Table of Contents

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 1, 2014
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
 
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, 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. 304,851,973 shares of Common Stock of 50 cents par value, as of December 5, 2014.



J. C. PENNEY COMPANY, INC.
FORM 10-Q
For the Quarterly Period Ended November 1, 2014
INDEX

 
 
 
Page
 
 
 
 

1

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
 
Nine Months Ended
(In millions, except per share data)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Total net sales
$
2,764

 
$
2,779

 
$
8,364

 
$
8,077

Cost of goods sold
1,751

 
1,960

 
5,417

 
5,659

Gross margin
1,013

 
819

 
2,947

 
2,418

Operating expenses/(income):
 
 
 
 
 
 
 
Selling, general and administrative (SG&A)
988

 
1,006

 
2,961

 
3,110

Pension
1

 
34

 
4

 
102

Depreciation and amortization
156

 
161

 
474

 
440

Real estate and other, net
(90
)
 
(27
)
 
(160
)
 
(117
)
Restructuring and management transition
12

 
46

 
39

 
165

Total operating expenses
1,067

 
1,220

 
3,318

 
3,700

Operating income/(loss)
(54
)
 
(401
)
 
(371
)
 
(1,282
)
Loss on extinguishment of debt
34

 

 
34

 
114

Net interest expense
103

 
99

 
306

 
255

Income/(loss) before income taxes
(191
)
 
(500
)
 
(711
)
 
(1,651
)
Income tax expense/(benefit)
(3
)
 
(11
)
 
1

 
(228
)
Net income/(loss)
$
(188
)
 
$
(489
)
 
$
(712
)
 
$
(1,423
)
Earnings/(loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.62
)
 
$
(1.94
)
 
$
(2.33
)
 
$
(6.17
)
Diluted
$
(0.62
)
 
$
(1.94
)
 
$
(2.33
)
 
$
(6.17
)
Weighted average shares – basic
305.3

 
251.8

 
305.1

 
230.8

Weighted average shares – diluted
305.3

 
251.8

 
305.1

 
230.8

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 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net income/(loss)
$
(188
)
 
$
(489
)
 
$
(712
)
 
$
(1,423
)
Other comprehensive income/(loss), net of tax:
 
 
 
 
 
 
 
Retirement benefit plans
 
 
 
 
 
 
 
Reclassification for amortization of net actuarial (gain)/loss
10

 
26

 
30

 
81

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

 
(1
)
 
(1
)
Total other comprehensive income/(loss), net of tax
9

 
26

 
29

 
80

Total comprehensive income/(loss), net of tax
$
(179
)
 
$
(463
)
 
$
(683
)
 
$
(1,343
)
See the accompanying notes to the unaudited Interim Consolidated Financial Statements.

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J. C. PENNEY COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
 
November 1,
2014
 
November 2,
2013
 
February 1,
2014
(In millions, except per share data)
(Unaudited)
 
(Unaudited)
 
 
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash in banks and in transit
$
141

 
$
151

 
$
113

Cash short-term investments
543

 
1,076

 
1,402

Cash and cash equivalents
684

 
1,227

 
1,515

Merchandise inventory
3,358

 
3,747

 
2,935

Deferred taxes
175

 
119

 
193

Prepaid expenses and other
223

 
249

 
190

Total current assets
4,440

 
5,342

 
4,833

Property and equipment (net of accumulated depreciation of $3,558, $3,178 and $3,315)
5,312

 
5,753

 
5,619

Prepaid pension
695

 
36

 
663

Other assets
718

 
744

 
686

Total Assets
$
11,165

 
$
11,875

 
$
11,801

Liabilities and Stockholders’ Equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Merchandise accounts payable
$
1,289

 
$
1,409

 
$
948

Other accounts payable and accrued expenses
1,163

 
1,269

 
1,198

Short-term borrowings

 
650

 
650

Current portion of capital leases and note payable
30

 
27

 
27

Current maturities of long-term debt
28

 
23

 
23

Total current liabilities
2,510

 
3,378

 
2,846

Long-term capital leases and note payable
40

 
67

 
62

Long-term debt
5,329

 
4,845

 
4,839

Deferred taxes
357

 
250

 
335

Other liabilities
499

 
688

 
632

Total Liabilities
8,735

 
9,228

 
8,714

Stockholders’ Equity
 
 
 
 
 
Common stock(1)
152

 
153

 
152

Additional paid-in capital
4,597

 
4,575

 
4,571

Reinvested earnings/(accumulated deficit)
(1,720
)
 
(1,043
)
 
(1,008
)
Accumulated other comprehensive income/(loss)
(599
)
 
(1,038
)
 
(628
)
Total Stockholders’ Equity
2,430

 
2,647

 
3,087

Total Liabilities and Stockholders’ Equity
$
11,165

 
$
11,875

 
$
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, 304.6 million and 304.6 million as of November 1, 2014November 2, 2013 and February 1, 2014, respectively.
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)
 
Three Months Ended
 
Nine Months Ended
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Cash flows from operating activities
 
 
 
 
 
 
 
Net income/(loss)
$
(188
)
 
$
(489
)
 
$
(712
)
 
$
(1,423
)
Adjustments to reconcile net income/(loss) to net cash provided by/(used in) operating activities:
 
 
 
 
 
 
 
Restructuring and management transition
2

 
48

 
5

 
109

Asset impairments and other charges
5

 
3

 
9

 
12

Net gain on sale of non-operating assets
(2
)
 
(24
)
 
(23
)
 
(86
)
Net gain on sale of operating assets
(90
)
 

 
(91
)
 
(18
)
Loss on extinguishment of debt
34

 

 
34

 
114

Depreciation and amortization
156

 
161

 
474

 
440

Benefit plans
(5
)
 
16

 
(18
)
 
57

Stock-based compensation
8

 
6

 
24

 
22

Deferred taxes
(5
)
 
(14
)
 
(24
)
 
(203
)
Change in cash from:
 
 
 
 
 
 
 
Inventory
(510
)
 
(592
)
 
(423
)
 
(1,406
)
Prepaid expenses and other assets
(15
)
 
(30
)
 
(34
)
 
11

Merchandise accounts payable
305

 
133

 
341

 
247

Current income taxes
2

 
2

 
6

 
62

Accrued expenses and other
(17
)
 
43

 
(22
)
 
(135
)
Net cash provided by/(used in) operating activities
(320
)
 
(737
)
 
(454
)
 
(2,197
)
Cash flows from investing activities
 
 
 
 
 
 
 
Capital expenditures
(61
)
 
(161
)
 
(202
)
 
(814
)
Net proceeds from sale of non-operating assets
2

 
33

 
28

 
88

Net proceeds from sale of operating assets
66

 

 
68

 
19

Joint venture return of investment

 

 
8

 

Net cash provided by/(used in) investing activities
7

 
(128
)
 
(98
)
 
(707
)
Cash flows from financing activities
 
 
 
 
 
 
 
Proceeds from short-term borrowings

 

 

 
850

Payments on short-term borrowings

 
(200
)
 
(650
)
 
(200
)
Net proceeds from issuance of long-term debt
393

 

 
893

 
2,180

Premium on early retirement of debt
(33
)
 

 
(33
)
 
(110
)
Payments of capital leases and note payable
(4
)
 
(5
)
 
(22
)
 
(24
)
Payments of long-term debt
(394
)
 
(5
)
 
(405
)
 
(250
)
Financing costs
(1
)
 
(18
)
 
(61
)
 
(30
)
Net proceeds from common stock issued

 
786

 

 
786

Proceeds from stock options exercised

 

 

 
7

Tax withholding payments for vested restricted stock

 
(1
)
 
(1
)
 
(8
)
Net cash provided by/(used in) financing activities
(39
)
 
557

 
(279
)
 
3,201

Net increase/(decrease) in cash and cash equivalents
(352
)
 
(308
)
 
(831
)
 
297

Cash and cash equivalents at beginning of period
1,036

 
1,535

 
1,515

 
930

Cash and cash equivalents at end of period
$
684

 
$
1,227

 
$
684

 
$
1,227

 
 
 
 
 
 
 
 
Supplemental cash flow information
 
 
 
 
 
 
 
Income taxes received/(paid), net
(1
)
 
(1
)
 
(20
)
 
87

Interest received/(paid), net
(160
)
 
(125
)
 
(343
)
 
(361
)
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
(2
)
 
(53
)
 
(7
)
 
49

Financing costs withheld from proceeds of long-term debt
7

 

 
7

 
70

Purchase of property and equipment and software through capital leases and a note payable

 
1

 
3

 
4

Issuance costs withheld from proceeds of common stock issued

 
24

 

 
24

Return of shares of Martha Stewart Living Omnimedia Inc. previously acquired by the Company

 
36

 

 
36


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

5

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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 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 November 1, 2014” and “three months ended November 2, 2013” refer to the 13-week periods ended November 1, 2014 and November 2, 2013, respectively. “Nine months ended November 1, 2014” and “nine months ended November 2, 2013,” refer to the 39-week periods ended November 1, 2014 and November 2, 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 the 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.

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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
 
Nine Months Ended
(in millions, except per share data)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Earnings/(loss)
 
 
 
 
 
 
 
Net income/(loss)
$
(188
)
 
$
(489
)
 
$
(712
)
 
$
(1,423
)
Shares
 
 
 
 
 
 
 
Weighted average common shares outstanding (basic shares)(1)
305.3


251.8

 
305.1

 
230.8

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

 

 

 

Weighted average shares assuming dilution (diluted shares)
305.3

 
251.8

 
305.1

 
230.8

EPS
 
 
 
 
 
 
 
Basic
$
(0.62
)
 
$
(1.94
)
 
$
(2.33
)
 
$
(6.17
)
Diluted
$
(0.62
)
 
$
(1.94
)
 
$
(2.33
)
 
$
(6.17
)
(1) On October 1, 2013, we issued 84 million shares of common stock with a par value of $0.50 per share.
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 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Stock options, restricted stock awards and warrant
26.9

 
23.9

 
26.1

 
24.6

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, is calculated as 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 third quarter of 2014, we had $499 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 third quarter of 2014, we had $429 million in standby and import letters of credit outstanding under the

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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 Revolving Facility. As of the end of the third quarter of 2014, based on our September 2014 borrowing base, we had $1,421 million available for future borrowing, of which $1,236 million was accessible due to the minimum excess availability threshold.
4. Long-Term Debt
2014 Debt Issuance and Tender Offers
In September 2014, we issued $400 million aggregate principal amount of 8.125% Senior Notes due 2019 and used the majority of the $393 million of proceeds from the offering, net of underwriting discounts, to pay the tender consideration and related transaction fees and expenses for our contemporaneous cash tender offers (2014 Tender Offers) to purchase approximately $327 million aggregate principal amount of the three outstanding series of debt securities described below (collectively, the Securities).
Title of Security
 
Principal Amount Outstanding Prior to 2014 Tender Offers ($ in millions)
 
Tender Premium(1)
 
Principal Amount Tendered ($ in millions)
 
Principal Amount Accepted for Purchase ($ in millions)
 
Principal Amount Outstanding After the 2014 Tender Offers ($ in millions)
6.875% Medium-Term Notes due 2015
 
$
200

 
$
67.50

 
$
140

 
$
140

 
$
60

7.65% Debentures due 2016
 
200

 
105.00

 
122

 
122

 
78

7.95% Debentures due 2017
 
285

 
97.50

 
194

 
65

 
220

Total
 
$
685

 
 
 
$
456

 
$
327

 
$
358

(1)
Per $1,000 principal amount of Securities.
We paid approximately $362 million aggregate consideration, including $6 million of accrued interest, for the accepted Securities in October 2014. The 2014 Tender Offers resulted in a loss on extinguishment of debt of $30 million which includes the premium paid over face value of the accepted Securities of $29 million and reacquisition costs of $1 million.
2014 Debt Defeasance
In October 2014, subsequent to the completion of the 2014 Tender Offers, we deposited approximately $64 million with Wilmington Trust, National Association, as Trustee under the Indenture with respect to our 6.875% Medium-Term Notes due 2015 (2015 Notes), to effect a legal defeasance of the remaining outstanding principal amount of 2015 Notes. As a result of depositing funds with the Trustee sufficient to make all payments of interest and principal on the outstanding 2015 Notes through October 15, 2015, the stated maturity of the 2015 Notes, the Company has satisfied and discharged all of its obligations under the terms of the 2015 Notes and with respect to the 2015 Notes under the Indenture. The defeasance resulted in a loss on extinguishment of debt of $4 million which represents the portion of the deposited funds for future interest payments on the 2015 Notes.

2013 Tender Offer
On April 30, 2013 we announced the commencement of a cash tender offer (2013 Tender Offer) and consent solicitation for our 7.125% Debentures Due 2023 (2023 Notes). We also solicited consents to effect certain proposed amendments to the indenture governing the 2023 Notes (2023 Notes Indenture) that would eliminate most of the restrictive covenants and certain events of default and other provisions in the 2023 Notes Indenture (Proposed Amendments).

On May 22, 2013, we accepted for purchase $243 million in aggregate principal amount of the 2023 Notes, representing 95.41% of the outstanding principal amount, for aggregate tender offer consideration of $352 million. On June 5, 2013, we accepted for purchase an additional $2 million in aggregate principal amount of the 2023 Notes, for aggregate tender offer consideration of $3 million. The 2013 Tender Offer resulted in a loss on the extinguishment of debt of $114 million which includes the premium paid over face value of the accepted 2023 Notes of $110 million, reacquisition costs of $2 million and the write-off of unamortized debt issue costs of $2 million. As a result of receiving the requisite consent of the holders of at least 66 2/3% of aggregate principal amount of 2023 Notes outstanding, the Proposed Amendments were approved and became operative.


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2013 Term Loan Facility
On May 22, 2013, JCP entered into a $2.25 billion five-year senior secured term loan facility (2013 Term Loan Facility). The 2013 Term Loan Facility is guaranteed by J. C. Penney Company, Inc. and certain subsidiaries of JCP, and is secured by mortgages on certain real estate of JCP and the guarantors, in addition to substantially all other assets of JCP and the guarantors. Proceeds of the 2013 Term Loan Facility were used to fund the 2013 Tender Offer and will be used to fund ongoing working capital requirements and general corporate purposes. The 2013 Term Loan Facility bears interest at a rate of LIBOR plus 5.0%. We are required to make quarterly repayments in a principal amount equal to $5.625 million during the five-year term subject to certain reductions for mandatory and optional prepayments.
5. 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)
November 1, 2014
$

 
$

 
$

 
$

November 2, 2013
7

 
32

 

 

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:
 
 
November 1, 2014
 
November 2, 2013
 
February 1, 2014
($ in millions)
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Long-term debt, including current maturities
$
5,357

 
$
4,910

 
$
4,868

 
$
4,252

 
$
4,862

 
$
4,209

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 1, 2014November 2, 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.

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6. Stockholders’ Equity
The following table shows the change in the components of stockholders’ equity for the nine months ended November 1, 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)

 

 

 
(712
)
 

 
(712
)
Other comprehensive income/(loss)

 

 

 

 
29

 
29

Stock-based compensation
0.2

 

 
26

 

 

 
26

November 1, 2014
304.8

 
$
152

 
$
4,597

 
$
(1,720
)
 
$
(599
)
 
$
2,430


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

 
Three Months Ended
 
November 1, 2014
 
November 2, 2013
($ in millions)
Gross
Amount
 
Income
Tax
(Expense)/
Benefit
 
Net
Amount
 
Gross
Amount
 
Income
Tax
(Expense)/
Benefit
 
Net
Amount
REITs
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain/(loss)
$

 
$

 
$

 
$
(1
)
 
$
1

 
$

Retirement benefit plans
 
 
 
 
 
 
 
 
 
 
 
Reclassification for amortization of net actuarial (gain)/loss
16

 
(6
)
 
10

 
43

 
(17
)
 
26

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

 
(1
)
 
(1
)
 
1

 

Total
$
15

 
$
(6
)

$
9

 
$
41

 
$
(15
)
 
$
26


 
Nine Months Ended
 
November 1, 2014
 
November 2, 2013
($ in millions)
Gross
Amount
 
Income
Tax
(Expense)/
Benefit
 
Net
Amount
 
Gross
Amount
 
Income
Tax
(Expense)/
Benefit
 
Net
Amount
REITs
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain/(loss)
$

 
$

 
$

 
$
(1
)
 
$
1

 
$

Retirement benefit plans
 
 
 
 
 
 
 
 
 
 
 
Reclassification for amortization of net actuarial (gain)/loss
49

 
(19
)
 
30

 
$
131

 
(50
)
 
81

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

 
(1
)
 
(2
)
 
1

 
(1
)
Total
$
48

 
$
(19
)
 
$
29

 
$
128

 
$
(48
)
 
$
80




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The following table shows the changes in accumulated other comprehensive income/(loss) balances for the nine months ended November 1, 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
30

 
(1
)
 
29

Net current-period other comprehensive income
30

 
(1
)
 
29

November 1, 2014
$
(579
)
 
$
(20
)
 
$
(599
)

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
 
Nine Months Ended
 
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
 
Amortization of retirement benefit plans
 
 
 
 
 
 
 
 
 
Actuarial loss/(gain)(1)
$
16

 
$
44

 
$
49

 
$
132

 
Pension
Prior service cost/(credit)(1)
1

 
1

 
5

 
4

 
Pension
Actuarial loss/(gain)(1)

 
(1
)
 

 
(1
)
 
SG&A
Prior service cost/(credit)(1)
(2
)
 
(2
)
 
(6
)
 
(6
)
 
SG&A
Tax (expense)/benefit
(6
)
 
(16
)
 
(19
)
 
(49
)
 
Income tax expense/(benefit)
Total, net of tax
9

 
26

 
29

 
80

 
 
Total reclassifications
$
9

 
$
26

 
$
29

 
$
80

 
 
(1)
These accumulated other comprehensive components are included in the computation of net periodic benefits expense/(income). See Note 8 for additional details.

Issuance of Common Stock
On October 1, 2013, we issued 84 million shares of common stock with a par value of $0.50 per share for $9.65 per share for total net proceeds of $786 million after $24 million of fees.

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7. 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 an incoming executive officer of the Company. 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 November 1, 2014, a maximum of 24.0 million shares of stock were available for future grant under the 2014 Plan.
Stock-based compensation expense for the three months ended November 1, 2014 and November 2, 2013 was $10 million and $7 million, respectively. Stock-based compensation expense for the nine months ended November 1, 2014 and November 2, 2013 was $31 million and $39 million, respectively. Through the first nine months of 2014, the Company granted the following stock-based compensation awards:
 
 
Restricted Stock Units (RSU)
 
Stock Options
 
Weighted Average Grant Date Fair Value
Grant Date
 
Time-based
 
Performance-based
 
Performance-based
 
Weighted Average Exercise Price
 
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

August 19, 2014
 
883,000

 

 

 

 
10.25

Total
 
3,626,000

 
329,000

 
2,507,000

 
8.41

 
6.78

(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 $7.61 per share as of November 1, 2014. Compensation expense, which is variable, is recognized over the vesting period with a corresponding liability, which is recorded in Other liabilities in our unaudited Interim Consolidated Balance Sheets. On May 21, 2014, we also granted approximately 157,000 RSUs to directors with a fair value of $8.60 per RSU award. Additionally, on October 9, 2014, we granted approximately 13,000 RSUs to a new director with a fair value of $7.64 per RSU award.


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8. 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
 
Nine Months Ended
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Primary Pension Plan
 
 
 
 
 
 
 
Service cost
$
15

 
$
20

 
$
46

 
$
59

Interest cost
53

 
51

 
158

 
153

Expected return on plan assets
(87
)
 
(85
)
 
(261
)
 
(255
)
Amortization of actuarial loss/(gain)
13

 
38

 
38

 
114

Amortization of prior service cost/(credit)
1

 
1

 
5

 
4

Loss/(gain) on transfer of benefits
6

 

 
6

 

Net periodic benefit expense/(income)
$
1

 
$
25

 
$
(8
)
 
$
75

 
 
 
 
 
 
 
 
Supplemental Pension Plans
 
 
 
 
 
 
 
Service cost
$

 
$

 
$

 
$

Interest cost
3

 
3

 
7

 
9

Amortization of actuarial loss/(gain)
3

 
6

 
11

 
18

Amortization of prior service cost/(credit)

 

 

 

Loss/(gain) on transfer of benefits
(6
)
 

 
(6
)
 

Net periodic benefit expense/(income)
$

 
$
9

 
$
12

 
$
27

 
 
 
 
 
 
 
 
Primary and Supplemental Pension Plans Total
 
 
 
 
 
 
 
Service cost
$
15

 
$
20

 
$
46

 
$
59

Interest cost
56

 
54

 
165

 
162

Expected return on plan assets
(87
)
 
(85
)
 
(261
)
 
(255
)
Amortization of actuarial loss/(gain)
16

 
44

 
49

 
132

Amortization of prior service cost/(credit)
1

 
1

 
5

 
4

Loss/(gain) on transfer of benefits

 

 

 

Net periodic benefit expense/(income)
$
1

 
$
34

 
$
4

 
$
102

 
 
 
 
 
 
 
 
Postretirement Health and Welfare Plan
 
 
 
 
 
 
 
Service cost
$

 
$

 
$

 
$

Interest cost

 
1

 

 
1

Amortization of actuarial loss/(gain)

 
(1
)
 

 
(1
)
Amortization of prior service cost/(credit)
(2
)
 
(2
)
 
(6
)
 
(6
)
Net periodic benefit expense/(income)
$
(2
)
 
$
(2
)
 
$
(6
)
 
$
(6
)
 
 
 
 
 
 
 
 
Retirement Benefit Plans Total
 
 
 
 
 
 
 
Service cost
$
15

 
$
20

 
$
46

 
$
59

Interest cost
56

 
55

 
165

 
163

Expected return on plan assets
(87
)
 
(85
)
 
(261
)
 
(255
)
Amortization of actuarial loss/(gain)
16

 
43

 
49

 
131

Amortization of prior service cost/(credit)
(1
)
 
(1
)
 
(1
)
 
(2
)
Loss/(gain) on transfer of benefits


 

 

 

Net periodic benefit expense/(income)
$
(1
)
 
$
32

 
$
(2
)
 
$
96


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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.
During the third quarter of 2014, we transferred $25 million of supplemental pension plan benefits, as allowed under the Employee Retirement Income Security Act of 1974, out of one of our supplemental pension plans and into our Primary Pension Plan. The transfer did not have a significant impact on our unaudited Interim Consolidated Financial Statements.
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 both of the third quarters of 2014 and 2013 was $12 million and was predominantly included in SG&A expenses in the unaudited Interim Consolidated Statements of Operations. Total expense for the first nine months for both of 2014 and 2013 was $38 million.
9. Restructuring and Management Transition
The composition of restructuring and management transition charges was as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
Cumulative
Amount Through
November 1, 2014
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
 
Home office and stores
$
3

 
$
(6
)
 
$
15

 
$
26

 
$
217

Store fixtures

 
10

 

 
55

 
133

Management transition
7

 
3

 
15

 
32

 
223

Other
2

 
39

 
9

 
52

 
132

Total
$
12

 
$
46

 
$
39

 
$
165

 
$
705


Home Office and Stores
During the nine months ended November 1, 2014 and November 2, 2013, we recorded $15 million and $26 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. Through the first nine months of 2014, we incurred charges of $13 million for employee termination benefits and lease termination costs associated with the closure of those stores. Additionally, we incurred $2 million of other miscellaneous store restructuring costs.

The $32 million of charges through the first half of 2013 were associated with employee termination benefits for both store and home office associates. The $6 million credit for the third quarter of 2013 resulted from termination benefits paid that were lower than expected primarily because employees found other positions within the Company and revisions were made to the restructuring plan.
Store Fixtures
During the three months ended November 2, 2013, we recorded $2 million for the impairment of certain store fixtures related to our former shops strategy that were used in our prototype department store and $8 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 nine months ended November 2, 2013, we recorded $7 million of charges for the write-off of store fixtures related to the renovations in our home department and $37 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 nine months ended November 2, 2013, we recorded $11 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 November 1, 2014 and November 2, 2013, we implemented several changes within our management leadership team that resulted in management transition costs of $7 million and $3 million, respectively, for both incoming and outgoing members of management. During the nine months ended November 1, 2014 and November 2, 2013, we recorded charges of $15 million and $32 million, respectively.
Other
During the three months ended November 1, 2014 and November 2, 2013, we recorded $2 million and $39 million, respectively, of miscellaneous restructuring charges. During the nine months ended November 1, 2014 and November 2, 2013,

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we recorded $9 million and $52 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, including a non-cash charge of $36 million during the third quarter of 2013 relating to the return of shares of Martha Stewart Living Omnimedia Inc. previously acquired by the Company.

Activity for the restructuring and management transition liability for the nine months ended November 1, 2014 was as follows:
 
($ in millions)
Home Office
and Stores
 
Management
Transition
 
Other
 
Total
February 1, 2014
$

 
$
3

 
$
30

 
$
33

Charges
15

 
15

 
9

 
39

Cash payments
(6
)
 
(11
)
 
(21
)
 
(38
)
Non-cash
(2
)
 
(3
)
 

 
(5
)
November 1, 2014
$
7

 
$
4

 
$
18

 
$
29

The non-cash amounts represent charges primarily for stock-based compensation expense in conjunction with accelerated vesting related to terminations and for the write-off of store fixtures.
10. 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 November 1, 2014 and November 2, 2013, Real estate and other, net was income of $90 million and $27 million, respectively. For the nine months ended November 1, 2014 and November 2, 2013, Real estate and other, net was income of $160 million and $117 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 third quarter of 2014, we sold one closed store and one additional property used in our former auto center operations for net proceeds and a gain of $2 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. During the third quarter of 2013, we sold our investment in three joint ventures for $32 million, resulting in a net gain of $23 million and we sold approximately 10 acres of excess land for net proceeds and gain of $1 million.
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 the third quarter of 2014, we sold three department store locations and recognized a net gain on a payment received from a landlord to terminate an existing lease prior to its original expiration date for total net proceeds of $66 million and a net gain of $90 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.


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Table of Contents

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.
11. Income Taxes
Income taxes for the three months ended November 1, 2014 was a benefit of $3 million compared to a benefit of $11 million for the three months ended November 2, 2013. The effective tax rate for the three months ended November 1, 2014 was (1.6)% as compared to (2.2)% for the three months ended November 2, 2013. Income taxes for the nine months ended November 1, 2014 was an expense of $1 million compared to a benefit of $228 million for the nine months ended November 2, 2013. The effective tax rate for the nine months ended November 1, 2014 was 0.1% as compared to (13.8)% for the nine months ended November 2, 2013. Our effective tax rate for the nine months ended November 1, 2014 was impacted by a net increase to the tax valuation allowance for deferred tax assets of $255 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 third 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 $559 million has been recorded against our deferred tax assets as of November 1, 2014, which resulted in an increase to the valuation allowance during the quarter ended November 1, 2014 of $107 million.
The net tax benefit of $3 million for the third quarter of 2014 consisted of state and foreign tax expenses of $1 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 $6 million non-cash benefit relating to other comprehensive income. 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 $6 million in operating results, offset by a $6 million charge to other comprehensive income for the quarter.

The net tax expense of $1 million for the nine months ended November 1, 2014 consisted of a federal audit adjustment of $12 million, state and foreign tax expenses of $6 million and $6 million of expense related to the deferred tax asset change arising from the tax amortization of indefinite-lived intangible assets, offset by a $19 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 $19 million in operating results, offset by a $19 million charge to other comprehensive income for the quarter.
As of November 1, 2014, we have approximately $2.7 billion of net operating losses available for U.S. federal income tax purposes, which expire in 2032 through 2034 and $46 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 $567 million has been recorded, net of a valuation allowance of $393 million. A valuation allowance of $166 million fully offsets the deferred tax assets resulting from the state NOL carryforwards that expire at various dates through 2034.
12. 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

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Table of Contents

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.
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 November 1, 2014, we estimated our total potential environmental liabilities to range from $18 million to $24 million and recorded our best estimate of $20 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 November 1, 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 November 1, 2014, our maximum liability in connection with the assigned leases was $5 million.
13. Effect of New Accounting Standards

In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosures of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU requires management to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued or are available to be issued. This ASU also requires management to disclose certain information depending on the results of the going concern evaluation. The provisions of this ASU are effective for annual periods ending after December 15, 2016, and for interim and annual periods thereafter. Early adoption is permitted. This amendment is applicable to us beginning in the first quarter of 2017. We do not expect the adoption of this standard to have a material impact on our financial condition, results of operations or cash flows.

In June 2014, the FASB issued 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 operations 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

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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 financial condition, results of operations or cash flows.

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.

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 third quarter of 2014 of $46 million between Deferred taxes and Other liabilities and did not have a significant impact on our financial condition, results of operations or cash flows.




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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.

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Third Quarter Summary and Key Developments
 
For the third quarter of 2014, sales were $2,764 million with comparable store sales flat for the third quarter of 2014 and up 4.3% for the first nine months of 2014.

For the third quarter of 2014, gross margin as a percentage of sales increased to 36.6% compared to 29.5% in the same period last year and was positively impacted by a significant improvement in our mix and margin on clearance sales and higher margins on regular and promotional priced merchandise compared to the prior year quarter.

Selling, general and administrative (SG&A) expenses decreased $18 million, or 1.8%, for the third quarter of 2014 as compared to the corresponding quarter in 2013. These savings were primarily driven by lower store expenses and corporate overhead costs.

In the third quarter of 2014, we recognized a tax benefit of $3 million, reflecting a significant reduction in tax benefits typically recognized from federal and state loss carryforwards due to the recognition of a net $107 million tax valuation allowance during the quarter, which negatively impacted EPS by $0.35.

For the third quarter of 2014, earnings before interest expense, income tax (benefit)/expense and depreciation and amortization (EBITDA) was $102 million, a $342 million improvement from the same period last year. EBITDA for the quarter included a gain of $88 million related to the sale of certain store assets.

For the third quarter of 2014, our net loss was $188 million, or $0.62 per share, compared to a net loss of $489 million, or $1.94 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:

$12 million, or $0.04 per share, of restructuring and management transition charges;
$1 million, or $0.00 per share, of expense from our qualified defined benefit pension plan (Primary Pension Plan);
$34 million, or $0.11 per share, for the loss on extinguishment of debt;
$2 million, or $0.01 per share, for the net gain on the sale of non-operating assets;
$88 million, or $0.28 per share, for certain net gains; and
$6 million, or $0.02 per share, of tax benefit related to the Primary Pension Plan 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.

During the third quarter of 2014, we completed an offering of $400 million aggregate principal amount of 8.125% Senior Unsecured Notes due 2019 (2019 Notes). The majority of the net proceeds of the offering were used to pay the tender consideration and related transaction fees and expenses for our contemporaneous cash tender offers (2014 Tender Offers) for $327 million aggregate principal amount of our outstanding 6.875% Medium-Term Notes due 2015 (2015 Notes), 7.65% Debentures due 2016 (2016 Notes) and 7.95% Debentures due 2017 (2017 Notes). 

In October 2014, subsequent to the completion of the above 2014 Tender Offers, we used $64 million of available cash to effect a legal defeasance of the remaining outstanding principal amount of 2015 Notes by depositing funds with the Trustee for the 2015 Notes sufficient to make all payments of interest and principal on the outstanding 2015 Notes to the stated maturity of October 15, 2015.

Effective November 1, 2014, the Board of Directors (Board) elected Marvin R. Ellison as President and CEO-Designee and a Director of the Company. He will succeed Myron E. Ullman, III as CEO of the Company on August 1, 2015. At that time, Mr. Ullman will become Executive Chairman of the Board for a period of one year.

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Results of Operations
 
Three Months Ended
 
Nine Months Ended
($ in millions, except EPS)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Total net sales
$
2,764

 
$
2,779

 
$
8,364

 
$
8,077

Percent increase/(decrease) from prior year
(0.5
)%
 
(5.1
)%
 
3.6
 %
 
(11.3
)%
Comparable store sales increase/(decrease)(1)
0.0
 %
 
(4.1
)%
 
4.3
 %
 
(11.0
)%
Gross margin
1,013

 
819

 
2,947

 
2,418

Operating expenses/(income):
 
 
 
 
 
 
 
Selling, general and administrative
988

 
1,006

 
2,961

 
3,110

Primary pension plan
1

 
25

 
(8
)
 
75

Supplemental pension plans

 
9

 
12

 
27

Total pension
1

 
34

 
4

 
102

Depreciation and amortization
156

 
161

 
474

 
440

Real estate and other, net
(90
)
 
(27
)
 
(160
)
 
(117
)
Restructuring and management transition
12

 
46

 
39

 
165

Total operating expenses
1,067

 
1,220

 
3,318

 
3,700

Operating income/(loss)
(54
)
 
(401
)
 
(371
)
 
(1,282
)
Adjusted operating income/(loss) (non-GAAP)(2)
(131
)
 
(354
)
 
(494
)
 
(1,128
)
Loss on extinguishment of debt
34

 

 
34

 
114

Net interest expense
103

 
99

 
306

 
255

Income/(loss) before income taxes
(191
)
 
(500
)
 
(711
)
 
(1,651
)
Income tax expense/(benefit)
(3
)
 
(11
)
 
1

 
(228
)
Net income/(loss)
$
(188
)
 
$
(489
)
 
$
(712
)
 
$
(1,423
)
EBITDA (non-GAAP)(2)
$
102

 
$
(240
)
 
$
103

 
$
(842
)
Adjusted EBITDA (non-GAAP)(2)
$
25

 
$
(193
)
 
$
(20
)
 
$
(688
)
Adjusted net income/(loss) (non-GAAP)(2)
$
(235
)
 
$
(457
)
 
$
(816
)
 
$
(1,223
)
Diluted EPS
$
(0.62
)
 
$
(1.94
)
 
$
(2.33
)
 
$
(6.17
)
Adjusted diluted EPS (non-GAAP)(2)
$
(0.77
)
 
$
(1.81
)
 
$
(2.67
)
 
$
(5.30
)
Ratios as a percent of sales:
 
 
 
 
 
 
 
Gross margin
36.6
 %
 
29.5
 %
 
35.2
 %
 
29.9
 %
SG&A
35.7
 %
 
36.2
 %
 
35.4
 %
 
38.5
 %
Total operating expenses
38.6
 %
 
43.9
 %
 
39.6
 %
 
45.8
 %
Operating income/(loss)
(2.0
)%
 
(14.4
)%
 
(4.4
)%
 
(15.9
)%
Adjusted operating income/(loss) (non-GAAP)(2)
(4.7
)%
 
(12.7
)%
 
(5.9
)%
 
(14.0
)%
(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

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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, certain net gains and the 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). 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, certain net gains 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, certain net gains 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 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
 
Nine Months Ended
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Operating income/(loss)
$
(54
)
 
$
(401
)
 
$
(371
)
 
$
(1,282
)
As a percent of sales
(2.0
)%
 
(14.4
)%
 
(4.4
)%
 
(15.9
)%
Add: Restructuring and management transition charges
12

 
46

 
39

 
165

Add: Primary pension plan expense/(income)
1

 
25

 
(8
)
 
75

Less: Net gain on sale of non-operating assets
(2
)
 
(24
)
 
(23
)
 
(86
)
Less: Proportional share of net income from joint venture

 

 
(43
)
 

Less: Certain net gains(1)
(88
)
 

 
(88
)
 

Adjusted operating income/(loss) (non-GAAP)
$
(131
)
 
$
(354
)
 
$
(494
)
 
$
(1,128
)
As a percent of sales
(4.7
)%
 
(12.7
)%
 
(5.9
)%
 
(14.0
)%

(1)
Represents the net gain on the sale of one department store location and the net gain recognized on a payment received from a landlord to terminate an existing lease prior to its original expiration date.














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

 
Three Months Ended
 
Nine Months Ended
($ in millions)
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Net income/(loss)
$
(188
)
 
$
(489
)
 
$
(712
)
 
$
(1,423
)
Add: Net interest expense
103

 
99

 
306

 
255

Add: Loss on extinguishment of debt
34

 

 
34

 
114

Total interest expense
137

 
99

 
340

 
369

Add: Income tax expense/(benefit)
(3
)
 
(11
)
 
1

 
(228
)
Add: Depreciation and amortization
156

 
161

 
474

 
440

EBITDA (non-GAAP)
102

 
(240
)
 
103

 
(842
)
Add: Restructuring and management transition charges
12

 
46

 
39

 
165

Add: Primary pension plan expense/(income)
1

 
25

 
(8
)
 
75

Less: Net gain on the sale of non-operating assets
(2
)
 
(24
)
 
(23
)
 
(86
)
Less: Proportional share of net income from joint venture

 

 
(43
)
 

Less: Certain net gains
(88
)
 

 
(88
)
 

Adjusted EBITDA (non-GAAP)
$
25

 
$
(193
)
 
$
(20
)
 
$
(688
)
Adjusted Net Income/(Loss) and Adjusted Diluted EPS. The following table reconciles net income/(loss) and diluted EPS, the most directly comparable GAAP financial measures, to adjusted net income/(loss) and adjusted diluted EPS, which are non-GAAP financial measures:
 
 
Three Months Ended
 
Nine Months Ended
 
($ in millions, except per share data)
November 1,
2014