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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 November 3, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 1-15274
 jcpenneylogo2a13.jpg
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)

(972) 431-1000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x No  ¨
Indicate by check mark whether the registrant 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
Accelerated filer   ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨
Emerging growth company ¨
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ¨
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. 315,398,817 shares of Common Stock of 50 cents par value, as of November 23, 2018.


J. C. PENNEY COMPANY, INC.
FORM 10-Q
For the Quarterly Period Ended November 3, 2018
INDEX

 
 
 
Page
 
 
 
 

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Part I. Financial Information
Item 1. Unaudited Interim Consolidated Financial Statements

J. C. PENNEY COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
(In millions, except per share data)
November 3,
2018
 
October 28,
2017
 
November 3,
2018
 
October 28,
2017
 
 
 
As Adjusted
 
 
 
As Adjusted
Total net sales
$
2,653

 
$
2,817

 
$
7,999

 
$
8,503

Credit income and other
80

 
69

 
234

 
235

Total revenues
2,733

 
2,886

 
8,233

 
8,738

 
 
 
 
 
 
 
 
Costs and expenses/(income):
 
 
 
 
 
 
 
Cost of goods sold (exclusive of depreciation and amortization shown separately below)
1,808

 
1,859

 
5,351

 
5,516

Selling, general and administrative (SG&A)
883

 
920

 
2,589

 
2,793

Depreciation and amortization
138

 
131

 
419

 
420

Real estate and other, net
(7
)
 
2

 
(13
)
 
(135
)
Restructuring and management transition
11

 
52

 
20

 
175

Total costs and expenses
2,833

 
2,964

 
8,366

 
8,769

Operating income/(loss)
(100
)
 
(78
)
 
(133
)
 
(31
)
Other components of net periodic pension cost/(income)
(19
)
 
(2
)
 
(57
)
 
90

(Gain)/loss on extinguishment of debt
—

 
—

 
23

 
35

Net interest expense
78

 
78

 
235

 
244

Income/(loss) before income taxes
(159
)
 
(154
)
 
(334
)
 
(400
)
Income tax expense/(benefit)
(8
)
 
(29
)
 
(4
)
 
(40
)
Net income/(loss)
$
(151
)
 
$
(125
)
 
$
(330
)
 
$
(360
)
Earnings/(loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.48
)
 
$
(0.40
)
 
$
(1.05
)
 
$
(1.16
)
Diluted
$
(0.48
)
 
$
(0.40
)
 
$
(1.05
)
 
$
(1.16
)
Weighted average shares – basic
316.3

 
311.6

 
315.3

 
310.6

Weighted average shares – diluted
316.3

 
311.6

 
315.3

 
310.6

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



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J. C. PENNEY COMPANY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
($ in millions)
November 3,
2018
 
October 28,
2017
 
November 3,
2018
 
October 28,
2017
 
 
 
As Adjusted
 
 
 
As Adjusted
Net income/(loss)
$
(151
)
 
$
(125
)
 
$
(330
)
 
$
(360
)
Other comprehensive income/(loss), net of tax:
 
 
 
 
 
 
 
Retirement benefit plans
 
 
 
 
 
 
 
Net actuarial gain/(loss) arising during the period (1)
—

 
31

 
—

 
36

Reclassification for amortization of prior service (credit)/cost (2)
1

 
1

 
3

 
3

Net curtailment gain (3)
—

 
—

 
—

 
20

Net settlement gain (4)
—

 
8

 
—

 
8

Cash flow hedges
 
 
 
 
 
 
 
Gain/(loss) on interest rate swaps (5)
5

 
4

 
10

 
(2
)
Reclassification for periodic settlements (6)
—

 
1

 
—

 
5

Foreign currency translation
 
 
 
 
 
 
 
Unrealized (gain)/loss
—

 
(2
)
 
—

 
—

Total other comprehensive income/(loss), net of tax
6

 
43

 
13

 
70

Total comprehensive income/(loss), net of tax
$
(145
)
 
$
(82
)
 
$
(317
)
 
$
(290
)
See the accompanying notes to the unaudited Interim Consolidated Financial Statements.

(1)
Net of $(24) million and $(28) million in tax in the three and nine months ended October 28, 2017, respectively.                
(2)
Net of $(1) million and $(3) million in tax in the three and nine months ended November 3, 2018, respectively. Net of $(2) million in tax in the nine months ended October 28, 2017. Pre-tax amounts of $2 million and $6 million in the three and nine months ended November 3, 2018, respectively, and pre-tax amounts of $1 million and $5 million in the three and nine months ended October 28, 2017, respectively, were recognized in Other components of net periodic pension cost/(income) in the Consolidated Statements of Operations.
(3)
Net of $(11) million in tax in the nine months ended October 28, 2017. Pre-tax prior service cost of $5 million related to the curtailment is included in Other components of net periodic pension cost/(income) in the Consolidated Statements of Operations in the nine months ended October 28, 2017.
(4)
Net of $(4) million of tax in the three and nine months ended October 28, 2017. Pre-tax amounts of $12 million in the three and nine months ended October 28, 2017, respectively, were recognized in Other components of net periodic pension cost/(income) in the Consolidated Statements of Operations.
(5)
Net of $(1) million and $(2) million of tax in the three and nine months ended November 3, 2018, respectively, and net of $(1) million and $2 million of tax in the three and nine months ended October 28, 2017, respectively.
(6)
Net of $(1) million and $(3) million of tax in the three and nine months ended October 28, 2017, respectively, and $2 million and $8 million in pre-tax amounts for the three and nine months ended October 28, 2017, respectively, were recognized in Net interest expense in the Consolidated Statements of Operations.

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J. C. PENNEY COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
 
November 3,
2018
 
October 28,
2017
 
February 3,
2018
(In millions, except per share data)
(Unaudited)
 
(Unaudited)
 
 
 
 
 
As Adjusted
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash in banks and in transit
$
157

 
$
175

 
$
116

Cash short-term investments
11

 
10

 
342

Cash and cash equivalents
168

 
185

 
458

Merchandise inventory
3,223

 
3,406

 
2,803

Prepaid expenses and other
224

 
243

 
190

Total current assets
3,615

 
3,834

 
3,451

Property and equipment (net of accumulated depreciation of $3,371, $3,463 and $3,500)
4,005

 
4,316

 
4,281

Prepaid pension
100

 
3

 
61

Other assets
695

 
632

 
661

Total Assets
$
8,415

 
$
8,785

 
$
8,454

Liabilities and Stockholders’ Equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Merchandise accounts payable
$
1,234

 
$
1,342

 
$
973

Other accounts payable and accrued expenses
960

 
1,081

 
1,156

Current portion of capital leases, financing obligation and note payable
8

 
8

 
8

Current maturities of long-term debt
92

 
232

 
232

Total current liabilities
2,294

 
2,663

 
2,369

Long-term capital leases, financing obligation and note payable
206

 
214

 
212

Long-term debt
4,161

 
4,039

 
3,780

Deferred taxes
138

 
201

 
143

Other liabilities
542

 
574

 
567

Total Liabilities
7,341

 
7,691

 
7,071

Stockholders’ Equity
 
 
 
 
 
Common stock(1)
158

 
156

 
156

Additional paid-in capital
4,711

 
4,701

 
4,705

Reinvested earnings/(accumulated deficit)
(3,448
)
 
(3,360
)
 
(3,118
)
Accumulated other comprehensive income/(loss)
(347
)
 
(403
)
 
(360
)
Total Stockholders’ Equity
1,074

 
1,094

 
1,383

Total Liabilities and Stockholders’ Equity
$
8,415

 
$
8,785

 
$
8,454


(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 315.4 million, 311.1 million and 312.0 million as of November 3, 2018, October 28, 2017 and February 3, 2018, respectively.
See the accompanying notes to the unaudited Interim Consolidated Financial Statements.


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J. C. PENNEY COMPANY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
(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 3, 2018 - As Adjusted
312.0


$
156

 
$
4,705

 
$
(3,118
)
 
$
(360
)
 
$
1,383

Net income/(loss)
—

 
—

 
—

 
(78
)
 
—

 
(78
)
Other comprehensive income/(loss)
—

 
—

 
—

 
—

 
6

 
6

Stock-based compensation and other
2.3

 
1

 
3

 
—

 
—

 
4

May 5, 2018
314.3

 
$
157

 
$
4,708

 
$
(3,196
)
 
$
(354
)
 
$
1,315

Net income/(loss)
—

 
—

 
—

 
(101
)
 
—

 
(101
)
Other comprehensive income/(loss)
—

 
—

 
—

 
—

 
1

 
1

Stock-based compensation and other
0.5

 
—

 
1

 
—

 
—

 
1

August 4, 2018
314.8

 
$
157

 
$
4,709

 
$
(3,297
)
 
$
(353
)
 
$
1,216

Net income/(loss)
—

 
—

 
—

 
(151
)
 
—

 
(151
)
Other comprehensive income/(loss)
—

 
—

 
—

 
—

 
6

 
6

Stock-based compensation and other
0.6

 
1

 
2

 
—

 
—

 
3

November 3, 2018
315.4

 
$
158

 
$
4,711

 
$
(3,448
)
 
$
(347
)
 
$
1,074


(In millions)
Number of Common Shares
 
Common Stock
 
Additional Paid-in Capital
 
Reinvested Earnings/(Accumulated Deficit)
 
Accumulated Other Comprehensive Income/(Loss)
 
Total Stockholders' Equity
January 28, 2017 - As Adjusted
308.3

 
$
154

 
$
4,679

 
$
(3,000
)
 
$
(473
)
 
$
1,360

Net income/(loss)
—

 
—

 
—

 
(187
)
 
—

 
(187
)
Other comprehensive income/(loss)
—

 
—

 
—

 
—

 
25

 
25

Stock-based compensation and other
1.5

 
1

 
5

 
—

 
—

 
6

April 29, 2017 - As Adjusted
309.8

 
$
155

 
$
4,684

 
$
(3,187
)
 
$
(448
)
 
$
1,204

Net income/(loss)
—

 
—

 
—

 
(48
)
 
—

 
(48
)
Other comprehensive income/(loss)
—

 
—

 
—

 
—

 
2

 
2

Stock-based compensation and other
0.5

 
—

 
10

 
—

 
—

 
10

July 29, 2017 - As Adjusted
310.3

 
$
155

 
$
4,694

 
$
(3,235
)
 
$
(446
)
 
$
1,168

Net income/(loss)
—

 
—

 
—

 
(125
)
 
—

 
(125
)
Other comprehensive income/(loss)
—

 
—

 
—

 
—

 
43

 
43

Stock-based compensation and other
0.8

 
1

 
7

 
—

 
—

 
8

October 28, 2017 - As Adjusted
311.1

 
$
156

 
$
4,701

 
$
(3,360
)
 
$
(403
)
 
$
1,094

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


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J. C. PENNEY COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
($ in millions)
November 3,
2018
 
October 28,
2017
 
 
 
As Adjusted
Cash flows from operating activities
 
 
 
Net income/(loss)
$
(330
)
 
$
(360
)
Adjustments to reconcile net income/(loss) to net cash provided by/(used in) operating activities:
 
 
 
Restructuring and management transition
(3
)
 
72

Asset impairments and other charges
53

 
7

Net gain on sale of operating assets
(58
)
 
(119
)
(Gain)/loss on extinguishment of debt
23

 
35

Depreciation and amortization
419

 
420

Benefit plans
(56
)
 
95

Stock-based compensation
9

 
23

Deferred taxes
(9
)
 
(49
)
Change in cash from:
 
 
 
Inventory
(420
)
 
(510
)
Prepaid expenses and other
(37
)
 
(66
)
Merchandise accounts payable
261

 
365

Income taxes
(2
)
 
3

Accrued expenses and other
(161
)
 
(99
)
Net cash provided by/(used in) operating activities
(311
)
 
(183
)
Cash flows from investing activities
 
 
 
Capital expenditures
(321
)
 
(287
)
Net proceeds from sale of operating assets
132

 
153

Joint venture return of investment
3

 
9

Insurance proceeds received for damage to property and equipment
1

 
—

Net cash provided by/(used in) investing activities
(185
)
 
(125
)
Cash flows from financing activities
 
 
 
Proceeds from issuance of long-term debt
400

 
—

Proceeds from borrowings under the credit facility
3,466

 
521

Payments of borrowings under the credit facility
(3,029
)
 
(310
)
Premium on early retirement of debt
(20
)
 
(30
)
Payments of capital leases, financing obligation and note payable
(6
)
 
(14
)
Payments of long-term debt
(597
)
 
(552
)
Financing costs
(7
)
 
(9
)
Proceeds from stock issued under stock plans
2

 
4

Tax withholding payments for vested restricted stock
(3
)
 
(4
)
Net cash provided by/(used in) financing activities
206

 
(394
)
Net increase/(decrease) in cash and cash equivalents
(290
)
 
(702
)
Cash and cash equivalents at beginning of period
458

 
887

Cash and cash equivalents at end of period
$
168

 
$
185

 
 
 
 
Supplemental cash flow information
 
 
 
Income taxes received/(paid), net
$
(7
)
 
$
(6
)
Interest received/(paid), net
(242
)
 
(247
)
Supplemental non-cash investing and financing activity
 
 
 
Increase/(decrease) in other accounts payable related to purchases of property and equipment and software
(29
)
 
2


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

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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 3, 2018 (2017 Form 10-K). We follow substantially the same accounting policies to prepare quarterly financial statements as are followed in preparing annual financial statements. A description of such significant accounting policies is included in the 2017 Form 10-K. The February 3, 2018 financial information was derived from the audited Consolidated Financial Statements, with related footnotes, included in the 2017 Form 10-K. Because of the seasonal nature of the retail business, operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.
Fiscal Year
Our fiscal year ends on the Saturday closest to January 31. As used herein, “three months ended November 3, 2018” and “third quarter of 2018” refers to the 13-week period ended November 3, 2018, and “three months ended October 28, 2017” and “third quarter of 2017” refers to the 13-week period ended October 28, 2017. "Nine months ended November 3, 2018" and "nine months ended October 28, 2017" refer to the 39-week periods ended November 3, 2018 and October 28, 2017, respectively. Fiscal year 2018 contains 52 weeks, and fiscal year 2017 contains 53 weeks.
Basis of Consolidation
All significant inter-company transactions and balances have been eliminated in consolidation. Certain reclassifications were made to prior period amounts to conform to the current period presentation.

2. Changes in Accounting for Revenue Recognition and Retirement-Related Benefits
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) Topic 606 (ASC 606), Revenue from Contracts with Customers, a replacement of Revenue Recognition (Topic 605). The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We have adopted the new standard using the full retrospective approach on February 4, 2018, and with such adoption our revenue recognition policies related to gift card breakage, customer loyalty programs, credit card income and principal versus agent considerations were changed. Whereas we previously recognized gift card breakage, net of required escheatment, 60 months after the gift card was issued, we now recognize gift card breakage, net of required escheatment, over the redemption pattern of gift cards. Additionally, whereas we utilized the incremental cost method to account for our customer loyalty programs, we now account for our customer loyalty programs as revenue and are required to defer a portion of our sales to loyalty rewards to be earned by reward members for a future discount on a future sale.

We also changed the classification of profit sharing income earned in connection with our private label credit card and co-branded MasterCard® programs owned and serviced by Synchrony Financial (Synchrony).  Under our agreement with Synchrony, we receive cash payments from Synchrony based upon the performance of the credit card portfolios.  Previously,

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the income we earned under our agreement with Synchrony was included as an offset to SG&A expenses. In connection with the adoption of the new standard, we changed our presentation to include such income in a separate line item described as Credit income and other. Further, we adjusted our principal versus agent considerations for certain contracts and where we previously considered ourselves to be the agent (report net sales) under these contracts based on the risk and rewards of the arrangement, we now consider ourselves to be the principal (report gross sales) based on our control of the good or service before it is transferred to the customer. Lastly, we changed our balance sheet presentation of our sales return liability and where we previously reflected the balance as a net liability, we now recognize a gross refund liability for the sales amounts expected to be refunded to customers and an asset for the recoverable cost of the merchandise expected to be returned by customers.

In March 2017, the FASB issued Accounting Standards Update (ASU) 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. ASU 2017-07 requires companies to present the service cost component of net periodic pension cost in the same line items in which they report compensation cost. Companies will present all other components of net periodic pension cost outside of operating income, if this subtotal is presented. As required by the standard, we retrospectively adopted ASU 2017-07 on February 4, 2018, and we changed the presentation of our Consolidated Statement of Operations to exclude the Pension line item and to reflect the service cost component of our pension expense/(income) in SG&A and to reflect all other cost components in a new separate line item below operating income/(loss) described as Other components of net periodic pension cost/(income).
These changes have been reported through retrospective application of the new policies to all periods presented. The impacts of all adjustments made to the financial statements are summarized below:
Consolidated Statements of Operations
 
Three Months Ended
 
Nine Months Ended
 
October 28, 2017
 
October 28, 2017
($ in millions, except per share data)
Previously Reported
 
As Adjusted
 
Effect of Change
 
Previously Reported
 
As Adjusted
 
Effect of Change
Total net sales
$
2,807

 
$
2,817

 
$
10

 
$
8,475

 
$
8,503

 
$
28

Credit income and other
—

 
69

 
69

 
—

 
235

 
235

Cost of goods sold (exclusive of depreciation and amortization)
1,852

 
1,859

 
7

 
5,498

 
5,516

 
18

Selling, general and administrative (SG&A)
840

 
920

 
80

 
2,525

 
2,793

 
268

Pension
9

 
—

 
(9
)
 
3

 
—

 
(3
)
Restructuring and management transition
52

 
52

 
—

 
295

 
175

 
(120
)
Operating income/(loss)
(79
)
 
(78
)
 
1

 
(131
)
 
(31
)
 
100

Other components of net periodic pension cost/(income)
—

 
(2
)
 
(2
)
 
—

 
90

 
90

Income/(loss) before income taxes
(157
)
 
(154
)
 
3

 
(410
)
 
(400
)
 
10

Net income/(loss)
$
(128
)
 
$
(125
)
 
$
3

 
$
(370
)
 
$
(360
)
 
$
10

Basic earnings/(loss) per common share
$
(0.41
)
 
$
(0.40
)
 
$
0.01

 
$
(1.19
)
 
$
(1.16
)
 
$
0.03

Diluted earnings/(loss) per common share
$
(0.41
)
 
$
(0.40
)
 
$
0.01

 
$
(1.19
)
 
$
(1.16
)
 
$
0.03

Consolidated Statements of Comprehensive Income/(Loss)
 
Three Months Ended
 
Nine Months Ended
 
October 28, 2017
 
October 28, 2017
($ in millions)
Previously Reported
 
As Adjusted
 
Effect of Change
 
Previously Reported
 
As Adjusted
 
Effect of Change
Net income/(loss)
$
(128
)
 
$
(125
)
 
$
3

 
$
(370
)
 
$
(360
)
 
$
10


8
Table of Contents

Consolidated Balance Sheets
 
October 28, 2017
 
February 3, 2018
($ in millions)
Previously Reported
 
As Adjusted
 
Effect of Change
 
Previously Reported
 
As Adjusted
 
Effect of Change
Merchandise inventory
$
3,365

 
$
3,406

 
$
41

 
$
2,762

 
$
2,803

 
$
41

Other accounts payable and accrued expenses
1,056

 
1,081

 
25

 
1,119

 
1,156

 
37

Reinvested earnings/(accumulated deficit)
(3,376
)
 
(3,360
)
 
16

 
(3,122
)
 
(3,118
)
 
4

Consolidated Statements of Cash Flows
 
Nine Months Ended
 
October 28, 2017
($ in millions)
Previously Reported
 
As Adjusted
 
Effect of Change
Cash flows from operating activities:
 
 
 
 
 
Net income/(loss)
$
(370
)
 
$
(360
)
 
$
10

Inventory
(511
)
 
(510
)
 
1

Accrued expenses and other
(88
)
 
(99
)
 
(11
)

3. Effect of New Accounting Standards
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force) (ASU 2016-15). ASU 2016-15 clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods therein. Entities should apply the guidance retrospectively, but if it is impracticable to do so for an issue, the amendments related to that issue may be applied prospectively. We have adopted ASU 2016-15 on February 4, 2018 and it did not have a significant impact on our accounting and disclosures.
In February 2016, the FASB issued ASC Topic 842, Leases (Topic 842), a replacement of Leases (Topic 840) and updated by various targeted improvements, which will require lessees to recognize most leases on their balance sheets as lease liabilities with corresponding right-of-use assets. While many aspects of lessor accounting would remain the same, the new standard would make some changes, such as eliminating today’s real estate-specific guidance. As a globally converged standard, lessees and lessors would be required to classify most leases using a principle generally consistent with that of International Accounting Standards. The standard also would change what would be considered the initial direct costs of a lease. The standard would be effective for annual periods beginning after December 15, 2018 and interim periods within that year and must be adopted by a modified retrospective method, with elective reliefs, which requires application of the new guidance for all periods presented, or by an optional transition method, which would allow the application of current legacy guidance, including its disclosure requirements, in the comparative periods presented in the year of adoption. The Company plans to use the optional transition method when adopting the new standard.

We have developed a project team to analyze the impacts of the new standard on our current accounting policies and internal controls and the changes required to be made by our leasing software provider. With almost 70% of our store locations involved in an operating lease, the new standard will have a significant impact on our financial statements due to the recognition of lease liabilities and right-of-use assets that are not required by the current accounting requirements for operating leases. Given the magnitude of the project to implement the new standard, we are still evaluating the effect that the new accounting guidance will have on our financial condition, results of operations and cash flows.

4. Revenue

Our contracts with customers primarily consist of sales of merchandise and services at the point of sale, sales of gift cards to a customer for a future purchase, customer loyalty rewards that provide discount rewards to customers based on purchase activity, and certain licensing and profit sharing arrangements involving the use of our intellectual property by others.

9
Table of Contents

Revenue includes Total net sales and Credit income and other. Net sales are categorized by merchandise and service sale groupings as we believe it best depicts the nature, amount, timing and uncertainty of revenue and cash flow.

The following table provides the components of Net sales for the three and nine months ended November 3, 2018 and October 28, 2017:
 
Three Months Ended
 
Nine Months Ended
($ in millions)
November 3, 2018
 
October 28, 2017
 
November 3, 2018
 
October 28, 2017
 
 
 
 
 
As Adjusted
 
 
 
 
 
As Adjusted
Women’s apparel
$
597

 
23
%
 
$
610

 
22
%
 
$
1,905

 
24
%
 
$
2,036

 
24
%
Men’s apparel and accessories
552

 
21
%
 
571

 
20
%
 
1,615

 
20
%
 
1,718

 
20
%
Home
357

 
13
%
 
414

 
15
%
 
1,073

 
13
%
 
1,204

 
14
%
Women’s accessories, including Sephora
329

 
12
%
 
364

 
13
%
 
1,029

 
13
%
 
1,086

 
13
%
Children’s, including toys
280

 
11
%
 
307

 
11
%
 
728

 
9
%
 
780

 
9
%
Footwear and handbags
236

 
9
%
 
258

 
9
%
 
676

 
8
%
 
741

 
9
%
Jewelry
139

 
5
%
 
129

 
4
%
 
451

 
6
%
 
437

 
5
%
Services and other
163

 
6
%
 
164

 
6
%
 
522

 
7
%
 
501

 
6
%
Total net sales
$
2,653

 
100
%
 
$
2,817

 
100
%
 
$
7,999

 
100
%
 
$
8,503

 
100
%
Credit income and other encompasses the revenue earned from the agreement with Synchrony associated with our private label credit card and co-branded MasterCard® programs.
Merchandise and Service Sales
Total net sales, which exclude sales taxes and are net of estimated returns, are generally recorded when payment is received and the customer takes control of the merchandise. Service revenue is recorded at the time the customer receives the benefit of the service, such as salon, portrait, optical or custom decorating. Shipping and handling fees charged to customers are also included in total net sales with corresponding costs recorded as cost of goods sold. Net sales are not recognized for estimated future returns which are estimated based primarily on historical return rates and sales levels.

Gift Card Revenue
At the time gift cards are sold a performance obligation is created and no revenue is recognized; rather, a contract liability is established for our obligation to provide a merchandise or service sale to the customer for the face value of the card. The contract liability is relieved and a net sale is recognized when gift cards are redeemed for merchandise or services. We recognize gift card breakage, net of required escheatment, over the redemption pattern of gift cards. Breakage is estimated based on historical redemption patterns and the estimates can vary based on changes in the usage patterns of our customers.

Customer Loyalty Rewards
Customers who spend a certain amount with us using our private label card or registered loyalty card receive points that can accumulate towards earning JCPenney Rewards certificates which are redeemable for a discount on future purchases. Points earned by a loyalty customer do not expire but any certificates earned expire two months from the date of issuance. We account for our customer loyalty rewards by deferring a portion of our sales to loyalty points expected to be earned towards a reward certificate, and then recognize the reward certificate as a net sale when used by the customer in connection with a merchandise or service sale. The points earned toward a future reward are valued at their relative standalone selling price by applying fair value based on historical redemption patterns.

The liabilities related to our gift cards and our customer loyalty program are included in Other accounts payable and accrued expenses in the unaudited Interim Consolidated Balance Sheets and constitute our contract liability. The balance of these liabilities were as follows:
(in millions)
November 3, 2018
 
October 28, 2017
 
February 3, 2018
Gift cards
$
111

 
$
110

 
$
144

Loyalty rewards
60

 
73

 
73

Total contract liability
$
171

 
$
183

 
$
217


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Contract liability includes consideration received for gift card and loyalty related performance obligations which have not been satisfied as of a given date.

A rollforward of the amounts included in contract liability for the first nine months of 2018 and 2017 are as follows:
(in millions)
2018
 
2017
Beginning balance
$
217

 
$
228

Current period gift cards sold and loyalty reward points earned
232

 
289

Net sales from amounts included in contract liability opening balances
(75
)
 
(89
)
Net sales from current period usage
(203
)
 
(245
)
Ending balance
$
171

 
$
183


Licensing Agreements
Our private label credit card and co-branded MasterCard® programs are owned and serviced by Synchrony.  Under our agreement with Synchrony, we receive periodic cash payments from Synchrony based upon the consumer's usage of co-branded card and the performance of the credit card portfolio. We participate in the programs by providing marketing promotions designed to increase the use of each card, including enhanced marketing offers for cardholders. Additionally, we accept payments in our stores from cardholders who prefer to pay in person when they are shopping in our locations. Revenue related to this agreement is recognized over the time we have fulfilled our deliverables and is reflected in Credit income and other.

Principal Versus Agent
We assess principal versus agent considerations depending on our control of the good or service before it is transferred to the customer. When we are the principal and have control of the specified good or service, we include as a net sale the gross amount of consideration to which we expect to be entitled for that specified good or service in revenue. In contrast, when we are the agent and do not have control of the specified good or service, we include as a net sale the fee or commission to which we expect to be entitled for the agency service. In certain instances, the fee or commission might be the net amount retained after paying the supplier.

5. Earnings/(Loss) per Share
Net income/(loss) and shares used to compute basic and diluted earnings/(loss) per share (EPS) are reconciled below:
 
Three Months Ended
 
Nine Months Ended
(in millions, except per share data)
November 3,
2018
 
October 28,
2017
 
November 3,
2018
 
October 28,
2017
Earnings/(loss)
 
 
 
 
 
 
 
Net income/(loss)
$
(151
)
 
$
(125
)
 
$
(330
)
 
$
(360
)
Shares
 
 
 
 
 
 
 
Weighted average common shares outstanding (basic shares)
316.3


311.6

 
315.3

 
310.6

Adjustment for assumed dilution:
 
 
 
 
 
 
 
Stock options, restricted stock awards and warrant
—

 
—

 
—

 
—

Weighted average shares assuming dilution (diluted shares)
316.3

 
311.6

 
315.3

 
310.6

EPS
 
 
 
 
 
 
 
Basic
$
(0.48
)
 
$
(0.40
)
 
$
(1.05
)
 
$
(1.16
)
Diluted
$
(0.48
)
 
$
(0.40
)
 
$
(1.05
)
 
$
(1.16
)




11
Table of Contents

The following average potential shares of common stock were excluded from the diluted EPS calculation because their effect would have been anti-dilutive: 
 
Three Months Ended
 
Nine Months Ended
(Shares in millions)
November 3,
2018
 
October 28,
2017
 
November 3,
2018
 
October 28,
2017
Stock options, restricted stock awards and warrant
22.9

 
32.1

 
25.8

 
32.9


6. Long-Term Debt
($ in millions)
 
November 3, 2018
 
October 28, 2017
 
February 3, 2018
Issue:
 
 
 
 
 
 
5.75% Senior Notes Due 2018 (1)
 
$
—

 
$
190

 
$
190

8.125% Senior Notes Due 2019 (1)
 
50

 
175

 
175

5.65% Senior Notes Due 2020 (1)
 
110

 
400

 
360

2017 Credit Facility (Matures in 2022)
 
437

 
211

 
—

2016 Term Loan Facility (Matures in 2023)
 
1,593

 
1,635

 
1,625

5.875% Senior Secured Notes Due 2023 (1)
 
500

 
500

 
500

7.125% Debentures Due 2023
 
10

 
10

 
10

8.625% Senior Secured Second Priority Notes Due 2025 (1)
 
400

 
—

 
—

6.9% Notes Due 2026
 
2

 
2

 
2

6.375% Senior Notes Due 2036 (1)
 
388

 
388

 
388

7.4% Debentures Due 2037
 
313

 
313

 
313

7.625% Notes Due 2097
 
500

 
500

 
500

Total debt
 
4,303

 
4,324

 
4,063

Unamortized debt issuance costs
 
(50
)
 
(53
)
 
(51
)
Less: current maturities
 
(92
)
 
(232
)
 
(232
)
Total long-term debt
 
$
4,161

 
$
4,039

 
$
3,780


(1)
These debt issuances contain a change of control provision that would obligate us, at the holders’ option, to repurchase the debt at a price of 101%.
On March 12, 2018, JCP issued $400 million aggregate principal amount of senior secured second priority notes with a 8.625% interest rate (the "Notes"). The Notes are due in 2025 and are guaranteed, jointly and severally, by the Company and certain domestic subsidiaries of JCP that guarantee the Company's senior secured term loan facility and existing senior secured notes. The net proceeds from the Notes were used for the tender consideration for JCP's contemporaneous cash tender offers for $125 million aggregate principal amount of its 8.125% Senior Notes Due 2019 and $250 million aggregate principal amount of its 5.65% Senior Notes Due 2020 (collectively, the Securities). In doing so, we recognized a loss on extinguishment of debt of $23 million which includes the premium paid over the face value of the accepted Securities of $20 million, reacquisition costs of $1 million and the write off of unamortized debt issuance costs of $2 million.
As of November 3, 2018, outstanding borrowings under our $2.35 billion senior secured asset-based revolving credit facility (2017 Credit Facility) were $437 million. All borrowings under the 2017 Credit Facility accrue interest at a rate equal to, at the Company’s option, a base rate or an adjusted LIBOR rate plus a spread.
7. Derivative Financial Instruments

We use derivative financial instruments for hedging and non-trading purposes to manage our exposure to changes in interest rates. Use of derivative financial instruments in hedging programs subjects us to certain risks, such as market and credit risks. Market risk represents the possibility that the value of the derivative instrument will change. In a hedging relationship, the change in the value of the derivative is offset to a great extent by the change in the value of the underlying hedged item. Credit risk related to derivatives represents the possibility that the counterparty will not fulfill the terms of the contract. The notional,

12
Table of Contents

or contractual, amount of our derivative financial instruments is used to measure interest to be paid or received and does not represent our exposure due to credit risk. Credit risk is monitored through established approval procedures, including setting concentration limits by counterparty, reviewing credit ratings and requiring collateral (generally cash) from the counterparty when appropriate.

When we use derivative financial instruments for the purpose of hedging our exposure to interest rates, the contract terms of a hedged instrument closely mirror those of the hedged item, providing a high degree of risk reduction and correlation. Contracts that are effective at meeting the risk reduction and correlation criteria are recorded using hedge accounting. If a derivative instrument is a hedge, depending on the nature of the hedge, changes in the fair value of the instrument will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or be recognized in Accumulated other comprehensive income/(loss) until the hedged item is recognized in earnings. The ineffective portion of an instrument’s change in fair value will be immediately recognized in earnings during the period. Instruments that do not meet the criteria for hedge accounting, or contracts for which we have not elected to apply hedge accounting, are valued at fair value with unrealized gains or losses reported in earnings during the period of change.

We have entered into interest rate swap agreements with notional amounts totaling $1,250 million to fix a portion of our variable LIBOR-based interest payments. The interest rate swap agreements have a weighted-average fixed rate of 2.04%, mature on May 7, 2020 and have been designated as cash flow hedges. On September 4, 2018 we entered into additional interest rate swap agreements with notional amounts totaling $750 million to fix a portion of our variable LIBOR-based interest payments. The interest rate swap agreements have a weighted-average fixed rate of 3.135%, have an effective date from May 7, 2020 to May 7, 2025 and have been designated as cash flow hedges.

The fair value of our interest rate swaps are recorded on the unaudited Interim Consolidated Balance Sheets as an asset or a liability (see Note 9). The effective portion of the interest rate swaps' changes in fair values is reported in Accumulated other comprehensive income/(loss) (see Note 10), and the ineffective portion is reported in Net income/(loss). Amounts in Accumulated other comprehensive income/(loss) are reclassified into Net income/(loss) when the related interest payments affect earnings. For the periods presented, all of the interest rate swaps were 100% effective.
Information regarding the gross amounts of our derivative instruments in the unaudited Interim Consolidated Balance Sheets is as follows:
 
Asset Derivatives at Fair Value
 
Liability Derivatives at Fair Value
($ in millions)
Balance Sheet Location
 
November 3, 2018
 
October 28, 2017
 
February 3, 2018
 
Balance Sheet Location
 
November 3, 2018
 
October 28, 2017
 
February 3, 2018
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
Prepaid expenses and other
 
$
1

 
$
—

 
$
—

 
Other accounts payable and accrued expenses
 
$
—

 
$
2

 
$
1

Interest rate swaps
Other assets
 
23

 
—

 
9

 
Other liabilities
 
—

 
5

 
—

Total derivatives designated as hedging instruments
 
 
$
24

 
$
—

 
$
9

 
 
 
$
—

 
$
7

 
$
1

8. Restructuring and Management Transition

In the first quarter of 2017, the Company finalized plans to close 138 stores to help align the Company's brick-and-mortar presence with its omnichannel network, thereby redirecting capital resources to invest in locations and initiatives that offer the greatest revenue potential. The store closures resulted in a $77 million asset impairment charge for store assets with limited future use and a $14 million severance charge for the expected displacement of store associates. During the three months ended October 28, 2017, $52 million in store related closing and other costs such as certain lease obligations were recorded as a result of each respective store ceasing operations.

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Table of Contents

The components of Restructuring and management transition include:
•
Home office and stores — charges for actions to reduce our store and home office expenses including employee termination benefits, store lease termination and impairment charges;
•
Management transition — charges related to implementing changes within our management leadership team for both incoming and outgoing members of management; and
•
Other — charges related primarily to contract termination costs and costs related to the closure of certain supply chain locations.
The composition of Restructuring and management transition charges was as follows: 
 
Three Months Ended
 
Nine Months Ended
 
Cumulative
Amount From Program Inception Through
November 3, 2018
($ in millions)
November 3,
2018
 
October 28,
2017
 
November 3,
2018
 
October 28,
2017
 
Home office and stores
$
2

 
$
52

 
$
11

 
$
173

 
$
484

Management transition
9

 
—

 
9

 
—

 
9

Other
—

 
—

 
—

 
2

 
185

Total
$
11

 
$
52

 
$
20

 
$
175

 
$
678


Activity for the Restructuring and management transition liability for the nine months ended November 3, 2018 was as follows:
($ in millions)
Home Office
and Stores
 
Management
Transition
 
Other
 
Total
February 3, 2018
$
34

 
$
—

 
$
7

 
$
41

Charges
14

 
9

 
—

 
23

Cash payments
(30
)
 
(2
)
 
(4
)
 
(36
)
November 3, 2018
$
18

 
$
7

 
$
3

 
$
28


9. Fair Value Disclosures
In determining fair value, the accounting standards establish a three level hierarchy for inputs used in measuring fair value, as follows:

•
Level 1 — Quoted prices in active markets for identical assets or liabilities.
•
Level 2 — Significant observable inputs other than quoted prices in active markets for similar assets and liabilities, such as quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
•
Level 3 — Significant unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants.
Cash Flow Hedges Measured on a Recurring Basis
As of November 3, 2018, October 28, 2017 and February 3, 2018, the $23 million, $(5) million and $9 million fair value of our cash flow hedges, respectively, are valued in the market using discounted cash flow techniques which use quoted market interest rates in discounted cash flow calculations which consider the instrument's term, notional amount, discount rate and credit risk. Significant inputs to the derivative valuation for interest rate swaps are observable in the active markets and are classified as Level 2 in the fair value measurement hierarchy.
Other Non-Financial Assets Measured on a Non-Recurring Basis
In connection with the Company announcing its plan to close underperforming department stores in 2017, long-lived assets held and used with a carrying value of $86 million were written down to their fair value of $9 million, resulting in asset

14
Table of Contents

impairment charges of $77 million in the nine months ended October 28, 2017. The fair value was determined based on comparable market values of similar properties or on a rental income approach and the significant inputs related to valuing the store related assets are classified as Level 2 in the fair value measurement hierarchy.

In connection with the Company's decision to sell its three airplanes, long-lived assets held and used with a carrying value of $72 million were written down to their fair value of $20 million, resulting in asset impairment charges of $52 million in the nine months ended November 3, 2018. The fair value was determined based on dealer quotes using a market approach and the significant inputs related to valuing the airplanes are classified as Level 2 in the fair value measurement hierarchy.

Other Financial Instruments
Carrying values and fair values of financial instruments that are not carried at fair value in the unaudited Interim Consolidated Balance Sheets are as follows: 
 
November 3, 2018
 
October 28, 2017
 
February 3, 2018
($ in millions)
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Total debt, excluding unamortized debt issuance costs, capital leases, financing obligation and note payable
$
4,303

 
$
3,157

 
$
4,324

 
$
3,683

 
$
4,063

 
$
3,607

The fair value of long-term debt was estimated by obtaining quotes from brokers or was based on current rates offered for similar debt. As of November 3, 2018, October 28, 2017 and February 3, 2018, the fair values of cash and cash equivalents and accounts payable approximated their carrying values due to the short-term nature of these instruments.
Concentrations of Credit Risk
We have no significant concentrations of credit risk.

10. Accumulated Other Comprehensive Income/(Loss)

The following tables show the changes in accumulated other comprehensive income/(loss) balances for the nine months ended November 3, 2018 and the nine months ended October 28, 2017:
($ in millions)
Net  Actuarial
Gain/(Loss)
 
Prior Service
Credit/(Cost)
 
Foreign Currency Translation
 
Gain/(Loss) on Cash Flow Hedges
 
Accumulated
Other
Comprehensive
Income/(Loss)
February 3, 2018
$
(330
)
 
$
(26
)
 
$
—

 
$
(4
)
 
$
(360
)
Other comprehensive income/(loss) before reclassifications
—

 
—

 
—

 
10

 
10

Amounts reclassified from accumulated other comprehensive income
—

 
3

 
—

 
—

 
3

November 3, 2018
$
(330
)
 
$
(23
)
 
$
—

 
$
6

 
$
(347
)
($ in millions)
Net  Actuarial
Gain/(Loss)
 
Prior Service
Credit/(Cost)
 
Foreign Currency Translation
 
Gain/(Loss) on Cash Flow Hedges
 
Accumulated
Other
Comprehensive
Income/(Loss)
January 28, 2017
$
(421
)
 
$
(33
)
 
$
(2
)
 
$
(17
)
 
$
(473
)
Other comprehensive income/(loss) before reclassifications
53

 
—

 
—

 
(2
)
 
51

Amounts reclassified from accumulated other comprehensive income
8

 
6

 
—

 
5

 
19

October 28, 2017
$
(360
)
 
$
(27
)
 
$
(2
)
 
$
(14
)
 
$
(403
)


15
Table of Contents

11. Retirement Benefit Plans
The components of net periodic pension expense/(income) for our non-contributory qualified defined benefit pension plan and supplemental pension plans were as follows:
 
Three Months Ended
 
Nine Months Ended
($ in millions)
November 3,
2018
 
October 28,
2017
 
November 3,
2018
 
October 28,
2017
Service cost
$
9

 
$
11

 
$
28

 
$
32

 
 
 
 
 
 
 
 
Other components of net periodic pension cost/(income):
 
 
 
 
 
 
 
Interest cost
34

 
38

 
104

 
114

Expected return on plan assets
(55
)
 
(53
)
 
(167
)
 
(160
)
Amortization of prior service cost/(credit)
2

 
1

 
6

 
5

Settlement expense
—

 
12

 
—

 
12

Curtailment (gain)/loss recognized
—

 
—

 
—

 
7

Special termination benefit recognized
—

 
—

 
—

 
112

 
(19
)
 
(2
)
 
(57
)
 
90

Net periodic pension expense/(income)
$
(10
)
 
$
9

 
$
(29
)
 
$
122


Service cost is included in SG&A in the unaudited Interim Consolidated Statements of Operations.

In the first quarter of 2017, the Company initiated a Voluntary Early Retirement Program (VERP) for approximately 6,000 eligible associates. Eligibility for the VERP included home office, stores and supply chain personnel who met certain criteria related to age and years of service as of January 31, 2017. Based on the approximately 2,800 associates who elected to accept the VERP, we incurred a total charge of $112 million for special retirement benefits. The special retirement benefits increased the projected benefit obligation (PBO) of the qualified defined benefit pension plan (Primary Pension Plan) and the supplemental pension plans by $88 million and $24 million, respectively. In addition, we incurred curtailment charges of $7 million related to our pension plans as a result of the reduction in the expected years of future service related to these plans. As a result of these curtailments, the assets and the liabilities for our Primary Pension Plan and the liabilities of certain supplemental pension plans were remeasured as of March 31, 2017. The discount rate used for the March 31 remeasurements was 4.34% compared to the year-end 2016 discount rate of 4.40%. These events resulted in the PBO of our Primary Pension Plan decreasing by $3 million and the related assets increasing by $34 million and the PBO of our supplemental pension plans increasing by $3 million. The funded status of the Primary Pension Plan was 98% as of the remeasurement date.

During the third quarter of 2017, we recognized settlement expense of $12 million due to higher lump-sum payment activity to retirees primarily as a result of the VERP executed earlier in the year. The lump-sum payments reduced our pension obligation by $195 million. Following these payments and the completion of a remeasurement of plan assets and liabilities, the plan's funded status was 100% as of October 28, 2017. The discount rate used for the remeasurement as of October 28, 2017 was 3.94% compared to the year-end 2016 discount rate of 4.40%.

12. Real Estate and Other, Net
Real estate and other consists of ongoing operating income from our real estate subsidiaries. Real estate and other also includes net gains from the sale of facilities and equipment that are no longer used in operations, asset impairments, accruals for certain litigation and other non-operating charges and credits. In addition, we entered into a joint venture in 2014 in which we contributed approximately 220 acres of excess property adjacent to our home office facility in Plano, Texas (Home Office Land Joint Venture). The joint venture was formed to develop the contributed property and our proportional share of the joint venture's activities is recorded in Real estate and other, net. During the three months ended November 3, 2018, we sold our interest to the other partner and are no longer a member of the joint venture.


16
Table of Contents

The composition of Real estate and other, net was as follows:
 
Three Months Ended
 
Nine Months Ended
($ in millions)
November 3,
2018
 
October 28,
2017
 
November 3,
2018
 
October 28,
2017
Investment income from Home Office Land Joint Venture
$
(3
)
 
$
(3
)
 
$
(4
)
 
$
(23
)
Net gain from sale of operating assets
(1
)
 
(1
)
 
(58
)
 
(119
)
Impairments
—

 
—

 
52

 
—

Other
(3
)
 
6

 
(3
)
 
7

Total expense/(income)
$
(7
)
 
$
2

 
$
(13
)
 
$
(135
)

Investment Income from Joint Ventures
During the three and nine months ended November 3, 2018, the Company had income of $3 million and $4 million, respectively, related to its proportional share of the net income in the Home Office Land Joint Venture and received aggregate cash distributions of $3 million and $4 million, respectively. During the three and nine months ended October 28, 2017, the Company had income of $3 million and $23 million, respectively, related to its proportional share of the net income in the Home Office Land Joint Venture and received aggregate cash distributions of $3 million and $31 million, respectively. Additionally, during the three months ended November 3, 2018, we received $3 million in proceeds from the partner to buy out our remaining interest in the joint venture.

Net Gain from Sale of Operating Assets
During the first quarter of 2018, we completed the sale-leaseback of our Milwaukee, Wisconsin distribution facility for a net sale price of $30 million and recognized a net gain of $12 million. During the second quarter of 2018, we completed the sale of our Manchester, Connecticut distribution facility for a net sale price of $68 million and recognized a net gain of $38 million. During the first quarter of 2017, we completed the sale of our Buena Park, California distribution facility for a net sale price of $131 million and recorded a net gain of $111 million.

Impairments
During the second quarter of 2018, we recorded an impairment charge of $52 million related to the expected sale of three airplanes. Two of the airplanes were sold during the second quarter of 2018 at their fair value of $12 million. During the third quarter of 2018, the third airplane was sold at its fair value of $8 million.

13. Income Taxes
The net tax benefit of $8 million for the three months ended November 3, 2018 consisted of federal, state and foreign tax benefits of $2 million, a $2 million benefit relating to other comprehensive income and a $5 million benefit due to the release of valuation allowance, offset by $1 million of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets.
The net tax benefit of $4 million for the nine months ended November 3, 2018 consisted of federal, state and foreign tax expenses of $3 million, $3 million of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets and $1 million of net tax expense resulting from enacted state law changes, offset by a $5 million benefit relating to other comprehensive income, a $5 million benefit due to the release of valuation allowance and a net tax benefit of $1 million resulting from state audit settlements.
As of November 3, 2018, we have approximately $2.4 billion of net operating losses (NOLs) available for U.S. federal income tax purposes, which largely expire in 2032 through 2034 and $60 million of tax credit carryforwards that expire at various dates through 2037. A valuation allowance of $578 million (restated for the tax effects of revenue recognition) fully offsets the federal deferred tax assets resulting from the NOL and tax credit carryforwards that expire at various dates through 2037. A valuation allowance of $257 million fully offsets the deferred tax assets resulting from the state NOL carryforwards that expire at various dates through 2037. In assessing the need for the valuation allowance, we considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets. As a result of our periodic assessment, our estimate of the realization of deferred tax assets is solely based on the future reversals of existing taxable temporary differences and tax planning strategies that we would make use of to accelerate taxable income to utilize expiring NOL and tax credit carryforwards. Accordingly, in the three and nine months ended November 3, 2018, the valuation allowance was increased by

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$35 million and $69 million, respectively, to offset the net deferred tax assets created in the quarter relating primarily to the increase in NOL carryforwards.
14. Litigation and Other Contingencies
Litigation

Shareholder Derivative Litigation

Weitzman/Lipsius. In October 2013, two purported shareholder derivative actions were filed against certain present and former members of the Company’s Board of Directors and executives by the following parties in the U.S. District Court, Eastern District of Texas, Sherman Division: Weitzman (filed October 2, 2013) and Zauderer (filed October 3, 2013). The Company was named as a nominal defendant in both suits. The lawsuits asserted claims for breaches of fiduciary duties and unjust enrichment based upon alleged false and misleading statements and/or omissions regarding the Company’s financial condition. The lawsuits sought unspecified compensatory damages, restitution, disgorgement by the defendants of all profits, benefits and other compensation, equitable relief to reform the Company’s corporate governance and internal procedures, reasonable costs and expenses, and other relief as the court may deem just and proper. On October 28, 2013, the Court consolidated the two cases into the Weitzman lawsuit. Also, in March 2016, plaintiff Frank Lipsius filed a purported shareholder derivative action against certain present and former members of the Company's Board of Directors and executives in the District Court of Collin County in the State of Texas. The Company was named as a nominal defendant in the suit. The suit generally mirrored the allegations contained in the Weitzman and Zauderer suits and sought similar relief. On May 18, 2017, plaintiff in the Lipsius suit voluntarily dismissed the Collin County action, and on May 19, 2017, refiled the action in the District Court of Dallas County, Texas. The parties have settled the Weitzman and Lipsius derivative litigation and the federal court granted final approval of the settlement on September 12, 2018. The state court litigation was dismissed pursuant to the terms of the settlement shortly thereafter.

Rojas. On October 19, 2018, a shareholder of the Company, Juan Rojas, filed a shareholder derivative action against certain present and former members of the Company’s Board of Directors in the Delaware Court of Chancery. The Company is named as a nominal defendant. The lawsuit asserts claims for breaches of fiduciary duties based on alleged failures to prevent the Company from engaging in allegedly unlawful promotional pricing practices. While no assurance can be given as to the ultimate outcome of this matter, we believe that the final resolution of this action will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.

Other Legal Proceedings
The District Attorney’s office for the County of San Joaquin, California, joined by District Attorneys for other counties in California, recently concluded an investigation regarding the handling and disposal at JCP’s California stores and distribution centers of certain materials that may be deemed hazardous or universal waste under California law. On February 21, 2018, the District Attorneys provided a settlement demand to JCP that included a proposed civil penalty, reimbursement of investigation costs, enhancements to JCP’s compliance program and certain injunctive relief. JCP and the District Attorneys have reached an agreement to fully resolve this matter by entering into a stipulation for entry of final judgment and permanent injunction, which was approved by a California court on October 16, 2018.  JCP did not admit to any issue of law or fact, but agreed to pay a civil penalty and to reimburse the government’s enforcement costs. JCP also agreed to invest in enhancements to its compliance program over the next five years.  We do not believe the cost of the settlement and compliance with the final judgment will have a material adverse effect on our results of operations, financial position, liquidity or capital resources.

We are subject to various other legal and governmental proceedings involving routine litigation incidental to our business. Accruals have been established based on our best estimates of our potential liability in certain of these matters, including certain matters discussed above, all of which we believe aggregate to an amount that is not material to the Consolidated Financial Statements. These estimates were developed in consultation with in-house and outside counsel. While no assurance can be given as to the ultimate outcome of these matters, we currently believe that the final resolution of these actions, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.
Contingencies
As of November 3, 2018, we have an estimated accrual of $20 million related to potential environmental liabilities that is recorded in Other accounts payable and accrued expenses and Other liabilities in the unaudited Interim Consolidated Balance Sheet. This estimate covered potential liabilities primarily related to underground storage tanks, remediation of environmental conditions involving our former drugstore locations and asbestos removal in connection with approved plans to renovate or dispose of our facilities. We continue to assess required remediation and the adequacy of environmental reserves as new

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information becomes available and known conditions are further delineated. If we were to incur losses at the estimated amount, we do not believe that such losses would have a material effect on our financial condition, results of operations or liquidity.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
J. C. Penney Company, Inc. is a holding company whose principal operating subsidiary is J. C. Penney Corporation, Inc. (JCP). JCP was incorporated in Delaware in 1924, and J. C. Penney Company, Inc. was incorporated in Delaware in 2002, when the holding company structure was implemented. The holding company has no independent assets or operations and no direct subsidiaries other than JCP. The holding company and its consolidated subsidiaries, including JCP, are collectively referred to in this quarterly report as “we,” “us,” “our,” “ourselves” or the “Company,” unless otherwise indicated.
The holding company is a co-obligor (or guarantor, as appropriate) regarding the payment of principal and interest on JCP’s outstanding debt securities. The guarantee of certain of JCP’s outstanding debt securities by the holding company is full and unconditional.
This discussion is intended to provide information that will assist the reader in understanding our financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, how operating results affect the financial condition and results of operations of our Company as a whole, as well as how certain accounting principles affect the financial statements. It should be read in conjunction with our consolidated financial statements as of February 3, 2018, and for the year then ended, and related Notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), all contained in the Annual Report on Form 10-K for the fiscal year ended February 3, 2018 (2017 Form 10-K). Unless otherwise indicated, all references to earnings/(loss) per share (EPS) are on a diluted basis and all references to years relate to fiscal years rather than to calendar years.

Current Initiatives

While current management reassesses our business strategies, we will continue our focus on the following four initiatives:

•
Beauty;
•
Women's apparel business;
•
Omnichannel; and
•
Home refresh.

First, we will continue to focus on our beauty categories of Sephora, The Salon by InStyle and Fine Jewelry. In 2017, we opened 70 additional Sephora locations, bringing our total number of locations to 642. We added approximately 27 new Sephora locations and intend to continue to roll out and launch new brands in 2018. We are also continuing to rebrand our salons to The Salon by InStyle and plan to modernize and rebrand another 100 salons in 2018. Finally, we intend to continue to enhance our Fine Jewelry offerings to better provide the customer with a total beauty solution. Magnifying the importance of physical stores, we see Sephora, Salon and Fine Jewelry as differentiators to help drive traffic and increase the frequency of visits to our stores.

Second, we will continue to focus on improving our women's apparel offering by strategically adjusting our assortment to better align with customer preferences. Our focus will be in categories that offer the greatest opportunity for growth, particularly special sizes, active wear, dresses, contemporary and casual sportswear. In addition, we are taking steps in women's apparel to simplify the floor, better balance our career and casual offerings and create a stronger value statement with pricing.

Third, we remain committed to becoming a world-class omnichannel retailer. We plan to continue to enhance our site functionality and ship-from-store capabilities and develop additional enhancements to our improved mobile app.

Lastly, we will continue to focus on our home refresh initiative. We have established appliance showrooms in over 600 stores and have increased our mattress offering to approximately 500 in-store showrooms. We see our home refresh initiative as an opportunity for us to increase our revenue per customer.


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Third Quarter Overview
 
▪
Total net sales were $2,653 million with a total net sales decrease of 5.8% compared to the third quarter of 2017 and a comparable store sales decrease of 5.4%.

▪
Credit income and other was $80 million compared to $69 million in last year's third quarter. The increase was due to increased gain share resulting from improved performance of the credit portfolio.

▪
Cost of goods sold, which excludes depreciation and amortization, as a percentage of Total net sales increased to 68.1% compared to 66.0% in the same period last year. The increase as a rate of sales was primarily attributable to the clearance markdowns related to our decision to liquidate slower-moving, excess inventory, during the period.

▪
Selling, general and administrative (SG&A) expenses as a percentage of Total net sales increased to 33.3% for the third quarter of 2018 as compared to 32.7% for the same period last year. The net increase in SG&A expenses as a percentage of Total net sales for the quarter was primarily driven by the decrease in net sales and by higher store controllable costs and marketing spend relative to our sales volume, offset by a reduction in lease expense associated with the amortization of gains on the sales of leasehold interests.

▪
Our net loss was $151 million, or ($0.48) per share, compared to a net loss of $125 million, or ($0.40) per share, for the corresponding prior year quarter. Results for this quarter included the following amounts that are not directly related to our ongoing core business operations:

▪
$11 million, or ($0.03) per share, of restructuring and management transition charges;
▪
$19 million, or $0.06 per share, for other components of net periodic pension income;
▪
$3 million, or $0.01 per share, for our proportional share of net income from our joint venture formed to develop the excess property adjacent to our home office facility in Plano, Texas (Home Office Land Joint Venture); and
▪
$2 million, or $0.01 per share, for the tax benefit resulting from other comprehensive income allocation related to pension and interest rate swap activity.

▪
Adjusted net loss was $164 million, or ($0.52) per share, compared to an adjusted net loss of $108 million, or ($0.35) per share, in last year's third quarter. See the reconciliation of net income/(loss) and diluted EPS, the most directly comparable generally accepted accounting principles (GAAP) financial measures, to adjusted net income/(loss) and adjusted diluted EPS on page 27.

▪
Adjusted earnings before interest expense, income tax (benefit)/expense and depreciation and amortization (Adjusted EBITDA) (non-GAAP) was $46 million, a $56 million decline from the same period last year. See the reconciliation of net income/(loss), the most directly comparable GAAP financial measure, to Adjusted EBITDA on page 26.

▪
We completed a multi-year extension of our private-label and co-branded credit card agreement with Synchrony Bank. The amended and restated agreement provides for improved alignment with respect to the marketing and servicing alliance of the program.

▪
Effective October 15, 2018, the Board of Directors elected Jill Soltau as Chief Executive Officer of the Company.

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Results of Operations
 
Three Months Ended
 
Nine Months Ended
 
($ in millions, except EPS)
November 3,
2018
 
October 28,
2017
(1) 
November 3,
2018
 
October 28,
2017
(1) 
Total net sales
$
2,653

 
$
2,817

 
$
7,999

 
$
8,503

 
Credit income and other
80

 
69

 
234

 
235

 
Total revenues
2,733

 
2,886

 
8,233

 
8,738

 
Total net sales increase/(decrease) from prior year
(5.8
)%
 
(1.8
)%
 
(5.9
)%
 
(1.3
)%
 
Comparable store sales increase/(decrease) (2)
(5.4
)%
 
1.7
 %
 
(1.7
)%
 
(1.0
)%
 
 
 
 
 
 
 
 
 
 
Costs and expenses/(income):
 
 
 
 
 
 
 
 
Cost of goods sold (exclusive of depreciation and amortization shown separately below)
1,808

 
1,859

 
5,351

 
5,516

 
Selling, general and administrative
883

 
920

 
2,589

 
2,793

 
Depreciation and amortization
138

 
131

 
419

 
420

 
Real estate and other, net
(7
)
 
2

 
(13
)
 
(135
)
 
Restructuring and management transition
11

 
52

 
20

 
175

 
Total costs and expenses
2,833

 
2,964

 
8,366

 
8,769

 
Operating income/(loss)
(100
)
 
(78
)
 
(133
)
 
(31
)
 
Other components of net periodic pension cost/(income)
(19
)
 
(2
)
 
(57
)
 
90

 
(Gain)/loss on extinguishment of debt
—

 
—

 
23

 
35

 
Net interest expense
78

 
78

 
235

 
244

 
Income/(loss) before income taxes
(159
)
 
(154
)
 
(334
)
 
(400
)
 
Income tax expense/(benefit)
(8
)
 
(29
)
 
(4
)
 
(40
)
 
Net income/(loss)
$
(151
)
 
$
(125
)
 
$
(330
)
 
$
(360
)
 
Adjusted EBITDA (non-GAAP) (3)
$
46

 
$
102

 
$
302

 
$
541

 
Adjusted net income/(loss) (non-GAAP) (3)
$
(164
)
 
$
(108
)
 
$
(353
)
 
$
(129
)
 
Diluted EPS
$
(0.48
)
 
$
(0.40
)
 
$
(1.05
)
 
$
(1.16
)
 
Adjusted diluted EPS (non-GAAP) (3)
$
(0.52
)
 
$
(0.35
)
 
$
(1.12
)
 
$
(0.42
)
 
Ratios as a percent of total net sales:
 
 
 
 
 
 
 
 
Cost of goods sold
68.1
 %
 
66.0
 %
 
66.9