
Stock options, restricted stock awards and warrant	—			—			—			—
Weighted average shares assuming dilution (diluted shares)	305.2			220.6			305.1			220.2
EPS
Basic	$	(0.56	)	$	(2.66	)	$	(1.72	)	$	(4.24	)
Diluted	$	(0.56	)	$	(2.66	)	$	(1.72	)	$	(4.24	)

The following average potential shares of common stock were excluded from the diluted EPS calculation because their effect would have been anti-dilutive:



	Three Months Ended		Six Months Ended
(Shares in millions)	August 2, 2014	August 3, 2013	August 2, 2014	August 3, 2013
Stock options, restricted stock awards and warrant	26.7	25.0	25.4	25.0

3. Credit Facility

On June 20, 2014, J. C. Penney Company, Inc., JCP and J. C. Penney Purchasing Corporation (Purchasing) entered into a $2,350 million asset-based senior credit facility (2014 Credit Facility), comprised of a $1,850 million revolving line of credit (Revolving Facility) and a $500 million term loan (2014 Term Loan). The 2014 Credit Facility, which matures on June 20, 2019, replaced the Company’s prior credit agreement entered into in February 2013 and contains a letter of credit sublimit of $750 million. Proceeds from the 2014 Term Loan, in addition to $150 million of cash on hand, were used to pay down the $650 million cash borrowings that were outstanding under the previous facility.

The 2014 Credit Facility is an asset-based senior credit facility and is secured by a perfected first-priority security interest in substantially all of our eligible credit card receivables, accounts receivable and inventory. The Revolving Facility is available for general corporate purposes, including the issuance of letters of credit. Pricing under the Revolving Facility is tiered based on our utilization under the line of credit. JCP’s obligations under the 2014 Credit Facility are guaranteed by J. C. Penney Company, Inc.

The borrowing base under the Revolving Facility, which is limited to a maximum of $1,850 million, allows us to borrow up to 85% of eligible accounts receivable, plus 90% of eligible credit card receivables, plus 90% of the liquidation value of our inventory, net of certain reserves. Letters of credit reduce the amount available to borrow by their face value. In addition, the maximum availability is limited by a minimum excess availability threshold which is the greater of 10% of the borrowing base or $150 million.

As of the end of the second quarter of 2014, we had $500 million outstanding on the 2014 Term Loan and no borrowings outstanding under the Revolving Facility. The 2014 Term Loan bears interest at a rate of LIBOR plus 4.0% and requires quarterly repayments in a principal amount equal to $1.25 million during the five-year term beginning October 1, 2014. As of the end of the second quarter of 2014, we had $497 million in standby and import letters of credit outstanding under the Revolving Facility, the majority of which were standby letters of credit that support our merchandise initiatives and workers’ compensation. None of the standby or import letters of credit have been drawn on. The applicable rates for standby and import letters of credit were 2.75% and 1.375%, respectively, while the commitment fee was 0.375% for the unused portion of the

Table of Contents

Revolving Facility. As of the end of the second quarter of 2014, based on our June 2014 borrowing base, we had $1,050 million available for future borrowing, of which $895 million was accessible due to the minimum excess availability threshold.

4. Fair Value Disclosures

In determining fair value, the accounting standards establish a three-level hierarchy for inputs used in measuring fair value, as follows:


•	Level 1 — Quoted prices in active markets for identical assets or liabilities.


•	Level 2 — Significant observable inputs other than quoted prices in active markets for similar assets and liabilities, such as quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.


•	Level 3 — Significant unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants.

REIT Assets Measured on a Recurring Basis

During 2013, we sold our remaining investments in public REIT assets. The market value of our investment in public REIT assets were accounted for as available-for-sale securities and were carried at fair value on an ongoing basis in Other assets in the unaudited Interim Consolidated Balance Sheets. We determined the fair value of our investments in REITs using quoted market prices. There were no transfers in or out of any levels during any period presented. Our REIT assets measured at fair value were as follows:



			REIT Assets at Fair Value
($ in millions)	Cost Basis		Quoted Prices in Active Markets of Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
August 2, 2014	$	—	$	—	$	—	$	—
August 3, 2013	7		33		—		—
February 1, 2014	—		—		—		—

Other Financial Instruments

Carrying values and fair values of financial instruments that are not carried at fair value in the unaudited Interim Consolidated Balance Sheets are as follows:



	August 2, 2014				August 3, 2013				February 1, 2014
($ in millions)	Carrying Amount		Fair Value		Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt, including current maturities	$	5,351	$	5,072	$	4,873	$	4,272	$	4,862	$	4,209
Cost investment	—		—		36		—		—		—

The fair value of long-term debt was estimated by obtaining quotes from brokers or was based on current rates offered for similar debt. The cost investment was for equity securities that were not registered and freely tradable shares and their fair values were not readily determinable; however, we believe the carrying value approximated or was less than the fair value.

As of August 2, 2014, August 3, 2013 and February 1, 2014, the fair values of cash and cash equivalents, accounts payable and short-term borrowings approximated their carrying values due to the short-term nature of these instruments. In addition, the fair values of capital lease commitments and the note payable approximated their carrying values. These items have been excluded from the table above.

Concentrations of Credit Risk

We have no significant concentrations of credit risk.

Table of Contents

5. Stockholders’ Equity

The following table shows the change in the components of stockholders’ equity for the six months ended August 2, 2014:



(in millions)	Number of Common Shares	Common Stock		Additional Paid-in Capital		Reinvested Earnings/ (Accumulated Deficit)			Accumulated Other Comprehensive Income/(Loss)			Total Stockholders’ Equity
February 1, 2014	304.6	$	152	$	4,571	$	(1,008	)	$	(628	)	$	3,087
Net income/(loss)	—	—		—		(524		)	—			(524		)
Other comprehensive income/(loss)	—	—		—		—			20			20
Stock-based compensation	0.2	—		17		—			—			17
August 2, 2014	304.8	$	152	$	4,588	$	(1,532	)	$	(608	)	$	2,600

Comprehensive Income

The tax effects allocated to each component of other comprehensive income/(loss) are as follows:



	Three Months Ended
	August 2, 2014							August 3, 2013
($ in millions)	Gross Amount		Income Tax (Expense)/ Benefit			Net Amount		Gross Amount			Income Tax (Expense)/ Benefit			Net Amount
REITs
Unrealized gain/(loss)	$	—	$	—		$	—	$	(4	)	$	1		$	(3	)
Retirement benefit plans
Reclassification for amortization of net actuarial (gain)/loss	16		(7		)	9		44			(17		)	27
Reclassification for amortization of prior service (credit)/cost	1		—			1		—			—			—
Total	$	17	$	(7	)	$	10	$	40		$	(16	)	$	24



	Six Months Ended
	August 2, 2014							August 3, 2013
($ in millions)	Gross Amount		Income Tax (Expense)/ Benefit			Net Amount		Gross Amount			Income Tax (Expense)/ Benefit			Net Amount
Retirement benefit plans
Reclassification for amortization of net actuarial (gain)/loss	$	33	$	(13	)	$	20	$	88		$	(33	)	$	55
Reclassification for amortization of prior service (credit)/cost	—		—			—		(1		)	—			(1		)
Total	$	33	$	(13	)	$	20	$	87		$	(33	)	$	54

Table of Contents

The following table shows the changes in accumulated other comprehensive income/(loss) balances for the six months ended August 2, 2014:



($ in millions)	Net Actuarial Gain/(Loss)			Prior Service Credit/(Cost)			Accumulated Other Comprehensive Income/(Loss)
February 1, 2014	$	(609	)	$	(19	)	$	(628	)
Other comprehensive income/(loss) before reclassifications	—			—			—
Amounts reclassified from accumulated other comprehensive income	20			—			20
Net current-period other comprehensive income	20			—			20
August 2, 2014	$	(589	)	$	(19	)	$	(608	)

Reclassifications out of accumulated other comprehensive income/(loss) are as follows:



	Amount Reclassified from Accumulated Other Comprehensive Income/(Loss)												Line Item in the Unaudited Interim Consolidated Statements of Operations
	Three Months Ended						Six Months Ended
($ in millions)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Amortization of retirement benefit plans
Actuarial loss/(gain)⁽¹⁾	$	16		$	44		$	33		$	88		Pension
Prior service cost/(credit)⁽¹⁾	3			2			4			3			Pension
Prior service cost/(credit)⁽¹⁾	(2		)	(2		)	(4		)	(4		)	SG&A
Tax (expense)/benefit	(7		)	(17		)	(13		)	(33		)	Income tax expense/(benefit)
Total, net of tax	10			27			20			54
Total reclassifications	$	10		$	27		$	20		$	54


(1)	These accumulated other comprehensive components are included in the computation of net periodic benefits expense/(income). See Note 7 for additional details.

6. Stock-Based Compensation

We grant stock-based compensation awards to employees and non-employee directors under our equity compensation plan. On May 16, 2014, our stockholders approved the J. C. Penney Company, Inc. 2014 Long-Term Incentive Plan (2014 Plan), which has a fungible share design in which each stock option will count as one share issued and each stock award will count as two shares issued. The 2014 Plan reserved 16 million shares or 32 million options for future grants and will terminate on May 31, 2019. In addition, shares underlying any outstanding stock award or stock option grant canceled prior to vesting or exercise become available for use under the 2014 Plan. On May 21, 2014, the Company also approved an equity inducement award plan (2014 Equity Inducement Plan) which reserved 750,000 restricted stock units to grant to a certain officer of the Company in connection with his employment. Our prior 2012 Long-Term Incentive Plan (2012 Plan) terminated on May 16, 2014, except for outstanding awards, and all subsequent awards have been granted under the 2014 Plan or the 2014 Equity Inducement Plan. Under the terms of the 2014 Plan, all grants made after January 31, 2014 reduce the shares available for grant under the 2014 Plan. As of August 2, 2014, a maximum of 25.2 million shares of stock were available for future grant under the 2014 Plan.

Stock-based compensation expense for the three months ended August 2, 2014 and August 3, 2013 was $11 million and $18 million, respectively. Stock-based compensation expense for the six months ended August 2, 2014 and August 3, 2013 was $21 million and $32 million, respectively. During the first half of 2014, the Company granted the following stock-based compensation awards:

Table of Contents



	Restricted Stock Units (RSU)		Stock Options			Weighted Average Grant Date Fair Value
Grant Date	Time-based	Performance-based	Performance-based	Weighted Average Exercise Price		Weighted Average Grant Date Fair Value
March 3, 2014	25,000	—	—	$	—	$	7.96
March 20, 2014	2,328,000	329,000	2,322,000	8.36		6.09
March 27, 2014	84,000	—	185,000	8.97		5.59
May 20, 2014⁽¹⁾	306,000	—	—	—		8.93
Total	2,743,000	329,000	2,507,000	8.41		6.23


(1)	Includes approximately 224,000 RSUs that were granted under the 2014 Equity Inducement Plan.

Performance-based stock options and awards that ultimately vest are dependent on market performance targets measured by either the performance of the Company’s common stock (market condition) or on the achievement of a 2014 internal profitability target (performance condition).

In addition to the grants above, on March 20, 2014, we granted approximately 2.3 million phantom units as part of our management incentive compensation plan, which are similar to RSUs in that the number of units granted was based on the price of our stock, but the units will be settled in cash based on the value of our stock on the vesting date, limited to $16.72 per phantom unit. The fair value of the awards is remeasured at each reporting period and was $9.63 per share as of August 2, 2014. Compensation expense, which is variable, is recognized over the vesting period with a corresponding liability, which is recorded in Other accounts payable and accrued expenses in our unaudited Interim Consolidated Balance Sheets. We also granted approximately 157,000 fully vested RSUs to directors on May 21, 2014 with a fair value of $8.60 per RSU award.

Table of Contents

7. Retirement Benefit Plans

The components of net periodic benefit expense/(income) for our non-contributory qualified defined benefit pension plan (Primary Pension Plan), non-contributory supplemental pension plans and contributory postretirement health and welfare plan were as follows:



	Three Months Ended						Six Months Ended
($ in millions)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Primary Pension Plan
Service cost	$	16		$	19		$	31		$	39
Interest cost	52			51			105			102
Expected return on plan assets	(87		)	(85		)	(174		)	(170		)
Amortization of actuarial loss/(gain)	12			38			25			76
Amortization of prior service cost/(credit)	3			2			4			3
Net periodic benefit expense/(income)	$	(4	)	$	25		$	(9	)	$	50

Supplemental Pension Plans
Service cost	$	—		$	—		$	—		$	—
Interest cost	2			3			4			6
Amortization of actuarial loss/(gain)	4			6			8			12
Amortization of prior service cost/(credit)	—			—			—			—
Net periodic benefit expense/(income)	$	6		$	9		$	12		$	18

Primary and Supplemental Pension Plans Total
Service cost	$	16		$	19		$	31		$	39
Interest cost	54			54			109			108
Expected return on plan assets	(87		)	(85		)	(174		)	(170		)
Amortization of actuarial loss/(gain)	16			44			33			88
Amortization of prior service cost/(credit)	3			2			4			3
Net periodic benefit expense/(income)	$	2		$	34		$	3		$	68

Postretirement Health and Welfare Plan
Service cost	$	—		$	—		$	—		$	—
Interest cost	—			—			—			—
Amortization of actuarial loss/(gain)	—			—			—			—
Amortization of prior service cost/(credit)	(2		)	(2		)	(4		)	(4		)
Net periodic benefit expense/(income)	$	(2	)	$	(2	)	$	(4	)	$	(4	)

Retirement Benefit Plans Total
Service cost	$	16		$	19		$	31		$	39
Interest cost	54			54			109			108
Expected return on plan assets	(87		)	(85		)	(174		)	(170		)
Amortization of actuarial loss/(gain)	16			44			33			88
Amortization of prior service cost/(credit)	1			—			—			(1		)
Net periodic benefit expense/(income)	$	—		$	32		$	(1	)	$	64

Net periodic benefit expense/(income) for our noncontributory postretirement health and welfare plan was predominantly included in SG&A expense in the unaudited Interim Consolidated Statements of Operations.

Table of Contents

Defined Contribution Plans

Our defined contribution plans include a qualified Savings, Profit-Sharing and Stock Ownership Plan (401(k) plan), which includes a non-contributory retirement account, and a non-qualified contributory unfunded mirror savings plan offered to certain members of management. Total expense for our defined contribution plans for the second quarters of 2014 and 2013 was $13 million and $12 million, respectively, and was predominantly included in SG&A expenses in the unaudited Interim Consolidated Statements of Operations. Total expense for the first six months of 2014 and 2013 was $26 million and $26 million, respectively.

8. Restructuring and Management Transition

The composition of restructuring and management transition charges was as follows:



	Three Months Ended				Six Months Ended				Cumulative Amount Through August 2, 2014
($ in millions)	August 2, 2014		August 3, 2013		August 2, 2014		August 3, 2013		Cumulative Amount Through August 2, 2014
Home office and stores	$	—	$	4	$	12	$	32	$	214
Store fixtures	—		17		—		45		133
Management transition	1		13		8		29		216
Other	4		13		7		13		130
Total	$	5	$	47	$	27	$	119	$	693

Home office and stores

During the six months ended August 2, 2014 and August 3, 2013, we recorded $12 million and $32 million, respectively, of charges for actions taken to reduce our home office and store expenses. In January 2014, we announced the closing of 33 department stores as part of our turnaround efforts. During the first half of 2014, we incurred charges of $12 million for employee termination benefits and lease termination costs associated with the closure of 32 of those stores. We expect to close the remaining store during the third quarter of 2014. The $32 million of charges in the first half of 2013 were associated with employee termination benefits.

Store fixtures

During the three months ended August 3, 2013, we recorded $1 million of charges for the write-off of store fixtures related to the renovations in our home department and $16 million of increased depreciation as a result of shortening the useful lives of fixtures in our department stores that were replaced during 2013.

During the six months ended August 3, 2013, we recorded $7 million of charges for the write-off of store fixtures related to the renovations in our home department and $29 million of increased depreciation as a result of shortening the useful lives of fixtures in our department stores that were replaced during 2013. In addition, during the six months ended August 3, 2013, we recorded $9 million of charges for the impairment of certain store fixtures related to our former shops strategy that were used in our prototype department store.

Management transition

During the three months ended August 2, 2014 and August 3, 2013, we implemented several changes within our management leadership team that resulted in management transition costs of $1 million and $13 million, respectively, for both incoming and outgoing members of management. During the six months ended August 2, 2014 and August 3, 2013, we recorded charges of $8 million and $29 million, respectively.

Other

During the three months ended August 2, 2014 and August 3, 2013, we recorded $4 million and $13 million, respectively, of miscellaneous restructuring charges. During the six months ended August 2, 2014 and August 3, 2013, we recorded $7 million and $13 million, respectively, of miscellaneous restructuring charges. The charges during both years were related primarily to contract termination costs associated with our previous marketing and shops strategy.

Table of Contents

Activity for the restructuring and management transition liability for the six months ended August 2, 2014 was as follows:



($ in millions)	Home Office and Stores			Management Transition			Other			Total
February 1, 2014	$	—		$	3		$	30		$	33
Charges	12			8			7			27
Cash payments	(4		)	(9		)	(17		)	(30		)
Non-cash	—			(2		)	(1		)	(3		)
August 2, 2014	$	8		$	—		$	19		$	27

The non-cash amount represents charges primarily for stock-based compensation expense in conjunction with accelerated vesting related to terminations that did not result in cash expenditures.

9. Real Estate and Other, Net

Real estate and other consists of ongoing operating income from our real estate subsidiaries. Real estate and other also includes net gains from the sale of facilities and equipment that are no longer used in operations, asset impairments and other non-operating charges and credits. In addition, during the first quarter of 2014, we entered into a joint venture agreement in which we contributed approximately 220 acres of excess property adjacent to our home office facility in Plano, Texas (Home Office Land Joint Venture). The new joint venture was formed to develop the contributed property and our proportional share of the joint venture's activities will be recorded in Real estate and other, net. For the three months ended August 2, 2014 and August 3, 2013, Real estate and other, net was income of $53 million and $68 million, respectively. For the six months ended August 2, 2014 and August 3, 2013, Real estate and other, net was income of $70 million and $90 million, respectively. Real estate and other, net was comprised primarily of sales of non-operating and operating assets and our proportional share of net income from the Home Office Land Joint Venture as detailed below.

Non-Operating Assets

During the first quarter of 2014, we sold four properties used in our former auto center operations and excess property adjacent to our home office facility not contributed to the Home Office Land Joint Venture for net proceeds of $15 million, resulting in net gains totaling $12 million. During the second quarter of 2014, we sold four additional properties used in our former auto center operations for net proceeds of $11 million, resulting in net gains totaling $9 million.

During the second quarter of 2013, we sold our investment in a joint venture that owns regional mall properties for $55 million, resulting in a net gain of $62 million. The gain exceeded the cash proceeds as a result of distributions of cash related to refinancing transactions in prior periods that were recorded as net reductions in the carrying amount of the investment. The net book value of the joint venture investment was a negative $7 million and was included in Other liabilities in the Consolidated Balance Sheets.

Operating Assets

During the first quarter of 2014, we sold a former department store location with a net book value of $1 million for net proceeds of $2 million, realizing a gain of $1 million.

During the first quarter of 2013, we sold our leasehold interest in a former department store location with a net book value of $2 million for net proceeds of $18 million, realizing a gain of $16 million. During the second quarter of 2013, we sold two properties, realizing a gain of $2 million.

Other

During the second quarter of 2014, the Company recorded $43 million for our proportional share of net income from the Home Office Land Joint Venture and received an aggregate cash distribution of $51 million.

10. Income Taxes

Income taxes for the three months ended August 2, 2014 was a benefit of $4 million compared to a benefit of $18 million for the three months ended August 3, 2013. The effective tax rate for the three months ended August 2, 2014 was (2.3)% as compared to (3.0)% for the three months ended August 3, 2013. Income taxes for the six months ended August 2, 2014 was an expense of $4 million compared to a benefit of $217 million for the six months ended August 3, 2013. The effective tax rate for

Table of Contents

the six months ended August 2, 2014 was 0.8% as compared to (18.9)% for the six months ended August 3, 2013. Our effective tax rate for the six months ended August 2, 2014 was impacted by a net increase to the tax valuation allowance for deferred tax assets of $148 million.

In assessing the need for the valuation allowance, we considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets. As a result of our assessment, we concluded that, beginning in the second quarter of 2013, our estimate of the realization of deferred tax assets would be based solely on the future reversals of existing taxable temporary differences and tax planning strategies that we would make use of to accelerate taxable income to utilize expiring carryforwards. Accordingly, in the second quarter of 2014, the valuation allowance was increased to offset the net deferred tax assets created in the quarter relating primarily to the increase in net operating loss (NOL) carryforwards. A valuation allowance of $452 million has been recorded against our deferred tax assets as of August 2, 2014, which resulted in an increase to the valuation allowance during the quarter ended August 2, 2014 of $28 million.

The net tax benefit of $4 million for the second quarter of 2014 consisted of state and foreign tax expenses of $3 million and $2 million of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets, offset by a $7 million non-cash benefit relating to other comprehensive income and a $2 million benefit on settlement of certain state audits. In accordance with accounting standards, we are required to allocate a portion of our tax provision between operating losses and accumulated other comprehensive income. Application of this guidance required the recognition of a non-cash income tax benefit of $7 million in operating results, offset by a $7 million charge to other comprehensive income for the quarter.

The net tax expense of $4 million for the six months ended August 2, 2014 consisted of a federal audit adjustment of $12 million, state and foreign tax expenses of $5 million and $4 million of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets, offset by a $13 million non-cash benefit relating to other comprehensive income and a $4 million benefit on settlement of certain state audits. In accordance with accounting standards, we are required to allocate a portion of our tax provision between operating losses and accumulated other comprehensive income. Application of this guidance required the recognition of a non-cash income tax benefit of $13 million in operating results, offset by a $13 million charge to other comprehensive income for the quarter.

As of August 2, 2014, we have approximately $2.5 billion of net operating losses available for U.S. federal income tax purposes, which expire in 2032 through 2034 and $45 million of tax credit carryforwards that expire at various dates through 2034. For these NOL and tax credit carryforwards a net deferred tax asset of $550 million has been recorded, net of a valuation allowance of $307 million. A net deferred tax asset of $31 million, net of a valuation allowance of $145 million, has been recorded for state NOL carryforwards that expire at various dates through 2034.

11. Litigation, Other Contingencies and Guarantees

Litigation

Macy’s Litigation

On August 16, 2012, Macy’s, Inc. and Macy’s Merchandising Group, Inc. (together the Plaintiffs) filed suit against J. C. Penney Corporation, Inc. in the Supreme Court of the State of New York, County of New York, alleging that the Company tortiously interfered with, and engaged in unfair competition relating to a 2006 agreement between Macy’s and Martha Stewart Living Omnimedia, Inc. (MSLO) by entering into a partnership agreement with MSLO in December 2011. The Plaintiffs sought primarily to prevent the Company from implementing our partnership agreement with MSLO as it related to products in the bedding, bath, kitchen and cookware categories. The suit was consolidated with an already-existing breach of contract lawsuit by the Plaintiffs against MSLO, and a bench trial commenced on February 20, 2013. On March 7, 2013, the judge adjourned the trial until April 8, 2013, and ordered the parties into mediation. The parties did not reach a settlement, and the trial continued on April 8, 2013. The parties concluded their presentations of evidence on April 26, 2013, and completed post-trial briefs in late May, 2013. The court held closing arguments on August 1, 2013. On October 21, 2013, the Company and MSLO entered into an amendment of the partnership agreement, providing in part that the Company will not sell MSLO-designed merchandise in the bedding, bath, kitchen and cookware categories. On January 2, 2014, MSLO and Macy's announced that they had settled the case as to each other, and MSLO was subsequently dismissed as a defendant. On June 16, 2014, the Court issued a ruling against JCPenney on the remaining claim of intentional interference, and held that Macy’s is not entitled to punitive damages. The Court referred other issues related to damages to a Judicial Hearing Officer. On June 30, 2014, JCPenney appealed the Court’s decision, and Macy’s has cross-appealed a portion of the decision. While no assurance can be given as to the ultimate outcome of this matter, we currently believe that the final resolution of this action will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.

Table of Contents

Other Legal Proceedings

We are subject to various other legal and governmental proceedings involving routine litigation incidental to our business. Reserves have been established based on our best estimates of our potential liability in certain of these matters. These estimates were developed in consultation with in-house and outside counsel. While no assurance can be given as to the ultimate outcome of these matters, management currently believes that the final resolution of these actions, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.

Contingencies

As of August 2, 2014, we estimated our total potential environmental liabilities to range from $16 million to $23 million and recorded our best estimate of $18 million in Other accounts payable and accrued expenses and Other liabilities in the unaudited Interim Consolidated Balance Sheet as of that date. This estimate covered potential liabilities primarily related to underground storage tanks, remediation of environmental conditions involving our former drugstore locations and asbestos removal in connection with approved plans to renovate or dispose of our facilities. We continue to assess required remediation and the adequacy of environmental reserves as new information becomes available and known conditions are further delineated. If we were to incur losses at the upper end of the estimated range, we do not believe that such losses would have a material adverse effect on our results of operations, financial position, liquidity or capital resources.

Guarantees

As of August 2, 2014, we had a guarantee totaling $20 million for the maximum exposure on insurance reserves established by a former subsidiary included in the sale of our Direct Marketing Services business.

In addition, in connection with the sale of the operations of our catalog outlet stores, we assigned leases on certain outlet store locations to the purchaser. In the event that the purchaser fails to make the required lease payments, we continue for a period of time to be liable for lease payments to the landlords of several of the leased stores. The purchaser's obligations under the lease are guaranteed to us by certain principals and affiliates of the purchaser. However, the purchaser has exited the outlet business and is attempting to terminate the leases with the landlords. Consequently, we expect that our continuing obligations under each lease will be extinguished in connection with each termination. As of August 2, 2014, our maximum liability in connection with the assigned leases was $6 million.

12. Effect of New Accounting Standards

In June 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-12, Compensation - Stock Compensation, an amendment to FASB Accounting Standards Codification (ASC) Topic 718, Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update is effective for annual reporting periods beginning after December 15, 2015, with early adoption permitted. We do not expect the adoption of this standard to have a material impact on our financial condition, results of operation or cash flows.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, issued as a new Topic, ASC Topic 606. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU is effective for us beginning in fiscal 2017 and can be adopted by the Company either retrospectively or as a cumulative-effect adjustment as of the date of adoption. We are currently evaluating the effect that adopting this new accounting guidance will have on our consolidated results of operations, cash flows and financial position.

In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, an amendment to FASB ASC Topic 205, Presentation of Financial Statements, and FASB ASC Topic 360, Property, Plant and Equipment. The update revises the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity's operations and financial results, removing the lack of continuing involvement criteria and requiring discontinued operations reporting for the disposal of an equity method investment that meets the definition of discontinued operations. The update also requires expanded disclosures for discontinued operations, including disclosure of pretax profit or loss of an individually significant component of an entity that does not qualify for discontinued operations reporting. This ASU is effective for us prospectively beginning in fiscal 2015, with early adoption permitted.

Table of Contents

In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward or Tax Credit Carryforward Exists. This update provides that an entity is required to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. If a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The provisions of this update were effective February 2, 2014 for the Company and were applied prospectively. The implementation of this guidance resulted in a reclassification as of the end of the second quarter of 2014 of $44 million between Deferred taxes and Other liabilities and did not have a significant impact on the Company's results of operations, cash flows, financial position, or disclosures.

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

J. C. Penney Company, Inc. is a holding company whose principal operating subsidiary is J. C. Penney Corporation, Inc. (JCP). JCP was incorporated in Delaware in 1924, and J. C. Penney Company, Inc. was incorporated in Delaware in 2002, when the holding company structure was implemented. The holding company has no independent assets or operations and no direct subsidiaries other than JCP. The holding company and its consolidated subsidiaries, including JCP, are collectively referred to in this quarterly report as “we,” “us,” “our,” “ourselves” or the “Company,” unless otherwise indicated.

The holding company is a co-obligor (or guarantor, as appropriate) regarding the payment of principal and interest on JCP’s outstanding debt securities. The guarantee of certain of JCP’s outstanding debt securities by the holding company is full and unconditional.

This discussion is intended to provide information that will assist the reader in understanding our financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, how operating results affect the financial condition and results of operations of our Company as a whole, as well as how certain accounting principles affect the financial statements. It should be read in conjunction with our consolidated financial statements as of February 1, 2014, and for the year then ended, and related Notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), all contained in the Annual Report on Form 10-K for the fiscal year ended February 1, 2014 (2013 Form 10-K). Unless otherwise indicated, all references to earnings/(loss) per share (EPS) are on a diluted basis and all references to years relate to fiscal years rather than to calendar years.

Second Quarter Summary and Key Developments


▪	For the second quarter of 2014, sales were $2,799 million, an increase of 5.1% as compared to the corresponding quarter in 2013. Comparable store sales increased 6.0% for the second quarter of 2014. The increase in sales for the period was a result of our efforts to re-merchandise many areas of the store and our new marketing campaign.


▪	For the second quarter of 2014, gross margin as a percentage of sales increased to 36.0% compared to 29.6% in the same period last year and was positively impacted by better clearance sales performance.


▪	Selling, general and administrative (SG&A) expenses decreased $62 million, or 6.0%, for the second quarter of 2014 as compared to the corresponding quarter in 2013. These savings were primarily driven by lower store expenses, advertising and corporate overhead as well as improved credit income from the JCPenney private label credit card activities.


▪	In the second quarter of 2014, we recognized a tax benefit of $4 million, reflecting a significant reduction in tax benefits typically recognized from federal and state loss carryforwards due to the recognition of a net $28 million tax valuation allowance during the quarter, which negatively impacted EPS by $0.09.


▪	For the second quarter of 2014, our net loss was $172 million, or $0.56 per share, compared to a net loss of $586 million, or $2.66 per share, for the corresponding prior year quarter. Results for this quarter included the following amounts that are not directly related to our ongoing core business operations:


▪	$5 million, or $0.02 per share, of restructuring and management transition charges;


▪	$4 million, or $0.02 per share, of income from our qualified defined benefit pension plan (Primary Pension Plan);


▪	$9 million, or $0.03 per share, for the net gain on the sale of non-operating assets;


▪	$43 million, or $0.14 per share, for our proportional share of net income from our joint venture formed to develop the excess property adjacent to our home office facility in Plano, Texas (Home Office Land Joint Venture); and


▪	$5 million, or $0.02 per share, of tax benefit that resulted from our other comprehensive income allocation, related to the Primary Pension Plan, between our operating loss and the amortization of net actuarial losses and prior service credits from Accumulated other comprehensive income.


▪	On June 20, 2014, J. C. Penney Company, Inc., JCP and J. C. Penney Purchasing Corporation (Purchasing) entered into a $2,350 million asset-based senior credit facility (2014 Credit Facility), comprised of a $1,850 million revolving line of credit (Revolving Facility) and a $500 million term loan (2014 Term Loan).

Table of Contents

Results of Operations



	Three Months Ended						Six Months Ended
($ in millions, except EPS)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Total net sales	$	2,799		$	2,663		$	5,600		$	5,298
Percent increase/(decrease) from prior year	5.1		%	(11.9		)%	5.7		%	(14.2		)%
Comparable store sales increase/(decrease)⁽¹⁾	6.0		%	(11.5		)%	6.6		%	(14.3		)%
Gross margin	1,008			787			1,934			1,599
Operating expenses/(income):
Selling, general and administrative	964			1,026			1,973			2,104
Primary pension plan	(4		)	25			(9		)	50
Supplemental pension plans	6			9			12			18
Total pension	2			34			3			68
Depreciation and amortization	160			143			318			279
Real estate and other, net	(53		)	(68		)	(70		)	(90		)
Restructuring and management transition	5			47			27			119
Total operating expenses	1,078			1,182			2,251			2,480
Operating income/(loss)	(70		)	(395		)	(317		)	(881		)
Adjusted operating income/(loss) (non-GAAP)⁽²⁾	(121		)	(385		)	(363		)	(774		)
Loss on extinguishment of debt	—			114			—			114
Net interest expense	106			95			203			156
Income/(loss) before income taxes	(176		)	(604		)	(520		)	(1,151		)
Income tax expense/(benefit)	(4		)	(18		)	4			(217		)
Net income/(loss)	$	(172	)	$	(586	)	$	(524	)	$	(934	)
EBITDA (non-GAAP)⁽²⁾	$	90		$	(252	)	$	1		$	(602	)
Adjusted EBITDA (non-GAAP)⁽²⁾	$	39		$	(242	)	$	(45	)	$	(495	)
Adjusted net income/(loss) (non-GAAP)⁽²⁾	$	(228	)	$	(477	)	$	(581	)	$	(766	)
Diluted EPS	$	(0.56	)	$	(2.66	)	$	(1.72	)	$	(4.24	)
Adjusted diluted EPS (non-GAAP)⁽²⁾	$	(0.75	)	$	(2.16	)	$	(1.90	)	$	(3.48	)
Ratios as a percent of sales:
Gross margin	36.0		%	29.6		%	34.5		%	30.2		%
SG&A	34.4		%	38.5		%	35.2		%	39.7		%
Total operating expenses	38.5		%	44.4		%	40.2		%	46.8		%
Operating income/(loss)	(2.5		)%	(14.8		)%	(5.7		)%	(16.6		)%
Adjusted operating income/(loss) (non-GAAP)⁽²⁾	(4.3		)%	(14.5		)%	(6.5		)%	(14.6		)%

(1)

Comparable store sales include sales from all stores that have been open for 12 consecutive full fiscal months and Internet sales through jcp.com. Stores closed for an extended period are not included in comparable store sales calculations, while stores remodeled and minor expansions not requiring store closure remain in the calculations. Beginning in the first quarter of 2014, the Company simplified its comparable store sales calculation to better reflect year-over-year comparability. Certain items, such as sales return estimates and store liquidation sales, are now excluded from the Company’s calculation. Prior periods have been adjusted to reflect this new methodology.


(2)	See “Non-GAAP Financial Measures” below for a discussion of this non-GAAP measure and reconciliation to its most directly comparable GAAP financial measure and further information on its uses and limitations.

Non-GAAP Financial Measures

We report our financial information in accordance with generally accepted accounting principles in the United States (GAAP). However, we present certain financial measures and ratios identified as non-GAAP under the rules of the Securities and Exchange Commission (SEC) to assess our results. We believe the presentation of these non-GAAP financial measures and ratios is useful in order to better understand our financial performance as well as to facilitate the comparison of our results to the results of our peer companies. In addition, management uses these non-GAAP financial measures and ratios to assess the

Table of Contents

results of our operations. It is important to view non-GAAP financial measures in addition to, rather than as a substitute for, those measures and ratios prepared in accordance with GAAP. We have provided reconciliations of the most directly comparable GAAP measures to our non-GAAP financial measures presented.

The following non-GAAP financial measures are adjusted to exclude restructuring and management transition charges, the impact of our Primary Pension Plan, the loss on extinguishment of debt, the net gain on the sale of non-operating assets and the proportional share of net income from the Home Office Land Joint Venture. Unlike other operating expenses, restructuring and management transition charges, the loss on extinguishment of debt, the net gain on the sale of non-operating assets and the proportional share of net income from the Home Office Land Joint Venture are not directly related to our ongoing core business operations. Primary Pension Plan expense/(income) is determined using numerous complex assumptions about changes in pension assets and liabilities that are subject to factors beyond our control, such as market volatility. Accordingly, we eliminate our Primary Pension Plan expense/(income) in its entirety as we view all components of net periodic benefit expense/(income) as a single, net amount, consistent with its presentation in our Consolidated Financial Statements. We believe it is useful for investors to understand the impact of restructuring and management transition charges, Primary Pension Plan expense/(income), the loss on extinguishment of debt, the net gain on the sale of non-operating assets and the proportional share of net income from the Home Office Land Joint Venture on our financial results and therefore are presenting the following non-GAAP financial measures: (1) adjusted operating income/(loss); (2) adjusted earnings before net interest expense, income tax (benefit)/expense and depreciation and amortization (adjusted EBITDA); (3) adjusted net income/(loss); and (4) adjusted diluted EPS.

In addition, we believe that EBITDA is a useful measure in assessing our operating performance and are therefore presenting this non-GAAP financial measure in addition to the non-GAAP financial measures listed above.

Adjusted Operating Income/(Loss). The following table reconciles operating income/(loss), the most directly comparable GAAP financial measure, to adjusted operating income/(loss), a non-GAAP financial measure:



	Three Months Ended						Six Months Ended
($ in millions)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Operating income/(loss)	$	(70	)	$	(395	)	$	(317	)	$	(881	)
As a percent of sales	(2.5		)%	(14.8		)%	(5.7		)%	(16.6		)%
Add: Restructuring and management transition charges	5			47			27			119
Add: Primary pension plan expense/(income)	(4		)	25			(9		)	50
Less: Net gain on sale of non-operating assets	(9		)	(62		)	(21		)	(62		)
Less: Proportional share of net income from joint venture	(43		)	—			(43		)	—
Adjusted operating income/(loss) (non-GAAP)	$	(121	)	$	(385	)	$	(363	)	$	(774	)
As a percent of sales	(4.3		)%	(14.5		)%	(6.5		)%	(14.6		)%

Table of Contents

EBITDA and Adjusted EBITDA. The following table reconciles net income/(loss), the most directly comparable GAAP measure, to EBITDA and adjusted EBITDA, non-GAAP financial measures:



	Three Months Ended						Six Months Ended
($ in millions)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Net income/(loss)	$	(172	)	$	(586	)	$	(524	)	$	(934	)
Add: Net interest expense	106			95			203			156
Add: Loss on extinguishment of debt	—			114			—			114
Total net interest	106			209			203			270
Add: Income tax expense/(benefit)	(4		)	(18		)	4			(217		)
Add: Depreciation and amortization	160			143			318			279
EBITDA (non-GAAP)	90			(252		)	1			(602		)
Add: Restructuring and management transition charges	5			47			27			119
Add: Primary pension plan expense/(income)	(4		)	25			(9		)	50
Less: Net gain on the sale of non-operating assets	(9		)	(62		)	(21		)	(62		)
Less: Proportional share of net income from joint venture	(43		)	—			(43		)	—
Adjusted EBITDA (non-GAAP)	$	39		$	(242	)	$	(45	)	$	(495	)

Adjusted Net Income/(Loss) and Adjusted Diluted EPS. The following table reconciles net income/(loss) and diluted EPS, the most directly comparable GAAP financial measures, to adjusted net income/(loss) and adjusted diluted EPS, non-GAAP financial measures:



	Three Months Ended								Six Months Ended
($ in millions, except per share data)	August 2, 2014				August 3, 2013				August 2, 2014				August 3, 2013
Net income/(loss)	$	(172	)		$	(586	)		$	(524	)		$	(934	)
Diluted EPS	$	(0.56	)		$	(2.66	)		$	(1.72	)		$	(4.24	)
Add: Restructuring and management transition charges, net of tax of $-, $-, $- and $28	5			⁽¹⁾	47			⁽¹⁾	27			⁽¹⁾	91			⁽²⁾
Add: Primary pension plan expense/(income), net of tax of $-, $-, $- and $10	(4		)	⁽³⁾	25			⁽³⁾	(9		)	⁽³⁾	40			⁽⁴⁾
Add: Loss on extinguishment of debt, net of tax of $-, $-, $- and $-	—				114			⁽¹⁾	—				114			⁽¹⁾
Less: Net gain on sale of non-operating assets, net of tax of $-, $1, $- and $1 ⁽⁵⁾	(9		)		(61		)		(21		)		(61		)
Less: Net gain from fringe land joint venture, net of tax of $-, $-, $- and $-	(43		)	⁽¹⁾	—				(43		)	⁽¹⁾	—
Less: Tax benefit resulting from other comprehensive income allocation for the primary pension plan⁽⁶⁾	(5		)		(16		)		(11		)		(16		)
Adjusted net income/(loss) (non-GAAP)	$	(228	)		$	(477	)		$	(581	)		$	(766	)
Adjusted diluted EPS (non-GAAP)	$	(0.75	)		$	(2.16	)		$	(1.90	)		$	(3.48	)


(1)	Reflects no tax effect due to the impact of the Company's tax valuations allowance.


(2)	For the three months ended May 4, 2013, tax effect was calculated using the Company's statutory rate of 38.82%. The three months ended August 3, 2013, reflects no tax effect due to the impact of the Company's tax valuation allowance.


(3)	The tax effect was included in the line item Tax benefit resulting from other comprehensive income allocation. See footnote 6 below.


(4)	For the three months ended May 4, 2013, tax effect was calculated using the Company’s statutory rate of 38.82%. Tax benefit for the three months ended August 3, 2013 is included in the line item Tax benefit resulting from other comprehensive income allocation. See footnote 6 below.


(5)	Tax effect represented state taxes payable in separately filing states related to the sale of the non-operating assets.


(6)	Tax benefit that resulted from our other comprehensive income allocation between our operating loss and the amortization of net actuarial losses and prior service credits from Accumulated other comprehensive income.

Table of Contents

Total Net Sales



	Three Months Ended						Six Months Ended
($ in millions)	August 2, 2014			August 3, 2013			August 2, 2014			August 3, 2013
Total net sales	$	2,799		$	2,663		$	5,600		$	5,298
Sales percent increase/(decrease):
Total net sales	5.1		%	(11.9		)%	5.7		%	(14.2		)%
Comparable store sales ⁽¹⁾	6.0		%	(11.5		)%	6.6		%	(14.3		)%


(1)	Beginning in the first quarter of 2014, the Company simplified its comparable store sales calculation to better reflect year-over-year comparability. Certain items, such as sales return estimates and store liquidation sales, are now excluded from the Company’s calculation. Prior periods have been adjusted to reflect this new methodology.

Total net sales increased $136 million in the second quarter of 2014 compared to the second quarter of 2013. For the first six months of 2014, total net sales increased $302 million from the same period last year. The following table provides the components of the net sales increase:



	Three Months Ended			Six Months Ended
($ in millions)	August 2, 2014			August 2, 2014
Comparable store sales increase/(decrease)	$	156		$	346
New and closed stores, net	(33		)	(28		)
Other revenues and sales adjustments	13			(16		)
Total net sales increase/(decrease)	$	136		$	302

Store Count

The following table compares the number of stores and gross selling space for the three and six months ended August 2, 2014 and August 3, 2013:



	Three Months Ended		Six Months Ended
	August 2, 2014	August 3, 2013	August 2, 2014	August 3, 2013
JCPenney department stores
Beginning of period