-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TLM65gRbk+Mr+fsqcQU2uIMzUtpNSrdN1yattiBcAts7fQxEEx7O8lPXw7r0aC4D A4dNkwh8DtamAEGVwCCkcg== 0000930661-99-000921.txt : 19990427 0000930661-99-000921.hdr.sgml : 19990427 ACCESSION NUMBER: 0000930661-99-000921 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19990130 FILED AS OF DATE: 19990423 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENNEY J C FUNDING CORP CENTRAL INDEX KEY: 0000077193 STANDARD INDUSTRIAL CLASSIFICATION: SHORT-TERM BUSINESS CREDIT INSTITUTIONS [6153] IRS NUMBER: 510101524 STATE OF INCORPORATION: DE FISCAL YEAR END: 0126 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-04947 FILM NUMBER: 99600331 BUSINESS ADDRESS: STREET 1: 6501 LEGACY DRIVE CITY: PLANO STATE: TX ZIP: 75024-3698 BUSINESS PHONE: 2145912020 FORMER COMPANY: FORMER CONFORMED NAME: PENNEY J C FINANCIAL CORP DATE OF NAME CHANGE: 19880420 FORMER COMPANY: FORMER CONFORMED NAME: PENNEY J C CREDIT CORP DATE OF NAME CHANGE: 19710826 10-K405 1 FORM 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the 52 weeks ended January 30, 1999 Commission file number 1-4947-1 J. C. Penney Funding Corporation ------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 51-0101524 --------------------------- ---------- (State of incorporation) (I.R.S. Employer ID No.) 6501 LEGACY DRIVE, PLANO, TEXAS 75024-3698 - ----------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (972) 431-1000 - -------------------------------------------------- -------------- Securities registered pursuant to Section 12(b) of the Act: None - ---------------------------------------------------------- Securities registered pursuant to Section 12(g) of the Act: None - ---------------------------------------------------------- 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant: None ---- Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: 500,000 shares of Common Stock of $100 par value, as of March 31, 1999. DOCUMENTS INCORPORATED BY REFERENCE ----------------------------------- Portions of Registrant's 1998 Annual Report ("1998 Annual Report") are incorporated into Parts I, II, and IV. Portions of J. C. Penney Company, Inc.'s 1998 Annual Report to Stockholders ("JCPenney's 1998 Annual Report") are incorporated into Part I. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(A) AND (B) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT. PART I ------ 1. BUSINESS. -------- J. C. Penney Funding Corporation ("Funding"), which was incorporated in Delaware in 1964, is a wholly-owned subsidiary of J. C. Penney Company, Inc. ("JCPenney"), also incorporated in Delaware. Funding's executive offices are located in JCPenney's offices in Plano, Texas. Its business consists of financing a portion of JCPenney's operations through loans to JCPenney, the purchase of customer receivable balances that arise from the retail credit sales of JCPenney, or a combination of both. No receivables have been purchased by Funding since 1985. JCPenney, a company founded by James Cash Penney in 1902 and incorporated in 1924, is a major retailer operating approximately 1,150 JCPenney department stores in all 50 states, Puerto Rico, Mexico, and Chile. In addition, in January 1999, JCPenney completed the acquisition of the majority interest in a Brazilian department store chain that operates 21 stores under the Renner name. The major portion of JCPenney's business consists of providing merchandise and services to consumers through department stores that include catalog departments. JCPenney stores market predominantly family apparel, jewelry, shoes, accessories, and home furnishings. In addition, JCPenney, through its wholly-owned subsidiary, Eckerd Corporation, operates a chain of approximately 2,900 drugstores located throughout the northeast, southeast, and Sunbelt regions of the United States, including JCPenney's March 1999 acquisition of the New York-based Genovese drugstore chain. JCPenney also has several direct marketing subsidiaries, the principal of which is J. C. Penney Life Insurance Company, which market life, health, accident and credit insurance as well as a growing portfolio of membership services to both domestic and international customers. JCPenney's total revenues for the 52 weeks ended January 30, 1999 were $30.7 billion and net income was $594 million. Pursuant to the terms of financing agreements between Funding and JCPenney, payments from JCPenney to Funding are designed to produce earnings sufficient to cover Funding's fixed charges, principally interest on borrowings, at a coverage ratio mutually agreed upon between Funding and JCPenney. (See "Loan Agreement" and "Receivables Agreement", below.) The earnings to fixed charges coverage ratio has historically been, and in fiscal 1998 was, at least 1.5 to 1. Operations of Funding. To finance the operations of JCPenney as described --------------------- under "Business" above, Funding sells its short-term notes (commercial paper) to investors through dealer-placed programs. The short-term notes are guaranteed on a subordinated basis by JCPenney. Funding has, from time to time, issued long- term debt in public and private markets in the United States and abroad. Prior to April 3, 1992, Funding issued commercial paper and master notes to investors on a direct issue basis. Funding also has in place arrangements for short-term bank borrowings. Short-term debt in fiscal 1998 averaged $1,938 million compared to $2,247 million in fiscal 1997 and $2,041 million in fiscal 1996. Short-term debt rates averaged 5.5 percent in fiscal 1998, compared to 5.6 percent in fiscal 1997 and 5.5 percent in fiscal 1996. Interest expense decreased in fiscal 1998 compared to fiscal 1997 due to lower borrowing levels and lower short-term interest rates. Interest expense increased in fiscal 1997 as compared to fiscal 1996 due to higher borrowing levels and higher short-term interest rates. 2 Credit Operations of JCPenney. Virtually all types of merchandise and ----------------------------- services sold by JCPenney in the United States, Puerto Rico, Mexico, and Chile may be purchased on JCPenney's revolving credit card. In addition, JCPenney accepts American Express, Diners Club (Mexico and Brazil only), Discover (United States and Puerto Rico only), MasterCard, and Visa at JCPenney stores, catalog, and drugstores throughout the 50 states, Puerto Rico, Mexico, Chile, and Brazil. For additional information regarding the credit card operations of JCPenney, see "Net Interest Expense and Credit Operations" (page 17), which appears in the section of JCPenney's 1998 Annual Report entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations", and "Pre-tax cost of JCPenney credit card", "Department Stores and Catalog", and "Key JCPenney credit card information" (page 42), which appear in the section of JCPenney's 1998 Annual Report entitled "Supplemental Data (Unaudited)", on the pages indicated in the parenthetical references, which are incorporated by reference herein. Funding has never incurred any losses from JCPenney's retail credit operation since, pursuant to the Receivables Agreement, JCPenney itself administers the customer receivables when sold to Funding, receives all finance charge revenue on those customer receivables, and bears all related costs. Loan Agreement. Funding and JCPenney are parties to a Loan Agreement, -------------- dated as of January 28, 1986, as amended ("Loan Agreement"), which provides for unsecured loans to be made from time to time by Funding to JCPenney for the general business purposes of JCPenney, subject to the terms and conditions of the Loan Agreement. The loans may be either senior loans or subordinated loans, at the election of JCPenney, provided that, without the consent of the Board of Directors of Funding, the principal amount of loans outstanding at any time under the Loan Agreement may not exceed specified limits. Currently such limits may not exceed $8 billion in the aggregate for all loans and $1 billion in the aggregate for all subordinated loans. The terms of each loan under the Loan Agreement shall be as agreed upon at the time of such loan by Funding and JCPenney, provided that Funding may require upon demand that any loan be paid, and JCPenney may prepay without premium any loan, in whole or in part at any time. Under the terms of the Loan Agreement, JCPenney and Funding agree from time to time upon a mutually-acceptable earnings coverage of Funding's interest and other fixed charges. If at the end of each fiscal quarter during which a loan is outstanding, the earnings coverage of Funding's interest and other fixed charges is less than the agreed upon ratio, JCPenney will pay to Funding an additional amount sufficient to provide for such coverage to be not less than the agreed upon ratio. In the event that JCPenney and Funding have not agreed upon a mutually acceptable ratio for any fiscal quarter, the applicable quarterly payment with respect to such period will include an amount equal to the excess, if any, of one and one-half percent of the daily average of the aggregate principal amount outstanding on all loans during such period, over the aggregate amount of interest accrued on all such loans during such period. Receivables Agreement. Since December 1, 1985, JCPenney has not sold an --------------------- undivided interest in any of its customer receivables to Funding. The Receivables Agreement between Funding and JCPenney, as amended ("Receivables Agreement"), continues to be in full force and effect and while no purchases of JCPenney 3 customer receivables by Funding are presently contemplated, JCPenney may again commence sales of its customer receivables to Funding. The Receivables Agreement sets forth the terms and provisions governing sales of customer receivables (other than specified types of customer receivables immaterial in amount) by JCPenney to Funding. At the end of each monthly accounting period, JCPenney may sell to Funding an undivided interest in its undefaulted customer receivables which are not sold or contracted to be sold by JCPenney to anyone other than Funding. Settlements are made as of the end of each such monthly accounting period with respect to collections, defaults, and other adjustments to customers' accounts occurring during that month. The purchase price for the customer receivables acquired by Funding from JCPenney is equal to the aggregate dollar amount of such customer receivables. JCPenney pays to Funding at the end of each monthly accounting period a discount in an amount agreed upon from time to time. In the event of a failure to agree as to the amount of the discount, the amount to be paid is one-half of one percent of the average daily closing balance of conveyed customer receivables held by Funding during such monthly accounting period less the average daily closing balance of the Contract Reserve Account during such period. In addition, at the time of purchase of customer receivables from JCPenney, Funding withholds from the purchase price, and adds to the Contract Reserve Account, the lesser of (i) five percent of the amount of customer receivables then being purchased, or (ii) the amount, if any, by which the amount in the Contract Reserve Account is less than five percent of the total amount of customer receivables then owned by Funding. If the amount in the Contract Reserve Account should exceed five percent of the total amount of customer receivables owned by Funding at the end of any monthly accounting period, such excess is to be paid to JCPenney in accordance with the Receivables Agreement. If any portion of a customer receivable becomes more than 180 days past due or if the customer is, in the judgment of JCPenney, unable to make further payment, such customer receivable is considered to be in default for the purposes of the Receivables Agreement and is charged against the Contract Reserve Account. Collections with respect to any such defaulted customer receivable are credited to the Contract Reserve Account. As described above, all bad debts written off to date have been covered by the Contract Reserve Account. Funding acquires all of JCPenney's right, title, and interest in and to the undivided portion of the customer receivables being conveyed to it. All sales of customer receivables to Funding are without recourse to JCPenney. However, in the event of returned, rejected, or repossessed merchandise to which any previously conveyed undefaulted customer receivable relates, or in the event of a breach of a warranty made by JCPenney in the Receivables Agreement to which any previously conveyed undefaulted customer receivable relates, JCPenney is obligated to pay to Funding the amount by which Funding has been damaged. Either party has the right at any time to terminate the further sale or purchase, as the case may be, of customer receivables under the Receivables Agreement. 4 Certain state laws provide for recording or other notice formalities in connection with the assignment of accounts receivable. Funding does not deem it appropriate to utilize such procedures in connection with customer receivables purchased from JCPenney. In the event of the bankruptcy or receivership of JCPenney, it is possible that creditors of JCPenney might be deemed to have superior rights to some or all of the customer receivables previously purchased by Funding. Committed Bank Credit Facilities. Committed bank credit facilities -------------------------------- available to Funding and JCPenney as of January 30, 1999 amounted to $3.0 billion. These facilities, as amended and restated, support commercial paper borrowing arrangements and include a $1.5 billion, 364-day revolver and a $1.5 billion, five-year revolver. The 364-day revolver includes a $750 million seasonal credit line for the August to January period, thus allowing JCPenney to match its seasonal borrowing requirements. (See page 2 of Funding's 1998 Annual Report which is incorporated herein by reference.) Employment. Funding has had no employees since April 30, 1992. ---------- General. Legislation regulating consumer credit has been enacted in all ------- states and federally. Funding's operations have not been affected by such legislation since Funding does not deal directly with consumers. 2. PROPERTIES. ---------- Funding owns no physical properties. 3. LEGAL PROCEEDINGS. ----------------- Funding has no material legal proceedings pending against it. PART II ------- 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. -------------------------------- JCPenney owns all of Funding's outstanding common stock. Funding's common stock is not traded, and no dividends have been, or are currently intended to be, declared by Funding on its common stock. 5 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ------------------------------------------- The Balance Sheets of Funding as of January 30, 1999 and January 31, 1998, and the related statements of income, reinvested earnings, and cash flows for each of the years in the three-year period ended January 30, 1999, appearing on pages 3 through 5 of Funding's 1998 Annual Report, together with the related notes and the Independent Auditors' Report of KPMG LLP, independent certified public accountants, appearing on page 6 of Funding's 1998 Annual Report, the "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing on page 2 thereof, the section of Funding's 1998 Annual Report entitled "Five Year Financial Summary" appearing on page 7 thereof, and the unaudited quarterly financial highlights ("Quarterly Data") appearing on page 8 thereof, are incorporated herein by reference in response to Item 8 of Form 10-K. On April 15, 1999, Moody's Investors Service and Fitch IBCA lowered their respective ratings of the Company's long-term debt from A2 to A3 and from A to A-, and commercial paper from P1 to P2 and from F1 to F2. 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. -------------------------------------- None. PART IV ------- 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. ------------------- (a)(1) All Financial Statements. See Item 8 of this Form 10-K for financial statements incorporated by reference to Funding's 1998 Annual Report. (a)(2) Financial Statement Schedules. All schedules have been omitted as they are inapplicable or not required under the rules, or the information has been submitted in the financial statements or in the notes to the financial statements incorporated by reference to Funding's 1998 Annual Report. (a)(3) Exhibits. See separate Exhibit Index on pages G-1 through G-4. (b) Reports on Form 8-K filed during the fourth quarter of fiscal 1998. None. 6 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. J. C. PENNEY FUNDING CORPORATION -------------------------------- (Registrant) By /s/ R. B. Cavanaugh ----------------------------- R. B. Cavanaugh Chairman of the Board Dated: April 23, 1999 7 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURES TITLE DATE ---------- ----- ---- /s/ R. B. Cavanaugh - ------------------- R. B. Cavanaugh Chairman of the Board April 23, 1999 (principal executive officer); Director S. F. Walsh* - ------------ S. F. Walsh President April 23, 1999 (principal financial officer); Director W. J. Alcorn* - ------------- W. J. Alcorn Controller (principal April 23, 1999 accounting officer) D. A. McKay* - ------------ D. A. McKay Director April 23, 1999 *By /s/ R. B. Cavanaugh ------------------- R. B. Cavanaugh Attorney-in-fact 8 EXHIBIT INDEX Exhibit ------- 3. (i) Articles of Incorporation ------------------------- (a) Certificate of Incorporation of Funding, effective April 13, 1964 (incorporated by reference to Exhibit 3(a) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 29, 1994*). (b) Certificate of Amendment of Certificate of Incorporation, effective January 1, 1969 (incorporated by reference to Exhibit 3(b) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 29, 1994*). (c) Certificate of Amendment of Certificate of Incorporation, effective August 11, 1987 (incorporated by reference to Exhibit 3(c) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 29, 1994*). (d) Certificate of Amendment of Certificate of Incorporation, effective April 10, 1988 (incorporated by reference to Exhibit 3(d) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 29, 1994*). (ii) Bylaws ------ (a) Bylaws of Funding, as amended to May 19, 1995 (incorporated by reference to Exhibit 3(ii) to Funding's Quarterly Report on Form 10-Q for the 13 and 39 weeks ended October 26, 1996*). 4. Instruments defining the rights of security holders, including indentures ------------------------------------------------------------------------- (a) Issuing and Paying Agency Agreement dated as of March 16, 1992, between J. C. Penney Funding Corporation and Morgan Guaranty Trust Company of New York (incorporated by reference to Exhibit 4(a) to Funding's Current Report on Form 8-K, Date of Report - April 3, 1992*). (b) Issuing and Paying Agency Agreement dated as of February 3, 1997, between J. C. Penney Funding Corporation and The Chase Manhattan Bank (incorporated by reference to Exhibit 4(b) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 25, 1997*) . (c) Guaranty dated as of February 17, 1997, executed by J. C. Penney Company, Inc.(incorporated by reference to Exhibit 4(c) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 25, 1997*). (d) Amended and Restated 364-Day Revolving Credit Agreement dated as of December 3, 1996, among J. C. Penney Company, Inc., J. C. Penney Funding Corporation, the Lenders party thereto, Morgan Guaranty Trust Company of New York, as Agent for the Lenders, and Bank of America Illinois, Bankers Trust Company, The Chase Manhattan Bank, G-1 EXHIBIT INDEX Exhibit ------- Citibank, N.A., Credit Suisse, and NationsBank of Texas, N.A., as Co- Agents for the Lenders (incorporated by reference to Exhibit 4(d) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 25, 1997*). (e) Amended and Restated Five-Year Revolving Credit Agreement dated as of December 3, 1996, among J. C. Penney Company, Inc., J. C. Penney Funding Corporation, the Lenders party thereto, Morgan Guaranty Trust Company of New York, as Agent for the Lenders, and Bank of America Illinois, Bankers Trust Company, The Chase Manhattan Bank, Citibank, N.A., Credit Suisse, and NationsBank of Texas, N.A., as Co-Agents for the Lenders (incorporated by reference to Exhibit 4(e) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 25, 1997*). (f) Amendment and Restatement Agreement to 364-Day Revolving Credit Agreement, dated as of November 20, 1998, among J. C. Penney Company, Inc., J. C. Penney Funding Corporation, the Lenders party thereto, Morgan Guaranty Trust Company of New York, as Agent, Citibank, N.A., Nationsbanc Montgomery Securities LLC and The Chase Manhattan Bank, as Co-Syndication Agents, and Credit Suisse First Boston and First Union National Bank, as Managing Agents. (g) Amendment and Restatement Agreement to Five-Year Revolving Credit Agreement, dated as of November 21, 1997, among J. C. Penney Company, Inc., J. C. Penney Funding Corporation, the Lenders party thereto, Morgan Guaranty Trust Company of New York, as Agent, and Bank of America National Trust and Savings Association, Bankers Trust Company, The Chase Manhattan Bank, Citibank, N.A., Credit Suisse First Boston, and NationsBank of Texas, N.A., as Managing Agents (incorporated by reference to Exhibit 4(g) to Funding's Annual Report on Form 10-K for the 53 weeks ended January 31, 1998*). (h) Commercial Paper Dealer Agreement dated March 16, 1992 between J. C. Penney Funding Corporation and J.P. Morgan Securities Inc. (incorporated by reference to Exhibit 10(a) to Funding's Current Report on Form 8-K, Date of Report - April 3, 1992*). (i) Commercial Paper Dealer Agreement dated March 16, 1992 between J. C. Penney Funding Corporation and The First Boston Corporation (incorporated by reference to Exhibit 10(b) to Funding's Current Report on Form 8-K, Date of Report - April 3, 1992*). G-2 EXHIBIT INDEX Exhibit ------- (j) Commercial Paper Dealer Agreement dated May 3, 1994 between J. C. Penney Funding Corporation and Merrill Lynch Money Markets Inc. (incorporated by reference to Exhibit 4(g) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 28, 1995*). (k) Commercial Paper Dealer Agreement dated January 25, 1995 between J. C. Penney Funding Corporation and Morgan Stanley & Co. Incorporated (incorporated by reference to Exhibit 4(h) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 28, 1995*). (l) Commercial Paper Dealer Agreement dated February 7, 1997 between J. C. Penney Funding Corporation and Credit Suisse First Boston Corporation (incorporated by reference to Exhibit 4(l) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 25, 1997*).** (m) Guaranty dated as of December 3, 1996, executed by J. C. Penney Company, Inc. with respect to the Amended and Restated 364-Day and Five Year Revolving Credit Agreements, each dated as of December 3, 1996 (incorporated by reference to Exhibit 4(m) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 25, 1997*). Instruments evidencing long-term debt, previously issued but now fully prepaid, have not been filed as exhibits hereto because none of the debt authorized under any such instrument exceeded 10 percent of the total assets of the Registrant. The Registrant agrees to furnish a copy of any of its long-term debt instruments to the Securities and Exchange Commission upon request. 10. Material Contracts ------------------ THE CORPORATION HAS NO COMPENSATORY PLANS OR ARRANGEMENTS REQUIRED TO BE FILED AS EXHIBITS TO THIS REPORT PURSUANT TO ITEM 14(C) OF THIS REPORT. (a) Amended and Restated Receivables Agreement dated as of January 29, 1980 between J. C. Penney Company, Inc. and J. C. Penney Financial Corporation (incorporated by reference to Exhibit 10(a) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 29, 1994*). (b) Amendment No. 1 to Amended and Restated Receivables Agreement dated as of January 25, 1983 between J. C. Penney Company, Inc. and J. C. Penney Financial Corporation (incorporated by reference to Exhibit 10(b) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 29, 1994*). G-3 EXHIBIT INDEX Exhibit ------- (c) Loan Agreement dated as of January 28, 1986 between J. C. Penney Company, Inc. and J. C. Penney Financial Corporation (incorporated by reference to Exhibit 1 to Funding's Current Report on Form 8-K, Date of Report - January 28, 1986*). (d) Amendment No. 1 to Loan Agreement dated as of January 28, 1986 between J. C. Penney Company, Inc. and J. C. Penney Financial Corporation (incorporated by reference to Exhibit 1 to Funding's Current Report on Form 8-K, Date of Report - December 31, 1986*). (e) Amendment No. 2 to Loan Agreement dated as of January 28, 1986 between J. C. Penney Company, Inc. and J. C. Penney Funding Corporation (incorporated by reference to Exhibit 10(e) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 25, 1997*). (f) Line of Credit Agreement dated as of July 1, 1994, between J. C. Penney Funding Corporation and J. C. Penney Chile, Inc. (incorporated by reference to Exhibit 10(e) to Funding's Annual Report on Form 10-K for the 52 weeks ended January 28, 1995*). 13. Annual Report to Security Holders --------------------------------- Excerpt from Funding's 1998 Annual Report. 23. Independent Auditor's Consent ----------------------------- 24. Power of Attorney ----------------- 27. Financial Data Schedule ----------------------- Financial Data Schedule for the 52 week period ended January 30, 1999. 99. Additional Exhibits ------------------- Excerpt from JCPenney's 1998 Annual Report to Stockholders. *SEC file number 1-4947-1 ** Funding has entered into identical Commercial Paper Dealer Agreements dated February 7, 1997 with each of Merrill Lynch Money Markets Inc., J.P. Morgan Securities Inc., and Morgan Stanley & Co. Incorporated, which agreements are omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. Funding agrees to furnish a copy of any of such agreements to the Securities and Exchange Commission upon request. G-4 EX-4.F 2 AMENDED AND RESTATED REVOLVING CREDIT AGR. Exhibit 4(F) CONFORMED COPY ================================================================================ J. C. PENNEY COMPANY, INC. J. C. PENNEY FUNDING CORPORATION -------------------------- AMENDED AND RESTATED 364-DAY REVOLVING CREDIT AGREEMENT dated as of November 20, 1998 -------------------------- MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent, CITIBANK, N.A., NATIONSBANC MONTGOMERY SECURITIES LLC and THE CHASE MANHATTAN BANK, as Co-Syndication Agents, CREDIT SUISSE FIRST BOSTON and FIRST UNION NATIONAL BANK, as Managing Agents -------------------------- J.P. MORGAN SECURITIES INC., Lead Arranger ================================================================================ AMENDED AND RESTATED 364-DAY REVOLVING CREDIT AGREEMENT AMENDED AND RESTATED 364-DAY REVOLVING CREDIT AGREEMENT dated as of November 20, 1998 among J. C. PENNEY COMPANY, INC. and J. C. PENNEY FUNDING CORPORATION (the "Borrowers"), the LENDERS listed on the signature pages hereof (the "Lenders"), MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent (the "Agent"), and CITIBANK, N.A., NATIONSBANC MONTGOMERY SECURITIES LLC and THE CHASE MANHATTAN BANK, as Co-Syndication Agents (the "Co-Syndication Agents"), and CREDIT SUISSE FIRST BOSTON and FIRST UNION NATIONAL BANK, as Managing Agents (the "Managing Agents"). W I T N E S S E T H : WHEREAS, certain of the parties hereto have heretofore entered into a 364-Day Revolving Credit Agreement dated as of December 16, 1993, as amended and restated as of December 7, 1994, as amended as of December 6, 1995, as amended and restated as of December 3, 1996, and as amended and restated as of November 21, 1997 (the "Agreement"); WHEREAS, at the date hereof, there are no Loans outstanding under the Agreement; and WHEREAS, the parties hereto desire to amend such Agreement as set forth herein and to restate the Agreement in its entirety to read as set forth in the Agreement with the amendments specified below; NOW, THEREFORE, the parties hereto agree as follows: SECTION 1. Definitions; References. Unless otherwise specifically defined herein, each term used herein which is defined in the Agreement shall have the meaning assigned to such term in the Agreement. Each reference to "hereof", "hereunder", "herein" and "hereby" and each other similar reference and each reference to "this Agreement" and each other similar reference contained in the Agreement shall from and after the date hereof refer to the Agreement as amended and restated hereby. SECTION 2. Extension of Maturity Date. (a) The definition of "Maturity Date" in Section 1.01 of the Agreement is amended to read in its entirety as follows: "Maturity Date" shall mean November 19, 1999. (b) The date "November 20, 1998" in Section 2.11(d) of the Agreement is changed to "November 19, 1999". SECTION 3. Financial Statements. (a) Each reference to "January 25, 1997" in Sections 3.05 and 3.06 of the Agreement is changed to "January 31, 1998". (b) The date "July 26, 1997" in Section 3.05 of the Agreement is changed to "August 1, 1998". SECTION 4. The Agent. The last sentence of Article VIII of the Agreement is amended to read in its entirety as follows: No Co-Syndication Agent, Managing Agent or Co-Agent shall have any duties or responsibilities hereunder in its capacity as such. SECTION 5. Confirmation of Guaranty. J. C. Penney Company, Inc. confirms that its subordinated Guaranty of the obligations of J. C. Penney Funding Corporation dated as of December 3, 1996, shall apply to the obligations of J. C. Penney Funding Corporation under the Agreement as amended and restated hereby. SECTION 6. Changes in Commitments. With effect from and including the date this Amendment and Restatement becomes effective in accordance with Section 9 hereof, (i) each Person listed on the signature pages hereof which is not a party to the Agreement shall become a Lender party to the Agreement, (ii) the Commitment of each Lender shall be the amount set forth 2 opposite the name of such Lender on the Commitment Schedule annexed hereto and (iii) Schedule 2.01 to the Agreement shall be amended to read as set forth in Part I of said Commitment Schedule. Any Lender whose Commitment is changed to zero shall upon such effectiveness cease to be a Lender party to the Agreement, and all accrued fees and other amounts payable under the Agreement for the account of such Lender shall be due and payable on such date; provided that, subject to Section 2.20, the provisions of Sections 2.13, 2.15, 2.19 and 9.05 of the Agreement shall continue to inure to the benefit of each such Lender. SECTION 7. Pricing Schedule. Exhibit D to the Agreement is amended to read in its entirety as set forth in Exhibit A hereto. SECTION 8. Governing Law. This Amendment and Restatement shall be governed by and construed in accordance with the laws of the State of New York. SECTION 9. Counterparts; Conditions to Effectiveness. This Amendment and Restatement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Amendment and Restatement shall become effective as of the date hereof when the Agent shall have received: (a) duly executed counterparts hereof signed by the Borrowers and all of the Lenders (or, in the case of any party as to which an executed counterpart shall not have been received, the Agent shall have received telegraphic, telex or other written confirmation from such party of execution of a counterpart hereof by such party); (b) an opinion of Charles R. Lotter, General Counsel for the Borrowers, dated the date hereof and addressed to the Lenders, to the effect set forth in Exhibit B hereto, and the Borrowers hereby instruct such counsel to deliver such opinion to the Agent; (c) a certificate from a Responsible Officer of each Borrower, dated the date hereof, and certifying that the representations and warranties set forth in Article III of the Agreement shall be true and correct in all material respects on and as of the date hereof with the same effect as though made on and as of such date, except to the extent such representations and warranties expressly relate to an earlier date; 3 (d) a certificate from a Responsible Officer of each Borrower, dated the date hereof, and certifying that on such date, no Event of Default or Default shall have occurred and be continuing; (e) for its own account all fees due and payable to it and in such amounts as have been previously agreed upon in writing between the Borrowers and the Agent in connection with this Amendment and Restatement; and (f) (i) a certificate of the Secretary or Assistant Secretary of each Borrower, dated the date hereof and certifying (A) that attached thereto is a true and complete copy of resolutions duly adopted by the Board of Directors of such Borrower authorizing the execution, delivery and performance of the Agreement as hereby amended and restated and the borrowings thereunder, and that such resolutions have not been modified, rescinded or amended and are in full force and effect, and (B) as to the incumbency and specimen signature of each officer executing this Amendment and Restatement or any other document delivered in connection herewith on behalf of such Borrower and (ii) a certificate of another officer of each Borrower as to the incumbency and specimen signature of the Secretary or Assistant Secretary executing the certificate pursuant to (i) above. 4 IN WITNESS WHEREOF, the parties hereto have caused this Amendment and Restatement to be duly executed as of the date first above written. J. C. PENNEY COMPANY, INC. By /s/ Robert B. Cavanaugh ------------------------------------------- Title: Vice President and Treasurer J. C. PENNEY FUNDING CORPORATION By /s/ Stephen F. Walsh ------------------------------------------- Title: President MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Lender and as Agent By /s/ Maria H. Dell'Aquila ------------------------------------------- Title: Vice President THE CHASE MANHATTAN BANK, as Lender and as Co-Syndication Agent By /s/ Barry R. Bergman ------------------------------------------- Title: Vice President CITIBANK, N.A., as Lender and as Co-Syndication Agent By /s/ Robert A. Snell ------------------------------------------- Title: As Attorney in Fact NATIONSBANC MONTGOMERY SECURITIES LLC, as Co-Syndication Agent By /s/ Gary Kahn ------------------------------------------- Title: Managing Director NATIONSBANK N.A., as Lender By /s/ Kimberley A. Knop ------------------------------------------- Title: Vice President CREDIT SUISSE FIRST BOSTON, as Lender and as Managing Agent By /s/ Thomas G. Muoio ------------------------------------------- Title: Vice President By /s/ J. Scott Karro ------------------------------------------- Title: Associate FIRST UNION NATIONAL BANK, as Lender and as Managing Agent By /s/ Rodger Levenson ------------------------------------------- Title: Senior Vice President BANKERS TRUST COMPANY, as Lender and as Co-Agent By /s/ Anthony LoGrippo ------------------------------------------- Title: Vice President THE FIRST NATIONAL BANK OF CHICAGO, as Lender and as Co-Agent By /s/ Vincent R. Henchek ------------------------------------------- Title: Vice President FLEET NATIONAL BANK, as Lender and as Co-Agent By /s/ Thomas J. Bullard ------------------------------------------- Title: Vice President PNC BANK, NATIONAL ASSOCIATION, as Lender and as Co-Agent By /s/ Mark T. Kennedy ------------------------------------------- Title: Vice President WACHOVIA BANK, N.A., as Lender and as Co-Agent By /s/ Paige D. Mesaros ------------------------------------------- Title: Vice President WELLS FARGO BANK N.A., as Lender and as Co-Agent By /s/ Edith R. Lim ------------------------------------------- Title: Vice President By /s/ Mark Haberecht ------------------------------------------- Title: Assistant Vice President THE BANK OF TOKYO-MITSUBISHI, LTD., as Lender and as Co-Agent By /s/ John M. Mearns ------------------------------------------- Title: Vice President and Manager THE BANK OF NEW YORK By /s/ Charlotte Sohn ------------------------------------------- Title: Vice President BANKBOSTON, N.A. By /s/ Judith C.E. Kelly ------------------------------------------- Title: Vice President MARINE MIDLAND BANK By /s/ Robert Corder, #9428 ------------------------------------------- Title: Authorized Signatory MELLON BANK, N.A. By /s/ Richard J. Schaich ------------------------------------------- Title: Assistant Vice President SUNTRUST BANK, ATLANTA By /s/ Todd C. Davis ------------------------------------------- Title: Assistant Vice President By /s/ Deborah S. Armstrong ------------------------------------------- Title: First Vice President BANK OF HAWAII By /s/ Brenda K. Testerman ------------------------------------------- Title: Vice President FIRST AMERICAN NATIONAL BANK By /s/ Stephen Arnold ------------------------------------------- Title: Assistant Vice President FIRSTAR BANK MILWAUKEE, N.A. By /s/ Desiree K. Dujmic ------------------------------------------- Title: Commercial Banking Officer KEYBANK NATIONAL ASSOCIATION By /s/ Frank J. Jancar ------------------------------------------- Title: Vice President THE NORTHERN TRUST COMPANY By /s/ John E. Burda ------------------------------------------- Title: Second Vice President ROYAL BANK OF CANADA By /s/ Karen T. Hull ------------------------------------------- Title: Retail Group Manager STATE STREET BANK AND TRUST COMPANY By /s/ Johnny Ip ------------------------------------------- Title: Vice President CRESTAR BANK By /s/ James P. Duval, Jr. ------------------------------------------- Title: Vice President BARCLAYS BANK PLC By /s/ Marlene Wechselblatt ------------------------------------------- Title: Vice President HIBERNIA NATIONAL BANK By /s/ Angela Bentley ------------------------------------------- Title: Portfolio Manager By /s/ Katherine Gonzalez by Angela Bentley ------------------------------------------- Title: Relationship Manager NATIONAL CITY BANK By /s/ George M. Gevas ------------------------------------------- Title: Vice President UMB BANK, n.a. By /s/ David A. Proffitt ------------------------------------------- Title: Senior Vice President U.S. BANK NATIONAL ASSOCIATION By /s/ David A. Draxler ------------------------------------------- Title: Vice President FIRST SECURITY BANK, N.A. By /s/ Judy Callister ------------------------------------------- Title: Vice President DEPARTING LENDERS ----------------- CREDIT AGRICOLE INDOSUEZ By /s/ Katherine L. Abbott ------------------------------------------- Title: First Vice President By /s/ W. Leroy Startz ------------------------------------------- Title: First Vice President THE FUJI BANK, LTD. HOUSTON AGENCY By /s/ Kazuyuki Nishimura ------------------------------------------- Title: Senior Vice President ISTITUTO BANCARIO SAN PAOLO DI TORINO INSTITUTO MOBILIARE ITALIANO SPA By /s/ Robert Wurster ------------------------------------------- Title: First Vice President By /s/ Glen Binder ------------------------------------------- Title: Vice President NATIONAL AUSTRALIA BANK LIMITED A.C.N. 004044937 By /s/ Frank J. Campiglia ------------------------------------------- Title: Vice President NORWEST BANK MINNESOTA, N.A. By /s/ Mary D. Falck ------------------------------------------- Title: Vice President THE YASUDA TRUST AND BANKING CO., LTD., NEW YORK BRANCH By /s/ Junichiro Kawamura ------------------------------------------- Title: Vice President COMMITMENT SCHEDULE I. Continuing Lenders Name of Lender and Applicable Lending Office Commitment Morgan Guaranty Trust Company of New York $90,000,000 The Chase Manhattan Bank $85,000,000 Citibank, N.A. $85,000,000 NationsBank N.A. $85,000,000 Credit Suisse First Boston $80,000,000 First Union National Bank $80,000,000 Bankers Trust Company $72,500,000 The First National Bank of Chicago $60,000,000 Fleet National Bank $60,000,000 PNC Bank, National Association $60,000,000 Wachovia Bank, N.A. $60,000,000 Wells Fargo Bank N.A. $60,000,000 The Bank of Tokyo-Mitsubishi, Ltd. $55,000,000 The Bank of New York $45,000,000 BankBoston, N.A. $45,000,000 Marine Midland Bank $45,000,000 Mellon Bank, N.A. $45,000,000 SunTrust Bank, Atlanta $37,500,000 Bank of Hawaii $30,000,000 First American National Bank $30,000,000 S-1 Name of Lender and Applicable Lending Office Commitment Firstar Bank Milwaukee, N.A. $30,000,000 KeyBank National Association $30,000,000 The Northern Trust Company $30,000,000 Royal Bank of Canada $30,000,000 State Street Bank and Trust Company $30,000,000 Crestar Bank $25,000,000 Barclays Bank PLC $20,000,000 Hibernia National Bank $20,000,000 National City Bank $20,000,000 UMB Bank, n.a. $20,000,000 U.S. Bank National Association $20,000,000 First Security Bank, N.A. $15,000,000 S-2 II. Departing Lenders Name of Lender and Applicable Lending Office Commitment Credit Agricole Indosuez $0 The Fuji Bank, Ltd., Houston Agency $0 Istituto Bancario San Paolo Di Torino Instituto Mobiliare $0 Italiano SPA National Australia Bank Limited $0 Norwest Bank Minnesota, N.A. $0 The Yasuda Trust and Banking Co., Ltd., New York Branch $0 Total $1,500,000,000 ============== S-3 EXHIBIT A PRICING SCHEDULE The "Facility Fee Percentage" and "Euro-Dollar Margin" for any day are the respective percentages set forth below in the applicable row under the column corresponding to the Category and Utilization that exists on such day: ================================================================================ Category I II III IV V VI ================================================================================ Facility Fee 0.050% 0.070% 0.080% 0.100% 0.1750% 0.300% Percentage Euro-Dollar Margin Utilization less than 1/3 0.175% 0.180% 0.270% 0.300% 0.575% 0.700% Utilization greater than or equal to 1/3 0.225% 0.230% 0.370% 0.400% 0.825% 1.200% ================================================================================ For purposes of this Schedule, the following terms have the following meanings, subject to the further provisions of this Schedule: "Category I" exists at any date if, at such date, the Index Debt is rated at least A+ by S&P or A1 by Moody's. "Category II" exists at any date if, at such date, (i) the Index Debt is rated at least A by S&P or A2 by Moody's and (ii) Category I does not exist. "Category III" exists at any date if, at such date, (i) the Index Debt is rated at least A- by S&P or A3 by Moody's and (ii) neither Category I nor Category II exists. "Category IV" exists at any date if, at such date, (i) the Index Debt is rated at least BBB+ by S&P or Baa1 by Moody's and (ii) none of Category I, Category II and Category III exists. "Category V" exists at any date if, at such date, (i) the Index Debt is rated at least BBB- by S&P or Baa3 by Moody's and (ii) none of Category I, Category II, Category III and Category IV exists. A-1 "Category VI" exists at any date if, at such date, (i) the Index Debt is rated below BBB- by S&P or below Baa3 by Moody's and (ii) no other Category exists. "Category" refers to the determination of which of Category I, Category II, Category III, Category IV, Category V or Category VI exists at any date. "Moody's" means Moody's Investors Service, Inc. "S&P" means Standard & Poor's Ratings Services. "Utilization" means, at any date, a fraction (i) the numerator of which is the aggregate outstanding principal amount of all Loans at such date and (ii) the denominator of which is the aggregate amount of the Commitments at such date, determined in each case after giving effect to any transactions on such date; provided that if for any reason any Loans remain outstanding following termination of the Commitments, Utilization shall be deemed to be not less than 1/3. For purposes of the foregoing, (i) if no rating for the Index Debt shall be available from either rating agency, (other than because (a) such rating agency shall no longer be in the business of rating corporate debt obligations or (b) of any other reason outside the control of J. C. Penney and Funding), such rating agency shall be deemed to have established a rating in Category VI and (ii) if any rating established or deemed to have been established by Moody's or S&P shall be changed (other than as a result of a change in the rating system of either Moody's or S&P), such change shall be effective as of the date on which such change is first publicly announced by the rating agency making such change. If the rating system of either Moody's or S&P shall change prior to the Maturity Date, or if either such rating agency shall cease to be in the business of rating corporate debt obligations or shall no longer have in effect a rating for any reason outside the control of J. C. Penney and Funding, the Borrowers and the Lenders shall negotiate in good faith to amend the references to specific ratings in this definition to reflect such changed rating system or the absence of such a rating. Pending agreement on any such amendment, (i) if the rating system of one such rating agency shall remain unchanged, or if a rating shall be available from one such rating agency, the Facility Fee Percentage and the Euro- Dollar Margin shall be determined by reference to the rating established by such rating agency, (ii) if no rating for the A-2 Index Debt shall be available from either rating agency then (A) for 60 days, the Facility Fee Percentage and the Euro-Dollar Margin shall be determined by reference to the rating or ratings most recently available, (B) after 60 days, the Facility Fee Percentage and the Euro-Dollar Margin shall be determined by reference to Category V (or Category VI if such Percentage or Margin shall have been determined by reference to Category V or VI under clause (A) above) and (C) after 180 days, the Facility Fee Percentage and the Euro-Dollar Margin shall be determined by reference to Category VI. In the case of split ratings from S&P and Moody's, the rating to be used to determine Categories is the higher of the two (e.g., A+/A2 results in Category I); provided that in the event the split is more than one full ratings "notch", the average rating (or the higher of the two intermediate ratings) shall be used (e.g. A+/A3 results in Category II, as does A+/Baa1); and provided further that if at any date the Index Debt is rated BB+ or lower by S&P or Ba1 or lower by Moody's, the Facility Fee Percentage and the Euro-Dollar Margin shall be determined by reference to Category VI. A-3 EXHIBIT B November 20, 1998 Each of the lenders referred to below Re: Amended and Restated 364-Day Revolving Credit Agreement of J. C. Penney Company, Inc. and J. C. Penney Funding Corporation Ladies and Gentlemen: As the General Counsel of J. C. Penney Company, Inc., a Delaware corporation ("JCPenney"), and of J. C. Penney Funding Corporation, a Delaware corporation ("Funding" and, together with JCPenney, "Borrowers"), I have been asked to render an opinion pursuant to Section 9(b) of the Amended and Restated 364-Day Revolving Credit Agreement dated as of November 20, 1998 among the Borrowers, Morgan Guaranty Trust Company of New York, as Agent (the "Agent"), the lenders listed on the signature pages thereof (the "Lenders"), Citibank, N.A., Nationsbanc Montgomery Securities LLC and The Chase Manhattan Bank, as Co- Syndication Agents (the "Co-Syndication Agents"), and Credit Suisse First Boston and First Union National Bank, as Managing Agents (the "Managing Agents") (the "Amendment and Restatement") which amends and restates the 364-Day Revolving Credit Agreement dated as of December 16, 1993, as amended and restated with new Lenders as of December 7, 1994, as amended with new Lenders as of December 6, 1995, as amended and restated as of December 3, 1996, and as amended and restated as of November 21, 1997 (such Credit Agreement, as amended and restated by the Amendment and Restatement, the "Credit Agreement"). In rendering the opinion set forth below, I have examined originals, photostatic, or certified copies of the Credit Agreement, the respective corporate records and documents of the Borrowers, copies of public documents, certificates of the officers or representatives of the Borrowers, and such other instruments and documents, and have made such inquiries, as I have deemed necessary as a basis for such opinion. In making such examinations, I have assumed the genuineness of all signatures (other than the signatures of the B-1 Borrowers) and the authenticity of all documents submitted to me as originals, the conformity to original documents of all documents submitted to me as certified or photostatic copies, and the authenticity of the originals of such latter documents. As to questions of fact material to such opinion, to the extent I deemed necessary, I have relied upon the representations and warranties of the Borrowers made in the Credit Agreement and upon certificates of the officers of the Borrowers. Capitalized terms not otherwise defined in this opinion letter have the meanings specified in the Credit Agreement. Based upon the foregoing, I am of the opinion that: 1. Each of the Borrowers has been duly incorporated and is validly existing and in good standing under the laws of the State of Delaware, and is duly qualified as a foreign corporation and in good standing under the laws of each jurisdiction where the failure to so qualify would have a Material Adverse Effect. Each of the Borrowers has the requisite corporate power and authority to own, pledge, and operate its properties and assets, to lease the property it operates under lease, and to conduct its business as now conducted. 2. The execution, delivery, and performance by the Borrowers of the Credit Agreement, the Borrowings by the Borrowers under the Credit Agreement (i) are within the corporate power of each of the Borrowers; (ii)have been duly authorized by each of the Borrowers by all necessary corporate action; (iii) are not in contravention of JCPenney's Restated Certificate of Incorporation, Funding's Certificate of Incorporation, as amended, or either of the Borrower's bylaws; (iv) to the best of my knowledge do not violate any material law, statute, rule, or regulation, or any material order of any Governmental Authority, applicable to either of the Borrowers; (v) do not conflict with or result in the breach of, or constitute a default under, the material borrowing indentures, agreements, or other instruments of either of the Borrowers; (vi) do not result in the creation or imposition of any Lien upon any of the property or assets of either of the Borrowers other than any Lien created by the Credit Agreement; and (vii) do not require the consent or approval of, or any filing with, any Governmental Authority or any other person party to those agreements described above other than those that have been obtained or made or where the failure to obtain such consent or approval would not result in a Material Adverse Effect. B-2 3. The Credit Agreement has been duly executed and delivered by each of the Borrowers and constitutes a legal, valid, and binding obligation of each such Borrower, enforceable against such Borrower in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium, and similar laws of general applicability relating to or affecting creditors' rights and to general equity principles. 4. Neither Borrower is an "investment company" within the meaning of the Investment Company Act of 1940, as amended, or a "public-utility company" or a "holding company" within the meaning of the Public Utility Holding Company Act of 1935, as amended. 5. To the best of my knowledge, except as set forth in Schedule 3.09 of the Credit Agreement, no litigation by or before any Governmental Authority is now pending or threatened against JCPenney or Funding (i) which involves the Credit Agreement or (ii) as to which there is a reasonable possibility of an adverse determination and which, if adversely determined, would, individually or in the aggregate result in a Material Adverse Effect. 6. The Support Agreements have been duly executed and delivered by JCPenney and, where applicable, Funding and, as of the date hereof, are in full force and effect in accordance with their terms. The opinions expressed herein are limited to the laws of the State of Delaware with respect to the opinions provided in paragraph 1 (except as to due qualification as a foreign corporation and good standing under the laws of other jurisdictions) and clauses (i), (ii), and (iii) of paragraph 2. The other opinions expressed are limited to the laws of the State of New York and the laws of the United States. I do not express any opinion herein concerning any laws of any other jurisdictions. This opinion is furnished to you in connection with the transactions contemplated by the Credit Agreement, and may not be relied upon by any other person, firm, or corporation for any purpose or by you in any other context without my prior written consent. Very truly yours, Charles R. Lotter Executive Vice President, Secretary and General Counsel B-3 EX-13 3 ANNUAL REPORT TO SECURITY HOLDERS EXHIBIT 13 Management's Discussion and Analysis of 1998 Annual Report Financial Condition and Results of Operations J. C. Penney Funding Corporation ("Funding") is a wholly-owned consolidated subsidiary of J. C. Penney Company, Inc. ("JCPenney"). The business of Funding consists of financing a portion of JCPenney's operations through loans to JCPenney, the purchase of customer receivable balances that arise from the retail credit sales of JCPenney, or a combination of both. No receivables have been purchased by Funding since 1985. The loan agreement between Funding and JCPenney provides for unsecured loans to be made by Funding to JCPenney. Each loan is evidenced by a revolving promissory note and is payable upon demand in whole or in part as may be required by Funding. Copies of Funding's loan and receivables agreements with JCPenney are available upon request. Funding issues commercial paper through Credit Suisse First Boston Corporation, J.P. Morgan Securities Inc., Merrill Lynch Money Markets Inc., and Morgan Stanley Dean Witter to corporate and institutional investors in the domestic market. The commercial paper is guaranteed by JCPenney on a subordinated basis. The commercial paper was rated "A1" by Standard & Poor's Corporation, "P1" by Moody's Investors Service, and "F1" by Fitch Investors Service, Inc. at the end of fiscal 1998. As of January 1999, JCPenney and Funding's credit ratings were under review for possible downgrade. Income is derived primarily from earnings on loans to JCPenney and is designed to produce earnings sufficient to cover interest expense at a coverage ratio of at least one and one-half times. In 1998, net income decreased to $35 million from $43 million in 1997. Net income for 1997 increased from $38 million in 1996. The decrease in 1998 is attributed to lower lending levels and lower interest rates. The increase in 1997 is attributed to higher lending levels and higher interest rates. Interest expense was $106 million in 1998 compared with $127 million in 1997 and $111 million in 1996. Interest earned from JCPenney was $160 million in 1998 compared to $193 million in 1997 and $169 million in 1996. Commercial paper borrowings averaged $1,922 million in 1998 compared to $2,129 million in 1997 and $1,827 million in 1996. The average interest rate on commercial paper was 5.5 per cent in 1998, down from 5.6 per cent in 1997 and up from 5.5 percent in 1996. Committed bank credit facilities available to Funding and JCPenney as of January 30, 1999 amounted to $3 billion. The facilities, as amended and restated, support JCPenney's short term borrowing program, and are comprised of a $1.5 billion, 364-day revolver, and a $1.5 billion, five-year revolver. The 364-day revolver includes a $750 million seasonal credit line for the August to January period thus allowing JCPenney to match its seasonal borrowing requirements. There were no outstanding borrowings under these credit facilities during fiscal 1998. JCPenney has initiated actions to address the Year 2000 issue relating to Funding. Year 2000 readiness work was more than 90 per cent complete as of January 30, 1999. Since January 1999, JCPenney has been retesting all systems critical to JCPenney's core businesses. JCPenney has also focused on the Year 2000 readiness of its suppliers and service providers, both independently and in conjunction with the National Retail Federation. Total costs associated with these efforts are not expected to have a material impact on the financial results of either JCPenney or Funding. In addition, Funding has communicated with its commercial paper dealers to determine their Year 2000 readiness. However, there can be no guarantee that the systems of these commercial paper dealers on which Funding relies will be converted in a timely manner, or that a failure to convert would not have a material adverse effect on Funding's operations. We would like to express our appreciation to the institutional investment community, as well as to our credit line participants and commercial paper dealers for their continued support during 1998. /s/ Robert B. Cavanaugh - ----------------------- Chairman of the Board February 25, 1999 3 Statements of Income J. C. Penney Funding Corporation ($ in millions) For the Year 1998 1997 1996 --------------------- Interest income from JCPenney........................ $ 160 $ 193 $ 169 Interest expense..................................... 106 127 111 ------ ------ ----- Income before income taxes........................... 54 66 58 Income taxes...................................... 19 23 20 ------ ------ ----- Net income........................................... $ 35 $ 43 $ 38 ====== ====== ===== Statements of Reinvested Earnings ($ in millions) 1998 1997 1996 --------------------- Balance at beginning of year......................... $1,007 $ 964 $ 926 Net income........................................... 35 43 38 ------ ------ ----- Balance at end of year............................... $1,042 $1,007 $ 964 ====== ====== ===== See Notes to Financial Statements on page 7 4 Balance Sheets J. C. Penney Funding Corporation (In millions except share data) 1998 1997 -------------- Assets Loans to JCPenney.............................. $3,129 $2,591 ====== ====== Liabilities and Equity of JCPenney Current Liabilities Short term debt................................ $1,924 $1,416 Due to JCPenney................................ 18 23 ------ ------ Total Current Liabilities................. 1,942 1,439 Equity of JCPenney Common stock (including contributed capital), par value $100: Authorized, 750,000 shares - issued and outstanding, 500,000 shares.... 145 145 Reinvested earnings............................ 1,042 1,007 ------ ------ Total Equity of JCPenney.................. 1,187 1,152 ------ ------ Total Liabilities and Equity of JCPenney.. $3,129 $2,591 ====== ====== See Notes to Financial Statements on page 7 5 Statements of Cash Flows J. C. Penney Funding Corporation ($ in millions) For the Year 1998 1997 1996 -------------------------- Operating Activities Net income.................................... $ 35 $ 43 $ 38 (Increase)Decrease in loans to JCPenney....... (538) 2,471 (2,499) Increase(Decrease) in amount due to JCPenney.. (5) 22 (9) ----- -------- ------- $(508) $ 2,536 $(2,470) Financing Activities Increase(Decrease) in short term debt......... $ 508 $(2,536) $ 2,470 Supplemental Cash Flow Information Interest paid................................. $ 106 $ 127 $ 111 Income taxes paid............................. $ 23 $ 2 $ 28 See Notes to Financial Statements on page 7 6 Independent Auditors' Report J. C. Penney Funding Corporation To the Board of Directors of J. C. Penney Funding Corporation: We have audited the accompanying balance sheets of J. C. Penney Funding Corporation as of January 30, 1999 and January 31, 1998, and the related statements of income, reinvested earnings, and cash flows for each of the years in the three-year period ended January 30, 1999. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of J. C. Penney Funding Corporation as of January 30, 1999 and January 31, 1998, and the results of its operations and its cash flows for each of the years in the three-year period ended January 30, 1999 in conformity with generally accepted accounting principles. /s/ KPMG LLP Dallas, Texas February 25, 1999 - -------------------------------------------------------------------------------- Notes to Financial Statements Nature of Operations - -------------------- J. C. Penney Funding Corporation ("Funding") is a wholly-owned consolidated subsidiary of J. C. Penney Company, Inc. ("JCPenney"). The principal business of Funding consists of financing a portion of JCPenney's operations through loans to JCPenney. To finance its operations, Funding issues commercial paper, which is guaranteed by JCPenney on a subordinated basis, to corporate and institutional investors in the domestic market. Funding has, from time to time, issued long term debt in public and private markets in the United States and abroad. Definition of Fiscal Year Funding's fiscal year ends on the last Saturday in January. Fiscal 1998 ended January 30, 1999, fiscal 1997 ended January 31, 1998, and fiscal 1996 ended January 25, 1997. Fiscal 1997 was a 53- week year and Fiscal 1998 and 1996 were 52-week years. Commercial Paper Placement Funding places commercial paper solely through dealers. The average interest rate on commercial paper at year end 1998, 1997, and 1996 was 5.1%, 5.7%, and 5.5%, respectively. Summary Of Accounting Policies - ------------------------------ Income Taxes Funding's taxable income is included in the consolidated federal income tax return of JCPenney. Income taxes in Funding's statement of income are computed as if Funding filed a separate federal income tax return. Use of Estimates Funding's financial statements have been prepared in conformity with generally accepted accounting principles. Certain amounts included in the financial statements are estimated based on currently available information and management's judgment as to the outcome of future conditions and circumstances. While every effort is made to ensure the integrity of such estimates, including the use of third party specialists where appropriate, actual results could differ from these estimates. New Accounting Rules - -------------------- The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, in June 1997. This statement, which was effective for fiscal years beginning after December 15, 1997, had no impact on Funding as comprehensive income is equal to net income. Loans to JCPenney - ----------------- Funding and JCPenney are parties to a Loan Agreement which provides for unsecured loans, payable on demand, to be made from time to time by Funding to JCPenney for the general business purposes of JCPenney, subject to the terms and conditions of the Loan Agreement. Under the terms of the Loan Agreement, Funding and JCPenney agree upon a mutually-acceptable earnings coverage of Funding's interest and other fixed charges. The earnings to fixed charges ratio has historically been at least one and one-half times. Committed Bank Credit Facilities - -------------------------------- Committed bank credit facilities available to Funding and JCPenney as of January 30, 1999 amounted to $3 billion. The facilities, as amended and restated, support JCPenney's short term borrowing program, and are comprised of a $1.5 billion, 364-day revolver, and a $1.5 billion, five-year revolver. The 364-day revolver includes a $750 million seasonal credit line for the August to January period thus allowing JCPenney to match its seasonal borrowing requirements. There were no outstanding borrowings under these credit facilities at January 30, 1999. Fair Value of Financial Instruments - ----------------------------------- The fair value of short term debt (commercial paper) at January 30, 1999 and January 31, 1998 approximates the amount as reflected on the balance sheet due to its short average maturity. The fair value of loans to JCPenney at January 30, 1999, and January 31, 1998 also approximates the amount reflected on the balance sheet because the loan is payable on demand and the interest charged on the loan balance is adjusted to reflect current market interest rates. 7 Five Year Financial Summary J. C. Penney Funding Corporation ($ in millions)
At Year End 1998 1997 1996 1995 1994 ---------------------------------------------- Capitalization Short term debt Commercial paper.............. $1,924 $1,416 $2,049 $1,482 $2,074 Credit line advance........... -- -- 1,903 -- -- ------ ------ ------ ------ ------ Total short term debt..... 1,924 1,416 3,952 1,482 2,074 Equity of JCPenney................. 1,187 1,152 1,109 1,071 1,028 ------ ------ ------ ------ ------ Total capitalization..................... $3,111 $2,568 $5,061 $2,553 $3,102 ====== ====== ====== ====== ====== Committed bank credit facilities......... $3,000 $3,000 $6,000 $3,000 $2,500 For the Year Income................................... $ 160 $ 193 $ 169 $ 194 $ 143 Expenses................................. $ 106 $ 127 $ 111 $ 128 $ 94 Net income............................... $ 35 $ 43 $ 38 $ 43 $ 32 Fixed charges - times earned............. 1.52 1.52 1.52 1.52 1.52 Peak short term debt..................... $3,117 $4,295 $4,010 $2,771 $2,649 Average debt............................. $1,938 $2,247 $2,041 $2,145 $1,990 Average interest rates................... 5.5% 5.6% 5.5% 5.9% 4.6%
8 Quarterly Data J. C. Penney Funding Corporation ($ in millions) (Unaudited)
First Second Third Fourth ----------------- ------------------- -------------------- ------------------ 1998 1997 1996 1998 1997 1996 1998 1997 1996 1998 1997 1996 ----- ---- ---- ----- ----- ----- ----- ----- ----- ----- ---- ----- Income....................... $ 34 82 32 33 29 33 46 35 36 47 47 68 Expenses..................... $ 22 54 21 22 19 22 30 23 24 32 31 44 Income before taxes.......... $ 12 28 11 11 10 11 16 12 12 15 16 24 Net income................... $ 8 18 7 7 7 7 10 8 8 10 10 16 Fixed charges - times earned............... 1.52 1.52 1.52 1.52 1.52 1.52 1.52 1.52 1.52 1.52 1.52 1.52
Committed Revolving Credit Facilities as of January 30, 1999 Bank of America NT & SA Mellon Bank, N.A. Bank of Hawaii Morgan Guaranty Trust Company The Bank of New York of New York The Bank of Tokyo-Mitsubishi, Ltd. National Australia Bank Limited Bank One, Texas N.A. NationsBank, N.A. BankBoston, N.A. The Northern Trust Company Bankers Trust Company PNC Bank, N.A. Barclays Bank PLC Royal Bank of Canada The Chase Manhattan Bank The Sakura Bank, Ltd. Citibank, N.A. State Street Bank & Trust Company Credit Agricole Indosuez SunTrust Bank, Atlanta Credit Suisse First Boston UMB Bank, N.A. First National Bank of Chicago U.S. Bank National Association First Security Bank of Utah, N.A. Wachovia Bank, N.A. First Union National Bank Wells Fargo Bank, N.A. Firstar Bank Milwaukee, N.A. Fleet National Bank The Fuji Bank, Ltd. Hibernia National Bank Istituto Bancario San Paolo di Torino S.p.A. Marine Midland Bank 9 EX-23 4 INDEPENDENT AUDITORS' CONSENT Exhibit 23 INDEPENDENT AUDITOR'S CONSENT The Board of Directors of J. C. Penney Funding Corporation: We consent to incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-28390, 33-59666, 33-59668, 33-66070, 33-66072, 33-56995, 333-13949, 333-13951, 333-22627, 333-22607, 333-33343, 333-27329, 333-71237) and Form S-3 (No. 333-57019) of J. C. Penney Company, Inc. of our report dated February 25, 1999, relating to the balance sheets of J. C. Penney Funding Corporation as of January 30, 1999 and January 31, 1998, and the related statements of income, reinvested earnings, and cash flows for each of the years in the three-year period ended January 30, 1999, which report is incorporated by reference in the January 30, 1999 Annual Report on Form 10-K of J. C. Penney Funding Corporation. /s/ KPMG LLP Dallas, Texas April 23, 1999 EX-24 5 POWER OF ATTORNEY Exhibit 24 POWER OF ATTORNEY ----------------- Each of the undersigned directors and officers of J. C. PENNEY FUNDING CORPORATION, a Delaware corporation, which is about to file with the Securities and Exchange Commission, Washington, D.C., under the provisions of the Securities Exchange Act of 1934, its Annual Report on Form 10-K for the 52 weeks ended January 30, 1999, hereby constitutes and appoints W. J. Alcorn and R. B. Cavanaugh, and each of them, his or her true and lawful attorneys-in-fact and agents, with full power to act without the other, for him or her and in his or her name, place, and stead, in any and all capacities, to sign said Annual Report, which is about to be filed, and any and all subsequent amendments to said Annual Report, and to file said Annual Report and each subsequent amendment so signed, with all exhibits thereto, and any and all documents in connection therewith, and to appear before the Securities and Exchange Commission in connection with any matter relating to said Annual Report and any subsequent amendments, hereby granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform any and all acts and things requisite and necessary to be done in and about the premises as fully and to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may lawfully do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned have executed this Power of Attorney as of the 23rd day of April, 1999. /s/ R. B. Cavanaugh /s/ W. J. Alcorn - ------------------------------ -------------------------------- R. B. Cavanaugh W. J. Alcorn Chairman of the Board Controller (principal executive officer); (principal accounting officer) Director /s/ S. F. Walsh - ------------------------------ S. F. Walsh President (principal financial officer); Director /s/ D. A. McKay - ---------------------------- D. A. McKay Director EX-27 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND RELATED CONSOLIDATED STATEMENT OF INCOME OF J. C. PENNEY FUNDING CORPORATION AS OF JANUARY 30, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS JAN-30-1999 JAN-30-1999 0 0 3,129 0 0 3,129 0 0 3,129 1,942 0 0 0 145 1,042 3,129 0 0 0 0 0 0 (54) 54 19 35 0 0 0 35 0 0
EX-99 7 EXCERPT FROM JCPENNEY'S 1998 ANNUAL REPORT Exhibit 99 M a n a g e m e n t 's D i s c u s s i o n a n d A n a l y s i s of Financial Condition and Results of Operations
J. C. Penney Company, Inc. - -------------------------------------------------- 52 Weeks 53 Weeks 52 Weeks ($ in millions) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Segment operating profit Department stores and catalog (LIFO) $ 1,013 $ 1,368 $ 1,183 Eckerd drugstores (LIFO) 254 347 99 Direct marketing 233 214 186 - ---------------------------------------------------------------------------------------------------------- Total segments 1,500 1,929 1,468 Other unallocated 26 39 45 Net interest expense and credit operations (480) (547) (278) Amortization of intangible assets (113) (117) (23) Other charges, net 22 (379)(1) (303)(2) Income before income taxes 955 925 909 Income taxes (361) (359) (344) - ---------------------------------------------------------------------------------------------------------- Net income $ 594 $ 566 $ 565 - ----------------------------------------------------------------------------------------------------------
(1) The Company previously reported $447 million (pre-tax) of other charges, net (formerly labeled as restructuring and business integration expenses, net), in 1997. $45 million of this amount has been reclassified as a reduction to drugstore gross margin and $23 million has been reclassified as an increase to department stores and catalog SG&A. (2) The Company previously reported $354 million (pre-tax) of other charges, net, in 1996. $31 million of this amount has been reclassified as a reduction to drugstore gross margin and $20 million has been reclassified as an increase to department stores and catalog SG&A. 12 R e s u l t s o f O p e r a t i o n s Net income in 1998 totaled $594 million, or $2.19 per share, compared with $566 million, or $2.10 per share, in 1997 and $565 million, or $2.25 per share, in 1996. Operating results for 1998 include credits of $13 million, net of tax, or five cents per share, related to the reversal of reserves established in 1997. Operating results for 1997 include $231 million in other charges, net of tax, or 86 cents per share, related principally to an early retirement program, closing of underperforming department stores, and drugstore integration activities. Operating results for 1996 include $196 million in other charges, net of tax, or 79 cents per share, related primarily to drugstore integration activities (see Note 13 to the consolidated financial statements on page 33 for further discussion of the 1997 and 1996 charges). Excluding these items, earnings per share totaled $2.14 in 1998 compared with $2.96 in 1997 and $3.04 in 1996. All references to earnings per share are on a diluted basis. Certain amounts reported as other charges (formerly labeled as restructuring and business integration expenses), net, have been reclassified in this year's report. Charges related to one-time start-up activities have been reclassified to department stores and catalog selling, general, and administrative (SG&A) expenses, and inventory integration losses associated with the Company's drugstore operations have been reclassified to drugstore gross margin. Following is a summary of the reclassifications and their effects on reported earnings per share before other charges: - ------------------------------------------- 1997 1996 ($ in millions, except per share data) $ EPS $ EPS - -------------------------------------------------------------------------------- As previously reported Net income $ 566 $ 2.10 $ 565 $ 2.25 Other charges, net 273 1.02 228 0.92 ------------------------------------- Earnings before other charges, net $ 839 $ 3.12 $ 793 $ 3.17 Reclassifications (net of tax) to: Drugstore gross margin (28) (0.11) (19) (0.08) Department stores and catalog SG&A (14) (0.05) (13) (0.05) ------------------------------------- Total reclassifications (42) (0.16) (32) (0.13) Revised Net income $ 566 $ 2.10 $ 565 $ 2.25 Other charges, net 231 0.86 196 0.79 ------------------------------------- Earnings before other charges, net $ 797 $ 2.96 $ 761 $ 3.04 - -------------------------------------------------------------------------------- The following discussion addresses results of operations on a segment basis. The discussion addresses changes in comparable store sales (those open for more than a year) where appropriate, and changes in costs and expenses as a per cent of sales because 1997 included an extra week. 13 Department stores and catalog - ------------------------------------- 52 Weeks 53 Weeks 52 Weeks ($ in millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Retail sales, net Department stores $ 15,402 $ 16,047 $ 15,734 Catalog 3,929 3,908 3,772 --------------------------------------- Total retail sales, net 19,331 19,955 19,506 - -------------------------------------------------------------------------------- FIFO gross margin 5,697 6,152 5,872 LIFO credit 35 20 20 --------------------------------------- Total gross margin 5,732 6,172 5,892 SG&A expenses (4,719) (4,804) (4,709) - -------------------------------------------------------------------------------- Operating profit $ 1,013 $ 1,368 $ 1,183 - -------------------------------------------------------------------------------- Sales per cent inc/(dec) Department stores(1) (2.8)% 0.7% 5.1% Comparable stores (1.9)% (0.3)% 3.4% Catalog(1) 1.5% 2.7% 0.9% Ratios as a per cent of sales FIFO gross margin 29.5% 30.8% 30.1% LIFO gross margin 29.7% 30.9% 30.2% SG&A expenses 24.4% 24.1% 24.1% LIFO operating profit 5.3% 6.8% 6.1% LIFO EBITDA(2) 8.6% 9.7% 9.0% - -------------------------------------------------------------------------------- (1) Sales comparisons are shown on a 52-week basis for all periods presented. Including 1997's 53rd week, department stores sales declined by 3.9 per cent in 1998 and increased 2.0 per cent in 1997, while catalog sales increased by 0.6 per cent and 3.6 per cent for 1998 and 1997, respectively. (2) Earnings before interest, including interest on operating leases, income taxes, depreciation, and amortization. EBITDA includes finance revenue net of credit operating costs and bad debt. EBITDA is provided as an alternative assessment of operating performance and is not intended to be a substitute for GAAP measurements. Calculations may vary for other companies. 1998 compared with 1997. Operating profit totaled $1,013 million in 1998 compared with $1,368 million in 1997. The decline for the year was primarily attributable to lower sales coupled with lower gross margins. Sales in comparable department stores declined by 1.9 per cent and were especially soft in the fourth quarter. Department store sales were strongest in women's apparel, while athletic apparel and footwear were particularly hard hit by softening sales throughout 1998. Sales were weak across all regions of the country. Catalog sales increased by 1.5 per cent on a 52-week basis and were strongest in the third quarter when they increased by 8.0 per cent. Third quarter catalog sales benefited from participation in department store promotional programs which may have shifted buying patterns for catalog shoppers from the fourth quarter to third quarter. Both department stores and catalog results, although not readily quantifiable, were impacted by disruptions caused by the many organizational and process changes initiated in 1997 and completed in 1998. These changes impacted both the flow of merchandise and store personnel serving customers. LIFO gross margin as a per cent of sales for department stores and catalog declined by 120 basis points compared with 1997, principally as a result of aggressive promotional programs during the fourth quarter. As the fourth quarter progressed, the Company increased promotions to stimulate sales. While this generated unit sales and helped manage inventory levels, it had a negative impact on gross margin as a per cent of sales. Markup improved in 1998 as the Company continued to drive down its merchandise sourcing costs and improved efficiencies with its supplier base. The improvement in markup partially offset the effects of the higher markdowns. Gross margin includes a LIFO credit of $35 million in 1998 and $20 million in 1997. The LIFO credits for both years are generally the result of a combination of flat to declining retail 14 prices as measured by the Company's internally developed inflation index, and improving markup. The Company continued to control its SG&A expense levels throughout 1998. However, they were not leveraged as a per cent of sales due to sales declines, increasing by 30 basis points from prior year levels. In 1998 the Company realized savings of approximately $95 million related to the early retirement and reduction in force programs as well as other cost-saving initiatives. These savings were reinvested in programs designed to enhance customer service in the stores and into advertising and promotional programs. 1997 compared with 1996. Operating profit for department stores and catalog was $1,368 million in 1997, an increase of $185 million, or 15.6 per cent, compared with 1996. The increase in operating profit was principally related to improvements in gross margin and well-managed expense levels. Comparable store sales declined 0.3 per cent for the year compared with 1996. Department store sales were strongest in the first half of the year as the Company emphasized promotional programs designed to reduce its inventory levels. Sales performance in department stores was led by the women's apparel division, particularly dresses and career and casual wear, and the children's and shoe division. Catalog sales for the year increased by 2.7 per cent compared with 1996 on a 52-week basis, and were led by women's and men's apparel as well as the home division. Gross margin for department stores and catalog increased by 70 basis points in 1997 compared with 1996, and included a LIFO credit of $20 million in both 1997 and 1996. SG&A expenses were well managed across all areas, particularly advertising, and were flat as a percentage of sales as compared with 1996. Eckerd drugstores
52 Weeks 53 Weeks 52 Weeks - -------------------------------- 1996(1) ($ in millions) 1998 1997(1) Pro Forma Historical - --------------------------------------------------------------------------------------------------- Retail sales, net $ 10,325 $ 9,663 $ 8,526 $ 3,147 ----------------------------------------------------------------- FIFO gross margin 2,208 2,093 1,870 708 LIFO charge (45) (32) (23) (5) Inventory integration losses (98) (45) (31) (31) ----------------------------------------------------------------- Total gross margin 2,065 2,016 1,816 672 SG&A expenses (1,811) (1,669) (1,510) (573) ----------------------------------------------------------------- Operating profit $ 254 $ 347 $ 306 $ 99 ----------------------------------------------------------------- Sales per cent increase Total sales(2) 8.9% 11.2%(3) 10.3% 100.0+% Comparable stores 9.2% 7.4% 7.8% 7.7% Ratios as a per cent of sales FIFO gross margin 20.4% 21.2% 21.6% 21.5% LIFO gross margin 20.0% 20.9% 21.3% 21.3% SG&A expenses 17.5% 17.3% 17.7% 18.2% LIFO operating profit 2.5% 3.6% 3.6% 3.1% LIFO EBITDA(4) 5.1% 5.8% 5.7% 5.4% -----------------------------------------------------------------
(1) 1997 and 1996 gross margin, operating profit, and EBITDA have been restated to reflect inventory integration charges that were previously reported as part of the Company's other charges. The inventory charges were primarily related to the liquidation of nonconforming merchandise that resulted from conversion of all drugstores to the Eckerd name and format. (2) Sales comparisons are shown on a 52-week basis for all periods presented. Including 1997's 53rd week, drugstore sales increased by 6.9 per cent and 13.3 per cent for 1998 and 1997, respectively. (3) 1997 sales increase is calculated based upon 1996 pro forma sales. (4) Earnings before interest, including interest on operating leases, income taxes, depreciation, and amortization. EBITDA is provided as an alternative assessment of operating performance and is not intended to be a substitute for GAAP measurements. Calculations may vary for other companies. 15 1998 compared with 1997. Operating profit for the Company's drugstore segment totaled $254 million in 1998 compared with $347 million for the prior year. Sales grew at a strong pace throughout the year, increasing by 9.2 per cent for comparable stores. Sales growth was fueled by a 15.0 per cent gain in comparable pharmacy sales, which account for approximately 60 per cent of total store sales. Non-pharmacy merchandise sales increased 1.5 per cent for the year, and strengthened as the year progressed. Sales also benefited from the relocation of 175 stores to more convenient free-standing locations during the year; these relocated stores typically generate sales growth of over 30 per cent. Both 1998 and 1997 included charges related to the liquidation of nonconforming merchandise resulting from the conversion of the former Thrift, Fay's, Kerr, and certain acquired Rite Aid and Revco drugstores into the Eckerd name and format. These charges totaled $98 million in 1998 and $45 million in 1997. Excluding these charges, gross margin declined by 40 basis points in 1998. Gross margin declines were principally attributable to a higher percentage of pharmacy sales, especially managed care sales, which carry lower margins. Approximately 85 per cent of pharmacy sales are processed through managed care providers. Gross margin for non-pharmacy merchandise improved for the year. Gross margin includes a LIFO charge of $45 million in 1998 compared with a $32 million charge last year as a result of continuing inflation in drugstore merchandise, particularly pharmaceuticals. SG&A expenses as a per cent of sales increased by 20 basis points for the year, and were negatively impacted by additional staffing costs in connection with the integration of the various drugstore formats during the first half of the year. In the second half, expenses were leveraged. 1997 compared with 1996. The acquisition of Eckerd Corporation (Eckerd), which was completed in February 1997, transformed the Company's drugstores from a $3 billion to a $9 billion operation. Due to the dramatic increase in the size of the combined operation, management believes that it is more meaningful to compare 1997 operating results to 1996 pro forma operating results, assuming the acquisitions had occurred at the beginning of 1996. The following comments are based upon such a comparison. Historical information is provided in the table on the previous page for reference purposes only. During 1997, Eckerd was heavily involved in the integration of the Company's former drugstore operations into the Eckerd organization. Despite the significant integration activities that were occurring throughout 1997, operating profit increased to $347 million from $306 million in 1996, an increase of $41 million. The improvement was principally related to increased sales volumes and reduced SG&A expenses from the combined operations. Sales growth was strong the entire year, increasing by 11.2 per cent on a 52-week basis and 7.4 per cent on a comparable store basis. Sales improvement was driven by increases in pharmacy sales. Pharmacy sales continue to be positively impacted by growth in managed care sales, which account for approximately 80 per cent of the prescription business. Both 1997 and 1996 included charges related to the liquidation of nonconforming merchandise resulting from the conversion of drugstores to the Eckerd name and format. These charges totaled $45 million in 1997 and $31 million in 1996. Excluding these charges, gross margin declined by 40 basis points as a per cent of sales. The decline in gross margin per cent was primarily attributable to grand reopening promotional activities for the converted regions and growth in the managed care prescription business, which carries lower margins. Gross margin included a $32 million LIFO charge compared with a $23 million charge in 1996, reflecting continued inflation in prescription drug prices. SG&A expenses were well leveraged as a result of higher sales volumes and the elimination of duplicate support functions. For the year, SG&A expenses improved by 40 basis points as a per cent of sales. 16 Direct Marketing - -------------------------------------- ($ in millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Operating revenue Insurance premiums, net $ 872 $ 800 $ 711 Membership fees 65 50 37 Investment income 85 78 70 ------------------------------------------ Total revenue 1,022 928 818 Claims and benefits (340) (332) (298) Other operating expenses(1) (449) (382) (334) - -------------------------------------------------------------------------------- Operating profit $ 233 $ 214 $ 186 - -------------------------------------------------------------------------------- Revenue increase 10.1% 13.4% 20.3% Operating profit increase 8.9% 15.1% 18.5% Operating profit as a per cent of revenue 22.8% 23.1% 22.7% - -------------------------------------------------------------------------------- (1) Includes amortization of deferred acquisition costs of $195 million, $170 million, and $149 million, respectively. In 1998, JCPenney Insurance Group changed its name to J. C. Penney Direct Marketing Services, Inc. (Direct Marketing) to more properly reflect the nature of its business - marketing both insurance and membership services. Direct Marketing's operating profit has been consistently strong, totaling $233 million in 1998 compared with $214 million in 1997 and $186 million in 1996, representing approximately 23 per cent of revenues in each year. Both revenue and operating profit for Direct Marketing improved in 1998 for the eleventh consecutive year. Total revenue exceeded $1 billion for the first time in 1998, increasing from $928 million in 1997 and $818 million in 1996. The increase during both 1998 and 1997 was principally related to health insurance premiums, which account for approximately 70 per cent of total premiums, and which increased by 11.7 per cent and 17.6 per cent, respectively. Revenue growth for the three-year period is attributable to successfully maintaining and enhancing marketing relationships with businesses for the sale of insurance products throughout the United States and Canada, principally banks, oil companies, and retailers. In 1998, Direct Marketing expanded its international operations when it began marketing through business relationships in the United Kingdom and initiated activity in Australia. Membership services, which consist principally of benefits for dental, pharmacy, vision and hearing, as well as services for travelers and motorists represent a small but growing component of the Direct Marketing business. Net interest expense and credit operations - ---------------------------- ($ in millions) 1998 1997 1996 - ------------------------------------------------------------- Revenue $ (702) $ (675) $ (650) Bad debt expense 229 307 238 Operating expenses 342 334 331 Interest expense, net 611 581 359 - ------------------------------------------------------------- Net interest expense and credit operations $ 480 $ 547 $ 278 90-day delinquency rate 3.0% 3.9% 3.7% - ------------------------------------------------------------- Includes amounts related to the Company's retained interest in JCP Master Credit Card Trust. See page 42 for additional information. Net interest expense and credit operations improved by $67 million in 1998 compared with 1997, principally as a result of declines in bad debt expenses. Bad debt expense declined by $78 million for the year as a result of favorable credit industry trends as well as the Company's efforts to tighten credit underwriting standards to improve portfolio performance and reduce risk. At the end of fiscal 1998, 90-day delinquencies were 3.0 per cent of receivables compared with 3.9 per cent at the end of 1997. Higher revenues in 1998 reflect the increase in owned customer receivables from $2,956 million to $3,406 million. Interest expense, net, including financing costs for receivables, inventory, and capital, increased to $611 million from $581 million last year due to higher borrowing levels. Net interest expense and credit operations increased in 1997 compared to 1996, principally as a result of rising bad debt on customer receivables and interest expense on debt related to the drugstore acquisitions. While revenue increased in 1997, primarily as a result of modifications that were made to credit terms in selected states, it was more than offset by an increase of $69 million in bad debt expense. Bad debt expense in both 1997 and 1996 was negatively impacted by high delinquency rates and high levels of personal bankruptcies that were affecting the entire credit industry. The 90-day delinquency rate was 3.9 per cent at the end of 1997 compared with 3.7 per cent at the end of 1996. Interest expense increased in 1997 primarily as a result of $3.0 billion of debt that was issued in connection with the Eckerd acquisition. 17 The Company has experienced a migration of credit sales from its proprietary credit card to third-party cards over the past several years (see Supplemental Data on page 42). The Company has not experienced any significant adverse effects on total credit sales from the decline in proprietary card usage and continues to successfully manage both its proprietary card levels and its relationships with bankcard providers. The decline in receivable balances, however, has had a positive impact on the Company's cash flow. Income taxes. The effective income tax rate in 1998 decreased to 37.8 per cent compared with 38.8 per cent in 1997 and 37.9 per cent in 1996. F I N A N C I A l C O N D I T I O N Cash flow from operating activities was $1,058 million in 1998 compared with $1,218 million in 1997 and $382 million in 1996. Declines in receivable and inventory levels had a positive impact on cash flow for the year. While net income has remained relatively flat in recent years, cash flow has remained strong as a result of the increases in non-cash charges, primarily related to the Eckerd acquisition. 1998 cash flow from operations, adjusted for the effects of receivables financing, was sufficient to fund substantially all of the Company's operating needs - working capital, capital expenditures, and dividends. Management expects cash flow to cover the Company's operating needs for the foreseeable future. Merchandise inventory. Total LIFO inventory was $6,031 million in 1998 compared with $6,162 million in 1997 and $5,722 million in 1996. The increase in 1997 was related to growth within Eckerd drugstores. FIFO merchandise inventory for department stores and catalog was $4,082 million, a decrease of 3.7 per cent on an overall basis and approximately two per cent for comparable stores compared with 1997 levels as the Company continued to focus on improving its merchandise procurement processes and increasing inventory turnover. Eckerd FIFO merchandise inventory was $2,176 million, an increase of 1.3 per cent compared with the prior year. It is anticipated that Eckerd inventories will grow as a result of its store expansion plans and its strategy to relocate older strip center stores to free-standing locations. Properties. Property, plant, and equipment, net of accumulated depreciation, totaled $5,458 million at January 30, 1999, compared with $5,329 million and $5,014 million at the ends of fiscal 1997 and 1996, respectively. At the end of 1998, the Company operated 1,148 JCPenney department stores, comprising 115.3 million gross square feet. The decline in the store count over the past two years was principally related to the closing of underperforming stores that was a component of the Company's 1997 other charges. All stores slated for closing had closed by the end of fiscal 1998. In addition, the Company operated 2,756 Eckerd drugstores as of the end of fiscal 1998, comprising 27.6 million square feet. Eckerd store counts have declined as a result of closing underperforming and overlapping stores during the conversion of former drugstore formats to Eckerd. Capital expenditures - ------------------------ ($ in millions) 1998 1997 1996 - ------------------------------------------------------ Department stores and catalog $ 420 $ 443 $ 636 Eckerd drugstores 256 341 103 Other corporate 20 26 51 ------------------------------ Total $ 696 $ 810 $ 790 - ------------------------------------------------------ 1998 capital spending levels for property, plant, and equipment declined for both department stores and catalog and Eckerd drugstores. In 1998, the Company spent approximately $150 million on existing department store locations compared with approximately $200 million in both 1997 and 1996. It is expected that capital spending for department stores and catalog will total approximately $300 million in 1999. Capital spending for drugstores declined in 1998 by $85 million. Capital spending levels in 1997 included additional capital requirements needed to support the conversion of drugstores to the Eckerd name and format. During 1998, Eckerd added 256 new, relocated, and acquired stores and expects to add an additional 275 in 1999, excluding the Genovese acquisition. Capital spending in 1999 is projected at approximately $300 million, with the majority of the spending related to the new and relocated stores. Total capital spending for 1999 is currently projected at approximately $650 million. 18 Acquisitions. The Company completed the acquisition of a majority interest in Lojas Renner S.A. (Renner), a 21-store Brazilian department store chain, in January 1999. The total purchase price of $139 million is being allocated to assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over fair value is expected to be $58 million and is included in intangible assets in the consolidated balance sheets. The acquisition is being accounted for under the purchase method. Renner is a calendar year company, and therefore their results will be included with Company results of operations beginning in fiscal 1999. During fiscal 1998, Direct Marketing formed Quest Membership Services, Inc. and acquired certain assets to expand its membership services operation to include travel services. In addition, Direct Marketing acquired Insurance Consultants, Inc. which strengthens its access to other business relationships. The total purchase price for the two acquisitions was approximately $72 million. Intangible assets. At the end of 1998, goodwill and other intangible assets, net, totalled $2,933 million compared with $2,940 million in 1997 and $1,861 million in 1996. Intangible assets consist principally of favorable lease rights, prescription files, software, trade name, and goodwill. They represent the excess of the purchase price over the fair value of assets received in the Company's drugstore acquisitions. The increase in 1997 was related to the completion of the Eckerd acquisition in February 1997. Reserves. At the end of 1998, the consolidated balance sheet included reserves totaling $110 million which are included as a component of accounts payable and accrued expenses and $25 million in receivables, net. These reserves were established in connection with 1996 and 1997 restructuring charges, principally those related to drugstore integration activities and the closing of underperforming department stores. The reserves consisted principally of the present value of future lease obligations for closed stores and for severance and outplacement costs related to a reduction in force program. Reserve balances were calculated based upon estimated costs to complete the various programs. Actual costs were below the original estimates for the reduction in force program and closing of underperforming stores. Consequently, reserves were adjusted in the fourth quarter of 1998, resulting in a pre-tax credit of $22 million that is reported as other charges, net. Reserve balances were reduced by $84 million in 1998 for cash payments made during the year. Also, in connection with the Company's early retirement program, reserves were established for the periodic future payments to be made under the Company's pension plans. These reserves are included in pension liabilities which are discussed in Note 12 to the consolidated financial statements, Retirement Plans, on page 32. Payments for both lease obligations and pension benefits will be paid out over an extended period of time. See Note 13, Other Charges, Net, on page 33 for additional information. Debt to capital 1998 1997 1996 - --------------------------------------------------------------- Debt to capital per cent 62.7%* 60.4% 64.5%** - --------------------------------------------------------------- * Upon completion of the Genovese Drug Stores, Inc. acquisition, the debt to capital ratio declined to 61.9 per cent. ** Upon completion of the Eckerd acquisition, the debt to capital ratio declined to 60.1 per cent. The Company's debt to capital per cent, assuming completion of the drugstore acquisitions, has increased over the past three years. The Company expects the debt to capital ratio to improve over the next several years. During the fourth quarter of 1998, JCP Receivables, Inc., an indirect wholly owned special purpose subsidiary of the Company, completed a public offering of $650 million aggregate principal amount of 5.5 per cent Series E asset-backed securities of the JCP Master Credit Card Trust. In addition, the Company retired $449 million of debt at the normal maturity date during the year, including the debt associated with the Company's ESOP. In 1997's first quarter, the Company issued $3.0 billion of long-term debt, which principally represented a conversion of short-term debt that had been issued in 1996 in connection with the initial phase of the Eckerd acquisition. The average effective interest rate on the debt issued in 1997 was 7.5 per cent and the average maturity was 30 years. Total debt, both on and off-balance-sheet, was $12,044 million at the end of 1998 compared with $11,237 million in 1997 and $10,807 million in 1996. During the past three years, the Company has issued 28.4 million shares of common stock related to its drugstore acquisitions. The Company repurchased 5.0 million shares of its common stock in the fourth quarter of 1998 for $270 million and 7.5 million shares in 1996 for $366 million as part of previously approved share repurchase programs. The Company has the authority to repurchase an additional 5.0 million shares under these programs. 19 Year 2000 readiness. The Year 2000 issue exists because many computer systems store and process dates using only the last two digits of the year. Such systems, if not changed, may interpret "00" as "1900" instead of the year "2000." The Company has been working to identify and address Year 2000 issues since January 1995. The scope of this effort includes internally developed information technology systems, purchased and leased software, embedded systems, and electronic data interchange transaction processing. In October 1996, a companywide task force was formed to provide guidance to the Company's operating and support departments and to monitor the progress of efforts to address Year 2000 issues. The Company has also consulted with various third parties, including, but not limited to, outside consultants, outside service providers, infrastructure suppliers, industry groups, and other retail companies and associations to develop industrywide approaches to the Year 2000 issue, to gain insights to problems, and to provide additional perspectives on solutions. Year 2000 readiness work was more than 90 per cent complete as of January 30, 1999. Since January 1999, the Company has been retesting all systems critical to the Company's core businesses. The Company has also focused on the Year 2000 readiness of its suppliers and service providers, both independently and in conjunction with the National Retail Federation. Despite the significant efforts to address Year 2000 concerns, the Company could potentially experience disruptions to some of its operations, including those resulting from noncompliant systems used by third-party business and governmental entities. The Company has developed contingency plans to address potential Year 2000 disruptions. These plans include business continuity plans that address accessibility and functionality of Company facilities as well as steps to be taken if an event causes failure of a system critical to the Company's core business activities. Through the end of fiscal 1998, the Company had incurred approximately $32 million to achieve Year 2000 compliance, including approximately $9 million related to capital projects. The Company's projected cost for Year 2000 remediation is currently estimated to be $46 million. Total costs have not had, and are not expected to have, a material impact on the Company's financial results. Inflation and changing prices. Inflation and changing prices have not had a significant impact on the Company in recent years due to low levels of inflation. Subsequent events. In February 1999, the Company redeemed approximately $199 million principal amount of 9.25 per cent of Eckerd notes that had an original maturity date in 2004. On March 1, 1999, the Company completed the acquisition of Genovese Drug Stores, Inc. (Genovese), a 141-drugstore chain with locations in New York, New Jersey, and Connecticut, with 1998 sales of approximately $800 million. The acquisition was accomplished through an exchange of approximately 9.6 million shares of JCPenney common stock for the outstanding shares of Genovese, and the conversion of outstanding Genovese stock options into approximately 550 thousand common stock options of the Company. The total value of the transaction, including the assumption of approximately $65 million of debt, was approximately $420 million. The purchase price will be allocated to assets acquired and liabilities assumed based on their estimated fair values, as well as intangible assets acquired, primarily prescription files and favorable lease rights. The excess purchase price over the fair value of assets acquired and liabilities assumed will be classified as goodwill and amortized over 40 years. The acquisition will be accounted for under the purchase method. 20 COMPANY STATEMENT ON FINANCIAL INFORMATION The Company is responsible for the information presented in this Annual Report. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and present fairly, in all material respects, the Company's results of operations, financial position, and cash flows. Certain amounts included in the consolidated financial statements are estimated based on currently available information and judgment as to the outcome of future conditions and circumstances. Financial information elsewhere in this Annual Report is consistent with that in the consolidated financial statements. The Company's system of internal controls is supported by written policies and procedures and supplemented by a staff of internal auditors. This system is designed to provide reasonable assurance, at suitable costs, that assets are safeguarded and that transactions are executed in accordance with appropriate authorization, and are recorded and reported properly. The system is continually reviewed, evaluated, and where appropriate, modified to accommodate current conditions. Emphasis is placed on the careful selection, training, and development of professional managers. An organizational alignment that is premised upon appropriate delegation of authority and division of responsibility is fundamental to this system. Communication programs are aimed at assuring that established policies and procedures are disseminated and understood throughout the Company. The consolidated financial statements have been audited by independent auditors whose report appears to the right. Their audit was conducted in accordance with generally accepted auditing standards, which include the consideration of the Company's internal controls to the extent necessary to form an independent opinion on the consolidated financial statements prepared by management. The Audit Committee of the Board of Directors is composed solely of directors who are not officers or employees of the Company. The Audit Committee's responsibilities include recommending to the Board for stockholder approval the independent auditors for the annual audit of the Company's consolidated financial statements. The Committee also reviews the independent auditors' audit strategy and plan, scope, fees, audit results, and non-audit services and related fees; internal audit reports on the adequacy of internal controls; the Company's ethics program; status of significant legal matters; the scope of the internal auditors' plans and budget and results of their audits; and the effectiveness of the Company's program for correcting audit findings. The independent auditors and Company personnel, including internal auditors, meet periodically with the Audit Committee to discuss auditing and financial reporting matters. /s/ Donald A. McKay Donald A. McKay Executive Vice President and Chief Financial Officer INDEPENDENT AUDITORS' REPORT To the Stockholders and Board of Directors of J. C. Penney Company, Inc.: We have audited the accompanying consolidated balance sheets of J. C. Penney Company, Inc. and Subsidiaries as of January 30, 1999, and January 31, 1998, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended January 30, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of J. C. Penney Company, Inc. and Subsidiaries as of January 30, 1999, and January 31, 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended January 30, 1999, in conformity with generally accepted accounting principles. KPMG LLP KPMG LLP Dallas, Texas February 25, 1999 21 CONSOLIDATED STATEMENTS OF INCOME J. C. Penney Company, Inc. and Subsidiaries
- ------------------------------------------------------ ($ in millions) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Revenue Retail sales, net $ 29,656 $ 29,618 $ 22,653 Direct marketing revenue 1,022 928 818 -------------------------------------------------- Total revenue 30,678 30,546 23,471 Costs and expenses Cost of goods sold 21,761 21,385 16,058 Drugstore inventory integration losses 98 45 31 -------------------------------------------------- Total cost of goods sold 21,859 21,430 16,089 Selling, general, and administrative expenses 6,530 6,473 5,282 Costs and expenses of Direct Marketing 789 714 632 Other unallocated (26) (39) (45) Net interest expense and credit operations 480 547 278 Amortization of intangible assets 113 117 23 Other charges, net (22) 379 303 -------------------------------------------------- Total costs and expenses 29,723 29,621 22,562 -------------------------------------------------- Income before income taxes 955 925 909 Income taxes 361 359 344 - --------------------------------------------------------------------------------------------------------- Net income $ 594 $ 566 $ 565 - --------------------------------------------------------------------------------------------------------- Earnings per common share - ------------------------------------------------------ Average (in millions, except per share data) Income Shares EPS - --------------------------------------------------------------------------------------------------------- 1998 Net income $ 594 Less preferred stock dividends (38) --------------------------------------------------- Basic EPS 556 253 $ 2.20 Stock options and convertible preferred stock 37 18 - --------------------------------------------------------------------------------------------------------- Diluted EPS $ 593 271 $ 2.19 - --------------------------------------------------------------------------------------------------------- 1997 Net income $ 566 Less preferred stock dividends (40) --------------------------------------------------- Basic EPS 526 247 $ 2.13 Stock options and convertible preferred stock 36 21 - --------------------------------------------------------------------------------------------------------- Diluted EPS $ 562 268 $ 2.10 - --------------------------------------------------------------------------------------------------------- 1996 Net income $ 565 Less preferred stock dividends (40) --------------------------------------------------- Basic EPS 525 226 $ 2.32 Stock options and convertible preferred stock 35 22 - --------------------------------------------------------------------------------------------------------- Diluted EPS $ 560 248 $ 2.25 - ---------------------------------------------------------------------------------------------------------
See Notes to the Consolidated Financial Statements on pages 26 through 39. 22 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY J. C. Penney Company, Inc. and Subsidiaries
Accumulated Guaranteed Other Total - ----------------------- Common Preferred LESOP Reinvested Comprehensive Stockholders' ($ in millions) Stock Stock Obligation Earnings Income/(Loss)(1) Equity - ------------------------------------------------------------------------------------------------------------ January 27, 1996 $ 1,112 $ 603 $ (228) $ 4,339 $ 58 $ 5,884 - ------------------------------------------------------------------------------------------------------------ Net income 565 565 Net unrealized change in investments (18) (18) Currency translation adjustments (3) (3) ----------------------------------------------------------------------------------- Total comprehensive income 565 (21) 544 Dividends declared (511) (511) Common stock issued 350 350 Common stock retired (46) (320) (366) Preferred stock retired (35) (35) LESOP payment 86 86 - ------------------------------------------------------------------------------------------------------------ January 25, 1997 1,416 568 (142) 4,073 37 5,952 - ------------------------------------------------------------------------------------------------------------ Net income 566 566 Net unrealized change in investments 14 14 Currency translation adjustments (3) (3) ----------------------------------------------------------------------------------- Total comprehensive income 566 11 577 Dividends declared (573) (573) Common stock issued 1,350 1,350 Preferred stock retired (42) (42) LESOP payment 93 93 - ------------------------------------------------------------------------------------------------------------ January 31, 1998 2,766 526 (49) 4,066 48 7,357 - ------------------------------------------------------------------------------------------------------------ Net income 594 594 Net unrealized change in investments (1) (1) Currency translation adjustments(2) (61) (61) ----------------------------------------------------------------------------------- Total comprehensive income 594 (62) 532 Dividends declared (588) (588) Common stock issued 140 140 Common stock retired (56) (214) (270) Preferred stock retired (51) (51) LESOP payment 49 49 - ------------------------------------------------------------------------------------------------------------ January 30, 1999 $ 2,850 $ 475 $ - $ 3,858 $ (14) $ 7,169 - ------------------------------------------------------------------------------------------------------------
(1) Net unrealized changes in investment securities are shown net of deferred taxes of $36 million, $39 million, and $30 million, respectively. A deferred tax asset has not been established for currency translation adjustments. (2) 1998 currency translation adjustments include $(49) million associated with assets acquired and liabilities assumed in the purchase of Renner. See Notes to the Consolidated Financial Statements on pages 26 through 39. 23 CONSOLIDATED BALANCE SHEETS J. C. Penney Company, Inc. and Subsidiaries
- ---------------------------------------------------------------------- ($ in millions) 1998 1997 - --------------------------------------------------------------------------------------------------------- Assets Current assets Cash (including short-term investments of $95 and $208) $ 96 $ 287 Retained interest in JCP Master Credit Card Trust 415 1,073 Receivables, net (bad debt reserve of $149 and $135) 4,415 3,819 Merchandise inventory (including LIFO reserves of $227 and $225) 6,031 6,162 Prepaid expenses 168 143 ---------------------------------- Total current assets 11,125 11,484 Property, plant, and equipment Land and buildings 3,109 2,993 Furniture and fixtures 4,045 4,089 Leasehold improvements 1,179 1,192 Accumulated depreciation (2,875) (2,945) ---------------------------------- Property, plant, and equipment, net 5,458 5,329 Investments, principally held by Direct Marketing 1,961 1,774 Deferred policy acquisition costs 847 752 Goodwill and other intangible assets, net (accumulated amortization of $221 and $108) 2,933 2,940 Other assets 1,314 1,214 - --------------------------------------------------------------------------------------------------------- Total Assets $ 23,638 $ 23,493 - --------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity Current liabilities Accounts payable and accrued expenses $ 3,465 $ 4,059 Short-term debt 1,924 1,417 Current maturities of long-term debt 438 449 Deferred taxes 143 116 ---------------------------------- Total current liabilities 5,970 6,041 Long-term debt 7,143 6,986 Deferred taxes 1,517 1,325 Insurance policy and claims reserves 946 872 Other liabilities 893 912 ---------------------------------- Total Liabilities 16,469 16,136 Stockholders' Equity Preferred stock: authorized, 25 million shares; issued and outstanding, 0.8 million and 0.9 million shares Series B ESOP Convertible Preferred 475 526 Guaranteed LESOP obligation - (49) Common stock, par value 50 cents: authorized, 1,250 million shares; issued and outstanding 250 million and 251 million shares 2,850 2,766 Reinvested earnings 3,858 4,066 Accumulated other comprehensive income/(loss) (14) 48 ---------------------------------- Total Stockholders' Equity 7,169 7,357 - --------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 23,638 $ 23,493 - ---------------------------------------------------------------------------------------------------------
See Notes to the Consolidated Financial Statements on pages 26 through 39. 24 CONSOLIDATED STATEMENTS OF CASH FLOWS J. C. Penney Company, Inc. and Subsidiaries
- ---------------------------------------------------- ($ in millions) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 594 $ 566 $ 565 Gain on the sale of banking assets - (52) - Other charges, net (22) 371 310 Depreciation and amortization, including intangible assets 637 584 381 Deferred taxes 219 1 (18) Change in cash from: Customer receivables 258 215 (172) Inventory, net of trade payables 64 (395) (521) Current taxes payable (171) 116 31 Other assets and liabilities, net (521)(1) (188) (194) ----------------------------------------------------- 1,058 1,218 382 - --------------------------------------------------------------------------------------------------------- Investing Activities Capital expenditures (744) (824) (704) Proceeds from the sale of banking assets, net - 276 - Acquisitions(2) (247) - (1,776) Purchase of investment securities (611) (401) (471) Proceeds from the sale of investment securities 447 252 493 ----------------------------------------------------- (1,155) (697) (2,458) - --------------------------------------------------------------------------------------------------------- Financing Activities Change in short-term debt 507 (2,533) 2,401 Proceeds from the issuance of long-term debt 644 2,990 596 Payment of long-term debt (478) (343) (133) Common stock issued, net 89 79 33 Common stock purchased and retired (270) - (366) Dividends paid, preferred and common (586) (558) (497) ----------------------------------------------------- (94) (365) 2,034 - --------------------------------------------------------------------------------------------------------- Net Increase/(Decrease) in Cash and Short-Term Investments (191) 156 (42) Cash and short-term investments at beginning of year 287 131 173 - --------------------------------------------------------------------------------------------------------- Cash and Short-Term Investments at End of Year $ 96 $ 287 $ 131 - --------------------------------------------------------------------------------------------------------- Supplemental Cash Flow Information Interest paid $ 649 $ 571 $ 390 Interest received 45 71 60 Income taxes paid 307 225 356 - ---------------------------------------------------------------------------------------------------------
(1) The increase in other assets and liabilities, net, is principally related to increases in Eckerd receivables and payments related to reserves established in 1997. (2) Reflects total cash changes related to acquisitions. Non-cash transactions: In 1997, the Company issued 23.2 million shares of common stock having a value of $1.3 billion to complete the acquisition of Eckerd. In 1996, the Company issued 5.2 million shares of common stock having a value of $278 million for the acquisition of Fay's Incorporated. See Notes to the Consolidated Financial Statements on pages 26 through 39. 25 Notes to the Consolidated Financial Statements 1 Summary of Accounting Policies 2 Retained Interest in JCP Master Credit Card Trust 3 Investments and Fair Value of Financial Instruments 4 Accounts Payable and Accrued Expenses 5 Short-Term Debt 6 Long-Term Debt 7 Capital Stock 8 Stock-Based Compensation 9 Interest Expense, Net 10 Lease Commitments 11 Advertising Costs 12 Retirement Plans 13 Other Charges, Net 14 Taxes 15 Segment Reporting 26 1 SUMMARY OF ACCOUNTING POLICIES Basis of presentation. Certain prior year amounts have been reclassified to conform to the current year presentation. Basis of consolidation. The consolidated financial statements present the results of J. C. Penney Company, Inc. and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Definition of fiscal year. The Company's fiscal year ends on the last Saturday in January. Fiscal 1998 ended January 30, 1999; fiscal 1997 ended January 31, 1998; and fiscal 1996 ended January 25, 1997. Fiscal 1997 was a 53-week year; fiscal 1998 and 1996 were 52-week years. The accounts of Direct Marketing and Renner are on a calendar-year basis. Retail sales, net. Retail sales include merchandise and services, net of returns, and exclude all taxes. Direct marketing revenue. Premium income for life insurance contracts is recognized as income when due. Premium income for accident and health, and credit insurance and membership services income is reported as earned over the coverage period. Premiums and fees paid in advance are deferred and recognized as income over the coverage period. Earnings per common share. Basic earnings per share is computed by dividing net income less dividend requirements on the Series B ESOP convertible preferred stock, net of tax, by the weighted average common stock outstanding. Diluted earnings per share assumes the exercise of stock options and the conversion of the Series B ESOP convertible preferred stock into the Company's common stock. Additionally, it assumes adjustment of net income for the additional cash requirements, net of tax, needed to fund the ESOP debt service resulting from the assumed replacement of the preferred dividends with common stock dividends. Cash and short-term investments. The Company's short-term investments are comprised principally of commercial paper which has a maturity at the acquisition date of less than three months. All other securities are classified as investments on the consolidated balance sheets. Accounts receivable. The Company's policy is to write off accounts when the scheduled minimum payment has not been received for six consecutive months, if any portion of the balance is more than 12 months past due, or if it is otherwise determined that the customer is unable to pay. Collection efforts continue subsequent to write-off, and recoveries are applied as a reduction of bad debt losses. Merchandise inventory. Substantially all merchandise inventory is valued at the lower of cost (last-in, first-out) or market, determined by the retail method. The Company determines the lower of cost or market on an aggregated basis for similar types of merchandise. The Company applies internally developed indices to measure increases and decreases in its own retail prices. Depreciation and amortization. All long-lived assets are amortized on a straight-line basis over their respective useful lives. The primary useful life for buildings is 50 years, and ranges from three to 20 years for furniture and equipment. Improvements to leased premises are amortized over the expected term of the lease or their estimated useful lives, whichever is shorter. Trade name and goodwill are generally amortized over 40 years. Other intangible assets, whose fair value is determined at the date of acquisition, are amortized over periods ranging from five to seven years. Impairment of assets. The Company assesses the recoverability of asset values, including goodwill and other intangible assets, on a periodic basis by comparing expected cash flows to net book value. Impaired assets are written down to estimated fair value. Deferred charges. Deferred policy acquisition and advertising costs, principally solicitation and marketing costs and commissions, incurred by Direct Marketing to secure new business are amortized over the expected premium-paying period of the related policies and over the expected period of benefits for memberships. Capitalized software costs. Costs associated with the acquisition or development of software for internal use are capitalized and amortized over the expected useful life of the software. The amortization period generally ranges from three to 10 years. Investments. The Company's investments are classified as available-for-sale and are carried at fair value. Changes in unrealized gains and losses are included in other comprehensive income, net of applicable income taxes. Insurance policy reserves. Liabilities established by Direct Marketing for future policy benefits are computed using a net level premium method including assumptions as to investment yields, mortality, morbidity, and persistency based on the Company's experience. Advertising. Costs for newspaper, television, radio, and other media advertising are expensed as incurred. Catalog book preparation and printing costs, which are considered direct response advertising, are charged to expense over the life of the catalog, not to exceed six months. 27 Pre-opening expenses. Costs associated with the opening of new stores are expensed in the period incurred. Derivative financial instruments. The Company selectively uses non-leveraged, off-balance-sheet derivative instruments to manage its market and interest rate risk, and does not hold derivative positions for trading purposes. The current derivative position consists of a non-leveraged, off-balance-sheet interest rate swap which is accounted for by recording the net interest received or paid as an adjustment to interest expense on a current basis. Gains or losses resulting from market movements are not recognized. Use of estimates. Certain amounts included in the Company's consolidated financial statements are based upon estimates. Actual results may differ from these estimates. New accounting rules. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards (FAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, in June 1998. The new rules are effective for quarters beginning after June 15, 1999. The Company has a limited exposure to derivative products and does not expect these new rules to have a material impact on reported results. The American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, in March 1998. The Company adopted the new rules in 1998 and capitalized approximately $20 million of software development costs during the year. Due to the significance of systems development costs, it is expected that capitalized software costs will increase over the next several years. The AICPA also issued SOP No. 98-5, Reporting on the Costs of Start-Up Activities, in April 1998. The Company adopted the new accounting rules in 1998. The new rules require that start-up costs, including store pre-opening expenses, be expensed as incurred. The Company's existing accounting policy conforms with the new rules; accordingly, there was no impact on the Company's results of operation. 2 RETAINED INTEREST IN JCP MASTER CREDIT CARD TRUST The Company has transferred portions of its customer receivables to a trust which, in turn, has sold certificates in public offerings representing undivided interests in the trust. As of January 30, 1999, $1,143 million of the certificates were outstanding and the balance of the receivables in the trust was $1,578 million. The Company owns the remaining undivided interest in the trust not represented by the certificates. The retained interest in the trust is accounted for as an investment in accordance with FAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The carrying value of $415 million in 1998 and $1,073 million in 1997 includes a valuation reserve of $15 million and $40 million, respectively. Due to the short-term nature of this investment, the carrying value approximates fair value. 3 INVESTMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS 1998 1997 - ----------------------------------------------------------------------------- Amortized Fair Amortized Fair ($ in millions) Cost Value Cost Value - ----------------------------------------------------------------------------- Fixed income securities $ 1,269 $ 1,322 $ 1,126 $ 1,167 Asset-backed certificates 431 449 431 459 Equity securities 159 190 113 148 - ----------------------------------------------------------------------------- Total $ 1,859 $ 1,961 $ 1,670 $ 1,774 - ----------------------------------------------------------------------------- Investments. The Company's investments are recorded at fair value based on quoted market prices and consist principally of fixed income and equity securities, substantially all of which are held by Direct Marketing, and asset-backed certificates. The majority of the fixed income securities mature during the next ten years. Unrealized gains and losses are included in stockholders' equity, net of tax, and are shown as a component of other comprehensive income. Financial liabilities. Financial liabilities are recorded in the consolidated balance sheets at historical cost, which approximates fair value. Such fair values are not necessarily indicative of actual market transactions. The fair value of long-term debt, excluding capital leases, is based on the interest rate environment and the Company's credit rating. All long-term debt is fixed rate and therefore the Company is not exposed to fluctuations in market rates except to the extent described in the following paragraph. Derivative financial instruments. The Company's current derivative position consists of one interest rate swap which was entered into in connection with the issuance of asset-backed certificates in 1990. This swap helps to protect certificate holders by reducing the effects of an early amortization of the 28 principal. According to the terms of the swap, the Company pays fixed interest at 9.625 per cent and receives variable interest based on floating commercial paper rates. The Company's total exposure resulting from the swap is not material. As discussed in Note 1, the net amount paid or received is included in interest expense. Concentrations of credit risk. The Company has no significant concentrations of credit risk. Individual accounts comprising accounts receivable are widely dispersed and investments are well diversified. 4 ACCOUNTS PAYABLE AND ACCRUED EXPENSES - ------------------------------------------------- ($ in millions) 1998 1997 - ------------------------------------------------------------------------- Trade payables $ 1,496 $ 1,551 Accrued salaries, vacation, and bonus 444 487 Taxes payable 232 486 Interest payable 165 165 Common dividends payable 140 136 Other(1) 988 1,234 - ------------------------------------------------------------------------- Total $ 3,465 $ 4,059 - ------------------------------------------------------------------------- (1) Includes $110 million and $216 million for 1998 and 1997, respectively, related to other charges, principally future lease obligations. 5 SHORT-TERM DEBT - ------------------------------------------------- ($ in millions) 1998 1997 - ------------------------------------------------------------------------- Commercial paper $ 1,924 $ 1,417 Average interest rate at year-end 5.1% 5.6% - ------------------------------------------------------------------------- Committed bank credit facilities available to the Company as of January 30, 1999 totaled $3.0 billion. The facilities, as amended and restated in 1998, support the Company's short-term borrowing program and are comprised of a $1.5 billion, 364-day revolver and a $1.5 billion, five-year revolver. The 364-day revolver includes a $750 million seasonal credit line for the August to January period, allowing the Company to match its seasonal borrowing requirements. None of the borrowing facilities was in use as of January 30, 1999. The Company also has $910 million of uncommitted credit lines in the form of letters of credit with seven banks to support its direct import merchandise program. As of January 30, 1999, $280 million of letters of credit issued by the Company were outstanding. 6 LONG-TERM DEBT Jan. 30, 1999 Jan. 31, 1998 - ----------------------- Avg. Avg. ($ in millions) Rate Balance Rate Balance - ------------------------------------------------------------ Notes and debentures Due Year 1 8.0% $ 424 5.4% $ 400 Due Year 2 6.7% 625 6.9% 225 Due Year 3 9.1% 250 6.7% 625 Due Year 4 7.5% 1,100 9.1% 250 Due Year 5 5.8% 1,000 7.5% 1,100 Due 6-10 years 8.0% 1,441 7.8% 1,760 Due 11-15 years 9.0% 125 8.0% 325 Due 16-20 years 7.6% 767 7.7% 780 Due 21-30 years 7.5% 875 7.5% 887 Due thereafter 7.5% 900 7.5% 900 ------------------------------------- Total notes and debentures 7.4% 7,507 7.5% 7,252 Guaranteed LESOP notes, due 1998 - 49 Capital lease obligations and other 74 134 Less current maturities (438) (449) - ------------------------------------------------------------ Total long-term debt $ 7,143 $ 6,986 - ------------------------------------------------------------ During 1998, JCP Receivables, Inc., an indirect wholly owned special purpose subsidiary of the Company, completed a public offering of $650 million aggregate principal amount of Series E asset-backed certificates of JCPenney Master Credit Card Trust. The certificates have a maturity of five years and an interest rate of 5.5 per cent. This transaction did not meet the criteria for sale accounting under FAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, and accordingly it was recorded as a secured borrowing by the Company. Proceeds from the offering were used for general corporate purposes. In 1997, the Company issued $3.0 billion of debt in connection with its drugstore acquisitions. These notes and debentures had an average maturity of 30 years and an average interest rate of 7.5 per cent. All notes and debentures have similar characteristics regardless of due date and therefore are grouped by maturity date. 29 7 CAPITAL STOCK At January 30, 1999, there were approximately 56 thousand stockholders of record. On a combined basis, the Company's savings plans, including the Company's employee stock ownership plan (ESOP), held 43.4 million shares of common stock, or 16.3 per cent of the Company's common shares after giving effect to the conversion of preferred stock. Common stock. The Company has authorized 1,250 million shares, par value $.50; 250 million shares were issued and outstanding as of January 30, 1999, and 251 million shares were issued and outstanding as of January 31, 1998. Preferred stock. The Company has authorized 25 million shares; 792 thousand shares of Series B ESOP Convertible Preferred Stock were issued and outstanding as of January 30, 1999, and 876 thousand shares were issued and outstanding as of January 31, 1998. Each share is convertible into 20 shares of the Company's common stock at $30 per common share. Dividends are cumulative and are payable semi-annually at a rate of $2.37 per common share equivalent, a yield of 7.9 per cent. Shares may be redeemed at the option of the Company or the ESOP under certain circumstances. The redemption price may be satisfied in cash or common stock or a combination of both, at the Company's sole discretion. Preferred stock purchase rights. In March 1999, the Board of Directors declared a dividend distribution of one preferred stock purchase right on each outstanding share of common stock in connection with the redemption of the Company's then existing preferred stock purchase rights program. These rights entitle the holder to purchase, for each right held, 1/1000 of a share of Series A Junior Participating Preferred Stock at a price of $140. The rights are exercisable by the holder upon the occurrence of certain events and are redeemable by the Company under certain circumstances as described by the rights agreement. The rights agreement contains a three-year independent director evaluation provision. This "TIDE" feature provides that a committee of the Company's independent directors will review the rights agreement at least every three years and, if they deem it appropriate, may recommend to the Board a modification or termination of the rights agreement. 8 STOCK-BASED COMPENSATION The Company has a stock-based compensation plan which was approved by stockholders in 1997. The plan reserved 14 million shares of common stock for issuance to plan participants upon the exercise of options over the 10-year term of the plan. Approximately 2,000 employees, comprised principally of selected management employees, are eligible to participate. Both the number of shares and the exercise price, which is based on the average market price, are fixed at the date of grant and have a maximum term of 10 years. The plan also provides for grants of stock options and stock awards to outside members of the Board of Directors. Shares acquired by such directors are not transferable until a director terminates service. The Company accounts for stock-based compensation under the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, net income and earnings per share shown in the consolidated statements of income appearing on page 22 do not reflect any compensation cost for the Company's fixed stock options. In accordance with FAS No. 123, Accounting for Stock-Based Compensation, the fair value of each fixed option granted is estimated on the date of grant using the Black-Scholes option pricing model, as follows: Option assumptions 1998 1997 1996 - ---------------------------------------------------------- Dividend yield 3.8% 4.0% 3.9% Expected volatility 20.5% 21.3% 22.3% Risk-free interest rate 5.7% 6.3% 5.6% Expected option term 6 years 6 years 5 years Fair value per share of options granted $ 13.66 $ 9.76 $ 8.88 - ---------------------------------------------------------- Compensation expense recorded under FAS No. 123 would have been approximately $21 million in 1998 and $11 million in 1997 and 1996, reducing earnings per share by eight cents in 1998, and approximately four cents in the other two years. The following table summarizes the status of the Company's fixed stock option plans for the years ended January 30, 1999, January 31, 1998, and January 25, 1997: 30 Options
- -------------------------------- (shares in thousands; price 1998 1997 1996 is weighted average) Shares Price Shares Price Shares Price - ------------------------------------------------------------------------------------------------------------ Beginning of year 7,583 $ 40 8,633 $ 36 8,867 $ 33 Granted 1,643 71 1,413 45 1,266 48 Exercised (2,100) (36) (2,347) (30) (1,427) (27) Expired and cancelled (154) (61) (116) (48) (73) (42) ---------------------------------------------------------------------------- Outstanding at end of year 6,972 48 7,583 40 8,633 36 Exercisable at end of year 5,418 41 6,428 38 7,419 35 - ------------------------------------------------------------------------------------------------------------
Options as of January 30, 1999
Outstanding Exercisable - ---------------------------------------------------------------------------------------------------------- (shares in thousands; price and Remaining remaining term are weighted averages) Shares Price Term (Yrs.) Shares Price - ---------------------------------------------------------------------------------------------------------- Under $25 83 $ 9 4.6 83 $ 9 $25-$35 1,761 28 2.3 1,761 28 $35-$45 998 42 5.7 980 42 $45-$55 1,842 48 7.6 1,842 48 Over $55 2,288 66 8.2 752 55 - ---------------------------------------------------------------------------------------------------------- Total 6,972 $ 48 6.0 5,418 $ 41 - ----------------------------------------------------------------------------------------------------------
9 INTEREST EXPENSE, NET - ---------------------- ($ in millions) 1998 1997 1996 - --------------------------------------------------- Short-term debt $ 106 $ 121 $ 102 Long-term debt 557 527 312 Other, net* (52) (67) (55) - --------------------------------------------------- Interest expense, net $ 611 $ 581 $ 359 - --------------------------------------------------- * Includes $39 million in 1998 and $34 million in 1997 and 1996 for interest income from the Company's investment in asset-backed certificates. 10 LEASE COMMITMENTS The Company conducts the major part of its operations from leased premises that include retail stores, warehouses, offices, and other facilities. Almost all leases will expire during the next 20 years; however, most leases will be renewed or replaced by leases on other premises. Rent expense for real property operating leases totaled $585 million in 1998, $541 million in 1997, and $333 million in 1996, including contingent rent based on sales of $66 million, $72 million, and $48 million for the three years, respectively. The Company also leases data processing equipment and other personal property under operating leases of primarily three to five years. Rent expense for personal property leases was $123 million in 1998, $126 million in 1997, and $106 million in 1996. Future minimum lease payments for noncancelable operating and capital leases, net of subleases, as of January 30, 1999 were: - ------------------------------ ($ in millions) Operating Capital - -------------------------------------------------------- 1999 $ 565 $ 11 2000 510 11 2001 440 11 2002 408 6 2003 384 1 Thereafter 2,841 - - -------------------------------------------------------- Total minimum lease payments $ 5,148 $ 40 Present value $ 2,715 $ 35 Weighted average interest rate 10% 10% - -------------------------------------------------------- Minimum lease payments are shown net of estimated executory costs, principally real estate taxes, maintenance, and insurance. 31 11 ADVERTISING COSTS Advertising costs consist principally of newspaper, television, radio, and catalog book costs. In 1998, the total cost of advertising was $1,077 million compared with $977 million in 1997, and $988 million in 1996. The "other assets" section of the consolidated balance sheets includes deferred catalog book costs of $87 million as of January 30, 1999, and $89 million as of January 31, 1998. 12 RETIREMENT PLANS The Company's retirement plans consist principally of a noncontributory pension plan, a noncontributory supplemental retirement program for certain management associates, a contributory medical and dental plan, and a savings plan, including a 401(k) plan and an employee stock ownership plan. In addition, in 1998, the Company adopted two nonqualified savings plans. Pension plan assets are invested in a balanced portfolio of equity and debt securities managed by third party investment managers. In addition, Eckerd has a noncontributory pension plan. As of January 1, 1999, all Eckerd retirement benefit plans were frozen and all employees began to accrue benefits under the Company's retirement plans. The following tables include the benefit obligation related to the Company's early retirement program (see Note 13, page 33, for additional information). The cost of these programs and the December 31 balances of plan assets and obligations are shown below: Expense - ----------------------------- ($ in millions) 1998 1997 1996 - ------------------------------------------------------- Pension and health care Service cost $ 76 $ 68 $ 73 Interest cost 221 200 186 Projected return on assets (283) (488) (386) Net amortization 14 248 174 -------------------------- 28 28 47 Savings plan expense 76 71 56 - ------------------------------------------------------- Total retirement plans $ 104 $ 99 $ 103 - ------------------------------------------------------- Assumptions 1998 1997 1996 - ------------------------------------------------------- Discount rate 6.75% 7.25% 8.0% Expected return on plan assets 9.5% 9.5% 9.5% Salary progression rate 4.0% 4.0% 4.0% Health care trend rate 7.0% 7.0% 7.0% - ------------------------------------------------------- Assets and obligations Pension plans* - ------------------------------------ ($ in millions) 1998 1997 - ------------------------------------------------------- Projected benefit obligation Beginning of year $ 2,749 $ 2,187 Service and interest cost 273 243 Actuarial (gain)/loss 184 400 Benefits paid (200) (210) Amendments and other - 129 - ------------------------------------------------------- End of year 3,006 2,749 Fair value of plan assets Beginning of year 3,064 2,735 Company contributions 32 29 Net gains/(losses) 497 510 Benefits paid (200) (210) - ------------------------------------------------------- End of year 3,393 3,064 Excess of fair value over projected benefits 387 315 Unrecognized gains and prior service cost 75 125 - ------------------------------------------------------- Prepaid pension cost $ 462 $ 440 - ------------------------------------------------------- * Includes supplemental retirement plan. Medical and dental - ----------------------------------- ($ in millions) 1998 1997 - ------------------------------------------------------- Accumulated benefit obligation $ 334 $ 335 Net unrecognized losses 10 13 - ------------------------------------------------------- Net medical and dental liability $ 344 $ 348 - ------------------------------------------------------- A one per cent change in the health care trend rate would change the accumulated benefit obligation and expense by approximately $24 million and $2 million, respectively. 32 13 OTHER CHARGES, NET During 1996 and 1997, the Company recorded other charges principally related to drugstore integration activities, department store closings and FAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (FAS 121), impairments, and early retirements and reduction in force programs. The following tables provide a summary of the charges by year and by category as well as a roll forward of reserves that were established for certain of the charges. 1996 Charges
1996 ------------------------------------------------- - -------------------------------------------------------- Cash Other Y/E ($ in millions) Expense Outlays Changes Reserve - --------------------------------------------------------------------------------------------------------- Department stores and catalog Reduction in force $ 11 $ (11) $ - $ - - --------------------------------------------------------------------------------------------------------- Eckerd drugstores FAS 121 impairments and loss on the divestiture of drugstore assets(1) 174 - (174) - Future lease obligations and severance(2) 69 - - 69 Allowance for notes receivable(3) - - 25 25 Headquarters severance(2) 17 - - 17 Other(2) 32 (12) (16) 4 ------------------------------------------------- 292 (12) (165) 115 - --------------------------------------------------------------------------------------------------------- Total $ 303 $ (23) $ (165) $ 115 - --------------------------------------------------------------------------------------------------------- 1996 | 1997 | 1998 -----------|--------------------------------|----------------------------------- - ---------------------------- Y/E | Cash Other Y/E | Cash Other Y/E ($ in millions) Reserve | Outlays Changes Reserve | Outlays Changes Reserve - ---------------------------------------|--------------------------------|----------------------------------- | | Eckerd drugstores | | | | Future lease obligations | | and severance(2) $ 69 | $ (3) $ - $ 66 | $ (7) $ - $ 59 | | Allowance for notes | | receivable(3) 25 | - - 25 | - - 25 | | Headquarters severance(2) 17 | (16) - 1 | (1) - - | | Other(2) 4 | - - 4 | - - 4 - ---------------------------------------|--------------------------------|----------------------------------- Total $ 115 | $ (19) $ - $ 96 | $ (8) $ - $ 88 - ------------------------------------------------------------------------------------------------------------
(1) Charges related to FAS 121 impairments were recorded as a reduction of property, plant, and equipment balances. (2) Reserve balances are included as a component of accounts payable and accrued expenses. (3) The allowance for notes receivable is included as a reduction of receivables, net. 33 Department stores and catalog Reduction in force. As part of the Company's ongoing program to reduce the cost structure for stores and catalog and improve the Company's competitive position and future performance, it announced the elimination of 119 store and field support positions in September 1996, all of which were subsequently eliminated. Subsequent periods benefited from the elimination of related salary costs. The charges, which were expensed and paid in the fourth quarter of 1996, related to severance and outplacement. Eckerd drugstores FAS 121 impairments and loss on the divestiture of drugstore assets. In the fourth quarter of 1996, the Company recorded $174 million of charges associated with the Eckerd acquisition. This amount was comprised of the following components: 1) $53 million related to the closing of certain underperforming and/or overlapping drugstores; 2) $96 million related to the divestiture of certain Rite Aid and Kerr drugstores; and 3) $25 million related principally to the write-off of goodwill associated with previous acquisitions. Each of these items is discussed in more detail below: 1) In October 1996, the Company acquired Fay's Incorporated (Fay's), a chain of approximately 270 drugstores. Also in October 1996, Thrift Drug, Inc., a wholly owned subsidiary of the Company, entered into an agreement to acquire substantially all of the assets of approximately 190 Rite Aid drugstores in North and South Carolina. At the time of the acquisition, no significant changes to the operations of these stores were expected. In November 1996, the Company entered into an agreement to acquire Eckerd, a chain of 1,748 drugstores. Upon entering into the agreement to acquire Eckerd, the Company began to plan for the integration of its approximately 1,100 existing drugstores into the Eckerd name and format. The integration plan provided for, among other things, the closing of 86 overlapping and/or under-performing Thrift and Fay's drugstores, all of which were leased facilities. These stores had a sales base of approximately $130 million and operating losses of approximately $9 million before non-cash operating expenses, such as depreciation. During 1997, 64 stores were closed. The remaining store closings were delayed into fiscal 1998 to facilitate a timely and orderly transition between the operations of the stores to be closed and the surrounding stores that were to remain open and operating. All stores were closed as of the end of fiscal 1998. A FAS 121 impairment charge of $53 million related to these stores was recorded by the Company in 1996. Impaired assets consisted primarily of store fixtures and leasehold improvements. Since these assets could not readily be used at other store locations and no ready market existed outside the Company, they were discarded at the time of closing. Accordingly, the impairment charge recorded for these assets represented their carrying value as of the end of fiscal 1996. Asset values were reduced to zero and as a result, depreciation was discontinued. The stores were operating at a loss and continued to do so subsequent to the FAS 121 impairment charge. Operating results for the individual stores were included in operations through the date of closing. There were no significant changes to the Company's initial estimate of impairment. 2) As a condition of its approval of the Eckerd acquisition, the Federal Trade Commission (FTC) required that the Company divest itself of 164 stores (divested stores) in North and South Carolina (consisting of both Rite Aid and Kerr drugstores) to a single buyer to maintain adequate competition in the two states. Pursuant to the FTC agreement, the consummation of the acquisition of the Rite Aid stores was delayed until the Company entered into an agreement to sell the divested stores. Ultimately, the Company entered into an agreement with a former member of Thrift management and other parties to sell the divested stores for $75 million ($42 million in cash and $33 million in notes receivable). The Company recognized a FAS 121 impairment charge of $75 million related to the Rite Aid stores. The impairment charge was necessary as the undiscounted cash flows for these units were not sufficient to support recorded asset values, including furniture and fixtures and other intangibles. The amount of the impairment charge was determined based on the difference between the fair value of the assets, as calculated through discounted expected cash flows, and the carrying amount for those assets. In addition, the Company recorded a loss of $21 million related to the divestiture of the Kerr stores. These 34 Kerr stores had a sales base of approximately $59 million and operating income of approximately $3 million before non-cash operating expenses. 3) As part of the acquisition of Eckerd, the decision was made to operate all drugstores under the Eckerd name and format. Consequently, goodwill in the amount of $10 million, which had been allocated under purchase accounting to the Fay's trade name, was determined to have no value. In addition, the Company recorded an impairment charge of $15 million related to goodwill associated with unprofitable business units operated by the former drugstore operations. 34 Future lease obligations and severance. In connection with these drugstore closings and the sale of divested stores, the Company established a $69 million reserve for the present value of future lease obligations. The store closing plan anticipated that Eckerd would remain liable for all future lease payments. The present value of future lease obligations was calculated using a 6.7 per cent discount rate and anticipated no subleasing activity or lease buyouts. Costs are being charged against the reserve as incurred; the interest component related to lease payments is recorded as rent expense with no corresponding increase in the reserve. Payments during the next five years are expected to be approximately $2 million per year. These reserves will be assessed periodically to determine their adequacy. No changes have been deemed necessary through the end of 1998. Approximately 1,150 store employees, including store managers as well as salaried and non-salaried personnel, were terminated as a result of store closings. Allowance for notes receivable. A portion of the proceeds related to the sale of the divested stores was financed by the Company through a note receivable of $33 million. The FTC agreement provided that the Company could not maintain a continuing interest in the divested stores. This placed significant constraints on the Company's ability to collect on the note which remains uncertain. Consequently, a reserve for 75 per cent ($25 million) of the face value of the note receivable was established. This reserve is reviewed for adequacy on a periodic basis. No adjustments have been deemed necessary through the end of 1998. Headquarters severance. A reserve of $17 million was established for termination benefits related to the elimination of the Thrift headquarters and certain support facilities upon the acquisition of Eckerd. Approximately 400 employees were affected by the plan to eliminate these functions, which included all levels of Thrift management and administrative staff. Ultimately, 436 employees were terminated under this program, with the majority of the employees being terminated during 1997. Actual termination costs were charged against the reserve as incurred with $16 million being incurred and charged against the reserve in 1997. The program has been completed and no adjustments were required to the reserve. Other. The principal component of other integration charges was $15 million related to the change of the Thrift accounting policy for certain contractual vendor payments to a more preferable accounting method. This item was established as unearned income on the consolidated balance sheet as of year-end 1996 and is being recognized over the contract terms through the year 2002. The remaining $17 million, the majority of which was expensed as incurred, was related to integration activities for the Fay's stores and other activities such as contract terminations. 1997 Charges
1997 - ---------------------------------------------------------------------------------------------------------- Cash Other Y/E ($ in millions) Expense Outlays Changes Reserve - ---------------------------------------------------------------------------------------------------------- Department stores and catalog Early retirement(1) $ 151 $ (1) $ (150) $ - Reduction in force(2) 55 - - 55 FAS 121 impairments(3) 72 - (72) - Future lease obligations and severance(2) 61 (6) - 55 ------------------------------------------------------------- 339 (7) (222) 110 - ---------------------------------------------------------------------------------------------------------- Sale of business units (63) 63 - - - ---------------------------------------------------------------------------------------------------------- Eckerd drugstores Store integration 61 (61) - - Systems integration 26 (26) - - Advertising/grand reopening 26 (26) - - Future obligations, primarily leases(2) 37 (2) - 35 Gain on the sale of institutional pharmacy (47) 47 - - -------------------------------------------------------------- 103 (68) - 35 - ---------------------------------------------------------------------------------------------------------- Total $ 379 $ (12) $ (222) $ 145 - ----------------------------------------------------------------------------------------------------------
35
1997 1998 ----------------------------------------------------------------- - ----------------------------------------- Y/E Cash Other Y/E ($ in millions) Reserves Outlays Changes Reserve - ---------------------------------------------------------------------------------------------------------- Department stores and catalog Reduction in force(2) $ 55 $ (44) $ (11) $ - Future obligations and severance(2) 55 (24) (11) 20 ----------------------------------------------------------------- 110 (68) (22) 20 - ---------------------------------------------------------------------------------------------------------- Eckerd drugstores Future obligations, primarily leases(2) 35 (8) - 27 - ---------------------------------------------------------------------------------------------------------- Total $ 145 $ (76) $ (22) $ 47 - ----------------------------------------------------------------------------------------------------------
(1) The early retirement program was reflected in the 1997 year end balance sheet as follows: $58 million in enhanced pension benefits was credited against prepaid pension assets which are included in other assets; $5 million of retiree medical liability and $85 million for the new non-qualified retirement plan are included in other liabilities; and such amounts are included in retirement plan disclosures in Note 12 on page 32. In addition, $2 million of plan administration costs was included in accounts payable and accrued expenses in 1997. (2) Reserve balances are included as a component of accounts payable and accrued expenses. (3) Charges related to FAS 121 impairments were recorded as a reduction of property, plant, and equipment balances. Department stores and catalog As part of the Company's initiatives to reduce the cost structure for department stores and catalog and improve the Company's competitive position and future performance, the following actions were taken in the third and fourth quarters of 1997: Early retirement. In August 1997 the Company announced a voluntary early retirement program (Program) to all department stores, catalog, and corporate support management employees who were age 55 or older and had at least 10 years of service. Approximately 1,600 employees were eligible to participate in the program, and approximately 1,245, or 78 per cent, elected to retire under the Program. The charge of $151 million includes $158 million of termination benefits that were actuarially calculated based on the employees electing to retire under the Program (representing lump-sum payments as well as the present value of periodic future payments determined at a discount rate of 7.5%), $5 million of actuarially calculated post retirement welfare benefits, and $3 million of outside consulting and administration costs. These costs were offset by a $15 million pension curtailment gain which was the result of a decrease in the projected benefit obligation (PBO) of the Company's qualified pension plan. The PBO was reduced due to the elimination of the liability for future salary increases resulting from the early termination of employees who elected to retire under the Program. Of the $3 million of outside consulting and administrative costs, approximately $2 million represented cash outlays, and the remainder was reversed in the fourth quarter of 1998. All other amounts recorded under this program are included in Retirement Plans disclosure in Note 12 on page 32. Reduction in force. In the fourth quarter of 1997, the Company announced a restructuring plan to eliminate approximately 1,700 management employees. The $55 million charge represents severance, outplacement, and other termination benefits offered to all affected associates. There was no cash outlay in 1997 because, while employees were notified of the restructuring plan in the fourth quarter of 1997, they did not leave the Company until 1998. Cash outlays of $44 million in 1998 represent termination benefits paid to the approximately 1,550 employees terminated. The plan was completed in the fourth quarter of 1998 at less cost than originally estimated due in part to employee resignations prior to being involuntarily terminated and employees obtaining positions elsewhere in the Company. Consequently, approximately $11 million was reversed in the fourth quarter of 1998. FAS 121 impairments. The Company identified 97 underperforming stores that did not meet the Company's profit objectives and several support units (credit service centers and warehouses) which were no longer needed. This unit closing plan (Plan) represents unit closings over and above the normal course of store closures within a given year, which are typically relocations. All units were closed by the end of fiscal 1998. The major actions comprising the Plan consisted of the identification of a closing date (to coincide with termination rights and/or other trigger dates contained in the lease, if applicable), and the notification of affected parties (e.g., employees, landlords, and community representatives) in accordance with the Company's store closing procedures. Substantially all of the stores and support units included in the portfolio were leased, and as such, the Company was not responsible for the disposal of property, other than fixtures, which for 36 the most part were discarded. Unit closing costs include future lease obligations and termination benefits, and FAS 121 impairments. Impaired assets resulting from the store closings consist primarily of store furniture and fixtures, and leasehold improvements. The majority of the stores identified for closure were older stores in small markets and the associated furniture and fixtures were outdated. Therefore, these items could not be readily used at another location, and there was not a ready market for these items to determine a fair value. Accordingly, the impairment charge recorded for these assets represents the carrying value of the assets as of the end of fiscal 1997. Depreciation of these assets was discontinued as the impairment charges reduced the asset balances to zero. The stores were operating at a loss and continued to do so subsequent to the FAS 121 impairment charge. There were no significant changes to the Company's initial estimate of impairment. Future lease obligations and severance. In connection with the above store closings, the Company established a $61 million reserve for the present value of future lease obligations ($31 million) and other store closing costs ($30 million), principally severance and outplacement. The store closing plan anticipated that the Company would remain liable for all future lease payments. Present values were calculated assuming a ten per cent discount rate and anticipated no subleasing activity or lease buyouts. Costs are being charged against the reserve as incurred. The cash outlays in 1997 and 1998 represent severance benefits paid for approximately 1,550 employees terminated under the program, and lease payments for closed stores. The interest component of lease payments of approximately $2 million in 1998 was recorded as interest expense, with a corresponding increase in the reserve, in the fourth quarter of 1998 and future years. The remaining reserve as of the end of 1998 represents future lease obligations for all closed stores. The actual timing of store closings did not differ significantly from the estimate upon which the liability for future lease obligations was based. On average, the remaining lease term for closed stores was seven years, and payments during the next five years are expected to be approximately $4 million per year. Adjustments to the reserves in 1998 included reversals of approximately $5 million due to reduced lease obligations stemming from subleased facilities, and $6 million for employment-related costs. Employment-related costs were less than original estimates as a result of several factors, including voluntary resignations, a higher rate of employee transfers, and the termination of a higher proportion of employees with less tenure with the Company. These reserves will continue to be assessed periodically. The stores identified for closure were generally those with a poor performance history, and to a large extent, declining sales. The short-term effect of the closings was the net loss of approximately $225 million in sales and the elimination of approximately $15 million in operating losses before non-cash operating charges such as depreciation. The Company expects to realize benefits of approximately $32 million per year as a result of eliminating operating losses associated with the closed stores and the redeployment of working capital. Sale of business units A gain on the sale of business units of $63 million was included in the 1997 other charges. JCPenney National Bank (JCPNB), a consumer bank which issued VISA and MasterCard credit cards, was sold in 1997 at a gain of $49 million. In addition, the Company recorded a $14 million gain representing a supplemental, contingent payment related to the 1995 sale of JCPenney Business Services, Inc. (BSI). BSI provided credit-related services to third party credit-card issuers. JCPNB 1996 revenues and operating income were $129 million and $2 million, respectively. The sale of JCPNB did not have a negative impact on the Company's results of operations or financial position in 1997, and it is not expected to have a material impact in future periods. Eckerd drugstores The majority of drugstore charges recorded as other charges in 1997 relate to integration activities that were expensed as incurred in accordance with EITF 95-3. Such costs were comprised of the following: Store integration - charges totaling $61 million related to the conversion of the former Thrift, Fay's, and Kerr stores and certain warehouse facilities to the Eckerd name and format, including training, overhead redundancies during the transition period, and other similar integration-related costs. Systems integration - costs associated with the conversion of the previously owned drugstores to the Eckerd systems platform totaled $26 million. Advertising and grand pre-opening - costs associated with introducing the Eckerd name in converted regions as well as costs related to the grand re-opening of converted drugstores totaled $26 million. In addition, the Company recorded the following drugstore related items as other charges in 1997: Future obligations, primarily leases. In the second quarter of 1997, as part of the ongoing drugstore integration process, the Company closed 26 additional drugstores. These stores were part of the portfolio of retained Rite Aid stores (see previous discussion). The Company recorded a FAS 121 37 impairment charge for the store assets in 1996. These closings did not involve any termination benefits. The liability in 1997 was limited to future lease obligations on these stores. The reserve for future lease obligations for these stores is based on the present value of lease obligations through the year 2017. Additionally, in the fourth quarter of 1997, the Company became obligated to make future lease payments for 27 stores that Fay's had sold prior to being acquired by the Company on which the buyer had defaulted and failed to make lease payments. Fay's, and therefore the Company, was contractually obligated to make the lease payments. Accordingly, the Company recorded a charge for future lease obligations on these stores at the time the liability became known. The reserve for future lease obligations on these stores is based on lease payments through the year 2009. A charge of $25 million related to all of these lease obligations was recorded. These events are not expected to have an effect on future sales, and other than future lease obligations, there will be no impact on future operating results as none of the stores operated as part of Thrift drugstores. In addition, an $8 million charge was recorded for liabilities established for pending litigation, and the remaining $4 million relates to other miscellaneous charges, each individually insignificant. As of the end of 1998, these combined reserves totaled $27 million. There have been no adjustments to these liabilities as of the end of 1998. Gain on the sale of institutional pharmacy. As part of the integration plan, the Company sold its underperforming institutional pharmacy operation in the fourth quarter of 1997 and recorded a gain of $47 million. This operation generated sales of $80 million in 1997. 14 TAXES Deferred tax assets and liabilities reflected on the Company's consolidated balance sheets were measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The major components of deferred tax (assets)/liabilities as of January 30, 1999 and January 31, 1998 were as follows: Temporary differences - --------------------------------- ($ in millions) 1998 1997 - --------------------------------------------------------- Depreciation and amortization $ 1,084 $ 977 Leases 312 339 Other charges, net (46) (139) Deferred acquisition costs 233 211 Other, including comprehensive income 77 53 - --------------------------------------------------------- Total $ 1,660 $ 1,441 - --------------------------------------------------------- Income tax expense - ----------------------- ($ in millions) 1998 1997 1996 - --------------------------------------------------------- Current Federal and foreign $ 111 $ 319 $ 321 State and local 31 39 43 ----------------------------- 142 358 364 - --------------------------------------------------------- Deferred Federal and foreign 219 3 (19) State and local - (2) (1) ----------------------------- 219 1 (20) - --------------------------------------------------------- Total $ 361 $ 359 $ 344 Effective tax rate 37.8% 38.8% 37.9% - --------------------------------------------------------- Reconciliation of tax rates - ------------------------------ (per cent of pre-tax income) 1998 1997 1996 - --------------------------------------------------------- Federal income tax at statutory rate 35.0 35.0 35.0 State and local income taxes, less federal income tax benefit 2.2 2.8 3.0 Tax effect of dividends on allocated ESOP shares (1.4) (1.3) (1.3) Tax credits and other 2.0 2.3 1.2 - --------------------------------------------------------- Total 37.8 38.8 37.9 - --------------------------------------------------------- 38 15 SEGMENT REPORTING The Company operates in three business segments: department stores and catalog, Eckerd drugstores, and Direct Marketing. The results of department stores and catalog are combined because they generally serve the same customer, have virtually the same mix of merchandise, and the majority of catalog sales are completed in department stores. For more detailed descriptions of each business segment, including products sold, see page 1 and pages 4 through 10 of this report. Other items are shown in the table below for purposes of reconciling to total Company consolidated amounts.
Depreciation - --------------------------------- Operating Total Capital and ($ in millions) Year Revenue Earnings Assets Expenditures Amortization - ------------------------------------------------------------------------------------------------------------ Department stores and catalog 1998 $19,331 $ 1,013 $ 14,563 $ 439 $ 380 1997 19,955 1,368 14,980 464 366 1996 19,506 1,183 14,754 680 325 Eckerd drugstores 1998 10,325 254 6,361 256 138 1997 9,663 347 6,064 341 112 1996 3,147 99 4,389 103 41 Direct Marketing 1998 1,022 233 2,603 1 6 1997 928 214 2,283 5 5 1996 818 186 1,986 7 6 Total segments 1998 30,678 1,500 23,527 696 524 1997 30,546 1,929 23,327 810 483 1996 23,471 1,468 21,129 790 372 Net interest expense and credit operations 1998 (480) 1997 (547) 1996 (278) Other unallocated and amortization of intangible assets 1998 (87) 111 113 1997 (78) 166 101 1996 22 959 9 Other charges, net 1998 22 1997 (379) 1996 (303) Total Company 1998 30,678 955 23,638 696 637 1997 30,546 925 23,493 810 584 1996 23,471 909 22,088 790 381 - ---------------------------------------------------------------------------------------------------------
Total Company operating earnings equals income before income taxes as shown on the Company's consolidated statements of income. 39 QUARTERLY DATA (UNAUDITED) J. C. Penney Company, Inc. and Subsidiaries
- ------------------------------------------ First Second Third Fourth ($ in millions, except per share data) 1998 1997 1998 1997 1998 1997(1) 1998 1997(1) - --------------------------------------------------------------------------------------------------------------------------- Retail sales, net $ 6,806 $ 6,481 $ 6,510 $ 6,420 $ 7,297 $ 7,208 $ 9,043 $ 9,509 Total revenue 7,052 6,705 6,761 6,649 7,549 7,441 9,316 9,751 LIFO gross margin 1,904 1,804 1,629 1,709 2,015 2,038 2,249 2,637 Net income 174 139 27 90 186 136 207 201 Net income per common share, diluted 0.64 0.53 0.08 0.32 0.68 0.49 0.77 0.76 Dividend per common share 0.545 0.535 0.545 0.535 0.545 0.535 0.545 0.535 Price range: High 77 7/8 51 5/8 78 3/4 59 59 3/8 64 1/4 56 1/8 68 1/4 Low 64 11/16 44 7/8 58 45 5/8 42 5/8 54 11/16 38 1/8 53 1/4 Close 71 15/16 45 7/8 58 11/16 57 15/16 47 1/2 56 7/16 39 67 3/8 - --------------------------------------------------------------------------------------------------------------------------
(1) 3rd and 4th quarter net income and net income per share have been restated to shift $23 million, net of tax, of voluntary early retirement costs from 3rd to 4th quarter. The restatement had no effect on full year net income or net income per share. FIVE YEAR FINANCIAL SUMMARY J. C. Penney Company, Inc. and Subsidiaries
- ---------------------------------------------- (in millions, except per share data) 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------- Results for the year Total revenue $ 30,678 $ 30,546 $ 23,471 $ 21,242 $ 20,937 Retail sales, net 29,656 29,618 22,653 20,562 20,380 Per cent increase 0.1% 30.7% 10.2% 0.9% 7.4% Net income 594 566 565 838 1,057 Return on beginning stockholders' equity 8.1% 7.9%(1) 9.6% 14.9% 19.7% Per common share Net income, diluted $ 2.19 $ 2.10 $ 2.25 $ 3.33 $ 4.05 Dividends 2.18 2.14 2.08 1.92 1.68 Stockholders' equity 26.99 27.57 25.67 24.76 23.45 Financial position Capital expenditures 696 810 790 749 544 Total assets 23,638 23,493 22,088 17,102 16,202 Long-term debt 7,143 6,986 4,565 4,080 3,335 Stockholders' equity 7,169 7,357 5,952 5,884 5,615 Other Common shares outstanding at end of year 250 251 224 224 227 Weighted average common shares Basic 253 247 226 226 234 Diluted 271 268 248 249 258 Number of employees at end of year (in thousands) 262 260 252 205 202 - -----------------------------------------------------------------------------------------------------------
(1) Assumes the completion of the Eckerd acquisition in beginning equity. 40 FIVE YEAR OPERATIONS SUMMARY J. C. Penney Company, Inc. and Subsidiaries
1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------- Department stores Number of stores Beginning of year 1,203 1,228 1,238 1,233 1,246 Openings 12 34 36 43 29 Closings (67) (59) (46) (38) (42) -------------------------------------------------------------- End of year 1,148(1) 1,203 1,228 1,238 1,233 Gross selling space (in millions) 115.3 118.4 117.2 114.3 113.0 Sales (in millions) $ 15,402 $ 16,047 $ 15,734 $ 14,973 $ 15,023 Sales including catalog desks (in millions) 18,208 19,089 18,694 17,930 18,048 Sales per gross square foot 156 157 159 156 159 - ----------------------------------------------------------------------------------------------------------- Catalog Number of catalog units Department stores 1,139 1,199 1,226 1,228 1,233 Freestanding sales centers and other 512 554 569 565 568 Drugstores 139 110 107 106 94 -------------------------------------------------------------- Total 1,790 1,863 1,902 1,899 1,895 Sales (in millions) $ 3,929 $ 3,908 $ 3,772 $ 3,738 $ 3,817 - ----------------------------------------------------------------------------------------------------------- Eckerd drugstores Number of stores Beginning of year 2,778 2,699 645 526 506 Openings 220(2) 199(2) 47 37 46 Acquisitions 36 200 2,020 97 - Closings (278)(2) (320)(2) (13) (15) (26) -------------------------------------------------------------- End of year 2,756 2,778 2,699 645 526 Gross selling space (in millions) 27.6 27.4 26.4 6.2 4.5 Sales (in millions) $ 10,325 $ 9,663 $ 3,147 $ 1,851 $ 1,540 Sales per gross square foot 350 314 261 253 243 - ----------------------------------------------------------------------------------------------------------- Direct Marketing Revenue (in millions) $ 1,022 $ 928 $ 818 $ 680 $ 557 Distribution of revenue JCPenney customers 50% 53% 56% 65% 73% Other non-JCPenney customers 50% 47% 44% 35% 27% Policies, certificates, and memberships in force at year end (in millions) 14.7 13.2 11.3 9.6 7.5 - -----------------------------------------------------------------------------------------------------------
(1) Excludes 21 department stores operated in Brazil under the Renner name. (2) Includes relocations of 175 drugstores in 1998 and 127 drugstores in 1997. 41 SUPPLEMENTAL DATA (UNAUDITED) General. The following information is provided as a supplement to the Company's audited financial statements. Its purpose is to facilitate an understanding of the Company's credit operations, capital structure, and cash flows. Credit operations. The following presents the results of the Company's proprietary credit card operation and shows both the net cost of credit in support of the Company's retail businesses and the net cost of credit measured on an all-inclusive, economic basis. The "economic basis" of the cost of credit includes the cost of equity capital in addition to debt used to finance accounts receivable balances. The cost of equity capital is based on the Company's minimum return on equity objective of 16 per cent. The results presented below cover all JCPenney credit card accounts receivable serviced. Pre-tax cost of JCPenney credit card
- ---------------------------------------------- ($ in millions) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------- Revenue $ (788) $ (803) $ (772) --------------------------------------------------- Bad debt expense 264 356 277 Operating expenses (including in-store costs) 270 281 298 Interest expense on debt financing 262 285 281 --------------------------------------------------- Total costs 796 922 856 Pre-tax cost of credit Retail operations 8 119 84 Equity capital 131 144 138 - ------------------------------------------------------------------------------------------------------- Total - economic basis 139 263 222 Per cent of JCPenney credit sales 1.8% 3.0% 2.4% - -------------------------------------------------------------------------------------------------------
Department stores and catalog
- --------------------------------- ($ in billions) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------- Per cent of Per cent of Per cent of Eligible Eligible Eligible Sales Sales Sales Sales Sales Sales - ------------------------------------------------------------------------------------------------------------- JCPenney credit card $ 7.6 39.4% $ 8.6 43.4% $ 9.1 46.9% Third-party credit cards 5.0 26.1% 4.7 23.5% 4.1 21.2% - ------------------------------------------------------------------------------------------------------------- Total $ 12.6 65.4% $ 13.3 66.9% $ 13.2 68.1% - -------------------------------------------------------------------------------------------------------------
Key JCPenney credit card information
- ----------------------------------------------- (in millions, except where noted) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------- Number of accounts serviced with balances 14.1 16.4 18.9 Total customer receivables serviced $ 4,149 $ 4,721 $ 5,006 Average customer receivables serviced $ 4,123 $ 4,576 $ 4,428 Average account balance (in dollars) $ 295 $ 287 $ 265 Average account maturity (in months) 4.7 4.5 4.5 90-day delinquency rate 3.0% 3.9% 3.7% - -------------------------------------------------------------------------------------------------------------
42 Capital structure. The Company's objective is to maintain a capital structure that will assure continuing access to financial markets so that it can, at reasonable cost, provide for future needs and capitalize on attractive opportunities for growth. The debt to capital per cent shown in the table below includes both debt recorded on the Company's consolidated balance sheets as well as off-balance-sheet debt related to operating leases and the securitization of a portion of the Company's customer accounts receivable (asset-backed certificates). Debt to capital per cent - ------------------------ ($ in millions) 1998 1997 1996 - --------------------------------------------------------- Short-term debt, net of cash investments $ 1,602 $ 1,209 $ 3,818 Long-term debt, including current maturities 7,581 7,435 4,815 ----------------------------- 9,183 8,644 8,633 Off-balance-sheet debt: Present value of operating leases 2,715 2,250 1,800 Securitization of receivables, net 146 343 374 ----------------------------- Total debt 12,044 11,237 10,807 Consolidated equity 7,169 7,357 5,952 - --------------------------------------------------------- Total capital $ 19,213 $ 18,594 $ 16,759 Per cent of total debt to capital 62.7%* 60.4% 64.5%** - --------------------------------------------------------- * Upon completion of the Genovese acquisition, the Company's debt to capital ratio decreased to 61.9 per cent. ** Upon completion of the Eckerd acquisition, the Company's debt to capital ratio decreased to 60.1 per cent. The Company's debt to capital per cent has increased over the past three years which is reflective of its drugstore acquisitions. The Company currently expects the per cent to improve over the next several years. Financing costs incurred by the Company to finance its operations, including those costs related to off-balance-sheet liabilities, were as follows: - -------------------------- ($ in millions) 1998 1997 1996 - ---------------------------------------------------------- Interest expense, net $ 611 $ 581 $ 359 Interest portion of LESOP debt payment 2 10 17 Off-balance-sheet financing costs: Interest imputed on operating leases 225 180 110 Asset-backed certificate interest 46 68 68 - ---------------------------------------------------------- Total $ 884 $ 839 $ 554 - ---------------------------------------------------------- Economic Value Added (EVA(R)). During 1998 the Company put the EVA concept in place as a key decision-making criterion for management. EVA is a tool that enables companies to measure the creation of financial value. Since the changes in EVA are often closely related to the changes in a company's stock price, the Company believes that management of the business on the basis of EVA will maximize the return on capital invested by its stockholders. Training for all management employees, focusing on the use of EVA as a management measurement tool, will be completed in 1999. The Company's principal aim is the continual improvement in EVA, which directs attention to long-term performance. EVA principles are being incorporated into decision-making processes, including acquisition analyses, capital expenditure allocations, inventory management, and other strategic plans. The Company has begun linking EVA performance with incentive compensation programs. In 1998, approximately 400 senior management employees had EVA performance as a component of their incentive compensation. 1998's EVA performance plan award was zero because the EVA growth target for 1998 was not met. In 1999, incentive compensation that includes an EVA component will be expanded to cover additional management employees who participate in the Company's incentive compensation program. 43 EBITDA. Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a key measure of cash flow generated and is provided as an alternative assessment of operating performance. It is not intended to be a substitute for GAAP measurements. Following is a calculation of EBITDA by operating segment on an individual and combined basis (excludes other unallocated); calculations may vary for other companies: Department Eckerd - ----------------- stores & drug- Direct Total ($ in millions) catalog stores Marketing Segments - -------------------------------------------------------- 1998 Revenue $ 19,331 $ 10,325 $ 1,022 $ 30,678 Operating profit 1,013 254 233 1,500 Depreciation and amortization 380 138 6 524 Credit operating results 131 - - 131 Other(1) 139 134 - 273 --------------------------------------- EBITDA 1,663 526 239 2,428 % of revenue 8.6% 5.1% 23.4% 7.9% - -------------------------------------------------------- 1997 Revenue $ 19,955 $9,663 $ 928 $30,546 Operating profit 1,368 347 214 1,929 Depreciation and amortization 366 112 5 483 Credit operating results 35 - - 35 Other(1) 160 97 - 257 --------------------------------------- EBITDA $ 1,929 $ 556 $ 219 $ 2,704 % of revenue 9.7% 5.8% 23.6% 8.9% - -------------------------------------------------------- 1996 Revenue $ 19,506 $ 3,147 $ 818 $23,471 Operating profit 1,183 99 186 1,468 Depreciation and amortization 325 41 6 372 Credit operating results 81 - - 81 Other(1) 165 30 - 195 --------------------------------------- EBITDA $ 1,754 $ 170 $ 192 $ 2,116 % of revenue 9.0% 5.4% 23.5% 9.0% - -------------------------------------------------------- (1) Consists of interest on operating leases and the ESOP, and the impact of asset-backed certificates. Credit ratings. The Company's objective is to maintain a strong investment grade rating on its senior long-term debt and commercial paper. As of March 1999, the Company's credit ratings were under review for possible downgrade. Credit ratings at year end were: Long-Term Commercial Debt Paper - ----------------------------------------------------- Standard & Poor's Corporation A A1 Moody's Investors Service A2 P1 Fitch Investors Service, Inc. A F1 - ----------------------------------------------------- 44 -----END PRIVACY-ENHANCED MESSAGE-----